We currently lease approximately 21,250 square feet of office space at 20 Burton Hills Boulevard, Nashville, Tennessee, for our corporate headquarters. We recently amended the corporate office lease to lease an additional 20,800 square feet of office space effective January 1, 2003, with an option to relinquish up to approximately 8,900 square feet of the original leased space. Our headquarters office lease expires on August 31, 2008.
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 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 or its predecessor for, or as the end of, each of the five years ended June 30, 2002. The selected financial data for the years ended June 30, 1998, 1999, 2000, 2001 and 2002 are derived from our audited financial statements. Financial data for the eleven months ended May 31, 1998, has been derived from unaudited financial statements of our predecessor, Maryvale Hospital Medical Center. The timing of acquisitions completed during fiscal years 1998, 2000, 2001 and 2002 affects the comparability of the selected historical financial data. Please read this table in conjunction with the “
This annual report on Form 10-K contains “forward-looking statements” within the meaning of the Federal securities laws that are intended to be covered by safe harbors created thereby. Forward-looking statements are those statements that are based upon management’s current plans and expectations as opposed to historical and current facts and are often identified herein by use of words including but not limited to “may,” “believe,” “will,” “project,” “expect,” “estimate,” “anticipate,” and “plan.” These statements are based upon estimates and assumptions made by the Company’s management that, although believed to be reasonable, are subject to numerous factors, risks and uncertainties that could cause actual outcomes and results to be materially different from those projected. These factors, risks and uncertainties include, among others, the following:
• Governmental regulation of the industry including Medicare and Medicaid reimbursement levels
• Our ability to attract and retain qualified management and medical personnel, including physicians and
• Costs associated with newly enacted HIPAA regulations and other management information system
Except as required by law, we undertake no obligation to publicly update any forward-looking statements, whether as a result of new information, future events or otherwise. We advise you, however, to consult any additional disclosures we make in our filings with the Securities and Exchange Commission, including, without limitation, the discussion of risks and other uncertainties under the caption “Risk Factors” contained in Item 1 of this report under the caption “Business-Risk Factors”. You are cautioned not to rely on such forward-looking statements when evaluating the information contained in this report. In light of the significant uncertainties inherent in the forward-looking statements in this report, you should not regard the inclusion of such information as a representation by the Company that objectives and plans anticipated by the forward-looking statements will occur or be achieved, or if any of them do occur or are achieved, of the impact they will have on the Company’s results of operations and financial condition.
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 that 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 February 1, 2000, we acquired MacNeal Hospital in Berwyn, Illinois, and its affiliated primary care and occupational medicine centers located around the metropolitan Chicago area. We financed this acquisition through sales of our common stock to our existing stockholders, by issuing 20,000 shares of our Payable-In-Kind Preferred Stock to the seller and by borrowing under our 2000 credit facility. The fiscal 2000 results of operations include five months of operations for these facilities.
On April 1, 2000, we acquired La Palma Intercommunity Hospital in La Palma, California. We financed this acquisition primarily through sales of our common stock to our existing stockholders. The fiscal 2000 results of operations include three months of operations for this hospital.
We paid a total of approximately $406.8 million for all the facilities we acquired in fiscal 2000. We financed these acquisitions through the sale of approximately $236.7 million of our common stock to our existing stockholders, the borrowing of approximately $88.8 million under our 2000 credit facility, the issuance of 20,000 shares of Payable-In-Kind Preferred Stock valued at $20.0 million and the assumption of liabilities of $61.3 million.
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. We paid a total of approximately $90.6 million for all of the acquisitions completed in fiscal 2001. We financed these acquisitions through 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, for a purchase price of $59.9 million comprised of cash of $41.2 million and assumed liabilities of $18.7 million. The Company owns 80.1% of the acquiring joint venture corporation with an affiliate of the seller maintaining a 19.9% ownership interest. The Company received $2.5 million for the minority joint venture partner’s 19.9% interest in the acquisition subsidiary. 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.
Managed care, Medicare and Medicaid revenues are significant to our business and are subject to pricing pressures. For the year ended June 30, 2002, patient days attributable to managed care, Medicare and Medicaid were 51%, 35% and 9% of total patient days, respectively. For the year ended June 30, 2002, managed care, Medicare and Medicaid payers accounted for 60%, 25% and 7% of gross patient revenues, respectively. These payers receive significant discounts compared to other payers, and these payers continually seek to reduce payments to lower the cost of health care for their members. We are also at risk for highly acute cases for payers using a prospective payment system.
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, 2002, 70.0% of the total surgeries performed by our hospitals were outpatient surgeries compared to 69.4% for the year ended June 30, 2001. Typically, the payments we receive for outpatient procedures are less than those for the same procedures performed in an inpatient setting.
As is typical in the health care industry, we are subject to claims and legal actions by patients and others in the ordinary course of business. Through May 31, 2002, we maintained third-party insurance coverage on a claims-made basis for individual malpractice claims exceeding $1.0 million and annual aggregate claims exceeding $13.6 million. Due to pricing pressures and the limited availability of carriers willing to underwrite professional and general liability coverage, we were unable to renew our previous policy with favorable terms upon its expiration on May 31, 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 level. We maintain excess coverage for individual claims exceeding $10.0 million per occurrence up to $100.0 million in the aggregate. We intend to complete a transfer of the loss portfolio for our self-insured retention of reported incidents prior to June 1, 2002, to the captive subsidiary during fiscal 2003. The captive subsidiary intends to fund claims costs from proceeds of premium payments received from us.
As a result of the unfavorable professional and general liability market and increased premiums for property insurance, our insurance expense increased by $11.5 million during fiscal 2002 comprised of the following: (1) a $5.7 million increase in our professional and general liability reserve for claims incurred prior to June 1, 2002, but reported after June 1, 2002, as a result of our increased retention limits; (2) a $2.6 million increase in our professional and general liability reserves throughout fiscal 2002 due to the lack of maturity of our claims; (3) professional and general and property insurance 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 a previous third party carrier. We expect our insurance expense to increase by an additional $4.9 million during fiscal 2003.
In February 2002, the Pennsylvania Insurance Commissioner placed PHICO Insurance Company into liquidation. PHICO provided the Company’s primary general and professional liability coverage during the period June 1, 1999 to May 31, 2000. We are aware of multiple claims for which PHICO is responsible under this policy. Our costs for these claims may be subject to partial reimbursement from state insurance guaranty funds and/or PHICO’s estate. While we are unable to predict the outcome of these claims, management believes that the professional and general liability reserve is adequate to cover such claims should PHICO not be able to pay all or a portion of the claims.
During the year ended June 30, 2002, the Company renegotiated many of its 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. Even 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 negatively impacted to the extent we are unable to achieve positive reimbursement arrangements while maintaining patient volume.
Health plan revenues increased from $55.1 million to $184.8 million during fiscal 2002. This significant increase affects our comparisons of various expenses to net revenues during 2002 and 2001.
The following table sets forth certain operating statistics for the years ended June 30, 2000, 2001 and 2002. Same hospital results for 2000 are not presented because the acquisitions during fiscal 2000 affect the comparability between the periods as a result of how the same hospital indicators are defined below.
Same hospital patient days are patient days for hospitals owned for the entire 2001 and 2002 fiscal years.
Same hospital adjusted patient days-hospitals is calculated by multiplying patient days by the sum of gross hospital inpatient and outpatient revenues and dividing the result by gross hospital inpatient revenues for all hospitals owned for the entire 2001 and 2002 fiscal years.
The following table presents a summary of our operating results for the years ended June 30, 2000, 2001 and 2002.
EBITDA is defined as income before interest expense (net of interest income), income taxes, depreciation, amortization, minority interests, gain or loss on the sale of assets, non-cash stock compensation, equity method income and debt extinguishment costs. While you should not consider EBITDA in isolation or as a substitute for net income, operating cash flows or other cash flow statement data determined in accordance with accounting principles generally accepted in the United States, management understands that EBITDA is a commonly used analytical indicator within the health care industry and serves as a measure of leverage capacity and debt service ability. EBITDA, as presented, may not be comparable to similarly titled measures of other companies.
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 have experienced particular difficulty in retaining and recruiting nurses in our Phoenix, Arizona and Los Angeles/Orange County, California markets. Recent reports forecast this shortage to continue into the near future. We have begun 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. However, should we be unsuccessful in our attempts to maintain nursing coverage adequate for our present and future needs, our future operating results could be adversely impacted.
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 $10.0 million retention level; (2) a $2.6 million increase in our professional and general liability reserve due to routine increases related 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 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.
Our health plans segment contributed $12.9 million or 17.9% of consolidated EBITDA for fiscal 2002 compared to $2.4 million or 4.7% of consolidated EBITDA for fiscal 2001. The significant increase in EBITDA is primarily due to a full year of operations for Phoenix Health Plan in fiscal 2002 as compared to only two months in fiscal 2001. During fiscal 2002, membership in Phoenix Health Plan increased from 49,500 members to 68,500 members primarily due to the enactment of Proposition 204 which broadened eligibility for Medicaid coverage.
Interest. The $10.1 million increase in net interest expense during fiscal 2002 primarily relates to the issuance of the 9.75% Notes on July 30, 2001, offset by the repayment of outstanding term loans under the 2000 credit facility. In addition, the Company incurred deferred loan costs of approximately $11.5 million related to the issuance of the 9.75% Notes and $3.5 million for the establishment of the 2001 credit facility. The aforementioned increases to net interest expense were offset by an increase in interest income on invested cash of approximately $2.1 million during fiscal 2002. On February 15, 2002, we entered into an interest rate swap agreement with Bank of America, N.A. for a notional amount of $100 million of the 9.75% Notes. Under this agreement, the 9.75% coupon interest rate on the $100 million notional amount is swapped for a variable rate based upon the 6-month LIBOR rate in effect on each semi-annual settlement date plus a fixed margin of 3.63%. The swap agreement resulted in a decrease to net interest expense of $1.5 million during fiscal 2002.
Minority interests and other. Minority interests represent the third party portion of earnings of certain of our non-wholly owned affiliates included in our consolidated statements of operations. Minority interests for fiscal 2002 remained comparable to fiscal 2001 at $0.8 million. The $1.6 million decrease in minority interests and other expenses during fiscal 2002 primarily relates to gains on sales of land and other assets of $0.8 million during fiscal 2002 as compared to losses on sales of assets of $0.5 million during fiscal 2001.
Net income. Net income decreased from $10.2 million in fiscal 2001 to $6.8 million in fiscal 2002. The $19.7 million increase in EBITDA during 2002 was offset by the significant increases in depreciation and amortization and interest as a result of the 2001 and 2002 acquisitions and the issuance of the 9.75% Notes, respectively, as well as the debt extinguishment costs of $6.6 million. We view these costs as products of the Company’s strategic growth initiative.
Medical claims expense. The $23.4 million increase in medical claims expense during fiscal 2001 is attributable to the acquisition of Phoenix Health Plan on May 1, 2001, and the effect of the full year of operations of MacNeal Health Providers during 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. Revenues and expenses between the health plans and the Company’s wholly owned hospitals and related outpatient service providers are eliminated in consolidation.
Other operating expenses. The $52.4 million increase in other operating expenses, which include professional fees, purchased services, rents and leases, repairs and maintenance, utilities and non-income taxes, was primarily attributable to our 2001 and 2000 acquisitions. Other operating expenses as a percentage of revenues decreased from 16.7% for fiscal 2000 to 15.5% for fiscal 2001. This decrease reflects our efforts to achieve efficiencies and upgrade capital at acquired hospitals resulting in reduced operating expenses. Additionally, for hospitals acquired during 2000 with a full year of operations during 2001, we were able to reduce costs associated with information systems through software conversions and utilization of corporate expertise thereby reducing related professional fees.
Interest expense. Interest expense increased by $7.8 million from fiscal 2000 to fiscal 2001 due to approximately $95.7 million of additional debt incurred in February 2000 and June 2000 to fund acquisitions and reduce certain assumed liabilities from the acquisitions. We also incurred approximately $4.5 million of deferred loan costs during fiscal 2000 that were being amortized over the life of the 2000 credit facility.
Net income. Net income increased to $10.2 million for fiscal 2001 from a loss of $1.4 million for fiscal 2000, an increase of $11.6 million. The significant increase is due to the income from continuing operations of our fiscal 2001 and 2000 acquisitions, which enabled us to utilize economies of scale and provided an additional revenue base to cover corporate overhead expenses and interest costs and the $1.1 million of debt extinguishment costs incurred during fiscal 2000. Our health plans contributed $0.5 million and $2.2 million of pre-tax net income during fiscal 2000 and 2001, respectively. We expect revenues from our health plans to continue to increase as additional persons become eligible for the Arizona Medicaid program under Proposition 204.
At June 30, 2002, we had working capital of $87.9 million, including cash and cash equivalents of $55.4 million. Working capital at June 30, 2001 was $15.3 million. The increase in working capital is primarily due to operating cash flows during fiscal 2002. The increase in cash from the issuance of the 9.75% Notes has essentially been utilized through acquisitions, capital expenditures, payments of long-term debt and payments of loan costs. Cash provided by operating activities increased from $6.7 million for the year ended June 30, 2001 to $44.7 million for the year ended June 30, 2002. We generated cash flows from operations through improved EBITDA, an improvement in collections of net accounts receivable and the timing of payment of accrued expenses and other liabilities.
Our 2001 credit facility contains provisions that limit annual capital expenditures. For the year ended June 30, 2002, we are in compliance with these capital expenditure provisions. We believe our capital expenditure program is sufficient to service, expand and improve our existing facilities to meet our quality objectives.
We are subject to certain restrictive and financial covenants under the 2001 credit facility including a required EBITDA to debt ratio and interest coverage ratio. Should our results of operations or cash flows decline and result in violation of one or more of these covenants, amounts outstanding under the 2001 credit facility could become immediately payable and additional borrowings could be restricted. As of June 30, 2002, the only amounts drawn against the 2001 credit facility were letters of credit totaling approximately $5.6 million. However, restrictions on additional borrowings under the 2001 credit facility could significantly impact our acquisition growth objectives. We are in compliance with all such covenants as of June 30, 2002.
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, 2002.
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 12.0% of accounts receivable, net of contractual discounts, as of June 30, 2002. The primary collection risk lies with uninsured patient accounts or patient accounts for which primary insurance 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 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.
materially affected by increased or decreased utilization of our owned health care facilities by enrollees of our health plans.
Health Insurance Portability and Accountability Act of 1996. The Health Insurance Portability and Accountability Act (“HIPAA”) was enacted in August 1996 to assure health insurance portability, reduce health care fraud and abuse, guarantee security and privacy of health information and enforce standards for health information. Generally, organizations were required to be in compliance with certain HIPAA provisions regarding uniform electronic data transmission standards for health care information beginning in October 2002; however, entities may extend the deadline to October 2003 by filing a compliance plan with the Department of Health and Human Services. In addition, compliance with privacy standards issued in December 2000 and amended in August 2002 and electronic data security standards proposed in August 1998 but not yet finalized, could result in significant costs for us. We are in the process of implementing the necessary changes pursuant to the provisions of HIPAA but are unable to estimate the financial impact of compliance with these provisions at this time.
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.
Malpractice and General Liability Claims. Plaintiffs frequently bring actions against hospitals and other health care providers alleging malpractice or other liabilities. Many of these claims involve large claims and significant defense costs. We maintain professional and general liability insurance in amounts we believe are sufficient to cover claims arising out of the operations of our facilities. Some of the claims, however, could exceed the scope of the coverage in effect or coverage of particular claims or damages could be denied. Furthermore, our coverage may not continue to be available at a reasonable cost. We are, from time to time, also subject to claims arising in the ordinary course of business, including employment related claims, damages related to personal injuries and other general claims. Although management is not aware of any specific proceeding that would have a material adverse effect on our business, financial position or results of operations, the outcome of these cases are subject to numerous factors, and potential judgments could exceed our current insurance coverage.
Although we attempt to structure our acquisitions as asset acquisitions in which we do not assume liability for seller’s wrongful actions and institute policies and procedures designed to conform practices to our standards following completion of acquisitions, we may become liable for such past actions of acquired entities deemed improper by private plaintiffs or government agencies. We generally obtain indemnification from prospective sellers covering such matters; however, such indemnification may not cover such actions or may not be adequate to cover potential losses and fines.