universal helath services ar_2002_financials

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  • 1. FINANCIAL INFORMATION _________________________________________________________________________________ Management’s Discussion and Analysis _________24 Selected Financial Data _________42 Consolidated Financial Statements _________43 Notes _________48 Independent Auditors’ Report _________70 ΩUNIVERSAL HEALTH SERVICES, INC. SUBSIDIARIES AND 23
  • 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF OPERATIONS AND FINANCIAL CONDITION _________________________________________________________________________________ FORWARD-LOOKING STATEMENTS AND RISK FACTORS _________________________________________________________________________________ The matters discussed in this report as well as the reduce the demand for healthcare; the ability to attract and news releases issued from time to time by the Company retain qualified personnel, including nurses and physicians; include certain statements containing the words “believes” , the ability of the Company to successfully integrate its “anticipates”, “intends”, “expects” and words of similar acquisitions; the Company’s ability to finance growth on import, which constitute “forward-looking statements” favorable terms; and, other factors referenced in the within the meaning of the Private Securities Litigation Company’s 2002 Form 10-K. Additionally, the Company’s Reform Act of 1995. Such forward-looking statements financial statements reflect large amounts due from various involve known and unknown risks, uncertainties and other commercial payors and there can be no assurance that fail- factors that may cause the actual results, performance or ure of the payors to remit amounts due to the Company achievements of the Company or industry results to be will not have a material adverse effect on the Company’s materially different from any future results, performance future results of operations. Also, the Company has or achievements expressed or implied by such forward- experienced a significant increase in professional and gen- looking statements. Such factors include, among other eral liability and property insurance expense caused by things, the following: that the majority of the Company’s unfavorable pricing and availability trends of commercial revenues are produced by a small number of its total facili- insurance. As a result, the Company has assumed a greater ties; possible unfavorable changes in the levels and terms of portion of its liability risk and there can be no assurance reimbursement for the Company’s charges by government that a continuation of these unfavorable trends, or a sharp programs, including Medicare or Medicaid or other third increase in claims asserted against the Company which are party payors; industry capacity; demographic changes; self-insured, will not have a material adverse effect on the existing laws and government regulations and changes in Company’s future results of operations. Given these uncer- or failure to comply with laws and governmental regula- tainties, prospective investors are cautioned not to place tions; the ability to enter into managed care provider undue reliance on such forward-looking statements. agreements on acceptable terms; liability and other claims Management disclaims any obligation to update any such asserted against the Company; competition; the loss of factors or to publicly announce the result of any revisions significant customers; technological and pharmaceutical to any of the forward-looking statements contained herein improvements that increase the cost of providing, or to reflect future events or developments. RESULTS OF OPERATIONS _________________________________________________________________________________ Net revenues increased 15% to $3.26 billion in both years, and; (ii) $324 million of net revenues gen- 2002 as compared to 2001 and 27% to $2.84 billion in erated at acute care and behavioral health care facilities 2001 as compared to 2000. The $420 million increase in acquired in the U.S and France since January 1, 2000 net revenues during 2002 as compared to 2001 primarily (excludes revenues generated at these facilities one year resulted from: (i) a $255 million or 9% increase in net after acquisition). revenues generated at acute care hospitals (located in the Net revenues from the Company’s acute care facili- U.S., Puerto Rico and France) and behavioral health care ties (including the nine hospitals located in France) and facilities owned during both years, and; (ii) $159 million ambulatory treatment centers accounted for 82%, 81% of revenues generated at acute care and behavioral health and 84% of consolidated net revenues during 2002, 2001 care facilities acquired in the U.S. and France purchased and 2000, respectively. Net revenues from the Company’s at various times subsequent to January 1, 2001 (excludes behavioral health services facilities accounted for 17%, revenues generated at these facilities one year after 19% and 16% of consolidated net revenues during 2002, acquisition). 2001 and 2000, respectively. The $600 million increase in net revenues during Operating income (defined as net revenues less 2001 as compared to 2000 resulted from: (i) a $276 mil- salaries, wages and benefits, other operating expenses, lion or 13% increase in net revenues generated at acute supplies expense and provision for doubtful accounts) care and behavioral health care facilities owned during increased 17% to $516 million in 2002 from $442 million UNIVERSAL HEALTH SERVICES, INC. SUBSIDIARIES AND 24
  • 3. _________________________________________________________________________________ in 2001. In 2001, operating income increased 23% to Company’s overall operating margins during the last three $442 million from $359 million in 2000. Overall operat- years are discussed below. ing margins (defined as operating income divided by net Below is a reconciliation of consolidated operating revenues) were 15.8% in 2002, 15.6% in 2001 and 16.0% income to consolidated income before income taxes and in 2000. The factors causing the fluctuations in the the extraordinary charge, recorded in 2001: 2002 2001 2000 ___________________________________ $516,019) $441,921 $359,325 Consolidated operating income 124,794) 127,523 112,809 Less: Depreciation and amortization 61,712) 53,945 49,039 Lease and rental 34,746) 36,176 29,941 Interest expense, net —) 40,000 — Provision for insurance settlements (2,182) — 7,747 (Recovery of )/facility closure costs 220) 8,862 — Losses on foreign exchange and derivative transactions 19,658) 17,518 13,681 Minority interest in earnings of consolidated entities ___________________________________ $277,071) $157,897 $146,108 Consolidated income before income tax and extraordinary charge ___________________________________ 15.8%) 15.6% 16.0% Operating margin ___________________________________ Net income was $175.4 million in 2002 as com- including $15.6 million of after-tax goodwill amortization pared to $99.7 million in 2001. The increase of approxi- expense which ceased upon the January 1, 2002 adoption mately $76 million during 2002 as compared to 2001 was of the provisions of SFAS No. 142, “Goodwill and Other primarily attributable to: (i) an increase of approximately Intangible Assets” (this decrease was substantially offset by $33 million, after-tax, in operating income from acute care an increase during 2002, in depreciation expense attribut- and behavioral health care facilities owned during both able to capital additions and acquisitions, including depre- periods located in the U.S., Puerto Rico and France, due ciation expense on the newly constructed 371-bed George to the factors described below in Acute Care Services and Washington University Hospital which opened during the Behavioral Health Services; (ii) an increase of approximate- third quarter of 2002), and; (iv) the 2001 period including ly $10 million, after-tax, in operating income from acute approximately $31 million of after-tax charges relating to care and behavioral health care facilities acquired in the provision for insurance settlements, losses on foreign U.S., Puerto Rico and France during 2001 and 2002 exchange contracts, derivative transactions and debt (excludes operating income, after-tax, generated at these extinguishment. facilities one year after acquisition); (iii) the 2001 period ACUTE CARE SERVICES _________________________________________________________________________________ In addition to the increase in inpatient volumes, On a same facility basis, net revenues at the the Company’s same facility net revenues were favorably Company’s acute care hospitals located in the U.S. and impacted by an increase in prices charged to private payors Puerto Rico increased 10% in 2002 as compared to 2001 including health maintenance organizations and preferred and 14% in 2001 as compared to 2000. On a same facility provider organizations as well as an increase in Medicare basis, admissions and patient days increased 6.9% and reimbursements which commenced on April 1, 2001. On 5.5%, respectively, in 2002 as compared to 2001 as the a same facility basis, at the Company’s acute care hospitals average length of stay remained unchanged at 4.7 days. located in the U.S. and Puerto Rico, net revenue per Admissions and patient days at the Company’s acute care adjusted admission (adjusted for outpatient activity) hospitals located in the U.S. and Puerto Rico increased increased 3.6% and net revenue per adjusted patient day 4.8% and 5.7%, respectively, in 2001 as compared to (adjusted for outpatient activity) increased 4.6% in 2002 2000 as the average length of stay was 4.8 days in 2001 as compared to 2001. Also on a same facility basis, net as compared to 4.7 days in 2000. UNIVERSAL HEALTH SERVICES, INC. SUBSIDIARIES AND 25
  • 4. MANAGEMENT DISCUSSION AND ANALYSIS OF OPERATIONS AND FINANCIAL CONDITION (continued) _________________________________________________________________________________ revenue per adjusted admission increased 8.4% and net Puerto Rico were 82.5% in 2002 and 82.3% in 2001 as revenue per adjusted patient day increased 7.4% in 2001 operating margins at these facilities were 17.5% in 2002 as compared to 2000. Included in the same facility acute and 17.7% in 2001. On a same facility basis during 2001 care financial results and patient statistical data are the as compared to 2000, operating expenses as a percentage operating results generated at the 60-bed McAllen Heart of net revenues at these facilities were 82.6% in 2001 and Hospital which was acquired by the Company in March of 81.6% in 2000 as operating margins at these facilities 2001. Upon acquisition, the facility began operating under were 17.4% in 2001 and 18.4% in 2000. the same license as an integrated department of McAllen Favorably impacting the operating margins at the Medical Center and therefore the financial and statistical Company’s acute care hospitals located in the U.S. and results are not separable. Puerto Rico during 2002 as compared to 2001 was a Despite the increase in patient volume at the reduction in the provision for doubtful accounts which, Company’s acute care hospitals, inpatient utilization as a percentage of net revenues, decreased to 8.3% in 2002 continues to be negatively affected by payor-required, as compared to 9.7% in 2001. This improvement was pri- pre-admission authorization and by payor pressure to marily attributable to more aggressive efforts to properly maximize outpatient and alternative healthcare delivery categorize charges related to charity care, improved billing services for less acutely ill patients. The increase in net and collection procedures and an increase in collection of revenue was negatively affected by lower payments from amounts previously reserved. Unfavorably impacting the the government under the Medicare program as a result operating margins at these facilities during 2002 as com- of the Balanced Budget Act of 1997 (“BBA-97”) and pared to 2001 was an increase in other operating expenses discounts to insurance and managed care companies which increased to 23.8% of net revenues in 2002 as com- (see General Trends). During 2002, 2001 and 2000, 43%, pared to 22.5% in 2001 and an increase in salaries, wages 43% and 44%, respectively, of the net patient revenues at and benefits which increased to 36.2% of net revenues in the Company’s acute care facilities were derived from 2002 as compared to 35.5% in 2001. The increase in other Medicare and Medicaid (excludes revenues generated from operating expenses was due primarily to a significant managed Medicare and Medicaid programs). During increase in professional and general liability insurance 2002, 2001 and 2000, 37%, 36% and 35%, respectively, expense caused by unfavorable pricing and availability of the net patient revenues at the Company’s acute care trends of commercial insurance (see General Trends). The facilities were derived from managed care companies which increase in salaries, wages and benefits was due primarily includes health maintenance organizations, preferred to rising labor rates particularly in the area of skilled nurs- provider organizations and managed Medicare and ing. The Company expects the expense factors mentioned Medicaid programs. The Company anticipates that the above to continue to pressure future operating margins. percentage of its revenue from managed care business will Despite the strong revenue growth experienced at continue to increase in the future. The Company generally the Company’s acute care facilities during 2001 as com- receives lower payments per patient from managed care pared to 2000, operating margins at these facilities were payors than it does from traditional indemnity insurers. lower in 2001 as compared to the prior year due primarily At the Company’s acute care facilities located in the to increases in salaries, wages and benefits, pharmaceutical U.S. and Puerto Rico, operating expenses (salaries, wages expense and insurance expense. Salaries, wages and bene- and benefits, other operating expenses, supplies expense fits increased primarily as a result of rising labor rates, par- and provision for doubtful accounts) as a percentage of net ticularly in the area of skilled nursing and the increase in revenues were 82.8% in 2002, 82.2% in 2001 and 81.4% pharmaceutical expense was caused primarily by increased in 2000. Operating margins (defined as net revenues less utilization of high-cost drugs. The Company experienced operating expenses divided by net revenues) at these facili- an increase in insurance expense on the self-insured reten- ties were 17.2% in 2002, 17.8% in 2001 and 18.6% in tion limits at certain of its subsidiaries caused primarily 2000. On a same facility basis during 2002 as compared to by unfavorable industry-wide pricing trends for hospital 2001, operating expenses as a percentage of net revenues at professional and general liability coverage. the Company’s acute care hospitals located in the U.S. and UNIVERSAL HEALTH SERVICES, INC. SUBSIDIARIES AND 26
  • 5. _________________________________________________________________________________ BEHAVIORAL HEALTH SERVICES _________________________________________________________________________________ On a same facility basis, net revenues at the health hospitals under the Medicare program, effective for Company’s behavioral health care facilities increased 4% in cost reporting periods beginning on or after October 1, 2002 as compared to 2001 and 7% in 2001 as compared 2002. This PPS must include an adequate patient classifi- to 2000. Admissions and patient days at these facilities cation system that reflects the differences in patient increased 6.4% and 5.2%, respectively, in 2002 as resource use and costs among these hospitals and must compared to 2001 as the average length of stay decreased maintain budget neutrality. However, implementation of to 11.9 days in 2002 as compared to 12.1 days in 2001. this PPS for inpatient services furnished by behavioral Admissions and patient days at the Company’s behavioral health hospitals has been delayed until the first quarter of health care facilities owned in both 2001 and 2000 2004. Although Management of the Company believes the increased 6.7% and 4.4%, respectively, in 2001 as implementation of inpatient PPS may have a favorable compared to 2000 as the average length of stay decreased effect on the Company’s future results of operations, to 11.9 days in 2001 as compared to 12.2 days in 2000. Management can not predict the ultimate effect of inpa- On a same facility basis, at the Company’s behav- tient PPS on the Company’s future operating results until ioral health care facilities, net revenue per adjusted admis- the provisions are finalized. During 2002, 2001 and 2000, sion (adjusted for outpatient activity) decreased 0.4% and 35%, 38% and 45%, respectively, of the net patient rev- net revenue per adjusted patient day (adjusted for outpa- enues at the Company’s behavioral health care facilities tient activity) increased 1.1% in 2002 as compared to were derived from Medicare and Medicaid (excludes rev- 2001. Also on a same facility basis, net revenue per adjust- enues generated from managed Medicare and Medicaid ed admission increased 1.7% and net revenue per adjusted programs). During 2002, 2001 and 2000, 48%, 39% patient day increased 4.2% in 2001 as compared to 2000. and 35%, respectively, of the net patient revenues at the Behavioral health facilities, which are excluded from Company’s behavioral health care facilities were derived the inpatient services prospective payment system (“PPS”) from managed care companies which includes health applicable to acute care hospitals, are reimbursed on a rea- maintenance organizations, preferred provider organiza- sonable cost basis by the Medicare program, but are gener- tions and managed Medicare and Medicaid programs. ally subject to a per discharge ceiling, calculated based on At the Company’s behavioral health care facilities, an annual allowable rate of increase over the hospital’s base operating expenses (salaries, wages and benefits, other year amount under the Medicare law and regulations. operating expenses, supplies expense and provision for Capital-related costs are exempt from this limitation. In doubtful accounts) as a percentage of net revenues were the Balanced Budget Act of 1997 (“BBA-97”), Congress 79.8% in 2002, 81.0% in 2001 and 81.8% in 2000. significantly revised the Medicare payment provisions for The Company’s behavioral health care division generated PPS-excluded hospitals, including behavioral health ser- operating margins (defined as net revenues less operating vices facilities. Effective for Medicare cost reporting peri- expenses divided by net revenues) of 20.2% in 2002, ods beginning on or after October 1, 1997, different caps 19.0% in 2001 and 18.2% in 2000. On a same facility are applied to behavioral health services hospitals’ target basis during 2002 as compared to 2001, operating expens- amounts depending upon whether a hospital was excluded es as a percentage of net revenues at the Company’s behav- from PPS before or after that date, with higher caps for ioral health care facilities were 79.7% in 2002 and 81.0% hospitals excluded before that date. Congress also revised in 2001 as operating margins at these facilities were 20.3% the rate-of-increase percentages for PPS-excluded hospitals in 2002 and 19.0% in 2001. On a same facility basis dur- and eliminated the new provider PPS-exemption for ing 2001 as compared to 2000, operating expenses as a behavioral health hospitals. In addition, the Health Care percentage of net revenues at these facilities were 80.3% Financing Administration, now known as the Centers for in 2001 and 81.8% in 2000 as operating margins at these Medicare and Medicaid Services (“CMS”), has implement- facilities were 19.7% in 2001 and 18.2% in 2000. In an ed requirements applicable to behavioral health services effort to maintain and potentially further improve the hospitals that share a facility or campus with another hos- operating margins at its behavioral health care facilities, pital. The Medicare, Medicaid and SCHIP Balance Budget management of the Company continues to implement Refinement Act of 1999 requires that CMS develop a per cost controls and price increases and has also increased diem PPS for inpatient services furnished by behavioral its focus on receivables management. UNIVERSAL HEALTH SERVICES, INC. SUBSIDIARIES AND 27
  • 6. MANAGEMENT DISCUSSION AND ANALYSIS OF OPERATIONS AND FINANCIAL CONDITION (continued) _________________________________________________________________________________ OTHER OPERATING RESULTS _________________________________________________________________________________ Combined net revenues from the Company’s other 2001, pending the outcome of the state supreme court operating entities including outpatient surgery centers, review, the Company recorded interest expense related to radiation centers and an 80% ownership interest in an this unfavorable jury verdict of $700,000 in each year. operating company that owns nine hospitals in France During the fourth quarter of 2002, as a result of the sale of increased to $161 million during 2002 as compared to the real estate of this closed facility, the Company recorded $113 million in 2001 and $61 million in 2000. The a pre-tax $2.2 million recovery of facility closure costs. increase in combined net revenues in 2002 and 2001 The Company recorded minority interest expense in as compared to 2000 was primarily attributable to the the earnings of consolidated entities amounting to $19.7 Company’s purchase, in March of 2001, of an 80% owner- million in 2002, $17.5 million in 2001 and $13.7 million ship interest in an operating company that owns nine in 2000. The minority interest expense includes the hospitals located in France. Combined operating mar- minority ownerships’ share of the net income of four acute gins from the Company’s other operating entities were care facilities located in the U.S., three of which are locat- 21.3% in 2002, 20.2% in 2001 and 15.1% in 2000. ed in Las Vegas, Nevada and one located in Washington, During the fourth quarter of 2001, the Company D.C, and nine acute care facilities located in France recorded the following charges: (i) a $40.0 million pre-tax (acquired during 2001). charge to reserve for malpractice expenses that may result Depreciation and amortization expense was $124.8 from the Company’s third party malpractice insurance million in 2002, $127.5 million in 2001 and $112.8 mil- company (PHICO) that was placed in liquidation in lion in 2000. Effective January 1, 2002, the Company February, 2002 (see General Trends); (ii) a $7.4 million adopted the provisions of SFAS No. 142, “Goodwill and pre-tax loss on derivative transactions resulting from the Other Intangible Assets” and accordingly, ceased amor- early termination of interest rate swaps, and; (iii) a $1.0 tizing goodwill as of that date. For the years ended million after-tax ($1.6 million pre-tax) extraordinary December 31, 2001 and 2000, the Company recorded expense resulting from the early redemption of the $24.7 million and $19.5 million of pre-tax goodwill amor- Company’s $135 million 8.75% notes issued in 1995. tization expense, respectively. Substantially offsetting the During the fourth quarter of 2000, the Company decrease during 2002 as compared to 2001 caused by the recognized a pre-tax charge of $7.7 million to reflect the adoption of SFAS No. 142 was an increase in depreciation amount of an unfavorable jury verdict and reserve for expense during 2002 attributable to capital additions and future legal costs relating to an unprofitable facility that acquisitions, including depreciation expense on the newly was closed during the first quarter of 2001. During 2001, constructed 371-bed George Washington University an appellate court issued an opinion affirming the jury ver- Hospital which opened during the third quarter of 2002. dict and during the first quarter of 2002, the Company The effective tax rate was 36.7% in 2002, 36.2% in filed a petition for review by the Texas Supreme Court, 2001 and 36.1% in 2000. which has accepted the case for review. During 2002 and GENERAL TRENDS _________________________________________________________________________________ A significant portion of the Company’s revenue is addition, reimbursement is generally subject to audit and derived from federal and state healthcare programs, includ- review by third party payors. Management believes that ing Medicare and Medicaid (excluding managed Medicare adequate provision has been made for any adjustment that and Medicaid programs), which accounted for 42%, 42% might result therefrom. and 44% of the Company’s net patient revenues during The federal government makes payments to partici- 2002, 2001 and 2000, respectively. Under the statutory pating hospitals under the Medicare program based on var- framework of the Medicare and Medicaid programs, many ious formulas. The Company’s general acute care hospitals of the Company’s operations are subject to administrative are subject to a prospective payment system (“PPS”). For rulings, interpretations and discretion which may affect inpatient services, PPS pays hospitals a predetermined payments made under either or both of such programs. In amount per diagnostic related group (“DRG”), for which UNIVERSAL HEALTH SERVICES, INC. SUBSIDIARIES AND 28
  • 7. _________________________________________________________________________________ payment amounts are adjusted to account for geographic neutrality. However, implementation of this PPS for inpa- wage differences. Beginning August 1, 2000 under an out- tient services furnished by certain behavioral health patient prospective payment system (“OPPS”) mandated hospitals has been delayed until the first quarter of 2004. by Congress in the Balanced Budget Act of 1997 (“BBA- Although Management of the Company believes the 97”), both general acute and behavioral health hospitals implementation of inpatient PPS may have a favorable are paid for outpatient services included in the OPPS effect on the Company’s future results of operations, according to ambulatory procedure codes (“APC”), which Management can not predict the ultimate effect of group together services that are comparable both clinically behavioral health inpatient PPS on the Company’s future and with respect to the use of resources. The payment for operating results until the provisions are finalized. each item or service is determined by the APC to which it In addition to the trends described above that con- is assigned. The APC payment rates are calculated on a tinue to have an impact on the Company’s operating national basis and adjusted to account for certain geo- results, there are a number of other more general factors graphic wage differences. The Medicare, Medicaid and affecting the Company’s business. BBA-97 called for the SCHIP Balanced Budget Refinement Act of 1999 government to trim the growth of federal spending on (“BBRA of 1999”) included “transitional corridor pay- Medicare by $115 billion and on Medicaid by $13 billion ments” through fiscal year 2003, which provide some over the ensuing 5 years. This enacted legislation also financial relief for any hospital that generally incurs a called for reductions in the future rate of increases to pay- reduction to its Medicare outpatient reimbursement ments made to hospitals and reduced the amount of pay- under the new OPPS. ments for outpatient services, bad debt expense and capital Behavioral health facilities, which are generally costs. Some of these reductions were temporarily reversed excluded from the inpatient services PPS are reimbursed with the passage of the Medicare, Medicaid and SCHIP on a reasonable cost basis by the Medicare program, but Benefits Improvement and Protection Act of 2000 are generally subject to a per discharge ceiling, calculated (“BIPA”) which, among other things, increased Medicare based on an annual allowable rate of increase over the and Medicaid payments to healthcare providers by $35 bil- hospital’s base year amount under the Medicare law and lion over the ensuing 5 years with approximately $12 bil- regulations. Capital-related costs are exempt from this lion of this amount targeted for hospitals and $11 billion limitation. In the BBA-97, Congress significantly revised for managed care payors. However, many of the payment the Medicare payment provisions for PPS-excluded hospi- reductions reversed by Congress in BIPA are expiring. In tals, including certain behavioral health services facilities. addition, without further Congressional action, in fiscal Effective for Medicare cost reporting periods beginning on year 2003 hospitals will receive less than a full market bas- or after October 1, 1997, different caps are applied to cer- ket inflation adjustment for services paid under the inpa- tain behavioral health services hospitals’ target amounts tient PPS (inpatient PPS update of the market basket depending upon whether a hospital was excluded from minus 0.55 percentage points is estimated to equal 2.95% PPS before or after that date, with higher caps for hospitals in fiscal year 2003), although CMS estimates that for the excluded before that date. Congress also revised the rate- same time period, Medicare payment rates under OPPS of-increase percentages for PPS-excluded hospitals and will increase, for each service, by an average of 3.7 percent. eliminated the new provider PPS-exemption for behavioral In February, 2003, the federal fiscal year 2003 omnibus health hospitals. In addition, the Health Care Financing spending federal legislation was signed into law. This legis- Administration, now known as the Centers for Medicare lation includes approximately $800 million in increased and Medicaid Services (“CMS”), has implemented require- spending for hospitals. More specifically, $300 million ments applicable to behavioral health services hospitals of this amount is targeted for rural and certain urban that share a facility or campus with another hospital. The hospitals effective for the period of April, 2003 through BBRA of 1999 requires that CMS develop a per diem PPS September, 2003. Certain of the Company’s hospitals are for inpatient services furnished by certain behavioral health eligible for and are expected to receive the increased hospitals under the Medicare program, effective for cost Medicare reimbursement resulting from this legislation, reporting periods beginning on or after October 1, 2002. however, the impact is not expected to have a material This PPS must include an adequate patient classification effect on the Company’s future results of operations. system that reflects the differences in patient resource use Certain Medicare inpatient hospital cases with extra- and costs among these hospitals and must maintain budget ordinarily high costs in relation to other cases within a UNIVERSAL HEALTH SERVICES, INC. SUBSIDIARIES AND 29
  • 8. MANAGEMENT’S DISCUSSION AND ANALYSIS OF OPERATIONS AND FINANCIAL CONDITION (continued) _________________________________________________________________________________ given DRG may receive an additional payment from not have a material adverse effect on the Company’s future Medicare (“Outlier Payments”). In general, to qualify for results of operations. Furthermore, the Company can the additional Outlier Payments, the gross charges associ- provide no assurances that future reductions to federal ated with an individual patient’s case must exceed the and state budgets that contain certain further reduc- applicable standard DRG payment plus a threshold estab- tions or decreases in the rate of increase of Medicare and lished annually by CMS. In the federal 2003 fiscal year, Medicaid spending, will not adversely affect the the unadjusted Outlier Payment threshold increased to Company’s future operations. $33,560 from $21,025. Outlier Payments are currently In 1991, the Texas legislature authorized the subject to multiple factors including but not limited to: LoneSTAR Health Initiative, a pilot program in two areas (i) the hospital’s estimated operating costs based on its of the state, to establish for Medicaid beneficiaries a historical ratio of costs to gross charges; (ii) the patient’s healthcare delivery system based on managed care princi- case acuity; (iii) the CMS established threshold; and; (iv) ples. The program is now known as the STAR program, the hospital’s geographic location. However, in February, which is short for State of Texas Access Reform. Since 2003, CMS issued a proposed rule that would change the 1995, the Texas Health and Human Services Commission, outlier formula in an effort to promote more accurate with the help of other Texas agencies such as the Texas spending for outlier payments to hospitals. Management Department of Health, has rolled out STAR Medicaid of the Company ultimately believes the increase in the managed care pilot programs in several geographic areas of Outlier Payments threshold and potential change in the the state. Under the STAR program, the Texas Health and Outlier Payment methodology will result in a decrease in Human Services Commission either contracts with health the overall Outlier Payments expected to be received by maintenance organizations in each area to arrange for cov- the Company during the 2003 federal fiscal year. This ered services to Medicaid beneficiaries, or contracts direct- decrease is expected to substantially offset the increase in ly with healthcare providers and oversees the furnishing of Medicare payments resulting from the market basket infla- care in the role of a case manager. Two carve-out pilot pro- tion adjustment as mentioned above. The Company’s total grams are the STAR+PLUS program, which provides long- Outlier Payments in 2002 were less than 1% of its consoli- term care to elderly and disabled Medicaid beneficiaries dated net revenues and Management expects that Outlier in the Harris County service area, and the NorthSTAR Payments in 2003 will amount to less than 0.5% of the program, which furnishes behavioral health services to Company’s consolidated net revenues. Medicaid beneficiaries in the Dallas County service area. Within certain limits, a hospital can manage its The Texas Health and Human Services Commission is costs, and to the extent this is done effectively, a hospital currently seeking a waiver to extend a limited Medicaid may benefit from the DRG system. However, many hospi- benefits package to low income persons with serious men- tal operating costs are incurred in order to satisfy licensing tal illness. The waiver is limited to individuals residing in laws, standards of the Joint Commission on Accreditation Harris County or the NorthSTAR service areas. Effective of Healthcare Organizations (“JCAHO”) and quality of in the fall of 1999, however, the Texas legislature imposed care concerns. In addition, hospital costs are affected by a moratorium on the implementation of additional pilot the level of patient acuity, occupancy rates and local physi- programs until the 2001 legislative session. While Texas cian practice patterns, including length of stay and number Senate Bill 1, effective September 1, 2001, directed and type of tests and procedures ordered. A hospital’s abili- the Texas Health and Human Services Commission to ty to control or influence these factors which affect costs is, implement Medicaid cost containment measures including in many cases, limited. a statewide rollout of the primary care case management In addition to revenues received pursuant to the program in non-STAR areas, expansion of this program Medicare program, the Company receives a large portion has been delayed in response to concerns from hospitals of its revenues either directly from Medicaid programs or and physicians. Although no legislation has passed yet, from managed care companies managing Medicaid with a such actions could have a material unfavorable impact on large concentration of the Company’s Medicaid revenues the reimbursement the Texas hospitals receive during the received from Texas, Pennsylvania and Massachusetts. The period of September, 2003 to September, 2005. Company can provide no assurance that reductions to Upon meeting certain conditions, and serving a dis- Medicaid revenues in any state in which it operates, will proportionately high share of Texas’ and South Carolina’s UNIVERSAL HEALTH SERVICES, INC. SUBSIDIARIES AND 30
  • 9. _________________________________________________________________________________ low income patients, five of the Company’s facilities locat- and raise awareness of various regulatory issues among ed in Texas and one facility located in South Carolina employees, to stress the importance of complying with all became eligible and received additional reimbursement federal and state laws and regulations and to promote the from each state’s disproportionate share hospital (“DSH”) Company’s standards of conduct. As part of the program, fund. In order to receive DSH funds, the facility must the Company provides ethics and compliance training qualify to receive such payments. To qualify for DSH to its employees. The Company also provides additional funds in Texas, the facility must have either a dispropor- compliance training in specialized areas to the employees tionate total number of inpatient days for Medicaid responsible for these areas. The program encourages all patients, a disproportionate percentage of all inpatient employees to report any potential or perceived violations days that are for Medicaid patients, or a disproportionate directly to the applicable compliance officer or to the percentage of all inpatient days that are for low-income Company through the use of a toll-free telephone hotline patients. Included in the Company’s financial results was or a compliance post office box. an aggregate of $33.0 million in 2002, $32.6 million in Pressures to control health care costs and a shift 2001 and $28.9 million in 2000, related to DSH pro- away from traditional Medicare to Medicare managed care grams. The Office of Inspector General recently published plans have resulted in an increase in the number of a report indicating that Texas Medicaid may have overpaid patients whose health care coverage is provided under Texas hospitals for DSH payments. Although it is not yet managed care plans. Approximately 39% in 2002, 37% clear how this issue will be resolved, it may have an adverse in 2001 and 35% in 2000, of the Company’s net patient effect on the Company’s hospitals located in Texas that have revenues were generated from managed care companies, significant Medicaid populations. Both states have renewed which includes health maintenance organizations, pre- their programs for the 2003 fiscal years, however, failure to ferred provider organizations and managed Medicare and renew these programs beyond their scheduled termination Medicaid programs. In general, the Company expects the date (June 30, 2003 for South Carolina and August 31, percentage of its business from managed care programs to 2003 for Texas), failure to qualify for DSH funds under continue to grow. The consequent growth in managed care these programs, or reductions in reimbursements (includ- networks and the resulting impact of these networks on ing reductions related to the potential Texas Medicaid over- the operating results of the Company’s facilities vary payments mentioned above), could have a material adverse among the markets in which the Company operates. effect on the Company’s future results of operations. Typically, the Company receives lower payments per The healthcare industry is subject to numerous fed- patient from managed care payors than it does from tradi- eral and state laws and regulations which include, among tional indemnity insurers, however, during the past two other things, participation requirements of federal and years, the Company secured price increases from many of state health care programs, various licensure and accredita- its commercial payors including managed care companies. tion requirements, reimbursement rules for patient ser- Due to unfavorable pricing and availability trends in vices, False Claims Act provisions, patient privacy rules the professional and general liability insurance markets, the and Medicare and Medicaid anti-fraud and abuse provi- Company’s subsidiaries have assumed a greater portion of sions. Providers that are found to have violated these laws the hospital professional and general liability risk as the and regulations may be excluded from participating in cost of commercial professional and general liability insur- federal and state healthcare programs, subjected to fines ance coverage has risen significantly. As a result, effective or penalties or required to repay amounts received from January 1, 2002, most of the Company’s subsidiaries were government for previously billed patient services. While self-insured for malpractice exposure up to $25 million per management of the Company believes its policies, proce- occurrence. The Company, on behalf of its subsidiaries, dures and practices comply with applicable laws and purchased an umbrella excess policy through a commercial regulations, no assurance can be given that the Company insurance carrier for coverage in excess of $25 million per will not be subjected to governmental inquiries or occurrence with a $75 million aggregate limitation. Total actions or that governmental authorities may not find insurance expense including professional and general lia- the Company to be in violation of a law or regulation bility, property, auto and workers’ compensation, was as a result of an inquiry or action. approximately $25 million higher in 2002 as compared to The Company voluntarily maintains a corporate 2001. Given these insurance market conditions, there can compliance program. The program is designed to monitor be no assurance that a continuation of these unfavorable UNIVERSAL HEALTH SERVICES, INC. SUBSIDIARIES AND 31
  • 10. MANAGEMENT DISCUSSION AND ANALYSIS OF OPERATIONS AND FINANCIAL CONDITION (continued) _________________________________________________________________________________ Included in other assets as of December 31, 2002 trends, or a sharp increase in claims asserted against the and 2001, were estimates of approximately $37 million Company, will not have a material adverse effect on the and $54 million, respectively, representing expected recov- Company’s future results of operations. eries from various state guaranty funds. The reduction in For the period from January 1, 1998 through estimated recoveries as of December 31, 2002 as compared December 31, 2001, most of the Company’s subsidiaries to December 31, 2001 is due to Management’s reassess- were covered under professional and general liability insur- ment of its ultimate liability for general and professional ance policies with PHICO, a Pennsylvania-based commer- liability claims relating to the period from 1998 through cial insurance company. Certain subsidiaries, including 2001, its estimate of related recoveries under state guaranty hospitals located in Washington, D.C, Puerto Rico and funds, and payments received during 2002 from such state south Texas were covered under policies with various guaranty funds. While Management continues to monitor coverage limits up to $5 million per occurrence through the factors used in making these estimates, the Company’s December 31, 2001. The majority of the remaining sub- ultimate liability for professional and general liability sidiaries were covered under policies, which provided for claims and its actual recoveries from state guaranty funds, a self-insured retention limit up to $1 million per occur- could change materially from current estimates due to the rence, with an annual aggregate retention amount of inherent uncertainties involved in making such estimates. approximately $4 million in 1998, $5 million in 1999, Therefore, there can be no assurance that changes in these $7 million in 2000 and $11 million in 2001. These sub- estimates, if any, will not have a material adverse effect on sidiaries maintain excess coverage up to $100 million the Company’s financial position, results of operations or with other major insurance carriers. cash flows in future periods. Early in the first quarter of 2002, PHICO was As of December 31, 2002, the total accrual for placed in liquidation by the Pennsylvania Insurance the Company’s professional and general liability claims, Commissioner. As a result, during the fourth quarter of including all PHICO related claims was $168.2 million 2001, the Company recorded a $40 million pre-tax charge ($131.2 million net of expected recoveries from state guar- to earnings to accrue for its estimated liability that resulted anty funds), of which $12.0 million is included in other from this event. Management estimated this liability based current liabilities. As of December 31, 2001, the total on a number of factors including, among other things, the reserve for the Company’s professional and general liability number of asserted claims and reported incidents, esti- claims was $158.1 million ($104.1 million net of expected mates of losses for these claims based on recent and histori- recoveries from state guaranty funds), of which $26.0 cal settlement amounts, estimates of unasserted claims million is included in other current liabilities. based on historical experience, and estimated recoveries The Company maintains a non-contributory from state guaranty funds. defined benefit plan which covers the employees of one When PHICO entered liquidation proceedings, of the Company’s subsidiaries. The benefits are based on each state’s department of insurance was required to years of service and the employee’s highest compensation declare PHICO as insolvent or impaired. That designation for any five years of employment. The Company’s funding effectively triggers coverage under the applicable state’s policy is to contribute annually at least the minimum insurance guaranty association, which operates as replace- amount that should be funded in accordance with the ment coverage, subject to the terms, conditions and limits provisions of ERISA. The plan had invested assets with set forth in that particular state. Therefore, the Company a market value as of December 31, 2002 of $42.9 million is entitled to receive reimbursement from those state’s of which approximately 70% were invested in equity based guaranty funds for which it meets the eligibility require- securities and 30% in fixed income securities. As a result of ments. In addition, the Company may be entitled to the unfavorable general market conditions and lower than receive reimbursement from PHICO’s estate for a por- anticipated returns on assets, the Company believes its tion of the claims ultimately paid by the Company. expense related to this plan will be $3 million higher in Management expects that the remaining cash payments 2003 as compared to 2002. related to these claims will be made over the next seven years as the cases are settled or adjudicated. UNIVERSAL HEALTH SERVICES, INC. SUBSIDIARIES AND 32
  • 11. _________________________________________________________________________________ PRIVACY AND SECURITY REQUIREMENTS UNDER THE HEALTH INSURANCE PORTABILITY AND ACCOUNTABILITY ACT OF 1996 _________________________________________________________________________________ The Health Insurance Portability and Accountability • Mandating the adoption of privacy standards to Act (“HIPAA”) was enacted in August, 1996 to assure protect the confidentiality and privacy of health informa- health insurance portability, reduce healthcare fraud and tion. Prior to HIPAA there were no federally recognized abuse, guarantee security and privacy of health informa- healthcare standards governing the privacy of health infor- tion and enforce standards for health information. mation that includes all the necessary components to pro- Provisions not yet finalized are required to be implemented tect the data integrity and confidentiality of a patient’s two years after the effective date of the regulation. electronically maintained or transmitted personal health Organizations are subject to significant fines and penalties record. The final modifications to the privacy regulations if found not to be compliant with the provisions outlined were published in August, 2002. Most covered entities in the regulations. Regulations related to HIPAA are must comply with the privacy regulations by April, 2003. expected to impact the Company and others in the health- • Creating unique identifiers for the four con- care industry by: stituents in healthcare: payors, providers, patients and • Establishing standardized code sets for financial employers. HIPAA mandates the need for the unique and clinical electronic data interchange (“EDI”) transac- identifiers for healthcare providers in an effort to ease the tions to enable more efficient flow of information. administrative challenge of maintaining and transmitting Currently there is no common standard for the transfer clinical data across disparate episodes of patient care. of information between the constituents in healthcare and • Requiring covered entities to establish procedures therefore providers have had to conform to each standard and mechanisms to protect the confidentiality, integrity utilized by every party with which they interact. One of and availability of electronic protected health information. the goals of HIPAA is to create one common national The rule requires covered entities to implement adminis- standard for EDI and once the HIPAA regulation takes trative, physical, and technical safeguards to protect effect, payors will be required to accept the national electronic protected health information that they receive, standard employed by providers. The final regulations store, or transmit. Most covered entities will have until establishing electronic data transmission standards that April, 2005 to comply with these security standards. The all healthcare providers must use when submitting or Company believes that it will be able to comply; however, receiving certain healthcare transactions electronically the cost of compliance cannot yet be ascertained. were published in August, 2000 and compliance with these The Company is in the process of implementing regulations is required by October, 2003, if a request for a the necessary changes required pursuant to HIPAA. The one-year extension for compliance was properly submitted Company expects that the implementation cost of the to the Department of Health and Human Services. The HIPAA related modifications will not have a material Company was granted the one-year extension. adverse effect on the Company’s financial condition or results of operations. UNIVERSAL HEALTH SERVICES, INC. SUBSIDIARIES AND 33
  • 12. MANAGEMENT’S DISCUSSION AND ANALYSIS OF OPERATIONS AND FINANCIAL CONDITION (continued) _________________________________________________________________________________ MARKET RISKS ASSOCIATED WITH FINANCIAL INSTRUMENTS _________________________________________________________________________________ the swaps mature on June 30, 2005. The Company pays The Company’s interest expense is sensitive to an average fixed rate of 4.35% and receives six month changes in the general level of interest rates. To mitigate EURIBOR. The effective floating rate for these swaps the impact of fluctuations in domestic interest rates, a por- as of December 31, 2002 was 2.87%. tion of the Company’s debt is fixed rate accomplished by The interest rate swap agreements do not constitute either borrowing on a long-term basis at fixed rates or by positions independent of the underlying exposures. The entering into interest rate swap transactions. The interest Company does not hold or issue derivative instruments rate swap agreements are contracts that require the for trading purposes and is not a party to any instruments Company to pay fixed and receive floating interest rates with leverage features. The Company is exposed to credit over the life of the agreements. The floating-rates are based losses in the event of nonperformance by the counterpar- on LIBOR and the fixed-rate is determined at the time ties to its financial instruments. The counterparties are the swap agreement is consummated. creditworthy financial institutions, rated AA or better by As of December 31, 2002, the Company had three Moody’s Investor Services and the Company anticipates U.S. dollar interest rate swaps. One fixed rate swap with that the counterparties will be able to fully satisfy their a notional principal amount of $125 million expires in obligations under the contracts. For the years ended August, 2005. The Company pays a fixed rate of 6.76% December 31, 2002, 2001 and 2000, the Company and receives a floating rate equal to three month LIBOR. received weighted average rates of 3.5%, 5.9% and 7.2%, As of December 31, 2002, the effective floating rate of this respectively, and paid a weighted average rate on its interest rate swap was 1.40%. The Company is also a party interest rate swap agreements of 5.7% in 2002, 6.9% to two floating rate swaps having a notional principal in 2001 and 7.5% in 2000. amount of $60 million in which the Company receives The table below presents information about the a fixed rate of 6.75% and pays a floating rate equal to Company’s derivative financial instruments and other 6 month LIBOR plus a spread. The initial term of these financial instruments that are sensitive to changes in inter- swaps was ten years and they are both scheduled to expire est rates, including long-term debt and interest rate swaps on November 15, 2011. As of December 31, 2002, the as of December 31, 2002. For debt obligations, the table average floating rate of the $60 million of interest rate presents principal cash flows and related weighted-average swaps was 2.68%. interest rates by contractual maturity dates. For interest As of December 31, 2002, a majority-owned rate swap agreements, the table presents notional amounts subsidiary of the Company had two interest rate swaps by maturity date and weighted average interest rates based denominated in Euros. These two interest rate swaps are on rates in effect at December 31, 2002. The fair values of for a total notional amount of 41.2 million Euros ($40.9 long-term debt and interest rate swaps were determined million based on the end of period currency exchange based on market prices quoted at December 31, 2002, rate). The notional amount decreases to 35.0 million for the same or similar debt issues. Euros ($34.8 million) on December 30, 2003, 27.5 mil- lion Euros, ($27.3 million) on December 30, 2004 and UNIVERSAL HEALTH SERVICES, INC. SUBSIDIARIES AND 34
  • 13. _________________________________________________________________________________ Maturity Date, Fiscal Year Ending December 31 (Dollars in thousands) There- 2003 2004 2005 2006 2007) after Total _________________________________________________________________________________ Long-term debt: $3,715 $6,573 $3,346) $2,965) $1,051) $587,787(a) $605,437) Fixed rate-Fair value $3,715 $6,573 $3,346) $2,965) $1,051) $485,477(a) $503,127) Fixed rate-Carrying value 6.7% 7.6% 5.8%) 5.6%) 4.8%) 5.8%(a) 5.8%) Average interest rates $4,539 $6,059 $7,568) $139,088) $9,088) $19,298(a) $185,640) Variable rate long-term debt Interest rate swaps: Pay fixed/receive variable $125,000) $125,000) notional amounts ($15,648) (a) ($15,648) Fair value 6.76%) ) Average pay rate 3 month) Average receive rate LIBOR) Pay variable/receive fixed ($60,000)a) ($60,000) notional amounts $6,517((a (a)$6,517) Fair value 6 month((a Average pay rate LIBOR plus)(a spread(a) 6.75%(a) Average receive rate Euro denominated swaps: Pay fixed/receive variable $6,055 $7,568) $27,276) $40,899) notional amount ($1,223) ($1,223) Fair value 4.4% 4.4%) 4.4%) ) Average pay rate 6 month 6 month) 6 month) Average receive rate EURIBOR EURIBOR) EURIBOR) (a) The fair value of the Company’s 5% Convertible Debentures (“Debentures”) at December 31, 2002 is $375 million, however, the Company has the right to redeem the Debentures any time on or after June 23, 2006 at a price equal to the issue price of the Debentures plus accrued original issue discount and accrued cash interest to the date of redemption. On June 23, 2006 the amount necessary to redeem all Debentures would be $319 million. If the Debentures could be redeemed at the same basis at December 31, 2002 the redemption amount would be $276 million. The holders of the Debentures may convert the Debentures to the Company’s Class B stock at any time. If all Debentures were converted, the result would be the issuance of 6.6 million shares of the Company’s Class B Common Stock. EFFECTS OF INFLATION AND SEASONALITY _________________________________________________________________________________ Although inflation has not had a material impact markets, the cost of commercial professional and general on the Company’s results of operations over the last three liability insurance coverage has risen significantly. As a years, the healthcare industry is very labor intensive and result, on an annual basis, the Company’s total insurance salaries and benefits are subject to inflationary pressures as expense, including professional and general liability, prop- are rising supply costs which tend to escalate as vendors erty, auto and workers’ compensation, was approximately pass on the rising costs through price increases. The $25 million higher in 2002 as compared to 2001 and is Company’s acute care and behavioral health care facilities expected to increase by approximately $9 million or 15% are experiencing the effects of the tight labor market, in 2003 as compared to 2002. The Company’s subsidiaries including a shortage of nurses, which has caused and may have also assumed a greater portion of the hospital profes- continue to cause an increase in the Company’s salaries, sional and general liability risk. wages and benefits expense in excess of the inflation rate. Although the Company cannot predict its ability In addition, due to unfavorable pricing and availability to continue to cover future cost increases, Management trends in the professional and general liability insurance believes that through adherence to cost containment poli- UNIVERSAL HEALTH SERVICES, INC. SUBSIDIARIES AND 35
  • 14. MANAGEMENT’S DISCUSSION AND ANALYSIS OF OPERATIONS AND FINANCIAL CONDITION (continued) _________________________________________________________________________________ cies, labor management and reasonable price increases, the Company’s ability to maintain margins through price effects of inflation on future operating margins should be increases to non-Medicare patients is limited. manageable. However, the Company’s ability to pass on The Company’s business is seasonal, with higher these increased costs associated with providing healthcare patient volumes and net patient service revenue in the first to Medicare and Medicaid patients is limited due to vari- and fourth quarters of the Company’s year. This seasonali- ous federal, state and local laws which have been enacted ty occurs because, generally, more people become ill during that, in certain cases, limit the Company’s ability to the winter months, which results in significant increases in increase prices. In addition, as a result of increasing regula- the number of patients treated in the Company’s hospitals tory and competitive pressures and a continuing industry during those months. wide shift of patients into managed care plans, the LIQUIDITY AND CAPITAL RESOURCES _________________________________________________________________________________ Net cash provided by operating activities was $331 change in income plus the addback of adjustments to million in 2002, $298 million in 2001 and $175 million reconcile net cash provided by operating activities was a in 2000. The $33 million increase during 2002 as com- pre-tax $40 million non-cash reserve established during pared to 2001 was primarily attributable to: (i) a favorable the fourth quarter of 2001 related to the liquidation of $23 million change due to an increase in net income plus PHICO, the Company’s third party hospital professional the addback of adjustments to reconcile net cash provided and general liability insurance company (see General by operating activities (depreciation & amortization, Trends). The increase in net income taxes paid during accretion of discount on convertible debentures, losses 2001 was due to a reduction in the 2000 net income tax on foreign exchange, derivative transactions & debt payments resulting primarily from higher tax benefits from extinguishment and provision for insurance settlements employee stock options and the decreases in accrued taxes and other non-cash charges); (ii) a $36 million unfavor- attributable to overpayments in 1999. The $31 million able change in accounts receivable (partially due to the favorable change in accounts receivable resulted from timing of Medicare settlements and the increased patient improved accounts receivable management during 2001. volume and revenue at the new George Washington Capital expenditures were $201 million in 2002, University Hospital which opened during the third quarter $153 million in 2001 and $114 million in 2000. Included of 2002); (iii) a $19 million favorable change in accrued in the 2002 capital expenditures were costs related to the insurance expense net of payments made in settlement completion of the new George Washington University of self-insurance claims and commercial premiums paid Hospital located in Washington, D.C. (opened in August, caused primarily by the Company’s subsidiaries assuming a 2002), a 56-bed patient tower at Auburn Regional greater portion of the professional and general liability risk Medical Center located in Auburn, Washington (opened beginning in January, 2002; (iv) a $17 million favorable in January, 2003) and the first phase of a new 176-bed change due to timing of income tax payments, and; (v) acute care hospital located in Las Vegas, Nevada (scheduled $10 million of other net favorable working capital changes. to be completed in the fourth quarter of 2003). Capital The $123 million increase during 2001 as compared expenditures for capital equipment, renovations and new to 2000 was primarily attributable to: (i) a favorable $69 projects at existing hospitals and completion of major million change due to an increase in net income plus the construction projects in progress at December 31, 2002 addback of adjustments to reconcile net cash provided by are expected to total approximately $225 million to $240 operating activities (depreciation & amortization, accre- million in 2003. Included in the 2003 projected capital tion of discount on convertible debentures, losses on expenditures are the expenditures on a major new cardi- foreign exchange, derivative transactions & debt extin- ology wing and 90-bed expansion of Northwest Texas guishment and provision for insurance settlement and Healthcare System located in Amarillo, Texas (scheduled to other non-cash charges); (ii) an unfavorable $38 million be completed in the fourth quarter of 2003) and construc- change due to timing of net income tax payments; (iii) a tion of a new 120-bed acute care hospital in Manatee $31 million favorable change in accounts receivable; (iv) a County, Florida (scheduled to open in May, 2004). $28 million favorable change in other assets and deferred Included in the 2001 capital expenditures were costs related charges, and; (v) $33 million of other net favorable work- to the completion of a 180-bed acute care hospital located ing capital changes. Included in the $69 million favorable in Laredo, Texas and the 126-bed addition to the Desert UNIVERSAL HEALTH SERVICES, INC. SUBSIDIARIES AND 36
  • 15. _________________________________________________________________________________ the aggregate) during 2002. Since inception of the stock Springs Hospital in Las Vegas, Nevada. The Company purchase program in 1998 through December 31, 2002, believes that its capital expendi-ture program is adequate the Company purchased a total of 9.5 million shares at an to expand, improve and equip its existing hospitals. average purchase price of $22.74 per share ($216.4 million During 2002, the Company spent $3 million to in the aggregate). acquire a majority ownership interest in an outpatient In April, 2001, the Company declared a two-for-one surgery center located in Puerto Rico. During 2001, the stock split in the form of a 100% stock dividend which Company spent $263 million to acquire the assets and was paid on June 1, 2001 to shareholders of record as of operations of: (i) four acute care facilities located in the May 16, 2001. All classes of common stock participated on U.S. (two of which were effective on January 1, 2002); (ii) a pro rata basis and all references to share quantities and two behavioral health care facilities located in the U.S. and earnings per share for all periods presented have been one located in Puerto Rico; (iii) an 80% ownership interest adjusted to reflect the two-for-one stock split. in a French hospital company that owns nine hospitals The Company has a $400 million unsecured non- located in France, and; (iv) majority ownership interests amortizing revolving credit agreement, which expires on in two ambulatory surgery centers. During 2000, the December 13, 2006. The agreement includes a $50 Company spent $141 million to acquire the assets and million sublimit for letters of credit of which $29 million operations of twelve behavioral health care facilities and was available at December 31, 2002. The interest rate two acute care hospitals and $12 million to acquire a on borrowings is determined at the Company’s option at minority ownership interest in an e-commerce marketplace the prime rate, certificate of deposit rate plus .925% to for the purchase and sale of health care supplies, equip- 1.275%, LIBOR plus .80% to 1.150% or a money mar- ment and services to the healthcare industry. ket rate. A facility fee ranging from .20% to .35% is During 2002, the Company received net cash pro- required on the total commitment. The margins over the ceeds of $8 million resulting from the sale of real estate certificate of deposit, the LIBOR rates and the facility related to a women’s hospital and radiation oncology cen- fee are based upon the Company’s leverage ratio. At ter both of which were closed in a prior year and written December 31, 2002, the applicable margins over the cer- down to their estimated net realizable values. The sale of tificate of deposit and the LIBOR rate were 1.125% and the real property of the women’s hospital resulted in a $2.2 1.00%, respectively, and the commitment fee was .25 %. million recovery of closure costs and the net gain on the There are no compensating balance requirements. At sale of the assets of the radiation therapy center did not December 31, 2002, the Company had $349 million of have a material impact on the 2002 results of operations. unused borrowing capacity available under the revolving During 2000, the Company received net cash proceeds of credit agreement. $16 million resulting from the divestiture of the real prop- During 2001, the Company issued $200 million of erty of a behavioral health care facility located in Florida, a Senior Notes which have a 6.75% coupon rate and which medical office building located in Nevada, and its owner- mature on November 15, 2011. (“Notes”). The interest on ship interests in a specialized women’s health center and the Notes is paid semiannually in arrears on May 15 and two physician practices located in Oklahoma. The net November 15 of each year. The notes can be redeemed in gain/loss resulting from these transactions did not have whole at any time and in part from time to time. a material impact on the 2000 results of operations. The Company also has a $100 million commercial During 1998 and 1999, the Company’s Board of paper credit facility. The majority of the Company’s acute Directors approved stock purchase programs authorizing care patient accounts receivable are pledged as collateral to the Company to purchase up to 12 million shares of its secure this commercial paper program. A commitment fee outstanding Class B Common Stock on the open market of .40% is required on the used portion and .20% on the at prevailing market prices or in negotiated transactions off unused portion of the commitment. This annually renew- the market. Pursuant to the terms of these programs, the able program, which began in November 1993, is sched- Company purchased 2.4 million shares at an average uled to expire or be renewed in October of each year. purchase price of $14.95 per share ($36.0 million in the Outstanding amounts of commercial paper which can aggregate) during 2000, 178,000 shares at an average be refinanced through available borrowings under the purchase price of $43.33 per share ($7.7 million in the Company’s revolving credit agreement are classified as aggregate) during 2001 and 1.7 million shares at an aver- long-term. As of December 31, 2002, the Company had age purchase price of $44.71 per share ($76.6 million in UNIVERSAL HEALTH SERVICES, INC. SUBSIDIARIES AND 37
  • 16. MANAGEMENT’S DISCUSSION AND ANALYSIS OF OPERATIONS AND FINANCIAL CONDITION (continued) _________________________________________________________________________________ $270.9 million in 2000. no unused borrowing capacity under the terms of the Total debt as a percentage of total capitalization was commercial paper facility. 43% at December 31, 2002 and 47% at December 31, During the fourth quarter of 2001, the Company 2001. redeemed all of its outstanding $135.0 million, 8.75% The Company has two floating rate swaps having Senior Notes (“Senior Notes”) due 2005 for an aggregate a notional principal amount of $60 million in which the redemption price of $136.5 million. The redemption of Company receives a fixed rate of 6.75% and pays a float- the Senior Notes was financed with borrowings under the ing rate equal to 6 month LIBOR plus a spread. The term Company’s commercial paper and revolving credit facili- of these swaps is ten years and they are both scheduled to ties. In connection with the redemption of the Senior expire on November 15, 2011. As of December 31, 2002, Notes, the Company recorded a net loss on debt extin- the average floating rate of the $60 million of interest rate guishment of $1.6 million during the fourth quarter swaps was 2.68%. During 2002 the Company recorded a of 2001. decrease of $8.0 million in other assets to recognize the fair The Company issued discounted Convertible value of these swaps and a $8.0 million increase of long Debentures in 2000 which are due in 2020 term debt to recognize the difference between the carrying (“Debentures”). The aggregate issue price of the value and fair value of the related hedged liability. Debentures was $250 million or $587 million aggregate As of December 31, 2002, the Company has one principal amount at maturity. The Debentures were issued fixed rate swap with a notional principal amount of $125 at a price of $425.90 per $1,000 principal amount of million which expires in August 2005. The Company pays Debenture. The Debentures’ yield to maturity is 5% per a fixed rate of 6.76% and receives a floating rate equal to annum, .426% of which is cash interest. The interest on three month LIBOR. As of December 31, 2002, the the bonds is paid semiannually in arrears on June 23 and floating rate of this interest rate swap was 1.40%. December 23 of each year. The Debentures are convertible As of December 31, 2002, a majority-owned at the option of the holders into 5.6024 shares of the subsidiary of the Company had two interest rate swaps Company’s Class B Common Stock per $1,000 of denominated in Euros. These two interest rate swaps are Debentures, however, the Company has the right to for a total notional amount of 41.2 million Euros ($40.9 redeem the Debenture any time on or after June 23, 2006 million based on the end of period currency exchange at a price equal to the issue price of the Debentures plus rate). The notional amount decreases to 35.0 million accrued original issue discount and accrued cash interest Euros ($34.8 million) on December 30, 2003, 27.5 mil- to the date of redemption. lion Euros, ($27.3 million) on December 30, 2004 and During 2002, a majority-owned subsidiary of the the swaps mature on June 30, 2005. The Company pays Company entered into a line of credit agreement denomi- an average fixed rate of 4.35% and receives six month nated in Euros amounting to 45.8 million Euros ($44.9 EURIBOR. The effective floating rate for these swaps as million based on the end of period currency exchange of December 31, 2002 was 2.87%. rate.) The loan, which is non-recourse to the Company, During the year ended December 31, 2002 and amortizes to zero over the life of the agreement and 2001, the Company recorded in accumulated other com- matures on December 31, 2007. Interest on the loan is at prehensive income (“AOCI”), pre-tax losses of $6.4 mil- the option of the Company’s majority-owned subsidiary lion ($4.1 million after-tax) to recognize the change in fair and can be based on the one, two, three and six month value of all derivatives that are designated as cash flow EURIBOR plus a spread of 2.5%. As of December 31, hedging instruments. The income or losses are reclassified 2002, the interest rate was 5.4% and the effective interest into earnings as the underlying hedged item affects earn- rate including the effects of the designated interest rate ings, such as when the forecasted interest payment occurs. swaps was 6.9%. Assuming market rates remain unchanged from December The average amounts outstanding during 2002, 31, 2002, it is expected that $7.2 million of pre-tax net 2001 and 2000 under the revolving credit and demand losses in accumulated AOCI will be reclassified into earn- notes and commercial paper program were $140.3 million, ings within the next twelve months. During the year ended $220.0 million and $170.0 million, respectively, with December 31, 2002, the Company also recorded $169,000 corresponding effective interest rates of 3.3%, 5.1% and ($107,000 after-tax) to recognize the ineffective portion of 7.4% including commitment and facility fees. The the cash flow hedging instruments. As of December 31, maximum amounts outstanding at any month-end were, 2002, the maximum length of time over which the $170.0 million in 2002, $343.9 million in 2001 and UNIVERSAL HEALTH SERVICES, INC. SUBSIDIARIES AND 38
  • 17. _________________________________________________________________________________ Company is hedging its exposure to the variability in The effective interest rate on the Company’s revolv- future cash flows for forecasted transactions is through ing credit, demand notes and commercial paper program, August 2005. including the respective interest expense and income Upon the adoption of SFAS No. 133 on January 1, incurred on existing and now expired interest rate swaps, 2001, the Company recorded the cumulative effect of an was 6.3%, 6.4% and 7.1% during 2002, 2001 and accounting change of approximately $7.6 million ($4.8 2000, respectively. Additional interest (expense)/income million after-tax) in accumulated other comprehensive recorded as a result of the Company’s U.S. dollar denomi- income (loss) to recognize the fair value of all derivatives nated hedging activity was ($4,228,000) in 2002, that were designated as cash flow hedging instruments. ($2,730,000) in 2001 and $414,000 in 2000. The During the year ended December 31, 2001, the Company Company is exposed to credit loss in the event of non- recorded, in AOCI, a pre-tax charge of $2.4 million ($1.5 performance by the counter-party to the interest rate swap million after-tax) to recognize the change in fair value of agreements. All of the counter-parties are creditworthy all derivatives that were designated as cash flow hedging financial institutions rated AA or better by Moody’s instruments. During the year ended December 31, 2001, Investor Service and the Company does not anticipate the Company also recorded a charge to earnings of approx- non-performance. The estimated fair value of the cost to imately $300,000 ($200,000 after-tax) to recognize the the Company to terminate the interest rate swap obliga- ineffective portion of its cash flow hedging instruments. tions, including the Euro denominated interest rate swaps, The Company had a fixed rate swap having a at December 31, 2002 and 2001 was approximately $10.4 notional principal amount of $135 million whereby the million and $11.7 million, respectively. Company paid a fixed rate of 6.76% and received a float- Covenants relating to long-term debt require main- ing rate from the counter-party. During 2001, the notional tenance of a minimum net worth, specified debt to total amount of this swap was reduced to $125 million. The capital and fixed charge coverage ratios. The Company is Company had two interest rate swaps to fix the rate of in compliance with all required covenants as of December interest on a total notional principal amount of $75 mil- 31, 2002. lion with a scheduled maturity date of August, 2005 that The fair value of the Company’s long-term debt at were terminated in November, 2001. The average fixed December 31, 2002 and 2001 was approximately $791.1 rate on the $75 million of interest rate swaps, including million and $751.5 million, respectively. the Company’s borrowing spread of .35%, was 7.05%. The Company expects to finance all capital expendi- The total cost of all swaps terminated in 2001 was $7.4 tures and acquisitions with internally generated funds and million. This amount was reclassified from accumulated borrowed funds. Additional borrowed funds may be other comprehensive loss due to the probability of the obtained either through refinancing the existing revolving original forecasted interest payments not occurring. credit agreement and/or the commercial paper facility and/or the issuance of equity or long-term debt. The following represents the scheduled maturities of the Company’s contractual obligations as of December 31, 2002: Payments Due by Period (dollars in thousands) Contractual Obligation Total Less than 1 Year 2-3 years 4-5 years After 5 years _________________________________________________________________________________ $503,127 $3,715 $9,919 $4,016 $485,477 (b) Long-term debt-fixed (a) 185,640 4,538 13,628 148,176 19,298 (b) Long-term debt-variable 3,690 3,690 — — (b) Accrued interest — 40,000 — — 40,000 — (b) Construction commitments (c) 105,860 32,704 49,151 18,957 5,048 (b) Operating leases Total contractual cash _________ ________ ________ _________ _________ (b) $838,317 $44,647 $72,698 $211,149 _________ (b) $509,823 (b) obligations _________ ________ ________ _________ _________ (b) _________ ________ ________ _________ (a) Includes capital lease obligations. (b) Amount is presented net of discount on Convertible Debentures of $310,527 (c) Estimated cost of completion on the construction of a new 100-bed acute care facility in Eagle Pass, Texas. UNIVERSAL HEALTH SERVICES, INC. SUBSIDIARIES AND 39
  • 18. MANAGEMENT’S DISCUSSION AND ANALYSIS OF OPERATIONS AND FINANCIAL CONDITION (continued) _________________________________________________________________________________ SIGNIFICANT ACCOUNTING POLICIES _________________________________________________________________________________ The Company has determined that the following The Company provides care to patients who meet accounting policies and estimates are critical to the certain financial or economic criteria without charge understanding of the Company’s consolidated financial or at amounts substantially less than its established rates. statements. Because the Company does not pursue collection of Revenue Recognition: Revenue and the related amounts determined to qualify as charity care, they receivables for health care services are recorded in the are not reported in net revenues or in provision for accounting records, at the time the services are rendered, doubtful accounts. on an accrual basis at the Company’s established charges. Self-Insured Risks: The Company provides for self- The provision for contractual adjustments, which repre- insured risks, primarily general and professional liability sents the difference between established charges and claims and workers’ compensation claims, based on esti- estimated third-party payor payments, is also recognized mates of the ultimate costs for both reported claims and on an accrual basis and deducted from gross revenue to claims incurred but not reported. determine net revenues. Payment arrangements with The ultimate costs of such claims, which include third-party payors may include prospectively determined costs associated with litigating or settling claims, are rates per discharge, a discount from established charges, accrued when the incidents that give rise to the claim per-diem payments and reimbursed costs. Estimates of occur. Estimated losses from asserted and unasserted contractual adjustments are reported in the period during claims are accrued, based on Management’s estimates of which the services are provided and adjusted in future the ultimate costs of the claims and the relationship of past periods, as the actual amounts become known. Revenues reported incidents to eventual claims payments. All rele- recorded under cost-based reimbursement programs may vant information, including the Company’s own historical be adjusted in future periods as a result of audits, reviews experience, the nature and extent of existing asserted or investigations. Laws and regulations governing the claims, and reported incidents, and independent actuarial Medicare and Medicaid programs are extremely complex analyses of this information, is used in estimating the and subject to interpretation. As a result, there is at least a expected amount of claims. The accrual also includes an reasonable possibility that recorded estimates will change estimate of the losses that will result from unreported inci- by material amounts in the near term. Medicare and dents, which are probable of having occurred before the Medicaid net revenues represented 42%, 42% and 44% of end of the reporting period. net patient revenues for the years 2002, 2001 and 2000, In addition, the Company also maintains self- respectively. In addition, approximately 39% in 2002, insured employee benefits programs for healthcare and 37% in 2001 and 35% in 2000, of the Company’s net dental claims. The ultimate costs related to these programs patient revenues were generated from managed care com- includes expenses for claims incurred and paid in addition panies, which includes health maintenance organizations to an accrual for the estimated expenses incurred in con- and preferred provider organizations. nection with claims incurred but not reported. The Company establishes an allowance for doubtful Estimated losses are reviewed and changed, if neces- accounts to reduce its receivables to their net realizable sary, at each reporting date. The amounts of the changes value. The allowances are estimated by management based are recognized currently as additional expense or as a on general factors such as payor mix, the agings of the reduction of expense. receivables and historical collection experience. At Reference is made to Note 1 to the financial state- December 31, 2002 and 2001, accounts receivable are ments for additional information on other accounting recorded net of allowance for doubtful accounts of $59.1 policies and new accounting pronouncements. million and $61.1 million, respectively. UNIVERSAL HEALTH SERVICES, INC. SUBSIDIARIES AND 40
  • 19. _________________________________________________________________________________ RELATED PARTY TRANSACTIONS _________________________________________________________________________________ the Trust for these properties was $112.5 million. The At December 31, 2002, the Company held approxi- Company received an advisory fee from the Trust of $1.4 mately 6.6% of the outstanding shares of Universal Health million in 2002 and $1.3 million in both 2001 and 2000 Realty Income Trust (the “Trust”). The Company serves as for investment and administrative services provided under Advisor to the Trust under an annually renewable advisory a contractual agreement which is included in net revenues agreement. Pursuant to the terms of this advisory agree- in the accompanying consolidated statements of income. ment, the Company conducts the Trust’s day to day affairs, During 2000, the Company sold the real property provides administrative services and presents investment of a medical office building to a limited liability company opportunities. In addition, certain officers and directors of that is majority owned by the Trust for cash proceeds of the Company are also officers and/or directors of the Trust. approximately $10.5 million. Tenants in the multi-tenant Management believes that it has the ability to exercise sig- building include subsidiaries of the Company as well as nificant influence over the Trust, therefore the Company unrelated parties. accounts for its investment in the Trust using the equity In connection with a long-term incentive com- method of accounting. The Company’s pre-tax share of pensation plan that was terminated during the third income from the Trust was $1.4 million during 2002, quarter of 2002, the Company had $18 million as of $1.3 million during 2001 and $1.2 million during 2000, December 31, 2002 and $21 million as of December 31, and is included in net revenues in the accompanying 2001, of gross loans outstanding to various employees consolidated statements of income. The carrying value of which $15 million as of December 31, 2002 and $18 of this investment was $9.1 million and $9.0 million at million as of December 31, 2001 were charged to com- December 31, 2002 and 2001, respectively, and is included pensation expense through that date. Included in the in other assets in the accompanying consolidated balance gross loan amounts outstanding were loans to officers sheets. The market value of this investment was $20.3 of the Company amounting to $13 million as of Dec- million at December 31, 2002 and $18.0 million at ember 31, 2002 and $16 million as of December 31, December 31, 2001. 2001 (see Note 5). As of December 31, 2002, the Company leased six The Company’s Chairman and Chief Executive hospital facilities from the Trust with terms expiring in Officer is a member of the Board of Directors of 2004 through 2008. These leases contain up to six 5-year Broadlane, Inc. In addition, the Company and certain renewal options. During 2002, the Company exercised the members of executive management own approximately five-year renewal option on an acute care hospital leased 6% of the outstanding shares of Broadlane, Inc. as of from the Trust which was scheduled to expire in 2003. December 31, 2002. Broadlane, Inc. provides contracting The renewal rate on this facility is based upon the five year and other supply chain services to various healthcare Treasury rate on March 29, 2003 plus a spread. Future organizations, including the Company. minimum lease payments to the Trust are included in Note A member of the Company’s Board of Directors and 7. Total rent expense under these operating leases was member of the Executive Committee is Of Counsel to the $17.2 million in 2002, $16.5 million in 2001 and $17.1 law firm used by the Company as its principal outside million in 2000. The terms of the lease provide that in the counsel. This Board member is also the trustee of certain event the Company discontinues operations at the leased trusts for the benefit of the Chief Executive Officer and his facility for more than one year, the Company is obligated family. This law firm also provides personal legal services to offer a substitute property. If the Trust does not accept to the Company’s Chief Executive Officer. Another mem- the substitute property offered, the Company is obligated ber of the Company’s Board of Directors and member of to purchase the leased facility back from the Trust at a the Board’s Executive and Audit Committees was formerly price equal to the greater of its then fair market value Senior Vice Chairman and Managing Director of the or the original purchase price paid by the Trust. As of investment banking firm used by the Company as one December 31, 2002, the aggregate fair market value of the of its Initial Purchasers for the Convertible Debentures Company’s facilities leased from the Trust is not known, issued in 2000. however, the aggregate original purchase price paid by UNIVERSAL HEALTH SERVICES, INC. SUBSIDIARIES AND 41
  • 20. SELECTED FINANCIAL DATA _________________________________________________________________________________ Universal Health Services, Inc. and Subsidiaries _________________________________________________________________________________ 2002 2001 2000 1999 1998 Year Ended December 31 _________________________________________________________________________________ Summary of Operations (in thousands) $3,258,898% $2,840,491% $2,242,444% $2,042,380% $1,874,487% Net revenues $0,175,361% $0,099,742% $0,093,362% $0,077,775% $0,079,558% Net income 5.4% 3.5% 4.2% 3.8% 4.2% Net margin 19.6% 12.8% 13.7% 12.1% 13.1% Return on average equity Financial Data (in thousands) Cash provided by $1,331,259% $1,297,543% $1,174,821% $1,157,118% $1,149,933% operating activities $1,207,627% $1,160,748% $ 1,115,751% $1,168,695% $1,196,808% Capital expenditures(1) $2,323,229% $2,168,589% $1,742,377% $1,497,973% $1,448,095% Total assets $1,680,514% $1,718,830% $1,548,064% $1,419,203% $1,418,188% Long-term borrowings $1,917,459% $1,807,900% $1,716,574% $1,641,611% $1,627,007% Common stockholders’ equity Percentage of total debt 43% 47% 43% 40% 40% to total capitalization Operating Data – Acute Care Hospitals(2) 6,896% 6,234% 4,980% 4,806% 4,696% Average licensed beds 5,885% 5,351% 4,220% 4,099% 3,985% Average available beds 330,042% 276,429% 214,771% 204,538% 187,833% Hospital admissions 4.7% 4.7% 4.7% 4.7% 4.7% Average length of patient stay 1,558,140% 1,303,375% 1,017,646% 963,842% 884,966% Patient days 62% 57% 56% 55% 52% Occupancy rate for licensed beds 73% 67% 66% 64% 61% Occupancy rate for available beds Operating Data – Behavioral Health Facilities 3,752% 3,732% 2,612% 1,976% 1,782% Average licensed beds 3,608% 3,588% 2,552% 1,961% 1,767% Average available beds 84,348% 78,688% 49,971% 37,810% 32,400% Hospital admissions 11.9% 12.1% 12.2% 11.8% 11.3% Average length of patient stay 1,005,882% 950,236% 608,423% 444,632% 365,935% Patient days 73% 70% 64% 62% 56% Occupancy rate for licensed beds 76% 73% 65% 62% 57% Occupancy rate for available beds Per Share Data $0,0002.94% $0,0001.67% $0,0001.55% $0,0001.24% $0,0001.23% Net income – basic(3) $0,0002.74% $0,0001.60% $0,0001.50% $0,0001.22% $0,0001.19% Net income – diluted(3) Other Information (in thousands) Weighted average number of 59,730% 59,874% 60,220% 62,834% 65,022% shares outstanding – basic(3) Weighted average number of shares and share equivalents 67,075% 67,220% 64,820% 63,980% 66,586% outstanding – diluted(3) Common Stock Performance Market price of common stock High-Low, by quarter(4) $43.00 - $37.80 $50.69 - $38.88 $24.50 - $18.25 $26.50 - $18.94 $29.06 - $23.53 1st $51.90 - $42.31 $46.75 - $37.82 $35.03 - $24.50 $27.44 - $19.75 $29.81 - $26.50 2nd $51.40 - $41.90 $52.60 - $42.65 $42.81 - $31.91 $23.69 - $11.84 $29.25 - $19.38 3rd _________________________________________ $56.20 - $43.00 $48.60 - $38.25 $55.88 - $38.63 $18.25 - $12.00 $27.16 - $20.22 4th Amount includes non-cash capital lease obligations. (1) Includes data for nine hospitals located in France owned by an operating Company in which the Company purchased an 80% ownership during 2001. (2) In April 2001, the Company declared a two-for-one stock split in the form of a 100% stock dividend which was paid in June 2001. All classes of (3) common stock participated on a pro rata basis. The weighted average number of common shares and equivalents and earnings per common and common equivalent share for all years presented have been adjusted to reflect the two-for-one stock split. There were no other dividends declared or paid during the other years presented. The Company has no current plans to declare cash dividends. These prices are the high and low closing sales prices of the Company’s Class B Common Stock as reported by the New York Stock Exchange (4) (all periods have been adjusted to reflect the two-for-one stock split in the form of a 100% stock dividend paid in June 2001). Class A, C and D common stock are convertible on a share-for-share basis into Class B Common Stock. UNIVERSAL HEALTH SERVICES, INC. SUBSIDIARIES AND 42
  • 21. CONSOLIDATED STATEMENTS OF INCOME _________________________________________________________________________________ Year Ended December 31 Universal Health Services, Inc. and Subsidiaries (In thousands, except per share data) _________________________________________________________________________________ 2002 2001 2000 __________________________________ $3,258,898) $2,840,491 $2,242,444 Net revenues Operating charges 1,298,967) 1,122,428 873,747 Salaries, wages and benefits 787,408) 668,026 515,084 Other operating expenses 425,142) 368,091 301,663 Supplies expense 231,362) 240,025 192,625 Provision for doubtful accounts 124,794) 127,523 112,809 Depreciation & amortization 61,712) 53,945 49,039 Lease and rental expense 34,746) 36,176 29,941 Interest expense, net —) 40,000 — Provision for insurance settlements (2,182) — 7,747 Facility closure (recoveries)/costs 220) 8,862 — Losses on foreign exchange and derivative transactions __________________________________ 2,962,169) 2,665,076 2,082,655 __________________________________ 296,729) 175,415 159,789 Income before minority interests, income taxes and extraordinary charge 19,658) 17,518 13,681 Minority interests in earnings of consolidated entities __________________________________ 277,071) 157,897 146,108 Income before income taxes and extraordinary charge 101,710) 57,147 52,746 Provision for income taxes __________________________________ 175,361) 100,750 93,362 Net income before extraordinary charge —) 1,008 — Extraordinary charge from early extinguishment of debt, net of taxes __________________________________ __________________ $0,175,361) $0,199,742 $0,193,362 Net income Earnings per Common Share before extraordinary charge: __________________ $0,0002.94) $0,0001.68 $0,0001.55 Basic __________________ $0,0002.74) $0,0001.62 $0,0001.50 Diluted Earnings per Common Share after extraordinary charge: __________________ $0,0002.94) $0,0001.67 $0,0001.55 Basic __________________ $0,0002.74) $0,0001.60 $0,0001.50 Diluted 59,730) 59,874 60,220 Weighted average number of common shares – basic 7,345) 7,346 4,600 Weighted average number of common share equivalents __________________________________ Weighted average number of common shares and __________________ 67,075) 67,220 64,820 equivalents – diluted The accompanying notes are an integral part of these consolidated financial statements. UNIVERSAL HEALTH SERVICES, INC. SUBSIDIARIES AND 43
  • 22. CONSOLIDATED BALANCE SHEETS _________________________________________________________________________________ Universal Health Services, Inc. and Subsidiaries Assets (Dollar amounts in thousands) _________________________________________________________________________________ 2002 2001 Current Assets ______________________ $0,017,750) $0,022,848) Cash and cash equivalents 474,763) 418,083) Accounts receivable, net 58,217) 54,764) Supplies 25,023) 25,227) Deferred income taxes 30,823) 27,340) Other current assets ______________________ 606,576) 548,262) Total current assets Property and Equipment 154,804) 149,208) Land 978,655) 845,523) Buildings and improvements 586,096) 505,310) Equipment 42,346) 31,902) Property under capital lease ______________________) 1,761,901) 1,531,943) Accumulated depreciation (687,430) (594,602) ______________________ 1,074,471) 937,341) —) 196) Funds restricted for construction 92,816) 93,668) Construction-in-progress ______________________ 1,167,287) 1,031,205) Other Assets 410,320) 372,627) Goodwill 14,390) 16,533) Deferred charges 124,656) 199,962) Other ______________________ 549,366) 589,122) ______________________ ____________ $2,323,229) $2,168,589) The accompanying notes are an integral part of these consolidated financial statements. UNIVERSAL HEALTH SERVICES, INC. SUBSIDIARIES AND 44
  • 23. CONSOLIDATED BALANCE SHEETS _________________________________________________________________________________ December 31, Universal Health Services, Inc. and Subsidiaries Liabilities and Common Stockholders’ Equity (Dollar amounts in thousands) _________________________________________________________________________________ 2002 2001 Current Liabilities ______________________ $2,148,253) $2,162,436) Current maturities of long-term debt 170,471) 144,163) Accounts payable Accrued liabilities 82,900) 58,607) Compensation and related benefits 3,690) 3,050) Interest 25,068) 26,525) Taxes other than income 67,969) 87,050) Other 12,062) 885) Federal and state taxes ______________________ 370,413) 322,716) Total current liabilities 206,238) 164,390) Other Noncurrent Liabilities 134,339) 125,914) Minority Interests 680,514) 718,830) Long-Term Debt 14,266) 28,839) Deferred Income Taxes Commitments and Contingencies (Note 8) Common Stockholders’ Equity Class A Common Stock, voting, $.01 par value; authorized 12,000,000 shares; issued and outstanding 33) 38) 3,328,404 shares in 2002 and 3,848,886 in 2001 Class B Common Stock, limited voting, $.01 par value; authorized 150,000,000 shares; issued and outstanding 553) 556) 55,341,350 shares in 2002 and 55,603,686 in 2001 Class C Common Stock, voting, $.01 par value; authorized 1,200,000 shares; issued and outstanding 3) 4) 335,800 shares in 2002 and 387,848 in 2001 Class D Common Stock, limited voting, $.01 par value; authorized 5,000,000 shares; issued and outstanding —) —) 35,506 shares in 2002 and 39,109 in 2001 Capital in excess of par value, net of deferred compensation 84,135) 137,400) of $14,247 in 2002 and $203 in 2001 851,425) 676,064) Retained earnings (18,690) (6,162) Accumulated other comprehensive loss ______________________ 917,459) 807,900) ______________________ ____________ $2,323,229) $2,168,589) The accompanying notes are an integral part of these consolidated financial statements. UNIVERSAL HEALTH SERVICES, INC. SUBSIDIARIES AND 45
  • 24. CONSOLIDATED STATEMENTS OF COMMON STOCKHOLDERS’ EQUITY _________________________________________________________________________________ (Amounts in thousands) Universal Health Services, Inc. and Subsidiaries Accumulated For the Years Ended Capital in Other December 31, 2002, Class A Class B Class C Class D Excess of Retained Comprehensive _________________________________________________________________________________ 2001, and 2000Common Common Common Common Par Value Earnings Income (Loss) Total Balance $20) $284) $2) —) $158,345) $482,960) —) $641,611) January 1, 2000 Common Stock (1) 6) —) —) 16,629) —) —) 16,634) Issued —) (12) —) —) (35,973) —) —) (35,985) Repurchased Amortization of deferred —) —) —) —) 952) —) —) 952) compensation —) —) —) —) —) 93,362) —) 93,362) Net income _________________________________________________________________________________ Balance 19) 278) 2) —) 139,953) 576,322) —) 716,574) January 1, 2001 Common Stock —) 1) —) —) 4,844) —) —) 4,845) Issued 19) 278) 2) —) (299) —) —) —) Stock dividend —) (1) —) —) (7,733) —) —) (7,734) Repurchased Amortization of deferred —) —) —) —) 635) —) —) 635) compensation Comprehensive Income: —) —) —) —) —) 99,742) —) 99,742) Net income Foreign currency — —) —) —) —) —) 161) 161) translation adjustments Cumulative effect of change in accounting principle (SFAS No. 133) on other comprehensive income (net of income tax effect —) —) —) —) —) —) (4,779) (4,779) of $2,801) Adjustment for losses reclassified into income (net of income tax effect —) —) —) —) —) —) 2,947) 2,947) of $1,727) Unrealized derivative gains on cash flow hedges (net of income tax effect —) —) —) —) —) —) (4,491) (4,491) of $2,632) _________________________________________________________________________________ Subtotal – comprehensive income —) —) —) —) —) 99,742) (6,162) 93,580) _________________________________________________________________________________ Balance 38) 556) 4) —) 137,400) 676,064) (6,162) 807,900) January 1, 2002 Common Stock (5) 14) (1) —) 6,558) —) —) 6,566) Issued/(converted) —) (17) —) —) (76,598) —) —) (76,615) Repurchased Amortization of deferred —) —) —) —) 15,396) —) —) 15,396) compensation —) —) —) —) 1,379) —) —) 1,379) Stock option expense Comprehensive Income: —) —) —) —) —) 175,361) —) 175,361) Net income Foreign currency —) —) —) —) —) —) (719) (719) translation adjustments Adjustment for losses reclassified into income (net of income tax effect —) —) —) —) —) —) 4,073) 4,073) of $2,387) Unrealized derivative losses on cash flow hedges (net of income tax effect —) —) —) —) —) —) (8,161) (8,161) of $4,783) Minimum pension liability (net of income tax effect —) —) —) —) —) —) (7,721) (7,721) of $4,525) _________________________________________________________________________________ Subtotal – comprehensive income —) —) —) —) —) 175,361) (12,528) 162,833) _________________________________________________________________________________ Balance _________________________________________$33) $553) $3) —) $184,135) $851,425) ($18,690) $917,459) December 31, 2002 The accompanying notes are an integral part of these consolidated financial statements. UNIVERSAL HEALTH SERVICES, INC. SUBSIDIARIES AND 46
  • 25. CONSOLIDATED STATEMENTS OF CASH FLOWS _________________________________________________________________________________ Year Ended December 31 Universal Health Services, Inc. and Subsidiaries (Amounts in thousands) _________________________________________________________________________________ 2002 2001 2000 ___________________________________ Cash Flows from Operating Activities: $(175,361) $(199,742) $(193,362) Net income Adjustments to reconcile net income to net cash provided by operating activities: 124,794) 127,523) 112,809) Depreciation and amortization 10,903) 10,323) 5,239) Accretion of discount on convertible debentures Losses on foreign exchange, derivative transactions & 220) 10,460) —) debt extinguishment —) 40,000) 7,747) Provision for insurance settlements and other non-cash charges Changes in assets and liabilities, net of effects from acquisitions and dispositions: (34,987) 1,384) (29,391) Accounts receivable 640) (1,914) (1,020) Accrued interest 7,347) (9,292) 28,489) Accrued and deferred income taxes 23,679) 13,913) 1,408) Other working capital accounts (5,113) 10,689) (17,237) Other assets and deferred charges —) (9,133) (24,155) Increase in working capital at acquired facilities (6,192) (7,304) (6,209) Other Minority interests in earnings of consolidated entities, 7,425) 2,874) 6,048) net of distributions Accrued insurance expense, net of 58,316) 23,531) 9,012) commercial premiums paid Payments made in settlement of (31,134) (15,253) (11,281) self-insurance claims ___________________________________ 331,259) 297,543) 174,821) Net cash provided by operating activities ___________________________________ Cash Flows from Investing Activities: (200,930) (152,938) (113,900) Property and equipment additions (3,000) (263,463) (141,333) Acquisition of businesses 8,369) —) 16,253) Proceeds received from merger, sale or disposition of assets —) —) (12,273) Investment in business ___________________________________ (195,561) (416,401) (251,253) Net cash used in investing activities ___________________________________ Cash Flows from Financing Activities: 39,311) 280,499) 252,566) Additional borrowings, net of financing costs (106,439) (137,005) (141,045) Reduction of long-term debt Net cash paid related to termination of interest rate swap, —) (6,608) —) foreign currency exchange and early extinguishment of debt 2,947) 2,009) 5,260) Issuance of common stock (76,615) (7,734) (35,985) Repurchase of common shares ___________________________________ 131,161) 80,796) Net cash provided by (used in) financing activities (140,796) ___________________________________ (5,098) 12,303) 4,364) (Decrease) Increase in Cash and Cash Equivalents 22,848) 10,545) 6,181) Cash and Cash Equivalents, Beginning of Period ___________________________________ __________________ $ 017,750) $ 022,848) $ 010,545) Cash and Cash Equivalents, End of Period Supplemental Disclosures of Cash Flow Information: $(123,203) $(127,767) $(125,722) Interest paid $(194,412) $(164,492) $(124,284) Income taxes paid, net of refunds Supplemental Disclosures of Noncash Investing and Financing Activities: See Notes 2 and 7 The accompanying notes are an integral part of these consolidated financial statements. UNIVERSAL HEALTH SERVICES, INC. SUBSIDIARIES AND 47
  • 26. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS _________________________________________________________________________________ 1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES _________________________________________________________________________________ The consolidated financial statements include per discharge, a discount from established charges, per- the accounts of Universal Health Services, Inc. (the diem payments and reimbursed costs. Estimates of con- “Company”), its majority-owned subsidiaries and partner- tractual adjustments are reported in the period during ships controlled by the Company or its subsidiaries as which the services are provided and adjusted in future the managing general partner. The Company’s France periods, as the actual amounts become known. Revenues subsidiary is included on the basis of the year ending recorded under cost-based reimbursement programs may November 30th. All significant intercompany accounts be adjusted in future periods as a result of audits, reviews and transactions have been eliminated. The more signifi- or investigations. Laws and regulations governing the cant accounting policies follow: Medicare and Medicaid programs are extremely complex Nature of Operations: The principal business of and subject to interpretation. As a result, there is at least a the Company is owning and operating, through its sub- reasonable possibility that recorded estimates will change sidiaries, acute care hospitals, behavioral health centers, by material amounts in the near term. Medicare and ambulatory surgery centers and radiation oncology centers. Medicaid net revenues represented 42%, 42% and 44% At December 31, 2002, the Company operated 34 acute of net patient revenues for the years 2002, 2001 and 2000, care hospitals and 38 behavioral health centers located in respectively. In addition, approximately 39% in 2002, 22 states, Washington, DC, Puerto Rico and France. The 37% in 2001, 35% in 2000, of the Company’s net patient Company, as part of its ambulatory treatment centers divi- revenues were generated from managed care companies, sion owns outright, or in partnership with physicians, and which includes health maintenance organizations and operates or manages 24 surgery and radiation oncology preferred provider organizations. centers located in 12 states and Puerto Rico. The Company establishes an allowance for doubtful Services provided by the Company’s hospitals accounts to reduce its receivables to their net realizable include general surgery, internal medicine, obstetrics, value. The allowances are estimated by management based emergency room care, radiology, diagnostic care, coronary on general factors such as payor mix, the agings of the care, pediatric services and behavioral health services. receivables and historical collection experience. At The Company provides capital resources as well as a December 31, 2002 and 2001, accounts receivable are variety of management services to its facilities, including recorded net of allowance for doubtful accounts of $59.1 central purchasing, information services, finance and con- million and $61.1 million, respectively. trol systems, facilities planning, physician recruitment The Company provides care to patients who meet services, administrative personnel management, marketing certain financial or economic criteria without charge or and public relations. at amounts substantially less than its established rates. Net revenues from the Company’s acute care hospi- Because the Company does not pursue collection of tals and ambulatory and outpatient treatment centers amounts determined to qualify as charity care, they accounted for 82%, 81% and 84% of consolidated net are not reported in net revenues or in provision for revenues in 2002, 2001 and 2000, respectively. Net rev- doubtful accounts. enues from the Company’s behavioral health care facilities Concentration of Revenues: The three majority- accounted for 17%, 19% and 16%, of consolidated net owned facilities operating in the Las Vegas market con- revenues in 2002, 2001 and 2000, respectively. tributed on a combined basis 15% of the Company’s 2002 Revenue Recognition: Revenue and the related consolidated net revenues. The two facilities located in receivables for health care services are recorded in the the McAllen/Edinburg, Texas market contributed, on a accounting records, at the time the services are rendered, combined basis, 11% of the Company’s 2002 consolidated on an accrual basis at the Company’s established charges. net revenues. The provision for contractual adjustments, which repre- Cash and Cash Equivalents: The Company consid- sents the difference between established charges and esti- ers all highly liquid investments purchased with maturities mated third-party payor payments, is also recognized on of three months or less to be cash equivalents. Interest an accrual basis and deducted from gross revenue to deter- expense in the consolidated statements of income is net of mine net revenues. Payment arrangements with third- interest income of approximately $600,000 in 2002, $1.9 party payors may include prospectively determined rates million in 2001 and $2.7 million in 2000. UNIVERSAL HEALTH SERVICES, INC. SUBSIDIARIES AND 48
  • 27. _________________________________________________________________________________ and establishes a single accounting model for long-lived Property and Equipment: Property and equipment assets to be disposed of by sale. It retains the requirement are stated at cost. Expenditures for renewals and improve- of Opinion No.30 to report separately discontinued opera- ments are charged to the property accounts. Replacements, tions, and extends that reporting for all periods presented maintenance and repairs which do not improve or extend to a component of an entity that, subsequent to or on the life of the respective asset are expensed as incurred. The January 1,2002, either has been disposed of or is classified Company removes the cost and the related accumulated as held for sale. Additionally, SFAS No.144 requires that depreciation from the accounts for assets sold or retired assets and liabilities of components held for sale, if materi- and the resulting gains or losses are included in the results al, be disclosed separately in the balance sheet. of operations. If events or circumstances indicate that the carrying The Company capitalizes interest expense on major value of a long-lived asset to be held and used may be construction projects while in process. The Company capi- impaired, management estimates the undiscounted future talized $4.6 million, $3.0 million and $453,000 of interest cash flows to be generated from the asset. If the analysis related to major construction in projects in 2002, 2001 indicates that the carrying value is not recoverable from and 2000, respectively. future cash flows, the asset is written down to its estimated Depreciation is provided on the straight-line method fair value and an impairment loss is recognized. Fair values over the estimated useful lives of buildings and improve- are determined based on estimated future cash flows using ments (twenty to forty years) and equipment (three to appropriate discount rates. fifteen years). Depreciation expense was $113.7 million, Goodwill: The Company adopted SFAS No. 142 $96.1 million and $86.8 million in 2002, 2001 and on January 1, 2002, and accordingly, ceased amortizing 2000, respectively. goodwill as of that date. As required by SFAS No. 142, Long-Lived Assets: Effective January 1, 2002, the the Company performed an impairment test on goodwill Company adopted SFAS No.144, “Accounting for the as of January 1, 2002, which indicated no impairment of Impairment or Disposal of Long-Lived Assets.” SFAS goodwill. Management has designated September 1st as No.144 supersedes SFAS No.121, “Accounting for the the Company’s annual impairment assessment date and Impairment of Long-Lived Assets and for Long-Lived performed its impairment assessment as of September 1, Assets to be Disposed Of,” and APB Opinion No. 30, 2002, which indicated no impairment of goodwill. “Reporting the Results of Operations - Reporting the The following table sets forth the computation Effects of Disposal of a Segment of a Business, and of basic and diluted earnings per share on a pro-forma Extraordinary, Unusual and Infrequently Occurring Events basis assuming that SFAS No. 142 was adopted on and Transactions.” The Statement does not change the January 1, 2000: fundamental provisions of SFAS No.121; however, it resolves various implementation issues of SFAS No.121 Twelve Months Ended December 31, ___________________________________________ 2002 2001 2000 ___________________________________________ (in thousands, except per share data) $175,361 $199,742 $193,362 Reported net income Add back: goodwill amortization, net of tax of $9.1 million and $7.2 million — 15,600 12,300 in 2001 and 2000, respectively ___________________________________________ _________________ $175,361 $ 115,342 $105,662 Adjusted net income Basic earnings per share: $1002.94 $1001.67 $1051.55 Reported net income — 0.26 0.20 Goodwill amortization ___________________________________________ _________________ $1072.94 $1001.93 $1051.75 Adjusted net income Diluted earnings per share: $1002.74 $1.60 Reported net income $1.50 — 0.24 0.19 Goodwill amortization ___________________________________________ _________________ $1002.74 $1001.84 $1051.69 Adjusted net income For the year ended December 31, 2001, adjusted income before extraordinary charge would have been $116,350, adjusted income before extraordinary charge per basic share would have been $1.94 and adjusted income before extraordinary charge per diluted share would have been $1.85. UNIVERSAL HEALTH SERVICES, INC. SUBSIDIARIES AND 49
  • 28. _________________________________________________________________________________ Changes in the carrying amount of goodwill for the year ended December 31, 2002 were as follows (in thousands): Acute Behavioral Care Health Total _________________________________________________________________________________ Services Services Other Consolidated $277,692 $54,122 $40,813 $372,627 Balance, January 1, 2002 30,246 328 3,022 33,596 Goodwill acquired during the period — — 4,097 4,097 Adjustments to goodwill (A) _______________________________________________________________ _________________________ $307,938 $54,450 $47,932 $410,320 Balance, December 31, 2002 (A) Consists of the foreign currency translation adjustment on goodwill recorded in connection with the Company’s acquisition of an 80% ownership interest in an operating company that owns nine acute care facilities in France. dents, which are probable of having occurred before the Other Assets: During 1994, the Company estab- end of the reporting period. lished an employee life insurance program covering In addition, the Company also maintains self- approximately 2,200 employees. The cash surrender value insured employee benefits programs for healthcare and of the policies ($15.8 million at December 31, 2002 and dental claims. The ultimate costs related to these programs $15.9 million at December 31, 2001) was recorded net includes expenses for claims incurred and paid in addition of related loans ($15.7 million at December 31, 2002 and to an accrual for the estimated expenses incurred in con- $15.8 million at December 31, 2001) and is included nection with claims incurred but not reported. in other assets. Estimated losses are reviewed and changed, if neces- Included in other assets are estimates of expected sary, at each reporting date. The amounts of the changes recoveries from various state guaranty funds in connection are recognized currently as additional expense or as a with PHICO related professional and general liability reduction of expense. claims payments amounting to $37.0 million and $54.0 Income Taxes: Deferred taxes are recognized for million at December 31, 2002 and December 31, 2001, the amount of taxes payable or deductible in future years respectively. Actual recoveries may vary from these esti- as a result of differences between the tax bases of assets mates due to the inherent uncertainties involved in making and liabilities and their reported amounts in the financial such estimates (See Note 8). Other assets at December 31, statements. 2001 also include $70 million of deposits on acquisitions, Other Noncurrent Liabilities: Other noncurrent which were consummated on January 1, 2002. liabilities include the long-term portion of the Company’s As of December 31, 2002 and 2001, other intangible professional and general liability, workers’ compensation assets, net of accumulated amortization, were not material. reserves and pension liability. Self-Insured Risks: The Company provides for self- Minority Interest: As of December 31, 2002 and insured risks, primarily general and professional liability 2001, the $134.3 million and $126.0 million, respectively, claims and workers’ compensation claims, based on esti- minority interest consists primarily of a 27.5% outside mates of the ultimate costs for both reported claims and ownership interest in three acute care facilities located in claims incurred but not reported. Las Vegas, Nevada, a 20% outside ownership interest in an The ultimate costs of such claims, which include acute care facility located in Washington, DC and a 20% costs associated with litigating or settling claims, are outside ownership interest in an operating company that accrued when the incidents that give rise to the claims owns nine hospitals in France. occur. Estimated losses from asserted and unasserted Comprehensive Income: Comprehensive income or claims are accrued, based on Management’s estimates of loss is recorded in accordance with the provisions of SFAS the ultimate costs of the claims and the relationship of past No.130, “Reporting Comprehensive Income” SFAS . reported incidents to eventual claims payments. All rele- No.130 establishes standards for reporting comprehensive vant information, including the Company’s own historical income and its components in financial statements. experience, the nature and extent of existing asserted Comprehensive income (loss), is comprised of net income, claims, and reported incidents, and independent actuarial changes in unrealized gains or losses on derivative financial analyses of this information, is used in estimating the instruments, foreign currency translation adjustments and expected amount of claims. The accrual also includes an the minimum pension liability. estimate of the losses that will result from unreported inci- UNIVERSAL HEALTH SERVICES, INC. SUBSIDIARIES AND 50
  • 29. _________________________________________________________________________________ accounted for by recording the changes in the fair value of Accounting for Derivative Financial Investments both the derivative instrument and the hedged item in the and Hedging Activities: The Company manages its ratio income statement. of fixed to floating rate debt with the objective of achiev- For hedge transactions that do not qualify for the ing a mix that management believes is appropriate. To short-cut method, at the hedge’s inception and on a manage this risk in a cost-effective manner, the Company, regular basis thereafter, a formal assessment is performed from time to time, enters into interest rate swap agree- to determine whether changes in the fair values or cash ments, in which it agrees to exchange various combina- flows of the derivative instruments have been highly tions of fixed and/or variable interest rates based on agreed effective in offsetting changes in cash flows of the hedged upon notional amounts. items and whether they are expected to be highly effective Effective January 1, 2001, the Company began in the future. accounting for its derivative and hedging activities using Foreign Currency: One of the Company’s sub- SFAS 133, “Accounting for Derivative Instruments and sidiaries operates in France, whose currency is denominat- Hedging Activities,” as amended, which requires all deriva- ed in Euros. The French subsidiary translates its assets tive instruments, including certain derivative instruments and liabilities into U.S. dollars at the current exchange embedded in other contracts, to be carried at fair value on rates in effect at the end of the fiscal period. Any resulting the balance sheet. For derivative transactions designated as gains or losses are recorded in accumulated other compre- hedges, the Company formally documents all relationships hensive income (loss) in the accompanying consolidated between the hedging instrument and the related hedged balance sheet. item, as well as its risk-management objective and strategy The revenue and expense accounts of the France for undertaking each hedge transaction. subsidiary are translated into U.S. dollars at the average Derivative instruments designated in a hedge rela- exchange rate that prevailed during the period. Therefore, tionship to mitigate exposure to variability in expected the U.S. dollar value of the French subsidiary’s operating future cash flows, or other types of forecasted transactions, results may fluctuate from period to period due to changes are considered cash flow hedges. Cash flow hedges are in exchange rates. accounted for by recording the fair value of the derivative Stock-Based Compensation: At December 31, instrument on the balance sheet as either an asset or liabili- 2002, the Company has a number of stock-based employ- ty, with a corresponding amount recorded in accumulated ee compensation plans, which are more fully described in other comprehensive income (“AOCI”) within sharehold- Note 5. The Company accounts for these plans under the ers’ equity. Amounts are reclassified from AOCI to the recognition and measurement principles of APB Opinion income statement in the period or periods the hedged No.25, “Accounting for Stock Issued to Employees,” and transaction affects earnings. related Interpretations. No compensation cost is reflected The Company uses interest rate swaps in its cash in net income for most stock option grants, as all options flow hedge transactions. The interest rate swaps are granted under the plan had an original exercise price equal designed to be highly effective in offsetting changes in the to the market value of the underlying common shares on cash flows related to the hedged liability. For derivative the date of grant. The following table illustrates the effect instruments designated as cash flow hedges, the ineffective on net income and earnings per share if the Company had portion of the change in expected cash flows of the hedged applied the fair value recognition provisions of FASB item are recognized currently in the income statement. Statement No.123,“Accounting for Stock-Based Derivative instruments designated in a hedge rela- Compensation,” to stock-based employee compensation. tionship to mitigate exposure to changes in the fair value The Company recognizes compensation cost related to of an asset, liability, or firm commitment attributable to restricted share awards over the respective vesting periods, a particular risk, such as interest rate risk, are considered using an accelerated method. fair value hedges under SFAS 133. Fair value hedges are UNIVERSAL HEALTH SERVICES, INC. SUBSIDIARIES AND 51
  • 30. _________________________________________________________________________________ Twelve Months Ended December 31, ___________________________________________ 2002 2001 2000 ___________________________________________ (in thousands, except per share data) $175,361) $99,742) $93,362) Net income Add: total stock-based compensation expenses included in net income, net of tax of $6.3 million, 10,691) 425) 178) $249 and $104 in 2002, 2001 and 2000, respectively Deduct: total stock-based employee compensation expenses determined under fair value based methods for all awards, net of tax of $11.0 million, $5.1 million and $2.0 million (18,894) (8,725) (3,341) in 2002, 2001 and 2000, respectively ___________________________________________ _________________ $167,158) $91,442) $90,199) Pro forma net income $1002.94) $101.67) $051.55) Basic earnings per share, as reported $1002.80) $101.53) $051.50) Basic earnings per share, pro forma $1002.74) $101.60) Diluted earnings per share, as reported $1.50) $1002.62) $101.48) Diluted earnings per share, pro forma $1.45) For the year ended December 31, 2001, net income before extraordinary charge would have been $100,750, earnings per basic share before extraordinary charge would have been $1.68 on an as reported basis and $1.54 on a proforma basis and earnings per diluted share before extraordinary charge would have been $1.62 on an as reported basis and $1.50 on a proforma basis. Earnings per Share: Basic earnings per share are based on the weighted average number of common shares outstanding during the year. Diluted earnings per share are based on the weighted average number of common shares outstanding during the year adjusted to give effect to common stock equivalents. The following table sets forth the computation of basic and diluted earnings per share, after the $1.0 million after-tax extraordinary charge recorded in 2001, (effect on basic and diluted earnings per share of $0.01 and $0.02, respectively) for the periods indicated: Twelve Months Ended December 31, ___________________________________________ 2002 2001 2000 ___________________________________________ (in thousands, except per share data) Basic: $175,361 $199,742 $93,362 Net income 59,730 59,874 60,220 Weighted average number of common shares ___________________________________________ _________________ $2.94 $ 1.67 $1.55 Earnings per common share-basic Diluted: $175,361 $199,742 $93,362 Net income Add discounted convertible debenture interest, 8,451 8,120 4,092 net of income tax effect ___________________________________________ _________________ $183,812 $107,862 $97,454 Adjusted net income 59,730 59,874 60,220 Weighted average number of common shares Net effect of dilutive stock options and grants 768 769 1,096 based on the treasury stock method Assumed conversion of discounted 6,577 6,577 3,504 convertible debentures ___________________________________________ 67,075 67,220 64,820 Weighted average number of common shares and equivalents ___________________________________________ _________________ $1752.74 $1001.60 $001.50 Earnings per common share—diluted For the year ended December 31, 2001, net income before extraordinary charge would have been $100,750, earnings per basic share before extraordinary charge would have been $1.68 and earnings per diluted share before extraordinary charge would have been $1.62. UNIVERSAL HEALTH SERVICES, INC. SUBSIDIARIES AND 52
  • 31. _________________________________________________________________________________ eliminate an inconsistency between the required account- Fair Value of Financial Instruments: The fair val- ing for certain lease modifications that have economic ues of the Company’s registered debt, interest rate swap effects that are similar to sale-leaseback transactions. agreements and investments are based on quoted market Any gain or loss that does not meet the criteria in APB prices. The fair values of other long-term debt, including Opinion 30 for classification as an extraordinary item shall capital lease obligations, are estimated by discounting cash be reclassified. This provision will be effective for the flows using period-end interest rates and market condi- Company beginning January 1, 2003. Except for the pos- tions for instruments with similar maturities and credit sible reclassification of the extraordinary charge on early quality. The carrying amounts reported in the balance extinguishment of debt recorded in 2001, Management sheet for cash, accounts receivable, accounts payable, and does not believe that this Statement will have a material short-term borrowings approximates their fair values due effect on the Company’s financial statements. to the short-term nature of these instruments. Accordingly, In June 2002, the FASB issued SFAS No. 146, these items have been excluded from the fair value disclo- “Accounting for Costs Associated with Exit of Disposal sures included elsewhere in these notes to consolidated Activities.” The Statement addresses financial accounting financial statements. and reporting for costs associated with exit or disposal Use of Estimates: The preparation of financial activities and nullifies Emerging Issues Task Force (EITF) statements in conformity with generally accepted account- Issue 94-3, “Liability Recognition for Certain Employee ing principles requires Management to make estimates and Termination Benefits and Other Costs to Exit an Activity assumptions that affect the reported amounts of assets and (including Certain Costs Incurred in a Restructuring).” liabilities and disclosure of contingent assets and liabilities The Statement generally requires that a cost associated at the date of the financial statements and the reported with an exit or disposal activity be recognized and mea- amounts of revenues and expenses during the reporting sured initially at its fair value in the period in which the period. Actual results could differ from those estimates. liability is incurred. The Statement is effective for all exit Reclassifications: Certain prior period amounts or disposal activities initiated after December 31, 2002, have been reclassified to conform to the current period with earlier application encouraged. Management does not presentation. believe that this Statement will have a material effect on New Accounting Pronouncements: In June 2001, the Company’s financial statements. the FASB issued SFAS No. 143, “Accounting for Asset In November 2002, the FASB issued Interpretation Retirement Obligations”. The Statement addresses finan- No. 45, “Guarantor’s Accounting and Disclosure cial accounting and reporting for obligations associated Requirements for Guarantees; including Guarantees of with the retirement of tangible long-lived assets and associ- Indebtedness of Others.” This interpretation requires ated asset retirement costs. The Statement requires that the that a liability must be recognized at the inception of a fair value of a liability for an asset retirement obligation be guarantee issued or modified after December 31, 2002 recognized in the period in which it is incurred. The asset whether or not payment under the guarantee is probable. retirement obligations will be capitalized as part of the For guarantees entered into prior to December 31, 2002, carrying amount of the long-lived asset. The Statement the interpretation requires certain information related to applies to legal obligations associated with the retirement the guarantees be disclosed in the guarantor’s financial of long-lived assets that result from the acquisition, con- statements. The disclosure requirements of this interpreta- struction, development and normal operation of long-lived tion are effective for the year ended December 31, 2002, assets. The Statement is effective January 1, 2003 for the and are included in the Notes to the Consolidated Company, with earlier adoption permitted. Management Financial Statements. does not believe that this Statement will have a material In December 2002, the FASB issued SFAS No. 148, effect on the Company’s financial statements. “Accounting for Stock-Based Compensation – Transition In April, 2002, the FASB issued SFAS No. 145, and Disclosure, an amendment of FASB Statement No. which rescinds SFAS No. 4 “Reporting Gains and 123”. This Statement amends FASB Statement No. 123, Losses from Extinguishment of Debt”, SFAS No. 44, “Accounting for Stock-Based Compensation”, to provide “Accounting for Intangible Assets of Motor Carriers, and alternative methods of transition for a voluntary change SFAS No. 64, “Extinguishment of Debt Made to Satisfy to the fair value method of accounting for stock-based Sinking Fund Requirements” (SFAS 145). SFAS No. 145 employee compensation. In addition, this Statement also amends SFAS No. 13, “Accounting for Leases” to UNIVERSAL HEALTH SERVICES, INC. SUBSIDIARIES AND 53
  • 32. _________________________________________________________________________________ enterprises of variable interest entities. This Interpretation amends the disclosure requirements of Statement No. 123 applies immediately to variable interest entities created to require prominent disclosures in both annual and after January 31, 2003, and to variable interest entities in interim financial statements. Certain of the disclosure which an enterprise obtains an interest after that date. It modifications are required for fiscal years ending after applies in the first fiscal year or interim period beginning December 15, 2002 and are included in the notes to after June 15, 2003, to variable interest entities in which these consolidated financial statements. an enterprise holds a variable interest that it acquired In January 2003, the FASB issued Interpretation before February 1, 2003. As of December 31, 2002, the No. 46, “Consolidation of Variable Interest Entities an Company does not have any unconsolidated variable interpretation of ARB No. 51.” This Interpretation of interest entities. Accounting Research Bulletin No. 51, “Consolidated Financial Statements”, addresses consolidation by business 2) ACQUISITIONS AND DIVESTITURES _________________________________________________________________________________ The pro forma effect of these acquisitions on the 2003 – Subsequent to December 31, 2002, the Company’s net revenues, net income and basic and diluted Company spent $39.9 million to acquire the assets and earnings per share for the year ended December 31, 2002 operations of: (i) a 108-bed behavioral health system in and 2001 were immaterial. During 2002, the Company Anchorage, Alaska, and; (ii) two hospitals located in received net proceeds of $8.4 million resulting from the France that were purchased by an operating company sale of real estate related to a women’s hospital and a radia- which is 80% owned by the Company. tion oncology center, both of which were closed in a prior 2002- During 2002, the Company spent $3 year and written down to their estimated net realizable million to acquire a majority ownership interest in the values. The sale of the real estate of the women’s hospital assets and operations of a surgery center located in Puerto resulted in a $2.2 million gain. The gain on the sale of the Rico. In addition, effective January 1, 2002, the Company radiation center did not have a material effect on the acquired the assets and operations of: (i) a 150-bed acute Company’s financial statements. care facility located in Lansdale, Pennsylvania, and; (ii) a 2001 – During 2001, the Company spent $263 mil- 117-bed acute care facility located in Lancaster, California. lion to acquire the assets and operations of: (i) a 108-bed Included in other assets at December 31, 2001 were $70 behavioral health care facility located in San Juan million of deposits related to the acquisition of these Capestrano, Puerto Rico; (ii) a 96-bed acute care facility two facilities. located in Murrieta, California; (iii) two behavioral health The aggregate net purchase price of the facilities was care facilities located in Boston, Massachusetts; (iv) a allocated on a preliminary basis to assets and liabilities 60-bed specialty heart hospital located in McAllen, Texas; based on their estimated fair values as follows: (v) an 80% ownership interest in an operating company Amount that owns nine hospitals located in France; (vi) two ambu- (000s) latory surgery centers located in Nevada and Louisiana; ________ Working capital, net $114,000) (vii) a 150-bed acute care facility located in Lansdale, Property and equipment 32,000) Pennsylvania (ownership effective January 1, 2002), and; Goodwill 34,000) (viii) a 117-bed acute care facility located in Lancaster, Debt (3,000) California (ownership effective January 1, 2002). Other liabilities (4,000) ________ The aggregate net purchase price of the facilities was Total Cash Purchase Price 73,000) allocated on a preliminary basis to assets and liabilities Less: cash deposits made in 2001 (70,000) ________ based on their estimated fair values as follows: Cash paid for acquisitions in 2002 $263,000) ________ ________ UNIVERSAL HEALTH SERVICES, INC. SUBSIDIARIES AND 54
  • 33. _________________________________________________________________________________ the Company agreed to construct a new 100-bed facility Amount (000s) scheduled to be completed and opened by the fourth ________ quarter of 2006. Working capital, net $115,000) The aggregate net purchase price of the facilities was Property, plant & equipment 95,000) Goodwill 87,000) allocated on a preliminary basis to assets and liabilities Other assets 22,000) based on their estimated fair values as follows: Debt (9,000) Other liabilities (7,000) ________ Amount Cash purchase price for (000s) ________ 2001 acquisitions 193,000) Working capital, net $145,000) Cash deposits made for Property, plant & equipment 77,000) 2002 acquisitions 70,000) ________ Goodwill 58,000) Cash paid for acquisitions in 2001 $263,000) Other assets 1,000) ________ ________ ________ Cash paid for acquisitions in 2000 $141,000) ________ ________ The increase of $9 million in other working capital The increases of $24.2 million in other working accounts at acquired facilities from their date of acquisition capital accounts at acquired facilities from their date of through December 31, 2001 consisted of the following: acquisition through December 31, 2000 consisted of the following: Amount (000s) ________ Amount Accounts receivable $19,000) (000s) ________ Other working capital accounts (2,000) Accounts receivable $36,800) Other (8,000) ________ Other working capital accounts (7,700) Total working capital changes $19,000) Other (4,900) ________ ________ ________ Total working capital changes $24,200) ________ ________ The pro forma effect of these acquisitions on the Company’s net revenues, net income and basic and diluted Assuming the 2000 acquisitions had been completed earnings per share for the year ended December 31, 2001, as of January 1, 2000, the unaudited pro forma net rev- was immaterial, as the majority of the acquisitions enues and net income for the year ended December 31, occurred early in 2001. Assuming the 2001 acquisitions 2000 would have been approximately $2.4 billion and had been completed as of January 1, 2000, the unaudited $100.4 million, respectively and the unaudited pro forma pro forma net revenues and net income for the year ended basic and diluted earnings per share would have been December 31, 2000 would have been approximately $2.4 $1.67 and $1.62, respectively. billion and $100.7 million, respectively, and the unaudited During 2000, the Company sold the real property of pro forma basic and diluted earnings per share would have a behavioral health care facility located in Florida and its been $1.67 and $1.62, respectively. ownership interests in a women’s hospital and two physi- 2000 — During 2000, the Company spent $141 cian practices located in Oklahoma for net proceeds of million to acquire the assets and operations of: (i) a 277- approximately $5.5 million. In addition, the Company bed acute care facility located in Enid, Oklahoma; (ii) 12 sold a medical office building located in Nevada to a limit- behavioral health care facilities located in Pennsylvania, ed liability company that is majority owned by Universal Delaware, Georgia, Kentucky, South Carolina, Tennessee, Health Realty Income Trust (see Note 9). The net gain/loss Mississippi, Utah and Texas; (iii) a 77-bed acute care facili- from these transactions was not material. ty located in Eagle Pass, Texas, and; (iv) the operations of The goodwill acquired during the last three years as a behavioral health care facility in Texas. In connection presented above, is expected to be fully deductible for with the acquisition of the facility in Eagle Pass, Texas, income tax purposes. UNIVERSAL HEALTH SERVICES, INC. SUBSIDIARIES AND 55
  • 34. _________________________________________________________________________________ 3) FINANCIAL INSTRUMENTS ________________________________________________________________________________ Fair Value Hedges: The Company has two floating lion Euros, ($27.3 million) on December 30, 2004 and rate swaps having a notional principal amount of $60 mil- the swaps mature on June 30, 2005. The Company pays lion in which the Company receives a fixed rate of 6.75% an average fixed rate of 4.35% and receives six month and pays a floating rate equal to 6 month LIBOR plus a EURIBOR. The effective floating rate for these swaps spread. The term of these swaps is ten years and they are as of December 31, 2002 was 2.87%. both scheduled to expire on November 15, 2011. As of During the year ended December 31, 2002, the December 31, 2002, the average floating rate on these Company recorded in accumulated other comprehensive swaps was 2.68%. During 2002 the Company recorded an income (“AOCI”), pre-tax losses of $6.4 million ($4.1 mil- increase of $8.0 million in other assets to recognize the fair lion after-tax) to recognize the change in fair value of all value of these swaps and an $8.0 million increase in long derivatives that are designated as cash flow hedging instru- term debt to recognize the difference between the carrying ments. The gains or losses are reclassified into earnings as value and fair value of the related hedged liability. the underlying hedged item affects earnings, such as when Upon the adoption of SFAS No. 133 on January 1, the forecasted interest payment occurs. Assuming market 2001, the Company recorded an adjustment to increase rates remain unchanged from December 31, 2002, it is other assets and long-term debt by $3.3 million to recog- expected that $7.2 million of pre-tax net losses in accumu- nize the fair value of an interest rate swap that was desig- lated OCI will be reclassified into earnings within the next nated as a fair-value hedge and to recognize the difference twelve months. During the year ended December 31, between the carrying value and fair value of the related 2002, the Company also recorded a charge to earnings of hedged liability. During the third quarter of 2001, the $169,000 ($107,000 after-tax) during the year to recognize counter-party to this interest rate swap, which had a the ineffective portion of its cash flow hedging instru- notional principal amount of $135 million, elected to ter- ments. As of December 31, 2002, the maximum length of minate the interest rate swap. This swap had been desig- time over which the Company is hedging its exposure to nated as a fair value hedge of the Company’s $135 million the variability in future cash flows for forecasted transac- 8.75% Senior Notes that were redeemed in October, tions is through August, 2005. 2001. The termination resulted in a net payment to the Upon the adoption of SFAS No. 133 on January 1, Company of approximately $3.8 million. Upon the 2001, the Company recorded the cumulative effect of an termination of the fair value hedge, the Company ceased accounting change of approximately $7.6 million ($4.8 adjusting the fair value of the debt. The effective interest million after-tax) in accumulated other comprehensive method was used to amortize the resulting difference income (loss) to recognize the fair value all derivatives that between the fair value at termination and the face amount were designated as cash flow hedging instruments. During of the debt through the maturity date of the Senior Notes. the year ended December 31, 2001, the Company record- In connection with the redemption of the Senior Notes in ed, in AOCI, a pre-tax charge of $2.4 million ($1.5 mil- the fourth quarter of 2001, the Company recorded a pre- lion after-tax) to recognize the change in fair value of all tax loss on debt extinguishment of $1.6 million. derivatives that were designated as cash flow hedging Cash Flow Hedges: As of December 31, 2002, the instruments. During the year ended December 31, 2001, Company has one fixed rate swap with a notional principal the Company also recorded a charge to earnings of approx- amount of $125 million which expires in August 2005. imately $300,000 ($200,000 after-tax) to recognize the The Company pays a fixed rate of 6.76% and receives ineffective portion of its cash flow hedging instruments. a floating rate equal to three month LIBOR. As of The Company had a fixed rate swap having a December 31, 2002, the floating rate of this interest notional principal amount of $135 million whereby the rate swap was 1.40%. Company paid a fixed rate of 6.76% and received a float- As of December 31, 2002, a majority-owned ing rate from the counter-party. During 2001, the notional subsidiary of the Company had two interest rate swaps amount of this swap was reduced to $125 million. The denominated in Euros. These two interest rate swaps are Company had two interest rate swaps to fix the rate of for a total notional amount of 41.2 million Euros ($40.9 interest on a total notional principal amount of $75 mil- million based on the end of period currency exchange lion with a scheduled maturity date of August, 2005 that rate). The notional amount decreases to 35.0 million were terminated in November, 2001. The average fixed Euros ($34.8 million) on December 30, 2003, 27.5 mil- rate on the $75 million of interest rate swaps, included the UNIVERSAL HEALTH SERVICES, INC. SUBSIDIARIES AND 56
  • 35. _________________________________________________________________________________ Company’s borrowing spread of .35%, was 7.05%. The tuations related to this intercompany loan. During the sec- total cost of all swaps terminated in 2001 was $7.4 million. ond quarter of 2001, the Company entered into certain This amount was reclassified from accumulated other forward exchange contracts to hedge the exposure associat- comprehensive loss due to the probability of the original ed with foreign currency fluctuations on the intercompany forecasted interest payments not occurring. loan. These contracts, which are now expired, were not Foreign Currency Risk: In connection with the designated as hedging instruments and changes in the fair Company’s purchase of a 80% ownership interest in an value of these items were recorded in earnings to offset the operating company that owns hospitals in France in the foreign exchange gains and losses of the intercompany first quarter of 2001, the Company extended an intercom- loan. The effect of the change in fair value of the contract pany loan denominated in francs. During the first quarter for the year ended December 31, 2001 was a loss of of 2001, the Company recorded a $1.3 million pre-tax loss $200,000 which offset a $200,000 exchange gain on the ($800,000 after-tax), resulting from foreign exchange fluc- intercompany loan. 4) LONG-TERM DEBT _________________________________________________________________________________ A summary of long-term debt follows: (000s) ______________________________ 2002 2001 December 31 _________________________________________________________________________________ Long-term debt: Notes payable and Mortgages payable (including obligations under capitalized leases of $17,921 in 2002 and $11,919 in 2001) and term loans with varying maturities through 2006; weighted average interest at 6.2% in 2002 and 6.8% in 2001 $065,677 $018,061 (see Note 7 regarding capitalized leases) 30,000 121,000 Revolving credit and demand notes 100,000 100,000 Commercial paper Revenue bonds: Interest at floating rates of 1.55% at 10,200 18,200 December 31, 2002 with varying maturities through 2015 5.00% Convertible Debentures due 2020, net of the unamortized discount of 276,465 265,562 $310,527 in 2002 and $321,430 in 2001 6.75% Senior Notes due 2011, net of the unamortized discount of $92 in 2002 and $102 in 2001, and fair market value debt 206,425 198,443 adjustment of $6,517 in 2002 and ($1,455) in 2001. ________________________ 688,767 721,266 8,253 2,436 Less-Amounts due within one year ________________________ ____________ $680,514 $718,830 The Company has a $400 million unsecured non- tificate of deposit and the Euro-dollar rate were 1.125% amortizing revolving credit agreement, which expires on and 1.00%, respectively, and the commitment fee was December 13, 2006. The agreement includes a $50 mil- .25%. There are no compensating balance requirements. lion sublimit for letters of credit of which $29 million was At December 31, 2002, the Company had $349 million available at December 31, 2002. The interest rate on bor- of unused borrowing capacity available under the revolving rowings is determined at the Company’s option at the credit agreement. prime rate, certificate of deposit rate plus .925% to During 2002, a majority-owned subsidiary of the 1.275%, Euro-dollar plus .80% to 1.150% or a money Company entered into a senior credit agreement denomi- market rate. A facility fee ranging from .20% to .35% is nated in Euros amounting to 45.8 million Euros ($44.9 required on the total commitment. The margins over the million based on the end of period currency exchange certificate of deposit, the Euro-dollar rates and the facility rate.) The loan, which is non-recourse to the Company, fee are based upon the Company’s leverage ratio. At amortizes to zero over the life of the agreement and December 31, 2002, the applicable margins over the cer- matures on December 31, 2007. Interest on the loan is at UNIVERSAL HEALTH SERVICES, INC. SUBSIDIARIES AND 57
  • 36. _________________________________________________________________________________ the option of the Company’s majority-owned subsidiary amounts outstanding at any month-end were, $170 and can be based on the one, two three and six month million in 2002, $343.9 million in 2001 and $270.9 EURIBOR plus a spread of 2.5%. As of December 31, million in 2000. 2002, the interest rate was 5.4% and the effective interest The effective interest rate on the Company’s rate including the effects of the designated interest rate revolving credit, demand notes and commercial paper swaps was 6.9%. program, including the respective interest expense and The Company also has a $100 million commercial income incurred on existing and now expired designated paper credit facility. The majority of the Company’s acute interest rate swaps, was 6.3%, 6.4% and 7.1% during care patient accounts receivable are pledged as collateral to 2002, 2001 and 2000, respectively. Additional interest secure this commercial paper program. A commitment fee (expense)/income recorded as a result of the Company’s of .40% is required on the used portion and .20% on the U.S. dollar denominated hedging activity was ($4,228,000) unused portion of the commitment. This annually renew- in 2002, ($2,730,000) in 2001 and $414,000 in 2000. able program, which began in November 1993, is sched- The Company is exposed to credit loss in the event of uled to expire or be renewed in October of each year. non-performance by the counter-party to the interest Outstanding amounts of commercial paper which can rate swap agreements. All of the counter-parties are credit- be refinanced through available borrowings under the worthy financial institutions rated AA or better by Company’s revolving credit agreement are classified as Moody’s Investor Service and the Company does not long-term. As of December 31, 2002, the Company had anticipate non-performance. The estimated fair value of no unused borrowing capacity under the terms of the the cost to the Company to terminate the interest rate commercial paper facility. swap obligations, including the Euro denominated interest During 2001, the Company issued $200 million of rate swaps, at December 31, 2002 and 2001 was approxi- Senior Notes which have a 6.75% coupon rate and which mately $10.4 million and $11.7 million, respectively. mature on November 15, 2011. (“Notes”). The interest on Covenants relating to long-term debt require main- the Notes is paid semiannually in arrears on May 15 and tenance of a minimum net worth, specified debt to total November 15 of each year. The notes can be redeemed in capital and fixed charge coverage ratios. The Company is whole at any time and in part from time to time. in compliance with all required covenants as of December The Company issued discounted Convertible 31, 2002. Debentures in 2000 which are due in 2020 The fair value of the Company’s long-term debt at (“Debentures”). The aggregate issue price of the December 31, 2002 and 2001 was approximately $791.1 Debentures was $250 million or $587 million aggregate million and $751.5 million, respectively. principal amount at maturity. The Debentures were issued Aggregate maturities follow: at a price of $425.90 per $1,000 principal amount of (000s) ________________________ Debenture. The Debentures’ yield to maturity is 5% per $998,253) 2003 annum, .426% of which is cash interest. The interest on 12,632) 2004 10,915) 2005 the bonds is paid semiannually in arrears on June 23 and 142,053) 2006 December 23 of each year. The Debentures are convertible 10,139) 2007 at the option of the holders into 5.6024 shares of the 815,302) Later ________________________ Company’s common stock per $1,000 of Debentures, $999,294) Total however, the Company has the right to redeem the Less: Discount on Debenture any time on or after June 23, 2006 at a price Convertible equal to the issue price of the Debentures plus accrued (310,527) Debentures _________ ____________ original issue discount and accrued cash interest to the $688,767) Net total date of redemption. Included in the aggregate maturities shown above, The average amounts outstanding during 2002, are maturities related to the Company’s Euro denominated 2001 and 2000 under the revolving credit and demand debt ($45.4 million in the aggregate) which mature as notes and commercial paper program were $140.3 million, follows: $4.5 million in 2003; $6.1 million in 2004; $7.6 $220.0 million and $170.0 million. respectively, with cor- million in 2005; $9.1 million in 2006; $9.1 million in responding effective interest rates of 3.3%, 5.1% and 7.4% 2007 and $9.0 million in later years. including commitment and facility fees. The maximum UNIVERSAL HEALTH SERVICES, INC. SUBSIDIARIES AND 58
  • 37. _________________________________________________________________________________ 5) COMMON STOCK _________________________________________________________________________________ In April, 2001, the Company declared a two-for-one purchase program in 1998 through December 31, 2002, stock split in the form of a 100% stock dividend which the Company purchased a total of 9,517,602 shares at an was paid on June 1, 2001 to shareholders of record as of average purchase price of $22.74 per share ($216.4 million May 16, 2001. All classes of common stock participated on in the aggregate). a pro rata basis and all references to share quantities and At December 31, 2002, 17,584,459 shares of Class earnings per share for all periods presented have been B Common Stock were reserved for issuance upon conver- adjusted to reflect the two-for-one stock split. sion of shares of Class A, C and D Common Stock out- During 1998 and 1999, the Company’s Board of standing, for issuance upon exercise of options to purchase Directors approved stock purchase programs authorizing Class B Common Stock, for issuance upon conversion of the Company to purchase up to twelve million shares of its the Company’s discounted Convertible Debentures and outstanding Class B Common Stock on the open market for issuance of stock under other incentive plans. Class A, at prevailing market prices or in negotiated transactions off C and D Common Stock are convertible on a share for the market. Pursuant to the terms of these programs, the share basis into Class B Common Stock. Company purchased 2,408,000 shares at an average As discussed in Note 1, the Company accounts for purchase price of $14.95 per share ($36.0 million in the stock-based compensation using the intrinsic value method aggregate) during 2000, 178,057 shares at an average in APB No. 25, as permitted under SFAS No. 123. The purchase price of $43.33 per share ($7.7 million in the fair value of each option grant was estimated on the date of aggregate) during 2001 and 1,713,787 shares at an average grant using the Black-Scholes option-pricing model with purchase price of $44.71 per share ($76.6 million in the the following range of assumptions used for the fifteen aggregate) during 2002. Since inception of the stock option grants that occurred during 2002, 2001 and 2000: 2002 2001 2000 Year Ended December 31 _________________________________________________________________________________ 53%-57% 21%-49% 21%-44% Volatility 3%-4% 4%-6% 5%-7% Interest rate 3.7 3.8 3.7 Expected life (years) 4% 7% 1% Forfeiture rate _________________________________________________________________________________ Stock options to purchase Class B Common Stock have been granted to officers, key employees and directors of the Company under various plans. Information with respect to these options is summarized as follows: Average Number Option Range Outstanding Options of Shares Price (High-Low) _________________________________________________________________________________ 3,404,910) $17.14 $28.28 - $17.32 Balance, January 1, 2000 529,000) $23.05 $33.72 - $22.28 Granted (1,455,740) $13.81 $28.28 - $07.32 Exercised (94,126) $21.54 $28.28 - $ 11.85 Cancelled _________________________________________________________________________________ 2,384,044) $20.32 $33.72 - $ 11.85 Balance, January 1, 2001 2,051,200) $42.23 $42.65 - $37.82 Granted (318,525) $21.38 $33.72 - $ 11.85 Exercised (298,750) $31.35 $ 42.41 - $ 11.85 Cancelled _________________________________________________________________________________ 3,817,969) $31.14 $42.65 - $ 11.85 Balance, January 1, 2002 320,500) $41.76 $51.40 - $39.96 Granted (470,385) $24.34 $42.41 - $ 11.85 Exercised (74,000) $35.02 $ 43.50 - $20.22 Cancelled _________________________________________________________________________________ _________________________________________ 3,594,084) $32.89 $51.40 - $ 11.85 Balance, December 31, 2002 UNIVERSAL HEALTH SERVICES, INC. SUBSIDIARIES AND 59
  • 38. _________________________________________________________________________________ Outstanding Options at December 31, 2002: Average Option Range Number of Shares Price (High-Low) Contractual Life _______________ _____________ __________ _____________ 2,529,500 $12.1764 $16.8750 - $11.8438 1.8 2,946,784 $23.7443 $33.7200 - $20.2188 1.2 2,096,300 $42.0703 $44.0000 - $34.0000 3.2 2,021,500 $51.3784 $51.4000 - $51.0900 4.7 __________ ____ 3,594,084 All stock options were granted with an exercise price (“CEO”) which are also scheduled to vest ratably on the equal to the fair market value on the date of the grant. third, fourth and fifth anniversary dates of the award. Options are exercisable ratably over a four-year period However, subject to stockholder approval of certain beginning one year after the date of the grant. The options amendments to the Restricted Stock Purchase Plan, the expire five years after the date of the grant. The outstand- shares issued to the Company’s CEO will be awarded only ing stock options at December 31, 2002 have an average if the Company achieves a 14% cumulative increase in remaining contractual life of 2.5 years. At December 31, earnings during the two-year period ending December 31, 2002, options for 2,054,614 shares were available for 2004, as compared to the year ended December 31, 2002. grant. At December 31, 2002, options for 1,393,143 In connection with the Loan Program, it was the shares of Class B Common Stock with an aggregate pur- Company’s policy to charge compensation expense for chase price of $36.9 million (average of $26.48 per share) the loan forgiveness over the employees’ estimated service were exercisable. period or approximately six years on average. As of During the third quarter of 2002, the Company December 31, 2002, the Company had approximately $18 restructured certain elements of its long-term incentive million of loans outstanding in connection with the Loan compensation plans in response to recent changes in regu- Program (approximately $13 million of which was loaned lations relating to such plans. Prior to the third quarter of to officers of the Company), of which approximately $15 2002, the Company loaned employees funds (“Loan million was charged to compensation expense through that Program”) to pay the income tax liabilities incurred upon date. The balance will be charged to compensation expense the exercise of their stock options. Advances pursuant to over the remaining service periods (through March, 2007), the Loan Program were secured by full recourse promissory assuming the forgiveness criteria are met. In addition, as of notes that were forgiven after three years, if the borrower July 1, 2002, the Company had recorded an additional remained employed by the Company. If the forgiveness accrual of approximately $16.0 million related to the criteria were not met, the employee was required to repay estimated benefits earned under the Loan Program for the loan at the time of separation. which loans had not yet been extended. As a result of the During the third quarter of 2002, this Loan termination of the Loan Program, this accrued liability Program was terminated. As a replacement long-term was adjusted by reducing compensation expense by $16.0 incentive plan, the Compensation Committee of the million during 2002 (the majority of which was recorded Company’s Board of Directors approved the issuance of during the third quarter of 2002) since the Company 575,997 shares (net of cancellations) of restricted stock at does not have any future obligations related to the benefits $51.15 per share ($29.5 million in the aggregate) to vari- that employees might have been entitled to if the Loan ous officers and employees pursuant to the Company’s Program had continued. 2001 Employees’ Restricted Stock Purchase Plan Since the Restricted Stock awards were primarily (“Restricted Stock”). The number of shares and the current intended to replace the benefits that had been earned value of the Restricted Stock issued to each employee were under the Loan Program, a portion of the awards was based on the estimated benefits lost by that employee as a attributable to services rendered by employees in prior result of the termination of the Loan Program. The periods. Accordingly, in connection with the issuance of Restricted Stock is scheduled to vest ratably on the third, the Restricted Stock awards during 2002, during the third fourth and fifth anniversary dates of the award. Included quarter of 2002 the Company recorded approximately in the Restricted Stock granted was 319,490 restricted $14.1 million of compensation expense which represented shares issued to the Company’s Chief Executive Officer the prior service portion of the expense related to the UNIVERSAL HEALTH SERVICES, INC. SUBSIDIARIES AND 60
  • 39. _________________________________________________________________________________ Restricted Stock awards. During the fourth quarter of gible employee 90% of the purchase price for the shares, 2002, an additional $1.2 million of compensation expense subject to certain limitations, (loans are partially recourse was recorded related to the Restricted Stock awards. The to the employees); (iii) a 2001 Restricted Stock Purchase remaining expense associated with the Restricted Stock Plan which allows eligible participants to purchase shares awards (estimated at $14.2 million as of December 31, of Class B Common Stock at par value, subject to certain 2002, but subject to adjustment based on the market value restrictions (575,997 shares issued during 2002), and; (iv) of the shares granted to the Company’s CEO) will be a Stock Purchase Plan which allows eligible employees to recorded over the vesting periods of the awards (through purchase shares of Class B Common Stock at a ten percent the third quarter of 2007), assuming the recipients remain discount. The Company has reserved 3.4 million shares of employed by the Company. Class B Common Stock for issuance under these various In addition to the stock option plan the Company plans (excluding terminated plans) and has issued 1.6 mil- has the following stock incentive and purchase plans: (i) a lion shares pursuant to the terms of these plans (excluding Stock Compensation Plan which expires in November, terminated plans) as of December 31, 2002, of which 2004 under which Class B Common Shares may be grant- 38,432, 3,542 and 54,076 became fully vested during ed to key employees, consultants and independent contrac- 2002, 2001 and 2000, respectively. tors (officers and directors are ineligible); (ii) a Stock In connection with the long-term incentive plans Ownership Plan whereby eligible employees (officers of the described above, the Company recorded net compensation Company are no longer eligible) may purchase shares of expense of $3.6 million in 2002, $12.6 million in 2001 Class B Common Stock directly from the Company at and $6.8 million in 2000. current market value and the Company will loan each eli- 6) INCOME TAXES _________________________________________________________________________________ Components of income taxes are as follows: 2002 2001 2000 Year Ended December 31 (000s) _________________________________________________________________________________ Currently payable $197,070 $66,122 $35,506) Federal and foreign 8,384 5,851 3,217) State _________________________________________________________________________________ 105,454 71,973 38,723) Deferred (3,440) (13,622) 12,884) Federal (304) (1,204) 1,139) State _________________________________________________________________________________ (3,744) (14,826) 14,023) _________________________________________________________________________________ _________________________________________ $101,710 $57,147 $52,746) Total The Company accounts for income taxes under the related assets and liabilities which give rise to temporary provisions of Statement of Financial Accounting Standards differences. Deferred taxes result from temporary differ- No. 109, “Accounting for Income Taxes,” (SFAS 109). ences between the financial statement carrying amounts Under SFAS 109, deferred taxes are required to be classi- and the tax bases of assets and liabilities. The components fied based on the financial statement classification of the of deferred taxes are as follows: 2002 2001 Year Ended December 31 (000s) _________________________________________________________________________________ $51,737) $40,730) Self-insurance reserves (13,351) (11,063) Doubtful accounts and other reserves 1,087) 321) State income taxes 40,935) 23,141) Other deferred tax assets (69,651) (56,741) Depreciable and amortizable assets _________________________________________________________________________________ _________________________________________ $10,757) ($3,612) Total deferred taxes UNIVERSAL HEALTH SERVICES, INC. SUBSIDIARIES AND 61
  • 40. _________________________________________________________________________________ A reconciliation between the federal statutory rate and the effective tax rate is as follows: 2002 2001 2000 Year Ended December 31 _________________________________________________________________________________ 35.0% 35.0%) 35.0%)) Federal statutory rate (0.2)% (0.7)% (0.8)% Deductible depreciation, amortization and other 1.9% 1.9)% 1.9)% State taxes, net of federal income tax benefit _________________________________________________________________________________ _________________________________________ 36.7% 36.2% 36.1% Effective tax rate The net deferred tax assets and liabilities are comprised as follows: 2002 2001 Year Ended December 31 (000s) _________________________________________________________________________________ Current deferred taxes $38,374) $36,290) Assets (13,351) (11,063) Liabilities _________________________________________________________________________________ 25,023) 25,227) Total deferred taxes-current Noncurrent deferred taxes 55,385) 27,902) Assets (69,651) (56,741) Liabilities _________________________________________________________________________________ (14,266) (28,839) Total deferred taxes-noncurrent _________________________________________________________________________________ _________________________________________ $10,757) ($3,612) Total deferred taxes The assets and liabilities classified as current relate future taxable income. Although realization is not assured, primarily to the allowance for uncollectible patient management believes it is more likely than not that all accounts and the current portion of the temporary differ- the deferred tax assets will be realized. Accordingly, the ences related to self-insurance reserves. Under SFAS 109, a Company has not provided a valuation allowance. The valuation allowance is required when it is more likely than amount of the deferred tax asset considered realizable, not that some portion of the deferred tax assets will not be however, could be reduced if estimates of future taxable realized. Realization is dependent on generating sufficient income during the carry-forward period are reduced. 7) LEASE COMMITMENTS _________________________________________________________________________________ Certain of the Company’s hospital and medical Company to purchase the leased assets during the term or office facilities and equipment are held under operating or at the expiration of the lease at fair market value. capital leases which expire through 2008 (See Note 9). A summary of property under capital lease follows: Certain of these leases also contain provisions allowing the (000s) __________________________ 2002 2001 Year Ended December 31 ______________________________________________________________________________________________________ $42,346) $31,902) Land, buildings and equipment (23,140) Less: accumulated amortization (23,551) _________________________________________________________________________________ _________________________________________ $18,795) $08,762) UNIVERSAL HEALTH SERVICES, INC. SUBSIDIARIES AND 62
  • 41. _________________________________________________________________________________ Future minimum rental payments under lease commitments with a term of more than one year as of December 31, 2002, are as follows: (000s) __________________________ Capital Operating Year Leases Leases _________________________________________________________________________________ $15,048 $132,704 2003 5,426 28,180 2004 4,026 20,971 2005 3,571 16,043 2006 1,482 2,914 2007 5,920 5,048 Later Years _________________________________________________________________________________ $25,473 $105,860 Total minimum rental 7,552 Less: Amount representing interest _________________________________________________________________________________ 17,921 Present value of minimum rental commitments 3,496 Less: Current portion of capital lease obligations _________________________________________________________________________________ _________________________________________ $14,425 Long-term portion of capital lease obligations Capital lease obligations of $9.5 million in 2002, new equipment or assumed capital lease obligations upon $10.6 million in 2001 and $1.9 million in 2000 were the acquisition of facilities. incurred when the Company entered into capital leases for 8) COMMITMENTS AND CONTINGENCIES _________________________________________________________________________________ Due to unfavorable pricing and availability trends in coverage limits up to $5 million per occurrence through the professional and general liability insurance markets, the December 31, 2001. The majority of the remaining sub- Company’s subsidiaries have assumed a greater portion of sidiaries were covered under policies, which provided for the hospital professional and general liability risk as the a self-insured retention limit up to $1 million per occur- cost of commercial professional and general liability insur- rence, with an annual aggregate retention amount of ance coverage has risen significantly. As a result, effective approximately $4 million in 1998, $5 million in 1999, January 1, 2002, most of the Company’s subsidiaries were $7 million in 2000 and $11 million in 2001. These sub- self-insured for malpractice exposure up to $25 million per sidiaries maintain excess coverage up to $100 million occurrence. The Company, on behalf of its subsidiaries, with other major insurance carriers. purchased an umbrella excess policy through a commercial Early in the first quarter of 2002, PHICO was insurance carrier for coverage in excess of $25 million per placed in liquidation by the Pennsylvania Insurance occurrence with a $75 million aggregate limitation. Total Commissioner. As a result, during the fourth quarter of insurance expense including professional and general lia- 2001, the Company recorded a $40 million pre-tax charge bility, property, auto and workers’ compensation, was to earnings to accrue for its estimated liability that resulted approximately $25 million higher in 2002 as compared to from this event. Management estimated this liability based 2001. Given these insurance market conditions, there can on a number of factors including, among other things, the be no assurance that a continuation of these unfavorable number of asserted claims and reported incidents, esti- trends, or a sharp increase in claims asserted against the mates of losses for these claims based on recent and histori- Company, will not have a material adverse effect on the cal settlement amounts, estimates of unasserted claims Company’s future results of operations. based on historical experience, and estimated recoveries For the period from January 1, 1998 through from state guaranty funds. December 31, 2001, most of the Company’s subsidiaries When PHICO entered liquidation proceedings, were covered under professional and general liability insur- each state’s department of insurance was required to ance policies with PHICO, a Pennsylvania-based commer- declare PHICO as insolvent or impaired. That designation cial insurance company. Certain subsidiaries, including effectively triggers coverage under the applicable state’s hospitals located in Washington, D.C, Puerto Rico and insurance guarantee association, which operates as replace- south Texas were covered under policies with various ment coverage, subject to the terms, conditions and limits UNIVERSAL HEALTH SERVICES, INC. SUBSIDIARIES AND 63
  • 42. _________________________________________________________________________________ set forth in that particular state. Therefore, the Company During the fourth quarter of 2000, the Company is entitled to receive reimbursement from those state’s recognized a pre-tax charge of $7.7 million to reflect the guarantee funds for which it meets the eligibility require- amount of an unfavorable jury verdict and reserve for ments. In addition, the Company may be entitled to future legal costs relating to an unprofitable facility that receive reimbursement from PHICO’s estate for a portion was closed during the first quarter of 2001. During 2001, of the claims ultimately paid by the Company. Manage- an appellate court issued an opinion affirming the jury ver- ment expects that the remaining cash payments related to dict and during the first quarter of 2002, the Company these claims will be made over the next seven years as the filed a petition for review by the Texas Supreme Court, cases are settled or adjudicated. which has accepted the case for review. Pending the out- Included in other assets as of December 31, 2002 come of the state supreme court review, the Company and 2001, were estimates of approximately $37 million recorded interest expense related to this unfavorable jury and $54 million, respectively, representing expected recov- verdict in the amount of $700,000 in both 2002 and eries from various state guaranty funds. The reduction in 2001. During the fourth quarter of 2002, as a result of the estimated recoveries as of December 31, 2002 as compared sale of the real estate of this facility, the Company recorded to December 31, 2001 is due to Management’s reassess- a pre-tax $2.2 million gain. ment of its ultimate liability for general and professional In addition, various suits and claims arising in liability claims relating to the period from 1998 through the ordinary course of business are pending against the 2001, its estimate of related recoveries under state guaranty Company. In the opinion of management, the outcome funds, and payments received during 2002 from such state of such claims and litigation will not materially affect guaranty funds. While Management continues to monitor the Company’s consolidated financial position or results the factors used in making these estimates, the Company’s of operations. ultimate liability for professional and general liability The healthcare industry is subject to numerous laws claims and its actual recoveries from state guaranty funds, and regulations which include, among other things, mat- could change materially from current estimates due to the ters such as government healthcare participation require- inherent uncertainties involved in making such estimates. ments, various licensure and accreditations, reimbursement Therefore, there can be no assurance that changes in these for patient services, and Medicare and Medicaid fraud and estimates, if any, will not have a material adverse effect on abuse. Government action has increased with respect to the Company’s financial position, results of operations or investigations and/or allegations concerning possible viola- cash flows in future periods. tions of fraud and abuse and false claims statutes and/or As of December 31, 2002, the total accrual for regulations by healthcare providers. Providers that are the Company’s professional and general liability claims, found to have violated these laws and regulations may be including all PHICO related claims was $168.2 million excluded from participating in government healthcare pro- ($131.2 million net of expected recoveries from state guar- grams, subjected to fines or penalties or required to repay anty funds), of which $12.0 million is included in other amounts received from government for previously billed current liabilities. As of December 31, 2001, the total patient services. While management of the Company reserve for the Company’s professional and general liability believes its policies, procedures and practices comply with claims was $158.1 million ($104.1 million net of expected governmental regulations, no assurance can be given that recoveries from state guaranty funds), of which $26.0 the Company will not be subjected to governmental million is included in other current liabilities. inquiries or actions. As of December 31, 2002, the Company has out- The Health Insurance Portability and Accountability standing letters of credit and surety bonds totaling $28.4 Act (“HIPAA”) was enacted in August, 1996 to assure million consisting of: (i) $22.5 million related to the health insurance portability, reduce healthcare fraud and Company’s self insurance programs, and; (ii) $5.9 million abuse, guarantee security and privacy of health informa- consisting primarily of collateral for outstanding bonds of tion and enforce standards for health information. an unaffiliated party and public utility. Organizations are required to be in compliance with The Company entered into a long-term contract certain HIPAA provisions beginning in April, 2003. with a third party, that expires in 2012, to provide certain Provisions not yet finalized are required to be implemented data processing services for its acute care and behavioral two years after the effective date of the regulation. health facilities. Organizations are subject to significant fines and penalties if found not to be compliant with the provisions outlined UNIVERSAL HEALTH SERVICES, INC. SUBSIDIARIES AND 64
  • 43. _________________________________________________________________________________ in the regulations. The Company is in the process of the implementation cost of the HIPAA related modifica- implementation of the necessary changes required pur- tions will not have a material adverse effect on the suant to the terms of HIPAA. The Company expects that Company’s financial condition or results of operations. 9) RELATED PARTY TRANSACTIONS _________________________________________________________________________________ At December 31, 2002, the Company held approxi- however, the aggregate original purchase price paid by mately 6.6% of the outstanding shares of Universal Health the Trust for these properties was $112.5 million. The Realty Income Trust (the “Trust”). The Company serves Company received an advisory fee from the Trust of $1.4 as Advisor to the Trust under an annually renewable million in 2002 and $1.3 million in both 2001 and 2000 advisory agreement. Pursuant to the terms of this advisory for investment and administrative services provided under agreement, the Company conducts the Trust’s day to day a contractual agreement which is included in net revenues affairs, provides administrative services and presents in the accompanying consolidated statements of income. investment opportunities. In addition, certain officers and During 2000, the Company sold the real property directors of the Company are also officers and/or directors of a medical office building to limited liability company of the Trust. Management believes that it has the ability that is majority owned by the Trust for cash proceeds of to exercise significant influence over the Trust, therefore approximately $10.5 million. Tenants in the multi-tenant the Company accounts for its investment in the Trust building include subsidiaries of the Company as well as using the equity method of accounting. The Company’s unrelated parties. pre-tax share of income from the Trust was $1.4 million In connection with a long-term incentive compensa- during 2002, $1.3 million during 2001 and $1.2 million tion plan that was terminated during the third quarter of during 2000, and is included in net revenues in the 2002, the Company had $18 million as of December 31, accompanying consolidated statements of income. The 2002 and $21 million as of December 31, 2001, of gross carrying value of this investment was $9.1 million and loans outstanding to various employees of which $15 mil- $9.0 million at December 31, 2002 and 2001, respectively, lion as of December 31, 2002 and $18 million as of and is included in other assets in the accompanying December 31, 2001 were charged to compensation consolidated balance sheets. The market value of this expense through that date. Included in the amounts out- investment was $20.3 million at December 31, 2002 standing were gross loans to officers of the Company and $18.0 million at December 31, 2001. amounting to $13 million as of December 31, 2002 and As of December 31, 2002, the Company leased six $16 million as of December 31, 2001 (see Note 5). hospital facilities from the Trust with terms expiring in The Company’s Chairman and Chief Executive 2004 through 2008. These leases contain up to six 5-year Officer is member of the Board of Directors of Broadlane, renewal options. During 2002, the Company exercised the Inc. In addition, the Company and certain members of five-year renewal option on an acute care hospital leased executive management own approximately 6% of the out- from the Trust which was scheduled to expire in 2003. standing shares of Broadlane, Inc. as of December 31, The renewal rate on this facility is based upon the five year 2002. Broadlane, Inc. provides contracting and other sup- Treasury rate on March 29, 2003 plus a spread. Future ply chain services to various healthcare organizations, minimum lease payments to the Trust are included in including the Company. Note 7. Total rent expense under these operating leases was A member of the Company’s Board of Directors and $17.2 million in 2002, $16.5 million in 2001 and $17.1 member of the Executive Committee is Of Counsel to the million in 2000. The terms of the lease provide that in the law firm used by the Company as its principal outside event the Company discontinues operations at the leased counsel. This Board member is also the trustee of certain facility for more than one year, the Company is obligated trusts for the benefit of the Chief Executive Officer and his to offer a substitute property. If the Trust does not accept family. This law firm also provides personal legal services the substitute property offered, the Company is obligated to the Company’s Chief Executive Officer. Another mem- to purchase the leased facility back from the Trust at a ber of the Company’s Board of Directors and member of price equal to the greater of its then fair market value the Board’s Executive and Audit Committees was formerly or the original purchase price paid by the Trust. As of Senior Vice Chairman and Managing Director of the December 31, 2002, the aggregate fair market value of the investment banking firm used by the Company as one of Company’s facilities leased from the Trust is not known, its Initial Purchasers for the Convertible Debentures issued in 2000. UNIVERSAL HEALTH SERVICES, INC. SUBSIDIARIES AND 65
  • 44. _________________________________________________________________________________ 10) PENSION PLAN _________________________________________________________________________________ The Company maintains contributory and non- employees of one of the Company’s subsidiaries. The bene- contributory retirement plans for eligible employees. fits are based on years of service and the employee’s highest The Company’s contributions to the contributory plan compensation for any five years of employment. The amounted to $7.2 million, $6.2 million and $4.7 million Company’s funding policy is to contribute annually at least in 2002, 2001 and 2000, respectively. The non-contributo- the minimum amount that should be funded in accor- ry plan is a defined benefit pension plan which covers dance with the provisions of ERISA. The following table shows reconciliations of the defined benefit pension plan for the Company as of December 31, 2002 and 2001: (000s) ________________________ 2002__ 2001 _ Change in benefit obligation: ______ ______ $(54,100) $49,754) Benefit obligation at beginning of year $(40,986) $(40,923) Service cost $(43,856) $(43,667) Interest cost $0(1,732) $0(1,810) Benefits paid ____ ___ $0(4,417) $0(1,566) Actuarial loss ($(61,627) ($54,100) Benefit obligation at end of year Change in plan assets: $(50,456) $53,329) Fair value of plan assets at beginning of year $(4(5,553) $(4(873) Actual return on plan assets $0(1,732) $0(1,810) Benefits paid ____ ___ $03,1 (253) $03,1 (190) Administrative expenses $(42,918) $50,456) Fair value of plan assets at end of year $(18,709) $ (3,644) Funded status of the plan ____ ___ $017,289) $02,607) Unrecognized actuarial loss $5(1,420) $5(1,037) Net amount recognized Total amounts recognized in the balance sheet consist of: $(13,666) $((1,037) Accrued benefit liability ____ ___ $0111111112,246) $0—) Accumulated other comprehensive income $$5(1,420) $ (1,037) Net amount recognized Accumulated other comprehensive loss attributable to $(12,246) —) change in additional minimum liability recognition Weighted average assumptions as of December 31 $$6.75% $$7.25% Discount rate $$9.00% $$9.00% Expected long-term rate of return on plan assets $$4.00% $$4.00% Rate of compensation increase (000s) __________________________________________) 2002_)) 2001 _) 2000 ______ _______ ____ ___ Components of net periodic benefit cost $1,((986) $(00,923) $1,((921) Service cost $(3,856) $(3,667) 3,428) Interest cost $(4,459) $(4,723) (4,700) Expected return on plan assets ____ ____ ___ $—) $—) (413) Recognized actuarial gain ____ ____ ___ $(3,(383) $ 00,(133) $(3,(764) Net periodic cost (benefit) UNIVERSAL HEALTH SERVICES, INC. SUBSIDIARIES AND 66
  • 45. _________________________________________________________________________________ income securities, exceeded the accumulated benefit oblig- The projected benefit obligation, accumulated bene- ations of the plan, as of December 31, 2001. As a result of fit obligation and fair value of plan assets for the pension a reduction in the expected long-term rate of return to 8% plan with accumulated benefit obligations in excess of plan and reduction of the discount rate to 6.75% for 2003, the assets were $61,627, $56,584 and $42,918, respectively as Company’s pension expense is estimated to increase by of December 31, 2002. The fair value of plan assets, com- approximately $3 million as compared to 2002. prised of approximately 70% equities and 30% fixed 11) SEGMENT REPORTING _________________________________________________________________________________ The Company’s reportable operating segments President and Chief Executive Officer, and the lead consist of acute care services and behavioral health care executives of each of the Company’s two primary operating services. The “Other” segment column below includes segments. The lead executive for each operating segment centralized services including information services, pur- also manages the profitability of each respective segment’s chasing, reimbursement, accounting, taxation, legal, various hospitals. The acute care and behavioral health ser- advertising, design and construction, and patient account- vices’ operating segments are managed separately because ing as well as the operating results for the Company’s each operating segment represents a business unit that other operating entities including outpatient surgery and offers different types of healthcare services. The accounting radiation centers and an 80% ownership interest in an policies of the operating segments are the same as those operating company that owns nine hospitals located in described in the Summary of Significant Accounting France. The Company’s France subsidiary is included on Policies included in Footnote 1 to the Consolidated the basis of the year ended November 30th. The chief Financial Statements. The Company adopted SFAS operating decision making group for the Company’s acute Nos. 142 and 144, effective January 1, 2002. There was care services and behavioral health care services located in no impact on the segment data presented as a result of the U.S. and Puerto Rico is comprised of the Company’s the adoption of these pronouncements. (Dollar amounts in thousands) _______________________________________________________________ Acute Behavioral Care Health Care Total _________________________________________________________________________________ 2002 Services Services Other Consolidated $5,183,944 $979,824 $094,511) $6,258,279 Gross inpatient revenues $1,814,757 $149,604 $159,905) $2,124,266 Gross outpatient revenues $2,524,292 $565,585 $169,021) $3,258,898 Total net revenues $2,433,369 $114,341 $ (31,691) $2,516,019 Operating income (a) $1,692,360 $259,019 $371,850) $2,323,229 Total assets 5,813 3,752 1,083) 10,648 Licensed beds 4,802 3,608 1,083) 9,493 Available beds 1,239,040 1,005,882 319,100) 2,564,022 Patient days 266,261 84,348 63,781) 414,390 Admissions 4.7 11.9 5.0) 6.2 Average length of stay Acute Behavioral Care Health Care Total _________________________________________________________________________________ 2001 Services Services Other Consolidated $4,032,623 $908,424 $053,725) $4,994,772 Gross inpatient revenues $1,432,232 $143,907 $145,398) $1,721,537 Gross outpatient revenues $2,182,052 $538,443 $119,996) $2,840,491 Total net revenues $1,389,179 $102,502 $ (49,760) $2,441,921 Operating income (a) $1,488,979 $274,013 $405,597) $2,168,589 Total assets 5,514 3,732 720) 9,966 Licensed beds 4,631 3,588 720) 8,939 Available beds 1,123,264 950,236 180,111) 2,253,611 Patient days 237,802 78,688 38,627) 355,117 Admissions 4.7 12.1 4.7) 6.3 Average length of stay UNIVERSAL HEALTH SERVICES, INC. SUBSIDIARIES AND 67
  • 46. _________________________________________________________________________________ (Dollar amounts in thousands) _______________________________________________________________ Acute Behavioral Care Health Care Total _________________________________________________________________________________ 2000 Services Services Other Consolidated $3,152,132 $584,030 $021,071) $3,757,233 Gross inpatient revenues $1,104,264 $103,015 $ 116,765) $1,324,044 Gross outpatient revenues $1,816,353 $356,340 $069,751) $2,242,444 Total net revenues $1,337,580 $364,960 $ (43,215) $2,359,325 Operating income (a) $1,346,150 $267,427 $128,800) $1,742,377 Total assets 4,980 2,612 —) 7,592 Licensed beds 4,220 2,552 —) 6,772 Available beds 1,017,646 608,423 —) 1,626,069 Patient days 214,771 49,971 —) 264,742 Admissions 4.7 12.2 —) 6.1 Average length of stay (a) Operating income is defined as net revenues less salaries, wages & benefits, other operating expenses, supplies expense and provision for doubtful accounts. Below is a reconciliation of consolidated operating income to consolidated net income before income taxes and extraordinary charge: (amount in thousands) _____________________________________ ________) 2002 2001 2000 ________ _________ _________ $516,019) $441,921) $359,325 Consolidated operating income 124,794) 127,523) 112,809 Less: Depreciation & amortization 61,712) 53,945) 49,039 Lease & rental expense $(34,746) $(36,176) 29,941 Interest expense, net $—) $40,000) — Provision for insurance settlements $(2,182) —) 7,747 (Recovery of )/facility closure costs $19,658) 17,518) 13,681 Minority interests in earnings of consolidated entities ___) ___) ___ $220) 8,862) — Losses on foreign exchange and derivative transactions ___) ___) ___ $277,071) $157,897) $146,108 Consolidated income before income taxes and extraordinary charge 12) QUARTERLY RESULTS (unaudited) _________________________________________________________________________________ The following tables summarize the Company’s quarterly financial data for the two years ended December 31, 2002: (000s, except per share amounts) _________________________________________________________________________________ First Second Third Fourth 2002 Quarter Quarter Quarter Quarter _________________________________________________________________________________ $804,371 $805,945 $813,104 $835,478 Net revenues Income before income taxes $072,165 $070,072 $065,489 $069,345 and extraordinary charge $045,673 $044,347 $041,451 $043,890 Net income $0000.76 $0000.74 $0000.69 $0000.74 Earnings per share – basic _________________________________________ $0000.71 $0000.69 $0000.65 $0000.69 Earnings per share – diluted Net revenues in 2002 include $33.0 million of addi- beyond their scheduled termination dates (June 30, 2003 tional revenues received from Medicaid disproportionate for South Carolina and August 31, 2003 for Texas), failure share hospital (“DSH”) funds in Texas and South to qualify for DSH funds under these programs, or reduc- Carolina. Of this amount, $8.4 million was recorded in tions in reimbursements, could have a material adverse the first quarter, $8.8 million in the second quarter, $7.0 effect on the Company’s future results of operations. million in the third quarter and $8.8 million in the fourth Included in the Company’s results during the fourth quar- quarter. These amounts were recorded in periods that the ter of 2002 is a $2.2 million pre-tax gain on the sale of the Company met all of the requirements to be entitled to real estate of a hospital that was closed in 2001 ($.02 per these reimbursements. Failure to renew these programs diluted share after-tax). UNIVERSAL HEALTH SERVICES, INC. SUBSIDIARIES AND 68
  • 47. _________________________________________________________________________________ (000s, except per share amounts) _________________________________________________________________________________ First Second Third Fourth 2001 Quarter Quarter Quarter Quarter _________________________________________________________________________________ $676,949 $718,596 $720,784 $724,162 Net revenues Income before income taxes $056,923 $050,888 $047,519 $002,567 and extraordinary charge $036,171 $032,390 $030,254 $019,927 Net income Earnings per share after extraordinary $0000.60 $0000.54 $0000.50 $0000.02 charge – basic Earnings per share after extraordinary _________________________________________ $0000.57 $0000.51 $0000.48 $0000.02 charge – diluted Net revenues in 2001 include $32.6 million of addi- charges: (i) a $40.0 million pre-tax charge ($.38 per dilut- tional revenues received from DSH funds in Texas and ed share after-tax) to reserve for malpractice expenses that South Carolina. Of this amount, $6.4 million was record- may result from the liquidation of the Company’s third ed in the first quarter, $9.1 million in the second quarter, party malpractice insurance company (PHICO); (ii) a $7.4 $8.8 million in the third quarter and $8.3 million in the million pre-tax charge ($.07 per diluted share after-tax) fourth quarter. These amounts were recorded in periods resulting from the early termination of interest rate swaps, that the Company met all of the requirements to be enti- and; (iii) a $1.6 million pre-tax charge ($.01 per diluted tled to these reimbursements. Included in the Company’s share after-tax) from the early extinguishment of debt. results for the fourth quarter of 2001 are the following UNIVERSAL HEALTH SERVICES, INC. SUBSIDIARIES AND 69
  • 48. INDEPENDENT AUDITORS’ REPORT _________________________________________________________________________________ To the Board of Directors and Stockholders of Universal Health Services, Inc.: We have audited the accompanying consolidated balance sheet of Universal Health Services, Inc. (a Delaware corporation) and subsidiaries as of December 31, 2002, and the related consolidated statements of income, common stockholders’ equity and cash flows for the year then ended. These financial statements are the responsibility of the Company’s man- agement. Our responsibility is to express an opinion on these financial statements based on our audit. The accompanying consolidated balance sheet of Universal Health Services, Inc. and subsidiaries as of December 31, 2001, and the related consolidated statements of income, common stockholders’ equity and cash flows for each of the years in the two year period ended December 31, 2001, were audited by other auditors who have ceased opera- tions. Those auditors expressed an unqualified opinion on those financial statements before the revisions as described in Note 1 to the financial statements, in their report dated February 13, 2002. We conducted our audit in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material mis- statement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the 2002 consolidated financial statements referred to above present fairly, in all material respects, the financial position on Universal Health Services, Inc. and subsidiaries as of December 31, 2002, and the results of their operations and their cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America. As discussed, the above financial statements of Universal Health Services, Inc. and subsidiaries as of December 31, 2001, and for each of the years in the two-year period ended December 31, 2001 were audited by other auditors who have ceased operations. As described in Note 1, the consolidated financial statements have been revised to include the transitional disclosures required by Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets,” which was adopted as of January 1, 2002. In our opinion, the disclosures for 2001 and 2000 in Note 1 are appropriate. However, we were not engaged to audit, review, or apply any procedures to the 2001 and 2000 consolidated financial state- ments of Universal Health Services, Inc. and subsidiaries other than with respect to such disclosures, and accordingly, we do not express an opinion or any other form of assurance on the 2001 and 2000 consolidated financial statements taken as a whole. Philadelphia, Pennsylvania February 28, 2003 UNIVERSAL HEALTH SERVICES, INC. SUBSIDIARIES AND 70
  • 49. The following report is a copy of a previously issued Arthur Andersen LLP (“Andersen”) report, and the report has not been reissued by Andersen. The Andersen report refers to the consolidated balance sheet as of December 31, 2000 and the consolidated state- ments of income, common stockholders’ equity and cash flows for the year ended December 31, 1999, which are no longer included in the accompanying financial statements. REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS _________________________________________________________________________________ To the Stockholders and Board of Directors of Universal Health Services, Inc.: We have audited the accompanying consolidated balance sheets of Universal Health Services, Inc. (a Delaware corporation) and subsidiaries as of December 31, 2001 and 2000, and the related consolidated statements of income, common stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2001. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstate- ment. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Universal Health Services, Inc. and sub- sidiaries as of December 31, 2001 and 2000, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2001 in conformity with accounting principles generally accepted in the United States. Arthur Andersen LLP Philadelphia, Pennsylvania February 13, 2002 UNIVERSAL HEALTH SERVICES, INC. SUBSIDIARIES AND 71