UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

 

 

Form 10-Q

 

 

 

Commission file number: 000-51251

 

(Exact name of registrant as specified in its charter)

 

 

 

(615) 372-8500

(Registrant’s Telephone Number, Including Area Code)

 

Not Applicable

(Former name, former address and former fiscal year, if changed since last report)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes þ     No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):  Large accelerated filer þ     Accelerated filer o     Non-accelerated filer o

 

Indicate by check mark whether the registrant is a shell company (as defined in the Rule 12b-2 of the Exchange Act).  Yes o     No þ

 

As of September 30, 2007, the number of outstanding shares of Common Stock of LifePoint Hospitals, Inc. was 58,102,436.

 

 

TABLE OF CONTENTS

 

 

PART I — FINANCIAL INFORMATION

 

 

LIFEPOINT HOSPITALS, INC.

 

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

Unaudited

(In millions, except per share amounts)

 

 

See accompanying notes.

LIFEPOINT HOSPITALS, INC.

 

CONDENSED CONSOLIDATED BALANCE SHEETS

(Dollars in millions, except per share amounts)

 

 

 

 

See accompanying notes.

LIFEPOINT HOSPITALS, INC.

 

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

Unaudited

(In millions)

 

 

See accompanying notes.

LIFEPOINT HOSPITALS, INC.

 

CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY

For the Nine Months Ended September 30, 2007

Unaudited

(In millions)

 

 

See accompanying notes.

LIFEPOINT HOSPITALS, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2007

Unaudited

 

 

LifePoint Hospitals, Inc. is a holding company that is one of the largest owners and operators of general acute care hospitals in non-urban communities in the United States. Its subsidiaries own or lease their respective facilities and other assets. Unless the context otherwise indicates, references in this report to “LifePoint,” the “Company,” “we,” “our” or “us” are references to LifePoint Hospitals, Inc. and/or its wholly-owned and majority-owned subsidiaries. Any reference herein to its hospitals, facilities or employees refers to the hospitals, facilities or employees of subsidiaries of LifePoint Hospitals, Inc.

 

At September 30, 2007, the Company operated 49 hospitals, including one hospital that is being held for disposal. In all but three of the communities in which its hospitals are located, LifePoint is the only provider of acute care hospital services. The Company’s hospitals are geographically diversified across 18 states: Alabama; Arizona; California; Colorado; Florida; Indiana; Kansas; Kentucky; Louisiana; Mississippi; Nevada; New Mexico; Tennessee; Texas; Utah; Virginia; West Virginia and Wyoming.

 

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and with the requirements of Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and notes required by GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments) and disclosures considered necessary for a fair presentation have been included. Operating results for the three and nine months ended September 30, 2007 are not necessarily indicative of the results that may be expected for the year ending December 31, 2007. For further information, refer to the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2006, filed by the Company.

 

The majority of the Company’s expenses are “cost of revenue” items. Costs that could be classified as “general and administrative” by the Company would include LifePoint corporate overhead costs, which were $19.2 million and $20.1 million for the three months ended September 30, 2006 and 2007, respectively, and $57.5 million and $61.9 million for the nine months ended September 30, 2006 and 2007, respectively.

 

Certain prior year amounts have been reclassified to conform to the current year presentation for discontinued operations. This reclassification has no impact on the Company’s total assets, liabilities, stockholders’ equity, net income or cash flows. Unless noted otherwise, discussions in these notes pertain to the Company’s continuing operations.

 

 

Four HCA Hospitals

 

Effective July 1, 2006, the Company completed its acquisition of four hospitals from HCA Inc. (“HCA”) for a purchase price of $239.0 million plus specific working capital and capital expenditures as set forth in the purchase agreement. The four hospitals that the Company acquired were 200-bed Clinch Valley Medical Center, Richlands, Virginia (“Clinch Valley”); 325-bed St. Joseph’s Hospital, Parkersburg, West Virginia (“St. Joseph’s”); 155-bed Saint Francis Hospital, Charleston, West Virginia (“Saint Francis”); and 369-bed Raleigh General Hospital, Beckley, West Virginia (“Raleigh”). The Company borrowed $250.0 million under its Credit Agreement to pay for this acquisition.

 

Under the purchase method of accounting, in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 141, “Business Combinations,” the total purchase price of the four former HCA hospitals was allocated to the net tangible and intangible assets based upon their estimated fair values as of July 1, 2006. The excess of the purchase price over the estimated fair value of the net tangible and intangible

 

LIFEPOINT HOSPITALS, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

assets was recorded as goodwill. The results of operations of these hospitals are included in LifePoint’s results of operations beginning July 1, 2006. During the three months ended September 30, 2007, the Company finalized the purchase price allocation for the four former HCA hospitals.

 

The fair values of assets acquired and liabilities assumed at the date of acquisition were as follows (in millions):

 

 

In connection with the purchase price allocation, the Company recognized an increase in depreciation and amortization expense of approximately $3.2 million ($1.9 million, net of income taxes), or $0.03 per diluted share, during the nine months ended September 30, 2007. This increased depreciation and amortization expense was the result of higher values of certain buildings, equipment and intangible assets than the Company originally anticipated in the preliminary purchase price allocations.

 

The Company classified St. Joseph’s and Saint Francis as assets held for sale/discontinued operations, in accordance with the provisions of SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (“SFAS No. 144”), effective as of the acquisition date of July 1, 2006. The Company sold Saint Francis effective January 1, 2007 and St. Joseph’s effective May 1, 2007, as further discussed in Note 3.

 

 

Coastal Carolina Medical Center (“Coastal”)

 

Effective July 1, 2007, the Company completed the sale of Coastal to Tenet Healthcare Corporation (“Tenet”) for $35.0 million plus adjustments for working capital and other items. In connection with the sale, the Company recognized an impairment charge of $7.8 million, net of income taxes, or $0.14 loss per diluted share, in discontinued operations during the nine months ended September 30, 2007. The $7.8 million impairment charge was comprised of a $0.5 million impairment of intangible assets, a $7.1 million impairment

 

LIFEPOINT HOSPITALS, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

of goodwill and $0.2 million of an income tax provision. The following table sets forth the calculation of Coastal’s impairment charge (in millions):

 

 

Colorado River Medical Center

 

In March 2007, the Company, through its indirect wholly-owned subsidiary, Principal-Needles, Inc. (“PNI”), signed a letter of intent with the Board of Trustees of Needles Desert Communities Hospital (the “Board of Trustees”) to transfer to the Board of Trustees substantially all of the operating assets and net working capital of Colorado River Medical Center (“Colorado River”) plus $1.5 million in cash, which approximates the net present value of future lease payments due under the lease agreement between PNI and the Board of Trustees in consideration for the termination of the existing operating lease agreement. In connection with the signing of the letter of intent, the Company recognized an impairment adjustment (charge) of $0.3 million and $(8.3) million, net of income taxes, or $0.01 and $(0.15) earnings (loss) per diluted share, in discontinued operations for the three and nine months ended September 30, 2007, respectively. The impairment charge relates to goodwill impairment and the property and equipment and net working capital to be transferred to the Board of Trustees, for which the Company anticipates receiving no consideration. The impairment adjustment during the three months ended September 30, 2007, related to a decrease in Colorado River’s working capital during the three months ended September 30, 2007, which the Company had previously recorded as an impairment charge. The following table sets forth the components of Colorado River’s impairment adjustment (charge) for the three and nine months ended September 30, 2007 (in millions):

 

 

Two Former HCA Hospitals

 

In connection with the acquisition of four hospitals from HCA effective July 1, 2006, the Company committed to a plan to divest two of the acquired hospitals, St. Joseph’s and Saint Francis. The Company sold Saint Francis effective January 1, 2007 to Herbert J. Thomas Memorial Hospital Association and St. Joseph’s effective May 1, 2007 to Signature Hospital, LLC.

 

LIFEPOINT HOSPITALS, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

Smith County Memorial Hospital

 

In February 2006, the Company announced that it had entered into a definitive agreement to sell Smith County Memorial Hospital, Carthage, Tennessee (“Smith County”), to Sumner Regional Health System. The Company completed the sale of Smith County effective March 31, 2006 and recognized a gain on the sale of approximately $3.8 million, net of income taxes, or $0.07 per diluted share, during the nine months ended September 30, 2006.

 

Medical Center of Southern Indiana and Ashland Regional Medical Center

 

During the second quarter of 2005, the Company’s management committed to a plan to divest two hospitals, Medical Center of Southern Indiana, Charlestown, Indiana (“MCSI”) and Ashland Regional Medical Center, Ashland, Pennsylvania (“Ashland”). The Company completed the sale of both MCSI and Ashland to Saint Catherine Healthcare effective May 1, 2006.

 

Impact of Discontinued Operations

 

The results of operations, net of income taxes, of Coastal, Colorado River, St. Joseph’s, Saint Francis, Smith County, MCSI and Ashland are reflected in the accompanying condensed consolidated financial statements as discontinued operations in accordance with SFAS No. 144.

 

The Company allocated to discontinued operations interest expense of $2.3 million and a nominal amount for the three months ended September 30, 2006 and 2007, respectively, and $3.1 million and $2.5 million for the nine months ended September 30, 2006 and 2007, respectively. For those disposed assets that were part of an acquisition group for which specifically identifiable debt was incurred, the allocation of interest expense to discontinued operations was based on the ratio of the disposed net assets to the sum of total net assets of the acquisition group plus the debt that was incurred. For those asset acquisitions for which specifically identifiable debt was not incurred, the allocation of interest expense to discontinued operations was based on the ratio of disposed net assets to the sum of total net assets of the Company plus the Company’s total outstanding debt.

 

The revenues and loss before income taxes, excluding impairment of assets and gain (loss) on sale of hospitals, of discontinued operations for the three and nine months ended September 30, 2006 and 2007 were as follows (in millions):

 

 

The following table presents the changes in the Company’s assets held for sale for the nine months ended September 30, 2007 (in millions):

 

 

LIFEPOINT HOSPITALS, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 

The Company performed its most recent goodwill annual impairment test as of October 1, 2006 and did not incur an impairment charge related to the impairment test. In connection with the sale of Coastal and the signing of a letter of intent for Colorado River, as discussed in Note 3, the Company recognized a combined pretax impairment charge related to goodwill of approximately $10.2 million during the nine months ended September 30, 2007. Additionally, in connection with the sale of Coastal, the Company wrote off additional goodwill of $7.0 million during the three months ended September 30, 2007. Finally, during the nine months ended September 30, 2007, the Company had purchase price allocation adjustments for the four former HCA hospitals, as discussed in Note 2, resulting in a decrease in the carrying value of goodwill of approximately $51.4 million. The following table presents the changes in the carrying amount of goodwill for the nine months ended September 30, 2007 (in millions):

 

 

LIFEPOINT HOSPITALS, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

The following table provides information regarding the Company’s intangible assets, which are included in the accompanying condensed consolidated balance sheets (in millions):

 

 

Contract-Based Physician Minimum Revenue Guarantees

 

The Company accounts for contract-based physician minimum revenue guarantees in accordance with Financial Accounting Standards Board (the “FASB”) Staff Position No. 45-3, “Application of FASB Interpretation No. 45 to Minimum Revenue Guarantees Granted to a Business or Its Owners” (“FSP FIN 45-3”). Under FSP FIN 45-3, the Company records a contract-based intangible asset and related guarantee liability at the inception of a physician minimum revenue guarantee. The contract-based intangible assets are amortized into other operating expenses over the period of the physician contract, which is typically five years. As of September 30, 2007, the Company’s liability balance for contract-based physician minimum revenue guarantees was $16.2 million, which is included in other current liabilities in the Company’s accompanying condensed consolidated balance sheets.

 

LIFEPOINT HOSPITALS, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

Non-Competition Agreements

 

The Company has entered into non-competition agreements and these non-competition agreements are amortized on a straight-line basis over the term of the agreements.

 

Certificates of Need

 

The construction of new facilities, the acquisition or expansion of existing facilities and the addition of new services and certain equipment at the Company’s facilities may be subject to state laws that require prior approval by state regulatory agencies. These certificates of need laws generally require that a state agency determine the public need and give approval prior to the construction or acquisition of facilities or the addition of new services. The Company operates hospitals in certain states that have adopted certificate of need laws. If the Company fails to obtain necessary state approval, the Company will not be able to expand its facilities, complete acquisitions or add new services at its facilities in these states. An independent appraiser values each certificate of need when the Company acquires a hospital. These intangible assets have been determined to have indefinite lives and, accordingly, are not amortized.

 

 

Effective January 1, 2007, the Company adopted the provisions of FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes – An Interpretation of FASB Statement No. 109” (“FIN 48”). In connection with the adoption of FIN 48, the Company recorded a $52.0 million net liability for unrecognized tax benefits, accrued interest and penalties which was comprised of the following (in millions):

 

 

The provisions of FIN 48 allow for the classification election of interest on an underpayment of income taxes, when the tax law requires interest to be paid, and penalties, when a tax position does not meet the minimum statutory threshold to avoid payment of penalties, in income taxes, interest expense or another appropriate expense classification, based on the accounting policy election of the company. The Company has elected to continue its historical practice of classifying interest and penalties as a component of income tax expense.

 

During the three and nine months ended September 30, 2007, subsequent to the adoption of FIN 48, the Company recorded an increase of $1.1 million and $3.3 million, respectively, to its long-term income tax liability for the potential payment of additional interest. Of the $47.6 million unrecognized tax benefits at September 30, 2007, approximately $7.5 million, if recognized, would affect the Company’s effective tax rate. The Company’s long-term income tax liability was comprised of the following at January 1, 2007 and September 30, 2007 (in millions):

 

 

LIFEPOINT HOSPITALS, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

The Company’s U.S. federal income tax returns for tax years 1999 and beyond remain subject to examination by the Internal Revenue Service (“IRS”). During 2003, the IRS notified the Company regarding its findings relating to the examination of the Company’s tax returns for the years ended December 31, 1999, 2000 and 2001. The Company reached a partial settlement with the IRS on all issues except for the Company’s method of determining its bad debt deduction, for which the IRS has proposed an additional assessment of $7.4 million. All of the adjustments proposed by the IRS are temporary differences. The IRS has delayed final settlement of this assessment until resolution of certain pending court proceedings related to the use of this bad debt deduction method by HCA. On October 4, 2004, HCA was denied certiorari on its appeal of this matter to the United States Supreme Court. As a result, HCA and the IRS are currently working through the complex calculations for the many HCA tax years that are impacted. Due to the complex computations and many impacted HCA tax years (including HCA tax years preceding the spin-off of the Company from HCA), neither the Company nor HCA is currently able to estimate when the final settlement of the HCA tax years will occur. The Company cannot reach resolution of its IRS examination until after the final settlement of HCA’s tax years preceding the spin-off of the Company from HCA on May 11, 1999. The Company applied its 2002 federal income tax refund in the amount of $6.6 million as a deposit against any potential settlement to forestall the tolling of interest on such settlement beyond the March 15, 2003 deposit date. The Company has extended the statutes of limitation for the federal tax returns for tax years ended December 31, 1999, 2000 and 2001 through December 31, 2009 and will likely extend the statutes of limitation further at that time.

 

In 2005, the IRS commenced an examination of the Company’s federal income tax return for the year ended December 31, 2003. Furthermore, during the second quarter of 2006, the IRS commenced an examination of select items within the Company’s federal income tax return for the year ended December 31, 2002, thereby allowing the IRS to incorporate any carry forward adjustments from the examination of the 1999 through 2001 federal income tax returns. The Company anticipates that the examination for its tax year ended December 31, 2002 will be concluded by the end of 2007. The Company has extended the statute of limitation for its 2002 and 2003 returns through June 30, 2008 and will likely extend the statute of limitation further.

 

Finally, in 2005 the IRS commenced an examination of the federal income tax return of Province Healthcare Company and Subsidiaries (“Province”), which the Company merged with effective April 15, 2005, for the year ended December 31, 2003. During the quarter ended June 30, 2007, the Company and the IRS concluded the examination of Province’s federal income tax return for the year ended December 31, 2003, with the Company making a $1.4 million payment (including interest) in settlement of all matters. Of the $1.4 million payment, $0.8 million reduced the Company’s long-term income tax liability, and $0.6 million decreased non-current deferred tax liabilities. In addition, the Company reduced its long-term income tax liability by $0.8 million and decreased the goodwill associated with the Province business combination in accordance with SFAS No. 109. The Company has extended the statute of limitation for this return through December 31, 2007. Province’s U.S. federal income tax returns for tax years 2003 through April 15, 2005 remain subject to examination by the IRS.

 

Based on the outcome of these examinations or as a result of the expiration of statutes of limitation for specific taxing jurisdictions, it is reasonably possible that unrecognized tax positions could change within the next twelve months. However, the Company cannot currently estimate the range of any possible change.

 

LIFEPOINT HOSPITALS, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 

The following table sets forth the computation of basic and diluted earnings (loss) per share (in millions, except per share amounts):

 

 

The Company’s $575.0 million 31/2% Convertible Senior Subordinated Notes due May 15, 2014 and $225.0 million 31/4% Convertible Senior Subordinated Debentures due August 15, 2025 are included in the calculation of diluted earnings per share whether or not the contingent requirements have been met for conversion using the treasury stock method if the conversion price of $51.79 and $61.22, respectively, is less than the average market price of the Company’s common stock for the period. Upon conversion, the par value is settled in cash, and only the conversion premium is settled in shares of the Company’s common stock. The impact of the 31/2% Convertible Senior Subordinated Notes due May 15, 2014 and the 31/4% Convertible Senior Subordinated Debentures due August 15, 2025 has been excluded because the effect would have been anti-dilutive for the three and nine month periods ended September 30, 2006 and 2007.

 

LIFEPOINT HOSPITALS, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS No. 157”). SFAS No. 157 defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years. The provisions for SFAS No. 157 are to be applied prospectively as of the beginning of the fiscal year in which it is initially applied, except in limited circumstances including certain positions in financial instruments that trade in active markets as well as certain financial and hybrid financial instruments initially measured under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” (“SFAS No. 133”), using the transaction price method. In these circumstances, the transition adjustment, measured as the difference between the carrying amounts and the fair values of those financial instruments at the date SFAS No. 157 is initially applied, shall be recognized as a cumulative-effect adjustment to the opening balance of retained earnings for the fiscal year in which SFAS No. 157 is initially applied. The Company does not anticipate that the adoption of SFAS No. 157 will have a material impact on the Company’s results of operations or financial position.

 

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities — Including an Amendment of FASB Statement No. 115,” (“SFAS No. 159”). SFAS No. 159 permits a company to choose to measure many financial instruments and certain other items at fair value at specified election dates. Most of the provisions in SFAS No. 159 are elective; however, it applies to all companies with available-for-sale and trading securities. A company will report unrealized gains and losses on items for which the fair value option has been elected in earnings (or another performance indicator if the company does not report earnings) at each subsequent reporting date. The fair value option: (a) may be applied instrument by instrument, with a few exceptions, such as investments otherwise accounted for by the equity method; (b) is irrevocable (unless a new election date occurs); and (c) is applied only to entire instruments and not to portions of instruments. SFAS No. 159 is effective as of the beginning of a company’s first fiscal year beginning after November 15, 2007. The Company does not anticipate that the adoption of SFAS No. 159 will have a material impact on the Company’s results of operations or financial position.

 

 

David M. Dill assumed the position of Chief Financial Officer of the Company effective July 12, 2007, and replaced Michael J. Culotta, who resigned effective April 26, 2007. On May 8, 2007, the Compensation Committee of the Company’s Board of Directors granted Mr. Dill 50,000 shares of the Company’s nonvested stock awards and stock options to purchase 90,000 shares of the Company’s common stock under the Company’s Amended and Restated 1998 Long-Term Incentive Plan.

 

On May 4, 2007, LifePoint CSGP, LLC, a subsidiary of the Company, and Mr. Culotta entered into an Agreement to Cooperate and General Release (the “Release Agreement”). Under the Release Agreement, Mr. Culotta agreed to cooperate with the Company in various matters in which his knowledge of the business of the Company may be relevant and to assist the Company so as to facilitate a smooth and seamless transition of the responsibilities held and information learned by him while employed by the Company. Mr. Culotta agreed that his participation in various employment plans sponsored by the Company had ceased with his resignation and to release any claims he may have against the Company. As consideration for entering into the Release Agreement, the Company agreed to pay Mr. Culotta a total amount of approximately $0.8 million over the course of 18 months following the date of the Release Agreement. Mr. Culotta also acknowledged certain terms of existing stock options and rights under Company plans, including the expiration thereof, in relation to his resignation. Finally, Mr. Culotta agreed to certain confidentiality, non-competition, non-solicitation and other requirements under the Release Agreement.

 

As a result of Mr. Culotta’s resignation, the Company incurred a net decrease in compensation expense of approximately $0.7 million ($0.4 million, net of income taxes), or an increase in diluted earnings per share of

 

LIFEPOINT HOSPITALS, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

$0.01, during the nine months ended September 30, 2007. This net decrease in compensation expense consists of approximately $0.8 million recognized in connection with the Release Agreement, as described above, offset by an approximate $1.5 million reversal of stock compensation expense resulting from the termination of his unvested stock options and nonvested stock.

 

 

The Company issues stock options and other stock-based awards to key employees and directors under various stockholder-approved stock-based compensation plans. The Company currently has the following four types of stock-based awards outstanding under these plans: stock options; nonvested stock; restricted stock units; and deferred stock units. The Company accounts for its stock-based awards in accordance with the provisions of SFAS No. 123(R), “Share-Based Payment” (“SFAS No. 123(R)”). Under SFAS No. 123(R), the Company recognizes compensation expense based on the grant date fair value estimated in accordance with the standard.

 

Stock Options

 

The Company estimated the fair value of stock options granted during the three and nine month periods ended September 30, 2006 and 2007 using the Hull-White II lattice option Valuation Model (“HW-II”) and a single option award approach. The Company is amortizing the fair value on a straight-line basis over the requisite service periods of the awards, which are the vesting periods of three years. The Company granted stock options to purchase 904,745 and 661,526 shares of the Company’s common stock to certain key employees during the nine months ended September 30, 2006 and 2007, respectively. The stock options that were granted during these periods vest 33.3% on each grant anniversary date over three years of continued employment.

 

In addition, during March 2007, the Company granted performance-based stock options to certain senior executives to acquire up to an aggregate of 760,000 shares of the Company’s common stock. These stock options are subject to forfeiture unless certain targeted levels of diluted earnings per share are achieved for the year ending December 31, 2007. Depending on the level of diluted earnings per share achieved for the current fiscal year, the senior executives will forfeit zero to 100% of these stock options. The stock options that are not forfeited at year end will vest ratably beginning one year from the date of the grant to three years after the date of the grant. Through June 30, 2007, for purposes of accounting for the expense of these stock options, the Company assumed a target level of diluted earnings per share that resulted in the recognition of stock compensation expense assuming earned options to acquire an aggregate of 380,000 shares and forfeited options for the remaining 380,000 shares. During the three months ended September 30, 2007, based on the Company’s performance through the nine months ended September 30, 2007, the Company determined that it is not probable that the Company will achieve the required targeted level of diluted earnings per share for the issuance of any of the performance-based stock options and accordingly, reversed the previously recognized stock compensation expense associated with these stock options. The impact of cancelling these performance-based options resulted in a decrease in stock compensation expense of approximately $0.4 million ($0.2 million, net of income taxes), for the three months ended September 30, 2007.

 

LIFEPOINT HOSPITALS, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

The following table shows the weighted average assumptions the Company used to develop the fair value estimates under its HW-II option valuation model and the resulting estimates of weighted-average fair value per share of stock options granted during the nine month periods ended September 30, 2006 and 2007:

 

 

The Company received $0.4 million in cash from stock option exercises for the three months ended September 30, 2007, and $0.3 million and $12.5 million for the nine months ended September 30, 2006 and 2007, respectively. There was a nominal amount of actual tax benefits realized for the tax deductions from stock option exercises for the nine month period ended September 30, 2006. The Company recognized actual tax benefits for the tax deductions from stock option exercises of $0.1 million and $1.1 million for the three and nine month periods ended September 30, 2007.

 

As of September 30, 2007, there was $9.9 million of total unrecognized compensation cost related to stock option compensation arrangements. Total unrecognized compensation cost will be adjusted for future changes in estimated forfeitures. The Company expects to recognize that cost over a weighted-average period of 2.0 years.

 

Nonvested Stock

 

The fair value of nonvested stock is determined based on the closing price of the Company’s common stock on the day prior to the grant date. The nonvested stock requires no payment from employees and directors, and stock-based compensation expense is recorded equally over the vesting periods (three to five years).

 

The Company granted 389,719 and 448,351 shares of nonvested stock awards to certain key employees during the nine months ended September 30, 2006 and 2007, respectively. These nonvested stock awards cliff-vest three years from the grant date. The weighted-average fair market value at the date of grant of the 389,719 and 448,351 shares of nonvested stock awards was $33.23 and $36.45 per share, respectively.

 

Of the 448,351 shares of nonvested stock awards granted during the nine months ended September 30, 2007, 190,000 shares are performance-based. In addition to requiring continuing service of an employee, the vesting of these nonvested stock awards is contingent upon the satisfaction of certain financial goals, specifically related to the achievement of budgeted annual revenues and earnings targets. If these goals are achieved, the nonvested stock awards will cliff-vest three years after the grant date. The fair value for each of these nonvested stock awards was determined based on the closing price of the Company’s common stock on the day prior to the grant date and assumes that the performance goals will be achieved. If these performance goals are not met, no compensation expense will be recognized, and any recognized compensation expense will be reversed.

 

As of September 30, 2007, there was $22.7 million of total unrecognized compensation cost related to nonvested stock compensation arrangements. Total unrecognized compensation cost will be adjusted for future changes in estimated forfeitures. The Company expects to recognize that cost over a weighted-average period of 2.2 years.

 

LIFEPOINT HOSPITALS, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

On May 8, 2007, pursuant to the Outside Directors Stock and Incentive Compensation Plan (“ODSICP”), the Company’s Board of Directors, upon recommendations of the Compensation Committee of the Board of Directors, approved the grant of 3,500 restricted stock unit awards to each of the seven members of the Board of Directors who are not employees of the Company or any of its subsidiaries. This award will be fully vested and no longer subject to forfeiture upon the earliest of any of the following conditions to occur: (i) the date that is immediately prior to the date of the 2008 Annual Meeting of Stockholders of the Company; (ii) the death or disability of the non-employee director; or (iii) events described in Section 7.1 of the ODSICP. Generally, such shares will be forfeited in their entirety unless the individual continues to serve as a director of the Company on the day prior to the 2008 Annual Meeting of Stockholders. The non-employee director’s receipt of shares of common stock pursuant to the restricted stock unit award is deferred until the first business day following the earliest to occur of (i) the third anniversary of the date of grant, or (ii) the date the non-employee director ceases to be a member of the Company’s Board of Directors.

 

The following table summarizes the Company’s total stock-based compensation expense as well as the total recognized tax benefits related thereto for the three and nine month periods ended September 30, 2006 and 2007 (in millions):

 

 

The Company did not capitalize any stock-based compensation cost for the three or nine month periods ended September 30, 2006 and 2007. As of September 30, 2007, there was $32.6 million of total unrecognized compensation cost related to all of the Company’s stock compensation arrangements. Total unrecognized compensation cost may be adjusted for future changes in estimated forfeitures. The Company expects to recognize that cost over a weighted-average period of 2.1 years.

 

LIFEPOINT HOSPITALS, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 

Long-term debt consists of the following at December 31, 2006 and September 30, 2007 (in millions):

 

 

Senior Secured Credit Facilities

 

During the nine months ended September 30, 2007, the Company repaid a portion of its outstanding term B loans (the “Term B Loans”) and all of its outstanding revolving loans (the “Revolving Loans”) under the Credit Agreement, primarily with the proceeds from the issuance of the Company’s 31/2% Convertible Senior Subordinated Notes due May 15, 2014, as discussed further in this note, and from the proceeds from the sales of St. Joseph’s effective May 1, 2007, and Coastal effective July 1, 2007, as discussed in Note 3.

 

Effective May 11, 2007, the Company amended its Credit Agreement and increased its additional tranches available under its Term B Loans and Revolving Loans by $200.0 million and $50.0 million, respectively. Additionally, the amendment allows for the issuance of up to $250.0 million in term A loans, previously unavailable. Finally, the amendment modified certain existing non-monetary terms of the Credit Agreement to allow for the flexibility in the issuance of the 31/2% Convertible Senior Subordinated Notes, as discussed further in this note.

 

31/2% Convertible Senior Subordinated Notes due May 15, 2014

 

On May 29, 2007, the Company issued $500.0 million of its 31/2% Convertible Senior Subordinated Notes due May 15, 2014, and on May 31, 2007, the Company issued another $75.0 million pursuant to the underwriters’ exercise of their overallotment option. The net proceeds of approximately $561.7 million were used to repay a portion of the outstanding borrowings under the Credit Agreement, as previously discussed in this note. The 31/2% Convertible Senior Subordinated Notes bear interest at the rate of 31/2% per year, payable semi-annually on May 15 and November 15, commencing November 15, 2007.

 

The 31/2% Convertible Senior Subordinated Notes are convertible prior to March 15, 2014 under the following circumstances: (1) if the price of the Company’s common stock reaches a specified threshold during the specified periods; (2) if the trading price of the 31/2% Convertible Senior Subordinated Notes is below a

 

LIFEPOINT HOSPITALS, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

specified threshold; or (3) upon the occurrence of specified corporate transactions or other specified events. On or after March 15, 2014, holders may convert their 31/2% Convertible Senior Subordinated Notes at any time prior to the close of business on the scheduled trading day immediately preceding May 15, 2014 regardless of whether any of the foregoing conditions are satisfied.

 

Subject to certain exceptions, the Company will deliver cash and shares of its common stock upon conversion of each $1,000 principal amount of its 31/2% Convertible Senior Subordinated Notes as follows: (i) an amount in cash (the “principal return”) equal to the sum of, for each of the 20 volume-weighted average price trading days during the conversion period, the lesser of the daily conversion value for such volume-weighted average price trading day and $50; and (ii) a number of shares in an amount equal to the sum of, for each of the 20 volume-weighted average price trading days during the conversion period, any excess of the daily conversion value above $50. The Company’s ability to pay the principal return in cash is subject to important limitations imposed by the Credit Agreement and other credit facilities or indebtedness the Company may incur in the future. If the Company does not make any payment it is obligated to make under the terms of the 31/2% Convertible Senior Subordinated Notes, holders may declare an event of default.

 

The initial conversion rate is 19.3095 shares of the Company’s common stock per $1,000 principal amount of the 31/2% Convertible Senior Subordinated Notes (subject to adjustments and certain events). This represents an initial conversion price of approximately $51.79 per share of the Company’s common stock. In addition, if certain corporate transactions that constitute a change of control occur prior to maturity, the Company will increase the conversion rate in certain circumstances.

 

Upon the occurrence of a fundamental change (as specified in the indenture), each holder of the 31/2% Convertible Senior Subordinated Notes may require the Company to purchase some or all of the 31/2% Convertible Senior Subordinated Notes at a purchase price in cash equal to 100% of the principal amount of the 31/2% Convertible Senior Subordinated Notes surrendered, plus any accrued and unpaid interest.

 

The indenture for the 31/2% Convertible Senior Subordinated Notes does not contain any financial covenants or any restrictions on the payment of dividends, the incurrence of senior or secured debt or other indebtedness, or the issuance or repurchase of securities by the Company. The indenture contains no covenants or other provisions to protect holders of the 31/2% Convertible Senior Subordinated Notes in the event of a highly leveraged transaction or other events that do not constitute a fundamental change.

 

 

On June 1, 2006, the Company entered into an interest rate swap agreement with Citibank N.A., New York (the “Counterparty” or “Citibank”). The interest swap agreement, as amended, was effective as of November 30, 2006 and has a maturity date of May 30, 2011. The Company entered into the interest rate swap agreement to mitigate the floating interest rate risk on a portion of its outstanding variable rate borrowings under its Credit Agreement. The interest rate swap agreement requires the Company to make quarterly fixed rate payments to the Counterparty calculated on a notional amount as set forth in the schedule below at a fixed rate of 5.585% while the Counterparty will be obligated to make quarterly floating payments to the Company based on the three-month London Interbank Offered Rate on the same referenced notional amount. Notwithstanding the terms of the interest rate swap transaction, the Company is ultimately obligated for all amounts due and payable under the Credit Agreement.

 

LIFEPOINT HOSPITALS, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

Notional Schedule

 

 

The fair value of the interest rate swap agreement is the amount at which it could be settled, based on estimates obtained from the Counterparty. The Company has designated the interest rate swap as a cash flow hedge instrument, which is recorded in the Company’s accompanying condensed consolidated balance sheets at its fair value. The Company assesses the effectiveness of this cash flow hedge instrument on a quarterly basis. For the three months ended June 30, 2007 and September 30, 2007, the Company completed an assessment of the cash flow hedge instrument and determined the hedge to be partially ineffective in accordance with SFAS No. 133. As of June 30, 2007 and September 30, 2007, the outstanding balance due under the Credit Agreement was $714.4 million and $706.0 million, respectively. Because the notional amount of the interest rate swap in effect as of June 30, 2007 and September 30, 2007 exceeded the Company’s outstanding borrowings under its variable rate debt under the Credit Agreement, a portion of the cash flow hedge instrument was determined to be ineffective. The Company recognized an increase in interest expense of a nominal amount and approximately $0.3 million related to the ineffective portion of its interest rate swap during the three and nine month periods ended September 30, 2007, respectively.

 

The interest rate swap agreement exposes the Company to credit risk in the event of non-performance by the Counterparty. However, the Company does not anticipate non-performance by the Counterparty. The Company does not hold or issue derivative financial instruments for trading purposes. The fair value of the Company’s interest rate swap at December 31, 2006 and September 30, 2007, reflected a liability of approximately $14.7 million and $18.3 million, respectively, and is included in professional and general liability claims and other liabilities in the Company’s accompanying condensed consolidated balance sheets. The interest rate swap reflects a liability balance as of December 31, 2006 and September 30, 2007 because of a decrease in market interest rates since inception.

 

 

Americans with Disabilities Act Claim

 

On January 12, 2001, a class action lawsuit was filed in the United States District Court of the Eastern District of Tennessee (the “District Court”) against each of the Company’s existing hospitals alleging non-compliance with the accessibility guidelines of the Americans with Disabilities Act (“ADA”). On April 20, 2007 and again on May 2, 2007, the plaintiff amended the lawsuit to add hospitals subsequently acquired by the Company, including the former Province facilities, Wythe County Community Hospital (“WCCH”), Danville Regional Medical Center, (“DRMC”), Clinch Valley and Raleigh and to dismiss divested facilities. The lawsuit does not seek any monetary damages, but seeks injunctive relief requiring facility modification, where necessary, to meet ADA guidelines, in addition to attorneys’ fees and costs. The Company is currently unable to estimate the costs that could be associated with modifying these facilities because these costs are negotiated and determined on a facility-by-facility basis and, therefore, have varied and will continue to vary significantly among facilities. The Company may be required to make significant capital expenditures at one or more of its facilities in order to comply with the ADA, and the Company’s business, financial condition or results of operations could be adversely affected as a result.

 

In January 2002, the District Court certified the class action and issued a scheduling order that requires the parties to complete discovery and inspection for approximately six facilities per year. The Company is

 

LIFEPOINT HOSPITALS, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

vigorously defending the lawsuit, recognizing the Company’s obligation to correct any deficiencies in order to comply with the ADA. Noncompliance with the requirements of the ADA could result in the imposition of fines against the Company by the federal government or the payment of damages by the Company. As of October 11, 2007, the plaintiffs have conducted inspections at 32 of the Company’s hospitals (including the now divested Smith County and closed Guyan Valley Hospital). As of September 30, 2007, the District Court has approved settlement agreements between the parties relating to 13 of the Company’s facilities. On June 21, 2007, the case was reassigned to a new judge. On July 16, 2007, the parties filed a Notice of Partial Settlement and Request for Fairness Hearing for five facilities. On July 19, 2007, the District Court held a status conference to review the procedural and substantive status of the case. The Company is now moving forward in implementing facility modifications in accordance with the terms of the settlements. The Company has completed corrective work on three facilities for a cost of $1.0 million. The Company currently anticipates that the costs associated with the ten other facilities that have court approved settlement agreements will range from $5.1 million to $7.0 million.

 

Legal Proceedings and General Liability Claims

 

The Company is, from time to time, subject to claims and suits arising in the ordinary course of business, including claims for damages for personal injuries, medical malpractice, breach of contracts, wrongful restriction of or interference with physicians’ staff privileges and employment related claims. In certain of these actions, plaintiffs request payment for damages, including punitive damages that may not be covered by insurance. The Company is currently not a party to any proceeding which, in management’s opinion, would have a material adverse effect on the Company’s business, financial condition or results of operations.

 

Physician Commitments

 

The Company has committed to provide certain financial assistance pursuant to recruiting agreements with various physicians practicing in the communities it serves. In consideration for a physician relocating to one of its communities and agreeing to engage in private practice for the benefit of the respective community, the Company may advance certain amounts of money to a physician, normally over a period of one year, to assist in establishing the physician’s practice. The amount of commitments the Company estimates it will advance approximates $16.2 million and often depends upon the financial results of a physician’s private practice during the guarantee period. Generally, amounts advanced under the recruiting agreements may be forgiven pro rata over a period of 48 months contingent upon the physician continuing to practice in the respective community. Pursuant to the Company’s standard physician recruiting agreement, any breach or non-fulfillment by a physician under the physician recruiting agreement gives the Company the right to recover any payments made to the physician under the agreement. The Company accounts for advances to physicians in accordance with FSP FIN 45-3, as further discussed in Note 4.

 

Capital Expenditure Commitments

 

The Company is reconfiguring some of its facilities to more effectively accommodate patient services and restructuring existing surgical capacity in some of its hospitals to permit additional patient volume and a greater variety of services. The Company has incurred approximately $36.3 million in uncompleted projects at September 30, 2007, which is included in construction in progress in the Company’s accompanying condensed consolidated balance sheets. At September 30, 2007, the Company had projects under construction with an estimated cost to complete and equip of approximately $79.7 million.

 

Pursuant to the asset purchase agreement for DRMC, the Company has agreed to spend at least $11.3 million for capital expenditures and improvements before July 1, 2008. As of September 30, 2007, the Company has exceeded the $11.3 million minimum required capital expenditures and improvements.

 

LIFEPOINT HOSPITALS, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

The Company agreed in connection with the lease of WCCH to make capital expenditures or improvements to the hospital of a value not less than $10.3 million prior to June 1, 2008, and an additional $4.2 million, for an aggregate total of $14.5 million, before June 1, 2013. The Company has incurred approximately $7.5 million of the required capital expenditures and improvements as of September 30, 2007.

 

There are required annual capital expenditure commitments in connection with several of the Company’s other facilities. In accordance with the purchase agreements for Memorial Hospital of Martinsville and Henry County, Martinsville, Virginia; Memorial Medical Center of Las Cruces, Las Cruces, New Mexico; and Los Alamos Medical Center, Los Alamos, New Mexico facilities, the Company is obligated to make ongoing annual expenditures based on a percentage of net revenues.

 

Development Agreement with the City of Ennis

 

The Company entered into a Development Agreement with the City of Ennis, Texas during 2005 to construct a new hospital (“Ennis New”) to replace the existing Ennis Regional Medical Center (“Ennis Old”). The Company previously leased Ennis Old from the City of Ennis. Under the Development Agreement, the Company constructed and equipped Ennis New for approximately $35.0 million, all of which was paid for by the Company. The construction was completed during July, 2007, and the Company moved its operations from Ennis Old to Ennis New. Pursuant to the terms of the Development Agreement, the City of Ennis paid $14.7 million of the construction cost to the Company during August 2007, which the Company has included in professional and general liability claims and other liabilities in the Company’s condensed consolidated balance sheet as of September 30, 2007.

 

Acquisitions

 

The Company has historically acquired businesses with prior operating histories. Acquired companies may have unknown or contingent liabilities, including liabilities for failure to comply with healthcare laws and regulations, medical and general professional liabilities, workers compensation liabilities, previous tax liabilities and unacceptable business practices. Although the Company institutes policies designed to conform practices to its standards following completion of acquisitions, there can be no assurance that the Company will not become liable for past activities that may later be asserted to be improper by private plaintiffs or government agencies. Although the Company generally seeks to obtain indemnification from prospective sellers covering such matters, there can be no assurance that any such matter will be covered by indemnification, or if covered, that such indemnification will be adequate to cover potential losses and fines. The Company was not indemnified by Province in connection with the Province business combination.

 

 

We recommend that you read this discussion together with our unaudited condensed consolidated financial statements and related notes included elsewhere in this report, as well as our Annual Report on Form 10-K for the year ended December 31, 2006. Unless otherwise indicated, all relevant financial and statistical information included herein relates to our continuing operations.

 

Overview

 

Our revenues for the three and nine months ended September 30, 2007 compared to the three and nine months ended September 30, 2006 were favorably impacted by an increase in revenues per equivalent admission and the third quarter 2006 acquisition of two hospitals from HCA. Our income from continuing operations and diluted earnings per share from continuing operations for the three and nine months ended September 30, 2007, as compared to the three and nine months ended September 30, 2006, were negatively affected by increases in our provision for doubtful accounts and professional fees expense. The following table reflects our summarized operating results for the periods presented (in millions, except per share amounts):

 

 

Key Challenges

 

We have the following internal and external key challenges to overcome:

 

 

Our quarterly provision for doubtful accounts for consolidated operations which comprises our continuing and discontinued operations, was as follows for the periods presented (in millions):

 

 

Our revenues decrease when we write-off patient accounts identified as charity and indigent care. Our hospitals write-off a portion of a patient’s account upon the determination that the patient qualifies under the hospital’s charity/indigent care policy. In the event that a patient account was previously classified as self-pay when the determination of charity/indigent status is made, a corresponding reduction in the provision for doubtful accounts may occur.

The following table reflects our quarterly consolidated charity and indigent care write-offs for the periods presented (in millions):

 

 

The provision for doubtful accounts, as well as charity and indigent care write-offs, relate primarily to self-pay revenues. The following table reflects our quarterly consolidated self-pay revenues, net of charity and indigent care write-offs, for the periods presented (in millions):

 

 

The following table shows our consolidated revenue days outstanding reflected in our consolidated net accounts receivable as of the dates indicated:

 

 

The approximate percentages of billed hospital receivables (which is a component of total accounts receivable) are summarized as follows as of the dates presented: