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UNITED STATESSECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549
 FORM 10-Q x
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934For the quarterly period ended June 30, 2004ORo
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934For the transition period from toCommission
File Number 333-110117
 Ardent Health Services LLC  Delaware
    
    62-1862223(State or Other Jurisdiction of
    
    (I.R.S. EmployerIncorporation or Organization)
    
    Identification Number)
 One Burton Hills Blvd., Suite 250Nashville, TN
    
    37215(Address of Principal Executive Offices)
    
    (Zip Code)
 Registrants telephone number, including area code: (615) 296-3000 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: None Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes x No o Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes o No x As
of August 12, 2004, there were 69,981,650 of the registrants common
units outstanding (all of which are privately owned and are not traded on any
public market).




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TABLE OF CONTENTS  
 PageNo.PART I. FINANCIAL INFORMATIONItem 1. Financial Statements (Unaudited):Condensed Consolidated Statements of Operations for the Three
Months and Six Months ended June 30, 2004 and 2003
    3Condensed Consolidated Balance Sheets as of June 30, 2004 and
December 31, 2003
    4Condensed Consolidated Statements of Cash Flows for the Six
Months ended June 30, 2004 and 2003
    5Notes to Condensed Consolidated Financial Statements
    7Pro
Forma Condensed Consolidated Financial Statements
    25Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    27Item 4. Controls and Procedures
    50PART II OTHER INFORMATIONItem 2. Changes in Securities, Use of Proceeds and Issuer Purchases of
Equity Securities
    52Item 6. Exhibits and Reports on Form 8-K
    52Signature
    53Exhibit Index
    54Ex-2.1 Asset Purchase Agreement, dated as of May 11, 2004Ex-2.2 Asset Purchase Agreement, dated as of July 20, 2004Ex-10.1 First Amendment to Credit AgreementEx-10.2 Second Amendment to Credit AgreementEx-10.3 Second Amended and Restated Intercompany Promissory NoteEx-10.4 Employment AgreementEx-10.5 Amended and Restated Employment and Consulting AgreementEX-31.1  SECTION 302 CEO CERTIFICATIONEX-31.2  SECTION 302 CFO CERTIFICATIONEX-32.1  SECTION 906 CEO CERTIFICATIONEX-32.2  SECTION 906 CFO CERTIFICATION
  2




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PART I FINANCIAL INFORMATION 
 Item 1. Financial Statements (Unaudited) ARDENT HEALTH SERVICES LLC AND SUBSIDIARIES 
 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
 (Unaudited)
 ( Dollars in thousands)
 Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003Revenues:Net patient service revenue
    
    $
    180,144
    
    
    $
    152,196
    
    
    $
    369,987
    
    
    $
    299,973Premium revenue
    
    
    157,596
    
    
    
    145,575
    
    
    
    312,802
    
    
    
    288,328Other revenue
    
    
    19,473
    
    
    
    20,103
    
    
    
    40,093
    
    
    
    38,957Total net revenues
    
    
    357,213
    
    
    
    317,874
    
    
    
    722,882
    
    
    
    627,258Expenses:Salaries and benefits
    
    
    142,055
    
    
    
    126,657
    
    
    
    288,321
    
    
    
    250,201Professional fees
    
    
    35,890
    
    
    
    32,407
    
    
    
    66,013
    
    
    
    62,068Claims and capitation
    
    
    75,096
    
    
    
    67,640
    
    
    
    146,317
    
    
    
    135,132Supplies
    
    
    41,825
    
    
    
    37,719
    
    
    
    83,812
    
    
    
    74,586Provision for doubtful accounts
    
    
    15,976
    
    
    
    12,290
    
    
    
    33,333
    
    
    
    23,206Interest, net
    
    
    7,042
    
    
    
    4,780
    
    
    
    13,541
    
    
    
    8,459Change in fair value of interest rate swap
agreements
    
    
    2,624
    
    
    
    
    
    
    
    1,389
    
    
    
    Depreciation and amortization
    
    
    11,713
    
    
    
    7,314
    
    
    
    22,529
    
    
    
    14,641Loss (gain) on divestitures
    
    
    
    
    
    
    310
    
    
    
    
    
    
    
    (618
    )Other
    
    
    29,773
    
    
    
    29,545
    
    
    
    62,185
    
    
    
    56,596Total expenses
    
    
    361,994
    
    
    
    318,662
    
    
    
    717,440
    
    
    
    624,271Income (loss) from continuing operations
before income taxes
    
    
    (4,781
    )
    
    
    (788
    )
    
    
    5,442
    
    
    
    2,987Income tax expense (benefit)
    
    
    (1,780
    )
    
    
    (302
    )
    
    
    2,123
    
    
    
    1,199Income (loss) from continuing operations, net
    
    
    (3,001
    )
    
    
    (486
    )
    
    
    3,319
    
    
    
    1,788Discontinued operations:Loss from discontinued operations
    
    
    (144
    )
    
    
    (724
    )
    
    
    (444
    )
    
    
    (835
    )Gain on divestitures of discontinued operations
    
    
    3,622
    
    
    
    250
    
    
    
    3,622
    
    
    
    949Income (loss) from discontinued operations
before income taxes
    
    
    3,478
    
    
    
    (474
    )
    
    
    3,178
    
    
    
    114Income tax expense (benefit)
    
    
    1,441
    
    
    
    (200
    )
    
    
    1,332
    
    
    
    44Income (loss) from discontinued operations, net
    
    
    2,037
    
    
    
    (274
    )
    
    
    1,846
    
    
    
    70Net income (loss)
    
    
    (964
    )
    
    
    (760
    )
    
    
    5,165
    
    
    
    1,858Accrued preferred dividends
    
    
    2,203
    
    
    
    2,017
    
    
    
    4,377
    
    
    
    3,964Net income available for (loss
attributable to) common members
    
    $
    (3,167
    )
    
    $
    (2,777
    )
    
    $
    788
    
    
    $
    (2,106
    )
 See accompanying notes to unaudited condensed consolidated financial statements. 3




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ARDENT HEALTH SERVICES LLC AND SUBSIDIARIES 
 CONDENSED CONSOLIDATED BALANCE SHEETS
 (Unaudited)
 ( Dollars in thousands)
 June 30,
    
    December 31,2004
    
    2003ASSETSCurrent assets:Cash and cash equivalents
    
    $
    122,711
    
    
    $
    89,762Accounts receivable, less allowance for
doubtful accounts of $64,806 at June 30, 2004
and $42,438 at December 31, 2003
    
    
    135,039
    
    
    
    116,515Premiums receivable
    
    
    10,890
    
    
    
    14,733Inventories
    
    
    16,973
    
    
    
    16,759Deferred income taxes
    
    
    30,697
    
    
    
    27,792Prepaid expenses and other current assets
    
    
    37,247
    
    
    
    31,514Assets held for sale
    
    
    
    
    
    
    3,336Income tax receivable
    
    
    2,453
    
    
    
    2,128Total current assets
    
    
    356,010
    
    
    
    302,539Property, plant and equipment, net
    
    
    366,597
    
    
    
    365,321Goodwill
    
    
    75,529
    
    
    
    75,529Other intangible assets
    
    
    45,866
    
    
    
    48,289Deferred income taxes
    
    
    5,654
    
    
    
    5,682Other assets
    
    
    19,015
    
    
    
    20,644Total assets
    
    $
    868,671
    
    
    $
    818,004LIABILITIES AND MEMBERS EQUITYCurrent liabilities:Current installments of long-term debt
    
    $
    2,170
    
    
    $
    2,082Accounts payable
    
    
    54,011
    
    
    
    53,301Medical claims payable
    
    
    44,259
    
    
    
    45,751Accrued salaries and benefits
    
    
    48,493
    
    
    
    44,692Accrued interest
    
    
    9,473
    
    
    
    10,133Unearned premiums
    
    
    3,194
    
    
    
    15,399Other accrued expenses and liabilities
    
    
    22,445
    
    
    
    25,771Total current liabilities
    
    
    184,045
    
    
    
    197,129Long-term debt, less current installments
    
    
    258,439
    
    
    
    259,361Other long-term liabilities
    
    
    6,541
    
    
    
    6,573Self-insured liabilities
    
    
    32,018
    
    
    
    21,920Total liabilities
    
    
    481,043
    
    
    
    484,983Redeemable preferred units and accrued
dividends, $3.43 unit price, $3.43 per unit
redemption value; authorized, issued, and
outstanding: 28,141,807 units
    
    
    116,308
    
    
    
    111,931Members equity:Authorized:
80,532,766 units at June 30, 2004
and 69,961,407 units at December 31, 2003;
issued and outstanding: 68,107,299 units at
June 30, 2004 and 56,998,444 units at December
31, 2003
    
    
    273,773
    
    
    
    224,331Accumulated deficit
    
    
    (2,453
    )
    
    
    (3,241
    )Total members equity
    
    
    271,320
    
    
    
    221,090Total liabilities and members equity
    
    $
    868,671
    
    
    $
    818,004
 See accompanying notes to unaudited condensed consolidated financial statements. 4




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ARDENT HEALTH SERVICES LLC AND SUBSIDIARIES 
 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
 ( Unaudited )
 (Dollars in thousands)
 Six Months EndedJune 30,2004
    
    2003Cash flows from operating activities:Income from continuing operations, net
    
    $
    3,319
    
    
    $
    1,788Adjustments to reconcile income from continuing operations, net, to
net cash provided by (used in) operating activities, net of
acquisitions and divestitures:Provision for doubtful accounts
    
    
    33,333
    
    
    
    23,206Change in fair value of interest rate swap agreements
    
    
    1,389
    
    
    
    Depreciation and amortization
    
    
    22,529
    
    
    
    14,641Gain on divestitures
    
    
    
    
    
    
    (618
    )Amortization of deferred financing costs
    
    
    1,019
    
    
    
    2,378Deferred income taxes
    
    
    (3,753
    )
    
    
    (6,110
    )Changes in operating assets and liabilities:Accounts receivable
    
    
    (52,121
    )
    
    
    (22,936
    )Other current assets
    
    
    (1,669
    )
    
    
    777Income tax receivable (payable)
    
    
    (325
    )
    
    
    6,003Accounts payable and accrued expenses
    
    
    (13,004
    )
    
    
    (12,971
    )Self-insured liabilities
    
    
    10,633
    
    
    
    4,147Medical claims payable
    
    
    (1,492
    )
    
    
    5,241Net cash provided by (used in) operating activities
    
    
    (142
    )
    
    
    15,546Net cash provided by (used in) discontinued operations
    
    
    (1,253
    )
    
    
    211Cash flows from investing activities:Investments
in acquisitions, less cash acquired
    
    
    
    
    
    
    (194,117
    )Purchases of
property, plant and equipment, net
    
    
    (20,288
    )
    
    
    (27,431
    )Proceeds from divestitures
    
    
    5,972
    
    
    
    6,311Other
    
    
    505
    
    
    
    2,584Net cash used in investing activities
    
    
    (13,811
    )
    
    
    (212,653
    )Cash flows from financing activities:Change in revolving line of credit
    
    
    
    
    
    
    (11,443
    )Proceeds from long-term debt
    
    
    
    
    
    
    148,500Payments on long-term debt
    
    
    (1,047
    )
    
    
    (29,804
    )Debt financing costs paid
    
    
    (784
    )
    
    
    (4,587
    )Proceeds from issuance of common and preferred units
    
    
    49,986
    
    
    
    11,487Common unit issuance costs
    
    
    
    
    
    
    (1,982
    )Net cash provided by financing activities
    
    
    48,155
    
    
    
    112,171Net increase (decrease) in cash and cash equivalents
    
    
    32,949
    
    
    
    (84,725
    )Cash and cash equivalents, beginning of period
    
    
    89,762
    
    
    
    113,859Cash and cash equivalents, end of period
    
    $
    122,711
    
    
    $
    29,134
 See accompanying notes to
unaudited condensed consolidated financial statements. 5




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ARDENT HEALTH SERVICES LLC AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)(Dollars in thousands) Six Months EndedJune 30,2004
    
    2003Supplemental cash flow information:Interest payments
    
    $
    13,639
    
    
    $
    3,635Income tax payments, net of refunds
    
    
    6,658
    
    
    
    734Non-cash common units issued
    
    
    
    
    
    
    4,639Preferred unit dividends accrued
    
    
    4,377
    
    
    
    3,964
 See accompanying notes to unaudited condensed consolidated financial statements. 6




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ARDENT HEALTH SERVICES LLC AND SUBSIDIARIES 
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 (Unaudited)
 June 30, 2004
 1. Basis of Presentation and Organization Ardent Health Services LLC is a holding company whose affiliates own and
operate hospitals and related health care entities. The term affiliates
includes direct and indirect subsidiaries of Ardent Health Services LLC and
partnerships and joint ventures in which such subsidiaries are partners. At
June 30, 2004, these affiliates owned and operated seven acute care hospitals
(including one inpatient rehabilitation hospital), 20 behavioral hospitals,
and other related health care businesses. The fully integrated health care
delivery system in Albuquerque, New Mexico (the Lovelace Sandia Health
System) comprises five of the seven acute care hospitals and includes an
approximately 164,000 member health plan (the Lovelace Health Plan or the
Health Plan), approximately 335 employed physicians, 15 primary care clinics
and a full service reference laboratory. The terms Ardent or the Company,
as used in this Quarterly Report on Form 10-Q, refer to Ardent Health Services
LLC and its affiliates unless stated otherwise or indicated by context. The unaudited condensed consolidated financial statements have been
prepared in conformity with U.S. generally accepted accounting principles for interim financial reporting and in accordance with Rule
10-01 of Regulation S-X. Accordingly, they do not include all of the
information and notes required by U.S. generally accepted accounting principles for complete financial statements. In the opinion of management, the unaudited condensed consolidated
financial statements reflect all material adjustments (consisting of normal
recurring items) necessary for a fair presentation of the financial position
and the results of operations for the periods presented. The results of
operations for the periods presented are not necessarily indicative of the
expected results for the year ending December 31, 2004. The interim unaudited
condensed consolidated financial statements should be read in connection with
the audited consolidated financial statements as of and for the year ended
December 31, 2003, included in the Companys Annual Report on Form 10-K filed
with the Securities and Exchange Commission. The
preparation of financial statements in conformity with U.S. generally accepted accounting
principles requires management to make
estimates and assumptions that affect the amounts reported in the accompanying
unaudited condensed consolidated financial statements and notes. Actual
results could differ from those estimates. Certain prior year amounts have been reclassified to conform to the
current year presentation. Additionally, certain prior year amounts have been
reclassified due to accounting for discontinued operations in
accordance with Statement of Financial Accounting Standards (SFAS) No. 144,
Accounting for the Impairment and Disposal of Long-Lived
Assets. Refer to Note 3 for further discussion. As none of the Companys common units are publicly held, no earnings per
share information is presented in the accompanying unaudited condensed
consolidated financial statements. The majority of the Companys expenses are
cost of revenue items. 2. Recently Issued Accounting Standards In May 2003, the Financial Accounting Standards Board (the FASB) issued
SFAS No. 150, Accounting for Certain Financial Instruments with
Characteristics of both Liabilities and Equity(SFAS No. 150). SFAS No.
150 requires issuers to classify as liabilities, or assets in some
circumstances, three classes of freestanding financial instruments that embody
obligations of the issuer. Generally, SFAS No. 150 was effective for financial
instruments entered into or modified after May 31, 2003 and was otherwise
effective for interim periods beginning after June 15, 2003. For mandatorily
redeemable financial instruments, as defined by SFAS No. 150, the statement is
effective for fiscal periods beginning after December 15, 2003. Prior to being
amended, the Companys mandatorily redeemable preferred units would have been
reflected as a liability effective January 1, 2004. However, in January 2004, the 7




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holders of the Companys common units and mandatorily redeemable preferred
units voted to delete the mandatory redemption feature of the preferred units.
Therefore, the application of SFAS No. 150 did not have a material effect on
the Companys financial position or results of operations. In December 2003, the FASB issued Interpretation No. 46 (revised December
2003), Consolidation of Variable Interest Entities(FIN46R). FIN46R replaces
Interpretation No. 46, Consolidation of Variable Interest Entities, an
interpretation of ARB No. 51, which was issued in January 2003. FIN46R
addresses the consolidation by business enterprises of variable interest
entities as defined within FIN46R. The Company must immediately apply the
provisions of FIN46R to variable interests in variable interest entities
created after December 31, 2003. The Company must apply the provisions of
FIN46R to all other variable interests in variable interest entities by
January 1, 2005. The application of FIN46R did not have and is not expected to
have a material effect on the Companys financial position or results of
operations. 3.
Acquisitions, Divestitures and Joint Venture Acquisitions Acquisitions are accounted for using the purchase method of accounting as
prescribed by SFAS No. 141, Business Combinations,and the results of
operations are included in the accompanying unaudited condensed consolidated
statements of operations from the respective dates of acquisition. Effective January 1, 2003, the Company acquired Lovelace Health Systems,
Inc. (Lovelace) in Albuquerque, New Mexico from CIGNA Health Plan (Cigna).
The aggregate purchase price of $209.4 million plus acquisition costs was paid
in cash and was financed with debt issued in 2003 and equity issued in 2002.
In conjunction with the acquisition, certain post-closing items have resulted
in a dispute with Cigna related to a net worth settlement provision. The
dispute, when resolved, could result in a change to the purchase price. The
Company expects the dispute to be resolved during 2004. Effective October 8, 2003, the Company acquired the 146-bed Northwestern
Institute of Psychiatry (renamed Brooke Glen), a private behavioral health
services facility in Fort Washington, Pennsylvania, for $7.7 million,
plus acquisition costs. The purchase price was paid in cash and funded from
the proceeds of $225.0 million senior subordinated notes issued in August
2003. Subsequent
to June 30, 2004, the Company completed certain previously announced acquisitions. Refer to Note 9 for further discussion. Divestitures Effective April 1, 2004, the Company sold a behavioral hospital for
consideration of approximately $6.1 million, which resulted in a pretax gain
of $3.6 million recorded during the three months ended June 30, 2004. The
hospitals results of operations, including gain on divestiture, and net
assets are included in income from discontinued operations and assets held for
sale, respectively, for the periods presented in the accompanying unaudited
condensed consolidated financial statements in accordance with SFAS No. 144. For the six months ended June 30, 2003, the Company recorded pretax gains
of $949,000, which included pretax gains of $250,000 recorded during the three
months ended June 30, 2003, from the sale of one behavioral hospital and
recoveries of fully reserved items related to a behavioral hospital sold in
2002. The hospitals were identified as held for sale under SFAS No. 144, under
which the results of operations and related gains on divestitures are included
in income from discontinued operations in the accompanying unaudited condensed
consolidated statements of operations. For the six months ended June 30, 2003, the Company also recorded pretax
gains of $618,000, which included a pretax loss of $310,000 recorded during
the three months ended June 30, 2003, from the sales of two behavioral
hospitals. The hospitals were previously identified as held for sale under
SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed Of(SFAS
No. 121), under which the net gains
are recorded in the accompanying unaudited condensed consolidated statements
of operations as gains on divestitures and the historical results of
operations and financial position are not reclassified as discontinued
operations. Joint
Venture On June 9, 2004 the Company entered into a letter of intent with Ochsner
Clinic Foundation to partner in the ownership of Summit Hospital in Baton
Rouge, Louisiana. The Company has solely owned Summit Hospital since July
2001, and accordingly consolidates the accounts and results of operations of
the hospital. Subject to closing conditions, the transaction is expected to be
completed by the fall of 2004, at which time management expects to account for
the Companys noncontrolling interest in Summit Hospital as an equity-method
investment. 8




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Pro Forma Results of Operations The pro forma effect of the Companys acquisitions and divestitures on
the Companys results of operations for the periods prior to the respective
transaction dates was not significant for the periods presented.
Refer to the unaudited Pro Forma Condensed Consolidated Financial
Statements included elsewhere in this Form 10-Q for further
discussion. 4. Long-Term Debt and Financing Arrangements Long-term debt includes the following (in thousands): June 30,
    
    December 31,2004
    
    2003Senior subordinated notes (interest at 10.0%)
    
    $
    225,000
    
    
    $
    225,000Subordinated debt (interest at 10.2%), net
of unamortized discount of $3.8 million and
$4.0 million at June 30, 2004 and December
31, 2003, respectively
    
    
    32,209
    
    
    
    31,996Bank facilities (interest on revolving line
of credit at LIBOR plus 3.75%)
    
    
    
    
    
    
    Notes payable
    
    
    2,316
    
    
    
    3,157Other
    
    
    1,084
    
    
    
    1,290Total long-term debt
    
    
    260,609
    
    
    
    261,443Less current installments
    
    
    (2,170
    )
    
    
    (2,082
    )Long-term debt, less current installments
    
    $
    258,439
    
    
    $
    259,361
 Subsequent to
June 30, 2004, the Company borrowed an additional
$300.0 million of senior secured term debt
in connection with the acquisition of Hillcrest
HealthCare System and increased its senior secured revolving line of
credit to
$150.0 million. Refer to Note 9 for further discussion. Interest Rate Swap Agreements In September 2003, the Company entered into four interest rate swap
agreements with financial institutions to convert a notional amount of $80.0
million of the $225.0 million fixed-rate borrowings under the 10.0% senior
subordinated notes into floating-rate borrowings. The swap agreements mature
in $40.0 million increments on August 15, 2006 and August 15, 2008. The
floating interest rate is based on six month LIBOR plus a margin and is
determined for the six months ended in arrears on semi-annual settlement dates
of February 15 and August 15. As the interest rate swap agreements do not qualify for hedge accounting
under the provisions of SFAS No. 133, Accounting for Derivative Instruments
and Hedging Activities,changes in the fair value of the Companys interest
rate hedging arrangements are recognized each period in earnings. The fair
value of the swap obligations was a liability of $831,000 at June 30, 2004 and is included in other accrued expenses and
liabilities in the accompanying unaudited condensed consolidated balance sheet. On
August 5, 2004, the Company terminated its interest rate swap agreements,
resulting in a payment of $267,000, which was the fair market value of the
related liability. 5. Stock-Based Compensation 9




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The Company, from time to time, grants options for a fixed number of
common units to employees. SFAS No. 123, Accounting for Stock-Based
Compensation(SFAS No. 123),encourages, but does not require, companies to
record compensation cost for stock-based employee compensation plans at fair
value. The Company has chosen to continue to account for employee
unit-based compensation using the intrinsic value method as prescribed
in Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and related
interpretations. If the Company had determined compensation cost based on the fair value
at the grant date for its unit options under SFAS No. 123, the Companys net
income (loss) would have been changed to the pro forma amounts indicated below
(in thousands):


Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003Net income (loss), as reported
    
    $
    (964
    )
    
    $
    (760
    )
    
    $
    5,165
    
    
    $
    1,858Less total unit-based
employee compensation expense
determined under fair-value
based method for all awards,
net of tax
    
    
    (345
    )
    
    
    (313
    )
    
    
    (696
    )
    
    
    (541
    )Pro forma net income (loss)
    
    $
    (1,309
    )
    
    $
    (1,073
    )
    
    $
    4,469
    
    
    $
    1,317
 The effect of applying SFAS No. 123 for providing pro forma disclosure is
not likely to be representative of the effect on reported net income for
future years. The weighted average fair values of the Companys options granted during
the three months ended June 30, 2004 and 2003 were $1.63 and $1.36,
respectively. The weighted average fair values of the Companys options granted
during the six months ended June 30, 2004 and 2003 were $1.57 and $1.37,
respectively. The fair value of each option grant is estimated on the date of
grant using a minimum value option pricing model. The weighted average
assumptions used for grants are as follows: Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003Risk-free investment interest rate
    
    
    4.6
    %
    
    
    3.6
    %
    
    
    4.3
    %
    
    
    3.7
    %Expected life in years
    
    
    10
    
    
    
    10
    
    
    
    10
    
    
    
    10Expected dividend yield
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
 10




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##### Table of Contents



6. Segment Information The Companys acute care hospitals and related health care businesses are
similar in their activities and the economic environments in which they
operate (i.e., urban and suburban markets). Accordingly, the Companys
reportable operating segments consist of (1) acute care hospitals and related
health care businesses, (2) the Lovelace Health Plan and (3) behavioral
hospitals. The Other segment column below consists of centralized services
including information services, reimbursement, accounting, taxation,
legal, internal audit and risk management as well as the Companys wholly-owned
insurance subsidiary. Total
net revenue within the consolidated acute care services
segment prior to January 1, 2004 excludes patient service revenue for services provided to the
Lovelace Health Plan members. During 2003, the Health Plan did not qualify as
a separate operating segment in accordance with the criteria set forth by SFAS
No. 131, Disclosures about Segments of an Enterprise and Related Information.
However, beginning on January 1, 2004, the Company managed the Health Plan as
a separate operating segment and the acute care services segment excluded the
operations of the Health Plan and included patient service revenue related to
services rendered at the Companys acute care hospitals to its Health Plan
members. The Companys management believes this allows them to better manage
the businesses within the Company and make better financial and operational
decisions. As a result of this change in the Companys management of these
operations, the Health Plan business is a separate reportable segment in 2004.
However, due to system limitations, it is impractical to restate the Companys
segment information for the three months and six months ended June 30, 2003 to
correspond with this change in reportable segments. For purposes of
comparability, the Companys segment information for the three months and six
months ended June 30, 2004 includes the consolidated acute care services
segment consistent with the basis of segmentation in effect prior to January
1, 2004. Adjusted EBITDA represents income from continuing operations, net, before
interest, change in fair value of interest rate swap agreements, depreciation
and amortization and income tax expense. Adjusted EBITDA for the Companys
segment information is presented because the Companys management uses it as a
measure of segment performance and as a useful indicator with which to
allocate resources among segments. Additionally, the Companys management
believes it is a useful measure of its liquidity. Adjusted EBITDA for the
Company on a consolidated basis, subject to certain adjustments, is also used
as a measure in certain of the covenants in the Companys senior secured
credit facility and the indenture governing its subsidiarys 10.0% Senior Subordinated Notes due
2013. Adjusted EBITDA should not be considered in isolation from, and is not
intended as an alternative measure of, net income or cash flow from
operations, each as determined in accordance with accounting principles
generally accepted in the United States. Adjusted EBITDA is not necessarily
comparable to similarly titled measures used by other companies. 11




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##### Table of Contents



The following is a financial summary by business segment for the periods
indicated (in thousands): For the Three Months Ended June 30, 2004ConsolidatedAcute
    
    Lovelace
    
    
    
    
    
    Acute
    
    BehavioralCare
    
    Health
    
    
    
    
    
    Care
    
    CareServices
    
    Plan
    
    Eliminations
    
    Services
    
    Services
    
    Other
    
    Eliminations
    
    TotalTotal net revenues
    
    $
    183,792
    
    
    $
    161,152
    
    
    $
    (60,741
    )
    
    $
    284,203
    
    
    $
    74,042
    
    
    $
    
    
    
    $
    (1,032
    )
    
    $
    357,213Adjusted EBITDA
    
    
    7,756
    
    
    
    7,485
    
    
    
    
    
    
    
    15,241
    
    
    
    11,984
    
    
    
    (10,627
    )
    
    
    
    
    
    
    16,598Segment assets
    
    
    448,125
    
    
    
    87,919
    
    
    
    
    
    
    
    536,044
    
    
    
    142,309
    
    
    
    190,318
    
    
    
    
    
    
    
    868,671Goodwill
    
    
    64,169
    
    
    
    
    
    
    
    
    
    
    
    64,169
    
    
    
    11,360
    
    
    
    
    
    
    
    
    
    
    
    75,529Other identifiable intangible assets
    
    
    
    
    
    
    45,866
    
    
    
    
    
    
    
    45,866
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    45,866Capital expenditures
    
    
    4,932
    
    
    
    1,902
    
    
    
    
    
    
    
    6,834
    
    
    
    2,369
    
    
    
    1,766
    
    
    
    
    
    
    
    10,969For the Three Months Ended June 30, 2003Consolidated
    
    BehavioralAcute Care
    
    CareServices
    
    Services
    
    Other
    
    Eliminations
    
    TotalTotal net revenues
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    249,666
    
    
    $
    68,809
    
    
    $
    
    
    
    $
    (601
    )
    
    $
    317,874Adjusted EBITDA
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    8,332
    
    
    
    13,008
    
    
    
    (10,034
    )
    
    
    
    
    
    
    11,306Segment assets
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    478,779
    
    
    
    127,176
    
    
    
    72,742
    
    
    
    
    
    
    
    678,697Goodwill
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    62,990
    
    
    
    11,360
    
    
    
    
    
    
    
    
    
    
    
    74,350Other identifiable intangible assets
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    48,350
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    48,350Capital expenditures
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    14,257
    
    
    
    1,851
    
    
    
    3,467
    
    
    
    
    
    
    
    19,575For the Six Months Ended June 30, 2004ConsolidatedAcute
    
    Lovelace
    
    
    
    
    
    Acute
    
    BehavioralCare
    
    Health
    
    
    
    
    
    Care
    
    CareServices
    
    Plan
    
    Eliminations
    
    Services
    
    Services
    
    Other
    
    Eliminations
    
    TotalTotal net revenues
    
    $
    380,393
    
    
    $
    319,730
    
    
    $
    (122,860
    )
    
    $
    577,263
    
    
    $
    147,969
    
    
    $
    
    
    
    $
    (2,350
    )
    
    $
    722,882Adjusted EBITDA
    
    
    25,669
    
    
    
    14,370
    
    
    
    
    
    
    
    40,039
    
    
    
    23,566
    
    
    
    (20,704
    )
    
    
    
    
    
    
    42,901Capital expenditures
    
    
    6,684
    
    
    
    3,614
    
    
    
    
    
    
    
    10,298
    
    
    
    4,897
    
    
    
    5,093
    
    
    
    
    
    
    
    20,288For the Six Months Ended June 30, 2003Consolidated
    
    BehavioralAcute Care
    
    CareServices
    
    Services
    
    Other
    
    Eliminations
    
    TotalTotal net revenues
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    493,328
    
    
    $
    135,484
    
    
    $
    
    
    
    $
    (1,554
    )
    
    $
    627,258Adjusted EBITDA
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    17,613
    
    
    
    26,147
    
    
    
    (17,673
    )
    
    
    
    
    
    
    26,087Capital expenditures
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    20,793
    
    
    
    2,905
    
    
    
    3,733
    
    
    
    
    
    
    
    27,431
 12




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##### Table of Contents



The following is a reconciliation of Adjusted EBITDA to cash flows from
operating activities (in thousands): Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003Net cash provided by (used in) operating
activities
    
    $
    24,153
    
    
    $
    6,173
    
    
    $
    (142
    )
    
    $
    15,546Changes in working capital items and other
    
    
    (29,191
    )
    
    
    (6,385
    )
    
    
    1,615
    
    
    
    (13,828
    )Income (loss) from discontinued operations,
net
    
    
    2,037
    
    
    
    (274
    )
    
    
    1,846
    
    
    
    70Income (loss) from continuing operations, net
    
    
    (3,001
    )
    
    
    (486
    )
    
    
    3,319
    
    
    
    1,788Interest, net
    
    
    7,042
    
    
    
    4,780
    
    
    
    13,541
    
    
    
    8,459Change in fair value of interest rate swap
agreements
    
    
    2,624
    
    
    
    
    
    
    
    1,389
    
    
    
    Depreciation and amortization
    
    
    11,713
    
    
    
    7,314
    
    
    
    22,529
    
    
    
    14,641Income tax expense (benefit)
    
    
    (1,780
    )
    
    
    (302
    )
    
    
    2,123
    
    
    
    1,199Adjusted EBITDA
    
    $
    16,598
    
    
    $
    11,306
    
    
    $
    42,901
    
    
    $
    26,087
 7. Members Equity The Company entered into a subscription agreement with Welsh, Carson,
Anderson and Stowe IX, L.P. (WCAS) and FFC Partners II, L.P. (Ferrer
Freeman) on December 11, 2002, pursuant to which WCAS and Ferrer Freeman have
the right, under certain circumstances, in WCASs discretion, to purchase up
to an aggregate of $165.0 million of the Companys common units at a purchase
price of $4.50 per common unit. The subscription agreement was amended in
February 2003 to add BancAmerica Capital Investors I, L.P. (BAC) as a
purchaser of up to an additional $10.0 million of common units at the same
purchase price per common unit. Pursuant to the subscription agreement, as
amended, WCAS, Ferrer Freeman and BAC had invested a total of $116.7 million
at December 31, 2003, and had the right, under certain circumstances, at
WCASs discretion, to invest up to an additional $58.3 million. In a series of transactions beginning on June 30, 2004, WCAS, Ferrer
Freeman and BAC exercised the right to invest an additional $58.3 million,
pursuant to the subscription agreement. On June 30, 2004, the Company issued
11,111,109 common member units to WCAS and related investors for $50.0
million, or $4.50 per common unit. Such transaction is reflected in the
Companys financial position at June 30, 2004. On July 2, 2004, the Company
issued 1,851,851 common member units to Ferrer Freeman and BAC for $8.3
million, or $4.50 per common unit. Such transaction was recorded subsequent to
June 30, 2004 and is not reflected in the Companys financial position at June
30, 2004. The Company used the majority of the proceeds to fund, in part, the
acquisition of Hillcrest HealthCare System. Refer to Note 9 for further
discussion of the acquisition. 8. Commitments and Contingencies Capital Expenditure Commitments In
connection with the acquisitions in the Albuquerque market, the
Company has committed to the previous owners to invest $80.0 million in
capital expenditures in the Albuquerque market through 2008. The Company had
invested $58.9 million through June 30, 2004. In connection
with the acquisition of Hillcrest HealthCare System, the Company
committed to invest approximately $100.0 million in capital
expenditures in the Tulsa market over the next five years. Net Revenue The Medicare and Medicaid regulations and various managed care contracts
under which the discounts from the Companys standard charges must be
calculated are complex and are subject to interpretation and adjustment. The
Company estimates the allowance for contractual discounts on a payor-specific
basis given its interpretation of the applicable regulations or contract
terms. However, the services authorized and provided and resulting
reimbursements are often subject to interpretation. These interpretations
sometimes result in payments that differ 13




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##### Table of Contents



from the Companys
estimates. Additionally, updated regulations and contract renegotiations
occur frequently necessitating continual review and assessment of the
estimation process by management. The
Company has recently received notice from a state Medicaid program
that certain amounts paid by the program to
one of the Companys behavioral hospitals in prior years were
paid in error and that the Company owes the amounts back to the
program. The Company believes that it has fully complied with both
the applicable laws and previous agreements established with the
program during previous years and that final resolution of these disputed amounts
will not have a material adverse effect on the Companys
business, results of operations or financial position. The final determination of amounts earned under Medicare and Medicaid
programs often does not occur until fiscal years subsequent to submission of
claims due to audits by the administering agency, rights of appeal and the
application of numerous technical provisions. Differences between original
estimates and subsequent revisions, including final settlements, are included
in the results of operations of the period in which the revisions are made.
Adjustments to estimated settlements resulted in increases to net patient
service revenue of $1.7 million and $668,000 for the three months ended June
30, 2004 and 2003, respectively, and $2.1 million and $1.1 million for the six
months ended June 30, 2004 and 2003, respectively. Litigation and Regulatory Matters From time to time, claims and suits arise in the ordinary course of the
Companys business. In certain of these actions, plaintiffs request punitive
or other damages against the Company that may not be covered by insurance. The
Company does not believe that it is a party to any proceeding that, in
managements opinion, would have a material adverse effect on the Companys
business, financial condition or results of operations. Acquisitions The Company has acquired and plans to continue to acquire businesses with
prior operating histories. Acquired companies may have unknown or contingent
liabilities, including liabilities for failure to comply with health care laws
and regulations, such as billing and reimbursement, fraud and abuse and
anti-kickback laws. The Company has from time to time identified certain past
practices of acquired companies that do not conform to its standards. Although
the Company institutes policies designed to conform such practices to its
standards following completion of acquisitions, there can be no assurance that
the Company will not become liable for the past activities of these acquired
facilities that may later be asserted to be improper by private plaintiffs or
government agencies. Although the Company generally seeks to obtain
indemnification from prospective sellers covering such matters, there can be
no assurance that any such matter will be covered by indemnification, or if
covered, that such indemnification will be adequate to cover potential losses
and fines. 9. Subsequent Events Acquisitions Effective August 1, 2004, the Company completed its previously announced
transaction with Molina Healthcare, Inc. to transfer approximately
30,000 commercial members of Cimarron Health Plan
(Cimarron) to the Lovelace Health Plan,
which is part of Lovelace Sandia Health System, Inc., for
approximately $16.0
million, plus additional contingent consideration of up to $3.5 million
subject to the satisfaction of certain conditions. The Company funded the
transaction with available cash on hand. On
August 12, 2004, the Company completed its previously announced
acquisition of Hillcrest HealthCare System (Hillcrest) in Tulsa, Oklahoma.
The Company acquired substantially all of the net
operating assets of Hillcrest for $326.3 million, including
preliminary working capital, subject to customary adjustments. The acquisition consisted primarily
of two metropolitan Tulsa hospitals and related health care entities, as well
as six regional hospitals acquired or intended to be acquired through
long-term operating agreements. In connection with the Hillcrest acquisition, the Company committed to
invest approximately $100.0 million in capital expenditures in the Tulsa
market over the next five years. The aggregate purchase price of the acquisition was paid in
cash and financed, in part, with the $58.3 million of proceeds invested by
WCAS, Ferrer Freeman, BAC and related investors pursuant to the aforementioned subscription
agreement with the Company and cash on hand. The remaining purchase price was
financed through an additional
borrowing of senior secured term debt on August 12, 2004 in
the principal amount of $300.0 million, as further discussed below. The Company is currently in the process of
allocating the respective purchase prices of the Cimarron and
Hillcrest acquisitions to the fair market value of assets acquired and
liabilities assumed, subject to working capital adjustments, valuation of
fixed assets, and identification and valuation of identifiable intangible
assets. 14




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##### Table of Contents



In connection with the Companys recent acquisitions, the Companys management
began evaluating its information systems in the acute care segment, primarily
related to patient accounting and clinical information systems, to
determine the feasibility of moving to a single operating platform across its acute care
hospitals. Management has evaluated the
carrying amounts of the related information system assets for recoverability
and does not believe any indicators of impairment exist. However, should
events, changes in circumstances or other indicators of potential impairment
exist in the future, the Company may be required to record impairment charges
on long-lived assets, which could have a material adverse effect on its results of
operations and financial condition. Long-term
Debt On August 12, 2004, the Company amended its August 2003 Credit Agreement to, among other things, increase
its $125.0 million revolving line of credit to a $150.0 million revolving line
of credit and add $300.0 million of additional borrowing available under an
add-on term loan (Term Loan B). The Company also retained the $200.0 million
of incremental term loans available, under certain conditions, under the
existing August 2003 Credit Agreement. Concurrent with the amendment, the Company
received $300.0 million through borrowings of the amount available under Term
Loan B. Interest on Term Loan B is payable quarterly at an interest rate of
either LIBOR plus 2.25% or a base rate plus 1.25%. Principal payments of 0.25% of the original principal
borrowed on Term Loan B are to be paid quarterly, with the remaining principal
to be paid at maturity. Term Loan B matures August 12, 2011. The revolving
line of credit bears interest initially at LIBOR plus 2.50%. The interest on
the revolving line of credit is payable on the outstanding principal balance
on the last day of the selected interest period. The principal amount of the
revolving line of credit is to be paid in full on August 19, 2008. The
Company has not incurred borrowings under the revolving line of credit or
incremental term loans as of August 16, 2004; other than standby
letters of credit totaling $10.4 million that reduce the amount
available under the revolving line of credit. The Company continues to pay a commitment fee ranging from 0.50% to 0.75%
of the average daily amount of availability under the revolving credit
facility and other fees based on the applicable LIBOR margin on outstanding
standby letters of credit. The August 2003 Credit Agreement, as
amended, contains various
financial covenants including requirements for the Company to maintain a
minimum interest coverage ratio, a total leverage ratio, a senior leverage
ratio, a minimum net worth of the health maintenance organization affiliates
and a capital expenditures maximum. The August 2003 Credit
Agreement, as amended, also
restricts certain activities of the Company, including its ability to incur
additional debt, declare dividends, repurchase stock, engage in mergers or
acquisitions and sell assets. The August 2003 Credit Agreement,
as amended, is guaranteed
by the Company and its material and future affiliates, other than Lovelace
Sandia Health System, Inc. and the Companys captive insurance affiliate, and
is secured by substantially all of the Companys existing and future property
and assets and capital stock of all of the Companys affiliates. In connection with the merger of the Companys New Mexico affiliates on
October 1, 2003, Lovelace Sandia Health System, Inc. (the surviving entity)
issued a $70.0 million intercompany note to Ardent Health Services, Inc. The
Company was required to maintain a pledge of the intercompany note in favor of
the lenders of the Companys August 2003 Credit Agreement and the holders of
the Companys $225.0 million senior subordinated notes. On July 12, 2004, the
August 2003 Credit Agreement was amended to, among other things, reduce the
pledge required to be maintained by the Company to $43.0 million, upon which
the intercompany note was also amended to reduce the principal amount of the
note to $43.0 million. Divestitures Effective July 31, 2004, the Company sold its Lovelace Home Health
operations for $200,000 in cash, subject to certain adjustments, which is expected to
result in a minimal gain. The entity was identified as held
for sale during the three months ended June 30, 2004. Accordingly, the
entitys results of operations are included in income (loss) from discontinued
operations for all periods presented in the accompanying unaudited condensed
consolidated statements of operations. 15




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##### Table of Contents



10. Financial Information for the Company and Its Subsidiaries The Companys $225.0 million senior subordinated notes are fully and
unconditionally guaranteed on a joint and several basis by all of the
Companys material subsidiaries except for entities comprising Lovelace Sandia
Health System, Inc. and RIVID Insurance Company Ltd., the Companys
wholly-owned captive insurance subsidiary. The Company conducts substantially all of its business through its
subsidiaries. Presented below are condensed consolidating balance sheets as of
June 30, 2004 and December 31, 2003, condensed consolidating statements of
operations for the three months and six months ended June 30, 2004 and June
30, 2003 and condensed consolidating statements of cash flows for the six
months ended June 30, 2004 and June 30, 2003 for the Company and its
subsidiaries. The information segregates the parent company (Ardent Health
Services LLC), the issuer of the senior subordinated notes (Ardent Health
Services, Inc.), the combined Subsidiary Guarantors, the combined
Non-Guarantors (the entities comprising Lovelace Sandia Health System, Inc.
and RIVID Insurance Company Ltd.), and eliminations. The issuer and each of
the Subsidiary Guarantors and Non-Guarantors are 100% owned, directly or
indirectly, by Ardent Health Services LLC. 16




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##### Table of Contents



ARDENT HEALTH SERVICES LLC AND SUBSIDIARIES
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
Three Months Ended June 30, 2004
(Dollars in thousands) Subsidiary
    
    Non-
    
    
    
    
    
    CondensedParent
    
    Issuer
    
    Guarantors
    
    Guarantors
    
    Eliminations
    
    ConsolidatedRevenues:Net patient service revenue
    
    $
    
    
    
    $
    
    
    
    $
    92,907
    
    
    $
    87,237
    
    
    $
    
    
    
    $
    180,144Premium revenue
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    157,586
    
    
    
    10
    
    
    
    157,596Other revenue
    
    
    (964
    )
    
    
    7,096
    
    
    
    17,342
    
    
    
    11,004
    
    
    
    (15,005
    )
    
    
    19,473Total net revenues
    
    
    (964
    )
    
    
    7,096
    
    
    
    110,249
    
    
    
    255,827
    
    
    
    (14,995
    )
    
    
    357,213Expenses:Salaries and benefits
    
    
    
    
    
    
    
    
    
    
    65,991
    
    
    
    76,090
    
    
    
    (26
    )
    
    
    142,055Professional fees
    
    
    
    
    
    
    
    
    
    
    11,832
    
    
    
    30,501
    
    
    
    (6,443
    )
    
    
    35,890Claims and capitation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    75,818
    
    
    
    (722
    )
    
    
    75,096Supplies
    
    
    
    
    
    
    
    
    
    
    12,436
    
    
    
    29,389
    
    
    
    
    
    
    
    41,825Provision for doubtful accounts
    
    
    
    
    
    
    
    
    
    
    6,009
    
    
    
    9,967
    
    
    
    
    
    
    
    15,976Interest, net
    
    
    
    
    
    
    5,436
    
    
    
    216
    
    
    
    1,390
    
    
    
    
    
    
    
    7,042Change in fair value of interest rate swap
agreements
    
    
    
    
    
    
    2,624
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,624Depreciation and amortization
    
    
    
    
    
    
    
    
    
    
    5,441
    
    
    
    6,272
    
    
    
    
    
    
    
    11,713Other
    
    
    
    
    
    
    
    
    
    
    5,324
    
    
    
    24,921
    
    
    
    (472
    )
    
    
    29,773Total expenses
    
    
    
    
    
    
    8,060
    
    
    
    107,249
    
    
    
    254,348
    
    
    
    (7,663
    )
    
    
    361,994Income (loss) from continuing operations
before income taxes
    
    
    (964
    )
    
    
    (964
    )
    
    
    3,000
    
    
    
    1,479
    
    
    
    (7,332
    )
    
    
    (4,781
    )Income
tax expense (benefit)
    
    
    
    
    
    
    
    
    
    
    (1,780
    )
    
    
    
    
    
    
    
    
    
    
    (1,780
    )Income (loss) from continuing operations, net
    
    
    (964
    )
    
    
    (964
    )
    
    
    4,780
    
    
    
    1,479
    
    
    
    (7,332
    )
    
    
    (3,001
    )Discontinued operations:Income (loss) from discontinued operations
    
    
    
    
    
    
    
    
    
    
    3,894
    
    
    
    (416
    )
    
    
    
    
    
    
    3,478Income tax
expense (benefit)
    
    
    
    
    
    
    
    
    
    
    1,572
    
    
    
    (131
    )
    
    
    
    
    
    
    1,441Income
(loss) from discontinued operations, net
    
    
    
    
    
    
    
    
    
    
    2,322
    
    
    
    (285
    )
    
    
    
    
    
    
    2,037Net income (loss)
    
    
    (964
    )
    
    
    (964
    )
    
    
    7,102
    
    
    
    1,194
    
    
    
    (7,332
    )
    
    
    (964
    )Accrued preferred dividends
    
    
    2,203
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,203Net income
available for (loss attributable
to) common members
    
    $
    (3,167
    )
    
    $
    (964
    )
    
    $
    7,102
    
    
    $
    1,194
    
    
    $
    (7,332
    )
    
    $
    (3,167
    )
 17




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##### Table of Contents



ARDENT HEALTH SERVICES LLC AND SUBSIDIARIES
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
Six Months Ended June 30, 2004(Dollars in thousands) Subsidiary
    
    Non-
    
    
    
    
    
    CondensedParent
    
    Issuer
    
    Guarantors
    
    Guarantors
    
    Eliminations
    
    ConsolidatedRevenues:Net patient service revenue
    
    $
    
    
    
    $
    
    
    
    $
    185,053
    
    
    $
    184,934
    
    
    $
    
    
    
    $
    369,987Premium revenue
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    312,802
    
    
    
    
    
    
    
    312,802Other revenue
    
    
    5,165
    
    
    
    17,134
    
    
    
    39,377
    
    
    
    24,419
    
    
    
    (46,002
    )
    
    
    40,093Total net revenues
    
    
    5,165
    
    
    
    17,134
    
    
    
    224,430
    
    
    
    522,155
    
    
    
    (46,002
    )
    
    
    722,882Expenses:Salaries and benefits
    
    
    
    
    
    
    
    
    
    
    130,226
    
    
    
    158,144
    
    
    
    (49
    )
    
    
    288,321Professional fees
    
    
    
    
    
    
    
    
    
    
    22,893
    
    
    
    56,540
    
    
    
    (13,420
    )
    
    
    66,013Claims and capitation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    148,011
    
    
    
    (1,694
    )
    
    
    146,317Supplies
    
    
    
    
    
    
    
    
    
    
    24,362
    
    
    
    59,450
    
    
    
    
    
    
    
    83,812Provision for doubtful accounts
    
    
    
    
    
    
    
    
    
    
    11,615
    
    
    
    21,718
    
    
    
    
    
    
    
    33,333Interest, net
    
    
    
    
    
    
    10,580
    
    
    
    214
    
    
    
    2,747
    
    
    
    
    
    
    
    13,541Change in fair value of interest rate swap agreements
    
    
    
    
    
    
    1,389
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,389Depreciation and amortization
    
    
    
    
    
    
    
    
    
    
    10,093
    
    
    
    12,436
    
    
    
    
    
    
    
    22,529Other
    
    
    
    
    
    
    
    
    
    
    8,191
    
    
    
    54,940
    
    
    
    (946
    )
    
    
    62,185Total expenses
    
    
    
    
    
    
    11,969
    
    
    
    207,594
    
    
    
    513,986
    
    
    
    (16,109
    )
    
    
    717,440Income
(loss) from continuing operations before
income taxes
    
    
    5,165
    
    
    
    5,165
    
    
    
    16,836
    
    
    
    8,169
    
    
    
    (29,893
    )
    
    
    5,442Income tax expense
    
    
    
    
    
    
    
    
    
    
    2,123
    
    
    
    
    
    
    
    
    
    
    
    2,123Income
(loss) from continuing operations, net
    
    
    5,165
    
    
    
    5,165
    
    
    
    14,713
    
    
    
    8,169
    
    
    
    (29,893
    )
    
    
    3,319Discontinued operations:Income (loss) from discontinued operations
    
    
    
    
    
    
    
    
    
    
    4,088
    
    
    
    (910
    )
    
    
    
    
    
    
    3,178Income tax
expense (benefit)
    
    
    
    
    
    
    
    
    
    
    1,650
    
    
    
    (318
    )
    
    
    
    
    
    
    1,332Income (loss) from discontinued operations, net
    
    
    
    
    
    
    
    
    
    
    2,438
    
    
    
    (592
    )
    
    
    
    
    
    
    1,846Net income (loss)
    
    
    5,165
    
    
    
    5,165
    
    
    
    17,151
    
    
    
    7,577
    
    
    
    (29,893
    )
    
    
    5,165Accrued preferred dividends
    
    
    4,377
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4,377Net income
available for common members
    
    $
    788
    
    
    $
    5,165
    
    
    $
    17,151
    
    
    $
    7,577
    
    
    $
    (29,893
    )
    
    $
    788
 18




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##### Table of Contents



ARDENT HEALTH SERVICES LLC AND SUBSIDIARIES
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
Three Months Ended June 30, 2003(Dollars in thousands) Subsidiary
    
    Non-
    
    
    
    
    
    CondensedParent
    
    Issuer
    
    Guarantors
    
    Guarantors
    
    Eliminations
    
    ConsolidatedRevenues:Net patient service revenue
    
    $
    
    
    
    $
    
    
    
    $
    83,897
    
    
    $
    68,299
    
    
    $
    
    
    
    $
    152,196Premium revenue
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    145,575
    
    
    
    
    
    
    
    145,575Other revenue
    
    
    (760
    )
    
    
    3,725
    
    
    
    5,432
    
    
    
    9,566
    
    
    
    2,140
    
    
    
    20,103Total net revenues
    
    
    (760
    )
    
    
    3,725
    
    
    
    89,329
    
    
    
    223,440
    
    
    
    2,140
    
    
    
    317,874Expenses:Salaries and benefits
    
    
    
    
    
    
    
    
    
    
    54,057
    
    
    
    72,600
    
    
    
    
    
    
    
    126,657Professional fees
    
    
    
    
    
    
    
    
    
    
    13,103
    
    
    
    21,391
    
    
    

(2,087
    )
    
    
    32,407Claims and capitation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    67,640
    
    
    
    
    
    
    
    67,640Supplies
    
    
    
    
    
    
    
    
    
    
    10,173
    
    
    
    27,546
    
    
    
    
    
    
    
    37,719Provision for doubtful accounts
    
    
    
    
    
    
    
    
    
    
    4,428
    
    
    
    7,862
    
    
    
    
    
    
    
    12,290Interest, net
    
    
    
    
    
    
    4,485
    
    
    
    (152
    )
    
    
    447
    
    
    
    
    
    
    
    4,780Depreciation and amortization
    
    
    
    
    
    
    
    
    
    
    2,396
    
    
    
    4,918
    
    
    
    
    
    
    
    7,314Loss on divestitures
    
    
    
    
    
    
    
    
    
    
    310
    
    
    
    
    
    
    
    
    
    
    
    310Other
    
    
    
    
    
    
    
    
    
    
    1,791
    
    
    
    27,806
    
    
    
    (52
    )
    
    
    29,545Total expenses
    
    
    
    
    
    
    4,485
    
    
    
    86,106
    
    
    
    230,210
    
    
    
    (2,139
    )
    
    
    318,662Income (loss) from continuing operations
before income taxes
    
    
    (760
    )
    
    
    (760
    )
    
    
    3,223
    
    
    
    (6,770
    )
    
    
    4,279
    
    
    
    (788
    )Income tax
expense (benefit)
    
    
    
    
    
    
    
    
    
    
    (302
    )
    
    
    
    
    
    
    
    
    
    
    (302
    )Income (loss) from continuing operations, net
    
    
    (760
    )
    
    
    (760
    )
    
    
    3,525
    
    
    
    (6,770
    )
    
    
    4,279
    
    
    
    (486
    )Discontinued operations:Income
from discontinued operations
    
    
    
    
    
    
    
    
    
    
    291
    
    
    
    (765
    )
    
    
    
    
    
    
    (474
    )Income tax
expense (benefit)
    
    
    
    
    
    
    
    
    
    
    91
    
    
    
    (291
    )
    
    
    
    
    
    
    (200
    )Income
(loss) from discontinued operations, net
    
    
    
    
    
    
    
    
    
    
    200
    
    
    
    (474
    )
    
    
    
    
    
    
    (274
    )Net income (loss)
    
    
    (760
    )
    
    
    (760
    )
    
    
    3,725
    
    
    
    (7,244
    )
    
    
    4,279
    
    
    
    (760
    )Accrued preferred dividends
    
    
    2,017
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,017Net income
available for (loss attributable
to) common members
    
    $
    (2,777
    )
    
    $
    (760
    )
    
    $
    3,725
    
    
    $
    (7,244
    )
    
    $
    4,279
    
    
    $
    (2,777
    )
 19




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##### Table of Contents



ARDENT HEALTH SERVICES LLC AND SUBSIDIARIES
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
Six Months Ended June 30, 2003
(Dollars in thousands) Subsidiary
    
    Non-
    
    
    
    
    
    CondensedParent
    
    Issuer
    
    Guarantors
    
    Guarantors
    
    Eliminations
    
    ConsolidatedRevenues:Net patient service revenue
    
    $
    
    
    
    $
    
    
    
    $
    165,705
    
    
    $
    134,268
    
    
    $
    
    
    
    $
    299,973Premium revenue
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    288,328
    
    
    
    
    
    
    
    288,328Other revenue
    
    
    1,858
    
    
    
    9,513
    
    
    
    16,489
    
    
    
    18,400
    
    
    
    (7,303
    )
    
    
    38,957Total net revenues
    
    
    1,858
    
    
    
    9,513
    
    
    
    182,194
    
    
    
    440,996
    
    
    
    (7,303
    )
    
    
    627,258Expenses:Salaries and benefits
    
    
    
    
    
    
    
    
    
    
    106,481
    
    
    
    143,720
    
    
    
    
    
    
    
    250,201Professional fees
    
    
    
    
    
    
    
    
    
    
    24,772
    
    
    
    41,612
    
    
    
    (4,316
    )
    
    
    62,068Claims and capitation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    135,132
    
    
    
    
    
    
    
    135,132Supplies
    
    
    
    
    
    
    
    
    
    
    20,012
    
    
    
    54,574
    
    
    
    
    
    
    
    74,586Provision for doubtful accounts
    
    
    
    
    
    
    
    
    
    
    8,829
    
    
    
    14,377
    
    
    
    
    
    
    
    23,206Interest, net
    
    
    
    
    
    
    7,655
    
    
    
    968
    
    
    
    (164
    )
    
    
    
    
    
    
    8,459Depreciation and amortization
    
    
    
    
    
    
    
    
    
    
    4,703
    
    
    
    9,938
    
    
    
    
    
    
    
    14,641Loss (gain) on divestitures
    
    
    
    
    
    
    
    
    
    
    (618
    )
    
    
    
    
    
    
    
    
    
    
    (618
    )Other
    
    
    
    
    
    
    
    
    
    
    7,150
    
    
    
    49,551
    
    
    
    (105
    )
    
    
    56,596Total expenses
    
    
    
    
    
    
    7,655
    
    
    
    172,297
    
    
    
    448,740
    
    
    
    (4,421
    )
    
    
    624,271Income (loss) from continuing operations
before income taxes
    
    
    1,858
    
    
    
    1,858
    
    
    
    9,897
    
    
    
    (7,744
    )
    
    
    (2,882
    )
    
    
    2,987Income tax expense
    
    
    
    
    
    
    
    
    
    
    1,199
    
    
    
    
    
    
    
    
    
    
    
    1,199Income (loss) from continuing operations, net
    
    
    1,858
    
    
    
    1,858
    
    
    
    8,698
    
    
    
    (7,744
    )
    
    
    (2,882
    )
    
    
    1,788Discontinued operations:Income
(loss) from discontinued operations
    
    
    
    
    
    
    
    
    
    
    1,316
    
    
    
    (1,202
    )
    
    
    
    
    
    
    114Income tax
expense (benefit)
    
    
    
    
    
    
    
    
    
    
    501
    
    
    
    (457
    )
    
    
    
    
    
    
    44Income
(loss) from discontinued operations, net
    
    
    
    
    
    
    
    
    
    
    815
    
    
    
    (745
    )
    
    
    
    
    
    
    70Net income (loss)
    
    
    1,858
    
    
    
    1,858
    
    
    
    9,513
    
    
    
    (8,489
    )
    
    
    (2,882
    )
    
    
    1,858Accrued preferred dividends
    
    
    3,964
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,964Net income
available for (loss attributable
to) common members
    
    $
    (2,106
    )
    
    $
    1,858
    
    
    $
    9,513
    
    
    $
    (8,489
    )
    
    $
    (2,882
    )
    
    $
    (2,106
    )
 20




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##### Table of Contents



ARDENT HEALTH SERVICES LLC AND SUBSIDIARIES CONDENSED CONSOLIDATING BALANCE SHEET
 June 30, 2004
(Dollars in thousands)
 Subsidiary
    
    Non-
    
    
    
    
    
    CondensedParent
    
    Issuer
    
    Guarantors
    
    Guarantors
    
    Eliminations
    
    ConsolidatedASSETSCurrent assets:Cash and cash equivalents
    
    $
    
    
    
    $
    
    
    
    $
    94,918
    
    
    $
    27,793
    
    
    $
    
    
    
    $
    122,711Accounts
receivable, net
    
    
    
    
    
    
    
    
    
    
    63,491
    
    
    
    71,548
    
    
    
    
    
    
    
    135,039Premiums receivable
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    10,890
    
    
    
    
    
    
    
    10,890Inventories
    
    
    
    
    
    
    
    
    
    
    6,723
    
    
    
    10,250
    
    
    
    
    
    
    
    16,973Deferred income taxes
    
    
    
    
    
    
    
    
    
    
    26,122
    
    
    
    4,575
    
    
    
    
    
    
    
    30,697Prepaid expenses and other current assets
    
    
    
    
    
    
    
    
    
    
    17,185
    
    
    
    20,062
    
    
    
    
    
    
    
    37,247Assets held for sale
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Income tax
receivable
    
    
    
    
    
    
    
    
    
    
    2,453
    
    
    
    
    
    
    
    
    
    
    
    2,453Total current assets
    
    
    
    
    
    
    
    
    
    
    210,892
    
    
    
    145,118
    
    
    
    
    
    
    
    356,010Property, plant and equipment, net
    
    
    
    
    
    
    
    
    
    
    156,479
    
    
    
    210,118
    
    
    
    
    
    
    
    366,597Goodwill
    
    
    
    
    
    
    
    
    
    
    13,073
    
    
    
    62,456
    
    
    
    
    
    
    
    75,529Other intangible assets
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    45,866
    
    
    
    
    
    
    
    45,866Deferred income taxes
    
    
    
    
    
    
    
    
    
    
    5,654
    
    
    
    
    
    
    
    
    
    
    
    5,654Other assets
    
    
    387,628
    
    
    
    655,040
    
    
    
    271,783
    
    
    
    3,660
    
    
    
    (1,299,096
    )
    
    
    19,015Total assets
    
    $
    387,628
    
    
    $
    655,040
    
    
    $
    657,881
    
    
    $
    467,218
    
    
    $
    (1,299,096
    )
    
    $
    868,671LIABILITIES AND MEMBERS AND STOCKHOLDERS EQUITYCurrent liabilities:Current installments of long-term debt
    
    $
    
    
    
    $
    
    
    
    $
    2,013
    
    
    $
    157
    
    
    $
    
    
    
    $
    2,170Accounts payable
    
    
    
    
    
    
    
    
    
    
    25,124
    
    
    
    28,887
    
    
    
    
    
    
    
    54,011Medical claims payable
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    44,259
    
    
    
    
    
    
    
    44,259Accrued salaries and benefits
    
    
    
    
    
    
    
    
    
    
    24,379
    
    
    
    24,114
    
    
    
    
    
    
    
    48,493Accrued interest
    
    
    
    
    
    
    9,455
    
    
    
    18
    
    
    
    
    
    
    
    
    
    
    
    9,473Unearned premiums
    
    
    
    
    
    
    
    
    
    
    (106
    )
    
    
    3,300
    
    
    
    
    
    
    
    3,194Other accrued expenses and liabilities
    
    
    
    
    
    
    831
    
    
    
    11,337
    
    
    
    10,277
    
    
    
    
    
    
    
    22,445Total current liabilities
    
    
    
    
    
    
    10,286
    
    
    
    62,765
    
    
    
    110,994
    
    
    
    
    
    
    
    184,045Long-term debt, less current installments
    
    
    
    
    
    
    257,209
    
    
    
    853
    
    
    
    377
    
    
    
    
    
    
    
    258,439Other long-term liabilities
    
    
    
    
    
    
    
    
    
    
    6,541
    
    
    
    
    
    
    
    
    
    
    
    6,541Self-insured liabilities
    
    
    
    
    
    
    
    
    
    
    27,699
    
    
    
    4,319
    
    
    
    
    
    
    
    32,018Note payable to Parent
    
    
    
    
    
    
    
    
    
    
    (72,353
    )
    
    
    72,353
    
    
    
    
    
    
    
    Due to (from) Parent
    
    
    
    
    
    
    
    
    
    
    (9,088
    )
    
    
    9,088
    
    
    
    
    
    
    
    Total liabilities
    
    
    
    
    
    
    267,495
    
    
    
    16,417
    
    
    
    197,131
    
    
    
    
    
    
    
    481,043Redeemable preferred units and accrued
dividends
    
    
    116,308
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    116,308Members and stockholders equity:Capital stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    150
    
    
    
    (150
    )
    
    
    Common units
    
    
    273,773
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    273,773Additional paid in capital
    
    
    
    
    
    
    370,320
    
    
    
    594,405
    
    
    
    262,254
    
    
    
    (1,226,979
    )
    
    
    Retained
earnings (accumulated
deficit)
    
    
    (2,453
    )
    
    
    17,225
    
    
    
    47,059
    
    
    
    7,683
    
    
    
    (71,967
    )
    
    
    (2,453
    )Total members and stockholders equity
    
    
    271,320
    
    
    
    387,545
    
    
    
    641,464
    
    
    
    270,087
    
    
    
    (1,299,096
    )
    
    
    271,320Total liabilities and members equity
    
    $
    387,628
    
    
    $
    655,040
    
    
    $
    657,881
    
    
    $
    467,218
    
    
    $
    (1,299,096
    )
    
    $
    868,671
 21




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##### Table of Contents



ARDENT HEALTH SERVICES LLC AND SUBSIDIARIES CONDENSED CONSOLIDATING BALANCE SHEET
 December 31,
2003
(Dollars in thousands)
 Subsidiary
    
    Non-
    
    
    
    
    
    CondensedParent
    

Issuer
    
    Guarantors
    
    Guarantors
    
    Eliminations
    
    ConsolidatedASSETSCurrent assets:Cash and cash equivalents
    
    $
    
    
    
    $
    
    
    
    $
    49,919
    
    
    $
    39,843
    
    
    $
    
    
    
    $
    89,762Accounts receivable, net
    
    
    
    
    
    
    
    
    
    
    59,743
    
    
    
    56,772
    
    
    
    
    
    
    
    116,515Premiums receivable
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    14,733
    
    
    
    
    
    
    
    14,733Inventories
    
    
    
    
    
    
    
    
    
    
    6,523
    
    
    
    10,236
    
    
    
    
    
    
    
    16,759Deferred income taxes
    
    
    
    
    
    
    
    
    
    
    23,217
    
    
    
    4,575
    
    
    
    
    
    
    
    27,792Prepaid expenses and other current assets
    
    
    
    
    
    
    
    
    
    
    16,966
    
    
    
    14,548
    
    
    
    
    
    
    
    31,514Assets held for sale
    
    
    
    
    
    
    
    
    
    
    3,336
    
    
    
    
    
    
    
    
    
    
    
    3,336Income tax receivable
    
    
    
    
    
    
    
    
    
    
    2,128
    
    
    
    
    
    
    
    
    
    
    
    2,128Total current assets
    
    
    
    
    
    
    
    
    
    
    161,832
    
    
    
    140,707
    
    
    
    
    
    
    
    302,539Property, plant and equipment, net
    
    
    
    
    
    
    
    
    
    
    154,095
    
    
    
    211,226
    
    
    
    
    
    
    
    365,321Goodwill
    
    
    
    
    
    
    
    
    
    
    13,072
    
    
    
    62,457
    
    
    
    
    
    
    
    75,529Other intangible assets
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    48,289
    
    
    
    
    
    
    
    48,289Deferred income taxes
    
    
    
    
    
    
    
    
    
    
    5,682
    
    
    
    
    
    
    
    
    
    
    
    5,682Other assets
    
    
    333,021
    
    
    
    528,109
    
    
    
    261,617
    
    
    
    6,174
    
    
    
    (1,108,277
    )
    
    
    20,644Total assets
    
    $
    333,021
    
    
    $
    528,109
    
    
    $
    596,298
    
    
    $
    468,853
    
    
    $
    (1,108,277
    )
    
    $
    818,004LIABILITIES AND MEMBERS AND STOCKHOLDERS EQUITYCurrent liabilities:Current installments of long-term debt
    
    $
    
    
    
    $
    
    
    
    $
    1,931
    
    
    $
    151
    
    
    $
    
    
    
    $
    2,082Accounts payable
    
    
    
    
    
    
    
    
    
    
    26,175
    
    
    
    27,126
    
    
    
    
    
    
    
    53,301Medical claims payable
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    45,751
    
    
    
    
    
    
    
    45,751Accrued salaries and benefits
    
    
    
    
    
    
    
    
    
    
    23,429
    
    
    
    21,263
    
    
    
    
    
    
    
    44,692Accrued interest
    
    
    
    
    
    
    10,133
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    10,133Unearned premiums
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    15,399
    
    
    
    
    
    
    
    15,399Other accrued expenses and liabilities
    
    
    
    
    
    
    
    
    
    
    9,423
    
    
    
    16,348
    
    
    
    
    
    
    
    25,771Total current liabilities
    
    
    
    
    
    
    10,133
    
    
    
    60,958
    
    
    
    126,038
    
    
    
    
    
    
    
    197,129Long-term debt, less current installments
    
    
    
    
    
    
    256,996
    
    
    
    1,908
    
    
    
    457
    
    
    
    
    
    
    
    259,361Other long-term liabilities
    
    
    
    
    
    
    
    
    
    
    6,573
    
    
    
    
    
    
    
    
    
    
    
    6,573Self-insured liabilities
    
    
    
    
    
    
    
    
    
    
    10,255
    
    
    
    11,665
    
    
    
    
    
    
    
    21,920Note payable to Parent
    
    
    
    
    
    
    (71,412
    )
    
    
    
    
    
    
    71,412
    
    
    
    
    
    
    
    Due to (from) Parent
    
    
    
    
    
    
    
    
    
    
    3,228
    
    
    
    (3,228
    )
    
    
    
    
    
    
    Total liabilities
    
    
    
    
    
    
    195,717
    
    
    
    82,922
    
    
    
    206,344
    
    
    
    
    
    
    
    484,983Redeemable preferred units and accrued dividends
    
    
    111,931
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    111,931Members and stockholders equity:Capital stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    150
    
    
    
    (150
    )
    
    
    Common units
    
    
    224,331
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    224,331Additional paid in capital
    
    
    
    
    
    
    320,332
    
    
    
    484,587
    
    
    
    262,254
    
    
    
    (1,067,173
    )
    
    
    Retained
earnings (accumulated
deficit)
    
    
    (3,241
    )
    
    
    12,060
    
    
    
    28,789
    
    
    
    105
    
    
    
    (40,954
    )
    
    
    (3,241
    )Total members and stockholders equity
    
    
    221,090
    
    
    
    332,392
    
    
    
    513,376
    
    
    
    262,509
    
    
    
    (1,108,277
    )
    
    
    221,090Total liabilities and members equity
    
    $
    333,021
    
    
    $
    528,109
    
    
    $
    596,298
    
    
    $
    468,853
    
    
    $
    (1,108,277
    )
    
    $
    818,004
 22




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##### Table of Contents



ARDENT HEALTH SERVICES LLC AND SUBSIDIARIES
CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS
Six Months Ended June 30, 2004(Dollars in thousands) Subsidiary
    
    Non-
    
    
    
    
    
    CondensedParent
    
    Issuer
    
    Guarantors
    
    Guarantors
    
    Eliminations
    
    ConsolidatedNet cash
provided by (used in) operating activities
    
    $
    
    
    
    $
    (9,561
    )
    
    $
    27,402
    
    
    $
    (17,983
    )
    
    $
    
    
    
    $
    (142
    )Net cash provided by (used in) discontinued operations
    
    
    
    
    
    
    
    
    
    
    (1,253
    )
    
    
    
    
    
    
    
    
    
    
    (1,253
    )Cash flows from investing activities:Purchases of
property, plant and equipment, net
    
    
    
    
    
    
    
    
    
    
    (11,712
    )
    
    
    (8,576
    )
    
    
    
    
    
    
    (20,288
    )Proceeds from divestitures
    
    
    
    
    
    
    
    
    
    
    5,972
    
    
    
    
    
    
    
    
    
    
    
    5,972Other
    
    
    
    
    
    
    
    
    
    
    (2,010
    )
    
    
    2,515
    
    
    
    
    
    
    
    505Net cash provided by (used in) investing activities
    
    
    
    
    
    
    
    
    
    
    (7,750
    )
    
    
    (6,061
    )
    
    
    
    
    
    
    (13,811
    )Cash flows from financing activities:Payments on long-term debt
    
    
    
    
    
    
    
    
    
    
    (973
    )
    
    
    (74
    )
    
    
    
    
    
    
    (1,047
    )Debt financing costs paid
    
    
    
    
    
    
    (784
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (784
    )Intercompany advances, net
    
    
    
    
    
    
    
    
    
    
    (11,126
    )
    
    
    11,126
    
    
    
    
    
    
    
    Contributions from Parent
    
    
    (49,986
    )
    
    
    10,345
    
    
    
    39,641
    
    
    
    
    
    
    
    
    
    
    
    Note payable to Issuer
    
    
    
    
    
    
    
    
    
    
    (942
    )
    
    
    942
    
    
    
    
    
    
    
    Proceeds
from the issuance of common units
    
    
    49,986
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    49,986Net cash provided by (used in) financing
activities
    
    
    
    
    
    
    9,561
    
    
    
    26,600
    
    
    
    11,994
    
    
    
    
    
    
    
    48,155Net increase (decrease) in cash and cash equivalents
    
    
    
    
    
    
    
    
    
    
    44,999
    
    
    
    (12,050
    )
    
    
    
    
    
    
    32,949Cash and cash equivalents, beginning of period
    
    
    
    
    
    
    
    
    
    
    49,919
    
    
    
    39,843
    
    
    
    
    
    
    
    89,762Cash and cash equivalents, end of period
    
    $
    
    
    
    $
    
    
    
    $
    94,918
    
    
    $
    27,793
    
    
    $
    
    
    
    $
    122,711Supplemental cash flow information:Cash paid for interest
    
    $
    
    
    
    $
    10,239
    
    
    $
    653
    
    
    $
    2,747
    
    
    $
    
    
    
    $
    13,639Cash paid for income taxes
    
    
    
    
    
    
    
    
    
    
    6,658
    
    
    
    
    
    
    
    
    
    
    
    6,658Preferred unit dividends accrued
    
    
    4,377
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4,377
 23




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##### Table of Contents



ARDENT HEALTH SERVICES LLC AND SUBSIDIARIES
CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS
Six Months Ended June 30, 2003(Dollars in thousands) Subsidiary
    
    Non-
    
    
    
    
    
    CondensedParent
    
    Issuer
    
    Guarantors
    
    Guarantors
    
    Eliminations
    
    ConsolidatedNet cash
(used in) provided by operating activities
    
    $
    
    
    
    $
    (5,277)
    
    
    $
    14,176
    
    
    $
    6,647
    
    
    $
    
    
    
    $
    15,546Net
cash provided by discontinued operations
    
    
    
    
    
    
    
    
    
    
    211
    
    
    
    
    
    
    
    
    
    
    
    211Cash flow
from investing activities:Investments
in acquisitions, less cash acquired
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (194,117
    )
    
    
    
    
    
    
    (194,117
    )Purchases
of property, plant and equipment, net
    
    
    
    
    
    
    
    
    
    
    (11,779
    )
    
    
    (15,652
    )
    
    
    
    
    
    
    (27,431
    )Transfer
of assets
    
    
    
    
    
    
    
    
    
    
    6,570
    
    
    
    (6,570
    )
    
    
    
    
    
    
    Proceeds
from divestitures
    
    
    
    
    
    
    
    
    
    
    6,311
    
    
    
    
    
    
    
    
    
    
    
    6,311Other
    
    
    
    
    
    
    
    
    
    
    2,414
    
    
    
    170
    
    
    
    
    
    
    
    2,584Net
cash provided by (used in) investing activities
    
    
    
    
    
    
    
    
    
    
    3,516
    
    
    
    (216,169
    )
    
    
    
    
    
    
    (212,653
    )Cash flows
from financing activities:Proceeds
from (payments on) revolving line of credit, net
    
    
    
    
    
    
    
    
    
    
    (11,443
    )
    
    
    
    
    
    
    
    
    
    
    (11,443
    )Proceeds
from long-term debt
    
    
    
    
    
    
    148,500
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    148,500Payments
on long-term debt
    
    
    
    
    
    
    
    
    
    
    (29,772
    )
    
    
    (32
    )
    
    
    
    
    
    
    (29,804
    )Debt
financing costs paid
    
    
    
    
    
    
    (4,587
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (4,587
    )Intercompany
advances, net
    
    
    
    
    
    
    
    
    
    
    (62,380
    )
    
    
    62,380
    
    
    
    
    
    
    
    Contributions
from (distributions to) Parent
    
    
    (9,505
    )
    
    
    (138,636
    )
    
    
    (11,394
    )
    
    
    159,535
    
    
    
    
    
    
    
    Proceeds
from the issuance of common units
    
    
    11,487
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    11,487Preferred
and common unit issuance costs
    
    
    (1,982
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,982
    )Net
cash provided by (used in) financing activities
    
    
    
    
    
    
    5,277
    
    
    
    (114,989
    )
    
    
    221,883
    
    
    
    
    
    
    
    112,171Net
increase (decrease) in cash and cash equivalents
    
    
    
    
    
    
    
    
    
    
    (97,086
    )
    
    
    12,361
    
    
    
    
    
    
    
    (84,725
    )Cash
and cash equivalents, beginning of period
    
    
    
    
    
    
    
    
    
    
    102,853
    
    
    
    11,006
    
    
    
    
    
    
    
    113,859Cash and cash
equivalents, end of period
    
    $

    
    
    
    $

    
    
    
    $
    5,767
    
    
    $

    23,367
    
    
    $

    
    
    
    $

    29,134Supplemental
cash flow information:Cash
paid for interest
    
    $

    
    
    
    $

    2,074
    
    
    $
    1,561
    
    
    $

    
    
    
    $

    
    
    
    $

    3,635Cash
paid for income taxes
    
    
    
    
    
    
    
    
    
    
    734
    
    
    
    
    
    
    
    
    
    
    
    734Noncash
common units issued
    
    
    4,639
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4,639Preferred
unit dividends accrued
    
    
    3,964
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,964
 24




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##### Table of Contents



ARDENT HEALTH SERVICES LLC AND SUBSIDIARIES 
 PRO FORMA CONDENSED
CONSOLIDATED FINANCIAL STATEMENTS
 (Unaudited)
 Introduction Effective July 31, 2004,
the Company sold its Lovelace Home Health operations and certain
related assets in Albuquerque, New Mexico to Heritage Home Healthcare
in an arms length transaction for $200,000 in cash. Effective April 1,
2004, the Company sold the operations and certain assets of Northern
Indiana Hospital, a behavioral hospital in Plymouth, Indiana. The
following balance sheet narrative as of June 30, 2004 gives
effect to the Lovelace Home Health business disposition as if the
transaction had been completed as of June 30, 2004. The
following results of operations narrative for the six months ended
June 30, 2004 and unaudited condensed consolidated statements of
operations for the year ended December 31, 2003 give effect to
the business dispositions by the Company as if the transactions had
been completed on January 1, 2003. The following narratives and
unaudited pro forma condensed consolidated statements of operations
presented herein do not intend to represent what the Companys
financial position or results of operations would have been had such
transactions occurred at the beginning of the periods presented or to
project the Companys results of operations in any future
period. The following pro forma information should be read in
conjunction with the Companys audited consolidated financial
statements included in its Annual Report on Form 10-K for the year
ended December 31, 2003 and its unaudited condensed
consolidated financial statements included elsewhere in this Form 10-Q. Balance Sheet as
of June 30, 2004 The unaudited
condensed consolidated balance sheet as of June 30,
2004 included elsewhere in this Form 10-Q already gives effect to the disposition of Northern Indiana
Hospital and includes $33,000 of net property, plant and equipment
that was included in the sale of its Lovelace Home Health operations. Pro Forma Results of Operations for
the Six Months Ended June 30, 2004 The accompanying unaudited
pro forma condensed consolidated statement of operations for the six months
ended June 30, 2004 reflects the results of operations of the
Lovelace Home Health and Northern Indiana Hospital as discontinued
operations. For the six months ended June 30, 2004, income (loss) from
discontinued operations includes the following (dollars in thousands): TotalLovelace
    
    Northern
    
    DiscontinuedHome Health
    
    Indiana
    
    OperationsTotal net
revenues
    
    $
    1,937
    
    
    $
    2,742
    
    
    $
    4,679Total expenses
    
    
    2,846
    
    
    
    2,277
    
    
    
    5,123Income (loss)
from discontinued operations
    
    
    (909
    )
    
    
    465
    
    
    
    (444
    )Gain on
divestitures of discontinued operations
    
    
    
    
    
    
    3,622
    
    
    
    3,622Income (loss)
from discontinued operations before income taxes
    
    
    (909
    )
    
    
    4,087
    
    
    
    3,178Income tax
expense (benefit)
    
    
    (318
    )
    
    
    1,650
    
    
    
    1,332Income (loss)
from discontinued operations, net
    
    $
    (591
    )
    
    $
    2,437
    
    
    $
    1,846
 25




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##### Table of Contents



ARDENT HEALTH SERVICES LLC AND
SUBSIDIARIESPRO FORMA CONDENSED CONSOLIDATED STATEMENT OF
OPERATIONS

Year Ended December 31, 2003
(Unaudited)(Dollars in thousands)


|          |                                                                  |                    |   |         |             |  |   |          |        |   |             |        |        |           |   |      |      |  |   |         |           | 
|--------- | ---------------------------------------------------------------- | ------------------ | - | ------- | ----------- |  | - | -------- | ------ | - | ----------- | ------ | ------ | --------- | - | ---- | ---- |  | - | ------- | --------- | 
|          |                                                                  | Historical         |   |         | Lovelace    |  |   | Northern |        |   | Pro Forma   |        |        | Pro Forma |  
|          |                                                                  | Ardent             |   |         | Home Health |  |   | Indiana  |        |   | Adjustments |        |        | Ardent    |  
|          |                                                                  |                    |   |         |             |  |   |          |        |   |             |        |        |           |  
|Revenues: |                                                                  |                    |   |         |             |  |   |          |        |   |             |        |        |           |   |      |      |  |   |        
|          | Net patient service revenue                                      |                    | $ | 640,920 |             |  | $ | (4,648   | )      |   | $           | (9,039 | )      |           | $ |     |      |  | $ | 627,233 |          
|          | Premium revenue                                                  |                    |   | 592,293 |             |  |   |         |        |   |             |       |        |           |   |     |      |  |   | 592,293 |          
|          | Other revenue                                                    |                    |   | 86,461  |             |  |   | (23      | )      |   |             | (159   | )      |           |   |     |      |  |   | 86,279  |          
|          |                                                                  |                    |   |         |             |  |   |          |        |   |             |        |        |           |  
|          |                                                                  | Total net revenues |   |         | 1,319,674   |  |   |          | (4,671 | ) |             |        | (9,198 | )         |   |      |     |  |   |         | 1,305,805 | 
|Expenses: |                                                                  |                    |   |         |             |  |   |          |        |   |             |        |        |           |   |      |      |  |   |        
|          | Salaries and benefits                                            |                    |   | 531,893 |             |  |   | (5,550   | )      |   |             | (5,120 | )      |           |   |     |      |  |   | 521,223 |          
|          | Professional fees                                                |                    |   | 127,295 |             |  |   | (381     | )      |   |             | (998   | )      |           |   |     |      |  |   | 125,916 |          
|          | Claims and capitation                                            |                    |   | 272,872 |             |  |   |         |        |   |             |       |        |           |   |     |      |  |   | 272,872 |          
|          | Supplies                                                         |                    |   | 149,063 |             |  |   | (297     | )      |   |             | (571   | )      |           |   |     |      |  |   | 148,195 |          
|          | Provision for doubtful accounts                                  |                    |   | 52,749  |             |  |   | (254     | )      |   |             | (393   | )      |           |   |     |      |  |   | 52,102  |          
|          | Interest, net                                                    |                    |   | 22,155  |             |  |   | (31      | )      |   |             | (386   | )      |           |   | 281  | (a)  |  |   | 22,019  |          
|          | Change in fair value of interest rate swap
    agreements        |                    |   | (558    | )           |  |   |         |        |   |             |       |        |           |   |     |      |  |   | (558    | )        
|          | Depreciation and amortization                                    |                    |   | 35,742  |             |  |   | (81      | )      |   |             | (182   | )      |           |   |     |      |  |   | 35,479  |          
|          | Impairment of long-lived assets and restructuring
    costs      |                    |   | 2,913   |             |  |   |         |        |   |             |       |        |           |   |     |      |  |   | 2,913   |          
|          | Loss on divestitures                                             |                    |   | 61      |             |  |   |         |        |   |             |       |        |           |   |     |      |  |   | 61      |          
|          | Other                                                            |                    |   | 119,472 |             |  |   | (1,278   | )      |   |             | (1,303 | )      |           |   | 711  | (b)  |  |   | 117,602 |          
|          |                                                                  |                    |   |         |             |  |   |          |        |   |             |        |        |           |  
|          |                                                                  | Total expenses     |   |         | 1,313,657   |  |   |          | (7,872 | ) |             |        | (8,953 | )         |   |      | 992  |  |   |         | 1,297,824 | 
|          |                                                                  |                    |   |         |             |  |   |          |        |   |             |        |        |           |  
|          | Income (loss) from continuing operations before income
    taxes |                    |   | 6,017   |             |  |   | 3,201    |        |   |             | (245   | )      |           |   | (992 | )    |  |   | 7,981   |          
|          | Income tax expense (benefit)                                     |                    |   | 2,312   |             |  |   | 1,216    |        |   |             | (93    | )      |           |   | (372 | )(c) |  |   | 3,063   |          
|          |                                                                  |                    |   |         |             |  |   |          |        |   |             |        |        |           |  
|          | Income (loss) from continuing operations, net                    |                    | $ | 3,705   |             |  | $ | 1,985    |        |   | $           | (152   | )      |           | $ | (620 | )    |  | $ | 4,918   |          
|          |                                                                  |                    |   |         |             |  |   |          |        |   |             |        |        |           |  



---

Notes to Pro Forma Condensed Consolidated
Statement of Operations:



|    |                                                                                                                                      
|--- | -------------------------------------------------------------------------------------------------------------------------------------
|(a) | Adjustment to exclude interest expense allocated
    to the disposed businesses but not directly attributable to the
    disposition.
|   
|(b) | Adjustment to exclude management fees allocated
    to the disposed businesses that are eliminated upon
    consolidation.           
|   
|(c) | Adjustment to give effect to the income tax effect
of pro forma adjustments.                                                         

26



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##### Table of Contents



Item 2. Managements Discussion and Analysis of Financial Condition and
Results of Operations. The following discussion and analysis of financial condition and results
of operations should be read in conjunction with our unaudited condensed
consolidated financial statements and related notes appearing elsewhere in
this report and the more detailed discussion contained in Managements
Discussion and Analysis of Financial Condition and Results of Operations
contained in our Annual Report on Form 10-K for the year ended December 31,
2003. Forward Looking Statements This Quarterly Report on Form 10-Q includes forward-looking statements
within the meaning of the Private Securities Litigation Reform Act of 1995
which are intended to be covered by the safe harbors created under that Act.
These statements are based on our current estimates and expectations.
Forward-looking statements may include words such as may, will, plans,
estimates, anticipates, believes, expects, intends and similar
expressions. These forward-looking statements are subject to various factors,
risks and uncertainties that could cause actual outcomes and results to be
materially different from those projected or assumed. These factors, risks
and uncertainties include, without limitation, possible changes in the
Medicare and Medicaid programs that may limit reimbursement to health care
providers and insurers; a possible reduction of profitability of our Health
Plan caused by lower enrollment; our failure to maintain satisfactory
relationships with providers or our ability to effectively price our health
care premiums or manage medical costs; the geographic concentration of our
operations, particularly in Albuquerque, New Mexico and Tulsa, Oklahoma; the
availability, cost and terms of malpractice insurance coverage; claims and
legal actions relating to professional liabilities or other matters exceeding
the scope of our liability coverage; the highly competitive nature of the
health care business, including the competition to recruit and retain
physicians and other health care personnel and the ability to retain
qualified management; the potential adverse impact of government
investigations or qui tam lawsuits brought under the False Claims Act or
other whistleblower statutes; our ability to integrate newly acquired
facilities and improve their operations and realize the anticipated benefits
of the acquisitions; our ability to acquire hospitals and other related
health care entities that meet our target criteria; our ability to manage and
integrate our information systems effectively; any reduction in payments to
health care providers by government and commercial third-party payors, as
well as cost-containment efforts of insurers and other payors; uncertainty
associated with compliance with HIPAA and other privacy laws and regulations;
the restrictions and covenants in our credit facility and debt instruments
and the potential lack of adequate alternative financing; changes in, or
violations of, federal, state or local regulation affecting the health care
industry; the possible enactment of Federal or state health care reform;
changes in general economic conditions and those factors, risks, and
uncertainties described in our Annual Report on Form 10-K under the caption
Risk Factors and from time to time in our filings with the Securities and
Exchange Commission (the SEC). We can give no assurance that the
forward-looking statements included in this report will prove to be accurate.
In light of the significant uncertainties inherent in the forward-looking
statements included herein, you should not regard the inclusion of such
information as a representation by us or any other person that our objectives
and plans will be achieved. We undertake no obligation to publicly release
any revisions to any forward-looking statements contained in this report. Executive Overview 2004 Operations Summary During the three months and six months ended June 30, 2004, we have
continued to achieve positive results, including:  
    
    increased admissions and patient days over prior year periods in both our acute care and
behavioral segments, including on a same facility basis;  
    
    increased net patient service revenue per adjusted admission and
patient day over prior year periods in both the consolidated acute care and behavioral
segments;  
    
    progress towards finalizing the previously announced
Hillcrest and Cimarron acquisitions, which were completed subsequent to
June 30, 2004; 27




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##### Table of Contents




    
    increased Health Plan revenue, successful retention of plan members
and effective management of the cost of medical care; and  
    
    certification by the Centers for Medicare and Medicaid Services
(CMS) in May 2004 of our Brooke Glen behavioral hospital, which will
allow for increased access to patient admissions in future periods. However, we continue to face certain challenges, including:  
    
    continued deterioration in the collectability of self-pay accounts
due to industry-wide trends, which continues to negatively
impact our bad debt expense;  
    
    integration of the recently completed Hillcrest and Cimarron
acquisitions, including integration of disparate information systems;  
    
    continued labor pricing and recruitment pressures brought on
by the nationwide nursing shortage; and  
    
    continued challenges in managing our general and professional
liability and workers compensation risks in a cost-effective manner. Revenues We generate revenue predominantly through three sources: the provision
of patient care at our acute care and behavioral facilities; premiums charged
to our Health Plan membership; and other health care services. We evaluate
the growth of our revenue in many ways. In our acute care segment, we utilize
admissions and adjusted admissions, which are volume measures, and revenue
per adjusted admission, which is a pricing and acuity measure. However, it
has been difficult to utilize revenue per adjusted admission due to the
historical treatment of revenues associated with our Health Plan members who
receive health care services at our acute care hospitals, which is discussed
below under net patient service revenue. In our behavioral care segment, we
utilize patient days, adjusted patient days and average length of stay,
measures of volume and acuity, as well as revenue per patient day and
adjusted patient day, measures of pricing and acuity. The following is an analysis of our revenue from each source (in
thousands): Three Months Ended June 30,
    
    Six Months Ended June 30,2004
    
    2003
    
    2004
    
    2003Net patient service
revenue
    
    $
    180,144
    

    
    50.4
    %
    
    $
    152,196
    
    
    47.9
    %
    
    $
    369,987
    
    
    51.2
    %
    
    $
    299,973
    
    

    47.8
    %Premium revenue
    
    
    157,596
    

    
    44.1
    
    
    
    145,575
    
    
    45.8
    
    
    
    312,802
    
    
    43.3
    
    
    
    288,328
    
    

    46.0Other revenue
    
    
    19,473
    
    
    5.5
    
    
    
    20,103
    
    
    6.3
    
    
    
    40,093
    
    
    5.5
    
    
    
    38,957
    
    

    6.2Total net revenues
    
    $
    357,213
    

    
    100.0
    %
    
    $
    317,874
    
    
    100.0
    %
    
    $
    722,882
    
    
    100.0
    %
    
    $
    627,258
    
    
    100.0
    %
 28




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##### Table of Contents



Net Patient Service Revenue Our net patient service revenue is primarily derived from Medicare and
Medicaid programs and managed care contracts. These revenues are net of
contractual adjustments and policy discounts, which represent the difference
between our hospitals established charges and the payment rates under the
Medicare and Medicaid programs and managed care programs. The percentage of
our net patient service revenue from Medicare and Medicaid programs and
managed care programs (expressed in patient days) was as follows: Three Months Ended June 30,
    
    Six Months Ended June 30,2004
    
    2003
    
    2004
    
    2003Acute
    
    Behavioral
    
    Acute
    
    Behavioral
    
    Acute
    
    Behavioral
    
    Acute
    
    BehavioralMedicare
    
    
    40.6
    %
    
    
    8.9
    %
    
    
    44.0
    %
    
    
    9.0
    %
    
    
    40.9
    %
    
    
    9.2
    %
    
    
    43.7
    %
    
    
    8.9
    %Medicaid
    
    
    5.6
    
    
    
    38.4
    
    
    
    6.2
    
    
    
    34.3
    
    
    
    5.6
    
    
    
    36.8
    
    
    
    6.1
    
    
    
    34.5Managed care
    
    
    43.9
    
    
    
    28.3
    
    
    
    38.1
    
    
    
    29.6
    
    
    
    44.4
    
    
    
    29.2
    
    
    
    39.1
    
    
    
    30.1Other payors
    
    
    9.9
    
    
    
    24.4
    
    
    
    11.7
    
    
    
    27.1
    
    
    
    9.1
    
    
    
    24.8
    
    
    
    11.1
    
    
    
    26.5100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0

    %
 Other payors primarily include state and local governments, commercial
payors, workers compensation and self pay patients. Net patient service revenue within our consolidated acute care services
segment prior to January 1, 2004 excludes revenue for services provided to
our Health Plan members. During 2003, the Health Plan did not qualify as a
separate operating segment in accordance with the criteria set forth by SFAS
No. 131, Disclosures about Segments of an Enterprise and Related Information.
However, beginning on January 1, 2004, we managed the Health Plan as a
separate operating segment and our acute care services segment excludes the
operations of the Health Plan and includes net patient service revenue
related to services rendered at our acute care hospitals to our Health Plan
members. We believe this allows us to better manage the businesses within our
company and make better financial and operational decisions. As a result of
this change in how we managed these operations, our Health Plan business is a
separate reportable segment in 2004. However, due to system limitations it is
impractical to restate our segment information for prior periods to
correspond with this change in our reportable segments. The final determination of amounts earned under Medicare and Medicaid
programs often does not occur until fiscal years subsequent to submission of
claims due to audits by the administering agency, rights of appeal and the
application of numerous technical provisions. Differences between original
estimates and subsequent revisions, including final settlements of cost
reports, are included in the results of operations of the period in which the
revisions are made. We did not assume any of the cost report settlements
under these programs for our acquisitions for dates prior to our purchases.
Adjustments to estimated settlements resulted in increases to net patient
service revenue of $1.7 million and $668,000 for the three months ended June
30, 2004 and 2003, respectively, and $2.1 million and $1.1 million for the
six months ended June 30, 2004 and 2003, respectively. We
recently received notice from a state Medicaid program that certain
amounts paid by the program to one of
our behavioral hospitals in prior years were paid in error and that
we owe the amounts back to the program. We believe that we have fully
complied with both the applicable laws and previous agreements
established with the program during previous years and that final resolution of
these disputed amounts will not have a material adverse effect on our
business, results of operations or financial position. Recent Behavioral Hospital Trends The Medicare, Medicaid and SCHIP Balanced Budget Refinement Act of 1999
(BBRA of 1999) required CMS to develop an inpatient psychiatric per diem
effective for the federal fiscal year beginning October 1, 2002. On November
28, 2003, CMS proposed a rule to implement a prospective payment system
(PPS) for psychiatric hospitals and units. This new system will replace the
current inpatient psychiatric payment system. The proposed rule designates
that PPS under the new system will be effective for cost reports beginning on
or after April 1, 2004. CMS has not issued a final rule for the inpatient
psychiatric PPS to accomplish the proposed effective date of April 1, 2004.
According to CMS recent notice on Proposed Changes to the Hospital Inpatient
Prospective Payment Systems and Fiscal Year 2005 Rates, CMS is still in the
process of analyzing public comments and developing a final rule related to
this new system. The effective date of this new system would occur five
months following publication of the final rule. The plan is scheduled to be
implemented through a three year transition, ultimately phasing into 100% PPS
(year one: 75% cost/25% PPS; year two: 50% cost/50% 29




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##### Table of Contents



PPS; year three: 25%
cost/75% PPS; year four: 100% PPS). We cannot predict the date the final rule
will be
published, the actual effective date of the final rule, or whether the
final rule will mirror provisions of the proposed rule or its ultimate impact
on our results of operations. Charity Care and Contemplated Revisions to Policies In February 2004, CMS and the Office of Inspector General issued
guidance that hospitals have the ability under Medicare regulations to
provide relief to uninsured and under-insured patients who cannot afford
their hospital bills and to Medicare beneficiaries who cannot afford their
Medicare cost sharing amounts. Beginning in August 2004, we implemented a
pilot charity care policy that provides discounts to uninsured and
under-insured patients. The policy requires facility personnel to first
determine if a patient has insurance or can qualify for state or locally
funded programs. If not, facility personnel seek to qualify the patient for
charity care. The policy considers income level, family size and the total
annual family medical bills. Discounts are applied on a sliding scale
depending on income and family size. We began the program at a pilot hospital
and plan to evaluate its results and eventually implement the policy
throughout all of our facilities. Implementation of this policy could result
in decreased net patient service revenue with a commensurate offsetting
decrease to the provision for doubtful accounts. Premium Revenue Our premium revenue is derived from our Health Plan in New Mexico. We
offer a portfolio of health plan products to private and public purchasers.
Premium revenue is comprised of premiums we receive from our Health Plan
members, for which we then are responsible for the costs of health care
services provided to those members. Because our Health Plan is part of our
integrated health care delivery network in New Mexico, we ultimately provide
many of those health care services to our Health Plan members. Although premium revenue was 44.1% and 43.3% of total net revenues for
the three months and six months ended June 30, 2004, respectively, expanding
our presence in the managed care business is not one of our primary growth
strategies. One of our key growth strategies is to expand through the
selective acquisition of acute care and behavioral hospitals in targeted
markets. Effective August 1, 2004, we completed the previously announced
transaction with Molina Healthcare, Inc. to transfer approximately 30,000
commercial members of Cimarron Health Plan to our Health Plan in New Mexico.
The transaction provided a strategic opportunity to expand our current Health
Plan services in the Albuquerque market and increase the integrated delivery systems access
to these members; however, we do not generally plan to
acquire additional health plans unless these plans are tangential parts of
the hospitals or systems that we acquire. The Health Plan is an important
part of our integrated delivery system in Albuquerque, and we expect to
ultimately provide a higher proportion of health care services to the former
Cimarron commercial members as a result of transferring them to our Health
Plan. As we expand into new targeted markets over time, we anticipate that
Health Plan revenues will become a smaller percentage of our total net
revenues. Other Revenue We also derive revenue from our commercial laboratory, retail pharmacies
within our hospitals, provider network access and medical management services
through our Health Plan, and educational services through our behavioral
segment. Accounts Receivable Collection Risks and Resulting Increased Provision for Bad
Debts We
are susceptible to the industry-wide trend of increased collection
risk on uninsured self-pay patients as well as insured patients whose
employers have required them to pay higher deductibles and co-payments. This
increase in uninsured self-pay patients has caused deterioration in our
accounts receivable, primarily related to the uninsured self-pay patients,
which has resulted in increased write-offs and a larger provision for
doubtful accounts as a percentage of total net revenues. The increase in
self-pay accounts receivable results from a combination of factors including
general economic weakness, higher levels of patient deductibles and
co-insurance, continuing state budget struggles resulting in reductions of
Medicaid enrollees and an increase in uninsured patients who may not qualify
for charity care programs. We have implemented policies and procedures
designed to accelerate upfront cash collections as well as to continue to
focus on cash collection efforts after 30




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##### Table of Contents



discharge. However, we believe that increased bad debts will remain a
prevalent trend in the hospital industry during the foreseeable future. Our self-pay amounts due from patients were $39.4 million and our total
allowance for doubtful accounts was $64.8 million at June 30, 2004. The
valuation allowance related to the self-pay portion of our business is
substantially greater than any other payor and is based upon our historical
collection rates. Our total allowance for doubtful accounts exceeds self-pay
amounts due from patients primarily due to our billing systems not currently
tracking co-payments and deductibles due from patients for which collection
of the primary payor accounts has not occurred. Therefore, our accounts
receivable agings reflect certain co-payments and deductibles as due from
third-party payors until those third-party payors have made payment, at which
time the co-payments and deductibles due from patients are reclassified to
self-pay. Our total allowance for doubtful accounts represented approximately
164.6% and 152.0% of self-pay amounts due from patients at June 30, 2004 and
December 31, 2003, respectively. The increase in our allowance for doubtful accounts and related provision for doubtful
accounts is primarily the result of increased allowances on self-pay accounts
as a result of deterioration in the estimated collectability of such
accounts. Our accounts receivable has increased due to a corresponding
increase in net patient service revenue and an increase in days sales
outstanding, which were 67 days and 59 days as of June 30, 2004 and December
31, 2003, respectively. The increase in days sales outstanding is primarily related to changes
in how we manage the acute care activity within the Lovelace Sandia Health
System. Beginning on January 1, 2004, we managed the Health Plan as a
separate operating segment and our acute care services segment excludes the
operations of the Health Plan and includes net patient service revenue
related to services rendered at our acute care hospitals to our Health Plan
members. We believe this allows us to better manage the businesses within our
company and make better financial and operational decisions. As a result of
this change in how we managed these operations, we began adjudicating claims
for services provided to our Health Plan members. The adjudication of our
Health Plan claims, coupled with increased adjusted admissions and patient
days, significantly increased the volume of claims that our business
office was required to process and resulted in a build up of accounts receivable during the six months
ended June 30, 2004. We expect to decrease our days sales outstanding during
the remainder of 2004 as we continue to increase our business office
personnel to adjust to the increased volumes and enhance our collection
processes. Our Business Strategy Key elements of our business strategy include the following:  
    
    Physician Recruiting and Retention.We strive to recruit both
primary and specialty care physicians who can provide quality services
that we believe are currently needed in the communities we serve. We
similarly seek to recruit new physicians (primarily psychiatrists) to
our behavioral hospitals to provide services to our patients. This
reflects our strategy to expand capacity and more importantly our
service lines at our facilities. Additionally, we strive to retain our
physicians by maintaining strong relationships with them, by enhancing
the scope and quality of services at our hospitals, and by constantly
improving our hospitals work environment. We believe that as we
continue to strengthen our position in each of our markets, we will
further improve our ability to attract and retain quality physicians.
An example of our retention efforts is the use of a program we refer to
as Physician Leadership Councils, or PLCs. PLCs generally consist of
leading physicians in our communities who provide their ideas and
recommendations to the management of each facility on improving its
operations. We use PLCs to develop and maintain strong relationships
with members of the medical staffs at each of our acute care hospitals.
Generally, PLCs meet with our hospital management teams on a regular
basis to discuss operating and strategic issues, serve as a sounding
board for the medical community at each hospital and enable our local
management teams to communicate on a regular basis with the medical
staff. PLCs also actively participate in the strategic planning process
of each of our acute care hospitals.  
    
    Acquisitions.An integral part of our business strategy is the
continued selective acquisitions of acute care hospitals in urban and
suburban markets and behavioral hospitals. To accomplish this, we
selectively seek acquisition opportunities in markets with populations
over 100,000 and growth rates above the national 31




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##### Table of Contents



average, either through the acquisition of a network of hospitals and
other health care facilities or a single well-positioned facility, where
we generally can improve operating performance and profitability. For
example, in August 2004, we completed the previously announced
acquisition of Hillcrest HealthCare System in Tulsa, Oklahoma for
$326.3 million, including preliminary working capital, subject to customary
adjustments. We have generally acquired relatively underperforming acute
care hospitals where we believe we can improve their operational
performance, profitability and their financial systems and internal
controls. After we acquire a hospital, we implement a number of measures
designed to increase revenues, lower operating costs and improve their
financial systems and internal controls. We also may make significant
investments in the acquired hospital to expand services, strengthen the
medical staff, improve our market position overall and integrate the
acquired hospitals systems into our systems.  
    
    Capital Expenditures.Upon acquisition of a health care system or a
single facility, we generally invest substantial capital in those new
markets. For example, upon the acquisition of the facilities now
comprising Lovelace Sandia Health System, we committed to invest $80.0
million of capital into those facilities in the Albuquerque market over
a five-year period. Through June 30, 2004, we had invested
approximately $58.9 million and we anticipate completing our commitment
during 2004. As part of the Hillcrest acquisition, we have committed to
invest approximately $100.0 million in capital expenditures in the
Tulsa market over the next five years. See Liquidity and Capital
Resources below for additional discussion of our capital expenditures. Our ability to realize the benefits of these strategies will be affected
by a number of important factors, including factors described under the
captions, Risk Factors and Managements Discussion and Analysis of
Financial Condition and Results of Operations  Known Legislative, Industry
and Economic Trends contained in our Annual Report on Form 10-K for the year
ended December 31, 2003. Acquisitions,
Divestitures and Joint Venture 2003 Acquisitions Effective January 1, 2003, we acquired Lovelace Health Systems, Inc. in
Albuquerque, New Mexico, for $209.4 million, plus acquisition costs. Lovelace
Health Systems, Inc. included Lovelace Medical Center, a 201 bed acute care
hospital, and the Lovelace Health Plan, a health maintenance organization. We
financed the acquisition of Lovelace Health Systems, Inc. through a
combination of $112.5 million of bank debt, $36.0 million of subordinated
debt and the balance from the proceeds of the sale of equity securities.
Results of operations for the year ended December 31, 2003 include an entire
year of operations for this system. Effective October 1, 2003, we completed
the merger of Sandia Health System (previously acquired in 2002) and Lovelace
Health Systems, Inc. The merged entity is named Lovelace Sandia Health
System, Inc., and is part of Lovelace Sandia Health System, the second
largest integrated health care delivery system in Albuquerque, New Mexico. Effective October 8, 2003, we acquired the 146-bed Northwestern
Institute of Psychiatry (renamed Brooke Glen), a private behavioral health
services facility located in Fort Washington, Pennsylvania, for $7.7 million,
plus acquisition costs. The purchase price was paid in cash and funded from
the proceeds of our $225.0 million senior subordinated notes issued in August
2003. Results of operations for the year ended December 31, 2003 include
approximately three months of operations for this facility. 2004 Acquisitions Effective
August 1, 2004, we completed the previously announced
transaction with Molina Healthcare, Inc. to transfer approximately
30,000 commercial members of Cimarron Health Plan to the Lovelace Health
Plan, which is part of Lovelace Sandia Health System, Inc., for approximately
$16.0 million, plus additional contingent consideration of up to $3.5 million
subject to the satisfaction of certain conditions. We funded the transaction
with available cash on hand. On August 12,
2004, we completed the previously announced acquisition of
Hillcrest HealthCare System in Tulsa,
Oklahoma. We acquired substantially all of the net operating 32




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##### Table of Contents



assets of
Hillcrest for $326.3 million, including preliminary working capital, subject to customary adjustments. The acquisition consisted primarily of two
metropolitan Tulsa hospitals and related health care entities, as well as six
regional hospitals acquired or intended to be acquired through long-term
operating agreements. In connection with the Hillcrest acquisition, we
committed to invest approximately $100.0 million in capital expenditures in
the Tulsa market over the next five years. The aggregate purchase price of the Hillcrest acquisition was paid in
cash and financed, in part, with the $58.3 million of proceeds invested by
WCAS, Ferrer Freeman, BAC and related investors pursuant to the subscription agreement with us,
as discussed in Note 7 to the accompanying unaudited condensed consolidated
financial statements. The remaining purchase price was financed through
an additional borrowing of senior secured term debt on August 12, 2004 in the principal
amount of $300.0 million, as further discussed in Capital Resources. In connection with our recent acquisitions, management began evaluating
its information systems in the acute care segment, primarily related to
patient accounting and clinical information systems, to determine the
feasibility of
moving to a single operating platform across the acute care hospitals. We have evaluated the carrying amounts of the related
information system assets for recoverability and do not believe any
indicators of impairment exist. However, should events, changes in
circumstances or other indicators of potential impairment exist in the
future, we may be required to record impairment charges on long-lived assets,
which could have a material adverse effect on our results of operations and financial
condition. 2003 Divestitures For the six months ended June 30, 2003, we recorded pretax gains of
$949,000, which included pretax gains of $250,000 recorded during the three
months ended June 30, 2003, from the sale of one behavioral hospital and
recoveries of fully reserved items related to a behavioral hospital sold in
2002. The hospitals were identified as held for sale under SFAS No. 144,
under which the results of operations and related gains on divestitures are
included in income from discontinued operations in the accompanying
unaudited condensed consolidated statements of operations. For the six months ended June 30, 2003, we also recorded pretax gains of
$618,000, which included a pretax loss of $310,000 recorded during the three
months ended June 30, 2003, from the sales of two behavioral hospitals. The
hospitals were previously identified as held for sale under SFAS No. 121,
Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets
to be Disposed Of, under which the net gains are recorded in the accompanying
unaudited condensed consolidated statements of operations as gains on divestitures and the historical results of
operations and financial position are not reclassified as discontinued
operations. 2004 Divestitures Effective April 1, 2004, we sold a behavioral hospital for consideration
of approximately $6.1 million, which resulted in a pretax gain of $3.6
million that was recorded during the three months ended June 30, 2004. The
hospitals results of operations, including gain on divestiture, and net
assets are included in income from discontinued operations and assets held
for sale, respectively, for the periods presented in the accompanying
unaudited condensed consolidated financial statements in accordance with SFAS
No. 144. Effective
July 31, 2004, we sold our Lovelace Home Health operations and
certain related assets for
$200,000 in cash, subject to certain adjustments, which is expected to result in a
minimal gain. The entity was identified as held for 33




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##### Table of Contents



sale during the three months ended June 30, 2004. Accordingly, the entitys
results of operations are included in income from discontinued operations
for all periods presented in the accompanying unaudited condensed
consolidated statements of operations. 2004 Joint Venture On June 9, 2004 we entered into a letter of intent with Ochsner Clinic
Foundation to partner in the ownership of Summit Hospital in Baton Rouge,
Louisiana. We have solely owned Summit Hospital since July 2001, and
accordingly consolidate the accounts and results of operations of the
hospital. Subject to closing conditions, the transaction is expected to be
completed by the fall 2004, at which time we expect to account for our
noncontrolling interest in Summit as an equity-method investment. In addition
to income recorded from our equity investment, we expect to receive
management fees pursuant to our continued management of the hospital. Critical Accounting Policies A summary of significant accounting policies is disclosed in Note 1 to
the Consolidated Financial Statements contained in our Annual Report on Form
10-K for the year ended December 31, 2003. Our critical accounting policies
are further described under the caption Critical Accounting Policies in
Managements Discussion and Analysis of Financial Condition and Results of
Operations contained in our Annual Report on Form 10-K for the year ended
December 31, 2003. There have been no significant changes in the nature of
our critical accounting policies or the application of those policies since
December 31, 2003. Results of Operations The following table sets forth for the periods indicated selected
results of operations data expressed in dollar terms and as a percentage of
total net revenues (dollars in thousands). Three Months Ended
    
    Six Months EndedJune 30, 2004
    
    June 30, 2003
    
    June 30, 2004
    
    June 30, 2003CONSOLIDATED
    
    Amount
    
    %
    
    Amount
    
    %
    
    Amount
    
    %
    
    Amount
    
    %Revenues:Net patient service revenue
    
    $
    180,144
    
    
    
    50.4
    %
    
    $
    152,196
    
    
    
    47.9
    %
    
    $
    369,987
    
    
    
    51.2
    %
    
    $
    299,973
    
    
    
    47.8
    %Premium revenue
    
    
    157,596
    
    
    
    44.1
    
    
    
    145,575
    
    
    
    45.8
    
    
    
    312,802
    
    
    
    43.3
    
    
    
    288,328
    
    
    
    46.0Other revenue
    
    
    19,473
    
    
    
    5.5
    
    
    
    20,103
    
    
    
    6.3
    
    
    
    40,093
    
    
    
    5.5
    
    
    
    38,957
    
    
    
    6.2Total net revenues
    
    
    357,213
    
    
    
    100.0
    %
    
    
    317,874
    
    
    
    100.0
    %
    
    
    722,882
    
    
    
    100.0
    %
    
    
    627,258
    
    
    
    100.0
    %Expenses:Salaries and benefits
    
    
    142,055
    
    
    
    39.8
    
    
    
    126,657
    
    
    
    39.8
    
    
    
    288,321
    
    
    
    39.9
    
    
    
    250,201
    
    
    
    39.9Professional fees
    
    
    35,890
    
    
    
    10.0
    
    
    
    32,407
    
    
    
    10.2
    
    
    
    66,013
    
    
    
    9.1
    
    
    
    62,068
    
    
    
    9.9Claims and capitation
    
    
    75,096
    
    
    
    21.0
    
    
    
    67,640
    
    
    
    21.3
    
    
    
    146,317
    
    
    
    20.2
    
    
    
    135,132
    
    
    
    21.5Supplies
    
    
    41,825
    
    
    
    11.7
    
    
    
    37,719
    
    
    
    11.9
    
    
    
    83,812
    
    
    
    11.6
    
    
    
    74,586
    
    
    
    11.9Provision for doubtful accounts
    
    
    15,976
    
    
    
    4.5
    
    
    
    12,290
    
    
    
    3.9
    
    
    
    33,333
    
    
    
    4.6
    
    
    
    23,206
    
    
    
    3.7Interest, net
    
    
    7,042
    
    
    
    2.0
    
    
    
    4,780
    
    
    
    1.5
    
    
    
    13,541
    
    
    
    1.9
    
    
    
    8,459
    
    
    
    1.3Change in fair value of interest rate swap
agreements
    
    
    2,624
    
    
    
    0.7
    
    
    
    
    
    
    
    
    
    
    
    1,389
    
    
    
    0.2
    
    
    
    
    
    
    
    Depreciation and amortization
    
    
    11,713
    
    
    
    3.3
    
    
    
    7,314
    
    
    
    2.3
    
    
    
    22,529
    
    
    
    3.1
    
    
    
    14,641
    
    
    
    2.4Loss (gain) on divestitures
    
    
    
    
    
    
    
    
    
    
    310
    
    
    
    0.1
    
    
    
    
    
    
    
    
    
    
    
    (618
    )
    
    
    (0.1
    )Other
    
    
    29,773
    
    
    
    8.3
    
    
    
    29,545
    
    
    
    9.3
    
    
    
    62,185
    
    
    
    8.6
    
    
    
    56,596
    
    
    
    9.0Income (loss) from continuing operations before
income taxes
    
    
    (4,781
    )
    
    
    (1.3
    )
    
    
    (788
    )
    
    
    (0.3
    )
    
    
    5,442
    
    
    
    0.8
    
    
    
    2,987
    
    
    
    0.5Income tax expense (benefit)
    
    
    (1,780
    )
    
    
    (0.5
    )
    
    
    (302
    )
    
    
    (0.1
    )
    
    
    2,123
    
    
    
    0.3
    
    
    
    1,199
    
    
    
    0.2Income
(loss) from continuing operations, net
    
    
    (3,001
    )
    
    
    (0.8
    )
    
    
    (486
    )
    
    
    (0.2
    )
    
    
    3,319
    
    
    
    0.5
    
    
    
    1,788
    
    
    
    0.3Discontinued operations:Income (loss) from discontinued operations
    
    
    3,478
    
    
    
    0.9
    
    
    
    (474
    )
    
    
    (0.1
    )
    
    
    3,178
    
    
    
    0.4
    
    
    
    114
    
    
    
    Income tax expense (benefit)
    
    
    1,441
    
    
    
    0.4
    
    
    
    (200
    )
    
    
    
    
    
    
    1,332
    
    
    
    0.2
    
    
    
    44
    
    
    
    Income (loss) from discontinued operations, net
    
    
    2,037
    
    
    
    0.5
    
    
    
    (274
    )
    
    
    (0.1
    )
    
    
    1,846
    
    
    
    0.2
    
    
    
    70
    
    
    
    Net income (loss)
    
    
    (964
    )
    
    
    (0.3
    )
    
    
    (760
    )
    
    
    (0.3
    )
    
    
    5,165
    
    
    
    0.7
    
    
    
    1,858
    
    
    
    0.3Accrued preferred dividends
    
    
    2,203
    
    
    
    0.6
    
    
    
    2,017
    
    
    
    0.6
    
    
    
    4,377
    
    
    
    0.6
    
    
    
    3,964
    
    
    
    0.6Net income
available for (loss attributable to) common members
    
    $
    (3,167
    )
    
    
    (0.9
    %)
    
    $
    (2,777
    )
    
    
    (0.9
    %)
    
    $
    788
    
    
    
    0.1
    %
    
    
    $(2,106
    )
    
    
    (0.3
    %)
 34




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##### Table of Contents



Three Months Ended
    
    Three Months EndedJune 30, 2004
    
    June 30, 2003Acute
    
    Lovelace
    
    
    
    
    
    Consolidated
    
    
    
    
    
    ConsolidatedCONSOLIDATED ACUTE CARE
    
    Care
    
    Health
    
    
    
    
    
    Acute Care
    
    
    
    
    
    Acute CareSERVICES SEGMENT
    
    Services
    
    Plan
    
    Eliminations
    
    Services
    
    %
    
    Services
    
    %Revenues:Net patient service revenue
    
    $
    164,702
    
    
    $
    
    
    
    $
    (53,502
    )
    
    $
    111,200
    
    
    
    39.1
    %
    
    $
    87,702
    
    
    
    35.1
    %Premium revenue
    
    
    
    
    
    
    157,586
    
    
    
    
    
    
    
    157,586
    
    
    
    55.4
    
    
    
    145,575
    
    
    
    58.3Other revenue
    
    
    19,090
    
    
    
    3,566
    
    
    
    (7,239
    )
    
    
    15,417
    
    
    
    5.5
    
    
    
    16,389
    
    
    
    6.6Total net revenues
    
    
    183,792
    
    
    
    161,152
    
    
    
    (60,741
    )
    
    
    284,203
    
    
    
    100.0
    
    
    
    249,666
    
    
    
    100.0Expenses:Salaries and benefits
    
    
    86,430
    
    
    
    4,867
    
    
    
    (247
    )
    
    
    91,050
    
    
    
    32.0
    
    
    
    84,531
    
    
    
    33.9Professional fees
    
    
    18,598
    
    
    
    10,333
    
    
    
    
    
    
    
    28,931
    
    
    
    10.2
    
    
    
    22,179
    
    
    
    8.9Claims and capitation
    
    
    
    
    
    
    135,590
    
    
    
    (60,494
    )
    
    
    75,096
    
    
    
    26.4
    
    
    
    67,640
    
    
    
    27.1Supplies
    
    
    37,782
    
    
    
    74
    
    
    
    
    
    
    
    37,856
    
    
    
    13.3
    
    
    
    34,007
    
    
    
    13.6Provision for doubtful accounts
    
    
    14,810
    
    
    
    
    
    
    
    
    
    
    
    14,810
    
    
    
    5.2
    
    
    
    10,820
    
    
    
    4.3Other
    
    
    18,416
    
    
    
    2,803
    
    
    
    
    
    
    
    21,219
    
    
    
    7.5
    
    
    
    22,157
    
    
    
    8.9Adjusted EBITDA
    
    $
    7,756
    
    
    $
    7,485
    
    
    $
    
    
    
    $
    15,241
    
    
    
    5.4
    %
    
    $
    8,332
    
    
    
    3.3
    %
 Six Months Ended
    
    Six Months EndedJune 30, 2004
    
    June 30, 2003Acute
    
    Lovelace
    
    
    
    
    
    Consolidated
    
    
    
    
    
    ConsolidatedCONSOLIDATED ACUTE CARE
    
    Care
    
    Health
    
    
    
    
    
    Acute Care
    
    
    
    
    
    Acute CareSERVICES SEGMENT
    
    Services
    
    Plan
    
    Eliminations
    
    Services
    
    %
    
    Services
    
    %Revenues:Net patient service revenue
    
    $
    339,382
    
    
    $
    
    
    
    $
    (107,220
    )
    
    $
    232,162
    
    
    
    40.2
    %
    
    $
    173,091
    
    
    
    35.1
    %Premium revenue
    
    
    
    
    
    
    312,802
    
    
    
    
    
    
    
    312,802
    
    
    
    54.2
    
    
    
    288,328
    
    
    
    58.4Other revenue
    
    
    41,011
    
    
    
    6,928
    
    
    
    (15,640
    )
    
    
    32,299
    
    
    
    5.6
    
    
    
    31,909
    
    
    
    6.5Total net revenues
    
    
    380,393
    
    
    
    319,730
    
    
    
    (122,860
    )
    
    
    577,263
    
    
    
    100.0
    
    
    
    493,328
    
    
    
    100.0Expenses:Salaries and benefits
    
    
    178,828
    
    
    
    9,853
    
    
    
    (543
    )
    
    
    188,138
    

    
    
    32.6
    
    
    
    167,177
    
    
    
    33.9Professional fees
    
    
    33,011
    
    
    
    19,451
    
    
    
    
    
    
    
    52,462
    
    
    
    9.1
    
    
    
    43,734
    
    
    
    8.9Claims and capitation
    
    
    
    
    
    
    268,634
    
    
    
    (122,317
    )
    
    
    146,317
    
    
    
    25.3
    
    
    
    135,132
    
    
    
    27.4Supplies
    
    
    75,818
    
    
    
    140
    
    
    
    
    
    
    
    75,958
    
    
    
    13.2
    
    
    
    67,228
    
    
    
    13.6Provision for doubtful accounts
    
    
    30,040
    
    
    
    
    
    
    
    
    
    
    
    30,040
    
    
    
    5.2
    
    
    
    20,030
    
    
    
    4.0Other
    
    
    37,027
    
    
    
    7,282
    
    
    
    
    
    
    
    44,309
    
    
    
    7.7
    
    
    
    42,414
    
    
    
    8.6Adjusted EBITDA
    
    $
    25,669
    
    
    $
    14,370
    
    
    $
    
    
    
    $
    40,039
    
    
    
    6.9
    %
    
    $
    17,613
    
    
    
    3.6
    %
 35




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##### Table of Contents



Three Months Ended
    

    
    Six Months EndedJune 30, 2004
    
    June 30, 2003
    
    June 30, 2004
    
    June 30, 2003BEHAVIORAL CARE SERVICES SEGMENT
    
    Amount
    
    %
    
    Amount
    
    %
    
    Amount
    
    %
    
    Amount
    
    %Revenues:Net patient service revenue
    
    $
    68,944
    
    
    
    93.1
    %
    
    $
    64,494
    
    
    
    93.7
    %
    
    $
    137,825
    
    
    
    93.1
    %
    
    $
    126,882
    
    
    
    93.7
    %Other revenue
    
    
    5,098
    
    
    
    6.9
    
    
    
    4,315
    
    
    
    6.3
    
    
    
    10,144
    
    
    
    6.9
    
    
    
    8,602
    
    
    
    6.3Total net revenues
    
    
    74,042
    
    
    
    100.0
    
    
    
    68,809
    
    
    
    100.0
    
    
    
    147,969
    
    
    
    100.0
    
    
    
    135,484
    
    
    
    100.0Expenses:Salaries and benefits
    
    
    42,382
    
    
    
    57.2
    
    
    
    37,249
    
    
    
    54.1
    
    
    
    84,322
    
    
    
    57.0
    
    
    
    73,976
    
    
    
    54.6Professional fees
    
    
    8,244
    
    
    
    11.1
    
    
    
    7,549
    
    
    
    11.0
    
    
    
    16,368
    
    
    
    11.1
    
    
    
    14,462
    
    
    
    10.7Supplies
    
    
    3,866
    
    
    
    5.2
    
    
    
    3,617
    
    
    
    5.3
    
    
    
    7,686
    
    
    
    5.2
    
    
    
    7,192
    
    
    
    5.3Provision for doubtful accounts
    
    
    1,166
    
    
    
    1.6
    
    
    
    1,470
    
    
    
    2.1
    
    
    
    3,293
    
    
    
    2.2
    
    
    
    3,176
    
    
    
    2.3Loss (gain) on divestitures
    
    
    
    
    
    
    
    
    
    
    310
    
    
    
    0.5
    
    
    
    
    
    
    
    
    
    
    
    (618
    )
    
    
    (0.4
    )Other
    
    
    6,400
    
    
    
    8.7
    
    
    
    5,606
    
    
    
    8.1
    
    
    
    12,734
    
    
    
    8.6
    
    
    
    11,149
    
    
    
    8.2Adjusted EBITDA
    
    $
    11,984
    
    
    
    16.2
    %
    
    $
    13,008
    
    
    
    18.9
    %
    
    $
    23,566
    
    
    
    15.9
    %
    
    $
    26,147
    
    
    
    19.3
    %
 36




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##### Table of Contents



Selected Operating Statistics The following table sets forth certain operating data for each of the
periods presented: Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003Acute Care Operating Data:Actual and Same Facilities for 2004 (1):Number of hospitals (end of period)
    
    
    7
    
    
    
    7
    
    
    
    7
    
    
    
    7Number of licensed beds (end of period)(2)
    
    
    1,263
    
    
    
    1,269
    
    
    
    1,263
    
    
    
    1,269Total delivery system admissions(3) (4)
    
    
    8,424
    
    
    
    8,034
    
    
    
    17,004
    
    
    
    16,170% Change
    
    
    4.9
    %
    
    

    
    
    
    
    5.2
    %Total delivery system adjusted admissions
(AA) (4)(5)
    
    
    20,073
    
    
    
    18,579
    
    
    
    39,842
    
    
    
    36,755% Change
    
    
    8.0
    %
    
    
    
    
    
    
    8.4
    %Average length of stay (days)(6)
    
    
    5.0
    
    
    
    5.4
    
    
    
    5.3
    
    
    
    5.5Net patient
service revenue/AA(7)
    
    $
    8,205
    
    
    
    
    
    
    $
    8,518
    
    
    
    Behavioral Operating Data:Actual (1):Number of hospitals (end of period)
    
    
    20
    
    
    
    19
    
    
    
    20
    
    
    
    19Number of licensed beds (end of period)
(2)
    
    
    1,999
    
    
    
    1,853
    
    
    
    1,999
    
    
    
    1,853Admissions (3)
    
    
    9,197
    
    
    
    8,290
    
    
    
    18,694
    
    
    
    16,620% Change
    
    
    10.9
    %
    
    
    
    
    
    
    12.5
    %Adjusted Admissions (5)
    
    
    9,697
    
    
    
    8,760
    
    
    
    19,710
    
    
    
    17,552% Change
    
    
    10.7
    %
    
    
    
    
    
    
    12.3
    %Patient
days(8)
    
    
    125,810
    
    
    
    122,874
    
    
    
    252,682
    
    
    
    241,503% Change
    
    
    2.4
    %
    
    
    
    
    
    
    4.6
    %Adjusted patient days (APD) (5)
    
    
    132,657
    
    
    
    129,844
    
    
    
    266,422
    
    
    
    255,042% Change
    
    
    2.2
    %
    
    
    
    
    
    
    4.5
    %Net patient service revenue/APD
    
    $
    520
    
    
    $
    497
    
    
    $
    517
    
    
    $
    498% Change
    
    
    4.5
    %
    
    
    
    
    
    
    3.9
    %Average length of stay (days)(6)
    
    
    13.7
    
    
    
    14.8
    
    
    
    13.5
    
    
    
    14.5Same Facilities for 2004 (1):Number of hospitals (end of period)
    
    
    19
    
    
    
    19
    
    
    
    19
    
    
    
    19Number of licensed beds (end of period)
(2)
    
    
    1,853
    
    
    
    1,853
    
    
    
    1,853
    
    
    
    1,853Admissions (3)
    
    
    9,028
    
    
    
    8,290
    
    
    
    18,314
    
    
    
    16,620% Change
    
    
    8.9
    %
    
    
    
    
    
    
    10.2
    %Adjusted Admissions (5)
    
    
    9,529
    
    
    
    8,760
    
    
    
    19,332
    
    
    
    17,552% Change
    
    
    8.8
    %
    
    
    
    
    
    
    10.1
    %Patient
days(8)
    
    
    123,878
    
    
    
    122,874
    
    
    
    248,095
    
    
    
    241,503% Change
    
    
    0.8
    %
    
    
    
    
    
    
    2.7
    %Adjusted patient days (5)
    
    
    130,734
    
    
    
    129,844
    
    
    
    261,887
    
    
    
    255,042% Change
    
    
    0.7
    %
    
    
    
    
    
    
    2.7
    %Net patient service revenue/APD
    
    $
    520
    
    
    $
    497
    
    
    $
    517
    
    
    $
    498% Change
    
    
    4.8
    %
    
    
    
    
    
    
    4.1
    %Average length of stay (days)(6)
    
    
    13.7
    
    
    
    14.8
    
    
    
    13.5
    
    
    
    14.5Health Plan Operating Data:Health Plan members (end of period)
    
    
    164,461
    
    
    
    167,749
    
    
    
    164,461
    
    
    
    167,749
   (1)
    
    The segment operating data excludes statistics for discontinued
operations. Same facility statistics exclude the operations of facilities
that were either acquired or divested subsequent to January 1,
2003. 37




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(2)
    
    Licensed beds are those beds for which a facility has been granted
approval to operate from the applicable state licensing agency.(3)
    
    Represents the total number of patients admitted (for a period in excess
of 23 hours) to our hospitals and is used by management and certain
investors as a general measure of inpatient volume.(4)
    
    Total delivery system includes all operating data at our owned hospitals
prior to elimination of services rendered to our Health Plan members.(5)
    
    Adjusted admissions and adjusted patient days are used by management and
certain investors as a general measure of combined inpatient and
outpatient volume. Adjusted admissions/patient days are computed by
multiplying admissions/patient days (inpatient volume) by the sum of gross
inpatient revenue and gross outpatient revenue and then dividing the
resulting amount by gross inpatient revenue. The adjusted
admissions/patient days computation equates outpatient revenue to the
volume measure (admissions/patient days) used to measure inpatient volume
resulting in a general measure of combined inpatient and outpatient
volume.(6)
    
    Represents the average number of days admitted patients stay in our
hospitals.(7)
    
    Net patient service revenue and related
admissions and adjusted admissions operating data within the
consolidated acute care services segment prior to January 1,
2004 excludes revenue and related operating data for services provided to the Lovelace Health
Plan members. Due to system limitations, it is impracticable to
restate net patient service revenues and related operating data for the three months and six
months ended June 30, 2003 for purposes of comparability.
Excluding Health Plan members, admissions and adjusted admissions were
6,185 and 13,155, respectively, for the three months ended June 30, 2004
and 12,596 and 26,305, respectively, for the six months ended June 30,
2004.(8)
    
    Represents the total number of days that
patients stayed in our hospitals over the
period. Three Months Ended June 30, 2004 Compared to Three Months Ended June 30,
2003 Total Net Revenues.The $39.3 million increase in total net revenues, a
12.4% increase over the three months ended June 30, 2003, was due to a
combination of an increase of $34.5 million in total net revenues from our
consolidated acute care services segment, and an increase of $5.2 million in
total net revenues from our behavioral care services segment. The $34.5 million, or 13.8%, increase in our consolidated acute care
total net revenues was primarily due to increases of $23.5 million in net
patient service revenue and $12.0 million in premium revenues. Net patient
service revenue increased due to an increase in patient volumes (including new
services and the expansion of existing services) and pricing increases. Total
delivery system adjusted admissions increased 8.0% during the three months
ended June 30, 2004. Premium revenue increased primarily due to an increase
in pricing as membership remained relatively flat. The $5.2 million, or 7.6%, increase in our behavioral care total net
revenues was attributed to $941,000 in total net revenues from the
acquisition of Brooke Glen effective October 8, 2003, as well as a $4.4
million increase in our same facility behavioral care total net revenues.
Adjusted patient days contributed by Brooke Glen totaled 1,896 during the
three months ended June 30, 2004. Since the acquisition in October 2003, we
have experienced a delay in obtaining our Medicare certification at Brooke
Glen. This delay has had a negative impact on our 2004 total net revenues and
results of operations. In May 2004, we received CMS certification of Brooke
Glen, which will allow for increased access to patient admissions and
improved results of operations in future periods. The $4.4 million increase
in same facility behavioral care total net revenues was predominantly related
to increases in patient volumes, pricing, expansion of existing services and
intensity of services. Adjusted admissions on a same facility basis increased
8.8%. Adjusted patient days on a same facility basis increased 0.7%. Salaries and Benefits.Salaries and benefits were 39.8% of total net
revenues for each of the three months ended June 30, 2004 and 2003. Salaries
and benefits in our consolidated acute care services segment were 32.0% of
total net revenues for the three months ended June 30, 2004, compared to
33.9% of total net revenues for the three months ended June 30, 2003. The
improvement in our consolidated acute care salaries and benefits as a
percentage of total net revenues was primarily due to the growth in our
markets and the related economies of scale. Lovelace was acquired on January
1, 2003. Due to the size of this acquisition, its integration and the related
synergies and economies of scale were not immediately recognized, but
occurred throughout 2003. Salaries and benefits in our behavioral care
services segment were 57.2% of total net revenues for the three months ended
June 30, 2004, compared to 54.1% of total net revenues for the three months
ended June 30, 2003. On a same facility basis, salaries and benefits as a
percentage of total net revenues were 55.3% and 54.2% for the three months
ended June 30, 2004 and 2003, respectively, in our behavioral care services
segment. These increases, on a same facility basis, were primarily
attributable to wage inflation brought on by nursing labor pressures due to 38




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the national shortage of nurses. The overall increase incremental to the
aforementioned same facility increases was primarily related to the delay in
obtaining our Medicare certification at Brooke Glen, which resulted in a
significantly higher than average staffing ratio on low volumes. The remainder of our salaries and benefits relate to costs not allocated
to our reportable operating segments, which include centralized services such
as information services, reimbursement, accounting, taxation, legal,
internal audit and risk management. Salaries and benefits not allocated were $8.6 million
during the three months ended June 30, 2004, or 2.4% of total net revenues,
compared to $4.9 million during the three months ended June 30, 2003, or 1.5%
of total net revenues. The increase in unallocated salaries and benefits
relates to the growth of our centralized services as we continued to enhance
these areas in connection with beginning to implement the internal control requirements of the Sarbanes-Oxley
Act and preparing for future growth. We anticipate our centralized services
costs to continue to increase in total during 2004 as we continue to grow and
integrate recent acquisitions. However, as a percentage of total net
revenues, we expect these costs to decline during 2004. During the three months ended June 30, 2004 our consolidated acute care
services segment was able to successfully manage the delivery of health care
services with proper staffing and utilization. However, we have been
negatively impacted by the industry-wide shortage of nurses, which has caused
labor pricing pressures and some level of dependence on contracted labor.
Should we be unable in the future to provide adequate nursing coverage at our
facilities, our future operating results could be negatively impacted through
increased salaries and wages and contract labor. Professional Fees.Professional fees include amounts paid to
non-employed physicians, third-party contractors and legal, accounting and
banking firms. Professional fees were 10.0% of total net revenues for the
three months ended June 30, 2004, compared to 10.2% of total net revenues for
the three months ended June 30, 2003. Professional fees in our consolidated
acute care services segment were 10.2% of total net revenues for the three
months ended June 30, 2004, compared to 8.9% of total net revenues for the
three months ended June 30, 2003. Professional fees in our behavioral care
services segment were 11.1% of total net revenues for the three months ended
June 30, 2004, compared to 11.0% of total net revenues for the three months
ended June 30, 2003. On a same facility basis, professional fees as a
percentage of total net revenues were 10.9% and 10.8% for the three months
ended June 30, 2004 and 2003, respectively, in our behavioral care services
segment. The
increase in our consolidated acute care professional fees as a percentage of
total net revenues is due to the growth within our markets, to
increased costs related to outsourcing certain claims administration
functions at our health plan and to
increased costs associated with information systems implementation. The increase in our same facility behavioral care
professional fees as a percentage of total net revenues was due primarily to
the increase in patient admissions. As a percentage of
revenues, we expect our professional fees to decline slightly in future
periods as a result of synergies and benefits from economies of scale
expected to be achieved from our recent acquisitions. The remainder of our professional fees relate to costs not allocated to
our reportable operating segments. Professional fees related to our
centralized services, including information services, legal and accounting,
were approximately $3.2 million and $3.5 million for the three months ended
June 30, 2004 and 2003, respectively. Beginning in 2004, we allocated such
costs to our reportable operating segments. In connection with becoming a public reporting entity in January, 2004, we began the
process of evaluating our business processes and related internal controls in
order to satisfy the internal control requirements of the
Sarbanes-Oxley Act. The implementation of the requirements of the Sarbanes-Oxley Act has and will continue to require
significant effort from our employees as well as our professional advisors.
We expect our professional fees to continue to increase in the near term
related to our Sarbanes-Oxley implementation. Claims and Capitation.Claims and capitation expense was 21.0% of total
net revenues for the three months ended June 30, 2004, compared to 21.3% of
total net revenues for the three months ended June 30, 2003. Before
eliminations, our medical care ratio, the claims and capitation costs as a
percentage of premium revenue, was 86.0% during the three months ended June
30, 2004. Prior to 2004, we did not record patient revenue within our acute
care facilities or claims and capitation expense on the Lovelace Health Plan
for health plan members who 39




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received services within our integrated Lovelace Sandia Health System
network. Beginning January 1, 2004, we began to present the Lovelace Health
Plan as a separate reportable segment. Supplies.Supply costs were 11.7% of total net revenues for the three
months ended June 30, 2004, compared to 11.9% of total net revenues for the
three months ended June 30, 2003. Supply costs in our consolidated acute care
services segment were 13.3% of total net revenues for the three months ended
June 30, 2004, compared to 13.6% of total net revenues during the three
months ended June 30, 2003. Supply costs in our consolidated acute care
services segment include the pharmaceutical costs of our retail pharmacies,
which were 90.7% of retail pharmacy revenue. Supply costs in our behavioral
care services segment were 5.2% of total net revenues for the three months
ended June 30, 2004, compared to 5.3% of total net revenues for the three
months ended June 30, 2003. On a same facility basis, supply costs as a
percentage of total net revenues were also 5.2% and 5.3% for the three months
ended June 30, 2004 and 2003, respectively, in our behavioral care services
segment. Provision for Doubtful Accounts.The provision for doubtful accounts was
4.5% of total net revenues during the three months ended June 30, 2004,
compared to 3.9% of total net revenues during the three months ended June 30,
2003. The provision for doubtful accounts in our consolidated acute care
services segment was 5.2% of total net revenues during the three months ended
June 30, 2004, compared to 4.3% of total net revenues during the three months
ended June 30, 2003. The provision for doubtful accounts in our behavioral
care services segment was 1.6% of total net revenues during the three months
ended June 30, 2004, compared to 2.1% of total net revenues during the three
months ended June 30, 2003. On a same facility basis, provision for doubtful
accounts as a percentage of total net revenues was 2.0% and 2.2% during the
three months ended June 30, 2004 and 2003, respectively, in our behavioral
care services segment. As previously discussed, we have experienced an increase in self-pay
amounts due from patients and a deterioration in the collectability of such
amounts, which has resulted in an increase in our provision for doubtful
accounts as a percentage of total net revenues. The increase in days sales outstanding is primarily related to changes
in how we manage the acute care activity within the Lovelace Sandia Health
System. Beginning on January 1, 2004, we managed the Health Plan as a
separate operating segment and our acute care services segment excludes the
operations of the Health Plan and includes net patient service revenue
related to services rendered at our acute care hospitals to our Health Plan
members. We believe this allows us to better manage the businesses within our
company and make better financial and operational decisions. As a result of
this change in how we managed these operations, we began adjudicating claims
for services provided to our Health Plan members. The adjudication of our
Health Plan claims, coupled with increased adjusted admissions and patient
days, significantly increased the volume of claims that our business
office was required to process and resulted in a build up of accounts receivable. We expect to decrease our days sales outstanding during
the remainder of 2004 as we continue to increase our business office
personnel to adjust to the increased volumes and enhance our
collection processes. The decrease in the provision for doubtful accounts in our behavioral
care services segment is primarily attributable to receiving our Medicare
certification at Brooke Glen, which has allowed for improved collections on
accounts that were previously estimated as uncollectable due to the delay in
certification. On a same facility basis, the provision for doubtful accounts
remained relatively consistent at 2.0% and 2.2% of total net revenues for the
three months ended June 30, 2004 and 2003, respectively. Interest and Change in Fair Value of Interest Rate Swap Agreements.
Interest expense and change in fair value of interest rate swap agreements
increased to $9.7 million, in aggregate, for the three months ended June 30,
2004 compared to $4.8 million for the three months ended June 30, 2003. Our
long-term debt balance was $260.6 million at June 30, 2004, compared to
$176.3 million at June 30, 2003. Our weighted average interest rate on our
outstanding debt increased due to our senior subordinated notes and
subordinated debt (issued in August 2003) having interest rates at 10.0% and 10.2%, respectively. 40




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In conjunction with our $225.0 million senior subordinated notes, we
entered into four interest rate swap agreements which converted $80.0 million
of the $225.0 million fixed-rate 10.0% borrowings to floating-rate
borrowings. Our interest rate swap agreements did not qualify for hedge
accounting under the provisions of SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities;therefore, we have recognized the changes
in fair value of the swaps in earnings. At June 30, 2004, the fair value of
our interest rate swap agreements was a liability of $831,000. On August 5,
2004, we terminated our interest rate swap agreements, resulting in a payment
of $267,000, which was the fair market value of the related liability. Depreciation and Amortization.Depreciation and amortization expense
increased to $11.7 million for the three months ended June 30, 2004 from $7.3
million for the three months ended June 30, 2003. Depreciation and
amortization in our Albuquerque market increased $1.5 million during the
three months ended June 30, 2004. In addition, depreciation not allocated to
our reportable operating segments increased $2.1 million during the three
months ended June 30, 2004, which was predominantly related to the
information systems build out to support our centralized services and public
reporting structure. Our capital expenditures for the three months ended June
30, 2004 and 2003 totaled $11.0 million and $19.6 million, respectively. The
capital expenditures during the 2003 fiscal year were $87.0 million. These
capital expenditures contributed to the increase in depreciation as the
respective assets became utilized and depreciable. Gain on Divestitures.Our gain on divestitures for the three months
ended June 30, 2003 was related to the sale of a behavioral hospital in
Oregon that was previously identified for sale under SFAS No. 121. Other Operating Expenses.Other operating expenses consist of insurance
costs (primarily general and professional liability), non-income
taxes (various states in which we operate have gross receipts taxes or
premium taxes), utilities, rents and leases, repairs and maintenance and
other operating expenses. Other operating expenses were 8.3% of total net
revenues during the three months ended June 30, 2004, compared to 9.3% of
total net revenues during the three months ended June 30, 2003. Other
operating expenses in our consolidated acute care services segment were 7.5%
of total net revenues during the three months ended June 30, 2004, compared
to 8.9% of total net revenues during the three months ended June 30, 2003.
Other operating expenses in our behavioral care services segment were 8.6% of
total net revenues during the three months ended June 30, 2004, compared to
8.1% of total net revenues during the three months ended June 30, 2003. On a
same facility basis, other operating expenses as a percentage of total net
revenues were 8.2% and 8.1% during the three months ended June 30, 2004 and
2003, respectively, in our behavioral care services segment. The decrease in our consolidated acute care services segment other
operating expenses as a percentage of total net revenues was due to the
growth within our markets and related economies of scale. The behavioral care
segment other operating expenses have remained relatively constant. The remainder of our other operating expenses relate to costs not
allocated to our reportable operating segments. Other operating expenses not
allocated were $2.2 million during the three months ended June 30, 2004
compared to $1.8 million during the three months ended June 30, 2003. These
costs predominantly relate to our centralized services, specifically our
lease costs for our corporate and information services facilities, which
increased as we grew our infrastructure. We anticipate these costs to decline
as a percentage of total net revenues during 2004 as we complete the build
out of our public reporting structure. We expect to see continued increases in the cost of insurance,
especially for general and professional liability, as the market has fewer
competitors and remains depressed. We have offset the pace of increases
through the establishment of a wholly-owned captive insurance subsidiary that
now insures our professional and general liability risk for claims up to $2.0
million, subject to a $500,000 deductible per claim. In addition, we
purchased excess insurance coverage with independent third-party carriers for
claims totaling up to $75.0 million per occurrence and in the aggregate. Income Tax Expense.Our income tax effective rate from continuing
operations was 37.2% for the three months ended June 30, 2004 compared to
38.3% for the three months ended June 30, 2003. The change primarily relates
to our state income tax rates. 41




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Net Income from Continuing Operations.Net loss from continuing
operations increased to $3.0 million for the three months ended June 30, 2004
from $486,000 for the three months ended June 30, 2003, primarily as a result
of proportionately higher increases in certain operating expenses compared to
total net revenues, most notably the $4.9 million increase in interest
expense and change in fair value of interest rate swap agreements and
the $4.4 million increase in depreciation and amortization. Income
(Loss) from Discontinued Operations. Income from
discontinued operations was $3.5 million for the three months
ended June 30, 2004 compared to a loss of
$474,000 for the three months ended June 30, 2003. For the three months ended June 30, 2004 we recorded a
gain on divestitures of $3.6 million associated with the divestiture
of a behavioral hospital effective April 1, 2004. Accrued Preferred Dividends.Our accrued preferred dividends amount to
8.0% of the principal amount and accrued unpaid dividends outstanding on our
redeemable preferred units. Effective January 2004, we amended the terms of
the preferred units such that the mandatory redemption date of August 19,
2014 was deleted, thereby removing the mandatory redemption feature. Had we
not amended the preferred units, effective January 1, 2004 we would have been
required to account for the preferred units as a liability and record the
dividends as interest expense. Six Months Ended June 30, 2004 Compared to Six Months Ended June 30,
2003 Total Net Revenues.The $95.6 million increase in total net revenues, a
15.2% increase over the six months ended June 30, 2003, was due to a
combination of an increase of $83.9 million in total net revenues from our
consolidated acute care services segment, and an increase of $12.5 million in
total net revenues from our behavioral care services segment. The $83.9 million, or 17.0%, increase in our consolidated acute care
total net revenues was primarily due to increases of $59.1 million in net
patient revenue and $24.5 million in premium revenues. Net patient revenue
increased due to an increase in patient volumes (including new
services and the
expansion of existing services) and pricing increases. Total delivery system
adjusted admissions increased 8.4% during the six months ended June 30, 2004.
Premium revenue increased primarily due to an increase in pricing as
membership remained relatively flat. The $12.5 million, or 9.2%, increase in our behavioral care total net
revenues was attributed to $2.2 million in total net revenues from the
acquisition of Brooke Glen effective October 8, 2003, as well as a $10.2
million increase in our same facility behavioral care total net revenues.
Adjusted patient days contributed by Brooke Glen totaled 4,587 during the six
months ended June 30, 2004. Since the acquisition in October 2003, we experienced a delay in obtaining our Medicare certification at Brooke Glen.
This delay has had a negative impact on our 2004 total net revenues and
results of operations. In May 2004, we received CMS certification of Brooke
Glen, which will allow for increased access to patient admissions and
improved results of operations in future periods. The $10.2 million increase
in same facility behavioral care total net revenues was predominantly related
to increases in patient volumes, pricing, expansion of existing services and
intensity of services. Adjusted admissions on a same facility basis
increased 10.1%. Adjusted patient days on a same facility basis increased
2.7%. Salaries and Benefits.Salaries and benefits were 39.9% of total net
revenues for each of the six months ended June 30, 2004 and 2003. Salaries
and benefits in our consolidated acute care services segment were 32.6% of
total net revenues for the six months ended June 30, 2004, compared to 33.9%
of total net revenues for the six months ended June 30, 2003. The improvement
in our consolidated acute care salaries and benefits as a percentage of total
net revenues was primarily due to the growth in our markets and the related
economies of scale. Lovelace was acquired on January 1, 2003. Due to the size
of this acquisition, its integration and the related synergies and economies
of scale were not immediately recognized, but occurred throughout 2003.
Salaries and benefits in our behavioral care services segment were 57.0% of
total net revenues for the six months ended June 30, 2004, compared to 54.6%
of total net revenues for the six months ended June 30, 2003. On a same
facility basis, salaries and benefits as a percentage of total net revenues
were 55.3% and 54.7% for the six months ended June 30, 2004 and 2003,
respectively, in our behavioral care services segment. These increases on a
same facility basis, were primarily attributable to wage inflation brought on
by nursing labor pressures due to the national shortage of nurses. The
overall increase incremental to the aforementioned same facility increases
was primarily related to the delay in obtaining our Medicare certification at
Brooke Glen, which resulted in a significantly higher than average staffing
ratio on low volumes. The remainder of our salaries and benefits relate to costs not allocated
to our reportable operating segments, which include centralized services such
as information services, reimbursement, accounting, taxation, legal,
internal audit and risk management. 42




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Salaries and benefits not allocated were $15.9 million
during the six months ended June 30, 2004, or 2.2% of total net revenues,
compared to $9.0 million during the six months ended June 30, 2003, or 1.4%
of total net revenues. The increase in unallocated salaries and benefits
relates to the growth of our centralized services as we continued to enhance
these areas in connection with beginning to implement the internal
control requirements of the Sarbanes-Oxley Act and
preparing for future growth. We anticipate our centralized services costs to
continue to increase in total during 2004 as we continue to grow and
integrate recent acquisitions. However, as a percentage of total net
revenues, we expect these costs to decline during 2004. During the six months ended June 30, 2004 our consolidated acute care
services segment was able to successfully manage the delivery of health care
services with proper staffing and utilization. However, we have been
negatively impacted by the industry-wide shortage of nurses, which has caused
labor pricing pressures and some level of dependence on contracted labor.
Should we be unable in the future to provide adequate nursing coverage at our
facilities, our future operating results could be negatively impacted through
increased salaries and wages and contract labor. Professional Fees.Professional fees were 9.1% of total net revenues for the six
months ended June 30, 2004, compared to 9.9% of total net revenues for the
six months ended June 30, 2003. Professional fees in our consolidated acute
care services segment were 9.1% of total net revenues for the six months
ended June 30, 2004, compared to 8.9% of total net revenues for the six
months ended June 30, 2003. Professional fees in our behavioral care services
segment were 11.1% of total net revenues for the six months ended June 30,
2004, compared to 10.7% of total net revenues for the six months ended June
30, 2003. On a same facility basis, professional fees as a percentage of
total net revenues were 10.8% and 10.5% for the six months ended June 30,
2004 and 2003, respectively, in our behavioral care services segment. The
increase in our consolidated acute care professional fees as a percentage of
total net revenues was due to the growth within our markets, to
increased costs related to outsourcing certain claims administration
functions at our health plan and to increased costs associated with
information systems implementation. The increase in our same facility behavioral care
professional fees as a percentage of total net revenues was due primarily to
the increase in patient admissions. As a percentage of revenues, we expect our
professional fees to decline slightly in future periods as a result of
synergies and benefits from economies of scale expected to be achieved from
our recent acquisitions. The remainder
of our professional fees relate to costs not allocated to
our reportable operating segments during 2003. Professional fees related to
our centralized services, including information services, legal and
accounting, were approximately $6.7 million and $5.9 million for the six
months ended June 30, 2004 and 2003, respectively. Beginning in 2004, we
allocated such costs to our reportable operating segments. In connection with becoming a public
reporting entity in January, 2004, we began the process of evaluating our
business processes and related internal controls in order to satisfy
the internal control requirements of the Sarbanes-Oxley Act. The
implementation of the requirements of
Sarbanes-Oxley Act has and will continue to require significant effort from our
employees as well as our professional advisors. We expect our professional
fees to continue to increase in the near term related to our Sarbanes-Oxley
implementation. Claims and Capitation.Claims and capitation expense was 20.2% of total
net revenues for the six months ended June 30, 2004, compared to 21.5% of
total net revenues for the six months ended June 30, 2003. Before
eliminations, our medical care ratio, the claims and capitation costs as a
percentage of premium revenue, was 85.9% during the six months ended June 30,
2004. Prior to 2004, we did not record patient revenue within the acute care
hospitals or claims and capitation expense on the Lovelace Health Plan for
health plan members who received services within our integrated Lovelace
Sandia Health System network. Beginning January 1, 2004, we began to present
the Lovelace Health Plan as a separate reportable segment. Supplies.Supply costs were 11.6% of total net revenues for the six
months ended June 30, 2004, compared to 11.9% of total net revenues for the
six months ended June 30, 2003. Supply costs in our consolidated acute care
services segment were 13.2% of total net revenues for the six months ended
June 30, 2004, compared to 13.6% of total net revenues during
the six months ended June 30, 2003. Supply costs in our consolidated acute care
services segment include the pharmaceutical costs of our retail pharmacies,
which were 81.4% of retail pharmacy revenue. Supply costs in our behavioral
care services segment were 5.2% of total net revenues for the 43




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six months ended June 30, 2004, compared to 5.3% of total net revenues
for the six months ended June 30, 2003. On a same facility basis, supply
costs as a percentage of total net revenues were also 5.2% and 5.3% for the
six months ended June 30, 2004 and 2003, respectively, in our behavioral care
services segment. Provision for Doubtful Accounts.The provision for doubtful accounts was
4.6% of total net revenues during the six months ended June 30, 2004,
compared to 3.7% of total net revenues during the six months ended June 30,
2003. The provision for doubtful accounts in our consolidated acute care
services segment was 5.2% of total net revenues during the six months ended
June 30, 2004, compared to 4.0% of total net revenues during the six months
ended June 30, 2003. The provision for doubtful accounts in our behavioral
care services segment was 2.2% of total net revenues during the six months
ended June 30, 2004, compared to 2.3% of total net revenues during the six
months ended June 30, 2003. On a same facility basis, provision for doubtful
accounts as a percentage of total net revenues was 2.3% and 2.5% during the
six months ended June 30, 2004 and 2003, respectively, in our behavioral care
services segment. As previously discussed, we have experienced an increase in self-pay
amounts due from patients and a deterioration in the collectability of such
amounts, which has resulted in an increase in our provision for doubtful
accounts as a percentage of total net revenues. Our accounts receivable has increased due to a corresponding
increase in net patient service revenue and an increase in days sales
outstanding, which were 67 and 59 as of June 30, 2004 and December 31, 2003,
respectively. The increase in days sales outstanding is primarily related to changes
in how we manage the acute care activity within the Lovelace Sandia Health
System. Beginning on January 1, 2004, we managed the Health Plan as a
separate operating segment and our acute care services segment excludes the
operations of the Health Plan and includes net patient service revenue
related to services rendered at our acute care hospitals to our Health Plan
members. We believe this allows us to better manage the businesses within our
company and make better financial and operational decisions. As a result of
this change in how we managed these operations, we began adjudicating claims
for services provided to our Health Plan members. The adjudication of our
Health Plan claims, coupled with increased adjusted admissions and patient
days, significantly increased the volume of claims that our business
office was required to process and resulted in a build up of accounts receivable during the six months
ended June 30, 2004. We expect to decrease our days sales outstanding during
the remainder of 2004 as we continue to increase our business office
personnel to adjust to the increased volumes and enhance our
collection processes. Interest and Change in Fair Value of Interest Rate Swap Agreements.
Interest expense and change in fair market value of interest rate swap
agreements increased to $14.9 million, in aggregate, for the six months ended
June 30, 2004 from $8.5 million for the six months ended June 30, 2003. Our
long-term debt balance was $260.6 million at June 30, 2004, compared to
$176.3 million at June 30, 2003. Our weighted average interest rate on our
outstanding debt increased due to our senior subordinated notes and
subordinated debt (issued in August 2003) having interest rates at 10.0% and 10.2%, respectively. In conjunction with our $225.0 million senior subordinated notes, we
entered into four interest rate swap agreements which converted $80.0 million
of the $225.0 million fixed-rate 10.0% borrowings to floating-rate
borrowings. Our interest rate swap agreements did not qualify for hedge
accounting under the provisions of SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities;therefore, we have recognized the changes
in fair value of the swaps in earnings. At June 30, 2004, the fair value of
our interest rate swap agreements was a liability of $831,000. On August 5,
2004, we terminated our interest rate swap agreements, resulting in a payment
of $267,000, which was the fair market value of the related liability. Depreciation and Amortization.Depreciation and amortization expense
increased to $22.5 million for the six months ended June 30, 2004 from $14.6
million for the six months ended June 30, 2003. Depreciation and amortization
in our Albuquerque market increased $2.4 million during the six months ended
June 30, 2004. In addition, depreciation not allocated to our reportable
operating segments increased $4.0 million during the six months ended June
30, 2004, which was predominantly related to the information systems build
out to support our centralized services and public reporting structure. Our
capital expenditures for the six months ended June 30, 2004 and 2003 totaled
$20.3 million and $27.4 million, respectively. The capital expenditures
during the 2003 44




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fiscal year were $87.0 million. These capital expenditures contributed
to the increase in depreciation as the respective assets became utilized and
depreciable. Gain on Divestitures.Our gain on divestitures for the six months ended
June 30, 2003 was related to the sale of a behavioral hospital in Oregon that
was previously identified for sale under SFAS No. 121. Other Operating Expenses.Other operating expenses consist of insurance
costs (primarily general and professional liability), non-income
taxes (various states in which we operate have gross receipts taxes or
premium taxes), utilities, rents and leases, repairs and maintenance and
other operating expenses. Other operating expenses were 8.6% of total net
revenues during the six months ended June 30, 2004, compared to 9.0% of total
net revenues during the six months ended June 30, 2003. Other operating
expenses in our consolidated acute care services segment were 7.7% of total
net revenues during the six months ended June 30, 2004, compared to 8.6% of
total net revenues during the six months ended June 30, 2003. Other operating
expenses in our behavioral care services segment were 8.6% of total net
revenues during the six months ended June 30, 2004, compared to 8.2% of total
net revenues during the six months ended June 30, 2003. On a same facility
basis, other operating expenses as a percentage of total net revenues were
8.2% during each of the six months ended June 30, 2004 and 2003, in our
behavioral care services segment. The decrease in our consolidated acute care services segment other
operating expenses as a percentage of total net revenues was due to the
growth within our markets and related economies of scale. The behavioral care
segment other operating expenses have remained relatively constant. The remainder of our other operating expenses relate to costs not
allocated to our reportable operating segments. Other operating expenses not
allocated were $5.2 million during the six months ended June 30, 2004
compared to $3.0 million during the six months ended June 30, 2003. These
costs predominantly relate to our centralized services, specifically our
lease costs for our corporate and information services facilities, which
increased as we grew our infrastructure. We anticipate these costs to decline
as a percentage of total net revenues during 2004 as we complete the build
out of our public reporting structure. We expect to see continued increases in the cost of insurance,
especially for general and professional liability, as the market has fewer
competitors and remains depressed. We have offset the pace of increases
through the establishment of a wholly-owned captive insurance subsidiary that
now insures our professional and general liability risk for claims up to $2.0
million, subject to a $500,000 deductible per claim. In addition, we
purchased excess insurance coverage with independent third-party carriers for
claims totaling up to $75.0 million per occurrence and in the aggregate. Income Tax Expense.Our income tax effective rate from continuing
operations was 39.0% for the six months ended June 30, 2004 compared to 40.1%
for the six months ended June 30, 2003. The change primarily relates to our
state income tax rates. Net Income from Continuing Operations.Net income from continuing
operations increased to $3.3 million for the six months ended June 30, 2004
from $1.8 million for the six months ended June 30, 2003, primarily as a
result of the increase in total net revenues while effectively managing the
utilization of our resources. Income
from Discontinued Operations. Income from
discontinued operations was $3.2 million and $114,000 for
the six months ended June 30, 2004 and 2003, respectively. For the
six months ended June 30, 2004, we recorded a gain on divestitures of
$3.6 million associated with the divestiture of a behavioral hospital
effective April 1, 2004. For the six months ended June 30, 2003, we
recorded pretax gains of $949,000 from the sale of another behavioral
hospital and recoveries of fully reserved items related to a
behavioral hospital sold in 2002. Accrued Preferred Dividends.Our accrued preferred dividends amount to
8.0% of the principal amount and accrued unpaid dividends outstanding on our
redeemable preferred units. Effective January 2004, we amended the terms of
the preferred units such that the mandatory redemption date of August 19,
2014 was deleted, thereby removing the mandatory redemption feature. Had we
not amended the preferred units, effective January 1, 2004 we would have been
required to account for the preferred units as a liability and record the
dividends as interest expense. Liquidity and Capital Resources Liquidity 45




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We require capital principally for the acquisition of additional acute
care and behavioral hospitals, the expansion of the services provided through
our existing facilities, improvements to these facilities, including
designing and implementing new information systems, and for debt service.
Historically, we have financed our capital requirements, including our
acquisitions, through a combination of cash flows from operations, borrowings
under credit facilities and proceeds from the issuance of subordinated debt
and equity securities. Sources and Uses of Cash Our cash and cash equivalents were $122.7 million at June 30, 2004,
compared to $89.8 million at December 31, 2003, an increase of $32.9 million
primarily related to proceeds from the issuance of common units. A more
detailed discussion on specific sources and uses of cash is set forth below. Three Months
    
    Six MonthsEnded June 30,
    
    Ended June 30,2004
    
    2003
    
    2004
    
    2003Statement of cash flows information:Cash flows provided by (used in) operating activities
    
    $
    24,153
    
    
    $
    6,173
    
    
    $
    (142
    )
    
    $
    15,546Cash flows used in investing activities
    
    
    (3,590
    )
    
    
    (18,520
    )
    
    
    (13,811
    )
    
    
    (212,653
    )Cash flows provided by (used in) financing activities
    
    
    49,239
    
    
    
    (8,032
    )
    
    
    48,155
    
    
    
    112,171
 Cash
flows used in operating activities were $142,000 for the six months
ended June 30, 2004, compared to cash flows provided by operating activities
of $15.5 million for the six months ended June 30, 2003. Our cash flows used
in operating activities were negatively impacted primarily by a $52.1 million
increase in accounts receivable. The increase in accounts receivable relates
to the previously discussed increase in our days sales outstanding, which
increased from 59 days at December 31, 2003 to 67 days at June 30, 2004. The
increase in days sales outstanding equates to approximately $16.6 million.
The remaining increase is due primarily to an increase in net patient service
revenue, which resulted in a corresponding increase in accounts receivable. Cash flows used in investing activities decreased to $13.8 million for
the six months ended June 30, 2004, compared to $212.7 million for the six
months ended June 30, 2003. Our total cash spent for the six months ended
June 30, 2004 related to capital expenditures was $20.3 million. During the
six months ended June 30, 2003, we spent $194.1 million on acquisitions,
primarily to acquire Lovelace Health System, Inc. Cash flows provided by financing activities were $48.2 million in 2004,
compared to cash flows provided by financing activities of $112.2 million in
2003. We financed our Lovelace acquisition primarily from our credit
facilities, which were paid in full from the proceeds of our senior
subordinated notes and equity issued in 2002. Restrictions on Cash Flows Lovelace Sandia Health System, Inc., our wholly-owned subsidiary,
includes, in addition to hospitals and other health care facilities, the
Lovelace Health Plan. Lovelace Sandia Health System, Inc. is therefore
subject to certain restrictions on its ability to pay dividends or make other
distributions to us by state insurance company laws and regulations. These
laws and regulations require Lovelace Sandia Health System, Inc. to give
notice to the New Mexico Department of Insurance prior to paying dividends or
making distributions to us. Lovelace Sandia Health System, Inc. has paid
dividends of $25.0 million to our affiliates since its acquisition. As of
June 30, 2004, cash and cash equivalents at Lovelace Sandia Health System,
Inc. were $21.9 million. In addition, Lovelace Sandia Health System, Inc. is
subject to state-imposed net worth-based capital requirements that
effectively limit the amount of funds it has available to distribute to us.
As of June 30, 2004, Lovelace Sandia Health System, Inc. is required to
maintain a net worth of approximately $34.8 million (based on the unaudited
annual statement filing with the State of New Mexico), as well as a minimum
requirement of $610,000 in cash or short-term government instruments. Actual
net worth exceeded the requirement by $10.3 million and, subject to the
requirements, may be available to us. On July 12, 2004, Lovelace
Sandia Health System, Inc.s intercompany note was reduced from
$70.0 million to $43.0 million with a corresponding
increase to net worth. Refer to Capital Resources for
further discussion. This additional net worth will provide, in part, the additional capital required in connection with our acquisition
of approximately 30,000 commercial members of Cimarron Health Plan. In addition, as part of Lovelace Health
Plans participation in the Medicaid Salud! program for New Mexico, Lovelace
Sandia Health System, Inc. is required to maintain a cash reserve of at least
3.0% of the annual capitated payments per member for each month of the first
year of the 46




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contract. As of June 30, 2004, Lovelace Sandia Health System, Inc.
maintained a balance of $3.4 million to meet these two required reserve
amounts. As a result of the consolidation and merger of our New Mexico operations
in October 2003, all of our operations in New Mexico (other than the
operations of AHS S.E.D. Medical Laboratories, Inc.) are owned by Lovelace
Sandia Health System, Inc. and are subject to the restrictions and
requirements described above. Cash Requirements During the three months and six months ended June 30, 2004, there were
no material changes in our contractual obligations presented in our 2003
Annual Report on Form 10-K. In connection with the Hillcrest
acquisition in August 2004, we
borrowed an additional $300.0 million of senior secured term
debt under the August 2003 Credit
Agreement, as amended, as further discussed in Capital
Resources, and assumed or replaced certain operating and
capital leases of Hillcrest. We also committed to invest
approximately $100.0 million in capital expenditures in the Tulsa
market over the next five years. Letters of Credit We are required to issue letters of credit for the benefit of our
insurers related to our workers compensation and professional liability
insurance coverage. As of June 30, 2004, we had issued $7.1 million of
standby letters of credit which were secured by the collateral of our August
2003 Credit Agreement. In connection with the Hillcrest acquisition and
related amendment to the August 2003 Credit Agreement, we issued an additional
$3.3 million of standby letters of credit on August 12, 2004. Capital Expenditures (including Capital Commitments) Capital expenditures, excluding amounts paid for acquisitions, were
$11.0 million and $19.6 million for the three months ended June 30, 2004 and
2003, respectively, and $20.3 million and $27.4 million for the six months ended June 30,
2004 and 2003, respectively. Generally, the facilities and equipment at the
hospitals we have acquired were in good condition; however, we have invested,
and will continue to invest, significant funds into facility improvements and
service enhancements undertaken by our hospitals. Excluding Hillcrest, we expect to make
total capital expenditures in our existing facilities of approximately $60.0
million during 2004. We expect to fund these expenditures through cash
provided by operating activities and borrowings under our bank
facility. As previously discussed, we have committed to invest $80.0 million of
capital expenditures in the Albuquerque market through 2008, of which $58.9
million has been invested through June 30, 2004. We expect that the remaining
$21.1 million will be invested in the Albuquerque market during the remainder
of 2004 as we continue to upgrade financial and clinical systems, expand
service lines and refurbish and retool facilities. Effective August 1, 2004, we completed the previously announced
transaction with Molina Healthcare, Inc. to transfer approximately
30,000 commercial members of Cimarron Health Plan to the Lovelace Health
Plan, which is part of Lovelace Sandia Health System, Inc., for approximately
$16.0 million, plus additional contingent consideration of up to $3.5 million
subject to the satisfaction of certain conditions. We funded the transaction
with available cash on hand. On
August 12, 2004, we completed the previously announced acquisition of
Hillcrest in Tulsa, Oklahoma. We acquired substantially all of the net operating assets of
Hillcrest for $326.3 million, including preliminary working capital, subject to customary adjustments. The
acquisition consisted primarily of two metropolitan Tulsa hospitals and
related health care entities, as well as six regional hospitals acquired
or intended to be acquired through long-term operating agreements. In connection with the Hillcrest
acquisition, we committed to invest approximately $100.0 million in capital
expenditures in the Tulsa market over the next five years. 47




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The
aggregate purchase price of the Hillcrest acquisition was paid in
cash and financed, in part, with the $58.3 million of proceeds invested by
WCAS, Ferrer Freeman and BAC pursuant to the subscription agreement with us
and further discussed in Note 7 to the accompanying unaudited condensed
consolidated financial statements. The remaining purchase price was financed
through an additional borrowing of senior secured term debt borrowed on August 12, 2004 in the
principal amount of $300.0 million, as further discussed in Capital
Resources. Our August 2003 Credit Agreement described below contains provisions
that limit annual capital expenditures. We increased this limit in
conjunction with the August 2003 Credit Agreement, as amended, to provide for forecasted
capital expenditures, including the $100.0 million capital expenditure
commitment related to the recently completed Hillcrest acquisition. We
believe our forecasted and committed capital expenditures will be sufficient
to meet our quality and growth objectives while allowing us to expand our
service lines and complete our implementation of clinical and information
systems; however, there can be no assurance that we will be able to obtain
the financing required to provide for forecasted capital expenditures. Capital Resources Long-term Debt and Capital On August 19, 2003, we received $225.0 million through the issuance of
10.0% senior subordinated notes due on August 15, 2013. We used the proceeds
from the offering to repay all amounts outstanding under our then existing
credit facilities of $155.2 million plus accrued interest. On March 1, 2004,
we exchanged all of our outstanding 10.0% senior subordinated notes due
August 15, 2013, for 10.0% senior subordinated notes due August 15, 2013,
that have been registered under the Securities Act of 1933, as amended. Terms
and conditions of the exchange offer were as set forth in the registration
statement on Form S-1 filed with the Securities and Exchange Commission that
became effective on January 28, 2004. Interest on the senior subordinated
notes is payable semi-annually on February 15 and August 15. We may redeem
the senior subordinated notes, in whole or in part, at any time before August
15, 2008, at the principal amount plus a premium and accrued and unpaid
interest. We may redeem the senior subordinated notes after August 15, 2008,
at redemption prices ranging from 105.0% to 100.0%, plus accrued and unpaid
interest. Additionally, at any time prior to August 15, 2006, we may redeem
up to 35.0% of the principal amount of the senior subordinated notes with the
net cash proceeds of one or more sales of our capital stock at a redemption
price of 110.0% plus accrued and unpaid interest to the redemption date;
provided that at least 65.0% of the aggregate principal amount of the senior
subordinated notes originally issued on August 19, 2003 remains outstanding
after each such redemption and the redemption occurs within 90 days of the
date of closing of the equity offering. Payment of the principal and interest of the senior subordinated notes
is subordinate to amounts owed for our existing and future senior
indebtedness. The senior subordinated notes are guaranteed, fully and
unconditionally, jointly and severally, on an unsecured senior subordinated
basis by all of our material subsidiaries (the Subsidiary Guarantors), other
than Lovelace Sandia Health System, Inc. and our captive insurance
subsidiary.
We are subject to certain restrictive covenants under the Indenture governing
the senior subordinated notes.  We have designated certain of our
immaterial affiliates as unrestricted subsidiaries under the indenture
governing the senior subordinated notes. None of these unrestricted
subsidiaries carry on any significant business or conduct any operations and,
as a result, they are not material to our business, financial condition or
results of operations. On August 19, 2003, concurrent with the issuance of the senior
subordinated notes, we replaced our existing credit agreement with
the August 2003 Credit Agreement with a
syndicate of banks and other institutional lenders. The August 2003 Credit
Agreement consisted of a $125.0 million revolving line of credit, subject to a
borrowing base, including a swing-line loan of $10.0 million and an
incremental term loan under which we were permitted to request term loans of up to $200.0
million.  The
August 2003 Credit Agreement contained various financial covenants including
requirements to maintain a minimum interest coverage ratio, a total leverage
ratio, a senior leverage ratio, a minimum net worth of the health
maintenance organization subsidiaries,
and a capital expenditures maximum. At June 30, 2004, we were in compliance
with all such covenants. The August 2003 Credit Agreement also
restricted
certain of our activities including our ability to incur additional debt,
declare dividends, 48




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repurchase stock, engage in mergers and acquisitions and sell assets. On August 12, 2004, we amended our August 2003 Credit Agreement to,
among other things, increase our $125.0 million revolving line of credit to a
$150.0 million revolving line of credit and add $300 million of additional
borrowing available under an add-on term loan (Term Loan B). We also
retained the $200.0 million of incremental term loans available, under
certain conditions, under the existing August 2003 Credit Agreement. Concurrent with
the amendment, we received $300.0 million through borrowings of the amount
available under Term Loan B. Interest on Term Loan B is payable quarterly at
an interest rate of either LIBOR plus 2.25% or a base rate plus 1.25%. Principal payments of 0.25% of the
original principal borrowed on Term Loan B are to be paid quarterly, with the
remaining principal to be paid at maturity. Term Loan B matures August 12,
2011. The revolving line of credit bears interest initially at LIBOR plus
2.50%. The interest on the revolving line of credit is payable on the
outstanding principal balance on the last day of the selected interest
period. The principal amount of the revolving line of credit is to be paid in
full on August 19, 2008. We have not incurred borrowings under the revolving
line of credit or incremental term loans as of August 16, 2004; other
than standby letters of credit totaling $10.4 million that reduce the
amount available under the revolving line of credit. We continue to pay a commitment fee ranging from 0.50% to 0.75% of the
average daily amount of availability under the revolving credit facility and
other fees based on the applicable LIBOR margin on outstanding standby
letters of credit. The August 2003 Credit Agreement, as amended, contains various
financial covenants including requirements for us to maintain a minimum
interest coverage ratio, a total leverage ratio, a senior leverage ratio, a
minimum net worth of the health maintenance organization subsidiaries and a
capital expenditures maximum. The August 2003 Credit Agreement,
as amended, also restricts
certain of our activities, including our ability to incur additional debt,
declare dividends, repurchase stock, engage in mergers or acquisitions and
sell assets. The August 2003 Credit Agreement, as amended, is guaranteed by us and our
material and future subsidiaries, other than Lovelace Sandia Health System,
Inc. and our captive insurance subsidiary, and is secured by substantially all
of our existing and future property and assets and capital stock of all of
our subsidiaries. In connection with the merger of our New Mexico subsidiaries on October
1, 2003, Lovelace Sandia Health System, Inc. (the surviving entity) issued a
$70.0 million intercompany note to Ardent Health Services, Inc. Interest
accrues at a rate equal to the greater of (i) our base rate plus 4.0% or (ii)
6.0%. Interest is payable on demand. Principal is payable on the later of
November 19, 2008 or 30 days after the maturity date of our incremental term
loan, if any. We were required to maintain a pledge of the intercompany note
in favor of the lenders of our August 2003 Credit Agreement and the holders
of the senior subordinated notes. Effective January 1, 2004, the intercompany
note was transferred to a subsidiary of Ardent Health Services, Inc. On July
12, 2004, the August 2003 Credit Agreement was amended to, among other
things, reduce the pledge required to be maintained by the Company to $43.0
million, upon which the intercompany note was also amended to reduce the
principal amount of the note to $43.0 million. Interest Rate Swap Agreements In September 2003, we entered into four interest rate swap agreements
with large financial institutions which converted a notional amount of $80.0
million of the senior subordinated notes to floating-rate borrowings. The
swap agreements mature in $40.0 million increments on August 15, 2006 and
August 15, 2008. The floating interest rate is based on six month LIBOR plus
a margin and is determined for the six months ended in arrears on semi-annual
settlement dates of February 15 and August 15. The swap agreements do not qualify for hedge
accounting, thus changes in the fair value of our interest rate hedging
arrangements are recognized each period in earnings. All earnings adjustments
resulting from changes in the fair values of the interest rate swaps are
non-cash charges or credits and do not impact cash flows from operations or
operating income. There may be periods with significant non-cash increases or
decreases to our earnings relating to the change in the fair value of the
interest rate swap agreements. The fair value of the swap obligations was a
liability of $831,000 at June 30, 2004. On August 5, 2004, we terminated our 49




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interest rate swap agreements, resulting in a payment of $267,000, which
was the fair market value of the related liability. Availability of Capital Resources We believe that the cash flows generated by our operations, together
with amounts available under our August 2003 Credit Agreement,
as amended, and cash on
hand will be sufficient to meet our operating and capital needs for at least
the next twelve months. At June 30, 2004, we had borrowing capacity of $117.9 million on our
revolving line of credit and, in certain circumstances, $200.0 million on our
term loans. In connection with our acquisition of Hillcrest on August 12,
2004, we amended our credit facility to, among other things, accommodate an
additional $25.0 million borrowing capacity on our revolving line of credit
and add $300.0 million of additional borrowing available under an
add-on term loan. Concurrent with the
amendment, we borrowed the $300.0 million available under our Term Loan B to
fund, in part, the Hillcrest acquisition, after which we have borrowing
capacity of $139.6 million on our revolving line of credit and, in certain
circumstances, $200.0 million on our term loans. We intend to acquire
additional hospitals and are actively seeking acquisitions that fit our
corporate growth strategy. These acquisitions may, however, require financing
in addition to the capital on hand and future cash flows from operations. We
continually assess our capital needs and may seek additional financing,
including debt or equity, as considered necessary to fund potential
acquisitions or for other corporate purposes. We anticipate that our
acquisition strategy will necessitate the funding of future acquisitions
through use of our amended credit facility and use of other financing means
that may not be available to us at those times. We expect to finance our
future acquisitions in large part through additional borrowings; however,
there can be no assurance that we will be able to obtain future financing or
financing on terms favorable to us. Recently Issued Accounting Standards A discussion of recently issued accounting pronouncements and their
effect on our financial position and results of operations can be found in
Note 2 to our unaudited condensed consolidated financial statements. Seasonality We typically experience higher patient volumes in the first and fourth
quarters of each year. We typically experience such seasonal volume peaks
because more people generally become ill during the winter months, which in
turn results in significant increases in the number of patients we treat
during those months. Inflation The health care industry is labor intensive. Wages, contract labor and
other expenses increase during periods of inflation and when shortages in
marketplaces occur. In addition, our supply costs and insurance costs are
subject to inflation as the respective vendors pass along their increased
costs to us in the form of higher prices. Our ability to pass on these
increased costs is limited because of increasing regulatory and competitive
pressures. Accordingly, inflationary pressures could have a material adverse
effect on our results of operations. 
 Item 4. Controls and Procedures. We conducted an evaluation, under the supervision of our chief executive
officer and chief financial officer, of the effectiveness as of June 30, 2004
of our disclosure controls and procedures (as defined in Rules 13a-15(e) and
15d-15(e) under the Securities Exchange Act of 1934, as amended (the
Exchange
Act)). Based on this evaluation, our chief executive officer and chief
financial officer have concluded that our disclosure controls and 50




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procedures were effective as of June 30, 2004. There was no change in our internal control over financial reporting
during our last fiscal quarter that has materially affected, or is reasonably
likely to materially affect, our internal control over financial reporting. As previously disclosed, we have identified certain matters with
respect to period-end closing processes, including matters related to
the lack of timely and accurate review and reconciliations of account
balances. We also are in the initial phases of our efforts to comply
with the internal control requirements of Section 404 of the
Sarbanes-Oxley Act. Additionally, an integral part of our
business strategy is the continued selective acquisitions of acute
care and behavioral hospitals. Many of our acquisition targets may
not have systems of internal control over financial reporting that
would comply with the internal control requirements of Section 404 of the
Sarbanes-Oxley Act. Based on the matters previously identified, our
continued efforts to comply with the internal control requirements of Section 404 of the Sarbanes-Oxley Act and our acquisition strategy, we anticipate that we will
identify additional weaknesses and deficiencies in our internal control over
financial reporting. We have implemented and will continue to
implement action plans to remedy any deficiencies or weaknesses
identified. 51




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PART II OTHER INFORMATION 
 Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of
Equity Securities During the three months ended June 30, 2004, certain holders of the
Companys common units exercised their right to purchase 11,111,109 common
units at $4.50 per unit pursuant to a subscription agreement between the
Company and such holders. These transactions were exempt from registration
pursuant to, among other things, Section 4(2) and Regulation D under the
Securities Act of 1933, as amended (the Securities Act). In addition, an
employee of the Company exercised options to purchase 2,500 common units at
$3.43 per unit. This transaction was exempt from registration pursuant to,
among other things, Rule 701 under the Securities Act. 
 Item 6. Exhibits and Reports on Form 8-K. (a) Exhibits: The following exhibits are filed with this report. Exhibit No.
    
    Description2.1
    
    Asset Purchase Agreement, dated as
of May 11, 2004, between Hillcrest HealthCare System and Ardent Health
Services, Inc.2.2
    
    Assets Purchase Agreement, dated as of July 20, 2004, between Heritage
Home Healthcare and Lovelace Sandia Health System, Inc.3.1
    
    Certificate of Formation of Ardent Health Services LLC, as
filed with the Delaware Secretary of State on June 1, 2001
(Incorporated by reference to Exhibit 3.1 to the Registrants
Registration Statement on Form S-1, File No. 333-110117)3.2
    
    Limited Liability Company Agreement of Ardent Health Services
LLC, including Amendment No. 1 thereto (Incorporated by
reference to Exhibit 3.2 to the Registrants Registration
Statement on Form S-1, File No. 333-110117)3.3
    
    Amendment No. 2 to Limited Liability Company Agreement of
Ardent Health Services LLC (Incorporated by reference to
Exhibit 3.3 to the Registrants Annual Report on Form 10-K for
the year ended December 31, 2003)10.1
    
    First Amendment to Credit Agreement dated as of December 31,
2003 among Ardent Health Services, Inc., as Borrower, Ardent
Health Services LLC and certain of its subsidiaries as
Guarantors, Bank One, NA, as Administrative Agent, Swing Line
Lender and L/C Issuer and the Lenders party thereto10.2
    
    Second Amendment to Credit Agreement dated as of July 12, 2004
among Ardent Health Services, Inc. as Borrower, Ardent Health
Services LLC and certain of its subsidiaries as Guarantors,
Bank One, NA, as Administrative Agent, Swing Line Lender and
L/C Issuer and the other Lenders party thereto10.3
    
    Second Amended and Restated Intercompany Promissory Note dated
July 12, 2004 issued by Lovelace Sandia Health System, Inc. in
favor of Ardent Medical Services, Inc.10.4
    
    Employment Agreement, dated as of
July 1, 2004, between AHS Management Company, Inc. and David T.
Vandewater10.5
    
    Amended and Restated Employment and
Consulting Agreement, dated as of June 7, 2004, between AHS
Management Company, Inc. and Vernon S. Westrich31.1
    
    Certification of CEO pursuant to Rule 13a-14(a)/15d-14(a), as
adopted pursuant to Section 302 of the Sarbanes-Oxley Act of
200231.2
    
    Certification of CFO pursuant to Rule 13a-14(a)/15d-14(a), as
adopted pursuant to Section 302 of the Sarbanes-Oxley Act of
200232.1
    
    Certification of CEO pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
200232.2
    
    Certification of CFO pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002
 (b) Reports on Form 8-K During the Quarter Ended June 30, 2004 On April 7, 2004, the Company filed a Current Report on Form 8-K, pursuant
to Item 4, regarding changes in the Companys certifying accountant. On May 4, 2004, the Company furnished a Current Report on Form 8-K,
pursuant to Item 12, regarding the Companys press release announcing its
financial results for the first quarter ended March 31, 2004. On May 12, 2004, the Company filed a Current Report on Form 8-K, pursuant to
Item 5, relating to the Companys execution of a definitive agreement to
acquire Hillcrest HealthCare System in Tulsa, Oklahoma. 52




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##### Table of Contents



SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized. ARDENT HEALTH SERVICES LLCBy:
    /s/ R. Dirk
AllisonR. Dirk AllisonExecutive Vice President and Chief Financial Officer(Principal Financial Officer, Chief
Accounting Officer and Authorized Signatory)
 Date: August 16, 2004 53




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##### Table of Contents



EXHIBIT INDEX Exhibit No.
    
    Description2.1
    
    Asset Purchase Agreement, dated as
of May 11, 2004, between Hillcrest HealthCare System and Ardent Health
Services, Inc.2.2
    
    Assets Purchase Agreement, dated as of July 20, 2004, between Heritage
Home Healthcare and Lovelace Sandia Health System, Inc.3.1
    
    Certificate of Formation of Ardent Health Services LLC, as
filed with the Delaware Secretary of State on June 1, 2001
(Incorporated by reference to Exhibit 3.1 to the Registrants
Registration Statement on Form S-1, File No. 333-110117)3.2
    
    Limited Liability Company Agreement of Ardent Health Services
LLC, including Amendment No. 1 thereto (Incorporated by
reference to Exhibit 3.2 to the Registrants Registration
Statement on Form S-1, File No. 333-110117)3.3
    
    Amendment No. 2 to Limited Liability Company Agreement of
Ardent Health Services LLC (Incorporated by reference to
Exhibit 3.3 to the Registrants Annual Report on Form 10-K for
the year ended December 31, 2003)10.1
    
    First Amendment to Credit Agreement dated as of December 31,
2003 among Ardent Health Services, Inc., as Borrower, Ardent
Health Services LLC and certain of its subsidiaries as
Guarantors, Bank One, NA, as Administrative Agent, Swing Line
Lender and L/C Issuer and the Lenders party thereto10.2
    
    Second Amendment to Credit Agreement dated as of July 12, 2004
among Ardent Health Services, Inc. as Borrower, Ardent Health
Services LLC and certain of its subsidiaries as Guarantors,
Bank One, NA, as Administrative Agent, Swing Line Lender and
L/C Issuer and the other Lenders party thereto10.3
    
    Second Amended and Restated Intercompany Promissory Note dated
July 12, 2004 issued by Lovelace Sandia Health System, Inc. in
favor of Ardent Medical Services, Inc.10.4
    
    Employment Agreement, dated as of
July 1, 2004, between AHS Management Company, Inc. and David T.
Vandewater10.5
    
    Amended and Restated Employment and
Consulting Agreement, dated as of June 7, 2004, between AHS
Management Company, Inc. and Vernon S. Westrich31.1
    
    Certification of CEO pursuant to Rule 13a-14(a)/15d-14(a), as
adopted pursuant to Section 302 of the Sarbanes-Oxley Act of
200231.2
    
    Certification of CFO pursuant to Rule 13a-14(a)/15d-14(a), as
adopted pursuant to Section 302 of the Sarbanes-Oxley Act of
200232.1
    
    Certification of CEO pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
200232.2
    
    Certification of CFO pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002
 54