We currently lease approximately 40,500 square feet of office space at 20 Burton Hills Boulevard, Nashville, Tennessee, for our corporate headquarters.
The following table sets forth our selected historical financial and operating data for, or as of the end of, each of the five years ended June 30, 2005 (including the predecessor and successor periods). The selected historical financial data as of and for each of the predecessor years ended June 30, 2001, 2002, 2003, 2004 and the combined predecessor and successor year ended June 30, 2005 were derived from our audited consolidated financial statements that have been audited by Ernst & Young LLP, an independent registered public accounting firm. Comparability of the selected historical financial and operating data has been impacted by the timing of acquisitions completed during fiscal 2001, 2002, 2003, 2004 and 2005. Please read the section on “Impact of Acquisitions” included in “
We own and operate 19 hospitals with a total of 4,557 licensed beds, and related outpatient service facilities complementary to the hospitals in San Antonio, Texas, metropolitan Phoenix, Arizona, metropolitan Chicago, Illinois, Orange County, California, and Massachusetts. We also own two health plans: a Medicaid managed health plan, Phoenix Health Plan (“PHP”), which served approximately 100,200 members in Arizona as of June 30, 2005; and MacNeal Health Providers (“MHP”), which had responsibility, under capitated contracts covering certain physician and outpatient services, for approximately 46,500 member lives in metropolitan Chicago, Illinois, as of June 30, 2005. Our objective is to provide high-quality, cost-effective healthcare services through an integrated delivery platform serving the needs of the communities in which we operate. We focus our business development efforts and operations on hospital and other related healthcare facilities where we see an opportunity to improve operating performance and profitability and increase market share. We were incorporated in July 1997 and acquired our first hospital, Maryvale Hospital, on June 1, 1998.
We believe the following operating initiatives, among others, will improve our operating results.
Implementing programs and procedures to improve the quality of healthcare services provided to our patients. We have implemented multiple initiatives to improve quality of care including: 1) Facilitating a working environment from the top down that prioritizes quality of care; 2) Refining and updating our training programs for chief nursing officers, quality directors, physicians and other clinical staff on a continual basis; 3) Sharing information among our hospitals to implement best practices and 4) Employing chief medical officers at the regional level to review and improve clinical protocols. We have implemented clinical information systems in our hospitals that allow us to monitor compliance with clinical protocols and standards including those necessary to meet or exceed accreditation and regulatory requirements. We also utilize patient care evaluations and satisfaction surveys from patients, physicians and employees to measure the results of our quality of care objectives. We believe that the core of our success is the quality of care we provide, and that each of our strategic goals and objectives is an extension of this core principle.
Although we expect the above initiatives to increase our patient volumes, the following risk factors could offset those increases to revenues.
Managed care, Medicare and Medicaid revenues are significant to our business and are all subject to pricing pressures. For the year ended June 30, 2005, managed care (including Medicare and Medicaid managed care plans and commercial plans), Medicare and Medicaid payers accounted for 52%, 31% and 7% of patient service revenues, respectively. We continue to aggressively renegotiate managed care contracts in order to improve pricing for the healthcare services we provide. Managed care payers are subject to cost pressures that often complicate our renegotiation efforts. After renegotiating contracts with improved reimbursement, we have, in some cases, experienced volume declines from 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 affected to the extent we are unable to improve reimbursement and maintain patient volumes. We are also at risk for highly acute cases reimbursed by payers under pre-determined, fixed rates such as Medicare diagnosis related group payments.
Intense market competition may limit our ability to enter choice markets or to recruit and retain quality healthcare personnel. We face growing competition in our industry. Consolidation of hospitals into for-profit or not-for-profit systems continues to increase as other hospital companies realize that regional market strength is pivotal in efficiently providing comprehensive healthcare services, recruiting and retaining qualified healthcare professionals and effectively managing payer relationships.
Acquiring acute care hospitals in urban and suburban markets that fit our strategic objectives 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, since we own a relatively small number of hospitals, even a single hospital acquisition can 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 we often 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 December 31, 2004, certain of our subsidiaries acquired the property, plant and equipment, investments and certain current assets and assumed certain current liabilities of three acute-care hospitals with a total of 768 licensed beds and related healthcare businesses located in or around Worcester, Framingham and Natick, Massachusetts (the “Massachusetts hospitals”) from subsidiaries of Tenet Healthcare Corporation. We paid $87.4 million at closing, including the base purchase price of $104.7 million for the property, plant and equipment and investments of the Massachusetts hospitals less $17.3 million for the excess of the current liabilities assumed and closing costs incurred over the current assets acquired. We funded the purchase price by borrowing $60.0 million of the $150.0 million acquisition delayed draw term facility under our new senior secured credit facilities, entered into in connection with the merger, and by using $27.4 million of cash on hand. We invested an additional $37.4 million during our third fiscal quarter related to the build-up of working capital at the Massachusetts hospitals. On February 18, 2005, we borrowed the remaining $90.0 million available to us under the acquisition delayed draw term loan facility to fund the working capital build-up at the Massachusetts hospitals and to fund capital expenditures at the Massachusetts hospitals and our other hospitals. Operating results for the Massachusetts hospitals are included in our consolidated statements of operations for the second half of our fiscal year ended June 30, 2005.
Our revenues depend upon inpatient occupancy levels, outpatient procedures performed at our facilities, the ancillary services and therapy programs ordered by physicians and provided to patients and our ability to successfully negotiate appropriate rates for these services with third party payers. During the year ended June 30, 2005, we experienced a 15.9% increase in discharges and a 21.7% increase in hospital adjusted discharges compared to the same period in fiscal 2004 partially due to the acquisition of the Massachusetts hospitals. On a same hospital basis, the period over period increases in discharges and hospital adjusted discharges were 4.4% and 6.3%, respectively. The following table provides details of discharges by payer for the years ended June 30, 2003, 2004 and 2005.
The majority of our revenues are based on negotiated, per diem or pre-determined payment structures. Our facilities’ gross charges typically do not reflect what the facilities are actually paid. In addition to volume factors described above, patient mix, acuity factors and pricing trends affect our revenues. Patient revenues per adjusted hospital discharge increased 6.5% from $6,477 during fiscal 2004 to $6,899 during fiscal 2005. This increase reflects improved reimbursement for services provided under negotiated managed care contracts and improved Medicare reimbursements. Additionally, the ability of our hospitals to provide the appropriate mix of services having favorable reimbursement structures and meeting the needs of our patients impacts this statistic. Increases in levels of charity care and negotiated self-pay discounts also impact this statistic by decreasing revenues and decreasing the provision for doubtful accounts. On a same hospital basis, patient revenues per adjusted hospital discharge increased by 6.6% to $6,907 during fiscal 2005, from $6,477 during fiscal 2004. We cannot assure you
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 diagnosis related group payments. To achieve this mandate, in recent years CMS has periodically increased the cost threshold used to determine eligibility for and allocation of available Medicare outlier payments, although the threshold will decrease for the upcoming 2006 Medicare fiscal year. 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 ratio of Medicare outlier payments to Medicare DRG payments is approximately 1.9%. Thus, we do not believe that we have a high level of outlier payments. We also do not believe that our current level of outlier payments will be materially affected by recent regulations set forth by CMS.
We recognize premium revenues from PHP and MHP. Premium revenues increased by $39.7 million or 13.5% during fiscal 2005 compared to fiscal 2004. The primary reason for this revenue increase was the 17,000-member increase in PHP membership during October 2003 and an increase in per member capitation rates. On October 1, 2003, a competing plan withdrew from the AHCCCS program, and its members were allocated to other plans, including PHP. Our contract with AHCCCS was renewed during fiscal 2004 for the three-year period ending September 30, 2006, with an option for AHCCCS to renew the contract for two additional one-year periods thereafter. Should our contract with AHCCCS terminate, our future operating results and cash flows could be materially reduced.
Similar to others in the hospital industry, the collectibility of our accounts receivable has deteriorated primarily due to an increase in self-pay accounts receivable. The following table provides a summary of our accounts receivable by age since discharge date for both insured and uninsured payers as of June 30, 2003, 2004 and 2005 (in millions).
The Medicare Prescription Drug, Improvement, and Modernization Act of 2003, or the “2003 Act”, which was signed into law on December 8, 2003, made a number of significant changes to the Medicare program. In
a provision effective October 1, 2004 setting a lower threshold for determining when CMS is required to provide additional reimbursement for new technologies that would receive inadequate payment if assigned to a standard diagnosis related group;
a provision increasing the payments teaching hospitals receive for the indirect operating expenses incurred for training interns and residents in the last half of federal fiscal year 2004 and all of federal fiscal years 2005 and 2006, but decreasing such amount slightly in federal fiscal year 2007;
a provision allocating $250.0 million per year for federal years 2005-2008 to pay for healthcare costs of undocumented aliens;
a provision eliminating the requirement that hospitals must obtain secondary payment information from all Medicare beneficiaries receiving reference laboratory services; and
a provision mandating that CMS pay the routine costs associated with category A (experimental/investigational) clinical trials beginning January 1, 2005.
We do not pursue collection of amounts due from uninsured patients that qualify for charity care under our guidelines (currently those uninsured patients whose incomes are equal to or less than 200% of the current federal poverty guidelines set forth by the Department of Health and Human Services). We exclude charity care accounts from revenues when we determine that the account meets our charity care guidelines. In June 2004, we adopted revised policies that provide expanded discounts from billed charges and alternative payment structures for uninsured patients who do not qualify for charity care but meet certain other minimum income guidelines, primarily those uninsured patients with incomes between 200% and 500% of the federal poverty guidelines. CMS has indicated that it is aware of no regulations or guidelines preventing implementation of such policies. During the fiscal years ended 2003, 2004 and 2005, we deducted $27.4 million, $37.1 million and $55.6 million of charity care from revenues, respectively.
program includes, among other things, initial and periodic ethics and compliance training, a toll-free reporting hotline for employees, annual fraud and abuse audits and annual coding audits. The organizational structure of our compliance program includes oversight by our board of directors and a high-level corporate management compliance committee. Our Senior Vice President of Compliance and Ethics reports jointly to our Chairman and Chief Executive Officer and to our board of directors, serves as Chief Compliance Officer and is charged with direct responsibility for the day-to-day management of our compliance program. The financial resources necessary for program oversight, enforcement and periodic improvements to our program continue to grow, especially when we add new features to our program or engage external resources to assist with these highly complex matters.
We recognize patient service revenues during the period the healthcare services are provided based upon estimated amounts due from payers. We estimate contractual adjustments and allowances based upon payment terms set forth in managed care health plan contracts and by federal and state regulations. For the majority of our patient service revenues, contractual adjustments are applied to patient accounts at the time of billing using specific payer contract terms entered into the accounts receivable systems, but in some cases we record an estimated allowance until we receive payment. We derive most of our patient service revenues from healthcare services provided to patients with Medicare or managed care insurance (including commercial insurance) coverage. During fiscal 2004 and 2005, combined Medicare and managed care revenues accounted for 81% and 82% of net patient revenues, respectively. For those same periods, Medicaid revenues accounted for 7% of net patient revenues. Services provided to Medicare patients are generally reimbursed at prospectively determined rates per diagnosis (“PPS”), while services provided to managed care patients are generally reimbursed based upon predetermined rates per diagnosis, per diem rates or discounted fee-for-service rates. Medicaid reimbursements vary by state. Other than Medicare, no individual payer represents more than 10% of our patient revenues, either on a gross or net basis.
Medicare regulations and our principal managed care contracts are often complex and may include multiple reimbursement mechanisms for different types of services provided in our healthcare facilities. To obtain reimbursement for certain services under the Medicare program, we must submit annual cost reports and record estimates of amounts owed to or receivable from Medicare. These cost reports include complex calculations and estimates because the level of services authorized and provided and the related reimbursement for such services are often subject to interpretation that could result in payments that differ from our estimates. We include differences between original estimates and subsequent revisions to those estimates (including final cost report settlements) in the consolidated statements of operations in the period in which the revisions are made. Net adjustments for final third party settlements resulted in increases to patient service revenues of $6.4 million, $10.9 million and $6.1 million during the years ended June 30, 2003, 2004 and 2005, respectively. Additionally, updated regulations and contract negotiations occur frequently, which necessitates continual review of estimation processes by management.
We had premium revenues of $218.8 million, $293.8 million and $333.5 million during the years ended June 30, 2003, 2004 and 2005, respectively. Our health plans have agreements with AHCCCS and various health maintenance organizations (“HMOs”) to contract to provide medical services to subscribing participants. Under these agreements, our health plans receive monthly payments based on the number of HMO participants or the number of AHCCCS enrollees in the plans. Our health plans recognize the payments as revenues in the month in which members are entitled to healthcare services.
The following table sets forth certain operating statistics for the periods indicated below. Same hospital results for fiscal 2003 are not presented because the acquisitions during fiscal 2003 affect the comparability between the periods as a result of how the same hospital indicators are defined below.
Same hospital average length stay represent average length of stay days for hospitals owned for the full 12 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 12 months of both years presented. This statistic measures the average net payment expected to be received for a patient’s stay in those hospitals owned during both respective periods.
Same hospital emergency room visits represent the number of patient visits to receive treatment at a hospital or freestanding emergency room owned for the full 12 months of both years presented, regardless of whether an overnight stay is subsequently required.
Revenues. Revenues increased by $486.1 million during fiscal 2005 compared fiscal 2004 due to the acquisition of the Massachusetts hospitals, same hospital volume increases and improved reimbursement for services provided. Hospital adjusted discharges increased by 21.7% during fiscal 2005. Emergency room visits increased by 15.8% and outpatient surgery volumes increased by 21.7% during fiscal 2005. Same hospital revenues increased by $245.9 million or 13.8% as a result of increases in same hospital adjusted discharges, emergency room visits and outpatient surgeries of 6.3%, 4.7% and 5.5%, respectively. In addition, same hospital net revenue per hospital adjusted discharge increased 6.6% year over year. Our service expansion initiatives and managed care contracting strategies played significant roles in inpatient and outpatient volume improvements and were responsive to increased demand for such healthcare services created by the high population growth in most of the markets we serve. We expect same hospital growth to continue during our fiscal year 2006, although factors outside our control including patient demand for healthcare services and increased competition could limit our ability to sustain revenue growth.
Revenues, exclusive of health plan premium and other non-hospital revenues, per adjusted discharge increased 6.5% during fiscal 2005. We continue to negotiate with managed care payers to receive favorable reimbursement for our services. We have made considerable progress in these negotiations during the past two years but challenges still remain to adjust these rates to appropriate levels to reflect rising healthcare costs. The acuity of care required by our patients also affects this statistic. We continually identify and implement services that enable us to maximize our return on investment and address the needs of our patients.
We continue to implement physician recruitment, emergency department expansion, surgery unit expansion, specialty service expansions and intra-market resource sharing strategies. Current capital projects underway, or initiatives expected to begin during the next 12 months, include expansions and upgraded technology for obstetrics, emergency services, radiation therapy, women’s services, cardiac, radiology and general surgery units as well as real estate projects to support hospital buildouts and construction of medical office buildings, primary care clinics and surgery centers.
Salaries and benefits. Salaries and benefits as a percentage of total revenues increased to 45.6% during fiscal 2005 from 41.6% during fiscal 2004. As a result of the merger, stock compensation expense increased from $0.1 million during fiscal year 2004 to $97.4 million during fiscal 2005. Absent the effect of stock compensation, salaries and benefits as a percentage of revenues would have been 41.3% during fiscal 2005. On a same hospital basis, absent the effect of stock compensation, salaries and benefits as a percentage of total revenues decreased to 39.8% during fiscal 2005 as a result of our care management, nurse utilization and service expansion strategies. Our improvements in this same hospital ratio were offset by higher salaries and benefits in our newly-acquired Massachusetts hospitals, in which approximately 1,100 of our employees are unionized and participate in collective bargaining agreements with the hospitals.
Revenues. $292.1 million of the $442.3 million increase in total revenues during fiscal 2004 related to our five hospitals and related healthcare business in San Antonio acquired on January 1, 2003, while same hospital revenues improved by $150.2 million. Same hospital adjusted discharges increased by 6.6% during fiscal 2004. Same hospital emergency room visits and outpatient surgery volumes increased by 11.8% and 6.5%, respectively, during fiscal 2004. Our service expansion initiatives and managed care contracting strategies played significant roles in inpatient and outpatient volume improvements and were responsive to increased demand for such healthcare services created by the high population growth in the markets we serve.
The national nursing shortage hindered our ability to control salaries and benefits. We experienced particular difficulty in retaining and recruiting nurses in our metropolitan Phoenix and Orange County markets and were required to utilize more costly temporary nurse staffing. Additionally, state mandated increased nurse staffing ratios went into effect in California on January 1, 2004, which further exacerbated the nursing shortage.
Supplies. Supplies as a percentage of total revenues increased to 15.9% during fiscal 2004 from 15.1% during fiscal 2003. Supplies as a percentage of patient service revenues increased to 19.0% during fiscal 2004 compared to 18.1% during fiscal 2003. These increases were primarily due to the increase in the acuity of services provided during fiscal 2004, including increased orthopedic and cardiology services.
Income taxes. The effective tax rate decreased slightly from 39.2% in fiscal 2003 to 38.3% in fiscal 2004. A portion of this decrease is due to having a full year of operations for our San Antonio facilities during 2004, for which the state income tax rate is less than our remaining mix of business.
Cash used in investing activities increased from $225.1 million during fiscal 2004 to $324.3 million during fiscal 2005, primarily as a result of the $51.2 million of direct acquisition costs we paid during fiscal 2005 related to the merger, the $87.4 million purchase price paid for the Massachusetts hospitals and an $87.2 million period over period increase in capital expenditures offset by a $116.0 million change in net proceeds related to short-term investments.
Will increase post partum capacity to better utilize labor, delivery and recovery suites.
An expanded emergency room was opened in July 2004, expanding capacity from 16 to 28 bays.
In addition to increasing the number of licensed beds by 22, the expansion will allow for the utilization of 18 previously licensed beds.
We anticipate spending a total of $325.0 million to $350.0 million in capital expenditures during fiscal 2006. This estimate includes the expansion projects mentioned above and all other renovation projects and technology upgrades at our facilities. These capital expenditures will be funded by cash flows from operations and availability under our senior credit facilities. We believe our capital expenditure program is sufficient to service, expand and improve our existing facilities to meet our quality objectives.
Cash provided by financing activities increased from $139.0 million during fiscal 2004 to $151.6 million during fiscal 2005, as a result of the merger on September 23, 2004.
After completing the merger and acquiring the Massachusetts hospitals, we had significantly more debt. We expect to fund our future liquidity needs with cash from operations and amounts available under our senior credit facilities. We also expect to borrow the remaining $175.0 million of delayed draw term loans available to us under our senior credit facilities on or prior to September 23, 2005. On August 25, 2005, we received commitments from lenders pursuant to an amendment to our senior credit facilities to refinance on September 26, 2005 our approximate $795.7 million of term loans then projected to be outstanding thereunder with new replacement term loans in the same amount bearing interest at a rate equal to, at our option, a base rate plus 1.25% per annum or LIBOR plus 2.25% per annum. These interest rates reflect a savings of 1.00% per annum over our current interest rate options for term loans under our senior credit facilities. The amendment made no change to our revolving credit facility. Our ability to borrow the delayed draw term loans and to consummate the refinancing of our outstanding term loans are subject to certain conditions and there can be no assurances that all such conditions will be satisfied. We expect that our primary future liquidity requirements will be for debt service, working capital and capital expenditures.
As of June 30, 2005, we had outstanding $1,357.1 million in aggregate indebtedness, including $23.0 million borrowed under the revolving credit facility to achieve compliance with an annual minimum liquidity ratio requirement set forth by AHCCCS at our PHP subsidiary. The $23.0 million borrowing was repaid on July 1, 2005. As of September 13, 2005, we had $211.2 million of available borrowing capacity under our revolving credit facility ($250.0 million net of outstanding letters of credit of $38.8 million). Our liquidity requirements are significant, primarily due to debt service requirements. The 9.0% Notes require semi-annual interest payments. However, prior to October 1, 2009, the interest expense on the 11.25% Notes will consist solely of non-cash accretions of principal.
In addition to paying interest on outstanding principal under the senior credit facilities, we are required to pay a commitment fee to the lenders under the revolving credit facility in respect of the unutilized commitments thereunder at a rate equal to 0.50% per annum. We are also required to pay commitment fees to the lenders under the credit facility at a rate equal to 2.25% per annum in respect of the unutilized commitments under the $175.0 million term loan facility that expires on September 23, 2005 for working capital, capital expenditures and other general corporate purposes. We also pay customary letter of credit fees.
preferred stock, repay other indebtedness (including the 9.0% Notes and 11.25% Notes), pay dividends and distributions or repurchase our capital stock, create liens on assets, make investments, loans or advances, make certain acquisitions, engage in mergers or consolidations, enter into sale and leaseback transactions, engage in certain transactions with affiliates, amend certain material agreements governing our indebtedness, including the 9.0% Notes and 11.25% Notes, change the business conducted by our subsidiaries and enter into hedging agreements. In addition, the senior credit facilities require us to maintain the following financial covenants: a maximum total leverage ratio, a maximum senior leverage ratio, a minimum interest coverage ratio and a maximum capital expenditures limitation.
As of June 30, 2005, we were in compliance with the debt covenant ratios as defined in our senior secured credit agreement, as follows.
• create liens on pari passu or subordinated indebtedness without securing the notes;
• sell certain assets or merge with or into other companies or otherwise dispose of all or substantially all of
We expect that cash generated from our operations, our expected $175.0 million borrowing under the delayed draw term loan facilities and cash available to us under our revolving credit facility will be sufficient to meet our working capital needs, debt service requirements and planned capital expenditure programs that we
consider necessary to continue our growth. However, we cannot assure you that our operations will generate sufficient cash or that future borrowings under our refinanced senior credit facilities will be available to enable us to meet these requirements and needs.
We also intend to continue to pursue acquisitions or partnering arrangements, either in existing markets or new markets, which fit our growth strategies. To finance such transactions, we might have to draw upon amounts available under our refinanced senior credit facilities or seek additional funding sources. We continually assess our capital needs and may seek additional financing, including debt or equity, as considered necessary to fund potential acquisitions, fund capital projects or for other corporate purposes. However, should our operating results and borrowing capacities not sufficiently support these capital projects or acquisition opportunities, our growth strategies may not be fully realized. Our future operating performance, ability to service or refinance our new debt and ability to draw upon other sources of capital will be subject to future economic conditions and other business factors, many of which are beyond our control.