SEC Info - Kindred Healthcare, Inc - ‘424B4’ on 11/8/01

SEC Info℠

Home

Help

Please Sign In

Kindred Healthcare, Inc – ‘424B4’ on 11/8/01

On: Thursday, 11/8/01 · Accession #: 950109-1-504807 · File #: 333-68838

  As Of                Filer                Filing    For·On·As Docs:Size              Issuer               Agent

11/08/01  Kindred Healthcare, Inc           424B4                  1:636K                                   Donnelley R R & S… 01/FA

Prospectus — Rule 424(b)(4)
Filing Table of Contents

Document/Exhibit                   Description                      Pages   Size 

 1: 424B4       Final Prospectus                                     184   1.01M

Document Table of Contents

Page	(sequential)	\|	(alphabetic)	Top
			Alternative Formats (Word, et al.) Accounts receivable Assets Business Capitalization Cash and cash equivalents Certificates of Need and State Licensing Common Stock Corporate Integrity Agreement Corporate overhead Description of Capital Stock Dividend Policy Experts Forward-Looking Statements Goodwill Government Regulation Health services division Hospital Division Income Taxes Information systems Inventories James H. Gillenwater, Jr Legal Matters Legal Proceedings Liabilities subject to compromise Long-term debt Management Management's Discussion and Analysis of Financial Condition and Results of Operations Master Lease Agreements Medicaid Medicare Notice to Canadian Residents Offering, The Predecessor Company Preferred Stock Price Range of Common Stock Principal and Selling Stockholders Professional liability risks Property and equipment Prospectus Summary Reorganized Company Report of Ernst & Young LLP Report of PricewaterhouseCoopers LLP Revenues Risk Factors Selected Consolidated Financial and Other Data Shares Eligible for Future Sale Spin-off Stockholders' equity (deficit) The Offering Unaudited Pro Forma Consolidated Financial Statements Underwriting United States Federal Income Tax Considerations for Non-United States Holders Unusual transactions Use of Proceeds We may not be able to meet our substantial rent and debt service requirements Where You Can Find More Information 2000
1	1st Page - Filing Submission
"	Common Stock
4	Prospectus Summary
5	Health services division
"	Hospital Division
7	The Offering
9	Reorganized Company
17	Risk Factors
19	We may not be able to meet our substantial rent and debt service requirements
25	Forward-Looking Statements
26	Use of Proceeds
"	Price Range of Common Stock
"	Dividend Policy
27	Capitalization
28	Selected Consolidated Financial and Other Data
30	Unaudited Pro Forma Consolidated Financial Statements
34	Assets
39	Management's Discussion and Analysis of Financial Condition and Results of Operations
44	Corporate overhead
"	Income Taxes
47	Predecessor Company
53	Unusual transactions
"	2000
65	Business
74	Medicare
"	Medicaid
77	Master Lease Agreements
80	Corporate Integrity Agreement
81	Government Regulation
83	Certificates of Need and State Licensing
89	Information systems
"	Legal Proceedings
93	Management
94	James H. Gillenwater, Jr
96	Principal and Selling Stockholders
99	Description of Capital Stock
"	Preferred Stock
102	Shares Eligible for Future Sale
104	United States Federal Income Tax Considerations for Non-United States Holders
106	Underwriting
109	Notice to Canadian Residents
110	Legal Matters
"	Experts
"	Where You Can Find More Information
117	Spin-off
138	Report of PricewaterhouseCoopers LLP
139	Report of Ernst & Young LLP
141	Stockholders' equity (deficit)
145	Revenues
146	Cash and cash equivalents
"	Accounts receivable
"	Inventories
"	Property and equipment
"	Goodwill
147	Professional liability risks
152	Liabilities subject to compromise
"	Long-term debt

424B4 1st Page of 184 TOC ↑Top Previous Next ↓Bottom Just 1st
Filed pursuant to Rule 424 (b)(4)
Registration No. (333-68838)
Prospectus

3,246,900 Shares

[LOGO] Kindred Healthcare

Common Stock

------------

We are selling 1,750,000 shares of common stock and the selling stockholders
are selling 1,496,900 shares of common stock. We will not receive any of the
proceeds from the shares of common stock sold by the selling stockholders.

Our common stock is quoted on the OTC Bulletin Board under the symbol
"KIND." On November 7, 2001, the average of the bid and asked prices per share
of our common stock on the OTC Bulletin Board was $48.75. The underwriters
determined the public offering price for our common stock by reference to the
market price of our common stock at the time of pricing the offering. Our
common stock has been approved for quotation on The Nasdaq National Market
under the symbol "KIND," subject to official notice of issuance.

The underwriters have an option to purchase from us a maximum of 487,035
additional shares to cover over-allotments of shares.

Investing in our common stock involves risks. See "Risk Factors" on page 14.

[Enlarge/Download Table]

Underwriting Proceeds to Proceeds to
Price to Discounts and Kindred Selling
Public Commissions Healthcare Stockholders
------------- ------------- ------------- -------------

Per Share.................... $46.00 $2.30 $43.70 $43.70
Total ....................... $149,357,400 $7,467,870 $76,475,000 $65,414,530

Delivery of the shares of common stock will be made on or about November 14,
2001.

Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities or determined if
this prospectus is truthful or complete. Any representation to the contrary is
a criminal offense.

Credit Suisse First Boston Goldman, Sachs & Co.

UBS Warburg
JPMorgan
Lehman Brothers

The date of this prospectus is November 7, 2001.

424B4 2nd Page of 184 TOC 1st Previous Next ↓Bottom Just 2nd
On this page is a map of the United States reflecting the location of each
of our nursing centers, hospitals, pulmonary units and institutional
pharmacies.

MAP of United States

424B4 3rd Page of 184 TOC 1st Previous Next ↓Bottom Just 3rd
------------

TABLE OF CONTENTS

[Download Table]

Page
----

Prospectus Summary.................. 1
Risk Factors........................ 14
Forward-Looking Statements.......... 22
Use of Proceeds..................... 23
Price Range of Common Stock......... 23
Dividend Policy..................... 23
Capitalization...................... 24
Selected Consolidated Financial and
Other Data......................... 25
Unaudited Pro Forma Consolidated
Financial Statements............... 27
Management's Discussion and Analysis
of Financial Condition and Results
of Operations...................... 36
Business............................ 62
[Download Table]

Page
----

Management.......................... 90
Principal and Selling Stockholders.. 93
Description of Capital Stock........ 96
Shares Eligible for Future Sale..... 99
United States Federal Income Tax
Considerations for Non-United
States Holders..................... 101
Underwriting........................ 103
Notice to Canadian Residents........ 106
Legal Matters....................... 107
Experts............................. 107
Where You Can Find More
Information........................ 107
Index to Consolidated Financial
Statements......................... F-1

------------

You should rely only on the information contained in this document or to
which we have referred you. We have not authorized anyone to provide you with
information that is different. This document may only be used where it is legal
to sell these securities. The information in this document may only be accurate
on the date of this document.

All references in this prospectus to "Kindred," "our company," "we," "us" or
"our" mean Kindred Healthcare, Inc. and, unless the context otherwise requires,
its consolidated subsidiaries. For periods prior to May 1, 1998, such terms
refer to the company's business as it was conducted by Ventas, Inc. On that
date Ventas completed the spin-off of its healthcare operations by distributing
shares of our pre-reorganization common stock to its stockholders while
retaining substantially all of its real estate assets.

424B4 4th Page of 184 TOC 1st Previous Next ↓Bottom Just 4th
PROSPECTUS SUMMARY

This summary highlights information contained elsewhere in this prospectus
or in the documents incorporated by reference in this prospectus. This summary
does not contain all of the information that you should consider before
investing in the common stock. You should read carefully the entire prospectus,
including the documents incorporated by reference in this prospectus,
especially the risks of investing in the common stock discussed under "Risk
Factors."

Kindred Healthcare, Inc.

We are one of the largest providers of long-term healthcare services in the
United States based on revenues. Our health services division provides long-
term care services by operating nursing centers and a rehabilitation therapy
business, and our hospital division provides long-term acute care services by
operating hospitals and an institutional pharmacy business. As of June 30,
2001, we operated:

. 315 nursing centers with 40,607 licensed beds in 32 states, making us
the fourth largest operator of nursing centers in the United States, and

. 56 hospitals with 4,867 licensed beds in 23 states, including 52 long-
term acute care hospitals, making us the largest operator of such
hospitals in the United States.

Competitive Strengths

Premier Long-Term Acute Care Hospital Operator. Since opening our first
hospital in 1985, we have grown into the largest network of long-term acute
care hospitals in the United States based on revenues. As a result of our
commitment to the long-term acute care business and our comprehensive program
of care for medically complex patients, we believe that we are the premier
operator of long-term acute care hospitals in the United States.

Proven Management Team. Our senior management team has an average of 22
years of experience in the healthcare industry, offering a breadth of
experience in the operation of nursing centers and long-term acute care
hospitals.

Geographic Diversity and Independent Business Lines. We believe the
geographic diversity of our nursing centers and hospitals and two independent
business lines reduce our exposure to any single state Medicaid reimbursement
source and adverse regional and local economic conditions.

Economies of Scale. In addition to operating the largest network of long-
term acute care hospitals in the United States, we are the fourth largest
operator of nursing centers in the United States based on revenues. The scale
of our operations allows us to achieve cost efficiencies and gives us an
advantage in negotiating contracts with suppliers, vendors, commercial insurers
and other third parties. Due to our size, we have the ability to centralize
various administrative services and spread the costs of these services over our
entire base of operations.

424B4 5th Page of 184 TOC 1st Previous Next ↓Bottom Just 5th
Health Services Division

Through our nursing centers, we provide residents with long-term care
services, a full range of pharmacy, medical and clinical services and routine
services, including daily dietary, social and recreational services. We also
provide rehabilitation services, including physical, occupational and speech
therapies. In addition, we believe that we are a leading provider of care for
patients with Alzheimer's disease, offering specialized programs at more than
80 nursing centers for patients suffering from this disease.

The principal elements of our health services division strategy are:

Providing Quality, Clinical-Based Services. The health services division is
focused on qualitative and quantitative clinical performance indicators with
the goal of providing quality care under the cost containment objectives
imposed by government and private payors.

Enhancing Sales and Marketing Programs. The health services division intends
to increase our nursing center patient volumes through enhanced sales and
marketing programs and improved relationships with local referral sources.

Increasing Operating Efficiency. The health services division continually
seeks to improve operating efficiency with a view to maintaining high quality
care in an environment that demands an increasingly greater control of costs.
We believe that operating efficiency is critical in maintaining our position as
a leading provider of nursing center services in the United States.

Managing Efficient Delivery of Ancillary Services. The health services
division realigned and refocused its ancillary services business in response to
the decline in the demand for ancillary services that followed the
implementation of the prospective payment system in 1998. Today, our nursing
centers generally provide ancillary services to their patients through the use
of internal staff. We are continuing to refine the delivery of ancillary
services to external customers to maintain profitability under the cost
constraints of the prospective payment system.

Hospital Division

In our hospitals, we primarily provide long-term acute care services to
medically complex patients who are suffering 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 and developmental anomalies. In particular, we have a
core competency in treating patients with pulmonary disorders. Medically
complex patients often are dependent on technology for continued life support,
and approximately 50% of the hospital division's patients are ventilator-
dependent for some period of time during their hospitalization.

The principal elements of our hospital division strategy are:

Maintaining High Quality of Care. The hospital division seeks to
differentiate its hospitals through its ability to care for medically complex
patients in a high-quality, cost-effective setting. We are committed to
maintaining and improving the quality of our patient care by dedicating
appropriate resources to each facility and refining our clinical initiatives.

Improving Operating Efficiency. The hospital division is continuously
focused on improving operating efficiency with a view to maintaining quality
patient care in an environment that demands an increasingly

424B4 6th Page of 184 TOC 1st Previous Next ↓Bottom Just 6th
greater control of costs. Our hospital division seeks to improve operating
efficiencies by standardizing its operations and optimizing the skill mix of
its staff based on the hospital's occupancy and the clinical needs of its
patients.

Growing Through Business Development and Acquisitions. Our growth strategy
is focused on the development and expansion of our services, including
opportunities to establish new hospital-in-hospital and pulmonary units in
hospitals operated by third parties. We believe that we are well positioned to
acquire or develop new free-standing hospitals and selectively pursue other
strategic opportunities.

Expanding Breadth of Industry Leadership. We are the leading provider of
long-term acute care to patients with pulmonary dysfunction. However, we also
deliver other services in areas such as wound care, surgery, acute
rehabilitation and pain management. We intend to broaden our expertise beyond
pulmonary services and to leverage our leadership position in pulmonary care to
expand our market strength to other clinical services.

Increasing Higher Margin Commercial Volume. Historically, we have received
higher reimbursement rates from commercial insurers than we have from the
Medicare and Medicaid programs. As a result, we work to expand relationships
with insurers to increase commercial patient volume.

Other Information

From September 13, 1999 until April 20, 2001, we operated as a debtor-in-
possession under the jurisdiction of the United States Bankruptcy Court for the
District of Delaware. On April 20, 2001, our Fourth Amended Joint Plan of
Reorganization became effective and we emerged from bankruptcy with our current
capital structure, amended master lease agreements with Ventas, Inc., from whom
we lease 210 nursing centers and 44 hospitals, and a new board of directors. In
connection with our emergence from bankruptcy, we also changed our name to
Kindred Healthcare, Inc.

In connection with our emergence from bankruptcy, we adopted fresh-start
accounting on April 1, 2001 which materially changed the amounts previously
recorded in our consolidated financial statements. We believe that business
segment operating income before and after our reorganization is generally
comparable. However, capital costs such as rent, interest, depreciation and
amortization are not comparable. In addition, our reported financial position
and cash flows for periods prior to April 1, 2001 generally are not comparable
to those for periods after that date.

------------

Our principal executive office is located at 680 South Fourth Street,
Louisville, Kentucky 40202 and our telephone number is (502) 596-7300. Our Web
site is located at www.kindredhealthcare.com. We are not incorporating by
reference in this document any material from our Web site. The reference above
to our Web site is an inactive textual reference to the uniform resource
locator (URL) and is for your reference only.

424B4 7th Page of 184 TOC 1st Previous Next ↓Bottom Just 7th
THE OFFERING

[Download Table]

Common stock offered by us.......................... 1,750,000 shares

Common stock offered by selling stockholders........ 1,496,900 shares

Common stock to be outstanding after this offering.. 17,350,000 shares

Over-allotment option............................... 487,035 shares

Use of proceeds..................................... We intend to use the net
proceeds from the sale of
common stock we are
offering to repay
outstanding indebtedness.
We will not receive any
of the proceeds from the
sale of the shares of
common stock offered by
the selling stockholders.
See "Use of Proceeds."

Trading............................................. Our common stock is
quoted on the OTC
Bulletin Board under the
symbol "KIND." Our common
stock has been approved
for quotation on The
Nasdaq National Market
under the symbol "KIND,"
subject to official
notice of issuance.

As of June 30, 2001, 15,600,000 shares of our common stock were outstanding.
The common stock outstanding after this offering does not include:

. 2,000,000 shares reserved for issuance upon the exercise of outstanding
Series A warrants with an exercise price of $30.00 per share,

. 5,000,000 shares reserved for issuance upon the exercise of outstanding
Series B warrants with an exercise price of $33.33 per share, and

. 1,600,000 shares reserved for issuance under our stock option plans,
under which options to purchase 934,200 shares were outstanding as of
June 30, 2001 at a weighted average exercise price of $32.00 per share.

Unless we indicate otherwise, the information in this prospectus assumes
that the underwriters do not exercise their option to purchase up to 487,035
additional shares of common stock from us to cover over-allotments.

424B4 8th Page of 184 TOC 1st Previous Next ↓Bottom Just 8th
SUMMARY CONSOLIDATED FINANCIAL AND OTHER DATA

The summary consolidated financial and other data presented below should be
read in conjunction with "Management's Discussion and Analysis of Financial
Condition and Results of Operations," our unaudited pro forma consolidated
financial statements and the accompanying notes, and our consolidated financial
statements and the accompanying notes included in this prospectus. The summary
consolidated financial data for the years ended December 31, 1998, 1999 and
2000 have been derived from our audited consolidated financial statements
included in this prospectus. The summary consolidated financial data for the
six months ended June 30, 2000, the three months ended March 31, 2001 and as of
and for the three months ended June 30, 2001 have been derived from our
unaudited condensed consolidated financial statements included in this
prospectus.

We adopted fresh-start accounting in connection with our emergence from
bankruptcy. Under fresh-start accounting, a new reporting entity is deemed to
be created and the recorded amounts of assets and liabilities are adjusted to
reflect their estimated fair values. For accounting purposes, the fresh-start
adjustments have been recorded in our consolidated financial statements as of
April 1, 2001. Since fresh-start accounting materially changed the amounts
previously recorded in our consolidated financial statements, a black line
separates the post-emergence financial data from the pre-emergence financial
data to signify the difference in the basis of preparation of the financial
statements for each respective entity.

As used in this prospectus, the term "Predecessor Company" refers to the
company and its operations for periods prior to April 1, 2001, while the term
"Reorganized Company" is used to describe the company and its operations for
periods after that date.

424B4 9th Page of 184 TOC 1st Previous Next ↓Bottom Just 9th
[Enlarge/Download Table]

Reorganized
Predecessor Company Company
--------------------------------------------------------- -----------
Three Three
Six months months months
Year ended December 31, ended ended ended
---------------------------------- June 30, March 31, June 30,
1998 1999 2000 2000 2001 2001
---------- ---------- ---------- ---------- --------- -----------
(in thousands, except per share amounts)

Consolidated Statement
of Operations Data:
Revenues............... $2,999,739 $2,665,641 $2,888,542 $1,428,880 $752,409 $770,764
Operating income
(loss) before
reorganization items
(a)................... (41,226) (212,788) 386,277 197,808 103,740 114,884
Income (loss) before
reorganization items
and income taxes...... (502,307) (686,358) (50,115) (19,954) (3,981) 29,393
Income (loss) from
operations............ (578,406) (705,464) (64,751) (26,549) 49,185 16,489
Net income (loss)...... (656,343) (714,387) (64,751) (26,549) 471,976 17,885
Earnings (loss) per
common share from
operations:
Basic................ $ (8.47) $ (10.03) $ (0.94) $ (0.39) $ 0.69 $ 1.09
Diluted.............. (8.47) (10.03) (0.94) (0.39) 0.69 1.00
Shares used in
computing earnings
(loss) per common
share:
Basic................ 68,343 70,406 70,229 70,194 70,261 15,090
Diluted.............. 68,343 70,406 70,229 70,194 71,656 16,533
Other Financial Data:
Operating income
(loss) as a % of
revenues.............. (b) (b) 13.4% 13.8% 13.8% 14.9%
EBITDA (c)............. $ 163,755 $ (105,490) $ 83,169 $ 40,265 $ 26,745 $ 50,304
EBITDA as a % of
revenues.............. 5.5% (b) 2.9% 2.8% 3.6% 6.5%
Cash flows provided by
operating
activities............ $ 323,196 $ 231,387 $ 185,540 $ 106,039 $ 35,831 $ 40,264
Cash flows used in
investing
activities............ 62,156 112,588 114,567 41,899 49,992 26,597
Cash flows used in
financing
activities............ 282,116 5,000 34,681 29,344 10,426 65,998

[Download Table]

Reorganized Company
-------------------------
As of June 30, 2001
-------------------------
(in thousands)
Pro Forma
Actual as Adjusted(d)
---------- --------------

Consolidated Balance Sheet Data:
Cash and cash equivalents.......................... $ 102,823 $ 102,823
Cash-restricted available for repayment of long-
term debt......................................... 40,984 40,984
Working capital.................................... 237,345 237,345
Total assets....................................... 1,434,774 1,434,774
Long-term debt, including amounts due within one
year.............................................. 302,536 227,221
Total stockholders' equity......................... 462,536 537,851

--------------------
(a) Operating income (loss) is defined as income (loss) before interest,
income taxes, rent, depreciation and amortization.
(b) Not meaningful.
(c) We define EBITDA as income (loss) before interest, income taxes,
depreciation, amortization, unusual transactions and reorganization items.
EBITDA is not a measure of financial performance under generally accepted
accounting principles. Items excluded from EBITDA are significant
components in understanding and assessing financial performance. EBITDA is
a measure commonly used by financial analysts and investors to evaluate
the financial results of companies in our industry, and we believe it
therefore provides useful information to investors. EBITDA should not be
considered in isolation or as an alternative to net income, cash flows
generated by operations, investing or financing activities, or other
financial statement data presented in the consolidated financial
statements as indicators of financial performance or liquidity. Because
EBITDA is not a measurement determined in accordance with generally
accepted accounting principles and is susceptible to varying calculations,
EBITDA as presented may not be comparable to similarly titled measures of
other companies.
(d) The pro forma consolidated balance sheet data as of June 30, 2001 has been
adjusted to give effect to the sale by us of 1,750,000 shares of our
common stock at the public offering price of $46.00 per share and the
repayment of outstanding indebtedness from the net proceeds of such sale.

424B4 10th Page of 184 TOC 1st Previous Next ↓Bottom Just 10th
Summary Operating Data

The following table sets forth certain operating data for the health
services and hospital divisions. A black line separates our post-reorganization
operating data from our pre-reorganization operating data since they have not
been prepared on a consistent basis of accounting.

[Enlarge/Download Table]

Reorganized
Predecessor Company Company
----------------------------------------------------- ------------
Three months
Year ended December 31, Three months ended
------------------------------------- ended June 30,
1998 1999 2000 March 31, 2001 2001
----------- ----------- ----------- -------------- ------------
(in thousands, except statistics)

Health Services
Division:
Nursing centers:
Revenues............ $ 1,667,343 $ 1,594,244 $ 1,675,627 $ 429,523 $ 444,137
Operating income
(a)................ $ 213,036 $ 169,128 $ 278,738 $ 70,543 $ 78,735
Facilities at end of
period:
Owned or leased... 278 282 278 278 280
Managed........... 13 13 34 35 35
Licensed beds at end
of period (b):
Owned or leased... 36,701 36,912 36,466 36,469 36,746
Managed........... 1,661 1,661 3,723 3,861 3,861
Patient days (c).... 11,939,266 11,656,439 11,580,295 2,804,982 2,822,752
Revenues per patient
day................ $ 140 $ 137 $ 145 $ 153 $ 157
Average daily census
(d)................ 32,710 31,935 31,640 31,166 31,019
Occupancy (e)....... 87.3% 86.8% 86.1% 85.2% 84.8%
Rehabilitation
services:
Revenues............ $ 264,574 $ 195,731 $ 135,036 $ 10,695 $ 9,244
Operating income.... $ 18,398 $ 2,891 $ 8,047 $ 690 $ 1,809
Other ancillary
services:
Revenues............ $ 168,165 $ 43,527 $ - $ - $ -
Operating income.... $ 30,183 $ 4,166 $ 4,737 $ 250 $ 103
Total division:
Revenues............ $ 1,975,582 $ 1,705,235 $ 1,733,472 $ 440,218 $ 453,381
Operating income.... $ 261,617 $ 176,185 $ 291,522 $ 71,483 $ 80,647
EBITDA (f).......... $ 128,092 $ 2,529 $ 114,177 $ 27,191 $ 40,427
Hospital Division:
Hospitals:
Revenues............ $ 919,847 $ 850,548 $ 1,007,947 $ 271,984 $ 276,112
Operating income.... $ 247,272 $ 132,050 $ 205,858 $ 54,778 $ 55,685
Facilities at end of
period............. 57 56 56 56 56
Licensed beds at end
of period.......... 4,979 4,931 4,886 4,867 4,867
Patient days........ 947,488 982,301 1,044,663 273,029 270,721
Revenues per patient
day................ $ 971 $ 866 $ 965 $ 996 $ 1,020
Average daily
census............. 2,596 2,691 2,854 3,034 2,975
Occupancy........... 54.0% 56.9% 60.8% 65.3% 64.0%
Pharmacy:
Revenues............ $ 149,991 $ 171,493 $ 204,252 $ 54,880 $ 56,567
Operating income.... $ 15,301 $ 342 $ 7,421 $ 6,176 $ 6,036
Total division:
Revenues............ $ 1,069,838 $ 1,022,041 $ 1,212,199 $ 326,864 $ 332,679
Operating income.... $ 262,573 $ 132,392 $ 213,279 $ 60,954 $ 61,721
EBITDA.............. $ 171,939 $ 7,097 $ 85,899 $ 29,174 $ 37,836

424B4 11th Page of 184 TOC 1st Previous Next ↓Bottom Just 11th
--------------------
(a) Operating income is defined as income before interest, income taxes, rent,
depreciation, amortization, corporate overhead, unusual transactions and
reorganization items.
(b) Licensed beds refers to the maximum number of beds permitted in the
facility under its license regardless of whether the beds are actually
available for patient care.
(c) Patient days refers to the total number of days of patient care provided
for the periods indicated.
(d) Average daily census is computed by dividing each facility's patient days
by the number of calendar days the respective facility was in operation.
(e) Occupancy is computed by dividing average daily census by the number of
licensed beds, adjusted for the length of time each facility was in
operation during the respective period.
(f) We define EBITDA as income (loss) before interest, income taxes,
depreciation, amortization, corporate overhead, unusual transactions and
reorganization items. EBITDA is not a measure of financial performance
under generally accepted accounting principles. Items excluded from EBITDA
are significant components in understanding and assessing financial
performance. EBITDA is a measure commonly used by financial analysts and
investors to evaluate the financial results of companies in our industry,
and we believe it therefore provides useful information to investors.
EBITDA should not be considered in isolation or as an alternative to net
income, cash flows generated by operations, investing or financing
activities, or other financial statement data presented in the consolidated
financial statements as indicators of financial performance or liquidity.
Because EBITDA is not a measurement determined in accordance with generally
accepted accounting principles and is susceptible to varying calculations,
EBITDA as presented may not be comparable to similarly titled measures of
other companies.

424B4 12th Page of 184 TOC 1st Previous Next ↓Bottom Just 12th
SUMMARY UNAUDITED PRO FORMA CONSOLIDATED FINANCIAL DATA

The following table sets forth certain summary unaudited pro forma
consolidated financial data of the company. The pro forma consolidated
statement of operations data for the year ended December 31, 2000 and the six
months ended June 30, 2000 and 2001 assume that our Fourth Amended Joint Plan
of Reorganization, our sale of the common stock we are offering and the
repayment of outstanding indebtedness from the net proceeds of such sale were
consummated on January 1, 2000. The pro forma consolidated balance sheet data
at June 30, 2001 assumes the sale of common stock we are offering and the
repayment of indebtedness from the net proceeds of such sale were consummated
on June 30, 2001. The pro forma information presented below may not necessarily
reflect the financial position or results of operations which would have been
obtained if these transactions had been consummated on the dates indicated in
the unaudited pro forma consolidated financial statements. In addition, the pro
forma financial data do not purport to be indicative of our future operating
results.

The information below should be read in conjunction with our unaudited pro
forma consolidated financial statements and the accompanying notes included in
this prospectus.

[Download Table]

Six months ended June
Year ended 30,
December 31, ---------------------
2000 2000 2001
------------ ---------- ----------
(in thousands, except per share
amounts)

Statement of Operations Data:
Revenues.................................. $2,888,542 $1,428,880 $1,523,173
Income from operations.................... 20,448 12,096 28,861
Earnings per common share from operations:
Basic................................... $ 1.21 $ 0.71 $ 1.70
Diluted................................. $ 1.11 $ 0.66 $ 1.57
Shares used in computing earnings per
common share:
Basic................................... 16,950 16,950 16,950
Diluted................................. 18,393 18,393 18,393

[Download Table]

June 30,
2001
----------

Balance Sheet Data:
Total assets...................................................... $1,434,774
Long-term debt, including amounts due within one year............. 227,221
Common stockholders' equity....................................... 537,851
Book value per common share (a)................................... $ 31.00

--------------------
(a) The computation is based upon the pro forma issued and outstanding shares
of 17,350,000 at June 30, 2001.

424B4 13th Page of 184 TOC 1st Previous Next ↓Bottom Just 13th
Recent Developments

On October 15, 2001, we released our operating results for the three months
ended September 30, 2001. Summary comparative financial and operating data
follows:

KINDRED HEALTHCARE, INC.
Condensed Consolidated Statement of Operations
(Unaudited)
(In thousands, except per share amounts)

[Download Table]

Predecessor Reorganized
Company Company
------------- -------------
Three months Three months
ended ended
September 30, September 30,
2000 2001
------------- -------------

Revenues.......................................... $717,253 $768,680
-------- --------
Salaries, wages and benefits...................... 405,510 436,196
Supplies.......................................... 92,251 97,089
Rent.............................................. 77,870 65,233
Other operating expenses.......................... 135,345 123,000
Depreciation and amortization..................... 17,464 16,768
Interest expense.................................. 14,415 7,523
Investment income................................. (1,490) (3,210)
-------- --------
741,365 742,599
-------- --------
Income (loss) before reorganization items and
income taxes..................................... (24,112) 26,081
Reorganization items.............................. 4,745 -
-------- --------
Income (loss) before income taxes................. (28,857) 26,081
Provision for income taxes........................ 500 11,282
-------- --------
Net income (loss)................................. (29,357) 14,799
Preferred stock dividend requirements............. (261) -
-------- --------
Income (loss) available to common stockholders.. $(29,618) $ 14,799
======== ========
Earnings (loss) per common share:
Basic........................................... $ (0.42) $ 0.97
Diluted......................................... $ (0.42) $ 0.80
Shares used in computing earnings (loss) per
common share:
Basic........................................... 70,265 15,202
Diluted......................................... 70,265 18,497

424B4 14th Page of 184 TOC 1st Previous Next ↓Bottom Just 14th
KINDRED HEALTHCARE, INC.
Condensed Business Segment Data
(Unaudited)
(In thousands)

[Enlarge/Download Table]

Predecessor Reorganized
Company Company
------------- -------------
Three months Three months
ended ended
September 30, September 30,
2000 2001
------------- -------------

Revenues:
Health services division:
Nursing centers................................................................................... $ 420,588 $447,428
Rehabilitation services........................................................................... 34,032 9,122
Other ancillary services.......................................................................... (1) -
Elimination....................................................................................... (19,671) -
--------- --------
434,948 456,550
Hospital division:
Hospitals......................................................................................... 244,391 268,578
Pharmacy.......................................................................................... 51,593 58,750
--------- --------
295,984 327,328
--------- --------
730,932 783,878
Elimination of pharmacy charges to
Company nursing centers........................................................................... (13,679) (15,198)
--------- --------
$717,253 $768,680
========= ========
Net income (loss):
Operating income (loss):
Health services division:
Nursing centers.................................................................................. $ 69,493 $ 80,339
Rehabilitation services.......................................................................... 2,837 2,178
Other ancillary services......................................................................... 2,687 226
--------- --------
75,017 82,743
Hospital division:
Hospitals........................................................................................ 47,284 49,809
Pharmacy......................................................................................... 1,075 7,002
--------- --------
48,359 56,811
--------- --------
Corporate overhead................................................................................ (29,993) (30,397)
Unusual transactions.............................................................................. (9,236) 3,238
Reorganization items.............................................................................. (4,745) -
--------- --------
Operating income................................................................................. 79,402 112,395
Rent............................................................................................... (77,870) (65,233)
Depreciation and amortization...................................................................... (17,464) (16,768)
Interest, net...................................................................................... (12,925) (4,313)
--------- --------
Income (loss) before income taxes.................................................................. (28,857) 26,081
Provision for income taxes......................................................................... 500 11,282
--------- --------
$ (29,357) $ 14,799
========= ========

424B4 15th Page of 184 TOC 1st Previous Next ↓Bottom Just 15th
KINDRED HEALTHCARE, INC.
Condensed Business Segment Data (Continued)
(Unaudited)
(In thousands)

[Download Table]

Predecessor Reorganized
Company Company
------------- -------------
Three months Three months
ended ended
September 30, September 30,
2000 2001
------------- -------------

Rent:
Health services division:
Nursing centers................................... $45,037 $41,311
Rehabilitation services........................... 80 24
Other ancillary services.......................... 33 1
------- -------
45,150 41,336
Hospital division:
Hospitals......................................... 31,089 22,771
Pharmacy.......................................... 921 984
------- -------
32,010 23,755
------- -------
Corporate.......................................... 710 142
------- -------
$77,870 $65,233
======= =======
Depreciation and amortization:
Health services division:
Nursing centers................................... $ 6,741 $ 5,713
Rehabilitation services........................... 2 2
Other ancillary services.......................... (69) -
------- -------
6,674 5,715
Hospital division:
Hospitals......................................... 5,020 5,742
Pharmacy.......................................... 547 476
------- -------
5,567 6,218
------- -------
Corporate.......................................... 5,223 4,835
------- -------
$17,464 $16,768
======= =======

424B4 16th Page of 184 TOC 1st Previous Next ↓Bottom Just 16th
KINDRED HEALTHCARE, INC.
Condensed Business Segment Data (Continued)
(Unaudited)

[Download Table]

Predecessor Reorganized
Company Company
------------- -------------
Three months Three months
ended ended
September 30, September 30,
2000 2001
------------- -------------

Nursing Center Data:
End of period data:
Number of nursing centers:
Owned or leased................................... 278 280
Managed........................................... 39 34
--------- ----------
317 314
========= ==========
Number of licensed beds:
Owned or leased................................... 36,465 36,729
Managed........................................... 4,070 3,626
--------- ----------
40,535 40,355
========= ==========
Revenue mix %:
Medicare........................................... 27 31
Medicaid........................................... 50 48
Private and other.................................. 23 21
Patient days (excludes managed facilities):
Medicare........................................... 381,890 399,441
Medicaid........................................... 1,960,359 1,933,822
Private and other.................................. 570,679 542,284
--------- ----------
2,912,928 2,875,547
========= ==========
Revenues per patient day:
Medicare........................................... $ 301 $ 348
Medicaid........................................... 107 111
Private and other.................................. 169 174
Weighted average................................... 144 156
Hospital Data:
End of period data:
Number of hospitals................................ 56 56
Number of licensed beds............................ 4,886 4,867
Revenue mix %:
Medicare........................................... 56 56
Medicaid........................................... 12 11
Private and other.................................. 32 33
Patient days:
Medicare........................................... 167,946 172,692
Medicaid........................................... 34,052 35,098
Private and other.................................. 50,567 55,050
--------- ----------
252,565 262,840
========= ==========
Revenues per patient day:
Medicare........................................... $ 814 $ 872
Medicaid........................................... 847 807
Private and other.................................. 1,557 1,628
Weighted average................................... 968 1,022

424B4 17th Page of 184 TOC 1st Previous Next ↓Bottom Just 17th
RISK FACTORS

An investment in our common stock involves a number of risks, some of which,
including market, liquidity, credit, operational, legal and regulatory risks,
could be substantial and are inherent in our businesses. Additional risks and
uncertainties not known to us or that we currently deem immaterial may impair
our business operations. You should carefully consider the following
information about these risks, together with the other information in this
prospectus, before buying shares of our common stock.

Changes in the reimbursement rates or methods of payment from third-party
payors, including the Medicare and Medicaid programs, or the implementation of
other measures to reduce reimbursement for our services could result in a
substantial reduction in our revenues and operating margins.

We depend on reimbursement from third-party payors, including the Medicare
and Medicaid programs, for substantially all of our revenues. For the six
months ended June 30, 2001, we derived approximately 70% of our total revenues
from the Medicare and Medicaid programs and approximately 30% from private
third-party payors, such as commercial insurance companies, health maintenance
organizations, preferred provider organizations and contracted providers.

The Medicare and Medicaid programs are highly regulated and subject to
frequent and substantial changes. The Balanced Budget Act of 1997, which
established a plan to balance the federal budget by fiscal year 2002, contained
extensive changes to the Medicare and Medicaid programs intended to reduce
significantly the projected amount of increase in payments under those
programs. The Balanced Budget Act, among other things:

. substantially reduced Medicare reimbursement payments to our nursing
centers by establishing a prospective payment system covering
substantially all services provided to Medicare patients, including
ancillary services such as respiratory therapy, physical therapy,
occupational therapy, speech therapy and certain covered
pharmaceuticals,

. reduced payments made to our hospitals by reducing the Tax Equity and
Fiscal Responsibility Act of 1982, or TEFRA, incentive payments,
allowable costs for capital expenditures and bad debts, and payments for
services to patients transferred from a general acute care hospital, and

. repealed the federal payment standard for Medicaid reimbursement levels
often referred to as the "Boren Amendment" for hospitals and nursing
facilities.

Congress has directed the Secretary of the U.S. Department of Health and
Human Services to develop a prospective payment system applicable specifically
to long-term acute care hospitals by October 1, 2001. The new prospective
payment system would be effective for cost report periods beginning on or after
October 1, 2002. This payment system would not impact us until September 1,
2003. To date, the Secretary has not proposed such a prospective payment
system. Congress has further directed that if the Secretary is unable to
implement a prospective payment system specific to long-term acute care
hospitals by October 1, 2002, the Secretary shall instead implement, as of such
date, a prospective payment system for long-term acute care hospitals based
upon existing hospital diagnosis-related groups modified where feasible to
account for resource use of long-term acute care hospital patients. We cannot
predict the content or timing of such regulations. We cannot assure you that
such regulations will not have a material adverse impact on our financial
condition and results of operations.

There also continue to be legislative and regulatory proposals that would
impose further limitations on government and private payments to healthcare
providers. By repealing the Boren Amendment, the Balanced Budget Act eased
existing impediments on the ability of states to reduce their Medicaid
reimbursement levels. In some cases, states have enacted or are considering
enacting measures that are designed to reduce their Medicaid expenditures and
to make certain changes to private healthcare insurance.

424B4 18th Page of 184 TOC 1st Previous Next ↓Bottom Just 18th
In addition, private third-party payors are continuing their efforts to
control healthcare costs through direct contracts with healthcare providers,
increased utilization review and greater enrollment in managed care programs
and preferred provider organizations. These private payors increasingly are
demanding discounted fee structures and the assumption by healthcare providers
of all or a portion of the financial risk.

We could be adversely affected by the continuing efforts of governmental and
private third-party payors to contain the amount of reimbursement we receive
for healthcare services. We cannot assure you that reimbursement payments under
governmental and private third-party payor programs will remain at levels
comparable to present levels or will be sufficient to cover the costs allocable
to patients eligible for reimbursement pursuant to such programs. Future
changes in the reimbursement rates or methods of third-party payors, including
the Medicare and Medicaid programs, or the implementation of other measures to
reduce reimbursement for our services could result in a substantial reduction
in our net operating revenues. Our operating margins may continue to be under
pressure because of deterioration in pricing flexibility, changes in payor mix
and growth in operating expenses in excess of increases in payments by third-
party payors. In addition, as a result of competitive pressures, our ability to
maintain operating margins through price increases to private patients is
limited. See "Business--Government Regulation."

Our failure to pay rent, or Ventas' exercise of its right to reset the annual
aggregate minimum rent, under the Master Lease Agreements could materially
adversely affect our liquidity, financial condition and results of operations.

We currently lease 210 of our 315 nursing centers and 44 of our 56 hospitals
from Ventas under four Master Lease Agreements. Our failure to pay the rent or
otherwise comply with a material provision of any of our Master Lease
Agreements with Ventas would result in an "Event of Default" under such Master
Lease Agreement. Upon an Event of Default, remedies available to Ventas
include, without limitation, terminating such Master Lease Agreement,
repossessing and reletting the leased properties and requiring us to remain
liable for all obligations under such Master Lease Agreement, including the
difference between the rent under such Master Lease Agreement and the rent
payable as a result of reletting the leased properties, or requiring us to pay
the net present value of the rent due for the balance of the term of such
Master Lease Agreement. The exercise of such remedies could have a material
adverse effect on our financial condition and our business.

In addition, the Master Lease Agreements provide Ventas with a one-time
option, that may be exercised by Ventas within one year from July 2006, to
reset the annual aggregate minimum rent under one or more of the Master Lease
Agreements to the then current fair market rental of the relevant leased
properties in exchange for a payment to us. Accordingly, if the operations or
value of our leased properties improve, the relevant fair market rental
likewise may increase over the current rental if the option is exercised. If
Ventas were to exercise this option, the potential increase in our annual
aggregate minimum rent payments could be so substantial as to have a material
adverse effect on our financial condition and results of operations. See
"Business--Master Lease Agreements."

We could experience significant increases to our operating costs due to
shortages in qualified nurses and other healthcare professionals.

The market for qualified nurses and other healthcare professionals is highly
competitive. We, like other healthcare providers, have experienced difficulties
in attracting and retaining qualified personnel such as nurses, certified
nurse's assistants, nurse's aides and other important providers of healthcare.
Our hospitals are particularly dependent on nurses for patient care. Salaries,
wages and benefits were approximately 56% of our revenues for the three months
ended June 30, 2001. The difficulty our nursing centers and hospitals are
experiencing in hiring and retaining qualified personnel has increased our
average wage rate and forced us to increase our use of contract nursing
personnel. We may continue to experience increases in our labor costs primarily
due to higher wages and greater benefits required to attract and retain
qualified healthcare personnel. Our ability to control labor costs will
significantly affect our future operating results.

424B4 19th Page of 184 TOC 1st Previous Next ↓Bottom Just 19th
We operate 20 nursing centers in the State of Florida. The State of Florida
recently enacted legislation establishing certain minimum staffing requirements
for nursing centers operating in that state. Beginning January 1, 2002, each
Florida nursing center must satisfy certain minimum hours of direct care per
resident per day by both licensed nurses and certified nursing assistants and
certain minimum staff/patient ratios for both licensed nurses and certified
nurse assistants. The implementation of these staffing requirements in Florida
is not contingent upon any additional appropriation of state funds in any
budget act or other statute. Other states in which we operate nursing centers
also may establish minimum staffing requirements in the future. Our ability to
satisfy such staffing requirements will depend upon our ability to attract and
retain the qualified nurses, certified nurse assistants and other staff.
Failure to comply with such minimum staffing requirements may result in the
imposition of fines or other sanctions. If states do not appropriate sufficient
additional funds (through Medicaid program appropriations or otherwise) to pay
for any additional operating costs resulting from such minimum staffing
requirements, our profitability may be adversely affected.

We may not be able to meet our substantial rent and debt service requirements.

A substantial portion of our cash flows from operations is dedicated to the
payment of rents related to our leased properties as well as interest on our
outstanding indebtedness of $302 million at June 30, 2001. If we are unable to
generate sufficient funds to meet our obligations, we may be required to
refinance, restructure or otherwise amend some or all of such obligations, sell
assets or raise additional cash through the sale of our equity. We cannot
assure you that such restructuring activities, sales of assets or issuances of
equity can be accomplished or, if accomplished, would raise sufficient funds to
meet these obligations. Our high degree of leverage and related financial
covenants:

. require us to dedicate a substantial portion of our cash flow to
payments on our rent and interest obligations, thereby reducing the
availability of cash flow to fund working capital, capital expenditures
and other general corporate activities,

. require us to pledge as collateral substantially all of our assets, and

. require us to maintain certain debt coverage and financial ratios at
specified levels, thereby reducing our financial flexibility.

These provisions:

. could have a material adverse effect on our ability to withstand
competitive pressures or adverse economic conditions (including adverse
regulatory changes),

. could affect adversely our ability to make material acquisitions, obtain
future financing or take advantage of business opportunities that may
arise, and

. increase our vulnerability to a downturn in general economic conditions
or in our business.

If we fail to cultivate new or maintain established relationships with the
referral sources in our markets, our revenues may decline.

Our success, in large part, is dependent upon the admissions and referrals
from physicians and other healthcare providers in the communities that our
hospitals and nursing centers serve, and our ability to maintain good relations
with these referral sources. Physicians referring patients to our hospitals are
generally not our employees and, in many of the markets that we serve, most
physicians have admitting privileges at other hospitals and are free to refer
their patients to other providers. If we are unable to successfully cultivate
and maintain strong relationships with these referral sources, the admissions
at our hospitals and nursing centers may decrease and cause revenues to
decline.

Significant legal actions, particularly in the State of Florida, could subject
us to increased operating costs and substantial uninsured liabilities, which
could materially and adversely affect our liquidity, financial condition and
results of operations.

We have experienced substantial increases in both the number and size of
patient care liability claims in recent years. In addition to large
compensatory claims, plaintiffs' attorneys increasingly are seeking significant

424B4 20th Page of 184 TOC 1st Previous Next ↓Bottom Just 20th
punitive damages and attorney's fees. As a result, general and professional
liability costs have become increasingly expensive and unpredictable.

We operate 20 nursing centers and seven hospitals in the State of Florida.
In Florida, general liability and professional liability costs for the long-
term care industry have become increasingly expensive and difficult to
estimate. Industry statistics show that Florida long-term care providers:

. incur more than four times the number of general liability claims per
patient day as compared to the rest of the country,

. pay an average claim approximately three times higher in amount than
elsewhere in the country, and

. incur 44% of the total general liability losses for the entire country,
but represent only approximately 10% of the total nursing facility beds.

Many insurance companies are exiting the State of Florida or severely
restricting their underwriting of long-term care general liability insurance in
that state. Insurers have decided that they cannot provide coverage when faced
with the magnitude of losses and the explosive growth of claims in that state.
Accordingly, our overall general liability costs per bed in Florida are
substantially higher than other states and continue to escalate. The Florida
legislature recently has enacted certain tort reforms relating to professional
liability claims. We are currently unable to determine what impact, if any,
this legislation may have on our claims experience in Florida.

We insure our professional liability risks primarily through a wholly-owned,
limited purpose insurance company. The limited purpose insurance company
insures initial losses up to specified coverage levels per occurrence and in
the aggregate. Coverages for losses in excess of those levels are maintained
through unaffiliated commercial insurance carriers. Effective November 30,
2000, the limited purpose insurance company insures all claims arising in
Florida up to a per occurrence limit without the benefit of any aggregate
coverage limit through unaffiliated commercial insurance carriers. We maintain
general liability insurance and professional malpractice liability insurance in
amounts and with deductibles that management believes are sufficient for our
operations. However, our insurance coverage might not cover all claims against
us or continue to be available to us at a reasonable cost. If we are unable to
maintain adequate insurance coverage or are required to pay punitive damages,
we may be exposed to substantial liabilities. We also are subject to lawsuits
under a federal whistleblower statute designed to combat fraud and abuse in the
healthcare industry. These lawsuits can involve significant monetary and award
bounties to private plaintiffs who successfully bring these suits. See
"Business--Legal Proceedings."

We conduct business in a heavily regulated industry, and changes in regulations
or violations of regulations may result in increased costs or sanctions that
reduce our revenues and profitability.

In the ordinary course of our business, we are subject regularly to
inquiries, investigations and audits by federal and state agencies that oversee
healthcare regulations.

The extensive federal, state and local regulations affecting the healthcare
industry include, but are not limited to, regulations relating to licensure,
conduct of operations, ownership of facilities, addition of facilities,
allowable costs, services and prices for services. See "Business--Government
Regulation." In particular, various laws including, antikickback, antifraud and
abuse amendments codified under the Social Security Act, prohibit certain
business practices and relationships that might affect the provision and cost
of healthcare 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
antikickback, antifraud and abuse amendments under the Social Security Act
include criminal penalties and civil sanctions, including fines and possible
exclusion from government programs such as Medicare and Medicaid.

In addition, the Social Security Act broadly defines the scope of prohibited
physician referrals under the Medicare and Medicaid programs to providers with
which they have ownership or certain other financial

424B4 21st Page of 184 TOC 1st Previous Next ↓Bottom Just 21st
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 complex and limited judicial or regulatory interpretation
exists. We cannot assure you that governmental officials charged with
responsibility for enforcing the provisions of these laws and regulations will
not assert that one or more of our arrangements are in violation of the
provisions of such laws and regulations.

We believe that the regulatory environment surrounding the long-term care
industry has intensified, particularly for large for-profit, multi-facility
providers like us. In the State of Florida, for example, a new statute requires
the State to revoke, absent sufficient mitigating factors, all licenses of
commonly controlled facilities even if only one facility has serious regulatory
deficiencies. The federal government has imposed intensive enforcement policies
resulting in a significant increase in the number of inspections, citations of
regulatory deficiencies and other regulatory sanctions, including terminations
from the Medicare and Medicaid programs, bars on Medicare and Medicaid payments
for new admissions and civil monetary penalties. If we fail to comply with the
extensive laws and regulations applicable to our businesses, we could become
ineligible to receive government program reimbursement, suffer civil or
criminal penalties or be required to make significant changes to our
operations. In addition, we could be forced to expend considerable resources
responding to an investigation or other enforcement action under these laws or
regulations. Furthermore, should we lose licenses for a number of our
facilities as a result of regulatory action or otherwise, we could be in
default under our Master Lease Agreements and our credit agreements. See "Risk
Factors--We may not be able to meet our substantial rent and debt service
requirements."

We are unable to predict the future course of federal, state and local
regulation or legislation, including Medicare and Medicaid statutes and
regulations, or the intensity of federal and state enforcement actions. Changes
in the regulatory framework and sanctions from various enforcement actions
could have a material adverse effect on our liquidity, financial condition and
results of operations.

If we fail to attract patients and residents and compete effectively with other
healthcare providers, our revenues and profitability may decline.

The long-term healthcare services industry is highly competitive. Our
nursing centers compete on a local and regional basis with other nursing
centers and other long-term healthcare providers. Some of our competitors'
facilities are located in newer buildings and may offer services not provided
by us or are operated by entities having greater financial and other resources
than us. Our hospitals face competition from general acute care hospitals and
long-term hospitals that provide services comparable to those offered by our
hospitals. Many competing general acute care hospitals are larger and more
established than our hospitals. We may experience increased competition from
existing hospitals as well as hospitals converted, in whole or in part, to
specialized care facilities.

The long-term industry is divided into a variety of competitive areas that
market similar services. These competitors include nursing centers, hospitals,
extended care centers, assisted living facilities, home health agencies and
similar institutions. Our facilities generally operate in communities that also
are served by similar facilities operated by our competitors. Certain of our
competitors are operated by not-for-profit, non-taxpaying or governmental
agencies that can finance capital expenditures on a tax-exempt basis and that
receive funds and charitable contributions unavailable to us. Our facilities
compete based on factors such as our reputation for quality care; the
commitment and expertise of our staff and physicians; the quality and
comprehensiveness of our treatment programs; charges for services; and the
physical appearance, location and condition of our facilities. We also compete
with other companies in providing rehabilitation therapy services and
institutional pharmacy services. Many of these competing companies have greater
financial and other resources than we have. We cannot assure you that increased
competition in the future will not adversely affect our financial condition and
results of operations.

424B4 22nd Page of 184 TOC 1st Previous Next ↓Bottom Just 22nd
We have limited operational flexibility since we lease substantially all of our
facilities.

We lease substantially all of our facilities from Ventas and other third
parties. Under our leases, we generally are required to operate continuously
our leased properties as a provider of healthcare services. In addition, these
leases generally limit or restrict our ability to assign the lease to another
party. Our failure to comply with these lease provisions would result in an
event of default under the leases and subject us to material damages. Given
these restrictions, we may be forced to continue operating non-profitable
facilities to avoid defaults under our leases. See "Business--Master Lease
Agreements."

If we fail to comply with our Corporate Integrity Agreement, we could be
subject to severe sanctions.

On August 8, 2000, we entered into a Corporate Integrity Agreement with the
Office of Inspector General of the U.S. Department of Health and Human Services
to promote our compliance with the requirements of Medicare, Medicaid and all
other federal healthcare programs. On April 20, 2001, our Corporate Integrity
Agreement became effective. Under the Corporate Integrity Agreement, we must
implement a comprehensive internal quality improvement program and a system of
internal financial controls in our nursing centers, long-term hospitals and
regional and corporate offices. We are also subject to extensive reporting
requirements under the Corporate Integrity Agreement pursuant to which we must
inform the Office of the Inspector General of the U.S. Department of Health and
Human Services of (1) the findings of our internal audit and review program,
(2) any investigations or legal proceedings brought or conducted by any
governmental entity involving an allegation that we have committed any crime or
engaged in any fraudulent activity, (3) any billing, reporting or other
practices or policies that have resulted in our receipt of any substantial
overpayment under any federal healthcare program and the corresponding
corrective plan that we have implemented, (4) certain "material deficiencies"
as defined in the Corporate Integrity Agreement, and (5) other compliance-
related matters addressed in the Corporate Integrity Agreement. The Corporate
Integrity Agreement will be effective for five years. A breach of the Corporate
Integrity Agreement could subject us to substantial monetary penalties and
exclusion from participation in the Medicare and Medicaid programs. Any such
sanctions could have a material adverse effect on our financial condition and
results of operations. See "Business--Corporate Integrity Agreement."

Financial information related to our post-emergence operations is limited.

Since we emerged from bankruptcy on April 20, 2001, there is limited
operating and financial data available from which to analyze our operating
results and cash flows based on the terms of our Fourth Amended Joint Plan of
Reorganization. As a result of fresh-start accounting, you also will be unable
to compare information reflecting our results of operations and financial
condition after our emergence to prior periods.

Future acquisitions may use significant resources, may be unsuccessful and
could expose us to unforeseen liabilities.

As part of our growth strategy, we intend to selectively pursue acquisitions
of nursing centers, long-term acute care hospitals, pharmacies and other
related healthcare operations. Acquisitions may involve significant cash
expenditures, debt incurrence, additional operating losses, amortization of the
intangible assets of acquired companies, dilutive issuances of equity
securities and expenses that could have a material adverse effect on our
financial condition and results of operations. Acquisitions involve numerous
risks, including:

. difficulties integrating acquired operations, personnel and information
systems,

. diversion of management's time from existing operations,

. potential loss of key employees or customers of acquired companies, and

. assumption of the liabilities and exposure to unforeseen liabilities of
acquired companies, including liabilities for failure to comply with
healthcare regulations.

We cannot assure you that we will succeed in obtaining financing for
acquisitions at a reasonable cost, or that such financing will not contain
restrictive covenants that limit our operating flexibility. We also may be

424B4 23rd Page of 184 TOC 1st Previous Next ↓Bottom Just 23rd
unable to operate acquired facilities profitably or succeed in achieving
improvements in their financial performance.

Competition may limit our ability to acquire nursing centers and hospitals and
adversely affect our growth.

We face competition in acquiring nursing centers and long-term acute care
hospitals. Our competitors may acquire or seek to acquire many of the
facilities that would be suitable acquisition candidates for us. This could
limit our ability to grow by acquisitions or increase the cost of our
acquisitions.

Holders of our common stock may face a lack of liquidity and an absence of an
active market for our common stock.

Our common stock has been trading on the OTC Bulletin Board only since April
26, 2001. As a result, there is currently a very limited trading market for our
common stock. We cannot assure you that any active trading market will develop
or will be sustained for the common stock. Our common stock has been approved
for quotation on The Nasdaq National Market, subject to official notice of
issuance, although we cannot assure you that an active market will develop or
be sustained there.

Even if an active market for our common stock develops, it may be subject to
disruptions that will make it difficult or impossible for the holders of our
common stock to sell shares at a time they would like, and they may be unable
to sell them at all. Moreover, the shares of our common stock are owned of
record by a relatively small number of holders, which may contribute to a lack
of liquidity in the market for our common stock. Additionally, in recent years,
the stock market has experienced a high level of price and volume volatility
and market prices for the stock of many companies have experienced wide price
fluctuations that have not necessarily been related to the operating
performance or prospects of such companies.

The rights of holders of our common stock may be negatively affected by the
issuance of preferred stock.

Our Amended and Restated Certificate of Incorporation authorizes the board
of directors, without the approval of the holders of the common stock, to issue
preferred stock in one or more series which has voting, dividend or liquidation
rights superior to the common stock and which may adversely affect the rights
of holders of the common stock. The issuance of preferred stock could, among
other things, adversely affect the voting power of the holders of common stock
and could have the effect of delaying, deferring or preventing a change in
control of the company.

A significant number of our shares are or will be eligible for future sale,
which may cause the price of our common stock to decline.

Sales of a substantial number of shares of our common stock in the public
market or the exercise of substantial number of options or warrants to purchase
shares of our common stock, or the perception that such sales or exercises
might occur, could cause the market price of our common stock to decline. After
giving effect to the offering, we will have outstanding 17,350,000 shares of
our common stock. Of these shares, all but 400,000 will be freely tradeable
without restriction or further registration under the Securities Act of 1933,
unless the shares are owned by one of our "affiliates," as that term is defined
in Rule 405 under the Securities Act. An additional 1,600,000 shares may be
issued in the future upon exercise of options granted and to be granted under
our stock option plans. These shares have been registered under the Securities
Act and, therefore, will be freely tradable when issued (subject to the volume
limitations and other conditions of Rule 144 under the Securities Act, in the
case of shares to be sold by our affiliates). An aggregate of 7,000,000 shares
of our common stock are reserved for issuance upon exercise of our outstanding
Series A and Series B warrants. All of these warrants, which are currently
exercisable, and the shares of common stock issuable upon exercise of these
warrants are freely tradeable without restriction or further registration under
the Securities Act, unless the warrants or shares are owned by one of our
"affiliates," as that term is defined in Rule 405 under the Securities Act.

Our officers, directors and the selling stockholders have agreed, with
exceptions, not to offer, sell, contract to sell, pledge or otherwise dispose
of, directly or indirectly, any shares of our common stock or securities

424B4 24th Page of 184 TOC 1st Previous Next ↓Bottom Just 24th
convertible into or exchangeable or exercisable for shares of our common stock
for 90 days after the date of this prospectus without the prior written consent
of Credit Suisse First Boston Corporation. As an exception to this agreement
and without such consent, Ventas may (but is not obligated to) distribute up to
350,000 shares of our common stock to Ventas stockholders on or after December
24, 2001, such stockholders may resell such shares and Ventas may publicly
disclose the Ventas entities' intention to effect such distributions without
the prior written consent of Credit Suisse First Boston Corporation. Credit
Suisse First Boston Corporation may, in its sole discretion, release all or any
portion of the securities from the lock-up agreements.

Under the terms of a registration rights agreement with Appaloosa Management
L.P., Franklin Mutual Advisers, LLC, Goldman, Sachs & Co. and Ventas Realty,
Limited Partnership, which collectively hold 9,352,676 shares of our
common stock and Series A and Series B warrants to purchase an aggregate of
5,079,317 shares of our common stock, we are obligated to file a shelf
registration statement with respect to such common stock and warrants. We filed
the shelf registration statement with the SEC on September 19, 2001. The shelf
registration statement became effective on November 7, 2001. In addition, under
the registration rights agreement, these holders have demand and piggy-back
registration rights. However, under the terms of this agreement, these security
holders may not sell shares or warrants pursuant to the shelf registration
statement, and we are not obligated to register any shares or warrants held by
these security holders upon their request, in each case for the period from
seven days prior to, through and including the 90th day after, the date of this
prospectus. After the expiration of this period, these security holders may
sell their shares or warrants pursuant to the shelf registration statement or
demand that we register all or any portion of their shares or warrants at any
time. As an exception to this restriction on sales for purposes of this
offering, Ventas may (but is not obligated to) distribute up to 350,000 shares
of our common stock to Ventas stockholders on or after December 24, 2001, and
such stockholders may resell such shares.

Because certain of our significant stockholders collectively own more than 50%
of our common stock, they will be able to determine the outcome of all matters
submitted to our stockholders for approval, regardless of the preferences of
the minority stockholders.

After completion of the offering, Appaloosa Management L.P. and its
affiliates, Franklin Mutual Advisers, LLC, Goldman, Sachs & Co. and its
affiliates and Stephen Feinberg will together beneficially own approximately
57.8% of our outstanding common stock, or approximately 56.6% if the
underwriters exercise their over-allotment option in full. As long as these
stockholders together have the right to vote a majority of our outstanding
common stock, they will have the ability to control all matters affecting
Kindred if they elect to vote the same way, including:

. the composition of our board of directors and, through it, any
determination with respect to our business direction and policies,
including the appointment and removal of officers,

. any determinations with respect to mergers or other business
combinations,

. our acquisition or disposition of assets,

. our financings, and

. the payment of dividends on our common stock.

Appaloosa Management, Franklin Mutual Advisers, Goldman Sachs and Stephen
Feinberg also, if they elected to vote the same way, would be able to prevent
or cause a change in control of our company and may be able to amend our
certificate of incorporation and by-laws without the approval of any other
stockholder. Their interests may conflict with the interests of our other
stockholders.

424B4 25th Page of 184 TOC 1st Previous Next ↓Bottom Just 25th
FORWARD-LOOKING STATEMENTS

Certain statements made in this prospectus and the documents we incorporate
by reference in this prospectus, including, but not limited to, statements
containing the words such as "anticipate," "believe," "plan," "estimate,"
"expect," "intend," "may" and other similar expressions, are forward-looking
statements within the meaning of the Private Securities Litigation Reform Act
of 1995. Such forward-looking statements are inherently uncertain, and you must
recognize that actual results may differ materially from our expectations as a
result of a variety of factors, including, without limitation, those discussed
below. Such forward-looking statements are based on management's current
expectations and include known and unknown risks, uncertainties and other
factors, many of which we are unable to predict or control, that may cause our
actual results or performance to differ materially from any future results or
performance expressed or implied by such forward-looking statements. These
statements involve risks, uncertainties and other factors discussed under "Risk
Factors" above and detailed from time to time in our filings with the SEC.
Factors that may affect our plans or results include, without limitation:

. our ability to operate pursuant to the terms of our debt obligations and
the Master Lease Agreements as described below under "Business--Master
Lease Agreements,"

. our ability to meet our rental and debt services obligations,

. adverse developments with respect to our liquidity or results of
operations,

. our ability to attract and retain key executives and other healthcare
personnel,

. the effects of healthcare reform and government regulations,
interpretation of regulations and changes in the nature and enforcement
of regulations governing the healthcare industry,

. changes in Medicare and Medicaid reimbursement rates,

. national and regional economic conditions, including their effect on the
availability and cost of labor, materials and other services,

. our ability to control costs, including labor costs, in response to the
prospective payment system, implementation of the Corporate Integrity
Agreement described below in "Business--Corporate Integrity Agreement"
and other regulatory actions,

. our ability to comply with the terms of our Corporate Integrity
Agreement,

. the effect of a restatement of our previously issued consolidated
financial statements, and

. the increase in costs of defending and insuring against alleged patient
care liability claims.

Many of these factors are beyond our control. We caution potential investors
that any forward-looking statements made by us are not guarantees of future
performance. We disclaim any obligation to update any such factors or to
announce publicly the results of any revisions to any of the forward-looking
statements to reflect future events or developments.

424B4 26th Page of 184 TOC 1st Previous Next ↓Bottom Just 26th
USE OF PROCEEDS

We will receive net proceeds of approximately $75.3 million from the sale of
the 1,750,000 shares of common stock we are offering after deducting
underwriting discounts and commissions and estimated offering expenses payable
by us. If the underwriters exercise their over-allotment option in full, we
will receive total net proceeds of approximately $96.6 million. We intend to
use our net proceeds from this offering to reduce our outstanding indebtedness
by redeeming up to $96.6 million of our senior secured notes due 2008. The
senior secured notes bear interest at the London Interbank Offered Rate plus 4
1/2% starting approximately two quarters after April 20, 2001 and were issued
to some of the claim holders in our bankruptcy proceeding as part of our Fourth
Amended Joint Plan of Reorganization.

We will not receive any of the proceeds from the sale of the shares of
common stock by the selling stockholders.

PRICE RANGE OF COMMON STOCK

Our common stock commenced trading on the OTC Bulletin Board on April 26,
2001 under the symbol "KIND." Our common stock was initially issued on April
20, 2001. Between April 20, 2001 and April 26, 2001, there was no public market
for our common stock. The following table sets forth, for the periods
indicated, the high and low bid quotations per share of our common stock, as
reported on the OTC Bulletin Board. The average of the bid and asked prices per
share of our common stock on the OTC Bulletin Board on November 7, 2001 was
$48.75 per share.

[Download Table]

Bid Quotations for
Common Stock
-------------------
2001 High Low
---- --------- ---------

Second Quarter (since April 26, 2001).................... $46.00 $31.00
Third Quarter............................................ $ 65.00 $ 44.00
Fourth Quarter (through November 7, 2001)................ $ 59.50 $ 46.50

The prices noted above represent inter-dealer prices, without retail mark-
up, mark-down or commission, and may not necessarily represent actual
transactions.

As of June 30, 2001, there were 49 holders of record of our common stock.

DIVIDEND POLICY

We have never paid dividends on our common stock and we do not intend to pay
cash dividends for the foreseeable future. It is our present policy to retain
earnings to finance our future operations and growth. In addition, our debt
instruments contain negative covenants that restrict, among other things, the
ability of Kindred Healthcare Operating, Inc., our principal operating
subsidiary, to pay dividends to us. Any determination to pay dividends in the
future will be dependent upon our results of operations, financial condition,
contractual restrictions, restrictions imposed by applicable laws and other
factors deemed relevant by our board of directors.

424B4 27th Page of 184 TOC 1st Previous Next ↓Bottom Just 27th
CAPITALIZATION

The following table sets forth our capitalization as of June 30, 2001 and as
adjusted to give effect to the sale of common stock offered by us.

The table below sets forth the following information:

. our actual capitalization as of June 30, 2001, and

. our capitalization as adjusted to give effect to the sale by us of
1,750,000 shares of common stock in this offering, using the public
offering price of $46.00 per share and the application of the net
proceeds to us as described under "Use of Proceeds."

This table should be read in conjunction with "Selected Consolidated
Financial and Other Data," "Management's Discussion and Analysis of Financial
Condition and Results of Operations," our unaudited pro forma consolidated
financial statements and the accompanying notes, our consolidated financial
statements and the accompanying notes and the other financial information
included in this prospectus.

[Download Table]

As of June 30, 2001
----------------------
As
Actual Adjusted
---------- ----------
(in thousands)

Cash and cash equivalents.............................. $ 102,823 $ 102,823
Cash-restricted available for repayment of long-term
debt.................................................. 40,984 40,984
---------- ----------
$ 143,807 $ 143,807
========== ==========
Liabilities:
Current liabilities.................................. $ 524,964 $ 524,964
Long-term debt....................................... 302,038 226,723
Professional liability risks......................... 113,829 113,829
Deferred credits and other liabilities............... 31,407 31,407
---------- ----------
Total liabilities.................................. 972,238 896,923
---------- ----------
Stockholders' equity:
Preferred stock, $0.25 par value; authorized
1,000,000 shares; none issued
and outstanding..................................... - -
Common stock, $0.25 par value; 39,000,000 shares
authorized; 15,600,000 shares issued, actual;
17,350,000 shares issued, as adjusted............... 3,900 4,338
Capital in excess of par value....................... 460,473 535,350
Deferred compensation................................ (19,722) (19,722)
Retained earnings.................................... 17,885 17,885
---------- ----------
Total stockholders' equity......................... 462,536 537,851
---------- ----------
Total capitalization............................... $1,434,774 $1,434,774
========== ==========

Common stock data assumes that the underwriters' over-allotment option is
not exercised and excludes shares of common stock reserved for issuance under:

. our stock option plans, under which options to purchase 934,200 shares
were outstanding as of June 30, 2001 at a weighted average exercise
price of $32.00 per share,

. our outstanding Series A warrants to purchase 2,000,000 shares at an
exercise price of $30.00 per share, and

. our outstanding Series B warrants to purchase 5,000,000 shares at an
exercise price of $33.33 per share.

424B4 28th Page of 184 TOC 1st Previous Next ↓Bottom Just 28th
SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA
The selected consolidated financial and other data presented below should be
read in conjunction with "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and our consolidated financial statements
and the accompanying notes included or incorporated by reference in this
prospectus. The selected consolidated financial data as of December 31, 1996,
1997 and 1998 and for the years ended December 31, 1996 and 1997 have been
derived from our audited financial statements which are not included in this
prospectus. The selected consolidated financial data as of December 31, 1999
and 2000 and for the years ended December 31, 1998, 1999 and 2000 have been
derived from our audited consolidated financial statements included in this
prospectus. The selected consolidated financial data as of June 30, 2001 for
the three months ended June 30, 2000 and 2001 have been derived from our
unaudited condensed consolidated financial statements included in this
prospectus. The selected consolidated financial data as of June 30, 2000 have
been derived from our unaudited condensed consolidated financial statements not
included in this prospectus.

[Enlarge/Download Table]

Reorganized
Predecessor Company Company
-------------------------------------------------------------------- -----------
Three Three
months months
Year ended December 31, ended ended
---------------------------------------------------------- June 30, June 30,
1996 1997 1998 1999 2000 2000 2001
---------- ---------- ---------- ---------- ---------- -------- -----------
(in thousands, except per share amounts)

Statement of Operations:
Revenues................ $2,577,783 $3,116,004 $2,999,739 $2,665,641 $2,888,542 $713,424 $770,764
---------- ---------- ---------- ---------- ---------- -------- --------
Salaries, wages and
benefits............... 1,490,938 1,788,053 1,753,023 1,566,227 1,623,955 392,383 432,182
Supplies................ 303,463 347,127 340,053 347,789 374,540 94,619 96,043
Rent.................... 77,795 89,474 234,144 305,120 307,809 76,788 64,580
Other operating
expenses............... 489,155 446,340 947,889 964,413 503,770 122,770 127,655
Depreciation and
amortization........... 99,533 123,865 124,617 93,196 73,545 18,168 15,886
Interest expense........ 45,922 102,736 107,008 80,442 60,431 14,663 8,463
Investment income....... (12,203) (6,057) (4,688) (5,188) (5,393) (1,012) (3,438)
---------- ---------- ---------- ---------- ---------- -------- --------
2,494,603 2,891,538 3,502,046 3,351,999 2,938,657 718,379 741,371
---------- ---------- ---------- ---------- ---------- -------- --------
Income (loss) before
reorganization items
and income taxes....... 83,180 224,466 (502,307) (686,358) (50,115) (4,955) 29,393
Reorganization items.... - - - 18,606 12,636 2,530 -
---------- ---------- ---------- ---------- ---------- -------- --------
Income (loss) before
income taxes........... 83,180 224,466 (502,307) (704,964) (62,751) (7,485) 29,393
Provision for income
taxes.................. 35,175 89,338 76,099 500 2,000 500 12,904
---------- ---------- ---------- ---------- ---------- -------- --------
Income (loss) from
operations before
extraordinary items... 48,005 135,128 (578,406) (705,464) (64,751) (7,985) 16,489
Cumulative effect of
change in accounting
for start-up costs..... - - - (8,923) - - -
Extraordinary gain
(loss) on
extinguishment of
debt................... - (4,195) (77,937) - - - 1,396
---------- ---------- ---------- ---------- ---------- -------- --------
Net income (loss)...... $ 48,005 $ 130,933 $ (656,343) $ (714,387) $ (64,751) $ (7,985) $ 17,885
========== ========== ========== ========== ========== ======== ========
Earnings (loss) per
common share:
Basic:
Income (loss) from
operations before
extraordinary items... $ 0.69 $ 1.96 $ (8.47) $ (10.03) $ (0.94) $ (0.12) $ 1.09
Cumulative effect of
change in accounting
for start-up costs.... - - - (0.13) - - -
Extraordinary gain
(loss) on
extinguishment of
debt.................. - (0.06) (1.14) - - - 0.09
---------- ---------- ---------- ---------- ---------- -------- --------
Net income (loss).... $ 0.69 $ 1.90 $ (9.61) $ (10.16) $ (0.94) $ (0.12) $ 1.18
========== ========== ========== ========== ========== ======== ========
Diluted:
Income (loss) from
operations before
extraordinary items... $ 0.68 $ 1.92 $ (8.47) $ (10.03) $ (0.94) $ (0.12) $ 1.00
Cumulative effect of
change in accounting
for start-up costs.... - - - (0.13) - - -
Extraordinary gain
(loss) on
extinguishment of
debt.................. - (0.06) (1.14) - - - 0.08
---------- ---------- ---------- ---------- ---------- -------- --------
Net income (loss).... $ 0.68 $ 1.86 $ (9.61) $ (10.16) $ (0.94) $ (0.12) $ 1.08
========== ========== ========== ========== ========== ======== ========
Shares used in computing
earnings (loss) per
common share:
Basic.................. 69,704 68,938 68,343 70,406 70,229 70,147 15,090
Diluted................ 70,702 70,359 68,343 70,406 70,229 70,147 16,533

424B4 29th Page of 184 TOC 1st Previous Next ↓Bottom Just 29th
[Enlarge/Download Table]

Reorganized
Predecessor Company Company
---------------------------------------------------------------------- -----------
Three Three
months months
Year ended December 31, ended ended
---------------------------------------------------------- June 30, June 30,
1996 1997 1998 1999 2000 2000 2001
---------- ---------- ---------- ---------- ---------- ---------- -----------
(in thousands, except statistics)

Financial Position:
Working capital
(deficit).............. $ 316,615 $ 431,113 $ (682,569) $ 195,011 $ 267,161 $ 263,076 $ 237,345
Assets.................. 1,968,856 3,334,739 1,774,372 1,235,974 1,334,414 1,248,379 1,434,774
Long-term debt.......... 710,507 1,919,624 6,600 - - - 302,536
Long-term debt in
default classified as
current................ - - 760,885 - - - -
Liabilities subject to
compromise............. - - - 1,159,417 1,260,373 1,195,660 -
Stockholders' equity
(deficit).............. 797,091 905,350 307,747 (406,022) (471,734) (433,058) 462,536
Operating Data:
Number of nursing
centers:
Owned or leased........ 297 296 278 282 278 280 280
Managed................ 16 13 13 13 34 41 35
Number of nursing center
licensed beds:
Owned or leased........ 37,444 38,694 36,701 36,912 36,466 36,677 36,746
Managed................ 2,175 1,689 1,661 1,661 3,723 4,436 3,861
Number of nursing center
patient days (a)....... 12,566,763 12,622,238 11,939,266 11,656,439 11,580,295 2,879,490 2,822,752
Nursing center occupancy
% (a).................. 91.9% 90.5% 87.3% 86.8% 86.1% 86.0% 84.8%
Number of hospitals..... 38 60 57 56 56 56 56
Number of hospital
licensed beds.......... 3,325 5,273 4,979 4,931 4,886 4,880 4,867
Number of hospital
patient days........... 586,144 767,810 947,488 982,301 1,044,663 262,242 270,721
Hospital occupancy %.... 53.7% 52.9% 54.0% 56.9% 60.8% 60.9% 64.0%

---------------------
(a) Excludes managed facilities.

424B4 30th Page of 184 TOC 1st Previous Next ↓Bottom Just 30th
UNAUDITED PRO FORMA CONSOLIDATED FINANCIAL STATEMENTS

The unaudited pro forma consolidated statements of operations for the six
months ended June 30, 2001 and 2000 and the year ended December 31, 2000 give
effect to our emergence from bankruptcy in accordance with our Fourth Amended
Joint Plan of Reorganization, the sale of common stock we are offering and the
repayment of outstanding indebtedness from the net proceeds of such sale
assuming these transactions occurred on January 1, 2000. Since our historical
consolidated balance sheet at June 30, 2001 already reflects the terms of our
Fourth Amended Joint Plan of Reorganization, the unaudited pro forma
consolidated balance sheet gives effect to the sale of common stock we are
offering and the repayment of outstanding indebtedness from the net proceeds of
such sale assuming these transactions occurred on June 30, 2001. The unaudited
pro forma consolidated financial statements should be read in conjunction with
our historical consolidated financial statements and accompanying notes
included in this prospectus. The unaudited pro forma consolidated financial
statements may not necessarily reflect the financial position or results of
operations which would have been obtained if these transactions had been
consummated on the dates indicated in the unaudited pro forma consolidated
financial statements. In addition, the pro forma financial statements do no
purport to be indicative of our future operating results.

424B4 31st Page of 184 TOC 1st Previous Next ↓Bottom Just 31st
KINDRED HEALTHCARE, INC.
UNAUDITED PRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS
For the six months ended June 30, 2001
(in thousands, except per share amounts)

[Enlarge/Download Table]

Historical
----------------------------
Predecessor Reorganized Pro Forma
Company Company Adjustments
-------------- ------------- ----------------------
Three months Three months Emergence
ended ended from Equity
March 31, 2001 June 30, 2001 Bankruptcy Offering Pro Forma
-------------- ------------- ---------- -------- ----------

Revenues................ $752,409 $770,764 $ - $ - $1,523,173
-------- -------- -------- ------- ----------
Salaries, wages and
benefits............... 427,649 432,182 1,027 (a) - 860,858
Supplies................ 94,319 96,043 - - 190,362
Rent.................... 76,995 64,580 (12,605)(b) - 128,970
Other operating
expenses............... 126,701 127,655 - - 254,356
Depreciation and
amortization........... 18,645 15,886 (3,775)(c) - 30,756
Interest expense........ 14,000 8,463 (5,280)(d) (3,171)(i) 14,012
Investment income....... (1,919) (3,438) (1,865)(e) - (7,222)
-------- -------- -------- ------- ----------
756,390 741,371 (22,498) (3,171) 1,472,092
-------- -------- -------- ------- ----------
Income (loss) before
reorganization items
and income taxes ...... (3,981) 29,393 22,498 3,171 51,081
Reorganization items.... (53,666) - 1,865 (e) - -
51,801 (f)
-------- -------- -------- ------- ----------
Income (loss) before
income taxes........... 49,685 29,393 (31,168) 3,171 51,081
Provision for income
taxes.................. 500 12,904 7,724 (g) 1,092 (g) 22,220
-------- -------- -------- ------- ----------
Income (loss) from
operations............. $ 49,185 $ 16,489 $(38,892) $ 2,079 $ 28,861
======== ======== ======== ======= ==========
Earnings per common
share:
Basic................. $ 0.69 $ 1.09 $ 1.70
Diluted............... 0.69 1.00 1.57
Shares used in computing
earnings per common
share:
Basic................. 70,261 15,090 110 (h) 1,750 (j) 16,950
Diluted............... 71,656 16,533 110 (h) 1,750 (j) 18,393

See accompanying notes.

424B4 32nd Page of 184 TOC 1st Previous Next ↓Bottom Just 32nd
KINDRED HEALTHCARE, INC.
UNAUDITED PRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS
For the six months ended June 30, 2000
(in thousands, except per share amounts)

[Download Table]

Pro Forma
Adjustments
----------------------
Historical Emergence
Predecessor from Equity
Company Bankruptcy Offering Pro Forma
----------- ---------- -------- ----------

Revenues.................. $1,428,880 $ - $ - $1,428,880
---------- -------- ------- ----------
Salaries, wages and
benefits................. 797,696 3,208 (a) - 800,904
Supplies.................. 188,017 - - 188,017
Rent...................... 153,008 (25,737)(b) - 127,271
Other operating expenses.. 245,359 - - 245,359
Depreciation and
amortization............. 36,070 (4,935)(c) - 31,135
Interest expense.......... 30,902 (11,850)(d) (3,171)(i) 15,881
Investment income......... (2,218) (2,307)(e) - (4,525)
---------- -------- ------- ----------
1,448,834 (41,621) (3,171) 1,404,042
---------- -------- ------- ----------
Income (loss) before
reorganization items and
income taxes............. (19,954) 41,621 3,171 24,838
Reorganization items...... 5,595 2,307 (e) - -
(7,902)(f)
---------- -------- ------- ----------
Income (loss) before
income taxes............. (25,549) 47,216 3,171 24,838
Provision for income
taxes.................... 1,000 10,614 (g) 1,128 (g) 12,742
---------- -------- ------- ----------
Income (loss) from
operations............... $ (26,549) $ 36,602 $ 2,043 $ 12,096
========== ======== ======= ==========
Earnings (loss) per common
share:
Basic................... $ (0.39) $ 0.71
Diluted................. (0.39) 0.66
Shares used in computing
earnings (loss) per
common share:
Basic................... 70,194 (54,994)(h) 1,750 (j) 16,950
Diluted................. 70,194 (53,551)(h) 1,750 (j) 18,393

See accompanying notes.

424B4 33rd Page of 184 TOC 1st Previous Next ↓Bottom Just 33rd
KINDRED HEALTHCARE, INC.
UNAUDITED PRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS
For the year ended December 31, 2000
(in thousands, except per share amounts)

[Download Table]

Pro Forma Adjustments
---------------------------
Historical Emergence
Predecessor from Equity
Company Bankruptcy Offering Pro Forma
----------- ----------- ---------- ----------

Revenues................ $2,888,542 $ - $ - $2,888,542
---------- ----------- ---------- ----------
Salaries, wages and
benefits............... 1,623,955 6,417 (a) - 1,630,372
Supplies................ 374,540 - - 374,540
Rent.................... 307,809 (50,947)(b) - 256,862
Other operating
expenses............... 503,770 - - 503,770
Depreciation and
amortization........... 73,545 (11,755)(c) - 61,790
Interest expense........ 60,431 (22,963)(d) (6,342)(i) 31,126
Investment income....... (5,393) (6,513)(e) - (11,906)
---------- ----------- ---------- ----------
2,938,657 (85,761) (6,342) 2,846,554
---------- ----------- ---------- ----------
Income (loss) before
reorganization items
and income taxes....... (50,115) 85,761 6,342 41,988
Reorganization items.... 12,636 6,513 (e) - -
(19,149)(f)
---------- ----------- ---------- ----------
Income (loss) before
income taxes........... (62,751) 98,397 6,342 41,988
Provision for income
taxes.................. 2,000 17,106 (g) 2,434 (g) 21,540
---------- ----------- ---------- ----------
Income (loss) from
operations............. $ (64,751) $ 81,291 $ 3,908 $ 20,448
========== =========== ========== ==========
Earnings (loss) per
common share:
Basic................. $ (0.94) $ 1.21
Diluted............... (0.94) 1.11
Shares used in computing
earnings (loss) per
common share:
Basic................. 70,229 (55,029)(h) 1,750 (j) 16,950
Diluted............... 70,229 (53,586)(h) 1,750 (j) 18,393

See accompanying notes.

424B4 34th Page of 184 TOC 1st Previous Next ↓Bottom Just 34th
KINDRED HEALTHCARE, INC.
UNAUDITED PRO FORMA CONSOLIDATED BALANCE SHEET
June 30, 2001
(in thousands)

[Download Table]

Pro Forma
Historical Adjustments Pro Forma
---------- ----------- ----------

ASSETS
Current assets:
Cash and cash equivalents............. $ 102,823 $ - $ 102,823
Cash-restricted....................... 55,442 - 55,442
Insurance subsidiary investments...... 98,810 - 98,810
Accounts receivable less allowance for
loss................................. 414,942 - 414,942
Inventories........................... 29,685 - 29,685
Other................................. 60,607 - 60,607
---------- ------- ----------
762,309 - 762,309
Property and equipment.................. 456,126 - 456,126
Accumulated depreciation................ (13,596) - (13,596)
---------- ------- ----------
442,530 - 442,530
Reorganized value in excess of amounts
allocable to identifiable assets....... 155,984 - 155,984
Other................................... 73,951 - 73,951
---------- ------- ----------
$1,434,774 $ - $1,434,774
========== ======= ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable...................... $ 90,896 $ - $ 90,896
Salaries, wages and other
compensation......................... 192,026 - 192,026
Due to third-party payors............. 39,969 - 39,969
Other accrued liabilities............. 170,779 - 170,779
Income taxes.......................... 30,796 - 30,796
Long-term debt due within one year.... 498 - 498
---------- ------- ----------
524,964 - 524,964
Long-term debt.......................... 302,038 (75,315)(k) 226,723
Professional liability risks............ 113,829 - 113,829
Deferred credits and other liabilities.. 31,407 - 31,407
Stockholders' equity:
Common stock.......................... 3,900 438 (k) 4,338
Capital in excess of par value........ 460,473 74,877 (k) 535,350
Deferred compensation................. (19,722) - (19,722)
Retained earnings..................... 17,885 - 17,885
---------- ------- ----------
462,536 75,315 537,851
---------- ------- ----------
$1,434,774 $ - $1,434,774
========== ======= ==========

See accompanying notes.

424B4 35th Page of 184 TOC 1st Previous Next ↓Bottom Just 35th
KINDRED HEALTHCARE, INC.
NOTES TO UNAUDITED PRO FORMA CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1--BASIS OF PRESENTATION

The accompanying unaudited pro forma consolidated financial statements are
based upon our historical consolidated financial statements. As used in this
prospectus, the term "Predecessor Company" refers to the company and its
operations for periods prior to April 1, 2001, while the term "Reorganized
Company" is used to describe the company and its operations for periods
thereafter.

The unaudited pro forma statement of operations for the six months ended
June 30, 2001 has been derived from the separate statements of operations of
the Predecessor Company for the three months ended March 31, 2001 and of the
Reorganized Company for the three months ended June 30, 2001 because the basis
of preparation of these financial statements differs as a result of the fresh-
start accounting adopted on April 1, 2001.

NOTE 2--FRESH-START ACCOUNTING

For purposes of the accompanying unaudited pro forma consolidated financial
statements, the fresh-start adjustments have been recorded assuming that we
emerged from bankruptcy on January 1, 2000. Since the accompanying unaudited
pro forma consolidated statements of operations have been prepared assuming the
revaluation of our property and equipment and intangible assets as of April 1,
2001 occurred on January 1, 2000, pro forma depreciation and amortization
recorded in the accompanying unaudited pro forma consolidated statements of
operations do not necessarily reflect the amounts that would have been reported
had the property and equipment and intangible assets been revalued as of
January 1, 2000.

NOTE 3--PRO FORMA ADJUSTMENTS

Since we recorded the fresh-start adjustments on April 1, 2001, our
historical operating results for the three months ended June 30, 2001 reflect
the terms of our Fourth Amended Joint Plan of Reorganization and, accordingly,
no pro forma adjustments are required for this three month period to reflect
the terms of our Fourth Amended Joint Plan of Reorganization. As a result, the
pro forma adjustments related to our Fourth Amended Joint Plan of
Reorganization detailed in (a) through (g) for the six months ended June 30,
2001 reflect only the amounts necessary to adjust our historical operating
results for the three months ended March 31, 2001.

(a) To reflect the amortization of restricted stock issued in connection with
our Fourth Amended Joint Plan of Reorganization.

(b) To adjust historical rent due to Ventas, calculated as follows (dollars in
thousands):

[Download Table]

Six months ended
June 30, Year ended
------------------- December 31,
2001 2000 2000
-------- --------- ------------

Annual aggregated minimum rent pursuant
to
Master Lease Agreements............... $174,600 $ 174,600 $ 174,600
Interim period factor.................. /4 /2 -
-------- --------- ---------
Adjusted rents due under Master Lease
Agreements............................ 43,650 87,300 174,600
Adjustment to reflect assumed annual
escalator of 3 1/2% effective May 1,
2000.................................. 1,528 1,019 4,074
-------- --------- ---------
Ventas pro forma rent expense.......... 45,178 88,319 178,674
Less historical pre-emergence Ventas
rent expense.......................... (57,783) (114,056) (229,621)
-------- --------- ---------
Pro forma adjustments................ $(12,605) $ (25,737) $ (50,947)
======== ========= =========

424B4 36th Page of 184 TOC 1st Previous Next ↓Bottom Just 36th
KINDRED HEALTHCARE, INC.
NOTES TO UNAUDITED PRO FORMA CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 3--PRO FORMA ADJUSTMENTS (Continued)

(c) To adjust historical depreciation and amortization to reflect the
revaluation of property and equipment, the establishment of reorganized
value in excess of amounts allocable to identifiable assets and the
elimination of historical goodwill, calculated as follows (in thousands):

[Download Table]

Six months
ended June 30, Year ended
---------------- December 31,
2001 2000 2000
------- ------- ------------

Fresh-start accounting:
Depreciation of property and equipment
based on independent appraisals.......... $12,749 $26,671 $ 52,925
Amortization of reorganized value in
excess of amounts allocable to
identifiable assets (using the straight-
line method over 20 years)............... 1,974 3,949 7,898
Other amortization costs.................. 147 515 967
------- ------- --------
Pro forma depreciation and amortization... 14,870 31,135 61,790
------- ------- --------
Historical accounting:
Depreciation of property and equipment.... 15,989 29,670 60,889
Amortization of goodwill.................. 2,509 5,885 11,689
Other amortization costs.................. 147 515 967
------- ------- --------
Historical depreciation and amortization.. 18,645 36,070 73,545
------- ------- --------
Pro forma adjustments................... $(3,775) $(4,935) $(11,755)
======= ======= ========

As discussed in note 1 of the notes to the unaudited condensed consolidated
financial statements for the three months ended June 30, 2001 included in this
prospectus, we will adopt the provisions of Statement of Financial Accounting
Standards No. 142, "Goodwill and Other Intangible Assets," on January 1, 2002.
This new pronouncement will eliminate the amortization of reorganized value in
excess of amounts allocable to identifiable assets. If this new pronouncement
were implemented on January 1, 2000, annual amortization expense would be
reduced by approximately $8 million.

(d) To adjust historical interest expense to reflect our new capital structure,
calculated as follows (in thousands):

[Download Table]

Six months ended
June 30, Year ended
------------------ December 31,
2001 2000 2000
-------- -------- ------------

Interest costs associated with
obligations under our Fourth Amended
Joint Plan of Reorganization:
Senior secured notes (floating rate of
8.42%)............................... $ 6,315 $ 12,630 $ 25,260
CMS obligation (fixed rate of 10.2%).. 1,617 3,937 7,479
Government settlement obligation
(fixed rate of 6%)................... - 465 465
Other................................. 788 2,020 4,264
-------- -------- --------
Pro forma interest expense............ 8,720 19,052 37,468
Historical interest expense............. (14,000) (30,902) (60,431)
-------- -------- --------
Pro forma adjustments............... $ (5,280) $(11,850) $(22,963)
======== ======== ========

Our $300 million senior secured notes bear interest based on floating rates.
For purposes of our pro forma consolidated financial statements, interest costs
related to these notes were calculated using the effective rate at

424B4 37th Page of 184 TOC 1st Previous Next ↓Bottom Just 37th
KINDRED HEALTHCARE, INC.
NOTES TO UNAUDITED PRO FORMA CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 3--PRO FORMA ADJUSTMENTS (Continued)

June 30, 2001. A variance of 1/8% in market interest rates would change our
annual income from operations by approximately $150,000.

(e) To reclassify investment income previously presented as a reduction in
reorganization items.

(f) To eliminate historical reorganization items.

(g) To record the pro forma provision for income taxes based upon the pro forma
annual estimated pretax income resulting from the effects of our Fourth
Amended Joint Plan of Reorganization and the repayment of indebtedness from
the net proceeds of the sale of common stock we are offering. Estimated
income taxes for each respective period were based on a combined state and
federal tax rate of 39% adjusted for certain nondeductible items, including
the amortization of reorganized value in excess of amounts allocable to
identifiable assets.

(h) To adjust the number of historical shares used in computing earnings per
common share as if the date of emergence from bankruptcy were January 1,
2000.

(i) To record the pro forma reduction in interest expense related to the
repayment of our senior secured notes from the net proceeds of the sale of
the common stock we are offering detailed in adjustment (k), calculated as
follows (dollars in thousands):

[Download Table]

Six months ended June 30, Year ended
-------------------------- December 31,
2001 2000 2000
------------ ------------ ------------

Outstanding principal amount of
senior secured notes after
repayment from the net proceeds
of the common stock we are
offering ($300,000 less
$75,315)....................... $ 224,685 $ 224,685 $224,685
Effective interest rate......... 8.42% 8.42% 8.42%
------------ ------------ --------
18,918 18,918 18,918
Interim period factor........... /2 /2 -
------------ ------------ --------
9,459 9,459 18,918
------------ ------------ --------
Outstanding principal amount of
senior secured notes before the
sale of common stock we are
offering....................... 300,000 300,000 300,000
Effective interest rate......... 8.42% 8.42% 8.42%
------------ ------------ --------
25,260 25,260 25,260
Interim period factor........... /2 /2 -
------------ ------------ --------
12,630 12,630 25,260
------------ ------------ --------
Pro forma adjustments......... $ (3,171) $ (3,171) $ (6,342)
============ ============ ========

In connection with the above repayment of our senior secured notes, we
expect to record an after-tax extraordinary gain of approximately $2 million.
We have not reflected this gain in the unaudited pro forma consolidated
financial statements.

(j) To adjust the number of shares used in computing pro forma earnings per
common share for the number of shares issued by us in the offering.

424B4 38th Page of 184 TOC 1st Previous Next ↓Bottom Just 38th
KINDRED HEALTHCARE, INC.
NOTES TO UNAUDITED PRO FORMA CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 3--PRO FORMA ADJUSTMENTS (Continued)

(k) To record the issuance of common stock by us in the offering, calculated
as follows (in thousands, except the per share amount):

[Download Table]

Number of common shares issued by us in the offering............ 1,750
Public offering price per common share.......................... $ 46.00
-------
Gross proceeds.................................................. 80,500
Less estimated costs and expenses............................... (5,185)
-------
Pro forma net proceeds........................................ $75,315
=======
Allocation of the net proceeds to us from the offering:
Pro forma net proceeds.......................................... $75,315
Pro forma adjustment to common stock par value (1,750,000 shares
at $0.25 per share)............................................ (438)
-------
Pro forma adjustment to capital in excess of par value........ $74,877
=======

NOTE 4--PRO FORMA EARNINGS PER COMMON SHARE

A summary of the shares used in computing pro forma earnings per common
share follows (in thousands):

[Download Table]

Shares issued on the effective date of our Fourth Amended Joint
Plan of Reorganization........................................... 15,600
Shares issued by us in the offering............................... 1,750
Less non-vested restricted stock.................................. (400)
------
Pro forma basic shares.......................................... 16,950
Dilutive effect of our Series A warrants, Series B warrants,
employee stock options and non-vested restricted stock using
market share price data from April 20, 2001 through June 30,
2001............................................................. 1,443
------
Pro forma diluted shares........................................ 18,393
======

424B4 39th Page of 184 TOC 1st Previous Next ↓Bottom Just 39th
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

You should read the following discussion together with our consolidated
financial statements and the accompanying notes, which are included elsewhere
in this prospectus. In addition to the other information in this prospectus,
you should carefully consider the following discussion and the information set
forth in "Risk Factors" and "Forward-Looking Statements" in evaluating us and
our business before purchasing our common stock in this offering.

Overview

We provide long-term healthcare services primarily through the operation of
nursing centers and hospitals. At June 30, 2001, our health services division
operated 315 nursing centers with 40,607 licensed beds in 32 states and a
rehabilitation therapy business. Our hospital division operated 56 hospitals
with 4,867 licensed beds in 23 states and an institutional pharmacy business.

On May 1, 1998, Ventas completed the spin-off of its healthcare operations
to its stockholders through the distribution of our common stock to its
stockholders. Ventas retained ownership of substantially all of its real
property and leases such real property to us under the Master Lease Agreements.
In anticipation of the spin-off, we were incorporated on March 27, 1998. For
accounting purposes, the consolidated historical financial statements of Ventas
became our historical financial statements following the spin-off. Any
discussion concerning events prior to May 1, 1998 refers to our business as it
was conducted by Ventas prior to the spin-off.

From September 13, 1999 until April 20, 2001, we operated as a debtor-in-
possession under the jurisdiction of the United States Bankruptcy Court for the
District of Delaware. On April 20, 2001, our Fourth Amended Joint Plan of
Reorganization became effective and we emerged from bankruptcy with our current
capital structure and amended Master Lease Agreements with Ventas. In
connection with our emergence from bankruptcy, we also changed our name to
Kindred Healthcare, Inc.

Regulatory Changes

The Balanced Budget Act contained extensive changes to the Medicare and
Medicaid programs intended to reduce the projected amount of increase in
payments under those programs over a five year period. Virtually all spending
reductions were derived from reimbursements to providers and changes in program
components. The Balanced Budget Act has affected adversely the revenues in each
of our operating divisions.

The Balanced Budget Act established a Medicare prospective payment system,
known as "PPS," for nursing centers for cost reporting periods beginning on or
after July 1, 1998. All of our nursing centers adopted PPS on July 1, 1998.
During the first three years, the per diem rates for nursing centers were based
on a blend of facility-specific costs and federal rates. Thereafter, the per
diem rates are based solely on federal rates. The payments received under PPS
cover all services for Medicare patients including all ancillary services, such
as respiratory therapy, physical therapy, occupational therapy, speech therapy
and certain covered pharmaceuticals.

The Balanced Budget Act also reduced payments made to the hospitals operated
by our hospital division by reducing TEFRA incentive payments, allowable costs
for capital expenditures and bad debts, and payments for services to patients
transferred from a general acute care hospital. The reductions in allowable
costs for capital expenditures became effective October 1, 1997. The reductions
in the TEFRA incentive payments and

424B4 40th Page of 184 TOC 1st Previous Next ↓Bottom Just 40th
allowable costs for bad debts became effective between May 1, 1998 and
September 1, 1998. The reductions in payments for services to patients
transferred from a general acute care hospital became effective October 1,
1998. These reductions have had a material adverse impact on hospital revenues.
In addition, these reductions also may affect adversely the hospital division's
ability to develop or acquire additional free-standing, long-term acute care
hospitals in the future.

Under PPS, the volume of ancillary services provided per patient day to
nursing center patients also has declined dramatically. Medicare reimbursements
to nursing centers under PPS include substantially all services provided to
patients, including ancillary services. Prior to the implementation of PPS, the
costs of such services were reimbursed under cost-based reimbursement rules.
The decline in the demand for ancillary services since the implementation of
PPS is mostly attributable to efforts by nursing centers to reduce operating
costs. As a result, many nursing centers have elected to provide ancillary
services to their patients through internal staff. In response to PPS and a
significant decline in the demand for ancillary services, we realigned our
former ancillary services division in 1999 by integrating the physical
rehabilitation, speech and occupational therapy businesses into the health
services division and assigning the institutional pharmacy business to the
hospital division. Our respiratory therapy and other ancillary businesses were
discontinued.

Since November 1999, various legislative and regulatory actions have
provided a measure of relief from the impact of the Balanced Budget Act. In
November 1999, the Balanced Budget Refinement Act, commonly referred to as the
"BBRA," was enacted. Effective April 1, 2000, the BBRA (a) implemented a 20%
upward adjustment in the payment rates for the care of higher acuity patients,
effective until the enactment of a revised Resource Utilization Grouping
payment system and (b) allowed nursing centers to transition more rapidly to
the federal payment rates. The BBRA also imposed a two-year moratorium on
certain therapy limitations for skilled nursing center patients covered under
Medicare Part B. Effective October 1, 2000, the BBRA increased all PPS payment
categories by 4% through September 30, 2002.

In April 2000, the Centers for Medicare and Medicaid Services (formerly the
Health Care Financing Administration), commonly referred to as "CMS," published
a proposed rule which sets forth updates to the Resource Utilization Grouping
payment rates used under PPS for nursing centers. On July 31, 2000, CMS issued
a final rule that indefinitely postponed any refinements to the Resource
Utilization Grouping categories used under PPS. As such, the 20% upward
adjustment for certain higher acuity Resource Utilization Grouping categories
set forth in the BBRA was automatically extended until the Resource Utilization
Grouping refinements are enacted. On July 31, 2001, CMS issued another final
rule which did not establish such refinements, and accordingly, the 20%
adjustment will remain in place until the Resource Utilization Grouping
categories are refined.

In December 2000, the Medicare, Medicaid, and State Child Health Insurance
Program Benefits Improvement and Protection Act of 2000, commonly referred to
as "BIPA," was enacted to provide up to $35 billion in additional funding to
the Medicare and Medicaid programs over the next five years. Under BIPA, the
nursing component for each Resource Utilization Grouping category increased by
16.66% over the existing rates for skilled nursing care for the period April 1,
2001 through September 30, 2002. BIPA also provided some relief from scheduled
reductions to the annual inflation adjustments to the Resource Utilization
Grouping payment rates through September 2001.

In addition, BIPA slightly increased payments for inpatient services and
TEFRA incentive payments for long-term acute care hospitals. Allowable costs
for bad debts also will be increased by 15%. Both of these provisions are
effective for cost reporting periods beginning on or after September 1, 2001.

Despite the recent legislation and regulatory actions discussed above,
Medicare revenues recorded under PPS in our health services division are less
than the cost-based reimbursement we received before the enactment of the
Balanced Budget Act. In addition, the recent legislation did not impact
materially the reductions in Medicare revenues received by our hospitals as a
result of the Balanced Budget Act.

424B4 41st Page of 184 TOC 1st Previous Next ↓Bottom Just 41st
There continue to be legislative and regulatory proposals that would impose
more limitations on government and private payments to providers of healthcare
services. Congress has directed the Secretary of the U.S. Department of Health
and Human Services to develop a prospective payment system applicable
specifically to long-term acute care hospitals by October 1, 2001. The new
prospective payment system would be effective for cost report periods beginning
on or after October 1, 2002. This payment system would not impact us until
September 1, 2003. To date, the Secretary has not proposed such a prospective
payment system. Congress has further directed that if the Secretary is unable
to implement a prospective payment system specific to long-term acute care
hospitals by October 1, 2002, the Secretary shall instead implement, as of such
date, a prospective payment system for long-term acute care hospitals based
upon existing hospital diagnosis-related groups modified where feasible to
account for resource use of long-term acute care hospital patients. We cannot
predict the content or timing of such regulations. We cannot assure you that
such regulations will not have a material adverse impact on our financial
condition and results of operations.

By repealing the Boren Amendment, the Balanced Budget Act eased existing
impediments on the ability of states to reduce their Medicaid reimbursement
levels. Many states are considering or have enacted measures that are designed
to reduce their Medicaid expenditures and to make certain changes to private
healthcare insurance. Some states also are considering regulatory changes that
include a moratorium on the designation of additional long-term care hospitals.
Additionally, regulatory changes in the Medicaid reimbursement system
applicable to the hospital division also are being considered. There also are
legislative proposals including cost caps and the establishment of Medicaid
prospective payment systems for nursing centers.

We could be affected adversely by the continuing efforts of governmental and
private third-party payors to contain healthcare costs. We cannot assure you
that payments under governmental and private third-party payor programs will
remain at levels comparable to present levels or will be sufficient to cover
the costs allocable to patients eligible for reimbursement pursuant to such
programs. In addition, we cannot assure you that the facilities we operate, or
the provision of services and supplies by us, will meet the requirements for
participation in such programs.

We cannot assure you that future healthcare legislation or other changes in
the administration or interpretation of governmental healthcare programs will
not have a material adverse effect on our results of operations, liquidity and
financial position.

Other Information

Effects of Inflation and Changing Prices. We derive a substantial portion of
our revenues from the Medicare and Medicaid programs. In recent years,
significant cost containment measures enacted by Congress and certain state
legislators have limited our ability to recover our cost increases through
increased pricing of our healthcare services. Medicare revenues in our nursing
centers are subject to fixed payments under PPS. Medicaid reimbursement rates
in many states in which we operate nursing centers also are based on fixed
payment systems. Generally, these rates are adjusted annually for inflation but
may not reflect the actual increase in the costs of providing services. In
addition, by repealing the Boren Amendment, the Balanced Budget Act eased
existing impediments on the states' ability to reduce their Medicaid
reimbursement levels to our nursing centers. Medicare revenues in our hospitals
also have been reduced by the Balanced Budget Act.

During 2000, the BBRA provided a measure of relief to the Medicare
reimbursement reductions imposed by the Balanced Budget Act. Under BIPA, the
nursing component of each Resource Utilization Grouping category was increased
by 16.66% over the previous rates for skilled nursing care beginning on April
1, 2001. The provisions of both the BBRA and BIPA increased Medicare
reimbursement to our nursing centers during the second quarter of 2001. We
believe that the provisions of the BBRA and BIPA will have a positive effect on
our operating results in 2001, particularly in the health services division.

We believe, however, that our operating margins may continue to be under
pressure because of continuing regulatory scrutiny and growth in operating
expenses, particularly labor costs, in excess of increases in payments by
third-party payors. In addition, as a result of competitive pressures, our
ability to maintain operating margins through price increases to private
patients is limited.

424B4 42nd Page of 184 TOC 1st Previous Next ↓Bottom Just 42nd
Restatement of Previously Issued Financial Statements. As discussed in note
2 of the notes to the condensed consolidated financial statements for the three
months ended June 30, 2001 included in this prospectus, we restated certain of
our previously issued consolidated financial statements as a result of an
oversight related to the allowance for professional liability risks. We do not
believe that the restatement of prior year results will have a material effect
on our operating results for fiscal 2001.

Litigation. We are a party to certain material litigation. See "Business--
Legal Proceedings."

Management's Discussion and Analysis of Financial Condition and Results of
Operations for the Three Months Ended June 30, 2001 and 2000

Basis of Presentation

Since filing for protection under Chapter 11 of Title 11 of the United
States Bankruptcy Code on September 13, 1999, we had operated our businesses as
a debtor-in-possession subject to the jurisdiction of the United States
Bankruptcy Court for the District of Delaware. Accordingly, our consolidated
financial statements were prepared in accordance with the American Institute of
Certified Public Accountants Statement of Position 90-7, "Financial Reporting
by Entities in Reorganization under the Bankruptcy Code ("SOP 90-7") and
generally accepted accounting principles applicable to a going concern, which
assume that assets will be realized and liabilities will be discharged in the
normal course of business.

In connection with our emergence from bankruptcy, we reflected the terms of
our Fourth Amended Joint Plan of Reorganization in our consolidated financial
statements by adopting the fresh-start accounting provisions of SOP 90-7. Under
fresh-start accounting, a new reporting entity is deemed to be created and the
recorded amounts of assets and liabilities are adjusted to reflect their
estimated fair values. For accounting purposes, the fresh-start adjustments
were recorded in our consolidated financial statements as of April 1, 2001.
Since fresh-start accounting materially changed the amounts previously recorded
in our consolidated financial statements, a black line separates the post-
emergence financial data from the pre-emergence financial data to signify the
difference in the basis of preparation of the financial statements for each
respective entity. See note 4 of the notes to the unaudited condensed
consolidated financial statements for the three months ended June 30, 2001
included in this prospectus.

The adoption of fresh-start accounting as of April 1, 2001 materially
changed the amounts previously recorded in our consolidated financial
statements. With respect to reported operating results, we believe that our
business segment operating income prior to April 1, 2001 is generally
comparable to our business segment operating income after April 1, 2001.
However, our capital costs (rent, interest, depreciation and amortization)
prior to April 1, 2001 that were based on pre-petition contractual agreements
and historical costs are not comparable to those capital costs after April 1,
2001. In addition, our reported financial position and cash flows for periods
prior to April 1, 2001 generally are not comparable to those for periods
thereafter.

In connection with the implementation of fresh-start accounting, we recorded
an extraordinary gain of $422.8 million from the restructuring of our debt in
accordance with the provisions of our Fourth Amended Joint Plan of
Reorganization. Other significant adjustments also were recorded to reflect the
provisions of our Fourth Amended Joint Plan of Reorganization and the fair
values of our assets and liabilities as of April 1, 2001. For accounting
purposes, these transactions have been reflected in our operating results for
the three months ended March 31, 2001.

Results of Operations--Second Quarter 2001 compared to Second Quarter 2000

Health Services Division--Nursing Centers

Revenues increased 7% to $444 million in the second quarter of 2001 from
$413 million in the same quarter of 2000. On a same-store basis, average daily
patient census declined 1% from the second quarter of 2000 (including a 7%
decline in private patient census). The increase in revenues was attributable
to increased

424B4 43rd Page of 184 TOC 1st Previous Next ↓Bottom Just 43rd
Medicare and Medicaid funding and price increases to private payors. Medicare
revenues per patient day grew 14% to $344 in the second quarter of 2001
compared to $301 in the second quarter a year ago. The increase was primarily
attributable to reimbursement increases associated with the BBRA and BIPA. As
previously discussed, the BBRA established, among other things, a 4% increase
in all PPS payments beginning on October 1, 2000. Under the provisions of BIPA,
the nursing component of each Resource Utilization Grouping category was
increased 16.66% over the existing rates for skilled nursing care beginning on
April 1, 2001. As a result, the provisions of the BBRA and BIPA increased
Medicare reimbursement to our nursing centers in the second quarter of 2001 by
approximately $3.5 million and $9.5 million, respectively, compared to the same
period a year ago.

Nursing center operating income was $79 million for the second quarter of
2001 compared to $75 million for the second quarter last year. Despite an
increase in revenues, operating margins declined to 17.7% in the second quarter
of 2001 from 18.2% last year, principally due to growth in costs for
professional liability risks, employee health benefits and doubtful accounts.
Costs related to professional liability risks totaled $14 million in the second
quarter of 2001 compared to $9 million in the second quarter of 2000, while
employee health benefits were $12 million and $9 million for the respective
periods. The provision for doubtful accounts rose to $6 million in the second
quarter of 2001 from $3 million for the same period last year. Operating
margins also were adversely impacted by the decline in private census.

Health Services Division--Rehabilitation Services

Revenues declined 72% to $9 million in the second quarter of 2001 from $33
million a year ago. The decline in revenues was primarily attributable to the
transfer, beginning on January 1, 2001, of all remaining services provided to
company-operated nursing centers to the internal staff of those nursing
centers. Revenues for these services approximated $19 million in the second
quarter of 2000. Revenues also declined as a result of the elimination of
unprofitable external contracts.

Operating income totaled $2 million in the second quarter of 2001 compared
to a loss of $1 million in the second quarter last year. The improvement
resulted from the elimination of unprofitable external contracts and reduced
provisions for doubtful accounts based upon collections of past due accounts.
Effective January 1, 2000, revenues for rehabilitation services provided to
company-operated nursing centers approximate the costs of providing such
services. Accordingly, operating results for the second quarter of both 2001
and 2000 do not reflect any operating income related to company-operated
nursing centers. While the health services division will continue to provide
rehabilitation services to nursing center customers, revenues related to these
services may continue to decline.

Health Services Division--Other Ancillary Services

Other ancillary services refers to certain ancillary businesses (primarily
respiratory therapy) that were discontinued as part of the realignment of our
former ancillary services division in 1999.

Hospital Division--Hospitals

Revenues increased 10% to $276 million in the second quarter of 2001 from
$250 million in the same period a year ago. Patient days increased 3% from a
year ago. The increase in revenues was primarily attributable to growth in
volumes and a 7% growth in aggregate revenues per patient day, most of which
was attributable to increased Medicare and Medicaid funding. Revenues from
private payors declined 3% in the second quarter of 2001 despite growth in
patient volumes.

Hospital operating income grew 8% to $56 million in the second quarter of
2001 from $52 million in the second quarter of 2000. Despite increases in
patient volumes and revenues, hospital operating margins declined to 20.2% in
the second quarter of 2001 from 20.6% for the same period last year primarily
as a result of growth in labor and benefit costs. On a per patient day basis,
labor and benefits costs increased 13% to $508 in

424B4 44th Page of 184 TOC 1st Previous Next ↓Bottom Just 44th
2001 from $449 in the second quarter of 2000. The recent rise in labor costs is
primarily attributable to increased rates of pay necessary to attract and
retain qualified nurses and other healthcare professionals. We believe that
hospital operating margins may decline in the future as a result of these wage
pressures.

Hospital Division--Pharmacy

Revenues increased 13% to $57 million in the second quarter of 2001 compared
to $50 million a year ago. The increase resulted primarily from price
increases.

Our pharmacies reported an operating profit of $6 million in the second
quarter of 2001 compared to $1 million in the same period of the prior year.
The cost of goods sold as a percentage of revenues declined to 58% in the
second quarter of 2001 from 60% in 2000. The improvement in operating income in
the second quarter of 2001 was primarily attributable to growth in revenues,
improved inventory and cost controls and a decline in the provision for
doubtful accounts resulting from improved cash collections.

Corporate Overhead

Operating income for our operating divisions excludes allocation of
corporate overhead. These costs aggregated $27 million in the second quarter of
2001 compared to $28 million last year. As a percentage of revenues (before
eliminations), the overhead ratio was 3.5% in the second quarter of 2001
compared to 3.8% in the same period of 2000.

Capital Costs

As previously discussed, the adjustments recorded in connection with fresh-
start accounting materially changed the recorded amounts for rent, interest,
depreciation and amortization in our unaudited consolidated statement of
operations for the three months ended June 30, 2001. As a result, our capital
costs after April 1, 2001 are not comparable to our capital costs prior to
April 1, 2001.

Capital costs for the second quarter of 2001 reflect the terms of our Fourth
Amended Joint Plan of Reorganization and include the effects of reduced rent
obligations under the Master Lease Agreements and interest costs incurred in
connection with our $300 million senior secured notes, the government
settlement obligation and the agreement with CMS to pay the remaining balance
of the obligations owed to CMS (approximately $59 million as of April 20, 2001)
pursuant to the terms previously agreed to by us. Depreciation and amortization
for the second quarter of 2001 were recorded based on asset carrying amounts
that were adjusted in fresh-start accounting to reflect fair value on April 1,
2001.

During the pendency of our Chapter 11 cases, we recorded the contractual
amount of interest expense related to our former $1.0 billion bank credit
facility and the rents due to Ventas under the pre-petition master lease
agreements. No interest costs were recorded related to our former $300 million
9 7/8% Guaranteed Senior Subordinated Notes due 2005 since the filing of our
Chapter 11 cases. Contractual interest expense not accrued for our $300 million
9 7/8% Guaranteed Senior Subordinated Notes in each of the three months ended
June 30, 2000 and March 31, 2001 approximated $7 million. For the six months
ended June 30, 2000, the amount of interest not accrued for our $300 million 9
7/8% Guaranteed Senior Subordinated Notes aggregated $15 million.

Income Taxes

The provision for income taxes is based upon our estimate of taxable income
or loss for the respective periods and includes the effect of certain non-
taxable and non-deductible items, such as reorganization intangible
amortization, and the increase or decrease in the deferred tax valuation
allowance.

We have reduced our net deferred tax assets by a valuation allowance to the
extent we do not believe it is "more likely than not" that the asset ultimately
will be realizable. If all or a portion of the pre-reorganization deferred tax
asset is realized in the future, or considered to "more likely than not" be
realizable by us, the

424B4 45th Page of 184 TOC 1st Previous Next ↓Bottom Just 45th
reorganization intangible recorded in connection with fresh-start accounting
will be reduced accordingly. If the reorganization intangible is eliminated in
full, other intangibles will then be reduced, with any excess treated as an
increase to capital in excess of par value.

The provision for income taxes for the three months ended June 30, 2000 and
March 31, 2001 and the six months ended June 30, 2000 included charges of $2.5
million, $685,000 and $8.4 million, respectively, related to the deferred tax
valuation allowance. No changes in the valuation allowance were recorded in the
second quarter of 2001. As a result of fresh-start accounting, the deferred tax
valuation allowance included in our unaudited condensed consolidated balance
sheet aggregated $284 million at June 30, 2001.

In connection with the reorganization, we realized a gain from the
extinguishment of certain indebtedness. This gain will not be taxable since the
gain resulted from our reorganization under the Bankruptcy Code. However, we
will be required, as of the beginning of our 2002 taxable year, to reduce
certain tax attributes relating to us including (a) net operating losses, (b)
certain tax credits and (c) tax bases in assets in an amount equal to such gain
on extinguishment. Our reorganization on April 20, 2001 constituted an
ownership change under Section 382 of the Internal Revenue Code and the use of
any of our net operating losses and tax credits generated prior to the
ownership change, that are not reduced pursuant to the provisions discussed
above, will be subject to an overall annual limitation of approximately $22
million.

We had net operating losses of approximately $164 million (after reductions
in the attributes discussed above) and $215 million as of June 30, 2001 and
December 31, 2000, respectively. These carryforwards expire in various amounts
through 2021.

Consolidated Results

We reported pretax income of $29 million for the second quarter of 2001,
resulting from improved operating income and the significant impact of our
Fourth Amended Joint Plan of Reorganization. For the same period of 2000, we
reported a pretax operating loss of $7 million. Our operating loss in the
second quarter of 2000 includes a gain of approximately $5 million on the sale
of a closed hospital and reorganization items, consisting principally of
professional fees incurred in connection with our restructuring activities,
aggregated $3 million.

Income from operations before extraordinary items in the second quarter of
2001 aggregated $16 million compared to a loss of $8 million in the second
quarter of 2000.

Liquidity

Cash flows from operations before reorganization items for the three months
ended June 30, 2001 aggregated $65 million, approximately the same as reported
in the second quarter of 2000. Cash flows in both periods were sufficient to
fund capital expenditures and required repayments of debt.

Working capital totaled $237 million (including $55 million of "cash-
restricted") at June 30, 2001. We believe that existing cash levels and the
availability of borrowings under our $120 million revolving credit facility are
sufficient to meet our current liquidity needs.

In May 2001, we prepaid approximately $56 million in full satisfaction of
our obligation owed to CMS. The transaction was financed through the use of
existing cash.

In connection with the emergence from bankruptcy, we entered into a $120
million revolving credit facility on April 20, 2001. Our revolving credit
facility constitutes a working capital facility for general corporate purposes
including payments related to our obligations under our Fourth Amended Joint
Plan of Reorganization. The revolving credit facility consists of a five-year
$120 million revolving credit facility and provides for a $40 million letter of
credit subfacility. Direct borrowings under our revolving credit facility will
bear interest, at our option, at (a) prime (or, if higher, the federal funds
rate plus 1/2%) plus 3% or (b) the

424B4 46th Page of 184 TOC 1st Previous Next ↓Bottom Just 46th
London Interbank Offered Rate (as defined in the agreement) plus 4%. The
revolving credit facility is collateralized by substantially all of our assets,
including certain owned real property. At June 30, 2001, there were no
outstanding borrowings under our revolving credit facility.

Cash and cash equivalents totaled $103 million at June 30, 2001. Based upon
our cash position, expected cash flows and capital spending, and the
availability of borrowings under our $120 million revolving credit facility, we
believe we have the necessary financial resources to satisfy our expected
liquidity needs on both a short-term and long-term basis.

As part of our Fourth Amended Joint Plan of Reorganization, we also issued
$300 million of senior secured notes on April 20, 2001. Our $300 million senior
secured notes have a maturity of seven years and bear interest at the London
Interbank Offered Rate (as defined in the agreement) plus 4 1/2%. The interest
on our $300 million senior secured notes will begin to accrue approximately two
quarters following April 20, 2001. For accounting purposes, we recorded the
appropriate interest costs in the second quarter of 2001 and intend to amortize
the amount accrued during the interest-free period over the remaining life of
the debt. Our $300 million senior secured notes are collateralized by a second
priority lien on substantially all of our assets, including certain owned real
property.

At June 30, 2001, we were in compliance with the terms of our revolving
credit facility and our $300 million senior secured notes.

As previously reported, we were informed by the Department of Justice that
we and Ventas were the subjects of ongoing investigations into various Medicare
reimbursement issues, including hospital cost reporting issues, ancillary
services billing practices and various quality of care issues in the hospitals
and nursing centers formerly operated by Ventas and currently operated by us.
The claims of the Department of Justice were settled through the government
settlement contained in our Fourth Amended Joint Plan of Reorganization. The
government settlement also provides for the dismissal of certain pending claims
and lawsuits filed against us. See notes 3 and 11 of the notes to the condensed
consolidated financial statements for the three months ended June 30, 2001
included in this prospectus and "Business--Legal Proceedings."

In January 2000, we filed our hospital cost reports for the year ended
August 31, 1999. These documents are filed annually in settlement of amounts
due to or from the various agencies administering the reimbursement programs.
These cost reports indicated amounts due to Medicare aggregating $58 million.
This liability arose during 1999 as part of our routine settlement of Medicare
reimbursement overpayments. Such amounts were classified as liabilities subject
to compromise in our unaudited condensed consolidated balance sheet and,
accordingly, no funds were disbursed by us in settlement of such pre-petition
liabilities. Under the terms of our Fourth Amended Joint Plan of
Reorganization, this obligation was discharged.

Capital Resources

Capital expenditures totaled $26 million and $14 million for the three
months ended June 30, 2001 and 2000, respectively. Excluding acquisitions,
capital expenditures could approximate $75 million in 2001. We believe that our
capital expenditure program is adequate to improve and equip existing
facilities. Capital expenditures in both periods were financed through
internally generated funds. At June 30, 2001, the estimated cost to complete
and equip construction in progress approximated $7 million.

In May 2001, we sold our investment in Behavioral Healthcare Corporation for
$40 million. Under the terms of our revolving credit facility and $300 million
senior secured notes, proceeds from the sale of assets will be available to
fund future capital expenditures for a period of approximately one year from
the sale. Any proceeds not expended during that period would be used to
permanently reduce the commitments under our revolving credit facility to as
low as $75 million and repay any outstanding loans in excess of such
commitment. Any remaining proceeds would be used to repay loans under our $300
million senior secured notes. For accounting purposes, we have classified these
funds as "cash-restricted" in our unaudited condensed consolidated balance
sheet at June 30, 2001.

The terms of our $300 million senior secured notes and our revolving credit
facility include certain covenants which limit our annual capital expenditures
and limit the amount of debt we may incur in financing acquisitions.

424B4 47th Page of 184 TOC 1st Previous Next ↓Bottom Just 47th
Unaudited Condensed Consolidated Quarterly Statement of Operations
(in thousands, except per share amounts)

[Enlarge/Download Table]

Predecessor Company
------------------------------------------------ Reorganized
(Restated) Company
-------------------------------------- -----------
2000 Quarters First Second
-------------------------------------- Quarter Quarter
First Second Third Fourth 2001 2001
-------- -------- -------- -------- -------- -----------

Revenues................ $715,456 $713,424 $717,253 $742,409 $752,409 $770,764
-------- -------- -------- -------- -------- --------
Salaries, wages and
benefits............... 405,313 392,383 405,510 420,749 427,649 432,182
Supplies................ 93,398 94,619 92,251 94,272 94,319 96,043
Rent.................... 76,220 76,788 77,870 76,931 76,995 64,580
Other operating
expenses............... 122,589 122,770 135,345 123,066 126,701 127,655
Depreciation and
amortization........... 17,902 18,168 17,464 20,011 18,645 15,886
Interest expense........ 16,239 14,663 14,415 15,114 14,000 8,463
Investment income....... (1,206) (1,012) (1,490) (1,685) (1,919) (3,438)
-------- -------- -------- -------- -------- --------
730,455 718,379 741,365 748,458 756,390 741,371
-------- -------- -------- -------- -------- --------
Income (loss) before
reorganization items
and income taxes....... (14,999) (4,955) (24,112) (6,049) (3,981) 29,393
Reorganization items.... 3,065 2,530 4,745 2,296 (53,666) -
-------- -------- -------- -------- -------- --------
Income (loss) before
income taxes........... (18,064) (7,485) (28,857) (8,345) 49,685 29,393
Provision for income
taxes.................. 500 500 500 500 500 12,904
-------- -------- -------- -------- -------- --------
Income (loss) from
operations before
extraordinary items.. (18,564) (7,985) (29,357) (8,845) 49,185 16,489
Extraordinary gain on
extinguishment of
debt................... - - - - 422,791 1,396
-------- -------- -------- -------- -------- --------
Net income (loss)..... (18,564) (7,985) (29,357) (8,845) 471,976 17,885
Preferred stock dividend
requirements........... (261) (262) (261) (262) (261) -
-------- -------- -------- -------- -------- --------
Income (loss)
available to common
stockholders......... $(18,825) $ (8,247) $(29,618) $ (9,107) $471,715 $ 17,885
======== ======== ======== ======== ======== ========
Earnings (loss) per
common share:
Basic:
Income (loss) from
operations before
extraordinary
items............... $ (0.27) $ (0.12) $ (0.42) $ (0.13) $ 0.69 $ 1.09
Extraordinary gain on
extinguishment of
debt................ - - - - 6.02 0.09
-------- -------- -------- -------- -------- --------
Net income (loss).. $ (0.27) $ (0.12) $ (0.42) $ (0.13) $ 6.71 $ 1.18
======== ======== ======== ======== ======== ========
Diluted:
Income (loss) from
operations before
extraordinary
items............... $ (0.27) $ (0.12) $ (0.42) $ (0.13) $ 0.69 $ 1.00
Extraordinary gain on
extinguishment of
debt................ - - - - 5.90 0.08
-------- -------- -------- -------- -------- --------
Net income (loss).. $ (0.27) $ (0.12) $ (0.42) $ (0.13) $ 6.59 $ 1.08
======== ======== ======== ======== ======== ========
Shares used in computing
earnings (loss) per
common share:
Basic................. 70,240 70,147 70,265 70,262 70,261 15,090
Diluted............... 70,240 70,147 70,265 70,262 71,656 16,533

424B4 48th Page of 184 TOC 1st Previous Next ↓Bottom Just 48th
Unaudited Quarterly Operating Data
(in thousands)

[Enlarge/Download Table]

Reorganized
Predecessor Company Company
------------------------------------------------ -----------
(Restated)
--------------------------------------
2000 Quarters First Second
-------------------------------------- Quarter Quarter
First Second Third Fourth 2001 2001
-------- -------- -------- -------- -------- -----------

Revenues:
Health services division:
Nursing centers.............................................. $412,703 $413,159 $420,588 $429,177 $429,523 $444,137
Rehabilitation services...................................... 34,377 33,173 34,032 33,454 10,695 9,244
Other ancillary services..................................... (5) (2) (1) 8 - -
Elimination.................................................. (18,091) (18,509) (19,671) (20,920) - -
-------- -------- -------- -------- -------- --------
428,984 427,821 434,948 441,719 440,218 453,381
Hospital division:
Hospitals.................................................... 253,591 250,027 244,391 259,938 271,984 276,112
Pharmacy..................................................... 47,468 49,949 51,593 55,242 54,880 56,567
-------- -------- -------- -------- -------- --------
301,059 299,976 295,984 315,180 326,864 332,679
-------- -------- -------- -------- -------- --------
730,043 727,797 730,932 756,899 767,082 786,060
Elimination of pharmacy charges to our nursing centers........ (14,587) (14,373) (13,679) (14,490) (14,673) (15,296)
-------- -------- -------- -------- -------- --------
$715,456 $713,424 $717,253 $742,409 $752,409 $770,764
======== ======== ======== ======== ======== ========
Income (loss) from operations before extraordinary items:
Operating income (loss):
Health services division:
Nursing centers............................................. $ 68,712 $ 75,348 $ 69,493 $ 65,185 $ 70,543 $ 78,735
Rehabilitation services..................................... 486 (1,059) 2,837 5,783 690 1,809
Other ancillary services.................................... 130 242 2,687 1,678 250 103
-------- -------- -------- -------- -------- --------
69,328 74,531 75,017 72,646 71,483 80,647
Hospital division:
Hospitals................................................... 55,398 51,547 47,284 51,629 54,778 55,685
Pharmacy.................................................... (1,200) 789 1,075 6,757 6,176 6,036
-------- -------- -------- -------- -------- --------
54,198 52,336 48,359 58,386 60,954 61,721
-------- -------- -------- -------- -------- --------
Corporate overhead........................................... (29,370) (27,750) (29,993) (26,710) (28,697) (27,484)
Unusual transactions......................................... - 4,535 (9,236) - - -
Reorganization items......................................... (3,065) (2,530) (4,745) (2,296) 53,666 -
-------- -------- -------- -------- -------- --------
Operating income............................................ 91,091 101,122 79,402 102,026 157,406 114,884
Rent.......................................................... (76,220) (76,788) (77,870) (76,931) (76,995) (64,580)
Depreciation and amortization................................. (17,902) (18,168) (17,464) (20,011) (18,645) (15,886)
Interest, net................................................. (15,033) (13,651) (12,925) (13,429) (12,081) (5,025)
-------- -------- -------- -------- -------- --------
Income (loss) before income taxes............................. (18,064) (7,485) (28,857) (8,345) 49,685 29,393
Provision for income taxes.................................... 500 500 500 500 500 12,904
-------- -------- -------- -------- -------- --------
-------------------------------------------------- $(18,564) $ (7,985) $(29,357) $ (8,845) $ 49,185 $ 16,489
======== ======== ======== ======== ======== ========

424B4 49th Page of 184 TOC 1st Previous Next ↓Bottom Just 49th
Unaudited Quarterly Operating Data (Continued)
(in thousands)

[Enlarge/Download Table]

Reorganized
Predecessor Company Company
----------------------------------------- -----------
(Restated)
--------------------------------
2000 Quarters First Second
-------------------------------- Quarter Quarter
First Second Third Fourth 2001 2001
------- ------- ------- ------- ------- -----------

Rent:
Health services division:
Nursing centers....................................................... $43,589 $43,888 $45,037 $44,288 $44,253 $40,190
Rehabilitation services............................................... 69 130 80 150 39 27
Other ancillary services.............................................. 20 17 33 44 - 3
------- ------- ------- ------- ------- -------
43,678 44,035 45,150 44,482 44,292 40,220
Hospital division:
Hospitals............................................................. 30,695 31,199 31,089 30,783 30,839 22,917
Pharmacy.............................................................. 900 853 921 940 941 968
------- ------- ------- ------- ------- -------
31,595 32,052 32,010 31,723 31,780 23,885
------- ------- ------- ------- ------- -------
Corporate.............................................................. 947 701 710 726 923 475
------- ------- ------- ------- ------- -------
$76,220 $76,788 $77,870 $76,931 $76,995 $64,580
======= ======= ======= ======= ======= =======
Depreciation and amortization:
Health services division:
Nursing centers....................................................... $ 6,670 $ 6,720 $ 6,741 $ 7,765 $ 7,219 $ 5,055
Rehabilitation services............................................... 3 1 2 (2) - 11
Other ancillary services.............................................. 285 263 (69) 134 129 -
------- ------- ------- ------- ------- -------
6,958 6,984 6,674 7,897 7,348 5,066
Hospital division:
Hospitals............................................................. 5,307 5,271 5,020 5,572 5,457 5,690
Pharmacy.............................................................. 526 491 547 534 627 447
------- ------- ------- ------- ------- -------
5,833 5,762 5,567 6,106 6,084 6,137
------- ------- ------- ------- ------- -------
Corporate.............................................................. 5,111 5,422 5,223 6,008 5,213 4,683
------- ------- ------- ------- ------- -------
$17,902 $18,168 $17,464 $20,011 $18,645 $15,886
======= ======= ======= ======= ======= =======
Capital expenditures:
Health services division............................................... $ 2,908 $ 3,794 $ 5,611 $16,138 $ 7,962 $ 4,529
Hospital division...................................................... 3,536 2,944 3,162 14,033 8,901 8,644
Corporate:
Information systems................................................... 1,346 6,767 11,333 6,029 3,496 3,135
Other................................................................. 460 568 16 1,343 1,679 9,331
------- ------- ------- ------- ------- -------
$ 8,250 $14,073 $20,122 $37,543 $22,038 $25,639
--------------------------------------------------
======= ======= ======= ======= ======= =======

424B4 50th Page of 184 TOC 1st Previous Next ↓Bottom Just 50th
Unaudited Quarterly Operating Data (Continued)

[Enlarge/Download Table]

Reorganized
Predecessor Company Company
------------------------------------------------------ -----------
2000 Quarters First Second
------------------------------------------- Quarter Quarter
First Second Third Fourth 2001 2001
---------- ---------- ---------- ---------- ---------- -----------

Nursing Center Data:
End of period data:
Number of nursing
centers:
Owned or leased....... 280 280 278 278 278 280
Managed............... 40 41 39 34 35 35
---------- ---------- ---------- ---------- ---------- ----------
320 321 317 312 313 315
========== ========== ========== ========== ========== ==========
Number of licensed
beds:
Owned or leased....... 36,653 36,677 36,465 36,466 36,469 36,746
Managed............... 4,262 4,436 4,070 3,723 3,861 3,861
---------- ---------- ---------- ---------- ---------- ----------
40,915 41,113 40,535 40,189 40,330 40,607
========== ========== ========== ========== ========== ==========
Revenue mix %:
Medicare............... 28 28 27 28 31 32
Medicaid............... 48 48 50 49 47 47
Private and other...... 24 24 23 23 22 21
Patient days (excludes
managed facilities):
Medicare............... 398,329 382,933 381,890 378,782 411,783 417,065
Medicaid............... 1,918,732 1,917,429 1,960,359 1,939,047 1,860,256 1,871,895
Private and other...... 590,619 579,128 570,679 562,368 532,943 533,792
---------- ---------- ---------- ---------- ---------- ----------
2,907,680 2,879,490 2,912,928 2,880,197 2,804,982 2,822,752
========== ========== ========== ========== ========== ==========
Revenues per patient
day:
Medicare............... $ 292 $ 301 $ 301 $ 321 $ 325 $ 344
Medicaid............... 103 104 107 109 109 110
Private and other...... 167 171 169 171 175 176
Weighted average....... 142 143 144 149 153 157

Hospital Data:
End of period data:
Number of hospitals.... 56 56 56 56 56 56
Number of licensed
beds.................. 4,931 4,880 4,886 4,886 4,867 4,867
Revenue mix %:
Medicare............... 58 53 56 53 56 56
Medicaid............... 10 9 12 11 11 11
Private and other...... 32 38 32 36 33 33
Patient days:
Medicare............... 188,063 177,083 167,946 171,060 185,731 182,906
Medicaid............... 31,964 33,416 34,052 35,322 34,872 34,799
Private and other...... 51,747 51,743 50,567 51,700 52,426 53,016
---------- ---------- ---------- ---------- ---------- ----------
271,774 262,242 252,565 258,082 273,029 270,721
========== ========== ========== ========== ========== ==========
Revenues per patient
day:
Medicare............... $ 782 $ 754 $ 814 $ 808 $ 820 $ 839
Medicaid............... 767 632 847 839 871 872
Private and other...... 1,584 1,845 1,557 1,782 1,703 1,742
Weighted average....... 933 953 968 1,007 996 1,020

424B4 51st Page of 184 TOC 1st Previous Next ↓Bottom Just 51st
Management's Discussion and Analysis of Financial Condition and Results of
Operations For the Years Ended December 31, 2000, 1999 and 1998

Basis of Presentation

Our consolidated financial statements for the years ended December 31, 2000,
1999 and 1998 were prepared on the basis of accounting principles applicable to
going concerns and contemplate the realization of assets and the settlement of
liabilities and commitments in the normal course of business. These
consolidated financial statements do not include any adjustments resulting from
the resolution of our Chapter 11 cases or other matters discussed herein. Since
these consolidated financial statements relate to periods prior to our
emergence from bankruptcy, they do not reflect the adoption of fresh-start
accounting.

Results of Operations--For the Years Ended December 31, 2000, 1999 and 1998

Health Services Division--Nursing Centers

Revenues increased 5% in 2000 to $1.68 billion. Substantially all of the
increase was attributable to increased Medicare and Medicaid funding and price
increases to private payors. Medicaid and private payor rates both increased
approximately 5% in 2000 compared to 1999. Medicare revenues per patient day
grew 5% to $303 in 2000 from $290 in 1999 primarily as a result of
reimbursement increases associated with the BBRA. As previously discussed, the
BBRA established, among other things, a 20% increase in Medicare payment rates
for higher acuity patients effective April 1, 2000 and a 4% increase in all PPS
payment categories effective October 1, 2000. As result of the phase-in of the
provisions of the BBRA, Medicare revenues per patient day in the fourth quarter
of 2000 averaged $321 or 10% higher than the same period in 1999.

Revenues declined 4% in 1999 to $1.59 billion. Medicaid rates increased
approximately 5% in 1999 compared to 1998, while private payor rates were
relatively unchanged. All of our nursing centers adopted PPS on July 1, 1998,
resulting in substantially less Medicare reimbursement to our nursing centers.
Average Medicare revenues per patient day in 1999 declined 11% from $326 in
1998. Lower average Medicare reimbursement rates in 1999 resulted primarily
from the full-year effect of PPS.

Same-store patient days were relatively unchanged during the last three
years. We believe that our Chapter 11 cases had little, if any, impact on
nursing center patient days.

Nursing center operating income in 2000 totaled $279 million compared to
$169 million in 1999. A substantial portion of the improvement resulted from
operating efficiencies related to the fourth quarter 1999 realignment of our
former ancillary services division and growth in revenues. In addition, the
provision for doubtful accounts declined in 2000 to $23 million from $51
million last year as a result of improved collection processes.

Nursing center operating income in 1999 declined 21% from $213 million in
1998. The decline was primarily attributable to reductions in Medicare
reimbursement under PPS. While we achieved some operating efficiencies in 1999
in response to PPS, expenses related to professional liability risks and
doubtful accounts increased substantially. Professional liability costs
aggregated $45 million in 1999 compared to $18 million in 1998, while costs for
doubtful accounts increased to $51 million in 1999 from $17 million in 1998.

Nursing center professional liability costs have risen due to substantial
increases in claims and litigation activity, particularly in the State of
Florida. Growth in the provision for doubtful accounts was primarily
attributable to changes in collection patterns. We are unable to predict with
certainty whether these costs will increase or decrease in the future.

Health Services Division--Rehabilitation Services

Revenues declined 31% in 2000 to $135 million and 26% in 1999 to $196
million. Revenue declines in both periods were primarily attributable to
reduced customer demand for ancillary services in response to fixed

424B4 52nd Page of 184 TOC 1st Previous Next ↓Bottom Just 52nd
reimbursement rates under PPS and the elimination of unprofitable external
contracts. Approximately one-half of the revenue decline in 2000 was
attributable to company-operated nursing centers. Under PPS, the reimbursement
for ancillary services provided to nursing center patients is a component of
the total reimbursement allowed per nursing center patient. As a result, many
nursing center customers (including our nursing centers) have elected to
provide ancillary services to their patients through internal staff and no
longer contract with outside parties for ancillary services.

Rehabilitation services reported operating income of $8 million in 2000
compared to $3 million in 1999 and $18 million in 1998. Operating results for
both 2000 and 1999 were adversely impacted by the decline in revenues. A
significant portion of operating income in 2000 resulted from favorable
adjustments for doubtful accounts based on collections from past due customers.
In addition, effective January 1, 2000, revenues for rehabilitation services
provided to company-operated nursing centers approximated the costs of
providing such services. Accordingly, fiscal 2000 operating results do not
reflect any operating income related to intercompany transactions. Operating
results in 1999 also were negatively impacted as a result of a $26 million
increase in the provision for doubtful accounts. Operating results in 1998
include a $12 million charge related to third-party reimbursements. While the
health services division will continue to provide rehabilitation services to
nursing center customers, revenues and operating income related to these
services may continue to decline in 2001.

Health Services Division--Other Ancillary Services

Other ancillary services refers to certain ancillary businesses (primarily
respiratory therapy) that were discontinued as part of the realignment of our
former ancillary services division in the fourth quarter of 1999. Operating
results for 2000 reflected a $4 million favorable adjustment for doubtful
accounts resulting from collections from discontinued customer accounts. See
note 4 of the notes to the consolidated financial statements for the year ended
December 31, 2000 included in this prospectus for a description of the 1999
realignment of our ancillary services division.

Hospital Division--Hospitals

Revenues increased 19% in 2000 to $1.0 billion and declined 8% in 1999 to
$851 million. Revenues for both 2000 and 1999 were adversely impacted by
certain third-party reimbursement issues.

Prior to September 1999, Medicare revenues recorded by our hospitals
included reimbursement for expenses related to certain costs associated with
hospital-based ancillary services provided by the former ancillary services
division to our nursing center customers. As part of its investigation, the
Department of Justice objected to including such costs on the Medicare cost
reports filed by our hospitals. Medicare revenues related to the reimbursement
of such costs aggregated $18 million in 1999 and $47 million in 1998. In
connection with the negotiation of the government settlement, we agreed to
discontinue recording such revenues beginning on September 1, 1999.

We provide care to patients covered by Medicare supplement insurance
policies which generally become effective when a patient's Medicare benefits
are exhausted. Disputes related to the level of payments to our hospitals have
arisen with private insurance companies issuing these policies as a result of
different interpretations of policy provisions and federal and state laws
governing the policies. While we continue to pursue favorable resolutions of
these claims, provisions for loss aggregating $20 million and $19 million were
recorded in 2000 and 1999, respectively.

Revenues in 1999 were also reduced by adjustments for changes in estimates
for certain third-party reimbursements aggregating $60 million.

Excluding the effect of the previously discussed third-party reimbursement
issues, revenues grew 13% to $1.03 billion in 2000 and 4% to $912 million in
1999 compared to $873 million in 1998. The increase was primarily attributable
to patient day growth of 6% in 2000 and 4% in 1999. In addition, price
increases to private payors also contributed to revenue growth in 2000. Price
increases in 1999 were not significant.

424B4 53rd Page of 184 TOC 1st Previous Next ↓Bottom Just 53rd
Hospital operating income in 2000 totaled $206 million compared to $132
million in 1999 and $247 million in 1998. Excluding the previously discussed
third-party reimbursement issues, operating income totaled $226 million in
2000, $192 million in 1999 and $201 million in 1998. Growth in adjusted
operating income in 2000 was primarily attributable to revenue growth. Adjusted
operating income declined in 1999 compared to 1998 as a result of growth in
labor costs.

Hospital Division--Pharmacy

Revenues increased 19% in 2000 to $204 million and 14% in 1999 to $171
million. The increase in both periods resulted primarily from growth in the
number of nursing center customers and, in 1999, from price increases to
company-operated nursing centers.

Our pharmacies reported operating income of $7 million in 2000 compared to
$342,000 in 1999 and $15 million in 1998. Operating income in 1999 was reduced
by a $11 million increase in the provision for doubtful accounts compared to
the prior year. Operating results in 1998 include the effect of approximately
$8 million of charges recorded in the fourth quarter related to accounts
receivable. We believe that operating income in both 2000 and 1999 was
adversely impacted by pricing pressures associated with PPS for external
customers.

Corporate Overhead

Operating income for our operating divisions excludes allocations of
corporate overhead. These costs aggregated $114 million, $109 million and $126
million during each of the last three years, respectively. As a percentage of
revenues (before eliminations), corporate overhead totaled 3.9% in 2000, 4.0%
in 1999 and 4.1% in 1998.

Unusual Transactions

Operating results for each of the last three years include certain unusual
transactions. These transactions are included in other operating expenses in
the consolidated statement of operations (unless otherwise indicated) for the
respective periods in which they were recorded. See note 6 of the notes to the
consolidated financial statements for the year ended December 31, 2000 included
in this prospectus.

2000

Operating results for 2000 include a $9.2 million write-off of an impaired
investment recorded in the third quarter and a $4.5 million gain on the sale of
a closed hospital recorded in the second quarter.

1999

The following table summarizes the pretax impact of unusual transactions
recorded during 1999 (in millions):

[Download Table]

Quarters
-------------------------
First Second Third Fourth Year
----- ------ ----- ------ ------

(Income)/expense
Asset valuation losses:
Long-lived asset impairment............... $330.4 $330.4
Investment in Behavioral Healthcare
Corporation.............................. $15.2 15.2
Cancellation of software development
project.................................... 5.6 5.6
Realignment of ancillary services division.. 56.3 56.3
Retirement plan curtailment................. 7.3 7.3
Corporate properties........................ (2.4) (2.4)
--- ----- --- ------ ------
$ - $20.8 $ - $391.6 $412.4
=== ===== === ====== ======

424B4 54th Page of 184 TOC 1st Previous Next ↓Bottom Just 54th
Long-lived asset impairment--Statement of Financial Accounting Standards
("SFAS") No. 121 "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed of," ("SFAS 121"), requires impairment losses
to be recognized for long-lived assets used in operations when indications of
impairment are present and the estimate of undiscounted future cash flows is
not sufficient to recover asset carrying amounts. SFAS 121 also requires that
long-lived assets held for disposal be carried at the lower of carrying value
or fair value less costs of disposal, once management has committed to a plan
of disposal.

Operating results and related cash flows for 1999 did not meet our
expectations. These expectations were the basis upon which we valued our long-
lived assets at December 31, 1998, in accordance with SFAS 121. In addition,
certain events occurred in 1999 which had a negative impact on our operating
results and are expected to impact negatively our operations in the future. In
connection with the negotiation of the government settlement, we agreed to
exclude certain expenses from our hospital Medicare cost reports beginning
September 1, 1999 for which we had been reimbursed in prior years. Medicare
revenues related to the reimbursement of such costs aggregated $18 million in
1999 and $47 million in 1998. In addition, hospital revenues in 1999 were
reduced by approximately $19 million as a result of disputes with certain
insurers who issued Medicare supplement insurance policies to individuals who
became patients of our hospitals. We also reviewed the expected impact of the
BBRA enacted in November 1999 (which provided a measure of relief for some of
the impact of the Balanced Budget Act) and the realignment of our former
ancillary services division completed in the fourth quarter of 1999. The actual
and expected future impact of these issues served as an indication to us that
the carrying values of our long-lived assets may be impaired.

In accordance with SFAS 121, we estimated the future undiscounted cash flows
for each of our facilities and compared these estimates to the carrying values
of the underlying assets. As a result of these estimates, we reduced the
carrying amounts of the assets associated with 71 nursing centers and 21
hospitals to their respective estimated fair values. The determination of the
fair values of the impaired facilities was based upon the net present value of
estimated future cash flows.

A summary of the impairment charges follows (in millions):

[Download Table]

Property and
Goodwill Equipment Total
-------- ------------ ------

Health services division.......................... $ 18.3 $ 37.7 $ 56.0
Hospital division................................. 198.9 75.5 274.4
------ ------ ------
$217.2 $113.2 $330.4
====== ====== ======

Investment in Behavioral Healthcare Corporation--In connection with our
merger with Transitional Hospitals Corporation, we acquired a 44% voting equity
interest (61% equity interest) in Behavioral Healthcare Corporation, an
operator of psychiatric and behavioral clinics. In the second quarter of 1999,
we wrote off our remaining investment in Behavioral Healthcare Corporation
aggregating $15.2 million as a result of deteriorating financial performance.
See the discussion of unusual transactions recorded in 1998 for further
information related to our investment in Behavioral Healthcare Corporation.

Cancellation of software development project--In the second quarter of 1999,
we canceled a nursing center software development project and charged
previously capitalized costs to operations.

Realignment of ancillary services division--As discussed in note 4 of the
notes to the consolidated financial statements for the year ended December 31,
2000 included in this prospectus, we realigned our former ancillary services
division in the fourth quarter of 1999. As a result, we recorded a charge
aggregating $56.3 million, including the write-off of goodwill totaling $42.3
million. The remainder of the charge related to the write-down of certain
equipment to net realizable value and the recording of employee severance
costs.

Retirement plan curtailment--In December 1999, the Board of Directors
approved the curtailment of benefits under our supplemental executive
retirement plan, resulting in an actuarially determined charge of

424B4 55th Page of 184 TOC 1st Previous Next ↓Bottom Just 55th
$7.3 million. Under the terms of the curtailment, plan benefits were vested for
each eligible participant through December 31, 1999 and the accrual of future
benefits under the plan was substantially eliminated. The Board of Directors
also deferred the time at which certain benefits would be paid by us.

Corporate properties--During 1999, we adjusted estimated property loss
provisions recorded in the fourth quarter of 1998, resulting in a pretax credit
of $2.4 million.

1998

The following table summarizes the pretax impact of unusual transactions
recorded during 1998 (in millions):

[Download Table]

Quarters
---------------------------
First Second Third Fourth Year
----- ------ ------ ------ -------

(Income)/expense
Asset valuation losses:
Long-lived asset impairment........... $307.8 $ 307.8
Investment in Behavioral Healthcare
Corporation.......................... $ 8.5 43.1 51.6
Wisconsin nursing center.............. 27.5 27.5
Corporate properties.................. $ 8.8 2.9 15.1 26.8
Acquired entities..................... 13.5 13.5
Gain on sale of investments............. (98.5) (13.0) (111.5)
Losses from termination of construction
projects............................... 71.3 71.3
Spin-off transaction costs.............. $7.7 9.6 17.3
Write-off of clinical information
systems................................ 10.1 10.1
Doubtful accounts related to sold
operations............................. 9.6 9.6
Settlement of litigation................ 7.8 7.8
Loss on sale and closure of home health
and hospice businesses................. 7.3 7.3
---- ----- ------ ------ -------
$7.7 $25.7 $ (6.2) $411.9 $ 439.1
==== ===== ====== ====== =======

Long-lived asset impairment--As previously discussed, all of our nursing
centers became subject to PPS effective July 1, 1998. During 1998, revenues
recorded under PPS in our health services division were substantially less than
the cost-based reimbursement we received before the enactment of the Balanced
Budget Act.

The Balanced Budget Act also reduced payments to our hospitals by reducing
incentive payments pursuant to TEFRA, allowable costs for capital expenditures
and bad debts, and payments for services to patients transferred from a general
acute care hospital. These reductions, most of which became effective in 1998,
had a material adverse impact on our hospital revenues.

We provide ancillary services to both company-operated and non-affiliated
nursing centers. While most of the nursing center industry became subject to
PPS on or after January 1, 1999, we believe that our ability to maintain
services and revenues was impacted adversely during 1998, particularly in the
third and fourth quarters, since nursing centers were reluctant to enter into
ancillary service contracts while transitioning to the new fixed payment system
under PPS. Medicare reimbursements to nursing centers under PPS include
substantially all services provided to patients, including ancillary services.
We believe that the decline in demand for our ancillary services in 1998,
particularly respiratory therapy and rehabilitation therapy, was mostly
attributable to efforts by nursing center customers to reduce operating costs.
In addition, as a result of these regulatory changes, many nursing centers
began providing ancillary services to their patients through internal staff and
no longer contracted with outside parties for ancillary services.

In January 1998, CMS issued rules changing Medicare reimbursement guidelines
for therapy services provided by us. Under these rules, CMS established salary
equivalency limits for speech and occupational

424B4 56th Page of 184 TOC 1st Previous Next ↓Bottom Just 56th
therapy services and revised limits for physical and respiratory therapy
services. The new limits became effective for services provided on or after
April 10, 1998 and negatively impacted operating results of our ancillary
services businesses in 1998.

These significant regulatory changes and the impact of such changes on our
operating results in the third and fourth quarters of 1998 served as an
indication to us that the carrying values of the assets of our nursing center
and hospital facilities, as well as certain portions of our ancillary services
business, may be impaired.

In accordance with SFAS 121, we estimated the future undiscounted cash flows
for each of our facilities and ancillary services lines of business and
compared these estimates to the carrying values of the underlying assets. As a
result of these estimates, we reduced the carrying amounts of the assets
associated with 110 nursing centers, 12 hospitals and a portion of the goodwill
associated with our rehabilitation therapy business to their respective
estimated fair values. The determination of the fair values of the impaired
facilities and rehabilitation therapy business was based upon the net present
value of estimated future cash flows.

A summary of the impairment charges follows (in millions):

[Download Table]

Property and
Goodwill Equipment Total
-------- ------------ ------

Health services division:
Nursing centers.................................. $ 27.7 $ 71.6 $ 99.3
Ancillary services............................... 99.2 0.2 99.4
Hospital division.................................. 74.4 34.7 109.1
------ ------ ------
$201.3 $106.5 $307.8
====== ====== ======

In addition to the above impairment charges, the amortization period for the
remaining goodwill associated with our rehabilitation therapy business was
reduced from forty years to seven years, effective October 1, 1998. We believed
that the provisions of the Balanced Budget Act altered the expected long-term
cash flows and business prospects associated with this business to such an
extent that a shorter amortization period was deemed appropriate. The change in
the amortization period resulted in an additional pretax charge to operations
of $6.4 million in the fourth quarter of 1998. In the fourth quarter of 1999,
in connection with the realignment of our former ancillary services division,
we wrote off all of the goodwill associated with the rehabilitation therapy
business. See note 6 of the notes to the consolidated financial statements for
the year ended December 31, 2000 included in this prospectus.

Investment in Behavioral Healthcare Corporation--Subsequent to our merger
with Transitional Hospitals Corporation, we had been unsuccessful in our
attempts to sell our investment in Behavioral Healthcare Corporation. In July
1998, we entered into an agreement to sell our interest in Behavioral
Healthcare Corporation for an amount less than its carrying value and
accordingly, a provision for loss of $8.5 million was recorded during the third
quarter. In November 1998, the agreement to sell our interest in Behavioral
Healthcare Corporation was terminated by the prospective buyer, indicating to
us that the carrying amount of our investment may be impaired. Following an
independent appraisal, we recorded a $43.1 million write-down of the investment
in the fourth quarter of 1998. The net carrying amount of the investment
aggregated $20.0 million at December 31, 1998.

Wisconsin nursing center--We recorded an asset impairment charge of $27.5
million in the fourth quarter of 1998 related to a nursing center in Wisconsin
that is leased from Ventas. The impairment resulted primarily from certain
fourth quarter regulatory actions by state and federal agencies with respect to
the operation of the facility. In the fourth quarter of 1998, the facility
reported a pretax loss of $4.2 million and is not expected to generate positive
cash flows in the future.

Corporate properties and acquired entities--During 1998, we recorded $26.8
million of charges related to the valuation of certain corporate assets, the
most significant of which relates to previously capitalized amounts

424B4 57th Page of 184 TOC 1st Previous Next ↓Bottom Just 57th
and expected property disposal losses associated with the cancellation of a
corporate headquarters construction project. We also recorded $13.5 million of
asset write-downs associated with our merger with The Hillhaven Corporation,
TheraTx, Incorporated and Transitional Hospitals Corporation, including
provisions for obsolete or abandoned computer equipment and miscellaneous
receivables.

Gain on sale of investments--In September 1998, we sold our investment in
our assisted living affiliate, Atria Communities, Inc., for $177.5 million in
cash and an equity interest in the surviving corporation, resulting in a gain
of $98.5 million. In November 1998, our investment in Colorado MEDtech, Inc.
was sold at a gain of $13.0 million. Proceeds from the sale were $22.0 million.

Losses from termination of construction projects--In the third quarter of
1998, as a result of substantial reductions in Medicare reimbursement to our
nursing centers and hospitals in connection with the Balanced Budget Act, we
determined to suspend all acquisition and development activities, terminate the
construction of substantially all of our development properties, and close two
recently acquired hospitals. Accordingly, we recorded pretax charges
aggregating $71.3 million, of which $53.9 million related to the cancellation
of construction projects and the remainder related to the planned closure of
the hospitals. In connection with the construction termination charge, we
decided that we would not replace certain facilities that previously were
accounted for as assets intended for disposal. Accordingly, the $53.9 million
charge discussed above included a $10.0 million reversal of a previously
recorded valuation allowance (the amount necessary to reduce the carrying value
to fair value less costs of disposal) related to such facilities.

Spin-off transaction costs--The spin-off was completed on May 1, 1998.
Direct costs related to the transaction totaled $17.3 million and primarily
included costs for professional services.

Write-off of clinical information systems--During 1997, we began the
installation of our proprietary clinical information system, ProTouch(TM), in
several of our nursing centers. During the pilot process, we determined that
ProTouch(TM) did not support effectively the nursing center processes,
especially in facilities with lower acuity patients. Accordingly, we determined
in the fourth quarter of 1998 to remove ProTouch(TM) from these facilities
during 1999. A loss of $10.1 million was recorded to reflect the write-off of
the equipment and estimated costs of removal from the facilities.

Doubtful accounts related to sold operations--In the third quarter of 1998,
we recorded $9.6 million of additional provisions for doubtful accounts for
accounts receivable associated with previously sold facilities.

Settlement of litigation--We settled a legal action entitled Highland Pines
Nursing Center, Inc., et al. v. TheraTx, Incorporated, et al. (assumed in
connection with our merger with TheraTx, Incorporated) which resulted in a
payment of $16.2 million. Approximately $7.8 million of the settlement was
charged to earnings in the fourth quarter of 1998, and the remainder of such
costs had been previously accrued in connection with the purchase price
allocation.

Loss on sale and closure of home health and hospice businesses--We began
operating our home health and hospice businesses in 1996. These operations
generally were unprofitable. In the second quarter of 1998, we decided to cease
operations and either close or sell these businesses, resulting in a loss of
$7.3 million.

Capital Costs

Upon completion of our spin-off from Ventas, we leased substantially all of
our facilities. Prior thereto, we owned 271 facilities and leased 80 facilities
from third parties. Depreciation and amortization, rent and net interest costs
aggregated $436 million in 2000, $474 million in 1999 and $461 million in 1998.
Rent expense incurred by us in connection with our original master lease
agreements aggregated $230 million in 2000, $225 million in 1999 and $148
million for the eight months ended December 31, 1998. In connection with the
spin-off in 1998, approximately $992 million of long-term debt was retained by
Ventas.

424B4 58th Page of 184 TOC 1st Previous Next ↓Bottom Just 58th
During the pendency of our Chapter 11 cases, we continued to record the
entire contractual amount of interest expense related to our former credit
agreement and the rents due to Ventas under the original master lease
agreements. No interest payments were made related to the former credit
agreement following the filing of our Chapter 11 cases. In accordance with a
stipulation agreement with Ventas, we paid a reduced aggregate monthly rent of
approximately $15.1 million.

No interest costs were recorded related to our former $300 million 9 7/8%
Guaranteed Senior Subordinated Notes due 2005 since the filing of our Chapter
11 cases. Contractual interest expense for our $300 million 9 7/8% Guaranteed
Senior Subordinated Notes due 2005 not recorded in the consolidated statement
of operations aggregated $30 million in 2000 and $9 million in 1999.

Fourth Quarter Adjustments

Preparation of the financial statements requires a number of estimates and
judgments that are based upon the best available evidence at the time. In
addition, we regularly review the methods used to recognize revenues and
allocate costs to ensure that our financial statements reflect properly the
results of interim periods.

In addition to the unusual transactions previously discussed, during the
fourth quarter of 1999 and 1998, we recorded certain adjustments which
significantly impacted our operating results. A summary of such adjustments
follows (in millions):

[Download Table]

(Restated)
-----------------------------------------------------
Health Services
Division Hospital Division
----------------- ------------------
Nursing Ancillary
Centers Services Hospitals Pharmacy Corporate Total
------- --------- --------- -------- --------- ------

1999
(Income)/expense
Provision for doubtful
accounts............. $40.2 $26.8 $ 6.5 $ 8.9 $ 82.4
Medicare supplement
insurance disputes... 18.8 18.8
Third-party
reimbursements and
contractual
allowances, including
amounts due from
government agencies
and other payors that
are subject to
dispute.............. 2.0 59.6 61.6
Professional liability
risks................ 14.7 0.4 1.8 0.1 17.0
Employee benefits..... (6.3) (1.5) (1.8) (9.6)
Incentive
compensation......... 2.2 (1.9) (1.1) (0.8)
Inventories........... 0.9 6.3 7.2
Other................. 1.7 (0.4) 2.0 (4.4) $ (2.8) (3.9)
----- ----- ----- ----- ------ ------
$55.4 $25.3 $85.0 $ 9.8 $ (2.8) $172.7
===== ===== ===== ===== ====== ======

424B4 59th Page of 184 TOC 1st Previous Next ↓Bottom Just 59th
[Download Table]

(Restated)
-----------------------------------------------------
Health Services
Division Hospital Division
------------------ ------------------
Nursing Ancillary
Centers Services Hospitals Pharmacy Corporate Total
------- --------- --------- -------- --------- -----

1998
(Income)/expense
Provision for doubtful
accounts.............. $ 14.0 $ 6.8 $ 5.7 $ 2.5 $29.0
Third-party
reimbursements and
contractual
allowances, including
amounts due from
government agencies
and other payors that
are subject to
dispute............... 4.8 11.5 11.4 27.7
Change in goodwill
amortization period
related to
rehabilitation therapy
business.............. 6.4 6.4
Taxes other than
income................ $ 6.4 6.4
Professional liability
risks................. 3.5 0.2 1.8 5.5
Compensated absences... 2.1 1.3 (0.8) 0.7 3.3
Incentive
compensation.......... (1.0) (0.4) (0.8) (0.1) (2.9) (5.2)
Litigation and
regulatory actions.... 3.5 3.5
Miscellaneous
receivables........... 5.2 5.2
Gain on sale of
assets................ (2.0) (2.0)
Other.................. 1.2 0.4 (1.0) 0.3 3.7 4.6
------ ----- ----- ----- ----- -----
$ 24.6 $24.2 $16.3 $ 7.9 $11.4 $84.4
====== ===== ===== ===== ===== =====

We regularly review our accounts receivable and record provisions for loss
based upon the best available evidence. Factors such as changes in collection
patterns, the composition of patient accounts by payor type, the status of
ongoing disputes with third-party payors (including both government and non-
government sources), the effect of increased regulatory activities, general
industry conditions and our financial condition and that of our ancillary
service customers, among other things, are considered by us in determining the
expected collectibility of accounts receivable.

During 1999 and 1998, we recorded significant adjustments in the fourth
quarter related to contractual allowances and doubtful accounts in each of our
divisions. These adjustments represented changes in estimates resulting from
our assessment of our collection processes, the general financial deterioration
of the long-term healthcare industry and, in 1999, the realignment of our
former ancillary services division (including the cancellation of unprofitable
contracts and the discontinuance of certain services) and the filing of our
Chapter 11 cases in September 1999.

In addition, we recorded a significant adjustment in the fourth quarter of
1999 related to professional liability risks. This adjustment was recorded
based upon actuarially determined estimates completed in the fourth quarter and
reflected a substantial increases in claims and litigation activity in our
nursing center business during 1999. We believe that cost increases for
professional liability risks are negatively impacting other providers in the
long-term healthcare industry and expect that our operating results in the
future may be impacted negatively by additional professional liability costs.
See note 10 of the notes to the consolidated financial statements for the year
ended December 31, 2000 included in this prospectus.

Income Taxes

Prior to 1998, we believed that recorded deferred tax assets ultimately
would be realized. Our conclusions at that time were based primarily on the
existence of sufficient taxable income within the allowable carryback periods
to realize the tax benefits of deductible temporary differences recorded at
December 31, 1997. For the fourth quarter of 1998, we reported a pretax loss of
$512 million. Additionally, we revised our operating

424B4 60th Page of 184 TOC 1st Previous Next ↓Bottom Just 60th
budgets as a result of the Balanced Budget Act and the less than expected
operating results in 1998. Based upon those revised forecasts, we did not
believe that we could generate sufficient taxable income to realize the net
deferred tax assets recorded at December 31, 1998. Accordingly, we recorded a
deferred tax valuation allowance aggregating $205 million in the fourth quarter
of 1998. Deferred tax valuation allowances recorded in 1999 and 2000 totaled
$155 million and $12 million, respectively. The deferred tax valuation
allowance included in the consolidated balance sheet at December 31, 2000
totaled $372 million. See note 9 of the notes to the consolidated financial
statements for the year ended December 31, 2000 included in this prospectus.

Consolidated Results

We reported a pretax loss from operations before reorganization costs of $50
million in 2000 compared to $686 million in 1999 and $502 million in 1998.
Reorganization costs in 2000 and 1999 aggregating $13 million and $19 million,
respectively, principally comprised of professional fees and, in 1999, certain
management incentive payments incurred in connection with our restructuring
activities.

The net loss from operations in 2000 totaled $65 million compared to $705
million in 1999 and $578 million in 1998 (including charges to record the
deferred tax valuation allowance).

Effective January 1, 1999, we adopted the provisions of the American
Institute of Certified Public Accountants Statement of Position 98-5,
"Reporting on the Costs of Start-Up Activities" ("SOP 98-5"), which requires us
to expense start-up costs, including organizational costs, as incurred. In
accordance with the provision of SOP 98-5, we wrote off $8.9 million of such
unamortized costs as a cumulative effect of a change in accounting principle in
the first quarter of 1999. The pro forma effect of the change in accounting for
start-up costs, assuming the change occurred on January 1, 1998, was not
significant.

In conjunction with the spin-off from Ventas in 1998, we incurred an
extraordinary loss on extinguishment of debt aggregating $78 million.

Liquidity

On September 14, 1999, we received approval from the Bankruptcy Court to pay
pre-petition and post-petition employee wages, salaries, benefits and other
employee obligations. The Bankruptcy Court also approved orders granting
authority, among other things, to pay pre-petition claims of certain critical
vendors, utilities and patient obligations. All other pre-petition liabilities
were classified in our consolidated balance sheet as liabilities subject to
compromise. We paid the post-petition claims of all vendors and providers in
the ordinary course of business.

In connection with our Chapter 11 cases, we entered into debtor-in-
possession financing aggregating $100 million. The Bankruptcy Court granted
final approval of the debtor-in-possession financing on October 1, 1999. The
debtor-in-possession financing was initially comprised of a $75 million tranche
A loan and a $25 million tranche B loan. Interest was payable at prime plus 2
1/2% on the tranche A loan and prime plus 4 1/2% on the tranche B loan.

Available aggregate borrowings under the tranche A loan were initially
limited to $45 million in September 1999 and increased to $65 million in
October 1999, $70 million in November 1999 and $75 million thereafter.

We reported a net loss from operations in 1998 aggregating $578 million,
resulting in certain financial covenant violations under our former $1.0
billion credit agreement. Prior to the commencement of our Chapter 11 cases, we
received a series of temporary waivers of these covenant violations. The
waivers generally included certain borrowing limitations under the $300 million
revolving credit portion of the former credit agreement. The final waiver was
scheduled to expire on September 24, 1999.

424B4 61st Page of 184 TOC 1st Previous Next ↓Bottom Just 61st
We were informed on April 9, 1999 by CMS that the Medicare program had made
a demand for repayment of approximately $90 million of reimbursement
overpayments. On April 21, 1999, we reached an agreement with CMS to extend the
repayment of such amounts over 60 monthly installments. Under the CMS
agreement, non-interest bearing monthly payments of approximately $1.5 million
commenced in May 1999. Beginning in December 1999, interest began to accrue on
the balance of the overpayments at a statutory rate approximating 13.4%,
resulting in a monthly payment of approximately $2.0 million through March
2004. If we are delinquent with two consecutive payments, the CMS agreement
would be defaulted and all subsequent Medicare reimbursement payments to us
might be withheld. Amounts due under the CMS agreement aggregated $63.4 million
at December 31, 2000 and were classified as liabilities subject to compromise
in our consolidated balance sheet. We received Bankruptcy Court approval to
continue to make the monthly payments under the CMS agreement during the
pendency of our Chapter 11 cases.

On May 3, 1999, we elected not to make the interest payment of approximately
$14.8 million due on our former $300 million 9 7/8% Guaranteed Senior
Subordinated Notes due 2005. The failure to pay interest resulted in an event
of default under these notes.

In accordance with SOP 90-7, outstanding borrowings under the former credit
agreement ($511 million) and the principal amount of our former 9 7/8%
Guaranteed Senior Subordinated Notes due 2005 ($300 million) were presented as
liabilities subject to compromise in our consolidated balance sheet at December
31, 2000. If our Chapter 11 cases had not been filed, we would have reported a
working capital deficit approximating $942 million at December 31, 2000. No
interest costs were recorded related to our former 9 7/8% Guaranteed Senior
Subordinated Notes due 2005 following the filing of our Chapter 11 cases.
Contractual interest expense for these notes not recorded in the consolidated
statement of operations aggregated $30 million in 2000 and $9 million in 1999.

As previously reported, we were informed by the Department of Justice that
we and Ventas were the subjects of ongoing investigations into various Medicare
reimbursement issues, including hospital cost reporting issues, ancillary
services billing practices and various quality of care issues in the hospitals
and nursing centers formerly operated by Ventas and currently operated by us.
In connection with our Fourth Amended Joint Plan of Reorganization, the claims
of the Department of Justice were settled through the government settlement.
The government settlement also provides for the dismissal of certain pending
claims and lawsuits filed against us.

As a result of the uncertainty related to our Chapter 11 cases, the original
report of our independent accountants, PricewaterhouseCoopers LLP, referred to
our ability to continue as a going concern at December 31, 2000 and December
31, 1999. As a result of our net loss in 1998, our working capital deficiency
and our covenant defaults under our former credit agreement at December 31,
1998, the report of our former independent accountants, Ernst & Young LLP,
refers to our ability to continue as a going concern at December 31, 1998.

Cash provided by operations before reorganization costs totaled $194 million
for 2000 compared to $247 million for 1999 and $323 million for 1998. Cash
flows in 1999 and 1998 were unusually high due to growth in amounts due to
third parties. Overpayments from third-party payors resulted from the Medicare
program continuing to reimburse our nursing centers under the prior cost-based
reimbursement system after our nursing centers had converted to PPS.

In January 2000, we filed our hospital cost reports for the year ended
August 31, 1999. These documents are filed annually in settlement of amounts
due to or from the various agencies administering the reimbursement programs.
These cost reports indicated amounts due to Medicare aggregating $58 million.
This liability arose during 1999 as part of our routine settlement of Medicare
reimbursement overpayments. Such amounts were classified as liabilities subject
to compromise in our consolidated balance sheet and, accordingly, no funds were
disbursed by us in settlement of such pre-petition liabilities. Under the terms
of our Fourth Amended Joint Plan of Reorganization, this obligation was
discharged.

424B4 62nd Page of 184 TOC 1st Previous Next ↓Bottom Just 62nd
Cash and cash equivalents totaled $185 million at December 31, 2000. Based
upon our cash position, expected operating cash flows and capital spending, and
the availability of borrowings under our debtor-in-possession financing, we
believe that we have the necessary financial resources to satisfy our expected
liquidity needs on both a short-term and long-term basis.

Capital Resources

Excluding acquisitions, capital expenditures totaled $80 million for 2000
compared to $111 million for 1999 and $267 million for 1998. Planned capital
expenditures in 2001 (excluding acquisitions) are expected to approximate $75
million. We believe that our capital expenditure program is adequate to expand,
improve and equip existing facilities.

Capital expenditures during the last three years were financed primarily
through internally generated funds. At December 31, 2000, the estimated cost to
complete and equip construction in progress approximated $8 million.

Proceeds from the sale of assets totaled $15 million in 2000, $12 million in
1999 and $237 million in 1998. Substantially all of the proceeds in 1998 were
used to reduce long-term debt.

At December 31, 1999, we were a party to certain interest rate swap
agreements that eliminated the impact of changes in interest rates on $100
million of floating rate debt outstanding. The agreements provided for fixed
rates on $100 million of floating rate debt at 6.4% plus 3/8% to 1 1/8% and
expired in May 2000. We were not a party to any interest rate swap agreements
at December 31, 2000.

New Accounting Pronouncements

In June 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 141, "Business Combinations," which provides
that all business combinations should be accounted for using the purchase
method of accounting and establishes criteria for the initial recognition and
measurement of goodwill and other intangible assets recorded in connection with
a business combination. The provisions of this new pronouncement apply to all
business combinations initiated after June 30, 2001 and to all business
combinations accounted for by the purchase method that are completed after June
30, 2001.

In addition, the Financial Accounting Standards Board issued in June 2001
Statement of Financial Accounting Standards No. 142, "Goodwill and Other
Intangible Assets," which establishes the accounting for goodwill and other
intangible assets following their recognition. Statement No. 142 applies to all
goodwill and other intangible assets whether acquired singly, as part of a
group, or in a business combination, and also applies to excess reorganization
value recognized in accordance with SOP 90-7. The new pronouncement provides
that goodwill should not be amortized but should be tested for impairment
annually using a fair-value based approach. In addition, Statement No. 142
provides that intangible assets other than goodwill should be amortized over
their useful lives and reviewed for impairment in accordance with Statement of
Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-
Lived Assets and for Long-Lived Assets to Be Disposed Of." Statement No. 142
will become effective for us beginning on January 1, 2002. Upon adoption, we
will be required to perform a transitional impairment test for the excess
reorganized value recorded as of January 1, 2002. Any impairment loss recorded
as a result of the transitional impairment test will be treated as a change in
accounting principle. Management expects that the annual impact of eliminating
the amortization of excess reorganization value beginning on January 1, 2002
will approximately $8 million.

424B4 63rd Page of 184 TOC 1st Previous Next ↓Bottom Just 63rd
Operating Data
(dollars in thousands)

[Download Table]

Year ended December 31,
-------------------------------------
2000 1999 1998
----------- ----------- -----------

Revenues:
Health services division:
Nursing centers........................ $ 1,675,627 $ 1,594,244 $ 1,667,343
Rehabilitation services................ 135,036 195,731 264,574
Other ancillary services............... - 43,527 168,165
Elimination............................ (77,191) (128,267) (124,500)
----------- ----------- -----------
1,733,472 1,705,235 1,975,582
Hospital division:
Hospitals.............................. 1,007,947 850,548 919,847
Pharmacy............................... 204,252 171,493 149,991
----------- ----------- -----------
1,212,199 1,022,041 1,069,838
----------- ----------- -----------
2,945,671 2,727,276 3,045,420
Elimination of pharmacy charges to our
nursing centers........................ (57,129) (61,635) (45,681)
----------- ----------- -----------
$ 2,888,542 $ 2,665,641 $ 2,999,739
=========== =========== ===========
Income (loss) from operations
(restated):
Operating income (loss):
Health services division:
Nursing centers........................ $ 278,738 $ 169,128 $ 213,036
Rehabilitation services................ 8,047 2,891 18,398
Other ancillary services............... 4,737 4,166 30,183
----------- ----------- -----------
291,522 176,185 261,617
Hospital division:
Hospitals.............................. 205,858 132,050 247,272
Pharmacy............................... 7,421 342 15,301
----------- ----------- -----------
213,279 132,392 262,573
Corporate overhead..................... (113,823) (108,947) (126,291)
Unusual transactions................... (4,701) (412,418) (439,125)
Reorganization costs................... (12,636) (18,606) -
----------- ----------- -----------
Operating income (loss)............... 373,641 (231,394) (41,226)
Rent.................................... (307,809) (305,120) (234,144)
Depreciation and amortization........... (73,545) (93,196) (124,617)
Interest, net........................... (55,038) (75,254) (102,320)
----------- ----------- -----------
Loss before income taxes................ (62,751) (704,964) (502,307)
Provision for income taxes.............. 2,000 500 76,099
----------- ----------- -----------
$ (64,751) $ (705,464) $ (578,406)
=========== =========== ===========
Nursing center data (unaudited):
Revenue mix %:
Medicare............................... 27.9 26.1 29.3
Medicaid............................... 48.8 48.7 44.7
Private and other...................... 23.3 25.2 26.0
Patient days:
Medicare............................... 1,541,934 1,436,288 1,498,968
Medicaid............................... 7,735,567 7,718,963 7,746,401
Private and other...................... 2,302,794 2,501,188 2,693,897
----------- ----------- -----------
11,580,295 11,656,439 11,939,266
=========== =========== ===========
Average daily census.................... 31,640 31,935 32,710
Occupancy %............................. 86.1 86.8 87.3

Hospital data (unaudited):
Revenue mix %:
Medicare............................... 55.1 58.3 58.5
Medicaid............................... 10.3 10.5 9.7
Private and other...................... 34.6 31.2 31.8
Patient days:
Medicare............................... 704,152 669,976 647,283
Medicaid............................... 134,754 119,849 121,538
Private and other...................... 205,757 192,476 178,667
----------- ----------- -----------
1,044,663 982,301 947,488
=========== =========== ===========
Average daily census.................... 2,854 2,691 2,596
Occupancy %............................. 60.8 56.9 54.0

424B4 64th Page of 184 TOC 1st Previous Next ↓Bottom Just 64th
Quantitative and Qualitative Disclosure About Market Risk at June 30, 2001

The following discussion of our exposure to market risk contains "forward-
looking statements" that involve risks and uncertainties. The information
presented has been prepared utilizing certain assumptions considered reasonable
in light of information currently available to us. Given the unpredictability
of interest rates as well as other factors, actual results could differ
materially from those projected in such forward-looking information.

Our only significant exposure to market risk is changes in the London
Interbank Offered Rate, which affect the interest paid on our borrowings.

The following table provides information about our financial instruments
that are sensitive to changes in interest rates. The table presents principal
cash flows and related weighted average interest rates by expected maturity
date.

Interest Rate Sensitivity
Principal (Notional) Amount by Expected Maturity
Average Interest Rate
(dollars in thousands)

[Enlarge/Download Table]

Expected Maturities Fair
--------------------------------------------------- Value
2001 2002 2003 2004 2005 Thereafter Total 6/30/01
----- ----- ---- ---- ---- ---------- -------- --------

Liabilities:
Long-term debt,
including amounts due
within one year:
Fixed rate............. $ 350 $ 436 $197 $ 72 $ 48 $ 1,433 $ 2,536 $ 2,930
Average interest rate.. 10.1% 10.0% 9.6% 8.5% 8.8% 8.8%
Variable rate.......... $ - $ - $ - $ - $ - $300,000 $300,000 $280,500
Average interest rate
(a)

---------------------
(a) Interest is payable, at our option, at one, two, three or six month London
Interbank Offered Rate plus 4 1/2%.

424B4 65th Page of 184 TOC 1st Previous Next ↓Bottom Just 65th
BUSINESS

We are one of the largest providers of long-term healthcare services in the
United States based on revenues. We are organized into two operating divisions:
the health services division, which provides long-term care services by
operating nursing centers and a rehabilitation therapy business and the
hospital division, which provides long-term acute care services to medically
complex patients by operating hospitals and an institutional pharmacy business.
We believe that the independent focus of each division on the unique aspects
and quality concerns of its business enhances its ability to attract patients,
improve operations and achieve cost containment objectives. As of June 30,
2001, we operated 315 nursing centers with 40,607 licensed beds in 32 states
and 56 hospitals with 4,867 licensed beds in 23 states. For the year ended
December 31, 2000, we generated revenues before eliminations of $2.9 billion,
of which 59% was generated by our health services division and 41% was
generated by our hospital division. We believe that demand for long-term care
at all levels of the continuum of care is increasing and that we are well-
positioned to expand our business by continuing to provide high-quality long-
term care to our residents and patients.

Competitive Strengths

Premier Long-Term Acute Care Hospital Operator. Since opening our first
hospital in 1985, we have grown into the largest network of long-term acute
care hospitals in the United States based on revenues. As of June 30, 2001, we
operated 56 hospitals in 23 states. As a result of our commitment to the long-
term acute care business and our comprehensive program of care for medically
complex patients, we believe that we are the premier operator of long-term
acute care hospitals in the United States.

Geographic Diversity and Independent Business Lines. We believe the
geographic diversity of our nursing centers and hospitals and our two
independent business lines reduce our exposure to any single state Medicaid
reimbursement source and adverse regional and local economic conditions,
including those relating to the availability and cost of labor, materials and
other services.

Use of Industry-Leading Information Technology to Enhance Operational
Performance. We believe our industry-leading information technology allows us
to operate efficiently and effectively under fixed reimbursement systems and
increased regulatory compliance requirements. Our information systems
architecture provides a reliable, scalable infrastructure that is designed to
efficiently accommodate the operations of additional facilities in the future.
We are able to access sophisticated clinical and financial management
information at a local, regional and corporate level, which enhances our
ability to manage operational performance. Moreover, company-wide access to
various data through internet-based solutions has improved operating
efficiencies and reduced administrative costs. Our information systems network
allows us to operate over 8,000 distributed personal computers and 600
centrally located servers on a continuous basis.

Health Services Division

Our health services division provides high-quality, cost-effective long-term
care through the operation of a national network of 315 nursing centers (40,607
licensed beds) located in 32 states and a rehabilitation therapy

424B4 66th Page of 184 TOC 1st Previous Next ↓Bottom Just 66th
business. Through our nursing centers, we provide residents with long-term care
services, a full range of pharmacy, medical and clinical services and routine
services, including daily dietary, social and recreational services. We also
provide rehabilitation services, including physical, occupational and speech
therapies to our residents as well as to residents in nursing facilities
operated by other parties. For the year ended December 31, 2000, the health
services division generated $1.7 billion in revenues.

In addition, at more than 80 of our nursing centers, we offer specialized
programs for patients suffering from Alzheimer's disease. Within these nursing
centers, we provide quality care to these patients by dedicating to them
separate units run by teams of professionals that specialize in the unique
problems experienced by Alzheimer's patients. We believe that we are a leading
provider of nursing care to patients with Alzheimer's disease, based on the
specialization and size of our program for caring for these patients.

We monitor and enhance the quality of care at our nursing centers through
the use of quality assurance and performance improvement committees as well as
family satisfaction surveys. Our quality assurance and performance improvement
committees oversee patient healthcare needs and patient and staff safety.
Physicians serve on these committees as medical directors and advise on
healthcare policies and practices. We conduct surveys of patients' families
periodically and these surveys are reviewed by our performance improvement
committees at each facility to promote quality patient care. Substantially all
of our nursing centers are certified to provide services under Medicare and
Medicaid programs. Our centers have been certified because the quality of our
accommodations, equipment, services, safety, personnel, physical environment
and policies and procedures meet or exceed the standards of certification set
by those programs.

Health Services Division Strategy

Our goal is to become the provider of choice in the markets our health
services division serves, which we believe will allow us to increase our
patient census and enhance our payor mix. In addition, we have implemented
several initiatives to improve our profitability. To supplement these
internally-focused initiatives, we intend to expand selectively our operations
through development and acquisition activities. The principal elements of our
health services division strategy are:

. hire and retain quality healthcare personnel by becoming the employer of
choice in the industry,

. establish improved processes to monitor and promote our patient care
objectives,

. integrate clinical advice of our chief medical officer and other
physicians into our operational procedures, and

. develop and enhance our internal training programs.

Enhancing Sales and Marketing Programs. We conduct our nursing center
marketing efforts, which focus on the quality of care provided at our
facilities, at the local market level through our nursing center administrators
and admissions coordinators. The marketing efforts of our nursing center
personnel are supplemented by strategies provided by our regional marketing
staffs. In order to increase awareness of our services and the provision of
quality care, we intend to:

. direct a targeted marketing effort at the elderly population, which we
believe is the fastest growing segment in the U.S. and which will,
therefore, be the driving force behind the growth in our industry in the
coming years,

. improve our relationships with local referral sources, and

. employ a business development director to identify and develop market
needs analyses.

424B4 67th Page of 184 TOC 1st Previous Next ↓Bottom Just 67th
Increasing Operating Efficiency. The health services division continually
seeks to improve operating efficiency with a view to maintaining high-quality
care in an environment that demands an increasingly greater control of costs.
We believe that operating efficiency is critical in maintaining our position as
a leading provider of nursing center services in the United States. In our
effort to improve operating efficiency we have:

. centralized administrative functions such as accounting, payroll, legal,
reimbursement, compliance and human resources,

. developed an industry-leading management information system to aid in
financial reporting as well as billing and collecting, and

. focused our efforts to hire and retain quality personnel.

Managing Efficient Delivery of Ancillary Services. We are dedicated to
providing quality nursing services to the patients in our facilities while at
the same time optimizing our operating efficiency. We realigned and refocused
our ancillary services business in response to the decline in the demand for
ancillary services that followed the implementation of PPS. Today, our nursing
centers generally provide ancillary services to their patients through the use
of internal staff. We are continuing to refine the delivery of ancillary
services to external customers to maintain profitability under the cost
constraints of the prospective payment system. Accordingly, over the past 24
months, the health services division has terminated many unprofitable external
ancillary services contracts and does not intend to emphasize the marketing of
ancillary services contracts to third parties.

Expanding Selectively Through Acquisitions and Development Activities. We
believe that we are well positioned strategically and financially to pursue
opportunities to expand our business through acquisitions and development
activities on a selective basis. We will evaluate development opportunities to
expand our operations, either through acquiring or leasing individual or small
portfolios of nursing facilities in selected markets or by managing third
parties' operations. We also will evaluate opportunities to acquire companies
with operations in attractive markets.

424B4 68th Page of 184 TOC 1st Previous Next ↓Bottom Just 68th
Nursing Center Facilities

The following table lists by state the number of nursing centers and related
licensed beds owned by us, leased from Ventas and other third parties, or
managed by us as of June 30, 2001:

[Download Table]

Number of Facilities
----------------------------------
Leased
Leased from
Licensed Owned from Other
State Beds by Us Ventas Parties Managed Total
----- -------- ----- ------ ------- ------- -----

Alabama(1).......................... 781 - 3 1 2 6
Arizona............................. 1,393 - 6 - 6 12
California.......................... 2,205 1 11 4 2 18
Colorado............................ 695 - 4 1 - 5
Connecticut(1)...................... 983 - 8 - - 8
Florida(1).......................... 2,713 2 15 1 2 20
Georgia(1).......................... 1,211 - 5 4 - 9
Idaho............................... 880 1 8 - - 9
Indiana............................. 5,071 - 14 15 6 35
Kentucky(1)......................... 2,076 1 12 4 - 17
Louisiana(1)........................ 485 - - 1 2 3
Maine(1)............................ 775 - 10 - - 10
Massachusetts(1).................... 4,181 - 31 3 3 37
Mississippi(1)...................... 125 - - 1 - 1
Missouri(1)......................... 400 - - 3 - 3
Montana(1).......................... 446 - 2 1 - 3
Nebraska(1)......................... 163 - 1 - - 1
Nevada(1)........................... 180 - 2 - - 2
New Hampshire(1).................... 622 - 3 - 1 4
North Carolina(1)................... 2,764 - 19 4 - 23
Ohio(1)............................. 2,155 - 11 4 1 16
Oregon(1)........................... 254 - 2 - - 2
Pennsylvania........................ 200 - 1 1 - 2
Rhode Island(1)..................... 201 - 2 - - 2
Tennessee(1)........................ 2,541 - 4 11 - 15
Texas............................... 1,521 - 1 2 8 11
Utah................................ 848 - 5 1 1 7
Vermont(1).......................... 310 - 1 - 1 2
Virginia(1)......................... 629 - 4 - - 4
Washington(1)....................... 1,012 1 9 - - 10
Wisconsin(1)........................ 2,336 - 12 2 - 14
Wyoming............................. 451 - 4 - - 4
------ --- --- --- --- ---
Total............................. 40,607 6 210 64 35 315
====== === === === === ===

---------------------
(1) These states have certificate of need regulations (see "--Government
Regulation--Certificates of Need and State Licensing").

Health Services Division Management and Operations

Each of our nursing centers is managed by a state-licensed administrator who
is supported by other professional personnel, including a director of nursing,
staff development professional (responsible for employee training), activities
director, social services director, business office manager and, in general,
physical, occupational and speech therapists. The directors of nursing are
state-licensed nurses who supervise

424B4 69th Page of 184 TOC 1st Previous Next ↓Bottom Just 69th
our nursing staffs that include registered nurses, licensed practical nurses
and nursing assistants. Staff size and composition vary depending on the size
and occupancy of each nursing center and on the type of care provided by the
nursing center. The nursing centers contract with physicians who provide
medical director services and serve on quality assurance committees. We provide
our facilities with centralized information systems, human resources
management, state and federal reimbursement assistance, state licensing and
certification maintenance, legal, finance and accounting support and purchasing
and facilities management. The centralization of these services improves
efficiency and permits facility staff to focus on the delivery of high quality
nursing services.

Our health services division is managed by a divisional president and a
chief financial officer. Our nursing center operations are divided into four
geographic regions, each of which is headed by an operational vice president.
These four operational vice presidents report to the divisional president. The
ancillary services operations also are managed by a vice president who reports
to the divisional president. The clinical issues and quality concerns of the
health services division are managed by the division's chief medical officer
and vice president of clinical operations. District and/or regional staff in
the areas of nursing, dietary and rehabilitation services, state and federal
reimbursement, human resources management, maintenance, sales and financial
services supports the health services division. Regional and district nursing
professionals visit each nursing center periodically to review practices and,
where necessary, recommend improvements in the level of care provided.

Hospital Division

Our hospital division primarily provides long-term acute care services to
medically complex patients through the operation of a national network of 56
hospitals (which includes four hospitals certified as general acute care
hospitals) with 4,867 licensed beds located in 23 states. We opened our first
long-term acute care hospital in 1985 and today operate the largest network of
long-term acute care hospitals in the United States based on revenues. As a
result of our commitment to the long-term acute care business, we have
developed a comprehensive program of care for medically complex patients which
allows us to deliver high-quality care in a cost-effective manner. In addition,
the hospital division operates an institutional pharmacy business, which
focuses on providing a full array of institutional pharmacy services to nursing
centers and specialized care centers, including the nursing centers we operate.
For the year ended December 31, 2000, the hospital division generated $1.2
billion in revenues.

In addition to our long-term care hospitals, the hospital division operates
four hospitals licensed as general acute care hospitals. A number of the
hospital division's long-term acute care hospitals also provide outpatient
services. General acute care and outpatient services may include inpatient
services, diagnostic services, CT scanning, one-day surgery, laboratory, X-ray,
respiratory therapy, cardiology and physical therapy.

In our hospitals, we treat medically complex 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. In particular, we have a core
competency in treating patients with pulmonary disorders. Medically complex
patients often are dependent on technology, such as mechanical ventilators,
total parental nutrition, respiratory or cardiac monitors and dialysis
machines, for continued life support. Approximately 50% of our medically
complex patients are ventilator-dependent for some period of time during their
hospitalization. During 2000, the average length of stay for patients in our
long-term care hospitals was approximately 36 days. Although the hospital
division's patients range in age from pediatric to geriatric, approximately 70%
of these patients are over 65 years of age.

Our hospital division patients have conditions which require a high level of
monitoring and specialized care, yet may not need the services of a traditional
intensive care unit. Due to their severe medical conditions, these patients
generally are not clinically appropriate for admission to a nursing center and
their medical

424B4 70th Page of 184 TOC 1st Previous Next ↓Bottom Just 70th
conditions are periodically or chronically unstable. By combining selected
general acute care services with the ability to care for medically complex
patients, we believe that our long-term acute care hospitals provide their
patients with high quality, cost-effective care.

Our long-term acute care hospitals employ a comprehensive program of care
for their medically complex patients which draws upon the talents of
interdisciplinary teams, including physician specialists. The teams evaluate
medically complex patients upon admission to determine treatment programs. Our
hospital division has developed specialized treatment programs focused on the
needs of medically complex patients. Where appropriate, the treatment programs
may involve the services of several disciplines, such as pulmonary medicine,
physical medicine and their respective therapies. In our treatment programs, we
emphasize individual attention to patients.

Hospital Division Strategy

Our goal is to remain a leading operator of long-term acute care hospitals
in terms of both quality of care and operating efficiency. Our strategies for
achieving this goal include:

Maintaining High Quality of Care. The hospital division differentiates its
hospitals through its ability to care for medically complex patients in a high-
quality, cost-effective setting. We are committed to maintaining and improving
the quality of our patient care by dedicating appropriate resources to each
facility and refining our clinical initiatives. In this regard, we have taken
the following measures to improve and maintain the quality of care at our
hospitals:

. Established an integrated quality assessment and improvement program,
administered by a quality review manager, which encompasses utilization
review, quality improvement, infection control and risk management.

. Developed and implemented a patient classification system called
CustomCare that is designed to ensure that patients receive the
necessary level of care. This model allows the hospital division to
monitor employee skill mix and manage labor costs.

. Maintained a strategic outcomes program, which includes a concurrent
review of all of its patient population against utilization and quality
screenings, as well as quality of life outcomes data collection and
patient and family satisfaction surveys.

. Implemented a program whereby our hospitals are reviewed by internal
quality auditors for compliance with standards of the Joint Commission
on Accreditation of Health Care Organizations.

. Attempted to attract the highest quality of professional staff within
each market. The hospital division believes that its future success will
depend in part upon its continued ability to hire and retain qualified
healthcare personnel.

. Incorporated the clinical advice of our chief medical officer and other
physicians into our operational procedures.

Improving Operating Efficiency. The hospital division is continually focused
on improving operating efficiency and controlling costs while maintaining
quality patient care. Our hospital division seeks to improve operating
efficiencies and control costs by standardizing operations and optimizing the
skill mix of its staff based on the hospital's occupancy and the clinical needs
of its patients. The initiatives we have undertaken to control our costs and
improve efficiency include:

. managing pharmacy costs through adherence to formularies and utilization
management and leveraging drug costs through participation in a group
purchasing organization,

. centralizing administrative functions such as accounting, payroll,
legal, reimbursement, compliance and human resources, and

. utilizing industry-leading management information technology to aid in
financial reporting as well as billing and collecting.

424B4 71st Page of 184 TOC 1st Previous Next ↓Bottom Just 71st
Growing Through Business Development and Acquisitions. Our growth strategy
is focused on the development and expansion of our services:

. Hospital-in-Hospital. We look to partner with non-Kindred hospitals in
order to operate 30 to 40 long-term acute care hospital beds within the
partner hospital. Under such arrangements, we would lease space and
ancillary services from our partners and provide them with the option to
discharge their patients into our care.

. Pulmonary Units. We seek to operate 20 to 30 bed specialty pulmonary
care units within non-Kindred hospitals in attractive markets. Under
such arrangements we would lease space and ancillary services from our
partners. We believe that such arrangements will serve as bridges to
broader hospital-in-hospital opportunities and relationships within
these markets. Since our reorganization, we have entered into agreements
to develop two pulmonary units covering a total of 46 beds.

. Free-standing Hospitals. We seek to add free-standing hospitals in
certain strategic markets. We are currently in the process of completing
the construction of a new free-standing hospital in Las Vegas, Nevada
which will contain approximately 90 beds.

. Growing Through Acquisitions. We seek growth opportunities through
strategic acquisitions in selected target markets.

Expanding Breadth of Industry Leadership. We are the leading provider of
long-term acute care to patients with pulmonary dysfunction. In addition, we
deliver other services in areas such as wound care, surgery, acute
rehabilitation and pain management. We intend to broaden our expertise beyond
pulmonary services and to leverage our leadership position in pulmonary care to
expand our market strength to other clinical services.

Increasing Higher Margin Commercial Volume. We typically receive higher
reimbursement rates from commercial insurers than we do from the Medicare and
Medicaid programs. As a result, we work to expand relationships with insurers
to increase commercial patient volume. Each of our hospitals employs case
managers who focus on the patient intake and referral process.

Improving Relationships with Referring Providers. Substantially all of the
acute and medically complex patients admitted to our hospitals are transferred
from other healthcare providers such as general acute care hospitals, intensive
care units, managed care programs, physicians, nursing centers and home care
settings. Accordingly, we are focused on maintaining strong relationships with
these providers. In order to maintain these relationships, we employ case
managers who are responsible for coordinating admissions and assessing the
nature of services necessary for the proper care of the patient. Case managers
also are responsible for educating healthcare professionals from referral
sources as to the unique nature of the services provided by our long-term acute
care hospitals. Specifically, case managers train and educate the staffs of
referring institutions about long-term acute care hospital services and the
types of patients who could benefit from such services.

424B4 72nd Page of 184 TOC 1st Previous Next ↓Bottom Just 72nd
Hospital Facilities

The following table lists by state the number of hospitals and related
licensed beds owned by us or leased from Ventas and other third parties as of
June 30, 2001.

[Download Table]

Number of Facilities
--------------------------
Leased
Leased from
Licensed Owned from Other
State Beds by Us Ventas Parties Total
----- -------- ----- ------ ------- -----

Arizona..................................... 109 - 2 - 2
California.................................. 543 2 6 - 8
Colorado.................................... 68 - 1 - 1
Florida(1).................................. 536 - 6 1 7
Georgia(1).................................. 72 - - 1 1
Illinois(1)................................. 545 - 4 1 5
Indiana..................................... 167 - 2 1 3
Kentucky(1)................................. 374 - 1 - 1
Louisiana................................... 168 - 1 - 1
Massachusetts(1)............................ 86 - 2 - 2
Michigan(1)................................. 400 - 2 - 2
Minnesota................................... 92 - 1 - 1
Missouri(1)................................. 227 - 2 - 2
Nevada(1)................................... 52 - 1 - 1
New Mexico.................................. 61 - 1 - 1
North Carolina(1)........................... 124 - 1 - 1
Oklahoma.................................... 59 - 1 - 1
Pennsylvania................................ 115 - 2 - 2
Tennessee(1)................................ 49 - 1 - 1
Texas....................................... 714 2 6 2 10
Virginia(1)................................. 164 - 1 - 1
Washington(1)............................... 80 1 - - 1
Wisconsin................................... 62 1 - - 1
----- --- --- --- ---
Totals.................................... 4,867 6 44 6 56
===== === === === ===

---------------------
(1) These states have certificate of need regulations (see "--Government
Regulations--Certificates of Need and State Licensing").

Hospital Division Management and Operations

Each of our hospitals has a fully credentialed, multi-specialty medical
staff to meet the needs of the medically complex, long-term acute patient. Each
of our hospitals offers a broad range of physician services including,
pulmonology, internal medicine, infectious diseases, neurology, nephrology,
cardiology, radiology and pathology. In addition, each of our hospitals is
staffed with a multi-disciplinary team of healthcare professionals including: a
professional nursing staff trained to care for long-term acute patients,
respiratory, physical, occupational and speech therapists; pharmacists;
registered dietitians; and social workers.

Substantially all of the acute and medically complex patients admitted to
our hospitals are transferred from other healthcare providers. Patients are
referred from general acute care hospitals, nursing centers and home care
settings. Referral sources include physicians, discharge planners, case
managers of managed care plans, social workers, third-party administrators,
health maintenance organizations and insurance companies. The hospital division
employs case managers who are primarily responsible for coordinating admissions
and assessing the nature of services necessary for the proper care of the
patient. Case managers also are responsible

424B4 73rd Page of 184 TOC 1st Previous Next ↓Bottom Just 73rd
for educating healthcare professionals from referral sources as to the unique
nature of the services provided by our long-term acute care hospitals.
Specifically, case managers train and educate the staffs of referring
institutions about long-term acute care hospital services and the types of
patients who could benefit from such services.

Each hospital maintains a pre-admission assessment system to evaluate
clinical needs and other information in determining the appropriateness of each
patient referral. Upon admission, each patient's case is reviewed by the
hospital's interdisciplinary team to determine treatment programs. Where
appropriate, the treatment programs may involve the services of several
disciplines, such as pulmonary medicine, physical medicine and their respective
therapies.

A hospital chief executive officer supervises and is responsible for the
day-to-day operations at each of our hospitals. Each hospital also employs a
chief financial officer who monitors the financial matters of each hospital,
including the measurement of actual operating results compared to budgets. In
addition, each hospital employs a chief operating officer to oversee the
clinical operations of the hospital and a quality assurance manager to direct
an integrated quality assurance program. We provide centralized services in the
areas of information systems design and development, training, human resources
management, reimbursement expertise, legal advice, technical accounting support
and purchasing and facilities management to each of our hospitals. We believe
that this centralization improves efficiency and allows hospital staff to spend
more time on patient care.

A divisional president and a chief financial officer manage the hospital
division. The operations of the hospitals are divided into three geographic
regions with each region headed by an operational vice president, each of whom
reports to the divisional president. Institutional pharmacy operations also are
managed by a vice president who reports to the divisional president. The
clinical issues and quality concerns of the hospital division are managed by
the division's chief medical officer and vice president of clinical operations.
Our corporate headquarters also provides services in the areas of information
systems design and development, training, human resources management,
reimbursement expertise, legal advice, technical accounting support, purchasing
and facilities management.

Sources of Revenues

Sources of Nursing Center Revenues

Nursing center revenues are derived principally from Medicare and Medicaid
programs and from private payment patients. Consistent with the nursing center
industry as a whole, changes in the mix of the health services division's
patient population among these three categories of patients significantly
affect the profitability of its operations. Although Medicare and higher acuity
patients generally produce the most revenue per patient day, profitability with
respect to higher acuity patients is reduced by the costs associated with the
higher level of nursing care and other services generally required by such
patients. We believe that private payment patients generally constitute the
most profitable category and Medicaid patients generally constitute the least
profitable category.

The following table sets forth the approximate percentages of nursing center
patient days and revenues derived from the payor sources indicated.

[Download Table]

Private and
Medicare Medicaid Other
---------------- ---------------- ----------------
Patient Patient Patient
Period Days Revenues Days Revenues Days Revenues
------ ------- -------- ------- -------- ------- --------

Three months ended June 30,
2001...................... 15% 32% 66% 47% 19% 21%
Three months ended March
31, 2001.................. 15 31 66 47 19 22
Six months ended June 30,
2000...................... 14 28 66 48 20 24
Year ended December 31,
2000..................... 13 28 67 49 20 23
1999..................... 12 26 66 49 22 25
1998..................... 13 29 65 45 22 26

424B4 74th Page of 184 TOC 1st Previous Next ↓Bottom Just 74th
For the three months ended June 30, 2001, revenues of the health services
division totaled approximately $453.4 million, or 58% of our total revenues
(before eliminations).

Both governmental and private third-party payors employ cost containment
measures designed to limit payments made to healthcare providers. Those
measures include the adoption of initial and continuing recipient eligibility
criteria which may limit payment for services, the adoption of coverage
criteria which limit the services that will be reimbursed and the establishment
of payment ceilings which set the maximum reimbursement that a provider may
receive for services. Furthermore, government reimbursement programs are
subject to statutory and regulatory changes, retroactive rate adjustments,
administrative rulings and government funding restrictions, all of which may
materially increase or decrease the rate of program payments to the health
services division for its services.

Medicare. The Medicare Part A program provides reimbursement for extended
care services furnished to Medicare beneficiaries who are admitted to nursing
centers after at least a three-day stay in an acute care hospital. Covered
services include supervised nursing care, room and board, social services,
physical and occupational therapies, pharmaceuticals, supplies and other
necessary services provided by nursing centers.

The Balanced Budget Act established PPS for nursing centers for cost
reporting periods beginning on or after July 1, 1998. Prior to the
implementation of PPS, Medicare nursing centers were reimbursed based on the
facility-specific, reasonable direct and indirect costs of services provided to
their patients. All of our nursing centers adopted the prospective payment
system on July 1, 1998. The payments received under PPS cover all services for
Medicare patients including all ancillary services, such as respiratory
therapy, physical therapy, occupational therapy, speech therapy and certain
covered pharmaceuticals.

Medicaid. Medicaid is a state-administered program financed by state funds
and matching federal funds. The program provides for medical assistance to the
indigent and certain other eligible persons. Although administered under broad
federal regulations, states are given flexibility to construct programs and
payment methods consistent with their individual goals. Accordingly, these
programs differ in many respects from state to state.

The health services division provides to eligible individuals Medicaid-
covered services consisting of nursing care, room and board and social
services. In addition, states may at their option cover other services such as
physical, occupational and speech therapies and pharmaceuticals. Prior to the
Balanced Budget Act, federal law, generally referred to as the "Boren
Amendment," required Medicaid programs to pay rates that were reasonable and
adequate to meet the costs incurred by an efficiently and economically operated
nursing center providing quality care and services in conformity with all
applicable laws and regulations. Despite the federal requirements,
disagreements frequently arose between nursing centers and states regarding the
adequacy of Medicaid rates. By repealing the Boren Amendment, the Balanced
Budget Act eased the restrictions on the states' ability to reduce their
Medicaid reimbursement levels for such services. In addition, Medicaid programs
are subject to statutory and regulatory changes, administrative rulings,
interpretations of policy by the state agencies and certain government funding
limitations, all of which may materially increase or decrease the level of
program payments to nursing centers operated by the health services division.
We believe that the payments under many of these programs may not be sufficient
on an overall basis to cover the costs of serving certain patients
participating in these programs. Furthermore, the Omnibus Budget Reconciliation
Act of 1987, as amended, mandates an increased emphasis on ensuring quality
patient care, which has resulted in additional expenditures by nursing centers.

Private Payment. The health services division seeks to maximize the number
of private payment patients admitted to its nursing centers, including those
covered under private insurance and managed care health plans. Private payment
patients typically have financial resources (including insurance coverage) to
pay for their monthly services and do not rely on government programs for
support.

424B4 75th Page of 184 TOC 1st Previous Next ↓Bottom Just 75th
We cannot assure you that payments under governmental and private third-
party payor programs will remain at levels comparable to present levels or will
be sufficient to cover the costs allocable to patients eligible for
reimbursement pursuant to such programs. In addition, we cannot assure you that
facilities operated by the health services division, or the provision of
services and supplies by the health services division, will meet the
requirements for participation in such programs. We could be adversely affected
by the continuing efforts of governmental and private third-party payors to
contain the cost of healthcare services.

Sources of Hospital Revenues

The hospital division receives payment for its hospital services from third-
party payors, including government reimbursement programs such as Medicare and
Medicaid and non-government sources such as commercial insurance companies,
health maintenance organizations, preferred provider organizations and
contracted providers. Patients covered by non-government payors generally will
be more profitable to the hospital division than those covered by the Medicare
and Medicaid programs. The following table sets forth the approximate
percentages of the hospital patient days and revenues derived from the payor
sources indicated.

[Download Table]

Three months ended June 30,
2001...................... 68% 56% 13% 11% 19% 33%
Three months ended March
31, 2001.................. 68 56 13 11 19 33
Six months ended June 30,
2000...................... 68 56 12 9 20 35
Year ended December 31,
2000..................... 67 55 13 10 20 35
1999..................... 68 58 12 11 20 31
1998..................... 68 59 13 10 19 31

For the three months ended June 30, 2001, revenues of the hospital division
totaled approximately $332.7 million, or 42% of our total revenues (before
eliminations). Changes caused by the Balanced Budget Act have reduced Medicare
incentive payments made to the hospital division under TEFRA, allowable costs
for capital expenditures and bad debts and payments for services to patients
transferred from a general acute care hospital.

Competition

Health Services Division

Our nursing centers compete with other nursing centers and similar long-term
care facilities primarily on the basis of quality of care, reputation, their
location and physical appearance and, in the case of private patients, the
charges for our services. Some competitors are located in buildings that are
newer than those operated by us and may provide services that we do not offer.
Our nursing centers compete on a local and regional basis with other nursing
centers as well as with facilities providing similar services, including
hospitals, extended care centers, assisted living facilities, home health
agencies and similar institutions. The industry includes government-owned,
religious organization-owned, secular not-for-profit and for-profit
institutions. Many of these competitors have greater financial and other
resources than we do. Although there is limited, if any, price competition with
respect to Medicare and Medicaid patients (since revenues received for services
provided to such patients are based generally on fixed rates), there is
significant competition for private payment patients.

In addition, our health services division competes in the fragmented and
highly competitive ancillary services markets. In addition, many nursing
centers are developing internal staff to provide these services, particularly
in response to the implementation of PPS. The primary competitive factors for
the ancillary services markets are quality of services, charges for services
and responsiveness to the needs of patients, families and the facilities in
which the services are provided.

424B4 76th Page of 184 TOC 1st Previous Next ↓Bottom Just 76th
Hospital Division

As of June 30, 2001, the hospitals operated by the hospital division were
located in 42 geographic markets in 23 states. In each geographic market, there
are general acute care hospitals which provide services comparable to those
offered by our hospitals. In addition, the hospital division believes that as
of June 30, 2001 there were approximately 300 hospitals in the United States
certified by Medicare as general long-term hospitals, some of which provide
similar services to those provided by the hospital division. Certain competing
hospitals are operated by not-for-profit, nontaxpaying or governmental
agencies, which can finance capital expenditures on a tax-exempt basis, and
which receive funds and charitable contributions unavailable to the hospital
division.

Competition for patients covered by non-government reimbursement sources is
intense. The primary competitive factors in the long-term acute care business
include quality of services, charges for services and responsiveness to the
needs of patients, families, payors and physicians. Other companies have
entered the long-term acute care market with licensed hospitals that compete
with our hospitals. The competitive position of any hospital also is affected
by the ability of its management to negotiate contracts with purchasers of
group healthcare services, including private employers, managed care companies,
preferred provider organizations and health maintenance organizations. Such
organizations attempt to obtain discounts from established hospital charges.
The importance of obtaining contracts with preferred provider organizations,
health maintenance organizations and other organizations which finance
healthcare, and its effect on a hospital's competitive position, vary from
market to market, depending on the number and market strength of such
organizations.

Our Reorganization

As a result of decreased Medicare and Medicaid reimbursement rates
introduced by the Balanced Budget Act and other issues associated with our
company, we were unable to meet our then existing financial obligations,
including rent payable to Ventas and debt service obligations under our then
existing indebtedness. Accordingly, on September 13, 1999, we filed voluntary
petitions for protection under Chapter 11 of the United States Bankruptcy Code
in the United States Bankruptcy Court for the District of Delaware. From the
date of our bankruptcy filing until we emerged from bankruptcy on April 20,
2001, we operated our businesses as a "debtor-in-possession" subject to the
jurisdiction of the bankruptcy court. On March 1, 2001, the bankruptcy court
approved our Fourth Amended Joint Plan of Reorganization.

Pursuant to our Plan of Reorganization, on April 20, 2001, the effective
date of the Plan of Reorganization:

. we issued to certain claimholders, including senior creditors and
Ventas, in exchange for their claims:

-- an aggregate of $300 million of senior secured notes, bearing
interest at the London Interbank Offered Rate (as defined in the
agreement) plus 4 1/2%, which will begin to accrue interest
approximately two quarters after April 20, 2001,

-- an aggregate of 15,000,000 shares of our common stock,

-- an aggregate of 2,000,000 Series A warrants, and

-- an aggregate of 5,000,000 Series B warrants,

. we entered into a new $120 million revolving credit facility to provide
us with working capital and to be used for other general corporate
purposes,

. we entered into amended and restated Master Lease Agreements with Ventas
covering 210 of the nursing centers and 44 of the hospitals that we
operate,

. we entered into a registration rights agreement with Ventas and each
holder of 10% or more of our common stock following the exchange
described above, providing such holders with certain shelf, demand and
"piggy-back" registration rights, and

. our then existing senior indebtedness and debt and equity securities
were cancelled.

424B4 77th Page of 184 TOC 1st Previous Next ↓Bottom Just 77th
As a result of the exchange described above, the holders of certain claims
acquired control of our company and the holders of our pre-reorganization
common stock relinquished control.

In addition, in connection with our emergence from bankruptcy:

. we changed our name to Kindred Healthcare, Inc.,

. a new board of directors, including representatives of the principal
security holders following the exchange, was appointed, and

. effective April 1, 2001, we adopted fresh-start accounting in accordance
with SOP 90-7. This has resulted in the creation of a new reporting
entity for financial accounting reporting purposes and a revaluation of
our assets and liabilities to reflect their estimated fair values.
Because of the adoption of fresh-start accounting, amounts previously
recorded in our historical financial statements have changed materially.
As a result, our financial statements for periods after our emergence
from bankruptcy are not comparable in all respects to our financial
statements for periods prior to the reorganization.

Master Lease Agreements

Under our Fourth Amended Joint Plan of Reorganization, we assumed the
original master lease agreements with Ventas and its affiliates and
simultaneously amended and restated the agreements into four new master leases,
which we refer to as the "Master Lease Agreements." The following summary
description of the Master Lease Agreements is qualified in its entirety by
reference to the Master Lease Agreements, which are incorporated by reference
in this prospectus.

Term and Renewals

Each Master Lease Agreement includes land, buildings, structures and other
improvements on the land, easements and similar appurtenances to the land and
improvements, and permanently affixed equipment, machinery and other fixtures
relating to the operation of the leased properties. There are several bundles
of leased properties under each Master Lease Agreement, with each bundle
containing approximately 7 to 12 leased properties. Each bundle contains both
nursing centers and hospitals. All leased properties within a bundle have base
terms ranging from 10 to 15 years beginning from May 1, 1998, subject to
certain exceptions.

At our option, all, but not less than all, of the leased properties in a
bundle may be extended for one five-year renewal term beyond the base term at
the then existing rental rate plus the then existing escalation amount per
annum. We may further extend for two additional five-year renewal terms beyond
the first renewal term at the greater of the then existing rental rate plus the
then existing escalation amount per annum or the then fair market value rental
rate. The rental rate during the first renewal term and any additional renewal
term in which rent due is based on the then existing rental rate will escalate
each year during such term(s) at the applicable escalation rate.

We may not extend the Master Lease Agreements beyond the base term or any
previously exercised renewal term if, at the time we seek such extension and at
the time such extension takes effect (1) an event of default has occurred and
is continuing or (2) a Medicare/Medicaid event of default (as described below)
and/or a licensed bed event of default (as described below), has occurred and
is continuing with respect to three or more leased properties subject to a
particular Master Lease Agreement. The base term and renewal term of each
Master Lease Agreement are subject to termination upon default by us (subject
to certain exceptions) and certain other conditions described in the Master
Lease Agreements.

Rental Amounts and Escalators

Each Master Lease Agreement is commonly known as a triple-net lease or an
absolute-net lease. Accordingly, in addition to rent, we are required to pay
the following: (1) all insurance required in connection

424B4 78th Page of 184 TOC 1st Previous Next ↓Bottom Just 78th
with the leased properties and the business conducted on the leased properties,
(2) all taxes levied on or with respect to the leased properties (other than
taxes on the net income of Ventas) and (3) all utilities and other services
necessary or appropriate for the leased properties and the business conducted
on the leased properties.

Under each Master Lease Agreement, the aggregate annual rent is referred to
as base rent. Base rent equals the sum of current rent and accrued rent. We are
obligated to pay the portion of base rent that is current rent, and unpaid
accrued rent will be paid as set forth below.

From the effective date of the Master Lease Agreements through April 30,
2004, base rent will equal the current rent. Under the Master Lease Agreements,
the annual aggregate base rent owed by us currently is $180.7 million. For the
period from May 1, 2001 through April 30, 2004, annual aggregate base rent
payable in cash will escalate at an annual rate of 3 1/2% over the prior period
base rent if certain revenue parameters are obtained.

Each Master Lease Agreement also provides that beginning May 1, 2004, the
annual aggregate base rent payable in cash will escalate at an annual rate of
2% (plus, upon the occurrence of certain events, an additional annual accrued
escalator amount of 1.5% of the prior period base rent) which will accrete from
year to year including an interest accrual at the London Interbank Offered Rate
plus 4 1/2% to be added to the annual accreted amount. This interest will not
be added to the aggregate base rent in subsequent years.

The unpaid accrued rent will become payable upon the refinancing of our
existing debt or the termination or expiration of the applicable Master Lease
Agreement.

Reset Rights

During the one-year period commencing in July 2006, Ventas will have a one-
time option to reset the base rent, current rent and accrued rent under each
Master Lease Agreement to the then fair market rental of the leased properties.
Upon exercising this reset right, Ventas will pay us a fee equal to a prorated
portion of $5 million based upon the proportion of base rent payable under the
Master Lease Agreement(s) with respect to which rent is reset to the total base
rent payable under all of the Master Lease Agreements. The determination of the
fair market rental will be effectuated through the appraisal procedures in the
Master Lease Agreements.

Use of the Leased Property

The Master Lease Agreements require that we utilize the leased properties
solely for the provision of healthcare services and related uses and as Ventas
may otherwise consent. We are responsible for maintaining or causing to be
maintained all licenses, certificates and permits necessary for the leased
properties to comply with various healthcare regulations. We also are obligated
to operate continuously each leased property as a provider of healthcare
services.

Events of Default

Under each Master Lease Agreement, an "Event of Default" will be deemed to
occur if, among other things:

. we fail to pay rent or other amounts within five days after notice,

. we fail to comply with covenants, which failure continues for 30 days
or, so long as diligent efforts to cure such failure are being made,
such longer period (not over 180 days) as is necessary to cure such
failure,

. certain bankruptcy or insolvency events occur, including filing a
petition of bankruptcy or a petition for reorganization under the
Bankruptcy Code,

. an event of default arising from our failure to pay principal or
interest on our senior secured notes or any other indebtedness exceeding
$50 million,

. the maturity of the senior secured notes or any other indebtedness
exceeding $50 million is accelerated,

. we cease to operate any leased property as a provider of healthcare
services for a period of 30 days,

424B4 79th Page of 184 TOC 1st Previous Next ↓Bottom Just 79th
. a default occurs under any guaranty of any lease or the indemnity
agreements with Ventas,

. we or our subtenant lose any required healthcare license, permit or
approval or fail to comply with any legal requirements as determined by
a final unappealable determination,

. we fail to maintain insurance,

. we create or allow to remain certain liens,

. we breach any material representation or warranty,

. a reduction occurs in the number of licensed beds in a facility,
generally in excess of 10% (or less than 10% if we have voluntarily
"banked" licensed beds) of the number of licensed beds in the applicable
facility on the commencement date (a "licensed bed event of default"),

. Medicare or Medicaid certification with respect to a participating
facility is revoked and re-certification does not occur for 120 days
(plus an additional 60 days in certain circumstances) (a
"Medicare/Medicaid event of default"),

. we become subject to regulatory sanctions as determined by a final
unappealable determination and fail to cure such regulatory sanctions
within its specified cure period for any facility,

. we fail to cure a breach of any permitted encumbrance within the
applicable cure period and, as a result, a real property interest or
other beneficial property right of Ventas is at material risk of being
terminated, or

. we fail to cure the breach of any of the obligations of Ventas as lessee
under any existing ground lease within the applicable cure period and,
if such breach is a non-monetary, non-material breach, such existing
ground lease is at material risk of being terminated.

Remedies for an Event of Default

Except as noted below, upon an Event of Default under one of the Master
Lease Agreements, Ventas may, at its option, exercise the following remedies:

(1) after not less than ten days' notice to us, terminate the Master
Lease Agreement to which such Event of Default relates, repossess any
leased property, relet any leased property to a third party and require
that we pay to Ventas, as liquidated damages, the net present value of the
rent for the balance of the term, discounted at the prime rate,

(2) without terminating the Master Lease Agreement to which such Event
of Default relates, repossess the leased property and relet the leased
property with us remaining liable under such Master Lease Agreement for all
obligations to be performed by us thereunder, including the difference, if
any, between the rent under such Master Lease Agreement and the rent
payable as a result of the reletting of the leased property, and

(3) seek any and all other rights and remedies available under law or in
equity.

In addition to the remedies noted above, under the Master Lease Agreements,
in the case of a facility-specific event of default Ventas may terminate a
Master Lease Agreement as to the leased property to which the Event of Default
relates, and may, but need not, terminate the entire Master Lease Agreement.
Each of the Master Lease Agreements includes special rules relative to
Medicare/Medicaid events of default and licensed bed events of default. In the
event a Medicare/Medicaid event of default and/or a licensed bed event of
default occurs and is continuing (a) with respect to not more than two
properties at the same time under a Master Lease Agreement that covers 41 or
more properties and (b) with respect to not more than one property at the same
time under a Master Lease Agreement that covers 21 to and including 40
properties, Ventas may not exercise termination or dispossession remedies
against any property other than the property or properties to which the event
of default relates. Thus, in the event Medicare/Medicaid events of default and
licensed bed events of default would occur and be continuing (a) with respect
to one property under a Master Lease Agreement that covers less than 20
properties, (b) with respect to two or more properties at the same time

424B4 80th Page of 184 TOC 1st Previous Next ↓Bottom Just 80th
under a Master Lease Agreement that covers 21 to and including 40 properties,
or (c) with respect to three or more properties at the same time under a Master
Lease Agreement that covers 41 or more properties, then Ventas would be
entitled to exercise all rights and remedies available to it under the Master
Lease Agreements.

Assignment and Subletting

Except as noted below, the Master Lease Agreements provide that we may not
assign, sublease or otherwise transfer any leased property or any portion of a
leased property as a whole (or in substantial part), including by virtue of a
change of control, without the consent of Ventas, which may not be unreasonably
withheld if the proposed assignee (1) is a creditworthy entity with sufficient
financial stability to satisfy its obligations under the related Master Lease
Agreement, (2) has not less than four years experience in operating healthcare
facilities, (3) has a favorable business and operational reputation and
character and (4) has all licenses, permits, approvals and authorizations to
operate the facility and agrees to comply with the use restrictions in the
related Master Lease Agreement. The obligation of Ventas to consent to a
subletting or assignment is subject to the reasonable approval rights of any
mortgagee and/or the lenders under its credit agreement. We may sublease up to
20% of each leased property for restaurants, gift shops and other stores or
services customarily found in hospitals or nursing centers without the consent
of Ventas, subject, however, to there being no material alteration in the
character of the leased property or in the nature of the business conducted on
such leased property.

In addition, each Master Lease Agreement allows us to assign or sublease (a)
without the consent of Ventas, 10% of the nursing center facilities in each
Master Lease Agreement and (b) with Ventas' consent (which consent will not be
unreasonably withheld, delayed or conditioned), two hospitals in each Master
Lease Agreement, if either (i) the applicable regulatory authorities have
threatened to revoke an authorization necessary to operate such leased property
or (ii) we cannot profitably operate such leased property. Any such proposed
assignee/sublessee must satisfy the requirements listed above and it must have
all licenses, permits, approvals and other authorizations required to operate
the leased properties in accordance with the applicable permitted use. With
respect to any assignment or sublease made under this provision, Ventas agrees
to execute a nondisturbance and attornment agreement with such proposed
assignee or subtenant. Upon any assignment or subletting, we will not be
released from our obligations under the applicable Master Lease Agreement.

Subject to certain exclusions, we must pay to Ventas 80% of any
consideration received by us on account of an assignment and 80% (50% in the
case of existing subleases) of sublease rent payments (roughly equal to revenue
net of specified allowed expenses attributable to a sublease, and specifically
defined in the Master Lease Agreements), provided that Ventas' right to such
payments will be subordinate to that of our lenders.

Ventas will have the right to approve the purchaser at a foreclosure of one
or more of our leasehold mortgages by our lenders. Such approval will not be
unreasonably withheld so long as such purchaser is creditworthy, reputable and
has four years experience in operating healthcare facilities. Any dispute
regarding whether Ventas has unreasonably withheld its consent to such
purchaser will be subject to expedited arbitration.

Corporate Integrity Agreement

424B4 81st Page of 184 TOC 1st Previous Next ↓Bottom Just 81st
The Corporate Integrity Agreement became effective on April 20, 2001 and
applies to us and our managed entities. The Corporate Integrity Agreement also
will apply to newly acquired facilities after a phase-in period of six months.

As required by the Corporate Integrity Agreement, we have engaged the Long
Term Care Institute, Inc. to monitor and evaluate our quality improvement
program and report its findings to the Office of the Inspector General.

The Corporate Integrity Agreement includes compliance requirements which
obligate us to:

. Adopt and implement written standards on federal healthcare program
requirements with respect to financial and quality of care issues.

. Conduct training each year for all employees to promote compliance with
federal healthcare requirements. Every employee will undergo a minimum
of two hours of general compliance training annually. We also will
provide annually at least two hours of specific training, tailored to
issues affecting employees with certain job responsibilities, as well as
a minimum of two hours of training for care-giving employees focused on
quality care. In addition, we will continue to operate our internal
compliance hotline.

. Put in place a comprehensive internal quality improvement program, which
will include establishing committees at the facility, regional and
corporate levels to review quality-related data, direct quality
improvement activities and implement and monitor corrective action
plans. We focus on integrating compliance responsibilities with
operational functions. We recognize that our compliance with applicable
laws and regulations depends on individual employee action as well as
our operations. The Long Term Care Institute, Inc. has assisted in
program development and will evaluate its integrity and effectiveness
for the Office of the Inspector General.

. Enhance our current system of internal financial controls to promote
compliance with federal healthcare program requirements on billing and
related financial issues, including a variety of internal audit and
compliance reviews. We have retained an independent review organization
to evaluate the integrity and effectiveness of our internal systems. The
independent review organization will report annually its findings to the
Office of the Inspector General.

. Notify the Inspector General within 30 days of our discovery of any
ongoing investigation or legal proceeding conducted or brought by a
governmental entity or its agents involving any allegation that we have
committed a crime or engaged in a fraudulent activity, and within 30
days of our determination that we have received a substantial
overpayment relating to any federal healthcare program or any other
matter that a reasonable person would consider a potential violation of
the federal fraud and abuse laws or other criminal or civil laws related
to any federal healthcare program.

. Submit annual reports to the Inspector General demonstrating compliance
with the terms of the Corporate Integrity Agreement, including the
findings of our internal audit and review program. We submitted an
implementation report to the Office of Inspector General in August 2001.

The Corporate Integrity Agreement contains standard penalty provisions for
breach, which include stipulated cash penalties ranging from $1,000 per day to
$2,500 per day for each day we are in breach of the agreement. If we fail to
remedy our breach in the time specified in the agreement, we can be excluded
from participation in federal healthcare programs.

Government Regulation

Medicare and Medicaid

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 administered by each state pursuant to
which healthcare benefits are available to certain indigent patients. Within
the Medicare and

424B4 82nd Page of 184 TOC 1st Previous Next ↓Bottom Just 82nd
Medicaid statutory framework, there are substantial areas subject to
administrative rulings, interpretations and discretion that may affect payments
made under Medicare and Medicaid. A substantial portion of our revenues are
derived from patients covered by the Medicare and Medicaid programs.

Federal, State and Local Regulation

In the ordinary course of our business, we are subject regularly to
inquiries, investigations and audits by federal and state agencies that oversee
applicable healthcare regulations.

The extensive federal, state and local regulations affecting the healthcare
industry include, but are not limited to, regulations relating to licensure,
conduct of operations, ownership of facilities, addition of facilities,
allowable costs, services and prices for services. In addition, various laws
including antikickback, antifraud and abuse amendments codified under the
Social Security Act prohibit certain business practices and relationships that
might affect the provision and cost of healthcare 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 these antikickback amendments include
criminal penalties and civil sanctions, including fines and possible exclusion
from government programs such as the Medicare and Medicaid programs. The
Department of Health and Human Services has issued regulations that describe
some of the conduct and business relationships permissible under the
antikickback amendments. The fact that a given business arrangement does not
fall within one of these safe harbors does not render the arrangement per se
illegal. Business arrangements of healthcare service providers that fail to
satisfy the applicable criteria, however, risk increased scrutiny and possible
sanctions by enforcement authorities.

In addition, Section 1877 of the Social Security Act, which restricts
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 or certain other financial arrangements, was amended effective
January 1, 1995, to broaden significantly the scope of prohibited physician
referrals under the Medicare and Medicaid programs. 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
payment for the care. These laws and regulations are complex and limited
judicial or regulatory interpretation exists. We do not believe our
arrangements are in violation of these prohibitions. We cannot assure you,
however, that governmental officials charged with responsibility for enforcing
the provisions of these prohibitions will not assert that one or more of our
arrangements are in violation of such provisions.

The Balanced Budget Act also includes a number of antifraud and abuse
provisions. The Balanced Budget Act contains additional civil monetary
penalties for violations of the antikickback amendments discussed above and
imposes an affirmative duty on providers to ensure that they do not employ or
contract with persons excluded from the Medicare program. The Balanced Budget
Act also provides a minimum ten-year period for exclusion from participation in
federal healthcare programs for persons or entities convicted of a prior
healthcare offense.

The Federal Health Insurance Portability and Accountability Act of 1997,
commonly known as "HIPAA," signed into law on August 21, 1996, amended, among
other things, Title XI of the U.S. Code (42 U.S.C. (S)1301 et seq.) to broaden
the scope of fraud and abuse laws to include all health plans, whether or not
they are reimbursed under federal programs. In addition, HIPAA also mandates
the adoption of regulations aimed at standardizing transaction formats and
billing codes for documenting medical services, dealing with claims submissions
and protecting the privacy and security of individually identifiable health
information. HIPAA regulations that standardize transactions and code sets
became final in the fourth quarter of 2000. These regulations do not require
healthcare providers to submit claims electronically, but require standard
formatting for those that do. We currently submit our claims electronically and
will continue to do so. We will be required to comply with HIPAA transaction
and code set standards by October 2002.

424B4 83rd Page of 184 TOC 1st Previous Next ↓Bottom Just 83rd
Final HIPAA privacy regulations were published in December 2000. These
privacy regulations apply to "protected health information," which is defined
generally as individually identifiable health information transmitted or
maintained in any form or medium, excluding certain education records and
student medical records. The privacy regulations seek to limit the use and
disclosure of most paper and oral communications, as well as those in
electronic form, regarding an individual's past, present or future physical or
mental health or condition, or relating to the provision of healthcare to the
individual or payment for that healthcare, if the individual can or may be
identified by such information. HIPAA provides for the imposition of civil or
criminal penalties if protected health information is improperly disclosed. We
must comply with the privacy regulations by April 2003.

HIPAA's security regulations have not yet been finalized. The proposed
security regulations specify administrative procedures, physical safeguards and
technical services and mechanisms designed to ensure the privacy of protected
health information. We will be required to comply with the security regulations
26 months after the regulations become final.

We are currently evaluating the impact of compliance with HIPAA regulations,
but we have not completed our analysis or finalized the estimated costs of
compliance. We cannot assure you that our compliance with the HIPAA regulations
will not have an adverse affect on our financial position, results of
operations or cash flows.

We believe that the regulatory environment surrounding the long-term care
industry has intensified, particularly for large for-profit, multi-facility
providers like us. In the State of Florida, for example, a new statute requires
the State to revoke, absent sufficient mitigating factors, all licenses of
commonly controlled facilities even if only one facility has serious regulatory
deficiencies. The federal government has imposed extensive enforcement
policies, resulting in a significant increase in the number of inspections,
citations of regulatory deficiencies and other regulatory sanctions including
terminations from the Medicare and Medicaid programs, bars on Medicare and
Medicaid payments for new admissions and civil monetary penalties. Such
sanctions can have a material adverse effect on our results of operations,
liquidity and financial position. We vigorously contest such sanctions where
appropriate, and in several cases have obtained injunctions preventing
imposition of these regulatory sanctions. While we generally have been
successful to date in contesting these sanctions, these cases involve
significant legal expense and the time of management and we cannot assure you
that we will be successful in the future.

Certificates of Need and State Licensing. Certificate of need, or CON,
regulations control the development and expansion of healthcare services and
facilities in certain states. Certain states also require regulatory approval
prior to certain changes in ownership of a nursing center or hospital. Certain
states that do not have CON programs may have other laws or regulations that
limit or restrict the development or expansion of healthcare facilities. We
operate nursing centers in 22 states and hospitals in 12 states that require
state approval for the expansion of our facilities and services under CON
programs. To the extent that CONs or other similar approvals are required for
expansion of the operations of our nursing centers or hospitals, either through
facility acquisitions, expansion or provision of new services or other changes,
such expansion could be affected adversely by the failure or inability to
obtain the necessary approvals, changes in the standards applicable to such
approvals or possible delays and expenses associated with obtaining such
approvals.

We are required to obtain state licenses to operate each of our nursing
centers and hospitals and to ensure their participation in government programs.
Once a nursing center becomes licensed and operational, it must continue to
comply with federal, state and local licensing requirements in addition to
local building and life-safety codes. All nursing centers and hospitals have
the necessary licenses.

Health Services Division

The development and operation of nursing centers and the provision of
healthcare services are subject to federal, state and local laws relating to
the adequacy of medical care, equipment, personnel, operating policies, fire
prevention, rate-setting and compliance with building codes and environmental
laws. Nursing centers are subject to periodic inspection by governmental and
other authorities to assure continued compliance with

424B4 84th Page of 184 TOC 1st Previous Next ↓Bottom Just 84th
various standards, continued licensing under state law, certification under the
Medicare and Medicaid programs and continued participation in the Veterans
Administration program. The failure to obtain, retain or renew any required
regulatory approvals or licenses could adversely affect nursing center
operations.

Medicare and Medicaid and other Federal Regulation. The nursing centers
operated and managed by the health services division are licensed either on an
annual or bi-annual basis and generally are certified annually for
participation in Medicare and Medicaid programs through various regulatory
agencies that determine compliance with federal, state and local laws. These
legal requirements relate to the quality of the nursing care provided, the
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 centers. Federal regulations
affect the survey process for nursing centers and the authority of state survey
agencies and CMS to impose sanctions on facilities based upon noncompliance
with certain requirements. Available sanctions include, but are not limited to,
imposition of civil monetary penalties, temporary suspension of payment for new
admissions, appointment of a temporary manager, suspension of payment for
eligible patients and suspension or decertification from participation in the
Medicare and Medicaid programs.

We believe that substantially all of our nursing centers are in substantial
compliance with applicable Medicare and Medicaid requirements of participation.
In the ordinary course of business, however, the nursing centers receive
statements of deficiencies from regulatory agencies. In response, the health
services division implements plans of correction to address the alleged
deficiencies. In most instances, the regulatory agency will accept the
facility's plan of correction and place the nursing center back into compliance
with regulatory requirements. In some cases or upon repeat violations, the
regulatory agency may take a number of adverse actions against the nursing
center. These adverse actions may include the imposition of fines, temporary
suspension of admission of new patients to the nursing center, decertification
from participation in the Medicaid and/or Medicare programs and, in extreme
circumstances, revocation of the nursing center's license.

The health services division also is subject to federal and state laws that
govern financial and other arrangements between healthcare providers. These
laws often prohibit certain direct and indirect payments or fee-splitting
arrangements between healthcare providers that are designed to induce or
encourage the referral of patients to, or the recommendation of, a particular
provider for medical products and services. Such laws include the antikickback
amendments discussed above. These provisions prohibit, among other things, the
offer, payment, solicitation or receipt of any form of remuneration in return
for the referral of Medicare and Medicaid patients. In addition, some states
restrict certain business relationships between physicians and pharmacies, and
many states prohibit business corporations from providing, or holding
themselves out as a provider of, medical care. Possible sanctions for violation
of any of these restrictions or prohibitions include loss of licensure or
eligibility to participate in reimbursement programs as well as civil and
criminal penalties. These laws vary from state to state.

In certain circumstances, federal law mandates that conviction for certain
abusive or fraudulent behavior with respect to one nursing center may subject
other facilities under common control or ownership to disqualification from
participation in Medicare and Medicaid programs. In addition, some regulations
provide that all nursing centers under common control or ownership within a
state are subject to delicensure if any one or more of such facilities are
delicensed.

Hospital Division

Medicare and Medicaid and other Federal Regulation. The hospital division is
subject to various federal and state regulations. In order to receive Medicare
reimbursement, each hospital must meet the applicable conditions of
participation set forth by the Department of Health and Human Services 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. We have developed
a management system to facilitate our compliance with the various standards and
requirements. Each hospital employs a person who is responsible for an ongoing
quality

424B4 85th Page of 184 TOC 1st Previous Next ↓Bottom Just 85th
assessment and improvement program. Hospitals undergo periodic on-site Medicare
certification surveys, which generally are limited if the hospital is
accredited by the Joint Commission on Accreditation of Health Care
Organizations. As of June 30, 2001, all of the hospitals operated by the
hospital division were certified as Medicare providers and 52 of such hospitals
also were certified by their respective state Medicaid programs. A loss of
certification could affect adversely a hospital's ability to receive payments
from the Medicare and Medicaid programs.

Since 1983, Medicare has reimbursed general acute care hospitals under a
prospective payment system. Under the hospital prospective payment system,
Medicare inpatient costs are reimbursed based upon a fixed payment amount per
discharge using diagnosis related groups. The diagnosis-related group payment
under the hospital prospective payment system is based upon the national
average cost of treating a Medicare patient's condition. Although the average
length of stay varies for each diagnosis related group, the average stay for
all Medicare patients subject to the hospital prospective payment system is
approximately six days. An additional outlier payment is made for patients with
higher treatment costs. Outlier payments are only designed to cover marginal
costs. Accordingly, the hospital prospective payment system creates an economic
incentive for general short-term acute care hospitals to discharge medically
complex Medicare patients as soon as clinically possible. Hospitals that are
certified by Medicare as general long-term hospitals are excluded from the
hospital prospective payment system. We believe that the incentive for short-
term acute care hospitals to discharge medically complex patients as soon as
clinically possible creates a substantial referral source for our long-term
hospitals.

The Social Security Amendments of 1983 excluded certain hospitals, including
general long-term hospitals, from the hospital prospective payment system. A
general long-term hospital is defined as a hospital that has an average length
of stay greater than 25 days. Inpatient operating costs for general long-term
hospitals are reimbursed under the cost-based reimbursement system, subject to
a computed target rate per discharge for inpatient operating costs established
by TEFRA. As discussed below, the Balanced Budget Act made significant changes
to TEFRA's provisions.

Prior to the Balanced Budget Act, Medicare operating costs per discharge in
excess of the computed target rate were reimbursed at the rate of 50% of the
excess, up to 10% of the computed target rate. Hospitals whose operating costs
were lower than the computed target rate were reimbursed their actual costs
plus an incentive. For cost report periods beginning on or after October 1,
1997, the Balanced Budget Act reduced the incentive payments to an amount equal
to 15% of the difference between the actual costs and the computed target rate,
but not to exceed 2% of the computed target rate. Costs in excess of the
computed target rate are still being reimbursed at the rate of 50% of the
excess, up to 10% of the computed target rate, but the threshold to qualify for
such payments was raised from 100% to 110% of the computed target rate.

Since the adoption of the Balanced Budget Act, a new provider will no longer
receive unlimited cost-based reimbursement for its first few years in
operation. Instead, for the first two years, it will be paid the lower of its
costs or 110% of the median of TEFRA's computed target rate for 1996 adjusted
for inflation. During this two-year period, new providers are not eligible to
receive TEFRA relief or incentive payments discussed in the previous paragraph.

As of June 30, 2001, all of our long-term acute care hospitals were subject
to TEFRA's computed target rate provisions. The reduction in TEFRA's incentive
payments has had a material adverse effect on our hospital division's operating
results. These reductions, which began between May 1, 1998 and September 1,
1998 with respect to our hospitals, are expected to have a material adverse
impact on hospital division revenues in the future and may impact adversely our
ability to develop additional free-standing, long-term acute care hospitals.

We also operate four general acute care hospitals that are subject to the
hospital prospective payment system and are not subject to TEFRA's computed
target rate provisions.

424B4 86th Page of 184 TOC 1st Previous Next ↓Bottom Just 86th
Medicare and Medicaid reimbursements generally are determined from annual
cost reports that we file, which are subject to audit by the respective agency
administering the programs. We believe that adequate provisions for loss have
been recorded to reflect any adjustments that could result from audits of these
cost reports.

Federal regulations provide that admission to and utilization of hospitals
by Medicare and Medicaid patients must be reviewed by peer review organizations
in order to ensure efficient utilization of hospitals and services. A peer
review organization may conduct such review either prospectively or
retroactively and may, as appropriate, recommend denial of payments for
services provided to a patient. The review is subject to administrative and
judicial appeal. Each of the hospitals operated by our hospital division
employs a clinical professional to administer the hospital's integrated quality
assurance and improvement program, including its utilization review program.
Peer review organization denials have not had a material adverse effect on the
hospital division's operating results.

The antikickback amendments discussed above prohibit certain business
practices and relationships that might affect the provision and cost of
healthcare services reimbursable under federal healthcare programs. Sanctions
for violating these amendments include criminal and civil penalties and
exclusion from federal healthcare programs. Pursuant to the Medicare and
Medicaid Patient and Program Protection Act of 1987, the Department of Health
and Human Services and the Office of the Inspector General specified certain
safe harbors that describe conduct and business relationships permissible under
the antikickback amendments. These safe harbor regulations have resulted in
more aggressive enforcement of the antikickback amendments by the Department of
Health and Human Services and the Office of the Inspector General.

Section 1877 of the Social Security Act, commonly known as "Stark I," states
that a physician who has a financial relationship with a clinical laboratory
generally is prohibited from referring patients to that laboratory. The Omnibus
Budget Reconciliation Act of 1993 contains provisions, commonly known as "Stark
II," amending Section 1877 to expand greatly the scope of Stark I. Effective
January 1995, Stark II broadened the referral limitations of Stark I to
include, among other designated health services, inpatient and outpatient
hospital services. Under Stark I and Stark II, a "financial relationship" is
defined as an ownership interest or a compensation arrangement. If such a
financial relationship exists, the entity generally is prohibited from claiming
payment for such services under the Medicare or Medicaid programs. Compensation
arrangements generally are exempted from Stark I and Stark II if, among other
things, the compensation to be paid is set in advance, does not exceed fair
market value and is not determined in a manner that takes into account the
volume or value of any referrals or other business generated between the
parties. These laws and regulations, however, are complex and the industry has
the benefit of limited judicial or regulatory interpretation. We believe that
business practices of providers and financial relationships between providers
have become subject to increased scrutiny as healthcare reform efforts continue
on the federal and state levels.

The pharmacy operations within the hospital division are subject to
regulation by the various states in which business is conducted as well as by
the federal government. The pharmacies are regulated under the Food, Drug and
Cosmetic Act and the Prescription Drug Marketing Act, which are administered by
the United States Food and Drug Administration. Under the Comprehensive Drug
Abuse Prevention and Control Act of 1970, which is administered by the United
States Drug Enforcement Administration, dispensers of controlled substances
must register with the Drug Enforcement Administration, file reports of
inventories and transactions and provide adequate security measures. Failure to
comply with such requirements could result in civil or criminal penalties.

Joint Commission on Accreditation of Health Care Organizations. Hospitals
receive accreditation from the Joint Commission on Accreditation of Health Care
Organizations, a nationwide commission that establishes standards relating to
the physical plant, administration, quality of patient care and operation of
medical staffs of hospitals. Generally, hospitals and certain other healthcare
facilities are required to have been in operation at least six months in order
to be eligible for accreditation by the Joint Commission. After conducting on-
site surveys, the Joint Commission awards accreditation for up to three years
to hospitals found to be in substantial

424B4 87th Page of 184 TOC 1st Previous Next ↓Bottom Just 87th
compliance with Joint Commission standards. Accredited hospitals are
periodically resurveyed, at the option of the Joint Commission, upon a major
change in facilities or organization and after merger or consolidation. As of
June 30, 2001, all of the hospitals operated by the hospital division were
accredited by the Joint Commission. The hospital division intends to seek and
obtain Joint Commission accreditation for any additional facilities it may
purchase or lease and convert into long-term hospitals. We do not believe that
the failure to obtain Joint Commission accreditation at any hospital would have
a material adverse effect on the hospital division's results of operations.

Regulatory Changes

The Balanced Budget Act established a Medicare prospective payment system
for nursing centers for cost reporting periods beginning on or after July 1,
1998. All of our nursing centers adopted PPS on July 1, 1998. The payments
received under PPS cover all services for Medicare patients including all
ancillary services, such as respiratory therapy, physical therapy, occupational
therapy, speech therapy and certain covered pharmaceuticals.

The Balanced Budget Act also reduced payments made to our hospitals by
reducing TEFRA incentive payments, allowable costs for capital expenditures and
bad debts, and payments for services to patients transferred from a general
acute care 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. The reductions in payments for services to patients
transferred from a general acute care hospital became effective October 1,
1998. These reductions have had a material adverse impact on hospital revenues.
In addition, these reductions also may affect adversely the hospital division's
ability to develop or acquire additional free-standing, long-term acute care
hospitals in the future.

Under PPS, the volume of ancillary services provided per patient day to
nursing center patients also has declined dramatically. Medicare reimbursements
to nursing centers under PPS include substantially all services provided to
patients, including ancillary services. Prior to the implementation of PPS, the
costs of such services were reimbursed under cost-based reimbursement rules.
The decline in the demand for ancillary services since the implementation of
PPS is mostly attributable to efforts by nursing centers to reduce operating
costs. As a result, many nursing centers have elected to provide ancillary
services to their patients through internal staff. In response to PPS and a
significant decline in the demand for ancillary services, we realigned our
former ancillary services division in 1999 by integrating its physical
rehabilitation, speech and occupational therapy businesses into the health
services division and assigning its institutional pharmacy business to the
hospital division. Our respiratory therapy and other ancillary businesses were
discontinued.

Since November 1999, various legislative and regulatory actions have
provided a measure of relief from the impact of the Balanced Budget Act. In
November 1999, the BBRA was enacted. Effective April 1, 2000, the BBRA (a)
implemented a 20% upward adjustment in the payment rates for the care of higher
acuity patients, effective until the enactment of a revised Resource
Utilization Grouping payment system and (b) allowed nursing centers to
transition more rapidly to the federal payment rates. The BBRA also imposed a
two-year moratorium on certain therapy limitations for skilled nursing center
patients covered under Medicare Part B. Effective October 1, 2000, the BBRA
increased all PPS payment categories by 4% through September 30, 2002.

In April 2000, CMS published a proposed rule which sets forth updates to the
Resource Utilization Grouping payment rates used under PPS for nursing centers.
On July 31, 2000, CMS issued a final rule that

424B4 88th Page of 184 TOC 1st Previous Next ↓Bottom Just 88th
indefinitely postponed any refinements to the Resource Utilization Grouping
categories used under PPS. As such, the 20% upward adjustment for certain
higher acuity Resource Utilization Grouping categories set forth in the BBRA
was automatically extended until the Resource Utilization Grouping refinements
are enacted. On July 31, 2001, CMS issued another final rule which did not
establish such refinements, and accordingly, the 20% adjustment will remain in
place until the Resource Utilization Grouping categories are refined.

In December 2000, BIPA was enacted to provide up to $35 billion in
additional funding to the Medicare and Medicaid programs over the next five
years. Under BIPA, the nursing component for each Resource Utilization Grouping
category was increased by 16.66% over the existing rates for skilled nursing
care for the period April 1, 2001 through September 30, 2002. BIPA also
provided some relief from scheduled reductions to the annual inflation
adjustments to the Resource Utilization Grouping payment rates through
September 2001.

There continue to be legislative and regulatory proposals that would impose
more limitations on government and private payments to providers of healthcare
services. Congress has directed the Secretary of the U.S. Department of Health
and Human Services to develop a prospective payment system applicable
specifically to long-term acute care hospitals by October 1, 2001. The new
prospective payment system would be effective for cost report periods beginning
on or after October 1, 2002. This payment system would not impact us until
September 1, 2003. To date, the Secretary has not proposed such a prospective
payment system. Congress has further directed that if the Secretary is unable
to implement a prospective payment system specific to long-term acute care
hospitals by October 1, 2002, the Secretary shall instead implement, as of such
date, a prospective payment system for long-term acute care hospitals based
upon existing hospital diagnosis-related groups modified where feasible to
account for resource use of long-term acute care hospital patients. We cannot
predict the content or timing of such regulations. We cannot assure you that
such regulations will not have a material adverse impact on our financial
condition and results of operations.

We could be adversely affected by the continuing efforts of governmental and
private third-party payors to contain healthcare costs. We cannot assure you
that payments under governmental and private third-party payor programs will
remain at levels comparable to present levels or will be sufficient to cover
the costs allocable to patients eligible for reimbursement pursuant to such
programs. In addition, we cannot assure you that the facilities we operate, or
the provision of services and supplies by us, will meet the requirements for
participation in such programs.

424B4 89th Page of 184 TOC 1st Previous Next ↓Bottom Just 89th
Information Systems

Our information systems strategy is focused on utilizing industry-leading
technology to allow us to operate efficiently and effectively under fixed
reimbursement levels and increased regulatory compliance requirements. Our
information systems activities are determined by the operational strategies and
priorities of each of our operating divisions.

Our integrated financial system allows for timely monthly reporting of
financial results on a company-wide basis. In addition, extensive data
warehouse capabilities across each operating division allows us to access
sophisticated clinical and financial management information at a local,
regional and corporate level, enhancing our ability to manage operational
performance. In 2000, we installed a new integrated human resources and payroll
system in all of our hospitals and the corporate office. We are currently
implementing this system in our nursing centers.

In 2000, we developed new education tracking and event reporting systems to
support the Corporate Integrity Agreement. We also implemented in 2000 an
internet-based distance learning tool which provides a cost-effective method to
deliver timely training to employees. Company-wide access to various data
through internet-based solutions has improved operating efficiencies and
reduced administrative costs.

The information systems for the health services division provide support for
product line management and third-party reimbursement. The resident care system
is an internally developed business application that captures patient
assessment data to ensure that minimum data set assessment forms are filed
accurately and timely with reimbursement sources in each state. Our clinical
care management system blends clinical and financial results within our data
warehouse to provide a decision support platform for delivering high quality
care in an economical manner. Our quality reporting system, based on the
industry-standard quality indicators used by CMS, allows each facility to
monitor and manage the quality of care being delivered. A new internet-based
patient referral system is enhancing the health services division's
relationships with hospital discharge planners by facilitating the search to
locate appropriate nursing centers for patients and automating the
communication of critical patient data between the discharging and admitting
facilities.

Our hospitals utilize ProTouch(TM), formerly named VenTouch(TM), an
internally developed electronic patient medical record system that was designed
specifically for the long-term acute care environment. ProTouch(TM) is a
software application that allows nurses, physicians and other clinicians to
enter clinical information during the patient care delivery process and view an
electronic patient chart. In order to achieve compliance with the new HIPAA
regulations regarding electronically transmitted health data, we are enhancing
ProTouch(TM) to meet the government mandated patient data privacy and security
requirements. A new internally developed system, CustomCare, classifies
patients based on a combination of acuity and required nursing interventions,
which allows us to monitor employee skill mix and manage labor costs. Our
information systems also assist us in managing staffing levels and monitoring
quality indicators at the facility, regional and corporate levels.

Our information systems architecture provides a reliable, scalable
infrastructure that is based on personal computers in the facilities connected
by a wide-area network to our centralized data center in Louisville, Kentucky.
Our information system network allows us to operate over 8,000 distributed
personal computers and 600 centrally located servers on a continuous basis.

Employees

At June 30, 2001, we employed approximately 38,700 full-time employees and
12,600 part-time and per diem employees. Approximately 3,600 of our employees
are union members. We believe that our employee relations are satisfactory.

Legal Proceedings

Our subsidiary, formerly named TheraTx, Incorporated, is a plaintiff in a
declaratory judgment action entitled TheraTx, Incorporated v. James W. Duncan,
Jr., et al., No. 1:95-CV-3193, filed in the United States District Court for
the Northern District of Georgia and currently pending in the United States
Court of Appeals

424B4 90th Page of 184 TOC 1st Previous Next ↓Bottom Just 90th
for the Eleventh Circuit, No. 99-11451-FF. The defendants asserted
counterclaims against TheraTx under breach of contract, securities fraud,
negligent misrepresentation and other 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'
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. We and the
defendants/counterclaimants both appealed the court's rulings. The United
States Court of Appeals for the Eleventh Circuit affirmed the trial court's
rulings in TheraTx's favor, with the exception of the damages award, and
certified the question of the proper calculation of damages under Delaware law
to the Delaware Supreme Court. The Delaware Supreme Court issued an opinion on
June 1, 2001, which sets forth a rule for determining such damages but did not
calculate any actual damages. On June 25, 2001, the Eleventh Circuit remanded
the action to the trial court to render a decision consistent with the Delaware
Supreme Court's ruling. On July 24, 2001, the defendants filed a Notice of
Bankruptcy Stay in the trial court. We are defending the action vigorously.

On August 13, 2001, we and TheraTx, Incorporated filed an Objection and
Complaint in an action entitled Vencor, Inc. and TheraTx Inc. v. James W.
Duncan, et al., Adversary Proceeding No. 01-6117 (MFW), in the United States
Bankruptcy Court for the District of Delaware. The complaint seeks to
subordinate and disallow the defendants' bankruptcy claim or, alternatively, to
reduce the claim by and recover from the defendants a preferential payment made
by the debtors to the defendants. The complaint also seeks an injunction
against any efforts by the defendants to enforce the judgment ultimately
granted in the above litigation pending in the Northern District of Georgia.

We are pursuing various claims against private insurance companies who
issued Medicare supplement insurance policies to individuals who became
patients of our hospitals. After the patients' Medicare benefits are exhausted,
the insurance companies become liable to pay the insureds' bills pursuant to
the terms of these policies. We have filed numerous collection actions against
various of these insurers to collect the difference between what Medicare would
have paid and the hospitals' usual and customary charges. These disputes arise
from differences in interpretation of the policy provisions and federal and
state laws governing such policies. Various courts have issued various rulings
on the different issues, some of which have been adverse to us and most of
which have been appealed. We intend to continue to pursue these claims
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 class action claims
were brought by an alleged stockholder of our predecessor against us and Ventas
and certain of our and Ventas' current and former executive officers and
directors and those of Ventas. The complaint alleges that we, Ventas and
certain of our and Ventas' current and former executive officers during a
specified time frame violated Sections 10(b) and 20(a) of the Securities
Exchange Act of 1934, by, among other things, issuing to the investing public a
series of false and misleading statements concerning Ventas' then current
operations and the inherent value of its common stock. The complaint further
alleges that as a result of these purported false and misleading statements
concerning Ventas' revenues and successful acquisitions, the price of the
common stock was artificially inflated. In particular, the complaint alleges
that the defendants issued false and misleading financial statements during the
first, second and third calendar quarters of 1997 which misrepresented and
understated the impact that changes in Medicare reimbursement policies would
have on Ventas' core services and profitability. The complaint further alleges
that the defendants issued a series of materially false statements concerning
the purportedly successful integration of Ventas' acquisitions and prospective
earnings per share for 1997 and 1998 which the defendants 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-

424B4 91st Page of 184 TOC 1st Previous Next ↓Bottom Just 91st
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 December
1998, the defendants filed a motion to dismiss the case. The court converted
the defendants' motion to dismiss into a motion for summary judgment and
granted summary judgment as to all defendants. The plaintiff appealed the
ruling to the United States Court of Appeals for the Sixth Circuit. On April
24, 2000, the Sixth Circuit affirmed the district court's dismissal of the
action on the grounds that the plaintiff failed to state a claim upon which
relief could be granted. On July 14, 2000, the Sixth Circuit granted the
plaintiff's petition for a rehearing en banc. On May 31, 2001, the Sixth
Circuit issued its en banc decision reversing the trial court's dismissal of
the complaint. The defendants filed a Petition for Certiorari seeking review of
the Sixth Circuit's decision in the United States Supreme Court on September
27, 2001. We are defending this action vigorously.

A shareholder derivative suit entitled Thomas G. White on behalf of Vencor,
Inc. and Ventas, Inc. v. W. Bruce Lunsford, et al., Case No. 98CI03669, was
filed in June 1998 in the Jefferson County, Kentucky, Circuit Court. The suit
was brought on behalf of us and Ventas against certain current and former
executive officers and directors of ours and Ventas. The complaint alleges that
the defendants damaged us and Ventas by engaging in violations of the
securities laws, engaging in insider trading, fraud and securities fraud and
damaging our reputation and that of Ventas. 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 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 we and
Ventas have an effective remedy. We believe that the allegations in the
complaint are without merit and intend to defend this action vigorously.

A class action lawsuit entitled Jules Brody v. Transitional Hospitals
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 Hospitals
Corporation common stock during the period from February 26, 1997 through May
4, 1997, inclusive. 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 the Transitional 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, 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 our motion to dismiss with leave to amend the Section
10(b) claim and the state law claims for misrepresentation. The court denied
our motion to dismiss the Section 14(e) and Section 20(a) claims, after which
we filed a motion for reconsideration. On March 23, 1999, the court granted our
motion to dismiss all remaining claims and the case was dismissed. The
plaintiff has appealed this ruling to the United States Court of Appeals for
the Ninth Circuit. We are defending this action vigorously.

In connection with our Fourth Amended Joint Plan of Reorganization, we,
Ventas and the Department of Justice, acting on behalf of itself, the
Department of Health and Human Services' Office of Inspector General and CMS,
entered into a government settlement, which resolved all known claims arising
out of all known investigations being made by the Department of Justice and the
Office of Inspector General including certain pending qui tam, or
whistleblower, actions. Under the government settlement, the government was
required to move to dismiss with prejudice to the United States and the
relators (except for certain claims which will be dismissed without prejudice
to the United States in certain of the cases) the pending qui tam actions as
against any or all of us and our subsidiaries, Ventas and any current or former
officers, directors and employees of either entity.

424B4 92nd Page of 184 TOC 1st Previous Next ↓Bottom Just 92nd
Except for the qui tam action described in this paragraph, all other known
pending qui tam actions against us have been resolved by the government
settlement. The only remaining case is entitled United States, et al., ex rel.
Phillips-Minks, et al. v. Transitional Corp., et al., filed in the United
States District Court for Southern District of California on July 23, 1998. In
this action, the defendants, including Transitional Hospitals Corporation and
Ventas, are alleged to have submitted and conspired to submit false claims and
statements to Medicare, Medicaid, and other federal and state funded programs
during a period commencing in 1993. The conduct complained of allegedly
violates the Federal Civil False Claims Act, the California False Claims Act,
the Florida False Claims Act, the Tennessee Health Care False Claims Act, and
the Illinois Whistleblower Reward and Protection Act. The defendants allegedly
submitted improper and erroneous claims to Medicare, Medicaid and other
programs, for improper or unnecessary services and services not performed,
inadequate collections efforts associated with billing and collecting bad
debts, inflated and nonexistent laboratory charges, false and inadequate
documentation of claims, splitting charges, shifting revenues and expenses,
transferring patients to hospitals that are reimbursed by Medicare at a higher
level, failing to return duplicate reimbursement payments, and improperly
allocating hospital insurance expenses. In addition, the complaint alleges that
the defendants were inconsistent in their reporting of cost report data, paid
kickbacks to increase patient referrals to hospitals, and incorrectly reported
employee compensation resulting in inflated employee 401(k) contributions. The
complaint seeks unspecified damages. We dispute the allegations in the
complaint and intend to defend this action vigorously. On July 27, 2001, the
court ordered that the Department of Justice be allowed to intervene in the
action to effectuate the government settlement contained in our Fourth Amended
Joint Plan of Reorganization. There can be no assurance that the court will
dismiss this case upon the motion by the Department of Justice.

In connection with our spin-off from Ventas in 1998, liabilities arising
from various legal proceedings and other actions were assumed by us and we
agreed to indemnify Ventas against any losses, including any costs or expenses,
it may incur arising out of or in connection with such legal proceedings and
other actions. The indemnification provided by us also covers losses, including
costs and expenses, which may arise from any future claims asserted against
Ventas based on the former healthcare operations of Ventas. In connection with
our indemnification obligation, we assumed the defense of various legal
proceedings and other actions. Under our Fourth Amended Joint Plan of
Reorganization, we agreed to continue to fulfill our indemnification
obligations arising from the 1998 spin-off.

We are a party to certain legal actions and regulatory investigations
arising in the normal course of our business. We are unable to predict the
ultimate outcome of pending litigation and regulatory investigations. In
addition, there can be no assurance that the Department of Justice, CMS or
other regulatory agencies will not initiate additional investigations related
to our businesses 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 our results of
operations, liquidity or financial position. In addition, the above litigation
and investigations (as well as future litigation and investigations) are
expected to consume the time and attention of our management and may have a
disruptive effect upon our operations.

Environmental Matters

We are subject to various federal, state and local laws and regulations
governing the use, discharge and disposal of hazardous materials, including
medical waste products. Compliance with these laws and regulations is not
expected to have a material adverse effect on us. It is possible, however, that
environmental issues may arise in the future which we cannot now predict.

424B4 93rd Page of 184 TOC 1st Previous Next ↓Bottom Just 93rd
MANAGEMENT

The following sets forth information regarding our executive officers and
directors as of June 30, 2001.

[Download Table]

Name Age Position
---- --- -----------------------------------------------

Edward L. Kuntz.......... 56 Chairman of the Board, Chief Executive Officer
and President
Richard A. Schweinhart... 51 Senior Vice President and Chief Financial
Officer
Frank J. Battafarano..... 50 President, Hospital Division
Donald D. Finney......... 54 President, Health Services Division
Richard E. Chapman....... 53 Chief Administrative and Information Officer
and Senior Vice President
James H. Gillenwater,
Jr...................... 44 Senior Vice President, Planning and Development
M. Suzanne Riedman....... 50 Senior Vice President and General Counsel
William M. Altman........ 42 Vice President of Compliance and Government
Programs
Richard A. Lechleiter.... 43 Vice President, Finance, Corporate Controller
and Treasurer
James Bolin.............. 42 Director
Michael J. Embler........ 37 Director
Garry N. Garrison........ 54 Director
Isaac Kaufman............ 54 Director
John H. Klein............ 55 Director
David A. Tepper.......... 43 Director

Edward L. Kuntz has served as our Chairman of the Board, Chief Executive
Officer and President since January 1999. He served as our President, Chief
Operating Officer and director from November 1998 to January 1999. Mr. Kuntz
was Chairman and Chief Executive Officer of Living Centers of America, Inc., a
leading provider of long-term healthcare, from 1992 to 1997. After leaving
Living Centers of America, Inc., he served as an advisor and consultant to a
number of healthcare services and investment companies and was affiliated with
Austin Ventures, a venture capital firm. In addition, Mr. Kuntz served as
Associate General Counsel and later as Executive Vice President of ARA Living
Centers until the formation of Living Centers of America, Inc. in 1992.

Richard A. Schweinhart, a certified public accountant, has served as our
Senior Vice President and Chief Financial Officer since September 1998. Mr.
Schweinhart was Senior Vice President--Columbia Sponsored Networks for
Columbia/HCA Healthcare Corp. from March 1996 through September 1998. From
April 1995 until March 1996, he served as Senior Vice President--Nonhospital
Operations and from September 1993 until April 1995 as Senior Vice President--
Finance of Columbia/HCA Healthcare Corp. Mr. Schweinhart served as Senior Vice
President--Finance for both Galen Health Care, Inc. and Humana, Inc. from
November 1991 to September 1993.

Frank J. Battafarano has served as our President, Hospital Division since
November 1998. He served as our Vice President of Operations from April 1998 to
November 1998. He held the same position with our predecessor from February
1998 to April 1998. From May 1996 to January 1998, Mr. Battafarano served as
Senior Vice President of the central regional office of our predecessor. From
January 1992 to April 1996, he served as an executive director and hospital
administrator for our predecessor.

Donald D. Finney has served as our President, Health Services Division since
January 1999. During 1998, Mr. Finney was Chief Executive Officer of HCMF
Corporation, a privately held post-acute and assisted living provider. From
January 1997 to December 1997, he served as Chief Operating Officer of
Summerville Healthcare Group, Inc., an operator of assisted living facilities.
He served as President of the Facilities Division

424B4 94th Page of 184 TOC 1st Previous Next ↓Bottom Just 94th
of GranCare, Inc. from July 1995 to January 1997. From October 1990 to July
1995, Mr. Finney served as Chief Operating Officer of Evergreen Healthcare,
Inc., an operator of long-term care and assisted living facilities.

Richard E. Chapman has served as our Chief Administrative and Information
Officer and Senior Vice President since January 2001. From April 1998 to
January 2001, he served as our Senior Vice President and Chief Information
Officer. Mr. Chapman served as Senior Vice President and Chief Information
Officer of our predecessor from October 1997 to April 1998. From March 1993 to
October 1997, he was Senior Vice President of Information Systems of
Columbia/HCA Healthcare Corp., Vice President of Galen Health Care, Inc. from
March 1993 to August 1993, and Vice President of Humana, Inc. from September
1988 to February 1993.

James H. Gillenwater, Jr. has served as our Senior Vice President, Planning
and Development since April 1998. Mr. Gillenwater served as Senior Vice
President, Planning and Development of our predecessor from December 1996 to
April 1998. From November 1995 through December 1996, he served as Vice
President, Planning and Development of our predecessor and was Director of
Planning and Development from 1989 to November 1995.

M. Suzanne Riedman, an attorney, has served as our Senior Vice President and
General Counsel since August 1999. She served as our Vice President and
Associate General Counsel from April 1998 to August 1999. Ms. Riedman held the
same position with our predecessor from January 1997 to April 1998. She joined
our predecessor as counsel in September 1995 and became Associate General
Counsel in January 1996. Ms. Riedman served as counsel to another large long-
term healthcare provider in various capacities from 1990 to 1995. Prior to that
time, Ms. Riedman was in the private practice of law for 11 years.

William M. Altman, an attorney, has served as our Vice President of
Compliance and Government Programs since October 1999. He served as Operations
Counsel in our law department from May 1998 to September 1999. He held the same
position with our predecessor from June 1996 through April 1998. Prior to
joining our predecessor, Mr. Altman was in the private practice of law for ten
years and held other consulting and government positions in healthcare.

Richard A. Lechleiter, a certified public accountant, has served as our Vice
President, Finance and Corporate Controller since April 1998 and also has
served as Treasurer since July 1998. Mr. Lechleiter served as Vice President,
Finance and Corporate Controller of our predecessor from November 1995 to April
1998. From June 1995 to November 1995, he was Director of Finance for our
predecessor. Mr. Lechleiter was Vice President and Controller of Columbia/HCA
Healthcare Corp. from September 1993 to May 1995, of Galen Health Care, Inc.
from March 1993 to August 1993, and of Humana, Inc. from September 1990 to
February 1993.

James Bolin has served as a director of our company since April 2001. Since
1995, Mr. Bolin has been Vice President and Secretary of Appaloosa Management
L.P. Mr. Bolin serves as a director of Inamed Corporation, a global surgical
and medical device company, and Bio-Plexus, Inc., a designer and manufacturer
of safety medical products.

Michael J. Embler has served as a director of our company since July 2001.
Since July 2001, Mr. Embler has been Vice President of Franklin Mutual
Advisers, LLC. From October 1992 to May 2001, he served in various positions
with Nomura Holding America, most recently as Managing Director.

Garry N. Garrison has served as a director of our company since April 2001.
From 1997 to 2000, Mr. Garrison served as Senior Vice President of Dynamic
Healthcare Solutions, Inc., a venture capital firm specializing in high-growth,
health related businesses. From 1996 to 1997, he served as President and Chief
Executive Officer, Specialty Services Division of the Foundation Health
Systems, Inc., overseeing operations

424B4 95th Page of 184 TOC 1st Previous Next ↓Bottom Just 95th
for various specialty services companies. Mr. Garrison also served as President
and Chief Operating Officer of Integrated Pharmaceutical Services from 1994 to
1996.

Isaac Kaufman, a certified public accountant, has served as a director of
our company since April 2001. Since September 1998, Mr. Kaufman has served as
the Senior Vice President and Chief Financial Officer of Advanced Medical
Management Inc., a manager of medical practices and an outpatient surgical
center. From February 1998 to September 1998, he served as the Chief Financial
Officer of Bio Science Contract Production Corp., a contract manufacturer of
bulk pharmaceuticals and biologics. Mr. Kaufman also served as Chief Financial
Officer of VSI Group, Inc. From October 1996 to February 1998. Mr. Kaufman
serves as a director of TransWorld Entertainment Corporation, a leading
specialty retailer of music and video products.

John H. Klein has served as a director of our company since April 2001. Mr.
Klein has been the Chairman and Chief Executive Officer of Strategic Business
and Technology Solutions, LLC, a strategy business and technology advisory
firm, since June 1998. Mr. Klein also has served as the Chairman and Chief
Executive Officer of BI Logix, Inc., a business intelligence software solutions
company, since May 1998. In addition, he has served as Chairman and Chief
Executive Officer of DentalLine.com, a group benefit and internet company,
since July 1999. From March 1998 to August 2000, he served as Director and Vice
Chairman of Image Vision, a developer and marketer of imaging systems and
products. Mr. Klein also served as Chairman and Chief Executive Officer of the
MIM Corporation, a provider of pharmacy benefit services, from 1996 to May
1998. Mr. Klein is a director of U.S. Interactive, Inc. and Sunbeam
Corporation.

David A. Tepper has served as a director of our company since April 2001.
Mr. Tepper has been President of Appaloosa Management, L.P. since 1993. Mr.
Tepper also serves as a director of Inamed Corporation, a global surgical and
medical device company.

Each of the executive officers serves at the pleasure of the board of
directors.

In addition to the executive officers listed above, we are currently
searching for an individual to serve as President of our company. This
individual will be responsible for various management duties, including
management of our day-to-day operations, and would report directly to Mr.
Kuntz, who will continue to serve as Chairman and Chief Executive Officer. We
expect to fill this position by the end of 2001.

424B4 96th Page of 184 TOC 1st Previous Next ↓Bottom Just 96th
PRINCIPAL AND SELLING STOCKHOLDERS

The following table sets forth, as of June 30, 2001, certain information
regarding the beneficial ownership of shares of our common stock immediately
prior to the consummation of the offering and as adjusted to reflect the sale
of the shares of common stock pursuant to the offering. The table provides
information for:

. each of our directors and executive officers,

. all of our directors and executive officers as a group,

. each person who is known by us to beneficially own more than 5% of our
common stock, and

. other selling stockholders.

Unless otherwise stated, the address for each of our directors and executive
officers is 680 South Fourth Street, Louisville, Kentucky 40202-2412.

[Download Table]

Shares Beneficially Shares Beneficially
Owned Owned
Prior to Offering (1) After the Offering
-------------------------- Shares ---------------------
Name of Beneficial Number of Being Number of
Owners Shares Percent Offered Shares Percent
------------------ ------------- --------- ------- ------------ --------

Directors and Executive
Officers
Edward L. Kuntz......... 135,000 (2) * 10,000 125,000 *
James Bolin............. 5,496,822 (3) 30.3 500,000 4,996,822 25.1
Michael J. Embler....... - - - - -
Garry N. Garrison....... - - - - -
Isaac Kaufman........... - - - - -
John H. Klein........... - - - - -
David A. Tepper......... 5,496,822 (3) 30.3 500,000 4,996,822 25.1
William M. Altman....... 23,700 (2) * 3,900 19,800 *
Frank J. Battafarano.... 33,900 (2) * 3,000 30,900 *
Richard E. Chapman...... 38,500 (2) * 7,500 31,000 *
Donald D. Finney........ 38,500 (2) * 10,000 28,500 *
James H. Gillenwater,
Jr..................... 22,300 (2) * 2,500 19,800 *
Richard A. Lechleiter... 23,700 (2) * 6,500 17,200 *
M. Suzanne Riedman...... 28,000 (2) * 2,300 25,700 *
Richard A. Schweinhart.. 38,500 (2) * 7,500 31,000 *
All Directors and
Executive Officers as a
Group (15 persons)..... 5,878,922 (4) 32.4 553,200 5,325,722 26.8
Other Stockholders with
More than 5% Ownership
Appaloosa Management
L.P., Appaloosa
Partners, Inc. and
David A. Tepper (3).... 5,496,822 30.3 500,000 4,996,822 25.1
Stephen Feinberg (5).... 1,181,451 7.6 - 1,181,451 6.8
Franklin Mutual
Advisers, LLC (6)...... 5,423,181 30.9 400,000 5,023,181 26.0
Goldman, Sachs & Co. and
The Goldman Sachs
Group, Inc. (7)........ 2,013,490 12.4 250,000 1,763,490 9.8
Van Kampen Prime Rate
Income Trust (8)....... 1,064,604 6.8 86,100 978,504 5.6
Ventas Realty, Limited
Partnership (9)........ 1,498,500 9.6 83,300 1,415,200 8.2

424B4 97th Page of 184 TOC 1st Previous Next ↓Bottom Just 97th
[Download Table]

Shares Beneficially Shares Beneficially
Owned Owned
Prior to Offering (1) After the Offering
---------------------------Shares ---------------------
Name of Beneficial Number of Being Number of
Owners Shares Percent Offered Shares Percent
------------------ ------------ ------------------ ----------- --------

Other Selling
Stockholders
Rodrick J. Cowgill,
Jr..................... 7,900 (2) * 1,200 6,700 *
Dennis J. Hansen........ 9,900 (2) * 1,000 8,900 *
Ruth A. Lusk............ 9,200 (2) * 1,500 7,700 *
Katheryn J. Markham..... 11,100 (2) * 1,800 9,300 *
Mark A. McCullough...... 9,400 (2) * 400 9,000 *
Steven L. Monaghan...... 12,200 (2) * 1,500 10,700 *
Susan E. Moss........... 8,600 (2) * 700 7,900 *
Sean R. Muldoon......... 9,200 (2) * 2,000 7,200 *
Robert E. Schmidt....... 11,200 (2) * 2,500 8,700 *
T. Terry Tackett........ 10,000 (2) * 3,300 6,700 *
Morgan Guaranty Trust
Co. of New York........ 157,276 * 59,500 97,776 *
Van Kampen Senior Income
Trust.................. 543,875 3.5 44,000 499,875 2.9
Van Kampen Senior
Floating Rate Fund..... 59,981 * 4,900 55,081 *

---------------------
* Denotes less than 1%.

(1) Such information assumes that (a) options or warrants that are held by
such person (but not those held by any other person) and which are
exercisable within 60 days from the date of this prospectus have been
exercised and (b) to the extent publicly available information does
not specify which portion of certain shares of common stock is in the
form of warrants, such shares are held in the form of common stock.
Unless otherwise noted, we believe that all persons named in the table
have sole voting and investment power with respect to all shares of
common stock and/or warrants beneficially owned by them.
(2) These shares represent restricted shares awarded under our restricted
share plan. One-third of these shares vested on May 21, 2001 and the
remaining two-thirds will vest as follows: 15% on each of the first
and second anniversary of the date of grant; 20% on the third
anniversary of the date of grant and 50% on the fourth anniversary of
the date of grant.
(3) Based on a Schedule 13D jointly filed by Appaloosa Management L.P.,
Appaloosa Partners, Inc. and David A. Tepper on April 26, 2001 with
the SEC and a Form 3 jointly filed with the SEC by Appaloosa
Management L.P., Appaloosa Partners, Inc., David A. Tepper and James
Bolin. According to these filings, Mr. Tepper is the sole stockholder
and President of Appaloosa Partners, Inc. Mr. Bolin is a Vice
President and Secretary of Appaloosa Partners, Inc. Appaloosa
Partners, Inc. is the general partner of Appaloosa Management L.P.
Appaloosa Management L.P. is the general partner of Appaloosa
Investment Limited Partnership I and acts as an investment advisor to
Palomino Fund Ltd. Under our Fourth Amended Joint Plan of
Reorganization, Appaloosa Investment Limited Partnership I and
Palomino Fund Ltd. received (a) 2,975,428 shares of common stock,
(b) 720,398 Series A warrants and (c) 1,800,996 Series B warrants.
According to the Schedule 13D, Appaloosa Management L.P., Appaloosa
Partners, Inc. and Mr. Tepper may be deemed to have the sole voting
and dispositive power with respect to 5,496,822 shares of common
stock, of which 2,521,394 represent shares issuable upon exercise of
the Series A and Series B warrants. The address of Appaloosa
Management L.P., Appaloosa Partners, Inc., David A. Tepper and James
Bolin is 26 Main Street, 1st Floor, Chatham, New Jersey 07928.
(4) The number of shares of common stock shown in the table includes shares
issuable upon the exercise of 720,398 Series A warrants and 1,800,996
Series B warrants. See note 3.

424B4 98th Page of 184 TOC 1st Previous Next ↓Bottom Just 98th
(5) Based on a Schedule 13D filed by Stephen Feinberg on May 8, 2001 with
the SEC. Cerberus Institutional Partners, L.P. is the holder of 244,530
shares of common stock, Cerberus International, Ltd. is the holder of
630,157 shares of common stock and various other private investment
funds own in the aggregate 306,764 shares of common stock. Based on the
Schedule 13D, Stephen Feinberg possesses sole power to vote and direct
the disposition of all securities described in the immediately
preceding sentence. The address of Mr. Feinberg is 450 Park Avenue,
28th Floor, New York, New York 10022.
(6) Based on a Schedule 13D filed by Franklin Mutual Advisers, LLC on
April 20, 2001 with the SEC and other information available to us.
According to the Schedule 13D, the common stock reported in the
Schedule 13D is beneficially owned by one or more open-end investment
companies or other management accounts of Franklin Mutual Advisers,
LLC. Under its advisory contracts, Franklin Mutual Advisers, LLC has
sole voting and investment discretion over these securities. The
number of shares of common stock shown in the table includes shares
issuable upon the exercise of 560,242 Series A warrants and 1,400,603
Series B warrants. Michael J. Embler is a Vice President of Franklin
Mutual Advisers, LLC and disclaims beneficial ownership of shares held
by Franklin Mutual Advisers, LLC. The address of Franklin Mutual
Advisers, LLC is 51 John F. Kennedy Parkway, Short Hills, New Jersey
07078.
(7) Based on a Schedule 13G jointly filed by Goldman, Sachs & Co. and The
Goldman Sachs Group, Inc. on May 10, 2001 with the SEC and a Form 3
jointly filed with the SEC by Goldman, Sachs & Co. and The Goldman
Sachs Group, Inc. According to the Schedule 13G, Goldman, Sachs & Co.
and The Goldman Sachs Group, Inc. share voting and dispositive power
with respect to these securities. The number of shares of common stock
shown in the table includes shares issuable upon the exercise of
170,594 Series A warrants and 426,484 Series B warrants. The address
of Goldman, Sachs & Co. and The Goldman Sachs Group, Inc. is 85 Broad
Street, New York, New York 10004.
(8) Based on information provided to us by Van Kampen Prime Rate Income
Trust. The address of Van Kampen Prime Rate Income Trust is 1 Parkview
Plaza, Oakbrook Terrace, Illinois 60181.
(9) Based on a Schedule 13G jointly filed by Ventas, Inc. and Ventas
Realty, Limited Partnership on October 10, 2001 with the SEC. According
to the Schedule 13G, each of Ventas, Inc. and Ventas Realty, Limited
Partnership has shared ownership and voting dispositive power with
respect to these securities. Ventas, Inc. is the sole general partner
of Ventas Realty, Limited Partnership, and Ventas LP Realty, LLC is the
sole limited partner of Ventas Realty, Limited Partnership. The address
of each of Ventas, Inc. and Ventas Realty, Limited Partnership is 4360
Brownsboro Road, Suite 115, Louisville, Kentucky 40207-1642.

424B4 99th Page of 184 TOC 1st Previous Next ↓Bottom Just 99th
DESCRIPTION OF CAPITAL STOCK

The following summary description of our capital stock is qualified in its
entirety by reference to our Amended and Restated Certificate of Incorporation
and our Amended and Restated By-laws.

General

Authorized, Issued and Outstanding Capital Stock

We are authorized to issue a total of 40,000,000 shares of capital stock,
consisting of 39,000,000 shares of common stock and 1,000,000 shares of
preferred stock. As of June 30, 2001, there were 15,600,000 shares of common
stock outstanding and no shares of preferred stock outstanding.

Fully Paid

The issued and outstanding shares of common stock, and any shares of common
stock issuable under the stock option plans or upon the exercise of warrants
for common stock, will be duly authorized, validly issued, fully paid and non-
assessable.

Common Stock

Listing

Our common stock is quoted on the OTC Bulletin Board under the trading
symbol "KIND."

Dividends

Holders of common stock are entitled to receive ratably such dividends as
may be declared by the board of directors out of funds legally available
therefor. We are subject to certain limitations on the declaration and payment
of dividends, other than stock dividends, pursuant to the terms of our new
senior secured notes and the terms of our revolving credit facility. We do not
expect to pay cash dividends on the common stock in the foreseeable future.

Rights Upon Liquidation, Dissolution or Winding Up

In the event of a liquidation, dissolution or winding up of our company,
holders of common stock would have the right to a ratable portion of assets
remaining after payment of liabilities and subject to the prior rights of any
holders of preferred stock then outstanding. Holders of common stock will have
no preemptive rights.

Voting

Holders of common stock are entitled to one vote per share for each share
held of record on all matters submitted to a vote of stockholders.

Registrar and Transfer Agent

The registrar and transfer agent for the common stock is National City Bank,
629 Euclid Avenue, Room 635, Cleveland, Ohio 44114, (800) 622-8100.

Preferred Stock

Our Amended and Restated Certificate of Incorporation authorizes the board
of directors to issue preferred stock in one or more series and to establish
the designations, powers, preferences and rights and the qualifications,
limitations and restrictions of any series with respect to the number of shares
included in such

424B4 100th Page of 184 TOC 1st Previous Next ↓Bottom Just 100th
series, the rate and nature of dividends, the price and terms and conditions on
which shares may be redeemed, the terms and conditions for conversion or
exchange into any other class or series of stock, voting rights and other
terms. We may issue, without the approval of the holders of the common stock,
preferred stock which has voting, dividend or liquidation rights superior to
the common stock and which may adversely affect the rights of holders of the
common stock. The issuance of preferred stock could, among other things,
adversely affect the voting power of the holders of common stock and could have
the effect of delaying, deferring or preventing a change in control of the
company.

Certain Restrictions

Our Amended and Restated Certificate of Incorporation states that we may not
issue nonvoting equity securities to the extent prohibited by Section
1123(6)(a) of the Bankruptcy Code. In addition, in order to help ensure that
Ventas continues to meet the requirements for treatment as a real estate
investment trust, the Amended and Restated Certificate of Incorporation
prohibits a particular shareholder, Tenet Healthcare Corporation and its
successors, from beneficially owning, directly or indirectly (including by
application of certain attribution rules under the Internal Revenue Code),
shares of our common stock in excess of the existing holder limit set forth in
the Amended and Restated Certificate of Incorporation for so long as Tenet
Healthcare Corporation and its successors remain a significant shareholder in
Ventas. Any shares of our common stock beneficially owned by Tenet Healthcare
Corporation and its successors in excess of such existing holder limit,
including shares beneficially owned by persons that are or become related to
Tenet Healthcare Corporation and its successors under the attribution rules,
will be designated as "excess stock" and treated as described in the Amended
and Restated Certificate of Incorporation. The certificates evidencing our
common stock contain a legend referencing the above restriction. In addition,
if we engage in an "Accretive Transaction" (as defined in the Amended and
Restated Certificate of Incorporation), we will purchase from Ventas such
number of shares as are necessary to prevent Ventas from beneficially owning in
excess of 9.9% of our company after giving effect to such Accretive
Transaction.

Indemnification of Directors and Officers

Section 145 of the Delaware General Corporation Law permits a Delaware
corporation to indemnify any person who is or was a party to any actual or
threatened legal action, whether criminal, civil, administrative or
investigative, by reason of the fact that the person is or was an officer,
director or agent of the corporation, or is or was serving at the request of
the corporation as a director, officer or agent of another corporation,
partnership or other enterprise, against expenses (including attorney's fees),
judgments, fines and settlement payments reasonably and actually incurred by
him or her in connection with such proceeding, if he or she acted in good faith
and in a manner he or she reasonably believed to be in or not opposed to the
best interests of the corporation and, with respect to any criminal action or
proceeding, had no reasonable cause to believe was unlawful, except that, with
respect to any legal action by or in the right of the corporation itself, an
officer, director or agent of the corporation is entitled to indemnification
only for expenses (including attorney's fees) reasonably and actually incurred,
and is not entitled to indemnification in respect of any claim, issue or matter
as to which he or she is found liable to the corporation, unless the court
determines otherwise.

Section 6.4 of our Amended and Restated By-laws requires us to indemnify, to
the full extent permitted from time to time under the Delaware General
Corporation Law, each person who is made or threatened to be made a party to
any threatened, pending or completed action, suit or proceeding by reason of
the fact that such person is or was a director or officer of our company.

However, the indemnification provisions of Section 6.4 are limited to:

. officers, directors, agents and employees who as of or after September
13, 1999, were or are employed by, or serving as directors of, our
company, and

. agents and employees who were no longer employed by us as of September
13, 1999, other than such agents and employees who were our officers and
directors prior to September 13, 1999.

424B4 101st Page of 184 TOC 1st Previous Next ↓Bottom Just 101st
Section 203 of the Delaware General Corporation Law

In our Amended and Restated Certificate of Incorporation, we have elected
not to be governed by Section 203 of the Delaware General Corporation Law.
Section 203 prohibits a publicly held Delaware corporation from engaging in a
"business combination" with an "interested stockholder" (as such terms are used
in Section 203) for a period of three years after the time of the transaction
in which the person became an interested stockholder, unless (1) prior to such
time of the business combination or the transaction which resulted in the
stockholder becoming an interested stockholder, the transaction is approved by
the board of directors of the corporation, (2) upon consummation of the
transaction which resulted in the stockholder becoming an interested
stockholder, the interested stockholder owns at least 85% of the outstanding
voting stock, or (3) at or subsequent to such time, the business combination is
approved by the board of directors and by the affirmative vote of at least 66-
2/3% of the outstanding voting stock that is not owned by the interested
stockholder. For purposes of Section 203, a "business combination" includes a
merger, asset sale or other transaction resulting in a financial benefit to the
interested stockholder, and an "interested stockholder" is a person who,
together with affiliates and associates, owns (or within three years, did own)
15% or more of the corporation's voting stock.

424B4 102nd Page of 184 TOC 1st Previous Next ↓Bottom Just 102nd
SHARES ELIGIBLE FOR FUTURE SALE

An aggregate of 15,000,000 shares of common stock, 2,000,000 Series A
warrants and 5,000,000 Series B warrants were issued on April 20, 2001 under
our Fourth Amended Joint Plan of Reorganization. All these warrants, which are
currently exercisable, and shares of common stock and the shares of common
stock issued in the offering are freely tradeable without registration under
the Securities Act, except for shares that are issued to an "underwriter" (as
defined in Section 1145(b) of the Bankruptcy Code) or that are acquired by an
"affiliate" of ours.

We have entered into a registration rights agreement with Appaloosa
Management L.P., Franklin Mutual Advisers, LLC, Goldman, Sachs & Co. and Ventas
Realty, Limited Partnership, which collectively hold 9,352,676 shares of our
common stock and warrants to purchase 5,079,317 shares of common stock. The
registration rights agreement requires us to use our reasonable best efforts to
file, cause to be declared effective and keep effective for at least two years
or until all their shares of common stock or warrants are sold, a "shelf"
registration statement covering sales of their shares of common stock and
warrants or, in the case of Ventas, the distribution of some or all of the
shares of our common stock that it owns to the Ventas stockholders. We filed
the shelf registration statement with the SEC on September 19, 2001. The shelf
registration statement became effective on November 7, 2001.

However, under the terms of the registration rights agreement, these
security holders may not sell common stock or warrants pursuant to the shelf
registration statement, and we are not obligated to register any shares or
warrants held by these security holders upon their request, in each case for
the period from seven days prior to, through and including the 90th day after,
the date of this prospectus. After the expiration of this period, these
security holders may sell their shares or warrants pursuant to the shelf
registration statement or may demand that we register all or any portion of
their shares or warrants at any time. As an exception to this restriction on
sales for purposes of this offering, Ventas may (but is not obligated to)
distribute up to 350,000 shares of our common stock to Ventas stockholders on
or after December 24, 2001, and such stockholders may resell such shares.

The registration rights agreement provides that, subject to certain
limitations, each security holder party thereto has the right to demand that we
register all or a part of the common stock and warrants acquired by that
security holder pursuant to the Fourth Amended Joint Plan of Reorganization,
provided that the estimated market value of the common stock and warrants to be
registered is at least $10 million in the aggregate or not less than 5% of the
common stock and warrants. We are required to use our reasonable best efforts
to effect any such registration. Such registrations will be at our expense,
subject to certain exceptions.

In addition, under the registration rights agreement, the security holders
party thereto have certain rights to require us to include in any registration
statement we file with respect to any offering of equity securities (whether
for our own account or for the account of any holders of our securities) such
amount of common stock and warrants as are requested by the security holder to
be included in the registration statement, subject to certain exceptions. Such
registrations will be at our expense, subject to certain exceptions.

Furthermore, since April 20, 2001, 600,000 shares were issued under our
restricted share plan and an additional 1,600,000 shares may be issued in the
future upon exercise of options granted and to be granted under our stock
option plans. These shares have been registered under the Securities Act and,
therefore, will be freely tradable when issued (subject to the volume
limitations and other conditions of Rule 144, in the case of shares to be sold
by our affiliates).

Future sales of common stock, including common stock underlying the Series A
and Series B warrants, by our stockholders could adversely affect the market
price of the common stock, and future sales of Series A and Series B warrants
by the warrant holders could adversely affect the market price of the Series A
or Series B warrants, as the case may be. These sales also might make it more
difficult for us to sell equity securities in the future at a time and a price
that we deem appropriate.

424B4 103rd Page of 184 TOC 1st Previous Next ↓Bottom Just 103rd
We, our officers and directors, and the selling stockholders have agreed not
to offer, sell, contract to sell, pledge or otherwise dispose of, directly or
indirectly, any shares of our common stock or securities convertible into or
exchangeable or exercisable for shares of our common stock for a period of 90
days after the date of this prospectus without the prior written consent of
Credit Suisse First Boston Corporation. As an exception to this agreement and
without such consent, we may issue shares of our common stock pursuant to the
conversion or exchange of convertible or exchangeable securities, the exercise
of warrants or options and the exercise of employee stock options, in each case
outstanding on the date of this prospectus, or pursuant to our stock option
plans. In addition, Ventas may (but is not obligated to) distribute up to
350,000 shares of our common stock to Ventas stockholders on or after December
24, 2001, such stockholders may resell such shares and Ventas may publicly
disclose the Ventas entities' intention to effect such distributions without
the prior written consent of Credit Suisse First Boston Corporation. For more
information relating to these restrictions, see "Underwriting."

100

424B4 104th Page of 184 TOC 1st Previous Next ↓Bottom Just 104th
UNITED STATES FEDERAL INCOME TAX
CONSIDERATIONS FOR NON-UNITED STATES HOLDERS

The following is a general discussion of certain U.S. federal income and
estate tax consequences of the ownership and disposition of our common stock by
a person that is not a "United States person" for U.S. federal income tax
purposes (a "non-U.S. holder"). For this purpose, a "United States person" is a
citizen or resident of the United States, a corporation, partnership or other
entity created or organized in or under the laws of the United States or any
political subdivision thereof, an estate, the income of which is subject to
U.S. federal income taxation regardless of its source, or a trust if (i) a U.S.
court is able to exercise primary supervision over the trust's administration
and (ii) one or more United States persons have the authority to control all of
the trust's substantial decisions. The discussion does not consider specific
facts and circumstances that may be relevant to a particular non-U.S. holder's
tax position. Special rules may apply to certain non-U.S. holders, such as
"controlled foreign corporations," "passive foreign investment companies,"
"foreign personal holding companies," and corporations that accumulate earnings
to avoid U.S. federal income tax, that are subject to special treatment under
the Internal Revenue Code. This discussion is limited to beneficial owners of
the common stock who hold the common stock as capital assets. It does not
address any aspect of state, local, or foreign law, persons who hold common
stock through a partnership or other pass-through entity, or persons who are
former citizens or long-term residents of the United States. Accordingly, each
non-U.S. holder is urged to consult its own tax advisor with respect to the
United States tax consequences of the ownership and disposition of common
stock, as well as any tax consequences that may arise under the laws of any
state, municipality, foreign country or other taxing jurisdiction.

Dividends

Dividends paid to a non-U.S. holder of our common stock ordinarily will be
subject to withholding of U.S. federal income tax at a 30 percent rate, or at a
lower rate if the non-U.S. holder claims a reduced rate of withholding under an
applicable income tax treaty, generally by providing a Form W-8BEN. However, if
the dividends are effectively connected with the conduct by the non-U.S. holder
of a trade or business within the United States and, where a tax treaty
applies, are attributable to a United States permanent establishment of the
non-U.S. holder, then the dividends will be exempt from the withholding tax
described above and instead will be subject to United States federal income tax
on a net income basis.

Gain on Disposition of Common Stock

A non-U.S. holder generally will not be subject to United States federal
income tax in respect of gain realized on a disposition of our common stock,
provided that (a) the gain is not effectively connected with a trade or
business conducted by the non-U.S. holder in the United States and (b) in the
case of a non-U.S. holder who is an individual and who holds our common stock
as a capital asset, such holder is present in the United States for less than
183 days in the taxable year of the sale and other conditions are met.

Federal Estate Taxes

Our common stock owned or treated as being owned by a non-U.S. holder at the
time of death will be included in that holder's gross estate for U.S. federal
estate tax purposes, unless an applicable estate tax treaty provides otherwise.

U.S. Information Reporting Requirements and Backup Withholding Tax

U.S. information reporting on Form 1099 and backup withholding tax will not
apply to dividends paid on our common stock to a non-U.S. holder, provided that
the non-U.S. holder provides a Form W-8BEN (or satisfies certain certification
documentary evidence requirements for establishing that it is a non-United
States person under U.S. Treasury regulations) or otherwise establishes an
exemption. Distributions on our common stock will, however, be reported to the
Internal Revenue Service and to that non-U.S. holder on Form 1042-S.

101

424B4 105th Page of 184 TOC 1st Previous Next ↓Bottom Just 105th
Information reporting and backup withholding also generally will not apply to a
payment of the proceeds of a sale of our common stock effected outside the
United States by a foreign office of a foreign broker. However, information
reporting requirements (but not backup withholding) will apply to a payment of
the proceeds of a sale of our common stock effected outside the United States
by a foreign office of a broker if the broker (i) is a United States person,
(ii) derives 50 percent or more of its gross income for certain periods from
the conduct of a trade or business in the United States, (iii) is a "controlled
foreign corporation" as to the United States, or (iv) is a foreign partnership
that, at any time during its taxable year, is 50 percent or more (by income or
capital interest) owned by United States persons or is engaged in the conduct
of a U.S. trade or business, unless in any such case the broker has documentary
evidence in its records that the holder is a non-U.S. holder and certain
conditions are met, or the holder otherwise establishes an exemption. Payment
by a United States office of a broker of the proceeds of a sale of our common
stock will be subject to both backup withholding and information reporting
unless the holder certifies its non-U.S. status under penalties of perjury or
otherwise establishes an exemption. Any amounts withheld under the backup
withholding rules may be allowed as a refund or a credit against that holder's
U.S. federal income tax liability provided the required information is
furnished to the IRS.

102

424B4 106th Page of 184 TOC 1st Previous Next ↓Bottom Just 106th
UNDERWRITING

Under the terms and subject to the conditions contained in an underwriting
agreement dated November 7, 2001, we and the selling stockholders have agreed
to sell to the underwriters named below, for whom Credit Suisse First Boston
Corporation, Goldman, Sachs & Co., UBS Warburg LLC, J.P. Morgan Securities Inc.
and Lehman Brothers Inc. are acting as representatives, the following
respective numbers of shares of common stock:

[Download Table]

Number of
Underwriter Shares
----------- ---------

Credit Suisse First Boston Corporation............................. 1,101,415
Goldman, Sachs & Co................................................ 1,101,415
UBS Warburg LLC.................................................... 472,035
J.P. Morgan Securities Inc......................................... 314,690
Lehman Brothers Inc................................................ 157,345
Legg Mason Wood Walker, Incorporated............................... 25,000
Raymond James & Associates, Inc.................................... 25,000
Stephens Inc....................................................... 25,000
Thomas Weisel Partners LLC......................................... 25,000
---------
Total............................................................ 3,246,900
=========

The underwriting agreement provides that the underwriters are obligated to
purchase all the shares of common stock in the offering if any are purchased,
other than those shares covered by the over-allotment option described below.
The underwriting agreement also provides that if an underwriter defaults, the
purchase commitments of non-defaulting underwriters may be increased or the
offering may be terminated.

We have granted to the underwriters a 30-day option to purchase on a pro
rata basis up to 487,035 additional shares at the initial public offering price
less the underwriting discounts and commissions. The option may be exercised
only to cover any over-allotments of common stock.

The underwriters propose to offer the shares of common stock initially at
the public offering price on the cover page of this prospectus and to selling
group members at that price less a selling concession of $1.38 per share. The
underwriters and selling group members may allow a discount of $0.10 per share
on sales to other broker/dealers. After the initial public offering, the
representatives may change the public offering price and concession and
discount to broker/dealers. The underwriters determined the public offering
price for our common stock by reference to the market price of our common stock
at the time of pricing the offering.

The following table summarizes the compensation and estimated expenses we
and the selling stockholders will pay:

[Enlarge/Download Table]

Per Share Total
----------------------------- -----------------------------
Without With Without With
Over-allotment Over-allotment Over-allotment Over-allotment
-------------- -------------- -------------- --------------

Underwriting discounts
and commissions paid by
us..................... $2.30 $2.30 $4,025,000.00 $5,145,180.50
Expenses payable by us.. $0.66 $0.52 $1,160,000.00 $1,160,000.00
Underwriting discounts
and commissions paid by
the selling
stockholders........... $2.30 $2.30 $3,442,870.00 $3,442,870.00
Expenses payable by the
selling stockholders... $0.01 $0.01 $ 10,000.00 $ 10,000.00

No National Association of Securities Dealers, Inc., or NASD, member
participating in the distribution will be permitted to confirm sales to
accounts over which it exercises discretionary authority without the prior
specific written consent of the customer.

103

424B4 107th Page of 184 TOC 1st Previous Next ↓Bottom Just 107th
Goldman, Sachs & Co., one of the underwriters, may be deemed to be our
affiliate. The offering therefore is being conducted in accordance with the
applicable provisions of Rule 2720 of the NASD Conduct Rules. Rule 2720
requires that the public offering price of the shares of common stock not be
higher than that recommended by a "qualified independent underwriter" meeting
certain standards. Accordingly, Credit Suisse First Boston Corporation is
assuming the responsibilities of acting as the qualified independent
underwriter in pricing the offering and conducting due diligence. The initial
public offering price of the shares of common stock will be no higher than the
price recommended by Credit Suisse First Boston Corporation.

We have agreed that we will not offer, sell, contract to sell, pledge or
otherwise dispose of, directly or indirectly, or file with the Securities and
Exchange Commission a registration statement under the Securities Act relating
to, any additional shares of our common stock or securities convertible into or
exchangeable or exercisable for any shares of our common stock, or publicly
disclose the intention to make any offer, sale, pledge, disposition or filing,
without the prior written consent of Credit Suisse First Boston Corporation for
a period of 90 days after the date of this prospectus, except issuances
pursuant to the conversion or exchange of convertible or exchangeable
securities, the exercise of warrants or options and the exercise of employee
stock options, in each case outstanding on the date of this prospectus, or
grants of options to purchase shares of common stock under our stock option
plans existing and in effect on the date of this prospectus.

Our officers and directors and the selling stockholders have agreed that
they will not offer, sell, contract to sell, pledge or otherwise dispose of,
directly or indirectly, any additional shares of our common stock or securities
convertible into or exchangeable or exercisable for any shares of our common
stock, enter into a transaction that would have the same effect, or enter into
any swap, hedge or other arrangement that transfers, in whole or in part, any
of the economic consequences of ownership of our common stock, whether any of
these transactions are to be settled by delivery of our common stock or other
securities, in cash or otherwise, or publicly disclose the intention to make
any offer, sale, pledge or disposition, or to enter into any transaction, swap,
hedge or other arrangement, without, in each case, the prior written consent of
Credit Suisse First Boston Corporation for a period of 90 days after the date
of this prospectus. As an exception to this agreement, Ventas may (but is not
obligated to) distribute up to 350,000 shares of our common stock to Ventas
stockholders on or after December 24, 2001, such stockholders may resell such
shares and Ventas may publicly disclose the Ventas entities' intention to
effect such distributions without the prior written consent of Credit Suisse
First Boston Corporation.

The underwriters have reserved for sale at the initial public offering price
up to 25,000 shares of the common stock for employees, directors and their
immediate family members who have expressed an interest in purchasing common
stock in the offering. The number of shares available for sale to the general
public in the offering will be reduced to the extent these persons purchase the
reserved shares. Any reserved shares not so purchased will be offered by the
underwriters to the general public on the same terms as the other shares.

Purchasers of shares pursuant to the reserved share program will not be
subject to lock-up agreements in respect of the shares so purchased unless
required by the Conduct Rules of the NASD. The NASD's Conduct Rules will
require that some purchasers of shares who are affiliated or associated with
NASD members or who hold senior positions at financial institutions or members
of their immediate families be subject to three-month lock-up agreements.

Subject to certain limitations, we and the selling stockholders have agreed
to indemnify the underwriters against liabilities under the Securities Act or
contribute to payments which the underwriters may be required to make in that
respect.

The shares of our common stock are quoted on the OTC Bulletin Board under
the symbol "KIND." Our common stock has been approved for quotation on The
Nasdaq National Market under the symbol "KIND," subject to official notice of
issuance.

104

424B4 108th Page of 184 TOC 1st Previous Next ↓Bottom Just 108th
In connection with the offering the representatives may engage in
stabilizing transactions, over-allotment transactions, syndicate covering
transactions and penalty bids in accordance with Regulation M under the
Exchange Act.

. Stabilizing transactions permit bids to purchase the underlying security
so long as the stabilizing bids do not exceed a specified maximum.

. Over-allotment involves sales by the underwriters of shares in excess of
the number of shares the underwriters are obligated to purchase, which
creates a syndicate short position. The short position may be either a
covered short position or a naked short position. In a covered short
position, the number of shares over-allotted by the underwriters is not
greater than the number of shares that they may purchase in the over-
allotment option. In a naked short position, the number of shares
involved is greater than the number of shares in the over-allotment
option. The underwriters may close out any covered short position by
either exercising their over-allotment option and/or purchasing shares
in the open market.

. Syndicate covering transactions involve purchases of the common stock in
the open market after the distribution has been completed in order to
cover syndicate short positions. In determining the source of shares to
close out the short position, the underwriters will consider, among
other things, the price of shares available for purchase in the open
market as compared to the price at which they may purchase shares
through the over-allotment option. If the underwriters sell more shares
than could be covered by the over-allotment option, a naked short
position, the position can only be closed out by buying shares in the
open market. A naked short position is more likely to be created if the
underwriters are concerned that there could be downward pressure on the
price of the shares in the open market after pricing that could
adversely affect investors who purchase in the offering.

. Penalty bids permit the representatives to reclaim a selling concession
from a syndicate member when the common stock originally sold by the
syndicate member is purchased in a stabilizing or syndicate covering
transaction to cover syndicate short positions.

These stabilizing transactions, syndicate covering transactions and penalty
bids may have the effect of raising or maintaining the market price of our
common stock or preventing or retarding a decline in the market price of the
common stock. As a result, the price of our common stock may be higher than the
price that might otherwise exist in the open market. These transactions may be
effected on The Nasdaq National Market or otherwise and, if commenced, may be
discontinued at any time.

A prospectus in electronic format will be made available on the web sites
maintained by one or more of the underwriters participating in this offering.
The representatives may agree to allocate a number of shares to underwriters
for sale to their online brokerage account holders. Internet distributions will
be allocated by the underwriters that will make internet distributions on the
same basis as other allocations. Credit Suisse First Boston Corporation may
effect an on-line distribution through its affiliate, CSFBdirect Inc., an on-
line broker/dealer, as a selling group member.

Certain of the underwriters and their affiliates have engaged in
transactions with and provided various investment banking, commercial banking
and other services for us and our affiliates in the past and may do so from
time to time in the future. They have received customary fees and commissions
for these transactions. Goldman, Sachs & Co. and its affiliate, The Goldman
Sachs Group, Inc., together beneficially own 2,013,490 shares of our common
stock, including 597,078 shares issuable upon the exercise of currently
exercisable warrants, and are selling stockholders in this offering. Morgan
Guaranty Trust Co. of New York, an affiliate of J.P. Morgan Securities Inc.,
beneficially owns 157,276 shares of our common stock and is a selling
stockholder in this offering. An affiliate of J.P. Morgan Securities Inc. acted
as arranger, administrative agent and collateral agent with respect to our $100
million debtor-in-possession financing. In addition, an affiliate of J.P.
Morgan Securities Inc. is the administrative agent and a lender with respect to
our five-year $120 million revolving credit facility and our $300 million
senior secured notes.

105

424B4 109th Page of 184 TOC 1st Previous Next ↓Bottom Just 109th
NOTICE TO CANADIAN RESIDENTS

Resale Restrictions

The distribution of the common stock in Canada is being made only on a
private placement basis exempt from the requirement that we and the selling
stockholders prepare and file a prospectus with the securities regulatory
authorities in each province where trades of common stock are made. Any resale
of the common stock in Canada must be made under applicable securities laws
which will vary depending on the relevant jurisdiction, and which may require
resales to be made under available statutory exemptions or under a
discretionary exemption granted by the applicable Canadian securities
regulatory authority. Purchasers are advised to seek legal advice prior to any
resale of the common stock.

Representations of Purchasers

By purchasing common stock in Canada and accepting a purchase confirmation,
a purchaser is representing to us, the selling stockholders and the dealer from
whom the purchase confirmation is received that:

. the purchaser is entitled under applicable provincial securities laws to
purchase the common stock without the benefit of a prospectus qualified
under those securities laws,

. where required by law, that the purchaser is purchasing as principal and
not as agent, and

. the purchaser has reviewed the text above under Resale Restrictions.

Rights of Action--Ontario Purchasers

The securities being offered are those of a foreign issuer and Ontario
purchasers will not receive the contractual right of action prescribed by
Ontario securities law. As a result, Ontario purchasers must rely on other
remedies that may be available, including common law rights of action for
damages or rescission or rights of action under the civil liability provisions
of the U.S. federal securities laws.

Enforcement of Legal Rights

All of the issuer's directors and officers as well as the experts named
herein and the selling stockholders may be located outside of Canada and, as a
result, it may not be possible for Canadian purchasers to effect service of
process within Canada upon us or such persons. All or a substantial portion of
the assets of the issuer and such persons may be located outside of Canada and,
as a result, it may not be possible to satisfy a judgment against the issuer or
such persons in Canada or to enforce a judgment obtained in Canadian courts
against such issuer or persons outside of Canada.

Taxation and Eligibility for Investment

Canadian purchasers of common stock should consult their own legal and tax
advisors with respect to the tax consequences of an investment in the common
stock in their particular circumstances and about the eligibility of the common
stock for investment by the purchaser under relevant Canadian legislation.

106

424B4 110th Page of 184 TOC 1st Previous Next ↓Bottom Just 110th
LEGAL MATTERS

The validity of the shares of common stock offered by this prospectus will
be passed upon for us by Cleary, Gottlieb, Steen & Hamilton, New York, New
York. Shearman & Sterling, New York, New York, will pass upon certain legal
matters for the underwriters.

EXPERTS

The consolidated financial statements as of December 31, 2000 and 1999 and
for the years then ended included in this prospectus have been so included in
reliance on the report (which includes an explanatory paragraph regarding
circumstances alleviating substantial doubt about the company's ability to
continue as a going concern) of PricewaterhouseCoopers LLP, independent
accountants, given on the authority of said firm as experts in auditing and
accounting. The consolidated financial statements and financial statement
schedule as of December 31, 2000 and 1999 and for the years then ended
incorporated in this prospectus by reference to the Annual Report on Form 10-
K/A and the consolidated balance sheet as of April 1, 2001 incorporated in this
prospectus by reference to the Current Report on Form 8-K filed on August 21,
2001 have been so incorporated in reliance on the reports of
PricewaterhouseCoopers LLP.

The consolidated financial statements of Kindred Healthcare, Inc., formerly
Vencor, Inc., for the year ended December 31 1998 appearing in this prospectus
have been audited by Ernst & Young LLP, independent auditors, as set forth in
their report thereon (which contain an explanatory paragraph describing
conditions that raise substantial doubt about the company's ability to continue
as a going concern as described in Note 3 to the consolidated financial
statements) appearing elsewhere herein, and are included in reliance upon such
report given on the authority of such firm as experts in accounting and
auditing.

WHERE YOU CAN FIND MORE INFORMATION

We file annual, quarterly and special reports, proxy statements and other
information with the SEC under the Securities Exchange Act.

You may also obtain copies of this information in person or by mail from the
Public Reference Room of the SEC, 450 Fifth Street, N.W., Washington, D.C.
20549, at prescribed rates. You may obtain information on the operation of the
Public Reference Room by calling the SEC at (800) SEC-0330. Please call the SEC
at 1-800-SEC-0330 for further information on the public reference rooms. Our
filings with the SEC are also available to the public on the SEC's Internet web
site at http://www.sec.gov. You may also inspect reports, proxy statements and
other information about us at the office of the National Association of
Securities Dealers, Inc. at 1735 K Street, N.W., Washington, D.C. 20006.

We have filed a registration statement on Form S-3 with the SEC relating to
the shares of common stock covered by this prospectus. This prospectus is a
part of the registration statement and does not contain all of the information
in the registration statement. Whenever a reference is made in this prospectus
to a contract or other document of ours, please be aware that the reference is
only a summary and that you should refer to the exhibits that are a part of the
registration statement for a copy of the contract or other document. You may
review a copy of the registration statement at the SEC's public reference room
in Washington, D.C., as well as through the SEC's Internet site.

The SEC allows us to "incorporate by reference" the information we file with
it, which means that we can disclose important information to you by referring
you to those documents. The information incorporated by reference is considered
to be part of this prospectus, and information that we file with the SEC later
will automatically update and supersede this information. The following
documents filed by us and any future filings made by us with the SEC under
Sections 13(a), 13(c), 14 or 15(d) of the Exchange Act prior to the termination
of the offering are incorporated by reference in this prospectus:

. Our Annual Report on Form 10-K for the fiscal year ended December 31,
2000,

. Our Annual Report on Form 10-K/A for the fiscal year ended December 31,
2000,

107

424B4 111th Page of 184 TOC 1st Previous Next ↓Bottom Just 111th
. Our Quarterly Reports on Form 10-Q for the fiscal quarters ended March
31, 2001 and June 30, 2001,

. Our Quarterly Reports on Form 10-Q/A for the fiscal quarters ended March
31, 2001 and June 30, 2001,

. Our Registration Statement on Form 8-A filed on April 20, 2001, and

. Our Current Reports on Form 8-K filed on January 19, 2001, March 19,
2001, May 2, 2001 and August 21, 2001.

You may request a copy of these filings, at no cost, by writing or
telephoning us at:

Kindred Healthcare, Inc.
680 South Fourth Street
Louisville, Kentucky 40202-2412
Attention: Corporate Secretary
Telephone: (502) 596-7300

108

424B4 112th Page of 184 TOC 1st Previous Next ↓Bottom Just 112th
KINDRED HEALTHCARE, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

[Download Table]

Condensed Consolidated Financial Statements (Unaudited): Page
----
Condensed Consolidated Statement of Operations:
Reorganized Company -- for the three months ended June 30, 2001
Predecessor Company -- for the three months ended June 30, 2000 (restated)
and March 31, 2001 and the six months ended June 30, 2000 (restated)..... F-2
Condensed Consolidated Balance Sheets:
Reorganized Company -- June 30, 2001
Predecessor Company -- December 31, 2000 (restated)....................... F-3
Condensed Consolidated Statement of Cash Flows:
Reorganized Company -- for the three months ended June 30, 2001
Predecessor Company -- for the three months ended June 30, 2000 (restated)
and March 31, 2001 and the six months ended June 30, 2000 (restated)..... F-4
Notes to Condensed Consolidated Financial Statements....................... F-5
Consolidated Financial Statements (restated):
Report of PricewaterhouseCoopers LLP....................................... F-27
Report of Ernst & Young LLP................................................ F-28
Consolidated Statement of Operations for the years ended December 31, 2000,
1999 and 1998............................................................. F-29
Consolidated Balance Sheet, December 31, 2000 and 1999..................... F-30
Consolidated Statement of Stockholders' Equity (Deficit) for the years
ended December 31, 2000, 1999 and 1998.................................... F-31
Consolidated Statement of Cash Flows for the years ended December 31, 2000,
1999 and 1998............................................................. F-32
Notes to Consolidated Financial Statements................................. F-33

F-1

424B4 113th Page of 184 TOC 1st Previous Next ↓Bottom Just 113th
KINDRED HEALTHCARE, INC.
CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
(Unaudited)
(In thousands, except per share amounts)

[Download Table]

Reorganized
Company Predecessor Company
------------ ------------------------------------
Three months Three months Three months Six months
ended ended ended ended
June 30, June 30, March 31, June 30,
2001 2000 2001 2000
------------ ------------ ------------ ----------
(Restated--see (Restated)
Note 2)

Revenues.................... $770,764 $713,424 $752,409 $1,428,880
-------- -------- -------- ----------
Salaries, wages and
benefits................... 432,182 392,383 427,649 797,696
Supplies.................... 96,043 94,619 94,319 188,017
Rent........................ 64,580 76,788 76,995 153,008
Other operating expenses.... 127,655 122,770 126,701 245,359
Depreciation and
amortization............... 15,886 18,168 18,645 36,070
Interest expense............ 8,463 14,663 14,000 30,902
Investment income........... (3,438) (1,012) (1,919) (2,218)
-------- -------- -------- ----------
741,371 718,379 756,390 1,448,834
-------- -------- -------- ----------
Income (loss) before
reorganization items and
income taxes............... 29,393 (4,955) (3,981) (19,954)
Reorganization items........ - 2,530 (53,666) 5,595
-------- -------- -------- ----------
Income (loss) before income
taxes...................... 29,393 (7,485) 49,685 (25,549)
Provision for income taxes.. 12,904 500 500 1,000
-------- -------- -------- ----------
Income (loss) from
operations before
extraordinary items...... 16,489 (7,985) 49,185 (26,549)
Extraordinary gain on
extinguishment of debt..... 1,396 - 422,791 -
-------- -------- -------- ----------
Net income (loss)......... 17,885 (7,985) 471,976 (26,549)
Preferred stock dividend
requirements............... - (262) (261) (523)
-------- -------- -------- ----------
Income (loss) available to
common stockholders...... $ 17,885 $ (8,247) $471,715 $ (27,072)
======== ======== ======== ==========
Earnings (loss) per common
share:
Basic:
Income (loss) from
operations before
extraordinary items...... $ 1.09 $ (0.12) $ 0.69 $ (0.39)
Extraordinary gain on
extinguishment of debt... 0.09 - 6.02 -
-------- -------- -------- ----------
Net income (loss)........ $ 1.18 $ (0.12) $ 6.71 $ (0.39)
======== ======== ======== ==========
Diluted:
Income (loss) from
operations before
extraordinary items...... $ 1.00 $ (0.12) $ 0.69 $ (0.39)
Extraordinary gain on
extinguishment of debt... 0.08 - 5.90 -
-------- -------- -------- ----------
Net income (loss)........ $ 1.08 $ (0.12) $ 6.59 $ (0.39)
======== ======== ======== ==========
Shares used in computing
earnings (loss) per
common share:
Basic...................... 15,090 70,147 70,261 70,194
Diluted.................... 16,533 70,147 71,656 70,194

See accompanying notes.

F-2

424B4 114th Page of 184 TOC 1st Previous Next ↓Bottom Just 114th
KINDRED HEALTHCARE, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
(In thousands, except per share amounts)

[Download Table]

Reorganized Predecessor
Company Company
----------- ------------
June 30, December 31,
2001 2000
----------- ------------
(Restated)

ASSETS
Current assets:
Cash and cash equivalents................................ $ 102,823 $ 184,642
Cash-restricted (see Note 12)............................ 55,442 10,674
Insurance subsidiary investments......................... 98,810 62,453
Accounts receivable less allowance for loss.............. 414,942 322,483
Inventories.............................................. 29,685 29,707
Other.................................................... 60,607 85,893
---------- ----------
762,309 695,852
Property and equipment.................................... 456,126 693,586
Accumulated depreciation.................................. (13,596) (300,881)
---------- ----------
442,530 392,705
Reorganized value in excess of amounts allocable to
identifiable assets...................................... 155,984 -
Goodwill.................................................. - 159,277
Other..................................................... 73,951 86,580
---------- ----------
$1,434,774 $1,334,414
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable......................................... $ 90,896 $ 115,468
Salaries, wages and other compensation................... 192,026 184,860
Due to third-party payors................................ 39,969 44,561
Other accrued liabilities................................ 170,779 81,452
Income taxes............................................. 30,796 2,350
Long-term debt due within one year....................... 498 -
---------- ----------
524,964 428,691
Long-term debt............................................ 302,038 -
Professional liability risks.............................. 113,829 101,209
Deferred credits and other liabilities.................... 31,407 14,132
Liabilities subject to compromise......................... - 1,260,373
Series A preferred stock (subject to compromise at
December 31, 2000)....................................... - 1,743
Contingencies
Stockholders' equity (deficit):
Reorganized Company common stock, $0.25 par value;
authorized
39,000 shares; issued 15,600 shares -- June 30.......... 3,900 -
Predecessor Company common stock, $0.25 par value;
authorized
180,000 shares; issued 70,261 shares -- December 31..... - 17,565
Capital in excess of par value........................... 460,473 667,168
Deferred compensation.................................... (19,722) -
Retained earnings (accumulated deficit).................. 17,885 (1,156,467)
---------- ----------
462,536 (471,734)
---------- ----------
$1,434,774 $1,334,414
========== ==========

See accompanying notes.

F-3

424B4 115th Page of 184 TOC 1st Previous Next ↓Bottom Just 115th
KINDRED HEALTHCARE, INC.
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(Unaudited)
(In thousands)

[Download Table]

Cash flows from operating
activities:
Net income (loss)........... $ 17,885 $ (7,985) $ 471,976 $(26,549)
Adjustments to reconcile net
income (loss) to net
cash provided by operating
activities:
Depreciation and amortiza-
tion...................... 15,886 18,168 18,645 36,070
Provision for doubtful ac-
counts.................... 8,740 8,567 6,305 17,368
Extraordinary gain on ex-
tinguishment of debt...... (2,271) - (422,791) -
Unusual transactions....... - (4,535) - (4,535)
Reorganization items....... - 2,530 (53,666) 5,595
Other...................... 271 7,267 1,357 10,853
Changes in operating assets
and liabilities:
Accounts receivable....... (19,698) 11,667 (14,668) 9,816
Inventories and other as-
sets..................... 10,954 2,235 12,476 (462)
Accounts payable.......... (3,034) 6,874 (10,845) 6,487
Income taxes.............. 13,079 788 108 1,563
Due to third-party
payors................... (13,886) (23,186) 2,051 (10,551)
Other accrued liabili-
ties..................... 37,061 42,357 28,628 64,103
-------- -------- --------- --------
Net cash provided by op-
erating activities
before reorganization
items................... 64,987 64,747 39,576 109,758
Payment of reorganization
items...................... (24,723) (1,371) (3,745) (3,719)
-------- -------- --------- --------
Net cash provided by op-
erating activities...... 40,264 63,376 35,831 106,039
-------- -------- --------- --------
Cash flows from investing
activities:
Purchase of property and
equipment.................. (25,639) (14,073) (22,038) (22,323)
Sale of investment in
Behavioral Healthcare
Corporation................ 40,000 - - -
Sale of other assets........ 5,162 10,715 - 13,069
Surety bond deposits........ (300) (200) - (4,147)
Net change in investments... (45,985) (7,915) (28,178) (30,485)
Other....................... 165 285 224 1,987
-------- -------- --------- --------
Net cash used in invest-
ing activities.......... (26,597) (11,188) (49,992) (41,899)
-------- -------- --------- --------
Cash flows from financing
activities:
Repayment of long-term
debt....................... (59,386) (4,350) (4,355) (10,061)
Payment of debtor-in-
possession deferred
financing costs............ - - (100) (600)
Other....................... (6,612) (6,598) (5,971) (18,683)
-------- -------- --------- --------
Net cash used in financ-
ing activities.......... (65,998) (10,948) (10,426) (29,344)
-------- -------- --------- --------
Change in cash and cash
equivalents................. (52,331) 41,240 (24,587) 34,796
Cash and cash equivalents at
beginning of period......... 155,154 141,906 184,642 148,350
-------- -------- --------- --------
Cash and cash equivalents at
end of period............... $102,823 $183,146 $ 160,055 $183,146
======== ======== ========= ========
Supplemental information:
Interest payments........... $ 950 $ 2,720 $ 2,606 $ 6,164
Income tax payments
(refunds).................. 749 (229) 392 (504)

See accompanying notes.

F-4

424B4 116th Page of 184 TOC 1st Previous Next ↓Bottom Just 116th
KINDRED HEALTHCARE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

NOTE 1 -- BASIS OF PRESENTATION

Business

Kindred Healthcare, Inc. ("Kindred" or the "Company") (formerly Vencor,
Inc.) provides long-term healthcare services primarily through the operation of
nursing centers and hospitals. At June 30, 2001, the Company's health services
division operated 315 nursing centers in 32 states and a rehabilitation therapy
business. The Company's hospital division operated 56 hospitals in 23 states
and an institutional pharmacy business.

Reorganization

On April 20, 2001 (the "Effective Date"), the Company and its subsidiaries
emerged from proceedings under Chapter 11 of Title 11 of the United States Code
(the "Bankruptcy Code") pursuant to the terms of its Amended Plan (as defined).
On March 1, 2001, the United States Bankruptcy Court for the District of
Delaware (the "Bankruptcy Court") approved the Company's fourth amended plan of
reorganization filed with the Bankruptcy Court on December 14, 2000, as
modified at the confirmation hearing (the "Amended Plan"). In connection with
its emergence, the Company also changed its name to Kindred Healthcare, Inc.

Since filing for protection under the Bankruptcy Code on September 13, 1999,
the Company had operated its businesses as a debtor-in-possession subject to
the jurisdiction of the Bankruptcy Court. Accordingly, the unaudited condensed
consolidated financial statements of the Company have been prepared in
accordance with the American Institute of Certified Public Accountants
Statement of Position 90-7, "Financial Reporting by Entities in Reorganization
Under the Bankruptcy Code" ("SOP 90-7") and generally accepted accounting
principles applicable to a going concern, which assume that assets will be
realized and liabilities will be discharged in the normal course of business.

In connection with its emergence from bankruptcy, the Company reflected the
terms of the Amended Plan in its consolidated financial statements by adopting
the fresh-start accounting provisions of SOP 90-7. Under fresh-start
accounting, a new reporting entity is deemed to be created and the recorded
amounts of assets and liabilities are adjusted to reflect their estimated fair
values. For accounting purposes, the fresh-start adjustments have been recorded
in the unaudited condensed consolidated financial statements as of April 1,
2001. Since fresh-start accounting materially changed the amounts previously
recorded in the Company's consolidated financial statements, a black line
separates the post-emergence financial data from the pre-emergence data to
signify the difference in the basis of preparation of the financial statements
for each respective entity.

As used in this Form 10-Q/A, the term "Predecessor Company" refers to the
Company and its operations for periods prior to April 1, 2001, while the term
"Reorganized Company" is used to describe the Company and its operations for
periods thereafter.

Comparability of Financial Information

The adoption of fresh-start accounting as of April 1, 2001 materially
changed the amounts previously recorded in the consolidated financial
statements of the Predecessor Company. With respect to reported operating
results, management believes that business segment operating income of the
Predecessor Company is generally comparable to that of the Reorganized Company.
However, capital costs (rent, interest, depreciation and amortization) of the
Predecessor Company that were based on pre-petition contractual agreements and
historical costs are not comparable to those of the Reorganized Company. In
addition, the reported financial position and cash flows of the Predecessor
Company for periods prior to April 1, 2001 generally are not comparable to
those of the Reorganized Company.

F-5

424B4 117th Page of 184 TOC 1st Previous Next ↓Bottom Just 117th
KINDRED HEALTHCARE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)

NOTE 1 -- BASIS OF PRESENTATION (Continued)

Comparability of Financial Information (Continued)

In connection with the implementation of fresh-start accounting, the Company
recorded an extraordinary gain of $422.8 million from the restructuring of its
debt in accordance with the provisions of the Amended Plan. Other significant
adjustments also were recorded to reflect the provisions of the Amended Plan
and the fair values of the assets and liabilities of the Reorganized Company as
of April 1, 2001. For accounting purposes, these transactions have been
reflected in the operating results of the Predecessor Company for the three
months ended March 31, 2001.

Spin-off

On May 1, 1998, Ventas, Inc. ("Ventas") completed the spin-off of its
healthcare operations to its stockholders through the distribution of the
Predecessor Company's equity securities (the "Spin-off"). Ventas retained
ownership of substantially all of its real property and leases such real
property to the Company. In anticipation of the Spin-off, the Company was
incorporated on March 27, 1998 as a Delaware corporation. For accounting
purposes, the consolidated historical financial statements of Ventas became the
Company's historical financial statements following the Spin-off.

New Accounting Pronouncements

On January 1, 2001, the Company adopted the provisions of Statement of
Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative
Instruments and Hedging Activities." The adoption of this pronouncement did not
have a material impact on the Company's financial position or results of
operations.

In June 2001, the Financial Accounting Standards Board (the "FASB") issued
SFAS No. 141 ("SFAS 141"), "Business Combinations," which provides that all
business combinations should be accounted for using the purchase method of
accounting and establishes criteria for the initial recognition and measurement
of goodwill and other intangible assets recorded in connection with a business
combination. The provisions of SFAS 141 apply to all business combinations
initiated after June 30, 2001 and to all business combinations accounted for by
the purchase method that are completed after June 30, 2001.

In addition, the FASB issued in June 2001 SFAS No. 142 ("SFAS 142"),
"Goodwill and Other Intangible Assets," which establishes the accounting for
goodwill and other intangible assets following their recognition. SFAS 142
applies to all goodwill and other intangible assets whether acquired singly, as
part of a group, or in a business combination. SFAS 142 also applies to excess
reorganization value recognized in accordance with SOP 90-7. The new
pronouncement provides that goodwill should not be amortized but should be
tested for impairment annually using a fair-value based approach. In addition,
SFAS 142 provides that intangible assets other than goodwill should be
amortized over their useful lives and reviewed for impairment in accordance
with SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of." SFAS 142 will become effective for the
Company beginning on January 1, 2002. Upon adoption, the Company will be
required to perform a transitional impairment test for the excess
reorganization value recorded as of January 1, 2002. Any impairment loss
recorded as a result of the transitional impairment test will be treated as a
change in accounting principle. Management expects that the annual impact of
eliminating the amortization of excess reorganization value beginning on
January 1, 2002 will approximate $8 million. See Note 4.

Other Information

The accompanying unaudited condensed consolidated financial statements do
not include all of the disclosures normally required by generally accepted
accounting principles or those normally required in annual

F-6

424B4 118th Page of 184 TOC 1st Previous Next ↓Bottom Just 118th
KINDRED HEALTHCARE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)

NOTE 1 -- BASIS OF PRESENTATION (Continued)
Other Information (Continued)

reports on Form 10-K. The Reorganized Company has adopted the accounting
policies of the Predecessor Company as described in the audited consolidated
financial statements of the Predecessor Company for the year ended December 31,
2000 filed with the Securities and Exchange Commission (the "Commission") on
Form 10-K/A.

The accompanying unaudited condensed consolidated financial statements have
been prepared in accordance with the Company's customary accounting practices
and the provisions of SOP 90-7. Management believes that the financial
information included herein reflects all adjustments necessary for a fair
presentation of interim results and, except for the items described in Note 4,
all such adjustments are of a normal and recurring nature. Certain prior period
amounts have been reclassified to conform with the current presentation.

On April 20, 2001, the Company announced that PricewaterhouseCoopers LLP
("PwC") had advised the Company that certain non-audit services provided to the
Company during PwC's engagement as the Company's independent accountants by a
subsidiary of PwC in connection with the Company's efforts to sell an equity
investment raised an issue as to PwC's independence. PwC disclosed the
situation to the Commission, which is currently investigating the issue. PwC
has further advised the Company that, notwithstanding the provision of such
non-audit services, PwC was and continues to be independent accountants with
respect to the Company, and it is the present intention of PwC to sign audit
opinions and consents to incorporation as necessary in connection with
documents filed by the Company with the Commission and other third parties. The
Company cannot predict at this time how this issue will be resolved or what
impact, if any, such resolution will have on the Company's past or future
filings with the Commission and other third parties.

NOTE 2 -- RESTATEMENT OF PREVIOUSLY ISSUED FINANCIAL STATEMENTS

On August 14, 2001, the Company announced that it will restate certain of
its previously issued consolidated financial statements. The Company recently
determined that an oversight related to the allowance for professional
liability risks had occurred in its consolidated financial statements beginning
in 1998. The oversight resulted in the understatement of the provision for
professional liability claims in 1998, 1999 and 2000 because the Company did
not record a reserve for claims incurred but not reported at the respective
balance sheet dates.

The cumulative understatement of professional liability claims reserves
approximated $5 million at December 31, 1998, $28 million at December 31, 1999
and $39 million at December 31, 2000. The previously reported cash flows of the
Company will not be affected by the restatement. The restatement of prior year
results had no effect on the Company's reported operating results for the first
or second quarters of 2001.

The unaudited condensed consolidated financial statements included herein
amend those previously included in the Company's Quarterly Report on Form 10-Q
for the three months ended June 30, 2001. Consolidated financial statement
information and related disclosures included in these amended unaudited
condensed consolidated financial statements reflect, where appropriate, changes
resulting from the restatement.

F-7

424B4 119th Page of 184 TOC 1st Previous Next ↓Bottom Just 119th
KINDRED HEALTHCARE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)

NOTE 2 -- RESTATEMENT OF PREVIOUSLY ISSUED FINANCIAL STATEMENTS (Continued)

The effect of the restatement on the Company's previously issued unaudited
condensed consolidated financial statements follows (in thousands, except per
share amounts):

[Download Table]

June 30, 2000
----------------------------------------
Three months ended Six months ended
------------------- -------------------
As As
previously As previously As
reported restated reported restated
---------- -------- ---------- --------

Loss from operations.................. $(5,192) $(7,985) $(20,963) $(26,549)
Net loss.............................. (5,192) (7,985) (20,963) (26,549)
Loss per common share:
Basic:
Loss from operations................ $ (0.08) $ (0.12) $ (0.31) $ (0.39)
Net loss............................ (0.08) (0.12) (0.31) (0.39)
Diluted:
Loss from operations................ $ (0.08) $ (0.12) $ (0.31) $ (0.39)
Net loss............................ (0.08) (0.12) (0.31) (0.39)

[Download Table]

December 31, 2000
------------------------
As
previously As
reported restated
----------- -----------

Professional liability
risks.................. $ 62,327 $ 101,209
Total liabilities....... 1,765,523 1,804,405
Accumulated deficit..... (1,117,585) (1,156,467)
Stockholders' deficit... (432,852) (471,734)

NOTE 3 -- REORGANIZATION UNDER CHAPTER 11 OF THE BANKRUPTCY CODE

On April 20, 2001, the Company and its subsidiaries emerged from proceedings
under Chapter 11 of the Bankruptcy Code pursuant to the terms of the Amended
Plan. The Company and substantially all of its subsidiaries filed voluntary
petitions with the Bankruptcy Court for protection under Chapter 11 of the
Bankruptcy Code on September 13, 1999.

The Chapter 11 cases were consolidated for purposes of joint administration
under Case Nos. 99-3199 (MFW) through 99-3327 (MFW) (collectively, the "Chapter
11 Cases"). Following emergence, the Company is continuing to resolve proofs of
claims filed in the Chapter 11 Cases. On the Effective Date, the automatic stay
imposed by the Bankruptcy Code was terminated.

Amended Plan of Reorganization

The Amended Plan represents a consensual arrangement among Ventas, the
Company's former senior bank lenders (the "Senior Lenders"), holders of the
Company's $300 million 9 7/8% Guaranteed Senior Subordinated Notes due 2005
(the "1998 Notes"), the United States Department of Justice (the "DOJ"), acting
on behalf of the Department of Health and Human Services' Office of the
Inspector General (the "OIG"), and the Centers for Medicare and Medicaid
Services (formerly the Health Care Financing Administration) ("CMS")
(collectively, the "Government") and the advisors to the official committee of
unsecured creditors.

F-8

424B4 120th Page of 184 TOC 1st Previous Next ↓Bottom Just 120th
KINDRED HEALTHCARE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)

NOTE 3 -- REORGANIZATION UNDER CHAPTER 11 OF THE BANKRUPTCY CODE (Continued)

Amended Plan of Reorganization (Continued)

The Amended Plan provided for, among other things, the following
distributions:

Senior Lender Claims--On the Effective Date, the Senior Lenders received the
Senior Secured Notes aggregating $300 million, bearing interest at the rate of
LIBOR (as defined in the agreement) plus 4 1/2%, with a maturity of seven
years. The interest on the Senior Secured Notes will begin to accrue
approximately two quarters following the Effective Date and, in lieu of
interest payments, the Company will pay a $25.9 million obligation under the
Government Settlement (as defined) within the first two full fiscal quarters
following the Effective Date as described below. In addition, holders of the
Senior Lender claims received an aggregate distribution of 9,826,092 shares of
the new common stock of Kindred (the "Common Stock") on the Effective Date.

Subordinated Noteholder Claims--The holders of the 1998 Notes and the
remaining $2.4 million of the Company's 8 5/8% Senior Subordinated Notes due
2007 (collectively, the "Subordinated Noteholder Claims") received, in the
aggregate, 3,675,408 shares of the Common Stock on the Effective Date. In
addition, the holders of the Subordinated Noteholder Claims received warrants
issued by the Company for the purchase of an aggregate of 7,000,000 shares of
Common Stock, with a five-year term, comprised of warrants to purchase
2,000,000 shares at a price per share of $30.00 and warrants to purchase
5,000,000 shares at a price per share of $33.33 (collectively, the "Warrants").

Ventas Claim--Ventas received the following treatment under the Amended
Plan:

On the Effective Date, the four master leases and a single facility lease
with Ventas were assumed and simultaneously amended and restated as the Amended
Leases. The principal economic terms of the Amended Leases are as follows:

(1)A decrease of $52 million in the aggregate minimum rent from the
annual rent as of May 1, 1999 to a new initial aggregate minimum rent of
$174.6 million (subject to the escalation described below).

(2)Annual aggregate minimum rent payable in cash will escalate at an
annual rate of 3.5% over the prior period annual aggregate minimum rent
for the period from May 1, 2001 through April 30, 2004. Thereafter,
annual aggregate minimum rent payable in cash will escalate at an annual
rate of 2.0%, plus an additional annual accrued escalator amount of 1.5%
of the prior period annual aggregate minimum rent which will accrete
from year to year (with an interest accrual at LIBOR plus 4 1/2%). All
accrued rent will be payable upon the repayment or refinancing of the
Senior Secured Notes, after which the annual aggregate minimum rent
payable in cash will escalate at an annual rate of 3.5% and there will
be no further accrual feature. The annual escalator in each period is
contingent upon the attainment of certain financial targets as described
in the Amended Leases.

(3)A one-time option, that can be exercised by Ventas 5 1/4 years after
the Effective Date, to reset the annual aggregate minimum rent under one
or more of the Amended Leases to the then current fair market rental in
exchange for a payment of $5 million (or a pro rata portion thereof if
fewer than all of the Amended Leases are reset) to the Company.

(4)Under the Amended Leases, the "Event of Default" provisions also were
substantially modified and provide Ventas with more flexibility in
exercising remedies for events of default.

In addition to the Amended Leases, Ventas received a distribution of
1,498,500 shares of the Common Stock on the Effective Date.

F-9

424B4 121st Page of 184 TOC 1st Previous Next ↓Bottom Just 121st
KINDRED HEALTHCARE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)

NOTE 3 -- REORGANIZATION UNDER CHAPTER 11 OF THE BANKRUPTCY CODE (Continued)

Amended Plan of Reorganization (Continued)

Ventas and the Company also entered into a tax escrow agreement as of the
Effective Date that provides for the escrow of approximately $30 million of
federal, state and local refunds until the expiration of the applicable
statutes of limitation for the auditing of the refund applications (the "Tax
Escrow Agreement"). The escrowed funds will be available for the payment of
certain tax deficiencies during the escrow period except that all interest
paid by the government in connection with any refund or earned on the escrowed
funds will be distributed equally to the parties. At the end of the escrow
period, the Company and Ventas will each be entitled to 50% of any proceeds
remaining in the escrow account.

All agreements and indemnification obligations between the Company and
Ventas, except those modified by the Amended Plan, were assumed by the Company
as of the Effective Date.

United States Claims--The claims of the Government (other than claims of
the Internal Revenue Service and criminal claims, if any) were settled through
a government settlement with the Company and Ventas which was effectuated
through the Amended Plan (the "Government Settlement").

Under the Government Settlement, the Company will pay the Government a
total of $25.9 million as follows:

(1)$10 million was paid on the Effective Date, and

(2)an aggregate of $15.9 million will be paid during the first two full
fiscal quarters following the Effective Date, plus accrued interest at the
rate of 6% per annum beginning as of the Effective Date.

Under the Government Settlement, Ventas will pay the Government a total of
$103.6 million as follows:

(1)$34 million was paid on the Effective Date, and

(2)the remainder will be paid over five years, bearing interest at the rate
of 6% per annum beginning as of the Effective Date.

In addition, the Company agreed to repay the remaining balance of the
obligations owed to CMS (approximately $59 million as of the Effective Date)
pursuant to the terms previously agreed to by the Company (the "CMS
Agreement").

As previously announced, the Company entered into a Corporate Integrity
Agreement with the OIG as part of the overall Government Settlement. The
Corporate Integrity Agreement became effective on the Effective Date. The
Government Settlement also provides for the dismissal of certain pending
claims and lawsuits filed against the Company. See Note 11.

General Unsecured Creditors Claims--The general unsecured creditors of the
Company will be paid the full amount of their allowed claims existing as of
the date of the Company's filing for protection under the Bankruptcy Code.
These amounts generally will be paid in equal quarterly installments over
three years beginning on September 30, 2001. The Company will pay interest on
these claims at the rate of 6% per annum
from the Effective Date, subject to certain exceptions. A convenience class of
unsecured creditors, consisting of creditors holding allowed claims in an
amount less than or equal to $3,000, were paid in full within 30 days of the
Effective Date.

Preferred Stockholder and Common Stockholder Claims--The holders of
preferred stock and common stock of the Company prior to the Effective Date
did not receive any distributions under the Amended Plan. The former preferred
stock and common stock were canceled on the Effective Date.

F-10

424B4 122nd Page of 184 TOC 1st Previous Next ↓Bottom Just 122nd
KINDRED HEALTHCARE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)

NOTE 3 -- REORGANIZATION UNDER CHAPTER 11 OF THE BANKRUPTCY CODE (Continued)

Amended Plan of Reorganization (Continued)

Other Significant Provisions--As of the Effective Date, the board of
directors of the Company consisted of seven members: Edward L. Kuntz, Chairman
of the Board of Directors, Jeff Altman of Franklin Mutual Advisers, L.L.C.,
James Bolin of Appaloosa Management, L.P., Garry N. Garrison, Isaac Kaufman of
Advanced Medical Management, Inc., John H. Klein of SBTS and David Tepper of
Appaloosa Management, L.P.

A restricted share plan was approved under the Amended Plan that provided
for the issuance of 600,000 shares of Common Stock to certain key employees of
the Company. The restricted shares are non-transferable and subject to
forfeiture until they have vested generally over a four-year period. In
addition, a new stock option plan was approved under the Amended Plan for the
issuance of stock options for up to 600,000 shares of Common Stock to certain
key employees of the Company. The Amended Plan also approved the Vencor, Inc.
2000 Long-Term Incentive Plan that provides cash bonus awards to certain key
employees on the attainment by the Company of specified performance goals, and
also provided for the continuation of the Company's management retention plan
and the payment of certain performance bonuses on the Effective Date.

Matters Related to Emergence

On the Effective Date, the Company entered into the Credit Facility, a five-
year $120 million senior revolving credit facility (including a $40 million
letter of credit subfacility) with a lending group led by Morgan Guaranty Trust
Company of New York. The Credit Facility constitutes a working capital facility
for general corporate purposes including payments related to the Company's
obligations under the Amended Plan. Direct borrowings under the Credit Facility
will bear interest, at the option of the Company, at (a) prime (or, if higher,
the federal funds rate plus 1/2%) plus 3% or (b) LIBOR (as defined in the
agreement) plus 4%. The Credit Facility is collateralized by substantially all
of the assets of the Company and its subsidiaries, including certain owned real
property.

On the Effective Date, the Company filed a registration statement on Form 8-
A (the "Form 8-A") with the Commission to register its Common Stock and
Warrants under Section 12(g) of the Securities Exchange Act of 1934 (the
"Exchange Act").

NOTE 4 -- FRESH-START ACCOUNTING

As previously discussed, the Company adopted the provisions of fresh-start
accounting as of April 1, 2001. In adopting fresh-start accounting, the Company
engaged an independent financial advisor to assist in the determination of the
reorganization value or fair value of the entity. The independent financial
advisor determined an estimated reorganization value of $762 million before
considering any long-term debt or other obligations assumed in connection with
the Amended Plan. This estimate was based upon the Company's cash flows,
selected comparable market multiples of publicly traded companies, operating
lease obligations and other applicable ratios and valuation techniques. The
estimated total equity value of the Reorganized Company aggregating $435
million was determined after taking into account the values of the obligations
assumed in connection with the Amended Plan.

F-11

424B4 123rd Page of 184 TOC 1st Previous Next ↓Bottom Just 123rd
KINDRED HEALTHCARE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)

NOTE 4 -- FRESH-START ACCOUNTING (Continued)
A reconciliation of fresh-start accounting recorded as of April 1, 2001
follows (in thousands):

[Enlarge/Download Table]

Predecessor Reorganized
Company Fresh-start Company
-------------- ------------------------------------------------ -------------
Debt
March 31, 2001 Restructuring Adjustments Reclassifications April 1, 2001
-------------- ------------- ----------- ----------------- -------------
ASSETS (Restated)

Current assets:
Cash and cash
equivalents........... $ 160,055 $ - $ (4,901)(i) $ - $ 155,154
Cash-restricted........ 11,008 (2,763)(a) 6,000 (i) - 14,245
Insurance subsidiary
investments........... 90,617 - - - 90,617
Accounts receivable
less allowance for
loss.................. 330,846 73,138 (b) - - 403,984
Inventories............ 29,132 - - - 29,132
Other.................. 74,732 1,360 (a) - - 76,092
----------- --------- --------- --------- ----------
696,390 71,735 1,099 - 769,224
Property and equipment.. 708,232 - (268,528)(j) - 439,704
Accumulated
depreciation........... (316,862) - 316,862 (j) - -
----------- --------- --------- --------- ----------
391,370 - 48,334 - 439,704
Reorganized value in
excess of amounts
allocable
to identifiable
assets................. - - 157,958 (k) - 157,958
Goodwill................ 156,765 - (156,765)(l) - -
Investment in
affiliates............. 7,824 - 40,282 (m) - 48,106
Other................... 77,673 (7,668)(a) (1,823)(i) - 70,925
2,795 (c) (52)(j)
----------- --------- --------- --------- ----------
$ 1,330,022 $ 66,862 $ 89,033 $ - $1,485,917
=========== ========= ========= ========= ==========
LIABILITIES AND
STOCKHOLDERS' EQUITY
(DEFICIT)
Current liabilities:
Accounts payable....... $ 90,279 $ (2,264)(b) $ (4,030)(i) $ 1,602 (r) $ 85,587
Salaries, wages and
other compensation.... 178,319 - (93)(i) 1,404 (r) 195,841
7,700 (n)
8,511 (o)
Due to third-party
payors................ 47,773 (4,569)(b) - 10,651 (r) 53,855
Other accrued
liabilities........... 91,132 2,795 (c) 25,337 (o) 43,865 (r) 189,029
25,900 (d)
Income taxes........... 2,850 - - 14,867 (r) 17,717
Long-term debt due
within one year....... - - - 18,316 (r) 18,316
----------- --------- --------- --------- ----------
410,353 21,862 37,425 90,705 560,345
Long-term debt.......... - 300,000 (e) - 43,606 (r) 343,606
Professional liability
risks.................. 106,505 - - - 106,505
Deferred credits and
other liabilities...... 14,128 - (1,777)(p) 28,071 (r) 40,422
Liabilities subject to
compromise............. 1,278,223 2,580 (a) (2,028)(i) (162,382)(r) -
(113,576)(b) (2,726)(p)
(902,755)(f)
(94,285)(g)
(3,051)(h)
Series A preferred stock
(subject to compromise
at March 31, 2001)..... 1,743 (1,743)(h) - - -
Stockholders' equity
(deficit):
Reorganized Company
common stock, par
value................. - 3,750 (h) - - 3,750
Predecessor Company
common stock, par
value................. 17,565 - (17,565)(q) - -
Capital in excess of
par value............. 667,187 431,289 (h) 17,565 (q) (684,752)(s) 431,289
Retained earnings
(accumulated
deficit).............. (1,165,682) (11,651)(a) 5,427 (i) 684,752 (s) -
193,547 (b) 48,282 (j)
(25,900)(d) 157,958 (k)
(300,000)(e) (156,765)(l)
902,755 (f) 40,282 (m)
94,285 (g) (7,700)(n)
(430,245)(h) (33,848)(o)
4,503 (p)
----------- --------- --------- --------- ----------
(480,930) 857,830 58,139 - 435,039
----------- --------- --------- --------- ----------
$ 1,330,022 $ 66,862 $ 89,033 $ - $1,485,917
=========== ========= ========= ========= ==========

F-12

424B4 124th Page of 184 TOC 1st Previous Next ↓Bottom Just 124th
KINDRED HEALTHCARE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)

NOTE 4 -- FRESH-START ACCOUNTING (Continued)

(a) To record the effect of the Tax Escrow Agreement.

(b) To record the discharge of pre-petition accounts receivable, allowances
for loss and liabilities related to the Medicare program in connection
with the Government Settlement.

(d) To record the Government Settlement obligation.

(e) To record the issuance of the Senior Secured Notes.

(f) To record the discharge of indebtedness in accordance with the Amended
Plan (in thousands):

[Download Table]

Senior Lender Claims........................................... $510,908
Subordinated Noteholder Claims................................. 302,391
Accrued interest............................................... 99,185
Unamortized deferred financing costs........................... (9,729)
--------
$902,755
========

(g) To write off accrued Ventas rent discharged in accordance with the
Amended Plan.

(h) To record the issuance of the Common Stock and Warrants of the
Reorganized Company and eliminate the preferred stock (and related
loans) and accrued dividends of the Predecessor Company in accordance
with the Amended Plan.

(i) To record miscellaneous provisions of the Amended Plan.

(j) To adjust the property and equipment to fair value and to write off
previously recorded accumulated depreciation.

(k) To record the reorganized value of the Company in excess of amounts
allocable to identifiable assets. These costs will be amortized using
the straight-line method over 20 years.

(l) To write off historical goodwill of the Predecessor Company.

(m) To adjust investment in affiliates to fair value.

(n) To record the value of the vested portion of restricted stock in
accordance with the Amended Plan.

(o) To record reorganization costs consisting primarily of professional
fees and management compensation to be paid in accordance with the
Amended Plan.

(p) To adjust allowances for loss related to property disposals and non-
income tax deficiencies.

(q) To eliminate the common stock of the Predecessor Company.

(r) To reclassify the pre-petition priority, secured and unsecured claims
that were assumed by the Company in accordance with the Amended Plan.

(s) To eliminate the historical accumulated deficit and adjust
stockholders' equity to reflect the fair value of the Company's total
equity.

F-13

424B4 125th Page of 184 TOC 1st Previous Next ↓Bottom Just 125th
KINDRED HEALTHCARE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)

NOTE 5 -- PRO FORMA INFORMATION

The unaudited condensed pro forma effect of the Amended Plan assuming that
the Effective Date occurred on January 1, 2000 follows (in thousands, except
per share amounts):

[Download Table]

Six months ended
June 30,
---------------------
2001 2000
---------- ----------
(Restated)

Revenues.............................................. $1,523,173 $1,428,880
Income from operations before extraordinary items..... 26,782 10,053
Net income............................................ 28,178 10,053
Basic:
Income from operations before extraordinary items... $ 1.76 $ 0.66
Net income.......................................... 1.85 0.66
Diluted:
Income from operations before extraordinary items... $ 1.62 $ 0.61
Net income.......................................... 1.70 0.61

The pro forma results exclude reorganization items recorded prior to April
1, 2001. The pro forma results are not necessarily indicative of the financial
results that might have resulted had the effective date of the Amended Plan
actually occurred on January 1, 2000.

NOTE 6 -- REVENUES

Revenues are recorded based upon estimated amounts due from patients and
third-party payors for healthcare services provided, including anticipated
settlements under reimbursement agreements with Medicare, Medicaid and other
third-party payors.

A summary of revenues by payor type follows (in thousands):

[Enlarge/Download Table]

Reorganized
Company Predecessor Company
----------- ------------------------------
Three Three Three Six
months months months months
ended ended ended ended
June 30, June 30, March June 30,
2001 2000 31, 2001 2000
----------- -------- -------- ----------

Medicare............................................................................ $298,671 $249,057 $288,390 $ 512,934
Medicaid............................................................................ 263,796 220,562 233,160 443,075
Private and other................................................................... 223,593 258,178 245,532 501,831
-------- -------- -------- ----------
786,060 727,797 767,082 1,457,840
Elimination......................................................................... (15,296) (14,373) (14,673) (28,960)
-------- -------- -------- ----------
$770,764 $713,424 $752,409 $1,428,880
======== ======== ======== ==========

NOTE 7 -- EARNINGS PER SHARE

Earnings per common share are based upon the weighted average number of
common shares outstanding during the respective periods. The diluted
calculation of earnings per common share for the Reorganized Company includes
the dilutive effect of the Warrants issued in connection with the Amended Plan
and stock options and non-vested restricted stock issued under various
incentive plans. For the three months ended March 31, 2001, the diluted
calculation of earnings per common share for the Predecessor Company includes
the dilutive effect of its former convertible preferred stock.

F-14

424B4 126th Page of 184 TOC 1st Previous Next ↓Bottom Just 126th
KINDRED HEALTHCARE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)

NOTE 7 -- EARNINGS PER SHARE (Continued)

A computation of the earnings per common share follows (in thousands, except
per share amounts):

[Download Table]

Reorganized
Company Predecessor Company
----------- --------------------------------
Three Three Three
months months months Six months
ended ended ended ended
June 30, June 30, March 31, June 30,
2001 2000 2001 2000
----------- ---------- --------- ----------
(Restated) (Restated)

Earnings (loss):
Income (loss) from operations
before extraordinary items....... $16,489 $(7,985) $ 49,185 $(26,549)
Extraordinary gain on
extinguishment of debt........... 1,396 - 422,791 -
------- ------- -------- --------
Net income (loss)................. 17,885 (7,985) 471,976 (26,549)
Preferred stock dividend
requirements..................... - (262) (261) (523)
------- ------- -------- --------
Income (loss) available to common
stockholders--basic computation.. 17,885 (8,247) 471,715 (27,072)
Elimination of preferred stock
dividend requirements upon
assumed conversion of preferred
stock............................ - - 261 -
------- ------- -------- --------
Net income (loss)--diluted
computation...................... $17,885 $(8,247) $471,976 $(27,072)
======= ======= ======== ========
Shares used in the computation:
Weighted average shares
outstanding--basic computation... 15,090 70,147 70,261 70,194
Dilutive effect of the Warrants,
employee stock options and non-
vested restricted stock.......... 1,443 - - -
Assumed conversion of preferred
stock............................ - - 1,395 -
------- ------- -------- --------
Adjusted weighted average shares
outstanding--diluted
computation...................... 16,533 70,147 71,656 70,194
======= ======= ======== ========
Earnings (loss) per common share:
Basic:
Income (loss) from operations
before extraordinary items....... $ 1.09 $ (0.12) $ 0.69 $ (0.39)
Extraordinary gain on
extinguishment of debt........... 0.09 - 6.02 -
------- ------- -------- --------
Net income (loss)................ $ 1.18 $ (0.12) $ 6.71 $ (0.39)
======= ======= ======== ========
Diluted:
Income (loss) from operations
before extraordinary items....... $ 1.00 $ (0.12) $ 0.69 $ (0.39)
Extraordinary gain on
extinguishment of debt........... 0.08 - 5.90 -
------- ------- -------- --------
Net income (loss)................ $ 1.08 $ (0.12) $ 6.59 $ (0.39)
======= ======= ======== ========

NOTE 8 -- BUSINESS SEGMENT DATA

The Company operates two business segments: the health services division and
the hospital division. The health services division operates nursing centers
and a rehabilitation therapy business. The hospital division operates hospitals
and an institutional pharmacy business. The Company defines operating income as
earnings before interest, income taxes, depreciation, amortization and rent.
Operating income reported for each of the Company's business segments excludes
allocations of corporate overhead.

The carrying values of the Company's assets at June 30, 2001 and the capital
costs (rent, interest, depreciation and amortization) included in the unaudited
condensed consolidated statement of operations for the three months ended June
30, 2001 reflect the provisions of the Amended Plan and the impact of fresh-
start accounting. These costs for periods prior to the Company's emergence from
bankruptcy generally were recorded based on contractual agreements or
historical costs and did not reflect the provisions of the Amended Plan. In
addition, during the pendency of the Chapter 11 Cases, no interest costs were
recorded related to the 1998 Notes. Accordingly, assets by business segment at
June 30, 2001 and capital costs of the Reorganized Company for the three months
ended June 30, 2001 are not comparable to those of the Predecessor Company.

F-15

424B4 127th Page of 184 TOC 1st Previous Next ↓Bottom Just 127th
KINDRED HEALTHCARE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)

NOTE 8 -- BUSINESS SEGMENT DATA (Continued)

The following table sets forth certain financial data by business segment
(in thousands):

[Download Table]

Reorganized
Company Predecessor Company
----------- --------------------------------
Three Three
months Three months Six months
ended months ended ended
June 30, ended June March 31, June 30,
2001 30, 2000 2001 2000
----------- ---------- --------- ----------
(Restated) (Restated)

Revenues:
Health services division:
Nursing centers.................. $444,137 $413,159 $429,523 $ 825,862
Rehabilitation services.......... 9,244 33,173 10,695 67,550
Other ancillary services......... - (2) - (7)
Elimination...................... - (18,509) - (36,600)
-------- -------- -------- ----------
453,381 427,821 440,218 856,805
Hospital division:
Hospitals........................ 276,112 250,027 271,984 503,618
Pharmacy......................... 56,567 49,949 54,880 97,417
-------- -------- -------- ----------
332,679 299,976 326,864 601,035
-------- -------- -------- ----------
786,060 727,797 767,082 1,457,840
Elimination of pharmacy charges to
Company nursing centers.......... (15,296) (14,373) (14,673) (28,960)
-------- -------- -------- ----------
$770,764 $713,424 $752,409 $1,428,880
======== ======== ======== ==========
Income (loss) from operations
before extraordinary items:
Operating income (loss):
Health services division:
Nursing centers.................. $ 78,735 $ 75,348 $ 70,543 $ 144,060
Rehabilitation services.......... 1,809 (1,059) 690 (573)
Other ancillary services......... 103 242 250 372
-------- -------- -------- ----------
80,647 74,531 71,483 143,859
Hospital division:
Hospitals........................ 55,685 51,547 54,778 106,945
Pharmacy......................... 6,036 789 6,176 (411)
-------- -------- -------- ----------
61,721 52,336 60,954 106,534
-------- -------- -------- ----------
Corporate overhead............... (27,484) (27,750) (28,697) (57,120)
Unusual transactions............. - 4,535 - 4,535
Reorganization items............. - (2,530) 53,666 (5,595)
-------- -------- -------- ----------
Operating income................ 114,884 101,122 157,406 192,213
Rent.............................. (64,580) (76,788) (76,995) (153,008)
Depreciation and amortization..... (15,886) (18,168) (18,645) (36,070)
Interest, net..................... (5,025) (13,651) (12,081) (28,684)
-------- -------- -------- ----------
Income (loss) before income
taxes............................ 29,393 (7,485) 49,685 (25,549)
Provision for income taxes........ 12,904 500 500 1,000
-------- -------- -------- ----------
$ 16,489 $ (7,985) $ 49,185 $ (26,549)
======== ======== ======== ==========
Rent:
Health services division:
Nursing centers.................. $ 40,190 $ 43,888 $ 44,253 $ 87,477
Rehabilitation services.......... 27 130 39 199
Other ancillary services......... 3 17 - 37
-------- -------- -------- ----------
40,220 44,035 44,292 87,713
Hospital division:
Hospitals........................ 22,917 31,199 30,839 61,894
Pharmacy......................... 968 853 941 1,753
-------- -------- -------- ----------
23,885 32,052 31,780 63,647
-------- -------- -------- ----------
Corporate........................ 475 701 923 1,648
-------- -------- -------- ----------
$ 64,580 $ 76,788 $ 76,995 $ 153,008
======== ======== ======== ==========

F-16

424B4 128th Page of 184 TOC 1st Previous Next ↓Bottom Just 128th
KINDRED HEALTHCARE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)

NOTE 8 -- BUSINESS SEGMENT DATA (Continued)

[Download Table]

Reorganized
Company Predecessor Company
----------- -------------------------------
Three Three Three Six
months months months months
ended ended ended ended
June 30, June 30, March 31, June 30,
2001 2000 2001 2000
----------- ------------ --------- --------

Depreciation and amortization:
Health services division:
Nursing centers................... $ 5,055 $ 6,720 $ 7,219 $13,390
Rehabilitation services........... 11 1 - 4
Other ancillary services.......... - 263 129 548
---------- ---------- ------- -------
5,066 6,984 7,348 13,942
Hospital division:
Hospitals......................... 5,690 5,271 5,457 10,578
Pharmacy.......................... 447 491 627 1,017
---------- ---------- ------- -------
6,137 5,762 6,084 11,595
---------- ---------- ------- -------
Corporate......................... 4,683 5,422 5,213 10,533
---------- ---------- ------- -------
$ 15,886 $ 18,168 $18,645 $36,070
========== ========== ======= =======
Capital expenditures:
Health services division.......... $ 4,529 $ 3,794 $ 7,962 $ 6,702
Hospital division................. 8,644 2,944 8,901 6,480
Corporate:
Information systems............... 3,135 6,767 3,496 8,113
Other............................. 9,331 568 1,679 1,028
---------- ---------- ------- -------
$ 25,639 $ 14,073 $22,038 $22,323
========== ========== ======= =======

Reorganized Predecessor
Company Company
----------- ------------
June 30, December 31,
2001 2000
----------- ------------

Assets:
Health services division.......... $ 395,934 $ 494,636
Hospital division................. 460,426 354,302
Corporate......................... 578,414 485,476
---------- ----------
$1,434,774 $1,334,414
========== ==========

NOTE 9 -- INCOME TAXES

The provision for income taxes is based upon management's estimate of
taxable income or loss for the respective periods and includes the effect of
certain non-taxable and non-deductible items, such as reorganization intangible
amortization, and the increase or decrease in the deferred tax valuation
allowance.

The Company has reduced its net deferred tax assets by a valuation allowance
to the extent management does not believe it is "more likely than not" that the
asset ultimately will be realizable. If all or a portion of the pre-
reorganization deferred tax asset is realized in the future, or considered to
"more likely than not" be realizable by management, the reorganization
intangible recorded in connection with fresh-start accounting will be reduced
accordingly. If the reorganization intangible is eliminated in full, other
intangibles will then be reduced, with any excess treated as an increase to
capital in excess of par value.

The provision for income taxes for the three months ended June 30, 2000 and
March 31, 2001 and the six months ended June 30, 2000 included charges of $2.5
million, $685,000 and $8.4 million, respectively, related to the deferred tax
valuation allowance. No changes in the valuation allowance were recorded in the
second quarter of 2001. As a result of fresh-start accounting, the deferred tax
valuation allowance included in the Company's unaudited condensed consolidated
balance sheet aggregated $284 million at June 30, 2001.

F-17

424B4 129th Page of 184 TOC 1st Previous Next ↓Bottom Just 129th
KINDRED HEALTHCARE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)

NOTE 9 -- INCOME TAXES (Continued)

In connection with the reorganization, the Company realized a gain from the
extinguishment of certain indebtedness. This gain will not be taxable since the
gain resulted from the reorganization under the Bankruptcy Code. However, the
Company will be required, as of the beginning of its 2002 taxable year, to
reduce certain tax attributes relating to the Company including (a) net
operating loss carryforwards ("NOLs"), (b) certain tax credits and (c) tax
bases in assets in an amount equal to such gain on extinguishment. The
reorganization of the Company on the Effective Date constituted an ownership
change under Section 382 of the Internal Revenue Code and the use of any of the
Company's NOLs and tax credits generated prior to the ownership change, that
are not reduced pursuant to the provisions discussed above, will be subject to
an overall annual limitation of approximately $22 million.

The Company had NOLs of approximately $164 million (after the reductions in
the attributes discussed above) and $215 million as of June 30, 2001 and
December 31, 2000, respectively. These carryforwards expire in various amounts
through 2021.

NOTE 10 -- EARLY EXTINGUISHMENT OF DEBT

In connection with the restructuring of its debt in accordance with the
provisions of the Amended Plan, the Company realized an extraordinary gain of
$422.8 million. For accounting purposes, this gain has been reflected in the
operating results of the Predecessor Company for the three months ended March
31, 2001.

A summary of the extraordinary gain follows (in thousands):

[Download Table]

Liabilities restructured:
Debt obligations:
Senior Lender Claims........................................... $ 510,908
Subordinated Noteholder Claims................................. 302,391
Accrued interest............................................... 99,185
Unamortized deferred financing costs........................... (9,729)
---------
902,755
Amounts related to prior year Medicare cost reports............. 193,547
Accrued Ventas rent............................................. 94,285
Other........................................................... (6,857)
---------
1,183,730
---------
Consideration exchanged:
Senior Secured Notes............................................ 300,000
Common Stock.................................................... 368,339
Warrants........................................................ 66,700
Government Settlement obligation................................ 25,900
---------
760,939
---------
$ 422,791
=========

On May 30, 2001, the Company prepaid the outstanding balance in full
satisfaction of its obligations under the CMS Agreement, resulting in an
extraordinary gain of $1.4 million. The transaction was financed through the
use of existing cash.

F-18

424B4 130th Page of 184 TOC 1st Previous Next ↓Bottom Just 130th
KINDRED HEALTHCARE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)

NOTE 11 -- LITIGATION

Summary descriptions of various significant legal and regulatory activities
follow.

On September 13, 1999, the Company and substantially all of its subsidiaries
filed voluntary petitions for protection under Chapter 11 of the Bankruptcy
Code. The Chapter 11 Cases have been styled In re: Vencor, Inc., et al.,
Debtors and Debtors in Possession, Case Nos. 99-3199 (MFW) through 99-3327
(MFW), Chapter 11, Jointly Administered. On March 1, 2001, the Bankruptcy Court
approved the Company's fourth amended plan of reorganization filed with the
Bankruptcy Court on December 14, 2000, as modified at the confirmation hearing.
The order confirming the Amended Plan was signed on March 16, 2001 and entered
on the docket of the Bankruptcy Court on March 19, 2001. The effective date of
the Amended Plan was April 20, 2001. See Note 3.

On March 18, 1999, the Company served Ventas with a demand for mediation
pursuant to the Agreement and Plan of Reorganization governing the Spin-off
(the "Spin-off Agreement"). The Company was seeking a reduction in rent and
other concessions under its master lease agreements with Ventas. On March 31,
1999, the Company and Ventas entered into a standstill agreement which provided
that both companies would postpone through April 12, 1999 any claims either may
have against the other. On April 12, 1999, the Company and Ventas entered into
a second standstill which provided that neither party would pursue any claims
against the other or any other third party related to the Spin-off as long as
the Company complied with certain rent payment terms. The second standstill was
scheduled to terminate on May 5, 1999. Pursuant to a tolling agreement, the
Company and Ventas also agreed that any statutes of limitations or other time-
related constraints in a bankruptcy or other proceeding that might be asserted
by one party against the other would be extended and tolled from April 12, 1999
until May 5, 1999 or until the termination of the second standstill. As a
result of the Company's failure to pay rent, Ventas served the Company with
notices of nonpayment under the master lease agreements. Subsequently, the
Company and Ventas entered into further amendments to the second standstill and
the tolling agreement to extend the time during which no remedies may be
pursued by either party and to extend the date by which the Company may cure
its failure to pay rent.

In connection with the Chapter 11 Cases, the Company and Ventas entered into
the stipulation that provided for the payment by the Company of a reduced
aggregate monthly rent of approximately $15.1 million (the "Stipulation"). The
Stipulation was approved by the Bankruptcy Court. The Stipulation tolled any
statutes of limitations or other time constraints in a bankruptcy proceeding
for claims that might be asserted by the Company against Ventas. The
Stipulation automatically renewed for one-month periods unless either party
provided a 14-day notice of termination. The Stipulation also provided that the
Company would continue to fulfill its indemnification obligations arising from
the Spin-off. The Stipulation was terminated on the Effective Date.

As a result of the consummation of the Amended Plan, the Company believes
that all known material disputes between the Company and Ventas have been
resolved. The Amended Plan also provided for comprehensive mutual releases
between the Company and Ventas, other than for obligations that the Company is
assuming under the Amended Plan.

The Company's subsidiary, formerly named TheraTx, Incorporated, is a
plaintiff in a declaratory judgment action entitled TheraTx, Incorporated v.
James W. Duncan, Jr., et al., No. 1:95-CV-3193, filed in the United States
District Court for the Northern District of Georgia and currently pending in
the United States Court of Appeals for the Eleventh Circuit, No. 99-11451-FF.
The defendants asserted counterclaims against TheraTx, Incorporated ("TheraTx")
under breach of contract, securities fraud, negligent misrepresentation and
other

F-19

424B4 131st Page of 184 TOC 1st Previous Next ↓Bottom Just 131st
KINDRED HEALTHCARE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)

NOTE 11 -- LITIGATION (Continued)
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 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'
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. The Company and the
defendants/counterclaimants both appealed the court's rulings. The United
States Court of Appeals for the Eleventh Circuit affirmed the trial court's
rulings in TheraTx's favor, with the exception of the damages award, and
certified the question of the proper calculation of damages under Delaware law
to the Delaware Supreme Court. The Delaware Supreme Court issued an opinion on
June 1, 2001, which sets forth a rule for determining such damages but did not
calculate any actual damages. On June 25, 2001, the Eleventh Circuit remanded
the action to the trial court to render a decision consistent with the Delaware
Supreme Court's ruling. The Company is defending the action vigorously.

The Company is pursuing various claims against private insurance companies
who issued Medicare supplement insurance policies to individuals who became
patients of the Company's hospitals. After the patients' Medicare benefits are
exhausted, the insurance companies become liable to pay the insureds' bills
pursuant to the terms of these policies. The Company has filed numerous
collection actions against various of these insurers to collect the difference
between what Medicare would have paid and the hospitals' usual and customary
charges. These disputes arise from differences in interpretation of the policy
provisions and federal and state laws governing such policies. Various courts
have issued various rulings on the different issues, some of which have been
adverse to the Company and most of which have been appealed. The Company
intends to continue to pursue these claims vigorously. If the Company does not
prevail on these issues, future results of operations and liquidity could be
materially adversely affected.

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 class action claims
were brought by an alleged stockholder of the Company's predecessor against the
Company and Ventas and certain current and former executive officers and
directors of the Company and Ventas. The complaint alleges that the Company,
Ventas and certain current and former executive officers of the Company and
Ventas 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 Ventas' then current operations
and the inherent value of its common stock. The complaint further alleges that
as a result of these purported false and misleading statements concerning
Ventas' revenues and successful acquisitions, the price of the common stock was
artificially inflated. In particular, the complaint alleges that the defendants
issued false and misleading financial statements during the first, second and
third calendar quarters of 1997 which misrepresented and understated the impact
that changes in Medicare reimbursement policies would have on Ventas' core
services and profitability. The complaint further alleges that the defendants
issued a series of materially false statements concerning the purportedly
successful integration of Ventas' acquisitions and prospective earnings per
share for 1997 and 1998 which the defendants 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.

F-20

424B4 132nd Page of 184 TOC 1st Previous Next ↓Bottom Just 132nd
KINDRED HEALTHCARE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)

NOTE 11 -- LITIGATION (Continued)
In December 1998, the defendants filed a motion to dismiss the case. The court
converted the defendants' motion to dismiss into a motion for summary judgment
and granted summary judgment as to all defendants. The plaintiff appealed the
ruling to the United States Court of Appeals for the Sixth Circuit. On April
24, 2000, the Sixth Circuit affirmed the district court's dismissal of the
action on the grounds that the plaintiff failed to state a claim upon which
relief could be granted. On July 14, 2000, the Sixth Circuit granted the
plaintiff's petition for a rehearing en banc. On May 31, 2001, the Sixth
Circuit issued its en banc decision reversing the trial court's dismissal of
the complaint. The Company is defending this action vigorously.

A shareholder derivative suit entitled Thomas G. White on behalf of Vencor,
Inc. and Ventas, Inc. v. W. Bruce Lunsford, et al., Case No. 98CI03669, was
filed in June 1998 in the Jefferson County, Kentucky, Circuit Court. The suit
was brought on behalf of the Company and Ventas against certain current and
former executive officers and directors of the Company and Ventas. The
complaint alleges that the defendants damaged the Company and Ventas by
engaging in violations of the securities laws, engaging in insider trading,
fraud and securities fraud and damaging the reputation of the Company and
Ventas. 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 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 Company and Ventas have an effective remedy. The Company
believes that the allegations in the complaint are without merit and intends to
defend this action vigorously.

A class action lawsuit entitled Jules Brody v. Transitional Hospitals
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 Hospitals
Corporation ("Transitional") common stock during the period from February 26,
1997 through May 4, 1997, inclusive. 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 the Transitional 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
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
the Company's motion to dismiss with leave to amend the Section 10(b) claim and
the state law claims for misrepresentation. The court denied the Company's
motion to dismiss the Section 14(e) and Section 20(a) claims, after which the
Company filed a motion for reconsideration. On March 23, 1999, the court
granted the Company's motion to dismiss all remaining claims and the case was
dismissed. The plaintiff has appealed this ruling to the United States Court of
Appeals for the Ninth Circuit. The Company is defending this action vigorously.

The Company was informed by the DOJ that the Company and Ventas were the
subjects of investigations into various Medicare reimbursement issues,
including hospital cost reporting issues, billing practices for ancillary
services and various quality of care issues in the hospitals and nursing
centers formerly operated by Ventas and currently operated by the Company.
These investigations included some matters for which the

F-21

424B4 133rd Page of 184 TOC 1st Previous Next ↓Bottom Just 133rd
KINDRED HEALTHCARE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)

NOTE 11 -- LITIGATION (Continued)
Company indemnified Ventas in the Spin-off. In cases where neither the Company
nor any of its subsidiaries are defendants but Ventas is the defendant, the
Company agreed to defend and indemnify Ventas for such claims as part of the
Spin-off. The Company cooperated fully in the investigations. All of these
investigations have been resolved by the Government Settlement contained in the
Amended Plan.

The DOJ previously informed the Company that it had intervened in several
pending qui tam actions asserted against the Company and/or Ventas in
connection with these investigations. In addition, the DOJ filed proofs of
claims with respect to certain alleged claims in the Chapter 11 Cases. The
Company, Ventas and the DOJ entered into the Government Settlement, which
resolved all of the DOJ investigations including the pending qui tam actions,
as part of the Amended Plan. The Government Settlement provides that within 30
days after the Effective Date, the Government will move to dismiss with
prejudice to the United States and the relators (except for certain claims
which will be dismissed without prejudice to the United States in certain of
the cases) the pending qui tam actions as against any or all of the Company and
its subsidiaries, Ventas and any current or former officers, directors and
employees of either entity. There can be no assurance that each court before
which a qui tam action is pending will dismiss the case on the DOJ's motion.
For a summary of the terms of the Government Settlement contained in the
Amended Plan, see Note 3.

The following is a summary of the qui tam actions pending or previously
pending against the Company and/or Ventas in which the DOJ intervened. Certain
of the actions described below name other defendants in addition to the Company
and Ventas.

(a) The Company, Ventas and the Company's subsidiary, American X-Rays,
Inc. ("AXR"), are defendants in a civil qui tam action styled United States
ex rel. Doe v. American X-Rays Inc., et al., No. LR-C-95-332, pending in
the United States District Court for the Eastern District of Arkansas and
served on AXR on July 7, 1997. The DOJ intervened in the suit which was
brought under the Federal Civil False Claims Act and added the Company and
Ventas as defendants. 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. AXR provided portable X-ray services to nursing centers (including
some of those operated by Ventas or the Company) and other healthcare
providers. The civil suit 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. The Company has
defended this action vigorously. The court dismissed the action based upon
the pending settlement between the DOJ, the Company and Ventas. In a
related criminal investigation, the United States Attorney's Office for the
Eastern District of Arkansas ("USAO") indicted four former employees of
AXR; those individuals were convicted of various fraud related counts in
January 1999. AXR had been informed previously that it was not a target of
the criminal investigation, and AXR was not indicted. However, the Company
received several grand jury subpoenas for documents and witnesses which it
moved to quash. The USAO has withdrawn the subpoenas which rendered the
motion moot. The complaint against the Company, Ventas and AXR has been
dismissed with prejudice as to the relators and the United States in
accordance with the Government Settlement contained in the Amended Plan.

F-22

424B4 134th Page of 184 TOC 1st Previous Next ↓Bottom Just 134th
KINDRED HEALTHCARE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)

NOTE 11 -- LITIGATION (Continued)
skilled nursing facilities more for the same drugs for Medicare patients
than for non-Medicare patients; (b) improperly claimed special dispensing
fees that it was not entitled to under Medicaid; and (c) 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. The complaint also alleges that Medisave had a
policy of offering kickbacks, such as free equipment, to skilled nursing
centers to secure and maintain their business. The complaint seeks treble
damages, other unspecified damages, civil penalties, attorneys' fees and
other costs. The Company disputes the allegations in the complaint. The
complaint has been dismissed in accordance with the Government Settlement
contained in the Amended Plan.

(c) Ventas and the Company's subsidiary, Kindred Rehab Services, Inc.
(formerly Vencare, Inc.) ("Vencare"), among others, are defendants in the
action styled United States ex rel. Roberts v. Vencor, Inc., et al., No.
3:97CV-349-J, filed in the United States District Court for the Western
District of Kansas on June 25, 1996 and consolidated with the action styled
United States of America ex rel. Meharg, et al. v. Vencor, Inc., et al.,
No. 3:98SC-737-H, filed in the United States District Court for the Middle
District of Florida on June 4, 1998. The complaint alleges that the
defendants knowingly submitted and conspired to submit false claims and
statements to the Medicare program in connection with their purported
provision of respiratory therapy services to skilled nursing center
residents. The defendants 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 their therapists. It is further
alleged that the defendants 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 centers 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, attorneys' fees and
other costs. The Company disputes the allegations in the complaints. The
two complaints have been dismissed in accordance with the Government
Settlement contained in the Amended Plan.

(d) 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, the Company's subsidiary,
Transitional, and two unrelated entities, Gambro Healthcare, Inc. and
Dialysis Holdings, Inc., are defendants in this suit alleging that they
violated the Federal Civil False Claims Act and the Medicare and Medicaid
antikickback, antifraud and abuse regulations 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 cost in
return for referral of substantially all non-routine testing in violation
of Medicare and Medicaid antikickback and antifraud regulations. 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 antikickback and antifraud regulations.
Transitional has moved to dismiss the case. Transitional disputes the
allegations in the complaint. The claims against Transitional have been
dismissed with prejudice in accordance with the Government Settlement
contained in the Amended Plan.

F-23

424B4 135th Page of 184 TOC 1st Previous Next ↓Bottom Just 135th
KINDRED HEALTHCARE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)

NOTE 11 -- LITIGATION (Continued)

(e) The Company and/or Ventas are defendants in the action styled United
States ex rel. Huff and Dolan v. Vencor, Inc., et al., No. 97-4358 AHM
(Mcx), filed in the United States District Court for the Central District
of California on June 13, 1997. The plaintiff alleges that the defendant
violated the Federal Civil False Claims Act by submitting false claims to
the Medicare, Medicaid and CHAMPUS programs by allegedly: (a) falsifying
patient bills and submitting the bills to the Medicare, Medicaid and
CHAMPUS programs, (b) submitting bills for intensive and critical care not
actually administered to patients, (c) falsifying patient charts in
relation to the billing, (d) charging for physical therapy services
allegedly not provided and pharmacy services allegedly provided by non-
pharmacists, and (e) billing for sales calls made by nurses to prospective
patients. The complaint seeks treble damages, other unspecified damages,
civil penalties, attorneys' fees and other costs. Defendants dispute the
allegations in the complaint. The complaint has been dismissed in
accordance with the Government Settlement contained in the Amended Plan.

(f) Ventas is the defendant in the action styled United States ex rel.
Brzycki v. Vencor, Inc., Civ. No. 97-451-JD, filed in the United States
District Court for the District of New Hampshire on September 8, 1997.
Ventas is alleged to have knowingly violated the Federal Civil False Claims
Act by submitting and conspiring to submit false claims to the Medicare
program. The complaint alleges that Ventas: (a) fabricated diagnosis codes
by ordering medically unnecessary services, such as respiratory therapy;
(b) changed referring physicians' diagnoses in order to qualify for
Medicare reimbursement; and (c) billed Medicare for oxygen use by patients
regardless of whether the oxygen was actually administered to particular
patients. The complaint further alleges that Ventas paid illegal kickbacks
to referring healthcare professionals in the form of medical consulting
service agreements as an alleged inducement to refer patients, in violation
of the Federal Civil False Claims Act, the antikickback and antifraud
regulations and the Stark provisions. It is additionally alleged that
Ventas consistently submitted Medicare claims for clinical services that
were not performed or were performed at lower actual costs. The complaint
seeks unspecified damages, civil penalties, attorneys' fees and costs.
Ventas disputes the allegations in the complaint. The complaint has been
dismissed in accordance with the Government Settlement contained in the
Amended Plan.

(g) United States ex rel. Lanford and Cavanaugh v. Vencor, Inc., et al.,
Civ. No. 97-CV-2845, was filed against Ventas in the United States District
Court for the Middle District of Florida, on November 24, 1997. The United
States intervened in this civil qui tam lawsuit on May 17, 1999. On July
23, 1999, the United States filed its amended complaint in the lawsuit and
added the Company as a defendant. The lawsuit alleges that the Company and
Ventas 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
defendants' nursing centers and for third-party nursing center operators
that the United States alleges are not properly reimbursable costs through
the hospitals' cost reports. The lawsuit involves the Company's hospitals
which were owned by Ventas prior to the Spin-off. The complaint does not
specify the amount of damages sought. The Company and Ventas dispute the
allegations in the amended complaint. The complaint has been dismissed with
prejudice in accordance with the Government Settlement contained in the
Amended Plan.

(h) In United States ex rel. Harris and Young v. Vencor, Inc., et al.,
filed in the United States District Court for the Eastern District of
Missouri on May 25, 1999, the defendants include the Company, Vencare, and
Ventas. The defendants allegedly submitted and conspired to submit false
claims for payment to the Medicare and CHAMPUS programs, in violation of
the Federal Civil False Claims Act. According to the complaint, the
Company, through its subsidiary, Vencare, allegedly (a) over billed for
respiratory therapy

F-24

424B4 136th Page of 184 TOC 1st Previous Next ↓Bottom Just 136th
KINDRED HEALTHCARE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)

NOTE 11 -- LITIGATION (Continued)
services, (b) rendered medically unnecessary treatment, and (c) falsified
supply, clinical and equipment records. The defendants also allegedly
encouraged or instructed therapists to falsify clinical records and over
prescribe therapy services. The complaint seeks treble damages, other
unspecified damages, civil penalties, attorneys' fees and other costs. The
Company disputes the allegations in the complaint. The plaintiffs have
filed an amended complaint with the court which removes all defendants
associated with the Company or Ventas.

(i) In United States ex rel. George Mitchell, et al. v. Vencor, Inc., et
al., filed in the United States District Court for the Southern District of
Ohio on August 13, 1999, the defendants, consisting of the Company and its
two subsidiaries, Vencare and Kindred Hospice, Inc. (formerly Vencor
Hospice, Inc.), are alleged to have violated the Federal Civil False Claims
Act by obtaining improper reimbursement from Medicare concerning the
treatment of hospice patients. Defendants are alleged to have obtained
inflated Medicare reimbursement for admitting, treating and/or failing to
discharge in a timely manner hospice patients who were not "hospice
appropriate." The complaint further alleges that the defendants obtained
inflated reimbursement for providing medications for these hospice
patients. The complaint alleges damages in excess of $1,000,000. The
Company disputes the allegations in the complaint. The complaint has been
dismissed in accordance with the Government Settlement contained in the
Amended Plan.

(j) In Gary Graham, on Behalf of the United States of America v. Vencor
Operating, Inc. et. al., filed in the United States District Court for the
Southern District of Florida on or about June 8, 1999, the defendants,
including the Company, its subsidiary, Kindred Healthcare Operating, Inc.
(formerly Vencor Operating, Inc.), Ventas, Hillhaven and Medisave, are
alleged to have presented or caused to be presented false or fraudulent
claims for payment to the Medicare program in violation of, among other
things, the Federal Civil False Claims Act. The complaint alleges that
Medisave, a subsidiary of the Company which was transferred from Ventas to
the Company in the Spin-off, systematically up-charged for drugs and
supplies dispensed to Medicare patients. The complaint seeks unspecified
damages, civil penalties, interest, attorneys' fees and other costs. The
Company disputes the allegations in the complaint. The plaintiffs have
filed an amended complaint with the court which removes all defendants
associated with the Company or Ventas.

(k) In United States, et al., ex rel. Phillips-Minks, et al. v.
Transitional Corp., et al., filed in the United States District Court for
Southern District of California on July 23, 1998, the defendants, including
Transitional and Ventas, are alleged to have submitted and conspired to
submit false claims and statements to Medicare, Medicaid, and other federal
and state funded programs during a period commencing in 1993. The conduct
complained of allegedly violates the Federal Civil False Claims Act, the
California False Claims Act, the Florida False Claims Act, the Tennessee
Health Care False Claims Act, and the Illinois Whistleblower Reward and
Protection Act. The defendants allegedly submitted improper and erroneous
claims to Medicare, Medicaid and other programs, for improper or
unnecessary services and services not performed, inadequate collections
efforts associated with billing and collecting bad debts, inflated and
nonexistent laboratory charges, false and inadequate documentation of
claims, splitting charges, shifting revenues and expenses, transferring
patients to hospitals that are reimbursed by Medicare at a higher level,
failing to return duplicate reimbursement payments, and improperly
allocating hospital insurance expenses. In addition, the complaint alleges
that the defendants were inconsistent in their reporting of cost report
data, paid kickbacks to increase patient referrals to hospitals, and
incorrectly reported employee compensation resulting in inflated employee
401(k) contributions. The complaint seeks unspecified damages. The Company
disputes the allegations in the complaint and intends to defend this action
vigorously. On July 27, 2001, the court ordered that the DOJ be allowed to
intervene in the action to effectuate the Government Settlement contained
in the Amended Plan.

F-25

424B4 137th Page of 184 TOC 1st Previous Next ↓Bottom Just 137th
KINDRED HEALTHCARE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)

NOTE 11 -- LITIGATION (Continued)

In connection with the Spin-off, liabilities arising from various legal
proceedings and other actions were assumed by the Company and the Company
agreed to indemnify Ventas against any losses, including any costs or expenses,
it may incur arising out of or in connection with such legal proceedings and
other actions. The indemnification provided by the Company also covers losses,
including costs and expenses, which may arise from any future claims asserted
against Ventas based on the former healthcare operations of Ventas. In
connection with its indemnification obligation, the Company has assumed the
defense of various legal proceedings and other actions. Under the Amended Plan,
the Company agreed to continue to fulfill its indemnification obligations
arising from the Spin-off.

The Company is a party to certain legal actions and regulatory
investigations arising in the normal course of its business. The Company is
unable to predict the ultimate outcome of pending litigation and regulatory
investigations. In addition, there can be no assurance that the DOJ, CMS or
other regulatory agencies will not initiate additional investigations related
to the Company's businesses 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's
results of operations, liquidity or financial position. In addition, the above
litigation and investigations (as well as future litigation and investigations)
are expected to consume the time and attention of the Company's management and
may have a disruptive effect upon the Company's operations.

NOTE 12 -- SALE OF INVESTMENT

On May 2, 2001, the Company sold its investment in Behavioral Healthcare
Corporation ("BHC") for $40 million. No gain or loss was recorded in connection
with this transaction because the Company reflected the fair value of the
investment on April 1, 2001 in connection with fresh-start accounting. Under
the terms of the Credit Facility and Senior Secured Notes, proceeds from the
sale of BHC will be available to fund future capital expenditures for a period
of approximately one year from the sale. Any proceeds not expended during that
period would be used to permanently reduce the commitments under the Credit
Facility to $75 million and repay any outstanding loans in excess of such
commitment. Any remaining proceeds would be used to repay loans under the
Senior Secured Notes. For accounting purposes, the Company has classified these
funds as "cash-restricted" in the unaudited condensed consolidated balance
sheet at June 30, 2001.

F-26

424B4 138th Page of 184 TOC 1st Previous Next ↓Bottom Just 138th
REPORT OF PRICEWATERHOUSECOOPERS LLP

To the Board of Directors and Stockholders
of Kindred Healthcare, Inc.:

In our opinion, the consolidated financial statements listed in the
accompanying index, after the restatement described in Note 2, present fairly,
in all material respects, the financial position of Kindred Healthcare, Inc.
(formerly Vencor, Inc.) and its subsidiaries at December 31, 2000 and
December 31, 1999, and the results of their operations and their cash flows for
each of the two years in the period ended December 31, 2000, in conformity with
accounting principles generally accepted in the United States of America. These
financial statements are the responsibility of the Company's management; our
responsibility is to express an opinion on these financial statements based on
our audits. We conducted our audits of these statements in accordance with
auditing standards generally accepted in the United States of America, which
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, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.

In our original report, we included an explanatory paragraph regarding to
the Company's ability to continue as a going concern. As discussed in Note 22
to the consolidated financial statements, the Company emerged from bankruptcy
effective April 20, 2001, alleviating substantial doubt about the Company's
ability to continue as a going concern.

/s/ PricewaterhouseCoopers LLP

Louisville, Kentucky
March 16, 2001, except for Note 22,
as to which the date is April 20,
2001, and Notes 2 and 10, as to
which the date is August 22, 2001

F-27

424B4 139th Page of 184 TOC 1st Previous Next ↓Bottom Just 139th
REPORT OF ERNST & YOUNG LLP

To the Board of Directors and Stockholders
Kindred Healthcare, Inc.

We have audited the accompanying consolidated statements of operations,
stockholders' equity and cash flows of Kindred Healthcare, Inc. (formerly
Vencor, Inc.) for the year ended December 31, 1998. These financial statements
for 1998 are the responsibility of the Company's management. Our responsibility
is to express an opinion on these financial statements based on our audit.

We conducted our audit 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 audit provides 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 Kindred Healthcare, Inc. at December 31, 1998 and the consolidated results
of its operations and its cash flows for the year ended December 31, 1998 in
conformity with accounting principles generally accepted in the United States.

The accompanying 1998 consolidated financial statements have been prepared
assuming that the Company will continue as a going concern. As more fully
described in Note 3, the Company incurred a net loss in 1998 and was not in
compliance with certain covenants of a loan agreement at December 31, 1998. In
addition, the Company had a working capital deficiency at December 31, 1998.
These conditions raise substantial doubts about the Company's ability to
continue as a going concern. The 1998 consolidated financial statements do not
include adjustments, if any, to reflect the possible future effects on the
recoverability and classification of recorded asset amounts or the amounts and
classifications of liabilities that may result from the outcome of this
uncertainty.

/s/ Ernst & Young LLP

Louisville, Kentucky
April 13, 1999, except for Note 2,
as to which the date is August 22,
2001

F-28

424B4 140th Page of 184 TOC 1st Previous Next ↓Bottom Just 140th
KINDRED HEALTHCARE, INC.
(Formerly Vencor, Inc., a Debtor-in-Possession)
CONSOLIDATED STATEMENT OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998
(In thousands, except per share amounts)

[Download Table]

(Restated--see Note 2)
----------------------------------
2000 1999 1998
---------- ---------- ----------

Revenues................................... $2,888,542 $2,665,641 $2,999,739
---------- ---------- ----------
Salaries, wages and benefits............... 1,623,955 1,566,227 1,753,023
Supplies................................... 374,540 347,789 340,053
Rent....................................... 307,809 305,120 234,144
Other operating expenses................... 503,770 964,413 947,889
Depreciation and amortization.............. 73,545 93,196 124,617
Interest expense........................... 60,431 80,442 107,008
Investment income.......................... (5,393) (5,188) (4,688)
---------- ---------- ----------
2,938,657 3,351,999 3,502,046
---------- ---------- ----------
Loss before reorganization costs and income
taxes..................................... (50,115) (686,358) (502,307)
Reorganization costs....................... 12,636 18,606 -
---------- ---------- ----------
Loss before income taxes................... (62,751) (704,964) (502,307)
Provision for income taxes................. 2,000 500 76,099
---------- ---------- ----------
Loss from operations....................... (64,751) (705,464) (578,406)
Cumulative effect of change in accounting
for start-up costs........................ - (8,923) -
Extraordinary loss on extinguishment of
debt, net of income tax
benefit of $48,789........................ - - (77,937)
---------- ---------- ----------
Net loss............................. (64,751) (714,387) (656,343)
Preferred stock dividend requirements...... (1,046) (1,046) (697)
---------- ---------- ----------
Loss available to common
stockholders........................ $ (65,797) $ (715,433) $ (657,040)
========== ========== ==========
Loss per common share:
Basic:
Loss from operations................... $ (0.94) $ (10.03) $ (8.47)
Cumulative effect of change in
accounting for start-up costs......... - (0.13) -
Extraordinary loss on extinguishment of
debt.................................. - - (1.14)
---------- ---------- ----------
Net loss............................. $ (0.94) $ (10.16) $ (9.61)
========== ========== ==========
Diluted:
Loss from operations................... $ (0.94) $ (10.03) $ (8.47)
Cumulative effect of change in
accounting for start-up costs......... - (0.13) -
Extraordinary loss on extinguishment of
debt.................................. - - (1.14)
---------- ---------- ----------
Net loss............................. $ (0.94) $ (10.16) $ (9.61)
========== ========== ==========
Shares used in computing loss per common
share:
Basic.................................... 70,229 70,406 68,343
Diluted.................................. 70,229 70,406 68,343

See accompanying notes.

F-29

424B4 141st Page of 184 TOC 1st Previous Next ↓Bottom Just 141st
KINDRED HEALTHCARE, INC.
(Formerly Vencor, Inc., a Debtor-in-Possession)
CONSOLIDATED BALANCE SHEET
DECEMBER 31, 2000 AND 1999
(In thousands, except per share amounts)

[Download Table]

(Restated)
------------------------
2000 1999
----------- -----------

ASSETS
Current assets:
Cash and cash equivalents.......................... $ 184,642 $ 148,350
Accounts receivable less allowance for loss of
$139,445--2000 and $180,055--1999................. 322,483 324,135
Inventories........................................ 29,707 28,956
Insurance subsidiary investments................... 62,453 16,483
Other.............................................. 96,567 73,960
----------- -----------
695,852 591,884
Property and equipment, at cost:
Land............................................... 26,380 26,002
Buildings.......................................... 248,175 215,508
Equipment.......................................... 389,824 330,925
Construction in progress (estimated cost to
complete and equip after December 31, 2000--$8
million).......................................... 29,207 42,725
----------- -----------
693,586 615,160
Accumulated depreciation........................... (300,881) (243,526)
----------- -----------
392,705 371,634

Goodwill less accumulated amortization of $28,779--
2000 and
$17,817--1999....................................... 159,277 173,818
Other................................................ 86,580 98,638
----------- -----------
$ 1,334,414 $ 1,235,974
=========== ===========

LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable................................... $ 115,468 $ 101,219
Salaries, wages and other compensation............. 184,860 159,482
Due to third-party payors.......................... 44,561 52,205
Other accrued liabilities.......................... 83,802 83,967
----------- -----------
428,691 396,873

Professional liability risks......................... 101,209 72,785
Deferred credits and other liabilities............... 14,132 11,178
Liabilities subject to compromise.................... 1,260,373 1,159,417
Series A preferred stock (subject to compromise)..... 1,743 1,743

Contingencies

Stockholders' equity (deficit):
Preferred stock, $1.00 par value; authorized 10,000
shares; none issued
and outstanding................................... - -
Common stock, $0.25 par value; authorized 180,000
shares; issued
70,261 shares--2000 and 70,278 shares--1999....... 17,565 17,570
Capital in excess of par value..................... 667,168 667,078
Accumulated deficit................................ (1,156,467) (1,090,670)
----------- -----------
(471,734) (406,022)
----------- -----------
$ 1,334,414 $ 1,235,974
=========== ===========

See accompanying notes.

F-30

424B4 142nd Page of 184 TOC 1st Previous Next ↓Bottom Just 142nd
KINDRED HEALTHCARE, INC.
(Formerly Vencor, Inc., a Debtor-in-Possession)
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (DEFICIT)
FOR THE YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998
(In thousands)

[Enlarge/Download Table]

Shares
---------------- Par Capital
Common Value in Retained Common
Common Treasury Common Excess of Earnings Treasury
Stock Stock Stock Par Value (Deficit) Stock Total
------ -------- ------- --------- ----------- --------- ---------
(Restated)

Balances, December 31,
1997................... 73,470 (6,159) $18,368 $ 766,078 $ 281,803 $(160,899) $ 905,350
Net loss............... (656,343) (656,343)
Non-cash spin-off
transactions with
Ventas, Inc.:
Property and equipment,
net................... (953,534) (953,534)
Long-term debt......... 991,768 991,768
Common treasury stock.. (5,917) 5,917 (1,479) (156,390) 157,869 -
Series A preferred
stock................. (17,700) (17,700)
Deferred income taxes.. 15,907 15,907
Issuance of common
stock in connection
with employee benefit
plans................. 2,593 242 648 14,396 3,030 18,074
Preferred stock
dividend
requirements.......... (697) (697)
Other.................. 4,922 4,922
------ ------ ------- --------- ----------- --------- ---------
Balances, December 31,
1998................... 70,146 - 17,537 665,447 (375,237) - 307,747
Net loss............... (714,387) (714,387)
Issuance of common
stock in connection
with employee benefit
plans................. 132 33 309 342
Preferred stock
dividend
requirements.......... (1,046) (1,046)
Other.................. 1,322 1,322
------ ------ ------- --------- ----------- --------- ---------
Balances, December 31,
1999................... 70,278 - 17,570 667,078 (1,090,670) - (406,022)
Net loss............... (64,751) - (64,751)
Issuance (forfeiture)
of common stock in
connection with
employee benefit
plans................. (17) (5) 35 30
Preferred stock
dividend
requirements.......... (1,046) (1,046)
Other.................. 55 55
------ ------ ------- --------- ----------- --------- ---------
Balances, December 31,
2000................... 70,261 - $17,565 $ 667,168 $(1,156,467) $ - $(471,734)
====== ====== ======= ========= =========== ========= =========

See accompanying notes.

F-31

424B4 143rd Page of 184 TOC 1st Previous Next ↓Bottom Just 143rd
KINDRED HEALTHCARE, INC.
(Formerly Vencor, Inc., a Debtor-in-Possession)
CONSOLIDATED STATEMENT OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998
(In thousands)

[Download Table]

(Restated)
-------------------------------
2000 1999 1998
--------- --------- ---------

Cash flows from operating activities:
Net loss..................................... $ (64,751) $(714,387) $(656,343)
Adjustments to reconcile net loss to net cash
provided by operating activities:
Depreciation and amortization................ 73,545 93,196 124,617
Provision for doubtful accounts.............. 28,911 114,578 55,561
Deferred income taxes........................ - - 71,496
Extraordinary loss on extinguishment of
debt........................................ - - 126,726
Unusual transactions......................... 4,701 411,615 506,003
Gain on sale of investment in Atria
Communities, Inc............................ - - (98,461)
Reorganization costs......................... 12,636 18,606 -
Cumulative effect of change in accounting
for start-up costs.......................... - 8,923 -
Other........................................ 17,166 19,247 2,173
Change in operating assets and liabilities:
Accounts receivable......................... (21,590) 90,428 43,649
Inventories and other assets................ (20,154) 5,868 (11,920)
Accounts payable............................ 15,639 25,580 52,437
Income taxes................................ 2,961 6,431 (17,167)
Due to third-party payors................... (4,278) 99,370 155,333
Other accrued liabilities................... 149,279 67,616 (30,908)
--------- --------- ---------
Net cash provided by operating activities
before reorganization costs............... 194,065 247,071 323,196
Payment of reorganization costs.............. (8,525) (15,684) -
--------- --------- ---------
Net cash provided by operating activities.. 185,540 231,387 323,196
--------- --------- ---------
Cash flows from investing activities:
Purchase of property and equipment........... (79,988) (111,493) (267,288)
Other acquisitions........................... - - (24,227)
Sale of investment in Atria Communities,
Inc......................................... - - 177,500
Sale of investment in Colorado MEDtech,
Inc......................................... - - 22,001
Sale of other assets......................... 15,241 12,289 37,827
Surety bond deposits......................... (4,647) (17,213) -
Series A preferred stock loans............... - - (15,930)
Net change in investments.................... (46,904) 6,377 13,164
Other........................................ 1,731 (2,548) (5,203)
--------- --------- ---------
Net cash used in investing activities...... (114,567) (112,588) (62,156)
--------- --------- ---------
Cash flows from financing activities:
Net change in borrowings under revolving
lines of credit............................. - 55,000 (251,146)
Issuance of long-term debt................... - - 700,000
Net proceeds from senior subordinated notes
offerings................................... - - 294,000
Redemption of senior subordinated notes...... - - (732,547)
Repayment of long-term debt.................. (18,696) (26,776) (281,316)
Payment of debtor-in-possession deferred
financing costs............................. (1,226) (3,752) -
Payment of other deferred financing costs.... - (2,068) (11,334)
Other........................................ (14,759) (27,404) 227
--------- --------- ---------
Net cash used in financing activities...... (34,681) (5,000) (282,116)
--------- --------- ---------
Change in cash and cash equivalents........... 36,292 113,799 (21,076)
Cash and cash equivalents at beginning of
period....................................... 148,350 34,551 55,627
--------- --------- ---------
Cash and cash equivalents at end of period.... $ 184,642 $ 148,350 $ 34,551
========= ========= =========
Supplemental information:
Interest payments............................ $ 11,930 $ 35,783 $ 129,395
Income tax refunds........................... (713) (5,931) (31,576)

See accompanying notes.

F-32

424B4 144th Page of 184 TOC 1st Previous Next ↓Bottom Just 144th
KINDRED HEALTHCARE, INC.
(Formerly Vencor, Inc., a Debtor-in-Possession)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1--ACCOUNTING POLICIES

Reporting Entity

Kindred Healthcare, Inc. ("Kindred" or the "Company") (formerly Vencor,
Inc.) provides long-term healthcare services primarily through the operation of
nursing centers and hospitals. At December 31, 2000, the Company's health
services division operated 312 nursing centers (40,189 licensed beds) in 31
states and a rehabilitation therapy business. The Company's hospital division
operated 56 hospitals (4,886 licensed beds) in 23 states and an institutional
pharmacy business.

The Company and substantially all of its subsidiaries filed voluntary
petitions for protection under Chapter 11 of Title 11 of the United States Code
(the "Bankruptcy Code") on September 13, 1999. The Company currently is
operating its businesses as a debtor-in-possession subject to the jurisdiction
of the United States Bankruptcy Court in Delaware (the "Bankruptcy Court").
Accordingly, the consolidated financial statements of the Company have been
prepared in accordance with the American Institute of Certified Public
Accountants Statement of Position ("SOP") 90-7, "Financial Reporting by
Entities in Reorganization Under the Bankruptcy Code" ("SOP 90-7") and
generally accepted accounting principles applicable to a going concern, which
assumes that assets will be realized and liabilities will be discharged in the
normal course of business. The consolidated financial statements do not include
any adjustments that might result from the resolution of the Chapter 11 Cases
(as defined) or other matters discussed in the accompanying notes. The
Company's recent operating losses, liquidity issues and the Chapter 11 Cases
raise substantial doubt about the Company's ability to continue as a going
concern. The ability of the Company to continue as a going concern and the
appropriateness of using the going concern basis of accounting are dependent
upon, among other things, (a) the Company's ability to comply with the terms of
the DIP Financing (as defined), (b) consummation of the Amended Plan (as
defined), (c) the Company's ability to achieve profitable operations after such
consummation, and (d) the Company's ability to generate sufficient cash from
operations to meet its obligations. The Amended Plan and other actions during
the Chapter 11 Cases could change materially the amounts currently recorded in
the consolidated financial statements. See Note 3.

On May 1, 1998, Ventas, Inc. ("Ventas" or the "Company's predecessor")
completed the spin-off of its healthcare operations to its stockholders through
the distribution of the Company's common stock (the "Spin-off"). Ventas
retained ownership of substantially all of its real property and leases such
real property to the Company under four master lease agreements. In
anticipation of the Spin-off, the Company was incorporated on March 27, 1998 as
a Delaware corporation. For accounting purposes, the consolidated historical
financial statements of Ventas became the Company's historical financial
statements following the Spin-off. Any discussion concerning events prior to
May 1, 1998 refers to the Company's business as it was conducted by Ventas
prior to the Spin-off. See Notes 3 and 17.

Basis of Presentation

The consolidated financial statements include all subsidiaries. Significant
intercompany transactions have been eliminated. Investments in affiliates in
which the Company has a 50% or less interest are accounted for by either the
equity or cost method.

The accompanying consolidated financial statements have been prepared in
accordance with generally accepted accounting principles and include amounts
based upon the estimates and judgments of management. Actual amounts may differ
from these estimates.

F-33

424B4 145th Page of 184 TOC 1st Previous Next ↓Bottom Just 145th
KINDRED HEALTHCARE, INC.
(Formerly Vencor, Inc., a Debtor-in-Possession)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

NOTE 1--ACCOUNTING POLICIES (Continued)

Impact of Recent Accounting Pronouncements

Beginning in 1998, the Company adopted the provisions of Statement of
Financial Accounting Standards ("SFAS") No. 130 "Reporting Comprehensive
Income," ("SFAS 130"), which established new rules for the reporting of
comprehensive income and its components. SFAS 130 requires, among other things,
unrealized gains or losses on the Company's available-for-sale securities,
which prior to adoption were reported as changes in common stockholders'
equity, to be disclosed as other comprehensive income. There were no
significant comprehensive income items for the years ended December 31, 2000,
1999 and 1998.

Beginning in 1998, the Company adopted the provisions of SFAS No. 131,
"Disclosures about Segments of an Enterprise and Related Information," which
requires revised disclosures for segments of a company based upon management's
approach to defining business operating segments. See Note 8.

Effective January 1, 1999, the Company adopted SOP 98-5, "Reporting on the
Costs of Start-Up Activities" ("SOP 98-5"), which requires the Company to
expense start-up costs, including organizational costs, as incurred. In
accordance with the provisions of SOP 98-5, the Company wrote off $8.9 million
of such unamortized costs as a cumulative effect of a change in accounting
principle in the first quarter of 1999. The pro forma effect of the change in
accounting for start-up costs, assuming the change occurred on January 1, 1998,
was not significant.

In the first quarter of 1999, the Company adopted SOP 98-1, "Accounting for
the Costs of Computer Software Developed or Obtained for Internal Use" ("SOP
98-1"). SOP 98-1 provides guidance on accounting for the costs of computer
software developed or obtained for internal use. The adoption of SOP 98-1 did
not have a material effect on the Company's consolidated financial position or
results of operations.

In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements"
("SAB 101"). SAB 101 provides guidance on revenue recognition and related
disclosures and was effective beginning October 1, 2000. The Company was
previously following the requirements provided under SAB 101 and, accordingly,
the implementation of this pronouncement had no impact on the Company's
financial position or results of operations.

In June 1998, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 133, "Accounting for Derivative Instruments and Hedging Activities," ("SFAS
133") which was required to be adopted in fiscal years beginning after June 15,
1999. In June 1999, FASB delayed the effective date of SFAS 133 for one year.
Management has determined that the adoption of SFAS 133 on January 1, 2001 will
not have a material impact on the Company's financial position or results of
operations.

Reclassifications

Certain prior year amounts have been reclassified to conform with the
current year presentation.

Revenues

F-34

424B4 146th Page of 184 TOC 1st Previous Next ↓Bottom Just 146th
KINDRED HEALTHCARE, INC.
(Formerly Vencor, Inc., a Debtor-in-Possession)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

NOTE 1--ACCOUNTING POLICIES (Continued)

Revenues (Continued)

A summary of revenues by payor type follows (in thousands):

[Download Table]

2000 1999 1998
---------- ---------- ----------

Medicare................................. $1,050,758 $ 918,395 $1,038,669
Medicaid................................. 925,356 902,032 869,923
Private and other........................ 969,557 906,849 1,136,828
---------- ---------- ----------
2,945,671 2,727,276 3,045,420
Elimination.............................. (57,129) (61,635) (45,681)
---------- ---------- ----------
$2,888,542 $2,665,641 $2,999,739
========== ========== ==========

Cash and Cash Equivalents

Cash and cash equivalents include unrestricted highly liquid investments
with an original maturity of three months or less when purchased. Carrying
values of cash and cash equivalents approximate fair value due to the short-
term nature of these instruments.

Accounts Receivable

Accounts receivable consist primarily of amounts due from the Medicare and
Medicaid programs, other government programs, managed care health plans,
commercial insurance companies and individual patients. Amounts recorded
include estimated provisions for loss related to uncollectible accounts and
disputed items that have continuing significance, such as third-party
reimbursements that continue to be claimed in current cost reports.

In evaluating the collectibility of accounts receivable, the Company takes
into account a number of factors, including the age of the accounts, changes in
collection patterns, the composition of patient accounts by payor type, the
status of ongoing disputes with third-party payors and general industry
conditions. Amounts for disputed items are included in the estimated provisions
for loss related to uncollectible accounts to the extent it is probable that a
portion or all of these amounts will not be collected.

Inventories

Inventories consist primarily of medical supplies and are stated at the
lower of cost (first-in, first-out) or market.

Property and Equipment

Depreciation expense, computed by the straight-line method, was $60.9
million in 2000, $68.9 million in 1999 and $90.9 million in 1998. Depreciation
rates for buildings range generally from 20 to 45 years. Estimated useful lives
of equipment vary from 5 to 15 years.

Goodwill

Effective January 1, 2000, costs in excess of the fair value of identifiable
net assets of acquired entities are amortized using the straight-line method
principally over 20 years. Prior thereto, such costs were amortized over 40
years. Amortization expense recorded for 2000, 1999 and 1998 totaled $11.7
million, $23.3 million and $27.2 million, respectively.

F-35

424B4 147th Page of 184 TOC 1st Previous Next ↓Bottom Just 147th
KINDRED HEALTHCARE, INC.
(Formerly Vencor, Inc., a Debtor-in-Possession)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

NOTE 1--ACCOUNTING POLICIES (Continued)

Effective October 1, 1998, the Company reduced the amortization period for
goodwill related to its rehabilitation therapy business to seven years. In the
fourth quarter of 1999, in connection with the realignment of its former
Vencare division, the Company wrote off all of the goodwill associated with its
rehabilitation therapy business. See Note 4.

Long-Lived Assets

The Company regularly reviews the carrying value of certain long-lived
assets and the related identifiable intangible assets with respect to any
events or circumstances that indicate impairment or adjustment to the
amortization period. If such circumstances suggest the recorded amounts cannot
be recovered, calculated based upon estimated future cash flows (undiscounted),
the carrying values of such assets are reduced to fair value. See Note 6.

Professional Liability Risks

Provisions for loss for professional liability risks are based upon
actuarially determined estimates. To the extent that subsequent claims
information varies from management's estimates, earnings are charged or
credited.

Derivative Instruments

Prior to May 15, 2000, the Company was a party to interest rate swap
agreements that eliminated the impact of changes in interest rates on certain
outstanding floating rate debt. Each interest rate swap agreement was
associated with all or a portion of the principal balance of a specific debt
obligation. These agreements involved the exchange of amounts based on variable
rates for amounts based on fixed interest rates over the life of the agreement,
without an exchange of the notional amount upon which the payments were based.
The differential paid or received as interest rates changed was accrued and
recognized as an adjustment of interest expense related to the debt, and the
related amount payable to or receivable from counterparties was included in
accrued interest. The fair values of the swap agreements were not recognized in
the consolidated financial statements. Gains and losses on terminations of
interest rate swap agreements were deferred (included in other assets) and
amortized as an adjustment to interest expense over the remaining term of the
original contract life of the terminated swap agreement.

Earnings per Common Share

Basic earnings per common share are based upon the weighted average number
of common shares outstanding. No incremental shares are included in the
calculations of the diluted loss per common share since the result would be
antidilutive.

NOTE 2--RESTATEMENT OF PREVIOUSLY ISSUED FINANCIAL STATEMENTS

F-36

424B4 148th Page of 184 TOC 1st Previous Next ↓Bottom Just 148th
KINDRED HEALTHCARE, INC.
(Formerly Vencor, Inc., a Debtor-in-Possession)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

NOTE 2--RESTATEMENT OF PREVIOUSLY ISSUED FINANCIAL STATEMENTS (Continued)

$5 million at December 31, 1998, $28 million at December 31, 1999 and $39
million at December 31, 2000. The restatement had no effect on previously
reported cash flows from operations.

The consolidated financial statements included herein amend those previously
included in the Company's Annual Report on Form 10-K for the year ended
December 31, 2000. Consolidated financial statement information and related
disclosures included in these amended financial statements reflect, where
appropriate, changes resulting from the restatement.

The effect of the restatement on the Company's previously issued audited
consolidated financial statements follows (in thousands, except per share
amounts):

[Enlarge/Download Table]

For the year ended December 31,
---------------------------------------------------------------------------
2000 1999 1998
------------------------ ------------------------ -----------------------
As As
previously As previously As As previously As
reported restated reported restated reported restated
----------- ----------- ----------- ----------- ------------- ---------

Loss from operations.... $ (53,582) $ (64,751) $ (683,249) $ (705,464) $(572,908) $(578,406)
Net loss................ (53,582) (64,751) (692,172) (714,387) (650,845) (656,343)
Loss per common share:
Basic:
Loss from operations.. $ (0.78) $ (0.94) $ (9.72) $ (10.03) $ (8.39) $ (8.47)
Net loss.............. (0.78) (0.94) (9.85) (10.16) (9.53) (9.61)
Diluted:
Loss from operations.. $ (0.78) $ (0.94) $ (9.72) $ (10.03) $ (8.39) $ (8.47)
Net loss.............. (0.78) (0.94) (9.85) (10.16) (9.53) (9.61)

December 31, 2000 December 31, 1999
------------------------ ------------------------
As As
previously As previously As
reported restated reported restated
----------- ----------- ----------- -----------

Professional liability
risks.................. $ 62,327 $ 101,209 $ 45,072 $ 72,785
Total liabilities....... 1,765,523 1,804,405 1,612,540 1,640,253
Accumulated deficit..... (1,117,585) (1,156,467) (1,062,957) (1,090,670)
Stockholders' deficit... (432,852) (471,734) (378,309) (406,022)

The Company has revised its professional liability risks disclosure in Note
10 for the impact of the restatement.

In addition, in Note 12, the Company has revised its disclosure of future
minimum lease payments under non-cancelable operating leases to exclude
contingent rentals.

NOTE 3--PROCEEDINGS UNDER CHAPTER 11 OF THE BANKRUPTCY CODE

On September 13, 1999, the Company and substantially all of its subsidiaries
filed voluntary petitions for protection under Chapter 11 of the Bankruptcy
Code. The Chapter 11 cases have been consolidated for purposes of joint
administration under Case Nos. 99-3199 (MFW) through 99-3327 (MFW)
(collectively, the "Chapter 11 Cases"). The Company currently is operating its
businesses as a debtor-in-possession subject to the jurisdiction of the
Bankruptcy Court.

On March 1, 2001, the Bankruptcy Court approved the Company's fourth amended
plan of reorganization filed with the Bankruptcy Court on December 14, 2000, as
modified at the confirmation hearing (the "Amended

F-37

424B4 149th Page of 184 TOC 1st Previous Next ↓Bottom Just 149th
KINDRED HEALTHCARE, INC.
(Formerly Vencor, Inc., a Debtor-in-Possession)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

NOTE 3--PROCEEDINGS UNDER CHAPTER 11 OF THE BANKRUPTCY CODE (Continued)

Plan"). The order confirming the Amended Plan was entered on March 16, 2001.
The Amended Plan must be effective no later than May 1, 2001.

In connection with the confirmation hearing, the Company entered into a
commitment letter for a $120 million senior exit facility with a lending group
led by Morgan Guaranty Trust Company of New York (the "Exit Facility"). The
Exit Facility will be available to fund the Company's obligations under the
Amended Plan and its ongoing operations following emergence from bankruptcy.

The consummation of the Amended Plan is subject to a number of material
conditions including, without limitation, the negotiation and execution of
definitive agreements for the Exit Facility. There can be no assurance that the
Amended Plan will be consummated. See Notes 21 and 22.

In connection with the Chapter 11 Cases, the Company entered into a $100
million debtor-in-possession financing agreement (the "DIP Financing"). The
Bankruptcy Court granted final approval of the DIP Financing on October 1,
1999. The DIP Financing was initially comprised of a $75 million tranche A
revolving loan (the "Tranche A Loan") and a $25 million tranche B revolving
loan (the "Tranche B Loan"). Interest is payable at prime plus 2 1/2% on the
Tranche A Loan and prime plus 4 1/2% on the Tranche B Loan.

Available aggregate borrowings under the Tranche A Loan were initially
limited to $45 million in September 1999 and increased to $65 million in
October 1999, $70 million in November 1999 and $75 million thereafter. Pursuant
to the most recent amendment to the DIP Financing, the aggregate borrowing
limitations under the Tranche A Loan are limited to approximately $48 million
until maturity and are reduced for asset sales made by the Company. In
addition, Tranche B Loan aggregate borrowings are limited to $23 million as a
result of the most recent amendment to the DIP Financing. Borrowings under the
Tranche B Loan require the approval of lenders holding at least 75% of the
credit exposure under the DIP Financing. The DIP Financing is secured by
substantially all of the assets of the Company and its subsidiaries, including
certain owned real property. The DIP Financing contains standard
representations and warranties and other affirmative and restrictive covenants.
At December 31, 2000, there were no outstanding borrowings under the DIP
Financing.

Since the consummation of the DIP Financing, the Company and the lenders
under the DIP Financing (the "DIP Lenders") have agreed to several amendments
to the DIP Financing. In the most recent amendment to the DIP Financing, the
parties agreed, among other things, to extend the maturity date of the DIP
Financing until March 31, 2001 and to revise and update certain financial
covenants. In addition, the most recent amendment extends the period of time
for the Company to file the appropriate pleadings to request confirmation and
consummation of the Amended Plan through March 31, 2001. At December 31, 2000,
the Company was in compliance with the terms of the DIP Financing.

The Company expects to terminate the DIP Financing on or prior to the
effective date of the Amended Plan.

Events Leading to Reorganization

The Company reported a net loss from operations in 1998 aggregating $578
million, resulting in certain financial covenant violations under the Company's
$1.0 billion bank credit facility (the "Credit Agreement"). Prior to the
commencement of the Chapter 11 Cases, the Company received a series of
temporary waivers of these covenant violations. The waivers generally included
certain borrowing limitations under the $300 million revolving credit portion
of the Credit Agreement. The final waiver was scheduled to expire on September
24, 1999.

F-38

424B4 150th Page of 184 TOC 1st Previous Next ↓Bottom Just 150th
KINDRED HEALTHCARE, INC.
(Formerly Vencor, Inc., a Debtor-in-Possession)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

NOTE 3--PROCEEDINGS UNDER CHAPTER 11 OF THE BANKRUPTCY CODE (Continued)

Events Leading to Reorganization (Continued)

The Company was informed on April 9, 1999 by the Health Care Financing
Administration ("HCFA") that the Medicare program had made a demand for
repayment of approximately $90 million of reimbursement overpayments. On April
21, 1999, the Company reached an agreement with HCFA to extend the repayment of
such amounts over 60 monthly installments (the "HCFA Agreement"). Under the
HCFA Agreement, non-interest bearing monthly payments of approximately $1.5
million commenced in May 1999. Beginning in December 1999, interest began to
accrue on the balance of the overpayments at a statutory rate approximating
13.4%, resulting in a monthly payment of approximately $2.0 million through
March 2004. If the Company is delinquent with two consecutive payments, the
HCFA Agreement will be defaulted and all subsequent Medicare reimbursement
payments to the Company may be withheld. Amounts due under the HCFA Agreement
aggregated $63.4 million at December 31, 2000 and have been classified as
liabilities subject to compromise in the Company's consolidated balance sheet.
The Company has received Bankruptcy Court approval to continue to make the
monthly payments under the HCFA Agreement during the pendency of the Chapter 11
Cases.

On May 3, 1999, the Company elected not to make the interest payment of
approximately $14.8 million due on the $300 million 9 7/8% Guaranteed Senior
Subordinated Notes due 2005 (the "1998 Notes"). The failure to pay interest
resulted in an event of default under the 1998 Notes.

In accordance with SOP 90-7, outstanding borrowings under the Credit
Agreement ($511 million) and the principal amount of the 1998 Notes ($300
million) have been presented as liabilities subject to compromise in the
Company's consolidated balance sheet at December 31, 2000. If the Chapter 11
Cases had not been filed, the Company would have reported a working capital
deficit approximating $942 million at December 31, 2000. The consolidated
financial statements do not include any adjustments that might result from the
resolution of the Chapter 11 Cases or other matters discussed herein. During
the pendency of the Chapter 11 Cases, the Company is continuing to record the
contractual amount of interest expense related to the Credit Agreement. No
interest costs have been recorded related to the 1998 Notes since the filing of
the Chapter 11 Cases. Contractual interest expense for the 1998 Notes not
recorded in the consolidated statement of operations aggregated $30 million in
2000 and $9 million in 1999.

As previously reported, the Company was informed by the United States
Department of Justice (the "DOJ") that the Company and Ventas are the subjects
of ongoing investigations into various Medicare reimbursement issues, including
hospital cost reporting issues, Vencare billing practices and various quality
of care issues in the hospitals and nursing centers formerly operated by Ventas
and currently operated by the Company. In connection with the Amended Plan, the
claims of the DOJ will be settled through a government settlement entered into
with the Company and Ventas (the "Government Settlement"). The Government
Settlement also provides for the dismissal of certain pending claims and
lawsuits filed against the Company. See Note 20.

Agreements with Ventas

F-39

424B4 151st Page of 184 TOC 1st Previous Next ↓Bottom Just 151st
KINDRED HEALTHCARE, INC.
(Formerly Vencor, Inc., a Debtor-in-Possession)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

NOTE 3--PROCEEDINGS UNDER CHAPTER 11 OF THE BANKRUPTCY CODE (Continued)

Agreements with Ventas (Continued)

As a result of the Company's failure to pay rent, Ventas served the Company
with notices of nonpayment under the Master Lease Agreements. Subsequently, the
Company and Ventas entered into further amendments to the second standstill and
the tolling agreements to extend the time during which no remedies may be
pursued by either party and to extend the date by which the Company may cure
its failure to pay rent.

In connection with the Chapter 11 Cases, the Company and Ventas entered into
a stipulation (the "Stipulation") that provides for the payment by the Company
of a reduced aggregate monthly rent of approximately $15.1 million. The
Stipulation has been approved by the Bankruptcy Court. The difference between
the base rent under the Master Lease Agreements and the reduced aggregate
monthly rent is being accrued as an administrative expense subject to
compromise in the Chapter 11 Cases.

The Stipulation also continues to toll any statutes of limitations for
claims that might be asserted by the Company against Ventas and provides that
the Company will continue to fulfill its indemnification obligations arising
from the Spin-off. The Stipulation automatically renews for one-month periods
unless either party provides a 14-day notice of termination. The Stipulation
will be terminated upon the effective date of the Amended Plan. See Note 20.

On May 31, 2000, the Company announced that the Bankruptcy Court had
approved a tax stipulation agreement between the Company and Ventas (the "Tax
Stipulation"). The Tax Stipulation provides that certain refunds of federal,
state and local taxes received by either party on or after September 13, 1999
will be held by the recipient of such refunds in segregated interest bearing
accounts. The Tax Stipulation requires notification before either party can
withdraw funds from the segregated accounts and will terminate upon the
effective date of the Amended Plan.

The Company believes that the Amended Plan, if consummated, will resolve all
material disputes between the Company and Ventas. The Amended Plan also
provides for comprehensive mutual releases between the Company and Ventas,
other than for obligations that the Company is assuming under the Amended Plan.

If the Amended Plan does not become effective and the Company and Ventas are
unable to otherwise resolve their disputes or maintain an interim resolution,
the Company may seek to pursue claims against Ventas arising out of the Spin-
off and seek judicial relief barring Ventas from exercising any remedies based
on the Company's failure to pay some or all of the rent to Ventas. The
Company's failure to pay rent or otherwise comply with the Stipulation, in the
absence of judicial relief, would result in an "Event of Default" under the
Master Lease Agreements. Upon an Event of Default under the Master Lease
Agreements, assuming Ventas were to be granted relief from the automatic stay
by the Bankruptcy Court, the remedies available to Ventas include, without
limitation, terminating the Master Lease Agreements, repossessing and reletting
the leased properties and requiring the Company to (a) remain liable for all
obligations under the Master Lease Agreements, including the difference between
the rent under the Master Lease Agreements and the rent payable as a result of
reletting the leased properties or (b) pay the net present value of the rent
due for the balance of the terms of the Master Lease Agreements. Such remedies,
however, would be subject to the supervision of the Bankruptcy Court.

General

On September 14, 1999, the Company received approval from the Bankruptcy
Court to pay pre-petition and post-petition employee wages, salaries, benefits
and other employee obligations. The Bankruptcy Court also approved orders
granting authority, among other things, to pay pre-petition claims of certain
critical vendors, utilities and patient obligations. All other pre-petition
liabilities are classified in the consolidated balance sheet

F-40

424B4 152nd Page of 184 TOC 1st Previous Next ↓Bottom Just 152nd
KINDRED HEALTHCARE, INC.
(Formerly Vencor, Inc., a Debtor-in-Possession)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

NOTE 3--PROCEEDINGS UNDER CHAPTER 11 OF THE BANKRUPTCY CODE (Continued)

General (Continued)

as liabilities subject to compromise. The Company currently is paying the post-
petition claims of all vendors and providers in the ordinary course of
business.

Under the Bankruptcy Code, actions to collect pre-petition indebtedness
against the Company are subject to an automatic stay and other contractual
obligations against the Company may not be enforced. The automatic stay does
not necessarily apply to certain actions against Ventas for which the Company
has agreed to indemnify Ventas in connection with the Spin-off. In addition,
the Company may assume or reject executory contracts, including lease
obligations, under the Bankruptcy Code. Parties affected by these rejections
may file claims with the Bankruptcy Court in accordance with the reorganization
process.

Liabilities Subject to Compromise

A substantial portion of pre-petition liabilities are subject to settlement
under the Amended Plan. "Liabilities subject to compromise" refers to
liabilities incurred prior to the commencement of the Chapter 11 Cases. These
liabilities, consisting primarily of long-term debt, amounts due to third-party
payors and certain accounts payable and accrued liabilities, represent the
Company's estimate of known or potential claims to be resolved in connection
with the Chapter 11 Cases. Such claims remain subject to future adjustments
based on assertions of additional claims, negotiations, actions of the
Bankruptcy Court, further developments with respect to disputed claims, future
rejection of executory contracts or unexpired leases, determination as to the
value of any collateral securing claims and other events. Proposed payment
terms for these amounts are set forth in the Amended Plan.

All pre-petition liabilities, other than those for which the Company has
received Bankruptcy Court approval to pay, have been classified in the
consolidated balance sheet as liabilities subject to compromise. A summary of
the principal categories of claims classified as liabilities subject to
compromise under the Chapter 11 Cases follows (in thousands):

[Download Table]

December 31, December 31,
2000 1999
------------ ------------

Long-term debt:
Credit Agreement................................. $ 510,908 $ 506,114
1998 Notes....................................... 300,000 300,000
Amounts due under the HCFA Agreement............. 63,405 80,296
8 5/8% Senior Subordinated Notes................. 2,391 2,391
Unamortized deferred financing costs............. (10,306) (12,626)
Other............................................ 2,873 4,592
---------- ----------
869,271 880,767
---------- ----------

Due to third-party payors.......................... 116,062 112,694
Accounts payable................................... 36,053 33,693
Income taxes....................................... 13,478 -
Accrued liabilities:
Interest......................................... 90,655 45,521
Ventas rent...................................... 81,902 33,884
Other............................................ 52,952 52,858
---------- ----------
225,509 132,263
---------- ----------
$1,260,373 $1,159,417
========== ==========

F-41

424B4 153rd Page of 184 TOC 1st Previous Next ↓Bottom Just 153rd
KINDRED HEALTHCARE, INC.
(Formerly Vencor, Inc., a Debtor-in-Possession)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

Liabilities Subject to Compromise (Continued)

Substantially all of the liabilities subject to compromise would have been
classified as current liabilities if the Chapter 11 Cases had not been filed.

NOTE 4--VENCARE REALIGNMENT

During 1999, the Company operated its Vencare ancillary services business
which provided respiratory and rehabilitation therapies and medical and
pharmacy management services to nursing centers and other healthcare providers.
As a result of significant declines in the demand for ancillary services caused
by the Balanced Budget Act of 1997 (the "Budget Act"), management completed a
realignment of its Vencare division in the fourth quarter of 1999. Vencare's
physical rehabilitation, speech and occupational therapies were integrated into
the Company's nursing center division and the division was renamed the health
services division. Vencare's institutional pharmacy business was assigned to
the hospital division. Vencare's respiratory therapy and other ancillary
businesses have been discontinued.

In connection with the realignment, the Company recorded a charge
aggregating $56.3 million in the fourth quarter of 1999. See Note 6.

NOTE 5--BUSINESS COMBINATIONS

Acquisitions of healthcare facilities (including certain previously leased
facilities) and other related businesses, have been accounted for by the
purchase method. Accordingly, the aggregate purchase price of these
transactions has been allocated to tangible and identifiable intangible assets
acquired and liabilities assumed based upon their respective fair values. The
consolidated financial statements include the operations of acquired entities
since the respective acquisition dates. The pro forma effect of these
acquisitions on the Company's results of operations prior to consummation was
not significant.

The following is a summary of acquisitions consummated during 1998 under the
purchase method of accounting (in thousands):

[Download Table]

Fair value of assets acquired....................................... $32,286
Fair value of liabilities assumed................................... (8,059)
-------
Net cash paid for acquisitions.................................... $24,227
=======

The purchase price paid in excess of the fair value of identifiable net
assets of acquired entities aggregated $7.9 million.

NOTE 6--UNUSUAL TRANSACTIONS

2000

F-42

424B4 154th Page of 184 TOC 1st Previous Next ↓Bottom Just 154th
KINDRED HEALTHCARE, INC.
(Formerly Vencor, Inc., a Debtor-in-Possession)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

NOTE 6--UNUSUAL TRANSACTIONS (Continued)

1999

The following table summarizes the pretax impact of unusual transactions
recorded during 1999 (in millions):

[Download Table]

Quarters
-------------------------
First Second Third Fourth Year
----- ------ ----- ------ ------

(Income)/expense
Asset valuation losses:
Long-lived asset impairment........... $330.4 $330.4
Investment in BHC..................... $15.2 15.2
Cancellation of software development
project................................ 5.6 5.6
Realignment of Vencare division......... 56.3 56.3
Retirement plan curtailment............. 7.3 7.3
Corporate properties.................... (2.4) (2.4)
--- ----- --- ------ ------
$ - $20.8 $ - $391.6 $412.4
=== ===== === ====== ======

Long-lived asset impairment--SFAS No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed of" ("SFAS 121"),
requires impairment losses to be recognized for long-lived assets used in
operations when indications of impairment are present and the estimate of
undiscounted future cash flows is not sufficient to recover asset carrying
amounts. SFAS 121 also requires that long-lived assets held for disposal be
carried at the lower of carrying value or fair value less costs of disposal,
once management has committed to a plan of disposal.

Operating results and related cash flows for 1999 did not meet management's
expectations. These expectations were the basis upon which the Company valued
its long-lived assets at December 31, 1998, in accordance with SFAS 121. In
addition, certain events occurred in 1999 which had a negative impact on the
Company's operating results and are expected to impact negatively its
operations in the future. In connection with the negotiation of the Government
Settlement, the Company agreed to exclude certain expenses from its hospital
Medicare cost reports beginning September 1, 1999 for which the Company had
been reimbursed in prior years. Medicare revenues related to the reimbursement
of such costs aggregated $18 million in 1999 and $47 million in 1998. In
addition, hospital revenues in 1999 were reduced by approximately $19 million
as a result of disputes with certain insurers who issued Medicare supplement
insurance policies to individuals who became patients of the Company's
hospitals. The Company also reviewed the expected impact of the Balanced Budget
Refinement Act (the "BBRA") enacted in November 1999 (which provided a measure
of relief for some impact of the Budget Act) and the realignment of the Vencare
ancillary services business completed in the fourth quarter of 1999. The actual
and expected future impact of these issues served as an indication to
management that the carrying values of the Company's long-lived assets may be
impaired.

In accordance with SFAS 121, management estimated the future undiscounted
cash flows for each of its facilities and compared these estimates to the
carrying values of the underlying assets. As a result of these estimates, the
Company reduced the carrying amounts of the assets associated with 71 nursing
centers and 21 hospitals to their respective estimated fair values. The
determination of the fair values of the impaired facilities was based upon the
net present value of estimated future cash flows.

F-43

424B4 155th Page of 184 TOC 1st Previous Next ↓Bottom Just 155th
KINDRED HEALTHCARE, INC.
(Formerly Vencor, Inc., a Debtor-in-Possession)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

NOTE 6--UNUSUAL TRANSACTIONS (Continued)

A summary of the impairment charges follows (in millions):

[Download Table]

Property and
Goodwill Equipment Total
-------- ------------ ------

Health services division....................... $ 18.3 $ 37.7 $ 56.0
Hospital division.............................. 198.9 75.5 274.4
------- ------ ------
$ 217.2 $113.2 $330.4
======= ====== ======

Investment in BHC--In connection with the acquisition of Transitional
Hospitals Corporation ("Transitional") in 1997, the Company acquired a 44%
voting equity interest (61% equity interest) in Behavioral Healthcare
Corporation ("BHC"), an operator of psychiatric and behavioral clinics. In the
second quarter of 1999, the Company wrote off its remaining investment in BHC
aggregating $15.2 million as a result of deteriorating financial performance.
See the discussion of unusual transactions recorded in 1998 for further
information related to the Company's investment in BHC.

Cancellation of software development project--In the second quarter of 1999,
the Company canceled a nursing center software development project and charged
previously capitalized costs to operations.

Realignment of Vencare division--As discussed in Note 4, the Company
realigned the Vencare ancillary services division in the fourth quarter of
1999. As a result, the Company recorded a charge aggregating $56.3 million,
including the write-off of goodwill totaling $42.3 million. The remainder of
the charge related to the write-down of certain equipment to net realizable
value and the recording of employee severance costs.

Retirement plan curtailment--In December 1999, the Board of Directors
approved the curtailment of benefits under the Company's supplemental executive
retirement plan, resulting in an actuarially determined charge of $7.3 million.
Under the terms of the curtailment, plan benefits were vested for each eligible
participant through December 31, 1999 and the accrual of future benefits under
the plan was substantially eliminated. The Board of Directors also deferred the
time at which certain benefits would be paid by the Company.

Corporate properties--During 1999, the Company adjusted estimated property
loss provisions recorded in the fourth quarter of 1998, resulting in a pretax
credit of $2.4 million.

F-44

424B4 156th Page of 184 TOC 1st Previous Next ↓Bottom Just 156th
KINDRED HEALTHCARE, INC.
(Formerly Vencor, Inc., a Debtor-in-Possession)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

NOTE 6--UNUSUAL TRANSACTIONS (Continued)

1998

The following table summarizes the pretax impact of unusual transactions
recorded during 1998 (in millions):

[Download Table]

Quarters
----------------------------
First Second Third Fourth Year
----- ------ ------- ------ --------

(Income)/expense
Asset valuation losses:
Long-lived asset impairment...... $307.8 $ 307.8
Investment in BHC................ $ 8.5 43.1 51.6
Wisconsin nursing center......... 27.5 27.5
Corporate properties............. $ 8.8 2.9 15.1 26.8
Acquired entities................ 13.5 13.5
Gain on sale of investments........ (98.5) (13.0) (111.5)
Losses from termination of
construction projects............. 71.3 71.3
Spin-off transaction costs......... $7.7 9.6 17.3
Write-off of clinical information
systems........................... 10.1 10.1
Doubtful accounts related to sold
operations........................ 9.6 9.6
Settlement of litigation........... 7.8 7.8
Loss on sale and closure of home
health and hospice businesses..... 7.3 7.3
---- ----- ------- ------ --------
$7.7 $25.7 $ (6.2) $411.9 $ 439.1
==== ===== ======= ====== ========

Long-lived asset impairment--The Budget Act established, among other things,
a new Medicare prospective payment system ("PPS") for nursing centers. All of
the Company's nursing centers became subject to PPS effective July 1, 1998.
During the first three years, the per diem rates for nursing centers are based
on a blend of facility-specific and federal costs. Thereafter, the per diem
rates will be based solely on federal costs. The revenues recorded under PPS in
the Company's health services division were substantially less than the cost-
based reimbursement it received before the enactment of the Budget Act.

The Budget Act also reduced payments to the Company's hospitals by reducing
incentive payments pursuant to the Tax Equity and Fiscal Responsibility Act of
1982 ("TEFRA"), allowable costs for capital expenditures and bad debts, and
payments for services to patients transferred from a general acute care
hospital. The reductions in allowable costs for capital expenditures became
effective in the fourth quarter of 1997. The reductions in TEFRA incentive
payments and allowable costs for bad debts became effective in the third and
fourth quarters of 1998. The reduction for payments for services to patients
transferred from a general acute care hospital became effective in the fourth
quarter of 1998. These reductions had a material adverse impact on hospital
revenues in 1998.

The Company provides ancillary services to both Company-operated and non-
affiliated nursing centers. While most of the nursing center industry became
subject to PPS on or after January 1, 1999, management believed that Vencare's
ability to maintain services and revenues was impacted adversely during 1998,
particularly in the third and fourth quarters, since nursing centers were
reluctant to enter into ancillary service contracts while transitioning to the
new fixed payment system under PPS. Medicare reimbursements to nursing centers
under PPS include substantially all services provided to patients, including
ancillary services. Management believes that the decline in demand for its
Vencare services in 1998, particularly respiratory

F-45

424B4 157th Page of 184 TOC 1st Previous Next ↓Bottom Just 157th
KINDRED HEALTHCARE, INC.
(Formerly Vencor, Inc., a Debtor-in-Possession)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

NOTE 6--UNUSUAL TRANSACTIONS (Continued)

therapy and rehabilitation therapy, was mostly attributable to efforts by
nursing center customers to reduce operating costs. In addition, as a result of
these regulatory changes, many nursing centers began providing ancillary
services to their patients through internal staff and no longer contracted with
outside parties for ancillary services.

In January 1998, HCFA issued rules changing Medicare reimbursement
guidelines for therapy services provided by the Company. Under these rules,
HCFA established salary equivalency limits for speech and occupational therapy
services and revised limits for physical and respiratory therapy services. The
new limits became effective for services provided on or after April 10, 1998
and negatively impacted operating results of the Company's ancillary services
businesses in 1998.

These significant regulatory changes and the impact of such changes on the
Company's operating results in the third and fourth quarters of 1998 served as
an indication to management that the carrying values of the assets of its
nursing center and hospital facilities, as well as certain portions of its
ancillary services business, may be impaired.

In accordance with SFAS 121, management estimated the future undiscounted
cash flows for each of its facilities and ancillary services lines of business
and compared these estimates to the carrying values of the underlying assets.
As a result of these estimates, the Company reduced the carrying amounts of the
assets associated with 110 nursing centers, 12 hospitals and a portion of the
goodwill associated with its rehabilitation therapy business to their
respective estimated fair values. The determination of the fair values of the
impaired facilities and rehabilitation therapy business was based upon the net
present value of estimated future cash flows.

A summary of the impairment charges follows (in millions):

[Download Table]

Property and
Goodwill Equipment Total
-------- ------------ ------

Health services division:
Nursing centers.............................. $ 27.7 $ 71.6 $ 99.3
Ancillary services........................... 99.2 0.2 99.4
Hospital division.............................. 74.4 34.7 109.1
------ ------ ------
$201.3 $106.5 $307.8
====== ====== ======

In addition to the above impairment charges, the amortization period for the
remaining goodwill associated with the Company's rehabilitation therapy
business was reduced from forty years to seven years, effective October 1,
1998. Management believed that the provisions of the Budget Act altered the
expected long-term cash flows and business prospects associated with this
business to such an extent that a shorter amortization period was deemed
appropriate. The change in the amortization period resulted in an additional
pretax charge to operations of $6.4 million in the fourth quarter of 1998. In
the fourth quarter of 1999, in connection with the realignment of Vencare, the
Company wrote off all of the goodwill associated with the rehabilitation
therapy business.

Investment in BHC--Subsequent to the Transitional merger, the Company had
been unsuccessful in its attempts to sell its investment in BHC. In July 1998,
the Company entered into an agreement to sell its interest in BHC for an amount
less than its carrying value and accordingly, a provision for loss of $8.5
million was recorded during the third quarter. In November 1998, the agreement
to sell the Company's interest in BHC was

F-46

424B4 158th Page of 184 TOC 1st Previous Next ↓Bottom Just 158th
KINDRED HEALTHCARE, INC.
(Formerly Vencor, Inc., a Debtor-in-Possession)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

NOTE 6--UNUSUAL TRANSACTIONS (Continued)

terminated by the prospective buyer, indicating to the Company that the
carrying amount of its investment may be impaired. Following an independent
appraisal, the Company recorded a $43.1 million write-down of the investment in
the fourth quarter of 1998. The net carrying amount of the investment
aggregated $20.0 million at December 31, 1998.

Wisconsin nursing center--The Company recorded an asset impairment charge of
$27.5 million in the fourth quarter of 1998 related to a nursing center in
Wisconsin that is leased from Ventas. The impairment resulted primarily from
certain fourth quarter regulatory actions by state and federal agencies with
respect to the operation of the facility. In the fourth quarter of 1998, the
facility reported a pretax loss of $4.2 million and is not expected to generate
positive cash flows in the future.

Corporate properties and acquired entities--During 1998, the Company
recorded $26.8 million of charges related to the valuation of certain corporate
assets, the most significant of which relates to previously capitalized amounts
and expected property disposal losses associated with the cancellation of a
corporate headquarters construction project. The Company also recorded $13.5
million of asset write-downs associated with the acquisition of The Hillhaven
Corporation ("Hillhaven"), TheraTx, Incorporated ("TheraTx") and Transitional,
including provisions for obsolete or abandoned computer equipment and
miscellaneous receivables.

Gain on sale of investments--In September 1998, the Company sold its
investment in its assisted living affiliate, Atria Communities, Inc. ("Atria"),
for $177.5 million in cash and an equity interest in the surviving corporation,
resulting in a gain of $98.5 million. In November 1998, the Company's
investment in Colorado MEDtech, Inc. was sold at a gain of $13.0 million.
Proceeds from the sale were $22.0 million.

Losses from termination of construction projects--In the third quarter of
1998, as a result of substantial reductions in Medicare reimbursement to the
Company's nursing centers and hospitals in connection with the Budget Act,
management determined to suspend all acquisition and development activities,
terminate the construction of substantially all of its development properties,
and close two recently acquired hospitals. Accordingly, the Company recorded
pretax charges aggregating $71.3 million, of which $53.9 million related to the
cancellation of construction projects and the remainder related to the planned
closure of the hospitals. In connection with the construction termination
charge, the Company decided that it would not replace certain facilities that
previously were accounted for as assets intended for disposal. Accordingly, the
$53.9 million charge discussed above included a $10.0 million reversal of a
previously recorded valuation allowance (the amount necessary to reduce the
carrying value to fair value less costs of disposal) related to such
facilities.

Spin-off transaction costs--The Spin-off was completed on May 1, 1998.
Direct costs related to the transaction totaled $17.3 million and primarily
included costs for professional services.

Write-off of clinical information systems--During 1997, the Company began
the installation of its proprietary clinical information system, ProTouch(TM),
in several of its nursing centers. During the pilot process, the Company
determined that ProTouch(TM) did not support effectively the nursing center
processes, especially in facilities with lower acuity patients. Accordingly,
management determined in the fourth quarter of 1998 to remove ProTouch(TM) from
these facilities during 1999. A loss of $10.1 million was recorded to reflect
the write-off of the equipment and estimated costs of removal from the
facilities.

Doubtful accounts related to sold operations--In the third quarter of 1998,
the Company recorded $9.6 million of additional provisions for doubtful
accounts for accounts receivable associated with previously sold facilities.

F-47

424B4 159th Page of 184 TOC 1st Previous Next ↓Bottom Just 159th
KINDRED HEALTHCARE, INC.
(Formerly Vencor, Inc., a Debtor-in-Possession)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

NOTE 6--UNUSUAL TRANSACTIONS (Continued)

Settlement of litigation--The Company settled a legal action entitled
Highland Pines Nursing Center, Inc., et al. v. TheraTx, Incorporated, et al.
(assumed in connection with the TheraTx merger) which resulted in a payment of
$16.2 million. Approximately $7.8 million of the settlement was charged to
earnings in the fourth quarter of 1998, and the remainder of such costs had
been previously accrued in connection with the purchase price allocation.

Loss on sale and closure of home health and hospice businesses--The Company
began operating its home health and hospice businesses in 1996. These
operations generally were unprofitable. In the second quarter of 1998,
management decided to cease operations and either close or sell these
businesses, resulting in a loss of $7.3 million.

NOTE 7--FOURTH QUARTER ADJUSTMENTS

In addition to the unusual transactions discussed in Note 6, during the
fourth quarter of 1999 and 1998, the Company recorded certain adjustments which
significantly impacted operating results. A summary of such adjustments follows
(in millions):

[Download Table]

(Income)/expense
Provision for doubtful
accounts............... $40.2 $26.8 $ 6.5 $ 8.9 $ 82.4
Medicare supplement
insurance disputes..... 18.8 18.8
Third-party
reimbursements and
contractual allowances,
including amounts due
from government
agencies and other
payors that are subject
to dispute............. 2.0 59.6 61.6
Professional liability
risks.................. 14.7 0.4 1.8 0.1 17.0
Employee benefits....... (6.3) (1.5) (1.8) (9.6)
Incentive compensation.. 2.2 (1.9) (1.1) (0.8)
Inventories............. 0.9 6.3 7.2
Other................... 1.7 (0.4) 2.0 (4.4) $(2.8) (3.9)
----- ----- ----- ----- ----- ------
$55.4 $25.3 $85.0 $ 9.8 $(2.8) $172.7
===== ===== ===== ===== ===== ======

F-48

424B4 160th Page of 184 TOC 1st Previous Next ↓Bottom Just 160th
KINDRED HEALTHCARE, INC.
(Formerly Vencor, Inc., a Debtor-in-Possession)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

NOTE 7--FOURTH QUARTER ADJUSTMENTS (Continued)

[Download Table]

(Income)/expense
Provision for doubtful
accounts............... $ 14.0 $ 6.8 $ 5.7 $2.5 $29.0
Third-party
reimbursements and
contractual allowances,
including amounts due
from government
agencies and other
payors that are subject
to dispute............. 4.8 11.5 11.4 27.7
Change in goodwill
amortization period
related to
rehabilitation therapy
business............... 6.4 6.4
Taxes other than
income................. $ 6.4 6.4
Professional liability
risks.................. 3.5 0.2 1.8 5.5
Compensated absences.... 2.1 1.3 (0.8) 0.7 3.3
Incentive compensation.. (1.0) (0.4) (0.8) (0.1) (2.9) (5.2)
Litigation and
regulatory actions..... 3.5 3.5
Miscellaneous
receivables............ 5.2 5.2
Gain on sale of assets.. (2.0) (2.0)
Other................... 1.2 0.4 (1.0) 0.3 3.7 4.6
------ ----- ----- ---- ----- -----
$ 24.6 $24.2 $16.3 $7.9 $11.4 $84.4
====== ===== ===== ==== ===== =====

The Company regularly reviews its accounts receivable and records provisions
for loss based upon the best available evidence. Factors such as changes in
collection patterns, the composition of patient accounts by payor type, the
status of ongoing disputes with third-party payors (including both government
and non-government sources), the effect of increased regulatory activities,
general industry conditions and the financial condition of the Company and its
ancillary service customers, among other things, are considered by management
in determining the expected collectibility of accounts receivable.

During 1999 and 1998, the Company recorded significant adjustments in the
fourth quarter related to contractual allowances and doubtful accounts in each
of its divisions. These adjustments represented changes in estimates resulting
from management's assessment of its collection processes, the general financial
deterioration of the long-term healthcare industry and, in 1999, the
realignment of the Vencare businesses (including the cancellation of
unprofitable contracts and the discontinuance of certain services) and the
filing of the Chapter 11 Cases in September 1999.

In addition, the Company recorded a significant adjustment in the fourth
quarter of 1999 related to professional liability risks. This adjustment was
recorded based upon actuarially determined estimates completed in the fourth
quarter and reflects substantial increases in claims and litigation activity in
the Company's nursing center business during 1999.

F-49

424B4 161st Page of 184 TOC 1st Previous Next ↓Bottom Just 161st
KINDRED HEALTHCARE, INC.
(Formerly Vencor, Inc., a Debtor-in-Possession)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

NOTE 8--BUSINESS SEGMENT DATA

The following table represents the Company's revenues, operating results,
capital expenditures and assets by operating segment and gives effect to the
realignment of the former Vencare businesses for all periods presented. The
Company defines operating income as earnings before interest, income taxes,
depreciation, amortization and rent. Operating income reported for each of the
Company's business segments excludes allocations of corporate overhead.

[Download Table]

2000 1999 1998
---------- ---------- ----------
(In thousands)

Revenues:
Health services division:
Nursing centers........................... $1,675,627 $1,594,244 $1,667,343
Rehabilitation services................... 135,036 195,731 264,574
Other ancillary services.................. - 43,527 168,165
Elimination............................... (77,191) (128,267) (124,500)
---------- ---------- ----------
1,733,472 1,705,235 1,975,582
Hospital division:
Hospitals................................. 1,007,947 850,548 919,847
Pharmacy.................................. 204,252 171,493 149,991
---------- ---------- ----------
1,212,199 1,022,041 1,069,838
---------- ---------- ----------
2,945,671 2,727,276 3,045,420
Elimination of pharmacy charges to Company
nursing centers.......................... (57,129) (61,635) (45,681)
---------- ---------- ----------
$2,888,542 $2,665,641 $2,999,739
========== ========== ==========
Income (loss) from operations (restated):
Operating income (loss):
Health services division:
Nursing centers.......................... $ 278,738 $ 169,128 $ 213,036
Rehabilitation services.................. 8,047 2,891 18,398
Other ancillary services................. 4,737 4,166 30,183
---------- ---------- ----------
291,522 176,185 261,617
Hospital division:
Hospitals................................ 205,858 132,050 247,272
Pharmacy................................. 7,421 342 15,301
---------- ---------- ----------
213,279 132,392 262,573
Corporate overhead........................ (113,823) (108,947) (126,291)
Unusual transactions...................... (4,701) (412,418) (439,125)
Reorganization costs...................... (12,636) (18,606) -
---------- ---------- ----------
Operating income (loss).................. 373,641 (231,394) (41,226)
Rent...................................... (307,809) (305,120) (234,144)
Depreciation and amortization............. (73,545) (93,196) (124,617)
Interest, net............................. (55,038) (75,254) (102,320)
---------- ---------- ----------
Loss before income taxes.................. (62,751) (704,964) (502,307)
Provision for income taxes................ 2,000 500 76,099
---------- ---------- ----------
$ (64,751) $ (705,464) $ (578,406)
========== ========== ==========
Capital expenditures:
Health services division.................. $ 28,451 $ 42,144 $ 126,880
Hospital division......................... 23,675 23,918 55,789
Corporate:
Information systems....................... 25,475 40,777 47,541
Other..................................... 2,387 4,654 37,078
---------- ---------- ----------
$ 79,988 $ 111,493 $ 267,288
========== ========== ==========
Assets at end of period:
Health services division.................. $ 494,636 $ 489,316
Hospital division......................... 354,302 337,218
Corporate................................. 485,476 409,440
---------- ----------
$1,334,414 $1,235,974
========== ==========

F-50

424B4 162nd Page of 184 TOC 1st Previous Next ↓Bottom Just 162nd
KINDRED HEALTHCARE, INC.
(Formerly Vencor, Inc., a Debtor-in-Possession)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

NOTE 9--INCOME TAXES

Provision for income taxes consists of the following (in thousands):

[Download Table]

2000 1999 1998
------ ---- ----------
(Restated)

Current:
Federal............................................. $ - $ - $ 2,131
State............................................... 2,000 500 355
------ ---- -------
2,000 500 2,486
Deferred.............................................. - - 73,613
------ ---- -------
$2,000 $500 $76,099
====== ==== =======

Reconciliation of federal statutory tax expense to the provision for income
taxes follows (in thousands):

[Download Table]

(Restated)
------------------------------
2000 1999 1998
-------- --------- ---------

Income tax benefit at federal rate......... $(21,963) $(249,861) $(175,807)
State income tax benefit, net of federal
income tax benefit........................ (2,197) (24,985) (17,581)
Merger related costs....................... - - 5,943
Goodwill amortization...................... 3,997 8,541 8,823
Write-off of goodwill...................... - 99,902 77,482
Gain on sale of Atria...................... - - (37,908)
Acquisition costs and merger adjustments... - - 8,851
Valuation allowance........................ 12,222 154,933 205,066
Reorganization costs....................... 7,372 4,672 -
Other items, net........................... 2,569 7,298 1,230
-------- --------- ---------
$ 2,000 $ 500 $ 76,099
======== ========= =========

A summary of deferred income taxes by source included in the consolidated
balance sheet at December 31 follows (in thousands):

[Download Table]

2000 1999
----------------------- -----------------------
Assets Liabilities Assets Liabilities
---------- ----------- ---------- -----------
(Restated) (Restated)

Depreciation............... $ - $28,047 $ - $11,275
Insurance.................. 33,747 - 21,335 -
Doubtful accounts.......... 140,526 - 143,193 -
Property................... 102,865 - 105,555 -
Compensation............... 21,785 - 16,234 -
Subsidiary net operating
losses (expiring in
2020)..................... 79,915 - 56,087 -
Other...................... 47,484 26,054 47,086 18,216
--------- ------- --------- -------
426,322 $54,101 389,490 $29,491
======= =======
Reclassification of
deferred tax liabilities.. (54,101) (29,491)
--------- ---------
Net deferred tax assets.... 372,221 359,999
Valuation allowance........ (372,221) (359,999)
--------- ---------
$ - $ -
========= =========

F-51

424B4 163rd Page of 184 TOC 1st Previous Next ↓Bottom Just 163rd
KINDRED HEALTHCARE, INC.
(Formerly Vencor, Inc., a Debtor-in-Possession)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

NOTE 9--INCOME TAXES (Continued)

Prior to 1998, management believed that recorded deferred tax assets
ultimately would be realized. Management's conclusions at that time were based
primarily on the existence of sufficient taxable income within the allowable
carryback periods to realize the tax benefits of deductible temporary
differences recorded at December 31, 1997. For the fourth quarter of 1998, the
Company reported a pretax loss of $512 million. Additionally, the Company
revised its operating budgets as a result of the Budget Act and the less than
expected operating results in 1998. Based upon those revised forecasts,
management did not believe that the Company could generate sufficient taxable
income to realize the net deferred tax assets recorded at December 31, 1998.
Accordingly, the Company recorded a deferred tax asset valuation allowance
aggregating $205 million in the fourth quarter of 1998. Deferred tax valuation
allowances recorded in 1999 and 2000 totaled $155 million and $12 million,
respectively. The deferred tax valuation allowance included in the consolidated
balance sheet at December 31, 2000 totaled $372 million.

At the time of the Spin-off, the Company recorded both a deferred tax asset
and a valuation allowance for identical amounts in connection with the
difference in book and tax basis of the Company's investment in Atria which
resulted from the Spin-off. The valuation allowance was recorded due to the
litigation and other uncertainties associated with the realization of the
deferred tax asset, based upon the available evidence at the time of the Spin-
off. During the third quarter of 1998, upon favorable resolution of such
litigation and completion of the Atria sale, the Company adjusted the valuation
allowance that had been recorded in the second quarter of 1998.

NOTE 10--PROFESSIONAL LIABILITY RISKS

The Company insures a substantial portion of its professional and general
liability risks primarily through a wholly owned insurance subsidiary.
Provisions for such risks were $47.2 million for 2000, $61.3 million for 1999
and $22.2 million for 1998.

The allowance for professional liability risks aggregated $119.1 million and
$95.4 million at December 31, 2000 and 1999, respectively, including $17.9
million and $22.6 million, respectively, classified as a current liability. The
Company also maintains reinsurance contracts with an unrelated insurer.
Reinsurance recoverables related to these risks (included in accounts
receivable and noncurrent assets) aggregated $21.7 million and $34.8 million at
December 31, 2000 and 1999, respectively.

At December 31, 2000 and 1999, investments held for the payment of claims
and expenses related to self-insured risks aggregated $64.6 million and $18.8
million, respectively, including $2.1 million and $2.3 million, respectively,
classified as a noncurrent asset.

F-52

424B4 164th Page of 184 TOC 1st Previous Next ↓Bottom Just 164th
KINDRED HEALTHCARE, INC.
(Formerly Vencor, Inc., a Debtor-in-Possession)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

NOTE 11--LONG-TERM DEBT

Capitalization

All long-term debt has been classified as liabilities subject to compromise.
A summary of long-term debt at December 31 follows (in thousands):

[Download Table]

2000 1999
--------- ---------

Senior collateralized debt, 8% to 8.75% (rates
generally floating) payable in periodic installments
through 2017........................................ $ 1,746 $ 1,851
Term A Loan, 7.9% to 8.6% (rates generally floating)
payable in periodic installments through 2003....... 224,623 224,623
Term B Loan, 8.4% to 9.1% (rates generally floating)
payable in periodic installments through 2005....... 226,491 226,491
Bank revolving credit agreement due 2003 (floating
rates averaging 10%)................................ 59,794 55,000
9 7/8% Guaranteed Senior Subordinated Notes due
2005................................................ 300,000 300,000
8 5/8% Senior Subordinated Notes due 2007............ 2,391 2,391
Amounts due to HCFA, 13.4% payable in monthly
installments through 2004........................... 63,405 80,296
Unamortized deferred financing costs................. (10,306) (12,626)
Other................................................ 1,127 2,741
--------- ---------
Total debt, average life of four years (rates
averaging 9.5%)................................... 869,271 880,767
Amounts subject to compromise........................ (869,271) (880,767)
--------- ---------
Long-term debt..................................... $ - $ -
========= =========

In accordance with SOP 90-7, unamortized deferred financing costs have been
classified as reductions of long-term debt subject to compromise.

In connection with the Chapter 11 Cases, the Company entered into the DIP
Financing with the DIP Lenders. At December 31, 2000, the Company was in
compliance with the terms of the DIP Financing.

In connection with the Spin-off, the Company consummated the $1.0 billion
Credit Agreement which includes: (a) a five-year $300 million revolving credit
facility (the "Revolving Credit Facility"), (b) a $250 million Term A Loan (the
"Term A Loan") payable in various installments over five years, (c) a
$250 million Term B Loan (the "Term B Loan") payable in installments of 1% per
year with the outstanding balance due in seven years and (d) a $200 million
Bridge Loan (the "Bridge Loan") which was repaid in September 1998 primarily
from the proceeds of the sale of the Company's investment in Atria. Interest is
payable, depending on certain leverage ratios and other factors, at a rate of
prime plus 2% to 3 1/2% for the Revolving Credit Facility, LIBOR plus 3/4% to
3% for the Term A Loan, and LIBOR plus 2 1/4% to 3 1/2% for the Term B Loan.

On April 30, 1998, the Company completed the private placement of $300
million aggregate principal amount of the 1998 Notes, which are not callable by
the Company until 2002. On September 10, 1998, the Company exchanged the 1998
Notes for publicly registered securities having identical terms and conditions.

Approximately $831 million of debt subject to compromise would have been
classified as current liabilities if the Chapter 11 Cases had not been filed.

Refinancing Activities

In connection with the Spin-off, the Company refinanced substantially all of
its long-term debt, resulting in after-tax losses of $78 million in 1998.

F-53

424B4 165th Page of 184 TOC 1st Previous Next ↓Bottom Just 165th
KINDRED HEALTHCARE, INC.
(Formerly Vencor, Inc., a Debtor-in-Possession)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

NOTE 11--LONG-TERM DEBT (Continued)

Other Information

At December 31, 1999, the Company was a party to certain interest rate swap
agreements that eliminated the impact of changes in interest rates on $100
million of floating rate debt outstanding. The agreements provided for fixed
rates on $100 million of floating rate debt at 6.4% plus 3/8% to 1 1/8% and
expired in May 2000. The fair value of the swap agreements, or the estimated
amount the Company would have paid to terminate the agreements based on current
interest rates, was not recognized in the consolidated financial statements.
The Company was not a party to any interest rate swap agreements at December
31, 2000.

If the Chapter 11 Cases had not been filed, the scheduled maturities of
long-term debt in years 2002 through 2005 would be $148 million, $118 million,
$183 million and $342 million, respectively.

The estimated fair value of the Company's long-term debt was $537 million
and $485 million at December 31, 2000 and 1999, respectively, compared to
carrying amounts aggregating $880 million and $893 million. The estimate of
fair value at December 31, 1999 includes the effect of the interest rate swap
agreements and is based upon the quoted market prices for the same or similar
issues of long-term debt, or on rates available to the Company for debt of the
same remaining maturities. The estimated fair value of the interest rate swap
agreements was $157,000 (payable position) at December 31, 1999.

NOTE 12--LEASES

The Company leases real estate and equipment under cancelable and non-
cancelable arrangements. The Company may assume or reject executory contracts,
including lease agreements, under the Bankruptcy Code. The Company has not
rejected any lease agreements since the Chapter 11 Cases were filed. Future
minimum payments and related sublease income under non-cancelable operating
leases are as follows (in thousands):

[Download Table]

Minimum Payments
----------------------------- Sublease
Ventas Other Total Income
---------- ------- ---------- --------
(Restated)

2001................................ $ 231,135 $46,823 $ 277,958 $4,343
2002................................ 231,135 31,537 262,672 2,514
2003................................ 231,135 23,762 254,897 2,157
2004................................ 231,135 13,950 245,085 1,571
2005................................ 231,135 12,420 243,555 1,571
Thereafter.......................... 1,034,673 58,058 1,092,731 7,092

Sublease income aggregated $2.4 million, $2.4 million and $6.9 million for
2000, 1999 and 1998, respectively.

NOTE 13--CONTINGENCIES

Management continually evaluates contingencies based upon the best available
evidence. In addition, allowances for loss are provided currently for disputed
items that have continuing significance, such as certain third-party
reimbursements and deductions that continue to be claimed in current cost
reports and tax returns.

F-54

424B4 166th Page of 184 TOC 1st Previous Next ↓Bottom Just 166th
KINDRED HEALTHCARE, INC.
(Formerly Vencor, Inc., a Debtor-in-Possession)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

NOTE 13--CONTINGENCIES (Continued)

Management believes that allowances for losses have been provided to the
extent necessary and that its assessment of contingencies is reasonable.

Principal contingencies are described below:

Revenues--Certain third-party payments are subject to examination by
agencies administering the programs. The Company is contesting certain
issues raised in audits of prior year cost reports.

Professional liability risks--The Company has provided for loss for
professional liability risks based upon actuarially determined estimates.
Actual settlements may differ from the provisions for loss.

Guarantees of indebtedness--Letters of credit and guarantees of
indebtedness aggregated $3.3 million at December 31, 2000.

Income taxes--The Company is contesting adjustments proposed by the
Internal Revenue Service for years 1995 through 1997. In addition, the
Company claims that it is entitled to certain prior year tax refunds
currently held by Ventas.

Litigation--The Company is a party to certain material litigation and
regulatory actions as well as various suits and claims arising in the
ordinary course of business. See Note 20.

NOTE 14--CAPITAL STOCK

Plan Descriptions

The Company has plans under which options to purchase common stock may be
granted to officers, employees and certain non-employee directors. Options have
been granted at not less than market price on the date of grant. Exercise
provisions vary, but most options are exercisable in whole or in part beginning
one to four years after grant and ending ten years after grant. Activity in the
plans is summarized below:

[Download Table]

Shares Weighted
under Option Price Average
Option per Share Exercise Price
---------- --------------- --------------

Balances, December 31, 1997..... 4,395,170 $0.20 to $43.88 $26.77
Granted....................... 6,422,132 3.81 to 10.98 7.00
Exchange offer:
Canceled..................... (5,721,027) 6.12 to 16.87 10.14
Issued....................... 4,631,694 5.50 5.50
Exercised..................... (48,431) 0.12 to 10.96 2.69
Canceled or expired........... (855,904) 3.67 to 16.58 8.22
----------
Balances, December 31, 1998..... 8,823,634 0.08 to 16.58 5.72
Granted....................... 423,000 0.63 to 4.50 2.50
Exercised..................... (7,031) 0.34 0.34
Canceled or expired........... (1,196,924) 0.34 to 16.58 6.19
----------
Balances, December 31, 1999..... 8,042,679 0.08 to 15.09 5.50
Canceled or expired........... (1,813,066) 0.39 to 14.93 6.98
----------
Balances, December 31, 2000..... 6,229,613 $0.08 to $15.09 $ 5.07
==========

F-55

424B4 167th Page of 184 TOC 1st Previous Next ↓Bottom Just 167th
KINDRED HEALTHCARE, INC.
(Formerly Vencor, Inc., a Debtor-in-Possession)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

NOTE 14--CAPITAL STOCK (Continued)

Plan Descriptions (Continued)

A summary of stock options outstanding at December 31, 2000 follows:

[Enlarge/Download Table]

Options Outstanding Options Exercisable
-------------------------------------- ------------------------
Number Weighted Number Weighted
Outstanding Remaining Average Exercisable Average
Range of at December 31, Contractual Exercise at December 31, Exercise
Exercise Prices 2000 Life Price 2000 Price
--------------- --------------- ------------- -------- --------------- --------

$0.08 to $10.72......... 296,414 1 to 4 years $5.81 296,414 $5.81
$5.50 to $15.09......... 3,280,849 5 to 7 years 5.76 2,935,149 5.72
$0.63 to $5.50.......... 2,652,350 8 to 10 years 4.14 1,659,800 4.32
--------- ---------
6,229,613 $5.07 4,891,363 $5.25
========= =========

The weighted average remaining contractual life of options outstanding at
December 31, 2000 approximated seven years. Shares of common stock available
for future grants were 6,001,333, 3,824,628 and 2,670,846 at December 31, 2000,
1999 and 1998, respectively. The number of options exercisable at December 31,
1999 and December 31, 1998 was 5,347,955 and 1,321,370, respectively.

In connection with the Spin-off, options outstanding prior thereto were
bifurcated on a one-for-one basis between the Company and Ventas, and
corresponding option prices were adjusted in proportion to the fair values of
the respective common stocks immediately following the Spin-off. Option data
for periods prior to the Spin-off have not been restated.

On December 19, 1998, the Company completed the exchange of employee stock
options. The exchange offer entitled employees to exchange outstanding stock
options for a reduced number of options with an exercise price equal to the
closing price of the Company's common stock on November 9, 1998. Exchange
ratios were calculated using a Black-Scholes option valuation model. The
exchange resulted in the cancellation of options to purchase approximately 5.7
million shares and the issuance of options to purchase approximately 4.6
million shares.

In connection with the Spin-off, the Company adopted an employee incentive
compensation and a stock option plan for non-employee directors. These plans
replaced similar plans in effect prior to the Spin-off.

Statement No. 123 Data

The Company has elected to follow Accounting Principles Board Opinion No.
25, "Accounting for Stock Issued to Employees" ("APB 25") and related
interpretations in accounting for its employee stock options because, as
discussed below, the alternative fair value accounting provided for under SFAS
No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123"), requires use
of option valuation models that were not developed for use in valuing employee
stock options. Under APB 25, because the exercise price of the Company's
employee stock options is equal to the market price of the underlying stock on
the date of grant, no compensation expense is recognized.

Pro forma information regarding net income and earnings per share is
required by SFAS 123, which also requires that the information be determined as
if the Company has accounted for its employee stock options granted subsequent
to December 31, 1994 under the fair value method of SFAS 123. The fair value of
such options was estimated at the date of grant using a Black-Scholes option
valuation model with the following weighted average assumptions: risk-free
interest rate of 5.90% for 2000, 5.30% for 1999 and 4.96% for 1998; no dividend
yield; expected term of seven years and volatility factors of the expected
market price of the Company's common stock of .85 for 2000, .82 for 1999 and
.42 for 1998.

F-56

424B4 168th Page of 184 TOC 1st Previous Next ↓Bottom Just 168th
KINDRED HEALTHCARE, INC.
(Formerly Vencor, Inc., a Debtor-in-Possession)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

NOTE 14--CAPITAL STOCK (Continued)

Statement No. 123 Data (Continued)

A Black-Scholes option 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 the changes in the
subjective input assumptions can affect materially 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.

For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the respective vesting period. The
weighted average fair values of options granted during 1999 and 1998 under a
Black-Scholes valuation model were $1.92 and $2.62, respectively. There were no
options granted during 2000. Pro forma information follows (in thousands except
per share amounts):

[Download Table]

2000 1999 1998
-------- --------- ---------

Pro forma loss available to common
stockholders........................... $(71,296) $(725,319) $(663,440)
Pro forma loss per common share:
Basic................................. $ (1.02) $ (10.30) $ (9.71)
Diluted............................... $ (1.02) $ (10.30) $ (9.71)

NOTE 15--EMPLOYEE BENEFIT PLANS

The Company maintains defined contribution retirement plans covering
employees who meet certain minimum eligibility requirements. Benefits are
determined as a percentage of a participant's contributions and generally are
vested based upon length of service. Retirement plan expense was $8.8 million
for 2000, $10.8 million for 1999 and $12.7 million for 1998. Amounts equal to
retirement plan expense are funded annually.

The Company also established a supplemental executive retirement plan in
1998 covering certain officers under which benefits are determined based
primarily upon participants' compensation and length of service to the Company.
The cost of the plan aggregated $300,000 for 2000 and $11.0 million for 1999.
In January 1999, the Company funded $3.7 million of plan obligations to
participants through the purchase of annuities. As discussed in Note 6, the
plan was curtailed by the Board of Directors in December 1999.

NOTE 16--ACCRUED LIABILITIES

A summary of other accrued liabilities at December 31 follows (in
thousands):

[Download Table]

2000 1999
------- -------

Patient accounts.......................................... $24,490 $23,893
Professional liability risks.............................. 17,888 22,632
Taxes other than income................................... 16,723 11,353
Other..................................................... 24,701 26,089
------- -------
$83,802 $83,967
======= =======

F-57

424B4 169th Page of 184 TOC 1st Previous Next ↓Bottom Just 169th
KINDRED HEALTHCARE, INC.
(Formerly Vencor, Inc., a Debtor-in-Possession)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

NOTE 17--TRANSACTIONS WITH VENTAS

For the purpose of governing certain of the ongoing relationships between
the Company and Ventas after the Spin-off and to provide mechanisms for an
orderly transition, the Company and Ventas entered into various agreements. The
most significant agreements are as follows:

Master Lease Agreements

Ventas retained substantially all of the real property, buildings and other
improvements (primarily nursing centers and long-term acute care hospitals) in
the Spin-off and leases them to the Company under four master lease agreements
which set forth the material terms governing the lease of each of the leased
properties. In August 1998, the Company and Ventas entered into a fifth lease
agreement with respect to a nursing center in Corydon, Indiana (the "Corydon
Lease"). The provisions of the Corydon Lease, except for the provisions
relating to rental amounts and the termination date, are substantially similar
to the terms of the other master lease agreements with Ventas. The four master
lease agreements, as amended, and the Corydon Lease shall be referred to herein
collectively as the "Master Lease Agreements" and each, a "Master Lease
Agreement."

Each Master Lease Agreement includes land, buildings, structures and other
improvements on the land, easements and similar appurtenances to the land and
improvements, permanently affixed equipment, and machinery and other fixtures
relating to the operation of the leased properties. There are multiple bundles
of leased properties under each Master Lease Agreement (other than the Corydon
Lease) with each bundle containing approximately seven to twelve leased
properties. All leased properties within a bundle have the same primary terms,
ranging from 10 to 15 years (the "Base Term"). At the option of the Company,
all, but not less than all, of the leased properties in a bundle may be
extended for one five-year renewal term beyond the Base Term (the "First
Renewal Term") at the then existing rental rate plus 2% per annum. At the
option of the Company, all, but not less than all, of the leased properties in
a bundle may be extended for two additional five-year renewal terms beyond the
First Renewal Term (together with the First Renewal Term, the "Renewal Term")
at the then fair market value rental rate. The Base Term and Renewal Term of
each leased property are subject to termination upon default by either party
and certain other conditions described in the Master Lease Agreements.

The Master Lease Agreements are structured as triple-net leases or absolute-
net leases. In addition to the aggregate annual rent plus 2% per annum
escalator over the previous twelve-month period if certain lessee revenue
parameters are obtained, the Company is required to pay all insurance, taxes,
utilities and maintenance related to the leased properties. Rent expense
related to Ventas in 2000, 1999 and in 1998 (eight months) aggregated $230
million, $225 million and $148 million, respectively. In connection with the
Chapter 11 Cases, the Company and Ventas entered into the Stipulation which
provides for the payment by the Company of a reduced aggregate monthly rent of
approximately $15.1 million beginning in September 1999. The difference between
the $19.3 million aggregate monthly rent under the Master Lease Agreements and
the reduced monthly rent under the Stipulation is being accrued as an
administrative expense subject to compromise in the Chapter 11 Cases. During
the pendency of the Chapter 11 Cases, the Company is recording the entire
contractual amount of the aggregate monthly rent.

An "Event of Default" will be deemed to have occurred under any Master Lease
Agreement if, among other things, the Company fails to pay rent or other
amounts within five days after notice; the Company fails to comply with
covenants continuing for 30 days or, so long as diligent efforts to cure such
failure are being made, such longer period (not to exceed 180 days) as is
necessary to cure such failure; certain bankruptcy or insolvency events occur,
including filing a petition of bankruptcy or a petition for reorganization
under the Bankruptcy Code; the Company ceases to operate any leased property as
a provider of healthcare services for a

F-58

424B4 170th Page of 184 TOC 1st Previous Next ↓Bottom Just 170th
KINDRED HEALTHCARE, INC.
(Formerly Vencor, Inc., a Debtor-in-Possession)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

NOTE 17--TRANSACTIONS WITH VENTAS (Continued)

Master Lease Agreements (Continued)

period of 30 days; the Company loses any required healthcare license, permit or
approval; the Company fails to maintain insurance; the Company creates or
allows to remain certain liens; a reduction occurs in the number of licensed
beds in excess of 10% of the number of licensed beds in the applicable facility
on the date the applicable facility was leased; certification for reimbursement
under Medicare with respect to a participating facility is revoked; there is
any breach of any material representation or warranty of the Company; the
Company becomes subject to regulatory sanctions and has failed to cure or
satisfy such regulatory sanctions within its specified cure period in any
material respect with respect to any facility; or there is any default under
any guaranty of the lease or under certain indemnity agreements between the
Company and Ventas.

Except as noted below, upon an Event of Default under a particular Master
Lease Agreement, Ventas may, at its option, exercise the following remedies:
(a) after not less than ten days' notice to the Company, terminate the Master
Lease Agreement, repossess the leased property and relet the leased property to
a third party and require the Company pay to Ventas, as liquidated damages, the
net present value of the rent for the balance of the term, discounted at the
prime rate; (b) without terminating the Master Lease Agreement, repossess the
leased property and relet the leased property with the Company remaining liable
under the Master Lease Agreement for all obligations to be performed by the
Company thereunder, including the difference, if any, between the rent under
the Master Lease Agreement and the rent payable as a result of the reletting of
the leased property; and (c) seek any and all other rights and remedies
available under law or in equity.

Certain Events of Default are considered facility-specific events of
default. A facility-specific event of default is caused by (a) the loss of any
required healthcare license, permit or approval, (b) a reduction in the number
of licensed beds in excess of 10% of the number of licensed beds in the
applicable facility or a revocation of certification for reimbursement under
Medicare with respect to any facility that participates in such programs, or
(c) the Company becoming subject to regulatory sanctions and failing to cure or
satisfy such regulatory sanctions within its specified cure period. Upon the
occurrence of a facility-specific event of default, Ventas may, if it so
desires, terminate the related Master Lease Agreement with respect to only the
applicable facility that is the subject of the facility-specific event of
default and collect liquidated damages attributable to such facility multiplied
by the number of years remaining on the applicable lease; provided, however,
that upon the occurrence of the fifth facility-specific event of default,
determined on a cumulative basis, Ventas would be permitted to exercise all of
the rights and remedies set forth in the Master Lease Agreement with respect to
all facilities covered under the Master Lease Agreement, without regard to the
facility from which such fifth facility-specific event of default emanated.

Any remedies provided under the Master Lease Agreements currently are
subject to the supervision of the Bankruptcy Court. See Note 3.

Development Agreement

Under the terms of the Development Agreement, the Company, 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, Ventas has the
option to purchase the development property from the Company at a purchase
price equal to the amount of the Company's actual costs in acquiring,
developing and improving such development property prior to the purchase date.
If Ventas purchases the development property, the Company will lease the
development property from Ventas. The annual base rent under such a lease will
be ten percent of the actual costs incurred by the Company in acquiring and
developing the development property. The other terms of the lease for the

F-59

424B4 171st Page of 184 TOC 1st Previous Next ↓Bottom Just 171st
KINDRED HEALTHCARE, INC.
(Formerly Vencor, Inc., a Debtor-in-Possession)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

NOTE 17--TRANSACTIONS WITH VENTAS (Continued)

Development Agreement (Continued)

development property will be substantially similar to those set forth in the
Master Lease Agreements. Since the Spin-off, the Company has sold one skilled
nursing center to Ventas under the Development Agreement for $6.2 million.

Participation Agreement

Under the terms and conditions of the Participation Agreement, the Company
has a right of first offer to become the lessee of any real property acquired
or developed by Ventas which is to be operated as a hospital, nursing center or
other healthcare facility, provided that the Company and Ventas negotiate a
mutually satisfactory lease arrangement.

The Participation Agreement also provides, subject to certain terms, that
the Company will provide Ventas with a right of first offer to purchase or
finance any healthcare related real property that the Company determines to
sell or mortgage to a third party, provided that the Company and Ventas
negotiate mutually satisfactory terms for such purchase or mortgage.

Transition Services Agreement

The Transition Services Agreement provided that the Company provide Ventas
with transitional administrative and support services, including but not
limited to finance and accounting, human resources, risk management, legal, and
information systems support through December 31, 1998. Ventas paid the Company
$1.6 million in 1998 under the Transition Services Agreement.

Tax Allocation Agreement

The Tax Allocation Agreement provides that Ventas will be liable for taxes
of the Ventas consolidated group attributable to periods prior to the Spin-off
with respect to the portion of such taxes attributable to the property held by
Ventas after the Spin-off and the Company will be liable for such pre-
distribution taxes with respect to the portion of such taxes attributable to
the property held by the Company after the Spin-off. The Tax Allocation
Agreement further provides that Ventas will be liable for any taxes
attributable to the Spin-off except that the Company will be liable for any
such taxes to the extent that the Company derives certain future tax benefits
as a result of the payment of such taxes. Ventas and its subsidiaries are
liable for taxes payable with respect to periods after the Spin-off that are
attributable to Ventas operations and the Company and its subsidiaries are
liable for taxes payable with respect to periods after the Spin-off that are
attributable to the Company's operations. If, in connection with a tax audit or
filing of an amended return, a taxing authority adjusts the tax liability of
either the Company or Ventas with respect to taxes for which the other party
was liable under the Tax Allocation Agreement, such other party would be liable
for the resulting tax assessment or would be entitled to the resulting tax
refund. During 1998, $6.7 million was received from Ventas under the Tax
Allocation Agreement. At December 31, 1998, the Company owed Ventas $5.9
million for a tax settlement under the Tax Allocation Agreement (which was
repaid to Ventas in January 1999). This transaction had no impact on earnings.

The Company and Ventas disagree with respect to certain interpretations of
the Tax Allocation Agreement described above. On May 31, 2000, the Company
announced that the Bankruptcy Court had approved a tax stipulation agreement
between the Company and Ventas (the "Tax Stipulation"). The Tax Stipulation
provides that certain refunds of federal, state and local taxes received by
either party on or after September 13, 1999 will be held by the recipient of
such refunds in segregated interest bearing accounts. The Tax Stipulation
requires notification before either party can withdraw funds from the
segregated accounts and will terminate upon the effective date of the Amended
Plan.

F-60

424B4 172nd Page of 184 TOC 1st Previous Next ↓Bottom Just 172nd
KINDRED HEALTHCARE, INC.
(Formerly Vencor, Inc., a Debtor-in-Possession)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

NOTE 18--OTHER RELATED PARTY TRANSACTIONS

In connection with the Spin-off, the Company loaned certain executive
officers an amount equal to the estimated personal income taxes payable by them
as a result of the Spin-off (the "Tax Loans"). Each Tax Loan is evidenced by a
promissory note which has a term of ten years and bears interest at 5.77% per
annum. Principal on the Tax Loans is scheduled to be repaid in ten equal annual
installments which began on June 15, 1999. Interest is payable quarterly;
however, any interest payment on the Tax Loans is forgiven if the officer
remains in his or her position with the Company on the date on which such
interest payment is due. Moreover, in the event of a change in control of the
Company, the entire balance of the Tax Loan will be forgiven. The terms of the
Tax Loans with certain former executive officers were amended in connection
with their severance agreements to provide that the payment of the principal
and interest on the Tax Loans be deferred until the fifth anniversary of their
respective date of termination. All Tax Loans made to current executive
officers have been repaid in full.

As part of the Spin-off, the Company issued $17.7 million of its 6% Series A
Non-Voting Convertible Preferred Stock (the "Preferred Stock") to Ventas as
part of the consideration for the assets transferred from Ventas to the
Company. The Preferred Stock (par value $1,000) includes a ten-year mandatory
redemption provision and is convertible into common stock at a price of $12.50
per share. In connection with the purchases of the Preferred Stock, the Company
loaned certain officers 90% of the purchase price ($15.9 million) of the
Preferred Stock (the "Preferred Stock Loans"). Each Preferred Stock Loan is
evidenced by a promissory note which has a ten year term and bears interest at
5.74%, payable annually. No principal payments are due under the promissory
notes until their maturity. The promissory notes are secured by a first
priority security interest in the Preferred Stock purchased by each such
officer. As of December 31, 2000, $15.7 million of these loans remained
outstanding. The terms of the Preferred Stock Loans with certain former
officers were amended in connection with their severance agreements to provide,
generally, that (a) the Preferred Stock Loan will not be due and payable until
April 30, 2008, (b) payments on the Preferred Stock Loan will be deferred until
the fifth anniversary of the date of termination, (c) interest payments will be
forgiven if the average closing price of the common stock for the 90 days prior
to any interest payment date is less than $8.00 and (d) during the five-day
period following the expiration of the fifth anniversary of the date of
termination, the former officer will have the right to put the Preferred Stock
underlying the Preferred Stock Loan to the Company at par.

In August 1999, the Company entered into agreements with certain officers
which permit such officer to put the Preferred Stock to the Company for an
amount equal to the outstanding principal and interest on the officer's
Preferred Stock Loan (the "Preferred Stock Agreements"). The officer could put
the Preferred Stock to the Company after January 1, 2000. During the Chapter 11
Cases, the Company cannot honor the terms of the Preferred Stock Agreements.
The Preferred Stock Agreements were entered into with each officer employed by
the Company in August 1999 who owned the Preferred Stock.

NOTE 19--FAIR VALUE DATA

A summary of fair value data at December 31 follows (in thousands):

[Download Table]

2000 1999
----------------- -----------------
Carrying Fair Carrying Fair
Value Value Value Value
-------- -------- -------- --------

Cash and cash equivalents............... $184,642 $184,642 $148,350 $148,350
Insurance subsidiary investments........ 62,453 62,453 16,483 16,483
Restricted funds (included in other
current assets)........................ 10,674 10,674 9,522 9,522
Long-term debt, including amounts due
within one
year................................... 879,577 537,330 893,393 485,314
Interest rate swap agreements (included
in long-term
debt).................................. - - - 157

F-61

424B4 173rd Page of 184 TOC 1st Previous Next ↓Bottom Just 173rd
KINDRED HEALTHCARE, INC.
(Formerly Vencor, Inc., a Debtor-in-Possession)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

NOTE 20--LITIGATION

Summary descriptions of various significant legal and regulatory activities
follow.

On September 13, 1999, the Company and substantially all of its subsidiaries
filed voluntary petitions for protection under Chapter 11 of the Bankruptcy
Code. The Chapter 11 Cases have been styled In re: Vencor, Inc., et al.,
Debtors and Debtors in Possession, Case Nos. 99-3199 (MFW) through 99-3327
(MFW), Chapter 11, Jointly Administered. On December 14, 2000, the Company
filed its Amended Plan with the Bankruptcy Court. On March 1, 2001, the
Bankruptcy Court approved the Company's Amended Plan and an order was entered
confirming the Amended Plan on March 16, 2001. See Note 3 for further
discussion of the Chapter 11 Cases.

On March 18, 1999, the Company served Ventas with a demand for mediation
pursuant to the Spin-off Agreement. The Company was seeking a reduction in rent
and other concessions under its Master Lease Agreements with Ventas. On March
31, 1999, the Company and Ventas entered into a standstill agreement which
provided that both companies would postpone through April 12, 1999 any claims
either may have against the other. On April 12, 1999, the Company and Ventas
entered into a second standstill which provided that neither party would pursue
any claims against the other or any other third party related to the Spin-off
as long as the Company complied with certain rent payment terms. The second
standstill was scheduled to terminate on May 5, 1999. Pursuant to a tolling
agreement, the Company and Ventas also agreed that any statutes of limitations
or other time-related constraints in a bankruptcy or other proceeding that
might be asserted by one party against the other would be extended and tolled
from April 12, 1999 until May 5, 1999 or until the termination of the second
standstill. As a result of the Company's failure to pay rent, Ventas served the
Company with notices of nonpayment under the Master Lease Agreements.
Subsequently, the Company and Ventas entered into further amendments to the
second standstill and the tolling agreement to extend the time during which no
remedies may be pursued by either party and to extend the date by which the
Company may cure its failure to pay rent.

In connection with the Chapter 11 Cases, the Company and Ventas entered into
the Stipulation that provides for the payment by the Company of a reduced
aggregate monthly rent of approximately $15.1 million. The Stipulation has been
approved by the Bankruptcy Court. The Stipulation also continues to toll any
statutes of limitations or other time constraints in a bankruptcy proceeding
for claims that might be asserted by the Company against Ventas. The
Stipulation automatically renews for one-month periods unless either party
provides a 14-day notice of termination. The Stipulation also may be terminated
prior to its expiration upon a payment default by the Company, the consummation
of a plan of reorganization or the occurrence of certain defaults under the DIP
Financing. The Stipulation also provides that the Company will continue to
fulfill its indemnification obligations arising from the Spin-off. The
Stipulation will terminate upon the effective date of the Amended Plan.

F-62

424B4 174th Page of 184 TOC 1st Previous Next ↓Bottom Just 174th
KINDRED HEALTHCARE, INC.
(Formerly Vencor, Inc., a Debtor-in-Possession)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

NOTE 20--LITIGATION (Continued)

properties and requiring the Company to (a) remain liable for all obligations
under the Master Lease Agreements, including the difference between the rent
under the Master Lease Agreements and the rent payable as a result of reletting
the leased properties or (b) pay the net present value of the rent due for the
balance of the terms of the Master Lease Agreements. Such remedies, however,
would be subject to the supervision of the Bankruptcy Court.

The Company's subsidiary, formerly named TheraTx, Incorporated, is plaintiff
in a declaratory judgment action entitled TheraTx, Incorporated v. James W.
Duncan, Jr., et al., No. 1:95-CV-3193, filed in the United States District
Court for the Northern District of Georgia and currently pending in the United
States Court of Appeals for the Eleventh Circuit, No. 99-11451-FF. The
defendants have asserted counterclaims against TheraTx under breach of
contract, securities fraud, negligent misrepresentation and other 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 "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' 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. The Company and
the defendants/counterclaimants both appealed the court's rulings. The Court of
Appeals for the Eleventh Circuit affirmed the trial court's rulings with the
exception of the damages award and certified the question of the proper
calculation of damages under Delaware law to the Delaware Supreme Court. The
Company is defending the action vigorously.

F-63

424B4 175th Page of 184 TOC 1st Previous Next ↓Bottom Just 175th
KINDRED HEALTHCARE, INC.
(Formerly Vencor, Inc., a Debtor-in-Possession)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

NOTE 20--LITIGATION (Continued)

in Medicare reimbursement policies would have on Ventas' core services and
profitability. The complaint further alleges that the defendants issued a
series of materially false statements concerning the purportedly successful
integration of Ventas' acquisitions and prospective earnings per share for 1997
and 1998 which the defendants 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 December 1998, the defendants filed a motion to dismiss the case.
The court converted the defendants' motion to dismiss into a motion for summary
judgment and granted summary judgment as to all defendants. The plaintiff
appealed the ruling to the United States Court of Appeals for the Sixth
Circuit. On April 24, 2000, the Sixth Circuit affirmed the district court's
dismissal of the action on the grounds that the plaintiff failed to state a
claim upon which relief could be granted. On July 14, 2000, the Sixth Circuit
granted the plaintiff's petition for a rehearing en banc. The Company is
defending this action vigorously.

A shareholder derivative suit entitled Thomas G. White on behalf of Vencor,
Inc. and Ventas, Inc. v. W. Bruce Lunsford, et al., Case No. 98CI03669, was
filed in June 1998 in the Jefferson County, Kentucky, Circuit Court. The suit
was brought on behalf of the Company and Ventas against certain current and
former executive officers and directors of the Company and Ventas. The
complaint alleges that the defendants damaged the Company and Ventas by
engaging in violations of the securities laws, engaging in insider trading,
fraud and securities fraud and damaging the reputation of the Company and
Ventas. 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 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 Company and Ventas have an effective remedy. The Company
believes that the allegations in the complaint are without merit and intends to
defend this action vigorously.

A class action lawsuit entitled Jules Brody v. Transitional Hospitals
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 common stock
during the period from February 26, 1997 through May 4, 1997, inclusive. 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 the Transitional 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 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 the Company's motion to dismiss with
leave to amend the Section 10(b) claim and the state law claims for
misrepresentation. The court denied the Company's motion to dismiss the Section
14(e) and Section 20(a) claims, after which the Company filed a motion for
reconsideration. On March 23, 1999, the court granted the Company's motion to
dismiss all remaining claims and the case was dismissed. The plaintiff has
appealed this ruling to the United States Court of Appeals for the Ninth
Circuit. The Company is defending this action vigorously.

F-64

424B4 176th Page of 184 TOC 1st Previous Next ↓Bottom Just 176th
KINDRED HEALTHCARE, INC.
(Formerly Vencor, Inc., a Debtor-in-Possession)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

NOTE 20--LITIGATION (Continued)

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
centers 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. The Company 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. Lenox and its subsidiaries filed for protection under Chapter 11
of the Bankruptcy Code on November 3, 1999. By virtue of both the Company's and
Lenox's separate filings for Chapter 11 protection, the two Lenox actions and
the Company's counterclaims were stayed. Subsequently, the parties entered into
a settlement, which was approved by their respective bankruptcy courts, that
requires the dismissal of the two above actions. Joint motions to dismiss have
been filed by the parties in each court.

The Company was informed by the DOJ that the Company and Ventas are the
subjects of investigations into various Medicare reimbursement issues,
including hospital cost reporting issues, Vencare billing practices and various
quality of care issues in the hospitals and nursing centers formerly operated
by Ventas and currently operated by the Company. These investigations include
some matters for which the Company indemnified Ventas in the Spin-off. In cases
where neither the Company nor any of its subsidiaries are defendants but Ventas
is the defendant, the Company had agreed to defend and indemnify Ventas for
such claims as part of the Spin-off. The Stipulation entered into with Ventas
provides that the Company will continue to fulfill its indemnification
obligations arising from the Spin-off. The Company has cooperated fully in the
investigations.

The DOJ has informed the Company that it has intervened in several pending
qui tam actions asserted against the Company and/or Ventas in connection with
these investigations. In addition, the DOJ has filed proofs of claims with
respect to certain alleged claims in the Chapter 11 Cases. The Company, Ventas
and the DOJ have finalized the terms of the Government Settlement which will
resolve all of the DOJ investigations including the pending qui tam actions.
The Government Settlement provides that within 30 days after the Amended Plan
becomes effective, the Government will move to dismiss with prejudice to the
United States and the relators (except for certain claims which will be
dismissed without prejudice to the United States in certain of these cases) the
pending qui tam actions as against any or all of the Company and its
subsidiaries, Ventas and any current or former officers, directors and
employees of either entity. There can be no assurance that each court before
which a qui tam action is pending will dismiss the case on the DOJ's motion.

The following is a summary of the qui tam actions pending against the
Company and/or Ventas in which the DOJ has intervened. In connection with the
DOJ's intervention, the courts ordered these previously non-public actions to
be unsealed. Certain of the actions described below name other defendants in
addition to the Company and Ventas.

F-65

424B4 177th Page of 184 TOC 1st Previous Next ↓Bottom Just 177th
KINDRED HEALTHCARE, INC.
(Formerly Vencor, Inc., a Debtor-in-Possession)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

NOTE 20--LITIGATION (Continued)

providers. The civil suit 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. The Company has
defended this action vigorously. The court has dismissed the action based
upon the possible pending settlement between the DOJ, the Company and
Ventas. In a related criminal investigation, the United States Attorney's
Office for the Eastern District of Arkansas ("USAO") indicted four former
employees of AXR; those individuals were convicted of various fraud related
counts in January 1999. AXR had been informed previously that it was not a
target of the criminal investigation, and AXR was not indicted. However,
the Company received several grand jury subpoenas for documents and
witnesses which it moved to quash. The USAO has withdrawn the subpoenas
which rendered the motion moot.

(b) The Company's subsidiary, Medisave Pharmacies, Inc. ("Medisave"),
Ventas and Hillhaven (former parent company to Medisave), are the
defendants in a civil qui tam action styled United States ex rel. Danley v.
Medisave Pharmacies, Inc., et al., No. CV-N-96-00170-HDM, filed in the
United States District Court for the District of Nevada on March 15, 1996.
The plaintiff alleges that Medisave, an institutional pharmacy provider,
formerly owned by Ventas and owned by the Company since the Spin-off: (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. The complaint also alleges
that Medisave had a policy of offering kickbacks, such as free equipment,
to skilled nursing centers to secure and maintain their business. The
complaint seeks treble damages, other unspecified damages, civil penalties,
attorneys' fees and other costs. The Company disputes the allegations in
the complaint. The defendants intend to defend this action vigorously.

(c) Ventas and the Company's subsidiary, Vencare, Inc. ("Vencare"),
among others, are defendants in the action styled United States ex rel.
Roberts v. Vencor, Inc., et al., No. 3:97CV-349-J, filed in the United
States District Court for the Western District of Kansas on June 25, 1996
and consolidated with the action styled United States of America ex rel.
Meharg, et al. v. Vencor, Inc., et al., No. 3:98SC-737-H, filed in the
United States District Court for the Middle District of Florida on June 4,
1998. The complaint alleges that the defendants knowingly submitted and
conspired to submit false claims and statements to the Medicare program in
connection with their purported provision of respiratory therapy services
to skilled nursing center residents. The defendants 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
their therapists. It is further alleged that the defendants 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 centers 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, attorneys' fees and other costs. The Company disputes the
allegations in the complaint. The defendants intend to defend this action
vigorously.

F-66

424B4 178th Page of 184 TOC 1st Previous Next ↓Bottom Just 178th
KINDRED HEALTHCARE, INC.
(Formerly Vencor, Inc., a Debtor-in-Possession)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

NOTE 20--LITIGATION (Continued)

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 cost in return for referral of substantially all
non-routine testing in violation of Medicare and Medicaid antikickback and
antifraud regulations. 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 antikickback and
antifraud regulations. Transitional has moved to dismiss the case.
Transitional disputes the allegations in the complaint and is defending the
action vigorously.

(e) The Company and/or Ventas are defendants in the action styled United
States ex rel. Huff and Dolan v. Vencor, Inc., et al., No. 97-4358 AHM
(Mcx), filed in the United States District Court for the Central District
of California on June 13, 1997. The plaintiff alleges that the defendant
violated the Federal Civil False Claims Act by submitting false claims to
the Medicare, Medicaid and CHAMPUS programs by allegedly: (1) falsifying
patient bills and submitting the bills to the Medicare, Medicaid and
CHAMPUS programs, (2) submitting bills for intensive and critical care not
actually administered to patients, (3) falsifying 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 seeks treble damages, other unspecified damages,
civil penalties, attorneys' fees and other costs. Defendants dispute the
allegations in the complaint. The Company, on behalf of itself and Ventas,
intends to defend this action vigorously.

(f) Ventas is the defendant in the action styled United States ex rel.
Brzycki v. Vencor, Inc., Civ. No. 97-451-JD, filed in the United States
District Court for the District of New Hampshire on September 8, 1997.
Ventas is alleged to have knowingly violated the Federal Civil False Claims
Act by submitting and conspiring to submit false claims to the Medicare
program. The complaint alleges that Ventas: (1) fabricated diagnosis codes
by ordering medically unnecessary services, such as respiratory therapy;
(2) changed referring physicians' diagnoses in order to qualify for
Medicare reimbursement; and (3) billed Medicare for oxygen use by patients
regardless of whether the oxygen was actually administered to particular
patients. The complaint further alleges that Ventas paid illegal kickbacks
to referring healthcare professionals in the form of medical consulting
service agreements as an alleged inducement to refer patients, in violation
of the Federal Civil False Claims Act, the antikickback and antifraud
regulations and the Stark provisions. It is additionally alleged that
Ventas consistently submitted Medicare claims for clinical services that
were not performed or were performed at lower actual costs. The complaint
seeks unspecified damages, civil penalties, attorneys' fees and costs.
Ventas disputes the allegations in the complaint. The Company, on behalf of
Ventas, intends to defend the action vigorously.

(g) United States ex rel. Lanford and Cavanaugh v. Vencor, Inc., et al.,
Civ. No. 97-CV-2845, was filed against Ventas in the United States District
Court for the Middle District of Florida, on November 24, 1997. The United
States of America intervened in this civil qui tam lawsuit on May 17, 1999.
On July 23, 1999, the United States filed its amended complaint in the
lawsuit and added the Company as a defendant. The lawsuit alleges that the
Company and Ventas 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
defendants' nursing centers and for third-party nursing center operators
that the United States alleges are not properly reimbursable costs through
the hospitals' cost reports. The lawsuit involves the Company's hospitals
which were owned by Ventas prior to the Spin-off. The complaint does not
specify the amount of damages sought. The Company and Ventas dispute the
allegations in the amended complaint and intend to defend this action
vigorously.

F-67

424B4 179th Page of 184 TOC 1st Previous Next ↓Bottom Just 179th
KINDRED HEALTHCARE, INC.
(Formerly Vencor, Inc., a Debtor-in-Possession)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

NOTE 20--LITIGATION (Continued)

(h) In United States ex rel. Harris and Young v. Vencor, Inc., et al.,
filed in the Eastern District of Missouri on May 25, 1999, the defendants
include the Company, Vencare, and Ventas. The defendants allegedly
submitted and conspired to submit false claims for payment to the Medicare
and CHAMPUS programs, in violation of the Federal Civil False Claims Act.
According to the complaint, the Company, through its subsidiary, Vencare,
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
therapists to falsify clinical records and over prescribe therapy services.
The complaint seeks treble damages, other unspecified damages, civil
penalties, attorneys' fees and other costs. The Company disputes the
allegations in the complaint and intends to defend this action vigorously.
The action has been dismissed with prejudice as to the relator and without
prejudice as to the United States.

(i) In United States ex rel. George Mitchell, et al. v. Vencor, Inc., et
al., filed in the United States District Court for the Southern District of
Ohio on August 13, 1999, the defendants, consisting of the Company and its
two subsidiaries, Vencare and Vencor Hospice, Inc., are alleged to have
violated the Federal Civil False Claims Act by obtaining improper
reimbursement from Medicare concerning the treatment of hospice patients.
Defendants are alleged to have obtained inflated Medicare reimbursement for
admitting, treating and/or failing to discharge in a timely manner hospice
patients who were not "hospice appropriate." The complaint further alleges
that the defendants obtained inflated reimbursement for providing
medications for these hospice patients. The complaint alleges damages in
excess of $1,000,000. The Company disputes the allegations in the complaint
and intends to defend vigorously the action.

(j) In Gary Graham, on Behalf of the United States of America v. Vencor
Operating, Inc. et. al., filed in the United States District Court for the
Southern District of Florida on or about June 8, 1999, the defendants,
including the Company, its subsidiary, Vencor Operating, Inc., Ventas,
Hillhaven and Medisave, are alleged to have presented or caused to be
presented false or fraudulent claims for payment to the Medicare program in
violation of, among other things, the Federal Civil False Claims Act. The
complaint alleges that Medisave, a subsidiary of the Company which was
transferred from Ventas to the Company in the Spin-off, systematically up-
charged for drugs and supplies dispensed to Medicare patients. The
complaint seeks unspecified damages, civil penalties, interest, attorneys'
fees and other costs. The Company disputes the allegations in the complaint
and intends to defend this action vigorously.

F-68

424B4 180th Page of 184 TOC 1st Previous Next ↓Bottom Just 180th
KINDRED HEALTHCARE, INC.
(Formerly Vencor, Inc., a Debtor-in-Possession)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

NOTE 20--LITIGATION (Continued)

compensation resulting in inflated employee 401(k) contributions. The
complaint seeks unspecified damages. The Company disputes the allegations in
the complaint and intends to defend this action vigorously.

In connection with the Spin-off, liabilities arising from various legal
proceedings and other actions were assumed by the Company and the Company
agreed to indemnify Ventas against any losses, including any costs or expenses,
it may incur arising out of or in connection with such legal proceedings and
other actions. The indemnification provided by the Company also covers losses,
including costs and expenses, which may arise from any future claims asserted
against Ventas based on the former healthcare operations of Ventas. In
connection with its indemnification obligation, the Company has assumed the
defense of various legal proceedings and other actions. The Stipulation entered
into with Ventas provides that the Company will continue to fulfill its
indemnification obligations arising from the Spin-off.

The Company is a party to certain legal actions and regulatory
investigations arising in the normal course of its business. The Company is
unable to predict the ultimate outcome of pending litigation and regulatory
investigations. In addition, there can be no assurance that the DOJ, HCFA or
other regulatory agencies will not initiate additional investigations related
to the Company's businesses 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's
results of operations, liquidity or financial position. In addition, the above
litigation and investigations (as well as future litigation and investigations)
are expected to consume the time and attention of the Company's management and
may have a disruptive effect upon the Company's operations.

NOTE 21--COURT APPROVAL OF PLAN OF REORGANIZATION

On March 1, 2001, the Bankruptcy Court approved the Amended Plan. The order
confirming the Amended Plan was entered on March 16, 2001. The Amended Plan
must be effective no later than May 1, 2001.

In connection with the confirmation hearing, the Company entered into a
commitment letter for the Exit Facility. The Exit Facility will be available to
fund the Company's obligations under the Amended Plan and its ongoing
operations following emergence from bankruptcy.

Amended Plan of Reorganization

The Amended Plan represents a consensual arrangement among Ventas, the
Company's senior bank lenders (the "Senior Lenders"), holders of the 1998
Notes, the DOJ, acting on behalf of the Department of Health and Human
Services' Office of the Inspector General (the "OIG") and HCFA (collectively,
the "Government") and the advisors to the official committee of unsecured
creditors.

The Company distributed its disclosure materials soliciting approval of the
Amended Plan on December 29, 2000. Voting on the Amended Plan concluded on
February 15, 2001 (other than for Ventas, which voted prior to the confirmation
hearing) and the Company received the requisite acceptances from various
creditor classes to confirm the Amended Plan.

F-69

424B4 181st Page of 184 TOC 1st Previous Next ↓Bottom Just 181st
KINDRED HEALTHCARE, INC.
(Formerly Vencor, Inc., a Debtor-in-Possession)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

NOTE 21--COURT APPROVAL OF PLAN OF REORGANIZATION (Continued)

Amended Plan of Reorganization (Continued)

The following is a summary of certain material provisions of the Amended
Plan. The summary does not purport to be complete and is qualified in its
entirety by reference to all of the provisions of the Amended Plan, including
all exhibits and documents described therein, as filed with the Bankruptcy
Court and as may otherwise be amended, modified or supplemented.

The Amended Plan provides for, among other things, the following
distributions:

Senior Lender Claims--The Senior Lenders will receive, in the aggregate, new
senior subordinated secured notes in the principal amount of $300 million,
bearing interest at the rate of LIBOR plus 4 1/2%, with a maturity of seven
years (the "New Senior Secured Notes"). The interest on the New Senior Secured
Notes will begin to accrue approximately two quarters following the effective
date of the Amended Plan and, in lieu of interest payments, the Company will
pay a $25.9 million obligation under the Government Settlement within the first
two full fiscal quarters following the effective date of the Amended Plan as
described below. In addition, holders of the Senior Lender claims will receive
an aggregate distribution of 65.51% of the new common stock (the "New Common
Stock") of the reorganized Company (subject to dilution from stock issuances
occurring after the effective date of the Amended Plan).

Senior Subordinated Noteholder Claims--The holders of the 1998 Notes and the
remaining $2.4 million of the Company's 8 5/8% Senior Subordinated Notes due
2007 (collectively, the "Subordinated Noteholder Claims") will receive, in the
aggregate, 24.50% of the New Common Stock (subject to dilution from stock
issuances occurring after the effective date of the Amended Plan). In addition,
the holders of the Subordinated Noteholder Claims will receive, in the
aggregate, warrants issued by the Company for the purchase of an aggregate of
7,000,000 shares of New Common Stock, with a five-year term, which will consist
of warrants to purchase 2,000,000 shares at a price per share of $30.00, and
warrants to purchase 5,000,000 shares at a price per share of $33.33.

Ventas Claim--Ventas will receive the following treatment under the Amended
Plan:

The four master leases and the Corydon Lease with Ventas will be assumed and
simultaneously amended and restated as of the effective date of the Amended
Plan (the "Amended Leases"). The principal economic terms of the Amended Leases
are as follows:

(1) A decrease of $52 million in the aggregate minimum rent from the
annual rent as of May 1, 1999 to a new initial aggregate minimum rent of
$174.6 million as of the first month after the effective date of the
Amended Plan.

(2) Annual aggregate minimum rent payable in cash will escalate at an
annual rate of 3.5% over the prior period annual aggregate minimum rent for
the period from May 1, 2001 through April 30, 2004. Thereafter, annual
aggregate minimum rent payable in cash will escalate at an annual rate of
2%, plus an additional annual accrued escalator amount of 1.5% of the prior
period annual aggregate minimum rent which will accrete from year to year
(with an interest accrual at LIBOR plus 4 1/2%). All accrued rent will be
payable upon the repayment or refinancing of the New Senior Secured Notes,
after which the annual aggregate minimum rent payable in cash will escalate
at an annual rate of 3.5% and there will be no further accrual feature.

(3) A one-time option, that can be exercised by Ventas 5 1/4 years after
the effective date of the Amended Plan, to reset the annual aggregate
minimum rent under one or more of the Amended Leases to the then current
fair market rental in exchange for a payment of $5 million (or a pro rata
portion thereof if fewer than all of the Amended Leases are reset) to the
Company.

F-70

424B4 182nd Page of 184 TOC 1st Previous Next ↓Bottom Just 182nd
KINDRED HEALTHCARE, INC.
(Formerly Vencor, Inc., a Debtor-in-Possession)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

NOTE 21--COURT APPROVAL OF PLAN OF REORGANIZATION (Continued)

Amended Plan of Reorganization (Continued)

(4) Under the Amended Leases, the "Event of Default" provisions also
will be substantially modified and will provide Ventas with more
flexibility in exercising remedies for events of default.

In addition to the Amended Leases, Ventas will receive a distribution of
9.99% of the New Common Stock (subject to dilution from stock issuances
occurring after the effective date of the Amended Plan).

Ventas also will enter into a tax escrow agreement with the Company as of
the effective date that will provide for the escrow of approximately $30
million of federal, state and local refunds until the expiration of the
applicable statutes of limitation for the auditing of the refund applications.
The escrowed funds will be available for the payment of certain tax
deficiencies during the escrow period except that all interest paid by the
government in connection with any refund or earned on the escrowed funds will
be distributed equally to the parties. At the end of the escrow period, the
Company and Ventas will each be entitled to 50% of any proceeds remaining in
the escrow account.

All agreements and indemnification obligations between the Company and
Ventas, except those modified by the Amended Plan, will be assumed by the
Company as of the effective date of the Amended Plan.

United States Claims--The claims of the Government (other than claims of the
Internal Revenue Service and criminal claims, if any) will be settled through a
government settlement with the Company and Ventas which will be effectuated
through the Amended Plan.

Under the Government Settlement, the Company will pay the Government a total
of $25.9 million, which will be paid as follows:

(1) $10 million on the effective date of the Amended Plan, and

(2) an aggregate of $15.9 million during the first two full fiscal
quarters following the effective date, plus accrued interest at the rate of
6% per annum beginning as of the effective date of the Amended Plan.

Under the Government Settlement, Ventas will pay the Government a total of
$103.6 million, which will be paid as follows:

(1) $34 million on the effective date of the Amended Plan, and

(2) the remainder paid over five years, bearing interest at the rate of
6% per annum beginning as of the effective date of the Amended Plan.

In addition, the Company will repay the remaining balance of the obligations
under the HCFA Agreement (approximately $63.4 million as of December 31, 2000)
pursuant to the terms previously agreed to by the Company. As previously
announced, the Company has entered into a Corporate Integrity Agreement with
the OIG as part of the overall Government Settlement. The Government Settlement
also provides for the dismissal of certain pending claims and lawsuits filed
against the Company. See Note 20.

General Unsecured Creditors Claims--The general unsecured creditors of the
Company will be paid the full amount of their allowed claims existing as of the
date of the Company's filing for protection under the Bankruptcy Code. These
amounts will be paid in equal quarterly installments over three years beginning
at the end of the first full fiscal quarter following the effective date. The
Company will pay interest on these claims at the rate of 6% per annum from the
effective date of the Amended Plan, subject to certain exceptions. A
convenience class of unsecured creditors, consisting of creditors holding
allowed claims in an amount less than or equal to $3,000, will be paid in full
within 30 days of the effective date of the Amended Plan.

F-71

424B4 183rd Page of 184 TOC 1st Previous Next ↓Bottom Just 183rd
KINDRED HEALTHCARE, INC.
(Formerly Vencor, Inc., a Debtor-in-Possession)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

NOTE 21--COURT APPROVAL OF PLAN OF REORGANIZATION (Continued)

Amended Plan of Reorganization (Continued)

Preferred Stockholder and Common Stockholder Claims--The holders of
preferred stock and common stock of the Company will not receive any
distributions under the Amended Plan. The preferred stock and common stock will
be canceled on the effective date of the Amended Plan.

NOTE 22--EMERGENCE FROM PROCEEDINGS UNDER CHAPTER 11

On April 20, 2001, the Company and its subsidiaries emerged from proceedings
under the Bankruptcy Code pursuant to the terms of the Amended Plan described
in Note 21.

On the date of emergence, the Company entered into a five-year $120 million
senior revolving credit facility (including a $40 million letter of credit
subfacility) with a lending group led by Morgan Guaranty Trust Company of New
York (the "Credit Facility"). The Credit Facility constitutes a working capital
facility for general corporate purposes including payments related to the
Company's obligations under the Amended Plan. Direct borrowings under the
Credit Facility will bear interest, at the option of the Company, at (a) prime
(or, if higher, the federal funds rate plus 1/2%) plus 3% or (b) one, two,
three or six month LIBOR plus 4%. The Credit Facility is collateralized by
substantially all of the assets of the Company and its subsidiaries, including
certain owned real property.

F-72

424B4 Last Page of 184 TOC 1st Previous Next ↓Bottom Just 184th
[Back cover of prospectus]
[Company logo appears here]

424B4	1st Page of 184	TOC	↑Top	Previous	Next	↓Bottom	Just 1st

424B4	2nd Page of 184	TOC	1st	Previous	Next	↓Bottom	Just 2nd

424B4	3rd Page of 184	TOC	1st	Previous	Next	↓Bottom	Just 3rd

424B4	4th Page of 184	TOC	1st	Previous	Next	↓Bottom	Just 4th

424B4	5th Page of 184	TOC	1st	Previous	Next	↓Bottom	Just 5th

424B4	6th Page of 184	TOC	1st	Previous	Next	↓Bottom	Just 6th

424B4	7th Page of 184	TOC	1st	Previous	Next	↓Bottom	Just 7th

424B4	8th Page of 184	TOC	1st	Previous	Next	↓Bottom	Just 8th

424B4	9th Page of 184	TOC	1st	Previous	Next	↓Bottom	Just 9th

424B4	10th Page of 184	TOC	1st	Previous	Next	↓Bottom	Just 10th

424B4	11th Page of 184	TOC	1st	Previous	Next	↓Bottom	Just 11th

424B4	12th Page of 184	TOC	1st	Previous	Next	↓Bottom	Just 12th

424B4	13th Page of 184	TOC	1st	Previous	Next	↓Bottom	Just 13th

424B4	14th Page of 184	TOC	1st	Previous	Next	↓Bottom	Just 14th

424B4	15th Page of 184	TOC	1st	Previous	Next	↓Bottom	Just 15th

424B4	16th Page of 184	TOC	1st	Previous	Next	↓Bottom	Just 16th

424B4	17th Page of 184	TOC	1st	Previous	Next	↓Bottom	Just 17th

424B4	18th Page of 184	TOC	1st	Previous	Next	↓Bottom	Just 18th

424B4	19th Page of 184	TOC	1st	Previous	Next	↓Bottom	Just 19th

424B4	20th Page of 184	TOC	1st	Previous	Next	↓Bottom	Just 20th

424B4	21st Page of 184	TOC	1st	Previous	Next	↓Bottom	Just 21st

424B4	22nd Page of 184	TOC	1st	Previous	Next	↓Bottom	Just 22nd

424B4	23rd Page of 184	TOC	1st	Previous	Next	↓Bottom	Just 23rd

424B4	24th Page of 184	TOC	1st	Previous	Next	↓Bottom	Just 24th

424B4	25th Page of 184	TOC	1st	Previous	Next	↓Bottom	Just 25th

424B4	26th Page of 184	TOC	1st	Previous	Next	↓Bottom	Just 26th

424B4	27th Page of 184	TOC	1st	Previous	Next	↓Bottom	Just 27th

424B4	28th Page of 184	TOC	1st	Previous	Next	↓Bottom	Just 28th

424B4	29th Page of 184	TOC	1st	Previous	Next	↓Bottom	Just 29th

424B4	30th Page of 184	TOC	1st	Previous	Next	↓Bottom	Just 30th

424B4	31st Page of 184	TOC	1st	Previous	Next	↓Bottom	Just 31st

424B4	32nd Page of 184	TOC	1st	Previous	Next	↓Bottom	Just 32nd

424B4	33rd Page of 184	TOC	1st	Previous	Next	↓Bottom	Just 33rd

424B4	34th Page of 184	TOC	1st	Previous	Next	↓Bottom	Just 34th

424B4	35th Page of 184	TOC	1st	Previous	Next	↓Bottom	Just 35th

424B4	36th Page of 184	TOC	1st	Previous	Next	↓Bottom	Just 36th

424B4	37th Page of 184	TOC	1st	Previous	Next	↓Bottom	Just 37th

424B4	38th Page of 184	TOC	1st	Previous	Next	↓Bottom	Just 38th

424B4	39th Page of 184	TOC	1st	Previous	Next	↓Bottom	Just 39th

424B4	40th Page of 184	TOC	1st	Previous	Next	↓Bottom	Just 40th

424B4	41st Page of 184	TOC	1st	Previous	Next	↓Bottom	Just 41st

424B4	42nd Page of 184	TOC	1st	Previous	Next	↓Bottom	Just 42nd

424B4	43rd Page of 184	TOC	1st	Previous	Next	↓Bottom	Just 43rd

424B4	44th Page of 184	TOC	1st	Previous	Next	↓Bottom	Just 44th

Dates Referenced Herein and Documents Incorporated by Reference

		Referenced-On Page
This ‘424B4’ Filing	Date	First	Last	Other Filings

	4/30/08	172
	5/1/04	78
	4/30/04	78	181
	9/1/03	17	88
	10/1/02	17	88
	9/30/02	40	88	10-Q
	1/1/02	19	117
	12/24/01	24	107
	11/14/01	1		10-Q
Filed on:	11/8/01
	11/7/01	1	106	S-3/A
	10/15/01	13
	10/10/01	98		SC 13G
	10/1/01	17	88
	9/30/01	13	121	10-Q
	9/27/01	91
	9/19/01	24	102	S-3
	9/1/01	40	88
	8/22/01	138	139
	8/21/01	110	111	8-K
	8/14/01	118	147	10-Q, 8-K
	8/13/01	90
	7/31/01	40	88
	7/27/01	92	136
	7/24/01	90
	6/30/01	4	137	10-Q, 10-Q/A
	6/25/01	90	131
	6/1/01	90	131
	5/31/01	91	132	S-8
	5/30/01	129
	5/21/01	97
	5/10/01	98		SC 13G
	5/8/01	98		SC 13D
	5/2/01	111	137	8-K
	5/1/01	78	181
	4/26/01	23	97	S-8, SC 13D
	4/20/01	6	183	3, 8-A12G, 8-K
	4/1/01	6	137
	3/31/01	8	149	10-Q, 10-Q/A
	3/19/01	111	130	8-K
	3/16/01	130	180	8-K
	3/1/01	76	180
	2/15/01	180
	1/19/01	111		8-K
	1/1/01	43	145
	12/31/00	8	182	10-K405, 10-K405/A
	12/29/00	180
	12/14/00	116	173
	11/30/00	20
	10/1/00	40	145
	8/8/00	22	80	8-K
	7/31/00	40	87
	7/14/00	91	175
	6/30/00	8	128	10-Q, 10-Q/A
	5/31/00	151	171	8-K
	5/15/00	147
	5/1/00	35
	4/24/00	91	175
	4/1/00	40	87
	1/1/00	12	172
	12/31/99	8	167	10-K405
	11/3/99	176
	10/1/99	60	149	8-K
	9/24/99	60	149
	9/14/99	60	151
	9/13/99	6	173	8-K
	9/1/99	52	154
	8/31/99	46	61
	8/13/99	136	179	10-Q
	7/23/99	135	178
	6/15/99	145	172
	6/8/99	136	179	8-K
	5/25/99	135	179
	5/17/99	135	178
	5/5/99	130	173
	5/3/99	61	150	8-K
	5/1/99	120	181
	4/21/99	61	150	8-K
	4/14/99	176
	4/13/99	139
	4/12/99	130	173
	4/9/99	61	150
	3/31/99	130	173	10-Q, 8-K
	3/23/99	91	175
	3/18/99	130	173
	1/1/99	55	156
	12/31/98	8	171	10-K405, 8-K, NT 10-K
	12/19/98	167
	11/9/98	167
	10/15/98	134	177
	10/1/98	40	157
	9/10/98	164
	9/1/98	40	87
	7/23/98	92	179
	7/1/98	39	156
	6/4/98	134	177
	5/1/98	3	158
	4/30/98	164		8-K
	4/10/98	56	157
	3/27/98	39	144
	1/1/98	60	145
	12/31/97	28	166
	12/24/97	90	174
	11/24/97	135	178
	10/1/97	39	87
	9/8/97	135	178
	7/7/97	133	176
	6/19/97	91	175
	6/13/97	135	178
	5/4/97	91	175
	2/26/97	91	175
	12/31/96	28
	8/21/96	82
	6/25/96	134	177
	3/15/96	133	177
	1/1/95	82
	12/31/94	167
				List all Filings

↑Top

Filing Submission 0000950109-01-504807 – Alternative Formats (Word / Rich Text, HTML, Plain Text, et al.)

Kindred Healthcare, Inc – ‘424B4’ on 11/8/01

On: Thursday, 11/8/01 · Accession #: 950109-1-504807 · File #: 333-68838

Prospectus — Rule 424(b)(4)Filing Table of Contents

Document Table of Contents

Dates Referenced Herein and Documents Incorporated by Reference

Prospectus — Rule 424(b)(4)
Filing Table of Contents