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TenetQ307PreparedRemarks_Final
1. Tenet’s Q3 2007 Earnings Call Prepared Remarks
November 6, 2007
Trevor Fetter, President and Chief Executive Officer
Thank you operator, and good morning. Our performance in the
third quarter was the best in several years, and all of us at Tenet are
very pleased with our progress.
If you look at the charts of key performance indicators we posted
on our Web site today, it is clear that the trends in volumes, pricing
and cost control are moving in the right direction. There are other
metrics we watch, in areas like physician activity and the revenue
cycle, and they are trending positively as well.
I’ll start with patient volumes. Same-hospital inpatient admissions
declined by 0.8 percent. This is a significant improvement over
the second quarter’s year-over-year comparison of negative 2.2
percent. More importantly, same-hospital commercial managed
care volumes declined by only 0.6 percent year-over-year, which is
the best performance in this statistic since we began reporting it
two years ago.
Many of you like to know how our business is doing outside of
Florida and USC University Hospital. In the rest of our company,
same-hospital admissions increased by 0.1 percent and commercial
managed care admissions increased by 0.4 percent.
The trend in outpatient visits also showed improvement, declining
just 1.4 percent in the quarter compared to a decline of 3.1 percent
in the second quarter.
1
2. The improving trend in volumes continued in October. Same-
hospital admissions increased 1 percent in the month. You may
remember that on last year’s third quarter call I mentioned that
October 2006 admissions were up 1.2 percent versus October
2005, so I’m pleased that we’re up in 2007 against this tough
comparison and off to a good start for the fourth quarter. Of
course, since we’re dealing with such small percentages, I should
point out that there was an extra weekday in October 2007
compared to 2006.
Adjusted EBITDA was $177 million, well above analyst estimates
for the quarter and up more than 50 percent from prior year. This
performance is impressive even on a sequential basis, with same-
hospital adjusted EBITDA up 7.9 percent from the second quarter,
despite the seasonal softness which typically reduces earnings from
the second to the third quarters in our industry.
With an EBITDA margin of just 8 percent, we still have plenty of
room for improvement; but we’re making good progress, and I
believe that our strategies are working.
Good trends in nearly every line item contributed to this stronger-
than-expected EBITDA.
Pricing increases made a solid contribution to earnings growth.
Some of the adverse trends that we were seeing in patient mix
within managed care not only were abated in the third quarter, but
actually reversed themselves. Same-hospital net revenue per
adjusted admission was up by 6.8 percent and up 7.4 percent per
adjusted patient day.
An additional round of cost reductions helped our same-hospital
revenue growth of 7.0 percent translate into growth in the bottom
line. Tenet’s same-hospital growth in controllable operating
2
3. expense per adjusted patient day of 4.2 percent in the third quarter
continues to represent one of the best cost control metrics in the
industry.
Bad debt expense was flat year-over-year at 7.2 percent, although
we had expected to be able to reduce it. We described at our
investor day all the actions we’re taking to contain bad debt.
Also in the quarter, we made continued progress in clinical quality.
Our CMS Hospital Compare Data for the four quarters ended Q207
stands at a new high of 92.5 percent, which is well above our peers
and the national average. As you can see on slide 6 of the
presentation we posted to our Web site, this measure extends the
positive trend we have achieved since launching our Commitment
to Quality in the first quarter of 2004.
The next trend in government reporting is in a standardized
measure of patient satisfaction. Tenet was an early volunteer in
this program, called HCAHPS, and I’m pleased that our initial
satisfaction scores in overall hospital rating and willingness to
recommend our hospitals already exceed the national average by 3
percent.
Like all of you, we remain keenly aware of the challenges facing
the hospital industry and our company, most notably high levels of
uncompensated care and soft volumes. I feel today that our
strategies to deal with those challenges are increasingly effective.
We have positioned Tenet to capitalize on future trends in
population growth, aging, obesity and other disease states, as well
as the trend in consumerism going forward. Our strategies, from
Commitment to Quality to Targeted Growth to our emphasis on
physician relations, to the improvements we’ve made in clinical IT
3
4. and the revenue cycle, have all been designed to put us back on a
growth track.
We are feeling much more confident about our performance
outlook for the balance of 2007, based on our strong EBITDA
performance and the breadth of factors that contributed to those
robust third quarter results.
Biggs will provide more detail on our outlook for the near and
intermediate term in just a few moments, but at a summary level, I
want to say that we are confident we can achieve adjusted
EBITDA in the range of $675 to $725 million we provided in our
second quarter call in early August.
Before I turn over the floor, let me briefly comment on some
upcoming IR events.
As many of you know, we have limited our investor relations
activities in the past few years to holding our annual investor day
in June, appearing at only one or two investor conferences per
year, and hosting a limited number of meetings in our hospitals and
headquarters. Due to a recent increase in requests for in-person
meetings, next week, Steve Newman, Biggs Porter, Tom Rice and
I plan to meet with some of our larger shareholders in New York,
Boston and a few other cities.
We also will make a presentation at the Merrill Lynch Conference
in New York on November 27th – and we will present at one or
two other investor conferences in early 2008.
Tom will begin scheduling these meetings this afternoon. Please
give him a call if you’re interested in meeting with us, and we’ll
see if we can find a way to get together.
4
5. With that, let me introduce our COO, Dr. Steve Newman.
Dr. Stephen Newman, Chief Operating Officer
Thank you Trevor, and good morning everyone.
I want to focus my remarks this morning on five key elements of
our turnaround strategy that are showing positive results and have
contributed to our improved financial performance in the third
quarter. They are:
First, the effectiveness of our cost management initiatives;
Second, how our Targeted Growth Initiative contributed to the
improvement we achieved in commercial managed care
business in the third quarter;
Third, the significant progress we are making in adding new
doctors to our medical staffs, primarily by recruiting them to
private practices but also by selective direct hiring, redirecting
more of the business of physicians already in our service areas,
and attracting more admissions from the doctors we already
have on staff;
Fourth, the results we’re seeing so far from the extensive
initiatives we have launched to turn around our key Florida
operations; and
Fifth, a few examples of success stories where hospitals such
as Houston Northwest and North Shore Medical Center in
Miami, which were deeply distressed as recently as 18 months
ago, have demonstrated remarkable improvements after
embracing our strategies, implementing TGI, and executing
effectively.
Let’s begin with our company-wide cost-management efforts. We
accelerated those efforts in the third quarter, and they have
produced significant results. The resizing of our work force within
5
6. the hospitals resulted in the elimination of 1,275 full-time positions
over the course of the last year. That amounts to a 2.7 percent
reduction – a significantly larger “delta” than the 0.8 percent
decline in total admissions over the same time period.
We have also cut 208 full-time positions in corporate, regional and
other support areas so far this year, amounting to about 7.5 percent
of the total overhead jobs above the hospital level. This was
achieved through layoffs, retirements, attrition and restructuring.
All these job eliminations made an important contribution to
restrain the growth of same-hospital controllable costs per adjusted
patient day to 4.2 percent versus a year ago. Since some of the
most aggressive actions were taken towards the end of the third
quarter, the full financial impact won’t be visible until the fourth
quarter.
Also we recently completed multi-year wage agreements for our
union-represented employees at our hospitals in California and
Florida. These agreements cover several classes of employees,
including registered nurses, technicians and clerical employees.
They provide for wage increases for these workers ranging from 5
to 7 percent annually over the term of the agreements. These wage
increases were already substantially embedded in our overall
financial assumptions for next year and beyond.
Supply cost management also played a major role in our overall
cost management success in the quarter. For several quarters, we
have been accelerating our supply cost management efforts
through an expansion of our Performance Management and
Innovation group. As a result, same-hospital supply costs were
held to an increase of just 2.6 percent per adjusted patient day in
the quarter. Supply costs represented 17.3 percent of net revenue
6
7. in the quarter, and our overall cost management continues to be
exemplary.
Now let’s talk about our commercial business. As Trevor
mentioned, we are gratified by the sequential improvement in
commercial managed care business we saw in the third quarter. As
you know, commercial managed care is our most profitable
business line. Over the past two years, 52 Tenet hospitals have
used the Targeted Growth Initiative in a disciplined process to
make future business planning decisions. Those hospitals have all
completed Phase I of TGI, which identified the product lines that
are most needed by a hospital’s community and have the best
profit potential. Many have now progressed through Phase 2 of
TGI, in which the decisions made in Phase I are implemented. This
implementation process is being carefully monitored and will
continue through 2008.
The third-quarter results demonstrate that TGI is working as we
intended. Here are a few examples. During the quarter, we saw
12.7 percent increase in commercial neonatal services, a 5.5
percent increase in commercial oncological surgeries, and a 5.4
percent increase in commercial open heart surgeries. Not all of our
targeted service lines were up in the quarter over quarter.
Commercial neurosurgery was down 2.4 percent for the quarter,
but this decrease has improved sequentially.
As you know, open heart surgery has been a challenge for Tenet,
particularly as a result of new competitors in certain Florida
markets and an overall decline in open heart surgeries in the wake
of clinical and technological advances. Because it’s now been a
year since the opening of some of these new Florida heart
programs with the largest adverse impacts on Tenet, the 5.4
percent increase in commercial open heart surgeries we reported
this quarter clearly demonstrates that we are succeeding in
7
8. capturing and maintaining market share even in this tough
competitive environment.
Having said that, we realize that another new heart program is
opening in January in the Palm Beach market. Initially, we expect
to feel some negative effect from this new competitor, but I’m
confident that in a relatively short period we will absorb the
impact, just as we have all the others.
In summary, we are very pleased with our volume improvement in
commercial managed care in the third quarter, which outperformed
overall volume improvement. I believe that this success is
attributable to two factors: the elimination of “out-of-network”
situations we have negotiated with our managed care partners in
recent years and the improved mix we’ve seen in the services we
have provided. This improved mix, I believe, can be credited in
large part to the precise business line targeting achieved by TGI.
Now let’s talk about our success in adding more doctors to our
medical staffs. We know that the real key to our sustained future
growth will come from more doctors admitting more patients to
our hospitals. Of course, we have continued our traditional efforts
to attract more doctors by improving both the quality and service
we deliver, and Trevor shared with you the great progress we’ve
made in those areas. More recently, we’ve also launched targeted
efforts to expand our medical staffs through increased recruitment,
redirection, relocation, and, to a lesser extent, employment.
In the third quarter, we added 726 new physicians with active staff
privileges. After taking into account normal attrition, the net
expansion of our active medical staff was 370 physicians in the
quarter. That’s an increase of 3.4 percent. For the nine months
ended September 30, we added 1,562 new active physicians to our
staffs, or a net expansion of 845 after normal attrition. That’s an
8
9. increase of 7.7 percent. You may recall that we use a conservative
definition for active staff status that requires at least 10 inpatient
admissions or at least 10 outpatient surgeries per year, which
makes these increases particularly impressive.
In the third quarter, we also hired 35 employed physicians, mainly
in Texas and our Southern States Region. This employment of
physicians is consistent with the plans we shared with you on
investor day, in which we envisioned hiring 270 physicians by the
end of 2010. At that point, we expect our total employed
physicians to number about 590. Let me reiterate that physician
employment at Tenet is limited to selected geographies and
specific situations where the employment model is considered
essential for competitive reasons.
I want to assure you that most of our volume growth will continue
to come from redirection of admissions by physicians already
affiliated with our medical staffs, as well as recruitment and
succession planning for existing medical groups. As our new
physicians and our re-recruited physicians ramp up, we expect
admission and outpatient growth.
The addition of many of these new physicians to our medical staffs
comes as a direct result of the expansion and retooling of our
Physician Relationship Program (PRP). Beginning early this year,
we added an outreach program to local physicians that previously
did not practice at our hospitals. We continue to expand and
improve both techniques and tools for our hospital leaders and PRP
representatives to use in their daily activities in physicians offices.
In the third quarter, we visited more than 5,900 physicians, an
increase of 60 percent, from the more than 3,700 visits in the third
quarter of 2006. Included in these totals were 930 first-time visits
to existing active staff physicians. As part of our expanded
9
10. outreach program, we also visited for the first time 419 physicians
that were not members of our medical staff. Once physicians join
our hospitals’ staffs, after appropriate credentialing, and are told
about the services offered by our hospitals, we expect to see
incremental volume growth.
Now let’s discuss the actions we are taking to help our Florida
market. Nothing has been more difficult for us recently than
dealing with our challenges in Florida. Florida has traditionally
been a very good region for us with a strong market position in
several areas and our most concentrated geographic footprint. We
are confident that it will be again.
During the third quarter, we took a number of actions to accelerate
our turnaround in Florida:
First, we hired a new executive to lead the region. Marsha
Powers joined us from Triad with a proven track record of
building successful relationships with physicians, payers and
community leaders.
Second, we consolidated our two-market structure in Palm
Beach and Miami-Dade/Broward into a single region under
Marsha’s leadership. This will permit us to handle certain
functions at the region level that currently are handled by the
hospitals individually, thus generating economies of scale, and
helping us focus on regional business development
opportunities and cost management.
Third, we made tangible progress in stemming patient out-
migration in neonatology, cardiovascular services such as
electrophysiology and rehabilitation inpatient admissions. We
expect these efforts to accelerate in the fourth quarter and
10
11. contribute to admission retention and growth as we move
forward.
Fourth, we are addressing the critical need to add more
physicians to our Florida medical staffs, especially those with
large commercial managed care practices or those with
demonstrated experience in capitation and caring for the
geriatric patients. I expect to have good results to tell you about
in our future calls.
Fifth, we have accelerated our cost-cutting efforts in Florida to
align our infrastructure expenses with the realities of our current
volumes. This alignment included our decision, announced last
month, to divest North Ridge Medical Center in Fort
Lauderdale. Given our many competitive disadvantages at
North Ridge, the decision to divest that hospital is consistent
with our intention to remain active managers of our portfolio, a
strategy which will include periodic acquisitions and
divestitures.
Sixth, we are successfully negotiating new managed care
contracts in Florida that achieve not only good pricing but also
the elimination of “out-of-network” situations for all our
hospitals. Some of these new contracts have been structured to
include volume guarantees. This approach should contribute to
tangible growth in volumes as well as our market share over
time, even if the economics and demographics in South Florida
remain temporarily stagnant.
Let me conclude by sharing a few of the individual turnaround
stories we have within Tenet. I bring this up because sometimes
these successes are not readily apparent in the aggregate numbers
we report. The simple truth is that we have a number of hospitals
which have built – or in some cases re-built – great market
11
12. positions, and whose performance has improved dramatically even
as our aggregate performance has sometimes lagged. Here are
some examples of how we have renewed or maintained our
competitive strength in individual hospitals and markets.
I’ll start with our Philadelphia market. Not too long ago, some of
you on this call were questioning why we even still owned
hospitals there. We certainly know that Philly is a tough,
competitive market. But the fact is, we have made substantial
progress in growing our market share, reaching more competitive
reimbursement with our managed care payers, and dealing with
structural challenges in our two faculty practice plans. In the third
quarter, Philadelphia’s admissions were up 3.3 percent and year-to-
date they are up 3.0 percent. Margin expansion at Hahnemann
University Hospital, under our CEO Mike Halter and his team, and
St. Christopher’s Hospital for Children, under our CEO Bernadette
Mangan and her team, has been dramatic. This reflects the
powerful operating leverage inherent in our business model. In
addition, the affiliation between Temple University and St. Chris
that we announced last month should add more momentum to our
progress in Philadelphia.
Our North Shore Medical Center in Miami had an increase in
inpatient admissions of almost 6 percent in the third quarter. That
is remarkable, but not unusual for North Shore. Under our CEO
Manny Linares and his team, the hospital has seen consistent
growth of 2 percent or more for the past 18 months. By contrast,
however, from 2004 to 2005 admissions at North Shore fell 3.3
percent.
Our Atlanta Medical Center under CEO Bill Moore and his team
saw a jump of 8.5 percent in admissions in the third quarter, but its
admissions have been growing by an annual rate of more than 5
12
13. percent for almost two years. This effectively doubled the rate of
annual admission growth from 2003 to 2005.
Perhaps most dramatically, our Houston Northwest Medical Center
under CEO Drew Kahn and his team saw admissions rise by 8.4
percent in the third quarter – which is entirely consistent with the
more than 9 percent increase they’ve had over the past year. By
contrast, from 2004 to 2006 admissions were down a cumulative
17.4 percent.
Those are just a few examples of dramatically improving
performance we are seeing in our portfolio. Obviously, our goal is
to have every single Tenet hospital growing consistently, quarter
after quarter. But I think the Philadelphia market, North Shore,
Atlanta Medical Center and Houston Northwest examples should
demonstrate not only that our hospitals are capable of producing
consistent results – but also that many of them already are.
So, to sum it up, I am gratified by what I am seeing in our cost
management initiatives, our targeted growth in commercial
managed care business, our efforts to add more doctors, the signs
of progress in Florida, and some dramatic turnarounds in a number
of our hospitals. I believe the progress we saw in the third quarter
in adjusted EBITDA, commercial admissions, and net revenue for
both inpatients and outpatients provide compelling, tangible
evidence of the progress we have made, and intend to continue to
make, in our turnaround.
With that, I will turn it over to Biggs Porter, our chief financial
officer. Biggs?
13
14. Biggs Porter, Chief Financial Officer
Thank you Steve, and good morning everyone.
Let me start by echoing the assessments you’ve just heard from
Trevor and Steve: that the third quarter demonstrated progress on a
number of fronts.
Adjusted EBITDA came in at $177 million for the quarter, an
increase of 55 percent over last year, and an increase over the
second quarter of 8 percent. Given that the third quarter is typically
our weakest quarter given soft seasonal volumes in July and
August, this $177 million in adjusted EBITDA is a particularly
notable achievement and positions us well for the full year. I’ll
return to this topic in a few minutes. Before I go further, I should
note that the appropriate reconciliations to GAAP related to my
comments are included in our release and the slides on our Web
site.
Trevor and Steve have already discussed the favorable
developments we saw on the volume front, so I want to go to
revenues pretty quickly. The only thing I will say about volumes is
that we have always said improvement would have its bumps. But
if you look at the last two years, as shown on slides 17 through 19
on our Web site, and plot a statistical regression line against year-
over-year comparisons of admissions, particularly commercial
admissions and outpatient visits, you will see significant
momentum developing.
To me, the critical message at this time is not about this quarter or
any perfect view of the next quarter, but rather that there is a trend
developing and a series of actions underneath that trend which are
taking hold. Progress has been and will be bumpy due to all the
14
15. externalities and variables, but we believe the actions we are taking
are the right actions to improve our results and that the trends are
beginning to show this.
Now on revenues:
Mix between payer categories improved in the quarter, with
commercial managed care admissions trending more favorably
than in the trend in total admissions. Revenue was also supported
by continued progress in commercial pricing. These combined to
produce a 7 percent increase in same hospital net operating
revenues to $2.2 billion in the quarter. This strong top-line growth
was a key to our performance and very gratifying given that
volumes, despite evidence of an improving growth trend, came in
weaker than we had anticipated earlier in the year.
Cost report adjustments contributed $22 million to the quarter,
compared to an adverse $10 million impact in the third quarter last
year. The favorable impact in the current quarter is fairly typical of
recent trends.
Turning to pricing, we experienced solid progress in all our key
pricing metrics. Notable among these impressive stats were:
A 7.8 percent increase in net inpatient revenue per admission,
and
A 9.7 percent growth in net outpatient revenue per visit.
This consistent strengthening in pricing has clearly benefited from
some of the favorable new contracts we announced in recent
months. You should be aware that two contracts we signed and
announced late in the second quarter with Aetna and Blue Cross of
Texas were fully effective July 1. So, the full impact of these
contracts was visible in the third quarter metrics I just reviewed.
15
16. Pricing was also favorably influenced by the approximately $32
million year-over-year variance in cost report adjustments and the
effects of emergency department scoring and charge increases.
We have some additional contracts we expect to sign in the fourth
quarter, which will further improve pricing next year. Combined
with those already negotiated, these additional contracts provide a
credible basis for expecting continued robust commercial managed
care pricing growth going into next year.
In summary, we are very pleased with our continued progress with
regard to pricing and are achieving results fully consistent, if not
stronger, than the levels we have previously discussed as our
objective for commercial pricing.
Not everything in pricing that happened in the last few months is
positive, however. Unfortunately the states of Georgia and Florida
will reduce Medicaid funding to our hospitals by approximately
$60 million in the aggregate on an annual basis beginning next
year. This will absorb some of the benefit otherwise produced by
favorable managed care negotiations and other price increases.
We are not counting on it in any forecasts, but we continue to
watch with interest California’s attempts to address the issue of the
uninsured. Although estimates have varied significantly based on
the various structures proposed, the last iteration or estimate by us
was that this would improve our annual results by approximately
$60 million if the reform was enacted.
We also have steady progress to report on the cost front. The
summary level indication is on slide 22 on our Web. Same hospital
controllable operating expenses per adjusted patient day were
restrained to an increase of 4.2 percent. This reflects overhead and
supply cost reductions, partially offset by the effects of volume
16
17. loss and higher medical fees. Medical fees were up $15 million
year-over-year, but have been relatively flat over the course of this
year. Corporate overhead is down $27 million year-over-year for
the third quarter reflecting our initiatives to control costs in line
with the reduction of our business base.
We also have addressed the effects of a lower business base at the
hospital level. As Steve Newman just reviewed, we have recently
implemented initiatives which are intended to reduce our hospital-
level, primarily non-patient care, staffing costs by approximately
$60 million on an annualized basis. As many of these actions were
implemented only late in the third quarter, savings and severance
costs offset in that quarter, with nothing falling to the bottom line.
However, the impact on our fourth quarter is expected to be
approximately $15 million. There are other cost initiatives, as I
have spoken about previously, and other pressures, which I will
comment on in a moment.
Let me now update you on our cost and other initiatives. The
benefits of these initiatives were all previewed as part of the list of
detailed profitability enhancements we provided at our June
investor day and subsequently updated on our second quarter call
in August. Slide 23 shows how we laid these initiatives out at that
time, but, more importantly, slide 24 shows the current estimates.
The initiatives discussed at that point came in two pieces: an
approximately $50 million commitment to cost reductions
involving specific actions, which we had fully identified as far
back as April. When fully implemented by year-end 2007, we
estimated the continuing impact of these actions would yield $65
to $85 million in calendar year 2008.
Through the end of the third quarter, approximately $43 million of
these had been captured year-to-date, with $19 million in Q3 and
17
18. approximately $11 million of savings expected in Q4. We now
believe the annualized effect of these will be in the $95 million
territory, meaning that 2008 and 2009 will benefit by an estimated
$41 million of annual cost improvements relative to 2007 related to
these initiatives.
The second “bucket” of profitability enhancements included
specific revenue initiatives as well as additional cost reductions.
We stated that these additional contributions to profitability could
be quite significant, but since some of the initiatives were still in
the planning stages, we limited our commitment to a minimum of a
$30 million favorable impact in 2007 with an estimated annualized
impact of least $60 million to be contributed to EBITDA in
subsequent periods. Let me emphasize again, that these
enhancements were independent of our volume outlook – meaning
that these cost savings and revenue pickups are above and beyond
what we expect to capture in scale economies from volume
growth.
Through the end of the third quarter, approximately $36 million of
these had been captured year-to-date, with $20 million in Q3 and
approximately $37 million of benefits expected in Q4. We now
believe the annualized effect of these will be in the $150 million
territory, meaning that 2008 and 2009 will benefit by an estimated
$77 million of annual improvement relative to 2007 related to
these initiatives. The initiatives in this bucket include the recently
implemented staff reductions Steve and I have discussed, which
comprise approximately $45 million of the incremental 2008
savings. They also include the benefits of ED scoring and the other
revenue-related initiatives we have previously discussed in this
bucket. These are all estimated net of any related bad debt expense.
Admittedly, some of these initiatives are harder to trace through
the revenue line to their bottom line effect, but we believe these are
reasonable estimates.
18
19. Combining the two buckets of initiatives together, we are at $79
million estimated benefit year-to-date, with $39 million having
benefited the third quarter and approximately $48 million
estimated to be beneficial to the fourth quarter. The incremental
benefit to 2008 and 2009, beyond what we expect to have captured
in 2007, is estimated to be approximately $118 million.
Unfortunately, not all of this value has flowed to the bottom line in
2007 due to offsetting increases in medical fees, bad debts and the
effects of lower volumes compared to last year. With volumes and
medical fees beginning to stabilize, these should be more traceable
to the bottom line in 2008. We are, however, as I will say in a
moment, in the process of our 2008 and three-year plan, so there
may be other cost or investment considerations which will
influence the final result.
Not included in the results above are the elements of our initiatives
related to bad debts. Although we have had some success in these
actions, they have been overcome by growth in uninsured
admissions. If uninsured admissions stabilize, we would expect to
also have net yield from our bad debt initiatives.
Our bad debt experience for the third quarter has favorable and
unfavorable trends. We continue to see rising numbers of
uninsured patients and associated revenue. Uninsured admissions
rose by 7 percent in the third quarter, and revenues from the
uninsured rose by 22 percent or $30 million. As a reminder, this
increase in uninsured revenue is after the discounts applied under
our Compact. Beyond the effects of uninsured admissions growth,
uninsured revenue was impacted by price increases and by
increases in emergency department acuity related to our ED
scoring initiative. Fundamentally, to the extent price increases or
ED scoring effects uninsured revenues it becomes offset by bad
19
20. debt expense, so only about 12 cents of the dollar falls to the
bottom line. So, to that extent, bad debt related to these initiatives
is just an offset to an increase elsewhere in the P&L. The value of
these is, however, in its effect on insured revenues where there is a
much greater bottom line effect.
A favorable experience this quarter comes with respect to balance-
after. As you know, we have seen an increase for several
sequential quarters of balance-after which is directly related to
“cost-shifting,” which moves increasing amounts of the financial
burden of health care off the commercial plan sponsors and
transfers the payment responsibility to the plan members
themselves. We saw a stabilization of this trend during the quarter,
although keep in mind, one quarter does not a trend make.
We also continue to see one variable of bad debt expense, over
which we have some control, evidence continued and material
improvement. I’m referring to our collection rates, where the
multiple initiatives you heard about at investor day continue to
produce tangible results.
Through focused effort, we have been successful in raising self-
pay collection rates to 36 percent from 30 percent a year ago and
commercial managed care collection rates to 98 percent in the third
quarter from 97 percent a year ago.
You may have also noticed that charity care outpatient visits rose
by 58.4 percent in the quarter. This was due to a new assembly bill
that went into effect in California this year outlining new charity
requirements and one of our Georgia hospitals that is experiencing
an increase due to market needs.
Turning to cash flow and capital expenditures, I would refer you to
slide 29 on the Web.
20
21. Capital expenditures were $179 million in the quarter, of which
$175 million were in continuing operations, including $16 million
in construction expenditures for our East Side Hospital in El Paso.
Adjusted operating cash flow year-to-date is $82 million and for
the quarter came in at $93 million. There are a few things to
consider in evaluating cash flow for the quarter relative to our
expectation for the year. First, the $22 million in cost report
adjustments in the quarter have the effect of increasing receivables.
Secondly, in terms of activity which does not recur in the fourth
quarter we have insurance premiums, which are paid in the third
quarter of $14 million, and we had a receipt related to the sale of
the Philadelphia HMO of $12 million for a net $2 million outflow.
Finally, interest payments are high in the quarter, at $123 million
compared to approximately $82 million of gross interest payments
in the fourth quarter, including $15 million of interest related to
last year’s global settlement. If you take these into consideration,
third quarter cash flow is within the range, which is reasonable for
the income generated in the quarter. Relative to the third quarter
then, the fourth quarter should be approximately $43 million better
than the third just for the $2 million in effects of the nonrecurring
items and the $41 million difference in interest payments.
In addition, the third quarter does not yet reflect the working
capital initiatives currently in place. The two key elements of this,
which we are targeting for the fourth quarter, are the reduction of
accounts receivables days by one as driven by our bad debt and
collection initiatives, and an increase in accounts payable. The
payables growth is expected to be driven in part by normal fourth
quarter build up and also by restoring our payables processing
parameters to be more in line with our standard procurement terms,
which we expect to increase days in accounts payable by as much
as four. We expect these, net of other variables, to favorably affect
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22. the fourth quarter relative to the third by more than $62 million,
with $102 million being the middle of the range. The normal
increases in accruals for incentive and stock compensation and our
401K match benefit both the third and fourth quarter, so are neutral
to a quarter-to-quarter comparison. They are, however, reflected in
the cash walk forward included on slide 30 our Web site so that
you can see the more full view or more full projection of the fourth
quarter cash flow statement.
You can read the press release and 10-Q to get more of the details,
but we ended the quarter with $655 million in cash and cash
equivalents.
You may recall that I have talked about Tenet being increasingly
focused on improving return on invested capital. We also said on
our second quarter call that we would be making a thorough
review of our balance sheet to ensure that it was efficiently
structured. That process is making good progress, although I am
not yet in a position to provide details on our findings beyond what
I have just described about our near-term working capital targets.
We intend to provide a detailed analysis when we share our 2008
Outlook with you in mid- to late-February, but I do believe there is
significant opportunity.
It is important, however, for me to reiterate that irrespective of this
effort we do not believe we are capital constrained. To the extent
we are constrained, it is self imposed. It is first to ensure that our
investments are sound ones, which enhance shareholder value
through improving our services and capabilities and secondly to
maintain a focus on achieving positive free cash flow. To the
extent this is constraining, it is just reflective of being a good
steward, and it has a greater effect on long-term new development
in new markets than on maintaining a sound level of investment in
our existing facilities and markets. Also, as I have said before, and
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23. as is reflected in slide 31 on our Web site, we believe with the
higher level of spending we are making this year, we are caught up
with the level of spending of our peers over the last three years.
Before concluding, let me offer a few thoughts on the outlook for
the remainder of 2007 and implications of the progress
demonstrated in our third quarter performance for our longer-term
Outlook. Slide 32 on the Web presents the figures I will be
referring to.
At the end of our second quarter, we refined our 2007 outlook to a
range of $675 to $725 million for adjusted EBITDA. With adjusted
EBITDA of $535 million for the nine months ended September 30,
2007, this would require us to achieve $140 to $190 million in
adjusted EBITDA in the fourth quarter to produce results within
that range.
With $177 million of adjusted EBITDA in the seasonally weak
third quarter, and with the support of recently implemented
hospital-level cost reductions we remain comfortable with our
prior EBITDA outlook for 2007. We might have been tempted to
move higher within the range, but we are choosing to remain
conservative primarily due to the fourth quarter effects of wage
increases, the unpredictability of mix, and admissions levels,
which are modest relative to our prior expectation.
On volumes, at the end of the second quarter we expected to have
second-half admissions growth of zero to 1 percent and outpatient
visits of minus 0.5 to positive 1.6 percent. Although there was
marked improvement in the third quarter, it was not on enough
pace to maintain that expected level of growth in the second half
absent a significant swing in the fourth quarter. At this point we
would expect the fourth quarter to have admissions growth from a
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24. negative 0.5 percent to a positive 0.5 percent and visits growth of
zero to a positive 1 percent over the prior year fourth quarter.
Because of the additional cash realized in the third quarter from
life insurance and other sources, we now also believe we can
achieve a year-end cash position within the range of $530 to $670
million. We now project cash from operations of $280 to $360
million for the full year. To be in this range, we will need to
improve our performance with regard to working capital from what
it was at the end of the third quarter. As I said, in addition to the
normal seasonality of interest payments, accruals and accounts
payable growth, we are targeting improvements in both days in
receivables and days in payables in the fourth quarter. Outside of
expected improvements in working capital, the year-end outlook
for cash is without dependence on the balance sheet improvements
I mentioned a few minutes ago.
We have also factored a significant pick-up in capital expenditures
into our year-end cash forecast. While certain delays have reduced
our capex in recent quarters, we expect capex to rise to the range of
$235 to $285 million in the fourth quarter.
On the longer term, our intermediate outlook is still much as I
described it in the last conference call. Slide 35 on our Web site
shows the walk forward from 2007 to 2009 as I last presented it.
You may recall that in last quarter’s call I put the range of risk at
$0 to $100 million. Since that point in time, we have had one
significant risk or negative event materialize. That is the Georgia
and Florida Medicaid reductions of almost 60 million I referred to
earlier. To a much lesser extent, we also have had an unexpected
increase in employee benefit costs in California projected for 2008,
which is more than offset by increasing yield on our other
initiatives. Volume enhancements from transactions such as the
Temple Children’s affiliation also create lift for the longer term.
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25. We are currently in our detailed annual planning process, and we
will want to complete that as usual with a final board approval in
December before we give more specifics as to 2008 and 2009.
While we aren’t giving guidance on 2008 at this time, I would ask
you to remember that we expect to be making significant progress
in 2008 toward the 2009 objective. This is supported by the
annualized effects of our core and upside initiatives, including the
$60 million reductions in force we mentioned earlier. As I said, on
an annual basis, we expect to generate $100 million or more
incrementally from these efforts annually in 2008 and 2009 over
the estimated $127 million amount we are on the path to achieving
in 2007. Also, comparing 2008 to the fourth quarter of 2007, you
will need to remember that merit increases are substantially given
in the fourth quarter, so the first three quarters of 2008 will see
price increases without a corresponding growth in labor costs
compared to the fourth quarter of this year.
I will also repeat what I have said in the past that 2009 is not an
end point and that we can continue to lift earnings and return on
invested capital in the future by additional efficiency, but more
importantly by the benefits of the estimated 40 percent effective
margin from volume growth expected to continue beyond 2009.
So to summarize briefly,
Our results, particularly on volumes, have been and will
likely continue to be bumpy, but we do believe there is a
positive trajectory developing.
We showed real progress on volumes and pricing and took
significant cost actions in the quarter.
We remain focused on mitigating the demographic and
external pressures on bad debt expense through positive
action.
And we are driving on cash and return on invested capital as
a key indicator of shareholder value growth.
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26. Let me now turn back to the operator for questions.
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