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  1. 1. Tenet’s Q1 2007 Earnings Call Prepared Remarks May 8, 2007 Trevor Fetter, President and Chief Executive Officer Thank you, operator, and good morning, everyone. I intend to keep my comments relatively brief this morning, so you can hear from our new chief operating officer, Dr. Steve Newman, on our operating strategies, and from Biggs Porter on the financial aspects of the quarter. Also, please remember that we will discuss our operating strategy in greater detail in less than a month at our upcoming Investor Day on June 5 here in Dallas. The meeting will also be available via live webcast at www.tenethealth.com. In addition to providing further insight into our strategies at Investor Day, we’ll share specific examples of the impact our initiatives are having on performance. You’ll hear from the individuals leading the initiatives as well as from some of the operators who are implementing them. Again, the date is June 5. Before I turn things over to Steve and Biggs, let me offer my own thoughts and provide some context to the quarter. I see a good deal of evidence that our turnaround strategies are working. I remain confident that we are on the right course, even though our performance likely will not improve in a straight line. As I’ll discuss in a minute, we have some regions and hospitals that are not improving according to our plans or as rapidly as other regions. That is what held us back in the quarter. To put volumes in context, our admissions decline in the first quarter, while still a decline, was less than the decline a year ago. While the breakeven in pre-tax income from continuing operations was essentially even with last year, it’s difficult to make a blanket statement about the quarter without getting into a detailed discussion. Biggs will do that in his remarks because it’s important you understand all of the drivers. As you recall, we launched a series of initiatives to build a more sustainable foundation for the company at the same time that we worked to resolve our legacy issues and rebuild the trust and confidence among our physician base. These efforts were grounded in our Commitment to Quality. As we started earning external recognition for clinical quality, we focused on developing strategies to leverage this distinctiveness into growth. These strategies fell under the umbrella of our Targeted Growth Initiative, or “TGI.” There is continuing evidence that these strategies are producing their intended results. 1
  2. 2. Our California Region continued its strong fourth quarter results into the first quarter, with a 0.9 percent increase in admissions. Our Texas Region, which followed California in our phased rollout of TGI, increased admissions year-over-year by 2.9 percent, excluding the two Dallas hospitals that we will stop operating this summer. The one region in which we continue to struggle is Florida where, among other factors, we have been hit hard by new competition in cardiology. You may recall that a few years ago the Certificate of Need regulations in the state were relaxed. Three of our hospitals gained new competitive threats, and one of our hospitals gained an opportunity to compete with a new program of its own. In addition to opening new and competing heart programs, certain of our competitors are also engaging in aggressive physician employment strategies. The success of our Commitment to Quality is directly visible in the differential volume growth which distinguishes our service lines earning the coveted Centers of Excellence designations. In Q1, the delta in year-over-year volumes between hospitals with and without United Healthcare Centers of Excellence designations in cardiology is 10 percentage points. Hospitals with Centers of Excellence designations were down 1 percent in volume and hospitals without the designations were down 11 percent. While the absolute growth was negative, the relative difference still demonstrates the value of pursuing these designations through excellent clinical quality. Our performance was also affected by a number of unique situations, such as USC University Hospital in Los Angeles, where volumes have been soft due to instability within the medical school. I also mentioned Florida a minute ago, where the decline in just cardiology volumes represents more than half of the total declines in admissions we saw nationwide in the first quarter. If you add the admissions impact of these two items and exclude the two Dallas hospitals we will stop operating this summer, the negative impact from basically five hospitals accounts for more than 80 percent of the decline in admissions company-wide in the quarter. Now, I’d prefer to be reporting a quarter where all of our regions and hospitals were performing more consistently, but I believe that the negative drivers I just mentioned are isolated instances that should not be mistaken as flaws in our overall strategy, nor should investors conclude that the weakness in volumes is company-wide. Twenty-six of our 55 go-forward hospitals generated positive growth in admissions. The strategy that we set back in 2003 is sound. It requires that we maintain and enhance our commitments to quality, service and volume-building activities. Here to talk more about these items is Dr. Steve Newman, Steve. Dr. Stephen Newman, Chief Operating Officer Thank you, Trevor, and good morning everyone. This was my first quarter as chief operating officer. I have spent virtually all of my time fine- tuning the turnaround strategies we’ve initiated over the past few years and making sure our operators are focusing their efforts only on the levers that drive improved performance. After 2
  3. 3. visiting our hospitals in six states in the first quarter, it’s clear to me that we have the right strategies to get the job done. But what’s needed now is a much more consistent level of excellence in implementing these strategies across our entire system. At our annual management conference in Dallas last month, I told our hospital teams the only priorities that really matter right now are these: 1. Continue to improve the quality of our excellent clinical care; 2. Grow inpatient and outpatient volumes and revenues consistent with our Targeted Growth Initiative; 3. Retain and recruit the best employees and physicians; and 4. Improve cost management each day. I called these my “prescription for success” at Tenet. And I told our hospital leaders that these four priorities – and only these four – should guide everything they do every day. My most critical assignment right now is to assure that our hospital leaders are not distracted from executing our turnaround strategies. I intend to remove anything that gets in their way. I also intend to make sure we have the appropriate level of rigor and a real sense of urgency at every level in the organization. With enhanced focus and increased accountability, I expect to see noticeable improvement in both our quality and earnings metrics in the months ahead. We are already seeing the benefit of this effort in some of our first quarter results. Let me share with you some of the highlights. California Since I was the regional leader in California until the end of the year, I am particularly pleased with the continuing recovery in that region during the first quarter. If we exclude USC University Hospital’s results from California’s performance, California’s admissions were up 0.9 percent in the first quarter. In large measure, we can credit the second part of my prescription I just told you about for the California recovery; that is, a tight focus on growing volumes consistent with our Targeted Growth Initiative. You will recall that TGI is our initiative to use a rigorous, evidence-based approach to decide which services to emphasize and which to de- emphasize at each hospital. As Trevor mentioned, admissions are down at USC. Since USC has been a very successful hospital for us in the past, its downturn has a ripple effect on other aggregate company metrics, including pricing. We remain hopeful that this situation will be resolved favorably. Texas Moving on to the Texas Region, we saw a strong recovery in the first quarter with admissions up 2.9 percent when RHD and Trinity are excluded. This resulted from multiple factors: 1. The implementation of our Targeted Growth Initiative, which we launched about 18 months ago in Texas and which is now maturing in most hospitals. 3
  4. 4. 2. Over the last 18 months, we have hired five new chief executive officers at our Texas hospitals. These enthusiastic leaders have now had sufficient time to settle into their jobs and develop the kinds of productive working relationships with their physicians that are critical to growing market share and improving financial performance. 3. We’ve made progress with our physician alignment strategies in Texas. Our initiative to develop an effective physician employment model in Texas appears to be yielding early positive results. For instance, we’ve established primary care clinics at four locations as part of our newly created Cypress Fairbanks Health Network in Houston. This is helping us to secure a loyal base of primary care physicians and, in some selective cases, specialists as well. We have learned many lessons from our own past mistakes, and those of others, with regard to physician employment. We are not purchasing any existing physician practices, for example, and we are adding productivity targets and incentives for meeting quality metrics to our physician employment agreements. I should caution you about the sustainability of this rate of improvement in Texas. The gain in key operating statistics in Texas exceeded our own first quarter expectations. Obviously, we can’t be sure the current rate will continue, but we’ve been working on the Texas issue for some time, and we are optimistic that the improvement we’ve seen will continue even if the rate of progress begins to slow at some point. The good news here is that our turnaround in Texas is clearly linked to consistent execution of our strategies. That bodes well for the entire company over time. Florida In Florida, our hospitals continued to experience soft admissions in the first quarter. We believe this, in part, resulted from fewer “snow birds” making their annual trek south during the winter months, as well as loss of year-round population in some areas. In Palm Beach County, where we have our largest cluster of hospitals, we’ve lost some market share in cardiology and in managed care in general. We believe the diversion of a significant portion of our cardiovascular business to new open-heart surgery competitors is primarily responsible for this noticeable drop in both Medicare and commercial managed care business at our hospitals. We’re taking multiple actions in Florida to address the recent softness. Since I became chief operating officer in January, I have made three trips there to assess the situation and meet with our hospital managers. We are currently completing the implementation of several new strategies to stem the loss of volumes in Florida and we are confident there are significant opportunities for us in cancer, neurology and neurosurgery, as well as the cardiovascular services where we have traditionally been very strong. For example, we recently started an open-heart surgery program at Palmetto General Hospital in Dade County. In the first quarter of 2007, we performed 25 open-heart surgeries and 280 4
  5. 5. percutaneous cardiac interventions at Palmetto. The good news is that all of this volume is incremental new business that we couldn’t capture previously. In addition, we recently undertook an analysis of the demographic data regarding our physicians in Florida in order to better understand the factors causing our weaker admissions. The analysis shows a worrisome aging of the primary care base, especially for our Palm Beach hospitals. As they pass a certain age, physicians see fewer patients in their offices and scale back the number of hospital patients they render care to. The malpractice climate in Florida has been a barrier to the recruitment of private, primary care physicians who are necessary to meet community needs. We are embarking on new strategies to recruit new, younger primary care physicians, similar to our recent physician employment efforts in Texas. In addition, we are more aggressively implementing our physician sales and service program in Florida, and we are beginning to see the impact it can have on growing our patient volumes. However, these efforts take time, and you should not expect us to reverse our loss of Florida volumes quickly. I have also made it a top priority to augment our marketing and business development efforts in Florida by recruiting experienced business development directors and PSSP coordinators at all of our hospitals. We have also deployed more marketing resources and increased our Florida advertising budgets. The bottom line in Florida is that we’ve implemented a variety of turnaround strategies, but they are less mature than in other regions. We are now focused intensely on consistent execution of these strategies and improvement in physician relations as we rebuild our market share in the state. PSSP Part of the third element of my “prescription for success” that I mentioned earlier is a focus on recruiting and retaining physicians. We have described PSSP, our principal initiative in this area, in earlier calls. And I can tell you that we’re still seeing improved referral patterns from the physicians that have been our primary focus so far. As we gain more experience and improve our focus, we are providing new tools to help our people. For example, today we are launching our volume-building workshops for hospital chief executive officers. These intensive, one-day education programs consist of didactic and role-playing modules focused on interactions with physicians. The workshops are being held for Texas CEOs today, but over the next 120 days we will roll them into every region. In addition, we now develop lists of all physicians within the zip codes that define a hospital’s market. And we have begun calling on high-prospect physicians that are not affiliated with our hospitals. This is in addition to those physicians that have long-standing relationships with Tenet hospitals, but may have diminished their referrals or become inactive members of our medical staff. When we meet with non-Tenet physicians, we not only explain the culture change and new investments at the hospital and at Tenet, but we also work collaboratively with them to get them properly credentialed by the local hospital medical staffs. 5
  6. 6. As we dig deeper into our prospect lists, we are continuing to generate the kinds of satisfying results we have shared with you on earlier calls. We added just over 1,100 physicians to our focus list in the first quarter. Most of those on the list who had already affiliated with us had been referring far fewer patients than they had in the past. But in the first quarter, we saw an increase of 13.6 percent, or 560 admissions, from these physicians compared to their admissions to our hospitals in the first quarter of 2006. When you recall that Tenet’s goal for admissions growth for 2007 is approximately 6,000 incremental admissions, it’s clear that PSSP continues to make a meaningful contribution towards this goal. We also have refined PSSP to put priority on visiting physicians that have received quality designations by the managed care plans. Some of these physicians may not currently have or use admitting privileges at a Tenet hospital, but they are on our focus list because there is a geographic match. For example, Aetna has a strategy of identifying physicians, rather than hospitals, as the primary focus of its quality strategy. Aetna offers financial incentives to its members to use these doctors based on their patterns of utilization and quality outcomes. While our reward for targeting these physicians may take longer than other parts of our PSSP initiative, we believe this approach holds significant promise over the longer term. Centers of Excellence The first element of my “prescription for success” is a focus on improving clinical quality. As you know, one aspect of our strategy for growth is to gain quality centers of excellence designations for our hospitals from the managed care payers. In the first quarter, we again saw a dramatic differential in admissions between our hospitals that have designated centers of excellence and those that don’t. Although both rates were still negative in the quarter, our COE hospitals saw cardiology admissions decline by only 1 percent, while our non-COE hospitals were down almost 11 percent. The issue comes into better focus if we exclude Florida where, as I mentioned earlier, some of our cardiology programs have experienced significant declines due to new competitors. Not counting Florida, our centers of excellence hospitals were actually up 4.5 percent in cardiology admissions, while the non-COE hospitals declined by 7.1 percent. In other words, there is even a wider growth gap between COE and non-COE cardiology programs of almost 1,200 basis points. That evidence is what gives us confidence that our quality strategy is playing an increasingly important role in generating our future growth. Unions Let me conclude with a brief comment on our ongoing union negotiations. As many of you know, some of our employees in California, and at three hospitals in Florida, have been working under a month-by-month extension of our contract with the Service Employees International Union that expired at the end of 2006. We’ve also been negotiating with the California Nurses Association since last October on a new wage agreement for CNA-affiliated nurses at some of our hospitals in California. The existing CNA agreement also expired at the end of 2006 and our unionized nurses have been working under a month-by-month extension. We have not yet been 6
  7. 7. able to reach a new agreement with either union. We remain optimistic that we’ll be able to do so. But in the meantime, it’s possible that you may hear about some union activities or see some negative media coverage as we continue these tough negotiations. With that, I’d like to turn it over to Biggs Porter, our chief financial officer, Biggs. Biggs Porter, Chief Financial Officer Thank you Steve and good morning everyone. I’ll start my review of the quarter with a look at patient volumes. When we issued our outlook for admissions growth of 0.5 to 1.5 percent for 2007 two months ago, we expected to see a reversal of the rate of decline and then for volumes to build gradually through 2007, versus prior year quarters, as our strategies to drive profitable growth take further hold. As it is, there was a year-over-year decline of 1.7 percent in the first quarter, or even in the more relevant metric of 1.4 percent after excluding the two Dallas hospitals to be divested this summer. This is neither stellar nor acceptable, but there is still some moderation in the statistics as last quarter’s decline in commercial managed care admissions, excluding the two Dallas hospitals, was 3.1 percent for the quarter compared to 3.2 percent in the fourth quarter. Growth in admissions in the outlook range of 50 to 150 basis points requires an incremental 2,800 to 8,400 admissions for the year. Excluding the two hospitals to be divested in Dallas, the first quarter decline was 2,090 admissions, so our outlook range remains an achievable objective. I will talk more about this later, but I want everyone to remember that, while volume growth is critical for us to achieve our long term earnings potential, we can continue to improve our results over the near and intermediate term through price, cost and cash flow focus as well. Turning to revenues, net operating revenues grew by 3.1 percent, reflecting soft volumes, but helped by reasonably good pricing. We saw good growth of 8.1 percent in managed care revenues, which was driven, in part, by the continued migration from traditional Medicare and Medicaid programs to managed programs. Revenues were affected by favorable cost report settlements of almost $12 million in the quarter, down from just over $27 million in last year’s first quarter. While cost report settlements and adjustments from them may continue, we can’t say at what value. Cost control Total controllable operating expenses were up 4.1 percent, but the more important measure was the measure of unit costs which rose by 6.3 percent, which, although we may have made some 7
  8. 8. progress, still reflected higher staffing expense and fixed cost absorption than what we believe is necessary for our current volumes. This is not just about headcount, but also the effects of higher than desired turnover and higher contract labor cost. I will talk more about that in a moment when I speak to the full-year expectations and our actions to mitigate the risk of volume shortfalls. I should also note that we had reductions in length of stay of 2 percent and this correspondingly drives cost per day. Supply costs actually declined in the quarter by 0.7 percent. While it’s true that this cost item tends to move with patient volumes, and part of the decline was clearly the result of a decline in surgeries, this kind of result is still quite extraordinary given the otherwise steady adverse impact of the high rate of medical inflation. “Other Operating Expenses” rose by 8.8 percent. This line item includes the costs of increased medical fees, including the increased burden of ED on-call payments as well as subsidies to hospital based physician groups, especially anesthesiologists, who are in short supply. We also had some significant costs for systems development recorded here and malpractice expense increased to $49 million from $43 million a year ago. There were a few adverse awards or settlements during the quarter, which contributed to the increase in malpractice expense. While we cannot say with certainty, this may be an anomaly for the quarter. Rising rents also contributed to the increase, along with a decline in the amount of overhead costs allocated to discontinued operations. These costs were partially offset by a $7 million gain on the sale of a medical office building. To say it again, as I mentioned in my fourth quarter remarks, we are continuing to carry staff costs in excess of our immediate, current needs. We have facility-level plans in place to realign staffing to current volumes. We also have specific targeted reductions in baseline overhead costs and discretionary overhead spending, which should have a positive effect on the profitability of future quarters. Bad debt Bad debt as a percent of net operating revenues came in at 6.2 percent, compared to 5.5 percent in the first quarter a year ago and 5.7 percent in the fourth quarter. If we exclude the two Dallas hospitals to be divested this summer, bad debt would have been 6 percent. More importantly, after normalizing fourth quarter of last year for the effect on bad debt expense of improved collections, the first quarter shows a fairly stable bad debt situation. We continue to deploy our bad debt reduction strategies to mitigate risk in this area or, hopefully, to yield net improvement over time. 8
  9. 9. Pricing Net inpatient revenue per patient day rose by 3.6 percent while net outpatient pricing per visit increased by a much stronger 11 percent. One factor contributing to this was the relative mix change toward higher priced commercial managed care volumes. As we’ve said many times in past quarters, pricing metrics can be somewhat misleading in that they are significantly impacted by the particular type of patient presenting themselves at a specific hospital. The decline of volumes at USC provides an interesting example of this. If we exclude USC from both last year’s and this year’s first quarters in calculating the increase in net inpatient revenue per patient day, the increase would have been 4.6 percent rather than the 3.6 percent reported number. Those of you who have followed Tenet closely over the last few years will notice that we have reduced the amount of detail we are disclosing this quarter on some of our commercial pricing metrics. It has gotten to the point that the disclosure of this type of detailed information has become counterproductive in our on-going negotiations with managed care payors. The fact is that, while we have received steady increases in most of our markets, we still have a number of markets where our information on competitors’ pricing indicates that Tenet is being underpaid. Our pricing objective remains to achieve rate parity across all our plans, in all of our facilities and in all of our markets. On this basis, we still have several markets and contracts which need to have greater-than-average increases to obtain rate parity. Cash flow We ended the quarter with $584 million in cash, down $200 million from year-end. Adjusted free cash flow used in continuing operations was $272 million. Adjusted free cash flow is a non- GAAP term we define and reconcile to GAAP in the release. Discontinued operations provided $17 million in cash, primarily due to the on-going collection of accounts receivable from sold hospitals. Excluding this cash from disc ops, as well as payments against reserves of $7 million and a small tax payment of $2 million, cash used in continuing operations would have been $162 million. Note that this $162 million included the combined $96 million annual funding of our 401(k) match and incentive compensation. It should be noted that shortly after the end of the first quarter, we received the tax refund of $171 million, which we have previously disclosed as being expected around this time. It is worth noting that our focus on cash flow is increasing. We have always had cash related targets, but the more comprehensive measure of free cash flow has been added to our balance scorecard metrics in 2007. 9
  10. 10. Total company capital expenditures were $111 million in the quarter, of which $110 million was in continuing operations. These capital investments included $11 million for the construction of our new East Side Hospital in El Paso and $35 million related to the $150 million of bolus capital we authorized for commitment last year. This brings our total spending on the bolus to about $75 million, with the remainder in the pipeline. The deployment of our bolus capital has been slower than we anticipated due to long lead times in regulatory approvals and moving from the placing of an order to the final installation, including any construction and site preparation activities. We otherwise find ourselves walking the fine line of ensuring value generating expenditures are executed expeditiously and applying good discipline to more mundane capital activities. Adjusted EBITDA and our outlook Adjusted EBITDA was $189 million for the first quarter for a margin of 8.3 percent. The reconciliation of this number to the GAAP definition of net income is provided in the earnings release we issued this morning. This number included $6 million of negative EBITDA for Trinity and RHD, which will be discontinued by year-end and are not in our 2007 outlook for continuing operations. It also included a number of other items reflected in our earnings release. In late February, we provided an outlook for 2007 which put adjusted EBITDA in the range $700 to $800 million. While the first quarter was somewhat weaker than we had anticipated in terms of patient volumes, we saw many signs that our growth strategies are gaining traction, but were held back by Florida and USC. As a result, it is entirely too early to start refining our outlook for 2007, or even commenting on whether it is more likely that we will be at the high or low end of the range. Since I know some of you struggled to reconcile our 2007 outlook, I’m going to take a moment to give you a sample walk forward. The purpose of doing this is not to give you specific new line item guidance, but to show you how the variables operate and to communicate the types of actions we are engaged in to mitigate risk or give us upside. As I said earlier, I want to emphasize that near-term performance is not all about volumes. If you assume normalized adjusted EBITDA for the first quarter was around $180 million, then annualized you would have $720 million. Using around $180 million for this purpose seems reasonable after eliminating the $6 million of losses at RHD and Trinity and the $7 million gain on sale of the MOB, and normalizing for cost reports, malpractice expense and dish payments. This is subjective and I recognize everyone will have to draw their own conclusions about this starting point. The question then becomes one of how do you get a model to work from the $720 million level to say the middle of our outlook or higher. Here is one bridge to that result: 10
  11. 11. First, we should add back to the annualized figure above the detail plans we have to reduce overhead and staffing costs over the next three quarters relative to first quarter expense levels. These efficiencies aggregate to over $50 million for the rest of this year. Second, we have initiatives with a potential to significantly contribute to 2007 results. These include: • Additional staffing reductions at the hospitals • DRG documentation corrective actions to increase recovery to the level we are entitled • Similarly improve our ED coding to ensure services and severity are all properly captured • Charge capture and other revenue-related initiatives • Improved denial management • Improved bad debt expense from our bad debt initiatives • Continued success in improving costs on medical devices • Further reductions in consulting and other overhead spending The list of our action plans is in fact longer, but I will stop here as the remaining items become increasingly finite. Now, let’s assume a starting point at the conservative end of our outlook for admissions. I am not leading you to this as an assumption, but it will be a good way to show how the variables work. In order to have admissions and visits for the year at 0.5 percent and 2 percent growth, respectively, our remaining quarters need to have admissions growth over the prior year quarter’s of 1.2 percent, and outpatient visit growth of 3.3 percent. Since the first quarter has higher admissions than average for the year, this would result in equivalent admissions of 2.2 percent below the first quarter. At first quarter average pricing and mix, this would result in lower average quarterly revenue of $50 million for the next three quarters compared to the run-rate we achieved in the first quarter, or $150 million, in the aggregate for the next three quarters. You may recall that we believe the incremental margin on each admission is 40 percent, other variables remaining constant. Versus our first quarter, this would suggest a reduction in quarterly income for the next three quarters of an aggregate $60 million versus the first quarter, so $150 million times 40 percent for $60 million. Although our merit increases are not until the fourth quarter, let’s assume that, absent mitigating actions on our part, our cost and pricing move at the same rate of growth for the remainder of the year, so that the $60 million is a logically produced number. Using this data set and assuming we only capture just over $30 million from the initiatives above, we would be around the middle of our outlook. If you start with a different normalized EBITDA number for the first quarter and hold the same volume assumptions, it just changes how much I would say we have to achieve of our initiatives in order to hit the middle of the range. We are actively pursuing the full capture of the initiatives, which are of much higher potential value than what I used a moment ago, and also performance much better than the admissions data I used above. If we are successful, then there is upside or additional mitigation of volume risk. 11
  12. 12. I have said before that our objective is to have a balanced outlook with offsetting risks and opportunities, with good risk mitigation and opportunity capture plans. There is a lot of the year and risk left ahead of us, but I believe we still have that balance. Of course, in the end, it is our performance that matters. Q and A With that we can turn to Q and A. Operator, could you please provide the instructions for our callers to wish to ask a question. [END] 12