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EX-10.15 - EXHIBIT 10.15 - IASIS Healthcare LLCc92860exv10w15.htm
EX-10.13 - EXHIBIT 10.13 - IASIS Healthcare LLCc92860exv10w13.htm
EX-10.16 - EXHIBIT 10.16 - IASIS Healthcare LLCc92860exv10w16.htm
EX-10.11 - EXHIBIT 10.11 - IASIS Healthcare LLCc92860exv10w11.htm
EX-10.17 - EXHIBIT 10.17 - IASIS Healthcare LLCc92860exv10w17.htm
EX-10.12 - EXHIBIT 10.12 - IASIS Healthcare LLCc92860exv10w12.htm
EX-21 - EXHIBIT 21 - IASIS Healthcare LLCc92860exv21.htm
EX-31.2 - EXHIBIT 31.2 - IASIS Healthcare LLCc92860exv31w2.htm
EX-31.1 - EXHIBIT 31.1 - IASIS Healthcare LLCc92860exv31w1.htm
EX-10.18 - EXHIBIT 10.18 - IASIS Healthcare LLCc92860exv10w18.htm
EX-10.14 - EXHIBIT 10.14 - IASIS Healthcare LLCc92860exv10w14.htm
Table of Contents

 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
þ   ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended September 30, 2009
or
     
o   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                      to                     .
Commission File Number: 333-117362
IASIS HEALTHCARE LLC
(Exact name of registrant as specified in its charter)
     
DELAWARE
(State or other jurisdiction
of incorporation or organization)
  20-1150104
(I.R.S. Employer
Identification No.)
     
DOVER CENTRE
117 SEABOARD LANE, BUILDING E
FRANKLIN, TENNESSEE

(Address of principal executive offices)
 

37067

(Zip Code)
Registrant’s telephone number, including area code: (615) 844-2747
Securities Registered Pursuant to Section 12(b) of the Act: None
Securities Registered Pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. YES o NO þ
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. YES þ NO o
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to the filing requirements for the past 90 days. YES þ NO o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). YES o NO o
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 the 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. þ
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer or a smaller reporting company. See definition of “accelerated filer,” “non-accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
             
Large Accelerated filer o   Accelerated filer o   Non-Accelerated filer þ   Smaller reporting company o
        (Do not check if a smaller reporting company)    
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). YES o NO þ
As of November 25, 2009, 100% of the registrant’s common interests outstanding (all of which are privately owned and are not traded on any public market) were owned by IASIS Healthcare Corporation, its sole member.
 
 

 

 


 

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 Exhibit 10.11
 Exhibit 10.12
 Exhibit 10.13
 Exhibit 10.14
 Exhibit 10.15
 Exhibit 10.16
 Exhibit 10.17
 Exhibit 10.18
 Exhibit 21
 Exhibit 31.1
 Exhibit 31.2

 

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IASIS HEALTHCARE LLC
PART I
Item 1. Business.
Company Overview
We are a leading owner and operator of medium-sized acute care hospitals in high-growth urban and suburban markets. We operate our hospitals with a strong community focus by offering and developing healthcare services targeted to the needs of the markets we serve, promoting strong relationships with physicians and working with local managed care plans. As of September 30, 2009, we owned or leased 15 acute care hospital facilities and one behavioral health hospital facility with a total of 2,853 beds in service. Except for West Monroe, Louisiana, each of our hospital facilities is located in a region that has a projected population growth rate in excess of the national average. We operate in the following regions:
    Salt Lake City, Utah;
    Phoenix, Arizona;
    Tampa-St. Petersburg, Florida;
    three cities in Texas, including San Antonio;
    Las Vegas, Nevada; and
    West Monroe, Louisiana.
Our general, acute care hospital facilities offer a variety of medical and surgical services commonly available in hospitals, including emergency services, general surgery, internal medicine, cardiology, obstetrics, orthopedics, psychiatry and physical rehabilitation. In addition, our facilities provide outpatient and ancillary services including outpatient surgery, physical therapy, radiation therapy, diagnostic imaging and respiratory therapy.
We also own and operate Health Choice Arizona, Inc. (“Health Choice” or the “Plan”), a Medicaid and Medicare managed health plan in Phoenix that served over 190,000 members as of September 30, 2009.
For the year ended September 30, 2009, we generated net revenue of $2.4 billion, of which 70.4% was derived from our acute care segment.
Our principal executive offices are located at Dover Centre, 117 Seaboard Lane, Building E, Franklin, Tennessee 37067 and our telephone number at that address is (615) 844-2747. Our Internet website address is www.iasishealthcare.com. Information contained on our website is not part of this annual report on Form 10-K.
In this report, unless we indicate otherwise or the context requires, “we,” “us,” “our” or “our company” refers to IASIS Healthcare LLC (“IASIS”) and its consolidated subsidiaries. Our parent company, IASIS Healthcare Corporation (“IAS”), is our sole member.
Business Strategy
Our objective is to provide high-quality, cost-effective healthcare services in the communities we serve. The key elements of our business strategy are:

 

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Focus on Operational Excellence. Our management team has extensive multi-facility operating experience and focuses on operational excellence at each of our facilities. We intend to continue to improve our operations and profitability by:
    using our advanced information systems platform across all of our hospitals to provide us with accurate, real-time and cost-effective financial and clinical information;
    expanding our profitable product lines and improving our business mix;
    focusing on efficient staffing, outsourcing programs and supply utilization;
    capitalizing on purchasing efficiencies and reducing operating costs through monitoring compliance with our national group purchasing contract; and
    improving our processes for patient registration, including patient qualification for financial assistance and point-of-service collections, billing, collections, managed care contract compliance and all other aspects of our revenue cycle.
Provide High-Quality Services. We strive to provide high-quality services at each of our facilities. This includes monitoring and tracking clinical performance and patient safety, which is a focus of all our hospitals. We believe that the measurement of quality of care has become an increasingly important factor in third-party reimbursement, as well as in negotiating preferred managed care contracting rates. Reflecting our commitment to the quality of care and in an effort to maximize our reimbursement, we have implemented an advanced clinical information system at all of our hospitals, providing us with more timely availability of key clinical care data. We believe that this system helps us enhance patient safety, reduce medical errors through bar coding, increase staff time available for direct patient care and continue to meet or exceed desired patient care outcomes and quality of care indicators for reimbursement. Our commitment and success at delivering high-quality services are evidenced by items such as:
    dedicated corporate and hospital resources;
    on-going training and education of both medical and non-medical personnel;
    utilizing our hospital medical management quality program to drive improvements in case management and allocation of resources, as well as quality and safety of care;
    leveraging our information systems to enhance clinical operations;
    either Det Norske Veritas (“DNV”) or The Joint Commission accreditation at all hospitals;
    regulatory achievement and continuous compliance from numerous organizations such as the College of American Pathologists and the Society of Chest Pain Centers;
    centers of excellence within our hospitals, across many different service lines;
    HealthGrades 5-Star, Top 5% and Top 10% ratings at numerous hospitals; and
    various other independent ratings.
Strategically Invest in Our Markets to Expand Services and Increase Revenue. We are continually engaged in strategic investments in our markets to expand services and increase revenue. Over the past three years, we have invested over $250.0 million in growth capital expenditures at our existing facilities, which includes various expansion and renovation projects, along with upgrades in imaging and other diagnostic equipment. We opened Mountain Vista Medical Center (“Mountain Vista”) in Mesa, Arizona, in July 2007, which has become a leading acute care hospital in this high growth service area. During 2009, we opened patient tower expansions at Jordan Valley Medical Center and Davis Hospital and Medical Center, which we believe will further enhance our presence in the Salt Lake City, Utah area. Additionally, we have invested over $100.0 million in capital to upgrade hardware and software related to our advanced clinicals and other information systems.

 

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Our disciplined approach to investing our capital includes analyzing demographic data, using our advanced information systems to identify the profitability of our product lines, improving the patient care experience and consulting with physicians and payors to prioritize the healthcare needs of the communities we serve. Recent investments have increased our revenue and local presence by focusing on:
    upgrading and expanding specialty services and surgical capacity, including cardiology, orthopedics, women’s services and sub-acute care;
    expanding emergency room capacity;
    updating our technology in surgery, such as robotic surgery, diagnostic imaging and other medical equipment;
    improving clinical and operating efficiencies through installation of automated laboratory systems at certain of our hospitals;
    increasing capacity and utilization of inpatient services at certain of our hospitals; and
    enhancing the convenience and quality of our outpatient services, including expansion of outpatient surgery, imaging and other specialty services.
Employing Physicians to Meet Community Needs in Certain Markets. In response to the competitive environment in certain of our growing markets and based on the needs of those communities, we have implemented a strategy of employing primary care and specialty physicians. This strategy has required significant investment in labor costs, as well as corporate and information systems infrastructure associated with physician practice management. This strategy has provided greater physician specialty coverage in our primary service areas, as well as expanded physician coverage for our emergency departments.
Recruit and Retain Quality Physicians. Consistent with community needs and regulatory requirements, we intend to continue to recruit and retain quality physicians for our medical staffs and maintain their loyalty to our facilities by:
    dedicating corporate personnel and resources to physician recruitment;
    equipping our hospitals with technologically advanced equipment;
    enhancing physician convenience and access, including the development of medical office space on or near our hospital campuses;
    sponsoring training programs to educate physicians on advanced medical procedures; and
    allowing physicians to remotely access clinical data through our advanced information systems, facilitating more convenient and timely patient care.
Continue to Develop Reasonable Managed Care Relationships. Managed care rate increases have moderated over the recent past as a result of pricing pressures from payors. In addition, the consolidation of payors in certain of our markets, as well as general economic conditions impacting enrollment in managed care plans, will continue to affect reimbursement from managed care organizations in future periods. While more difficult than in previous years, we believe that by maintaining market-based relationships, we will be able to continue to negotiate reasonable terms with managed care plans, enter into contracts with additional managed care plans and align reimbursement with acuity of services. Additionally, our advanced information systems improve our hospitals’ ability to administer managed care contracts, helping to ensure that claims are adjudicated correctly. We believe that the broad geographic coverage of our hospitals in certain of the regions in which we operate increases our attractiveness to managed care plans in those areas.

 

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Selectively Pursue Acquisitions and Strategic Alliances. We intend to selectively pursue acquisitions that allow us to enhance our presence, both regionally and nationally. These acquisitions may include the acquisition of individual hospitals, groups of hospitals or health systems. We will also continue to identify opportunities to expand our presence through strategic alliances with other healthcare providers.
Implement Operational Initiatives in Response to Healthcare Reform. Congress is currently considering proposed legislation intended to decrease the number of uninsured individuals and reduce healthcare costs. In addition, many states, including the states in which we operate, have experienced budget constraints and are considering, or may in the future consider, measures designed to reduce or provide alternative funding for their healthcare programs. We believe that our consistent focus on quality and patient satisfaction programs, coupled with the significant investments we have made in information systems, positions us to respond promptly and effectively to any changes resulting from the enactment of legislation at both the federal and state levels.
Although we expect our business strategy to increase our patient volumes and reimbursement and allow us to control costs, certain risk factors could offset those increases to our net revenue and profitability. Please see Item 1A., “Risk Factors” beginning on page 29 for a discussion of risk factors affecting our business.
Our Markets
Our hospitals are located in regions with some of the fastest growing populations in the United States.
Salt Lake City, Utah
We operate four acute care hospital facilities with a total of 681 licensed beds in the Salt Lake City area. The population in this area is projected to grow by 8.8% from 2009 to 2014, which is approximately 1.3 times above the projected national average growth rate. We believe our hospitals in Utah benefit from attractive strategic locations. We also believe the reimbursement environment in Utah is favorable, with the majority of our net patient revenue derived from managed care payors. For the year ended September 30, 2009, we generated approximately 27.1% of our total acute care revenue in this market.
Over the past five fiscal years, we have completed capital projects totaling $110.0 million at our existing facilities in this market. These projects have provided additional capacity for women’s and neonatal services, inpatient and outpatient surgery, including cardiac catheterization services, intensive care, emergency rooms, pediatric services, inpatient psychiatric and various diagnostic services, along with upgraded imaging technology. Our significant capital investments in our Salt Lake City area facilities are yielding strong returns. Most recently, we have invested in the following capital projects in our Utah market:
    An expansion project at Davis Hospital and Medical Center, which included opening the majority of a new patient tower in June 2009. This expansion project includes: 67 additional beds; a conversion to all private rooms; a new 20 bed psychiatric unit; a new 14 bed intensive care unit; a women’s surgical services unit; and expanded pediatric, medical/surgical and inpatient services;
    An expansion project at Jordan Valley Medical Center, including the patient tower which opened in January 2009. The expansion project consists of three new hospital patient floors, including: 10 additional critical care beds; 88 new inpatient beds; 15 new beds in the emergency room; a new, fully automated laboratory system; a redesigned outpatient cardiology center; and a Level III neonatal intensive care unit; and
    Emergency room and intensive care unit expansions at Salt Lake Regional Medical Center.
As a result of strong competition for patients in the Salt Lake City area, managed care organizations have aligned themselves with certain provider networks in this market. In response to this and other competitive factors, we have implemented a strategy to employ physicians in general and specialty practices. This strategy is allowing our hospitals to more effectively meet the needs of the communities we serve in this market. While we anticipate that our physician employment strategy will help us compete more effectively in this market, we are unable to provide any assurance regarding the success of our strategy.

 

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Phoenix, Arizona
We operate three acute care hospital facilities and one behavioral health hospital facility with a total of 621 licensed beds in the Phoenix area. The population in this area is projected to grow by 14.8% from 2009 to 2014, which is nearly 3.1 times the projected national average growth rate. The population in the primary service area for Mountain Vista is projected to grow 20.7% from 2007 to 2012. While we anticipate continued growth at elevated levels in this market, the prolonged economic recession has negatively impacted tourism and property values, which could have the effect of slowing the long-term population growth in this area.
Although Mountain Vista’s operations and medical staff continue to mature since its opening in July 2007, it has already become a state-of-the-art market leader. With the expanded capacity provided by Mountain Vista, as well as our continued focus on profitable product lines in our other facilities, such as outpatient imaging, psychiatric and orthopedic services, we believe we can continue to achieve growth in this market. For the year ended September 30, 2009, exclusive of Health Choice, we generated approximately 19.8% of our total acute care revenue in this market.
In connection with the growing operations at Mountain Vista over the past two years, we have implemented a physician employment strategy in our Arizona market. This strategy, which primarily benefits our Mountain Vista facility, focuses on enhancing our physician specialty and emergency room coverage, and is allowing our hospitals to more effectively meet the needs of the communities we serve. While we anticipate that our physician employment strategy will help us compete more effectively in this market, we are unable to provide any assurance regarding the success of our strategy.
Tampa-St. Petersburg, Florida
We operate three acute care hospital facilities with a total of 688 licensed beds in the Tampa-St. Petersburg area. The population in this area is projected to grow by 9.0% from 2009 to 2014, which is approximately 1.8 times the projected national average growth rate. While we anticipate continued growth in this market, the prolonged economic recession has negatively impacted tourism and property values, which could have the effect of slowing the long-term population growth in this area. Additionally, Florida has a large Medicare population and high managed care penetration, which can create a business environment that can be more challenging than other markets in which we operate. For the year ended September 30, 2009, we generated approximately 12.7% of our total acute care revenue in this market.
Certain material capital projects, including the addition of new beds or services, require regulatory approval under Florida’s certificate of need program. Our ability to expand operations in this market is restricted by such requirements, as well as the impact of the prolonged economic recession in the area. However, we believe we can maintain our competitive position in the Tampa-St. Petersburg market through maintaining and improving quality of services and focusing on profitable product lines, such as orthopedic, psychiatric, bariatric, outpatient imaging and non-invasive radiosurgery services.
Texas
We operate three acute care hospital facilities with a total of 773 licensed beds in San Antonio, Odessa, and Port Arthur, Texas. The weighted average projected population growth rate for these cities from 2009 to 2014 is 8.0%, which is approximately 1.4 times the projected national average growth rate. We believe our facilities in Texas benefit from favorable reimbursement rates and the lack of a single dominant competitor in their service areas. For the year ended September 30, 2009, we generated approximately 27.0% of our total acute care revenue in this market.
During fiscal 2008, we completed various capital projects at Southwest General Hospital, which focused on higher acuity service lines, including neurosurgery, the expansion of our cardiology program to include cardio-thoracic services, and the expansion of obstetric, neonatology and other surgical services. Our focus on expanding product lines with higher acuity services has allowed us to increase profitability and diversify our payor mix at this hospital.

 

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Effective May 31, 2007, we acquired Alliance Hospital (“Alliance”) in Odessa, Texas, with a total of 50 licensed beds. Upon acquisition, the operations of Alliance were immediately merged into Odessa Regional Hospital (“Odessa”) to form Odessa Regional Medical Center, which allowed us to combine the expertise of these two facilities into a comprehensive medical center, located on one campus. The integration of these two facilities has positioned Odessa Regional Medical Center in its community as a highly regarded full service hospital that provides general acute, emergency and women’s services, cardiovascular care, orthopedics, vascular and urology services. Since the acquisition and integration of Alliance, Odessa has focused on improving its operations through the expansion of its neonatal intensive care unit and the opening of a primary care clinic in the community served by Odessa.
We believe our strategic decisions, including the Alliance acquisition and capital projects completed over the recent years, have positioned each of our Texas hospitals for future success.
Las Vegas, Nevada
We operate North Vista Hospital, with a total of 178 licensed beds, in Las Vegas. While historically a high growth area, the prolonged economic recession has negatively impacted tourism, property values and the gaming industry, which could affect the long-term population growth in this area. In addition, significant declines in state tax revenue, budgetary shortfalls and reductions in state Medicaid and local indigent care programs may potentially impact our revenue. For the year ended September 30, 2009, we generated approximately 6.6% of our total acute care revenue in this market.
In response to these challenges, we plan to continue improvements in the operating performance of North Vista Hospital by maintaining our focus on operational excellence and managed care contracting, as well as expanding profitable product lines, including bariatric, psychiatric and other services.
West Monroe, Louisiana
We operate Glenwood Regional Medical Center (“Glenwood”) with a total of 221 licensed beds, in West Monroe, Louisiana, which we acquired effective January 31, 2007. Glenwood has a growing service area with a population of approximately 150,000. Medical services provided by Glenwood and its physicians cover many specialties and subspecialties, including cardiology and orthopedic services. For the year ended September 30, 2009, we generated approximately 6.8% of our total acute care revenue in this market.
During our first three years of ownership, we have spent over $18.0 million in renovations, expansion and other various capital projects at Glenwood, with an emphasis on expanding the hospital’s cardiovascular program, expanding and renovating operating rooms, and purchasing new diagnostic imaging, automated laboratory systems and other equipment. In addition to our capital projects, as part of our effort to more effectively serve the community in which Glenwood operates, we have improved the facility’s hospitalist program, expanded emergency room coverage and re-opened the inpatient psychiatric program.
Effective February 1, 2008, we purchased a majority ownership interest in Ouachita Community Hospital (“Ouachita”), a ten-bed surgical hospital located in West Monroe, Louisiana. The purchase price for the majority ownership interest was approximately $16.8 million. We believe this strategic acquisition has provided additional surgical capacity and allowed us to expand our market presence.
We believe that with these strategic initiatives and future strategic capital investments, our Louisiana market will yield a strong return on capital.

 

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Our Properties
We operate 15 acute care hospital facilities and one behavioral health hospital facility. As of September 30, 2009, we owned 14 and leased one of our hospital facilities. Seven of our acute care hospitals have third-party investors. The following table contains information concerning our hospitals.
             
        Licensed  
Hospitals   City   Beds  
Utah
           
Davis Hospital & Medical Center (1)
  Layton     191  
Jordan Valley Medical Center (2)
  West Jordan     183  
Pioneer Valley Hospital (3)
  West Valley City     139  
Salt Lake Regional Medical Center (4)
  Salt Lake City     168  
Arizona
           
Mountain Vista Medical Center (5)
  Mesa     178  
St. Luke’s Medical Center (6)
  Phoenix     232  
St. Luke’s Behavioral Health Hospital
  Phoenix     124  
Tempe St. Luke’s Hospital (7)
  Tempe     87  
Florida
           
Memorial Hospital of Tampa
  Tampa     180  
Palms of Pasadena Hospital
  St. Petersburg     307  
Town & Country Hospital
  Tampa     201  
Nevada
           
North Vista Hospital
  Las Vegas     178  
Texas
           
Odessa Regional Medical Center (8)
  Odessa     222  
Southwest General Hospital (9)
  San Antonio     327  
The Medical Center of Southeast Texas (10)
  Port Arthur     224  
Louisiana
           
Glenwood Regional Medical Center (11)
  West Monroe     221  
 
         
Total
        3,162  
 
         
 
     
(1)   Owned by a limited partnership in which we own a 96.2% interest.
 
(2)   On July 1, 2007, Jordan Valley Medical Center acquired Pioneer Valley Hospital, a wholly-owned subsidiary of IASIS. The combined entity is owned by a limited partnership in which we own a 95.6% interest.
 
(3)   A separate campus of Jordan Valley Medical Center, which is leased under an agreement that expires on January 31, 2019. We have options to extend the term of the lease through January 31, 2039.
 
(4)   Owned by a limited partnership in which we own an 98.0% interest.
 
(5)   Owned by a limited partnership in which we own an 90.8% interest.
 
(6)   On September 28, 2007, St. Luke’s Medical Center acquired Tempe St. Luke’s Hospital, a wholly-owned subsidiary of IASIS.
 
(7)   A separate campus of St. Luke’s Medical Center.
 
(8)   Owned by a limited partnership in which we own an 88.4% interest.
 
(9)   Owned by a limited partnership in which we own a 93.7% interest.
 
(10)   Owned by a limited partnership in which we own an 87.9% interest.
 
(11)   Includes Ouachita, a surgical hospital with 10 licensed beds.
We also operate and lease medical office buildings in conjunction with our hospitals. These office buildings are occupied primarily by physicians who practice at our hospitals.

 

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Hospital Operations
Our senior management team has extensive multi-facility operating experience and focuses on maintaining clinical and operational excellence at our facilities. At each hospital we operate, we have implemented policies and procedures to improve the hospital’s operating and financial performance. A hospital’s local management team is generally comprised of a chief executive officer, chief financial officer and chief nursing officer. Local management teams, in consultation with our corporate staff, develop annual operating plans setting forth quality and patient satisfaction goals, revenue growth and operating profit strategies. These strategies can include the expansion of services offered by the hospital, the recruitment and employment of physicians in each community, plans to enhance quality of care and improvements in operating efficiencies to reduce costs. We believe that the competence, skills and experience of the management team at each hospital is critical to the hospital’s success because of its role in executing the hospital’s operating plan. Our performance-based compensation program for each local management team is based upon the achievement of qualitative and quantitative goals set forth in the annual operating plan. Our hospital management teams are advised by boards of trustees that include members of hospital medical staffs, as well as community leaders. Each board of trustees establishes policies concerning medical, professional and ethical practices, monitors such practices and is responsible for ensuring that these practices conform to established standards.
Factors that affect demand for our services include:
    local economic conditions;
    the geographic location of our hospital facilities and their convenience for patients and physicians;
    our participation in managed care programs;
    utilization management practices of managed care plans;
    consolidation of managed care payors;
    capital investment at our facilities;
    the quality of our medical staff;
    competition from other healthcare providers;
    the size of and growth in local population; and
    improved treatment protocols as a result of advances in medical technology and pharmacology.
We believe that the ability of our hospitals to meet the healthcare needs of their communities is determined by the:
    level of physician support;
    availability of nurses and other healthcare professionals;
    quality, skills and compassion of our employees;
    breadth of our services;
    physical capacity and level of technological advancement at our facilities; and
    emphasis on quality of care.
We continuously evaluate our services with the intention of improving quality of care, expanding our profitable lines of business and improving our business mix. We use our advanced information systems to perform detailed clinical process reviews, product line margin analyses and monitor the profitability of the services provided at our facilities. We employ these analyses to capitalize on price and volume trends through the expansion and improvement of certain services. We use our information systems to monitor patient care and other quality of care assessment activities on a continuing basis.

 

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Sources of Acute Care Revenue
We receive payment for patient services primarily from:
    the federal government, primarily under the Medicare program;
    state Medicaid programs, including managed Medicaid plans;
    managed care payors, including health maintenance organizations, preferred provider organizations and managed Medicare plans; and
    individual patients and private insurers.
The following table presents the approximate percentages of our hospitals’ net patient revenue from these sources:
                         
    Year Ended September 30,  
Payor Source   2009     2008     2007  
Medicare
    22.7 %     23.4 %     22.2 %
Managed Medicare
    8.0       7.7       6.8  
Medicaid
    6.5       5.4       5.4  
Managed Medicaid
    8.7       8.4       8.6  
Managed care
    43.0       46.0       47.5  
Self-pay
    11.1       9.1       9.5  
 
                 
Total(1)
    100.0 %     100.0 %     100.0 %
 
                 
 
     
(1)   For the years ended September 30, 2009, 2008 and 2007, net patient revenue comprised 70.4%, 73.8% and 74.5%, respectively, of our consolidated net revenue.
Our hospitals offer discounts from established charges to managed care plans if they are large group purchasers of healthcare services. Additionally, we offer discounts to all uninsured patients receiving healthcare services who do not qualify for assistance under state Medicaid, other federal or state assistance plans or charity care. These discount programs generally limit our ability to increase net patient revenue in response to increasing costs. Patients generally are not responsible for any difference between established hospital charges and amounts reimbursed for such services under Medicare, Medicaid, health maintenance organizations, preferred provider organizations or private insurance plans. Patients generally are responsible for services not covered by these plans, along with exclusions, deductibles or co-insurance features of their coverage. Collecting amounts due from patients is more difficult than collecting from governmental programs, managed care plans or private insurers. Increases in the population of uninsured individuals, changes in the states’ indigent and Medicaid eligibility requirements, continued efforts by employers to pass more out-of-pocket healthcare costs to employees in the form of increased co-payments and deductibles, and the effects of a prolonged economic recession have resulted in an increase in our provision for bad debts.
Medicare
Medicare is a federal program that provides hospital and medical insurance benefits to persons age 65 and over, some disabled persons and persons with Lou Gehrig’s Disease and end-stage renal disease. All of our hospitals are certified as providers of Medicare services. Under the Medicare program, acute care hospitals receive reimbursement under a prospective payment system for inpatient and outpatient hospital services. Currently, certain types of facilities are exempt or partially exempt from the prospective payment system methodology, including children’s hospitals and cancer hospitals. Hospitals and units exempt from the prospective payment system are reimbursed on a reasonable cost-based system, subject to cost limits.

 

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Under the inpatient prospective payment system, a hospital receives a fixed payment based on the patient’s assigned Medicare severity diagnosis-related group (“MS-DRG”). The Centers for Medicare & Medicaid Services (“CMS”) recently completed a two-year transition to full implementation of MS-DRGs to replace the previously used Medicare diagnosis related groups in an effort to better recognize severity of illness in Medicare payment rates. The MS-DRG system classifies categories of illnesses according to the estimated intensity of hospital resources necessary to furnish care for each principal diagnosis. The MS-DRG rates for acute care hospitals are based upon a statistically normal distribution of severity. The MS-DRG payments do not consider a specific hospital’s actual costs but are adjusted for geographic area wage differentials. Inpatient capital costs for acute care hospitals are reimbursed on a prospective system based on diagnosis related group weights multiplied by geographically adjusted federal weights. When treatments for patients fall well outside the normal distribution, providers may receive additional payments known as outlier payments. For federal fiscal year 2010, CMS has established an outlier threshold of $23,140.
The MS-DRG rates are adjusted each federal fiscal year and have been affected by federal legislation. The index used to adjust the MS-DRG rates, known as the “market basket index,” gives consideration to the inflation experienced by hospitals and entities outside of the healthcare industry in purchasing goods and services. However, in past years the percentage increases to the MS-DRG rates have been lower than the percentage increases in the costs of goods and services purchased by hospitals. Based on the historical adjustments to the market baskets, future legislation or rulemaking may decrease the future rate of increase for diagnosis related group payments or make other changes to the diagnosis related groups, but we are unable to predict the amount of the reduction. For federal fiscal year 2010, CMS has issued a final rule updating the MS-DRG rates by the full market basket of 2.1%.
In federal fiscal years 2008 and 2009, CMS reduced payments to hospitals through a documentation and coding adjustment intended to account for coding and classification changes under the new MS-DRG system that were unrelated to changes in patient case mix. In addition, Congress has given CMS the ability to determine retrospectively whether the documentation and coding adjustment levels for federal fiscal years 2008 and 2009 were adequate to account for changes in payments not related to changes in patient case mix. CMS has not imposed an adjustment for federal fiscal year 2010, but has announced its intent to impose reductions to payments in federal fiscal years 2011 and 2012 because of what CMS has determined to be an inadequate adjustment in federal fiscal year 2008. Such payment adjustments may adversely affect the results of our operations.
Quality of care provided is becoming an increasingly important factor in Medicare reimbursement. The Medicare Modernization Act provides for diagnosis related group rate increases at the full market basket if the facility submits data for certain patient care indicators to the Secretary of Health and Human Services. Initially, CMS required the reporting of ten quality measures. As required by the Deficit Reduction Act of 2005 (“DEFRA”), CMS has expanded, through a series of rulemakings, the number of patient care indicators that hospitals must report. Currently, CMS requires hospitals to report 46 quality measures in order to qualify for the full market basket update to the inpatient prospective payment system in fiscal year 2011. Those hospitals not submitting the required data will receive an increase in payment equal to the market basket minus two percentage points. We currently have the ability to monitor our compliance with the quality indicators and intend to submit the quality data required to receive the full market basket pricing update when appropriate.
For discharges occurring on or after October 1, 2008, Medicare no longer pays hospitals additional amounts for the treatment of certain preventable adverse events, also known as hospital-acquired conditions, unless the condition was present at admission. Currently, there are ten categories of conditions on the list of hospital-acquired conditions. DEFRA provides that CMS may revise the list of conditions from time to time. On January 15, 2009, CMS announced three National Coverage Determinations (“NCDs”) that prohibit Medicare reimbursement for erroneous surgical procedures performed on an inpatient or outpatient basis. These three erroneous surgical procedures are in addition to the hospital-acquired conditions designated by regulation. Additionally, the healthcare reform bill passed by the U.S. House of Representatives and the bill currently under consideration by the U.S. Senate include several provisions addressing quality that attempt to reposition CMS as a value-based purchaser of healthcare services. These measures include requiring reporting of healthcare associated infections, reductions in payment for hospitals with excessive readmissions or hospital acquired conditions and the study of and proposal for the revision of CMS payment policies to promote high value healthcare. It is uncertain whether the bill will become law or if these provisions will be included in any final healthcare reform legislation.

 

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CMS reimburses hospital outpatient services and certain Medicare Part B services furnished to hospital inpatients who have no Part A coverage on a prospective payment system basis. CMS uses fee schedules to pay for physical, occupational and speech therapies, durable medical equipment, clinical diagnostic laboratory services and nonimplantable orthotics and prosthetics.
All services paid under the prospective payment system for hospital outpatient services are classified into groups called ambulatory payment classifications or “APCs.” Services in each APC are similar clinically and in terms of the resources they require. A payment rate is established for each APC. CMS increased the conversion factor by approximately 3.6% for calendar year 2009. CMS has announced a final rule updating the conversion factor for calendar year 2010 using a market basket of 2.1%. We anticipate that future legislation may decrease the future rate of increase for APC payments, but we are unable to predict the amount of the reduction.
CMS requires hospitals to submit quality data regarding eleven measures relating to outpatient care in order to receive the full market basket increase under the outpatient prospective payment system in calendar year 2010. CMS will continue to require hospitals to report the existing eleven quality measures to receive the full market basket increase under the outpatient prospective payment system in calendar year 2011. Hospitals that fail to submit such data will receive the market basket update minus two percentage points for the outpatient prospective payment system.
Hospitals that treat a disproportionately large number of low-income patients (Medicaid and Medicare patients eligible to receive supplemental Social Security income) currently receive additional payments from the federal government in the form of disproportionate share payments. CMS is required by law to study the formula used to calculate these payments and could propose changes, such as giving greater weight to the amount of uncompensated care provided by a hospital than to the number of low-income patients treated.
Inpatient rehabilitation hospitals and designated units are reimbursed under a prospective payment system. Under this prospective payment system, patients are classified into case mix groups based upon impairment, age, co-morbidities and functional capability. Inpatient rehabilitation facilities are paid a predetermined amount per discharge that reflects the patient’s case mix group and is adjusted for area wage levels, low-income patients, rural areas and high-cost outliers. The Medicare, Medicaid and SCHIP Extension Act of 2007 (“MMSEA”) provided for no update to the conversion factor for fiscal year 2009. For fiscal year 2010, CMS issued a final rule setting the market basket increase factor at 2.5%.
On May 7, 2004, CMS issued a final rule modifying the criteria for classification as an inpatient rehabilitation facility as a result of data indicating that most facilities do not meet the existing criteria. Under the previous requirements, in order for a facility to be considered an inpatient rehabilitation facility, at least 75% of the facility’s inpatient population during the most recent 12-month cost reporting period must have required intensive rehabilitation services for one or more of ten specified conditions. A subsequent rule expanded the list of specified conditions to 13, and subsequent legislation and regulations temporarily reduced the percentage of the patient population who must have one of the specified conditions. For cost reporting periods beginning on or after July 1, 2007, CMS required 65% of the patient population to have one of the specified conditions. Currently, the percentage is set by statute at 60% of the patient population. Effective January 1, 2010, inpatient rehabilitation facilities must meet additional coverage criteria, including patient selection and care requirements relating to pre-admission screenings, post-admission evaluations, ongoing coordination of care and involvement of rehabilitation physicians. As of September 30, 2009, we operated eight inpatient rehabilitation units within our hospitals.
Inpatient psychiatric facilities are paid based on a prospective payment system. Under this prospective payment system, inpatient psychiatric facilities receive a federal per diem base rate that is based on the sum of the average routine operating, ancillary and capital costs for each patient day of psychiatric care in an inpatient psychiatric facility, adjusted for budget neutrality. This federal per diem base rate is further adjusted to reflect certain patient and facility characteristics, including patient age, certain diagnostic related groups, facility wage index adjustment, and facility rural location. The payment rates are adjusted annually on a July 1 update cycle. Inpatient psychiatric facilities receive additional outlier payments for cases in which estimated costs for the case exceed an adjusted threshold amount plus the total adjusted payment amount for the stay. CMS updated payments for rate year 2010 by 2.1%. As of October 1, 2009, we operated one behavioral health hospital facility and four specially designated psychiatric units that are subject to these rules.

 

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Effective January 1, 2008, CMS issued final regulations that change payment for procedures performed in an ambulatory surgery center (“ASC”). Under this rule, ASC payment groups increased from nine clinically disparate payment groups to over 200 APCs used under the outpatient prospective payment system for these surgical services. In addition, CMS significantly expanded the types of procedures that may be performed in ASCs. More Medicare procedures that are now performed in hospitals, such as ours, may be moved to ASCs, potentially reducing surgical volume in our hospitals.
The Medicare Prescription Drug, Improvement, and Modernization Act of 2003 (the “Medicare Modernization Act”) established the Recovery Audit Contractor (“RAC”) three-year demonstration program. Under this program, CMS contracts with third-parties to conduct post-payment reviews on a contingency fee basis to detect and correct improper payments in the fee-for-service Medicare program. Beginning in 2005, CMS contracted with three different RACs to conduct these reviews in California, Florida and New York. The program was expanded in August 2007 to include Massachusetts and South Carolina. The Tax Relief and Health Care Act of 2006 made the RAC program permanent and mandates its nationwide expansion by 2010. CMS has awarded contracts to four RACs that will implement the permanent RAC program on a nationwide basis. The full impact of the implementation of the RAC program cannot be predicted.
Managed Medicare
Managed Medicare plans represent arrangements where CMS contracts with private companies to provide members with Medicare Part A, Part B and Part D benefits. Managed Medicare plans can be structured as health maintenance organizations, preferred provider organizations, or private fee-for-service plans. The Medicare program allows beneficiaries to choose enrollment in certain managed Medicare plans. The Medicare Modernization Act increases reimbursement to managed Medicare plans and includes provisions limiting, to some extent, the financial risk to the companies offering the plans. Following these changes, the number of beneficiaries choosing to receive their Medicare benefits through such plans has increased. However, several provisions of the Medicare Improvements for Patients and Providers Act of 2008 addressed excess payments made to managed Medicare plans. In addition, both the healthcare reform bill passed by the House of Representatives and the healthcare reform bill currently under consideration by the Senate would reduce payments to managed Medicare plans. In light of the prolonged economic recession and political climate, managed Medicare plans may experience reduced premium payments, which may lead to decreased enrollment in such plans.
Medicaid
Medicaid programs are jointly funded by federal and state governments and are administered by states under an approved plan that provides hospital and other healthcare benefits to qualifying individuals who are unable to afford care. All of our hospitals are certified as providers of Medicaid services. State Medicaid programs may use a prospective payment system, cost-based or other payment methodology for hospital services. Medicaid programs are required to take into account and make additional payments to hospitals serving disproportionate numbers of low income patients with special needs. Some of our hospitals receive such additional payments.
The federal government and many states from time to time consider altering the level of Medicaid funding or expanding Medicaid benefits in a manner that could adversely affect future levels of Medicaid reimbursement received by our hospitals. DEFRA, signed into law on February 8, 2006, included Medicaid cuts of approximately $4.8 billion over five years. CMS has published a number of proposed and final regulations that, if implemented, would result in significant additional reductions in Medicaid funding. These regulations have been subject to Congressional moratoria, rescinded, invalidated by court order or otherwise delayed. However, CMS could pursue implementation of these regulations or other regulatory measures that would further reduce Medicaid funding in the future. Healthcare reform efforts may also impact Medicaid funding and coverage. In November 2009, the U.S. House of Representatives passed a healthcare reform bill that, among other things, would expand Medicaid eligibility for low-income individuals and families. A separate healthcare reform bill under consideration in the U.S. Senate would similarly expand Medicaid eligibility.

 

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Additionally, the states in which we operate have experienced budget constraints as a result of increased costs and lower than expected tax collections. For example, an Arizona legislative committee has projected a $2.0 billion shortfall in the state’s budget this year. Current economic conditions may increase these budget pressures. Health and human services programs, including Medicaid and similar programs, represent a significant portion of state budgets. Most of the states in which we operate have responded to these budget concerns by decreasing funding for healthcare programs or making structural changes that have resulted or may result in a reduction to Medicaid hospital revenues in fiscal years 2009 and 2010. For example, Arizona has frozen hospital inpatient and outpatient reimbursements at the October 1, 2007 rates and discontinued a state health benefits program for low-income parents. Louisiana reduced inpatient hospital rates by 3.5% and 6.3% and outpatient hospital rates by 3.5% and 5.7% in fiscal years 2009 and 2010, respectively, but still projects a Medicaid program deficit in excess of $300.0 million for the remainder of fiscal year 2010. In fiscal year 2009, Nevada cut inpatient hospital rates by 5.0% and eliminated rate enhancements for pediatric and obstetric care. Utah has cut hospital rates for fiscal year 2010 by more than 11.0%. Florida has reduced hospital reimbursement rates for fiscal years 2009 and 2010. Additional Medicaid spending cuts may be implemented in the future in the states in which we operate.
The American Recovery and Reinvestment Act of 2009 (“ARRA”), which was signed into law on February 17, 2009, included approximately $87.0 billion in additional federal Medicaid funding to states through December 2010. As part of this legislation, Congress has temporarily increased the share of program costs paid by the federal government to fund each state’s Medicaid program. Although these funds have provided a benefit to state Medicaid programs by helping to avoid more extensive program and reimbursement cuts, this increased federal funding is scheduled to end December 31, 2010. State legislatures are anticipating that this termination in increased federal funding could result in significant reductions to states’ Medicaid programs.
Through DEFRA, Congress has expanded the federal government’s involvement in fighting fraud, waste and abuse in the Medicaid program by creating the Medicaid Integrity Program. Among other things, this legislation requires CMS to employ private contractors, referred to as Medicaid Integrity Contractors (“MICs”), to perform reviews and post-payment audits of Medicaid claims and identify overpayments. MICs have commenced audits of Medicaid providers in most jurisdictions, and audits are anticipated to begin in the remaining jurisdictions by June 2010.
Changes in laws or regulations regarding government health programs or other changes in the administration of government health programs could have a material, adverse effect on our financial position and results of operations.
Managed Medicaid
Managed Medicaid programs represent arrangements in which states contract with one or more entities for patient enrollment, care management and claims adjudication. The states usually do not give up program responsibilities for financing, eligibility criteria and core benefit plan design. We generally contract directly with one of the designated entities, usually a managed care organization. The provisions of these programs are state-specific.
As state governments seek to control the cost of Medicaid programs, enrollment in managed Medicaid plans, including states in which we operate, has increased in recent years. For example, Florida legislation has established a goal of statewide implementation of Medicaid managed care programs by 2011. Furthermore, Florida could lose $300.0 million of federal funding for hospital charity care if this goal is not met. Louisiana has requested a section 1115 Medicaid waiver from the federal government that, if approved, would result in an expansion of Medicaid managed care plans. The Texas legislature and the Texas Health and Human Services Commission have recommended expanding Medicaid managed care enrollment for certain Medicaid beneficiaries. However, fiscal budgetary issues resulting from general economic conditions in the states in which we operate may require reductions in premium payments to these plans.
Annual Cost Reports
All hospitals participating in the Medicare and Medicaid programs, whether paid on a reasonable cost basis or under a prospective payment system, are required to meet specific financial reporting requirements. Federal regulations require submission of annual cost reports identifying medical costs and expenses associated with the services provided by each hospital to Medicare beneficiaries and Medicaid recipients. These annual cost reports are subject to routine audits, which may result in adjustments to the amounts ultimately determined to be due to us under these reimbursement programs. The audit process may take several years to reach the final determination of allowable amounts under the programs. Providers also have the right of appeal, and it is common to contest issues raised in audits of prior years’ reports.

 

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Cost reports filed by our facilities generally remain open for three years after the notice of program reimbursement date. If any of our facilities are found to have been in violation of federal or state laws relating to preparing and filing of Medicare or Medicaid cost reports, whether prior to or after our ownership of these facilities, we and our facilities could be subject to substantial monetary fines, civil and criminal penalties and exclusion from participation in the Medicare and Medicaid programs. If an allegation is lodged against one of our facilities for a violation occurring during the time period before we owned the facility, we may have indemnification rights against the former owner of the facility for any damages we may incur based on negotiated indemnification and hold harmless provisions in the transaction documents. However, we offer no assurances that any such matter would be covered by indemnification, or if covered, that such indemnification would be adequate to cover any potential losses, fines and penalties. Additionally, we offer no assurances that the former owner would have the financial ability to satisfy indemnification claims.
Managed Care
Managed care payors, including health maintenance organizations and preferred provider organizations, are organizations that provide insurance coverage and a network of healthcare providers to members for a fixed monthly premium. To control costs, these organizations typically contract with hospitals and other providers for discounted prices, review medical services to ensure that no unnecessary services are provided, and market providers within their networks to patients. A significant percentage of our overall payor mix is commercial managed care. We generally receive lower payments from commercial managed care payors than from traditional commercial/indemnity insurers for similar services.
Commercial Insurance
Our hospitals provide services to a decreasing number of individuals covered by traditional private healthcare insurance. Private insurance carriers make direct payments to hospitals or, in some cases, reimburse their policy holders, based upon negotiated discounts from the particular hospital’s established charges and the particular coverage provided in the insurance policy.
Commercial insurers are continuing efforts to limit the payments for hospital services by adopting discounted payment mechanisms, including prospective payment or diagnosis related group-based payment systems, for more inpatient and outpatient services. In addition, commercial insurers increasingly are implementing quality requirements and refusing to pay for serious adverse events, similar to Medicare. To the extent that these efforts are successful, hospitals may receive reduced levels of reimbursement, which would have a negative effect on operating results.
Charity Care
In the ordinary course of business, we provide care without charge to patients who are financially unable to pay for the healthcare services they receive. Because we do not pursue collection of amounts determined to qualify as charity care, they are not reported in net revenue. We currently record revenue deductions for patient accounts that meet our guidelines for charity care. We provide charity care to patients with income levels below 200% of the federal property level. Additionally, at all of our hospitals, a sliding scale of reduced rates is offered to all uninsured patients, who are not covered through federal, state or private insurance, with incomes between 200% and 400% of the federal poverty level. As a result of the current economic environment and growth in the uninsured population, our charity care has increased over the prior years. We anticipate our charity care may continue to increase in the near term; however, we are unable to predict the impact this will have on our results of operations and financial condition. Further, healthcare reform, if enacted, could reduce the number of patients who are uninsured or under-insured.

 

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Competition
Our facilities and related businesses operate in competitive environments. A number of factors affect our competitive position, including:
    the local economies in which we operate;
 
    decline in tourism in our service areas;
    our managed care contracting relationships;
    the number, availability, quality and specialties of physicians, nurses and other healthcare professionals;
    the scope, breadth and quality of services;
    the reputation of our facilities and physicians;
    growth in hospital capacity in the markets we serve;
    the physical condition of our facilities and medical equipment;
    the location of our facilities and availability of physician office space;
    certificate of need restrictions, where applicable;
    the availability of parking or proximity to public transportation;
    accumulation, access and interpretation of publicly reported quality indicators;
    growth in outpatient service providers;
    charges for services; and
    the geographic coverage of our hospitals in the regions in which we operate.
We currently face competition from established, not-for-profit healthcare companies, investor-owned hospital companies, large tertiary care centers, specialty hospitals and outpatient service providers, such as surgery centers and imaging centers. In addition, some of our hospitals operate in regions with vertically integrated healthcare providers that include both payors and healthcare providers, which could affect our ability to obtain managed care contracts. We continue to encounter increased competition from specialty hospitals, outpatient service providers, not-for-profit healthcare companies and companies, like ours, that consolidate hospitals and healthcare companies in specific geographic markets. Continued consolidation in the healthcare industry will be a leading contributing factor to increased competition in markets in which we already have a presence and in markets we may enter in the future.
Another factor in the competitive position of a hospital is the ability of its management to obtain contracts with purchasers of group healthcare services. The importance of obtaining managed care contracts continues as private and government payors and others turn to managed care organizations to help control rising healthcare costs. Most of our markets have experienced significant managed care penetration, along with consolidation of major managed care plans. The revenue and operating results of our hospitals are significantly affected by our hospitals’ ability to negotiate reasonable contracts with managed care plans. Health maintenance organizations and preferred provider organizations use managed care contracts to encourage patients to use certain hospitals in exchange for discounts from the hospitals’ established charges. Traditional health insurers also contain costs through similar contracts with hospitals.
An additional competitive factor is whether a hospital is part of a local hospital network, as well as the scope and quality of services offered by the network compared to competing networks. A hospital that is part of a network offering a broad range of services in a wide geographic area is more likely to obtain more favorable managed care contracts, than a hospital that is not. On an ongoing basis, we evaluate changing circumstances in each geographic area in which we operate. We may position ourselves to compete in these managed care markets by forming our own, or joining with others to form, local hospital networks.

 

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As we continue to focus on our physician employment strategy, we face significant competition for skilled physicians in certain of our markets, as more providers are adopting a physician staffing model approach, coupled with a general shortage of physicians across most specialties. This increased competition has resulted in efforts by managed care organizations to align with certain provider networks in the markets in which we operate. While we anticipate that our physician employment strategy will help us compete more effectively in our markets, we are unable to provide any assurance regarding the success of our strategy.
Employees And Medical Staff
As of September 30, 2009, we had 10,959 employees, including 3,131 part-time employees. We consider our employee relations to be good. We recruit and retain nurses and medical support personnel by creating a desirable, professional work environment, providing competitive wages, benefits and long-term incentives, and providing career development and other training programs. In order to supplement our current employee base, we have expanded our relationship with local colleges and universities, including our sponsorship of nursing scholarship programs, in our markets.
Our hospitals are staffed by licensed physicians who have been admitted to the medical staff of our individual hospitals. Any licensed physician may apply to be admitted to the medical staff of any of our hospitals, but admission to the staff must be approved by each hospital’s medical staff and the appropriate governing board of the hospital in accordance with established credentialing criteria. In an effort to meet community needs in certain markets in which we operate, we have implemented a strategy of employing physicians, with an emphasis on those practicing within certain specialties. While we believe this strategy is consistent with industry trends, we cannot be assured of the long-term success of such a strategy, which includes related integration of physician practice management.
Compliance Program
Our compliance program is designed to ensure that we maintain high standards of conduct in the operation of our business and implement policies and procedures so that employees act in compliance with all applicable laws, regulations and company policies. The organizational structure of our compliance program includes a compliance committee of our board of directors, a corporate management compliance committee and local management compliance committees at each of our hospitals. These committees have the oversight responsibility for the effective development and implementation of our program. Our Vice President of Ethics and Business Practices, who reports directly to our Chairman and Chief Executive Officer and to the compliance committee of our board of directors, serves as Chief Compliance Officer and is charged with direct responsibility for the development and implementation of our compliance program. Other features of our compliance program include the designation of a Regional Compliance Officer for each of our hospitals, periodic ethics and compliance training and effectiveness reviews, the development and implementation of policies and procedures, including a mechanism for employees to report, without fear of retaliation, any suspected legal or ethical violations.
Government Regulation and Other Factors
A framework of extremely complex federal and state laws, rules and regulations governs the healthcare industry and, for many provisions, there is little history of regulatory or judicial interpretation upon which to rely.
Licensure, Certification and Accreditation
Healthcare facility construction and operation is subject to federal, state and local regulations relating to the adequacy of medical care, equipment, personnel, operating policies and procedures, fire prevention, rate-setting and compliance with building codes and environmental protection laws. Our facilities also are subject to periodic inspection by governmental and other authorities to assure continued compliance with the various standards necessary for licensing and accreditation. We believe that all of our operating healthcare facilities are properly licensed under appropriate state healthcare laws, but we cannot assure you that government agencies or other entities enforcing licensure requirements would find our facilities in compliance with such requirements.

 

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All of our operating hospitals are certified under the Medicare program and are accredited by either The Joint Commission or DNV, the effect of which is to permit the facilities to participate in the Medicare and Medicaid programs. If any facility loses its accreditation by either The Joint Commission or DNV, as applicable, or otherwise loses its certification under the Medicare program, then the facility will be unable to receive reimbursement from the Medicare and Medicaid programs. We intend to conduct our operations in compliance with current applicable federal, state, local and independent review body regulations and standards, but we cannot assure you that government agencies or other entities enforcing such requirements would find our facilities in compliance with such requirements. The requirements for licensure, certification and accreditation are subject to change and, in order to remain qualified, we may need to make changes in our facilities, equipment, personnel and services.
Utilization Review
Federal law contains numerous provisions designed to ensure that services rendered by hospitals to Medicare and Medicaid patients meet professionally recognized standards and are medically necessary and that claims for reimbursement are properly filed. These provisions include a requirement that a sampling of admissions of Medicare and Medicaid patients be reviewed by quality improvement organizations that analyze the appropriateness of Medicare and Medicaid patient admissions and discharges, quality of care provided, validity of diagnosis related group classifications and appropriateness of cases of extraordinary length of stay or cost. Quality improvement organizations may deny payment for services provided, assess fines and recommend to the Department of Health and Human Services (the “Department”) that a provider not in substantial compliance with the standards of the quality improvement organization be excluded from participation in the Medicare program. Most non-governmental managed care organizations also require utilization review.
Federal and State Fraud and Abuse Provisions
Participation in any federal healthcare program, like Medicare, is regulated heavily by statute and regulation. If a hospital provider fails to substantially comply with the numerous conditions of participation in the Medicare or Medicaid program or performs specific prohibited acts, the hospital’s participation in the Medicare and Medicaid programs may be terminated or civil or criminal penalties may be imposed upon it under provisions of the Social Security Act and other statutes.
Among these statutes is a section of the Social Security Act known as the federal anti-kickback statute. This law prohibits providers and others from soliciting, receiving, offering or paying, directly or indirectly, any remuneration with the intent of generating referrals or orders for services or items covered by a federal healthcare program. Violation of this statute is a felony.
The Office of Inspector General of the U.S. Department of Health and Human Services (“OIG”) has published final safe harbor regulations that outline categories of activities that are deemed protected from prosecution under the anti-kickback statute. Currently there are safe harbors for various activities, including the following: investment interests, space rental, equipment rental, practitioner recruitment, personal services and management contracts, sale of practice, referral services, warranties, discounts, employees, group purchasing organizations, waiver of beneficiary coinsurance and deductible amounts, managed care arrangements, obstetrical malpractice insurance subsidies, investments in group practices, ambulatory surgery centers, and referral agreements for specialty services.
The fact that conduct or a business arrangement does not fall within a safe harbor does not automatically render the conduct or business arrangement illegal under the anti-kickback statute. The conduct or business arrangement, however, does risk increased scrutiny by government enforcement authorities. We may be less willing than some of our competitors to take actions or enter into business arrangements that do not clearly satisfy the safe harbors. As a result, this unwillingness may put us at a competitive disadvantage.
The OIG, among other regulatory agencies, is responsible for identifying and eliminating fraud, abuse and waste. The OIG carries out this mission through a nationwide program of audits, investigations and inspections. In order to provide guidance to healthcare providers, the OIG has from time to time issued “fraud alerts” that, although they do not have the force of law, identify features of a transaction that may indicate that the transaction could violate the anti-kickback statute or other federal healthcare laws. The OIG has identified several incentive arrangements as potential violations, including:
    payment of any incentive by the hospital when a physician refers a patient to the hospital;
    use of free or significantly discounted office space or equipment for physicians in facilities usually located close to the hospital;

 

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    provision of free or significantly discounted billing, nursing, or other staff services;
    free training for a physician’s office staff, including management and laboratory techniques;
    guarantees that provide that, if the physician’s income fails to reach a predetermined level, the hospital will pay any portion of the remainder;
    low-interest or interest-free loans, or loans which may be forgiven if a physician refers patients to the hospital;
    payment of the costs of a physician’s travel and expenses for conferences or a physician’s continuing education courses;
    coverage on the hospital’s group health insurance plans at an inappropriately low cost to the physician;
    rental of space in physician offices, at other than fair market value terms, by persons or entities to which physicians refer;
    payment of services which require few, if any, substantive duties by the physician, or payment for services in excess of the fair market value of the services rendered; or
    “gainsharing,” the practice of giving physicians a share of any reduction in a hospital’s costs for patient care attributable in part to the physician’s efforts.
In addition to issuing fraud alerts, the OIG from time to time issues compliance program guidance for certain types of healthcare providers. In January 2005, the OIG issued supplemental compliance program guidance for hospitals. In the supplemental compliance guidance, the OIG identifies areas of potential risk of liability under federal fraud and abuse statutes and regulations. These areas of risk include compensation arrangements with physicians, recruitment arrangements with physicians and joint venture relationships with physicians. The OIG recommends structuring arrangements to fit squarely within a safe harbor.
We have a variety of financial relationships with physicians who refer patients to our hospitals. Physicians currently own interests in seven of our full service acute care hospitals. We may sell ownership interests in certain other of our facilities to physicians and other qualified investors in the future. We also have other joint venture relationships with physicians and contracts with physicians providing for a variety of financial arrangements, including employment contracts, leases and professional service agreements. We provide financial incentives to recruit physicians to relocate to communities served by our hospitals, including minimum cash collections guarantees and forgiveness of repayment obligations. Although we have established policies and procedures to ensure that our arrangements with physicians comply with current law and available interpretations, we cannot assure you that regulatory authorities that enforce these laws will not determine that some of these arrangements violate the anti-kickback statute or other applicable laws. This determination could subject us to liabilities under the Social Security Act, including criminal penalties of imprisonment or fines, civil penalties up to $50,000, damages up to three times the total amount of the improper payment to the referral source and exclusion from participation in Medicare, Medicaid or other federal healthcare programs, any of which could have a material adverse effect on our business, financial condition or results of operations.
The Social Security Act also imposes criminal and civil penalties for submitting false claims to Medicare and Medicaid. False claims include, but are not limited to, billing for services not rendered, misrepresenting actual services rendered in order to obtain higher reimbursement and cost report fraud. Like the anti-kickback statute, these provisions are very broad. Further, the Social Security Act contains civil penalties for conduct including improper coding and billing for unnecessary goods and services. To avoid liability, providers must, among other things, carefully and accurately code claims for reimbursement, as well as accurately prepare cost reports.

 

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Some of these provisions, including the federal Civil Monetary Penalty Law, require a lower burden of proof than other fraud and abuse laws, including the federal anti-kickback statute. Civil monetary penalties that may be imposed under the federal Civil Monetary Penalty Law range from $10,000 to $50,000 per act, and in some cases may result in penalties of up to three times the remuneration offered, paid, solicited or received. In addition, a violator may be subject to exclusion from federal and state healthcare programs. Federal and state governments increasingly use the federal Civil Monetary Penalty Law, especially where they believe they cannot meet the higher burden of proof requirements under the federal anti-kickback statute.
The Health Insurance Portability and Accountability Act of 1996 (“HIPAA”) broadened the scope of the fraud and abuse laws by adding several criminal provisions for healthcare fraud offenses that apply to all health benefit programs. This act also created new enforcement mechanisms to combat fraud and abuse, including the Medicare Integrity Program and an incentive program under which individuals can receive up to $1,000 for providing information on Medicare fraud and abuse that leads to the recovery of at least $100 of Medicare funds. In addition, federal enforcement officials now have the ability to exclude from Medicare and Medicaid any investors, officers and managing employees associated with business entities that have committed healthcare fraud. Additionally, this act establishes a violation for the payment of inducements to Medicare or Medicaid beneficiaries in order to influence those beneficiaries to order or receive services from a particular provider or practitioner.
The Social Security Act also includes a provision commonly known as the “Stark Law.” This law prohibits physicians from referring Medicare and Medicaid patients to entities with which they or any of their immediate family members have a financial relationship for the provision of certain designated health services that are reimbursable by Medicare or Medicaid, including inpatient and outpatient hospital services. The law also prohibits the entity from billing the Medicare program for any items or services that stem from a prohibited referral. Sanctions for violating the Stark Law include civil monetary penalties up to $15,000 per item or service improperly billed and exclusion from the federal healthcare programs. There are a number of exceptions to the self-referral prohibition, including an exception for a physician’s ownership interest in an entire hospital as opposed to an ownership interest in a hospital department. There are also exceptions for many of the customary financial arrangements between physicians and providers, including employment contracts, leases, professional services agreements, non-cash gifts having a value less than $355 (effective January 1, 2009) and recruitment agreements.
Through a series of rulemakings, CMS has issued final regulations implementing the Stark Law. Additional changes to these regulations, which became effective October 1, 2009, further restrict the types of arrangements that hospitals and physicians may enter, including restrictions on certain leases, percentage compensation arrangements, and agreements under which a hospital purchases services under arrangements. While these regulations help clarify the requirements of the exceptions to the Stark Law, it is unclear how the government will interpret many of these exceptions for enforcement purposes. CMS has indicated that it is considering additional changes to the Stark Law regulations. We cannot assure you that the arrangements entered into by us and our hospitals will be found to be in compliance with the Stark Law, as it ultimately may be implemented or interpreted.
The Department has proposed to collect information from 400 hospitals regarding their ownership, investment and compensation arrangements with physicians. It has indicated that at least three of our hospitals would be among the 400 hospitals. The Department has indicated that it intends to use the data to monitor compliance with the Stark Law and that it may share the information with other government agencies. Many of these agencies have not previously analyzed this information and have the authority to bring enforcement actions against hospitals filing such reports. The survey instrument, which is referred to as the Disclosure of Financial Relationships Report, is under review by the Office of Management and Budget, and it is unclear when, or if, it will be finalized.
In 2003, Congress passed legislation that modified the hospital ownership exception to the Stark Law by creating a moratorium on allowing physicians to own interests in new specialty hospitals. The moratorium was extended by regulatory and legislative action and expired on August 8, 2006. In December 2004, the Medicare Payment Advisory Commission considered, but did not adopt, a recommendation that Congress eliminate the exception for physician ownership in an entire hospital, including whole hospitals or non-specialty hospitals (the “whole hospital exception”). In recent years, both houses of the U.S. Congress have passed bills that would have eliminated or significantly restricted the whole hospital exception, but these bills did not become law. In November 2009, the House of Representatives passed a healthcare reform bill that would eliminate the whole hospital exception subject to a grandfathering provision for most hospitals that currently have physician ownership. In order to fall within this grandfathering provision, a hospital would have to abide by a number of restrictions, including limits on future expansion and reporting and disclosure requirements. The Senate healthcare reform bill currently under consideration contains a similar prohibition on physician-owned hospitals. If Congress enacts legislation that eliminates or alters the whole hospital exception, we could be required to unwind the physician ownership of some of our hospitals or our physician-owned hospitals could be subject to disclosure and reporting requirements and significant restrictions on their ability to expand current operations.

 

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Physician-owned hospitals that receive referrals from physician owners must disclose in writing to patients that such hospitals are owned by physicians and that patients may receive a list of the hospitals’ physician investors upon request. Additionally, a physician-owned hospital must require all physician owners who are members of the hospital’s medical staff to agree, as a condition of continued medical staff membership or admitting privileges, to disclose in writing to all patients whom they refer to the hospital their (or an immediate family member’s) ownership interest in the hospital. A hospital is considered to be physician-owned if any physician, or an immediate family member of a physician, holds debt, stock or other types of investment in the hospital or in any owner of the hospital, excluding physician ownership through publicly traded securities that meet certain conditions. If a hospital fails to comply with these provisions, the hospital could lose its Medicare provider agreement and be unable to participate in Medicare.
Evolving interpretations of current, or the adoption of new, federal or state laws or regulations could affect many of the arrangements entered into by each of our hospitals. In addition, law enforcement authorities, including the OIG, the courts and Congress are increasing scrutiny of arrangements between healthcare providers and potential referral sources to ensure that the arrangements are not designed as a mechanism to improperly pay for patient referrals and or other business. Investigators also have demonstrated a willingness to look behind the formalities of a business transaction to determine the underlying purpose of payments between healthcare providers and potential referral sources.
Many of the states in which we operate also have adopted laws that prohibit payments to physicians in exchange for referrals similar to the federal anti-kickback statute or that otherwise prohibit fraud and abuse activities. Many states also have passed self-referral legislation similar to the Stark Law, prohibiting the referral of patients to entities with which the physician has a financial relationship. Often these state laws are broad in scope and they may apply regardless of the source of payment for care. These statutes typically provide criminal and civil penalties, as well as loss of licensure. Little precedent exists for the interpretation or enforcement of these state laws.
Our operations could be adversely affected by the failure of our arrangements to comply with the anti-kickback statute, the Stark Law, billing laws and regulations, current state laws or other legislation or regulations in these areas adopted in the future. We are unable to predict whether other legislation or regulations at the federal or state level in any of these areas will be adopted, what form such legislation or regulations may take or how they may affect our operations. We are continuing to enter into new financial arrangements with physicians and other providers in a manner structured to comply in all material respects with these laws. We cannot assure you, however, that governmental officials responsible for enforcing these laws or whistleblowers will not assert that we are in violation of them or that such statutes or regulations ultimately will be interpreted by the courts in a manner consistent with our interpretation.
The Federal False Claims Act and Similar State Laws
Another trend affecting the healthcare industry today is the increased use of the federal False Claims Act (“FCA”) and, in particular, actions being brought by individuals on the government’s behalf under the FCA’s “qui tam” or whistleblower provisions. Whistleblower provisions allow private individuals to bring actions on behalf of the government alleging that the defendant has defrauded the federal government. If the government intervenes in the action and prevails, the party filing the initial complaint may share in any settlement or judgment. If the government does not intervene in the action, the whistleblower plaintiff may pursue the action independently, and may receive a larger share of any settlement or judgment. When a private party brings a qui tam action under the FCA, the defendant generally will not be made aware of the lawsuit until the government commences its own investigation or makes a determination whether it will intervene. Further, every entity that receives at least $5.0 million annually in Medicaid payments must have written policies for all employees, contractors or agents, providing detailed information about false claims, false statements and whistleblower protections under certain federal laws, including the FCA, and similar state laws.

 

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When a defendant is determined by a court of law to be liable under the FCA, the defendant must pay three times the actual damages sustained by the government, plus mandatory civil penalties of between $5,500 to $11,000 for each separate false claim. Settlements entered into prior to litigation usually involve a less severe calculation of damages. There are many potential bases for liability under the FCA. Liability often arises when an entity knowingly submits a false claim for reimbursement to the federal government. The FCA defines the term “knowingly” broadly. Although simple negligence will not give rise to liability under the FCA, submitting a claim with reckless disregard to its truth or falsity can constitute “knowingly” submitting a false claim and result in liability. In some cases, whistleblowers, the federal government and some courts have taken the position that providers who allegedly have violated other statutes, such as the anti-kickback statute or the Stark Law, have thereby submitted false claims under the FCA. The Fraud Enforcement and Recovery Act of 2009 expanded the scope of the FCA by, among other things, creating liability for knowingly and improperly avoiding repayment of an overpayment received from the government and broadening protections for whistleblowers.
A number of states, including states in which we operate, have adopted their own false claims provisions as well as their own whistleblower provisions whereby a private party may file a civil lawsuit in state court. DEFRA creates an incentive for states to enact false claims laws that are comparable to the FCA. From time to time, companies in the healthcare industry, including ours, may be subject to actions under the FCA or similar state laws.
Corporate Practice of Medicine/Fee Splitting
The states in which we operate have laws that prohibit unlicensed persons or business entities, including corporations, from employing physicians or laws that prohibit certain direct or indirect payments or fee-splitting arrangements between physicians and unlicensed persons or business entities. Possible sanctions for violations of these restrictions include loss of a physician’s license, civil and criminal penalties and rescission of business arrangements that may violate these restrictions. These statutes vary from state to state, are often vague and seldom have been interpreted by the courts or regulatory agencies. Although we exercise care to structure our arrangements with healthcare providers to comply with relevant state laws, we cannot assure you that governmental officials responsible for enforcing these laws will not assert that we, or transactions in which we are involved, are in violation of such laws, or that such laws ultimately will be interpreted by the courts in a manner consistent with our interpretations.
HIPAA Administrative Simplification and Privacy and Security Requirements
HIPAA requires the use of uniform electronic data transmission standards for healthcare claims and payment transactions submitted or received electronically. These provisions are intended to encourage electronic commerce in the healthcare industry. The Department has established electronic data transmission standards that all healthcare providers must use when submitting or receiving certain healthcare transactions electronically. In addition, HIPAA requires that each provider use a National Provider Identifier. In January 2009, CMS published a final rule making changes to the formats used for certain electronic transactions and requiring the use of updated standard code sets for certain diagnoses and procedures known as ICD-10 code sets. Although use of the ICD-10 code sets is not mandatory until October 1, 2013, we will be modifying our payment systems and processes to prepare for their implementation. Use of the ICD-10 code sets will require significant changes; however, we believe that the cost of compliance with these regulations has not had and is not expected to have a material adverse effect on our business, financial position or results of operations.
As required by HIPAA, the Department has issued privacy and security regulations that extensively regulate the use and disclosure of individually identifiable health-related information and require healthcare providers to implement administrative, physical and technical practices to protect the security of individually identifiable health information that is electronically maintained or transmitted. ARRA broadens the scope of the HIPAA privacy and security regulations. In addition, ARRA extends the application of certain provisions of the security and privacy regulations to business associates (entities that handle identifiable health-related information on behalf of covered entities) and subjects business associates to civil and criminal penalties for violation of the regulations. We have developed and utilize a HIPAA compliance plan as part of our effort to comply with HIPAA privacy and security requirements. The privacy regulations and security regulations have and will continue to impose significant costs on our facilities in order to comply with these standards.
As required by ARRA, the Department published an interim final rule on August 24, 2009, that requires covered entities to report breaches of unsecured protected health information to affected individuals without unreasonable delay, but not to exceed 60 days of discovery of the breach by the covered entity or its agents. Notification must also be made to the Department and, in certain situations involving large breaches, to the media. Various state laws and regulations may also require us to notify affected individuals in the event of a data breach involving individually identifiable information.

 

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Violations of the HIPAA privacy and security regulations may result in civil and criminal penalties, and ARRA has strengthened the enforcement provisions of HIPAA, which may result in increased enforcement activity. Under ARRA, the Department is required to conduct periodic compliance audits of covered entities and their business associates. ARRA broadens the applicability of the criminal penalty provisions to employees of covered entities and requires the Department to impose penalties for violations resulting from willful neglect. ARRA significantly increases the amount of the civil penalties, with penalties of up to $50,000 per violation for a maximum civil penalty of $1,500,000 in a calendar year for violations of the same requirement. Further, ARRA authorizes state attorneys general to bring civil actions seeking either injunction or damages in response to violations of HIPAA privacy and security regulations that threaten the privacy of state residents. Our facilities also are subject to any federal or state privacy-related laws that are more restrictive than the privacy regulations issued under HIPAA. These laws vary and could impose additional penalties.
There are numerous other laws and legislative and regulatory initiatives at the federal and state levels addressing privacy and security concerns. For example, in October 2007, the Federal Trade Commission issued a final rule requiring financial institutions and creditors, which may include hospitals and other healthcare providers, to implement written identity theft prevention programs to detect, prevent, and mitigate identity theft in connection with certain accounts. The enforcement date for this rule has been postponed until June 1, 2010.
The Emergency Medical Treatment and Active Labor Act
The Federal Emergency Medical Treatment and Active Labor Act (“EMTALA”) was adopted by Congress in response to reports of a widespread hospital emergency room practice of “patient dumping.” At the time of the enactment, patient dumping was considered to have occurred when a hospital capable of providing the needed care sent a patient to another facility or simply turned the patient away based on such patient’s inability to pay for his or her care. The law imposes requirements upon physicians, hospitals and other facilities that provide emergency medical services. Such requirements pertain to what care must be provided to anyone who comes to such facilities seeking care before they may be transferred to another facility or otherwise denied care. The government broadly interprets the law to cover situations in which patients do not actually present to a hospital’s emergency department, but present to a hospital-based clinic that treats emergency medical conditions on an urgent basis or are transported in a hospital-owned ambulance, subject to certain exceptions. At least one court has interpreted the law also to apply to a hospital that has been notified of a patient’s pending arrival in a non-hospital owned ambulance. Sanctions for violations of this statute include termination of a hospital’s Medicare provider agreement, exclusion of a physician from participation in Medicare and Medicaid programs and civil money penalties. In addition, the law creates private civil remedies that enable an individual who suffers personal harm as a direct result of a violation of the law, and a medical facility that suffers a financial loss as a direct result of another participating hospital’s violation of the law, to sue the offending hospital for damages and equitable relief. We can give no assurance that governmental officials responsible for enforcing the law, individuals or other medical facilities will not assert from time to time that our facilities are in violation of this statute.
Healthcare Reform
National healthcare reform is a focus at the federal level. This focus on healthcare reform may increase the likelihood of significant changes affecting the healthcare industry. On November 7, 2009, the House of Representatives passed the Affordable Health Care for America Act (the “House Reform Bill”). The House Reform Bill would reduce the number of uninsured persons by requiring most individuals to obtain health insurance, expanding Medicaid eligibility, limiting preexisting conditions exclusions and creating a temporary national high risk pool for coverage of currently uninsured individuals with medical conditions. The House Reform Bill would also create a National Health Insurance Exchange for individuals and small employers to obtain health insurance. This exchange would include a public health insurance option to be administered by the Secretary of the Department, who would negotiate payment rates with providers.

 

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The House Reform Bill also would modify the Medicare program, including changes to delivery and payment systems. For example, hospitals could experience productivity-based reductions to market basket updates and decreased payments in the event of excessive readmissions. The House Reform Bill also would increase funding for fighting fraud and abuse, require the return of overpayments within 60 days of their discovery, create new penalties for fraud and abuse violations and restrict physician ownership of hospitals.
Currently, the U.S. Senate is considering, but has not yet passed, a reform bill that is also designed to decrease the number of uninsured individuals and reduce healthcare costs. It is not possible to predict whether federal healthcare reform legislation will be enacted or the impact of any enacted federal healthcare reform legislation. For example, the creation of a public health insurance option could result in a migration of enrollees from higher paying commercial health plans, which could have a negative impact on hospital revenues. Similarly, payment reductions or other changes to the Medicare program that may be enacted as part of federal reform legislation could negatively impact hospital revenues. However, these negative impacts could be offset by a reduction in bad debt and charity care as a result of the creation of a public health insurance option and other aspects of healthcare reform.
In addition to the provisions found in the House Reform Bill and the U.S. Senate bill, the Medicaid program has been subject, in recent years and currently, to federal and state efforts to reduce expenditures but also to expand eligibility. For example, DEFRA, signed into law on February 8, 2006, includes Medicaid cuts of approximately $4.8 billion over five years. CMS has published a number of proposed and final regulations that, if implemented, would result in significant additional reductions in Medicaid funding. These regulations have been subject to Congressional moratoria, rescinded, invalidated by court order or otherwise delayed. However, CMS could pursue implementation of these regulations or other regulatory measures that would further reduce Medicaid funding in the future.
Most states, including the states in which we operate, have applied for and been granted federal waivers from current Medicaid regulations to allow them to serve some or all of their Medicaid participants through managed care providers. Most of the states in which we operate have experienced budget constraints as a result of increased costs and lower than expected tax collections. Current economic conditions have increased these budget pressures. Medicaid spending cuts or structural changes that may have the affect of decreasing reimbursement may be implemented in the future in the states in which we operate. In addition, from time to time, states in which we operate may enact measures that impact private healthcare insurance, which may result in insurers reducing coverage or negotiating lower rates or otherwise have an indirect adverse effect on providers.
Creation of a National Health Insurance Exchange, including a public health insurance option, changes in the Medicare, Medicaid and other programs, hospital cost-containment initiatives by public and private payors, proposals to limit payments and healthcare spending and industry-wide competitive factors are highly significant to the healthcare industry. We are unable to predict the future course of federal, state or local healthcare legislation. Further changes in the law or regulatory framework that reduce our revenue or increase our costs could have a material adverse effect on our business, financial condition or results of operations.
Conversion Legislation
Many states have enacted or are considering enacting laws affecting the conversion or sale of not-for-profit hospitals. These laws generally include provisions relating to attorney general approval, advance notification and community involvement. In addition, attorneys general in states without specific conversion legislation may exercise authority over these transactions based upon existing law. In many states, there has been an increased interest in the oversight of not-for-profit conversions. The adoption of conversion legislation and the increased review of not-for-profit hospital conversions may increase the cost and difficulty or prevent the completion of transactions with or acquisitions of not-for-profit organizations in various states.

 

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Healthcare Industry Investigations
Significant media and public attention has focused in recent years on the hospital industry. Recently, increased attention has been paid by government investigators as well as private parties pursuing civil lawsuits to the amounts charged by hospitals to uninsured and indigent patients and the related collection practices of hospitals. Other current areas of interest include hospitals with high Medicare outlier payments and recruitment arrangements with physicians. Further, there are numerous ongoing federal and state investigations regarding multiple issues. These investigations have targeted hospital companies as well as their executives and managers. We have substantial Medicare, Medicaid and other governmental billings, which could result in heightened scrutiny of our operations. We continue to monitor these and all other aspects of our business and have developed a compliance program to assist us in gaining comfort that our business practices are consistent with both legal principles and current industry standards. However, because the law in this area is complex and constantly evolving, we cannot assure you that government investigations will not result in interpretations that are inconsistent with industry practices, including ours. In public statements surrounding current investigations, governmental authorities have taken positions on a number of issues, including some for which little official interpretation previously has been available, that appear to be inconsistent with practices that have been common within the industry and that previously have not been challenged in this manner. In some instances, government investigations that have in the past been conducted under the civil provisions of federal law may now be conducted as criminal investigations. Additionally, the federal government has recently indicated that it plans to expand its use of civil monetary penalties and Medicare program exclusions to focus on those in the healthcare industry who accept kickbacks or present false claims, in addition to the federal government’s continuing efforts to focus on the companies that offer or pay kickbacks. Failure to comply with applicable laws and regulations could subject us to significant regulatory action, including fines, penalties and exclusion from the Medicare and Medicaid programs.
Many current healthcare investigations are national initiatives in which federal agencies target an entire segment of the healthcare industry. One example is the federal government’s initiative regarding hospital providers’ improper requests for separate payments for services rendered to a patient on an outpatient basis within three days prior to the patient’s admission to the hospital, where reimbursement for such services is included as part of the reimbursement for services furnished during an inpatient stay. In particular, the government has targeted all hospital providers to ensure conformity with this reimbursement rule. Further, the federal government continues to investigate Medicare overpayments to prospective payment hospitals that incorrectly report transfers of patients to other prospective payment system hospitals as discharges. We are aware that prior to our acquisition of them, several of our hospitals were contacted in relation to certain government investigations that were targeted at an entire segment of the healthcare industry. Although we take the position that, under the terms of the acquisition agreements, the prior owners of these hospitals retained any liability resulting from these government investigations, we cannot assure you that the prior owners’ resolution of these matters or failure to resolve these matters, in the event that any resolution was deemed necessary, will not have a material adverse effect on our operations.
On March 31, 2008, the United States District Court for the District of Arizona (the “District Court”) dismissed with prejudice the qui tam complaint against IAS, our parent company. The qui tam action sought monetary damages and civil penalties under the FCA and included allegations that certain business practices related to physician relationships and the medical necessity of certain procedures resulted in the submission of claims for reimbursement in violation of the FCA. The case dates back to March 2005 and became the subject of a subpoena by the OIG in September 2005. In August 2007, the case was unsealed and became a private lawsuit after the Department of Justice declined to intervene. The United States District Judge dismissed the case from the bench at the conclusion of oral arguments on IAS’ motion to dismiss. On April 21, 2008, the court issued a written order dismissing the case with prejudice and entering formal judgment for IAS. On May 7, 2008, the qui tam relator’s counsel filed a Notice of Appeal to the United States Court of Appeals for the Ninth Circuit to appeal the District Court’s dismissal of the case. On May 21, 2008, IAS filed a Notice of Cross-Appeal to the United States Court of Appeals for the Ninth Circuit from a portion of the April 21, 2008 Order and, on July 22, 2008, IAS filed a Motion to Disqualify relator’s counsel related to their misappropriation of information subject to a claim of attorney-client privilege by IAS. On August 21, 2008, the court issued a written order denying IAS’ Motion to Disqualify and resetting the briefing schedule associated with the Ninth Circuit appellate proceedings. On October 21, 2008, the relator filed his appeal brief with the United States Court of Appeals for the Ninth Circuit. IAS filed its cross-appeal brief on January 20, 2009. Currently, the Ninth Circuit appeal is expected to take another six to nine months to complete.

 

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Certificates of Need
In some states, the construction of new facilities, acquisition of existing facilities or addition of new beds or services may be subject to review by state regulatory agencies under a certificate of need program. Florida and Nevada are the only states in which we currently operate that require approval of acute care hospitals under a certificate of need program. These laws generally require appropriate state agency determination of public need and approval prior to the addition of beds or services or other capital expenditures. Failure to obtain necessary state approval can result in the inability to expand facilities, add services and complete an acquisition or change ownership. Further, violation may result in the imposition of civil sanctions or the revocation of a facility’s license.
Health Choice
Health Choice is a prepaid Medicaid and Medicare managed health plan in the Phoenix, Arizona area. For the years ended September 30, 2009, 2008 and 2007, premium revenue comprised approximately 29.6%, 26.2% and 25.5%, respectively, of our consolidated net revenue. Premium revenue is generated through capitated contracts whereby the Plan provides healthcare services in exchange for fixed periodic payments from the Arizona Health Care Cost Containment System (“AHCCCS”) and CMS. Capitation payments received by Health Choice are recognized as revenue in the month that members are entitled to healthcare services.
Effective October 1, 2008, Health Choice began its current contract with AHCCCS, which provides for a three-year term, with AHCCCS having the option to renew for two additional one-year periods. The contract, which continues our state-wide presence, covers Medicaid members in the following Arizona counties: Apache, Coconino, Maricopa, Mohave, Navajo, Pima, Yuma, La Paz and Santa Cruz. As of September 30, 2009, Health Choice’s enrollment exceeded 187,000 members, compared to over 142,000 members in the prior year. While we anticipate that our membership in the near term will continue to exceed prior year amounts, we cannot guarantee the continued growth of our membership.
In connection with our contract effective October 1, 2008, AHCCCS implemented a risk-based or severity-adjusted payment methodology for all health plans, which resulted in a reduction to our premium revenue on a per member per basis during the year ended September 30, 2009. Implementation of this new payment methodology was retroactive to October 1, 2008, and is also expected to negatively impact premium rates paid to Health Choice going forward. Based upon the risk score adjustment factors provided by AHCCCS, we have estimated slight reductions in our future capitation premium rates.
Effective January 1, 2006, pursuant to a contract with CMS, Health Choice began providing coverage as a Medicare Advantage Prescription Drug (“MAPD”) Special Needs Plan (“SNP”) to its Medicare enrollees in Maricopa, Pima, Pinal, Coconino, Apache and Navajo counties. The SNP allows Health Choice to offer Medicare and Part D drug benefit coverage for new and existing dual-eligible members, or those that are eligible for Medicare and Medicaid. The contract with CMS includes successive one-year renewal options at the discretion of CMS. CMS has notified Health Choice that it is exercising its option to extend the contract through December 31, 2010. Although legislation has been proposed to extend Congressional authority for SNPs, under current law, CMS’ authority to designate SNPs expires on December 31, 2010. Unless this law is changed, CMS may not be able to renew Health Choice’s SNP contract after December 31, 2010. Additionally, federal law prohibits CMS from designating additional disproportionate percentage SNPs through December 31, 2010, and prohibits existing SNPs from enrolling individuals outside of their existing geographic areas through December 31, 2009.
The Plan receives reinsurance and other supplemental payments from AHCCCS for healthcare costs that exceed stated amounts at a rate ranging from 75% to 100% of qualified healthcare costs in excess of stated levels of up to $50,000 per claim, depending on the eligibility classification of the member. Qualified costs must be incurred during the contract year and are the lesser of the amount paid by the Plan or the AHCCCS fee schedule. Reinsurance recoveries are recognized under the contract with AHCCCS when healthcare costs exceed stated amounts as provided under the contract, including estimates of such costs at the end of each accounting period.

 

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Premiums received from AHCCCS and CMS to provide services to our members have been impacted by moderating rate increases. Additionally, the state of Arizona is currently facing significant budgetary concerns. As a result, the state legislature passed a fiscal 2010 budget on July 1, 2009, that includes AHCCCS funding at a lower rate of growth than in prior years, but does include funding for medical cost inflation and increased enrollment in the program. In regards to the fiscal 2010 year, depending on member mix, we generally believe Health Choice could experience flat to slightly declining rates received on a per member per month basis, which may negatively impact our premium revenue. In addition, there are a number of alternatives being considered to address Arizona’s budget concerns, including increases in sales and property taxes, a reduction in AHCCCS’ total expenditures, a reduction in rates paid by AHCCCS to facilities, and elimination of KidsCare, Arizona’s Children’s Health Insurance Program. If additional budgetary measures such as these were to occur, we anticipate it would negatively impact our premium revenue in the future; however, we are unable to predict the impact on our results of operations and cash flows.
As of September 30, 2009, we provided a performance guaranty in the form of letters of credit totaling $43.2 million for the benefit of AHCCCS to support our obligations under our contract to provide and pay for the healthcare services. The amount of the performance guaranty is based primarily upon the membership in the Plan and the related capitation paid to us.
Health Choice is subject to state and federal laws and regulations, and CMS and AHCCCS have the right to audit Health Choice to determine the plan’s compliance with such standards. Health Choice is required to file periodic reports with CMS and AHCCCS and to meet certain financial viability standards. Health Choice also must provide its enrollees with certain mandated benefits and must meet certain quality assurance and improvement requirements. Health Choice must also comply with the electronic transactions regulations and privacy and security standards of HIPAA.
The federal anti-kickback statute has been interpreted to prohibit the payment, solicitation, offering or receipt of any form of remuneration in return for the referral of federal healthcare program patients or any item or service that is reimbursed, in whole or in part, by any federal healthcare program. Similar anti-kickback statutes have been adopted in Arizona, which apply regardless of the source of reimbursement. The Department has adopted safe harbor regulations specifying the following relationships and activities that are deemed not to violate the federal anti-kickback statute that specifically relate to managed care:
    waivers by health maintenance organizations of Medicare and Medicaid beneficiaries’ obligation to pay cost-sharing amounts or to provide other incentives in order to attract Medicare and Medicaid enrollees;
    certain discounts offered to prepaid health plans by contracting providers;
    certain price reductions offered to eligible managed care organizations; and
    certain price reductions offered by contractors with substantial financial risk to managed care organizations.
We believe that the incentives offered by Health Choice to its Medicaid and Medicare enrollees and the discounts it receives from contracting healthcare providers satisfy the requirements of the safe harbor regulations. However, failure to satisfy each criterion of the applicable safe harbor does not mean that the arrangement constitutes a violation of the law; rather the safe harbor regulations provide that the arrangement must be analyzed on the basis of its specific facts and circumstances. We believe that Health Choice’s arrangements comply in all material respects with the federal anti-kickback statute and similar Arizona statutes.
Environmental Matters
We are subject to various federal, state and local environmental laws and regulations, including those relating to the protection of human health and the environment. The principal environmental requirements applicable to our operations relate to:
    the proper handling and disposal of medical waste, hazardous waste and low-level radioactive medical waste;
 
    the proper use, storage and handling of mercury and other hazardous materials;

 

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    underground and above-ground storage tanks;
    management of hydraulic fluid or oil associated with elevators, chiller units or other equipment;
    management of asbestos-containing materials or lead-based paint present or likely to be present at some locations; and
    air emission permits and standards for boilers or other equipment.
We do not expect our obligations under these or other applicable environmental laws and requirements to have a material effect on us. In the course of our operations, we may also identify other circumstances at our facilities, such as water intrusion or the presence of mold or fungus, which warrant action, and we can and do incur additional costs to address those circumstances. Under various environmental laws, we may also be required to clean up or contribute to the cost of cleaning up substances that have been released to the environment either at properties owned or operated by us or our predecessors or at properties to which substances from our operations were sent for off-site treatment or disposal. These remediation obligations may be imposed without regard to fault, and liability for environmental remediation can be substantial. While we cannot predict whether or to what extent we might be held responsible for such cleanup costs in the future, at present we have not identified any significant cleanup costs or liabilities that are expected to have a material effect on us.
Professional and General Liability Insurance
As is typical in the healthcare industry, we are subject to claims and legal actions by patients in the ordinary course of business. To cover these claims, we maintain professional malpractice liability insurance and general liability insurance in amounts that we believe to be sufficient for our operations, including our employed physicians, although some claims may exceed the scope of the coverage in effect. We also maintain umbrella coverage. Losses up to our self-insured retentions and any losses incurred in excess of amounts maintained under such insurance will be funded from working capital.
The cost of malpractice and other liability insurance, and the premiums and self-retention limits of such insurance, have moderated as a result of tort reform legislation limiting the size of malpractice judgments in certain states such as Florida and Texas, as well as improvements in our claims experience. For fiscal 2010, our self-insured retention for professional and general liability coverage is $5.0 million per claim, with an excess aggregate limit of $55.0 million. The maximum coverage under our insurance policies remains unchanged at $75.0 million. Our self-insurance reserves for estimated claims incurred but not yet reported is based upon estimates determined by third-party actuaries. Funding for the self-insured retention of such claims is derived from operating cash flows. We cannot assure you that this insurance will continue to be available at reasonable prices that will allow us to maintain adequate levels of coverage. We also cannot assure you that our cash flow will be adequate to provide for professional and general liability claims in the future. Additionally, the negative impact of the current economic downturn on insurance companies’ investment portfolios may result in an increase in premiums for future policy renewal periods.
Our Information Systems
We use a common information systems platform across all of our hospitals. We use McKesson’s clinical, patient accounting, laboratory, radiology and decision support software and Lawson’s financial application and enterprise resource planning software. We use other vendors for specialized information systems needs for our decision support, emergency and radiology departments.
Our information systems are essential to the following areas of our business operations, among others:
    patient accounting, including billing and collection of net revenue;
    financial, accounting, reporting and payroll;
    coding and compliance;

 

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    laboratory, radiology and pharmacy systems;
    materials and asset management;
    negotiating, pricing and administering our managed care contracts; and
    monitoring of quality of care and collecting data on quality measures necessary for full Medicare payment updates.
Utilizing a common information systems platform across all our hospitals allows us to:
    enhance patient safety, automate medication administration and increase staff time available for direct patient care;
    optimize staffing levels according to patient volumes, acuity and seasonal needs at each facility;
    perform product line analyses;
    continue to meet or exceed quality of care indicators on a current basis;
    effectively monitor registration, billing, collections, managed care contract compliance and all other aspects of our revenue cycle;
    control supply costs by complying with our group purchasing organization contract; and
    effectively monitor financial results.
The cost of maintaining our information systems has increased significantly in recent years. Information systems maintenance expense increased $1.1 million to $8.0 million for the fiscal year ended September 30, 2009, as compared to the prior year. We expect the trend of increased maintenance costs in this area to continue in the future. In addition, we expect to spend approximately $8.0 million on various hardware and software upgrades during 2010.
The ARRA included approximately $21.0 billion in funding for various healthcare information technology (“IT”) initiatives, including incentives for hospitals and physicians to implement systems supporting electronic health records (“EHRs”). Though additional investments in hardware and software will be required, we believe our historical capital investments in advanced clinicals and other information systems, as well as quality of care programs, provides a solid platform to build upon for timely compliance with the healthcare IT requirements of the ARRA.

 

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Item 1A. Risk Factors.
Servicing Our Indebtedness Requires A Significant Amount of Cash. Our Ability To Generate Sufficient Cash Depends On Numerous Factors Beyond Our Control, And We May Be Unable To Generate Sufficient Cash Flow To Service Our Debt Obligations, Including Making Payments On Our 8 3/4% Notes And Term Loans.
We have issued $475.0 million in aggregate principal amount of 8 3/4% senior subordinated notes due 2014, that have been registered under the Securities Act of 1933, as amended, (“the 8 3/4% notes”). We have also entered into our senior secured credit facilities, which includes a $439.0 million senior secured term loan and a $150.0 million senior secured delayed draw term loan, both maturing on March 15, 2014. We cannot assure you that our business will generate sufficient cash flow from operations or that future borrowing will be available to us under our senior secured credit facilities in an amount sufficient to enable us to pay the principal, if any, and interest on our indebtedness, including the 8 3/4% notes and term loans, or to fund our other liquidity needs. Our ability to fund these payments is subject to general economic, financial, competitive, legislative, regulatory and other factors that are beyond our control. We may need to refinance all or a portion of our indebtedness, including the 8 3/4% notes and term loans, on or before maturity. We cannot assure you that we will be able to refinance any of our indebtedness, on commercially reasonable terms or at all. In addition, the terms of existing or future debt agreements, including the amended and restated credit agreement governing the senior secured credit facilities and the indenture governing the 8 3/4% notes, may restrict us from affecting any of these alternatives.
The senior secured credit facilities also include a senior secured revolving credit facility of $225.0 million, with a $100.0 million sub-limit for letters of credit that matures on April 27, 2013. Our ability to borrow funds under our revolving credit facility is subject to the financial viability of the participating financial institutions. Currently, we have identified one defaulting lender, Lehman Brothers (“Lehman”), who has been unable to fund its proportionate share of borrowings under our revolving credit facility since September 2008. Lehman’s participation in our revolving credit facility is approximately 8.9%, or $20.0 million of our total revolver capacity. We are currently working to replace this lender with a financially viable institution; however, we are unable to provide any assurance that this will be possible. If any of our remaining creditors were to suffer similar financial difficulties, or if the credit markets were to deteriorate as they did towards the end of calendar 2008, our ability to access available funds under our revolving credit facility could be limited.
During the next twelve months, along with interest on our senior secured credit facilities, we are required to repay $5.9 million in principal under our senior secured credit facilities, $41.6 million in interest under the 8 3/4% notes and $2.7 in principal under our capital lease and other obligations. If we cannot make scheduled payments on our debt, we will be in default and, as a result:
    our debt holders could declare all outstanding principal and interest to be due and payable;
    our secured debt lenders could terminate their commitments and commence foreclosure proceedings against our assets; and
    we could be forced into bankruptcy or liquidation.
Our Substantial Level Of Indebtedness Could Adversely Affect Our Financial Condition And Prevent Us From Fulfilling Our Obligations Under The 8 3/4% Notes And Senior Secured Credit Facilities.
We have a significant amount of indebtedness. At September 30, 2009, we had $475.0 million of outstanding 8 3/4% notes and $584.8 million of other indebtedness (of which $576.2 million consisted of borrowings under our senior secured credit facilities, and $8.7 million consisted of capital lease obligations and other debt). All of our other indebtedness ranks senior to the 8 3/4% notes. In addition, subject to restrictions in the indenture governing the 8 3/4% notes and the amended and restated credit agreement governing the senior secured credit facilities, we may incur additional indebtedness.

 

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Our substantial indebtedness could have important consequences to our financial condition and results of operations, including the following:
    it may be more difficult for us to satisfy our obligations, including debt service requirements under our outstanding debt;
    our ability to obtain additional financing for working capital, acquisitions, capital expenditures, debt service requirements, or other general corporate purposes may be impaired;
    we must use a substantial portion of our cash flow to pay principal and interest on our 8 3/4% notes, senior secured credit facilities, and other indebtedness which will reduce the funds available to us for other purposes;
    we are more vulnerable to economic downturns and adverse industry conditions;
    our ability to capitalize on business opportunities and to react to competitive pressures as compared to our competitors may be compromised due to our high level of indebtedness; and
    our ability to borrow additional funds or to refinance indebtedness may be limited.
Our senior secured credit facilities are rated by Moody’s and Standard & Poor’s. If these ratings were ever downgraded, our access to and cost of future capital could be adversely affected. In addition, our ability to borrow additional funds may be reduced and the risks related to our substantial indebtedness would intensify.
An Increase In Interest Rates Would Increase The Cost Of Servicing Our Debt And Could Reduce Our Profitability.
Borrowings under our senior secured credit facilities bear interest at variable rates. As of September 30, 2009, we had outstanding variable rate debt of $576.2 million. We have managed our market exposure to changes in interest rates by converting $425.0 million of this variable rate debt to fixed rate debt through the use of interest rate swap agreements, effectively leaving $151.2 million in debt subject to variable rates. As a result, an increase in interest rates, whether because of an increase in market interest rates or an increase in our own cost of borrowing, would increase the cost of servicing our debt and could materially reduce our profitability. For more discussion on the effect of changes in interest rates, see “Item 7A. — Quantitative and Qualitative Disclosures About Market Risk.”
We Are Controlled By Our Principal Equity Sponsors.
We are controlled by our principal equity sponsors who have the ability to control our financial-related policies and decisions. For example, our principal equity sponsors could cause us to enter into transactions that, in their judgment, could enhance their equity investment, even though such transactions might reduce our cash flows or capital reserves. So long as our principal equity sponsors continue to own a significant amount of our equity interests, they will continue to be able to strongly influence and effectively control the decisions related to our company. Additionally, our principal equity sponsors may from time to time acquire and hold interests in businesses that compete directly or indirectly with us and, therefore, have interests that may conflict with the interests of our company.

 

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If We Are Unable To Retain And Negotiate Reasonable Contracts With Managed Care Plans, Our Net Revenue May Be Reduced.
Our ability to obtain reasonable contracts with health maintenance organizations, preferred provider organizations and other managed care plans significantly affects the revenue and operating results of our hospitals. Revenue derived from health maintenance organizations, preferred provider organizations and other managed care plans accounted for 43.0%, 46.0% and 47.5% of our hospitals’ net patient revenue for the years ended September 30, 2009, 2008 and 2007, respectively. Our hospitals have over 300 managed care contracts with no one commercial payor representing more than 10.0% of our net patient revenue. In most cases, we negotiate our managed care contracts annually as they come up for renewal at various times during the year. Further, many of these contracts are terminable by either party on relatively short notice. Our future success will depend, in part, on our ability to retain and renew our managed care contracts and enter into new managed care contracts on terms favorable to us. Other healthcare providers, including some with integrated health systems, provider networks, greater geographic coverage or a wider range of services, may impact our ability to enter into managed care contracts or negotiate increases in our reimbursement and other favorable terms and conditions. For example, some of our competitors may negotiate exclusivity provisions with managed care plans or otherwise restrict the ability of managed care companies to contract with us. In one region in which we operate, the largest healthcare provider organization controls one of the largest payor organizations and operates it primarily as a closed network. The patients enrolled in this integrated health system are largely unavailable to us. In addition, consolidation among managed care companies and organizations may reduce our ability to negotiate favorable contracts with such payors.
In addition, the House Reform Bill, which has passed the U.S. House of Representatives but is not yet law, includes a public health insurance option to be administered by the Secretary of the Department, who would negotiate payment rates with providers. The healthcare reform bill currently under consideration by the U.S. Senate also includes a public health insurance option. The creation of a public health insurance option could result in a migration of enrollees from higher paying commercial health plans, which could have a negative impact on hospital revenues. However, this negative impact could be offset by a reduction in bad debt and charity care as a result of the creation of a public health insurance option and other aspects of healthcare reform that are intended to provide insurance coverage for most uninsured individuals.
Healthcare Reform and Other Changes In Governmental Programs May Significantly Reduce Government Healthcare Spending And Our Revenue.
National healthcare reform is a focus at the federal level. The House Reform Bill has passed the U.S. House of Representatives, but has not yet been approved by the U.S. Senate. The House Reform Bill would reduce the number of uninsured persons by requiring most individuals to obtain health insurance, expanding Medicaid eligibility, limiting preexisting conditions exclusions and creating a temporary national high risk pool for coverage of currently uninsured individuals with medical conditions. The House Reform Bill would also create a National Health Insurance Exchange for individuals and small employers to obtain health insurance. This exchange would include a public health insurance option to be administered by the Secretary of the Department, who would negotiate payment rates with providers.
The House Reform Bill also would modify the Medicare program, including changes to delivery and payment systems. For example, hospitals could experience productivity-based reductions to market basket updates and decreased payments in the event of excessive readmissions. The House Reform Bill also would increase funding for fighting fraud and abuse, require the return of overpayments within 60 days of their discovery, create new penalties for fraud and abuse violations and restrict physician ownership of hospitals.
Currently, the U.S. Senate is considering a reform bill, entitled the Patient Protection and Affordable Care Act, which is also designed to decrease the number of uninsured individuals and reduce healthcare costs. It is not possible to predict whether federal healthcare reform legislation will be enacted or the impact of any enacted federal healthcare reform legislation. For example, the creation of a public health insurance option could result in a migration of enrollees from higher paying commercial health plans, which could have a negative impact on hospital revenues. Similarly, reductions in the market basket update for hospitals or other changes to the Medicare program that may be enacted as part of federal reform legislation could negatively impact hospital revenues. However, these negative impacts could be offset by a reduction in bad debt and charity care as a result of the creation of a public health insurance option and other aspects of healthcare reform that are intended to provide insurance coverage for most uninsured individuals. Federal healthcare reform may reduce our revenue, increase our costs, or otherwise have a material adverse effect on our business, financial condition or results of operations. We are unable to predict the course of federal, state, or local healthcare legislation.
The focus on healthcare reform may also increase the likelihood of significant changes affecting existing government healthcare programs. A significant portion of our patient volumes is derived from government healthcare programs. Governmental healthcare programs, principally Medicare and Medicaid, including managed Medicare and managed Medicaid, accounted for 45.9%, 44.9% and 43.0% of our hospitals’ net patient revenue for the years ended September 30, 2009, 2008 and 2007, respectively. In recent years, legislative changes have resulted in limitations on and, in some cases, reductions in levels of, payments to healthcare providers for certain services under many of these government programs. Further, legislative and regulatory changes have altered the method of payment for various services under the Medicare, Medicaid and other federal healthcare programs. For example, CMS has significantly expanded the number of procedures that Medicare reimburses if performed in an ASC. More Medicare procedures that are now performed in hospitals, such as ours, may be moved to ASCs, reducing surgical volume in our hospitals. Possible future changes in the Medicare, Medicaid and other state programs may reduce reimbursements to healthcare providers and may also increase our operating costs, which could reduce our profitability.

 

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CMS has recently completed a two-year transition to full implementation of the MS-DRG. Changes to the MS-DRG system could impact the margins we receive for certain services. For federal fiscal year 2010, CMS has provided a 2.1% market basket update for hospitals that submit certain quality patient care indicators and a 0.1% update for hospitals that do not submit this data. While we will endeavor to comply with all quality data submission requirements, our submissions may not be deemed timely or sufficient to entitle us to the full market basket adjustment for all of our hospitals. Medicare payments to hospitals in federal fiscal years 2008 and 2009 were reduced to eliminate what CMS estimated to be the effect of coding or classifications changes as a result of hospitals implementing the MS-DRG system. If CMS retrospectively determines that adjustment levels for federal fiscal years 2008 and 2009 were inadequate, CMS may impose additional adjustments in future years. Although CMS has not imposed an adjustment for federal fiscal year 2010, CMS has announced its intent to impose payment adjustments in federal fiscal years 2011 and 2012 because of what CMS has determined to be an inadequate adjustment in federal fiscal year 2008. Additionally, Medicare payments to hospitals are subject to a number of other adjustments, and the actual impact on payments to specific hospitals may vary. In some cases, commercial third-party payors and other payors such as some state Medicaid programs rely on all or portions of the Medicare MS-DRG system to determine payment rates, and adjustments that negatively impact Medicare payments may also negatively impact payments from Medicaid programs or commercial third-party payors and other payors.
We believe that hospital operating margins across the country, including ours, have been and may continue to be under pressure because of limited pricing flexibility and growth in operating expenses in excess of the increase in prospective payments under the Medicare program. Further, DEFRA, signed into law on February 8, 2006, includes Medicaid cuts of approximately $4.8 billion over five years. CMS has published a number of proposed and final regulations that, if implemented, would result in significant additional reductions in Medicaid funding. These regulations have been subject to Congressional moratoria, rescinded, invalidated by court order or otherwise delayed. However, CMS could pursue implementation of these regulations or other regulatory measures that would further reduce Medicaid funding in the future.
In addition, from time to time, state legislatures consider healthcare reform measures or changes to the regulation of private healthcare insurance. Because of economic conditions and other factors, a number of states are experiencing budget problems and have adopted or are considering legislation designed to reduce their Medicaid expenditures and to provide universal coverage and additional care, including enrolling Medicaid recipients in managed care programs and imposing additional taxes on hospitals to help finance or expand states’ Medicaid systems. The states in which we operate have decreased funding for healthcare programs or made other structural changes resulting in a reduction in Medicaid hospital rates for fiscal years 2009 and 2010. For example, Arizona has frozen hospital inpatient and outpatient reimbursements at the October 1, 2007 rates and discontinued a state health benefits program for low-income parents. Louisiana reduced inpatient hospital rates by 3.5% and 6.3% and outpatient hospital rates by 3.5% and 5.7% in fiscal years 2009 and 2010, respectively, but still projects a Medicaid program deficit in excess of $300 million for the remainder of fiscal year 2010. In fiscal year 2009, Nevada cut inpatient hospital rates by 5% and eliminated rate enhancements for pediatric and obstetric care. Utah has cut hospital rates for fiscal year 2010 by more than 11%. Florida has reduced hospital reimbursement rates for fiscal years 2009 and 2010. Additional Medicaid spending cuts may be implemented in the future in the states in which we operate, including reductions in supplemental Medicaid reimbursement programs. Our Texas hospitals participate in private supplemental Medicaid reimbursement programs that are structured to expand the community safety net by providing indigent healthcare services and result in additional revenues for participating hospitals. We cannot predict whether the Texas private supplemental Medicaid reimbursement programs will continue or guarantee that revenues recognized from the programs will not decrease.
Changes in laws or regulations regarding government health programs or other changes in the administration of government health programs could have a material, adverse effect on our financial position and results of operations.

 

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Our Hospitals Face Competition For Patients From Other Hospitals And Healthcare Providers That Could Impact Patient Volume.
In general, the hospital industry is highly competitive. Our hospitals face competition for patients from other hospitals in our markets, large vertically integrated providers, large tertiary care centers and outpatient service providers that provide similar services to those provided by our hospitals. All of our facilities are located in geographic areas in which at least one other hospital provides services comparable to those offered by our hospitals. Some of the hospitals that compete with ours are owned by governmental agencies or not-for-profit corporations supported by endowments and charitable contributions and can finance capital expenditures and operations on a tax-exempt basis. In addition, the number of freestanding specialty hospitals, outpatient surgery centers and outpatient diagnostic centers has increased significantly in the areas in which we operate. Some of our competitors also have greater geographic coverage, offer a wider range of services or invest more capital or other resources than we do. If our competitors are able to achieve greater geographic coverage, improve access and convenience to physicians and patients, recruit physicians to provide competing services at their facilities, expand or improve their services or obtain more favorable managed care contracts, we may experience a decline in patient volume.
CMS publicizes performance data relating to quality measures that hospitals submit in connection with their Medicare reimbursement. If any of our hospitals should achieve poor results (or results that are lower than our competitors) on these quality criteria, patient volumes could decline. In the future, other trends toward clinical transparency and value-based purchasing of healthcare services may have an adverse impact on our competitive position and patient volume.
If We Continue To Experience Growth In Volume And Revenue Related To Uncompensated Care, Our Financial Condition Or Results Of Operations Could Be Adversely Affected.
Like others in the hospital industry, we have experienced an increase in our uncompensated care, including charity care and our provision for bad debts. Our provision for bad debts and charity care as a percentage of acute care revenue has increased due to a growth in self-pay volume and revenue resulting in large part from an increase in the number of uninsured patients, along with an increase in the amount of co-payments and deductibles passed on by employers to employees. In addition, as a result of the prolonged economic recession and rising levels of unemployment, we believe that our hospitals may continue to experience growth in bad debts and charity care. Although we continue to seek ways of improving point of service collection efforts and implementing appropriate payment plans with our patients, if we continue to experience growth in self-pay volume and revenue, our results of operations could be adversely affected. Further, our ability to improve collections for self-pay patients may be limited by regulatory and investigatory initiatives, including private lawsuits directed at hospital charges and collection practices for uninsured and underinsured patients.
If We Are Unable To Attract And Retain Quality Medical Staffs, Our Financial Condition Or Results Of Operations Could Be Adversely Affected.
The success of our hospitals depends on the following factors, among others:
    the number and quality of the physicians on the medical staffs of our hospitals;
    the admitting practices of those physicians; and
    our maintenance of good relations with those physicians.
Our efforts to attract and retain physicians are affected by our managed care contracting relationships, national shortages in some specialties, such as anesthesiology and radiology, the adequacy of our support personnel, the condition of our facilities and medical equipment, the availability of suitable medical office space and federal and state laws and regulations prohibiting financial relationships that may have the effect of inducing patient referrals.
In an effort to meet community needs in certain markets in which we operate, we have implemented a strategy to employ physicians in certain specialties. The deployment of a physician employment strategy includes increased salary costs, potential malpractice insurance coverage costs, risks of successful physician integration and difficulties associated with physician practice management. While we believe this strategy is consistent with industry trends, we cannot be assured of the long-term success of such a strategy.

 

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Our Hospitals Face Competition For Staffing, Which May Increase Our Labor Costs And Reduce Profitability.
We compete with other healthcare providers in recruiting and retaining qualified management and staff personnel responsible for the day-to-day operations of each of our hospitals, including nurses and other non-physician healthcare professionals. In the past, the limited supply of nurses and other medical support personnel presented a significant operating issue. In part, due to the prolonged economic recession, we have seen an improvement in the availability of nursing personnel and other skilled labor. If such a shortage were to occur again, it may require us to enhance wages and benefits to recruit and retain nurses and other medical support personnel, and contract with more expensive temporary personnel. We also depend on the available labor pool of semi-skilled and unskilled employees in each of the markets in which we operate. Because a significant percentage of our revenue consists of fixed, prospective payments, our ability to pass along increased labor costs to third-party payors is constrained. Our failure to recruit and retain qualified management, nurses and other medical support personnel, or to control our labor costs could have a material adverse effect on our financial condition or results of operations.
If We Fail To Continually Enhance Our Hospitals With The Most Recent Technological Advances In Diagnostic And Surgical Equipment, Our Ability To Maintain And Expand Our Markets May Be Adversely Affected.
Technological advances with respect to computed axial tomography (CT), magnetic resonance imaging (MRI) and positron emission tomography (PET) equipment, as well as other equipment used in our facilities, are continually evolving. In an effort to compete with other healthcare providers, we must constantly be evaluating our equipment needs and upgrading equipment as a result of technological improvements. Such equipment costs typically range from $1.0 million to $3.0 million, exclusive of construction or build-out costs. If we fail to remain current with the technological advancements of the medical community, our volumes and revenue may be negatively impacted.
If We Fail To Comply With Extensive Laws And Government Regulations, We Could Suffer Penalties, Be Required To Alter Arrangements With Investors In Our Hospitals Or Be Required To Make Significant Changes To Our Operations.
The healthcare industry, including our company, is required to comply with extensive and complex laws and regulations at the federal, state and local government levels relating to, among other things:
    billing for services;
    relationships with physicians and other referral sources;
    adequacy of medical care;
    quality of medical equipment and services;
    qualifications of medical and support personnel;
    confidentiality, maintenance, data breach, identity theft and security issues associated with individually identifiable information and medical records;
    the screening, stabilization and transfer of patients who have emergency medical conditions;
    licensure and certification;
    operating policies and procedures;

 

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    addition of facilities and services;
    provider-based reimbursement, including complying with requirements allowing multiple locations of a hospital to be billed under the hospital’s Medicare provider number; and
    disclosures to patients, including disclosure of any physician ownership in a hospital.
Because many of these laws and regulations are relatively new, we do not always have the benefit of significant regulatory or judicial interpretation of these laws and regulations. For that reason and because these laws and regulations are so complex, hospital companies face a risk of inadvertent violations. In the future, different interpretations or enforcement of these laws and regulations could subject our current or past practices to allegations of impropriety or illegality or could require us to make changes in our facilities, equipment, personnel, services, capital expenditure programs and operating expenses.
If we fail to comply with applicable laws and regulations, we could be subjected to liabilities, including:
    criminal penalties;
    civil penalties, including the loss of our licenses to operate one or more of our facilities; and
    exclusion of one or more of our facilities from participation in the Medicare, Medicaid and other federal and state healthcare programs.
Congress Is Considering And May Enact Legislation That Would Impose Significant Restrictions On Hospitals That Have Physician Owners, Including Our Hospitals That Have Physician Owners.
In recent years, both houses of the U.S. Congress have passed bills that included provisions that would have eliminated or significantly restricted the whole hospital exception, the exception under the Stark Law that allows for direct physician ownership in hospitals. While the whole hospital exception provisions in these bills did not become law, this issue continues to attract significant interest in Congress. In November 2009, the House of Representatives passed a healthcare reform bill that would eliminate the whole hospital exception subject to a grandfathering provision for most hospitals that currently have physician ownership. In order to fall within this grandfathering provision, a hospital would have to abide by a number of restrictions, including limits on future expansion and reporting and disclosure requirements. The Senate healthcare reform bill currently under consideration contains a similar prohibition on physician-owned hospitals.
We are unable to predict whether Congress will enact legislation that eliminates or alters the whole hospital exception. If legislation restricting or eliminating the whole hospital exception becomes law, we could be required to unwind the physician ownership of seven of our hospitals, resulting in a repurchase of minority partners’ interests, or such hospitals could be subject to significant restrictions on their current operations or future expansion, among other areas.
Some Of Our Hospitals May Be Required To Submit To The Department Information On Their Relationships With Physicians, Including Information Regarding Physician Investors, And This Submission Could Subject Such Hospitals And Us To Liability.
The Department has proposed to collect information on ownership, investment, and compensation arrangements with physicians from 400 hospitals by requiring these hospitals to submit Disclosure of Financial Relationship Reports (“DFRR”). The Department has indicated that at least three of our hospitals would be among these 400 hospitals required to submit a DFRR. The DFRR and its supporting documentation are currently under review by the Office of Management and Budget, and it is unclear when, or if, it will be finalized. The Department intends to use this data to monitor compliance with the Stark Law, and the Department may share the information with other government agencies. Many of these agencies have not previously analyzed this information and have the authority to bring enforcement actions against the partnership and the hospital. As currently proposed by the Department, once a hospital receives this request, the hospital would have a limited amount of time to compile a significant amount of information relating to its financial relationships with physicians, including any ownership by physicians. The hospital may be subject to substantial penalties if it is unable to assemble and report this information within the required timeframe or if the Department or any other government agency determines that the submission is inaccurate or incomplete. The hospital may be the subject of investigations or enforcement actions if a government agency determines that any of the information indicates a potential violation of law. In addition, a whistleblower acting pursuant to the FCA or similar state laws may assert that the hospital has submitted false claims based on allegations that the DFRR submission is inaccurate or incomplete or that material disclosed in the submission constitutes a violation of applicable laws. Any such investigation, enforcement action, or whistleblower allegation could materially adversely affect the results of our operations.

 

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We May Incur Material Fees, Costs And Expenses In Connection With An Appeal Of The Court Order Dismissing With Prejudice the Qui Tam Action And Investigation of IAS.
On March 31, 2008, the District Court dismissed with prejudice the qui tam complaint against IAS, our parent company. The qui tam action sought monetary damages and civil penalties under the FCA and included allegations that certain business practices related to physician relationships and the medical necessity of certain procedures resulted in the submission of claims for reimbursement in violation of the FCA. The case dates back to March 2005 and became the subject of a subpoena by the OIG in September 2005. In August 2007, the case was unsealed and became a private lawsuit after the Department of Justice declined to intervene. The United States District Judge dismissed the case from the bench at the conclusion of oral arguments on IAS’ motion to dismiss. On April 21, 2008, the court issued a written order dismissing the case with prejudice and entering formal judgment for IAS. On May 7, 2008, the qui tam relator’s counsel filed a Notice of Appeal to the United States Court of Appeals for the Ninth Circuit to appeal the District Court’s dismissal of the case. On May 21, 2008, IAS filed a Notice of Cross-Appeal to the United States Court of Appeals for the Ninth Circuit from a portion of the April 21, 2008 Order and, on July 22, 2008, IAS filed a Motion to Disqualify relator’s counsel related to their misappropriation of information subject to a claim of attorney-client privilege by IAS. On August 21, 2008, the court issued a written order denying IAS’ Motion to Disqualify and resetting the briefing schedule associated with the Ninth Circuit appellate proceedings. On October 21, 2008, the relator filed his appeal brief with the United States Court of Appeals for the Ninth Circuit. IAS filed its cross-appeal brief on January 20, 2009. Currently, the Ninth Circuit appeal is expected to take another six to nine months to complete. If the appeal of the order dismissing the qui tam action with prejudice was to be resolved in a manner unfavorable to us, it could have a material adverse effect on our business, financial condition and results of operations, including exclusion from the Medicare and Medicaid programs. In addition, we may incur material fees, costs and expenses in connection with an appeal of the court order dismissing with prejudice the qui tam litigation, or in defending the qui tam action should the dismissal be reversed.
Providers In The Healthcare Industry Have Been The Subject Of Federal And State Investigations, And We May Become Subject To Additional Investigations In The Future That Could Result In Significant Liabilities Or Penalties To Us.
Both federal and state government agencies have increased their focus on and coordination of civil and criminal enforcement efforts in the healthcare area. As a result, there are numerous ongoing investigations of hospital companies, as well as their executives and managers. The OIG and the Department of Justice have, from time to time, established national enforcement initiatives that focus on specific billing practices or other suspected areas of abuse. Further, under the FCA, private parties have the right to bring “qui tam” whistleblower lawsuits against companies that submit false claims for payments to, or improperly retain overpayments from, the government. Some states have adopted similar state whistleblower and false claims provisions.
Federal and state investigations relate to a wide variety of routine healthcare operations including:
    cost reporting and billing practices;
    financial arrangements with referral sources;
    physician recruitment activities;
    physician joint ventures; and
    hospital charges and collection practices for self-pay patients.
We engage in many of these and other activities which could be the subject of governmental investigations or inquiries from time to time. For example, we have significant Medicare and Medicaid billings, we have numerous financial arrangements with physicians who are referral sources to our hospitals, we have seven hospitals that have physician investors, and we may sell ownership interests in certain other of our facilities to physicians and other qualified investors in the future. In addition, our executives and managers, many of whom have worked at other healthcare companies that are or may become the subject of federal and state investigations and private litigation, may be included in governmental investigations or named as defendants in private litigation. Any additional investigations of us, our executives or managers could result in significant liabilities or penalties to us, as well as adverse publicity.

 

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In addition, governmental agencies and their agents, such as the Medicare Administrative Contractors, fiscal intermediaries and carriers, as well as the OIG, CMS and state Medicaid programs, conduct audits of our healthcare operations. Private payors may conduct similar post-payment audits, and we also perform internal audits and monitoring. Depending on the nature of the conduct found in such audits and whether the underlying conduct could be considered systemic, the resolution of these audits could have a material, adverse effect on our financial position, results of operations and liquidity.
CMS is in the process of implementing a nationwide RAC program as required by the Tax Relief and Health Care Act of 2006, following a three-year demonstration RAC program conducted in a limited number of states pursuant to the Medicare Modernization Act. Under the RAC program, CMS engages private contractors to conduct post-payment reviews to detect and correct improper payments in the fee-for-service Medicare program, and the contractors receive a contingency fee based on the amount of corrected, improper payments.
In addition, through DEFRA, Congress has expanded the federal government’s involvement in fighting fraud, waste and abuse in the Medicaid program by creating the Medicaid Integrity Program. Under this program, CMS engages private contractors, referred to as MICs, to perform post-payment audits of Medicaid claims and identify overpayments. MICs have commenced audits of Medicaid providers in most jurisdictions, and audits are anticipated to begin in the remaining jurisdictions by June 2010.
Any such audit or investigation could have a material adverse effect on the results of our operations.
Compliance With Section 404 Of The Sarbanes-Oxley Act May Negatively Impact Our Results Of Operations And Failure To Comply May Subject The Company To Regulatory Scrutiny And A Loss Of Investors’ Confidence In Our Internal Control Over Financial Reporting.
We are required to perform an annual evaluation of our internal control over financial reporting and file management’s attestation with our annual report to comply with Section 404 of the Sarbanes-Oxley Act of 2002. In October 2009, the SEC extended the requirement of the auditor’s attestation on internal control over financial reporting for non-accelerated filers until fiscal years ending on or after June 15, 2010.
Compliance with all requirements and interpretive guidance associated with Section 404 of the Sarbanes-Oxley Act of 2002, and any changes in our internal control over financial reporting in response to our internal evaluations, may be expensive and time-consuming and may negatively impact our results of operations. In addition, we cannot assure you that we will be able to meet the annual required deadlines for compliance with Section 404. Any failure on our part to meet the required compliance deadlines may subject us to regulatory scrutiny and a loss of public confidence in our internal control over financial reporting.
A Failure Of Our Information Systems Would Adversely Affect Our Ability To Properly Manage Our Operations.
We rely on our advanced information systems and our ability to successfully use these systems in our operations. These systems are essential to the following areas of our business operations, among others:
    patient accounting, including billing and collection of net revenue;
    financial, accounting, reporting and payroll;

 

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    coding and compliance;
    laboratory, radiology and pharmacy systems;
    materials and asset management;
    negotiating, pricing and administering managed care contracts; and
    monitoring quality of care and collecting data on quality measures necessary for full Medicare payment updates.
If we are unable to use these systems effectively, we may experience delays in collection of net revenue and may not be able to properly manage our operations or oversee the compliance with laws or regulations.
If Any One Of The Regions In Which We Operate Experiences Or Continues To Experience An Economic Downturn Or Other Material Change, Our Overall Business Results May Suffer.
The U.S. economy is experiencing the effects of a prolonged economic recession. Tight credit markets, depressed consumer spending and high unemployment rates continue to pressure many industries. During economic downturns, governmental entities often experience budgetary constraints as a result of increased costs and lower than expected tax collections. These budgetary constraints may result in decreased spending for health and human service programs, including Medicare, Medicaid and similar programs, which represent significant payor sources for our hospitals. Many states, including states in which we operate, have decreased funding for state healthcare programs or made other structural changes resulting in a reduction in Medicaid spending. Additional Medicaid spending cuts may be implemented in the future in the states in which we operate. Other risks we face from general economic weakness include patient decisions to postpone or cancel elective and non-emergent healthcare procedures, increases in the uninsured population and further difficulties in our collection of patient co-payment and deductible receivables.
Of our 15 acute care hospital facilities, four are located in Salt Lake City, three are located in Phoenix, three are located in Tampa-St. Petersburg, three are located in the state of Texas, one is located in Las Vegas and one is located in West Monroe, Louisiana. In addition, our health plan, Health Choice, and our behavioral health hospital facility are located in Phoenix. For the year ended September 30, 2009, our net revenue was generated as follows:
         
Health Choice
    29.6 %
Salt Lake City, Utah
    19.1 %
Phoenix, Arizona (excluding Health Choice)
    13.9 %
Three cities in Texas, including San Antonio
    19.0 %
Tampa-St. Petersburg, Florida
    8.9 %
Other
    9.5 %
Any material change in the current demographic, economic, competitive or regulatory conditions in any of these regions could adversely affect our overall business results because of the significance of our operations in each of these regions to our overall operating performance. Moreover, our business is not as diversified as some competing multi-facility healthcare companies and, therefore, is subject to greater market risks. The projected population growth rates in these regions are based on assumptions beyond our control. Such projected growth may not be realized.
We May Be Subject To Liabilities Because Of Claims Brought Against Our Facilities.
Plaintiffs frequently bring actions against hospitals and other healthcare providers, alleging malpractice, product liability or other legal theories. Many of these actions involve large claims and significant defense costs. For example, certain other hospital companies have been subject to class-action claims in connection with their billing practices relating to uninsured patients.
We maintain professional malpractice liability insurance and general liability insurance in amounts we believe are sufficient to cover claims arising out of the operations of our facilities. Some of the claims could exceed the scope of the coverage in effect or coverage of particular claims or damages could be denied.

 

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The volatility of professional liability insurance and, in some cases, the lack of availability of such insurance coverage, for physicians with privileges at our hospitals increases our risk of vicarious liability in cases where both our hospital and the uninsured or underinsured physician are named as co-defendants. As a result, we are subject to greater self-insured risk and may be required to fund claims out of our operating cash flow to a greater extent than during 2009. We cannot assure you that we will be able to continue to obtain insurance coverage in the future or that such insurance coverage, if it is available, will be available on acceptable terms.
Our fiscal 2010 self-insured retention for professional and general liability coverage is $5.0 million per claim, with an excess aggregate limit of $55.0 million. The maximum coverage under our insurance policies is unchanged at $75.0 million.
Our Hospitals May Face Increasing Insurance Costs That May Reduce Our Cash Flows And Net Earnings.
The cost of liability insurance has moderated as a result of tort reform legislation limiting the size of malpractice judgments in certain states such as Florida and Texas, as well as improvements in our claims experience. However, there is no assurance that the recent moderation in insurance costs will continue. Furthermore, we cannot assure you that we will be able to continue to obtain insurance coverage in the future or that, such insurance coverage, if it is available, will be available on acceptable terms. Additionally, the negative impact of the economic downturn on insurance companies’ investment portfolios may result in an increase in premiums for future policy renewal periods.
Operations At Our Hospitals Have Been And May Be Negatively Impacted By Certain Factors, Including Severe Weather Conditions And The Impact Of Natural Disasters.
Our revenue and volume trends can be affected by many factors, including severe weather conditions and the impact of natural disasters, including hurricanes and tornados. These factors could have a material adverse effect on our operations, including revenue and volume trends, and will be outside of our control. Damages incurred by us and other companies with operations in the Gulf Coast area as a result of past catastrophic hurricanes have resulted in significant property loss claims and settlements for the insurance industry. Our current policy for property insurance provides maximum coverage of $500.0 million per occurrence with a $50,000 deductible, except in the occurrence of earthquakes and named wind and storms, which carries a 5% deductible based on insured value of each property or business damaged. Damage from past hurricanes, as well as the occurrence of future natural disasters, could continue to drive the cost of property insurance higher, as well as have an adverse economic impact on the regions we serve. We cannot be certain that any losses from business interruption or property damage, along with increases in property insurance costs, will not have a material effect on our results of operations and cash flows.
If Health Choice’s Contract With AHCCCS Was Discontinued, Our Net Revenue And Profitability Would Be Adversely Affected.
Effective October 1, 2008, Health Choice began its current contract with AHCCCS, which provides for a three-year term, with AHCCCS having the option to renew for two additional one-year periods. The contract is terminable without cause on 90 days’ written notice or for cause upon written notice if we fail to comply with any term or condition of the contract or fail to take corrective action as required to comply with the terms of the contract. Additionally, AHCCCS can terminate our contract in the event of the unavailability of state or federal funding. If our contract with AHCCCS is terminated, our financial condition, cash flows and results of operations would be adversely affected.

 

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If We Are Unable To Control Healthcare Costs At Health Choice, Our Profitability May Be Adversely Affected.
Health Choice derives its premium revenue through a contract with AHCCCS, which is the state agency that administers Arizona’s Medicaid program, and a contract with CMS for the MAPD SNP. For the years ended September 30, 2009, 2008 and 2007, we derived 27.8%, 24.2% and 23.1%, respectively, of our consolidated net revenue from our contract with AHCCCS. AHCCCS and CMS set the capitated rates we receive at Health Choice which, in turn, subcontracts with physicians, hospitals and other healthcare providers to provide services to its enrollees. If we fail to effectively manage healthcare costs, these costs may exceed the payments we receive. Historically, our medical claims expense as a percentage of premium revenue has fluctuated. Our medical loss ratio for the years ended September 30, 2009, 2008 and 2007, was 86.1%, 85.2% and 85.2%, respectively. Relatively small changes in these medical loss ratios can create significant changes in the profitability of Health Choice. Many factors can cause actual healthcare costs to exceed the capitated rates set by AHCCCS and CMS, including:
    our ability to contract with cost-effective healthcare providers;
    the increased cost of individual healthcare services;
    the type and number of individual healthcare services delivered; and
    the occurrence of catastrophes, epidemics or other unforeseen occurrences.
Although we have been able to manage medical claims expense through a variety of techniques, we may not be able to continue to effectively manage medical claims expense in the future. Additionally, any future growth in members increases the risk associated with effectively managing health claims expense. If our medical claims expense increases, our financial condition or results of operations may be adversely affected.
If AHCCCS Significantly Alters The Payment Structure Of Its Contracts Or The Amount Of Premiums Paid To Us, Our Net Revenue And Profitability Would Be Adversely Affected.
In connection with our contract effective October 1, 2008, AHCCCS implemented a risk-based or severity-adjusted payment methodology for all health plans, which resulted in a reduction to our premium revenue on a per member per month basis during the year ended September 30, 2009. Implementation of this new payment methodology was retroactive to October 1, 2008, and is also expected to negatively impact premium rates paid to Health Choice going forward. Based upon the risk score adjustment factors provided by AHCCCS, we have estimated slight reductions in our future capitation premium rates. If our estimates are incorrect or if AHCCCS makes further alterations to the payment structure of its contracts, our results of operations and cash flows could be materially impacted.
Significant Competition From Other Healthcare Companies And State Efforts To Regulate The Sale Of Not-For-Profit Hospitals May Affect Our Ability To Acquire Hospitals.
One element of our business strategy is to expand through selective acquisitions of hospitals in our existing markets and in new growing markets. We compete for acquisitions with other healthcare companies, some of which have greater competitive advantages or financial resources than us. Therefore, we may not be able to acquire hospitals on terms favorable to us or at all. Additionally, many states, including some where we have hospitals and others where we may in the future acquire hospitals, have adopted legislation regarding the sale or other disposition of hospitals operated by not-for-profit entities. In other states that do not have specific legislation, the attorneys general have demonstrated an interest in these transactions under their general obligations to protect charitable assets from waste. These legislative and administrative efforts focus primarily on the appropriate valuation of the assets divested and the use of the proceeds of the sale by the not-for-profit seller. These review and approval processes can add time to the closing of an acquisition of a not-for-profit hospital and future actions on the state level could seriously delay or even prevent our ability to acquire not-for-profit hospitals in the future.
Difficulties With The Integration Of Acquisitions May Disrupt Our Ongoing Operations.
The process of integrating acquired hospitals may require a disproportionate amount of management’s time and attention, potentially distracting management from its other day-to-day responsibilities. In addition, poor integration of acquired facilities could cause interruptions to our business activities, including those of the acquired facilities. As a result, we may not realize all or any of the anticipated benefits of an acquisition and we may incur significant costs related to the acquisitions or integration of these facilities. In addition, we may acquire hospitals that have unknown or contingent liabilities, including liabilities for failure to comply with healthcare laws and regulations. Although we seek indemnification from prospective sellers covering these matters, we may nevertheless have material liabilities for past activities of acquired hospitals.

 

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Difficulties With Current Construction Projects Or New Construction Projects Would Involve Significant Capital Expenditures Which Could Have An Adverse Impact On Our Liquidity.
As part of our business strategy, we are currently involved or may decide to continue expanding capacity at our existing hospitals, as well as construct an additional hospital or hospitals in the future. Our ability to complete construction of projects on our anticipated budget and schedule would depend on a number of factors, including, but not limited to:
    our ability to control construction costs;
    the ability of general contractors or subcontractors to perform under their contracts;
    adverse weather conditions;
    shortages of labor or materials;
    our ability to obtain necessary licensing and other required governmental authorizations; and
    other unforeseen problems and delays.
As a result of these and other factors, we cannot assure you that we would not experience increased construction costs, or that we would be able to construct any current or future projects as originally planned. In addition, the construction of a new hospital would involve a significant commitment of capital with no revenue associated with the hospital during construction, which could have an adverse impact on our liquidity.
State Efforts To Regulate The Construction Or Expansion Of Hospitals Could Impair Our Ability To Operate And Expand Our Operations.
Some states require healthcare providers to obtain prior approval, known as certificates of need, for:
    the purchase, construction or expansion of healthcare facilities;
    capital expenditures exceeding a prescribed amount; or
    changes in services or bed capacity.
In giving approval, these states consider the need for additional or expanded healthcare facilities or services. Florida and Nevada are the only states in which we currently operate hospitals that have certificate of need laws applicable to acute care hospitals. The failure to obtain any required certificate of need could impair our ability to operate or expand operations.
We Are Dependent On Key Personnel And The Loss Of One Or More Of Our Senior Management Team Or Local Management Personnel Could Have A Material Adverse Effect On Our Business.
Our business strongly depends upon the services and management experience of our senior management team. We depend on the ability of our senior management team and key employees to manage growth successfully and on our ability to attract and retain skilled employees. If any of our executive officers resign or otherwise are unable to serve, our management expertise and ability to deliver healthcare services efficiently and to effectively execute our business strategy could be diminished. If we fail to attract and retain managers at our hospitals and related facilities, our operations could be adversely effected. Moreover, we do not maintain key man life insurance policies on any of our officers.

 

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Our Hospitals Are Subject To Potential Responsibilities And Costs Under Environmental Laws That Could Lead To Material Expenditures Or Liability.
We are subject to various federal, state and local environmental laws and regulations, including those relating to the protection of human health and the environment. We could incur substantial costs to maintain compliance with these laws and regulations. To our knowledge, we have not been and are not currently the subject of any investigations relating to noncompliance with environmental laws and regulations. We could become the subject of future investigations, which could lead to fines or criminal penalties if we are found to be in violation of these laws and regulations. The principal environmental requirements and concerns applicable to our operations relate to proper management of hazardous materials, hazardous waste and medical waste, above-ground and underground storage tanks, operation of boilers, chillers and other equipment, and management of building conditions, such as the presence of mold, lead-based paint or asbestos. Our hospitals engage independent contractors for the transportation and disposal of hazardous waste, and we require that our hospitals be named as additional insureds on the liability insurance policies maintained by these contractors. In addition, we maintain insurance coverage for third-party liability related to the storage tanks located at our facilities in the amount $2.0 million per claim and $25.0 million in the aggregate.
We also may be subject to requirements related to the remediation of substances that have been released into the environment at properties owned or operated by us or our predecessors or at properties where substances were sent for off-site treatment or disposal. These remediation requirements may be imposed without regard to fault, and liability for environmental remediation can be substantial.
If The Fair Value Of Our Reporting Units Declines, A Material Non-Cash Charge To Earnings From Impairment Of Our Goodwill Could Result.
As a result of our annual impairment test during the year ended September 30, 2009, we recorded a $64.6 million non-cash charge to pre-tax earnings related to the impairment of goodwill in our Florida market. We have experienced limitations on our ability to expand in our Florida market as a result of CON restrictions, along with high Medicare utilization and expanded managed care penetration. In addition, we have experienced changes in market conditions and the business mix in our Florida market, which have negatively impacted operating results, producing trends that may not be temporary in nature. As a result, we have written off all goodwill associated with the Florida market, resulting in $717.9 million of remaining goodwill recorded in our financial statements at September 30, 2009. We expect to recover the carrying value of the remaining goodwill through our future cash flows. On an ongoing basis, we evaluate, based on the fair value of our reporting units, whether the carrying value of our goodwill is impaired. If the carrying value of our goodwill is impaired, we may incur additional material non-cash charges to earnings.
Item 2. Properties.
Information with respect to our hospitals and other healthcare related properties can be found in Item 1 of this report under the caption, “Business—Our Properties.”
Additionally, our principal executive offices in Franklin, Tennessee are located in approximately 58,000 square feet of office space. Our office space is leased pursuant to two contracts which both expire on December 31, 2010. Our principal executive offices, hospitals and other facilities are suitable for their respective uses and generally are adequate for our present needs.

 

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Item 3. Legal Proceedings.
On March 31, 2008, the District Court dismissed with prejudice the qui tam complaint against IAS, our parent company. The qui tam action sought monetary damages and civil penalties under the FCA and included allegations that certain business practices related to physician relationships and the medical necessity of certain procedures resulted in the submission of claims for reimbursement in violation of the FCA. The case dates back to March 2005 and became the subject of a subpoena by the OIG in September 2005. In August 2007, the case was unsealed and became a private lawsuit after the Department of Justice declined to intervene. The United States District Judge dismissed the case from the bench at the conclusion of oral arguments on IAS’ motion to dismiss. On April 21, 2008, the court issued a written order dismissing the case with prejudice and entering formal judgment for IAS. On May 7, 2008, the qui tam relator’s counsel filed a Notice of Appeal to the United States Court of Appeals for the Ninth Circuit to appeal the District Court’s dismissal of the case. On May 21, 2008, IAS filed a Notice of Cross-Appeal to the United States Court of Appeals for the Ninth Circuit from a portion of the April 21, 2008 Order and, on July 22, 2008, IAS filed a Motion to Disqualify relator’s counsel related to their misappropriation of information subject to a claim of attorney-client privilege by IAS. On August 21, 2008, the court issued a written order denying IAS’ Motion to Disqualify and resetting the briefing schedule associated with the Ninth Circuit appellate proceedings. On October 21, 2008, the relator filed his appeal brief with the United States Court of Appeals for the Ninth Circuit. IAS filed its cross-appeal brief on January 20, 2009. Currently, the Ninth Circuit appeal is expected to take another six to nine months to complete.
Item 4. Submission of Matters to a Vote of Security Holders.
No matters were submitted to a vote of security holders during the fourth quarter ended September 30, 2009.

 

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PART II
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
There is no established public trading market for our common interests. At September 30, 2009, all of our common interests were owned by IASIS Healthcare Corporation, a Delaware corporation, referred to as IAS.
See Item 12., “Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters,” included elsewhere in this report for information regarding our equity compensation plans.
Item 6. Selected Financial Data.
The following table presents selected historical financial data for the fiscal years ended September 30, 2009, 2008, 2007, 2006 and 2005, and was derived from the audited consolidated financial statements.
Our audited consolidated financial statements referenced above, together with the related report of the independent registered public accounting firm, are included elsewhere in this report. The selected financial information and other data presented below should be read in conjunction with the information contained in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements and the related notes thereto included elsewhere in this report.
                                         
    Year Ended     Year Ended     Year Ended     Year Ended     Year Ended  
    September 30,     September 30,     September 30,     September 30,     September 30,  
    2009     2008     2007     2006     2005  
Statement of Operations Data (1)(6):
                                       
Net revenue
  $ 2,361,972     $ 2,065,536     $ 1,766,079     $ 1,539,577     $ 1,429,429  
Costs and expenses:
                                       
Salaries and benefits
    660,921       632,109       533,792       439,349       410,119  
Supplies
    250,573       231,259       194,915       167,616       166,159  
Medical claims
    592,760       452,055       376,505       347,217       302,204  
Other operating expenses
    325,735       283,123       266,263       223,946       191,538  
Provision for bad debts
    192,563       161,936       136,233       134,614       123,728  
Rentals and leases
    39,127       36,633       31,546       30,277       28,502  
Interest expense, net
    67,890       75,665       71,206       67,124       63,398  
Depreciation and amortization
    97,462       96,741       75,388       69,137       68,358  
Management fees
    5,000       5,000       4,746       4,189       3,791  
Impairment of goodwill (3)
    64,639                          
Hurricane-related property damage (2)
    938       3,589                   4,762  
Business interruption insurance recoveries (4)
                (3,443 )     (8,974 )      
Loss on extinguishment of debt (5)
                6,229              
 
                             
Total costs and expenses
    2,297,608       1,978,110       1,693,380       1,474,495       1,362,559  
 
                             
Earnings from continuing operations before gain (loss) on disposal of assets, minority interests and income taxes
    64,364       87,426       72,699       65,082       66,870  
 
                                       
Gain (loss) on disposal of assets, net
    1,465       (75 )     (1,359 )     913       (231 )
Minority interests
    (9,987 )     (4,437 )     (4,496 )     (3,546 )     (2,891 )
 
                             
 
                                       
Earnings from continuing operations before income taxes
    55,842       82,914       66,844       62,449       63,748  
Income tax expense
    27,576       35,325       25,909       22,515       25,402  
 
                             
 
                                       
Net earnings from continuing operations
    28,266       47,589       40,935       39,934       38,346  
Earnings (loss) from discontinued operations, net of income taxes
    (176 )     (11,275 )     669       (385 )     2,246  
 
                             
 
                                       
Net earnings
  $ 28,090     $ 36,314     $ 41,604     $ 39,549     $ 40,592  
 
                             
 
                                       
Balance Sheet Data (at end of period):
                                       
Cash and cash equivalents
  $ 206,528     $ 80,738     $     $ 95,415     $ 89,097  
Total assets
  $ 2,357,204     $ 2,308,147     $ 2,186,422     $ 1,967,835     $ 1,852,724  
Long-term debt and capital lease obligations (including current portion)
  $ 1,059,837     $ 1,114,622     $ 1,031,657     $ 896,945     $ 904,808  
Member’s equity
  $ 780,847     $ 727,769     $ 691,514     $ 656,496     $ 616,947  
 
     
(1)   The results of Glenwood and Alliance are included from January 31, 2007 and May 31, 2007, respectively, their dates of acquisition.

 

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(2)   Results for the years ended September 30, 2009 and 2008, include an adverse financial impact totaling $938,000 and $3.6 million, respectively, before income taxes related to property damage sustained at The Medical Center of Southeast Texas, as a result of Hurricane Ike. Results for the year ended September 30, 2005, include an adverse financial impact totaling $4.8 million before income taxes related to property damage sustained at The Medical Center of Southeast Texas, as a result of Hurricane Rita.
 
(3)   Results for the year ended September 30, 2009, include a $64.6 million non-cash charge ($43.2 million after taxes) related to the impairment of goodwill in our Florida market.
 
(4)   Results for the years ended September 30, 2007 and 2006, include $3.4 million and $9.0 million, respectively, of business interruption insurance recoveries received in connection with the temporary closure and disruption of operations at The Medical Center of Southeast Texas, as a result of Hurricane Rita. Cumulative business interruption insurance recoveries of $12.4 million received through fiscal 2007 were reduced by related insurance deductibles of $4.6 million.
 
(5)   Results for the year ended September 30, 2007, include a $6.2 million loss on extinguishment of debt related to the refinancing of our senior secured credit facilities.
 
(6)   Excludes Mesa General Hospital and Biltmore Surgery Center, where operations were discontinued effective May 31, 2008 and April 30, 2008, respectively.
Selected Operating Data
The following table sets forth certain unaudited operating data for each of the periods presented.
                         
    Year Ended September 30,  
    2009     2008     2007  
Acute Care (1)
                       
Number of acute care hospital facilities at end of period (2)
    15       15       15  
Beds in service at end of period
    2,853       2,644       2,565  
Average length of stay (days) (3)
    4.7       4.7       4.6  
Occupancy rates (average beds in service)
    47.0 %     48.9 %     49.5 %
Admissions (4)
    101,083       101,302       92,198  
Adjusted admissions (5)
    169,721       165,819       150,774  
Patient days (6)
    473,601       471,853       427,244  
Adjusted patient days (5)
    762,234       741,466       669,999  
Net patient revenue per adjusted admission
  $ 9,703     $ 9,101     $ 8,639  
 
                       
Health Choice:
                       
Medicaid covered lives
    187,104       142,193       122,437  
Dual-eligible lives (7)
    3,659       3,300       3,482  
Medical loss ratio (8)
    86.1 %     85.2 %     85.2 %
 
     
(1)   Excludes Mesa General Hospital, which discontinued services effective May 31, 2008.
 
(2)   Excludes St. Luke’s Behavioral Hospital.
 
(3)   Represents the average number of days that a patient stayed in our hospitals.
 
(4)   Represents the total number of patients admitted to our hospitals for stays in excess of 23 hours. Management and investors use this number as a general measure of inpatient volume.
 
(5)   Adjusted admissions and adjusted patient days are general measures of combined inpatient and outpatient volume. We compute adjusted admissions/patient days by multiplying admissions/patient days by gross patient revenue and then dividing that number by gross inpatient revenue.
 
(6)   Represents the number of days our beds were occupied by inpatients over the period.
 
(7)   Represents members eligible for Medicare and Medicaid benefits under Health Choice’s contract with CMS to provide coverage as a MAPD SNP.
 
(8)   Represents medical claims expense as a percentage of premium revenue, including claims paid to our hospitals.

 

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The following discussion and analysis of financial condition and results of operations should be read in conjunction with our audited consolidated financial statements, the notes to our audited consolidated financial statements, and the other financial information appearing elsewhere in this report. We intend for this discussion to provide you with information that will assist you in understanding our financial statements, the changes in certain key items in those financial statements from year to year, and the primary factors that accounted for those changes. It includes the following sections:
    Forward Looking Statements;
    Executive Overview;
    Critical Accounting Policies and Estimates;
    Results of Operations Summary;
    Liquidity and Capital Resources;
    Off-Balance Sheet Arrangements; and
    Recent Accounting Pronouncements.
Data for the fiscal years ended September 30, 2009, 2008 and 2007, has been derived from our audited consolidated financial statements. References herein to “we,” “us,” “our” and “our company” are to IASIS Healthcare LLC and its subsidiaries, unless indicated otherwise.
FORWARD LOOKING STATEMENTS
Some of the statements we make in this annual report on Form 10-K are forward-looking within the meaning of the federal securities laws, which are intended to be covered by the safe harbors created thereby. Those forward-looking statements include all statements that are not historical statements of fact and those regarding our intent, belief or expectations including, but not limited to, the discussions of our operating and growth strategy (including possible acquisitions and dispositions), financing needs, projections of revenue, income or loss, capital expenditures and future operations. Forward-looking statements involve known and unknown risks and uncertainties that may cause actual results in future periods to differ materially from those anticipated in the forward-looking statements.
Those risks and uncertainties include, among others, the risks and uncertainties discussed under Item 1A, “Risk Factors” in this Annual Report on Form 10-K. Although we believe that the assumptions underlying the forward-looking statements contained in this report are reasonable, any of these assumptions could prove to be inaccurate and, therefore, there can be no assurance that the forward-looking statements included in this report will prove to be accurate. In light of the significant uncertainties inherent in the forward-looking statements included in this report, you should not regard the inclusion of such information as a representation by us or any other person that our objectives and plans will be achieved. We undertake no obligation to publicly release any revisions to any forward-looking statements contained herein to reflect events and circumstances occurring after the date hereof or to reflect the occurrence of unanticipated events.

 

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EXECUTIVE OVERVIEW
We are a leading owner and operator of medium-sized acute care hospitals in high-growth urban and suburban markets. We operate our hospitals with a strong community focus by offering and developing healthcare services targeted to the needs of the markets we serve, promoting strong relationships with physicians and working with local managed care plans. At September 30, 2009, we owned or leased 15 acute care hospital facilities and one behavioral health hospital facility, with a total of 2,853 beds in service, located in six regions:
    Salt Lake City, Utah;
    Phoenix, Arizona;
    Tampa-St. Petersburg, Florida;
    three cities in Texas, including San Antonio;
    Las Vegas, Nevada; and
    West Monroe, Louisiana.
We also own and operate Health Choice, a Medicaid and Medicare managed health plan in Phoenix.
Revenue and Volume Trends
Net revenue is comprised of acute care and premium revenue. Net revenue for the year ended September 30, 2009, increased 14.4% to $2.4 billion, compared to $2.1 billion in the prior year. Acute care revenue contributed $138.7 million to the increase in total net revenue for the year ended September 30, 2009, while premium revenue contributed $157.8 million.
Acute Care Revenue
Acute care revenue is comprised of net patient revenue and other revenue. A large percentage of our hospitals’ net patient revenue consists of fixed payment, discounted sources, including Medicare, Medicaid and managed care organizations. Reimbursement for Medicare and Medicaid services are often fixed regardless of the cost incurred or the level of services provided. Similarly, a greater percentage of the managed care companies we contract with reimburse providers on a fixed payment basis regardless of the costs incurred or the level of services provided. Net patient revenue is reported net of discounts and contractual adjustments. Contractual adjustments principally result from differences between the hospitals’ established charges and payment rates under Medicare, Medicaid and various managed care plans. Additionally, discounts and contractual adjustments result from our uninsured discount and charity care programs. Other revenue includes medical office building rental income and other miscellaneous revenue.
Admissions decreased 0.2% and adjusted admissions increased 2.4%, respectively, for the year ended September 30, 2009, compared to the prior year. While our volume has benefitted from the continued improvements at Mountain Vista in Mesa, Arizona, our newest hospital which opened in July 2007, as well as the recent opening of the patient tower projects at Jordan Valley Medical Center and Davis Hospital and Medical Center, in our Utah market, we believe that volume has been negatively impacted, in part, by the effect of the prolonged economic recession. Along with impact of rising unemployment, we believe the economic recession resulted in patient decisions to defer or cancel elective and non-emergent healthcare procedures until their conditions became more acute, particularly in the first half of our fiscal year. Volume growth has improved in the second half of our fiscal year, as compared to the first half. Additionally, we have experienced a shift in our service mix to more outpatient procedures, particularly in service lines such as cardiology, bariatrics and diagnostic imaging, as well as other services. The shift in our service mix is part of an industry trend, as a result of advances in pharmaceutical and medical technologies, where services once performed on an inpatient basis are being converted to outpatient procedures. Given the shift in our service mix and the current economic environment, we anticipate our inpatient volumes could continue to be negatively impacted over the near term. Despite the near term impact from these factors, we believe our volumes over the long-term will grow as a result of our business strategies, including our recent capital investments, and the general aging of the population.

 

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The following table provides the sources of our gross patient revenue by payor for the years ended September 30, 2009, 2008 and 2007.
                         
    Year Ended September 30,  
    2009     2008     2007  
Medicare
    31.1 %     31.9 %     30.7 %
Managed Medicare
    11.5       10.9       9.4  
Medicaid
    8.4       7.2       7.2  
Managed Medicaid
    11.2       10.6       10.4  
Managed care
    32.8       34.7       37.1  
Self-pay
    5.0       4.7       5.2  
 
                 
Total
    100.0 %     100.0 %     100.0 %
 
                 
Since the implementation of the Medicare Advantage program, including Medicare Part D coverage, we have experienced a shift of traditional Medicare beneficiaries to managed Medicare. We expect patient volumes in Medicare and managed Medicare to increase over the long-term due to the general aging of the population. In addition, as a result of the current economic climate and related increase in unemployment, we expect patient volumes and revenue from Medicaid and managed Medicaid, as well as self-pay, to increase over the near term. Conversely, the economic downturn has resulted in a decline in commercial and managed care enrollment and volumes.
Net patient revenue per adjusted admission increased 6.6% for the year ended September 30, 2009, compared to the prior year. Our net patient revenue per adjusted admission has benefited from increases in managed care rates, the increase in supplemental Medicaid reimbursement in our Texas market, as well as improvements in acuity and pricing at Mountain Vista. While our net patient revenue per adjusted admission continues to increase, the reduced rates of growth we have experienced compared to the prior years are the result of recent industry pressures, including the shift in our service mix to more outpatient procedures, a decline in commercial and managed care volumes, moderating rate increases from commercial and managed care payors, frozen or state cuts in Medicaid reimbursement rates and as a result of the current economic environment, the impact of an increasing uninsured and indigent population on charity care and Medicaid enrollment. These general industry pricing pressures, along with the consolidation of payors in certain markets, may result in reduced reimbursement from managed care organizations in future periods. Such consolidation of managed care organizations has resulted in a greater focus on case management, as well as increased efforts by payors to align themselves with networks of providers in certain markets in which we operate.
Certain of our acute care hospitals receive supplemental Medicaid reimbursement, including reimbursement from programs for participating private hospitals that enter into indigent care affiliation agreements with public hospitals or county governments in the state of Texas. Under the CMS approved programs, affiliated hospitals, including our Texas hospitals, have expanded the community healthcare safety net by providing indigent healthcare services. Participation in indigent care affiliation agreements by our Texas hospitals has resulted in an increase in acute care revenue by virtue of the hospitals’ entitlement to supplemental Medicaid inpatient reimbursement. Revenue recognized under these Texas private supplemental Medicaid reimbursement programs for the year ended September 30, 2009, was $57.2 million, compared to $22.4 million in the prior year.
We offer discounts to all uninsured patients receiving healthcare services who do not qualify for assistance under state Medicaid, other federal or state assistance plans, or charity care. We provided uninsured discounts totaling $69.7 million, $57.9 million and $50.3 million for the years ended September 30, 2009, 2008 and 2007, respectively.
Premium Revenue
Premium revenue generated under the AHCCCS and CMS contracts with Health Choice represented 29.6%, 26.2% and 25.5% of our consolidated net revenue for the years ended September 30, 2009, 2008 and 2007, respectively. Most premium revenue at Health Choice is derived through a contract with AHCCCS to provide specified health services to qualified Medicaid enrollees through contracted providers. AHCCCS is the state agency that administers Arizona’s Medicaid program. The contract requires Health Choice to arrange for healthcare services for enrolled Medicaid patients in exchange for fixed monthly premiums, based upon negotiated per capita member rates, and supplemental payments from AHCCCS. Health Choice also contracts with CMS to provide coverage as a MAPD SNP. This contract allows Health Choice to offer Medicare and Part D drug benefit coverage to new and existing dual-eligible members (i.e. those that are eligible for Medicare and Medicaid).

 

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Effective October 1, 2008, Health Choice began its current contract with AHCCCS, which provides for a three-year term, with AHCCCS having the option to renew for two additional one-year periods. The new contract, which continues our state-wide presence, covers Medicaid members in the following Arizona counties: Apache, Coconino, Maricopa, Mohave, Navajo, Pima, Yuma, La Paz and Santa Cruz. As a result of our current contract and increasing enrollment in the state program attributable to a rising indigent population resulting from the prolonged economic recession, Health Choice’s enrollment through its AHCCCS contract at September 30, 2009, exceeded 187,000 members, compared to over 142,000 members in the prior year. While we anticipate our membership will continue to increase in the near term, we cannot guarantee the continued growth of our membership.
In connection with our contract effective October 1, 2008, AHCCCS implemented a risk-based or severity-adjusted payment methodology for all health plans, which resulted in a reduction to our premium revenue on a per member per month basis during the year ended September 30, 2009. Implementation of this new payment methodology was retroactive to October 1, 2008, and is also expected to negatively impact premium rates paid to Health Choice going forward. Based upon the risk score adjustment factors provided by AHCCCS, we have estimated slight reductions in our future capitation premium rates.
Premiums received from AHCCCS and CMS to provide services to our members have been impacted by moderating rate increases. Additionally, the state of Arizona has faced and is currently facing significant budgetary concerns. As a result, the state legislature passed a fiscal 2010 budget on July 1, 2009, that includes AHCCCS funding at a lower rate of growth than in prior years, but does include funding for medical cost inflation and increased enrollment in the program. In regards to the fiscal 2010 year, depending on member mix, we generally believe Health Choice could experience flat to slightly declining rates received on a per member per month basis, which may negatively impact our premium revenue. In addition, there are a number of alternatives being considered to address Arizona’s budget concerns, including increases in sales and property taxes, a reduction in AHCCCS’ total expenditures, a reduction in rates paid by AHCCCS to facilities, and elimination of KidsCare, Arizona’s Children’s Health Insurance Program.
Significant Industry Trends
The following paragraphs discuss recent trends that we believe are significant factors in our current and/or future operating results and cash flows. Certain of these trends apply to the entire acute care hospital industry while others may apply to us more specifically. These trends could be short-term in nature or could require long-term attention and resources. While these trends may involve certain factors that are outside of our control, the extent to which these trends affect our hospitals and our ability to manage the impact of these trends play vital roles in our current and future success. In many cases, we are unable to predict what impact, if any, these trends will have on us.
General Economic Environment
The U.S. economy has weakened significantly as a result of the effects of a prolonged economic recession. Tightened credit markets, depressed consumer spending and higher unemployment rates continue to pressure many industries, including the healthcare industry. During economic downturns, governmental entities often experience budgetary constraints as a result of increased costs and lower than expected tax collections. These budgetary constraints may result in decreased spending for health and human service programs, including Medicare, Medicaid and similar programs, which represent significant payor sources for our hospitals. Other risks we face from the general economic weakness include patient decisions to defer or cancel elective and non-emergent healthcare procedures until their conditions become more acute. These economically challenging times have resulted in increases in the uninsured and under-insured population, often as a result of job losses and continued shifts in healthcare payment responsibility from employers to employees, resulting in further difficulties in our ability to collect patient co-payment and deductible receivables.
Value-Based Reimbursement
There is a trend in the healthcare industry towards value-based purchasing of healthcare services. These value-based purchasing programs include both public reporting and financial incentives tied to the quality and efficiency of care provided by facilities. The House Reform Bill and the reform bill under consideration in the U.S. Senate would expand value-based purchasing initiatives as well. We expect programs of this type to become more common in the healthcare industry.

 

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Since 2003, Medicare has required providers to report certain quality measures in order to receive full reimbursement increases that previously were awarded automatically. CMS has expanded, through a series of rulemakings, the number of patient care indicators that hospitals must report. CMS currently requires hospitals to report 46 quality measures in order to qualify for the full market basket update to the inpatient prospective payment system for fiscal year 2011. CMS also requires hospitals to submit quality data regarding eleven measures relating to outpatient care in order to receive the full market basket increase under the outpatient prospective payment system in calendar year 2011. We anticipate that CMS will continue to expand the number of inpatient and outpatient quality measures. We have invested significant capital in the implementation of our advanced clinical system that assists us in reporting these quality measures. CMS makes the data submitted by hospitals, including our hospitals, public on its website.
For discharges on or after October 1, 2008, Medicare no longer pays hospitals additional amounts for the treatment of certain preventable adverse events, also known as hospital-acquired conditions, unless the condition was present at admission. Currently, there are ten categories of conditions on the list of hospital-acquired conditions. On January 15, 2009, CMS announced three NCDs that prohibit Medicare reimbursement for erroneous surgical procedures performed on an inpatient or outpatient basis. These three erroneous surgical procedures are in addition to the hospital-acquired conditions designated by CMS by regulation. DEFRA provides that CMS may revise the list of hospital-acquired conditions from time to time. Additionally, the House Reform Bill passed by the U.S. House of Representatives in November 2009 would codify limitations of payment for health-care acquired conditions. The House Reform Bill addresses quality and value based purchasing through a variety of initiatives, including requiring public reporting and posting of healthcare associated infections, reducing payments to hospitals with excessive inpatient readmissions, establishing a process for adding and evaluating quality measures to be reported to CMS, and establishing a Center for Quality Improvement that would be charged with implementing best practices for healthcare delivery. The House Reform Bill also commissions the Institute of Medicine to study spending and high value healthcare in order to issue a proposal by 2011 of how to revise the Medicare payment system to encourage value based purchasing of healthcare services. Currently, the U.S. Senate is considering a reform bill, which would require implementation of a value-based purchasing system for hospitals. It is uncertain whether these or other quality-related provisions will become law.
Many large commercial payors currently require providers to report quality data. Several commercial payors have announced that they will stop reimbursing hospitals for certain preventable adverse events. A number of state hospital associations have also announced policies addressing the waiver of patient bills for care related to a serious adverse event. In addition, managed care organizations may begin programs that condition payment on performance against specified measures. The quality measurement criteria used by commercial payors may be similar to or even more stringent than Medicare requirements.
We expect these trends towards value-based purchasing of healthcare services by Medicare and other payors to continue. Because of these trends, our ability to demonstrate quality of care in our facilities could significantly impact our operating results in the future.
Physician Integration
In an effort to meet community needs and address coverage issues, we continue to recruit and employ physicians with primary emphasis on family practice and internal medicine, general surgery, hospitalists, obstetrics and gynecology, cardiology, neurology and orthopedics. Our ability to attract and retain skilled physicians to our hospitals is critical to our success and is affected by the quality of care at our hospitals. This is one reason we have taken significant steps in implementing our expanded quality of care initiatives. We believe intense efforts focusing on quality of care will enhance our ability to recruit and retain the skilled physicians necessary to make our hospitals successful.
We experience certain risks associated with the integration of medical staffs at our hospitals. As we continue to focus on our physician employment strategy, we face significant competition for skilled physicians in certain of our markets as more providers adopt a physician staffing model approach, coupled with a general shortage of physicians across most specialties. This increased competition has resulted in efforts by managed care organizations to align with certain provider networks in the markets in which we operate. We expect that employing physicians should provide relief on cost pressures associated with on-call coverage and other professional fees. However, we anticipate incurring additional labor and other start-up related costs as we continue the integration of employed physicians.

 

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We also face risk from competition for outpatient business. We expect to mitigate this risk through continued focus on our physician employment strategy, our commitment to capital investment in our hospitals, including updated technology and equipment, and our commitment to our quality of care initiatives that some competitors, including individual physicians or physician groups, may not be equipped to implement.
Growth in Uncompensated Care
Like others in the hospital industry, we continue to experience increases in our uncompensated care, including charity care and our provision for bad debts. This increase is driven by growth in the number of uninsured patients seeking care at our hospitals, as well as increases in the amount of co-payments and deductibles as employers continue to pass more of these costs on to their employees. In addition, as a result of the effects of a prolonged economic recession and rising unemployment, we believe that our hospitals may continue to experience growth in bad debts and charity care. While the volume of patients registered as uninsured continues to increase, we continue to be successful in qualifying many of these uninsured patients for Medicaid or other third-party coverage. More recently, our provision for bad debts has been increasingly affected by the volume of under-insured patients or patient balances after insurance. As a result of rising unemployment, increasing healthcare costs and other factors beyond our control, collections of these patient balances may become more difficult. Accordingly, we continue to monitor our self-pay admissions on a daily basis and continue to focus on the efficiency of our emergency rooms, point-of-service cash collections, Medicaid eligibility automation and process-flow improvements. At September 30, 2009, our accounts receivable included self-pay balances after insurance of $37.3 million, as compared to $36.4 million at September 30, 2008. We anticipate that if we experience further growth in self-pay volume and revenue, along with continued increases in co-payments and deductibles for insured patients, our provision for bad debts will continue to increase and our results of operations could be adversely affected.
The percentages of insured and uninsured gross hospital receivables (prior to allowances for contractual adjustments and doubtful accounts) are summarized as follows:
                 
    September 30,     September 30,  
    2009     2008  
Insured receivables
    62.0 %     64.8 %
Uninsured receivables
    38.0 %     35.2 %
 
           
 
               
Total
    100.0 %     100.0 %
 
           
The percentages in the table above are calculated using gross receivable balances. Uninsured and insured receivables are net of discounts and contractual adjustments recorded at the time of billing. Included in insured receivables are accounts that are pending approval from Medicaid. These receivables were approximately 3.2% and 3.0% of gross hospital receivables at September 30, 2009 and 2008, respectively.
The percentages of gross hospital receivables in summarized aging categories are as follows:
                 
    September 30,     September 30,  
    2009     2008  
0 to 90 days
    69.4 %     67.5 %
91 to 180 days
    18.1 %     17.9 %
Over 180 days
    12.5 %     14.6 %
 
           
 
               
Total
    100.0 %     100.0 %
 
           
Sub-Acute Care Services
Inpatient care is expanding to include sub-acute care when a less intensive, lower cost level of care is appropriate. We have been proactive in the development of a variety of sub-acute inpatient services to utilize a portion of our available capacity. By offering cost-effective sub-acute services in appropriate circumstances, we are able to provide a continuum of care when the demand for such services exists. We have identified opportunities to expand sub-acute services within our facilities as appropriate, including inpatient psychiatric and rehabilitation.

 

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Changes in Patient Service Mix
From an industry trend perspective, a number of procedures once performed only on an inpatient basis have been and will continue to be converted to outpatient procedures, as a result of advances in pharmaceutical and medical technologies. We have continued to experience a shift in our patient service mix to more outpatient procedures, in areas such as cardiovascular, bariatrics, diagnostic imaging and other services. Generally, the payments we receive for outpatient procedures are less than those for similar procedures performed in an inpatient setting.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Our consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles. In preparing our financial statements, we make estimates, judgments and assumptions that affect the reported amounts of assets and liabilities at the dates of the financial statements and the reported amounts of revenue and expenses during the reporting periods. Actual results could differ from those estimates.
We have determined an accounting estimate to be critical if: (1) the accounting estimate requires us to make assumptions about matters that were highly uncertain at the time the accounting estimate was made and (2) changes in the estimate would have a material impact on our financial condition or results of operations. There are other items within our financial statements that require estimation but are not deemed critical as defined herein. Changes in estimates used in these and other items could have a material impact on our financial statements.
Allowance for Doubtful Accounts. Our ability to collect outstanding receivables from third-party payors and patients is critical to our operating performance and cash flows. The primary collection risk lies with uninsured patient accounts or patient accounts for which primary insurance has paid but a patient portion remains outstanding. The provision for bad debts and the allowance for doubtful accounts relate primarily to amounts due directly from patients. Our estimation of the allowance for doubtful accounts is based primarily upon the type and age of the patient accounts receivable and the effectiveness of our collection efforts. Our policy is to reserve a portion of all self-pay receivables, including amounts due from the uninsured and amounts related to co-payments and deductibles, as these charges are recorded. We monitor our accounts receivable balances and the effectiveness of our reserve policies on a monthly basis and review various analytics to support the basis for our estimates. These efforts primarily consist of reviewing the following:
    Historical write-off and collection experience using a hindsight or look-back approach;
    Revenue and volume trends by payor, particularly the self-pay components;
    Changes in the aging and payor mix of accounts receivable, including increased focus on accounts due from the uninsured and accounts that represent co-payments and deductibles due from patients;
    Cash collections as a percentage of net patient revenue less bad debt expense;
    Trending of days revenue in accounts receivable; and
    Various allowance coverage statistics.
We regularly perform hindsight procedures to evaluate historical write-off and collection experience throughout the year to assist in determining the reasonableness of our process for estimating the allowance for doubtful accounts. We do not pursue collection of amounts related to patients who qualify for charity care under our guidelines. Charity care accounts are deducted from gross revenue and do not affect the provision for bad debts.
At September 30, 2009, our self-pay receivables, including amounts due from uninsured patients and co-payment and deductible amounts due from insured patients, were $162.4 million and our allowance for doubtful accounts was $126.1 million. Excluding third-party settlement balances, days revenue in accounts receivable were 49 days at September 30, 2009, compared to 53 days at September 30, 2008. For the year ended September 30, 2009, the provision for bad debts increased to 11.5% of acute care revenue, compared to 10.6% in the prior year. Significant changes in payor mix or business office operations could have a significant impact on the provision for bad debts, as well as our results of operations and cash flows.

 

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Allowance for Contractual Discounts and Settlement Estimates. We derive a significant portion of our net patient revenue from Medicare, Medicaid and managed care payors that receive discounts from our standard charges. For the years ended September 30, 2009, 2008 and 2007, Medicare, Medicaid and managed care revenue together accounted for 88.9%, 90.9% and 90.5%, respectively, of our hospitals’ net patient revenue.
We estimate contractual discounts and allowances based upon payment terms outlined in our managed care contracts, by federal and state regulations for the Medicare and various Medicaid programs, and in accordance with terms of our uninsured discount program. Contractual discounts for most of our patient revenue are determined by an automated process that establishes the discount on a patient-by-patient basis. The payment terms or fee schedules for most payors have been entered into our patient accounting systems. Automated (system-generated) contractual discounts are recorded, at the time a patient account is billed, based upon the system-loaded payment terms. In certain instances for payors that are not significant or who have not entered into a contract with us, we make manual estimates in determining contractual allowances based upon historical collection rates. At the end of each month, we estimate contractual allowances for all unbilled accounts based on payor-specific six-month average contractual discount rates.
For governmental payors such as Medicare and Medicaid, we determine contractual discounts or allowances based upon the program’s reimbursement (payment) methodology (i.e. either prospectively determined or retrospectively determined based on costs as defined by the government payor). These contractual discounts are determined by an automated process in a manner similar to the process used for managed care revenue. Under prospective payment programs, we record contractual discounts based upon predetermined reimbursement rates. For retrospective cost-based revenues, which are less prevalent, we estimate contractual allowances based upon historical and current factors which are adjusted as necessary in future periods, when final settlements of filed cost reports are received. Net adjustments to estimated third-party payor settlements, also known as prior year contractuals, resulted in an increase in acute care revenue of $3.2 million, $1.0 million and $365,000 for the years ended September 30, 2009, 2008 and 2007, respectively.
Management continually reviews the contractual estimation process to consider and incorporate updates to laws and regulations and the frequent changes in managed care contractual terms that result from contract renegotiations and renewals. All contractual adjustments, regardless of type of payor or method of calculation, are reviewed and compared to actual payment experience on an individual patient account basis. Discrepancies between expected and actual payments are reviewed, and as necessary, appropriate corrections to the patient accounts are made to reflect actual payments received. If a discrepancy exists between the payment terms loaded into the contract management system and the actual discount based on payments received, the system is updated accordingly to ensure appropriate discounting of future charges.
Additionally, we rely on other analytical tools to ensure our contractual discounts are reasonably estimated. These include, but are not limited to, monitoring of collection experience by payor, reviewing total patient collections as a percentage of net patient revenue (adjusted for the provision for bad debts) on a trailing twelve-month basis, gross to net patient revenue comparisons, contractual allowance metrics, etc. As well, patient accounts are continually reviewed to ensure all patient accounts reflect either system-generated discounts or estimated contractual allowances, as necessary.
Medicare and Medicaid regulations and various managed care contracts are often complex and may include multiple reimbursement mechanisms for different types of services provided in our healthcare facilities, requiring complex calculations and assumptions which are subject to interpretation. Additionally, the services authorized and provided and resulting reimbursement are often subject to interpretation. These interpretations sometimes result in payments that differ from our estimates. Additionally, updates to regulations and contract renegotiations occur frequently, necessitating continual review and assessment of the estimation process by management. We have made significant investments in our patient accounting information systems, human resources and internal controls, which we believe greatly reduces the likelihood of a significant variance occurring between the recorded and estimated contractual discounts. Given that most of our contractual discounts are pre-defined or contractually based, and as a result of continual internal monitoring processes and our use of analytical tools, we believe the aggregate differences between amounts recorded for initial contractual discounts and final contractual discounts resulting from payments received are not significant. Finally, we believe that having a wide variety and large number of managed care contracts that are subject to review and administration on a hospital-by-hospital basis minimizes the impact on the Company’s net revenue of any imprecision in recorded contractual discounts caused by the system-load of payment terms of a particular payor. We believe that our systems and processes, as well as other items discussed, provide reasonable assurance that any change in estimate related to contractual discounts is immaterial to our financial position, results of operations and cash flows.

 

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Insurance Reserves. Given the nature of our operating environment, we may become subject to medical malpractice or workers compensation claims or lawsuits. We maintain third-party insurance coverage for individual malpractice and workers compensation claims to mitigate a portion of this risk. In addition, we maintain excess coverage limiting our exposure to an aggregate annual amount for claims. We estimate our reserve for self-insured professional and general liability and workers compensation risks using historical claims data, demographic factors, severity factors, current incident logs and other actuarial analysis. At September 30, 2009 and 2008, our professional and general liability accrual for asserted and unasserted claims was $41.7 million and $34.3 million, respectively. For the year ended September 30, 2009, our total premiums and self-insured retention cost for professional and general liability insurance was $25.5 million, compared with $15.9 million in the prior year.
The estimated accrual for medical malpractice and workers compensation claims could be significantly affected should current and future occurrences differ from historical claims trends. The estimation process is also complicated by the complexity and changing nature of tort reform in the states in which we operate. While we monitor current claims closely and consider outcomes when estimating our insurance accruals, the complexity of the claims and wide range of potential outcomes often hampers timely adjustments to the assumptions used in the estimates.
Valuations from our independent actuary for professional and general liability losses resulted in a change in related estimates for prior years which decreased professional and general liability expense by the following amounts (in millions):
         
Year ended September 30, 2009
  $ (1.2 )
Year ended September 30, 2008
  $ (6.8 )
Year ended September 30, 2007
  $ (6.6 )
Our estimate of the reserve for professional and general liability claims is based upon actuarial calculations that are completed semi-annually. The changes in estimates noted above were recognized in the periods in which the independent actuarial calculations were received. The key assumptions underlying the development of our estimate (loss development, trends and increased limits factors) have not changed materially, as they are largely based upon professional liability insurance industry data published by the Insurance Services Office (“ISO”), a leading provider of data, underwriting, risk management and legal/regulatory services. The reductions in professional and general liability expense related to changes in prior year estimates reflected above for the years ended September 30, 2009, 2008 and 2007, are the result of better than expected claims experience as compared to the industry benchmarks for loss development included in the original actuarial estimate.
Sensitivity in the estimate of our professional and general liability claims reserve is reflected in various actuarial confidence levels. We utilize a statistical confidence level of 50% in developing our best estimate of the reserve for professional and general liability claims. Higher statistical confidence levels, while not representative of our best estimate, provide a range of reasonably likely outcomes upon resolution of the related claims. The following table outlines our reported reserve amounts compared to reserve levels established at the higher statistical confidence levels.
         
As reported at September 30, 2009
  $ 41.7  
75% Confidence Level
  $ 48.9  
90% Confidence Level
  $ 60.8  

 

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Valuations from our independent actuary for workers’ compensation losses resulted in a change in related estimates for prior years which increased (decreased) workers’ compensation expense by the following amounts (in millions):
         
Year ended September 30, 2009
  $ (0.5 )
Year ended September 30, 2008
  $ 0.8  
Year ended September 30, 2007
  $ (1.0 )
Medical Claims Payable. Medical claims expense, including claims paid to our hospitals, was $602.1 million, $461.6 million and $384.0 million, or 86.1%, 85.2% and 85.2% of premium revenue, for the years ended September 30, 2009, 2008 and 2007, respectively. For the years ended September 30, 2009, 2008 and 2007, $9.3 million, $9.6 million and $7.5 million, respectively, of health plan payments made to hospitals and other healthcare entities owned by us for services provided to our enrollees were eliminated in consolidation.
The following table shows the components of the change in medical claims payable for the years ended September 30, 2009 and 2008 (in thousands):
                 
    Year Ended     Year Ended  
    September 30,     September 30,  
    2009     2008  
Medical claims payable as of October 1
  $ 97,343     $ 81,309  
Medical claims expense incurred during the year:
               
Related to current year
    620,153       464,055  
Related to prior years
    (18,077 )     (2,406 )
 
           
Total expenses
    602,076       461,649  
 
           
Medical claims payments during the year:
               
Related to current year
    (508,299 )     (368,392 )
Related to prior years
    (77,601 )     (77,223 )
 
           
Total payments
    (585,900 )     (445,615 )
 
           
Medical claims payable as of September 30
  $ 113,519     $ 97,343  
 
           
As reflected in the table above, medical claims expense for the year ended September 30, 2009, includes an $18.1 million reduction of medical costs related to prior years resulting from favorable development in the Medicaid and Medicare product lines of $15.5 million and $2.6 million, respectively. The favorable development is attributable to lower than anticipated medical costs and is offset, in part, by $10.8 million in reductions in premium revenue associated with settlements of various prior year program receivables.
We estimate our medical claims payable using historical claims experience (including severity and payment lag time) and other actuarial analysis including number of enrollees, age of enrollees and certain enrollee health indicators to predict the cost of healthcare services provided to enrollees during any given period. While management believes that its estimation methodology effectively captures trends in medical claims costs, actual payments could differ significantly from our estimates given changes in healthcare costs or adverse experience. For example, our medical claims payable is primarily composed of estimates related to the most recent three months and periods prior to the most recent three months. The claims trend factor, which is developed through a comprehensive analysis of claims incurred in prior months, is the most significant component used in developing the claims liability estimates for the most recent three months. The completion factor is an actuarial estimate, based upon historical experience, of the percentage of incurred claims during a given period that have been adjudicated as of the date of estimation. The completion factor is the most significant component used in developing the claims liability estimates for the periods prior to the most recent three months. The following table illustrates the sensitivity of our medical claims payable at September 30, 2009, and the estimated potential impact on our results of operations, to changes in these factors that management believes are reasonably likely based upon our historical experience and currently available information (dollars in thousands):
                                 
Claims Trend Factor     Completion Factor  
            Increase (Decrease) in             Increase (Decrease) in  
Increase (Decrease) in         Medical Claims     Increase (Decrease) in     Medical Claims  
Factor         Payable     Factor     Payable  
       
 
                       
  (3.0 )%  
 
  $ (4,661 )     1.0 %   $ (5,560 )
  (2.0 )  
 
    (3,103 )     0.5       (2,787 )
  (1.0 )  
 
    (1,552 )     (0.5 )     2,845  
  1.0    
 
    1,564       (1.0 )     5,705  

 

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Goodwill and Other Intangibles. The accounting policies and estimates related to goodwill and other intangibles are considered critical because of the significant impact that impairment could have on our operating results. We record all assets and liabilities acquired in purchase acquisitions, including goodwill, indefinite-lived intangibles, and other intangibles, at fair value as required by Financial Accounting Standards Board (“FASB”) authoritative guidance regarding business combinations. Goodwill, which was $717.9 million at September 30, 2009, is not amortized but is subject to tests for impairment annually or more often if events or circumstances indicate it may be impaired. The initial recording of goodwill and other intangibles requires subjective judgments concerning estimates of the fair value of the acquired assets. An impairment loss is recorded to the extent that the carrying amount of goodwill exceeds its implied fair value. During the year ended September 30, 2009, we recorded a $64.6 million non-cash charge ($43.2 million after tax) related to the impairment of goodwill in our Florida market. Other identifiable intangible assets, net of accumulated amortization, were $30.0 million at September 30, 2009, compared to $33.0 million in the prior year. These are amortized over their estimated useful lives and are evaluated for impairment if events and circumstances indicate a possible impairment. Such evaluation of other intangible assets is based on undiscounted cash flow projections. Estimated cash flows may extend far into the future and, by their nature, are difficult to determine over an extended timeframe. Factors that may significantly affect the estimates include, among others, competitive forces, customer behaviors and attrition, changes in revenue growth trends, cost structures and technology, and changes in discount rates and specific industry or market sector conditions. Other key judgments in accounting for intangibles include useful life and classification between goodwill and indefinite-lived intangibles or other intangibles which require amortization. See “Goodwill and Other Intangibles Assets” in the Notes to Consolidated Financial Statements for additional information regarding intangible assets. To assist in assessing the impact of a goodwill or intangible asset impairment charge at September 30, 2009, we have $747.9 million of goodwill and intangible assets. The impact of a 5% impairment charge would result in a reduction in pre-tax income of approximately $37.4 million.
Income Taxes. Certain tax matters require interpretations of tax law that may be subject to future challenge and may not be upheld under tax audit. Significant judgment is required in determining and assessing the impact of such tax-related contingencies. We establish accruals when, despite our belief that our tax return positions are fully supportable, it is probable that we have incurred a loss related to tax contingencies and the loss or range of loss can be reasonably estimated. We adjust the accruals related to tax contingencies based upon changing facts and circumstances, including the progress of tax audits and legislative, regulatory or judicial developments. Additionally, we estimate and record a valuation allowance to reduce deferred tax assets to the amount we believe is more likely than not to be realized in future periods based on all relevant information. We believe that future income as well as the reversal of deferred tax liabilities will enable us to realize the deferred tax assets we have recorded, net of the valuation allowance we have established.
Effective October 1, 2007, we adopted the provisions of FASB authoritative guidance regarding accounting for uncertainty in income taxes, which prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of all tax positions accounted for in accordance with provisions of FASB authoritative guidance regarding accounting for income taxes. In addition, the provisions related to accounting for uncertainty in income taxes provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. We applied these provisions to all tax positions upon initial adoption of this guidance. Only tax positions that meet the more-likely-than-not recognition threshold at the effective date, October 1, 2007, have been recognized in connection with these provisions.
As a result of adopting the provision regarding accounting for uncertainty in income taxes, we recorded a liability for unrecognized tax benefits of $8.1 million, including accrued interest of $83,000. The adjustment was comprised of a cumulative effect decrease to member’s equity of $59,000, and a decrease to net noncurrent deferred tax liabilities of $8.1 million. An additional $9.9 million of unrecognized tax benefits are reflected as a reduction to deferred tax assets for federal and state net operating losses generated by uncertain tax deductions.
The provision regarding accounting for uncertainty in income taxes permits interest and penalties on underpayments of income taxes to be classified as interest expense, income tax expense, or another appropriate expense classification based on the accounting election of the company. Our policy is to classify interest and penalties as a component of income tax expense.

 

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The estimates, judgments and assumptions used by us under “Allowance for Doubtful Accounts,” “Allowance for Contractual Discounts and Settlement Estimates,” “Insurance Reserves,” “Medical Claims Payable,” “Goodwill and Other Intangibles” and “Income Taxes” are, we believe, reasonable, but involve inherent uncertainties as described above, which may or may not be controllable by management. As a result, the accounting for such items could result in different amounts if management used different assumptions or if different conditions occur in future periods.
RESULTS OF OPERATIONS SUMMARY
Consolidated
The following table sets forth, for the periods indicated, results of consolidated operations expressed in dollar terms and as a percentage of net revenue. Such information has been derived from our audited consolidated statements of operations.
                                                 
    Year Ended     Year Ended     Year Ended  
    September 30, 2009     September 30, 2008     September 30, 2007  
($ in thousands)   Amount     Percentage     Amount     Percentage     Amount     Percentage  
 
                                               
Net revenue:
                                               
Acute care revenue
  $ 1,662,469       70.4 %   $ 1,523,790       73.8 %   $ 1,315,438       74.5 %
Premium revenue
    699,503       29.6 %     541,746       26.2 %     450,641       25.5 %
 
                                   
Total net revenue
    2,361,972       100.0 %     2,065,536       100.0 %     1,766,079       100.0 %
 
                                               
Costs and expenses:
                                               
Salaries and benefits
    660,921       28.0 %     632,109       30.6 %     533,792       30.2 %
Supplies
    250,573       10.6 %     231,259       11.2 %     194,915       11.0 %
Medical claims
    592,760       25.1 %     452,055       21.9 %     376,505       21.3 %
Other operating expenses
    325,735       13.8 %     283,123       13.7 %     266,263       15.1 %
Provision for bad debts
    192,563       8.2 %     161,936       7.8 %     136,233       7.7 %
Rentals and leases
    39,127       1.7 %     36,633       1.8 %     31,546       1.8 %
Interest expense, net
    67,890       2.9 %     75,665       3.7 %     71,206       4.0 %
Depreciation and amortization
    97,462       4.1 %     96,741       4.7 %     75,388       4.3 %
Management fees
    5,000       0.2 %     5,000       0.2 %     4,746       0.3 %
Impairment of goodwill
    64,639       2.7 %                        
Hurricane-related property damage
    938       0.0 %     3,589       0.2 %            
Loss on extinguishment of debt
                            6,229       0.4 %
Business interruption insurance recoveries
                            (3,443 )     (0.2 )%
 
                                   
Total costs and expenses
    2,297,608       97.3 %     1,978,110       95.8 %     1,693,380       95.9 %
 
                                               
Earnings from continuing operations before gain (loss) on disposal of assets, minority interests and income taxes
    64,364       2.7 %     87,426       4.2 %     72,699       4.1 %
 
                                               
Gain (loss) on disposal of assets, net
    1,465       0.1 %     (75 )     (0.0 )%     (1,359 )     (0.1 )%
Minority interests
    (9,987 )     (0.4 )%     (4,437 )     (0.2 )%     (4,496 )     (0.2 )%
 
                                   
 
                                               
Earnings from continuing operations before income taxes
    55,842       2.4 %     82,914       4.0 %     66,844       3.8 %
 
                                               
Income tax expense
    27,576       1.2 %     35,325       1.7 %     25,909       1.5 %
 
                                   
Net earnings from continuing operations
    28,266       1.2 %     47,589       2.3 %     40,935       2.3 %
Earnings (loss) from discontinued operations, net of income taxes
    (176 )     (0.0 )%     (11,275 )     (0.5 )%     669       0.0 %
 
                                   
 
                                               
Net earnings
  $ 28,090       1.2 %   $ 36,314       1.8 %   $ 41,604       2.3 %
 
                                   

 

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Acute Care
The following table sets forth, for the periods indicated, results of our acute care operations expressed in dollar terms and as a percentage of net revenue. Such information has been derived from our audited consolidated statements of operations.
                                                 
    Year Ended     Year Ended     Year Ended  
    September 30, 2009     September 30, 2008     September 30, 2007  
($ in thousands)   Amount     Percentage     Amount     Percentage     Amount     Percentage  
 
                                               
Net revenue:
                                               
Acute care revenue
  $ 1,662,469       99.4 %   $ 1,523,790       99.4 %   $ 1,315,438       99.4 %
Revenue between segments
    9,316       0.6 %     9,594       0.6 %     7,540       0.6 %
 
                                   
Total net revenue (1)
    1,671,785       100.0 %     1,533,384       100.0 %     1,322,978       100.0 %
 
                                               
Costs and expenses:
                                               
Salaries and benefits
    641,893       38.4 %     614,442       40.1 %     518,989       39.2 %
Supplies
    250,310       15.0 %     231,001       15.1 %     194,630       14.7 %
Other operating expenses
    302,804       18.1 %     264,814       17.3 %     251,167       19.0 %
Provision for bad debts
    192,563       11.5 %     161,936       10.6 %     136,233       10.3 %
Rentals and leases
    37,563       2.2 %     35,466       2.3 %     30,384       2.3 %
Interest expense, net
    67,890       4.1 %     75,665       4.9 %     71,206       5.4 %
Depreciation and amortization
    94,014       5.6 %     93,003       6.0 %     71,828       5.4 %
Management fees
    5,000       0.3 %     5,000       0.3 %     4,746       0.4 %
Impairment of goodwill
    64,639       3.9 %                        
Hurricane-related property damage
    938       0.1 %     3,589       0.2 %            
Loss on extinguishment of debt
                            6,229       0.5 %
Business interruption insurance recoveries
                            (3,443 )     (0.3 )%
 
                                   
 
                                               
Total costs and expenses
    1,657,614       99.2 %     1,484,916       96.8 %     1,281,969       96.9 %
 
                                               
Earnings from continuing operations before gain (loss) on disposal of assets, minority interests and income taxes
    14,171       0.8 %     48,468       3.2 %     41,009       3.1 %
 
                                               
Gain (loss) on disposal of assets, net
    1,616       0.1 %     (75 )     (0.0 )%     (1,359 )     (0.1 )%
Minority interests
    (9,987 )     (0.6 )%     (4,437 )     (0.3 )%     (4,496 )     (0.3 )%
 
                                   
Earnings from continuing operations before income taxes
  $ 5,800       0.3 %   $ 43,956       2.9 %   $ 35,154       2.7 %
 
                                   
 
     
(1)   Revenue between segments is eliminated in our consolidated results.
Years Ended September 30, 2009 and 2008
Acute care revenue — Acute care revenue from our hospital operations for the year ended September 30, 2009, was $1.7 billion, an increase of $138.4 million, or 9.0%, compared to $1.5 billion in the prior year. Approximately 2.1% of this increase is attributable to the increase in revenue associated with the supplemental Medicaid reimbursement programs in our Texas market. The remaining increase in acute care revenue of 6.9% is comprised of an increase in adjusted admissions of 2.4% and an increase in net patient revenue per adjusted admission of 4.4%, excluding the impact of supplemental Medicaid reimbursement.
Salaries and benefits — Salaries and benefits expense from our hospital operations for the year ended September 30, 2009, was $641.9 million, or 38.4% of acute care revenue, compared to $614.4 million, or 40.1% of acute care revenue in the prior year. The decline in salaries and benefits expense as a percentage of acute care revenue is attributable to a reduction in employee medical and pharmacy claims experience, primarily resulting from changes in our employee health plan design. Additionally, our nursing contract labor as a percentage of acute care revenue declined to 0.8% for the year ended September 30, 2009, compared to 1.2% in the prior year.
Other operating expenses — Other operating expenses from our hospital operations for the year ended September 30, 2009, were $302.8 million, or 18.1% of acute care revenue, compared to $264.8 million, or 17.3% of acute care revenue in the prior year. The increase in other operating expenses as a percentage of acute care revenue was the result of additional professional fees incurred at our Texas hospitals to provide indigent care services during the current year, compared to the prior year.

 

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Provision for bad debts — Provision for bad debts from our hospital operations for the year ended September 30, 2009, was $192.6 million, or 11.5% of acute care revenue, compared to $161.9 million, or 10.6% of acute care revenue in the prior year. We believe, as a result of the prolonged economic recession and rising unemployment, we continue to experience an increase in self-pay volume and revenue, as well as increases in the amount of co-payments and deductibles passed on by employers to employees. For the year ended September 30, 2009, our self-pay admissions as a percentage of total admissions were 6.0%, compared to 5.2% in the prior year. These trends continue to be the main driver behind the increase in our provision for bad debts.
Interest expense, net — Interest expense, net of interest income, for the year ended September 30, 2009, was $67.9 million, compared to $75.7 million in the prior year. This decrease of $7.8 million was primarily due to the impact of lower LIBOR interest rates in the current year, compared to the prior year. The weighted average interest rate of outstanding borrowings under our senior secured credit facilities was 3.6% for the year ended September 30, 2009, compared to 5.6% in the prior year.
Impairment of goodwill — Impairment of goodwill for the year ended September 30, 2009, includes a $64.6 million non-cash charge related to our Florida market. We have experienced other than temporary changes in market conditions and the business mix of our Florida operations, which have negatively impacted operating results in this market. Accordingly, we have written off the goodwill associated with our Florida market.
Earnings from continuing operations before income taxes — Earnings from continuing operations before income taxes decreased $38.2 million to $5.8 million for the year ended September 30, 2009, compared to $44.0 million in the prior year. Earnings from continuing operations before income taxes for the year ended September 30, 2009, included the impact of a $64.6 million non-cash charge related to the impairment of goodwill in our Florida market.
Years Ended September 30, 2008 and 2007
Acute care revenue — Acute care revenue from our hospital operations for the year ended September 30, 2008, was $1.5 billion, an increase of $210.4 million, or 15.9%, compared to $1.3 billion in the prior year. The increase in acute care revenue is due to an increase in admissions and adjusted admissions of 9.9% and 10.0%, respectively, compared to the prior year, along with an increase in net patient revenue per adjusted admission of 5.4% for the year ended September 30, 2008, compared to the prior year.
On a same-facility basis, acute care revenue from our hospital operations increased 6.6% for the year ended September 30, 2008, compared to the prior year. Same-facility admissions and adjusted admissions increased by 0.8% and 2.0%, respectively, for the year ended September 30, 2008, compared to the prior year.
Salaries and benefits — Salaries and benefits expense from our hospital operations for the year ended September 30, 2008, was $614.4 million, or 40.1% of acute care revenue, compared to $519.0 million, or 39.2% of acute care revenue in the prior year. The increase in salaries and benefits as a percentage of acute care revenue is the result of the implementation of our physician employment strategy. The increase in salaries and benefits as a percentage of acute care revenue was partially offset by the prior year impact of a $3.1 million special compensation payment related to our April 2007 refinancing and recapitalization transaction.
Supplies — Supplies expense from our hospital operations for the year ended September 30, 2008, was $231.0 million, or 15.1% of acute care revenue, compared to $194.6 million, or 14.7% of acute care revenue in the prior year. The increase in supply cost as a percentage of acute care revenue was driven by growth in higher acuity and supply utilization services, such as inpatient and outpatient surgical procedures.
Other operating expenses — Other operating expenses from our hospital operations for the year ended September 30, 2008, were $264.8 million, or 17.3% of acute care revenue, compared to $251.2 million, or 19.0% of acute care revenue in the prior year. The decline in other operating expenses as a percentage of acute care revenue included a 0.4% reduction in the use of purchased services due to changes in service mix, and a 0.4% decrease in expenses related to professional and general liability insurance costs resulting from continued improvements in claims experience. Other operating expenses for the years ended September 30, 2008 and 2007, include $3.8 million and $10.5 million, respectively, in qui tam related legal fees and other expenses.
Provision for bad debts — Provision for bad debts from our hospital operations for the year ended September 30, 2008, was $161.9 million, or 10.6% of acute care revenue, compared to $136.2 million, or 10.3% of acute care revenue in the prior year. The increase in the provision for bad debts as a percentage of acute care revenue is the result of continued growth in self-pay volume and revenue, including an increase in volume of under-insured patients or patient balances after insurance, which are increasingly difficult to collect, often as a result of economic factors beyond our control.

 

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Interest expense, net — Interest expense, net of interest income, for the year ended September 30, 2008, was $75.7 million, compared to $71.2 million in the prior year. This increase of $4.5 million was primarily due to increased borrowings under our senior secured credit facilities, which includes the outstanding balance under our delayed draw term loan and use of our revolving credit facility, during the year ended September 30, 2008, compared to the prior year. The increased interest expense resulting from additional debt balances was partially mitigated by declining interest rates, as borrowings under our senior secured credit facilities are subject to interest at variable rates. The weighted average interest rate of outstanding borrowings under the senior secured credit facilities was 5.6% for the year ended September 30, 2008, compared to 7.5% in the prior year.
Depreciation and amortization — Depreciation and amortization expense for the year ended September 30, 2008, was $93.0 million, compared to $71.8 million in the prior year. The increase of $21.2 million was related to depreciation and amortization expense resulting from new assets being placed into service, including the acquisitions of Glenwood and Alliance, as well as additions to property and equipment made in connection with the opening of Mountain Vista.
Earnings from continuing operations before income taxes — Earnings from continuing operations before income taxes increased $8.8 million to $44.0 million for the year ended September 30, 2008, compared to $35.2 million in the prior year. Earnings from continuing operations before income taxes included the impact of $3.6 million in hurricane-related property damage sustained by The Medical Center of Southeast Texas, as a result of Hurricane Ike in September 2008. Earnings from continuing operations before income taxes in the year ended September 30, 2007, included a $6.2 million loss on extinguishment of debt, a $3.1 million special compensation payment related to our April 2007 refinancing and recapitalization transaction, and $3.4 million in business interruption insurance recoveries related to the temporary closure and disruption of operations at The Medical Center of Southeast Texas, as a result of Hurricane Rita.
Health Choice
The following table sets forth, for the periods indicated, results of our Health Choice operations expressed in dollar terms and as a percentage of premium revenue. Such information has been derived from our audited consolidated statements of operations.
                                                 
    Year Ended     Year Ended     Year Ended  
    September 30, 2009     September 30, 2008     September 30, 2007  
Health Choice ($ in thousands)   Amount     Percentage     Amount     Percentage     Amount     Percentage  
 
                                               
Premium revenue
  $ 699,503       100.0 %   $ 541,746       100.0 %   $ 450,641       100.0 %
Costs and expenses:
                                               
Salaries and benefits
    19,028       2.7 %     17,667       3.3 %     14,803       3.3 %
Supplies
    263       0.0 %     258       0.0 %     285       0.1 %
Medical claims (1)
    602,076       86.1 %     461,649       85.2 %     384,045       85.2 %
Other operating expenses
    22,931       3.3 %     18,309       3.4 %     15,096       3.3 %
Rentals and leases
    1,564       0.2 %     1,167       0.2 %     1,162       0.3 %
Depreciation and amortization
    3,448       0.5 %     3,738       0.7 %     3,560       0.8 %
 
                                   
Total costs and expenses
    649,310       92.8 %     502,788       92.8 %     418,951       93.0 %
 
                                               
Earnings before loss on disposal of assets
    50,193       7.2 %     38,958       7.2 %     31,690       7.0 %
 
                                               
Loss on disposal of assets, net
    (151 )     (0.0 )%                        
 
                                   
 
                                               
Earnings before income taxes
  $ 50,042       7.2 %   $ 38,958       7.2 %   $ 31,690       7.0 %
 
                                   
 
     
(1)   Medical claims paid to our hospitals of $9.3 million, $9.6 million and $7.5 million for the years ended September 30, 2009, 2008 and 2007, respectively, are eliminated in our consolidated results.
Years Ended September 30, 2009 and 2008
Premium revenue - Premium revenue from Health Choice was $699.5 million for the year ended September 30, 2009, an increase of $157.8 million or 29.1%, compared to $541.7 million in the prior year. The growth in premium revenue was attributable to a 31.6% increase in Medicaid enrollees, resulting from Health Choice’s new contract with AHCCCS and increased enrollment in the state program. In addition, Health Choice has implemented successful outreach efforts, especially in its new counties, which have helped to increase the number of covered lives.

 

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Medical claims — Prior to eliminations, medical claims expense was $602.1 million for the year ended September 30, 2009, compared to $461.6 million in the prior year. Medical claims expense represents the amounts paid by Health Choice for healthcare services provided to its members. Medical claims expense as a percentage of premium revenue was 86.1% for the year ended September 30, 2009, compared to 85.2% in the prior year. The increase in medical claims expense as a percentage of premium revenue is the result of AHCCCS’ implementation of a new risk based payment methodology, which has negatively affected premium revenue on a per member per month basis in the current year.
Years Ended September 30, 2008 and 2007
Premium revenue - Premium revenue from Health Choice was $541.7 million for the year ended September 30, 2008, an increase of $91.1 million or 20.2%, compared to $450.6 million in the prior year. The increase in premium revenue was the result of increases in premium rates in our Medicaid and Medicare product lines, as well as a 16.1% increase in our Medicaid enrollees.
Medical claims — Prior to eliminations, medical claims expense was $461.6 million for the year ended September 30, 2008, compared to $384.0 million in the prior year. Medical claims expense as a percentage of premium revenue was 85.2% for the year ended September 30, 2008, which was consistent with the prior year.
Income Taxes
The following discussion sets forth, for the periods indicated, the impact of income taxes on our consolidated results. Such information has been derived from our audited consolidated statements of operations.
Years Ended September 30, 2009 and 2008
Income tax expense — We recorded a provision for income taxes from continuing operations of $27.6 million, resulting in an effective tax rate of 49.4% for the year ended September 30, 2009, compared to $35.3 million, for an effective tax rate of 42.6% in the prior year. The increase in our effective tax rate is the result of the impact of a non-deductible component of the $64.6 million non-cash charge related to the impairment of goodwill in our Florida market.
Years Ended September 30, 2008 and 2007
Income tax expense — We recorded a provision for income taxes from continuing operations of $35.3 million, resulting in an effective tax rate of 42.6% for the year ended September 30, 2008, compared to $25.9 million, for an effective tax rate of 38.8% in the prior year. The increase in the effective tax rate was primarily the result of losses generated by subsidiaries that are excluded from the consolidated federal and state tax returns. A valuation allowance was recorded against these federal net operating loss carry forwards. The losses did not generate state tax benefits. In addition, our effective tax rate in the prior year was impacted by an adjustment to our state income taxes for fiscal 2006, which was recorded in the year ended September 30, 2007, as the tax returns were filed.

 

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Summary of Operations by Quarter
The following table presents unaudited quarterly operating results for the years ended September 30, 2009 and 2008. We believe that all necessary adjustments have been included in the amounts stated below to present fairly the quarterly results when read in conjunction with the consolidated financial statements. Results of operations for any particular quarter are not necessarily indicative of results of operations for a full year or predictive of future periods.
                                 
    Quarter Ended  
    Sept. 30,     June 30,     March 31,     Dec. 31,  
    2009(1)     2009     2009(2)     2008  
    (in thousands)  
Net revenue
  $ 620,056     $ 601,618     $ 578,674     $ 561,624  
Earnings (loss) from continuing operations before income taxes
    (41,446 )     34,277       41,839       21,172  
Net earnings (loss) from continuing operations
    (30,047 )     20,562       25,390       12,361  
                                 
    Quarter Ended  
    Sept. 30,     June 30,     March 31,     Dec. 31,  
    2008(3)     2008     2008(4)     2007  
    (in thousands)  
Net revenue
  $ 515,419     $ 532,560     $ 524,820     $ 492,737  
Earnings from continuing operations before income taxes
    12,491       24,492       26,681       19,250  
Net earnings from continuing operations
    5,446       14,964       15,885       11,294  
 
     
(1)   Results for the quarter ended September 30, 2009, include a $64.6 million non-cash charge ($43.2 million after taxes) related to the impairment of goodwill in our Florida market, and a $2.0 million and a $326,000 increase in prior year estimates for professional and general liability losses and workers’ compensation claims, respectively, as a result of our semi-annual actuarial studies.
 
(2)   Results for the quarter ended March 31, 2009, include a $3.2 million and an $852,000 reduction in prior year estimates for professional and general liability losses and workers’ compensation claims, respectively, as a result of our semi-annual actuarial studies. Results for the quarter ended March 31, 2009, also include $938,000 in costs associated with property damage sustained at The Medical Center of Southeast Texas, as a result of Hurricane Ike.
 
(3)   Results for the quarter ended September 30, 2008, include a $2.9 million and a $44,000 reduction in prior year estimates for professional and general liability losses and workers’ compensation claims, respectively, as a result of our semi-annual actuarial studies, and $3.6 million in costs associated with property damage sustained at The Medical Center of Southeast Texas, as a result of Hurricane Ike in September 2008.
 
(4)   Results for the quarter ended March 31, 2008, include a $3.9 million reduction and an $803,000 increase in prior year estimates for professional and general liability losses and workers’ compensation claims, respectively, as a result of our semi-annual actuarial studies.
LIQUIDITY AND CAPITAL RESOURCES
Overview of Cash Flow Activities for the Years Ended September 30, 2009 and 2008
For the years ended September 30, 2009 and 2008, our cash flows are summarized as follows (in thousands):
                 
    2009     2008  
Cash flows from operating activities — continuing operations
  $ 270,499     $ 141,063  
Cash flows from investing activities — continuing operations
    (82,586 )     (149,263 )
Cash flows from financing activities — continuing operations
    (63,605 )     88,144  
Operating Activities
Our primary sources of liquidity are cash flow provided by our continuing operations and our senior secured revolving credit facility. The increase in operating cash flows is primarily the result of increased earnings before the non-cash impairment of goodwill, improved collections on accounts receivable, the timing of accounts payable and accrued expenses, payments received related to the supplemental Medicaid reimbursement programs in our Texas market, the impact of significant enrollment growth and the timing of cash flows related to the Medicaid product line at Health Choice and reduced interest costs resulting from lower interest rates.

 

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At September 30, 2009, we had $264.5 million in net working capital, compared to $187.4 million at September 30, 2008. Net accounts receivable increased $6.1 million to $230.2 million at September 30, 2009, from $224.1 million at September 30, 2008. Our days revenue in accounts receivable at September 30, 2009, were 49, compared to 53 at September 30, 2008.
Investing Activities
Capital expenditures for the year ended September 30, 2009, were $87.7 million, which included $25.8 million for the construction of two patient tower expansion projects in our Utah market, compared to $137.4 million in the prior year. The decline in capital expenditures reflects, in part, our efforts to effectively and efficiently manage our capital resources during the current economic environment.
Investing activities during the year ended September 30, 2008, included the acquisition of Ouachita Community Hospital for $16.8 million.
Financing Activities
During the year ended September 30, 2009, pursuant to the terms of our senior secured credit facilities, we made net payments totaling $53.7 million, including $47.8 million used to pay the outstanding balance of our revolving credit facility, compared to net borrowings of $82.0 million in the prior year. Additionally, we made payments totaling $1.8 million on capital leases and other debt obligations during the year ended September 30, 2009.
Financing activities during the year ended September 30, 2009, included payments of $1.4 million for the repurchase of partnership interests, compared to proceeds received from the sale of partnership interests, net of costs, of $15.1 million in the prior year.
Capital Resources
As of September 30, 2009, we had two separate debt arrangements:
    $854.0 million in senior secured credit facilities; and
    $475.0 million in 8 3/4% senior subordinated notes due 2014.
$854.0 Million Senior Secured Credit Facilities
The $854.0 million senior secured credit facilities include: (i) a senior secured term loan of $439.0 million; (ii) a senior secured delayed draw term loan of $150.0 million; (iii) a senior secured revolving credit facility of $225.0 million, with a $100.0 million sub-limit for letters of credit; and (iv) a senior secured synthetic letter of credit facility of $40.0 million. All facilities mature on March 15, 2014, except for the revolving credit facility, which matures on April 27, 2013. The term loans bear interest at an annual rate of LIBOR plus 2.00% or, at our option, the administrative agent’s base rate plus 1.00%. The revolving loans bear interest at an annual rate of LIBOR plus an applicable margin ranging from 1.25% to 1.75% or, at our option, the administrative agent’s base rate plus an applicable margin ranging from 0.25% to 0.75%, such rate in each case depending on our senior secured leverage ratio. A commitment fee ranging from 0.375% to 0.50% per annum is charged on the undrawn portion of the senior secured revolving credit facility and is payable in arrears.
Principal under the senior secured term loan is due in 24 consecutive equal quarterly installments in an aggregate annual amount equal to 1.0% of the original principal amount ($439.0 million) during the first six years thereof, with the balance payable in four equal installments in year seven. Principal under the senior secured delayed draw term loan is due in equal quarterly installments in an aggregate annual amount equal to 1.0% of the original principal amount ($150.0 million) until March 31, 2013, with the balance payable in four equal installments during the final year of the loan. Unless terminated earlier, the senior secured revolving credit facility has a single maturity of six years. The senior secured credit facilities are also subject to mandatory prepayment under specific circumstances, including a portion of excess cash flow, a portion of the net proceeds from an initial public offering, asset sales, debt issuances and specified casualty events, each subject to various exceptions.

 

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The senior secured credit facilities are (i) secured by a first mortgage and lien on our real property and related personal and intellectual property and pledges of equity interests in the entities that own such properties and (ii) guaranteed by certain of our subsidiaries.
In addition, the senior secured credit facilities contain certain covenants which, among other things, limit the incurrence of additional indebtedness, investments, dividends, transactions with affiliates, asset sales, acquisitions, mergers and consolidations, liens and encumbrances and other matters customarily restricted in such agreements.
At September 30, 2009, amounts outstanding under our senior secured credit facilities consisted of a $428.0 million term loan and a $148.1 million delayed draw term loan. In addition, we had $39.9 million and $24.7 million in letters of credit outstanding under the synthetic letter of credit facility and the revolving credit facility, respectively. The weighted average interest rate of outstanding borrowings under the senior secured credit facilities was 3.6% for the year ended September 30, 2009.
$475.0 Million 8 3/4% Senior Subordinated Notes Due 2014
We and our wholly-owned subsidiary, IASIS Capital Corporation, a holding company with no assets or operations, as issuers, have outstanding $475.0 million aggregate principal amount of 8 3/4% notes. Our 8 3/4% notes are general unsecured senior subordinated obligations of the issuers, are subordinated in right of payment to their existing and future senior debt, are pari passu in right of payment with any of their future senior subordinated debt and are senior in right of payment to any of their future subordinated debt. Our existing domestic subsidiaries, other than certain non-guarantor subsidiaries, which include Health Choice and our non-wholly owned subsidiaries, are guarantors of our 8 3/4% notes. Our 8 3/4% notes are effectively subordinated to all of the issuers’ and the guarantors’ secured debt to the extent of the value of the assets securing the debt and are structurally subordinated to all liabilities and commitments (including trade payables and capital lease obligations) of our subsidiaries that are not guarantors of our 8 3/4% notes. Our 8 3/4% notes require semi-annual interest payments in June and December. The indenture related to the 8 3/4% notes contains a customary restricted payments covenant, which, among others restrictions, limits the amount of dividends or other cash payments to IAS, including payments to fund the interest on the Holdings Senior Paid-in-Kind (“PIK”) Loans, which becomes cash pay in June 2012. As of September 30, 2009, we have $187.0 million available to expend free of any such restrictions pursuant to the restricted payment basket provisions set forth in this covenant.
$300.0 Million Holdings Senior PIK Loans
In fiscal 2007, IAS borrowed $300.0 million in Holdings Senior PIK Loans, which mature June 15, 2014. Proceeds were used to repurchase certain preferred equity from the stockholders of IAS. The Holdings Senior PIK Loans bear interest at an annual rate equal to LIBOR plus 5.25%. The Holdings Senior PIK Loans rank behind our existing debt and will convert to cash-pay after five years, at which time accrued interest becomes payable. At September 30, 2009, the outstanding balance of the Holdings Senior PIK Loans was $368.5 million, which includes $68.5 million of interest that has accrued to the principal of these loans since the date of issuance. The credit agreement related to the Holdings Senior PIK Loans includes a restricted payment covenant, which, among other restrictions, limits the amount of dividends that can be paid to the stockholders of IAS. As of September 30, 2009, we have $120.0 million available to expend free of any such restrictions pursuant to the restricted payment basket provisions set forth in this covenant.
Other
Effective March 2, 2009, we executed interest rate swap transactions with Citibank, N.A. (“Citibank”) and Wachovia Bank, N.A. (“Wachovia”), as counterparties, with notional amounts totaling $425.0 million, in an effort to manage exposure to floating interest rate risk on a portion of our variable rate debt. The arrangements with each counterparty include two interest rate swap agreements, one with a notional amount of $112.5 million maturing on February 28, 2011 and one with a notional amount of $100.0 million maturing on February 29, 2012. Under these agreements, we are required to make monthly interest payments to our counterparties at fixed annual interest rates ranging from 1.5% to 2.0%, depending upon the agreement. Our counterparties are obligated to make monthly interest payments to us based upon the one-month LIBOR rate in effect over the term of each agreement.
As of September 30, 2009, we provided a performance guaranty in the form of letters of credit totaling $43.2 million for the benefit of AHCCCS to support our obligations under the Health Choice contract to provide and pay for healthcare services. The amount of the performance guaranty is based in part upon the membership in the plan and the related capitation revenue paid to us.

 

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Capital Expenditures
We plan to finance our proposed capital expenditures with cash generated from operations, borrowings under our senior secured credit facilities and other capital sources that may become available. We expect our capital expenditures for fiscal 2010 to be $125.0 million to $135.0 million, including the following significant expenditures:
    $60.0 million to $65.0 million for other growth and new business projects;
    $45.0 million to $50.0 million in replacement or maintenance related projects at our hospitals;
    $12.0 million related to healthcare IT stimulus funds; and
    $8.0 million in hardware and software costs related to other information systems projects.
Liquidity
We rely on cash generated from our internal operations as our primary source of liquidity, as well as available credit facilities, project and bank financings and the issuance of long-term debt. From time to time, we have also utilized operating lease transactions that are sometimes referred to as off-balance sheet arrangements. We expect that our future funding for working capital needs, capital expenditures, long-term debt repayments and other financing activities will continue to be provided from some or all of these sources. Each of our existing and projected sources of cash is impacted by operational and financial risks that influence the overall amount of cash generated and the capital available to us. For example, cash generated by our business operations may be impacted by, among other things, economic downturns, weather-related catastrophes and adverse industry conditions. Our future liquidity will be impacted by our ability to access capital markets, which may be restricted due to our credit ratings, general market conditions, and by existing or future debt agreements. For a further discussion of risks that can impact our liquidity, see Item 1A., “Risk Factors,” beginning on page 29.
Including our senior secured credit facilities at September 30, 2009, we had available liquidity as follows (in millions):
         
Available cash
  $ 206.5  
Available capacity under our senior secured revolving credit facility
    200.3  
 
     
Net available liquidity at September 30, 2009
  $ 406.8  
 
     
Available capacity under our revolving credit facility assumes 100% participation from all lenders currently participating in our senior secured revolving credit facility. Currently, we have identified one defaulting lender, Lehman, who has been unable to fund its proportionate share of borrowings under our revolving credit facility since September 2008. Lehman’s participation in our revolving credit facility is approximately 8.9%, or $20.0 million of our total revolver capacity. Assuming Lehman continues to default under the terms of the agreement, our net available liquidity at September 30, 2009, would be reduced to $386.8 million. In addition to our available liquidity, we expect to generate significant operating cash flow in fiscal 2010. We will also utilize proceeds from our financing activities as needed.
Based upon our current level of operations and anticipated growth, we believe we have sufficient liquidity to meet our cash requirements over the short-term (next 12 months) and over the next three years. In evaluating the sufficiency of our liquidity for both the short-term and long-term, we considered the expected cash flow to be generated by our operations, cash on hand and the available borrowings under our senior secured credit facilities compared to our anticipated cash requirements for debt service, working capital, capital expenditures and the payment of taxes, as well as funding requirements for long-term liabilities.

 

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As a result of this evaluation, we believe that we will have sufficient liquidity for the next three years to fund the cash required for the payment of taxes and the capital expenditures required to maintain our facilities during this period of time. We are unable at this time to extend our evaluation of the sufficiency of our liquidity beyond three years. We cannot assure you, however, that our operating performance will generate sufficient cash flow from operations or that future borrowings will be available under our senior secured credit facilities, or otherwise, to enable us to grow our business, service our indebtedness, including the senior secured credit facilities and the 8 3/4% notes, or make anticipated capital expenditures. For more information, see Item 1A., “Risk Factors,” beginning on page 29.
One element of our business strategy is to selectively pursue acquisitions and strategic alliances in existing and new markets. Any acquisitions or strategic alliances may result in the incurrence of, or assumption by us, of additional indebtedness. We continually assess our capital needs and may seek additional financing, including debt or equity as considered necessary to fund capital expenditures and potential acquisitions or for other corporate purposes. Our future operating performance, ability to service or refinance our 8 3/4% notes and ability to service and extend or refinance the senior secured credit facilities will be subject to future economic conditions and to financial, business and other factors, many of which are beyond our control. For more information, see Item 1A., “Risk Factors,” beginning on page 29.
OFF-BALANCE SHEET ARRANGEMENTS
We are a party to certain rent shortfall agreements, master lease agreements and other similar arrangements with non-affiliated entities and an unconsolidated entity in the ordinary course of business. We do not believe we have engaged in any transaction or arrangement with an unconsolidated entity that is reasonably likely to materially affect liquidity.
We do not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. Accordingly, we are not materially exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in such relationships.
Tabular Disclosure of Contractual Obligations
The following table reflects a summary of obligations and commitments outstanding including both the principal and interest portions of long-term debt and capital lease obligations at September 30, 2009.
                                         
    Payments Due By Period  
    Less than                     More than        
    1 Year     1-3 Years     3-5 Years     5 Years     Total  
    (in millions)  
Contractual Cash Obligations:
                                       
Long-term debt, with interest (1)
  $ 69.5     $ 135.4     $ 1,129.6     $     $ 1,334.5  
Capital lease obligations, with interest
    1.1       1.6       1.1       5.2       9.0  
Medical claims
    113.5                         113.5  
Operating leases
    21.8       33.0       28.1       42.3       125.2  
Estimated self-insurance liabilities
    12.6       16.0       14.1       15.1       57.8  
Purchase obligations
    23.0       9.0       1.6       0.1       33.7  
 
                             
Subtotal
  $ 241.5     $ 195.0     $ 1,174.5     $ 62.7     $ 1,673.7  
 
                             
                                         
    Amount of Commitment Expiration Per Period  
    Less than                     More than        
    1 Year     1-3 Years     3-5 Years     5 Years     Total  
    (in millions)  
Other Commitments(2):
                                       
Construction and improvement commitments
  $ 13.7     $     $     $     $ 13.7  
Guarantees of surety bonds
    0.9                         0.9  
Letters of credit
          39.9       24.7             64.6  
Minimum revenue guarantees
    1.7                         1.7  
Other commitments
    3.3                         3.3  
 
                             
Subtotal
    19.6       39.9       24.7             84.2  
 
                             
Total obligations and commitments
  $ 261.1     $ 234.9     $ 1,199.2     $ 62.7     $ 1,757.9  
 
                             
 
     
(1)   We used 3.6%, the weighted average interest rate incurred on our senior secured credit facilities in fiscal 2009, which accrues actual interest at a variable rate. Actual interest will vary based on changes in interest rates. Included in the weighted average interest rate is the effect of our interest rate swap arrangements, which effectively converts $425.0 million of variable rate debt to fixed rate debt.
 
(2)   Excludes $7.8 million of unrecognized tax benefits and related interest that could result in a cash settlement, of which $6.2 million relates to timing differences between book and taxable income that may be offset by a reduction of cash tax obligations in future periods. We have not included these amounts in the above table as we cannot reliably estimate the amount and timing of payments related to these liabilities.

 

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Seasonality
The patient volumes and net revenue at our healthcare operations are subject to seasonal variations and generally are greater during the quarter ended March 31 than other quarters. These seasonal variations are caused by a number of factors, including seasonal cycles of illness, climate and weather conditions in our markets, vacation patterns of both patients and physicians and other factors relating to the timing of elective procedures.
RECENT ACCOUNTING PRONOUNCEMENTS
In December 2007, the FASB issued new authoritative guidance regarding business combinations, which applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. This new guidance establishes principles and requirements for recognition and measurement of items acquired during a business combination, as well as certain disclosure requirements in the financial statements. We do not believe the adoption of this new guidance will have a material impact on our results of operations or financial position; however, it is anticipated to have a material effect on our accounting for future acquisitions.
In December 2007, the FASB issued new authoritative guidance regarding noncontrolling interests in consolidated financial statements, which is effective for fiscal years beginning after December 15, 2008. The objective of this guidance is to improve the relevance, comparability, and transparency of financial information, specifically noncontrolling interests, that is provided in consolidated financial statements. We do not believe the adoption of this new guidance will have a material impact on our results of operations or financial position; however, it could potentially have a material effect on the presentation of our financial statements.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
We are subject to market risk from exposure to changes in interest rates based on our financing, investing, and cash management activities. The following components of our senior secured credit facilities bear interest at variable rates at specified margins above either the agent bank’s alternate base rate or the LIBOR rate: (i) a $439.0 million, seven-year term loan; (ii) a $150.0 million senior secured delayed draw term loan; and (iii) a $225.0 million, six-year senior secured revolving credit facility. As of September 30, 2009, we had outstanding variable rate debt of $576.2 million. We have managed our market exposure to changes in interest rates by converting $425.0 million of this variable rate debt to fixed rate debt through the use of interest rate swap agreements. Our interest rate swaps provide for $425.0 million of fixed rate debt under our senior secured credit facilities through February 28, 2011 and $200.0 million from March 1, 2011 through February 29, 2012, at rates ranging from 1.5% to 2.0% depending upon the terms of the specific agreement.

 

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Although changes in the alternate base rate or the LIBOR rate would affect the cost of funds borrowed in the future, we believe the effect, if any, of reasonably possible near-term changes in interest rates on our remaining variable rate debt or our consolidated financial position, results of operations or cash flows would not be material. Holding other variables constant, including levels of indebtedness and interest rate swaps, a 0.125% increase in interest rates would have an estimated impact on pre-tax earnings and cash flows for the next twelve month period of $189,000.
Our interest rate swap agreements expose us to credit risk in the event of non-performance by our counter parties, Citibank and Wachovia. However, we do not anticipate non-performance by Citibank or Wachovia.
We have $475.0 million in senior subordinated notes due December 15, 2014, with interest payable semi-annually at the rate of 8 3/4% per annum. At September 30, 2009, the fair market value of the outstanding 8 3/4% notes was $473.8 million, based upon quoted market prices as of that date.
We currently believe we have adequate liquidity to fund operations during the near term through the generation of operating cash flows, cash on hand and access to our revolving credit facility, despite the current conditions in the financial and capital markets. However, our ability to borrow funds under our revolving credit facility is subject to the financial viability of the participating financial institutions. Since September 2008, we have identified one defaulting lender, Lehman, who has been unable to fund its proportionate share of borrowings under our revolving credit facility. Lehman’s participation in our revolving credit facility is approximately 8.9%, or $20.0 million of our total revolver capacity. We are currently working to replace this lender with a financially viable institution; however, we are unable to provide any assurance that this will be possible. Any further deterioration in the credit markets could limit our ability to access available funds under our revolving credit facility.

 

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Item 8. Financial Statements and Supplementary Data.
IASIS Healthcare LLC
Index to Consolidated Financial Statements

 

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Report of Independent Registered Public Accounting Firm
To the Board of Directors of
IASIS Healthcare Corporation, sole member of IASIS Healthcare LLC
We have audited the accompanying consolidated balance sheets of IASIS Healthcare LLC as of September 30, 2009 and 2008, and the related consolidated statements of operations, member’s equity and cash flows for each of the three years in the period ended September 30, 2009. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. We were not engaged to perform an audit of the Company’s internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of IASIS Healthcare LLC at September 30, 2009 and 2008, and the consolidated results of their operations and their cash flows for each of the three years in the period ended September 30, 2009, in conformity with U.S. generally accepted accounting principles.
/s/ Ernst & Young LLP
Nashville, Tennessee
November 25, 2009

 

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IASIS HEALTHCARE LLC
CONSOLIDATED BALANCE SHEETS
(In thousands)
                 
    September 30,     September 30,  
    2009     2008  
ASSETS
               
Current assets:
               
Cash and cash equivalents
  $ 206,528     $ 80,738  
Accounts receivable, less allowance for doubtful accounts of $126,132 and $108,500 at September 30, 2009 and 2008, respectively
    230,198       224,138  
Inventories
    50,492       49,454  
Deferred income taxes
    39,038       38,860  
Prepaid expenses and other current assets
    49,453       60,053  
 
           
Total current assets
    575,709       453,243  
 
               
Property and equipment, net
    997,353       1,004,248  
Goodwill
    717,920       780,599  
Other intangible assets, net
    30,000       33,000  
Other assets, net
    36,222       37,057  
 
           
Total assets
  $ 2,357,204     $ 2,308,147  
 
           
 
               
LIABILITIES AND MEMBER’S EQUITY
               
 
               
Current liabilities:
               
Accounts payable
  $ 68,552     $ 64,851  
Salaries and benefits payable
    42,548       31,807  
Accrued interest payable
    12,511       12,460  
Medical claims payable
    113,519       97,343  
Other accrued expenses and other current liabilities
    65,701       51,802  
Current portion of long-term debt and capital lease obligations
    8,366       7,623  
 
           
Total current liabilities
    311,197       265,886  
 
               
Long-term debt and capital lease obligations
    1,051,471       1,106,999  
Deferred income taxes
    106,425       111,092  
Other long-term liabilities
    54,222       44,526  
Minority interests
    53,042       51,875  
 
               
Member’s equity:
               
Member’s equity
    780,847       727,769  
 
           
Total liabilities and member’s equity
  $ 2,357,204     $ 2,308,147  
 
           

 

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IASIS HEALTHCARE LLC
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands)
                         
    Year Ended     Year Ended     Year Ended  
    September 30,     September 30,     September 30,  
    2009     2008     2007  
Net revenue:
                       
Acute care revenue
  $ 1,662,469     $ 1,523,790     $ 1,315,438  
Premium revenue
    699,503       541,746       450,641  
 
                 
Total net revenue
    2,361,972       2,065,536       1,766,079  
 
                       
Costs and expenses:
                       
Salaries and benefits
    660,921       632,109       533,792  
Supplies
    250,573       231,259       194,915  
Medical claims
    592,760       452,055       376,505  
Other operating expenses
    325,735       283,123       266,263  
Provision for bad debts
    192,563       161,936       136,233  
Rentals and leases
    39,127       36,633       31,546  
Interest expense, net
    67,890       75,665       71,206  
Depreciation and amortization
    97,462       96,741       75,388  
Management fees
    5,000       5,000       4,746  
Impairment of goodwill
    64,639              
Hurricane-related property damage
    938       3,589        
Loss on extinguishment of debt
                6,229  
Business interruption insurance recoveries
                (3,443 )
 
                 
Total costs and expenses
    2,297,608       1,978,110       1,693,380  
 
                       
Earnings from continuing operations before gain (loss) on disposal of assets, minority interests and income taxes
    64,364       87,426       72,699  
Gain (loss) on disposal of assets, net
    1,465       (75 )     (1,359 )
Minority interests
    (9,987 )     (4,437 )     (4,496 )
 
                 
 
                       
Earnings from continuing operations before income taxes
    55,842       82,914       66,844  
Income tax expense
    27,576       35,325       25,909  
 
                 
 
                       
Net earnings from continuing operations
    28,266       47,589       40,935  
Earnings (loss) from discontinued operations, net of income taxes
    (176 )     (11,275 )     669  
 
                 
 
                       
Net earnings
  $ 28,090     $ 36,314     $ 41,604  
 
                 

 

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IASIS HEALTHCARE LLC
CONSOLIDATED STATEMENTS OF MEMBER’S EQUITY
(In thousands)
         
    Member’s  
    Equity  
 
Balance at September 30, 2006
  $ 656,496  
Distribution to parent for debt financing costs
    (6,586 )
Net earnings
    41,604  
 
     
Balance at September 30, 2007
  $ 691,514  
Cumulative effect of the adoption of FASB income tax guidance
    (59 )
Net earnings
    36,314  
 
     
Balance at September 30, 2008
  $ 727,769  
Income tax benefit resulting from exercise of employee stock options
    9  
Stock compensation costs
    561  
Other comprehensive loss
    (2,926 )
Contribution from parent related to tax benefit from Holdings Senior PIK Loans interest
    27,344  
Net earnings
    28,090  
 
     
Balance at September 30, 2009
  $ 780,847  
 
     

 

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IASIS HEALTHCARE LLC
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
                         
    Year Ended     Year Ended     Year Ended  
    September 30,     September 30,     September 30,  
    2009     2008     2007  
Cash flows from operating activities:
                       
Net earnings
  $ 28,090     $ 36,314     $ 41,604  
Adjustments to reconcile net earnings to net cash provided by operating activities:
                       
Loss (earnings) from discontinued operations
    176       11,275       (669 )
Depreciation and amortization
    97,462       96,741       75,388  
Amortization of loan costs
    3,029       2,913       2,942  
Minority interests
    9,987       4,437       4,496  
Deferred income taxes
    (5,572 )     19,368       24,103  
Income tax benefit from parent company interest
    27,344              
Loss (gain) on disposal of assets, net
    (1,465 )     75       1,359  
Impairment of goodwill
    64,639              
Hurricane-related property damage
    938       3,589        
Stock compensation costs
    561              
Loss on extinguishment of debt
                5,091  
Changes in operating assets and liabilities, net of the effect of acquisitions and dispositions:
                       
Accounts receivable, net
    (7,302 )     17,131       (52,749 )
Inventories, prepaid expenses and other current assets
    6,728       (21,361 )     (5,894 )
Accounts payable, other accrued expenses and other accrued liabilities
    45,884       (29,419 )     26,002  
 
                 
Net cash provided by operating activities — continuing operations
    270,499       141,063       121,673  
Net cash provided by operating activities — discontinued operations
    1,472       2,313       4,661  
 
                 
Net cash provided by operating activities
    271,971       143,376       126,334  
 
                 
 
                       
Cash flows from investing activities:
                       
Purchases of property and equipment
    (87,720 )     (137,415 )     (194,043 )
Cash paid for acquisitions
    (1,941 )     (16,821 )     (141,585 )
Proceeds from sale of assets
    5,252       360       1,026  
Change in other assets
    1,823       4,613       5,893  
 
                 
Net cash used in investing activities — continuing operations
    (82,586 )     (149,263 )     (328,709 )
Net cash provided by (used in) investing activities — discontinued operations
    10       (1,017 )     (929 )
 
                 
Net cash used in investing activities
    (82,576 )     (150,280 )     (329,638 )
 
                 
 
                       
Cash flows from financing activities:
                       
Payment of debt and capital lease obligations
    (55,476 )     (306,611 )     (650,305 )
Proceeds from debt borrowings
          384,978       778,800  
Debt financing costs incurred
                (8,200 )
Distribution to parent for debt financing costs
                (6,586 )
Distribution of minority interests
    (6,750 )     (5,485 )     (4,850 )
Proceeds received from sale (costs paid for repurchase) of partnership interests, net
    (1,379 )     15,070       (495 )
Other
          192        
 
                 
Net cash provided by (used in) financing activities — continuing operations
    (63,605 )     88,144       108,364  
Net cash used in financing activities — discontinued operations
          (502 )     (475 )
 
                 
Net cash provided by (used in) financing activities
    (63,605 )     87,642       107,889  
 
                 
Increase (decrease) in cash and cash equivalents
    125,790       80,738       (95,415 )
Cash and cash equivalents at beginning of period
    80,738             95,415  
 
                 
Cash and cash equivalents at end of period
  $ 206,528     $ 80,738     $  
 
                 
 
                       
Supplemental disclosure of cash flow information:
                       
Cash paid for interest
  $ 66,136     $ 83,126     $ 80,647  
 
                 
Cash paid (received) for income taxes, net
  $ 4,104     $ (925 )   $ 7,710  
 
                 
Cash paid in loss on extinguishment of debt
  $     $     $ 1,138  
 
                 
 
                       
Supplemental schedule of noncash investing and financing activities:
                       
Capital lease obligations resulting from acquisitions
  $     $ 4,849     $ 5,037  
 
                 
Property and equipment in accounts payable
  $ 1,184     $ 4,788     $ 6,401  
 
                 
Partnership interests issued for acquisition
  $     $     $ 3,517  
 
                 

 

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IASIS HEALTHCARE LLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION AND BASIS OF PRESENTATION
Organization
IASIS Healthcare LLC (“IASIS”) owns and operates medium-sized acute care hospitals in high-growth urban and suburban markets. At September 30, 2009, the Company owned or leased 15 acute care hospital facilities and one behavioral health hospital facility, with a total of 2,853 beds in service, located in six regions:
    Salt Lake City, Utah;
    Phoenix, Arizona;
    Tampa-St. Petersburg, Florida;
    three cities in Texas, including San Antonio;
    Las Vegas, Nevada; and
    West Monroe, Louisiana.
The Company also owns and operates Health Choice Arizona, Inc. (“Health Choice” or the “Plan”), a Medicaid and Medicare managed health plan in Phoenix.
Principles of Consolidation
The consolidated financial statements include all subsidiaries and entities under common control of the Company. Control is generally defined by the Company as ownership of a majority of the voting interest of an entity. In addition, control is demonstrated in instances when the Company is the sole general partner in a limited partnership. Significant intercompany transactions have been eliminated.
Use of Estimates
The preparation of the financial statements in conformity with U.S. generally accepted accounting principles (“GAAP”) requires management to make estimates and assumptions that affect the amounts reported in the accompanying audited consolidated financial statements and notes. Actual results could differ from those estimates.
Reclassifications
Certain prior year amounts have been reclassified to conform to the current year presentation. These reclassifications have no impact on the Company’s total assets, liabilities, or member’s equity.
General and Administrative
The majority of the Company’s expenses are “cost of revenue” items. Costs that could be classified as “general and administrative” by the Company would include the IASIS corporate office costs, which were $45.6 million, $50.5 million and $55.0 million, for the years ended September 30, 2009, 2008 and 2007, respectively.
Subsequent Events Consideration
The Company has evaluated its financial statements and disclosures for the impact of subsequent events up to the date of filing its annual report on Form 10-K with the Securities and Exchange Commission.

 

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2. SIGNIFICANT ACCOUNTING POLICIES
Net Revenue
Acute Care Revenue
The Company’s healthcare facilities have entered into agreements with third-party payors, including government programs and managed care health plans, under which the facilities are paid based upon established charges, the cost of providing services, predetermined rates per diagnosis, fixed per diem rates or discounts from established charges. Additionally, the Company offers discounts through its uninsured discount program to all uninsured patients receiving healthcare services who do not qualify for assistance under state Medicaid, other federal or state assistance plans, or charity care.
Net patient revenue is reported at the estimated net realizable amounts from third-party payors and others for services rendered, including estimated retroactive adjustments under reimbursement agreements with third-party payors. Retroactive adjustments are accrued on an estimated basis in the period the related services are rendered and are adjusted, if necessary, in future periods when final settlements are determined. Net adjustments to estimated third-party payor settlements (“prior year contractuals”) resulted in an increase in net revenue of $3.2 million, $1.0 million and $365,000 for the years ended September 30, 2009, 2008 and 2007, respectively.
In the ordinary course of business, the Company provides care without charge to patients who are financially unable to pay for the healthcare services they receive. Because the Company does not pursue collection of amounts determined to qualify as charity care, they are not reported in net revenue. The Company currently records revenue deductions for patient accounts that meet its guidelines for charity care. The Company provides charity care to patients with income levels below 200% of the federal property level. Additionally, at all of the Company’s hospitals, a sliding scale of reduced rates is offered to uninsured patients, who are not covered through federal, state or private insurance, with incomes between 200% and 400% of the federal poverty level. Charity care deductions based on gross charges for the years ended September 30, 2009, 2008 and 2007 were $38.6 million, $37.7 million and $31.3 million, respectively.
Premium Revenue
Health Choice is a prepaid Medicaid and Medicare managed health plan that derives most of its revenue through a contract with the Arizona Health Care Cost Containment System (“AHCCCS”) to provide specified health services to qualified Medicaid enrollees through contracted providers. AHCCCS is the state agency that administers Arizona’s Medicaid program. The contract requires the Plan to arrange for healthcare services for enrolled Medicaid patients in exchange for fixed monthly premiums, based upon negotiated per capita member rates, and supplemental payments from AHCCCS. Capitation payments received by Health Choice are recognized as revenue in the month that members are entitled to healthcare services.
Effective October 1, 2008, Health Choice began its current contract with AHCCCS, which provides for a three-year term, with AHCCCS having the option to renew for two additional one-year periods. The contract is terminable without cause on 90 days’ written notice or for cause upon written notice if the Company fails to comply with any term or condition of the contract or fails to take corrective action as required to comply with the terms of the contract. Additionally, AHCCCS can terminate the contract in the event of the unavailability of state or federal funding.
The Plan receives reinsurance and other supplemental payments from AHCCCS for healthcare costs that exceed stated amounts at a rate ranging from 75% to 100% of qualified healthcare costs in excess of stated levels of up to $50,000 per claim, depending on the eligibility classification of the member. Qualified costs must be incurred during the contract year and are the lesser of the amount paid by the Plan or the AHCCCS fee schedule. Reinsurance recoveries are recognized under the contract with AHCCCS when healthcare costs exceed stated amounts as provided under the contract, including estimates of such costs at the end of each accounting period.
Health Choice also provides coverage as a Medicare Advantage Prescription Drug (“MAPD”) Special Needs Plan (“SNP”) provider pursuant to its contract with the Centers for Medicare and Medicaid Services (“CMS”). The SNP allows Health Choice to offer Medicare and Part D drug benefit coverage for new and existing dual-eligible members, or those that are eligible for Medicare and Medicaid. The contract with CMS includes successive one-year renewal options at the discretion of CMS and is terminable without cause on 90 days’ written notice or for cause upon written notice if the Company fails to comply with any term or condition of the contract or fails to take corrective action as required to comply with the terms of the contract. Health Choice has received notification that CMS is exercising its option to extend its contract through December 31, 2010.

 

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The Plan subcontracts with hospitals, physicians and other medical providers within Arizona and surrounding states to provide services to its Medicaid enrollees in Apache, Coconino, Maricopa, Mohave, Navajo, Pima, Yuma, LaPaz and Santa Cruz counties, and to its Medicare enrollees in Maricopa, Pima, Pinal, Coconino, Apache and Navajo counties. These services are provided regardless of the actual costs incurred to provide these services.
Cash and Cash Equivalents
The Company considers highly liquid investments with original maturities of three months or less to be cash equivalents. The Company maintains its cash and cash equivalents balances primarily with high credit quality financial institutions. The Company manages its credit exposure by placing its investments in United States Treasury securities or other high quality securities, and by periodically evaluating the relative credit standing of the financial institution.
Accounts Receivable
The Company receives payments for services rendered from federal and state agencies (under the Medicare, Medicaid and TRICARE programs), managed care health plans, including Medicare and Medicaid managed health plans, commercial insurance companies, employers and patients. During the years ended September 30, 2009, 2008 and 2007, 43.0%, 46.0% and 47.5%, respectively, of the Company’s net patient revenue related to patients participating in the Medicare and Medicaid programs, including managed Medicare and managed Medicaid. The Company recognizes that revenue and receivables from government agencies are significant to its operations, but does not believe that there is significant credit risks associated with these government agencies. The Company believes that concentration of credit risk from other payors is limited due to the number of patients and payors.
Net Medicare settlement receivables estimated at September 30, 2009 and 2008, totaled $6.3 million and $2.9 million, respectively, are included in accounts receivable in the accompanying consolidated balance sheets.
Allowance for Doubtful Accounts
The Company’s estimation of the allowance for doubtful accounts is based primarily upon the type and age of the patient accounts receivable and the effectiveness of the Company’s collection efforts. The Company’s policy is to reserve a portion of all self-pay receivables, including amounts due from the uninsured and amounts related to co-payments and deductibles, as these charges are recorded. On a monthly basis, the Company reviews its accounts receivable balances, the effectiveness of the Company’s reserve policies and various analytics to support the basis for its estimates. These efforts primarily consist of reviewing the following:
    Historical write-off and collection experience using a hindsight or look-back approach;
 
    Revenue and volume trends by payor, particularly the self-pay components;
 
    Changes in the aging and payor mix of accounts receivable, including increased focus on accounts due from the uninsured and accounts that represent co-payments and deductibles due from patients;
 
    Cash collections as a percentage of net patient revenue less bad debt expense;
 
    Trending of days revenue in accounts receivable; and
 
    Various allowance coverage statistics.
The Company regularly performs hindsight procedures to evaluate historical write-off and collection experience throughout the year to assist in determining the reasonableness of its process for estimating the allowance for doubtful accounts.

 

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Inventories
Inventories, principally medical supplies, implants and pharmaceuticals, are stated at the lower of average cost or market.
Long-lived Assets
The primary components of the Company’s long-lived assets are discussed below. When events, circumstances or operating results indicate that the carrying values of certain long-lived assets and related identifiable intangible assets (excluding goodwill) that are expected to be held and used might be impaired under the provisions of Financial Accounting Standards Board (“FASB”) authoritative guidance regarding accounting for the impairment or disposal of long-lived assets, the Company considers the recoverability of assets to be held and used by comparing the carrying amount of the assets to the undiscounted value of future net cash flows expected to be generated by the assets. If assets are identified as impaired, the impairment is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets as determined by independent appraisals or estimates of discounted future cash flows. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell.
Property and Equipment
Property and equipment are stated at cost. Routine maintenance and repairs are charged to expense as incurred. Expenditures that increase capacities or extend useful lives are capitalized. Buildings and improvements are depreciated over estimated useful lives ranging generally from 14 to 40 years. Estimated useful lives of equipment vary generally from 3 to 25 years. Leasehold improvements are amortized on a straight-line basis over the lesser of the terms of the respective leases or their estimated useful lives. Depreciation expense, including amortization of assets capitalized under capital leases, is computed using the straight-line method and was $94.5 million, $93.7 million and $72.4 million for the years ended September 30, 2009, 2008 and 2007, respectively. In connection with certain construction projects, the Company capitalized interest totaling $1.2 million, $1.4 million and $6.9 million for the years ended September 30, 2009, 2008 and 2007, respectively.
Goodwill and Other Intangible Assets
See Note 9 for the values of goodwill and other intangible assets assigned to each business segment. Intangible assets are evaluated for impairment if events and circumstances indicate a possible impairment.
Goodwill is not amortized but is subject to annual tests for impairment or more often if events or circumstances indicate it may be impaired. An impairment loss is recorded to the extent that the carrying amount of goodwill exceeds its implied fair value. The Company completed its annual impairment test of goodwill during fiscal 2009. Results of the Company’s testing indicated impairment of goodwill associated with its Florida market. No other impairment was identified. See Note 9 for more details.
Other Assets
Other assets consist primarily of costs associated with the issuance of debt, which are amortized over the life of the related debt. Amortization of deferred financing costs is included in interest expense and totaled $3.0 million, $2.9 million and $2.9 million for the years ended September 30, 2009, 2008 and 2007, respectively. Deferred financing costs, net of accumulated amortization, totaled $15.2 million and $18.2 million at September 30, 2009 and 2008, respectively.
Insurance Reserves
The Company estimates its reserve for self-insured professional and general liability and workers compensation risks using historical claims data, demographic factors, severity factors, current incident logs and other actuarial analysis.

 

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Income Taxes
The Company accounts for income taxes under the asset and liability method in accordance with FASB authoritative guidance regarding accounting for income taxes and its related uncertainty. This approach requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the carrying amounts and the tax bases of assets and liabilities. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply when the temporary differences are expected to reverse. The Company assesses the likelihood that deferred tax assets will be recovered from future taxable income to determine whether a valuation allowance should be established.
Minority Interest in Consolidated Entities
The consolidated financial statements include all assets, liabilities, revenue and expenses of less than 100% owned entities controlled by the Company. Accordingly, management has recorded minority interests in the earnings and equity of such consolidated entities.
Medical Claims Payable
Monthly capitation payments made by Health Choice to physicians and other healthcare providers are expensed in the month services are contracted to be performed. Claims expense for non-capitated arrangements is accrued as services are rendered by hospitals, physicians and other healthcare providers during the year.
Medical claims payable related to Health Choice include claims received but not paid and an estimate of claims incurred but not reported. Incurred but not reported claims are estimated using a combination of historical claims experience (including severity and payment lag time) and other actuarial analysis, including number of enrollees, age of enrollees and certain enrollee health indicators, to predict the cost of healthcare services provided to enrollees during any given period. While management believes that its estimation methodology effectively captures trends in medical claims costs, actual payments could differ significantly from estimates given changes in the healthcare cost structure or adverse experience.
The following table shows the components of the change in medical claims payable for the years ended September 30, 2009, 2008 and 2007, respectively (in thousands):
                         
    Year Ended     Year Ended     Year Ended  
    September 30,     September 30,     September 30,  
    2009     2008     2007  
Medical claims payable as of October 1
  $ 97,343     $ 81,309     $ 81,822  
Medical claims expense incurred during the year:
                       
Related to current year
    620,153       464,055       396,152  
Related to prior years
    (18,077 )     (2,406 )     (12,107 )
 
                 
Total expenses
    602,076       461,649       384,045  
 
                 
Medical claims payments during the year:
                       
Related to current year
    (508,299 )     (368,392 )     (317,798 )
Related to prior years
    (77,601 )     (77,223 )     (66,760 )
 
                 
Total payments
    (585,900 )     (445,615 )     (384,558 )
 
                 
Medical claims payable as of September 30
  $ 113,519     $ 97,343     $ 81,309  
 
                 
As reflected in the table above, medical claims expense for the year ended September 30, 2009, includes an $18.1 million reduction of medical costs related to prior years resulting from favorable development in the Medicaid and Medicare product lines of $15.5 million and $2.6 million, respectively. The favorable development is attributable to lower than anticipated medical costs and is offset, in part, by $10.8 million in reductions in premium revenue associated with settlements of various prior year program receivables.
Health Choice has experienced an increase in the number of lives served by the plan. Enrollment in Health Choice at September 30, 2009 and 2008, was 190,763 and 145,493, respectively.
Stock Based Compensation
Although IASIS has no stock option plan or outstanding stock options, the Company, through its parent, IASIS Healthcare Corporation (“IAS”), grants stock options for a fixed number of common shares to employees. The Company accounts for this stock-based incentive plan under the measurement and recognition provisions of FASB authoritative guidance regarding share-based payments (“Share-Based Payments Guidance”). Accordingly, the Company has not recognized any compensation expense for the stock options granted prior to October 1, 2006, as the exercise price of the options equaled, or was greater than, the market value of the underlying stock on the date of grant.

 

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For stock options granted on or after October 1, 2006, the Company applies the fair value recognition provisions of the Share-Based Payments Guidance, requiring all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their fair values. In accordance with the provisions of the Share-Based Payments Guidance, the Company uses the Black-Scholes-Merton model in determining the fair value of its share-based payments. The fair value of compensation costs will be amortized on a straight-line basis over the requisite service periods of the awards, generally equal to the awards’ vesting periods.
Fair Value of Financial Instruments
Cash and cash equivalents, accounts receivable, accounts payable and accrued liabilities are reflected in the accompanying consolidated financial statements at amounts that approximate fair value because of the short-term nature of these instruments. The fair value of the Company’s capital lease obligations also approximate carrying value as they bear interest at current market rates. The estimated fair values of the Company’s 8 3/4% senior subordinated notes due 2014 (the “8 3/4% notes”) and senior secured credit facilities were $473.8 million and $540.1 million, respectively, at September 30, 2009, based upon quoted market prices at that date.
Management Services Agreement
The Company is party to a management services agreement with affiliates of TPG, JLL Partners Inc. and Trimaran Fund Management, L.L.C. The management services agreement provides that in exchange for consulting and management advisory services that will be provided to the Company by the investors, the Company will pay an aggregate monitoring fee of 0.25% of budgeted net revenue up to a maximum of $5.0 million per fiscal year to these parties (or certain of their respective affiliates) and reimburse them for their reasonable disbursements and out-of-pocket expenses. This monitoring fee is divided among the parties in proportion to their relative ownership percentages in IASIS Investment LLC, parent company and majority stockholder of IAS. The monitoring fee will be subordinated to the senior subordinated notes in the event of a bankruptcy of the Company. The management services agreement does not have a stated term. Pursuant to the provisions of the management services agreement, the Company has agreed to indemnify the investors (or certain of their respective affiliates) in certain situations arising from or relating to the agreement, the investors’ investment in the securities of IAS or any related transactions or the operations of the investors, except for losses that arise on account of the investors’ negligence or willful misconduct. For the years ended September 30, 2009, 2008 and 2007, the Company paid $5.0 million, $5.0 million and $4.7 million, respectively, in monitoring fees under the management services agreement.
Recently Issued Accounting Pronouncements
In December 2007, the FASB issued new authoritative guidance regarding business combinations, which applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. This new guidance establishes principles and requirements for recognition and measurement of items acquired during a business combination, as well as certain disclosure requirements in the financial statements. The Company does not believe the adoption of this new guidance will have a material impact on its results of operations or financial position; however, it is anticipated to have a material effect on the Company’s accounting for future acquisitions.

 

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In December 2007, the FASB issued new authoritative guidance regarding noncontrolling interests in consolidated financial statements, which is effective for fiscal years beginning after December 15, 2008. The objective of this guidance is to improve the relevance, comparability, and transparency of financial information, specifically noncontrolling interests, that is provided in consolidated financial statements. The Company does not believe the adoption of this new guidance will have a material impact on its results of operations or financial position; however, it could potentially have a material effect on the presentation of its financial statements.
3. LONG-TERM DEBT AND CAPITAL LEASE OBLIGATIONS
Long-term debt and capital lease obligations consist of the following (in thousands):
                 
    September 30,     September 30,  
    2009     2008  
Senior secured credit facilities
  $ 576,150     $ 629,818  
Senior subordinated notes
    475,000       475,000  
Capital leases and other obligations
    8,687       9,804  
 
           
 
    1,059,837       1,114,622  
 
               
Less current maturities
    8,366       7,623  
 
           
 
  $ 1,051,471     $ 1,106,999  
 
           
Senior Secured Credit Facilities
In fiscal 2007, the Company completed the refinancing of its bank credit facility to provide for $854.0 million in senior secured credit facilities. In connection with the refinancing, the Company wrote-off $5.1 million in deferred financing costs and paid an additional $1.1 million in creditor fees, which are included in the loss on extinguishment of debt in the accompanying consolidated statement of operations for the year ended September 30, 2007.
The $854.0 million senior secured credit facilities include: (i) a senior secured term loan of $439.0 million; (ii) a senior secured delayed draw term loan of $150.0 million; (iii) a senior secured revolving credit facility of $225.0 million, which includes a $100.0 million sub-limit for letters of credit; and (iv) a senior secured synthetic letter of credit facility of $40.0 million. All facilities mature on March 15, 2014, except for the revolving credit facility, which matures on April 27, 2013. The term loans bear interest at an annual rate of LIBOR plus 2.00% or, at the Company’s option, the administrative agent’s base rate plus 1.00%. The revolving loans bear interest at an annual rate of LIBOR plus an applicable margin ranging from 1.25% to 1.75% or, at the Company’s option, the administrative agent’s base rate plus an applicable margin ranging from 0.25% to 0.75%, such rate in each case depending on the Company’s senior secured leverage ratio. A commitment fee ranging from 0.375% to 0.5% per annum is charged on the undrawn portion of the senior secured revolving credit facility and is payable in arrears.
Principal under the senior secured term loan is due in 24 consecutive equal quarterly installments in an aggregate annual amount equal to 1.0% of the original principal amount ($439.0 million) during the first six years thereof, with the balance payable in four equal installments in year seven. Principal under the senior secured delayed draw term loan is due in equal quarterly installments in an aggregate annual amount equal to 1.0% of the original principal amount ($150.0 million) until March 31, 2013, with the balance payable in four equal installments during the final year of the loan. Unless terminated earlier, the senior secured revolving credit facility has a single maturity of six years. The senior secured credit facilities are also subject to mandatory prepayment under specific circumstances, including a portion of excess cash flow, a portion of the net proceeds from an initial public offering, asset sales, debt issuances and specified casualty events, each subject to various exceptions.
The senior secured credit facilities are (i) secured by a first mortgage and lien on the real property and related personal and intellectual property of the Company and pledges of equity interests in the entities that own such properties and (ii) guaranteed by certain of the Company’s subsidiaries.
In addition, the senior secured credit facilities contain certain covenants which, among other things, limit the incurrence of additional indebtedness, investments, dividends, transactions with affiliates, asset sales, acquisitions, mergers and consolidations, liens and encumbrances and other matters customarily restricted in such agreements.

 

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At September 30, 2009, amounts outstanding under the Company’s senior secured credit facilities consisted of a $428.0 million term loan and a $148.1 million delayed draw term loan. In addition, the Company had $39.9 million and $24.7 million in letters of credit outstanding under the synthetic letter of credit facility and the revolving credit facility, respectively. The weighted average interest rate of outstanding borrowings under the senior secured credit facilities was 3.6% and 5.6% for the years ended September 30, 2009 and 2008, respectively.
8 3/4% Senior Subordinated Notes
The Company, together with its wholly-owned subsidiary, IASIS Capital Corporation, a holding company with no assets or operations, as issuers, have outstanding $475.0 million aggregate principal amount of 8 3/4% notes. The 8 3/4% notes are general unsecured senior subordinated obligations and are subordinated in right of payment to all existing and future senior debt of the Company. The Company’s existing domestic subsidiaries, other than certain non-guarantor subsidiaries, which include Health Choice and the Company’s non-wholly owned subsidiaries, are guarantors of the 8 3/4% notes. The 8 3/4% notes are effectively subordinated to all of the issuers’ and the guarantors’ secured debt to the extent of the value of the assets securing the debt and are structurally subordinated to all liabilities and commitments (including trade payables and capital lease obligations) of the Company’s subsidiaries that are not guarantors of the 8 3/4% notes.
$300.0 Million Holdings Senior Paid-in-Kind Loans
In fiscal 2007, IAS issued $300.0 million in Holdings Senior Paid-in-Kind (“PIK”) Loans, which were used to repurchase certain preferred equity from its stockholders. The $300.0 million Holdings Senior PIK Loans mature June 15, 2014, and bear interest at an annual rate equal to LIBOR plus 5.25%. The Holdings Senior PIK Loans rank behind the Company’s existing debt and will convert to cash-pay after five years, at which time accrued interest becomes payable. At September 30, 2009, the outstanding balance of the Holdings Senior PIK Loans was $368.5 million, which includes $68.5 million of interest that has accrued to the principal of these loans since the date of issuance.
4. INTEREST RATE SWAPS
Effective March 2, 2009, the Company executed interest rate swap transactions with Citibank, N.A. and Wachovia Bank, N.A., as counterparties, with notional amounts totaling $425.0 million. The arrangements with each counterparty include two interest rate swap agreements, one with a notional amount of $112.5 million maturing on February 28, 2011 and one with a notional amount of $100.0 million maturing on February 29, 2012. The Company entered into these interest rate swap arrangements to mitigate the floating interest rate risk on a portion of its outstanding variable rate debt. Under these agreements, the Company is required to make monthly fixed rate payments to the counterparties, as calculated on the applicable notional amounts, at annual fixed rates, which range from 1.5% to 2.0% depending upon the agreement. The counterparties are obligated to make monthly floating rate payments to the Company based on the one-month LIBOR rate for the same referenced notional amount.
         
    Total Notional  
Date Range   Amounts  
    (in thousands)  
 
       
March 2, 2009 to February 28, 2011
  $ 225,000  
March 2, 2009 to February 29, 2012
  $ 200,000  
The Company accounts for its interest rate swaps in accordance with the provisions of FASB authoritative guidance regarding accounting for derivative instruments and hedging activities, which also includes enhanced disclosure requirements. In accordance with these provisions, the Company has designated its interest rate swaps as cash flow hedge instruments. The Company assesses the effectiveness of these cash flow hedges on a quarterly basis, with any ineffectiveness being measured using the hypothetical derivative method. The Company completed an assessment of its cash flow hedge instruments during the year ended September 30, 2009, and determined its hedging instruments to be highly effective. Accordingly, no gain or loss resulting from hedging ineffectiveness is reflected in the Company’s accompanying consolidated statements of operations.

 

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On October 1, 2008, the Company adopted the new provisions of FASB authoritative guidance regarding fair value measurements, which provides a single definition of fair value, establishes a framework for measuring fair value, and expands disclosures concerning fair value measurements. The Company applies these provisions to the valuation and disclosure of its interest rates swaps. This authoritative guidance establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value. These tiers include: (i) Level 1, which is defined as quoted prices in active markets that can be accessed at the measurement date; (ii) Level 2, which is defined as inputs other than quoted prices in active markets that are observable, either directly or indirectly; and (iii) Level 3, which is defined as unobservable inputs resulting from the existence of little or no market data, therefore potentially requiring an entity to develop its own assumptions.
The Company determines the fair value of its interest rate swaps in a manner consistent with that used by market participants in pricing hedging instruments, which includes using a discounted cash flow analysis based upon the terms of the agreements, the impact of the one-month forward LIBOR curve and an evaluation of credit risk. Given the use of observable market assumptions and the consideration of credit risk, the Company has categorized the valuation of its interest rate swaps as Level 2.
The fair value of the Company’s interest rate swaps at September 30, 2009, reflects a liability balance of $4.7 million and is included in other long-term liabilities in the accompanying consolidated balance sheet. The fair value of the Company’s interest rate swaps reflects a liability because the effect of the forward LIBOR curve on future interest payments results in less interest due to the Company under the variable rate component included in the interest rate swap agreements, as compared to the amount due the Company’s counterparties under the fixed interest rate component. Any change in the fair value of the Company’s interest rate swaps, net of income taxes, is included in other comprehensive loss as a component of member’s equity in the accompanying consolidated balance sheet.
5. OTHER COMPREHENSIVE LOSS
A summary of activity in the Company’s accumulated other comprehensive loss consists of the following (in thousands):
         
Balance at September 30, 2008
  $  
 
       
Change in fair value of interest rate swaps, net of income tax effect of $1,734
    (2,926 )
 
     
Balance at September 30, 2009
  $ (2,926 )
 
     
6. DISCONTINUED OPERATIONS
The Company’s lease agreements to operate Mesa General Hospital (“Mesa Hospital”), located in Mesa, Arizona, and Biltmore Surgery Center (“Biltmore”), located in Phoenix, Arizona, expired by their terms on July 31, 2008 and September 30, 2008, respectively. The Company discontinued services at Mesa General on May 31, 2008, and Biltmore on April 30, 2008. The operating results of Mesa General and Biltmore are classified in the Company’s accompanying consolidated financial statements as discontinued operations. The following table sets forth the components of discontinued operations for the years ended September 30, 2009, 2008 and 2007, respectively, (in thousands):
                         
    Year ended     Year ended     Year ended  
    September 30,     September 30,     September 30,  
    2009     2008     2007  
 
                       
Total net revenue
  $ 974     $ 49,974     $ 88,335  
 
                       
Operating expenses
    1,256       64,648       87,254  
Loss on disposal of assets
          3,928        
Income tax expense (benefit)
    (106 )     (7,327 )     412  
 
                 
 
                       
Earning (loss) from discontinued operations, net of income taxes
  $ (176 )   $ (11,275 )   $ 669  
 
                 

 

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The Company allocated to discontinued operations interest expense of $2.5 million for each of the years ended September 30, 2008 and 2007. The allocation of interest expense to discontinued operations was based on the ratio of disposed net assets of Mesa General and Biltmore to the sum of total net assets of the Company plus the Company’s total outstanding debt.
Income taxes allocated to the discontinued operations resulted in related effective tax rates of 37.6%, 39.4% and 38.2% for the years ended September 30, 2009, 2008 and 2007, respectively.
7. ACQUISITIONS
Acquisition of Glenwood Regional Medical Center
Effective January 31, 2007, the Company acquired substantially all of the assets of Glenwood Regional Medical Center (“Glenwood”) in West Monroe, Louisiana. The purchase price for the 237-bed hospital was $78.2 million, which was funded by cash on hand and borrowings under the Company’s revolving credit facility. The results of operations of Glenwood are included in the accompanying consolidated statements of operations from the effective date of the acquisition.
The purchase price for the Glenwood acquisition, including direct transaction costs, has been allocated as follows (in thousands):
         
Fair value of assets acquired and liabilities assumed:
       
Assets acquired
       
Accounts receivable, net
  $ 13,727  
Inventory, prepaid expenses and other current assets
    4,354  
Property and equipment
    66,640  
Other long-term assets
    1,529  
 
     
Total assets acquired
  $ 86,250  
 
     
Liabilities assumed
  $ 8,004  
 
     
Acquisition of Alliance Hospital
Effective May 31, 2007, the Company acquired substantially all of the assets of Alliance Hospital (“Alliance”) in Odessa, Texas. The purchase price for the 50-bed hospital was $66.7 million, which was funded in part by the Company’s senior secured credit facilities, as well as units of limited partnership interest of Odessa Regional Hospital, LP, and the assumption of certain liabilities of Alliance. Upon acquisition, the operations of Alliance were immediately merged into Odessa Regional Hospital to form Odessa Regional Medical Center. The results of operations of Alliance are included in the accompanying consolidated statements of operations from the effective date of the acquisition.
The purchase price for the Alliance acquisition, including direct transaction costs, has been allocated as follows (in thousands):
         
Fair value of assets acquired and liabilities assumed:
       
Assets acquired
       
Accounts receivable, net
  $ 4,230  
Inventory, prepaid expenses and other current assets
    1,873  
Property and equipment
    60,965  
Goodwill
    10,593  
 
     
Total assets acquired
  $ 77,661  
 
     
Liabilities assumed
  $ 10,932  
 
     
Other
Effective February 1, 2008, IASIS Glenwood Regional Medical Center, LP, a wholly-owned subsidiary of the Company, purchased a majority ownership interest in Ouachita Community Hospital, a ten-bed surgical hospital located in West Monroe, Louisiana. The purchase price for the majority ownership interest included approximately $16.8 million in cash.

 

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8. PROPERTY AND EQUIPMENT
Property and equipment consist of the following (in thousands):
                 
    September 30,     September 30,  
    2009     2008  
Land
  $ 102,499     $ 103,763  
Buildings and improvements
    792,467       693,113  
Equipment
    500,450       471,207  
 
           
 
    1,395,416       1,268,083  
Less accumulated depreciation and amortization
    (414,572 )     (325,560 )
 
           
 
    980,844       942,523  
Construction-in-progress (estimated cost to complete at September 30, 2009 — $13.7 million)
    16,509       61,725  
 
           
 
  $ 997,353     $ 1,004,248  
 
           
Included in equipment are assets acquired under capital leases of $4.6 million and $5.6 million, net of accumulated amortization of $3.4 million and $2.1 million, at September 30, 2009 and 2008, respectively.
9. GOODWILL AND OTHER INTANGIBLE ASSETS
The following table presents the changes in the carrying amount of goodwill from September 30, 2007 through September 30, 2009 (in thousands):
                         
    Acute     Health        
    Care     Choice     Total  
Balance at September 30, 2007
  $ 750,836     $ 5,757     $ 756,593  
Adjustments in deferred tax assets and liabilities
    (3,769 )           (3,769 )
Adjustment resulting from Ouachita Community Hospital
    17,134             17,134  
Adjustments resulting from purchase price allocation of Alliance Hospital
    10,593             10,593  
Other purchase price adjustments
    48             48  
 
                 
Balance at September 30, 2008
    774,842       5,757       780,599  
Impairment of Florida market goodwill
    (64,639 )           (64,639 )
Other acquisitions
    1,960             1,960  
 
                 
Balance at September 30, 2009
  $ 712,163     $ 5,757     $ 717,920  
 
                 
As a result of the Company’s annual impairment testing, the Company has recorded a $64.6 million non-cash charge ($43.2 million after tax) for the impairment of goodwill related to its Florida market. The Company assesses the recoverability of goodwill at its market levels and has determined the write-off of all Florida market goodwill to be appropriate. In connection with the analysis resulting in the write-off of Florida market goodwill, the Company has determined all remaining goodwill and long-lived assets to be recoverable, and therefore, no further impairment was deemed necessary.
Other intangible assets consist solely of Health Choice’s contract with AHCCCS, which is amortized over a period of 15 years, the contract’s estimated useful life, including assumed renewal periods. The gross intangible value originally assigned to the contract was $45.0 million. The Company expects amortization expense for this intangible asset, to be $3.0 million per year over the estimated life of the contract. Amortization of intangible assets is included in depreciation and amortization expense and totaled $3.0 million for each of the years ended September 30, 2009, 2008 and 2007. Net other intangible assets included in the accompanying consolidated balance sheets at September 30, 2009 and 2008 totaled $30.0 million and $33.0 million, respectively.

 

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10. MEMBER’S EQUITY
Common Interests of IASIS
As of September 30, 2009, all of the common interests of IASIS were owned by IAS, its sole member.
11. STOCK OPTIONS
Management Rollover Options
In 2004, an investor group led by TPG acquired IAS, the parent company of IASIS. Prior to the acquisition, IAS maintained the IASIS 2000 Stock Option Plan. In connection with the acquisition, certain holders of 299,900 of in-the-money common stock options elected to rollover and convert such options into options to purchase an aggregate 3,263 shares of preferred stock, with an exercise price of $437.48 per share, and an aggregate 163,150 shares of common stock, with an exercise price of $8.75 per share. The rollover options are fully vested and remain outstanding and exercisable for the remainder of their original term. All of the other outstanding options under the IASIS 2000 Stock Option Plan were cancelled upon consummation of the acquisition and the plan was terminated.
In connection with the issuance of the $300.0 million Holdings Senior PIK Loans in fiscal 2007, the preferred rollover options were cancelled in exchange for a cash payment equal to the excess of the accreted value of the preferred stock over the exercise price of $437.48 per share.
2004 Stock Option Plan
The IAS 2004 Stock Option Plan (the “2004 Stock Option Plan”) was established to promote the Company’s interests by providing additional incentives to its key employees, directors, service providers and consultants. The options granted under the plan represent the right to purchase IAS common stock upon exercise. Each option shall be identified as either an incentive stock option or a non-qualified stock option. The plan was adopted by the board of directors and majority stockholder of IAS in June 2004. The maximum number of shares of IAS common stock that may be issued pursuant to options granted under the 2004 Stock Option Plan is 2,340,650. In addition, prior to an initial public offering, an additional 146,000 shares of common stock will be available for grant in June of each year. The options become exercisable over a period not to exceed five years after the date of grant, subject to earlier vesting provisions as provided for in the 2004 Stock Option Plan. All options granted under the 2004 Stock Option Plan expire no later than 10 years from the respective dates of grant. At September 30, 2009, there were 580,475 options available for grant.
Information regarding the Company’s stock option activity for the years ended September 30, 2007 through September 30, 2009, is summarized below:
                                                 
    2004 Stock Option Plan     Rollover Options  
                    Weighted                     Weighted  
                    Average                     Average  
            Option Price     Exercise             Option Price     Exercise  
    Options     Per Share     Price     Options     Per Share     Price  
Options outstanding at September 30, 2006
    1,595,485     $ 20.00-$35.68     $ 22.28       166,413     $ 8.75-$437.48     $ 17.16  
 
                                   
Granted
    7,080     $ 34.75-$35.68     $ 35.54                    
Exercised
                                   
Cancelled/forfeited
    (111,440 )   $ 20.00-$35.68     $ 25.61       (3,263 )   $ 437.48     $ 437.48  
 
                                   
Options outstanding at September 30, 2007
    1,491,125     $ 20.00-$35.68     $ 22.09       163,150     $ 8.75     $ 8.75  
 
                                   
Granted
    1,080     $ 34.75     $ 34.75                    
Exercised
    (9,600 )   $ 20.00     $ 20.00                    
Cancelled/forfeited
    (80,720 )   $ 20.00-$35.68     $ 26.04                    
 
                                   
Options outstanding at September 30, 2008
    1,401,885     $ 20.00-$35.68     $ 21.82       163,150     $ 8.75     $ 8.75  
 
                                   
Granted
    477,700     $ 34.75     $ 34.75                    
Exercised
                                   
Cancelled/forfeited
    (119,410 )   $ 20.00-$35.68     $ 31.17                    
 
                                   
Options outstanding at September 30, 2009
    1,760,175     $ 20.00-$35.68     $ 24.70       163,150     $ 8.75     $ 8.75  
 
                                   
Options exercisable at September 30, 2009
    1,252,436     $ 20.00-$35.68     $ 21.11       163,150     $ 8.75     $ 8.75  
 
                                   

 

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The following table provides information regarding assumptions used in the fair value measurement for options granted on or after October 1, 2006, and the weighted average assumptions used in the fair value pro forma disclosures required for stock-options granted prior to October 1, 2006.
                 
    Options Granted     Options Granted  
    On or After     Prior to  
    October 1, 2006     October 1, 2006  
Risk-free interest
    3.1 %     4.6 %
Dividend yield
    0.0 %     0.0 %
Volatility
    35.0 %     N/A  
Expected option life
  7.3 years     9.8 years  
For options granted on or after October 1, 2006, the Company used the Black-Scholes-Merton valuation model in determining the fair value measurement. Volatility for such options was estimated based on the historical stock price information of certain peer group companies for a period of time equal to the expected option life period.
12. INCOME TAXES
Income tax expense on earnings from continuing operations consists of the following (in thousands):
                         
    Year Ended     Year Ended     Year Ended  
    September 30,     September 30,     September 30,  
    2009     2008     2007  
Current:
                       
Federal
  $ 28,220     $ 12,631     $ 132  
State
    4,933       3,326       1,674  
Deferred:
                       
Federal
    (5,092 )     15,522       23,172  
State
    (485 )     3,846       931  
 
                 
 
  $ 27,576     $ 35,325     $ 25,909  
 
                 
A reconciliation of the federal statutory rate to the effective income tax rate applied to earnings from continuing operations before income taxes for the years ended September 30, 2009, 2008 and 2007, is as follows (in thousands):
                         
    Year Ended     Year Ended     Year Ended  
    September 30,     September 30,     September 30,  
    2009     2008     2007  
Federal statutory rate
  $ 19,544     $ 29,020     $ 23,396  
State income taxes, net of federal income tax benefit
    2,892       4,663       1,693  
Nondeductible goodwill impairment charges
    2,470              
Other non-deductible expenses
    550       418       328  
Change in valuation allowance charged to federal tax provision
    1,576       970       541  
Other items, net
    544       254       (49 )
 
                 
Income tax expense
  $ 27,576     $ 35,325     $ 25,909  
 
                 

 

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A summary of the items comprising the deferred tax assets and liabilities is as follows (in thousands):
                                 
    September 30,     September 30,  
    2009     2008  
    Assets     Liabilities     Assets     Liabilities  
Depreciation and fixed asset basis differences
  $     $ 77,743     $     $ 67,317  
Amortization and intangible asset basis differences
          55,721             64,742  
Allowance for doubtful accounts
    30,769             29,958        
Professional liability
    15,561             12,801        
Accrued expenses and other liabilities
    14,625             13,436        
Deductible carryforwards and credits
    9,861             8,709        
Other, net
    3,841             570        
Valuation allowance
    (8,580 )           (5,647 )      
 
                       
Total
  $ 66,077     $ 133,464     $ 59,827     $ 132,059  
 
                       
Net current deferred tax assets of $39.0 million and $38.9 million and net non-current deferred tax liabilities of $106.4 million and $111.1 million are included in the accompanying consolidated balance sheets at September 30, 2009 and 2008, respectively. The Company had a net income tax payable of $3.4 million and $2.2 million included in other current liabilities at September 30, 2009 and 2008, respectively.
The Company and some of its subsidiaries are included in IAS’ consolidated filing group for U.S. federal income tax purposes, as well as in certain state and local income tax returns that include IAS. With respect to tax returns for any taxable period in which the Company or any of its subsidiaries are included in a tax return filing with IAS, the amount of taxes to be paid by the Company is determined, subject to some adjustments, as if it and its subsidiaries filed their own tax returns excluding IAS. As of September 30, 2009, member’s equity in the accompanying consolidated balance sheet includes $27.3 million in capital contributions representing cumulative tax benefits generated by IAS and utilized by the Company in the combined tax return filings, for which IAS did not require cash settlement from the Company. At September 30, 2008, the net income tax payable by the Company of $2.2 million was comprised of $3.2 million net taxes refundable from taxing authorities and $5.4 million payable to IAS for tax benefits generated by IAS and utilized by the Company in the combined tax return filings.
The Company maintains a valuation allowance for deferred tax assets it believes may not be utilized. The valuation allowance increased by $2.9 million and $1.8 million during the years ended September 30, 2009 and 2008, respectively. The increases in the valuation allowance for both years relate to the generation of net operating loss carryforwards by certain subsidiaries excluded from the IAS consolidated federal income tax return, as well as state net operating loss carryforwards that may not ultimately be utilized.
As of September 30, 2009, federal net operating loss carryforwards were available to offset $11.1 million of future taxable income generated by subsidiaries of the Company that are excluded from the IAS consolidated return. A valuation allowance has been established against $8.8 million of these carryforwards, which expire between 2026 and 2029. State net operating losses in the amount of $146.2 million were also available, but largely offset by a valuation allowance. The state net operating loss carryforwards expire between 2018 and 2029.
As a result of adopting the provisions of FASB authoritative guidance regarding accounting for uncertainty in income taxes, on October 1, 2007, the Company recorded a liability for unrecognized tax benefits of $8.1 million, including accrued interest of $83,000. The adjustment was comprised of a cumulative effect decrease to member’s equity of $59,000, and a decrease to net noncurrent deferred tax liabilities of $8.1 million. An additional $9.9 million of unrecognized tax benefits were reflected as a reduction to deferred tax assets for federal and state net operating losses generated by uncertain tax deductions as of October 1, 2007.
FASB authoritative guidance regarding accounting for uncertainty in income taxes permits interest and penalties on underpayments of income taxes to be classified as interest expense, income tax expense, or another appropriate expense classification based on the accounting election of the company. The Company’s policy is to classify interest and penalties as a component of income tax expense. Income tax expense for the year ended September 30, 2009, has been reduced by $122,000 due to a decrease in accrued interest payable in connection with uncertain tax positions (net of related tax benefits). Interest expense totaling $146,000 (net of related tax benefits) is included in income tax expense for the year ended September 30, 2008.

 

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The liability for unrecognized tax benefits included in the accompanying consolidated balance sheets was $7.8 million, including accrued interest of $122,000 at September 30, 2009, and $9.9 million, including accrued interest of $308,000 at September 30, 2008. An additional $5.9 million of unrecognized tax benefits are reflected as a reduction to deferred tax assets for state net operating losses generated by uncertain tax deductions as of September 30, 2009 and 2008. Of the total unrecognized tax benefits at September 30, 2009, approximately $1.4 million (net of the tax benefit on state taxes and interest) represents the amount of unrecognized tax and interest that, if recognized, would favorably impact the Company’s effective income tax rate. The remainder of the unrecognized tax positions consist of items for which the uncertainty relates only to the timing of the deductibility, and state net operating loss carryforwards for which ultimate recognition would result in the creation of an offsetting valuation allowance due to the unlikelihood of future taxable income in that state.
A summary of activity of the Company’s total amounts of unrecognized tax benefits is as follows (in thousands):
                 
    Year Ended     Year Ended  
    September 30,     September 30,  
    2009     2008  
Unrecognized tax benefits at October 1
  $ 15,550     $ 17,942  
Additions resulting from tax positions taken in a prior period
    14       937  
Reductions resulting from tax positions taken in a prior period
    (3,171 )     (6,258 )
Additions resulting from tax positions taken in the current period
    1,965       2,929  
Reductions resulting from lapse of statute of limitations
    (720 )      
 
           
Unrecognized tax benefits at September 30
  $ 13,638     $ 15,550  
 
           
During the year ended September 30, 2009, the IRS completed its examinations of the Company’s consolidated corporate tax return for the year ended September 30, 2006, and one of its partnership’s income tax return for the year ended September 30, 2005. The IRS proposed no adjustments in either examination. The Company’s tax years 2006 and beyond remain open to additional examinations by U.S. federal and state taxing authorities. It is reasonably possible that unrecognized tax benefits could significantly increase or decrease within the next twelve months. However, the Company is currently unable to estimate the range of any possible change.
13. COMMITMENTS AND CONTINGENCIES
Net Revenue
The calculation of appropriate payments from the Medicare and Medicaid programs, including supplemental Medicaid reimbursement, as well as terms governing agreements with other third-party payors are complex and subject to interpretation. Final determination of amounts earned under the Medicare and Medicaid programs often occurs subsequent to the year in which services are rendered because of audits by the programs, rights of appeal and the application of numerous technical provisions. In the opinion of management, adequate provision has been made for adjustments that may result from such routine audits and appeals.
Professional, General and Workers’ Compensation Liability Risks
The Company is subject to claims and legal actions in the ordinary course of business, including claims relating to patient treatment and personal injuries. To cover these types of claims, the Company maintains professional and general liability insurance in excess of self-insured retentions through a commercial insurance carrier in amounts that the Company believes to be sufficient for its operations, although, potentially, some claims may exceed the scope of coverage in effect. Plaintiffs in these matters may request punitive or other damages that may not be covered by insurance. The Company is currently not a party to any such proceedings that, in the Company’s opinion, would have a material adverse effect on the Company’s business, financial condition or results of operations. The Company expenses an estimate of the costs it expects to incur under the self-insured retention exposure for professional and general liability claims using historical claims data, demographic factors, severity factors, current incident logs and other actuarial analysis. At September 30, 2009 and 2008, the Company’s professional and general liability accrual for asserted and unasserted claims totaled $41.7 million and $34.3 million, respectively. The semi-annual valuations from the Company’s independent actuary for professional and general liability losses resulted in a change related to estimates for prior years which decreased professional and general liability expense by $1.2 million, $6.8 million and $6.6 million during the years ended September 30, 2009, 2008 and 2007, respectively.

 

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The Company is subject to claims and legal actions in the ordinary course of business relative to workers’ compensation and other labor and employment matters. To cover these types of claims, the Company maintains workers’ compensation insurance coverage with a self-insured retention. The Company accrues costs of workers’ compensation claims based upon estimates derived from its claims experience. The semi-annual valuations from the Company’s independent actuary for workers’ compensation losses resulted in a change related to estimates for prior years which decreased workers’ compensation expense by $526,000, during the year ended September 30, 2009, increased workers’ compensation expense by $759,000 during the year ended September 30, 2008, and decreased workers’ compensation expense by $1.0 million during the year ended September 30, 2007.
Health Choice
Health Choice has entered into capitated contracts whereby the Plan provides healthcare services in exchange for fixed periodic and supplemental payments from the AHCCCS and CMS. These services are provided regardless of the actual costs incurred to provide these services. The Company receives reinsurance and other supplemental payments from AHCCCS to cover certain costs of healthcare services that exceed certain thresholds. The Company believes the capitated payments, together with reinsurance and other supplemental payments are sufficient to pay for the services Health Choice is obligated to deliver. As of September 30, 2009, the Company has provided a performance guaranty in the form of letters of credit totaling $43.2 million for the benefit of AHCCCS to support its obligations under the Health Choice contract to provide and pay for the healthcare services. The amount of the performance guaranty is generally based in part upon the membership in the Plan and the related capitation revenue paid to Health Choice.
Acquisitions
The Company has acquired and in the future may choose to acquire businesses with prior operating histories. Such businesses may have unknown or contingent liabilities, including liabilities for failure to comply with healthcare laws and regulations, such as billing and reimbursement, fraud and abuse and similar anti-referral laws. Although the Company has procedures designed to conform business practices to its policies following the completion of any acquisition, there can be no assurance that the Company will not become liable for previous activities of prior owners that may later be asserted to be improper by private plaintiffs or government agencies. Although the Company generally seeks to obtain indemnification from prospective sellers covering such matters, there can be no assurance that any such matter will be covered by indemnification, or if covered, that such indemnification will be adequate to cover potential losses and fines.
Other
On March 31, 2008, the United States District Court for the District of Arizona (the “District Court”) dismissed with prejudice the qui tam complaint against IAS, the Company’s parent company. The qui tam action sought monetary damages and civil penalties under the federal False Claims Act (“FCA”) and included allegations that certain business practices related to physician relationships and the medical necessity of certain procedures resulted in the submission of claims for reimbursement in violation of the FCA. The case dates back to March 2005 and became the subject of a subpoena by the Office of Inspector General (“OIG”) in September 2005. In August 2007, the case was unsealed and became a private lawsuit after the Department of Justice declined to intervene. The United States District Judge dismissed the case from the bench at the conclusion of oral arguments on IAS’ motion to dismiss. On April 21, 2008, the court issued a written order dismissing the case with prejudice and entering formal judgment for IAS. On May 7, 2008, the qui tam relator’s counsel filed a Notice of Appeal to the United States Court of Appeals for the Ninth Circuit to appeal the District Court’s dismissal of the case. On May 21, 2008, IAS filed a Notice of Cross-Appeal to the United States Court of Appeals for the Ninth Circuit from a portion of the April 21, 2008 Order and, on July 22, 2008, IAS filed a Motion to Disqualify relator’s counsel related to their misappropriation of information subject to a claim of attorney-client privilege by IAS. On August 21, 2008, the court issued a written order denying IAS’ Motion to Disqualify and resetting the briefing schedule associated with the Ninth Circuit appellate proceedings. On October 21, 2008, the relator filed his appeal brief with the United States Court of Appeals for the Ninth Circuit. IAS filed its cross-appeal brief on January 20, 2009. Currently, the Ninth Circuit appeal is expected to take another six to nine months to complete. If the appeal of the order dismissing the qui tam action with prejudice was to be resolved in a manner unfavorable to IAS, it could have a material adverse effect on the Company’s business, financial condition and results of operations, including exclusion from the Medicare and Medicaid programs.

 

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The Company’s facilities obtain clinical and administrative services from a variety of vendors. One vendor, a medical practice that furnished cardiac catheterization services under contractual arrangements at Mesa General and St. Luke’s Medical Center (“St. Luke’s”) through March 31, 2008 and May 31, 2008, respectively, has claimed that, because of deferred fee adjustments that it claims are due under these arrangements, it is owed additional amounts for services rendered since April 1, 2006 at both facilities. The Company and the vendor have not reached agreement with respect to the amount of the fee adjustment, if any, that is contractually required, nor with respect to the methodology that may appropriately be used in determining such amount. On October 1, 2008, the vendor filed a complaint in arbitration for an aggregate adjustment in excess of amounts accrued to date by the Company. Although the Company cannot currently estimate the amount of any fee adjustment that Mesa General or St. Luke’s ultimately may be required to pay, it believes that the aggregate adjustment sought by the vendor is substantially in excess of any such amount. Likewise, the vendor has also filed a state-court complaint asserting its fee adjustment claims and also alleging certain tort claims that arise from the same fee dispute, as well as from the closure of Mesa General preceding expiration of the Company’s lease for the Mesa General property in July 2008. The majority of the vendor’s cardiac catheterization services were performed at the Mesa General facility, which is included in discontinued operations in the accompanying consolidated statements of operations. The Company’s motion to compel arbitration was granted without oral argument by the court in Phoenix on August 13, 2009 and the court ordered the parties to either agree on an arbitrator or submit their respective party-appointed arbitrators to the court, whereupon those appointed arbitrators would each submit a nominee for neutral third-party arbitrator to the court for the court’s selection. The parties are following the court-ordered procedure for appointment of the arbitration panel, after which time, the three-person panel will meet and set up a hearing among the parties to set the schedule and structure for the arbitration.
14. LEASES
The Company leases various buildings, office space and equipment under capital and operating lease agreements. These leases expire at various times and have various renewal options.
The Company is a party to an amended facility lease with a 15 year term that expires in January 31, 2019, and includes options to extend the term of the lease through January 31, 2039. The annual cost under this agreement is $6.4 million, payable in monthly installments. Future minimum lease payments at September 30, 2009, are as follows (in thousands):
                 
    Capital     Operating  
    Leases     Leases  
2010
  $ 1,118     $ 21,839  
2011
    923       17,560  
2012
    647       15,401  
2013
    562       14,734  
2014
    562       13,353  
Thereafter
    5,194       42,277  
 
           
Total minimum lease payments
  $ 9,006     $ 125,164  
 
             
Amount representing interest (at rates ranging from 4.4% to 14.2%)
    3,781          
 
             
Present value of net minimum lease payments (including $654 classified as current)
  $ 5,225          
 
             
Aggregate future minimum rentals to be received under noncancellable subleases as of September 30, 2009, were $4.3 million.
15. RETIREMENT PLANS
Substantially all employees who are employed by the Company or its subsidiaries, upon qualification, are eligible to participate in a defined contribution 401(k) plan (the “Retirement Plan”). Employees who elect to participate generally make contributions from 1% to 20% of their eligible compensation, and the Company matches, at its discretion, such contributions up to a maximum percentage. Generally, employees immediately vest 100% in their own contributions and vest in the employer portion of contributions over a period not to exceed five years. Company contributions to the Retirement Plan were $5.7 million, $5.0 million and $4.3 million for the years ended September 30, 2009, 2008 and 2007, respectively.

 

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16. SEGMENT AND GEOGRAPHIC INFORMATION
The Company’s acute care hospitals and related healthcare businesses are similar in their activities and the economic environments in which they operate (i.e., urban and suburban markets). Accordingly, the Company’s reportable operating segments consist of (1) acute care hospitals and related healthcare businesses, collectively, and (2) Health Choice. The following is a financial summary by business segment for the periods indicated (in thousands):
                                 
    For the Year Ended September 30, 2009  
    Acute Care     Health Choice     Eliminations     Consolidated  
Acute care revenue
  $ 1,662,469     $     $     $ 1,662,469  
Premium revenue
          699,503             699,503  
Revenue between segments
    9,316             (9,316 )      
 
                       
Total net revenue
    1,671,785       699,503       (9,316 )     2,361,972  
 
                               
Salaries and benefits
    641,893       19,028             660,921  
Supplies
    250,310       263             250,573  
Medical claims
          602,076       (9,316 )     592,760  
Other operating expenses
    302,804       22,931             325,735  
Provision for bad debts
    192,563                   192,563  
Rentals and leases
    37,563       1,564             39,127  
Hurricane-related property damage
    938                   938  
 
                       
Adjusted EBITDA(1)
    245,714       53,641             299,355  
 
                               
Interest expense, net
    67,890                   67,890  
Depreciation and amortization
    94,014       3,448             97,462  
Impairment of goodwill
    64,639                   64,639  
Management fees
    5,000                   5,000  
 
                       
Earnings from continuing operations before gain (loss) on disposal of assets, minority interests and income taxes
    14,171       50,193             64,364  
Gain (loss) on disposal of assets, net
    1,616       (151 )           1,465  
Minority interests
    (9,987 )                 (9,987 )
 
                       
Earnings from continuing operations before income taxes
  $ 5,800     $ 50,042     $     $ 55,842  
 
                       
Segment assets
  $ 2,109,422     $ 247,782             $ 2,357,204  
 
                         
Capital expenditures — continuing operations
  $ 86,875     $ 845             $ 87,720  
 
                         
Goodwill
  $ 712,163     $ 5,757             $ 717,920  
 
                         
                                 
    For the Year Ended September 30, 2008  
    Acute Care     Health Choice     Eliminations     Consolidated  
Acute care revenue
  $ 1,523,790     $     $     $ 1,523,790  
Premium revenue
          541,746             541,746  
Revenue between segments
    9,594             (9,594 )      
 
                       
Total net revenue
    1,533,384       541,746       (9,594 )     2,065,536  
 
                               
Salaries and benefits
    614,442       17,667             632,109  
Supplies
    231,001       258             231,259  
Medical claims
          461,649       (9,594 )     452,055  
Other operating expenses
    264,814       18,309             283,123  
Provision for bad debts
    161,936                   161,936  
Rentals and leases
    35,466       1,167             36,633  
Hurricane-related property damage
    3,589                   3,589  
 
                       
Adjusted EBITDA(1)
    222,136       42,696             264,832  
 
                               
Interest expense, net
    75,665                   75,665  
Depreciation and amortization
    93,003       3,738             96,741  
Management fees
    5,000                   5,000  
 
                       
Earnings from continuing operations before loss on disposal of assets, minority interests and income taxes
    48,468       38,958             87,426  
Loss on disposal of assets, net
    (75 )                 (75 )
Minority interests
    (4,437 )                 (4,437 )
 
                       
Earnings from continuing operations before income taxes
  $ 43,956     $ 38,958     $     $ 82,914  
 
                       
Segment assets
  $ 2,123,069     $ 185,078             $ 2,308,147  
 
                         
Capital expenditures — continuing operations
  $ 136,425     $ 990             $ 137,415  
 
                         
Goodwill
  $ 774,842     $ 5,757             $ 780,599  
 
                         

 

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    For the Year Ended September 30, 2007  
    Acute Care     Health Choice     Eliminations     Consolidated  
Acute care revenue
  $ 1,315,438     $     $     $ 1,315,438  
Premium revenue
          450,641             450,641  
Revenue between segments
    7,540             (7,540 )      
 
                       
Total net revenue
    1,322,978       450,641       (7,540 )     1,766,079  
 
                               
Salaries and benefits
    518,989       14,803             533,792  
Supplies
    194,630       285             194,915  
Medical claims
          384,045       (7,540 )     376,505  
Other operating expenses
    251,167       15,096             266,263  
Provision for bad debts
    136,233                   136,233  
Rentals and leases
    30,384       1,162             31,546  
Business interruption insurance recoveries
    (3,443 )                 (3,443 )
 
                       
Adjusted EBITDA(1)
    195,018       35,250             230,268  
 
                               
Interest expense, net
    71,206                   71,206  
Depreciation and amortization
    71,828       3,560             75,388  
Loss on extinguishment of debt
    6,229                   6,229  
Management fees
    4,746                   4,746  
 
                       
Earnings from continuing operations before loss on disposal of assets, minority interests and income taxes
    41,009       31,690             72,699  
Loss on disposal of assets, net
    (1,359 )                 (1,359 )
Minority interests
    (4,496 )                 (4,496 )
 
                       
Earnings from continuing operations before income taxes
  $ 35,154     $ 31,690     $     $ 66,844  
 
                       
Segment assets
  $ 2,035,386     $ 151,036             $ 2,186,422  
 
                         
Capital expenditures — continuing operations
  $ 193,570     $ 473             $ 194,043  
 
                         
Goodwill
  $ 750,836     $ 5,757             $ 756,593  
 
                         
     
(1)   Adjusted EBITDA represents net earnings before interest expense, income tax expense (benefit), depreciation and amortization, impairment of goodwill, loss on extinguishment of debt, gain (loss) on disposal of assets, minority interests and management fees. Management fees represent monitoring and advisory fees paid to TPG, the Company’s majority financial sponsor, and certain other members of IASIS Investment LLC. Management routinely calculates and communicates adjusted EBITDA and believes that it is useful to investors because it is commonly used as an analytical indicator within the healthcare industry to evaluate hospital performance, allocate resources and measure leverage capacity and debt service ability. In addition, the Company uses adjusted EBITDA as a measure of performance for its business segments and for incentive compensation purposes. Adjusted EBITDA should not be considered as a measure of financial performance under GAAP, and the items excluded from adjusted EBITDA are significant components in understanding and assessing financial performance. Adjusted EBITDA should not be considered in isolation or as an alternative to net earnings, cash flows generated by operating, investing, or financing activities or other financial statement data presented in the consolidated financial statements as an indicator of financial performance or liquidity. Adjusted EBITDA, as presented, differs from what is defined under the Company’s senior secured credit facilities and may not be comparable to similarly titled measures of other companies.
17. ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES
A summary of accrued expenses and other current liabilities consists of the following (in thousands):
                 
    September 30,     September 30,  
    2009     2008  
Employee health insurance payable
  $ 9,183     $ 10,834  
Accrued property taxes
    10,496       10,041  
Health Choice program settlements payable
    13,720        
Other
    32,302       30,927  
 
           
 
  $ 65,701     $ 51,802  
 
           

 

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18. ALLOWANCE FOR DOUBTFUL ACCOUNTS
A summary of activity in the Company’s allowance for doubtful accounts is as follows (in thousands):
                                                 
                            Accounts                
                            Written Off,                
    Beginning     Provision for             Net of             Ending  
    Balance     Bad Debts     Other (1)     Recoveries     Acquisitions     Balance  
Year Ended September 30, 2007
  $ 109,877       136,233       6,475       (167,900 )     13,144     $ 97,829  
Year Ended September 30, 2008
  $ 97,829       161,936       6,782       (158,092 )         $ 108,455  
Year Ended September 30, 2009
  $ 108,455       192,563       641       (175,527 )         $ 126,132  
 
     
(1)   Represents provision for bad debts recorded at facilities which are now included in discontinued operations.
The provision for bad debts increased $30.6 million during the year ended September 30, 2009, primarily as a result of increases in self-pay volume and revenue. The provision for bad debts increased $25.7 during the year end September 30, 2008, primarily as a result of increases in self-pay volume and revenue, as well as the effect of a full year of operations at Mountain Vista Medical Center, Alliance and Glenwood.
19. IMPACT OF HURRICANE ACTIVITY
The Medical Center of Southeast Texas, the Company’s hospital located in Port Arthur, Texas, was damaged during Hurricane Ike in September 2008. The hospital sustained roof and water intrusion damage. The majority of services at the hospital became operational during October of 2008. The Company’s results from operations include hurricane-related property damage of $938,000 and $3.6 million for the years ended September 30, 2009 and 2008, respectively.
During the year ended September 30, 2007, the Company received business interruption insurance recoveries of $3.4 million resulting from the temporary closure and disruption of operations at The Medical Center of Southeast Texas, as a result of Hurricane Rita in 2005. Amounts received during the year ended September 30, 2007, represent the final settlement of the Company’s business interruption insurance claim related to Hurricane Rita.
20. SUPPLEMENTAL CONDENSED CONSOLIDATING FINANCIAL INFORMATION
The 8 3/4% notes described in Note 3 are fully and unconditionally guaranteed on a joint and several basis by all of the Company’s existing domestic subsidiaries, other than non-guarantor subsidiaries which include Health Choice and the Company’s non-wholly owned subsidiaries.
Effective July 1, 2007, the operations of Pioneer Valley Hospital (“Pioneer”), formerly a subsidiary guarantor under the 8 3/4% notes, merged into Jordan Valley Hospital, a non-wholly owned subsidiary, to form Jordan Valley Medical Center. The Pioneer subsidiary was dissolved in connection with this merger. As a result, the combined operations of Jordan Valley Medical Center are included in the subsidiary non-guarantor information in the following summarized condensed consolidating financial statements.
Effective February 1, 2008, Salt Lake Regional Medical Center, LP (“Salt Lake”) sold limited partner units representing, in the aggregate, a 2.2% ownership interest in Salt Lake. As a result, the Company’s ownership interest in Salt Lake was reduced to 97.8%. Salt Lake is included in the condensed consolidating financial statements as a subsidiary non-guarantor.
Summarized condensed consolidating balance sheets at September 30, 2009 and 2008, condensed consolidating statements of operations and cash flows for the years ended September 30, 2009, 2008 and 2007, for the Company, segregating the parent company issuer, the subsidiary guarantors, the subsidiary non-guarantors and eliminations, are found below. Prior year amounts have been reclassified to conform to the current year presentation.

 

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IASIS Healthcare LLC
Condensed Consolidating Balance Sheet
September 30, 2009
(in thousands)
                                         
            Subsidiary     Subsidiary             Condensed  
    Parent Issuer     Guarantors     Non-Guarantors     Eliminations     Consolidated  
Assets
                                       
Current assets:
                                       
Cash and cash equivalents
  $     $ 206,331     $ 197     $     $ 206,528  
Accounts receivable, net
          90,883       139,315             230,198  
Inventories
          22,405       28,087             50,492  
Deferred income taxes
    39,038                         39,038  
Prepaid expenses and other current assets
          15,521       33,932             49,453  
 
                             
Total current assets
    39,038       335,140       201,531               575,709  
 
                                       
Property and equipment, net
          347,657       649,696             997,353  
Intercompany
          (243,956 )     243,956              
Net investment in and advances to subsidiaries
    1,690,127                   (1,690,127 )      
Goodwill
    17,331       67,445       633,144             717,920  
Other intangible assets, net
                30,000             30,000  
Other assets, net
    15,182       16,780       4,260             36,222  
 
                             
Total assets
  $ 1,761,678     $ 523,066     $ 1,762,587     $ (1,690,127 )   $ 2,357,204  
 
                             
 
                                       
Liabilities and Member’s Equity
                                       
Current liabilities:
                                       
Accounts payable
  $     $ 25,269     $ 43,283     $     $ 68,552  
Salaries and benefits payable
          25,008       17,540             42,548  
Accrued interest payable
    12,511       (3,239 )     3,239             12,511  
Medical claims payable
                113,519             113,519  
Other accrued expenses and other current liabilities
          39,559       26,142             65,701  
Current portion of long-term debt and capital lease obligations
    7,431       935       20,614       (20,614 )     8,366  
 
                             
Total current liabilities
    19,942       87,532       224,337       (20,614 )     311,197  
 
                                       
Long-term debt and capital lease obligations
    1,045,260       6,211       566,980       (566,980 )     1,051,471  
Deferred income taxes
    106,425                         106,425  
Other long-term liabilities
          53,577       645             54,222  
Minority interests
          53,042                   53,042  
 
                             
Total liabilities
    1,171,627       200,362       791,962       (587,594 )     1,576,357  
Member’s equity
    590,051       322,704       970,625       (1,102,533 )     780,847  
 
                             
Total liabilities and member’s equity
  $ 1,761,678     $ 523,066     $ 1,762,587     $ (1,690,127 )   $ 2,357,204  
 
                             

 

95


Table of Contents

IASIS Healthcare LLC
Condensed Consolidating Balance Sheet
September 30, 2008
(in thousands)
                                         
            Subsidiary     Subsidiary             Condensed  
    Parent Issuer     Guarantors     Non-Guarantors     Eliminations     Consolidated  
Assets
                                       
Current assets:
                                       
Cash and cash equivalents
  $     $ 80,336     $ 402     $     $ 80,738  
Accounts receivable, net
          101,291       122,847             224,138  
Inventories
          21,236       28,218             49,454  
Deferred income taxes
    38,860                         38,860  
Prepaid expenses and other current assets
          19,688       40,365             60,053  
 
                             
Total current assets
    38,860       222,551       191,832               453,243  
 
                                       
Property and equipment, net
          363,106       641,142             1,004,248  
Intercompany
          (190,870 )     190,870              
Net investment in and advances to subsidiaries
    1,717,907                   (1,717,907 )      
Goodwill
    18,609       128,764       633,226             780,599  
Other intangible assets, net
                33,000             33,000  
Other assets, net
    18,210       12,944       5,903             37,057