<PAGE> 1
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------
FORM 10-Q
[X] Quarterly report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the quarterly period ended September 30, 2000
OR
[ ] Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from to
----- -----
---------------
Commission file number 33-31717-A
---------------
QUORUM HEALTH GROUP, INC.
------------------------------------------------------
(Exact name of registrant as specified in its charter)
DELAWARE 62-1406040
------------------------ ---------------------------------
(State of incorporation) (IRS Employer Identification No.)
103 CONTINENTAL PLACE, BRENTWOOD, TENNESSEE 37027
------------------------------------------- -----------
(Address of principal executive offices) (Zip Code)
(615) 371-7979
----------------------------------------------------
(Registrant's telephone number, including area code)
NOT APPLICABLE
----------------------------------------------------
(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [X] No [ ]
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date.
CLASS OUTSTANDING AT NOVEMBER 8, 2000
----- -------------------------------
Common Stock, $.01 Par Value 71,508,237 Shares
<PAGE> 2
PART 1. FINANCIAL INFORMATION
ITEM I. FINANCIAL STATEMENTS
QUORUM HEALTH GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(In thousands, except per share amounts)
Three Months
Ended September 30
-------------------------
2000 1999
--------- ---------
Revenue:
Net patient service revenue $ 418,418 $ 396,645
Hospital management/professional services 20,258 19,553
Reimbursable expenses 15,303 15,087
--------- ---------
Net operating revenue 453,979 431,285
Salaries and benefits 191,253 178,239
Reimbursable expenses 15,303 15,087
Supplies 66,789 62,072
Fees 42,322 38,471
Other operating expenses 41,555 36,304
Provision for doubtful accounts 32,344 39,610
Equity in earnings of affiliates (4,145) (2,124)
Depreciation and amortization 26,373 26,199
Synthetic lease expense 2,979 2,503
Interest 16,388 16,730
Government settlements, investigation
and litigation related costs and strategic
alternatives related costs 96,564 1,098
Non-cash stock compensation 5,801 --
Minority interest (222) (349)
--------- ---------
Income (loss) before income taxes (79,325) 17,445
Provision (benefit) for income taxes (27,133) 6,821
--------- ---------
Net income (loss) $ (52,192) $ 10,624
========= =========
Earnings (loss) per share:
Basic $ (0.73) $ 0.15
========= =========
Diluted $ (0.73) $ 0.14
========= =========
Weighted average shares outstanding:
Basic 71,380 73,218
========= =========
Diluted 71,380 77,868
========= =========
See accompanying notes.
2
<PAGE> 3
QUORUM HEALTH GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(In thousands)
<TABLE>
<CAPTION>
September 30 June 30
2000 2000
---------- ----------
<S> <C> <C>
ASSETS
Current assets:
Cash $ 17,707 $ 13,944
Accounts receivable, less allowance for
doubtful accounts of $85,993 at
September 30, 2000 and $88,239 at
June 30, 2000 351,685 348,137
Supplies 42,538 41,072
Other 88,865 47,984
---------- ----------
Total current assets 500,795 451,137
Property, plant and equipment, at cost:
Land 89,520 88,922
Buildings and improvements 484,632 468,963
Equipment 673,629 657,400
Construction in progress 37,468 29,888
---------- ----------
1,285,249 1,245,173
Less accumulated depreciation 416,014 392,256
---------- ----------
869,235 852,917
Cost in excess of net assets acquired, net 220,443 222,191
Investments in unconsolidated entities 247,875 249,885
Other 94,375 80,308
---------- ----------
Total assets $1,932,723 $1,856,438
========== ==========
</TABLE>
3
<PAGE> 4
QUORUM HEALTH GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(In thousands, except per share amounts)
<TABLE>
<CAPTION>
September 30 June 30
2000 2000
---------- ----------
<S> <C> <C>
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses $ 98,961 $ 97,493
Accrued salaries and benefits 78,314 72,495
Accrued government settlements 95,500 --
Other current liabilities 41,508 26,407
Current maturities of long-term debt 716 817
---------- ----------
Total current liabilities 314,999 197,212
Long-term debt, less current maturities 843,374 851,045
Deferred income taxes 32,929 31,010
Professional liability risks and other
liabilities and deferrals 51,060 44,940
Minority interests in consolidated entities 63,568 64,142
Commitments and contingencies
Stockholders' equity:
Common stock, $.01 par value;
300,000 shares authorized; issued and
outstanding 71,490 and 71,281 at September 30,
2000 and June 30, 2000, respectively 715 713
Accumulated other comprehensive income 3,013 --
Additional paid-in capital 249,548 241,667
Retained earnings 373,517 425,709
---------- ----------
626,793 668,089
---------- ----------
Total liabilities and stockholders' equity $1,932,723 $1,856,438
========== ==========
</TABLE>
See accompanying notes.
4
<PAGE> 5
QUORUM HEALTH GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(In thousands)
<TABLE>
<CAPTION>
Three Months
Ended September 30
-------------------------
2000 1999
--------- ---------
<S> <C> <C>
Net cash provided by operating activities $ 54,580 $ 48,661
Investing activities:
Purchase of property, plant and equipment (27,115) (22,026)
Hospital construction (11,863) --
Purchase of acquired companies, net of
working capital settlements (8,102) --
Other (173) (277)
--------- ---------
Net cash used in investing activities (47,253) (22,303)
Financing activities:
Borrowings under bank debt 85,000 66,300
Repayments of bank debt (92,500) (244,600)
Borrowing under convertible subordinated
debentures -- 150,000
Proceeds from issuance of common stock, net 2,082 153
Change in outstanding checks and overnight
investment 2,789 (2,517)
Other (935) (1,390)
--------- ---------
Net cash used in financing activities (3,564) (32,054)
--------- ---------
Increase (decrease) in cash 3,763 (5,696)
Cash at beginning of period 13,944 22,258
--------- ---------
Cash at end of period $ 17,707 $ 16,562
========= =========
Supplemental cash flow information:
Interest paid $ (13,240) $ (13,340)
========= =========
Income taxes paid $ (735) $ (2,830)
========= =========
</TABLE>
See accompanying notes.
5
<PAGE> 6
QUORUM HEALTH GROUP, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements of Quorum
Health Group, Inc. and subsidiaries (the "Company") have been prepared in
accordance with generally accepted accounting principles for interim financial
information and with the instructions to Form 10-Q and Article 10 of Regulation
S-X. Accordingly, they do not include all of the information and footnotes
required by generally accepted accounting principles for complete financial
statements. In the opinion of management, all adjustments (consisting of normal
recurring accruals) considered necessary for a fair presentation have been
included. Operating results for the three months ended September 30, 2000 are
not necessarily indicative of the results that may be expected for the year
ending June 30, 2001. For further information, refer to the consolidated
financial statements and footnotes thereto included in the Company's annual
report on Form 10-K for the year ended June 30, 2000. Certain prior year amounts
have been reclassified to conform to the current year presentation.
2. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In 1998, the Financial Accounting Standards Board (FASB) issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities". This standard requires the Company to recognize all
derivatives on the balance sheet at fair value. The Company's interest rate
swaps are cash flow hedges which hedge the variability in expected cash flows
from a portion of its floating rate liabilities. The Company believes that its
hedges are highly effective with changes in effectiveness expected to be
reported in other comprehensive income. Changes in any ineffectiveness will be
reported through earnings. The adoption of this new FASB standard on July 1,
2000, resulted in a cumulative effect of an accounting change, net of tax, of
approximately $5.7 million being recognized as other comprehensive income.
During the three months ended September 30, 2000, the decrease in fair value of
interest rate swaps, net of tax, of approximately $2.7 million was recognized
through other comprehensive income (See Note 8). At September 30, 2000, the
interest rate swaps had a fair value of $4.9 million.
On March 31, 2000, the FASB issued its final interpretation of APB Opinion No.
25 "Accounting for Certain Transactions involving Stock Compensation." The final
interpretation requires variable-award accounting for stock options granted six
months before or after the cancellation or settlement of options if the new
options have a lower exercise price. The interpretation was effective July 1,
2000 and covers certain events that occurred after December 15, 1998. No
adjustments were made to financial statements for periods prior to the effective
date and no expense was recognized for any additional compensation costs
attributable to periods before the effective date.
During the three months ended September 30, 2000, the Company recorded $5.8
million in non-cash stock option compensation expense associated with the stock
options repriced in March 1999. This charge was based on the $2.69 increase in
the Company's stock price since July 1, 2000. The number of options subject to
6
<PAGE> 7
variable award accounting is comprised of 1.7 million vested options and a
percentage of approximately 1.4 million unvested options based on their vesting
schedule. The number of options affected will decrease for options exercised or
canceled and will increase as unvested options become vested.
3. ACQUISITIONS AND SALE
Effective July 1, 2000, the Company acquired Wells Community Hospital in
Bluffton, Indiana.
Effective December 1, 1999, the Company acquired Caylor-Nickel Medical Center in
Bluffton, Indiana. Effective March 1, 2000, the Company transferred its
operating lease of Clinton County Hospital in Frankfort, Indiana to an
Indianapolis, Indiana healthcare system.
The consideration for hospital and affiliated business acquisitions totaled $8.1
million for the three months ended September 30, 2000. The foregoing
acquisitions were accounted for using the purchase method of accounting. The
operating results of the acquisitions and sale have been included in the
accompanying Condensed Consolidated Statements of Operations for periods
subsequent to acquisition and for periods prior to sale. The pro forma effect of
the acquisitions and sale on the Company's results of operations for the periods
prior to acquisition and for periods after the sale were not significant.
4. GOVERNMENT SETTLEMENTS, INVESTIGATION AND LITIGATION RELATED COSTS AND
STRATEGIC ALTERNATIVES RELATED COSTS
During the three months ended September 30, 2000, the Company accrued $95.5
million in government settlements for tentative agreements reached with the
Civil Division, U.S. Department of Justice to settle two qui tam lawsuits. The
government settlements were expensed in the Condensed Consolidated Statement of
Operations for the three months ended September 30, 2000 and are accrued as a
current liability in the Condensed Consolidated Balance Sheet at September 30,
2000. The settlements were accrued based on available information and are
subject to further refinement (See Note 8).
During the three months ended September 30, 2000 and 1999, respectively, the
Company incurred $0.6 and $1.1 million in investigation and litigation related
costs related primarily to the qui tam and shareholder actions against the
Company (See Note 8).
During the three months ended September 30, 2000, the Company incurred $0.5
million in costs associated with exploring various strategic alternatives (See
Note 10).
5. INCOME TAXES
The provision for income taxes for the three months ended September 30, 2000 and
1999 is different from that which would be obtained by applying the statutory
federal income tax rate to income before income taxes due to permanent
differences and the provision for state income taxes.
7
<PAGE> 8
6. EARNINGS (LOSS) PER SHARE
Basic earnings (loss) per share is based on the weighted average number of
common shares outstanding. Diluted earnings (loss) per share is based on the
weighted average number of common shares outstanding, and the effect of dilutive
securities consisting of convertible subordinated debentures and stock options.
The convertible debentures and outstanding options to purchase 7.1 million
shares of common stock for the three months ended September 30, 2000 were not
included in the computation of diluted loss per share because the effect would
be anti-dilutive. Outstanding options to purchase 4.2 million shares of common
stock for the three months ended September 30, 1999 were not included in the
computation of diluted earnings per share because the options' exercise prices
were greater than the average market price of the common stock.
The following table sets forth the computation of basic and diluted earnings
(loss) per share (in thousands, except per share amounts):
Three Months
Ended
September 30
-----------------------
2000 1999
-------- --------
Numerator:
Net income (loss) $(52,192) $ 10,624
Interest expense on convertible subordinated
debentures, net of taxes -- 457
-------- --------
Numerator for dilutive earnings (loss)
per share $(52,192) $ 11,081
======== ========
Denominator:
Shares used for basic earnings (loss)
per share 71,380 73,218
Effect of dilutive securities:
Convertible subordinated debentures -- 4,444
Stock options -- 206
-------- --------
Shares used for dilutive earnings (loss)
per share 71,380 77,868
======== ========
Basic earnings (loss) per share $ (0.73) $ 0.15
======== ========
Diluted earnings (loss) per share $ (0.73) $ 0.14
======== ========
8
<PAGE> 9
7. COMMITMENTS
The Company is constructing a replacement hospital in Vicksburg, Mississippi and
a new acute-care hospital in Ft. Wayne, Indiana. The Vicksburg hospital has an
estimated total project cost of approximately $108 million with an expected
completion date of summer 2002. The Ft. Wayne hospital has an estimated total
project cost of approximately $44 million with an expected completion date of
spring 2001. In connection with the construction, the Company has contracts
outstanding for approximately $90 million, of which approximately $27 million
has been incurred to date.
8. CONTINGENCIES
Management continually evaluates contingencies based on the best available
evidence and believes that provision for losses has been provided to the extent
necessary.
Net Patient Service Revenue
Final determination of amounts earned under the Medicare and Medicaid programs
often occurs in subsequent years because of audits by the programs, rights of
appeal and the application of numerous technical provisions. In the opinion of
management, adequate provision has been made for adjustments that may result
from such routine audits and appeals.
Income Taxes
The Internal Revenue Service (IRS) is in the process of conducting examinations
of the Company's federal income tax returns for the fiscal years ended June 30,
1996 through 1998. The IRS has proposed certain adjustments in connection with
its prior examination of the Company's federal income tax returns for the fiscal
years ending June 30, 1993 through 1995. The most significant adjustments
involve the tax accounting methods adopted for computing bad debt expense and
the valuation of purchased hospital property, plant and equipment and related
depreciable lives. The Company has protested substantially all of the proposed
adjustments through the appeals process of the IRS. In the opinion of
management, the ultimate outcome of the IRS examinations will not have a
material effect on the Company's results of operations or financial position.
Litigation
The Company is currently, and from time to time expects to be, subject to claims
and suits arising in the ordinary course of business, including claims for
personal injuries and breach of management contracts. Plaintiffs in these
matters may request punitive or other damages that may not be covered by
insurance. Except for the litigation described below and other litigation,
administrative proceedings or investigations which may arise under the False
Claims Act or similar laws, the Company is not aware that it is currently a
party to any such proceeding which, in management's opinion, if adversely
decided, would have a material effect on the Company's results of operations or
financial position.
9
<PAGE> 10
Professional Liability Judgment
On February 29, 2000, an amended final trial judgment was entered against the
Company's subsidiary, Quorum Health Resources, LLC ("QHR"), in the amount of
approximately $57 million in the case of David X. and Veronica Rodriguez,
Individually and as Next Friends of Cristina Rodriguez, a minor v Quorum Health
Resources, LLC, in the 365th District Court, Maverick County, Texas. The lawsuit
arose out of the treatment provided beginning July 2, 1994 at Fort Duncan
Medical Center, an acute care hospital managed by QHR. QHR is appealing the
decision. Interest accrues on the judgment at 10% annually.
On July 20, 2000, a federal district court ruled that Maverick County Hospital
District (the owner of Fort Duncan Medical Center) was obligated to indemnify
QHR against all liabilities and costs that it may incur as a result of the
jury's finding of ordinary negligence in the Rodriguez litigation (W.D. Texas
No. A 99 CA 580SS). The Hospital District has appealed this decision. In
addition, Continental Insurance Company, which provides excess coverage of $15
million above QHR's primary insurance of $35 million, has denied coverage on
this judgment. QHR has filed an action seeking a declaratory judgment that
Continental Insurance Company is obligated to insure its portion of the judgment
(M.D. Tenn. No. 3-00-0806).
The Company currently believes that all or a substantial portion of the
judgment, if not overturned, will be covered by the Company's insurance carriers
and/or other interested parties. However, the Company cannot guarantee that the
judgment will be overturned or that the Company will receive any insurance
proceeds or other funds. If the Company were required to pay the judgment from
its own funds, it could have a material adverse effect on the Company.
False Claims Act Litigation
At a meeting in September 1998, the Company learned from the government that it
would likely join in a lawsuit filed against the Company under the False Claims
Act. The suit was filed in January 1993 by a former employee of a hospital
managed by a Company subsidiary. These lawsuits, commonly known as qui tam
actions, are filed "under seal." That means that the claims are kept secret
until the government decides whether to join the case. The person who files the
lawsuit is called a "relator". The government joined the case against the
Company in October 1998. The relator's lawsuit named the Company and its
subsidiary, Quorum Health Resources, HCA and all hospitals that the Company or
HCA owned, operated or managed from 1984 through 1997, as defendants. The
unsealed complaint, prepared by the relator, alleged that the Company knowingly
prepared and caused to be filed cost reports which claimed payments from
Medicare and other government payment programs greater than the amounts due.
On February 24, 1999, the government filed its own complaint in the case. The
new complaint alleges that the Company, on behalf of hospitals it managed
between 1985 and 1995 and hospitals it owned from 1990 to the date of the
complaint, violated the False Claims Act by filing false Medicare cost reports.
10
<PAGE> 11
The government asserts that the false claims in the cost reports are reflected
in "reserve analyses" created by the Company. The complaint also alleges that
these cost report filings were prepared as the result of Company policy. We
filed several motions to dismiss the government's complaint.
This qui tam action seeks three times the amount of damages caused to the United
States by the Company's submission of any alleged false claims to the
government, civil penalties of not less than $5,000 nor more than $10,000 for
each false claim, and attorneys' fees and costs.
On October 2, 2000, the Company announced that it had reached an understanding
with the Civil Division, U.S. Department of Justice to recommend an agreement to
settle the Medicare cost report qui tam lawsuit. Under the terms of the
tentative agreement, the settlement amount to be paid to the government is $77.5
million, with interest accruing at 7.25 percent from October 2, 2000 until final
resolution of a settlement agreement and a corporate integrity agreement, which
are scheduled to be completed by late January 2001. We decided to settle this
case to avoid the time and expense of continued litigation.
Other Qui Tam Actions and Related Investigations
In May 1998, the Company was informed that it was a defendant in another qui tam
action involving home health services provided by two of the Company's owned
hospitals and alleging that the Company had violated Medicare laws. This action
was filed under seal in June 1996 by a former employee, whom the Company fired
in April 1996. The United States Attorney's Office allowed the Company an
opportunity to review the results of the government's investigations and discuss
the allegations made in the action prior to the government making a decision to
intervene as a plaintiff. The Company cooperated fully with the United States
Attorney's Office and provided additional information and made employees
available for interviews.
On October 26, 2000, the Company completed settlement of the qui tam lawsuit
which primarily involved allocation of costs at Flowers Hospital, Dothan,
Alabama, to its home health services agency (CV-96-P1638-S, N.D. Alabama). The
Company paid approximately $18 million to the government on October 26, 2000 in
connection with this settlement. In addition to the settlement agreement, the
Company entered into a five year corporate integrity agreement with the
Department of Health and Human Services Office of the Inspector General
covering Flowers Hospital.
As part of its ongoing discussions, the Company has learned from the same U.S.
Attorney that there are two additional unrelated qui tam complaints against the
Company alleging Medicare violations at one owned and two managed hospitals.
Both matters remain under seal. The government has stated that it intends to
investigate these allegations. At this time, the Company cannot take a position
on how it will respond to these matters.
The Company from time to time may be the subject of additional investigations or
a party to additional litigation which alleges violations of law. The Company
may not know about such investigations, or about qui tam actions filed against
it.
Stockholder Class Action
In October and November 1998, some of the Company's stockholders filed lawsuits
against the Company in the U.S. District Court for the Middle District of
Tennessee. In January 1999, the court consolidated these cases into a single
lawsuit (M.D. Tenn. No. 3-98-1004). The plaintiffs filed an amended complaint in
March 1999. The plaintiffs seek to represent a class of plaintiffs who purchased
the Company's common stock from October 25, 1995 through October 21, 1998,
11
<PAGE> 12
except for insiders of the Company and their immediate families. The
consolidated complaint names the Company, several of its officers and one of its
outside directors, as defendants.
The complaint alleges that defendants violated the Securities Exchange Act of
1934. The plaintiffs claim that the Company materially inflated its net revenues
during the class period by including in those net revenues amounts received from
the settlement of cost reports that had allegedly been filed in violation of
applicable Medicare regulations years earlier and that, because of this
practice, this statement, which first appeared in the Company's Form 10-K filed
in September 1996, was false: "The Company believes that its owned hospitals are
in substantial compliance with current federal, state, local, and independent
review body regulations and standards." In May 1999, the Company filed a motion
to dismiss the complaint. On November 13, 2000, the judge denied our motion to
dismiss the complaint against us and James E. Dalton, Jr., our President/CEO. He
granted our motion to dismiss as to all other defendants. The Company intends to
vigorously defend the claims and allegations in this action.
The Company cannot at this time predict the final effect or outcome of any of
the ongoing investigations or the class or qui tam actions. If the Company is
found to have violated federal or state laws relating to Medicare, Medicaid or
other government programs, then it may be required to pay substantial fines and
civil and criminal penalties and also may be excluded from participating in the
Medicare and Medicaid programs and other government programs. Similarly, the
amount of damages sought in the qui tam actions are or in the future may be
substantial. The Company could be subject to substantial costs resulting from
defending, or from an adverse outcome in any current or future investigations,
administrative proceedings or litigation. In an effort to resolve one or more of
these matters, the Company may choose to negotiate a settlement. Amounts the
Company pays to settle any of these matters may be material. Agreements the
Company enters into as a part of any settlement could also materially adversely
effect it. Any current or future investigations or actions could have a material
adverse effect on the Company's results of operations or financial position.
8. COMPREHENSIVE INCOME (LOSS)
The components of comprehensive income (loss), net of related taxes (in
thousands):
Three Months Ended
September 30, 2000
-------------------
Net loss $ (52,192)
Cumulative effect of change in accounting
principle - fair value of interest rate swaps 5,661
Net change in fair value of interest rate swaps (2,648)
------------
Other comprehensive income 3,013
------------
Comprehensive loss $ (49,179)
============
12
<PAGE> 13
Accumulated other comprehensive income, net of related taxes, at September 30,
2000 is comprised of approximately $3.0 million relating to the fair value of
interest rate swaps.
9. SEGMENT INFORMATION
The Company's segments consist of (1) healthcare systems owned and operated by
the Company and (2) management of hospitals and healthcare systems for other
owners. The Company evaluates performance based on operating earnings of the
respective business units. All segment revenues are from external customers.
The Company's net revenues, EBITDA, assets, depreciation and amortization and
capital expenditures are summarized in the following table (EBITDA is defined as
earnings before interest, synthetic lease expense, depreciation and
amortization, income taxes, minority interest, government settlements,
investigation and litigation related costs, strategic alternatives related costs
and non-cash stock compensation expense)(in thousands):
<TABLE>
<CAPTION>
Three Months Ended September 30, 2000
----------------------------------------------------
Owned Management
Hospitals Services Total
----------- ---------- ----------
<S> <C> <C> <C>
Net revenues $ 418,266 $ 35,713 $ 453,979
EBITDA $ 61,221 $ 7,337 $ 68,558
Assets $ 1,884,381 $ 48,342 $ 1,932,723
Depreciation & amortization $ 25,965 $ 408 $ 26,373
Capital expenditures $ 38,901 $ 77 $ 38,978
</TABLE>
<TABLE>
<CAPTION>
Three Months Ended September 30, 1999
----------------------------------------------------
Owned Management
Hospitals Services Total
----------- ---------- ----------
<S> <C> <C> <C>
Net revenues $ 396,645 $ 34,640 $ 431,285
EBITDA $ 56,103 $ 7,523 $ 63,626
Assets $ 1,778,451 $ 42,513 $ 1,820,964
Depreciation & amortization $ 25,737 $ 462 $ 26,199
Capital expenditures $ 21,946 $ 80 $ 22,026
</TABLE>
EBITDA for owned hospitals include equity in earnings of affiliates of $4.1
million and $2.1 million for the three months ended September 30, 2000 and 1999,
respectively. Assets of owned hospitals include investments in unconsolidated
subsidiaries of $247.9 million and $248.2 million at September 30, 2000 and
1999, respectively.
A reconciliation of EBITDA to income (loss) before income taxes follows (in
thousands):
13
<PAGE> 14
<TABLE>
<CAPTION>
Three Months
Ended
September 30
-----------------------------
2000 1999
-------- --------
<S> <C> <C>
Total EBITDA for reportable segments $ 68,558 $ 63,626
Depreciation and amortization (26,373) (26,199)
Synthetic lease expense (2,979) (2,503)
Interest expense (16,388) (16,730)
Government settlements, investigation
and litigation related costs and
strategic alternatives related costs (96,564) (1,098)
Non-cash stock compensation (5,801) --
Minority interest 222 349
-------- --------
Income (loss) before income taxes $(79,325) $ 17,445
======== ========
</TABLE>
10. SUBSEQUENT EVENTS
PROPOSED SALE OF THE COMPANY
On October 18, 2000, the Company signed a definitive agreement for Triad
Hospitals Inc.("Triad") to acquire the Company through a combination of cash,
stock and the assumption of debt. Under the terms of the agreement, the
Company's shareholders will receive $3.50 in cash and 0.4107 shares of Triad
common stock for each outstanding share of the Company's stock. The transaction
is expected to be tax-free to the Company's shareholders with respect to the
stock portion of the consideration.
The Boards of Directors of both companies have unanimously approved the proposed
transaction, which is subject to customary conditions, including approval of
14
<PAGE> 15
Triad's shareholders and the Company's shareholders and antitrust clearance. The
transaction is also conditioned upon Triad's receipt of a private letter ruling
from the Internal Revenue Service that the transaction will not alter the
tax-free nature of Triad's spin-off from HCA in May 1999 and is conditioned upon
the receipt of necessary financing. Merrill Lynch & Co. has committed, subject
to customary conditions, to underwrite the entire $1.7 billion of debt needed to
fund the cash purchase price and the refinancing of certain existing debt. The
transaction is expected to be completed in the first half of calendar 2001.
15
<PAGE> 16
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION
You should read the following along with the Condensed Consolidated
Financial Statements and accompanying notes.
FORWARD-LOOKING INFORMATION
This discussion includes "forward-looking statements." Forward-looking
statements include all statements that do not relate solely to historical or
current facts, and often can be identified by the use of certain words, such as
"may," "believe," "will," "expect," "project," "estimate," "anticipate," "plan"
or "continue." We have based these forward-looking statements on our current
plans and expectations and our projections about future events. However, risks,
uncertainties and assumptions that would cause or contribute to material
differences in our future financial condition and results of operations include:
o possible changes in Medicare and Medicaid that may limit payments to
our owned hospitals;
o the efforts of insurers, managed care companies, patients and other
payors to reduce their payments to our owned hospitals;
o potential adverse impact of known and unknown litigation and
government investigations;
o difficulties in containing salaries, supplies and other costs in
relation to changes in payments from our payors;
o difficulties in improving financial results of our physician
clinics;
o difficulties in billing and collecting accounts receivable and the
related impact on cash flow and bad debt expense;
o difficulties in finding attractive acquisitions and integrating
acquired hospitals into our operations;
o geographic concentration of operations;
o claims and legal actions relating to professional liability;
o disruptions from information system conversions;
o our substantial indebtedness and difficulty raising capital in the
future;
o the possible enactment of federal, state or local health care
reforms;
o changes in federal, state or local regulations affecting the health
care industry;
16
<PAGE> 17
o the highly competitive nature of the health care business;
o potential loss of physicians or other key personnel;
o fluctuations in interest rates;
o fluctuations in the market value of our common stock;
o potential adverse impact in the event that the proposed sale
transaction is not consummated;
o disruptions from the sale of the Company;
o changes in accounting pronouncements; and
o changes in general economic conditions.
PROPOSED SALE OF THE COMPANY
On October 18, 2000, we signed a definitive agreement for Triad
Hospitals Inc.("Triad") to acquire us through a combination of cash, stock and
the assumption of debt. Under the terms of the merger agreement, our
shareholders will receive $3.50 in cash and 0.4107 shares of Triad common stock
for each outstanding share of our stock. The transaction is expected to be
tax-free to our shareholders with respect to the stock portion of the
consideration.
The Boards of Directors of both companies have unanimously approved the
proposed transaction, which is subject to customary conditions, including
approval of Triad's shareholders and our shareholders and antitrust clearance.
The transaction is also conditioned upon Triad's receipt of a private letter
ruling from the Internal Revenue Service that the transaction will not alter the
tax-free nature of Triad's spin-off from HCA in May 1999 and is conditioned upon
the receipt of necessary financing. Merrill Lynch & Co. has committed, subject
to customary conditions, to underwrite the entire $1.7 billion of debt needed to
fund the cash portion of the purchase price and the refinancing of certain
existing debt of both companies. The transaction is expected to be completed in
the first half of calendar 2001.
OVERVIEW
We are a leading provider of health care services through our owned
acute care hospitals and regional health care systems located throughout the
United States. We are also the largest provider of management services to acute
care hospitals in the United States, primarily through our subsidiary, Quorum
Health Resources, LLC.
For the three months ended September 30, 2000, our owned hospitals
accounted for 92% of our net operating revenue. Our Dothan, Alabama and Ft.
Wayne, Indiana service areas accounted for approximately 35% of owned hospital
revenue and 52% of owned hospital EBITDA, respectively. EBITDA means our
earnings before interest, synthetic lease expense, depreciation and
amortization, income taxes, minority interest, government settlements,
investigation and litigation related costs, strategic alternatives-related costs
and non-cash stock compensation expense.
For the three months ended September 30, 2000, our net income before
government settlements, investigation and litigation related costs, strategic
alternatives related costs and non-cash stock compensation was 25% higher than
the three months ended September 30, 1999. This increase was primarily due to
17
<PAGE> 18
higher earnings from our same store hospitals and higher earnings from our Las
Vegas joint venture. Operating results of same store hospitals include all of
our owned hospitals except (1) those we sold, (2) the Las Vegas and Macon joint
ventures, and (3) acquired hospitals until we owned them for 12 months. Our
increased same store earnings was primarily due to:
o increases in patient volumes,
o price increases, and
o better management of accounts receivable and bad debt expense.
Our objective is to continue to improve our operating and financial
consistency and stability. We focus on the following operating tactics:
o Grow existing markets;
o Enhance managed care contracting;
o Focus on cost control;
o Improve management of accounts receivable and bad debts; and
o Reduce losses from physician clinics.
IMPACT OF ACQUISITIONS AND SALES
Effective July 1, 2000, we acquired Wells Community Hospital in
Bluffton, Indiana.
Effective December 1, 1999, we acquired Caylor-Nickel Medical Center in
Bluffton, Indiana. Effective March 1, 2000, we transferred our operating lease
of Clinton County Hospital in Frankfort, Indiana to an Indianapolis, Indiana
health care system.
Because of the financial impact of acquisitions and sales, it is
difficult to make meaningful comparisons between our financial statements for
the periods presented. Due to the number of owned hospitals, each hospital we
acquire or sell can affect our overall operating margins or results of
operations.
18
<PAGE> 19
SELECTED OPERATING STATISTICS - OWNED HOSPITALS
The following table sets forth operating statistics for our owned
hospitals for each of the periods presented.
Three Months
Ended
September 30
-------------------------
2000 1999
-------- --------
Number of hospitals 21 21
Licensed beds 4,518 4,578
Beds in service 3,801 3,959
Admissions 35,959 34,705
Average length of stay 5.4 5.5
Patient days 195,498 190,340
Adjusted patient days 340,175 328,857
Occupancy rates (licensed beds) 46.9% 45.2%
Occupancy rates (beds in service) 55.5% 52.3%
Gross inpatient revenue (in thousands) $471,523 $430,227
Gross outpatient revenue (in thousands) $348,947 $313,091
RESULTS OF OPERATIONS
The following table reflects the percentage of net operating revenue
represented by various categories in our Condensed Consolidated Statements of
Operations.
19
<PAGE> 20
<TABLE>
<CAPTION>
Three Months
Ended
September 30
--------------------------
2000 1999
------ ------
<S> <C> <C>
Net operating revenue 100.0% 100.0%
Salaries and benefits 42.1 41.3
Reimbursable expenses 3.4 3.5
Supplies 14.7 14.4
Fees 9.3 8.9
Other operating expenses 9.2 8.4
Provision for doubtful accounts 7.1 9.2
Equity in earnings of affiliates (0.9) (0.5)
Depreciation and amortization 5.8 6.1
Synthetic lease expense 0.7 0.6
Interest expense 3.6 3.9
Government settlements, investigation and
litigation related costs and strategic
alternatives related costs
Non-cash stock compensation 21.3 0.3
Minority interest 1.2 --
0.0 (0.1)
----- -----
Income (loss) before income taxes (17.5) 4.0
Provision (benefit) for income taxes (6.0) 1.5
----- -----
Net income (loss) (11.5%) 2.5%
====== ======
</TABLE>
Three Months Ended September 30, 2000 Compared to Three Months Ended September
30, 1999.
Net Operating Revenue. Net operating revenue was $454.0 million for the
three months ended September 30, 2000, compared to $431.3 million for the three
months ended September 30, 1999. This represents an increase of $22.7 million or
5.3%. We attribute this increase to (1) a 4.5% increase in same store hospital
net operating revenue, (2) the hospitals we purchased during fiscal 2001 and
fiscal 2000 and (3) an increase in revenue from our management services. The
increase in net operating revenue was partially offset by the transfer of our
operating lease of Clinton County Hospital in fiscal 2000.
We attribute the 4.5% same store net operating revenue increase
principally to (1) a 1.7% increase in same store admissions, (2) price increases
and (3) increases in outpatient volumes. Our same store net operating revenue
would have increased more, except for (1) higher patient volumes from discounted
payors and (2) lower Medicare payments as a result of the Balanced Budget Act of
1997 ("BBA 97").
Salaries and Benefits, Reimbursable Expenses, Supplies, Fees, Provision
for Doubtful Accounts and Other Operating Expenses. Salaries and benefits,
reimbursable expenses, supplies, fees, provision for doubtful accounts and other
operating expenses totaled $389.6 million for the three months ended September
30, 2000, compared to $369.8 million for the three months ended September 30,
1999. This represents an increase of $19.8 million or 5.4%. These expenses as a
20
<PAGE> 21
percentage of net operating revenue increased to 85.8% for the three months
ended September 30, 2000 from 85.7% for the three months ended September 30,
1999. Salaries and benefits, reimbursable expenses, supplies, fees, provision
for doubtful accounts and other operating expenses as a percentage of net
operating revenue for our owned hospitals were 86.4% for the three months ended
September 30, 2000 and September 30, 1999.
For our same store hospitals, salaries and benefits, reimbursable
expenses, supplies, fees, provision for doubtful accounts and other operating
expenses as a percent of net operating revenue were 85.8% for the three months
ended September 30, 2000. This percentage was flat with the prior year. Our
improvements in net revenue and bad debt expense were offset by increased labor
costs, supplies and physician clinic expenses. Bad debt expense decreased
primarily due to our improvement in cash collections, especially our collection
of older accounts receivable. Salaries and benefits expense increased due to
wage pressures, which were partially offset by productivity improvements. Our
productivity improvement would have been greater, except for higher levels of
staff training during the three months ended September 30, 2000. Supplies
expense increased due to 1) the acquisition of a retail pharmacy in North
Dakota, 2) increased volumes in cardiac services, and 3) increased costs of new
products and technology, primarily drugs, implants and blood.
During the three months ended September 30, 2000, we recruited more
physicians to our owned hospitals than we had expected and we acquired a
physician clinic in North Dakota. We are focusing efforts on reducing the losses
of our physician clinics. We have been selectively exiting physician contracts,
except when the contract is core to our service area strategy. We plan to have
fewer employed physicians by recruiting physicians without employing them,
whenever possible, and by negotiating or transitioning out of contracts with
physicians with mature practices. We also plan to lower physician clinic losses
by changing the ways we pay employed physicians.
Equity in Earnings of Affiliates. Equity in earnings of affiliates was
$4.1 million for the three months ended September 30, 2000, compared to $2.1
million for the three months ended September 30, 1999, an increase of $2.0
million. Equity in earnings of affiliates represented 0.9% of our net operating
revenue for the three months ended September 30, 2000, compared to 0.5% of our
net operating revenue for the three months ended September 30, 1999. This
increase was due primarily to higher earnings at our Las Vegas joint venture
which was partially offset by lower earnings at our Macon joint venture.
Depreciation and Amortization. Depreciation and amortization expense
for the three months ended September 30, 2000 was $26.4 million compared to
$26.2 million for the three months ended September 30, 1999. This represents an
increase of $0.2 million or 0.7%. Depreciation and amortization expense as a
21
<PAGE> 22
percentage of net operating revenue decreased to 5.8% for the three months ended
September 30, 2000 from 6.1% for the three months ended September 30, 1999. This
decrease was primarily due to Lutheran Hospital property purchased in 1995 that
became fully depreciated, longer estimated useful lives of certain equipment
and our net revenue growth.
Synthetic Lease Expense. Synthetic lease expense is comprised of lease
expense associated with our End Loaded Lease Facility (ELLF) agreement (See
Liquidity and Capital Resources). Synthetic lease expense was $3.0 million for
the three months ended September 30, 2000, compared to $2.5 million for the
three months ended September 30, 1999, an increase of $0.5 million. Synthetic
lease expense as a percentage of net operating revenue increased to 0.7% for the
three months ended September 30, 2000 compared to 0.6% for the three months
ended September 30, 1999.
Interest Expense. Interest expense for the three months ended September
30, 2000 was $16.4 million, compared to $16.7 million for the three months ended
September 30, 1999, a decrease of $0.3 million, or 2.0%. Interest expense as a
percentage of net operating revenue decreased to 3.6% for the three months ended
September 30, 2000 from 3.9% for the three months ended September 30, 1999. The
decrease was due principally to cash flow from operations used to make payments
on our revolving line of credit and the issuance of convertible subordinated
debentures in August 1999 at 6%, which is lower than the rate on our revolving
line of credit. This decrease was partially offset by an increase in LIBOR
rates. Our interest rate swaps mitigated the effect of the increase in LIBOR
rates.
Government Settlements, Investigation and Litigation Related Costs and
Strategic Alternatives Related Costs. During the three months ended September
30, 2000, we accrued $95.5 million in government settlements for tentative
agreements reached with the Civil Division, U.S. Department of Justice to settle
two qui tam lawsuits. The government settlements were expensed in the Condensed
Consolidated Statement of Operations for the three months ended September 30,
2000 and are accrued as a current liability in the Condensed Consolidated
Balance Sheet at September 30, 2000. The settlements were accrued based on
available information and are subject to further refinement (See "Litigation).
During the three months ended September 30, 2000 and 1999,
respectively, we incurred $0.6 and $1.1 million in investigation and litigation
related costs related primarily to the qui tam and shareholder actions against
us (See "Litigation").
During the three months ended September 30, 2000, we incurred $0.5
million in costs associated with exploring various strategic alternatives (See
"Proposed Sale of Company").
Non-cash Stock Compensation Expense. During the three months ended
September 30, 2000, we recorded $5.8 million in non-cash stock option
compensation expense associated with the stock options repriced in March 1999.
This charge was based on the $2.69 increase in our stock price since July 1,
2000. The number of options subject to variable award accounting is comprised of
22
<PAGE> 23
1.7 million vested options and a percentage of approximately 1.4 million
unvested options based on their vesting schedule. The number of options affected
will decrease for options exercised or canceled and will increase as unvested
options become vested.
Minority Interest Income. Minority interest income was $0.2 million for
the three months ended September 30, 2000, compared to $0.3 million for the
three months ended September 30, 1999, a change of $0.1 million.
Income Taxes. The benefit for income taxes for the three months ended
September 30, 2000 was $27.1 million compared to a provision of $6.8 million for
the three months ended September 30, 1999, a decrease of $33.9 million.
Excluding the effect of government settlements, our effective income tax rate
was 38.9% for the three months ended September 30, 2000 compared to 39.1% for
the three months ended September 30, 1999. The $95.5 million government
settlements for the three months ended September 30, 2000 were tax effected at
35.0%.
Net Income (Loss). Net loss for the three months ended September 30,
2000 was $52.2 million, compared to net income of $10.6 million for the three
months ended September 30, 1999, a decrease of $62.8 million. Excluding the
government settlements, investigation and litigation related costs, strategic
alternatives related costs and non-cash stock compensation, net income increased
25% to $14.1 million or 3.1% of net operating revenue for the three months ended
September 30, 2000, from $11.3 million or 2.6% of net operating revenue for the
three months ended September 30, 1999.
LIQUIDITY AND CAPITAL RESOURCES
At September 30, 2000, our working capital was $281.3 million excluding
government settlements. Our ratio of current assets to current liabilities was
2.3 to 1.0 at September 30, 2000 and June 30, 2000, excluding government
settlements.
Cash Flows
Our principal sources of cash are net cash provided by operating
activities and cash available under our bank revolving line of credit facility.
Our principal uses of funds are hospital acquisitions, capital expenditures,
payments of principal and interest on our long-term debt and share repurchases.
Accounts receivable collections contribute significantly to our net
cash flow from operating activities. Billing and collecting accounts receivable
by hospitals is very difficult because of the complexity of Medicare and
Medicaid regulations, increases in managed care, hospital personnel turnover,
including business office managers, computer system conversions and upgrades by
hospital and government authorities, dependence of hospitals on physician
documentation of medical records, and the subjective judgment involved in
submitting and collecting Medicare and Medicaid bills. Our cash flow can also be
affected by temporary delays in billing Medicare and Medicaid accounts
23
<PAGE> 24
receivable while waiting for the government to process hospital change in
ownership forms. There can be no assurance that this complexity will not
negatively impact our future cash flow or results of operations.
Three Months Ended September 30, 2000 Cash Flows Compared to Three Months Ended
September 30, 1999 Cash Flows.
Cash provided by operating activities totaled $54.6 million for the
three months ended September 30, 2000, compared to $48.7 million for the three
months ended September 30, 1999. This represents an increase of $5.9 million, or
12.1%, which was due primarily to higher EBITDA(1) and lower payments on
accounts payable and accrued expenses.
EBITDA for the three months ended September 30, 2000 was $68.6 million,
compared to $63.6 million for the three months ended September 30, 1999, an
increase of $5.0 million or 7.8%. EBITDA as a percentage of net operating
revenue was 15.1% for the three months ended September 30, 2000, compared to
14.8% for the three months ended September 30, 1999. EBITDA as a percentage of
net operating revenue for our owned hospitals was 14.6% for the three months
ended September 30, 2000, compared to 14.1% for the three months ended September
30, 1999. EBITDA as a percentage of net operating revenue for our same store
hospitals was 14.3% for the three months ended September 30, 2000, compared to
14.2% for the three months ended September 30, 1999. EBITDA as a percentage of
net operating revenue for our management services business was 20.5% for the
three months ended September 30, 2000, compared to 21.7% for the three months
ended September 30, 1999. We attribute the increase in consolidated EBITDA
principally to (1) growth in net operating revenue from higher volumes and
better pricing, (2) improvements in receivables management and bad debt expense
and (3) higher earnings from our Las Vegas joint venture. EBITDA as a percentage
of net operating revenue for our same store hospitals excluding physician
clinics was 17.7% for the three months ended September 30, 2000.
Net cash used for investing activities for the three months ended
September 30, 2000 totaled $47.3 million compared to $22.3 million for the three
months ended September 30, 1999. Our primary investment activities for the three
months ended September 30, 2000 were routine capital expenditures, hospital
construction and acquisitions. Routine capital expenditures were $27.1 million
for the three months ended September 30, 2000 compared to $22.0 for the three
months ended September 30, 1999. Hospital construction was $11.9 million for the
three months ended September 30, 2000. We acquired one hospital and affiliated
health care entities for $8.1 million for the three months ended September 30,
2000.
--------
(1) EBITDA is commonly used as an analytical indicator, and also serves as a
measure of indebtedness capacity and debt service ability. EBITDA should
not be considered a measure of financial performance under generally
accepted accounting principles, and the items excluded from EBITDA are
significant components in understanding and assessing financial
performance. EBITDA should not be considered in isolation or as an
alternative to net income, cash flows generated by operating, investing or
financing activities or other financial statement data presented in the
consolidated financial statements as an indicator of financial performance
or liquidity. Because EBITDA is not a measurement determined in accordance
with generally accepted accounting principles and is susceptible to varying
calculations, EBITDA as presented may not be comparable to other similarly
titled measures of other companies.
24
<PAGE> 25
Capital Expenditures
Capital expenditures excluding acquisitions for the three months ended
September 30, 2000 totaled $39.0 million. These capital expenditures consisted
of $11.9 million for constructing two hospitals and routine capital expenditures
of $27.1 million. We expect to make routine capital expenditures for fiscal 2001
of approximately $100 million before acquisitions and before construction of the
two hospitals.
We are constructing a replacement hospital in Vicksburg, Mississippi
and a new acute-care hospital in Ft. Wayne, Indiana. The Vicksburg hospital has
an estimated total project cost of approximately $108 million with an expected
completion date of summer 2002. The Ft. Wayne hospital has an estimated total
project cost of approximately $44 million with an expected completion date of
spring 2001. We expect to make construction capital expenditures of
approximately $80 million to $85 million for fiscal 2001. In connection with the
construction, we have contracts outstanding for approximately $90 million, of
which approximately $27 million has been incurred through September 30, 2000.
Capital expenditures excluding acquisitions for the three months ended
September 30, 1999 totaled $22.0 million.
Capital Resources
Our revolving credit facility consists of an $850.0 million secured
credit facility expiring November 26, 2002, which coincides with the expiration
date of our ELLF. On November 26 of each year, we can request an incremental one
year extension, which is subject to approval of all of the lenders. The credit
facility bears interest at our option at generally the lender's base rate,
swing-line rate or a fluctuating rate ranging from .55 to 1.55 percentage points
above LIBOR. Also, we pay a facility fee ranging from .20 to .45 percentage
points on the commitment. The interest rate margins and facility fee rates are
based on our leverage ratio. Substantially all stock of our subsidiaries has
been pledged under the terms of the credit facility. We may prepay the amount
outstanding at any time. At October 31, 2000, we had approximately $297.3
million committed and undrawn under our credit facility.
We also have a $150.0 million ELLF agreement to provide a financing
option for acquisition and/or construction. The interest rate margins, facility
fee rates, the option to extend and financial covenants are substantially the
same as our credit facility. Under this agreement, we have guaranteed all lease
payments, including contingent lease payments, of up to 85% of the amount
utilized under this agreement. At October 31, 2000, we had approximately $11.8
million available under this agreement.
We have $150.0 million of 8 3/4% senior subordinated notes, which
mature on November 1, 2005. We have the option to redeem these notes at 104.375%
of the principal amount on or after November 1, 2000, 102.188% of the principal
25
<PAGE> 26
amount on or after November 1, 2001, or at par value on or after November 1,
2002. Upon a change of control, we must make an offer to purchase these notes at
101% of the principal amount. These notes are unsecured and subordinated in
right of payment to all existing and future senior debt.
On August 31, 1999, we issued $150.0 million of convertible
subordinated debentures due 2009 to Welsh, Carson, Anderson & Stowe, VIII, LP
(WCAS VIII) and certain WCAS VIII affiliates, including Russell L. Carson,
Chairman of our Board of Directors. We sold the debentures for cash at their
face value. The debentures bear interest at 6.0% per annum. Interest is payable
quarterly. The debentures are convertible into common shares at a conversion
price of $11.25 per share. The debentures automatically convert at any time
after three years if the average of the closing price of our stock over any 90
day period is more than 150% of the conversion price. We can call the debentures
at par after August 31, 2001. In the event of a merger, consolidation or sale of
more than 50% of our assets, the holder of the debentures has the option to have
the debentures prepaid in full. In connection with the merger agreement with
Triad, the debentures are to be converted into our common stock immediately
prior to the merger. The debentures have antidilution protection, including,
under certain circumstances, issuance of common stock below the then applicable
conversion price. The shares into which the debentures are convertible have
certain voting restrictions and must be held until August 2001. The debentures
are subordinated in right of payment to all our debt. We did not register the
debentures under the Securities Act of 1933. The sale of the debentures was
exempt from registration under Section 4(2) of the Securities Act because it was
a privately negotiated transaction and did not involve a public offering. We
used the proceeds to reduce our outstanding debt under our revolving credit
facility.
The credit facilities governing our revolving line of credit, ELLF and
senior subordinated notes contain certain financial covenants including but not
limited to a limitation on debt levels, prohibition of dividend payments and
other distributions and restrictions on investments, repurchases of common
stock, asset dispositions, the ability to merge or consolidate with or transfer
assets to another entity, and the maintenance of various financial ratios,
including a net worth ratio, a fixed charge ratio and a leverage ratio. The
amount available under our revolving line of credit is based on our leverage
ratio and was approximately $272.7 million at September 30, 2000.
During fiscal 2000, we repurchased 2.8 million shares of our common
stock for an aggregate purchase price of $18.6 million. We repurchased all of
these shares in open market transactions. There are approximately 1.6 million
shares remaining for repurchase under the existing 5.0 million share repurchase
program authorized in October 1998.
We adopted a stockholder rights plan in fiscal 1997 and declared a
dividend of one right for each share of common stock. The plan was amended in
August 1999. Each right entitles stockholders to acquire one-third of a share of
common stock at an exercise price of $100, subject to adjustment. The rights
become exercisable only if (1) Welsh, Carson, Anderson & Stowe VIII, L.P., WCAS
Management Corporation and certain parties which purchase the convertible
26
<PAGE> 27
debentures from these entities acquire beneficial ownership of 30% or more of
our common stock or start an offer which would result in those entities owning
30% or more of our common stock or (2) any other person or group acquires
beneficial ownership of 15% or more of our common stock or starts an offer which
would result in that person or group owning 15% or more of our common stock. At
that time, each right owned by unaffiliated others entitles its holder to
purchase common stock (or any combination of common stock, preferred stock, debt
securities and cash, as determined by our board of directors) worth two times
the exercise price of the right. If we are involved in a business combination
transaction with another person or if we sell 50% or more of our assets or
earning power to another person, each right entitles its holder to purchase
shares of our common stock or the acquiring company's common stock worth two
times the exercise price of the right. In connection with the merger agreement
with Triad, we have agreed to amend the stockholder's rights plan so that the
rights will not be made exercisable as a result of the merger. We may redeem the
rights for $.01 each at any time until the tenth day following public
announcement that an ownership position as described above has been acquired.
The rights expire on April 28, 2007.
SEASONALITY AND INFLATION
Our business is seasonal, with higher patient volumes and net operating
revenues in the third quarter of our fiscal year than in the remainder of the
year. This seasonality happens because more people become ill during the winter,
which in turn increases the number of patients in our owned hospitals.
The health care industry is labor intensive. This means that our owned
hospitals need many employees, who we pay salaries and other benefits. These
salaries and benefits increase during periods of inflation and shortages of
qualified potential employees. Some of our hospitals are now experiencing
pressures to increase salaries. In addition, we are experiencing increased costs
of new products and technology, primarily drugs, implants and blood.
MARKET RISKS ASSOCIATED WITH FINANCIAL INSTRUMENTS
Our interest expense is sensitive to changes in the general level of
interest rates. To mitigate the impact of fluctuations in interest rates, we
generally maintain 50%-75% of our debt at a fixed rate, either by borrowing on a
long-term basis or entering into interest rate swaps. At September 30, 2000,
approximately 70% of our outstanding debt and ELLF amounts were effectively at a
fixed rate. Interest rate swaps are contracts which allow us to periodically
exchange fixed and floating interest rate payments over the life of the
agreements. Floating-rate payments are based on LIBOR and fixed-rate payments
are dependent upon market levels at the time the interest rate swap was
consummated. Interest rate swaps are cash flow hedges, which effectively convert
an aggregate notional amount of $400 million of floating rate borrowings to
fixed rate borrowings at September 30, 2000. The initial terms of the interest
rate swaps expire at various dates through fiscal 2003. Our policy is to not
hold or issue derivatives for trading purposes and to avoid derivatives with
27
<PAGE> 28
leverage features. We are exposed to credit losses in the event of
nonperformance by the counterparties to our financial instruments. Our
counterparties are creditworthy financial institutions and we anticipate that
they will be able to fully satisfy their obligations under the contracts for
the three months ended September 30, 2000 and 1999, we received a weighted
average rate of 6.8% and 5.2% and paid a weighted average rate of 5.9% and 5.9%,
respectively.
The following table presents information about our market-sensitive
financial instruments, including long-term debt and interest rate swaps as of
September 30, 2000. For debt obligations, the table presents principal cash
flows and related weighted-average interest rates by expected maturity dates.
For interest rate swaps, the table presents notional amounts by expected
maturity date and weighted average interest rates based on rates in effect at
September 30, 2000. We determined the fair value of our publicly traded notes
using the quoted market price at September 30, 2000. The fair value of the
option feature in the convertible debentures is estimated using an option
pricing model. The fair values of the remaining long-term debt are estimated
using discounted cash flows based on our incremental borrowing rates. The fair
values of our interest rate swaps is based on the cash which would be realized
in the event of termination of the agreements.
Maturity Date, Fiscal Year Ending June 30
(Dollars in millions)
<TABLE>
<CAPTION>
September 30, 2000
Fair Value of
2001 2002 2003 2004 2005 Thereafter Total Liabilities
---- ---- ---- ---- ---- ---------- ----- ----------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Long-term debt:
Fixed rate long-term
debt $0.5 $0.6 $0.6 $0.7 $0.6 $301.0 $304.0 $343.9
Average interest rates 7.9% 7.8% 7.7% 7.8% 7.7% 7.4%
Variable rate long-
term debt $540.1 $540.1 $540.1
Average interest rates 7.8%
Interest rate swaps:
Pay fixed/receive
variable notional
amounts $200.0 $200.0 $400.0 $(4.9)
Average pay rate 6.0% 5.7%
Average receive rate 6.7% 6.7%
</TABLE>
LITIGATION
We are currently, and from time to time expect to be, subject to claims
and suits arising in the ordinary course of business, including claims for
personal injuries and breach of management contracts. Plaintiffs in these
matters may request punitive or other damages that may not be covered by
28
<PAGE> 29
insurance. Except for the litigation described below and other litigation,
administrative proceedings or investigations which may arise under the False
Claims Act or similar laws, we are not aware that we are currently a party to
any such proceeding which, in our opinion, if adversely decided, would have a
material effect on our results of operations or financial position.
PROFESSIONAL LIABILITY JUDGMENT
On February 29, 2000, an amended final trial judgment was entered
against our subsidiary, Quorum Health Resources, LLC ("QHR"), in the amount of
approximately $57 million in the case of David X. and Veronica Rodriguez,
Individually and as Next Friends of Cristina Rodriguez, a minor v Quorum Health
Resources, LLC, in the 365th District Court, Maverick County, Texas. The lawsuit
arose out of the treatment provided beginning July 2, 1994 at Fort Duncan
Medical Center, an acute care hospital managed by QHR. QHR is appealing the
decision. Interest accrues on the judgment at 10% annually.
On July 20, 2000, a federal district court ruled that Maverick County
Hospital District (the owner of Fort Duncan Medical Center) was obligated to
indemnify QHR against all liabilities and costs that it may incur as a result of
the jury's finding of ordinary negligence in the Rodriguez litigation (W.D.
Texas No. A 99 CA 580SS). The Hospital District has appealed this decision. In
addition, Continental Insurance Company, which provides excess coverage of $15
million above QHR's primary insurance of $35 million, has denied coverage on
this judgment. QHR has filed an action seeking a declaratory judgment that
Continental Insurance Company is obligated to insure its portion of the judgment
(M.D. Tenn. No. 3-00-0806).
We currently believe that all or a substantial portion of the judgment,
if not overturned, will be covered by our insurance carriers and/or other
interested parties. However, we cannot guarantee that the judgment will be
overturned or that we will receive any insurance proceeds or other funds. If we
were required to pay the judgment from our own funds, it could have a material
adverse effect on us.
FALSE CLAIMS ACT LITIGATION
At a meeting in September 1998, we learned from the government that it
would likely join in a lawsuit filed against us under the False Claims Act. The
suit was filed in January 1993 by a former employee of a hospital we managed.
These lawsuits, commonly known as qui tam actions, are filed "under seal." That
means that the claims are kept secret until the government decides whether to
join the case. The person who files the lawsuit is called a "relator". The
government joined the case against us in October 1998. The relator's lawsuit
named us and our subsidiary, Quorum Health Resources, HCA and all hospitals that
we or HCA owned, operated or managed from 1984 through 1997, as defendants. The
unsealed complaint, prepared by the relator, alleged that we knowingly prepared
and caused to be filed cost reports which claimed payments from Medicare and
other government payment programs greater than the amounts due.
29
<PAGE> 30
On February 24, 1999, the government filed its own complaint in the
case. The new complaint alleges that we, on behalf of hospitals we managed
between 1985 and 1995 and hospitals we owned from 1990 to the date of the
complaint, violated the False Claims Act by filing false Medicare cost reports.
The government asserts that the false claims in the cost reports are reflected
in "reserve analyses" we created. The complaint also alleges that these cost
report filings were prepared as the result of our policy. We filed several
motions to dismiss the government's complaint.
This qui tam action seeks three times the amount of damages caused to
the United States by our submission of any alleged false claims to the
government, civil penalties of not less than $5,000 nor more than $10,000 for
each false claim, and attorneys' fees and costs.
On October 2, 2000, we announced that we had reached an understanding
with the Civil Division, U.S. Department of Justice to recommend an agreement to
settle this qui tam lawsuit. Under the terms of the tentative agreement, the
Medicare cost report settlement amount to be paid to the government is $77.5
million, with interest accruing at 7.25 percent from October 2, 2000 until final
resolution of a settlement agreement and a corporate integrity agreement, which
are scheduled to be completed by late January 2001. We decided to settle this
case to avoid the time and expense of continued litigation.
OTHER QUI TAM ACTIONS AND RELATED INVESTIGATIONS
In May 1998, we were informed that we were a defendant in another qui
tam action involving home health services provided by two of our owned hospitals
and alleging that we had violated Medicare laws. This action was filed under
seal in June 1996 by a former employee, whom we fired in April 1996. The United
States Attorney's Office allowed us an opportunity to review the results of the
government's investigations and discuss the allegations made in the action prior
to the government making a decision to intervene as a plaintiff. We cooperated
fully with the United States Attorney's Office and provided additional
information and made employees available for interviews.
On October 26, 2000, we completed settlement of this qui tam lawsuit
which primarily involved allocation of costs at Flowers Hospital, Dothan,
Alabama, to its home health services agency(CV-96-P-1638-S, N.D. Alabama). We
paid approximately $18 million to the government on October 26, 2000 in
connection with this settlement. In addition to the settlement agreement, we
entered into a five year corporate integrity agreement with the Department of
Health and Human Services Office of the Inspector General covering Flowers
Hospital.
As part of our ongoing discussions, we have learned from the same U.S.
Attorney that there are two additional unrelated qui tam complaints against us
alleging Medicare violations at one owned and two managed hospitals. Both
matters remain under seal. The government has stated that it intends to
investigate these allegations. At this time, we cannot take a position on how we
will respond to these matters.
30
<PAGE> 31
From time to time, we may be the subject of additional investigations
or a party to additional litigation which alleges violations of law. We may not
know about such investigations, or about qui tam actions filed against us.
STOCKHOLDER CLASS ACTION
In October and November 1998, some of our stockholders filed lawsuits
against us in the U.S. District Court for the Middle District of Tennessee. In
January 1999, the court consolidated these cases into a single lawsuit. (M.D.
Tenn. No. 3-98-1004). The plaintiffs filed an amended complaint in March 1999.
The plaintiffs seek to represent a class of plaintiffs who purchased our common
stock from October 25, 1995 through October 21, 1998, except for our insiders
and their immediate families. The consolidated complaint names us, several of
our officers and one of our outside directors, as defendants.
The complaint alleges that defendants violated the Securities Exchange
Act of 1934. The plaintiffs claim that we materially inflated our net revenues
during the class period by including in those net revenues amounts received from
the settlement of cost reports that had allegedly been filed in violation of
applicable Medicare regulations years earlier and that, because of this
practice, this statement, which first appeared in our Form 10-K filed in
September 1996, was false: "The Company believes that its owned hospitals are in
substantial compliance with current federal, state, local, and independent
review body regulations and standards." In May 1999, we filed a motion to
dismiss the complaint. On November 13, 2000, the judge denied our motion to
dismiss the complaint against us and James E. Dalton, Jr., our President/CEO. He
granted our motion to dismiss as to all other defendants. We intend to
vigorously defend the claims and allegations in this action.
We cannot at this time predict the final effect or outcome of any of
the ongoing investigations or the class or qui tam actions. If we are found to
have violated federal or state laws relating to Medicare, Medicaid or other
government programs, then we may be required to pay substantial fines and civil
and criminal penalties and also may be excluded from participating in the
Medicare and Medicaid programs and other government programs. Similarly, the
amount of damages sought in the qui tam actions are or in the future may be
substantial. We could be subject to substantial costs resulting from defending,
or from an adverse outcome in any current or future investigations,
administrative proceedings or litigation. In an effort to resolve one or more of
these matters, we may choose to negotiate a settlement. Amounts we pay to settle
any of these matters may be material. Agreements we enter into as a part of any
settlement could also materially adversely affect us. Any current or future
investigations or actions could have a material adverse effect on our results of
operations or financial position.
GENERAL
We received from the Medicare and Medicaid programs approximately 42%
and 43% of net patient service revenue for the years ended June 30, 2000 and
1999, respectively.
31
<PAGE> 32
Medicare inpatient operating payment rates increased 2.3% effective
October 1, 2000. Medicare inpatient operating payment rates increased 0.5% for
October 1, 1998 through September 30, 1999 and 1.1% for October 1, 1999 through
September 30, 2000. These increases are less than inflation and increases
through September 30, 2002 are also scheduled to be less than inflation. Also,
the threshold to qualify for additional payments for treating costly inpatient
cases (outlier) increased on October 1, 1999 and increased again on October 1,
2000. Increases in this threshold result in decreased payments to hospitals.
Payments for Medicare skilled nursing facility services, outpatient
services and home health services historically have been paid based on costs,
subject to certain adjustments and limits. BBA 97 required that the payment for
those services be converted to prospective payment systems (PPS). PPS for
skilled nursing facilities began for cost reporting periods beginning on and
after July 1, 1998. PPS for outpatients began on August 1, 2000. PPS for home
health began on October 1, 2000.
Due to BBA 97, we received lower Medicare payments for home health
visits and skilled nursing facilities services. The reduction in home health
payments resulted in a decline in our home health visits of 10.5% and 14.1% for
the three months ended September 30, 2000 and September 30, 1999, respectively,
compared to the prior years. In response to BBA 97, we consolidated certain home
health agencies and skilled nursing facilities, reduced costs at our home health
agencies and skilled nursing facilities and closed or ceased admitting patients
to skilled nursing facilities at four hospitals.
On November 29, 1999 the President signed into law the Medicare,
Medicaid, and State Children's Health Insurance Programs Balanced Budget
Refinement Act of 1999 (BBRA). For us, the most significant provision of BBRA
was the requirement to eliminate a scheduled BBA 97 5.7% reduction in outpatient
payments and to partially subsidize losses in the first 3 1/2 years of the new
Medicare outpatient PPS.
Medicare outpatient PPS is a complex system which has required many
changes in our systems and processes. We are analyzing outpatient product lines,
the impact of changes on patient coinsurance and the financial impact of
outpatient PPS. The fiscal intermediaries are having some difficulties
processing payments timely and accurately under outpatient PPS. HCFA has
identified certain information system issues relating to the processing of
payments for outpatient PPS claims. HCFA has indicated that some of these issues
were resolved by October 1, 2000. Other issues may not be resolved until January
1, 2001. As of October 31, 2000, we estimate that over 45% of our claims under
the new Medicare outpatient PPS system have been paid.
The federal government originally estimated that BBA 97 would reduce
Medicare spending by approximately $103 billion. In July 1999, the federal
government revised its estimate to $206 billion. In November 1999, the federal
government lowered its estimate to $195 billion due to the positive impact of
BBRA. In January 2000, the federal government further revised its estimate to
$227 billion. BBA 97 reduced our ability to maintain our historical rate of net
revenue growth and operating margins. We believe the most significant payment
32
<PAGE> 33
reductions were phased in by the federal fiscal year that began on October 1,
1998. BBA 97 and further changes in the Medicare or Medicaid programs and other
proposals to limit health care spending could have a material adverse impact
upon the health care industry and our hospitals. We expect continuing pressure
to limit expenditures by governmental health care programs.
More of our patients are participating in managed care plans. Managed
care includes indemnity insurance and employer plans which pay less than full
charges, health maintenance organizations, preferred provider organizations and
various other forms of managed care. We are negotiating higher rates from
managed care payors, averaging increases of 5% to 7%. We are beginning to use a
managed care information system in twelve of our owned hospitals to improve the
information available to management and to help ensure that we are paid at the
contracted amounts. We expect to install these systems in four additional owned
hospitals in phases with most hospitals having basic functionality during
calendar year 2000. We plan to install these systems in most of the remaining
owned hospitals by June 30, 2001. The trend toward managed care has and may
continue to adversely affect our ability to grow net operating revenue and
improve operating margins.
Our acute care hospitals, like most acute care hospitals in the United
States, have significant unused capacity. The result is substantial competition
for patients and physicians. Inpatient volumes continue to be negatively
affected by payer-required pre-admission authorization and by payer pressure to
maximize outpatient and alternative health care delivery services for less
acutely ill patients. Over the long term, we expect the industry trend from
inpatient to outpatient services to continue due to the increased focus on
managed care and advances in technology. More outpatient procedures are now
being provided in physician offices. We expect increased competition and
admission constraints to continue. Our ability to successfully respond to these
trends, as well as spending reductions in governmental health care programs,
will be significant in determining our ability to grow net operating revenue and
improve operating margins.
Outpatient revenue of our owned hospitals was approximately 42.5% and
42.1% of gross patient service revenue for the three months ended September 30,
2000 and 1999, respectively.
In accordance with generally accepted accounting principles, we
estimate settlements with third party payers. These estimates are based on
assumptions and affect the amounts we report in our financial statements. For
example, we report net patient service revenue at net amounts we expect to
receive from our hospital patients, third party payers, and others for services
rendered, including estimated retroactive adjustments under agreements with
third party payers. We make estimates of settlements under agreements with third
33
<PAGE> 34
party payers in the period we provide the related services. We then adjust the
settlements as final settlements are determined or additional information is
obtained from the third party payer. Our quarterly or annual operating results
fluctuate based on the timing and amount of changes in estimates.
The IRS is in the process of conducting examinations of our federal
income tax returns for the fiscal years ended June 30, 1996 through 1998. The
IRS has proposed certain adjustments in connection with its prior examination of
our federal income tax returns for the fiscal years ending June 30, 1993 through
1995. The most significant adjustments relate to how we compute bad debt expense
and how we value property, plant and equipment of hospitals we acquire and their
related depreciable lives. We have protested substantially all of the proposed
adjustments through the appeals process of the IRS. In our opinion, the ultimate
outcome of the IRS examinations will not have a material effect on our results
of operations or financial position.
In 1998, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities". This standard requires us to recognize all
derivatives on our Condensed Consolidated Balance Sheet at fair value. Our
interest rate swaps are cash flow hedges which hedge the variability in expected
cash flows from a portion of our floating rate liabilities. We believe that our
hedges are highly effective with changes in effectiveness expected to be
reported in other comprehensive income. Changes in any ineffectiveness will be
reported in our Condensed Consolidated Statement of Operations. The adoption of
this new FASB standard on July 1, 2000 resulted in a cumulative effect of an
accounting change, net of tax, of approximately $5.7 million being recognized as
other comprehensive income. During the three months ended September 30, 2000,
the decrease in fair value of interest rate swaps, net of tax, of approximately
$2.7 million was recognized through other comprehensive income. Other
comprehensive income is not reported in our Condensed Consolidated Statement of
Operations. At September 30, 2000, the interest rate swaps had a fair value of
$4.9 million.
On March 31, 2000, FASB issued its final interpretation of APB Opinion
No. 25 "Accounting for Certain Transactions involving Stock Compensation." The
final interpretation requires variable-award accounting for stock options
granted six months before or after the cancellation or settlement of options if
the new options have a lower exercise price. The interpretation was effective
July 1, 2000 and covers certain events that occurred after December 15, 1998. No
adjustments were made to financial statements for periods prior to the effective
date and no expense was recognized for any additional compensation costs
attributable to periods before the effective date.
During the three months ended September 30, 2000, we recorded $5.8
million in non-cash stock option compensation expense associated with the stock
options repriced in March 1999. This charge was based on the $2.69 increase in
our stock price since July 1, 2000. The number of options subject to variable
award accounting is comprised of 1.7 million vested options and a percentage of
1.4 million unvested options based on their vesting schedule. The number of
options affected will decrease for options exercised or canceled and will
increase as unvested options become vested.
34
<PAGE> 35
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The information contained in Part I, Item 2 "Management's
Discussion and Analysis", under the caption "Litigation", is incorporated by
reference in its entirety into this Item 1.
ITEM 5. OTHER INFORMATION
On October 31, 2000, we notified Premier Purchasing Partners,
L.P. that we would not renew our supply purchasing arrangement which expires
June 30, 2001. Our supply purchasing arrangement with Premier will continue in
effect until at least June 30, 2001.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS. The exhibits filed as part of this Report are
listed in the Index to Exhibits immediately following the signature page.
(b) No reports on Form 8-K were filed during the quarter ended
September 30, 2000.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
QUORUM HEALTH GROUP, INC.
Date: November 14, 2000 By: /s/ TERRY ALLISON RAPPUHN
----------------------------
Terry Allison Rappuhn
Senior Vice President/
Chief Financial Officer
35
<PAGE> 36
EXHIBIT INDEX
EXHIBIT NO.
------------
27 -- Financial Data Schedule
