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FORM 10-K
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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(MARK ONE)
[X]ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 2001
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 No. 1-10765
UNIVERSAL HEALTH SERVICES, INC.
(Exact name of registrant as specified in its charter)
Delaware 23-2077891
(State or other jurisdiction of (I.R.S. Employer Identification
incorporation or organization) Number)
UNIVERSAL CORPORATE CENTER
367 South Gulph Road P.O. Box 61558
King of Prussia, Pennsylvania
(Address of principal executive 19406-0958
offices) (Zip Code)
Registrant's telephone number, including area code: (610) 768-3300
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Securities registered pursuant to Section 12(b) of the Act:
Title of each Class Name of each exchange on which
Class B Common Stock, $.01 par value registered
New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act:
Class D Common Stock, $.01 par value
(Title of each Class)
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Indicate by check mark whether the registrant (1) has filed all reports to be
filed by Section 13 or 15(d) of the Securities and 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. [_]
The number of shares of the registrant's Class A Common Stock, $.01 par value,
Class B Common Stock, $.01 par value, Class C Common Stock, $.01 par value,
and Class D Common Stock, $.01 par value, outstanding as of January 31, 2002,
was 3,848,886, 55,626,495, 387,848 and 38,989, respectively.
The aggregate market value of voting stock held by non-affiliates at January
31, 2002 $2,291,664,987. (For the purpose of this calculation, it was assumed
that Class A, Class C, and Class D Common Stock, which are not traded but are
convertible share-for-share into Class B Common Stock, have the same market
value as Class B Common Stock.)
DOCUMENTS INCORPORATED BY REFERENCE:
Portions of the registrant's definitive proxy statement for its 2002 Annual
Meeting of Stockholders, which will be filed with the Securities and Exchange
Commission within 120 days after December 31, 2001 (incorporated by reference
under Part III).
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PART I
ITEM 1. Business
The principal business of Universal Health Services, Inc. (together with its
subsidiaries, the "Company") is owning and operating acute care hospitals,
behavioral health centers, ambulatory surgery centers, radiation oncology
centers and women's centers. Presently, the Company operates 73 hospitals,
consisting of 35 acute care hospitals and 38 behavioral health centers located
in Arkansas, California, Delaware, the District of Columbia, Florida, Georgia,
Illinois, Indiana, Kentucky, Louisiana, Massachusetts, Michigan, Mississippi,
Missouri, Nevada, New Jersey, Oklahoma, Pennsylvania, Puerto Rico, South
Carolina, Tennessee, Texas, Utah, Washington and France. The Company, as part
of its Ambulatory Treatment Centers Division, owns outright, or in partnership
with physicians, and operates or manages 23 surgery and radiation oncology
centers located in 12 states.
Services provided by the Company's hospitals include general surgery,
internal medicine, obstetrics, emergency room care, radiology, oncology,
diagnostic care, coronary care, pediatric services and behavioral health
services. The Company provides capital resources as well as a variety of
management services to its facilities, including central purchasing,
information services, finance and control systems, facilities planning,
physician recruitment services, administrative personnel management, marketing
and public relations.
The Company selectively seeks opportunities to expand its base of operations
by acquiring, constructing or leasing additional hospital facilities. Such
expansion may provide the Company with access to new markets and new health
care delivery capabilities. The Company also seeks to increase the operating
revenues and profitability of owned hospitals by the introduction of new
services, improvement of existing services, physician recruitment and the
application of financial and operational controls. Pressures to contain health
care costs and technological developments allowing more procedures to be
performed on an outpatient basis have led payors to demand a shift to
ambulatory or outpatient care wherever possible. The Company is responding to
this trend by emphasizing the expansion of outpatient services. In addition,
in response to cost containment pressures, the Company intends to implement
programs designed to improve financial performance and efficiency while
continuing to provide quality care, including more efficient use of
professional and paraprofessional staff, monitoring and adjusting staffing
levels and equipment usage, improving patient management and reporting
procedures and implementing more efficient billing and collection procedures.
The Company also continues to examine its facilities and to dispose of those
facilities which it believes do not have the potential to contribute to the
Company's growth or operating strategy.
The Company is involved in continual development activities. Applications to
state health planning agencies to add new services in existing hospitals are
currently on file in states which require certificates of need (e.g.,
Washington, D.C.). Although the Company expects that some of these
applications will result in the addition of new facilities or services to the
Company's operations, no assurances can be made for ultimate success by the
Company in these efforts.
Recent and Proposed Acquisitions and Development Activities
In 2001, the Company proceeded with its development of new facilities and
consummated a number of acquisitions.
In January 2001, the Company acquired the assets of the following
facilities: (i) Rancho Springs Medical Center, an acute care hospital located
in Murrieta, California; (ii) Westwood Lodge Hospital and Pembroke Hospital,
two behavioral health care facilities located in Boston, Massachusetts, and;
(iii) Hospital San Juan Capestrano, a behavioral health care facility located
in Puerto Rico.
In February 2001, the Company acquired the assets of the McAllen Heart
Hospital, a specialty hospital located in McAllen, Texas. Upon acquisition,
this facility began operating under the same license as an integrated
department of McAllen Medical Center.
1
In March 2001, the Company acquired an 80% interest in an operating company
that as of December 31, 2001, owned nine hospitals located in France.
In March 2001, the Company acquired the assets of Surgical Arts Surgery
Center, an ambulatory surgery center located in Reno, Nevada.
In September 2001, the Company acquired the assets of St. Lukes's
Surgicenter, a multi-specialty center located in Hammond, Louisiana.
In December 2001, the Company acquired the assets (ownership effective
January 1, 2002) of Central Montgomery Medical Center, an acute care hospital
located in Lansdale, Pennsylvania.
Also in December 2001, the Company acquired the ownership interest
(ownership effective January 1, 2002) of Lancaster Hospital Corporation, which
owns and operates Lancaster Community Hospital, an acute care hospital in
Lancaster, California.
Bed Utilization and Occupancy Rates
The following table shows the historical bed utilization and occupancy rates
for the hospitals operated by the Company for the years indicated.
Accordingly, information related to hospitals acquired during the five year
period has been included from the respective dates of acquisition, and
information related to hospitals divested during the five year period has been
included up to the respective dates of divestiture.
2001 2000 1999 1998 1997
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Average Licensed Beds:
Acute Care Hospitals....... 6,234 4,980 4,806 4,696 3,389
Behavioral Health Centers.. 3,732 2,612 1,976 1,782 1,777
Average Available Beds(1):
Acute Care Hospitals....... 5,351 4,220 4,099 3,985 2,951
Behavioral Health Centers.. 3,588 2,552 1,961 1,767 1,762
Admissions:
Acute Care Hospitals....... 285,222 214,771 204,538 187,833 128,020
Behavioral Health Centers.. 78,688 49,971 37,810 32,400 28,350
Average Length of Stay
(Days):
Acute Care Hospitals....... 4.7 4.7 4.7 4.7 4.8
Behavioral Health Centers.. 12.1 12.2 11.8 11.3 11.9
Patient Days(2):
Acute Care Hospitals....... 1,328,609 1,017,646 963,842 884,966 616,965
Behavioral Health Centers.. 950,236 608,423 444,632 365,935 336,850
Occupancy Rate--Licensed
Beds(3):
Acute Care Hospitals....... 58% 56% 55% 52% 50%
Behavioral Health Centers.. 70% 64% 62% 56% 52%
Occupancy Rate--Available
Beds(3):
Acute Care Hospitals....... 68% 66% 64% 61% 57%
Behavioral Health Centers.. 73% 65% 62% 57% 52%
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Note: Included in the Acute Care Hospitals in 2001 is the data for the nine
hospitals located in France owned by an operating company in which the
Company purchased an 80% ownership interest during 2001.
(1) "Average Available Beds" is the number of beds which are actually in
service at any given time for immediate patient use with the necessary
equipment and staff available for patient care. A hospital may have
appropriate licenses for more beds than are in service for a number of
reasons, including lack of demand, incomplete construction, and
anticipation of future needs.
(2) "Patient Days" is the aggregate sum for all patients of the number of days
that hospital care is provided to each patient.
(3) "Occupancy Rate" is calculated by dividing average patient days (total
patient days divided by the total number of days in the period) by the
number of average beds, either available or licensed.
2
The number of patient days of a hospital is affected by a number of factors,
including the number of physicians using the hospital, changes in the number
of beds, the composition and size of the population of the community in which
the hospital is located, general and local economic conditions, variations in
local medical and surgical practices and the degree of outpatient use of the
hospital services. Current industry trends in utilization and occupancy have
been significantly affected by changes in reimbursement policies of third
party payors. A continuation of such industry trends could have a material
adverse impact upon the Company's future operating performance. The Company
has experienced growth in outpatient utilization over the past several years.
The Company is unable to predict the rate of growth and resulting impact on
the Company's future revenues because it is dependent upon developments in
medical technologies and physician practice patterns, both of which are
outside of the Company's control. The Company is also unable to predict the
extent to which other industry trends will continue or accelerate.
Sources of Revenue
The Company receives payment for services rendered from private insurers,
including managed care plans, the federal government under the Medicare
program, state governments under their respective Medicaid programs and
directly from patients. All of the Company's acute care hospitals and most of
the Company's behavioral health centers are certified as providers of Medicare
and Medicaid services by the appropriate governmental authorities. The
requirements for certification are subject to change, and, in order to remain
qualified for such programs, it may be necessary for the Company to make
changes from time to time in its facilities, equipment, personnel and
services. The costs for recertification are not material as many of the
requirements for recertification are integrated with the Company's internal
quality control processes. If a facility loses certification, it will be
unable to receive payment for patients under the Medicare or Medicaid
programs. Although the Company intends to continue in such programs, there is
no assurance that it will continue to qualify for participation.
The sources of the Company's hospital revenues are charges related to the
services provided by the hospitals and their staffs, such as radiology,
operating rooms, pharmacy, physiotherapy and laboratory procedures, and basic
charges for the hospital room and related services such as general nursing
care, meals, maintenance and housekeeping. Hospital revenues depend upon the
occupancy for inpatient routine services, the extent to which ancillary
services and therapy programs are ordered by physicians and provided to
patients, the volume of outpatient procedures and the charges or negotiated
payment rates for such services. Charges and reimbursement rates for inpatient
routine services vary depending on the type of bed occupied (e.g.,
medical/surgical, intensive care or psychiatric) and the geographic location
of the hospital.
McAllen Medical Center located in McAllen, Texas and Edinburg Regional
Medical Center located in Edinburg, Texas operate within the same market. On a
combined basis, these two facilities contributed 11% in 2001, and 12% in 2000
and 13% in 1999 of the Company's consolidated net revenues and 17% in 2001,
21% in 2000 and 25% in 1999 of the Company's consolidated earnings before
depreciation & amortization, interest, provision for insurance settlements,
facility closure costs, losses on foreign exchange & derivative transactions,
income taxes and extraordinary charge from early extinguishment of debt, net
of taxes (after deducting an allocation of corporate overhead) ("EBITDA"). The
Company has a majority ownership interest in three acute care hospitals in the
Las Vegas, Nevada market. These three hospitals, Valley Hospital Medical
Center, Summerlin Hospital Medical Center and Desert Springs Hospital, on a
combined basis, contributed 16% in 2001, 18% in 2000 and 18% in 1999 of the
Company's consolidated net revenues and 13% in 2001, 14% in 2000 and 10% in
1999 of the Company's consolidated EBITDA.
3
The following table shows approximate percentages of net patient revenue
derived by the Company's hospitals owned as of December 31, 2001 since their
respective dates of acquisition by the Company from third party sources,
including the additional Medicaid reimbursements received at five of the
Company's acute care facilities located in Texas and one in South Carolina
totaling $32.6 in 2001, $28.9 in 2000, $37.0 million in 1999, $36.5 million in
1998, and $33.4 million in 1997, and from all other sources during the five
years ended December 31, 2001.
PERCENTAGE OF NET PATIENT REVENUES
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2001 2000 1999 1998 1997
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Third Party Payors:
Medicare................................ 31.5% 32.3% 33.5% 34.3% 35.6%
Medicaid................................ 10.5% 11.5% 12.6% 11.3% 14.5%
Managed Care (HMOs and PPOs)............ 36.9% 34.5% 31.5% 27.2% 19.1%
Other Sources........................... 21.1% 21.7% 22.4% 27.2% 30.8%
------ ------ ------ ------ ------
Total................................... 100% 100% 100% 100% 100%
Regulation and Other Factors
Within the statutory framework of the Medicare and Medicaid programs, there
are substantial areas subject to administrative rulings, interpretations and
discretion which may affect payments made under either or both of such
programs and reimbursement is subject to audit and review by third party
payors. Management believes that adequate provision has been made for any
adjustments that might result therefrom.
The Federal government makes payments to participating hospitals under its
Medicare program based on various formulas. Our general acute care hospitals
are subject to a prospective payment system ("PPS"). For inpatient services,
PPS pays hospitals a predetermined amount per diagnostic related group ("DRG")
based upon a hospital's location and the patient's diagnosis. Beginning August
1, 2000, under a new outpatient prospective payment system ("OPPS") mandated
by the Balanced Budget Act of 1997, both general acute and behavioral health
hospitals' outpatient services are paid a predetermined amount per Ambulatory
Payment Classification based upon a hospital's location and the procedures
performed. The Medicare, Medicaid and SCHIP Balanced Budget Refinement Act of
1999 ("BBRA of 1999") included "transitional corridor payments" through fiscal
year 2003, which provide some financial relief for any hospital that generally
incurs a reduction to its Medicare outpatient reimbursement under the new
OPPS.
Behavioral health facilities, which are excluded from the inpatient services
PPS, are cost reimbursed by the Medicare program, but are generally subject to
a per discharge ceiling, calculated based on an annual allowable rate of
increase over the hospital's base year amount under the Medicare law and
regulations. Capital related costs are exempt from this limitation. In the
Balanced Budget Act of 1997 ("BBA-97"), Congress significantly
revised the Medicare payment provisions for PPS-excluded hospitals, including
psychiatric hospitals. Effective for Medicare cost reporting periods beginning
on or after October 1, 1997, different caps are applied to psychiatric
hospitals' target amounts depending whether a hospital was excluded from PPS
before or after that date, with higher caps for hospitals excluded before that
date. Congress also revised the rate-of-increase percentages for PPS-excluded
hospitals and eliminated the new provider PPS-exemption for psychiatric
hospitals. In addition, the Health Care Financing Administration, now known as
the Centers for Medicare and Medicaid Services ("CMS"), has implemented
requirements applicable to psychiatric hospitals that share a facility or
campus with another hospital. The BBRA of 1999 requires that CMS develop an
inpatient psychiatric per diem prospective payment system effective for the
federal fiscal year beginning October 1, 2002, however, it is possible the
implementation may be delayed. Upon implementation, this new prospective
payment system will replace the current inpatient psychiatric payment system
described above.
On August 30, 1991, the CMS issued final Medicare regulations establishing a
PPS for inpatient hospital capital-related costs. These regulations apply to
hospitals which are reimbursed based upon the prospective payment system and
took effect for cost report years beginning on or after October 1, 1991. For
most of the
4
Company's hospitals, the new methodology began on January 1, 1992. In 2001,
the tenth year of the phase-in, most of the Company's hospitals are paid by
the Medicare program based on the blend of the federal capital rate and the
rate specific to each hospital (three hospitals still receive hold harmless
payments, which are described below.)
The regulations provide for the use of a 10-year transition period in which
a blend of the old and new capital payment provisions is utilized. One of two
methodologies applies during the 10-year transition period. If the hospital's
hospital-specific capital rate exceeds the federal capital rate, the hospital
is paid per discharge on the basis of a "hold harmless" methodology, which is
the higher of a blend of a portion of old capital costs and an amount for new
capital costs based on a proportion of the federal capital rate, or 100% of
the federal capital rate. Alternatively, with limited exceptions, if the
hospital-specific rate is below the federal capital rate, the hospital
receives payments based upon a "fully prospective" methodology, which is a
blend of the hospital's hospital-specific capital rate and the federal capital
rate. Each hospital's hospital-specific rate was determined based upon
allowable capital costs incurred during the "base year", which, for most of
the Company's hospitals, was the year ended December 31, 1990. Updated amounts
and factors necessary to determine PPS rates for Medicare hospital inpatient
services for operating costs and capital related costs are published annually.
In addition to the trends described above that continue to have an impact on
the operating results, there are a number of other more general factors
affecting our business. BBA-97 called for the government to trim the growth of
federal spending on Medicare by $115 billion and on Medicaid by $13 billion
over the following years. The act also called for reductions in the future
rate of increases to payments made to hospitals and reduced the amount of
reimbursement for outpatient services, bad debt expense and capital costs.
Some of these reductions were reversed with the passage on December 15, 2000
of the Medicare, Medicaid and SCHIP Benefits Improvement and Protection Act of
2000 ("BIPA") which, among other things, increased Medicare and Medicaid
payments to healthcare providers by $35 billion over 5 years with
approximately $12 billion of this amount targeted for hospitals and $11
billion for managed care payors. These increased reimbursements to hospitals
pursuant to the terms of BIPA commenced in April, 2001. BBA-97 established the
annual update for Medicare at market basket minus 1.1% in both fiscal years
2001 (October 1, 2000 through September 30, 2001) and 2002 and BIPA revised
the update at the full market basket in fiscal year 2001 and market basket
minus .55% in fiscal years 2002 and 2003. Additionally, BBA-97 reduced
reimbursement to hospitals for Medicare bad debts to 55% and BIPA increased
the reimbursement to 70%, with an effective date for the Company of January 1,
2001. It is possible that future federal budgets will contain certain further
reductions or increases in the rate of increase of Medicare and Medicaid
spending.
The Company can provide no assurances that the reductions in the PPS update,
and other changes required by BBA-97, will not adversely affect the Company's
operations. However, within certain limits, a hospital can manage its costs,
and, to the extent this is done effectively, a hospital may benefit from the
DRG system. However, many hospital operating costs are incurred in order to
satisfy licensing laws, standards of the Joint Commission on the Accreditation
of Healthcare Organizations ("JCAHO") and quality of care concerns. In
addition, hospital costs are affected by the level of patient acuity,
occupancy rates and local physician practice patterns, including length of
stay, judgments and number and type of tests and procedures ordered. A
hospital's ability to control or influence these factors which affect costs
is, in many cases, limited.
In addition to Federal health reform efforts, several states have adopted or
are considering healthcare reform legislation. Several states are considering
wider use of managed care for their Medicaid populations and providing
coverage for some people who presently are uninsured. The enactment of
Medicaid managed care initiatives is designed to provide low-cost coverage.
The Company currently operates three behavioral health centers with a total of
501 beds in Massachusetts, which has mandated hospital rate-setting. The
Company also operates three hospitals containing an aggregate of 688 beds in
Florida that are subject to a mandated form of rate-setting if increases in
hospital revenues per admission exceed certain target percentages.
In 1991, the Texas legislature authorized the LoneSTAR Health Initiative, a
pilot program in two areas of the state, to establish for Medicaid
beneficiaries a healthcare delivery system based on managed care principles.
The program is now known as the STAR Program, which is short for State of
Texas Access Reform. Since 1995,
5
the Texas Health and Human Services Commission, with the help of other Texas
agencies such as the Texas Department of Health, has rolled out STAR Medicaid
managed care pilot programs in several geographic areas of the state. Under
the STAR program, the Texas Department of Health either contracts with health
maintenance organizations in each area to arrange for covered services to
Medicaid beneficiaries, or contracts directly with healthcare providers and
oversees the furnishing of care in the role of the case manager. Two carve-out
pilot programs are the STAR+PLUS program, which provides long-term care to
elderly and disabled Medicaid beneficiaries in the Harris County service area,
and the NorthSTAR program, which furnishes behavioral health services to
Medicaid beneficiaries in the Dallas County service area. Effective in the
fall of 1999, however, the Texas legislature imposed a moratorium on the
implementation of additional pilot programs until the 2001 legislative
session. A study on the effectiveness of Medicaid managed care was issued in
November, 2000. In June 2001, the state enacted House Bill 3038, which
requires the enrollment in group health plans of Medicaid and SCHIP recipients
who are eligible for such plans, if the state determines that such enrollment
is cost-effective. The effective date for this requirement is September 1,
2001. The state has indicated, however, that it will not be expanding the
Medicaid Managed Care program to any additional areas within the next year.
Upon meeting certain conditions, and serving a disproportionately high share
of Texas' and South Carolina's low income patients, five of the Company's
facilities located in Texas and one facility located in South Carolina became
eligible and received additional reimbursement from each state's
disproportionate share hospital fund. Included in our financial results was an
aggregate of $32.6 million in 2001, $28.9 million in 2000, $37.0 million in
1999, $36.5 million in 1998 and $33.4 million in 1997 received pursuant to the
terms of these programs. The Texas and South Carolina programs have been
renewed for the 2002 fiscal year and the Company expects its reimbursements,
as scheduled pursuant to the terms of these programs, to increase by
approximately $4.2 million annually as compared to the 2001 fiscal year.
Failure to renew these programs, which are scheduled to terminate in the third
quarter of 2002, or reduction in reimbursements, could have a material adverse
effect on our future results of operations.
The healthcare industry is subject to numerous laws and regulations which
include, among other things, matters such as government healthcare
participation requirements, various licensure and accreditations,
reimbursement for patient services, and Medicare and Medicaid fraud and abuse.
Providers that are found to have violated these laws and regulations may be
excluded from participating in government healthcare programs, subjected to
fines or penalties or required to repay amounts received from government for
previously billed patient services. While management of the Company believes
its policies, procedures and practices comply with governmental regulations,
no assurance can be given that the Company will not be subjected to
governmental inquiries or actions.
The federal physician self-referral and payment prohibitions (codified in 42
U.S.C. Section 1395nn, Section 1877 of the Social Security Act) generally
forbid, absent qualifying for one of the exceptions, a physician from making
referrals for the furnishing of any "designated health services," for which
payment may be made under the Medicare or Medicaid programs, to any entity
with which the physician (or an immediate family member) has a "financial
relationship." The legislation was effective January 1, 1992 for clinical
laboratory services ("Stark I") and January 1, 1995 for ten other designated
health services ("Stark II"). A "financial relationship" under Stark I and II
includes any direct or indirect "compensation arrangement" with an entity for
payment of any remuneration, and any direct or indirect "ownership or
investment interest" in the entity. The legislation contains certain
exceptions including, for example, where the referring physician has an
ownership interest in a hospital as a whole or where the physician is an
employee of an entity to which he or she refers. The Stark I and II self-
referral and payment prohibitions include specific reporting requirements
providing that each entity providing covered items or services must provide
certain information concerning its ownership, investment, and compensation
arrangements. In August 1995, HCFA published a final rule regarding physician
self-referrals for clinical lab services (Stark I). On January 4, 2001, HCFA
published a portion of the final rules regarding physician self referrals for
the ten other designated health services (Stark II). The remaining portions of
the final rule for Stark II are still forthcoming. Penalties for violating
Stark I and Stark II include denial of payment for any services rendered by an
entity in violation of the prohibitions, civil money penalties of up to
$15,000 for each offense, and exclusion from the Medicare and Medicaid
programs.
6
The federal anti-kickback statute (codified in 42 U.S.C. (S) 1320a-7b(b))
prohibits individuals and entities from knowingly and willfully soliciting,
receiving, offering or paying any remuneration to other individuals and
entities (directly or indirectly, overtly or covertly, in cash or in kind):
1. in return for referring an individual to a person for the furnishing or
arranging for the furnishing of any item or service for which payment may
be made under a federal or state health care program; or
2. in return for purchasing, leasing, ordering or arranging for or
recommending purchasing, leasing, or ordering any good, facility, service
or item for which payment may be made under a federal or state health care
program.
Starting in 1991, the Inspector General of the Department of Health and
Human Services ("HHS") issued regulations which provide for "safe harbors"
from the federal anti-kickback statute; if an arrangement or transaction meets
each of the standards established for a particular safe harbor, the
arrangement will not be subject to challenge by the Inspector General. If an
arrangement does not meet the safe harbor criteria, it will be subject to
scrutiny under its particular facts and circumstances to determine whether it
violates the federal anti-kickback statute. Safe harbors include protection
for certain limited investment interests, space rental, equipment rental,
personal service/management contracts, sales of a physician practice, referral
services, warranties, employees, discounts and group purchasing arrangements,
among others. The criminal sanctions for a conviction under the anti-kickback
statute include imprisonment, fines, or both. Civil sanctions include
exclusion from federal and state healthcare programs.
Many states have also enacted similar illegal remuneration statutes that
apply to healthcare services reimbursed by private insurance, not just those
reimbursed by a federal or state health care program. In many instances, the
state statutes provide that any arrangement falling in a federal safe harbor
will be immune from scrutiny under the state statutes.
We do not anticipate that the Stark provisions, the anti-kickback statute or
similar state law provisions will have material adverse effects on our
operations.
As further discussed under the heading "Management's Discussion and Analysis
of Financial Condition and Results of Operations -- Year Ended December 31,
2001 Compared to Years Ended December 31, 2000 and 1999 -- Health Insurance
Portability and Accountability Act of 1996", we are subject to the provisions
of the HIPAA and have begun preliminary planning for implementation of the
necessary changes required pursuant to the terms of HIPAA. However, we cannot
currently estimate the implementation cost of the HIPAA related modifications
and consequently can give no assurances that issues related to HIPAA will not
have a material adverse effect on our financial condition or results of
operations.
Several states, including Florida and Nevada, have passed legislation which
limits physician ownership in medical facilities providing imaging services,
rehabilitation services, laboratory testing, physical therapy and other
services. This legislation is not expected to significantly affect our
operations. Many states have laws and regulations which prohibit payments for
referral of patients and fee-splitting with physicians. We do not make any
such payments or have any such arrangements.
All hospitals are subject to compliance with various federal, state and
local statutes and regulations and receive periodic inspection by state
licensing agencies to review standards of medical care, equipment and
cleanliness. Our hospitals must comply with the conditions of participation
and licensing requirements of federal, state and local health agencies, as
well as the requirements of municipal building codes, health codes and local
fire departments. In granting and renewing licenses, a department of health
considers, among other things, the physical buildings and equipment, the
qualifications of the administrative personnel and nursing staff, the quality
of care and continuing compliance with the laws and regulations relating to
the operation of the facilities. State licensing of facilities is a
prerequisite to certification under the Medicare and Medicaid programs.
Various other licenses and permits are also required in order to dispense
narcotics, operate pharmacies, handle radioactive materials and operate
certain equipment. All our eligible hospitals have been accredited by the
JCAHO. The
7
JCAHO reviews each hospital's accreditation once every three years. The review
period for each state's licensing body varies, but generally ranges from once
a year to once every three years.
The Social Security Act and regulations thereunder contain numerous
provisions which affect the scope of Medicare coverage and the basis for
reimbursement of Medicare providers. Among other things, this law S-18
provides that in states which have executed an agreement with the Secretary of
HHS, Medicare reimbursement may be denied with respect to depreciation,
interest on borrowed funds and other expenses in connection with capital
expenditures which have not received prior approval by a designated state
health planning agency. Additionally, many of the states in which our
hospitals are located have enacted legislation requiring certificates of need
("CON") as a condition prior to hospital capital expenditures, construction,
expansion, modernization or initiation of major new services. Failure to
obtain necessary state approval can result in the inability to complete an
acquisition or change of ownership, the imposition of civil or, in some cases,
criminal sanctions, the inability to receive Medicare or Medicaid
reimbursement or the revocation of a facility's license. We have not
experienced and do not expect to experience any material adverse effects from
those requirements.
Health planning statutes and regulatory mechanisms are in place in many
states in which we operate. These provisions govern the distribution of
healthcare services, the number of new and replacement hospital beds,
administer required state CON laws, contain healthcare costs, and meet the
priorities established therein. Significant CON reforms have been proposed in
a number of states, including increases in the capital spending thresholds and
exemptions of various services from review requirements. We are unable to
predict the impact of these changes upon our operations.
Federal regulations provide that admissions and utilization of facilities by
Medicare and Medicaid patients must be reviewed in order to insure efficient
utilization of facilities and services. The law and regulations require Peer
Review Organizations ("PROs") to review the appropriateness of Medicare and
Medicaid patient admissions and discharges, the quality of care provided, the
validity of DRG classifications and the appropriateness of cases of
extraordinary length of stay. PROs may deny payment for services provided,
assess fines and also have the authority to recommend to HHS that a provider
that is in substantial non-compliance with the standards of the PRO be
excluded from participating in the Medicare program. We have contracted with
PROs in each state where we do business as to the scope of such functions.
Our healthcare operations generate medical waste that must be disposed of in
compliance with federal, state and local environmental laws, rules and
regulations. In 1988, Congress passed the Medical Waste Tracking Act (42
U.S.C. (S) 6992). Infectious waste generators, including hospitals, now face
substantial penalties for improper arrangements regarding disposal of medical
waste, including civil penalties of up to $25,000 per day of noncompliance,
criminal penalties of up to $50,000 per day, imprisonment, and remedial costs.
The comprehensive legislation establishes programs for medical waste treatment
and disposal in designated states. The legislation also provides for sweeping
inspection authority in the Environmental Protection Agency, including
monitoring and testing. We believe that our disposal of such wastes is in
material compliance with all state and federal laws.
Health Insurance Portability and Accountability Act
The Health Insurance Portability and Accountability Act (HIPAA) was enacted
in August, 1996 to assure health insurance portability, reduce healthcare
fraud and abuse, guarantee security and privacy of health information and
enforce standards for health information. Generally, organizations are
required to be in compliance with certain HIPAA provisions beginning in
October, 2002. Provisions not yet finalized are required to be implemented two
years after the effective date of the regulation. Organizations are subject to
significant fines and penalties if found not to be compliant with the
provisions outlined in the regulations. Regulations related to HIPAA are
expected to impact the Company and others in the healthcare industry by:
(i) Establishing standardized code sets for financial and clinical electronic
data interchange ("EDI") transactions to enable more efficient flow of
information. Currently there is no common standard for the
8
transfer of information between the constituents in healthcare and
therefore providers have had to conform to different standards utilized by
each party with which they interact. The goal of HIPAA is to create one
common national standard for EDI and once the HIPAA regulations take
effect, payors will be required to accept the national standard employed by
providers. The final regulations establishing electronic data transmission
standards that all healthcare providers must use when submitting or
receiving certain healthcare transactions electronically were published in
August, 2000 and compliance with these regulations is required by October,
2002.
(ii) Mandating the adoption of security standards to preserve the
confidentiality of medical information that identifies individuals.
Currently there is no recognized healthcare standard that includes all
the necessary components to protect the data integrity and
confidentiality of a patient's electronically maintained or transmitted
personal medical record. The final regulations containing the privacy
standards were released in December, 2000 and require compliance by
April, 2003.
(iii) Creating unique identifiers for the four constituents in healthcare:
payors, providers, patients and employers. HIPAA will mandate the need
for the unique identifiers for healthcare providers in an effort to ease
the administrative challenge of maintaining and transmitting clinical
data across disparate episodes of patient care.
The Company is in the process of implementation of the necessary changes
required pursuant to the terms of HIPAA. The Company expects that the
implementation cost of the HIPAA related modifications will not have a
material adverse effect on the Company's financial condition or results of
operations.
Medical Staff and Employees
The Company's hospitals are staffed by licensed physicians who have been
admitted to the medical staff of individual hospitals. With a few exceptions,
physicians are not employees of the Company's hospitals and members of the
medical staffs of the Company's hospitals also serve on the medical staffs of
hospitals not owned by the Company and may terminate their affiliation with
the Company's hospitals at any time. Each of the Company's hospitals is
managed on a day-to-day basis by a managing director employed by the Company.
In addition, a Board of Governors, including members of the hospital's medical
staff, governs the medical, professional and ethical practices at each
hospital. The Company's facilities had approximately 30,300 employees at
December 31, 2001, of whom approximately 21,200 were employed full-time.
Approximately 1,678 of the Company's employees at six of its hospitals are
unionized. At Valley Hospital, unionized employees belong to the Culinary
Workers and Bartenders Union, the International Union of Operating Engineers
and the Service Employees International Union. Registered nurses at Auburn
Regional Medical Center located in Washington state, are represented by the
United Staff Nurses Union, the technical employees are represented by the
United Food and Commercial Workers, and the service employees are represented
by the Service Employees International Union. At The George Washington
University Hospital, unionized employees are represented by the Service
Employees International Union and the Hospital Police Association. Nurses at
Desert Springs Hospital are represented by the Service Employees International
Union. Registered Nurses, Licensed Practical Nurses, certain technicians and
therapists, pharmacy assistants, and some clerical employees at HRI Hospital
in Boston are represented by the Service Employees International Union.
Unionized employees at Hospital San Fransisco in Puerto Rico are represented
by the Labor Union of Nurses and Health Employees. The Company believes that
its relations with its employees are satisfactory.
Competition
In all geographical areas in which the Company operates, there are other
hospitals which provide services comparable to those offered by the Company's
hospitals, some of which are owned by governmental agencies and supported by
tax revenues, and others of which are owned by nonprofit corporations and may
be supported to a large extent by endowments and charitable contributions.
Such support is not available to the Company's hospitals. Certain of the
Company's competitors have greater financial resources, are better equipped
and offer a
9
broader range of services than the Company. Outpatient treatment and
diagnostic facilities, outpatient surgical centers and freestanding ambulatory
surgical centers also impact the healthcare marketplace. In recent years,
competition among healthcare providers for patients has intensified as
hospital occupancy rates in the United States have declined due to, among
other things, regulatory and technological changes, increasing use of managed
care payment systems, cost containment pressures, a shift toward outpatient
treatment and an increasing supply of physicians. The Company's strategies are
designed, and management believes that its facilities are positioned, to be
competitive under these changing circumstances.
Liability Insurance
For the period from January 1, 1998 through December 31, 2001, most of the
Company's subsidiaries were covered under commercial insurance policies with
PHICO, a Pennsylvania based insurance company. The policies provided for a
self-insured retention limit for professional and general liability claims for
the Company's subsidiaries up to $1 million per occurrence, with an average
annual aggregate for covered subsidiaries of $7 million through 2001. These
subsidiaries maintain excess coverage up to $100 million with other major
insurance carriers.
In February of 2002, PHICO was placed in liquidation by the Pennsylvania
Insurance Commissioner and as a result, the Company recorded a pre-tax charge
to earnings of $40 million during the fourth quarter of 2001 to reserve for
malpractice expenses that may result from PHICO's liquidation. PHICO continues
to have substantial liability to pay claims on behalf of the Company and
although those claims could become the Company's liability, the Company may be
entitled to receive reimbursement from state insurance guaranty funds and/or
PHICO's estate for a portion of certain claims ultimately paid by the Company.
The Company expects that the cash payments related to these claims will be
made over the next eight years as the cases are settled or adjudicated. In
estimating the $40 million pre-tax charge, the Company evaluated all known
factors, however, there can be no assurance that the Company's ultimate
liability will not be materially different than the estimated charge recorded.
Additionally, if the ultimate PHICO liability assumed by the Company is
substantially greater than the established reserve, there can be no assurance
that the additional amount required will not have a material adverse effect on
the Company's future results of operations.
Due to unfavorable pricing and availability trends in the professional and
general liability insurance markets, the cost of commercial professional and
general liability insurance coverage has risen significantly. As a result, the
Company expects its total insurance expense including professional and general
liability, property, auto and workers' compensation to increase approximately
$25 million in 2002 as compared to 2001. The Company's subsidiaries have also
assumed a greater portion of the hospital professional and general liability
risk for its facilities. Effective January 1, 2002, most of the Company's
subsidiaries are self-insured for malpractice exposure up to $25 million per
occurrence. The Company purchased an umbrella excess policy through a
commercial insurance carrier for coverage in excess of $25 million per
occurrence with a $75 million aggregate limitation.
Relationship with Universal Health Realty Income Trust
At December 31, 2001, the Company held approximately 6.6% of the outstanding
shares of Universal Health Realty Income Trust (the "Trust") and has an option
to purchase shares of the Trust at fair market value to maintain a minimum 5%
interest. The Company serves as advisor to the Trust under an annually
renewable advisory agreement. Pursuant to the terms of this advisory
agreement, the Company conducts the Trust's day to day affairs, provides
administrative services and presents investment opportunities. In addition,
certain officers and directors of the Company are also officers and/or
directors of the Trust. Management believes that it has the ability to
exercise significant influence over the Trust, therefore the Company accounts
for its investment in the Trust using the equity method of accounting. The
Company's pre-tax share of income from the Trust was $1.3 million for the year
ended December 31, 2001, $1.2 million for the year ended December 31, 2000 and
$1.1 million for the year ended December 31, 1999, and is included in net
revenues in the Company's consolidated statements of income. The carrying
value of this investment was $9.0 million at both December 31, 2001 and 2000
and is included in other assets in the Company's consolidated balance sheets.
The market value of this investment was $18.0 million at December 31, 2001 and
$15.1 million at December 31, 2000.
10
As of December 31, 2001, the Company leased six hospital facilities from the
Trust with terms expiring in 2003 through 2006. These leases contain up to
five 5-year renewal options. During 2001, the Company exercised the five-year
renewal option on an acute care hospital leased from the Trust which was
scheduled to expire in 2001. The lease on this facility was renewed at the
same lease rate and term as the initial lease. Future minimum lease payments
to the Trust are included in Note 7 to Consolidated Financial Statements.
Total rent expense under these operating leases was $16.5 million in 2001,
$17.1 million in 2000, and $16.6 million in 1999. The terms of the lease
provide that in the event the Company discontinues operations at the leased
facility for more than one year, the Company is obligated to offer a
substitute property. If the Trust does not accept the substitute property
offered, the Company is obligated to purchase the leased facility back from
the Trust at a price equal to the greater of its then fair market value or the
original purchase price paid by the Trust. The Company received an advisory
fee from the Trust of $1.3 million in both 2001 and 2000 and $1.2 million in
1999 for investment and administrative services provided under a contractual
agreement which is included in net revenues in the Company's consolidated
statements of income.
Executive Officers of the Registrant
The executive officers of the Company, whose terms will expire at such time
as their successors are elected, are as follows:
Name and Age Present Position with the Company
------------ ---------------------------------
Alan B. Miller (64)............................. Director, Chairman of the Board,
President and Chief Executive Officer
Senior Vice President and Chief
Kirk E. Gorman (51)............................. Financial Officer
O. Edwin French (55)............................ Senior Vice President
Steve G. Filton (44)............................ Vice President, Controller and Secretary
Debra Osteen (46)............................... Vice President
Richard C. Wright (54).......................... Vice President
Mr. Alan B. Miller has been Chairman of the Board, President and Chief
Executive Officer of the Company since its inception. Prior thereto, he was
President, Chairman of the Board and Chief Executive Officer of American
Medicorp, Inc. He currently serves as Chairman of the Board, Chief Executive
Officer and Trustee of the Trust. Mr. Miller also serves as a Director of Penn
Mutual Life Insurance Company, CDI Corp. (provides staffing services and
placements) and Broadlane, Inc. (an e-commerce marketplace for healthcare
supplies, equipment and services).
Mr. Gorman was elected Senior Vice President and Chief Financial Officer in
December 1992, and has served as Vice President and Treasurer of the Company
since April 1987. From 1984 until then, he served as Senior Vice President of
Mellon Bank, N.A. Prior thereto, he served as Vice President of Mellon Bank,
N.A. He currently serves as President, Chief Financial Officer, Secretary and
Trustee of the Trust. Mr. Gorman also serves as a Director of VIASYS
Healthcare, Inc. (a medical technology products company) and Physician's
Dialysis, Inc. (provides hospital based dialysis services).
Mr. Wright was elected Vice President of the Company in May 1986. He has
served in various capacities with the Company since 1978 and currently heads
the Development function.
Mr. Filton has been Vice President and Controller of the Company since
November 1991. Prior thereto he had served as Director of Accounting and
Control. In September 1999, he was elected Secretary of the Company.
Ms. Osteen was elected Vice President of the Company in January 2000,
responsible for the Behavioral Health Division. She has served in various
capacities with the Company since 1984 including responsibility for
approximately one-half of the Behavioral Health Division's facilities.
Mr. French joined the Company in October 2001, as Senior Vice President,
responsible for the Acute Care Hospital Division. He had served as President
and Chief Operating Officer of Physician Reliance Network from 1997 to 2000,
as Senior Vice President of American Medical International from 1992 to 1995,
as Executive Vice President of Samaritan Health Systems of Phoenix from 1991
to 1992 and as Senior Vice President of Methodist Health Systems, Inc. in
Memphis from 1985 to 1991.
11
ITEM 2. Properties
Executive Offices
The Company owns an office building with 68,000 square feet available for
use located on 11 acres of land in King of Prussia, Pennsylvania.
Facilities
The following tables set forth the name, location, type of facility and, for
acute care hospitals and behavioral health centers, the number of beds, for
each of the Company's facilities:
Acute Care Hospitals
Number Ownership
Name of Facility Location of Beds Interest
- ---------------- -------- ------- ---------
Aiken Regional Medical
Centers................... Aiken, South Carolina 225 Owned
Auburn Regional Medical
Center.................... Auburn, Washington 149 Owned
Central Montgomery Medical
Center.................... Lansdale, Pennsylvania 150 Owned
Chalmette Medical
Center(1)................. Chalmette, Louisiana 195 Leased
Desert Springs
Hospital(2)............... Las Vegas, Nevada 351 Owned
Doctors' Hospital of
Laredo.................... Laredo, Texas 180 Owned
Doctors' Hospital of
Shreveport(3)............. Shreveport, Louisiana 136 Leased
Edinburg Regional Medical
Center.................... Edinburg, Texas 169 Owned
Fort Duncan Medical
Center.................... Eagle Pass, Texas 77 Owned
The George Washington
University Hospital(4).... Washington, D.C. 501 Owned
Hospital San Francisco..... Rio Piedras, Puerto Rico 160 Owned
Hospital San Pablo......... Bayamon, Puerto Rico 430 Owned
Hospital San Pablo del
Este...................... Fajardo, Puerto Rico 180 Owned
Inland Valley Regional
Medical Center(5)......... Wildomar, California 80 Leased
Lancaster Community
Hospital.................. Lancaster, California 117 Owned
Manatee Memorial Hospital.. Bradenton, Florida 491 Owned
McAllen Medical Center(6).. McAllen, Texas 633 Leased
Northern Nevada Medical
Center(4)................. Sparks, Nevada 100 Owned
Northwest Texas Healthcare
System.................... Amarillo, Texas 357 Owned
Rancho Springs Medical
Center.................... Murrieta, California 96 Owned
River Parishes Hospitals... LaPlace and Chalmette, Louisiana 106 Owned
St. Mary's Regional Medical
Center.................... Enid, Oklahoma 277 Owned
Summerlin Hospital Medical
Center(2)................. Las Vegas, Nevada 166 Owned
Valley Hospital Medical
Center(2)................. Las Vegas, Nevada 400 Owned
Wellington Regional Medical
Center(5)................. West Palm Beach, Florida 120 Leased
Medi-Partenaires (Paris/Bordeaux)
Number Ownership
Name of Facility Location of Beds Interest
- ---------------- -------- ------- ---------
Clinique Ambroise Pare..... Toulouse, France 204 Owned
Clinique Richelieu......... Saintes, France 82 Owned
Clinique Bercy............. Charenton le Pont, France 100 Owned
Clinique Villette.......... Dunkerque, France 123 Owned
Clinique Pasteur........... Bergerac, France 72 Owned
Clinique Bon Secours....... Le Puy en Velay, France 101 Owned
Clinique Aressy............ Aressy, France 179 Owned
Clinique Saint-Augustin.... Bordeaux, France 159 Owned
Clinique Saint-Jean........ Montpellier, France 118 Owned
12
Behavioral Health Centers
Number Ownership
Name of Facility Location of Beds Interest
- ---------------- -------- ------- ---------
Anchor Hospital.............. Atlanta, Georgia 74 Owned
The Arbour Hospital.......... Boston, Massachusetts 118 Owned
The Bridgeway(5)............. North Little Rock, Arkansas 70 Leased
The Carolina Center for
Behavioral Health........... Greer, South Carolina 66 Owned
Clarion Psychiatric Center... Clarion, Pennsylvania 70 Owned
Del Amo Hospital............. Torrance, California 166 Owned
Fairmount Behavioral Health
System...................... Philadelphia, Pennsylvania 169 Owned
Forest View Hospital......... Grand Rapids, Michigan 62 Owned
Fuller Memorial Hospital..... South Attleboro, Massachusetts 82 Owned
Glen Oaks Hospital........... Greenville, Texas 54 Owned
Hampton Hospital............. Westhampton, New Jersey 100 Owned
Hartgrove Hospital........... Chicago, Illinois 119 Owned
The Horsham Clinic........... Ambler, Pennsylvania 146 Owned
Hospital San Juan Capestrano
............................ Rio Piedras, Puerto Rico 108 Owned
HRI Hospital................. Brookline, Massachusetts 68 Owned
KeyStone Center(7)........... Wallingford, Pennsylvania 114 Owned
La Amistad Residential
Treatment Center............ Maitland, Florida 56 Owned
Lakeside Behavioral Health
System...................... Memphis, Tennessee 204 Owned
Laurel Heights Hospital...... Atlanta, Georgia 102 Owned
The Meadows Psychiatric
Center...................... Centre Hall, Pennsylvania 101 Owned
Meridell Achievement Center.. Austin, Texas 114 Owned
The Midwest Center for Youth
and Families................ Kouts, Illinois 50 Owned
Parkwood Behavioral Health
System...................... Olive Branch, Mississippi 106 Owned
The Pavilion................. Champaign, Illinois 46 Owned
Peachford Behavioral Health
System of Atlanta........... Atlanta, Georgia 184 Owned
Pembroke Hospital............ Pembroke, Massachusetts 107 Owned
Provo Canyon School.......... Provo, Utah 211 Owned
Ridge Behavioral Health
System...................... Lexington, Kentucky 110 Owned
River Crest Hospital......... San Angelo, Texas 80 Owned
River Oaks Hospital.......... New Orleans, Louisiana 126 Owned
Rockford Center.............. Newark, Delaware 74 Owned
Roxbury(7)................... Shippensburg, Pennsylvania 53 Owned
St. Louis Behavioral Medicine
Institute................... St. Louis, Missouri -- Owned
Talbott Recovery Campus...... Atlanta, Georgia -- Owned
Timberlawn Mental Health
System...................... Dallas, Texas 124 Owned
Turning Point Care
Center(7)................... Moultrie, Georgia 59 Owned
Two Rivers Psychiatric
Hospital.................... Kansas City, Missouri 80 Owned
Westwood Lodge Hospital...... Westwood, Massachusetts 126 Owned
Ambulatory Surgery Centers
Name of Facility(8) Location
------------------- --------
Arkansas Surgery Center of Fayetteville............ Fayetteville, Arkansas
Brownsville Surgicare.............................. Brownsville, Texas
Goldring Surgical and Diagnostic Center............ Las Vegas, Nevada
Hope Square Surgery Center......................... Rancho Mirage, California
Northwest Texas Surgery Center..................... Amarillo, Texas
Outpatient Surgical Center of Ponca City........... Ponca City, Oklahoma
13
Name of Facility(8) Location
------------------- --------
Plaza Surgery Center............................... Las Vegas, Nevada
St. George Surgical Center......................... St. George, Utah
St. Lukes's Surgicenter............................ Hammond, Louisiana
Surgery Center of Littleton........................ Littleton, Colorado
Surgery Center of Midwest City..................... Midwest City, Oklahoma
Surgery Center of Springfield...................... Springfield, Missouri
Surgical Arts Surgery Center....................... Reno, Nevada
Surgical Center of New Albany...................... New Albany, Indiana
Radiation Oncology Centers
Name of Facility Location
---------------- --------
Auburn Regional Center for Cancer Care............. Auburn, Washington
Bluegrass Cancer Center............................ Frankfort, Kentucky
Cancer Institute of Nevada(9)...................... Las Vegas, Nevada
Danville Radiation Therapy Center.................. Danville, Kentucky
Louisville Radiation Oncology Center(10)........... Louisville, Kentucky
Madison Radiation Therapy(9)....................... Madison, Indiana
Radiation Therapy Medical Associates of
Bakersfield(11)................................... Bakersfield, California
Southern Indiana Radiation Therapy................. Jeffersonville, Indiana
Specialized Women's Health Center
Name of Facility Location
---------------- --------
Renaissance Women's Center of Edmond(9)............ Edmond, Oklahoma
- --------
(1) Includes Chalmette Medical Center, which is a 118-bed medical/surgical
facility and The Virtue Street Pavilion, a 77-bed facility consisting of
a physical rehabilitation unit, skilled nursing and inpatient behavioral
health services. The real property of both facilities is leased from the
Trust.
(2) Desert Springs Hospital, Summerlin Hospital Medical Center and Valley
Hospital Medical Center are owned by a limited liability company in which
the Company has a 72.5% interest and Triad's subsidiary, NC-DSH, Inc.,
has a 27.5% interest. All hospitals are managed by the Company.
(3) Real property leased with an option to purchase.
(4) General partnership interest in limited partnership.
(5) Real property leased from the Trust.
(6) Real property of McAllen Medical Center is leased from the Trust. During
2000, the Company purchased the assets of an 80-bed non-acute care
facility located in McAllen, Texas. Although the real property of the
non-acute facility is not leased from the Trust, the license for this
facility is included in McAllen Medical Center's license.
(7) Addictive disease facility.
(8) Each facility, other than Goldring Surgical and Diagnostic Center and
Northwest Texas Surgery Center, is owned in partnership form with the
Company owning general and limited partnership interests in a limited
partnership. The real property is leased from third parties.
(9) Membership interest in limited liability company.
(10) Majority interest in a limited liability partnership.
(11) Managed facility, not included in the Company's consolidated financial
statements. A limited liability company, in which the Company is the sole
member, owns the equipment, but the property is leased.
14
Some of these facilities are subject to mortgages, and substantially all the
equipment located at these facilities is pledged as collateral to secure long-
term debt. The Company owns or leases medical office buildings adjoining
certain of its hospitals.
The Company believes that the leases or liens on the facilities leased or
owned by the Company do not impose any material limitation on the Company's
operations.
The aggregate lease payments on facilities leased by the Company were $29.4
million in 2001, $22.5 million in 2000 and $24.0 million in 1999.
ITEM 3. Legal Proceedings
The Company is subject to claims and suits in the ordinary course of
business, including those arising from care and treatment afforded at the
Company's hospitals and is party to various other litigation. However,
management believes the ultimate resolution of these pending proceedings will
not have a material adverse effect on the Company.
During 1999, the Company decided to close and divest one of its specialized
women's health centers and as a result, the Company recorded a $5.3 million
charge to reduce the carrying value of the facility to its estimated
realizable value of approximately $9 million, based on an independent
appraisal. A jury verdict unfavorable to the Company was rendered during the
fourth quarter of 2000 with respect to litigation regarding the closing of
this facility. Accordingly, during the fourth quarter of 2000, the Company
recognized a charge of $7.7 million to reflect the amount of the jury verdict
and a reserve for future legal costs and in February 2001, this unprofitable
facility was closed. During 2001, an appellate court issued an opinion
affirming the jury verdict and during the first quarter of 2002, the Company
filed a petition for review by the state supreme court.
ITEM 4. Submission of Matters to a Vote of Security Holders
Inapplicable. No matter was submitted during the fourth quarter of the
fiscal year ended December 31, 2001 to a vote of security holders.
15
PART II
ITEM 5. Market for Registrant's Common Equity and Related Stockholder Matters
See Item 6, Selected Financial Data
ITEM 6. Selected Financial Data
Year Ended December 31
------------------------------------------------------------------------------
2001 2000 1999 1998 1997
-------------- -------------- -------------- -------------- --------------
Summary of Operations (in thousands)
Net revenues........................... $ 2,840,491 $ 2,242,444 $ 2,042,380 $ 1,874,487 $ 1,442,677
Net income............................. $ 99,742 $ 93,362 $ 77,775 $ 79,558 $ 67,276
Net margin............................. 3.5% 4.2% 3.8% 4.2% 4.7%
Return on average equity............... 12.8% 13.7% 12.1% 13.1% 13.5%
Financial Data (in thousands)
Cash provided by operating activities.. $ 312,187 $ 182,454 $ 175,557 $ 151,684 $ 174,170
Capital expenditures(1)................ $ 160,748 $ 115,751 $ 68,695 $ 96,808 $ 132,258
Total assets........................... $ 2,114,584 $ 1,742,377 $ 1,497,973 $ 1,448,095 $ 1,085,349
Long-term borrowings................... $ 718,830 $ 548,064 $ 419,203 $ 418,188 $ 272,466
Common stockholders' equity............ $ 807,900 $ 716,574 $ 641,611 $ 627,007 $ 526,607
Percentage of total debt to total
capitalization........................ 47% 43% 40% 40% 35%
Operating Data--Acute Care Hospitals(2)
Average licensed beds.................. 6,234 4,980 4,806 4,696 3,389
Average available beds................. 5,351 4,220 4,099 3,985 2,951
Hospital admissions.................... 285,222 214,771 204,538 187,833 128,020
Average length of patient stay......... 4.7 4.7 4.7 4.7 4.8
Patient days........................... 1,328,609 1,017,646 963,842 884,966 616,965
Occupancy rate for licensed beds....... 58% 56% 55% 52% 50%
Occupancy rate for available beds...... 68% 66% 64% 61% 57%
Operating Data--Behavioral Health
Facilities
Average licensed beds.................. 3,732 2,612 1,976 1,782 1,777
Average available beds................. 3,588 2,552 1,961 1,767 1,762
Hospital admissions.................... 78,688 49,971 37,810 32,400 28,350
Average length of patient stay......... 12.1 12.2 11.8 11.3 11.9
Patient days........................... 950,236 608,423 444,632 365,935 336,850
Occupancy rate for licensed beds....... 70% 64% 62% 56% 52%
Occupancy rate for available beds...... 73% 65% 62% 57% 52%
Per Share Data
Net income--basic(3)................... $ 1.67 $ 1.55 $ 1.24 $ 1.23 $ 1.04
Net income--diluted(3)................. $ 1.60 $ 1.50 $ 1.22 $ 1.19 $ 1.02
Other Information (in thousands)
Weighted average number of shares
outstanding--basic(3)................. 59,874 60,220 62,834 65,022 64,642
Weighted average number of shares and
share equivalents outstanding--
diluted(3)............................ 67,220 64,820 63,980 66,586 66,196
Common Stock Performance
Market price of common stock
High--Low, by quarter(4)
1st.................................. $50.69--$38.88 $24.50--$18.25 $26.50--$18.94 $29.06--$23.53 $17.31--$13.94
2nd.................................. $46.75--$37.82 $35.03--$24.50 $27.44--$19.75 $29.81--$26.50 $20.25--$15.81
3rd.................................. $52.60--$42.65 $42.81--$31.91 $23.69--$11.84 $29.25--$19.38 $23.53--$19.53
4th.................................. $48.60--$38.25 $55.88--$38.63 $18.25--$12.00 $27.16--$20.22 $25.19--$20.34
- --------
(1) Amount includes non-cash capital lease obligations.
(2) Includes data for nine hospitals located in France owned by an operating
company in which the Company purchased an 80% ownership during 2001.
(3) In April 2001, the Company declared a two-for-one stock split in the form
of a 100% stock dividend which was paid in June 2001. All classes of
common stock participated on a pro rata basis. The weighted average
number of common shares and equivalents and earnings per common and
common equivalent share for all years presented have been adjusted to
reflect the two-for-one stock split.
(4) These prices are the high and low closing sales prices of the Company's
Class B Common Stock as reported by the New York Stock Exchange (all
periods have been adjusted to reflect the two-for-one stock split in the
form of a 100% stock dividend paid in June 2001). Class A, C and D common
stock are convertible on a share-for-share basis into Class B Common
Stock.
16
Number of shareholders of record as of January 31, 2002, were as follows:
- ------------------------------
Class A Common............ 6
Class B Common............ 442
Class C Common............ 5
Class D Common............ 200
- ------------------------------
ITEM 7. Management's Discussion And Analysis Of Operations And Financial
Condition
Forward-Looking Statements
The matters discussed in this report as well as the news releases issued
from time to time by the Company include certain statements containing the
words "believes", "anticipates", "intends", "expects" and words of similar
import, which constitute "forward-looking statements" within the meaning of
the Private Securities Litigation Reform Act of 1995. Such forward-looking
statements involve known and unknown risks, uncertainties and other factors
that may cause the actual results, performance or achievements of the Company
or industry results to be materially different from any future results,
performance or achievements expressed or implied by such forward-looking
statements. Such factors include, among other things, the following: that the
majority of the Company's revenues are produced by a small number of its total
facilities; possible changes in the levels and terms of reimbursement by
government programs, including Medicare or Medicaid or other third party
payors; industry capacity; demographic changes; existing laws and government
regulations and changes in or failure to comply with laws and governmental
regulations; the ability to enter into managed care provider agreements on
acceptable terms; liability and other claims asserted against the Company;
competition; the loss of significant customers; technological and
pharmaceutical improvements that increase the cost of providing, or reduce the
demand for healthcare; the ability to attract and retain qualified personnel,
including physicians; the ability of the Company to successfully integrate its
recent acquisitions; the Company's ability to finance growth on favorable
terms; and, other factors referenced in the Company's 2001 Form 10-K or
herein. Given these uncertainties, prospective investors are cautioned not to
place undue reliance on such forward-looking statements. The Company disclaims
any obligation to update any such factors or to publicly announce the result
of any revisions to any of the forward-looking statements contained herein to
reflect future events or developments.
Results of Operations
Net revenues increased 27% to $2.8 billion in 2001 as compared to 2000 and
10% to $2.2 billion in 2000 as compared to 1999. The $600 million increase in
net revenues during 2001 as compared to 2000 resulted from: (i) a $276 million
or 13% increase in net revenues generated at acute care and behavioral health
care facilities owned during both years, and; (ii) $324 million of net
revenues generated at twenty-eight acute care and behavioral health care
facilities acquired in the U.S and France since the third quarter of 2000
(excludes revenues generated at these facilities one year after acquisition).
The $200 million increase in net revenues during 2000 as compared to 1999
was due primarily to: (i) a $104 million or 5% increase in net revenues
generated at acute care and behavioral health care facilities owned during
both years, and; (ii) $88 million of net revenues generated at two acute care
and twelve behavioral health care facilities acquired during the third quarter
of 2000.
Operating income (defined as net revenues less salaries, wages & benefits,
other operating expenses, supply expense and provision for doubtful accounts)
increased 23% to $442 million in 2001 from $359 million in 2000. In 2000,
operating income increased 13% to $359 million in 2000 from $319 million in
1999. Overall operating margins (defined as operating income divided by net
revenues) were 15.6% in 2001, 16.0% in 2000 and 15.6%
in 1999. The factors causing the fluctuations in the Company's overall
operating margins during the last three years are discussed below.
17
Acute Care Services
Net revenues from the Company's acute care hospitals and ambulatory
treatment centers accounted for 81%, 84% and 86% of consolidated net revenues
in 2001, 2000 and 1999, respectively. Net revenues at the Company's acute care
facilities owned in both 2001 and 2000 increased 14% in 2001 as compared to
2000 as admissions and patient days at these facilities increased 5% and 6%,
respectively. The average length of stay at these facilities increased to 4.8
days in 2001 as compared to 4.7 days in 2000. Net revenues at the Company's
acute care facilities owned in both 2000 and 1999 increased 5% in 2000 as
compared to 1999 as admissions and patient days each increased 3% in 2000 as
compared to 1999. The average length of stay remained unchanged at 4.7 days in
2000 and 1999.
In addition to the increase in inpatient volumes, the Company's same
facility net revenues were favorably impacted by an increase in prices charged
to private payors including health maintenance organizations and preferred
provider organizations as well as an increase in Medicare reimbursements which
commenced on April 1, 2001. Net revenue per adjusted admission (adjusted for
outpatient activity) at the Company's acute care facilities owned during both
2001 and 2000 increased 8% in 2001 as compared to 2000 and net revenue per
adjusted patient day at these facilities increased 7% in 2001 over 2000.
Included in the same facility acute care financial results and patient
statistical data are the operating results generated at the 60-bed McAllen
Heart Hospital which was acquired by the Company in March of 2001. Upon
acquisition, the facility began operating under the same license as an
integrated department of McAllen Medical Center and therefore the financial
and statistical results are not separable.
The Company's facilities have experienced an increase in inpatient acuity
and intensity of services as less intensive services shift from an inpatient
basis to an outpatient basis. To accommodate the increased utilization of
outpatient services, the Company has expanded or redesigned several of its
outpatient facilities and services. Gross outpatient revenues at the Company's
acute care facilities owned during the last three years increased 22% in 2001
as compared to 2000 and increased 13% in 2000 as compared to 1999 and
comprised 26% of the Company's acute care gross patient revenue in each of the
last three years. Despite the increase in patient volume at the Company's
facilities, inpatient utilization continues to be negatively affected by
payor-required, pre-admission authorization and by payor pressure to maximize
outpatient and alternative healthcare delivery services for less acutely ill
patients. Additionally, the hospital industry in the United States as well as
the Company's acute care facilities continue to have significant unused
capacity which has created substantial competition for patients. The Company
expects the increased competition, admission constraints and payor pressures
to continue.
The increase in net revenue as discussed above was negatively affected by
lower payments from the government under the Medicare program as a result of
the Balanced Budget Act of 1997 ("BBA-97") and increased discounts to
insurance and managed care companies (see General Trends for additional
disclosure). The Company anticipates that the percentage of its revenue from
managed care business will continue to increase in the future. The Company
generally receives lower payments per patient from managed care payors than it
does from traditional indemnity insurers.
At the Company's acute care facilities, operating expenses (salaries, wages
and benefits, other operating expenses, supply expense and provision for
doubtful accounts) as a percentage of net revenues were 82.2% in 2001, 81.4%
in 2000 and 81.6% in 1999. Operating margins (defined as net revenues less
operating expenses divided by net revenues) at these facilities were 17.8% in
2001, 18.6% in 2000 and 18.4% in 1999. At the Company's acute care facilities
owned in both 2001 and 2000, operating expenses were 82.6% in 2001 and 81.6%
in 2000 and operating margins at these facilities were 17.4% in 2001 and 18.4%
in 2000. At the Company's acute care facilities owned in both 2000 and 1999,
operating expenses were 81.6% in 2000 and 81.8% in 1999 and operating margins
at these facilities were 18.4% in 2000 and 18.2% in 1999.
18
Despite the strong revenue growth experienced at the Company's acute care
facilities during 2001 as compared to 2000, operating margins at these
facilities were lower in 2001 as compared to the prior year due primarily to
increases in salaries, wages and benefits, pharmaceutical expense and
insurance expense. Salaries, wages and benefits increased primarily as a
result of rising labor rates, particularly in the area of skilled nursing and
the increase in pharmaceutical expense was caused primarily by increased
utilization of high-cost drugs. The Company experienced an increase in
insurance expense on the self-insured retention limits at certain of its
subsidiaries caused primarily by unfavorable industry-wide pricing trends for
hospital professional and general liability coverage. The Company expects the
expense factors mentioned above to continue to pressure future operating
margins.
Operating margins at the Company's acute care facilities increased slightly
in 2000 as compared to 1999 due primarily to (i) a reduction in salaries,
wages and benefits, other operating expenses and supply expense as a
percentage of net revenues resulting from increased efforts to control costs,
and; (ii) replacement of a capitation contract at the Company's three Las
Vegas facilities with a standard per diem contract commencing in January,
2000. These favorable factors were partially offset by an increase the
provision for bad debts at the Company's acute care facilities in 2000 as
compared to 1999 caused primarily by: (i) an increase in self-pay patients
which generally result in a larger portion of uncollectable accounts; (ii)
collection delays and difficulties with managed care payors, and; (iii) an
increase in gross patient charges instituted during the year which increases
the provision for doubtful accounts when accounts become uncollectable.
Behavioral Health Services
Net revenues from the Company's behavioral health care facilities accounted
for 19%, 16% and 13% of consolidated net revenues in 2001, 2000 and 1999,
respectively. The increases in 2001 as compared to 2000 and 2000 as compared
to 1999 were due primarily to the purchase of twelve behavioral health
facilities acquired during the third quarter of 2000.
Net revenues at the Company's behavioral health care facilities owned in
both 2001 and 2000 increased 7% in 2001 as compared to 2000. Admissions and
patient days at these facilities increased 7% and 4%, respectively, in 2001 as
compared to 2000 and the average length of stay decreased to 11.9 days in 2001
as compared to 12.2 days in 2000. Contributing to the increase in net revenues
at the Company's behavioral health care facilities owned in both 2001 and 2000
was a 2% increase in net revenue per adjusted admission in 2001 as compared to
2000 and a 4% increase in net revenue per adjusted patient day in 2001 as
compared to 2000. Net revenues at the Company's behavioral health care
facilities owned in both 2000 and 1999 increased 5% in 2000 as compared to
1999. Admissions and patient days at these facilities increased 4% and 3%,
respectively, in 2000 as compared to 1999 and the average length of stay
decreased to 11.7 days in 2000 as compared to 11.8 days in 1999.
At the Company's behavioral health care facilities, operating expenses
(salaries, wages and benefits, other operating expenses, supply expense and
provision for doubtful accounts) as a percentage of net revenues were 81.0% in
2001, 81.8% in 2000 and 83.4% in 1999. The Company's behavioral health care
division generated operating margins (defined as net revenues less operating
expenses divided by net revenues) of 19.0% in 2001, 18.2% in 2000 and 16.6% in
1999. Operating expenses as a percentage of net revenues at the Company's
behavioral health care facilities owned in both 2001 and 2000 were 80.3% in
2001 and 81.8% in 2000 while operating margins at theses facilities were 19.7%
in 2001 and 18.2% in 2000. Operating expenses as a percentage of net revenues
at the Company's behavioral health care facilities owned in both 2000 and 1999
were 81.4% in 2000 and 83.4% in 1999 while operating margins at these
facilities were 18.6% in 2000 and 16.6% in 1999.
During the last few years, there has been downsizing in the behavioral
health care industry which has created an opportunity for the Company to
increase its managed care rates which has contributed to the increased
operating margins. In an effort to maintain and potentially further improve
the operating margins at its behavioral health care facilities, management of
the Company continues to implement cost controls and price increases and has
also increased its focus on receivables management.
19
Other Operating Results
During the fourth quarter of 2001, the Company recorded the following
charges: (i) a $40.0 million pre-tax charge to reserve for malpractice
expenses that may result from the Company's third party malpractice insurance
company (PHICO) that was placed in liquidation in February, 2002 (see General
Trends); (ii) a $7.4 million pre-tax loss on derivative transactions resulting
from the early termination of interest rate swaps, and; (iii) a $1.0 million
after-tax ($1.6 million pre-tax) extraordinary expense resulting from the
early redemption of the Company's $135 million 8.75% notes issued in 1995.
During 1999, the Company decided to close and divest one of its specialized
women's health centers and as
a result, the Company recorded a $5.3 million charge to reduce the carrying
value of the facility to its estimated realizable value of approximately $9
million, based on an independent appraisal. A jury verdict unfavorable to the
Company was rendered during the fourth quarter of 2000 with respect to
litigation regarding the closing of this facility. Accordingly, during the
fourth quarter of 2000, the Company recognized a charge of $7.7 million to
reflect the amount of the jury verdict and a reserve for future legal costs
and in February of 2001, this unprofitable facility was closed. During 2001,
an appellate court issued an opinion affirming the jury verdict and during the
first quarter of 2002, the Company filed a petition for review by the state
supreme court.
The effective tax rate was 36.2% in 2001, 36.1% in 2000 and 36.7% in 1999.
General Trends
A significant portion of the Company's revenue is derived from fixed payment
services, including Medicare and Medicaid which accounted for 42%, 44% and 46%
of the Company's net patient revenues during 2001, 2000 and 1999,
respectively. Within the statutory framework of the Medicare and Medicaid
programs, there are substantial areas subject to administrative rulings,
interpretations and discretion which may affect payments made under either or
both of such programs and reimbursement is subject to audit and review by
third party payors. Management believes that adequate provision has been made
for any adjustment that might result therefrom.
The Federal government makes payments to participating hospitals under its
Medicare program based on various formulas. The Company's general acute care
hospitals are subject to a prospective payment system ("PPS"). For inpatient
services, PPS pays hospitals a predetermined amount per diagnostic related
group ("DRG") based upon a hospital's location and the patient's diagnosis.
Beginning August 1, 2000 under a new outpatient prospective payment system
("OPPS") mandated by the Balanced Budget Act of 1997, both general acute and
behavioral health hospitals' outpatient services are paid a predetermined
amount per Ambulatory Payment Classification based upon a hospital's location
and the procedures performed. The Medicare, Medicaid and SCHIP Balanced Budget
Refinement Act of 1999 ("BBRA of 1999") included "transitional corridor
payments" through fiscal year 2003, which provide some financial relief for
any hospital that generally incurs a reduction to its Medicare outpatient
reimbursement under the new OPPS.
Behavioral health facilities, which are excluded from the inpatient services
PPS, are cost reimbursed by the Medicare program, but are generally subject to
a per discharge ceiling, calculated based on an annual allowable rate of
increase over the hospital's base year amount under the Medicare law and
regulations. Capital related costs are exempt from this limitation. In the
Balanced Budget Act of 1997 ("BBA-97"), Congress significantly revised the
Medicare payment provisions for PPS-excluded hospitals, including psychiatric
hospitals. Effective for Medicare cost reporting periods beginning on or after
October 1, 1997, different caps are applied to psychiatric hospitals' target
amounts depending upon whether a hospital was excluded from PPS before or
after that date, with higher caps for hospitals excluded before that date.
Congress also revised the rate-of-increase percentages for PPS-excluded
hospitals and eliminated the new provider PPS-exemption for psychiatric
hospitals. In addition, the Health Care Financing Administration, now known as
the Centers for Medicare and Medicaid Services ("CMS"), has implemented
requirements applicable to psychiatric hospitals that share a facility or
campus with another hospital. The BBRA of 1999 requires that CMS develop an
inpatient psychiatric per diem prospective payment system effective for the
federal fiscal year beginning October 1, 2002, however, it is possible the
implementation may be delayed. Upon implementation, this new prospective
payment system will replace the current inpatient psychiatric payment system
described above.
20
On August 30, 1991, the CMS issued final Medicare regulations establishing a
PPS for inpatient hospital capital-related costs. These regulations apply to
hospitals which are reimbursed based upon the prospective payment system and
took effect for cost report years beginning on or after October 1, 1991. For
most of the Company's hospitals, the new methodology began on January 1, 1992.
In 2001, the tenth year of the phase-in, most of the Company's hospitals were
still being reimbursed by the Medicare program based on the blend of the
federal capital rate and the rate specific to each hospital (three hospitals
still receive hold harmless payments, which are described below).
The regulations provide for the use of a 10-year transition period during
which a blend of the old and new capital payment provision is utilized. One of
two methodologies applies during the 10-year transition period. If the
hospital's hospital-specific capital rate exceeds the federal capital rate,
the hospital is paid per discharge on the basis of a "hold harmless"
methodology, which is the higher of a blend of a portion of old capital costs
and an amount for new capital costs based on a proportion of the federal
capital rate, or 100% of the federal capital rate. Alternatively, with limited
exceptions, if the hospital-specific rate is below the federal capital rate,
the hospital receives payments based upon a "fully prospective" methodology,
which is a blend of the hospital's hospital-specific capital rate and the
federal capital rate. Each hospital's hospital-specific rate was determined
based upon allowable capital costs incurred during the "base year", which, for
most of the Company's hospitals, was the year ended December 31, 1990. Updated
amounts and factors necessary to determine PPS rates for Medicare hospital
inpatient services for operating costs and capital related costs are published
annually.
In addition to the trends described above that continue to have an impact on
the operating results, there are a number of other more general factors
affecting the Company's business. BBA-97 called for the government to trim the
growth of federal spending on Medicare by $115 billion and on Medicaid by $13
billion over the following years. The act also called for reductions in the
future rate of increases to payments made to hospitals and reduced the amount
of reimbursement for outpatient services, bad debt expense and capital costs.
Some of these reductions were reversed with the passage on December 15, 2000
of the Medicare, Medicaid and SCHIP Benefits Improvement and Protection Act of
2000 ("BIPA") which, among other things, increased Medicare and Medicaid
payments to healthcare providers by $35 billion over 5 years with
approximately $12 billion of this amount targeted for hospitals and $11
billion for managed care payors. These increased reimbursements to hospitals
pursuant to the terms of BIPA commenced in April, 2001. BBA-97 established the
annual update for Medicare at market basket minus 1.1% in both fiscal years
2001 (October 1, 2000 and through September 30, 2001) and 2002 and BIPA
revised the update at the full market basket in fiscal year 2001 and market
basket minus .55% in fiscal years 2002 and 2003. Additionally, BBA-97 reduced
reimbursement to hospitals for Medicare bad debts to 55% and BIPA increased
the reimbursement to 70%, with an effective date for the Company of January 1,
2001. It is possible that future federal budgets will contain certain further
reductions or increases in the rate of increase of Medicare and Medicaid
spending.
The Company can provide no assurances that the reductions in the PPS update,
and other changes required by BBA-97, will not adversely affect the Company's
operations. However, within certain limits, a hospital can manage its costs,
and, to the extent this is done effectively, a hospital may benefit from the
DRG system. However, many hospital operating costs are incurred in order to
satisfy licensing laws, standards of the Joint Commission on the Accreditation
of Healthcare Organizations ("JCAHO") and quality of care concerns. In
addition, hospital costs are affected by the level of patient acuity,
occupancy rates and local physician practice patterns, including length of
stay, judgments and number and type of tests and procedures ordered. A
hospital's ability to control or influence these factors which affect costs
is, in many cases, limited.
In addition to Federal health reform efforts, several states have adopted or
are considering healthcare reform legislation. Several states are considering
wider use of managed care for their Medicaid populations and providing
coverage for some people who presently are uninsured. The enactment of
Medicaid managed care initiatives is designed to provide low-cost coverage.
The Company currently operates three behavioral health centers with a total of
501 beds in Massachusetts, which has mandated hospital rate-setting. The
Company also operates three hospitals containing an aggregate of 688 beds in
Florida that are subject to a mandated form of rate-setting if increases in
hospital revenues per admission exceed certain target percentages.
21
In 1991, the Texas legislature authorized the LoneSTAR Health Initiative, a
pilot program in two areas of the state, to establish for Medicaid
beneficiaries a healthcare delivery system based on managed care principles.
The program is now known as the STAR program, which is short for State of
Texas Access Reform. Since 1995, the Texas Health and Human Services
Commission, with the help of other Texas agencies such as the Texas Department
of Health, has rolled out STAR Medicaid managed care pilot programs in several
geographic areas of the state. Under the STAR program, the Texas Department of
Health either contracts with health maintenance organizations in each area to
arrange for covered services to Medicaid beneficiaries, or contracts directly
with healthcare providers and oversees the furnishing of care in the role of
the case manager. Two carve-out pilot programs are the STAR+PLUS program,
which integrates acute care and long-term care into a managed care system in
the Harris County service area, and the NorthSTAR program, which furnishes
behavioral health services to Medicaid beneficiaries in the Dallas County
service area. Effective in the fall of 1999, however, the Texas legislature
imposed a moratorium on the implementation of additional pilot programs until
the 2001 legislative session. A study on the effectiveness of Medicaid managed
care was issued in November, 2000. In June 2001, the state enacted House Bill
3038, which requires the enrollment in group health plans of Medicaid and
SCHIP recipients who are eligible for such plans, if the state determines that
such enrollment is cost-effective. The effective date for this requirement was
September 1, 2001. The state has indicated, however, that it will not be
expanding the Medicaid Managed Care program to any additional areas within the
next year.
Upon meeting certain conditions, and serving a disproportionately high share
of Texas' and South Carolina's low income patients, five of the Company's
facilities located in Texas and one facility located in South Carolina became
eligible and received additional reimbursement from each state's
disproportionate share hospital fund. Included in the Company's financial
results was an aggregate of $32.6 million in 2001, $28.9 million in 2000 and
$37.0 million in 1999 received pursuant to these programs. The Texas and South
Carolina programs have been renewed for the 2002 fiscal year and the Company
expects its reimbursements, as scheduled pursuant to the terms of these
programs, to increase by approximately $4.2 million annually as compared to
the 2001 fiscal year. Failure to renew these programs, which are scheduled to
terminate in the third quarter of 2002, or reductions in reimbursements, could
have a material adverse effect on the Company's future results of operations.
The healthcare industry is subject to numerous laws and regulations which
include, among other things, matters such as government healthcare
participation requirements, various licensure and accreditations,
reimbursement for patient services, and Medicare and Medicaid fraud and abuse.
Providers that are found to have violated these laws and regulations may be
excluded from participating in government healthcare programs, subjected to
fines or penalties or required to repay amounts received from government for
previously billed patient services. While management of the Company believes
its policies, procedures and practices comply with governmental regulations,
no assurance can be given that the Company will not be subjected to
governmental inquiries or actions.
Pressures to control health care costs and a shift away from traditional
Medicare indemnity plans to Medicare managed care plans have resulted in an
increase in the number of patients whose health care coverage is provided
under managed care plans. Approximately 37% in 2001, 35% in 2000 and 32% in
1999, of the Company's net patient revenues were generated from managed care
companies, which includes health maintenance organizations and preferred
provider organizations. In general, the Company expects the percentage of its
business from managed care programs to continue to grow. The consequent growth
in managed care networks and the resulting impact of these networks on the
operating results of the Company's facilities vary among the markets in which
the Company operates. Typically, the Company receives lower payments per
patient from managed care payors than it does from traditional indemnity
insurers, however, during the past year, the Company secured price increases
from many of its commercial payors including managed care companies.
For the period from January 1, 1998 through December 31, 2001, most of the
Company's subsidiaries were covered under commercial insurance policies with
PHICO, a Pennsylvania based insurance company. The policies provided for a
self-insured retention limit for professional and general liability claims for
the Company's subsidiaries up to $1 million per occurrence, with an average
annual aggregate for covered subsidiaries of
22
$7 million through 2001. These subsidiaries maintain excess coverage up to
$100 million with other major insurance carriers.
In February of 2002, PHICO was placed in liquidation by the Pennsylvania
Insurance Commissioner and as a result, the Company recorded a pre-tax charge
to earnings of $40 million during the fourth quarter of 2001 to reserve for
malpractice expenses that may result from PHICO's liquidation. PHICO continues
to have substantial liability to pay claims on behalf of the Company and
although those claims could become the Company's liability, the Company may be
entitled to receive reimbursement from state insurance guaranty funds and/or
PHICO's estate for a portion of certain claims ultimately paid by the Company.
The Company expects that the cash payments related to these claims will be
made over the next eight years as the cases are settled or adjudicated. In
estimating the $40 million pre-tax charge, the Company evaluated all known
factors, however, there can be no assurance that the Company's ultimate
liability will not be materially different than the estimated charge recorded.
Additionally, if the ultimate PHICO liability assumed by the Company is
substantially greater than the established reserve, there can be no assurance
that the additional amount required will not have a material adverse effect on
the Company's future results of operations.
Due to unfavorable pricing and availability trends in the professional and
general liability insurance markets, the cost of commercial professional and
general liability insurance coverage has risen significantly. As a result, the
Company expects its total insurance expense including professional and general
liability, property, auto and workers' compensation to increase approximately
$25 million in 2002 as compared to 2001. The Company's subsidiaries have also
assumed a greater portion of the hospital professional and general liability
risk for its facilities. Effective January 1, 2002, most of the Company's
subsidiaries are self-insured for malpractice exposure up to $25 million per
occurrence. The Company purchased an umbrella excess policy through a
commercial insurance carrier for coverage in excess of $25 million per
occurrence with a $75 million aggregate limitation.
Health Insurance Portability and Accountability Act of 1996
The Health Insurance Portability and Accountability Act (HIPAA) was enacted
in August, 1996 to assure health insurance portability, reduce healthcare
fraud and abuse, guarantee security and privacy of health information and
enforce standards for health information. Generally, organizations are
required to be in compliance with certain HIPAA provisions beginning in
October, 2002. Provisions not yet finalized are required to be implemented two
years after the effective date of the regulation. Organizations are subject to
significant fines and penalties if found not to be compliant with the
provisions outlined in the regulations. Regulations related to HIPAA are
expected to impact the Company and others in the healthcare industry by:
. Establishing standardized code sets for financial and clinical electronic
data interchange ("EDI") transactions to enable more efficient flow of
information. Currently there is no common standard for the transfer of
information between the constituents in healthcare and therefore providers
have had to conform to different standards utilized by each party with
which they interact. The goal of HIPAA is to create one common national
standard for EDI and once the HIPAA regulations take effect, payors will be
required to accept the national standard employed by providers. The final
regulations establishing electronic data transmission standards that all
healthcare providers must use when submitting or receiving certain
healthcare
transactions electronically were published in August, 2000 and compliance
with these regulations is required by October, 2002.
. Mandating the adoption of security standards to preserve the
confidentiality, integrity and availability of medical information that
identifies individuals. Currently there is no recognized healthcare
standard that includes all the necessary components to protect the data
integrity and confidentiality of a patient's electronically maintained or
transmitted personal medical record. The final regulations containing the
privacy standards were released in December, 2000 and require compliance by
April, 2003.
. Creating unique identifiers for the four constituents in healthcare:
payors, providers, patients and employers. HIPAA will mandate the need for
the unique identifiers for healthcare providers in an effort to ease the
administrative challenge of maintaining and transmitting clinical data
across disparate episodes of patient care.
23
The Company is in the process of implementation of the necessary changes
required pursuant to the terms of HIPAA. The Company expects that the
implementation cost of the HIPAA related modifications will not have a
material adverse effect on the Company's financial condition or results of
operations.
Market Risks Associated with Financial Instruments
The Company's interest expense is sensitive to changes in the general level
of domestic interest rates. To mitigate the impact of fluctuations in domestic
interest rates, a portion of the Company's debt is fixed rate accomplished by
either borrowing on a long-term basis at fixed rates or by entering into
interest rate swap transactions. The interest rate swap agreements are
contracts that require the Company to pay fixed and receive floating interest
rates over the life of the agreements. The floating-rates are based on LIBOR
and the fixed-rate is determined at the time the swap agreement is
consummated.
As of December 31, 2001, the Company had three interest rate swaps. One
fixed rate swap with a notional principal amount of $125 million which expires
in August 2005. The Company pays a fixed rate of 6.76% and receives a floating
rate equal to three month LIBOR. As of December 31, 2001, the floating rate of
the $125 million of interest rate swaps was 2.01%. In November 2001, the
Company entered into two floating rate swaps having an aggregate notional
principal amount of $60 million in which the company receives a fixed rate of
6.75% and pays a floating rate equal to 6 month LIBOR plus a spread. The term
of these swaps is ten years and they are both scheduled to expire on November
15, 2011. As of December 31, 2001, the average floating rate of the
$60 million of interest rate swaps was 3.43%.
As of December 31, 2000, the Company had a five year interest rate swap
having a notional principal amount of $135 million whereby the Company pays a
floating rate and the counter-party pays the Company a fixed rate of 8.75%.
The counter-party had the right to cancel the swap at any time during the swap
term with thirty days notice. The option was exercised in 2001 and the swap
was cancelled. The termination resulted in a net payment to the Company of
approximately $3.8 million. The Company also had a fixed rate swap having a
notional principal amount of $135 million whereby the Company pays a fixed
rate of 6.76% and receives a floating rate from the counter-party. During
2001, the notional amount of this swap was reduced to $125 million. The
Company had two interest rate swaps to fix the rate of interest on a total
notional principal amount of $75 million with a maturity date of August, 2010.
The average fixed rate on the $75 million of interest rate swaps, including
the Company's borrowing spread of .35%, was 7.05%. The total cost of all swaps
terminated in 2001 was $7.4 million.
The interest rate swap agreements do not constitute positions independent of
the underlying exposures. The Company does not hold or issue derivative
instruments for trading purposes and is not a party to any instruments with
leverage features. The Company is exposed to credit losses in the event of
nonperformance by the counterparties to its financial instruments. The
counterparties are creditworthy financial institutions, rated AA or better by
Moody's Investor Services and the Company anticipates that the counterparties
will be able to fully satisfy their obligations under the contracts. For the
years ended December 31, 2001, 2000 and 1999, the
Company received weighted average rates of 5.9%, 7.2% and 5.5%, respectively,
and paid a weighted average rate on its interest rate swap agreements of 6.9%
in 2001, 7.5% in 2000 and 5.8% in 1999.
The table below presents information about the Company's derivative
financial instruments and other financial instruments that are sensitive to
changes in interest rates, including long-term debt and interest rate swaps as
of December 31, 2001. For debt obligations, the table presents principal cash
flows and related weighted-average interest rates by contractual maturity
dates. For interest rate swap agreements, the table presents notional amounts
by maturity date and weighted average interest rates based on rates in effect
at
24
December 31, 2001. The fair values of long-term debt and interest rate swaps
were determined based on market prices quoted at December 31, 2001, for the
same or similar debt issues.
Maturity Date, Fiscal Year Ending December 31
-----------------------------------------------------------------
There-
2002 2003 2004 2005 2006 after Total
------ ------ ------ ------ ----------- -------- --------
(Dollars in thousands)
Liabilities
Long-term debt:
Fixed rate--Fair
value................ $2,436 $3,055 $1,951 $1,894 $ 1,525 $502,924(a) $513,785
Fixed rate--Carrying
value................ $2,436 $3,055 $1,951 $1,894 $ 1,525 $471,205 $482,066
Average interest rates.. 7.4% 6.9% 6.6% 6.5% 6.3% 5.7%
Variable rate long-term
debt................... $ 221,000 $ 18,200 $239,200
Interest Rate
Derivatives
Interest rate swaps:
Pay fixed/receive
variable notional
amounts.............. $ 125,000 $125,000
Fair value............ $ (10,227) $(10,227)
Average pay rate...... 6.76%
Average receive rate.. 3 month
LIBOR
Pay variable/receive
fixed notional
amounts.............. $ (60,000) $(60,000)
Fair value (included
in long-term debt)... $ (1,455) $ (1,455)
Average pay rate...... 6 month
LIBOR
plus spread
Average receive rate.. 6.75%
- --------
(a) The fair value of the Company's 5% discounted convertible debentures
("Debentures") at December 31, 2001 is $303 million, however, the Company
has the right to redeem the Debentures any time on or after June 23, 2006
at a price equal to the issue price of the Debentures plus accrued
original issue discount and accrued cash interest to the date of
redemption. On June 23, 2006 the amount necessary to redeem all Debentures
would be $319 million. If the Debentures could be redeemed at the same
basis at December 31, 2001 the redemption amount would be $265 million.
The holders of the Debentures may convert the Debentures to the Company's
Class B stock at any time. If all Debentures were converted, the result
would be the issuance of 6.6 million shares of the Company's Class B
Common Stock.
Effects of Inflation and Seasonality
Although inflation has not had a material impact on the Company's results of
operations over the last three years, the healthcare industry is very labor
intensive and salaries and benefits are subject to inflationary pressures as
are rising supply costs which tend to escalate as vendors pass on the rising
costs through price increases. The Company's acute care and behavioral health
care facilities are experiencing the effects of the tight labor market,
including a shortage of nurses, which has caused and may continue to cause an
increase in the Company's salaries, wages and benefits expense in excess of
the inflation rate. Although the Company cannot predict its ability to
continue to cover future cost increases, management believes that through
adherence to cost containment policies, labor management and reasonable price
increases, the effects of inflation on future operating margins should be
manageable. However, the Company's ability to pass on these increased costs
associated with providing healthcare to Medicare and Medicaid patients is
limited due to various federal, state and local laws which have been enacted
that, in certain cases, limit the Company's ability to increase prices. In
addition, as a result of increasing regulatory and competitive pressures and a
continuing industry wide shift of patients into managed care plans, the
Company's ability to maintain margins through price increases to non-Medicare
patients is limited.
25
The Company's business is seasonal, with higher patient volumes and net
patient service revenue in the first and fourth quarters of the Company's
year. This seasonality occurs because, generally, more people become ill
during the winter months, which results in significant increases in the number
of patients treated in the Company's hospitals during those months.
Liquidity and Capital Resources
Net cash provided by operating activities was $312 million in 2001, $182
million in 2000 and $176 million in 1999. The $130 million increase during
2001 as compared to 2000 was primarily attributable to: (i) a favorable $73
million change due to an increase in net income plus the addback of
adjustments to reconcile net cash provided by operating activities
(depreciation & amortization, minority interests in earnings of consolidated
entities, accretion of discount on convertible debentures, losses on foreign
exchange, derivative transactions & debt extinguishment and provision for
insurance settlement and other non-cash charges); (ii) an unfavorable
$40 million change due to timing of net income tax payments; (iii) a $31
favorable change in accounts receivable; (iv) a $28 million favorable change
in other assets and deferred charges, and; (v) $38 million of other net
favorable working capital changes. Included in the $73 million favorable
change in income plus the addback of adjustments to reconcile net cash
provided by operating activities was a $40 million non-cash reserve
established during the fourth quarter of 2001 related to the liquidation of
PHICO, the Company's third party hospital professional and general liability
insurance