- ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549 FORM 10-K [X]Annual Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the fiscal year ended December 31, 1999 OR [_]Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 Commission File Number: 1-10989 VENTAS, INC. (Exact name of registrant as specified in its charter) Delaware 61-1055020 (I.R.S. Employer Identification (State or other jurisdiction of Number) incorporation or organization) 4360 Brownsboro Road 40207-1642 Suite 115 (Zip Code) Louisville, Kentucky (Address of principal executive offices) (502) 357-9000 (Registrant's telephone number, including area code) ---------------- Securities registered pursuant to Section 12(b) of the Act: <TABLE> <CAPTION> Name of Each Exchange Title of Each Class: on which Registered: <S> <C> Common Stock, par value $.25 per share New York Stock Exchange Preferred Stock Purchase Rights New York Stock Exchange </TABLE> Securities registered pursuant to Section 12(g) of the Act: None ---------------- 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 by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment of this Form 10-K. X As of March 17, 2000, there were 67,954,423 shares of the Registrant's common stock, $.25 par value ("Common Stock"), outstanding. The aggregate market value of the shares of the Registrant held by non-affiliates of the Registrant, based on the closing price of such stock on the New York Stock Exchange on March 17, 2000, was approximately $190,146,399. For purposes of the foregoing calculation only, all directors and executive officers of the Registrant have been deemed affiliates. Part III of this Annual Report on Form 10-K is incorporated herein by reference from the Company's definitive Proxy Statement for the Annual Meeting of Stockholders to be held on May 23, 2000 to be filed with the Securities and Exchange Commission no later than 120 days after the end of the fiscal year covered by this Form 10-K. - ------------------------------------------------------------------------------- - -------------------------------------------------------------------------------
CAUTIONARY STATEMENTS Forward Looking Statements This Form 10-K includes forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the "Securities Act"), and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). All statements regarding the Company's and its subsidiaries' expected future financial position, results of operations, cash flows, funds from operations, dividends and dividend plans, financing plans, business strategy, budgets, projected costs, capital expenditures, competitive positions, growth opportunities, expected lease income, ability to qualify as a real estate investment trust, plans and objectives of management for future operations and statements that include words such as "anticipate," "believe," "plan," "estimate," "expect," "intend," "may," "could," and other similar expressions are forward-looking statements. Such forward-looking statements are inherently uncertain, and stockholders must recognize that actual results may differ from the Company's expectations. Actual future results and trends for the Company may differ materially depending on a variety of factors discussed in this Form 10-K and elsewhere in the Company's filings with the Securities and Exchange Commission (the "Commission"). Factors that may affect the plans or results of the Company include, without limitation, (a) the treatment of the Company's claims in the chapter 11 cases of its primary tenant, Vencor, Inc. and certain affiliates (collectively, "Vencor"), as well as certain of its other tenants, (b) the ability and willingness of Vencor to continue to meet and/or honor its obligations under the Spin Agreements (as defined below), including, without limitation, the obligation to indemnify and defend the Company for all litigation and other claims relating to the health care operations and other assets and liabilities transferred to Vencor in the 1998 Spin Off (as defined below), (c) the ability of Vencor and the Company's other operators to maintain the financial strength and liquidity necessary to satisfy their respective obligations and duties under the leases and other agreements with the Company, and their existing credit agreements, (d) the Company's success in implementing its business strategy, (e) the nature and extent of future competition, (f) the extent of future health care reform and regulation, including cost containment measures and changes in reimbursement policies and procedures, (g) increases in the cost of borrowing for the Company, (h) the ability of the Company's operators to deliver high quality care and to attract patients, (i) the results of litigation affecting the Company, (j) the results of the settlement discussions Vencor and Ventas have been engaged in with the federal government seeking to resolve federal civil and administrative claims against them arising from the participation of Vencor facilities in various federal health benefit programs, (k) changes in general economic conditions and/or economic conditions in the markets in which the Company may, from time to time, compete, (l) the ability of the Company to pay down, refinance, restructure, and/or extend its indebtedness as it becomes due, and (m) the ability of the Company to qualify as a real estate investment trust. Many of such factors are beyond the control of the Company and its management. Vencor Information Vencor is subject to the reporting requirements of the Commission and is required to file with the Commission annual reports containing audited financial information and quarterly reports containing unaudited financial information. The information related to Vencor provided in this Form 10-K is derived from filings made with the Commission or other publicly available information, or has been provided by Vencor. The Company has not verified this information either through an independent investigation or by reviewing Vencor's public filings. The Company has no reason to believe that such information is inaccurate in any material respect, but there can be no assurance that all such information is accurate. The Company is providing this data for informational purposes only, and the reader of this Form 10-K is encouraged to obtain Vencor's publicly available filings from the Commission. 2
TABLE OF CONTENTS <TABLE> <C> <S> <C> PART I Item 1. Business....................................................... 4 Item 2. Properties..................................................... 41 Item 3. Legal Proceedings.............................................. 47 Item 4. Submission of Matters to a Vote of Security Holders............ 47 PART II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters........................................................ 49 Item 6. Selected Financial Data........................................ 50 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.......................................... 50 Item 7A. Quantitative and Qualitative Disclosures About Market Risk..... 61 Item 8. Financial Statements and Supplementary Data.................... 61 Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure........................................... 61 PART III Item 10. Directors and Executive Officers of the Registrant............. 61 Item 11. Executive Compensation......................................... 61 Item 12. Security Ownership of Certain Beneficial Owners and Management..................................................... 61 Item 13. Certain Relationships and Related Transactions................. 61 PART IV Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8- K.............................................................. 62 </TABLE> 3
PART I Item 1. Business General Ventas, Inc. ("Ventas" or the "Company") is a real estate company that owns or leases 45 hospitals (comprised of two acute care hospitals and 43 long-term acute care hospitals), 218 nursing facilities and eight personal care facilities in 36 states as of December 31, 1999. The Company conducts substantially all of its business through a wholly owned operating partnership, Ventas Realty, Limited Partnership ("Ventas Realty"). Although the Company currently expects to qualify as a real estate investment trust ("REIT") for the year ended December 31, 1999, it is possible that economic, market, legal, tax or other considerations may cause the Company to fail or not elect to qualify as a REIT. The Company operates in one segment which consists of owning and leasing health care facilities and leasing or subleasing such facilities to third parties. The Company was incorporated in Kentucky in 1983 as Vencare, Inc. and commenced operations in 1985. The Company changed its name to Vencor Incorporated in 1989 and to Vencor, Inc. in 1993. From 1985 through April 30, 1998, the Company was engaged in the business of owning, operating and acquiring health care facilities and companies engaged in providing health care services. On May 1, 1998, the Company effected a corporate reorganization (the "1998 Spin Off") pursuant to which the Company was separated into two publicly held corporations. A new corporation, subsequently named Vencor, Inc., was formed to operate the hospital, nursing facility and ancillary services businesses. Pursuant to the terms of the 1998 Spin Off, the Company distributed the common stock of Vencor to stockholders of record of the Company as of April 27, 1998. The Company, through its subsidiaries, continued to hold title to substantially all of the real property and to lease such real property to Vencor. At such time, the Company also changed its name to Ventas, Inc. and refinanced substantially all of its long-term debt. For financial reporting periods subsequent to the 1998 Spin Off, the historical financial statements of the Company were assumed by Vencor, and the Company is deemed to have commenced operations on May 1, 1998. In addition, for certain reporting purposes under this Form 10-K and other filings, the Commission treats the Company as having commenced operations on May 1, 1998. The Company owns and leases a geographically diverse portfolio of health care related facilities, including hospitals, nursing facilities and personal care facilities whose principal tenants are health care related companies. As a result of announcements during 1999 by Vencor and industry-wide factors, the Company suspended the implementation of its original business strategy during 1999. The Company's current principal objectives are preserving and maximizing stockholders' capital. Dependence on Vencor The Company leases all of its hospitals and 210 of its nursing facilities to Vencor under four master lease agreements relating to 209 facilities and a single facility lease (individually a "Master Lease" and collectively "the Master Leases"). For the year ended December 31, 1999 and for the period from May 1, 1998 to December 31, 1998, Vencor accounted for approximately 98.5% (98.3%, net of write-offs) and 98.7% of the Company's revenues, respectively. See "--Risk Factors--Dependence of the Company on Vencor" and "Note 3-- Concentration of Credit Risk" to the Consolidated Financial Statements. Recent Developments Regarding Vencor On September 13, 1999, Vencor filed for protection under chapter 11 of the United States Bankruptcy Code (the "Bankruptcy Code"). Under the automatic stay provisions of the Bankruptcy Code, the Company is currently prevented from exercising certain rights and remedies under its agreements with Vencor, including the Spin Agreements (as defined below), and from taking certain enforcement actions against Vencor. See "--Risk Factors--Effects of Bankruptcy Proceedings." The Company, Vencor and Vencor's major creditors have been 4
engaged in negotiations both prior and subsequent to Vencor's bankruptcy filing to restructure Vencor's debt and lease obligations. Terms of a preliminary, non-binding agreement among Vencor's major creditors, Vencor and Ventas, reached at the time of Vencor's filing for protection under the Bankruptcy Code regarding Vencor's plan of reorganization (the "September 1999 Agreement in Principle"), are set forth below. On March 22, 2000, the Delaware bankruptcy court granted Vencor's motion to extend through May 16, 2000, the period during which Vencor has the exclusive right to file a plan of reorganization, and Vencor recently extended the expiration date for its debtor-in-possession financing until June 30, 2000. Vencor has stated that events arising after the filing of its bankruptcy petition that resulted in adjustments to its financial projections have caused it to enter into additional negotiations with its various creditors and Ventas regarding the September 1999 Agreement in Principle. Vencor has also retained The Blackstone Group as its financial advisor in connection with the negotiation and consummation of a plan of reorganization. There can be no assurance that Vencor's plan of reorganization, when filed, will be on the terms of the September 1999 Agreement in Principle or otherwise be acceptable to the Company. Under the terms of the September 1999 Agreement in Principle, the Company would make approximately $45 million in annual rent concessions, effective as of May 1, 1999, resulting in annual base rent of approximately $181 million for the 1999-2000 lease year. The Company would also receive (a) in addition to the current 2% annual cash escalator contained in its Master Leases, a 1 1/2% annual non-cash rent escalator that would accrue at 6% per annum until the occurrence of certain specified events, at which time the accrual with interest would be due and payable and thereafter the 1 1/2% rent escalator would convert to a cash escalator totalling 3 1/2% per year; (b) an additional 1% annual cash rent bonus escalator payable if Vencor's net patient revenue growth at the Company's facilities exceeds a cumulative annual growth rate of 5%; (c) a one time, unilateral right to reset the rents for the facilities, exercisable on a lease by lease basis from May 2002 through May 2005, to a then fair rental rate, for a total fee of $5 million payable on a pro-rata basis at the time of exercise under any lease; (d) 15% of the common stock and warrants in reorganized Vencor (the Company, in order to qualify as a REIT, may not hold 10% or more of the total combined voting power or the total number of shares in Vencor; the Company is evaluating alternatives for dealing with any Vencor equity ultimately received in excess of the 10% or more limitation); and (e) a reaffirmation and continuation of Vencor's indemnity obligations under the Spin Agreements. The Development Agreement and the Participation Agreement between the Company and Vencor (each, as defined below) would be terminated, and the Tax Allocation Agreement and the Master Leases (each, as defined below) would be amended and clarified under the September 1999 Agreement in Principle. The terms of the September 1999 Agreement in Principle also provided that on the date that Vencor's plan of reorganization becomes effective (the "Vencor Effective Date") the Company would also receive approximately $3.4 million, representing reduced August 1999 minimum monthly base rent ("August 1999 Rent") (approximately $15.1 million), net of $11.7 million ($3.75 million reduction in rent per month for May, June and July 1999 rent, plus $0.45 million relating to previously paid rent for a disputed facility). However, there can be no assurance that Vencor's plan of reorganization, when filed, will be on the terms of the September 1999 Agreement in Principle or otherwise will be acceptable to the Company. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Results of Operations." Other terms of the September 1999 Agreement in Principle for Vencor include: (a) the principal amount of Vencor senior bank debt would be reduced from approximately $520 million to approximately $320 million in exchange for 56% of the common stock in the restructured Vencor, and (b) Vencor's senior subordinated notes would be converted into approximately 29% of the common stock in restructured Vencor, and the holders of such debt would receive warrants in the restructured company. There can be no assurance that Vencor's plan of reorganization, when filed, will be on the terms of the September 1999 Agreement in Principle or otherwise be acceptable to the Company. The Company believes that the best outcome for the Company, Vencor and their respective banks and other creditors is a global restructuring of Vencor's financial obligations in connection with Vencor's chapter 11 bankruptcy filing. Ventas and Vencor continue to be engaged in advanced settlement discussions with the federal government seeking to resolve all federal civil and administrative claims against them arising from the participation of Vencor facilities in various federal health benefit programs. The majority of these claims arise from lawsuits filed under the qui tam, or whistleblower, provision of the Federal Civil False Claims Act, which allows private 5
citizens to bring suit in the name of the United States. See "Note 11-- Litigation" to the Consolidated Financial Statements. The United States Department of Justice, Civil Division, filed two proofs of claim in the Vencor bankruptcy court covering the United States claims and the qui tam suits. The United States asserted approximately $1.3 billion, including triple damages, against Vencor in these proofs of claim. The Department of Justice has informed the Company that it is the Department of Justice's position that, if liability exists, the Company and Vencor will be jointly and severally liable for the portion of such claims related to the period prior to the date of the 1998 Spin Off. If the United States, Vencor and the Company reach a settlement, any liability of the Company and Vencor related to these matters would likely be resolved in the settlement. There can be no assurance that a settlement will be reached regarding these claims and suits, or, if reached, that the settlement will be on terms acceptable to the Company. There can be no assurance that Vencor will be successful in obtaining the approval of its creditors for a restructuring plan, that any such plan will be on the terms of the September 1999 Agreement in Principle or on other terms acceptable to the Company, Vencor and its creditors, or that any restructuring plan will not have a material adverse effect on the business, financial condition, results of operation and liquidity of the Company, on the Company's ability to service its indebtedness and on the Company's ability to make distributions to its stockholders as required to elect or maintain its status as a REIT (a "Material Adverse Effect"). Nor can there be any assurance that Vencor and the Company will be able to reach a settlement with the Department of Justice, or that any such settlement will be on terms acceptable to Vencor, Vencor's creditors and the Company. The Company, Vencor and its creditors are not legally bound by the terms of the September 1999 Agreement in Principle, and the terms of the September 1999 Agreement in Principle: (i) are mutually interdependent, (ii) are subject to agreement on a satisfactory plan of reorganization and confirmation thereof and (iii) are further subject to other conditions (including, but not limited to, negotiation and execution of definitive documentation). As discussed above, Vencor has entered into additional negotiations with its various creditors and Ventas regarding the September 1999 Agreement in Principle. Under the terms of the Amended and Restated Credit, Security, Guaranty and Pledge Agreement (the "Amended Credit Agreement") that the Company and all of its lenders entered into on January 31, 2000, it is an event of default if Vencor's plan of reorganization is not effective on or before December 31, 2000. See "--Recent Developments Regarding Liquidity" and "Note 4--Borrowing Arrangements" to the Consolidated Financial Statements. During the Company's discussions with Vencor, Vencor asserted various potential claims against the Company arising out of the 1998 Spin Off. See "Note 11--Litigation" to the Consolidated Financial Statements. The Company intends to defend these claims vigorously if they are asserted in a legal or mediation proceeding. In connection with the discussions between the Company and Vencor, both before and after Vencor's bankruptcy filing, regarding Vencor's contemplated restructuring, the Company and Vencor have entered into certain agreements, including a "Stipulation," "Second Standstill Agreement," and a "Tolling Agreement," as defined below. The Stipulation In connection with the bankruptcy filing by Vencor, the Company and Vencor entered into a stipulation (the "Stipulation") for the payment by Vencor to the Company of approximately $15.1 million per month starting in September 1999, to be applied against the total amount of minimum monthly base rent that is due and payable under the Master Leases. The Stipulation was approved by the bankruptcy court. During the period in which the Stipulation is in effect, Vencor has agreed to fulfill all of its obligations under the Spin Agreements as such obligations become due, including its obligation to indemnify and defend Ventas from and against all claims arising out of the Company's former health care operations or assets or liabilities transferred to Vencor in the 1998 Spin Off. Vencor has not, however, agreed to assume the Spin Agreements and has reserved its right to seek to reject such agreements pursuant and subject to the applicable provisions of the Bankruptcy Code. A termination of the Stipulation and/or rejection by Vencor of the Spin Agreements could have a Material Adverse Effect on the Company. See "--Risk Factors--Effects of Bankruptcy Proceedings." 6
The payments under the Stipulation are required to be made by the fifth day of each month, or on the first business day thereafter. Starting in September, 1999, the difference between the amount of minimum monthly base rent due under the Company's Master Leases with Vencor and the monthly payment of approximately $15.1 million accrues as a superpriority administrative expense in Vencor's bankruptcy, junior in right only to the following: (i) any liens or superpriority claims provided to lenders under Vencor's debtor-in- possession credit agreement (the "DIP facility"); (ii) any fees due to the Office of the United States Trustee; (iii) certain fees of Vencor's professionals; (iv) any liens or superpriority claims granted to pre-petition secured creditors as adequate protection for their claims under the interim DIP order issued by the bankruptcy court and the final DIP order; and (v) pre- petition liens granted to the lenders under Vencor's credit agreement, as amended, and related agreements, to the extent such pre-petition claims are allowed as secured, subject to challenge in the Vencor bankruptcy proceeding. The monthly payment of approximately $15.1 million under the Stipulation is not subject to offset, recoupment or challenge. August 1999 Rent in the amount of approximately $18.9 million remains unpaid and will be asserted as a claim in Vencor's chapter 11 case. The Stipulation by its terms initially would have expired on October 31, 1999, but automatically renews for one-month periods unless either party provides a fourteen-day notice of its election to terminate the Stipulation. To date, no such notice of termination has been given. The Stipulation may also be terminated prior to its expiration upon a payment default by Vencor, the consummation of a plan of reorganization for Vencor, or the occurrence of certain events under the DIP facility. There can be no assurance as to how long the Stipulation will remain in effect or that Vencor will continue to perform under the terms of the Stipulation. The Stipulation also addresses an agreement by Ventas and Vencor concerning any statutes of limitations and other time constraints. See "--The Tolling Agreement" below. The Second Standstill Agreement On April 12, 1999, the Company entered into a Second Standstill Agreement with Vencor, which was subsequently amended on May 5, May 8, June 6, July 6, August 5, and September 3, 1999 (as amended, the "Second Standstill Agreement"). The Second Standstill Agreement terminated on September 9, 1999. Under the Second Standstill Agreement, the Company agreed not to exercise its remedies under the Master Leases based on any default arising from or relating to disclosures made by Vencor to the Company, and to accept the payment of April, May, June and July 1999 rent pursuant to a specified schedule. These payments represent the full amount of rent that was due for each month's rent under the Master Leases. Vencor made all rent payments required by the Second Standstill Agreement with respect to the April, May, June and July 1999 lease payments. August 1999 Rent remains unpaid and will be asserted as a claim in Vencor's chapter 11 bankruptcy case. Also, under the Second Standstill Agreement, each of the Company and Vencor agreed not to pursue any claims against the other or any third party relating to the agreements entered into in connection with the 1998 Spin Off, or any of the Master Leases, or with respect to certain specified disputes, during a defined period that terminated on September 9, 1999. The Tolling Agreement The Company and Vencor have also entered into an agreement (the "Tolling Agreement") pursuant to which they have agreed that any statutes of limitations or other time constraints in a bankruptcy proceeding, including the assertion of certain "bankruptcy avoidance provisions" that might be asserted by one party against the other, are extended or tolled for a specified period. That period currently terminates on the termination date of the Stipulation. Pursuant to the Stipulation, the Tolling Agreement does not shorten any time period otherwise provided under the Bankruptcy Code. Recent Developments Regarding Liquidity On January 31, 2000, the Company and all of its lenders entered into the Amended Credit Agreement, which amended and restated the $1.2 billion credit agreement (the "Bank Credit Agreement") the Company entered into at the time of the 1998 Spin Off. Under the Amended Credit Agreement, borrowings bear interest at an 7
applicable margin over an interest rate selected by the Company. Such interest rate may be either (a) the Base Rate, which is the greater of (i) the prime rate or (ii) the federal funds rate plus 50 basis points, or (b) the London Interbank Offered Rate ("LIBOR"). Borrowings under the Amended Credit Agreement are comprised of: (1) a new $25.0 million revolving credit line (the "Revolving Credit Line") that expires on December 31, 2002, which bears interest at either LIBOR plus 2.75% or the Base Rate plus 1.75%; (2) a $200.0 million term loan due December 31, 2002 (the "Tranche A Loan"), which bears interest at either LIBOR plus 2.75% or the Base Rate plus 1.75%; (3) a $300.0 million term loan due December 31, 2005 (the "Tranche B Loan"), which bears interest at either LIBOR plus 3.75% or the Base Rate plus 2.75%; and (4) a $473.4 million term loan due December 31, 2007 (the "Tranche C Loan"), which bears interest at either LIBOR plus 4.25% or the Base Rate plus 3.25%. The interest rate on the Tranche B Loan will be reduced by .50% (50 basis points) once $150.0 million of the Tranche B Loan has been repaid. The Amended Credit Agreement requires the following amortization: (a) with respect to the Tranche A Loan, (i) $50.0 million of the Tranche A Loan was paid at closing on January 31, 2000, (ii) $50.0 million is due within 30 days after the Vencor Effective Date, and (iii) thereafter all Excess Cash Flow (as defined in the Amended Credit Agreement) of the Company will be applied to the Tranche A Loan until $200.0 million in total has been paid down on the Amended Credit Agreement, with the balance due December 31, 2002; (b) with respect to the Tranche B Loan, (i) after the $50.0 million paydown on the Tranche A Loan to be made within 30 days after the Vencor Effective Date and after consideration of other cash needs of the Company, a one-time paydown of Excess Cash (as defined in the Amended Credit Agreement) within 30 days of the Vencor Effective Date, and (ii) scheduled paydowns of $50.0 million on December 31, 2003 and December 31, 2004, with the balance due December 31, 2005; and (c) with respect to the Tranche C Loan, no scheduled paydowns with a final maturity of December 31, 2007. The facilities under the Amended Credit Agreement are pre-payable without premium or penalty. On October 29, 1999, in conjunction with the execution of an agreement with over 95% of the Company's lenders regarding the restructuring of the Company's long term debt, including the $275.0 million Bridge Loan (the "Waiver and Extension Agreement"), the Company paid a $2.4 million loan waiver fee. In connection with the consummation of the Amended Credit Agreement on January 31, 2000, the Company paid a $7.3 million loan restructuring fee. The fees are being amortized proportionately over the terms of the related loans and agreements. The Amended Credit Agreement is secured by liens on substantially all of the Company's real property and any related leases, rents and personal property. Certain properties are being held in escrow by counsel for the agents under the Amended Credit Agreement pending the receipt of third party consents and/or resolution of certain other matters. In addition, the Amended Credit Agreement contains certain restrictive covenants, including, but not limited to, the following: (a) until such time that $200.0 million in principal amount has been paid down, the Company can pay REIT dividends based on a certain minimum percentage of its taxable income (currently equal to 95 percent of its taxable income for the year ended December 31, 1999 and the year ending December 31, 2000 and 90 percent of its taxable income for years ending on or after December 31, 2001); however, after $200.0 million in total principal paydowns, the Company will be allowed to pay dividends for any year in amounts up to 80 percent of funds from operations ("FFO"), as defined in the Amended Credit Agreement; (b) limitations on additional indebtedness, acquisitions of assets, liens, guarantees, investments, restricted payments, leases and affiliate transactions; (c) limitations on capital expenditures; (d) certain financial covenants, including requiring that the Company have (i) $50.0 million in cash and cash equivalents on hand at the Vencor Effective Date; (ii) no more than $1.1 billion of total indebtedness on the Vencor Effective Date; and (iii) at least $99.0 million of Projected Consolidated EBITDA, as defined in the Amended Credit Agreement, for the 270 day period beginning in the first month following the Vencor Effective Date. The Amended Credit Agreement does not contain any financial covenants that are applicable to the Company prior to the Vencor Effective Date, and provides, among other things, that no action taken by any 8
person in the Vencor bankruptcy case (other than by the Company and its affiliates) shall be deemed to constitute or result in a "Material Adverse Effect," as defined in the Amended Credit Agreement. In addition, the Amended Credit Agreement provides that if the Company is in compliance with its financial covenants and the covenant relating to releases in the Vencor bankruptcy on the Vencor Effective Date, no event or condition arising primarily from the Vencor plan of reorganization shall be deemed to have caused a "Material Adverse Effect," as defined in the Amended Credit Agreement, to have occurred. Under the terms of the Amended Credit Agreement, however, an event of default is deemed to have occurred if the Vencor Effective Date does not occur on or before December 31, 2000. Other Recent Developments Certain of the Company's other operators have experienced financial difficulties that have impacted their ability to perform their obligations under agreements with the Company. See "--Risk Factors--Effects of Bankruptcy Proceedings" and "Note 9--Commitments and Contingencies" to the Consolidated Financial Statements. The 1998 Spin Off In order to govern certain of the relationships between the Company and Vencor after the 1998 Spin Off and to provide mechanisms for an orderly transition, the Company and Vencor entered into various agreements at the time of the 1998 Spin Off, including the Master Leases (the "Spin Agreements"). In connection with the 1998 Spin Off, an Independent Committee of the Board of Directors of the Company was formed. The function of the Independent Committee was to review and approve all agreements and transactions between the Company and Vencor to ensure that such agreements and transactions represent arm's length negotiations including, without limitation, the negotiation, enforcement and renegotiations of any leases between the Company and Vencor. On November 17, 1998, the Company appointed a new director to the Independent Committee and the committee appointed him the Chairman of the Independent Committee. As of the date hereof, the Company and Vencor have no common directors, officers or, to the Company's knowledge, common ownership by stockholders owning greater than 10% of both companies. During 1999, the Company moved its offices from space it shared with Vencor and no longer requires administrative support from Vencor. However, as discussed below, Vencor assisted in the preparation of certain Commission filings and tax returns and continues to provide certain information in connection with related audits of tax matters for the Company and to defend certain litigation to which the Company is or may become a party. Certain material terms of the Master Leases and certain of the other Spin Agreements are described below. The reader is also strongly encouraged to review and consider the factors described in "--Recent Developments Regarding Vencor" and "--Risk Factors--Effects of Bankruptcy Proceedings." Master Lease Agreements In the 1998 Spin Off, the Company retained substantially all of its real property, buildings and other improvements (primarily long-term acute care hospitals and nursing facilities) and leased nearly all these facilities to Vencor under four Master Leases. A single nursing facility in Corydon, Indiana was leased by the Company to Vencor in August, 1998 under the terms of a fifth Master Lease. The Master Leases contain terms which govern the rights, duties and responsibilities of the Company and Vencor relative to each of the leased properties. The leased properties include land, buildings, structures, easements, improvements on the land and permanently affixed equipment, machinery and other fixtures relating to the operation of the facilities. The Company's ability to exercise certain rights and remedies under the Master Leases described below has been stayed as a result of Vencor's filing for protection under chapter 11 of the Bankruptcy Code. The Bankruptcy Code, however, generally provides that a landlord is entitled to receive rent during the pendency of a tenant's bankruptcy proceeding, subject to such tenant's rights to reject the lease and its other legal defenses and rights. Vencor has disputed that it is required to pay rent at the rate set forth in the Master Leases and in the Stipulation has reserved the right to challenge the rate set forth in the Master Leases in the event the Stipulation is terminated. The Stipulation discussed above provides for Vencor to pay $15.1 million per month in minimum 9
base rent under the Master Leases while the Stipulation is in effect. Various provisions of the Master Leases may ultimately be challenged in Vencor's chapter 11 bankruptcy case, and certain provisions regarding payment of rent have been modified by the Stipulation in anticipation of the contemplated restructuring. The Company expects that the terms of the Master Leases will be substantially amended and reflected in the terms of new or restated master lease agreements in connection with the consummation of Vencor's plan of reorganization according to the terms of the September 1999 Agreement in Principle. See "--Recent Developments Regarding Vencor." The Master Leases are structured as triple-net leases pursuant to which Vencor is required to pay all or substantially all insurance, taxes, utilities and maintenance related to the properties. The base annual contract rent was approximately $226.6 million and $222.2 million at December 31, 1999 and 1998, respectively. Base annual rent increases 2% per annum, effective May 1 of each year, provided Vencor achieves net patient service revenue for the applicable year in excess of 75% of net patient service revenue for the base year of 1997. The initial terms of these leases were for periods ranging from 10 to 15 years. Under the terms of each Master Lease, except as noted below, upon the occurrence of an event of default thereunder, the Company may, at its option, exercise the remedies under a Master Lease on all properties included within that particular Master Lease. The remedies which may be exercised under the Master Lease by the Company, at its option, include the following: (i) after not less than 10 days' notice to Vencor, terminate the Master Lease, repossess the leased property and relet the leased property to a third party and require that Vencor pay to the Company, as liquidated damages, the net present value of the rent for the balance of the term, discounted at the prime rate; (ii) without terminating the Master Lease, repossess the leased property and relet the leased property with Vencor remaining liable under the Master Lease for all obligations to be performed by Vencor thereunder, including the difference, if any, between the rent under the Master Lease and the rent payable as a result of the reletting of the leased property and (iii) any and all other rights and remedies available at law or in equity. The Master Leases require Vencor to cooperate with the Company in connection with license transfers and certain other regulatory matters arising from a lease termination. Each Master Lease provides that the remedies under such Master Lease may be exercised with respect only to the property that is the subject of the default upon the occurrence of any one of the following events of default: (i) the occurrence of a final non-appealable revocation of Vencor's license to operate a facility; (ii) the reduction in the number of licensed beds at a facility in excess of 10% or the revocation of certification of a facility for reimbursement under Medicare; or (iii) Vencor becomes subject to regulatory sanctions at a facility and fails to cure the regulatory sanctions within the applicable cure period. Upon the occurrence of the fifth such event of default under a Master Lease with respect to any one or more properties, the Master Lease permits the Company, at its option, to exercise the rights and remedies under the Master Lease on all properties included within that Master Lease. The occurrence of any one of the following events of default constitutes an event of default under all Master Leases, permitting the Company, at its option, to exercise the rights and remedies under all of the Master Leases simultaneously: (i) the occurrence of an event of default under the Agreement of Indemnity--Third Party Leases between the Company and Vencor, (ii) the liquidation or dissolution of Vencor, (iii) if Vencor files a petition of bankruptcy or a petition for reorganization or arrangement under the federal bankruptcy laws, and (iv) a petition is filed against Vencor under federal bankruptcy laws and the same is not dismissed within 90 days of its institution. Any notice of the occurrence of an event of default under a Master Lease which the Company sends to Vencor must be sent simultaneously to Vencor's leasehold mortgagee (the "Leasehold Mortgagee"). Prior to terminating a Master Lease for all or any part of the leased property covered thereunder, the Company must give the Leasehold Mortgagee prior written notice and the opportunity to cure any such event of default within the cure period for Leasehold Mortgagees set forth in the Master Leases. Following the expiration of such cure period, the Company may then terminate a Master Lease by giving at least 10 days prior written notice of such termination. 10
Vencor may, with the prior written approval of the Company, sell, assign or sublet its interest in all or any portion of the leased property under a Master Lease. The Company may not unreasonably withhold its approval to any such transfer provided (i) the assignee is creditworthy, (ii) the assignee has at least four years of operational experience, (iii) the assignee has a favorable business and operational reputation, (iv) the assignee assumes the Master Lease in writing, (v) the sublease is subject and subordinate to the terms of the Master Lease, and (vi) Vencor and any guarantor remains primarily liable under the Master Lease. Each Master Lease requires Vencor to maintain specified levels of liability, all risk property and workers' compensation insurance for the properties. Each Master Lease further provides that in the event a property is totally destroyed, or is substantially destroyed such that the damage renders the property unsuitable for its intended use, Vencor will have the option either to restore the property at its cost to its pre-destruction condition or offer to purchase the leased property (in either event all insurance proceeds, net of administrative and related costs, will be made available to Vencor). If the Company rejects the offer to purchase, Vencor will have the option either to restore the property or terminate the applicable Master Lease as it relates to the property. If the damage is such that the property is not rendered unsuitable for its intended use, or if it is not covered by insurance, each Master Lease requires Vencor to restore the property to its original condition. Pursuant to the Spin Agreements, all controversies, claims or disputes arising out of the Master Leases are subject to mediation between the parties for a reasonable period of time in an effort to settle such controversy, claim or dispute. If the parties are unable to reach resolution after such period of time, then the dispute is to be submitted to arbitration. Development Agreement Under the terms of the Development Agreement, Vencor, if it so desires, will complete the construction of certain development properties substantially in accordance with the existing plans and specifications for each such property. Upon completion of each such development property, the Company has the option to purchase the development property from Vencor at a purchase price equal to the amount of Vencor's actual costs in acquiring and developing such development property prior to the purchase date. If the Company purchases the development property, Vencor will lease the development property from the Company. The initial annual base rent under such a lease will be 10% of the actual costs incurred by Vencor in acquiring and developing the development property. The other terms of the lease for the development property will be substantially similar to those set forth in the Master Leases. During the year ended December 31, 1999, the Company did not acquire any facilities under this agreement. During the period from May 1, 1998 to December 31, 1998, the Company acquired one skilled nursing facility under the Development Agreement for $6.2 million and has entered into a separate Master Lease with Vencor with respect to such facility. The Development Agreement has a five year term, and the Company and Vencor each have the right to terminate the Development Agreement in the event of a change of control. The ability of the Company to purchase properties pursuant to the terms of the Development Agreement is restricted by the terms of the Amended Credit Agreement. Any such future purchases would likely require the consent of the "Required Lenders" under the Amended Credit Agreement, and there can be no assurance that such consent would be obtained. The Company expects the Development Agreement to be terminated in the event the Company, Vencor and Vencor's creditors agree on a plan of reorganization for Vencor and such plan is consummated. Participation Agreement Under the terms and conditions of the Participation Agreement, Vencor has a right of first offer to become the lessee of any real property acquired or developed by the Company which is to be operated as a hospital, nursing facility or other health care facility, provided that Vencor and the Company can negotiate a mutually satisfactory lease arrangement and provided that the property is not leased by the Company to the existing operator of such facility. 11
The Participation Agreement also provides, subject to certain terms, that the Company has a right of first offer to purchase or finance any health care related real property that Vencor determines to sell or mortgage to a third party, provided that Vencor and the Company can negotiate mutually satisfactory terms for such purchase or mortgage. The Participation Agreement has a three year term, and the Company and Vencor each have the right to terminate the Participation Agreement in the event of a change of control. The ability of the Company to purchase or finance properties pursuant to the terms of the Participation Agreement is restricted by the terms of the Company's Amended Credit Agreement. Any such future purchases or financings would likely require the consent of the "Required Lenders" under the Amended Credit Agreement, and there can be no assurance that such consent would be obtained. The Company expects the Participation Agreement to be terminated in the event the Company, Vencor and Vencor's creditors agree on a plan of reorganization for Vencor and such plan is consummated. Tax Allocation Agreement The Tax Allocation Agreement provides that Vencor will be liable for, and will hold the Company harmless from and against, (i) any taxes of Vencor and its then subsidiaries (the "Vencor Group") for periods after the 1998 Spin Off, (ii) any taxes of the Company and its then subsidiaries (the "Company Group") or the Vencor Group for periods prior to the 1998 Spin Off (other than taxes associated with the Spin Off) with respect to the portion of such taxes attributable to assets owned by the Vencor Group immediately after completion of the 1998 Spin Off and (iii) any taxes attributable to the 1998 Spin Off to the extent that Vencor derives certain tax benefits as a result of the payment of such taxes. Vencor will be entitled to any refund or credit in respect of taxes owed or paid by Vencor under (i), (ii) or (iii) above. Vencor's liability for taxes for purposes of the Tax Allocation Agreement will be measured by the Company's actual liability for taxes after applying certain tax benefits otherwise available to the Company other than tax benefits that the Company in good faith determines would actually offset tax liabilities of the Company in other taxable years or periods. Any right to a refund for purposes of the Tax Allocation Agreement will be measured by the actual refund or credit attributable to the adjustment without regard to offsetting tax attributes of the Company. The Company will be liable for, and will hold Vencor harmless against, any taxes imposed on the Company Group or the Vencor Group other than taxes for which the Vencor Group is liable as described in the above paragraph. The Company will be entitled to any refund or credit for taxes owed or paid by the Company as described in this paragraph. The Company's liability for taxes for purposes of the Tax Allocation Agreement will be measured by the Vencor Group's actual liability for taxes after applying certain tax benefits otherwise available to the Vencor Group other than tax benefits that the Vencor Group in good faith determines would actually offset tax liabilities of the Vencor Group in other taxable years or periods. Any right to a refund will be measured by the actual refund or credit attributable to the adjustment without regard to offsetting tax attributes of the Vencor Group. See "Note 7-- Income Taxes" to the Consolidated Financial Statements. On February 3, 2000 the Company received a refund (the "Refund") of approximately $26.6 million from the Internal Revenue Service representing the refund of income taxes paid by it from 1996 and 1997 and accrued interest thereon arising out of the Company's 1998 federal income tax return. Although the Company believes that it is entitled to the Refund pursuant to the terms of the Tax Allocation Agreement and on other legal grounds, the Internal Revenue Service may assert a right to all or some portion of the Refund. In addition, Vencor has asserted that it is entitled to the Refund pursuant to the terms of the Tax Allocation Agreement and on other legal grounds. The Company intends to vigorously defend its rights to the Refund. There can be no assurance as to how such controversy will be resolved, or as to whether or not the Company will ultimately retain all or a portion of the Refund. Accordingly, the amount has been classified with the other liabilities of the Company at December 31, 1999 in the Consolidated Financial Statements. See "Note 7-- Income Taxes" and "Note 8--Transactions with Vencor--The 1998 Spin Off" to the Consolidated Financial Statements. Vencor and the Company are also engaged in a dispute relating to the entitlement to certain federal, state and local tax refunds, including the Refund. In connection with Vencor's bankruptcy filing, the Company and Vencor are currently discussing the terms of a stipulation relating to such tax refunds. There can be no assurance as to how such dispute will be resolved. 12
Agreement of Indemnity--Third Party Leases In connection with the 1998 Spin Off, the Company assigned its former third party lease obligations (i.e., leases under which an unrelated third party is the landlord) as a tenant or as a guarantor of tenant obligations to Vencor (the "Third Party Leases"). The lessors of these properties may claim that the Company remains liable on the Third Party Leases assigned to Vencor. Under the terms of the Agreement of Indemnity--Third Party Leases, Vencor and its subsidiaries have agreed to indemnify and hold the Company harmless from and against all claims against the Company arising out of the Third Party Leases assigned by the Company to Vencor. Either prior to or following the 1998 Spin Off, the tenant's rights under a subset of the Third Party Leases were assigned or sublet to unrelated third parties (the "Subleased Third Party Leases"). If Vencor or such third party subtenants are unable to satisfy the obligations under any Third Party Lease assigned by the Company to Vencor, and if the lessors prevail in a claim against the Company under the Third Party Leases, then the Company may be liable for the payment and performance of the obligations under any such Third Party Lease. In that event, the Company may be entitled to receive revenues from those properties that would mitigate the costs incurred in connection with the satisfaction of such obligations. The Third Party Leases relating to nursing facilities, hospitals, offices and warehouses have remaining terms (excluding renewal periods) of 1 to 11 years and total aggregate remaining minimum rental payments under those leases amount to $114.0 million. The Third Party Leases relating to ground leases have remaining terms from 1 to 81 years and total aggregate remaining minimum rental payments under those leases amount to $33.6 million. The annual minimum rental payments under all of these leases for 2000 equals approximately $35.3 million. Pursuant to the Stipulation, Vencor has agreed to fulfill its obligations under the Agreement of Indemnity--Third Party Leases during the period in which the Stipulation is in effect, and, except for disputes with Health Care Property Investors discussed in "Note 9--Commitments and Contingencies" to the Consolidated Financial Statements, has to date performed its obligations. See "--Risk Factors--Dependence of the Company on Vencor," "Note 8--Transactions With Vencor--The 1998 Spin Off" and "Note 9--Commitments and Contingencies" to the Consolidated Financial Statements. Agreement of Indemnity--Third Party Contracts In connection with the 1998 Spin Off, the Company assigned its former third party guaranty agreements to Vencor (the "Third Party Guarantees"). The Company may remain liable on the Third Party Guarantees assigned to Vencor. Under the terms of the Agreement of Indemnity--Third Party Contracts, Vencor and its subsidiaries have agreed to indemnify and hold the Company harmless from and against all claims against the Company arising out of the Third Party Guarantees assigned by the Company to Vencor. If Vencor is unable to satisfy the obligations under any Third Party Guaranty assigned by the Company to Vencor, then the Company may be liable for the payment and performance of the obligations under any such agreement. The Third Party Guarantees were entered into in connection with certain acquisitions and financing transactions. The aggregate exposure under these guarantees is approximately $49.8 million. Of that amount, Atria Communities, Inc. ("Atria") also has directly guaranteed and agreed to indemnify and hold the Company harmless from and against all claims against the Company arising out of one of the Third Party Guarantees, in an aggregate principal amount of approximately $34.5 million. The Company is engaged in discussions with Atria in an effort to have the $34.5 million liability formally assumed by Atria and the Company released from the liability. There can be no assurance that the Company will be successful in its attempt to be released from this liability. See "--Risk Factors-- Dependence of the Company on Vencor" and "Note 8--Transactions With Vencor-- The 1998 Spin Off" to the Consolidated Financial Statements. Transition Services Agreement The Transition Services Agreement, which expired pursuant to its terms on December 31, 1998, provided that Vencor would provide the Company with transitional administrative and support services, including but not limited to finance and accounting, human resources, risk management, legal, and information systems support. The Company paid Vencor $1.6 million for the period from May 1, 1998 to December 31, 1998 for services provided under the Transition Services Agreement. 13
After December 31, 1998, Vencor continued to provide the Company with certain administrative and support services (primarily computer systems, telephone networks, mail delivery and other office services). Effective March 15, 1999, the Company moved to new office space and those services were no longer provided by Vencor. During 1999, Vencor assisted in the preparation of Commission filings and certain tax returns and other tax filings made on behalf of the Company for the period ending on or before December 31, 1998 and is continuing to assist the Company under the terms of the Tax Allocation Agreement and the other Spin Agreements by providing certain information in connection with the Company's fixed asset records, ongoing audits of tax matters and defending certain litigation to which the Company is or may become liable. Assumption of Certain Operating Liabilities and Litigation In connection with the 1998 Spin Off, Vencor agreed to assume and to indemnify the Company for any and all liabilities that may arise out of the ownership or operation of the health care operations either before or after the date of the 1998 Spin Off. The indemnification provided by Vencor also covers losses, including costs and expenses, which may arise from any future claims asserted against the Company based on these health care operations. In addition, at the time of the 1998 Spin Off, Vencor agreed to assume the defense, on behalf of the Company, of any claims that were pending at the time of the 1998 Spin Off, and which arose out of the ownership or operation of the health care operations. Vencor also agreed to defend, on behalf of the Company, any claims asserted after the 1998 Spin Off which arise out of the ownership and operation of the health care operations. There can be no assurance that Vencor will have sufficient assets, income and access to financing to enable it to satisfy its obligations incurred in connection with the 1998 Spin Off or that Vencor will continue to honor its obligations incurred in connection with the 1998 Spin Off. For example, Vencor has not agreed to assume the Spin Agreements and has reserved its right to seek to reject such agreements pursuant and subject to the applicable provisions of the Bankruptcy Code. If Vencor does not satisfy or otherwise honor the obligations under these arrangements, then the Company may be liable for the payment and performance of such obligations and may have to assume the defense of such claims. In addition, if Vencor's plan of reorganization is consummated, it is likely that the Company will be required to make payments to settle certain government claims which will not be subject to recovery from or indemnification by Vencor. See "--Risk Factors--Dependence of the Company on Vencor." Portfolio of Properties The following table reflects the Company's portfolio of properties as of December 31, 1999. <TABLE> <CAPTION> Type of Percentage Number of Number of Number of Facility of Portfolio (1) Facilities Beds/Units States (2) -------- ---------------- ---------- ---------- ---------- <S> <C> <C> <C> <C> Hospitals.................... 40.0% 45 4,171 21 Skilled Nursing Facilities... 59.7% 218 27,992 31 Personal Care Facilities..... 0.3% 8 136 1 ----- --- ------ Total...................... 100.0% 271 32,299 36 ===== === ====== === </TABLE> - -------- (1) Based on the percentage of gross rent earned before write-offs by the Company for the year ended December 31, 1999. (2) The Company has properties located in 36 states operated by eight different operators. Hospital Facilities The Company's hospitals generally are long-term acute care hospitals that serve medically complex, chronically ill patients. The operator of these hospitals has the capability to treat patients who suffer from multiple systemic failures or conditions such as neurological disorders, head injuries, brain stem and spinal cord trauma, cerebral vascular accidents, chemical brain injuries, central nervous system disorders, developmental anomalies and cardiopulmonary disorders. Chronic patients are often dependent on technology for continued life support, such as mechanical ventilators, total parenteral nutrition, respiration or cardiac monitors and dialysis 14
machines. While these patients suffer from conditions which require a high level of monitoring and specialized care, they may not necessitate the continued services of an intensive care unit. Due to their severe medical conditions, these patients generally are not clinically appropriate for admission to a nursing facility or rehabilitation hospital. Nursing Facilities The Company's nursing facilities generally are skilled nursing facilities. In addition to the customary services provided by skilled nursing facilities, the operators of the Company's nursing facilities typically provide rehabilitation services, including physical, occupational and speech therapies. Personal Care Facilities The Company's personal care facilities serve persons with acquired or traumatic brain injury. The operator of the personal care facilities provides services including supported living services, neurorehabilitation, neurobehavioral management and vocational programs. Competition The Company competes for real property investments with health care providers, other health care related REITs, real estate partnerships, banks, insurance companies and other investors. Many of the Company's competitors are significantly larger and have greater financial resources and lower cost of capital than the Company. When the Company is permitted under the terms of the Amended Credit Facility to reinstate its original business strategy, the Company's ability to compete successfully for real property investments will be determined by numerous factors, including the ability of the Company to identify suitable acquisition targets, the ability of the Company to negotiate acceptable terms for any such acquisition, and the availability and cost of capital. See "Risk Factors--Implementation of Original Business Strategy" and "Note 4--Borrowing Arrangements" to the Consolidated Financial Statements. The operators of the Company's properties compete on a local and regional basis with other health care operators. The ability of the Company's operators to compete successfully for patients at the Company's facilities depends upon several factors, including the quality of care at the facility, the operational reputation of the operator, physician referral patterns, physical appearance of the facilities, other competitive systems of health care delivery within the community, population and demographics, and the financial condition of the operator. Private, federal and state reimbursement programs and the effect of other laws and regulations also may have a significant effect on the Company's operators to compete successfully for patients for the properties. Environmental Regulation Under various federal, state and local environmental laws, ordinances and regulations, a current or previous owner or operator of real property from which there is a release or threatened release of hazardous or toxic substances or an entity that arranges for the disposal or treatment of hazardous or toxic substances at a disposal site may be held jointly and severally liable for the cost of removal or remediation of certain hazardous or toxic substances, that could be located on, in or under such property or other affected property. Such laws and regulations often impose liability whether or not the owner, operator or otherwise responsible party, knew of, or caused the presence of the hazardous or toxic substances. The costs of any required remediation or removal of these substances could be substantial, and the liability of a responsible party as to any property is generally not limited under such laws and regulations and could exceed the property's value and the aggregate assets of the liable party. The presence of these substances or failure to remediate such substances properly also may adversely affect the owner's ability to sell or rent the property, or to borrow using the property as collateral. In connection with the ownership and leasing of the Company's properties, the Company could be liable for these costs as well as certain other costs, including governmental fines and injuries to person or properties or natural resources. In addition, owners and operators of real property are liable for the costs of complying with environmental, health, and safety laws, ordinances, and regulations and can be subjected to penalties for failure to comply. Such 15
ongoing compliance costs and penalties for non-compliance can be substantial. Changes to existing or the adoption of new environmental, health, and safety laws, ordinances, and regulations could substantially increase an owner or operator's environmental, health, and safety compliance costs and/or associated liabilities. Environmental, health, and safety laws, ordinances, and regulations potentially affecting the Company address a wide variety of topics, including, but not limited to, asbestos, polychlorinated biphenyls ("PCBs"), fuel oil management, wastewater discharges, air emissions, radioactive materials, medical wastes, and hazardous wastes. Under the Master Leases, Vencor has agreed to indemnify the Company against any environmental claims (including penalties and clean up costs) resulting from any condition arising in, on or under, or relating to, the leased properties at any time on or after the commencement date of the applicable Master Lease. Vencor also has agreed to indemnify the Company against any environmental claim (including penalties and clean up costs) resulting from any condition permitted to deteriorate, on or after the commencement date of the applicable Master Lease (including as a result of migration from adjacent properties not owned or operated by the Company or any of its affiliates other than Vencor and its direct affiliates). There can be no assurance that Vencor will have the financial capability to satisfy any such environmental claims. See "--Recent Developments Regarding Vencor" and "--Risk Factors--Dependence of the Company on Vencor." If Vencor is unable to satisfy such claims the Company will be required to satisfy the claims. The Company has agreed to indemnify Vencor against any environmental claims (including penalties and clean-up costs) resulting from any condition arising on or under, or relating to, the leased properties at any time before the commencement date of the Master Leases. The Company did not have to make any material capital expenditures in 1999 and does not expect that it will have to make any material capital expenditures in connection with such environmental, health, and safety laws, ordinances, and regulations during 2000. Governmental Regulation General The operators of the Company's properties derive a substantial portion of their revenues from third party payors, including the Medicare and Medicaid programs. Medicare is a federal program that provides certain hospital and medical insurance benefits to persons age 65 and over and certain disabled persons. Medicaid is a medical assistance program jointly funded by federal and state governments and administered by each state pursuant to which benefits are available to certain indigent patients. Within the Medicare and Medicaid statutory framework, there are substantial areas subject to administrative rulings, interpretations and discretion that may affect payments made under Medicare and Medicaid. The amounts of program payments received by the operators can be changed by legislative or regulatory actions and by determinations by agents for the programs. The Balanced Budget Act of 1997 (the "Budget Act") is intended to reduce the increase in Medicare payments by $115 billion and reduce the increase in Medicaid payments by $13 billion between 1998 through 2002 and made extensive changes in the Medicare and Medicaid programs. See "--Recent Developments Regarding Government Regulation" below. In addition, private payors, including managed care payors, increasingly are demanding discounted fee structures and the assumption by health care providers of all or a portion of the financial risk. Efforts to impose greater discounts and more stringent cost controls upon operators by private payors are expected to continue. Further, on March 25, 1999, President Clinton signed legislation preventing nursing facility operators that decide to withdraw from the Medicaid program from evicting or transferring patients who are residents as of the effective date of withdrawal, and who rely on Medicaid to cover their long-term care expenses. There can be no assurance that adequate reimbursement levels will continue to be available for services to be provided by the operators of the Company's properties, which currently are being reimbursed by Medicare, Medicaid or private payors. Significant limits on the scope of services reimbursed and on reimbursement rates and fees could have a material adverse effect on these operators' liquidity, financial condition and results of operations, which could affect adversely their ability to make rental payments to the Company. The operators of the Company's properties are subject to extensive federal, state and local laws and regulations including, but not limited to, laws and regulations relating to licensure, conduct of operations, 16
ownership of facilities, addition of facilities, services, prices for services and billing for services. These laws authorize periodic inspections and investigations, and identified deficiencies that, if not corrected, can result in sanctions that include loss of licensure to operate and loss of rights to participate in the Medicare and Medicaid programs. Regulatory agencies have substantial powers to affect the actions of operators of the Company's properties if the agencies believe that there is an imminent threat to patient welfare, and in some states these powers can include assumption of interim control over facilities through receiverships. Federal anti-kickback laws codified under Section 1128B(b) of the Social Security Act (the "Anti-kickback Laws") prohibit certain business practices and relationships that might affect the provision and cost of health care services reimbursable under Medicare and Medicaid, including the payment or receipt of remuneration for the referral of patients whose care will be paid by Medicare or other governmental programs. Sanctions for violating the Anti-kickback Laws include criminal penalties and civil sanctions, including fines and possible exclusion from government programs such as the Medicare and Medicaid programs. In the ordinary course of its business, the operators of the Company's properties are subject regularly to inquiries, investigations and audits by federal and state agencies that oversee these laws and regulations. Pursuant to the Medicare and Medicaid Patient and Program Protection Act of 1987, the Department of Health and Human Services ("HHS") periodically has issued regulations that describe some of the conduct and business relationships permissible under the Anti-kickback Laws ("Safe Harbors"). The fact that a given business arrangement does not fall within a Safe Harbor does not render the arrangement per se illegal. Business arrangements of health care service providers that fail to satisfy the applicable Safe Harbors criteria, however, risk increased scrutiny and possible sanctions by enforcement authorities. The operators of the Company's properties also are subject to Sections 1877 and 1903(s) of the Social Security Act, which restrict referrals by physicians of Medicare and other government-program patients to providers of a broad range of designated health services with which they have ownership interests or certain other financial arrangements. Many states have adopted or are considering similar legislative proposals, some of which extend beyond the Medicaid program to prohibit the payment or receipt of remuneration for the referral of patients and physician self-referrals regardless of the source of the payment for the care. These laws and regulations are extremely complex, and little judicial or regulatory interpretation exists. A violation of such laws and regulations could have a material adverse effect on these operators' liquidity, financial condition and results of operations which could affect adversely their ability to make rental payments to the Company. Government investigations and enforcement of health care laws has increased dramatically over the past several years and is expected to continue. The Health Insurance Portability and Accountability Act of 1996 (Pub. L. 104-191) ("HIPAA"), which became effective January 1, 1997, greatly expanded the definition of health care fraud and related offenses and broadened the scope to include private health care plans in addition to government payors. HIPAA also greatly increased funding for the Department of Justice, Federal Bureau of Investigation and the Office of the Inspector General to audit, investigate and prosecute suspected health care fraud. Private enforcement of health care fraud also has increased due in large part to amendments to the civil False Claims Act in 1986 that were designed to encourage private individuals to sue on behalf of the government. These whistleblower suits by private individuals, known as qui tam relators, may be filed by almost anyone, including present and former patients and nurses and other employees. These actions could have a material adverse effect on these operators' liquidity, financial condition and results of operations which could affect adversely their ability to make rental payments to the Company. The Budget Act also provides a number of additional anti-fraud and abuse provisions. The Budget Act contains new civil monetary penalties for an operator's violation of the Anti-kickback Laws and imposes an affirmative duty on operators to ensure that they do not employ or contract with persons excluded from the Medicare and other government programs. The Budget Act also provides a minimum ten-year period for exclusion from participation in federal health care programs for operators convicted of a prior health care offense. Some states require state approval for development and expansion of health care facilities and services, including findings of need for additional or expanded health care facilities or services. A certificate of need ("CON"), which is issued by governmental agencies with jurisdiction over health care facilities, is at times 17
required for expansion of existing facilities, construction of new facilities, addition of beds, acquisition of major items of equipment or introduction of new services. The CON rules and regulations may restrict an operator's ability to expand the Company's properties in certain circumstances. In the event that any operator of the Company's properties fails to make rental payments to the Company or to comply with the applicable health care regulations, and, in either case, such operators or their lenders fail to cure the default prior to the expiration of the applicable cure period, the ability of the Company to evict that operator and substitute another operator or operators may be materially delayed or limited by various state licensing, receivership, CON or other laws, as well as by Medicare and Medicaid change- of-ownership rules. Such delays and limitations could have a material adverse effect on the Company's ability to collect rent, to obtain possession of leased properties, or otherwise to exercise remedies for tenant default. In addition, the Company may also incur substantial additional expenses in connection with any such licensing, receivership or change-of-ownership proceedings. Long-Term Acute Care Hospitals All but two of the Company's hospitals are operated as long-term acute care hospitals. In order to receive Medicare and Medicaid reimbursement, each hospital must meet the applicable conditions of participation set forth by HHS relating to the type of hospital, its equipment, personnel and standard of medical care, as well as comply with state and local laws and regulations. Hospitals undergo periodic on-site certification surveys, which generally are limited if the hospital is accredited by the Joint Commission on Accreditation of Healthcare Organizations ("JCAHO"). A loss of certification could adversely affect a hospital's ability to receive payments from Medicare and Medicaid programs, which could in turn adversely impact Vencor's ability to make rental payments under the Master Leases. Hospitals that are certified by Medicare as long-term acute care hospitals are currently excluded from the prospective payment system that applies to acute care hospitals ("PPS"). A long-term acute care hospital has an average length of stay greater than 25 days. Inpatient operating costs for long-term acute care hospitals are reimbursed under the cost-based reimbursement system, subject to a computed target rate per discharge for inpatient operating costs established by the Tax Equity and Fiscal Responsibility Act of 1982 ("TEFRA"). Medicare and Medicaid reimbursements generally are determined from annual cost reports filed by Vencor and other operators which are subject to audit by the respective agency administering the program. Under such programs of cost-based reimbursement, costs which will be accepted for reimbursement are limited by statutes, regulations and program policies relating to numerous factors, including necessity, reasonableness, related-party principles and relatedness to patient care. Nursing Facilities The operators of the Company's nursing facilities generally are licensed on an annual or bi-annual basis and certified annually for participation in the Medicare and Medicaid programs through various regulatory agencies which determine compliance with federal, state and local laws. These legal requirements relate to the quality of the nursing care provided, qualifications of the administrative personnel and nursing staff, the adequacy of the physical plant and equipment and continuing compliance with the laws and regulations governing the operation of nursing facilities. The Budget Act also established a prospective payment system for Medicare skilled nursing facilities ("SNF") for cost reporting periods beginning on or after July 1, 1998 ("SNF PPS"). During a SNF's first three cost reporting periods under SNF PPS, the per diem rates are based on a blend of facility- specific costs and federal costs. Thereafter, the per diem rates will be based solely on federal costs. (The Medicare, Medicaid, and SCHIP Balanced Budget Refinement Act of 1999 (the "Refinement Act") permits an operator of a SNF to waive the three year transition period for a SNF and have that SNF immediately transitioned to the federal per diem rate.) The rates for such services were first published in the Federal Register on May 12, 1998, after the consummation of the 1998 Spin Off. The payments received under the new SNF PPS cover all services for Medicare patients, including all ancillary services, such as respiratory therapy, physical therapy, occupational therapy, speech therapy and certain covered drugs. Although there has been some payment relief under the 18
Refinement Act, the new SNF PPS has resulted, and will likely continue to result in, reduced reimbursement for the operators of the Company's properties relative to the period prior to the effective date of the SNF PPS, thereby adversely impacting the operators' ability to satisfy their obligations, including payment of rent, under the leases with the Company. See "--Recent Developments Regarding Government Regulation" below. Health Care Reform Health care is one of the largest industries in the United States and continues to attract much legislative interest and public attention. The Budget Act, enacted in August 1997, contained extensive changes to the Medicare and Medicaid programs intended to reduce the projected amount of increase in payments under those programs by $115 billion and $13 billion, respectively, between 1998 and 2002. Under the Budget Act, annual growth rates for Medicare will be reduced from over 10% to approximately 7.5% for the period between 1998 and 2002 based on specific program baseline projections from 1993 to 1997. Virtually all spending reductions have come from health care operators and changes in program components. For certain health care providers, including hospitals, home health agencies, SNFs and hospices, implementation of the Budget Act has resulted in more drastic reimbursement reductions than had been anticipated. In an effort to provide some relief for those health care providers, Congress enacted the Refinement Act which provides for an additional $16.0 billion in funding over 5 years. The Budget Act reduced payments made to the hospitals operated by Vencor and others by reducing incentive payments pursuant to TEFRA, allowable costs for capital expenditures and bad debts, and payments for services to patients transferred from a PPS hospital. The reductions in allowable costs for capital expenditures became effective October 1, 1997. The reductions in the TEFRA incentive payments and allowable costs for bad debts became effective between May 1, 1998 and September 1, 1998 with respect to the Company's hospitals. The reductions for payments for services to patients transferred from a PPS hospital became effective October 1, 1998. The Budget Act also established SNF PPS for cost reporting periods beginning on or after July 1, 1998. During a SNF's first three cost reporting periods under SNF PPS, the per diem rates will be based on a blend of facility-specific costs and federal costs. Thereafter, the per diem rates will be based solely on federal rates. (The Refinement Act permits an operator to waive the three year transition of a SNF to the federal per diem rate.) The rates for such services were published by the Health Care Financing Administration ("HCFA") in the Federal Register on May 12, 1998. The payments received under PPS cover all services for Medicare patients in a Part A stay, including all ancillary services, such as respiratory therapy, physical therapy, occupational therapy, speech therapy and certain covered drugs. The payments that Vencor and others are receiving under SNF PPS are substantially less than before enactment of the Budget Act, even with increases under the Refinement Act. Vencor has been subject to SNF PPS since July 1, 1998. The Budget Act established the National Bipartisan Commission on the Future of Medicare, which held its first meeting on March 6, 1998, and charged it with reviewing and analyzing financial conditions of Medicare, identifying problems that threaten the financial integrity of the Medicare Trust Fund, and making recommendations to address the program's long-term financing challenges. The Commission recently concluded its deliberations without making an official recommendation, but proposals considered by the Commission remain under independent consideration by the Congress. The Budget Act also afforded states more flexibility in administering their Medicaid plans, including the ability to shift most Medicaid enrollees into managed care plans without first obtaining a federal waiver. Accordingly, the Medicare and Medicaid programs, including payment levels and methods, are in a state of change and are less predictable than before enactment of the Budget Act. There can be no assurance that the Budget Act, the Refinement Act, future health care legislation, or other changes in the administration or interpretation of governmental health care programs will not have a material adverse effect on the liquidity, financial condition or results of operations of the Company's operators which could have a material adverse effect on their ability to make rental payments to the Company. 19
Recent Developments Regarding Government Regulation In response to widespread health care industry concern about the effects of the Budget Act, Congress passed the Refinement Act, which the President signed into law on November 29, 1999. The Refinement Act does not enact any fundamental changes in the Medicare system, but rather reverses or delays some of the reductions in Medicare payment increases mandated by the Budget Act. It is estimated that in the next five fiscal years this "givebacks" law will return to health care providers about $16.0 billion of the $115 billion the Budget Act was expected to cut from increases to the Medicare program. Specific providers receiving relief under the Refinement Act include skilled nursing facilities, which will receive temporary (effective April 1, 2000 to October 1, 2000) per diem payment increases for certain high cost patients, and outpatient rehabilitation therapy providers, which will no longer be subjected to a $1,500 annual cap on the amount of physical, occupational and speech therapy provided to a patient. The Refinement Act requires HHS to recommend a new payment policy for outpatient therapy by January 2001. The Refinement Act also specifies that the temporary per diem payment increase will be replaced by specific administrative rate increases. If such administrative rate increases are not final by October 1, 2000, the temporary per diem increases will remain in place. In addition, PPS rates are subject to a 4% inflationary adjustment effective October 1, 2000. Federal Income Tax Considerations The Company intends to make an election to be taxed as a REIT under the Internal Revenue Code of 1986, as amended (the "Code"), commencing with its taxable year that ended December 31, 1999. The Company believes it has been organized and has operated in such a manner as to enable it to qualify as a REIT commencing with that taxable year, subject to its ability to meet the minimum distribution requirements as discussed below. The Company intends to continue to operate in such a manner as to enable it to so qualify. The Company's actual qualification and taxation as a REIT, however, will depend upon its ability to meet on a continuing basis, through actual annual operating results, distribution levels, and stock ownership, the various qualification tests imposed under the Code. These tests are discussed below. No assurance can be given that the actual results of the Company's operations for any particular taxable year will satisfy such requirements. Although the Company is currently expected to qualify as a REIT for the year ended December 31, 1999, it is possible that economic, market, legal, tax or other considerations may cause the Company to fail or not elect to qualify as a REIT. For a discussion of the tax consequences of failing to qualify as a REIT, see "--Failure to Qualify," below. The discussion of "Federal Income Tax Considerations" set forth herein is not exhaustive of all possible tax considerations and is not tax advice. Moreover this summary does not deal with all tax aspects that might be relevant to a particular stockholder in light of such stockholder's circumstances, nor does it deal with particular types of stockholders that are subject to special treatment under the Code, such as insurance companies, financial institutions and broker-dealers. The Code provisions governing the federal income tax treatment of REITs are highly technical and complex, and this summary is qualified in its entirety by the applicable Code provisions, rules and Treasury regulations promulgated thereunder, and administrative and judicial interpretations thereof. The following discussion is based on current law, which could be changed at any time, possibly retroactively. Federal Income Taxation of the Company As noted above, the Company intends to make an election to be taxed as a REIT commencing with its taxable year that ended December 31, 1999 and to distribute 95% of its 1999 taxable income as a dividend on or prior to September 15, 2000. See "--Annual Distribution Requirements." With respect to that taxable year and subsequent taxable years, if the Company qualifies for taxation as a REIT, it generally will not be subject to federal corporate income tax on net income that it currently distributes to stockholders. This treatment substantially eliminates the "double taxation" (i.e., taxation at both the corporate and stockholder levels) that generally results from investment in a corporation. Notwithstanding its REIT election, however, the Company will be subject to federal income tax in the following circumstances. First, the Company will be taxed at regular corporate rates on any undistributed taxable income, including undistributed net capital gains. Second, under certain circumstances, the Company may be subject to the "alternative minimum tax" on its undistributed items 20
of tax preference. Third, if the Company has (i) net income from the sale or other disposition of "foreclosure property" (which is, in general, property acquired by foreclosure or otherwise on default of a loan secured by the property or property repossessed by the Company upon dispossessing a tenant after a lease default) that is held primarily for sale to customers in the ordinary course of business or (ii) other non-qualifying income from foreclosure property, it will be subject to tax at the highest corporate rate on such income. Fourth, if the Company has net income from "prohibited transactions" (which are, in general, certain sales or other dispositions of property (other than foreclosure property) held primarily for sale to customers in the ordinary course of business), such income will be subject to a 100% tax. Fifth, if the Company should fail to satisfy the 75% gross income test or the 95% gross income test (as discussed below), and has nonetheless maintained its qualification as a REIT because certain other requirements have been met, it will be subject to a 100% tax on the product of (a) the gross income attributable to the greater of the amount by which the Company fails the 75% or 95% gross income test, and (b) a fraction intended to reflect the Company's profitability. Sixth, if the Company should fail to distribute during each calendar year at least the sum of (i) 85% of its REIT ordinary income for such year, (ii) 95% of its REIT capital gain net income for such year (other than retained long-term capital gain the Company elects to treat as having been distributed to stockholders), and (iii) any undistributed taxable income from prior years, the Company would be subject to a non- deductible 4% excise tax on the excess of such required distribution over the amounts actually distributed. Seventh, if the Company should receive rents from a tenant deemed not to be fair market value rents, or if the Company values its assets incorrectly, the Company may be liable for valuation penalties. Finally, if the Company acquires any asset from a C corporation (i.e., a corporation generally subject to full corporate level tax) in a transaction in which the basis of the asset in the Company's hands is determined by reference to the basis of the asset (or any other asset) in the hands of the C corporation, and the Company recognizes gain on the disposition of such asset during the 10-year period (the "Recognition Period") beginning on the date on which such asset was acquired by the Company, then, to the extent of such asset's "Built-in Gain" (i.e., the excess of the fair market value of such property at the time of acquisition by the Company over the adjusted basis of such asset at such time), such gain will be subject to tax at the highest regular corporate rate applicable (as provided in regulations that have been announced but not yet promulgated (the "Built-in Gain Rules")). The Company owns appreciated assets that it held on January 1, 1999, the effective date of its anticipated REIT election. These assets are subject to the Built-in Gain Rules discussed above because the Company was a taxable C corporation prior to January 1, 1999. If the Company recognizes taxable gain upon the disposition of any of these assets within the ten-year Recognition Period, the Company generally will be subject to regular corporate income tax on that gain to the extent of the Built-in Gain in that asset as of January 1, 1999. The total amount of gain on which the Company can be taxed under the Built-in Gain Rules is limited to its net built-in gain at the time it became a REIT, i.e., the excess of the aggregate fair market value of its assets at the time it became a REIT over the adjusted tax bases of those assets at that time. The amount of any such capital gain realized would be limited to the extent of any available capital loss carryforwards. In connection with the sale of any assets, a portion of such gain could be treated as ordinary income instead of capital gain and be subject to taxation and/or the minimum REIT distribution requirements. See "--Annual Distribution Requirements" below. Requirements for Qualification To qualify as a REIT, the Company must elect to be so treated and must meet the requirements, discussed below, relating to the Company's organization, sources of income, nature of assets and distributions of income to stockholders. Organizational Requirements The Code defines a REIT as a corporation, trust or association (i) that is managed by one or more directors or trustees; (ii) the beneficial ownership of which is evidenced by transferable shares or by transferable certificates of beneficial interest; (iii) that would be taxable as a domestic corporation, but for Sections 856 through 859 of the Code; (iv) that is neither a financial institution nor an insurance company subject to certain 21
provisions of the Code; (v) the beneficial ownership of which is held by 100 or more persons during at least 335 days of a taxable year of 12 months, or during a proportionate part of a shorter taxable year (the "100 Shareholder Rule"); (vi) not more than 50% in value of the outstanding stock of which is owned, directly or indirectly, by five or fewer individuals (as defined in the Code to include certain entities) during the last half of each taxable year (the "5/50 Rule"); (vii) that makes an election to be a REIT (or has made such election for a previous taxable year) and satisfies all relevant filing and other administrative requirements established by the IRS that must be met in order to elect and to maintain REIT status; (viii) that uses a calendar year for federal income tax purposes; and (ix) that meets certain other tests, described below, regarding the nature of its income and assets. The 5/50 Rule and the 100 Shareholder Rule do not apply to the first taxable year for which an election is made to be taxed as a REIT; thus, these rules will not apply to the Company until the year 2000 (assuming as is anticipated that 1999 will be the Company's first taxable year as a REIT). As permitted by its certificate of incorporation, the Company has granted waivers of such ownership limitations to certain stockholders. Such waivers, in general, restrict such stockholders to owning less than 15% of the Common Stock of the Company, and terminate in circumstances where the stockholders' ownership of in excess of 9.9% of the Common Stock would jeopardize the Company's ability to elect (or maintain) REIT status. For purposes of the 5/50 Rule, an unemployment compensation benefits plan, a private foundation or a portion of a trust permanently set aside or used exclusively for charitable purposes generally is considered an individual. A trust that is a qualified trust under Section 401(a) of the Code, however, generally is not considered an individual and the beneficiaries of such trust are treated as holding shares of a REIT in proportion to their actuarial interests in such trust for purposes of the 5/50 Rule. A REIT will be treated as having satisfied the 5/50 Rule if it complies with certain regulations for ascertaining the ownership of its stock and if it did not know (or after the exercise of reasonable diligence would not have known) that its stock was sufficiently closely held to cause it to violate the 5/50 Rule. See "--Annual Record Keeping Requirements" below. In order to prevent a concentration of ownership of the Company's stock that would cause the Company to fail the 5/50 Rule or the 100 Shareholder Rule, the Company amended its Certificate of Incorporation on April 30, 1998 to provide that no holder (with certain exceptions) is permitted to own, either actually or constructively under the applicable attribution rules of the Code, more than 9.0% of the Common Stock or 9.9% of any class of preferred stock issued by the Company. Certain persons who owned stock in the Company in excess of the foregoing limits on April 30, 1998 (the date that the Certificate of Incorporation was amended) are not subject to the general ownership limits applicable to other stockholders; rather, they generally are permitted to own up to the same percentage of the Company's outstanding stock that they owned on April 30, 1998. No holder, however, is permitted to own, either actually or constructively under the applicable attribution rules of the Code, any shares of any class of the Company's stock if such ownership would cause more than 50% in value of the Company's outstanding stock to be owned by five or fewer individuals or would result in the Company's stock being beneficially owned by fewer than 100 persons (determined without reference to any rule of attribution). To qualify as a REIT, a corporation may not have (as of the end of the taxable year) any earnings and profits that were accumulated in periods before it elected REIT status. The Company believes that at December 31, 1999 it did not have any accumulated earnings and profits that are attributable to periods during which the Company was not a REIT, although the IRS would be entitled to challenge that determination. For taxable years beginning after 2000, a distribution made to meet the requirement that a REIT may not have non-REIT earnings and profits will be treated, on a first-in, first-out basis, as made from earnings and profits which, if not distributed, would result in a failure to meet such requirement. Thus, such earnings and profits are deemed distributed first from earnings and profits that would cause such a failure, starting with the earliest Company year for which such failure would occur. Section 856(i) of the Code provides that a corporation that is a "qualified REIT subsidiary" will not be treated as a separate corporation for federal income tax purposes, and all assets, liabilities, and items of income, deduction and credit of a qualified REIT subsidiary will be treated as assets, liabilities, and items of income, 22
deduction, and credit of the REIT. A "qualified subsidiary" is defined as any wholly owned corporate subsidiary of a REIT. The Company does not currently have any qualified REIT subsidiaries. Pursuant to Treasury Regulations relating to entity classification (the "Check-the-Box Regulations"), an unincorporated entity that has a single owner is disregarded as an entity separate from its owner for federal income tax purposes. The Company directly owns a 99% general partnership interest in the Operating Partnership and indirectly owns the remaining 1% limited partnership interest in the Operating Partnership through a wholly owned limited liability company. Under the Check-the-Box Regulations, the limited liability company, and therefore the Operating Partnership, is disregarded as an entity separate from the Company for federal income tax purposes. In the case of a REIT that is a partner in a partnership, Treasury regulations provide that the REIT will be deemed to own its proportionate share of the assets of the partnership and will be deemed to be entitled to the income of the partnership attributable to such share. In addition, the character of the assets and gross income of the partnership will retain the same character in the hands of the REIT for purposes of the income and asset tests described below. If and when the Operating Partnership admits a partner other than the Company, a qualified REIT subsidiary of the Company, or a entity that is disregarded under the Check-the-Box Regulations as an entity separate from the Company, the Company's proportionate share of the assets and gross income of the Operating Partnership will be treated as the assets and gross income of the Company for purposes of applying the requirements described herein. Income Tests To qualify as a REIT, the Company must satisfy certain annual gross income requirements. First, at least 75% of the Company's gross income (excluding gross income from prohibited transactions) for each taxable year must consist of defined types of income derived directly or indirectly from investments relating to real property or mortgages on real property (including "rents from real property" (defined below) and, in certain circumstances, interest) on certain types of temporary investment income. Second, at least 95% of the Company's gross income (excluding gross income from prohibited transactions) for each taxable year must be derived from such real property or temporary investments, dividends, interest and gain from the sale or disposition of stock or securities, or from any combination of the foregoing. Substantially all of the Company's gross income is derived from leasing its properties to Vencor under the Master Leases. Rents received or deemed received by the Company under its leases (including the Master Leases) will qualify as "rents from real property" in satisfying the gross income requirements described above only if the Company's leases are respected as "true" leases for federal income tax purposes and are not treated as service contracts, joint ventures, or some other type of arrangement. The determination of whether the Company's leases are true leases depends on an analysis of all the surrounding facts and circumstances. In making such a determination, courts have considered a variety of factors, including the following: (i) the intent of the parties, (ii) the form of the agreement, (iii) the degree of control over the property that is retained by the property owner (e.g., whether the lessee has substantial control over the operation of the property or whether the lessee was required to use its best efforts to perform its obligations under the agreement), and (iv) the extent to which the property owner retains the risk of loss with respect to the property (e.g., whether the lessee bears the risk of increases in operating expenses or the risk of damage to the property) or the potential for economic gains (e.g., appreciation) with respect to the property. Based upon advice of counsel at the time the Master Leases were negotiated, the Company believes that its leases should be treated as "true" leases for federal income tax purposes. Investors should be aware, however, that there are no controlling Treasury regulations, published rulings, or judicial decisions involving leases with terms substantially the same as the Company's leases that discuss whether such leases constitute true leases for federal income tax purposes. If the leases are recharacterized as service contracts or partnership agreements, rather than true leases, part or all of the payments that the Company receives from its tenants would not be considered rent or would not otherwise satisfy the various requirements for qualification as "rents from real property." In that case, the Company likely would not be able to satisfy either the 75% or the 95% gross income tests, and, as a result, would lose its REIT status. 23
Assuming that the Company's leases are "true" leases for tax purposes, rents received by the Company will qualify as "rents from real property" for purposes of the REIT gross income tests only if several additional conditions are satisfied. First, the amount of rent generally must not be based in whole or in part on the income or profits of any person. However, an amount received or accrued generally will not be excluded from the term "rents from real property" solely by reason of being based on a fixed percentage or percentages of receipts or sales. Second, amounts received from a tenant will not qualify as "rents from real property" if the Company, or an owner of 10% or more of the Company, directly or constructively is deemed to own 10% or more of the ownership interests in the tenant (a "Related Party Tenant"). Third, if rent attributable to personal property, leased in connection with a lease of real property, is greater than 15% of the total rent received under the lease (based on the fair market values after 2000), then the portion of rent attributable to such personal property will not qualify as "rents from real property." Finally, for rents received to qualify as "rents from real property," the Company generally must not operate or manage the property or furnish or render services to the tenants of such property, other than through an "independent contractor" who is adequately compensated and from whom the Company derives no income. The "independent contractor" requirement, however, does not apply to the extent that the services provided by the Company are "usually or customarily rendered in connection with the rental of space for occupancy only," which are services of a type that a tax-exempt organization can provide to its tenants without causing its rental income to be unrelated business taxable income ("UBTI"). In addition, the "independent contractor" requirement does not apply to noncustomary services provided by the Company, the annual value of which does not exceed 1% of the gross income derived from the property with respect to which the services are provided (the "1% de minimis exception"). For this purpose, such services may not be valued at less than 150% of the Company's direct cost of providing the services. An "independent contractor" is defined as an entity that does not own (directly or indirectly) more than 35% of the Company's stock or an entity not more than 35% owned (directly or indirectly) by persons who own more than 35% of the Company's stock. If any class of stock of the Company or the person being tested as an independent contractor is regularly traded on an established securities market, only persons who directly or indirectly own 5% or more of such class of stock shall be counted in determining whether the 35% ownership limitations have been exceeded. The Company has not, and does not anticipate that it will in the future, (i) charge rent that is based in whole or in part on the income or profits of any person (except by reason of being based on a fixed percentage or percentages of receipts or sales consistent with the rule described above), (ii) derive rent attributable to personal property leased in connection with real property that exceeds 15% of the total rents, (iii) derive rent attributable to a Related Party Tenant, or (iv) provide any noncustomary services to tenants other than through qualifying independent contractors, except as permitted by the 1% de minimis exception or to the extent that the amount of resulting nonqualifying income would not cause the Company to fail to satisfy the 95% and 75% gross income tests. If rents received by the Company from Vencor under the Master Leases do not represent fair market value rentals at the time of execution of the Master Leases and the IRS determines that the Company and Vencor were under common control at that time, the IRS may reallocate income between the Company and Vencor. The reallocation could cause the Company or Vencor to become subject to valuation penalties. The Company believes that the rent payments represent fair market value rentals. If the Company fails to satisfy one or both of the 75% or 95% gross income tests for any taxable year, it may nevertheless qualify as a REIT for such year if it is entitled to relief under certain provisions of the Code. These relief provisions generally will be available if the Company's failure to meet such tests was due to reasonable cause and not due to willful neglect, the Company attaches a schedule of the sources of its income to its return and any incorrect information on the schedules was not due to fraud with intent to evade tax. It is not possible, however, to state whether in all circumstances the Company would be entitled to the benefit of these relief provisions. Even if these relief provisions were to apply, a tax would be imposed with respect to the excess net income. 24
Foreclosure Property General The foreclosure property rules permit the Company (by the Company's election) to foreclose or repossess properties without being disqualified as a result of receiving income that does not qualify under the gross income tests; however, a corporate tax is imposed upon net income from "foreclosure property" that is not otherwise "good REIT" income. Detailed rules specify the calculation of the tax. The after tax amount increases the amount the REIT must distribute each year. "Foreclosure property" includes any real property and any personal property incident to such real property acquired by bid at foreclosure or by agreement or process of law after there was a default or a default was imminent on the leased property. The 90 day grace period for the foreclosure property, during which the Company may operate the foreclosed property without an "independent contractor" or qualifying lessee, will begin on the date the Company acquires possession of the property. To maintain foreclosure property treatment after the 90 day grace period, the Company must cause the property to be managed by an "independent contractor" (from whom the Company derives or receives no income) or lease the property pursuant to a lease qualifying as a true lease for income tax purposes to an unrelated third party. Ownership of the tenant must not be attributed to the Company in violation of the related tenant rule of Section 856(d)(2)(B) (relating to 10% or more owned tenants). If the property is leased to a third party under a true lease, the foreclosure property rules are not then relevant. Foreclosure property treatment will end on the first day on which the REIT enters into a lease of the property that will give rise to income that is not good rental income under Section 856(c)(3). In addition, foreclosure property treatment will end if any construction takes place on the property (other than completion of a building, or other improvement more than 10 percent complete before default became imminent). Foreclosure property treatment may be extended up to six years. Health Care Properties The Company is permitted to terminate leases of "qualified health care properties" other than by reason of default or imminent default. Except as noted below, health care foreclosure properties are subject to the foreclosure property tax and other rules under the general foreclosure property rules. The differences between this special health care rule and the general foreclosure rule are that (i) the initial foreclosure property period is for two rather than three years, although it may be extended for the same aggregate six years, (ii) the lease may be terminated without requirement of default, and (iii) income from the independent contract is permitted if received as otherwise qualifying rent. A "qualified health care property" includes any real property and any personal property incident to such real property which is a "health care facility" or is necessary or incidental to the use of a health care facility. The qualified health care facility may be operated by an independent contractor from whom the REIT does not derive or receive any income other than certain qualifying lease income from an independent contractor. Asset Tests At the close of each quarter of its taxable year, the Company must satisfy two tests relating to the nature of its assets. First, at least 75% of the value of the Company's total assets must be represented by cash or cash items (including certain receivables), government securities, "real estate assets" or, in cases where the Company raises new capital through stock or long-term (at least five years) debt offerings, temporary investments in stock or debt instruments during the one-year period following the Company's receipt of such capital (the "75% asset test"). The term "real estate asset" includes interests in real property, interests in mortgages on real property to the extent the mortgage balance does not exceed the value of the associated real property, and shares of other 25
REITs. For purposes of the 75% asset test, the term "interest in real property" includes an interest in land and improvements thereon, such as buildings or other inherently permanent structures (including items that are structural components of such buildings or structures), a leasehold in real property and an option to acquire real property (or a leasehold in real property). Second, of the investments not included in the 75% asset class, the value of any one issuer's debt and equity securities owned by the Company (other than the Company's interest in any entity classified as a partnership for federal income tax purposes, or the stock of a qualified REIT subsidiary) may not exceed 5% of the value of the Company's total assets (the "5% asset test"), and the Company may not own more than 10% of any one issuer's outstanding voting securities or after 2000, 10% of the value of any one issuer's outstanding securities, subject to limited "safe harbor" exceptions for certain straight debt obligations (except for the Company's ownership interest in an entity that is disregarded for federal income tax purposes, that is classified as a partnership for federal income tax purposes or that is the stock of a qualified REIT subsidiary) (the "10% voting securities test"). In addition, no more than 20% of the value of the Company's assets can be represented by securities of taxable REIT subsidiaries (as defined below). Taxable REIT Subsidiaries The Company, however, is permitted to own up to 100% of a "taxable REIT subsidiary." To qualify as a taxable REIT subsidiary, both the Company and the subsidiary corporation must join in an election to treat the subsidiary corporation as a taxable REIT subsidiary. In addition, any corporation (other than a REIT or a qualified REIT subsidiary) of which a taxable REIT subsidiary owns, directly or indirectly, more than 35 percent of the vote or value is automatically treated as a taxable REIT subsidiary. A taxable REIT subsidiary can provide services to tenants of the Company's properties (even if such services were not considered services customarily furnished in connection with the rental of real property), and can manage or operate properties, generally for third parties, without causing amounts received or accrued directly or indirectly by the Company for such activities to fail to be treated as rents from real property. However, rents paid to the Company generally are not qualified rents if the Company owns more than 10% (by vote or value) of the corporation paying the rents. Nevertheless, qualified rents do include rents that are paid by taxable REIT subsidiaries and that also meet a limited rental exception (where 90% of space is leased to third parties at comparable rents) and an exception for rents from certain lodging facilities (operated by an independent contractor). Moreover, the taxable REIT subsidiary cannot directly or indirectly operate or manage a lodging or health care facility, subject to special rules for certain lodging facilities. Also, the taxable REIT subsidiary generally cannot provide to any person rights to any brand name under which hotels or health care facilities are operated, unless the rights are provided to an independent contractor to operate or manage a lodging facility, if the rights are held by the taxable REIT subsidiary as licensee or franchisee and the lodging facility is owned by the taxable REIT subsidiary or leased to it by the Company. The taxable REIT subsidiary cannot deduct interest in any years that would exceed 50% of the taxable REIT subsidiary's adjusted gross income. If any amount of interest, rent, or other deductions of the taxable REIT subsidiary for amounts paid to the Company is determined to be other than at arm's length ("redetermined" items), an excise tax of 100% is imposed on the portion that was excessive, with limited "safe harbor" exceptions. If the Company should fail to satisfy the asset tests at the end of a calendar quarter except for its first calendar quarter, such a failure would not cause it to fail to qualify as a REIT or to lose its REIT status if (i) it satisfied all of the asset tests at the close of the preceding calendar quarter and (ii) the discrepancy between the value of the Company's assets and the asset test requirements arose from changes in the market values of its assets and was not wholly or partly caused by an acquisition of nonqualifying assets. If the condition described in clause (ii) of the preceding sentence were not satisfied, the Company still could avoid disqualification by eliminating any discrepancy within 30 days after the close of the calendar quarter in which it arose. The Company intends to maintain adequate records of the value of its assets to ensure compliance with the asset tests and to take such other actions as may be required to comply with those tests. 26
Annual Distribution Requirements In order to be taxed as a REIT, the Company is required to distribute dividends (other than capital gain dividends) to its stockholders in an amount at least equal to (i) the sum of (A) 95% (90% for taxable years beginning after December 31, 2000) of the Company's "REIT taxable income" (computed without regard to the dividends paid deduction and its net capital gain) and (B) 95% (90% for taxable years beginning after December 31, 2000) of the net income (after tax), if any, from foreclosure property, minus (ii) the sum of certain items of noncash income. Such distributions must be paid in the taxable year to which they relate, or in the following taxable year if declared before the Company timely files its tax return for such year and if paid on or before the first regular dividend payment after such declaration. To the extent that the Company does not distribute all of its net capital gain or distributes at least 95% (90% for taxable years beginning after December 31, 2000), but less than 100%, of its "REIT taxable income," as adjusted, it will be subject to tax on the undistributed amount at regular capital gains and ordinary corporate tax rates except to the extent of net operating loss or capital loss carryforwards. Furthermore, if the Company should fail to distribute during each calendar year at least the sum of (i) 85% of its REIT ordinary income for such year, (ii) 95% of its REIT capital gain net income for such year (other than long-term capital gain the Company elects to retain and treat as having been distributed to stockholders), and (iii) any undistributed taxable income from prior periods, the Company will be subject to a 4% nondeductible excise tax on the excess of such required distribution over the amounts actually distributed. In addition, during its Recognition Period, if the Company disposes of any assets subject to the Built-in Gain Rules, the Company will be required, pursuant to guidance issued by the IRS, to distribute at least 95% of the Built-in Gain (after tax), if any, recognized on the disposition of the asset. It is expected that the Company's REIT taxable income will be less than its cash flow due to the allowance of depreciation and other non-cash deductions in computing REIT taxable income. Accordingly, the Company anticipates that it generally will have sufficient cash or liquid assets to enable it to satisfy the 95% (90% for taxable years beginning after December 31, 2000) distribution requirement. It is possible, however, that the Company, from time to time, may not have sufficient cash or other liquid assets to meet the 95% (90% for taxable years beginning after December 31, 2000) distribution requirement or to distribute such greater amount as may be necessary to avoid income and excise taxation, as a result of timing differences between (i) the actual receipt of income and actual payment of deductible expenses and (ii) the inclusion of such income and deduction of such expenses in arriving at the Company's taxable income, or as a result of nondeductible expenses such as principal amortization or repayments, or capital expenditures in excess of noncash deductions. In the event that such timing differences or other cash needs occur, the Company may find it necessary to borrow funds or to issue equity securities (there being no assurance that it will be able to do so) or, if possible, to pay taxable stock dividends, distribute other property or securities or engage in a transaction intended to enable it to meet the REIT distribution requirements. The Company's ability to engage in certain of these transactions is restricted by the terms of the Amended Credit Agreement. Any such transaction would likely require the consent of the "Required Lenders" under the Amended Credit Agreement, and there can be no assurance that such consent would be obtained. In addition, the failure of Vencor to make rental payments under the Master Leases would impair materially the ability of the Company to make distributions. Consequently, there can be no assurance that the Company will be able to make distributions at the required distribution rate or any other rate. Under certain circumstances, the Company may be able to rectify a failure to meet the distribution requirement for a year by paying "deficiency dividends" to stockholders in a later year, which may be included in the Company's deduction for dividends paid for the earlier year. Although the Company may be able to avoid being taxed on amounts distributed as deficiency dividends, it will be required to pay a 4% excise tax and interest to the IRS based upon the amount of any deduction taken for deficiency dividends. The Company believes that it has met all of the tests required to be met as of December 31, 1999 in order to qualify as a REIT for 1999, with the exception of the annual distribution requirement. As discussed above, the Company can meet the annual distribution requirement through payment of 95% of its taxable income, less dividends paid in February 1999, by no later than September 15, 2000 (the extended due date of its 1999 federal income tax return). The 1999 dividend may be satisfied by a combination of cash and a distribution of Vencor 27
equity, which the Company expects to receive as part of the Vencor reorganization, if it occurs, or other property or securities. Since such distributions were not made by January 31, 2000, the Company is required to pay a 4% non-deductible excise tax on the portion of the distribution not paid by January 31, 2000. Failure to pay the required REIT dividend in 2000 with respect to 1999 would result in the Company not qualifying as a REIT in 1999 and being subject to substantial past due federal, state and local taxes, interest and penalties. Although the Company currently expects to qualify as a REIT for the year ended December 31, 1999, it is possible that economic, market, legal, tax or other considerations may cause the Company to fail or elect not to qualify as a REIT. Annual Record Keeping Requirements In its first taxable year in which it qualifies as a REIT and thereafter, the Company is required to maintain certain records and request on an annual basis certain information from its stockholders designed to disclose the actual ownership of its outstanding shares. The Company believes that it has complied with these requirements for 1999. The Company will be subject to a penalty of $25,000 ($50,000 for intentional violations) for any year in which it does not comply with the rules. Failure to Qualify If the Company does not make an election to be taxed as a REIT because it cannot meet the applicable requirements for REIT qualification, the Company will be subject to tax (including any applicable alternative minimum tax) on its taxable income at regular corporate rates except to the extent of net operating loss and capital loss carryforwards. Distributions to stockholders will not be deductible by the Company, nor will they be required to be made. To the extent of current and accumulated earnings and profits, all distributions to stockholders will be taxable as ordinary income, and, subject to certain limitations in the Code, corporate stockholders may be eligible for the dividends received deduction. If the Company does not make an election to be taxed as a REIT with respect to 1999, it will not for that reason be prevented from making an election to be taxed as a REIT with respect to any subsequent taxable year. If the Company elects to be taxed as a REIT and that election is revoked or terminated (e.g., due to a failure to meet the REIT qualification tests), the Company and its stockholders generally would be subject to the same tax consequences that are described in the preceding paragraph in the taxable year in which the Company ceased to qualify as a REIT. In addition, the Company would be prohibited from re-electing REIT status for the four taxable years following the year during which the Company ceased to qualify as a REIT, unless certain relief provisions of the Code applied. It is impossible to predict whether the Company would be entitled to such statutory relief. Taxation of U.S. Stockholders As used herein, the term "U.S. Stockholder" means a holder of the Company's Common Stock that for U.S. federal income tax purposes is (i) a citizen or resident of the United States, (ii) a corporation, partnership or other entity created or organized in or under the laws of the United States or of any political subdivision thereof, (iii) an estate whose income from sources without the United States is includible in gross income for U.S. federal income tax purposes regardless of its connection with the conduct of a trade or business within the United States or (iv) any trust with respect to which (A) a U.S. court is able to exercise primary supervision over the administration of such trust and (B) one or more U.S. persons have the authority to control all substantial decisions of the trust. As long as the Company qualifies as a REIT, distributions made to the Company's taxable U.S. Stockholders out of current or accumulated earnings and profits (and not designated as capital gain dividends) will be taken into account by such U.S. Stockholders as ordinary income and will not be eligible for the dividends received deduction generally available to corporations. Distributions that are designated as capital gain dividends will be taxed as a capital gain (to the extent such distributions do not exceed the Company's actual net capital 28
gain for the taxable year) without regard to the period for which the stockholder has held its shares. The tax rates applicable to such capital gains are discussed below. However, corporate stockholders may be required to treat up to 20% of certain capital gain dividends as ordinary income. Distributions in excess of current and accumulated earnings and profits will not be taxable to a stockholder to the extent that they do not exceed the adjusted basis of the stockholder's shares, but rather will reduce the adjusted basis of such shares. To the extent that distributions in excess of current and accumulated earnings and profits exceed the adjusted basis of a stockholder's shares, such distributions will be included in income as capital gains assuming the shares are capital assets in the hands of the stockholder. The tax rate applicable to such capital gain will depend on the stockholder's holding period for the shares. In addition, any distribution declared by the Company in October, November or December of any year and payable to a stockholder of record on a specified date in any such month shall be treated as both paid by the Company and received by the stockholder on December 31 of such year, provided that the distribution is actually paid by the Company during January of the following calendar year. If the Company should become a closely held REIT, any person owning at least 10% (by vote or value) of the Company is required to accelerate the recognition of year-end dividends attributable to the Company, for purposes of such person's estimated tax payments. A closely held REIT is defined as one in which at least 50% (by vote or value) is owned by five or fewer persons. Attribution rules apply to determine ownership. The Company may elect to treat all or a part of its undistributed net capital gain as if it had been distributed to its stockholders (including for purposes of the 4% excise tax discussed above under "Requirements for Qualification--Annual Distribution Requirements"). If the Company should make such an election, the Company's stockholders would be required to include in their income as long-term capital gain their proportionate share of the Company's undistributed net capital gain, as designated by the Company. Each such stockholder would be deemed to have paid its proportionate share of the income tax imposed on the Company with respect to such undistributed net capital gain, and this amount would be credited or refunded to the stockholder. In addition, the tax basis of the stockholder's shares would be increased by its proportionate share of undistributed net capital gains included in its income, less its proportionate share of the income tax imposed on the Company with respect to such gains. Stockholders may not include in their individual income tax returns any net operating losses or capital losses of the Company. Instead, such losses would be carried over by the Company for potential offset against its future income (subject to certain limitations). Taxable distributions from the Company and gain from the disposition of the Common Stock will not be treated as passive activity income and, therefore, stockholders generally will not be able to apply any "passive activity losses" (such as losses from certain types of limited partnerships in which the stockholder is a limited partner) against such income. In addition, taxable distributions from the Company generally will be treated as investment income for purposes of the investment interest limitations. Capital gains from the disposition of the shares (or distributions treated as such) will be treated as investment income only if the stockholder so elects, in which case such capital gains will be taxed at ordinary income rates. The Company will notify stockholders after the close of the Company's taxable year as to the portions of the distributions attributable to that year that constitute ordinary income, return of capital and capital gain. In general, any gain or loss realized upon a taxable disposition of the Common Stock by a stockholder who is not a dealer in securities will be treated as capital gain or loss. Lower marginal tax rates for individuals may apply in the case of capital gains, depending on the holding period of the shares that are sold. However, any loss upon a sale or exchange of shares by a stockholder who has held such shares for six months or less (after applying certain holding period rules) will be treated as a long-term capital loss to the extent of distributions from the Company required to be treated by such stockholder as long-term capital gain. All or a portion of any loss realized upon a taxable disposition of shares may be disallowed if other shares are purchased within 30 days before or after the disposition. For non-corporate taxpayers, the tax rate differential between capital gain and ordinary income may be significant. The highest marginal individual income tax rate applicable to ordinary income is 39.6%. Any capital gain generally will be taxed to a non-corporate taxpayer at a maximum rate of 20% with respect to capital assets 29
held for more than one year. The tax rates applicable to ordinary income apply to gain attributable to the sale or exchange of capital assets held for one year or less. In the case of capital gain attributable to the sale or exchange of certain real property held for more than one year, an amount of such gain equal to the amount of all prior depreciation deductions not otherwise required to be taxed as ordinary depreciation recapture income will be taxed at a maximum rate of 25%. With respect to distributions designated by a REIT as capital gain dividends (including deemed distributions of retained capital gains), the REIT also may designate (subject to certain limits) whether the dividend is taxable to non-corporate stockholders as a 20% rate gain distribution or an unrecaptured depreciation distribution taxed at a 25% rate. The characterization of income as capital or ordinary may affect the deductibility of capital losses. Capital losses not offset by capital gains may be deducted against a non-corporate taxpayer's ordinary income only up to a maximum annual amount of $3,000. Non-corporate taxpayers may carry forward their unused capital losses. All net capital gain of a corporate taxpayer is subject to tax at ordinary corporate rates. A corporate taxpayer can deduct capital losses only to the extent of capital gains, with unused losses being carried back three years and forward five years. Treatment of Tax-Exempt Stockholders Tax-exempt organizations, including qualified employee pension and profit sharing trusts and individual retirement accounts, (collectively, "Exempt Organizations") generally are exempt from federal income taxation. However, they are subject to taxation on their UBTI. While many investments in real estate generate UBTI, the IRS has issued a published ruling that dividend distributions by a REIT to an exempt employee pension trust do not constitute UBTI, provided that the shares of the REIT are not otherwise used in an unrelated trade or business of the exempt employee pension trust. Based on that ruling, and subject to the exceptions discussed below, amounts distributed by the Company to Exempt Organizations generally should not constitute UBTI. However, if an Exempt Organization finances its acquisition of the Common Stock with debt, a portion of its income from the Company will constitute UBTI pursuant to the "debt-financed property" rules. Furthermore, social clubs, voluntary employee benefit associations, supplemental unemployment benefit trusts and qualified group legal services plans that are exempt from taxation under paragraphs (7), (9), (17) and (20), respectively, of Section 501(c) of the Code are subject to different UBTI rules, which generally will require them to characterize distributions from the Company as UBTI. In addition, in certain circumstances, a pension trust that owns more than 10% of the Company's stock is required to treat a percentage of the dividends from the Company as UBTI (the "UBTI Percentage"). The UBTI Percentage is the gross income, less related direct expenses, derived by the Company from an unrelated trade or business (determined as if the Company were a pension trust) divided by the gross income, less related direct expenses, of the Company for the year in which the dividends are paid. The UBTI rule applies to a pension trust holding more than 10% of the Company's stock only if (i) the UBTI Percentage is at least 5%, (ii) the Company qualifies as a REIT by reason of the modification of the 5/50 Rule that allows the beneficiaries of the pension trust to be treated as holding shares of the Company in proportion to their actuarial interests in the pension trust and (iii) either (A) one pension trust owns more than 25% of the value of the Company's stock or (B) a group of pension trusts individually holding more than 10% of the value of the Company's stock collectively own more than 50% of the value of the Company's stock. Special Tax Considerations for Non-U.S. Stockholders The rules governing U.S. federal income taxation of nonresident alien individuals, foreign corporations, foreign partnerships and other foreign stockholders (collectively, "Non-U.S. Stockholders") are complex, and no attempt will be made herein to provide more than a summary of such rules. Non- U.S. stockholders should consult with their own tax advisors to determine the impact of federal, state and local income tax laws with regard to their ownership of the Common Stock, including any reporting requirements. For purposes of this discussion, the term "Non-U.S. Stockholder" does not include any foreign stockholder whose investment in the Company's stock is "effectively connected" with the conduct of a trade or business in the United States. Such a foreign stockholder, in general, will be subject to United States federal income tax 30
with respect to its investment in the Company's stock in the same manner as a U.S. Stockholder is taxed (subject to applicable alternative minimum tax and a special alternative minimum tax in the case of nonresident alien individuals). In addition, a foreign corporation receiving income that is treated as effectively connected with a U.S. trade or business also may be subject to an additional 30% "branch profits tax," unless an applicable tax treaty provides a lower rate or an exemption. Certain certification requirements must be satisfied in order for effectively connected income to be exempt from withholding. Distributions to Non-U.S. Stockholders that are not attributable to gain from sales or exchanges by the Company of U.S. real property interests and are not designated by the Company as capital gain dividends (or deemed distributions of retained capital gains) will be treated as dividends of ordinary income to the extent that they are made out of current or accumulated earnings and profits of the Company. Such distributions ordinarily will be subject to a withholding tax equal to 30% of the gross amount of the distribution unless an applicable tax treaty reduces or eliminates that tax. Distributions in excess of current and accumulated earnings and profits of the Company will not be taxable to a stockholder to the extent that such distributions do not exceed the adjusted basis of the stockholder's shares, but rather will reduce the adjusted basis of such shares. To the extent that distributions in excess of current and accumulated earnings and profits exceed the adjusted basis of a Non-U.S. Stockholder's shares, such distributions will give rise to tax liability if the Non-U.S. Stockholder would otherwise be subject to tax on any gain from the sale or disposition of its shares, as described below. For any year in which the Company qualifies as a REIT, distributions that are attributable to gain from sales or exchanges by the Company of U.S. real property interests will be taxed to a Non-U.S. Stockholder under the provisions of the Foreign Investment in Real Property Tax Act of 1980 ("FIRPTA"). Under FIRPTA, distributions attributable to gain from sales of U.S. real property interests are taxed to a Non-U.S. Stockholder as if such gain were effectively connected with a U.S. business. Non-U.S. Stockholders thus would be taxed at the normal capital gain rates applicable to U.S. Stockholders (subject to applicable alternative minimum tax and a special alternative minimum tax in the case of nonresident alien individuals). Distributions subject to FIRPTA also may be subject to a 30% branch profits tax in the hands of a foreign corporate stockholder not entitled to treaty relief or exemption. Unless a reduced rate of withholding applies under an applicable tax treaty, the Company generally will withhold from distributions to Non-U.S. Stockholders, and remit to the IRS, 30% of all distributions out of current or accumulated earnings and profits, subject to the application of FIRPTA withholding rules discussed below. In addition, the Company is required to withhold 10% of any distribution in excess of its current and accumulated earnings and profits. Because the Company generally cannot determine at the time a distribution is made whether or not it will be in excess of earnings and profits, the Company intends to withhold 30% of the entire amount of any distribution (other than distributions subject to the 35% withholding discussed below). Generally, however, a Non-U.S. Stockholder will be entitled to a refund from the IRS to the extent an amount is withheld from a distribution that exceeds the amount of U.S. tax owed by such Non-U.S. Stockholder. Under FIRPTA, the Company is required to withhold 35% of any distribution that is designated as a capital gain dividend or which could be designated as a capital gain dividend. Thus, if the Company designates previously made distributions as capital gain dividends, subsequent distributions (up to the amount of such prior distributions) will be treated as capital gain dividends for purposes of FIRPTA withholding. Under Regulations that are currently in effect, dividends paid to an address in a country outside the United States generally are presumed to be paid to a resident of such country for purposes of determining the applicability of withholding discussed above and the applicability of a tax treaty rate. Regulations issued in October 1997, however, provide that a Non-U.S. Stockholder who wishes to claim the benefit of an applicable treaty rate must satisfy certain certification and other requirements. Such Regulations generally will be effective for distributions made after December 31, 2000. For so long as the Common Stock continues to be regularly traded on an established securities market, the sale of such stock by any Non-U.S. Stockholder who is not a Five Percent Non-U.S. Stockholder (as defined 31
below) generally will not be subject to United States federal income tax (unless the Non-U.S. Stockholder is a nonresident alien individual who was present in the United States for more than 182 days during the taxable year of the sale and certain other conditions apply, in which case such gain will be subject to a 30% tax on a gross basis). A "Five Percent Non-U.S. Stockholder" is a Non-U.S. Stockholder who, at some time during the five-year period preceding such sale or disposition, beneficially owned (including under certain attribution rules) more than 5% of the total fair market value of the Common Stock (as outstanding from time to time) or owned shares of another class of stock of the Company that represented value greater than 5% of the Common Stock (measured at the time such shares were acquired). In general, the sale or other taxable disposition of the Common Stock by a Five Percent Non-U.S. Stockholder (as defined below) also will not be subject to United States federal income tax if the Company is a "domestically controlled REIT." A REIT is a "domestically controlled REIT" if, at all times during the five-year period preceding the relevant testing date, less than 50% in value of its shares is held directly or indirectly by Non-U.S. Stockholders (taking into account those persons required to include the Company's dividends in income for United States federal income tax purposes). Although the Company believes that it currently qualifies as a "domestically controlled REIT," because the Common Stock is publicly traded, no assurance can be given that the Company will qualify as a domestically controlled REIT at any time in the future. If the Company does not constitute a domestically controlled REIT, a Five Percent Non-U.S. Stockholder will be taxable in the same manner as a U.S. Stockholder with respect to gain on the sale of the Common Stock (subject to applicable alternative minimum tax and a special alternative minimum tax in the case of nonresident alien individuals). Information Reporting Requirements and Backup Withholding Tax The Company will report to its U.S. Stockholders and to the IRS the amount of distributions paid during each calendar year, and the amount of tax withheld, if any. Under the backup withholding rules, a stockholder may be subject to backup withholding at the rate of 31% with respect to distributions paid unless such holder (i) is a corporation or comes within certain other exempt categories and, when required, demonstrates this fact or (ii) provides a taxpayer identification number, certifies as to no loss of exemption from backup withholding and otherwise complies with the applicable requirements of the backup withholding rules. A stockholder who does not provide the Company with its correct taxpayer identification number also may be subject to penalties imposed by the IRS. In addition, the Company may be required to withhold a portion of capital gain distributions to any stockholders who fail to certify their non-foreign status to the Company. U.S. Stockholders should consult their own tax advisors regarding their qualifications for an exemption from backup withholding and the procedure for obtaining such an exemption. Backup withholding is not an additional tax. Rather, the amount of any backup withholding with respect to a payment to a U.S. Stockholder will be allowed as a credit against the U.S. Stockholder's United States federal income tax liability and may entitle the U.S. Stockholder to a refund, provided that the required information is furnished to the IRS. Backup withholding tax and information reporting generally will not apply to distributions paid to Non-U.S. Stockholders outside the United States that are treated as (i) dividends subject to the 30% (or lower treaty rate) withholding tax discussed above, (ii) capital gain dividends or (iii) distributions attributable to gain from the sale or exchange by the Company of U.S. real property interests. As a general matter, backup withholding and information reporting will not apply to a payment of the proceeds of a sale of the Common Stock by or through a foreign office of a foreign broker. Information reporting (but not backup withholding) will apply, however, to a payment of the proceeds of a sale of the Common Stock by a foreign office of a broker that (i) is a United States person, (ii) derives 50% or more of its gross income for certain periods from the conduct of a trade or business in the United States, or (iii) is a "controlled foreign corporation" for United States tax purposes, unless the broker has documentary evidence in its records that the holder is a Non-U.S. Stockholder and certain other conditions are satisfied, or the stockholder otherwise establishes an exemption. Payment to or through a United States office of a broker of the proceeds of a sale of the Common Stock is subject to both backup withholding and information reporting unless the stockholder certifies under penalties of perjury that the stockholder is a Non- 32
U.S. Stockholder or otherwise establishes an exemption. A Non-U.S. Stockholder may obtain a refund of any amounts withheld under the backup withholding rules by filing the appropriate claim for a refund with the IRS. The Treasury Department issued final Regulations in October 1997 concerning the withholding of tax and information reporting for certain amounts paid to non-resident alien individuals and foreign corporations. These new withholding rules alter the current withholding regime, and generally will be effective for distributions made after December 31, 2000. Stockholders should consult their tax advisors concerning the impact, if any, of these new Regulations on their ownership of shares of the Common Stock. Other Tax Considerations The Company and its stockholders may be subject to state and local tax in states and localities in which they do business or own property. The tax treatment of the Company and the stockholders in such jurisdictions may differ from the federal income tax treatment described above. Consequently, stockholders should consult their own tax advisors regarding the effect of state and local tax laws on their ownership of shares of the Common Stock. Employees As of December 31, 1999, the Company had ten full-time employees. The Company considers its relationship with its employees to be good. Insurance The Company maintains, or requires in its leases that its tenants maintain, appropriate liability and casualty insurance on its assets and operations. Under the Master Leases, Vencor is required to maintain, at its expense, certain insurance coverages related to the properties under the Master Leases and Vencor's operations at the related facilities. See "--The 1998 Spin Off." There can be no assurance that Vencor and the Company's other tenants will maintain such insurance and any failure by Vencor or the Company's other tenants to do so could have a Material Adverse Effect on the Company. The Company believes that Vencor and its other tenants are in substantial compliance with the insurance requirements contained in their respective leases with the Company. The Company believes that the amount and coverage of its insurance protection is customary for similarly situated companies in its industry. There can be no assurance that in the future such insurance will be available at a reasonable price or that the Company will be able to maintain adequate levels of insurance coverage. RISK FACTORS Dependence of the Company on Vencor The Company leases substantially all its properties to Vencor and, therefore, Vencor is the primary source of the Company's revenues, accounting for approximately 98.5% (98.3%, net of write-offs) of the Company's revenues in 1999. The operations of Vencor have been negatively impacted by changes in governmental reimbursement rates, by its current level of indebtedness and by certain other factors. Vencor filed for protection under chapter 11 of the Bankruptcy Code on September 13, 1999. See "--Effects of Bankruptcy Proceedings." Vencor's financial condition, ability and willingness to meet its rent obligations will determine the Company's revenues and the Company's ability to service its indebtedness and to make distributions to its stockholders. In addition, any failure by Vencor to conduct its operations effectively could have a Material Adverse Effect on the Company. There can be no assurance that Vencor will have sufficient assets, income and access to financing to enable it to satisfy its obligations under the Master Leases. Since the Master Leases are structured as triple-net leases under 33
which Vencor is responsible for all or substantially all insurance, taxes and maintenance and repair expenses required in connection with the leased properties, the inability or unwillingness of Vencor to satisfy its obligations under the Master Leases would have a Material Adverse Effect on the Company. In addition, the credit standing of the Company is affected by the general creditworthiness of Vencor. Due to the Company's dependence on Vencor's rental payments as the primary source of the Company's revenues, the Company may be negatively affected by enforcing its rights under the Master Leases or by terminating a Master Lease. If Vencor fails to comply with the terms of a Master Lease or to comply with applicable health care regulations and, in either case, Vencor or its lenders fail to cure such default within the specified cure period, the Company may have to find another lessee/operator for the properties covered by one or all of the Master Leases. While the Company is attempting to locate one or more lessee/operators there could be a decrease or cessation of rental payments by Vencor. There can be no assurance that the Company will be able to locate another suitable lessee/operator or that if the Company is successful in locating such an operator, that the rental payments from such new operator would not be materially less than the existing rental payments. The ability of the Company to locate another suitable lessee/operator may be materially delayed or limited by various state licensing, receivership, CON or other laws, as well as by Medicare and Medicaid change of ownership rules. In addition, pursuant to the 1998 Spin Off, the Company assigned to Vencor and Vencor assumed the Third Party Leases, and the rights, obligations and duties as a tenant thereunder, as well as the Third Party Guarantees. The rent obligation under the Third Party Leases for the year ending December 31, 2000 is expected to be approximately $35.3 million, and the aggregate exposure under the Third Party Guarantees is approximately $49.8 million. See "Note 8-- Transactions With Vencor--The 1998 Spin Off" to the Consolidated Financial Statements. In connection with these assignments, the Company may remain liable for substantially all of the obligations under the Third Party Leases and the Third Party Guarantees. Vencor has indemnified the Company for any losses, claims, liabilities and the like which may be incurred by or asserted against the Company in connection with the Third Party Leases and the Third Party Guarantees. There can be no assurance that Vencor will have sufficient assets, income and access to financing to enable it to satisfy its obligations under the arrangements or the indemnification or that Vencor will continue to honor its obligations incurred in connection with the 1998 Spin Off. If Vencor or certain third party subtenants are unable or unwilling to satisfy such obligations, the Company may be obligated to satisfy the obligations under the Third Party Leases and the Third Party Guarantees. In that event, the Company may be entitled to receive revenues from the leased properties that would mitigate the costs incurred in connection with the satisfaction of such obligations. Of the aggregate exposure under the Third Party Guarantees, Atria also has directly guaranteed and agreed to indemnify and hold the Company harmless from and against all claims against the Company arising out of one of the Third Party Guarantees in an aggregate principal amount of $34.5 million. Although the Company is engaged in discussions with Atria in an effort to have the $34.5 million liability formally assumed by Atria and the Company released from the liability, there can be no assurance that the Company will be successful in its attempt to be released from this liability. The Company's performance of these obligations could have a Material Adverse Effect on the Company. Failure to maintain REIT status would result in the Company incurring federal, state and local taxes, interest and penalties. In connection with the 1998 Spin Off, Vencor agreed to assume and to indemnify the Company for any and all liabilities that may arise out of the ownership or operation of the health care operations either before or after the date of the 1998 Spin Off. The indemnification provided by Vencor also covers losses, including costs and expenses, which may arise from any future claims asserted against the Company based on these health care operations. In addition, at the time of the 1998 Spin Off, Vencor agreed to assume the defense, on behalf of the Company, of any claims that (a) were pending at the time of the 1998 Spin Off and which arose out of the ownership or operation of the health care operations or (b) were asserted after the 1998 Spin Off and which arise out of the ownership and operation of the health care operations or any of the assets or liabilities transferred to Vencor in connection with the 1998 Spin Off and to indemnify the Company for any fees, costs, expenses and liabilities arising out of such operations. 34
There can be no assurance that Vencor will have sufficient assets, income and access to financing to enable it to satisfy its obligations incurred in connection with the 1998 Spin Off or that Vencor will continue to honor its obligations incurred in connection with the 1998 Spin Off. For example, Vencor has not agreed to assume the Spin Agreements and has reserved its right to seek to reject such agreements pursuant to and subject to the applicable provisions of the Bankruptcy Code. If Vencor does not satisfy or otherwise honor the obligations under these arrangements, then the Company may be liable for the payment and performance of such obligations and may have to assume the defense of such claims. In addition, if Vencor's plan of reorganization is consummated, it is likely that the Company will be required to make payments to settle certain government claims which will not be subject to recovery from or indemnification by Vencor. The Company's performance of these obligations and/or the assumption of the defense of such claims could have a Material Adverse Effect on the Company. In connection with the 1998 Spin Off, the Company sold or otherwise transferred substantially all of the Company's books and records relating to the hospital, nursing facility and ancillary services businesses to Vencor. Therefore, the Company must rely on Vencor in order to examine and/or obtain copies of such books and records. The failure of Vencor to provide the Company with access to or copies of such books and records could have a Material Adverse Effect on the Company. Effects of Bankruptcy Proceedings Vencor filed for protection under chapter 11 of the Bankruptcy Code on September 13, 1999. Several other tenants of the Company also have filed for bankruptcy protection. See "--Recent Developments Regarding Vencor" and "Note 9--Commitments and Contingencies" to the Consolidated Financial Statements. The limitations imposed by federal bankruptcy law on the ability of the Company to enforce its agreements with these parties could have a Material Adverse Effect on the Company. The Company's ability to manage its assets and operations is subject to federal and state laws that limit creditors' rights and remedies available to real property owners to collect delinquent rents, and with respect to tenants of the Company who are subject to a bankruptcy proceeding, to federal bankruptcy laws. If a tenant files for bankruptcy protection, the tenant, including without limitation Vencor, should have an obligation to pay rent to the Company as landlord during the pendency of the proceeding and pending the assumption or rejection of the respective lease. The tenants, however, may dispute the amount of rent to be paid pending the assumption or rejection of a lease. If the tenant assumes a real property lease, it generally must do so pursuant to the original contract terms and it must cure pre-petition and post-petition defaults under the lease unless the landlord has agreed to modify the contract terms or the bankruptcy court orders the terms modified. If the tenant rejects a real property lease, the Company may lease the property to another tenant. See "--Lack of Control Over Properties." If a tenant becomes insolvent or files for bankruptcy protection, there can be no assurance that the Company will be able to timely recover the premises from the tenant or from a trustee or debtor-in-possession in any bankruptcy proceeding relating to that tenant. There can also be no assurance that the Company will receive rent in the proceeding equal to the amount set forth in the leases or sufficient to cover the Company's expenses with respect to the premises. If a tenant becomes subject to federal bankruptcy protection, the Bankruptcy Code will apply, which may restrict the amount and recoverability of the Company's claims against the tenant. In addition, the automatic stay provisions of the Bankruptcy Code prevent a party from exercising certain of its contractual rights, including the right to payment of amounts past due, while the debtor is subject to federal bankruptcy protection. These proceedings could have a Material Adverse Effect on the Company. In connection with Vencor's bankruptcy filing, the Company and Vencor entered into a Stipulation for the payment by Vencor to the Company of approximately $15.1 million per month starting in September 1999, to be applied against the total amount of minimum monthly base rent that is due and payable under the Master Leases. During the period in which the Stipulation is in effect, Vencor has agreed to fulfill all of its obligations under the Spin Agreements as such obligations become due, including its obligation to indemnify and defend Ventas for any and all claims relating to the health care operations and assets and liabilities transferred to Vencor in the 35
1998 Spin Off. Vencor has not, however, agreed to assume the Spin Agreements and has reserved its right to seek to reject such agreements pursuant and subject to the applicable provisions of the Bankruptcy Code. A termination of the Stipulation and/or rejection by Vencor of the Spin Agreements could have a Material Adverse Effect on the Company. See "--Recent Developments Regarding Vencor." In addition, Vencor, as a debtor in possession in a bankruptcy case commenced under the Bankruptcy Code, or any trustee appointed for it, could seek to avoid one or more transfers made and obligations incurred as part of or subsequent to the 1998 Spin Off under the bankruptcy avoidance powers. Such transfers and obligations could be avoided if, among other things, they were preferential or otherwise were made or incurred with the actual intent to delay, hinder or defraud creditors. They also could be avoided if, as of the 1998 Spin Off, Vencor did not receive fair consideration or reasonably equivalent value in exchange for the transfers and obligations made and incurred by it and, at the time of the 1998 Spin Off, Vencor (i) was insolvent or was rendered insolvent, (ii) had unreasonably small capital with which to carry on its business and all businesses in which it intended to engage, or (iii) intended to incur, or believed it would incur, debts beyond its ability to repay such debts as they would mature. The Company believes that Vencor was solvent (in accordance with the foregoing definitions) at the time of 1998 Spin Off, was able to repay its debts as they matured following the 1998 Spin Off and had sufficient capital to carry on its business. Moreover, the Company at the time of the 1998 Spin Off received third party opinions as to Vencor's solvency and the adequacy of Vencor's capitalization. There is no certainty, however, that a court would reach the same conclusions in determining whether Vencor was insolvent or adequately capitalized at the time of, or after giving effect to, the 1998 Spin Off or that any transfer would not be avoided on other grounds. Substantial Leverage and Ability to Raise Capital On January 31, 2000, the Company finalized an agreement with all of its lenders under the Bank Credit Agreement to restructure its debt under the Bank Credit Agreement on a long term basis. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources" and "Note 4--Borrowing Arrangements" to the Consolidated Financial Statements. The Company is highly leveraged and a substantial portion of its cash flow from operations is dedicated to the payment of principal and interest on indebtedness. The Company is dependent upon lease payments from Vencor to meet its interest expense and principal repayment obligations under its current debt facilities. If the Company's cash flow from operations was not sufficient to meet all scheduled debt payments, the Company would be required to obtain additional borrowings or raise equity to meet its required debt payments. The ability of the Company to incur additional indebtedness is restricted by the terms of the Amended Credit Agreement. In addition, adverse economic conditions could cause the terms on which the Company can obtain additional borrowings to become unfavorable. In such circumstances, the Company may be required to raise equity in the capital markets or liquidate one or more investments in properties at times that may not permit realization of the maximum return on such investments, and which could result in adverse tax consequences to the Company. In addition, certain health care regulations may constrain the ability of the Company to sell assets. There can be no assurance that the Company will be able to meet its debt service obligations and the failure to do so could have a Material Adverse Effect on the Company. Lack of Control Over Properties The Company is dependent on the ability of Vencor, as triple-net lessee under the Master Leases, and its other lessees to manage and maintain the Company's leased properties. The Company may be unable to take action if it believes Vencor or such other lessees are operating one of the leased properties inefficiently or in a manner adverse to the Company's interests. See "--Effects of Bankruptcy Proceedings" and "Business--The 1998 Spin Off-- Master Lease Agreements." If a Master Lease or property under a Master Lease is rejected or otherwise returned to the Company, the Company would have to locate a suitable lessee/operator for the property. There can be no assurance that the Company will be able to locate another suitable lessee/operator or 36
that if the Company is successful in locating such an operator, that the rental payments from such new operator would not be materially less than the existing rental payments. In addition, the ability of the Company to locate another suitable lessee/operator may be materially delayed or limited by various state licensing, receivership, CON or other laws, as well as Medicare and Medicaid change of ownership rules. Conflicts of Interest Because of the pre-existing ownership interests and interrelationships between certain members of management and directors of the Company and Vencor, there may be conflicts of interest and loyalties with respect to the ongoing operations of the Company and Vencor. Currently, however, the Company and Vencor have no common officers, directors or, to the Company's knowledge, common ownership by stockholders owning greater than 10% of both companies. In addition, the Independent Committee of the Company's Board of Directors has been formed for the purpose of ensuring arm's length transactions and dealings between the Company and Vencor. Health Care Industry Risks Dependence on Health Care Industry Because all of the properties are used as health care facilities, the Company is directly affected by the risks associated with the health care industry. The ability of Vencor and the Company's other tenants and operators to generate profits and pay rent under their leases may be adversely affected by such risks. See "Business--Governmental Regulation." Vencor and the other lessees derive a substantial portion of their net operating revenues from third-party payors, including the Medicare and Medicaid programs. Such programs are highly regulated and subject to frequent and substantial changes. The Budget Act is intended to reduce the increase in Medicare payments by $115 billion and reduce the increase in Medicaid payments by $13 billion between 1998 through 2002 and made extensive changes in the Medicare and Medicaid programs. In addition, private payors, including managed care payors, increasingly are demanding discounted fee structures and the assumption by health care providers of all or a portion of the financial risk of operating a health care facility. Efforts to impose greater discounts and more stringent cost controls by private payors are expected to continue. There can be no assurance that adequate reimbursement levels will continue to be available for services to be provided by Vencor and other lessees which are currently being reimbursed by Medicare, Medicaid or private payors. Significant limits on the scope of services reimbursed and on reimbursement rates and fees could have a material adverse effect on the liquidity, financial condition and results of operations of Vencor and other lessees, which, in turn, could have a Material Adverse Effect on the Company. Extensive Regulation The health care industry is subject to extensive federal, state and local laws and regulations including, but not limited to, laws and regulations relating to licensure, conduct of operations, ownership of facilities, addition of facilities, services, prices for services and billing for services. These laws authorize periodic inspections and investigations. If not corrected, deficiencies can result in sanctions which include loss of licensure to operate and loss of rights to participate in the Medicare and Medicaid programs. Regulatory agencies have substantial powers to affect the actions of operators of the Company's properties if the agencies believe that there is an imminent threat to patient welfare, and in some states these powers can include assumption of interim control over facilities through receiverships. The Anti-kickback Laws prohibit certain business practices and relationships that might affect the provision and cost of health care services reimbursable under Medicare and Medicaid, including the payment or receipt of remuneration for the referral of patients whose care will be paid by Medicare or other governmental programs. Sanctions for violating the Anti-kickback Laws include criminal penalties and civil sanctions, including fines and possible exclusion from government programs such as the Medicare and Medicaid programs. In the ordinary course of their businesses, the Company's operators are subject regularly to inquiries, investigations and audits by federal and state agencies that oversee these laws and regulations. See "Business--Governmental Regulation." 37
The Company is unable to predict the future course of federal, state and local regulation or legislation, including Medicare and Medicaid statutes and regulations. Changes in the regulatory framework could have a material adverse effect on the operators' results of operations, financial condition, and their ability to make rental payments to the Company. In the event that any operator of the Company's properties fails to make rental payments to the Company or to comply with the applicable health care regulations and, in either case, such operators or their lenders fail to cure the default prior to the expiration of the applicable cure period, the ability of the Company to evict that operator and substitute another operator or operators may be materially delayed or limited by bankruptcy rules and by various state licensing, receivership, CON or other laws, as well as by Medicare and Medicaid change-of-ownership rules. Such delays and limitations could have a material adverse effect on the Company's ability to collect rent, to obtain possession of leased properties, or otherwise to exercise remedies for tenant default. In addition, the Company may also incur substantial additional expenses in connection with any such licensing, receivership or change-of-ownership proceedings. Health Care Reform Health care is one of the largest industries in the United States and continues to attract much legislative interest and public attention. The Budget Act, enacted in August 1997, contained extensive changes to the Medicare and Medicaid programs intended to reduce the projected amount of increase in payments under those programs by $115 billion and $13 billion, respectively, between 1998 and 2002. Under the Budget Act, annual growth rates for Medicare will be reduced from over 10% to approximately 7.5% for the period between 1998 and 2002 based on specific program baseline projections from the last five years. Virtually all spending reductions will come from health care operators and changes in program components. The Budget Act reduced payments made to the hospitals operated by Vencor by reducing incentive payments pursuant to TEFRA, allowable costs for capital expenditures and bad debts, and payments for services to patients transferred from a PPS hospital. The reductions in allowable costs for capital expenditures became effective October 1, 1997. The reductions in the TEFRA incentive payments and allowable costs for bad debts became effective between May 1, 1998 and September 1, 1998 with respect to the Company's hospitals. The reductions for payments for services to patients transferred from a PPS hospital became effective October 1, 1998. The Budget Act also established SNF PPS for Medicare cost reporting periods beginning on or after July 1, 1998. During a nursing facilities' first three cost reporting periods under SNF PPS, the per diem rates will be based on a blend of facility-specific costs and federal costs. Thereafter, the per diem rates will be based solely on federal costs. The rates for such services were published by HCFA in the Federal Register on May 12, 1998. The payments received under SNF PPS cover all services for Medicare Part A patients, including all ancillary services, such as respiratory therapy, physical therapy, occupational therapy, speech therapy and certain covered drugs. The payments that Vencor is receiving under SNF PPS are substantially less than before enactment of the Budget Act and will remain so even after the effective date of the Refinement Act. Vencor has been subject to SNF PPS since July 1, 1998. The Budget Act established the National Bipartisan Commission on the Future of Medicare, which held its first meeting on March 6, 1998, and charged it with reviewing and analyzing financial conditions of Medicare, identifying problems that threaten the financial integrity of the Medicare Trust Fund, and making recommendations to address the program's long-term financing challenges. This Commission recently concluded its deliberations without making an official recommendation, but proposals considered by the commission remain under independent consideration by the Congress. The Budget Act also afforded states more flexibility in administering their Medicaid plans, including the ability to shift most Medicaid enrollees into managed care plans without first obtaining a federal waiver. Accordingly, the Medicare and Medicaid programs, including payment levels and methods, are in a state of change and are less predictable than before enactment of the Budget Act. 38
There can be no assurance that the Budget Act, future health care legislation or other changes in the administration or interpretation of governmental health care programs will not have a material adverse effect on the liquidity, financial condition or results of operations of the Company's operators which could have a material adverse effect on their ability to make rental payments to the Company and a Material Adverse Effect on the Company. Implementation of Original Business Strategy At the time of the 1998 Spin Off, the business strategy of the Company was to diversify itself from its Vencor tenant concentration. However, current conditions have impeded this strategy. Also, the terms of the Amended Credit Agreement significantly limit the Company's ability to acquire or swap assets. See "Note 4--Borrowing Arrangements" to the Consolidated Financial Statements. Currently, the Company has no plans to acquire additional assets. If the Company obtains the contractual ability to acquire and swap assets under the terms of its credit arrangements, and if Vencor has stabilized its financial condition, the Company intends to re-implement its original business strategy, assuming it has the financial flexibility at that time to do so. Accordingly, if the Company does begin to pursue acquisitions or development of additional health care or other properties, it may encounter certain risks and/or financing constraints. Acquisitions entail general investment risk associated with any real estate investments, including risks that investments will fail to perform in accordance with expectations, the estimates of the cost of improvements necessary for acquired properties will prove inaccurate, and the inability of the lessee/operator to meet performance expectations. The Company does not presently contemplate any development projects, although if the Company were to pursue new development projects, such projects would be subject to numerous risks, including risks of construction delays or cost overruns that may increase project costs, new project commencement risks such as receipt of zoning, occupancy and other required governmental approvals and permits and the incurrence of development costs in connection with projects that are not pursued to completion. The fact that the Company must distribute 95% of its net taxable income in order to maintain its qualification as a REIT may limit the Company's ability to rely upon rental payments from its properties or subsequently acquired properties to finance acquisitions or new developments. As a result, if debt or equity financing is not available on acceptable terms, further acquisitions or development activities might be curtailed or cash available for distribution would be affected adversely. The Company would compete for investment opportunities with entities that have substantially greater financial resources than the Company. The Company's ability to compete successfully for such opportunities is affected by many factors, including the cost to the Company of obtaining debt and equity capital at rates comparable to or better than its competitors. Competition generally may reduce the number of suitable investment opportunities available to the Company and increase the bargaining power of property owners seeking to sell, thereby impeding the implementation of the Company's business strategy. Risks Associated with REIT Status Failure to Qualify If the Company does not make an election to be taxed as a REIT because it cannot meet the applicable requirements for REIT qualification or because it chooses not to make such election, the Company will be subject to tax (including any applicable alternative minimum tax) on its taxable income at regular corporate rates. Distributions to stockholders will not be deductible by the Company, nor will they be required to be made. To the extent of current and accumulated earnings and profits, all distributions to stockholders will be taxable as ordinary income, and, subject to certain limitations in the Code, corporate stockholders may be eligible for the dividends received deduction. If the Company does not make an election to be taxed as a REIT with respect to the taxable year, it will not for that reason be prevented from making an election to be taxed as a REIT with respect to any subsequent taxable year. However, in such case the Company will be liable for federal, state and local income taxes on its 1999 taxable income and will incur interest and penalties. If the Company elects to be taxed as a REIT and that election is revoked or terminated (e.g., due to a failure to meet the REIT qualification tests), the Company and its stockholders generally would be subject to the same tax consequences that are described in the preceding paragraph in the taxable year in which the Company ceased 39
to qualify as a REIT. In addition, the Company would be prohibited from re- electing REIT status for the four taxable years following the year during which the Company ceased to qualify as a REIT, unless certain relief provisions of the Code applied. It is impossible to predict whether the Company would be entitled to such statutory relief. Inability to Maintain Required Distributions The Company is required to make distributions to its stockholders to comply with the 95% (90% for taxable years beginning after December 31, 2000) distribution requirement and to avoid the nondeductible excise tax. See "-- Federal Income Tax Considerations--Annual Distribution Requirements." It is expected that the Company's REIT taxable income will be less than its cash flow due to the allowance of depreciation and other non-cash deductions in computing REIT taxable income. Accordingly, the Company anticipates that it generally will have sufficient cash or liquid assets to enable it to satisfy the 95% (90% for taxable years beginning after December 31, 2000) distribution requirement. It is possible, however, that the Company, from time to time, may not have sufficient cash or other liquid assets to meet the 95% (90% for taxable years beginning after December 31, 2000) distribution requirement or to distribute such greater amount as may be necessary to avoid income and excise taxation, as a result of timing differences between (i) the actual receipt of income and actual payment of deductible expenses and (ii) the inclusion of such income and deduction of such expenses in arriving at the Company's taxable income, or as a result of nondeductible expenses such as principal amortization or repayments, or capital expenditures in excess of noncash deductions. In the event that such timing differences or other cash needs occur, the Company may find it necessary to borrow funds or to issue equity securities (there being no assurance that it will be able to do so) or, if possible, to pay taxable stock dividends, distribute other property or securities or engage in a transaction intended to enable it to meet the REIT distribution requirements. The Company's ability to engage in certain of these transactions is restricted by the terms of the Amended Credit Agreement. Any such transaction would likely require the consent of the "Required Lenders" under the Amended Credit Agreement, and there can be no assurance that such consent would be obtained. In addition, the failure of Vencor to make rental payments under the Master Leases would impair materially the ability of the Company to make distributions. Consequently, there can be no assurance that the Company will be able to make distributions at the required distribution rate or any other rate. Although the Company currently expects to qualify as a REIT for the year ended December 31, 1999, it is possible that economic, market, legal, tax or other considerations may cause the Company to fail or elect not to qualify as a REIT. Potential Liabilities Due to Fraudulent Transfer Considerations, Legal Dividend Requirements and Other Claims The Company The 1998 Spin Off, including the simultaneous distribution of the Vencor common stock to the Ventas stockholders, is subject to review under fraudulent conveyance laws. Under these laws, if a court in a lawsuit by an unpaid creditor or a representative of creditors (such as a trustee or debtor-in- possession in bankruptcy of the Company or any of its respective subsidiaries) were to determine that, as of the 1998 Spin Off, the Company did not receive fair consideration or reasonably equivalent value for distributing the stock distributed in the 1998 Spin Off and, at the time of the 1998 Spin Off, the Company or any of its subsidiaries (i) was insolvent or was rendered insolvent, (ii) had unreasonably small capital with which to carry on its business and all businesses in which it intended to engage, or (iii) intended to incur, or believed it would incur, debts beyond its ability to repay such debts as they would mature, then such court could among other things order the holders of the stock distributed in the 1998 Spin Off to return the value of the stock and any dividends paid thereon and/or invalidate, in whole or in part, the 1998 Spin Off as a fraudulent conveyance. Vencor Although Vencor has not formally asserted a claim, Vencor's legal counsel has raised questions relating to potential fraudulent conveyance or obligation issues and other claims relating to the 1998 Spin Off. At the time of the 1998 Spin Off, the Company obtained an opinion from an independent third party that addressed issues of solvency and adequate capitalization. Nevertheless, if a fraudulent conveyance or obligation claim or other claim is ultimately asserted by Vencor, its creditors, or others, the ultimate outcome of any such claim cannot 40
presently be determined. The Company intends to defend these claims vigorously if they are asserted in a court, arbitration or mediation proceeding. If a Vencor plan of reorganization is confirmed according to the terms of the September 1999 Agreement in Principle, the potential claims relating to the 1998 Spin Off will be released. However, there can be no assurance that Vencor will be successful in achieving a plan of reorganization or that such releases will be included in a Vencor plan of reorganization which may be confirmed. If these claims were to prevail, they would have a Material Adverse Effect on the Company. See "Note 8--Transactions with Vencor" and "Note 11--Litigation" to the Consolidated Financial Statements. Legal Dividend Requirements In addition, the 1998 Spin Off is subject to review under state corporate distribution and dividend statutes. Under Delaware law, a corporation may not pay a dividend to its stockholders if (i) the net assets of the corporation do not exceed its capital, unless the amount proposed to be paid as a dividend is less than the corporation's net profits for the current and/or preceding fiscal year in which the dividend is to be paid, or (ii) the capital of the corporation is less than the aggregate amount allocable to all classes of its preferred stock. The Company believes that (i) the Company and each of its subsidiaries were solvent (in accordance with the foregoing definitions) at the time of 1998 Spin Off, were able to repay their debts as they matured following the 1998 Spin Off and had sufficient capital to carry on their respective businesses and (ii) the 1998 Spin Off was consummated entirely in compliance with Delaware law. There is no certainty, however, that a court would reach the same conclusions in determining whether the Company was insolvent at the time of, or after giving effect to, the 1998 Spin Off or whether lawful funds were available for the 1998 Spin Off. The Spin Agreements The Spin Agreements provide for the allocation, immediately prior to the 1998 Spin Off, of certain debt of the Company. Further, pursuant to the Spin Agreements, from and after the date of the 1998 Spin Off, each of the Company and Vencor is responsible for the debts, liabilities and other obligations related to the businesses which it owns and operates following the consummation of the 1998 Spin Off. It is possible that a court would disregard the allocation agreed to among the parties and require the Company or Vencor to assume responsibility for obligations allocated to the other, particularly if the other were to refuse or to be unable to pay or perform the subject allocated obligations. See "--Effects of Bankruptcy Proceedings," "Business-- Recent Developments Regarding Vencor" and "Note 11--Litigation" to the Consolidated Financial Statements. Tax Claims Following the Company's REIT election, if and when it is made, the Company will be deemed to be a former C corporation for income tax purposes. As such, the Company potentially remains subject to corporate level taxes for any asset dispositions occurring between January 1, 1999 and December 31, 2008. See "Note 7--Income Taxes" to the Consolidated Financial Statements. The Internal Revenue Service is currently reviewing the federal income tax returns for tax years ending December 31, 1996 and 1995 of the Company (which then operated under the name Vencor). The income tax returns for the Company for subsequent years are also subject to a review. Item 2. Properties The Company believes that it has a diversified portfolio of health care facilities in terms of geography and the health care services provided at such facilities. The Company believes that the geographic diversity of the properties makes the portfolio less susceptible to adverse changes in state regulation and regional economic downturns. The long-term acute care hospitals owned by the Company primarily provide long-term acute care to medically complex, chronically ill patients, covering approximately 4,171 beds in 45 hospitals. The nursing facilities owned by the Company are leading providers of rehabilitation services, including physical, occupational and speech therapies, and care for patients with Alzheimer's disease, covering approximately 27,992 beds in 218 nursing facilities. The personal care facilities owned by the Company provide services including supporting living services, neurorehabilitation, neurobehavioral management and vocational programs, covering approximately 136 beds in eight centers. 41
The following tables set forth information for each of the Master Leases and the facilities leased thereunder based on the contract rental amounts for 1999. The chart also includes under the heading "Other Facilities" those properties under leases with non-Vencor lessees. The 1999 rental income reflects the stated contract rent, as opposed to amounts paid pursuant to the Stipulation, without regard to write-offs: <TABLE> <CAPTION> Licensed Licensed Number of Skilled Number of Personal Number of Licensed Skilled Nursing Personal Care 1999 Rental Hospital Hospital Nursing Facility Care Facility Income Facilities ("H") Beds Facilities ("SNF") Beds Facilities Beds ----------- ---------------- -------- ------------------ -------- ---------- -------- ($'s in Thousands) <S> <C> <C> <C> <C> <C> <C> <C> Master Lease 1.............. $ 46,115 9 971 45 5,823 -- -- Master Lease 2.............. 44,541 10 768 38 4,877 -- -- Master Lease 3.............. 46,296 9 841 43 5,627 -- -- Master Lease 4 and Corydon.. 88,167 17 1,591 84 10,490 -- -- -------- --- ----- --- ------ --- --- TOTAL ALL VENCOR FACILITIES................. 225,119 45 4,171 210 26,817 -- -- Other Facilities............ 3,481 -- -- 8 1,175 8 136 -------- --- ----- --- ------ --- --- TOTAL ALL FACILITIES........ $228,600 45 4,171 218 27,992 8 136 ======== === ===== === ====== === === </TABLE> <TABLE> <CAPTION> Facility Facility Name City State Type - ------------- -------------- ----- -------- <S> <C> <C> <C> MASTER LEASE 1 Rehabilitation & Healthcare Center of Birmingham (1)............................................ Birmingham AL SNF Desert Life Rehabilitation & Care Center........ Tucson AZ SNF Vencor Hospital--Ontario........................ Ontario CA H Magnolia Gardens Care Center.................... Burlingame CA SNF Maywood Acres Healthcare Center................. Oxnard CA SNF Cherry Hills Health Care Center................. Englewood CO SNF Hamilton Rehabilitation & Healthcare Center..... Norwich CT SNF Homestead Health Center......................... Stamford CT SNF Vencor Hospital--St. Petersburg................. St. Petersburg FL H Vencor Hospital--Central Tampa.................. Tampa FL H Titusville Rehabilitation & Nursing Center...... Titusville FL SNF Bay Pointe Nursing Pavilion..................... St. Petersburg FL SNF Rehabilitation & Healthcare Center of Tampa..... Tampa FL SNF Rehabilitation & Health Center of Cape Coral.... Cape Coral FL SNF Casa Mora Rehabilitation & Ext Care (1)......... Bradenton FL SNF Lafayette Nursing & Rehabilitation Center....... Fayetteville GA SNF Hillcrest Rehabilitation Care Center............ Boise ID SNF Nampa Care Center............................... Nampa ID SNF Weiser Rehabilitation and Care Center........... Weiser ID SNF Vencor Hospital--Sycamore....................... Sycamore IL H Rolling Hills Health Care Center................ New Albany IN SNF Windsor Estates Health & Rehabilitation Ctr..... Kokomo IN SNF Parkwood Health Care Center..................... Lebanon IN SNF Columbus Health & Rehabilitation Center......... Columbus IN SNF Oakview Nursing & Rehabilitation Center......... Calvert City KY SNF Maple Manor Healthcare Center................... Greenville KY SNF Crawford Skilled Nursing & Rehabilitation Center......................................... Fall River MA SNF Hallmark Nursing & Rehabilitation Center........ New Bedford MA SNF Hillcrest Nursing Home.......................... Fitchburg MA SNF Country Gardens Sk. Nursing & Rehabilitation.... Swansea MA SNF </TABLE> 42
<TABLE> <CAPTION> Facility Facility Name City State Type - ------------- -------------- ----- -------- <S> <C> <C> <C> Franklin Sk. Nursing & Rehabilitation Center.... Franklin MA SNF Eastside Rehabilitation and Living Center....... Bangor ME SNF Kennebunk Nursing Center........................ Kennebunk ME SNF Vencor Hospital--Metro Detroit.................. Detroit MI H Vencor Hospital--Kansas City.................... Kansas City MO H LaSalle Healthcare Center....................... Durham NC SNF Guardian Care of Henderson...................... Henderson NC SNF Guardian Care of Kinston........................ Kinston NC SNF Guardian........................................ Elizabeth City NC SNF Greenbriar Terrace Healthcare (1)............... Nashua NH SNF Torrey Pines Care Center........................ Las Vegas NV SNF West Lafayette Rehabilitation & Nursing Ctr..... West Lafayette OH SNF Cambridge Health & Rehabilitation Center........ Cambridge OH SNF Health Havens Nursing & Rehabilitation Center... E. Providence RI SNF Primacy Healthcare & Rehabilitation Center...... Memphis TN SNF Vencor Hospital--Ft. Worth Southwest............ Ft. Worth TX H Vencor Hospital--Houston Northwest.............. Houston TX H Vencor Hospital--Ft. Worth West................. Ft. Worth TX H Wasatch Valley Rehabilitation................... Salt Lake City UT SNF Harbour Pointe Med. & Rehabilitation Ctr........ Norfolk VA SNF Bay Pointe Medical & Rehabilitation Centre...... Virginia Beach VA SNF Lakewood Healthcare Center...................... Lakewood WA SNF San Luis Medical & Rehabilitation Center........ Greenbay WI SNF Colonial Manor Medical & Rehabilitation Center.. Wausau WI SNF MASTER LEASE 2 Rehabilitation & Healthcare Center of Mobile (1)............................................ Mobile AL SNF Villa Campana Health Center..................... Tucson AZ SNF THC--Orange County.............................. Orange County CA H Californian Care Center......................... Bakersfield CA SNF Alta Vista Healthcare Center.................... Riverside CA SNF Brighton Care Center............................ Brighton CO SNF Camelot Nursing & Rehabilitation Center......... New London CT SNF Parkway Pavilion Healthcare..................... Enfield CT SNF Vencor Hospital--Hollywood...................... Hollywood FL H Healthcare & Rehabilitation Ctr of Sanford...... Sanford FL SNF Carrollwood Care Center......................... Tampa FL SNF Windsor Woods Convalescent Center............... Hudson FL SNF Highland Pines Rehabilitation Center............ Clearwater FL SNF Savannah Rehabilitation & Nursing Center........ Savannah GA SNF Specialty Care of Marietta...................... Marietta GA SNF Emmett Rehabilitation and Healthcare............ Emmett ID SNF Meadowvale Health & Rehabilitation Center....... Bluffton IN SNF Wedgewood Healthcare Center..................... Clarksville IN SNF Cedars of Lebanon Nursing Center................ Lebanon KY SNF Riverside Manor Health Care..................... Calhoun KY SNF Danville Centre for Health & Rehabilitation..... Danville KY SNF Vencor Hosp--Boston Northshore.................. Peabody MA H Vencor Hospital--Boston......................... Boston MA H Presentation Nursing & Rehabilitation Center.... Brighton MA SNF </TABLE> 43
<TABLE> <CAPTION> Facility Facility Name City State Type - ------------- ---------------- ----- -------- <S> <C> <C> <C> Sachem Nursing & Rehabilitation Center........ East Bridgewater MA SNF Newton and Wellesley Alzheimer Center......... Wellesley MA SNF River Terrace................................. Lancaster MA SNF Augusta Rehabilitation Center................. Augusta ME SNF Brewer Rehabilitation & Living Center......... Brewer ME SNF Westgate Manor................................ Bangor ME SNF Vencor Hospital--Detroit...................... Detroit MI H Vencor Hospital--Greensboro................... Greensboro NC H Pettigrew Rehabilitation & Healthcare Center.. Durham NC SNF Raleigh Rehabilitation & Healthcare Center.... Raleigh NC SNF Lincoln Nursing Center (1).................... Lincoln NC SNF Guardian Care of Zebulon...................... Zebulon NC SNF THC--Las Vegas Hospital....................... Las Vegas NV H Medford....................................... Medford OR SNF Wyomissing Nursing & Rehabilitation Center.... Reading PA SNF Cordova Rehabilitation & Nursing Center....... Cordova TN SNF Vencor Hospital--San Antonio.................. San Antonio TX H Vencor Hospital--Mansfield.................... Mansfield TX H Crosslands Rehabilitation & Health Care Ctr... Sandy UT SNF Edmonds Rehabilitation & Healthcare Center.... Edmonds WA SNF Vencor Hospital--Mt. Carmel................... Mt. Carmel WI H Vallhaven Care Center......................... Neenah WI SNF Mt. Carmel Medical & Rehabilitation Center.... Burlington WI SNF Mt. Carmel Medical & Rehabilitation Center.... Milwaukee WI SNF MASTER LEASE 3 Rehabilitation & Healthc. Center of Huntsville................................... Huntsville AL SNF Vencor Hospital--Tucson....................... Tucson AZ H Kachina Point Health Care & Rehabilitation.... Sedona AZ SNF Valley Gardens HC & Rehabilitation............ Stockton CA SNF Village Square Nursing & Rehabilitation Center....................................... San Marcos CA SNF Vencor Hospital--Denver....................... Denver CO H Castle Garden Care Center..................... Northglenn CO SNF Windsor Rehabilitation & Healthcare Center.... Windsor CT SNF Courtland Gardens Health Center, Inc.......... Stamford CT SNF Vencor Hospital--Ft. Lauderdale............... Ft. Lauderdale FL H Colonial Oaks Rehabilitation Center--Ft. Myers........................................ Ft. Meyers FL SNF Evergreen Woods Health & Rehabilitation....... Springhill FL SNF North Broward Rehabilitation & Nursing Center....................................... Pompano Beach FL SNF Pompano Rehabilitation/Nursing Center......... Pompano Beach FL SNF Abbey Rehabilitation & Nsg. Center............ St. Petersburg FL SNF Tucker Nursing Center......................... Tucker GA SNF Moscow Care Center............................ Moscow ID SNF Vencor Hospital--Lake Shore................... Chicago IL H Valley View Health Care Center................ Elkhart IN SNF Wildwood Healthcare Center.................... Indianapolis IN SNF Bremen Health Care Center..................... Bremen IN SNF Rosewood Health Care Center................... Bowling Green KY SNF Hillcrest Health Care Center.................. Owensboro KY SNF Woodland Terrace Health Care Fac.............. Elizabethtown KY SNF </TABLE> 44
<TABLE> <CAPTION> Facility Facility Name City State Type - ------------- ---------------- ----- -------- <S> <C> <C> <C> Harrodsburg Health Care Center................ Harrodsburg KY SNF Vencor Hospital--New Orleans.................. New Orleans LA H Brigham Manor Nursing & Rehabilitation Ctr.... Newburyport MA SNF Oakwood Rehabilitation & Nursing Center....... Webster MA SNF Star of David Nursing & Rehabilitation/Alz Center....................................... West Roxbury MA SNF Brittany Healthcare Center.................... Natick MA SNF Den-Mar Rehabilitation & Nursing Center (1)... Rockport MA SNF Embassy House Sk. Nursing & Rehabilitation.... Brockton MA SNF Great Barrington Rehabilitation & Nursing Center....................................... Great Barrington MA SNF Winship Green Nursing Center.................. Bath ME SNF Rose Manor Health Care Center................. Durham NC SNF Guardian Care of Rocky Mount. (1)............. Rocky Mount NC SNF Homestead Health Care & Rehabilitation Ctr.... Lincoln NE SNF Vencor Hospital--Albuquerque (1).............. Albuquerque NM H Chillicothe Nursing & Rehabilitation Center... Chillicothe OH SNF Pickerington Nursing & Rehabilitation Center.. Pickerington OH SNF Logan Health Care Center...................... Logan OH SNF Bridgepark Center for Rehabilitation & Nursing Sv........................................... Akron OH SNF Vencor Hospital--Philadelphia................. Philadelphia PA H Oak Hill Nursing & Rehabilitation Center...... Pawtucket RI SNF Vencor Hospital--Houston (1).................. Houston TX H San Pedro Manor............................... San Antonio TX SNF Vencor Hospital--Arlington, VA................ Arlington VA H Birchwood Terrace Healthcare (1).............. Burlington VT SNF Bellingham Health Care & Rehabilitation Svc... Bellingham WA SNF Eastview Medical & Rehabilitation Center...... Antigo WI SNF Kennedy Park Medical & Rehabilitation Center.. Schofield WI SNF South Central Wyoming HC. & Rehabilitation.... Rawlins WY SNF MASTER LEASE 4 AND CORYDON Vencor Hospital--Phoenix...................... Phoenix AZ H Valley Healthcare & Rehabilitation Center..... Tucson AZ SNF Sonoran Rehabilitation & Care Center.......... Phoenix AZ SNF Vencor Hospital--San Leandro.................. San Leandro CA H Vencor Hospital--Orange County................ Westminster CA H Vencor Hospital--San Diego.................... San Diego CA H Recovery Inn of Menlo Park.................... Menlo Park CA H Nob Hill Healthcare Center.................... San Francisco CA SNF Canyonwood Nursing & Rehabilitation Center.... Redding CA SNF Lawton Healthcare Center...................... San Francisco CA SNF La Veta Healthcare Center (1)................. Orange CA SNF Bay View Nursing & Rehabilitation Center...... Alameda CA SNF Aurora Care Center............................ Aurora CO SNF Andrew House Healthcare....................... New Britain CT SNF Nutmeg Pavilion Healthcare.................... New London CT SNF Vencor Hospital--Coral Gables................. Coral Gables FL H Vencor Hospital--North Florida................ Green Cove Spr. FL H East Manor Medical Care Center................ Sarasota FL SNF Savannah Specialty Care Center................ Savannah GA SNF Cascade Care Center........................... Caldwell ID SNF Lewiston Rehabilitation and Care Center....... Lewiston ID SNF </TABLE> 45
<TABLE> <CAPTION> Facility Facility Name City State Type - ------------- ---------------- ----- -------- <S> <C> <C> <C> Mountain Valley Care and Rehabilitation....... Kellogg ID SNF Vencor Hospital--Chicago North................ Chicago IL H Vencor Hospital--Northlake.................... Northlake IL H Vencor Hospital--LaGrange..................... LaGrange IN H Vencor Hospital--Indianapolis................. Indianapolis IN H Royal Oaks Healthcare & Rehabilitation Center....................................... Terre Haute IN SNF Southwood Health & Rehabilitation Center...... Terre Haute IN SNF Columbia Healthcare Facility.................. Evansville IN SNF Muncie Health Care & Rehabilitation........... Muncie IN SNF Westview Nursing & Rehabilitation Center...... Bedford IN SNF Vencor Corydon................................ Corydon IN SNF Vencor Hospital--Louisville................... Louisville KY H Winchester Centre for Health/Rehabilitation... Winchester KY SNF Lexington Centre for Health & Rehabilitation.. Lexington KY SNF North Centre for Health & Rehabilitation...... Louisville KY SNF Laurel Ridge Rehabilitation & Nursing Center.. Jamaica Plain MA SNF Blue Hills Alzheimer's Care Center............ Stoughton MA SNF Country Manor Rehabilitation & Nursing Center....................................... Newburyport MA SNF Hammersmith House Nursing Care Center......... Saugus MA SNF Timberlyn Heights Nursing & Alz. Center....... Great Barrington MA SNF Briarwood Health Care Nursing Ctr............. Needham MA SNF Westridge Healthcare Center................... Marlborough MA SNF Bolton Manor Nursing Home..................... Marlborough MA SNF Quincy Rehabilitation & Nursing Center........ Quincy MA SNF West Roxbury Manor............................ West Roxbury MA SNF Eagle Pond Rehabilitation & Living Center..... South Dennis MA SNF Blueberry Hill Healthcare..................... Beverly MA SNF Colony House Nursing & Rehabilitation Center.. Abington MA SNF Walden Rehabilitation & Nursing Center........ Concord MA SNF Harrington House Nursing & Rehabilitation Center....................................... Walpole MA SNF Norway Rehabilitation & Living Center......... Norway ME SNF Shore Village Rehabilitation & Nursing Center....................................... Rockland ME SNF Brentwood Rehabilitation & Nursing Center..... Yarmouth ME SNF Fieldcrest Manor Nursing Home................. Waldoboro ME SNF Vencor Hospital--Minneapolis.................. Golden Valley MN H Vencor Hospital--St. Louis.................... St. Louis MO H Park Place Health Care Center................. Great Falls MT SNF Parkview Acres Care & Rehabilitation Center... Dillon MT SNF Sunnybrook Alzheimer's & HC Spec.............. Raleigh NC SNF Blue Ridge Rehabilitation & Healthcare Center....................................... Asheville NC SNF Cypress Pointe Rehabilitation & HC Center..... Wilmington NC SNF Winston-Salem Rehabilitation & HC Center...... Winston-Salem NC SNF Silas Creek Manor............................. Winston-Salem NC SNF Guardian Care of Roanoke Rapids............... Roanoke Rapids NC SNF Rehabilitation & Nursing Center of Monroe..... Monroe NC SNF Rehabilitation & Health Center of Gastonia.... Gastonia NC SNF Chapel Hill Rehabilitation & Healthcare Center....................................... Chapel Hill NC SNF Dover Rehabilitation & Living Center.......... Dover NH SNF Hanover Terrace Healthcare.................... Hanover NH SNF Las Vegas Healthcare & Rehabilitation Center.. Las Vegas NV SNF </TABLE> 46
<TABLE> <CAPTION> Facility Facility Name City State Type - ------------- ---------------- ----- -------- <S> <C> <C> <C> Franklin Woods Health Care Center............. Columbus OH SNF Winchester Place Nursing & Rehabilitation Center....................................... Canal Winchester OH SNF Minerva Park Nursing & Rehabilitation Center.. Columbus OH SNF Coshocton Health & Rehabilitation Center...... Coshocton OH SNF Lebanon Country Manor......................... Lebanon OH SNF Vencor Hospital--Oklahoma City................ Oklahoma City OK H Sunnyside Care Center......................... Salem OR SNF Vencor Hospital--Pittsburgh................... Oakdale PA H Vencor Hospital--Chattanooga.................. Chattanooga TN H Madison Healthcare & Rehabilitation Center.... Madison TN SNF Masters Health Care Center.................... Algood TN SNF Wasatch Care Center........................... Ogden UT SNF St. George Care and Rehabilitation Center..... St. George UT SNF Federal Heights Rehabilitation & Nursing Center....................................... Salt Lake City UT SNF Nansemond Pointe Rehabilitation & HC Center... Suffolk VA SNF River Pointe Rehabilitation & Healthc. Center....................................... Virginia Beach VA SNF Arden Rehabilitation & Healthcare Ctr......... Seattle WA SNF Northwest Continuum Care Center............... Longview WA SNF Rainier Vista Care Center..................... Puyallup WA SNF Vencor of Vancouver HC & Rehabilitation....... Vancouver WA SNF Heritage Health & Rehabilitation Center....... Vancouver WA SNF Queen Anne Healthcare......................... Seattle WA SNF Colony Oaks Care Center....................... Appleton WI SNF North Ridge Med. & Rehabilitation Center...... Manitowoc WI SNF Family Heritage Med. & Rehabilitation Center.. Wisconsin Rapids WI SNF Sheridan Medical Complex...................... Kenosha WI SNF Woodstock Health & Rehabilitation Center...... Kenosha WI SNF Mountain Towers Healthcare & Rehabilitation... Cheyenne WY SNF Wind River Healthcare & Rehabilitation Ctr.... Riverton WY SNF Sage View Care Center......................... Rock Springs WY SNF </TABLE> - -------- (1) The land is leased under a ground lease and improvements are owned by the Company. Upon expiration of the ground lease, improvements revert to the landlord. <TABLE> <CAPTION> Facility Facility Name City State Type - ------------- ---------- ----- ------------- <S> <C> <C> <C> OTHER FACILITIES Birchwood Care Center............................ Marne MI SNF Grayling Health Care Center...................... Grayling MI SNF Clara Barton Terrace............................. Flint MI SNF Mary Avenue Care Center.......................... Lansing MI SNF Bearcreek Rehabilitation Center.................. Rochester MN SNF Shadowmountain Convalescent Center............... Las Vegas NV SNF Marietta Convalescent Center..................... Marietta OH SNF Marigande--Sylvania Nursing Center............... Toledo OH SNF Tangram--8 sites................................. San Marcos TX Personal Care </TABLE> Item 3. Legal Proceedings Reference is made to "Note 11--Litigation" to the Consolidated Financial Statements for a description of certain Legal Proceedings. Item 4. Submission of Matters to a Vote of Security Holders Not applicable. 47
EXECUTIVE OFFICERS OF THE REGISTRANT Set forth below are the names, ages (as of March 1, 2000) and present and past positions of the persons who are the current executive officers of the Company. <TABLE> <CAPTION> Name Age Position ---- --- -------- <S> <C> <C> W. Bruce Lunsford.. 52 Chairman of the Board Debra A. Cafaro.... 42 Chief Executive Officer, President and Director T. Richard Riney... 42 Executive Vice President, General Counsel and Secretary John C. Thompson... 32 Vice President, Corporate Development </TABLE> W. Bruce Lunsford, an attorney, has served as Chairman of the Board since the Company commenced operations on May 1, 1998. From May 1, 1998 through December 1998, Mr. Lunsford also served as Chief Executive Officer of the Company. Mr. Lunsford was a founder of Vencor and served as Chairman of the Board, Chief Executive Officer and President of Vencor from the time it commenced operations in 1985 until the time of the 1998 Spin Off. Mr. Lunsford served as Chairman of the Board and Chief Executive Officer of Vencor from May 1, 1998 until January 21, 1999 and as President of Vencor from May 1, 1998 until November 1998. Mr. Lunsford is a director of Churchill Downs Incorporated, National City Bank, Kentucky, and Res-Care, Inc. Debra A. Cafaro joined the Company on March 5, 1999. From April 1997 to May 1998, she served as President and Director of Ambassador Apartments, Inc. (NYSE: AAH), a real estate investment trust. Ms. Cafaro was a founding member of the Chicago law firm Barack Ferrazzano Kirschbaum Perlman & Nagelberg, becoming a partner in 1987, where her areas of concentration were real estate, finance and corporate transactions and where she continued to practice until 1997. Ms. Cafaro is admitted to the Bar in Illinois and Pennsylvania. She is a member of the National Association of Real Estate Investment Trusts ("NAREIT") and the National Multi-Housing Council. T. Richard Riney has served as Executive Vice President, General Counsel and Secretary of the Company from May 1998 to the present. He served as Transactions Counsel of Vencor from April 1996 to April 1998. From May 1992 to March 1996, Mr. Riney was a partner of Hirn, Reed & Harper, a law firm based in Louisville, Kentucky where his areas of concentration were real estate and corporate finance. He is a member of NAREIT. John C. Thompson has served as Vice President, Corporate Development of the Company since January 1999. He served as Director of Acquisitions from May 1998 to January 1999. Mr. Thompson served as Director of Development of Vencor from April 1996 to May 1998 and as Development Manager of Vencor from 1993 to April 1996. Mr. Thompson is a member of NAREIT. 48
PART II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters The Common Stock is listed and traded on the New York Stock Exchange ("NYSE") under the ticker symbol of VTR. As of the close of business on March 17, 2000, there were 67,954,423 shares of Common Stock outstanding and approximately 2,715 stockholders of record. The prices in the table below, for the calendar quarters indicated since the 1998 Spin Off, represent the high and low sales prices for the Common Stock as reported on the NYSE. Cash dividends of $.39 per share were paid in the first quarter of 1999. No other cash dividends were paid on Common Stock during such periods. <TABLE> <CAPTION> Sales Price of Common Stock ------------------ Calendar Quarter High Low - ---------------- -------- --------- <S> <C> <C> Second Quarter 1998 (since May 1,1998)....................... $18 1/8 $13 1/2 Third Quarter 1998........................................... 15 10 Fourth Quarter 1998.......................................... 13 1/8 9 1/2 First Quarter 1999........................................... 13 3/4 4 5/8 Second Quarter 1999.......................................... 6 1/16 3 3/16 Third Quarter 1999........................................... 5 1/2 3 3/8 Fourth Quarter 1999.......................................... 5 3/8 3 11/16 First Quarter 2000 (through March 17, 2000).................. 4 1/4 2 11/16 </TABLE> The Company declared its first dividend of $0.39 per share on January 13, 1999 payable to stockholders of record on January 29, 1999. The Company currently intends to make distributions to its stockholders and anticipates that its distributions in 1999 and 2000 with respect to 1999 will be equal to approximately 95% of taxable income (the "Distribution Policy"). See "Business--Federal Income Tax Considerations--Annual Distribution Requirements" and "Note 4--Borrowing Arrangements" to the Consolidated Financial Statements). The Company currently has not determined when any such distributions would be made, although the Company intends to pay the minimum required distribution for 1999 on or prior to September 15, 2000. There can be no assurance that the Company will meet or maintain its Distribution Policy. See "Business--Risk Factors." The Company's Distribution Policy and the frequency and amounts of any dividends could be affected by an adverse change in the results of operations of the Company, an adverse change in economic conditions affecting the Company's business or the business of Vencor and the other operators of its properties or adverse changes in market and competitive factors that the Company's Board deems relevant in setting a distribution policy, and limitations placed on the payment of distributions in the Company's Amended Credit Agreement. See "Note 4--Borrowing Arrangements" to the Consolidated Financial Statements. In particular, any nonpayment of rent by Vencor under the Master Leases, or any expectation that such nonpayment will occur in the future, would have a material impact on the amount of the Company's distributions. Subject to restrictions under the Company's Amended Credit Agreement and other obligations, the Board, in its sole discretion, will determine the actual distribution amount and rate. Although the Company currently expects to qualify as a REIT for the year ended December 31, 1999, it is possible that economic, market, legal, tax or other considerations may cause the Company to fail or elect not to qualify as a REIT. In order to elect and maintain REIT status, the Company will be required to make distributions to its stockholders to comply with the 95% (90% for taxable years beginning after December 31, 2000) distribution requirement and to avoid the nondeductible excise tax. See "Business--Federal Income Tax Considerations--Annual Distribution Requirements." It is possible, however, that the Company, from time to time, may not have sufficient cash or other liquid assets to meet the 95% (90% for taxable years beginning after December 31, 2000) distribution requirement or to distribute such greater amount as may be necessary to avoid income and excise taxation. See "Business--Risk Factors--Risks Associated with REIT Status--Inability to Maintain Required Distributions" and "Business--Federal Income Tax Considerations--Annual Distribution Requirements." 49
Item 6. Selected Financial Data The following selected financial data with respect to the Company should be read in conjunction with the Company's Consolidated Financial Statements which are listed under Item 14 and are included on pages F-1 through F-44. <TABLE> <CAPTION> For the period from May 1, Year Ended 1998 to December 31, December 31, 1999 1998 ------------ -------------- (In thousands, except per share amounts) <S> <C> <C> OPERATING DATA Rental income..................................... $ 228,600 $149,933 General and administrative and other expenses..... 21,566 5,697 Interest expense.................................. 88,753 59,428 Loss on impairment of assets and tenant receivables...................................... 36,345 -- Net Income before extraordinary charge............ 42,535 34,809 Net Income........................................ 42,535 26,758 OTHER DATA Net income per share before extraordinary charge, Basic............................................ $ 0.63 $ 0.51 Net income per share, Basic....................... 0.63 0.39 Net income per share, Diluted..................... 0.63 0.39 Dividend Paid per share........................... 0.39 -- Weighted Average Shares Outstanding, Basic........ 67,754 67,681 Weighted Average Shares Outstanding, Diluted...... 67,989 67,865 <CAPTION> As of As of December 31, December 31, 1999 1998 ------------ -------------- (In thousands) <S> <C> <C> BALANCE SHEET DATA Real estate investments, net...................... $ 894,791 $939,460 Cash and cash equivalents......................... 139,594 338 Total Assets...................................... 1,071,199 959,706 Notes Payable and Other Debt...................... 974,247 931,127 Stockholders' Equity (Deficit).................... 8,345 (9,009) </TABLE> Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations The following discussion should be read in conjunction with the Company's Consolidated Financial Statements and accompanying notes thereto included elsewhere in this report. Background Information The Company is a real estate company that owns or leases 45 hospitals (comprised of two acute care hospitals and 43 long-term acute care hospitals), 218 nursing facilities and eight personal care facilities in 36 states as of December 31, 1999. The Company conducts substantially all of its business through a wholly owned operating partnership, Ventas Realty. Although the Company currently expects to qualify as a REIT for the year ended December 31, 1999, it is possible that economic, market, legal, tax or other considerations may cause the Company to fail or elect not to qualify as a REIT. The Company operates in one segment which consists of owning and leasing health care facilities and leasing or subleasing such facilities to third parties. The Company was incorporated in Kentucky in 1983 as Vencare, Inc. and commenced operations in 1985. The Company changed its name to Vencor Incorporated in 1989 and to Vencor, Inc. in 1993. From 1985 through April 30, 1998, the Company was engaged in the business of owning, operating and acquiring health care facilities and companies engaged in providing health care services. 50
On May 1, 1998, the Company effected the 1998 Spin Off pursuant to which the Company was separated into two publicly held corporations. A new corporation, subsequently named Vencor, Inc., was formed to operate the hospital, nursing facility and ancillary services businesses. Pursuant to the terms of the 1998 Spin Off, the Company distributed the common stock of Vencor to stockholders of record of the Company as of April 27, 1998. The Company, through its subsidiaries, continued to hold title to substantially all of the real property and to lease such real property to Vencor. At such time, the Company also changed its name to Ventas, Inc. and refinanced substantially all of its long-term debt. For financial reporting periods subsequent to the 1998 Spin Off, the historical financial statements of the Company were assumed by Vencor, and the Company is deemed to have commenced operations on May 1, 1998. In addition, for certain reporting purposes under this Form 10-K and other filings, the Commission treats the Company as having commenced operations on May 1, 1998. The financial results for the year ended December 31, 1999 are not comparable to the period from May 1, 1998 to December 31, 1998 included in the Consolidated Statements of Income or the Consolidated Statements of Cash Flows due to the difference in the time periods covered and the omission of a net provision for income taxes in the 1999 financial statements due to the Company's intention to qualify as a REIT and the use of a portion of the Company's net operating loss carryforward. The Company owns and leases a geographically diverse portfolio of health care related facilities, including hospitals, nursing facilities and personal care facilities whose principal tenants are health care related companies. As a result of announcements during 1999 by Vencor and industry-wide factors, the Company suspended the implementation of its original business strategy during 1999. The Company's current principal objectives are preserving and maximizing stockholders' capital. The Company leases all of its hospitals and 210 of its nursing facilities to Vencor under the Master Leases. For the year ended December 31, 1999 and for the period from May 1, 1998 to December 31, 1998, Vencor accounted for approximately 98.5% (98.3%, net of write-offs) and 98.7% of the Company's revenues, respectively. See "--Risk Factors--Dependence of the Company on Vencor" and "Note 3--Concentration of Credit Risk" to the Consolidated Financial Statements. Portfolio Overview The following information as of December 31, 1999 provides an overview of the Company's portfolio of health care properties, which primarily include skilled nursing facilities and hospitals operated by Vencor. For a description of the principal terms and provisions of the Master Leases, see "Business-- Relationship with Vencor--Master Lease Agreements," "--Recent Developments Regarding Vencor" and "--Other Recent Developments." <TABLE> <CAPTION> Year ended December 31, 1999 -------------------------------------------------------------------------- Percent of Percent of # of # of 1999 Original Investment Portfolio by Type Properties Beds/Units Revenue* Revenue* Investment Investment Per Bed - ----------------- ---------- ---------- -------- ---------- ---------- ---------- ---------- ($'s in thousands) <S> <C> <C> <C> <C> <C> <C> <C> Skilled Nursing Facilities............. 218 27,992 $136,423 59.7% $ 830,630 70.2% $29.7 Personal Care Facilities............. 8 136 734 0.3 7,137 0.6 52.5 Hospitals............... 45 4,171 91,443 40.0 344,780 29.2 82.7 --- ------ -------- ----- ---------- ----- Total................. 271 32,299 $228,600 100.0% $1,182,547 100.0% $36.6 === ====== ======== ===== ========== ===== ===== </TABLE> <TABLE> <CAPTION> Year ended December 31, 1999 -------------------------- Portfolio by Operator/Tenant* Revenue* Percentage* - ----------------------------- -------------- ----------- (In thousands) <S> <C> <C> Vencor................................................ $225,119 98.5% Other................................................. 3,481 1.5 -------- ----- Total............................................... $228,600 100.0% ======== ===== </TABLE> - -------- * Based on the stated contract rent, as opposed to amounts paid pursuant to the Stipulation, and without regard to write-offs. 51
The Company's portfolio is broadly diversified by geographic location with lease revenues from facilities in any one state comprising less than ten percent of the Company's revenues. In addition to the diversification of lease revenues from the geographic diversification of the portfolio, the majority of the Company's facilities are located in states that have certificate of need requirements. Certain states require state approval for development and expansion of health care facilities and services, including findings of need for additional or expanded health care facilities or services. A certificate of need ("CON"), which is issued by governmental agencies with jurisdiction over health care facilities, is at times required for expansion of existing facilities, construction of new facilities, addition of beds, acquisition of major items of equipment or introduction of new services. The CON rules and regulations may restrict an operator's ability to expand the Company's properties in certain circumstances. <TABLE> <CAPTION> Revenue Percentage -------------------- Skilled Nursing Certificate of Need States Facilities Hospitals - -------------------------- ---------- --------- <S> <C> <C> States with CON Requirement................................ 73.1% 58.3% States without CON Requirement............................. 26.9 41.7 ----- ----- 100.0% 100.0% ===== ===== </TABLE> Results of Operations The Company intends to qualify as a REIT for federal income tax purposes for the year ended December 31, 1999. No net provision for federal corporate income taxes has been made for the year ended December 31, 1999 in the accompanying Consolidated Financial Statements due to the Company's intention to qualify as a REIT and the existence of net operating losses. The financial results for the year ended December 31, 1999 are not comparable to the period from May 1, 1998 to December 31, 1998 due to the difference in the time periods covered and the omission of a net provision for income taxes in the 1999 financial statements due to the Company's intention to qualify as a REIT and the use of a portion of the Company's net operating loss carryforward. Year ended December 31, 1999 Rental income for the year ended December 31, 1999 was $228.6 million, of which $225.1 million was from leases with Vencor. Interest and other income totaled approximately $4.6 million, and was primarily the result of earnings from investment of cash and cash equivalents during the year. Expenses for the year ended December 31, 1999 totaled $190.7 million and included $42.7 million of depreciation expense on real estate assets and $88.8 million of interest on and costs relating to the Company's Bank Credit Agreement and other debt. Included in operating expenses was a charge to earnings of $34.4 million representing: (1) $18.8 million for an amount due from Vencor that approximates the $3.75 million per month difference for August 1999 through December 1999 between the minimum monthly base rent due the Company under the current terms of the Master Leases with Vencor and the minimum monthly base rent that would be due under leases based on the September 1999 Agreement in Principle; although the September 1999 Agreement in Principle provides for a rent reduction for May, June and July, as well, the Company has not recorded a reserve for such months, as it has already collected the full amount of minimum monthly base rent for such months, and has no current legal obligation to return such amounts; (2) a $15.1 million write-off of the balance of the unpaid minimum monthly base rent for August 1999 (in addition to the $3.75 million portion of the August 1999 Rent discussed above) that is a claim in the extended Vencor bankruptcy proceedings; during the fourth quarter of 1999, the Company has written off this amount as uncollectible based upon delays in discussions with Vencor and the Company's determination that such amount may be uncollectible if Vencor rejects the Master Leases or if a consensual or other plan of reorganization does not provide for the payment of August 1999 minimum monthly base rent; even if the proposed 52
Vencor plan of reorganization is consummated under the terms of the September 1999 Agreement in Principle, the Company may receive only $3.4 million which represents such $15.1 million, less $11.7 million representing the sum of (i) the $3.75 million per month "overpayment" of May through July 1999 rent and (ii) $0.45 million of rent prior to May 1, 1999 on a disputed facility; the Company has not recorded a reserve or write-off for the amount of $11.7 million because it is under no current legal obligation to return such amount. (See "--Liquidity and Capital Resources--Proposed Vencor Plan of Reorganization"); (3) a $0.2 million charge for rent due under a lease with Vencor which is under dispute (see "Business--Recent Developments Regarding Vencor"); and (4) a $0.3 million charge to earnings for rent and other items due from non-Vencor tenants. Of the total $34.4 million charge, the Company recorded a reserve for $7.5 million during the third quarter of 1999. An impairment loss of $1.9 million was recorded to write down a facility to its estimated fair value. See "Note 2--Real Estate Investments" to the Consolidated Financial Statements. The Company retains its legal rights to recover and collect all amounts due from Vencor and other tenants that have been written off, and intends in all instances to vigorously assert and enforce such legal rights. There can be no assurances, however, that the Company will be successful in its efforts. General and administrative expenses totaled $7.8 million and included an estimate for federal excise taxes payable related to the delayed payment of the distribution required under REIT regulations for 1999. Professional fees totaled approximately $12.5 million and included approximately $10.7 million in unusual professional fees (legal and financial advisory fees) incurred as a result of ongoing negotiations with Vencor and in connection with the Company's business strategy alternatives as discussed above in "Business--Recent Developments Regarding Vencor" and "Business-- Recent Developments Regarding Liquidity." Substantial legal and financial advisory expenses will continue to be incurred by the Company until a resolution of the Vencor matter is reached, although there can be no assurance that such a resolution will be reached. Included in interest expense is amortized deferred financing fees of approximately $6.0 million, which included $1.6 million of amortization for fees incurred in the fourth quarter of 1999 related to the extension of the maturity of the $275 million Bridge Loan facility from October 30, 1999 to February 28, 2000. See "Note 4-- Borrowing Arrangements" to the Consolidated Financial Statements. The Company also incurred $1.3 million in non-recurring employee severance costs in the first quarter of 1999. Net income for the year ended December 31, 1999 was $42.5 million, or $0.63 per diluted share. The Company anticipates that total revenue will decrease from 1999 levels in the future as a result of reduced rent receipts from Vencor as a result of the Stipulation and the Vencor restructuring plan, if implemented according to the terms of the September 1999 Agreement in Principle, and interest expense may increase as a result of the increased interest rate associated with the Amended Credit Agreement. See "Business--Recent Developments Regarding Vencor--The Stipulation" and "--Liquidity and Capital Resources." In connection with the 1998 Spin Off and the consummation of the Bank Credit Agreement, the Company entered into an interest rate swap agreement (on a notional amount of $875 million at December 31, 1999) to reduce the impact of changes in interest rates on the Company's floating rate debt. On August 4, 1999, the Company entered into an agreement with the interest rate swap agreement counterparty to shorten the maturity of the interest rate swap agreement from December 31, 2007 to June 30, 2003, in exchange for a payment in 1999 from the counterparty to the Company of $21.6 million. So long as the Company has debt in excess of $750 million, the Company will amortize the $21.6 million payment for financial accounting purposes in future periods beginning in July 2003 and ending in December 2007. On January 31, 2000, the Company further amended the swap agreement, pursuant to which the parties agreed, for purposes of certain calculations set forth in the swap agreement, to continue to use certain defined terms set forth in the Bank Credit Agreement. The Company incurred expenses totalling $6.0 million in 1999 related to the interest rate swap agreement which are included in interest expense. 53
The Period from May 1, 1998 to December 31, 1998 Rental revenue for the period from May 1, 1998 to December 31, 1998 totaled $149.9 million, of which $147.9 million resulted from leases with Vencor. Operating expenses totaled $94.2 million and included $28.7 million of depreciation expense on real estate assets and $59.4 million of interest on bank credit facilities and other debt. Interest expense also included $1.2 million in net payments on the interest rate swap agreement and $3.2 million in amortization and deferred financing fees. The Company also recorded a provision for income taxes of approximately $21.2 million for the period from May 1, 1998 to December 31, 1998. Income from operations was $34.8 million, or $0.51 per share. The Company incurred an extraordinary loss for the period from May 1, 1998 to December 31, 1998 of $8.1 million, or $0.12 per share, net of income taxes, related to the extinguishment of debt. Net income for the period from May 1, 1998 to December 31, 1998 was $26.8 million, or $0.39 per diluted share. Funds from Operations Funds from operations ("FFO") for the year December 31, 1999 totaled $85.0 million or $1.25 per diluted share. FFO for the period from May 1, 1998 to December 31, 1998 totaled $84.7 million, or $1.25 per diluted share. FFO for 1999 has been decreased for the aforementioned non-recurring employee severance costs, the unusual professional fees, the write-off of tenant receivables and the asset impairment expense. In calculating FFO for the period from May 1, 1998 to December 31, 1998, the Company has added back to net income the $21.2 million of income tax expense to be consistent with the 1999 presentation when no income taxes are assumed to be due because of the Company's intention to qualify as a REIT. FFO for the year ended December 31, 1999 and the period from May 1, 1998 to December 31, 1998 is summarized in the following table: <TABLE> <CAPTION> For the period from May 1, Year Ended 1998 to December 31, December 31, 1999 1998 ------------ -------------- (In thousands, except per share amounts) <S> <C> <C> Net income...................................... $42,535 $26,758 Extraordinary loss on extinguishment of debt.... -- 8,051 ------- ------- Income before extraordinary loss................ 42,535 34,809 Provision for income taxes...................... -- 21,151 Depreciation on real estate assets.............. 42,742 28,700 Realized gain on sale of asset.................. (254) -- ------- ------- Funds from operations........................... $85,023 $84,660 ======= ======= FFO per diluted share........................... $ 1.25 $ 1.25 ======= ======= </TABLE> The Company considers FFO an appropriate measure of performance of an equity REIT and the Company uses the National Association of Real Estate Investment Trusts NAREIT's definition of FFO. NAREIT defines FFO as net income (computed in accordance with generally accepted accounting principles ("GAAP")), excluding gains (or losses) from debt restructuring and sales of property, plus depreciation for real estate assets, and after adjustments for unconsolidated partnerships and joint ventures. FFO presented herein is not necessarily comparable to FFO presented by other real estate companies due to the fact that not all real estate companies use the same definition. FFO should not be considered as an alternative to net income (determined in accordance with GAAP) as an indicator of the Company's financial performance or as an alternative to cash flow from operating activities (determined in accordance with GAAP) as a measure of the Company's liquidity, nor is FFO necessarily indicative of sufficient cash flow to fund all of the Company's needs. The Company believes that in order to facilitate a clear understanding of the consolidated historical operating results of the Company, FFO should be examined in conjunction with net income as presented in the Consolidated Financial Statements and data included elsewhere in this Form 10-K. 54
Asset/Liability Management Asset/liability management is a key element of the Company's overall risk management program. The objective of asset/liability management is to support the achievement of business strategies while maintaining appropriate risk levels. The asset/liability management process focuses on a variety of risks, including market risk (primarily interest rate risk) and credit risk. Effective management of these risks is an important determinant of the absolute levels and variability of FFO and net worth. The following discussion addresses the Company's integrated management of assets and liabilities, including the use of derivative financial instruments. The Company does not use derivative financial instruments for speculative purposes. Market Risk The following discussion of the Company's exposure to various market risks contains "forward looking statements" that involve risks and uncertainties. These projected results have been prepared utilizing certain assumptions considered reasonable in light of information currently available to the Company. Nevertheless, because of the inherent unpredictability of interest rates as well as other factors, actual results could differ materially from those projected in such forward looking information. The Company earns revenue by leasing its assets under leases that primarily are long-term triple net leases in which the rental rate is generally fixed with annual escalators, subject to certain limitations. The Company's debt obligations are floating rate obligations whose interest rate and related monthly interest payments vary with the movement in LIBOR. See "Note 4-- Borrowing Arrangements" to the Consolidated Financial Statements. The general fixed nature of the Company's assets and the variable nature of the Company's debt obligations creates interest rate risk. If interest rates were to rise significantly, the Company's lease revenue might not be sufficient to meet its debt obligations. In order to mitigate this risk, at or about the date the Company spun off its health care operations in connection with the 1998 Spin Off, it also entered into an interest rate swap to effectively convert most of its floating rate debt obligations to fixed rate debt obligations. Interest rate swaps generally involve the exchange of fixed and floating rate interest payments on an underlying notional amount. As of December 31, 1999, the Company had an $875 million interest rate swap outstanding with a highly rated counterparty in which the Company pays a fixed rate of 5.985% and receives LIBOR from the counterparty. The interest rate swap agreement originally was in a notional amount of $1 billion and would have expired in varying amounts on December 31 of each year through December 31, 2007. On August 4, 1999, the Company entered into an agreement with the interest rate swap agreement counterparty to shorten the maturity of the interest rate swap agreement from December 31, 2007 to June 30, 2003, in exchange for a payment from the counterparty to the Company of $21.6 million. The notional amount of the interest rate swap agreement is scheduled to decline as follows: <TABLE> <CAPTION> Amount Date ------------ ----------------- <S> <C> $875,000,000 December 31, 1999 850,000,000 December 31, 2000 800,000,000 December 31, 2001 775,000,000 December 31, 2002 -- June 30, 2003 </TABLE> When interest rates rise the interest rate swap agreement increases in fair value to the Company and when interest rates fall the interest rate swap agreement declines in value to the Company. As of December 31, 1999, interest rates had risen and the interest rate swap agreement was in an unrealized gain position to the Company of approximately $20.4 million. As of December 31, 1998, interest rates had generally fallen, and the interest rate swap agreement was in an unrealized loss position to the Company of approximately $39.2 million. In addition, at December 31, 1999 the interest rate swap agreement expires in 2003, whereas at December 31, 1998 it expires in 2007. Generally, interest rate swap agreements with longer terms evidence greater dollar values of variation when interest rates change. To highlight the sensitivity of the interest rate swap agreement to changes 55
in interest rates, the following summary shows the effects of a hypothetical instantaneous change of 100 basis points (BPS) in interest rates as of December 31, 1999 and December 31, 1998: <TABLE> <CAPTION> 1999 1998 ------------- ------------- <S> <C> <C> Notional Amount.................................. $875,000,000 $900,000,000 Fair Value to the Company........................ $ 20,369,672 ($ 39,175,449) Fair Value to the Company Reflecting Change in Interest Rates -100 BPS....................................... ($ 2,857,857) ($ 95,222,331) +100 BPS....................................... $ 42,698,286 $ 13,493,122 </TABLE> The terms of this interest rate swap agreement require that the Company make a cash payment or otherwise post collateral to the counterparty if the fair value loss to the Company exceed certain levels (the "threshold levels"). See "Note 4--Borrowing Arrangements" to the Consolidated Financial Statements. The threshold levels vary based on the relationship between the Company's debt obligations and the tangible fair value of its assets as defined in the Bank Credit Agreement. As of December 31, 1999, the threshold level under the interest rate swap agreement was a fair value unrealized loss of $35 million and the interest rate swap agreement was in an unrealized gain position to the Company of $20.4 million. Under the interest rate swap agreement, if collateral must be posted, the principal amount of such collateral must equal the difference between the fair value unrealized loss of the interest rate swap agreement at the time of such determination and the threshold amount. On January 31, 2000, the Company entered into a letter agreement with the counterparty to the swap agreement for the purpose of amending the swap agreement. The letter agreement provides that, for purposes of certain calculations set forth in the swap agreement, the parties agree to continue to use certain defined terms set forth in the Bank Credit Agreement. As of December 31, 1999, the interest rate swap agreement was in an unrealized gain position, and therefore no collateral was required to be posted under the interest rate swap agreement. As of December 31, 1998, the threshold level under the interest rate swap agreement was a market value loss of $35.0 million and the interest rate swap agreement was in an unrealized loss position to the Company of $39.2 million. As of December 31, 1998, the Company had a letter of credit outstanding as posted collateral under the interest rate swap agreement in the amount of $10.9 million, which reduced the availability of the Company's revolving line of credit under the Bank Credit Agreement as of that date by a similar amount. The differences in the Company's market risk exposure relating to the interest rate swap agreement at December 31, 1999 and December 31, 1998 were caused by fluctuations in interest rates and by the changes in the notional amount and maturity of the interest rate swap agreement effected in August 1999. Credit Risk The Company monitors credit risk under its lease agreements with its tenants by monitoring publicly available financial information, discussions with its tenants and review of information otherwise available to the Company. Pursuant to the 1998 Spin Off, the Company has a significant concentration of credit risk under its Master Leases. For the year ended December 31, 1999 and for the period from May 1, 1998 to December 31, 1998, lease revenues from Vencor comprised $225.1 million or 98.5% ($191.0 million or 98.3%, net of write-offs) and $147.9 million, or approximately 98.7%, respectively, of the Company's total lease revenues of $228.6 million ($194.2 million after write-offs) for the year ended December 31, 1999 and $149.9 million for the period from May 1, 1998 to December 31, 1998. Accordingly, Vencor's financial condition and ability to meet its rent obligations will determine the Company's revenues and its ability to make distributions to its stockholders. The operations of Vencor have been negatively impacted by changes in reimbursement rates, by its current level of indebtedness and by certain other factors. Vencor filed for protection under the Bankruptcy Code on September 13, 1999, and the Stipulation entered into by Vencor and the Company currently governs the rental payments to be made under the Master Leases. In addition, certain other tenants of the Company have filed for bankruptcy. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Background Information" and "Business--Risk Factors--Effects of Bankruptcy Proceedings" and "--Governmental Regulation." In addition, any failure by Vencor to effectively conduct its operations could have a material adverse effect on its business reputation or on its ability to enlist and maintain patients in its facilities. There can be no assurance that Vencor will have sufficient assets, income and access to financing to enable it to satisfy its obligations under the Master Leases. Since the Company derives in excess of 98% of its revenues from Vencor 56
and since the Master Leases are triple-net leases under which Vencor is responsible for all insurance, taxes and maintenance and repair expenses required in connection with the leased properties, the inability of Vencor to satisfy its obligations under the Master Leases would have a material adverse effect on the condition of the leased properties, as well as a Material Adverse Effect on the Company. See "Business--Federal Income Tax Considerations" and "--Risk Factors--Dependence on Vencor." Liquidity and Capital Resources Liquidity Cash provided by operations totaled $103.6 million for the year ended December 31, 1999 and $86.8 million for the period from May 1, 1998 to December 31, 1998. Net cash provided by investing activities for the year ended December 31, 1999 totaled $0.4 million. Net cash used in investing activities was $0.9 million for the period from May 1, 1998 to December 31, 1998. Net cash provided by financing activities totaled $35.3 million for the year ended December 31, 1999 and net cash used in financing activities totaled $85.5 million for the period from May 1, 1998 to December 31, 1998. Cash provided by financing activities for the year ended December 31, 1999 resulted primarily from borrowings under the Company's revolving line of credit and from a payment received in connection with the shortening of the Company's interest rate swap, net of dividends paid. The Company had cash and cash equivalents as of March 17, 2000 of $129.9 million which reflects: (1) receipt on February 3, 2000 of a $26.6 million federal tax refund from the Internal Revenue Service; (2) receipt of rent; and (3) a $50.0 million principal payment on the Company's Amended Credit Agreement in January 2000. See "Business--Recent Developments Regarding Liquidity" and "Business--The 1998 Spin Off--Tax Allocation Agreement." Credit Facility In connection with the 1998 Spin Off, the Company refinanced substantially all of its long-term debt. In connection with the refinancing arrangements, the Company entered into the Bank Credit Agreement and retained approximately $6.0 million of prior debt obligations. Borrowings under the Bank Credit Agreement bore interest at an applicable margin over an interest rate selected by the Company. Such interest rate could be either the "Base Rate," which is the higher of the prime rate or the federal funds rate, plus 50 basis points, or LIBOR. As of December 31, 1999, all borrowings were designated as LIBOR borrowings. The applicable margin on borrowings varied based on the type of borrowing and the Company's ratio of indebtedness to the tangible fair value of its assets. Borrowings under the Bank Credit Agreement were comprised of: (i) a three year $250.0 million Revolving Credit Facility priced at LIBOR plus 2.00% to 2.50% or the Base Rate plus 1.00% to 1.50% (the "Revolving Credit Facility"), (ii) a $200.0 million Term A Loan payable in various installments over three years priced at LIBOR plus 2.25% to 2.50%, or the Base Rate plus 1.25% to 1.50% (iii) a $350.0 million Term B Loan payable in various installments over five years priced at LIBOR plus 2.75% to 3.00%, or the Base Rate plus 1.75% to 2.00% and (iv) a $275.0 million term loan originally due on October 30, 1999 (the "Bridge Loan") and extended to February 28, 2000 as described below, priced at LIBOR plus 2.75% to 3.00%, or the Base Rate plus 1.75% to 2.00%. For the period from May 1, 1998 to December 31, 1998, the Company paid $12.0 million in financing fees related to establishing and maintaining the Bank Credit Agreement. The Bank Credit Agreement was secured by a pledge of the Company's direct and indirect partnership interests in Ventas Realty and contained various covenants and restrictions. As of December 31, 1999, the outstanding balances under the Bank Credit Agreement amounted to $974.2 million. On January 31, 2000, the Company and all of the lenders under the Bank Credit Agreement entered into the Amended Credit Agreement, which amended and restated the Bank Credit Agreement. Under the Amended Credit Agreement, borrowings bear interest at an applicable margin over an interest rate selected by the Company. Such interest rate may be either (a) the Base Rate, which is the greater of (i) the prime rate or (ii) the federal funds rate plus 50 basis points, or (b) LIBOR. Borrowings under the Amended Credit Agreement are comprised of: (1) a new $25.0 million revolving credit line (the "Revolving Credit Line") that expires on December 31, 2002, which bears interest at either LIBOR plus 2.75% or the Base Rate plus 1.75%; (2) a $200.0 57
million term loan due December 31, 2002 (the "Tranche A Loan"), which bears interest at either LIBOR plus 2.75% or the Base Rate plus 1.75%; (3) a $300.0 million term loan due December 31, 2005 (the "Tranche B Loan"), which bears interest at either LIBOR plus 3.75% or the Base Rate plus 2.75%; and (4) a $473.4 million term loan due December 31, 2007 (the "Tranche C Loan"), which bears interest at either LIBOR plus 4.25% or the Base Rate plus 3.25%. The interest rate on the Tranche B Loan will reduce by .50% (50 basis points) once $150.0 million of the Tranche B Loan has been repaid. The Amended Credit Agreement requires the following amortization: (a) with respect to the Tranche A Loan, (i) $50.0 million of the Tranche A Loan was paid at closing on January 31, 2000, (ii) $50.0 million is due within 30 days after the Vencor Effective Date, and (iii) thereafter all Excess Cash Flow (as defined in the Amended Credit Agreement) of the Company will be applied to the Tranche A Loan until $200.0 million in total has been paid down on the Amended Credit Agreement, with the balance if any due December 31, 2002; (b) with respect to the Tranche B Loan, (i) after the $50.0 million paydown on the Tranche A Loan to be made within 30 days after the Vencor Effective Date and after consideration of other cash needs of the Company, a one-time paydown of Excess Cash (as defined in the Amended Credit Agreement) and (ii) scheduled paydowns of $50.0 million on December 31, 2003 and December 31, 2004, with the balance due December 31, 2005; and (c) with respect to the Tranche C Loan, no scheduled paydowns with a final maturity of December 31, 2007. The facilities under the Amended Credit Agreement are pre-payable without premium or penalty. During the first quarter of 2000, the Company will incur an extraordinary loss of approximately $4.2 million relating to the write-off of the unamortized deferred financing costs associated with the Bank Credit Agreement. On October 29, 1999, in conjunction with the execution of the Waiver and Extension Agreement, the Company paid a $2.4 million loan waiver fee. In connection with the consummation of the Amended Credit Agreement on January 31, 2000, the Company paid a $7.3 million loan restructuring fee. The fees are being amortized proportionately over the terms of the related loans and agreements. The Amended Credit Agreement is secured by liens on substantially all of the Company's real property and any related leases, rents and personal property. Certain properties are being held in escrow by counsel for the agents under the Amended Credit Agreement pending the receipt of third party consents and/or resolution of certain other matters. In addition, the Amended Credit Agreement contains certain restrictive covenants, including, but not limited to, the following: (a) until such time that $200.0 million in principal amount has been paid down, the Company can pay REIT dividends based on a certain minimum percentage of its taxable income (currently equal to 95 percent of its taxable income for the year ended December 31, 1999 and the year ending December 31, 2000 and 90 percent of its taxable income for years ending on or after December 31, 2001); however, after $200.0 million in total principal paydowns, the Company will be allowed to pay dividends for any year in amounts up to 80 percent of FFO, as defined in the Amended Credit Agreement; (b) limitations on additional indebtedness, acquisitions of assets, liens, guarantees, investments, restricted payments, leases and affiliate transactions; (c) limitations on capital expenditures; (d) certain financial covenants, including requiring that the Company have (i) $50.0 million in cash and cash equivalents on hand at the Vencor Effective Date; (ii) no more than $1.1 billion of total indebtedness on the Vencor Effective Date; and (iii) at least $99.0 million of Projected Consolidated EBITDA, as defined in the Amended Credit Agreement, for the 270 day period beginning in the first month following the Vencor Effective Date. The Amended Credit Agreement does not contain any financial covenants that are applicable to the Company prior to the Vencor Effective Date, and provides, among other things, that no action taken by any person in the Vencor bankruptcy case (other than by the Company and its affiliates) shall be deemed to constitute or result in a "Material Adverse Effect," as defined in the Amended Credit Agreement. In addition, the Amended Credit Agreement provides that if the Company is in compliance with its financial covenants and the covenant relating to releases in the Vencor bankruptcy on the Vencor Effective Date, no event or condition arising 58
primarily from the Vencor plan of reorganization shall be deemed to have caused a "Material Adverse Effect," as defined in the Amended Credit Agreement to have occurred. Under the terms of the Amended Credit Agreement, however, an event of default is deemed to have occurred if the Vencor Effective Date does not occur on or before December 31, 2000. Interest Rate Swap In connection with the 1998 Spin Off, the Company entered into an interest rate swap agreement to reduce the impact of changes in interest rates on its floating rate debt obligations. See "--Asset/Liability Management--Market Risk." The interest rate swap resulted in a net increase in interest expense during 1999 of $6.0 million. See "--Results of Operations--Year Ended December 31, 1999." The fair value of the interest rate swap agreement is not recognized in the Consolidated Financial Statements. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Asset/Liability Management" and "Note 4--Borrowing Arrangements" to the Consolidated Financial Statements. Dividends In order to qualify as a REIT, the Company must make annual distributions to its stockholders of at least 95% of its "REIT taxable income" (excluding net capital gain). The Company intends to qualify as a REIT for the year ending December 31, 1999. Although such qualification requires the Company to distribute 95% of its taxable income by September 15, 2000, the Company announced on each of May 14, 1999, July 21, 1999, and November 1, 1999, that it would not declare or pay a dividend in the second, third or fourth quarter of 1999, respectively. The Company expects to pay a dividend for 1999 equal to 95% of its taxable income, less dividends paid in February 1999 of approximately $26.5 million. The Company expects to make the remaining required dividend payments for 1999 in 2000. The 1999 dividend may be satisfied by a combination of cash and a distribution of Vencor equity, which the Company expects to receive as part of the Vencor reorganization, if it occurs, or other property or securities. Since such distributions were not made by January 31, 2000, the Company is required to pay a 4% non-deductible excise tax on the portion of the distribution not paid by January 31, 2000. It is expected that the Company's REIT taxable income will be less than its cash flow due to the allowance of depreciation and other non-cash deductions in computing REIT taxable income. Accordingly, the Company anticipates that it generally will have sufficient cash or liquid assets to enable it to satisfy the 95% (90% for taxable years beginning after December 31, 2000) distribution requirement. It is possible, however, that the Company, from time to time, may not have sufficient cash or other liquid assets to meet the 95% (90% for taxable years beginning after December 31, 2000) distribution requirement or to distribute such greater amount as may be necessary to avoid income and excise taxation. See "Business--Risk Factors--Risks Associated with REIT Status--Inability to Maintain Required Distributions," "Market for Registrant's Common Equity and Related Stockholder Matters" and "Business-- Federal Income Tax Considerations." Capital Expenditures and Property Acquisitions Capital expenditures to maintain and improve the leased properties generally will be incurred by the tenants. Accordingly, the Company does not believe that it will incur any major expenditures in connection with the leased properties. After the terms of the leases expire, or in the event that the tenants are unable to meet their obligations under the leases, the Company anticipates that any expenditures for which it may become responsible to maintain the leased properties will be funded by cash flows from operations or through additional borrowings. To the extent that unanticipated expenditures or significant borrowings are required, the Company's liquidity may be affected adversely. The Company's ability to make expenditures and borrow funds is restricted by the terms of the Amended Credit Agreement. Any such capital expenditures or borrowings would likely require the consent of the "Required Lenders" under the Amended Credit Agreement, and there can be no assurance that such consent would be obtained. 59
The Company invested $14.6 million during the period from May 1, 1998 to December 31, 1998 to acquire health care-related properties. The properties purchased included two skilled nursing facilities and eight personal care facilities. One of the properties acquired was a skilled nursing facility purchased from Vencor under the Development Agreement for $6.2 million in the third quarter of 1998. The Company did not acquire any properties in 1999 and does not currently intend to acquire any additional properties in 2000. Effect of Vencor Bankruptcy The Company leases substantially all its properties to Vencor and, therefore, Vencor is the primary source of the Company's revenues. Vencor filed for protection under Chapter 11 of the Bankruptcy Code on September 13, 1999. Vencor's financial condition and ability to satisfy its rent obligations under the Master Leases and its obligations under the other Spin Agreements will impact the Company's revenues and could have a Material Adverse Effect on the Company. See "Business--Recent Developments Regarding Vencor" and "--Risk Factors--Dependence of the Company on Vencor" and "--Risk Factors--Effects of Bankruptcy Proceedings." Other The Company loaned, with interest provisions, approximately $3.6 million, net of repayments, to certain current and former executive officers of the Company to finance the income taxes payable by them as a result of the 1998 Spin Off. The loans are payable over a ten year period. In connection with the 1998 Spin Off, the Company also received newly issued Vencor Series A Non-Voting Convertible Preferred Stock. The Company sold the preferred stock to certain of its employees at the time, which includes both current Vencor employees and current and former employees of the Company, for $17.7 million and used the proceeds to repay long-term debt. In addition to Vencor, certain of the Company's other tenants have filed for protection under the Bankruptcy Code. In addition, the Company recently experienced a casualty of unknown origin at one of its facilities. Such filings and casualty could have a Material Adverse Effect on the Company. See "Business--Other Recent Developments" and "Note 9--Commitments and Contingencies" to the Consolidated Financial Statements. Proposed Vencor Plan of Reorganization See "Business--Recent Developments Regarding Vencor" for a discussion of the proposed Vencor Plan of Reorganization. Year 2000 The year 2000 ("Y2K") issue is a result of computer programs and embedded computer chips using two digits rather than four digits to define the applicable year. Without corrective action, computer programs and embedded chips potentially could recognize the date ending in "00" as the year 1900 (or some other year) rather than 2000, causing many computer applications to fail or to create erroneous results. The Company's information technology systems ("IT") and non-IT systems such as building infrastructure components (e.g., elevators, alarm systems, electrical systems and other systems) are affected by the Y2K issue. The Company has funded Y2K compliance efforts from cash flow from operations and, other than the transactions described below, has not incurred any significant costs to date related to Y2K issues. To date, there has been no material negative impact on the Company's results of operation or financial condition as a result of its Y2K compliance efforts. In January 1999, the Company purchased a new file server and converted to a new financial information system platform that is Y2K compliant. That conversion was completed during the first quarter of 1999. The Company acquired a fixed asset system that is Y2K compliant, which was installed in December 1999. The Company has received certification from all of its significant software and operating systems vendors that the 60
versions of their products currently being installed are Y2K compliant. The Company has not and does not anticipate independently verifying such compliance, but it has not been advised of any material Y2K problems by any such vendors to date. The Company does not anticipate any significant additional costs related to Y2K for its administrative systems. The Company also has Y2K exposure in non-IT applications with respect to its real estate properties. Computer technology employed in elevators, alarm systems, electrical systems, built-in health care systems and similar applications involved in the operations of the Company's properties may cause interruptions of service with respect to those properties. Under the terms of the Master Leases, Vencor is responsible for upgrading all building infrastructure components to be Y2K compliant in the facilities that it leases. If Vencor is unable to meet its Y2K compliance schedules or incurs costs substantially higher than its current expectations, Vencor's ability to operate the properties and/or make rental payments under the Master Leases could be impaired, which could result in a Material Adverse Effect on the Company. To date, Vencor has not advised the Company of any material Y2K problems. Vencor derives a substantial portion of its revenues from the Medicare and Medicaid programs. Vencor relies on these entities for accurate and timely reimbursement of claims, often through the use of electronic data interfaces. Vencor has indicated that it believes that while many commercial insurance carriers will be Y2K compliant, federal and state agencies are more likely to have system failures caused by Y2K issues. The failure of information systems of federal and state governmental agencies, other third party payors or suppliers could have a material adverse effect on Vencor's liquidity and financial condition, which in turn could have a Material Adverse Effect on the Company. To date, the Company has not been advised of any material impact on Vencor's results of operation and financial condition related to Y2K problems. Item 7A. Quantitative and Qualitative Disclosures About Market Risk For a discussion of certain quantitative and quantitative disclosures about market risk see "Management's Discussion and Analysis of Financial Condition and Results of Operations--Asset/Liability Management." Item 8. Financial Statements and Supplementary Data Financial statements and financial statement schedules required to be filed by this Item 8 are set forth following the index page at page F-1. Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure Not applicable. PART III Items 10, 11, 12 and 13. Directors and Executive Officers of the Registrant; Executive Compensation; Security Ownership of Certain Beneficial Owners and Management; and Certain Relationships and Related Transactions The information required by these Items is incorporated by reference from the definitive proxy statement to be filed by the Company pursuant to Regulation 14A not later than 120 days after the end of the fiscal year covered by this Form 10-K which includes the required information; however, certain information required by Item 10 is included in "Business--Executive Officers of the Registrant" and in "Note 13--Related Party Transactions" to the Consolidated Financial Statements." 61
PART IV Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K (a) Exhibits: <TABLE> <CAPTION> Exhibit Number Description of Document ------- ----------------------- <C> <S> 3.1.1(a) Certificate of Incorporation of the Company, as amended. 3.1.2(b) Certificate of Amendment to Certificate of Incorporation of the Company. 3.2(c) Third Amended and Restated Bylaws of the Company. 4.1(d) Specimen Common Stock Certificate. 4.2.1(e) Amended and Restated Credit, Security, Guaranty and Pledge Agreement, by and among Ventas Realty, Limited Partnership, a Delaware limited partnership, as borrower thereunder, each of the Company and Ventas LP Realty, L.L.C., a Delaware limited liability company, as guarantors, each of the Lenders therein named, Bank of America, N.A., as Administrative Agent, and Morgan Guaranty Trust Company of New York, as Documentation Agent, dated as of January 31, 2000. 4.2.2(f) Assignment of Leases and Rents, dated as of January 31, 2000, from Ventas Realty, Limited Partnership, Assignor, to Bank of America, N.A., as Administrative Agent, Assignee, with respect to Facility no. 111 located at Rolling Hills Health Care Center, 36255 St. Joseph Road, New Albany, Indiana (Floyd County). 4.2.3(g) Mortgage, Open End Mortgage, Deed of Trust, Trust Deed, Deed to Secure Debt, Credit Line Deed of Trust, Assignment of Leases and Rents, Security Agreement and Financing Statement, dated as of January 31, 2000, between Ventas Realty, Limited Partnership, Mortgagor/Trustor/Grantor/Debtor, to Bank of America, N.A., as Administrative Agent, Mortgagee/Beneficiary/Grantee/Secured Party, with respect to Facility no. 111 located at Rolling Hills Health Care Center, 36255 St. Joseph Road, New Albany, Indiana (Floyd County). 4.2.4(h) Schedule of Agreements Substantially Identical in all Material Respects to Agreements filed as Exhibits 4.2.2 and 4.2.3 to this filing, pursuant to Instruction 2 to Item 601 of Regulation S-K. 4.3.1(i) Rights Agreement, dated as of July 20, 1993, between the Company and National City Bank, as Rights Agent. 4.3.2(j) First Amendment to Rights Agreement, dated as of August 11, 1995, between the Company and National City Bank, as Rights Agent. 4.3.3(k) Second Amendment to Rights Agreement, dated February 1, 1998, between the Company and National City Bank, as Rights Agent. 4.3.4(l) Third Amendment to Rights Agreement, dated July 27, 1998, between the Company and National City Bank, as Rights Agent. 4.3.5(m) Fourth Amendment to Rights Agreement, dated as of April 15, 1999, between the Company and National City Bank, as Rights Agent. 4.3.6(n) Fifth Amendment to Rights Agreement, dated as of December 15, 1999, between the Company and National City Bank, as Rights Agent. 10.1(o)* Directors and Officers Insurance and Company Reimbursement Policies. 10.2(p)* Form of Ventas, Inc. Promissory Note. 10.3(q)* Amendment to Promissory Note entered into as of December 31, 1998 by and between Ventas Realty, Limited Partnership and W. Bruce Lunsford. 10.4.1(r) Form of Agreement and Plan of Reorganization between the Company and Vencor, Inc. </TABLE> 62
<TABLE> <CAPTION> Exhibit Number Description of Document ------- ----------------------- <C> <S> 10.4.2(s) Form of Distribution Agreement between Vencor, Inc. and the Company. 10.4.3(t) Form of Development Agreement between Vencor, Inc. and the Company. 10.4.4(u) Form of Participation Agreement between Vencor, Inc. and the Company. 10.4.5(v) Tax Allocation Agreement, dated as of April 30, 1998, by and between the Company and Vencor, Inc. 10.4.6(w) Agreement of Indemnity--Third Party Leases, dated April 30, 1998, by and between Vencor, Inc. and its subsidiaries and the Company. 10.4.7(x) Agreement of Indemnity--Third Party Contracts, dated April 30, 1998, by and between Vencor, Inc. and its subsidiaries and the Company. 10.5.1(y) Form of Master Lease Agreement between Vencor, Inc. and the Company. 10.5.2(z) Form of Amendment to Master Lease Agreement between Vencor, Inc. and the Company. 10.5.3(aa) Form of Second Amendment to Master Lease, dated April 12, 1999, between the Company and Vencor, Inc. 10.6.1(bb)* Form of Employment Agreement, dated as of July 31, 1998, between Ventas, Inc. and each of W. Bruce Lunsford and Thomas T. Ladt. 10.6.2(cc)* Amendment to Employment Agreement entered into as of December 31, 1998 by and between Ventas, Inc. and W. Bruce Lunsford. 10.6.3(dd)* Separation Agreement and Release of Claims dated as of March 5, 1999 between Ventas, Inc. and Thomas L. Ladt. 10.7(ee)* Separation and Release Agreement, dated February 29, 2000, between Ventas, Inc. and Steven T. Downey. 10.8(ff)* Employment Agreement, dated as of July 31, 1998, between Ventas, Inc. and T. Richard Riney. 10.9(gg)* Employment Agreement, dated as of January 13, 1999, between Ventas, Inc. and John Thompson. 10.10.1(hh)* 1987 Non-Employee Directors Stock Option Plan. 10.10.2(ii)* Amendment to the 1987 Non-Employee Directors Stock Option Plan, dated April 30, 1998. 10.11.1(jj)* 1987 Incentive Compensation Program. 10.11.2(kk)* Amendment to the 1987 Incentive Compensation Program, dated May 15, 1991. 10.11.3(ll)* Amendments to the 1987 Incentive Compensation Program, dated May 18, 1994. 10.11.4(mm)* Amendment to the 1987 Incentive Compensation Program, dated February 15, 1995. 10.11.5(nn)* Amendment to the 1987 Incentive Compensation Program, dated September 27, 1995. 10.11.6(oo)* Amendment to the 1987 Incentive Compensation Program, dated May 15, 1996. 10.11.7(pp)* Amendment to 1987 Incentive Compensation Program, dated April 30, 1998. 10.11.8(qq)* Amendment to the 1987 Incentive Compensation Program, dated December 31, 1998. 10.12.1(rr)* 1997 Incentive Compensation Plan, dated December 31, 1996. 10.12.2(ss)* Amendment No. 1, dated May 8, 1997, to the 1997 Incentive Compensation Plan. 10.12.3(tt)* Amendment to the 1997 Incentive Compensation Plan, dated April 30, 1998. 10.12.4(uu)* Amendment to the Ventas, Inc. 1997 Incentive Compensation Plan, dated December 31, 1998. 10.12.5* Amendment to the Ventas, Inc. 1997 Incentive Compensation Plan dated March 5, 1999. 10.13.1(vv)* 1997 Stock Option Plan for Non-Employee Directors, dated December 31, 1996. 10.13.2(ww)* Amendment to the 1997 Stock Option Plan for Non-Employee Directors, dated April 30, 1998. </TABLE> 63
<TABLE> <CAPTION> Exhibit Number Description of Document ------- ----------------------- <C> <S> 10.14.1(xx)* TheraTx, Incorporated Amended and Restated 1994 Stock Option/Stock Issuance Plan, as amended. 10.14.2(yy)* Amendment to the TheraTx, Incorporated Amended and Restated 1994 Stock Option/Stock Issuance Plan. 10.15(zz)* TheraTx, Incorporated 1996 Stock Option/Stock Issuance Plan. 10.16(aaa)* 1989 Amended and Restated Stock Option Plan of Helian Health Group, Inc. ("Helian"). 10.17.1(bbb)* Form of Ventas, Inc., formerly known as Vencor, Inc., Change-in- Control Severance Agreement. 10.17.2(ccc)* Amendment No. 1 to Change-in-Control Severance Agreement entered into as November 19, 1997 between the Company and W. Bruce Lunsford. 10.17.3(ddd)* Amendment No. 2 to Change-in-Control Severance Agreement entered into as of December 31, 1998 by and between the Company and W. Bruce Lunsford. 10.17.4(eee)* Form of Amendment to Change-in-Control Severance Agreement, dated as of September 30, 1999, between Ventas, Inc. and each of Steven T. Downey, T. Richard Riney and John C. Thompson. 10.18(fff) Form of Indemnification Agreement for directors of TheraTx. 10.19(ggg) Form of Assignment and Assumption of Lease Agreement between Hillhaven and certain subsidiaries, on the one hand, and Tenet and certain subsidiaries on the other hand, together with the related Guaranty by Hillhaven, dated on or prior to January 31, 1990. 10.20 Amended and Restated Guarantee Reimbursement Agreement dated as of April 28, 1998 among Vencor, Inc., Vencor Healthcare, Inc. and Tenet Healthcare Corporation, Inc. 10.21(hhh) Employment Agreement, dated March 5, 1999, between the Company and Debra A. Cafaro. 10.22(iii) Stipulation and Order by and among Vencor Inc., Vencor Operating Inc. and Vencor Nursing Centers Limited Partnership and Ventas, Inc. and Ventas Realty Limited Partnership, dated as of September 13, 1999. 10.23(jjj) Form of Amendment to Employment Agreement, dated as of September 30, 1999, between Ventas, Inc. and each of Steven T. Downey, T. Richard Riney and John C. Thompson. 10.24(kkk) First Amended and Restated Agreement of Limited Partnership, executed and delivered by the Company and Ventas LP Realty, L.L.C., dated as of January 31, 2000. 11 Statement regarding computation of per share earnings. 21(lll) Subsidiaries of the Company. 23 Consent of Independent Auditors. 27 Financial Data Schedule. </TABLE> - -------- * Compensatory plan or arrangement required to be filed as an exhibit pursuant to Item 14(c) of Form 10-K. (a) Incorporated herein by reference to Exhibit 3 to the Company's Form 10-Q for the quarterly period ended September 30, 1995. (b) Incorporated herein by reference to Exhibit 3.1 to the Company's Form 10-Q for the quarterly period ended June 30, 1998. (c) Incorporated herein by reference to Exhibit 3.2 to the Company's Form 10-K for the year ended December 31, 1997. (d) Incorporated herein by reference to Exhibit 4.1 to the Company's Form 10-K for the year ended December 31, 1998. (e) Incorporated herein by reference to Exhibit 10.1 to the Company's Form 8-K filed February 8, 2000. (f) Incorporated herein by reference to Exhibit 10.1.1 to the Company's Form 8-K filed March 8, 2000. (g) Incorporated herein by reference to Exhibit 10.1.2 to the Company's Form 8-K filed March 8, 2000. 64
(h) Incorporated herein by reference to Exhibit 10.1.3 to the Company's Form 8- K filed March 8, 2000. (i) Incorporated herein by reference to Exhibit 1 to the Company's Registration Statement on Form 8-A. (j) Incorporated herein by reference to Exhibit 2 to the Company's Registration Statement on Form 8-A/A. (k) Incorporated herein by reference to Exhibit 1 to the Company's Registration Statement on Form 8-A/A. (l) Incorporated herein by reference to Exhibit 1 to the Company's Registration Statement on Form 8-A12B/A. (m) Incorporated herein by reference to Exhibit 1 to the Company's Form 8-A/A, filed on April 19, 1999. (n) Incorporated herein by reference to Exhibit 1 to the Company's Registration Statement on Form 8-A12B/A, filed on December 22, 1999. (o) Incorporated herein by reference to Exhibit 10.1 to the Company's Form 10-K for the year ended December 31, 1995. (p) Incorporated herein by reference to Exhibit 10.3 to the Company's Form 10-Q for the quarterly period ended June 30, 1998. (q) Incorporated herein by reference to Exhibit 10.4 to the Company's Form 10-K for the year ended December 31, 1998. (r) Incorporated herein by reference to Exhibit 10.6 to the Company's Form 10-K for the year ended December 31, 1998. (s) Incorporated herein by reference to Exhibit 10.7 to the Company's Form 10-K for the year ended December 31, 1998. (t) Incorporated herein by reference to Exhibit 10.10 to the Company's Form 10- K for the year ended December 31, 1998. (u) Incorporated herein by reference to Exhibit 10.11 to the Company's Form 10- K for the year ended December 31, 1998. (v) Incorporated herein by reference to Exhibit 10.9 to the Company's Form 10-Q for the quarterly period ended June 30, 1998. (w) Incorporated herein by reference to Exhibit 10.11 to the Company's Form 10- Q for the quarterly period ended June 30, 1998. (x) Incorporated herein by reference to Exhibit 10.12 to the Company's Form 10- Q for the quarterly period ended June 30, 1998. (y) Incorporated herein by reference to Exhibit 10.8 to the Company's Form 10-K for the year ended December 31, 1998. (z) Incorporated herein by reference to Exhibit 10.9 to the Company's Form 10-K for the year ended December 31, 1998. (aa) Incorporated herein by reference to Exhibit 99.1 to the Company's 8-K filed April 12, 1999. (bb) Incorporated herein by reference to Exhibit 10.2 to the Company's Form 10- Q for the quarterly period ended September 30, 1998. (cc) Incorporated herein by reference to Exhibit 10.17 to the Company's Form 10-K for the year ended December 31, 1998. (dd) Incorporated herein by reference to Exhibit 10.21 to the Company's Form 10-K for the year ended December 31, 1998 (ee) Incorporated herein by reference to Exhibit 10.2 to the Company's Form 8-K filed March 8, 2000. (ff) Incorporated herein by reference to Exhibit 10.4 to the Company's Form 10- Q for the quarterly period ended September 30, 1998. (gg) Incorporated herein by reference to Exhibit 10.20 to the Company's Form 10-K for the year ended December 31, 1998. (hh) Incorporated herein by reference to Exhibit 10.10 to the Company's Registration Statement on Form S-1. (ii) Incorporated herein by reference to Exhibit 10.14 to the Company's Form 10-Q for the quarterly period ended June 30, 1998. (jj) Incorporated herein by reference to Exhibit 10.9 to the Company's Registration Statement on Form S-1. (kk) Incorporated herein by reference to Exhibit 4.4 to the Company's Registration Statement on Form S-8. (ll) Incorporated herein by reference to Exhibit 10.13 to the Company's Form 10-K for the year ended December 31, 1994. 65
(mm) Incorporated herein by reference to Exhibit 10.14 to the Company's Form 10-K for the year ended December 31, 1994. (nn) Incorporated herein by reference to Exhibit 10.17 to the Company's Form 10-K for the year ended December 31, 1995. (oo) Incorporated herein by reference to Exhibit 10.19 to the Company's Form 10-K for the year ended December 31, 1996. (pp) Incorporated herein by reference to Exhibit 10.13 to the Company's Form 10-Q for the quarterly period ended June 30, 1998. (qq) Incorporated herein by reference to Exhibit 10.30 to the Company's Form 10-K for the year ended December 31, 1998. (rr) Incorporated herein by reference to Exhibit 10.23 to the Company's Form 10-K for the year ended December 31, 1996. (ss) Incorporated herein by reference to Exhibit 10.3 to the Company's Form 10-Q for the quarterly period ended June 30, 1997. (tt) Incorporated herein by reference to Exhibit 10.15 to the Company's Form 10-Q for the quarterly period ended June 30, 1998. (uu) Incorporated herein by reference to Exhibit 10.35 to the Company's Form 10-K for the year ended December 31, 1998. (vv) Incorporated herein by reference to Exhibit 10.25 to the Company's Form 10-K for the year ended December 31, 1996. (ww) Incorporated herein by reference to Exhibit 10.16 to the Company's Form 10-Q for the quarterly period ended June 30, 1998. (xx) Incorporated herein by reference to Exhibit 10.7 to the Registration Statement on Form S-1 of TheraTx. (yy) Incorporated herein by reference to Exhibit 4.7 to the Company's Registration Statement on Form S-8. (zz) Incorporated herein by reference to Exhibit 99.1 to the Registration Statement on Form S-8 of TheraTx. (aaa) Incorporated herein by reference to Exhibit 10.47 to the Registration Statement on Form S-8 of Helian (reg. No. 33-31520), Amendment No. 2 thereto filed November 21, 1989 and Post-Effective Amendment No. 1 and No. 2 thereto filed November 22, 1990 and January 16, 1991. (bbb) Incorporated herein by reference to Exhibit 10.32 to the Company's Form 10-K for the year ended December 31, 1997. (ccc) Incorporated herein by reference to Exhibit 10.43 to the Company's Form 10-K for the year ended December 31, 1998. (ddd) Incorporated herein by reference to Exhibit 10.44 to the Company's Form 10-K for the year ended December 31, 1998. (eee) Incorporated herein by reference to Exhibit 10.5 to the Company's Form 10-Q for the quarterly period ended September 30, 1999. (fff) Incorporated herein by reference to Exhibit 10.13 to the Registration Statement on Form S-1 of TheraTx. (ggg) Incorporated herein by reference to Exhibit 10.37 to the Company's Form 10-K for the year ended December 31, 1995. (hhh) Incorporated herein by reference to Exhibit 10.1 to the Company's 10-Q for the quarterly period ended March 31, 1999. (iii) Incorporated herein by reference to Exhibit 10.1 to the Company's 8-K filed September 20, 1999. (jjj) Incorporated herein by reference to Exhibit 10.4 to the Company's 10-Q for the quarterly period ended September 30, 1999. (kkk) Incorporated herein by reference to Exhibit 10.2 to the Company's Form 8-K filed February 8, 2000. (lll) Incorporated herein by reference to Exhibit 21 to the Company's Form 10- K for the fiscal year ended December 31, 1998. (b) Reports on Form 8-K: On November 3, 1999, the Company filed a Current Report on Form 8-K announcing that it entered into a Waiver and Extension Agreement with over 95% of its lenders under its credit agreement and that it plans to enter into a new credit facility no later than January 31, 2000. 66
On February 8, 2000, the Company filed a Current Report on Form 8-K announcing that it entered into an Amended and Restated Credit, Security, Guaranty and Pledge Agreement with its senior lenders on January 31, 2000, providing for the restructuring of the approximately $973 million owed by the Company to its senior lenders, and the execution and delivery by the Company of the First Amended and Restated Agreement of Limited Partnership of Ventas Realty, Limited Partnership, on January 31, 2000. The Company also announced the Department of Justice's intervention in a qui tam lawsuit for the purpose of representing the United States' interests in the Vencor bankruptcy proceeding. On March 8, 2000, the Company filed a Current Report on Form 8-K announcing that on February 28, 2000 it had completed the post-closing requirements set forth in the Amended Credit Agreement. Under the terms of the Amended Credit Agreement the Company was required to execute and deliver to its lenders, by no later than February 28, 2000, mortgages, deeds of trust, assignments, and other related documentation granting liens and security interests in substantially all of their real property assets and in other related assets. The Company also announced that Steven T. Downey had resigned as the Company's Chief Financial Officer pursuant to a Separation and Release Agreement dated February 29, 2000. (c) Financial Statement Schedules: The response to this portion of Item 14 is included in the financial statement schedules listed in the index to Consolidated Financial Statements and Financial Statement Schedules listed on page F-1 of this Report. 67
ITEM 14(c). FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA VENTAS, INC INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES <TABLE> <S> <C> Report of Independent Auditors.............................................. F-2 Consolidated Balance Sheets at December 31, 1999 and 1998................... F-3 Consolidated Statements of Income for the year ended December 31, 1999 and the period from May 1, 1998 to December 31, 1998...................................... F-4 Consolidated Statements of Stockholders' Equity (Deficit) for the year ended December 31, 1999 and the period from May 1, 1998 to December 31, 1998....................... F-5 Consolidated Statements of Cash Flows for the year ended December 31, 1999 and the period from May 1, 1998 to December 31, 1998....................... F-6 Notes to Consolidated Financial Statements.................................. F-7 Consolidated Financial Statement Schedules Schedule III--Real Estate and Accumulated Depreciation.................... S-1 </TABLE> All other schedules for which provision is made in the applicable accounting regulation of the Securities and Exchange Commission are not required under the related instructions, and are inapplicable, or the information required is included in the Consolidated Financial Statements or notes thereto and therefore have been omitted. F-1
REPORT OF INDEPENDENT AUDITORS Stockholders and Board of Directors Ventas, Inc. We have audited the accompanying consolidated balance sheets of Ventas, Inc. as of December 31, 1999 and 1998, and the related consolidated statements of income, stockholders' equity (deficit) and cash flows for the year ended December 31, 1999 and the period from May 1, 1998 through December 31, 1998. Our audits also included the financial statement schedule listed in the Index at Item 14. These consolidated financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and schedule based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Ventas, Inc. at December 31, 1999 and 1998, and the consolidated results of its operations and its cash flows for the year ended December 31, 1999 and the period from May 1, 1998 through December 31, 1998, in conformity with accounting principles generally accepted in the United States. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein. /s/ Ernst & Young LLP Louisville, Kentucky March 23, 2000 F-2
VENTAS, INC. CONSOLIDATED BALANCE SHEETS December 31, 1999 and 1998 (In thousands) <TABLE> <CAPTION> 1999 1998 ---------- ---------- <S> <C> <C> Assets Real estate investments: Land................................................. $ 120,891 $ 120,928 Building and improvements............................ 1,061,656 1,065,041 ---------- ---------- 1,182,547 1,185,969 Accumulated depreciation............................. (287,756) (246,509) ---------- ---------- Total real estate investments...................... 894,791 939,460 Cash and cash equivalents.............................. 139,594 338 Deferred financing costs, net.......................... 5,702 8,816 Due from Vencor, Inc................................... -- 6,967 Notes receivable from employees........................ 3,611 4,027 Recoverable federal income taxes....................... 26,610 -- Other.................................................. 891 98 ---------- ---------- Total assets....................................... $1,071,199 $ 959,706 ========== ========== Liabilities and stockholders' equity (deficit) Liabilities: Notes payable and other debt......................... $ 974,247 $ 931,127 Deferred gain on partial termination of interest rate swap agreement...................................... 21,605 -- Accounts payable and other accrued liabilities....... 9,886 7,082 Other liabilities.................................... 26,610 -- Deferred income taxes................................ 30,506 30,506 ---------- ---------- Total liabilities.................................. 1,062,854 968,715 ---------- ---------- Commitments and contingencies Stockholders' equity (deficit): Preferred stock, 10,000 shares authorized, unissued.. -- -- Common stock, $0.25 par value; authorized 180,000 shares; issued 73,608 shares in 1999 and 1998............... 18,402 18,402 Capital in excess of par value....................... 139,723 140,103 Unearned compensation on restricted stock............ (2,080) (1,962) Retained earnings (deficit).......................... 6,409 (9,637) ---------- ---------- 162,454 146,906 Treasury stock--5,619 shares in 1999 and 5,759 in 1998................................................ (154,109) (155,915) ---------- ---------- Total stockholders' equity (deficit)............... 8,345 (9,009) ---------- ---------- Total liabilities and stockholders' equity......... $1,071,199 $ 959,706 ========== ========== </TABLE> See accompanying notes. F-3
VENTAS, INC. CONSOLIDATED STATEMENTS OF INCOME For the Year Ended December 31, 1999 and the Period From May 1, 1998 to December 31, 1998 (In thousands, except per share amounts) <TABLE> <CAPTION> For the Period From May 1, 1998 to December 31, 1999 1998 -------- -------------- <S> <C> <C> Revenues: Rental income....................................... $228,600 $149,933 Interest and other income........................... 4,645 201 -------- -------- Total revenues.................................... 233,245 150,134 -------- -------- Expenses: General and administrative.......................... 7,767 4,190 Professional fees................................... 12,527 1,507 Non-recurring employee severance costs.............. 1,272 -- Loss on uncollectible amounts due from tenants...... 34,418 -- Loss on impairment of assets........................ 1,927 -- Amortization of restricted stock grants............. 1,304 349 Depreciation on real estate investments............. 42,742 28,700 Interest............................................ 88,753 59,428 -------- -------- Total expenses.................................... 190,710 94,174 -------- -------- Income before provision for income taxes and extraordinary loss................................... 42,535 55,960 Provision for income taxes............................ -- 21,151 -------- -------- Income before extraordinary loss...................... 42,535 34,809 Extraordinary loss on extinguishment of debt, net of income tax benefit of $4,935......................... -- (8,051) -------- -------- Net income............................................ $ 42,535 $ 26,758 ======== ======== Earnings per common share: Basic: Income before extraordinary loss.................. $ 0.63 $ 0.51 Extraordinary loss on extinguishment of debt...... -- (0.12) -------- -------- Net income........................................ $ 0.63 $ 0.39 ======== ======== Diluted: Income before extraordinary loss.................. $ 0.63 $ 0.51 Extraordinary loss on extinguishment of debt...... -- (0.12) -------- -------- Net income........................................ $ 0.63 $ 0.39 ======== ======== Weighted average number of shares outstanding, basic.. 67,754 67,681 Weighted average number of shares outstanding, diluted.............................................. 67,989 67,865 </TABLE> See accompanying notes. F-4
VENTAS, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT) For the Year Ended December 31, 1999 and the Period From May 1, 1998 to December 31, 1998 (In thousands) <TABLE> <CAPTION> Unearned Common Capital in Compensation Retained Stock Excess of On Restricted Earnings Treasury Par Value Par Value Stock (Deficit) Stock Total --------- ---------- ------------- --------- --------- -------- <S> <C> <C> <C> <C> <C> <C> Balance at May 1, 1998.. $18,389 $139,480 $ -- $(36,395) $(157,869) $(36,395) Net income for the period from May 1, 1998 to December 31, 1998............... -- -- -- 26,758 -- 26,758 Proceeds from issuance of shares for stock incentive plans........ 13 142 -- -- -- 155 Grant of restricted stock, net of forfeitures............ -- 481 (2,311) -- 1,954 124 Amortization of restricted stock grants................. -- -- 349 -- -- 349 ------- -------- ------- -------- --------- -------- Balance at December 31, 1998................... 18,402 140,103 (1,962) (9,637) (155,915) (9,009) Net income for the year ended December 31, 1999................... -- -- -- 42,535 -- 42,535 Cash distributions to stockholders........... -- -- -- (26,489) -- (26,489) Proceeds from issuance of shares for stock incentive plans........ -- (58) -- -- 62 4 Grant of restricted stock, net of forfeitures............ -- (232) (1,512) -- 1,744 -- Amortization of restricted stock grants................. -- (90) 1,394 -- -- 1,304 ------- -------- ------- -------- --------- -------- Balance at December 31, 1999................... $18,402 $139,723 $(2,080) $ 6,409 $(154,109) $ 8,345 ======= ======== ======= ======== ========= ======== </TABLE> See accompanying notes. F-5
VENTAS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS For the Year Ended December 31, 1999 and the Period From May 1, 1998 to December 31, 1998 (In thousands) <TABLE> <CAPTION> For the Period From May 1, 1998 to December 31, 1999 1998 --------- -------------- <S> <C> <C> Cash flows from operating activities: Net income......................................... $ 42,535 $ 26,758 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation..................................... 42,803 28,700 Amortization of deferred financing costs......... 6,049 3,223 Amortization of restricted stock grants.......... 1,304 349 Normalized rents................................. (140) -- Loss on impairment of assets..................... 1,927 -- Gain on sale of assets........................... (254) -- Extraordinary loss on 1998 extinguishment of debt............................................ -- 8,051 Provision for deferred income taxes.............. -- 20,151 Changes in operating assets and liabilities: (Increase) decrease in amount due from Vencor, Inc............................................. 6,967 (6,843) Increase in accounts receivable and other assets.......................................... (27,025) (87) Increase in accounts payable and accrued and other liabilities............................... 29,414 6,455 --------- ----------- Net cash provided by operating activities...... 103,580 86,757 Cash flows from investing activities: Purchase of furniture and equipment................ (299) (15) Sale (purchase) of real estate properties.......... 254 (14,566) Repayment (issuance) of notes receivable from employees......................................... 416 (4,027) Sale of Vencor, Inc. preferred stock in connection with the 1998 Spin Off transaction................ -- 17,700 --------- ----------- Net cash provided by (used in) investing activities.................................... 371 (908) Cash flows from financing activities: Net change in borrowings under revolving line of credit............................................ 173,143 29,600 Proceeds from long-term debt....................... -- 951,540 Repayment of long-term debt........................ (130,023) (54,596) Repayment of long-term debt in connection with the 1998 Spin Off..................................... -- (1,000,171) Proceeds from partial termination of interest rate swap agreement.................................... 21,605 -- Payment of deferred financing costs................ (2,935) (12,039) Issuance of common stock........................... 4 155 Cash distribution to stockholders.................. (26,489) -- --------- ----------- Net cash provided by (used in) financing activities.................................... 35,305 (85,511) --------- ----------- Increase in cash and cash equivalents................ 139,256 338 Cash and cash equivalents at beginning of period..... 338 -- --------- ----------- Cash and cash equivalents at end of period........... $ 139,594 $ 338 ========= =========== Supplemental disclosure of cash flow information: Interest paid.................................... $ 86,125 $ 52,649 ========= =========== </TABLE> See accompanying notes. F-6
VENTAS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 1999 and 1998 1. Organization and Significant Accounting Policies Organization Ventas, Inc. ("Ventas" or the "Company") is a real estate company that owns or leases 45 hospitals (comprised of two acute care hospitals and 43 long-term acute care hospitals), 218 nursing facilities and eight personal care facilities in 36 states as of December 31, 1999. The Company conducts substantially all of its business through a wholly owned operating partnership, Ventas Realty, Limited Partnership ("Ventas Realty"). No net provision for federal corporate income taxes has been made for the year ended December 31, 1999, in the Consolidated Financial Statements due to the Company's intention to qualify as a real estate investment trust ("REIT") and distribute 95% of its 1999 taxable income as a dividend and the existence of net operating losses that will offset any remaining 1999 liability for federal corporate income taxes. Although the Company currently expects to qualify as a REIT for the year ended December 31, 1999, it is possible that economic, market, legal, tax or other considerations may cause the Company to fail or not elect to qualify as a REIT. The Company operates in one segment which consists of owning and leasing health care facilities and leasing or subleasing such facilities to third parties. The Company was incorporated in Kentucky in 1983 as Vencare, Inc. and commenced operations in 1985. The Company changed its name to Vencor Incorporated in 1989 and to Vencor, Inc. in 1993. From 1985 through April 30, 1998, the Company was engaged in the business of owning, operating and acquiring health care facilities and companies engaged in providing health care services. On April 30, 1998, the Company changed its name to Ventas, Inc. and on May 1, 1998, refinanced substantially all of its long-term debt in connection with the spin-off of its health care operations through the distribution of the common stock of a new entity (which assumed the Company's former name, Vencor, Inc. ("Vencor") to stockholders of the Company of record as of April 27, 1998 (the "1998 Spin Off"). The 1998 Spin Off was effected on May 1, 1998. For financial reporting periods subsequent to the 1998 Spin Off, the historical financial statements of the Company were assumed by Vencor and the Company is deemed to have commenced operations on May 1, 1998. The financial results for the year ended December 31, 1999 are not comparable to the period from May 1, 1998 to December 31, 1998 on the Consolidated Statements of Income or the Consolidated Statements of Cash Flows due to the difference in the time periods covered and the omission of a provision for income taxes in the 1999 financial statements due to the Company's intention to qualify as a REIT and the use of a portion of the Company's net operating loss carryforward. New Accounting Pronouncements In June 1997, the Financial Accounting Standards Board (the "FASB") issued SFAS No. 131 ("SFAS 131"), "Disclosures about Segments of an Enterprise and Related Information," which became effective in December 1998 and requires interim disclosures beginning in 1999. SFAS 131 requires public companies to report certain information about operating segments, products and services, the geographic areas in which they operate and major customers. The operating segments are to be based on the structure of the enterprise's internal organization whose operating results are regularly reviewed by senior management. Management has determined that the Company operates in a single business segment. Accordingly, the adoption of SFAS 131 has had no effect on the consolidated financial statement disclosures. In June 1998, the FASB issued SFAS No. 133 ("SFAS 133"), "Accounting for Derivative Instruments and Hedging Activities." SFAS 133, as amended, is required to be adopted in years beginning after June 15, 2000. The Company expects to adopt SFAS 133 effective January 1, 2001. SFAS 133 will require the Company to recognize all derivatives on the balance sheet at fair value. Derivatives that are not hedges must be adjusted to fair value through income. If the derivative is a hedge, depending on the nature of the hedge, changes in the fair F-7
VENTAS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) value of derivatives will either be offset against the change in fair value of the hedged assets, liabilities, or firm commitments through earnings or recognized in other comprehensive income until the hedged item is recognized in earnings. The ineffective portion of a derivative's change in fair value will be recognized immediately in earnings. Based on the Company's derivative positions and their related fair values of approximately $20.4 million at December 31, 1999, as well as the $21.6 million gain incurred but not yet reflected in net income on the terminated derivative position (see "Note 4-- Borrowing Arrangements"), the Company estimates that upon adoption it would report a positive adjustment of $42.0 million in other comprehensive income. The Company was not required to report the $20.4 million unrealized gain for the year ended December 31, 1999. Basis of Presentation The consolidated financial statements include the accounts of the Company, Ventas Realty and all subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation. Reclassifications Certain reclassifications have been made to the 1998 presentation to conform to the 1999 presentation. Real Estate Investments Investments in real estate properties are recorded at cost. The cost of the properties acquired is allocated between land and buildings based generally upon independent appraisals. Depreciation for buildings is recorded on the straight-line basis, using estimated useful lives ranging from 20 to 50 years. Impairment of Assets Provisions for impairment losses related to long-lived assets, if any, are recognized when expected future cash flows are less than the carrying values of the assets. If indicators of impairment are present, the Company evaluates the carrying value of the related real estate investments in relationship to the future undiscounted cash flows of the underlying operations. The Company adjusts the net book value of leased properties and other long-lived assets to fair value, if the sum of the expected future cash flow or sales proceeds is less than book value. See "Note 2--Real Estate Investments." Cash and Cash Equivalents Cash equivalents consist of highly liquid investments with a maturity date of three months or less when purchased. These investments are stated at cost which approximates fair value. Deferred Financing Costs Deferred financing costs are amortized as a component of interest expense over the terms of the related borrowings using a method that approximates a level yield, and are net of accumulated amortization of approximately $9.2 million and $3.2 million at December 31, 1999 and 1998, respectively. Revenue Recognition Rental revenue is recognized as earned over the terms of the related leases and are treated as operating leases. Such income includes periodic increases based on pre-determined formulas as defined in the lease agreements. See "Note 8--Transactions with Vencor--The 1998 Spin Off." Certain leases with tenants other than Vencor contain provisions relating to increases in rental payments over the terms of the leases. Rental income under these leases is recognized over the term of each lease on a straight-line basis. F-8
VENTAS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Stock Based Compensation The Company grants stock options to employees and directors with an exercise price equal to the fair value of the shares at the date of the grant. In accordance with the provisions of APB Opinion No. 25, Accounting for Stock Issued to Employees, compensation expense is not recognized for these stock option grants. In addition, the Company grants shares of restricted stock to certain executive officers and directors. Shares of restricted stock vest cumulatively in two to four equal annual installments beginning on the first anniversary of the date of the grant. In accordance with the provisions of APB Opinion No. 25, Accounting for Stock Issued to Employees, compensation expense is recognized for these restricted stock grants over the vesting period. Accounting Estimates The preparation of financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. 2. Real Estate Investments Substantially all of the Company's real estate investments are leased under provisions of four master leases and a single facility lease (individually a "Master Lease" and collectively the "Master Leases") with Vencor with initial terms ranging from 10 to 15 years, plus renewal options. Each Master Lease provides for minimum annual rentals which are subject to annual increases on May 1 of each calendar year of two percent (2%) as long as net patient service revenues of the facilities covered under the applicable Master Lease for the prior calendar year exceed seventy-five percent (75%) of patient service revenues in the base year of 1997. Under the terms of the Master Leases, the lessee is responsible for all or substantially all maintenance, repairs, taxes and insurance on the leased properties. The future contracted minimum rentals, excluding rent escalations but with normalized rents where applicable, for the remainder of the initial terms of the Master Leases and other leases are as follows (in thousands) (see "Note 8--Transactions with Vencor--Recent Developments Regarding Vencor"): <TABLE> <CAPTION> Vencor Other Total ---------- ------- ---------- <S> <C> <C> <C> 2000........................................... $ 226,603 $ 2,730 $ 229,333 2001........................................... 226,603 2,614 229,217 2002........................................... 226,603 1,992 228,595 2003........................................... 226,603 1,607 228,210 2004........................................... 226,603 1,272 227,875 Thereafter..................................... 1,196,131 5,101 1,201,232 ---------- ------- ---------- Total........................................ $2,329,146 $15,316 $2,344,462 ========== ======= ========== </TABLE> During the fourth quarter of 1999, a tenant at one of the Company's facilities ceased paying rent on one of the two facilities leased by them and has subsequently filed for protection under the United States Bankruptcy Code (the "Bankruptcy Code"). The Company has not yet located a new operator for the facility and has deemed the asset to be impaired and recorded a real estate impairment loss of $1.9 million to write down the asset to its estimated fair value. F-9
VENTAS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) 3. Concentration of Credit Risk As of December 31, 1999, 70.2% of the Company's real estate investments related to skilled nursing facilities. The remaining real estate investments consist of hospitals and personal care facilities. The Company's facilities are located in 36 states and lease revenues from operations in any one state do not account for more than ten percent (10%). Approximately 97.4% of the Company's real estate investments, based on the original cost of such investments, are operated by Vencor and approximately 98.5% (or 98.3%, net of write-offs) of rental revenue in 1999 was derived from Vencor leases. Because the Company leases substantially all of its properties to Vencor and Vencor is the primary source of the Company's revenues, Vencor's financial condition and ability to satisfy its rent obligations under the Master Leases and certain other agreements will significantly impact the Company's revenues and its ability to service its indebtedness and to make distributions to its stockholders. The operations of Vencor have been negatively impacted by changes in governmental reimbursement rates, by its current level of indebtedness and by certain other factors. On September 13, 1999, Vencor filed for protection under chapter 11 of the Bankruptcy Code in Wilmington, Delaware. The Company, Vencor and Vencor's major creditors have been engaged in negotiations to restructure Vencor's debt and lease obligations. There can be no assurance that Vencor will be successful in obtaining the approval of its creditors for a restructuring plan, that any such plan will be on terms acceptable to the Company, Vencor and its creditors, or that any restructuring plan will not have a material adverse effect on the business, financial condition, results of operation and liquidity of the Company, on the Company's ability to service its indebtedness and on the Company's ability to make distributions to its stockholders as required to elect or maintain its status as a REIT (a "Material Adverse Effect"). See "Note 8--Transactions with Vencor--Recent Developments Regarding Vencor." The Company generally invests excess cash in short term maturities of time deposits and other similar cash equivalents as required by the Amended Credit Agreement (as defined below). See "Note 4--Borrowing Arrangements." 4. Borrowing Arrangements In connection with the 1998 Spin Off, the Company refinanced substantially all of its long-term debt. As a result, the Company incurred an after tax extraordinary loss on extinguishment of debt of $8.1 million, net of a $4.9 million tax benefit for the period from May 1, 1998 to December 31, 1998. In connection with the refinancing arrangements, the Company entered into a $1.2 billion bank credit agreement, dated April 29, 1998, (the "Bank Credit Agreement") and retained approximately $6.0 million of prior debt obligations. Borrowings under the Bank Credit Agreement bore interest at an applicable margin over an interest rate selected by the Company. Such interest rate could be either the "Base Rate", which is the higher of the prime rate or the federal funds rate, plus 50 basis points, or the London Interbank Offered Rate ("LIBOR"). As of December 31, 1999, all borrowings were designated as LIBOR borrowings. The applicable margin on borrowings varied based on the type of borrowing and the Company's ratio of indebtedness to the tangible fair value of its assets. Borrowings under the Bank Credit Agreement were comprised of: (i) a three year $250.0 million Revolving Credit Facility priced at LIBOR plus 2.00% to 2.50% or the Base Rate plus 1.00% to 1.50% (the "Revolving Credit Facility"), (ii) a $200 million Term A Loan payable in various installments over three years priced at LIBOR plus 2.25% to 2.50%, or the Base Rate plus 1.25% to 1.50% (iii) a $350.0 million Term B Loan payable in various installments over five years priced at LIBOR plus 2.75% to 3.00%, or the Base Rate plus 1.75% to 2.00% and (iv) a $275.0 million term loan originally due on October 30, 1999 (the "Bridge Loan") and extended to February 28, 2000 as described below, priced at LIBOR plus 2.75% to 3.00%, or the Base Rate plus 1.75% to 2.00%. For the period from May 1, 1998 to December 31, 1998, the Company paid $12.0 million in financing fees related to establishing and maintaining the Bank Credit Agreement. The Bank Credit Agreement was secured by a pledge of the Company's direct and indirect partnership interests in Ventas Realty and contained various covenants and restrictions. F-10
VENTAS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) The following is a summary of long-term borrowings at December 31: <TABLE> <CAPTION> 1999 1998 -------- -------- (In thousands) <S> <C> <C> Revolving line of credit, bearing interest at a base rate of LIBOR plus 2.25% (8.72% to 8.74% at December 31, 1999).................... $202,743 $ 29,600 Bridge facility loan, bearing interest at a base rate of LIBOR plus 2.75% (9.23% at December 31, 1999)............................. 275,000 400,000 Term A Loan, bearing interest at a base rate of LIBOR plus 2.25% (8.74% at December 31, 1999)............................. 181,818 181,818 Term B Loan, bearing interest at a base rate of LIBOR plus 2.75% (9.24% at December 31, 1999)............................. 314,682 318,182 Other..................................................... 4 1,527 -------- -------- $974,247 $931,127 ======== ======== </TABLE> On January 31, 2000, the Company and the lenders under the Bank Credit Agreement entered into the Amended and Restated Credit, Security, Guaranty and Pledge Agreement (the "Amended Credit Agreement"), which amended and restated the Bank Credit Agreement. Under the Amended Credit Agreement, borrowings bear interest at an applicable margin over an interest rate selected by the Company. Such interest rate may be either (a) the Base Rate, which is the greater of (i) the prime rate or (ii) the federal funds rate plus 50 basis points, or (b) LIBOR. Borrowings under the Amended Credit Agreement are comprised of: (1) a $25.0 million revolving credit line (the "Revolving Credit Line") that expires on December 31, 2002, which bears interest at either LIBOR plus 2.75% or the Base Rate plus 1.75%; (2) a $200.0 million term loan due December 31, 2002 (the "Tranche A Loan"), which bears interest at either LIBOR plus 2.75% or the Base Rate plus 1.75%; (3) a $300.0 million term loan due December 31, 2005 (the "Tranche B Loan"), which bears interest at either LIBOR plus 3.75% or the Base Rate plus 2.75%; and (4) a $473.4 million term loan due December 31, 2007 (the "Tranche C Loan"), which bears interest at either LIBOR plus 4.25% or the Base Rate plus 3.25%. The interest rate on the Tranche B Loan will be reduced by .50% (50 basis points) once $150.0 million of the Tranche B Loan has been repaid. The Amended Credit Agreement requires the following amortization: (a) with respect to the Tranche A Loan, (i) $50.0 million of the Tranche A Loan was paid at closing on January 31, 2000, (ii) $50.0 million is due within 30 days after Vencor's plan of reorganization becomes effective (the "Vencor Effective Date"), and (iii) thereafter all Excess Cash Flow (as defined in the Amended Credit Agreement) of the Company will be applied to the Tranche A Loan until $200.0 million in total has been paid down on the Amended Credit Agreement, with the balance, if any, due December 31, 2002; (b) with respect to the Tranche B Loan, (i) after the $50.0 million paydown on the Tranche A Loan to be made within 30 days after the Vencor Effective Date and after consideration of other cash needs of the Company, a one-time paydown of Excess Cash (as defined in the Amended Credit Agreement) and (ii) scheduled paydowns of $50.0 million on December 31, 2003 and December 31, 2004, with the balance due December 31, 2005; and (c) with respect to the Tranche C Loan, no scheduled paydowns with a final maturity of December 31, 2007. The facilities under the Amended Credit Agreement are pre-payable without premium or penalty. During the first quarter of 2000, the Company will incur an extraordinary loss of approximately $4.2 million relating to the write-off of the unamortized deferred financing costs associated with the Bank Credit Agreement. On October 29, 1999, in conjunction with the execution of an agreement with over 95% of the Company's lenders regarding the restructuring of the Company's long term debt, including the $275.0 million Bridge Loan (the "Waiver and Extension Agreement"), the Company paid a $2.4 million waiver fee. In connection with the consummation of the Amended Credit Agreement on January 31, 2000, the Company paid a $7.3 million loan restructuring fee. The fees are being amortized proportionately over the terms of the related loans and agreements. F-11
VENTAS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) The Amended Credit Agreement is secured by liens on substantially all of the Company's real property and any related leases, rents and personal property. Certain properties are being held in escrow by counsel for the agents under the Amended Credit Agreement pending the receipt of third party consents and/or resolution of certain other matters. In addition, the Amended Credit Agreement contains certain restrictive covenants, including, but not limited to, the following: (a) until such time that $200.0 million in principal amount has been paid down, the Company can pay REIT dividends based on a certain minimum percentage of its taxable income (currently equal to 95 percent of its taxable income for the year ended December 31, 1999 and the year ending December 31, 2000 and 90 percent of its taxable income for years ending on or after December 31, 2001); however, after $200.0 million in total principal paydowns, the Company will be allowed to pay dividends for any year in amounts up to 80 percent of funds from operations ("FFO"), as defined in the Amended Credit Agreement; (b) limitations on additional indebtedness, acquisitions of assets, liens, guarantees, investments, restricted payments, leases and affiliate transactions; (c) limitations on capital expenditures; (d) certain financial covenants, including requiring that the Company have (i) $50.0 million in cash and cash equivalents on hand at the Vencor Effective Date; (ii) no more than $1.1 billion of total indebtedness on the Vencor Effective Date; and (iii) at least $99.0 million of Projected Consolidated EBITDA, as defined in the Amended Credit Agreement, for the 270 day period beginning in the first month after the Vencor Effective Date. The Amended Credit Agreement does not contain any financial covenants that are applicable to the Company prior to the Vencor Effective Date, and provides, among other things, that no action taken by any person in the Vencor bankruptcy case (other than by the Company and its affiliates) shall be deemed to constitute or result in a "Material Adverse Effect," as defined in the Amended Credit Agreement. In addition, the Amended Credit Agreement provides that if the Company is in compliance with its financial covenants and the covenant relating to releases in the Vencor bankruptcy on the Vencor Effective Date, no event or condition arising primarily from the Vencor plan of reorganization shall be deemed to have caused a "Material Adverse Effect," as defined in the Amended Credit Agreement, to have occurred. Under the terms of the Amended Credit Agreement, however, an event of default is deemed to have occurred if the Vencor Effective Date does not occur on or before December 31, 2000. In connection with the 1998 Spin Off and the consummation of the Bank Credit Agreement, the Company entered into an interest rate swap agreement (on a notional amount of $875.0 million outstanding at December 31, 1999) to reduce the impact of changes in interest rates on the Company's floating rate debt obligations. The original agreement expired in varying amounts through December 2007; however, as discussed below, the agreement was amended to expire in varying amounts through June 2003. The agreement provides for the Company to pay a fixed rate at 5.985% and receive LIBOR (floating rate). The terms of the interest rate swap agreement require that the Company make a cash payment or otherwise post collateral to the counterparty if the fair value loss to the Company exceeds certain levels. The threshold levels vary based on the relationship between the Company's debt obligations and the tangible fair value of its assets as defined in the Bank Credit Agreement. As of December 31, 1998, the threshold level under the interest rate swap agreement was a market value loss of $35.0 million and the interest rate swap agreement was in an unrealized loss position to the Company of $39.2 million. As of December 31, 1998, the Company had a letter of credit outstanding as posted collateral under the interest rate swap agreement in the amount of $10.9 million, which reduced the availability of the Company's revolving line of credit under the Bank Credit Agreement as of that date by a similar amount. On August 4, 1999, the Company entered into an agreement with the interest rate swap agreement counterparty to shorten the maturity of the interest rate swap agreement from December 31, 2007 to June 30, 2003, in exchange for a payment in 1999 from the counterparty to the Company of $21.6 million. So long as the Company has debt in excess of $750 million, the Company will amortize the $21.6 million payment for financial accounting purposes in future periods beginning in July 2003 and ending December 2007. F-12
VENTAS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) On January 31, 2000, the Company entered into a letter agreement with the counterparty to the swap agreement for the purpose of amending the swap agreement. The letter agreement provides that, for purposes of certain calculations set forth in the swap agreement, the parties agree to continue to use certain defined terms set forth in the Bank Credit Agreement. As of December 31, 1999, no collateral was required to be posted under the interest rate swap agreement. The notional amount of the interest rate swap agreement will amortize as follows (in thousands): <TABLE> <S> <C> December 31, 2000................................................... $ 25,000 December 31, 2001................................................... 50,000 December 31, 2002................................................... 25,000 June 30, 2003....................................................... 775,000 </TABLE> The Company is exposed to credit loss in the event of nonperformance by the other party to the interest rate swap agreement. However, the Company does not anticipate nonperformance by the financial institution counterparty. The net interest rate difference incurred on these contracts for the year ended December 31, 1999 and for the period from May 1, 1998 to December 31, 1999 was $6.4 million and $1.2 million, respectively, and has been included in interest expense in the Consolidated Financial Statements. 5. Fair Values of Financial Instruments The following methods and assumptions were used by the Company in estimating its fair value disclosures for financial instruments. . Cash and cash equivalents: The carrying amount of cash and cash equivalents reported in the balance sheet approximates fair value because of the short maturity of these instruments. . Notes receivable from employees: The fair values of the notes receivable from employees are estimated using a discounted cash flow analysis, using interest rates being offered for similar loans to borrowers with similar credit ratings. . Interest rate swap agreement: The fair values of the Company's interest rate swap agreement are based on rates being offered for similar arrangements. . Notes payable: The fair values of the Company's borrowings under variable rate agreements approximate their carrying value. At December 31, 1999 and 1998 the carrying amounts and fair values of the Company's financial instruments are as follows (in thousands): <TABLE> <CAPTION> 1999 1998 ----------------- ----------------- Carrying Fair Carrying Fair Amount Value Amount Amount -------- -------- -------- -------- <S> <C> <C> <C> <C> Cash and cash equivalents.................. $139,594 $139,594 $ 338 $ 338 Notes receivable from employees............ 3,611 3,219 4,027 3,285 Interest rate swap agreement............... -- 20,370 -- (39,175) Notes payable.............................. 974,247 974,247 931,127 931,127 </TABLE> Fair value estimates are subjective in nature and are dependent on a number of important assumptions, including estimates of future cash flows, risks, discount rates and relevant comparable market information associated with each financial instrument. The use of different market assumptions and estimation methodologies may have a material effect on the reported estimated fair value amounts. Accordingly, the estimates presented above are not necessarily indicative of the amounts the Company would realize in a current market exchange. F-13
VENTAS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) 6. Stockholders' Equity and Stock Options The Company has five plans under which options to purchase common stock have been, or may be, granted to officers, employees and non-employee directors (the following are collectively referred to as the "Plans"): (1) The 1987 Incentive Compensation Program (Employee Plan); (2) The 1997 Incentive Compensation Plan (Employee Plan); (3) The 1987 Stock Option Plan for Non- Employee Directors; (4) The 1997 Stock Option Plan for Non-Employee Directors; and (5) The TheraTx, Incorporated 1996 Stock Option/Stock Issuance Plan. Under the Plans, options are exercisable at the market price at the date of grant, expire ten years from the date of grant, and vest over varying periods ranging from two to four years. The Company has also granted options and restricted stock to certain officers, employees and non-employee directors outside of the Plans. The options and restricted stock that have been granted outside the Plans vest over varying periods and the options are exercisable at the market price at the date of grant and expire ten years from the date of grant. As of December 31, 1999, options for 4,410,669 shares had been granted to eligible participants and remained outstanding (including options granted and held by Vencor employees) under the provisions of the Plans. The weighted average exercise price for each Plan is noted in each table below. As of December 31, 1999, options for 655,861 shares had been granted outside of the Plans to certain employees and non-employee directors and remained outstanding. The Company granted 188,500 and 150,000 shares of restricted stock for the year ended December 31, 1999 and for the period from May 1, 1998 to December 31, 1998, respectively. The market value of the restricted shares on the date of the award has been recorded as unearned compensation on restricted stock, with the unamortized balance shown as a separate component of stockholders' equity. Unearned compensation is amortized to expense over the vesting period, with charges to operations of approximately $1.3 million and $0.3 million in 1999 and the period from May 1, 1998 to December 31, 1998, respectively. The Company currently utilizes the 1997 Incentive Compensation Plan (Employee Plan) and the 1997 Stock Option Plan for Non-Employee Directors for option and stock grants. Under the terms of the Ventas, Inc. 1997 Incentive Compensation Plan (Employee Plan), the Company has reserved 3,400,000 shares for grants to be issued to employees. Under the terms of the Ventas, Inc. 1997 Stock Option Plan for Non-Employee Directors, the Company has reserved 200,000 shares for grants to be issued to non-employee directors. As of December 31, 1999, shares available for future grants under the Ventas, Inc. 1997 Incentive Compensation Plan (Employee Plan) are 1,401,511 and under the Ventas, Inc. 1997 Stock Option Plan for Non-Employee Directors are 152,750. F-14
VENTAS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) The following is a summary of stock option activity for the Company in 1998 and 1999: I. 1987 Incentive Compensation Program (Employee Plan) A. 1999 Activity <TABLE> <CAPTION> Weighted Average Activity Shares Exercise Price Exercise Price -------- --------- --------------------- -------------- <S> <C> <C> <C> <C> <C> Outstanding at beginning of period ............. 3,215,290 $ 0.5479 - $23.6237 $16.4001 Options Granted....... -- -- - -- -- Options Exercised..... (7,031) 0.5479 - 0.5479 0.5479 Options Canceled...... (769,152) 1.4774 - 23.3159 16.3195 --------- -------- -------- -------- Outstanding at end of period ................ 2,439,107 $ 1.4774 - $23.6237 $16.4712 ========= Exercisable at end of period................. 1,973,502 $ 1.4774 - $23.6237 $16.1359 ========= B. 1998 Activity <CAPTION> Weighted Average Activity Shares Exercise Price Exercise Price -------- --------- --------------------- -------------- <S> <C> <C> <C> <C> <C> Outstanding at beginning of period.............. 3,859,178 $ 0.4925 - $23.6237 $16.3931 Options Granted....... -- -- - -- -- Options Exercised..... (40,005) 0.4925 - 17.5446 4.8193 Options Canceled...... (603,883) 11.3886 - 23.6237 17.1230 --------- -------- -------- -------- Outstanding at end of period................. 3,215,290 $ 0.5479 - $23.6237 $16.4001 ========= Exercisable at end of period................. 1,980,599 $ 0.5479 - $23.6237 $15.6940 ========= II. 1997 Incentive Compensation Plan (Employee Plan) A. 1999 Activity <CAPTION> Weighted Average Activity Shares Exercise Price Exercise Price -------- --------- --------------------- -------------- <S> <C> <C> <C> <C> <C> Outstanding at beginning of period.............. 1,854,050 $10.8125 - $27.0095 $14.2799 Options Granted....... 423,639 4.6880 - 8.1875 5.2544 Options Exercised..... -- -- - -- -- Options Canceled...... (472,450) 10.8125 - 26.0091 14.6185 --------- -------- -------- -------- Outstanding at end of period................. 1,805,239 $ 4.6880 - $27.0095 $12.0732 ========= Exercisable at end of period................. 469,413 $ 5.0000 - $27.0095 $12.5604 ========= B. 1998 Activity <CAPTION> Weighted Average Activity Shares Exercise Price Exercise Price -------- --------- --------------------- -------------- <S> <C> <C> <C> <C> <C> Outstanding at beginning of period.............. 110,000 $14.6590 - $27.0095 $19.0428 Options Granted....... 2,031,900 10.8125 - 17.5831 14.0234 Options Exercised..... -- -- - -- -- Options Canceled...... (287,850) 13.7356 - 26.5478 14.6413 --------- -------- -------- -------- Outstanding at end of period................. 1,854,050 $10.8125 - $27.0095 $14.2799 ========= Exercisable at end of period................. 22,750 $14.6590 - $27.0095 $18.4638 ========= </TABLE> F-15
VENTAS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) III. The 1987 Stock Option Plan for Non-Employee Directors A. 1999 Activity <TABLE> <CAPTION> Weighted Average Activity Shares Exercise Price Exercise Price -------- ------- --------------------- -------------- <S> <C> <C> <C> <C> <C> Outstanding at beginning of period................ 42,197 $12.2628 - $20.0070 $16.7225 Options Granted......... -- -- - -- -- Options Exercised....... -- -- - -- -- Options Canceled........ (7,737) 12.2628 - 20.0070 17.1014 ------- -------- -------- -------- Outstanding at end of period................... 34,460 $12.2628 - $20.0070 $16.6375 ======= Exercisable at end of period................... 31,644 $12.2628 - $20.0070 $16.3376 ======= B. 1998 Activity <CAPTION> Weighted Average Activity Shares Exercise Price Exercise Price -------- ------- --------------------- -------------- <S> <C> <C> <C> <C> <C> Outstanding at beginning of period................ 59,073 $ 0.4925 - $20.0070 $12.2941 Options Granted......... -- -- - -- -- Options Exercised....... (16,876) 0.4925 - 3.6628 1.2210 Options Canceled........ -- -- - -- -- ------- -------- -------- -------- Outstanding at end of period................... 42,197 $12.2628 - $20.0070 $16.7225 ======= Exercisable at end of period................... 32,346 $12.2628 - $20.0070 $15.9701 ======= IV. 1997 Stock Option Plan for Non-Employee Directors A. 1999 Activity <CAPTION> Weighted Average Activity Shares Exercise Price Exercise Price -------- ------- --------------------- -------------- <S> <C> <C> <C> <C> <C> Outstanding at beginning of period................ 36,000 $15.0437 - $19.4684 $16.8873 Options Granted......... 15,000 12.1875 - 12.1875 12.1875 Options Exercised....... -- -- - -- -- Options Canceled........ (6,750) 12.1875 - 19.4684 14.7575 ------- -------- -------- -------- Outstanding at end of period................... 44,250 $12.1875 - $19.4684 $15.6190 ======= Exercisable at end of period................... 12,750 $15.0437 - $19.4684 $17.6465 ======= B. 1998 Activity <CAPTION> Weighted Average Activity Shares Exercise Price Exercise Price -------- ------- --------------------- -------------- <S> <C> <C> <C> <C> <C> Outstanding at beginning of period................ 18,000 $19.4684 - $19.4684 $19.4684 Options Granted......... 21,000 15.0437 - 15.0437 15.0437 Options Exercised....... -- -- - -- -- Options Canceled........ (3,000) 19.4684 - 19.4684 19.4684 ------- -------- -------- -------- Outstanding at end of period................... 36,000 $15.0437 - $19.4684 $16.8873 ======= Exercisable at end of period................... 3,750 $19.4684 - $19.4684 $19.4684 ======= </TABLE> F-16
VENTAS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) V. TheraTx Incorporated 1996 Stock Option/Stock Issuance Plan A. 1999 Activity <TABLE> <CAPTION> Weighted Average Activity Shares Exercise Price Exercise Price -------- ------- --------------------- -------------- <S> <C> <C> <C> <C> <C> Outstanding at beginning of period................ 179,192 $ 0.1231 - $23.9037 $16.8713 Options Granted......... -- -- - -- -- Options Exercised....... -- -- - -- -- Options Canceled........ (91,579) 9.8127 - 23.9037 17.7696 ------- -------- -------- -------- Outstanding at end of period................... 87,613 $ 0.1231 - $23.9037 $15.9515 ======= Exercisable at end of period................... 74,456 $ 0.1231 - $23.9037 $15.9052 ======= B. 1998 Activity <CAPTION> Weighted Average Activity Shares Exercise Price Exercise Price -------- ------- --------------------- -------------- <S> <C> <C> <C> <C> <C> Outstanding at beginning of period................ 254,923 $ 0.1231 - $27.8200 $16.9872 Options Granted......... -- -- - -- -- Options Exercised....... (5,930) 0.1970 - 18.8004 7.5625 Options Canceled........ (69,801) 5.8851 - 27.8200 18.0341 ------- -------- -------- -------- Outstanding at end of period................... 179,192 $ 0.1231 - $23.9037 $16.8913 ======= Exercisable at end of period................... 129,261 $ 0.1231 - $23.9037 $16.8511 ======= VI. Outside the Plans A. 1999 Activity <CAPTION> Weighted Average Activity Shares Exercise Price Exercise Price -------- ------- --------------------- -------------- <S> <C> <C> <C> <C> <C> Outstanding at beginning of period................ 52,500 $10.8125 - $24.1623 $14.7952 Options Granted......... 613,361 5.0000 - 5.0630 5.0411 Options Exercised....... -- -- - -- -- Options Canceled........ (10,000) 10.8125 - 17.2500 14.0313 ------- -------- -------- -------- Outstanding at end of period................... 655,861 $ 5.0000 - $24.1623 $ 5.6848 ======= Exercisable at end of period................... 484,299 $ 5.0000 - $24.1623 $ 5.3441 ======= B. 1998 Activity <CAPTION> Weighted Average Activity Shares Exercise Price Exercise Price -------- ------- --------------------- -------------- <S> <C> <C> <C> <C> <C> Outstanding at beginning of period................ 7,500 $10.9761 - $24.1623 $21.5251 Options Granted......... 45,000 10.8125 - 17.2500 13.6736 Options Exercised....... -- -- - -- -- Options Canceled........ -- -- - -- -- ------- -------- -------- -------- Outstanding at end of period................... 52,500 $10.8125 - $24.1623 $14.7952 ======= Exercisable at end of period................... 3,000 $10.9761 - $24.1623 $17.5692 ======= </TABLE> F-17
VENTAS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Exercise prices for 1,468,454 and 3,598,076 options outstanding at December 31, 1999 range from $0.1231 to $13.2500 and $13.2501 to $27.8200, respectively. The weighted average contractual life of options outstanding on December 31, 1999 is 7.2 years. In 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standard No. 123, Accounting for Stock-Based Compensation (Statement 123). This standard prescribes a fair value based method of accounting for employee stock options or similar equity instruments and requires certain pro forma disclosures. For purposes of the pro forma disclosures required under Statement 123, the estimated fair value of the options is amortized to expense over the option's vesting period. The estimated fair value of options granted for the year ended December 31, 1999 and the period from May 1, 1998 to December 31, 1998 was approximately $1,232,000 and $817,000, respectively. Pro forma information follows (in thousands, except per share amounts): <TABLE> <CAPTION> 1999 1998 ------- ------- <S> <C> <C> Pro forma income available to common stockholders........... $36,203 $19,803 Pro forma earnings per common share: Basic..................................................... $ .53 $ .29 Diluted................................................... .53 .29 </TABLE> In determining the estimated fair value of the Company's stock options as of the date of grant, a Black-Scholes option pricing model was used with the following assumptions: <TABLE> <CAPTION> 1999 1998 ------- ------- <S> <C> <C> Risk free interest rate.................................... 6.0% 6.0% Dividend yield............................................. 12.0% 9.0% Volatility factors of the expected market price for the Company's common stock.................................... .25% .25% Weighted average expected life of options.................. 8 years 8 years </TABLE> The Black-Scholes options valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions, including the expected stock price volatility. Because the Company's employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options. 7. Income Taxes 1999 The Company intends to make an election to be taxed as a REIT under the Internal Revenue Code of 1986 (the "Code"), as amended, commencing with its taxable year that ended December 31, 1999. The Company believes it has been organized and has operated in such a manner as to enable it to qualify as a REIT commencing with that taxable year, subject to its ability to meet the minimum distribution requirements. The Company intends to operate in such a manner as to enable it to qualify. The Company's actual qualification and taxation as a REIT however, will depend upon its ability to meet, on a continuing basis, through actual annual operating results, distribution levels, stock ownership, and the various qualification tests imposed under the Code. No assurance can be given that the actual results of the Company's operation for any particular taxable year will satisfy such requirements. No net provision for income taxes has been recorded in the Consolidated Financial Statements for F-18
VENTAS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) the year ended December 31, 1999 due to the Company's intention to qualify as a REIT, distribute 95% of its 1999 taxable income as a dividend and the existence of operating losses that offset the remaining 1999 liability for federal corporate income taxes. Although the Company currently expects to qualify as a REIT for the year ended December 31, 1999, it is possible that economic, market, legal, tax or other considerations may cause the Company to fail or elect not to qualify as a REIT and be taxed at corporate statutory rates. As a REIT, the Company generally will not be subject to federal income tax on income it distributes to stockholders, as long as it distributes 100% of REIT taxable income. The Company can meet the annual distribution requirement by payment of 95% of its 1999 taxable income, less dividends paid in February 1999, by no later than September 15, 2000. The Company is subject to a federal excise tax under REIT regulations of the Code to the extent that required distributions to qualify as a REIT for 1999 were not paid by January 31, 2000 and has recorded an estimate of such expense and liability in the 1999 Consolidated Financial Statements. Ordinary income paid to stockholders, for federal income tax purposes, during the year ended December 31, 1999 was $.39 per share. Net taxable income for federal income tax purposes results from net income for financial reporting purposes adjusted for the differences between the financial reporting and tax bases of assets and liabilities, including depreciation, impairment losses on real estate and the deferred gain on the partial termination of the interest rate swap agreement. For the eight month period from May 1, 1998 to December 31, 1998, the Company was taxed at the statutory corporate rates as a C corporation. The tax basis of the Company's real estate investments for federal income tax purposes was approximately $880 million at December 31, 1999. The Company made no income tax payments for the year ended December 31, 1999 and the period from May 1, 1998 to December 31, 1998. As a former C corporation for federal income tax purposes, the Company potentially remains subject to corporate level taxes for any asset dispositions between January 1, 1999 to December 31, 2008 ("built-in gains tax"). The amount of income potentially subject to corporate level tax is generally equal to the excess of the fair value of the asset over its adjusted tax basis as of December 31, 1998, or the actual amount of taxable gain, whichever is greater. Any gain recognized during this period of time could be offset by available net operating losses and capital loss carryforwards. The remaining deferred income tax liability at December 31, 1999 reflects a previously established liability to be utilized for any built-in gain tax incurred on assets that are disposed of within the subsequent 10-year period. Prior Years See "Note 8--Transactions with Vencor--The 1998 Spin Off" for a discussion of the Tax Allocation Agreement the Company entered into with Vencor in connection with the 1998 Spin Off. The Internal Revenue Service is currently reviewing the federal income tax returns for tax years ending December 31, 1996 and 1995 of the Company (which then operated under the name Vencor). The income tax returns for the Company for subsequent years are also subject to a review. The ultimate outcome of these matters has not been determined and accordingly, no additional provision for any resulting tax liabilities, if any, has been made in the Consolidated Financial Statements at December 31, 1999. On February 3, 2000 the Company received a refund (the "Refund") of approximately $26.6 million from the Internal Revenue Service representing the refund of income taxes paid by it from 1996 and 1997 and accrued interest thereon arising out of the Company's 1998 federal income tax return. Although the Company believes that it is entitled to the Refund pursuant to the terms of the Tax Allocation Agreement and on other legal grounds, the Internal Revenue Service may assert a right to all or some portion of the Refund based upon its review of income tax returns for the years as previously discussed. In addition, Vencor has asserted that it is entitled to the F-19
VENTAS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Refund pursuant to the terms of the Tax Allocation Agreement and on other legal grounds. The Company intends to vigorously defend its rights to the Refund. There can be no assurance as to how such controversy will be resolved, or as to whether or not the Company will ultimately retain all or a portion of the Refund. Accordingly, the Refund has been classified with the other liabilities of the Company at December 31, 1999 in the Consolidated Financial Statements. Vencor and the Company are also engaged in a dispute relating to the entitlement to certain federal, state and local tax refunds, including the Refund. In connection with Vencor's bankruptcy filing, the Company and Vencor are currently discussing the terms of a stipulation relating to such tax refunds. There can be no assurance as to how such dispute will be resolved. The provision for income taxes for the period from May 1, 1998 to December 31, 1998 consists of the following (in thousands): <TABLE> <CAPTION> The Period From May 1, 1998 to December 31, 1998 -------------------- <S> <C> Deferred: Federal............................................. $18,602 State............................................... 2,549 ------- 21,151 Current tax benefit of extraordinary loss on extinguishment of debt: Federal............................................. (4,350) State............................................... (585) ------- (4,935) ------- Provision for income taxes............................ $16,216 ======= A summary of non-current deferred income taxes by source included in the consolidated balance sheet at December 31, 1998 follows (in thousands): <CAPTION> (Assets) Liabilities -------------------- December 31, 1998 -------------------- <S> <C> Depreciation.......................................... $14,700 Property.............................................. 905 Interest rate swap loss............................... 14,972 Compensation.......................................... (71) ------- $30,506 ======= </TABLE> On September 15, 1999, the Company completed and filed its calendar year 1998 U.S. Corporation Income Tax Return. On its return the Company reflected capital loss carryforwards of approximately $201.0 million which can only be utilized against future capital gains, if any. The carryforwards expire in 2019. The Company also has a net operating loss ("NOL") carryforward of $15.0 million, of which approximately $4.0 million was used to offset taxes for 1999 and $11.0 million can be used to offset future taxable income (and/or taxable income for prior years if audits of any prior year's return determine that amounts are owed), if any, remaining after the dividend paid deduction. The Company's ability to utilize tax carryforwards will be subject to a variety of factors including the Company's dividend distribution policy. In general, the Company will be entitled to utilize NOL's and tax credit carryforwards only to the extent that REIT taxable income exceeds the Company's deduction for dividends paid. As a result of the uncertainties relating to the ultimate utilization of favorable tax attributes described above, no net deferred tax benefit has been ascribed to capital loss and net operating loss carryforwards as of December 31, 1999 and 1998. F-20
VENTAS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) A reconciliation of the federal statutory rate to the effective income tax rate follows: <TABLE> <CAPTION> The Period From May 1, 1998 to December 31, 1998 --------------- <S> <C> Federal statutory rate....................................... 33.05% State income taxes, net of federal income tax benefit........ 4.75% ------ Effective income tax rate.................................... 37.80% ====== </TABLE> 8. Transactions with Vencor Recent Developments Regarding Vencor On September 13, 1999, Vencor filed for protection under chapter 11 of the United States Bankruptcy Code the ("Bankruptcy Code"). Under the automatic stay provisions of the Bankruptcy Code, the Company is currently prevented from exercising certain rights and remedies under its agreements with Vencor, including the Spin Agreements (as defined below), and from taking certain enforcement actions against Vencor. The Company, Vencor and Vencor's major creditors have been engaged in negotiations both prior and subsequent to Vencor's bankruptcy filing to restructure Vencor's debt and lease obligations. Terms of a preliminary, non-binding agreement among Vencor's major creditors, Vencor and Ventas, reached at the time of Vencor's bankruptcy filing regarding Vencor's plan of reorganization (the "September 1999 Agreement in Principle"), are set forth below. On March 22, 2000, the Delaware bankruptcy court granted Vencor's motion to extend through May 16, 2000 the period during which Vencor has the exclusive right to file a plan of reorganization, and Vencor recently extended the expiration date for its debtor-in-possession financing until June 30, 2000. There can be no assurance that Vencor's plan of reorganization, when filed, will be on the terms of the September 1999 Agreement in Principle or otherwise be acceptable to the Company. Under the terms of the September 1999 Agreement in Principle, the Company would make approximately $45 million in annual rent concessions, effective as of May 1, 1999, resulting in annual base rent of approximately $181 million for the 1999-2000 lease year. The Company would also receive (a) in addition to the current 2% annual cash escalator contained in its Master Leases, a 1 1/2% annual non-cash rent escalator that would accrue at 6% per annum until the occurrence of certain specified events, at which time the accrual with interest would be due and payable and thereafter the 1 1/2% rent escalator would convert to a cash escalator totalling 3 1/2% per year; (b) an additional 1% annual cash rent bonus escalator payable if Vencor's net patient revenue growth at the Company's facilities exceeds a cumulative annual growth rate of 5%; (c) a one time, unilateral right to reset the rents for the facilities, exercisable on a lease by lease basis from May 2002 through May 2005, to a then fair rental rate, for a total fee of $5 million payable on a pro-rata basis at the time of exercise under any lease; (d) 15% of the common stock and warrants in reorganized Vencor (the Company, in order to qualify as a REIT, may not hold 10% or more of the total combined voting power or the total number of shares in Vencor; the Company is evaluating alternatives for dealing with any Vencor equity ultimately received in excess of the 10% or more limitation); and (e) a reaffirmation and continuation of Vencor's indemnity obligations under the Spin Agreements. The Development Agreement and the Participation Agreement between the Company and Vencor (each, as defined below) would be terminated, and the Tax Allocation Agreement and the Master Leases (each, as defined below) would be amended and clarified under the September 1999 Agreement in Principle. The terms of the September 1999 Agreement in Principle also provided that on the Vencor Effective Date the Company would also receive approximately $3.4 million, representing reduced August 1999 minimum monthly base rent ("August 1999 Rent") (approximately $15.1 million), net of $11.7 million ($3.75 million reduction in rent per month for May, June and July 1999 rent, plus $0.45 million relating to previously paid rent for a disputed facility). However, there can be no assurance that Vencor's plan of reorganization, when filed, will be on the terms of the September 1999 Agreement in Principle or otherwise will be acceptable to the F-21
VENTAS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Company. As a result of delays in the extended Vencor bankruptcy proceeding and the determination that such amount is uncollectible, the Company wrote off approximately $34.4 million of rents receivable from tenants (of which approximately $26.9 million in expense was realized during the fourth quarter of 1999), primarily consisting of the following: (1) $18.8 million for an amount due from Vencor that approximates the $3.75 million per month difference for August 1999 through December 1999 between the minimum monthly base rent due the Company under the current terms of the Master Leases with Vencor and the minimum monthly base rent that would be due under leases based on the September 1999 Agreement in Principle; (2) a $15.1 million write-off of the balance of the unpaid minimum monthly base rent for August 1999 that is a claim in the extended Vencor bankruptcy proceedings; (3) a $0.2 million charge for rent due under a lease with Vencor which is under dispute; and (4) a $0.3 million charge to earnings for rent and other items due from non-Vencor tenants. Other terms of the September 1999 Agreement in Principle for Vencor include: (a) the principal amount of Vencor senior bank debt would be reduced from approximately $520 million to approximately $320 million in exchange for 56% of the common stock in the restructured Vencor, and (b) Vencor's senior subordinated notes would be converted into approximately 29% of the common stock in restructured Vencor, and the holders of such debt would receive warrants in the restructured company. The Company believes that the best outcome for the Company, Vencor and their respective banks and other creditors is a global restructuring of Vencor's financial obligations in connection with Vencor's chapter 11 bankruptcy filing. Ventas and Vencor continue to be engaged in advanced settlement discussions with the federal government seeking to resolve all federal civil and administrative claims against them arising from the participation of Vencor facilities in various federal health benefit programs. The majority of these claims arise from lawsuits filed under the qui tam, or whistleblower, provision of the Federal Civil False Claims Act, which allows private citizens to bring suit in the name of the United States. The United States Department of Justice, Civil Division, filed two proofs of claim in the Vencor bankruptcy court covering the United States claims and the qui tam suits. The United States asserted approximately $1.3 billion, including triple damages, against Vencor in these proofs of claim. The Department of Justice has informed the Company that it is the Department of Justice's position that, if liability exists, the Company and Vencor will be jointly and severally liable for the portion of such claims related to the period prior to the date of the 1998 Spin Off. If the United States, Vencor and the Company reach a settlement, any liability of the Company and Vencor related to these matters would likely be resolved in the settlement. There can be no assurance that a settlement will be reached regarding these claims and suits or, if reached, that the settlement will be on terms acceptable to the Company. See "Note 11-- Litigation." There can be no assurance that Vencor will be successful in obtaining the approval of its creditors for a restructuring plan, that any such plan will be on the terms of the September 1999 Agreement in Principle or on other terms acceptable to the Company, Vencor and its creditors, or that any restructuring plan will not have a Material Adverse Effect on the Company. Nor can there be any assurance that Vencor and the Company will be able to reach a settlement with the Department of Justice, or that any such settlement will be on terms acceptable to Vencor, Vencor's creditors and the Company. The Company, Vencor and its creditors are not legally bound by the terms of the September 1999 Agreement in Principle, and the terms of the September 1999 Agreement in Principle: (i) are mutually interdependent, (ii) are subject to agreement on a satisfactory plan of reorganization and confirmation thereof and (iii) are further subject to other conditions (including, but not limited to, negotiation and execution of definitive documentation). As discussed above, Vencor has entered into additional negotiations with its various creditors and Ventas regarding the September 1999 Agreement in Principle. Under the terms of the Amended Credit Agreement, it is an event of default if Vencor's plan of reorganization is not effective on or before December 31, 2000. See "Note 4-- Borrowing Arrangements." F-22
VENTAS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) The Stipulation In connection with the bankruptcy filing by Vencor, the Company and Vencor entered into a stipulation (the "Stipulation") for the payment by Vencor to the Company of approximately $15.1 million per month starting in September 1999, to be applied against the total amount of minimum monthly base rent that is due and payable under the Master Leases. The Stipulation was approved by the bankruptcy court. During the period in which the Stipulation is in effect, Vencor has agreed to fulfill all of its obligations under the Spin Agreements as such obligations become due, including its obligation to indemnify and defend Ventas from and against all claims arising out of the Company's former health care operations or assets or liabilities transferred to Vencor in the 1998 Spin Off. Vencor has not, however, agreed to assume the Spin Agreements and has reserved its right to seek to reject such agreements pursuant and subject to the applicable provisions of the Bankruptcy Code. A termination of the Stipulation and/or rejection by Vencor of the Spin Agreements could have a Material Adverse Effect on the Company. The payments under the Stipulation are required to be made by the fifth day of each month, or on the first business day thereafter. Starting in September, 1999, the difference between the amount of minimum monthly base rent due under the Company's Master Leases with Vencor and the monthly payment of approximately $15.1 million accrues as a superpriority administrative expense in Vencor's bankruptcy, junior in right only to the following: (i) any liens or superpriority claims provided to lenders under Vencor's debtor-in- possession credit agreement (the "DIP facility"); (ii) any fees due to the Office of the United States Trustee; (iii) certain fees of Vencor's professionals; (iv) any liens or superpriority claims granted to pre-petition secured creditors as adequate protection for their claims under the interim DIP order issued by the bankruptcy court and the final DIP order; and (v) pre- petition liens granted to the lenders under Vencor's credit agreement, as amended, and related agreements, to the extent such pre-petition claims are allowed as secured, subject to challenge in the Vencor bankruptcy proceeding. The monthly payment of approximately $15.1 million under the Stipulation is not subject to offset, recoupment or challenge. August 1999 Rent in the amount of approximately $18.9 million remains unpaid and will be asserted as a claim in Vencor's chapter 11 case. The Stipulation by its terms initially would have expired on October 31, 1999, but automatically renews for one-month periods unless either party provides a fourteen-day notice of its election to terminate the Stipulation. To date, no such notice of termination has been given. The Stipulation may also be terminated prior to its expiration upon a payment default by Vencor, the consummation of a plan of reorganization for Vencor, or the occurrence of certain events under the DIP facility. There can be no assurance as to how long the Stipulation will remain in effect or that Vencor will continue to perform under the terms of the Stipulation. The Stipulation also addresses an agreement by Ventas and Vencor concerning any statutes of limitations and other time constraints. See "--The Tolling Agreement" below. The Second Standstill Agreement On April 12, 1999, the Company entered into a Second Standstill Agreement with Vencor, which was subsequently amended on May 5, May 8, June 6, July 6, August 5, and September 3, 1999 (as amended, the "Second Standstill Agreement"). The Second Standstill Agreement terminated on September 9, 1999. Under the Second Standstill Agreement, the Company agreed not to exercise its remedies under the Master Leases based on any default arising from or relating to disclosures made by Vencor to the Company, and to accept the payment of April, May, June and July 1999 rent pursuant to a specified schedule. These payments represent the full amount of rent that was due for each month's rent under the Master Leases. Vencor made all rent payments required by the Second Standstill Agreement with respect to the April, May, June and July 1999 lease payments. August 1999 Rent remains unpaid and will be asserted as a claim in Vencor's chapter 11 bankruptcy case. F-23
VENTAS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Also, under the Second Standstill Agreement, each of the Company and Vencor agreed not to pursue any claims against the other or any third party relating to the agreements entered into in connection with the 1998 Spin Off, or any of the Master Leases, or with respect to certain specified disputes, during a defined period that terminated on September 9, 1999. The Tolling Agreement The Company and Vencor have also entered into an agreement (the "Tolling Agreement") pursuant to which they have agreed that any statutes of limitations or other time constraints in a bankruptcy proceeding, including the assertion of certain "bankruptcy avoidance provisions" that might be asserted by one party against the other, are extended or tolled for a specified period. That period currently terminates on the termination date of the Stipulation. Pursuant to the Stipulation, the Tolling Agreement does not shorten any time period otherwise provided under the Bankruptcy Code. The 1998 Spin Off In order to govern certain of the relationships between the Company and Vencor after the 1998 Spin Off and to provide mechanisms for an orderly transition, the Company and Vencor entered into various agreements at the time of the 1998 Spin Off, including the Master Leases (the "Spin Agreements"). In connection with the 1998 Spin Off, an Independent Committee of the Board of Directors of the Company was formed. The function of the Independent Committee was to review and approve all agreements and transactions between the Company and Vencor to ensure that such agreements and transactions represent arm's length negotiations including, without limitation, the negotiation, enforcement and renegotiations of any leases between the Company and Vencor. On November 17, 1998, the Company appointed a new director to the Independent Committee and the committee appointed him Chairman of the Independent Committee. As of the date hereof, the Company and Vencor have no common directors, officers or, to the Company's knowledge, common ownership by stockholders owning greater than 10% of both companies. During 1999, the Company moved its offices from space it shared with Vencor and no longer requires administrative support from Vencor. However, as discussed below, Vencor assisted in the preparation of certain Securities and Exchange Commission (the "Commission") filings and tax returns and continues to provide certain information in connection with related audits of tax matters for the Company and to defend certain litigation to which the Company is or may become a party. As described above in "--Recent Developments Regarding Vencor," under the automatic stay provisions of the Bankruptcy Code, the Company is currently prevented from exercising certain rights and remedies under the Spin Agreements and from taking certain enforcement actions against Vencor. In addition, certain provisions of the Spin Agreements are currently governed by the terms of the Stipulation. If a Vencor plan of reorganization is consummated according to the terms of the September 1999 Agreement in Principle, the Company expects that the terms of the Master Leases and certain other Spin Agreements will be substantially amended and reflected in the terms of new agreements and that certain of the Spin Agreements will be terminated. Certain material terms of the Master Leases and certain of the other Spin Agreements are described below. Master Lease Agreements In the 1998 Spin Off, the Company retained substantially all of its real property, buildings and other improvements (primarily long-term acute care hospitals and nursing facilities) and leased nearly all these facilities to Vencor under four Master Leases. A single nursing facility in Corydon, Indiana was leased by the Company to Vencor in August, 1998 under the terms of a fifth Master Lease. The Master Leases contain terms which govern the rights, duties and responsibilities of the Company and Vencor relative to each of the leased properties. The leased properties include land, buildings, structures, easements, improvements on the land and permanently affixed equipment, machinery and other fixtures relating to the operation of the facilities. F-24
VENTAS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) The Company's ability to exercise certain rights and remedies under the Master Leases described below has been stayed as a result of Vencor's filing for protection under chapter 11 of the Bankruptcy Code. The Bankruptcy Code, however, generally provides that a landlord is entitled to receive rent during the pendency of a tenant's bankruptcy proceeding, subject to such tenant's rights to reject the lease and its other legal defenses and rights. Vencor has disputed that it is required to pay rent at the rate set forth in the Master Leases and in the Stipulation has reserved the right to challenge the rate set forth in the Master Leases in the event the Stipulation is terminated. The Stipulation discussed above provides for Vencor to pay $15.1 million per month in minimum base rent under the Master Leases while the Stipulation is in effect. Various provisions of the Master Leases may ultimately be challenged in Vencor's chapter 11 bankruptcy case, and certain provisions regarding payment of rent have been modified by the Stipulation in anticipation of the contemplated restructuring. The Company expects that the terms of the Master Leases will be substantially amended and reflected in the the terms of new or restated master lease agreements in connection with the consummation of Vencor's plan of reorganization according to the terms of the September 1999 Agreement in Principle. See "--Recent Developments Regarding Vencor." The Master Leases are structured as triple-net leases pursuant to which Vencor is required to pay all or substantially all insurance, taxes, utilities and maintenance related to the properties. The base annual contract rent was approximately $226.6 million and $222.2 million at December 31, 1999 and 1998, respectively. Base annual rent increases 2% per annum, effective May 1 of each year, provided Vencor achieves net patient service revenue for the applicable year in excess of 75% of net patient service revenue for the base year of 1997. The initial terms of these leases were for periods ranging from 10 to 15 years. Under the terms of each Master Lease, except as noted below, upon the occurrence of an event of default thereunder, the Company may, at its option, exercise the remedies under a Master Lease on all properties included within that particular Master Lease. The remedies which may be exercised under the Master Lease by the Company, at its option, include the following: (i) after not less than 10 days' notice to Vencor, terminate the Master Lease, repossess the leased property and relet the leased property to a third party and require that Vencor pay to the Company, as liquidated damages, the net present value of the rent for the balance of the term, discounted at the prime rate; (ii) without terminating the Master Lease, repossess the leased property and relet the leased property with Vencor remaining liable under the Master Lease for all obligations to be performed by Vencor thereunder, including the difference, if any, between the rent under the Master Lease and the rent payable as a result of the reletting of the leased property and (iii) any and all other rights and remedies available at law or in equity. The Master Leases require Vencor to cooperate with the Company in connection with license transfers and certain other regulatory matters arising from a lease termination. Each Master Lease provides that the remedies under such Master Lease may be exercised with respect only to the property that is the subject of the default upon the occurrence of any one of the following events of default: (i) the occurrence of a final non-appealable revocation of Vencor's license to operate a facility; (ii) the reduction in the number of licensed beds at a facility in excess of 10% or the revocation of certification of a facility for reimbursement under Medicare; or (iii) Vencor becomes subject to regulatory sanctions at a facility and fails to cure the regulatory sanctions within the applicable cure period. Upon the occurrence of the fifth such event of default under a Master Lease with respect to any one or more properties, the Master Lease permits the Company, at its option, to exercise the rights and remedies under the Master Lease on all properties included within that Master Lease. The occurrence of any one of the following events of default constitutes an event of default under all Master Leases, permitting the Company, at its option, to exercise the rights and remedies under all of the Master Leases simultaneously: (i) the occurrence of an event of default under the Agreement of Indemnity--Third Party Leases between the Company and Vencor, (ii) the liquidation or dissolution of Vencor, (iii) if Vencor files a petition of bankruptcy or a petition for reorganization or arrangement under the federal bankruptcy laws, and (iv) a petition is filed against Vencor under federal bankruptcy laws and the same is not dismissed within 90 days of its institution. F-25
VENTAS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Any notice of the occurrence of an event of default under a Master Lease which the Company sends to Vencor must be sent simultaneously to Vencor's leasehold mortgagee (the "Leasehold Mortgagee"). Prior to terminating a Master Lease for all or any part of the leased property covered thereunder, the Company must give the Leasehold Mortgagee prior written notice and the opportunity to cure any such event of default within the cure period for Leasehold Mortgagees set forth in the Master Leases. Following the expiration of such cure period, the Company may then terminate a Master Lease by giving at least 10 days prior written notice of such termination. Vencor may, with the prior written approval of the Company, sell, assign or sublet its interest in all or any portion of the leased property under a Master Lease. The Company may not unreasonably withhold its approval to any such transfer provided (i) the assignee is creditworthy, (ii) the assignee has at least four years of operational experience, (iii) the assignee has a favorable business and operational reputation, (iv) the assignee assumes the Master Lease in writing, (v) the sublease is subject and subordinate to the terms of the Master Lease, and (vi) Vencor and any guarantor remains primarily liable under the Master Lease. Each Master Lease requires Vencor to maintain specified levels of liability, all risk property and workers' compensation insurance for the properties. Each Master Lease further provides that in the event a property is totally destroyed, or is substantially destroyed such that the damage renders the property unsuitable for its intended use, Vencor will have the option either to restore the property at its cost to its pre-destruction condition or offer to purchase the leased property (in either event all insurance proceeds, net of administrative and related costs, will be made available to Vencor). If the Company rejects the offer to purchase, Vencor will have the option either to restore the property or terminate the applicable Master Lease as it relates to the property. If the damage is such that the property is not rendered unsuitable for its intended use, or if it is not covered by insurance, each Master Lease requires Vencor to restore the property to its original condition. Pursuant to the Spin Agreements, all controversies, claims or disputes arising out of the Master Leases are subject to mediation between the parties for a reasonable period of time in an effort to settle such controversy, claim or dispute. If the parties are unable to reach resolution after such period of time, then the dispute is to be submitted to arbitration. Development Agreement Under the terms of the Development Agreement, Vencor if it so desires, will complete the construction of certain development properties substantially in accordance with the existing plans and specifications for each such property. Upon completion of each such development property, the Company has the option to purchase the development property from Vencor at a purchase price equal to the amount of Vencor's actual costs in acquiring and developing such development property prior to the purchase date. If the Company purchases the development property, Vencor will lease the development property from the Company. The initial annual base rent under such a lease will be 10% of the actual costs incurred by Vencor in acquiring and developing the development property. The other terms of the lease for the development property will be substantially similar to those set forth in the Master Leases. During the year ended December 31, 1999, the Company did not acquire any facilities under this agreement. During the period from May 1, 1998 to December 31, 1998, the Company acquired one skilled nursing facility under the Development Agreement for $6.2 million and has entered into a separate Master Lease with Vencor with respect to such facility. The Development Agreement has a five year term, and the Company and Vencor each have the right to terminate the Development Agreement in the event of a change of control. The ability of the Company to purchase properties pursuant to the terms of the Development Agreement is restricted by the terms of Amended Credit Agreement. Any such future purchases would likely require the consent of the "Required Lenders" under the Amended Credit Agreement, and there can be no assurance that such consent would be obtained. The Company expects the Development Agreement to be terminated in the event the Company, Vencor and Vencor's creditors agree on a plan of reorganization for Vencor and such plan is consummated. F-26
VENTAS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Participation Agreement Under the terms and conditions of the Participation Agreement, Vencor has a right of first offer to become the lessee of any real property acquired or developed by the Company which is to be operated as a hospital, nursing facility or other health care facility, provided that Vencor and the Company can negotiate a mutually satisfactory lease arrangement and provided that the property is not leased by the Company to the existing operator of such facility. The Participation Agreement also provides, subject to certain terms, that the Company has a right of first offer to purchase or finance any health care related real property that Vencor determines to sell or mortgage to a third party, provided that Vencor and the Company can negotiate mutually satisfactory terms for such purchase or mortgage. The Participation Agreement has a three year term, and the Company and Vencor each have the right to terminate the Participation Agreement in the event of a change of control. The ability of the Company to purchase or finance properties pursuant to the terms of the Participation Agreement is restricted by the terms of the Company's Amended Credit Agreement. Any such future purchases or financings would likely require the consent of the "Required Lenders" under the Amended Credit Agreement, and there can be no assurance that such consent would be obtained. The Company expects the Participation Agreement to be terminated in the event the Company, Vencor and Vencor's creditors agree on a plan of reorganization for Vencor and such plan is consummated. Tax Allocation Agreement The Tax Allocation Agreement provides that Vencor will be liable for, and will hold the Company harmless from and against, (i) any taxes of Vencor and its then subsidiaries (the "Vencor Group") for periods after the 1998 Spin Off, (ii) any taxes of the Company and its then subsidiaries (the "Company Group") or the Vencor Group for periods prior to the 1998 Spin Off (other than taxes associated with the Spin Off) with respect to the portion of such taxes attributable to assets owned by the Vencor Group immediately after completion of the 1998 Spin Off and (iii) any taxes attributable to the 1998 Spin Off to the extent that Vencor derives certain tax benefits as a result of the payment of such taxes. Vencor will be entitled to any refund or credit in respect of taxes owed or paid by Vencor under (i), (ii) or (iii) above. Vencor's liability for taxes for purposes of the Tax Allocation Agreement will be measured by the Company's actual liability for taxes after applying certain tax benefits otherwise available to the Company other than tax benefits that the Company in good faith determines would actually offset tax liabilities of the Company in other taxable years or periods. Any right to a refund for purposes of the Tax Allocation Agreement will be measured by the actual refund or credit attributable to the adjustment without regard to offsetting tax attributes of the Company. The Company will be liable for, and will hold Vencor harmless against, any taxes imposed on the Company Group or the Vencor Group other than taxes for which the Vencor Group is liable as described in the above paragraph. The Company will be entitled to any refund or credit for taxes owed or paid by the Company as described in this paragraph. The Company's liability for taxes for purposes of the Tax Allocation Agreement will be measured by the Vencor Group's actual liability for taxes after applying certain tax benefits otherwise available to the Vencor Group other than tax benefits that the Vencor Group in good faith determines would actually offset tax liabilities of the Vencor Group in other taxable years or periods. Any right to a refund will be measured by the actual refund or credit attributable to the adjustment without regard to offsetting tax attributes of the Vencor Group. See "Note 7-- Income Taxes." Agreement of Indemnity--Third Party Leases In connection with the 1998 Spin Off, the Company assigned its former third party lease obligations (i.e., leases under which an unrelated third party is the landlord) as a tenant or as a guarantor of tenant obligations to F-27
VENTAS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Vencor (the "Third Party Leases"). The lessors of these properties may claim that the Company remains liable on the Third Party Leases assigned to Vencor. Under the terms of the Agreement of Indemnity--Third Party Leases, Vencor and its subsidiaries have agreed to indemnify and hold the Company harmless from and against all claims against the Company arising out of the Third Party Leases assigned by the Company to Vencor. Either prior to or following the 1998 Spin Off, the tenant's rights under a subset of the Third Party Leases were assigned or sublet to unrelated third parties (the "Subleased Third Party Leases"). If Vencor or such third party subtenants are unable to satisfy the obligations under any Third Party Lease assigned by the Company to Vencor, and if the lessors prevail in a claim against the Company under the Third Party Leases, then the Company may be liable for the payment and performance of the obligations under any such Third Party Lease. In that event, the Company may be entitled to receive revenues from those properties that would mitigate the costs incurred in connection with the satisfaction of such obligations. The Third Party Leases relating to nursing facilities, hospitals, offices and warehouses have remaining terms (excluding renewal periods) of 1 to 11 years and total aggregate remaining minimum rental payments under those leases amount to $114.0 million. The Third Party Leases relating to ground leases have remaining terms from 1 to 81 years and total aggregate remaining minimum rental payments under those leases amount to $33.6 million. The annual minimum rental payments under all of these leases for 2000 equals approximately $35.3 million. Pursuant to the Stipulation, Vencor agreed to fulfill its obligations under the Agreement of Indemnity--Third Party Leases during the period in which the Stipulation is in effect, and, except for disputes with Health Care Property Investors discussed in "Note 9--Commitments and Contingencies," has to date performed its obligations. The total aggregate remaining minimum rental payments under these leases are as follows (in thousands): <TABLE> <CAPTION> Sub- Leased Skilled Third Nursing Office Party Facilities Hospitals Land Leases Leases Other Total ---------- --------- ------- ------ ------- ------ -------- <S> <C> <C> <C> <C> <C> <C> <C> 2000............ $22,619 $ 2,857 $ 1,211 $536 $ 7,660 $ 416 $ 35,299 2001............ 16,246 2,870 1,203 397 5,726 322 26,764 2002............ 9,948 2,726 1,165 50 2,782 296 16,967 2003............ 5,831 2,225 1,144 -- 2,587 265 12,052 2004............ 2,204 2,225 1,139 -- 2,017 265 7,850 Thereafter...... 4,057 4,999 27,717 -- 11,525 354 48,652 ------- ------- ------- ---- ------- ------ -------- $60,905 $17,902 $33,579 $983 $32,297 $1,918 $147,584 ======= ======= ======= ==== ======= ====== ======== </TABLE> Agreement of Indemnity--Third Party Contracts In connection with the 1998 Spin Off, the Company assigned its former third party guaranty agreements to Vencor (the "Third Party Guarantees"). The Company may remain liable on the Third Party Guarantees assigned to Vencor. Under the terms of the Agreement of Indemnity--Third Party Contracts, Vencor and its subsidiaries have agreed to indemnify and hold the Company harmless from and against all claims against the Company arising out of the Third Party Guarantees assigned by the Company to Vencor. If Vencor is unable to satisfy the obligations under any Third Party Guaranty assigned by the Company to Vencor, then the Company may be liable for the payment and performance of the obligations under any such agreement. The Third Party Guarantees were entered into in connection with certain acquisitions and financing transactions. The aggregate exposure under these guarantees is approximately $49.8 million. Of that amount, Atria Communities, Inc. ("Atria") also has directly guaranteed and agreed to indemnify and hold the Company harmless from and against all claims against the Company arising out of one of the Third Party Guarantees, in an aggregate principal amount of approximately $34.5 million. There can be no assurance that the Company will be successful in its attempt to be released from this liability. F-28
VENTAS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Transition Services Agreement The Transition Services Agreement, which expired pursuant to its terms on December 31, 1998, provided that Vencor would provide the Company with transitional administrative and support services, including but not limited to finance and accounting, human resources, risk management, legal, and information systems support. The Company paid Vencor $1.6 million for the period from May 1, 1998 to December 31, 1998 for services provided under the Transition Services Agreement. After December 31, 1998, Vencor continued to provide the Company with certain administrative and support services (primarily computer systems, telephone networks, mail delivery and other office services). Effective March 15, 1999, the Company moved to new office space and those services were no longer provided by Vencor. During 1999, Vencor assisted in the preparation of Commission filings and certain tax returns and other tax filings made on behalf of the Company for the period ending on or before December 31, 1998 and is continuing to assist the Company under the terms of the Tax Allocation Agreement and the other Spin Agreements by providing certain information in connection with the Company's fixed asset records, ongoing audits of tax matters and defending certain litigation to which the Company is or may become liable. Assumption of Certain Operating Liabilities and Litigation In connection with the 1998 Spin Off, Vencor agreed to assume and to indemnify the Company for any and all liabilities that may arise out of the ownership or operation of the health care operations either before or after the date of the 1998 Spin Off. The indemnification provided by Vencor also covers losses, including costs and expenses, which may arise from any future claims asserted against the Company based on these health care operations. In addition, at the time of the 1998 Spin Off, Vencor agreed to assume the defense, on behalf of the Company, of any claims that were pending at the time of the 1998 Spin Off, and which arose out of the ownership or operation of the health care operations. Vencor also agreed to defend, on behalf of the Company, any claims asserted after the 1998 Spin Off which arise out of the ownership and operation of the health care operations. There can be no assurance that Vencor will have sufficient assets, income and access to financing to enable it to satisfy its obligations incurred in connection with the 1998 Spin Off or that Vencor will continue to honor its obligations incurred in connection with the 1998 Spin Off. For example, Vencor has not agreed to assume the Spin Agreements and has reserved its right to seek to reject such agreements pursuant and subject to the applicable provisions of the Bankruptcy Code. If Vencor does not satisfy or otherwise honor the obligations under these arrangements, then the Company may be liable for the payment and performance of such obligations and may have to assume the defense of such claims. In addition, if Vencor's plan of reorganization is consummated, it is likely that the Company will be required to make payments to settle certain government claims which will not be subject to recovery from or indemnification by Vencor. 9. Commitments and Contingencies On August 3, 1999, Health Enterprises of Michigan, Inc. ("HEM"), the Company's tenant at three of its facilities in Michigan, filed a petition for relief under the United States Bankruptcy Code. The three leases to HEM provided for annual rental for the three Michigan facilities of approximately $1.05 million. The Company's leases with HEM were rejected by HEM in the bankruptcy proceeding. The Company has entered into leases for the three facilities with substitute tenants. The initial aggregate annual rental for the facilities under the leases with the new tenants is expected to be approximately $639,000. The Company has asserted a claim against HEM in the bankruptcy proceeding for the fees, costs, expenses and damages resulting from HEM's rejection of the leases for the three Michigan facilities. The amount of any such recovery against HEM will be limited by applicable bankruptcy law. In addition, there can be no assurance the Company would prevail in a claim against HEM or that HEM would have sufficient assets to satisfy such claim. Mr. Peter C. Kern guaranteed HEM's performance under the leases for two of the three Michigan facilities. The Company also has asserted claims F-29
VENTAS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) against Mr. Kern for HEM's failure to perform under the terms of the leases for the two applicable Michigan facilities. There can be no assurance the Company will prevail in a claim against Mr. Kern or whether Mr. Kern will have sufficient assets to satisfy any such claim. The Company has determined that these developments will not have any effect on the carrying value of the three Michigan facilities in the accompanying Consolidated Financial Statements. In addition, HEM or its parent company, Texas Health Enterprises, Inc., also operates, or is otherwise a sub-tenant of, nine facilities under sub-leases of primary leases (the "HEM Primary Leases"). The sub-leases and the HEM Primary Leases were assigned by the Company to Vencor; however, the Company may be liable to the landlord under the HEM Primary Leases, which are part of the Third Party Subleases discussed above. The annual lease payments on these nine facilities is approximately $2.2 million and the estimated remaining total lease payments are approximately $7.8 million. The sub-tenant filed a motion to reject six of the sub-lease agreements, which motion was granted. The annual lease payments on these six facilities approximate $1.5 million and the estimated total remaining lease payments are approximately $3.6 million. In conjunction with the 1998 Spin Off, Vencor indemnified the Company and agreed to hold the Company harmless from and against all claims against the Company arising from any of these obligations. Pursuant to its indemnification of the Company and the Stipulation, Vencor has either assumed operation of these six facilities or relet the facilities to another operator, and therefore the Company is not currently bearing any of the costs relating to such facilities. However, there can be no assurance that Vencor will continue to pay, indemnify and defend the claims or have sufficient assets, income and access to financing to enable it to satisfy such claims. The Company received demands for payment from Health Care Property Investors. ("HCPI") by letters dated October 19, 1999, February 4, 2000 and March 7, 2000 for obligations alleged to be due under lease agreements which were assigned to and assumed by Vencor in connection with the 1998 Spin Off. The aggregate amount alleged to be due to HCPI in such demand letters is approximately $3.7 million. In addition, by letter dated February 9, 2000, HCPI notified the Company and Vencor that HCPI intends to exercise its right to have the Company or Vencor purchase two facilities owned by HCPI (one in Evansville, Indiana and one in Kansas City, Missouri) and leased by Vencor under lease agreements that were assigned to and assumed by Vencor in connection with the 1998 Spin Off. The two facilities have allegedly been closed and HCPI has stated that if the facilities were not reopened within the required period of time, HCPI would demand that the Company or Vencor purchase the facility not so reopened for the greater of the minimum repurchase price or the fair value. The minimum repurchase price is approximately $8.5 million for the Evansville facility and $3.8 million for the Kansas City facility. HCPI contends that the Evansville facility must be reopened on or before April 24, 2000 and the Kansas City facility must be reopened on or before April 22, 2000. Vencor responded to the HCPI claims and demands and requested supporting documentation and clarification relating to certain claims, disputed the validity and enforceability of HCPI's ability to require the repurchase of the Evansville and Kansas City facilities, and agreed to pay a portion of the amounts alleged to be due to HCPI. In accordance with the terms of the 1998 Spin Off and the Stipulation, the Company has issued written demand to Vencor for payment, performance, indemnification and defense of the claims, obligations and allegations asserted by HCPI. There can be no assurance that Vencor will pay, indemnify and defend these claims or that Vencor will have sufficient assets, income and access to financing to enable it to satisfy such claims. Lenox Healthcare, Inc. and its subsidiaries (collectively, "Lenox") filed for protection under chapter 11 of the Bankruptcy Code on November 3, 1999. Lenox operates eight facilities under subleases of primary leases (the "Lenox Primary Leases"), which are part of the Third Party Subleases discussed above. In connection with the 1998 Spin Off, the Company assigned the subleases and Lenox Primary Leases to Vencor; however, the respective lessors may claim that the Company remains liable to them under the Lenox Primary Leases. The annual lease payments on these eight facilities approximate $2.4 million and the estimated total remaining lease payments are approximately $26.0 million (assuming Vencor exercises all available renewal rights). Lenox has F-30
VENTAS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) rejected three of the subleases. The annual lease payments on these three facilities is approximately $1.9 million and the estimated total remaining lease payments are approximately $5.6 million (assuming the tenant thereunder exercises all available renewal rights). Pursuant to its indemnification of the Company and the Stipulation, Vencor has either assumed operation of these three facilities or relet the facilities to another operator, and therefore the Company is not currently bearing any of the costs relating to such facilities. Lenox has not yet affirmed or rejected the five remaining subleases. In conjunction with the 1998 Spin Off, Vencor indemnified the Company and agreed to hold the Company harmless from and against all claims against the Company arising from any of these obligations. However, there can be no assurance that Vencor will continue to pay, indemnify or defend these claims or that Vencor will have sufficient assets, income and access to financing to enable it to satisfy such obligations. Based upon actions taken by Vencor in the past under its indemnity obligations related to these matters and similar matters, the agreement by Vencor under the Stipulation to continue to perform its indemnity obligations under the Spin Agreements, and the expected reaffirmation and continuation of Vencor's indemnity obligations in the contemplated restructuring between the Company, Vencor and Vencor's creditors, there have been no adjustments recorded in the accompanying Consolidated Financial Statements relating to the uncertainties regarding the HEM Primary Leases, the Lenox Primary Leases or the HCPI demand. Sun Healthcare Group, Inc. ("Sun") filed a petition for relief under the Bankruptcy Code in October 1999. Sun leases a single nursing facility in Toledo, Ohio from the Company. The annual rent under the Company's lease with Sun is $248,000. Sun currently is not in default in the payment of rent under the Company's lease, nor has it sought to reject such lease. In its bankruptcy proceeding, Sun may seek either to reject or assume the Company's lease. If Sun rejects the Company's lease, then the Company will have to locate a substitute tenant for the facility. There can be no assurance that the Company would be able to locate a satisfactory substitute tenant for the facility on terms that would be acceptable to the Company. Should the Company fail to locate a substitute tenant on terms acceptable to the Company, then the Company would have to assume operations at the facility, sell the facility or close the facility. The Company has determined that Sun's rejection of the lease, if it occurs, will not have any significant effect on the carrying value of this facility in the accompanying Consolidated Financial Statements. Integrated Health Services, Inc. and a number of its subsidiaries filed a petition for relief under the Bankruptcy Code in February 2000. IHS Acquisition No. 151, Inc. and Integrated Health Services of Naples, Inc. (collectively, "IHS"), affiliates of Integrated Health Services, Inc. included in the bankruptcy filings, each lease a nursing facility from the Company. The aggregate annual rental under the two leases is approximately $784,000. IHS is at least one month in arrears on the monthly rental payments on both of the facilities. In its bankruptcy proceeding, IHS may seek either to reject or assume the Company's leases. If IHS rejects either of the leases, then the Company will have to locate a substitute tenant for the facility. There can be no assurance that the Company would be able to locate satisfactory substitute tenants for the facilities on terms that are acceptable to the Company. Should the Company fail to locate substitute tenants on terms acceptable to the Company, then the Company would have to assume operations at the facilities, sell the facilities or close the facilities. The Company expects IHS will reject the lease on one of the two facilities, and accordingly, the Company has sought to locate an operator for that facility. The Company has not yet located a new operator for the affected facility and has recorded a real estate impairment loss of $1.9 million to write down the asset to its estimated fair value. On November 10, 1999, one of the Company's nursing facilities was damaged by a casualty of unconfirmed origin or cause. The nursing facility is located in Flint, Michigan and is leased and operated by Continuum of Flint, Inc. Three patients at the facility and two employees of Continuum of Flint, Inc. died as a result of the casualty. Under the terms of the lease agreement, Continuum of Flint, Inc. is required to maintain property and business interruption, steam boiler/pressure vessels, workers' compensation and general and professional liability F-31
VENTAS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) insurance with respect to the facility. The Company is named on the related policies as an additional insured and loss payee. All rental payments which have come due for this facility since the date of the casualty have been paid to the Company by Continuum of Flint, Inc.'s insurers. The Company also maintains general liability insurance. The Company notified its general liability carriers of the occurrence of this casualty. At this time the Company does not believe this casualty will have a Material Adverse Effect on the Company. Except for the $1.9 million real estate impairment loss, as discussed above, no adjustments or additional provision for liability, if any, resulting from the matters discussed above has been recorded in the Consolidated Financial Statements at December 31, 1999. 10. Earnings Per Share The following table shows the amounts used in computing basic and diluted earnings per share (in thousands, except per share amounts): <TABLE> <CAPTION> Period from Year Ended May 1, 1998 to December 31, December 31, 1999 1998 ------------ -------------- <S> <C> <C> Numerator for Basic and Diluted Earnings Per Share: Income before Extraordinary Item................. $42,535 $34,809 Extraordinary Item............................... -- (8,051) ------- ------- Net Income....................................... $42,535 $26,758 ======= ======= Denominator: Denominator for Basic Earnings Per Share-- Weighted Average Shares......................... 67,754 67,681 Effect of Dilutive Securities: Stock Options.................................. 15 46 Time Vesting Restricted Stock Awards........... 220 138 ------- ------- Dilutive Potential Common Stock................ 235 184 ------- ------- Denominator for Diluted Earnings Per Share-- Adjusted Weighted Average....................... $67,989 $67,865 ======= ======= Basic Earnings Per Share Income before Extraordinary Item................. $ 0.63 $ 0.51 Extraordinary Item............................... -- (0.12) ------- ------- Net Income....................................... $ 0.63 $ 0.39 ======= ======= Diluted Earnings Per Share Income before Extraordinary Item................. $ 0.63 $ 0.51 Extraordinary Item............................... -- (0.12) ------- ------- Net Income....................................... $ 0.63 $ 0.39 ======= ======= </TABLE> Options to purchase 5.1 million shares of common stock ranging from $5.890 to $27.8200, were outstanding at December 31, 1999 but were not included in the computation of diluted earnings per share because the options' exercise price was greater than the average market price of the common shares and, therefore, the effect would be antidilutive. Options to purchase 5.3 million shares of common stock ranging from $13.130 to $27.8200, were outstanding at December 31, 1998 but were not included in the computation of diluted earnings per share because the options' exercise price was greater than the average market price of the common shares and, therefore, the effect would be antidilutive. F-32
VENTAS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) 11. Litigation Legal Proceedings Defended and Indemnified by Vencor Under the Spin Agreements The following litigation and other matters arose from the Company's operations prior to the 1998 Spin Off or relate to assets or liabilities transferred to Vencor in connection with the 1998 Spin Off. Under the Spin Agreements, Vencor agreed to assume the defense, on behalf of the Company, of any claims that (a) were pending at the time of the 1998 Spin Off and which arose out of the ownership or operation of the healthcare operations or (b) were asserted after the 1998 Spin Off and which arose out of the ownership and operation of the healthcare operations or any of the assets or liabilities transferred to Vencor in connection with the 1998 Spin Off, and to indemnify the Company for any fees, costs, expenses and liabilities arising out of such operations (the "Indemnification"). Vencor is presently defending the Company in the following matters. Under the Stipulation (see "Note 8--Transactions with Vencor"), Vencor agreed to abide by the Indemnification and to continue to defend the Company in these and other matters as required under the Spin Agreements while the Stipulation is in effect. However, there can be no assurance that Vencor will continue to defend the Company in such matters or that Vencor will have sufficient assets, income and access to financing to enable it to satisfy such obligations or its obligations incurred in connection with the 1998 Spin Off. In addition, many of the following descriptions are based primarily on information included in Vencor's public filings and information provided to the Company by Vencor. There can be no assurance that Vencor has provided the Company with complete and accurate information in all instances. A class action lawsuit entitled Jules Brody v. Transitional Hospital Corporation, et al., Case No. CV-S-97-00747-PMP, was filed on June 19, 1997 in the United States District Court for the District of Nevada on behalf of a class consisting of all persons who sold shares of Transitional Hospital Corporation ("Transitional") common stock during the period from February 26, 1997 through May 4, 1997, inclusive. Transitional was, prior to the 1998 Spin- Off, a subsidiary of the Company. Transitional has been a subsidiary of Vencor since the 1998 Spin-Off. The complaint alleges that Transitional purchased shares of its common stock from members of the investing public after it had received a written offer to acquire all of Transitional's common stock and without making the required disclosure that such an offer had been made. The complaint further alleges that defendants disclosed that there were "expressions of interest" in acquiring Transitional when, in fact, at that time, the negotiations had reached an advanced stage with actual firm offers at substantial premiums to the trading price of Transitional's stock having been made which were actively being considered by Transitional's Board of Directors. The complaint asserts claims pursuant to Sections 10(b), 14(e) and 20(a) of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), and common law principles of negligent misrepresentation and names as defendants Transitional as well as certain former senior executives and directors of Transitional. The plaintiff seeks class certification, unspecified damages, attorneys' fees and costs. In June 1998, the court granted Vencor's motion to dismiss with leave to amend the Section 10(b) claim and the state law claims for misrepresentation. The court denied Vencor's motion to dismiss the Section 14(e) and Section 20(a) claims, after which Vencor filed a motion for reconsideration. On March 23, 1999, the court granted Vencor's motion to dismiss all remaining claims and the case has been dismissed. The plaintiff has appealed this ruling. Vencor has informed the Company that it intends to defend this action vigorously. A class action lawsuit entitled A. Carl Helwig v. Vencor, Inc., et al., was filed on December 24, 1997 in the United States District Court for the Western District of Kentucky (Civil Action No. 3-97CV-8354). The putative class action claims were brought by an alleged stockholder of the Company against the Company and certain executive officers and directors of the Company. The complaint alleges that the Company and certain current and former executive officers of the Company during a specified time frame violated Sections 10(b) and 20(a) of the Exchange Act, by, among other things, issuing to the investing public a series of false and misleading statements concerning the Company's current operations and the inherent value of the Company's common stock. The complaint further alleges that as a result of these purported false and misleading statements concerning F-33
VENTAS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) the Company's revenues and successful acquisitions, the price of the Company's common stock was artificially inflated. In particular, the complaint alleges that the Company issued false and misleading financial statements between February and October of 1997 which misrepresented and understated the impact that changes in Medicare reimbursement policies would have on the Company's core services and profitability. The complaint further alleges that the Company issued a series of materially false statements concerning the purportedly successful integration of its acquisitions and prospective earnings per share for 1997 and 1998 which the Company knew lacked any reasonable basis and were not being achieved. The suit seeks damages in an amount to be proven at trial, pre-judgment and post-judgment interest, reasonable attorneys' fees, expert witness fees and other costs, and any extraordinary equitable and/or injunctive relief permitted by law or equity to assure that the plaintiff has an effective remedy. In January 1999 the United States District Court for the Western District of Kentucky entered a judgment dismissing the action in its entirety as to all defendants in the case. The plaintiff has appealed the ruling to the United States Court of Appeals for the Sixth Circuit. The appeal has been fully briefed and was argued on December 15, 1999, and the Company is awaiting the Sixth Circuit decision. Vencor, on behalf of the Company, is defending this action vigorously. A stockholder derivative suit entitled Thomas G. White on behalf of Vencor, Inc. and Ventas, Inc. v. W. Bruce Lunsford, et al., Case No. 98 C103669 was filed in June 1998 in the Jefferson County, Kentucky, Circuit Court. The suit purports to have been brought on behalf of Vencor and the Company against certain current and former executive officers and directors of Vencor and the Company. The complaint alleges, among other things, that the defendants damaged Vencor and the Company by engaging in violations of the securities laws, including engaging in insider trading, fraud and securities fraud and damaging the reputation of Vencor and the Company. The plaintiff asserts that such actions were taken deliberately, in bad faith and constitute breaches of the defendants' duties of loyalty and due care. The complaint is largely based on substantially similar assertions to those made in the class action lawsuit entitled A. Carl Helwig v. Vencor, Inc., et al., discussed above. The suit seeks unspecified damages, interest, punitive damages, reasonable attorneys' fees, expert witness fees and other costs, and any extraordinary equitable and/or injunctive relief permitted by law or equity to assure that the plaintiff has an effective remedy. The parties have entered into a series of stipulations to stay all proceedings in the action. The current stipulation will expire upon the conclusion of the Vencor bankruptcy proceeding, at which point the plaintiff may file an amended complaint. The Company believes that the allegations in the complaint are without merit. Vencor has informed the Company that it also believes the allegations in the complaint are without merit, and that it intends to vigorously defend this action for and on behalf of the Company. A class action lawsuit styled Gary Hibbeln et al. v. Vencor, Incorporated, et al., was filed in Jefferson Circuit Court in Kentucky on April 28, 1999. The complaint alleges direct or indirect assertion of untrue statement or statements of material facts, and/or omission of material facts in connection with the sale of securities by the defendant to plaintiffs. This action was dismissed with prejudice on July 26, 1999. TheraTx, Incorporated ("TheraTx") was a subsidiary of the Company prior to the 1998 Spin Off. The Company transferred all of its interest in TheraTx to Vencor in the 1998 Spin Off. TheraTx is a plaintiff in a declaratory judgment action entitled TheraTx, Incorporated v. James W. Duncan, Jr., et al., Case No. 1:95-CV-3193 currently pending in the United States District Court for the Northern District of Georgia. The defendants in this lawsuit have asserted counterclaims against TheraTx under breach of contract, securities fraud, negligent misrepresentation and fraud theories for allegedly not performing as promised under a merger agreement related to TheraTx's purchase of a company called PersonaCare, Inc. and for allegedly failing to inform the defendants/counterclaimants prior to the merger that TheraTx's possible acquisition of Southern Management Services, Inc. might cause the suspension of TheraTx's shelf registration under relevant rules of the Securities and Exchange Commission. The court granted summary judgment for the defendants/counterclaimants and ruled that TheraTx breached the shelf registration provision in the merger agreement, but dismissed the defendants' F-34
VENTAS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) remaining counterclaims. Additionally, the court ruled after trial that defendants/counterclaimants were entitled to damages and prejudgment interest in the amount of approximately $1.3 million and attorneys' fees and other litigation expenses of approximately $700,000. Vencor and the defendants/counterclaimants both have appealed the court's rulings. On April 9, 1998, a class action lawsuit captioned Mongiovi et al. v. Vencor, Inc., et al., Case No. 98-769-CIV-T24E, was filed in the United States District Court for the Middle District of Florida on behalf of a purported class consisting of certain residents of Vencor's Tampa nursing facility and other residents in Vencor's nursing facilities nationwide (whose operations were transferred by the Company to Vencor in the 1998 Spin Off). The complaint alleges various breaches of contract, and statutory and regulatory violations including violations of federal and state RICO statutes. The original complaint has been amended to delineate several purported subclasses. The plaintiffs seek class certification, unspecified damages, attorneys' fees and costs. The action was dismissed without prejudice on July 5, 1999. Vencor received notice in June 1998 that the state of Georgia found regulatory violations with respect to patient discharges, among other things, at one of Vencor's nursing facilities in Savannah, Georgia. The Company transferred the operations of the subject nursing facility to Vencor at the 1998 Spin-Off. The state recommended a Federal fine of $543,000 for these violations, which HCFA has imposed. Vencor has appealed this fine. On April 14, 1999, a lawsuit entitled Lenox Healthcare, Inc., et al. v. Vencor, Inc., et al., Case No. BC 208750, was filed in the Superior Court of Los Angeles, California by Lenox Healthcare, Inc. ("Lenox") asserting various causes of action arising out of the Company's sale and lease of several nursing facilities to Lenox in 1997. Lenox subsequently removed certain of its causes of action and refiled these claims before the United States District Court for the Western District of Kentucky in a case entitled Lenox Healthcare, Inc. v. Vencor, Inc., et al., Case No. 3:99 CV-348-H. Vencor, on behalf of itself and the Company, has asserted counterclaims, including RICO claims, against Lenox in the Kentucky action. The Company believes that the allegations made by Lenox in both complaints are without merit. Vencor, on behalf of itself and the Company, intends to defend these actions vigorously. Lenox and its subsidiaries filed for protection under Chapter 11 of the Bankruptcy Code on November 3, 1999. An order was entered in the Kentucky action on September 21, 1999, staying the Kentucky action until further order of the court. On September 23, 1999, the Superior Court in the California action issued an order staying the California case, which stay was extended for six months by order of the court entered on February 28, 2000. A lawsuit styled Excelsior Care Centers, Inc. v. Ventas, Inc. and Lenox Healthcare, Inc. was filed in Page County Circuit Court in Virginia on October 8, 1999. The complaint alleges that the Company and Lenox permitted a nursing facility to fall into a state of disrepair, thereby willfully breaching the terms of a lease agreement with Excelsior Care Centers. The complaint further alleges that the Company breached the terms of a guaranty of the lease agreement and makes a statutory claim for waste against the Company and Lenox. Until November 1, 1999, the facility was operated by Lenox or one of its affiliates under a management agreement with the Company. The Company assigned the subject management agreement and lease agreement with Excelsior Care Centers to Vencor in connection with the 1998 Spin Off. The Company disputes the allegations contained in the complaint and the Company or Vencor, on behalf of the Company, intends to defend this action vigorously. Vencor has advised the Company that, effective November 1, 1999, Vencor began operating the facility. Vencor and the Company have been informed by the Department of Justice that they are the subject of ongoing investigations into various aspects of claims for reimbursement from government payers, billing practices and various quality of care issues in the hospitals and nursing facilities formerly operated by the Company and presently operated by Vencor. These investigations cover the Company's former healthcare F-35
VENTAS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) operations prior to the date of the 1998 Spin Off, and include matters arising out of the qui tam actions described below and additional potential claims. Certain of the complaints described below name other defendants in addition to the Company. The United States Department of Justice, Civil Division filed two proofs of claim in the Vencor bankruptcy court covering the United States' claims and the qui tam suits. The United States asserted approximately $1.3 billion, including triple damages, against Vencor in these proofs of claim. The Department of Justice has informed the Company that it is the Department of Justice's position that if liability exists in connection with such investigations or qui tam actions, the Company and Vencor will be jointly and severally liable for the portion of such claims related to the period prior to the date of the 1998 Spin Off. Any liability the Company may incur in connection with these matters will be subject to the Company's rights under the Indemnification and Vencor's ability and willingness to perform thereunder. American X-Rays, Inc. ("AXR") was a subsidiary of the Company prior to the 1998 Spin Off. The Company transferred all of its interest in AXR to Vencor in the 1998 Spin Off. AXR is the defendant in a civil qui tam lawsuit which was filed in the United States District Court for the Eastern District of Arkansas and served on the Company on July 7, 1997. The lawsuit is styled United States ex rel. Doe v. American X-Ray, Inc., No. LR-C-95-332 (E.D. Ark.). The United States of America has intervened in the suit which was brought under the Federal Civil False Claims Act. AXR provided portable X-ray services to nursing facilities (including those operated by the Company at the time) and other healthcare providers. The Company acquired an interest in AXR when The Hillhaven Corporation ("Hillhaven") was merged into the Company in September 1995 and purchased the remaining interest in AXR in February 1996. The civil lawsuit alleges that AXR submitted false claims to the Medicare and Medicaid programs. The suit seeks damages in an amount of not less than $1,000,000, treble damages and civil penalties. In a related criminal investigation, the United States Attorney's Office for the Eastern District of Arkansas indicted four former employees of AXR; those individuals were convicted of various fraud related counts in January 1999. The Company and Vencor have received several grand jury subpoenas for documents and witnesses which Vencor, on behalf of the Company has moved to quash. On May 4, 1999, the United States of America amended its civil complaint to include Vencor and the Company as defendants. Vencor and the Company have moved to dismiss the amended complaint. Vencor, on behalf of the Company, is defending this action vigorously. On November 24, 1997, a civil qui tam lawsuit was filed against the Company in the United States District Court for the Middle District of Florida. This lawsuit was brought under the Federal Civil False Claims Act and is styled United States of America, ex rel. Virginia Lee Lanford and Gwendolyne Cavanaugh v. Vencor, Inc., et al, No. 97-CV-2845. The United States of America intervened in the lawsuit on May 17, 1999. On July 23, 1999, the United States filed its Amended Complaint in the lawsuit. The lawsuit alleges that the Company and Vencor knowingly submitted false claims and false statements to the Medicare and Medicaid programs, including, but not limited to, claims for reimbursement of costs for certain ancillary services performed in Vencor's nursing facilities and for third party nursing facility operators that the United States of America claims are not reimbursable costs. The lawsuit involves the Company's former healthcare operations. The complaint does not specify the amount of damages claimed by the plaintiffs. The Company disputes the allegations contained in the complaint and the Company and/or Vencor, on behalf of the Company, intends to defend this action vigorously. In United States ex rel. Kneepkens v. Gambro Healthcare, Inc., et al., No. 97-10400-GAO, filed in the United States District Court for the District of Massachusetts on October 15, 1998, Transitional, the Company's former subsidiary which was transferred to Vencor in the 1998 Spin Off, and two unrelated entities, Gambro Healthcare, Inc. and Dialysis Holdings, Inc., are defendants. This suit alleges that the defendants violated the Federal Civil False Claims Act and the Anti-Kickback Statute and committed common law fraud, unjust enrichment and payment by mistake of fact. Specifically, the complaint alleges that a predecessor to Transitional formed a joint venture with Damon Clinical Laboratories to create and operate a clinical testing laboratory in Georgia that was then used to provide lab testing for dialysis patients, and that the joint venture billed at below F-36
VENTAS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) cost in return for referral of substantially all non-routine testing in violation of the Anti-Kickback Statute. It is further alleged that a predecessor to Transitional and Damon Clinical Laboratories used multiple panel testing of end stage renal disease rather than single panel testing that allegedly resulted in the generation of additional revenues from Medicare and that the entities allegedly added non-routine tests to tests otherwise ordered by physicians that were not requested or medically necessary but resulted in additional revenue from Medicare in violation of the Anti-Kickback Statute. Transitional has moved to dismiss the case. Transitional disputes the allegations in the complaint and is defending the action vigorously. On or about January 7, 2000 the United States of America intervened in each of the following previously sealed (and therefore previously non-public) qui- tam cases with respect to the claims against the Company and/or Vencor: United States ex rel George Mitchell et al. v. Vencor, Inc. et al (S.D. Ohio); United States ex rel. Danley v. Medisave Pharmacies, Inc., Hillhaven Corp., and Vencor, Inc., Civil No. CV-N-96-00170-HDM (D. Nev., Reno Div.); United States ex rel. Roberts v. Vencor, Inc. et al., Civil Action No. 3:97CV-349-J, (W.D. Kan.) consolidated with United States ex rel. Meharg, et al. v. Vencor, Inc., et al., Civil Action No. 3:98SC-737-H, (M.D. Fla.); United States ex rel. Huff, et. al. v. Vencor, Inc., et al., Civil No. 97-4358 AHM (MCX); United States ex rel Brzycki v. Vencor, Inc., Civil No. 97-451-JD; United States, et al., ex rel., Phillips-Minks, et al. v. Transitional Hospitals Corp., et al.; United States ex rel. Harris and Young v. Vencor, Inc., et. al., (E.D. Mo.) 4:99CB00842 and Gary Graham on Behalf of the United States of America v. Vencor Operating, Inc. et. al., (S.D. Fla.). Except for the order in United States ex rel. Harris and Young, which is described below, the order granting the United States' motions to intervene in these lawsuits state that the United States is intervening for the purpose of representing the United States' interests in the Vencor bankruptcy proceeding and to effectuate any settlement reached between the United States and, Vencor and/or the Company. The courts have ordered these lawsuits unsealed, but the Company has not been formally served with a complaint in any of these lawsuits. Each of these lawsuits is described in more detail immediately below. United States ex rel. George Mitchell et al. v. Vencor, Inc. et al (S.D. Ohio), filed on August 13, 1999, was brought under the Federal Civil False Claims Act. The lawsuit alleges that the Company and its former subsidiaries, Vencare, Inc. ("Vencare") and Vencor Hospice, Inc. (the Company transferred both subsidiaries to Vencor in the 1998 Spin-Off), submitted false statements to the Medicare program for, among other things, reimbursement for costs for patients who were not "hospice appropriate." The complaint alleges damages in excess of $1,000,000. The Company disputes the allegations contained in the complaint. If the United States and, Vencor and/or the Company, do not reach a settlement or should the complaint in this lawsuit be served on the Company, the Company and/or Vencor, on behalf of the Company, intends to defend this action vigorously. In United States ex rel. Danley v. Medisave Pharmacies, Inc., Hillhaven Corp., and Vencor, Inc., Civil No. CV-N-96-00170-HDM (D. Nev., Reno Div.), filed on March 15, 1996, it is alleged that Medisave Pharmacies, Inc. ("Medisave"), a former subsidiary of the Company and now a subsidiary of Vencor, (1) charged the Medicare program for unit dose drugs when bulk drugs were administered and charged skilled nursing facilities more for the same drugs for Medicare patients than for non-Medicare patients; (2) improperly claimed special dispensing fees that it was not entitled to under Medicaid; and (3) recouped unused drugs from skilled nursing facilities and returned these drugs to its stock without crediting Medicare or Medicaid, all in violation of the Federal Civil False Claims Act. It also alleged that Medisave had a policy of offering kickbacks such as free equipment to skilled nursing facilities to secure and maintain their business. The complaint seeks treble damages, other unspecified damages, civil penalties, attorney's fees and other costs. The Company disputes the allegations contained in the complaint. If the United States and, Vencor and/or the Company, do not reach a settlement or should the complaint in this lawsuit be served on the Company, the Company and/or Vencor, on behalf of the Company, intends to defend this action vigorously. In the lawsuits styled United States ex rel. Roberts v. Vencor, Inc. et al., Civil Action No. 3:97CV-349-J (W.D. Kan.), filed on June 25, 1996, consolidated with United States ex rel. Meharg, et al. v. Vencor, Inc., et al., Civil Action No. 3:98SC-737-H, (M.D. Fla.), filed on June 4, 1998, it is alleged that the Company, Vencor and F-37
VENTAS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Vencare, among others, submitted and conspired to submit false claims to the Medicare program in connection with their purported provision of respiratory therapy services to skilled nursing facility residents. The Company and Vencare allegedly billed Medicare for respiratory therapy services and supplies when those services were not medically necessary, billed for services not provided, exaggerated the time required to provide services or exaggerated the productivity of its therapists. It is further alleged that the Company and Vencare presented false claims and statements to the Medicare program in violation of the Federal Civil False Claims Act, by, among other things, allegedly causing skilled nursing facilities with which they had respiratory therapy contracts, to present false claims to Medicare for respiratory therapy services and supplies. The complaint seeks treble damages, other unspecified damages, civil penalties, attorney's fees and other costs. The Company disputes the allegations contained in the complaint. If the United States and, Vencor and/or the Company, do not reach a settlement or should the complaint in this lawsuit be served on the Company, the Company and/or Vencor, on behalf of the Company, intends to defend this action vigorously. The Company is a defendant in the case captioned United States ex rel. Huff, et. al. v. Vencor, Inc., et al., Civil No. 97-4358 AHM(MCX) filed in the United States District Court for the Central District of California on June 13, 1997. The complaint alleges, among other things, that the defendants violated the Federal Civil False Claims Act by submitting false claims to Medicare, Medicaid and CHAMPUS programs by allegedly (1) falsifying patient bills and submitting the bills to Medicare, Medicaid and CHAMPUS programs, (2) submitting bills for intensive and critical care not actually administered to patients, (3) the falsifying of patient charts in relation to the billing, (4) charging for physical therapy services allegedly not provided and pharmacy services allegedly provided by non-pharmacists, and (5) billing for sales calls made by nurses to prospective patients. The complaint further alleges the improper establishment of TEFRA rates. The complaint seeks treble damages, other unspecified damages, civil penalties, attorney's fees and other costs. The Company disputes the allegations contained in the complaint. If the United States and, Vencor and/or the Company, do not reach a settlement or should the complaint in this lawsuit be served on the Company, the Company and/or Vencor, on behalf of the Company, intends to defend this action vigorously. The Company is a defendant in the proceeding captioned United States ex rel Brzycki v. Vencor, Inc., Civil No. 97-451-JD, filed in the United States District Court for the District of New Hampshire on September 8, 1997. In this lawsuit the Company is accused of knowingly violating the Federal Civil False Claims Act by submitting and conspiring to submit false claims to the Medicare program. The complaint includes allegations that the Company (1) fabricated diagnostic codes by ordering and providing medically unnecessary ancillary services (such as respiratory therapy), (2) changed referring physicians' diagnoses in order to qualify for Medicare reimbursement; (3) billed for products or services not received or not received in the manner billed, and (4) paid illegal kickbacks to referring health care professionals in the form of medical consulting service agreements as an alleged inducement to refer patients in violation of the Anti-Kickback Act and Stark laws. The complaint seeks unspecified damages, civil penalties, attorney's fees and other costs. The Company disputes the allegations contained in the complaint. If the United States and, Vencor and/or the Company, do not reach a settlement or should the complaint in this lawsuit be served on the Company, the Company and/or Vencor, on behalf of the Company, intends to defend this action vigorously. In United States, et al., ex rel., Phillips-Minks, et al. v. Transitional Hospitals Corp., et al., filed in the Southern District of California on July 23, 1998, it is alleged that the defendants, including Transitional and the Company, submitted and conspired to submit false claims and statements to Medicare, Medicaid, and other federally and state funded programs during a period commencing in 1993 and certain other state law claims. The conduct complained of allegedly violates the Federal False Claims Act, the California False Claims Act, the Florida False Claims Act, the Tennessee Health Care False Claims Act, and the Illinois Whistleblower Reward and Protection Act. Defendants allegedly submitted improper and erroneous claims to Medicare, Medicaid and other programs, for improper, unnecessary and false services, excess collections associated with billing and collecting bad debts, inflated and nonexistent laboratory charges, false and inadequate documentation of claims, F-38
VENTAS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) splitting charges, shifting revenues and expenses, transferring patients to hospitals that reimburse at a higher level, and improperly allocating hospital insurance expenses. In addition, the complaint avers that defendants were inconsistent in their reporting of cost report data, paid out kickbacks to increase patient referrals to defendant hospitals, and incorrectly reported employee compensation resulting in inflated employee 401(k) contributions. The complaint seeks unspecified damages and expenses. The Company disputes the allegations contained in the complaint. If the United States and, Vencor and/or the Company, do not reach a settlement or should the complaint in this lawsuit be served on the Company, the Company and/or Vencor, on behalf of the Company, intends to defend this action vigorously. The lawsuit styled United States ex rel. Harris and Young v. Vencor, Inc., et. al., 4:99CB00842 (E.D. Mo.), filed on May 25, 1999, was brought under the Federal Civil False Claims Act. The lawsuit alleges that the defendants submitted or cause to be submitted false claims for reimbursement to the Medicare and CHAMPUS programs. Vencare, the Company's former subsidiary and the current subsidiary of Vencor, allegedly (1) over billed for respiratory therapy services, (2) rendered medically unnecessary treatment, and (3) falsified supply, clinical and equipment records. The defendants also allegedly encouraged or instructed therapist to falsify clinical records and over prescribe therapy services. The complaint seeks treble damages, other unspecified damages, civil penalties, attorney's fees and other costs. The Company disputes the allegations contained in the complaint. If the United States and, Vencor and/or the Company, do not reach a settlement or should the complaint in this lawsuit be served on the Company, the Company and/or Vencor, on behalf of the Company, intends to defend this action vigorously. In Gary Graham on Behalf of the United States of America v. Vencor Operating, Inc. et. al., (S.D. Fla.), filed on or about June 8, 1999, it is alleged that the defendants, including the Company, presented or caused to be presented false or fraudulent claims for payment to the United States under the Medicare program in violation of, among other things, the Federal Civil False Claims Act. The complaint claims that Medisave, a former subsidiary of the Company which was transferred to Vencor in the 1998 Spin Off, systematically up-charged for drugs and supplies dispensed to Medicare patients. The complaint seeks unspecified damages, civil penalties, interest, attorney's fees and other costs. The Company disputes the allegations contained in the complaint. If the United States and, Vencor and/or the Company, do not reach a settlement or should the complaint in this lawsuit be served on the Company, the Company and/or Vencor, on behalf of the Company, intends to defend this action vigorously. If the Department of Justice investigations and the qui tam claims were ultimately decided in a manner adverse to the Company, such adverse decisions could have a Material Adverse Effect on the Company. Although the Company believes it has numerous good faith, valid legal and factual defenses to the Department of Justice's and the qui tam claims, the Company and Vencor continue to be engaged in discussions with the Department of Justice regarding a settlement of the investigations and the qui tam actions. The United States has intervened in the Mitchell, Danley, Meharg, Roberts, Phillips-Minks, Bryzcki, Huff, Harris and Graham qui tam lawsuits described above for the purpose of facilitating any such settlement. Such a settlement, if reached, would resolve all of the actions in which the Department of Justice has intervened and other claims by the Department of Justice, and could involve the payments of amounts by the Company that would be material to the business, financial condition, results of operations and liquidity of the Company. There can be no assurance that the Company, Vencor and the Department of Justice will reach a settlement relative to all or any such claims. Vencor is a party to certain legal actions and regulatory investigations arising in the normal course of its business. Neither the Company nor Vencor is able to predict the ultimate outcome of pending litigation and regulatory investigations. In addition, there can be no assurance that the United States Health Care Financing Administration ("HCFA") or other regulatory agencies will not initiate additional investigations related to F-39
VENTAS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Vencor's business in the future, nor can there be any assurance that the resolution of any litigation or investigations, either individually or in the aggregate, would not have a material adverse effect on Vencor's liquidity, financial position or results of operations, which in turn could have a Material Adverse Effect on the Company. The Company is a party to certain legal actions and regulatory investigations which arise from the normal course of its prior healthcare operations. The Company is unable to predict the ultimate outcome of pending litigation and regulatory investigations. In addition, there can be no assurance that other regulatory agencies will not initiate additional investigations related to the Company's prior healthcare business in the future, nor can there be any assurance that the resolution of any litigation or investigations, either individually or in the aggregate, would not have a Material Adverse Effect on the Company. The Company is party to various other lawsuits, both as defendant and plaintiff, arising in the normal course of business. It is the opinion of management that, except as set forth in this Note 11, the disposition of these other lawsuits will not, individually or in the aggregate, have a Material Adverse Effect on the Company. If management's assessment of the Company's liability with respect to these actions is incorrect, such actions could have a Material Adverse Effect on the Company. Legal Proceedings Being Defended by the Company The Company is a plaintiff in an action seeking a declaratory judgment and damages entitled Ventas Realty, Limited Partnership et al. v. Black Diamond CLO 1998-1 Ltd., et al., Case No. 99C107076, filed November 22, 1999 in the Circuit Court of Jefferson County, Kentucky. Two of the three defendants in that action, Black Diamond International Funding, Ltd. and BDC Finance, LLC (collectively "Black Diamond") have asserted counterclaims against the Company under theories of breach of contract, tortious interference with contract and abuse of process. These counterclaims allege, among other things, that the Company wrongfully, and in violation of the terms of the Bank Credit Agreement, (1) failed to recognize an assignment of certain notes to Black Diamond, (2) failed to issue new notes to Black Diamond and (3) executed the Waiver and Extension Agreement dated October 29, 1999 between the Company and its lenders. The counterclaims further claim that the Company acted tortiously in commencing the action against the defendants. The counterclaims specifically allege that the foregoing actions wrongfully interfered with Black Diamond's profitable ongoing business relations with a third party and seek damages of $11,796,875 (the principal amount of the Company's Bridge Loan under the Bank Credit Agreement claimed to have been held by Black Diamond), plus interest, costs, and fees and additional unspecified amounts to be proven at trial; in addition Black Diamond is seeking a declaration that the Waiver and Extension Agreement is void and unenforceable. The Company disputes the material allegations contained in Black Diamond's counterclaims and the Company intends to pursue its claims and defend the counterclaims vigorously. The defendants have recently filed a motion for summary judgment on the Company's claims, contending that all such claims were released by the Company as part of the Amended Credit Agreement, to which defendants Black Diamond CLO 1998-1 Ltd. and Black Diamond International Funding Ltd. (but not defendant BDC Finance LLC) were signatories. The Company has not yet responded to this motion but intends to dispute it vigorously. Unasserted Claims--Potential Liabilities Due to Fraudulent Transfer Considerations, Legal Dividend Requirements and Other Claims The Company The 1998 Spin Off, including the simultaneous distribution of the Vencor common stock to the Ventas stockholders (the "Distribution"), is subject to review under fraudulent conveyance laws. Under these laws, if a court in a lawsuit by an unpaid creditor or a representative of creditors (such as a trustee or debtor-in-possession F-40
VENTAS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) in bankruptcy of the Company or any of its respective subsidiaries) were to determine that, as of the 1998 Spin Off, the Company did not receive fair consideration or reasonably equivalent value for distributing the stock distributed in the 1998 Spin Off and, at the time of the 1998 Spin Off, the Company or any of its subsidiaries (i) was insolvent or was rendered insolvent, (ii) had unreasonably small capital with which to carry on its business and all businesses in which it intended to engage, or (iii) intended to incur, or believed it would incur, debts beyond its ability to repay such debts as they would mature, then such court could among other things order the holders of the stock distributed in the 1998 Spin Off to return the value of the stock and any dividends paid thereon and/or invalidate, in whole or in part, the 1998 Spin Off as a fraudulent conveyance. Vencor Although Vencor has not formally asserted a claim, Vencor's legal counsel has raised questions relating to potential fraudulent conveyance or obligation issues and other claims relating to the 1998 Spin Off. At the time of the 1998 Spin Off, the Company obtained an opinion from an independent third party that addressed issues of solvency and adequate capitalization. Nevertheless, if a fraudulent conveyance or obligation claim or other claim is ultimately asserted by Vencor, its creditors, or others, the ultimate outcome of any such claim cannot presently be determined. The Company intends to defend these claims vigorously if they are asserted in a court, arbitration or mediation proceeding. If a Vencor plan of reorganization is confirmed according to the terms of the September 1999 Agreement in Principle, the potential claims relating to the 1998 Spin Off will be released. However, there can be no assurance that Vencor will be successful in achieving a plan of reorganization or that such releases will be included in a Vencor plan of reorganization which may be confirmed. If these claims were to prevail, it could have a Material Adverse Effect on the Company. Legal Dividend Requirements In addition, the 1998 Spin Off is subject to review under state corporate distribution and dividend statutes. Under Delaware law, a corporation may not pay a dividend to its stockholders if (i) the net assets of the corporation do not exceed its capital, unless the amount proposed to be paid as a dividend is less than the corporation's net profits for the current and/or preceding fiscal year in which the dividend is to be paid, or (ii) the capital of the corporation is less than the aggregate amount allocable to all classes of its preferred stock. The Company believes that (i) the Company and each of its subsidiaries were solvent (in accordance with the foregoing definitions) at the time of 1998 Spin Off, were able to repay their debts as they matured following the 1998 Spin Off and had sufficient capital to carry on their respective businesses and (ii) the 1998 Spin Off was consummated entirely in compliance with Delaware law. There is no certainty, however, that a court would reach the same conclusions in determining whether the Company was insolvent at the time of, or after giving effect to, the 1998 Spin Off or whether lawful funds were available for the 1998 Spin Off. The Spin Agreements The Spin Agreements provide for the allocation, immediately prior to the 1998 Spin Off, of certain debt of the Company. Further, pursuant to the Spin Agreements, from and after the date of the 1998 Spin Off, each of the Company and Vencor is responsible for the debts, liabilities and other obligations related to the businesses which it owns and operates following the consummation of the 1998 Spin Off. It is possible that a court would disregard the allocation agreed to among the parties and require the Company or Vencor to assume responsibility for obligations allocated to the other, particularly if the other were to refuse or to be unable to pay or perform the subject allocated obligations. No provision for liability, if any, resulting from the aforementioned litigation has been made in the financial statements at December 31, 1999. F-41
VENTAS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) 12. Capital Stock The authorized capital stock of the Company at December 31, 1998 and 1999 consisted of 180,000,000 shares of Common Stock, par value of $0.25 per share, and 10,000,000 shares of preferred stock of which 300,000 shares have been designated Series A Participating Preferred Stock. In order to preserve the Company's ability to elect and maintain REIT status, the Company's certificate of incorporation provides that if a person acquires beneficial ownership of greater than 9% of the outstanding stock of the Company, the shares that are beneficially owned in excess of such 9% limit are deemed to be "Excess Shares." Excess Shares are automatically deemed transferred to a trust for the benefit of a charitable institution or other qualifying organization selected by the Board of Directors of the Company. The trust is entitled to all dividends with respect to the Excess Shares and the trustee may exercise all voting power over the Excess Shares. The Company has the right to buy the Excess Shares for a purchase price equal to the lesser of (1) the price per share in the transaction that created the Excess Shares, or (2) the market price on the date the Company buys the shares. The Company has the right to defer payment of the purchase price for the Excess Shares for up to five years. If the Company does not purchase the Excess Shares, the trustee of the trust is required to transfer the Excess Shares at the direction of the Board of Directors. The owner of the Excess Shares is entitled to receive the lesser of the proceeds from the sale of the Excess Shares or the original purchase price for such Excess Shares, any additional amounts are payable to the beneficiary of the trust. The Board of Directors is empowered to grant waivers from the Excess Share provision of the Certificate of Incorporation, and certain holders of in excess of 9% of the common stock prior to the 1998 Spin Off are subject to different limitations. Subsequent to the 1998 Spin Off, the Board of Directors has granted such waivers to certain holders of the Company's Common Stock. The Company has issued Preferred Stock Purchase Rights (the "Rights") pursuant to the terms of Rights Agreement, dated July 20, 1993, as amended, with National City Bank as Rights Agent (the "Rights Agreement"). Under the terms of the Rights Agreement, the Company declared a dividend of one Right for each outstanding share of Common Stock of the Company to common stockholders of record on August 1, 1993. Each Right entitles the holder to purchase from the Company one-hundredth of a share of Series A Preferred Stock at a purchase price of $110. The Rights have certain anti-takeover effects and are intended to cause substantial dilution to a person or group that attempts to acquire the Company without conditioning the offer on the Rights being redeemed or a substantial number of the Rights being acquired. Under the terms of the Rights Agreement, if at such time as any person becomes the beneficial owner of 9.9% or more of the Common Stock (an "Acquiring Person"), (i) the Company is involved in a merger or other business combination in which the Common Stock is exchanged or changed (other than a merger with a person or group which both (a) acquired Common Stock pursuant to a Permitted Offer (as defined below) and (b) is offering not less than the price paid pursuant to the Permitted Offer and the same form of consideration paid in the Permitted Offer) or (ii) 50% or more of the Company's assets or earning power are sold, the Rights become exercisable for that number of shares of common stock of the acquiring company which at the time of such transaction would have a market value of two times the exercise price of the Right (such right being called the "Flip-over"). A "Permitted Offer" is a tender or exchange offer which is for all outstanding shares of Common Stock at a price and on terms determined, prior to the purchase of shares under such tender or exchange offer, by at least a majority of the members of the Board of Directors who are not officers of the Company and who are not Acquiring Persons or affiliates, associates, nominees or representatives of an Acquiring Person, to be adequate and otherwise in the best interests of the Company and its stockholders (other than the person or any affiliate or associate thereof on whose behalf the offer is being made) taking into account all factors that such directors deem relevant. F-42
VENTAS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) In the event any person becomes an Acquiring Person, for a 60 day period after such event, if the Flip-over right is not also triggered, the Rights become exerciseable for that number of shares of Common Stock having a market value of two times the exercise price of the Right, to the extent available, and then (after all authorized and unreserved shares of Common Stock have been issued), a common stock equivalent having a market value of two times the exercise price of the Right. Upon any person becoming an Acquiring Person (other than pursuant to a Permitted Offer), any rights issued to or beneficially owned by such Acquiring Person become null and void and thereafter may not be transferred to any other person. Certain persons and transactions are exempted from the operation of the Rights. Prior to a person becoming an Acquiring Person, the Board has the power to amend the Rights Agreement or cause the redemption of the Rights, at a purchase price of $0.01 in cash per Right. After the time a person becomes an Acquiring Person, the Board can only amend the Rights Agreement to make changes that do not adversely affect the interests of the holders of Rights. For purposes of the Rights Agreement a person is not deemed to be the beneficial owner of securities designated as Excess Shares under the Company's Certificate of Incorporation. 13. Related Party Transactions At December 31, 1999 and 1998, the Company had receivables of approximately $3.6 and $4.0 million, respectively, due from certain current and former executive officers of the Company. The loans include interest provisions (with a 5.7% average rate) and were to finance the income taxes payable by the executive officers primarily as a result of the 1998 Spin Off. The loans are payable over periods ranging from four years to ten years with the majority of the obligations amortizing quarterly. Interest expense on each note is forgiven on a periodic basis, provided that the officer remains an employee of the Company. In the event of a change in control of the Company (as defined in the note), the principal balance of the note is forgiven provided that the officer is still an employee of the Company. On October 15, 1998, the Company acquired eight personal care facilities and related facilities for approximately $7.1 million from Tangram Rehabilitation Network, Inc. (Tangram). Tangram is a wholly owned subsidiary of Res-Care, Inc. (Res-Care) of which a director of the Company is the Chairman, President and Chief Executive Officer and another director of the Company is a member of its board of directors. The Company leases the Tangram facilities to Tangram pursuant to a master lease agreement which is guaranteed by Res-Care. For the year ended December 31, 1999 and the period from May 1, 1998 to December 31, 1998, Tangram has paid the Company approximately $733,800 and $155,000, respectively, in rent payments. On February 29, 2000, the Company entered into a Separation and Release Agreement (the "Separation Agreement") with the former Executive Vice President and Chief Financial Officer ("CFO") of the Company. The Separation Agreement was entered into in connection with his resignation as Executive Vice President and CFO of the Company, effective February 9, 2000 (the "Termination Date"). The Separation Agreement provides for a lump sum severance payment of approximately $510,000 and certain other consideration from the Company, and an extension of certain employee benefits for a one-year period following the Termination Date. The Company entered into a Separation Agreement and Release of Claims (the "Ladt Separation Agreement") with Thomas T. Ladt pursuant to which Mr. Ladt resigned as President, Chief Executive Officer and Chief Operating Officer of the Company and from the Board of Directors of the Company as of March 5, 1999. The Ladt Separation Agreement provides for a lump sum payment of approximately $1.3 million and certain other consideration from the Company, and an extension of certain employee benefits for a two-year period following the date of his resignation. The Company further agreed to amend a tax loan that the Company had made to Mr. Ladt to provide that no principal or interest payments would be due under such tax loan prior to March 5, 2004. F-43
VENTAS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) 14. Quarterly Financial Information (Unaudited) Summarized unaudited consolidated quarterly information for the year ended December 31, 1999 and the period from May 1, 1998 to December 31, 1998 is provided below (amounts in thousands, except per share amounts). <TABLE> <CAPTION> First Second Third Fourth Quarter Quarter Quarter Quarter ------- ------- ------- -------- <S> <C> <C> <C> <C> Revenues Year end December 31, 1999......... $56,663 $57,909 $59,311 $ 59,392 Period from May 1, 1998 to December 31, 1998.......................... N/A $37,356 $56,168 $ 56,409 Income (Loss) before Extraordinary Item Year ended December 31, 1999....... $20,338 $20,166 $13,027 $(10,996)(2) Period from May 1, 1998 to December 31, 1998.......................... N/A $ 8,198 (1) $12,958 $ 13,653 Extraordinary Item, net of Income Taxes Year ended December 31, 1999....... -- -- -- -- Period from May 1, 1998 to December 31, 1998.......................... N/A $(7,970)(1) $ (81) -- Net Income (Loss) Year ended December 31, 1999....... $20,338 $20,166 $13,027 $(10,996)(2) Period from May 1, 1998 to December 31, 1998.......................... N/A $ 228 (1) $12,877 $ 13,653 Earnings per share Basic Income (Loss) before Extraordinary Item Year ended December 31, 1999..... $ .30 $ .30 $ .19 $ (.16)(2) Period from May 1, 1998 to December 31, 1998............... $ N/A $ .12 (1) $ .19 $ .20 Extraordinary Item, net of Income Taxes Year ended December 31, 1999..... $ -- $ -- $ -- $ -- Period from May 1, 1998 to December 31, 1998............... N/A $ (.12)(1) $ -- $ -- Net Income (Loss) Year ended December 31, 1999..... $ .30 $ .30 $ .19 $ (.16)(2) Period from May 1, 1998 to December 31, 1998............... N/A $ -- (1) $ .19 $ .20 Diluted Income (Loss) before Extraordinary Item Year ended December 31, 1999..... $ .30 $ .30 $ .19 $ (.16)(2) Period from May 1, 1998 to December 31, 1998............... N/A $ .12 (1) $ .19 $ .20 Extraordinary Item, net of Income Taxes Year ended December 31, 1999..... -- $ -- $ -- $ -- Period from May 1, 1998 to December 31, 1998............... $ N/A $ (.12)(1) $ -- $ -- Net Income (Loss) Year ended December 31, 1999..... $ .30 $ .30 $ .19 $ (.16)(2) Period from May 1, 1998 to December 31, 1998............... N/A $ -- (1) $ .19 $ .20 </TABLE> - -------- (1) Reflects operations since May 1, 1998. (2) Reflects the write-off of uncollectible amounts due from tenants and loss from impairment of assets as described in Notes 2 and 8. F-44
SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized. Date: March 29, 2000 Ventas, Inc. /s/ Debra A. Cafaro By: _________________________________ Debra A. Cafaro Chief Executive Officer and President Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. <TABLE> <CAPTION> Signatures Title Date ---------- ----- ---- <S> <C> <C> /s/ Walter F. Beran Director March 29, 2000 ______________________________________ Walter F. Beran /s/ Douglas Crocker II Director March 29, 2000 ______________________________________ Douglas Crocker II /s/ Ronald G. Geary Director March 29, 2000 ______________________________________ Ronald G. Geary /s/ R. Gene Smith Director March 29, 2000 ______________________________________ R. Gene Smith /s/ W. Bruce Lunsford Chairman of the Board and March 29, 2000 ______________________________________ Director W. Bruce Lunsford /s/ Debra A. Cafaro Chief Executive Officer, March 29, 2000 ______________________________________ President (Principal Debra A. Cafaro Executive Officer, Acting Principal Financial Officer and Acting Principal Accounting Officer) and Director </TABLE>
VENTAS, INC. SCHEDULE III* REAL ESTATE AND ACCUMULATED DEPRECIATION December 31, 1999 (Dollars in Thousands) <TABLE> <CAPTION> Gross Amount Initial Cost to Carried at Close Location Company Cost of Period - -------------------------------------- ------------------- Capitalized ------------------- Buildings Subsequent Buildings and Improve- to and Improve- Accumulated Date of Date Facility name City State Land ments Acquisition Land ments Depreciation Construction Acquired - ---------------- -------------- ----- ------ ------------ ----------- ------ ------------ ------------ ------------ -------- <S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> VENCOR SKILLED NURSING FACILITIES Rehab. & Healthc. Ctr. of Huntsville Huntsville AL $ 534 $4,216 -- $ 534 $4,216 $1,439 1968 1998 Rehab. & Healthc. Ctr. of Birmingham Birmingham AL -- 1,921 -- -- 1,921 859 1971 1998 Rehab. & Healthcare Ctr. Of Mobile Mobile AL 5 2,981 -- 5 2,981 839 1967 1998 Valley Healthcare & Rehab. Center Tucson AZ 383 1,954 -- 383 1,954 596 1964 1998 Sonoran Rehab & Care Center Phoenix AZ 781 2,755 -- 781 2,755 645 1962 1998 Desert Life Rehab & Care Center Tucson AZ 611 5,117 -- 611 5,117 2,225 1979 1998 Villa Campana Health Center Tucson AZ 533 2,201 -- 533 2,201 528 1983 1998 Kachina Point Health Care & Rehab. Sedona AZ 364 4,179 -- 364 4,179 1,526 1983 1998 Nob Hill Healthcare Center San Francisco CA 1,902 7,531 -- 1,902 7,531 2,118 1967 1998 Canyonwood Nursing & Rehab. Ctr. Redding CA 401 3,784 -- 401 3,784 902 1989 1998 Californian Care Center Bakersfield CA 1,438 5,609 -- 1,438 5,609 1,064 1988 1998 Magnolia Gardens Care Center Burlingame CA 1,832 3,186 -- 1,832 3,186 873 1955 1998 Lawton Healthcare Center San Francisco CA 943 514 -- 943 514 188 1962 1998 Valley Gardens HC & Rehab. Stockton CA 516 3,405 -- 516 3,405 950 1988 1998 Alta Vista Healthcare Center Riverside CA 376 1,669 -- 376 1,669 519 1966 1998 Maywood Acres Healthcare Center Oxnard CA 465 2,363 -- 465 2,363 632 1964 1998 La Veta Healthcare Center Orange CA 47 1,459 -- 47 1,459 408 1964 1998 Bay View Nursing & Rehab. Center Alameda CA 1,462 5,981 -- 1,462 5,981 1,646 1967 1998 Village Square Nsg. & Rehab. Ctr. San Marcos CA 766 3,507 -- 766 3,507 576 1989 1998 Cherry Hills Health Care Center Englewood CO 241 2,180 -- 241 2,180 768 1960 1998 Aurora Care Center Aurora CO 197 2,328 -- 197 2,328 631 1962 1998 Castle Garden Care Center Northglenn CO 501 8,294 -- 501 8,294 2,102 1971 1998 Brighton Care Center Brighton CO 282 3,377 -- 282 3,377 864 1969 1998 Andrew House Healthcare New Britain CT 247 1,963 -- 247 1,963 485 1967 1998 Camelot Nursing & Rehab. Center New London CT 202 2,363 -- 202 2,363 532 1969 1998 Hamilton Rehab. & Healthcare Center Norwich CT 456 2,808 -- 456 2,808 737 1969 1998 Windsor Rehab. & Healthcare Center Windsor CT 368 2,520 -- 368 2,520 668 1965 1998 Nutmeg Pavilion Healthcare New London CT 401 2,777 -- 401 2,777 781 1968 1998 Parkway Pavilion Healthcare Enfield CT 337 3,607 -- 337 3,607 973 1968 1998 Courtland Gardens Health Ctr., Inc. Stamford CT 1,126 9,399 -- 1,126 9,399 637 1956 1998 Homestead Health Center Stamford CT 511 2,764 -- 511 2,764 200 1959 1998 East Manor Medical Care Center Sarasota FL 390 5,499 -- 390 5,499 1,432 1966 1998 Healthcare & Rehab Ctr of Sanford Sanford FL 329 3,074 -- 329 3,074 822 1965 1998 Titusville Rehab. & Nursing Center Titusville FL 398 3,810 -- 398 3,810 1,030 1966 1998 Bay Pointe Nursing Pavilion St. Petersburg FL 750 4,392 -- 750 4,392 744 1984 1998 Colonial Oaks Rehab. Ctr-Ft. Myers Ft. Meyers FL 1,058 5,754 -- 1,058 5,754 621 1995 1998 Carrollwood Core Center Tampa FL 268 4,128 -- 268 4,128 1,167 1986 1998 <CAPTION> Life on Which Depreciation in Income Statement is Facility name Computed - ----------------- ------------ <S> <C> VENCOR SKILLED NURSING FACILITIES Rehab. & Healthc. Ctr. of Huntsville 25 years Rehab. & Healthc. Ctr. of Birmingham 20 years Rehab. & Healthcare Ctr. Of Mobile 29 years Valley Healthcare & Rehab. Center 28 years Sonoran Rehab & Care Center 29 years Desert Life Rehab & Care Center 37 years Villa Campana Health Center 35 years Kachina Point Health Care & Rehab. 45 years Nob Hill Healthcare Center 28 years Canyonwood Nursing & Rehab. Ctr. 45 years Californian Care Center 40 years Magnolia Gardens Care Center 28.5 years Lawton Healthcare Center 20 years Valley Gardens HC & Rehab. 29 years Alta Vista Healthcare Center 29 years Maywood Acres Healthcare Center 29 years La Veta Healthcare Center 28 years Bay View Nursing & Rehab. Center 45 years Village Square Nsg. & Rehab. Ctr. 42 years Cherry Hills Health Care Center 30 years Aurora Care Center 30 years Castle Garden Care Center 29 years Brighton Care Center 30 years Andrew House Healthcare 29 years Camelot Nursing & Rehab. Center 28 years Hamilton Rehab. & Healthcare Center 29 years Windsor Rehab. & Healthcare Center 30 years Nutmeg Pavilion Healthcare 29 years Parkway Pavilion Healthcare 28 years Courtland Gardens Health Ctr., Inc. 45 years Homestead Health Center 20 years East Manor Medical Care Center 28 years Healthcare & Rehab Ctr of Sanford 29 years Titusville Rehab. & Nursing Center 29 years Bay Pointe Nursing Pavilion 35 years Colonial Oaks Rehab. Ctr-Ft. Myers 45 years Carrollwood Core Center 37.5 years </TABLE> S-1
<TABLE> <CAPTION> Gross Amount Initial Cost to Carried at Close Location Company Cost of Period - -------------------------------------- ------------------ Capitalized ------------------ Buildings Subsequent Buildings and Improve- to and Improve- Accumulated Date of Date Facility name City State Land ments Acquisition Land ments Depreciation Construction Acquired - ---------------- -------------- ----- ----- ------------ ----------- ----- ------------ ------------ ------------ -------- <S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> Evergreen Woods Health & Rehab. Springhill FL 234 3,566 -- 234 3,566 827 1988 1998 Rehab. & Healthcare Ctr. of Tampa Tampa FL 355 8,291 -- 355 8,291 1,630 1969 1998 Rehab & Health Ctr. of Cape Coral Cape Coral FL 1,002 4,153 -- 1,002 4,153 1,082 1978 1998 Windsor Woods Convalescent Center Hudson FL 859 3,172 -- 859 3,172 789 N/A 1998 Casa Mora Rehab. & Ext Care Bradenton FL 823 6,093 -- 823 6,093 427 1977 1998 North Broward Rehab. & Nsg. Ctr. Pompano Beach FL 1,360 5,913 -- 1,360 5,913 383 1965 1998 Highland Pines Rehab. Center Clearwater FL 863 5,793 -- 863 5,793 394 1965 1998 Pompano Rehab/Nursing Ctr. Pompano Beach FL 890 3,252 -- 890 3,252 209 1975 1998 Abbey Rehab. & Nsg. Center St. Petersburg FL 563 2,842 -- 563 2,842 360 1962 1998 Savannah Rehab. & Nursing Center Savannah GA 213 2,772 -- 213 2,772 753 1968 1998 Specialty Care of Marietta Marietta GA 241 2,782 -- 241 2,782 836 1968 1998 Savannah Specialty Care Center Savannah GA 157 2,219 -- 157 2,219 698 1972 1998 Lafayette Nsg. & Rehab. Ctr. Fayetteville GA 598 6,623 -- 598 6,623 882 1989 1998 Tucker Nursing Center Tucker GA 512 8,153 -- 512 8,153 586 1972 1998 Hillcrest Rehab. Care Center Boise ID 256 3,593 -- 256 3,593 499 1977 1998 Cascade Care Center Caldwell ID 312 2,050 -- 312 2,050 263 1974 1998 Emmett Rehabilitation and Healthcare Emmett ID 185 1,670 -- 185 1,670 1,006 1960 1998 Lewiston Rehabilitation and Care Ctr. Lewiston ID 133 3,982 -- 133 3,982 1,171 1964 1998 Nampa Care Center Nampa ID 252 2,810 -- 252 2,810 1,647 1950's 1998 Weiser Rehabilitation and Care Ctr. Weiser ID 157 1,760 -- 157 1,760 1,175 1963 1998 Moscow Care Center Moscow ID 261 2,571 -- 261 2,571 951 1955 1998 Mountain Valley Care and Rehab. Kellogg ID 68 1,281 -- 68 1,281 787 1971 1998 Rolling Hills Health Care Center New Albany IN 81 1,894 -- 81 1,894 484 1984 1998 Royal Oaks Healthcare & Rehab Ctr. Terre Haute IN 418 5,779 -- 418 5,779 602 1995 1998 Southwood Health & Rehab Center Terre Haute IN 90 2,868 -- 90 2,868 629 1988 1998 Vencor Corydon Corydon IN 125 6,068 -- 125 6,068 199 N/A 1998 Valley View Health Care Center Elkhart IN 87 2,665 -- 87 2,665 646 1985 1998 Wildwood Healthcare Center Indianapolis IN 134 4,983 -- 134 4,983 1,120 1988 1998 Meadowvale Health & Rehab. Ctr. Bluffton IN 7 787 -- 7 787 79 1962 1998 Columbia Healthcare Facility Evansville IN 416 6,317 -- 416 6,317 1,436 1983 1998 Bremen Health Care Center Bremen IN 109 3,354 -- 109 3,354 518 1982 1998 Windsor Estates Health & Rehab Ctr Kokomo IN 256 6,625 -- 256 6,625 1,116 1962 1998 Muncie Health Care & Rehab. Muncie IN 108 4,202 -- 108 4,202 830 1980 1998 Parkwood Health Care Center Lebanon IN 121 4,512 -- 121 4,512 949 1977 1998 Wedgewood Healthcare Center Clarksville IN 119 5,115 -- 119 5,115 669 1985 1998 Westview Nursing & Rehab. Center Bedford IN 255 4,207 -- 255 4,207 941 1970 1998 Columbus Health & Rehab. Center Columbus IN 345 6,817 -- 345 6,817 2,206 1966 1998 Rosewood Health Care Center Bowling Green KY 248 5,371 -- 248 5,371 1,636 1970 1998 Oakview Nursing & Rehab. Ctr. Calvert City KY 124 2,882 -- 124 2,882 874 1967 1998 Cedars of Lebanon Nursing Center Lebanon KY 40 1,253 -- 40 1,253 382 1930 1998 Winchester Centre for Health/Rehab. Winchester KY 137 6,120 -- 137 6,120 1,844 1967 1998 Riverside Manor Health Care Calhoun KY 103 2,119 -- 103 2,119 650 1963 1998 Maple Manor Healthcare Center Greenville KY 59 3,187 -- 59 3,187 974 1968 1998 Danville Centre for Health & Rehab. Danville KY 322 3,538 -- 322 3,538 765 1962 1998 Lexington Centre for Health & Rehab. Lexington KY 647 4,892 -- 647 4,892 1,349 1963 1998 North Centre for Health & Rehab. Louisville KY 285 1,555 -- 285 1,555 542 1969 1998 Hillcrest Health Care Center Owensboro KY 544 2,619 -- 544 2,619 1,860 1963 1998 <CAPTION> Life on Which Depreciation in Income Statement is Facility name Computed - ----------------- ------------ <S> <C> Evergreen Woods Health & Rehab. 25 years Rehab. & Healthcare Ctr. of Tampa 28 years Rehab & Health Ctr. of Cape Coral 32 years Windsor Woods Convalescent Center 45 years Casa Mora Rehab. & Ext Care 45 years North Broward Rehab. & Nsg. Ctr. 45 years Highland Pines Rehab. Center 20 years Pompano Rehab/Nursing Ctr. 45 years Abbey Rehab. & Nsg. Center 35 years Savannah Rehab. & Nursing Center 28.5 years Specialty Care of Marietta 28.5 years Savannah Specialty Care Center 26 years Lafayette Nsg. & Rehab. Ctr. 20 years Tucker Nursing Center 45 years Hillcrest Rehab. Care Center 45 years Cascade Care Center 45 years Emmett Rehabilitation and Healthcare 28 years Lewiston Rehabilitation and Care Ctr. 29 years Nampa Care Center 25 years Weiser Rehabilitation and Care Ctr. 25 years Moscow Care Center 25 years Mountain Valley Care and Rehab. 25 years Rolling Hills Health Care Center 25 years Royal Oaks Healthcare & Rehab Ctr. 45 years Southwood Health & Rehab Center 25 years Vencor Corydon 45 years Valley View Health Care Center 25 years Wildwood Healthcare Center 25 years Meadowvale Health & Rehab. Ctr. 22 years Columbia Healthcare Facility 35 years Bremen Health Care Center 45 years Windsor Estates Health & Rehab Ctr 35 years Muncie Health Care & Rehab. 25 years Parkwood Health Care Center 25 years Wedgewood Healthcare Center 35 years Westview Nursing & Rehab. Center 29 years Columbus Health & Rehab. Center 25 years Rosewood Health Care Center 30 years Oakview Nursing & Rehab. Ctr. 30 years Cedars of Lebanon Nursing Center 30 years Winchester Centre for Health/Rehab. 30 years Riverside Manor Health Care 30 years Maple Manor Healthcare Center 30 years Danville Centre for Health & Rehab. 30 years Lexington Centre for Health & Rehab. 28 years North Centre for Health & Rehab. 30 years Hillcrest Health Care Center 22 years </TABLE> S-2
<TABLE> <CAPTION> Gross Amount Initial Cost to Carried at Close Location Company Cost of Period - ---------------------------------------- ----------------- Capitalized ----------------- Buildings Subsequent Buildings and Improve- to and Improve- Accumulated Date of Date Facility name City State Land ments Acquisition Land ments Depreciation Construction Acquired - ---------------- ---------------- ----- ---- ------------ ----------- ---- ------------ ------------ ------------ -------- <S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> Woodland Terrace Health Care Fac. Elizabethtown KY 216 1,795 -- 216 1,795 1,252 1969 1998 Harrodsburg Health Care Center Harrodsburg KY 137 1,830 -- 137 1,830 795 1974 1998 Laurel Ridge Rehab. & Nursing Ctr. Jamaica Plain MA 194 1,617 -- 194 1,617 588 1968 1998 Blue Hills Alzheimer's Care Center Stoughton MA 511 1,026 -- 511 1,026 727 1965 1998 Brigham Manor Nursing & Rehab Ctr Newburyport MA 126 1,708 -- 126 1,708 675 1806 1998 Presentation Nursing & Rehab. Ctr. Brighton MA 184 1,220 -- 184 1,220 782 1968 1998 Country Manor Rehab. & Nsg. Center Newburyport MA 199 3,004 -- 199 3,004 1,196 1968 1998 Crawford Skilled Nsg. & Rehab. Ctr. Fall River MA 127 1,109 -- 127 1,109 649 1968 1998 Hallmark Nursing & Rehab. Ctr. New Bedford MA 202 2,694 -- 202 2,694 1,105 1968 1998 Sachem Nursing & Rehab. Ctr. East Bridgewater MA 529 1,238 -- 529 1,238 834 1968 1998 Hammersmith House Nsg. Care Ctr. Saugus MA 112 1,919 -- 112 1,919 701 1965 1998 Oakwood Rehab. & Nursing Center Webster MA 102 1,154 -- 102 1,154 663 1967 1998 Timberlyn Heights Nsg. & Alz. Ctr. Great Barrington MA 120 1,305 -- 120 1,305 674 1968 1998 Star of David Nsg. & Rehab/Alz Ctr. West Roxbury MA 359 2,324 -- 359 2,324 1,530 1968 1998 Brittany Healthcare Center Natick MA 249 1,328 -- 249 1,328 703 1996 1998 Briarwood Health Care Nursing Ctr Needham MA 154 1,502 -- 154 1,502 757 1970 1998 Westridge Healthcare Center Marlborough MA 453 3,286 -- 453 3,286 1,848 1964 1998 Bolton Manor Nursing Home Marlborough MA 222 2,431 -- 222 2,431 1,151 1973 1998 Hillcrest Nursing Facility Fitchburg MA 175 1,461 -- 175 1,461 928 1957 1998 Country Gardens Sk. Nsg. & Rehab. Swansea MA 415 2,675 -- 415 2,675 1,017 1969 1998 Quincy Rehab. & Nursing Center Quincy MA 216 2,911 -- 216 2,911 1,451 1965 1998 West Roxbury Manor West Roxbury MA 91 1,001 -- 91 1,001 791 1960 1998 Newton and Wellesley Alzheimer Ctr. Wellesley MA 297 3,250 -- 297 3,250 1,234 1971 1998 Den-Mar Rehab. & Nursing Center Rockport MA 23 1,560 -- 23 1,560 733 1963 1998 Eagle Pond Rehab. & Living Center South Dennis MA 296 6,896 -- 296 6,896 1,806 1985 1998 Blueberry Hill Healthcare Beverly MA 129 4,290 -- 129 4,290 1,787 1965 1998 Colony House Nsg. & Rehab. Ctr. Abington MA 132 999 -- 132 999 689 1965 1998 Embassy House Sk. Nsg. & Rehab. Brockton MA 166 1,004 -- 166 1,004 628 1968 1998 Franklin Sk. Nsg. & Rehab. Center Franklin MA 156 757 -- 156 757 528 1967 1998 Great Barrington Rehab. & Nsg. Ctr. Great Barrington MA 60 1,142 -- 60 1,142 757 1967 1998 River Terrace Lancaster MA 268 957 -- 268 957 684 1969 1998 Walden Rehab. & Nursing Center Concord MA 181 1,347 -- 181 1,347 954 1969 1998 Harrington House Nsg. & Rehab. Ctr. Walpole MA 4 4,444 -- 4 4,444 874 1991 1998 Eastside Rehab. and Living Center Bangor ME 316 1,349 -- 316 1,349 512 1967 1998 Winship Green Nursing Center Bath ME 110 1,455 -- 110 1,455 591 1974 1998 Brewer Rehabilitation & Living Center Brewer ME 228 2,737 -- 228 2,737 965 1974 1998 Augusta Rehabilitation Center Augusta ME 152 1,074 -- 152 1,074 516 1968 1998 Kennebunk Nursing Center Kennebunk ME 99 1,898 -- 99 1,898 690 1977 1998 Norway Rehabilitation & Living Center Norway ME 133 1,658 -- 133 1,658 638 1972 1998 Shore Village Rehab. & Nursing Ctr. Rockland ME 100 1,051 -- 100 1,051 493 1968 1998 Westgate Manor Bangor ME 287 2,718 -- 287 2,718 981 1969 1998 Brentwood Rehab. & Nsg. Center Yarmouth ME 181 2,789 -- 181 2,789 1,010 1945 1998 Fieldcrest Manor Nursing Center Waldoboro ME 101 1,020 -- 101 1,020 500 1963 1998 Park Place Health Care Center Great Falls MT 600 6,311 -- 600 6,311 1,732 1963 1998 Parkview Acres Care & Rehab Ctr. Dillon MT 207 2,578 -- 207 2,578 703 1965 1998 Pettigrew Rehab. & Healthcare Ctr. Durham NC 101 2,889 -- 101 2,889 833 1969 1998 LaSalle Healthcare Center Durham NC 140 3,238 -- 140 3,238 781 1969 1998 <CAPTION> Life on Which Depreciation in Income Statement is Facility name Computed - ----------------- ------------ <S> <C> Woodland Terrace Health Care Fac. 26 years Harrodsburg Health Care Center 35 years Laurel Ridge Rehab. & Nursing Ctr. 30 years Blue Hills Alzheimer's Care Center 28 years Brigham Manor Nursing & Rehab Ctr 27 years Presentation Nursing & Rehab. Ctr. 28 years Country Manor Rehab. & Nsg. Center 27 years Crawford Skilled Nsg. & Rehab. Ctr. 29 years Hallmark Nursing & Rehab. Ctr. 26 years Sachem Nursing & Rehab. Ctr. 27 years Hammersmith House Nsg. Care Ctr. 28 years Oakwood Rehab. & Nursing Center 31 years Timberlyn Heights Nsg. & Alz. Ctr. 29 years Star of David Nsg. & Rehab/Alz Ctr. 26 years Brittany Healthcare Center 31 years Briarwood Health Care Nursing Ctr 30 years Westridge Healthcare Center 28.5 years Bolton Manor Nursing Home 34.5 years Hillcrest Nursing Facility 25 years Country Gardens Sk. Nsg. & Rehab. 27 years Quincy Rehab. & Nursing Center 24 years West Roxbury Manor 20 years Newton and Wellesley Alzheimer Ctr. 30 years Den-Mar Rehab. & Nursing Center 30 years Eagle Pond Rehab. & Living Center 50 years Blueberry Hill Healthcare 40 years Colony House Nsg. & Rehab. Ctr. 40 years Embassy House Sk. Nsg. & Rehab. 40 years Franklin Sk. Nsg. & Rehab. Center 40 years Great Barrington Rehab. & Nsg. Ctr. 40 years River Terrace 40 years Walden Rehab. & Nursing Center 40 years Harrington House Nsg. & Rehab. Ctr. 45 years Eastside Rehab. and Living Center 30 years Winship Green Nursing Center 35 years Brewer Rehabilitation & Living Center 33 years Augusta Rehabilitation Center 30 years Kennebunk Nursing Center 35 years Norway Rehabilitation & Living Center 39 years Shore Village Rehab. & Nursing Ctr. 30 years Westgate Manor 31 years Brentwood Rehab. & Nsg. Center 45 years Fieldcrest Manor Nursing Center 32 years Park Place Health Care Center 28 years Parkview Acres Care & Rehab Ctr. 29 years Pettigrew Rehab. & Healthcare Ctr. 28 years LaSalle Healthcare Center 29 years </TABLE> S-3
<TABLE> <CAPTION> Gross Amount Initial Cost to Carried at Close Location Company Cost of Period - ---------------------------------------- ------------------ Capitalized ------------------ Buildings Subsequent Buildings and Improve- to and Improve- Accumulated Date of Date Facility name City State Land ments Acquisition Land ments Depreciation Construction Acquired - ---------------- ---------------- ----- ----- ------------ ----------- ----- ------------ ------------ ------------ -------- <S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> Sunnybrook Alzheimer's & HC Spec. Raleigh NC 187 3,409 -- 187 3,409 1,115 1971 1998 Blue Ridge Rehab. & Healthcare Ctr. Asheville NC 250 3,819 -- 250 3,819 975 1977 1998 Raleigh Rehab. & Healthcare Center Raleigh NC 316 5,470 -- 316 5,470 1,804 1969 1998 Rose Manor Health Care Center Durham NC 201 3,527 -- 201 3,527 1,113 1972 1998 Cypress Pointe Rehab & HC Center Winmington NC 233 3,710 -- 233 3,710 1,095 1966 1998 Winston-Salem Rehab & HC Center Winston-Salem NC 305 5,142 -- 305 5,142 1,670 1968 1998 Silas Creek Manor Winston-Salem NC 211 1,893 -- 211 1,893 521 1966 1998 Lincoln Nursing Center Lincoln NC 39 3,309 -- 39 3,309 1,260 1976 1998 Guardian Care of Roanoke Rapids Roanoke Rapids NC 339 4,132 -- 339 4,132 1,320 1967 1998 Guardian Care of Henderson Henderson NC 206 1,997 -- 206 1,997 551 1957 1998 Rehab. & Nursing Center of Monroe Monroe NC 185 2,654 -- 185 2,654 879 1963 1998 Guardian Care of Kinston Kinston NC 186 3,038 -- 186 3,038 807 1961 1998 Guardian Care of Zebulon Zebulon NC 179 1,933 -- 179 1,933 526 1973 1998 Guardian Care of Rocky Mount. Rocky Mount NC 240 1,732 -- 240 1,732 403 1975 1998 Rehab. & Health Center of Gastonia Gastonia NC 158 2,359 -- 158 2,359 684 1968 1998 Guardian Care of Elizabeth City Elizabeth City NC 71 561 -- 71 561 380 1977 1998 Chapel Hill Rehab. & Healthcare Ctr. Chapel Hill NC 347 3,029 -- 347 3,029 944 1984 1998 Homestead Health Care & Rehab Ctr Lincoln NE 277 1,528 1,178 277 2,706 1,830 1961 1998 Dover Rehab. & Living Center Dover NH 355 3,797 -- 355 3,797 1,397 1969 1998 Greenbriar Terrace Healthcare Nashua NH 776 6,011 -- 776 6,011 2,030 1963 1998 Hanover Terrace Healthcare Hanover NH 326 1,825 -- 326 1,825 489 1969 1998 Las Vegas Healthcare & Rehab. Ctr. Las Vegas NV 454 1,018 -- 454 1,018 188 1940 1998 Torrey Pines Care Center Las Vegas NV 256 1,324 -- 256 1,324 375 1971 1998 Franklin Woods Health Care Center Columbus OH 190 4,712 -- 190 4,712 1,014 1986 1998 Chillicothe Nursing & Rehab. Center Chillicothe OH 128 3,481 -- 128 3,481 1,308 1976 1998 Pickerington Nursing & Rehab. Ctr. Pickerington OH 312 4,382 -- 312 4,382 914 1984 1998 Logan Health Care Center Logan OH 169 3,750 -- 169 3,750 1,013 1979 1998 Winchester Place Nsg. & Rehab. Ctr. Canal Winchestr. OH 454 7,149 -- 454 7,149 2,055 1974 1998 Minerva Park Nursing & Rehab. Ctr. Columbus OH 210 3,684 -- 210 3,684 469 1973 1998 West Lafayette Rehab & Nsg Ctr West Lafayette OH 185 3,278 -- 185 3,278 467 1972 1998 Cambridge Health & Rehab. Center Cambridge OH 108 2,642 -- 108 2,642 668 1975 1998 Coshocton Health & Rehab. Center Coshocton OH 203 1,979 -- 203 1,979 504 1974 1998 Bridgepark Ctr. for Rehab. & Nsg. Sv. Akron OH 341 5,491 -- 341 5,491 1,568 1970 1998 Lebanon Country Manor Lebanon OH 105 3,617 -- 105 3,617 1,094 1984 1998 Sunnyside Care Center Salem OR 1,519 2,688 -- 1,519 2,688 746 1981 1998 Medford Rehab. & Healthcare Center Medford OR 362 4,610 -- 362 4,610 1,243 N/A 1998 Wyomissing Nsg. & Rehab. Ctr. Reading PA 61 5,095 -- 61 5,095 360 1966 1998 Health Havens Nursing & Rehab. Ctr. E. Providence RI 174 2,643 -- 174 2,643 190 1962 1998 Oak Hill Nursing & Rehab. Ctr. Pawtucket RI 91 6,724 -- 91 6,724 475 1966 1998 Madison Healthcare & Rehab Ctr. Madison TN 168 1,445 -- 168 1,445 412 1968 1998 Cordova Rehab. & Nursing Center Cordova TN 322 8,830 -- 322 8,830 2,954 1979 1998 Primacy Healthcare & Rehab Ctr. Memphis TN 1,222 8,344 -- 1,222 8,344 1,904 1980 1998 Masters Health Care Center Algood TN 524 4,370 -- 524 4,370 1,404 1981 1998 San Pedro Manor San Antonio TX 602 4,178 -- 602 4,178 326 1985 1998 Wasatch Care Center Ogden UT 373 597 -- 373 597 366 1964 1998 Crosslands Rehab. & Health Care Ctr Sandy UT 334 4,300 -- 334 4,300 798 1987 1998 St. George Care and Rehab. Center St. George UT 420 4,465 -- 420 4,465 1,311 1976 1998 <CAPTION> Life on Which Depreciation in Income Statement is Facility name Computed - ----------------- ------------ <S> <C> Sunnybrook Alzheimer's & HC Spec. 25 years Blue Ridge Rehab. & Healthcare Ctr. 32 years Raleigh Rehab. & Healthcare Center 25 years Rose Manor Health Care Center 26 years Cypress Pointe Rehab & HC Center 28.5 years Winston-Salem Rehab & HC Center 25 years Silas Creek Manor 28.5 years Lincoln Nursing Center 35 years Guardian Care of Roanoke Rapids 25 years Guardian Care of Henderson 29 years Rehab. & Nursing Center of Monroe 28 years Guardian Care of Kinston 29 years Guardian Care of Zebulon 29 years Guardian Care of Rocky Mount. 25 years Rehab. & Health Center of Gastonia 29 years Guardian Care of Elizabeth City 20 years Chapel Hill Rehab. & Healthcare Ctr. 28 years Homestead Health Care & Rehab Ctr 45 years Dover Rehab. & Living Center 25 years Greenbriar Terrace Healthcare 25 years Hanover Terrace Healthcare 29 years Las Vegas Healthcare & Rehab. Ctr. 30 years Torrey Pines Care Center 29 years Franklin Woods Health Care Center 38 years Chillicothe Nursing & Rehab. Center 34 years Pickerington Nursing & Rehab. Ctr. 37 years Logan Health Care Center 30 years Winchester Place Nsg. & Rehab. Ctr. 28 years Minerva Park Nursing & Rehab. Ctr. 45 years West Lafayette Rehab & Nsg Ctr 45 years Cambridge Health & Rehab. Center 25 years Coshocton Health & Rehab. Center 25 years Bridgepark Ctr. for Rehab. & Nsg. Sv. 28 years Lebanon Country Manor 43 years Sunnyside Care Center 30 years Medford Rehab. & Healthcare Center 34 years Wyomissing Nsg. & Rehab. Ctr. 45 years Health Havens Nursing & Rehab. Ctr. 45 years Oak Hill Nursing & Rehab. Ctr. 45 years Madison Healthcare & Rehab Ctr. 29 years Cordova Rehab. & Nursing Center 39 years Primacy Healthcare & Rehab Ctr. 37 years Masters Health Care Center 38 years San Pedro Manor 45 years Wasatch Care Center 25 years Crosslands Rehab. & Health Care Ctr 40 years St. George Care and Rehab. Center 29 years </TABLE> S-4
<TABLE> <CAPTION> Gross Amount Initial Cost to Carried at Close Location Company Cost of Period - ---------------------------------------- ------------------- Capitalized ------------------- Buildings Subsequent Buildings and Improve- to and Improve- Accumulated Date of Date Facility name City State Land ments Acquisition Land ments Depreciation Construction Acquired - ---------------- ---------------- ----- ------ ------------ ----------- ------ ------------ ------------ ------------ -------- <S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> Federal Heights Rehab. & Nsg. Ctr. Salt Lake City UT 201 2,322 -- 201 2,322 647 1962 1998 Wasatch Valley Rehabilitation Salt Lake City UT 389 3,545 -- 389 3,545 858 1962 1998 Nansemond Pointe Rehab. & HC Ctr. Suffolk VA 534 6,990 -- 534 6,990 1,803 1963 1998 Harbour Pointe Med. & Rehab. Ctr Norfolk VA 427 4,441 -- 427 4,441 1,232 1969 1998 River Pointe Rehab. & Healthc. Ctr. Virginia Beach VA 770 4,440 -- 770 4,440 1,576 1953 1998 Bay Pointe Medical & Rehab. Centre Virginia Beach VA 805 2,886 -- 805 2,886 762 1971 1998 Birchwood Terrace Healthcare Burlington VT 15 4,656 -- 15 4,656 1,630 1965 1998 Arden Rehabilitation & Healthcare Ctr Seattle WA 1,111 4,013 -- 1,111 4,013 1,086 1950's 1998 Northwest Continuum Care Center Longview WA 145 2,563 -- 145 2,563 719 1955 1998 Bellingham Health Care & Rehab Svc Bellingham WA 441 3,824 -- 441 3,824 1,021 1972 1998 Rainier Vista Care Center Puyallup WA 520 4,780 -- 520 4,780 1,006 1986 1998 Lakewood Healthcare Center Lakewood WA 504 3,511 -- 504 3,511 711 1989 1998 Vencor of Vancouver HC & Rehab. Vancouver WA 449 2,964 -- 449 2,964 852 1970 1998 Heritage Health & Rehab. Center Vancouver WA 76 835 -- 76 835 213 1955 1998 Edmonds Rehab. & Healthcare Ctr. Edmonds WA 355 3,032 -- 355 3,032 952 1961 1998 Queen Anne Healthcare Seattle WA 570 2,750 -- 570 2,750 763 1970 1998 San Luis Medical & Rehab Center Greenbay WI 259 5,299 -- 259 5,299 1,181 N/A 1998 Eastview Medical & Rehab. Center Antigo WI 200 4,047 -- 200 4,047 1,290 1962 1998 Colonial Manor Medical & Rehab Ctr. Wausau WI 169 3,370 -- 169 3,370 1,009 1964 1998 Colony Oaks Care Center Appleton WI 353 3,571 -- 353 3,571 1,054 1967 1998 North Ridge Med. & Rehab. Center Manitowoc WI 206 3,785 -- 206 3,785 1,034 1964 1998 Vallhaven Care Center Neenah WI 337 5,125 -- 337 5,125 1,467 1966 1998 Kennedy Park Medical & Rehab. Ctr. Schofield WI 301 3,596 -- 301 3,596 2,076 1966 1998 Family Heritage Med. & Rehab. Ctr. Wisconsin Rapids WI 240 3,350 -- 240 3,350 2,119 1966 1998 Mt. Carmel Medical & Rehab. Ctr. Burlington WI 274 7,205 -- 274 7,205 1,797 1971 1998 Mt. Carmel Medical & Rehab. Ctr. Milwaukee WI 2,356 22,571 -- 2,356 22,571 6,585 1958 1998 Sheridan Medical Complex Kenosha WI 282 4,910 -- 282 4,910 1,613 1964 1998 Woodstock Health & Rehab. Center Kenosha WI 562 7,424 -- 562 7,424 2,559 1970 1998 Mountain Towers Healthcare & Rehab Cheyenne WY 342 3,814 -- 342 3,814 941 1964 1998 South Central Wyoming HC. & Rehab Rawlins WY 151 1,738 -- 151 1,738 462 1955 1998 Wind River Healthcare & Rehab. Ctr Riverton WY 179 1,559 -- 179 1,559 409 1967 1998 Sage View Care Center Rock Springs WY 287 2,392 -- 287 2,392 659 1964 1998 ------ ------- ----- ------ ------- ------- TOTAL VENCOR NURSING FACILITIES 74,939 731,367 1,178 74,939 732,545 204,823 <CAPTION> Life on Which Depreciation in Income Statement is Facility name Computed - ----------------- ------------ <S> <C> Federal Heights Rehab. & Nsg. Ctr. 29 years Wasatch Valley Rehabilitation 29 years Nansemond Pointe Rehab. & HC Ctr. 32 years Harbour Pointe Med. & Rehab. Ctr 28 years River Pointe Rehab. & Healthc. Ctr. 25 years Bay Pointe Medical & Rehab. Centre 29 years Birchwood Terrace Healthcare 27 years Arden Rehabilitation & Healthcare Ctr 28.5 years Northwest Continuum Care Center 29 years Bellingham Health Care & Rehab Svc 28.5 years Rainier Vista Care Center 40 years Lakewood Healthcare Center 45 years Vencor of Vancouver HC & Rehab. 28 years Heritage Health & Rehab. Center 29 years Edmonds Rehab. & Healthcare Ctr. 25 years Queen Anne Healthcare 29 years San Luis Medical & Rehab Center 25 years Eastview Medical & Rehab. Center 28 years Colonial Manor Medical & Rehab Ctr. 30 years Colony Oaks Care Center 29 years North Ridge Med. & Rehab. Center 29 years Vallhaven Care Center 28 years Kennedy Park Medical & Rehab. Ctr. 29 years Family Heritage Med. & Rehab. Ctr. 26 years Mt. Carmel Medical & Rehab. Ctr. 30 years Mt. Carmel Medical & Rehab. Ctr. 30 years Sheridan Medical Complex 25 years Woodstock Health & Rehab. Center 25 years Mountain Towers Healthcare & Rehab 29 years South Central Wyoming HC. & Rehab 29 years Wind River Healthcare & Rehab. Ctr 29 years Sage View Care Center 30 years TOTAL VENCOR NURSING FACILITIES NON-VENCOR SKILLED NURSING FACILITIES Birchwood Care Center MI 291 6,187 -- 285 3,095 1,169 N/A 1998 Grayling Health Care Center MI 76 3,234 -- 76 3,234 1,087 N/A 1998 Clara Barton Terrace MI 375 2,219 -- 375 2,219 2,009 N/A 1998 Mary Avenue Care Center MI 162 1,744 -- 162 1,744 1,495 N/A 1998 Woodside Convalescent Center MN 639 3,440 56 639 3,496 2,147 N/A 1998 Hillhaven Convalescent Center NV 121 1,181 -- 121 1,181 762 N/A 1998 Marigarde- Sylvania Nursing Home OH 667 2,428 -- 667 2,428 1,117 N/A 1998 Marietta Convalescent Center OH 158 3,266 -- 158 3,266 696 N/A 1998 ------ ------- ----- ------ ------- ------- TOTAL NON-VENCOR SKILLED NURSING FACILITIES 2,489 23,699 56 2,483 20,663 10,482 ------ ------- ----- ------ ------- ------- TOTAL FOR SKILLED NURSING FACILITIES 77,428 755,066 1,234 77,422 753,208 215,305 NON-VENCOR SKILLED NURSING FACILITIES Birchwood Care Center 36 years Grayling Health Care Center 43 years Clara Barton Terrace 21 years Mary Avenue Care Center 21 years Woodside Convalescent Center 28 years Hillhaven Convalescent Center 40 years Marigarde- Sylvania Nursing Home 30 years Marietta Convalescent Center 25 years </TABLE> S-5
<TABLE> <CAPTION> Initial Cost to Gross Amount Carried Location Company Cost at Close of Period - --------------------------------------- --------------------- Capitalized -------------------- Buildings Subsequent Buildings and Improve- to and Improv- Accumulated Date of Date Facility name City State Land ments Acquisition Land ments Depreciation Construction Acquired - ---------------- --------------- ----- -------- ------------ ----------- -------- ----------- ------------ ------------ -------- <S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> VENCOR HOSPITALS Vencor Hospital-- Phoenix Phoenix AZ 226 3,359 -- 226 3,359 1,005 N/A 1998 Vencor Hospital--Tucson Tucson AZ 130 3,091 -- 130 3,091 984 N/A 1998 Vencor Hospital-- Ontario Ontario CA 523 2,988 -- 523 2,988 738 N/A 1998 Vencor Hospital--San Leandro San Leandro CA 2,735 5,870 -- 2,735 5,870 2,903 N/A 1998 Vencor Hospital--Orange County Westminster CA 728 7,384 -- 728 7,384 2,450 N/A 1998 THC--Orange County Orange County CA 3,144 2,611 -- 3,144 2,611 189 1990 1998 Vencor Hospital--San Diego San Diego CA 670 11,764 -- 670 11,764 2,552 N/A 1998 Recovery Inn of Menlo Park Menlo Park CA -- 2,799 -- 2,799 983 1992 1998 Vencor Hospital--Denver Denver CO 896 6,367 -- 896 6,367 2,201 N/A 1998 Vencor Hospital--Coral Gables Coral Gables FL 1,071 5,348 -- 1,071 5,348 1,937 N/A 1998 Vencor Hospital--St. Petersburg St. Petersburg FL 1,418 17,525 7 1,418 17,532 2,776 1968 1998 Vencor Hospital--Ft. Lauderdale Ft. Lauderdale FL 1,758 14,080 -- 1,758 14,080 4,340 N/A 1998 Vencor Hospital--North Florida Green Cove Spr. FL 145 4,613 -- 145 4,613 1,012 N/A 1998 Vencor Hospital-- Central Tampa Tampa FL 2,732 7,676 -- 2,732 7,676 712 1970 1998 Vencor Hospital-- Hollywood Hollywood FL 605 5,229 -- 605 5,229 695 1937 1998 Vencor Hospital-- Sycamore Sycamore IL 77 8,549 -- 77 8,549 1,989 N/A 1998 Vencor Hospital-- Chicago North Chicago IL 1,583 19,980 -- 1,583 19,980 3,889 N/A 1998 Vencor Hospital--Lake Shore Chicago IL 1,513 9,525 -- 1,513 9,525 2,123 1995 1998 Vencor Hospital-- Northlake Northlake IL 850 6,498 -- 850 6,498 2,126 N/A 1998 Vencor Hospital-- LaGrange LaGrange IN 173 2,330 -- 173 2,330 1,524 N/A 1998 Vencor Hospital-- Indianapolis Indianapolis IN 985 3,801 -- 985 3,801 1,245 N/A 1998 Vencor Hospital-- Louisville Louisville KY 3,041 12,330 -- 3,041 12,330 2,536 N/A 1998 Vencor Hospital--New Orleans New Orleans LA 648 4,971 -- 648 4,971 2,039 1968 1998 Vencor Hosp-- Boston Northshore Peabody MA 543 7,568 -- 543 7,568 718 1974 1998 Vencor Hospital--Boston Boston MA 1,551 9,796 -- 1,551 9,796 3,829 N/A 1998 Vencor Hospital-- Detroit Detroit MI 355 3,544 -- 355 3,544 1,312 N/A 1998 Vencor Hospital--Metro Detroit Detroit MI 564 4,896 -- 564 4,896 361 1980 1998 Vencor Hospital-- Minneapolis Golden Valley MN 223 8,120 -- 223 8,120 1,412 1952 1998 Vencor Hospital--Kansas City Kansas City MO 277 2,914 -- 277 2,914 995 N/A 1998 Vencor Hospital--St. Louis St. Louis MO 1,126 2,087 -- 1,126 2,087 871 N/A 1998 Vencor Hospital-- Greensboro Greensboro NC 1,010 7,586 -- 1,010 7,586 2,199 N/A 1998 Vencor Hospital-- Albuquerque Albuquerque NM 11 4,253 -- 11 4,253 341 1985 1998 THC--Las Vegas Hospital Las Vegas NV 1,110 2,177 -- 1,110 2,177 194 1980 1998 Vencor Hospital-- Oklahoma City Oklahoma City OK 293 5,607 -- 293 5,607 1,454 N/A 1998 Vencor Hospital-- Philadelphia Philadelphia PA 135 5,223 -- 135 5,223 763 N/A 1998 Vencor Hospital-- Pittsburgh Oakdale PA 662 12,854 -- 662 12,854 1,831 N/A 1998 Vencor Hospital-- Chattanooga Chattanooga TN 757 4,415 -- 757 4,415 1,479 N/A 1998 Vencor Hospital--San Antonio San Antonio TX 249 11,413 -- 249 11,413 2,805 N/A 1998 Vencor Hospital--Ft. Worth Southwest Ft. Worth TX 2,342 7,458 -- 2,342 7,458 1,153 1987 1998 Vencor Hospital-- Houston Northwest Houston TX 1,699 6,788 -- 1,699 6,788 886 1986 1998 Vencor Hospital-- Mansfield Mansfield TX 267 2,462 -- 267 2,462 725 N/A 1998 Vencor Hospital--Ft. Worth West Ft. Worth TX 648 10,608 -- 648 10,608 2,207 N/A 1998 Vencor Hospital-- Houston Houston TX 33 7,062 -- 33 7,062 1,957 N/A 1998 Vencor Hospital-- Arlington, VA Arlington VA 3,025 3,105 -- 3,025 3,105 898 N/A 1998 Vencor Hospital--Mt. Carmel Mt. Carmel WI 322 3,296 -- 322 3,296 705 1989 1998 -------- ---------- ------ -------- ---------- -------- TOTAL FOR VENCOR HOSPITALS 42,853 301,920 7 42,853 301,927 72,043 PERSONAL CARE FACILITIES ResCare-- Tangram--8 sites San Marcos TX 616 6,512 4 616 6,521 408 N/A -------- ---------- ------ -------- ---------- -------- $120,897 $1,063,498 $1,245 $120,891 $1,061,656 $287,756 ======== ========== ====== ======== ========== ======== <CAPTION> Life on Which Depreciation in Income Statement is Facility name Computed - ----------------- ------------ <S> <C> VENCOR HOSPITALS Vencor Hospital-- Phoenix 30 years Vencor Hospital--Tucson 25 years Vencor Hospital-- Ontario 25 years Vencor Hospital--San Leandro 25 years Vencor Hospital--Orange County 20 years THC--Orange County 40 years Vencor Hospital--San Diego 25 years Recovery Inn of Menlo Park 20 years Vencor Hospital--Denver 20 years Vencor Hospital--Coral Gables 30 years Vencor Hospital--St. Petersburg 40 years Vencor Hospital--Ft. Lauderdale 30 years Vencor Hospital--North Florida 20 years Vencor Hospital-- Central Tampa 40 years Vencor Hospital-- Hollywood 20 years Vencor Hospital-- Sycamore 20 years Vencor Hospital-- Chicago North 25 years Vencor Hospital--Lake Shore 20 years Vencor Hospital-- Northlake 30 years Vencor Hospital-- LaGrange 25 years Vencor Hospital-- Indianapolis 30 years Vencor Hospital-- Louisville 20 years Vencor Hospital--New Orleans 20 years Vencor Hosp-- Boston Northshore 40 years Vencor Hospital--Boston 25 years Vencor Hospital-- Detroit 20 years Vencor Hospital--Metro Detroit 40 years Vencor Hospital-- Minneapolis 40 years Vencor Hospital--Kansas City 30 years Vencor Hospital--St. Louis 40 years Vencor Hospital-- Greensboro 20 years Vencor Hospital-- Albuquerque 40 years THC--Las Vegas Hospital 40 years Vencor Hospital-- Oklahoma City 30 years Vencor Hospital-- Philadelphia 35 years Vencor Hospital-- Pittsburgh 40 years Vencor Hospital-- Chattanooga 22 years Vencor Hospital--San Antonio 30 years Vencor Hospital--Ft. Worth Southwest 20 years Vencor Hospital-- Houston Northwest 40 years Vencor Hospital-- Mansfield 40 years Vencor Hospital--Ft. Worth West 34 years Vencor Hospital-- Houston 20 years Vencor Hospital-- Arlington, VA 28 years Vencor Hospital--Mt. Carmel 20 years TOTAL FOR VENCOR HOSPITALS PERSONAL CARE FACILITIES ResCare-- Tangram--8 sites 20 years </TABLE> <TABLE> <S> <C> Reconciliation of real estate: Carrying cost: Balance at beginning of period: $1,185,969 Additions during period: Acquisitions -- Dispositions: Asset impairment (3,422) ---------- Balance end of period $1,182,547 ========== </TABLE> <TABLE> <S> <C> Accumulated depreciation: Balance at beginning of period: $246,509 Additions during period: Depreciation expense 42,742 Dispositions: Asset impairment (1,495) -------- Balance end of period $287,756 ======== </TABLE> - ----- *Pursuant to the terms of the Amended Credit Agreement, a mortgage was granted on all properties, effective February 28, 2000 S-6