Universal Health Services, Inc - Form 10-Q

 

FORM 10-Q

 


 

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

(MARK ONE)

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended June 30, 2005

 

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from              to             

 

Commission file number 1-10765

 


 

UNIVERSAL HEALTH SERVICES, INC.

(Exact name of registrant as specified in its charter)

 


 

DELAWARE   23-2077891

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

 

UNIVERSAL CORPORATE CENTER

367 SOUTH GULPH ROAD

KING OF PRUSSIA, PENNSYLVANIA 19406

(Address of principal executive offices) (Zip Code)

 

Registrant’s telephone number, including area code (610) 768-3300

 


 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).    Yes  x    No  ¨

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date. Common shares outstanding, as of July 31, 2005:

 

Class A     3,328,404
Class B   52,042,467
Class C        335,800
Class D          26,846

 



UNIVERSAL HEALTH SERVICES, INC.

 

I N D E X

 

     PAGE NO.

      

PART I. FINANCIAL INFORMATION

    

Item 1. Financial Statements

    

   Condensed Consolidated Statements of Income - Three and Six Months Ended June 30, 2005 and 2004

   3

   Condensed Consolidated Balance Sheets – June 30, 2005 and December 31, 2004

   4

   Condensed Consolidated Statements of Cash Flows Six Months Ended June 30, 2005 and 2004

   5

Notes to Condensed Consolidated Financial Statements

   6 through 16

Item 2. Management’s Discussion and Analysis of Results of Operations and Financial Condition

   17 through 32

PART II. Other Information

   33 through 35

Signatures

   36

 

Page 2 of 36 Pages


PART I. FINANCIAL INFORMATION

 

UNIVERSAL HEALTH SERVICES, INC. AND SUBSIDIARIES

 

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(amounts in thousands, except per share amounts)

(unaudited)

 

    

Three Month Ended

June 30,


  

Six Month Ended

June 30,


     2005

   2004

   2005

   2004

Net revenues

   $ 990,888    $ 905,494    $ 1,997,533    $ 1,812,620

Operating charges:

                           

Salaries, wages and benefits

     407,897      369,335      814,237      740,793

Other operating expenses

     234,707      213,274      465,872      421,229

Supplies expense

     126,124      113,521      252,660      229,105

Provision for doubtful accounts

     95,478      74,244      177,886      157,801

Depreciation and amortization

     37,988      35,033      77,684      68,342

Lease and rental expense

     15,288      15,255      30,755      30,148
    

  

  

  

       917,482      820,662      1,819,094      1,647,418
    

  

  

  

Income before interest expense, minority interests and income taxes

     73,406      84,832      178,439      165,202

Interest expense, net

     7,450      9,359      18,126      18,926

Minority interests in earnings of consolidated entities

     7,926      5,183      15,845      8,710
    

  

  

  

Income before income taxes

     58,030      70,290      144,468      137,566

Provision for income taxes

     21,398      25,908      53,146      50,671
    

  

  

  

Income from continuing operations

     36,632      44,382      91,322      86,895

Income from discontinued operations, net of income tax expense of $57,516 and $2,470 during the three month periods ended June 30, 2005 and 2004, respectively, and $61,723 and $4,874 during the six months ended June 30, 2005 and 2004, respectively

     122,211      3,907      128,930      7,578
    

  

  

  

Net income

   $ 158,843    $ 48,289    $ 220,252    $ 94,473
    

  

  

  

Basic earnings per share:

                           

From continuing operations

   $ 0.65    $ 0.77    $ 1.60    $ 1.51

From discontinued operations

     2.16      0.07      2.26      0.13
    

  

  

  

Total basic earnings per share

   $ 2.81    $ 0.84    $ 3.86    $ 1.64
    

  

  

  

Diluted earnings per share:

                           

From continuing operations

   $ 0.61    $ 0.72    $ 1.50    $ 1.40

From discontinued operations

     1.92      0.06      2.01      0.12
    

  

  

  

Total diluted earnings per share

   $ 2.53    $ 0.78    $ 3.51    $ 1.52
    

  

  

  

Weighted average number of common shares - basic

     56,425      57,622      56,974      57,593

Add: Shares for conversion of convertible debentures

     6,577      6,577      6,577      6,577

Other share equivalents

     646      774      481      860
    

  

  

  

Weighted average number of common shares and equivalents - diluted

     63,648      64,973      64,032      65,030
    

  

  

  

 

See accompanying notes to these condensed consolidated financial statements.

 

Page 3 of 36 Pages


UNIVERSAL HEALTH SERVICES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(dollar amounts in thousands, unaudited)

 

    

June 30,

2005


    December 31,
2004


 
Assets                 

Current assets:

                

Cash and cash equivalents

   $ 114,747     $ 33,125  

Accounts receivable, net

     550,437       552,538  

Supplies

     54,479       60,729  

Other current assets

     33,784       29,663  

Deferred income taxes

     9,328       —    

Assets of facilities held for sale

     —         132,870  
    


 


Total current assets

     762,775       808,925  
    


 


Property and equipment

     2,202,369       2,267,284  

Less: accumulated depreciation

     (851,307 )     (819,218 )
    


 


       1,351,062       1,448,066  

Other assets:

                

Goodwill

     531,959       619,064  

Deferred charges

     10,505       14,416  

Other

     107,124       132,372  
    


 


       649,588       765,852  
    


 


     $ 2,763,425     $ 3,022,843  
    


 


Liabilities and Stockholders’ Equity                 

Current liabilities:

                

Current maturities of long-term debt

   $ 3,994     $ 16,968  

Accounts payable and accrued liabilities

     401,773       419,116  

Federal and state taxes

     77,814       22,456  

Liabilities of facilities held for sale

     —         11,116  
    


 


Total current liabilities

     483,581       469,656  
    


 


Other noncurrent liabilities

     254,199       243,617  

Minority interests

     168,849       186,543  

Long-term debt

     525,849       852,229  

Deferred income taxes

     49,161       50,212  

Commitments and contingencies

                

Common stockholders’ equity:

                

Class A Common Stock, 3,328,404 shares outstanding in 2005 and 3,328,404 in 2004

     33       33  

Class B Common Stock, 52,036,190 shares outstanding in 2005 and 54,058,695 in 2004

     520       541  

Class C Common Stock, 335,800 shares outstanding in 2005 and 335,800 in 2004

     3       3  

Class D Common Stock, 26,956 shares outstanding in 2005 and 27,401 in 2004

     —         —    

Capital in excess of par

     —         22,890  

Deferred compensation

     (12,314 )     (1,659 )

Cumulative dividends

     (32,387 )     (23,272 )

Retained earnings

     1,335,654       1,220,186  

Accumulated other comprehensive (loss) income

     (9,723 )     1,864  
    


 


       1,281,786       1,220,586  
    


 


     $ 2,763,425     $ 3,022,843  
    


 


 

See accompanying notes to these condensed consolidated financial statements.

 

Page 4 of 36 Pages


UNIVERSAL HEALTH SERVICES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(amounts in thousands, unaudited)

 

    

Six Months Ended

June 30,


 
     2005

    2004

 

Cash Flows from Operating Activities:

                

Net income

   $ 220,252     $ 94,473  

Adjustments to reconcile net income to net cash provided by operating activities:

                

Depreciation & amortization

     85,758       81,399  

Accretion of discount on convertible debentures

     6,244       5,997  

Gains on sales of assets and businesses, net of accrued income taxes

     (126,507 )     (1,486 )

Provision for asset impairment

     3,105       —    

Changes in assets & liabilities, net of effects from acquisitions and dispositions:

                

Accounts receivable

     (46,358 )     (39,323 )

Accrued interest

     734       28  

Accrued and deferred income taxes, excluding income taxes on gains on sales of assets and businesses

     (4,140 )     15,152  

Other working capital accounts

     47,485       42,350  

Other assets and deferred charges

     3,554       (2,259 )

Other

     4,117       1,386  

Minority interest in earnings of consolidated entities, net of distributions

     12,668       11,742  

Accrued insurance expense, net of commercial premiums paid

     42,945       39,307  

Payments made in settlement of self-insurance claims

     (19,419 )     (24,091 )
    


 


Net cash provided by operating activities

     230,438       224,675  
    


 


Cash Flows from Investing Activities:

                

Property and equipment additions, net of disposals

     (108,847 )     (118,018 )

Proceeds received from sales of assets and businesses

     377,136       68,777  

Acquisition of businesses

     (5,225 )     (142,391 )
    


 


Net cash provided by (used in) investing activities

     263,064       (191,632 )
    


 


Cash Flows from Financing Activities:

                

Additional borrowings

     7,823       —    

Reduction of long-term debt

     (263,290 )     (23,713 )

Issuance of common stock

     11,443       1,795  

Repurchase of common shares

     (157,526 )     (350 )

Dividends paid

     (9,115 )     (9,303 )

Financing costs on new revolving credit facility

     (1,215 )     —    
    


 


Net cash used in financing activities

     (411,880 )     (31,571 )
    


 


Increase in cash and cash equivalents

     81,622       1,472  

Cash and cash equivalents, beginning of period

     33,125       34,863  
    


 


Cash and cash equivalents, end of period

   $ 114,747     $ 36,335  
    


 


Supplemental Disclosures of Cash Flow Information:

                

Interest paid

   $ 15,397     $ 15,796  
    


 


Income taxes paid, net of refunds

   $ 58,195     $ 40,494  
    


 


 

See accompanying notes to these condensed consolidated financial statements.

 

Page 5 of 36 Pages


UNIVERSAL HEALTH SERVICES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

(1) General

 

This Report on Form 10-Q is for the Quarterly period ended June 30, 2005. In this Quarterly Report, “we,” “us,” “our” and the “Company” refer to Universal Health Services, Inc. and its subsidiaries.

 

You should carefully review the information contained in this Quarterly Report, and should particularly consider any risk factors that we set forth in this Quarterly Report and in other reports or documents that we file from time to time with the SEC. In this Quarterly Report, we state our beliefs of future events and of our future financial performance. In some cases, you can identify those so-called “forward-looking statements” by words such as “may,” “will,” “should,” “expects,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “potential,” or “continue” or the negative of those words and other comparable words. You should be aware that those statements are only our predictions. Actual events or results may differ materially. In evaluating those statements, you should specifically consider various factors, including the risks outlined in Item 2. Management’s Discussion and Analysis of Results of Operations and Financial Condition – Forward Looking Statements and Risk Factors. Those factors may cause our actual results to differ materially from any of our forward-looking statements.

 

The condensed consolidated financial statements include the accounts of our majority-owned subsidiaries and partnerships controlled by us, or our subsidiaries, as managing general partner. The condensed consolidated financial statements included herein have been prepared by us, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission and reflect all normal and recurring adjustments which, in our opinion, are necessary to fairly present results for the interim periods. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to such rules and regulations, although we believe that the accompanying disclosures are adequate to make the information presented not misleading. It is suggested that these condensed consolidated financial statements be read in conjunction with the consolidated financial statements, significant accounting policies and the notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2004. Certain prior year amounts have been reclassified to conform with current year financial statement presentation.

 

(2) Relationship with Universal Health Realty Income Trust and Related Party Transactions

 

Relationship with Universal Health Realty Income Trust:

 

At June 30, 2005, we held approximately 6.7% of the outstanding shares of Universal Health Realty Income Trust (the “Trust”). We serve as Advisor to the Trust under an annually renewable advisory agreement pursuant to the terms of which, we conduct the Trust’s day-to-day affairs, provide administrative services and present investment opportunities. In addition, certain of our officers and directors are also officers and/or directors of the Trust. Management believes that it has the ability to exercise significant influence over the Trust, therefore we account for our investment in the Trust using the equity method of accounting. We earned an advisory fee from the Trust, which is included in net revenues in the accompanying condensed consolidated statements of income, of $353,000 and $367,000 during the three month periods ended June 30, 2005 and 2004, respectively, and $708,000 and $741,000 during the six month periods ended June 30, 2005 and 2004, respectively. Our pre-tax share of income from the Trust was $609,000 and $413,000 during the three month periods ended June 30, 2005 and 2004, respectively, and $909,000 and $755,000 during the six month periods ended June 30, 2005 and 2004, respectively, and is included in net revenues in the accompanying condensed consolidated statements of income. The carrying value of this investment was $8.8 million at June 30, 2005 and $9.5 million at December 31, 2004, and is included in other assets in the accompanying condensed consolidated balance sheets. The market value of this investment was $30.0 million at June 30, 2005 and $25.2 million at December 31, 2004.

 

Page 6 of 36 Pages


As of June 30, 2005, we leased the following five hospital facilities from the Trust:

 

Hospital Name


  

Type of Facility


   Annual
Minimum
Rent


  

End of Lease Term


  

Renewal
Term

(years)


 
McAllen Medical Center    Acute Care    $ 5,485,000    December, 2006    25 (a)
Wellington Regional Medical Center    Acute Care    $ 2,495,000    December, 2006    25 (b)

Southwest Healthcare System,

Inland Valley Campus

   Acute Care    $ 1,857,000    December, 2006    25 (b)
Chalmette Medical Center    Acute Care    $ 960,000    March, 2008    10 (c)
The Bridgeway    Behavioral Health    $ 683,000    December, 2009    15 (d)

(a) We have five 5-year renewal options at existing lease rates (through 2031).
(b) We have three 5-year renewal options at existing lease rates (through 2021) and two 5-year renewal options at fair market value lease rates (2022 through 2031).
(c) We have two 5-year renewal options at lease rates based upon the then five-year Treasury rate plus a spread (through March, 2018).
(d) We have one 5-year renewal option at existing lease rates (through 2014) and two 5-year renewal options at fair market value lease rates (2015 through 2024).

 

The Trust commenced operations in 1986 by purchasing certain subsidiaries from us and immediately leasing the properties back to our respective subsidiaries. Most of the leases were entered into at the time the Trust commenced operations and provided for initial terms of 13 to 15 years with up to six additional 5-year renewal terms, with the base rents set forth in the leases effective for all but the last two renewal terms. Each lease also provided for additional or bonus rental, as discussed below. In 1998, the lease for McAllen Medical Center was amended to provide that the last two renewal terms would also be fixed at the initial agreed upon rental. This lease amendment was in connection with certain concessions granted by us with respect to the renewal of other leases. The base rents are paid monthly and the bonus rents are computed and paid on a quarterly basis, based upon a computation that compares current quarter revenue to a corresponding quarter in the base year. The leases with our subsidiaries are unconditionally guaranteed by us and are cross-defaulted with one another.

 

Pursuant to the terms of the leases with the Trust, we have the option to renew the leases at the lease terms described above by providing notice to the Trust at least 90 days prior to the termination of the then current term. We also have the right to purchase the respective leased facilities at the end of the lease terms or any renewal terms at the appraised market value. In addition, we have rights of first refusal to: (i) purchase the respective leased facilities during and for 180 days after the lease terms at the same price, terms and conditions of any third-party offer, or; (ii) renew the lease on the respective leased facility at the end of, and for 180 days after, the lease term at the same terms and conditions pursuant to any third-party offer.

 

Total rent expense under the operating leases on these five hospital facilities with the Trust was $4.0 million and $4.1 million during the three months ended June 30, 2005 and 2004, respectively, and $8.1 million and $8.2 million during six months ended June 30, 2005 and 2004, respectively. In addition, certain of our subsidiaries are tenants in several medical office buildings owned by limited liability companies in which the Trust holds non-controlling ownership interests.

 

Other Related Party Transactions:

 

Our Chairman and Chief Executive Officer is a member of the Board of Directors of Broadlane, Inc. In addition, the Company and certain Directors and members of our executive management team own approximately 6% of the outstanding shares of Broadlane, Inc. as of June 30, 2005. Broadlane, Inc. provides contracting and other supply chain services to us and various other healthcare organizations.

 

A member of our Board of Directors and member of the Executive Committee is Of Counsel to the law firm used by us as our principal outside counsel. This Board member is also the trustee of certain trusts for the benefit of the Chief Executive Officer and his family. This law firm also provides personal legal services to our Chief Executive Officer.

 

We invested $3.3 million for a 25% ownership interest in an information technology company that provides laboratory information system and order management technology to many of our acute care hospitals. We have also committed to pay this company a license fee totaling $25.3 million over a five-year period, of which $5.2 million has been paid as of June 30, 2005.

 

(3) Other Noncurrent and Minority Interest Liabilities

 

Other noncurrent liabilities include the long-term portion of our professional and general liability, workers’ compensation reserves, and pension liability.

 

As of June 30, 2005 and December 31, 2004, the $168.8 million and $186.5 million, respectively, minority interest liability consists primarily of: (i) a 27.5% outside ownership interest in four acute care facilities located in Las Vegas, Nevada; (ii) a 20% outside ownership in an acute care facility located in Washington D.C., and; (iii) a 10% outside ownership in two acute care facilities located in Louisiana.

 

Page 7 of 36 Pages


In connection with the four acute care facilities located in Las Vegas, the outside owners have certain “put rights” that may require the respective limited liabilities companies (“LLCs”) to purchase the minority member’s interests upon the occurrence of: (i) certain specified financial conditions falling below established thresholds; (ii) breach of the management contract by the managing member (a subsidiary of ours), or; (iii) if the minority member’s ownership percentage is reduced to less than certain thresholds.

 

With respect to two acute care facilities located in Louisiana owned by a LLC, in which we own a 90% controlling interest, the minority member has certain “put rights” which can be exercised at any time within 180 days of the third, fifth, tenth or fifteenth anniversary of the closing dates, or at any time if certain determinations are made as specified in the agreement. These put rights, if exercised, would require the LLC to purchase the minority member’s interest at a price that is the greater of: (i) a fixed amount as stipulated in the agreement that approximates the minority member’s interest in each facility at closing, or; (ii) the minority member’s interest multiplied by the annualized net revenue of each facility for the 12 month period ending on the date of exercise of the put right. We also have certain “call rights” that would allow the LLC to purchase the minority member’s shares which can be exercised at any time within 180 days of the third, fifth, tenth or fifteenth anniversary of the closing dates, or at any time if certain determinations are made as specified in the agreement. These call rights allow the LLC to purchase the minority member’s interest at a price that is the greater of: (i) a fixed amount as stipulated in the agreement that approximates the minority member’s interest in each facility at closing, plus a premium, or; (ii) the minority member’s percentage interest multiplied by a multiple of the annualized net revenue of each facility for the 12 month period ending on the date of exercise of the call right.

 

(4) Commitments and Contingencies

 

Due to unfavorable pricing and availability trends in the professional and general liability insurance markets, our subsidiaries have assumed a greater portion of the hospital professional and general liability risk as the cost of commercial professional and general liability insurance coverage has risen. As a result, effective January 1, 2002, most of our subsidiaries were self-insured for malpractice exposure up to $25 million per occurrence. We purchased umbrella excess policies for our subsidiaries through several commercial insurance carriers for coverage in excess of $25 million per occurrence with a $75 million aggregate limitation. Given these insurance market conditions, there can be no assurance that a continuation of these unfavorable trends, or a sharp increase in claims asserted against us, will not have a material adverse effect on our future results of operations.

 

Our estimated liability for professional and general liability claims is based on a number of factors including, among other things, the number of asserted claims and reported incidents, estimates of losses for these claims based on recent and historical settlement amounts, estimate of incurred but not reported claims based on historical experience, and estimates of amounts recoverable under our commercial insurance policies. While we continuously monitor these factors, our ultimate liability for professional and general liability claims could change materially from our current estimates due to inherent uncertainties involved in making this estimate.

 

For the period from January 1, 1998 through December 31, 2001, most of our subsidiaries were covered under commercial insurance policies with PHICO, a Pennsylvania based insurance company that was placed into liquidation during the first quarter of 2002. As a result of PHICO’s liquidation, we recorded a $40 million pre-tax charge during 2001 to reserve for PHICO claims that could become our liability, however, we are entitled to receive reimbursement from state insurance guaranty funds, other commercial insurers and/or PHICO’s estate for a portion of certain claims ultimately paid by us.

 

As of June 30, 2005, the total accrual for our professional and general liability claims was $215.3 million ($191.6 million net of expected recoveries), of which $28.0 million is included in other current liabilities. As of December 31, 2004, the total accrual for our professional and general liability claims was $204.1 million ($172.5 million net of expected recoveries), of which $28.0 million is included in other current liabilities. Included in other assets was $23.7 million as of June 30, 2005 and $31.6 million as of December 31, 2004, related to estimated expected recoveries from various state guaranty funds, insurance companies and other sources in connection with PHICO related professional and general liability claims payments.

 

Page 8 of 36 Pages


As of June 30, 2005, we had outstanding letters of credit and surety bonds totaling $65 million consisting of: (i) $52 million related to our self-insurance programs; (ii) $7 million consisting primarily of collateral for outstanding bonds of an unaffiliated third party and public utility, and; (iii) $6 million of debt guarantees related to entities in which we own a minority interest.

 

We have a long-term contract with a third party that expires in 2012, to provide certain data processing services for our acute care and behavioral health facilities.

 

On or about March 22 through March 26, 2004, two purported class action Complaints were filed against us and certain of our officers and directors in the United States District Court for the Eastern District of Pennsylvania alleging that defendants violated Section 10(b) of the Exchange Act and Rule 10b-5 promulgated thereunder by disclosing materially false and misleading information or failing to disclose material information necessary to make other disclosure not misleading or to correct prior disclosure with respect to our financial condition and operations. A claim was asserted against the individual defendants under section 20(a) of the Exchange Act alleging that because they controlled the Company, they should be held liable for damages caused by the Company’s violation of section 10(b) and Rule 10b-5 thereunder. Plaintiffs sought, on behalf of a purported class of purchasers of our common stock during a class period from July 21, 2003 through February 27, 2004, unspecified money damages, restitution, attorneys’ fees and reimbursement of expenses. Pursuant to an Order of the Court, these two cases were consolidated into one action captioned: In re Universal Health Services, Inc. Securities Litigation, Case No. CV-04-01233-JP. Subsequently, the plaintiffs filed an Amended Consolidated Class Action Complaint. The Court granted defendants’ motion to dismiss this complaint and thereafter dismissed the action with prejudice when plaintiffs chose not to replead.

 

On July 6, 2004, we were served with a complaint filed in the United States District Court for the Eastern District of Pennsylvania captioned Eastside Investors LLP, derivatively and on behalf of nominal defendant, Universal Health Services, Inc., v. Alan B. Miller, Robert Hotz, Anthony Pantaleoni and Steve G. Filton. Plaintiff subsequently filed an amended complaint which dropped Messrs Hotz and Pantaleoni as defendants. Plaintiff purported to assert claims derivatively on behalf of the Company against our officers and directors seeking to recover on behalf of the Company unspecified damages to redress alleged breaches of fiduciary duty, abuses of control and gross mismanagement by the individual defendants. This action also has been dismissed with prejudice as a result of a stipulation of counsel entered into contemporaneously with the dismissal of the above referenced class action.

 

On August 5, 2004, we were named, together with our subsidiary, Valley Hospital Medical Center, Inc., as defendants in a lawsuit filed in Clark County, Nevada, under the caption Deborah Louise Poblocki v. Universal Health Services, Inc., et al., No. 04-A-489927-C. The plaintiff alleges that we overcharged her and other similarly situated patients who lacked health insurance. The complaint seeks class action treatment. The complaint, filed by plaintiff individually and on behalf of other unnamed class members, alleges that Valley Hospital Medical Center charged her “unconscionable rates” because it charged her, an uninsured outpatient, more than it charged insured patients and more than the cost of the services provided. She claims that this alleged conduct violates state civil RICO laws as well as other state statutory and common law. We filed a notice of removal to federal court, and plaintiff filed a motion to remand back to state court. The court granted plaintiff’s motion to remand and the case will proceed in Nevada state court. On July 22, 2005, plaintiff’s counsel, with our consent, filed a first amended complaint, adding two additional plaintiff’s (husband and wife) alleging similar “facts” and claiming similar federal and state causes of action. We anticipate filing a motion to dismiss plaintiff’s claims in the next few weeks.

 

In October, 2004, one of our subsidiaries, Aiken Regional Medical Centers, Inc., received a complaint filed in state court in South Carolina (Case No. 04-CP-02-1275). The complaint, filed by the plaintiff individually and on behalf of other unnamed, putative class members, alleges that Aiken breached its contract with the plaintiff (and other putative plaintiffs), or in the alternative Aiken was unjustly enriched, by virtue of billing and collecting full hospital charges from the plaintiff and other putative class members. Aiken has filed a motion to dismiss the complaint. The plaintiff has voluntarily dismissed the complaint, without prejudice as to the purported class, but with prejudice as to the named plaintiff.

 

Page 9 of 36 Pages


We believe that the claims asserted against us in the proceedings described above are without merit and we deny all allegations of violations of law and any liability to the above named plaintiffs. There can be no assurance, however, as to the outcome or timing of the resolution of these proceedings. We therefore are unable to estimate the amount or potential range of any loss that may arise out of these proceedings. The range of possible resolutions could include determinations and judgments against us or settlements that could require substantial payments by us that could have a material adverse effect on our financial condition, results of operations and cash flows.

 

In addition, various suits and claims arising against us in the ordinary course of business are pending. In the opinion of management, the outcome of such claims and litigation will not materially affect our consolidated financial position or results of operations.

 

The healthcare industry is subject to numerous laws and regulations which include, among other things, matters such as government healthcare participation requirements, various licensure and accreditations, reimbursement for patient services, and Medicare and Medicaid fraud and abuse. Government action has increased with respect to investigations and/or allegations concerning possible violations of fraud and abuse and false claims statutes and/or regulations by healthcare providers. Providers that are found to have violated these laws and regulations may be excluded from participating in government healthcare programs, subjected to fines or penalties or required to repay amounts received from government for previously billed patient services. While management believes its policies, procedures and practices comply with governmental regulations, no assurance can be given that we will not be subjected to governmental inquiries or actions.

 

(5) Segment Reporting

 

Our reportable operating segments consist of acute care hospital services and behavioral health care services. The “Other” segment column below includes centralized services including information services, purchasing, reimbursement, accounting, taxation, legal, advertising, design and construction, and patient accounting as well as the operating results for our other operating entities including outpatient surgery and radiation centers. Also included in the Other segment column for both periods presented are the combined assets of $7.6 million and $466.1 million as of June 30, 2005 and 2004, respectively, related to the acute care facilities and international acute care hospital services reflected as discontinued operations on our Consolidated Statements of Income. The chief operating decision making group for our acute care hospital services and behavioral health care services is comprised of the President and Chief Executive Officer, and the lead executives of each operating segment. The lead executive for each operating segment also manages the profitability of each respective segment’s various facilities. The operating segments are managed separately because each operating segment represents a business unit that offers different types of healthcare services or operates in different healthcare environments. The accounting policies of the operating segments are the same as those described in the summary of significant accounting policies included in our Annual Report on Form 10-K for the year ended December 31, 2004.

 

     Three Months Ended June 30, 2005

     Acute Care
Hospital
Services


   Behavioral
Health
Services


   Other

    Total
Consolidated


     (Dollar amounts in thousands)

Gross inpatient revenues

   $ 1,839,847    $ 344,811      —       $ 2,184,658

Gross outpatient revenues

   $ 718,853    $ 51,466    $ 20,921     $ 791,240

Total net revenues

   $ 780,873    $ 199,388    $ 10,627     $ 990,888

Income/(loss) before income taxes

   $ 51,225    $ 43,890    $ (37,085 )   $ 58,030

Total assets as of 6/30/05

   $ 2,028,433    $ 428,654    $ 306,338     $ 2,763,425

Licensed beds

     5,552      4,456      —         10,008

Available beds

     5,134      4,373      —         9,507

Patient days

     289,568      343,214      —         632,782

Admissions

     64,301      25,983      —         90,284

Average length of stay

     4.5      13.2      —         7.0

 

 

Page 10 of 36 Pages


     Six Months Ended June 30, 2005

     Acute Care
Hospital
Services


   Behavioral
Health
Services


   Other

    Total
Consolidated


     (Dollar amounts in thousands)

Gross inpatient revenues

   $ 3,786,715    $ 670,708      —       $ 4,457,423

Gross outpatient revenues

   $ 1,409,433    $ 99,981    $ 44,111     $ 1,553,525

Total net revenues

   $ 1,587,497    $ 388,948    $ 21,088     $ 1,997,533

Income/(loss) before income taxes

   $ 134,429    $ 83,611    $ (73,572 )   $ 144,468

Total assets as of 6/30/05

   $ 2,028,433    $ 428,654    $ 306,338     $ 2,763,425

Licensed beds

     5,551      4,435      —         9,986

Available beds

     5,130      4,364      —         9,494

Patient days

     602,068      669,088      —         1,271,156

Admissions

     131,392      51,028      —         182,420

Average length of stay

     4.6      13.1      —         7.0

 

     Three Months Ended June 30, 2004

     Acute Care
Hospital
Services


   Behavioral
Health
Services


   Other

    Total
Consolidated


     (Dollar amounts in thousands)

Gross inpatient revenues

   $ 1,644,878    $ 310,737      —       $ 1,955,615

Gross outpatient revenues

   $ 632,882    $ 46,472    $ 19,124     $ 698,478

Total net revenues

   $ 718,327    $ 177,732    $ 9,435     $ 905,494

Income/(loss) before income taxes

   $ 66,642    $ 35,917    $ (32,269 )   $ 70,290

Total assets as of 6/30/04

   $ 1,925,414    $ 418,695    $ 620,101     $ 2,964,210

Licensed beds

     5,704      4,214      —         9,918

Available beds

     4,864      4,138      —         9,002

Patient days

     281,476      310,723      —         592,199

Admissions

     61,907      23,944      —         85,851

Average length of stay

     4.5      13.0      —         6.9

 

     Six Months Ended June 30, 2004

     Acute Care
Hospital
Services


   Behavioral
Health
Services


   Other

    Total
Consolidated


     (Dollar amounts in thousands)

Gross inpatient revenues

   $ 3,396,296    $ 604,466      —       $ 4,000,762

Gross outpatient revenues

   $ 1,249,316    $ 89,448    $ 36,182     $ 1,374,946

Total net revenues

   $ 1,450,778    $ 343,635    $ 18,207     $ 1,812,620

Income/(loss) before income taxes

   $ 132,019    $ 69,650    $ (64,103 )   $ 137,566

Total assets as of 6/30/04

   $ 1,925,414    $ 418,695    $ 620,101     $ 2,964,210

Licensed beds

     5,678      4,059      —         9,737

Available beds

     4,838      3,956      —         8,794

Patient days

     585,086      594,621      —         1,179,707

Admissions

     126,457      48,083      —         174,540

Average length of stay

     4.6      12.4      —         6.8

 

Page 11 of 36 Pages


(6) Earnings Per Share Data (“EPS”) and Stock Based Compensation

 

Basic earnings per share are based on the weighted average number of common shares outstanding during the year. Diluted earnings per share are based on the weighted average number of common shares outstanding during the year adjusted to give effect to common stock equivalents.

 

The following table sets forth the computation of basic and diluted earnings per share for the periods indicated (in thousands, except per share data):

 

     Three Months Ended
June 30,


    Six Months Ended
June 30,


 
     (amounts in thousands)

 
     2005

    2004

    2005

    2004

 

Basic:

                                

Income from continuing operations

   $ 36,632     $ 44,382     $ 91,322     $ 86,895  

Less: Dividends on unvested restricted stock, net of taxes

     (28 )     (28 )     (55 )     (56 )
    


 


 


 


Income from continuing operations – basic

   $ 36,604     $ 44,354     $ 91,267     $ 86,839  

Income from discontinued operations

     122,211       3,907       128,930       7,578  
    


 


 


 


Net income – basic

   $ 158,815     $ 48,261     $ 220,197     $ 94,417  
    


 


 


 


Diluted:

                                

Income from continuing operations

   $ 36,632     $ 44,382     $ 91,322     $ 86,895  

Less: Dividends on unvested restricted stock, net of taxes

     (28 )     (28 )     (55 )     (56 )

Add: Debenture interest, net of taxes

     2,382       2,305       4,764       4,573  
    


 


 


 


Income from continuing operations-diluted

   $ 38,986     $ 46,659     $ 96,031     $ 91,412  

Income from discontinued operations

     122,211       3,907       128,930       7,578  
    


 


 


 


Net income – diluted

   $ 161,197     $ 50,566     $ 224,961     $ 98,990  
    


 


 


 


Weighted average number of common shares

     56,425       57,622       56,974       57,593  

Net effect of dilutive stock options and grants based on the treasury stock method

     646       774       481       860  

Assumed conversion of discounted convertible debentures

     6,577       6,577       6,577       6,577  
    


 


 


 


Weighted average number of common shares and equivalents

     63,648       64,973       64,032       65,030  
    


 


 


 


Earnings Per Basic Share:

                                

From continuing operations

   $ 0.65     $ 0.77     $ 1.60     $ 1.51  

From discontinued operations

     2.16       0.07       2.26       0.13  
    


 


 


 


Total earnings per basic share

   $ 2.81     $ 0.84     $ 3.86     $ 1.64  
    


 


 


 


Earnings Per Diluted Share:

                                

From continuing operations

   $ 0.61     $ 0.72     $ 1.50     $ 1.40  

From discontinued operations

     1.92       0.06       2.01       0.12  
    


 


 


 


Total earnings per diluted share

   $ 2.53     $ 0.78     $ 3.51     $ 1.52  
    


 


 


 


 

Page 12 of 36 Pages


Stock-Based Compensation: At June 30, 2005, we have a number of stock-based employee compensation plans. We account for these plans under the recognition and measurement principles of APB Opinion No.25, “Accounting for Stock Issued to Employees,” and related Interpretations. No compensation cost is reflected in net income for the stock option grants, as all options granted under the plan had an original exercise price equal to the market value of the underlying common shares on the date of grant.

 

In December 2004, the FASB issued SFAS No. 123R, “Share-Based Payment,” a revision of SFAS No. 123. SFAS No. 123R requires a public entity to measure the cost of employee services received in exchange for an award of equity instruments based on the grant date fair value of the award (with limited exceptions), eliminating the alternative previously allowed by SFAS No. 123 to use the intrinsic value method of accounting. The grant date fair value will be estimated using option-pricing models adjusted for the unique characteristics of the instruments using methods similar to those required by SFAS No. 123 and currently used by us to calculate pro forma net income and earnings per share disclosures. The cost will be recognized ratably over the period during which the employee is required to provide services in exchange for the award.

 

The SEC deferred the effective date for SFAS 123R for public companies from the interim to the first annual period beginning after December 15, 2005. Accordingly, we will adopt SFAS No. 123R as of January 1, 2006. As a result of adopting SFAS No. 123R, we will recognize as compensation cost in our financial statements the unvested portion of existing options granted prior to the effective date and the cost of stock options granted to employees after the effective date based on the fair value of the stock options at grant date. Although we have not yet selected our option pricing model for applying SFAS 123R, using the Black-Scholes option pricing model, we would expect to record expense related to stock options outstanding as of June 30, 2005 (assuming no cancellations) of approximately $5.0 million for the year ended December 31, 2006. The stock-based compensation expense determined under a fair value method, specifically related to stock options, was $1.6 million and $2.2 million for the three months ended June 30, 2005 and 2004, respectively and $2.9 million and $4.5 million for the six months ended June 30, 2005 and 2004, respectively. These pro forma amounts may not be representative of future expense amounts since the estimated fair value of the stock options is amortized to expense over the vesting period, and additional options may be granted in future years.

 

The Securities and Exchange Commission’s (“SEC”) Office of the Chief Accountant and its Division of Corporation Finance announced the release of Staff Accounting Bulleting No. 107, “Share-Based Payment” (“SAB 107”) in response to frequently asked questions and to provide the SEC staff’s views regarding the application of Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payments (“SFAS 123R”). SAB 107 provides interpretive guidance related to the interaction between SFAS 123R and certain SEC rules and regulations; addresses the staff’s views on the subject of valuation of share-based payment transactions for public companies; and reiterates the importance of disclosures related to share-based payment transactions in the financial statements filed with the SEC.

 

The following table illustrates the effect on net income and earnings per share if we had applied the fair value recognition provisions of FASB Statement No.123, “Accounting for Stock-Based Compensation,” to all stock-based employee compensation. We recognize compensation cost related to restricted share awards over the respective vesting periods, using an accelerated method.

 

 

Page 13 of 36 Pages


     Three Months Ended
June 30,


    Six Months Ended
June 30,


 
     (in thousands, except per share data)

 
     2005

    2004

    2005

    2004

 

Income from continuing operations

   $ 36,632     $ 44,382     $ 91,322     $ 86,895  

Add: total stock-based compensation expenses included in net income (a)

     2,423       397       2,988       1,020  

Deduct: total stock-based employee compensation expenses determined under fair value based methods for all awards (b)

     (3,439 )     (1,782 )     (4,804 )     (3,855 )
    


 


 


 


Pro forma net income from continuing operations

     35,616       42,997       89,506       84,060  

Income from discontinued operations, net of income taxes

     122,211       3,907       128,930       7,578  
    


 


 


 


Pro forma net income

   $ 157,827     $ 46,904     $ 218,436     $ 91,638  
    


 


 


 


Basic earnings per share, as reported:

                                

From continuing operations

   $ 0.65     $ 0.77     $ 1.60     $ 1.51  

From discontinued operations

   $ 2.16     $ 0.07     $ 2.26     $ 0.13  
    


 


 


 


Total basic earnings per share, as reported

   $ 2.81     $ 0.84     $ 3.86     $ 1.64  
    


 


 


 


Basic earnings per share, pro forma:

                                

From continuing operations

   $ 0.64     $ 0.74     $ 1.57     $ 1.46  

From discontinued operations

   $ 2.16     $ 0.07     $ 2.26     $ 0.13  
    


 


 


 


Total basic earnings per share, pro forma

   $ 2.80     $ 0.81     $ 3.83     $ 1.59  
    


 


 


 


Diluted earnings per share, as reported:

                                

From continuing operations

   $ 0.61     $ 0.72     $ 1.50     $ 1.40  

From discontinued operations

   $ 1.92     $ 0.06     $ 2.01     $ 0.12  
    


 


 


 


Total diluted earnings per share, as reported

   $ 2.53     $ 0.78     $ 3.51     $ 1.52  
    


 


 


 


Diluted earnings per share, pro forma:

                                

From continuing operations

   $ 0.60     $ 0.70     $ 1.47     $ 1.36  

From discontinued operations

   $ 1.92     $ 0.06     $ 2.01     $ 0.12  
    


 


 


 


Total diluted earnings per share, pro forma

   $ 2.52     $ 0.76     $ 3.48     $ 1.48  
    


 


 


 



(a) Net of income tax benefit of $1.4 million and $228,000 during the three month periods ended June 30, 2005 and 2004, respectively, and $1.7 million and $585,000 during the six month periods ended June 30, 2005 and 2004, respectively.
(b) Net of income tax provision of $2.0 million and $1.0 million during the three month periods ended June 30, 2005 and 2004, respectively, and $2.8 million and $2.2 million during the six month periods ended June 30, 2005 and 2004, respectively.

 

(7) Comprehensive Income

 

Comprehensive income or loss is recorded in accordance with the provisions of SFAS No.130, “Reporting Comprehensive Income”. SFAS No.130 establishes standards for reporting comprehensive income and its components in financial statements. Comprehensive income (loss), is comprised of net income, changes in unrealized gains or losses on derivative financial instruments and foreign currency translation adjustments.

 

     Three Months Ended
June 30,


    Six Months Ended
June 30,


 

(amounts in thousands)

 

   2005

    2004

    2005

    2004

 

Net income

   $ 158,843     $ 48,289     $ 220,252     $ 94,473  

Other comprehensive income (loss):

                                

Foreign currency translation adjustments (a)

     (9,856 )     (1,091 )     (13,544 )     (3,705 )

Adjustment for losses reclassified into income (b)

     62       1,231       794       2,531  

Unrealized derivative gains/(losses) on cash flow hedges (c)

     1,346       795       1,163       (296 )
    


 


 


 


Comprehensive income

   $ 150,395     $ 49,224     $ 208,665     $ 93,003  
    


 


 


 



(a) Upon sale of our French assets during the second quarter of 2005, the cumulative foreign currency translation adjustments included in accumulated other comprehensive income/loss, net of income taxes, were reclassified through the income statement and included in the $120.7 million after-tax gain on sale recorded during the second quarter of 2005.
(b) Net of income tax provision of $35 and $705 during the three month periods ended June 30, 2005 and 2004, respectively, and $683 and $1.5 million during the six month periods ended June 30, 2005 and 2004, respectively.
(c) Net of income tax provision/(benefit) of $771 and $456 during the three month periods ended June 30, 2005 and 2004, respectively, and $666 and ($170) during the six month periods ended June 30, 2005 and 2004, respectively.

 

Page 14 of 36 Pages


(8) Dispositions and Acquisitions

 

Dispositions during the six months ended June 30, 2005

 

During the second quarter of 2005, we sold our 81.5% ownership interest in the Médi-Partenaires Group, an operating company which owned and managed 14 acute care hospitals in France. At the time of sale, we received net cash proceeds (net of closing costs and cash balances at time of sale) before income taxes, of $252.5 million. The operating results of these facilities, as well as the $120.7 million after-tax gain ($177.1 million pre-tax) recorded during the second quarter of 2005, are reflected as “Income from discontinued operations, net of income tax” in the Consolidated Statements of Income for all periods presented.

 

During the first quarter of 2005, we completed the sale of two acute care facilities located in Puerto Rico: Hospital San Pablo, a 430-bed acute care hospital located in Bayamon and Hospital San Pablo del Este, a 180-bed acute care hospital in Fajardo. The sale proceeds were approximately $122 million in cash. We also retained certain components of working capital. The operating results of these facilities, as well as the $3.8 million after-tax gain ($6.0 million pre-tax), recorded during the first quarter of 2005, are reflected as “Income from discontinued operations, net of income tax” in the Condensed Consolidated Statements of Income for all periods presented. Also during the first quarter of 2005, we sold a home health business in Bradenton, Florida for total sale proceeds of $3.2 million. This transaction resulted in an after-tax gain of $2.0 million ($3.1 million pre-tax) which was recorded during the first quarter of 2005.

 

Dispositions during the six months ended June 30, 2004

 

During the second quarter of 2004, in conjunction with our strategic plan to sell two recently acquired acute care hospitals in California as well as certain other under-performing assets, we sold the following acute care facilities for combined cash proceeds of approximately $68 million: (i) a 112-bed hospital located in San Luis Obispo, California; (ii) a 65-bed hospital located in Arroyo Grande, California; (iii) a 136-bed leased hospital in Shreveport, Louisiana, and; (iv) a 106-bed hospital located in La Place, Louisiana. In addition, subsequent to the end of the quarter, we sold a 160-bed pediatric and surgery hospital located in Rio Piedras, Puerto Rico. The operating results of all these facilities, as well as the $1.2 million after-tax net gain resulting from the divestitures during the second quarter of 2004, are reflected as “Income from discontinued operations, net of income tax” in the Condensed Consolidated Statements of Income for the three-month and six-month periods ended June 30, 2004.

 

The following table shows the results of operations of these facilities, on a combined basis, for all facilities reflected as discontinued operations the three and six month periods ended June 30, 2005 and 2004 (amounts in thousands):

 

Discontinued Operations

 

     Three Months Ended
June 30,


   

Six Months Ended

June 30,


 
     2005

    2004

    2005

    2004

 

Net revenues

   $ 46,258     $ 142,976     $ 165,808     $ 301,137  

Operating income

     6,989       15,684       19,841       35,649  

Income before gain and income taxes

     2,602       4,039       4,433       10,114  

Gain, net of losses, on divestitures

     177,125       2,338       186,220       2,338  
    


 


 


 


Income from discontinued operations

     179,727       6,377       190,653       12,452  

Income tax provision

     (57,516 )     (2,470 )     (61,723 )     (4,874 )
    


 


 


 


Income from discontinued operations, net of income taxes

   $ 122,211     $ 3,907     $ 128,930     $ 7,578  
    


 


 


 


 

Acquisitions during the six months ended June 30, 2005

 

During the first quarter of 2005, we acquired the membership interests of McAllen Medical Center Physicians, Inc. and Health Clinic P.L.L.C., a Texas professional limited liability company. In connection with this transaction, we paid $5.2 million in cash and assumed a $9.8 million purchase price payable, which is contingent on certain conditions as set forth in the purchase agreement.

 

Page 15 of 36 Pages


Acquisitions during the six months ended June 30, 2004

 

During the second quarter of 2004, we spent approximately $105 million to purchase the following behavioral health care facilities: (i) a 63-bed behavioral health hospital, partial services, a school, group homes and detox services located in Stonington, Connecticut; (ii) a 112-bed facility in Savannah, Georgia; (iii) a 77-bed facility in Benton, Arkansas; (iv) the operations of an 82-bed facility in Las Vegas, Nevada, and; (v) a 72-bed facility in Bowling Green, Kentucky.

 

During the first quarter of 2004, we spent approximately $37 million on acquisitions consisting of the following: (i) a 90% controlling ownership interest in a 156-bed acute care hospital located in New Orleans, Louisiana, and; (ii) a 48-bed acute care facility and a 76-bed acute care facility, both of which are located in France and acquired by an operating company in which we owned an 80% controlling ownership interest. Also, effective January 1, 2004, we acquired four acute care facilities consisting of: (i) a 90% controlling ownership interest in a 306-bed facility located in East New Orleans, Louisiana; (ii) a 228-bed facility located in Corona, California; (iii) a 112-bed facility located in San Luis Obispo, California (this facility was sold during the second quarter of 2004), and; (iv) a 65-bed facility located in Arroyo Grande, California (this facility was sold during the second quarter of 2004). The $230 million combined purchase price for these four acute care facilities was funded in late December, 2003 and was included in other assets on our consolidated balance sheet as of December 31, 2003.

 

Assuming these acquisitions occurred on January 1, 2004, our proforma net revenues for the three and six months ended June 30, 2004 would have been approximately $1.024 billion and $2.059 billion, respectively, and the proforma effect on our net income and basic and diluted earnings per share during the three and six months ended June 30, 2004 was immaterial.

 

(9) Dividends

 

A dividend of $.08 per share or $4.5 million in the aggregate was declared by the Board of Directors on May 13, 2005 and was paid on June 15, 2005 to shareholders of record as of June 1, 2005.

 

(10) Pension Plan

 

The following table shows the components of net periodic pension cost for our defined benefit pension plan as of June 30, 2005 and 2004 (amounts in thousands):

 

     Three Months Ended
June 30,


    Six Months Ended
June 30,


 
     2005

    2004

    2005

    2004

 

Service cost

   $ 247     $ 260     $ 494     $ 520  

Interest cost

     1,072       1,076       2,144       2,152  

Expected return on assets

     (957 )     (987 )     (1,914 )     (1,974 )

Recognized actuarial loss

     415       267       830       534  
    


 


 


 


Net periodic pension cost

   $ 777     $ 616     $ 1,554     $ 1,232  
    


 


 


 


 

During the six months ended June 30, 2005 there were no employer contributions paid.

 

 

Page 16 of 36 Pages


Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION

 

Overview

 

Our principal business is owning and operating, through our subsidiaries, acute care hospitals, behavioral health centers and ambulatory surgery and radiation oncology centers. As of June 30, 2005, we operated 28 acute care hospitals and 49 behavioral health centers located in 24 states, Washington, DC and Puerto Rico. As part of our ambulatory treatment centers division, we manage and own outright or in partnership with physicians, 11 surgery and radiation oncology centers located in 6 states and Puerto Rico.

 

Net revenues from our acute care hospitals and our ambulatory and radiation oncology centers accounted for 80% of our consolidated net revenues during each of the three month periods ended June 30, 2005 and 2004 and 80% and 81% of our consolidated net revenues during the six month periods ended June 30, 2005 and 2004, respectively. Net revenues from our behavioral health care facilities accounted for 20% of our consolidated net revenues during each of the three month periods ended June 30, 2005 and 2004 and 20% and 19% of our consolidated net revenues during the six month periods ended June 30, 2005 and 2004, respectively.

 

Services provided by our hospitals include general surgery, internal medicine, obstetrics, emergency room care, radiology, diagnostic care, coronary care, pediatric services and behavioral health services. We provide capital resources as well as a variety of management services to our facilities, including central purchasing, information services, finance and control systems, facilities planning, physician recruitment services, administrative personnel management, marketing and public relations.

 

Forward-Looking Statements and Risk Factors

 

The matters discussed in this report as well as our news releases issued from time to time include certain statements containing the words “believes”, “anticipates”, “intends”, “expects” and words of similar import, which constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause industry results and/or our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. Such factors include, among other things, the following:

 

    possible unfavorable changes in the levels and terms of reimbursement for our charges by third party payors or government programs, including Medicare or Medicaid;

 

    industry capacity, demographic changes, existing laws and government regulations and changes in or failure to comply with laws and governmental regulations;

 

    our ability to enter into managed care provider agreements on acceptable terms;

 

    liability and other claims asserted against us;

 

    the continuing high number of governmental inquiries, investigations and administrative and legal actions being taken against health care providers, which, if directed at us or one of our facilities, could significantly increase costs and expenses;

 

    competition from other healthcare providers, including physician owned facilities in certain markets, including McAllen, Texas, the site of one of our largest acute care facilities, and/or the loss of significant customers;

 

    technological and pharmaceutical improvements that increase the cost of providing, or reduce the demand for healthcare;

 

    our ability to attract and retain qualified personnel, including nurses, and our ability to recruit physicians to provide services at our facilities;

 

    our ability to successfully integrate our recent acquisitions;

 

    a significant portion of our revenues are produced by a small number of our facilities;

 

    our ability to finance growth on favorable terms;

 

    some of our acute care facilities continue to experience decreasing inpatient admission trends;

 

    from time to time, our acute care facilities experience an increase in uninsured and self-pay patients which unfavorably impacts the collectibility of our patient accounts;

 

Page 17 of 36 Pages


    our financial statements reflect large amounts due from various commercial and private payors (including amounts due from patients) and there can be no assurance that failure of the payors to remit amounts due to us will not have a material adverse effect on our future results of operations;

 

    we have experienced increases in professional and general liability and property insurance expense during the past few years caused by unfavorable pricing and availability trends of commercial insurance and as a result, we have assumed a greater portion of our liability risk and consequently, there can be no assurance that a continuation of these unfavorable trends, or a sharp increase in claims asserted against us, which are self-insured, will not have a material adverse effect on our future results of operations, and;

 

    other factors referenced herein or in our other filings with the Securities and Exchange Commission.

 

Given these uncertainties, prospective investors are cautioned not to place undue reliance on such forward-looking statements. We disclaim any obligation to update any such factors or to publicly announce the result of any revisions to any of the forward-looking statements contained herein to reflect future events or developments.

 

Critical Accounting Policies and Estimates

 

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires us to make estimates and assumptions that affect the amounts reported in our consolidated financial statements and accompanying notes. We consider our critical accounting policies to be those that require us to make significant judgments and estimates when we prepare our financial statements, including the following:

 

Revenue recognition: We record revenues and related receivables for health care services at the time the services are provided. We have agreements with third-party payors that provide for payments to us at amounts different from our established rates. Payment arrangements include prospectively determined rates per discharge, reimbursed costs, discounted charges and per diem payments. We report net patient service revenue at the estimated net realizable amounts from patients and third-party payors and others for services rendered.

 

Laws and regulations governing the Medicare and Medicaid programs are extremely complex and subject to interpretation and as a result, there is at least a reasonable possibility that recorded estimates will change by material amounts in the near term. We estimated certain Medicare and Medicaid revenues using the latest available financial information, patient utilization data, government provided data and in accordance with applicable Medicare and Medicaid payment rules and regulations. Certain types of payments by the Medicare program and state Medicaid programs are subject to retroactive adjustment in future periods. We accrue for the estimated amount of these retroactive adjustments in the period when the services subject to retroactive settlement are performed. Such amounts are included in accounts receivable, net, on our condensed consolidated balance sheets. These revenues (e.g. Medicare Disproportionate Share Hospital, Medicare Allowable Bad Debts and Inpatient Psychiatric Services) are subject to retrospective review and final settlement by the Medicare program.

 

Medicare and Medicaid revenues represented 39% of our net revenues during each of the three month periods ended June 30, 2005 and 2004 and 38% and 39% of our net revenues during the six month periods ended June 30, 2005 and 2004, respectively. Revenues from managed care entities, including health maintenance organizations and managed Medicare and Medicaid programs accounted for 42% of our net revenues during each of the three month periods ended June 30, 2005 and 2004, and 42% and 41% of our net revenues during the six month periods ended June 30, 2005 and 2004, respectively.

 

We provide care to patients who meet certain financial or economic criteria without charge or at amounts substantially less than our established rates. Because we do not pursue collection of amounts determined to qualify as charity care, they are not reported in net revenues or in accounts receivable, net. Our acute care hospitals located in the U.S. provided charity care, based on charges at established rates, amounting to $75.3 million and $61.6 million during the three month periods ended June 30, 2005 and 2004, respectively, and $151.5 million and $129.2 million during the six month periods ended June 30, 2005 and 2004, respectively.

 

Page 18 of 36 Pages


Provision for Doubtful Accounts: Collection of receivables from third-party payors and patients is our primary source of cash and is critical to our operating performance. Our primary collection risks relate to uninsured patients and the portion of the bill which is the patient’s responsibility, primarily co-payments and deductibles. We estimate our provisions for doubtful accounts based on general factors such as payor mix, the agings of the receivables and historical collection experience. We routinely review accounts receivable balances in conjunction with these factors and other economic conditions which might ultimately affect the collectibility of the patient accounts and make adjustments to our allowances as warranted. At our acute care hospitals, third party liability accounts are pursued at the hospital level until all payment and adjustments are posted to the patient account. For those accounts with a patient balance after third party liability is exhausted, the patient is sent at least two statements followed by a series of three collection letters. If the patient is deemed unwilling or unable to pay, the account is written off as bad debt and transferred to an outside collection agency for additional collection effort. Self-pay receivables are outsourced to several early out collection agencies under contract with the hospital. The collection vendor must make at least three patient contacts and send three statements from the date of placement. If the patient fails to respond or express a willingness to pay, the account is returned to the hospital and subsequently written off as bad debt and transferred to an outside agency for additional collection effort.

 

During the collection process the hospital establishes a partial reserve in the allowance for doubtful accounts for self-pay balances outstanding for greater than 60 days from the date of discharge. All self-pay accounts at the hospital level are fully reserved if they become outstanding for greater than 90 days from the date of discharge. Third party liability accounts are fully reserved in the allowance for doubtful accounts when the balance ages past 180 days from the date of discharge. On a consolidated basis, we monitor our total self-pay receivables to ensure that the total allowance for doubtful accounts provides adequate coverage based on historical collection experience. At June 30, 2005 and December 31, 2004, accounts receivable are recorded net of allowance for doubtful accounts of $101.8 million and $71.4 million, respectively.

 

Self-Insured Risks: We provide for self-insured risks, primarily general and professional liability claims and workers’ compensation claims, based on estimates of the ultimate costs for both reported claims and claims incurred but not reported. Estimated losses from asserted and unasserted claims are accrued based on our estimates of the ultimate costs of the claims, which includes costs associated with litigating or settling claims, and the relationship of past reported incidents to eventual claims payments. All relevant information, including our own historical experience, the nature and extent of existing asserted claims and reported incidents, and independent actuarial analyses of this information, is used in estimating the expected amount of claims. We also consider amounts that may be recovered from excess insurance carriers, state guaranty funds and other sources in estimating our ultimate net liability for such risk. We also maintain self-insured employee benefits programs for workers’ compensation and employee healthcare and dental claims. The ultimate costs related to these programs includes expenses for claims incurred and reported in addition to an accrual for the estimated expenses incurred in connection with claims incurred but not yet reported. Our estimated self-insured reserves are reviewed and changed, if necessary, at each reporting date. The amounts of the changes are recognized currently as additional expense or as a reduction of expense.

 

Long-Lived Assets: In accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”, we review our long-lived assets, including amortizable intangible assets, for impairment whenever events or circumstances indicate that the carrying value of these assets may not be recoverable. The assessment of possible impairment is based on our ability to recover the carrying value of our asset based on our estimate of its undiscounted future cash flow. If the analysis indicates that the carrying value is not recoverable from future cash flows, the asset is written down to its estimated fair value and an impairment loss is recognized. Fair values are determined based on estimated future cash flows using appropriate discount rates.

 

Goodwill: In accordance with SFAS No. 142, “Goodwill and Other Intangible Assets”, we ceased amortizing goodwill as of January 1, 2002. Goodwill is reviewed for impairment at the reporting unit level as, defined by SFAS No. 142, on an annual basis or sooner if the indicators of impairment arise. Our judgments regarding the existence of impairment indicators are based on market conditions and operational performance of each reporting unit. We have designated September 1st as our annual impairment assessment date and performed an impairment assessment as of September 1, 2004, which indicated no impairment of goodwill. Future changes in the estimates used to conduct the impairment review, including profitability and market value projections, could indicate impairment in future periods potentially resulting in a write-off of a portion or all of our goodwill.

 

Page 19 of 36 Pages


Income Taxes: Deferred tax assets and liabilities are recognized for the amount of taxes payable or deductible in future years as a result of differences between the tax bases of assets and liabilities and their reported amounts in the financial statements. We believe that future income will enable us to realize our deferred tax assets and therefore no valuation allowances have been recorded.

 

We operate in multiple jurisdictions with varying tax laws. We are subject to audits by any of these taxing authorities. Our tax returns have been examined by the Internal Revenue Service through the year ended December 31, 2002. We believe that adequate accruals have been provided for federal, foreign and state taxes. During the second quarter of 2005, we reversed our APB 23 reserve since we have repatriated all earnings associated with our business in France which was sold during the quarter.

 

The American Jobs Creation Act (AJCA) was signed into law on October 22, 2004. AJCA provides for a deduction of 85% of certain foreign earnings that are repatriated in accordance with the requirement of AJCA. We have evaluated the potential benefit under the Act and have concluded it is unlikely we will derive a material benefit.

 

Results of Operations

 

The following table summarizes our results of operations, and is used in the discussion below, for the three months ended June 30, 2005 and 2004 (dollar amounts in thousands):

 

     Three months ended
June 30, 2005


    Three months ended
June 30, 2004


 
     Amount

   % of
Revenues


    Amount

   % of
Revenues


 

Net revenues

   $ 990,888    100.0 %   $ 905,494    100.0 %

Operating charges:

                          

Salaries, wages and benefits

     407,897    41.2 %     369,335    40.8 %

Other operating expenses

     234,707    23.7 %     213,274    23.5 %

Supplies expense

     126,124    12.7 %     113,521    12.5 %

Provision for doubtful accounts

     95,478    9.6 %     74,244    8.2 %

Depreciation and amortization

     37,988    3.8 %     35,033    3.9 %

Lease and rental expense

     15,288    1.6 %     15,255    1.7 %
    

  

 

  

       917,482    92.6 %     820,662    90.6 %
    

  

 

  

Income before interest expense, minority interests and income taxes

     73,406    7.4 %     84,832    9.4 %

Interest expense, net

     7,450    0.7 %     9,359    1.0 %

Minority interests in earnings of consolidated entities

     7,926    0.8 %     5,183    0.6 %
    

  

 

  

Income before income taxes

     58,030    5.9 %     70,290    7.8 %

Provision for income taxes

     21,398    2.2 %     25,908    2.9 %
    

  

 

  

Income from continuing operations

     36,632    3.7 %     44,382    4.9 %

Income from discontinued operations, net of income taxes

     122,211    12.3 %     3,907    0.4 %
    

  

 

  

Net income

   $ 158,843    16.0 %   $ 48,289    5.3 %
    

  

 

  

 

Page 20 of 36 Pages


Net revenues increased 9% to $991 million during the three month period ended June 30, 2005 as compared to $905 million during the comparable prior year quarter. The $86 million increase during the 2005 second quarter, as compared to the comparable prior year quarter, was primarily attributable to:

 

    a $64 million or 7% increase in net revenues generated at acute care hospitals and behavioral health care facilities owned during both periods (which we refer to as “same facility”), and;

 

    $20 million of revenues generated primarily at an acute care hospital opened during the third quarter of 2004 and behavioral health facilities acquired during April and May of 2004.

 

Income before income taxes decreased $12 million to $58 million during the three months ended June 30, 2005 as compared to $70 million during the comparable prior year quarter due primarily to:

 

    a $15 million decrease in income before income taxes generated at our acute care facilities (as discussed below in Acute Care Hospital Services);

 

    an $8 million increase in income before income taxes generated at our behavioral health care facilities (as discussed below in Behavioral Health Services);

 

    a $5 million decrease in income before income taxes due to an increase resulting from other combined net unfavorable changes.

 

Net income increased $111 million during the second quarter of 2005, as compared to the comparable prior year quarter due primarily to:

 

    a $118 million after-tax increase in income from discontinued operations, net of income taxes, resulting primarily from a $121 million after-tax gain recorded during the second quarter of 2005 on the sale of our ownership interest in an operating company that owned 14 hospitals in France;

 

    the $12 million decrease in income before income taxes, as discussed above;

 

    a favorable $4 million decrease in income taxes resulting from the tax benefit on the $12 million decrease in income before income taxes.

 

The following table summarizes our results of operations, and is used in the discussion below, for the six months ended June 30, 2005 and 2004 (dollar amounts in thousands):

 

    

Six months ended

June 30, 2005


   

Six months ended

June 30, 2004


 
     Amount

   % of
Revenues


    Amount

   % of
Revenues


 

Net revenues

   $ 1,997,533    100.0 %   $ 1,812,620    100.0 %

Operating charges:

                          

Salaries, wages and benefits

     814,237    40.8 %     740,793    40.9 %

Other operating expenses

     465,872    23.3 %     421,229    23.2 %

Supplies expense

     252,660    12.6 %     229,105    12.6 %

Provision for doubtful accounts

     177,886    8.9 %     157,801    8.7 %

Depreciation and amortization

     77,684    3.9 %     68,342    3.8 %

Lease and rental expense

     30,755    1.6 %     30,148    1.7 %
    

  

 

  

       1,819,094    91.1 %     1,647,418    90.9 %
    

  

 

  

Income before interest expense, minority interests and income taxes

     178,439    8.9 %     165,202    9.1 %

Interest expense, net

     18,126    0.9 %     18,926    1.0 %

Minority interests in earnings of consolidated entities

     15,845    0.8 %     8,710    0.5 %
    

  

 

  

Income before income taxes

     144,468    7.2 %     137,566    7.6 %

Provision for income taxes

     53,146    2.6 %     50,671    2.8 %
    

  

 

  

Income from continuing operations

     91,322    4.6 %     86,895    4.8 %

Income from discontinued operations, net of income taxes

     128,930    6.4 %     7,578    0.4 %
    

  

 

  

Net income

   $ 220,252    11.0 %   $ 94,473    5.2 %
    

  

 

  

 

Page 21 of 36 Pages


Net revenues increased 10% to $2.0 billion during the six month period ended June 30, 2005 as compared to $1.8 billion during the comparable prior year period. The $185 million increase during the 2005 six month period, as compared to the comparable prior year period, was attributable to:

 

    a $135 million or 8% increase in net revenues generated at acute care hospitals and behavioral health care facilities owned during both periods (which we refer to as “same facility”), and;

 

    $50 million of revenues generated primarily at an acute care hospital opened during the third quarter of 2004 and behavioral health facilities acquired in April and May of 2004.

 

Income before income taxes increased $7 million to $144 million during the six months ended June 30, 2005 as compared to $137 million during the comparable prior year period due primarily to:

 

    a $2 million increase in income before income taxes generated at our acute care facilities (as discussed below in Acute Care Hospital Services);

 

    a $14 million increase in income before income taxes generated at our behavioral health care facilities (as discussed below in Behavioral Health Services);

 

    a $9 million decrease to income before income taxes due to an increase resulting from other combined net unfavorable changes.

 

Net income increased $126 million to $220 million during the six month period ended June 30, 2005, as compared to $94 million during the comparable prior year period due primarily to:

 

    a $121 million after-tax increase in income from discontinued operations, net of income taxes, resulting primarily from a $121 million after-tax gain recorded during the second quarter of 2005 on the sale of our ownership interest in an operating company that owned 14 hospitals in France;

 

    the $7 million increase in income before income taxes, as discussed above;

 

    an unfavorable $2 million increase in income taxes resulting from the tax provision on the increase in income before income taxes.

 

Acute Care Hospital Services

 

The following table summarizes the results of operations for our acute care facilities on a same facility basis, and is used in the discussion below for the three and six months ended June 30, 2005 and 2004 (dollar amounts in thousands):

 

Same Facility – Acute Care

 

    

Three Months Ended

June 30,


  

Six Months Ended

June 30,


     2005

    %

   2004

   %

   2005

   %

   2004

   %

Net revenues

   $ 765,648     100.0    $ 718,032    100.0    $ 1,558,159    100.0    $ 1,447,396    100.0

Salaries, wages and benefits

     285,926     37.3      267,515    37.3      574,382    36.9      542,758    37.5

Other operating expenses

     180,235     23.6      166,041    23.1      361,316    23.1      330,570    22.8

Supplies expense

     110,871     14.5      100,658    14.0      222,547    14.3      204,973    14.2

Provision for doubtful accounts

     86,845     11.3      69,323    9.7      163,399    10.5      147,861    10.2

Depreciation and amortization

     31,219     4.1      29,137    4.1      62,477    4.0      57,638    4.0

Lease and rental

     11,512     1.5      11,869    1.6      22,939    1.5      23,738    1.6
    


 
  

  
  

  
  

  

Subtotal operating expenses

     706,608     92.3      644,543    89.8      1,407,060    90.3      1,307,538    90.3
    


 
  

  
  

  
  

  

Income before interest expense, minority interests and income taxes

     59,040     7.7      73,489    10.2      151,099    9.7      139,858    9.7

Interest expense, net

     (4 )   0.0      91    0.0      149    0.0      156    0.0

Minority interests in earnings of consolidated entities

     7,064     0.9      4,599    0.6      14,122    0.9      7,658    0.6
    


 
  

  
  

  
  

  

Income before income taxes

   $ 51,980     6.8    $ 68,799    9.6    $ 136,828    8.8    $ 132,044    9.1
    


 
  

  
  

  
  

  

 

Page 22 of 36 Pages


On a same facility basis during the three month period ended June 30, 2005, as compared to the comparable prior year quarter, net revenues at our acute care hospitals increased $48 million or 7% and income before income taxes decreased $17 million or 24% to $52 million during the 2005 quarter as compared to $69 million during the 2004 second quarter. Inpatient admissions to these facilities increased 2.7% during the 2005 second quarter, as compared to the prior year’s quarter, while patient days increased 2.1%. The average length of patient stay at these facilities remained unchanged at 4.5 days during each of the three month periods ended June 30, 2005 and 2004. The occupancy rate, based on the average available beds at these facilities, was 63% during the second quarter of 2005, as compared to 64% during the prior year quarter. Our same facility net revenues were favorably impacted by an increase in prices charged to private payors including health maintenance organizations and preferred provider organizations and Medicare increases that became effective on October 1, 2004. On a same facility basis, net revenue per adjusted admission (adjusted for outpatient activity) at our acute care facilities increased 3.9% and net revenue per adjusted patient day at these facilities increased 4.1% during the second quarter of 2005, as compared to the comparable prior year quarter.

 

Revenue growth in the acute care division resulted primarily from admissions growth and an increase in revenue per adjusted patient day. Admissions growth was particularly strong in the Las Vegas market, which has benefited from the higher occupancy rates at Spring Valley Hospital Medical Center (opened late in 2003) and by additional capacity opened at Summerlin Hospital Medical Center in the summer of 2004.

 

The large majority of the decline in income before income taxes at our acute care facilities during the second quarter of 2005, as compared to the comparable prior year quarter, can be attributed to a decline in profitability in the McAllen/Edinburg market, as discussed below, as well as an increase in bad debt expense and charity care. The level of uninsured patients at our acute care facilities increased during the second quarter of 2005 as compared to the comparable 2004 quarter. As a result, on a same facility basis, bad debt expense as a percentage of net revenues increased to 11.3% during the second quarter of 2005, as compared to 9.7% during last year’s second quarter, and charity care (based on gross charges) increased to $75 million during the quarter ended June 30, 2005 as compared to $62 million during the three months ended June 30, 2004.

 

During the three month period ended June 30, 2005, combined admissions and patients days at our two acute care hospitals located in the McAllen/Edinburg, Texas market decreased 9.0% and 13.6%, respectively, as compared to the second quarter of 2004. During the six month period ended June 30, 2005, combined admissions and patient days at these two facilities decreased 7.5% and 10.3%, respectively, as compared to the prior year period. Combined income before income taxes at these two facilities, which decreased $23 million during the twelve months ended December 31, 2004 as compared to the 2003 twelve month period, decreased $10 million during the second quarter of 2005 and $11 million during the six month period ended June 30, 2005, as compared to the comparable prior year periods. These declines were due primarily to continued intense hospital and physician competition. We expect the competitive pressures in the market to continue and potentially intensify. A physician-owned hospital in the market added new inpatient capacity in late 2004 which has eroded a portion of our higher margin business, including cardiac procedures. As competition in the market has increased, wage rates and physician recruiting costs have risen increasing the continued pressure on operating margins and profitability. In response to these competitive pressures, we have recruited a substantial number of new physicians to the market, are working with many of our managed care plans for greater exclusivity and have undertaken significant capital investment in the market, including a new dedicated 94-bed children’s facility as well as a 134-bed replacement behavioral facility, both of which are scheduled to be completed and opened during the first quarter of 2006.

 

During the last several quarters, the operating factors mentioned above have resulted in a certain degree of volatility in our income from continuing operations. Although we have undertaken actions in regards to physician recruitment and other measures as mentioned above in the McAllen/Edinburg market, the ultimate impact and timing of potential improvements in the operating results of the facilities in the market are beyond our ability to predict. A continuation of the unfavorable operating results experienced in this market and/or a continuation of the increased level of uninsured patients to our facilities and the resulting adverse trends in bad debt expense and charity care, could have a material unfavorable impact on our future operating results.

 

Page 23 of 36 Pages


On a same facility basis during the six month period ended June 30, 2005, as compared to the comparable prior year period, net revenues at our acute care hospitals increased $111 million or 8% and income before income taxes increased $5 million or 4% to $137 million during the 2005 six months as compared to $132 million during the 2004 six month period. Inpatient admissions to these facilities increased 2.6% during the 2005 six month period, as compared to the prior period, while patient days increased 2.4%. The average length of patient stay at these facilities remained unchanged at 4.6 days during each of the six month periods ended June 30, 2005 and 2004. The occupancy rate, based on the average available beds at these facilities, was 66% during the 2005 six month period, as compared to 67% during the prior year period. On a same facility basis, net revenue per adjusted admission at our acute care facilities increased 5.1% and net revenue per adjusted patient day at these facilities increased 5.7% during the six months ended June 30, 2005 as compared to the comparable prior year period.

 

The following table summarizes the results of operations for all our acute care operations during the three and six months ended June 30, 2005 and 2004 (dollar amounts in thousands):

 

All Acute Care Facilities

 

    

Three Months Ended

June 30,


  

Six Months Ended

June 30,


     2005

   %

   2004

   %

   2005

   %

   2004

   %

Net revenues

   $ 780,873    100.0    $ 718,327    100.0    $ 1,587,497    100.0    $ 1,450,778    100.0

Salaries, wages and benefits

     293,251    37.6      269,337    37.5      589,287    37.1      545,027    37.6

Other operating expenses

     183,233    23.4      166,535    23.2      366,844    23.1      331,408    22.8

Supplies expense

     112,260    14.4      100,715    14.0      225,527    14.2      205,056    14.1

Provision for doubtful accounts

     89,300    11.4      69,238    9.6      167,599    10.6      147,776    10.2

Depreciation and amortization

     32,094    4.1      29,191    4.1      65,147    4.1      57,692    4.0

Lease and rental

     12,165    1.6      12,032    1.7      24,154    1.5      24,039    1.7
    

  
  

  
  

  
  

  

Subtotal operating expenses

     722,303    92.5      647,048    90.1      1,438,558    90.6      1,310,998    90.4
    

  
  

  
  

  
  

  

Income before interest expense, minority interest and income taxes

     58,570    7.5      71,279    9.9      148,939    9.4      139,780    9.6

Interest expense, net

     333    0.0      91    0.0      486    0.0      156    0.0

Minority interests in earnings of consolidated entities

     7,012    0.9      4,546    0.6      14,024    0.9      7,605    0.5
    

  
  

  
  

  
  

  

Income before income taxes

   $ 51,225    6.6    $ 66,642    9.3    $ 134,429    8.5    $ 132,019    9.1
    

  
  

  
  

  
  

  

 

Acute Care Hospital Services-General

 

The federal government makes payments to participating hospitals under its Medicare program based on various formulas. For inpatient services, our general acute care hospitals are subject to a prospective payment system (“PPS”) under which the hospitals are paid a predetermined amount per admission. The payment is based upon a diagnostic related group (“DRG”), for which payment amounts are adjusted to account for geographic wage differences. For outpatient services, both general acute and behavioral health hospitals are paid under an outpatient prospective payment system (“OPPS”) according to ambulatory procedure codes (“APC”) that group together services that are comparable both clinically and with respect to the use of resources, as adjusted to account for certain geographic wage differences.

 

A significant portion of the revenue generated at our acute care hospital facilities is derived from federal and state healthcare programs, including Medicare and Medicaid (excluding managed Medicare and Medicaid programs), which accounted for 39% of our net patient revenues during each of the three month periods ended June 30, 2005 and 2004, and 37% and 39% of our net patient revenues during the six month periods ended June 30, 2005 and 2004, respectively. Under the statutory framework of the Medicare and Medicaid programs, many of our operations are subject to changing regulations, administrative rulings, interpretations and discretion that may affect payments made under either or both of such programs as well as by other third party payors. Management believes that adequate provision has been made for any adjustment that might result therefrom.

 

Page 24 of 36 Pages


During each of the quarters ended June 30, 2005 and 2004, approximately 41% of the net patient revenues at our acute care hospital facilities were generated from managed care companies, which include health maintenance organizations, preferred provider organizations and managed Medicare and Medicaid programs. During the six month periods ended June 30, 2005 and 2004, approximately 40% and 39%, respectively, of the net patient revenues at our acute care facilities were generated from managed care companies. Typically, we receive lower payments per patient from managed care payors than we do from traditional indemnity insurers, however, during the past few years, we have secured price increases from many of our commercial payors including managed care companies.

 

Upon meeting certain conditions, and serving a disproportionately high share of Texas’ and South Carolina’s low income patients, five of our facilities located in Texas and one facility located in South Carolina became eligible and received additional reimbursement from each state’s disproportionate share hospital (“DSH”) fund. To qualify for DSH funds in Texas, the facility must have either a disproportionate total number of inpatient days for Medicaid patients, a disproportionate percentage of all inpatient days that are for Medicaid patients, or a disproportionate percentage of all inpatient days that are for low-income patients. Included in our financial results was an aggregate of $9.3 million and $7.1 million during the three month periods ended June 30, 2005 and 2004, respectively, and $18.6 million and $17.6 million during the six month periods ended June 30, 2005 and 2004, respectively, related to DSH programs. We have not yet received notification from either state as to the renewal status of the programs beyond the respective scheduled termination dates (June 30, 2005 for South Carolina and August 31, 2005 for Texas). However, failure to renew these DSH programs, failure of our hospitals that currently receive DSH payments to qualify for future DSH funds under these programs, or reductions in reimbursements, could have a material adverse effect on our future results of operations.

 

During 2004, the Centers for Medicaid Services (“CMS”) approved a plan, submitted by the state of Texas, requesting CMS’s approval to expand the Texas supplemental inpatient reimbursement methodology. The general provisions of this supplemental payment methodology, which is governed by federal statute and regulations, includes: (i) matching federal dollars to the state for certain qualifying Medicaid expenditures; (ii) the federal government permitting the state to use the inter-governmental transfer of funds between state and local entities, and; (iii) subjecting supplemental payments made to hospitals to federally mandated limits. Included in our financial results during the three and six months ended June 30, 2005 was $3.3 million and $6.6 million, respectively, of incremental revenue earned pursuant to the provisions of this program. Although we can provide no assurance that this program will remain in place, we expect to earn on an incremental basis (assuming the program remains unchanged and including the amount earned during the first six months of 2005), approximately $13 million during 2005 in connection with this program. During the second quarter of 2005, the State of Texas submitted to CMS, an amendment to its Medicaid State Plan seeking approval to make supplemental payments to certain hospitals located in Hidalgo, Maverick and Webb counties. If approved, our four acute care hospital facilities located in these counties may be eligible to receive supplemental Medicaid payments. However, we are unable to predict if these payments will be approved or the amounts our facilities would receive if approved.

 

Behavioral Health Services

 

The following table summarizes the results of operations for our behavioral health care facilities, on a same facility basis, and is used in the discussion below for the three and six months ended June 30, 2005 and 2004 (dollar amounts in thousands):

 

Same Facility – Behavioral Health

 

    

Three Months Ended

June 30,


  

Six Months Ended

June 30,


     2005

   %

   2004

   %

   2005

   %

   2004

   %

Net revenues

   $ 194,041    100.0    $ 177,732    100.0    $ 368,030    100.0    $ 343,635    100.0

Salaries, wages and benefits

     90,201    46.5      84,151    47.3      172,517    46.9      162,499    47.4

Other operating expenses

     36,676    18.9      35,207    19.8      70,723    19.2      68,327    19.9

Supplies expense

     11,672    6.0      10,648    6.0      22,108    6.0      20,371    5.9

Provision for doubtful accounts

     6,053    3.1      4,892    2.8      10,207    2.8      9,759    2.8

Depreciation and amortization

     4,041    2.1      4,330    2.4      7,879    2.1      8,173    2.4

Lease and rental

     2,350    1.2      2,477    1.4      4,389    1.2      4,609    1.3
    

  
  

  
  

  
  

  

Subtotal operating expenses

     150,993    77.8      141,705    79.7      287,823    78.2      273,738    79.7
    

  
  

  
  

  
  

  

Income before interest expense, minority interests and income taxes

     43,048    22.2      36,027    20.3      80,207    21.8      69,897    20.3

Interest expense, net

     3    0.0      2    0.0      6    0.0      5    0.0

Minority interests in earnings of consolidated entities

     213    0.1      108    0.1      362    0.1      242    0.0
    

  
  

  
  

  
  

  

Income before income taxes

   $ 42,832    22.1    $ 35,917    20.2    $ 79,839    21.7    $ 69,650    20.3
    

  
  

  
  

  
  

  

 

Page 25 of 36 Pages


On a same facility basis during the three month period ended June 30, 2005, as compared to the comparable prior year quarter, net revenues at our behavioral health care facilities increased $16 million or 9%. Income before income taxes increased $7 million or 19% to $43 million during the 2005 second quarter as compared to $36 million during the 2004 second quarter. Inpatient admissions to these facilities increased 7.6% during the 2005 second quarter, as compared to the prior year quarter, while patient days increased 7.3%. The average length of stay decreased to 12.9 days during the second quarter of 2005 as compared to 13.0 days during the comparable prior year quarter. The occupancy rate, based on the average available beds at these facilities, was 86% during the second quarter of 2005, as compared to 83% during the prior year quarter. On a same facility basis, net revenue per adjusted admission (adjusted for outpatient activity) at our behavioral health care facilities increased 2.1% and net revenue per adjusted patient day at these facilities increased 2.0% during the second quarter of 2005, as compared to the comparable prior year quarter.

 

On a same facility basis during the six month period ended June 30, 2005, as compared to the comparable prior year period, net revenues at our behavioral health care facilities increased $24 million or 7%. Income before income taxes increased $10 million or 15% to $80 million during the 2005 six month period as compared to $70 million during the 2004 six month period. Inpatient admissions to these facilities increased 4.0% during the 2005 six month period, as compared to the prior year period, while patient days increased 5.8%. The average length of stay increased to 12.5 days during the six month period ended June 30, 2005 as compared to 12.4 days during the comparable prior year period. The occupancy rate, based on the average available beds at these facilities, was 84% during the 2005 six month period, as compared to 83% during the prior year period. On a same facility basis, net revenue per adjusted admission at our behavioral health care facilities increased 3.7% and net revenue per adjusted patient day at these facilities increased 2.3% during the six months ended June 30, 2005, as compared to the comparable prior year period.

 

The following table summarizes the results of operations for our behavioral health care facilities, including newly acquired facilities, for the three and six months ended June 30, 2005 and 2004 (dollar amounts in thousands):

 

All Behavioral Health Care Facilities

 

    

Three Months Ended

June 30,


  

Six Months Ended

June 30,


     2005

   %

   2004

   %

   2005

   %

   2004

   %

Net revenues

   $ 199,388    100.0    $ 177,732    100.0    $ 388,948    100.0    $ 343,635    100.0

Salaries, wages and benefits

     93,111    46.7      84,151    47.3      184,319    47.4      162,499    47.4

Other operating expenses

     37,493    18.9      35,207    19.8      74,119    19.0      68,327    19.9

Supplies expense

     11,984    6.0      10,648    6.0      23,282    6.0      20,371    5.9

Provision for doubtful accounts

     6,036    3.0      4,892    2.8      9,929    2.5      9,759    2.8

Depreciation and amortization

     4,168    2.1      4,330    2.4      8,388    2.2      8,173    2.4

Lease and rental

     2,490    1.2      2,477    1.4      4,932    1.3      4,609    1.3
    

  
  

  
  

  
  

  

Subtotal operating expenses

     155,282    77.9      141,705    79.7      304,969    78.4      273,738    79.7
    

  
  

  
  

  
  

  

Income before interest expense, minority interests and income taxes

     44,106    22.1      36,027    20.3      83,979    21.6      69,897    20.3

Interest expense, net

     3    0.0      2    0.0      6    0.0      5    0.0

Minority interests in earnings of consolidated entities

     213    0.1      108    0.1      362    0.1      242    0.0
    

  
  

  
  

  
  

  

Income before income taxes

   $ 43,890    22.0    $ 35,917    20.2    $ 83,611    21.5    $ 69,650    20.3
    

  
  

  
  

  
  

  

 

Page 26 of 36 Pages


Behavioral Health Care Services-General

 

Prior to January 1, 2005, behavioral health facilities, which traditionally had been excluded from the inpatient services PPS, were reimbursed on a reasonable cost basis by the Medicare program (“TEFRA Payment”), but were generally subject to a per discharge ceiling, calculated based on an annual allowable rate of increase over the hospital’s base year amount under the Medicare law and regulations. Capital-related costs were exempt from this limitation. The discharge ceiling is higher for those hospitals that were excluded from PPS before October 1, 1997. Congress required the Centers for Medicare and Medicaid Services (“CMS”) to develop a per diem PPS for inpatient services furnished by behavioral health hospitals under the Medicare program (“Psych PPS”). On November 15, 2004, CMS published final regulations that implement Psych PPS, which is effective beginning on an inpatient psychiatric facility’s first cost reporting period beginning on or after January 1, 2005. This new system generally became effective for most of our hospitals on January 1, 2005. The federal prospective rate is a base prospective per diem rate and is adjusted for individual hospital demographic factors including: geographic location, resident teaching program status and licensed emergency room department status. The base per diem rate is also adjusted for patient specific demographic factors including: patient age, medical diagnosis and the existence of certain co-morbid medical conditions. The base per diem rate is paid based on sliding scale payment adjustment factors wherein a provider will receive an increased per diem for day one of the patient stay and the per diem payment will decrease during the patient hospital stay based on a published CMS sliding scale. Psych PPS will be implemented over a four-year period with Year 1 having a blended Medicare payment rate based on seventy-five percent (75%) TEFRA payment and twenty-five percent (25%) Psych PPS payment. For PPS transition Years 2, 3 and 4, the blended rate is 50% TEFRA and 50% Psych PPS, 25% TEFRA and 75% Psych PPS, 0% TEFRA and 100% Psych PPS, respectively. We believe the implementation of behavioral health impatient PPS will have a favorable effect on our future results of operations, however, due to the four-year phase-in period, we do not believe the favorable effect will have a material impact on our 2005 results of operations.

 

A significant portion of the revenue generated at our behavioral health care facilities is derived from federal and state healthcare programs, including Medicare and Medicaid (excluding managed Medicare and Medicaid programs), which accounted for 40% and 39% of our net patient revenues during the three month periods ended June 30, 2005 and 2004, respectively, and 40% and 38% of our net patient revenues during the six month periods ended June 30, 2005 and 2004, respectively.

 

Approximately 48% during the second quarter of 2005 and 50% during the second quarter of 2004, of the net patient revenues at our behavioral health care facilities were generated from managed care companies, which include health maintenance organizations, preferred provider organizations and managed Medicare and Medicaid programs. During the six month periods ended June 30, 2005 and 2004, approximately 49% and 50%, respectively, of the net patient revenues at our behavioral health care facilities were generated from managed care companies. Typically, we receive lower payments per patient from managed care payors than we do from traditional indemnity insurers, however, during the past few years, we have secured price increases from many of our commercial payors including managed care companies.

 

Other Operating Results

 

Combined net revenues from our outpatient surgery and radiation centers were $8 million and $7 million during the three month periods ended June 30, 2005 and 2004, respectively, and $17 million and $14 million

 

Page 27 of 36 Pages


during the six month periods ended June 30, 2005 and 2004, respectively. Combined income before income taxes from the other operating entities was $486,000 and $363,000 during the three months ended June 30, 2005 and 2004, respectively, and $1.7 million and $1.3 million during the six month periods ended June 30, 2005 and 2004, respectively.

 

During the first quarter of 2005, we recorded a $3 million pre-tax asset impairment charge recorded in connection with a women’s hospital located in Edmond, Oklahoma which reduced the carrying-value of the facility to its estimated net realizable value. The operating results and the asset impairment charge for this facility, which is scheduled to close in September, 2005, are reflected as “Income from discontinued operations, net of income tax” in the Condensed Consolidated Statements of Income for the three and six month periods ended June 30, 2005 and 2004.

 

Interest expense decreased $2 million to $7 million during the three months ended June 30, 2005 as compared to $9 million during the comparable prior year quarter and decreased $1 million to $18 million during the six month period ended June 30, 2005 as compared to $19 million during the comparable prior year period. During the six months ended June 30, 2005, we made approximately $256 million of net debt repayments using a portion of the cash generated from the sale of our acute care hospitals located in France and Puerto Rico.

 

The effective tax rate was 36.9% during each of the three month periods ended June 30, 2005 and 2004 and 36.8% during each of the six month periods ended June 30, 2005 and 2004.

 

Discontinued Operations

 

During 2005 and 2004, in conjunction with our strategic plan to sell certain acute care hospitals, as well as certain other under-performing assets, we sold acute care hospitals and related businesses, surgery and radiation therapy centers and planned for the closure of a women’s hospital, as listed below:

 

  (i) sold a 430-bed hospital located in Bayamon, Puerto Rico during the first quarter of 2005;

 

  (ii) sold a 180-bed hospital located in Fajardo, Puerto Rico during the first quarter of 2005;

 

  (iii) sold a home health business in Bradenton, Florida during the first quarter of 2005;

 

  (iv) sold our 81.5% ownership interest in Medi-Partenaires, an operating company that owned and managed 14 hospitals in France, during the second quarter of 2005;

 

  (v) planned for the September, 2005 closure of a women’s hospital located in Edmond, Oklahoma;

 

  (vi) sold a 112-bed hospital located in San Luis Obispo, California during the second quarter of 2004;

 

  (vii) sold a 65-bed hospital located in Arroyo Grande, California during the second quarter of 2004;

 

  (viii) sold a 136-bed leased hospital in Shreveport, Louisiana during the second quarter of 2004;

 

  (ix) sold a 106-bed hospital located in La Place, Louisiana during the second quarter of 2004;

 

  (x) sold a 160-bed pediatric and surgery hospital located in Rio Piedras, Puerto Rico during the third quarter of 2004, and;

 

  (xi) sold our ownership interests in six outpatient surgery centers and a radiation therapy at various times during 2005 and 2004.

 

The operating results of the divested hospitals, surgery and radiation therapy centers and women’s hospital are reflected as “Income from discontinued operations, net of income tax” in the Condensed Consolidated Statements of Income for the three and six month periods ended June 30, 2005 and 2004.

 

The following table shows the results of operations of these facilities, on a combined basis, for all facilities reflected as discontinued operations for the three and six month periods ended June 30, 2005 and 2004 (amounts in thousands):

 

Discontinued Operations

 

     Three Months Ended
June 30,


   

Six Months Ended

June 30,


 
     2005

    2004

    2005

    2004

 

Net revenues

   $ 46,258     $ 142,976     $ 165,808     $ 301,137  

Operating income

     6,989       15,684       19,841       35,649  

Income before gain and income taxes

     2,602       4,039       4,433       10,114  

Gain, net of losses, on divestitures

     177,125       2,338       186,220       2,338  
    


 


 


 


Income from discontinued operations

     179,727       6,377       190,653       12,452  

Income tax provision

     (57,516 )     (2,470 )     (61,723 )     (4,874 )
    


 


 


 


Income from discontinued operations, net of income taxes

   $ 122,211     $ 3,907     $ 128,930     $ 7,578  
    


 


 


 


 

Page 28 of 36 Pages


Professional and General Liability Claims

 

Due to unfavorable pricing and availability trends in the professional and general liability insurance markets, our subsidiaries have assumed a greater portion of the hospital professional and general liability risk as the cost of commercial professional and general liability insurance coverage has risen. As a result, effective January 1, 2002, most of our subsidiaries were self-insured for malpractice exposure up to $25 million per occurrence. We purchased umbrella excess policies for our subsidiaries through several commercial insurance carriers for coverage in excess of $25 million per occurrence with a $75 million aggregate limitation. Given these insurance market conditions, there can be no assurance that a continuation of these unfavorable trends, or a sharp increase in claims asserted against us, will not have a material adverse effect on our future results of operations.

 

Our estimated liability for professional and general liability claims is based on a number of factors including, among other things, the number of asserted claims and reported incidents, estimates of losses for these claims based on recent and historical settlement amounts, estimate of incurred but not reported claims based on historical experience, and estimates of amounts recoverable under our commercial insurance policies. While we continuously monitor these factors, our ultimate liability for professional and general liability claims could change materially from our current estimates due to inherent uncertainties involved in making this estimate.

 

For the period from January 1, 1998 through December 31, 2001, most of our subsidiaries were covered under commercial insurance policies with PHICO, a Pennsylvania based insurance company that was placed into liquidation during the first quarter of 2002. As a result of PHICO’s liquidation, we recorded a $40 million pre-tax charge during 2001 to reserve for PHICO claims that could become our liability, however, we are entitled to receive reimbursement from state insurance guaranty funds, other commercial insurers and/or PHICO’s estate for a portion of certain claims ultimately paid by us.

 

As of June 30, 2005, the total accrual for our professional and general liability claims was $215.3 million ($191.6 million net of expected recoveries), of which $28.0 million is included in other current liabilities. As of December 31, 2004, the total accrual for our professional and general liability claims was $204.1 million ($172.5 million net of expected recoveries), of which $28.0 million is included in other current liabilities. Included in other assets was $23.7 million as of June 30, 2005 and $31.6 million as of December 31, 2004, related to estimated expected recoveries from various state guaranty funds, insurance companies and other sources in connection with PHICO related professional and general liability claims payments.

 

Liquidity

 

Net cash provided by operating activities

 

Net cash provided by operating activities was $230 million during the six months ended June 30, 2005 and $225 million during the comparable prior year period. Included in the $5 million net increase was the following:

 

    a net favorable change of $8 million due to an increase in net income plus or minus the adjustments to reconcile net income to net cash provided by operating activities (depreciation and amortization, accretion of discount on convertible debentures, gains on sales of assets and businesses, net of accrued income taxes, and provision for asset impairment);

 

    an unfavorable change of $7 million in accounts receivable;

 

    an unfavorable change of $19 million in accrued and deferred income taxes, excluding income taxes on gains on sales of businesses, resulting from increased income tax payments;

 

    a favorable $9 million change in accrued self-insurance expense, net of payments made in settlement of claims payments

 

    $14 million of other net favorable changes.

 

Page 29 of 36 Pages


Net cash provided by/used in investing activities

 

During the six month period ended June 30, 2005, we generated $263 million of net cash provided by investing activities as compared to $192 million of net cash used in investing activities during the six months ended June 30, 2004.

 

During the first six months of 2005, we generated $263 million of net cash from investing activities as follows:

 

    generated $124 million of proceeds during the first quarter from the sale of two acute care facilities located in Puerto Rico and a home health business in Florida;

 

    generated $253 million of cash proceeds (net of closing costs and cash balances at the time of sale) during the second quarter from the sale of our 81.5% ownership interest in Medi-Partenaires, an operating company that owned and managed 14 hospitals in France;

 

    spent $109 million to finance capital expenditures at our facilities ($58 million spent in first quarter and $51 million in second quarter);

 

    spent $5 million during the first quarter to purchase membership interests in McAllen Medical Center Physicians, Inc. and Health Clinic, P.L.L.C.

 

During the first six months of 2004, we used $192 million of net cash in investing activities as follows:

 

    spent $118 million to finance capital expenditures at our facilities ($70 million spent in first quarter of 2004 and $48 million in second quarter);

 

    spent $142 million ($38 million spent in first quarter and $104 million in second quarter) on the following acquisitions: (i) a 90% controlling ownership interest in a 156-bed acute care hospital located in New Orleans, Louisiana; (ii) a 48-bed and a 76-bed acute care facility, located in France; (iii) a 63-bed behavioral health hospital, partial services, a school, group homes and detox services located in Stonington, Connecticut; (iv) a 112-bed behavioral health facility in Savannah, Georgia; (v) a 77-bed behavioral health facility in Benton, Arkansas; (vi) the operations of an 82-bed behavioral health facility in Las Vegas, Nevada, and; (vii) a 72-bed behavioral health facility in Bowling Green, Kentucky.

 

    generated $68 million of proceeds during the second quarter of 2004 from the sale of the following: (i) a 112-bed acute care hospital located in San Luis Obispo, California; (ii) a 65-bed acute care hospital located in Arroyo Grande, California; (iii) a 136-bed leased acute care hospital in Shreveport, Louisiana, and; (iv) a 106-bed acute care hospital located in La Place, Louisiana.

 

We expect to spend approximately $140 million for capital expenditures during the remaining six months of 2005, including expenditures for capital equipment, renovations and new projects at existing hospitals and completion of major construction projects in progress. We believe that our capital expenditure program is adequate to expand, improve and equip our existing hospitals.

 

Net cash provided by/used in financing activities

 

During the six month period ended June 30, 2005, we used $412 million of net cash in financing activities as compared to $32 million of net cash provided by financing activities during the first six months of 2004.

 

During the first six months of 2005, we used $412 million of net cash in financing activities as follows:

 

    spent $255 million of net debt repayments consisting primarily of repayments under our $500 million unsecured non-amortizing revolving credit agreement;

 

    spent $158 million to purchase 2.68 million shares of our Class B Common Stock on the open market;

 

    spent $9 million to pay an $.08 per share quarterly cash dividend, and;

 

    generated $10 million of cash due primarily to the issuance of common stock in connection with employee stock incentive plans.

 

During the first six months of 2004, we used $32 million of net cash in financing activities as follows:

 

    spent $24 million to reduce long-term debt;

 

    spent $9 million to pay an $.08 per share quarterly cash dividend, and;

 

    generated $1 million of other net cash provided by financing activities.

 

Page 30 of 36 Pages


As of June 30, 2005, we have approximately $115 million of dollar and euro denominated cash invested in various short-term investment vehicles.

 

Capital Resources

 

Credit Facilities and Outstanding Debt Securities

 

We have a $500 million unsecured non-amortizing revolving credit agreement, which expires on March 4, 2010. The agreement includes a $75 million sub-limit for letters of credit. The interest rate on borrowings is determined at our option at the prime rate, LIBOR plus a spread of .32% to .80% or a money market rate. A facility fee ranging from .08% to .20% is required on the total commitment. The applicable margins over LIBOR and the facility fee are based upon our debt ratings by Standard & Poor’s Ratings Group and Moody’s Investor Services Inc. At June 30, 2005, the applicable margin over the LIBOR rate was .50% and the commitment fee was .125%. There are no compensating balance requirements. As of June 30, 2005, we had no borrowings outstanding under our revolving credit agreement and we had $444 million of available borrowing capacity, net of $56 million of outstanding letters of credit.

 

During 2001, we issued $200 million of Senior Notes which have a 6.75% coupon rate and which mature on November 15, 2011. (“Notes”). The interest on the Notes is paid semiannually in arrears on May 15 and November 15 of each year. The Notes can be redeemed in whole at any time and in part from time to time.

 

We issued discounted Convertible Debentures in 2000 which are due in 2020 (“Debentures”). The aggregate issue price of the Debentures was $250 million or $587 million aggregate principal amount at maturity. The Debentures were issued at a price of $425.90 per $1,000 principal amount of Debenture. The Debentures’ yield to maturity is 5% per annum, .426% of which is cash interest. The interest on the bonds is paid semiannually in arrears on June 23 and December 23 of each year. The Debentures are convertible at the option of the holders into 11.2048 shares of our common stock per $1,000 of Debentures, however, we have the right to redeem the Debenture any time on or after June 23, 2006 at a price equal to the issue price of the Debentures plus accrued original issue discount and accrued cash interest to the date of redemption.

 

Upon the sale of our ownership interest in Medi-Partenaires, an operating company that owned and managed 14 hospitals in France, the 85 million euro senior credit agreement was terminated and all outstanding borrowings were repaid.

 

Our total debt as a percentage of total capitalization was 29% at June 30, 2005 and 42% at December 31, 2004. Covenants relating to long-term debt require maintenance of a minimum net worth, specified debt to total capital and fixed charge coverage ratios. We are in compliance with all required covenants as of June 30, 2005.

 

We expect to finance all capital expenditures, acquisitions and potential stock repurchases with internally generated and additional funds. Additional funds may be obtained through: (i) the issuance of equity; (ii) borrowings under our existing revolving credit facility or through refinancing the existing revolving credit agreement, and/or; (iii) the issuance of other long-term debt.

 

Off-Balance Sheet Arrangements

 

During the three months ended June 30, 2005, there have been no material changes in the off-balance sheet arrangements consisting of operating leases and standby letters of credit and surety bonds. Reference is made to Item 7. Management’s Discussion and Analysis of Operations and Financial Condition – Off-Balance Sheet Arrangements, in our Annual Report on Form 10-K for the year ended December 31, 2004.

 

As of June 30, 2005, we had outstanding letters of credit and surety bonds totaling $65 million consisting of: (i) $52 million related to our self-insurance programs; (ii) $7 million consisting primarily of collateral for outstanding bonds of an unaffiliated third party and public utility, and; (iii) $6 million of debt guarantees related to entities in which we own a minority interest.

 

We have various obligations under operating leases or master leases for real property and under operating leases for equipment. The real property master leases are leases for buildings on or near hospital property for which we guarantee a certain level of rental income. We sublease space in these buildings and any amounts

 

Page 31 of 36 Pages


received from these subleases are offset against the expense. In addition, we lease five hospital facilities from Universal Health Realty Income Trust with terms expiring in 2006 through 2009. These leases contain up to five, 5-year renewal options (see Note 2 to the Condensed Consolidated Financial Statements).

 

Item 3. Quantitative and Qualitative Disclosures about Market Risk

 

There have been no material changes in the quantitative and qualitative disclosures during the three months of 2005. Reference is made to Item 7A. Quantitative and Qualitative Disclosures about Market Risk in our Annual Report on Form 10-K for the year ended December 31, 2004.

 

Item 4. Controls and Procedures

 

As of June 30, 2005, under the supervision and with the participation of our management, including our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), an evaluation of the effectiveness of our disclosure controls and procedures was performed. Based on this evaluation, the CEO and CFO have concluded that our disclosure controls and procedures are effective to ensure that material information is recorded, processed, summarized and reported by management on a timely basis in order to comply with our disclosure obligations under the Securities and Exchange Act of 1934 and the SEC rules thereunder. There have been no significant changes in our internal control over financial reporting or in other factors during the second quarter of 2005 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

Page 32 of 36 Pages


PART II. OTHER INFORMATION

 

UNIVERSAL HEALTH SERVICES, INC. AND SUBSIDIARIES

 

Item 1. Legal Proceedings

 

On or about March 22 through March 26, 2004, two purported class action Complaints were filed against us and certain of our officers and directors in the United States District Court for the Eastern District of Pennsylvania alleging that defendants violated Section 10(b) of the Exchange Act and Rule 10b-5 promulgated thereunder by disclosing materially false and misleading information or failing to disclose material information necessary to make other disclosure not misleading or to correct prior disclosure with respect to our financial condition and operations. A claim was asserted against the individual defendants under section 20(a) of the Exchange Act alleging that because they controlled the Company, they should be held liable for damages caused by the Company’s violation of section 10(b) and Rule 10b-5 thereunder. Plaintiffs sought, on behalf of a purported class of purchasers of our common stock during a class period from July 21, 2003 through February 27, 2004, unspecified money damages, restitution, attorneys’ fees and reimbursement of expenses. Pursuant to an Order of the Court, these two cases were consolidated into one action captioned: In re Universal Health Services, Inc. Securities Litigation, Case No. CV-04-01233-JP. Subsequently, the plaintiffs filed an Amended Consolidated Class Action Complaint. The Court granted defendants’ motion to dismiss this complaint and thereafter dismissed the action with prejudice when plaintiffs chose not to replead.

 

On July 6, 2004, we were served with a complaint filed in the United States District Court for the Eastern District of Pennsylvania captioned Eastside Investors LLP, derivatively and on behalf of nominal defendant, Universal Health Services, Inc., v. Alan B. Miller, Robert Hotz, Anthony Pantaleoni and Steve G. Filton. Plaintiff subsequently filed an amended complaint which dropped Messrs Hotz and Pantaleoni as defendants. Plaintiff purported to assert claims derivatively on behalf of the Company against our officers and directors seeking to recover on behalf of the Company unspecified damages to redress alleged breaches of fiduciary duty, abuses of control and gross mismanagement by the individual defendants. This action also has been dismissed with prejudice as a result of a stipulation of counsel entered into contemporaneously with the dismissal of the above referenced class action.

 

On August 5, 2004, we were named, together with our subsidiary, Valley Hospital Medical Center, Inc., as defendants in a lawsuit filed in Clark County, Nevada, under the caption Deborah Louise Poblocki v. Universal Health Services, Inc., et al., No. 04-A-489927-C. The plaintiff alleges that we overcharged her and other similarly situated patients who lacked health insurance. The complaint seeks class action treatment. The complaint, filed by plaintiff individually and on behalf of other unnamed class members, alleges that Valley Hospital Medical Center charged her “unconscionable rates” because it charged her, an uninsured outpatient, more than it charged insured patients and more than the cost of the services provided. She claims that this alleged conduct violates state civil RICO laws as well as other state statutory and common law. We filed a notice of removal to federal court, and plaintiff filed a motion to remand back to state court. The court granted plaintiff’s motion to remand and the case will proceed in Nevada state court. On July 22, 2005, plaintiff’s counsel, with our consent, filed a first amended complaint, adding two additional plaintiff’s (husband and wife) alleging similar “facts” and claiming similar federal and state causes of action. We anticipate filing a motion to dismiss plaintiff’s claims in the next few weeks.

 

In October, 2004, one of our subsidiaries, Aiken Regional Medical Centers, Inc., received a complaint filed in state court in South Carolina (Case No. 04-CP-02-1275). The complaint, filed by the plaintiff individually and on behalf of other unnamed, putative class members, alleges that Aiken breached its contract with the plaintiff (and other putative plaintiffs), or in the alternative Aiken was unjustly enriched, by virtue of billing and collecting full hospital charges from the plaintiff and other putative class members. Aiken has filed a motion to dismiss the complaint. The plaintiff has voluntarily dismissed the complaint, without prejudice as to the purported class, but with prejudice as to the named plaintiff.

 

We believe that the claims asserted against us in the proceedings described above are without merit and we deny all allegations of violations of law and any liability to the above named plaintiffs. There can be no assurance, however, as to the outcome or timing of the resolution of these proceedings. We therefore are

 

Page 33 of 36 Pages


unable to estimate the amount or potential range of any loss that may arise out of these proceedings. The range of possible resolutions could include determinations and judgments against us or settlements that could require substantial payments by us that could have a material adverse effect on our financial condition, results of operations and cash flows.

 

The legal proceedings described above have previously been disclosed in the Report on Form 10-Q for the quarterly period ended March 31, 2005.

 

Item 2. Unregistered sales of Equity Securities and Use of Proceeds

 

During 1998, 1999 and 2004, our Board of Directors approved stock repurchase programs authorizing us to purchase up to 14 million shares of our outstanding Class B Common Stock on the open market at prevailing market prices or in negotiated transactions off the market. In June of 2005, our Board of Directors authorized the repurchase of an additional 3.5 million shares thereby increasing the total to 17.5 million shares. The Board of Directors also gave management discretion to use the authorization to purchase its convertible debentures which are due in 2020. Pursuant to the stock and convertible debenture repurchase program, we may purchase shares or debentures on the open market or in negotiated private transactions. Pursuant to the terms of these programs, we purchased 2,652,900 shares at an average price of $58.91 per share or $156.3 million in the aggregate during the second quarter of 2005. Since inception of the stock purchase program in 1998 through June 30, 2005, we purchased a total of 14,118,949 shares at an average purchase price of $32.02 per share or $452.1 million in the aggregate. As of June 30, 2005, the maximum number of shares that may yet be purchased under the program is 3,381,051 shares.

 

2005 period


   Total
number of
shares
purchased


   Number of
shares
purchased as
part of
publicly
announced
programs


   Average
price paid per
share


   Aggregate
purchase
price paid (in
thousands)


   Maximum
number of
shares that
may yet be
purchased
under the
program


April, 2005

   1,500    1,500    $ 55.40    $ 83    2,532,451
    
  
  

  

  

May, 2005

   2,448,400    2,448,400    $ 58.74    $ 143,813    84,051
    
  
  

  

  

June, 2005

   203,000    203,000    $ 60.96    $ 12,375    3,381,051
    
  
  

  

  

Total April through June

   2,652,900    2,652,900    $ 58.91    $ 156,271    3,381,051
    
  
  

  

  

 

Dividends

 

During each of the quarters ended June 30, 2005 and 2004, we declared and paid dividends of $.08 per share.

 

Item 4. Submission of Matters to a Vote of Security Holders

 

  (a) The following information relates to matters submitted to the stockholders of Universal Health Services, Inc. at the Annual Meeting of Stockholders held on June 2, 2005.

 

  (b) At the meeting, the following directors were elected by the votes indicated:

 

 

Election by Class A & Class C stockholders of a Class III Director, Alan B. Miller:

 

Votes cast in favor

  3,654,204

Votes withheld

  0

 

Election by Class A & Class C stockholders of a Class III Director, Robert A. Meister:

 

Votes cast in favor

  3,654,204

Votes withheld

  0

 

Election by Class B & Class D stockholders of a Class III Director, John F. Williams, Jr., M.D.:

 

Votes cast in favor

  45,763,920

Votes withheld

  1,322,459

 

       The following directors’ term of office as a director continued after the meeting: John H. Herrell, Leatrice Ducat, Anthony Pantaleoni and Robert H. Hotz.

 

Page 34 of 36 Pages


  (c) At the meeting, the following proposals, as described in the proxy statement delivered to all of our stockholders, were approved by the votes indicated:

 

Approval of the Universal Health Services, Inc. 2005 Stock Incentive Plan:

 

Votes cast in favor

  40,133,445

Votes against

  810,903

 

Approval of the Universal Health Services, Inc. 2005 Executive Incentive Plan:

 

Votes cast in favor

  40,844,377

Votes against

  99,410

 

Approval of the Universal Health Services, Inc. Employee Stock Purchase Plan:

 

Votes cast in favor

  40,907,301

Votes against

  34,085

 

The consideration of one stockholder proposal:

 

Votes cast in favor

  1,172,764

Votes against

  39,360,741

 

Item 6. Exhibits

 

(a) Exhibits:

 

31.1 Certification of the Company’s Chief Executive Officer pursuant to Rule 13a-14(a)/15d-14(a) under the Securities and Exchange Act of 1934.

 

31.2 Certification of the Company’s Chief Financial Officer pursuant to Rule 13a-14(a)/15d-14(a) under the Securities and Exchange Act of 1934.

 

32.1 Certification of the Company’s Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

32.2 Certification of the Company’s Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

11. Statement re computation of per share earnings is set forth in Note 6 of the Notes to Condensed Consolidated Financial Statements.

 

All other items of this Report are inapplicable.

 

Page 35 of 36 Pages


UNIVERSAL HEALTH SERVICES, INC. AND SUBSIDIARIES

 

Signature

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

    Universal Health Services, Inc.
            (Registrant)

Date: August 9, 2005

 

/s/ Alan B. Miller


    Alan B. Miller, Chairman of the Board,
    President and Chief Executive Officer
    (Principal Executive Officer)
   

/s/ Steve Filton


    Steve Filton, Senior Vice President,
    Chief Financial Officer
    (Principal Financial Officer and
    Duly Authorized Officer).

 

Page 36 of 36 Pages

Section 302 CEO Certification

Exhibit 31.1

 

CERTIFICATION - Chief Executive Officer

 

I, Alan B. Miller, certify that:

 

1. I have reviewed this quarterly report on Form 10-Q of Universal Health Services, Inc.;

 

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

 

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

 

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

 

a. Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

 

b. Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

 

c. Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation, and;


d. Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

 

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

 

a. All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

 

b. Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls over financial reporting.

 

Date: August 9, 2005

 

 

/s/ Alan B. Miller


President and Chief Executive Officer

Section 302 CFO Certification

Exhibit 31.2

 

CERTIFICATION - Chief Financial Officer

 

I, Steve Filton, certify that:

 

1. I have reviewed this quarterly report on Form 10-Q of Universal Health Services, Inc.;

 

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

 

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

 

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

 

a. Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

 

b. Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

 

c. Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation, and;


d. Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

 

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

 

a. All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

 

b. Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls over financial reporting.

 

Date: August 9, 2005

 

/s/ Steve Filton


Senior Vice President and Chief

Financial Officer

Section 906 CEO Certification

EXHIBIT 32.1

 

CERTIFICATION PURSUANT TO

18 U.S.C. SECTION 1350,

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

 

In connection with the Quarterly Report of Universal Health Services, Inc. (the “Company”) on Form 10-Q for the quarter ended June 30, 2005, as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Alan B. Miller, President and Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. § 1350, as adopted pursuant to § 906 of the Sarbanes-Oxley Act of 2002, and to the best of my knowledge, that:

 

(1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

 

(2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

 

/s/ Alan B. Miller


President and Chief Executive Officer

August 9, 2005

 

A signed original of this written statement required by Section 906 has been provided to the Company and will be retained and furnished to the Securities and Exchange Commission or its staff upon request.

Section 906 CFO Certification

EXHIBIT 32.2

 

CERTIFICATION PURSUANT TO

18 U.S.C. SECTION 1350,

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

 

In connection with the Quarterly Report of Universal Health Services, Inc. (the “Company”) on Form 10-Q for the quarter ended June 30, 2005, as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Steve Filton, Senior Vice President and Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. § 1350, as adopted pursuant to § 906 of the Sarbanes-Oxley Act of 2002, and to the best of my knowledge, that:

 

(1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

 

(2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

 

/s/ Steve Filton


Senior Vice President and Chief

Financial Officer

August 9, 2005

 

A signed original of this written statement required by Section 906 has been provided to the Company and will be retained and furnished to the Securities and Exchange Commission or its staff upon request.