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  1. 1. Tenet’s Q3 2007 Earnings Call Prepared Remarks November 6, 2007 Trevor Fetter, President and Chief Executive Officer Thank you operator, and good morning. Our performance in the third quarter was the best in several years, and all of us at Tenet are very pleased with our progress. If you look at the charts of key performance indicators we posted on our Web site today, it is clear that the trends in volumes, pricing and cost control are moving in the right direction. There are other metrics we watch, in areas like physician activity and the revenue cycle, and they are trending positively as well. I’ll start with patient volumes. Same-hospital inpatient admissions declined by 0.8 percent. This is a significant improvement over the second quarter’s year-over-year comparison of negative 2.2 percent. More importantly, same-hospital commercial managed care volumes declined by only 0.6 percent year-over-year, which is the best performance in this statistic since we began reporting it two years ago. Many of you like to know how our business is doing outside of Florida and USC University Hospital. In the rest of our company, same-hospital admissions increased by 0.1 percent and commercial managed care admissions increased by 0.4 percent. The trend in outpatient visits also showed improvement, declining just 1.4 percent in the quarter compared to a decline of 3.1 percent in the second quarter. 1
  2. 2. The improving trend in volumes continued in October. Same- hospital admissions increased 1 percent in the month. You may remember that on last year’s third quarter call I mentioned that October 2006 admissions were up 1.2 percent versus October 2005, so I’m pleased that we’re up in 2007 against this tough comparison and off to a good start for the fourth quarter. Of course, since we’re dealing with such small percentages, I should point out that there was an extra weekday in October 2007 compared to 2006. Adjusted EBITDA was $177 million, well above analyst estimates for the quarter and up more than 50 percent from prior year. This performance is impressive even on a sequential basis, with same- hospital adjusted EBITDA up 7.9 percent from the second quarter, despite the seasonal softness which typically reduces earnings from the second to the third quarters in our industry. With an EBITDA margin of just 8 percent, we still have plenty of room for improvement; but we’re making good progress, and I believe that our strategies are working. Good trends in nearly every line item contributed to this stronger- than-expected EBITDA. Pricing increases made a solid contribution to earnings growth. Some of the adverse trends that we were seeing in patient mix within managed care not only were abated in the third quarter, but actually reversed themselves. Same-hospital net revenue per adjusted admission was up by 6.8 percent and up 7.4 percent per adjusted patient day. An additional round of cost reductions helped our same-hospital revenue growth of 7.0 percent translate into growth in the bottom line. Tenet’s same-hospital growth in controllable operating 2
  3. 3. expense per adjusted patient day of 4.2 percent in the third quarter continues to represent one of the best cost control metrics in the industry. Bad debt expense was flat year-over-year at 7.2 percent, although we had expected to be able to reduce it. We described at our investor day all the actions we’re taking to contain bad debt. Also in the quarter, we made continued progress in clinical quality. Our CMS Hospital Compare Data for the four quarters ended Q207 stands at a new high of 92.5 percent, which is well above our peers and the national average. As you can see on slide 6 of the presentation we posted to our Web site, this measure extends the positive trend we have achieved since launching our Commitment to Quality in the first quarter of 2004. The next trend in government reporting is in a standardized measure of patient satisfaction. Tenet was an early volunteer in this program, called HCAHPS, and I’m pleased that our initial satisfaction scores in overall hospital rating and willingness to recommend our hospitals already exceed the national average by 3 percent. Like all of you, we remain keenly aware of the challenges facing the hospital industry and our company, most notably high levels of uncompensated care and soft volumes. I feel today that our strategies to deal with those challenges are increasingly effective. We have positioned Tenet to capitalize on future trends in population growth, aging, obesity and other disease states, as well as the trend in consumerism going forward. Our strategies, from Commitment to Quality to Targeted Growth to our emphasis on physician relations, to the improvements we’ve made in clinical IT 3
  4. 4. and the revenue cycle, have all been designed to put us back on a growth track. We are feeling much more confident about our performance outlook for the balance of 2007, based on our strong EBITDA performance and the breadth of factors that contributed to those robust third quarter results. Biggs will provide more detail on our outlook for the near and intermediate term in just a few moments, but at a summary level, I want to say that we are confident we can achieve adjusted EBITDA in the range of $675 to $725 million we provided in our second quarter call in early August. Before I turn over the floor, let me briefly comment on some upcoming IR events. As many of you know, we have limited our investor relations activities in the past few years to holding our annual investor day in June, appearing at only one or two investor conferences per year, and hosting a limited number of meetings in our hospitals and headquarters. Due to a recent increase in requests for in-person meetings, next week, Steve Newman, Biggs Porter, Tom Rice and I plan to meet with some of our larger shareholders in New York, Boston and a few other cities. We also will make a presentation at the Merrill Lynch Conference in New York on November 27th – and we will present at one or two other investor conferences in early 2008. Tom will begin scheduling these meetings this afternoon. Please give him a call if you’re interested in meeting with us, and we’ll see if we can find a way to get together. 4
  5. 5. With that, let me introduce our COO, Dr. Steve Newman. Dr. Stephen Newman, Chief Operating Officer Thank you Trevor, and good morning everyone. I want to focus my remarks this morning on five key elements of our turnaround strategy that are showing positive results and have contributed to our improved financial performance in the third quarter. They are: First, the effectiveness of our cost management initiatives; Second, how our Targeted Growth Initiative contributed to the improvement we achieved in commercial managed care business in the third quarter; Third, the significant progress we are making in adding new doctors to our medical staffs, primarily by recruiting them to private practices but also by selective direct hiring, redirecting more of the business of physicians already in our service areas, and attracting more admissions from the doctors we already have on staff; Fourth, the results we’re seeing so far from the extensive initiatives we have launched to turn around our key Florida operations; and Fifth, a few examples of success stories where hospitals such as Houston Northwest and North Shore Medical Center in Miami, which were deeply distressed as recently as 18 months ago, have demonstrated remarkable improvements after embracing our strategies, implementing TGI, and executing effectively. Let’s begin with our company-wide cost-management efforts. We accelerated those efforts in the third quarter, and they have produced significant results. The resizing of our work force within 5
  6. 6. the hospitals resulted in the elimination of 1,275 full-time positions over the course of the last year. That amounts to a 2.7 percent reduction – a significantly larger “delta” than the 0.8 percent decline in total admissions over the same time period. We have also cut 208 full-time positions in corporate, regional and other support areas so far this year, amounting to about 7.5 percent of the total overhead jobs above the hospital level. This was achieved through layoffs, retirements, attrition and restructuring. All these job eliminations made an important contribution to restrain the growth of same-hospital controllable costs per adjusted patient day to 4.2 percent versus a year ago. Since some of the most aggressive actions were taken towards the end of the third quarter, the full financial impact won’t be visible until the fourth quarter. Also we recently completed multi-year wage agreements for our union-represented employees at our hospitals in California and Florida. These agreements cover several classes of employees, including registered nurses, technicians and clerical employees. They provide for wage increases for these workers ranging from 5 to 7 percent annually over the term of the agreements. These wage increases were already substantially embedded in our overall financial assumptions for next year and beyond. Supply cost management also played a major role in our overall cost management success in the quarter. For several quarters, we have been accelerating our supply cost management efforts through an expansion of our Performance Management and Innovation group. As a result, same-hospital supply costs were held to an increase of just 2.6 percent per adjusted patient day in the quarter. Supply costs represented 17.3 percent of net revenue 6
  7. 7. in the quarter, and our overall cost management continues to be exemplary. Now let’s talk about our commercial business. As Trevor mentioned, we are gratified by the sequential improvement in commercial managed care business we saw in the third quarter. As you know, commercial managed care is our most profitable business line. Over the past two years, 52 Tenet hospitals have used the Targeted Growth Initiative in a disciplined process to make future business planning decisions. Those hospitals have all completed Phase I of TGI, which identified the product lines that are most needed by a hospital’s community and have the best profit potential. Many have now progressed through Phase 2 of TGI, in which the decisions made in Phase I are implemented. This implementation process is being carefully monitored and will continue through 2008. The third-quarter results demonstrate that TGI is working as we intended. Here are a few examples. During the quarter, we saw 12.7 percent increase in commercial neonatal services, a 5.5 percent increase in commercial oncological surgeries, and a 5.4 percent increase in commercial open heart surgeries. Not all of our targeted service lines were up in the quarter over quarter. Commercial neurosurgery was down 2.4 percent for the quarter, but this decrease has improved sequentially. As you know, open heart surgery has been a challenge for Tenet, particularly as a result of new competitors in certain Florida markets and an overall decline in open heart surgeries in the wake of clinical and technological advances. Because it’s now been a year since the opening of some of these new Florida heart programs with the largest adverse impacts on Tenet, the 5.4 percent increase in commercial open heart surgeries we reported this quarter clearly demonstrates that we are succeeding in 7
  8. 8. capturing and maintaining market share even in this tough competitive environment. Having said that, we realize that another new heart program is opening in January in the Palm Beach market. Initially, we expect to feel some negative effect from this new competitor, but I’m confident that in a relatively short period we will absorb the impact, just as we have all the others. In summary, we are very pleased with our volume improvement in commercial managed care in the third quarter, which outperformed overall volume improvement. I believe that this success is attributable to two factors: the elimination of “out-of-network” situations we have negotiated with our managed care partners in recent years and the improved mix we’ve seen in the services we have provided. This improved mix, I believe, can be credited in large part to the precise business line targeting achieved by TGI. Now let’s talk about our success in adding more doctors to our medical staffs. We know that the real key to our sustained future growth will come from more doctors admitting more patients to our hospitals. Of course, we have continued our traditional efforts to attract more doctors by improving both the quality and service we deliver, and Trevor shared with you the great progress we’ve made in those areas. More recently, we’ve also launched targeted efforts to expand our medical staffs through increased recruitment, redirection, relocation, and, to a lesser extent, employment. In the third quarter, we added 726 new physicians with active staff privileges. After taking into account normal attrition, the net expansion of our active medical staff was 370 physicians in the quarter. That’s an increase of 3.4 percent. For the nine months ended September 30, we added 1,562 new active physicians to our staffs, or a net expansion of 845 after normal attrition. That’s an 8
  9. 9. increase of 7.7 percent. You may recall that we use a conservative definition for active staff status that requires at least 10 inpatient admissions or at least 10 outpatient surgeries per year, which makes these increases particularly impressive. In the third quarter, we also hired 35 employed physicians, mainly in Texas and our Southern States Region. This employment of physicians is consistent with the plans we shared with you on investor day, in which we envisioned hiring 270 physicians by the end of 2010. At that point, we expect our total employed physicians to number about 590. Let me reiterate that physician employment at Tenet is limited to selected geographies and specific situations where the employment model is considered essential for competitive reasons. I want to assure you that most of our volume growth will continue to come from redirection of admissions by physicians already affiliated with our medical staffs, as well as recruitment and succession planning for existing medical groups. As our new physicians and our re-recruited physicians ramp up, we expect admission and outpatient growth. The addition of many of these new physicians to our medical staffs comes as a direct result of the expansion and retooling of our Physician Relationship Program (PRP). Beginning early this year, we added an outreach program to local physicians that previously did not practice at our hospitals. We continue to expand and improve both techniques and tools for our hospital leaders and PRP representatives to use in their daily activities in physicians offices. In the third quarter, we visited more than 5,900 physicians, an increase of 60 percent, from the more than 3,700 visits in the third quarter of 2006. Included in these totals were 930 first-time visits to existing active staff physicians. As part of our expanded 9
  10. 10. outreach program, we also visited for the first time 419 physicians that were not members of our medical staff. Once physicians join our hospitals’ staffs, after appropriate credentialing, and are told about the services offered by our hospitals, we expect to see incremental volume growth. Now let’s discuss the actions we are taking to help our Florida market. Nothing has been more difficult for us recently than dealing with our challenges in Florida. Florida has traditionally been a very good region for us with a strong market position in several areas and our most concentrated geographic footprint. We are confident that it will be again. During the third quarter, we took a number of actions to accelerate our turnaround in Florida: First, we hired a new executive to lead the region. Marsha Powers joined us from Triad with a proven track record of building successful relationships with physicians, payers and community leaders. Second, we consolidated our two-market structure in Palm Beach and Miami-Dade/Broward into a single region under Marsha’s leadership. This will permit us to handle certain functions at the region level that currently are handled by the hospitals individually, thus generating economies of scale, and helping us focus on regional business development opportunities and cost management. Third, we made tangible progress in stemming patient out- migration in neonatology, cardiovascular services such as electrophysiology and rehabilitation inpatient admissions. We expect these efforts to accelerate in the fourth quarter and 10
  11. 11. contribute to admission retention and growth as we move forward. Fourth, we are addressing the critical need to add more physicians to our Florida medical staffs, especially those with large commercial managed care practices or those with demonstrated experience in capitation and caring for the geriatric patients. I expect to have good results to tell you about in our future calls. Fifth, we have accelerated our cost-cutting efforts in Florida to align our infrastructure expenses with the realities of our current volumes. This alignment included our decision, announced last month, to divest North Ridge Medical Center in Fort Lauderdale. Given our many competitive disadvantages at North Ridge, the decision to divest that hospital is consistent with our intention to remain active managers of our portfolio, a strategy which will include periodic acquisitions and divestitures. Sixth, we are successfully negotiating new managed care contracts in Florida that achieve not only good pricing but also the elimination of “out-of-network” situations for all our hospitals. Some of these new contracts have been structured to include volume guarantees. This approach should contribute to tangible growth in volumes as well as our market share over time, even if the economics and demographics in South Florida remain temporarily stagnant. Let me conclude by sharing a few of the individual turnaround stories we have within Tenet. I bring this up because sometimes these successes are not readily apparent in the aggregate numbers we report. The simple truth is that we have a number of hospitals which have built – or in some cases re-built – great market 11
  12. 12. positions, and whose performance has improved dramatically even as our aggregate performance has sometimes lagged. Here are some examples of how we have renewed or maintained our competitive strength in individual hospitals and markets. I’ll start with our Philadelphia market. Not too long ago, some of you on this call were questioning why we even still owned hospitals there. We certainly know that Philly is a tough, competitive market. But the fact is, we have made substantial progress in growing our market share, reaching more competitive reimbursement with our managed care payers, and dealing with structural challenges in our two faculty practice plans. In the third quarter, Philadelphia’s admissions were up 3.3 percent and year-to- date they are up 3.0 percent. Margin expansion at Hahnemann University Hospital, under our CEO Mike Halter and his team, and St. Christopher’s Hospital for Children, under our CEO Bernadette Mangan and her team, has been dramatic. This reflects the powerful operating leverage inherent in our business model. In addition, the affiliation between Temple University and St. Chris that we announced last month should add more momentum to our progress in Philadelphia. Our North Shore Medical Center in Miami had an increase in inpatient admissions of almost 6 percent in the third quarter. That is remarkable, but not unusual for North Shore. Under our CEO Manny Linares and his team, the hospital has seen consistent growth of 2 percent or more for the past 18 months. By contrast, however, from 2004 to 2005 admissions at North Shore fell 3.3 percent. Our Atlanta Medical Center under CEO Bill Moore and his team saw a jump of 8.5 percent in admissions in the third quarter, but its admissions have been growing by an annual rate of more than 5 12
  13. 13. percent for almost two years. This effectively doubled the rate of annual admission growth from 2003 to 2005. Perhaps most dramatically, our Houston Northwest Medical Center under CEO Drew Kahn and his team saw admissions rise by 8.4 percent in the third quarter – which is entirely consistent with the more than 9 percent increase they’ve had over the past year. By contrast, from 2004 to 2006 admissions were down a cumulative 17.4 percent. Those are just a few examples of dramatically improving performance we are seeing in our portfolio. Obviously, our goal is to have every single Tenet hospital growing consistently, quarter after quarter. But I think the Philadelphia market, North Shore, Atlanta Medical Center and Houston Northwest examples should demonstrate not only that our hospitals are capable of producing consistent results – but also that many of them already are. So, to sum it up, I am gratified by what I am seeing in our cost management initiatives, our targeted growth in commercial managed care business, our efforts to add more doctors, the signs of progress in Florida, and some dramatic turnarounds in a number of our hospitals. I believe the progress we saw in the third quarter in adjusted EBITDA, commercial admissions, and net revenue for both inpatients and outpatients provide compelling, tangible evidence of the progress we have made, and intend to continue to make, in our turnaround. With that, I will turn it over to Biggs Porter, our chief financial officer. Biggs? 13
  14. 14. Biggs Porter, Chief Financial Officer Thank you Steve, and good morning everyone. Let me start by echoing the assessments you’ve just heard from Trevor and Steve: that the third quarter demonstrated progress on a number of fronts. Adjusted EBITDA came in at $177 million for the quarter, an increase of 55 percent over last year, and an increase over the second quarter of 8 percent. Given that the third quarter is typically our weakest quarter given soft seasonal volumes in July and August, this $177 million in adjusted EBITDA is a particularly notable achievement and positions us well for the full year. I’ll return to this topic in a few minutes. Before I go further, I should note that the appropriate reconciliations to GAAP related to my comments are included in our release and the slides on our Web site. Trevor and Steve have already discussed the favorable developments we saw on the volume front, so I want to go to revenues pretty quickly. The only thing I will say about volumes is that we have always said improvement would have its bumps. But if you look at the last two years, as shown on slides 17 through 19 on our Web site, and plot a statistical regression line against year- over-year comparisons of admissions, particularly commercial admissions and outpatient visits, you will see significant momentum developing. To me, the critical message at this time is not about this quarter or any perfect view of the next quarter, but rather that there is a trend developing and a series of actions underneath that trend which are taking hold. Progress has been and will be bumpy due to all the 14
  15. 15. externalities and variables, but we believe the actions we are taking are the right actions to improve our results and that the trends are beginning to show this. Now on revenues: Mix between payer categories improved in the quarter, with commercial managed care admissions trending more favorably than in the trend in total admissions. Revenue was also supported by continued progress in commercial pricing. These combined to produce a 7 percent increase in same hospital net operating revenues to $2.2 billion in the quarter. This strong top-line growth was a key to our performance and very gratifying given that volumes, despite evidence of an improving growth trend, came in weaker than we had anticipated earlier in the year. Cost report adjustments contributed $22 million to the quarter, compared to an adverse $10 million impact in the third quarter last year. The favorable impact in the current quarter is fairly typical of recent trends. Turning to pricing, we experienced solid progress in all our key pricing metrics. Notable among these impressive stats were: A 7.8 percent increase in net inpatient revenue per admission, and A 9.7 percent growth in net outpatient revenue per visit. This consistent strengthening in pricing has clearly benefited from some of the favorable new contracts we announced in recent months. You should be aware that two contracts we signed and announced late in the second quarter with Aetna and Blue Cross of Texas were fully effective July 1. So, the full impact of these contracts was visible in the third quarter metrics I just reviewed. 15
  16. 16. Pricing was also favorably influenced by the approximately $32 million year-over-year variance in cost report adjustments and the effects of emergency department scoring and charge increases. We have some additional contracts we expect to sign in the fourth quarter, which will further improve pricing next year. Combined with those already negotiated, these additional contracts provide a credible basis for expecting continued robust commercial managed care pricing growth going into next year. In summary, we are very pleased with our continued progress with regard to pricing and are achieving results fully consistent, if not stronger, than the levels we have previously discussed as our objective for commercial pricing. Not everything in pricing that happened in the last few months is positive, however. Unfortunately the states of Georgia and Florida will reduce Medicaid funding to our hospitals by approximately $60 million in the aggregate on an annual basis beginning next year. This will absorb some of the benefit otherwise produced by favorable managed care negotiations and other price increases. We are not counting on it in any forecasts, but we continue to watch with interest California’s attempts to address the issue of the uninsured. Although estimates have varied significantly based on the various structures proposed, the last iteration or estimate by us was that this would improve our annual results by approximately $60 million if the reform was enacted. We also have steady progress to report on the cost front. The summary level indication is on slide 22 on our Web. Same hospital controllable operating expenses per adjusted patient day were restrained to an increase of 4.2 percent. This reflects overhead and supply cost reductions, partially offset by the effects of volume 16
  17. 17. loss and higher medical fees. Medical fees were up $15 million year-over-year, but have been relatively flat over the course of this year. Corporate overhead is down $27 million year-over-year for the third quarter reflecting our initiatives to control costs in line with the reduction of our business base. We also have addressed the effects of a lower business base at the hospital level. As Steve Newman just reviewed, we have recently implemented initiatives which are intended to reduce our hospital- level, primarily non-patient care, staffing costs by approximately $60 million on an annualized basis. As many of these actions were implemented only late in the third quarter, savings and severance costs offset in that quarter, with nothing falling to the bottom line. However, the impact on our fourth quarter is expected to be approximately $15 million. There are other cost initiatives, as I have spoken about previously, and other pressures, which I will comment on in a moment. Let me now update you on our cost and other initiatives. The benefits of these initiatives were all previewed as part of the list of detailed profitability enhancements we provided at our June investor day and subsequently updated on our second quarter call in August. Slide 23 shows how we laid these initiatives out at that time, but, more importantly, slide 24 shows the current estimates. The initiatives discussed at that point came in two pieces: an approximately $50 million commitment to cost reductions involving specific actions, which we had fully identified as far back as April. When fully implemented by year-end 2007, we estimated the continuing impact of these actions would yield $65 to $85 million in calendar year 2008. Through the end of the third quarter, approximately $43 million of these had been captured year-to-date, with $19 million in Q3 and 17
  18. 18. approximately $11 million of savings expected in Q4. We now believe the annualized effect of these will be in the $95 million territory, meaning that 2008 and 2009 will benefit by an estimated $41 million of annual cost improvements relative to 2007 related to these initiatives. The second “bucket” of profitability enhancements included specific revenue initiatives as well as additional cost reductions. We stated that these additional contributions to profitability could be quite significant, but since some of the initiatives were still in the planning stages, we limited our commitment to a minimum of a $30 million favorable impact in 2007 with an estimated annualized impact of least $60 million to be contributed to EBITDA in subsequent periods. Let me emphasize again, that these enhancements were independent of our volume outlook – meaning that these cost savings and revenue pickups are above and beyond what we expect to capture in scale economies from volume growth. Through the end of the third quarter, approximately $36 million of these had been captured year-to-date, with $20 million in Q3 and approximately $37 million of benefits expected in Q4. We now believe the annualized effect of these will be in the $150 million territory, meaning that 2008 and 2009 will benefit by an estimated $77 million of annual improvement relative to 2007 related to these initiatives. The initiatives in this bucket include the recently implemented staff reductions Steve and I have discussed, which comprise approximately $45 million of the incremental 2008 savings. They also include the benefits of ED scoring and the other revenue-related initiatives we have previously discussed in this bucket. These are all estimated net of any related bad debt expense. Admittedly, some of these initiatives are harder to trace through the revenue line to their bottom line effect, but we believe these are reasonable estimates. 18
  19. 19. Combining the two buckets of initiatives together, we are at $79 million estimated benefit year-to-date, with $39 million having benefited the third quarter and approximately $48 million estimated to be beneficial to the fourth quarter. The incremental benefit to 2008 and 2009, beyond what we expect to have captured in 2007, is estimated to be approximately $118 million. Unfortunately, not all of this value has flowed to the bottom line in 2007 due to offsetting increases in medical fees, bad debts and the effects of lower volumes compared to last year. With volumes and medical fees beginning to stabilize, these should be more traceable to the bottom line in 2008. We are, however, as I will say in a moment, in the process of our 2008 and three-year plan, so there may be other cost or investment considerations which will influence the final result. Not included in the results above are the elements of our initiatives related to bad debts. Although we have had some success in these actions, they have been overcome by growth in uninsured admissions. If uninsured admissions stabilize, we would expect to also have net yield from our bad debt initiatives. Our bad debt experience for the third quarter has favorable and unfavorable trends. We continue to see rising numbers of uninsured patients and associated revenue. Uninsured admissions rose by 7 percent in the third quarter, and revenues from the uninsured rose by 22 percent or $30 million. As a reminder, this increase in uninsured revenue is after the discounts applied under our Compact. Beyond the effects of uninsured admissions growth, uninsured revenue was impacted by price increases and by increases in emergency department acuity related to our ED scoring initiative. Fundamentally, to the extent price increases or ED scoring effects uninsured revenues it becomes offset by bad 19
  20. 20. debt expense, so only about 12 cents of the dollar falls to the bottom line. So, to that extent, bad debt related to these initiatives is just an offset to an increase elsewhere in the P&L. The value of these is, however, in its effect on insured revenues where there is a much greater bottom line effect. A favorable experience this quarter comes with respect to balance- after. As you know, we have seen an increase for several sequential quarters of balance-after which is directly related to “cost-shifting,” which moves increasing amounts of the financial burden of health care off the commercial plan sponsors and transfers the payment responsibility to the plan members themselves. We saw a stabilization of this trend during the quarter, although keep in mind, one quarter does not a trend make. We also continue to see one variable of bad debt expense, over which we have some control, evidence continued and material improvement. I’m referring to our collection rates, where the multiple initiatives you heard about at investor day continue to produce tangible results. Through focused effort, we have been successful in raising self- pay collection rates to 36 percent from 30 percent a year ago and commercial managed care collection rates to 98 percent in the third quarter from 97 percent a year ago. You may have also noticed that charity care outpatient visits rose by 58.4 percent in the quarter. This was due to a new assembly bill that went into effect in California this year outlining new charity requirements and one of our Georgia hospitals that is experiencing an increase due to market needs. Turning to cash flow and capital expenditures, I would refer you to slide 29 on the Web. 20
  21. 21. Capital expenditures were $179 million in the quarter, of which $175 million were in continuing operations, including $16 million in construction expenditures for our East Side Hospital in El Paso. Adjusted operating cash flow year-to-date is $82 million and for the quarter came in at $93 million. There are a few things to consider in evaluating cash flow for the quarter relative to our expectation for the year. First, the $22 million in cost report adjustments in the quarter have the effect of increasing receivables. Secondly, in terms of activity which does not recur in the fourth quarter we have insurance premiums, which are paid in the third quarter of $14 million, and we had a receipt related to the sale of the Philadelphia HMO of $12 million for a net $2 million outflow. Finally, interest payments are high in the quarter, at $123 million compared to approximately $82 million of gross interest payments in the fourth quarter, including $15 million of interest related to last year’s global settlement. If you take these into consideration, third quarter cash flow is within the range, which is reasonable for the income generated in the quarter. Relative to the third quarter then, the fourth quarter should be approximately $43 million better than the third just for the $2 million in effects of the nonrecurring items and the $41 million difference in interest payments. In addition, the third quarter does not yet reflect the working capital initiatives currently in place. The two key elements of this, which we are targeting for the fourth quarter, are the reduction of accounts receivables days by one as driven by our bad debt and collection initiatives, and an increase in accounts payable. The payables growth is expected to be driven in part by normal fourth quarter build up and also by restoring our payables processing parameters to be more in line with our standard procurement terms, which we expect to increase days in accounts payable by as much as four. We expect these, net of other variables, to favorably affect 21
  22. 22. the fourth quarter relative to the third by more than $62 million, with $102 million being the middle of the range. The normal increases in accruals for incentive and stock compensation and our 401K match benefit both the third and fourth quarter, so are neutral to a quarter-to-quarter comparison. They are, however, reflected in the cash walk forward included on slide 30 our Web site so that you can see the more full view or more full projection of the fourth quarter cash flow statement. You can read the press release and 10-Q to get more of the details, but we ended the quarter with $655 million in cash and cash equivalents. You may recall that I have talked about Tenet being increasingly focused on improving return on invested capital. We also said on our second quarter call that we would be making a thorough review of our balance sheet to ensure that it was efficiently structured. That process is making good progress, although I am not yet in a position to provide details on our findings beyond what I have just described about our near-term working capital targets. We intend to provide a detailed analysis when we share our 2008 Outlook with you in mid- to late-February, but I do believe there is significant opportunity. It is important, however, for me to reiterate that irrespective of this effort we do not believe we are capital constrained. To the extent we are constrained, it is self imposed. It is first to ensure that our investments are sound ones, which enhance shareholder value through improving our services and capabilities and secondly to maintain a focus on achieving positive free cash flow. To the extent this is constraining, it is just reflective of being a good steward, and it has a greater effect on long-term new development in new markets than on maintaining a sound level of investment in our existing facilities and markets. Also, as I have said before, and 22
  23. 23. as is reflected in slide 31 on our Web site, we believe with the higher level of spending we are making this year, we are caught up with the level of spending of our peers over the last three years. Before concluding, let me offer a few thoughts on the outlook for the remainder of 2007 and implications of the progress demonstrated in our third quarter performance for our longer-term Outlook. Slide 32 on the Web presents the figures I will be referring to. At the end of our second quarter, we refined our 2007 outlook to a range of $675 to $725 million for adjusted EBITDA. With adjusted EBITDA of $535 million for the nine months ended September 30, 2007, this would require us to achieve $140 to $190 million in adjusted EBITDA in the fourth quarter to produce results within that range. With $177 million of adjusted EBITDA in the seasonally weak third quarter, and with the support of recently implemented hospital-level cost reductions we remain comfortable with our prior EBITDA outlook for 2007. We might have been tempted to move higher within the range, but we are choosing to remain conservative primarily due to the fourth quarter effects of wage increases, the unpredictability of mix, and admissions levels, which are modest relative to our prior expectation. On volumes, at the end of the second quarter we expected to have second-half admissions growth of zero to 1 percent and outpatient visits of minus 0.5 to positive 1.6 percent. Although there was marked improvement in the third quarter, it was not on enough pace to maintain that expected level of growth in the second half absent a significant swing in the fourth quarter. At this point we would expect the fourth quarter to have admissions growth from a 23
  24. 24. negative 0.5 percent to a positive 0.5 percent and visits growth of zero to a positive 1 percent over the prior year fourth quarter. Because of the additional cash realized in the third quarter from life insurance and other sources, we now also believe we can achieve a year-end cash position within the range of $530 to $670 million. We now project cash from operations of $280 to $360 million for the full year. To be in this range, we will need to improve our performance with regard to working capital from what it was at the end of the third quarter. As I said, in addition to the normal seasonality of interest payments, accruals and accounts payable growth, we are targeting improvements in both days in receivables and days in payables in the fourth quarter. Outside of expected improvements in working capital, the year-end outlook for cash is without dependence on the balance sheet improvements I mentioned a few minutes ago. We have also factored a significant pick-up in capital expenditures into our year-end cash forecast. While certain delays have reduced our capex in recent quarters, we expect capex to rise to the range of $235 to $285 million in the fourth quarter. On the longer term, our intermediate outlook is still much as I described it in the last conference call. Slide 35 on our Web site shows the walk forward from 2007 to 2009 as I last presented it. You may recall that in last quarter’s call I put the range of risk at $0 to $100 million. Since that point in time, we have had one significant risk or negative event materialize. That is the Georgia and Florida Medicaid reductions of almost 60 million I referred to earlier. To a much lesser extent, we also have had an unexpected increase in employee benefit costs in California projected for 2008, which is more than offset by increasing yield on our other initiatives. Volume enhancements from transactions such as the Temple Children’s affiliation also create lift for the longer term. 24
  25. 25. We are currently in our detailed annual planning process, and we will want to complete that as usual with a final board approval in December before we give more specifics as to 2008 and 2009. While we aren’t giving guidance on 2008 at this time, I would ask you to remember that we expect to be making significant progress in 2008 toward the 2009 objective. This is supported by the annualized effects of our core and upside initiatives, including the $60 million reductions in force we mentioned earlier. As I said, on an annual basis, we expect to generate $100 million or more incrementally from these efforts annually in 2008 and 2009 over the estimated $127 million amount we are on the path to achieving in 2007. Also, comparing 2008 to the fourth quarter of 2007, you will need to remember that merit increases are substantially given in the fourth quarter, so the first three quarters of 2008 will see price increases without a corresponding growth in labor costs compared to the fourth quarter of this year. I will also repeat what I have said in the past that 2009 is not an end point and that we can continue to lift earnings and return on invested capital in the future by additional efficiency, but more importantly by the benefits of the estimated 40 percent effective margin from volume growth expected to continue beyond 2009. So to summarize briefly, Our results, particularly on volumes, have been and will likely continue to be bumpy, but we do believe there is a positive trajectory developing. We showed real progress on volumes and pricing and took significant cost actions in the quarter. We remain focused on mitigating the demographic and external pressures on bad debt expense through positive action. And we are driving on cash and return on invested capital as a key indicator of shareholder value growth. 25
  26. 26. Let me now turn back to the operator for questions. 26