UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2001.
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: 1-10989
Ventas, Inc.
(Exact name of registrant as specified in its charter)
Delaware 61-1055020
(State or other jurisdiction) (I.R.S. Employer Identification Number)
4360 Brownsboro Road, Suite 115 40207-1642
Louisville, Kentucky (Zip Code)
(Address of principal executive offices)
(502) 357-9000
(Registrant's telephone number, including area code)
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. [X] Yes [_] No
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Class of Common Stock: Outstanding at August 6, 2001:
Common Stock, $.25 par value Shares 68,833,436
1
VENTAS, INC.
FORM 10-Q
INDEX
Page
----
PART I--FINANCIAL INFORMATION.......................................................................... 3
Item 1. Financial Statements........................................................................... 3
Condensed Consolidated Balance Sheets as of June 30, 2001 and December 31, 2000................ 3
Condensed Consolidated Statements of Income for the Three Months Ended and Six
Months Ended June 30, 2001 and June 30, 2000................................................. 4
Condensed Consolidated Statements of Cash Flows for the
Six Months Ended June 30, 2001 and June 30, 2000............................................. 5
Notes To Condensed Consolidated Financial Statements........................................... 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.......... 31
Item 3. Quantitative and Qualitative Disclosures About Market Risk..................................... 45
PART II--OTHER INFORMATION............................................................................. 46
Item 1. Legal Proceedings.............................................................................. 46
Item 2. Changes in Securities and Use of Proceeds...................................................... 46
Item 4. Submission of Matters to a Vote of Security Holders............................................ 46
Item 6. Exhibits and Reports on Form 8-K............................................................... 47
2
PART I--FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
VENTAS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
June 30, December 31,
2001 2000
(Unaudited) (Audited)
----------------- ----------------
Assets
Real estate investments:
Land................................................................... $ 120,151 $ 120,151
Building and improvements.............................................. 1,055,992 1,055,992
---------------- --------------
1,176,143 1,176,143
Accumulated depreciation............................................... (348,547) (327,598)
---------------- --------------
Total real estate investments....................................... 827,596 848,545
Cash and cash equivalents................................................ 23,384 87,401
Restricted cash--held in tax escrow...................................... 14,363 26,893
Recoverable federal income taxes........................................ 2,036 3,211
Deferred financing costs, net............................................ 9,653 10,875
Investment in Kindred Healthcare, Inc.................................... 18,200 --
Notes receivable from employees.......................................... 3,543 3,422
Other.................................................................... 2,358 798
---------------- --------------
Total assets........................................................ $ 901,133 $ 981,145
================ ==============
Liabilities and stockholders' equity
Liabilities:
Notes payable and other debt........................................... $ 850,420 $ 886,385
United States Settlement............................................... 59,711 96,493
Deferred gain on partial termination of interest rate swap agreement... -- 21,605
Deferred revenue....................................................... 22,282 --
Interest rate hedge.................................................... 20,145 --
Accrued dividend....................................................... -- 19,846
Accounts payable and other accrued liabilities......................... 13,052 13,720
Other liabilities--disputed federal, state and local tax refunds....... 15,386 30,104
Deferred income taxes.................................................. 30,506 30,506
----------------- ----------------
Total liabilities................................................... 1,011,502 1,098,659
----------------- ----------------
Commitments and contingencies
Stockholders' equity:
Preferred stock, unissued.............................................. -- --
Common stock........................................................... 18,402 18,402
Capital in excess of par value......................................... 123,347 132,228
Unearned compensation on restricted stock.............................. (1,891) (1,338)
Accumulated other comprehensive income................................. 1,460 --
Retained earnings (deficit)............................................ (117,763) (121,323)
----------------- ----------------
23,555 27,969
Treasury stock......................................................... (133,924) (145,483)
----------------- ----------------
Total stockholders' equity (deficit)................................ (110,369) (117,514)
----------------- ----------------
Total liabilities and stockholders' equity.......................... $ 901,133 $ 981,145
================= ================
See notes to condensed consolidated financial statements
3
VENTAS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
(In thousands, except per share amounts)
Three Months Ended June 30, Six Months Ended June 30,
---------------------------------- ---------------------------------
2001 2000 2001 2000
--------------- -------------- ---------------------------------
Revenues:
Rental income.................................. $46,294 $58,238 $92,412 $115,721
Interest and other income...................... 1,062 1,736 2,568 3,353
--------------- --------------- ---------------------------------
47,356 59,974 94,980 119,074
General and administrative..................... 2,593 2,478 5,142 4,747
Professional fees.............................. 1,097 3,271 2,896 6,593
Non-recurring employee severance costs......... -- -- -- 355
Loss on uncollectible amounts due from tenant.. -- 12,061 -- 23,368
Amortization of restricted stock grants........ 439 330 842 735
Depreciation................................... 10,507 10,545 21,005 21,198
Interest....................................... 21,957 23,777 43,078 47,626
Interest on United States Settlement........... 1,448 -- 1,448 --
--------------- --------------- ---------------------------------
38,041 52,462 74,411 104,622
--------------- --------------- ---------------------------------
Income before extraordinary loss and taxes.......... 9,315 7,512 20,569 14,452
Provision for income taxes.......................... 1,210 -- 1,885 --
--------------- --------------- ---------------------------------
Income before extraordinary loss.................... 8,105 7,512 18,684 14,452
Extraordinary loss on extinguishment of debt........ -- -- -- (4,207)
--------------- --------------- ---------------------------------
Net income.......................................... $ 8,105 $ 7,512 $18,684 $ 10,245
=============== =============== =================================
Earnings per common share:
Basic:
Income before extraordinary loss.......... $ 0.12 $ 0.11 $ 0.27 $ 0.21
Extraordinary loss on extinguishment of
debt..................................... -- -- -- (.06)
--------------- --------------- ---------------------------------
Net income................................ $ 0.12 $ 0.11 $ 0.27 $ 0.15
=============== =============== =================================
Diluted:
Income before extraordinary loss.......... $ 0.12 $ 0.11 $ 0.27 $ 0.21
Extraordinary loss on extinguishment of
debt..................................... -- -- -- (.06)
--------------- --------------- ---------------------------------
Net income................................ $ 0.12 $ 0.11 $ 0.27 $ 0.15
=============== =============== =================================
Shares used in computing earnings per
common share:
Basic.......................................... 68,409 68,027 68,316 67,963
Diluted........................................ 69,307 68,101 69,090 68,007
See notes to condensed consolidated financial statements
4
VENTAS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In thousands)
Six Months Ended
----------------------------------------------------
June 30, June 30,
2001 2000
------------------------ ----------------------
Cash flows from operating activities:
Net income................................................................. $ 18,684 $ 10,245
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation.......................................................... 21,005 21,197
Amortization of deferred financing costs.............................. 1,222 2,014
Amortization of restricted stock grants............................... 842 735
Normalized rents...................................................... 7 (98)
Extraordinary loss on extinguishment of debt.......................... -- 4,207
Amortization of deferred revenue...................................... (418) --
Changes in operating assets and liabilities:
(Increase) decrease in restricted cash................................ 12,530 (27,763)
(Increase) decrease in accounts receivable and other assets........... (1,452) 26,046
Increase (decrease) in accounts payable and accrued and other
liabilities......................................................... (8,967) 2,952
------------------------ ----------------------
Net cash provided by operating activities.......................... 43,453 39,535
Cash flows from investing activities:
Purchase of furniture and equipment...................................... (169) --
Increase in notes receivable from employees.............................. (121) --
------------------------ ----------------------
Net cash used in investing activities............................. (290) --
Cash flows from financing activities:
Repayment of long-term debt.............................................. (35,965) (50,879)
Payment on United States Settlement...................................... (36,782) --
Payment of deferred financing costs...................................... -- (12,616)
Issuance of stock........................................................ 537 14
Cash dividends to stockholders.......................................... (34,970) --
------------------------ ----------------------
Net cash used in financing activities.............................. (107,180) (63,481)
------------------------ ----------------------
Decrease in cash and cash equivalents...................................... (64,017) (23,946)
Cash and cash equivalents--beginning of period............................. 87,401 139,594
------------------------ ----------------------
Cash and cash equivalents--end of period................................... $ 23,384 $115,648
======================== ======================
Supplemental Schedule of noncash activities:
Receipt of Kindred Healthcare, Inc. common stock................. $ 18,200 --
======================== ======================
See notes to condensed consolidated financial statements
5
VENTAS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1--REPORTING ENTITY
Ventas, Inc. ("Ventas" or the "Company") is a Delaware corporation that
elected to be taxed as a real estate investment trust ("REIT") under the
Internal Revenue Code of 1986, as amended (the "Code"), beginning with the tax
year ended December 31, 1999. Although the Company believes that it has
satisfied the requirements to continue to qualify as a REIT for the year ended
December 31, 2000 and although the Company intends to continue to qualify as a
REIT for the tax year ending December 31, 2001 and subsequent tax years, it is
possible that economic, market, legal, tax or other considerations may cause the
Company to fail or elect not to continue to qualify as a REIT in any such tax
year. The Company owns or leases 44 hospitals, 216 nursing facilities and eight
personal care facilities in 36 states, as of June 30, 2001. The Company conducts
substantially all of its business through a wholly owned operating partnership,
Ventas Realty, Limited Partnership ("Ventas Realty"). The Company operates in
one segment which consists of owning and leasing health care facilities and
leasing or subleasing such facilities to third parties.
NOTE 2--BASIS OF PRESENTATION
The accompanying unaudited Condensed Consolidated Financial Statements have
been prepared in accordance with accounting principles generally accepted in the
United States for interim financial information and with 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 accounting principles generally
accepted in the United States 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 six -month period ended June 30, 2001 are not necessarily an
indication of the results that may be expected for the year ending December 31,
2001. The Condensed Consolidated Balance Sheet as of December 31, 2000 has been
derived from the Company's audited consolidated financial statements for the
year ended December 31, 2000. These financial statements and related notes
should be read in conjunction with the financial statements and footnotes
thereto included in the Company's Annual Report on Form 10-K for the year ended
December 31, 2000.
Segment Reporting
-----------------
The Company has one primary reportable segment, which consists of investment
in real estate. The Company's primary business is owning and leasing health care
facilities and leasing or subleasing such facilities to third parties, primarily
Kindred Healthcare, Inc. (formerly known as Vencor, Inc.) ("Kindred") (See
"Note 3--Concentration of Credit Risk and Recent Developments"). All of the
Company's leases are triple-net leases, which require the tenants to pay all
property related expenses. Substantially all depreciation and interest expenses
reflected in the condensed consolidated statements of income relate to the
ownership of the Company's investment in real estate.
Change in Accounting Principle
------------------------------
In June of 2000 the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting ("SFAS") No. 138 "Accounting for Derivative
Instruments and Hedging Activities" which amends SFAS No. 133, "Accounting for
Derivative Instruments and Hedging Activities." SFAS No. 133, as amended,
requires companies to record derivatives on the balance sheet as assets or
liabilities, measured at fair value. On January 1, 2001, the Company adopted
SFAS No. 133, and at that time, designated the derivative instruments in
accordance with the requirements of the new standard. The adoption of the
standard as of January 1, 2001 resulted in the recognition of a liability of
$4.1 million to reflect the fair value of the Company's interest rate swap
agreement and an identical reduction to other comprehensive income, a component
of stockholders' equity. In addition, the $21.6 million
6
VENTAS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
deferred gain recognized on a terminated derivative position was reclassified to
other comprehensive income, resulting in a cumulative adjustment to other
comprehensive income of $17.5 million. The transition amounts were determined
based on the interpretive guidance issued by the FASB to date. The FASB
continues to issue interpretive guidance that could require changes in the
Company's application of the standard and adjustments to the transition amounts.
SFAS No. 133 may increase or decrease reported net income and stockholders'
equity prospectively, depending on future levels of interest rates, the computed
"effectiveness" of the derivatives, as that term is defined by SFAS No. 133,
and other variables affecting the fair values of derivative instruments and
hedged items, but will have no effect on cash flows. The Company believes that
the hedge is highly effective as defined by SFAS No. 133. On June 30, 2001, the
derivative instrument was reported at its fair value as a liability in the
Condensed Consolidated Balance Sheet at $20.1 million. The offsetting adjustment
is reported as a deferred loss in Accumulated Other Comprehensive Income. See
"Note 4--Bank Credit Facility."
NOTE 3--CONCENTRATION OF CREDIT RISK AND RECENT DEVELOPMENTS
Concentration of Credit Risk
As of June 30, 2001, approximately 70.1% of the Company's real estate
investments (based on cost) related to skilled nursing facilities. The remaining
real estate investments consist of hospitals and personal care facilities. The
Company's facilities are located in 36 states, and lease revenues from
operations in only one state account for more than 10% of rental revenues. The
Company leases all of its hospitals and 210 of its nursing facilities to Kindred
and certain of its subsidiaries under four amended and restated master lease
agreements dated April 20, 2001 (individually an "Amended Master Lease" and
collectively the "Amended Master Leases"). See "--Recent Developments Regarding
Kindred--Spin Agreements and Other Arrangements Under the Final Plan--Amended
Master Leases."
Because the Company leases substantially all of its properties to Kindred and
Kindred is the primary source of the Company's revenues, Kindred's financial
condition and ability to satisfy its obligations under the Amended Master Leases
and certain other agreements will significantly impact the Company's revenues
and its ability to service its indebtedness and other obligations and to make
distributions to its stockholders. The operations of Kindred were negatively
impacted by changes in governmental reimbursement rates, by its level of
indebtedness and by certain other factors. As a result, Kindred filed for
protection under chapter 11 of the United States Bankruptcy Code (the
"Bankruptcy Code") on September 13, 1999. On March 19, 2001, the United States
Bankruptcy Court for the District of Delaware (the "Bankruptcy Court") entered
an order on the docket confirming Kindred's final plan of reorganization, which
plan restructured Kindred's debt and lease obligations. Kindred emerged from
bankruptcy pursuant to the Final Plan (as defined below) on April 20, 2001.
Kindred's financial condition and its ability and willingness to meet its rent
obligations will determine the Company's rental revenues and the Company's
ability to service its indebtedness and other obligations and to make
distributions to its stockholders. In addition, any failure by Kindred to
conduct its operations effectively could have a material adverse effect on the
business, financial condition, results of operations and liquidity of the
Company, on the Company's ability to service its indebtedness and other
obligations and on the Company's ability to make distributions to its
stockholders as required to continue to qualify as a REIT (a "Material Adverse
Effect"). There can be no assurance that Kindred will have sufficient assets,
income and access to financing to enable it to satisfy its obligations under the
Amended Master Leases or that Kindred will perform its obligations under the
Amended Master Leases. Since the Amended Master Leases are structured as triple-
net leases under which Kindred is responsible for all or substantially all
insurance, taxes and maintenance and repair expenses required in connection with
the leased properties, the inability or unwillingness of Kindred to satisfy its
obligations under the Amended Master Leases would have a Material Adverse Effect
on the Company. In addition, the credit standing of the Company is affected by
the general creditworthiness of Kindred.
7
VENTAS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
Recent Developments Regarding Kindred
Kindred Bankruptcy
On September 13, 1999 (the "Petition Date"), Kindred filed for protection
under chapter 11 of the Bankruptcy Code with the Bankruptcy Court. On December
14, 2000, Kindred filed its fourth amended plan of reorganization (the "Fourth
Amended Plan") with the Bankruptcy Court, containing the terms of the
restructuring of Kindred's debt and lease obligations.
A hearing on the confirmation of the Fourth Amended Plan was held before the
Bankruptcy Court on March 1, 2001 (the "Confirmation Hearing"). The Fourth
Amended Plan, which was modified on the record of the Confirmation Hearing, was
confirmed (as confirmed, the "Final Plan") by an order of the Bankruptcy
Court, which order was entered on the docket on March 19, 2001 (the "Kindred
Confirmation Date"). The Final Plan became effective and Kindred emerged from
bankruptcy on April 20, 2001 (the "Kindred Effective Date").
Summary of Economic Terms of the Final Plan
Under the terms of the Final Plan, the Company, among other things, (i)
retained all rent paid by Kindred through the Kindred Effective Date, (ii)
amended and restated its leases with Kindred in the form of the Amended Master
Leases and (iii) received 1,498,500 shares of the common stock of Kindred
together with certain registration rights.
Annual base rent under the Amended Master Leases is scheduled to be $180.7
million from May 1, 2001 to April 30, 2002. For the period through April 30,
2004, annual base rent, which is payable in all cash, will escalate 3.5% on May
1 of each year, commencing May 1, 2002, if certain tenant revenue parameters are
achieved. Assuming such tenant revenue parameters are achieved, annual base rent
under the Amended Master Leases will be $187.0 million from May 1, 2002 to April
30, 2003 and $193.6 million from May 1, 2003 to April 30, 2004. All of the
annual base rent will be paid in cash through April 30, 2004. Commencing May 1,
2004, if a Kindred Bank Refinancing Transaction (as defined below) has occurred,
the 3.5% annual escalator will be paid in cash and the full amount of the annual
base rent will be paid in cash. If a Kindred Bank Refinancing Transaction has
not occurred, then on May 1, 2004 the 3.5% annual escalator under the Amended
Master Leases will be comprised of (a) an annual cash escalator of approximately
2% on the rent payable in cash during the prior lease year and (b) a 1.5% annual
non-cash rent escalator that will accrue at the annual rate of the London
Interbank Offered Market Rate ("LIBOR") plus 450 basis points until the
occurrence of a Kindred Bank Refinancing Transaction, at which time the accrual
with interest shall be due and payable and thereafter the 1.5% non-cash rent
escalator will convert to a cash escalator so that the total cash escalator
thereafter will equal 3.5% per year. Under the terms of the Final Plan, Kindred
paid $15.1 million in base rent for April 2001, which is the monthly base rent
amount under the stipulation and order entered by the Bankruptcy Court on or
about September 13, 1999 (the "Rent Stipulation"). The Company also has the
one time right to reset the rents under the Amended Master Leases, exercisable 5
1/4 years after the Kindred Effective Date on an Amended Master Lease by Amended
Master Lease basis, to a then fair market rental rate, for a total fee of $5.0
million payable on a pro-rata basis at the time of exercise under the applicable
Amended Master Lease. See "--Amended Master Leases."
On the Kindred Effective Date, Ventas Realty received 1,498,500 shares of the
common stock in Kindred as restructured under the Final Plan, representing 9.99%
(subject to dilution from warrants issued on the Kindred Effective Date and from
stock issuances by Kindred occurring after the Kindred Effective Date) of the
issued and outstanding common stock in Kindred as of the Kindred Effective Date
(the "New Kindred Common Stock"). The New Kindred Common Stock was issued to
Ventas Realty as additional future rent in consideration of the Company and
Ventas Realty's agreement to charge the base rent as provided in the Amended
Master Leases. On the Kindred
8
VENTAS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
Effective Date, the Company also received a $4.5
million cash payment as additional future rent under the Amended Master Leases.
The value of the Company's New Kindred Common Stock and the $4.5 million of
additional future rent will be amortized as future rent over the weighted
average remaining term of the Amended Master Leases for financial reporting
purposes.
Except as explained below, Kindred has assumed and agreed to continue to
perform its obligations under the various agreements (the "Spin Agreements")
entered into by the Company and Kindred at the time of the corporate
reorganization on May 1, 1998, pursuant to which the Company was separated into
two publicly held corporations (the "1998 Spin Off"), including, without
limitation, the obligation to indemnify and defend the Company for all
litigation and other claims relating to the health care operations and other
assets and liabilities transferred to Kindred in the 1998 Spin Off. See "--Spin
Agreements and Other Arrangements under the Final Plan."
As of the Kindred Effective Date, certain federal, state and local tax refund
proceeds received on or after September 13, 1999 by Kindred or the Company for
tax periods prior to and including the 1998 Spin Off (the "Subject Periods")
were placed into an escrow account to be used to satisfy any potential tax
liabilities for the Subject Periods. When audits of the relevant tax periods
have been concluded, any residual amount remaining in escrow will be shared
equally by the Company and Kindred. All interest accruing on the escrowed
amounts will be distributed annually equally between the Company and Kindred.
See "--Tax Allocation Agreement and Tax Refund Escrow Agreement."
The Company waived the right to the payment of (a) $18.9 million for the
August 1999 unpaid monthly base rent under the Original Master Leases (as
defined below) and (b) approximately $79.5 million, representing the difference
between the rent required to be paid under the terms of the Original Master
Leases and the rent paid to the Company after the Petition Date and prior to the
first calendar month following the Kindred Effective Date pursuant to the terms
of the Rent Stipulation. In 2000, the outcome of Kindred's bankruptcy was
uncertain and the difference between the rent provided for in the Original
Master Lease and rent actually received in 2000 from Kindred was written off to
uncollectible rent expense. Rental revenue for the six months ended June 30,
2001 reflects net rental income received under the Rent Stipulation for the
period commencing January 1, 2001 and ending April 30, 2001 as required in the
Final Plan and rental income received under the Amended Master Leases for May
and June 2001.
Spin Agreements and Other Arrangements Under the Final Plan
In order to govern certain of the relationships between the Company and
Kindred after the 1998 Spin Off and to provide mechanisms for an orderly
transition, the Company and Kindred entered into the Spin Agreements at the time
of the 1998 Spin Off. Except as noted below, each and every written agreement by
and among Kindred and the Company and/or Ventas Realty was assumed by Kindred
and certain of these agreements were simultaneously amended in accordance with
the terms of the Final Plan.
The Company and Kindred also entered into certain agreements and stipulations
and orders both prior to and during the pendency of Kindred's bankruptcy
proceedings governing certain aspects of the business relationships between the
Company and Kindred prior to the Kindred Effective Date. These agreements and
stipulations and orders were terminated on the Kindred Effective Date in
accordance with the Final Plan.
Set forth below is a description of the material terms of (a) certain of the
Spin Agreements, as assumed by Kindred, including the terms of amendments or
restatements of such Spin Agreements, where applicable, (b) those Spin
Agreements and other agreements terminated under the Final Plan, and (c) new
agreements entered into between the Company and Kindred in accordance with the
Final Plan.
9
VENTAS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
Amended Master Leases
In the 1998 Spin Off, the Company and Ventas Realty (collectively, the
"Landlord") and Kindred, Inc. and Kindred Operating, Inc. (collectively, the
"Tenant") entered into the four master lease agreements governing the lease of
substantially all of the Company's real property, buildings and other
improvements (primarily long-term acute care hospitals and nursing facilities).
In August 1998, Ventas Realty and Kindred Nursing Centers Limited Partnership
entered into a fifth master lease agreement for a single nursing facility in
Corydon, Indiana. The five master lease agreements are individually referred to
as an "Original Master Lease" and collectively as the "Original Master Leases".
Under the Final Plan, the Tenant assumed the Original Master Leases and the
Tenant and the Landlord simultaneously amended and restated the Original Master
Leases in the form of the four Amended Master Leases setting forth the material
terms governing the properties covered by the Amended Master Leases. The
Corydon, Indiana facility was incorporated into Amended Master Lease #4. The
following description of the Amended Master Leases is a summary and does not
purport to be a complete description of the Amended Master Leases; reference is
made to the terms of the Amended Master Leases, one of which is attached as an
exhibit to a Current Report on Form 8-K/A filed with the Commission on April 24,
2001.
Each Amended Master Lease includes land, buildings, structures and other
improvements on the land, easements and similar appurtenances to the land and
improvements, and permanently affixed equipment, machinery and other fixtures
relating to the operation of the properties covered by the Amended Master
Leases. There are several renewal bundles of properties under each Amended
Master Lease, with each bundle containing approximately 7 to 12 properties. All
properties within a bundle have primary terms ranging from 10 to 15 years from
May 1, 1998, subject to certain exceptions, and are subject to three five-year
renewal terms.
Each Amended Master Lease covers between 47 and 100 leased properties and is a
"triple-net lease" or an "absolute-net lease" pursuant to which Tenant is
required to pay all insurance, property taxes, utilities, maintenance and
repairs related to the properties. Under each Amended Master Lease, the
aggregate annual rent is referred to as Base Rent (as defined in each Amended
Master Lease). Base Rent equals the sum of Current Rent (as defined in each
Amended Master Lease) and Accrued Rent (as defined in each Amended Master
Lease). The Tenant is obligated to pay the portion of Base Rent that is Current
Rent, and unpaid Accrued Rent is paid as set forth below. From May 1, 2001
through April 30, 2004, Base Rent will equal Current Rent. Under the Amended
Master Leases, the initial annual aggregate Base Rent is scheduled to be $180.7
million from May 1, 2001 to April 30, 2002. For the period from May 1, 2002
through April 30, 2004, annual aggregate Base Rent, payable in cash, escalates
at an annual rate of 3.5% over the Prior Period Base Rent (as defined in the
Amended Master Leases) on May 1 of each year, if certain Tenant revenue
parameters are obtained. Assuming such Tenant revenue parameters are obtained,
Annual Base Rent under the Amended Master Leases will be $187.0 million from May
1, 2002 to April 30, 2003 and $193.6 million from May 1, 2003 to April 30, 2004.
Base Rent for April 2001 was $15.1 million, which equaled the monthly rental
paid under the Rent Stipulation.
Each Amended Master Lease provides that, beginning May 1, 2004, if a Kindred
Bank Refinancing Transaction has occurred, the 3.5% annual escalator will be
paid in cash and the Base Rent shall continue to equal Current Rent. If a
Kindred Bank Refinancing Transaction has not occurred, then on May 1, 2004 the
annual aggregate Base Rent will be comprised of (a) Current Rent payable in cash
which will escalate annually by an amount equal to 2% of prior period Base Rent
and (b) an additional annual non-cash accrued escalator amount of 1.5% of the
Prior Period Base Rent which will accrete from year to year including an
interest accrual at LIBOR (as defined in the Amended Master Leases) plus 450
basis points (compounded annually) to be added to the annual accreted amount
(but such interest will not be added to the aggregate Base Rent in subsequent
years). The Unpaid Accrued Rent will become payable, and all future Base Rent
escalators will be payable in cash, upon the occurrence of any one of the
following (a "Kindred Bank Refinancing Transaction"): (a) any transaction
pursuant to which all or substantially all of the indebtedness of the Tenant
under the Tenant's new senior secured credit agreement is
10
VENTAS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
purchased by the Tenant or another party at the Tenant's direction or is repaid;
(b) any amendment of the new senior secured notes or new senior secured credit
agreement pursuant to which either (i) the principal amount of the Tenant's
indebtedness thereunder (as such indebtedness is in effect immediately prior to
such amendment) is increased (excepting therefrom increases attributable to the
capitalization of accrued interest or protective advances by the lenders under
the new senior secured notes), or (ii) the loan amount, maturity or other
material terms and conditions thereof (as such terms and conditions are in
effect immediately prior to such amendment), are modified to match, better or
otherwise respond to the terms and conditions of alternative financing which has
been offered to the Tenant; (c) any bona fide, binding offer is made to the
Tenant to provide financing on terms better than those of the new senior secured
credit agreement, sufficient to (i) pay in full, or purchase at or above par,
all of the indebtedness of the Tenant under the new senior secured credit
agreement and (ii) pay in full all Unpaid Accrued Rent owing as of such date,
whether or not such offer is accepted or consummated; and (d) the termination or
expiration of the applicable Amended Master Lease as to all properties under
such lease. However, with respect to subsection (d) above, the Landlord's right
to receive payment of the Unpaid Accrued Rent is subordinate to the receipt of
payment of the indebtedness of the Tenant by the lenders under the new senior
secured notes issued pursuant to the new senior secured credit agreement. Upon
the occurrence of any of the events referenced in subsections (a) through (d)
above, the annual aggregate Base Rent payable in cash will thereafter escalate
at the annual rate of 3.5% and there will be no further accrual feature for
rents arising after the occurrence of such events.
During the one-year period commencing on the date which is 5 1/4 years after
the Kindred Effective Date, the Landlord has a one-time option (the "Reset
Right") to reset the Base Rent, Current Rent and Accrued Rent (as defined in
each Amended Master Lease) under any one or more Amended Master Leases to the
then fair market rental. Upon exercising this reset right, the Landlord must pay
the Tenant a fee equal to a prorated portion of $5.0 million based upon the
proportion of Base Rent payable under the Amended Master Lease(s) with respect
to which rent is reset to the total Base Rent payable under all of the Amended
Master Leases. The fair market rental will be determined through the appraisal
procedures in the Amended Master Leases. Once the fair market rental is so
determined, the Landlord, in its sole discretion, shall determine whether to
exercise the Reset Right. If the Landlord elects to exercise the Reset Right,
the new fair market rental will be effective retroactive on the later of (a) the
date the Landlord notifies the Tenant of its interest in exercising the Reset
Right and (b) the date which is 5 1/4 years after the Kindred Effective Date.
The rental rate for any renewal term will also be reset in connection with
Landlord's election to exercise a Reset Right.
The Amended Master Leases require that the Tenant utilize the leased
properties solely for the provision of health care services and related uses and
as the Landlord may otherwise consent (such consent not to be unreasonably
withheld). The Tenant is responsible for maintaining or causing to be maintained
all licenses, certificates and permits necessary for it to comply with various
health care regulations. The Tenant is obligated to operate continuously each
leased property as a provider of health care services.
The Tenant is required to maintain the leased properties in good repair and
condition, making all repairs, modifications and additions required by law,
including any Capital Addition (as defined in each of the Amended Master
Leases). The Tenant is required to pay for all capital expenditures and other
expenses for the maintenance, repair, restoration or refurbishment of a leased
property (and any Capital Addition). The Tenant also is required to maintain all
personal property at each of the leased properties in good order, condition and
repair, as is necessary to operate the leased property in compliance with all
applicable licensure, certification, legal and insurance requirements and
otherwise in accordance with customary practice in the industry.
The Tenant is required to maintain liability, all risk property and workers'
compensation insurance for the leased properties at a level at least comparable
to those in place with respect to the leased properties prior to the 1998 Spin
Off.
11
VENTAS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
Subject to certain restrictions, each Amended Master Lease permits the
Landlord, as determined in its sole discretion and for a legitimate business
purpose, to remove properties from the Amended Master Leases and place such
properties in newly created separate lease(s), which newly created lease(s)
shall be on the same terms as the original Amended Master Leases. Any such new
lease will not be cross-defaulted with the original Amended Master Leases or
with any other new leases. The Tenant is not permitted to remove properties from
an Amended Master Lease without the consent of the Landlord.
An "Event of Default" will be deemed to have occurred under an Amended
Master Lease if, among other things, (i) the Tenant fails to pay rent or other
amounts when due and fails to cure such default within five days after notice;
(ii) the Tenant fails to comply with covenants, which failure continues for 30
days after notice or, so long as diligent efforts to cure such failure are being
made, such longer period (not over 180 days) as is necessary to cure such
failure; (iii) certain bankruptcy or insolvency events occur, including filing a
petition of bankruptcy or a petition for reorganization under the Bankruptcy
Code; (iv) the Tenant ceases to operate any property as a provider of health
care services for the particular required use (e.g., hospital or nursing
center); (v) a default occurs under any guaranty of the lease or the Indemnity
Agreement (as defined in the Amended Master Leases) and is not cured within the
cure period specified in the Amended Master Leases; (vi) the Tenant or its
applicable subtenant loses any required health care license, permit or approval
or fails to comply with any legal requirements in each case by a final
unappealable determination; (vii) the Tenant fails to maintain required
insurance; (viii) the Tenant creates or suffers to exist certain liens and does
not cure the same within the cure period specified in the Amended Master Leases;
(ix) the Tenant fails to perform any covenant with respect to complying with or
contesting any legal requirements, impositions or insurance requirements and
does not cure the same within the cure period specified in the Amended Master
Leases; (x) any breach occurs of any material representation or warranty of the
Tenant; (xi) a reduction occurs in the number of licensed beds in excess of 10%
(or 5% in certain cases), or less than 10% if the Tenant has voluntarily banked
more than 15% (or, in certain cases, a percentage less than 5% if the Tenant has
voluntarily banked more than 20%) of licensed beds, of the number of licensed
beds in, or deemed to be in, the applicable facility on the Commencement Date
(as defined in the Amended Master Leases) (subject to certain exceptions for
involuntary reductions in excess of 10%) (a "Licensed Bed Event of Default");
(xii) certification for reimbursement under Medicare or Medicaid with respect to
a participating facility is revoked and re-certification does not occur for 120
days (plus an additional 60 days in certain circumstances) (a
"Medicare/Medicaid Event of Default"); (xiii) the appointment of a receiver or
custodian by any federal, state or local government pursuant to a final
unappealable determination; (xiv) the Tenant becomes subject to regulatory
sanctions and fails to cure such regulatory sanctions within its specified cure
period in any material respect with respect to any facility; (xv) the Tenant
fails to cure its breach of any Permitted Encumbrance (as defined in the Amended
Master Leases) within the applicable cure period and, as a result, a real
property interest or other beneficial property right of the Lessor is terminated
or at material risk of being terminated; (xvi) the Tenant fails to cure its
breach of any of the obligations of the Landlord as lessee under an Existing
Ground Lease (as defined in the Amended Master Leases) within the applicable
cure period and, if such breach is a non-monetary, non-material breach, such
Existing Ground Lease is terminated or at material risk of being terminated;
(xvii) the Tenant fails to pay principal or interest with respect to the new
senior secured notes issued by Tenant on the Kindred Effective Date or otherwise
fails to pay principal or interest when due (including applicable notice and
cure periods) with respect to any indebtedness for borrowed money of Tenant with
an aggregate outstanding principal balance equal to or exceeding $50.0 million;
or (xviii) the maturity of the new senior secured notes issued by Tenant on the
Kindred Effective Date or any other indebtedness owing under the Tenant's new
senior secured credit agreement or any other indebtedness for borrowed money of
Tenant with an aggregate outstanding principal balance equal to or exceeding
$50.0 million has been accelerated. The Amended Master Leases are not cross-
defaulted with each other.
Except as noted below, upon an Event of Default under one of the Amended
Master Leases, the Landlord may, at its option, exercise the following remedies:
(i) after not less than 10 days notice to the Tenant (less in certain
circumstances), terminate that particular entire Amended Master Lease, repossess
all leased properties under such
12
VENTAS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
Amended Master Lease and require that the Tenant pay to the Landlord, as
liquidated damages, the net present value of the rent for the balance of the
term; (ii) without terminating the particular Amended Master Lease agreement,
repossess all leased properties under such Amended Master Lease and relet the
leased properties with the Tenant remaining liable under the particular Amended
Master Lease for all obligations to be performed by the Tenant thereunder,
including the difference, if any, between the rent under the particular Amended
Master Lease and the rent payable as a result of the reletting of the leased
property; and (iii) seek any and all other rights and remedies available under
law or in equity. In the case of an Event of Default that relates specifically
to a particular leased property, in lieu of terminating the Amended Master Lease
and/or dispossessing the Tenant as to all leased properties under such Amended
Master Lease and subject to the special rules noted below relative to Licensed
Bed Events of Default and Medicare/Medicaid Events of Default, the Landlord may
terminate the Amended Master Lease and/or dispossess Tenant as to the aforesaid
leased property. Each of the Amended Master Leases includes special rules
relative to Medicare/Medicaid Events of Default and Licensed Bed Events of
Default. In the event Medicare/Medicaid Events of Default and/or Licensed Bed
Events of Default shall occur and be continuing (i) with respect to not more
than two properties at the same time under an Amended Master Lease that covers
41 or more properties and (ii) with respect to not more than one property at the
same time under an Amended Master Lease that covers 21 to and including 40
properties, the Lessor may not exercise termination/dispossession remedies
against any property other than the property(ies) to which the Events of Default
described above relate.
Tax Allocation Agreement and Tax Refund Escrow Agreement
The Tax Allocation Agreement, entered into at the time of the 1998 Spin Off
and described in more detail below, was assumed by Kindred under the Final Plan
and then amended and supplemented by the Tax Refund Escrow Agreement, also
described below.
The Tax Allocation Agreement provides that Kindred will be liable for, and
will hold the Company harmless from and against, (i) any taxes of Kindred and
its then subsidiaries (the "Kindred Group") for periods after the 1998 Spin
Off, (ii) any taxes of the Company and its then subsidiaries (the "Company
Group") or the Kindred Group for periods prior to the 1998 Spin Off (other than
taxes associated with the Spin Off) with respect to the portion of such taxes
attributable to assets owned by the Kindred Group immediately after completion
of the 1998 Spin Off and (iii) any taxes attributable to the 1998 Spin Off to
the extent that Kindred derives certain tax benefits as a result of the payment
of such taxes. Under the Tax Allocation Agreement, Kindred would be entitled to
any refund or credit in respect of taxes owed or paid by Kindred under (i), (ii)
or (iii) above. Kindred's liability for taxes for purposes of the Tax Allocation
Agreement would be measured by the Company's actual liability for taxes after
applying certain tax benefits otherwise available to the Company other than tax
benefits that the Company in good faith determines would actually offset tax
liabilities of the Company in other taxable years or periods. Any right to a
refund for purposes of the Tax Allocation Agreement would be measured by the
actual refund or credit attributable to the adjustment without regard to
offsetting tax attributes of the Company.
Under the Tax Allocation Agreement, the Company would be liable for, and would
hold Kindred harmless against, any taxes imposed on the Company Group or the
Kindred Group other than taxes for which the Kindred Group is liable as
described in the above paragraph. The Company would be entitled to any refund or
credit for taxes owed or paid by the Company as described in this paragraph. The
Company's liability for taxes for purposes of the Tax Allocation Agreement would
be measured by the Kindred Group's actual liability for taxes after applying
certain tax benefits otherwise available to the Kindred Group other than tax
benefits that the Kindred Group in good faith determines would actually offset
tax liabilities of the Kindred Group in other taxable years or periods. Any
right to a refund would be measured by the actual refund or credit attributable
to the adjustment without regard to offsetting tax attributes of the Kindred
Group.
13
VENTAS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
On the Kindred Effective Date, Kindred and the Company entered into the Tax
Refund Escrow Agreement and First Amendment of the Tax Allocation Agreement (the
"Tax Refund Escrow Agreement") governing their relative entitlement to certain
tax refunds for the Subject Periods that each has received or may receive in the
future. The Tax Refund Escrow Agreement amends and supplements the Tax
Allocation Agreement. Under the terms of the Tax Refund Escrow Agreement,
refunds ("Subject Refunds") received on or after September 13, 1999 by either
Kindred or the Company with respect to federal, state or local income, gross
receipts, windfall profits, transfer, duty, value-added, property, franchise,
license, excise, sales and use, capital, employment, withholding, payroll,
occupational or similar business taxes (including interest, penalties and
additions to tax, but excluding certain refunds), for taxable periods ending on
or prior to May 1, 1998, or including May 1, 1998 ("Subject Taxes") were
deposited into an escrow account with a third-party escrow agent on the Kindred
Effective Date.
The Tax Refund Escrow Agreement provides, inter alia, that each party shall
notify the other of any asserted Subject Tax liability of which it becomes
aware, that either party may request that asserted liabilities for Subject Taxes
be contested, that neither party may settle such a contest without the consent
of the other, that each party shall have a right to participate in any such
contest, and that the parties generally shall cooperate with regard to Subject
Taxes and Subject Refunds and shall mutually and jointly control any audit or
review process related thereto.
The funds in the escrow account (the "Escrow Funds") may be released from
the escrow account to pay Subject Taxes and as otherwise provided therein.
The Tax Refund Escrow Agreement provides generally that Kindred and the
Company waive their rights under the Tax Allocation Agreement to make claims
against each other with respect to Subject Taxes satisfied by the Escrow Funds,
notwithstanding the indemnification provisions of the Tax Allocation Agreement.
To the extent that the Escrow Funds are insufficient to satisfy all liabilities
for Subject Taxes that are finally determined to be due (such excess amount,
"Excess Taxes"), the relative liability of Kindred and the Company to pay such
Excess Taxes shall be determined as provided in the Tax Refund Escrow Agreement.
Disputes under the Tax Refund Escrow Agreement, and the determination of the
relative liability of Kindred and the Company to pay Excess Taxes, if any, are
governed by the arbitration provision of the Tax Allocation Agreement.
Interest earned on the Escrow Funds or included in refund amounts received
from governmental authorities will be distributed equally to each of Kindred and
the Company on an annual basis. Any Escrow Funds remaining in the escrow account
after no further claims may be made by governmental authorities with respect to
Subject Taxes or Subject Refunds (because of the expiration of statutes of
limitation or otherwise) will be distributed equally to Kindred and the Company.
One half (1/2) of the balance of the Escrow Funds as of June 30, 2001 is
reported as restricted cash on the Company's balance sheet. Due to the
uncertainty concerning the Company's ability to ultimately recognize any portion
of the Subject Refunds, a corresponding liability has been recorded as of June
30, 2001.
Agreement of Indemnity--Third Party Leases
In connection with the 1998 Spin Off, the Company assigned its former third
party lease obligations (i.e., leases under which an unrelated third party is
the landlord) as a tenant or as a guarantor of tenant obligations to Kindred
(the "Third Party Leases"). The lessors of these properties may claim that the
Company remains liable on the Third Party Leases assigned to Kindred. Under the
terms of the Agreement of Indemnity--Third Party Leases, Kindred and its
subsidiaries have agreed to indemnify and hold the Company harmless from and
against all claims against the Company arising out of the Third Party Leases
assigned by the Company to Kindred. Either prior to or following the 1998 Spin
Off, the tenant's rights under a subset of the Third Party Leases were assigned
or sublet to unrelated third parties (the "Subleased Third Party Leases"). If
Kindred or such third party subtenants are unable to or do not satisfy the
obligations under any Third Party Lease assigned by the Company to Kindred, and
if the lessors prevail
14
VENTAS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
in a claim against the Company under the Third Party Leases, then the Company
may be liable for the payment and performance of the obligations under any such
Third Party Lease. The Company believes it may have valid legal defenses to any
such claim by certain lessors under the Third Party Leases. However, there can
be no assurance the Company would prevail in a claim brought by a lessor under a
Third Party Lease. In the event that a lessor should prevail in a claim against
the Company, the Company may be entitled to receive revenues from those
properties that would mitigate the costs incurred in connection with the
satisfaction of such obligations. Under the Final Plan, Kindred assumed and has
agreed to fulfill its obligations under the Agreement of Indemnity--Third Party
Leases, and, except for certain disputes with one lessor, has to date performed
its obligations under the Agreement of Indemnity--Third Party Leases. There can
be no assurance that Kindred will have sufficient assets, income and access to
financing to enable it to satisfy its obligations under the Agreement of
Indemnity--Third Party Leases or that Kindred will continue to honor its
obligations under the Agreement of Indemnity--Third Party Leases. If Kindred
does not satisfy or otherwise honor the obligations under the Agreement of
Indemnity--Third Party Leases, then the Company may be liable for the payment
and performance of such obligations, subject to the Company's assertion of
available defenses. If Kindred is unable to or chooses not to satisfy its
obligations under the Agreement of Indemnity--Third Party Leases, such action
could have a Material Adverse Effect on the Company. Under the Final Plan,
Kindred has agreed not to renew or extend any Third Party Lease unless it first
obtains a release of the Company from liability under such Third Party Lease.
Since December 31, 2000, total future minimum rental payments due under the
Third Party Leases declined $10.6 million from the expiration of Third Party
Leases in accordance with their terms and $17.0 million due to the early
termination and release of one of the Third Party Leases.
Agreement of Indemnity--Third Party Contracts
In connection with the 1998 Spin Off, the Company assigned its former third
party guaranty agreements to Kindred (the "Third Party Guarantees"). The
Company may remain liable on the Third Party Guarantees assigned to Kindred.
Under the terms of the Agreement of Indemnity--Third Party Contracts, Kindred
and its subsidiaries have agreed to indemnify and hold the Company harmless from
and against all claims against the Company arising out of the Third Party
Guarantees assigned by the Company to Kindred. If Kindred is unable to or does
not satisfy the obligations under any Third Party Guarantee assigned by the
Company to Kindred, then the Company may be liable for the payment and
performance of the obligations under any such agreement.
The Third Party Guarantees were entered into in connection with certain
acquisitions and financing transactions. Under the Final Plan, Kindred assumed
and has agreed to fulfill its obligations under the Agreement of Indemnity--
Third Party Contracts. There can be no assurance that Kindred will have
sufficient assets, income and access to financing to enable it to satisfy its
obligations incurred in connection with the Agreement of Indemnity--Third Party
Contracts or that Kindred will continue to honor its obligations under the
Agreement of Indemnity--Third Party Contracts. If Kindred does not satisfy or
otherwise honor the obligations under the Agreement of Indemnity--Third Party
Contracts, then the Company may be liable for the payment and performance of
such obligations. If Kindred is unable to or chooses not to satisfy its
obligations under the Agreement of Indemnity--Third Party Contracts, such action
could have a Material Adverse Effect on the Company.
Assumption of Certain Operating Liabilities and Litigation
In connection with the 1998 Spin Off, Kindred agreed in various Spin
Agreements to assume and to indemnify the Company for any and all liabilities
that may arise out of the ownership or operation of the health care operations
either before or after the date of the 1998 Spin Off. The indemnification
provided by Kindred also covers losses, including costs and expenses, which may
arise from any future claims asserted against the Company based on these health
care operations. In addition, at the time of the 1998 Spin Off, Kindred agreed
to assume the defense, on
15
VENTAS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
behalf of the Company, of any claims that were pending at the time of the 1998
Spin Off, and which arose out of the ownership or operation of the health care
operations. Kindred also agreed to defend, on behalf of the Company, any claims
asserted after the 1998 Spin Off which arise out of the ownership and operation
of the health care operations. Under the Final Plan, Kindred assumed and agreed
to perform its obligations under these indemnifications; however, such
indemnification obligation does not extend to the Company's obligation under the
United States Settlement described below. There can be no assurance that Kindred
will have sufficient assets, income and access to financing to enable it to
satisfy its obligations incurred in connection with the 1998 Spin Off or that
Kindred will continue to honor its obligations incurred in connection with the
1998 Spin Off. If Kindred does not satisfy or otherwise honor the obligations
under these arrangements, then the Company may be liable for the payment and
performance of such obligations and may have to assume the defense of such
claims. If Kindred is unable to or chooses not to satisfy its obligations
incurred in connection with the 1998 Spin Off, such action could have a Material
Adverse Effect on the Company.
Registration Rights Agreement
Under the terms of the Final Plan, 1,498,500 shares of New Kindred Common
Stock were distributed to Ventas Realty on the Kindred Effective Date. On the
Kindred Effective Date, Kindred executed and delivered to Ventas Realty, certain
other initial holders of New Kindred Common Stock and other signatories, a
registration rights agreement (the "Registration Rights Agreement"), which,
among other things, requires Kindred to (a) file a shelf registration statement
with respect to the securities subject thereto, including the New Kindred Common
Stock as soon as practicable after the Kindred Effective Date, but in no event
later than 120 days following the Kindred Effective Date provided that, subject
to certain limitations, such period may be extended if the audited financial
statements of Kindred which are to be included in such registration statement
are not available for reasons beyond Kindred's reasonable control and (b) use
its reasonable best efforts to cause such registration statement to be declared
effective as soon as practicable and to keep such registration statement
continuously effective for a period of two years with respect to such securities
(subject to customary exceptions and suspension periods). Under the Registration
Rights Agreement, Ventas Realty is entitled to exercise certain demand and
"piggyback" registration rights with respect to the New Kindred Common Stock,
subject to customary exceptions and black-out and suspension periods. In
addition, until such time as the New Kindred Common Stock is listed on a
national securities exchange, Kindred has agreed to comply with certain of the
corporate governance requirements in the rules of the National Association of
Securities Dealers, Inc. as if it were subject to such rules. In the event
Kindred fails to comply with its obligations under the Registration Rights
Agreement, the other parties to the Registration Rights Agreement are entitled
to seek specific performance in addition to other remedies that might be
available.
Terminated Agreements
The Participation Agreement and the Development Agreement, both executed in
connection with the 1998 Spin Off, were terminated on the Kindred Effective
Date. The Company and Kindred are deemed to have waived any and all damages,
claims, liabilities, obligations, and causes of action related to or arising out
of these agreements. The Second Standstill Agreement and the Tolling Agreement,
both entered into by the Company and Kindred in April 1999, and the Tax
Stipulation and the Rent Stipulation were all terminated on the Kindred
Effective Date and are of no further force or effect.
Settlement of United States Claims
Kindred and the Company were the subject of investigations by the United
States Department of Justice into various aspects of claims for reimbursement
from government payers, billing practices and various quality of care issues in
the hospitals and nursing facilities formerly operated by the Company and
presently operated by Kindred. These investigations covered the Company's former
health care operations prior to the date of the 1998 Spin Off,
16
VENTAS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
and included matters arising from lawsuits filed under the qui tam, or
whistleblower, provision of the Federal Civil False Claims Act, which allows
private citizens to bring a suit in the name of the United States. See "Note
5--Litigation". The United States Department of Justice, Civil Division filed
two proofs of claim in the Bankruptcy Court covering the United States' claims
and the qui tam suits. The United States asserted claims of approximately $1.3
billion, including treble damages, against Kindred in these proofs of claim.
The Final Plan contains a comprehensive settlement of all of the foregoing
United States claims (the "United States Settlement"). The provisions of the
United States Settlement are documented in the Final Plan.
Under the United States Settlement, the Company will pay $103.6 million to the
United States, of which $34.0 million was paid on the Kindred Effective Date.
The balance of $69.6 million bears interest at 6% per annum and is payable in
equal quarterly installments over a five-year term commencing on June 30, 2001
and ending in 2006. The Company made the first quarterly installment under the
United States Settlement on June 29, 2001. Kindred will pay the United States a
total of $25.9 million, $10.0 million of which was to be paid on the Kindred
Effective Date and the balance (with interest at 6% per annum) of which is to be
paid during the first two quarters following the Kindred Effective Date. The
Company paid approximately $0.4 million to legal counsel for the relators in the
qui tam actions. In the fourth quarter of 2000, the Company recorded the full
amount of the obligation under the United States Settlement for $96.5 million
based on an imputed interest rate of 10.75%.
If the Company fails to make any payment under the United States Settlement
within five business days of receipt of written notice from the United States,
then the United States may, in its discretion, by written notice to the Company,
declare all unpaid principal and accrued and unpaid interest payable by the
Company under the United States Settlement to be immediately due and payable.
Under the United States Settlement, the Company agreed with the United States,
that if, from and after the Kindred Effective Date either:
(a) the loans under the Company's Amended Credit Agreement (the "Ventas
Senior Bank Debt") are amended and, as a result of such amendment, (i) the
final maturity date of the Ventas Senior Bank Debt is scheduled to occur prior
to the final maturity date of the payments due from the Company under the
United States Settlement, or (ii) less than $100.0 million of the outstanding
principal under the Ventas Senior Bank Debt is scheduled to be paid after the
final maturity date of the obligations due from the Company under the United
States Settlement, or
(b) the Ventas Senior Bank Debt is replaced in whole by new debt (the
"Refinancing Debt"), and (i) the final maturity date of the Refinancing Debt
is scheduled to occur prior to the final maturity date of the payments due
from the Company under the United States Settlement, or (ii) less than $100.0
million of the outstanding principal of the Refinancing Debt is scheduled to
be paid after the final maturity date of the obligations due from the Company
under the United States Settlement,
then in either case, the final maturity date of the obligations payable by the
Company under the United States Settlement and the remaining payments thereunder
shall be proportionately and equitably adjusted in time and amount so that the
final maturity date and the scheduled principal payments of the Ventas Senior
Bank Debt or the Refinancing Debt, as the case may be, and the remaining
obligations of the Company under the United States Settlement shall have the
same proportionate relationship as before such amendment or replacement, and in
any such event, at least $100.0 million of the outstanding principal balance of
the Ventas Senior Bank Debt or the Refinancing Debt, as applicable, is required
to be scheduled to be paid after the due date of the final payment under the
United States Settlement.
17
VENTAS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
The United States Settlement provides that if the Company shall fail to make
any payment required to be paid by the Company under the United States
Settlement as and when due, then, during the period commencing on the due date
of the delinquent payment and continuing to and until such time as the
delinquent payment shall be paid to the United States (such period being
referred to as a "Delinquency Period"), the Company shall suspend the payment
of dividends on account of shares of any class of stock of the Company,
provided, however, during any Delinquency Period, the Company may declare and
pay an amount equal to the minimum REIT dividend for the applicable taxable year
(or the unpaid portion of the minimum REIT dividend for the applicable taxable
year) as necessary for the Company to maintain its status as a REIT under the
Code for the applicable tax year.
The United States Settlement provides that the Company is not responsible in
any manner for the payments owed by Kindred under the United States Settlement,
and any failure of Kindred to make such payments shall not affect the Company's
rights, duties, benefits, and/or obligations under the United States Settlement.
Recent Developments Regarding Income Taxes
The Internal Revenue Service is currently reviewing the federal income tax
returns of the Company for tax years ended December 31, 1997 and 1998. There
can be no assurances as to the ultimate outcome of these matters or whether such
outcome will have a Material Adverse Effect on the Company. However, the
resulting tax liabilities, if any, for the tax years ended December 31, 1997 and
1998 will be satisfied first from net operating loss ("NOL") carryforwards
(including the NOL carryforwards that were utilized to offset the Company's
federal income tax liability for 1999 and 2000), and if the tax liabilities
exceed the amount of NOL carryforwards, then from the escrowed amounts under the
Tax Refund Escrow Agreement. To the extent the NOL carryforwards and the
escrowed amounts under the Tax Refund Escrow Agreement are not sufficient to
satisfy such liabilities, Kindred has indemnified the Company for certain but
not all of these tax liabilities under the Tax Allocation Agreement. There can
be no assurances that the NOL carryforwards and the escrowed amounts under the
Tax Refund Escrow Agreement will be sufficient to satisfy these liabilities or
that Kindred has any obligation to indemnify the Company for particular
liabilities or that Kindred will have sufficient assets, income and access to
financing to enable it to satisfy its indemnity obligations under the Tax
Allocation Agreement or that Kindred will continue to honor its indemnification
obligations.
As a result of the uncertainties relating to the Company's ability to retain
its NOL's, the Company has recorded a charge for taxes on the 10% of its
estimated 2001 taxable income which the Company does not expect to distribute as
a dividend.
Recent Developments Regarding Dividends
The Company filed its federal income tax return for the tax year ended
December 31, 1999 (the "1999 Tax Year") on September 14, 2000 electing to
qualify as a REIT for the 1999 Tax Year. The Company believes that it met the
annual distribution requirement of payment of 95% of its 1999 taxable income as
a result of its $0.39 per share dividend paid in February 1999 and its $0.62 per
share dividend paid in September 2000. The Company believes it has met the REIT
annual distribution requirement of payment of 95% of its estimated 2000 taxable
income as a result of its payment of a $0.29 per share dividend on January 15,
2001. The Company intends to continue to qualify as a REIT for the tax year
ending December 31, 2001 (the "2001 Tax Year") and subsequent tax years. Such
qualification requires the Company to declare a distribution of 90% of its
taxable income for any given tax year not later than September 15 of the year
following the end of the tax year in respect of which the dividend is to be paid
(i.e., September 15, 2002 for the 2001 Tax Year) and pay such dividend not later
than December 31 of that same year (i.e., December 31, 2002 for the 2001 Tax
Year), or, if earlier, prior to the payment of the first regular dividend for
the then current year. While such distributions are not required to be made
quarterly, if they are not made by January 31 of the year following the end of
the tax year in respect of which the dividend is to be paid (i.e., January 31,
2002 for the 2001 Tax Year), the Company is required to pay a 4% non-deductible
excise tax on the
18
VENTAS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
difference between 85% of its taxable net income for the year in respect of
which the dividend is to be paid and the aggregate amount of dividends paid for
that tax year on or prior to January 31 of the year following the year in
respect of which the dividend is to be paid.
Consistent with its stated intention to begin paying quarterly dividends, on
April 20, 2001, the Company declared the first quarterly dividend for 2001 of
$0.22 per share. The dividend was paid in cash on May 14, 2001 to stockholders
of record as of May 2, 2001. On July 3, 2001, the Company declared the second
quarterly dividend for 2001 of $0.22 a share. The second quarterly dividend for
2001 was paid on July 23, 2001 to shareholders of record on July 13, 2001. The
first and second quarterly dividends for 2001 represent a portion of 90% of the
Company's estimated annual net taxable income for 2001. Although the Company
currently intends to distribute 90% of its taxable income for the 2001 Tax Year,
there can be no assurance that it will do so or when such distribution will be
made. The Company's dividend for the 2001 Tax Year may be satisfied by a
distribution of a combination of cash and property or securities, including the
New Kindred Common Stock received by the Company on the Kindred Effective Date.
In estimating its 2001 taxable net income and the related dividends, the
Company previously assumed a value of $20.0 million for the New Kindred Common
Stock received by the Company on the Kindred Effective Date. Based on
applicable laws, regulations, advice from experts, an appraisal, the trading
performance of the equity and other appropriate facts and circumstances
including the equity's illiquidity and lack of registration when received and
the Company's lack of significant influence over Kindred, the Company has
determined that the value of the New Kindred Common Stock was $18.2 million on
the date received. One hundred percent of the value of the New Kindred Common
Stock will be included in the Company's 2001 taxable income. For financial
reporting purposes, the value of the Company's New Kindred Common Stock is being
amortized as future rent over the weighted average remaining term of the Amended
Master Leases.
The Company is accounting for the New Kindred Common Stock under the cost
method of accounting. Under the cost method of accounting, income and dividends
are recognized when received.
The Company's estimation of its 2001 taxable income and the related quarterly
dividends is based on a number of assumptions, including, but not limited to,
the following: Kindred performs its obligations under the Amended Master Leases
and the Spin Agreements; no capital transactions occur; the Company's tax
positions do not change; the Company does not incur any impact from new
accounting rule FASB 133 relating to derivatives; interest rates remain
constant; the Company pays 90% of its taxable net income as a dividend for 2001
and pays federal income tax on the remaining 10% of its taxable net income; and
the Company's issued and outstanding shares are unchanged.
It is important to note for purposes of the required REIT distributions that
the Company's taxable income may vary significantly from historical results and
from current income determined in accordance with accounting principles
generally accepted in the United States depending on the resolution of a variety
of factors. Under certain circumstances, the Company may be required to make
distributions in excess of funds from operations ("FFO") (as defined by the
National Association of Real Estate Investment Trusts) in order to meet such
distribution requirements. In the event that timing differences or cash needs
occur, the Company may find it necessary to borrow funds or to issue equity
securities (there being no assurance that it will be able to do so) or, if
possible, to pay taxable stock dividends, distribute other property or
securities or engage in a transaction intended to enable it to meet the REIT
distribution requirements. The Company's ability to engage in certain of these
transactions is restricted by the terms of the Amended Credit Agreement. Any
such transaction would likely require the consent of the "Required Lenders"
under the Amended Credit Agreement, and there can be no assurance that such
consent would be obtained. In addition, the failure of Kindred to make rental
payments under the Amended Master Leases
19
VENTAS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
would impair materially the ability of the Company to make distributions.
Consequently, there can be no assurance that the Company will be able to make
distributions at the required distribution rate or any other rate.
Although the Company intends to continue to qualify as a REIT for the 2001 Tax
Year and subsequent tax years, it is possible that economic, market, legal, tax
or other considerations may cause the Company to fail or elect not to continue
to qualify as a REIT in any such tax year. If the Company were to fail or elect
not to continue to qualify as a REIT in any such tax year, the Company would be
subject to 35% federal income tax and to the applicable state and local income
taxes for the affected years. Such tax obligations would have a Material Adverse
Effect on the Company. Unless eligible for limited relief, if the Company
failed, or revoked its election, to qualify as a REIT, the Company would not be
eligible to elect again to be treated as a REIT before the fifth taxable year
after the year of such termination or revocation.
Other Recent Developments
Third Party Leases
On July 10, 2001, Lenox Healthcare, Inc. and certain of its subsidiaries
(collectively, "Lenox") filed a voluntary petition under chapter 11 of the
Bankruptcy Code. Lenox is a third party subtenant under certain of the Subleased
Third Party Leases. In its filings, Lenox disclosed that it intends to seek the
orderly liquidation of its assets. Lenox's chapter 11 filing followed its
emergence from chapter 11 on December 27, 2000. If Kindred fails or is unable
to satisfy the obligations under the Third Party Leases assigned by the Company
to Kindred, including those Third Party Leases sublet or assigned to Lenox, and
if the lessors prevail in a claim against the Company under the applicable Third
Party Leases, the Company may be liable for the payment and performance of the
obligations under such Third Party Leases. In that event, the Company may be
entitled to receive revenues from those properties that would mitigate the costs
incurred in connection with the satisfaction of such obligations. There can be
no assurance that Kindred will continue to pay, indemnify and defend the claims
or have sufficient assets, income and access to financing to enable it to
satisfy such claims.
The Company received demands for payment from Health Care Property Investors
("HCPI") by letters dated October 19, 1999, February 4, 2000, March 7, 2000,
April 19, 2000 and July 7, 2000 for obligations alleged to be due under certain
Third Party Leases. In accordance with the terms of the Spin Agreements, the
Company issued written demands to Kindred for payment, performance,
indemnification and defense of the claims, obligations and allegations asserted
by HCPI. There can be no assurance that Kindred will pay, indemnify and defend
these claims or that Kindred will have sufficient assets, income and access to
financing to enable it to satisfy such claims. The Company has been advised by
Kindred that all of the foregoing obligations have either been satisfied by
Kindred or otherwise resolved.
Third Party Tenants
Integrated Health Services, Inc. ("IHS") and a number of its subsidiaries
filed a petition for relief under the Bankruptcy Code in February 2000 (the
"IHS Petition Date"). IHS Acquisition No. 151, Inc. ("IHS Acquisition"), an
affiliate debtor of IHS, leases a nursing facility from the Company in Marne,
Michigan known as Birchwood Care Center. The aggregate annual rental under the
lease is approximately $0.5 million. In June 2001, IHS Acquisition removed all
of the patients from the facility and closed it in violation of the terms of the
lease. While IHS remains in bankruptcy, the automatic stay provisions of the
Bankruptcy Code prevent the Company from exercising certain of its contractual
rights under the Birchwood lease, including the right to enforce the payment of
past due pre-petition rent. IHS Acquisition filed a motion in the bankruptcy
proceeding to reject the lease with the Company. The hearing on the motion as it
relates to this lease was postponed and has been rescheduled for August 14,
2001. To date, the Company has not located a substitute tenant for the nursing
facility. If the Bankruptcy Court approves the IHS motion to reject the lease
and the Company does not locate a substitute tenant for the facility on
20
VENTAS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
terms that are acceptable to the Company, the Company may elect to sell the
facility or take certain other action relative to the facility. There can be no
assurance that the Company will locate a satisfactory substitute tenant for the
facility on terms acceptable to the Company. The Company's ability to engage in
certain of these transactions is restricted by the terms of the Amended Credit
Agreement. Any such transaction would likely require the consent of the
"Required Lenders" under the Amended Credit Agreement, and there can be no
assurance that such consent would be obtained. On or about August 25, 2000, the
Company filed a general claim (as amended on or about August 28, 2000) against
IHS in the bankruptcy proceeding for, among other things, the fees, costs,
expenses and damages resulting from any rejection of the Company's lease.
Applicable bankruptcy law may limit the amount of any such recovery against IHS.
There can be no assurance the Company will prevail in the claim against IHS or
that IHS will have sufficient assets to satisfy such claim. The Company recorded
a $1.9 million real estate impairment for Birchwood Care Center for the year
ended December 31, 1999.
NOTE 4--BANK CREDIT FACILITY
On January 31, 2000, the Company and the lenders under its then existing
credit agreement (the "Bank Credit Agreement") entered into the Amended Credit
Agreement, which amended and restated the Bank Credit Agreement. Under the
Amended Credit Agreement, borrowings bear interest at an applicable margin over
an interest rate selected by the Company. Such interest rate may be either (a)
the Base Rate, which is the greater of (i) the prime rate or (ii) the federal
funds rate plus 50 basis points, or (b) LIBOR. Borrowings under the Amended
Credit Agreement comprised of: (1) a $25.0 million revolving credit line (the
"Revolving Credit Line") that expires on December 31, 2002, which bears interest
at either LIBOR plus 2.75% or the Base Rate plus 1.75%; (2) a $200.0 million
term loan due December 31, 2002 (the "Tranche A Loan"), which bears interest at
either LIBOR plus 2.75% or the Base Rate plus 1.75%; (3) a $300.0 million term
loan due December 31, 2005 (the "Tranche B Loan"), which bears interest at
either LIBOR plus 3.75% or the Base Rate plus 2.75%; and (4) a $473.4 million
term loan due December 31, 2007 (the "Tranche C Loan"), which bears interest at
either LIBOR plus 4.25% or the Base Rate plus 3.25%. The interest rate on the
Tranche B Loan will be reduced by .50% (50 basis points) once $150.0 million of
the Tranche B Loan has been repaid. As of June 30, 2001, the outstanding
principal balance of the Tranche A Loan was $97.5 million, the outstanding
principal balance of the Tranche B Loan was $279.6 million and the outstanding
principal balance of the Tranche C Loan was $473.4 million.
Under the terms of the Amended Credit Agreement, it was an Event of Default if
the Kindred Effective Date did not occur on or before December 31, 2000 (the
"Kindred Effective Date Deadline"). The Company and substantially all of its
lenders entered into an Amendment and Waiver dated as of December 20, 2000 (the
"Amendment and Waiver") to the Amended Credit Agreement that extended the
Kindred Effective Date Deadline was extended from December 31, 2000 to March 31,
2001. In consideration for this extension, the Company paid a fee of $0.2
million to the lenders executing the Amendment and Waiver and agreed to amend
the amortization schedules on certain of the loans under the Amended Credit
Agreement. The Company exercised its option under the Amendment and Waiver to
extend the Kindred Effective Date Deadline from March 31, 2001 to April 30,
2001. In consideration of this extension, the Company paid a fee of
approximately $0.1 million to the lenders that executed the Amendment and
Waiver. The Kindred Effective Date occurred on April 20, 2001.
The Amended Credit Agreement, as revised by the Amendment and Waiver, provides
for the following amortization schedule: (a) with respect to the Tranche A Loan,
(i) $50.0 million was paid at closing on January 31, 2000, (ii) $35.0 million
was paid on December 20, 2000, (iii) $15.0 million was paid on March 30, 2001,
and (iv) thereafter, all Excess Cash Flow pursuant to a monthly sweep as more
fully described below (the "Monthly Sweep") is applied to the Tranche A Loan
until $200.0 million in total has been paid down on the Amended Credit
Agreement, with the remaining principal balance of the Tranche A Loan due
December 31, 2002; (b) with respect to the Tranche B Loan, (i) $20.0 million was
paid on March 30, 2001, (ii) a one-time paydown of Excess Cash of $0.4 million
was paid on May 21, 2001, as more fully described below (the "B Sweep"), (iii)
$30.0 million is scheduled to be paid on December 30, 2003 and $50.0 million is
scheduled to be paid on December 30, 2004 and (iv) the
21
VENTAS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
remaining principal balance is due December 31, 2005; and (c) with respect to
the Tranche C Loan, there are no scheduled paydowns of principal and the final
maturity of December 31, 2007. The facilities under the Amended Credit Agreement
are pre-payable without premium or penalty.
The Company paid the B Sweep on May 21, 2001 in the amount of $0.4 million.
The B Sweep was a one-time payment equal to the Company's cash and cash
equivalents on hand on May 21, 2001 minus the sum of (to the extent not yet
paid) (i) amounts payable under the United States Settlement during the
succeeding three months, (ii) a reasonable reserve to pay the applicable portion
of the Company's minimum REIT dividend for the tax year ended December 31, 2000
and for quarters in 2001 prior to and including the Kindred Effective Date,
(iii) $1.0 million and (iv) other specified amounts.
The first Monthly Sweep was scheduled to be made on July 31, 2001 and covered
the period from May 21, 2001 through June 30, 2001. The Company was not
required to pay any amounts under the first Monthly Sweep. Future Monthly Sweeps
will be made on the last business day of each month for the preceding month. The
Monthly Sweep will be in an amount equal to the Company's total cash receipts
for the applicable period, minus the sum of (i) cash disbursements by the
Company during the applicable period, (ii) up to $1.0 million for a working
capital reserve, (iii) a reserve in an amount equal to the unpaid minimum REIT
dividend for all prior periods and for the current calendar quarter, (iv) the
obligations due under the United States Settlement during the next three months,
(v) taxes and (vi) other specified amounts. The obligation of the Company to
make Monthly Sweeps terminates once $200 million in principal amount has been
paid down or refinanced under the Amended Credit Agreement. As of June 30,
2001, $123.6 million of principal has been paid down under the Amended Credit
Agreement.
The following is a summary of long-term borrowings at June 30, 2001 and
December 31, 2000 (in thousands):
June 30, December 31,
-------- ------------
2001 2000
---- ----
Tranche A Loan, bearing interest at a rate of LIBOR plus 2.75%
(7.60% at June 30, 2001, 9.48% at December 31, 2000),
due December 31, 2002............................................... $ 97,480 $113,017
Tranche B Loan, bearing interest at a rate of LIBOR plus 3.75%
(8.60% at June 30, 2001, 10.48% at December 31, 2000),
due December 31, 2005.............................................. 279,572 300,000
Tranche C Loan, bearing interest at a rate of LIBOR plus 4.25%
(9.10% at June 30, 2001, 10.98% at December 31, 2000),
due December 31, 2007.............................................. 473,368 473,368
-------- --------
$850,420 $886,385
======== ========
During the first quarter of 2000, the Company incurred an extraordinary loss
of approximately $4.2 million relating to the write-off of the unamortized
deferred financing costs associated with the Bank Credit Agreement.
The Amended Credit Agreement is secured by liens on substantially all of the
Company's real property and any related leases, rents and personal property. In
addition, the Amended Credit Agreement contains certain restrictive covenants,
including, but not limited to, the following: (a) until such time that $200.0
million in principal amount has been paid down or refinanced, the Company can
pay REIT dividends based on a certain minimum percentage of its taxable income
(equal to 90% of its taxable income for years ending on or after December 31,
2001); however, after $200.0 million in total principal paydowns, the Company
will be allowed to pay dividends for any year in amounts up to 80% of FFO, as
defined in the Amended Credit Agreement (as of June 30, 2001, $123.6 million of
principal has been paid down under the Amended Credit Agreement); (b)
limitations on additional indebtedness, acquisitions of assets, liens,
guarantees, investments, restricted payments, leases and affiliate transactions;
(c) limitations on capital expenditures; and (d) certain financial covenants,
including those requiring the Company to
22
VENTAS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
have (i) Consolidated EBITDA (as defined in the Amended Credit Agreement) on the
last day of each fiscal quarter after the Kindred Effective Date at least equal
to 80% of the Company's Projected Consolidated EBITDA (as defined in the Amended
Credit Agreement) on the Kindred Effective Date; and (ii) a ratio of
Consolidated EBITDA to Consolidated Interest Expense (as defined in the Amended
Credit Agreement) on a trailing four quarter basis (or such shorter period from
May 1, 2001 through the end of the reported quarter), of at least 1.20 to 1.00.
Certain of these covenants may be waived by holders of 51% or more of the
principal indebtedness under the Amended Credit Agreement.
Derivatives and Hedging
- -----------------------
In the normal course of business, the Company is exposed to the effect of
interest rate changes. The Company limits these risks by following established
risk management policies and procedures including the use of derivatives. For
interest rate exposures, derivatives are used primarily to fix the rate on debt
based on floating-rate indices and manage the cost of borrowing obligations.
The Company currently uses an interest rate swap derivative product that manages
interest rate risk. The Company prohibits the use of derivative instruments for
trading or speculative purposes. Further, the Company has a policy of only
entering into contracts with major financial institutions based upon their
credit ratings and other factors. When viewed in conjunction with the
underlying and offsetting exposure that the derivative is designed to hedge, the
Company has not sustained a material loss from those instruments nor does it
anticipate any Material Adverse Effect on its net income or financial position
in the future from the use of derivatives.
The Company has an interest rate swap agreement with a notional principal
amount of $850.0 million, under which the Company pays a fixed rate at 5.985%
and receives LIBOR (floating rate). The terms of the interest rate swap
agreement require that the Company make a cash deposit or otherwise post
collateral to the counterparty if the fair value loss to the Company exceeds
certain levels. The threshold levels vary based on the relationship between the
Company's debt obligations and the tangible fair value of its assets as defined
in the Bank Credit Agreement. As of June 30, 2001, no collateral was required
to be posted under the interest rate swap agreement.
As of June 30, 2001, the Company's interest rate swap agreement had a notional
value of $850 million maturing June 30, 2003. On June 30, 2001, the derivative
instrument was reported at fair value in liabilities in the Condensed
Consolidated Balance Sheet of $20.1 million. The offsetting adjustment is
reported as a deferred loss in Accumulated Other Comprehensive Income.
The Company's interest rate swap is treated as a cash flow hedge. Cash flow
hedges address the risk associated with future cash flows of debt transactions.
Over time, the unrealized gains and losses held in Accumulated Other
Comprehensive Income will be reclassified into earnings in the same periods in
which the hedged interest payments affect earnings. Assuming no changes in
interest rates, the Company estimates that approximately $10.1 million of the
current balance held in Accumulated Other Comprehensive Income will be recorded
as interest expense within the next twelve months consistent with historical
reporting. The amount reclassified into interest expense for the three months
ended and six months ended June 30, 2001 was $2.3 million and $1.4 million,
respectively. See Note 2 "Basis of Presentation--Change in Accounting
Principle".
On August 4, 1999, the Company entered into an agreement with the interest
rate swap agreement counterparty to shorten the maturity of the interest rate
swap agreement from December 31, 2007 to June 30, 2003, in exchange for a
payment in 1999 from the counterparty to the Company of $21.6 million. So long
as the Company has debt in excess of $750.0 million, the Company will amortize
the $21.6 million payment for financial accounting purposes in future periods
beginning in July 2003 and ending December 2007.
On January 31, 2000, the Company entered into a letter agreement with the
counterparty to the swap agreement for the purpose of amending the swap
agreement. The letter agreement provides that, for purposes of certain
23
VENTAS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
calculations set forth in the swap agreement, the parties agree to continue to
use certain defined terms set forth in the Bank Credit Agreement.
NOTE 5--Litigation
Legal Proceedings Presently Defended and Indemnified by Kindred Under the Spin
- ------------------------------------------------------------------------------
Agreements
- ----------
The following litigation and other matters arose from the Company's operations
prior to the 1998 Spin Off or relate to assets or liabilities transferred to
Kindred in connection with the 1998 Spin Off. Under the Spin Agreements, Kindred
agreed to assume the defense, on behalf of the Company, of any claims that (a)
were pending at the time of the 1998 Spin Off and which arose out of the
ownership or operation of the health care operations or any of the assets or
liabilities transferred to Kindred in connection with the 1998 Spin Off, or (b)
were asserted after the 1998 Spin Off and which arose out of the ownership and
operation of the health care operations or any of the assets or liabilities
transferred to Kindred in connection with the 1998 Spin Off, and to indemnify
the Company for any fees, costs, expenses and liabilities arising out of such
operations (the "Indemnification"). Kindred is presently defending the Company
in the following matters. Under the Final Plan, Kindred assumed and agreed to
abide by the Indemnification and to defend the Company in these and other
matters as required under the Spin Agreements. See "Note 3--Recent Developments
Regarding Kindred--Spin Agreements and Other Arrangements Under the Final Plan--
Assumption of Certain Operating Liabilities and Litigation." However, there can
be no assurance that Kindred will continue to defend the Company in such matters
or that Kindred will have sufficient assets, income and access to financing to
enable it to satisfy such obligations or its obligations incurred in connection
with the 1998 Spin Off. If Kindred is unwilling or unable to abide by the
Indemnification, such action could have a Material Adverse Effect on the
Company. In addition, many of the following descriptions are based primarily on
information included in Kindred's public filings and information provided to the
Company by Kindred. There can be no assurance that Kindred has provided the
Company with complete and accurate information in all instances.
A class action lawsuit entitled A. Carl Helwig v. Vencor, Inc. et al. was
filed on December 24, 1997 in the United States District Court for the Western
District of Kentucky (Civil Action No. 3-97CV-8354). The putative class action
claims were brought by an alleged stockholder of the Company against the Company
and certain executive officers and directors of the Company. The complaint
alleges that the Company and certain current and former executive officers of
the Company during a specified time frame violated Sections 10(b) and 20(a) of
the Securities Exchange Act of 1934 (the "Exchange Act"), by, among other
things, issuing to the investing public a series of false and misleading
statements concerning the Company's current operations and the inherent value of
the Company's common stock. The complaint further alleges that as a result of
these purported false and misleading statements concerning the Company's
revenues and successful acquisitions, the price of the Company's common stock
was artificially inflated. In particular, the complaint alleges that the Company
issued false and misleading financial statements between February and October of
1997 which misrepresented and understated the impact that changes in Medicare
reimbursement policies would have on the Company's core services and
profitability. The complaint further alleges that the Company issued a series of
materially false statements concerning the purportedly successful integration of
its acquisitions and prospective earnings per share for 1997 and 1998 which the
Company knew lacked any reasonable basis and were not being achieved. The suit
seeks damages in an amount to be proven at trial, pre-judgment and post-judgment
interest, reasonable attorneys' fees, expert witness fees and other costs, and
any extraordinary equitable and/or injunctive relief permitted by law or equity
to assure that the plaintiff has an effective remedy. In January 1999, prior to
a trial on the merits, the United States District Court for the Western District
of Kentucky entered a judgment dismissing the action in its entirety as to all
defendants in the case. A divided three-judge panel of the United States Court
of Appeals for the Sixth Circuit affirmed the dismissal in an opinion dated
April 24, 2000. On May 31, 2001, the Sixth Circuit, in a 7-6 en banc decision,
reversed the dismissal of the complaint and remanded the action to the District
Court for further proceedings. Kindred has advised the Company that Kindred and
the Company's insurer intend to appeal the decision by the Sixth Circuit by
applying for
24
VENTAS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
a writ of certiorari to the United States Supreme Court. Kindred, on behalf of
the Company, is defending this action vigorously.
A class action lawsuit entitled Sally Pratt, et al. v. Ventas, Inc. et al. was
filed on May 25, 2001 in the United States District Court for the Western
District of Kentucky (Civil Action No. 3-01CV-317-H). The putative class action
complaint alleges that the Company and certain current and former officers and
employees of the Company engaged in a fraudulent scheme to conceal the true
nature and substance of the 1998 Spin Off resulting in (a) a violation of the
Racketeer Influenced and Corrupt Organizations Act, (b) bankruptcy fraud, (c)
common law fraud, and (d) a deprivation of plaintiffs' civil rights. The
plaintiffs allege that the defendants failed to act affirmatively to explain and
disclose the fact that the Company was the entity that had been known as Vencor,
Inc. prior to the 1998 Spin Off and that a new separate and distinct legal
entity assumed the name of Vencor, Inc. after the 1998 Spin Off. The plaintiffs
contend that the defendants filed misleading documents in the plaintiffs' state
court lawsuits that were pending at the time of the 1998 Spin Off and that the
defendants deceptively used the bankruptcy proceedings of Vencor, Inc. (now
known as Kindred Healthcare, Inc.) to stay lawsuits against the Company. As a
result of these actions, the plaintiffs maintain that they and similarly
situated individuals suffered and will continue to suffer severe financial harm.
The suit seeks compensatory damages (trebled with interest), actual and punitive
damages, reasonable attorneys' fees, costs and expenses, declaratory and
injunctive and any and all other relief to which the plaintiffs may be entitled.
A motion to dismiss was filed in this action on behalf of all defendants on July
24, 2001. Kindred, on behalf of the Company, is defending this action
vigorously.
Kindred and the Company were informed by the Department of Justice that they
were the subject of ongoing investigations into various aspects of claims for
reimbursement from government payers, billing practices and various quality of
care issues in the hospitals and nursing facilities formerly operated by the
Company and presently operated by Kindred. These investigations cover the
Company's former health care operations prior to the date of the 1998 Spin Off,
and include matters arising out of the qui tam actions described below and
additional potential claims. Certain of the complaints described below name
other defendants in addition to the Company.
Under the United States Settlement, documented in the Final Plan, the United
States released the Company from claims which were being investigated by the
United States, including the claims alleged in the qui tam actions described
below (See "Note 3--Recent Developments Regarding Kindred--Settlement of United
States Claims"). In accordance with the United States Settlement, the three qui
tam actions described in subparagraphs (a), (d) and (g) below have been
dismissed with prejudice as to the United States and the relators. Also in
accordance with the United States Settlement, the qui tam actions described in
subparagraphs (b), (c), (e), (f), (i) and (j) have been dismissed (i) with
prejudice as to the relators for all claims except claims under 31 U.S.C. (S)
3730(h), (ii) with prejudice as to the United States for certain conduct alleged
in such qui tam actions which was investigated by the United States (the
"Covered Conduct"), and (iii) without prejudice as to the United States for
any claims other than for the Covered Conduct. Under the United States
Settlement, the United States has agreed to move to dismiss the qui tam action
described in subparagraph (h), such dismissal to be (i) with prejudice as to the
relators for all claims except claims under 31 U.S.C. (S) 3730(h), (ii) with
prejudice as to the United States for the Covered Conduct and (iii) without
prejudice as to the United States for any claims other than for the Covered
Conduct. The Company believes that the United States is the real party in
interest for all of the claims in the following qui tam actions and that the
United States has the requisite authority to dismiss these actions as to the
United States and the relators. One of the relators in the qui tam action
described in subsection (h) below has challenged the authority of the United
States to dismiss the claims in such qui tam action on behalf of the relator.
There can be no assurance as to the outcome of this challenge to the authority
of the United States to dismiss the claims.
(a) American X-Ray, Inc. ("AXR") was a subsidiary of the Company prior to
the 1998 Spin Off. The Company transferred all of its interest in AXR to
Kindred in the 1998 Spin Off. AXR is the defendant in a civil qui tam lawsuit
which was filed in the United States District Court for the Eastern District
of Arkansas and
25
VENTAS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
served on the Company on July 7, 1997. The lawsuit is styled United States ex
rel. Doe v. American X-Ray, Inc., No. LR-C-95-332 (E.D. Ark.). The United
States of America has intervened in the suit which was brought under the
Federal Civil False Claims Act. AXR provided portable X-ray services to
nursing facilities (including those operated by the Company at the time) and
other health care providers. The Company acquired an interest in AXR when The
Hillhaven Corporation ("Hillhaven") was merged into the Company in September
1995 and purchased the remaining interest in AXR in February 1996. The civil
lawsuit alleges that AXR submitted false claims to the Medicare and Medicaid
programs. The suit seeks damages in an amount of not less than $1,000,000,
treble damages and civil penalties. This action was dismissed with prejudice
as to AXR, the Company and Vencor, Inc. (now known as Kindred) on May 23,
2001.
In a related criminal investigation, the United States Attorney's Office
for the Eastern District of Arkansas indicted four former employees of AXR;
those individuals were convicted of various fraud related counts in January
1999. The Company received several grand jury subpoenas for documents and
witnesses which Kindred, on behalf of the Company, moved to quash. The United
States Attorney's Office has withdrawn the subpoenas, which rendered the
motion to quash moot.
(b) In United States ex rel. Danley v. Medisave Pharmacies, Inc., Hillhaven
Corp., and Vencor, Inc., Civil No. 3:00 CV-156-J (W.D. Ky.), transferred on
March 14, 2000 from the United States District Court for the District of
Nevada, Reno Division, filed on March 15, 1996, it is alleged that Medisave
Pharmacies, Inc. ("Medisave"), a former subsidiary of the Company and now a
subsidiary of Kindred, (1) charged the Medicare program for unit dose drugs
when bulk drugs were administered and charged skilled nursing facilities more
for the same drugs for Medicare patients than for non-Medicare patients; (2)
improperly claimed special dispensing fees that it was not entitled to under
Medicaid; and (3) recouped unused drugs from skilled nursing facilities and
returned these drugs to its stock without crediting Medicare or Medicaid, all
in violation of the Federal Civil False Claims Act. It also alleged that
Medisave had a policy of offering kickbacks such as free equipment to skilled
nursing facilities to secure and maintain their business. The complaint seeks
treble damages, other unspecified damages, civil penalties, attorney's fees
and other costs. This action was dismissed on May 25, 2001 (i) with prejudice
as to the relator (ii) with prejudice as to the United States for Covered
Conduct, and (iii) without prejudice as to the United States for any claims
other than Covered Conduct.
(c) In the lawsuits styled United States ex rel. Roberts v. Vencor, Inc. et
al., Civil Action No. 3:97CV-349-J (W.D. Ky.), filed on June 25, 1996,
consolidated with United States ex rel. Meharg, et al. v. Vencor, Inc., et
al., Civil Action No. 3:98SC-737-H (M.D. Fla.), filed on June 4, 1998, it is
alleged that the Company, Kindred and Vencare, among others, submitted and
conspired to submit false claims to the Medicare program in connection with
their purported provision of respiratory therapy services to skilled nursing
facility residents. The Company and Vencare allegedly billed Medicare for
respiratory therapy services and supplies when those services were not
medically necessary, billed for services not provided, exaggerated the time
required to provide services or exaggerated the productivity of its
therapists. It is further alleged that the Company and Vencare presented false
claims and statements to the Medicare program in violation of the Federal
Civil False Claims Act, by, among other things, allegedly causing skilled
nursing facilities with which they had respiratory therapy contracts to
present false claims to Medicare for respiratory therapy services and
supplies. The complaint seeks treble damages, other unspecified damages, civil
penalties, attorney's fees and other costs. This action was dismissed on May
30, 2001 (i) with prejudice as to the relator, (ii) with prejudice as to the
United States for Covered Conduct, and (iii) without prejudice as to the
United States for any claims other than Covered Conduct.
(d) In United States ex rel. Kneepkens v. Gambro Healthcare, Inc., et al.,
No. 97-10400-GAO, filed in the United States District Court for the District
of Massachusetts on October 15, 1998, Transitional, the Company's former
subsidiary which was transferred to Kindred in the 1998 Spin Off, and two
unrelated entities, Gambro
26
VENTAS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
Healthcare, Inc. and Dialysis Holdings, Inc., are defendants. This suit
alleges that the defendants violated the Federal Civil False Claims Act and
the Anti-Kickback Statute and committed common law fraud, unjust enrichment
and payment by mistake of fact. Specifically, the complaint alleges that a
predecessor to Transitional formed a joint venture with Damon Clinical
Laboratories to create and operate a clinical testing laboratory in Georgia
that was then used to provide lab testing for dialysis patients, and that the
joint venture billed at below cost in return for referral of substantially all
non-routine testing in violation of the Anti-Kickback Statute. It is further
alleged that a predecessor to Transitional and Damon Clinical Laboratories
used multiple panel testing of end stage renal disease rather than single
panel testing that allegedly resulted in the generation of additional revenues
from Medicare and that the entities allegedly added non-routine tests to tests
otherwise ordered by physicians that were not requested or medically necessary
but resulted in additional revenue from Medicare in violation of the Anti-
Kickback Statute. This action was dismissed with prejudice as to the relator
and the United States and the Company on May 22, 2001.
(e) The Company is a defendant in the case captioned United States ex rel.
Huff, et. al. v. Vencor, Inc., et al., Civil No. 97-4358 AHM(MCX) filed in the
United States District Court for the Central District of California on June
13, 1997. The complaint alleges, among other things, that the defendants
violated the Federal Civil False Claims Act by submitting false claims to
Medicare, Medicaid and CHAMPUS programs by allegedly (1) falsifying patient
bills and submitting the bills to Medicare, Medicaid and CHAMPUS programs, (2)
submitting bills for intensive and critical care not actually administered to
patients, (3) the falsifying of patient charts in relation to the billing, (4)
charging for physical therapy services allegedly not provided and pharmacy
services allegedly provided by non-pharmacists, and (5) billing for sales
calls made by nurses to prospective patients. The complaint further alleges
the improper establishment of TEFRA rates. The complaint seeks treble damages,
other unspecified damages, civil penalties, attorney's fees and other costs.
The Company disputes the allegations contained in the complaint. This action
was dismissed on May 21, 2001 (i) with prejudice as to the relator (ii) with
prejudice as to the United States for Covered Conduct, and (iii) without
prejudice as to the United States for any claims other than Covered Conduct.
(f) The Company is a defendant in the proceeding captioned United States ex
rel. Brzycki v. Vencor, Inc., Civil No. 97-451-JD, filed in the United States
District Court for the District of New Hampshire on September 8, 1997. In this
lawsuit the Company is accused of knowingly violating the Federal Civil False
Claims Act by submitting and conspiring to submit false claims to the Medicare
program. The complaint includes allegations that the Company (1) fabricated
diagnostic codes by ordering and providing medically unnecessary ancillary
services (such as respiratory therapy), (2) changed referring physicians'
diagnoses in order to qualify for Medicare reimbursement; (3) billed for
products or services not received or not received in the manner billed, and
(4) paid illegal kickbacks to referring health care professionals in the form
of medical consulting service agreements as an alleged inducement to refer
patients in violation of the Anti-Kickback Act and Stark laws. The complaint
seeks unspecified damages, civil penalties, attorney's fees and other costs.
This action was dismissed on May 23, 2001 (i) with prejudice as to the relator
for all claims except claims under 31.U.S.C. (S) 3730(h), (ii) with prejudice
as to the United States for Covered Conduct, and (iii) without prejudice as to
the United States for any claims other than Covered Conduct.
(g) On November 24, 1997, a civil qui tam lawsuit was filed against the
Company in the United States District Court for the Middle District of
Florida. This lawsuit was brought under the Federal Civil False Claims Act and
is styled United States of America ex rel. Virginia Lee Lanford and Gwendolyne
Cavanaugh v. Vencor, Inc., et al., No. 97-CV-2845. The United States of
America intervened in the lawsuit on May 17, 1999. On July 23, 1999, the
United States filed its Amended Complaint in the lawsuit. The lawsuit alleges
that the Company and Kindred knowingly submitted false claims and false
statements to the Medicare and Medicaid programs, including, but not limited
to, claims for reimbursement of costs for certain ancillary services performed
in Kindred's nursing facilities and for third party nursing facility operators
that the United States of America
27
VENTAS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
claims are not reimbursable costs. The lawsuit involves the Company's former
health care operations. The complaint does not specify the amount of damages
claimed by the plaintiffs. This action was dismissed with prejudice as to all
parties on May 25, 2001.
(h) In United States, et al., ex rel., Phillips-Minks, et al. v.
Transitional Hospitals Corp., et al., Case No. 98CV1012-IEG (LAB) filed in the
Southern District of California on July 23, 1998, it is alleged that the
defendants submitted and conspired to submit false claims and statements to
Medicare, Medicaid, and other federally and state funded programs during a
period commencing in 1993 and certain other state law claims. The conduct
complained of allegedly violates the Federal False Claims Act, the California
False Claims Act, the Florida False Claims Act, the Tennessee Health Care
False Claims Act, and the Illinois Whistleblower Reward and Protection Act.
Defendants allegedly submitted improper and erroneous claims to Medicare,
Medicaid and other programs, for improper, unnecessary and false services,
excess collections associated with billing and collecting bad debts, inflated
and nonexistent laboratory charges, false and inadequate documentation of
claims, splitting charges, shifting revenues and expenses, transferring
patients to hospitals that reimburse at a higher level, and improperly
allocating hospital insurance expenses. In addition, the complaint avers that
defendants were inconsistent in their reporting of cost report data, paid out
kickbacks to increase patient referrals to defendant hospitals, and
incorrectly reported employee compensation resulting in inflated employee
401(k) contributions. The complaint seeks unspecified damages and expenses.
On March 21, 2001 the United States moved to intervene to effectuate the
United States Settlement. The United States' motion to intervene was granted
on July 27, 2001.
(i) In Gary Graham on Behalf of the United States of America v. Vencor
Operating, Inc. et al., (S.D. Fla.), filed on or about June 8, 1999, it is
alleged that the defendants, including the Company, presented or caused to be
presented false or fraudulent claims for payment to the United States under
the Medicare program in violation of, among other things, the Federal Civil
False Claims Act. The complaint claims that Medisave, a former subsidiary of
the Company which was transferred to Kindred in the 1998 Spin Off,
systematically up-charged for drugs and supplies dispensed to Medicare
patients. The complaint seeks unspecified damages, civil penalties, interest,
attorney's fees and other costs. The Company disputes the allegations
contained in the complaint. On or about January 7, 2000, the United States
intervened in this case for purposes of representing its interests in the
Kindred bankruptcy and to effectuate the settlement among the United States,
Kindred and the Company. The Company has been advised by the Department of
Justice that this action was dismissed with respect to the Company and Kindred
(i) with prejudice as to the relator for all claims except claims under
31.U.S.C. (S) 3730(h), (ii) with prejudice as to the United States for Covered
Conduct, and (iii) without prejudice as to the United States for any claims
other than Covered Conduct.
(j) United States ex rel. George Mitchell et al. v. Vencor, Inc. et al.
Civil Case No. C2-00-0015 (S.D. Ohio), filed with the United States District
Court for the Southern District of Ohio on August 13, 1999, was brought under
the Federal Civil False Claims Act. The lawsuit alleges that the Company and
its former subsidiaries, Vencare, Inc. ("Vencare") and Vencor Hospice, Inc.
(the Company transferred both subsidiaries to Kindred in the 1998 Spin Off),
submitted false statements to the Medicare program for, among other things,
reimbursement for costs for patients who were not "hospice appropriate." The
complaint alleges damages in excess of $1,000,000. The Company disputes the
allegations contained in the complaint. On or about January 7, 2000, the
United States intervened in this case for purposes of representing its
interests in the Kindred bankruptcy and to effectuate the United States
Settlement. This action was dismissed on May 22, 2001 (i) with prejudice as to
the relator, (ii) with prejudice as to the United States for Covered Conduct,
and (iii) without prejudice as to the United States for any claims other than
Covered Conduct.
Kindred is a party to certain legal actions and regulatory investigations
arising in the normal course of its business. Neither the Company nor Kindred is
able to predict the ultimate outcome of pending litigation and
28
VENTAS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
regulatory investigations. In addition, there can be no assurance that the
United States Health Care Financing Administration ("HCFA") or other
regulatory agencies will not initiate additional investigations related to
Kindred's business in the future, nor can there be any assurance that the
resolution of any litigation or investigations, either individually or in the
aggregate, would not have a material adverse effect on Kindred's liquidity,
financial position or results of operations, which in turn could have a Material
Adverse Effect on the Company.
The Company is a party to certain legal actions and regulatory investigations
which arise from the normal course of its prior health care operations. The
Company is unable to predict the ultimate outcome of pending litigation and
regulatory investigations. In addition, there can be no assurance that other
regulatory agencies will not initiate additional investigations related to the
Company's prior health care business in the future, nor can there be any
assurance that the resolution of any litigation or investigations, either
individually or in the aggregate, would not have a Material Adverse Effect on
the Company. The Company is party to various other lawsuits, both as defendant
and plaintiff, arising in the normal course of business. It is the opinion of
management that, except as set forth in this Note 5, the disposition of these
other lawsuits will not, individually or in the aggregate, have a Material
Adverse Effect on the Company. If management's assessment of the Company's
liability with respect to these actions is incorrect, such actions could have a
Material Adverse Effect on the Company.
Other Litigation
- ----------------
The Company and Atria, Inc. ("Atria") have been engaged in ongoing discussions
regarding the parties respective rights and obligations relative to the issuance
of mortgage resident bonds (the "Bonds") to the new residents of New Pond
Village, a senior housing facility in Walpole, Massachusetts, owned by the
Company and leased to and operated by Atria. On August 6, 2001, Atria filed a
lawsuit styled Atria, Inc. v. Ventas Realty, Limited Partnership in the Superior
Court Department of the Trial Court in Norfolk County, Massachusetts (Civil
Action Number 01 01233). The complaint alleges that the Company has a duty to
sign and issue Bonds to new residents of New Pond Village and that, as a result
of an alleged failure of the Company to issue Bonds, the Company has, among
other things, breached contractual obligations under the Bond Indenture. The
complaint seeks a declaration that Atria's indemnity obligation in favor of the
Company relating to the Bonds is void and unenforceable and injunctive and
declaratory relief requiring the Company to sign and issue Bonds to new
residents of New Pond Village. The complaint also seeks damages, interest,
attorneys' fees and other costs. The Company believes that the allegations in
the complaint are without merit. The Company further believes that the disputes
in this action are subject to mandatory mediation and arbitration under the
agreements entered into in connection with the Company's spin off of its
assisted living operations to Atria in August 1996. The Company intends to move
to dismiss this action and, if not dismissed, to defend its positions vigorously
and to assert any appropriate counterclaims against Atria and its controlling
parties.
Unasserted Claims--Potential Liabilities Due to Fraudulent Transfer
- -------------------------------------------------------------------
Considerations and Other Claims
- -------------------------------
Although no claims were ever formally asserted, legal counsel for Kindred and
certain of its creditors raised questions relating to potential fraudulent
conveyance or obligation issues and other claims relating to the 1998 Spin Off.
These potential fraudulent conveyance and obligation claims of Kindred relating
to the 1998 Spin Off were released by Kindred and its creditors under the Final
Plan.
No provision for liability resulting from the aforementioned litigation has
been made in the Condensed Consolidation Financial Statements for the six months
ended June 30, 2001.
29
VENTAS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 6 -- Earnings Per Share
The following table shows the amounts used in computing basic and diluted
earnings per share ($'s in thousands, except per share amounts):
Three Months Ended Six Months Ended
------------------ ----------------
June 30, June 30, June 30, June 30,
-------- -------- -------- ----------
2001 2000 2001 2000
---- ---- ---- ----
Numerator for Basic and Diluted Earnings Per Share:
Income before Extraordinary Item.................... $ 8,105 $ 7,512 $18,684 $14,452
Extraordinary Item.................................. -- -- -- (4,207)
------- ------- ------- -------
Net Income.......................................... $ 8,105 $ 7,512 $18,684 $10,245
======= ======= ======= =======
Denominator:
Denominator for Basic Earnings Per Share
--Weighted Average Shares........................ 68,409 68,027 68,316 67,963
Effect of Dilutive Securities:
Stock Options.................................... 765 40 661 27
Time Vesting Restricted Stock Awards............. 133 34 113 17
------- ------- ------- -------
Dilutive Potential Common Stock.................. 898 74 774 44
------- ------- ------- -------
Denominator for Diluted Earnings Per Share
--Adjusted Weighted Average...................... 69,307 68,101 69,090 68,007
======= ======= ======= =======
Basic Earnings Per Share:
Income before Extraordinary Item.................... $ 0.12 $ 0.11 $ 0.27 $ 0.21
Extraordinary Item.................................. -- -- -- (0.06)
------- ------- ------- -------
Net Income.......................................... $ 0.12 $ 0.11 $ 0.27 $ 0.15
======= ======= ======= =======
Diluted Earnings Per Share:
Income before Extraordinary Item.................... $ 0.12 $ 0.11 $ 0.27 $ 0.21
Extraordinary Item.................................. -- -- -- (0.06)
------- ------- ------- -------
Net Income.......................................... $ 0.12 $ 0.11 $ 0.27 $ 0.15
======= ======= ======= =======
30
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Cautionary Statements
Forward Looking Statements
This Form 10-Q includes forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended (the "Securities Act"),
and Section 21E of the Securities Exchange Act of 1934, as amended (the
"Exchange Act"). All statements regarding Ventas, Inc.'s ("Ventas" or the
"Company") and its subsidiaries' expected future financial position, results of
operations, cash flows, funds from operations, dividends and dividend plans,
financing plans, business strategy, budgets, projected costs, capital
expenditures, competitive positions, growth opportunities, expected lease
income, continued qualification as a real estate investment trust ("REIT"),
plans and objectives of management for future operations and statements that
include words such as "if," "anticipate," "believe," "plan," "estimate,"
"expect," "intend," "may," "could," "should," "will" and other similar
expressions are forward-looking statements. Such forward-looking statements are
inherently uncertain, and stockholders must recognize that actual results may
differ from the Company's expectations. The Company does not undertake a duty to
update such forward-looking statements.
Actual future results and trends for the Company may differ materially
depending on a variety of factors discussed in this Form 10-Q, the Company's
Annual Report on Form 10-K for the year ended December 31, 2000 and elsewhere in
the Company's filings with the Securities and Exchange Commission (the
"Commission"). Factors that may affect the plans or results of the Company
include, without limitation, (a) the ability and willingness of Kindred
Healthcare, Inc. and certain of its affiliates (collectively, "Kindred") to
continue to meet and/or honor its obligations under its contractual arrangements
with the Company and the Company's wholly owned operating partnership, Ventas
Realty, Limited Partnership ("Ventas Realty"), including without limitation
the various agreements (the "Spin Agreements") entered into by the Company and
Kindred at the time of the corporate reorganization on May 1, 1998 (the "1998
Spin Off") pursuant to which the Company was separated into two publicly held
corporations, (b) the ability and willingness of Kindred to continue to meet
and/or honor its obligation to indemnify and defend the Company for all
litigation and other claims relating to the health care operations and other
assets and liabilities transferred to Kindred in the 1998 Spin Off, (c) the
ability of Kindred and the Company's other operators to maintain the financial
strength and liquidity necessary to satisfy their respective obligations and
duties under the leases and other agreements with the Company, and their
existing credit agreements, (d) the Company's success in implementing its
business strategy, (e) the nature and extent of future competition, (f) the
extent of future health care reform and regulation, including cost containment
measures and changes in reimbursement policies and procedures, (g) increases in
the cost of borrowing for the Company, (h) the ability of the Company's
operators to deliver high quality care and to attract patients, (i) the results
of litigation affecting the Company, (j) changes in general economic conditions
and/or economic conditions in the markets in which the Company may, from time to
time, compete, (k) the ability of the Company to pay down, refinance,
restructure, and/or extend its indebtedness as it becomes due, (l) the movement
of interest rates and the resulting impact on the value of the Company's
interest rate swap agreement and the ability of the Company to satisfy its
obligation to post cash collateral if required to do so under such interest rate
swap agreement, (m) the ability and willingness of Atria, Inc. to continue to
meet and honor its contractual arrangements with the Company and Ventas Realty
entered into connection with the Company's spin off of its assisted living
operations and related assets and liabilities to Atria in August 1996, (n) the
ability and willingness of the Company to maintain its qualification as a REIT
due to economic, market, legal, tax or other considerations, (o) the outcome of
the audit being conducted by the Internal Revenue Service for the Company's tax
years ended December 31, 1997 and 1998, (p) final determination of the Company's
net taxable income for the tax years ended December 31, 2000 and December 31,
2001, (q) the treatment of the Company's claims in the chapter 11 cases of
certain of the Company's tenants and former tenants, including Integrated Health
Services, Inc. and certain of its affiliates, and (r) the ability and
willingness of the Company's tenants to renew their leases with the Company upon
expiration of the leases and the Company's ability
31
to relet its properties on the same or better terms in the event such leases
expire and are not renewed by the existing tenants. Many of such factors are
beyond the control of the Company and its management.
Kindred Information
Kindred is subject to the reporting requirements of the Commission and is
required to file with the Commission annual reports containing audited financial
information and quarterly reports containing unaudited financial information.
The information related to Kindred provided in this Form 10-Q is derived from
filings made with the Commission or other publicly available information, or has
been provided by Kindred. The Company has not verified this information either
through an independent investigation or by reviewing Kindred's public filings.
The Company has no reason to believe that such information is inaccurate in any
material respect, but there can be no assurance that all such information is
accurate. The Company is providing this data for informational purposes only,
and the reader of this Form 10-Q is encouraged to obtain Kindred's publicly
available filings from the Commission.
Background Information
The Company is a Delaware corporation that elected to be taxed as a REIT under
the Internal Revenue Code of 1986, as amended (the "Code"), beginning with the
tax year ended December 31, 1999. Although the Company believes that it has
satisfied the requirements to continue to qualify as a REIT for the year ended
December 31, 2000 and although the Company intends to continue to qualify as a
REIT for the tax year ending December 31, 2001 and subsequent tax years, it is
possible that economic, market, legal, tax or other considerations may cause the
Company to fail or elect not to continue to qualify as a REIT in any such tax
year. The Company owns or leases 44 hospitals, 216 nursing facilities and eight
personal care facilities in 36 states, as of June 30, 2001. The Company conducts
substantially all of its business through a wholly owned operating partnership,
Ventas Realty. The Company operates in one segment which consists of owning and
leasing health care facilities and leasing or subleasing such facilities to
third parties.
Recent Developments Regarding Kindred
Kindred Bankruptcy
On September 13, 1999 (the "Petition Date"), Kindred filed for protection
under chapter 11 of the Bankruptcy Code with the United States Bankruptcy Court
for the District of Delaware (the "Bankruptcy Court"). On December 14, 2000,
Kindred filed its fourth amended plan of reorganization (the "Fourth Amended
Plan") with the Bankruptcy Court, containing the terms of the restructuring of
Kindred's debt and lease obligations. A hearing on the confirmation of the
Fourth Amended Plan was held before the Bankruptcy Court on March 1, 2001 (the
"Confirmation Hearing"). The Fourth Amended Plan, which was modified on the
record of the Confirmation Hearing, was confirmed (as confirmed, the "Final
Plan") by an order of the Bankruptcy Court, which order was entered on the
docket on March 19, 2001 (the "Kindred Confirmation Date"). The Final Plan
became effective and Kindred emerged from bankruptcy on April 20, 2001 (the
"Kindred Effective Date").
Summary of Economic Terms of the Final Plan
Under the terms of the Final Plan, the Company, among other things, (i)
retained all rent paid by Kindred through the Kindred Effective Date, (ii)
amended and restated its leases with Kindred in the form of four Amended and
Restated Master Lease Agreements all dated April 20, 2001 (individually an
"Amended Master Lease" and collectively the "Amended Master Leases"), and (iii)
received 1,498,500 shares of the common stock of Kindred together with certain
registration rights.
Annual base rent under the Amended Master Leases is scheduled to be $180.7
million from May 1, 2001 to April 30, 2002. For the period through April 30,
2004, annual base rent, which is payable in all cash, will escalate 3.5% on May
1 of each year, commencing May 1, 2002, if certain tenant revenue parameters are
achieved.
32
Assuming such tenant revenue parameters are achieved, annual base rent under the
Amended Master Leases will be $187.0 million from May 1, 2002 to April 30, 2003
and $193.6 million from May 1, 2003 to April 30, 2004. All of the annual base
rent will be paid in cash through April 30, 2004. Commencing May 1, 2004, if a
Kindred Bank Refinancing Transaction (as defined below) has occurred, the 3.5%
annual escalator will be paid in cash and the full amount of the annual base
rent will be paid in cash. If a Kindred Bank Refinancing Transaction has not
occurred, then on May 1, 2004 the 3.5% annual escalator under the Amended Master
Leases will be comprised of (a) an annual cash escalator of approximately 2% on
the rent payable in cash during the prior lease year and (b) a 1.5% annual non-
cash rent escalator that will accrue at the annual rate of the London Interbank
Offered Market Rate plus 450 basis points until the occurrence of a "Kindred
Bank Refinancing Transaction," at which time the accrual with interest shall be
due and payable and thereafter the 1.5% non-cash rent escalator will convert to
a cash escalator so that the total cash escalator thereafter will equal 3.5% per
year. Under the terms of the Final Plan, Kindred paid $15.1 million in base rent
for April 2001, which is the monthly base rent amount under the stipulation and
order entered by the Bankruptcy Court on or about September 13, 1999 (the "Rent
Stipulation"). The Company also has the one time right to reset the rents under
the Amended Master Leases, exercisable 5 1/4 years after the Kindred Effective
Date on an Amended Master Lease by Amended Master Lease basis, to a then fair
market rental rate, for a total fee of $5.0 million payable on a pro-rata basis
at the time of exercise under the applicable Amended Master Lease. See "Note
3--Concentration of Credit Risk and Recent Developments--Recent Developments
Regarding Kindred--Spin Agreements and Other Arrangements Under the Final Plan--
Amended Master Leases" to the Condensed Consolidated Financial Statements.
On the Kindred Effective Date, Ventas Realty received 1,498,500 shares of the
common stock in Kindred as restructured under the Final Plan, representing 9.99%
(subject to dilution from warrants issued on the Kindred Effective Date and from
stock issuances by Kindred occurring after the Kindred Effective Date) of the
issued and outstanding common stock in Kindred as of the Kindred Effective Date
(the "New Kindred Common Stock"). The New Kindred Common Stock was issued to
Ventas Realty as additional future rent in consideration of the Company's and
Ventas Realty's agreement to charge the base rent as provided in the Amended
Master Leases. On the Kindred Effective Date, the Company also received a $4.5
million cash payment as additional future rent under the Amended Master Leases.
The value of the Company's New Kindred Common Stock, determined as of the date
received by the Company and the $4.5 million of additional future rent will be
amortized as future rent over the weighted average remaining term of the Amended
Master Leases for financial reporting purposes.
Under the Code, if the Company directly or indirectly is deemed to own 10%
or more of any class of Kindred's issued and outstanding voting securities or
10% or more of the value of any class of Kindred's issued and outstanding
securities (the "10% securities test"), Kindred would be a "Related Party
Tenant". As a Related Party Tenant, the Company's rental revenue from Kindred
would not qualify as "rents from real property" and the Company would lose its
REIT status because it likely would not be able to satisfy either the 75% or the
95% gross income test. The Company's loss of REIT status would have a material
adverse effect on the business, financial condition, results of operations and
liquidity of the Company, on the Company's ability to service its indebtedness
and other obligations and on the Company's ability to make distributions to its
stockholders as required to continue to quality as a REIT (a "Material Adverse
Effect").
The Company believes that, based upon applicable tax authorities and decisions
and advice from the Internal Revenue Service, all common stock underlying
warrants and options issued by Kindred and performance shares issued by Kindred
will be deemed outstanding for purposes of calculating the Company's ownership
percentage under the 10% securities test. Accordingly, the Company believes that
for purposes of the 10% securities test, its ownership percentage in Kindred is
materially less than 9.99%.
In addition, the Company has taken a number of steps to reduce the risk of the
Company's loss of REIT status due to the violation of the 10% securities test.
33
First, under Article Twelfth of the Kindred Amended and Restated Certificate
of Incorporation (the "Kindred Corporate Charter"), if Kindred proposes to enter
into a transaction which would cause the Company to violate the 10% securities
test, Kindred must give the Company fifteen days prior written notice of such
transaction, which notice constitutes an offer by Kindred to purchase from the
Company immediately prior to the consummation of such transaction a number of
shares of the New Kindred Common Stock such that after the consummation of the
proposed transaction the Company's ownership interest in Kindred will not exceed
9.99%. The Company will not be required to accept such offer but may in its
discretion do so. The Kindred corporate charter provides that Kindred will not
close the transaction until it has purchased the appropriate amount of the New
Kindred Common Stock from the Company if the Company elects to accept the
Kindred offer.
Second, the Company may sell the New Kindred Common Stock to a third party or
distribute the New Kindred Common Stock to its stockholders, subject to
compliance with the registration requirements of the Securities Act. On the
Kindred Effective Date, Kindred executed and delivered a registration rights
agreement to Ventas Realty, certain other initial holders of New Kindred Common
Stock and other signatories (the "Registration Rights Agreement.) Under the
Registration Rights Agreement, Kindred agreed to file a registration statement
within 120 days after the Kindred Effective Date to register the New Kindred
Common Stock under the Securities Act. See "Note 3--Concentration of Credit Risk
and Recent Developments--Recent Developments Regarding Kindred--Spin Agreements
and Other Arrangements Under the Final Plan--Registration Rights Agreement." The
New Kindred Common Stock could be sold in the public trading markets, in a
private sale or distributed by the Company to its stockholders as a dividend
upon compliance with the rules and regulations of the New York Stock Exchange
and the Commission and all other applicable laws, rules and regulations.
However, if the Company were required to dispose of all or a portion of the New
Kindred Common Stock, there can be no assurance that a public market will exist
for the New Kindred Common Stock, that a private buyer could be found for the
New Kindred Common Stock, the price at which a sale could be effected, or
whether a registration statement relating to the proposed transaction would be
declared effective in time to effectuate such sale in order for the Company to
avoid the loss of its REIT status.
The Company has also taken steps to prevent the attribution of the New Kindred
Common Stock owned by its stockholders to the Company. The Company has amended
the waivers of the ownership limits in its charter such that the only greater
than 10% stockholder of the Company's stock is Tenet Healthcare Corporation
("Tenet"). Tenet owns approximately 12% of the Company's issued and outstanding
Common Stock. Certain provisions under the Code provide that any ownership
interest in Kindred that Tenet may purchase may be attributed to the Company. If
any such attribution occurs at a time when the Company owns 9.99% of the issued
and outstanding New Kindred Common Stock, the Company could violate the 10%
securities test and lose its REIT status unless under applicable laws, rules and
regulations or interpretations, the Company is otherwise deemed not to have
violated the 10% securities test. There can be no assurance that relief for a
violation of the 10% securities test would be available in all circumstances. If
the Company should lose its REIT status, it would have a Material Adverse Effect
on the Company. To reduce the likelihood of such an occurrence, the Company has
implemented certain protective measures. As part of the Final Plan, the Company
negotiated for the inclusion of Article Tenth of the Kindred Corporate Charter.
Article Tenth of the Kindred Corporate Charter, which became effective on the
Kindred Effective Date, is designed to prohibit Tenet from gaining beneficial
ownership of any New Kindred Common Stock if such ownership when combined with
the Company's ownership would exceed 9.9% of any class of stock or all stock in
the aggregate. If Tenet should nevertheless violate this provision, either
directly or as a result of the attribution rules under the Code, any shares of
the New Kindred Common Stock so purchased by or attributed to Tenet will
automatically, without any action by any party, become "Excess Stock" in Kindred
and will be deemed to be owned by a trust for the benefit of a third party and
Tenet will have no legal title to such "Excess Stock" in Kindred. Tenet would
have the limited right to receive certain distributions on and a certain portion
of the proceeds of a sale of such "Excess Stock" in Kindred.
In addition, under the Company's Certificate of Incorporation, under a formal
interpretation by the Board of Directors, if Tenet should purchase any New
Kindred Common Stock while Tenet owns in excess of 10% of the
34
Company's Common Stock, then all of Tenet's holdings of the Company's Common
Stock in excess of 9.9% will automatically become "Excess Shares" in the Company
and will be deemed to be owned by a trust for the benefit of a third party and
Tenet would have no legal title to such "Excess Shares" in the Company. Tenet
would have the limited right to receive certain distributions on and a certain
portion of the proceeds of a sale of such Excess Shares in the Company.
While the Company believes that these and other safeguards which have been
instituted by the Company are adequate, there can be no assurances that such
safeguards will be adequate to prevent the Company from violating the 10%
securities test and losing its REIT status. Loss of REIT status would have a
Material Adverse Effect on the Company.
If the Company fails to satisfy one or both of the 75% or 95% gross income
tests for any taxable year, it may nevertheless continue to qualify as a REIT
for such year if it is entitled to relief under certain provisions of the Code.
These relief provisions generally will be available if the Company's failure to
meet such tests was due to reasonable cause and not due to willful neglect, the
Company attaches a schedule of the sources of its income to its return and any
incorrect information on the schedules was not due to fraud with intent to evade
tax. It is not possible, however, to state whether in all circumstances the
Company would be entitled to the benefit of these relief provisions. Even if
these relief provisions were to apply, a tax would be imposed with respect to
the excess net income.
Except for a Participation Agreement and a Development Agreement, which the
Company terminated, Kindred has assumed and agreed to continue to perform its
obligations under the Spin Agreements including, without limitation, the
obligation to indemnify and defend the Company for all litigation and other
claims relating to the health care operations and other assets and liabilities
transferred to Kindred in the 1998 Spin Off. See "Note 3--Concentration of
Credit Risk and Recent Developments--Recent Developments Regarding Kindred--Spin
Agreements and Other Arrangements Under the Final Plan" to the Condensed
Consolidated Financial Statements.
As of the Kindred Effective Date, certain federal, state and local tax refund
proceeds received on or after September 13, 1999 by Kindred or the Company for
tax periods prior to and including the 1998 Spin Off (the "Subject Periods")
were placed into an escrow account to be used to satisfy any potential tax
liabilities for the Subject Periods. When audits of the relevant tax periods
have been concluded, any residual amount remaining in escrow will be shared
equally by the Company and Kindred. All interest accruing on the escrowed
amounts will be distributed annually equally between the Company and Kindred.
See "Note 3--Concentration of Credit Risk and Recent Developments--Recent
Developments Regarding Kindred--Spin Agreements and Other Arrangements Under the
Final Plan--Tax Allocation Agreement and Tax Refund Escrow Agreement" to the
Condensed Consolidated Financial Statements.
The Company waived the right to the payment of (a) $18.9 million for the
August 1999 unpaid monthly base rent under the four multi-facility master lease
agreements entered into by the Company and Kindred at the time of the 1998 Spin
Off and the single facility master lease agreement dated August 7, 1998 between
Ventas Realty and Kindred Nursing Centers Limited Partnership (collectively, the
"Original Master Leases") and (b) approximately $79.5 million, representing the
difference between the rent required to be paid under the terms of the Original
Master Leases and the rent paid to the Company after the Petition Date and prior
to the first calendar month following the Kindred Effective Date pursuant to the
terms of the Rent Stipulation.
Under the Final Plan, the Kindred Senior Bank Debt was restructured as
follows: (i) the principal and accrued interest amount of the Kindred Senior
Bank Debt was reduced from approximately $578.0 million to $300.0 million, (ii)
the restructured debt has a maturity date on the seventh anniversary of the
Kindred Effective Date and bears interest at LIBOR plus 450 basis points, (iii)
no interest accrues on the restructured debt until the amount of foregone
interest equals $15.9 million, (iv) the restructured debt is secured by a second
lien on substantially all of the assets of Kindred, and (v) the holders of the
Kindred Senior Bank Debt received 9,826,092 shares of the New Kindred Common
Stock representing approximately 65.5% of the issued and outstanding New Kindred
Common
35
Stock as of the Kindred Effective Date, subject to dilution from warrants issued
on the Kindred Effective Date and from stock issuances by Kindred after the
Kindred Effective Date.
Under the Final Plan the holders of the Kindred Senior Subordinated Notes
converted their claim of approximately $374.0 million of principal and accrued
interest as of the Kindred Petition Date into (i) 3,675,408 shares of New
Kindred Common Stock, representing approximately 24.5% of the issued and
outstanding New Kindred Common Stock as of the Kindred Effective Date, subject
to dilution from warrants issued on the Kindred Effective Date and from stock
issuances by Kindred after the Kindred Effective Date and (ii) warrants to
purchase in the aggregate 7 million shares of New Kindred Common Stock divided
into two series, one of which represents the right to purchase 2 million shares
at an exercise price of $30.00 per share and the second of which represents the
right to purchase 5 million shares at an exercise price of $33.33 per share.
These warrants, if exercised, will result in the issuance of New Kindred Common
Stock representing approximately 30% of the fully diluted equity of Kindred
assuming the warrants were exercised on the Kindred Effective Date.
Under the Final Plan, stock incentive plans were adopted and implemented by
Kindred (the "Kindred Stock Incentive Plans") for the benefit of the senior
management of Kindred. Options to purchase 0.6 million shares of New Kindred
Common Stock and 0.6 million restricted shares of New Kindred Common Stock are
available for grant under the Kindred Stock Incentive Plans.
Spin Agreements and Other Arrangements Under the Final Plan
See "Note 3--Concentration of Credit Risk and Recent Developments--Recent
Developments Regarding Kindred--Spin Agreements and Other Arrangements Under the
Final Plan" to the Condensed Consolidated Financial Statements for a description
of the material terms of (a) certain of the Spin Agreements, as assumed by
Kindred, including the terms of amendments or restatements of such Spin
Agreements, where applicable, (b) those Spin Agreements and other agreements
terminated under the Final Plan, and (c) new agreements entered into between the
Company and Kindred in accordance with the Final Plan.
Releases Under the Final Plan
Release of United States Claims
The Final Plan contains a comprehensive settlement of all civil and
administrative claims by the United States against the Company and Kindred
arising from the participation of the Kindred facilities, formerly operated by
the Company, in various federal health benefit programs (the "United States
Settlement"). See "Note 3--Recent Developments Regarding Kindred--Settlement of
United States Claims" to the Condensed Consolidated Financial Statements.
Under the terms of the United States Settlement, the United States released
the Company from all civil or administrative monetary claims or causes of
actions the United States or others authorized to bring suits in its name and on
its behalf including third party claimants under 31 U.S.C. Section 3730(b) or
(d), had or may have against the Company under the False Claims Act, 31 U.S.C.
Section 3729-3733 (the "False Claims Act"), the Civil Monetary Penalties Law,
42 U.S.C. Section 1320a-7a (the "Civil Monetary Penalties Law"), the Program
Fraud Civil Remedies Act, 31 U.S.C. Sections 3801-3812 (the "Program Fraud
Civil Remedies Act"), and/or common law doctrines of payment by mistake, unjust
enrichment, breach of contract or fraud, for certain conduct of the Company
and/or Kindred alleged to have occurred under the qui tam actions and certain
other conduct investigated by the United States. Such conduct includes, without
limitation, overbilling in connection with the provision of mobile radiology and
diagnostic services, improper pharmacy charges, improper billing for respiratory
therapy services and associated supplies, certain quality of care issues and
certain other facility specific conduct (collectively, the "Covered Conduct").
With respect to the Covered Conduct, the United States also released the Company
for administrative overpayments under the Medicare Program ("Medicare"), Title
XVIII of the Social Security Act, 42
36
U.S.C. Sections 1395-1395ggg (the "Social Security Act") under the TRICARE
Program, 10 U.S.C. Sections 1071-1106 (the "TRICARE Program"), civil monetary
penalties imposed under 42 U.S.C. (S) 1395i--3(h)(2)(B)(ii) and 42 U.S.C.
Section 1396r(h)(2)(A)(ii) and actions for permissive exclusion from Medicare,
Medicaid and other federal health programs.
Under the terms of the United States Settlement, the Company received a
release from the United States and others authorized to bring suits in its name
and on its behalf including third party claims under 31 U.S.C. Section 3730(b)
or (d) for all known or unknown, asserted or unasserted, civil and
administrative monetary claims, actions and causes of actions arising on or
before the Kindred Effective Date for (a) administrative overpayments under
Medicare, the Social Security Act, and the TRICARE Program, (b) claims relating
to any of the federal health care programs under the False Claims Act, Civil
Monetary Penalties Law, the Program Fraud Civil Remedies Act, Medicare and the
regulations thereunder, and other federal statutes, (c) claims for money arising
out of quality of care issues, (d) claims based on submission of Medicare cost
reports, or payments made with respect thereto or otherwise relating to
participation in the Medicare program for periods prior to September 1999, (e)
common law claims relating to any of the federal health care programs, (f) all
claims asserted by the United States in its proof of claims filed in the Kindred
Bankruptcy and (g) all claims alleged in the qui tam cases. The United States
executed a joinder to the Final Plan acknowledging and confirming its agreement
to the United States Settlement.
Except as set forth below, the current and former directors, officers and
employees of the Company generally received a release from the United States
coextensive with the United States' release of the Company but only to the
extent a current or former director, officer or employee of the Company is
entitled to indemnification, contribution and/or similar relief from the Company
or Kindred. However, if the United States brings a claim against a current or
former officer, director or employee of either Kindred or the Company, even
though such claim would otherwise have been released as provided above, the
United States may collect for any such claim the lesser of (i) $13.0 million in
the aggregate for all such claims against all directors, officers and employees
of the Company and Kindred, and (ii) the amount of any insurance proceeds
actually available to satisfy such claims. Any and all such claims by the United
States against the directors, officers and employees of the Company or Kindred
over and above this specified amount are released. Kindred and the Company
agreed in the Final Plan not to materially alter the coverage as it existed as
of September 1, 2000 under such corporate liability policy, without the
reasonable consent of the United States.
The following claims are specifically excluded from the releases provided by
the United States under the United States Settlement: (a) claims under the Code,
(b) claims for criminal liability, (c) claims brought by the Commission or other
governmental or regulatory agency related to securities laws violations,
including but not limited to, claims based on the Securities Act, the Exchange
Act, the Investment Advisors Act of 1940, the Investment Company Act, the
Commodity Exchange Act and the rules and regulations under such statutes, (d)
claims under state health care reimbursement programs, and (e) claims for
mandatory exclusion from federal health care benefit programs.
Other Releases under the Final Plan
In consideration for the Company and Ventas Realty entering into the Amended
Master Leases and agreeing to their treatment under the Final Plan, Kindred
directly released the Company and Ventas Realty and their current and former
directors, officers and employees, in their capacities as such, from all claims,
that arose before the Kindred Confirmation Date and including, without
limitation, any claim, demand, debt, right, cause of action or liability for an
avoidance or a recovery on account of or due to fraudulent conveyance,
preferential payment, fraudulent transfer and fraudulent obligations and all
other claims relating to or arising out of the 1998 Spin Off. However, the
Company was not released from, and the Company remains liable for, the
performance of its obligations under the Final Plan, the Spin Agreements, the
Amended Master Leases and all other agreements between the Company or Ventas
Realty and Kindred which were assumed by or entered into by Kindred under the
Final Plan.
37
The Final Plan generally provides that the Company and Ventas Realty and their
current and former directors, officers and employees, solely in their capacity
as such, are released by the holders of certain claims against Kindred
(including the holders of general unsecured claims, senior bank debt claims,
subordinated noteholder claims and certain preferred equity put right claims),
of all claims, that arose before the Kindred Confirmation Date and including,
without limitation, any claim, demand, debt, right, cause of action or liability
for an avoidance or a recovery on account of or due to fraudulent conveyance,
preferential payment, fraudulent transfer and fraudulent obligations and all
other claims relating to or arising out of the 1998 Spin Off. The following
claims are specifically excluded from these releases: (a) obligations of the
Company and Ventas Realty under the Final Plan and all of the documents related
thereto; and (b) direct claims against the Company or Ventas Realty which (i)
are unrelated to the 1998 Spin Off, (ii) are unrelated to Kindred (including
Kindred's operations prior to the 1998 Spin Off), and (iii) were not asserted
and could not have been asserted against Kindred in the Kindred bankruptcy
proceedings. At the Confirmation Hearing, the Bankruptcy Court judge approved
these releases. The Company believes that these releases generally meet the
requirements to be enforceable against non-debtor parties. However, there exists
a complex and evolving body of case law governing the enforceability of releases
in bankruptcy by non-debtor parties and there can be no assurance that such a
releasing party will not seek to challenge such releases or what the outcome
will be if the enforceability of the releases is so challenged.
The releases in favor of the Company's officers, directors or employees are
limited to claims that arose out of the officer/director/employee relationship.
The Company was not released from any indemnification claims of any current and
former officers, directors and employees of the Company.
The Company directly released Kindred and its officers, directors and
employees, solely in their capacity as such, from all claims, whether reduced to
judgment or not, liquidated or unliquidated, contingent or noncontingent,
asserted or unasserted, fixed or not, matured or unmatured, disputed or
undisputed, legal or equitable, known or unknown that arose before the Kindred
Confirmation Date. However, Kindred was not released from, and Kindred remains
liable for, the performance of all obligations under the Final Plan and the Spin
Agreements, the Amended Master Leases and all other agreements between Kindred
and the Company or Ventas Realty which were assumed or entered into by Kindred
under the Final Plan. The releases by the Company of the officers, directors and
employees of Kindred are limited to those claims against an officer, director or
employee that arose out of the officer/director/employee relationship.
The Company released the holders of the Kindred senior bank debt and the
Kindred subordinated noteholders, and their respective officers, directors,
employees, members, principals, attorneys advisors, agents, professionals,
representatives, benefit plan administrators or trustees (each of the foregoing,
solely in their capacity as such) from all claims, whether reduced to judgment
or not, liquidated or unliquidated, contingent or noncontingent, asserted or
unasserted, fixed or not, matured or unmatured, disputed or undisputed, legal or
equitable, known or unknown, that arose before the Kindred Effective Date and
are related to the 1998 Spin Off. The Company did not release any claims under
the Company's Amended Credit Agreement or any document or instrument related
thereto or any direct claims unrelated to the 1998 Spin Off.
Recent Developments Regarding Income Taxes
The Internal Revenue Service is currently reviewing the federal income tax
returns of the Company for tax years ending December 31, 1997 and 1998. There
can be no assurances as to the ultimate outcome of these matters or whether such
outcome will have a Material Adverse Effect on the Company. However, the
resulting tax liabilities, if any, for the tax years ended December 31, 1997 and
1998 will be satisfied first from the loss of net operating loss ("NOL")
carryforwards (including the NOL carryforwards that were utilized to offset the
Company's federal income tax liability for 1999 and 2000), and if the tax
liabilities exceed the amount of NOL carryforwards, then from the escrowed
amounts under the Tax Refund Escrow Agreement. To the extent the NOL
carryforwards and the escrowed amounts under the Tax Refund Escrow Agreement are
not sufficient to satisfy such liabilities, Kindred has indemnified the Company
for certain but not all of these tax liabilities under the Tax Allocation
Agreement. There can be no assurances that the NOL carryforwards and the
escrowed amounts under the Tax
38
Refund Escrow Agreement will be sufficient to satisfy these liabilities or that
Kindred has any obligation to indemnify the Company for particular liabilities
or that Kindred will have sufficient assets, income and access to financing to
enable it to satisfy its indemnity obligations under the Tax Allocation
Agreement or that Kindred will continue to honor its indemnification
obligations.
Other Recent Developments
Certain of the Company's other operators, tenants and subtenants have
experienced financial difficulties that have impacted their ability to perform
their obligations under their agreements with the Company. See "Note 3 --
Concentration of Credit Risk and Recent Developments--Other Recent Developments"
to the Condensed Consolidated Financial Statements.
Results of Operations
The Company elected to qualify as a REIT for federal income tax purposes for
the tax year ended December 31, 1999. The Company believes that it has
satisfied the requirements to continue to qualify as a REIT for federal income
tax purposes for the year ended December 31, 2000. Although the Company intends
to continue to qualify as a REIT for the year ended December 31, 2001 and
subsequent tax years, it is possible that economic, market, legal, tax or other
considerations may cause the Company to fail or elect not to continue to qualify
as a REIT. The Company's failure to continue to qualify as a REIT could have a
Material Adverse Effect on the Company.
Three months ended June 30, 2001 and 2000
Rental income for the three months ended June 30, 2001 was $46.3 million, of
which $45.7 million (98.8%) resulted from leases with Kindred. The rental income
from Kindred includes $0.4 million related to the amortization of deferred
revenue recorded as a result of the receipt of the New Kindred Common Stock and
the $4.5 million of additional future rent under the Amended Master Leases. The
rental income for the three months ended June 30, 2001 is approximately equal to
net rental income (rental income less uncollectible rent from tenants) for the
three months ended June 30, 2000 of $46.2 million, of which $45.3 million
(98.2%) resulted from leases with Kindred. Under the Final Plan, the Company
waived its right to the payment of the difference between rent required to be
paid under the terms of the Original Master Leases and the rent received by the
Company after the Petition Date and prior to the beginning of the month
immediately following the Kindred Effective Date. As a result of this waiver,
the Company recorded revenue in the second quarter of 2001 equal to the amount
actually paid by Kindred. In the second quarter of 2000, the outcome of
Kindred's bankruptcy was uncertain, and the difference between the rent provided
for in the Original Master Lease and rent actually received from Kindred was
written off to uncollectible rent expense. Interest income totaled approximately
$1.1 million for the three months ended June 30, 2001 as compared to
approximately $1.7 million for the three months ended June 30, 2000. The
decrease in interest income was primarily the result of earnings from
investments in smaller cash balances and reduced interest rates.
Expenses totaled $38.0 million for the quarter ended June 30, 2001 and
included $10.5 million of depreciation expense on real estate assets and $22.0
million of interest on the Amended Credit Agreement and $1.4 million of interest
on the United States Settlement. See "Note 3--Concentration of Credit Risk and
Recent Developments" to the Condensed Consolidated Financial Statements. For the
quarter ended June 30, 2000, expenses totaled $52.5 million and included $10.6
million of depreciation expense on real estate assets and $23.8 million of
interest on the Amended Credit Agreement.The $14.4 million decrease in expenses
was due primarily to (a) a charge to earnings of $12.1 million for the quarter
ended June 30, 2000 for uncollectible rent from tenants, which primarily
includes the difference between the minimum monthly base rent due under the
terms of the Original Master Leases and the base rent that was paid under the
terms of the Rent Stipulation and (b) decreased professional fees.
Interest expense on the Amended Credit Agreement decreased $1.8 million to
$22.0 million for the three months ended June 30, 2001 from $23.8 million for
the three months ended June 30, 2000. The decrease is primarily a result of
reduced principal balances. See "Note 4--Bank Credit Facility" to the Condensed
Consolidated Financial Statements.
39
Professional fees totaled approximately $1.1 million for the three months
ended June 30, 2001, as compared to $3.3 million for the three months ended June
30, 2000. The decrease relates primarily to the reduction in professional fees
incurred as a result of Kindred's emergence from bankruptcy. Fees incurred in
the first quarter of 2000 were significant in connection with Kindred's
bankruptcy filing as discussed above in "--Recent Developments Regarding
Kindred". As anticipated, legal and financial advisory fees have declined
after the Kindred Effective Date but may continue to be material.
As a result of the uncertainties relating to the Company's ability to retain
its NOL's, the Company recorded a charge for taxes on the 10% of its estimated
2001 taxable income, the portion of its taxable income which the Company does
not expect to distribute as a dividend. See "Note 3-- Concentration of Credit
Risk and Recent Developments--Recent Developments Regarding Income Taxes" to the
Condensed Consolidated Financial Statements. The Company's estimation of its
2001 taxable income and the related quarterly dividends is based on a number of
assumptions, including, but not limited to, the following: Kindred performs its
obligations under the Amended Master Leases and the Spin Agreements; no capital
transactions occur; the Company's tax positions do not change; the Company does
not incur any impact from new accounting rule FASB 133 relating to derivatives;
interest rates remain constant; the Company pays 90% of its taxable net income
as a dividend for 2001 and pays federal income tax on the remaining 10% of its
taxable net income; and the number of the Company's issued and outstanding
shares remain unchanged. The $1.2 million tax provision reported in the second
quarter of 2001 included $0.7 million related to the receipt of the New Kindred
Common Stock, of which 100% was taxable income to the Company in the second
quarter of 2001.
Net income for the three months ended June 30, 2001 was $8.1 million, or
$0.12 per diluted share. Net income for the three months ended June 30, 2000,
was $7.5 million or $0.11 per diluted share.
Six months ended June 30, 2001 and 2000
Rental income for the six months ended June 30, 2001 was $92.4 million, of
which $91.2 million (98.6%) resulted from leases with Kindred. The rental income
from Kindred includes $0.4 million related to the amortization of deferred
revenue recorded as a result of the receipt of the New Kindred Common Stock and
the $4.5 million of additional future rent under the Amended Master Leases. The
rental income for the six months ended June 30, 2001 is approximately equal to
net rental income for the six months ended June 30, 2000 of $92.4 million, of
which $90.7 million (98.2%) resulted from leases with Kindred. Under the Final
Plan, the Company waived its right to the payment of the difference between rent
required to be paid under the terms of the Original Master Leases and the rent
received by the Company after the Petition Date and prior to the beginning of
the month immediately following the Kindred Effective Date. As a result of this
waiver, the Company recorded revenue in 2001 equal to the amount actually paid
by Kindred. In 2000, the outcome of the Kindred bankruptcy was uncertain, and
the difference between the rent provided for in the Original Master Lease and
rent actually received from Kindred was written off to uncollectible rent
expense. Interest income totaled approximately $2.6 million for the six months
ended June 30, 2001 as compared to approximately $3.4 million for the six months
ended June 30, 2000. The decrease in interest income was primarily the result of
earnings from investments in smaller cash balances and reduced interest rates.
Expenses totaled $74.4 million for the six months ended June 30, 2001 and
included $21.0 million of depreciation expense on real estate assets and $43.1
million of interest on the Amended Credit Agreement and $1.4 million of interest
on the United States Settlement. For the six months ended June 30, 2000,
expenses totaled $104.6 million and included $21.2 million of depreciation
expense on real estate assets and $47.6 million of interest on the Amended
Credit Agreement, the United States Settlement and other debt. The $30.2 million
decrease in expenses was due primarily to (a) a charge to earnings of $23.4
million for the six months ended June 30, 2000 for uncollectible rent from
tenants, which primarily includes the difference between the minimum monthly
base rent due under the terms of the Original Master Leases and the base rent
that was paid under the terms of the Rent Stipulation and (b) decreased
professional fees and (c) decreased interest expense under the Amended Credit
Agreement.
40
Interest expense on the Amended Credit Agreement decreased $4.5 million to
$43.1 million for the six months ended June 30, 2001 from $47.6 million for the
six months ended June 30, 2000. The decrease is primarily a result of reduced
principal, reduced amortization of deferred financing fees and the favorable
impact in the first quarter of 2001of timing differences in the rate setting
under the Company's interest rate swap agreement and the Amended Credit
Agreement. See "Note 4--Bank Credit Facility" to the Condensed Consolidated
Financial Statements.
Professional fees totaled approximately $2.9 million for the six months ended
June 30, 2001, as compared to $6.6 million for the six months ended June 30,
2000. The decrease relates primarily to the reduction in professional fees
incurred as a result of Kindred's emergence from bankruptcy. Fees incurred in
2000 were significant in connection with Kindred's bankruptcy filing as
discussed above in "--Recent Developments Regarding Kindred". As anticipated,
legal and financial advisory fees have declined after the Kindred Effective Date
but may continue to be material.
The Internal Revenue Service is currently reviewing the federal income tax
returns of the Company for tax years ending December 31, 1997 and 1998. There
can be no assurances as to the ultimate outcome of these matters or whether such
outcome will have a Material Adverse Effect on the Company. However, the
resulting tax liabilities, if any, for the tax years ended December 31, 1997 and
1998 will be satisfied first from the loss of NOL carryforwards (including the
NOL carryforwards that were utilized to offset the Company's federal income tax
liability for 1999 and 2000).
As a result of the uncertainties relating to the Company's ability to retain
its NOL's, the Company recorded a charge for taxes on the 10% of its estimated
2001 taxable income which the Company does not expect to distribute as a
dividend. The Company's estimation of its 2001 taxable income and the related
quarterly dividends is based on a number of assumptions, including, but not
limited to, the following: Kindred performs its obligations under the Amended
Master Leases and the Spin Agreements; no capital transactions occur; the
Company's tax positions do not change; the Company does not incur any impact
from new accounting rule FASB 133 relating to derivatives; interest rates remain
constant; the Company pays 90% of its taxable net income as a dividend for 2001
and pays federal income tax on the remaining 10% of its taxable net income; and
the Company's issued and outstanding shares remain unchanged. The $1.9 million
tax provision reported for the six months ended June 30, 2001 included $0.7
million related to the receipt of the New Kindred Common Stock, of which 100% is
taxable income to the Company in the second quarter of 2001.
During the first quarter of 2000, the Company incurred an extraordinary loss
of $4.2 million relating to the write-off of the unamortized deferred financing
costs associated with the Bank Credit Agreement. See "Note 4--Bank Credit
Facility" to the Condensed Consolidated Financial Statements.
Net income for the six months ended June 30, 2001 was $18.7 million, or $0.27
per diluted share. After an extraordinary loss of $4.2 million, or $0.06 per
diluted share, as discussed above, net income for the six months ended June 30,
2000, was $10.2 million or $0.15 per diluted share.
Funds from Operations
Funds from operations ("FFO") for the three months ended and six months ended
June 30, 2001 totaled $18.6 million and $39.6 million, or $0.27 and $0.57 per
diluted share, respectively. FFO for the comparable period in 2000 totaled $18.0
million and $35.6 million or, $0.26 and $0.52 per diluted share, respectively.
In calculating net income and FFO for the three months and six months ended June
30, 2001 and 2000, the Company included in its expenses (and thus reduced net
income and FFO) the aforementioned legal and financial advisory expenses,
interest expense related to the United States Settlement, and the provision for
income taxes. FFO for the three months and six months ended June 30, 2001 and
2000 is summarized in the following table:
41
Three Months Ended Six Months Ended
------------------ ----------------
June 30, June 30, June 30, June 30,
-------- -------- -------- --------
2001 2000 2001 2000
---- ---- ---- ----
Net income........................................... $ 8,105 $ 7,512 $18,684 $10,245
Extraordinary loss on extinguishment of debt......... -- -- -- 4,207
------- ------- ------- -------
Income before extraordinary loss.................. 8,105 7,512 18,684 14,452
Add: depreciation on real estate investments......... 10,476 10,526 20,951 21,160
------- ------- ------- -------
Funds from operations............................. $18,581 $18,038 $39,635 $35,612
======= ======= ======= =======
FFO per diluted share................................ $ 0.27 $ 0.26 $ 0.57 $ 0.52
======= ======= ======= =======
Diluted Shares....................................... 69,307 68,101 69,090 68,007
======= ======= ======= =======
The Company considers FFO an appropriate measure of performance of an equity
REIT, and the Company uses the National Association of Real Estate Investment
Trust's, or NAREIT's, definition of FFO. NAREIT defines FFO as net income
(computed in accordance with accounting principles generally accepted in the
United States ("GAAP")), excluding gains (or losses) from debt restructuring and
sales of property, plus depreciation for real estate assets, and after
adjustments for unconsolidated partnerships and joint ventures. FFO presented
herein is not necessarily comparable to FFO presented by other real estate
companies due to the fact that not all real estate companies use the same
definition. FFO should not be considered as an alternative to net income
(determined in accordance with GAAP) as an indicator of the Company's financial
performance or as an alternative to cash flow from operating activities
(determined in accordance with GAAP) as a measure of the Company's liquidity,
nor is FFO necessarily indicative of sufficient cash flow to fund all of the
Company's needs. The Company believes that in order to facilitate a clear
understanding of the consolidated historical operating results of the Company,
FFO should be examined in conjunction with net income as presented in the
Condensed Consolidated Financial Statements and data included elsewhere in this
Form 10-Q.
Liquidity and Capital Resources
Cash provided by operations totaled $43.5 million for the six months ended
June 30, 2001 and included a $4.5 million cash payment received from Kindred as
additional future rent under the Amended Master Leases on the Kindred Effective
Date. For financial reporting purposes, the Company is amortizing the $4.5
million of additional future rent as future rent over the weighted average
remaining term of the Amended Master Leases. For the six months ended June 30,
2000 cash provided by operations totaled $39.5 million. Net cash used in
financing activities for the six months ended June 30, 2001 totaled $107.2
million and included a $36.0 million payment of principal on the Amended Credit
Agreement, a $36.8 million payment on the United States Settlement, and $34.5
million of cash dividend payments, including a $0.29 per common share to
stockholders of record on December 30, 2000 and a $0.22 per common share
dividend to stockholders of record on May 2, 2001. Net cash used in financing
activities for the six months ended June 30, 2000 totaled $63.5 million after
payment of $50.9 million on principal on the Amended Credit Agreement and
deferred financing payments of $12.6 million.
The Company had cash and cash equivalents of $23.4 million (excluding
restricted cash of $14.4 million) and outstanding debt of $850.4 million on
June 30, 2001.
In order to continue to qualify as a REIT, the Company must make annual
distributions to its stockholders of at least 90% for tax years ending on or
after December 31, 2001 of its "REIT taxable income" (excluding net capital
gain). The Company elected to qualify as a REIT for the year ended December 31,
1999. The Company believes that it has satisfied the requirements to qualify as
a REIT for the tax year ending December 31, 2000 and subsequent years. The
Company intends to pay a dividend for 2001 equal to at least 90% of the
Company's taxable income for 2001. The 2001 dividend may be satisfied by a
combination of cash or other property or securities, including the New Kindred
Common Stock. On April 20, 2001 and July 3, 2001 the Company declared dividends
of $0.22 per share each. These amounts represent a portion of 90% of the
Company's estimated annual net taxable income for 2001.
42
In estimating its 2001 taxable net income and the related dividends, the
Company previously assumed a value of $20.0 million for the New Kindred Common
Stock received by the Company on the Kindred Effective Date. The Company has
determined that the value of the New Kindred Common Stock was $18.2 million on
the date received. One hundred percent of the value of the New Kindred Common
Stock will be included in the Company's 2001 taxable income. For financial
reporting purposes, the value of the Company's New Kindred Common Stock is being
amortized as future rent over the weighted average remaining term of the Amended
Master Leases.
The Company is accounting for the New Kindred Common Stock under the cost
method of accounting. Under the cost method of accounting, income and dividends
are recognized when received.
The Company's estimation of its 2001 taxable income is based on a number of
assumptions, including, but not limited to, those set forth under "--Results of
Operations--Three Months ended June 30, 2001 and 2000."
It is expected that the Company's REIT taxable income will be less than its
cash flow due to the allowance of depreciation and other non-cash deductions in
computing REIT taxable income. However, this will be partially offset by the
value of the New Kindred Common Stock received by the Company on the Kindred
Effective Date which will be included in taxable income in the year received by
the Company. The Company anticipates that it generally will have sufficient cash
or liquid assets to enable it to satisfy the 90% distribution requirement. It is
possible, however, that the Company, from time to time, may not have sufficient
cash or other liquid assets to meet the 90% distribution requirement or to
distribute such greater amount as may be necessary to avoid income and excise
taxation.
It is important to note for purposes of the required REIT distributions that
the Company's taxable income may vary significantly from historical results and
from current income determined in accordance with GAAP depending on the
resolution of a variety of factors. Under certain circumstances, the Company may
be required to make distributions in excess of FFO (as defined by the National
Association of Real Estate Investment Trusts) in order to meet such distribution
requirements. In the event that timing differences or cash needs occur, the
Company may find it necessary to borrow funds or to issue equity securities
(there being no assurance that it will be able to do so) or, if possible, to pay
taxable stock dividends, distribute other property or securities or engage in a
transaction intended to enable it to meet the REIT distribution requirements.
The Company's ability to engage in certain of these transactions is restricted
by the terms of the Amended Credit Agreement. Any such transaction would likely
require the consent of the "Required Lenders" under the Amended Credit
Agreement, and there can be no assurance that such consent would be obtained. In
addition, the failure of Kindred to make rental payments under the Amended
Master Leases would impair materially the ability of the Company to make
distributions. Consequently, there can be no assurance that the Company will be
able to make distributions at the required distribution rate or any other rate.
Although the Company intends to continue to qualify as a REIT for the 2001 Tax
Year and subsequent tax years, it is possible that economic, market, legal, tax
or other considerations may cause the Company to fail or elect not to continue
to qualify as a REIT in any such tax year. If the Company were to fail or elect
not to continue to qualify as a REIT in any such tax year, the Company would be
subject to 35% federal income tax and to the applicable state and local income
taxes for the affected years. Such tax obligations would have a Material Adverse
Effect on the Company. Unless eligible for limited relief, if the Company
failed, or revoked its election to qualify as a REIT the Company would not be
eligible to elect again to be treated as a REIT before the fifth taxable year
after the year of such termination or revocation.
Under the terms of the Amended Credit Agreement, it was an Event of Default if
the Kindred Effective Date did not occur on or before December 31, 2000 (the
"Kindred Effective Date Deadline"). The Company and substantially all of its
lenders entered into an Amendment and Waiver dated as of December 20, 2000 (the
"Amendment and Waiver") to the Amended Credit Agreement that extended the
Kindred Effective Date Deadline was extended from December 31, 2000 to March 31,
2001. In consideration for this extension, the Company paid a fee of $0.2
million to the lenders executing the Amendment and Waiver and agreed to amend
the amortization
43
schedules on certain of the loans under the Amended Credit Agreement. The
Company exercised its option under the Amendment and Waiver to extend the
Kindred Effective Date Deadline from March 31, 2001 to April 30, 2001. In
consideration of this extension, the Company paid a fee of approximately $0.1
million to the lenders that executed the Amendment and Waiver. The Kindred
Effective date occurred on April 20, 2001.
The Amended Credit Agreement, as revised by the Amendment and Waiver, provides
for the following amortization schedule: (a) with respect to the Tranche A Loan,
(i) $50.0 million was paid at closing on January 31, 2000, (ii) $35.0 million
was paid on December 20, 2000, (iii) $15.0 million was paid on March 30, 2001,
and (iv) thereafter, all Excess Cash Flow pursuant to a monthly sweep as more
fully described below (the "Monthly Sweep") is applied to the Tranche A Loan
until $200.0 million in total has been paid down on the Amended Credit
Agreement, with the remaining principal balance of the Tranche A Loan due
December 31, 2002 (as of June 30, 2001, $123.6 million of principal has been
paid down under the Amended Credit Agreement), (b) with respect to the Tranche B
Loan, (i) $20.0 million was paid on March 30, 2001, (ii) a one-time paydown of
Excess Cash of $0.4 million was made on May 21, 2001, as more fully described
below (the "B Sweep"), (iii) $30.0 million is scheduled to be paid on December
30, 2003 and $50.0 million is scheduled to be paid on December 30, 2004 and (iv)
the remaining principal balance is due December 31, 2005; and (c) with respect
to the Tranche C Loan, there are no scheduled paydowns of principal and the
final maturity of December 31, 2007. The facilities under the Amended Credit
Agreement are pre-payable without premium or penalty.
The Company paid the B Sweep on May 21, 2001 in an amount of $0.4 million. The
B Sweep was a one-time payment equal to the Company's cash and cash equivalents
on hand on May 21, 2001 minus the sum of (to the extent not yet paid) (i)
amounts payable under the United States Settlement during the succeeding three
months, (ii) a reasonable reserve to pay the applicable portion of the Company's
minimum REIT dividend for the tax year ended December 31, 2000 and for quarters
in 2001 prior to and including the Kindred Effective Date, (iii) $1.0 million
and (iv) other specified amounts.
The first Monthly Sweep was scheduled to be made on July 31, 2001 and covered
the period from May 21, 2001 through June 30, 2001. The Company was not required
to pay any amounts under the first Monthly Sweep. Future Monthly Sweeps will
be made on the last business day of each month for the preceding month. The
Monthly Sweep will be in an amount equal to the Company's total cash receipts
for the applicable period, minus the sum of (i) cash disbursements by the
Company during the applicable period, (ii) up to $1.0 million for a working
capital reserve, (iii) a reserve in an amount equal to the unpaid minimum REIT
dividend for all prior periods and for the current calendar quarter, (iv) the
obligations due under the United States Settlement during the next three months,
(v) taxes and (vi) other specified amounts. The obligation of the Company to
make Monthly Sweeps terminates once $200 million in principal amount has been
paid down or refinanced under the Amended Credit Agreement. As of June 30,
2001, $123.6 million of principal has been paid down under the Amended Credit
Agreement.
Capital expenditures to maintain and improve the leased properties generally
will be incurred by the tenants under the leases with the Company. Accordingly,
the Company does not believe that it will incur any major expenditures in
connection with the leased properties. After the terms of the leases expire, or
in the event that the tenants are unable to meet their obligations under the
leases, the Company anticipates that any expenditures for which it may become
responsible to maintain the leased properties will be funded by cash flows from
operations and, in the case of major expenditures, through additional borrowings
or issuance of equity. To the extent that unanticipated expenditures or
significant borrowings are required, the Company's liquidity may be affected
adversely.
44
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The following discussion of the Company's exposure to various market risks
contains "forward looking statements" that involve risks and uncertainties.
These projected results have been prepared utilizing certain assumptions
considered reasonable in light of information currently available to the
Company. Nevertheless, because of the inherent unpredictability of interest
rates as well as other factors, actual results could differ materially from
those projected in such forward looking information.
The Company earns revenue by leasing its assets under leases that primarily
are long-term triple net leases in which the rental rate is generally fixed with
annual escalators, subject to certain limitations. The Company's debt
obligations are floating rate obligations whose interest rate and related
monthly interest payments vary with the movement in LIBOR. See "Note 4--Bank
Credit Facility" to the Condensed Consolidated Financial Statements. The general
fixed nature of the Company's assets and the variable nature of the Company's
debt obligations creates interest rate risk. If interest rates were to rise
significantly, the Company's lease revenue might not be sufficient to meet its
debt obligations. In order to mitigate this risk, at or about the date the
Company spun off its health care operations in connection with the 1998 Spin
Off, it also entered into an interest rate swap to effectively convert most of
its floating rate debt obligations to fixed rate debt obligations. Interest rate
swaps generally involve the exchange of fixed and floating rate interest
payments on an underlying notional amount. As of June 30, 2001, the Company had
an $850 million notional amount interest rate swap outstanding with a highly
rated counterparty in which the Company pays a fixed rate of 5.985% and receives
LIBOR from the counterparty. The notional amount of the interest rate swap
agreement is scheduled to decline as follows:
Notional Amount Date
--------------- -------------------
800,000,000 December 31, 2001
775,000,000 December 31, 2002
-- September 30, 2003
When interest rates rise the interest rate swap agreement increases in fair
value to the Company and when interest rates fall the interest rate swap
agreement declines in value to the Company. As of June 30, 2001, interest rates
had fallen and the interest rate swap agreement was in an unrealized loss
position to the Company of approximately $20.1 million. Generally, interest rate
swap agreements with longer terms evidence greater dollar values of variation
when interest rates change. To highlight the sensitivity of the interest rate
swap agreement to changes in interest rates, the following summary shows the
effects of a hypothetical instantaneous change of 100 basis points (BPS) in
interest rates as of June 30, 2001:
Notional Amount............................................ $ 850,000,000
Fair Value to the Company.................................. ($20,145,058)
Fair Value to the Company Reflecting
Change in Interest Rates
-100 BPS................................................ ($35,518,535)
+100 BPS................................................ ($5,103,564)
The terms of this interest rate swap agreement require that the Company make a
cash deposit or otherwise post collateral to the counterparty if the fair value
loss to the Company exceed certain levels (the "threshold levels"). The
threshold levels vary based on the relationship between the Company's debt
obligations and the tangible fair value of its assets as defined in the Bank
Credit Agreement. As of June 30, 2001, the Company believes that the threshold
level under the interest rate swap agreement was a fair value unrealized loss of
$35.0 million and the interest rate swap agreement was in an unrealized loss
position to the Company of $20.1 million; therefore, no collateral was required
to be posted. Under the interest rate swap agreement, if collateral must be
posted, the principal amount of such collateral must equal the difference
between the fair value unrealized loss of the interest rate swap agreement at
the time of such determination and the threshold amount. On January 31, 2000,
the Company entered into a letter agreement with the counterparty to the swap
agreement for the purpose of amending the swap agreement. The letter agreement
provides that, for purposes of certain calculations set forth in the swap
agreement, the parties agree to continue to use certain defined terms set forth
in the Bank Credit Agreement. See "Note 4--Bank Credit Facility" to the
Condensed Consolidated Financial Statements.
45
PART II--OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Except as set forth in "Note 5--Litigation" to the Condensed Consolidated
Financial Statements (which is incorporated by reference into this Item 1),
there has been no material change in the status of the litigation reported in
the Company's Annual Report on Form 10-K for the year ended December 31, 2000
and the Company's Quarterly Report on Form 10-Q for the quarter ended March 31,
2001.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
Since April 1, 2001, the Company has issued the following equity securities in
transactions that were not registered under the Securities Act:
On April 20, 2001, the Company granted to the members of the Board of
Directors 20,114 shares of common stock, par value of $0.25 per share of the
Company (the "Common Stock"). Fifty percent of the restricted stock vested on
the grant date and the remaining 50% will vest on the first anniversary date of
the grant date. There were no proceeds to the Company from the issuance of the
restricted stock. Based upon the number of offerees and the nature of their
relationship with the Company, the restricted stock was issued without
registration under the Securities Act, in reliance on an exemption contained in
Section 4(2) of the Securities Act.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
(a) The Annual Meeting of the stockholders of the Company was held on May 15,
2001.
(b) Proxies for the Annual Meeting were solicited pursuant to Regulation 14A
under the Exchange Act. There were no solicitations in opposition to
management's nominees for the Board of Directors and other proposals
listed in the Company's proxy statement. All nominees listed in the proxy
statement were elected and all proposals listed in the proxy statement
were approved.
(c) The election of six directors for the ensuing year was voted upon at the
Annual Meeting. The number of votes cast for and withheld for each nominee
for director is set forth below:
Nominee: For: Withheld:
-------- ---- --------
Walter F. Beran........................ 55,456,946 122,395
Debra A. Cafaro........................ 53,586,172 1,993,169
Douglas Crocker, II ................... 55,463,282 116,059
Ronald G. Geary........................ 54,782,791 796,550
W. Bruce Lunsford...................... 52,110,527 3,468,814
Sheli Z. Rosenberg..................... 55,461,720 37,613
(d) A proposal to ratify the selection of Ernst & Young LLP as the Company's
independent auditors for fiscal year 2001 was voted upon at the Annual
Meeting. The number of votes that were cast for and against this proposal,
the number of abstentions and the number of broker non-votes are set forth
below:
For: Against: Abstain: Broker Non-Votes:
---- -------- -------- -----------------
52,260,365 410,937 33,173 0
46
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS:
10.1 Ventas, Inc. Common Stock Purchase Plan for Directors dated June 22,
2001
(b) REPORTS ON FORM 8-K:
On July 5, 2001, the Company filed a Current Report on Form 8-K announcing
that on July 3, 2001 its Board of Directors voted to pay a cash dividend of
$0.22 per share payable on July 23, 2001 to stockholders of record on July 13,
2001.
On July 25, 2001, the Company filed a Current Report on Form 8-K announcing
that on July 23, 2001 the Company adopted a Distribution Reinvestment and Stock
Purchase Plan for existing shareholders and interested new investors. The
Company also announced that it planned to release second quarter 2001 earnings
on Friday, August 10, 2001 and that it planned to hold a web cast conference
call to discuss earnings and other matters at 10:00 a.m. Eastern Time on August
10, 2001.
47
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.
Date: August 10, 2001
Ventas, Inc.
By: /s/ Debra A. Cafaro
-------------------
Debra A. Cafaro
Chief Executive Officer and President
By: /s/ Mary L. Smith
-----------------
Mary L. Smith
Principal Accounting Officer
48