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  1. 1. Tenet’s Q2 2007 Earnings Call Prepared Remarks August 7, 2007 Trevor Fetter, President and Chief Executive Officer Thank you, operator, and good morning. Like many other companies in the hospital sector, Tenet reported disappointing results for the second quarter, largely the result of weak volumes and rising levels of uncompensated care. At our Investor Day in June, we disclosed that patient volumes were negative for the first two months of the quarter. While we had reacted to these softer volumes by reducing our cost structure, unfortunately, our volumes declined further in June with admissions down 3.9 percent in the month, a result which was much weaker than the trend in April and May. Again, we took action to protect earnings by flexing costs, but the decline in June was too sharp for these cost cuts to fully offset the impact from weak volumes. As a result, our second quarter numbers are disappointing in almost every respect. We’re pleased that business bounced back in July, which was essentially flat. To be precise, July same hospital inpatient admissions increased 1.1 percent over the prior year and outpatient visits increased 1 percent, excluding the two leased hospitals in Dallas. But I’m more comfortable characterizing July as flat, due to the extra weekday in July 2007 versus July 2006. This extra weekday disappears in September, so the quarters will be equal year-to-year. Though I would ask you not to place too much importance on just one month, and we do not yet have an income statement for July, at least from a volume perspective, we’re off to a better start in the third quarter than in the second. While not yet reflected in current financial performance, we continued to make significant progress in what I believe will be the fundamental drivers of our longer term success such as quality, outpatient services and implementation of our growth strategies. However, given our performance for the quarter, we’ve adjusted our financial outlook accordingly, and Biggs Porter will provide details on those changes shortly. Before Biggs gets into the outlook, I want to share with you my personal assessment of the state of our progress to-date. Let me begin with volumes. Nearly 60 percent of our volume loss for the quarter came from the same areas we talked about in the first quarter call: USC University Hospital, Palm Beach and our two Dallas hospitals whose leases expire on August 31. But notice that, instead of attributing particular weakness to all of Florida for the quarter, it was concentrated in Palm Beach. The rest of our hospitals across the country, in the aggregate, are performing better than the statistics for the whole company, with an admissions decline of 1.1 percent. 1
  2. 2. Looking deeper into the volume picture, I’m pleased to report that we continue to make significant, tangible progress with regard to managed care admissions. While we had seen a number of quarters with declines in commercial managed care admissions in the 3 percent to 6 percent area, the declines moderated markedly in the second quarter, falling by only 2.1 percent, which was actually modestly better than our aggregate admissions decline. This is the most valuable portion of our business, and we are working hard to build our volumes with managed care companies and physician groups. At the other end of the spectrum, uncompensated care increased 13.5 percent to $302 million for the quarter. As we’ve mentioned for several quarters, commercial managed care payors and plan sponsors continue transferring to individual patients a larger portion of the financial obligation for the cost of their care. This is a concerning trend because these additional dollars, which we call balance after, were previously paid by the managed care payors, from whom we have very high collection rates. Conversely, we only collect about 60 cents on the dollar when the payment source comes from an individual patient. To give you some statistics on this, the number of patients with a balance after insurance increased by 2.4 percent over the second quarter of 2006. But the average dollar balance, as well as the total dollars these patients owe us, increased by 50 percent. This difference, between 2 percent and 50 percent, illustrates the effect of this cost shifting by plan sponsors. We continue to build stronger relationships with physicians. Steve Newman will tell you how we’ve revamped the program to develop physician relationships. In addition to actively calling on physicians to make sure we’re meeting their needs, we have increased our activities in the centralized recruitment of physicians and, to a more limited extent, employment of physicians. In markets where it makes sense, we’re even opening free-standing physician clinics. The first of six new clinics in the Dallas area opened just a few weeks ago, and the other five will open over the next three months. These Dallas clinics are following the same strategy we’ve employed in Houston, where we already have five clinics up and running. Also, a number of new construction projects have either recently come on-line or are nearing completion and should begin contributing to our growth, some as early as the last half of 2007. Let me take a moment to provide examples of the dynamic changes we’re making in our hospital portfolio to drive future growth: • We completed construction and opened a new $46 million tower at Twin Cities Community Hospital in California; • We’re actively building and renovating at many of our hospitals, including North Fulton Regional in Georgia, where a $43 million expansion project will house new patient beds, two new operating rooms and a critical care unit; • At Houston Northwest, we are investing more than $17 million in the construction of a new cardiac care center and endoscopy suite; and 2
  3. 3. • At Delray Medical Center in Florida and Saint Francis Hospital in Memphis, we are expanding and/or building new emergency departments. In addition to these projects, we are scheduled to spend approximately $83 million during this year on refurbishments and upgrades to patient floors and ancillary areas at our other hospitals. You should note, however, that we’ve spent less in the past 12 months than you might have expected. There are several principal reasons: first, as we’ve undertaken these projects, we’ve not relaxed our normal review and approval discipline; second, many of the planned projects are in California where we’ve encountered unusually long delays in seeking regulatory approval. For those of you who aren’t aware of this, any hospital project in California that exceeds $50,000 in cost must be approved by the state health agency. And third, a significant portion of the planned capital infusion has been for major equipment. We aggregated the purchasing of this equipment in order to drive greater discounts. Among the terms we negotiated were low deposits with the vast majority of the price due upon first use of the equipment. Much of this equipment required physical changes to the hospitals, which triggered the regulatory approvals I just mentioned. So I’d say upon having reviewed the capital plans for the last 12 months, that we proceeded deliberately and not as expeditiously, as I expected. Our review indicates that 90 percent of the capital projects contained in the additional capital infusion program of 2006 are in progress. I certainly wish we had moved faster to get the projects completed, but I believe we did benefit from the commitment and announcement of the projects, all of which should be completed by year-end. On July 1 we announced the acquisition of Coastal Carolina Medical Center. This acquisition, our first in five years, fits our strategy to leverage the strength of our current hospitals to grow in key markets where we already operate. Coastal Carolina is adjacent not only to our Hilton Head Regional Medical Center, but also to a free-standing surgery center that we own in the same market. The market we serve is growing rapidly, and we now represent a unique health care resource in this market with our only principal competitors a 45- to 60-minute drive away. We expect this acquisition to be accretive in the first year with a very attractive return on invested capital. I’d like to point out that the investments I just mentioned, including the purchase of Coastal Carolina, demonstrate that even though we’re in the midst of a turnaround situation, we have both the capacity and the will to continue to actively invest in our hospitals to leverage our existing strengths. At our Investor Day 60 days ago, we outlined at length all the strategies we’re employing to put this company on a growth track. They fall into these five categories: 3
  4. 4. 1. Our Commitment to Quality, through which we aspire to build a competitive advantage in quality and service, leading to organic growth; 2. Optimizing the services that we offer at each hospital, we call this the Targeted Growth Initiative; 3. A focus on physicians, which encompasses our physician relationship program, physician employment, joint venturing and clinic development strategies; 4. Enhancing operational effectiveness, which goes beyond our actions to increase pricing and reduce costs. We are deploying teams of people into the field from our Performance Management and Innovation group, improving our performance in labor management, the supply chain and the revenue cycle; and 5. Building and improving our outpatient business. I believe that we are pursuing the right strategies. At the same time, I’m disappointed in the pace of our recovery and the consistency of our results. In August 2006, I didn’t anticipate that, a year following our government settlement, we would have a quarter with lower volumes and earnings like the quarter we just reported. Some of it is weakness in the industry. Some of it is due to specific situations in our markets, like Florida, and some with our specific hospitals, like USC. But regardless of the causes, we’re working harder than ever, with better tools and information than ever, in order to turn this around. One postscript I’d like to mention is that last week a federal judge in Florida dismissed the attempted class action lawsuit regarding outlier payments that had been brought against Tenet by Boca Raton Community Hospital. That lawsuit constituted the last of the significant pre-2003 legacy legal issues that we faced. I’ll now turn it over to our COO, Dr. Steve Newman, Steve. Dr. Stephen Newman, Chief Operating Officer Thank you, Trevor and good morning everyone. Let me start with a deeper dive into the volume picture. Not surprisingly, we experienced our largest volume declines in Florida. I say, not surprisingly, because Florida has been our primary area of weakness since the third quarter of 2005. And, as we have been telling you, it is simply going to take time for the recovery to take hold in that market. Overall, Florida admissions were down 5 percent. But the challenge this quarter was much more concentrated in our Palm Beach market than in the past. Admissions in our Miami- Dade/Broward market were down 2.1 percent, which is in-line with the company as a whole. 4
  5. 5. But our six hospitals in Palm Beach saw admissions decline by 7.3 percent. That loss of 1,315 admissions versus a year ago represents 42 percent of Tenet’s aggregate volume decline in the second quarter. As we highlighted during our Investor Day in June, we are redoubling our efforts in Florida to reduce patient out-migration and retain more tertiary care patients within our network. For example, we have been successful in reducing out-migration in neonatology and cardiac services by focusing on referring these patients to our regionally recognized neonatal intensive care unit at St. Mary’s Medical Center in West Palm Beach, and by adding electrophysiology services at Delray Medical Center. Both of these programs are ahead of budget year-to-date. We are also really ramping up our efforts in Florida to bring more physicians to our hospital medical staffs, especially primary care doctors. Turning to our other markets, results in California moderated a bit from the stronger trend we saw in the first quarter, with admissions down 1.9 percent, or 0.6 percent if we exclude the results of USC University Hospital. The situation in California continues to be a series of situations unique to a number of our hospitals that, taken together, reduced our aggregate numbers in the second quarter. For example, Lakewood Regional Medical Center was hurt in the quarter by redirection of inpatient business from a major physician-owned IPA following a contract dispute. I’m happy to report that, late in the quarter, Lakewood reached agreement in principle with two physician-owned managed care intermediaries to begin using our hospital for their general inpatient and cardiac needs. We should see a positive impact from these new contracts in the third quarter and beyond. Our outpatient business in California saw a decline of 3.3 percent, or a more moderate 2.4 percent if USC is excluded. By comparison, we had a 7.4 percent decline in the second quarter of 2006. Outpatient volume in California was impacted by new competitors such as the ambulatory surgery center associated with a new hospital being built in Modesto by Kaiser. That hospital isn’t scheduled to open until mid-2008, but the surgery center on the campus has already opened for business. We had anticipated this and are addressing it with a major refurbishment of our own McHenry Surgery Center on the campus of our Doctors Medical Center in Modesto, and we have a new master plan for the hospital designed to respond to the broader challenges represented by this new competition. You will recall that Texas had a very robust first quarter that came in well ahead of our expectations. Unfortunately, this growth was not sustained in the second quarter, as Texas admissions fell by 2.6 percent and outpatient visits were off by 8.6 percent. About half of the decline in admissions occurred at one hospital in Houston, where strong competition from a new physician-owned facility moved significant market share in the quarter. We knew that this new facility would affect us for a while and that’s why our hospital has invested significantly in new tertiary services and established five new primary care clinics with employed physicians in order to differentiate itself from the new competition. We expect our hospital to recover its lost volume and grow as our differentiation strategies take hold. In El Paso, admissions at our Sierra Providence network of two acute hospitals were down 5.1 percent in the quarter, and we have taken aggressive actions to remedy the principal causes, 5
  6. 6. namely staffing problems in our emergency departments and lack of participation in several new Medicare managed care programs. Longer term, we expect to see more volume in El Paso because of major shifts occurring in local health plans that will bring thousands more members to plans in which we fully participate. For example, with the recent dismantling of one managed care entity that had exclusive contracts with HCA, we will have access to an incremental 25,000 covered lives over the next six months. In addition, we are very excited about the opportunities we expect to have at our new Eastside Hospital in El Paso, where construction is well along and occupancy is scheduled for sometime next summer. Our outpatient business throughout Texas continues to be a challenge because new, competing surgery and imaging centers are opening at an even faster pace than in the past. As we have told you in previous calls, this is a very troubling trend, but we have responded to it by aggressively managing and promoting our existing centers and by syndicating ownership stakes in some of our newly acquired centers. Overall, even though second quarter admissions were a disappointment both in the aggregate and in several of our biggest markets, it’s important to note that we are showing healthy growth in many of our geographies. In Atlanta, for instance, admissions were up 5.2 percent in the second quarter. And in Philadelphia, our admissions were up two percent. Those are very satisfying results, given the tough environment being reported by most hospital operators. Going forward, we will continue to address our volume challenges through a number of existing initiatives, as well as new approaches which we believe have significant incremental potential. In the past three months, accompanied by our regional leaders, I have met face-to-face with 27 of our hospital administrative teams to review their progress on specific initiatives. We reviewed their targeted growth plans, market assessments, and staff and physician requirements to provide the services needed in their communities. I am pleased to report that we identified a number of opportunities to grow our volumes in a fashion consistent with the Targeted Growth Initiative. We are following up on those growth opportunities on an organized weekly basis with each region and hospital. In subsequent quarters I will report to you on our success in capturing more of this preferred business. We have started weekly, 90-minute volume growth calls with each region of the company as well as with the Outpatient Services Group. This intense focus on growing volume is augmented by a deeper understanding of the cause of the volume shortfall by service line and payer. Each hospital is assigned a customized set of actions to mitigate these shortfalls with a timeline for execution and reporting of results. Best practices have been effectively shared throughout the company using this new technique. Now let me update you on our specific initiatives to grow inpatient and outpatient volumes, as well as better control our operating costs. First, we are accelerating our efforts to recruit, relocate and employ more doctors. Our target is to add 1,000 physicians to our medical staffs during the third and fourth quarters. For your reference, we added 483 physicians in the first quarter and 417 in the second quarter. To meet 6
  7. 7. that goal, we have added resources at the corporate and regional level to support hospital-based recruitment and relocation efforts. We have created a centralized recruitment function here in Dallas. And we are working to create stronger practice management systems for our employed and recruited doctors. In this endeavor, our goal is not volume growth at any cost. Our goal is to grow the right volume. Second, we are pursuing and obtaining new managed care contracts that place all of our hospitals, freestanding outpatient centers and physician-owned practices into the networks of our most preferred managed care payors. During the second quarter, we announced a new multi-year agreement with Aetna that includes all of our hospitals nationwide. This breakthrough agreement added nine of our largest hospitals to Aetna’s network that were not previously included. We anticipate that the new Aetna agreement may generate 500 additional admissions per year. The Aetna contract reflects our approach that, in any given market, we want all our facilities to participate in a managed care network. In many of our new agreements, we also are securing volume guarantees to assure that much of the growth we anticipate will be achieved. We estimate that, taken together, these actions will generate an estimated 1,000 incremental admissions annually going forward. Third, to help us fully leverage all our managed care relationships, we have launched an effort to connect the dots with our physicians and managed care partners. For example, we want all the doctors that currently have privileges at our hospitals to accept the same health plans we do. And we want to attract more doctors to our hospital staffs that already participate in the plans we participate in. I categorize this as low-hanging fruit in the managed care arena. It is simply a matter of insuring that both our doctors and our hospitals are capturing the full value inherent in our relationships. Fourth, as I mentioned in the Florida discussion, we are plugging holes in our processes that cause us to lose patients who need services that a particular facility does not provide. We are stemming this patient out-migration by making sure that such referrals are made to nearby Tenet hospitals wherever possible. This effort may generate an incremental 3,500 admissions company-wide every year. That includes 1,100 admissions just in the Palm Beach market alone. Fifth, we continue to build on the success of what we initially called our Physician Sales and Service Program. To recognize all the ancillary efforts we’ve added since PSSP was originally launched, you will now hear us refer to this broader initiative as the Physician Relationship Program, or PRP. We continue to see admissions growth as we visit more physicians and pay return visits to them. In the second quarter, we visited 717 physicians for the first time and saw a 46 percent increase in admissions from that group. As PRP has matured, we have learned that targeting and prioritizing our physician visits is the key to greater success. For example, we have exported across our system a best practice that was developed at our San Ramon Regional Medical Center in California. San Ramon has a very detailed method of classifying physicians as core members of their medical staff, physicians who also use our competitors, or those who are new or do not have active staff privileges at the hospitals. With those classifications, the hospital prioritizes visits and tracks success. This system helps reduce wasted efforts and strengthens the PRP program by pointing our hospital representatives to their best opportunities. We have hired 17 additional PRP representatives at the hospital level since the first of this year. 7
  8. 8. All our PRP reps visited more than 5,100 physicians in the second quarter, and that group of doctors admitted more than 1,700 additional patients in the quarter than they admitted in the same quarter of 2006. That’s a 2.5 percent year-over-year increase. Obviously, given the overall decline in admissions we saw in the quarter, we know we still have a lot of work to do across a variety of disciplines. It is important to keep in mind that our PRP is not a panacea for all our admissions challenges. By design, PRP affects only a physician’s discretionary, or elective, admissions and outpatient orders. It does not affect emergency admissions, which still represent more than half of our total admissions. But PRP is an effective method to embed service to physicians into our hospital management cultures and to build physician loyalty. In the second quarter, we completed the first round of our PRP training designed to improve communications skills and share best practices across the company. The second round of training begins this month with training of hospital chief operating officers, chief nursing officers and key department heads, such as operating room and emergency department directors. In September, we will deploy an improved tracking system for PRP that will give our hospital staffs a better tool to generate ad hoc reports and also permit our leadership teams at the regional and corporate levels to have even more insight into trends that are affecting our business. PRP is more than a name change. We are adding significant leverage to all our physician relationship efforts. Sixth, we are continuing to shift the emphasis and increase the effectiveness of our Outpatient Services Group, which we believe has significant growth potential. The group has now worked for several months with a number of existing hospital and campus-based surgery centers and diagnostic imaging centers. We have begun to see the positive result of that effort. Let me give you a few examples: • Diagnostic Imaging Services, our existing free-standing imaging operation with five centers in New Orleans, showed a 4 percent increase in volume from the first quarter to the second quarter. • Camp Creek is our relatively new stand-alone diagnostic imaging center affiliated with South Fulton Medical Center in Atlanta. It saw a 36 percent increase in exams from the first quarter to the second quarter. That amounted to 717 more scans in the second quarter. The center is just now adding MRI and CT capabilities, which should help drive additional referrals and profitability going forward. • The Sierra Providence health system diagnostic imaging centers in El Paso, made significant progress in the second quarter. The East Side Center saw a 25 percent increase in scans, which amounts to 500 more MRIs, CTs and ultrasounds in the second quarter versus the first quarter. And the TotalCare Center in El Paso had a 34 percent increase in higher modality exams in the quarter, translating to more than 200 additional scans driven largely by MRI and CT orders. • Finally, a great example of success on the ASC front is our Nacogdoches Medical Center ambulatory surgery center joint-venture in Texas. This facility has exceeded 8
  9. 9. its budgeted volume year-to-date by 10 percent and more than doubled its EBITDA projections during the same time period. Those are just some examples of the progress we’re making in the outpatient arena, and we expect that as our Outpatient Services Group continues to mature, this progress will be extended to all of our outpatient diagnostic imaging and ambulatory surgery centers company-wide. Seventh, let me briefly mention our efforts to more effectively manage our costs. Managing labor cost has been especially difficult as volumes continue to come in below our expectations. To mitigate the excess costs that result from volume shortfalls, we have developed new on-line productivity tools to assist our hospital leaders and department heads manage their full-time employee costs even more efficiently than we have in the past. Our labor cost management has been acceptable in the past, but some recent actions will result in faster improvement. These on- line tools and definitive interventions at the hospital level, coupled with new human resources management initiatives aimed at improving our employee retention rate, should make a meaningful improvement in our overall SWB costs. As you compare our rate of growth in controllable costs, like labor and supplies, against other companies, once again this quarter you’ll find that our cost control compares very favorably. Eighth, in the area of supply cost management, where we have always been an industry leader, we added a new monthly report that identifies specific items to target. We call it the left-on-the- table report, and it is designed to give our managers an easy way to recognize savings opportunities in supply utilization. Finally, I am delighted to mention during the second quarter three of our hospitals made the prestigious list of Best Hospitals in America compiled by U.S.News & World Report. This honor was given to only 173 of the more than 5,400 acute care hospitals in America. Tenet’s honorees are Hahnemann University Hospital in Philadelphia, Saint Louis University Hospital and USC University Hospital in Los Angeles. Congratulations to these outstanding hospitals. We are very proud of you. To summarize, I believe you can see that we have a lot of initiatives at work designed to take advantage of our opportunities with the highest potential. We are showing positive results from those initiatives that haven’t yet rolled up into our aggregate numbers. We continue to have confidence in these strategies, and we believe that it is only a matter of time before we see tangible, much improved results. With that, let me turn it over to Biggs Porter, our CFO, for a review of our financials, Biggs. Biggs Porter, Chief Financial Officer Thank you Steve and good morning everyone. 9
  10. 10. EBITDA Adjusted EBITDA for the second quarter was $156 million for a margin of 7 percent. Excluding our two Dallas hospitals – RHD and Trinity – for which leases expire at the end of this month, adjusted EBITDA was $163 million. For the first six months of 2007, adjusted EBITDA was $345 million for continuing operations and $358 million if we exclude the two Dallas hospitals. At our year-end conference call in February, we gave an outlook for adjusted EBITDA for 2007 of $700 to $800 million, based on admissions growth of 0.5 percent to 1.5 percent for the year. At our Investor Day in June, I cautioned that April and May volumes were negative, but that we would wait to see June’s results in order to assess any revision to our outlook. I also cautioned that, without a near term shift in admissions, the upper end of the 2007 range was at risk and a continuation of the volume losses from the first quarter could make the lower end of our range a challenge. Because June and the second quarter’s volumes did not progress, but in fact worsened from the trend in April and May, and there was a corresponding negative effect on income in the second quarter, we are refining our adjusted EBITDA outlook for 2007 to a range of $675 to $725 million. There is a reconciliation of our adjusted EBITDA outlook to GAAP income from continuing operations included in our earnings release. This EBITDA outlook assumes our admissions for the second half of the year to be in a range of a zero percent to a positive 1 percent and visit growth to be a negative 0.5 percent to a positive 1.6 percent. If our assumption for second half volume growth proves accurate, our admissions for full year 2007 should be in a range of a decline of -0.5 percent to -1 percent and visits for the year to decline in the range of -0.5 percent to -1.5 percent, respectively. I will provide additional color on this in a moment. Volumes Trevor and Steve have discussed the volume softness we experienced in the quarter and our initiatives to respond to that challenge. As I said at our investor conference, our results during our recovery are likely to be bumpy. We certainly saw this in the second quarter, exacerbated rather than offset by a weak June, which was down year-over-year in admissions by a negative 3.9 percent. July is encouraging, but it is just one month. I’ll cover the refinements to our 2007 volume outlook in a few minutes. Income statement Net operating revenues grew by 1.5 percent in the second quarter, reflecting the soft volumes environment offset by pricing. Managed care revenues increased by $42 million, or 3.8 percent, and commercial managed care revenues grew by $23 million, or 2.6 percent, as continued pricing increases more than offset a 2.1 percent decline in commercial managed care admissions 10
  11. 11. and a 4.7 percent decline in commercial outpatient visits. As noted in the release, we have continued to see a moderation in the rate of decline of our commercial managed care admissions. Although it is difficult to celebrate a less negative number, it is none the less a positive indicator that we may be achieving stability in this most important element of our patient mix. Cost report adjustments added $13 million to revenues in the quarter compared to $4 million in last year’s second quarter. As you know, our recent history is for favorable adjustments from this source. Although not easily forecasted, going forward we believe the size of these favorable adjustments is likely to be lower. Turning to pricing, revenues per equivalent admission increased by 3.1 percent in the second quarter 2007 relative to the second quarter last year. The increase in revenue per equivalent patient day was a comparable 3.2 percent. Our pricing metrics continue to reflect the pattern of volume losses at specific hospitals. Of particular note, volume losses at USC have depressed our managed care pricing statistics by a full 160 basis points for inpatient revenue per admissions and 20 basis points for outpatient revenue per visit. If we exclude USC from both last year’s and this year’s second quarter revenues, the increase in managed care revenue per admission would have been 4.2 percent as opposed to the reported 2.6 percent. Correspondingly, the increase in managed care revenue per outpatient visit would have been 5 percent versus the 4.8 percent reported figure. We also have had some favorable recent managed care negotiations, which will start showing up in pricing in the third quarter. This includes the Texas Blue Cross contract, which was originally targeted to affect the first half of the year, and our national Aetna contract. The terms of the recently negotiated contracts I just referred to are consistent with the pricing objectives we previously laid out for the next two years. Total controllable operating expense was up 3.4 percent and controllable operating expense per equivalent patient day increased by 4.5 percent, showing again the effect of volumes on our fixed and semi-variable cost base. Like some of our competitors, we saw a $7 million, or 15.1 percent, increase in contract labor. Also, physician medical fees, including for ED coverage, physician guarantees and hospitalists, increased by $12 million, or 29.1 percent. These increases in medical fees reflect structural changes in our business model and probably need to be viewed as a more fixed piece of our cost structure going forward. Supply costs were virtually flat relative to last year’s second quarter with a year-over-year increase constrained to 0.3 percent. Since supply costs are extremely sensitive to volumes, it is important to normalize for volume declines. On a per equivalent patient day basis, supply costs increased by 1.3 percent. We continue to view this as excellent performance given the underlying trends in medical supply costs. 11
  12. 12. Bad debt expense rose to $151 million, or 6.8 percent, of net operating revenues, an increase of $23 million, or 18 percent, from last year’s second quarter, and an increase of 100 basis points from the bad debt ratio a year ago. This is slightly above the high end of our previously expressed full year outlook for 2007 of a range of 6 to 6.7 percent. On a year-to-date basis we are still within that range at 6.5 percent. More importantly, if you exclude Trinity and RHD, bad debt for the first half of 2007 would have been 6.2 percent, and therefore, well within the range. The increase in the quarter compared to last year can most easily be explained as related to a growth in uninsured revenue offset by improvement in collections. While the growth in uninsured admissions was 7.3 percent, our uninsured revenue grew by $36 million or 27 percent. This higher level of revenue growth was fueled by a higher intensity level of our uninsured ED cases as well as price increases, which have primarily affected our outpatient business. The primary offset to the increase in uninsured revenue was improved collection on aged managed care accounts, which reduced bad debt expense by about $9 million. As Trevor mentioned earlier, we also saw an increase in self pay balance after accounts, consistent with cost shifting by payors. For the quarter, the effects of this were offset by our effort to improve cash collections as we discussed at our Investor Day. These efforts resulted in improvements to our collections of aged self pay accounts. It is important to note that we have not changed our practice of reserving based on historical collections, but as we collect older accounts at levels better than that at which we have reserved, we do have improvements in bad debt expense. If these collections trends are sustained over time, we will reduce the amount we reserve at the time of discharge. Collections of self pay receivables, which include both uninsured and balance-after accounts, rose to 35 percent from 33 percent in Q107 and from 32 percent in Q406. This includes both point of service cash collections and receivables collections. Collections on managed care receivables rose from 97 percent in the last two sequential quarters to 98 percent this quarter. It is also of interest to note that charity admissions moved in the opposite direction, declining by 10.1 percent from last year’s second quarter. However, we saw a 44.7 percent increase in our charity visits. This is part an anomaly in the quarter and part a function of the closure of one local clinic that shifted charity outpatient visits to our hospitals. The effect of this is not significant, but it does distort the statistics. Cash flow and capital expenditures Capital expenditures in the quarter were $150 million, of which $148 million was in continuing operations. This included $16 million for the construction of our new Eastside Hospital in El Paso. Excluding this investment in new construction, our investments in our existing franchise were $132 million in the second quarter. Our year-to-date capital expenditures in our existing business for 2007 was $231 million through June 30. This compares to $213 million through 12
  13. 13. June of last year, so slightly ahead of last year’s pace, but low relative to the annual expectation for this year. We expect the usual trend to continue of significantly higher spending as we close out the year, but we may not reach the $700 to $750 million level we previously anticipated. As a result we are adjusting our CAPEX outlook for 2007 to the range of $675 to $725 million. I should note that we are not consciously restricting investment, but rather the spend rate is a function of timing. Having said that, I would expect any spending shortfall to our original expectations for this year not to result in an equivalent increase in targeted spending for next year, but rather to be managed over time. On cash flow, net cash provided by operating activities was $285 million in the second quarter. In accordance with GAAP, this figure excludes capital expenditures, proceeds of asset sales and certain other items. Adding back the $8 million of cash consumed by discontinued ops and the $21 million in payments against restructuring reserves and then backing out the tax refund of $170 million received in the quarter, our cash provided by continuing operating activities would have been $144 million in the second quarter. Working capital was almost flat in the quarter with a net use of $15 million after backing out the $170 million tax refund received in April. Subtracting the $148 million in capital expenditures I spoke of a few minutes ago, gets you to adjusted free cash flow, a non-GAAP term we use internally to assess cash flow, of a negative $4 million in the second quarter. We provide a reconciliation of adjusted free cash flow to the relevant GAAP terms in our press release. Net of all these items and including $9 million from the sale of a New Orleans hospital and the $36 million purchase of Coastal Carolina at the end of the quarter, cash at June 30, 2007 was $675 million, an increase of $91 million over our cash position at the end of March. The impact of our Coastal Carolina acquisition, which became a part of continuing operations as of July 1, does not materially impact these refinements to our 2007 outlook as, with 41 beds, it is still relatively small, and since it is only 2½ years old, it is still ramping-up to its longer-term potential. Let me now cover some additional insights on our earnings outlook, both for the current year and 2009. As I said earlier, in terms of 2007, the outlook we issued earlier in the year anticipated admission increases of 50 to 150 basis points on a same-hospital basis. However, excluding Trinity and RHD, our admissions were down 1.4 percent in Q1 and 2.2 percent in Q2, for a total decline of 1.8 percent through June 30 relative to 2006. Accordingly, we have a fair amount of ground to make up, just to get back to zero in comparison to 2006. 13
  14. 14. Outpatient visits were down 3.1 percent in Q2 and 2.8 percent year-to-date, also putting incremental distance between our first half results and our earlier outlook for outpatient visits in 2007. Also as mentioned a moment ago, our projected range for the second half of 2007 versus 2006 is admission growth of a zero percent to a positive 1 percent and visit growth of a negative 0.5 percent to a positive 1.6 percent. Since I am always asked for an earnings and cash walk forward from actual results to full year outlook, I will save someone the question and lay it out now. For this purpose, I will walk forward to the upper end of the $675 to $725 million adjusted EBITDA range. What I am giving you in this walk forward is not intended to be spot estimates of all the variables, but is intended to give you the insight into how the walk forward will work even if you choose different values for any of the variables. On EBITDA, I would first adjust the first half results by adding back the $13 million in losses at our two Dallas hospitals, which will be in discontinued ops beginning the third quarter. This adjustment brings us to $358 million as a starting point for the first half of the year. Taking the $358 million as a baseline, I would normalize it by eliminating $13 million for second quarter cost reports and $15 million of normalization adjustments I made in the first quarter call. This would give us normalized first half results of $330 million. Using that as a starting estimate for the second half would give us an annual EBITDA number of $688 million, 358 first half actual plus 330 for the second half. If we assume growth in admission volumes in the second half of 1 percent and visits of 1.6 percent, using constant pricing and mix, this would give us second half revenues lower than the first half by approximately $10 million and would reduce EBITDA by $4 million assuming we hit our 40 percent incremental margin objective. Revenues are lower in the second half due to seasonality, with the third quarter being the low point. For simplicity, I will assume that second half pricing and cost increases, primarily annual merit increases in October, offset. Then we need to consider the effect of our cost and other initiatives, which should have a benefit in excess of $50 million in the second half relative to the first. The initiatives here include the second half expected yield of the $80 million of initiatives I discussed in May at the first quarter conference call. This would take us slightly above the upper end of the range at $725 million of EBITDA, leaving a little room for risk or rounding imbedded in the assumptions. This also assumes that bad debt for the second half of the year is consistent as a percentage of revenue with bad debt in the first half excluding the two Dallas hospitals. The lower end of our outlook range would then be primarily driven by volume variation and, if we have less success on either flexing or cost, achieving yield on our initiatives, in bad debt or some of the other variables. This by no means captures all the risks and opportunities that are out there, but at the halfway point, I think it is reasonable to tighten the range down to this level. I can assure you that we are also continuing to work additional mitigation plans to enhance our year end performance as well. On cash, starting with our ending second quarter cash of approximately $675 million, I would subtract $30 million in income tax payments, the principal amount of our DOJ settlement payment of $24 million and remaining interest payments, net of investment interest, of $200 million. I would then take the middle of the range on CAPEX of $440 million for the second 14
  15. 15. half. I would add $26 million associated with Philadelphia sale proceeds and net proceeds from the transfer of the two Dallas hospitals coming off lease. I would add the middle of the range on EBITDA of $342 million, add back $20 million of non-cash stock compensation expense and the middle of the range on accounts receivable and accounts payable change for the second half of $165 million. The result is approximately $535 million of year end cash. We would put the range of cash at year-end at the range of $450 to $620 million. Correspondingly, we would put the range of cash generated by continuing operations, excluding the tax refund, at $300 to $420 million for the full year. If our current forecasted volume losses relative to our prior expectation in fact do occur, they will absorb much of the risk cushion we had built into our intermediate term outlook and walk forward I showed at Investor Day. Looking out beyond this year, all other things equal, we will need to make up our current year volume shortfalls or have no other net negative pressures in order to achieve the $1.1 billion of EBITDA we previously discussed as the lower end of our outlook for 2009. This is achievable, but risk of its achievement has also increased. As I said in June, looking out 18 to 30 months remains very subjective, particularly with respect to volumes, with a real range of outcomes broader than what one normally conveys in an outlook. Accordingly, my view is that it is paradoxical to update a two to three year view every quarter. For that reason, I have tried to lay out the variables clearly so that everyone can evaluate the volume and non-volume assumptions. There are, of course, other risks and opportunities in both revenues and cost, some of which are expected to be realized, but the general parameters of moving from 2007 to 2009 in terms of managed care pricing and cost management are otherwise still as I laid them out in June at our investor conference. We have always said that achieving that level of earnings was conditional upon volume and we are now two more quarters into the year without aggregate improvement. I will say again that we believe we are doing the right things and will achieve results. It is just a matter of pace and timing, which I also understand is important. If we were to quantify the risk at this point, we would say it is that our recovery could slide by one half to a full year if we do not have a shift in our admissions trends at a level which puts us on a trajectory to make up for what we fell behind our estimates in the first half. That would put our 2009 EBITDA more in a range of $1 to $1.1 billion. This is a statement of risk and not, however, a prediction; it is too subjective. I should also say that 1.1 billion or the 11 to 13 percent EBITDA margin rate we have talked to previously does not represent a ceiling on our results by any means, and that we believe we should be able to get yield from volume growth beyond those numbers over time, on a basis similar to what I laid out at Investor Day given our excess capacity and relatively high level of fixed cost. Q and A With that, I’d like to ask the operator to poll our callers for any questions you may have, operator? [END] 15