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Professor: Results of Wellmont reaudit may be significant

Jeff Keeling • Jul 4, 2009 at 12:00 AM

Wellmont Health System needed operating profits of at least $250,000 a month between March and June this year or the holder of a $70 million bond could have demanded accelerated repayment.

That is one of several revelations from an audit released Monday that revised downward the Kingsport-based hospital system’s financials for 2006 and 2007 — revelations that system officials have chosen not to elaborate on despite media inquiries.

Wellmont officials may be mum on the possible implications of last week’s $19.6 million restatement, and the belated release of 2008 financials that showed a $4.6 million loss last year, but a local accounting professor said the consequences could be significant.

“One of the problem areas down the road is, what is this going to do to their bond rating,” said Milligan College accounting professor Bob Mahan. “If your bond rating goes down, your cost of debt goes up.”

In fact, the audit by accounting firm KPMG shows some interest- rate hikes may already have occurred due to Wellmont’s non-compliance with some of its bond covenants.

Mahan is chairman of Milligan’s business area of professional learning, an associate professor of accounting and a certified public accountant. Before entering the education field, he worked for KPMG, which took over Wellmont’s financial auditing from Grant Thornton at the end of fiscal 2008, one year ago.

Mahan also disputed the contention of former Wellmont CEO Dr. Richard Salluzzo that the restatement’s results amounted to little more than “a disagreement between auditors” over accounts receivable. Salluzzo announced in late May 2008 that he was leaving Wellmont after 3 1/2 years to run Cape Cod Healthcare Inc. in Hyannis, Mass., where he has been CEO for a year now.

“Auditors do disagree from time to time, but I just can’t imagine a $20 million difference between the two boiling down to that,” Mahan said.

“When you start having big differences like that, if it’s simply a disagreement between auditors, that would go to the integrity of the accounting profession.”

In its release Monday, Wellmont reiterated earlier statements that the changes did not involve any theft or personal gain, but it strongly suggested the system’s internal oversight had fallen short. The system has adopted “new policies and procedures for reconciling accounts, strengthening Wellmont’s internal audit department, building a stronger culture of compliance and closely coordinating with the Wellmont board of directors on all of the changes and actions taken,” the release said.

What prompted Wellmont’s board to authorize a reaudit of two years’ worth of financial records, a process whose expense could approach or exceed seven figures, is “the $20 million question,” said Mahan, who reviewed KPMG’s audit last week.

“It’s possible that when KPMG came in and took a look at the prior work, they found some areas of concern and raised those with Wellmont’s audit committee.”

In January, Wellmont suggested just that in a news release, noting that as KPMG and the audit committee prepared for the year-end audit, both “decided to initiate a review of certain historical accounting entries.”

That review was led by a law firm, Alston & Bird and included interviews with dozens of past and present employees and review of several hundred accounting entries.

Despite Salluzzo’s contention the whole matter amounts to “essentially a disagreement between auditors” — contained in an unsolicited statement released one hour after Wellmont released its financials — Mahan said it would be “highly unusual” for a system to initiate such an expensive and potentially embarrassing undertaking without good reason.

The changes show a $19.6 million (or 80 percent) reduction in Wellmont’s 2006-07 operating profits, from a combined $24.4 million to a combined $4.8 million. Whether bond rating agencies or bondholders punish Wellmont based on the results remains uncertain, but Mahan said the risk is there.

“You get down below a BBB minus (bond rating) and you’re in the range they call speculative; substantial risk to the investor.” Wellmont has a BBB plus rating, but one rating agency, Fitch, attached a “watch negative” label to that rating in January.

That status, Fitch said, was due to the delayed 2008 results, the pending 2006 and 2007 restatements, operating losses between July and November 2008, a worsening cash position and the departures of Salluzzo and chief financial officer Chris Knight.

Wellmont commented on the situation in January when it announced 86 layoffs and the delay on construction of a new patient tower at Kingsport’s Holston Valley Medical Center. The system said its audit committee and leadership already had taken steps to strengthen “Wellmont’s internal auditing function” and that the system “expects to report a positive operating profit for Fiscal Year 2008.”

That profit didn’t materialize, and Wellmont’s financial situation could cause it further trouble. The audit itself reveals that the system’s review, and its financial status of late 2008, had injected some precariousness into its relationship with bondholders.

According to the audit, Wellmont received a “forbearance” because it was out of compliance with certain debt covenants, including the ratio of its long-term debt to its capitalization. Basically, this means Wellmont’s available capital wasn’t enough to satisfy those covenants, which are contained in a “master trust indenture” and in some of Wellmont’s loan, letter-of-credit and lease agreements.

Along with the forbearance agreements, which are what required Wellmont to run at a monthly profit from March to June, the non-compliance matters were addressed “and/or by an increase in the rates charged by the other parties,” the audit stated.

Whether bondholders will take further action now that the restatement is complete remains unknown, but the audit anticipated some possible consequences. It noted that Wellmont’s lenders have the option to call about $16.8 million in lines of credit due to the noncompliance, which is why KPMG classified that amount as current liabilities in Wellmont’s balance sheet.

It also included the entire outstanding balance of Wellmont’s Series 2005 Bonds as maturing in fiscal 2010 since “the forbearance agreement for the letter of credit remarketing agreement ... does not extend beyond June 30, 2009.” Repayment on those bonds began in September 2007, and is scheduled in annual amounts ranging from $1.9 million to $3.4 million through 2032. Wellmont still owed almost $66 million on that bond on June 30, 2008 (the end of fiscal 2008).

Mahan said the situation is likely to raise questions from the public, coming as it does amid a backdrop of debate over health care.

“We’ve got the government talking about health care reform, and certainly a situation like this will probably make people in this area go, ‘Well, what’s going on with my hospital.’”

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