1
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 December 31, 1999
OR
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from to
--------------- -------------------
Commission file number 33-31717-A
QUORUM HEALTH GROUP, INC.
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Delaware 62-1406040
- ------------------------ ----------------
(State of incorporation) (I.R.S. Employer
Identification No.)
103 Continental Place, Brentwood, Tennessee 37027
- --------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
(615) 371-7979
- --------------------------------------------------------------------------------
(Registrant's telephone number, including area code)
- --------------------------------------------------------------------------------
(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [X] No [ ]
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date.
Class Outstanding at February 4, 2000
- ----- -------------------------------
Common Stock, $.01 Par Value 70,729,494 Shares
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
QUORUM HEALTH GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
(In thousands, except per share amounts)
Three Months
Ended December 31
------------------------
1999 1998
--------- ---------
Revenue:
Net patient service revenue $ 397,398 $ 349,335
Hospital management/professional services 20,278 20,798
Reimbursable expenses 15,178 15,944
--------- ---------
Net operating revenue 432,854 386,077
Salaries and benefits 180,616 169,610
Reimbursable expenses 15,178 15,944
Supplies 63,388 56,044
Fees 38,626 38,324
Other operating expenses 32,292 30,608
Provision for doubtful accounts 29,250 32,887
Equity in earnings of affiliates (2,764) (4,942)
Leases and rentals 9,255 8,146
Depreciation and amortization 27,047 23,134
Interest 16,883 12,743
Write-down of assets and investigation and
litigation related costs 1,836 30,976
Minority interest 542 (5,167)
--------- ---------
Income (loss) before income taxes 20,705 (22,230)
Provision (benefit) for income taxes 8,096 (3,488)
--------- ---------
Net income (loss) $ 12,609 $ (18,742)
========= =========
Earnings (loss) per share:
Basic $ 0.18 $ (0.26)
========= =========
Diluted $ 0.17 $ (0.26)
========= =========
Weighted average shares outstanding:
Basic 70,881 72,839
========= =========
Diluted 84,364 72,839
========= =========
See accompanying notes.
2
3
QUORUM HEALTH GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
(In thousands, except per share amounts)
Six Months
Ended December 31
------------------------
1999 1998
--------- ---------
Revenue:
Net patient service revenue $ 794,042 $ 701,794
Hospital management/professional services 39,832 41,590
Reimbursable expenses 30,265 32,054
--------- ---------
Net operating revenue 864,139 775,438
Salaries and benefits 358,855 327,456
Reimbursable expenses 30,265 32,054
Supplies 125,460 107,363
Fees 77,097 73,495
Other operating expenses 62,042 57,031
Provision for doubtful accounts 68,860 60,683
Equity in earnings of affiliates (4,888) (10,267)
Leases and rentals 18,312 15,275
Depreciation and amortization 53,246 44,459
Interest 33,613 21,876
Write-down of assets and investigation and
litigation related costs 2,934 30,976
Minority interest 193 (4,593)
--------- ---------
Income before income taxes 38,150 19,630
Provision for income taxes 14,917 12,879
--------- ---------
Net income $ 23,233 $ 6,751
========= =========
Earnings per share:
Basic $ 0.32 $ 0.09
========= =========
Diluted $ 0.31 $ 0.09
========= =========
Weighted average shares outstanding:
Basic 72,049 74,216
========= =========
Diluted 81,116 75,334
========= =========
See accompanying notes.
3
4
QUORUM HEALTH GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(In thousands)
December 31 June 30
1999 1999
---------- ----------
ASSETS
Current assets:
Cash $ 11,842 $ 22,258
Accounts receivable, less allowance for
doubtful accounts of $87,187 at
December 31, 1999 and $83,896 at
June 30, 1999 338,085 332,312
Supplies 40,872 39,003
Other 59,773 46,838
---------- ----------
Total current assets 450,572 440,411
Property, plant and equipment, at cost:
Land 89,736 88,157
Buildings and improvements 443,264 435,525
Equipment 627,909 584,017
Construction in progress 27,256 24,875
---------- ----------
1,188,165 1,132,574
Less accumulated depreciation 344,709 297,454
---------- ----------
843,456 835,120
Cost in excess of net assets acquired, net 227,488 226,038
Investments in unconsolidated entities 243,717 259,709
Other 94,371 70,670
---------- ----------
Total assets $1,859,604 $1,831,948
========== ==========
4
5
QUORUM HEALTH GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(In thousands, except per share amounts)
December 31 June 30
1999 1999
---------- ----------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses $ 94,131 $ 96,904
Accrued salaries and benefits 76,595 72,558
Other current liabilities 31,956 34,841
Current maturities of long-term debt 971 913
---------- ----------
Total current liabilities 203,653 205,216
Long-term debt, less current maturities 892,219 872,213
Deferred income taxes 33,422 33,422
Professional liability risks and other
liabilities and deferrals 40,472 36,456
Minority interests in consolidated entities 59,187 59,975
Commitments and contingencies
Stockholders' equity:
Common stock, $.01 par value;
300,000 shares authorized; 70,608
issued and outstanding at December 31,
1999 and 73,166 at June 30, 1999 706 732
Additional paid-in capital 236,491 253,714
Retained earnings 393,454 370,220
---------- ----------
630,651 624,666
---------- ----------
Total liabilities and stockholders' equity $1,859,604 $1,831,948
========== ==========
See accompanying notes.
5
6
QUORUM HEALTH GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(In thousands)
Six Months
Ended December 31
------------------------
1999 1998
--------- ---------
Net cash provided by operating activities $ 73,913 $ 52,063
Investing activities:
Purchase of acquired companies, net of
working capital settlements (20,448) (165,455)
Purchase of property, plant and equipment (57,328) (72,153)
Other 553 (750)
--------- ---------
Net cash used in investing activities (77,223) (238,358)
Financing activities:
Borrowings under bank debt 186,700 405,500
Repayments of bank debt (316,200) (174,900)
Borrowing under convertible subordinated
debentures 150,000 --
Change in outstanding checks and overnight
investment (8,352) 4,785
Repurchases of common stock (17,646) (48,102)
Other (1,608) (13,374)
--------- ---------
Net cash (used in) provided by financing activities (7,106) 173,909
--------- ---------
Decrease in cash (10,416) (12,386)
Cash at beginning of period 22,258 17,549
--------- ---------
Cash at end of period $ 11,842 $ 5,163
========= =========
Supplemental cash flow information:
Interest paid $ (32,739) $ (19,725)
========= =========
Income taxes paid $ (18,427) $ (28,936)
========= =========
See accompanying notes.
6
7
QUORUM HEALTH GROUP, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements of Quorum
Health Group, Inc. and subsidiaries (the "Company") have been prepared in
accordance with generally accepted accounting principles for interim financial
information and with the instructions to Form 10-Q and Article 10 of Regulation
S-X. Accordingly, they do not include all of the information and footnotes
required by generally accepted accounting principles for complete financial
statements. In the opinion of management, all adjustments (consisting of normal
recurring accruals) considered necessary for a fair presentation have been
included. Operating results for the three months and six months ended December
31, 1999 are not necessarily indicative of the results that may be expected for
the year ending June 30, 2000. For further information, refer to the
consolidated financial statements and footnotes thereto included in the
Company's annual report on Form 10-K for the year ended June 30, 1999. Certain
prior year amounts have been reclassified to conform to the current year
presentation.
2. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In 1998, the Financial Accounting Standards Board (FASB) issued Statement of
Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative
Instruments and Hedging Activities". This standard will require the Company to
recognize all derivatives on the balance sheet at their fair value. Derivatives
that are not hedges must be adjusted to fair value through changes to the
Company's income statement. For interest rate swap agreements that qualify as
hedges, the Company will offset changes in fair value against the change in fair
value of the hedged assets, liabilities, or firm commitments through changes to
the Company's earnings. The Company will adopt this new FASB standard on July 1,
2000. The Company is presently evaluating the new standard to determine its
effect on the earnings and financial position of the Company.
On March 31, 1999, the FASB released a proposed interpretation of APB Opinion
No. 25 "Accounting for Certain Transactions involving Stock Compensation." This
proposed interpretation requires variable-award accounting for repriced stock
options. The FASB expects this proposed interpretation to be effective on July
1, 2000. The interpretation would generally cover events that occur after
December 15, 1998. No adjustments would be made to financial statements for
periods prior to the effective date and no expense would be recognized for any
additional compensation costs attributable to periods before the effective date.
3. ACQUISITIONS, JOINT VENTURES AND SALES
Effective December 1, 1999, the Company acquired Caylor-Nickel Medical Center in
Bluffton, Indiana.
7
8
During fiscal 1999, the Company acquired four hospitals and affiliated health
care entities. In connection with the acquisitions, the Company entered into
operating lease agreements to lease certain land and buildings with an estimated
fair value of $108.7 million. Effective April 8, 1999, the Company sold Park
Medical Center in Columbus, Ohio.
Effective November 1, 1998, a majority-owned subsidiary of the Company and a
subsidiary of Columbia/HCA Healthcare Corp. (Col/HCA) formed a joint venture in
Vicksburg, Mississippi. Col/HCA contributed Vicksburg Medical Center. The
Company's subsidiary and its existing physician shareholders contributed
Parkview Regional Medical Center and affiliated businesses. The Company, through
its subsidiary, has a majority equity interest in the joint venture and is the
manager.
Hospital and affiliated business acquisitions are summarized as follows (in
thousands):
SIX MONTHS ENDED
DECEMBER 31
-----------------------
1999 1998
-------- ---------
Fair value of assets acquired $ 23,865 $ 180,974
Fair value of liabilities assumed (3,417) (15,519)
-------- ---------
Net cash used for acquisitions $ 20,448 $ 165,455
======== =========
The foregoing acquisitions were accounted for using the purchase method of
accounting. The allocation of the purchase price associated with certain of the
acquisitions has been determined by the Company based upon available information
and is subject to further refinement.
The operating results of the acquisitions, joint ventures and sales have been
consolidated in the accompanying condensed consolidated statements of income for
the periods subsequent to acquisition and for the periods prior to the sale.
The following unaudited pro forma results of operations give effect to the
operations of the joint venture and the entities acquired and sold in fiscal
2000 and 1999 as if the respective transactions had occurred at the beginning of
the period presented (in thousands, except per share data):
8
9
Three Months Six Months
Ended Ended
December 31 December 31
------------------------- -------------------------
1999 1998 1999 1998
----------- ----------- ----------- -----------
Net operating revenue $ 437,615 $ 416,435 $ 875,042 $ 853,665
Net income 12,713 (16,569) 23,526 8,063
Earnings per share:
Basic 0.18 (0.23) 0.33 0.11
Diluted 0.17 (0.23) 0.31 0.11
The pro forma results of operations do not purport to represent what the
Company's results of operations would have been had such transactions in fact
occurred at the beginning of the periods presented or to project the Company's
results of operations in any future period.
4. LONG-TERM DEBT
On August 31, 1999, the Company issued $150.0 million of convertible
subordinated debentures due 2009 to Welsh, Carson, Anderson & Stowe, VIII, LP
and certain WCAS VIII affiliates, including Russell L. Carson, Chairman of the
Company's Board of Directors. The debentures were sold for cash at their face
value. The debentures bear interest at 6.0% per annum. Interest is payable
quarterly. The debentures are convertible into common shares at a conversion
price of $11.25 per share. The debentures will automatically convert at any time
after three years if the average of the closing price of the Company's stock
over any 90 day period is more than 150% of the conversion price. The debentures
are callable at the Company's option at any time after August 31, 2001. In the
event of a merger, consolidation or sale of more than 50% of the Company's
assets, the holder of the debentures has the option to have the debentures
prepaid in full. The debentures have antidilution protection, including, under
certain circumstances, issuance of common stock below the then applicable
conversion price. The shares into which the debentures are convertible have
certain voting restrictions and must be held until August 2001. The debentures
are subordinated in right of payment to all debt. The proceeds were used to
reduce the Company's outstanding debt under its revolving credit facility.
5. WRITE-DOWN OF ASSETS AND INVESTIGATION AND LITIGATION RELATED COSTS
The Company incurred write-down of assets and investigation and litigation
related costs as follows (in thousands):
9
10
Three Months Six Months
Ended Ended
December 31 December 31
------------------ ------------------
1999 1998 1999 1998
------ ------- ------ -------
Investigation and litigation related
costs $1,836 $ 1,102 $2,934 $ 1,102
Write-down of assets -- 29,874 -- 29,874
------ ------- ------ -------
Total $1,836 $30,976 $2,934 $30,976
====== ======= ====== =======
Investigation and litigation related costs related primarily to the qui tam and
shareholder actions against the Company (See Note 9).
During the three months ended December 31, 1998, the Company recorded $25.6
million intangible asset write-downs relating to certain physician practices and
a $4.3 million write-down of assets primarily related to Park Medical Center
which was subsequently sold. The write-down of assets resulted primarily from
(1) the review of expected future cash flows of the Company's physician
practices and (2) the write-down of the carrying value of Park Medical Center to
estimated fair value based on divestiture negotiations. The Company's review of
its physician practices was a result of recent changes in the physician practice
management industry and the accumulation of sufficient historical financial
information as a basis for changing estimated future cash flows.
6. INCOME TAXES
The provision for income taxes for the three months and six months ended
December 31, 1999 and 1998 is different from that which would be obtained by
applying the statutory federal income tax rate to income before income taxes due
to permanent differences and the provision for state income taxes.
7. EARNINGS PER SHARE
Basic earnings per share is based on the weighted average number of common
shares outstanding. Diluted earnings per share is based on the weighted average
number of common shares outstanding, and the effect of dilutive securities which
are convertible subordinated debentures and stock options. Outstanding options
to purchase 5.6 million and 5.7 million shares of common stock for the three
months ended December 31, 1999 and 1998, respectively, and 4.9 million and 3.8
million shares of common stock for the six months ended December 31, 1999 and
1998, respectively, were not included in the computation of earnings per share
because the options' exercise prices were greater than the average market price
of the common stock (See Note 8).
The following table sets forth the computation of basic and diluted earnings per
share (in thousands, except per share amounts):
10
11
THREE MONTHS SIX MONTHS
ENDED ENDED
DECEMBER 31 DECEMBER 31
------------------ -----------------
1999 1998 1999 1998
------- -------- ------- -------
Numerator:
Net income (loss) $12,609 $(18,742) $23,233 $ 6,751
Interest expense on convertible subordinated
debentures, net of taxes 1,370 -- 1,827 --
------- -------- ------- -------
Numerator for dilutive earnings (loss)
per share $13,979 $(18,742) $25,060 $ 6,751
======= ======== ======= =======
Denominator:
Shares used for basic earnings
per share 70,881 72,839 72,049 74,216
Effect of dilutive securities:
Convertible subordinated debentures 13,333 -- 8,889 --
Stock options 150 -- 178 1,118
------- -------- ------- -------
Shares used for dilutive earnings
per share 84,364 72,839 81,116 75,334
======= ======== ======= =======
Basic earnings (loss) per share $ 0.18 $ (0.26) $ 0.32 $ 0.09
======= ======== ======= =======
Diluted earnings (loss) per share $ 0.17 $ (0.26) $ 0.31 $ 0.09
======= ======== ======= =======
8. STOCKHOLDERS' EQUITY AND STOCK BENEFIT PLANS
As of December 31, 1999, there were 6.2 million stock options outstanding with a
weighted average exercise price of $9.50. In March 1999, the Company's board of
directors approved a plan to allow employees to exchange "underwater" stock
options. These stock options had exercise prices higher than the market price of
the Company's common stock. Based on the exchange, the Company canceled 5.2
million options at exercise prices ranging from $12.09 to $33.06 and issued 3.6
million options at an exercise price of $9.00. The effect was to reduce the
number of options held to offset the benefit of a lower exercise price. The
estimated economic value of the grants was generally unchanged as a result of
the exchange. Under the proposed interpretation of APB Opinion No. 25, repriced
options would have variable-award accounting (See Note 2). Should the Company be
required to apply variable-award accounting to the repriced options, the options
under the terms of the option grant will vest and terminate thirty days after
the Company gives notice to the employees. Variable-award accounting for the
repriced options will be eliminated after the option termination date.
During the three months ended December 31, 1999, the Company repurchased 2.7
million shares of common stock for an aggregate purchase price of $17.6 million.
All of these shares were purchased in open market transactions. There are
approximately 1.7 million shares remaining for repurchase under the existing 5.0
million share stock repurchase program authorized in October 1998.
11
12
9. CONTINGENCIES
Management continually evaluates contingencies based on the best available
evidence and believes that provision for losses has been provided to the extent
necessary.
Net Patient Service Revenue
Final determination of amounts earned under the Medicare and Medicaid programs
often occurs in subsequent years because of audits by the programs, rights of
appeal and the application of numerous technical provisions. In the opinion of
management, adequate provision has been made for adjustments that may result
from such routine audits and appeals.
Income Taxes
The Internal Revenue Service (IRS) is in the process of conducting examinations
of the Company's federal income tax returns for the fiscal years ended June 30,
1993 through 1998. The IRS has proposed certain adjustments in connection with
its examination of the Company's federal income tax returns for the fiscal years
ending June 30, 1993 through 1995. The most significant adjustments involve the
tax accounting methods adopted for computing bad debt expense and the valuation
of purchased hospital property, plant and equipment and related depreciable
lives. The Company has protested substantially all of the proposed adjustments
through the appeals process of the IRS. In the opinion of management, the
ultimate outcome of the IRS examinations will not have a material effect on the
Company's results of operations or financial position.
Impact of Year 2000
The Company's owned hospitals and corporate office have not experienced any
significant adverse consequences as a result of the Year 2000 issues.
The Company is not aware of any significant adverse consequences experienced by
the Company's managed hospitals as a result of the Year 2000 issues. The Company
believes that it is not responsible for ensuring Year 2000 compliance by its
managed hospitals, but the Company cannot provide assurance that its managed
hospitals will not seek to hold it responsible, or that it will not ultimately
be found liable, for any losses they incur arising out of the Year 2000 problem.
Litigation
The Company is currently, and from time to time expects to be, subject to
claims, suits and investigations arising in the ordinary course of business. The
Company may not know about investigations or qui tam actions filed against the
Company by private parties on behalf of the federal or state governments.
Plaintiffs in these matters may request punitive or other damages that may not
be covered by insurance. Except for the litigation described below, the Company
is not currently a party to any such proceeding which, in management's opinion,
if adversely decided, would have a material effect on the Company's results of
operations or financial position.
12
13
False Claims Act Litigation
In June 1993, the Office of the Inspector General of the Department of Health
and Human Services requested information from the Company in connection with an
investigation involving the Company's procedures for preparing Medicare cost
reports. In January 1995, the United States Department of Justice issued a Civil
Investigative Demand which also requested information from the Company in
connection with the same investigation. As a part of the government's
investigation, several former and current employees were interviewed. The
Company cooperated fully with the investigation. The Company received no
communication from the government on this matter from approximately June 1996
until August 1998.
In August 1998, the government informed the Company that the investigation was
prompted by a lawsuit filed under the False Claims Act. The suit was filed in
January 1993 by a former employee of a hospital managed by a Company subsidiary.
These lawsuits, commonly known as qui tam actions, are filed "under seal." That
means that the claims are kept secret until the government decides whether to
join the case. The person who files the lawsuit is called a "relator". At a
meeting in September 1998, the Company learned from the government that it would
likely join in the case. The government joined the case against the Company in
October 1998. The former employee's lawsuit named the Company and its
subsidiary, Quorum Health Resources, Columbia/HCA Healthcare Corporation and all
hospitals that the Company or Columbia/HCA owned, operated or managed from 1984
through 1997, as defendants. The unsealed complaint, prepared by the relator,
alleged that the Company knowingly prepared and caused to be filed cost reports
which claimed payments from Medicare and other government payment programs
greater than the amounts due.
In January 1999, the Company filed motions with the court asking to be separated
from the case against co-defendant Columbia/HCA. The government did not oppose
the motion to separate the cases against the Company and Columbia/HCA. On
February 2, 1999, the government filed an amended complaint. On that date, the
government also filed a notice of non-intervention advising the Court that it
would not proceed on some of the relator's allegations, and that it would not
sue individual managed hospital clients. The government's complaint did not name
as defendants any hospital the Company managed. It does name the Company, Quorum
Health Resources and each subsidiary which now owns or has ever owned a
hospital. Subsequently, the court granted the Company's motion to be separated,
dismissed the Company from the case, and directed plaintiffs to file a new
action against the Company alone. Plaintiffs did so on February 24, 1999.
The February 24, 1999 complaint alleges that the Company, on behalf of hospitals
it managed between 1985 and 1995 and hospitals it owned from 1990 to the
date of the complaint, violated the False Claims Act by filing false Medicare
cost reports. The government asserts that the false claims in the cost reports
are reflected in "reserve analyses" created by the Company. The complaint also
alleges that these cost report filings were prepared as the result of Company
policy.
13
14
In March 1999, as the Company had requested, the court appointed a mediator to
facilitate settlement discussions between the Company and the government.
Meetings with the mediator were held on June 11, 1999, November 4, 1999 and
December 21, 1999.
In April 1999, the Company filed several motions to dismiss the government's
complaint in whole or in part as well as a motion to dismiss the relator from
the case. The government and the relator replied to the Company's motions in
June, 1999 and the Company filed a reply in July, 1999. In December 1999, the
Company filed a motion to move the litigation to the U.S. District Court for the
Middle District of Tennessee located in Nashville, Tennessee. The government and
the relator oppose this motion. The court has not ruled on the Company's
motions.
This qui tam action seeks three times the amount of damages caused to the United
States by the Company's submission of any alleged false claims to the
government, civil penalties of not less than $5,000 nor more than $10,000 for
each false claim, and attorneys' fees and costs.
Other Qui Tam Actions and Related Investigations
In May 1998, the Company was informed that it was a defendant in another qui tam
action involving home health services provided by two of the Company's owned
hospitals and alleging that the Company had violated Medicare laws. This action
was filed under seal in June 1996 by a former employee, whom the Company fired
in April 1996. The United States Attorney's Office allowed the Company an
opportunity to review the results of the government's investigations and discuss
the allegations made in the action prior to the government making a decision to
intervene as a plaintiff. The lawsuit remains under seal for all other purposes.
The Company has cooperated fully with the United States Attorney's Office and
provided additional information and made employees available for interviews. The
Company is now engaged in settlement discussions with the government.
As part of its ongoing discussions, the Company has learned from the same U.S.
Attorney that there are two additional unrelated qui tam complaints against the
Company alleging Medicare violations at one owned and two managed hospitals.
Both matters remain under seal. The Company has not seen the complaint in either
matter. The government has stated that it intends to investigate these
allegations. The Company intends to cooperate with the government's
investigation.
The Class and Derivative Actions
In October and November 1998, some of the Company's stockholders filed
lawsuits against the Company in the U.S. District Court for the Middle
District of Tennessee. In January 1999, the court consolidated these cases
into a single lawsuit. (M.D. Tenn. No. 3-98-1004) The plaintiffs filed an
amended complaint in March 1999. The plaintiffs seek to represent a class of
plaintiffs who purchased the Company's common stock from October 25, 1995
through October 21, 1998, except for insiders of the Company and their
immediate families. The consolidated complaint names the Company, several of
its officers and one of its outside directors, as defendants.
14
15
The complaint alleges that defendants violated the Securities Exchange Act of
1934. The plaintiffs claim that the Company materially inflated its net revenues
during the class period by including in those net revenues amounts received from
the settlement of cost reports that had allegedly been filed in violation of
applicable Medicare regulations years earlier and that, because of this
practice, this statement, which first appeared in the Company's Form 10-K filed
in September 1996, was false: "The Company believes that its owned hospitals are
in substantial compliance with current federal, state, local, and independent
review body regulations and standards." In May 1999, the Company filed a motion
to dismiss the complaint. The plaintiffs have filed papers opposing the motion,
and the judge has not yet ruled on the motion. The Company intends to defend
vigorously the claims and allegations in this action.
On November 2, 1998, a lawsuit was filed against the Company, all of its current
directors and two former directors in the U.S. District Court for the Northern
District of Alabama. On January 14, 1999, this suit was transferred by agreement
of the parties to the U.S. District Court for the Middle District of Tennessee.
(M.D. Tenn. No. 3-99-0055) On February 16, 1999, the defendants filed a motion
to dismiss the original complaint. The court then granted the plaintiff
permission to file a first amended complaint, which, when filed, mooted the
original motion to dismiss. On April 30, 1999, the defendants moved to dismiss
the first amended complaint. The court on July 1, 1999, granted plaintiff's
motion for leave to file a second amended complaint and denied as moot the
motion to dismiss the first amended complaint. The second amended complaint
asserts four claims: a shareholders' derivative claim for breach of fiduciary
duty, a shareholders' derivative claim for violations of the Racketeer
Influenced and Corrupt Organizations Act, a shareholders' derivative claim for
injunctive relief, and a purported class action claim for breach of fiduciary
duty. As the basis for each of these claims, plaintiff alleges that the
defendants in 1993 were aware that the Company was filing allegedly false cost
reports and that the defendants "mandated" that the illegal acts continue in
violation of applicable Medicare and Medicaid laws. The defendants have filed a
motion to dismiss the second amended complaint. The plaintiff has responded to
this motion, but the court has not yet ruled on this motion. All of the
defendants plan to vigorously defend this litigation.
The Company cannot at this time predict the effect or outcome of any of the
ongoing investigations or the qui tam, class or stockholders' derivative
15
16
actions, or whether any additional investigations or litigation will be
commenced. If the Company is found to have violated federal or state laws
relating to Medicare, Medicaid or other government programs, then it may be
required to pay substantial fines and civil and criminal penalties and also may
be excluded from participating in the Medicare and Medicaid programs and other
government programs. Similarly, the amount of damages sought in the qui tam
actions are substantial. The Company could be subject to substantial costs
resulting from an adverse outcome of any of these actions. In an effort to
promptly resolve one or more of these matters, the Company may choose to
negotiate a settlement. Amounts the Company pays to settle any of these matters
may be material. Any one or more of these actions or costs could have a material
adverse effect on the Company's results of operations or financial position.
10. SEGMENT INFORMATION
The Company's segments consist of (i) healthcare systems owned and operated by
the Company and (ii) management of hospitals and healthcare systems for other
owners. The Company evaluates performance based on operating earnings of the
respective business units.
The Company's net revenues, EBITDA, depreciation and amortization, capital
expenditures and assets are summarized in the following table (EBITDA is defined
as earnings before interest, income taxes, depreciation and amortization
expense, minority interest, write-down of assets and investigation and
litigation related costs)(in thousands):
THREE MONTHS ENDED DECEMBER 31, 1999
-------------------------------------
Owned Management
Hospitals Services Total
---------- -------- ----------
Net revenues $ 397,398 $35,456 $ 432,854
EBITDA $ 59,736 $ 7,277 $ 67,013
Depreciation & amortization $ 26,594 $ 453 $ 27,047
Capital expenditures $ 34,790 $ 512 $ 35,302
THREE MONTHS ENDED DECEMBER 31, 1998
-------------------------------------
Owned Management
Hospitals Services Total
---------- -------- ----------
Net revenues $ 349,335 $36,742 $ 386,077
EBITDA $ 30,326 $ 9,130 $ 39,456
Depreciation & amortization $ 22,746 $ 388 $ 23,134
Capital expenditures $ 41,034 $ 110 $ 41,144
16
17
SIX MONTHS ENDED DECEMBER 31, 1999
-------------------------------------
Owned Management
Hospitals Services Total
---------- -------- ----------
Net revenues $ 794,042 $70,097 $ 864,139
EBITDA $ 113,336 $14,800 $ 128,136
Assets $1,814,604 $45,000 $1,859,604
Depreciation & amortization $ 52,331 $ 915 $ 53,246
Capital expenditures $ 56,736 $ 592 $ 57,328
SIX MONTHS ENDED DECEMBER 31, 1998
-------------------------------------
Owned Management
Hospitals Services Total
---------- -------- ----------
Net revenues $ 701,794 $73,644 $ 775,438
EBITDA $ 94,455 $17,893 $ 112,348
Assets $1,709,100 $42,876 $1,751,976
Depreciation & amortization $ 43,693 $ 766 $ 44,459
Capital expenditures $ 71,910 $ 243 $ 72,153
EBITDA for owned hospitals include equity in earnings of affiliates of $2.8
million and $4.9 million for the three months ended December 31, 1999 and 1998,
respectively. EBITDA for owned hospitals include equity in earnings of
affiliates of $4.9 million and $10.3 million for the six months ended December
31, 1999 and 1998, respectively. Assets of owned hospitals include investments
in unconsolidated subsidiaries of $243.7 million and $252.0 million at December
31, 1999 and 1998, respectively.
Write-down of assets and investigation and litigation related costs are not
included in EBITDA. Investigation and litigation related costs for the three
months ended December 31, 1999 are comprised of $0.2 million related to the
Company's owned hospitals and $1.6 million related to the Company's management
services. Write-down of assets and investigation and litigation related costs
for the three months ended December 31, 1998 are comprised of $30.4 million
related to the Company's owned hospitals and $0.6 million related to management
services. Investigation and litigation related costs for the six months ended
December 31, 1999 are comprised of $0.3 million related to owned hospitals and
$2.6 million related to management services. Write-down of assets and
investigation and litigation related costs for the six months ended December 31,
1998 is comprised of $30.4 million related to owned hospitals and $0.6 million
related to management services.
17
18
THREE MONTHS SIX MONTHS
ENDED ENDED
DECEMBER 31 DECEMBER 31
------------------ --------------------
1999 1998 1999 1998
------- -------- -------- ---------
Total EBITDA for reportable segments $67,013 $ 39,456 $128,136 $ 112,348
Depreciation and amortization 27,047 23,134 53,246 44,459
Interest expense 16,883 12,743 33,613 21,876
Write-down of assets and
investigation and litigation
related costs 1,836 30,976 2,934 30,976
Minority interest 542 (5,167) 193 (4,593)
------- -------- -------- ---------
Income (loss) before income taxes $20,705 $(22,230) $ 38,150 $ 19,630
======= ======== ======== =========
18
19
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION
You should read the following along with the Condensed Consolidated
Financial Statements and accompanying notes.
FORWARD-LOOKING INFORMATION
This discussion includes "forward-looking statements." Forward-looking
statements include all statements that do not relate solely to historical or
current facts, and can be identified by the use of some words, including "may,"
"believe," "will," "expect," "project," "estimate," "anticipate," "plan" or
"continue." We have based these forward-looking statements on our current plans
and expectations and projections about future events. However, risks,
uncertainties and assumptions that would cause or contribute to material
differences in our future financial condition and results of operations include:
- possible changes in Medicare and Medicaid that may further
limit payments to our owned hospitals;
- the efforts of insurers, managed care companies, patients and
other payors to reduce their payments to our owned hospitals;
- potential adverse impact of known and unknown litigation and
government investigations;
- the possible enactment of federal, state or local health care
reforms;
- changes in federal, state or local regulations affecting the
health care industry;
- difficulties in containing costs in proportion to payments
from our payors;
- difficulties in billing and collecting accounts receivable and
the related impact upon cash flow and bad debt expense;
- difficulties in finding attractive acquisitions and
integrating acquired hospitals into our operations;
- market and geographic concentration of operations;
- the highly competitive nature of the health care business;
- potential loss of physicians or other key personnel;
- claims and legal actions relating to professional liability;
- disruptions from system conversions;
19
20
- our substantial indebtedness and difficulty raising capital in
the future;
- fluctuations in interest rates;
- fluctuations in the market value of our common stock;
- changes in accounting pronouncements; and
- changes in general economic conditions.
OVERVIEW
We are a leading provider of health care services through our owned
acute care hospitals and regional health care systems located throughout the
United States. We are also the largest provider of management services to acute
care hospitals in the United States, primarily through our subsidiary, Quorum
Health Resources, LLC.
For the six months ended December 31, 1999 and 1998, our owned
hospitals accounted for 92% and 91% of our net operating revenue, respectively.
For the six months ended December 31, 1999 and 1998, the Dothan, Alabama and Ft.
Wayne, Indiana areas (comprised of six hospitals) accounted for approximately
34% and 32% of owned hospital revenue and 58% and 53% of owned hospital EBITDA,
respectively. EBITDA means our earnings before interest, income taxes,
depreciation and amortization expense, minority interest and write-down of
assets and investigation and litigation related costs.
For the six months ended December 31, 1999, our net income before
write-down of assets and investigation and litigation related costs was 15%
lower than the six months ended December 31, 1998. We believe this was
principally due to the following issues:
- We experienced increased discounts to insurance and managed
care companies and increased charity care.
- We received lower payments from the government under the
Medicare program as a result of the Balanced Budget Act of
1997 (BBA 97).
- Our share of earnings from joint ventures decreased.
This decrease was partially offset by favorable estimated third-party payor
settlements for the six months ended December 31, 1999 compared to unfavorable
estimated third-party payor settlements for the six months ended December 31,
1998. (Estimated third-party payor settlements are discussed under the caption
"General").
As we begin calendar 2000, our objective is to continue to improve our
operating and financial consistency and stability. We plan to use the following
operating tactics:
- Strengthen our owned hospitals including the recent addition
of a third regional management team and building on the
calendar 1999 computer system installations and upgrades;
20
21
- Grow existing markets;
- Enhance managed care contracting;
- Improve management of accounts receivable/bad debts; and
- Focus on cost control.
IMPACT OF ACQUISITIONS, JOINT VENTURES AND SALES
Effective December 1, 1999, we acquired Caylor-Nickel Medical Center in
Bluffton, Indiana, which is included in our Ft. Wayne market.
In fiscal 1999, we acquired four hospitals and affiliated health care
entities. We also entered into a joint venture in Vicksburg, Mississippi. We
manage and have a controlling interest in the joint venture. Some of these
entities did not perform as well as we initially expected. This was due to some
of the same factors we experienced in our other owned hospitals. Also, we
initially had difficulties integrating some of the acquired hospitals into our
operations. In fiscal 2000, we have improved the financial performance of our
acquired hospitals and joint ventures. In fiscal 1999, we sold Park Medical
Center in Columbus, Ohio.
Because of the financial impact of acquisitions, joint ventures and
sales, it is difficult to make meaningful comparisons between our financial
statements for the periods presented. Due to the current number of owned
hospitals, each additional hospital we acquire can affect our overall operating
margins or results of operations.
LITIGATION
We are currently, and from time to time expect to be, subject to
claims, suits and investigations arising in the ordinary course of business. We
may not know about investigations or qui tam actions filed against us by private
parties on behalf of the federal or state governments. Plaintiffs in these
matters may request punitive or other damages that may not be covered by
insurance. Except for the litigation described below, we are not currently
involved in any litigation that we believe could have a material adverse effect
on our results of operations or financial position.
Professional Liability Judgment
On December 17, 1999, a final trial judgment was entered against our
subsidiary, Quorum Health Resources, LLC ("QHR"), in the amount of
approximately $47 million in the case of David X. and Veronica Rodriguez,
Individually and as Next Friends of Cristina Rodriguez, a minor v Quorum Health
Resources, LLC, in the 365th District Court, Maverick County, Texas. The
lawsuit arose out of the treatment provided beginning July 2, 1994 at Fort
Duncan Medical Center, an acute care hospital managed by QHR. QHR is appealing
the decision. Interest accrues on the judgment at 10% annually. We currently
believe that all or a substantial portion of this judgment, if not overturned,
will be covered by our insurance carriers and/or other interested parties.
However, we can not guarantee that the judgment will be overturned or that we
will receive any insurance proceeds. If we were required to pay the judgment
from our own funds, it could have a material adverse effect on us.
False Claims Act Litigation
In June 1993, the Office of the Inspector General of the Department of
Health and Human Services requested information from us in connection with an
investigation involving our procedures for preparing Medicare cost reports. In
January 1995, the United States Department of Justice issued a Civil
Investigative Demand which also requested information from us in connection with
the same investigation. As a part of the government's investigation, several
former and current employees were interviewed. We cooperated fully with the
investigation. We received no communication from the government on this matter
from approximately June 1996 through August 1998.
21
22
In August 1998, the government informed us that the investigation was
prompted by a lawsuit filed under the False Claims Act. The suit was filed in
January 1993 by a former employee of a hospital we managed. These lawsuits,
commonly known as qui tam actions, are filed "under seal." That means that the
claims are kept secret until the government decides whether to join the case.
The person who files the lawsuit is called a "relator". At a meeting in
September 1998, we learned from the government that it would likely join in the
case. The government joined the case against us in October 1998. The former
employee's lawsuit named us, our subsidiary Quorum Health Resources,
Columbia/HCA Healthcare Corporation and all hospitals that we or Columbia/HCA
owned, operated or managed from 1984 through 1997, as defendants. The unsealed
complaint, prepared by the relator, alleged that we knowingly prepared and
caused to be filed cost reports which claimed payments from Medicare and other
government payment programs greater than the amounts due.
In January 1999, we filed motions with the court asking to be separated
from the case against co-defendant Columbia/HCA. The government did not oppose
the motion to separate the cases against us and Columbia/HCA. On February 2,
1999, the government filed an amended complaint. On that date, the government
also filed a notice of non-intervention advising the Court that it would not
proceed on some of the relator's allegations, and that it would not sue
individual managed hospital clients. The government's complaint did not name as
defendants any hospital we managed. It does name us, Quorum Health Resources and
each subsidiary which now owns or has ever owned a hospital. Subsequently, the
court granted our motion to be separated, dismissed us from the case, and
directed plaintiffs to file a new action against us alone. Plaintiffs did so on
February 24, 1999.
The February 24, 1999 complaint alleges that we, on behalf of hospitals
we managed between 1985 and 1995 and hospitals we owned from 1990 to the date of
the complaint, violated the False Claims Act by filing false Medicare cost
reports. The government asserts that the false claims in the cost reports are
reflected in "reserve analyses" we created. The complaint also alleges that
these cost report filings were prepared as the result of our policy.
In March 1999, as we had requested, the court appointed a mediator to
facilitate settlement discussions between us and the government. Meetings with
the mediator were held on June 11, 1999 and November 4, 1999 and December 21,
1999.
In April 1999, we filed several motions to dismiss the government's
complaint in whole or in part as well as a motion to dismiss the relator from
the case. The government and the relator replied to our motions in June, 1999
and we filed a reply in July, 1999. In December 1999, we filed a motion to move
the litigation to the U.S. District Court for the Middle District of Tennessee
located in Nashville, Tennessee. The government and the relator oppose this
motion. The court has not ruled on our motions.
This qui tam action seeks three times the amount of damages caused to
the United States by our submission of any alleged false claims to the
government, civil penalties of not less than $5,000 nor more than $10,000 for
each false claim, and attorneys' fees and costs.
22
23
Other Qui Tam Actions and Related Investigations
In May 1998, we were informed that we were a defendant in another qui
tam action involving home health services provided by two of our owned hospitals
and alleging that we had violated Medicare laws. This action was filed under
seal in June 1996 by a former employee, whom we fired in April 1996. The United
States Attorney's Office gave us the opportunity to review the results of the
government's investigations and discuss the allegations made in the action prior
to the government making a decision to intervene as a plaintiff. The lawsuit
remains under seal for all other purposes. We have cooperated fully with the
United States Attorney's Office and provided additional information and made
employees available for interviews. We are now engaged in settlement discussions
with the government.
As part of our ongoing discussions, we have learned from the same U.S.
Attorney that there are two additional unrelated qui tam complaints against us
alleging Medicare violations at one owned and two managed hospitals. Both
matters remain under seal. We have not seen the complaint in either matter. The
government has told us that it intends to investigate these allegations. We
intend to cooperate with the government's investigation.
The Class and Derivative Actions
In October and November 1998, some of our stockholders filed lawsuits
against us in the U.S. District Court for the Middle District of Tennessee. In
January 1999, the court consolidated these cases into a single lawsuit (M.D.
Tenn. No. 3-98-1004). The plaintiffs filed an amended complaint in March
1999. The plaintiffs seek to represent a class of plaintiffs who purchased our
common stock from October 25, 1995 through October 21, 1998, except for our
insiders and their immediate families. The consolidated complaint names us,
several of our officers and one of our outside directors, as defendants.
The complaint alleges that defendants violated the Securities Exchange Act
of 1934. The plaintiffs claim that we materially inflated our net revenues
during the class period by including in those net revenues amounts received from
the settlement of cost reports that had allegedly been filed in violation of
applicable Medicare regulations years earlier and that, because of this
practice, this statement, which first appeared in our Form 10-K filed in
September 1996, was false: "The Company believes that its owned hospitals are in
substantial compliance with current federal, state, local, and independent
review body regulations and standards." In May 1999, we filed a motion to
dismiss the complaint. The plaintiffs have filed papers opposing the motion, and
the judge has not yet ruled on the motion. We intend to defend vigorously the
claims and allegations in this action.
On November 2, 1998, a lawsuit was filed against us, all of our current
directors and two former directors in the U.S. District Court for the Northern
District of Alabama. On January 14, 1999, this suit was transferred by
agreement of the parties to the U.S. District Court for the Middle District of
Tennessee (M.D. Tenn. No. 3-99-0055). On February 16, 1999, the defendants
filed a motion to dismiss the original complaint. The court then granted the
23
24
plaintiff permission to file a first amended complaint, which, when filed,
mooted the original motion to dismiss. On April 30, 1999, the defendants moved
to dismiss the first amended complaint. The court on July 1, 1999, granted
plaintiff's motion for leave to file a second amended complaint and denied as
moot the motion to dismiss the first amended complaint. The second amended
complaint asserts four claims: a shareholders' derivative claim for breach of
fiduciary duty, a shareholders' derivative claim for violations of the Racketeer
Influenced and Corrupt Organizations Act, a shareholders' derivative claim for
injunctive relief, and a purported class action claim for breach of fiduciary
duty. As the basis for each of these claims, plaintiff alleges that the
defendants in 1993 were aware that we were filing allegedly false cost reports
and that the defendants "mandated" that the illegal acts continue in violation
of applicable Medicare and Medicaid laws. The defendants have filed a motion to
dismiss the second amended complaint. The plaintiff has responded to this
motion, but the court has not yet ruled on this motion. All of the defendants
plan to vigorously defend this litigation.
It is too early to predict the effect or outcome of any of the ongoing
investigations or the qui tam, class or stockholders' derivative actions, or
whether any additional investigations or litigation will be commenced. If we are
found to have violated federal or state laws relating to Medicare, Medicaid or
other government programs, then we may be required to pay substantial fines and
civil and criminal penalties. We also may be excluded from participating in the
Medicare and Medicaid programs and other government programs. Similarly, the
amount of damages sought in the qui tam actions are substantial. We could be
subject to substantial costs resulting from an adverse outcome of any of these
actions. In an effort to promptly resolve one or more of these matters, we may
choose to negotiate a settlement. Amounts we pay to settle any of these matters
may be material. Any one or more of these actions or costs could have a material
adverse effect on our results of operations or financial position (See Note 9 -
Contingencies in the Notes to Condensed Consolidated Financial Statements).
SELECTED OPERATING STATISTICS - OWNED HOSPITALS
The following table sets forth operating statistics for our owned
hospitals for each of the periods presented. Statistics for the three months
ended December 31, 1999 include a full period of operations for twenty-one
24
25
hospitals and the joint ventures in which we are minority investors and a
partial period for one hospital acquired. Statistics for the three months ended
December 31, 1998 include three months of operations for nineteen hospitals and
the joint ventures in which we are minority investors and partial periods for
one hospital acquired and one hospital contributed by Columbia Healthcare Corp.
(Col/HCA) to a joint venture that we control.
Statistics for the six months ended December 31, 1999 include a full
period of operations for twenty-one hospitals and the joint ventures in which we
are minority investors and a partial period for one hospital acquired.
Statistics for the six months ended December 31, 1998 include six months of
operations for eighteen hospitals and the joint ventures in which we are
minority investors and partial periods for two hospitals acquired and one
hospital contributed by Col/HCA to a joint venture that we control.
Three Months Six Months
Ended Ended
December 31 December 31
-------------------- --------------------
1999 1998 1999 1998
-------- -------- -------- --------
Number of hospitals 22 21 22 21
Licensed beds 4,647 4,883 4,647 4,883
Beds in service 3,943 3,991 3,943 3,991
Admissions 35,503 32,811 70,208 63,333
Average length of stay 5.6 5.6 5.5 5.6
Patient days 197,558 184,517 387,898 353,511
Adjusted patient days 336,135 314,120 664,992 609,798
Occupancy rates (licensed beds) 46.8% 43.2% 46.0% 43.6%
Occupancy rates (beds in service) 55.3% 53.0% 53.8% 53.4%
Gross inpatient revenue (in thousands) $441,550 $388,207 $871,777 $740,170
Gross outpatient revenue (in thousands) $309,661 $272,762 $622,752 $536,606
25
26
RESULTS OF OPERATIONS
The following table reflects the percentage of net operating revenue
represented by various categories in our Condensed Consolidated Statements of
Income.
Three Months Six Months
Ended Ended
December 31 December 31
----------------- -----------------
1999 1998 1999 1998
------ ------ ------ ------
Net operating revenue 100.0% 100.0% 100.0% 100.0%
Salaries and benefits 41.7 44.0 41.6 42.3
Reimbursable expenses 3.5 4.1 3.5 4.1
Supplies 14.6 14.5 14.5 13.8
Fees 8.9 9.9 8.9 9.5
Other expenses 7.5 8.0 7.2 7.3
Provision for doubtful accounts 6.8 8.5 8.0 7.8
Equity in earnings of affiliates (0.6) (1.3) (0.6) (1.3)
Leases and rentals 2.1 2.1 2.1 2.0
Depreciation and amortization 6.3 6.0 6.2 5.7
Interest expense 3.9 3.3 3.9 2.8
Write-down of assets and
investigation and litigation
related costs 0.4 8.0 0.3 4.0
Minority interest 0.1 (1.3) 0.0 (0.6)
------ ------ ------ ------
Income (loss) before income taxes 4.8 (5.8) 4.4 2.6
Provision (benefit) for income taxes 1.9 (0.9) 1.7 1.7
------ ------ ------ ------
Net income (loss) 2.9% (4.9)% 2.7% 0.9%
====== ====== ====== ======
Three Months Ended December 31, 1999 Compared to Three Months Ended December
31, 1998
Net Operating Revenue. Net operating revenue was $432.9 million for the
three months ended December 31, 1999, compared to $386.1 million for the three
months ended December 31, 1998. This represents an increase of $46.8 million or
12.1%. We attribute this increase to (1) the acquisition of three hospitals
during fiscal 1999 and fiscal 2000, (2) the hospital contributed by Col/HCA in
fiscal 1999 to a joint venture that we control and (3) a 6.5% increase in net
operating revenue produced by same store hospitals. "Same store hospitals" was
calculated by comparing the same periods in both fiscal periods for hospitals
owned for one year or more. The increase in net operating revenue was partially
offset by the sale of Park Medical Center in
26
27
fiscal 1999 and a 3.5% decrease in revenue from our hospital management
services.
We attribute the 6.5% same store net operating revenue increase
principally to (1) a 2.2% increase in same store admissions, (2) price increases
and (3) favorable estimated settlements from the government under Medicare and
Medicaid programs and from insurance and managed care companies during the three
months ended December 31, 1999 compared to unfavorable estimated third-party
payor settlements of $10.6 million for the three months ended December 31,
1998.(Estimated third-party payor settlements are discussed under the caption
"General"). Our same store net operating revenue would have increased more,
except for (1) increased discounts to insurance and managed care companies and
increased charity care and (2) lower payments from the government under the
Medicare program as a result of BBA 97.
Salaries and Benefits, Reimbursable Expenses, Supplies, Fees, Provision
for Doubtful Accounts and Other Operating Expenses. Salaries and benefits,
reimbursable expenses, supplies, fees, provision for doubtful accounts and other
operating expenses totaled $359.4 million for the three months ended December
31, 1999, compared to $343.4 million for the three months ended December 31,
1998. This represents an increase of $16.0 million or 4.6%. These expenses as a
percentage of net operating revenue decreased to 83.0% for the three months
ended December 31, 1999 from 89.0% for the three months ended December 31, 1998.
Salaries and benefits, reimbursable expenses, supplies, fees, provision for
doubtful accounts and other operating expenses as a percentage of net operating
revenue for our owned hospitals totaled 83.5% for the three months ended
December 31, 1999, compared to 90.6% for the three months ended December 31,
1998. For our same store hospitals, these expenses as a percentage of net
operating revenue decreased to 83.5% for the three months ended December 31,
1999, from 90.0% for the three months ended December 31, 1998.
We attribute the same store hospital decrease in these expenses as a
percent of net operating revenue primarily to (1) our growth in net operating
revenue, (2) our overall improvement in containing our costs in proportion to
our revenue growth and (3) our decrease in bad debt expense. Our hospitals and
our corporate office have cost containment programs to reduce costs and to
mitigate the impact of salaries and wage rate pressures and increased costs
associated with new technology and products. We reduced our bad debt expense by
increasing our resources at corporate and our owned hospitals to collect and
manage accounts receivable. During calendar 1999, many of our hospitals
completed patient accounting computer systems conversions or major upgrades to
their systems which had previously strained our business office resources.
During the three months ended December 31, 1999, we focused efforts on
collecting older accounts which had an impact on bad debt expense in addition to
collecting current accounts receivable.
Equity in Earnings of Affiliates. Equity in earnings of affiliates
represents our share of earnings from joint ventures in which we hold a minority
interest. Equity in earnings of affiliates was $2.8 million for the three months
ended December 31, 1999, compared to $4.9 million for the three months ended
December 31, 1998, a decrease of $2.1 million. Equity in
27
28
earnings of affiliates represented 0.6% of our net operating revenue for the
three months ended December 31, 1999, compared to 1.3% of our net operating
revenue for the three months ended December 31, 1998. This decrease was due
primarily to a reduction in earnings at our Las Vegas joint venture.
Leases and Rentals. Leases and rentals were $9.3 million for the three
months ended December 31, 1999, compared to $8.1 million for the three months
ended December 31, 1998, an increase of $1.2 million, or 13.6%. Leases and
rentals as a percentage of net operating revenue was 2.1% for both periods.
Depreciation and Amortization. Depreciation and amortization expense
was $27.0 million for the three months ended December 31, 1999, compared to
$23.1 million for the three months ended December 31, 1998. This represents an
increase of $3.9 million, or 16.9%. We attribute this increase primarily to (1)
the acquisition of three hospitals during fiscal 1999 and fiscal 2000, (2) the
hospital contributed by Columbia/HCA in fiscal 1999 to a joint venture that we
control, (3) the opening of a replacement facility in Florence, South Carolina
in November 1998 and (4) depreciation related to routine capital expenditures,
including Year 2000 capital expenditures. This increase was partially offset by
a decrease in amortization expense related to the physician practice intangibles
which were written off during fiscal 1999. Depreciation and amortization expense
as a percentage of net operating revenue increased to 6.3% for the three months
ended December 31, 1999 from 6.0% for the three months ended December 31, 1998.
Interest Expense. Interest expense for the three months ended December
31, 1999 was $16.9 million, compared to $12.7 million for the three months ended
December 31, 1998, an increase of $4.2 million, or 32.5%. Interest expense as a
percentage of net operating revenue increased to 3.9% for the three months ended
December 31, 1999 from 3.3% for the three months ended December 31, 1998. The
increase was due principally to (1) additional borrowings related to fiscal 1999
and fiscal 2000 acquisitions, share repurchases, and the opening of the
replacement facility in November 1998 and (2) an increase in the interest rates
of our revolving line of credit. This increase was partially offset by the
issuance of convertible subordinated debentures in August 1999 at 6%, which is
lower than our revolving line of credit interest rates.
Write Down of Assets and Investigation and Litigation Related Costs.
During the three months ended December 31, 1999 and 1998, respectively, we
incurred investigation and litigation related costs of approximately $1.8
million and $1.1 million. In addition, we recorded a $29.9 million write down of
assets in the three months ended December 31, 1998 (See Note 5 - Write Down of
Assets and Investigation and Litigation Related Costs in the Notes to Condensed
Consolidated Financial Statements).
Minority Interest Expense (Income). Minority interest expense was $0.5
million for the three months ended December 31, 1999, compared to income of $5.2
million for the three months ended December 31, 1998, a change of $5.7 million.
Minority interest expense as a percentage of net operating revenue was 0.1% for
the three months ended December 31, 1999, compared to income of 1.3% for the
three months ended December 31, 1998. We attribute this change
28
29
primarily to the intangible asset write-downs during the three months ended
December 31, 1998 and the improved profitability of one market with minority
investors.
Income Taxes. The provision for income taxes for the three months ended
December 31, 1999 was expense of $8.1 million compared to a benefit of $3.5
million for the three months ended December 31, 1998, an increase of $11.6
million. Excluding the asset write-downs, our effective income tax rate was
39.1% for both periods. The asset write-downs were tax effected at 21.0% due to
the effect of certain permanent nondeductible intangible assets.
Net Income (Loss). Net income for the three months ended December 31,
1999 was $12.6 million, compared to a loss of $18.7 million for the three months
ended December 31, 1998, an increase of $31.3 million. Net income as a
percentage of net operating revenue was 2.9% for the three months ended December
31, 1999, compared to a loss of 4.9% for the three months ended December 31,
1998. Excluding the write-down of assets and investigation and litigation
related costs, net income as a percentage of net operating revenue was 3.2% for
the three months ended December 31, 1999, compared to 1.0% for the three months
ended December 31, 1998.
Six Months Ended December 31, 1999 Compared to Six Months Ended December 31,
1998
Net Operating Revenue. Net operating revenue was $864.1 million for the
six months ended December 31, 1999, compared to $775.4 million for the six
months ended December 31, 1998. This represents an increase of $88.7 million or
11.4%. We attribute this increase to (1) the acquisition of four hospitals
during fiscal 1999 and fiscal 2000, (2) the hospital contributed by Col/HCA in
fiscal 1999 to a joint venture that we control and (3) a 3.5% increase in net
operating revenue produced by same store hospitals. The increase in net
operating revenue was partially offset by the sale of Park Medical Center in
fiscal 1999 and a 4.8% decrease in revenue from our hospital management
services.
We attribute the 3.5% same store net operating revenue increase
principally to (1) a 1.7% increase in same store admissions, (2) price increases
and (3) favorable estimated settlements from the government under Medicare and
Medicaid programs and from insurance and managed care companies for the six
months ended December 31, 1999 compared to unfavorable estimated third-party
payor settlements for the six months ended December 31, 1998. Our same store net
operating revenue would have increased more, except for (1) increased discounts
to insurance and managed care companies and increased charity care and (2) lower
payments from the government under the Medicare program as a result of BBA 97.
Salaries and Benefits, Reimbursable Expenses, Supplies, Fees, Provision
for Doubtful Accounts and Other Operating Expenses. Salaries and benefits,
reimbursable expenses, supplies, fees, provision for doubtful accounts and other
operating expenses totaled $722.6 million for the six months ended December 31,
1999, compared to $658.1 million for the six months ended December 31, 1998.
This represents an increase of $64.5 million or 9.8%.
29
30
These expenses as a percentage of net operating revenue decreased to 83.7% for
the six months ended December 31, 1999 from 84.8% for the six months ended
December 31, 1998. Salaries and benefits, reimbursable expenses, supplies, fees,
provision for doubtful accounts and other operating expenses as a percentage of
net operating revenue for our owned hospitals totaled 84.2% for the six months
ended December 31, 1999, compared to 86.1% for the six months ended December 31,
1998. For our same store hospitals, these expenses as a percentage of net
operating revenue decreased to 83.7% for the six months ended December 31, 1999,
from 85.3% for the six months ended December 31, 1998.
We attribute the same store hospital decrease in these expenses as a
percent of net operating revenue primarily to our (1) growth in net operating
revenue, as discussed above, and (2) overall improvement in containing our costs
in proportion to our revenue growth. During the six months ended December 31,
1999, we implemented cost containment programs at our hospitals and our
corporate office to reduce costs and to mitigate the impact of salaries and wage
rate pressures and increased costs associated with new technology and products.
Equity in Earnings of Affiliates. Equity in earnings of affiliates was
$4.9 million for the six months ended December 31, 1999, compared to $10.3
million for the six months ended December 31, 1998, a decrease of $5.4 million.
Equity in earnings of affiliates represented 0.6% of our net operating revenue
for the six months ended December 31, 1999, compared to 1.3% of our net
operating revenue for the six months ended December 31, 1998. This decrease was
due primarily to a reduction in earnings at our Las Vegas joint venture.
Leases and Rentals. Leases and rentals were $18.3 million for the six
months ended December 31, 1999, compared to $15.3 million for the six months
ended December 31, 1998, an increase of $3.0 million, or 19.9%. Leases and
rentals as a percentage of net operating revenue increased to 2.1% for the six
months ended December 31, 1999, compared to 2.0% for the six months ended
December 31, 1998. This increase was due primarily to an increase in assets
leased under our end loaded lease financing agreement in connection with
hospital acquisitions in fiscal 1999.
Depreciation and Amortization. Depreciation and amortization expense
was $53.2 million for the six months ended December 31, 1999, compared to $44.5
million for the six months ended December 31, 1998. This represents an increase
of $8.7 million, or 19.8%. We attribute this increase primarily to (1) the
acquisition of four hospitals during fiscal 1999 and fiscal 2000, (2) the
hospital contributed by Columbia/HCA in fiscal 1999 to a joint venture that we
control, (3) the opening of a replacement facility in Florence, South Carolina
in November 1998 and (4) depreciation related to routine capital expenditures.
This increase was partially offset by a decrease in amortization expense related
to the physician practice intangibles which were written off during fiscal 1999.
Depreciation and amortization expense as a percentage of net operating revenue
increased to 6.2% for the six months ended December 31, 1999 from 5.7% for the
six months ended December 31, 1998.
30
31
Interest Expense. Interest expense for the six months ended December
31, 1999 was $33.6 million, compared to $21.9 million for the six months ended
December 31, 1998, an increase of $11.7 million, or 53.7%. Interest expense as a
percentage of net operating revenue increased to 3.9% for the six months ended
December 31, 1999 from 2.8% for the six months ended December 31, 1998. The
increase was due principally to (1) additional borrowings related to fiscal 1999
and fiscal 2000 acquisitions, share repurchases, and the opening of the
replacement facility in November 1998 and (2) an increase in the interest rates
of our revolving line of credit. This increase was partially offset by the
issuance of convertible subordinated debentures in August 1999 at 6%, which is
lower than our revolving line of credit interest rates.
Write Down of Assets and Investigation and Litigation Related Costs.
During the six months ended December 31, 1999 and 1998, respectively, we
incurred investigation and litigation related costs of approximately $2.9
million and $1.1 million. In addition, we recorded a $29.9 million write down of
assets in the six months ended December 31, 1998 (See Note 5 - Write Down of
Assets and Investigation and Litigation Related Costs in the Notes to Condensed
Consolidated Financial Statements).
Minority Interest Expense (Income). Minority interest expense was $0.2
million for the six months ended December 31, 1999, compared to income of $4.6
million for the six months ended December 31, 1998, a change of $4.8 million.
Minority interest expense as a percentage of net operating revenue was 0.0% for
the six months ended December 31, 1999, compared to income of 0.6% for the six
months ended December 31, 1998. We attribute this change primarily to the
intangible asset write-downs during the six months ended December 31, 1998 and
improved profitability of one market with minority investors.
Income Taxes. The provision for income taxes for the six months ended
December 31, 1999 was $14.9 million compared to $12.9 million for the six months
ended December 31, 1998, an increase of $2.0 million, or 15.8%. Excluding the
asset write-downs, our effective income tax rate was 39.1% for both periods. The
asset write-downs were tax effected at 21.0% due to the effect of certain
permanent nondeductible intangible assets.
Net Income. Net income for the six months ended December 31, 1999 was
$23.2 million, compared to $6.8 million in fiscal 1998, an increase of $16.4
million, or 244%. Net income as a percentage of net operating revenue was 2.7%
for the six months ended December 31, 1999, compared to 0.9% for the six months
ended December 31, 1998. Excluding the write-down of assets and investigation
and litigation related costs, net income as a percentage of net operating
revenue was 2.9% for the six months ended December 31, 1999, compared to 3.8%
for the six months ended December 31, 1998.
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 1999, our working capital was $246.9 million. Our ratio
of current assets to current liabilities was 2.2 to 1.0 at December 31, 1999
compared to 2.1 to 1.0 at June 30, 1999.
31
32
Cash Flows
Our principal sources of cash are net cash provided by operating
activities and cash available under our bank revolving line of credit facility.
Our principal uses of funds are hospital acquisitions, capital expenditures,
payments of principal and interest on our long-term debt and share repurchases.
Collection of accounts receivable is a significant contribution to our
cash flow from operating activities. The billing and collection of accounts
receivable by hospitals is very difficult because of the complexity of the
Medicare and Medicaid regulations, increases in managed care, hospital personnel
turnover including business office managers, computer system conversions by
hospital and government authorities, dependence of hospitals on physician
documentation of medical records, and the subjective judgement involved in
submitting and collecting Medicare and Medicaid bills. Our cash flow can also be
affected by temporary delays in billing of Medicare and Medicaid accounts
receivable while waiting for processing of change in ownership applications at
hospitals. There can be no assurance that this complexity will not negatively
impact our future cash flow or results of operations.
Six Months Ended December 31, 1999 Cash Flows Compared To Six Months
Ended December 31, 1998 Cash Flows. Cash provided by operating activities
totaled $73.9 million for the six months ended December 31, 1999, compared to
$52.1 million for the six months ended December 31, 1998. This represents an
increase of $21.8 million, or 41.8%, which was due primarily to higher EBITDA,
cash distributions received from our Macon and Las Vegas joint ventures and
lower tax payments. This increase was partially offset by increased payments on
accounts payable for the six months ended December 31, 1999 compared to the six
months ended December 31, 1998.
EBITDA. EBITDA* for the three months ended December 31, 1999 was $67.0
million, compared to $39.5 million for the three months ended December 31, 1998,
an increase of $27.5 million or 69.8%. EBITDA as a percentage of net operating
revenue was 15.5% for the three months ended December 31, 1999, compared to
10.2% for the three months ended December 31, 1998. EBITDA as a percentage of
net operating revenue for our owned hospitals was 15.0% for the three months
ended December 31, 1999, compared to 8.7% for the three months ended December
31, 1998. EBITDA as a percentage of net operating revenue for our same store
hospitals was 14.6% for the three months ended December 31,
- --------
* EBITDA is commonly used as an analytical indicator, and also serves
as a measure of indebtedness capacity and debt service ability. EBITDA should
not be considered a measure of financial performance under generally accepted
accounting principles, and the items excluded from EBITDA are significant
components in understanding and assessing financial performance. EBITDA should
not be considered in isolation or as alternatives to net income, cash flows
generated by operating, investing or financing activities or other financial
statement data presented in the condensed consolidated financial statements as
an indicator of financial performance or liquidity. Because EBITDA is not a
measurement determined in accordance with generally accepted accounting
principles and is susceptible to varying calculations, EBITDA as presented may
not be comparable to other similarly titled measures of other companies.
32
33
1999, compared to 8.0% for the three months ended December 31, 1998. EBITDA as a
percentage of net operating revenue for our management services business was
20.5% for the three months ended December 31, 1999, compared to 24.8% for the
three months ended December 31, 1998. We attribute the increase in consolidated
EBITDA principally to (1) the increase in net operating revenue, (2) overall
improvement in containing our costs, in proportion to our revenue growth and (3)
a decrease in bad debt expense. This increase was partially offset by (1)
discounts to insurance and managed care companies, (2) the impact of BBA 97 and
(3) the decrease in equity in earnings of affiliates.
EBITDA for the six months ended December 31, 1999 was $128.1 million,
compared to $112.3 million for the six months ended December 31, 1998, a
decrease of $15.8 million or 14.1%. EBITDA as a percentage of net operating
revenue was 14.8% for the six months ended December 31, 1999, compared to 14.5%
for the six months ended December 31, 1998. EBITDA as a percentage of net
operating revenue for our owned hospitals was 14.3% for the six months ended
December 31, 1999, compared to 13.5% for the six months ended December 31, 1998.
EBITDA as a percentage of net operating revenue for our same store hospitals was
14.5% for the six months ended December 31, 1999, compared to 12.8% for the six
months ended December 31, 1998. EBITDA as a percentage of net operating revenue
for our management services business was 21.1% for the six months ended December
31, 1999, compared to 24.3% for the six months ended December 31, 1998. We
attribute the increase in consolidated EBITDA principally to (1) the increase in
net operating revenue and (2) overall improvement in containing our costs, in
proportion to our revenue growth. This increase was partially offset by (1)
discounts to insurance and managed care companies (2) the impact of BBA 97 and
(3) the decrease in equity in earnings of affiliates.
Capital Expenditures
Capital expenditures excluding acquisitions for the six months ended
December 31, 1999 totaled $57.3 million. We expect to make routine capital
expenditures, including Year 2000 capital costs, for fiscal 2000 of
approximately $100 million before acquisitions of hospitals and affiliated
health care entities and before construction of new or replacement hospitals.
We have broken ground on a replacement hospital in Vicksburg,
Mississippi and a new acute-care hospital in Ft. Wayne, Indiana. The replacement
hospital has a total project cost of approximately $110 million with an expected
completion date of summer 2002. The new facility has a total project cost of
approximately $45 million with an expected completion date of summer 2001. We
expect to make construction capital expenditures of approximately $15 million
for fiscal 2000.
Capital expenditures excluding acquisitions for the six months ended
December 31, 1998 totaled $72.2 million. These capital expenditures consisted of
the construction of a replacement hospital and two medical office buildings in
Florence, South Carolina of approximately $35.2 million and routine capital
expenditures of $37.0 million.
33
34
Capital Resources
Our revolving credit facility consists of an $850.0 million credit
facility expiring November 26, 2002, which coincides with the expiration date of
our end loaded lease facility. On November 26 of each year, we can request an
incremental one-year extension, which is subject to approval of all of the
lenders. The credit facility bears interest at our option at generally the
lender's base rate, swing-line rate or a fluctuating rate ranging from .55 to
1.55 percentage points above LIBOR. Also, we pay a facility fee ranging from .20
to .45 percentage points on the commitment. The interest rate margins and
facility fee rates are based on our leverage ratio. Substantially all stock of
our subsidiaries has been pledged under the terms of the credit facility. We may
prepay the amount outstanding at any time. At January 31, 2000, we had $263.7
million available under our credit facility.
We also have a $150.0 million end loaded lease financing agreement to
provide a financing option for acquisition and/or construction. The interest
rate margins and facility fee rates are substantially similar to those under our
credit facility. Under this agreement, we have guaranteed all lease payments,
including contingent lease payments, of up to 85% of the amount utilized under
this agreement. At January 31, 2000, $5.0 million was available under this
agreement.
We have $150.0 million of 8 3/4% senior subordinated notes, which
mature on November 1, 2005. We have the option to redeem these notes at 104.375%
of the principal amount on or after November 1, 2000, at 102.188% of the
principal amount on or after November 1, 2001, or at par value on or after
November 1, 2002. Upon a change of control, we must make an offer to purchase
these notes at 101% of the principal amount. These notes are unsecured and
subordinated in right of payment to all existing and future senior debt.
On August 31, 1999, we issued $150.0 million of convertible
subordinated debentures due 2009 to Welsh, Carson, Anderson & Stowe, VIII, LP
and certain WCAS VIII affiliates, including Russell L. Carson, Chairman of our
Board of Directors. We sold the debentures for cash at their face value. The
debentures bear interest at 6.0% per annum. Interest is payable quarterly. The
debentures are convertible into common shares at a conversion price of $11.25
per share. The debentures automatically convert at any time after three years if
the average of the closing price of our stock over any 90 day period is more
than 150% of the conversion price. We can call the debentures at par after
August 31, 2001. In the event of a merger, consolidation or sale of more than
50% of our assets, the holder of the debentures has the option to have the
debentures prepaid in full. The debentures have antidilution protection,
including, under certain circumstances, issuance of common stock below the then
applicable conversion price. The shares into which the debentures are
convertible have certain voting restrictions and must be held until August 2001.
The debentures are subordinated in right of payment to all our debt. We did not
register the debentures under the Securities Act of 1933. The sale of the
debentures was exempt from registration under Section 4(2) of the Securities Act
because it was a privately negotiated transaction and did not involve a public
offering. We used the proceeds to reduce our outstanding debt under our
revolving credit facility.
34
35
The credit facilities governing our revolving line of credit and senior
subordinated notes contain certain financial covenants including but not limited
to a limitation on debt levels, the prohibition of dividend payments and other
distributions and restrictions on investments, repurchases of common stock,
asset dispositions, the ability to merge or consolidate with or transfer assets
to another entity, and the maintenance of various financial ratios, including a
net worth ratio, a fixed charge ratio and a leverage ratio.
During the three months ended December 31, 1999 we repurchased 2.7
million shares of our common stock for an aggregate purchase price of $17.6
million. We repurchased all of these shares in open market transactions. There
are approximately 1.7 million shares remaining for repurchase under the existing
5.0 million share repurchase program authorized in October 1998.
As of January 31, 2000, there were 5.9 million options outstanding with
a weighted average exercise price of $9.39. In March 1999, our board of
directors approved a plan to allow employees to exchange "underwater" stock
options. These stock options had exercise prices higher than the market price of
our common stock. Based on the exchange, we canceled 5.2 million options at
exercise prices ranging from $12.09 to $33.06 and issued 3.6 million options at
an exercise price of $9.00. The effect was to reduce the number of options held
to offset the benefit of a lower exercise price. The estimated economic value of
the grants was generally unchanged as a result of the exchange. Under the
proposed interpretation of APB Opinion No. 25, repriced options would receive
variable-award accounting. Should we be required to apply variable-award
accounting to the repriced options, the options under the terms of the option
grant will vest and terminate thirty days after we give notice to our employees.
Variable-award accounting for the repriced options will be eliminated after the
option termination date.
We adopted a stockholder rights plan in fiscal 1997 and declared a
dividend of one right for each share of common stock. The plan was amended in
August 1999. Each right entitles stockholders to acquire one-third of a share of
common stock at an exercise price of $100, subject to adjustment. The rights
become exercisable only if (1) Welsh, Carson, Anderson & Stowe VIII, L.P., WCAS
Management Corporation and certain parties which purchase the convertible
debentures from these entities acquire beneficial ownership of 30% or more of
our common stock or start an offer which would result in those entities owning
30% or more of our common stock or (2) any other person or group acquires
beneficial ownership of 15% or more of our common stock or starts an offer which
would result in that person or group owning 15% or more of our common stock. At
that time, each right owned by unaffiliated others entitles its holder to
purchase common stock (or any combination of common stock, preferred stock, debt
securities and cash, as determined by our board of directors) worth two times
the exercise price of the right. If we are involved in a business combination
transaction with another person or if we sell 50% or more of our assets or
earning power to another person, each right entitles its holder to purchase
shares of our common stock or the acquiring company's common stock worth two
times the exercise price of the right. We may redeem the rights for $.01 each at
any time until the tenth day following
35
36
public announcement that an ownership position as described above has been
acquired. The rights expire on April 28, 2007.
SEASONALITY AND INFLATION
Our business is seasonal, with higher patient volumes and net operating
revenues in the third quarter of our fiscal year than in the remainder of the
year. This seasonality happens because more people become ill during the winter,
which in turn increases the number of patients in our owned hospitals.
The health care industry is labor intensive. This means that our owned
hospitals need many employees, who we pay salaries and other benefits. These
salaries and benefits increase during periods of inflation and shortages of
qualified potential employees. In addition, our suppliers pass along rising
costs to us in the form of higher prices. We cannot assure you that we will be
able to offset or control future cost increases.
MARKET RISKS ASSOCIATED WITH FINANCIAL INSTRUMENTS
Our interest expense is sensitive to changes in the general level of
interest rates. To mitigate the impact of fluctuations in interest rates, we
generally maintain 50%-75% of our debt at a fixed rate, either by borrowing on a
long-term basis or entering into interest rate swaps. Interest rate swaps are
contracts which allow us to periodically exchange fixed and floating interest
rate payments over the life of the agreements. Floating-rate payments are based
on LIBOR and fixed-rate payments are dependent upon market levels at the time we
execute the swap agreement. Our policy is to not hold or issue derivatives for
trading purposes and to avoid derivatives with leverage features. Some of our
swap agreements allow the counter party a one-time option at the end of the
initial term to cancel the agreement or a one-time option at the end of the
initial term to extend the swaps for an incremental period of up to five years.
If our counter parties do not comply with their obligations under our financial
instruments, we may suffer losses. Our counter parties are creditworthy
financial institutions and we anticipate that they will be able to fully satisfy
their obligations under the contracts. For the six months ended December 31,
1999 and 1998, we received a weighted average rate of 5.4% and 5.5% and paid a
weighted average rate of 5.9% and 5.7%, respectively.
The following table presents information about our market-sensitive
financial instruments, including long-term debt and interest rate swaps as of
December 31, 1999. For debt obligations, the table presents principal cash flows
and related weighted-average interest rates by expected maturity dates. For
interest rate swap agreements, the table presents notional amounts by expected
maturity date (assuming the options to extend or cancel are not exercised) and
weighted average interest rates based on rates in effect at December 31, 1999.
We determined the fair values of long-term debt and interest rate swaps based on
quoted market prices at December 31, 1999 for the same or similar issues.
36
37
Maturity Date, Fiscal Year Ending June 30
----------------------------------------------
(Dollars in millions)
There- Fair Value of
2000 2001 2002 2003 2004 after Total Liabilities
----- ----- ----- ----- ----- ------ ------ -------------
Long-term debt:
Fixed rate long-term
debt $ 0.5 $ 0.8 $ 0.6 $ 0.6 $ 0.6 $301.6 $304.7 $296.4
Average interest rates 7.6% 7.7% 7.7% 7.7% 7.8% 7.4%
Variable rate long-
term debt $588.5 $588.5 $588.5
Average interest rates 7.6%
Interest rate swaps:
Pay fixed/receive
variable notional
amounts $400.0 $400.0 $(8.0)
Average pay rate 5.9%
Average receive rate 6.1%
YEAR 2000 ISSUES
Our owned hospitals and corporate office have not experienced any
significant adverse consequences as a result of the Year 2000 issues.
We are not aware of any significant adverse consequences experienced by
our managed hospitals as a result of the Year 2000 issues. We believe we are not
responsible for ensuring Year 2000 compliance by our managed hospitals, but we
cannot provide assurance that our managed hospitals will not seek to hold us
responsible, or that we will not ultimately be found liable, for any losses they
incur arising out of the Year 2000 problem.
Total cost to implement our Year 2000 strategy was approximately $18.0
million compared to our previous estimate of $20.0 million. This does not
include payroll costs for certain internal employees because we do not
separately track these costs. We incurred approximately $2.7 million in
operating costs and $5.4 million in capital costs during the first six months of
calendar 1999. We incurred an additional $1.2 million in operating costs and
$8.7 million in capital costs during the six months ended December 31, 1999.
37
38
GENERAL
We received from the Medicare and Medicaid programs approximately 54%
and 55% of gross patient service revenue for the years ended June 30, 1999 and
1998, respectively.
Under BBA 97, there were no increases in the inpatient operating
payment rates to acute care hospitals for services from October 1, 1997 through
September 30, 1998. Inpatient operating payment rates increased 0.5% for October
1, 1998 through September 30, 1999 and 1.1% for October 1, 1999 through
September 30, 2000. These increases are less than inflation and subsequent
increases are also expected to be less than inflation. Also, the threshold to
qualify for additional payments for treating costly inpatient cases (outliers)
increased, resulting in decreased payments to hospitals effective October 1,
1999. Payments for Medicare outpatient services, home health services and
skilled nursing facility services historically have been paid based on costs,
subject to certain adjustments and limits. BBA 97 required that the payment for
those services be converted to prospective payment systems (PPS). PPS for
skilled nursing facilities began for cost reporting periods beginning on and
after July 1, 1998. The Health Care Financing Administration's (HCFA) current
plan is to implement PPS for outpatients on July 1, 2000 and for home health on
October 1, 2000.
On November 29, 1999 the President signed into law the Medicare,
Medicaid, and State Children's Health Insurance Programs Balanced Budget
Refinement Act of 1999 (BBRA). For us, the most significant provision of BBRA is
a requirement to eliminate the planned 5.7% reduction in outpatient payments and
to partially subsidize losses in the first 3 1/2 years of the new outpatient
PPS.
Due to BBA 97, we had lower Medicare payments for outpatient services
and home health visits prior to implementation of PPS. We also had lower
payments under PPS for skilled nursing facilities. The reduction in home health
payments resulted in a decline in our home health volumes of 6.9% and 56.0% for
the six months ended December 31, 1999 and December 31, 1998, respectively,
compared to the prior year periods. In response to BBA 97, we have consolidated
certain home health agencies and skilled nursing facilities, reduced costs at
our home health agencies and skilled nursing facilities and ceased admitting
patients to skilled nursing facilities at two hospitals.
The federal government originally estimated that BBA 97 would reduce
Medicare spending by approximately $115 billion. In July 1999, the federal
government revised their estimate of reductions in Medicare spending by an
additional $103 billion. Recent projections by the federal government estimate a
further reduction in Medicare spending of $62 billion. BBA 97 has reduced our
ability to maintain our historical rate of net revenue growth and operating
margins. We believe the most significant payment reductions were phased in by
October 1, 1998. BBA 97 and further changes in the Medicare or Medicaid programs
and other proposals to limit health care spending could have a material adverse
impact upon the health care industry and our hospitals. We expect continuing
pressure to limit expenditures by governmental health care programs.
38
39
We are continuing to experience an increase in managed care discounts.
Managed care includes indemnity insurance and employer plans which pay less than
full charges, health maintenance organizations, preferred provider organizations
and various other forms of managed care. An increasing number of payors are
actively negotiating amounts paid to hospitals, which are lower than the
hospitals' standard rates. Additionally, some managed care payors pay less than
the negotiated rate which, if undetected, results in lower net revenues. To
assist the owned hospital management teams in evaluating and negotiating
contracts and obtaining better pricing, we employ managed care experts. In
several markets, we have canceled contracts with PPOs who allow discounts we
believe are not justified. We are reviewing other markets for similar activity.
Additionally, we are beginning to use managed care information systems in four
of our owned hospitals to improve the information available to management and to
help ensure that we are paid at the contracted amounts. We expect to install
these systems in fifteen additional owned hospitals in phases with most
hospitals having basic functionality by June 30, 2000. We plan to install these
systems in the remaining three owned hospitals during fiscal year 2001. The
trend toward managed care has and may continue to adversely affect our ability
to grow net operating revenue and improve operating margins.
Our acute care hospitals, like most acute care hospitals in the United
States, have significant unused capacity. The result is substantial competition
for patients and physicians. Inpatient volumes continue to be negatively
affected by payor-required pre-admission authorization and by payor pressure to
maximize outpatient and alternative health care delivery services for less
acutely ill patients. Over the long term, we expect the industry trend from
inpatient to outpatient services to continue due to the increased focus on
managed care and advances in technology. More outpatient procedures are now
being provided in physician's offices. We expect increased competition and
admission constraints to continue. Our ability to successfully respond to these
trends, as well as spending reductions in governmental health care programs,
will be significant in determining our ability to grow net operating revenue and
improve operating margins.
Outpatient revenue of our owned hospitals was approximately 41.7% and
42.0% of gross patient service revenue for the six months ended December 31,
1999 and 1998, respectively.
We face competition in acquiring hospitals from a number of well-
capitalized organizations. National studies indicate that acute care hospital
margins peaked in 1998 and are expected to decline for the next several years.
The pricing expected by hospital sellers may not yet reflect lower margins.
Additionally, some hospitals are sold through an "auction" process, which may
result in competitors paying higher prices for those properties than we believe
is reasonable. Many states have implemented review processes by the Attorneys
General of not-for-profit hospital acquisitions, resulting in delays to close an
acquisition. We believe that trends in the health care industry described above
may create possible future acquisition opportunities. In light of changes in
payments from Medicare and managed care payors, increased pricing pressures for
acquired hospitals and the substantial number of transactions completed in
fiscal 1999, we intend to be selective in pursuing
39
40
acquisitions. There can be no assurances that we can continue to grow through
hospital acquisitions and successfully integrate acquired hospitals into our
system.
In accordance with generally accepted accounting principles, we
estimate settlements with third party payors. These estimates are based on
assumptions and affect the amounts we report in our financial statements. For
example, we report net patient service revenue at net amounts we expect to
receive from our hospital patients, third party payors, and others for services
rendered, including estimated retroactive adjustments under agreements with
third party payors. We make estimates of settlements under agreements with third
party payors in the period we provide the related services. We then adjust the
settlements as final settlements are determined or additional information is
obtained from the third party payor. Our quarterly or annual operating results
fluctuate based on the timing and amount of changes in estimates.
The IRS is examining our federal income tax returns for fiscal years
1993 through 1998. The IRS has proposed to adjust our federal income tax returns
for fiscal years 1993 through 1995. The most significant adjustments relate to
how we compute bad debt expense and how we value property, plant and equipment
of hospitals we acquire and their related depreciable lives. We have protested
substantially all of the proposed adjustments through the appeals process of the
IRS. In our opinion, the ultimate outcome of the IRS examinations will not have
a material effect on our results of operations or financial condition.
In 1998, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 133, "Accounting for
Derivative Instruments and Hedging Activities". This standard will require us to
recognize all derivatives on the balance sheet at their fair value. Derivatives
that are not hedges must be adjusted to fair value through changes to our income
statement. For interest rate swap agreements that qualify as hedges, we will
offset changes in fair value against the change in fair value of the hedged
assets, liabilities, or firm commitments through changes to our earnings. We
will adopt this new FASB standard on July 1, 2000. We are presently evaluating
the new standard to determine its effect on our earnings and financial position.
On March 31, 1999, the FASB released a proposed interpretation of APB
Opinion No. 25 "Accounting for Certain Transactions involving Stock
Compensation". This proposed interpretation requires variable-award accounting
for repriced stock options. The FASB expects this proposed interpretation to be
effective July 1, 2000. The interpretation would generally cover events that
occur after December 15, 1998. No adjustments would be made to financial
statements for periods prior to the effective date and no expense would be
recognized for any additional compensation costs attributable to periods before
the effective date (See "Capital Resources" for a discussion of our option
repricing completed in March 1999).
Item 3. Qualitative and Quantitative Disclosures About Market Risk.
The information contained in Part I, Item 2. "Management's Discussion
and Analysis" under the caption "Market Risks Associated with Financial
Instruments" is incorporated by reference in its entirety into this Item 3.
40
41
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The information contained in Part I, Item 2. "Management's Discussion
and Analysis" under the caption "Litigation" is incorporated by reference in its
entirety into this item.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On November 16, 1999, the annual meeting of the stockholders of the
Company was held to elect directors, to vote on two other proposals presented by
the Company, and to ratify the selection of the Company's independent auditors.
Voting results are given below.
Election of Directors. The following were elected to serve as directors
until the next annual meeting of the stockholders:
Name For Against Abstain
---- --- ------- -------
Sam A. Brooks, Jr. 58,541,743 3,492,591
Russell L. Carson 58,543,679 3,490,655
James E. Dalton, Jr. 58,597,399 3,436,935
C. Edward Floyd, M.D. 58,536,854 3,497,480
Joseph C. Hutts 58,541,263 3,493,071
Kenneth J. Melkus 58,542,954 3,491,380
Thomas J. Murphy, Jr 58,543,255 3,491,079
Rocco A. Ortenzio 58,538,112 3,496,222
S. Douglas Smith 58,543,399 3,490,935
Colleen Conway Welch, Ph.D. 58,538,556 3,495,778
Amendment of Employee Stock Purchase Plan. The Shareholders approved he
amendment of the Company's Employee Stock Purchase Plan, increasing the
aggregate number of shares reserved for issuance under the Plan from 3,750,000
to 5,000,000, with 59,014,192 shares voted for the amendment; 2,987,572 shares
against; and 32,570 shares abstained.
Deferred Compensation Plan for Directors. The Shareholders approved the
adoption of a Deferred Compensation Plan for Directors of the Company, under
which 500,000 shares of Common Stock are reserved for issuance in lieu of cash
compensation for directors' fees. A total of 61,276,450 shares were voted for
the Plan; 676,719 shares against; and 81,165 abstained.
Independent Auditor. The accounting firm of Ernst & Young was ratified
as the Company's independent auditors for the fiscal year ending June 30, 2000,
with 61,809,311 shares voted for ratification; 19,180 shares against; and
205,843 shares abstained.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits. Exhibits filed with this Report are listed on the Exhibit
Index following the signature page.
42
(b) Reports on Form 8-K. No Reports on Form 8-K were filed during the
quarter ended December 31, 1999.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
QUORUM HEALTH GROUP, INC.
(Registrant)
Date: February 11, 2000 By: /s/ Terry Allison Rappuhn
------------------------------------
Terry Allison Rappuhn
Senior Vice President
& Chief Financial Officer
43
Exhibit Index
Exhibit No.
- -----------
10.D. Employee Stock Option Plan, as amended (Incorporated
by reference to Exhibit A to the Company's definitive
Proxy Statement for the Annual Meeting held November
16, 1999.)
10.L. Deferred Compensation Plan for Directors of Quorum
Health Group, Inc. (Incorporated by reference to
Exhibit B to the Company's definitive Proxy Statement
for the Annual Meeting held November 16, 1999.)
10.25.1. Second Amendment, dated as of January 11, 2000, to
Group Purchasing Organization Participating Agreement
between Premier Purchasing Partners, L.P., f/k/a APS
Healthcare Purchasing Partners, L.P.,dated November
30, 1995.
27 Financial Data Schedule (SEC use only)