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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
(MARK ONE)
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES AND EXCHANGE ACT OF 1934
FOR THE YEAR ENDED DECEMBER 31, 2000
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ______________ TO ______________
COMMISSION FILE NUMBER 001-15925
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COMMUNITY HEALTH SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 13-3893191
(State of incorporation) (IRS Employer Identification No.)
155 FRANKLIN ROAD, SUITE 400 37027
Brentwood, Tennessee (zip code)
(Address of principal executive
offices)
Registrant's telephone number, including area code: (615) 373-9600
Securities registered pursuant to Section 12(g) of the Act:
Title of Each Class Name of Each Exchange on Which Registered
Common Stock, $.01 par value New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: None
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Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes /X/ No / /
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. / /
As of March 16, 2001 there were 86,141,941 shares of Common Stock, par value
$.01 per share outstanding. The aggregate market value of the voting stock held
by non-affiliates of the Registrant is $1,041,749,979. Market value is
determined by reference to the closing price on March 16, 2001 of the
Registrant's Common Stock as reported by the New York Stock Exchange.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's definitive Proxy Statement to be filed under
Regulation 14A in connection with the Annual Meeting of Stockholders of the
Registrant scheduled to be held on May 22, 2001 have been incorporated by
reference into Part I and Part III of this Report.
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TABLE OF CONTENTS
FORM 10-K ANNUAL REPORT
COMMUNITY HEALTH SYSTEMS, INC.
YEAR ENDED DECEMBER 31, 2000
PAGE
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PART I
Item 1. Business.................................................... 1
Item 2. Properties.................................................. 18
Item 3. Legal Proceedings........................................... 21
Item 4. Submission of Matters to a Vote of Security Holders......... 22
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters....................................... 23
Item 6. Selected Financial Data..................................... 24
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................. 25
Item 7A. Quantitative and Qualitative Disclosures about Market
Risk...................................................... 34
Item 8. Financial Statements and Supplementary Data................. 36
Item 9. Changes in and Disagreements with Accountants on Accounting
and
Financial Disclosure...................................... 59
PART III
Item 10. Directors and Executive Officers of the Registrant.......... 59
Item 11. Executive Compensation...................................... 59
Item 12. Security Ownership of Certain Beneficial Owners and
Management................................................ 59
Item 13. Certain Relationships and Related Transactions.............. 59
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form
8-K....................................................... 59
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Note: Portions of the Registrant's definitive Proxy Statement to be filed under
Regulation 14A in connection with the Annual Meeting of Stockholders of
the Registrant scheduled to be held on May 22, 2001 have been
incorporated by reference into Part I, Item 4 and Part III, Items 10, 11,
12, and 13 of this Report.
PART I
ITEM 1.
BUSINESS OF COMMUNITY HEALTH SYSTEMS
OVERVIEW OF OUR COMPANY
We are the largest non-urban provider of general hospital healthcare
services in the United States in terms of number of facilities and the second
largest in terms of revenues and EBITDA. As of December 31, 2000, we owned,
leased or operated 52 hospitals, geographically diversified across 20 states,
with an aggregate of 4,688 licensed beds. In over 85% of our markets, we are the
sole provider of these services. In most of our other markets, we are one of two
providers of these services. For the fiscal year ended December 31, 2000, we
generated $1.34 billion in revenues and $252.7 million in adjusted EBITDA (as
such item is defined in footnote 10 of the table under the caption "Selected
Operating Data").
In July 1996, affiliates of Forstmann Little & Co. acquired our predecessor
company from its public stockholders. The predecessor company was formed in
1985. The aggregate purchase price for the acquisition was $1,100.2 million.
Wayne T. Smith, who has over 30 years of experience in the healthcare industry,
joined our company as President in January 1997. We named him Chief Executive
Officer in April 1997 and Chairman of the Board in February 2001. Under this new
ownership and leadership, we have:
- strengthened the senior management team in all key business areas;
- standardized and centralized our operations across key business areas;
- implemented a disciplined acquisition program;
- expanded and improved the services and facilities at our hospitals;
- recruited additional physicians to our hospitals;
- instituted a company-wide regulatory compliance program; and
- divested certain non-core assets.
As a result of these initiatives, we achieved revenue growth of 23.8% in
2000, 26.4% in 1999 and 15.1% in 1998. We also achieved growth in adjusted
EBITDA of 23.8% in 2000, 22.7% in 1999 and 36.1% in 1998. Our adjusted EBITDA
margins improved from 16.5% for 1997 to 18.9% for 2000.
Our hospitals typically have 50 to 200 beds and annual revenues ranging from
$12 million to $70 million. They generally are located in non-urban markets with
populations of 20,000 to 80,000 people and economically diverse employment
bases. These facilities, together with their medical staffs, provide a wide
range of inpatient and outpatient general hospital services and a variety of
specialty services.
We target growing, non-urban healthcare markets because of their favorable
demographic and economic trends and competitive conditions. Because non-urban
service areas have smaller populations, there are generally fewer hospitals and
other healthcare service providers in these communities. We believe that smaller
populations result in less direct competition for hospital-based services. Also,
we believe that non-urban communities generally view the local hospital as an
integral part of the community. There is generally a lower level of managed care
presence in these markets.
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OUR BUSINESS STRATEGY
The key elements of our business strategy are to:
- increase revenue at our facilities;
- grow through selective acquisitions;
- reduce costs; and
- improve quality.
INCREASE REVENUE AT OUR FACILITIES
OVERVIEW. We seek to increase revenue at our facilities by providing a
broader range of services in a more attractive care setting, as well as by
supporting and recruiting physicians. We identify the healthcare needs of the
community by analyzing demographic data and patient referral trends. We also
work with local hospital boards, management teams, and medical staffs to
determine the number and type of additional physicians needed. Our initiatives
to increase revenue include:
- recruiting additional primary care physicians and specialists;
- expanding the breadth of services offered at our hospitals through
targeted capital expenditures to support the addition of more complex
services, including orthopedics, cardiology, OB/GYN, and occupational
medicine; and
- providing the capital to invest in technology and the physical plant at
the facilities, particularly in our emergency rooms.
By taking these actions, we believe that we can increase our share of the
healthcare dollars spent by local residents and limit inpatient and outpatient
migration to larger urban facilities. Total revenue for hospitals operated by us
for a full year increased by 10.3% from 1999 to 2000. Total inpatient admissions
for those same hospitals increased by 6.3% over the same period.
PHYSICIAN RECRUITING. The primary method of adding or expanding medical
services is the recruitment of new physicians into the community. A core group
of primary care physicians is necessary as an initial contact point for all
local healthcare. The addition of specialists who offer services including
general surgery, OB/GYN, cardiology, and orthopedics completes the full range of
medical and surgical services required to meet a community's core healthcare
needs. When we acquire a hospital, we identify the healthcare needs of the
community by analyzing demographic data and patient referral trends. We are then
able to determine what we believe to be the optimum mix of primary care
physicians and specialists. We employ recruiters at the corporate level to
support the local hospital managers in their recruitment efforts. During the
past three years, we have increased the number of physicians affiliated with us
by 405, including 84 in 1998, 156 in 1999 and 165 in 2000. The percentage of
recruited or other physicians commencing practice that were surgeons or
specialists grew from 45% in 1997 to 65% in 2000. We do not employ most of our
physicians, but rather they are in private practice in their communities. We
have been successful in recruiting physicians because of the practice
opportunities afforded physicians in our markets, as well as the lower managed
care penetration as compared to urban areas. These physicians are able to earn
incomes comparable to incomes earned by physicians in urban centers. As of
December 31, 2000, approximately 2,000 physicians were on active staff with our
hospitals.
EMERGENCY ROOM INITIATIVES. Given that over 50% of our hospital admissions
originate in the emergency room, we systematically take steps to increase
patient flow in our emergency rooms as a means of optimizing utilization rates
for our hospitals. Furthermore, the impression of our overall operations by our
customers is substantially influenced by our emergency room since often that is
their
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first experience with our hospitals. The steps we take to increase patient flow
in our emergency rooms include renovating and expanding our emergency room
facilities, improving service, and reducing waiting times, as well as
publicizing our emergency room capabilities in the local community. We have
expanded or renovated 16 of our emergency room facilities since 1997. Since
1997, we have entered into approximately 30 new contracts with emergency room
operating groups to improve performance in our emergency rooms. We have
implemented marketing campaigns that emphasize the speed, convenience, and
quality of our emergency rooms to enhance each community's awareness of our
emergency room services.
Our upgrades include the implementation of specialized software programs
designed to assist physicians in making diagnoses and determining treatments.
The software also benefits patients and hospital personnel by assisting in
proper documentation of patient records. It enables our nurses to provide more
consistent patient care and provides clear instructions to patients at time of
discharge to help them better understand their treatments.
EXPANSION OF SERVICES. To capture a greater portion of the healthcare
spending in our markets and to more efficiently utilize our hospital facilities,
we have added a broad range of emergency, outpatient, and specialty services to
our hospitals. Depending on the needs of the community, we identify
opportunities to expand into various specialties, including orthopedics,
cardiology, OB/GYN, and occupational medicine. In addition to expanding
services, we have completed major capital projects at selected facilities to
offer these types of services. For example, in 1999 we invested $1 million in a
new cardiac catheterization laboratory at our Crestview, Florida hospital. As a
result, this laboratory increased the number of procedures it performed by 84%,
from 122 in 1998 to 224 in 1999. In 1999, major capital projects included
renovations to nine emergency rooms, two operating rooms, two OB/ GYN
facilities, and three intensive care units at various hospitals. In 2000, major
capital projects included expansion of five emergency rooms, upgrades to three
critical care units and two OB/GYN facilities and the purchase of an MRI and
cath lab at various hospitals. We believe that through these efforts we will
reduce patient migration to competing providers of healthcare services and
increase volume.
MANAGED CARE STRATEGY. Managed care has seen growth across the U.S. as
health plans expand service areas and membership. As we service primarily
non-urban markets, we have limited relationships with managed care
organizations. We have responded with a proactive and carefully considered
strategy developed specifically for each of our facilities. Our experienced
business development department reviews and approves all managed care contracts,
which are managed through a central database. The primary mission of this
department is to select and evaluate appropriate managed care opportunities,
manage existing reimbursement arrangements, negotiate contracts, and educate our
physicians. We have terminated our only risk sharing capitated contract, which
we acquired through our acquisition of a California hospital.
GROW THROUGH SELECTIVE ACQUISITIONS
ACQUISITION CRITERIA. Each year we intend to acquire, on a selective basis,
two to four hospitals that fit our acquisition criteria. We pursue acquisition
candidates that:
- have a general service area population between 20,000 and 80,000 with a
stable or growing population base;
- are the sole or primary provider of acute care services in the community;
- are located more than 25 miles from a competing hospital;
- are not located in an area that is dependent upon a single employer or
industry; and
- have financial performance that we believe will benefit from our
management's operating skills.
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Most hospitals we have acquired are located in service areas having
populations within the lower to middle range of our criteria. However, we have
also acquired hospitals having service area populations in the upper range of
our criteria. For example, in 1998, we acquired a 162-bed facility in Roswell,
New Mexico which has a service area population of over 70,000 and is located 200
miles from the nearest urban centers in Albuquerque, New Mexico and Lubbock,
Texas; in 2000 we acquired a 164-bed facility in Kirksville, Missouri which has
a service area population of over 100,000. Facilities similar to the ones
located in Roswell and Kirksville offer even greater opportunities to expand
services given their larger service area populations.
Most of our acquisition targets are municipal and other not-for-profit
hospitals. We believe that our access to capital and ability to recruit
physicians make us an attractive partner for these communities. In addition, we
have found that communities located in states where we already operate a
hospital are more receptive to us when they consider selling their hospital
because they are aware of our operating track record with respect to our
facilities within the state.
Pursuant to hospital purchase agreements in effect as of December 31, 2000,
we are required to construct four replacement hospitals through 2005 with an
aggregate estimated construction cost, including equipment, of approximately
$120 million. Of this amount, approximately $9 million has been expended as of
December 31, 2000.
REDUCE COSTS
OVERVIEW. To improve efficiencies and increase operating margins, we
implement cost containment programs and adhere to operating philosophies which
include:
- standardizing and centralizing our operations;
- optimizing resource allocation by utilizing our company-devised case and
resource management program, which assists in improving clinical care and
containing expenses;
- capitalizing on purchasing efficiencies through the use of company-wide
standardized purchasing contracts and terminating or renegotiating certain
vendor contracts;
- installing a standardized management information system, resulting in more
efficient billing and collection procedures; and
- managing staffing levels according to patient volumes and the appropriate
level of care.
In addition, each of our hospital management teams is supported by our
centralized operational, reimbursement, regulatory, and compliance expertise as
well as by our senior management team, which has an average of 20 years of
experience in the healthcare industry. Adjusted EBITDA margins on a same
hospitals basis improved from 18.8% in 1999 to 19.9% in 2000.
IMPROVE QUALITY
We have implemented various programs to ensure improvement in the quality of
care provided. We have developed training programs for all senior hospital
management, chief nursing officers, quality directors, physicians and other
clinical staff. We share information among our hospital management to implement
best practices and assist in complying with regulatory requirements. We have
standardized accreditation documentation and requirements. Corporate support is
provided to each facility to assist with accreditation reviews. Several of our
facilities have received accreditation "with commendation" from the Joint
Commission on Accreditation of Healthcare Organizations. All hospitals conduct
patient, physician, and staff satisfaction surveys to help identify methods of
improving the quality of care.
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Each of our hospitals is governed by a board of trustees, which includes
members of the hospital's medical staff. The board of trustees establishes
policies concerning the hospital's medical, professional, and ethical practices,
monitors these practices, and is responsible for ensuring that these practices
conform to legally required standards. We maintain quality assurance programs to
support and monitor quality of care standards and to meet Medicare and Medicaid
accreditation and regulatory requirements. Patient care evaluations and other
quality of care assessment activities are reviewed and monitored continuously.
SELECTED OPERATING DATA
The following table sets forth operating statistics for our hospitals for
each of the years presented. Statistics for 2000 include a full year of
operations for 45 hospitals, and partial periods for one hospital disposed of
and seven hospitals acquired during the year. Statistics for 1999 include a full
year of operations for 41 hospitals and partial periods for four hospitals
acquired, and one hospital constructed and opened, during the year. Statistics
for 1998 include a full year of operations for 37 hospitals and partial periods
for four hospitals acquired during the year.
YEARS ENDED DECEMBER 31,
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2000 1999 1998
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(DOLLARS IN THOUSANDS)
Number of hospitals (1).................................... 52 46 41
Licensed beds (1)(2)....................................... 4,688 4,115 3,644
Beds in service (1)(3)..................................... 3,587 3,123 2,776
Admissions (4)............................................. 143,310 120,414 100,114
Adjusted admissions (5).................................... 262,419 217,006 177,075
Patient days (6)........................................... 548,827 478,658 416,845
Average length of stay (days) (7).......................... 3.8 4.0 4.2
Occupancy rate (beds in service) (8)....................... 44.6% 44.1% 43.3%
Net operating revenues..................................... $1,337,501 $1,079,953 $854,580
Net inpatient revenues as a % of total net operating
revenues................................................. 51.0% 52.7% 55.7%
Net outpatient revenues as a % of total net operating
revenues................................................. 47.3% 45.5% 42.6%
Adjusted EBITDA as a % of total net operating revenues..... 18.9% 18.9% 19.5%
Net cash flows provided by (used in) operating
activities............................................... $ 22,985 $ (11,746) $ 15,719
Net cash flows used in investing activities................ (244,441) (155,541) (236,553)
Net cash flows provided by financing activities............ 230,914 164,850 219,890
YEAR ENDED DECEMBER 31,
----------------------- PERCENTAGE
INCREASE
2000 1999 (DECREASE)
---------- ---------- ----------
Same Hospitals Data (9)
Admissions (4)............................................. 125,207 117,768 6.3%
Adjusted admissions (5).................................... 227,780 212,246 7.3%
Patient days (6)........................................... 481,620 467,884 2.9%
Average length of stay (days) (7).......................... 3.8 4.0
Occupancy rate (beds in service) (8)....................... 45.1% 44.8%
Net operating revenues..................................... $1,155,850 $1,047,950
Adjusted EBITDA (10)....................................... 229,637 196,843 10.3%
Adjusted EBITDA, as a % of net operating revenues.......... 19.9% 18.8% 16.7%
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(1) At end of period.
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(2) Licensed beds are the number of beds for which the appropriate state agency
licenses a facility regardless of whether the beds are actually available
for patient use.
(3) Beds in service are the number of beds that are readily available for
patient use.
(4) Admissions represent the number of patients admitted for inpatient
treatment.
(5) Adjusted admissions is a general measure of combined inpatient and
outpatient volume. We computed adjusted admissions by multiplying admissions
by gross patient revenues and then dividing that number by gross inpatient
revenues.
(6) Patient days represent the total number of days of care provided to
inpatients.
(7) Average length of stay (days) represents the average number of days
inpatients stay in our hospitals.
(8) We calculated percentages by dividing the average daily number of inpatients
by the weighted average of beds in service.
(9) Includes acquired hospitals to the extent we operated them during comparable
periods in both years.
(10) We define adjusted EBITDA as EBITDA adjusted to exclude cumulative effect
of a change in accounting principle, impairment of long-lived assets and
compliance settlement and Year 2000 remediation costs. EBITDA consists of
income (loss) before interest, income taxes, depreciation and amortization,
and amortization of goodwill. EBITDA and adjusted EBITDA should not be
considered as measures of financial performance under generally accepted
accounting principles. Items excluded from EBITDA and adjusted EBITDA are
significant components in understanding and assessing financial performance.
EBITDA and adjusted EBITDA are key measures used by management to evaluate
our operations and provide useful information to investors. EBITDA and
adjusted EBITDA should not be considered in isolation or as alternatives to
net income, cash flows generated by operations, investing or financing
activities, or other financial statement data presented in the consolidated
financial statements as indicators of financial performance or liquidity.
Because EBITDA and adjusted EBITDA are not measurements determined in
accordance with generally accepted accounting principles and are thus
susceptible to varying calculations, EBITDA and adjusted EBITDA as presented
may not be comparable to other similarly titled measures of other companies.
SOURCES OF REVENUE
We receive payment for healthcare services provided by our hospitals from:
- the federal Medicare program;
- state Medicaid programs;
- healthcare insurance carriers, health maintenance organizations or "HMOs,"
preferred provider organizations or "PPOs," and other managed care
programs; and
- patients directly.
The following table presents the approximate percentages of net revenue
received from private, Medicare, Medicaid and other sources for the periods
indicated. The data for the years presented are
6
not strictly comparable due to the significant effect that hospital acquisitions
and dispositions have had on these statistics.
NET OPERATING REVENUES BY PAYOR SOURCE 2000 1999 1998
- -------------------------------------- -------- -------- --------
Medicare.................................................... 34.2% 36.2% 39.0%
Medicaid.................................................... 11.8% 11.9% 10.2%
Managed Care (HMO/PPO)...................................... 15.9% 14.3% 14.0%
Private and Other........................................... 38.1% 37.6% 36.8%
----- ----- -----
Total................................................... 100.0% 100.0% 100.0%
===== ===== =====
As shown above, we receive a substantial portion of our revenue from the
Medicare and Medicaid programs.
Medicare is a federal program that provides medical insurance benefits to
persons age 65 and over, some disabled persons, and persons with end-stage renal
disease. Medicaid is a federal-state funded program, administered by the states,
which provides medical benefits to individuals who are unable to afford
healthcare. All of our hospitals are certified as providers of Medicare and
Medicaid services. Amounts received under the Medicare and Medicaid programs are
generally significantly less than the hospital's customary charges for the
services provided. In recent years, changes made to the Medicare and Medicaid
programs have further reduced payment to hospitals. We expect this trend to
continue. Since an important portion of our revenues comes from patients under
Medicare and Medicaid programs, our ability to operate our business successfully
in the future will depend in large measure on our ability to adapt to changes in
these programs.
In addition to government programs, we are paid by private payors, which
include insurance companies, HMOs, PPOs, other managed care companies, and
employers, as well as by patients directly. Patients are generally not
responsible for any difference between customary hospital charges and amounts
paid for hospital services by Medicare and Medicaid programs, insurance
companies, HMOs, PPOs, and other managed care companies, but are responsible for
services not covered by these programs or plans, as well as for deductibles and
co-insurance obligations of their coverage. The amount of these deductibles and
co-insurance obligations has increased in recent years. Collection of amounts
due from individuals is typically more difficult than collection of amounts due
from government or business payors. To further reduce their healthcare costs, an
increasing number of insurance companies, HMOs, PPOs, and other managed care
companies are negotiating discounted fee structures or fixed amounts for
hospital services performed, rather than paying healthcare providers the amounts
billed. We negotiate discounts with managed care companies which are typically
smaller than discounts under governmental programs. If an increased number of
insurance companies, HMOs, PPOs, and other managed care companies succeed in
negotiating discounted fee structures or fixed amounts, our results of
operations may be negatively affected. For more information on the payment
programs on which our revenues depend, see "--Payment."
Hospital revenues depend upon inpatient occupancy levels, the volume of
outpatient procedures, and the charges or negotiated payment rates for hospital
services provided. Charges and payment rates for routine inpatient services vary
significantly depending on the type of service performed and the geographic
location of the hospital. In recent years, we have experienced a significant
increase in revenue received from outpatient services. We attribute this
increase to:
- advances in technology, which have permitted us to provide more services
on an outpatient basis; and
- pressure from Medicare or Medicaid programs, insurance companies, and
managed care plans to reduce hospital stays and to reduce costs by having
services provided on an outpatient rather than on an inpatient basis.
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SUPPLY CONTRACTS
During fiscal 1997, we entered into an affiliation agreement with BuyPower,
a group purchasing organization owned by Tenet Healthcare Corporation. Our
affiliation with BuyPower combines the purchasing power of our hospitals with
the purchasing power of more than 600 other healthcare providers affiliated with
the program. This increased purchasing power has resulted in reductions in the
prices paid by our hospitals for medical supplies and equipment and
pharmaceuticals. In March 2000, we entered into an agreement with
Broadlane Inc., an affiliate of Tenet Healthcare Corporation, to use their
e-commerce marketplace as our exclusive internet purchasing portal.
INDUSTRY OVERVIEW
The U.S. Healthcare Financing Administration estimated that in 2000, total
U.S. healthcare expenditures grew by 8.3% to $1.3 trillion. It projects total
U.S. healthcare spending to grow by 8.6% in 2001 and by 6.5% annually from 2002
through 2010. By these estimates, healthcare expenditures will account for
approximately $2.6 trillion, or 15.9% of the total U.S. gross domestic product,
by 2010.
Hospital services, the market in which we operate, is the largest single
category of healthcare at 32.1% of total healthcare spending in 2000, or
$415.8 billion. The U.S. Healthcare Financing Administration projects the
hospital services category to grow by 5.7% per year through 2010. It expects
growth in hospital healthcare spending to continue due to the aging of the U.S.
population and consumer demand for expanded medical services. As hospitals
remain the primary setting for healthcare delivery, it expects hospital services
to remain the largest category of healthcare spending.
U.S. HOSPITAL INDUSTRY. The U.S. hospital industry is broadly defined to
include acute care, rehabilitation, and psychiatric facilities that are either
public (government owned and operated), not-for-profit private (religious or
secular), or for-profit institutions (investor owned). According to the American
Hospital Association, there are approximately 5,015 inpatient hospitals in the
U.S. which are not-for-profit owned, investor owned, or state or local
government owned. Of these hospitals, 44% are located in non-urban communities.
These facilities offer a broad range of healthcare services, including internal
medicine, general surgery, cardiology, oncology, neurosurgery, orthopedics,
OB/GYN, and emergency services. In addition, hospitals also offer other
ancillary services including psychiatric, diagnostic, rehabilitation, home
health, and outpatient surgery services.
URBAN VS. NON-URBAN HOSPITALS
According to the U.S. Census Bureau, 25% of the U.S. population lives in
communities designated as non-urban. In these non-urban communities, hospitals
are typically the primary source of healthcare and, in many cases, a single
hospital is the only provider of general healthcare services. According to the
American Hospital Association, in 1998, there were 2,200 non-urban hospitals in
the U.S. We believe that a majority of these hospitals are owned by
not-for-profit or governmental entities.
FACTORS AFFECTING PERFORMANCE. Among the many factors that can influence a
hospital's financial and operating performance are:
- facility size and location;
- facility ownership structure (i.e., tax-exempt or investor owned);
- a facility's ability to participate in group purchasing organizations; and
- facility payor mix.
We believe that non-urban hospitals are generally able to obtain higher
operating margins than urban hospitals. Factors contributing to a non-urban
hospital's margin advantage include fewer patients with complex medical
problems, a lower cost structure, limited competition, and favorable Medicare
8
payment provisions. Patients needing the most complex care are more often served
by the larger and/or more specialized urban hospitals. A non-urban hospital's
lower cost structure results from its geographic location as well as the lower
number of patients treated who need the most highly advanced services.
Additionally, because non-urban hospitals are generally sole providers or one of
a small group of providers in their markets, there is limited competition. This
generally results in more favorable pricing with commercial payors. Medicare has
special payment provisions for "sole community hospitals." Under present law,
hospitals that qualify for this designation receive higher reimbursement rates
and are guaranteed capital reimbursement equal to 90% of capital costs. As of
December 31, 2000, 15 of our hospitals were "sole community hospitals." In
addition, we believe that non-urban communities are generally characterized by a
high level of patient and physician loyalty that fosters cooperative
relationships among the local hospitals, physicians, employees, and patients.
The type of third party responsible for the payment of services performed by
healthcare service providers is also an important factor which affects hospital
margins. These providers have increasingly exerted pressure on healthcare
service providers to reduce the cost of care. The most active providers in this
regard have been HMOs, PPOs, and other managed care organizations. The
characteristics of non-urban markets make them less attractive to these managed
care organizations. This is partly because the limited size of non-urban markets
and their diverse, non-national employer bases minimize the ability of managed
care organizations to achieve economies of scale. In 2000, approximately 16% of
our revenues were paid by managed care organizations.
HOSPITAL INDUSTRY TRENDS
DEMOGRAPHIC TRENDS. According to the U.S. Census Bureau, there are
approximately 35 million Americans aged 65 or older in the U.S. today, who
comprise approximately 13% of the total U.S. population. By the year 2030 the
number of elderly is expected to climb to 69 million, or 20% of the total
population. Due to the increasing life expectancy of Americans, the number of
people aged 85 years and older is also expected to increase from 4.3 million to
8.5 million by the year 2030. This increase in life expectancy will increase
demand for healthcare services and, as importantly, the demand for innovative,
more sophisticated means of delivering those services. Hospitals, as the largest
category of care in the healthcare market, will be among the main beneficiaries
of this increase in demand. Based on data compiled for us, the populations of
the service areas where our hospitals are located grew by 6.9% from 1990 to 1997
and are projected to grow by 4.6% from 1998 to 2002. The number of people aged
65 or older in these service areas grew by 16.4% from 1990 to 1997 and is
projected to grow by 5.7% from 1998 to 2002.
CONSOLIDATION. During the late 1980s and early 1990s, there was significant
industry consolidation involving large, investor owned hospital companies
seeking to achieve economies of scale. While consolidation activity in the
hospital industry is continuing, the consolidations are primarily taking place
through mergers and acquisitions involving not-for-profit hospital systems.
Reasons for this activity include:
- limited access to capital;
- financial performance issues, including challenges associated with changes
in reimbursement;
- the desire to enhance the local availability of healthcare in the
community;
- the need and ability to recruit primary care physicians and specialists;
and
- the need to achieve general economies of scale and to gain access to
standardized and centralized functions, including favorable supply
agreements.
9
SHIFTING UTILIZATION TRENDS. Over the past decade, many procedures that had
previously required hospital visits with overnight stays have been performed on
an outpatient basis. This shift has been driven by cost containment efforts led
by private and government payors. The focus on cost containment has coincided
with advancements in medical technology that have allowed patients to be treated
with less invasive procedures that do not require overnight stays. According to
the American Hospital Association, the number of surgeries performed on an
inpatient basis declined from 1994 to 1998 at an average annual rate of 0.3%,
from 9.8 million in 1994 to 9.7 million in 1998. During the same period, the
number of outpatient surgeries increased at an average annual rate of 4.3%, from
13.2 million in 1994 to 15.6 million in 1998. The mix of inpatient as compared
to outpatient surgeries shifted from a ratio of 42.8% inpatient to 57.2%
outpatient in 1994 to a ratio of 38.4% inpatient to 61.6% outpatient in 1998.
These trends have led to a reduction in the average length of stay and, as a
result, inpatient utilization rates. According to the American Hospital
Association, the average length of stay in general hospitals has declined from
6.7 days in 1994 to 6.0 days in 1998.
GOVERNMENT REGULATION
OVERVIEW. The healthcare industry is required to comply with extensive
government regulation at the federal, state, and local levels. Under these
regulations, hospitals must meet requirements to be certified as hospitals and
qualified to participate in government programs, including the Medicare and
Medicaid programs. These requirements relate to the adequacy of medical care,
equipment, personnel, operating policies and procedures, maintenance of adequate
records, hospital use, rate-setting, compliance with building codes, and
environmental protection laws. There are also extensive regulations governing a
hospital's participation in these government programs. If we fail to comply with
applicable laws and regulations, we can be subject to criminal penalties and
civil sanctions, our hospitals can lose their licenses and we could lose our
ability to participate in these government programs. In addition, government
regulations may change. If that happens, we may have to make changes in our
facilities, equipment, personnel, and services so that our hospitals remain
certified as hospitals and qualified to participate in these programs. We
believe that our hospitals are in substantial compliance with current federal,
state, and local regulations and standards.
Hospitals are subject to periodic inspection by federal, state, and local
authorities to determine their compliance with applicable regulations and
requirements necessary for licensing and certification. All of our hospitals are
licensed under appropriate state laws and are qualified to participate in
Medicare and Medicaid programs. In addition, most of our hospitals are
accredited by the Joint Commission on Accreditation of Healthcare Organizations.
This accreditation indicates that a hospital satisfies the applicable health and
administrative standards to participate in Medicare and Medicaid programs.
FRAUD AND ABUSE LAWS. Participation in the Medicare program is heavily
regulated by federal statute and regulation. If a hospital fails substantially
to comply with the requirements for participating in the Medicare program, the
hospital's participation in the Medicare program may be terminated and/or civil
or criminal penalties may be imposed. For example, a hospital may lose its
ability to participate in the Medicare program if it performs any of the
following acts:
- making claims to Medicare for services not provided or misrepresenting
actual services provided in order to obtain higher payments;
- paying money to induce the referral of patients where services are
reimbursable under a federal health program; or
10
- failing to provide treatment to any individual who comes to a hospital's
emergency room with an "emergency medical condition" or otherwise failing
to properly treat and transfer emergency patients.
The Health Insurance Portability and Accountability Act of 1996 broadened
the scope of the fraud and abuse laws by adding several criminal statutes that
are not related to receipt of payments from a federal healthcare program. The
Accountability Act created civil penalties for conduct, including upcoding and
billing for medically unnecessary goods or services. It established new
enforcement mechanisms to combat fraud and abuse. These include a bounty system,
where a portion of the payments recovered is returned to the government
agencies, as well as a whistleblower program. This law also expanded the
categories of persons that may be excluded from participation in federal
healthcare programs.
Another law regulating the healthcare industry is a section of the Social
Security Act, known as the "anti-kickback" or "fraud and abuse" statute. This
law prohibits some business practices and relationships under Medicare,
Medicaid, and other federal healthcare programs. These practices include the
payment, receipt, offer, or solicitation of money in connection with the
referral of patients covered by a federal or state healthcare program.
Violations of the anti-kickback statute may be punished by criminal and civil
fines, exclusion from federal healthcare programs, and damages up to three times
the total dollar amount involved.
The Office of Inspector General of the Department of Health and Human
Services is authorized to publish regulations outlining activities and business
relationships that would be deemed not to violate the anti-kickback statute.
These regulations are known as "safe harbor" regulations. However, the failure
of a particular activity to comply with the safe harbor regulations does not
mean that the activity violates the anti-kickback statute.
The Office of Inspector General is responsible for identifying fraud and
abuse activities in government programs. In order to fulfill its duties, the
Office of Inspector General performs audits, investigations, and inspections. In
addition, it provides guidance to healthcare providers by identifying types of
activities that could violate the anti-kickback statute. The Office of the
Inspector General has identified the following incentive arrangements as
potential violations:
- payment of any incentive by the hospital each time a physician refers a
patient to the hospital;
- use of free or significantly discounted office space or equipment for
physicians in facilities usually located close to the hospital;
- provision of free or significantly discounted billing, nursing, or other
staff services;
- free training for a physician's office staff including management and
laboratory techniques;
- guarantees which provide that if the physician's income fails to reach a
predetermined level, the hospital will pay any portion of the remainder;
- low-interest or interest-free loans, or loans which may be forgiven if a
physician refers patients to the hospital;
- payment of the costs of a physician's travel and expenses for conferences;
- payment of services which require few, if any, substantive duties by the
physician, or payment for services in excess of the fair market value of
the services rendered; or
- purchasing goods or services from physicians at prices in excess of their
fair market value.
We have a variety of financial relationships with physicians who refer
patients to our hospitals. Physicians own interests in a few of our facilities.
Physicians may also own our stock. We also have contracts with physicians
providing for a variety of financial arrangements, including employment
11
contracts, leases, management agreements, and professional service agreements.
We provide financial incentives to recruit physicians to relocate to communities
served by our hospitals. These incentives include revenue guarantees and, in
some cases, loans. Although we believe that we have structured our arrangements
with physicians in light of the "safe harbor" rules, we cannot assure you that
regulatory authorities will not determine otherwise. If that happens, we would
be subject to criminal and civil penalties and/or exclusion from participating
in Medicare, Medicaid, or other government healthcare programs.
The Social Security Act also includes a provision commonly known as the
"Stark law." This law prohibits physicians from referring Medicare and Medicaid
patients to healthcare entities in which they or any of their immediate family
members have ownership or other financial interests. These types of referrals
are commonly known as "self referrals." Sanctions for violating the Stark law
include civil money penalties, assessments equal to twice the dollar value of
each service, and exclusion from Medicare and Medicaid programs. There are
ownership and compensation arrangement exceptions to the self-referral
prohibition. One exception allows a physician to make a referral to a hospital
if the physician owns the entire hospital, as opposed to an ownership interest
in a department of the hospital. Another exception allows a physician to refer
patients to a healthcare entity in which the physician has an ownership interest
if the entity is located in a rural area, as defined in the statute. There are
also exceptions for many of the customary financial arrangements between
physicians and providers, including employment contracts, leases, and
recruitment agreements. The federal government has not finalized its regulations
which will interpret several of the provisions included in the Stark law. We
have structured our financial arrangements with physicians to comply with the
statutory exceptions included in the Stark law. However, when the government
finalizes these regulations, it may interpret certain provisions of this law in
a manner different from the manner with which we have interpreted them. We
cannot predict the final form that such regulations will take or the effect
those regulations will have on us.
Many states in which we operate also have adopted, or are considering
adopting, similar laws. Some of these state laws apply even if the payment for
care does not come from the government. These statutes typically provide
criminal and civil penalties as well as loss of licensure. While there is little
precedent for the interpretation or enforcement of these state laws, we have
attempted to structure our financial relationships with physicians and others in
light of these laws. However, if we are found to have violated these state laws,
it could result in the imposition of criminal and civil penalties as well as
possible licensure revocation.
CORPORATE PRACTICE OF MEDICINE; FEE-SPLITTING. Some states have laws that
prohibit unlicensed persons or business entities, including corporations, from
employing physicians. Some states also have adopted laws that prohibit direct or
indirect payments or fee-splitting arrangements between physicians and
unlicensed persons or business entities. Possible sanctions for violations of
these restrictions include loss of a physician's license, civil and criminal
penalties and rescission of business arrangements. These laws vary from state to
state, are often vague and have seldom been interpreted by the courts or
regulatory agencies. We structure our arrangements with healthcare providers to
comply with the relevant state law. However, we cannot assure you that
governmental officials charged with responsibility for enforcing these laws will
not assert that we, or transactions in which we are involved, are in violation
of these laws. These laws may also be interpreted by the courts in a manner
inconsistent with our interpretations.
EMERGENCY MEDICAL TREATMENT AND ACTIVE LABOR ACT. The Emergency Medical
Treatment and Active Labor Act imposes requirements as to the care that must be
provided to anyone who comes to facilities providing emergency medical services
seeking care before they may be transferred to another facility or otherwise
denied care. Regulations have recently been adopted, but not yet implemented,
that expand the areas within a facility that must provide emergency treatment.
Sanctions for failing to
12
fulfill these requirements include exclusion from participation in Medicare and
Medicaid programs and civil money penalties. In addition, the law creates
private civil remedies which enable an individual who suffers personal harm as a
direct result of a violation of the law to sue the offending hospital for
damages and equitable relief. A medical facility that suffers a financial loss
as a direct result of another participating hospital's violation of the law also
has a similar right. Although we believe that our practices are in compliance
with the law, we can give no assurance that governmental officials responsible
for enforcing the law or others will not assert we are in violation of these
laws.
FALSE CLAIMS ACT. Another trend in healthcare litigation is the use of the
False Claims Act. This law has been used not only by the U.S. government, but
also by individuals who bring an action on behalf of the government under the
law's "qui tam" or "whistleblower" provisions. When a private party brings a qui
tam action under the False Claims Act, the defendant will generally not be aware
of the lawsuit until the government makes a determination whether it will
intervene and take a lead in the litigation.
Civil liability under the False Claims Act can be up to three times the
actual damages sustained by the government plus civil penalties for each
separate false claim. There are many potential bases for liability under the
False Claims Act. Although liability under the False Claims Act arises when an
entity knowingly submits a false claim for reimbursement to the federal
government, the False Claims Act defines the term "knowingly" broadly. Thus,
although simple negligence generally will not give rise to liability under the
False Claims Act, submitting a claim with reckless disregard to its truth or
falsity can constitute "knowingly" submitting a claim. See "Item 3--Legal
Proceedings" for a description of pending, False Claims Act litigation.
HEALTHCARE REFORM. The healthcare industry continues to attract much
legislative interest and public attention. In recent years, an increasing number
of legislative proposals have been introduced or proposed in Congress and in
some state legislatures that would effect major changes in the healthcare
system. Proposals that have been considered include cost controls on hospitals,
insurance market reforms to increase the availability of group health insurance
to small businesses, and mandatory health insurance coverage for employees. The
costs of implementing some of these proposals would be financed, in part, by
reductions in payments to healthcare providers under Medicare, Medicaid, and
other government programs. We cannot predict the course of future healthcare
legislation or other changes in the administration or interpretation of
governmental healthcare programs and the effect that any legislation,
interpretation, or change may have on us.
CONVERSION LEGISLATION. Many states, including some where we have hospitals
and others where we may in the future acquire hospitals, have adopted
legislation regarding the sale or other disposition of hospitals operated by
not-for-profit entities. In other states that do not have specific legislation,
the attorneys general have demonstrated an interest in these transactions under
their general obligations to protect charitable assets from waste. These
legislative and administrative efforts primarily focus on the appropriate
valuation of the assets divested and the use of the proceeds of the sale by the
not-for-profit seller. While these review and, in some instances, approval
processes can add additional time to the closing of a hospital acquisition, we
have not had any significant difficulties or delays in completing any of our
recent hospital acquisitions. There can be no assurance, however, that future
actions on the state level will not seriously delay or even prevent our ability
to acquire hospitals. If these activities are widespread, they could have a
negative impact on our ability to acquire additional hospitals. See "--Our
Business Strategy."
CERTIFICATES OF NEED. The construction of new facilities, the acquisition
of existing facilities and the addition of new services at our facilities may be
subject to state laws that require prior approval by state regulatory agencies.
These certificate of need laws generally require that a state agency determine
the public need and give approval prior to the construction or acquisition of
facilities or the addition of new services. We operate hospitals in 11 states
that have adopted certificate of need laws. If we fail to
13
obtain necessary state approval, we will not be able to expand our facilities,
complete acquisitions or add new services in these states. Violation of these
state laws may result in the imposition of civil sanctions or the revocation of
a hospital's licenses.
PAYMENT
MEDICARE. Under the Medicare program, we are paid for inpatient and
outpatient services performed by our hospitals.
Payments for inpatient acute services are generally made pursuant to a
prospective payment system, commonly known as "PPS." Under a PPS, our hospitals
are paid a prospectively determined amount for each hospital discharge based on
the patient's diagnosis. Specifically, each discharge is assigned to a
diagnosis-related group, commonly known as a "DRG," based upon the patient's
condition and treatment during the relevant inpatient stay. Each DRG is assigned
a payment rate that is prospectively set using national average costs per case
for treating a patient for a particular diagnosis. DRG payments do not consider
the actual costs incurred by a hospital in providing a particular inpatient
service. However, DRG payments are adjusted by a predetermined geographic
adjustment factor assigned to the geographic area in which the hospital is
located. While a hospital generally does not receive payment in addition to a
DRG payment, hospitals may qualify for an "outlier" payment when the relevant
patient's treatment costs are extraordinarily high and exceed a specified
threshold.
The DRG rates are adjusted by an update factor each federal fiscal year,
which begins on October 1. The update factor is determined, in part, by the
projected increase in the cost of goods and services that are purchased by
hospitals. For several years the annual update factor has been lower than the
projected increases in the costs of goods and services purchased by hospitals.
DRG rate increases were 1.1% for federal fiscal year 1995, 1.5% for federal
fiscal year 1996, and 2.0% for federal fiscal year 1997. For federal fiscal year
1998, there was no increase. The DRG rate was increased by the projected
increase in the cost of goods and services minus 1.9% for federal fiscal year
1999; 1.8% for federal fiscal year 2000; and by the full increase in the cost of
goods and services for federal fiscal year 2001. For both federal fiscal years
2002 and 2003, the DRG rate will be increased by the projected increase in the
cost of goods and services minus 1.1%. Future legislation may decrease the rate
of increase for DRG payments, but we are not able to predict the amount of the
reduction or the effect that the reduction will have on us.
Outpatient services have traditionally been paid at the lower of customary
charges or on a reasonable cost basis. The Balanced Budget Act established a PPS
for outpatient hospital services that commenced on August 1, 2000. All services
paid under the new PPS for hospital outpatient services are classified into
groups called ambulatory payment classifications or "APCs". Services in each APC
are similar clinically and in terms of the resources they require. Depending on
the services provided, each outpatient encounter could result in the assignment
of multiple APC payments. The Balanced Budget Refinement Act of 1999 eliminated
the anticipated average reduction of 5.7% for various Medicare outpatient
business under the Balanced Budget Act of 1997. Under the Balanced Budget
Refinement Act of 1999, non-urban hospitals with 100 beds or less are held
harmless under Medicare outpatient PPS through December 31, 2003. Thirty-four of
our hospitals qualify for this relief. Losses under Medicare outpatient PPS for
non-urban hospitals with greater than 100 beds and urban hospitals will be
mitigated through a corridor reimbursement approach, where a percentage of
losses will be reimbursed through December 31, 2003. All of our remaining
hospitals qualify for relief under this provision.
Skilled nursing facilities have historically been paid by Medicare on the
basis of actual costs, subject to limitations. The Balanced Budget Act
established a PPS for Medicare skilled nursing facilities. The new PPS commenced
in July 1998, and is being implemented progressively over a three year term. We
have experienced reductions in payments for our skilled nursing services.
However, the
14
Balanced Budget Refinement Act of 1999, effective as of October 1, 2000 and the
Benefit and Improvement Act of 2000 established adjustments to the PPS payments
made to skilled nursing facilities.
The Balanced Budget Act also required the Department of Health and Human
Services to establish a PPS for home health services. The Balanced Budget Act of
1997 put in place the interim payment system, commonly known as "IPS," until the
home health PPS could be implemented. As of October 1, 2000, the home health PPS
replaced IPS. We have experienced reductions in payments for our home health
services and a decline in home health visits due to a reduction in benefits by
reason of the Balanced Budget Act. Home health PPS has increased payments for
our home health services.
MEDICAID. Most state Medicaid payments are made under a PPS, reasonable
cost, per diem, or established fee schedules. Medicaid is currently funded
jointly by state and federal governments. The federal government and many states
are currently considering significantly reducing Medicaid funding, while at the
same time expanding Medicaid benefits. This could adversely affect future levels
of Medicaid payments received by our hospitals.
ANNUAL COST REPORTS. Hospitals participating in the Medicare and some
Medicaid programs, whether paid on a reasonable cost basis or under a PPS, are
required to meet certain financial reporting requirements. Federal and, where
applicable, state regulations require submission of annual cost reports
identifying medical costs and expenses associated with the services provided by
each hospital to Medicare beneficiaries and Medicaid recipients.
Annual cost reports required under the Medicare and some Medicaid programs
are subject to routine governmental audits. These audits may result in
adjustments to the amounts ultimately determined to be due to us under these
reimbursement programs. Finalization of these audits often takes several years.
Providers can appeal any final determination made in connection with an audit.
COMMERCIAL INSURANCE. Our hospitals provide services to individuals covered
by private healthcare insurance. Private insurance carriers pay our hospitals or
in some cases reimburse their policyholders based upon the hospital's
established charges and the coverage provided in the insurance policy.
Commercial insurers are trying to limit the costs of hospital services by
negotiating discounts, including PPS, which would reduce payments by commercial
insurers to our hospitals. Reductions in payments for services provided by our
hospitals to individuals covered by commercial insurers could adversely affect
us.
COMPETITION
The hospital industry is highly competitive. An important part of our
business strategy is to acquire hospitals each year in non-urban markets.
However, not-for-profit hospital systems and other for-profit hospital companies
generally attempt to acquire the same type of hospitals as we do. In addition,
some hospitals are sold through an auction process, which may result in higher
purchase prices than we believe are reasonable.
In addition to the competition we face for acquisitions and physicians, we
must also compete with other hospitals and healthcare providers for patients.
The competition among hospitals and other healthcare providers for patients has
intensified in recent years. Our hospitals are located in non-urban service
areas. Most of our hospitals face no direct competition because there are no
other hospitals in their primary service areas. However, these hospitals do face
competition from hospitals outside of their primary service area, including
hospitals in urban areas that provide more complex services. These facilities
are generally located in excess of 25 miles from our facilities. Patients in our
primary service areas may travel to these other hospitals for a variety of
reasons, including the need for services we do not offer or physician referrals.
Patients who are required to seek services from these other hospitals may
subsequently shift their preferences to those hospitals for services we do
provide.
15
Some of our hospitals operate in primary service areas where they compete
with one other hospital. One of our hospitals competes with more than one other
hospital in its primary service area. Some of these competing hospitals use
equipment and services more specialized than those available at our hospitals.
In addition, some of the hospitals that compete with us are owned by
tax-supported governmental agencies or not-for-profit entities supported by
endowments and charitable contributions. These hospitals can make capital
expenditures without paying sales, property and income taxes. We also face
competition from other specialized care providers, including outpatient surgery,
orthopedic, oncology, and diagnostic centers.
The number and quality of the physicians on a hospital's staff is an
important factor in a hospital's competitive advantage. Physicians decide
whether a patient is admitted to the hospital and the procedures to be
performed. Admitting physicians may be on the medical staffs of other hospitals
in addition to those of our hospitals. We attempt to attract our physicians'
patients to our hospitals by offering quality services and facilities,
convenient locations, and state-of-the-art equipment.
COMPLIANCE PROGRAM
OUR COMPLIANCE PROGRAM. In early 1997, under our new management and
leadership, we voluntarily adopted a company-wide compliance program. The
program included the appointment of a compliance officer and committee, adoption
of an ethics and business conduct code, employee education and training,
implementation of an internal system for reporting concerns, auditing and
monitoring programs, and a means for enforcing the program's policies.
We take an operations team approach to compliance and utilize corporate
experts for program design efforts and facility leaders for employee-level
implementation. Compliance is another area that demonstrates our utilization of
standardization and centralization techniques and initiatives which yield
efficiencies and consistency throughout our facilities. We recognize that our
compliance with applicable laws and regulations depends on individual employee
actions as well as company operations. Our approach focuses on integrating
compliance responsibilities with operational function. This approach is intended
to reinforce our company-wide commitment to operate strictly in accordance with
the laws and regulations that govern our business.
Since its initial adoption, the compliance program continues to be expanded
and developed to meet the industry's expectations and our needs. Specific
written policies, procedures, training and educational materials and programs,
as well as auditing and monitoring activities have been prepared and implemented
to address the functional and operational aspects of our business. Included
within these functional areas are materials and activities for business
sub-units, including laboratory, radiology, pharmacy, emergency, surgery,
observation, home health, skilled nursing, and clinics. Specific areas
identified through regulatory interpretation and enforcement activities have
also been addressed in our program. Claims preparation and submission, including
coding, billing, and cost reports, comprise the bulk of these areas. Financial
arrangements with physicians and other referral sources, including anti-kickback
and Stark laws, emergency department treatment and transfer requirements, and
other patient disposition issues are also the focus of policy and training,
standardized documentation requirements, and review and audit.
INPATIENT CODING COMPLIANCE ISSUE. In August 1997, during a routine
internal audit at one of our facilities, we discovered inaccuracies in the DRG
coding for some of our inpatient medical records. At that time, this was the
primary auditing activity for our compliance program. These inaccuracies
involved inpatient coding practices that had been put in place prior to the time
we acquired our operating company in 1996.
Because of the concerns raised by the internal audit, we performed an
internal review of historical inpatient coding practices. At the completion of
this review in December 1997, we voluntarily disclosed the coding problems to
the Office of Inspector General of the U.S. Department of Health and Human
16
Services. After discussions with the Inspector General, we agreed to have an
independent consultant audit the coding for eight specific DRGs. This audit
ultimately involved a review by the consultant of approximately 1,500 patient
files. The audit procedures we followed generated a statistically valid estimate
of the dollar amounts related to coding errors for these DRGs at 36 of our
hospitals for the period 1993 to 1997.
The results of this audit were reviewed by the Inspector General and the
Department of Justice, who also conducted their own investigation. We cooperated
fully with their investigation. The government agencies advised us of potential
liability under various legal theories, including the False Claims Act. Under
the False Claims Act, we could be liable for as much as treble damages and
penalties of between $5,000 and $10,000 per false claim submitted to Medicare
and Medicaid.
We entered into a settlement agreement in May 2000 with these federal
government agencies and the applicable state Medicaid programs. Pursuant to the
settlement agreement, we paid approximately $31.8 million in May 2000 and were
released from all civil claims relating to the coding of the eight specific DRGs
for the hospitals and time periods covered in the audit. We funded this payment
from our acquisition loan facility. During 1998 and 1999, we established a
liability in our financial statements for this amount. We have also agreed with
the Inspector General to continue our existing voluntary compliance program
under a corporate compliance agreement and to adopt various additional
compliance measures for a period of three years. These additional compliance
measures include making various reports to the federal government and having our
actions pursuant to the compliance agreement reviewed annually by a third party.
The compliance measures and reporting and auditing requirements contained in
the compliance agreement include:
- continuing the duties and activities of our corporate compliance officer,
corporate compliance work group, and facility compliance chairs and
committees;
- maintaining our written ethics and conduct policy, which sets out our
commitment to full compliance with all statutes, regulations, and
guidelines applicable to federal healthcare programs;
- maintaining our written policies and procedures addressing the operation
of our compliance program, including proper coding for inpatient hospital
stays;
- continuing our general training on the ethics and conduct policy and
adding training about our compliance program and the compliance agreement;
- continuing our specific training for the appropriate personnel on billing
and coding issues;
- continuing independent third party periodic audits of our facilities'
inpatient DRG coding;
- having an independent third party perform an annual review of our
compliance with the compliance agreement;
- continuing our confidential disclosure program and "ethics hotline" to
enable employees or others to disclose issues or questions regarding
possible inappropriate policies or behavior;
- enhancing our screening program to ensure that we do not hire or engage
employees or contractors who are ineligible persons for federal healthcare
programs;
- reporting any material deficiency which resulted in an overpayment to us
by a federal healthcare program; and
- submitting annual reports to the Inspector General which describe in
detail the operations of our corporate compliance program for the past
year.
17
Our substantial adherence to the terms and conditions of the compliance
agreement will constitute an element of our eligibility to participate in the
federal healthcare programs. Consequently, material, uncorrected violations of
the compliance agreement could lead to suspension or disbarment from these
federal programs. In addition, we will be subject to possible civil penalties
for a failure to substantially comply with the terms of the compliance
agreement, including stipulated penalties ranging between $1,000 to $2,500 per
day. We will also be subject to a stipulated penalty of $25,000 per day,
following notice and cure periods, for any deliberate and/or flagrant breach of
the material provisions of the compliance agreement.
EMPLOYEES
At December 31, 2000, we employed approximately 14,073 full time employees
and 3,616 part-time employees. Of these employees, approximately 973 are
represented by labor organizations. We believe that our labor relations are
good.
PROFESSIONAL LIABILITY
As part of our business of owning and operating hospitals, we are subject to
legal actions alleging liability on our part. To cover claims arising out of the
operations of hospitals, we generally maintain professional malpractice
liability insurance and general liability insurance on a claims made basis in
amounts and with deductibles that we believe to be sufficient for our
operations. We also maintain umbrella liability coverage covering claims which,
due to their nature or amount, are not covered by our insurance policies. We
cannot assure you that professional liability insurance will cover all claims
against us or continue to be available at reasonable costs for us to maintain
adequate levels of insurance.
ENVIRONMENTAL MATTERS
We are subject to various federal, state, and local laws and regulations
governing the use, discharge, and disposal of hazardous materials, including
medical waste products. Compliance with these laws and regulations is not
expected to have a material adverse effect on us. It is possible, however, that
environmental issues may arise in the future which we cannot now predict.
ITEM 2.
PROPERTIES
Our hospitals are general care hospitals offering a wide range of inpatient
and outpatient medical services. These services generally include internal
medicine, general surgery, cardiology, oncology, orthopedics, OB/GYN, diagnostic
and emergency room services, outpatient surgery, laboratory, radiology,
respiratory therapy, physical therapy, and rehabilitation services. In addition,
some of our hospitals provide skilled nursing and home health services based on
individual community needs.
18
For each of our hospitals, the following table shows its location, the date
of its acquisition or lease inception and the number of licensed beds as of
December 31, 2000:
DATE OF
LICENSE ACQUISITION/LEASE OWNERSHIP
HOSPITAL CITY BEDS(1) INCEPTION TYPE
- -------- -------------- -------- ----------------- ------------
ALABAMA
Woodland Community Hospital........... Cullman 100 October, 1994 Owned
Parkway Medical Center Hospital....... Decatur 120 October, 1994 Owned
L.V. Stabler Memorial Hospital........ Greenville 72 October, 1994 Owned
Hartselle Medical Center.............. Hartselle 150 October, 1994 Owned
Edge Regional Hospital................ Troy 97 December, 1994 Owned
Lakeview Community Hospital........... Eufaula 74 April, 2000 Owned
South Baldwin Regional................ Foley 82 June, 2000 Leased
ARIZONA
Payson Regional Medical Center........ Payson 66 August, 1997 Leased
Western Arizona Regional.............. Bullhead City 90 July, 2000 Owned
ARKANSAS
Harris Hospital....................... Newport 132 October, 1994 Owned
Randolph County Medical Center........ Pocahontas 50 October, 1994 Leased
CALIFORNIA
Barstow Community Hospital............ Barstow 56 January, 1993 Leased
Fallbrook Hospital.................... Fallbrook 47 November, 1998 Operated (2)
Watsonville Community Hospital........ Watsonville 102 September, 1998 Owned
FLORIDA
North Okaloosa Medical Center......... Crestview 110 March, 1996 Owned
GEORGIA
Berrien County Hospital............... Nashville 71 October, 1994 Leased
Fannin Regional Hospital.............. Blue Ridge 34 January, 1986 Owned
ILLINOIS
Crossroads Community Hospital......... Mt. Vernon 55 October, 1994 Owned
Marion Memorial Hospital.............. Marion 99 October, 1996 Leased
KENTUCKY
Parkway Regional Hospital............. Fulton 70 May, 1992 Owned
Three Rivers Medical Center........... Louisa 90 May, 1993 Owned
Kentucky River Medical Center......... Jackson 55 August, 1995 Leased
19
DATE OF
LICENSE ACQUISITION/LEASE OWNERSHIP
HOSPITAL CITY BEDS(1) INCEPTION TYPE
- -------- -------------- -------- ----------------- ------------
LOUISIANA
Byrd Regional Hospital................ Leesville 70 October, 1994 Owned
Sabine Medical Center................. Many 52 October, 1994 Owned
River West Medical Center............. Plaquemine 80 August, 1996 Leased
MISSISSIPPI
The King's Daughters Hospital......... Greenville 137 September, 1999 Owned
MISSOURI
Moberly Regional Medical Center....... Moberly 114 November, 1993 Owned
Northeastern Regional Medical
Center.............................. Kirksville 164 December, 2000 Owned
NEW MEXICO
Mimbres Memorial Hospital............. Deming 49 March, 1996 Owned
Eastern New Mexico Medical Center..... Roswell 162 April, 1998 Owned
Northeastern Regional Hospital........ Las Vegas 54 April, 2000 Leased
NORTH CAROLINA
Martin General Hospital............... Williamston 49 November, 1998 Leased
PENNSYLVANIA
Berwick Hospital...................... Berwick 144 March, 1999 Owned
SOUTH CAROLINA
Marlboro Park Hospital................ Bennettsville 109 August, 1996 Leased
Chesterfield General Hospital......... Cheraw 66 August, 1996 Leased
Springs Memorial Hospital............. Lancaster 194 November, 1994 Owned
TENNESSEE
Lakeway Regional Hospital............. Morristown 135 May, 1993 Owned
Scott County Hospital................. Oneida 99 November, 1989 Leased
Cleveland Community Hospital.......... Cleveland 100 October, 1994 Owned
White County Community Hospital....... Sparta 60 October, 1994 Owned
TEXAS
Big Bend Regional Medical Center...... Alpine 40 October, 1999 Owned
Northeast Medical Center.............. Bonham 75 August, 1996 Owned
Cleveland Regional Medical Center..... Cleveland 115 August, 1996 Leased
Highland Medical Center............... Lubbock 123 September, 1986 Owned
Scenic Mountain Medical Center........ Big Spring 150 October, 1994 Owned
20
DATE OF
LICENSE ACQUISITION/LEASE OWNERSHIP
HOSPITAL CITY BEDS(1) INCEPTION TYPE
- -------- -------------- -------- ----------------- ------------
Hill Regional Hospital................ Hillsboro 92 October, 1994 Owned
Lake Granbury Medical Center.......... Granbury 56 January, 1997 Leased
UTAH
Tooele Valley Regional Medical
Center.............................. Tooele 38 October, 2000 Owned (3)
VIRGINIA
Greensville Memorial Hospital......... Emporia 114 March, 1999 Leased
Russell County Medical Center......... Lebanon 78 September, 1986 Owned
Southampton Memorial Hospital......... Franklin 105 March, 2000 Leased
WYOMING
Evanston Regional Hospital............ Evanston 42 November, 1999 Owned
- ------------------------
(1) Licensed beds are the number of beds for which the appropriate state agency
licenses a facility regardless of whether the beds are actually available
for patient use.
(2) We operate this hospital under a lease-leaseback and operating agreement. We
recognize all operating statistics, revenue and expenses associated with
this hospital in our consolidated financial statements.
(3) We acquired this hospital as of October 1, 2000. Prior to the acquisition,
we operated this hospital under a management agreement and did not include
the operating statistics of this hospital in our consolidated statistics.
During the term of the management agreement, our fee was equal to the
hospital's EBITDA.
ITEM 3.
LEGAL PROCEEDINGS
We entered into a settlement agreement in May 2000 with the Inspector
General, the Department of Justice, and the applicable state Medicaid programs
pursuant to which we paid approximately $31.8 million in exchange for a release
of civil claims associated with possible inaccurate inpatient coding for the
period 1993 to 1997. For a description of the terms of the settlement agreement
as well as the events giving rise to the settlement agreement, see "Item
1--Compliance Program."
In May 1999, we were served with a complaint in U.S. EX REL. BLEDSOE V.
COMMUNITY HEALTH SYSTEMS, INC., Case # 1-98-CV-0435-MHS (N.D. Ga.). This qui tam
action seeks treble damages and penalties under the False Claims Act against us.
The Department of Justice did not intervene in this action. The allegations in
the amended complaint are extremely general, but involve Medicare billing at our
White County Community Hospital in Sparta, Tennessee. In September 2000, the
court granted our motion to transfer this case to federal court in Tennessee and
our motion to dismiss the case is before the court. Based on our review of the
allegations of the relator, we do not believe that this lawsuit is meritorious
and we intend to vigorously defend ourselves against this action.
The Department of Justice also has notified us of the existence of U.S. EX
REL. SMITH V. COMMUNITY HEALTH SYSTEMS, INC., filed in September 1999 in the
federal court in Nashville, Tennessee. This qui tam lawsuit was brought against
us by a former employee of our Lakeway Regional Hospital. The complaint alleges
violations of the False Claims Act in connection with alleged inflated costs
caused by incorrect allocation of employee salaries to Lakeway Regional
Hospital's rehabilitation unit, as well as improper
21
Medicare reimbursement for patients readmitted to that hospital from the
rehabilitation unit. Our review indicates that the allegations relating to the
reimbursement for the readmitted patients lack factual support. In addition, our
review indicates that any inaccuracies in salary allocations to the
rehabilitation unit's cost reports were relatively minimal in amount. The
Department of Justice has advised us informally that it has decided not to
intervene, but we have not been formally served with the complaint. We intend to
assert a number of factual and legal defenses to these allegations.
The Department of Justice also has notified us of the existence of U.S. EX
REL. KOWATLI V. RUSSELL COUNTY MEDICAL CENTER, ET AL., filed in January 1999 in
the federal court in Abingdon, Virginia. This lawsuit was brought by a physician
who formerly had privileges at Russell County Medical Center. The complaint is
filed under the False Claims Act against various individual doctors as well as
Russell County Medical Center and us. The complaint alleges that the defendants
engaged in unnecessary and unsafe medical procedures, tests and
hospitalizations. The physician had previously filed two antitrust actions
against the doctors and hospital which were both found to be without merit and
dismissed by the courts. Based upon our investigation into the allegations at
the request and direction of the Department of Justice, we do not believe this
lawsuit has any merit. We have not been served with the complaint, and the
Department of Justice has not made a decision to intervene.
In 1999, we received federal grand jury subpoenas from the U.S. Attorney's
Office for the Eastern District of Arkansas seeking documents from our Harris
Hospital facility relating to its mammography department. Investigators from the
Food and Drug Administration and the State of Arkansas also sought documents and
interviewed employees relating to the activities of the Harris Hospital
mammography department. We have cooperated with the government's investigation
and made documents and individuals available. In January 2001, we received a
contact letter in connection with this matter from the Civil Division of the
United States Attorney's Office. The letter alleges violations of the False
Claims Act and the Mammography Quality Standards Act. We have reopened our
investigation into this matter to determine whether the allegations have merits
and will defend them accordingly.
Because of the uncertain nature of litigation, we cannot predict the outcome
of these matters.
We also receive various inquiries or subpoenas from state regulators, fiscal
intermediaries, and the Department of Justice regarding various Medicare and
Medicaid issues. In addition, we are subject to other claims and lawsuits
arising in the ordinary course of our business or arising out of transactions.
Plaintiffs in these lawsuits generally request punitive or other damages that by
state law may not be able to be covered by insurance. We are not aware of any
pending or threatened litigation which we believe would have a material adverse
impact on us.
ITEM 4.
SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth
quarter of the year ended December 31, 2000.
22
PART II
ITEM 5.
MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
We completed an initial public offering of our Common Stock which began
trading on June 9, 2000 and was closed on June 14, 2000. Our Common Stock is
listed on the New York Stock Exchange under the symbol CYH. At March 16, 2001,
there were approximately 48 record holders and 4,150 beneficial holders of our
Common Stock. The following table sets forth, for the periods indicated, the
high and low sale prices per share of our Common Stock as reported by the New
York Stock Exchange. Our Common Stock did not trade below the June 9, 2000
initial public offering price of $13.00.
HIGH LOW
-------- --------
Year Ended December 31, 2000
Second Quarter (beginning June 9, 2000)................ $16.3125 $ 13.00
Third Quarter.......................................... 32.50 15.625
Fourth Quarter......................................... 37.20 24.25
We have not paid any cash dividends since its inception, and do not
anticipate the payment of cash dividends in the foreseeable future.
The shares of our Common Stock sold in our initial public offering were
registered under the Securities Act of 1933, as amended, on a Registration
Statement on Form S-1 (the "Registration Statement") (Registration
No. 333-31790). In total, we sold 20,425,717 shares in the offering at $13.00
per share, including 1,675,717 shares sold on July 3, 2000 in connection with
the exercise by the underwriters of their overallotment option. After deducting
the underwriting discounts and commissions and the offering expenses described
above, the Company received net proceeds from the offering of $245.7 million
which was used to repay long-term debt.
On November 3, 2000, we closed a second public offering of Common Stock. The
shares of our Common Stock sold in the offering were registered under the
Securities Act of 1933, as amended, on a Registration Statement on Form S-1 (the
"Registration Statement") (Registration No. 333-47354). The 10,000,000 shares
offered by the Company and 8,000,000 shares offered by the selling shareholders
under the Registration Statement were sold at a price of $28.1875 per share.
After deducting the underwriting discounts and commissions and the offering
expenses described above, the Company received net proceeds from the offering of
$268.9 million which was used to repay long-term debt.
23
ITEM 6.
SELECTED FINANCIAL DATA
PERIOD FROM PREDECESSOR(1)
JULY 1 PERIOD FROM
THROUGH JANUARY 1
YEAR ENDED DECEMBER 31, DECEMBER THROUGH JUNE
--------------------------------------------------- 31, 30,
2000 1999 1998 1997 1996(3) 1996(2)
---------- ---------- ----------- ----------- ----------- --------------
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
CONSOLIDATED STATEMENT OF
OPERATIONS DATA
Net operating revenues... $1,337,501 $1,079,953 $ 854,580 $ 742,350 $ 327,922 $294,166
Income (loss) from
operations............. 155,112 105,255 (95,152) 53,081 27,118 (34,069)
Net income (loss)........ 9,569 (16,789) (183,290) (32,171) (13,102) (27,252)
Net income (loss) per
share -- Diluted....... 0.14 (0.31) (3.38) (0.60) (0.24) --
Weighted-average number
of shares outstanding
-- Diluted (4)......... 69,187,191 54,545,030 54,249,895 53,989,089 53,786,432 --
CONSOLIDATED BALANCE
SHEET DATA (AS OF END
OF PERIOD OR YEAR)
Cash and cash
equivalents............ $ 13,740 $ 4,282 $ 6,719 $ 7,663 $ 26,588 $ 10,410
Total assets............. 2,213,837 1,895,084 1,747,016 1,643,521 1,630,630 506,323
Long-term obligations.... 1,216,790 1,430,099 1,273,502 1,053,450 1,009,698 246,216
Stockholders' equity..... 756,174 229,708 246,826 433,625 465,673 165,879
- --------------------------
(1) Effective in July 1996, we acquired all of the outstanding common stock of
our principal subsidiary, CHS/Community Health Systems, Inc. The predecessor
company had a substantially different capital structure compared to ours.
Because of the limited usefulness of the earnings per share information for
the predecessor company, these amounts have been excluded.
(2) Includes two acquisitions.
(3) Includes six acquisitions.
(4) See note 10 to the consolidated financial statements, included later in this
Form 10-K.
24
ITEM 7.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
You should read this discussion together with our consolidated financial
statements and the accompanying notes and Selected Financial Data included
elsewhere in this Form 10-K.
OVERVIEW
We are the largest non-urban provider of general hospital healthcare
services in the United States in terms of number of facilities and the second
largest in terms of revenues and EBITDA. As of December 31, 2000, we owned,
leased or operated 52 hospitals, geographically diversified across 20 states,
with an aggregate of 4,688 licensed beds. In over 85% of our markets, we are the
sole provider of general hospital healthcare services. In most of our other
markets, we are one of two providers of general hospital healthcare services.
For the fiscal year ended December 31, 2000, we generated $1.34 billion in net
operating revenues and $252.7 million in adjusted EBITDA. We achieved revenue
growth of 23.8% in 2000 and 26.4% in 1999. We also achieved growth in adjusted
EBITDA of 23.8% in 2000 and 22.7% in 1999.
ACQUISITIONS
During 2000, we acquired, through five purchases and two capital lease
transactions, most of the assets, including working capital, of seven hospitals.
These acquisitions include the purchase of assets of a hospital which we were
managing under an operating agreement. We had purchased the working capital
accounts of that hospital in 1998. The consideration for the seven hospitals
totaled approximately $247 million. This consideration consisted of
$148 million in cash, which we borrowed under our acquisition loan facilities,
and assumed liabilities of $99 million. We prepaid the lease obligation relating
to each lease transaction. We included the prepayment as part of the cash
consideration.
During 1999, we acquired, through three purchases and one capital lease
transaction, most of the assets, including working capital, of four hospitals.
The consideration for the four hospitals totaled approximately $78 million. This
consideration consisted of $59.7 million in cash, which we borrowed under our
acquisition loan facility, and assumed liabilities of $18.1 million. We prepaid
the entire lease obligation relating to the lease transaction. We included the
prepayment as part of the cash consideration. We also opened one additional
hospital, after completion of construction, at a cost of $15.3 million. This
owned hospital replaced a hospital that we managed.
During 1998, we acquired, through two purchase and two capital lease
transactions, most of the assets, including working capital, of four hospitals.
The consideration for the four hospitals totaled approximately $219 million.
This consideration consisted of $169.8 million in cash, which we borrowed under
our acquisition loan facility, and assumed liabilities of $48.8 million. We
prepaid the entire lease obligation relating to each lease transaction. We
included the prepayment as part of the cash consideration. Also, effective
December 1, 1998, we entered into an operating agreement relating to a 38
licensed bed hospital. We also purchased the working capital accounts of that
hospital. The cash payment made for this hospital was $2.8 million. Pursuant to
this operating agreement, upon specified conditions being met, we will be
obligated to construct a replacement hospital and to purchase for $0.9 million
the remaining assets of the hospital. Upon completion, all rights of ownership
and operation will transfer to us.
Goodwill from the acquisition of our predecessor company in 1996 was
$662.1 million and from subsequent hospital acquisitions was $323.5 million as
of December 31, 2000. Based on management's
25
assessment of the goodwill's estimated useful life, we generally amortize our
goodwill over 40 years. Goodwill represented 130.3% of our shareholders' equity
as of December 31, 2000; the amount of goodwill amortized equaled 16.6% of our
income from operations for the year ended December 31, 2000. Significant adverse
changes in facts regarding our industry, markets and operations could cause our
management to shorten the estimated useful life used to amortize our goodwill.
This could result in material increases in amortization of goodwill, or cause
impairments to the carrying amount of such goodwill, resulting in a non-cash
charge which would reduce operating income.
In the future, we intend to acquire, on a selective basis, two to four
hospitals in our target markets annually. Because of the financial impact of
acquisitions, it is difficult to make meaningful comparisons between our
financial statements for the periods presented. Because EBITDA margins at
hospitals we acquire are, at the time of acquisition, lower than those of our
existing hospitals, acquisitions can negatively affect our EBITDA margins on a
consolidated basis.
On May 1, 2000, we terminated the lease of a hospital previously held for
disposition. At December 31, 2000, the carrying amounts of one of our hospitals,
which is being held for disposition, were segregated from our remaining assets
and classified in other assets, net in our consolidated balance sheet as of
December 31, 2000. We do not expect the impact of any gain or loss on our
financial results to be material.
SOURCES OF REVENUE
Net operating revenues include amounts estimated by management to be
reimbursable by Medicare and Medicaid under prospective payment systems and
provisions of cost-reimbursement and other payment methods. Approximately 46% of
net operating revenues for the year ended December 31, 2000, 48% for the year
ended December 31, 1999, and 49% for the year ended December 31, 1998, are
related to services rendered to patients covered by the Medicare and Medicaid
programs. In addition, we are reimbursed by non-governmental payors using a
variety of payment methodologies. Amounts we receive for treatment of patients
covered by these programs are generally less than the standard billing rates. We
account for the differences between the estimated program reimbursement rates
and the standard billing rates as contractual adjustments, which we deduct from
gross revenues to arrive at net operating revenues. Final settlements under some
of these programs are subject to adjustment based on administrative review and
audit by third parties. We record adjustments to the estimated billings in the
periods that such adjustments become known. We account for adjustments to
previous program reimbursement estimates as contractual adjustments and report
them in future periods as final settlements are determined. Adjustments related
to final settlements or appeals that increased revenue were insignificant in
each of the years ended December 31, 2000, 1999 and 1998. Net amounts due to
third-party payors as of December 31, 2000 were $2.3 million and as of
December 31, 1999 were $9.1 million. We included these amounts in "Accrued
Liabilities--Other" in our balance sheets. Substantially all Medicare and
Medicaid cost reports are final settled through 1997.
We expect the percentage of revenues received from the Medicare program to
increase due to the general aging of the population and the restoration of some
payments under the Balanced Budget Refinement Act of 1999 and Benefit and
Improvement Protection Act of 2000. The payment rates under the Medicare program
for inpatients are based on a prospective payment system, based upon the
diagnosis of a patient. While these rates are indexed for inflation annually,
the increases have historically been less than actual inflation. Reductions in
the rate of increase in Medicare reimbursement may have an adverse impact on our
net operating revenue growth.
The implementation of Medicare's new prospective payment system for
outpatient hospital care, effective August 1, 2000, had a favorable impact,
however, not material to our overall operating results. The Health Care
Financing Administration estimated that this new prospective payment system will
result in an overall 9.7% increase in projected outpatient payments which began
August 1, 2000.
26
In December 2000, the Benefit Improvement and Protection Act of 2000 became
law. It is estimated that the changes to be implemented to many facets of the
Medicare reimbursement system will increase reimbursement. We do not believe
these increases will be material to our overall operating results.
In addition, Medicaid programs, insurance companies, and employers are
actively negotiating the amounts paid to hospitals as opposed to their standard
rates. The trend toward increased enrollment in managed care may adversely
affect our net operating revenue growth.
RESULTS OF OPERATIONS
Our hospitals offer a variety of services involving a broad range of
inpatient and outpatient medical and surgical services. These include
orthopedics, cardiology, OB/GYN, occupational medicine, rehabilitation
treatment, home health, and skilled nursing. The strongest demand for hospital
services generally occurs during January through April and the weakest demand
for these services occurs during the summer months. Accordingly, eliminating the
effect of new acquisitions, our net operating revenues and earnings are
generally highest during the first quarter and lowest during the third quarter.
The following tables summarize, for the periods indicated, selected
operating data.
YEARS ENDED DECEMBER 31,
---------------------------------
2000 1999 1998
--------- --------- ---------
(EXPRESSED AS A PERCENTAGE OF NET
OPERATING REVENUES)
Net operating revenues...................................... 100.0 100.0 100.0
Operating expenses (1)...................................... (81.1) (81.1) (80.5)
----- ----- -----
Adjusted EBITDA (2)......................................... 18.9 18.9 19.5
Depreciation and amortization............................... (5.4) (5.3) (5.8)
Amortization of goodwill.................................... (1.9) (2.3) (3.1)
Impairment of long-lived assets............................. -- -- (19.3)
Compliance settlement and Year 2000 remediation costs (3)... -- (1.6) (2.4)
----- ----- -----
Income (loss) from operations............................... 11.6 9.7 (11.1)
Interest, net............................................... (9.5) (10.8) (11.8)
----- ----- -----
Income (loss) before cumulative effect of a change in
accounting principle and income taxes..................... 2.1 (1.1) (22.9)
Provision for (benefit from) income taxes................... 1.4 0.5 (1.5)
----- ----- -----
Income (loss) before cumulative effect of a change in
accounting principle...................................... 0.7 (1.6) (21.4)
===== ===== =====
27
YEARS ENDED
DECEMBER 31,
-------------------
2000 1999
-------- --------
Percentage change from prior period:
Net operating revenues...................................... 23.8 26.4
Admissions.................................................. 19.0 20.3
Adjusted admissions (4)..................................... 20.9 22.6
Average length of stay...................................... (5.0) (4.8)
Adjusted EBITDA (2)......................................... 23.8 22.7
Same hospitals percentage change from prior period (5):
Net operating revenues...................................... 10.3 7.6
Admissions.................................................. 6.3 4.9
Adjusted admissions......................................... 7.3 7.7
Adjusted EBITDA (2)......................................... 16.7 12.6
- ------------------------
(1) Operating expenses include salaries and benefits, provision for bad debts,
supplies, rent, and other operating expenses, and exclude the items that are
excluded for purposes of determining adjusted EBITDA as discussed in
footnote (2) below.
(2) We define adjusted EBITDA as EBITDA adjusted to exclude cumulative effect of
a change in accounting principle, impairment of long-lived assets and
compliance settlement and Year 2000 remediation costs. EBITDA consists of
income (loss) before interest, income taxes, depreciation and amortization,
and amortization of goodwill. EBITDA and adjusted EBITDA should not be
considered as measures of financial performance under generally accepted
accounting principles. Items excluded from EBITDA and adjusted EBITDA are
significant components in understanding and assessing financial performance.
EBITDA and adjusted EBITDA are key measures used by management to evaluate
our operations and provide useful information to investors. EBITDA and
adjusted EBITDA should not be considered in isolation or as alternatives to
net income, cash flows generated by operations, investing or financing
activities, or other financial statement data presented in the consolidated
financial statements as indicators of financial performance or liquidity.
Because EBITDA and adjusted EBITDA are not measurements determined in
accordance with generally accepted accounting principles and are thus
susceptible to varying calculations, EBITDA and adjusted EBITDA as presented
may not be comparable to other similarly titled measures of other companies.
(3) Includes Year 2000 remediation costs representing 0.0% in 1998, 0.3% in 1999
and 0.0% in 2000.
(4) Adjusted admissions is a general measure of combined inpatient and
outpatient volume. We computed adjusted admissions by multiplying admissions
by gross patient revenues and then dividing that number by gross inpatient
revenues.
(5) Includes acquired hospitals to the extent we operated them during comparable
periods in both years.
28
YEAR ENDED DECEMBER 31, 2000 COMPARED TO YEAR ENDED DECEMBER 31, 1999
Net operating revenues increased by 23.8% to $1,337.5 million in 2000 from
$1,080.0 million in 1999. Of the $257.5 million increase in net operating
revenues, the hospitals we acquired, including one constructed, in 2000 and
1999, contributed $149.6 million and hospitals we owned throughout both periods
contributed $107.9 million. The $107.9 million, or 10.3%, increase in same
hospitals net operating revenues was attributable primarily to inpatient and
outpatient volume increases. In 2000, we experienced an estimated $25 million of
reductions from the Balanced Budget Act of 1997. We have experienced lower
payments from a number of payors, resulting primarily from:
- reductions mandated by the Balanced Budget Act of 1997, particularly in
the areas of reimbursement for Medicare outpatient, capital, bad debts,
home health, and skilled nursing;
- reductions in various states' Medicaid programs; and
- reductions in length of stay for patients not reimbursed on an admission
basis.
We expect the Balanced Budget Refinement Act of 1999 and the Benefit
Improvement and Protection Act of 2000 to lessen the impact of these reductions
in future periods.
Inpatient admissions increased by 19.0%. Adjusted admissions increased by
20.9%. Average length of stay decreased by 5.0%. On a same hospitals basis,
inpatient admissions increased by 6.3% and adjusted admissions increased by
7.3%. The increase in same hospitals inpatient admissions and adjusted
admissions was due primarily to an increase in services offered, physician
relationship development efforts, and the addition of physicians through our
focused recruitment program. On a same hospitals basis, net outpatient operating
revenues increased 13.7%. Outpatient growth reflects the continued trend toward
a preference for outpatient procedures, where appropriate, by patients,
physicians, and payors.
Operating expenses, as a percentage of net operating revenues, remained
unchanged at 81.1% from 1999 to 2000. Adjusted EBITDA margin remained unchanged
at 18.9% from 1999 to 2000. Salaries and benefits, as a percentage of net
operating revenues, decreased from 38.8% in 1999 to 38.7% in 2000. Provision for
bad debts, as a percentage of net operating revenues, increased to 9.1% in 2000
from 8.8% in 1999 due to an increase in self-pay revenues and payor remittance
slowdowns in part caused by an increase in the number of acquisition
conversions. The conversion is the process by which the Company must apply for
new Medicare and Medicaid provider numbers on acquired hospitals. This process
results in billing delays and payor remittance slowdowns and subsequently an
increase in the allowance for uncollectible receivables during the conversion
period. Supplies, as a percentage of net operating revenues, decreased to 11.5%
in 2000 from 11.7% in 1999. Rent and other operating expenses, as a percentage
of net operating revenues, remained unchanged at 21.7% from 1999 to 2000.
On a same hospitals basis, operating expenses as a percentage of net
operating revenues decreased from 81.2% in 1999 to 80.1% in 2000 and adjusted
EBITDA margin increased from 18.8% in 1999 to 19.9% in 2000. These efficiency
and productivity gains resulted from the achievement of target staffing ratios,
physician recruiting efforts, and improved compliance with national purchasing
contracts. Operating expenses improved as a percentage of net operating revenues
in every major category except provision for bad debts which increased slightly
and other operating expenses which were flat compared to 1999.
Depreciation and amortization increased by $15.0 million from $56.9 million
in 1999 to $71.9 million in 2000. The twelve hospitals acquired in 1999 and 2000
accounted for $5.9 million of the increase and facility renovations and
purchases of equipment primarily accounted for the remaining $9.1 million.
29
Amortization of goodwill increased by $1.0 million from $24.7 million in
1999 to $25.7 million in 2000. This increase primarily related to the twelve
hospitals acquired, including one constructed, in 1999 and 2000.
Interest, net increased by $10.9 million from $116.5 million in 1999 to
$127.4 million in 2000. The twelve hospitals acquired, including one
constructed, in 1999 and 2000 accounted for approximately $8.5 million of the
increase, borrowings under our credit agreement to finance capital expenditures
and physician recruiting accounted for $10.0 million of the increase, borrowings
to fund our compliance settlement accounted for $1.9 million of the increase and
changes in interest rates accounted for $8.2 million of the increase. These
increases were offset by savings of approximately $16.0 million from the
repayment of long-term debt with the proceeds from our initial public and
secondary offerings in 2000 and a savings of $1.7 million from an increase in
cash flow from operations.
Income before income taxes for 2000 was $27.7 million compared to a loss of
$11.2 million in 1999. This improvement is primarily the result of revenue
growth from both acquisitions and same store hospitals, management's ability to
control expenses and a reduction in the growth rate of interest expense.
The provision for income taxes in 2000 was $18.2 million compared to
$5.6 million in 1999. Due to the non-deductible nature of certain goodwill
amortization, the resulting effective tax rate is in excess of the statutory
rate.
Net income for 2000 was $9.6 million as compared to $16.8 million net loss
in 1999.
YEAR ENDED DECEMBER 31, 1999 COMPARED TO YEAR ENDED DECEMBER 31, 1998
Net operating revenues increased by 26.4% to $1,080.0 million in 1999 from
$854.6 million in 1998. Of the $225.4 million increase in net operating
revenues, the nine hospitals we acquired, including one constructed, in 1998 and
1999, contributed $160.6 million and hospitals we owned throughout both periods
contributed $64.8 million. The $64.8 million, or 7.6%, increase in same
hospitals net operating revenues was attributable primarily to inpatient and
outpatient volume increases, partially offset by a decrease in reimbursement. In
1999, we experienced an estimated $23 million of revenue reductions from the
Balanced Budget Act of 1997. We have experienced lower payments from a number of
payors, resulting primarily from:
- reductions mandated by the Balanced Budget Act of 1997, particularly in
the areas of reimbursement for Medicare outpatient, capital, bad debts,
home health, and skilled nursing;
- reductions in various states' Medicaid programs; and
- reductions in length of stay for patients not reimbursed on an admission
basis.
Inpatient admissions increased by 20.3%. Adjusted admissions increased by
22.6%. Average length of stay decreased by 4.8%. On a same hospitals basis,
inpatient admissions increased by 4.9% and adjusted admissions increased by
7.7%. The increase in same hospitals inpatient admissions and adjusted
admissions was due primarily to an increase in services offered, physician
relationship development efforts, and the addition of physicians through our
focused recruitment program. On a same hospitals basis, net outpatient operating
revenues increased 14.8%. Outpatient growth reflects the continued trend toward
a preference for outpatient procedures, where appropriate, by patients,
physicians, and payors.
Operating expenses, as a percentage of net operating revenues, increased
from 80.5% in 1998 to 81.1% in 1999 due to higher operating expenses and lower
initial adjusted EBITDA margins associated with acquired hospitals and one
recently constructed hospital. Adjusted EBITDA margin decreased from 19.5% in
1998 to 18.9% in 1999. Salaries and benefits, as a percentage of net operating
revenues, increased to 38.8% in 1999 from 38.4% in 1998, due to acquisitions of
hospitals in 1998 and 1999
30
having higher salaries and benefits as a percentage of net operating revenues
than our 1998 results. Provision for bad debts, as a percentage of net operating
revenues, increased to 8.8