TenetSettlementPreparedRemarks

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  • 1. Tenet Settlement Prepared Remarks June 29, 2006 Trevor Fetter, President and Chief Executive Officer Thank you, operator and good morning. Earlier today, we announced a broad settlement agreement with the United States Department of Justice concluding federal investigations into Medicare outlier payments, physician relations and Medicare coding issues. The settlement closes this very difficult chapter in Tenet’s history. It provides us with much-needed clarity regarding our true financial condition and leaves us with the ability to make essential capital expenditures on a sustained basis. These capital expenditures will build greater confidence on the part of physicians that our hospitals will be winners in their local markets. Under the settlement agreement, Tenet will pay the government $450 million immediately and another $275 million in installments over the three years beginning November 1, 2007 through August 1, 2010. As part of our settlement, the Department of Justice has agreed not to file new suits or charges in connection with the various matters covered in the settlement agreement, including Tenet's receipt of outlier payments and its physician relationships. The DOJ has also agreed to dismiss existing litigation, including the global DRG lawsuit. We have also agreed upon the outline of a multi-year corporate integrity agreement with the Department of Health and Human Services that will ultimately result in the HHS Inspector General foregoing its authority to exclude our hospitals from federal health care programs over the matters at issue. Because of the strong compliance program that we have put in place over the past few years, the corporate integrity agreement is something that we can operate under. The only added cost should be for expanded training and independent reviews that will be required under the agreement. You will note that this settlement does not include any finding that Tenet had engaged in illegal behavior, but we’ve paid an enormous cost for the failed pricing strategy that was terminated more than three years ago. At the time, many observers said that what 50 Tenet hospitals did with respect to outlier payments was legal. But what ultimately matters is that the company’s actions did not meet the highest ethical standards that the public, and I use that term in the broadest sense, expects. I am now confident that we will be successful in implementing our long-term vision for Tenet. One reason for this confidence is the solid track record that our new management team has built over the past three years. We successfully addressed several enormous problems, such as pricing and cost control. We dramatically improved clinical quality. We sold what didn’t fit in our new business plan and where it makes sense, we are building new hospitals. We brought in top flight 1
  • 2. executives. We changed standards and policies. We closed our old headquarters and consolidated our corporate functions here in Dallas. And throughout this period we kept our focus on our prime mission – delivering quality health care to our patients. Let me add just a few specifics: • We have earned national recognition for our quality of patient care and our industry- leading Commitment to Quality initiative; • We have rebuilt productive relationships with our managed care payors and demonstrated this success by generating healthy pricing growth in recent quarters; • We have reshaped our portfolio of hospitals and focused on growth opportunities in markets where we already operate; • We have succeeded in containing the rate of growth in costs; and, • We have achieved top rankings both in our sector and all of U.S. industry for corporate governance. These accomplishments create a very solid foundation for our future success. At the same time, we’ve also had profound challenges in three areas: weak volumes, record levels of bad debt expense, and the damage done by Hurricane Katrina. I’ve been in this industry now for nearly eleven years, and it’s safe to say that the two worst years out of the last eleven for volumes, throughout the industry, have been 2004 and 2005. The same is true of bad debt expense. And regarding Katrina, you probably know that Tenet was the largest operator of hospitals in New Orleans. My point is that when we’ve set out to accomplish something, we’ve accomplished it. Where there has been an industry challenge, we’ve been hit with it, as hard or harder, than our competitors, but we’ve continued to make progress towards our goals. We are taking the same approach to volumes and bad debt that we took to clinical quality and the other successes that we’ve had: understand and analyze the problem, identify the solutions, and implement them. We have removed the cloud of uncertainty caused by government investigations and the resulting concerns about our future. Now, our hospitals can move quickly to communicate a positive and confident message of growth and stability to our patients, physicians and communities. Together, our senior leaders and hospital operators are passionate about achieving a great future for Tenet Healthcare. We’ve worked very hard to get to this point and are even more excited about taking our company to the next level. 2
  • 3. Tenet developed and launched a clear strategy almost three years ago – build a high quality, cost effective operating platform and couple it with innovative approaches to service line development and growth. This strategy is based on superior execution and value, not on the structural advantages, like acquisitions and physician-hospital contracts of the past. Over the last three years, we have laid a solid foundation of quality and operational efficiency. Therefore, service-line development and growth will be our primary focus areas in the near-term. The government settlement has liberated the organization to pursue this strategy with much more focus and vigor. I wanted to announce not only the settlement today, but also several key elements of our go- forward strategy that have been in the works for quite some time. Prior to today, there were significant uncertainties regarding our capital structure, financial condition and liquidity. The amount we might pay to the government was just too big an unknown. That’s why we decided to announce several key items today. These initiatives should help you gain a comprehensive understanding of where we intend to take the company in the near to intermediate term. Capital infusion The first of these elements is a significant ramp-up in our capital expenditures. For more than a year, we’ve had an intense effort to increase our communication with the physicians who have stayed loyal to our hospitals through all the difficulties. We’ve surveyed them; we’ve conducted focus groups; and Reynold and I, and key members of the corporate management team, have visited them. And most importantly, our hospital management teams have visited more than 11,000 – or 80 percent – of these physicians. At the top of their list is having ready access to advanced technologies, new equipment and excellent physical plants. Now that our financial position is resolved, we will increase the capital that we are committing to our hospitals in 2006. Our total capital spending and commitments this year will reach approximately $800 million, up significantly from our earlier projection. These investments will be tangible evidence of our continuing commitment to maintaining the competitive positions of our hospitals. The vast majority of this additional capital will be devoted to areas that have the greatest direct impact on physician attitudes about referring their patients to us. Divestitures We also announced this morning our plan to sell nine hospitals. This should help us improve our profitability, focus capital investments in our remaining hospitals and help fund the cost of the settlement. These hospitals include three in Philadelphia; four in New Orleans; and two in Florida. I want to make it clear that we are not completely exiting the Philadelphia and New Orleans markets. In 3
  • 4. both of those markets, we are retaining the hospitals and ancillary businesses that we believe are in the strongest strategic positions. These divestitures are in addition to the previously announced requirement to divest Alvarado Medical Center in San Diego. In addition, our partner in the Cleveland Clinic Hospital in Florida has indicated its intention to exercise its option to purchase Tenet’s 51 percent interest. I should also mention that we operate two hospitals in Dallas pursuant to a master lease that expires in mid-2007. It’s possible that we will not continue to operate those hospitals after the lease expires. In summary then, we are talking about a total of 11 divestitures, with the possibility that the total will rise to 13 by mid-2007. And that’s before we count the recent sale of Gulf Coast Medical Center in Biloxi, Mississippi, a transaction which closed earlier this month. Gulf Coast brings the mid-2007 total potential divestitures to 12 or 14, depending on the outcome of the two Dallas hospitals. In the aggregate, these divestitures will allow us to focus our investments on a go-forward portfolio of 55 to 57 hospitals. However, we’ve already announced plans for two new hospitals – one in El Paso, and the other in South Carolina – they will come on-line in a few years. In total, we anticipate proceeds of $250 million to $275 million in cash, including liquidation of working capital, once these sales are completed. Revised 2006 Outlook Let me take a few minutes to explain how these divestitures will impact the outlook for 2006 that we shared with you in early March. That outlook included an expectation of pre-tax results from the 69 hospitals in continuing operations in a range between breakeven and a pre-tax loss of $100 million. The outlook excluded any impact of special charges relating to litigation, impairment, or restructuring; the results of discontinued operations; or recoveries from insurance carriers. The outlook also included a critical assumption that we could achieve one percent growth in admissions in 2006. As the 57 hospitals, which will now be reported in continuing operations for 2006, experienced an admissions decline of 2.8 percent in the first quarter, we are revising our admissions assumption to a two percent decline for the full year 2006 for these hospitals. This assumption includes our expectation of modest improvement in admissions following our enhanced capital investments and the elimination of the litigation overhang. As a result of the divestitures and lower anticipated patient volumes for 2006, the company’s revised 2006 outlook for continuing operations ranges from a pre-tax loss of $75 million to pre- tax income of $25 million. The corresponding outlook for EBITDA is a range of $670 million to $770 million. This outlook excludes any impact of the items I mentioned earlier. The “take- away” here is that we have improved our outlook by $25 million by removing the divested hospitals, despite a softer outlook for volumes. 4
  • 5. In terms of the line items going into this outlook, we are making a modest change in our bad debt assumption, which we are reducing from 14 percent to approximately 13.5 percent on a Compact-adjusted basis. This reduction in bad debt expense reflects a stronger performance in the first quarter, which came in at 12.9 percent, on a same-hospital basis, and the fact that the 12 hospitals to be moved to discontinued operations in the second quarter generated higher bad debt. Compact-adjusted bad debt expense for the 57 hospitals now in continuing operations was 12.8 percent in the first quarter. Depreciation and amortization are expected to total $360 million for continuing operations. Our expectations for interest expense net of interest income and minority interests are approximately $385 million. Net cash flow from operating activities is expected to be negative in the range of $275 million to $375 million after expected actual cash outlays for capital expenditures of $700 million. This cash flow expectation is before the total of $643 million in payments to settle litigation and investigations that we’ve announced so far this year, including today. Including likely receipt of cash from insurance coverage and proceeds from the sales of divested hospitals, we are reasonably confident that our cash balance at year-end has the potential to be in the neighborhood of one billion dollars. Intermediate-Term Earnings Potential This morning’s press release also provides our assessment of Tenet’s potential for improved profitability over the next two to three years. I want to spend a few minutes on some of the specifics of our expectations. As a preface to these comments, let me remind you that we intend to hold an in-depth, day-long investor conference in Dallas on July 13th. The investor conference is intended to be an opportunity for us to explain our strategy, operations and initiatives in greater detail and to allow more time for Q&A. Within that context, and following the divestitures I just described, I believe that Tenet has the potential to achieve an EBITDA margin of approximately 11 to 13 percent within the next two to three years, excluding special charges. This compares favorably to the EBITDA margin of 6.9 percent for these same 55 hospitals in 2005, excluding unusual items. In the first quarter of 2006, these 55 hospitals achieved a margin of 10.1 percent. Although it’s always possible that Tenet’s financial performance might not improve, the company has implemented multiple initiatives aimed at improving volume growth, cost efficiency and pricing with the objective of enhancing financial performance. The first quarter margin improvement of our 55 go-forward hospitals demonstrates that we are making tangible progress. 5
  • 6. To reach a margin in the range of 11 to 13 percent, we will need to achieve consistent annual admission growth, starting in 2007, of approximately 1.5 percent, including comparable growth in commercial managed care admissions. On the outpatient side, we need to achieve growth of approximately two percent in both the aggregate and in commercial managed care visits. In terms of bad debt, as I mentioned earlier, we have assumed a 13.5 percent rate on a Compact- adjusted basis in 2006, gradually falling to 12.5 percent over the next two to three years. Intermediate-Term Earnings Potential – Environmental Assumptions I want to be clear on a few points regarding your interpretation of our earnings potential. First, we are executing our recovery while fighting strong industry headwinds in the form of a soft admissions environment, high bad debt levels, consolidation of managed care payors and new forms of competition, including doctor-owned facilities. This is an industry with cyclical elements, and, since 2003, we have found ourselves in the unfortunate position of trying to engineer a recovery through one of the weakest cycles that anyone can remember. Were the industry in a stronger position, I can assure you our outlook would be considerably more upbeat. Second, we are incurring considerable costs to implement strategies that we are convinced will serve us well over the longer-term. Our emphasis on quality and compliance are part of a strategy to achieve consistent returns for shareholders without the boom and bust patterns of the past. I am convinced that these investments are the right thing to do and will create long-term value. Third, we’re often asked about our margin potential in relation to HCA. I’ve been saying this for three years, and it’s important to understand that compared to HCA’s footprint, we have higher concentrations of hospitals in markets with generally lower margins and lower concentrations of hospitals in markets with generally higher margins. We believe that our hospitals can ultimately achieve competitive margins in their respective geographies over the next two to three years, but some of the markets or states are just less profitable than others. Our company was assembled over the years through many acquisitions. Nearly 100 hospitals were acquired since Tenet was formed in early 1995. In hindsight, many of these acquisitions were ones that we should not have made. But we have dramatically changed our strategy since 2003. We’ve retained the best of the nearly 120 hospitals the company owned three and one-half years ago. Our growth in the future will come from building upon our strength in markets that we know and not by expanding into markets that we don’t know. While some of our hospital operators will be discussing structural and market issues more thoroughly at our investor day, let me provide you with an overview of these issues. For purposes of comparing ourselves to HCA's footprint, however, I will aggregate today at a regional level. 6
  • 7. Southern States Let’s start with our most profitable region, the Southern States, which includes our 10 hospitals in Alabama, Georgia, as well as North and South Carolina. Going forward, these hospitals should produce just shy of 20 percent of our revenues over this two to three year time period. The reasons our Southern States markets are so profitable include: • The low cost of living, which results in salaries approximately six percent below the national average, • A favorable payor mix, with attractive reimbursement levels from managed care, and • A favorable certificate of need environment that provides stability for existing operators. California The environment in California, our largest market as measured by revenues, presents dramatically different business challenges. We have 15 hospitals in California. In this discussion of California, I am excluding USC University Hospital in Los Angeles, which I will address separately with our Academic Medical Centers. California is expected to be the source of approximately 22 to 23 percent of aggregate revenues going forward. There are a number of serious structural issues that limit the profitability in the California market, including: • Mandated nurse staffing ratios and other regulations, which are more onerous than anywhere else in the country. • Nurse salaries that are 30 percent higher than the national average. • Unionization that raises costs and reduces productivity. For example, 44 percent of our California employees are represented by unions, including 61 percent of our nurses. Outside of California, only six percent of Tenet’s employees belong to unions. But California has some very significant attractions. It remains one of the fastest-growing markets in the United States and is expected to remain so for the foreseeable future. In addition, it has significantly lower bad debt than we see in our Florida and Texas markets. Managed care started in California and has now reached a plateau in penetration and consolidation of the payors. In addition, some of our highest pricing is received in the California market. California citizens seem to be committed to funding health care. We are anticipating 7
  • 8. new targeted funding programs there that should help to control the cost of bad debt, and we have not faced the types of Medicaid cuts in California as we’ve seen in other states. Before I close on California, I’d like to mention the remarkable turnaround we’ve achieved there. Three and one-half years ago, California was the epicenter of Tenet’s problems in pricing, quality and compliance. Our managers in California have done an excellent job of changing the composition of our hospital portfolio, totally renegotiating our managed care contracts, restoring outstanding clinical quality, dramatically improving morale, and building confidence among physicians. California has led many of our key initiatives, such as the Targeted Growth Initiative, that are transforming the way that we manage service lines in our hospitals. This is a work in progress, but the trajectory has been very strong. Texas and Louisiana Moving east to Texas and Louisiana, we will now have 11 hospitals: ten in Texas, excluding the two leased hospitals that I mentioned, and one in Louisiana. We believe this region can contribute 17 to 18 percent of Tenet’s total revenues going forward. This region generally has good pricing and low costs, but it also has structural challenges, including: • Texas leads the nation in uninsured residents and has higher-than-average bad debt levels, which have recently run as much as ten percentage points higher than our California markets, and • Doctor-owned facilities that are expected to capture a growing proportion of the markets’ most profitable business. I’d also point out that Texas represents a great example of how you can’t make a general statement about even a local market. Take Dallas as an example. It is impossible to arrive at a single, comprehensive assessment of the Dallas market for hospital management companies. Market conditions at RHD and Trinity, the two Dallas hospitals I mentioned earlier that are under a master lease, are challenging at best, while market conditions at our hospital in nearby Frisco are quite strong. Despite being less than 15 miles apart, these hospitals are competing in very different business environments. They have markedly different patient demographics, a different physician base, and a very different payor mix. Fifteen miles can make a world of difference in assessing whether a hospital is positioned to thrive. The city or state in which it’s located is far less relevant. Florida 8
  • 9. Our 11 continuing Florida hospitals are expected to be the source of approximately 18 to 19 percent of Tenet’s revenues going forward. The structural issues we face there include: • The number of new physicians entering Florida is insufficient to replace those who are leaving or retiring, • There is a shortage of specialist physicians, • There is an unusually difficult malpractice environment and, • There is an increase in the number of uninsured, which makes Florida our second toughest state for bad debt (behind Texas). On the positive side, our Florida hospitals represent the tightest and most concentrated network that we have. We have excellent clinical quality, strength in negotiating with payors and strong market positions in certain clinical service lines. We have the largest market share in the three counties of Dade, Broward and Palm Beach. In addition, people have been retiring to Florida for decades, and there is every reason to expect that pattern will continue. With this growing demographic, utilization rates will continue to rise, providing a solid foundation for our hospitals to grow. Central States Our Central States market, again excluding Academic Medical Centers, consists of our three hospitals in Missouri and Tennessee. These hospitals produce margins which are considerably softer than in the Southern States. At approximately five percent of Tenet’s expected revenues, these hospitals do enjoy lower costs of doing business and strong volume growth, but below average managed care rates. Academic Medical Centers Finally, Tenet owns five Academic Medical Centers, or “AMCs,” that face a unique set of structural issues which strongly influence our profitability. These five hospitals are Creighton University Hospital in Omaha, Saint Louis University Hospital in St. Louis, USC University Hospital in Los Angeles, and our two remaining Philadelphia hospitals, Hahnemann University Hospital and St. Christopher’s Hospital for Children. Together, the AMCs are likely to contribute approximately 17 to 18 percent of the company’s go-forward revenues. These hospitals are highly complex entities with a multi-faceted and challenging role in the delivery of medical services to their communities. They attract some of the most difficult medical cases with significantly higher utilization of resources and, therefore, cost of service. The AMCs command higher pricing than community hospitals, but even with government 9
  • 10. support of teaching expenses, the higher prices do not fully compensate for the higher cost of service. Some of these hospitals suffered disproportionately from the dramatic drop in outlier and stop- loss payments after the failure of the company’s former pricing strategy, and are still in a turnaround mode as a result of losing those revenues so abruptly. Our AMCs, however, produce a number of benefits for Tenet, which are not reflected in their own P&Ls. Reynold Jennings will be discussing these benefits and the role played by the AMCs in Tenet’s overall business strategy at our upcoming investor day. Summary on EBITDA In summary, we think our go-forward portfolio of hospitals has the potential to achieve an EBITDA level of approximately $1.1 to $1.3 billion over the next two to three years. On assumed revenues of $9.6 to $10.2 billion, this generates a potential margin in the range of 11 to 13 percent. We are engaged in multiple initiatives to drive our margins toward the upper end of this range in the intermediate term. These initiatives should help us achieve at least geographically-adjusted industry average performance in the longer term. Within the past three years we’ve succeeded with initiatives in quality, pricing and cost control, so I have confidence in our ability to overcome serious challenges. I don't want to leave you with the impression that we are satisfied with geographically-adjusted industry average performance, either. We are not. We have a broad portfolio of initiatives that affect every key area of our business, and with the settlement behind us, we will be able to focus 100 percent of our energy on the future. We have found, and will continue to identify, new and sustainable ways to break through some of the barriers and inefficiency that have limited the economic potential of our hospitals in the past. The bottom line is that we will not be satisfied with average performance. Conclusion Between our press release and my remarks this morning, we have given you a lot of information. Again, in order to explore these topics in greater detail, we have scheduled an investor day in Dallas for July 13th. In the interim, we’ll be prepared to take a limited number of questions this morning. There are many constituencies with whom we need to communicate, so I apologize in advance that our time for Q & A will be limited. Before I open it up to Q&A and ask the operator to assemble the roster, I would like to turn the call to Peter Urbanowicz for a moment to describe a couple specifics about the settlement agreement, Peter. 10
  • 11. Peter Urbanowicz, General Counsel Thank you Trevor and good morning. Later today, we will be filing an 8-K with a copy of the actual settlement agreement. We were delayed in getting the settlement agreement edgarized for filing because of the timing late in the day yesterday. The settlement agreement will be redacted in some places. There are places where some of the sealed qui tam cases may be mentioned. As part of the settlement, we agreed with the Justice Department that they will move to unseal and settle and dismiss those cases. But, until a judge signs an unsealing order, we’ve agreed with the Justice Department not to reference the names of those qui tam suits. The 8-K will also have the quarterly dates for the future payments, as well as the calculation of interest on those dates. Additionally, you’ll note in the agreement that we’ve agreed to continue to assist the Department of Justice in some of their continuing investigations against individuals. Our agreement is a settlement agreement with Tenet and its corporate entities. Individuals are not named as covered parties in the agreement. It is possible that the DOJ may continue investigations against former employees or former officers. From time to time, corporations may have legal obligations to indemnify former officers and former employees. We have an agreement with the Department of Justice in our settlement agreement that any indemnification requirements that we might have towards former officers or employees would be capped in the aggregate in the amount of $75 million. And, finally in our 8-K, we will note that as a result of the divestitures we are announcing today, that we will be recording material charges for impairment to these long-lived assets and the goodwill associated with those assets as of the reporting period ending June 30. At this time, we cannot provide an estimate of the impairment charges. With that, I’ll turn it over to Trevor. Operator, we are ready to begin the Q& A period, if you would assemble the roster. [END] 11