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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, 2000
OR
[ ] Transition Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the transition period from _______________ to _______________
Commission file number 33-31717-A
QUORUM HEALTH GROUP, INC.
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(Exact name of registrant as specified in its charter)
Delaware 62-1406040
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(State of incorporation) (I.R.S. Employer
Identification No.)
103 Continental Place, Brentwood, Tennessee 37027
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(Address of principal executive offices) (Zip Code)
(615) 371-7979
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(Registrant's telephone number, including area code)
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(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 January 31, 2001
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Common Stock, $.01 Par Value 71,646,316 Shares
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
QUORUM HEALTH GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(In thousands, except per share amounts)
Three Months
Ended December 31
----------------------
2000 1999
--------- ---------
Revenue:
Net patient service revenue $ 421,783 $ 397,398
Hospital management/professional services 21,532 20,278
Reimbursable expenses 15,270 15,178
--------- ---------
Net operating revenue 458,585 432,854
Salaries and benefits 192,124 180,616
Reimbursable expenses 15,270 15,178
Supplies 66,055 63,388
Fees 41,322 38,626
Other operating expenses 41,817 38,920
Provision for doubtful accounts 33,667 29,250
Equity in earnings of affiliates (3,498) (2,764)
Depreciation and amortization 26,003 27,047
Synthetic lease expense 2,809 2,627
Interest 17,332 16,883
Government settlements, investigation
and litigation related costs and strategic
alternatives related costs 1,186 1,836
Non-cash stock compensation 6,484 --
Minority interest 194 542
--------- ---------
Income before income taxes 17,820 20,705
Provision for income taxes 6,932 8,096
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Net income $ 10,888 $ 12,609
========= =========
Earnings per share:
Basic $ 0.15 $ 0.18
========= =========
Diluted $ 0.14 $ 0.17
========= =========
Weighted average shares outstanding:
Basic 71,526 70,881
========= =========
Diluted 86,496 84,364
========= =========
See accompanying notes.
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QUORUM HEALTH GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(In thousands, except per share amounts)
Six Months
Ended December 31
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2000 1999
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Revenue:
Net patient service revenue $ 840,201 $ 794,042
Hospital management/professional services 41,790 39,832
Reimbursable expenses 30,573 30,265
--------- ---------
Net operating revenue 912,564 864,139
Salaries and benefits 383,377 358,855
Reimbursable expenses 30,573 30,265
Supplies 132,844 125,460
Fees 83,644 77,097
Other operating expenses 83,372 75,224
Provision for doubtful accounts 66,011 68,860
Equity in earnings of affiliates (7,643) (4,888)
Depreciation and amortization 52,376 53,246
Synthetic lease expense 5,788 5,130
Interest 33,720 33,613
Government settlements, investigation
and litigation related costs and strategic
alternatives related costs 97,750 2,934
Non-cash stock compensation 12,285 --
Minority interest (28) 193
--------- ---------
Income (loss) before income taxes (61,505) 38,150
Provision (benefit) for income taxes (20,201) 14,917
--------- ---------
Net income (loss) $ (41,304) $ 23,233
========= =========
Earnings (loss) per share:
Basic $ (0.58) $ 0.32
========= =========
Diluted $ (0.58) $ 0.31
========= =========
Weighted average shares outstanding:
Basic 71,453 72,049
========= =========
Diluted 71,453 81,116
========= =========
See accompanying notes.
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QUORUM HEALTH GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(In thousands)
December 31 June 30
2000 2000
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ASSETS
Current assets:
Cash $ 11,473 $ 13,944
Accounts receivable, less allowance for
doubtful accounts of $79,143 at
December 31, 2000 and $88,239 at
June 30, 2000 355,790 348,137
Supplies 43,385 41,072
Other 81,479 47,984
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Total current assets 492,127 451,137
Property, plant and equipment, at cost:
Land 92,042 88,922
Buildings and improvements 486,596 468,963
Equipment 682,190 657,400
Construction in progress 56,058 29,888
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1,316,886 1,245,173
Less accumulated depreciation 439,355 392,256
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877,531 852,917
Cost in excess of net assets acquired, net 220,492 222,191
Investments in unconsolidated entities 245,860 249,885
Other 82,587 80,308
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Total assets $ 1,918,597 $1,856,438
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QUORUM HEALTH GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(In thousands, except per share amount)
December 31 June 30
2000 2000
----------- ----------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses $ 94,965 $ 97,493
Accrued salaries and benefits 82,311 72,495
Accrued government settlements 77,500 --
Other current liabilities 36,520 26,407
Current maturities of long-term debt 622 817
----------- ----------
Total current liabilities 291,918 197,212
Long-term debt, less current maturities 847,621 851,045
Deferred income taxes 29,577 31,010
Professional liability risks and other
liabilities and deferrals 46,080 44,940
Minority interests in consolidated entities 62,105 64,142
Commitments and contingencies
Stockholders' equity:
Common stock, $.01 par value;
300,000 shares authorized; issued and
outstanding 71,578 and 71,281 at December 31,
2000 and June 30, 2000, respectively 716 713
Accumulated other comprehensive loss (498) --
Additional paid-in capital 256,672 241,667
Retained earnings 384,406 425,709
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641,296 668,089
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Total liabilities and stockholders' equity $ 1,918,597 $1,856,438
=========== ==========
See accompanying notes.
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QUORUM HEALTH GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(In thousands)
Six Months
Ended December 31
----------------------
2000 1999
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Net cash provided by operating activities $ 83,255 $ 73,913
Investing activities:
Purchase of property, plant and equipment (42,650) (54,910)
Hospital construction (28,774) (2,418)
Purchase of acquired companies, net of
working capital settlements (9,038) (20,448)
Other 558 553
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Net cash used in investing activities (79,904) (77,223)
Financing activities:
Borrowings under bank debt 184,600 186,700
Repayments of bank debt (187,700) (316,200)
Borrowing under convertible subordinated
debentures -- 150,000
Proceeds from issuance of common stock, net 2,456 397
Repurchase of common stock -- (17,646)
Change in outstanding checks and overnight
investment (2,594) (8,352)
Other (2,584) (2,005)
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Net cash used in financing activities (5,822) (7,106)
--------- ---------
Decrease in cash (2,471) (10,416)
Cash at beginning of period 13,944 22,258
--------- ---------
Cash at end of period $ 11,473 $ 11,842
========= =========
Supplemental cash flow information:
Interest paid $ (33,361) $ (32,739)
========= =========
Income taxes paid $ (2,944) $ (18,427)
========= =========
See accompanying notes.
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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, 2000 are not necessarily indicative of the results that may be expected for
the year ending June 30, 2001. For further information, refer to the
consolidated financial statements and footnotes thereto included in the
Company's annual report on Form 10-K for the year ended June 30, 2000. Certain
prior year amounts have been reclassified to conform to the current year
presentation.
2. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In 1998, the Financial Accounting Standards Board (FASB) issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities". This standard requires the Company to recognize all
derivatives on the balance sheet at fair value. The Company's interest rate
swaps are cash flow hedges which hedge the variability in expected cash flows
from a portion of its floating rate liabilities. The Company believes that its
hedges are highly effective with changes in effectiveness expected to be
reported in other comprehensive income. Changes in any ineffectiveness will be
reported through earnings. The adoption of this new FASB standard on July 1,
2000, resulted in a cumulative effect of an accounting change, net of tax, of
approximately $5.7 million being recognized as other comprehensive income for
the increase in fair value of the interest rate swaps. During the six months
ended December 31, 2000, the decrease in fair value of interest rate swaps, net
of tax, of approximately $6.2 million was recognized through other comprehensive
income (See Note 10). At December 31, 2000, the fair value of the interest rate
swaps was a liability of $0.8 million.
On March 31, 2000, the FASB issued its final interpretation of APB Opinion No.
25 "Accounting for Certain Transactions involving Stock Compensation." The final
interpretation requires variable-award accounting for stock options granted six
months before or after the cancellation or settlement of options if the new
options have a lower exercise price. The interpretation was effective July 1,
2000 and covers certain events that occurred after December 15, 1998. No
adjustments were made to financial statements for periods prior to the effective
date and no expense was recognized for any additional compensation costs
attributable to periods before the effective date.
During the three months ended December 31, 2000, the Company recorded $6.5
million in non-cash stock option compensation expense associated with the
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stock options repriced in March 1999. This change was based on the $2.75
increase in the Company's stock price since September 1, 2000. During the six
months ended December 31, 2000, the Company recorded $12.3 million in non-cash
stock option compensation expense associated with the stock options repriced in
March 1999. This charge was based on the $5.44 increase in the Company's stock
price since July 1, 2000. The number of options subject to variable award
accounting is comprised of 1.7 million vested options and a percentage of
approximately 1.4 million unvested options based on their vesting schedule. The
number of options affected will decrease for options exercised or canceled and
will increase as unvested options become vested.
3. PROPOSED SALE OF THE COMPANY
On October 18, 2000, the Company signed a definitive agreement for Triad
Hospitals Inc.("Triad") to acquire the Company through a combination of cash,
stock and the assumption of debt. Under the terms of the merger agreement, the
Company's shareholders will receive $3.50 in cash and 0.4107 shares of Triad
common stock for each share of the Company's common stock held, plus cash in
lieu of fractional shares of Triad common stock. The transaction is expected to
be tax-free to the Company's shareholders with respect to the stock portion of
the consideration.
The Boards of Directors of both companies have unanimously approved the proposed
transaction, which is subject to customary conditions, including approval of
Triad's shareholders and the Company's shareholders and antitrust clearance. The
transaction is also conditioned upon receipt by Triad and HCA-The Healthcare
Company of acceptable private letter rulings from the Internal Revenue Service
(IRS) that the merger and related transactions will not cause the spin-off of
Triad or LifePoint from HCA or the restructuring transactions that preceded the
spin-off to fail to qualify for the tax treatment specified in IRS private
letter rulings previously issued to HCA and is conditioned upon the receipt of
necessary financing. Merrill Lynch & Co. and Bank of America and certain of its
affiliates have committed, subject to customary conditions, to underwrite the
entire $1.7 billion of debt needed to fund the cash portion of the purchase
price and the refinancing of certain existing debt of both companies. The
transaction is expected to be completed in the first half of calendar 2001.
4. ACQUISITIONS AND TERMINATION/TRANSFER OF LEASES
Pending Lease Termination. In November 2000, the Company notified the landlord
of Carolinas Hospital System-Kingstree that the Company would discontinue
certain services as permitted by the lease. In response to this notice, the
landlord has notified the Company that it intends to cancel the lease effective
February 28, 2001. The Company is currently discussing with the landlord the
lease termination date and the purchase of certain assets by the landlord.
Acquisitions. Effective July 1, 2000, the Company acquired Wells Community
Hospital in Bluffton, Indiana. Effective December 1, 1999, the Company
acquired Caylor-Nickel Medical Center in Bluffton, Indiana.
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Lease Transfer. Effective March 1, 2000, the Company transferred its operating
lease of Clinton County Hospital in Frankfort, Indiana to an Indianapolis,
Indiana healthcare system.
The consideration for hospital and affiliated business acquisitions totaled $9.0
million for the six months ended December 31, 2000. These acquisitions were
accounted for using the purchase method of accounting. The operating results of
the acquisitions and lease transfer have been included in the accompanying
Condensed Consolidated Statements of Operations for periods subsequent to
acquisition and for periods prior to lease transfer. The pro forma effect of the
acquisitions and lease transfer on the Company's results of operations for the
periods prior to acquisition and for periods after the lease transfer were not
significant.
5. GOVERNMENT SETTLEMENTS, INVESTIGATION AND LITIGATION RELATED COSTS AND
STRATEGIC ALTERNATIVES RELATED COSTS
During the six months ended December 31, 2000, the Company recorded $99.5
million in government settlements in its Condensed Consolidated Statement of
Operations for tentative and final agreements reached with the Civil Division,
U.S. Department of Justice to settle two qui tam lawsuits. On October 26, 2000
the Company completed settlement of the first qui tam lawsuit which primarily
involved allegedly improper allocation of costs at Flowers Hospital, Dothan,
Alabama, to its home health agency. The Company paid to the government on
October 26, 2000 approximately $18 million in connection with this settlement.
The Company has accrued a current liability related to the governmental
settlement for the tentative agreement to settle the second qui tam lawsuit,
involving Medicare cost reports. Under the terms of the tentative agreement, the
settlement amount to be paid to the government is $77.5 million, with interest
accruing at 7.25 percent from October 2, 2000 until final resolution of a
settlement agreement and a corporate integrity agreement. The tentative
agreement is conditioned on negotiation and completion of a mutually
satisfactory settlement agreement and corporate integrity agreement. This
settlement was accrued based on available information and is subject to further
refinement (See Note 9).
The Company incurred investigation and litigation related costs related
primarily to the qui tam and shareholder actions against the Company of $0.5
million and $1.8 million during the three months ended December 31, 2000 and
1999, respectively, and $1.2 million and $2.9 million during the six months
ended December 31, 2000 and 1999 (See Note 9).
The Company incurred costs associated with exploring various strategic
alternatives and the proposed sale of the Company to Triad of $0.7 million
during the three months ended December 31, 2000 and $1.1 million during the six
months ended December 31, 2000 (See Note 3).
6. INCOME TAXES
The provision for income taxes for the three months and six months ended
December 31, 2000 and 1999 is different from that which would be obtained by
applying the statutory federal income tax rate to income before income taxes due
to permanent differences and the provision for state income taxes.
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7. EARNINGS (LOSS) PER SHARE
Basic earnings (loss) per share is based on the weighted average number of
common shares outstanding. Diluted earnings (loss) per share is based on the
weighted average number of common shares outstanding, and the effect of dilutive
securities consisting of convertible subordinated debentures and stock options.
Outstanding options to purchase 0.2 million and 5.6 million shares of common
stock for the three months ended December 31, 2000 and 1999, respectively, and
4.9 million shares of common stock for the six months ended December 31, 1999
were not included in the computation of diluted earnings per share because the
options' exercise prices were greater than the average market price of the
common stock. The convertible debentures and outstanding options to purchase 6.9
million shares of common stock for the six months ended December 31, 2000 were
not included in the computation of diluted loss per share because the effect
would be anti-dilutive.
The following table sets forth the computation of basic and diluted earnings
(loss) per share (in thousands, except per share amounts):
Three Months Six Months
Ended Ended
December 31 December 31
----------------- -------------------
2000 1999 2000 1999
------- ------- -------- -------
Numerator:
Net income (loss) $10,888 $12,609 $(41,304) $23,233
Interest expense on convertible
subordinated debentures, net of taxes 1,375 1,370 -- 1,827
------- ------- -------- -------
Numerator for dilutive earnings (loss)
per share $12,263 $13,979 $(41,304) $25,060
======= ======= ======== =======
Denominator:
Shares used for basic earnings (loss)
per share 71,526 70,881 71,453 72,049
Effect of dilutive securities:
Convertible subordinated debentures 13,333 13,333 -- 8,889
Stock options 1,637 150 -- 178
------- ------- -------- -------
Shares used for dilutive earnings
(loss) per share 86,496 84,364 71,453 81,116
======= ======= ======== =======
Basic earnings (loss) per share $ 0.15 $ 0.18 $ (0.58) $ 0.32
======= ======= ======== =======
Diluted earnings (loss) per share $ 0.14 $ 0.17 $ (0.58) $ 0.31
======= ======= ======== =======
8. COMMITMENTS
The Company is constructing a replacement hospital in Vicksburg, Mississippi
and a new acute-care hospital in Ft. Wayne, Indiana. The Vicksburg hospital
has an estimated total project cost of approximately $108 million with an
expected completion date of February 2002. The Ft. Wayne hospital has an
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estimated total project cost of approximately $44 million with an expected
completion date of April 2001. In connection with the construction, the Company
has contracts outstanding for approximately $90 million, of which approximately
$43 million has been incurred to date.
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 IRS is in the process of conducting examinations of the Company's federal
income tax returns for the fiscal years ended June 30, 1996 through 1998. The
IRS has proposed certain adjustments in connection with its prior examination of
the Company's federal income tax returns for the fiscal years ending June 30,
1993 through 1995. The most significant adjustments involve the tax accounting
methods adopted for computing bad debt expense and the valuation of purchased
hospital property, plant and equipment and related depreciable lives. The
Company has protested substantially all of the proposed adjustments through the
appeals process of the IRS. In the opinion of management, the ultimate outcome
of the IRS examinations will not have a material effect on the Company's results
of operations or financial position.
Litigation
The Company is currently, and from time to time expects to be, subject to claims
and suits arising in the ordinary course of business, including claims for
personal injuries and breach of management contracts. Plaintiffs in these
matters may request punitive or other damages that may not be covered by
insurance. Except for the litigation described below and other litigation,
administrative proceedings or investigations which may arise under the False
Claims Act or similar laws, the Company is not aware that it is currently a
party to any such proceeding which, in management's opinion, if adversely
decided, would have a material effect on the Company's results of operations or
financial position.
Professional Liability Judgment. On February 29, 2000, an amended final trial
judgment was entered against the Company's subsidiary, Quorum Health Resources,
LLC ("QHR"), in the amount of approximately $57 million in the case of David X.
and Veronica Rodriguez, Individually and as Next Friends of Cristina Rodriguez,
a minor v Quorum Health Resources, LLC, in the 365th District Court, Maverick
County, Texas. The lawsuit arose out of the treatment provided beginning July 2,
1994 at Fort Duncan Medical Center, an
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acute care hospital formerly managed by QHR. While the Company's appeal of the
judgment was pending, the litigation was settled. The Company's primary insurer
is funding this settlement.
False Claims Act Litigation. At a meeting in September 1998, the Company learned
from the government that it would likely join in a lawsuit filed against the
Company under the False Claims Act. The suit was filed in January 1993 by a
former employee of a hospital managed by a Company subsidiary. These lawsuits,
commonly known as qui tam actions, are filed "under seal." That means that the
claims are kept secret until the government decides whether to join the case.
The person who files the lawsuit is called a "relator". The government joined
the case against the Company in October 1998. The relator's lawsuit named the
Company and its subsidiary, Quorum Health Resources, HCA and all hospitals that
the Company or HCA owned, operated or managed from 1984 through 1997, as
defendants. The unsealed complaint, prepared by the relator, alleged that the
Company knowingly prepared and caused to be filed cost reports which claimed
payments from Medicare and other government payment programs greater than the
amounts due.
On February 24, 1999, the government filed its own complaint in the case. The
new complaint alleges that the Company, on behalf of hospitals it managed
between 1985 and 1995 and hospitals it owned from 1990 to the date of the
complaint, violated the False Claims Act by knowingly submitting or causing to
be submitted false Medicare cost reports, resulting in the submission of false
claims to the federal health care programs.
The government asserts that the alleged false claims in the cost reports are, in
part, 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.
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 the relator's attorneys' fees and costs.
On October 2, 2000, the Company announced that it had reached an understanding
with the Civil Division, U.S. Department of Justice to recommend an agreement to
settle the Medicare cost report qui tam lawsuit. Under the terms of the
tentative agreement, the settlement amount to be paid to the government is $77.5
million, with interest accruing at 7.25% from October 2, 2000 until final
resolution of a settlement agreement and a corporate integrity agreement. The
tentative agreement is conditioned on negotiation and completion of a mutually
satisfactory settlement agreement and corporate integrity agreement. The
Company may require a waiver under the Company's credit facilities to pay the
settlement amount in a lump sum.
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
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made in the action prior to the government making a decision to intervene as a
plaintiff. The Company cooperated with the United States Attorney's Office and
provided additional information and made employees available for interviews.
On October 26, 2000, the Company completed settlement of a qui tam lawsuit which
primarily involved allegedly improper allocation of costs at Flowers Hospital,
Dothan, Alabama, to its home health agency (CV-96-P1638-S, N.D. Alabama). The
Company paid to the government on October 26, 2000 approximately $18 million in
connection with this settlement which was accrued in the three months ended
September 30, 2000. In addition to the settlement agreement, the Company entered
into a five year corporate integrity agreement covering Flowers Hospital with
the Department of Health and Human Services Office of the Inspector General. The
corporate integrity agreement imposes certain oversight and reporting
obligations that may be costly and may have a material adverse effect on Flowers
Hospital's operations. The government always reserves the right to investigate
and pursue other allegations made by a relator under a complaint. However, under
the settlement agreement, the relator is prohibited from pursuing these
additional allegations.
As a result of its ongoing discussions with the government, the Company has
learned that there are two additional unrelated qui tam complaints against the
Company alleging violations of the False Claims Act at one owned and two managed
hospitals. Both matters remain under seal. The government has stated that it
intends to investigate certain of these allegations. At this time, the Company
cannot take a position on how it will respond to these matters.
The Company from time to time may be the subject of additional investigations or
a party to additional litigation which alleges violations of law. The Company
may not know about such investigations, or about qui tam actions filed against
it.
Stockholder Class 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.
The complaint alleges that defendants violated the Securities Exchange Act of
1934. The plaintiffs claim that the Company materially inflated its net revenues
during the class period by including in those net revenues amounts received from
the settlement of cost reports that had allegedly been filed in violation of
applicable Medicare regulations years earlier and that, because of this
practice, this statement, which first appeared in the Company's Form 10-K filed
in September 1996, was false: "The Company believes that its owned hospitals are
in substantial compliance with current federal, state, local, and independent
review body regulations and standards." In May 1999, the Company filed a motion
to dismiss the complaint. On November 13, 2000, the judge denied the Company's
motion to dismiss the complaint against the Company
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and James E. Dalton, Jr., the Company's President/CEO. The judge granted the
Company's motion to dismiss as to all other defendants. The judge has agreed
to hear an oral argument on Mr. Dalton's motion to reconsider the judge's
denial of Mr. Dalton's motion to dismiss. The Company intends to vigorously
defend the claims and allegations in this action.
On October 20, 2000, a class action lawsuit was filed against Triad and members
of the Company's board of directors in the Circuit Court of Davidson County,
Tennessee, on behalf of all of the Company's public stockholders. The complaint
alleges that the Company's directors breached their fiduciary duties of loyalty
and due care by failing to implement reasonable procedures designed to maximize
stockholder value and to obtain the highest price reasonably available for the
Company's stockholders. The complaint alleges that Triad aided and abetted the
Company's directors' breach of their fiduciary duties. The complaint seeks an
injunction preventing consummation of the merger, or the Company's acquisition
by or business combination with any third party, until the Company adopts and
implements a procedure or process, such as an auction, to obtain the highest
possible price for the Company's business. Alternatively, the complaint seeks
compensatory damages in the event the merger of the Company with Triad is
consummated. The complaint also seeks an award of costs and attorneys' fees.
Triad and the Company believe the claims are without merit and will vigorously
defend the action.
The Company cannot at this time predict the final effect or outcome of any of
the ongoing investigations, settlement negotiations or the class or qui tam
actions. If the Company is found to have violated federal or state laws relating
to Medicare, Medicaid or other government programs, then it may be required to
pay substantial fines and civil and criminal penalties and also may be excluded
from participating in the Medicare and Medicaid programs and other government
programs. Similarly, the amount of damages sought in the qui tam actions are or
in the future may be substantial. The Company could be subject to substantial
costs resulting from defending, or from an adverse outcome in any current or
future investigations, administrative proceedings or litigation. In an effort to
resolve one or more of these matters, the Company may choose to negotiate a
settlement. Amounts the Company pays to settle any of these matters may be
material. Agreements the Company enters into as a part of any settlement could
also materially adversely affect it. Any current or future investigations or
actions could have a material adverse effect on the Company's results of
operations or financial position.
10. COMPREHENSIVE INCOME (LOSS)
The components of comprehensive income (loss), net of related taxes (in
thousands):
Three Months Six Months
Ended Ended
December 31, December 31,
2000 2000
-------- --------
Net income (loss) $ 10,888 $(41,304)
Cumulative effect of change in accounting
principle - fair value of interest rate swaps -- 5,661
Net change in fair value of interest rate swaps (3,511) (6,159)
-------- --------
Other comprehensive loss (3,511) (498)
-------- --------
Comprehensive income (loss) $ 7,377 $(41,802)
======== ========
Accumulated other comprehensive loss, net of related taxes, at December 31, 2000
is comprised of approximately $0.5 million relating to the fair value of
interest rate swaps.
11. SEGMENT INFORMATION
The Company's segments consist of (1) healthcare systems owned and operated by
the Company and (2) management of hospitals and healthcare systems for other
owners. The Company evaluates performance based on operating earnings of the
respective business units. All segment revenues are from external customers.
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The Company's net revenues, EBITDA, assets, depreciation and amortization and
capital expenditures are summarized in the following table (EBITDA is defined as
earnings before interest, synthetic lease expense, depreciation and
amortization, income taxes, minority interest, government settlements,
investigation and litigation related costs, strategic alternatives-related costs
and non-cash stock compensation expense)(in thousands):
Three Months Ended December 31, 2000
-------------------------------------
Owned Management
Hospitals Services Total
---------- -------- ----------
Net revenues $ 422,101 $36,484 $ 458,585
EBITDA $ 63,374 $ 8,454 $ 71,828
Depreciation & amortization $ 25,586 $ 417 $ 26,003
Capital expenditures $ 32,397 $ 49 $ 32,446
Three Months Ended December 31, 1999
-------------------------------------
Owned Management
Hospitals Services Total
---------- -------- ----------
Net revenues $ 397,398 $35,456 $ 432,854
EBITDA $ 62,363 $ 7,277 $ 69,640
Depreciation & amortization $ 26,594 $ 453 $ 27,047
Capital expenditures $ 34,790 $ 512 $ 35,302
Six Months Ended December 31, 2000
-------------------------------------
Owned Management
Hospitals Services Total
---------- -------- ----------
Net revenues $ 840,367 $72,197 $ 912,564
EBITDA $ 124,595 $15,791 $ 140,386
Assets $1,871,806 $46,791 $1,918,597
Depreciation & amortization $ 51,551 $ 825 $ 52,376
Capital expenditures $ 71,298 $ 126 $ 71,424
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Six Months Ended December 31, 1999
-------------------------------------
Owned Management
Hospitals Services Total
---------- -------- ----------
Net revenues $ 794,042 $70,097 $ 864,139
EBITDA $ 118,466 $14,800 $ 133,266
Assets $1,814,604 $45,000 $1,859,604
Depreciation & amortization $ 52,331 $ 915 $ 53,246
Capital expenditures $ 56,736 $ 592 $ 57,328
EBITDA for owned hospitals include equity in earnings of affiliates of $3.5
million and $2.8 million for the three months ended December 31, 2000 and 1999,
respectively. EBITDA for owned hospitals include equity in earnings of
affiliates of $7.6 million and $4.9 million for the six months ended December
31, 2000 and 1999, respectively. Assets of owned hospitals include investments
in unconsolidated subsidiaries of $245.9 million and $243.7 million at December
31, 2000 and 1999, respectively.
A reconciliation of EBITDA to income (loss) before income taxes follows (in
thousands):
Three Months Six Months
Ended Ended
December 31 December 31
-------------------- ----------------------
2000 1999 2000 1999
-------- -------- --------- ---------
Total EBITDA for reportable segments $ 71,828 $ 69,640 $ 140,386 $ 133,266
Depreciation and amortization (26,003) (27,047) (52,376) (53,246)
Synthetic lease expense (2,809) (2,627) (5,788) (5,130)
Interest expense (17,332) (16,883) (33,720) (33,613)
Government settlements, investigation
and litigation related costs and
strategic alternatives related costs (1,186) (1,836) (97,750) (2,934)
Non-cash stock compensation (6,484) -- (12,285) --
Minority interest (194) (542) 28 (193)
-------- -------- --------- ---------
Income (loss) before income taxes $ 17,820 $ 20,705 $ (61,505) $ 38,150
======== ======== ========= =========
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION
You should read the following along with the Condensed Consolidated
Financial Statements and accompanying notes.
FORWARD-LOOKING INFORMATION
This discussion includes "forward-looking statements." Forward-looking
statements include all statements that do not relate solely to historical or
current facts, and often can be identified by the use of certain words, such as
"may," "believe," "will," "expect," "project," "estimate," "anticipate," "plan"
or "continue." We have based these forward-looking statements on our current
plans and expectations and our projections about future events. However, risks,
uncertainties and assumptions that would cause or contribute to material
differences in our future financial condition and results of operations include:
- potential adverse impact in the event that the proposed merger
with Triad is not consummated;
- potential adverse impact on our operations arising from the
proposed merger with Triad, including provisions in the Triad
merger agreement that limit our ability to take certain
actions pending the merger;
- possible changes in the Medicare and Medicaid programs that
may 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;
- difficulties in containing salaries, supplies and other costs
in relation to changes in payments from our payors;
- difficulties in improving financial results of our physician
clinics;
- difficulties in billing and collecting accounts receivable and
the related impact on cash flow and bad debt expense;
- geographic concentration of our operations;
- claims and legal actions relating to professional liabilities
and other matters;
- disruptions from information system conversions;
- our substantial indebtedness and difficulty raising capital in
the future;
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- the possible enactment of federal, state or local health care
reforms;
- changes in federal, state or local regulations affecting the
health care industry;
- future divestitures which may result in additional charges;
- the highly competitive nature of the health care business;
- difficulties in attracting and retaining physicians and other
qualified healthcare professionals, including those resulting
wholly or in part from the pending merger with Triad;
- fluctuations in interest rates;
- fluctuations in the market value of our common stock;
- changes in accounting pronouncements; and
- changes in general economic conditions.
PROPOSED SALE OF THE COMPANY
On October 18, 2000, we signed a definitive agreement for Triad to
acquire us through a combination of cash, stock and the assumption of debt.
Under the terms of the merger agreement, our shareholders will receive $3.50 in
cash and 0.4107 shares of Triad common stock for each share of our common stock
held, plus cash in lieu of fractional shares of Triad stock. The transaction is
expected to be tax-free to our shareholders with respect to the stock portion of
the consideration.
The Boards of Directors of both companies have unanimously approved the
proposed transaction, which is subject to customary conditions, including
approval of Triad's shareholders and our shareholders and antitrust clearance.
The transaction is also conditioned upon receipt by Triad and HCA of private
letter rulings from the IRS that the merger related transactions will not cause
the spin-off of Triad or LifePoint from HCA or the restructuring transactions
that preceded the spin-off to fail to qualify for the tax treatment specified in
IRS private letter rulings previously issued to HCA and is conditioned upon the
receipt of necessary financing. Merrill Lynch & Co. and Bank of America and
certain of its affiliates have committed, subject to customary conditions, to
underwrite the entire $1.7 billion of debt needed to fund the cash portion of
the purchase price and the refinancing of certain existing debt of both
companies. The transaction is expected to be completed in the first half of
calendar 2001.
OVERVIEW
We are a leading provider of health care services through our owned
acute care hospitals and regional health care systems located throughout the
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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, 2000, our owned hospitals
accounted for 92% of our net operating revenue. Our Dothan, Alabama and Ft.
Wayne, Indiana service areas accounted for approximately 35% of owned hospital
revenue and 52% of owned hospital EBITDA. EBITDA means our earnings before
interest, synthetic lease expense, depreciation and amortization, income taxes,
minority interest, government settlements, investigation and litigation related
costs, strategic alternatives-related costs and non-cash stock compensation
expense.
For the six months ended December 31, 2000, our net income before
government settlements, investigation and litigation related costs, strategic
alternatives-related costs and non-cash stock compensation was 19% higher than
for the six months ended December 31, 1999. This increase was primarily due to
higher earnings from our same store hospitals and higher earnings from our Las
Vegas joint venture. Operating results of same store hospitals include all of
our owned hospitals except (1) those we sold, (2) the Las Vegas and Macon joint
ventures, and (3) acquired hospitals until we owned them for 12 months. Our
increased same store earnings was primarily due to price increases and increases
in patient volumes.
Our objective is to continue to improve our operating and financial
consistency and stability. We focus on the following operating tactics:
- Grow existing markets;
- Enhance managed care contracting;
- Focus on cost control;
- Improve management of accounts receivable and bad debts; and
- Reduce losses from physician clinics.
Our proposed merger with Triad may make it harder to achieve our
objectives before the merger. The merger agreement limits our ability to take
certain actions or enter into certain commitments pending the merger without
Triad's consent. Also, during this period, it is more difficult to make
long-term decisions and commitments. Because of the inherent uncertainties
created by the proposed merger, employee and physician recruiting and retention
become more difficult. In addition, Triad has announced its intention to sell
several of our hospitals and the management services business. This may create
additional challenges to maintaining and improving operations before the merger.
IMPACT OF ACQUISITIONS AND TERMINATION/TRANSFER OF LEASES
Pending Lease Termination. In November 2000, we notified the landlord
of Carolinas Hospital System-Kingstree that we would discontinue certain
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services as permitted by the lease. In response to this notice, the landlord
has notified us that it intends to cancel the lease effective February 28, 2001.
We are currently discussing with the landlord the lease termination date and the
purchase of certain assets by the landlord.
Acquisitions. Effective July 1, 2000, we acquired Wells Community
Hospital in Bluffton, Indiana. Effective December 1, 1999, we acquired
Caylor-Nickel Medical Center in Bluffton, Indiana.
Lease Transfer. Effective March 1, 2000, we transferred our operating
lease of Clinton County Hospital in Frankfort, Indiana to an Indianapolis,
Indiana health care system.
Because of the financial impact of acquisitions and sales, it is
difficult to make meaningful comparisons between our financial statements for
the periods presented. Due to the number of owned hospitals, each hospital we
acquire or sell can affect our overall operating margins or results of
operations.
SELECTED OPERATING STATISTICS - OWNED HOSPITALS
The following table contains operating statistics for our owned
hospitals for each of the periods presented.
Three Months Six Months
Ended Ended
December 31 December 31
-------------------- --------------------
2000 1999 2000 1999
-------- -------- -------- --------
Number of hospitals at end of period 21 22 21 22
Licensed beds at end of period 4,518 4,647 4,518 4,647
Weighted average licensed beds 4,518 4,584 4,524 4,581
Number of available beds at end of period 3,801 3,943 3,801 3,943
Admissions 35,447 35,503 71,406 70,208
Adjusted admissions 61,636 60,401 124,206 120,361
Average length of stay (days) 5.4 5.6 5.4 5.5
Patient days 192,942 197,558 388,440 387,898
Adjusted patient days 335,490 336,135 675,665 664,992
Occupancy rate (licensed beds) 46.4% 46.8% 46.7% 46.0%
Occupancy rate (available beds) 55.2% 55.3% 55.3% 53.8%
Gross inpatient revenue (in thousands) $470,045 $441,550 $941,568 $871,777
Gross outpatient revenue (in thousands) $347,279 $309,661 $696,225 $622,752
RESULTS OF OPERATIONS
The following table reflects the percentage of net operating revenue
represented by various categories in our Condensed Consolidated Statements of
Operations.
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Three Months Six Months
Ended Ended
December 31 December 31
---------------- ----------------
2000 1999 2000 1999
----- ----- ----- -----
Net operating revenue 100.0% 100.0% 100.0% 100.0%
Salaries and benefits 41.9 41.7 42.0 41.6
Reimbursable expenses 3.3 3.5 3.4 3.5
Supplies 14.4 14.6 14.6 14.5
Fees 9.0 8.9 9.1 8.9
Other operating expenses 9.2 9.0 9.1 8.7
Provision for doubtful accounts 7.3 6.8 7.2 8.0
Equity in earnings of affiliates (0.8) (0.6) (0.8) (0.6)
Depreciation and amortization 5.7 6.3 5.7 6.2
Synthetic lease expense 0.6 0.6 0.7 0.6
Interest expense 3.8 3.9 3.7 3.9
Government settlements, investigation and
litigation related costs and strategic
alternatives related costs 0.3 0.4 10.7 0.3
Non-cash stock compensation 1.4 -- 1.3 --
Minority interest 0.0 0.1 0.0 0.0
----- ----- ----- -----
Income (loss) before income taxes 3.9 4.8 (6.7) 4.4
Provision (benefit) for income taxes 1.5 1.9 (2.2) 1.7
----- ----- ----- -----
Net income (loss) 2.4% 2.9% (4.5)% 2.7%
===== ===== ===== =====
Three Months Ended December 31, 2000 Compared to Three Months Ended December 31,
1999.
Net Operating Revenue. Net operating revenue was $458.6 million for the
three months ended December 31, 2000, compared to $432.9 million for the three
months ended December 31, 1999. This represents an increase of $25.7 million or
5.9%. We attribute this increase primarily to a 5.9% increase in same store
hospital net operating revenue. In addition, the increase in net operating
revenue was due to the hospitals we purchased during fiscal 2001 and fiscal
2000, which was partially offset by the reduction from the transfer of our
operating lease of Clinton County Hospital in fiscal 2000.
We attribute the 5.9% same store net operating revenue increase
principally to price increases and increases in outpatient volumes. Our same
store net operating revenue would have increased more, except for (1) a 1.0%
decrease in same store admissions primarily due to lower respiratory admissions
(flu, pneumonia, bronchitis, etc.), (2) higher patient volumes from discounted
payors and (3) lower Medicare payments as a result of the Balanced Budget Act of
1997 ("BBA 97").
Salaries and Benefits, Reimbursable Expenses, Supplies, Fees, Provision
for Doubtful Accounts and Other Operating Expenses. Salaries and benefits,
reimbursable expenses, supplies, fees, provision for doubtful accounts and
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other operating expenses totaled $390.3 million for the three months ended
December 31, 2000, compared to $366.0 million for the three months ended
December 31, 1999. This represents an increase of $24.3 million or 6.6%. These
expenses as a percentage of net operating revenue increased to 85.1% for the
three months ended December 31, 2000 from 84.5% for the three months ended
December 31, 1999. Salaries and benefits, reimbursable expenses, supplies, fees,
provision for doubtful accounts and other operating expenses as a percentage of
net operating revenue for our owned hospitals increased to 85.8% for the three
months ended December 31, 2000 from 85.0% for the three months ended December
31, 1999.
For our same store hospitals, salaries and benefits, reimbursable
expenses, supplies, fees, provision for doubtful accounts and other operating
expenses as a percent of net operating revenue increased to 85.5% for the three
months ended December 31, 2000 from 84.5% for the three months ended December
31, 1999. Our improvements in net revenue were offset by increased salaries and
benefits expense and bad debt expense. Salaries and benefits expense as a
percentage of net operating revenue increased primarily due to wage pressures
and higher employee health insurance costs. Bad debt expense as a percentage of
net operating revenue was 7.3% for the three months ended December 31, 2000
compared to 6.8% for the three months ended December 31, 1999. In 1999, many of
our hospitals had computer system conversions or major upgrades to systems,
resulting in slower collections for the three months ended September 30, 1999.
During the three months ended December 31, 1999, we expanded our efforts to
collect these accounts, which favorably impacted our bad debt expense for that
period.
Equity in Earnings of Affiliates. Equity in earnings of affiliates was
$3.5 million for the three months ended December 31, 2000, compared to $2.8
million for the three months ended December 31, 1999, an increase of $0.7
million. Equity in earnings of affiliates represented 0.8% of net operating
revenue for the three months ended December 31, 2000, compared to 0.6% of net
operating revenue for the three months ended December 31, 1999. This increase
was due primarily to higher earnings at our Las Vegas joint venture which was
partially offset by lower earnings at our Macon joint venture.
Depreciation and Amortization. Depreciation and amortization expense
for the three months ended December 31, 2000 was $26.0 million compared to $27.0
million for the three months ended December 31, 1999. This represents a decrease
of $1.0 million or 3.9%. Depreciation and amortization expense as a percentage
of net operating revenue decreased to 5.7% for the three months ended December
31, 2000 from 6.3% for the three months ended December 31, 1999. This decrease
was primarily due to Lutheran Hospital property purchased in 1995 that became
fully depreciated in July 2000, longer estimated useful lives of certain
equipment and our net revenue growth.
Synthetic Lease Expense. Synthetic lease expense is comprised of lease
expense associated with our End Loaded Lease Facility (ELLF) agreement (See
Liquidity and Capital Resources). Synthetic lease expense was $2.8 million
for the three months ended December 31, 2000, compared to $2.6 million for the
three months ended December 31, 1999, an increase of $0.2 million. Synthetic
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lease expense as a percentage of net operating revenue was 0.6% for the three
months ended December 31, 2000 and December 31, 1999.
Interest Expense. Interest expense for the three months ended December
31, 2000 was $17.3 million, compared to $16.9 million for the three months ended
December 31, 1999, an increase of $0.4 million, or 2.7%. Interest expense as a
percentage of net operating revenue decreased to 3.8% for the three months ended
December 31, 2000 from 3.9% for the three months ended December 31, 1999. The
decrease was due principally to cash flow from operations used to make payments
on our revolving line of credit and our net revenue growth. This decrease was
partially offset by interest on the government settlements and an increase in
LIBOR rates. Our interest rate swaps lessened the effect of the increase in
LIBOR rates.
Government Settlements, Investigation and Litigation Related Costs and
Strategic Alternatives Related Costs. During the three months ended December 31,
2000 and 1999, respectively, we incurred $0.5 and $1.8 million in investigation
and litigation related costs related primarily to the qui tam and shareholder
actions against us (See "Litigation"). During the three months ended December
31, 2000, we incurred $0.7 million in costs associated with exploring various
strategic alternatives and the proposed sale of our Company to Triad. (See
"Proposed Sale of Company").
Non-Cash Stock Compensation Expense. During the three months ended
December 31, 2000, we recorded $6.5 million in non-cash stock option
compensation expense associated with the stock options repriced in March 1999.
This charge was based on the $2.75 increase in our stock price since October 1,
2000. The number of options subject to variable award accounting was comprised
of 1.7 million vested options and a percentage of approximately 1.4 million
unvested options based on their vesting schedule. The number of options affected
will decrease for options exercised or canceled and will increase as unvested
options become vested.
Minority Interest Expense. Minority interest expense was $0.2 million
for the three months ended December 31, 2000, compared to $0.5 million for the
three months ended December 31, 1999, a change of $0.3 million.
Income Taxes. The provision for income taxes for the three months ended
December 31, 2000 was $6.9 million compared to $8.1 million for the three months
ended December 31, 1999, a decrease of $1.2 million. Our effective income tax
rate was 38.9% for the three months ended December 31, 2000 compared to 39.1%
for the three months ended December 31, 1999.
Net Income. Net income for the three months ended December 31, 2000 was
$10.9 million, compared to $12.6 million for the three months ended December 31,
1999, a decrease of $1.7 million. Excluding the government settlements,
investigation and litigation related costs, strategic alternatives-related costs
and non-cash stock compensation, net income was $15.6 million or 3.4% of net
operating revenue for the three months ended December 31, 2000, compared to
$13.7 million or 3.2% of net operating revenue for the three months ended
December 31, 1999.
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Six Months Ended December 31, 2000 Compared to Six Months Ended December 31,
1999.
Net Operating Revenue. Net operating revenue was $912.6 million for the
six months ended December 31, 2000, compared to $864.1 million for the six
months ended December 31, 1999. This represents an increase of $48.5 million or
5.6%. We attribute this increase primarily to a 5.2% increase in same store
hospital net operating revenue. The increase in net operating revenue was also
due to the hospitals we purchased during fiscal 2001 and fiscal 2000 and an
increase in turnaround management and consulting revenue from our management
services business. The increase in net operating revenue was partially offset by
the transfer of our operating lease of Clinton County Hospital in fiscal 2000.
We attribute the 5.2% same store net operating revenue increase
principally to (1) a 0.3% increase in same store admissions, (2) price increases
and (3) increases in outpatient volumes. Our same store net operating revenue
would have increased more, except for (1) higher patient volumes from discounted
payors and (2) lower Medicare payments as a result of 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 $779.8 million for the six months ended December 31,
2000, compared to $735.8 million for the six months ended December 31, 1999.
This represents an increase of $44.0 million or 6.0%. These expenses as a
percentage of net operating revenue increased to 85.4% for the six months ended
December 31, 2000 from 85.2% for the six months ended December 31, 1999.
Salaries and benefits, reimbursable expenses, supplies, fees, provision for
doubtful accounts and other operating expenses as a percentage of net operating
revenue for our owned hospitals increased to 86.1% for the six months ended
December 31, 2000 from 85.7% for the six months ended December 31, 1999.
For our same store hospitals, salaries and benefits, reimbursable
expenses, supplies, fees, provision for doubtful accounts and other operating
expenses as a percent of net operating revenue increased to 85.7% for the six
months ended December 31, 2000 from 85.1% for the six months ended December 31,
1999. Our improvements in net revenue and bad debt expense were offset by
increased salaries and benefits expense, insurance expense at one of our owned
hospitals and physician clinic expenses. Bad debt expense decreased primarily
due to our improvement in cash collections, especially our collection of older
accounts receivable. Salaries and benefits expense increased primarily due to
wage pressures.
During the six months ended December 31, 2000, our physician clinic
expenses increased primarily due to the recruitment of the more physicians to
our owned hospitals than we had expected and the acquisition of a physician
clinic in North Dakota. We are focusing efforts on reducing the losses of our
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physician clinics. We have been selectively exiting physician contracts, except
when the contract is core to our service area strategy. We plan to have fewer
employed physicians by recruiting physicians without employing them, whenever
possible, and by negotiating or transitioning out of contracts with physicians
with mature practices. We also plan to lower physician clinic losses by changing
the ways we pay employed physicians.
Equity in Earnings of Affiliates. Equity in earnings of affiliates was
$7.6 million for the six months ended December 31, 2000, compared to $4.9
million for the six months ended December 31, 1999, an increase of $2.7 million.
Equity in earnings of affiliates represented 0.8% of net operating revenue for
the six months ended December 31, 2000, compared to 0.6% of net operating
revenue for the six months ended December 31, 1999. This increase was due
primarily to higher earnings at our Las Vegas joint venture which was partially
offset by lower earnings at our Macon joint venture.
Depreciation and Amortization. Depreciation and amortization expense
for the six months ended December 31, 2000 was $52.4 million compared to $53.2
million for the six months ended December 31, 1999. This represents an decrease
of $0.8 million or 1.6%. Depreciation and amortization expense as a percentage
of net operating revenue decreased to 5.7% for the six months ended December 31,
2000 from 6.2% for the six months ended December 31, 1999. This decrease was
primarily due to Lutheran Hospital property purchased in 1995 that became fully
depreciated in July 2000, longer estimated useful lives of certain equipment and
our net revenue growth.
Synthetic Lease Expense. Synthetic lease expense was $5.8 million for
the six months ended December 31, 2000, compared to $5.1 million for the six
months ended December 31, 1999, an increase of $0.7 million. Synthetic lease
expense as a percentage of net operating revenue increased to 0.7% for the six
months ended December 31, 2000 compared to 0.6% for the six months ended
December 31, 1999.
Interest Expense. Interest expense for the six months ended December
31, 2000 was $33.7 million, compared to $33.6 million for the six months ended
December 31, 1999, an increase of $0.1 million. Interest expense as a percentage
of net operating revenue decreased to 3.7% for the six months ended December 31,
2000 from 3.9% for the six months ended December 31, 1999. The decrease was due
principally to (1) cash flow from operations used to make payments on our
revolving line of credit, (2) the issuance of convertible subordinated
debentures in August 1999 at 6%, which is lower than the rate on our revolving
line of credit and (3) our net revenue growth. This decrease was partially
offset by interest on the government settlements and an increase in LIBOR rates.
Our interest rate swaps lessened the effect of the increase in LIBOR rates.
Government Settlements, Investigation and Litigation Related Costs and
Strategic Alternatives-Related Costs. During the six months ended December 31,
2000, we recorded government settlements of $95.5 million in our Condensed
Consolidated Statement of Operations for tentative and final agreements reached
with the Civil Division, U.S. Department of Justice to settle two qui
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tam lawsuits. On October 26, 2000 we completed settlement of the first qui tam
lawsuit which primarily involved allegedly improper allocation of costs at
Flowers Hospital, Dothan, Alabama, to its home health agency. We paid to the
government on October 26, 2000 approximately $18 million in connection with this
settlement. We have accrued a current liability related to the governmental
settlement for the tentative agreement to settle the second qui tam lawsuit,
involving Medicare cost reports. Under the terms of the tentative agreement, the
settlement amount to be paid to the government is $77.5 million, with interest
accruing at 7.25% from October 2, 2000 until final resolution of a settlement
agreement and a corporate integrity agreement. The tentative agreement is
conditioned on negotiation and completion of a mutually satisfactory settlement
agreement and corporate integrity agreement. This settlement was accrued based
on available information and is subject to further refinement. (See
"Litigation").
During the six months ended December 31, 2000 and 1999, respectively,
we incurred $1.2 and $2.9 million in investigation and litigation related costs
related primarily to the qui tam and shareholder actions against us (See
"Litigation").
During the six months ended December 31, 2000, we incurred $1.1 million
in costs associated with exploring various strategic alternatives and the
proposed sale of our Company to Triad. (See "Proposed Sale of Company").
Non-Cash Stock Compensation Expense. During the six months ended
December 31, 2000, we recorded $12.3 million in non-cash stock option
compensation expense associated with the stock options repriced in March 1999.
This charge was based on the $5.44 increase in our stock price since July 1,
2000. The number of options subject to variable award accounting was comprised
of 1.7 million vested options and a percentage of approximately 1.4 million
unvested options based on their vesting schedule. The number of options affected
will decrease for options exercised or canceled and will increase as unvested
options become vested.
Minority Interest Expense. Minority interest expense decreased $0.2
million for the six months ended December 31, 2000, from $0.2 million for the
six months ended December 31, 1999.
Income Taxes. The benefit for income taxes for the six months ended
December 31, 2000 was $20.2 million compared to a provision of $14.9 million for
the six months ended December 31, 1999, a total difference of $35.1 million.
Excluding the effect of government settlements, our effective income tax rate
was 38.9% for the six months ended December 31, 2000 compared to 39.1% for the
six months ended December 31, 1999. The $95.5 million government settlements for
the six months ended December 31, 2000 were tax effected at 35.0%.
Net Income (Loss). Net loss for the six months ended December 31, 2000
was $41.3 million, compared to net income of $23.2 million for the six months
ended December 31, 1999, a decrease of $64.5 million. Excluding government
settlements, investigation and litigation related costs, strategic
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alternatives-related costs and non-cash stock compensation, net income was $29.7
million or 3.2% of net operating revenue for the six months ended December 31,
2000, compared to $25.0 million or 2.9% of net operating revenue for the six
months ended December 31, 1999.
LIQUIDITY
At December 31, 2000, our working capital was $277.7 million excluding
accrued government settlements. Our ratio of current assets to current
liabilities was 2.3 to 1.0 at December 31, 2000 and June 30, 2000, excluding
accrued government settlements.
Cash Flows. Our principal sources of cash are net cash provided by
operating activities and cash available under our bank revolving line of credit
facility. Our principal uses of cash are hospital acquisitions, capital
expenditures, payments of principal and interest on our long-term debt and share
repurchases. We have no current plans to acquire hospitals or repurchase our
common stock due to the pending sale of our Company.
Accounts receivable collections contribute significantly to our net
cash flow from operating activities. Billing and collecting accounts receivable
by hospitals is very difficult because of the complexity of Medicare and
Medicaid regulations, increases in the volume of managed care, hospital
personnel turnover, including business office managers, computer system
conversions and upgrades by hospital and government authorities, dependence of
hospitals on physician documentation of medical records, and the subjective
judgment involved in submitting and collecting Medicare and Medicaid bills. Our
cash flow can also be affected by temporary delays in billing Medicare and
Medicaid accounts receivable while waiting for the government to process
hospital change in ownership forms. There can be no assurance that this
complexity will not negatively impact our future cash flow or results of
operations.
Six Months Ended December 31, 2000 Cash Flows Compared to Six Months
Ended December 31, 1999 Cash Flows.
Cash provided by operating activities totaled $83.3 million for the six
months ended December 31, 2000. Excluding government settlements, cash provided
by operating activities totaled $101.3 million for the six months ended December
31, 2000 compared to $73.9 million for the six months ended December 31, 1999.
This represents an increase of $27.4 million, or
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37.1%,which was due primarily to higher EBITDA(1) and lower income tax
payments.
EBITDA for the three months ended December 31, 2000 was $71.8 million,
compared to $69.6 million for the three months ended December 31, 1999, an
increase of $2.2 million or 3.1%. EBITDA as a percentage of net operating
revenue was 15.7% for the three months ended December 31, 2000, compared to
16.1% for the three months ended December 31, 1999. EBITDA as a percentage of
net operating revenue for our owned hospitals was 15.0% for the three months
ended December 31, 2000, compared to 15.7% for the three months ended December
31, 1999. EBITDA as a percentage of net operating revenue for our same store
hospitals was 14.6% for the three months ended December 31, 2000, compared to
15.5% for the three months ended December 31, 1999. EBITDA as a percentage of
net operating revenue for our management services business was 23.2% for the
three months ended December 31, 2000, compared to 20.5% for the three months
ended December 31, 1999. We attribute the increase in consolidated EBITDA
principally to better pricing, higher earnings from our management services
business and our Las Vegas joint venture. EBITDA as a percentage of net
operating revenue for our same store hospitals excluding physician clinics was
18.1% for the three months ended December 31, 2000.
EBITDA for the six months ended December 31, 2000 was $140.4 million,
compared to $133.3 million for the six months ended December 31, 1999, an
increase of $7.1 million or 5.3%. EBITDA as a percentage of net operating
revenue was 15.4% for the six months ended December 31, 2000, the same as the
six months ended December 31, 1999. EBITDA as a percentage of net operating
revenue for our owned hospitals was 14.8% for the six months ended December 31,
2000, compared to 14.9% for the six months ended December 31, 1999. EBITDA as a
percentage of net operating revenue for our same store hospitals was 14.4% for
the six months ended December 31, 2000, compared to 14.9% for the six months
ended December 31, 1999. EBITDA as a percentage of net operating revenue for our
management services business was 21.9% for the six months ended December 31,
2000, compared to 21.1% for the six months ended December 31, 1999. We attribute
the increase in consolidated EBITDA principally to (1) growth in net operating
revenue from higher volumes and better pricing, (2) improvements in receivables
management and bad debt expense and (3) higher earnings from our Las Vegas joint
venture. EBITDA as a percentage of net operating revenue for our same store
hospitals excluding physician clinics was 18.2% for the six months ended
December 31, 2000.
- --------
(1)EBITDA is commonly used as an analytical indicator, and also serves as a
measure of indebtedness capacity and debt service ability. EBITDA should not be
considered a measure of financial performance under generally accepted
accounting principles, and the items excluded from EBITDA are significant
components in understanding and assessing financial performance. EBITDA should
not be considered in isolation or as an alternative to net income, cash flows
generated by operating, investing or financing activities or other financial
statement data presented in the consolidated financial statements as an
indicator of financial performance or liquidity. Because EBITDA is not a
measurement determined in accordance with generally accepted accounting
principles and is susceptible to varying calculations, EBITDA as presented may
not be comparable to other similarly titled measures of other companies.
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Net cash used for investing activities for the six months ended
December 31, 2000 totaled $79.9 million compared to $77.2 million for the six
months ended December 31, 1999. Our primary investment activities for the six
months ended December 31, 2000 were routine capital expenditures, hospital
construction and acquisitions. Routine capital expenditures were $42.6 million
for the six months ended December 31, 2000 compared to $54.9 for the six months
ended December 31, 1999. Hospital construction was $28.8 million for the six
months ended December 31, 2000 compared to $2.4 million for the six months ended
December 31, 1999. We acquired one hospital and affiliated health care entities
for $9.0 million for the six months ended December 31, 2000.
Capital Expenditures. Capital expenditures excluding acquisitions for
the six months ended December 31, 2000 totaled $71.4 million. These capital
expenditures consisted of $28.8 million for constructing two hospitals and
routine capital expenditures of $42.6 million. We expect to make routine capital
expenditures for fiscal 2001 of approximately $100 million before acquisitions
and before construction of the two hospitals.
We are constructing a replacement hospital in Vicksburg, Mississippi
and a new acute-care hospital in Ft. Wayne, Indiana. The Vicksburg hospital has
an estimated total project cost of approximately $108 million with an expected
completion date of February 2002. The Ft. Wayne hospital has an estimated total
project cost of approximately $44 million with an expected completion date of
April 2001. We expect to make construction capital expenditures of approximately
$80 million to $85 million for fiscal 2001. In connection with the construction,
we have contracts outstanding for approximately $90 million, of which
approximately $43 million has been incurred through December 31, 2000.
Capital expenditures excluding acquisitions for the six months ended
December 31, 1999 totaled $57.3 million. These capital expenditures consisted of
$2.4 million for hospital construction and routine capital expenditures of $54.9
million.
Capital Resources
Our revolving credit facility consists of an $850.0 million secured
credit facility expiring November 26, 2002, which coincides with the expiration
date of our ELLF. On November 26 of each year, we can request an incremental one
year extension, which is subject to approval of all of the lenders. The credit
facility bears interest at our option at generally the lender's base rate,
swing-line rate or a fluctuating rate ranging from .55 to 1.55 percentage points
above LIBOR. Also, we pay a facility fee ranging from .20 to .45 percentage
points on the commitment. The interest rate margins and facility fee rates are
based on our leverage ratio. Substantially all stock of our subsidiaries has
been pledged under the terms of the credit facility. We may prepay the amount
outstanding at any time. At January 31, 2001, we had approximately $300
million committed and undrawn under our credit facility.
We also have a $150.0 million ELLF agreement to provide a financing
option for acquisition and/or construction. The interest rate margins,
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facility fee rates, the option to extend and financial covenants are
substantially the same as our credit facility. Under this agreement, we have
guaranteed all lease payments, including contingent lease payments, of up to 85%
of the amount utilized under this agreement. At January 31, 2001, we had
approximately $9.7 million available under this agreement.
We have $150.0 million of 8 3/4% senior subordinated notes outstanding,
which mature on November 1, 2005. We have the option to redeem these notes at
104.375% of the principal amount on or after November 1, 2000, 102.188% of the
principal amount on or after November 1, 2001, or at par value on or after
November 1, 2002. Upon a change of control, we must make an offer to purchase
these notes at 101% of the principal amount. These notes are unsecured and
subordinated in right of payment to all existing and future senior debt.
On August 31, 1999, we issued $150.0 million of convertible
subordinated debentures due 2009 to Welsh, Carson, Anderson & Stowe, VIII, LP
(WCAS VIII) and certain WCAS VIII affiliates, including Russell L. Carson,
Chairman of our Board of Directors. We sold the debentures for cash at their
face value. The debentures bear interest at 6.0% per annum. Interest is payable
quarterly. The debentures are convertible into common shares at a conversion
price of $11.25 per share. The debentures automatically convert at any time
after three years if the average of the closing price of our stock over any 90
day period is more than 150% of the conversion price. We can call the debentures
at par after August 31, 2001. In the event of a merger, consolidation or sale of
more than 50% of our assets, the holder of the debentures has the option to have
the debentures prepaid in full. In connection with the merger agreement with
Triad, the debentures are to be converted into our common stock immediately
prior to the merger. The debentures have antidilution protection, including,
under certain circumstances, issuance of common stock below the then applicable
conversion price. The shares into which the debentures are convertible have
certain voting restrictions and must be held until August 2001. The debentures
are subordinated in right of payment to all our debt. We did not register the
debentures under the Securities Act of 1933. The sale of the debentures was
exempt from registration under Section 4(2) of the Securities Act because it was
a privately negotiated transaction and did not involve a public offering. We
used the proceeds to reduce our outstanding debt under our revolving credit
facility.
The credit facilities governing our revolving line of credit, ELLF and
senior subordinated notes contain certain financial covenants including but not
limited to a limitation on debt levels, prohibition of dividend payments and
other distributions and restrictions on investments, repurchases of common
stock, asset dispositions, the ability to merge or consolidate with or transfer
assets to another entity, and the maintenance of various financial ratios,
including a net worth ratio, a fixed charge ratio and a leverage ratio. The
amount available under our revolving line of credit changes based on our
leverage ratio under our revolving line of credit and our cash flow ratio under
our senior subordinated notes indenture. At January 31, 2001, the amount
available under our revolving line of credit was approximately $100 million.
During fiscal 2000, we repurchased 2.8 million shares of our common
stock for an aggregate purchase price of $18.6 million. We repurchased all of
these shares in open market transactions. There are approximately 1.6 million
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shares remaining for repurchase under the existing 5.0 million share repurchase
program authorized in October 1998.
We adopted a stockholder rights plan in fiscal 1997 and declared a
dividend of one right for each share of common stock. The plan was amended in
August 1999. Each right entitles stockholders to acquire one-third of a share of
common stock at an exercise price of $100, subject to adjustment. The rights
become exercisable only if (1) WCAS 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. In connection with the merger agreement with Triad, we have agreed to
amend the stockholder's rights plan so that the rights will not be made
exercisable as a result of the merger. We may redeem the rights for $.01 each at
any time until the tenth day following public announcement that an ownership
position as described above has been acquired. The rights expire on April 28,
2007.
SEASONALITY AND INFLATION
Our business is seasonal, with higher patient volumes and net operating
revenues in the third quarter of our fiscal year than in the remainder of the
year. This seasonality happens because more people become ill during the winter,
which in turn increases the number of patients in our owned hospitals.
The health care industry is labor intensive. This means that our owned
hospitals need many employees, to whom we pay salaries and other benefits. These
salaries and benefits increase during periods of inflation and shortages of
qualified potential employees. Some of our hospitals are now experiencing
pressures to increase salaries. In addition, we are experiencing increased costs
of new products and technology, primarily drugs, implants and blood.
MARKET RISKS ASSOCIATED WITH FINANCIAL INSTRUMENTS
Our interest expense is sensitive to changes in the general level of
interest rates. To mitigate the impact of fluctuations in interest rates, we
generally maintain 50%-75% of our debt at a fixed rate, either by borrowing on a
long-term fixed-rate basis or entering into interest rate swaps. At December 31,
2000, approximately 70% of our outstanding debt and ELLF amounts were
effectively at a fixed rate. Interest rate swaps are contracts which allow us to
periodically exchange fixed and floating interest rate payments over the life of
the agreements. Floating-rate payments are based on LIBOR and
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fixed-rate payments are dependent upon market levels at the time the interest
rate swap was consummated. Interest rate swaps are cash flow hedges, which
effectively convert an aggregate notional amount of $400 million of floating
rate borrowings to fixed rate borrowings at December 31, 2000. The initial term
of the interest rate swaps expire at various dates through fiscal 2003. Our
policy is to not hold or issue derivatives for trading purposes and to avoid
derivatives with leverage features. We are exposed to credit losses in the event
of nonperformance by the counterparties to our financial instruments. Our
counterparties are creditworthy financial institutions and we anticipate that
they will be able to fully satisfy their obligations under the contracts. For
the six months ended December 31, 2000 and 1999, we received a weighted average
rate of 6.7% and 5.4% and paid a weighted average rate of 5.9% and 5.9%,
respectively.
The following table presents information about our market-sensitive
financial instruments, including long-term debt and interest rate swaps as of
December 31, 2000. For debt obligations, the table presents principal cash flows
and related weighted-average interest rates by expected maturity dates. For
interest rate swaps, the table presents notional amounts by expected maturity
date and weighted average interest rates based on rates in effect at December
31, 2000. We determined the fair value of our publicly traded notes using the
quoted market price at December 31, 2000. The fair value of the option feature
in the convertible debentures is estimated using an option pricing model. The
fair values of the remaining long-term debt are estimated using discounted cash
flows based on our incremental borrowing rates. The fair values of our interest
rate swaps is based on the cash which would be realized in the event of
termination of the agreements.
Maturity Date, Fiscal Year Ending June 30
--------------------------------------------------------------------
(Dollars in millions)
December 31,
2000
There- Fair Value of
2001 2002 2003 2004 2005 after Total Liabilities
------ ------ ------ ------ ------ ------ ------ -----------
Long-term debt:
Fixed rate long-term
debt $ 0.2 $ 0.6 $ 0.6 $ 0.7 $ 0.6 $301.0 $303.7 $373.8
Average interest rates 7.9% 7.8% 7.7% 7.8% 7.7% 7.4%
Variable rate long-
term debt $544.5 $544.5 $544.5
Average interest rates 7.8%
Interest rate swaps:
Pay fixed/receive
variable notional
amounts $200.0 $200.0 $400.0 $ 0.8
Average pay rate 6.0% 5.7%
Average receive rate 6.5% 6.5%
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LITIGATION
We are currently, and from time to time expect to be, subject to claims
and suits arising in the ordinary course of business, including claims for
personal injuries and breach of management contracts. Plaintiffs in these
matters may request punitive or other damages that may not be covered by
insurance. Except for the litigation described below and other litigation,
administrative proceedings or investigations which may arise under the False
Claims Act or similar laws, we are not aware that we are currently a party to
any such proceeding which, in our opinion, if adversely decided, would have a
material effect on our results of operations or financial position.
Professional Liability Judgment. On February 29, 2000, an amended final
trial judgment was entered against our subsidiary, Quorum Health Resources, LLC
("QHR"), in the amount of approximately $57 million in the case of David X. and
Veronica Rodriguez, Individually and as Next Friends of Cristina Rodriguez, a
minor v Quorum Health Resources, LLC, in the 365th District Court, Maverick
County, Texas. The lawsuit arose out of the treatment provided beginning July 2,
1994 at Fort Duncan Medical Center, an acute care hospital formerly managed by
QHR. While our appeal of the judgement was pending, the litigation was settled.
Our primary insurer is funding this settlement.
False Claims Act Litigation. At a meeting in September 1998, we learned
from the government that it would likely join in a lawsuit filed against us
under the False Claims Act. The suit was filed in January 1993 by a former
employee of a hospital we managed. These lawsuits, commonly known as qui tam
actions, are filed "under seal." That means that the claims are kept secret
until the government decides whether to join the case. The person who files the
lawsuit is called a "relator". The government joined the case against us in
October 1998. The relator's lawsuit named us and our subsidiary, Quorum Health
Resources, HCA and all hospitals that we or HCA owned, operated or managed from
1984 through 1997, as defendants. The unsealed complaint, prepared by the
relator, alleged that we knowingly prepared and caused to be filed cost reports
which claimed payments from Medicare and other government payment programs
greater than the amounts due.
On February 24, 1999, the government filed its own complaint in the
case. The new complaint alleges that we, on behalf of hospitals we managed
between 1985 and 1995 and hospitals we owned from 1990 to the date of the
complaint, violated the False Claims Act by knowingly submitting or causing to
be submitted false Medicare cost reports, resulting in the submission of false
claims to federal health care programs.
The government asserts that the alleged false claims in the cost
reports are, in part, reflected in "reserve analyses" we created. The complaint
also alleges that these cost report filings were prepared as the result of our
policy.
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
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government, civil penalties of not less than $5,000 nor more than $10,000 for
each false claim, and the relator's attorneys' fees and costs.
On October 2, 2000, we announced that we had reached an understanding
with the Civil Division, U.S. Department of Justice to recommend an agreement to
settle this Medicare cost report qui tam lawsuit. Under the terms of the
tentative agreement, the settlement amount to be paid to the government is $77.5
million, with interest accruing at 7.25% from October 2, 2000 until final
resolution of a settlement agreement and a corporate integrity agreement. The
tentative agreement is conditioned on negotiation and completion of a mutually
satisfactory settlement agreement and corporate integrity agreement. We may
require a waiver under our credit facilities to pay the settlement amount in a
lump sum.
Other Qui Tam Actions and Related Investigations. In May 1998, we were
informed that we were a defendant in another qui tam action involving home
health services provided by two of our owned hospitals and alleging that we had
violated Medicare laws. This action was filed under seal in June 1996 by a
former employee, whom we fired in April 1996. The United States Attorney's
Office allowed us an opportunity to review the results of the government's
investigations and discuss the allegations made in the action prior to the
government making a decision to intervene as a plaintiff. We cooperated with the
United States Attorney's Office and provided additional information and made
employees available for interviews.
On October 26, 2000, we completed settlement of a qui tam lawsuit which
primarily involved allegedly improper allocation of costs at Flowers Hospital,
Dothan, Alabama, to its home health agency(CV-96-P-1638-S, N.D. Alabama). We
paid to the government on October 26, 2000 approximately $18 million in
connection with this settlement which was accrued in the three months ended
September 30, 2000. In addition to the settlement agreement, we entered into a
five year corporate integrity agreement covering Flowers Hospital with the
Department of Health and Human Services Office of the Inspector General. The
corporate integrity agreement imposes certain oversight and reporting
obligations that may be costly and may have a material adverse effect on Flowers
Hospital's operations. The government always reserves the right to investigate
and pursue other allegations made by a relator under a complaint. However, under
the settlement agreement, the relator is prohibited from pursuing these
additional allegations.
As a result of our ongoing discussions with the government, we have
learned that there are two additional unrelated qui tam complaints against us
alleging violations of the False Claims Act at one owned and two managed
hospitals. Both matters remain under seal. The government has stated that it
intends to investigate certain of these allegations. At this time, we cannot
take a position on how we will respond to these matters.
From time to time, we may be the subject of additional investigations
or a party to additional litigation which alleges violations of law. We may not
know about such investigations, or about qui tam actions filed against us.
Stockholder Class Actions. In October and November 1998, some of our
stockholders filed lawsuits against us in the U.S. District Court for the
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Middle District of Tennessee. In January 1999, the court consolidated these
cases into a single lawsuit. (M.D. Tenn. No. 3-98-1004). The plaintiffs filed
an amended complaint in March 1999. The plaintiffs seek to represent a class
of plaintiffs who purchased our common stock from October 25, 1995 through
October 21, 1998, except for our insiders and their immediate families. The
consolidated complaint names us, several of our officers and one of our
outside directors, as defendants.
The complaint alleges that defendants violated the Securities Exchange
Act of 1934. The plaintiffs claim that we materially inflated our net revenues
during the class period by including in those net revenues amounts received from
the settlement of cost reports that had allegedly been filed in violation of
applicable Medicare regulations years earlier and that, because of this
practice, this statement, which first appeared in our Form 10-K filed in
September 1996, was false: "The Company believes that its owned hospitals are in
substantial compliance with current federal, state, local, and independent
review body regulations and standards." In May 1999, we filed a motion to
dismiss the complaint. On November 13, 2000, the judge denied our motion to
dismiss the complaint against us and James E. Dalton, Jr., our President/CEO.
The judge granted our motion to dismiss as to all other defendants. The judge
has agreed to hear an oral argument on Mr. Dalton's motion to reconsider the
judge's denial of Mr. Dalton's motion to dismiss. We intend to vigorously defend
the claims and allegations in this action.
On October 20, 2000, a class action lawsuit was filed against Triad and
members of our board of directors in the Circuit Court of Davidson County,
Tennessee, on behalf of all our public stockholders. The complaint alleges that
our directors breached their fiduciary duties of loyalty and due care by failing
to implement reasonable procedures designed to maximize stockholder value and to
obtain the highest price reasonably available for our stockholders. The
complaint alleges that Triad aided and abetted our director's breach of their
fiduciary duties. The complaint seeks an injunction preventing consummation of
the merger, or our acquisition by or business combination with any third party,
until we adopt and implement a procedure or process, such as an auction, to
obtain the highest possible price for our business. Alternatively, the complaint
seeks compensatory damages in the event our merger with Triad is consummated.
The complaint also seeks an award of costs and attorneys' fees. We and Triad
believe the claims are without merit and will vigorously defend the action.
We cannot at this time predict the final effect or outcome of any of
the ongoing investigations, settlement negotiations or the class or qui tam
actions. If we are found to have violated federal or state laws relating to
Medicare, Medicaid or other government programs, then we may be required to pay
substantial fines and civil and criminal penalties and also may be excluded from
participating in the Medicare and Medicaid programs and other government
programs. Similarly, the amount of damages sought in the qui tam actions are or
in the future may be substantial. We could be subject to substantial costs
resulting from defending, or from an adverse outcome in any current or future
investigations, administrative proceedings or litigation. In an effort to
resolve one or more of these matters, we may choose to negotiate a settlement.
Amounts we pay to settle any of these matters may be material. Agreements we
enter into as a part of any settlement could also materially adversely affect
us. Any current or future investigations or actions could have a material
adverse effect on our results of operations or financial position.
GENERAL
We received from the Medicare and Medicaid programs approximately 42%
and 43% of net patient service revenue for the years ended June 30, 2000 and
1999, respectively.
BBA 97 reduced Medicare payments. The federal government originally
estimated that BBA 97 would reduce Medicare spending by approximately $103
billion. In July 1999, the federal government revised its estimate to $206
billion. The Medicare, Medicaid, and State Children's Health Insurance Programs
Balanced Budget Refinement Act of 1999 (BBRA) increased Medicare payments. The
federal government then lowered its estimate of the BBA 97
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reduction to $195 billion due to the positive impact of BBRA. In January 2000,
the federal government further revised its estimate to $227 billion. BIPA is
expected to increase Medicare and Medicaid spending by $35 billion. BBA 97
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 the federal fiscal year that began on October 1, 1998. BBA 97 and
further changes in the Medicare or Medicaid programs 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.
Medicare inpatient operating payment rates increased 1.1% on October 1,
1999 and 2.3% on October 1, 2000. For many years increases to these rates have
been lower than the increases in the costs of goods and services purchased by
hospitals. The Benefits Improvement Protection Act of 2000 (BIPA) increased the
inpatient operating rates that hospitals receive to 4.5% effective April 1,
2001. For Federal fiscal years 2002 and 2003, hospitals generally will receive
the market basket index minus 0.55%. For Federal fiscal year 2004, hospitals
generally will receive the full market basket index. Future legislation may
decrease the rate of increase for inpatient operating payments. Reductions make
it more difficult for us to grow net revenue and to maintain or improve our
operating margins.
Only when the cost of patient treatment substantially exceeds the
payment for a particular diagnosis, do we receive additional payments. The
threshold to qualify for additional payments for treating inpatients increased
October 1, 1999 and again on October 1, 2000. Increases in this threshold result
in decreased payments to hospitals.
Payments for Medicare skilled nursing facility services, rehabilitation
services, outpatient services and home health services historically have been
paid based on costs, subject to certain adjustments and limits. BBA 97 required
that the payment for those services be converted to prospective payment systems
(PPS). PPS for skilled nursing facilities began for cost reporting periods
beginning on and after July 1, 1998. PPS for outpatients began on August 1,
2000. PPS for home health began on October 1, 2000. Healthcare Financing
Administration (HCFA) has indicated that the implementation of rehabilitation
PPS will be delayed until July 1, 2001 or later.
In response to BBA 97, we consolidated certain home health agencies and
skilled nursing facilities, reduced costs at our home health agencies and
skilled nursing facilities and closed or ceased admitting patients to skilled
nursing facilities at four hospitals.
Medicare outpatient PPS is a complex system which has required many
changes in our systems and processes. We are analyzing outpatient product lines,
the impact of changes on patient coinsurance and the financial impact of
outpatient PPS. We estimated that Medicare outpatient PPS has been favorable to
us by approximately $1 million for the five months it had been in effect as of
December 31, 2000.
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Further reductions in Medicare spending, or other changes to the
program, may be required to maintain the solvency of the Medicare program or the
Social Security system as a whole. Our ability to operate our business
successfully in the future will depend in large measure on our ability to adapt
to changes as a result of BBA 97 and any subsequent Medicare legislation and
regulations.
More of our patients participate in managed care plans. Managed care
includes indemnity insurance and employer plans which pay less than full
charges, health maintenance organizations, preferred provider organizations and
various other forms of managed care. We are negotiating higher rates from
managed care payors, averaging increases of 5% to 7%. We have installed a
managed care information system in most of our owned hospitals and are beginning
to use it to improve the information available to management and to help ensure
that we are paid at the contracted amounts. The trend toward managed care has
adversely affected and may continue to adversely affect our ability to grow net
operating revenue and improve operating margins.
Our acute care hospitals, like most acute care hospitals in the United
States, have significant unused capacity. The result is substantial competition
for patients and physicians. Inpatient volumes continue to be negatively
affected by payer-required pre-admission authorization and by payer pressure to
maximize outpatient and alternative health care delivery services for less
acutely ill patients. 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.
Over the long term, we expect the industry trend from inpatient to
outpatient services to continue due to the increased focus on managed care and
advances in technology. More outpatient procedures are now being provided in
physician offices. Outpatient revenue of our owned hospitals was approximately
42.5% and 41.7% of gross patient service revenue for the six months ended
December 31, 2000 and 1999, respectively.
In accordance with generally accepted accounting principles, we
estimate settlements with third party payers. These estimates are based on
assumptions and affect the amounts we report in our financial statements. For
example, we report net patient service revenue at net amounts we expect to
receive from our hospital patients, third party payers, and others for services
rendered, including estimated retroactive adjustments under agreements with
third party payers. We make estimates of settlements under agreements with third
party payers in the period we provide the related services. We then adjust the
settlements as final settlements are determined or additional information is
obtained from the third party payer. Our quarterly or annual operating results
fluctuate based on the timing and amount of changes in estimates.
The IRS is in the process of conducting examinations of our federal
income tax returns for the fiscal years ended June 30, 1996 through 1998. The
IRS has proposed certain adjustments in connection with its prior examination of
our federal income tax returns for the fiscal years ending June 30, 1993
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through 1995. The most significant adjustments relate to how we compute bad debt
expense and how we value property, plant and equipment of hospitals we acquire
and their related depreciable lives. We have protested substantially all of the
proposed adjustments through the appeals process of the IRS. In our opinion, the
ultimate outcome of the IRS examinations will not have a material effect on our
results of operations or financial position.
In 1998, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities". This standard requires us to recognize all
derivatives on our balance sheet at fair value. Our interest rate swaps are cash
flow hedges which hedge the variability in expected cash flows from a portion of
our floating rate liabilities. We believe that our hedges are highly effective
with changes in effectiveness expected to be reported in other comprehensive
income. Changes in any ineffectiveness will be reported in our Condensed
Consolidated Statement of Operations. The adoption of this new FASB standard on
July 1, 2000 resulted in a cumulative effect of an accounting change, net of
tax, of approximately $5.7 million being recognized as other comprehensive
income for the increase in fair value of the interest rate swaps. During the six
months ended December 31, 2000, the decrease in fair value of interest rate
swaps, net of tax, of approximately $6.2 million was recognized through other
comprehensive income. At December 31, 2000, the fair value of the interest rate
swaps was a liability of $0.8 million.
On March 31, 2000, FASB issued its final interpretation of APB Opinion
No. 25 "Accounting for Certain Transactions involving Stock Compensation." The
final interpretation requires variable-award accounting for stock options
granted six months before or after the cancellation or settlement of options if
the new options have a lower exercise price. The interpretation was effective
July 1, 2000 and covers certain events that occurred after December 15, 1998. No
adjustments were made to financial statements for periods prior to the effective
date and no expense was recognized for any additional compensation costs
attributable to periods before the effective date.
During the three months and six months ended December 31, 2000,
respectively, we recorded $6.5 million and $12.3 million in non-cash stock
option compensation expense associated with the stock options repriced in March
1999. This charge was based on the increase in our stock price since the
beginning of the period. The number of options subject to variable award
accounting is comprised of 1.7 million vested options and a percentage of 1.4
million unvested options based on their vesting schedule. The number of options
affected will decrease for options exercised or canceled and will increase as
unvested options become vested.
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PART II. OTHER INFORMATION
Item 1. Legal Proceedings
The information contained in Part 1, Item 2 "Management's Discussion
and Analysis," under the caption "Litigation," is incorporated by reference in
its entirety into this Item 2.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits. No exhibits have been filed with this Report.
(b) Reports on Form 8-K. The following Reports on Form 8-K were filed
during the quarter ended December 31, 2000:
(1) Report on Form 8-K on October 2, 2000 with Item 5 report of
tentative agreements with the Civil Division, U.S. Department of Justice to
recommend agreements to settle two qui tam lawsuits.
(2) Report on Form 8-K filed on October 20, 2000 with Item 5 report
that on October 18, 2000, we signed a definitive agreement for Triad Hospitals,
Inc. to acquire the Company for approximately $2.4 million in cash, stock, and
assumption of debt.
(3) Report on Form 8-K filed on November 3, 2000 with Item 5 report
that on October 26, 2000, we completed settlement of a qui tam lawsuit which
primarily involved allocation of costs at Flowers Hospital in Dothan, Alabama,
to its home health agency; entered into a five year corporate integrity
agreement covering Flowers Hospital with the Department of Health and Human
Services Office of Inspector General; and paid approximately $18 million to the
government in connection with the settlement.
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 9, 2001 By: /s/ Terry Allison Rappuhn
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Terry Allison Rappuhn, Senior Vice
President/Chief Financial Officer