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 SEPTEMBER 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 November 8, 2001:
Common Stock, $.25 par value 68,840,027 Shares
VENTAS, INC.
FORM 10-Q
INDEX
Page
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PART I--FINANCIAL INFORMATION........................................................................... 3
Item 1. Financial Statements........................................................................ 3
Condensed Consolidated Balance Sheets as of September 30, 2001 and December 31, 2000........ 3
Condensed Consolidated Statements of Income for the Three Months Ended and Nine
Months Ended September 30, 2001 and September 30, 2000.................................... 4
Condensed Consolidated Statement of Comprehensive Income.................................... 5
Condensed Consolidated Statements of Cash Flows for the
Nine Months Ended September 30, 2001 and September 30, 2000............................... 6
Notes To Condensed Consolidated Financial Statements........................................ 7
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations....... 31
Item 3. Quantitative and Qualitative Disclosures About Market Risk.................................. 40
PART II--OTHER INFORMATION.............................................................................. 42
Item 1. Legal Proceedings........................................................................... 42
Item 6. Exhibits and Reports on Form 8-K............................................................ 42
2
PART I--FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
VENTAS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
September 30, December 31,
2001 2000
(Unaudited) (Audited)
------------- -------------
Assets
Real estate investments:
Land......................................................................... $ 119,771 $ 120,151
Building and improvements.................................................... 1,055,992 1,055,992
------------- -------------
1,175,763 1,176,143
Accumulated depreciation (359,023) (327,598)
------------- -------------
Total real estate investments.............................................. 816,740 848,545
Cash and cash equivalents..................................................... 23,827 87,401
Restricted cash--held in tax escrow........................................... 15,906 26,893
Restricted cash--held as swap collateral...................................... 2,833 --
Recoverable federal income taxes.............................................. -- 3,211
Deferred financing costs, net................................................. 9,039 10,875
Investment in Kindred Healthcare, Inc. common stock........................... 88,412 --
Notes receivable from employees 3,589 3,422
Other......................................................................... 2,436 798
------------- -------------
Total assets............................................................... $ 962,782 $ 981,145
============= =============
Liabilities and stockholders' equity
Liabilities:
Notes payable and other debt................................................. $ 850,016 $ 886,385
United States Settlement..................................................... 57,262 96,493
Deferred gain on partial termination of interest rate swap agreement......... -- 21,605
Deferred revenue............................................................. 21,655 --
Interest rate hedges......................................................... 40,942 --
Accrued dividend............................................................. 15,148 19,846
Accounts payable and other accrued liabilities............................... 13,700 13,720
Other liabilities--disputed federal, state and local tax refunds............. 15,183 30,104
Deferred income taxes........................................................ 30,506 30,506
------------- -------------
Total liabilities............................................................. 1,044,412 1,098,659
------------- -------------
Commitments and contingencies
Stockholders' equity:
Preferred stock, unissued.................................................... -- --
Common stock................................................................. 18,402 18,402
Capital in excess of par value............................................... 123,323 132,228
Unearned compensation on restricted stock.................................... (1,446) (1,338)
Accumulated other comprehensive income....................................... 50,875 --
Retained earnings (deficit).................................................. (138,899) (121,323)
------------- -------------
52,255 27,969
Treasury stock............................................................... (133,885) (145,483)
------------- -------------
Total stockholders' equity (deficit)....................................... (81,630) (117,514)
------------- -------------
Total liabilities and stockholders' equity................................. $ 962,782 $ 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 Nine Months Ended
September 30, September 30,
------------------------------- --------------------------------
2001 2000 2001 2000
---------------- --------------- --------------- ----------------
Revenues:
Rental income................................... $46,357 $58,567 $138,769 $174,288
Interest and other income....................... 939 2,312 3,507 5,665
---------------- --------------- --------------- ----------------
47,296 60,879 142,276 179,953
Expenses:
General and administrative...................... 2,598 2,583 7,740 7,330
Professional fees............................... 699 2,735 3,595 9,328
Non-recurring employee severance costs.......... -- -- -- 355
Loss on uncollectible amounts due from tenant... -- 12,469 -- 35,837
Amortization of restricted stock grants......... 444 309 1,286 1,044
Depreciation.................................... 10,510 10,541 31,515 31,739
Interest........................................ 22,103 23,661 65,181 71,287
Interest on United States Settlement............ 1,605 -- 3,053 --
---------------- --------------- --------------- ----------------
Total expenses................................ 37,959 52,298 112,370 156,920
---------------- --------------- --------------- ----------------
Income before gain on real estate, income taxes and
extraordinary loss............................... 9,337 8,581 29,906 23,033
Net gain on real estate disposal..................... 290 -- 290 --
---------------- --------------- --------------- ----------------
Income before income taxes and extraordinary loss.... 9,627 8,581 30,196 23,033
Provision for income taxes........................... 470 -- 2,355 --
---------------- --------------- --------------- ----------------
Income before extraordinary loss..................... 9,157 8,581 27,841 23,033
Extraordinary loss on extinguishment of debt......... -- -- -- (4,207)
---------------- --------------- --------------- ----------------
Net income........................................... $ 9,157 $ 8,581 $ 27,841 $ 18,826
================ =============== =============== ================
Earnings per common share:
Basic:
Income before extraordinary loss........... $ 0.13 $ 0.13 $ 0.41 $ 0.34
Extraordinary loss on extinguishment of
debt...................................... -- -- -- (0.06)
---------------- --------------- --------------- ----------------
Net income................................. $ 0.13 $ 0.13 $ 0.41 $ 0.28
================ =============== =============== ================
Diluted:
Income before extraordinary loss........... $ 0.13 $ 0.13 $ 0.40 $ 0.34
Extraordinary loss on extinguishment of
debt...................................... -- -- -- (0.06)
---------------- --------------- --------------- ----------------
Net income................................. $ 0.13 $ 0.13 $ 0.40 $ 0.28
================ =============== =============== ================
Shares used in computing earnings per
common share:
Basic........................................... 68,491 68,037 68,375 67,986
Diluted......................................... 69,584 68,224 69,255 68,077
Dividend declared per common share.................. $ 0.22 $ 0.62 $ 0.66 $ 0.62
See notes to condensed consolidated financial statements
4
VENTAS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
(In thousands)
For Three Months For Nine Months
Ended Ended
September 30, 2001 September 30, 2001
------------------------ ---------------------
Net income................................................ $ 9,157 $ 27,841
Other comprehensive income (loss):
Cumulative effect from change in accounting for
derivatives...................................... -- 17,476
Unrealized loss on interest rate swap................ (20,797) (36,813)
Unrealized gain on Kindred, Inc. common stock........ 70,212 70,212
------------------------ ---------------------
49,415 50,875
------------------------ ---------------------
Net comprehensive income............................. $ 58,572 $ 78,716
======================== =====================
See notes to condensed consolidated financial statements
5
VENTAS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In thousands)
Nine Months Ended
-------------------------------------------------
September 30, September 30,
2001 2000
--------------------- -------------------
Cash flows from operating activities:
Net income................................................................. $ 27,841 $ 18,826
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation.......................................................... 31,515 31,739
Amortization of deferred financing costs.............................. 1,836 2,625
Amortization of restricted stock grants............................... 1,286 1,044
Normalized rents...................................................... 7 (113)
Extraordinary loss on extinguishment of debt.......................... -- 4,207
Gain on sale of real estate........................................... (290) --
Other................................................................. 13 --
Amortization of deferred revenue...................................... (1,045) --
Changes in operating assets and liabilities:
(Increase) decrease in restricted cash................................ 8,154 (28,223)
(Increase) decrease in accounts receivable and other assets........... (1,513) 23,957
Increase (decrease) in accounts payable and accrued and other
liabilities......................................................... (6,480) 8,173
--------------------- -------------------
Net cash provided by operating activities......................... 61,324 62,235
Cash flows from investing activities:
Proceeds from sale of real estate........................................ 670 --
Purchase of furniture and equipment...................................... (220) --
Decrease (increase) in notes receivable from employees................... (167) 225
--------------------- -------------------
Net cash provided by investing activities.......................... 283 225
Cash flows from financing activities:
Repayment of long-term debt.............................................. (36,369) (50,879)
Payment on United States Settlement...................................... (39,231) --
Payment of deferred financing costs...................................... -- (12,616)
Issuance of stock........................................................ 537 14
Cash dividends to stockholders........................................... (50,118) (42,435)
--------------------- -------------------
Net cash used in financing activities.............................. (125,181) (105,916)
--------------------- -------------------
Decrease in cash and cash equivalents...................................... (63,574) (43,456)
Cash and cash equivalents--beginning of period............................. 87,401 139,594
--------------------- -------------------
Cash and cash equivalents--end of period................................... $ 23,827 $ 96,138
======================= =====================
Supplemental Schedule of noncash activities:
Receipt of Kindred Healthcare, Inc. common stock........................ $ 18,200 --
======================= =====================
See notes to condensed consolidated financial statements
6
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. The Company believes that it has satisfied the
requirements to qualify as a REIT for the tax year ended December 31, 2000.
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 September 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 nine-month period ended September 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. The Company does not operate these facilities nor
does it allocate capital to maintain the properties. 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
7
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 September 30, 2001,
the Company's derivative instruments were reported at fair value as liabilities
in the Condensed Consolidated Balance Sheet at $40.9 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 September 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 impact 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. As a consequence of
the foregoing, the credit standing of the Company is affected by the general
creditworthiness of Kindred.
8
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, which is payable in all
cash, 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 will 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 "Kindred Common Stock"). The Kindred Common Stock was issued to Ventas
Realty as additional future rent in consideration of the Company and
9
VENTAS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
Ventas Realty's agreement with Kindred 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 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 nine months ended September
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 from May
1, 2001 through September 30, 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.
10
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 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 will 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
11
VENTAS,INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
or substantially all of the indebtedness of the Tenant under the Tenant's
new senior secured credit agreement is 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, will 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.
12
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) will
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
13
VENTAS,INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
circumstances), terminate that particular entire Amended Master Lease, repossess
all leased properties under such 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.
14
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. For the nine months ended September 30, 2001,
the Company has recorded $0.7 million of interest income related to the Escrow
Funds. 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 September 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 September 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
15
VENTAS,INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
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 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 $13.2 million from the expiration of Third Party
Leases in accordance with their terms and $17.2 million due to the early
termination and release of certain 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,
16
VENTAS,INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
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 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 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 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 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 Kindred Common Stock,
subject to customary exceptions and black-out and suspension periods. In
addition, until such time as the 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.
Pursuant to Amendment No. 1 to the Registration Rights Agreement dated as
of August 13, 2001, Ventas Realty and the other signatories to the Registration
Rights Agreement agreed to extend the deadline for Kindred to file a shelf
registration statement from 120 days to 150 days after the Kindred Effective
Date. Kindred filed a shelf registration statement on Form S-3 with the
Commission on September 19, 2001. The shelf registration statement was declared
effective by the Commission on November 7, 2001. Under the shelf registration
statement, subject to certain restrictions, the Company and Ventas Realty, may,
but are not obligated to, sell, distribute or otherwise transfer, some or all of
the shares of Kindred Common Stock owned by Ventas Realty at any time.
Kindred filed a registration statement on Form S-3 with the Commission on
August 31, 2001 (the "Underwritten Offering Registration Statement") with
respect to an underwritten offering of shares of Kindred Common Stock (the
"Underwritten Offering"). Ventas Realty exercised its "piggyback" registration
rights with respect to the Underwritten Offering Registration Statement to sell
83,300 shares of Kindred Common Stock. The Underwritten Offering Registration
Statement was declared effective by the Commission on November 7, 2001.
17
VENTAS,INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Under the terms of the Registration Rights Agreement, the Company would have
been prohibited from selling, disposing or otherwise transferring any Kindred
Common Stock pursuant to the shelf registration statement through and including
February 5, 2002. Pursuant to Amendment No. 2 to the Registration Rights
Agreement dated as of October 22, 2001, as an exception to such restriction the
Company may (but is not obligated to) distribute up to 350,000 shares of the
Kindred Common Stock to its stockholders on or after December 24, 2001 and its
stockholders may resell such shares.
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, 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 two quarterly installments
under the United States Settlement.
The Company also 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:
18
VENTAS,INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(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
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.
The United States Settlement provides that if the Company fails 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 will not affect the
Company's rights, duties, benefits, and/or obligations under the United States
Settlement
Sale of 83,300 Shares of Kindred Common Stock
Ventas Realty exercised its "piggyback" registration rights under the
Registration Rights Agreement to sell 83,300 shares of Kindred Common Stock in
the Underwritten Offering under the Underwritten Offering Registration
Statement. If the Underwritten Offering is consummated, the Company intends to
apply the net proceeds from the sale of the 83,300 shares of Kindred Common
Stock as a prepayment on the Company's indebtedness under the Amended Credit
Agreement. However, there can be no assurance that the Underwritten Offering
will occur, or, if it does occur, the amount of proceeds that Ventas Realty will
receive from such sale.
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
19
VENTAS,INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
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 due to limitations contained in the Amended Credit Agreement.
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 filed its federal income tax
return for the tax year ended December 31, 2000 (the "2000 Tax Year") on
September 14, 2001. The Company believes it has met the REIT annual distribution
requirement of payment of 95% of its estimated 2000 taxable net 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 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 per share. The second quarterly dividend
for 2001 was paid on July 23, 2001 to stockholders of record on July 13, 2001.
On September 11, 2001, the Company declared the third quarterly dividend for
2001 of $0.22 per share. The third quarterly dividend was paid on October 1,
2001 to stockholders of record on September 21, 2001. The first, second and
third 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 the remaining distributions will be
made. The remaining portion of 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 Kindred Common Stock received by the Company on the
Kindred Effective Date.
20
VENTAS,INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
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 Kindred Common Stock was $18.2
million on the date received. One hundred percent of this value of the Kindred
Common Stock will be included in the Company's 2001 taxable income. For
financial reporting purposes, this value of the Company's Kindred Common Stock
is being amortized as future rent over the weighted average remaining term of
the Amended Master Leases.
Due to the lack of marketability at June 30, 2001, the Kindred Common Stock
was accounted for under the cost method in the Company's Quarterly Report on
Form 10-Q for the quarter ended June 30, 2001. Due to trading volume growth and
pricing consistency in the over the counter market, the Kindred Common Stock was
considered marketable for accounting purposes at September 30, 2001 and
classified as available for sale in accordance with SFAS No. 115, Accounting for
Certain Investments in Debt and Equity Securities. Accordingly, the Kindred
Common Stock is measured at fair value as of September 30, 2001. The unrealized
gains and losses are reported as a component of Accumulated Other Comprehensive
Income. As of September 30, 2001, the fair value of the Kindred Common Stock
was $88.4 million. A $70.2 million unrealized gain on the Kindred Common Stock
was reported in Accumulated Other Comprehensive Income at September 30, 2001.
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 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.
21
VENTAS,INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
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 July 2001 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. On August 30, 2001 the Bankruptcy Court approved IHS
Acquisition's motion to reject the lease effective as of August 14, 2001. To
date, the Company has not located a substitute tenant for the nursing facility.
If the Company does not locate a substitute tenant for the facility on 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. The
Company filed an Amended Proof of Claim on October 12, 2001 for damages
resulting from the 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.
22
VENTAS,INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
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 September 30, 2001, the outstanding
principal balance of the Tranche A Loan was $97.0 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.
The Amended Credit Agreement, as revised by an 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 remaining principal
balance is due December 31, 2005; and (c) with respect to the Tranche C Loan,
there are no scheduled paydowns of principal until 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. Monthly Sweeps were
scheduled for August 31, 2001, September 28, 2001 and October 31, 2001. The
Company has not yet been required to pay any amounts under the Monthly Sweeps.
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 September 30, 2001, $124.0 million of principal has been paid down under the
Amended Credit Agreement.
23
VENTAS,INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The following is a summary of long-term borrowings at September 30, 2001
and December 31, 2000 (in thousands):
September 30, December 31,
------------- ------------
2001 2000
---- ----
Tranche A Loan, bearing interest at a rate of LIBOR plus 2.75%
(5.42% at September 30, 2001, 9.48% at December 31, 2000),
due December 31, 2002.............................................. $ 97,076 $113,017
Tranche B Loan, bearing interest at a rate of LIBOR plus 3.75%
(6.38% at September 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%
(6.85% at September 30, 2001, 10.98% at December 31, 2000),
due December 31, 2007.............................................. 473,368 473,368
-------- --------
$850,016 $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 September 30, 2001,
$124.0 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 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.
Under the Amended Credit Agreement, the Company is required to apply as a
prepayment on Tranche A the net cash proceeds from, among other things, the sale
of the Company's real estate assets. On September 24, 2001, the Company received
$0.7 million for the sale of excess undeveloped land. The Company applied $0.4
million of the proceeds from the sale to paydown Tranche A debt, as required by
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 has two interest rate swaps to manage interest rate risk.
The Company prohibits the use of derivative instruments for trading or
speculative purposes. Further, the
24
VENTAS,INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
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.
One of the Company's interest rate swap agreements has a notional principal
amount of $850.0 million, under which the Company pays a fixed rate at 5.985%
and receives LIBOR (floating rate) maturing June 30, 2003 (the "1998 Swap"). The
terms of the 1998 Swap 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 its prior Bank Credit Agreement. As of September 30, 2001, $2.8
million in cash was posted as collateral under the 1998 Swap.
As a result of falling interest rates, the 1998 Swap has declined further
in value since September 30, 2001. As of October 31, 2001, the Company had
posted a total of $9.9 million of collateral in the form of a letter of credit.
If the 1998 Swap continues to decline in value, the Company will have to post
additional collateral in the form of cash, one or more letters of credit or
other permitted credit support. The Company is permitted to issue up to $15
million in principal amount of letters of credit under the $25 million revolving
credit facility under the Amended Credit Agreement. If the Company should be
required to post collateral under the 1998 Swap in excess of $15 million, the
Company expects to post such additional collateral in the form of cash from cash
reserves, cash flows from operations, and/or draws on the Company's revolving
credit facility under the Amended Credit Agreement up to a principal amount of
$25 million, net of outstanding letters of credit. However, there can be no
assurance that the Company will have sufficient cash to post such additional
collateral, if required.
The notional amount of the 1998 Swap is scheduled to decline as follows:
Notional Amount Date
--------------- --------------
800,000,000 December 31, 2001
775,000,000 December 31, 2002
-- June 30, 2003
The 1998 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 $22.4 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 nine months
ended September 30, 2001 was $4.9 million and $6.2 million, respectively. See
"Note 2-- Basis of Presentation--Change in Accounting Principle".
On August 4, 1999, the Company entered into an agreement with the 1998 Swap
counterparty to shorten the maturity of the 1998 Swap 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. The Company expects to 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
1998 Swap counterparty 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.
25
VENTAS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
On September 28, 2001, the Company entered into a second interest rate swap
agreement (the "2003-2008 Swap") to hedge floating-rate debt for the period
between July 1, 2003 and June 30, 2008, under which the Company pays a fixed
rate at 5.385% and receives LIBOR from the counterparty to the agreement. The
2003-2008 Swap is treated as a cash flow hedge. There are no collateral
requirements under this agreement. The notional amount of the 2003-2008 Swap is
$450 million and is scheduled to decline as follows:
Notional Amount Date
--------------- ----
$300,000,000 June 30, 2006
150,000,000 June 30, 2007
On September 30, 2001, the derivative instruments were reported at fair value
in liabilities in the Condensed Consolidated Balance Sheet of $40.9 million.
The offsetting adjustment is reported as a deferred loss in Accumulated Other
Comprehensive Income.
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
26
VENTAS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
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, on behalf of the Company, filed a Petition for Certiorari
on September 27, 2001 seeking review of the Sixth Circuit's decision in 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. Plaintiffs filed their memorandum in opposition to the defendant's
motion to dismiss on October 10, 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 covered the
Company's former health care operations prior to the date of the 1998 Spin Off.
In the United States Settlement, documented in the Final Plan, the United
States, the Company and Kindred resolved all claims arising out of the
investigations by the Department of Justice and the Office of Inspector General
including certain pending qui tam, or whistleblower, actions. Under the United
States Settlement, the United States was required to move to dismiss with
prejudice to the United States and the relators (except for certain claims which
will be dismissed without prejudice to the United States in certain of the
cases) the pending qui tam actions as against the Company, Kindred and any
current or former officers, directors and employees of either entity.
Except for the qui tam action described in this paragraph, all other pending
qui tam actions against the Company have been resolved by the United States
Settlement. The only remaining case is entitled United States, et al., ex rel.
Phillips-Minks, et al. v. Transitional Corp., et al., filed in the United States
District Court for Southern District of California on July 23, 1998. In this
action, the defendants, including Transitional Hospitals Corporation and the
Company, are alleged to have submitted and conspired to submit false claims and
statements to Medicare, Medicaid, and other federal and state funded programs
during a period commencing in 1993. The conduct
27
VENTAS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
complained of allegedly violates the Federal Civil 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.
The defendants allegedly submitted improper and erroneous claims to Medicare,
Medicaid and other programs for improper or unnecessary services and services
not performed, made inadequate collection efforts associated with billing and
collecting bad debts, submitted inflated and nonexistent laboratory charges,
submitted false and inadequate documentation of claims, split charges, shifted
revenues and expenses, transferred patients to hospitals that were reimbursed by
Medicare at a higher level, failed to return duplicate reimbursement payments,
and improperly allocated hospital insurance expenses. In addition, the complaint
alleges that the defendants were inconsistent in their reporting of cost report
data, paid kickbacks to increase patient referrals to hospitals, and incorrectly
reported employee compensation resulting in inflated employee 401(k)
contributions. The complaint seeks unspecified damages. On July 27, 2001, the
court ordered that the Department of Justice be allowed to intervene in the
action to effectuate the United States Settlement contained in the Final Plan.
The Department of Justice informed the Company that on September 6, 2001, the
Department of Justice filed a motion to dismiss this case with prejudice to the
United States and the relators (except for certain claims which will be
dismissed without prejudice to the United States) as against the Company,
Kindred and any current or former officers, directors and employees of either
entity. There can be no assurance that the court will dismiss this case upon the
motion by the Department of Justice.
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 regulatory
investigations. In addition, there can be no assurance that the Center for
Medicare and Medicaid Services (formerly known as United States Health Care
Financing Administration) ("CMS") 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
28
VENTAS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
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
filed a motion to dismiss this action on August 27, 2001. A hearing on the
Company's motion to dismiss was held on October 25, 2001. As of November 9,
2001, the court had not rendered a ruling on the Company's motion to dismiss.
The Company intends to defend its positions vigorously and to assert any
appropriate counterclaims against Atria and its controlling parties.
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 Nine Months Ended
------------------------------- --------------------------------
Sept. 30, Sept. 30, Sept. 30, Sept. 30,
--------- --------- --------- ---------
2001 2000 2001 2000
---- ---- ---- ----
Numerator for Basic and Diluted Earnings Per Share:
Income before Extraordinary Item ...................... $ 9,157 $ 8,581 $27,841 $23,033
Extraordinary Item..................................... -- -- -- (4,207)
------- ------- ------- -------
Net Income............................................. $ 9,157 $ 8,581 $27,841 $18,826
======= ======= ======= =======
Denominator:
Denominator for Basic Earnings Per Share
--Weighted Average Shares........................... 68,491 68,037 68,375 67,986
Effect of Dilutive Securities:
Stock Options....................................... 924 99 749 51
Time Vesting Restricted Stock Awards................ 169 88 131 40
------- ------- ------- -------
Dilutive Potential Common Stock..................... 1,093 187 880 91
------- ------- ------- -------
Denominator for Diluted Earnings Per Share
--Adjusted Weighted Average ......................... 69,584 68,224 69,255 68,077
======= ======= ======= ========
Basic Earnings Per Share:
Income before Extraordinary Item........................ $ 0.13 $ 0.13 $ 0.41 $ 0.34
Extraordinary Item...................................... -- -- -- (0.06)
------- ------- ------- -------
Net Income.............................................. $ 0.13 $ 0.13 $ 0.41 $ 0.28
======= ======= ======= =======
Diluted Earnings Per Share:
Income before Extraordinary Item........................ $ 0.13 $ 0.13 $ 0.40 $ 0.34
Extraordinary Item...................................... -- -- -- (0.06)
------- ------- ------- -------
Net Income.............................................. $ 0.13 $ 0.13 $ 0.40 $ 0.28
======= ======= ======= =======
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 agreements 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, including, without
limitation, the Company's failure to qualify as a REIT due to its ownership of
Kindred common stock, (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
year ended December 31, 2001, (q) 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 to relet its properties on the same or better terms in the
event such leases expire and are not renewed by the existing tenants and (r) the
limitations on the ability of the Company to sell, transfer or otherwise dispose
of its common stock in Kindred arising out of the securities laws and the
registration rights agreement, the Company entered into with Kindred and certain
of the holders of the Kindred Common Stock. Many of such factors are beyond the
control of the Company and its management.
31
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 September 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
Amendments to Registration Rights Agreement
Under the terms of Kindred's Fourth Amended Plan of Reorganization, as
modified on the record at the confirmation hearing held on March 1, 2001(as
modified, the "Final Plan"), 1,498,500 shares of the common stock of Kindred
(the "Kindred Common Stock") were distributed to Ventas Realty on April 20,
2001, the effective date of the Final Plan (the "Kindred Effective Date"). On
the Kindred Effective Date, Kindred executed and delivered to Ventas Realty,
certain other initial holders of 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 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). See "Note 3--
Concentration of Credit Risk and Recent Developments-Recent Developments
Regarding Kindred-Registration Rights Agreement" to the Condensed Consolidated
Financial Statements.
Pursuant to Amendment No. 1 to the Registration Rights Agreement dated as of
August 13, 2001, Ventas Realty and the other signatories to the Registration
Rights Agreement agreed to extend the deadline for Kindred to file a shelf
registration statement from 120 days to 150 days after the Kindred Effective
Date. Kindred filed a shelf registration statement with the Securities and
Exchange Commission (the "Commission") on September 19, 2001. The shelf
registration statement on Form S-3 was declared effective by the Commission on
November 7, 2001. Under the shelf registration statement, subject to certain
restrictions, the Company and Ventas Realty, may, but are not obligated to,
sell, distribute or otherwise transfer, some or all of the shares of Kindred
Common Stock owned by Ventas Realty at any time.
Kindred filed a registration statement on Form S-3 with the Commission on
August 31, 2001 (the "Underwritten Offering Registration Statement") with
respect to an underwritten offering of shares of the Kindred Common Stock (the
"Underwritten Offering"). Ventas Realty exercised its "piggy back" registration
rights with respect to the Underwritten Offering Registration
32
Statement to sell 83,300 shares of Kindred Common Stock. The Underwritten
Offering Registration Statement was declared effective by the Commission on
November 7, 2001. Under the terms of the Registration Rights Agreement, the
Company would have been prohibited from selling, disposing or otherwise
transferring any Kindred Common Stock pursuant to the shelf registration
statement through and including February 5, 2002, except as provided in
Amendment No. 2 to the Registration Rights Agreement dated as of October 22,
2001. Pursuant to Amendment No. 2 to the Registration Rights Agreement, as an
exception to such restriction, the Company may (but is not obligated to)
distribute up to 350,000 shares of the Kindred Common Stock to its stockholders
on or after December 24, 2001 and its stockholders may resell such shares.
Sale of 83,300 Shares of Kindred Common Stock
Ventas Realty exercised its "piggyback" registration rights under the
Registration Rights Agreement to sell 83,300 shares of Kindred Common Stock in
the Underwritten Offering under the Underwritten Offering Registration
Statement. If the Underwritten Offering is consummated, the Company intends to
apply the net proceeds from the sale of the 83,300 shares of Kindred Common
Stock as a prepayment on the Company's indebtedness under the Amended Credit
Agreement. However, there can be no assurance that the Underwritten Offering
will occur, or, if it does occur, the amount of proceeds that Ventas Realty will
receive from such sale.
Results of Operations
The Company elected to qualify as a REIT for federal income tax purposes for
the tax years ended December 31, 1999 and 2000. 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. The Company's failure to continue to qualify as a REIT 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").
Three months ended September 30, 2001 and 2000
Rental income for the three months ended September 30, 2001 was $46.4 million,
of which $45.9 million (98.9%) resulted from leases with Kindred. The rental
income from Kindred includes $0.6 million related to the amortization of
deferred revenue recorded as a result of the receipt on April 20, 2001 of the
Kindred Common Stock and the $4.5 million of additional future rent under the
four Amended and Restated Master Lease Agreements all dated April 20, 2001 by
and among Kindred and Kindred Operating, Inc., as tenant, and Ventas Realty, as
landlord (individually an "Amended Master Lease" and collectively the "Amended
Master Leases"). The rental income for the three months ended September 30, 2001
is approximately equal to net rental income (rental income less uncollectible
rent from tenants) for the three months ended September 30, 2000 of $46.1
million, of which $45.3 million (98.3%) resulted from leases with Kindred. In
the third quarter of 2000, the outcome of Kindred's bankruptcy was uncertain,
and the difference between the rent provided for under the terms of 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 rent actually
received from Kindred was written off to uncollectible rent expense. The
Company included in its revenue computation for the third quarter of 2001 an
amount equal to the amount of rent paid by Kindred under the Amended Master
Leases.
Interest income totaled approximately $0.9 million for the three months
ended September 30, 2001 as compared to approximately $2.3 million for the three
months ended September 30, 2000. The decrease in interest income was primarily
the result of lower cash balances and reduced interest rates.
Expenses totaled $38.0 million for the quarter ended September 30, 2001 and
included $10.5 million of depreciation expense on real estate assets and $22.1
million of interest on the Amended Credit Agreement and $1.6 million of interest
on the settlement contained in the Final Plan of the civil and administrative
claims asserted by the United States against the Company and Kindred (the
"United States Settlement"). See "Note 3--Concentration of Credit Risk and
Recent Developments" to the Condensed Consolidated Financial Statements. For the
quarter ended September 30, 2000, expenses totaled $52.3 million and
33
included $10.5 million of depreciation expense on real estate assets and $23.7
million of interest on the Amended Credit Agreement. The $14.3 million decrease
in expenses was due primarily to (a) a charge to earnings of $12.5 million for
the quarter ended September 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 stipulation and order entered by the Bankruptcy Court on
or about September 13, 1999 (the "Rent Stipulation") and (b) decreased
professional fees.
Interest expense on the Amended Credit Agreement decreased $1.6 million to
$22.1 million for the three months ended September 30, 2001 from $23.7 million
for the three months ended September 30, 2000. The decrease is primarily a
result of reduced principal balances. See "Note 4--Bank Credit Facility" to the
Condensed Consolidated Financial Statements.
Professional fees totaled approximately $0.7 million for the three months
ended September 30, 2001, as compared to $2.7 million for the three months ended
September 30, 2000. The decrease relates primarily to the reduction in
professional fees incurred as a result of Kindred's emergence from bankruptcy.
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 net operating losses ("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. 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.
Net income for the three months ended September 30, 2001 was $9.2 million, or
$0.13 per diluted share. Net income for the three months ended September 30,
2000, was $8.6 million or $0.13 per diluted share.
Nine months ended September 30, 2001 and 2000
Rental income for the nine months ended September 30, 2001 was $138.8 million,
of which $137.0 million (98.7%) resulted from leases with Kindred. The rental
income from Kindred includes $1.0 million related to the amortization of
deferred revenue recorded as a result of the receipt of the Kindred Common Stock
and the $4.5 million of additional future rent under the Amended Master Leases.
The rental income for the nine months ended September 30, 2001 is approximately
equal to net rental income for the nine months ended September 30, 2000 of
$138.5 million, of which $136.0 million (98.2%) resulted from leases with
Kindred. In 2000, the outcome of the Kindred bankruptcy was uncertain, and the
difference between the rent provided for in the Original Master Leases and rent
actually received from Kindred was written off to uncollectible rent expense.
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 date that Kindred
filed for protection under chapter 11 of the Bankruptcy Code (the "Petition
Date" ) and prior to the beginning of the month immediately following the
Kindred Effective Date. As a result of this waiver, for the period in 2001
preceding the Kindred Effective Date, or January 2001 through April 2001, the
Company recorded revenue equal to the amount actually paid by Kindred. The
Company included in its revenue computation for the period May 2001 through
September 2001 an amount equal to the amount of rent paid by Kindred under the
Amended Master Leases.
Interest income totaled approximately $3.5 million for the nine months ended
September 30, 2001 as compared to approximately $5.7 million for the nine months
ended September 30, 2000. The decrease in interest income was primarily the
result of lower cash balances and reduced interest rates.
Expenses totaled $112.4 million for the nine months ended September 30, 2001
and included $31.4 million of depreciation expense on real estate assets and
$65.2 million of interest on the Amended Credit Agreement and $3.1 million of
interest on the United States Settlement. For the nine months ended September
30, 2000, expenses totaled $156.9 million and
34
included $31.7 million of depreciation expense on real estate assets and $71.3
million of interest on the Amended Credit Agreement and other debt. The $44.5
million decrease in expenses was due primarily to (a) a charge to earnings of
$35.8 million for the nine months ended September 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.
Professional fees totaled approximately $3.6 million for the nine months
ended September 30, 2001, as compared to $9.3 million for the nine months ended
September 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. See "Note 3-- Concentration of Credit Risk and Recent Developments--
Recent Developments Regarding Kindred" to the Condensed Consolidated Financial
Statements. As anticipated, legal and financial advisory fees have declined
after the Kindred Effective Date but may continue to be material.
Interest expense on the Amended Credit Agreement decreased $6.1 million to
$65.2 million for the nine months ended September 30, 2001 from $71.3 million
for the nine months ended September 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 2001 of 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.
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 use 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 $2.4 million
tax provision reported for the nine months ended September 30, 2001 included
$0.7 million related to the receipt of the Kindred Common Stock, of which 100%
was 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 nine months ended September 30, 2001 was $27.8 million, or
$0.40 per diluted share. After an extraordinary loss of $4.2 million, or $0.06
per diluted share, as discussed above, net income for the nine months ended
September 30, 2000, was $18.8 million or $0.28 per diluted share.
Funds from Operations
Funds from operations ("FFO") for the three months and nine months ended
September 30, 2001 totaled $19.3 million and $59.0 million, respectively. FFO
for the comparable period in 2000 totaled $19.1 million and $54.7 million,
respectively. In calculating net income and FFO for the three months and nine
months ended September 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 nine months ended
September 30, 2001 and 2000 is summarized in the following table:
35
Three Months Ended Nine Months Ended
------------------------- -------------------------
Sept. 30, Sept. 30, Sept. 30, Sept. 30,
2001 2000 2001 2000
------- ------- ------- -------
Net income............................................ $ 9,157 $ 8,581 $27,841 $18,826
Extraordinary loss on extinguishment of debt.......... -- -- -- 4,207
------- ------- ------- -------
Income before extraordinary loss.................... 9,157 8,581 27,841 23,033
Depreciation on real estate investments................ 10,476 10,522 31,427 31,682
Realized gain on sale of assets.................. (290) -- (290) --
------- ------- ------- -------
Funds from operations............................... $19,343 $19,103 $58,978 $54,715
======= ======= ======= =======
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 $61.3 million for the nine months ended
September 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 nine months ended September
30, 2000 cash provided by operations totaled $62.2 million. Net cash used in
financing activities for the nine months ended September 30, 2001 totaled $125.2
million and included a $36.4 million payment of principal on the Amended Credit
Agreement, a $39.2 million payment on the United States Settlement, and $50.1
million of cash dividend payments, including a $0.29 per common share dividend
to stockholders of record on December 30, 2000 and a $0.22 per common share
dividend to stockholders of record on May 2, 2001 and on July 13, 2001. Net cash
used in financing activities for the nine months ended September 30, 2000
totaled $105.9 million after payment of $50.9 million on principal on the
Amended Credit Agreement and deferred financing payments of $12.6 million.
On September 24, 2001, the Company received $0.7 million for the sale of
excess underdeveloped land. The Company applied $0.4 million of the net cash
proceeds from the sale to paydown Tranche A debt, as required by the Amended
Credit Agreement.
Sale of 83,300 Shares of Kindred Common Stock
- ---------------------------------------------
Ventas Realty exercised its "piggyback" registration rights under the
Registration Rights Agreement to sell 83,300 shares of Kindred Common Stock in
the Underwritten Offering under the Underwritten Offering Registration
Statement. If the Underwritten Offering is consummated, the Company intends to
apply the net proceeds from the sale of the 83,300 shares of Kindred Common
Stock as a prepayment on the Company's indebtedness under the Amended Credit
Agreement. However, there can be no assurance that the Underwritten Offering
will occur, or, if it does occur, the amount of proceeds that Ventas Realty will
receive from such sale.
36
The Company had cash and cash equivalents of $23.8 million (excluding
restricted cash of $18.7 million) and outstanding debt of $850.0 million on
September 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 tax year ended December
31, 1999. The Company believes that it has satisfied the requirements to
qualify as a REIT in 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 Kindred Common Stock. On April 20, 2001, July 3, 2001
and September 11, 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.
In estimating its 2001 taxable net income and the related dividends, one
hundred percent of the value of the Kindred Common Stock as of the Kindred
Effective Date determined in accordance with Internal Revenue Services Rules
will be included in the Company's 2001 taxable income. For financial reporting
purposes, this value of the Company's Kindred Common Stock is being amortized as
future rent over the weighted average remaining term of the Amended Master
Leases.
Due to the lack of marketability at June 30, 2001, the Kindred Common Stock
was accounted for under the cost method in the Company's Quarterly Report on
Form 10-Q for the quarter ended June 30, 2001. Due to trading volume growth and
pricing consistency in the over the counter market, the Kindred Common Stock was
considered marketable for accounting purposes at September 30, 2001 and
classified as available for sale in accordance with SFAS No. 115, Accounting for
Certain Investments in Debt and Equity Securities. Accordingly, the Kindred
Common Stock is measured at fair value as of September 30, 2001. The unrealized
gains and losses are reported a component of Accumulated Other Comprehensive
Income. As of September 30, 2001, the fair value of the Kindred Common Stock
was $88.4 million. A $70.2 million unrealized gain on the Kindred Common Stock
was reported in Accumulated Other Comprehensive Income at September 30, 2001.
See "Note 3--Concentration of Credit Risk and Recent Developments--Recent
Developments Regarding Dividends" to the Condensed Consolidated Financial
Statements.
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 September 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 Kindred Common Stock received by the Company on the Kindred
Effective Date which will be included in taxable income in the 2001 tax year.
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.
37
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 interest rate swap agreement dated June 16, 1998, as
amended (the "1998 Swap"), the Company is required to post collateral with the
counterparty in the form of cash, letter of credit or other permitted credit
support, if the fair value loss to the Company of the 1998 Swap exceeds 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. Generally, once the fair
value loss exceeds the applicable Threshold Level, collateral is either posted
by the Company or returned to the Company if the value of the 1998 Swap
fluctuates by $2.0 million or more following a determination of value by the
counterparty. As of September 30, 2001, the Company believes that the Threshold
Level under the 1998 Swap was a fair value unrealized loss of $35.0 million. The
1998 Swap was in an unrealized loss position to the Company of $39.2 million on
September 30, 2001. As of September 30, 2001 the Company had posted cash
collateral of $2.8 million with the counterparty under the 1998 Swap.
As a result of falling interest rates, the 1998 Swap has declined further
in value since September 30, 2001. As of October 31, 2001, the Company had
posted a total of $9.9 million of collateral in the form of a letter of credit.
If the 1998 Swap continues to decline in value, the Company will have to post
additional collateral in the form of cash, one or more letters of credit or
other permitted credit support. The Company is permitted to issue up to $15
million in principal amount of letters of credit under the $25 million revolving
credit facility under the Amended Credit Agreement. If the Company should be
required to post collateral under the 1998 Swap in excess of $15 million, the
Company expects to post such additional collateral in the form of cash from cash
reserves, cash flows from operations, and/or draws on the Company's revolving
credit facility under the Amended Credit Agreement up to a principal amount of
$25 million, net of outstanding letters of credit. However, there can be no
assurance that the Company will have sufficient cash to post such additional
collateral, if required. See "Note 4--Bank Credit Facility--Derivatives and
Hedging" to the Condensed Consolidated Financial Statements.
The Amended Credit Agreement, as revised by an 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 September 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
until 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. Monthly Sweeps were
scheduled for August 31, 2001, September 28, 2001 and October 31, 2001. The
Company has not yet been required to pay any amounts under the Monthly Sweep.
Future Monthly Sweeps will be made on
38
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 September 30, 2001, $124.0
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.
The Company has engaged an investment banking firm to act as placement
agent with respect to a proposed offering of floating-rate, investment grade
bonds to be issued by a wholly-owned subsidiary of the Company (the "Proposed
Financing Transaction"). The bonds would be secured by a first-mortgage lien on
40 skilled nursing facilities currently owned by Ventas Realty that would be
transferred to the subsidiary if the Proposed Financing Transaction is
consummated. If consummated, the Proposed Financing Transaction could yield
gross loan proceeds of between $200 million and $225 million, which would be
disbursed by such subsidiary to the Company and then applied as a prepayment on
the Company's indebtedness under the Amended Credit Agreement. Terms of the
Proposed Financing Transaction are currently being negotiated and are still
subject to change. There can be no assurance as to the final terms of the
Proposed Financing Transaction, including without limitation, the amount of
proceeds, interest rates, amortization schedule or the collateral. The Company
anticipates that if the Proposed Financing Transaction is finalized, it would
close in the fourth quarter of 2001. There can be no assurance that the Proposed
Financing Transaction will be finalized, or, if it is finalized that it will
close by the fourth quarter of 2001. In addition, uncertainty in the capital
markets due to world events and other factors may delay or preclude any
financing transaction from being consummated, including the Proposed Financing
Transaction.
39
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 the 1998 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 September 30, 2001, pursuant to
the 1998 Swap 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 1998 Swap is scheduled to decline as follows:
Notional Amount Date
--------------- -----------------
800,000,000 December 31, 2001
775,000,000 December 31, 2002
-- June 30, 2003
The terms of the 1998 Swap 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"). 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 its prior Bank Credit Agreement.
As of September 30, 2001, the Company believes that the threshold level under
the 1998 Swap was a fair value unrealized loss of $35.0 million and the 1998
Swap was in an unrealized loss position to the Company of $39.2 million. As of
September 30, 2001, the Company had posted cash collateral of $2.8 million.
Generally, once the fair value loss exceeds the applicable Threshold Level,
collateral is either posted by the Company or returned to the Company if the
value of the 1998 Swap fluctuates by $2.0 million or more following a
determination of value by the counterparty. Under the1998 Swap, if collateral
must be posted, the principal amount of such collateral must equal the
difference between the fair value unrealized loss of the 1998 Swap at the time
of such determination and the threshold amount. As a result of falling interest
rates, the 1998 Swap has declined further in value since September 30, 2001. As
of October 31, 2001, the Company had posted a total of $9.9 million of
collateral in the form of a letter of credit. If the 1998 Swap continues to
decline in value, the Company will have to post additional collateral in the
form of cash, letter of credit or other permitted credit support. The Company
is permitted to issue up to $15 million in principal amount of letters of credit
under the $25 million revolving credit facility under the Amended Credit
Agreement. If the Company should be required to post collateral under the 1998
Swap in excess of $15 million, the Company expects to post such additional
collateral exposure in the form of cash from cash reserves, cash flows from
operations, and/or draws on the Company's revolving credit facility under the
Amended Credit Agreement up to the principal amount of $25 million, net of
outstanding letters of credit. However, there can be no assurance that the
Company will have sufficient cash to post such additional collateral, if
required. On January 31, 2000, the Company entered into a letter agreement with
the counterparty to the 1998 Swap for the purpose of amending the 1998 Swap. The
letter agreement provides that, for purposes of certain calculations set forth
in the 1998 Swap, the parties agree to continue to use certain defined terms set
forth in the prior Bank Credit Agreement. See "Note 4--Bank Credit Facility" to
the Condensed Consolidated Financial Statements.
On September 28, 2001, the Company entered into a second interest rate swap
agreement (the "2003-2008 Swap") to hedge floating rate debt for the period
between July 1, 2003 and June 30, 2008, under which the Company pays a fixed
rate at 5.385% and receives LIBOR from the counterparty of the agreement. The
2003-2008 Swap is treated as a cash flow hedge. There are no collateral
requirements included in the 2003-2008 Swap. The notional amount of the 2003-
2008 Swap is $450 million and is scheduled to decline as follows (in thousands):
40
Notional Amount Date
--------------- ----
$300,000,000 June 30, 2006
150,000,000 June 30, 2007
When interest rates rise the interest rate swaps increase in fair value to
the Company and when interest rates fall the interest rate swaps decline in fair
value to the Company. As of September 30, 2001, interest rates had fallen and
the interest rate swaps were in an unrealized loss position to the Company of
approximately $40.9 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 swaps 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 September
30, 2001:
2003-3008
1998 Swap Swap
------------ ----------------
Notional Amount........................................................ $ 850,000,000 $ 450,000,000
Fair Value to the Company................................................ ($39,258,291) ($1,684,577)
Fair Value to the Company Reflecting
Change in Interest Rates
-100 BPS.......................................................... ($52,976,223) ($17,407,550)
+100 BPS.......................................................... ($25,841,327) $ 12,874,209
41
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 quarters ended March 31,
2001 and June 30, 2001.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS:
10.1 Amendment No. 1 to Registration Rights Agreement dated as of August 13,
2001 by and among Kindred Healthcare, Inc., Ventas Realty, Limited Partnership
and others.
10.2 Amendment No. 2 to Registration Rights Agreement dated as of October
22, 2001 by and among Kindred Healthcare, Inc., Ventas Realty, Limited
Partnership and others.
10.3 Waiver Agreement dated as of August 13, 2001 by and among Ventas
Realty, Limited Partnership, Kindred Healthcare, Inc. and Kindred Operating,
Inc.
10.4 Lock-up Agreement dated October 22, 2001 by and among Kindred
Healthcare, Inc., Credit Suisse First Boston Corporation, Goldman Sachs &
Company, J.P. Morgan Securities, Inc. UBS Warburg LLC, Lehman Brothers, Inc. and
Ventas Realty, Limited Partnership.
(b) REPORTS ON FORM 8-K:
On September 17, 2001, the Company filed a Current Report on Form 8-K
announcing that Jay M. Gellert, Chief Executive Officer and Director of Health
Net, Inc. and Gary W. Loveman, President, Chief Operating Officer and Director
of Harrah's Entertainment, Inc., had been elected to the Company's Board of
Directors. The Company also announced that its Board of Directors voted to pay
a cash dividend of $0.22 per share payable on October 1, 2001 to stockholders of
record on September 21, 2001.
42
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: November 13, 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
43