SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K
o |
Annual report pursuant to section 13 or 15(d) of the Securities Exchange Act of 1934 for the fiscal year ended . |
OR | |
ý |
Transition report pursuant to section 13 or 15(d) of the Securities Exchange Act of 1934 for the transition period from June 1, 2002 to December 31, 2002. |
Commission file number 1-7293
TENET HEALTHCARE CORPORATION
(Exact name of registrant as specified in its charter)
Nevada (State or other jurisdiction of incorporation or organization) |
95-2557091 (IRS Employer Identification No.) |
|
3820 State Street Santa Barbara, CA 93105 (Address of principal executive offices) |
||
(805) 563-7000 (Registrant's telephone number, including area code) |
Securities registered pursuant to Section 12(b) of the Act:
Title of each class |
Name of each exchange on which registered |
|
---|---|---|
Common stock | New York Stock Exchange and Pacific Stock Exchange | |
85/8% Senior Notes due 2003 | New York Stock Exchange | |
77/8% Senior Notes due 2003 | New York Stock Exchange | |
8% Senior Notes due 2005 | New York Stock Exchange | |
53/8% Senior Notes due 2006 | New York Stock Exchange | |
5% Senior Notes due 2007 | New York Stock Exchange | |
63/8% Senior Notes due 2011 | New York Stock Exchange | |
61/2% Senior Notes due 2012 | New York Stock Exchange | |
73/8% Senior Notes due 2013 | New York Stock Exchange | |
67/8% Senior Notes due 2031 | New York Stock Exchange | |
81/8% Senior Subordinated Notes due 2008 | New York Stock Exchange |
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months and (2) has been subject to such filing requirements for the past 90 days: Yes ý No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of the Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ý
Indicate by check mark whether the Registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2): Yes ý No o
As of November 29, 2002 there were 473,718,479 shares of common stock outstanding. The aggregate market value of the shares of common stock held by non-affiliates of the Registrant as of November 29, 2002, based on the closing price of these shares on the New York Stock Exchange, was $8,703,344,109. This information is being provided pursuant to SEC rules. As of April 30, 2003, there were 466,624,622 shares of common stock outstanding. The aggregate market value of the shares of common stock held by non-affiliates of the Registrant as of April 30, 2003, based on the closing price of these shares on the New York Stock Exchange, was $6,888,053,091. Reporting this information as of April 30, 2003 is not required by SEC rules, but the Registrant is furnishing it to give our shareholders a more recent statement of the value of our stock held by non-affiliates. For the purposes of the foregoing calculations only, all directors and executive officers of the Registrant have been deemed affiliates.
PART I | ||||
Item 1. | Business | 2 | ||
Item 2. |
Properties |
7 |
||
Item 3. |
Legal Proceedings |
19 |
||
Item 4. |
Submission of Matters to a Vote of Security Holders |
27 |
||
PART II |
||||
Item 5. |
Market for Company's Common Equity and Related Stockholder Matters |
28 |
||
Item 6. |
Selected Financial Data |
29 |
||
Item 7. |
Management's Discussion and Analysis of Financial Condition and Results of Operations |
31 |
||
Item 7A. |
Quantitative and Qualitative Disclosures about Market Risk |
55 |
||
Item 8. |
Financial Statements and Supplementary Data |
56 |
||
Consolidated Financial Statements |
58 |
|||
Notes to Consolidated Financial Statements |
62 |
|||
Item 9. |
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure |
90 |
||
PART III |
||||
Item 10. |
Directors and Executive Officers of the Registrant |
91 |
||
Item 11. |
Executive Compensation |
96 |
||
Item 12. |
Security Ownership of Certain Beneficial Owners and Management |
111 |
||
Item 13. |
Certain Relationships and Related Transactions |
114 |
||
Item 14. |
Controls and Procedures |
116 |
||
Item 15. |
Principal Accountant Fees and Services |
116 |
||
PART IV |
||||
Item 16. |
Exhibits, Financial Statement Schedules and Reports on Form 8-K |
117 |
1
ITEM 1. BUSINESS
GENERAL
Tenet Healthcare Corporation (together with its subsidiaries referred to as "Tenet," the "Company," "we," or "us") is the second largest investor-owned health care services company in the United States. At December 31, 2002, our subsidiaries and affiliates (collectively "subsidiaries") owned or operated 114 domestic general hospitals with 27,870 licensed beds and related health care facilities serving urban and rural communities in 16 states. They also owned one general hospital and related health care facilities in Barcelona, Spain, and held investments in other health care companies. Our related health care facilities included a small number of rehabilitation hospitals, specialty hospitals, long-term-care facilities, a psychiatric facility and medical office buildingsall of which are located on the same campus as, or nearby, one of our general hospitals. Our subsidiaries also owned physician practices and various ancillary health care businesses, including outpatient surgery centers, home health care agencies, occupational and rural health care clinics and health maintenance organizations.
In March 2003, our board of directors approved a change in our fiscal year. Instead of a fiscal year ending on May 31, we will now have a fiscal year that coincides with the calendar year, effective December 31, 2002. Our next quarterly report will cover the three months ended March 31, 2003 and will be the first quarterly report for the fiscal year ending December 31, 2003. We plan to file that report by May 15, 2003.
Tenet's operating strategies include initiatives to (1) focus on core services such as cardiology, orthopedics and neurology designed to meet the health care needs of the aging baby-boomer generation, (2) improve the quality of care provided at its hospitals by identifying best practices and exporting those best practices to all of its hospitals, (3) improve operating efficiencies and reduce costs while maintaining or improving the quality of care provided, (4) reduce bad debts and improve cash flow, (5) acquire new, or expand and enhance existing, integrated health care delivery systems, (6) improve patient, physician and employee satisfaction, and (7) improve recruitment and retention of nurses and other employees.
We regularly review our subsidiaries' portfolio of facilities to assess performance and allocate resources. We intend to continue our strategic acquisitions of, and partnerships or affiliations with, additional general hospitals and related health care businesses in order to expand and enhance our integrated health care delivery systems. At times, we also may close or sell facilities or convert them to alternate uses.
As discussed in more detail under Operations on page 3, our subsidiaries acquired one general hospital, closed one, and sold another during the seven-month transition period ended December 31, 2002 ("reporting period"). During this period, we also began construction on a general hospital in Frisco, Texas. On March 18, 2003, we announced our intention to divest 14 general hospitals.
On March 1, 2001, we entered into a senior unsecured $500 million 364-day credit agreement and a senior unsecured $1.5 billion 5-year revolving credit agreement. On February 28, 2002, we renewed the 364-day agreement. Those credit agreements allowed us to borrow, repay and reborrow up to $2 billion prior to March 1, 2003 and up to $1.5 billion prior to March 1, 2006. We had $1.0 billion available under our credit agreements at December 31, 2002. Subsequently, Tenet's January 2003 issuance of $1 billion of 73/8% Senior Notes due 2013 enabled us to repay our then current borrowings under those credit facilities. The $500 million 364-day credit agreement expired on February 28, 2003; it was undrawn and not renewed.
The Company and its subsidiaries operate in one line of business: the provision of health care through general hospitals and related health care facilities. Our domestic general hospitals generated
2
93.4%, 95.8% and 96.9% of our net operating revenues in the years ended May 31, 2000, 2001 and 2002, respectively, and 97.1% in the seven-month period ended December 31, 2002.
Through March 10, 2003, we had organized these general hospitals and our other health care related facilities into three operating segments or divisions. The divisions' economic characteristics, the nature of their operations, the regulatory environment in which they operated and the manner in which they were managed were all similar. The components of these divisions shared certain resources and they benefited from many common clinical and management practices. Accordingly, we aggregated these divisions into a single reportable operating segment, as that term is defined by Statement of Financial Accounting Standards No. 131, "Disclosures about Segments of an Enterprise and Related Information."
On March 10, 2003, we announced the consolidation of our operating divisions from three to two with five new underlying regions. Our new Eastern Division will consist of three regionsFlorida, Central-Northeast and Southern States. These regions will initially include 59 of our general hospitals located in Alabama, Arkansas, Florida, Georgia, Louisiana, Massachusetts, Mississippi, Missouri, North Carolina, Pennsylvania, South Carolina and Tennessee. Our new Western Division will consist of two regionsCalifornia and Texasand will initially include 55 of our hospitals located in California, Nebraska, Nevada and Texas.
OPERATIONS
All of Tenet's operations are conducted through its subsidiaries. At December 31, 2002, our subsidiaries operated 114 domestic general hospitals with 27,870 licensed beds serving urban and rural communities in 16 states. Of those general hospitals, 94 are owned by Tenet subsidiaries and 20 are owned by third parties and leased by Tenet subsidiaries (including one Tenet-owned facility that is on land leased from a third party). A Tenet subsidiary also owns one general hospital and ancillary health care operations in Barcelona, Spain.
During the reporting period, a subsidiary acquired Roxborough Memorial Hospital, a 125-bed hospital that has served the Roxborough community of Philadelphia for 112 years. Included in the acquisition was a 100-year-old school of nursing, which Tenet has pledged to continue to operate. During the reporting period, Tenet sold Winona Memorial Hospital in Indianapolis, Indiana, and closed St. Luke Medical Center in Pasadena, California.
During the reporting period, Tenet subsidiaries began construction on a 150-bed general hospital and medical complex in Frisco, Texas, and completed the initial phase of construction on a 90-bed hospital in Bartlett, Tennessee.
Each of our general hospitals offers acute care services, operating and recovery rooms, radiology services, respiratory therapy services, clinical laboratories, and pharmacies; most offer intensive care, critical care and/or coronary care units, physical therapy, and orthopedic, oncology and outpatient services. A number of the hospitals also offer tertiary care services such as open-heart surgery, neonatal intensive care and neuroscience. Eight of our hospitalsMemorial Medical Center, USC University Hospital, St. Louis University Hospital, Hahnemann University Hospital, Sierra Medical Center, Western Medical Center, St. Christopher's Hospital for Children and the Cleveland Clinic Florida Hospitaloffer quaternary care in such areas as heart, lung, liver and kidney transplants. USC University Hospital, Sierra Medical Center and Good Samaritan Hospital also offer gamma-knife brain surgery and St. Louis University Hospital, Hahneman University Hospital and Memorial Medical Center offer bone marrow transplants. Except for one small hospital that has not sought to be accredited, each of our hospitals that are eligible for accreditation is fully accredited by the Joint Commission on Accreditation of Healthcare Organizations, the Commission on Accreditation of Rehabilitation Facilities (in the case of rehabilitation hospitals), The American Osteopathic Association (in the case of two hospitals) or another appropriate accreditation agency. With such accreditation, our
3
hospitals are eligible to participate in the Medicare and Medicaid programs. The one hospital that is not accredited participates in the Medicare program through a special waiver that must be renewed each year.
For many years, such factors as significantly underutilized beds at U.S. hospitals, payor-required preadmission authorization, and payor pressure to maximize outpatient and alternative health care delivery services for less acutely ill patients created an environment where hospital admissions and length of stay declined significantly. More recently, as the baby-boomer generation enters the stage of life where hospital utilization increases, admissions have begun to increase.
Among the various initiatives that we have implemented to address this trend is a focus on core services, such as cardiology, orthopedics and neurology, to meet the health care needs of the baby-boomer generation. Our hospitals also will continue to emphasize those outpatient services that can be provided on a quality, cost-effective basis and that we believe will meet the needs of the communities served by the facilities. The patient volumes and net operating revenues at our general hospitals and related health care facilities are subject to seasonal variations caused by a number of factors, including, but not limited to, seasonal cycles of illness, climate and weather conditions, vacation patterns of both patients and physicians and other factors relating to the timing of elective procedures.
The following table lists, by state, the general hospitals owned or leased by our subsidiaries and operated domestically as of December 31, 2002:
Hospital |
Location |
Licensed Beds |
Status |
||||
---|---|---|---|---|---|---|---|
Alabama | |||||||
Brookwood Medical Center | Birmingham | 586 | Owned | ||||
Arkansas |
|||||||
Central Arkansas Hospital | Searcy | 193 | Owned | ||||
National Park Medical Center | Hot Springs | 166 | Owned | ||||
Regional Medical Center of NEA(1) | Jonesboro | 104 | Owned | ||||
St. Mary's Regional Medical Center | Russellville | 170 | Owned | ||||
California |
|||||||
Alvarado Hospital Medical Center/SDRI | San Diego | 311 | Owned | ||||
Brotman Medical Center | Culver City | 420 | Owned | ||||
Centinela Hospital Medical Center | Inglewood | 370 | Owned | ||||
Century City Hospital | Los Angeles | 190 | Leased | ||||
Chapman Medical Center | Orange | 114 | Leased | ||||
Coastal Communities Hospital | Santa Ana | 178 | Owned | ||||
Community Hospital of Huntington Park | Huntington Park | 81 | Leased | ||||
Community Hospital of Los Gatos | Los Gatos | 143 | Leased | ||||
Daniel Freeman Marina Hospital | Marina del Rey | 166 | Owned | ||||
Daniel Freeman Memorial Hospital | Inglewood | 358 | Owned | ||||
Desert Regional Medical Center | Palm Springs | 393 | Leased | ||||
Doctors Hospital of Manteca | Manteca | 73 | Owned | ||||
Doctors Medical Center | Modesto | 465 | Owned | ||||
Doctors Medical Center | San Pablo | 232 | Leased | ||||
Encino-Tarzana Regional Medical Center(2) | Encino | 151 | Leased | ||||
Encino-Tarzana Regional Medical Center(2) | Tarzana | 236 | Leased | ||||
Fountain Valley Regional Hospital and Medical Center | Fountain Valley | 400 | Owned | ||||
Garden Grove Hospital and Medical Center | Garden Grove | 167 | Owned | ||||
Garfield Medical Center | Monterey Park | 210 | Owned | ||||
Greater El Monte Community Hospital | South El Monte | 117 | Owned | ||||
Irvine Regional Hospital and Medical Center | Irvine | 176 | Leased | ||||
John F. Kennedy Memorial Hospital | Indio | 162 | Owned | ||||
4
Lakewood Regional Medical Center | Lakewood | 161 | Owned | ||||
Los Alamitos Medical Center | Los Alamitos | 167 | Owned | ||||
Midway Hospital Medical Center | Los Angeles | 225 | Owned | ||||
Mission Hospital of Huntington Park | Huntington Park | 109 | Owned | ||||
Monterey Park Hospital | Monterey Park | 101 | Owned | ||||
Placentia Linda Hospital | Placentia | 114 | Owned | ||||
Queen of Angels/Hollywood Presbyterian Medical Center | Los Angeles | 434 | Owned | ||||
Redding Medical Center | Redding | 269 | Owned | ||||
San Dimas Community Hospital | San Dimas | 93 | Owned | ||||
San Ramon Regional Medical Center | San Ramon | 123 | Owned | ||||
Santa Ana Hospital Medical Center | Santa Ana | 69 | Leased | ||||
Sierra Vista Regional Medical Center | San Luis Obispo | 201 | Owned | ||||
Suburban Medical Center | Paramount | 182 | Leased | ||||
Twin Cities Community Hospital | Templeton | 84 | Owned | ||||
USC University Hospital(3) | Los Angeles | 269 | Leased | ||||
Western Medical Center | Santa Ana | 280 | Owned | ||||
Western Medical Center Hospital Anaheim | Anaheim | 188 | Owned | ||||
Whittier Hospital Medical Center | Whittier | 181 | Owned | ||||
Florida |
|||||||
Cleveland Clinic Hospital(4) | Weston | 150 | Owned | ||||
Coral Gables Hospital | Coral Gables | 273 | Owned | ||||
Delray Medical Center | Delray Beach | 343 | Owned | ||||
Florida Medical Center | Fort Lauderdale | 459 | Owned | ||||
Good Samaritan Hospital | West Palm Beach | 341 | Owned | ||||
Hialeah Hospital | Hialeah | 378 | Owned | ||||
Hollywood Medical Center | Hollywood | 324 | Owned | ||||
North Ridge Medical Center | Fort Lauderdale | 332 | Owned | ||||
North Shore Medical Center | Miami | 357 | Owned | ||||
Palm Beach Gardens Medical Center | Palm Beach Gardens | 204 | Leased | ||||
Palmetto General Hospital | Hialeah | 360 | Owned | ||||
Parkway Regional Medical Center | North Miami Beach | 382 | Owned | ||||
Saint Mary's Medical Center | West Palm Beach | 460 | Owned | ||||
Seven Rivers Community Hospital | Crystal River | 128 | Owned | ||||
West Boca Medical Center | Boca Raton | 185 | Owned | ||||
Georgia |
|||||||
Atlanta Medical Center | Atlanta | 460 | Owned | ||||
North Fulton Regional Hospital | Roswell | 167 | Leased | ||||
South Fulton Medical Center | East Point | 392 | Owned | ||||
Spalding Regional Hospital | Griffin | 160 | Owned | ||||
Sylvan Grove Hospital | Jackson | 25 | Leased | ||||
Louisiana |
|||||||
Doctors Hospital of Jefferson | Metairie | 124 | Owned | ||||
Kenner Regional Medical Center | Kenner | 203 | Owned | ||||
Meadowcrest Hospital | Gretna | 203 | Owned | ||||
Memorial Medical CenterMid-City Campus | New Orleans | 181 | Owned | ||||
Memorial Medical CenterUptown Campus | New Orleans | 399 | Owned | ||||
Northshore Regional Medical Center | Slidell | 174 | Leased | ||||
St. Charles General Hospital | New Orleans | 154 | Owned | ||||
Massachusetts |
|||||||
MetroWest Medical CenterLeonard Morse Campus(5) | Natick | 182 | Owned | ||||
MetroWest Medical CenterUnion Campus(5) | Framingham | 238 | Owned | ||||
5
Saint Vincent Hospital at Worcester Medical Center(6) | Worcester | 348 | Owned | ||||
Mississippi |
|||||||
Gulf Coast Medical Center | Biloxi | 189 | Owned | ||||
Missouri |
|||||||
Des Peres Hospital | St. Louis | 167 | Owned | ||||
Forest Park Hospital | St. Louis | 450 | Owned | ||||
St. Alexius Hospital | St. Louis | 203 | Owned | ||||
St. Louis University Hospital | St. Louis | 356 | Owned | ||||
Three Rivers HealthcareNorth Campus | Poplar Bluff | 201 | Leased | ||||
Three Rivers HealthcareSouth Campus | Poplar Bluff | 222 | Owned | ||||
Twin Rivers Regional Medical Center | Kennett | 116 | Owned | ||||
Nebraska |
|||||||
Creighton University Medical Center(7) | Omaha | 388 | Owned | ||||
Nevada |
|||||||
Lake Mead Hospital Medical Center | North Las Vegas | 198 | Owned | ||||
North Carolina |
|||||||
Central Carolina Hospital | Sanford | 137 | Owned | ||||
Frye Regional Medical Center | Hickory | 355 | Leased | ||||
Pennsylvania |
|||||||
Elkins Park Hospital | Elkins Park | 243 | Owned | ||||
Graduate Hospital | Philadelphia | 303 | Owned | ||||
Hahnemann University Hospital | Philadelphia | 618 | Owned | ||||
Medical College of Pennsylvania Hospital | Philadelphia | 379 | Owned | ||||
Parkview Hospital | Philadelphia | 200 | Owned | ||||
Roxborough Memorial Hospital | Philadelphia | 125 | Owned | ||||
St. Christopher's Hospital for Children | Philadelphia | 183 | Owned | ||||
Warminster Hospital | Warminster | 145 | Owned | ||||
South Carolina |
|||||||
East Cooper Regional Medical Center | Mt. Pleasant | 100 | Owned | ||||
Hilton Head Medical Center and Clinics | Hilton Head | 93 | Owned | ||||
Piedmont Medical Center | Rock Hill | 268 | Owned | ||||
Tennessee |
|||||||
John W. Harton Regional Medical Center | Tullahoma | 137 | Owned | ||||
Saint Francis Hospital | Memphis | 651 | Owned | ||||
University Medical Center | Lebanon | 257 | Owned | ||||
Texas |
|||||||
Brownsville Medical Center | Brownsville | 243 | Owned | ||||
Cypress Fairbanks Medical Center | Houston | 140 | Owned | ||||
Doctors Hospital | Dallas | 198 | Owned | ||||
Houston Northwest Medical Center | Houston | 498 | Owned | ||||
Lake Pointe Medical Center | Rowlett | 97 | Owned | ||||
Nacogdoches Medical Center | Nacogdoches | 150 | Owned | ||||
Park Plaza Hospital | Houston | 468 | Owned | ||||
Providence Memorial Hospital | El Paso | 508 | Owned | ||||
RHD Memorial Medical Center | Dallas | 150 | Leased | ||||
Shelby Regional Medical Center | Center | 54 | Owned | ||||
Sierra Medical Center | El Paso | 351 | Owned | ||||
Trinity Medical Center | Carrollton | 137 | Leased | ||||
6
Twelve Oaks Medical Center | Houston | 524 | Owned |
The largest concentrations of our licensed beds are in California (30.0 percent), Florida (16.8 percent) and Texas (12.6 percent). Strong concentrations of hospital beds within geographic areas help us contract more successfully with managed-care payors, reduce management, marketing and other expenses, and more efficiently utilize resources. However, such concentrations increase the risk that, should any adverse economic, regulatory or other development occur within these states, our business, financial position or results of operations could be adversely affected.
We believe that our hospitals are well-positioned to compete effectively in the rapidly evolving health care environment. We continually analyze whether each of our hospitals fits within our strategic plans and also analyze ways in which such assets could best be used to maximize shareholder value. To that end, we occasionally close, sell or consolidate certain facilities and services in order to eliminate duplicate services, non-core assets, or excess capacity, or because of changing market conditions. On March 18, 2003, we announced our intention to divest 14 hospitals.
The following table shows certain information about the general hospitals owned or leased domestically by our subsidiaries for the fiscal years ended May 31, 2000, 2001 and 2002 and for the reporting period. (Information about our general hospital in Barcelona, Spain, our rehabilitation hospitals, long-term-care facilities, psychiatric facility, outpatient surgery centers or other ancillary facilities is not included.)
|
Years ended May 31 |
|
|||||||
---|---|---|---|---|---|---|---|---|---|
|
Seven months ended December 31, 2002 |
||||||||
|
2000 |
2001 |
2002 |
||||||
Total number of facilities (at end of period) | 110 | 111 | 116 | 114 | |||||
Total number of licensed beds (at end of period) | 26,939 | 27,277 | 28,667 | 27,870 | |||||
Utilization of licensed beds | 46.8 | % | 50.0 | % | 51.6 | % | 52.4 | % |
PROPERTIES
Our principal executive offices are located at 3820 State Street, Santa Barbara, California 93105. We purchased our headquarters building in January 2003. The building is on land that is leased by a Tenet subsidiary under a long-term ground lease that expires in 2068. The telephone number of our Santa Barbara headquarters is (805) 563-7000. Support services for our subsidiaries and their hospitals are primarily located at our Dallas, Texas service center. A Tenet subsidiary leases the space for our service center under a lease that terminates in 2010 subject to the lessee's exercise of one or both of its two 5-year renewal options. At December 31, 2002, our subsidiaries were also leasing space for regional
7
offices in California, Florida, Georgia, Louisiana, Missouri, Pennsylvania and Texas. In addition, our subsidiaries domestically operated 163 medical office buildings, most of which are adjacent to our general hospitals. The number of licensed beds and locations of our general hospitals are described on pages 4 through 7.
As of December 31, 2002, we had approximately $51 million of outstanding loans secured by property and equipment, and we had approximately $46 million of capitalized lease obligations. We believe that all of these properties, as well as the administrative and medical office buildings described above, are suitable for their intended purposes.
MEDICAL STAFF AND EMPLOYEES
Tenet's hospitals are staffed by licensed physicians who have been admitted to the medical staff of individual hospitals. Members of the medical staffs of our hospitals also often serve on the medical staffs of hospitals not owned by Tenet. Members of our medical staffs are free to terminate their affiliation with Tenet hospitals or shift some or all of their admissions to competing hospitals at any time. Although Tenet owns some physician practices and, where permitted by law, employs some physicians, the overwhelming majority of the physicians who practice at our hospitals are not employees. Nurses, therapists, lab technicians, facility maintenance staff and the administrative staff of hospitals, however, normally are employees. Tenet is subject to the federal minimum wage and hour laws and maintains various employee benefit plans.
Our operations depend on the efforts, ability and experience of our employees and affiliated physicians. Our continued growth depends on (1) our ability to attract and retain skilled employees, (2) our ability to attract and retain physicians and other health care professionals, and (3) our ability to manage growth successfully. Therefore, the success of Tenet, in part, depends upon the quality, quantity and specialties of physicians on our hospitals' medical staffs, most of whom have no long-term contractual relationship with Tenet. Although we believe we will continue to successfully attract and retain key employees, qualified physicians and other health care professionals, the loss of some or all of our key employees or the inability to attract or retain sufficient numbers of qualified physicians and other health care professionals could have a material adverse effect on our business, financial position or results of operations.
At December 31, 2002, the approximate number of Tenet employees (of which approximately 30 percent were part-time employees) was as follows:
General hospital and related health care facilities(1) | 113,788 | ||
Tenet Service Center and regional and support offices | 1,174 | ||
Corporate headquarters | 167 | ||
Total | 115,129 | ||
8
The largest concentrations of our employees are in those states in which we have the largest concentrations of licensed hospital beds:
|
% of employees |
% of licensed beds |
||
---|---|---|---|---|
California: | 30.5 | 30.0 | ||
Florida: | 13.8 | 16.8 | ||
Texas: | 13.0 | 12.6 |
Approximately 8 percent of our employees are represented by labor unions, and labor relations at our facilities generally have been satisfactory. The hospital industry, including Tenet hospitals, is seeing an increase in the amount of union activity, particularly in California. In May 2003, we entered into an agreement with the Service Employees International Union and the American Federation of Federal, State, County and Municipal Employees with respect to all of our California hospitals and two hospitals in Florida. The agreement is expected to streamline the contract negotiation process if employees choose to organize into collective bargaining units at a facility. The agreement provides a framework for pre-negotiated salaries and benefits at these hospitals, and includes a no-strike agreement by these organizations at our other facilities for up to three years.
The hospital industry is experiencing a nationwide nursing shortage. This shortage is more serious in certain specialties and in certain geographic areas than others, including several areas in which we operate hospitals, such as South Florida, Southern California and Texas. The nursing shortage has become a significant operating issue to health care providers, including Tenet, and has resulted in increased costs for nursing personnel. We cannot predict the degree to which Tenet will be affected by the future availability or cost of nursing personnel, but we expect the nursing shortage to continue. We may be required to enhance wages and benefits to recruit and retain nurses. We may also be required to increase our use of more expensive temporary personnel. Among the steps we are taking to attract and retain employees in generally, and nurses in particular, is our "employer of choice" program, through which we strive to be the employer of choice in the regions in which we are located.
COMPETITION
Tenet's general hospitals and other health care businesses operate in competitive environments. We believe that competition among health care providers occurs primarily at the local level. We believe that a hospital's competitive position within the geographic area in which it operates is affected by a number of competitive factors, including: the scope, breadth and quality of services a hospital offers to its patients and physicians; the number, quality and specialties of the physicians who refer patients to the hospital; nurses and other health care professionals employed by the hospital or on its staff; its reputation; its managed-care contracting relationships; the extent to which it is part of an integrated health care delivery system; its location; the location and number of competitive facilities and other health care alternatives; the physical condition of its buildings and improvements; the quality, age and state of the art of its medical equipment; its parking or proximity to public transportation; the length of time it has been a part of the community; and its charges for services. Tax-exempt competitors may have certain financial advantages not available to Tenet's facilities, such as endowments, charitable contributions, tax-exempt financing, and exemptions from sales, property and income taxes. Accordingly, we tailor our local and regional strategies to address these specific competitive factors.
INTEGRATED HEALTH CARE DELIVERY SYSTEMS
The importance of our hospitals' obtaining managed-care contracts has increased over the years as employers, private and government payors, and others try to control rising health care costs. Our domestic general hospitals' net patient revenues from managed care contracts comprised 46.2% of our total net patient revenues for the seven-month period ended December 31, 2002. The revenues and
9
operating results of most of our hospitals are significantly affected by our ability to negotiate favorable contracts with managed-care payors.
A health care provider's ability to compete for favorable managed-care contracts is affected by many factors, including the competitive factors referred to above. We believe that one of the most important of those factors is whether the hospital is part of an integrated health care delivery system. A hospital that is part of a system with many hospitals in a geographic area is more likely to obtain managed-care contractsand to obtain more favorable terms in those contractsthan a hospital that is not. Other important factors are the scope, breadth and quality of services offered by such a system as compared to those offered by competing systems.
We evaluate changing circumstances in each of our geographic areas on an ongoing basis, and we position ourselves to compete in the managed-care market either by forming our own integrated health care delivery systems or by joining with others to do so. A majority of our hospitals are located in geographic areas where they have the number one or number two market share. In those areas, we negotiate with managed-care providers with the goal of including all of our hospitals within the region in each managed-care contract.
Our networks in Southern California, South Florida, the greater New Orleans area, St. Louis, Philadelphia and Atlanta are models of how we have developed networks of our own hospitals and related health care facilities to meet the health care needs of those communities. In geographic areas where Tenet has fewer hospitals, those hospitals may join with other hospitals and health care providers to create integrated health care delivery systems in order to better compete for managed-care contracts.
PHYSICIAN AND EMPLOYEE SATISFACTION
Another important factor in Tenet's future success is the ability of its hospitals to continue to attract and retain staff physicians. We attract physicians to our hospitals by equipping our hospitals with technologically advanced equipment and physical plant, properly maintaining the equipment and physical plant, sponsoring training programs to educate physicians on advanced medical procedures providing high-quality care to our patients and otherwise creating an environment within which physicians prefer to practice. We also attract physicians to our hospitals by using local governing boards, consisting primarily of physicians and community members, to develop short-and long-term plans for the hospital and review and approve, as appropriate, actions of the medical staff, including staff appointments, credentialing, peer review and quality assurance. While physicians may terminate their association with a hospital at any time, Tenet believes that by striving to maintain and improve the quality of care at its hospitals and by maintaining ethical and professional standards, it will attract and retain qualified physicians with a variety of specialties.
"Target 100" and "Partnership for Change" are two important programs that we have adopted to enhance physician satisfaction and make our hospitals more attractive to physicians. The "Target 100" program targets 100 percent satisfaction rates among patients, physicians and employees at Tenet's facilities. Under the program, employees at every hospital are trained to focus on the following five pillars in every aspect of their jobs: Service, Quality, Cost, People and Growth. Tenet's Partnership for Change program is designed to create a quality monitoring culture among Tenet's employees, physicians and other health care professionals who practice at Tenet's hospitals. The program employs a computerized outcomes-management system that contains clinical and demographic information from our hospitals and physicians and allows users to identify "best practices" for treating specific diagnosis-related groups. As discussed in Tenet's earnings announcement on April 10, 2003, our goal is to improve the quality of care provided at its hospitals by maximizing the most effective clinical practices and eliminating those that have proven not to be effective.
10
The health care industry continues to contend with a nursing shortage and increased competition for nurses and other health care professionals. These issues are described in the discussion concerning Medical Staff and Employees on pages 8-9.
The health care industry has seen a significant rise in malpractice expense due to unfavorable pricing and availability trends in the professional and general liability insurance markets and increases in the magnitude of claim settlements. We expect this trend may continue unless meaningful tort reform legislation is enacted.
Changes in medical technology, existing and future legislation, regulations, interpretations of those regulations, competitive contracting for provider services by payors and other competitive factors may require changes in our facilities, equipment, personnel, procedures, rates and/or services in the future. We believe we have the capital available to respond to those challenges.
To meet the foregoing challenges, we have implemented the business strategies described above and in the Business Strategies & Outlook section of Management's Discussion and Analysis on pages 31-33.
HEALTH CARE REGULATION AND LICENSING
CERTAIN BACKGROUND INFORMATION
Health care, as one of the largest industries in the United States, continues to attract much legislative interest and public attention. Changes in Medicare, Medicaid and other programs, hospital cost-containment initiatives by public and private payors, proposals to limit payments and health care spending and industry-wide competitive factors are highly significant to the health care industry. In addition, the health care industry is governed by a framework of federal and state laws, rules and regulations that are extremely complex and for which the industry has the benefit of little or no regulatory or judicial interpretation. Although we believe we are in compliance in all material respects with such laws, rules and regulations, if a determination is made that we were in material violation of such laws, rules or regulations, our business, financial position or results of operations could be adversely affected.
As discussed under Government Programs starting on page 33, the Balanced Budget Act of 1997 has had the effect of reducing payments to hospitals and other health care providers under Medicare programs. Although mitigated to some extent by the Benefits Improvement and Protection Act of 2000 and the Balanced Budget Refinement Act of 1999, the reductions in payments and other changes mandated by the act have had a significant impact on our revenues under Medicare programs. In addition, there continue to be federal and state proposals that would, and actions that do, impose more limitations on payments to providers such as Tenet and proposals to increase copayments and deductibles from patients.
In addition to certain statutory coverage limits and exclusions, federal law and regulations require healthcare providers, including hospitals that furnish or order health care services that may be paid for under the Medicare or state health care programs, to assure that claims for reimbursement are for services or items that are (1) provided economically and only when, and to the extent, they are medically necessary; (2) of a quality that meets professionally recognized standards of health care; and (3) supported by appropriate evidence of medical necessity and quality. In addition, the Centers for Medicare and Medicaid Services has requested quality improvement organizations to monitor hospital admission and coding patterns by ongoing analysis of Medicare discharge data. The quality improvement organizations have the authority to deny payment for services provided and recommend to the Department of Health and Human Services that a provider that is in substantial noncompliance with the certain standards be excluded from participating in the Medicare program. Managed-care
11
organizations also have concurrent utilization review protocols, as well as prepayment utilization review procedures.
Many states have enacted or are considering enacting measures that are designed to reduce their Medicaid expenditures and to make certain changes to private health care insurance. Various states have applied, or are considering applying, for a federal waiver from current Medicaid regulations to allow them to serve some of their Medicaid participants through managed-care providers. Texas was denied a waiver under Section 1115 of the Balanced Budget Act but has implemented regional managed-care programs under a more limited waiver. Texas also has applied for federal funds for children's health programs under the Balanced Budget Act. Louisiana is considering wider use of managed care for its Medicaid population. California has created a voluntary health insurance purchasing cooperative that seeks to make health care coverage more affordable for businesses with five to 50 employees, and changed the payment system for participants in its Medicaid program in certain counties from fee-for-service arrangements to managed-care plans. Florida also has legislation, and other states are considering adopting legislation, imposing a tax on net revenues of hospitals to help finance or expand the provision of health care to uninsured and underinsured persons. Several other states are considering the enactment of managed-care initiatives designed to provide universal low-cost coverage. These proposals also may attempt to include coverage for some people who currently are uninsured.
CERTIFICATE OF NEED REQUIREMENTS
Some states require state approval for construction and expansion of health care facilities, including findings of need for additional or expanded health care facilities or services. Certificates of need, which are issued by governmental agencies with jurisdiction over health care facilities, are at times required for capital expenditures exceeding a prescribed amount, changes in bed capacity or services and certain other matters. Following a number of years of decline, the number of states requiring certificates of need is once again on the rise as state legislators are looking at the certificate of need process as a way to contain rising health care costs. At December 31, 2002, Tenet operated hospitals in nine states that require state approval under certificate of need programs. Tenet is unable to predict whether it will be able to obtain any additional certificates of need in any jurisdiction where such Certificates of Need are required.
ANTIKICKBACK AND SELF-REFERRAL REGULATIONS
The health care industry is subject to extensive federal, state and local regulation relating to licensure, conduct of operations, ownership of facilities, addition of facilities and services and prices for services. In particular, Medicare and Medicaid antikickback and antifraud and abuse amendments codified under Section 1128B(b) of the Social Security Act (the "Antikickback Amendments") prohibit certain business practices and relationships that might affect the provision and cost of health care services payable under the Medicare, Medicaid and other government programs, including the payment or receipt of remuneration for the referral of patients whose care will be paid for by such programs. Sanctions for violating the Antikickback Amendments include criminal penalties and civil sanctions, including fines and possible exclusion from government programs such as Medicare and Medicaid. Many states have statutes similar to the federal Anitikickback Amendments, except that the state statutes usually apply to referrals for services reimbursed by all third-party payors, not just federal programs.
In addition, it is a violation of the Federal Civil Monetary Penalties Law to offer or transfer anything of value to Medicare or Medicaid beneficiaries that is likely to influence their decision to obtain covered goods or services from one provider or service over another.
12
In addition to addressing other matters, as discussed below, the Health Insurance Portability and Accountability Act of 1996 amends Title XI (42 U.S.C. 1301 et seq.) to broaden the scope of current fraud and abuse laws to include all health plans, whether or not payments under such health plans are made pursuant to a federal program.
Section 1877 of the Social Security Act (commonly referred to as the "Stark" laws) restricts referrals by physicians of Medicare or Medicaid patients to providers of a broad range of designated health services with which they or an immediate family member have ownership or certain other financial arrangements, unless one of several exceptions applies. These exceptions cover a broad range of common financial relationships. These statutory and regulatory exceptions are available to protect certain employment relationships, leases, group practice arrangements, medical directorships, and other common relationships between physicians and providers of designated health services. A violation of the Stark laws may result in a denial of payment, required refunds to patients and to the Medicare program, civil monetary penalties of up to $15,000 for each violation, civil monetary penalties of up to $100,000 for "sham" arrangements, civil monetary penalties of up to $10,000 for each day in which an entity fails to report required information and exclusion from participation in the Medicare, Medicaid and other federal 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 the payment for the care. Tenet's participation in and development of joint ventures and other financial relationships with physicians could be adversely affected by these amendments and similar state enactments.
On January 4, 2001, the Department of Health and Human Services issued final regulations, subject to comment, intended to clarify parts of the Stark laws and some of the exceptions to them. These regulations are considered the first phase of a two-phase process, with the remaining regulations to be published at an unknown future date. While the Department of Health and Human Services may add new exceptions to the final regulations, the current statutory exceptions, discussed above, will continue to be available. We cannot predict the final form that these regulations will take or the effect that the final regulations will have on our operations.
The federal government has issued regulations that describe some of the conduct and business relationships that are permissible under the Antikickback Amendments ("Safe Harbors"). The fact that certain conduct or a given business arrangement does not fall within a Safe Harbor does not render the conduct or business arrangement automatically illegal under the Antikickback Amendments. Such conduct and business arrangements, however, do risk increased scrutiny by government enforcement authorities. Tenet may be less willing than some of its competitors to enter into conduct or business arrangements that do not clearly satisfy the Safe Harbors. Passing up certain of those opportunities of which its competitors are willing to take advantage may put Tenet at a competitive disadvantage. Tenet has a voluntary regulatory compliance program and systematically reviews all of its operations to ensure that they comply with federal and state laws related to health care, such as the Antikickback Amendments, the Stark laws and similar state statutes.
Both federal and state government agencies continue heightened and coordinated civil and criminal enforcement efforts against the health care industry. As part of an announced work plan, which is implemented through the use of national initiatives against health care providers, including Tenet, the government is scrutinizing, among other things, the terms of acquisitions of physician practices and the coding practices related to certain clinical laboratory procedures and inpatient procedures. We believe that the health care industry will continue to be subject to increased government scrutiny and investigations such as this.
Another trend impacting health care providers, including Tenet, is the increased use of the False Claims Act, particularly by individuals who bring actions. Such qui tam or "whistleblower" actions allow
13
private individuals to bring actions on behalf of the government alleging that a hospital has defrauded the federal government. If the government intervenes in the action and prevails the defendant may be required to pay three times the actual damages sustained by the government, plus mandatory civil penalties of between $5,500 and $11,000 for each false claim submitted to the government. As part of the resolution of a qui tam case, the party filing the initial complaint may share in a portion of any settlement or judgment. If the government does not intervene in the action, the qui tam plaintiff may pursue the action independently. Although companies in the health care industry in general, and Tenet in particular, have been and may continue to be subject to qui tam actions, we are unable to predict the impact of such actions on its business, financial position or results of operations.
We are unable to predict the future course of federal, state and local regulation or legislation, including Medicare and Medicaid statutes and regulations (discussed on pages 36 through 37). Further changes in the regulatory framework could have a material adverse effect on our business, financial position or results of operations.
HEALTH INSURANCE PORTABILITY AND ACCOUNTABILITY ACT
The Health Insurance Portability and Accountability Act mandates the adoption of standards for the exchange of health information in an effort to encourage overall administrative simplification and enhance the effectiveness and efficiency of the health care industry. Ensuring privacy and security of patient information"accountability"is one of the key factors driving the legislation. The other major factor"portability"refers to Congress' intention to ensure that individuals may take their medical and insurance records with them when they change employers.
In August 2000, the Department of Health and Human Services issued final regulations establishing electronic data transmission standards that health care providers must use when submitting or receiving certain health care data electronically. All affected entities, including Tenet, were required to comply with these regulations by October 16, 2002.
On December 27, 2001, President George W. Bush signed into law H.R. 3323, the Administrative Simplification Compliance Act. This act requires that, by October 16, 2002, hospitals and other covered entities must either: (1) be in compliance with the electronic data transmission standards under the Health Insurance Portability and Accountability Act, or (2) submit a summary plan to the Secretary of Health and Human Services describing how the entity will come into full compliance with the standards by October 16, 2003. Tenet continues to work toward compliance with the electronic data transmission standards. Tenet submitted a summary plan to the Secretary of Health and Human Services and expects to be in compliance with the standards by October 16, 2003.
In December 2000, Health and Human Services issued final regulations concerning the privacy of health care information. These regulations, which were amended in August 2002, regulate the use and disclosure of individuals' health care information, whether communicated electronically, on paper or orally. All affected entities, including Tenet, were required to comply with these regulations by April 14, 2003. The regulations also provide patients with significant new rights related to understanding and controlling how their health information is used or disclosed. We are substantially in compliance with these regulations.
On February 20, 2003, Health and Human Services issued final regulations concerning the security of electronic health care information. These regulations require health care providers to implement administrative, physical and technical safeguards to protect the security of patient information. We are required to comply with these regulations by April 21, 2005.
14
In April 2003, Health and Human Services published an interim final rule that establishes procedures for the imposition, by the Secretary of Health and Human Services, of civil monetary penalties on entities that violate the administrative simplification provisions of the Health Insurance Portability and Accountability Act. This was the first installment of the enforcement rule. When issued in complete form, the enforcement rule will set forth procedural and substantive requirements for imposition of civil monetary penalties. The act also provides for criminal penalties for violations. We have established a plan and committed the resources necessary to comply with the act. At this time, we anticipate that we will be able to fully comply with the act's regulations that have been issued and with the proposed regulations. Based on the existing and proposed regulations, we believe that the cost of our compliance with the act will not have a material adverse effect on our business, financial position or results of operations.
ENVIRONMENTAL REGULATIONS
Our health care operations generate medical waste that must be disposed of in compliance with federal, state and local environmental laws, rules and regulations. Our operations, as well as our purchases and sales of facilities, also are subject to compliance with various other environmental laws, rules and regulations. We believe that the cost of such compliance will not have a material effect on our future capital expenditures, earnings or competitive position.
HEALTH CARE FACILITY LICENSING REQUIREMENTS
Tenet's health care facilities are subject to extensive federal, state and local legislation and regulation. In order to maintain their operating licenses, health care facilities must comply with strict standards concerning medical care, equipment and hygiene. Various licenses and permits also are required in order to dispense narcotics, operate pharmacies, handle radioactive materials and operate certain equipment. Tenet's health care facilities hold all required governmental approvals, licenses and permits. Except for one small hospital that has not sought to be accredited, each of Tenet's facilities that is eligible for accreditation is fully accredited by the Joint Commission on Accreditation of Healthcare Organizations, Commission on Accreditation of Rehabilitation Facilities (in the case of rehabilitation hospitals), The American Osteopathic Association (in the case of two hospitals) or other appropriate accreditation agencies. With such accreditation, our hospitals are eligible to participate in government-sponsored provider programs such as the Medicare and Medicaid programs. The one hospital that is not accredited participates in the Medicare program through a special waiver that must be renewed each year.
UTILIZATION REVIEW COMPLIANCE AND HOSPITAL GOVERNANCE
Tenet's health care facilities are subject to and comply with various forms of utilization review. In addition, under the Medicare prospective payment system, each state must have a quality improvement organization to carry out a federally mandated system of review of Medicare patient admissions, treatments and discharges in general hospitals. Medical and surgical services and practices are extensively supervised by committees of staff doctors at each health care facility, are overseen by each health care facility's local governing board, the members of which primarily are physicians and community members, and are reviewed by Tenet's quality assurance personnel. The local hospital governing board also helps maintain standards for quality care, develop long-range plans, establish, review and enforce practices and procedures and approve the credentials and disciplining of medical staff members.
COMPLIANCE AND ETHICS PROGRAMS
We voluntarily maintain a multifaceted corporate compliance and ethics program that meets or exceeds all applicable federal guidelines and industry standards. The program is designed to monitor
15
and raise awareness of various regulatory issues among employees, to stress the importance of complying with all governmental laws and regulations and to promote the Company's Standards of Conduct.
All of our employees, including our chief executive officer, chief financial officer, chief accounting officer and controller, are required to abide by our Standards of Conduct to ensure that our business is conducted in a consistently legal and ethical manner. These standards reflect our basic values and form the foundation of a comprehensive process that includes compliance with all corporate policies, procedures and practices. Our standards cover such areas as quality patient care, compliance with all applicable laws and regulations, appropriate use of our assets, appropriate treatment of patient and company records and avoidance of conflicts of interest.
As part of the program, we provide annual ethics and compliance training to every employee. We also provide additional compliance training in specialized areas to the employees responsible for these areas. All employees are required to report incidents that they believe in good faith may be in violation of the standards, and are encouraged to contact our toll-free Ethics Action Line when they have questions about the standards or other ethics concerns. All reports are confidential, and employees have the option to remain anonymous. Tenet maintains a zero-tolerance retaliation policy.
The full text of our standards is published on our web site, at tenethealth.com, under the "Corporate Governance" caption. A copy of our standards is also available upon written request of our corporate secretary.
MANAGEMENT
Our executive officers who are not also directors are:
|
Position |
Age |
||
---|---|---|---|---|
Stephen D. Farber | Chief Financial Officer (effective November 7, 2002) | 33 | ||
Trevor Fetter | President (effective November 7, 2002) | 43 | ||
Reynold J. Jennings | PresidentEastern Division (effective March 10, 2003) | 56 | ||
Raymond L. Mathiasen | Executive Vice President and Chief Accounting Officer | 59 | ||
Barry P. Schochet | Vice Chairman | 52 | ||
W. Randolph Smith | PresidentWestern Division (effective March 10, 2003) | 54 | ||
Christi R. Sulzbach | Chief Corporate Officer (effective November 22, 2002) and General Counsel | 48 |
Mr. Farber was elected Chief Financial Officer on November 7, 2002. Prior to his current position, Mr. Farber served as Tenet's Senior Vice President of Corporate Finance and Treasurer. Mr. Farber rejoined Tenet in May 1999 from J.P. Morgan & Co. in New York, where he served as Vice President, health care investment banking. He previously served Tenet as Vice President, Corporate Finance, from February 1997 to October 1998. From 1993 to 1997, Mr. Farber worked as an investment banker in the Los Angeles office of Donaldson, Lufkin & Jenrette. Mr. Farber has a bachelor of science degree in economics from the University of Pennsylvania's Wharton School of Business and completed the Advanced Management Program at Harvard Business School.
Mr. Fetter was elected President effective November 7, 2002. Prior to that, he was Chairman and Chief Executive Officer of Broadlane, Inc. from March 2000 to November 2002. He remains Chairman of Broadlane. From 1995 to February 2000, he served in several senior management positions at Tenet, including Executive Vice President and Chief Financial Officer and Chief Corporate Officer in the office of the President. Prior to joining Tenet, Mr. Fetter served as Executive Vice President and Chief Financial Officer at Metro-Goldwyn-Mayer, Inc. Before joining MGM in 1988, Mr. Fetter worked in the investment banking division of Merrill Lynch Capital Markets. Mr. Fetter holds a M.B.A. from the Harvard Business School and a bachelor's degree in economics from Stanford University.
16
Mr. Jennings was promoted to President of our Eastern Division on March 10, 2003. Prior to that, he served as Executive Vice President of the former Southeast Division. Jennings rejoined Tenet in 1997 from Ramsay Health Care Inc., where he was President and Chief Executive Officer from 1993 to 1996. Before that, he served as Senior Vice President, Operations, for National Medical Enterprises' Dallas region from 1991 to 1993. His career experience includes executive directorships at a number of acute care hospitals. He has a master's degree in business administration from the University of South Carolina and a bachelor's degree in pharmacy from the University of Georgia. Jennings is a fellow of the American College of Healthcare Executives and a board member of the American Federation of Hospitals.
Mr. Mathiasen was elected Executive Vice President on March 22, 1999. Since March 1996, Mr. Mathiasen has been Chief Accounting Officer. From February 1994 to March 1996, Mr. Mathiasen served as Senior Vice President and Chief Financial Officer and from September 1993 to February 1994, Mr. Mathiasen served as Senior Vice President and acting Chief Financial Officer. Mr. Mathiasen was elected to the position of Senior Vice President in 1990 and Chief Operating Financial Officer in 1991. Prior to joining Tenet as a Vice President in 1985, he was a partner with Ernst & Young. Mr. Mathiasen holds a bachelor's degree in accounting from California State University, Long Beach.
Mr. Schochet was elected Vice Chairman of Tenet in January 1999. Mr. Schochet joined Tenet in 1979 and has held a variety of executive positions since that time, including Executive Vice President of Operations from March 1995 to January 1999. He is a diplomat of the American College of Healthcare Executives and is Chair of the Board of Directors of the Federal of American Hospitals. Mr. Schochet holds a bachelor's degree in zoology from the University of Maine and a master's degree in hospital administration from George Washington University.
Mr. Smith was promoted to President of our Western Division on March 10, 2003. Prior to that, he was Executive Vice President of the former Central-Northeast Division. Before joining Tenet in 1995, Mr. Smith served as Executive Vice President, Operations, for American Medical International, where he held various positions over 16 years. Mr. Smith has a bachelor's degree in business administration from Furman University and a master's degree in health care administration from Duke University. He has served in leadership positions for a variety of health care and community organizations, including the Federation of American Hospitals, Esoterix, Inc., and Epic Healthcare Corporation.
Ms. Sulzbach was elected Chief Corporate Officer on November 22, 2002. Ms. Sulzbach has served as General Counsel since February 1999, and was an Executive Vice President from February 1999 until her appointment as Chief Corporate Officer. Ms. Sulzbach previously served as Associate General Counsel in charge of Compliance and Litigation and as Senior Vice President, Public Affairs. She joined Tenet in 1983 and has held a variety of positions in the Law Department since that time. She serves on the boards of directors of the Federation of American Hospitals, the Los Angeles Chapter of the Federal Bar Association and Laguna Blanca School. Ms. Sulzbach holds bachelor degrees in political science and psychology from the University of Southern California and a J.D. from Loyola University in Los Angeles.
PROFESSIONAL AND GENERAL LIABILITY INSURANCE
Through May 31, 2002, we insured substantially all of our professional and comprehensive general liability risks in excess of self-insured retentions through a majority-owned insurance subsidiary (Hospital Underwriting Group) under a mature claims-made policy with a 10-year discovery period. These self-insured retentions were $1 million per occurrence for the three years ended May 31, 2002, and in prior years varied by hospital and by policy period from $500,000 to $5 million per occurrence. Hospital Underwriting Group's retentions covered the next $2 million per occurrence. Claims in excess
17
of $3 million per occurrence were, in turn, reinsured with major independent insurance companies. Effective June 1, 2002, we formed a new insurance subsidiary. This subsidiary insures these risks under a first-year only claims-made policy, and, in turn, reinsures its risks in excess of $5 million per occurrence with major independent insurance companies. Subsequent to May 31, 2002, our retention limit is $2 million. Our new subsidiary's retention covers the next $3 million. That program will expire on May 31, 2003. Effective June 1, 2003, we anticipate having a new insurance program in place.
In addition to the reserves recorded by the above insurance subsidiaries, we maintain reserves based on actuarial estimates for the portion of our professional liability risks, including incurred but not reported claims, for which we do not have insurance coverage. Reserves for losses and related expenses are estimated using expected loss-reporting patterns and are discounted to their present value under a risk-free rate approach using a Federal Reserve 10-year maturity composite rate at December 31, 2002 that approximates our claims payout period. If actual payments of claims materially exceed projected estimates of claims, Tenet's financial position or results of operations could be materially adversely affected.
FORWARD-LOOKING STATEMENTS
Certain statements contained in this Transition Report on Form 10-K, including, but not limited to, statements containing the words "believe," "anticipate," "expect," "will," "may," "might," "should," "estimate," "intend," "appear" and words of similar import, and statements regarding our business strategy and plans, constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are based on our current expectations. They involve known and unknown risks, uncertainties and other factorsmany of which we are unable to predict or controlthat may cause our actual results, performance or achievements, or health care industry results, to be materially different from those expressed or implied by forward-looking statements. Such factors include, among others, the following:
18
Given these uncertainties, investors and prospective investors are cautioned not to rely on such forward-looking statements. We disclaim any obligation, and make no promise, to update any such factors or forward-looking statements or to publicly announce the results of any revisions to any such forward-looking statements, whether as a result of changes in underlying factors, to reflect new information, as a result of the occurrence of events or developments or otherwise.
ITEM 2. PROPERTIES
Note: Item 2. Properties is included with Item 1.
ITEM 3. LEGAL PROCEEDINGS
We are subject to claims and lawsuits in the normal course of our business. We believe that our liability for damages resulting from such claims and lawsuits is adequately covered by insurance or is adequately provided for in our consolidated financial statements. Although the results of these claims and lawsuits cannot be predicted with certainty, we believe that the ultimate resolution of these claims and lawsuits will not have a material adverse effect on our business, financial position or results of operations.
In addition, we currently are subject to the following unusual claims, lawsuits and investigations. The existence of each action marked with an asterisk (*) has been previously disclosed in reports we have filed with the SEC or in press releases, and a current description of the status of each of those actions, as well as other more recent actions, is set forth below.
IN RE TENET HEALTHCARE CORPORATION SECURITIES LITIGATION, UNITED STATES DISTRICT COURT, CENTRAL DISTRICT OF CALIFORNIA, CASE NO. 02-8462 RSWL*
From November 2002 through January 2003, twenty securities class action lawsuits were filed against Tenet Healthcare Corporation (the "Parent") and certain of its officers and directors in the United States District Court for the Central District of California and the Southern District of New York on behalf of all persons or entities who purchased the Parent's securities during the various class periods specified in the complaints. All of these actions have been consolidated under the above-listed case number in the United States District Court for the Central District of California. The procedures of the Private Litigation Securities Reform Act ("PLSRA") apply to these cases.
19
Under the procedures set forth in the PLSRA, on February 10, 2003, the State of New Jersey was appointed "lead" plaintiff in the consolidated actions and its counsel, the law firm of Schiffrin & Barroway, was appointed as lead class counsel. On March 27, 2003, the Rudman Partners and related entities, who were not selected as lead plaintiffs, filed a writ of mandamus in the United States Court of Appeals for the Ninth Circuit seeking to overturn the appointment of the State of New Jersey as lead plaintiff and requesting that they be appointed lead plaintiffs.
We have entered into a stipulation with lead plaintiffs' counsel concerning the filing of a single Consolidated Amended Complaint that will become the operative complaint for purposes of the consolidated actions. Pursuant to the stipulation, the State of New Jersey will file the Consolidated Amended Complaint on or before May 16, 2003. The defendants will file their responses on or before July 18, 2003. Under the PLSRA, discovery is stayed until a motion to dismiss is denied or defendants' file an answer to the consolidated amended complaint.
Although we do not know the class period that will be alleged in the Consolidated Amended Complaint, the longest class period alleged in the complaints that have been filed was from July 2000 to November 2002. Similarly, we do not know what factual allegations and legal claims will be asserted in the Consolidated Amended Complaint. The complaints that have been filed allege violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10(b)-5. The complaints seek compensatory damages, attorney's fees and injunctive relief. While the specific factual allegations vary slightly in each case, the complaints generally allege that defendants falsely represented the Parent's financial results by failing to disclose that they were inflated by (i) wrongfully inducing patients into undergoing unnecessary invasive coronary procedures at Redding Medical Center, alleged to be a "key profit center" for the Parent and (ii) the Parent's policy of charging "too aggressive" prices that enabled it to obtain excessive Medicare outlier payments.
In addition, a class action has been filed in the California Superior Court of Los Angeles County against Parent and its board of directors for breach of fiduciary duty in connection with the Parent's stock purchase plan for employees. Hamner v. Tenet Healthcare Corporation, et al., Case No. BC290646.* Although the complaint does not plead a cause of action under the federal securities laws, the plaintiff's theory is that stock purchase plan participants were not advised that their investments in the Parent's stock were at substantial risk due to the Parent's business strategies and allegedly illegal conduct, including the purportedly unnecessary surgeries performed by Drs. Moon and Realyvasquez at Redding Medical Center. On April 2, 2003, we removed the case to the United States District Court for the Central District of California on the basis that action was preempted by the Securities Litigation Uniform Standards Act and ERISA. We intend to seek to have the case consolidated with the other securities class actions pending there or, in the alternative, to move to dismiss it.
We believe the allegations in these cases are without merit and we intend to vigorously defend these actions. The Parent and its directors are beneficiaries of several layers of directors' and officers' insurance, which includes coverage for securities claims. The carriers have been notified of the pendency of the actions, but have not provided a formal position on coverage.
SHAREHOLDER DERIVATIVE ACTIONS
Included actions:
20
The listed cases are shareholder derivative actions filed against members of the board of directors and senior management of the Parent by shareholders purporting to pursue the action on behalf of the Parent and for its benefit. No pre-lawsuit demand to investigate the allegations or bring the action was made on the board of directors. The Parent also is named as a nominal defendant in each of the cases.
In the California derivative litigation, which involves ten cases that have been consolidated, the lead plaintiff filed a Consolidated Amended Complaint on March 3, 2003. On May 1, 2003, defendants filed a motion to stay the California derivative litigation in favor of the federal derivative litigation and demurrers to all of the causes of action alleged in the Consolidated Amended Complaint. The complaint alleges claims for breach of fiduciary duty, abuse of control, gross mismanagement, waste of corporate assets, unjust enrichment, indemnification and insider trading under California law. The complaint alleges that the individual defendants breached their fiduciary duties and engaged in gross mismanagement by allegedly ignoring indicators of the lack of control over the Parent's accounting and management practices, allowing the Parent to engage in improper conduct, permitting misleading information to be disseminated to shareholders, failing to monitor hospitals and doctors to prevent improper actions and otherwise failing to carry out their duties and obligations to Parent. Plaintiffs further allege that the defendants violated the California insider trading statute, Sections 25402 and 25502.5 of the California Corporation Code, because they allegedly knew, but did not disclose, that: (i) physicians at hospitals owned by subsidiaries of the Parent were routinely performing unnecessary procedures in order to take advantage of Medicare outlier reimbursement; (ii) the Parent deliberately raised its prices to take advantage of Medicare outlier reimbursement; (iii) the Parent's growth was dependent primarily on its continued receipt of Medicare outlier payments; and (iv) the rules and regulations related to Medicare outlier payments were being reformed to limit outlier payments, which would have a material negative effect on the Parent's revenues and earnings going forward.
In addition to the derivative litigation pending in California Superior Court, four derivative cases have also been filed in federal court. These four cases have been consolidated in the United States District Court for the Central District of California. Plaintiffs served their Consolidated Amended Complaint on March 28, 2003. Defendants' responses are currently due on May 20, 2003. In addition to common law claims of breach of fiduciary duty, abuse of control, waste of corporate assets, indemnification, insider trading and unjust enrichment, the Consolidated Amended Complaint alleges violations of Section 14(a) of the Securities Exchange Act of the 1934 and Rule 14a-9 and Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5. The Exchange Act claims involve allegations of false or misleading statements made in connection with (1) proxy statements regarding the election of certain directors and the approval of stock option grants and (2) Parent's purchase of stock as part of its stock repurchase program.
REDDING CIVIL LITIGATION
Included actions:
21
Generally these cases were filed as a result of an advertising campaign by various plaintiffs' counsel subsequent to the announcement of the government's investigation concerning whether two physicians, who are independent contractors with medical staff privileges at Redding Medical Center, may have performed unnecessary coronary procedures. When filed, these complaints alleged various claims including fraud, conspiracy to commit fraud, unfair and deceptive business practices in violation of California Business & Professions Code section 17200, elder abuse, battery, and intentional infliction of emotional distress. One of the cases also alleged a wrongful death claim. Although the specific claims varied from case to case, the complaints generally alleged that the physician defendants knowingly performed unnecessary coronary procedures on patients and that the Parent and RMC knew or should have known that such unnecessary procedures were being performed. These complaints sought injunctive relief, restitution, disgorgement and compensatory and punitive damages. Because we believed the complaints were without merit, we filed demurrers and motions to strike in response to the complaints. In each case the Court has either sustained the demurrers in their entirety or plaintiffs have voluntarily withdrawn their original complaints. Amended complaints are now being or already have been filed in these cases, and they allege various claims including fraud and conspiracy to commit fraud, breach of fiduciary duty and conspiracy to breach fiduciary duty, intentional infliction of emotional distress and conspiracy to intentionally inflict emotional distress, battery, elder abuse and negligence. The claim for unfair and deceptive business practices in violation of California Business & Professions Code section 17200 has been dropped from all but the California Foundation case. The wrongful death claim also has been dropped. Although the specific claims alleged in the amended complaints once again vary from case to case, they generally allege that the physician defendants knowingly performed unnecessary coronary procedures on patients and that the Parent and RMC knew or should have known that such unnecessary procedures were being performed. We believe the plaintiffs' claims are without merit and have again filed demurrers and motions to strike with respect to the amended complaints. We intend to vigorously defend these actions. We anticipate that additional actions with similar allegations will be filed.
During the period November 2002 to the present, the Parent was also served with several hundred notices of intent to commence civil actions for negligence with respect to allegedly unnecessary cardiac procedures performed at RMC by the non-employed physicians. Several such actions have been filed in California Superior Court in Shasta County and Sacramento County. These cases have not yet been served on the Parent. In addition to claims for professional negligence, the Parent anticipates these cases will also include other tort causes of action, such as battery, fraud and deceit, conspiracy, intentional infliction of emotional distress, negligent supervision and loss of consortium. The complaints in these cases seek compensatory and punitive damages and other relief. We anticipate that additional cases with similar allegations will be filed. Once the complaints are served, we intend to vigorously defend these actions.
UNITED STATES V. TENET HEALTHCARE CORP., ET AL.*
The U.S. Department of Justice, in conjunction with the U.S. Department of Health & Human Services, Office of Inspector General, has been investigating certain hospital billings to Medicare for
22
inpatient stays reimbursed pursuant to diagnosis-related groups ("DRG") 79 (pneumonia), 415 (operating room procedure for infectious and parasitic diseases), 416 (septicemia), and 475 (respiratory system diagnosis with mechanical ventilator). The investigation is believed to have stemmed initially from the government's nationwide pneumonia "upcoding" initiative and focuses on 103 acute care hospitals owned by subsidiaries of the Parent or its predecessors during the period September 1992 through December 1998. On January 9, 2003, the government filed a lawsuit in regard to this matter alleging violations, among other things, of the federal False Claims Act. We will defend ourselves vigorously against the allegations. On March 24, 2003, Parent filed a motion to dismiss the complaint and another motion attacking the government's complaint.
PHARMACEUTICAL PRICING LITIGATION
Included actions:
Since December 2002, the plaintiffs in the cases listed above brought suit against the Parent on behalf of themselves and a purported class of persons who allegedly paid unlawful or unfair prices for prescription drugs or medical products or procedures at hospitals or other medical facilities owned by the Parent and/or its subsidiaries. While the specific allegations vary from case to case, the plaintiffs generally allege that the Parent has engaged in an unlawful scheme to inflate the charges for medical services and procedures, pharmaceutical supplies and other products, and prescription drugs. The complaints primarily allege violations of California's unfair competition statutes (Cal. Bus. & Prof. Code Section 17200, et seq.) and the California Consumers' Legal Remedies Act (Cal. Civ. Code Section 1750). Several of the complaints also allege common law claims such as breach of contract and fraud and equitable claims such as unjust enrichment. Plaintiffs seek to enjoin the Parent from
23
continuing the alleged unfair pricing policies and practices, and to recover all sums wrongfully obtained by those policies and practices, including compensatory damages, punitive damages, restitution, disgorgement of profits, treble damages, and attorneys' fees and costs.
The Parent has not yet filed a responsive pleading in any of these matters. The parties requested that the Judicial Council of California to coordinate the first three actions that were filed (Bishop, Congress of California Seniors and Watson) in a single forum. The Judicial Council assigned the petition for coordination to a Shasta County Superior Court judge for decision. On March 17, 2003, the judge recommended that the three cases subject to the petition be coordinated in Los Angeles County. On March 27, 2003, the Judicial Council followed that recommendation, coordinating the cases and assigning them to Los Angeles County. The parties agree that the remaining cases (which were initiated after the petition for coordination of the first three cases had already been filed with the Judicial Council) also should be coordinated and we intend to file an "add on" request to coordinate those cases as well. We believe the allegations in these coordinated cases are without merit and we intend to vigorously defend them.
In addition, a similar class action (Wade v. Tenet Healthcare Corporation, et al., Case No.Ct-000250-03*) has been filed in Circuit Court in Memphis, Tennessee. The complaint alleges claims of violation of the Tennessee Consumer Protection Act, unjust enrichment, fraudulent concealment, declaratory relief and breach of contract. These claims are based on allegations that Parent excessively inflated its charges for medical products, medical services and prescription drugs at its hospitals. We filed a motion to dismiss the complaint on April 28, 2003. We believe the allegations in this case are without merit and we intend to vigorously defend it.
Finally, on March 31, 2003, Parent was served with a similar action filed in Louisiana. Jordan, et al. v. Tenet Healthcare Corporation, et al., Case No. 591-374, 24th Judicial District, Jefferson Parish, Louisiana.* The class action complaint alleges that the seven hospitals in Louisiana owned by subsidiaries of Parent charged excessive amounts for prescription drugs, medical services and medical products. The complaint alleges causes of action for violation of the Louisiana Unfair Trade Practice and Consumer Protection Law, L.S.A. § 51:1405 and seeks on behalf of the alleged class an accounting, injunctive relief, restitution, compensatory damages and attorneys' fees and costs. A nearly identical action, Wright v. Tenet Healthcare Corporation, Case No. 03-06262, Civil District Court, Orleans Parish, Louisiana, was filed on April 22, 2003. We believe the allegations in these cases are without merit and we intend to vigorously defend them. We anticipate that additional actions with similar allegations will be filed.
United States ex rel. Barbera v. Amisub (North Ridge Hospital), Inc., et al., United States District Court for the Southern District of Florida, Case No. 97-6590-CIV-JORDAN.*
As previously disclosed in our 1998 Form 10-K, this qui tam lawsuit under the False Claims Act, 31 U.S.C. Section 3729 et seq., was filed under seal by a former employee in 1997 after his employment with a subsidiary of the Parent was terminated after six months. The relator's original qui tam action, which was brought against the Parent and various subsidiaries, including the third-tier subsidiary that owns North Ridge Medical Center ("North Ridge"), a hospital located in Fort Lauderdale, Florida, contends that certain physician employment contracts violate (1) the federal anti-kickback statute, 42 U.S.C. Section 1320-7b(b), and (2) the Stark Act, 42 U.S.C. Section 1395nn. The relator also alleges that the Parent and North Ridge submitted improperly coded bills from certain physician practices to the Medicare program that caused them to receive excessive reimbursements.
The government intervened as to the Stark Act claims and also contends that North Ridge's cost reports for fiscal years 1993 through 1997 were false, principally because they improperly included non-reimbursable costs related solely to the physicians' private practices. The government also has brought various state law claims based on the same allegations.
24
The Parent filed answers denying all of the allegations made by the government and the relator. We believe the claims made by the relator and the government are without merit and we intend to vigorously defend this action. The case is set for trial on October 14, 2003.
FRANKLIN FUND LITIGATION
Franklin California Tax Free Income Fund et al. v. OrNda Hospital Corporation, et al., California Superior Court, Los Angeles County, Case No. BC 247479 and Vista Hospital Systems, Inc. v. OrNda Hospital Corporation, et al., California Superior Court, Los Angeles County, Case No. BC 272850.*
This action was filed on March 26, 2001 by ten separate mutual funds that in 1997 purchased $53,160,000 of "certificates of participation" (the "Bonds") issued by the City of San Luis Obispo as a tax-free "conduit" for the benefit of Vista Hospital Systems, Inc. ("Vista"). The Bonds were sold to finance Vista's acquisition of the French Hospital Medical Center from OrNda Hospital Corporation ("OrNda"), one of Parent's subsidiaries.
Plaintiffs assert causes of action for fraud, negligent misrepresentation and violation of the California Corporations Code against Parent, OrNda and Tenet HealthSystem HealthCorp., also a subsidiary (collectively "Defendants"). The claims are essentially based on the allegations that the Defendants provided false and misleading information to Vista and the Plaintiffs about French Hospital and that as a result Vista defaulted on the Bonds and the Plaintiffs suffered damages. The complaint seeks compensatory damages, punitive damages, and fees and costs. Defendants have denied all of the material allegations made by Plaintiffs.
On April 26, 2002, Vista filed its own complaint against Defendants. Following successful demurrers by Defendants, Vista subsequently withdrew certain of the claims and filed a First Amended Complaint alleging causes of action for fraud, negligent misrepresentation, breach of contract and unfair business practices under Section 17200 of the California Business and Professions Code. The allegations made by Vista are similar to those asserted by the Plaintiffs in the Franklin Fund case, except that Vista also asserts a claim for breach of the Stock Purchase Agreement by which OrNda sold the Hospital to Vista. The complaint seeks compensatory and punitive damages, rescission and fees and costs. On October 3, 2002, Defendants filed an Answer denying the material allegations made by Vista and also filed a Cross-Complaint against Vista, alleging causes of action for equitable indemnity, contribution, breach of contract and declaratory relief. Vista has denied the material allegations in the Cross-Complaint.
Both the Vista action and the Franklin Fund action are pending in the same court before the same judge. We believe the allegations in these cases are without merit and intend to vigorously defend these actions. Trial in both cases is set for September 8, 2003.
INVESTIGATIONS
Historically, the Parent and its subsidiaries have received subpoenas and other requests for information relating to a variety of subjects, including physician relationships, actions of certain independent contractors and employers, and other regulatory areas. In the present environment, we expect these historically routine enforcement activities to take on additional importance and for government enforcement activities to intensify.
The following matters represent those of which we are aware and that either could potentially impact a broad base of our operations or may, if adversely determined, have a material impact on our results of operations or financial position.
25
Transfer/DischargeGlobal Investigation*
The U.S. Department of Justice, in conjunction with the U.S. Department of Health & Human Services, Office of Inspector General, currently is investigating certain hospital billings to Medicare for inpatient stays reimbursed under the DRG system during the period from January 1, 1992, to June 30, 2000. The investigation is focusing on the coding of the patients' post-discharge status. The investigation stemmed from the government's nationwide transfer-discharge initiative. We are cooperating with the government regarding this investigation.
Redding Investigation*
On October 30, 2002, agents of the Federal Bureau of Investigation and the U.S. Department of Health & Human Services, Office of Inspector General, served a federal search warrant at Redding Medical Center ("RMC"), a hospital owned by a second-tier subsidiary of the Parent, which hospital is located in Redding, California. According to the affidavit filed in support of the search warrant application, the criminal investigation targets two physicians who are independent contractors with medical staff privileges at RMC and claims that the two physicians may have performed unnecessary invasive coronary procedures. At the same time the RMC search warrant was executed, the government also served search warrants at the medical offices of these two physicians. To date, no charges have been filed against anyone in connection with this matter. The Parent and RMC are cooperating with law enforcement authorities in regard to this investigation. As outlined above, RMC and the Parent also are experiencing a greater than normal level of civil litigation with respect to these physicians at RMC.
Alvarado Investigation*
On December 19, 2002, agents of the IRS and the U.S. Department of Health & Human Services, Office of Inspector General, served federal search warrants at two administrative offices within Alvarado Hospital Medical Center ("Alvarado"), a hospital owned by a second-tier subsidiary of the Parent, which hospital is located in San Diego, California. The searches focused on the offices of the hospital CEO and Director of Business Development. The investigation appears to relate to physician relocation, recruitment and consulting arrangements. To date, no charges have been filed against anyone in this matter. We are cooperating with law enforcement authorities in regard to this investigation.
Outlier Audit*
The Office of Audit Services of the U.S. Department of Health & Human Services is conducting an audit to determine whether outlier payments made to certain hospitals owned by the Parent's subsidiaries were paid in accordance with Medicare laws and regulations. We believe that this audit will demonstrate that those hospitals owned by the Parent's subsidiaries complied with relevant Medicare rules.
Outlier Investigation*
On January 2, 2003, the U.S. Attorney's office for the Central District of California issued an administrative investigative demand subpoena seeking production of documents related to Medicare outlier payments by the Parent and 19 hospitals owned by subsidiaries.
We are cooperating with the Office of Audit Services and the U.S. Attorney's Office, respectively, in regard to both of these investigations.
26
Women's Cancer Center
On or about April 17, 2003, we received an administrative subpoena duces tecum from the U.S. Department of Health and Human Services, Office of Inspector General, seeking documents relating to any agreements with the Women's Cancer Center, a physician's group practicing in the field of gynecologic oncology, and certain physicians affiliated with that group. The subpoena seeks documents from us as well as five subsidiary hospitals: Community Hospital of Los Gatos; Doctors Medical Center of Modesto; San Ramon Regional Medical Center; St. Luke Medical Center in Pasadena (now closed) and Lake Mead Hospital Medical Center.
We are cooperating with the Office of Inspector General in regard to this inquiry.
We cannot presently determine the ultimate resolution of these investigations and lawsuits. Accordingly, the likelihood of a loss, if any, for these matters, cannot be reasonably estimated and we have not recognized in the accompanying consolidated financial statements all of the potential liability that may arise from these matters. If adversely determined, the outcome of these matters could have a material adverse effect on our liquidity, financial position and results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
27
ITEM 5. MARKET PRICE FOR COMPANY'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
MARKET INFORMATION, HOLDERS AND DIVIDENDS
|
Quarters of Year ended May 31, 2001 |
Quarters of Year ended May 31, 2002 |
|
|||||||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Seven Months ended December 31, 2002 |
|||||||||||||||||||||||||||
|
First |
Second |
Third |
Fourth |
First |
Second |
Third |
Fourth |
||||||||||||||||||||
Price Range | ||||||||||||||||||||||||||||
High | $ | 21.79 | $ | 28.96 | $ | 31.33 | $ | 31.83 | $ | 39.26 | $ | 41.85 | $ | 44.27 | $ | 50.30 | $ | 52.50 | ||||||||||
Low | $ | 16.50 | $ | 20.38 | $ | 24.67 | $ | 25.33 | $ | 29.82 | $ | 35.00 | $ | 37.80 | $ | 37.67 | $ | 13.70 |
All periods have been adjusted to reflect a 3-for-2 stock split declared in May 2002 and distributed on June 28, 2002.
At April 30, 2003, there were approximately 9,700 holders of record of the Parent's common stock. The Parent's common stock is listed and traded on the New York Stock Exchange. The stock prices above are the high and low sale prices as reported in the NYSE composite tape for the last two fiscal years and the seven-month period ended December 31, 2002. The Parent has not paid cash dividends to its shareholders since the first quarter of fiscal 1994, nor does it intend to pay cash dividends in the foreseeable future.
Information regarding securities authorized for issuance under equity compensation plans is disclosed on pages 113-114.
28
ITEM 6. SELECTED FINANCIAL DATA
OPERATING RESULTS
In March 2003, our board of directors approved a change in our fiscal year. Instead of a fiscal year ending on May 31, we will now have a fiscal year that coincides with the calendar year, effective December 31, 2002. The following table presents selected audited consolidated financial data for Tenet Healthcare Corporation and its wholly owned and majority-owned subsidiaries for the years ended May 31, 1998 through 2002 and the seven-month transition period ended December 31, 2002. It also presents unaudited, comparable data for the seven months ended December 31, 2001.
|
Years ended May 31 |
Seven months ended December 31 |
|||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
1998 |
1999 |
2000 |
2001 |
2002 |
2001 |
2002 |
||||||||||||||||
|
|
|
|
|
|
(unaudited) |
|
||||||||||||||||
|
(Dollars in Millions, Except Per-Share Amounts) |
||||||||||||||||||||||
Net operating revenues | $ | 9,895 | $ | 10,880 | $ | 11,414 | $ | 12,053 | $ | 13,913 | $ | 7,832 | $ | 8,743 | |||||||||
Operating Expenses: | |||||||||||||||||||||||
Salaries and benefits | 4,052 | 4,412 | 4,508 | 4,680 | 5,346 | 3,012 | 3,327 | ||||||||||||||||
Supplies | 1,375 | 1,525 | 1,595 | 1,677 | 1,960 | 1,092 | 1,245 | ||||||||||||||||
Provision for doubtful accounts | 588 | 743 | 851 | 849 | 986 | 594 | 676 | ||||||||||||||||
Other operating expenses | 2,071 | 2,342 | 2,525 | 2,603 | 2,824 | 1,602 | 1,819 | ||||||||||||||||
Depreciation | 347 | 421 | 411 | 428 | 472 | 273 | 284 | ||||||||||||||||
Goodwill amortization | 90 | 105 | 94 | 99 | 101 | 59 | | ||||||||||||||||
Other amortization | 23 | 30 | 28 | 27 | 31 | 19 | 18 | ||||||||||||||||
Impairment of long-lived assets and restructuring charges | 221 | 363 | 355 | 143 | 99 | 99 | 396 | ||||||||||||||||
Loss from early extinguishment of debt | 189 | | | 56 | 383 | 281 | 4 | ||||||||||||||||
Operating income | 939 | 939 | 1,047 | 1,491 | 1,711 | 801 | 974 | ||||||||||||||||
Interest expense | (464 | ) | (485 | ) | (479 | ) | (456 | ) | (327 | ) | (209 | ) | (147 | ) | |||||||||
Investment earnings | 22 | 27 | 22 | 37 | 32 | 20 | 14 | ||||||||||||||||
Minority interests | (22 | ) | (7 | ) | (21 | ) | (14 | ) | (38 | ) | (22 | ) | (19 | ) | |||||||||
Net gains (losses) on sales of facilities and long-term investments | (17 | ) | | 49 | 28 | | | | |||||||||||||||
Impairment of investment securities | | | | | | | (64 | ) | |||||||||||||||
Income before income taxes | 458 | 474 | 618 | 1,086 | 1,378 | 590 | 758 | ||||||||||||||||
Income taxes | (197 | ) | (225 | ) | (278 | ) | (443 | ) | (593 | ) | (262 | ) | (299 | ) | |||||||||
Income from continuing operations, before discontinued operations and cumulative effect of accounting change | $ | 261 | $ | 249 | $ | 340 | $ | 643 | $ | 785 | $ | 328 | $ | 459 | |||||||||
Basic earnings per common share from continuing operations | $ | 0.57 | $ | 0.53 | $ | 0.73 | $ | 1.34 | $ | 1.60 | $ | 0.67 | $ | 0.95 | |||||||||
Diluted earnings per common share from continuing operations | $ | 0.56 | $ | 0.53 | $ | 0.72 | $ | 1.31 | $ | 1.56 | $ | 0.65 | $ | 0.93 | |||||||||
29
The selected financial data presented in the previous table are not necessarily indicative of our future financial condition or results of operations. Reasons for this include, but are not limited to, future changes in Medicare regulations, our adoption of a new method for calculating Medicare outlier payments effective January 1, 2003, the ultimate resolution of investigations and lawsuits, fluctuations in revenue allowances and discounts and changes in interest rates, tax rates, occupancy levels and patient volumes. Other items include the effects of impairment and restructuring charges, losses from early extinguishment of debt, and acquisitions and disposals of facilities and other assets, all of which have also occurred during all or some of the periods presented in the previous table above.
BALANCE SHEET DATA
|
May 31 |
December 31 |
||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
1998 |
1999 |
2000 |
2001 |
2002 |
2001 |
2002 |
|||||||||||||||
|
|
|
|
|
|
(unaudited) |
|
|||||||||||||||
|
(Dollars in Millions) |
|||||||||||||||||||||
Current assets | 2,890 | 3,962 | 3,594 | 3,226 | 3,394 | 3,339 | 3,792 | |||||||||||||||
Current liabilities | (1,708 | ) | (2,022 | ) | (1,912 | ) | (2,166 | ) | (2,584 | ) | (2,234 | ) | (2,381 | ) | ||||||||
Working capital | $ | 1,182 | $ | 1,940 | $ | 1,682 | $ | 1,060 | $ | 810 | $ | 1,105 | $ | 1,411 | ||||||||
Total assets | 12,774 | 13,771 | 13,161 | 12,995 | 13,814 | 13,550 | 13,780 | |||||||||||||||
Long-term debt, net of current portion | 5,829 | 6,391 | 5,668 | 4,202 | 3,919 | 4,392 | 3,872 | |||||||||||||||
Shareholders' equity | 3,558 | 3,870 | 4,066 | 5,079 | 5,619 | 5,314 | 5,723 |
CASH FLOW DATA
|
Years ended May 31 |
Seven months ended December 31 |
||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
1998 |
1999 |
2000 |
2001 |
2002 |
2001 |
2002 |
|||||||||||||||
|
|
|
|
|
|
(unaudited) |
|
|||||||||||||||
|
(Dollars in Millions) |
|||||||||||||||||||||
Net cash provided by operating activities | $ | 403 | $ | 582 | $ | 869 | $ | 1,818 | $ | 2,315 | $ | 1,113 | $ | 1,126 | ||||||||
Net cash used in investing activities | (1,083 | ) | (1,147 | ) | (36 | ) | (574 | ) | (1,227 | ) | (823 | ) | (389 | ) | ||||||||
Net cash provided by (used in) financing activities | 668 | 571 | (727 | ) | (1,317 | ) | (1,112 | ) | (290 | ) | (565 | ) |
30
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
BUSINESS STRATEGIES & OUTLOOK
OPERATING STRATEGIES
Our mission and objective is to provide quality health care services within existing regulatory and managed-care environments that are responsive to the needs of the communities we serve. We believe that competition among health care providers occurs primarily at the local level. A hospital's competitive position within the geographic area in which it operates is affected by a number of competitive factors, including, but not limited to: the scope, breadth and quality of services a hospital offers to its patients and physicians; the number, quality and specialties of the physicians who refer patients to the hospital; nurses and other health care professionals employed by the hospital or on the hospital's staff; its reputation; its managed-care contracting relationships; the extent to which it is part of an integrated health care delivery system; its location; the location and number of competitive facilities and other health care alternatives; the physical condition of its buildings and improvements; the quality, age and state of the art of its medical equipment; its parking or proximity to public transportation; the length of time it has been a part of the community; and its prices for services. Accordingly, we tailor our local strategies to address these competitive factors.
We adjust these strategies as needed in response to changes in the economic climate in which we operate and the success or failure of our various efforts. Effective January 1, 2003, we adopted a new method for calculating Medicare outlier payments (see page 35); we have restructured our operating divisions and regions; and we have realigned our senior executive management team.
On March 10, 2003, we announced the consolidation of our operating divisions from three to two, with five new underlying regions. Our new Eastern Division will consist of three regionsFlorida, Central-Northeast and Southern States. These regions will initially include 59 of our general hospitals located in Alabama, Arkansas, Florida, Georgia, Louisiana, Massachusetts, Mississippi, Missouri, North Carolina, Pennsylvania, South Carolina and Tennessee. Our new Western Division will consist of two regionsCalifornia and Texasand will initially include 55 of our hospitals located in California, Nebraska, Nevada and Texas.
In March 2003, we also announced a series of initiatives to sharpen our strategic focus, reduce operating expenses, and accelerate repurchases of our common stock.
We plan to divest or consolidate 14 general hospitals that no longer fit our core operating strategy of building competitive networks of quality hospitals in major markets. We intend to use the proceeds from these divestitures to repurchase our common stock and repay indebtedness.
Our operating expense reduction plan consists of (1) staff and expense reductions above the hospital level, as well as reductions in hospital departments that are not directly involved with patient care, (2) leveraging our size and strength to gain cost savings as well as enhanced levels of service through a comprehensive nurse agency contracting program, (3) changes in corporate travel policies, and (4) leveraging our regional strength to reduce the cost of energy procurement. We presently estimate that these plans will result in future savings of approximately $100 million annually.
PRICING APPROACH
In fiscal 2000, certain of our hospitals began to significantly increase gross charges. We believe that this practice, combined with the Medicare-prescribed formula for determining Medicare outlier payments, contributed to those hospitals receiving outlier payments that exceeded the norm. (Medicare outlier payments are described in more detail in the Government Programs section, page 33.
31
Gross charges are retail charges. They are not the same as actual pricing, and they generally do not reflect what a hospital is ultimately paid for providing patient care. Hospitals typically receive amounts that are negotiated by insurance companies or are set by the government. Gross charges are used to calculate Medicare outlier payments and to determine certain elements of managed-care contracts (such as stop-loss payments). And, because Medicare requires a hospital's gross charges to be the same for all patients (regardless of payor category), gross charges are also what hospitals charge self-pay patients.
In early December 2002, we announced a new pricing approach for our hospitals. The new approach de-emphasizes gross charges and refocuses on actual pricing.
We believe our hospitals' pricing practices are, and have been, in compliance with Medicare rules. However, by de-emphasizing gross charges and refocusing on actual pricing, the new pricing approach should create a structure with a larger fixed component. Our new approach includes the following components:
In addition to having a new pricing approach, on January 6, 2003, we announced to the Centers for Medicare and Medicaid Services ("CMS") that we had voluntarily adopted a new method for calculating Medicare outlier payments, retroactive to January 1, 2003. Using this new method, Medicare reimburses our hospitals in amounts equivalent to those amounts we anticipate receiving once the expected changes by CMS to Medicare outlier formulas are implemented. We decided to do this now to demonstrate our good faith and to support CMS's likely industrywide solution to the outlier issue. (See "Outlier Payments" in the Government Programs section, page 33, for further information on developments regarding the expected CMS changes.)
In the past, our hospitals' managed-care contracts were primarily charge-based. Over many years, some of them have evolved into contracts based primarily on negotiated, fixed per diem rates or case rates, combined with stop-loss payments (for high-cost patients) and pass-through payments (for high-cost devices and pharmaceuticals).
Our hospitals have thousands of managed-care contracts with various renewal/expiration dates. A majority of those contracts are "evergreen" contracts. Evergreen contracts extend automatically every year, but may be renegotiated or terminated by either party after 90 to 120 days notice.
In general, our new pricing approach will not involve any broad rollback of charges.
Our new pricing approach is intended to create a reimbursement structure with a larger fixed component that will become less dependent on gross charges. We expect that this new approach will provide a more predictable and sustainable payment structure for us. Although we believe that our new pricing approach will continue to allow for increases in prices and continued growth in net operating revenues in the future, we do not expect that the growth rates experienced in the past two years can be sustained. Additionally, our proposal is new in the industry and may take time to implement. We can offer no assurances that our managed-care contracting parties will agree to the changes we propose or any changes that result in higher prices. Nor can we offer assurances that this new pricing approach, in
32
the form implemented, will not have a material adverse effect on our business, financial condition or results of operations.
OUTLOOK
To address all the changes impacting the health care industry, while continuing to provide quality care to patients, we have implemented strategies to reduce inefficiencies, create synergies, obtain additional business, and control costs. Such strategies include selective acquisitions, sales or closures of certain facilities, the enhancement of integrated health care delivery systems, hospital cost-control programs, and overhead-reduction plans. We may acquire, sell or close some additional facilities and implement additional cost-control programs and other operating efficiencies in the future.
We believe that the key ongoing challenges facing us and the health care industry as a whole are (1) providing quality patient care in a competitive and highly regulated environment, (2) obtaining adequate compensation for the services we provide, and (3) managing our costs. The primary cost pressure facing us and the industry is the ongoing increase of labor costs due to a nationwide shortage of nurses. We expect the nursing shortage to continue, and we have implemented various initiatives to improve productivity, to better position our hospitals to attract and retain qualified nursing personnel, and to otherwise manage labor-cost pressures. In May 2003, we entered into an agreement with the Service Employees International Union and the American Federation of Federal, State, County and Municipal Employees with respect to all of our California hospitals and two hospitals in Florida. The agreement is expected to streamline the contract negotiation process if employees choose to organize into collective bargaining units at a facility. The agreement provides a framework for pre-negotiated salaries and benefits at these hospitals, and includes a no-strike agreement by these organizations at our other facilities for up to three years.
We are also experiencing cost pressure as a result of the sharp increase in professional and general liability insurance costs.
GOVERNMENT PROGRAMS
Payments from Medicare constitute a significant portion of our net operating revenues. The Medicare program is subject to statutory and regulatory changes, administrative rulings, interpretations and determinations, requirements for utilization review, and new governmental funding restrictionsall of which could materially increase or decrease program payments, as well as affect the cost of providing services to patients and the timing of payments to facilities. We are unable to predict the effect of future policy changes on our operations. However, if either the rates paid or scope of services covered by government payors is reduced, there could be a material adverse effect on our business, financial condition, or results of operations.
A final determination of certain amounts earned under the Medicare program often takes many years to resolve because of audits by the program representatives, providers' rights of appeal, and the application of numerous technical reimbursement provisions. We believe that adequate provision has been made in our consolidated financial statements for probable adjustments to historical net operating revenues. However, until final settlement, significant issues remain unresolved, and previously determined allowances could be more or less than ultimately required.
33
The major components of our Medicare net patient revenues for the years ended May 31, 2000, 2001, 2002 and the seven-month periods ended December 31, 2001 and 2002 approximate the following:
|
Years ended May 31 |
Seven Months ended December 31 |
|||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
2000 |
2001 |
2002 |
2001 |
2002 |
||||||||||
|
(Dollars in Millions) |
||||||||||||||
Diagnosis-related-group payments | $ | 1,621 | $ | 1,648 | $ | 1,852 | $ | 991 | $ | 1,091 | |||||
Capital cost payments | 190 | 201 | 244 | 131 | 127 | ||||||||||
Outlier payments | 368 | 570 | 765 | 416 | 495 | ||||||||||
Outpatient payments | 592 | 485 | 559 | 319 | 344 | ||||||||||
Disproportionate share payments | 240 | 257 | 309 | 168 | 190 | ||||||||||
Graduate and Indirect Medical Education payments | 125 | 140 | 164 | 88 | 94 | ||||||||||
Psychiatric, rehabilitation and skilled nursing facilities inpatient payments and other payment categories | 334 | 259 | 371 | 202 | 279 | ||||||||||
Prior years' contractual allowance adjustments | 117 | 9 | 25 | 8 | | ||||||||||
Total Medicare net patient revenues | $ | 3,587 | $ | 3,569 | $ | 4,289 | $ | 2,323 | $ | 2,620 | |||||
DIAGNOSIS-RELATED-GROUP PAYMENTS
Medicare payments for general hospital inpatient services are based on a prospective payment system that uses diagnosis-related groups. Under this system, a hospital receives a fixed amount for each Medicare patient based on the patient's assigned diagnosis-related group. Although these payments are adjusted for area-wage differentials, the adjustments do not take into consideration the hospital's operating costs. Moreover, as discussed below, diagnosis-related-group payments also exclude the reimbursement of capital costs (such as property taxes, lease expenses, depreciation, and interest related to capital expenditures).
The diagnosis-related-group rates are updated annually, giving consideration to the increased cost of goods and services purchased by hospitals. The rate increase that became effective on October 1, 2002 was 2.95 percent. As in prior years, this was below the cost increases for goods and services purchased by our hospitals. We expect that future rate increases will also be below such cost increases.
CAPITAL COST PAYMENTS
Medicare reimburses general hospitals for their capital costs separately from diagnosis-related-group payments. In 1992, a prospective payment system covering the reimbursement of inpatient capital costs generally became effective. As of October 1, 2002, after a gradual phase in, all of our hospitals are being reimbursed at a capital-cost rate that increases annually by a capital-cost-market-basket-update factor. However, as with the diagnosis-related-group rate increases, we expect that these increases will be below the cost increases of our capital asset purchases.
OUTLIER PAYMENTS
Outlier payments, which were established by Congress as part of the diagnosis-related-group prospective payment system, are additional payments made to hospitals for treating patients who are costlier to treat than the average patient.
A hospital receives outlier payments when its costs (as determined using gross charges, adjusted by the hospital's cost-to-charge ratio) exceed a certain threshold established annually by CMS. As mandated by Congress, CMS must limit total outlier payments to between 5 and 6 percent of total
34
diagnosis-related-group payments. CMS periodically changes the threshold in order to bring expected outlier payments within the mandated limit. An increase to the cost threshold reduces total outlier payments by (1) reducing the number of cases that qualify for outlier payments, and (2) reducing the dollar amount hospitals receive for those cases that still qualify. The most recent increase in the threshold became effective on October 1, 2002.
CMS currently uses a hospital's most recently settled cost report to set the hospital's cost-to-charge ratio. Those cost reports are typically two to three years old. Additionally, if a hospital's cost-to-charge ratio falls below a certain threshold (derived from the cost-to-charge ratios for all hospitals nationwide), then the cost-to-charge ratio used to calculate Medicare outlier payments defaults to the statewide average, which is considerably higher. The statewide average is also used when settled cost reports are not available (such as with newly acquired hospitals).
On February 28, 2003, CMS announced that it was proposing three changes to its rules governing the calculation of outlier payments: (1) Medicare would be allowed to use more recent data to calculate outlier payments, (2) the use of the statewide average ratio of costs to charges would be eliminated for hospitals with very low computed cost-to-charge ratios, and (3) Medicare would be allowed to recover overpayments if the actual costs of a hospital stay (which are reflected in the settled cost report) are less than that which was claimed by the provider. We expect these changes to have a material effect on the amount of outlier payments we receive.
In anticipation of these changes, on January 6, 2003, we announced to CMS that we had voluntarily adopted a new method for calculating Medicare outlier payments, retroactive to January 1, 2003. With this new method, instead of using recently settled cost reports for our outlier calculations, we are using current year cost-to-charge ratios. We have also eliminated the use of the statewide average, and we continue to use the current threshold amounts. These two changes have resulted in a drop of Medicare inpatient outlier payments from approximately $65 million per month to approximately $6 million per month. We voluntarily adopted this new method to demonstrate our good faith and to support CMS's likely industrywide solution to the outlier issue.
The proposed new rule is not yet final. Our voluntary proposal to CMS included a provision to reconcile the payments we received under our interim arrangement to those we would have received if the CMS rule had gone into effect on January 1, 2003. This could result in our receiving additional outlier payments, or it could result in our refunding some of the outlier payments recorded under the interim arrangement.
OUTPATIENT PAYMENTS
An outpatient prospective payment system was implemented as of August 1, 2000. This payment system established groups called ambulatory payment classifications for all outpatient procedures. Medicare pays for outpatient services based on the classification. The outpatient prospective payment system provides a transitional period that limits each hospital's losses during the first three and one-half years of the program. If a hospital's costs are less than the payment, the hospital keeps the difference. If a hospital's costs are higher than the payment, the hospital is subsidized for part of the loss. The outpatient prospective payment system has not had a material impact on our results of operations.
DISPROPORTIONATE SHARE PAYMENTS
Certain of our hospitals treat a disproportionately large number of low-income patients (i.e., Medicaid and Medicare patients eligible to receive supplemental Social Security income), and, therefore, receive additional payments from the federal government in the form of disproportionate-share payments. Congress recently mandated CMS to study the present formula used to calculate these payments. One change being considered would give greater weight to the amount of uncompensated
35
care provided by a hospital than it would to the number of low-income patients treated. We cannot predict the impact on our hospitals if CMS revises the formula, however, we do not expect that this change would have a material impact on our results of operations.
GRADUATE AND INDIRECT MEDICAL EDUCATION
Several of our hospitals are currently approved as teaching sites for the training of interns and residents under graduate medical education programs. Our participating hospitals receive additional paymentsgraduate-medical-education paymentsfor the cost of training residents. In addition, these hospitals receive indirect-medical-education payments, which are related to the teaching programs. These payments are add-ons to the regular diagnosis-related-group payments.
The current indirect-medical-education payment level is set at 5.5% of total diagnosis-related-group payments. However, CMS may recommend that the level be reduced to 2.7%. Such a reduction would require Congressional approval. If approved, the change would not become effective until October 1, 2003. Indirect-medical-education payments received by our hospitals for the three years ended May 31, 2000, 2001, 2002 and the seven-month periods ended December 31, 2001 and 2002 were approximately $79 million, $89 million, $110 million, $59 million and $56 million, respectively. If the above reduction is implemented, those payments to our hospitals could be reduced by approximately 50%.
PROPOSED CHANGES TO MEDICARE PAYMENTS
Under the Medicare law, CMS is required to annually update the prospective payments for acute, rehabilitation, and skilled nursing facilities. The updated payments are effective on October 1, the beginning of the federal fiscal year. CMS recently issued proposed rules affecting Medicare payments to acute hospitals, rehabilitation hospitals and units, and skilled nursing facilities. These proposed rules are subject to public comment, and we expect the final regulations to be issued on or about August 1, 2003.
On May 9, 2003, CMS proposed a rule for inpatient acute care that includes a 3.5 percent increase in payment rates, beginning October 1, 2003. Under the proposed rule, the outlier threshold would increase to $50,645, up from $33,560. CMS anticipates that its proposed rules governing outlier payments described above will be finalized during the comment period for the inpatient prospective payments rule, and changes to the outlier payment methodology adopted in that final rule may make it possible to significantly lower the outlier threshold in the final inpatient rule.
In addition, the proposed rules update other payment factors, including the wage index, DRG weights, and other factors that influence the prospective payments. Consequently, the percentage increases described above may not be fully realized in the final payments. We are currently analyzing the impact of all of the proposed changes.
MEDICAID
Payments we receive under various state Medicaid programs constitute approximately 8% of our net patient revenues. These payments are typically based on fixed rates determined by the individual states. (Only two states in which we operate have a Medicaid outlier payment formula.) We also receive disproportionate-share payments under various state Medicaid programs. For the three years ended May 31, 2000, 2001, 2002 and the seven-month periods ended December 31, 2001 and 2002, these payments were approximately $160 million, $161 million, $171 million, $91 million and $104 million, respectively.
Many of the states in which we operate are experiencing serious budgetary problems and have proposed, or are proposing, new legislation that would significantly reduce the payments they make to
36
hospitals under their Medicaid programs. These pending actions could have a material adverse effect on our financial condition and results of operations.
RESULTS OF OPERATIONS
The paragraphs in this section primarily discuss our historical results of operations. However, in light of recent events and our voluntary adoption of a new method for calculating Medicare outlier payments, and the fact that CMS has indicated its intent to change the program's rules regarding Medicare outlier payments, discussed on page 34, we are supplementing certain of the historical information with information presented on an adjusted basis (as if we had received no Medicare outlier revenues during the periods indicated). This adjusted-basis information includes numerical measures of our historical or future performance, financial position or cash flows that have the effect of depicting such measures of financial performance differently from that presented in our financial statements prepared in accordance with generally accepted accounting principles ("GAAP") and are defined under Securities and Exchange Commission rules as "non-GAAP financial measures." We believe that the information on this basis is important to our shareholders in order to show more clearly the significant effect that Medicare inpatient outlier revenue has had on elements of our historical results of operations, without necessarily estimating or suggesting their effect on future results of operations. Among the information presented on an adjusted basis are operating expenses expressed as percentages of net operating revenues, net inpatient revenues per patient day and per admission, net cash provided by operating activities, and EBITDA margins (which we define as the ratio of income from continuing operations before interest net of investment earnings, taxes, depreciation and amortization, and also excluding minority interests, impairment and restructuring charges, loss from early extinguishment of debt and gains or losses from assets sales to net operating revenues). Because costs in our business are largely influenced by volumes and thus generally analyzed as percentages of operating revenues, we provide this additional analytical information to better enable investors to measure expense categories between periods.
EBITDA, which is a non-GAAP financial measure, is commonly used as an analytical indicator within the healthcare industry. We use EBITDA as an analytical indicator for purposes of assessing hospitals' relative performance. EBITDA should not be considered as a measure of financial performance under GAAP, and the items excluded from EBITDA are significant components in understanding and assessing such financial performance. Because EBITDA is not a measurement determined in accordance with GAAP and is thus susceptible to varying calculations, EBITDA as presented may not be comparable to other similarly titled measures of other companies. Investors are encouraged to use GAAP measures when evaluating our performance.
For the seven months ended December 31, 2002, on a same-facility basis, admissions grew 3.5% over the prior-year period, net patient revenues were up 11.2% and net inpatient revenue per admission was up 7.2%.
On a same-facility basis, net patient revenues for the year ended May 31, 2002 improved 13.7%, admissions were up 2.4% and net inpatient revenue per admission improved 12.9% over the prior year. Total company operating margins (the ratio of operating income to net operating revenues) decreased from 12.4% to 12.3%. Net cash provided by operating activities increased by $497 million during the year to $2.32 billion.
We reported income from continuing operations before income taxes of $590 million in the seven months ended December 31, 2001 and pretax income of $758 million in the seven months ended December 31, 2002. We reported income from continuing operations before income taxes of $618 million in fiscal 2000, $1.09 billion in fiscal 2001, and $1.38 billion in fiscal 2002.
The table below shows the pretax and after-tax impact of (1) impairments of long-lived assets, (2) restructuring charges, (3) losses from early extinguishment of debt, (4) goodwill amortization,
37
(5) impairment of investment securities, and (6) net gains on sales of facilities and long-term investments for the years ended May 31, 2000 through 2002 and for the seven months ended December 31, 2001 and 2002:
|
Years ended May 31 |
Seven Months ended December 31 |
||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
2000 |
2001 |
2002 |
2001 |
2002 |
|||||||||||
|
(Dollars in Millions, except Per-Share Amounts) |
|||||||||||||||
(1) Impairment of goodwill and long-lived assets | $ | (244 | ) | $ | (55 | ) | $ | (76 | ) | $ | (76 | ) | $ | (383 | ) | |
(2) Restructuring charges | (111 | ) | (88 | ) | (23 | ) | (23 | ) | (13 | ) | ||||||
(3) Loss from early extinguishment of debt | | (56 | ) | (383 | ) | (281 | ) | (4 | ) | |||||||
(4) Goodwill amortization | (94 | ) | (99 | ) | (101 | ) | (59 | ) | | |||||||
(5) Impairment of investment securities | | | | | (64 | ) | ||||||||||
(6) Net gains on sales of facilities and long-term investments | 49 | 28 | | | | |||||||||||
Pretax impact | $ | (400 | ) | $ | (270 | ) | $ | (583 | ) | $ | (439 | ) | $ | (464 | ) | |
After-tax impact | $ | (315 | ) | $ | (193 | ) | $ | (393 | ) | $ | (293 | ) | $ | (286 | ) | |
Weighted average shares and dilutive securities outstanding (in millions) | 472 | 491 | 503 | 503 | 494 | |||||||||||
Diluted per-share impact of above items | $ | 0.66 | $ | 0.40 | $ | 0.78 | $ | 0.58 | $ | 0.58 | ||||||
Diluted earnings per share | $ | 0.72 | $ | 1.31 | $ | 1.56 | $ | 0.65 | $ | 0.93 | ||||||
Adjusted diluted earnings per share, excluding the effect of items (1) through (6) above | $ | 1.38 | $ | 1.71 | $ | 2.34 | $ | 1.23 | $ | 1.51 | ||||||
Adjusted diluted earnings per share in the above table excludes the effects of certain items that may not relate to the conditions and circumstances of the current operating environment, including differences in accounting policies, portfolio changes and financing actions, as well as the impact of impairment and restructuring charges. It is a metric used by senior management to measure the effectiveness of our operating strategies in the current operating environment and to allow more direct comparisons of operating performance trends between periods. It is not a measure of financial performance under GAAP, and the items excluded from it are significant components in understanding and assessing such financial performance. Because it is not a measure determined in accordance with GAAP, and is thus susceptible to varying calculations, as presented herein it may not be comparable to other similarly titled measures of other companies. Investors are encouraged to use GAAP measures when evaluating our financial performance.
The table below is a reconciliation of operating income to EBITDA and our EBITDA margins for the years ended May 31, 2000 to 2002 and the seven-month periods ended December 31, 2001 and 2002. Operating income is a performance measure under GAAP, whereas EBITDA is not. EBITDA is commonly used as an analytical indicator of operating performance within the healthcare industry. We use EBITDA as an analytical indicator for purposes of assessing hospitals' relative operating performance. EBITDA should not be considered as a measure of financial performance under GAAP, and the items excluded from EBITDA are significant components in understanding and assessing such financial performance. Because EBITDA is not a measurement determined in accordance with GAAP and is thus susceptible to varying calculations, it may not be comparable to other similarly titled
38
measures of other companies. Investors are encouraged to use GAAP measures when evaluating our financial performance.
|
Years ended May 31 |
Seven Months ended December 31 |
|||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
2000 |
2001 |
2002 |
2001 |
2002 |
||||||||||||
|
(Dollars in Millions) |
||||||||||||||||
Net operating revenues | $ | 11,414 | $ | 12,053 | $ | 13,913 | $ | 7,832 | $ | 8,743 | |||||||
Operating income | $ | 1,047 | $ | 1,491 | $ | 1,711 | $ | 801 | $ | 974 | |||||||
Operating margin | 9.2 | % | 12.4 | % | 12.3 | % | 10.2 | % | 11.1 | % | |||||||
Add back to operating income: | |||||||||||||||||
Depreciation | 411 | 428 | 472 | 273 | 284 | ||||||||||||
Amortization | 122 | 126 | 132 | 78 | 18 | ||||||||||||
Impairment and restructuring charges | 355 | 143 | 99 | 99 | 396 | ||||||||||||
Loss from early extinguishment of debt | | 56 | 383 | 281 | 4 | ||||||||||||
EBITDA | $ | 1,935 | $ | 2,244 | $ | 2,797 | $ | 1,532 | $ | 1,676 | |||||||
EBITDA margin | 17.0 | % | 18.6 | % | 20.1 | % | 19.6 | % | 19.2 | % |
The table below is a reconciliation of net operating revenues to adjusted net operating revenues and EBITDA to adjusted EBITDA (as if we had received no Medicare outlier revenue) and our adjusted EBITDA margins for the years ended May 31, 2000 to 2002 and the seven-month periods ended December 31, 2001 and 2002. Net operating revenue is a performance measure under GAAP, whereas adjusted net operating revenue is not. EBITDA is commonly used as an analytical indicator of operating performance within the healthcare industry. We use EBITDA and adjusted EBITDA as analytical indicators for purposes of assessing hospitals' relative operating performance. EBITDA and adjusted EBITDA should not be considered as measures of financial performance under GAAP, and the items excluded from EBITDA and adjusted EBITDA are significant components in understanding and assessing such financial performance. Because EBITDA and adjusted EBITDA are not measurements determined in accordance with GAAP and are thus susceptible to varying calculations, they may not be comparable to other similarly titled measures of other companies. Investors are encouraged to use GAAP measures when evaluating our performance.
|
Years ended May 31 |
Seven Months ended December 31 |
||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
2000 |
2001 |
2002 |
2001 |
2002 |
|||||||||||
|
(Dollars in Millions) |
|||||||||||||||
Net operating revenues | $ | 11,414 | $ | 12,053 | $ | 13,913 | $ | 7,832 | $ | 8,743 | ||||||
Less Medicare outlier revenue | (368 | ) | (570 | ) | (765 | ) | (416 | ) | (495 | ) | ||||||
Adjusted net operating revenues | $ | 11,046 | $ | 11,483 | $ | 13,148 | $ | 7,416 | $ | 8,248 | ||||||
Operating income | $ | 1,047 | $ | 1,491 | $ | 1,711 | $ | 801 | $ | 974 | ||||||
Less Medicare outlier revenue | (368 | ) | (570 | ) | (765 | ) | (416 | ) | (495 | ) | ||||||
Adjusted operating income | $ | 679 | $ | 921 | $ | 946 | $ | 385 | $ | 479 | ||||||
Adjusted operating margin | 6.1 | % | 8.0 | % | 7.2 | % | 5.2 | % | 5.8 | % | ||||||
EBITDA | $ | 1,935 | $ | 2,244 | $ | 2,797 | $ | 1,532 | $ | 1,676 | ||||||
Less Medicare outlier revenue | (368 | ) | (570 | ) | (765 | ) | (416 | ) | (495 | ) | ||||||
Adjusted EBITDA | $ | 1,567 | $ | 1,674 | $ | 2,032 | $ | 1,116 | $ | 1,181 | ||||||
Adjusted EBITDA margin | 14.2 | % | 14.6 | % | 15.5 | % | 15.0 | % | 14.3 | % |
39
Results of operations for the seven months ended December 31, 2002 include the operations of one general hospital acquired after December 31, 2001 and exclude the operations of three general hospitals sold, closed or consolidated and certain other facilities closed since then. Results of operations for the year ended May 31, 2002 include the operations of two general hospitals acquired in 2001, five general hospitals acquired in 2002 and a new 51%-owned general hospital opened after May 31, 2001, and exclude, from the dates of sale or closure, the operations of one general hospital and certain other facilities sold or closed since May 31, 2001. Results of operations for the year ended May 31, 2001 include the operations of one general hospital acquired in 2000 and two general hospitals acquired in 2001 and exclude, from the dates of sale or closure, the operations of one general hospital and certain other facilities sold or closed since May 31, 2000. The following is a summary of consolidated operations for the years ended May 31, 2000 through 2002 and the seven-month periods ended December 31, 2001 and 2002:
|
Years ended May 31 |
Seven Months ended December 31 |
||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
2000 |
2001 |
2002 |
2001 |
2002 |
|||||||||||
|
(Dollars in Millions) |
|||||||||||||||
Net operating revenues: | ||||||||||||||||
Domestic general hospitals | $ | 10,666 | $ | 11,542 | $ | 13,488 | $ | 7,558 | $ | 8,486 | ||||||
Other operations | 748 | 511 | 425 | 274 | 257 | |||||||||||
Net operating revenues | 11,414 | 12,053 | 13,913 | 7,832 | 8,743 | |||||||||||
Operating expenses: | ||||||||||||||||
Salaries and benefits | 4,508 | 4,680 | 5,346 | 3,012 | 3,327 | |||||||||||
Supplies | 1,595 | 1,677 | 1,960 | 1,092 | 1,245 | |||||||||||
Provision for doubtful accounts | 851 | 849 | 986 | 594 | 676 | |||||||||||
Other operating expenses | 2,525 | 2,603 | 2,824 | 1,602 | 1,819 | |||||||||||
Depreciation | 411 | 428 | 472 | 273 | 284 | |||||||||||
Amortization | 122 | 126 | 132 | 78 | 18 | |||||||||||
Operating income before impairment and restructuring charges and loss from early extinguishment of debt | 1,402 | 1,690 | 2,193 | 1,181 | 1,374 | |||||||||||
Impairment and restructuring charges | 355 | 143 | 99 | 99 | 396 | |||||||||||
Loss from early extinguishment of debt | | 56 | 383 | 281 | 4 | |||||||||||
Operating income | $ | 1,047 | $ | 1,491 | $ | 1,711 | $ | 801 | $ | 974 | ||||||
40
|
Years ended May 31 |
Seven Months ended December 31 |
||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|
|
2000 |
2001 |
2002 |
2001 |
2002 |
|||||||
|
(% of Net Operating Revenues) |
|||||||||||
Net operating revenues: | ||||||||||||
Domestic general hospitals(1) | 93.4 | % | 95.8 | % | 96.9 | % | 96.5 | % | 97.1 | % | ||
Other operations(2) | 6.6 | % | 4.2 | % | 3.1 | % | 3.5 | % | 2.9 | % | ||
Net operating revenues | 100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % | ||
Operating expenses: | ||||||||||||
Salaries and benefits | 39.5 | % | 38.8 | % | 38.4 | % | 38.5 | % | 38.1 | % | ||
Supplies | 14.0 | % | 13.9 | % | 14.1 | % | 13.9 | % | 14.2 | % | ||
Provision for doubtful accounts | 7.5 | % | 7.0 | % | 7.1 | % | 7.6 | % | 7.7 | % | ||
Other operating expenses | 22.1 | % | 21.6 | % | 20.3 | % | 20.5 | % | 20.8 | % | ||
Depreciation | 3.6 | % | 3.6 | % | 3.4 | % | 3.5 | % | 3.2 | % | ||
Amortization | 1.0 | % | 1.0 | % | 0.9 | % | 1.0 | % | 0.2 | % | ||
Operating income before impairment and restructuring charges and loss from early extinguishment of debt | 12.3 | % | 14.0 | % | 15.8 | % | 15.1 | % | 15.7 | % | ||
Impairment and restructuring charges | 3.1 | % | 1.2 | % | 0.7 | % | 1.3 | % | 4.5 | % | ||
Loss from early extinguishment of debt | | 0.5 | % | 2.8 | % | 3.6 | % | | ||||
Operating income | 9.2 | % | 12.4 | % | 12.3 | % | 10.2 | % | 11.1 | % | ||
Although our hospitals expect to receive some level of Medicare outlier revenue in future periods, as discussed earlier, the following two tables show a summary of consolidated results of operations for
41
the years ended May 31, 2000 through 2002 and the seven-month periods ended December 31, 2001 and 2002 as if we had received no Medicare outlier revenue during those periods:
|
Years ended May 31 |
Seven Months ended December 31 |
|||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
2000 |
2001 |
2002 |
2001 |
2002 |
||||||||||||
|
(Dollars in Millions) |
||||||||||||||||
Net operating revenues | $ | 11,414 | $ | 12,053 | $ | 13,913 | $ | 7,832 | $ | 8,743 | |||||||
Less Medicare outlier revenue | (368 | ) | (570 | ) | (765 | ) | (416 | ) | (495 | ) | |||||||
Adjusted net operating revenues | $ | 11,046 | $ | 11,483 | $ | 13,148 | $ | 7,416 | $ | 8,248 | |||||||
Operating expenses: | |||||||||||||||||
Salaries and benefits | 4,508 | 4,680 | 5,346 | 3,012 | 3,327 | ||||||||||||
Supplies | 1,595 | 1,677 | 1,960 | 1,092 | 1,245 | ||||||||||||
Provision for doubtful accounts | 851 | 849 | 986 | 594 | 676 | ||||||||||||
Other operating expenses | 2,525 | 2,603 | 2,824 | 1,602 | 1,819 | ||||||||||||
Depreciation | 411 | 428 | 472 | 273 | 284 | ||||||||||||
Amortization | 122 | 126 | 132 | 78 | 18 | ||||||||||||
Adjusted operating income before impairment and restructuring charges and loss from early extinguishment of debt | 1,034 | 1,120 | 1,428 | 765 | 879 | ||||||||||||
Impairment and restructuring charges | 355 | 143 | 99 | 99 | 396 | ||||||||||||
Loss from early extinguishment of debt | | 56 | 383 | 281 | 4 | ||||||||||||
Adjusted operating income | 679 | 921 | 946 | 385 | 479 | ||||||||||||
Add back Medicare outlier revenue | 368 | 570 | 765 | 416 | 495 | ||||||||||||
Operating income | $ | 1,047 | $ | 1,491 | $ | 1,711 | $ | 801 | $ | 974 | |||||||
|
Years ended May 31 |
Seven Months ended December 31 |
||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|
|
2000 |
2001 |
2002 |
2001 |
2002 |
|||||||
|
(% of Net Operating Revenues) |
|||||||||||
Adjusted net operating revenues | 100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % | ||
Operating expenses: | ||||||||||||
Salaries and benefits | 40.8 | % | 40.8 | % | 40.7 | % | 40.6 | % | 40.3 | % | ||
Supplies | 14.4 | % | 14.6 | % | 14.9 | % | 14.7 | % | 15.1 | % | ||
Provision for doubtful accounts | 7.7 | % | 7.4 | % | 7.5 | % | 8.0 | % | 8.2 | % | ||
Other operating expenses | 22.9 | % | 22.7 | % | 21.5 | % | 21.6 | % | 22.1 | % | ||
Depreciation | 3.7 | % | 3.7 | % | 3.6 | % | 3.7 | % | 3.4 | % | ||
Amortization | 1.1 | % | 1.1 | % | 1.0 | % | 1.1 | % | 0.2 | % | ||
Adjusted operating income before impairment and restructuring charges and loss from early extinguishment of debt | 9.4 | % | 9.8 | % | 10.9 | % | 10.3 | % | 10.7 | % | ||
Impairment and restructuring charges | 3.2 | % | 1.2 | % | 0.8 | % | 1.3 | % | 4.8 | % | ||
Loss from early extinguishment of debt | | 0.5 | % | 2.9 | % | 3.8 | % | | ||||
Adjusted operating income | 6.1 | % | 8.0 | % | 7.2 | % | 5.2 | % | 5.8 | % | ||
Medicare outlier revenue | 3.1 | % | 4.4 | % | 5.1 | % | 5.0 | % | 5.3 | % | ||
Operating income | 9.2 | % | 12.4 | % | 12.3 | % | 10.2 | % | 11.1 | % | ||
42
The table below shows certain selected historical operating statistics for our domestic general hospitals:
|
|
|
|
Seven months ended December 31 |
|||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Years ended May 31 |
||||||||||||
|
|
|
Increase (Decrease) |
||||||||||
|
2000 |
2001 |
2002 |
2001 |
2002 |
||||||||
Number of hospitals (at end of period) | 110 | 111 | 116 | 116 | 114 | (2 | )(1) | ||||||
Licensed beds (at end of period) | 26,939 | 27,277 | 28,667 | 28,748 | 27,870 | (3.1 | )% | ||||||
Net inpatient revenues (in millions)(2)(4) | $7,029 | $7,677 | $9,140 | $5,086 | $5,695 | 12.0 | % | ||||||
Net outpatient revenues (in millions)(2) | $3,394 | $3,603 | $4,108 | $2,336 | $2,648 | 13.4 | % | ||||||
Admissions | 936,142 | 939,601 | 1,001,036 | 566,454 | 592,503 | 4.6 | % | ||||||
Equivalent admissions(3) | 1,351,295 | 1,341,138 | 1,429,552 | 813,601 | 842,739 | 3.6 | % | ||||||
Average length of stay (days) | 5.2 | 5.3 | 5.3 | 5.3 | 5.3 | | (1) | ||||||
Patient days | 4,888,649 | 4,936,753 | 5,335,919 | 2,992,929 | 3,144,560 | 5.1 | % | ||||||
Equivalent patient days(3) | 6,975,306 | 6,956,539 | 7,516,306 | 4,240,038 | 4,411,780 | 4.1 | % | ||||||
Utilization of licensed beds | 46.8 | % | 50.0 | % | 51.6 | % | 49.8 | % | 52.4 | % | 2.6 | %(1) | |
Outpatient visits | 9,276,372 | 9,054,117 | 9,320,743 | 5,308,580 | 5,413,841 | 2.0 | % | ||||||
Net inpatient revenue per patient day(4) | $1,438 | $1,555 | $1,713 | $1,699 | $1,811 | 6.6 | % | ||||||
Net inpatient revenue per admission(4) | $7,508 | $8,170 | $9,131 | $8,979 | $9,612 | 7.0 | % |
|
Years ended May 31 |
Seven months ended December 31 |
||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
2000 |
2001 |
2002 |
2001 |
2002 |
Increase |
||||||||||||
|
(Dollars in Millions) |
|||||||||||||||||
Net inpatient revenues | $ | 7,029 | $ | 7,677 | $ | 9,140 | $ | 5,086 | $ | 5,695 | 12.0 | % | ||||||
Less Medicare outlier revenues | (368 | ) | (570 | ) | (765 | ) | (416 | ) | (495 | ) | 19.0 | % | ||||||
Adjusted net inpatient revenues | $ | 6,661 | $ | 7,107 | $ | 8,375 | $ | 4,670 | $ | 5,200 | 11.3 | % | ||||||
Adjusted net inpatient revenue per patient day | $ | 1,363 | $ | 1,440 | $ | 1,570 | $ | 1,560 | $ | 1,654 | 6.0 | % | ||||||
Adjusted net inpatient revenue per admission | $ | 7,115 | $ | 7,564 | $ | 8,366 | $ | 8,244 | $ | 8,776 | 6.5 | % |
43
The table below shows certain selected historical operating statistics for our continuing domestic general hospitals on a same-facility basis as of May 31, 2002 for the years ended May 31, 2001 and 2002, and as of December 31, 2002 for the seven-month periods ended December 31, 2001 and 2002:
|
Years ended May 31 |
Seven months ended December 31 |
|||||||||
---|---|---|---|---|---|---|---|---|---|---|---|
|
2001 |
2002 |
2001 |
2002 |
Increase |
||||||
Average licensed beds | 26,712 | 26,563 | 26,787 | 26,930 | 0.5 | % | |||||
Patient days | 4,891,119 | 5,075,670 | 2,914,978 | 3,039,684 | 4.3 | % | |||||
Admissions | 929,778 | 952,202 | 553,783 | 573,287 | 3.5 | % | |||||
Outpatient visits | 8,963,138 | 8,857,252 | 5,188,184 | 5,244,813 | 1.1 | % | |||||
Average length of stay (days) | 5.3 | 5.3 | 5.3 | 5.3 | | ||||||
Net inpatient revenue per patient day(1) | $1,559 | $1,737 | $1,717 | $1,828 | 6.5 | % | |||||
Net inpatient revenue per admission(1) | $8,201 | $9,259 | $9,040 | $9,693 | 7.2 | % |
|
Years ended May 31 |
Seven months ended December 31 |
|||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
2001 |
2002 |
2001 |
2002 |
Increase |
||||||||||
Net inpatient revenue per patient day | $ | 1,559 | $ | 1,737 | $ | 1,717 | $ | 1,828 | 6.5 | % | |||||
Less Medicare outlier revenue per day | (116 | ) | (145 | ) | (140 | ) | (159 | ) | 13.6 | % | |||||
Adjusted net inpatient revenue per patient day | $ | 1,443 | $ | 1,592 | $ | 1,577 | $ | 1,669 | 5.8 | % | |||||
Net inpatient revenue per admission | 8,201 | 9,259 | 9,040 | 9,693 | 7.2 | % | |||||||||
Less Medicare outlier revenue per admission | (609 | ) | (775 | ) | (740 | ) | (842 | ) | 13.8 | % | |||||
Adjusted net inpatient revenue per admission | 7,592 | 8,484 | 8,300 | 8,851 | 6.6 | % | |||||||||
The table below shows the sources of net patient revenues for our domestic general hospitals, expressed as percentages of net patient revenues from all sources:
|
|
|
|
Seven months ended December 31 |
|||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Years ended May 31 |
||||||||||||
|
|
|
Increase (Decrease)(1) |
||||||||||
|
2000 |
2001 |
2002 |
2001 |
2002 |
||||||||
Medicare | 32.6 | % | 30.8 | % | 31.8 | % | 30.7 | % | 30.7 | % | | ||
Medicaid | 8.3 | % | 8.2 | % | 8.6 | % | 8.1 | % | 8.0 | % | (0.1 | )% | |
Managed care | 40.7 | % | 43.3 | % | 43.9 | % | 43.8 | % | 46.2 | % | 2.4 | % | |
Indemnity and other | 18.4 | % | 17.7 | % | 15.7 | % | 17.4 | % | 15.1 | % | (2.3 | )% |
In comparing the seven-month period ended December 31, 2002 to the same period of 2001, total-facility admissions increased by 4.6%. Total-facility admissions for the year ended May 31, 2002 increased by 6.5% compared to 2001.
On a total-facility basis, net inpatient revenue per admission for the seven-months ended December 31, 2002 increased 7.0%, and on a same-facility basis, it increased by 7.2% over the prior-year period. For the year ended May 31, 2002, on a total-facility basis, this statistic increased 11.8% over the prior year and on a same-facility basis, it increased by 12.9%. Those percentages reflect lower Medicare outlier revenue, offset by changes in payor classes. As mentioned earlier, our new pricing approach, combined with our voluntary changes to the method we use to calculate Medicare outlier payments, and the anticipated change in Medicare regulations for determining outlier payments,
44
are expected to adversely impact our future revenues. For example, if we had received no Medicare outlier revenue, our net inpatient revenue per admission for the seven-month period ended December 31, 2002 would have increased by 6.5% instead of 7.0%. On a same-facility basis, the increase would have been 6.6% instead of 7.2% (see table on page 43 for our explanations of these adjusted performance measures).
Outpatient surgery and outpatient diagnostic procedures continue to increase, while the home health business, which generates lower per-visit revenues, continues to decrease. We experienced a 1.1% increase in same-facility outpatient visits during the seven-month period ended December 31, 2002 compared to the same period a year ago. Net outpatient revenues increased by 13.4% on a total-facility basis and by 11.6% on a same-facility basis compared to the prior-year period. Net outpatient revenues on a total-facility basis increased by 6.2% during the years ended May 31, 2001 compared to 2000 and increased 14.0% during 2002 compared to 2001.
Net operating revenues from the Company's other operations were $274 million and $257 million in the seven-month periods ended December 31, 2001 and 2002, respectively, and $748 million in fiscal 2000, $511 million in fiscal 2001 and $425 million in fiscal 2002. The decreases are primarily the result of terminations and contract expirations of unprofitable physician practices and sales of facilities other than general hospitals.
Salaries and benefits expense as a percentage of net operating revenues was 38.5% in the seven-month period ended December 31, 2001 and 38.1% in the current period. Without outlier revenue the percentages would have been 40.6% and 40.3%. Salaries and benefits expense as a percentage of net operating revenues was 39.5% in the year ended May 31, 2000, 38.8% in 2001 and 38.4% in 2002. Without outlier revenue the percentages would have been 40.8%, 40.8% and 40.7%. (See table on page 42 for our explanations of these adjusted performance measures.) We have experienced and expect to continue to experience significant wage and benefit pressures created by the current nursing shortage throughout the country and escalating state-mandated nurse staffing ratios. Also, we are seeing an increase in labor union activity at our hospitals, particularly in California, in attempts to organize our employees. Approximately 8% of our employees were represented by labor unions as of March 31, 2003. As union activity continues to increase at our hospitals and as additional states enact new laws regarding nurse-staffing ratios, our salaries and benefits expense is likely to increase more rapidly than our net operating revenues. In May 2003, we entered into an agreement with the Service Employees International Union and the American Federation of Federal, State, County and Municipal Employees with respect to all of our California hospitals and two hospitals in Florida. The agreement is expected to streamline the contract negotiation process if employees choose to organize into collective bargaining units at a facility. The agreement provides a framework for pre-negotiated salaries and benefits at these hospitals, and includes a no-strike agreement by these organizations at our other facilities for up to three years.
In March 2003, our board of directors approved a change in accounting for stock options granted to employees and directors from the intrinsic-value method to the fair-value method, as recommended by SFAS No. 123, effective for the new fiscal year ending December 31, 2003. Based on options granted through March 31, 2003, we estimate that this change will increase salaries and benefits expense by approximately $39 million each quarter throughout the 2003 calendar year.
The transition method we have chosen to report this change in accounting is the retroactive-restatement method. As such, future presentations of periods with dates ending prior to January 1, 2003 will be restated to reflect the fair-value method of accounting, as if the change had been effective throughout those earlier periods. For example, the results of operations for the four quarters prior to the change will be restated to reflect additional salaries and benefits expense ranging between $33 million and $37 million each quarter.
45
Supplies expense as a percentage of net operating revenues was 13.9% in the seven-month period ended December 31, 2001 and 14.2% in the current period. Without outlier revenue the percentages would have been 14.7% and 15.1%. (See table on page 42 for our explanations of these adjusted performance measures.). Supplies expense as a percentage of net operating revenues was 14.0% in the year ended May 31, 2000, 13.9% in 2001 and 14.1% in 2002. Without outlier payments the percentages would have been 14.4%, 14.6% and 14.9%. (See table on page 42 for our explanations of these adjusted performance measures.) We control supplies expense through improved utilization and by improving the supply chain process. We also utilize the group-purchasing and supplies-management services of Broadlane, Inc. Broadlane is a 67.3%-owned subsidiary that offers group-purchasing procurement strategy, outsourcing and e-commerce services to the health care industry.
The provision for doubtful accounts as a percentage of net operating revenues was 7.6% in the seven-month period ended December 31, 2001 and 7.7% in the current period. Without outlier revenue the percentages would have been 8.0% and 8.2%. (See table on page 42 for our explanations of these adjusted performance measures.) The provision for doubtful accounts as a percentage of non-program patient revenues (that is, revenues from all sources other than Medicare and Medicaid) was 12.1% in the seven-month period ended December 31, 2001 and 12.4% in the current period. The provision for doubtful accounts as a percentage of net operating revenues was 7.5% in year ended May 31, 2000, 7.0% in 2001 and 7.1% in 2002. Without outlier payments the percentages would have been 7.7%, 7.4% and 7.5%. (See table on page 42 for our explanations of these adjusted performance measures.) We continue to focus on initiatives that improve cash flow, which include improving the process for collecting receivables, pursuing timely payments from all payors, and standardizing and improving contract terms, billing systems and the patient registration process. Accounts receivable days outstanding declined from 68.4 days at May 31, 2001 to 59.7 days at May 31, 2002 and increased to 62.8 days at December 31, 2002.
Other operating expenses as a percentage of net operating revenues were 20.5% for the seven-month period ended December 31, 2001 and 20.8% for the current period. Without outlier revenue the percentages would have been 21.6% and 22.1%. (See table on page 42 for our explanations of these adjusted performance measures.) Other operating expenses as a percentage of net operating revenues were 22.1% in year ended May 31, 2000, 21.6% in 2001 and 20.3% in 2002. Without outlier revenue the percentages would have been 22.9%, 22.7% and 21.5%. (See table on page 42 for our explanations of these adjusted performance measures.) Included in other operating expenses is malpractice expense of $115 million in the seven-month period ended December 31, 2001 and $270 million in the current period. Malpractice expense was $120 million in the year ended May 31, 2000, $144 million in 2001 and $240 million in 2002. We continue to experience unfavorable pricing and availability trends in the professional and general liability insurance markets and increases in the size of claim settlements and awards in this area. We expect this trend to deteriorate further unless meaningful tort reform legislation is enacted. Our current coverage expires on May 31, 2003, but we anticipate having a new insurance program in place by then. We believe our future coverage will be more costly and may require us to assume more of these risks.
The $270 million of malpractice expense for the seven-month period ended December 31, 2002 includes charges of (1) approximately $36 million as a result of lowering the discount rate used from 7.5% to 4.61% at December 31, 2002, (2) $29 million due to an increase in reserves at our majority-owned insurance subsidiaryHospital Underwriting Groupas a result of an increase in the average cost of claims being paid by this subsidiary, and (3) $86 million to increase our self-insured retention reserves which are also due to a significant increase in the average cost of claim settlements and awards. The 7.5% rate was based on our average cost of borrowings. The 4.61% rate is based on a risk-free, Federal Reserve 10-year maturity composite rate for a period that approximates our estimated claims payout period.
46
In addition, the aggregate amount of claims reported to Hospital Underwriting Group for the year ended May 31, 2001 are approaching the $50 million aggregate policy limit for that year. Once the aggregate limit is exhausted for the policy year, we will bear the first $25 million of loss before any excess insurance coverage would apply.
Physicians, including those who practice at some of our hospitals, face similar increases in malpractice insurance premiums and limitations on availability, which could result in lower admissions to our hospitals.
Depreciation expense was $273 million in the seven-month period ended December 31, 2001 and $284 million in the current period. Depreciation and amortization expense was $533 million in the year ended May 31, 2000, $554 million in 2001 and $604 million in 2002. The increases were primarily due to increased capital expenditures, acquisitions, and the opening of new hospitals in fiscal 2001 and 2002.
Goodwill amortization expense was $59 million before taxes in the seven-months ended December 31, 2001. As a result of adopting a new accounting standard for goodwill and other intangible assets, we stopped amortizing goodwill on June 1, 2002.
In addition to the cessation of goodwill amortization, the new accounting standards require initial transition tests for goodwill impairment and call for subsequent impairment tests at least annually. In accordance with the new standards, we completed the initial transitional impairment evaluation by November 30, 2002 and as determined by this initial evaluation a transition impairment charge was not required. Because of the change in our fiscal year-end and recent changes in our business environment, particularly those related to changes in our method of calculating Medicare outlier payments and proposed changes in government policies regarding Medicare outlier payments, we completed an additional goodwill impairment evaluation as of December 31, 2002 and determined that an impairment charge was not required as of that date either. However, because our reporting units (as defined under SFAS No. 142) will change, due to the consolidation of our operating divisions and regions (announced in March and described on page 3), we recorded a goodwill impairment charge of approximately $187 million in March 2003 related to our Central-Northeast Region.
Our estimates of future cash flows from these assets or asset groups were based on assumptions and projections that we believe to be reasonable and supportable. The fair value estimates of our long-lived assets were derived from either independent appraisals, established market values of comparable assets, or internal calculations of estimated future net cash flows.
In March 2003, we announced a plan to dispose of or consolidate 14 general hospitals that no longer fit our core operating strategy of building and maintaining competitive networks of quality hospitals in major markets. Four of the ten general hospitals for which we recorded impairment charges in the seven months ended December 31, 2002 are part of that plan. We recorded additional impairment charges of approximately $61 million in March 2003 as a loss on the disposals of this asset group, primarily for the write-down of long-lived assets and goodwill allocated to these disposed businesses to estimated fair values, less costs to sell, at six of the facilities, using the relative fair-value method. The carrying values of the remaining facilities are less than their estimated fair values.
As previously disclosed, we anticipate selling 11 of the hospitals by the end of the calandar year. We will cease operations at one hospital when the long-term lease expires in August 2003. We plan to sell, consolidate or close two other hospitals. We intend to use the proceeds from the divestitures to repurchase common stock and repay indebtedness. These hospitals reported net operating revenues of $953 million for the 12-month period ended December 31, 2002. The income from operations of the asset group was $105 million for the same period.
We begin our process of determining if our long-lived assets are impaired (other than those related to the elimination of duplicate facilities or excess capacity) by reviewing the historical and projected
47
cash flows of each facility. Facilities whose cash flows are negative and/or trending significantly downward on this basis are selected for further impairment analysis. Future cash flows (undiscounted and without interest charges) for these selected facilities are estimated over the expected useful life of the facility, taking into account patient volumes, our analyses of expected changes in growth rates for revenues and expenses, changes in payor mix, changes in certain managed-care contract terms and the effect of projected reductions in Medicare outlier payments and other Medicare reimbursement and other payor payment patterns, which assumptions vary by type of facility. Over the past several years these factors have caused significant declines in cash flows at certain facilities such that estimated future cash flows were deemed inadequate to recover the carrying values of the related long-lived assets. Continued deterioration of operating results for certain of our physician practices also led to impairment and restructuring charges. Impairment charges have resulted in subsequent minor reductions in depreciation and amortization expense.
In addition to striving to continually improve our portfolio of general hospitals through acquisitions, we, at times, divest hospitals that are not essential to our strategic objectives. For the most part, these facilities are not part of an integrated delivery system. The size and performance of these facilities vary, but on average they are smaller, with lower margins. Such divestitures allow us to concentrate on markets in which we already have a strong presence.
Over the past several years, our subsidiaries have employed or entered into at-risk management agreements with physicians. A significant percentage of these physician practices were acquired as part of large hospital acquisitions or through the formation of integrated health care delivery systems. Many of these physician practices, however, were not profitable. During the latter part of fiscal 1999, we undertook the process of evaluating our physician strategy and began to develop plans to divest, terminate or allow to expire a number of our existing unprofitable physician contracts. During the year ended May 31, 2000, our management, with the authority to do so, authorized the termination, divesture or expiration of the contractual relationships with approximately 50% of our contracted physicians. The termination, divesture or expiration of additional unprofitable physician contracts similarly was authorized in the year ended May 31, 2001. As of May 31, 2002 we had exited most of the unprofitable contracts that management had authorized be terminated or allowed to expire.
In December 2002, we recorded impairment charges of $383 million for the write-down of long-lived assets to their estimated fair values at ten general hospitals, one psychiatric hospital and other properties which represent the lowest level of identifiable cash flows that are independent of other asset-group cash flows. We recognized the impairment of these long-lived assets because events or changes in circumstances indicated that the carrying amount of the assets or groups of assets might not be fully recoverable from estimated future cash flows. The facts and circumstances leading to that conclusion include: (1) our analyses of expected changes in growth rates for revenues and expenses and changes in payor mix, changes in certain managed-care contract terms, and (2) the effect of projected reductions in Medicare outlier payments on net operating revenues and operating cash flows.
The $64 million charge for impairment of investment securities in the seven months ended December 31, 2002 relates to our decision in November 2002 to sell our investment of 8,301,067 shares of common stock in Ventas, Inc. We sold the shares on December 20, 2002 for $86 million. Because the fair value of the shares at November 30, 2002 was less than their cost basis and because we did not expect the fair value of the shares to recover prior to the expected time of sale, we recorded the impairment charge in November 2002.
During the year ended May 31, 2002 we recorded impairment and restructuring charges of $99 million, primarily relating to the planned closure of two general hospitals and the sales of certain other health care businesses. The impairment and restructuring charges included the write-downs of $39 million for property and equipment, $13 million for goodwill and $24 million for other assets. The principal elements of the balance of the charges are $7 million in lease cancellation costs, $5 million in
48
severance costs related to the termination of 691 employees, $2 million in legal costs and settlements and $9 million in other exit costs. We decided to close these hospitals because they were operating at a loss and were not essential to our strategic objectives.
During the seven-month period ended December 31, 2002, we recorded restructuring charges of $13 million primarily for consulting fees and severance and employee relocation costs incurred in connection with changes in our senior executive management team. We expect to incur additional restructuring costs as we move forward with our plans to reduce our operating expenses.
Costs remaining in accrued liabilities at December 31, 2002 for impairment and restructuring charges include $43 million primarily for lease cancellations, $9 million in severance and other related costs, $7 million for unfavorable lease commitments and $4 million in estimated costs to buy out unprofitable physician contracts.
The $143 million of impairment and restructuring charges recorded in the year ended May 31, 2001 included $98 million related to the completion of our program to divest, terminate or allow to expire the unprofitable physician contracts mentioned above. That was the final charge for this program. Additional charges of $45 million were related to asset impairment write-downs for the closure of one hospital and certain other health care businesses. The total charge consists of $55 million in impairment write-downs of property, equipment and other assets to estimated fair values and $88 million for expected cash disbursements related to costs of terminating unprofitable physician contracts, severance costs, lease cancellation and other exit costs. The impairment charge consists of $29 million for the write-down of property and equipment and $26 million for the write-down of other assets. The principal elements of the balance of the charges are $56 million for the buyout of unprofitable physician contracts, $6 million in severance costs related to the termination of 322 employees, $3 million in lease cancellation costs and $23 million in other exit costs.
The $355 million of charges recorded in the year ended May 31, 2000 include $177 million relating to the divestiture or termination of unprofitable physician contracts and $178 million relating to the closure or planned sale of five general hospitals and other property and equipment.
Interest expense, net of capitalized interest, was $209 million in the seven-months ended December 31, 2001 and $147 million in the current period. Interest expense, net of capitalized interest, was $479 million in the year ended May 31, 2000, $456 million in 2001 and $327 million in 2002. The decreases were due to decreases in interest rates and the reduction of debt. From May 31, 2002 to December 31, 2002, we reduced our debt balance by $99 million. During the years ended May 31, 2001 and 2002, we refinanced most of our then-existing publicly traded debt with new publicly traded debt at lower rates, doubling the average maturity of such debt from five years to more than 10 years.
In connection with the refinancing of debt, we recorded extraordinary charges from early extinguishment of debt in the amounts of $56 million in the year ended May 31, 2001 and $383 million in the year ended May 31, 2002 (which includes $281 million in the seven-month period ended December 31, 2001). Under the provisions of Statement of Financial Accounting Standards No. 145, issued by the Financial Accounting Standards Board in April 2002 and adopted by us as of June 1, 2002, these extraordinary charges have been reclassified in the prior periods presented herein on a pretax basis as part of income from continuing operations. The new standard generally eliminates the previous requirement to report gains or losses from early extinguishment of debt as extraordinary items, net of taxes, in the income statement.
Investment earnings were earned primarily from notes receivable and investments in debt and equity securities.
Fluctuations in minority interests are primarily related to the changes in profitability of certain of these majority-owned subsidiaries.
49
The $49 million net gains from sales of facilities and other long-term investments in the year ended May 31, 2000 comprises $50 million in gains on sales of 17 general hospitals, three long-term-care facilities and various other businesses, and $61 million in gains from sales of investments in Internet-related health care ventures, offset by $62 million in net losses from sales of other investments. The $28 million net gains in the year ended May 31, 2001 comprise gains from sales of investments in various health care ventures. There were no such gains or losses in fiscal 2002 or the seven-month periods ended December 31, 2001 and 2002.
Our tax rate before the effect of impairment and restructuring charges and the loss from early extinguishment of debt was 41.2% for the seven months ended December 31, 2001 and 39.0% in the current seven-month period. The tax rates for the years ended May 31, 2000, 2001 and 2002 were 38.4%, 40.2% and 41.3%, respectively. The decline in the tax rates from the 2001 seven-month period to the 2002 seven-month period is primarily due to the cessation of non-deductible goodwill amortization.
LIQUIDITY AND CAPITAL RESOURCES
Our liquidity for the seven-month period ended December 31, 2002 and for the year ended May 31, 2002 was derived primarily from net cash provided by operating activities, proceeds from the sales of new senior notes, and borrowings under our unsecured revolving credit agreement. The revolving credit agreements allow us to borrow, repay and reborrow up to $2.0 billion prior to March 1, 2003 and $1.5 billion prior to March 1, 2006. Our 364-day revolving credit agreement for $500 million expired on February 28, 2003. It was undrawn and was not renewed.
Net cash provided by operating activities for the seven-month periods ended December 31, 2001 and 2002 was $1.1 billion in each period. Net cash provided by operating activities for the years ended May 31, 2000, 2001 and 2002 was $869 million, $1.8 billion and $2.3 billion, respectively. Although our hospitals expect to receive some level of Medicare outlier revenue in future periods, as discussed earlier, if we had received no Medicare outlier revenue during the periods, net cash provided by operating activities would have been $495 million less for the seven months ended December 31, 2002 and $416 million less for the same period a year ago.
During the seven months ended December 31, 2002, proceeds from borrowings under our revolving credit agreements amounted to $1.3 billion. Loan payments under the credit agreements were $1.5 billion.
Cash proceeds from the sale of new 5% Senior Notes were $395 million in the seven months ended December 31, 2002. We used the proceeds to redeem at par the $282 million balance of our 6% Exchangeable Subordinated Notes and to retire existing bank loans under the credit agreements.
In January 2003, we sold $1 billion of new 73/8% Senior Notes due 2013. We used the proceeds to repay indebtedness outstanding under our credit agreements and for general corporate purposes. These new senior notes are unsecured and rank equally with all of our other unsecured senior indebtedness and are redeemable at any time at our option with a redemption premium calculated at the time of redemption. With this transaction and other similar transactions in the past two years, the maturities of $2.6 billion of our long-term debt fall between the fiscal years ending December 31, 2011 and 2013. An additional $450 million is not due until 2031. We have no significant long-term debt that becomes due until March 1, 2006.
We believe that future cash provided by operating activities, the availability of credit under the credit agreement, and, depending on capital market conditions, other borrowings should be adequate to meet known debt service requirements. It should also be adequate to finance planned capital expenditures, acquisitions and other presently known operating needs over the next three years.
50
We are currently involved in significant investigations and legal proceedings. (See Part I. Item 3. Legal Proceedings beginning on page 19 for a description of these matters.) Although we cannot presently determine the timing or the amounts of any potential liabilities resulting from the ultimate resolutions of these investigations and lawsuits, we will incur significant costs in defending them and their outcomes could have a material adverse effect on our liquidity, financial position and results of operations.
During the years ended May 31, 2001 and 2002, we expended $556 million and $4.1 billion, respectively, to purchase $514 million and $3.7 billion principal amounts, respectively, of our senior and senior subordinated notes. The expenditures include payments for premiums and transaction costs.
During the years ended May 31, 2000, 2001 and 2002, we received net proceeds from the sales of facilities, long-term investments and other assets of $764 million, $132 million and $28 million, respectively.
Capital expenditures were $490 million in the seven months ended December 31, 2002, compared to $472 million in the corresponding period in 2001. Capital expenditures were $619 million in the year ended May 31, 2000, $601 million in 2001 and $889 million in 2002. We expect the level of capital expenditures in the near-term future to be somewhat lower. Our capital expenditures primarily relate to the development of integrated health care systems in selected geographic areas focusing on core services such as cardiology, orthopedics and neurosurgery, the design and construction of new buildings, expansion and renovation of existing facilities, equipment and systems additions and replacements, introduction of new medical technologies and various other capital improvements.
During the seven-month periods ended December 31, 2001 and 2002, we spent $324 million and $27 million, respectively, for purchases of new businesses, net of cash acquired. During the years ended May 31, 2000, 2001 and 2002, we spent $38 million, $29 million and $324 million, respectively, for purchases of new businesses, net of cash acquired.
During the year ended May 31, 2002, the Parent's board of directors authorized the repurchase of up to 30 million shares of its common stock to offset the dilutive effect of employee stock option exercises. On July 24, 2002, the board of directors authorized the repurchase of up to an additional 20 million shares of stock, not only to offset the dilutive effect of anticipated employee stock option exercises, but also to enable us to take advantage of opportunistic market conditions. On December 11, 2002, the board of directors authorized the use of net cash flows from operating activities after August 31, 2002, less capital expenditures, plus proceeds from asset sales (which includes the anticipated proceeds from the sales of the general hospitals whose planned divestitures we announced in March 2003) to repurchase up to 30 million shares of Parent's common stock (which includes 13,763,900 shares that remained under the previous authorizations). During the year ended May 31, 2002 and the seven months ended December 31, 2002, we repurchased a total of 36,263,100 shares for approximately $1.2 billion at an average cost of $33.53 per share. Through March 31, 2003, we have repurchased a total of 42,263,100 shares for approximately $1.3 billion at an average cost of $31.36 per share. As of March 31, 2003, we had a cumulative total of $120 million available for future share repurchases, of which amount $98 million was committed to purchase shares under a 10b5-1 plan between April 12 and May 15, 2003. The repurchased shares are held as treasury stock.
We have not purchased, nor do we intend to purchase, any shares from our directors, officers or employees.
At times, we have entered into forward-purchase agreements to repurchase common stock owned by unaffiliated counterparties. On October 29, 2002, we settled all of the then outstanding forward-purchase agreements and have not entered into any forward-purchase agreements since then.
Our growth strategy continues to include the prudent development of integrated health care delivery systems, such as acquiring general hospitals and related health care businesses or joining with
51
others to develop integrated health care delivery networks. These endeavors may be financed by net cash provided by operating activities, available credit under the credit agreement, the sale of assets, the sale of additional debt, or other bank borrowings. As of March 31, 2003, the available credit under our credit agreement was $1.39 billion.
Our existing credit agreement and the indentures governing our senior and senior subordinated notes contain affirmative, negative and financial covenants which have, among other requirements, limitations on (1) liens, (2) consolidations, merger or the sale of all or substantially all assets unless no default exists and, in the case of a consolidation or merger, the surviving entity assumes all of our obligations under the credit agreements, and (3) subsidiary debt. The covenants also provide that we may declare and pay a dividend and purchase our common stock so long as no default exists and our leverage ratio is less than 3.5-to-1. The leverage ratio is defined in the credit agreement as the ratio of our consolidated total debt to consolidated operating income plus the sum of depreciation, amortization, impairment and other unusual charges. This leverage ratio was 1.34 at December 31, 2002. The credit agreement was amended March 1, 2003 to change our leverage covenant from a maximum ratio of 3.0-to-1 to 2.5-to-1. The amendment also requires us to maintain specified levels of net worth ($3.7 billion at December 31, 2002) and a fixed-charge coverage greater than 2.0-to-1. At December 31, 2002, our fixed-charge coverage was 6.3-to-1. We are in compliance with all of our loan covenants.
Our obligations to make future cash payments under contracts (such as debt and lease agreements) and under contingent commitments (such as debt guarantees and standby letters of credit) are summarized in the table below, as of December 31, 2002:
|
|
Years ending December 31 |
|
|||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Total |
2003 |
2004 |
2005 |
2006 |
2007 |
Later Years |
|||||||||||||||
|
(Dollars in Millions |
|||||||||||||||||||||
Long-term debt | $ | 3,941 | $ | 43 | $ | 5 | $ | 25 | $ | 1,384 | $ | 403 | $ | 2,081 | ||||||||
Capital lease obligations | 46 | 4 | 14 | 1 | 1 | 20 | 6 | |||||||||||||||
Long-term operating leases | 790 | 198 | 131 | 100 | 85 | 78 | 198 | |||||||||||||||
Standby letters of credit and guarantees | 169 | 101 | 5 | 3 | 60 | | | |||||||||||||||
Total | $ | 4,946 | $ | 346 | $ | 155 | $ | 129 | $ | 1,530 | $ | 501 | $ | 2,285 | ||||||||
CRITICAL ACCOUNTING POLICIES
In preparing our financial statements in conformity with accounting principles generally accepted in the United States of America, we must use estimates and assumptions that affect the amounts reported in our consolidated financial statements and accompanying notes. We regularly evaluate the accounting policies and estimates we use. In general, we base the estimates on historical experience and on assumptions that we believe to be reasonable, given particular circumstances. Actual results may vary from those estimates.
We consider our critical accounting policies to be those that (1) involve significant judgments and uncertainties, (2) require estimates that are more difficult for management to determine, and (3) may produce materially different outcomes under different conditions or when using different assumptions. Our critical accounting policies cover the following areas:
52
REVENUE RECOGNITION
We recognize net operating revenues in the period in which services are performed. Net operating revenues consist primarily of net patient service revenues that are recorded based on established billing rates (i.e., gross charges), less estimated discounts for contractual allowances (principally for patients covered by Medicare, Medicaid and managed-care and other health plans).
The discounts for Medicare and Medicaid contractual allowances are based primarily on prospective payment systems. Discounts for retrospectively cost-based revenues, which were more prevalent in earlier periods, are estimated based on historical and current factors and are adjusted in future periods when settlements of filed cost reports are received. Final settlements under these programs are subject to adjustment based on administrative review and audit by third parties, which can take several years to resolve completely. Because the laws and regulations governing the Medicare and Medicaid programs are ever-changing and complex, the estimates recorded by the Company could change by material amounts. We record adjustments to our previously recorded contractual allowances in future periods as final settlements of Medicare and Medicaid cost reports are determined. Adjustments related to final settlements increased revenues in each of the years ended May 31, 2000, 2001 and 2002 by $103 million, $4 million and $36 million, respectively, and by $8 million and $5 million in the seven-month periods ended December 31, 2001 and 2002.
Revenues under managed-care health plans are based primarily on payment terms involving predetermined rates per diagnosis, per-diem rates, discounted fee-for-service rates and/or other similar contractual arrangements. These revenues also are subject to review and possible audit by the payors.
Management believes that adequate provision has been made for any adjustments that may result from final determination of amounts earned under all the above arrangements. There are no known material claims, disputes or unsettled matters with any payors that are not adequately provided for in the accompanying consolidated financial statements.
ACCRUALS FOR GENERAL AND PROFESSIONAL LIABILITY RISKS
Through May 31, 2002, we insured substantially all of our professional and comprehensive general liability risks in excess of self-insured retentions through a majority-owned insurance subsidiaryHospital Underwriting Groupunder a mature claims-made policy with a 10-year discovery period. These self-insured retentions were $1 million per occurrence for years ended May 31, 1996 through May 31, 2002, and in prior years varied by hospital and by policy period from $500,000 to $5 million per occurrence. Hospital Underwriting Group's retentions covered the next $2 million per occurrence. Claims in excess of $3 million per occurrence were, in turn, reinsured with major independent insurance companies. Effective June 1, 2002, we formed a new insurance subsidiary. This subsidiary insures these risks under a first-year only claims-made policy, and, in turn, reinsures its risks in excess of $5 million per occurrence with major independent insurance companies. Subsequent to May 31, 2002, our retention limit is $2 million. Our new subsidiary's retention covers the next $3 million.
In addition to the reserves recorded by the above insurance subsidiaries, we maintain reserves based on actuarial estimates by an independent third party for the portion of our professional liability risks, including incurred but not reported claims, for which we do not have insurance coverage. Reserves for losses and related expenses are estimated using expected loss-reporting patterns and are discounted to their present value under a risk-free rate approach using a Federal Reserve 10-year maturity composite rate that corresponds to our claims payout period. There can be no assurance that the ultimate liability will not exceed such estimates. Adjustments to the reserves are included in results of operations in the periods when such amounts are determined. These costs are included in other operating expenses.
53
IMPAIRMENT OF LONG-LIVED ASSETS AND GOODWILL
We evaluate our long-lived assets for possible impairment whenever events or changes in circumstances indicate that the carrying amount of the asset, or related group of assets, may not be recoverable from estimated future cash flows. Measurement of the amount of the impairment, if any, may be based on independent appraisals, established market values of comparable assets or estimates of future net cash flows expected to result from the use and ultimate disposition of the asset. The estimates of these future cash flows are based on assumptions and projections believed by management to be reasonable and supportable. They require management's subjective judgments and take into account assumptions about revenue and expense growth rates. These assumptions may vary by type of facility.
In general, long-lived assets to be disposed of are reported at the lower of their carrying amounts or fair values less costs to sell or close. In such circumstances, our estimates of fair value are usually based on independent appraisals, established market prices for comparable assets or internal calculations of estimated future cash flows.
Goodwill represents the excess of costs over the fair value of assets of businesses acquired. In accordance with Statement of Financial Accounting Standards ("SFAS") No. 142, that we adopted on June 1, 2002, goodwill and other intangible assets acquired in a purchase business combination and determined to have an indefinite useful life are not amortized, but instead are subject to impairment tests performed at least annually. For goodwill, the test is performed at the reporting unit level as defined by SFAS No. 142. If we find the carrying value of goodwill to be impaired, or if the carrying value of a business that is to be sold or otherwise disposed of exceeds its fair value, then we must reduce the carrying value, including any allocated goodwill, to fair value.
ACCOUNTING FOR INCOME TAXES
We account for income taxes under the asset and liability method. This approach requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the carrying amounts and the tax bases of assets and liabilities.
Developing our provision for income taxes and analysis of potential tax exposure items requires significant judgment and expertise in federal and state income tax laws, regulations and strategies, including the determination of deferred tax assets and liabilities and, if necessary, any valuation allowances that may be required for deferred tax assets. Our judgments and tax strategies are subject to audit by various taxing authorities. While we believe we have provided adequately for our income tax liabilities in our consolidated financial statements, adverse determinations by these taxing authorities could have a material adverse effect on our consolidated financial condition and results of operations.
PROVISIONS FOR DOUBTFUL ACCOUNTS
We provide for accounts receivable that could become uncollectible in the future by establishing an allowance to reduce the carrying value of such receivables to their estimated net realizable value. We estimate this allowance based on the aging of our accounts receivable and our historical collection experience by hospital and for each type of payor.
54
ITEM 7A. QUANTITIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
DISCLOSURES ABOUT MARKET RISK
The table below presents information about certain of our market-sensitive financial instruments as of December 31, 2002. The fair values were determined based on quoted market prices for the same or similar instruments. We are exposed to interest rate changes on our variable rate long-term debt. A 1% change in interest rates on that debt would have resulted in changes in net income of approximately $4 million in the seven-month period ended December 31, 2002.
We do not hold or issue derivative instruments for trading purposes and are not a party to any instruments with leverage or prepayment features.
|
Maturity Date, Year ending December 31 |
|
|
||||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
2003 |
2004 |
2005 |
2006 |
2007 |
Thereafter |
Total |
Fair Value |
|||||||||||||||||
Fixed-rate long-term debt | $ | 47 | $ | 19 | $ | 26 | $ | 555 | $ | 423 | $ | 2,087 | $ | 3,157 | $ | 2,812 | |||||||||
Average interest rates | 9.7 | % | 10.9 | % | 8.5 | % | 5.4 | % | 5.3 | % | 6.6 | % | 6.3 | % | | ||||||||||
Variable-rate long-term debt | | | | $ | 830 | | | $ | 830 | $ | 830 | ||||||||||||||
Average interest rates | | | | 2.6 | % | | | 2.6 | % | |
At December 31, 2002, we had no significant long-term, market-sensitive investments. Our market risk associated with our investments in debt securities classified as a current asset is substantially mitigated by the frequent turnover of the portfolio.
We have no affiliation with partnerships, trusts or other entities (sometimes referred to as special-purpose or variable-interest entities) whose purpose is to facilitate off-balance sheet financial transactions or similar arrangements. Thus, we have no exposure to the financing, liquidity, market or credit risks associated with such entities.
55
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF MANAGEMENT
To Our Shareholders:
The management of Tenet Healthcare Corporation (together with its subsidiaries, "Tenet") is responsible for the preparation, integrity and objectivity of Tenet's consolidated financial statements and all other information in this transition report for the seven-month period ended December 31, 2002. The consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America and, accordingly, include certain amounts that are based on management's informed judgment and best estimates.
Tenet maintains a comprehensive system of internal accounting controls to assist management in fulfilling its responsibility for financial reporting. These controls are supported by the careful selection and training of qualified personnel and an appropriate division of responsibilities. Management believes that these controls provide reasonable assurance that assets are safeguarded from loss or unauthorized use and that Tenet's financial records are a reliable basis for preparing the consolidated financial statements.
The audit committee of the board of directors (the "board"), comprised solely of directors who (1) are neither current nor former officers or employees, (2) otherwise meet the independence standards set forth in Tenet's corporate governance principles, and (3) the board has determined are "independent" as that term is defined by the New York Stock Exchange, meets regularly with Tenet's management, internal auditors and independent certified public accountants to review matters relating to financial reporting (including the quality of accounting principles), internal accounting controls and auditing. The independent accountants and the internal auditors report to the audit committee and have direct and confidential access to the audit committee at all times to discuss the results of their audits.
Tenet's independent certified public accountants, selected and engaged by the audit committee of the board, perform periodic audits of the consolidated financial statements of the Company in accordance with auditing standards generally accepted in the United States of America. These standards require a consideration of the system of internal controls and tests of transactions to the extent deemed necessary by the independent certified public accountants for purposes of supporting their opinion as set forth in their independent auditors' report. Their report expresses an independent opinion on the fairness of presentation of the consolidated financial statements.
Stephen D. Farber Chief Financial Officer |
Raymond L. Mathiasen Executive Vice President, Chief Accounting Officer |
56
INDEPENDENT AUDITORS' REPORT
The
Board of Directors and Shareholders
Tenet Healthcare Corporation:
We have audited the accompanying consolidated balance sheets of Tenet Healthcare Corporation and subsidiaries as of May 31, 2001 and 2002 and December 31, 2002, and the related consolidated statements of income, changes in shareholders' equity and cash flows for each of the years in the three-year period ended May 31, 2002 and for the seven-month transition period ended December 31, 2002. In connection with our audits of the consolidated financial statements, we have also audited the consolidated financial statement schedule included in Part IV of the Form 10-K. These consolidated financial statements and consolidated financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and consolidated financial statement schedule based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Tenet Healthcare Corporation and subsidiaries as of May 31, 2001 and 2002 and December 31, 2002, and the results of their operations and their cash flows for each of the years in the three-year period ended May 31, 2002 and for the seven-month transition period ended December 31, 2002, in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the related consolidated financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
As discussed in Note 2H to the consolidated financial statements, effective June 1, 2002, the Company changed its method of accounting for goodwill.
KPMG LLP
Los
Angeles, California
May 14, 2003
57
CONSOLIDATED FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS
Dollars in Millions
|
May 31 |
|
||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|
|
December 31 2002 |
|||||||||||
|
2001 |
2002 |
||||||||||
ASSETS | ||||||||||||
Current assets: | ||||||||||||
Cash and cash equivalents | $ | 62 | $ | 38 | $ | 210 | ||||||
Investments in debt securities | 104 | 100 | 85 | |||||||||
Accounts receivable, less allowance for doubtful accounts ($333 at May 31, 2001; $315 at May 31, 2002; and $350 at December 31, 2002) | 2,386 | 2,425 | 2,590 | |||||||||
Inventories of supplies, at cost | 214 | 231 | 241 | |||||||||
Deferred income taxes | 155 | 199 | 245 | |||||||||
Other current assets | 305 | 401 | 421 | |||||||||
Total current assets | 3,226 | 3,394 | 3,792 | |||||||||
Investments and other assets | 395 | 363 | 185 | |||||||||
Property and equipment, at cost less accumulated depreciation and amortization | 5,976 | 6,585 | 6,359 | |||||||||
Goodwill | 3,265 | 3,289 | 3,260 | |||||||||
Other intangible assets, at cost, less accumulated amortization ($90 at May 31, 2001; $107 at May 31, 2002; and $110 at December 31, 2002) | 133 | 183 | 184 | |||||||||
$ | 12,995 | $ | 13,814 | $ | 13,780 | |||||||
LIABILITIES AND SHAREHOLDERS' EQUITY | ||||||||||||
Current liabilities: | ||||||||||||
Current portion of long-term debt | $ | 25 | $ | 99 | $ | 47 | ||||||
Accounts payable | 775 | 968 | 898 | |||||||||
Accrued compensation and benefits | 476 | 591 | 555 | |||||||||
Accrued interest payable | 132 | 59 | 24 | |||||||||
Income taxes payable | | 34 | 213 | |||||||||
Other current liabilities | 758 | 833 | 644 | |||||||||
Total current liabilities | 2,166 | 2,584 | 2,381 | |||||||||
Long-term debt, net of current portion | 4,202 | 3,919 | 3,872 | |||||||||
Other long-term liabilities and minority interests | 994 | 1,003 | 1,278 | |||||||||
Deferred income taxes | 554 | 689 | 526 | |||||||||
Commitments and contingencies | ||||||||||||
Shareholders' equity: | ||||||||||||
Common stock, $0.05 par value; authorized 1,050,000,000 shares; 493,833,000 shares issued at May 31, 2001, 512,354,001 shares issued at May 31 2002 and 515,633,555 shares issued at December 31, 2002 | 25 | 26 | 26 | |||||||||
Additional paid-in capital | 2,898 | 3,367 | 3,483 | |||||||||
Accumulated other comprehensive loss | (44 | ) | (44 | ) | (15 | ) | ||||||
Retained earnings | 2,270 | 3,055 | 3,514 | |||||||||
Less common stock in treasury, at cost, 5,632,062 at May 31, 2001; 23,812,812 shares at May 31, 2002; 41,895,162 shares at December 31, 2002 | (70 | ) | (785 | ) | (1,285 | ) | ||||||
Total shareholders' equity | 5,079 | 5,619 | 5,723 | |||||||||
$ | 12,995 | $ | 13,814 | $ | 13,780 | |||||||
See accompanying Notes to Consolidated Financial Statements.
58
CONSOLIDATED STATEMENTS OF INCOME
Dollars in Millions, Except Per-Share Amounts
|
Years ended May 31 |
Seven months ended December 31 |
||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
2000 |
2001 |
2002 |
2001 |
2002 |
|||||||||||||
|
|
|
|
(unaudited) |
|
|||||||||||||
Net operating revenues | $ | 11,414 | $ | 12,053 | $ | 13,913 | $ | 7,832 | $ | 8,743 | ||||||||
Operating expenses: | ||||||||||||||||||
Salaries and benefits | 4,508 | 4,680 | 5,346 | 3,012 | 3,327 | |||||||||||||
Supplies | 1,595 | 1,677 | 1,960 | 1,092 | 1,245 | |||||||||||||
Provision for doubtful accounts | 851 | 849 | 986 | 594 | 676 | |||||||||||||
Other operating expenses | 2,525 | 2,603 | 2,824 | 1,602 | 1,819 | |||||||||||||
Depreciation | 411 | 428 | 472 | 273 | 284 | |||||||||||||
Goodwill amortization | 94 | 99 | 101 | 59 | | |||||||||||||
Other amortization | 28 | 27 | 31 | 19 | 18 | |||||||||||||
Impairment of goodwill and long-lived assets and restructuring charges | 355 | 143 | 99 | 99 | 396 | |||||||||||||
Loss from early extinguishment of debt | | 56 | 383 | 281 | 4 | |||||||||||||
Operating income | 1,047 | 1,491 | 1,711 | 801 | 974 | |||||||||||||
Interest expense | (479 | ) | (456 | ) | (327 | ) | (209 | ) | (147 | ) | ||||||||
Investment earnings | 22 | 37 | 32 | 20 | 14 | |||||||||||||
Minority interests | (21 | ) | (14 | ) | (38 | ) | (22 | ) | (19 | ) | ||||||||
Net gains on sales of facilities and long-term investments | 49 | 28 | | | | |||||||||||||
Impairment of investment securities | | | | | (64 | ) | ||||||||||||
Income before income taxes | 618 | 1,086 | 1,378 | 590 | 758 | |||||||||||||
Income taxes | (278 | ) | (443 | ) | (593 | ) | (262 | ) | (299 | ) | ||||||||
Income from continuing operations, before discontinued operations and cumulative effect of accounting change | 340 | 643 | 785 | 328 | 459 | |||||||||||||
Discontinued operations, net of taxes | (19 | ) | | | | | ||||||||||||
Cumulative effect of accounting change, net of taxes | (19 | ) | | | | | ||||||||||||
Net income | $ | 302 | $ | 643 | $ | 785 | $ | 328 | $ | 459 | ||||||||
Earnings (loss) per common share and common equivalent share | ||||||||||||||||||
Basic | ||||||||||||||||||
Continuing operations | $ | 0.73 | $ | 1.34 | $ | 1.60 | $ | 0.67 | $ | 0.95 | ||||||||
Discontinued operations | (0.04 | ) | | | | | ||||||||||||
Cumulative effect of accounting change | (0.04 | ) | | | | | ||||||||||||
$ | 0.65 | $ | 1.34 | $ | 1.60 | $ | 0.67 | $ | 0.95 | |||||||||
Diluted | ||||||||||||||||||
Continuing operations | $ | 0.72 | $ | 1.31 | $ | 1.56 | $ | 0.65 | $ | 0.93 | ||||||||
Discontinued operations | (0.04 | ) | | | | | ||||||||||||
Cumulative effect of accounting change | (0.04 | ) | | | | | ||||||||||||
$ | 0.64 | $ | 1.31 | $ | 1.56 | $ | 0.65 | $ | 0.93 | |||||||||
Weighted average shares and dilutive securities outstanding (in thousands): | ||||||||||||||||||
Basic | 467,970 | 479,621 | 489,717 | 489,046 | 484,877 | |||||||||||||
Diluted | 472,377 | 490,728 | 502,899 | 502,959 | 493,530 |
See accompanying Notes to Consolidated Financial Statements.
59
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
Dollars in Millions, Share Amounts in Thousands
|
Shares Outstanding |
Issued Par Amount |
Additional Paid-in Capital |
Other Comprehensive Income (Loss) |
Retained Earnings |
Treasury Stock |
Total Shareholders' Equity |
||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Balances, May 31, 1999 | 466,536 | $ | 24 | $ | 2,510 | $ | 77 | $ | 1,329 | $ | (70 | ) | $ | 3,870 | |||||||
Net income | 302 | 302 | |||||||||||||||||||
Other comprehensive loss | (147 | ) | (147 | ) | |||||||||||||||||
Issuance of common stock | 1,833 | 20 | 20 | ||||||||||||||||||
Stock options exercised, including tax benefit | 1,821 | 25 | 25 | ||||||||||||||||||
Redemption of shareholder rights | (4 | ) | (4 | ) | |||||||||||||||||
Balances, May 31, 2000 | 470,190 | $ | 24 | $ | 2,555 | $ | (70 | ) | $ | 1,627 | $ | (70 | ) | $ | 4,066 | ||||||
Net income | 643 | 643 | |||||||||||||||||||
Other comprehensive income | 26 | 26 | |||||||||||||||||||
Issuance of common stock | 840 | 1 | 15 | 16 | |||||||||||||||||
Stock options exercised, including tax benefit | 17,171 | 328 | 328 | ||||||||||||||||||
Balances, May 31, 2001 | 488,201 | $ | 25 | $ | 2,898 | $ | (44 | ) | $ | 2,270 | $ | (70 | ) | $ | 5,079 | ||||||
Net income | 785 | 785 | |||||||||||||||||||
Other comprehensive income | | | |||||||||||||||||||
Issuance of common stock | 692 | 21 | 21 | ||||||||||||||||||
Stock options exercised, including tax benefit | 17,829 | 1 | 448 | 449 | |||||||||||||||||
Repurchases of common stock | (18,181 | ) | (715 | ) | (715 | ) | |||||||||||||||
Balances, May 31, 2002 | 488,541 | $ | 26 | $ | 3,367 | $ | (44 | ) | $ | 3,055 | $ | (785 | ) | $ | 5,619 | ||||||
Net income | 459 | 459 | |||||||||||||||||||
Other comprehensive income | 29 | 29 | |||||||||||||||||||
Issuance of common stock | 376 | | 36 | 36 | |||||||||||||||||
Stock options exercised, including tax benefit | 2,903 | | 80 | 80 | |||||||||||||||||
Repurchases of common stock | (18,082 | ) | (500 | ) | (500 | ) | |||||||||||||||
Balances, December 31, 2002 | 473,738 | $ | 26 | $ | 3,483 | $ | (15 | ) | $ | 3,514 | $ | (1,285 | ) | $ | 5,723 | ||||||
See accompanying Notes to Consolidated Financial Statements.
60
CONSOLIDATED STATEMENTS OF CASH FLOWS
Dollars in Millions
|
Years ended May 31 |
Seven months ended December 31 |
||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
2000 |
2001 |
2002 |
2001 |
2002 |
|||||||||||||
|
|
|
|
(unaudited) |
|
|||||||||||||
Net income | $ | 302 | $ | 643 | $ | 785 | $ | 328 | $ | 459 | ||||||||
Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||||||||||||
Depreciation and amortization | 533 | 554 | 604 | 351 | 302 | |||||||||||||
Provision for doubtful accounts | 851 | 849 | 986 | 594 | 676 | |||||||||||||
Impairments and restructuring charges | 355 | 143 | 99 | 99 | 460 | |||||||||||||
Income tax benefit related to stock option exercises | 3 | 74 | 176 | 49 | 37 | |||||||||||||
Deferred income taxes | 2 | 48 | 90 | 19 | (255 | ) | ||||||||||||
Loss from early extinguishment of debt | | 56 | 383 | 281 | 4 | |||||||||||||
Other items | 19 | (1 | ) | 46 | 28 | 44 | ||||||||||||
Increases (decreases) in cash from changes in operating assets and liabilities, net of effects from purchases of new businesses and sales of facilities: | ||||||||||||||||||
Accounts receivable | (1,139 | ) | (735 | ) | (1,075 | ) | (654 | ) | (841 | ) | ||||||||
Inventories of supplies and other current assets | 51 | 45 | (104 | ) | (86 | ) | (26 | ) | ||||||||||
Income taxes payable | 41 | 54 | 51 | 93 | 208 | |||||||||||||
Accounts payable, accrued expenses and other current liabilities | (56 | ) | 237 | 332 | 28 | (195 | ) | |||||||||||
Other long-term liabilities | 17 | (20 | ) | 19 | 16 | 271 | ||||||||||||
Net expenditures for discontinued operations and restructuring charges | (110 | ) | (129 | ) | (77 | ) | (33 | ) | (18 | ) | ||||||||
Net cash provided by operating activities | $ | 869 | $ | 1,818 | $ | 2,315 | $ | 1,113 | $ | 1,126 | ||||||||
Cash flows from investing activities: | ||||||||||||||||||
Purchases of property and equipment | (619 | ) | (601 | ) | (889 | ) | (472 | ) | (490 | ) | ||||||||
Purchases of new businesses, net of cash acquired | (38 | ) | (29 | ) | (324 | ) | (324 | ) | (27 | ) | ||||||||
Proceeds from sales of facilities, long-term investments and other assets | 764 | 132 | 28 | 15 | 6 | |||||||||||||
Other items, including expenditures related to prior-year purchases of new businesses | (143 | ) | (76 | ) | (42 | ) | (42 | ) | 122 | |||||||||
Net cash used in investing activities | (36 | ) | (574 | ) | (1,227 | ) | (823 | ) | (389 | ) | ||||||||
Cash flows from financing activities: | ||||||||||||||||||
Proceeds from borrowings | 1,298 | 992 | 4,394 | 2,883 | 1,332 | |||||||||||||
Sale of new senior notes | | 395 | 2,541 | 1,925 | 395 | |||||||||||||
Repurchases of senior, senior subordinated and exchangeable subordinated notes | | (556 | ) | (4,063 | ) | (3,052 | ) | (282 | ) | |||||||||
Payments of borrowings | (2,085 | ) | (2,389 | ) | (3,513 | ) | (1,907 | ) | (1,551 | ) | ||||||||
Repurchases of common stock | | | (715 | ) | (246 | ) | (500 | ) | ||||||||||
Proceeds from exercise of stock options | 25 | 254 | 273 | 99 | 43 | |||||||||||||
Proceeds from sales of common stock | 20 | 15 | 21 | | 15 | |||||||||||||
Other items | 15 | (28 | ) | (50 | ) | 8 | (17 | ) | ||||||||||
Net cash used in financing activities | (727 | ) | (1,317 | ) | (1,112 | ) | (290 | ) | (565 | ) | ||||||||
Net increase (decrease) in cash and cash equivalents | 106 | (73 | ) | (24 | ) | | 172 | |||||||||||
Cash and cash equivalents at beginning of period | 29 | 135 | 62 | 62 | 38 | |||||||||||||
Cash and cash equivalents at end of period | $ | 135 | $ | 62 | $ | 38 | $ | 62 | $ | 210 | ||||||||
See accompanying Notes to Consolidated Financial Statements.
61
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 BASIS OF PRESENTATION
The accounting and reporting policies of Tenet Healthcare Corporation (together with its subsidiaries referred to as "Tenet," the "Company," "we" or "us") conform to accounting principles generally accepted in the United States of America and prevailing practices for investor-owned entities within the health care industry. The preparation of financial statements in conformity with generally accepted accounting principles requires us to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates.
As previously announced on March 18, 2003, our board of directors approved a change in our fiscal year. Instead of a fiscal year ending on May 31, we will now have a fiscal year that coincides with the calendar year, effective December 31, 2002. As a result of this change, our audited consolidated statements of income, cash flows and changes in shareholders' equity presented herein include the seven-month transition period ended December 31, 2002 and each of the three previous fiscal years ended May 31, 2000, 2001 and 2002. For comparative purposes only, we also include unaudited information for the seven-month period ended December 31, 2001.
Certain prior-year balances in the accompanying consolidated financial statements have been reclassified to conform to the current period's presentation of financial information. These reclassifications have no impact on total assets, liabilities, shareholders' equity, net income or cash flows. Our operating results for the seven-month period ended December 31, 2002 are not necessarily indicative of the results we would have had for a full twelve months. Reasons for this include overall revenue and cost trends, impairment charges, fluctuations in revenue allowances, revenue discounts and quarterly tax rates, the timing and magnitude of price changes, changes in Medicare regulations, our adoption of a new method for calculating Medicare outlier payments effective January 1, 2003, acquisitions and disposals of facilities and other assets, and changes in occupancy levels and patient volumes. Factors that affect patient volumes include seasonal cycles of illness, climate and weather conditions, vacation patterns of hospital patients and their admitting physicians, and other factors related to the timing of elective hospital procedures.
NOTE 2 SIGNIFICANT ACCOUNTING POLICIES
A. THE COMPANY
Tenet is an investor-owned health care services company whose subsidiaries and affiliates (collectively, "subsidiaries") own or operate general hospitals and related health care facilities, and hold investments in other companies (including health care companies). At December 31, 2002, our subsidiaries operated 114 domestic general hospitals serving urban and rural communities in 16 states, with a total of 27,870 licensed beds. They also owned or operated a small number of rehabilitation hospitals, specialty hospitals, long-term-care facilities, a psychiatric facility, and medical office buildingsall of which are located on, or nearby, one of our general hospital campuses; a general hospital and related health care facilities in Barcelona, Spain; physician practices; and various other ancillary health care businesses (including outpatient surgery centers, home health care agencies, occupational and rural health care clinics, and health maintenance organizations).
At December 31, 2002, our largest concentrations of hospital beds were in California with 30.0%, Florida with 16.8% and Texas with 12.6%. These high concentrations increase the risk that, should any adverse economic, regulatory or other such development occur within these states, our business, results of operations, or financial position could be adversely affected.
62
We are also subject to changes in government legislation that could impact Medicare and Medicaid payment levels, and to increased levels of managed-care penetration and changes in payor patterns that may impact the level and timing of payments for services rendered.
B. PRINCIPLES OF CONSOLIDATION
Our consolidated financial statements include the accounts of Tenet Healthcare Corporation and its wholly owned and majority-owned subsidiaries. Generally, we account for significant investments in other affiliated companies using the equity method. We eliminate intercompany accounts and transactions in consolidation, and we include the results of operations of businesses that are newly acquired in purchase transactions from their dates of acquisition.
C. NET OPERATING REVENUES
We recognize net operating revenues in the period in which services are performed. Net operating revenues consist primarily of net patient service revenues that are recorded based on established billing rates (gross charges), less estimated discounts for contractual allowances (principally for patients covered by Medicare, Medicaid and managed-care and other health plans).
Gross charges are retail charges. They are not the same as actual pricing, and they generally do not reflect what a hospital is ultimately paid and therefore are not displayed in our consolidated statements of income. Hospitals are typically paid amounts that are negotiated with insurance companies or are set by the government. Gross charges are used to calculate Medicare outlier payments and to determine certain elements of managed-care contracts (such as stop-loss payments). And, because Medicare requires that a hospital's gross charges be the same for all patients (regardless of payor category), gross charges are also what hospitals charge self-pay patients.
Percentages of consolidated net patient revenues, by payor type, for Tenet's domestic general hospitals for the past three fiscal years and the seven-month periods ended December 31, 2001 and 2002 are shown in the table below:
|
Years ended May 31 |
Seven Months ended December 31 |
|||||||||
---|---|---|---|---|---|---|---|---|---|---|---|
|
2000 |
2001 |
2002 |
2001 |
2002 |
||||||
|
|
|
|
(unaudited) |
|
||||||
Medicare | 32.6 | % | 30.8 | % | 31.8 | % | 30.7 | % | 30.7 | % | |
Medicaid | 8.3 | % | 8.2 | % | 8.6 | % | 8.1 | % | 8.0 | % | |
Managed care | 40.7 | % | 43.3 | % | 43.9 | % | 43.8 | % | 46.2 | % | |
Indemnity and other | 18.4 | % | 17.7 | % | 15.7 | % | 17.4 | % | 15.1 | % |
We recorded approximately $368 million, $570 million and $765 million of revenues related to Medicare outliers in the years ended May 31, 2000, 2001 and 2002, respectively. For the seven-month periods ended December 31, 2001 and 2002, we recorded $416 million and $495 million, respectively. These amounts represent approximately 10.3%, 16.0% and 17.8% of Medicare revenues and approximately 3.2%, 4.7% and 5.5% of total net operating revenues for fiscal 2000, 2001 and 2002, respectively, and approximately 17.9% and 18.9% of Medicare revenues and approximately 5.3% and 5.7% of total net operating revenues for the seven-month periods ended December 31, 2001 and 2002, respectively. On February 28, 2003, Centers for Medicare and Medicaid Services ("CMS") announced a proposed rule that would substantially change the methodology used to determine outlier payments. In addition, CMS increased the outlier cost threshold effective October 1, 2002, which will reduce the number of cases that qualify for outlier payments and the amount of payments for outlier cases that continue to qualify. In anticipation of these changes, on January 6, 2003, we announced to CMS that we had voluntarily adopted a new method for calculating Medicare outlier payments, retroactive to
63
January 1, 2003. With this new method, instead of using recently settled cost reports for our outlier calculations, we are using current year cost-to-charge ratios. We have also eliminated the use of the statewide average, and we continue to use the current threshold amounts. These two changes have resulted in a drop of Medicare inpatient outlier payments from approximately $65 million per month to approximately $6 million per month. We voluntarily adopted this new method to demonstrate our good faith and to support CMS's likely industrywide solution to the outlier issue.
The discounts for Medicare and Medicaid contractual allowances are based primarily on prospective payment systems. Discounts are estimated based on historical and current factors. Before final settlement of cost reports, claims are subjected to administrative reviews and audits by third parties. This process can take several years to complete. Because the laws and regulations governing the Medicare and Medicaid programs are ever-changing and complex, our recorded estimates could change by material amounts. We record adjustments to our previously recorded contractual allowances as final settlements are determined.
Adjustments related to final settlements of Medicare and Medicaid cost reports increased revenues in each of the years ended May 31, 2000, 2001 and 2002 by $103 million, $4 million and $36 million, respectively, and by $8 million and $5 million in the seven-month periods ended December 31, 2001 and 2002, respectively.
Our revenues under managed-care health plans are determined primarily on payment terms involving predetermined rates per diagnosis, per-diem rates, discounted fee-for-service rates and other similar contractual arrangements combined with stop-loss payments (for high-cost patients) and pass-through payments (for high-cost devices and pharmaceuticals). These revenues also are subject to review and possible audit by the payors.
We believe that we have made adequate provision for any adjustments that may result from final determination of amounts earned under all the above arrangements. We know of no material claims, disputes or unsettled matters with any payors for which we have not adequately provided for in the accompanying consolidated financial statements.
We provide care without charge, or at rates substantially lower than our established billing rates, to patients who meet certain financial or economic criteria. Because we do not pursue collection of amounts determined to qualify as charity care, we do not report them in net operating revenues or in operating expenses.
The approximate amounts of charges foregone under our charity policy for the years ended May 31, 2000 through May 31, 2002 and for the seven-month periods ended December 31, 2001 and December 31, 2002 are shown in the following table (unaudited and in millions):
Years ended May 31: | |||||
2000 | $ | 285 | |||
2001 | $ | 556 | |||
2002 | $ | 733 | |||
Seven months ended December 31: |
|||||
2001 | $ | 390 | |||
2002 | $ | 591 |
D. CASH EQUIVALENTS
We treat highly liquid investments with original maturities of three months or less as cash equivalents. Cash equivalents were less than $50 million at May 31, 2001 and 2002 and were approximately $181 million at December 31, 2002.
64
E. INVESTMENTS IN DEBT AND EQUITY SECURITIES
We classify investments in debt and equity securities as either available-for-sale, held-to-maturity or as part of a trading portfolio. At May 31, 2001 and 2002 and at December 31, 2002, we had no significant investments in securities classified as either held-to-maturity or trading. We carry securities classified as available-for-sale at fair value if unrestricted. We report their unrealized gains and losses, net of taxes, as accumulated other comprehensive income (loss) unless we determine that a loss is other than temporary, at which point we would record a realized loss in the statement of income. We include realized gains or losses in net income on the specific identification method.
F. PROVISION FOR DOUBTFUL ACCOUNTS
We provide for accounts receivable that could become uncollectible in the future by establishing an allowance to reduce the carrying value of such receivables to their estimated net realizable value. We estimate this allowance based on the aging of our accounts receivable and our historical collection experience by hospital and by each type of payor.
G. PROPERTY AND EQUIPMENT
We use the straight-line method of depreciation for buildings, building improvements and equipment. The estimated useful lives for buildings and improvements is primarily 25 to 40 years, and for equipment, 3 to 15 years. We record capital leases at the beginning of the lease term as assets and liabilities. The value recorded is the lower of either the present value of the minimum lease payments or the fair value of the asset. Such assets, including improvements, are amortized over the shorter of either the lease term or the estimated useful life. Interest costs related to construction projects are capitalized. In the years ended May 31, 2000, 2001 and 2002, capitalized interest was $29 million, $8 million and $9 million, respectively. In the seven months ended December 31, 2002 it was $4 million.
In accordance with Statement of Financial Accounting Standards ("SFAS") No. 144, which we adopted on June 1, 2002, we evaluate our long-lived assets for possible impairment whenever circumstances indicate that the carrying amount of the asset, or related group of assets, may not be recoverable from estimated future cash flows. Fair value estimates are derived from independent appraisals, established market values of comparable assets, or internal calculations of estimated future net cash flows. Our estimates of future cash flows are based on assumptions and projections we believe to be reasonable and supportable. Our assumptions take into account revenue and expense growth rates, patient volumes, changes in payor mix, and changes in legislation and other payor payment patterns. These assumptions vary by type of facility.
In general, we report long-lived assets to be disposed of at the lower of either their carrying amounts or their fair values less costs to sell or close. In such circumstances, our estimates of fair value are usually based on independent appraisals, established market prices for comparable assets or internal calculations of estimated future cash flows.
H. GOODWILL AND OTHER INTANGIBLE ASSETS
Goodwill represents the excess of costs over the fair value of assets of businesses acquired. In accordance with SFAS No. 142, which we adopted on June 1, 2002, goodwill and other intangible assets acquired in a purchase business combination and determined to have an indefinite useful life are not amortized, but instead are subject to impairment tests performed at least annually. For goodwill, the test is performed at the reporting unit level as defined by SFAS No. 142. If we find the carrying value of goodwill to be impaired, or if the carrying value of a business that is to be sold or otherwise disposed of exceeds its fair value, then we must reduce the carrying value, including any allocated goodwill, to fair value.
65
Prior to our adoption of the new standard, we amortized goodwill on a straight-line basis, primarily over 40 years.
I. ACCRUAL FOR GENERAL AND PROFESSIONAL LIABILITY RISKS
We maintain reserves, which are based on actuarial estimates by an independent third party, for the portion of our professional liability risks, including incurred but not reported claims, to the extent we do not have insurance coverage. We estimate reserves for losses and related expenses using expected loss-reporting patterns. Reserves are discounted to their estimated present value under a risk-free rate approach using a Federal Reserve 10-year maturity composite rate that approximates our claims payout period. There can be no assurance that the ultimate liability will not exceed our estimates. Adjustments to the estimated reserves in our results of operations are recorded in the periods when such amounts are determined.
J. INCOME TAXES
We account for income taxes using the asset-and-liability method. This approach requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the carrying amounts and the tax bases of assets and liabilities.
Developing our provision for income taxes requires significant judgment and expertise in federal and state income tax laws, regulations and strategies. That includes expertise determining deferred tax assets and liabilities and, if necessary, any valuation allowances that may be required for deferred tax assets. Our judgments and tax strategies are subject to audit by various taxing authorities. While we believe we have provided adequately for our income tax liabilities, determinations by these taxing authorities could have a material adverse effect on our consolidated financial position and results of operations.
K. STOCK OPTIONS
Through December 31, 2002, we applied the intrinsic-value-based method of accounting, prescribed by Accounting Principles Board Opinion No. 25, and its related interpretations (including FASB Interpretation No. 44, an interpretation of APB No. 25 issued in March 2000), to our stock-based compensation plans. In accordance with that method, no compensation cost was recognized for stock options granted to employees or directors under the plans through that date because the exercise prices for options granted were equal to the quoted market prices on the option grant dates.
In March 2003, we adopted Statement of Accounting Standards No. 123. The new policy had a retroactive effective date of January 1, 2003 (the first day of our new fiscal year). The accounting statement establishes a fair-value method of accounting for stock-based compensation plans (i.e., compensation costs will be based on the fair value of stock options granted). We also adopted the retroactive-restatement method to transition from the former accounting standard to the new one.
We have adopted, as of December 31, 2002, the disclosure only provisions of SFAS No. 123 for options issued, as amended by SFAS No. 148. Had compensation cost for the options we granted to our
66
employees and directors been determined based on the fair values at the grant dates, our net income and earnings per share would have been the amounts indicated below:
|
Years ended May 31, |
Seven Months ended December 31, 2002 |
||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
2000 |
2001 |
2002 |
|||||||||||
|
(dollars in millions, except per share amounts) |
|||||||||||||
Net income: | ||||||||||||||
As reported | $ | 302 | $ | 643 | $ | 785 | $ | 459 | ||||||
Add: stock-based employee compensation expense included in reported net income, net of related tax effects | | | | | ||||||||||
Deduct: Total stock-based employee compensation expense determined under fair valued-based method for all awards, net of tax effects | (57 | ) | (61 | ) | (82 | ) | (50 | ) | ||||||
Pro forma | $ | 245 | $ | 582 | $ | 703 | $ | 409 | ||||||
Basic earnings per common share: | ||||||||||||||
As reported | $ | 0.65 | $ | 1.34 | $ | 1.60 | $ | 0.95 | ||||||
Pro forma | $ | 0.53 | $ | 1.22 | $ | 1.44 | $ | 0.85 | ||||||
Diluted earnings per common share: |
||||||||||||||
As reported | $ | 0.64 | $ | 1.31 | $ | 1.56 | $ | 0.93 | ||||||
Pro forma | $ | 0.53 | $ | 1.19 | $ | 1.41 | $ | 0.83 |
The estimated weighted-average fair values of options we granted in the years ended May 31, 2000, 2001 and 2002 and the seven-month period ended December 31, 2002 were $5.47, $14.01, $18.45 and $9.09, respectively. These were calculated, as of the date of each grant, using a Black-Scholes option-pricing model with the following weighted-average assumptions:
|
May 31 |
|
|||||||
---|---|---|---|---|---|---|---|---|---|
|
December 31 2002 |
||||||||
|
2000 |
2001 |
2002 |
||||||
Expected volatility | 36.0 | % | 39.0 | % | 39.9 | % | 50.6 | % | |
Risk-free interest rates | 5.9 | % | 5.4 | % | 4.5 | % | 3.5 | % | |
Expected lives, in years | 6.6 | 7.0 | 6.8 | 5.5 | |||||
Expected dividend yield | 0.0 | % | 0.0 | % | 0.0 | % | 0.0 | % |
Expected volatility is derived using daily data drawn from the five years preceding the date of grant. The risk-free interest rate is the approximate yield on 7-year and 10-year United States Treasury Bonds on the date of grant. The expected life is an estimate of the number of years the option will be held before it is exercised. The valuation model was not adjusted for nontransferability, risk of forfeiture, or the vesting restrictions of the optionsall of which would reduce the value if factored into the calculation.
L. SEGMENT REPORTING
We operate in one line of business: the provision of health care through general hospitals and related health care facilities. Our domestic general hospitals generated 93.4%, 95.8% and 96.9% of our net operating revenues in the years ended May 31, 2000, 2001 and 2002, respectively, and 97.1% in the seven-month period ended December 31, 2002.
Through March 10, 2003, we had organized these general hospitals and our other health care related facilities into three operating segments or divisions. Subsequently, we consolidated into two
67
divisions. The divisions' economic characteristics, the nature of their operations, the regulatory environment in which they operate and the manner in which they are managed are all similar. These divisions share certain resources and they benefit from many common clinical and management practices. Accordingly, we aggregate these divisions into a single reportable operating segment, as that term is defined by Statement of Financial Accounting Standards No. 131.
NOTE 3 GOODWILL AND OTHER INTANGIBLE ASSETS
As of June 1, 2002, we adopted SFAS No. 142. Among the changes implemented by this new accounting standard is the cessation of amortization of goodwill and other intangible assets having indefinite useful lives. This change applies to the periods following the date of adoption.
The table below shows our income from continuing operations and net income for the seven months ended December 31, 2002 and the comparative pro forma amounts for the seven months ended December 31, 2001 and the years ended May 31, 2000, 2001 and 2002 as if the cessation of goodwill amortization had occurred as of June 1, 1999:
|
Years ended May 31 |
Seven months ended December 31 |
|||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
2000 |
2001 |
2002 |
2001 |
2002 |
||||||||||
|
(Dollars in Millions, except Per-Share Amounts) |
||||||||||||||
|
|
|
|
(unaudited) |
|
||||||||||
Income from continuing operations, as reported | $ | 340 | $ | 643 | $ | 785 | $ | 328 | $ | 459 | |||||
Goodwill amortization, net of applicable income tax benefits | 84 | 86 | 86 | 50 | | ||||||||||
Pro forma income from continuing operations | $ | 424 | $ | 729 | $ | 871 | $ | 378 | $ | 459 | |||||
Net income, as reported |
$ |
302 |
$ |
643 |
$ |
785 |
$ |
328 |
$ |
459 |
|||||
Goodwill amortization, net of applicable income tax benefits | 84 | 86 | 86 | 50 | | ||||||||||
Pro forma net income | $ | 386 | $ | 729 | $ | 871 | $ | 378 | $ | 459 | |||||
Diluted Earnings Per Common and Common Equivalent Share: |
|||||||||||||||
Continuing operations, as reported | $ | 0.72 | $ | 1.31 | $ | 1.56 | $ | 0.65 | $ | 0.93 | |||||
Goodwill amortization, net of applicable income tax benefits | 0.17 | 0.17 | 0.17 | 0.10 | | ||||||||||
Pro forma continuing operations | $ | 0.89 | $ | 1.48 | $ | 1.73 | $ | 0.75 | $ | 0.93 | |||||
Net income, as reported |
$ |
0.64 |
$ |
1.31 |
$ |
1.56 |
$ |
0.65 |
$ |
0.93 |
|||||
Goodwill amortization, net of applicable income tax benefits | 0.17 | 0.17 | 0.17 | 0.10 | | ||||||||||
Pro forma net income | $ | 0.81 | $ | 1.48 | $ | 1.73 | $ | 0.75 | $ | 0.93 | |||||
In accordance with SFAS No. 142, we completed our initial transitional impairment evaluation in the fiscal quarter ended November 30, 2002. As determined by this evaluation, we did not need to record an impairment charge. Because of recent changes in our business environment, particularly those related to changes in our method of calculating Medicare outlier payments and proposed changes in government policies regarding Medicare outlier payments, we completed an additional goodwill impairment evaluation as of December 31, 2002 and determined that we did not need to record an impairment charge as of that date either.
On March 10, 2003, we announced the consolidation of our operating divisions from three to two. Our new Eastern Division will consist of three regionsFlorida, Central-Northeast and Southern States. These regions will initially include 59 of our general hospitals located in Alabama, Arkansas, Florida, Georgia, Louisiana, Massachusetts, Mississippi, Missouri, North Carolina, Pennsylvania, South
68
Carolina and Tennessee. Our new Western Division will consist of two regionsCalifornia and Texasand will initially include 55 of our hospitals located in California, Nebraska, Nevada and Texas.
Because of the restructuring of our operating divisions and regions, along with a realignment of our executive management team and other factors, our goodwill "reporting units" (as defined under SFAS No. 142) have changed. Prior to the restructuring, they consisted of our three divisions; now they consist of our five new regions. Because of this change in reporting units, we performed another goodwill impairment evaluation, at March 31, 2003 resulting in a goodwill impairment charge of approximately $187 million related to our Central-Northeast Region.
NOTE 4 IMPAIRMENT OF LONG-LIVED ASSETS AND RESTRUCTURING CHARGES
In accordance with SFAS No. 144, in the seven-month period ended December 31, 2002, we recorded impairment charges of $383 million for the write-down of long-lived assets to their estimated fair values at ten general hospitals, one psychiatric hospital and other properties which represent the lowest level of identifiable cash flows that are independent of other asset-group cash flows. We recognized the impairment of these long-lived assets because events or changes in circumstances indicated that the carrying amount of the assets or groups of assets might not be fully recoverable from estimated future cash flows. The facts and circumstances leading to that conclusion include: (1) our analyses of expected changes in growth rates for revenues and expenses and changes in payor mix, changes in certain managed-care contract terms, and (2) the effect of projected reductions in Medicare outlier payments on net operating revenues and operating cash flows.
Our estimates of future cash flows from these assets or asset groups were based on assumptions and projections that we believe to be reasonable and supportable. The fair value estimates of our long-lived assets were derived from either independent appraisals, established market values of comparable assets, or internal calculations of estimated future net cash flows.
During the seven-month period ended December 31, 2002, we recorded restructuring charges of $13 million. The charges consist primarily of consulting fees and severance and employee relocation costs incurred in connection with changes in our senior executive management team. We expect to incur additional restructuring costs as we move forward with our plans to reduce our operating expenses.
YEAR ENDED MAY 31, 2002.
In the second quarter of the year ended May 31, 2002 we recorded impairment and restructuring charges of $99 million primarily related to the planned closure of two general hospitals and the sales of certain other health care businesses. The total charge consists of (1) impairment write-downs of property, equipment and other assets to estimated fair value, $76 million, and (2) expected cash disbursements related to lease cancellation costs, severance costs and other exit costs, $23 million.
The impairment charge consists of write-downs of $39 million for property and equipment, $13 million for goodwill and $24 million for other assets. The balance of the charges consist of $7 million in lease cancellation costs, $5 million in severance costs related to the termination of 691 employees, $2 million in legal costs and settlements and $9 million in other exit costs. We decided to close those two hospitals because they were operating at a loss, which was not significant, and were not essential to our strategic objectives. One of these hospitals has been closed and the other was sold.
YEAR ENDED MAY 31, 2001
In the fourth quarter of the year ended May 31, 2001, we recorded impairment and restructuring charges of $143 million relating to (1) completion of our program to terminate or buy out certain employment and management contracts with approximately 248 physicians, $98 million, and
69
(2) impairment of the carrying values of property and equipment and other assets in connection with the closure of one hospital and certain other health care businesses, $45 million.
The total charge consists of $55 million in impairment write-downs of property, equipment and other assets to estimated fair values and $88 million for expected cash disbursements related to costs of terminating unprofitable physician contracts, severance costs, lease cancellation and other exit costs. The impairment charge consists of write-downs of $29 million for property and equipment and $26 million for other assets. The balance of the charges consist of $56 million for the buyout of unprofitable physician contracts, $6 million in severance costs related to the termination of 322 employees, $3 million in lease cancellation costs, and $23 million in other exit costs.
We decided to terminate or buy out the physician contracts because they were not profitable. During the latter part of fiscal 1999, we evaluated our physician strategy and began developing plans to either terminate or allow to expire a significant number of our existing unprofitable contracts. During fiscal 2000, our management, with the authority to do so, authorized the termination of approximately 50% of our unprofitable physician contracts. The termination of additional physician contracts that were not profitable was similarly authorized in fiscal 2001. As of May 31, 2002, we had exited most of the unprofitable contracts that management had authorized to be terminated or allowed to expire. Substantially all such remaining contracts were terminated by July 31, 2002. The physicians, employees and property owners/lessors affected by this decision were duly notified, prior to our respective fiscal year-ends.
YEAR ENDED MAY 31, 2000
In the third and fourth quarters of the year ended May 31, 2000, we recorded impairment and restructuring charges of $355 million relating to (1) our plan to terminate or buy out certain employment and management contract with approximately 440 physicians, $177 million, and (2) the closure or sale of five general hospitals and other property and equipment, $178 million.
Of the $355 million in charges, $244 million was impairment write-downs of property, equipment and other assets to the lower of either the carrying values or the estimated fair values. The remaining $111 million was for the expected cash expenditures for lease cancellation and other exit costs, the estimated and actual costs to close or sell the five general hospitals, severance costs, and costs to terminate or buy out the unprofitable physician contracts. The impairment charge includes write-downs of $116 million for property and equipment, $69 million for goodwill, and $59 million for other assets. The other charges consist of $38 million in lease cancellation costs, $12 million in severance costs related to the termination of 713 employees, and $61 million in other exit costs.
70
The tables below are reconciliations of beginning and ending liability balances in connection with impairment, restructuring and other charges recorded during the years ended May 31, 2001 and 2002 and during the seven months ended December 31, 2002.
|
Balances at Beginning of Period(1) |
Charges |
Cash Payments |
Other Items(2) |
Balances at End of Period(1) |
||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
(Dollars in Millions) |
||||||||||||||
Year ended May 31, 2001 | |||||||||||||||
Lease cancellations, exit costs and estimated costs to sell or close hospitals and other facilities | $ | 106 | $ | 26 | $ | (42 | ) | $ | (5 | ) | $ | 85 | |||
Impairment losses to value property, equipment, goodwill and other assets at estimated fair values | | 55 | | (55 | ) | | |||||||||
Severance costs in connection with the implementation of hospital cost-control programs, general overhead-reduction plans, closure of home health agencies and closure of hospitals and termination of physician contracts | 17 | 6 | (11 | ) | | 12 | |||||||||
Accruals for unfavorable lease commitments at six medical office buildings | 12 | | (2 | ) | | 10 | |||||||||
Buyout of physician contracts | 4 | 56 | (32 | ) | | 28 | |||||||||
Other items | 2 | | (2 | ) | | | |||||||||
$ | 141 | $ | 143 | $ | (89 | ) | $ | (60 | ) | $ | 135 | ||||
Year ended May 31, 2002 |
|||||||||||||||
Lease cancellations, exit costs and estimated costs to sell or close hospitals and other facilities | $ | 85 | $ | 18 | $ | (36 | ) | $ | (5 | ) | $ | 62 | |||
Impairment losses to value property, equipment, goodwill and other assets at estimated fair values | | 76 | | (76 | ) | | |||||||||
Severance costs in connection with the implementation of hospital cost-control programs, general overhead-reduction plans, closure of home health agencies and closure of hospitals and termination of physician contracts |
12 | 5 | (8 | ) | | 9 | |||||||||
Accruals for unfavorable lease commitments at six medical office buildings | 10 | | (2 | ) | | 8 | |||||||||
Buyout of physician contracts | 28 | | (22 | ) | | 6 | |||||||||
$ | 135 | $ | 99 | $ | (68 | ) | $ | (81 | ) | $ | 85 | ||||
71
|
Balances at Beginning of Period(1) |
Charges |
Cash Payments |
Other Items(2) |
Balances at End of Period(1) |
||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
(Dollars in Millions) |
||||||||||||||
Seven months ended December 31, 2002 | |||||||||||||||
Lease cancellations, exit costs and estimated costs to sell or close hospitals and other facilities | $ | 62 | $ | | $ | (9 | ) | $ | (10 | ) | $ | 43 | |||
Impairment losses to value property and equipment at estimated fair values | | 383 | | (383 | ) | | |||||||||
Severance costs in connection with the implementation of hospital cost-control programs, general overhead-reduction plans, and cost-reduction consulting fees | 9 | 13 | (3 | ) | (10 | ) | 9 | ||||||||
Accruals for unfavorable lease commitments at six medical office buildings | 8 | | (1 | ) | | 7 | |||||||||
Buyout of physician contracts | 6 | | (2 | ) | | 4 | |||||||||
$ | 85 | $ | 396 | $ | (15 | ) | $ | (403 | ) | $ | 63 | ||||
Cash payments to be applied against these accruals as of December 31, 2002 are expected to be approximately $26 million in 2003 and $37 million thereafter.
NOTE 5 ACQUISITIONS AND DISPOSALS OF FACILITIES
During the past three fiscal years ended May 31, 2002 and the seven months ended December 31, 2002, our subsidiaries acquired nine general hospitals and certain other health care entities, as shown in the table below:
|
Years ended May 31 |
|
||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Seven months ended December 31, 2002 |
|||||||||||||
|
2000 |
2001 |
2002 |
|||||||||||
|
(Dollars in Millions) |
|||||||||||||
Number of hospitals | 1 | 2 | 5 | 1 | ||||||||||
Number of licensed beds | 230 | 417 | 1,528 | 125 | ||||||||||
Purchase price information: | ||||||||||||||
Fair value of assets acquired | $ | 55 | $ | 27 | $ | 370 | $ | 28 | ||||||
Liabilities assumed | (20 | ) | (7 | ) | (53 | ) | (1 | ) | ||||||
Net assets acquired | 35 | 20 | 317 | 27 | ||||||||||
Other health care entities | 3 | 9 | 7 | | ||||||||||
Net cash paid | $ | 38 | $ | 29 | $ | 324 | $ | 27 | ||||||
For the years ended May 31, 2000, 2001 and 2002, and the seven months ended December 31, 2002, goodwill from these acquisitions was $28 million, $8 million, $128 million and $9 million, respectively. On June 1, 2002, we adopted Statement of Financial Accounting Standards No. 142. Under this new accounting standard, goodwill is no longer amortized, but is subject to impairment tests performed at least annually. All of the goodwill related to those acquisitions is expected to be fully deductible for income tax purposes.
While we strive to continually improve our portfolio of general hospitals through acquisitions, we, at times, divest hospitals that are not essential to our strategic objectives. For the most part, these divested hospitals are not part of an integrated delivery system. Their sizes and performances vary, but
72
on average they are smaller and have lower margins. Such divestitures allow us to concentrate on, or strengthen, the integrated health care delivery systems in areas where we already have a strong presence.
During the year ended May 31, 2000, we sold 17 general hospitals, closed three, and terminated the lease on another. We also sold three long-term-care facilities. The net gain on the sales of these facilities in 2000 was $49 million. During the year ended May 31, 2001 we sold one general hospital and three long-term-care facilities, closed one long-term-care facility and combined the operations of one rehabilitation hospital with the operations of a general hospital. During the year ended May 31, 2002, we sold one general hospital and three long-term-care facilities. The results of operations of the sold or closed businesses were not significant.
In March 2003, we announced a plan to dispose of or consolidate 14 general hospitals that no longer fit our core operating strategy of building and maintaining competitive networks of quality hospitals in major markets. Four of the ten general hospitals for which we recorded impairment charges of $80 million during the seven months ended December 31, 2002 are part of that plan. We have recorded an impairment charge in the amount of approximately $61 million in March 2003 primarily for the write-down of long-lived assets and goodwill allocated to these disposed businesses using the relative fair-value method to arrive at estimated fair values, less costs to sell, of these facilities.
As previously announced, we anticipate selling 11 of the hospitals by the end of the calendar year and we plan to sell, consolidate or close two other hospitals. We will cease operations at one hospital when the long-term lease expires in August 2003. We intend to use the proceeds from the divestitures to repurchase common stock and repay indebtedness. These hospitals reported net operating revenues of $953 million for the 12-month period ended December 31, 2002. The income from operations of the asset group was $105 million for the same period.
NOTE 6 REPURCHASES OF COMMON STOCK
During the year ended May 31, 2002, our board of directors authorized the repurchase of up to 30 million shares of its common stock to offset the dilutive effect of employee stock option exercises. On July 24, 2002, the board of directors authorized the repurchase of up to an additional 20 million shares of stock, not only to offset the dilutive effect of anticipated employee stock option exercises, but also to enable us to take advantage of opportunistic market conditions. On December 11, 2002, the board of directors authorized the use of net cash flows from operating activities after August 31, 2002, less capital expenditures, plus proceeds from asset sales, to repurchase up to 30 million shares of our common stock, which includes 13,763,900 shares that remained under the previous authorizations. During the year ended May 31, 2002 and the seven months ended December 31, 2002, we repurchased an aggregate 36,263,100 shares for approximately $1.2 billion at an average cost of $33.53 per share, as shown in the following table:
|
Number of Shares |
Cost |
Average Cost Per Share |
|||||
---|---|---|---|---|---|---|---|---|
Quarter Ended | ||||||||
August 31, 2001 | 2,618,250 | $ | 94,512,283 | $ | 36.10 | |||
November 30, 2001 | 2,437,500 | 93,322,287 | 38.29 | |||||
February 28, 2002 | 7,500,000 | 292,122,301 | 38.95 | |||||
May 31, 2002 | 5,625,000 | 235,461,974 | 41.86 | |||||
Seven Months Ended |
||||||||
December 31, 2002 | 18,082,350 | 500,373,708 | 27.67 | |||||
Total | 36,263,100 | $ | 1,215,792,553 | $ | 33.53 | |||
The repurchased shares are held as treasury stock. We have not purchased, nor do we intend to purchase, any shares from our directors, officers or employees.
73
At times, we have entered into forward-purchase agreements to repurchase common stock owned by unaffiliated counterparties. Such forward-purchase agreements gave us the option of buying the stock through a full-physical, net-share or net-cash settlement. On October 29, 2002, we settled all of the then outstanding forward-purchase agreements for $225 million in cash5,164,150 shares at an average cost of $43.64 per shareand have not entered into any forward-purchase agreements since then. The closing market price of our common stock that day was $39.25. We accounted for these forward-purchase agreements as equity transactions within permanent equity.
Subsequent to December 31, 2002 and through April 30, 2003, we have repurchased 8,621,000 shares of common stock for approximately $148 million at an average cost of $17.16 per share.
NOTE 7 LONG-TERM DEBT AND LEASE OBLIGATIONS
The table below shows our long-term debt as of May 31, 2001 and 2002 and December 31, 2002:
|
May 31 |
|
||||||||
---|---|---|---|---|---|---|---|---|---|---|
|
December 31 2002 |
|||||||||
|
2001 |
2002 |
||||||||
|
(in millions) |
|||||||||
Loans payable to banks, unsecured | $ | 60 | $ | 975 | $ | 830 | ||||
53/8% Senior Notes due 2006 | | 550 | 550 | |||||||
5% Senior Notes due 2007 | | | 400 | |||||||
63/8% Senior Notes due 2011 | | 1,000 | 1,000 | |||||||
61/2% Senior Notes due 2012 | | 600 | 600 | |||||||
67/8% Senior Notes due 2031 | | 450 | 450 | |||||||
81/8% Senior Subordinated Notes due 2008 | 897 | 2 | 2 | |||||||
6% Exchangeable Subordinated Notes due 2005 | 320 | 282 | | |||||||
85/8% Senior Notes due 2003 | 455 | 16 | 16 | |||||||
77/8% Senior Notes due 2003 | 400 | 6 | 6 | |||||||
8% Senior Notes due 2005 | 811 | 22 | 22 | |||||||
75/8% Senior Notes due 2008 | 313 | | | |||||||
91/4 Senior Notes due 2010 | 238 | | | |||||||
85/8% Senior Notes due 2010 | 628 | | | |||||||
Zero-coupon guaranteed bonds due 2002 | 45 | 45 | | |||||||
Notes payable and capital lease obligations, secured by property and equipment, payable in installments to 2013 | 71 | 100 | 97 | |||||||
Other promissory notes, primarily unsecured | 53 | 37 | 14 | |||||||
Unamortized note discounts | (64 | ) | (67 | ) | (68 | ) | ||||
Total long-term debt | 4,227 | 4,018 | 3,919 | |||||||
Less current portion | (25 | ) | (99 | ) | (47 | ) | ||||
Long-term debt, net of current portion | $ | 4,202 | $ | 3,919 | $ | 3,872 | ||||
LOANS PAYABLE TO BANKS
On March 1, 2001, we entered into a new senior unsecured $500 million 364-day credit agreement and a new senior unsecured $1.5 billion five-year revolving credit agreement (together, the "credit agreement"). The credit agreement replaced our $2.8 billion five-year revolving bank credit agreement that would have expired on January 31, 2002. On February 28, 2002, we renewed the 364-day agreement for another 364 days. The 364-day agreement expired on February 28, 2003. It was undrawn and not renewed.
The 364-day agreement allowed us to borrow, repay and reborrow up to $500 million prior to March 1, 2003, and the five-year agreement allows us to borrow, repay and reborrow up to $1.5 billion
74
prior to March 1, 2006. The credit agreement extends our maturities, offers efficient pricing tied to quantifiable credit measures, and has more flexible covenants than the previous credit agreement. Our unused borrowing capacity under the credit agreement was $1.0 billion at December 31, 2002. At December 31, 2002 the interest rate on loans payable to banks under the credit agreement was 2.2%.
Loans under the credit agreement are unsecured and generally bear interest at a base rate equal to the prime rate or, if higher, the federal funds rate plus 0.5% or, at our option, an adjusted London Interbank Offered Rate ("LIBOR") plus an interest margin between 50 and 200 basis points. (On March 1, 2003, the interest margin was amended to 100 basis points.) We have agreed to pay the lenders an annual facility fee on the total loan commitment at rates between 20 and 57.5 basis points. The interest rate margins and the facility fee rates are based on the ratio of our consolidated total debt to consolidated operating income plus depreciation, amortization, impairment and certain restructuring charges.
SENIOR NOTES AND SENIOR SUBORDINATED NOTES
In May 2001, we repurchased an aggregate of $514 million of our senior and senior subordinated notes. In connection with the repurchase of debt and the refinancing of our bank credit agreement, we recorded a loss of $56 million from early extinguishment of debt in the fourth quarter of the year ended May 31, 2001.
During the seven-month period ended December 31, 2001, we repurchased approximately $1.1 billion of various issues of our senior notes. The transactions were funded with cash and borrowings under our credit agreement.
In November 2001, we sold $2.0 billion of the following new senior notes:
We used substantially all of the proceeds to repurchase approximately $1.6 billion of various issues of our senior and senior subordinated notes and to repay borrowings under the bank credit agreement. Those new senior notes are unsecured senior obligations; they rank equally with all of our other unsecured senior indebtedness; and they are redeemable at any time at our option.
During the year ended May 31, 2002, we repurchased the remaining $65 million of our 85/8% Senior Subordinated Notes due 2007, $56 million of our 81/8% Senior Subordinated Notes due 2008, and $24 million of our 6% Exchangeable Subordinated Notes due 2005. We also sold $600 million of new 61/2% Senior Notes due 2012 and we used the majority of the proceeds to repurchase our 81/8% Senior Subordinated Notes due 2008 and the remainder for general corporate purposes. In connection with the repurchases of debt during the year ended May 31, 2002, we recorded losses from early extinguishments of debt in the aggregate amount of $383 million.
In June 2002, we sold $400 million of new 5% Senior Notes due 2007. We used the proceeds from the sale to repay bank loans under our credit agreements and to repurchase, at par, the remaining $282 million balance of our 6% Exchangeable Subordinated Notes due 2005. As a result of that repurchase, we recorded a $4 million loss from early extinguishment of debt in the seven-month period ended December 31, 2002.
In April 2002, the FASB issued SFAS No. 145, which eliminates the requirement to report gains or losses from early extinguishments of debt as extraordinary items in the income statement, unless they meet the criteria for an extraordinary item under APB Opinion No. 30. The Company adopted SFAS No. 145 as of June 1, 2002. Under the new rule, such gains or losses are now generally reported as part
75
of income from continuing operations. Any gain or loss on early extinguishment of debt that was classified as an extraordinary item in prior periods presented has been reclassified.
In January 2003, we sold $1 billion of new 73/8% Senior Notes due 2013. We used the majority of the proceeds to repay all of the then outstanding debt under our credit agreement and the remainder for general corporate purposes. Those new senior notes are unsecured; they rank equally with all of our other unsecured senior indebtedness; and they are redeemable at any time at our option with a redemption premium calculated at the time of redemption.
Prior to the sale of the new senior notes in November 2001, March 2002 and January 2003, we used a hedging strategy to lock in the risk-free component of the interest rate that was in effect on the offering dates of the notes. The interest-rate-lock agreement was settled on the date the notes were issued. Because the risk-free interest rate declined during the hedge period, we incurred a loss on this transaction when we unwound the hedge. However, based on our assessment using the dollar-offset method (which was performed at the inception of the hedge), we determined that the hedge was highly effective. Therefore, the loss on the hedge was charged to other comprehensive income and is being amortized into earnings over the terms of the new senior notes. The loss will be entirely offset by the effect of the lower interest rate on the notes.
All of our remaining senior subordinated notes are unsecured obligations and are subordinated in right of payment to all existing and future senior debt, including the senior notes and borrowings under the credit agreement.
LOAN COVENANTS
With the retirement or substantial retirement of eight issues of senior notes and senior subordinated notes since May 31, 2001, together with amendments to the loan covenants, we have eliminated substantially all of the restrictive covenants associated with debt issued when we were considered a "high yield" issuer. During the year ended May 31, 2002, our senior notes and senior subordinated notes were upgraded to investment grade.
Our existing credit agreement and the indentures governing our senior and senior subordinated notes contain affirmative, negative and financial covenants that have, among other requirements, limitations on (1) liens, (2) consolidations, merger or the sale of all or substantially all assets unless no default exists and, in the case of a consolidation or merger, the surviving entity assumes all of our obligations under the credit agreements, and (3) subsidiary debt. The covenants also allow us to declare and pay a dividend and purchase our common stock so long as no default exists and our leverage ratio is less than 3.0-to-1. The leverage ratio is defined in the credit agreement as the ratio of the Company's consolidated total debt to consolidated operating income plus the sum of depreciation, amortization, impairment and other unusual charges. This leverage ratio was 1.34 at December 31, 2002. The existing credit agreement covenants also require that our leverage ratio not exceed 2.5-to-1, and that we maintain specified levels of net worth ($3.7 billion at December 31, 2002) and a fixed-charge coverage greater than 2.0-to-1. At December 31, 2002, our fixed-charge coverage was 6.3-to-1. We are in compliance with all of our loan covenants. There are no compensating balance requirements for any credit line or borrowing.
Future long-term debt maturities and minimum operating lease payments as of December 31, 2002 are as follows:
|
December 31 |
||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Total |
2003 |
2004 |
2005 |
2006 |
2007 |
Later Years |
||||||||||||||
|
(Dollars in Millions) |
||||||||||||||||||||
Long-term debt, including capital lease obligations | $ | 3,987 | $ | 47 | $ | 19 | $ | 26 | $ | 1,385 | $ | 423 | $ | 2,087 | |||||||
Long-term operating leases | 790 | 198 | 131 | 100 | 85 | 78 | 198 |
76
Rental expense under operating leases, including short-term leases, was $286 million in the year ended May 31, 2000, $237 million in the year ended May 31, 2001, $241 million in the year ended May 31, 2002, and $141 million in the seven-month period ended December 31, 2002.
NOTE 8 INCOME TAXES
The following tables relate to continuing operations:
|
May 31 |
December 31 |
|||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
2000 |
2001 |
2002 |
2001 |
2002 |
||||||||||||
|
(Dollars in Millions) |
||||||||||||||||
|
|
|
|
(unaudited) |
|
||||||||||||
Currently Payable | |||||||||||||||||
Federal | $ | 232 | $ | 342 | $ | 440 | $ | 213 | $ | 490 | |||||||
State | 32 | 53 | 63 | 30 | 64 | ||||||||||||
$ | 264 | $ | 395 | $ | 503 | $ | 243 | $ | 554 | ||||||||
Deferred | |||||||||||||||||
Federal | $ | (4 | ) | $ | 32 | $ | 58 | $ | 14 | $ | (240 | ) | |||||
State | 18 | 16 | 32 | 5 | (15 | ) | |||||||||||
$ | 14 | $ | 48 | $ | 90 | $ | 19 | $ | (255 | ) | |||||||
$ | 278 | $ | 443 | $ | 593 | $ | 262 | $ | 299 | ||||||||
A reconciliation between the amount of reported income tax expense and the amount computed by multiplying income from continuing operations before income taxes by the statutory Federal income tax rate is shown below:
|
May 31 |
December 31 |
|||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
2000 |
2001 |
2002 |
2001 |
2002 |
||||||||||
|
(Dollars in Millions) |
||||||||||||||
|
|
|
|
(unaudited) |
|
||||||||||
Tax provision at statutory federal rate of 35% | $ | 216 | $ | 380 | $ | 482 | $ | 207 | $ | 265 | |||||
State income taxes, net of federal income tax benefit | 32 | 43 | 62 | 24 | 32 | ||||||||||
Goodwill amortization | 23 | 22 | 22 | 13 | | ||||||||||
Nondeductible goodwill included in asset sales | 32 | | | | | ||||||||||
Nondeductible asset impairment charges | 1 | | 4 | 4 | | ||||||||||
Change in valuation allowance and tax contingency reserves | (32 | ) | (8 | ) | 13 | 8 | 1 | ||||||||
Other items | 6 | 6 | 10 | 6 | 1 | ||||||||||
$ | 278 | $ | 443 | $ | 593 | $ | 262 | $ | 299 | ||||||
77
Deferred tax assets and liabilities as of May 31, 2001 and 2002 and December 31, 2002 relate to the following:
|
May 31, 2001 |
May 31, 2002 |
December 31, 2002 |
|||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Assets |
Liabilities |
Assets |
Liabilities |
Assets |
Liabilities |
||||||||||||
|
(Dollars in Millions) |
|||||||||||||||||
Depreciation and fixed-asset differences | $ | | $ | 796 | $ | | $ | 866 | $ | | $ | 782 | ||||||
Charges related to discontinued operations, impairment and restructuring charges | 122 | | 101 | | 67 | | ||||||||||||
Receivables (doubtful accounts and adjustments) | | 10 | | 2 | 25 | | ||||||||||||
Accruals for insurance risks | 127 | | 142 | | 222 | | ||||||||||||
Intangible assets | | 68 | | 137 | | 202 | ||||||||||||
Other long-term liabilities | 39 | | 51 | | 61 | | ||||||||||||
Benefit plans | 79 | | 90 | | 171 | | ||||||||||||
Other accrued liabilities | 60 | | 94 | | 66 | | ||||||||||||
Investments and other assets | 30 | | | 8 | 67 | | ||||||||||||
Net operating loss carryforwards | 11 | | 21 | | 19 | | ||||||||||||
Other items | 7 | | 24 | | 5 | | ||||||||||||
$ | 475 | $ | 874 | $ | 523 | $ | 1,013 | $ | 703 | $ | 984 | |||||||
We believe that the realization of deferred tax assets is more likely than not to occur as the temporary differences reverse against future taxable income.
At December 31, 2002, our carryforwards from prior tax returns that were available to offset future federal net taxable income consisted of net operating loss carryforwards of approximately $21 million expiring in 2003 and $34 million expiring in 2014 through 2016. Allowable federal deductions relating to the $21 million in net operating losses expiring in 2003 are subject to annual limitations and as such we have established a valuation allowance included in other items to reserve a portion of this amount.
The Internal Revenue Service ("IRS") is currently examining our federal income tax returns for the years ended May 31, 1995, 1996 and 1997. We expect the examination to be concluded within the next several months. In connection with its examination, the IRS has issued a Notice of Proposed Adjustment ("NOPA") with respect to our treatment of a portion of the civil settlement paid to the federal government in June 1994 related to our discontinued psychiatric hospital business. The denial of this deduction could result in additional income taxes and interest of approximately $100 million. The IRS has also commented on a number of other matters, but has issued no proposed adjustment. At this time, no Revenue Agent's Report ("RAR") for the above fiscal years has been issued. In the event the final RAR contains adjustments with which we disagree (such as the issue covered by the NOPA discussed above), we will seek to resolve all disputed issues using the various means available to us. These would include, for example, filing a protest with the Appeals Division of the IRS or filing a petition for redetermination of a deficiency with the Tax Court. We are not currently able to predict the amounts that could eventually be paid upon the ultimate resolution of all the issues included in any final RAR.
NOTE 9 PROFESSIONAL AND GENERAL LIABILITY INSURANCE
Through May 31, 2002, we insured substantially all of our professional and comprehensive general liability risks in excess of self-insured retentions through a majority-owned insurance subsidiary (Hospital Underwriting Group) under a mature claims-made policy with a 10-year discovery period. These self-insured retentions were $1 million per occurrence for the three years ended May 31, 2002, and in prior years varied by hospital and by policy period from $500,000 to $5 million per occurrence. Hospital Underwriting Group's retentions covered the next $2 million per occurrence. Claims in excess
78
of $3 million per occurrence were, in turn, reinsured with major independent insurance companies. Effective June 1, 2002, we formed a new insurance subsidiary. This subsidiary insures these risks under a first-year only claims-made policy, and, in turn, reinsures its risks in excess of $5 million per occurrence with major independent insurance companies. Subsequent to May 31, 2002, our self-insured retention limit is $2 million. Our new subsidiary's retention covers the next $3 million. That program will expire on May 31, 2003. Effective June 1, 2003, we anticipate having a new insurance program in place.
Included in our other operating expenses in the accompanying consolidated income statements is malpractice insurance expense of $115 million for the seven months ended December 31, 2001 (unaudited) and $270 million for the current period. We continue to experience unfavorable trends in professional and general liability insurance risks, as well as increases in the size of claim settlements and awards in this area. We believe our future coverage will be more costly and may require us to assume more of these risks ourselves.
The $270 million expense consists of (1) a charge of approximately $36 million as a result of lowering the discount rate used from 7.5% to 4.61%, (2) a charge of $29 million due to an increase in Hospital Underwriting Group's reserves as a result of an increase in the average of claims being paid by them, and (3) a charge of $86 million to increase our self-insured self-retention reserves, also due to a significant increase in the severity of claims. The 7.5% rate was based on our average cost of borrowing. The 4.61% rate is based on a risk-free, Federal Reserve 10-year maturity composite rate as of December 31, 2002 for a period that approximates our estimated claims payout period.
In addition, the aggregate amount of claims reported to Hospital Underwriting Group for the fiscal year ended May 31, 2001 is approaching the $50 million aggregate policy limit for that year. Once the aggregate limit is exhausted for the policy year, we will bear the first $25 million of loss before any excess insurance coverage would apply.
NOTE 10 CLAIMS AND LAWSUITS
The Company is subject to claims and lawsuits in its normal course of business. We believe that our liability for damages resulting from such claims and lawsuits is adequately covered by insurance or is adequately provided for in our consolidated financial statements. Although the results of these claims and lawsuits cannot be predicted with certainty, we believe that the ultimate resolution of these claims and lawsuits will not have a material adverse effect on our business, financial position or results of operations.
The healthcare industry is also the subject of federal and state agencies heightened and coordinated civil and criminal enforcement efforts. Through the use of national initiatives, the government is scrutinizing, among other things, the terms of acquisitions of physician practices and the coding practices related to certain clinical laboratory procedures and inpatient procedures. Health care providers, including Tenet, continue to see increased use of the False Claims Act, particularly by individuals alleging that a hospital has defrauded the federal government. Companies in the health care industry in general, and Tenet in particular, have been and may continue to be subjected to these government investigations and other actions. At this time, we are unable to predict the impact of such actions on our business, financial condition or results of operations.
Finally, the Company and certain of its subsidiaries are currently involved in significant legal proceedings and investigations principally related to the following:
79
We believe the allegations in these cases are without merit and we intend to vigorously defend all the above actions.
We cannot presently determine the ultimate resolution of these investigations and lawsuits. Accordingly, the likelihood of a loss, if any, cannot be reasonably estimated and we have not recognized in the accompanying consolidated financial statements all of the liability arising from these matters. If adversely determined, the outcome of those matters could have a material adverse effect on our liquidity, financial position and results of operations.
80
NOTE 11 SELECTED BALANCE SHEET DETAILS
The principal components of other current assets are shown in the table below:
|
May 31 |
|
|||||||
---|---|---|---|---|---|---|---|---|---|
|
December 31 2002 |
||||||||
|
2001 |
2002 |
|||||||
|
(Dollars in Millions) |
||||||||
Other receivables | $ | 162 | $ | 252 | $ | 292 | |||
Prepaid expenses and other current items | 87 | 107 | 95 | ||||||
Assets held for sale or disposal, at the lower of carrying value or fair value less estimated costs to sell or dispose | 56 | 42 | 34 | ||||||
Other current assets | $ | 305 | $ | 401 | $ | 421 | |||
The results of operations of the assets held for sale or for disposal and the impact of suspending depreciation and amortization were not significant.
The principal components of property and equipment are shown in the table below:
|
May 31 |
|
||||||||
---|---|---|---|---|---|---|---|---|---|---|
|
December 31 2002 |
|||||||||
|
2001 |
2002 |
||||||||
|
(Dollars in Millions) |
|||||||||
Land | $ | 530 | $ | 594 | $ | 592 | ||||
Buildings and improvements | 4,949 | 5,412 | 5,216 | |||||||
Construction in progress | 199 | 262 | 297 | |||||||
Equipment | 2,905 | 3,303 | 3,268 | |||||||
$ | 8,583 | $ | 9,571 | $ | 9,373 | |||||
Less accumulated depreciation and amortization | (2,607 | ) | (2,986 | ) | (3,014 | ) | ||||
Net property and equipment | $ | 5,976 | $ | 6,585 | $ | 6,359 | ||||
Property and equipment is stated at cost, less accumulated depreciation and amortization and impairment write-downs related to assets held and used.
NOTE 12 STOCK BENEFIT PLANS
We currently grant stock-based awards pursuant to our 2001 Stock Incentive Plan. Under that plan, 60,000,000 shares of common stock were approved for stock-based awards. At December 31, 2002, there were 38,311,805 shares of common stock available for stock option grants and other incentive awards to our key employees, advisors, consultants and directors. Options generally have an exercise price equal to the fair market value of the shares on the date of grant. Normally, these options are exercisable at the rate of one-third per year, beginning one year from the date of the grant. In December 2002, however, we granted options for 11.1 million shares of common stock at an exercise price of $17.56 per share and an estimated weighted average fair value of $8.78 per share. These options will be fully vested four years after the date of grant. Earlier vesting may occur for these options on or after the first, second and third anniversaries of the grant date if the market price of our common stock reaches and remains at, or higher than, $24, $27 and $30 per share, respectively, for 20 consecutive trading days at such time. Stock options generally expire 10 years from the date of grant.
Under the 2001 Stock Incentive Plan, nonemployee directors receive 18,000 options per year and 36,000 options upon joining the board of directors. Awards have an exercise price equal to the fair market value of the Company's shares on the date of the grant. At the recommendation of independent compensation consultants retained by the compensation committee of our board of directors, the options granted vest immediately upon issuance and expire 10 years after the date of the grant.
81
The following table summarizes information about our outstanding stock options at December 31, 2002:
|
Options Outstanding |
Options Exercisable |
||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|
Range of Exercise Prices |
Number of Options |
Weighted Average Remaining Contractual Life |
Weighted Average Exercise Price |
Number of Options |
Weighted Average Exercise Price |
|||||||
$ 6.25 to $10.17 | 1,404,288 | 2.2 years | $ | 8.88 | 1,404,288 | $ | 8.88 | |||||
$10.18 to $20.34 | 22,613,040 | 7.5 years | 16.53 | 11,081,052 | 15.63 | |||||||
$20.35 to $30.50 | 13,081,964 | 7.6 years | 27.43 | 7,314,774 | 26.56 | |||||||
$30.51 to $40.67 | 10,237,791 | 8.6 years | 40.29 | 3,502,511 | 40.26 | |||||||
$40.68 to $50.84 | 175,850 | 9.4 years | 44.70 | 36,000 | 45.14 | |||||||
47,512,933 | 7.6 years | $ | 24.53 | 23,338,625 | $ | 22.39 | ||||||
The reconciliation below shows the changes to our stock option plans for the years ended May 31, 2000, 2001 and 2002, and for the seven months ended December 31, 2002:
|
Outstanding at beginning of period |
Granted |
Exercised |
Forfeited |
Outstanding at end of period |
Options Exercisable |
||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|
May 31, 2000 | ||||||||||||
Shares | 47,081,279 | 12,252,977 | (1,821,116 | ) | (4,549,214 | ) | 52,963,926 | 30,179,508 | ||||
Weighted average exercise price | $15.84 | $11.32 | $11.77 | $17.20 | $14.81 | $14.37 | ||||||
May 31, 2001 | ||||||||||||
Shares | 52,963,926 | 10,758,462 | (17,170,896 | ) | (424,737 | ) | 46,126,755 | 24,298,478 | ||||
Weighted average exercise price | $14.81 | $27.53 | $14.81 | $19.57 | $17.74 | $15.28 | ||||||
May 31, 2002 | ||||||||||||
Shares | 46,126,755 | 12,869,792 | (17,829,297 | ) | (770,678 | ) | 40,396,572 | 17,228,241 | ||||
Weighted average exercise price | $17.74 | $38.60 | $15.29 | $20.06 | $25.45 | $17.97 | ||||||
December 31, 2002 | ||||||||||||
Shares | 40,396,572 | 11,833,821 | (2,902,654 | ) | (1,814,806 | ) | 47,512,933 | 23,338,625 | ||||
Weighted average exercise price | $25.45 | $18.32 | $14.36 | $20.80 | $24.53 | $22.39 |
The estimated weighted-average fair values of options we granted in the years ended May 31, 2000, 2001 and 2002 and the seven-month period ended December 31, 2002 were $5.47, $14.01, $18.45 and $9.07, respectively. These were calculated, as of the date of each grant, using a Black-Scholes option-pricing model with the following weighted-average assumptions:
|
May 31 |
|
|||||||
---|---|---|---|---|---|---|---|---|---|
|
December 31 2002 |
||||||||
|
2000 |
2001 |
2002 |
||||||
Expected volatility | 36.0 | % | 39.0 | % | 39.9 | % | 50.6 | % | |
Risk-free interest rates | 5.9 | % | 5.4 | % | 4.5 | % | 3.5 | % | |
Expected lives, in years | 6.6 | 7.0 | 6.8 | 5.5 | |||||
Expected dividend yield | 0.0 | % | 0.0 | % | 0.0 | % | 0.0 | % |
Expected volatility is derived using daily data drawn from the five years preceding the date of grant. The risk-free interest rate is the approximate yield on 7-year and 10-year United States Treasury Bonds on the date of grant. The expected life is an estimate of the number of years the option will be held before it is exercised. The valuation model was not adjusted for nontransferability, risk of forfeiture, or the vesting restrictions of the optionsall of which would reduce the value if factored into the calculation.
82
Had compensation cost for stock options we granted to our employees and directors been determined based on these fair values, our net income and earnings per share would have been the amounts indicated below:
|
May 31 |
|
|||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
December 31 2002 |
||||||||||||
|
2000 |
2001 |
2002 |
||||||||||
|
(Dollars in Millions, except Per-Share Amounts) |
||||||||||||
Net income: | |||||||||||||
As reported | $ | 302 | $ | 643 | $ | 785 | $ | 459 | |||||
Pro forma | $ | 245 | $ | 582 | $ | 703 | $ | 409 | |||||
Basic earnings per common share: |
|||||||||||||
As reported | $ | 0.65 | $ | 1.34 | $ | 1.60 | $ | 0.95 | |||||
Pro forma | $ | 0.53 | $ | 1.22 | $ | 1.44 | $ | 0.85 | |||||
Diluted earnings per common share: |
|||||||||||||
As reported | $ | 0.64 | $ | 1.31 | $ | 1.56 | $ | 0.93 | |||||
Pro forma | $ | 0.53 | $ | 1.19 | $ | 1.41 | $ | 0.83 |
Prior to our shareholders approving the 2001 Stock Incentive Plan at their 2001 annual meeting, we granted stock-based awards to our directors and employees pursuant to other plans. Stock options remain outstanding under those other plans, but no additional stock-based awards will be granted under them. No performance-based incentive stock awards have been granted since fiscal 1994.
Pursuant to the terms of our stock-based compensation plans, awards granted under the plans vest and may be exercised as determined by the compensation committee of our board of directors. In the event of a change in control, the compensation committee may, at its sole discretion, without obtaining shareholder approval, accelerate the vesting or performance periods of the awards.
Through the end of the seven-month period ended December 31, 2002, we applied Accounting Principles Board Opinion No. 25 and its related interpretations in accounting for our plans. Accordingly, no compensation cost was recognized for stock options granted to employees or directors under the plans because the exercise prices for options granted were equal to the quoted market prices on the option grant dates.
In March 2003, our board of directors approved a change in accounting for stock options granted to employees and directors from the intrinsic-value method to the fair-value method recommended by SFAS No. 123, effective for the calendar year ending December 31, 2003. Beginning with our first quarterly report of that year, for the quarter ended March 31, 2003, compensation cost for stock options granted to our employees and directors will be reflected directly in our consolidated income statements instead of being presented as pro forma information. Based on options granted through March 1, 2003, we estimate that this charge will increase salaries and benefits expense by approximately $39 million per quarter throughout calendar year 2003. The transition method we have chosen to report this change in accounting is the retroactive-restatement method. As such, future presentations of periods ended prior to January 1, 2003 will be restated to reflect the fair-value method of accounting, as if the change had been effective throughout those prior periods.
NOTE 13 EMPLOYEE STOCK PURCHASE PLAN
We have an employee stock purchase plan under which we are authorized to issue up to 14,250,000 shares of common stock to eligible employees of the Company or its designated subsidiaries. Under the terms of the plan, eligible employees may elect to have between 1% and 10% of their base earnings withheld each calendar quarter to purchase shares of the our common stock. Shares are purchased on the last day of the quarter, at a purchase price equal to 85% of either the closing price
83
on the first day of the quarter or the closing price on the last day of the quarter, whichever is lower. Under the plan, no individual may purchase, in any year, shares with a fair market value in excess of $25,000.
Under the plan, we sold the following numbers of shares in each of the three years ended May 31, 2002, 2001 and 2002 and in the seven-month period ended December 31, 2002:
|
May 31 |
|
||||||
---|---|---|---|---|---|---|---|---|
|
December 31 2002 |
|||||||
|
2000 |
2001 |
2002 |
|||||
Number of shares | 1,647,831 | 839,982 | 691,704 | 378,431 | ||||
Weighted average price | $10.61 | $18.01 | $30.19 | $39.28 |
NOTE 14 EARNINGS PER COMMON SHARE
The table below is a reconciliation of the numerators and denominators of our basic and diluted earnings per common share calculations for income from continuing operations for each of the three years ended May 31, 2000 through 2002 and for the seven-month period ended December 31, 2002. We also present the reconciliations for the seven months ended December 31, 2001 for comparative purposes. Income is expressed in millions and weighted average shares are expressed in thousands.
|
Income (Numerator) |
Weighted Average Shares (Denominator) |
Per-Share Amount |
||||||
---|---|---|---|---|---|---|---|---|---|
|
(Dollars in Millions, except Per-Share Amounts) |
||||||||
Year ended May 31, 2000 | |||||||||
Income available to common shareholders for basic earnings per share | $ | 340 | 467,970 | $ | 0.73 | ||||
Effect of dilutive stock options, warrants and other contracts to issue common stock | | 4,407 | (0.01 | ) | |||||
Income available to common shareholders for diluted earnings per share | $ | 340 | 472,377 | $ | 0.72 | ||||
Year ended May 31, 2001 | |||||||||
Income available to common shareholders for basic earnings per share | $ | 643 | 479,621 | $ | 1.34 | ||||
Effect of dilutive stock options, warrants and other contracts to issue common stock | | 11,107 | (0.03 | ) | |||||
Income available to common shareholders for diluted earnings per share | $ | 643 | 490,728 | $ | 1.31 | ||||
Year ended May 31, 2002 | |||||||||
Income available to common shareholders for basic earnings per share | $ | 785 | 489,717 | $ | 1.60 | ||||
Effect of dilutive stock options, warrants and other contracts to issue common stock | | 13,182 | (0.04 | ) | |||||
Income available to common shareholders for diluted earnings per share | $ | 785 | 502,899 | $ | 1.56 | ||||
84
Seven Months ended December 31, 2001 (unaudited) | |||||||||
Income available to common shareholders for basic earnings per share | $ | 328 | 489,046 | $ | 0.67 | ||||
Effect of dilutive stock options, warrants and other contracts to issue common stock | | 13,913 | (0.02 | ) | |||||
Income available to common shareholders for diluted earnings per share | $ | 328 | 502,959 | $ | 0.65 | ||||
Seven Months ended December 31, 2002 | |||||||||
Income available to common shareholders for basic earnings per share | $ | 459 | 484,877 | $ | 0.95 | ||||
Effect of dilutive stock options, warrants and other contracts to issue common stock | | 8,653 | (0.02 | ) | |||||
Income available to common shareholders for diluted earnings per share | $ | 459 | 493,530 | $ | 0.93 | ||||
Stock options with prices that exceeded the average market price for the above periods are excluded from the earnings-per-share computations. For the years ended May 31, 2000, 2001 and 2002, the number of shares excluded was 15,321,000, 1,037,000 and 171,000, respectively, and for the seven-month period ended December 31, 2002, the number was 9,946,206.
NOTE 15 EMPLOYEE RETIREMENT PLAN
Substantially all domestic employees of Tenet or one of its subsidiaries, upon qualification, are eligible to participate in a defined contribution 401(k) plan. Under the plan, employees may contribute 1% to 20% of their eligible compensation, and we match such contributions up to a maximum percentage. Our contributions to the plan were approximately $52 million for the year ended May 31, 2000, $54 million for the year ended May 31, 2001, $60 million for the year ended May 31, 2002, and $40 million for the seven-month period ended December 31, 2002.
NOTE 16 INVESTMENTS AND OTHER ASSETS
Our principal long-term investments in unconsolidated affiliates at May 31, 2002 consisted of 8,301,067 shares of Ventas and shares of various other investments, primarily in health care ventures. As previously announced, in December 2002, we sold our entire portfolio of Ventas, Inc. shares for $86 million. We had decided to sell the shares in late November 2002. Prior to that time, we had accounted for the shares as an available-for-sale security whose fair value was less than its cost basis. Because we did not expect the fair value of the shares to recover prior to the expected time of sale, we recorded a $64 million charge ($40 million, net of taxes) in November 2002 for the impairment of the carrying value of these securities. Because of a difference between the tax basis of the investment and our book basis, we will report a tax gain on the sale in our next income tax return. The estimated tax on the gain amounted to $32 million, and was paid on February 15, 2003.
Also included in long-term investments at May 31, 2002 was an investment portfolio of U.S. government securities aggregating $69 million. Those securities were held in an escrow account for the benefit of the holders of our 6% Exchangeable Notes. The securities were released from escrow when we repurchased the notes in August 2002 (see Note 6) and were sold for cash in the normal course of business over several succeeding weeks.
85
Our policy has been to classify these investments as "available for sale." In doing so, the carrying values of the shares and debt instruments are adjusted at the end of each accounting period to their market values, net of income taxes. This is done through a credit or charge to other comprehensive income. Through May 31, 2001 and 2002, the accumulated unrealized loss on the Company's long-term investments was $71 million and $40 million, respectively, and through December 31, 2002, it was $15 million. At May 31, 2001 and 2002 the aggregate market value of these investments was $170 million and $200 million, respectively, and at December 31, 2002 it was $20 million.
In addition, during the year ended May 31, 2000, we recorded $61 million in gains from sales of investments in Internet-related health care ventures, which were offset by $62 million in net losses from sales of other investments. During the year ended May 31, 2001, we recorded $28 million in net gains from sales of investments in health care ventures. There were no such gains or losses in the year ended May 31, 2002 or the seven-month period ended December 31, 2002.
NOTE 17 DISCONTINUED OPERATIONSPSYCHIATRIC HOSPITAL BUSINESS
During the year ended May 31, 2000, the Company recorded a $30 million charge to discontinued operations ($19 million after taxes, or $0.04 per share) to reflect a July 19, 2000 agreement to settle substantially all of the remaining civil litigation related to certain of our former psychiatric hospitals. The settlements were paid during the year ended May 31, 2001.
NOTE 18 DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amounts of cash and cash equivalents, accounts receivable, current portion of long-term debt, accounts payable, and accrued interest payable approximate fair value because of the short maturity of these instruments. The carrying values of investments, both short-term and long-term (excluding investments accounted for by the equity method), are reported at fair value. Long-term receivables are carried at cost and are not materially different from their estimated fair values. The fair value of our long-term debt is based on quoted market prices and approximates its carrying value. At May 31, 2001 and 2002 and December 31, 2002, the estimated fair value of our long-term debt was approximately 99%, 101% and 93%, respectively, of the carrying value of the debt.
NOTE 19 SUPPLEMENTAL DISCLOSURES TO CONSOLIDATED STATEMENTS OF CASH FLOWS
|
Years ended May 31 |
Seven months ended December 31 |
|||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
2000 |
2001 |
2002 |
2001 |
2002 |
||||||||||
|
|
|
|
(unaudited) |
|
||||||||||
|
(Dollars in Millions) |
||||||||||||||
Interest paid | $ | 473 | $ | 462 | $ | 389 | $ | 308 | $ | 175 | |||||
Income taxes paid, net of refunds received | 226 | 257 | 268 | 93 | 307 |
86
NOTE 20 OTHER COMPREHENSIVE INCOME
The following table shows our consolidated statements of comprehensive income for the years ended May 31, 2000, 2001 and 2002, and for the seven-month periods ended December 31, 2001 and 2002:
|
Years ended May 31 |
Seven Months ended December 31 |
||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
2000 |
2001 |
2002 |
2001 |
2002 |
|||||||||||||
|
|
|
|
(unaudited) |
|
|||||||||||||
|
(Dollars in Millions) |
|||||||||||||||||
Net income | $ | 302 | $ | 643 | $ | 785 | 328 | $ | 459 | |||||||||
Other comprehensive income (loss): | ||||||||||||||||||
Unrealized gains (losses) on securities held as available for sale: | ||||||||||||||||||
Unrealized net holding gains (losses) during period | (142 | ) | 80 | 31 | 18 | (6 | ) | |||||||||||
Less: reclassification adjustments for (gains) losses included in net income | (92 | ) | (39 | ) | 1 | | 47 | |||||||||||
Foreign currency translation adjustments | (1 | ) | (3 | ) | (4 | ) | 2 | 5 | ||||||||||
Losses on derivative instruments designated and qualifying as cash-flow hedges | | | (28 | ) | (26 | ) | | |||||||||||
Other comprehensive income (loss) before income taxes | (235 | ) | 38 | | (6 | ) | 46 | |||||||||||
Income tax benefit (expense) related to items of other comprehensive income | 88 | (12 | ) | | 2 | (17 | ) | |||||||||||
Other comprehensive income (loss) | (147 | ) | 26 | | (4 | ) | 29 | |||||||||||
Comprehensive income | $ | 155 | $ | 669 | $ | 785 | $ | 324 | $ | 488 | ||||||||
The table below shows the tax effect allocated to each component of other comprehensive income for the years ended May 31, 2000, 2001 and 2002 and for the seven-month period ended December 31, 2002:
|
Before-Tax Amount |
Tax (Expense) Benefit |
Net-of-Tax Amount |
||||||||
---|---|---|---|---|---|---|---|---|---|---|---|
|
(Dollars in Millions) |
||||||||||
Year ended May 31, 2000 | |||||||||||
Foreign currency translation adjustment | $ | (1 | ) | $ | 1 | $ | | ||||
Unrealized losses on securities held as available-for-sale | (142 | ) | 53 | (89 | ) | ||||||
Less: reclassification adjustment for realized gains included in net income | (92 | ) | 34 | (58 | ) | ||||||
$ | (235 | ) | $ | 88 | $ | (147 | ) | ||||
Year ended May 31, 2001 | |||||||||||
Foreign currency translation adjustment | $ | (3 | ) | $ | 1 | $ | (2 | ) | |||
Unrealized losses on securities held as available-for-sale | 80 | (28 | ) | 52 | |||||||
Less: reclassification adjustment for realized gains included in net income | (39 | ) | 15 | (24 | ) | ||||||
$ | 38 | $ | (12 | ) | $ | 26 | |||||
87
Year ended May 31, 2002 | |||||||||||
Foreign currency translation adjustment | $ | (4 | ) | $ | 2 | $ | (2 | ) | |||
Losses on derivatives designated and qualifying as cash flow hedges | (28 | ) | 10 | (18 | ) | ||||||
Unrealized losses on securities held as available-for-sale | 31 | (12 | ) | 19 | |||||||
Less: reclassification adjustment for realized losses included in net income | 1 | | 1 | ||||||||
$ | | $ | | $ | | ||||||
Seven Months ended December 31, 2002 | |||||||||||
Foreign currency translation adjustment | $ | 5 | $ | (2 | ) | $ | 3 | ||||
Unrealized losses on securities held as available-for-sale | (6 | ) | 3 | (3 | ) | ||||||
Less: reclassification adjustment for realized losses included in net income | 47 | (18 | ) | 29 | |||||||
$ | 46 | $ | (17 | ) | $ | 29 | |||||
NOTE 21 RECENTLY ISSUED ACCOUNTING STANDARDS
In June 2002, the Financial Accounting Standards Board ("FASB") issued SFAS No. 146. The standard requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. (Under previous accounting standards, a liability for an exit cost was recognized at the date of an entity's commitment to an exit plan.) The provisions of the standard apply to exit or disposal activities initiated after December 31, 2002. In the event that we initiate exit or disposal activities after this date, such as our recently announced plan to divest or consolidate 14 of our general hospitals and our announced cost reduction program, the new accounting standard might have a material effect on the timing of the recognition of exit costs in our consolidated financial statements.
In November 2002, the FASB issued FASB Interpretation No. 45. The interpretation elaborates on the disclosures to be made by a guarantor in its interim and annual financial statements about its obligations under certain guarantees that it has issued. It also clarifies that a guarantor is required to recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. The initial recognition and measurement provisions of this interpretation are applicable, on a prospective basis, to guarantees issued or modified after December 31, 2002. This new interpretation did not have a material effect on our consolidated financial statements.
In December 2002, the FASB issued SFAS No. 148. This standard provides alternative methods for voluntarily transitioning to the fair-value method of accounting for stock-based employee compensation recommended by SFAS No. 123. It also requires prominent disclosures in both annual and quarterly financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. On March 12, 2003, our board of directors approved a change in accounting for stock options granted to our employees and directors from the intrinsic-value method to the fair-value method, effective for our new fiscal year ending December 31, 2003. We estimate that this change will increase salaries and benefits expense by approximately $38 million in each quarter of the 2003 calendar year.
The transition method we have chosen to report this change in accounting is the retroactive-restatement method. As such, future presentations of periods ended prior to January 1, 2003 will be restated to reflect the fair-value method of accounting, as if the change had been effective throughout those earlier periods. For example, the results of operations for the four quarters prior to the January change will be restated to reflect additional salaries and benefits expense ranging between $33 million and $37 million each quarter.
88
In January 2003, the FASB issued FIN 46. This interpretation of Accounting Research Bulletin No. 51 is intended to achieve more consistent application of consolidation policies to variable-interest entities. We do not believe it will have a material impact on our financial condition or results of operations.
NOTE 22 RELATED PARTY TRANSACTIONS
One of our board members is the president of St. Louis University ("SLU"). As a result of our 1998 acquisition of the SLU Hospital, we entered into a 30-year Academic Affiliation Agreement with SLU and in connection therewith we have paid SLU $23.7 million, $24.5 million and $25.3 million in the years ended May 31, 2000, 2001 and 2002, respectively, and $16.4 million in the seven-month period ended December 31, 2002.
SUPPLEMENTAL FINANCIAL INFORMATION
SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
|
Year ended May 31, 2001 |
||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
First |
Second |
Third |
Fourth |
|||||||||
|
(Dollars in Millions, except Per-Share Amounts) |
||||||||||||
Net operating revenues | $ | 2,893 | $ | 2,915 | $ | 3,036 | $ | 3,209 | |||||
Net income | 154 | 175 | 198 | 116 | |||||||||
Earnings per share from continuing operations: | |||||||||||||
Basic | $ | 0.33 | $ | 0.37 | $ | 0.41 | $ | 0.24 | |||||
Diluted | $ | 0.32 | $ | 0.36 | $ | 0.40 | $ | 0.23 | |||||
Year ended May 31, 2002 |
|||||||||||||
|
First |
Second |
Third |
Fourth |
|||||||||
|
(Dollars in Millions, except Per-Share Amounts) |
||||||||||||
Net operating revenues | $ | 3,297 | $ | 3,394 | $ | 3,484 | $ | 3,738 | |||||
Net income | 155 | 89 | 280 | 261 | |||||||||
Earnings per share from continuing operations: | |||||||||||||
Basic | $ | 0.32 | $ | 0.18 | $ | 0.57 | $ | 0.53 | |||||
Diluted | $ | 0.31 | $ | 0.18 | $ | 0.56 | $ | 0.52 |
SELECTED SEVEN-MONTH FINANCIAL DATA (UNAUDITED)
|
Seven months ended December 31 |
||||||
---|---|---|---|---|---|---|---|
|
2001 |
2002 |
|||||
|
(Dollars in Millions, except Per-Share Amounts) |
||||||
Net operating revenues | $ | 7,832 | $ | 8,743 | |||
Net income | 328 | 459 | |||||
Earnings per share from continuing operations: | |||||||
Basic | $ | 0.67 | $ | 0.95 | |||
Diluted | $ | 0.65 | $ | 0.93 |
All periods have been adjusted to reflect a 3-for-2 stock split declared in May 2002 and distributed on June 28, 2002.
89
Operating results for an interim period are not necessarily representative of operations for a full year for various reasons, including changes in Medicare regulations, levels of occupancy, interest rates, acquisitions, disposals, revenue allowance and discount fluctuations, the timing of price changes, gains and losses on sales of assets, impairment and restructuring charges and fluctuations in quarterly tax rates. For example, fiscal 2001 includes impairment of long-lived assets and restructuring charges of $143 million, loss from early extinguishment of debt of $56 million, and net gains on sales of facilities and long-term investments of $28 million recorded in the fourth quarter. Fiscal 2002 includes impairment of long-lived assets and restructuring charges of $99 million recorded in the second quarter and loss from early extinguishment of debt of $110 million, $165 million, $12 million and $96 million recorded in the first, second, third and fourth quarters, respectively. The seven months ended December 31, 2001 includes a $281 million charge for losses from early extinguishment of debt and a $99 million charge for impairment of long-lived assets and restructuring charges. The seven months ended December 31, 2002 includes a $396 million charge for impairment of long-lived assets and restructuring charges and a $64 million charge for impairment of investment securities.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
90
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS
COMPANY DIRECTORS AND NOMINEES
Jeffrey C. Barbakow
Chairman and Chief Executive Officer
Chair of Executive Committee
Age: 59
Mr. Barbakow has been our Chairman and Chief Executive Officer since June 1993. Prior to joining the Company, Mr. Barbakow served as a Managing Director of Donaldson, Lufkin & Jenrette Securities Corporation from September 1991 through May 1993. From 1988 until 1991, Mr. Barbakow served as Chairman, President and Chief Executive Officer of MGM/UA Communications, Inc. Prior to 1988, Mr. Barbakow served as a Managing Director of Merrill Lynch Capital Markets and an executive officer of several Merrill Lynch affiliates. In addition, Mr. Barbakow served as a director of MGM Grand, Inc. from November 1988 through May 1993. Mr. Barbakow is a director of H Group Holding, Inc., the U.S. Chamber of Commerce and Broadlane, Inc. He also serves as a member of the CEO Board of Advisors of the University of Southern California Marshall School of Business, The UCSB Foundation Board of Trustees, the Board of Trustees of the Thacher School and the Chancellor's Counsel at the University of California at Santa Barbara. Mr. Barbakow has been a director since 1990. His current term as a director expires at this year's Annual Meeting. Mr. Barbakow will retire from the Board effective immediately prior to the 2003 annual meeting of shareholders (the "Annual Meeting").
Lawrence Biondi, S.J.
Director
Chair of Ethics, Quality & Compliance Committee
Member of Executive Committee
Age: 64
Father Lawrence Biondi, a Jesuit priest, linguist and educator, has been President of Saint Louis University in Missouri since July 1987. From 1980 to 1987, Fr. Biondi was dean of the College of Arts & Sciences at Loyola University of Chicago, where he served on the faculty of modern languages since 1968. Fr. Biondi, who holds six degrees, is a widely published author in the field of sociolinguistics, in which he has analyzed issues in bilingual-bicultural education, patient-doctor communication and ethnicity. He is a former consultant on ethnicity for the City of Chicago. He sits on the boards of the Association of Jesuit Colleges and Universities; the Joint Commission on Accreditation of Healthcare Organizations; IberoAmericana University, Mexico City, Mexico; Civic Progress, St. Louis; Conference USA; Grand Center, St. Louis; Missouri Botanical Garden; Saint Louis University; St. Louis Art Museum; St. Louis Regional Chamber and Growth Association; St. Louis Symphony; and St. Louis Zoo. Fr. Biondi has been a director since 1998. His current term as a director expires at this year's Annual Meeting. Fr. Biondi will stand for election at this year's Annual Meeting.
Bernice B. Bratter
Director
Chair of Compensation Committee
Member of Executive and Nominating Committees
Age: 65
Ms. Bratter, a licensed Marriage and Family Therapist, served as the President of the Los Angeles Women's Foundation, a public foundation dedicated to reshaping the status of women and girls in Southern California, from October 1996 through May 2000. She provides free consulting services to a
91
number of non-profit and other entities, including Project Renewment, of which she is a co-founder and which explores the different challenges women executives face when leaving the workforce. Ms. Bratter served as Executive Director of the Center for Healthy Aging, formerly known as Senior Health and Peer Counseling, a nonprofit health care organization located in Santa Monica, California, from 1980 through her retirement from that position in March 1995. From March 1995 through September 1996, she lectured and served as a consultant in the fields of not-for-profit corporations and issues related to health care and aging. In 1981, Ms. Bratter was a gubernatorial appointee to the White House Conference on Aging as an observer. She is the recipient of numerous awards and commendations including the YWCA Woman of the Year Award, the Senior Health and Peer Counseling's Community Leader Award and other county, state and federal commendations. In 1991, Ms. Bratter was presented with an Honorary Doctor of Laws degree by Pepperdine University. Ms. Bratter has been a director since 1990. Ms. Bratter will retire from the Board effective upon the election of directors at this year's Annual Meeting.
Sanford Cloud, Jr.
Director
Chair of Corporate Governance Committee
Member of Executive, Ethics, Quality & Compliance and Audit Committees
Age: 58