A listing of our owned acute hospitals is included in Item 1 of this report under the caption “Business-Our Facilities”. We also own or lease space for outpatient service facilities complementary to our hospitals and own and operate certain medical office buildings (some of which are joint ventures) associated with our hospitals that are occupied primarily by physicians who practice at our hospitals. The most significant of these complementary outpatient health care facilities are two surgery centers in Orange County, California and five diagnostic imaging centers in metropolitan Phoenix, Arizona. All of these outpatient facilities are in leased facilities, and the surgery centers are owned in joint ventures where we have minority partners. Also, we just completed construction on West Valley Hospital Medical Center, a 74-bed acute care hospital in Goodyear, Arizona, which admitted its first patient on September 4, 2003.
Our headquarters, hospitals and other facilities are suitable for their respective uses and are, in general, adequate for our present needs. Our obligations under our amended 2001 credit facility are secured by a pledge of substantially all of our assets, including first priority mortgages on each of our hospitals. Also, our properties are subject to various federal, state and local statutes and ordinances regulating their operation. Management does not believe that compliance with such statutes and ordinances will materially affect our financial position or results from operations.
The following table sets forth selected consolidated financial data of our Company for, or as the end of, each of the five years ended June 30, 2003. The selected financial data for the years ended June 30, 1999, 2000, 2001, 2002 and 2003 are derived from our audited financial statements. The timing of acquisitions completed during fiscal years 2000, 2001, 2002 and 2003 affects the comparability of the selected historical financial data. Please read this table in conjunction with the “
The following discussion and analysis of financial conditions and results of operations should be read in conjunction with our consolidated financial statements, notes to our consolidated financial statements and other financial information appearing elsewhere in this report.
• Our ability to complete value-added acquisitions and to effectively and efficiently integrate those
• Costs associated with newly enacted HIPAA regulations and other management information system integrations
• Increased cost of professional and general liability insurance and increases in the quantity and severity
• The ability to maintain and increase patient volumes and control the costs of providing services including
• Our failure to comply, or allegations of our failure to comply, with applicable laws and regulations
Acquiring acute care hospitals in urban and suburban markets is a key part of our business strategy. Since we have grown most years through acquisitions, it is difficult to make meaningful comparisons between our financial statements for the fiscal periods presented. In addition, we own a relatively small number of hospitals, which can cause an individual acquisition to have a material effect on our overall operating performance. When we acquire a hospital, we generally implement a number of measures to lower costs and may also make significant investments in the facility to expand services, strengthen the medical staff and improve our overall market position. The effects of these initiatives are not generally realized immediately. Therefore, the financial performance of a newly acquired hospital may adversely affect our overall performance in the short term.
On May 1, 2001, we acquired Phoenix Memorial Hospital and the Phoenix Health Plan in Phoenix, Arizona. We financed this acquisition through sales of our common stock to existing stockholders and the assumption of certain liabilities of the seller. The fiscal 2001 results of operations include two months of operations for the hospital and health plan.
We also acquired non-significant health care related businesses during fiscal 2001 through the assumption of certain liabilities of the seller and use of available cash. The fiscal 2001 results of operations include operations for each of these acquisitions from the date of acquisition through June 30, 2001. The total purchase price for net assets acquired for the 2001 acquisitions was $31.6 million, comprised of assets acquired of $87.9 million and liabilities assumed of $56.3 million. We financed the purchase price for net assets acquired with cash raised from the sale of approximately $32.9 million of our common stock to our existing stockholders and the assumption of certain liabilities of the sellers.
On June 3, 2002, but effective June 1, 2002, we acquired, through a majority-owned acquisition subsidiary, substantially all of the assets of Louis A. Weiss Memorial Hospital in Chicago, Illinois. We paid cash of $44.0 million, net of a $2.5 million payment received for the minority joint venture partner’s 19.9% interest in the acquisition subsidiary, to satisfy the purchase price for net assets acquired. We financed the acquisition with a portion of the proceeds from the July 30, 2001 issuance of the 9.75% Notes. The fiscal 2002 results of operations include one month of operations for this hospital.
Expanding the spectrum of health care services provided by our facilities. We believe that a key factor in increasing patient volume is to provide the communities we serve a comprehensive medical solution. This strategy requires effective recruiting and retention programs for general practitioners and specialists and maintaining quality nursing support as well as a commitment to capital projects to provide current technology, service our existing facility framework and to expand facilities and services where necessary to meet the health care needs of the communities we serve. Also, we believe completing strategic acquisitions to achieve in-market or new market growth and efficiencies will allow us to better serve our patients while improving our operating performance. Our facility expansion strategies include construction of new facilities in underserved areas of our markets as demonstrated by our construction of West Valley Hospital Medical Center in western metropolitan Phoenix.
Identifying geographic markets that provide a strategic fit with our goals and objectives. We expect to continue pursuing acquisition activities in markets where we can obtain significant market share and capture additional volume of the aging U.S. population. According to the U.S. Census Bureau, there are approximately 35 million Americans aged 65 or older in the United States today, comprising approximately 13% of the total U.S. population. By the year 2030, the number of these elderly persons is expected to reach 69 million, or 20% of the total population. We believe that our initiatives will position us to capitalize on this demographic trend. Obtaining significant market share in key geographic markets provides opportunities to expand services to those communities, provides flexibility in negotiations with managed care and other third party payers and strengthens our base for recruitment of health care professionals.
Although we expect the initiatives above to increase our patient volumes and revenues, the following risk factors could offset those increases:
Many procedures once performed exclusively at hospitals are now being provided on an outpatient basis. Advances in technology and the focus of payers on treating lower acuity patients in a less expensive setting have driven the increase in outpatient utilization. For the year ended June 30, 2003, 65% of the total surgeries performed by our hospitals were outpatient surgeries. Outpatient revenues as a percentage of gross patient revenues were 34.5% for the year ended June 30, 2003. The significance of outpatient utilization is offset somewhat by the aging of the baby boomer population and population growth rates that exceed the national average in certain of our markets, which supports increased inpatient days and surgeries. Typically, the payments we receive for outpatient procedures are less than those for the same procedures performed in an inpatient setting.
Federal regulators, including the U.S. Department of Justice, the Office of the Inspector General of the U.S. Department of Health and Human Services and the Centers for Medicare and Medicaid Services (“CMS”), have recently intensified their scrutiny of Medicare outlier payments to hospitals. Medicare outlier payments are additional funds provided to hospitals for the treatment of patients who require more costly treatment than the typical patient. Congress has mandated that CMS limit Medicare outlier payments to between five and six percent of total DRG payments. To achieve this mandate, in recent years CMS periodically adjusted the cost threshold used to determine eligibility and allocation of available Medicare outlier payments. In December 2002, CMS began analyzing data to identify hospitals with high outlier payments for further audit or review and announced its intent to revise the current rules for determining outlier payments. Based upon data from our most recently filed Medicare cost reports, our Medicare outlier payments as a percentage of total Medicare DRG payments and as a percentage of total gross charges from all payer categories are 2.7% and 0.2%, respectively, which include the effects of the acquisition of the BHS hospitals and Weiss Hospital for a full one-year period. Thus, we do not believe that we have a high level of outlier payments. In June 2003, CMS published a final rule that modifies the outlier formula in an effort to more accurately distribute outlier payments from the outlier pool to hospitals and to ensure that hospitals cannot inappropriately manipulate outlier payments. The final rule did not increase the current outlier threshold of $33,560 for the balance of federal fiscal year 2003. Moreover, in July 2003 CMS decreased the outlier threshold for federal fiscal year 2004 to $31,000. The other modifications made by CMS include allowing fiscal intermediaries to utilize more recent tentative cost report information to determine outlier payments, requiring the use of hospital-specific cost to charge ratios in most cases and establishing a mechanism of recoupment of previous overpayments. Based on the guidelines set forth in the final rule, we do not believe that our current level of outlier payments will be materially affected.
Certain other hospital companies have recently proposed policies to provide discounts from gross charges to certain patients without qualifying insurance. CMS has granted preliminary approval to at least one of these proposals pending final approval from certain federal regulators. If final approval for these discount policies is received, we intend to adopt similar policies during fiscal 2004.
During the years ended June 30, 2002 and 2003, we renegotiated many of our contracts with managed care payers to improve reimbursement rates and improve operating results and cash flows. Managed care payers are subject to pricing pressures, which often complicates our renegotiation efforts. When renegotiating contracts with improved reimbursement, we have, in some cases, experienced volume declines from the managed care payers. Management continually reviews its portfolio of managed care relationships and attempts to balance pricing and volume issues; however, as long as strong competition remains in the markets we serve, these challenges will continue. Our future operating results and cash flows could be materially adversely impacted to the extent we are unable to achieve positive reimbursement arrangements while maintaining patient volume.
The following table sets forth certain operating statistics for the years ended June 30, 2001, 2002 and 2003. Same hospital results for 2001 are not presented because the acquisitions during fiscal 2001 affect the comparability between the periods as a result of how the same hospital indicators are defined below.
Gross inpatient revenue per discharge represents the average undiscounted charge for a patient stay and is an indicator of hospital pricing and acuity factors.
Emergency room visits represent the number of patient visits to a hospital or freestanding emergency room where treatment is received, regardless of whether an overnight stay is subsequently required.
Same hospital total revenues represent revenues from entities owned (including health plans) for the full twelve months of both years presented.
Same hospital discharges represent discharges for hospitals owned for the full twelve months of both years presented.
Same hospital adjusted patient days-hospitals is calculated by multiplying patient days by the sum of gross hospital inpatient and outpatient revenues and then dividing the result by gross hospital inpatient revenues for all hospitals owned for the full twelve months of both years presented.
Same hospital net revenue per adjusted discharge-hospitals is calculated by dividing net hospital patient revenues by adjusted discharges-hospitals for those hospitals owned for the full twelve months of both years presented. This statistic measures the average net payment expected to be received for a patient’s stay in the those hospitals owned during both respective periods.
Same hospital gross inpatient revenue per discharge represents the average undiscounted charge for a patient stay for those hospitals owned for the full twelve months of both years presented and is an indicator of pricing and acuity factors for those hospitals owned during both respective periods.
Same hospital outpatient surgeries represent the number of surgeries performed at hospitals or ambulatory surgery centers owned for the full twelve months of both years presented, on an outpatient basis (patient overnight stays not necessary).
The following table presents a summary of our operating results for the years ended June 30, 2001, 2002 and 2003.
Year Ended June 30, 2003 Compared to the Year Ended June 30,
Salaries and benefits. The $194.0 million increase in salaries and benefits is primarily attributable to acquisitions, which account for $172.2 million of the increase. Salaries and benefits as a percentage of revenues increased from 42.2% in 2002 to 43.2% during 2003 primarily due to the BHS acquisition as it typically takes an
Supplies. Acquisitions accounted for $78.9 million of the $86.5 million increase in supplies during fiscal 2003. Increased volume and acuity of surgeries on a same hospital basis accounted for the remaining increase. Same hospital surgeries increased by 0.9% during fiscal 2003. Surgeries typically require greater utilization of supplies than do non-surgical admissions.
Supplies expense as a percentage of revenues increased to 15.1% during fiscal 2003 from 12.7% during fiscal 2002. This increase is due to the BHS and Weiss hospital acquisitions. Supplies expense as a percentage of revenues are much higher at the BHS and Weiss hospitals compared to our other hospitals. On a same hospital basis, supplies expense as a percentage of revenues remained flat year over year. We expect this ratio to improve as we continue to transition supplies contracts at the BHS and Weiss hospitals to our purchasing group contract rates and fully implement materials management strategies. These improvements may be offset, however, by continued price increases for pharmaceuticals and medical supplies, including the impact of increased use of drug eluting stents.
Insurance. Acquisitions accounted for $8.9 million of the increase in insurance expense during fiscal 2003. Insurance expense on a same hospital basis decreased slightly during fiscal 2003. The slight decrease is a result of increases in professional and general liability premiums and claims experience during fiscal 2003 offset by the adjustment to expense during fiscal 2002 related to the changes in our professional and general liability coverage as described in the comparison of insurance for fiscal 2002 versus fiscal 2003. Effective June 1, 2002, we established a wholly owned captive subsidiary to insure our professional and general liability risks at a $10.0 million retention as compared to our $1.0 million self-insured retention under our previous insurance policy. We changed our coverage due to pricing pressures and the limited availability of carriers willing to underwrite professional and general liability insurance. We anticipate continued increases in insurance costs in the near future since the professional and general liability market remains depressed.
revenues decreased from 14.6% to 14.0% during fiscal 2003 as we managed these costs in relation to the rate of revenue growth during fiscal 2003.
Provision for doubtful accounts. During fiscal 2003, the provision for doubtful accounts increased by $28.0 million due to acquisitions and decreased by $7.9 million on a same hospital basis resulting in a net increase of $20.1 million. The same hospital improvement during fiscal 2003 was primarily a result of our efforts to improve cash collection processes and increase productivity of our hospital business offices. These efforts resulted in expedited cash collections and greater than expected recoveries of amounts previously considered uncollectible. The enactment of Proposition 204 in Arizona also positively affected our bad debt rate as many previously uninsured patients became qualified for state Medicaid coverage under Proposition 204.
Interest. The $8.2 million increase in net interest expense during fiscal 2003 primarily relates to $150.0 million of new term loan borrowings and related loan costs under the amended 2001 credit facility and issuance of $17.6 million of convertible subordinated notes to fund the BHS acquisition in January 2003 as well as the impact of paying an extra month of interest on our 9.75% Notes during fiscal 2003 as compared to fiscal 2002.
Debt extinguishment costs. During fiscal 2002, we incurred $6.6 million in debt extinguishment costs from the early buyout of certain capital leases, the write-off of deferred loan costs incurred as part of the 2000 credit facility and fees incurred to terminate the interest rate collar agreement required by the 2000 credit facility. On April 1, 2002, we adopted the provisions of SFAS 145 resulting in the treatment of these debt extinguishment costs as operating costs as opposed to extraordinary items.
Minority interests and other. Minority interests and other expenses decreased $0.4 million during fiscal 2003 compared to fiscal 2002. Minority interests represent the third party portion of earnings of certain of our non-wholly owned affiliates included in our consolidated income statements. Minority interests for fiscal 2003 decreased slightly to $0.7 million compared to $0.8 million for fiscal 2002. Other items contributing to the $0.4 million decrease in minority interests and other expenses during fiscal 2003 were increased equity method income during fiscal of $1.1 million, primarily from equity method investments acquired as part of the BHS acquisition, and decreased gains on sales of assets of $0.8 million.
Income taxes. The provision for income taxes increased from $2.9 million for fiscal 2002 to $10.9 million for fiscal 2003 resulting in an increase in the effective tax rate from 29.8% to 39.2%. The valuation allowance that offsets our deferred tax assets decreased by $1.4 million for the year ended June 30, 2002, resulting in a lower effective tax rate in 2002.
Revenues. The $242.8 million increase in revenues during fiscal 2002 was attributable to revenues from acquisitions of $239.9 million and same hospital revenue improvement of $2.9 million. Although same hospital discharges decreased by 1.3% during fiscal 2002, same hospital revenues increased slightly due to our ability to
Salaries and benefits. The $60.8 million increase in salaries and benefits is primarily attributable to acquisitions, which account for $58.1 million of the increase. Salaries and benefits as a percentage of revenues decreased from 48.5% in 2001 to 42.2% in 2002 due to having a full year of Phoenix Health Plan operations during fiscal 2002. Excluding the impact of Phoenix Health Plan, salaries and benefits as a percentage of revenues decreased to 49.5% during fiscal 2002 from 49.7% during fiscal 2001. We successfully managed staffing levels at our hospitals and improved labor productivity. However, our productivity efficiencies were partially offset by increased nursing compensation. The hospital industry continues to face a nationwide shortage of nurses. We experienced particular difficulty in retaining and recruiting nurses in our Phoenix, Arizona and Los Angeles/Orange County, California markets. During the first quarter of fiscal 2003, we initiated a comprehensive recruiting and retention plan for nurses that focuses on competitive salaries and benefits as well as employee satisfaction, best practices, tuition assistance, effective training programs and workplace environment.
Medical claims. The $101.2 million increase in medical claims is almost exclusively due to the acquisition of Phoenix Health Plan on May 1, 2001. Medical claims expense represents the amounts paid by the health plans for health care services provided to their members, including an estimate of incurred but not reported claims that is determined based upon lag data and other actuarial assumptions. Revenues and expenses between the health plans and our hospitals and related outpatient service providers of approximately $26.2 million, or 16.6% of gross health plan medical claims expense, were eliminated in consolidation during fiscal 2002.
Insurance. Acquisitions accounted for $2.1 million of the $11.5 million increase in insurance expense during fiscal 2002. Insurance expense on a same hospital basis increased by $9.4 million primarily due to changes in our professional and general liability coverage effective June 1, 2002. Effective June 1, 2002, we established a wholly owned captive subsidiary to insure our professional and general liability risks at a $10.0 million retention as compared to our $1.0 million self-insured retention under our previous insurance policy. We restructured our coverage due to pricing pressures and the limited availability of carriers willing to underwrite professional and general liability insurance. The $11.5 million increase is comprised of the following factors: (1) a $5.7 million increase in the professional and general liability reserve for the increased retention related to incurred but not reported claims; (2) a $2.6 million increase in our professional and general liability reserve at the $1.0 million retention level due to the lack of maturity of our claims; (3) professional and general liability and property premiums increases of $2.1 million and (4) an increase in our professional and general liability reserve of $1.1 million related to the liquidation of PHICO.
Provision for doubtful accounts. During fiscal 2002, the provision for doubtful accounts increased by $5.5 million due to acquisitions and decreased by $9.0 million on a same hospital basis resulting in a net decrease of $3.5 million. The same hospital improvement during fiscal 2002 was primarily a result of our efforts to improve cash collection processes and increase productivity of our hospital business offices. The enactment of Proposition 204 in Arizona also positively affected our bad debt rate as many previously uninsured patients qualified for Medicaid under Proposition 204. Additionally, the provision for doubtful accounts was negatively affected during the first quarter of fiscal 2001 as we transitioned the hospitals acquired during 2000 to our corporate policy regarding the allowance for doubtful accounts.
Net income. Net income decreased from $10.2 million in fiscal 2001 to $6.8 million in fiscal 2002. The decrease was primarily a result of increases in depreciation and amortization and interest resulting from the 2001 and 2002 acquisitions and the issuance of the 9.75% Notes, respectively. We also incurred debt extinguishment costs of $6.6 million during fiscal 2002. We view these costs as products of the Company’s strategic growth initiative.
At June 30, 2003, we had working capital of $37.1 million, including cash and cash equivalents of $27.2 million. $11.1 million of the cash balance was restricted for use by our captive insurance subsidiary. Working capital at June 30, 2002 was $87.9 million. The decrease in working capital is primarily due to the use of cash on hand to fund a portion of the BHS acquisition purchase price and to fund liabilities assumed in the BHS acquisition. Cash provided by operating activities increased from $44.7 million for the year ended June 30, 2002 to $117.7 million for the year ended June 30, 2003. We generated cash flows from operations through increased revenues over expenses, an improvement in collections of net accounts receivable and the timing of payment of accrued expenses and other liabilities.
Cash provided by financing activities increased from $134.0 million for the year ended June 30, 2002 to $198.1 million for the year ended June 30, 2003. The increase was attributable to our new term loan borrowings under the amended 2001 credit facility and our issuance of Common Stock to finance the BHS acquisition as described below.
On January 17, 2003, we entered into an agreement with Bank of America, N.A., to swap the variable 90-day LIBOR rate applicable to a notional amount of $147.0 million of our $150.0 million of terms loans under the amended 2001 credit facility for a fixed LIBOR rate of 1.77% for the one-year period beginning July 3, 2003 and ending July 3, 2004.
The following table reflects a summary of obligations and commitments outstanding, including both the principal and interest portions of long-term debt and capital leases, with payment dates as of June 30, 2003.
California has a statute and regulations that require hospitals to meet certain seismic performance standards. Hospitals that do not meet the standards may be required to retrofit their facilities. We have filed our
Our ability to collect outstanding receivables from third party payers is critical to our operating performance and cash flows. The allowance for doubtful accounts was approximately 17.6% of accounts receivable, net of contractual discounts, as of June 30, 2003. The primary collection risk lies with uninsured patient accounts or patient accounts in respect of which the primary insurance carrier has paid but patient deductibles or co-insurance portions remain outstanding. We estimate the allowance for doubtful accounts primarily based upon the age of the accounts since patient discharge date. We continually monitor our accounts receivable balances and utilize cash collections data and subsequent write-off data to support the basis for our estimates of the provision for doubtful accounts. Significant changes in payer mix or business office operations may have a significant impact on our results of operations and cash flows.
We typically receive payments from third party payers, including Medicare, Medicaid and managed care payers, that are less than billed charges requiring the estimation of contractual discount allowances. The Medicare and Medicaid regulations and various managed care contracts are often complex and may include multiple reimbursement mechanisms for different types of services provided in our health care facilities and cost settlement provisions requiring complex calculations and assumptions subject to interpretation. We estimate the allowance for contractual discounts on a payer-specific basis based upon our interpretation of the applicable regulations or contract terms. We have made significant investments in human resources and information systems to improve the estimation process. However, the services authorized and provided and related reimbursement are often subject to different interpretation that may result in payments that differ from our estimates. Additionally, updated regulations and contract renegotiations occur frequently necessitating management’s continual review and assessment of the estimation process.
Given the nature of our operating environment, we are continually subject to medical malpractice or workers compensation claims or lawsuits. Through May 31, 2002, we maintained third-party insurance coverage for individual malpractice claims exceeding $1.0 million and workers compensation claims exceeding $250,000 to mitigate a portion of this risk. Effective June 1, 2002, we established a wholly owned captive subsidiary to insure our professional and general liability risks at a $10.0 million retention level. We maintain excess coverage for individual claims exceeding $10.0 million per occurrence up to $100.0 million in the aggregate. We estimate our reserve for professional and general liability and workers compensation risks using historical claims data, demographic factors, severity factors, current incident logs and other actuarial data. As of June 30, 2003, our professional and general liability accrual for asserted and unasserted claims was approximately $26.5 million. The estimated accrual for malpractice and workers compensation claims could be significantly increased should current
Federal and State Regulation and Investigations. The health care industry is subject to extensive federal, state and local laws and regulations relating to licensing, conduct of operations, ownership of facilities, addition of facilities and services, confidentiality and security issues associated with medical records, billing for services and prices for services. These laws and regulations are extremely complex. In many instances, the industry does not have the benefit of significant regulatory or judicial interpretation of these laws and regulations. As a result of these laws and regulations, some of our activities could become the subject of governmental investigations or inquiries. Both federal and state government agencies have heightened and coordinated civil and criminal enforcement efforts as part of numerous ongoing investigations of hospital companies. In the event of a determination that we are in violation of any of these laws, rules or regulations, or if further changes in the regulatory framework occur, our results of operations could be significantly harmed.
Medicare Cost Reports. Hospitals participating in the Medicare program are required to meet certain financial reporting requirements, including submission of annual cost reports identifying medical costs and expenses associated with hospital services to Medicare recipients. Since implementation of outpatient PPS in August 2000, the due dates of all Medicare cost reports were extended due to delays in receiving necessary reports from the Medicare fiscal intermediaries. We have now filed all Medicare cost reports relating to Medicare fiscal year-ends 2002 and prior periods; however, we are still experiencing delays with fiscal intermediary audits of filed cost reports.