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Professor says results of Wellmont reaudit may be significant

JEFF KEELING • Jul 7, 2009 at 12:00 AM

Wellmont Health System need ed 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 de manded accelerated repayment.

That is one of several revela tions from an audit released Mon day that revised downward the Kingsport-based hospital system’s financials for 2006 and 2007 — rev elations 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 fi nancials that showed a $4.6 million loss last year, but a local account ing professor said the conse quences 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 pro fessor 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 oc curred due to Wellmont’s non-compliance with some of its bond covenants.

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

Mahan also disputed the con tention of former Wellmont CEO Dr. Richard Salluzzo that the re statement’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 Hyan nis, Mass., where he has been CEO for a year now.

"Auditors do disagree from time to time, but I just can’t imag ine a $20 million difference be tween the two boiling down to that," Mahan said.

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

In its release Monday, Well mont reiterated earlier statements that the changes did not involve any theft or personal gain, but it strongly suggested the system’s in ternal oversight had fallen short. The system has adopted "new policies and procedures for recon ciling accounts, strengthening

Wellmont’s internal audit depart ment, building a stronger culture of compliance and closely coordi nating 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 ap proach or exceed seven figures, is "the $20 million question," said Mahan, who reviewed KPMG’s au dit last week.

"It’s possible that when KPMG came in and took a look at the pri or 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 com mittee prepared for the year-end audit, both "decided to initiate a review of certain historical ac counting 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 en tries.

Despite Salluzzo’s contention the whole matter amounts to "es sentially a disagreement between auditors" — contained in an unso licited 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 po tentially embarrassing undertak ing without good reason.

The changes show a $19.6 mil lion (or 80 percent) reduction in Wellmont’s 2006-07 operating prof its, 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 un certain, but Mahan said the risk is there.

"You get down below a BBB mi nus (bond rating) and you’re in the range they call speculative; sub stantial risk to the investor." Well mont 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 re statements, operating losses be tween 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 an nounced 86 layoffs and the delay on construction of a new patient tower at Kingsport’s Holston Val ley Medical Center. The system said its audit committee and lead ership already had taken steps to strengthen "Wellmont’s internal auditing function" and that the system "expects to report a posi tive 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 sys tem’s review, and its financial sta tus of late 2008, had injected some precariousness into its relation ship with bondholders.

According to the audit, Well mont received a "forbearance" because it was out of compliance with certain debt covenants, in cluding 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 con tained in a "master trust inden ture" and in some of Wellmont’s loan, letter-of-credit and lease agreements.

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

Whether bondholders will take further action now that the re statement is complete remains un known, 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 KP MG classified that amount as cur rent liabilities in Wellmont’s bal ance sheet.

It also included the entire out standing 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." Re payment 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 like ly to raise questions from the pub lic, coming as it does amid a back drop 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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