TenetQ306PreparedRemarks1

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TenetQ306PreparedRemarks1

  1. 1. Tenet’s Q3 2006 Earnings Call Prepared Remarks November 7, 2006 Trevor Fetter, President and Chief Executive Officer Thank you, operator, and good morning. I’m just going to focus my remarks on the two headwinds we’ve been fighting all year: weak volumes and unprecedented high levels of bad debt expense. Macro Environment Let me start by giving you my perspective on these problems at a high level. Two trends that affect hospital volumes and bad debt expense have been taking place in the health benefits area: people have health coverage that is less comprehensive, and they bear a responsibility for a higher “out-of-pocket” portion of the cost of their health care. The weak volumes and higher bad debt expense across our industry have been in evidence now for a little bit more than three years. Over that same period of time, there have been three related trends in employee benefits: • First, fewer small employers, defined as companies that employ under 200 people, are offering health benefits at all. The percentage of small employers offering benefits has dropped from around 65 percent to 60 percent. Fortunately, employer-based health insurance in large firms is still high: 98 percent of firms that employ more than 200 people offer health benefits, and that percentage has been either 98 percent or 99 percent for each of the past three years. But, most of the job growth in this country, 84 percent to be exact, has been occurring in small firms during the three year period I’m talking about. As more people join small employers and those employers stop offering health benefits, more people become uninsured. • The second trend, the percentage of employees of all firms, regardless of size, who are covered by employer-based health benefits, has dropped from 62 percent to 59 percent. This is due to a variety of factors, such as employees not choosing to take coverage that is offered to them, as well as firms structuring their work force with an increasing percentage of part-time workers who don’t qualify for benefits. It’s very important to remember that 80 percent of the uninsured have at least one family member who has a job. So, these people have jobs; they just don’t have insurance. It’s either because they’ve chosen not to pay for the employee benefit, or they can’t afford to pay for it and still meet basic needs, or because their employer effectively does not offer it to them. 1
  2. 2. • The third trend is that in response to rising costs, employers of all sizes have steadily reduced the portion of health costs paid by the company and have shifted those costs toward the employee. Traditionally, the split between the employer portion and employee portion was 80/20. That ratio has changed just in the past two years. It was 78/22 in 2005, and estimated to be 77/23 in 2006. While this may not sound like a big shift, it has resulted in double-digit percentage increases in health premiums to employees in each of the past three years. These increases far exceed the percentage increases in wages generally, so it encourages employees to select the least expensive options or to drop coverage. The least expensive plans typically have the highest deductibles and co-pays. Tenet is actually on both sides of this problem. In the spirit of full disclosure, as a large employer, we have been pursuing these and other strategies to control our own benefits costs. So these three trends affect hospitals in ways that we can’t completely quantify. First, they may have the effect of suppressing volume because of the increasing cost to the patient. Second, when the patient does get treated, the financial burden is one that they choose not to pay or can not afford to pay. The bottom line is that a cost that has traditionally been borne by employers is now being shifted onto employees, who shift it to doctors and hospitals. In the simplest terms, we ultimately collect 97 cents of every dollar we bill to insurance companies, 60 cents of what we bill to insured individuals, and only 8 cents of what we bill to uninsured individuals who don’t qualify for charity care. These collection rates show the dramatic effect on Tenet’s earnings that can be caused by the trends in employee benefits design that I mentioned earlier. On top of this, there’s an additional factor suppressing industry volumes for which we don’t have hard data to provide statistics, but we see the impact in subtle ways. Managed care companies have been clamping down on utilization of medical services. The industry term is “increased medical management.” This has tended to go in cycles during the past ten years, but for the last two to three years managed care payors have been reverting to tougher controls on approving care, which suppresses hospital admissions and length of hospital stays. At Tenet, our Commitment to Quality initiatives have placed us ahead of this trend. For example, when we adopted Interqual admissions standards and American Heart Association and American College of Cardiology appropriateness criteria beginning three years ago, we were effectively preventing admissions for medical services that the managed care companies might later disapprove under tighter medical management standards. Let me tell you what we’re doing to mitigate the industry factors that I just spoke about: Bad Debt In the area of bad debt, in addition to initiatives we’ve previously discussed, we have enhanced our collection processes and intake procedures by refining our self-pay segmentation, introducing new easy-to-understand patient billing statements, and creating a new letter that we send to managed care patients with their estimated balance due. September was the first full 2
  3. 3. month in which we sent the letters to patients with a balance-after insurance, and that alone generated an additional $1 million in cash in the month. We also completed our Center for Patient Access, or CPAS, pilot with very impressive results. The results demonstrate an increase in the percentage of scheduled pre-registered patients financially cleared before service from 70 percent to over 95 percent. Although it is too early to see the results on denials and bad debt expense, we expect it to be positive. Volumes We’ve talked at length in prior calls about what we’re doing to grow patient volumes. Although Q3 was weak, I’m pleased to say that Q4 is off to a good start. Admissions increased 1.2 percent in October. Our preliminary information suggests that commercial managed care admissions grew in the month by 0.6 percent, so the admissions growth was not driven entirely by the uninsured. Now, please remember that this is only one month of volume data, and we have not yet closed the books for the month. Also, to give you some context, in October 2005 admissions declined by 3.1 percent versus October 2004 for these same hospitals. Normally, we would not report on one month’s data, but we thought we should bring October’s admissions results to your attention because it represents a very substantial change from the results of the third quarter. A part of our reasoning was that if this were a 400 basis point swing the in the wrong direction, we would also have disclosed it. We’ve laid a foundation for growing volume with the following categories of actions: 1. Resolving the legal overhang that clouded the company’s future 2. Injecting capital into our hospitals, and making commitments to our physicians and communities that we will keep these hospitals competitive 3. Actively managing our service lines through our targeted growth initiative 4. Employing classic sales techniques, through our Physician Sales and Service Program, to draw attention to these investments and ask physicians for their support 5. Driving better managed care contracting through the strategic use of data and information systems, and through participating aggressively in the payors’ quality designation programs 6. And most importantly, differentiating our hospitals on quality and service I’m confident that this approach will work and it will be sustainable. Reynold will cover the volume topic in detail in a few moments. 3
  4. 4. C2Q Strategy Turning to quality, those of you who have followed us for at least three years know that our strategy is to differentiate our hospitals on quality and service. You’ve been patiently waiting for proof that quality and economics go hand-in-hand. The first results we were able to report were the CMS Hospital Compare ratings. At our investor day, I went into detail on this, and the presentation is still on our website. Suffice it to say that our improvement trajectory is steeper than the national average; our performance compares favorably to some of the finest hospitals in the country; and our quality ratings are ahead of our peer companies. The next results we reported were the number of centers of excellence designations we received from major payors. Our United Healthcare Centers of Excellence designations were five times the national average rate of designation. Now, we’re able to compare volumes in those hospitals with centers of excellence-designated services to see what it means, in terms of volume, to differentiate a hospital on quality. Cardiology DRGs are the most mature of these programs. In the first nine months of the year, our United Healthcare Centers of Excellence hospitals grew cardiology volumes by 11 percent. This growth is incredibly strong. During the same nine months, cardiology volumes from United in our non-centers of excellence designated hospitals were up 3 percent. To place this in context, our cardiology volumes across all payors in the first nine months of the year were down 5 percent. Total cardiology admissions from just managed care payors were down 3 percent, which is in the range of the overall admissions decline. So, in a service line that was down more than overall admissions, through our managed care contracting strategies we achieved 2 percent better volumes from managed care (that’s the difference between negative 5 percent and negative 3 percent). We achieved growth of 6 percent with United Healthcare overall, and when we obtained the United Healthcare Centers of Excellence Designations, we grew cardiology volumes by 11 percent. And again, that’s for the first nine months of 2006. We knew at the outset that pursuing distinctive quality would be the right thing for our patients. These statistics show that it is also the right thing for the economic well-being of our hospitals. With that as an overview, I’ll turn the call over to Reynold Jennings for a more thorough explanation of our operating performance in the quarter. 4
  5. 5. Reynold Jennings, Chief Operating Officer Thank you Trevor and good morning everyone. I want to focus my comments this morning on two issues which are central to your understanding of how our performance improvement plan is coming together. These topics are first an update on the results of our Physician Sales and Service Program, which we refer to as PSSP, and secondly, the issues which have led to delayed earnings recoveries in three important markets: Houston, Texas; Palm Beach and Broward Counties, Florida; and certain California markets. In addition, I’ll provide a brief update on our plans for growing our outpatient business. Before reporting the progress on PSSP, however, I want to place this initiative in context. There are numerous previously reported strategies, which are being implemented across our company, to put us back on a sustainable growth path. PSSP is only one of these programs. I like to think about these efforts as supporting our objectives in the short, the middle and the long-term. Short term Initiative Impact In this regard, I define short-term as those initiatives which we can complete in the next six to 12 months. In addition to PSSP, this includes our Targeted Growth Initiative, which is already two-thirds of the way through its analytical phase and more than one-third through its implementation. Most of you are aware that TGI resulted in some self-inflicted volume losses in its early stages of implementation in California. Except for Florida, where we expect to exit some businesses, we are not seeing so far, material self-inflicted admissions declines in Southern States, Texas or our Central Northeast markets, including Philadelphia, as TGI is rolled out in these markets. Our incremental capital expenditure program – the approximate $150 million of the $800 million in capital commitments that we have targeted for 2006 – I also put under the heading of short- term. It is natural to be interested in whether these recent investments have generated incremental admissions, but this is an impossible question to answer with acceptable accuracy. If we call on a physician to communicate that we have just installed a long-desired piece of clinical equipment and then see incremental admissions from that doctor, should those admissions be credited to PSSP or our cap-ex program? Obviously, when you’ve got the types of inter-related strategies that we’re executing it is extremely difficult to make that type of distinction. 5
  6. 6. Mid-term Initiative Impact Turning to our mid-term strategies, which we define as those we can complete within 12 to 24 months, we also have a number of inter-related efforts going on. During this time frame, we will move into the volume building phase of TGI, particularly in California and Florida. This means we will be adding to or expanding the service lines TGI identified as addressing local market demand. In this time frame, we will also be moving aggressively into the building phase of our outpatient program. We introduced this program to you at investor day, and I’ll be exploring this program in more detail in just a few minutes, but within this mid-term 12-to-24 month time frame you should expect considerable activity on this front. In addition, we are developing some physician alignment strategies, including joint ventures and targeted physician employment strategies, which can be expected to contribute to our growth over the next 12 to 24 months. So that no one gets the wrong idea, when I say “targeted” physician employment, you can be sure that this targeting will be done with laser-like precision. I am not talking about a massive program with regard to physician employment. In passing, I should note that the number of employed physicians we have today is only 10 percent higher than we had four years ago. Long Term Initiative Impact Longer-term, looking out 24-to-36 months, still more initiatives will come into play, including the new capacity that we’re adding in El Paso, where we have already broken ground; Brookwood; USC University Hospital, North Fulton and Spalding, where we are completing existing projects; and other hospitals where we are actively seeking state agency permission to build. PSSP Update I hope that brief overview gives you some sense of the many fronts across which we are acting to grow our business and why the careful layering and interconnectivity will take about three years to establish the correct foundation for sustainable growth. As a program generating immediate benefits, Physician Sales and Service Program, or PSSP, certainly deserves all the attention it has received, but it needs to be viewed in the context of these other programs with which it forms an inter-related whole. With that said, let’s turn our attention to the performance of PSSP in the third quarter. From a management perspective, the fundamental question we want to answer is whether PSSP is generating an adequate yield from our physician visits and making a meaningful contribution to our growth strategy. 6
  7. 7. Consequently, just as we did with other systems in quality, managed care and patient financial services, we are evolving our PSSP management and information systems to help us answer that critical question. I’m anticipating that many of you may have a number of questions which would require us to cut the data in a number of creative ways, but remember, our goal, at the macro level, is to assess the efficacy of the initiative as a whole. At the micro, or hospital level, this data is tracked by each physician, but it can not currently be rolled up to the corporate level based on various scenarios one would want to analyze. So, the data I present to you will reflect that limitation. First, as a benchmark, let me review the PSSP data I shared with you at the end of the second quarter. At that time, we looked at the results of our concentration on 1,300 physicians of the total that we visited in the first half of 2006 and noted that these physicians increased their admissions by about 1,200 admissions in the second quarter relative to the first. Because the seasonality component is so dramatic in Florida, when comparing admissions between the first and second quarters, no Florida physicians were included in this analysis. Given additional time to refine our data collection and analysis, we can now express this data on a year-over-year, comparable quarter basis so that seasonality is not a factor. Also, taking a sequential quarterly view at the macro, or individual physician level, would be misleading since the third quarter is a peak vacation time for physicians and the fourth quarter has the major holiday and religious observance impacts on individual physician activity. Quarter over Quarter Q3 Visits Impact So, let me give you the admissions yield resulting from all of the 2,900 physicians we visited in the third quarter who were active in either the third quarter of ’05 or ’06. Our admissions from these physicians were up by 1.5 percent in the third quarter of ’06 versus third quarter of ’05. By contrast, this means that admissions from the roughly 6,550 physicians we did not visit declined by 3,850 admissions, or 6.5 percent. Let me make a few observations about this data: • First, these 2,900 physicians come from all our markets, including Florida. • Second, some of these physicians were visited for the first time in the third quarter, and some were among the 1,300 physicians on which we concentrated in the first half of ’06. • Third, admissions growth varied significantly across our markets. California and Florida again showed admissions declines from these physicians while, at the other end of the spectrum, our Central Northeast market achieved growth of just over 10 percent. 7
  8. 8. • And, lastly, some physician visits occurred very late in the quarter, and therefore, had little time to respond with incremental referrals. We have also tracked the outpatient visits we’ve received from the 2,900 physicians we visited in the third quarter and they increased by 2.5 percent in the third quarter of ’06 versus third quarter of ’05. This stronger outpatient growth confirms our earlier observation that outpatient referrals tend to precede the inpatient business. Then, if the outpatient experience is satisfactory, the inpatient business tends to follow. So that tells you the results achieved in the third quarter from the physicians we visited in the third quarter. Taking this data and adding it to the results that I shared with you in August when we released our second quarter results creates a reasonably convincing impression that PSSP can be effective in creating an immediate and meaningful increase in referrals. Now, I need to warn you that there is some imprecision in this data. Physician actions are not always readily trackable. One problem is the whole issue of hospitalists, which carries the potential that a visited doctor starts to send you increased volume, but that business shows up under a different doctor’s name. This issue is compounded when doctors move patients to their physician partners within a doctor group. But even with these difficulties, the power of PSSP to “move the needle” is clearly visible. Quarter over Quarter Q1 and Q2 Impact in Q3 So, what about the longer term impact of PSSP? When we examined the on-going behavior of the physicians we visited in the first half of the year, we unfortunately found that their third quarter admissions declined by 1,523, or 1.8 percent. That’s comparing admissions in the third quarter of ’06 to admissions in third quarter of ’05. But to place this result in context, the 4,600 physicians who were not visited in the first half of the year had a decline in admissions of 3,252, or 5.4 percent in the third quarter. So, at a minimum, PSSP was able to create an improvement in the growth rate of admissions by 360 basis points. In addition, I will note below some examples of unique local competition that suggests a major portion of the admissions decline had a rationale unassociated with our PSSP sales and service efforts. As we have come up on the learning curve with PSSP, we saw a need for more formal sales training, a need to maintain local focus, and a need to constantly enhance our systems data capture and the ability for quicker, deeper analytical review. To get at the first two needs, we hired John Landino as previously reported. John is going through a carefully structured education program at headquarters and at selected hospitals. His work products will be designed by the end of the year, and he will be full speed in January. On the last need, it took several 8
  9. 9. months to refine the other systems that I referred to above, so we believe it will take most of next year to get the PSSP system to the same level of operability. As of now, we are working on improving the third visit to a physician which, after listening and then solving service problems, is what I call “Closing the Sale.” If we’ve convinced the physician that we are moving the hospital in a positive direction, then in a direct statement, ask for increased business. Make it specifically clear that their support is necessary for further progress. It’s “Salesmanship 101,” but you’ve got to close the sale. In each of these visits, we also work to develop a solid relationship with the physician’s office manager. This individual can be incredibly important to the direction of patient flow and it’s critical to identify and address any issues at this level. The focus needs to be maintained on attention to detail and rigorous and timely follow-up. Market Focus I’d like to turn your attention now to a couple of markets where our turnaround efforts are lagging our initial expectations. Palm Beach and North Broward The first of these markets is Palm Beach and North Broward, Florida. While all of Florida has felt the economic effects of last year’s hurricanes, the effect has been magnified in the Palm Beach and North Broward market. In the winter months, these two counties have some of the most attractive demographics in Florida, or any other state for that matter. These two markets are more dependent on higher-income individuals with multiple options for their living arrangements than other Florida markets. So, fears of another bad hurricane season in 2006, which frankly, didn’t materialize, and decisions to stay up north while repairs triggered by last year’s storms were completed, hit this market hard. As a result, Tenet’s volumes in this market have yet to rebound from the declines in 2005. In the aftermath of a very quiet 2006 hurricane season, we are hopeful that the population statistics will soon return to normal levels. This will go a long way towards restoring the profitability of our hospitals in this market. We also took a hit in Palm Beach on the issue on “call pay” for emergency department coverage. In retrospect, it is clear that our refusal to provide an appropriate timely response to this issue was costly. We tried to hold the line on this cost issue, but ultimately, our competitors caved in. In the course of holding out, it is clear that we alienated some physicians. The solution is in place, but we have yet to win back any physicians we lost over this issue. Houston Moving to Texas, Houston has a different set of issues. The same high projected growth rate that makes Houston a high-potential market for Tenet, makes Houston equally attractive for the 9
  10. 10. significant investment the Houston market has seen in facilities with physician equity participation, as well as investments by the not-for-profits. These investments are made easier by the relatively light regulatory environment in Texas. The analytical phase our Targeted Growth Initiative was recently completed in Houston. We believe these actions will help to put us on a trajectory to intermediate-term enhancements to profitability. In the longer-term, even if we merely retain a position near our current market share, the anticipated growth in demographics should bolster Tenet’s longer-term performance in Houston. California And then lastly, four hospitals contributed to most of our shortfall in California with TGI and risk-based IPA contracts, the same drivers of shortfall as previously reported in the first two quarters. The net volume impact of TGI continues to be negative at this point in the implementation of the program. Given that California led the other regions in implementing TGI, this was not an unexpected result from their analytic data. However, given that California completed TGI in the first quarter of ’06, the expectation is for a net positive impact by the latter part of 2007. Update on Outpatient Initiative Let me switch gears now and bring you up to date on our outpatient strategy. At this summer’s investor day, we told you we were in the process of evaluating over 30 projects which were in various stages of development. That list has since been expanded to over 60 projects that are in various stages of analysis or development. Most of the surgery center projects are structured as joint ventures. At this point, we have identified 11 projects to which we are committed and should be completed in 2007. Four of our commitments are to ambulatory surgery centers and seven are to diagnostic imaging centers. While we have some urgent care primary care projects also under analysis, we have not yet committed to any of these projects. These free standing outpatient projects will require a commitment of approximately $40 million in capital expenditures over the next year, including something in the neighborhood of $5 million in the current quarter. I expect this level of investment will grow considerably by 2008. In closing, let me reiterate a point I emphasized several times in previous calls, which is we expected our progress across these many fronts to be anything but linear during the foundation period. However, we believe the sum total of our interconnecting operational strategies and initiatives to be the correct ones to land us at an appropriate place in the next 2-3 years. 10
  11. 11. Let me now turn the floor over to Biggs Porter, Tenet’s chief financial officer. Biggs Porter, Chief Financial Officer Thank you Reynold and good morning everyone. I want to offer some additional color on third quarter results and then provide some comments on the challenges we see going forward and our actions to mitigate their impact. To Begin with Earnings We reported a loss from continuing operations of $30 million, or 6 cents per share. We also listed five items in the press release this morning, which have a net favorable impact of 2 cents per share on continuing operations, and provided the details on these so you can draw your own conclusions on our underlying profitability for the quarter. Adjusted EBITDA for the quarter was $108 million, for a margin of 5.1 percent. On Volumes Trevor and Reynold have both explored various aspects of our results for patient volumes, so I won’t have a lot to add. While PSSP continues to suggest that volume declines can be reversed if given an appropriate focus, and the results of our COE hospitals are clearly impressive, the aggregate reality is that admissions were down 3.3 percent and commercial managed care admissions declined by 6.3 percent. Clearly, industry headwinds are generating formidable challenges, and the successful reversal of the declines in our volume picture is likely to take time and be subject to considerable volatility. Most of you estimated a more favorable third quarter than we did ourselves, but we missed our own expectation as well. Having said that, with the absence of hurricanes, our fourth quarter is traditionally stronger and we remain confident that the fourth quarter will generate an improvement in our admissions trend. With the higher volumes, we also expect better mix, as the seasonal fourth quarter volume growth is not normally driven by the uninsured. One of the greater uncertainties remains Florida, which although we have not had hurricanes this year, is still suffering the longer term effects of last year’s property loss and displacement of both the seasonal and permanent population. 11
  12. 12. With Respect to Pricing We achieved gains in pricing consistent with our expectations. As we stated on prior calls, we expected that these gains in managed care pricing would gradually moderate as prior year comps become more challenging. In the third quarter, this was the case, with the higher comps being the biggest factor in restraining our growth rate in pricing. While commercial managed care outpatient revenue per visit increased 7.2 percent over the prior year quarter, managed care net revenue per inpatient admission was up 3.9 percent. I want to take a few minutes to explore this increase more thoroughly, as there are a large number of factors which impacted this outcome, including: • Business mix • Average length of stay • A modest decline in our case mix index, and • Changes in admission patterns across regions and hospitals which occurred in the quarter Let me take these issues one at a time. One of the reasons for the smaller increase in managed care pricing than you have recently seen at Tenet is the continuing mix change between government programs and commercial managed care within the managed care portfolio. Commercial inpatient base rates were actually up 9.2 percent from a year ago. But a year ago, almost 83 percent of our managed care revenues came from the commercial piece of the business, while in this year’s third quarter the percentage from commercial declined to 79 percent. This changing business mix had a significant dilutive effect on our pricing progress. If the third quarter’s mix this year had been the same as last year, revenues this year would have been higher than reported by $35 million. The second impact on our pricing results was a significant drop in stop loss payments. Stop loss payments were $72 million in the third quarter, a decline of $19 million, or 21 percent from the $91 million reported in last year’s third quarter. As we have discussed previously, the primary driver is the change we instituted in our approach to structuring our managed care contracts, which shifted our payments toward base rates and away from stop loss. As a result of this approach to negotiating our contracts, we now receive stop-loss payments on 4.6 percent of our commercial managed care admissions. We believe this ratio is typical for the industry. The decline in stop-loss is also one of the reasons we were successful in maintaining solid growth in our base rates, which, as I just mentioned, were up 9.2 percent in the quarter. Within the commercial managed care portfolio, average length of stay declined from 4.01 days in the third quarter 2005 to 3.94 in the current quarter. These shorter stay times had a negative effect on revenue per admission by approximately 200 basis points. 12
  13. 13. In addition, we experienced a 1.6 percent decline in our case mix index from the second quarter. This reflects a normal seasonal decline, and therefore, has minimal impact on our year-over-year pricing metrics, but still makes it incrementally difficult to achieve a strong quarter from a pricing perspective. Lastly, the relatively larger decline in volumes in some of our Southern California hospitals, where Tenet tends to have its highest pricing, also restrained the advance in our pricing metrics for the quarter. This was influenced by the TGI implementation, which continues to rollout in those markets. This litany of causal factors illustrates a point we have made repeatedly: that pricing metrics can be surprisingly volatile given their inherent sensitivity to the specific patients who show up at which hospitals, and the precise nature of their medical conditions. With Respect to Bad Debt The increase in bad debt was higher than we anticipated and a definite disappointment. Compact-adjusted bad debt was 16.4 percent in the third quarter versus 14.9 percent a year ago, and 14.2 percent in the second quarter of this year. On a reported basis, which excludes the Compact adjustments, bad debt was 7.4 percent in the third quarter versus 5.8 percent in the second quarter, or an increase of $29 million. I am going to focus on the sequential quarter increase, as we feel that at this point it provides a more meaningful comparison by avoiding the distortion of the Compact adjustments. Before getting into the specifics of the increase, I thought it would be helpful to review Tenet’s accounting treatment for bad debt expense. Tenet recognizes bad debt expense by writing down self-pay accounts receivable, including accounts due from patients with insurance or “balance-after” accounts, to their net realizable value. Self-insured patients are reserved for at the point of discharge. Balance-after amounts are reserved once we receive the EOB from the carrier, about a 30 day lag. Trevor told you earlier that we collect 97 cents of every dollar we bill to insurance companies, 60 cents of what we bill to insured individuals, and only 8 cents of what we bill to uninsured individuals who don’t qualify for charity care. This reflects collections made within two years, including collections made at the point of service. We are reserving for these levels at the point of discharge, or in the case of balance-after, upon receipt of the EOB from the carrier. This level of initial reserving is generally sufficient to provide for adequate coverage of the receivables as they age, since it uses a composite of our collection history. In instances where it does not, because of greater or lesser than normal aging of receivables, we increase or decrease the reserve. 13
  14. 14. Typically, the balance-after bad debt exhibits a seasonal high in the first quarter when individuals have not yet met their deductibles, which gradually declines in later quarters. With that being said, let me now review the reasons behind the approximate $29 million increase in reported bad debt expense for Q3’06 over Q2’06. Approximately one-third of the increase resulted from increased self-pay volumes. An additional third was the result of a deterioration of the aging of managed care receivables. This aging was in the over 360 day category. These older balances relate to an earlier time period before we introduced enhanced contract language and defined better adjudication procedures. The remainder was from various other unusual factors, including: • Primarily, the resolution of older outstanding managed care accounts, which increased both bad debt expense and revenues in an offsetting manner, and; • To a lesser extent, an increase in self-pay accounts assigned to our collection agency, and; • Other miscellaneous items. There were no material changes to our geographic concentrations in bad debt. Texas and Florida continue to report percentages higher than other markets. We have spoken previously about our efforts to mitigate the growth in bad debt expense, and Trevor has just referred to these kinds of actions as well, so I am not going to reiterate. I will, however, emphasize that we are actively working this area in an effort to combat the industry challenge. On Cost Efficiency Solid cost management continues to contribute to our performance. Despite declining volumes and the adverse impact this has on operating leverage, controllable operating expense per equivalent patient day grew by just 3.5 percent in the quarter. Our performance on controlling the growth in supplies expense was truly outstanding. Again, on a per equivalent patient day basis, which neutralizes the impact of declining volumes, supplies expense was up only 1.3 percent – an impressive testament to a variety of programs we have introduced to control what can otherwise be a runaway cost item. With Respect to Capital Expenditures Capital expenditures for continuing operations in the third quarter were $133 million, a little below what we had anticipated. Recall, however, that much of the clinical technology 14
  15. 15. investments we expect to make this year have relatively long lead times, so not much of the increment we announced at the end of June was completed in the first 90 days. We expect a significant step-up in spending to be apparent in our fourth quarter numbers, although it is very possible, if not likely, that we fall short of the $700 million cash expenditure for continuing operations we had anticipated. Our best estimate for the fourth quarter is $250 to $300 million, which would bring total 2006 cap-ex up to approximately $650 million. As I said last quarter, any variance should be considered timing in nature, as we still plan on committing $800 million this year. As we have said before, on many items the lead time is significant, and we also are taking the time to ensure we achieve the best pricing and complete the necessary financial analysis. I should note that we have received very positive feedback from our physicians with regard to our investment plans. Although we wouldn’t normally comment on capital spending in discontinued operations, for the third quarter this includes a capital expenditure for the buy out of our joint venture partner at Encino-Tarzana in order to facilitate our exit of the business. Turning Now to Cash Current quarter cash flow from operations was $200 million and unrestricted cash on hand was $809 million at September 30 of this year. This still leaves us in position to have approximately $1 billion or more in cash at year end. The primary drivers for the fourth quarter are the federal income tax payments of approximately $110 million, capital spending of $250 to $300 million, proceeds from asset sales of about $80 million, the release of the restricted cash, fourth quarter EBITDA and year-end accrual and other working capital changes. I Will Give a Few Words on Taxes As announced last week, the company received a Revenue Agent’s Report, or “RAR,” which affected the company’s tax accounts and NOL carry forward. Tax accounting is not simple by any means, but to be brief, two things happen when you receive an RAR. First, you assess the position of the agent relative to what you have reserved, and secondly, you assess the effects of the RAR on your NOL and its recoverability under GAAP. The net effects of these are assigned to continuing and discontinued operations. The net effect for us was as indicated in the results for the quarter, with the only cash effect being that we have decided to pay the amounts not in dispute of $85 million plus interest in the fourth quarter. We had adequately provided for that amount and for what we believe to be the ultimate resolution of other matters in dispute, but assumed payment would not occur until conclusion of any appeals. After taking into account the effect of the RAR, the company’s net operating loss carry forward from 2004 and 2005 is approximately $1.3 billion. 15
  16. 16. Now, Turning to Our Outlook Last week, we indicated that we believed we would still achieve adjusted EBITDA for the year in the range of $670 to $770 million, although it was unlikely that we would be in the upper end of the range. I will elaborate: I have discussed our bad debt and admissions results for the quarter. As I noted earlier, we expect improved volumes in the fourth quarter from seasonal drivers alone. Any further success in our PSSP and other strategies will further support this. Year-to-date we have experienced admission declines of 2.9 percent. We believe that in the fourth quarter we can have slightly positive admission growth, which would be in line with our prior outlook for the full year and would support achievement of the middle of our range. October admissions to date have been consistent with this outlook for the fourth quarter, but I have to caution that one month does not a quarter make, and admissions are not the only financial variable. Also, our outpatient visit statistics are not final for October and, although improving, it appears they may lag inpatient growth. Improved admissions should be accompanied by better mix and improve bad debt as a percentage of revenues as well. If, on the contrary, we were to assume admissions declines, and uninsured and bad debt experience continued at the rate experienced in the third quarter, we would be around the lower end of the range for Q4. I know many of you are likely to ask about 2007 and out intermediate term outlook. We are still in the planning process, and would expect to not give any current outlook for 2007 and beyond until we release earnings for the full year 2006. Every quarter gives us better insight into our prospects and the degree to which our strategies are taking hold. Our fourth quarter will give us one more piece of information and be key indicator of how some of our markets are responding, particularly Florida. If you ask if bad debts, uninsured and admissions trends represent real risks to our intermediate outlook, I will have to say yes. However, we not only look at the risks and mitigation, but also the opportunities and are going to drive on those. Reynold has already talked about some of these, but they include rightsizing of our overhead costs to reflect the loss of business base due to dispositions; reduced third party contracting costs as some of our current initiatives mature; outpatient expansion; adjusting the FTE levels of our hospitals, which are above industry benchmarks (this includes some of our better performing hospitals); further leveraging of our initiatives to consolidate our buying power; denial management; length of stay reduction; leveraging clinical product development to improve not just quality, but also efficiency; and reductions in malpractice expense enabled by our quality initiative. I could go on and on. The point is that it is not all just about PSSP, TGI and bad debts. There are a number of things we are doing to improve our performance that will either act as mitigators of the external pressures or hopefully create upside. I am not going to give you specific targets for each of these or for those I haven’t mentioned. We also should expect the benefits of these actions to be realized over time and for our results to 16
  17. 17. fluctuate on the short term. I just want to be clear that there are a number of levers we are going to pull to improve our results. Finally, before we move to Q&A, since I missed our last investor day, I can’t wait to schedule the next one. So, at this time I would like to announce that we are going to hold our next investor day on June 5, 2007. Let me now ask the operator to poll our callers for the Q&A session. [END] 17

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