UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

 

Form 10-Q

 

x

Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the quarterly period ended June 30, 2006

 

 

 

OR

 

 

o

Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the transition period from                to                

 

Commission file number 1-7293

 


 

TENET HEALTHCARE CORPORATION

(Exact name of Registrant as specified in its charter)

 

Nevada

 

95-2557091

(State of Incorporation)

 

(IRS Employer

 

 

Identification No.)

 

13737 Noel Road

Dallas, TX 75240

(Address of principal executive offices, including zip code)

 

(469) 893-2200

(Registrant’s telephone number, including area code)

 


 

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, and (2) has been subject to such filing requirements for the past 90 days. Yes x  No o

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer (as defined in Exchange Act Rule 12b-2).   Large accelerated filer x   Accelerated filer o   Non-accelerated filer o

Indicate by check mark whether the Registrant is a shell company (as defined in Exchange Act Rule 12b-2). Yes o No x

As of July 31, 2006, there were 471,313,843 shares of common stock outstanding.

 




TENET HEALTHCARE CORPORATION

TABLE OF CONTENTS

 

 

Page

PART I.

FINANCIALINFORMATION

 

 

 

 

Item 1.

Financial Statements

 

 

 

 

 

 

Condensed Consolidated Financial Statements

1

 

 

 

 

 

Notes to Condensed Consolidated Financial Statements

4

 

 

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

22

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

44

 

 

 

Item 4.

Controls and Procedures

44

 

 

 

PART II.

OTHER INFORMATION

 

 

 

 

Item 1.

Legal Proceedings

45

 

 

 

Item 4.

Submission of Matters to a Vote of Security Holders

49

 

 

 

Item 5.

Other Information

49

 

 

 

Item 6.

Exhibits

49

 

i




PART I.

 

ITEM 1. FINANCIAL STATEMENTS

TENET HEALTHCARE CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

Dollars in Millions

 

 

June 30,

 

December 31,

 

 

 

2006

 

2005

 

 

 

(Unaudited)

 

 

 

ASSETS

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

568

 

$

1,373

 

Investments in marketable debt securities

 

11

 

5

 

Receivable for insurance recoveries

 

285

 

75

 

Accounts receivable, less allowance for doubtful accounts ($519 at June 30, 2006 and $594 at December 31, 2005)

 

1,484

 

1,525

 

Inventories of supplies, at cost

 

174

 

190

 

Income tax receivable

 

172

 

 

Deferred income taxes

 

113

 

107

 

Assets held for sale

 

303

 

11

 

Other current assets

 

239

 

222

 

Total current assets

 

3,349

 

3,508

 

Restricted cash

 

263

 

263

 

Investments and other assets

 

365

 

380

 

Property and equipment, at cost, less accumulated depreciation and amortization ($2,541 at
June 30, 2006 and $2,582 at December 31, 2005)

 

4,276

 

4,620

 

Goodwill

 

753

 

800

 

Other intangible assets, at cost, less accumulated amortization ($131 at June 30, 2006 and $134 at December 31, 2005)

 

194

 

241

 

Total assets

 

$

9,200

 

$

9,812

 

 

 

 

 

 

 

LIABILITIES AND SHAREHOLDERS’ EQUITY

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Current portion of long-term debt

 

$

19

 

$

19

 

Accounts payable

 

761

 

857

 

Accrued compensation and benefits

 

335

 

441

 

Professional and general liability reserves

 

136

 

145

 

Accrued interest payable

 

125

 

124

 

Accrued legal settlement costs

 

58

 

313

 

Other current liabilities

 

349

 

393

 

Total current liabilities

 

1,783

 

2,292

 

Long-term debt, net of current portion

 

4,787

 

4,784

 

Professional and general liability reserves

 

593

 

594

 

Accrued legal settlement costs

 

275

 

 

Other long-term liabilities and minority interests

 

914

 

909

 

Deferred income taxes

 

141

 

212

 

Total liabilities

 

8,493

 

8,791

 

Commitments and contingencies

 

 

 

 

 

Shareholders’ equity:

 

 

 

 

 

Common stock, $0.05 par value; authorized 1,050,000,000 shares; 526,860,533 shares issued at June 30, 2006 and 525,373,176 shares issued at December 31, 2005

 

26

 

26

 

Additional paid-in capital

 

4,335

 

4,320

 

Accumulated other comprehensive loss

 

(40

)

(39

)

Accumulated deficit

 

(2,135

)

(1,807

)

Less common stock in treasury, at cost, 56,206,714 shares at June 30, 2006 and 55,663,588 shares at December 31, 2005

 

(1,479

)

(1,479

)

Total shareholders’ equity

 

707

 

1,021

 

Total liabilities and shareholders’ equity

 

$

9,200

 

$

9,812

 

See accompanying Notes to Condensed Consolidated Financial Statements.




TENET HEALTHCARE CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

Dollars in Millions,

Except Per-Share Amounts

(Unaudited)

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30,

 

June 30,

 

 

 

2006

 

2005

 

2006

 

2005

 

Net operating revenues

 

$

2,195

 

$

2,142

 

$

4,405

 

$

4,341

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Salaries, wages and benefits

 

963

 

986

 

1,944

 

1,979

 

Supplies

 

398

 

388

 

809

 

786

 

Provision for doubtful accounts

 

128

 

140

 

249

 

294

 

Other operating expenses

 

497

 

475

 

977

 

931

 

Depreciation

 

76

 

74

 

152

 

151

 

Amortization

 

6

 

5

 

12

 

9

 

Impairment of long-lived assets and goodwill, and restructuring charges, net of insurance recoveries

 

27

 

(4

)

56

 

5

 

Hurricane insurance recoveries, net of costs

 

(13

)

 

(10

)

 

Costs of litigation and investigations

 

728

 

11

 

744

 

19

 

Loss from early extinguishment of debt

 

 

 

 

15

 

Operating income (loss)

 

(615

)

67

 

(528

)

152

 

Interest expense

 

(101

)

(102

)

(203

)

(203

)

Investment earnings

 

17

 

15

 

34

 

24

 

Minority interests

 

 

(1

)

(1

)

(1

)

Net gains on sales of investments

 

 

 

2

 

 

Loss from continuing operations, before income taxes

 

(699

)

(21

)

(696

)

(28

)

Income tax benefit

 

252

 

12

 

248

 

30

 

Income (loss) from continuing operations, before discontinued operations and cumulative effect of change in accounting principle

 

(447

)

(9

)

(448

)

2

 

Discontinued operations:

 

 

 

 

 

 

 

 

 

Loss from operations of asset group

 

(21

)

(29

)

(18

)

(58

)

Impairment of long-lived assets and goodwill, and restructuring charges, net of insurance recoveries

 

(101

)

(1

)

(76

)

(8

)

Hurricane insurance recoveries, net of costs

 

194

 

 

193

 

 

Litigation settlements, net of insurance recoveries

 

(21

)

 

24

 

 

Net gain (loss) on sales of asset group

 

(1

)

 

(1

)

22

 

Income tax (expense) benefit

 

(1

)

6

 

(4

)

5

 

Income (loss) from discontinued operations

 

49

 

(24

)

118

 

(39

)

Loss before cumulative effect of change in accounting principle

 

(398

)

(33

)

(330

)

(37

)

Cumulative effect of change in accounting principle, net of tax

 

 

 

2

 

 

Net loss

 

$

(398

)

$

(33

)

$

(328

)

$

(37

)

Earnings (loss) per common share and common equivalent share

 

 

 

 

 

 

 

 

 

Basic and Diluted

 

 

 

 

 

 

 

 

 

Continuing operations

 

$

(0.95

)

$

(0.02

)

$

(0.95

)

$

 

Discontinued operations

 

0.10

 

(0.05

)

0.25

 

(0.08

)

Cumulative effect of change in accounting principle, net of tax

 

 

 

 

 

 

 

$

(0.85

)

$

(0.07

)

$

(0.70

)

$

(0.08

)

Weighted average shares and dilutive securities outstanding (in thousands):

 

 

 

 

 

 

 

 

 

Basic

 

470,608

 

468,758

 

470,338

 

468,403

 

Diluted

 

470,608

 

468,758

 

470,338

 

469,635

 

 

See accompanying Notes to Condensed Consolidated Financial Statements.

2




TENET HEALTHCARE CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

Dollars in Millions

(Unaudited)

 

 

 

Six Months Ended
June 30,

 

 

 

2006

 

2005

 

Net loss

 

$

(328

)

$

(37

)

Adjustments to reconcile net loss to net cash provided by (used in) operating activities:

 

 

 

 

 

Depreciation and amortization

 

164

 

160

 

Provision for doubtful accounts

 

249

 

294

 

Deferred income tax benefit

 

(85

)

(38

)

Stock-based compensation charges

 

22

 

26

 

Impairment of long-lived assets and goodwill, and restructuring charges, net of insurance recoveries

 

56

 

5

 

Costs of litigation and investigations

 

744

 

19

 

Loss from early extinguishment of debt

 

 

15

 

Pre-tax (income) loss from discontinued operations

 

(122

)

44

 

Cumulative effect of change in accounting principle

 

(2

)

 

Other items

 

10

 

2

 

Increases (decreases) in cash from changes in operating assets and liabilities, net of effects from sales of facilities:

 

 

 

 

 

Accounts receivable

 

(216

)

(264

)

Inventories and other current assets

 

(39

)

(3

)

Income taxes

 

(163

)

541

 

Accounts payable, accrued expenses and other current liabilities

 

(238

)

(125

)

Other long-term liabilities

 

20

 

15

 

Payments against reserves for restructuring charges and litigation costs and settlements

 

(664

)

(42

)

Net cash provided by (used in) operating activities from discontinued operations, excluding income taxes

 

(49

)

88

 

Net cash provided by (used in) operating activities

 

(641

)

700

 

Cash flows from investing activities:

 

 

 

 

 

Purchases of property and equipment:

 

 

 

 

 

Continuing operations

 

(213

)

(209

)

Discontinued operations

 

(30

)

(15

)

Proceeds from sales of facilities, investments and other assets

 

30

 

117

 

Purchases of marketable securities

 

(6

)

(2

)

Insurance recoveries for property damage

 

36

 

8

 

Other items

 

17

 

(9

)

Net cash used in investing activities

 

(166

)

(110

)

Cash flows from financing activities:

 

 

 

 

 

Sale of new senior notes

 

 

773

 

Repurchases of senior notes

 

 

(413

)

Payments of borrowings

 

(1

)

(22

)

Proceeds from exercise of stock options

 

 

9

 

Other items

 

3

 

3

 

Net cash provided by financing activities

 

2

 

350

 

Net increase (decrease) in cash and cash equivalents

 

(805

)

940

 

Cash and cash equivalents at beginning of period

 

1,373

 

654

 

Cash and cash equivalents at end of period

 

$

568

 

$

1,594

 

Supplemental disclosures:

 

 

 

 

 

Interest paid, net of capitalized interest

 

$

(189

)

$

(161

)

Income tax refunds received (payments made), net

 

$

(3

)

$

535

 

 

See accompanying Notes to Condensed Consolidated Financial Statements.

3




TENET HEALTHCARE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1.  BASIS OF PRESENTATION

Description of Business

Tenet Healthcare Corporation (together with our subsidiaries, referred to as “Tenet,” the “Company,” “we” or “us”) is an investor-owned health care services company whose subsidiaries and affiliates (collectively, “subsidiaries”) operate general hospitals and related health care facilities, and hold investments in other companies (including health care companies). At June 30, 2006, our subsidiaries operated 70 general hospitals, including 13 hospitals not yet divested classified as discontinued operations, and two critical access hospitals with a total of 17,991 licensed beds, serving urban and rural communities in 12 states. We also owned or operated: various related health care facilities, including two rehabilitation hospitals, a long-term acute care hospital, a skilled nursing facility and a number of medical office buildings—all of which are located on, or nearby, one of our general hospital campuses; physician practices; captive insurance companies; and other ancillary health care businesses (including outpatient surgery centers, diagnostic imaging centers, and occupational and rural health care clinics).

Basis of Presentation

This quarterly report supplements our Annual Report on Form 10-K for the year ended December 31, 2005 (“Annual Report”). As permitted by the Securities and Exchange Commission (“SEC”) for interim reporting, we have omitted certain notes and disclosures that substantially duplicate those in our Annual Report. For further information, refer to the audited Consolidated Financial Statements and notes included in our Annual Report.

Certain balances in the accompanying Condensed Consolidated Financial Statements have been reclassified to conform to current year presentation or to give retrospective presentation to the discontinued operations described in Note 3.  Unless otherwise indicated, all financial and statistical information for all periods included herein relates to our continuing operations, with dollar amounts expressed in millions (except per-share amounts).

Although the Condensed Consolidated Financial Statements and related notes within this document are unaudited, we believe all adjustments considered necessary for fair presentation have been included. In preparing our financial statements in conformity with accounting principles generally accepted in the United States of America, we must use estimates and assumptions that affect the amounts reported in our Condensed Consolidated Financial Statements and accompanying notes. We regularly evaluate the accounting policies and estimates we use. In general, we base the estimates on historical experience and on assumptions that we believe to be reasonable, given the particular circumstances in which we operate. Actual results may vary from those estimates.

Operating results for the three-month and six-month periods ended June 30, 2006 are not necessarily indicative of the results that may be expected for the full fiscal year 2006. Reasons for this include, but are not limited to: overall revenue and cost trends, particularly trends in patient accounts receivable collectibility and associated provisions for doubtful accounts; the timing and magnitude of price changes; fluctuations in contractual allowances, including the impact of the discounting components of our Compact with Uninsured Patients (“Compact”) and cost report settlements and valuation allowances; managed care contract negotiations or terminations and payer consolidations; changes in Medicare regulations; Medicaid funding levels set by the states in which we operate; levels of malpractice expense and settlement trends; impairment of long-lived assets and goodwill; restructuring charges; losses, costs and insurance recoveries related to natural disasters; litigation and investigation costs; acquisitions and dispositions of facilities and other assets; income tax rates and valuation allowances; the timing and amounts of stock option and restricted stock unit grants to employees, directors and others; and changes in occupancy levels and patient volumes. Factors that affect patient volumes and, thereby, our results of operations at our hospitals and related health care facilities include, but are not limited to: the business environment of local communities; the number of uninsured and underinsured individuals in local communities treated at our hospitals; seasonal cycles of illness; climate and weather conditions; physician recruitment, retention and attrition; local health care competitors; managed care contract negotiations or terminations; unfavorable publicity, which impacts relationships with physicians and patients; and the timing of elective procedures. These considerations apply to year-to-year comparisons as well.

4




TENET HEALTHCARE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

Change in Accounting Principle

 

Effective January 1, 2006, we adopted Statement of Financial Accounting Standard (“SFAS”) No. 123(R), “Share-Based Payments,” and recorded a $2 million ($0.00 per share) credit, net of tax expense and related valuation allowance, as a cumulative effect of a change in accounting principle. See Note 6 for further information.

 

We adopted Financial Accounting Standards Board (“FASB”) Interpretation No. 47, “Accounting for Conditional Asset Retirement Obligations, an interpretation of FASB Statement No. 143,” (“FIN 47”) effective December 31, 2005 and recorded a liability of $19 million, of which $16 million was recorded as a cumulative effect of a change in accounting principle, net of tax benefit and related valuation allowance. Substantially all of the impact of adopting FIN 47 relates to estimated costs to remove asbestos that is contained within our facilities. If we had adopted FIN 47 effective January 1, 2005, it would have increased net loss for the three and six months ended June 30, 2005 by less than $0.5 million and $1 million, respectively. The impact of adopting FIN 47 on the three and six months ended June 30, 2006 was approximately $0.5 million and $1 million, respectively.

Change in Estimate

Based on updated historical cost report settlement trends and refinements to estimate such trends, the three and six months ended June 30, 2006 operating revenues include a favorable adjustment of $2 million and $16 million pre-tax, $2 million and $16 million net of tax and related valuation allowance ($0.00 per share and $0.03 per share), respectively, as a result of a change in estimate of the valuation allowances necessary for prior-year cost report periods not yet audited and settled by our fiscal intermediary. For further information on the estimation of valuation allowances for prior-year cost report periods, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Estimates—Revenue Recognition” in our Annual Report.

NOTE 2.  ACCOUNTS RECEIVABLE AND ALLOWANCE FOR DOUBTFUL ACCOUNTS

During the three and six months ended June 30, 2006, we recorded $235 million and $439 million, respectively, of discounts as contractual allowances on self-pay accounts under our Compact compared to $123 million and $256 million during the three and six months ended June 30, 2005, respectively. Prior to implementation of the Compact, a significant portion of these discounts would have been recorded as provision for doubtful accounts if the accounts were not collected. The discounts for uninsured patients were in effect at all 57 of our hospitals as of June 30, 2006, but at only 45 of our hospitals by June 30, 2005.

We also provide charity care to patients who are financially unable to pay for the health care services they receive. Most patients who qualify for charity care are charged a per diem amount for services received, subject to a cap.  Except for the per diem amounts, our policy is not to pursue collection of amounts determined to qualify as charity care; therefore, we do not report these amounts in net operating revenues or in provision for doubtful accounts. For the three and six months ended June 30, 2006, $138 million and $301 million, respectively, in charity care gross charges were excluded from net operating revenues and provision for doubtful accounts compared to $140 million and $281 million for the three and six months ended June 30, 2005, respectively.

Accounts that are pursued for collection through regional or hospital-based business offices are maintained on our hospitals’ books and reflected in patient accounts receivable with an allowance for doubtful accounts established based on their estimated net realizable value. (See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Estimates” in our Annual Report.)

5




TENET HEALTHCARE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

Accounts assigned to collection agencies (both in-house and external) are written off and excluded from patient accounts receivable and allowance for doubtful accounts; however, an estimate of future recoveries from all accounts in collection is determined based on historical experience and recorded on our hospitals’ books as a component of accounts receivable in the Condensed Consolidated Balance Sheets.

 

The principal components of accounts receivable are shown in the table below:

 

 

June 30,

 

December 31,

 

 

 

2006

 

2005

 

Continuing Operations:

 

 

 

 

 

Patient accounts receivable

 

$

1,730

 

$

1,860

 

Allowance for doubtful accounts

 

(452

)

(487

)

Estimated future recovery of accounts assigned to collection agencies

 

47

 

62

 

Net cost report settlements payable and valuation allowances

 

(26

)

(104

)

 

 

1,299

 

1,331

 

Discontinued Operations—Accounts receivable, net of allowance for doubtful accounts ($67 million at June 30, 2006 and $107 million at December 31, 2005) and net cost report settlements payable and valuation allowances ($2 million at June 30, 2006 and $15 million at December 31, 2005)

 

185

 

194

 

Accounts receivable, net

 

$

1,484

 

$

1,525

 

 

NOTE 3.  DISCONTINUED OPERATIONS

On June 29, 2006, we announced our strategic plan to divest 10 hospitals in addition to Gulf Coast Medical Center, which we sold in June 2006, and Alvarado Hospital Medical Center, which we agreed to sell or close as part of our settlement with the U.S. Attorney in San Diego, as discussed in Note 10. The 10 hospitals to be divested include four in Louisiana and three each in Pennsylvania and Florida. We have classified the results of operations of all 12 hospitals as discontinued operations for all periods presented in accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (“SFAS 144”).

In January 2004, we announced a major restructuring of our operations involving the proposed divestiture of 27 general hospitals (19 in California and eight others in Louisiana, Massachusetts, Missouri and Texas). As of June 30, 2006, we had completed the divestiture of 25 of the 27 facilities. Discussions and negotiations with potential buyers for the remaining two hospitals slated for divestiture were ongoing as of June 30, 2006. We have classified the results of operations of these hospitals and certain other prior period divestitures (see Note 5 to the Consolidated Financial Statements in our Annual Report) as discontinued operations for all periods presented in the accompanying Condensed Consolidated Statements of Operations in accordance with SFAS 144.

 

At June 30, 2006 and December 31, 2005, we classified $303 million and $6 million, respectively, of assets of the 13 and two hospitals then-currently held for sale and certain hospitals previously sold as “assets held for sale” in the accompanying Condensed Consolidated Balance Sheets. These assets consist primarily of property and equipment and were recorded at the lower of the asset’s carrying amount or its fair value less costs to sell. The fair value estimates were derived from independent appraisals, established market values of comparable assets, or internal estimates of future net cash flows. These fair value estimates can change by material amounts in subsequent periods.  Many factors and assumptions can impact the estimates, including the future financial results of these hospitals and how they are operated by us until they are divested, changes in health care industry trends and regulations until the hospitals are divested, and whether we ultimately divest the hospital assets to buyers who will continue to operate the assets as general hospitals or utilize the assets for other purposes. Because we do not intend to sell the accounts receivable of the asset group (except in the case of one hospital), these receivables, less the related allowance for doubtful accounts and net cost report settlements payable and valuation allowances, are included in our consolidated net accounts receivable in the accompanying Condensed Consolidated Balance Sheets. At June 30, 2006 and December 31, 2005, the accounts receivable, net of allowance for doubtful accounts and cost report settlements payable and valuation allowances, for the 13 hospitals currently held for sale and certain hospitals previously sold was $185 million and $194 million, respectively.

We recorded $76 million of impairment and restructuring charges in discontinued operations during the six months ended June 30, 2006 consisting primarily of $126 million for the write-down of long-lived assets to their estimated fair values, less estimated costs to sell, $12 million in goodwill impairment, $2 million for employee severance and retention costs, and

6




TENET HEALTHCARE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

$1 million in lease termination and other costs, offset by $65 million in insurance recoveries related to Hurricane Katrina property claims. The total impairment charges include $123 million of charges related to our announced disposition of 10 hospitals in June 2006.

In addition to the $65 million in insurance recoveries recorded as a reduction to the impairment charges in discontinued operations, we also recorded $193 million of insurance recoveries in the three months ended June 30, 2006 related to the disruption of our discontinued operations by Hurricane Katrina. The $193 million is included in hurricane insurance recoveries, net of costs, in the accompanying Condensed Consolidated Statements of Operations.  See Note 9 for additional information.

We recorded $8 million of impairment and restructuring charges in discontinued operations during the six months ended June 30, 2005 consisting primarily of $2 million for the write-down of long-lived assets, $9 million in employee severance and retention costs, and a $3 million reduction in reserves recorded in prior periods.

In December 2004, we agreed to pay $395 million to settle substantially all of the patient litigation against us and our subsidiaries arising out of allegations that medically unnecessary cardiac procedures were performed at Redding Medical Center, and we recorded a charge for that amount in discontinued operations. We sought recovery under our excess professional and general liability insurance policies for up to the $275 million aggregate limit of our insurance policies that covered such claims. Our three insurance carriers raised coverage defenses and refused to pay under these policies. In January 2005, we filed for arbitration against each of the three carriers to resolve the dispute. However, we recently reached a settlement with one of the excess carriers in the amount of $45 million, which we recorded as an insurance recovery in the quarter ended March 31, 2006 and collected in July 2006. This insurance recovery reduces the total remaining excess limits available under our excess policies to $230 million (including up to a maximum of $200 million for the Redding claims) for all occurrences prior to June 1, 2003.  We continue to pursue recovery from the other two carriers under these excess policies up to a maximum of $200 million for the Redding claims. We currently maintain other excess liability insurance policies having a maximum aggregate coverage limit of $275 million for occurrences from June 1, 2003 through May 31, 2007.

In addition to the $45 million insurance recovery related to Redding Medical Center, we recorded a $21 million charge during the quarter ended June 30, 2006 related to the civil settlement for Alvarado Hospital Medical Center.  This charge is reflected in litigation settlements, net of insurance recoveries, in discontinued operations in the accompanying Condensed Consolidated Statements of Operations.

Net operating revenues and income (loss) before taxes reported in discontinued operations for the three and six months ended June 30, 2006 and 2005 are as follows:

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2006

 

2005

 

2006

 

2005

 

Net operating revenues

 

$

251

 

$

348

 

$

521

 

$

806

 

Income (loss) before taxes

 

50

 

(30

)

122

 

(44

)

 

As we move forward with our previously announced divestiture plans, we may incur additional asset impairment and restructuring charges in future periods.

NOTE 4.  IMPAIRMENT AND RESTRUCTURING CHARGES

During the six months ended June 30, 2006, we recorded net impairment and restructuring charges of $56 million. Prior to our decision to divest five of our six hospitals in Louisiana, we recorded a $35 million goodwill impairment related to the formation of our NOLA Regional Health Network, which consisted of those six hospitals that were previously a part of our Texas-Gulf Coast Region, primarily due to the adverse current and anticipated future financial trends of those six hospitals. In addition, we had a $28 million write-down of long-lived assets to their estimated fair values, primarily due to the adverse current and anticipated future financial trends at one of our hospitals, in accordance with SFAS 144, offset by $3 million of insurance recoveries for property damage caused by Hurricane Katrina. The fair value estimates were derived from independent appraisals, established market values of comparable assets, or internal estimates of future net cash flows. These fair value estimates can change by material amounts in subsequent periods. Many factors and assumptions can impact the estimates, including the future financial results of these hospitals, how the hospitals are operated by us in the future, changes in health care industry trends and regulations, and the nature of the ultimate disposition of the assets. In addition, approximately $1 million in employee severance and related costs and $2 million in lease termination costs were

7




TENET HEALTHCARE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

recorded as restructuring charges during the six months ended June 30, 2006, offset by a $7 million reduction in restructuring reserves recorded in prior periods.  During the six months ended June 30, 2005, we recorded impairment and restructuring charges of $5 million consisting of $8 million in employee severance, benefits and relocation costs, $2 million of lease termination costs, $3 million of asset impairment charges and $4 million in non-cash stock option modification costs related to terminated employees, offset by a $12 million reduction primarily in restructuring reserves recorded in prior periods.

In the second quarter of 2006, we announced several changes to our operating structure. Previously, our four operating regions were: (1) California, which included all of our hospitals in California, as well as our hospital in Nebraska; (2) Central Northeast-Southern States, which included all of our hospitals in Georgia, Missouri, North Carolina, Pennsylvania, South Carolina and Tennessee; (3) Florida-Alabama, which included all of our hospitals in Florida, as well as our hospital in Alabama; and (4) Texas-Gulf Coast, which included all of our hospitals in Louisiana and Texas, as well as Gulf Coast Medical Center in Mississippi. As of June 30, 2006, our operations are now structured as follows:

·                  Our California region continues to include all of our hospitals in California and Nebraska;

·                  Our new Central-Northeast region includes all of our hospitals in Missouri, Pennsylvania and Tennessee;

·                  Our new Southern States region includes all of our hospitals in Alabama, Georgia, Louisiana, North Carolina and South Carolina;

·                  Our new Texas region includes all of our hospitals in Texas; and

·                  Our Florida hospitals are split into two separately managed networks:

·                  Miami-Dade/Broward Network, which includes our five hospitals in Miami-Dade and Broward counties; and

·                  Palm Beach Health Network, which includes our six hospitals in Palm Beach County.

All of our regions and the networks described above report directly to our chief operating officer. Because of the restructuring of our regions, our goodwill reporting units (as defined in SFAS No. 142, “Goodwill and Other Intangible Assets”) changed in the second quarter of 2006, requiring us to perform a goodwill impairment evaluation. Based on this evaluation, we recorded a goodwill impairment charge of approximately $35 million during the quarter ended June 30, 2006 related to the formation of our NOLA Regional Health Network, which was subsequently restructured. The other changes to our reporting units did not result in goodwill impairment charges. However, based on future financial trends and the possible impact of negative trends on our future outlook, further impairments of long-lived assets and goodwill may occur, and we will incur additional restructuring charges. Future restructuring of our operating structure that changes our goodwill reporting units could result in further impairments of our goodwill.

The table below is a reconciliation of beginning and ending liability balances in connection with restructuring charges recorded during the six months ended June 30, 2006 in continuing and discontinued operations:

 

 

Balances at
Beginning of
Period

 

Restructuring
Charges, Net

 

Cash
Payments

 

Balances
at End
of Period

 

Six months ended June 30, 2006

 

 

 

 

 

 

 

 

 

Continuing operations:

 

 

 

 

 

 

 

 

 

Severance costs in connection with hospital cost-control programs and general overhead-reduction plans

 

$

43

 

$

(4

)

$

(13

)

$

26

 

Discontinued operations:

 

 

 

 

 

 

 

 

 

Lease cancellations and estimated costs associated with the sale or closure of hospitals and other facilities

 

22

 

3

 

(11

)

14

 

 

 

$

65

 

$

(1

)

$

(24

)

$

40

 

 

The above liability balances are included in other current liabilities and other long-term liabilities in the accompanying Condensed Consolidated Balance Sheets. Cash payments to be applied against these accruals at June 30, 2006 are expected to be approximately $9 million in the remainder of 2006 and $31 million thereafter.

8




TENET HEALTHCARE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 5.  LONG-TERM DEBT, LEASE OBLIGATIONS AND GUARANTEES

The table below shows our long-term debt as of June 30, 2006 and December 31, 2005:

 

 

June 30,

 

December 31,

 

 

 

2006

 

2005

 

Senior notes:

 

 

 

 

 

6 3¤8%, due 2011

 

$

1,000

 

$

1,000

 

6 1¤2%, due 2012

 

600

 

600

 

7 3¤8%, due 2013

 

1,000

 

1,000

 

9 7¤8%, due 2014

 

1,000

 

1,000

 

9 1¤4%, due 2015

 

800

 

800

 

6 7¤8%, due 2031

 

450

 

450

 

Notes payable and capital lease obligations, secured by property and equipment, payable in installments to 2013 (1)

 

57

 

58

 

Unamortized note discounts

 

(101

)

(105

)

Total long-term debt

 

4,806

 

4,803

 

Less current portion

 

19

 

19

 

Long-term debt, net of current portion

 

$

4,787

 

$

4,784

 

 


(1)               Includes $11 million at June 30, 2006 and $12 million at December 31, 2005 related to general hospitals held for sale (see Note 3).

Senior Notes

On July 11, 2006, we filed an amended Form S-4 registration statement with the SEC to register $800 million principal amount of 9 1¤4% Senior Notes due 2015 to be issued and offered in exchange for the $800 million principal amount of unregistered 9 1¤4% Senior Notes due 2015 sold in January 2005.  The registration statement was declared effective on July 12, 2006, which ended the accrual period for additional interest on the unregistered senior notes. The additional interest of approximately $1.4 million was paid in full with the regular semi-annual interest payment on August 1, 2006.  The terms of the registered senior notes are substantially similar to the terms of the unregistered senior notes. The covenants governing the new issue are identical to the covenants for our other senior notes.

Covenants

Our letter of credit facility or the indentures governing our senior notes contain covenants and conditions that have, among other requirements, limitations on (1) liens, (2) consolidations, merger or the sale of all or substantially all assets unless no event of default exists, (3) subsidiary debt and (4) prepayment of debt.

Physician Relocation Agreements and Other Minimum Revenue Guarantees

Consistent with our policy on physician relocation and recruitment, we provide income guarantee agreements to certain physicians who agree to relocate to our communities to fill a need in the hospital’s service area and commit to remain in practice there. Under such agreements, we are required to make payments to the physicians in excess of the amounts they earn in their practice up to the amount of the income guarantee. The income guarantee periods are typically 12 months. Such payments are recoverable from the physicians if they do not fulfill their commitment period to the community, which is typically three years. We also provide minimum revenue collection guarantees to hospital-based physician groups providing certain services at our hospitals with terms generally ranging from one to three years. At June 30, 2006, the maximum potential amount of future payments under these guarantees was $60 million. In accordance with FASB Staff Position FIN 45-3, “Application of FASB Interpretation No. 45 to Minimum Revenue Guarantees Granted to a Business or Its Owners,” at June 30, 2006, we had a liability of $23 million for the fair value of new or modified guarantees entered into during the six month period ended June 30, 2006, with an offsetting asset recorded in other current assets on our Condensed Consolidated Balance Sheet, which will be amortized over the commitment period.

9




TENET HEALTHCARE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 6.  STOCK BENEFIT PLANS

At June 30, 2006, there were approximately 19.3 million shares of common stock available under our 2001 Stock Incentive Plan for future stock option grants and other incentive awards, including restricted stock units. Options have an exercise price equal to the fair market value of the shares on the date of grant and generally expire 10 years from the date of grant. A restricted stock unit is a contractual right to receive one share of our common stock in the future.  Options and restricted stock units typically vest one-third on each of the first three anniversary dates of the grant.

Effective January 1, 2006, we adopted SFAS No. 123(R), “Share-Based Payments” (“SFAS 123(R)”), using the modified prospective application transition method. Prior to 2006, we used the Black-Scholes option-pricing model to estimate the grant date fair value of stock option awards.  For grants subsequent to the adoption of SFAS 123(R), we estimate the fair value of awards on the date of grant using a binomial lattice model.  We believe that the binomial lattice model is a more appropriate model for valuing employee stock awards because it better reflects the impact of stock price changes on option exercise behavior. As a result of adopting SFAS 123(R) during the three months ended March 31, 2006, we recorded a $2 million credit as a cumulative effect of a change in accounting principle, net of income tax expense and related valuation allowance.  This adjustment related to the requirement under SFAS 123(R) to estimate the amount of stock-based awards expected to be forfeited rather than recognizing the effect of forfeitures only as they occur.

Prior to our adoption of SFAS 123(R), benefits of tax deductions in excess of recognized compensation costs were reported as operating cash flows.  SFAS 123(R) requires excess tax benefits be reported as a financing cash inflow.  We have not recognized any excess tax benefits during 2006.  During the six months ended June 30, 2005, there were no excess tax benefits recognized.

Our income from continuing operations for the six months ended June 30, 2006 includes $22 million pre-tax of compensation costs related to our stock-based compensation arrangements ($14 million after-tax, excluding the impact of the deferred tax valuation allowance). Our income from continuing operations for the six months ended June 30, 2005 included $30 million pre-tax of compensation costs (including $4 million in non-cash stock option modification costs related to terminated employees classified as restructuring charges) related to our stock-based compensation arrangements ($18 million after-tax, excluding the impact of the deferred tax valuation allowance).

Stock Options

The following table summarizes stock option activity during the six months ended June 30, 2006:

 

 

Options

 

Weighted
Average
Exercise
Price
Per
Share

 

Aggregate
Intrinsic
Value

 

Weighted
Average
Remaining
Life

 

 

 

 

 

 

 

 

 

 

 

Outstanding as of December 31, 2005

 

39,964,022

 

$

20.92

 

 

 

 

 

Granted

 

2,914,409

 

7.92

 

 

 

 

 

Exercised

 

 

 

 

 

 

 

Forfeited/Expired

 

(3,288,376

)

16.20

 

 

 

 

 

Outstanding as of June 30, 2006

 

39,590,055

 

$

20.35

 

$

 

5.2 years

 

Vested and expected to vest at June 30, 2006

 

39,173,510

 

$

20.47

 

$

 

5.7 years

 

Exercisable as of June 30, 2006

 

31,939,172

 

$

22.84

 

$

 

4.3 years

 

 

There were no options exercised during the six months ended June 30, 2006. The intrinsic value of options exercised during the six months ended June 30, 2005 totaled approximately $1 million.

As of June 30, 2006, there were $22 million of total unrecognized compensation costs related to stock options.  These costs are expected to be recognized over a weighted average period of two years.

10




TENET HEALTHCARE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

The weighted average estimated fair value of options we granted in the six months ended June 30, 2006 was $3.15 per share and was calculated based on each grant date, using a binomial lattice model with the following assumptions:

 

 

Top Four
Employees

 

All Other
Employees

 

 

 

 

 

 

 

Expected volatility

 

41%

 

41%

 

Expected dividend yield

 

0%

 

0%

 

Expected life

 

6.25 years

 

4 years

 

Expected forfeiture rate

 

0%

 

15%

 

Risk-free interest rate range

 

4.47% - 5.04%

 

4.47% - 5.04%

 

Early exercise threshold

 

50% gain

 

50% gain

 

Early exercise rate

 

50% per year

 

50% per year

 

 

The expected volatility used in the binomial lattice model incorporates historical and implied share-price volatility and is based on an analysis of historical prices of our stock and open market exchanged options, and was developed in consultation with an outside valuation specialist.  The expected volatility reflects the historical volatility for a duration consistent with the contractual life of the options, and the volatility implied by the trading of options to purchase our stock on open-market exchanges.  The historical share-price volatility excludes the movements in our stock price during the period October 1, 2002 through December 31, 2002 due to the extreme volatility of our stock price during this time period.  The expected life of options granted is derived from the output of the binomial lattice model, and represents the period of time that the options are expected to be outstanding for the distinct group of employees.  This model incorporates an early exercise assumption in the event of a significant increase in stock price.  The risk-free interest rates are based on zero-coupon United States Treasury yields in effect at the date of grant consistent with the expected exercise timeframes.

The following table summarizes information about our outstanding stock options at June 30, 2006:

 

 

Options Outstanding

 

Options Exercisable

 

Range of Exercise Prices

 

Number of
Options

 

Weighted Average
Remaining
Contractual Life

 

Weighted Average
Exercise Price

 

Number of
Options

 

Weighted Average
Exercise Price

 

$0.00 to $10.639

 

7,926,476

 

8.9 years

 

$

9.53

 

1,789,955

 

$

10.34

 

$10.64 to $13.959

 

6,897,363

 

5.5 years

 

11.82

 

5,671,336

 

11.78

 

$13.96 to $17.589

 

7,040,525

 

4.6 years

 

17.23

 

6,752,190

 

17.32

 

$17.59 to $28.759

 

9,076,605

 

2.9 years

 

23.69

 

9,076,605

 

23.69

 

$28.76 and over

 

8,649,086

 

4.4 years

 

36.10

 

8,649,086

 

36.10

 

 

 

39,590,055

 

5.2 years

 

$

20.35

 

31,939,172

 

$

22.84

 

 

The weighted average estimated fair value of options we granted in the six months ended June 30, 2005 was $3.92 per share and was calculated based on each grant date, using a Black-Scholes option-pricing model with the following assumptions:

 

All Employees

 

Expected volatility

 

40%

 

Expected dividend yield

 

0%

 

Expected life

 

4.2 years

 

Risk-free interest rate

 

3.7%

 

 

Expected volatility was derived using daily data drawn from five to seven years preceding the date of grant.  The risk-free interest rate is based on the approximate yield on five-year and seven-year United States Treasury Bonds as of the date of grant.  The expected lives are estimates of the number of years the options will be held before they are exercised.  The valuation model was not adjusted for non-transferability, risk of forfeiture or the vesting restrictions of the options, all of which would reduce the value if factored into the calculation.

11




TENET HEALTHCARE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

Restricted Stock Units

The following table summarizes restricted stock unit activity during the six months ended June 30, 2006:

 

 

Restricted Stock
Units

 

Weighted Average Grant
Date Fair Value Per Unit

 

 

 

 

 

 

 

Unvested as of December 31, 2005

 

4,916,677

 

$

10.74

 

Granted

 

4,466,377

 

7.90

 

Vested

 

(835,884

)

7.56

 

Forfeited

 

(356,017

)

10.68

 

Unvested as of June 30, 2006

 

8,191,153

 

$

9.52

 

 

As of June 30, 2006, there were $54 million of total unrecognized compensation costs related to restricted stock units. These costs are expected to be recognized over a weighted average period of two years.

Restricted Stock

In January 2003, we issued 200,000 shares of restricted stock to Trevor Fetter.  The stock vests on the second, third and fourth anniversary dates of the grant provided that Mr. Fetter is still employed by us and continues to hold 100,000 shares of our common stock purchased by him as a condition of the issuance of the restricted stock.

The following table summarizes restricted stock activity during the six months ended June 30, 2006:

 

Shares

 

Weighted
Average
Grant Date
Fair Value
Per Share

 

 

 

 

 

 

 

Unvested as of December 31, 2005

 

133,333

 

$

18.64

 

Granted

 

 

 

Vested

 

(66,666

)

18.64

 

Forfeited

 

 

 

Unvested as of June 30, 2006

 

66,667

 

$

18.64

 

 

As of June 30, 2006, there were $0.7 million of total unrecognized compensation costs related to restricted stock. These costs are expected to be recognized through January 2007.

NOTE 7.  SHAREHOLDERS’ EQUITY

The following table shows the changes in consolidated shareholders’ equity during the six months ended June 30, 2006 (dollars in millions, shares in thousands):

 

 

Shares
Outstanding

 

Issued
Par
Amount

 

Additional
Paid
-
in
Capital

 

Other
Comprehensive
Loss

 

Accumulated
Deficit

 

Treasury
Stock

 

Total
Shareholders’
Equity

 

Balances at December 31, 2005

 

469,710

 

$

26

 

$

4,320

 

$

(39

)

$

(1,807

)

$

(1,479

)

$

1,021

 

Net loss

 

 

 

 

 

(328

)

 

(328

)

Other comprehensive loss

 

 

 

 

(1

)

 

 

(1

)

Issuance of common stock

 

944

 

 

1

 

 

 

 

1

 

Subsidiary stock option repurchase

 

 

 

(6

)

 

 

 

(6

)

Stock-based compensation expense

 

 

 

20

 

 

 

 

20

 

Balances at June 30, 2006

 

470,654

 

$

26

 

$

4,335

 

$

(40

)

$

(2,135

)

$

(1,479

)

$

707

 

 

As a result of the repurchase by Broadlane, Inc., a company in which we currently hold a 49% interest, of some of its outstanding common stock and stock options, during the quarter ended June 30, 2006 we recorded a $6 million reduction

12




TENET HEALTHCARE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

of additional paid-in capital related to the stock option repurchase, and a $9 million asset classified as investments and other assets related to the common stock repurchase.

NOTE 8.  OTHER COMPREHENSIVE INCOME (LOSS)

The table below shows each component of other comprehensive income (loss) for the three and six months ended June 30, 2006 and 2005:

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30,

 

June 30,

 

 

 

2006

 

2005

 

2006

 

2005

 

Net loss

 

$

(398

)

$

(33

)

$

(328

)

$

(37

)

Other comprehensive income (loss):

 

 

 

 

 

 

 

 

 

Unrealized gains on securities held as available-for-sale

 

 

1

 

 

 

Reclassification adjustments for realized (gains) losses included in net loss

 

 

 

(1

)

1

 

Income tax (expense) benefit related to items of other comprehensive income (loss)

 

 

 

 

 

Other comprehensive income (loss)

 

 

1

 

(1

)

1

 

Comprehensive loss

 

$

(398

)

$

(32

)

$

(329

)

$

(36

)

 

NOTE 9.  PROPERTY AND PROFESSIONAL AND GENERAL LIABILITY INSURANCE

Property Insurance

On July 6, 2006, we announced a settlement totaling $340 million had been reached with our property insurers regarding claims related to the physical damage and business interruption we sustained as a result of Hurricane Katrina. Subsequent to the quarter, on July 5, 2006, we received $240 million, which is reflected in receivable for insurance recoveries in our Condensed Consolidated Balance Sheet at June 30, 2006, in addition to the $100 million previously recorded, in full resolution of our claims. Of the $100 million recorded earlier, $64 million was recorded in the quarter ended December 31, 2005 and $36 million was recorded in the quarter ended March 31, 2006, both as an offset to property damage recorded in impairment of long-lived assets, now in discontinued operations.  The $240 million of additional insurance recoveries was recorded in the quarter ended June 30, 2006 as an offset to impairment of long-lived assets in continuing operations in the amount of $3 million, and in discontinued operations in the amount of $28 million, representing recovery of property damage. The remaining $209 million was recorded as an offset to hurricane costs in the amount of $16 million in continuing operations and $193 million in discontinued operations, representing business interruption and other cost recoveries.

We have property, business interruption and related insurance coverage to mitigate the financial impact of catastrophic events or perils that is subject to deductible provisions based on the terms of the policies. These policies are on an occurrence basis. For the policy period April 1, 2005 through March 31, 2006, our policies provided up to $1 billion in coverage per occurrence and were subject to deductible provisions, exclusions and limits.  Deductibles were 2% of insured values for windstorms, 5% for floods and earthquakes, and $1 million for fires and other perils. One sub-limit, totaling $250 million per occurrence and in the aggregate, related to flood losses as defined in the insurance policies. For California earthquakes, there was, in general, a $100 million aggregate sub-limit under the policies.

Under the policies in effect for the period April 1, 2006 through March 31, 2007, we currently have coverage totaling $600 million per occurrence, after deductibles and exclusions, with annual aggregate sub-limits of $100 million each for windstorms, floods and earthquakes.  The new program also has an increased deductible for wind-related claims of 5% of insured values. If our limits are exhausted during the policy period, we may be able to reinstate, in certain situations, windstorm coverage for additional premiums with certain of our carriers.  With respect to fires and other perils, excluding windstorms, floods and earthquakes, the total $600 million limit of coverage per occurrence applies. Deductibles are 5% of insured values for windstorms, California earthquakes and floods, 2% of insured values for New Madrid fault earthquakes, and $1 million for fires and other perils.

 

Professional and General Liability Insurance

At June 30, 2006, the current and long-term professional and general liability reserves on our Condensed Consolidated Balance Sheet were approximately $729 million. These reserves include the reserves recorded by our captive

13




TENET HEALTHCARE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

insurance subsidiaries and self-insured retention reserves based on actuarial estimates for the portion of our professional and general liability risks, including incurred but not reported claims, for which we do not have insurance coverage. We estimated the reserves for losses and related expenses using expected loss-reporting patterns discounted to their present value under a risk-free rate approach using a Federal Reserve seven-year maturity composite rate of 4.5% and 4.0% at June 30, 2006 and 2005, respectively.

For the policy period June 1, 2006 through May 31, 2007, our hospitals’ generally have a self-insurance retention per occurrence of $2 million for losses incurred during this policy period. Our captive insurance company, The Healthcare Insurance Corporation, has a self-insured retention of $13 million per occurrence. The next $10 million of claims in excess of $15 million are 100% reinsured by The Healthcare Insurance Corporation with independent reinsurance companies. Claims in excess of $25 million are covered by our excess professional and general liability insurance policies from major independent insurance companies, on a claims-made basis, subject to an aggregate limit of $275 million.

 

Included in other operating expenses in the accompanying Condensed Consolidated Statements of Operations is malpractice expense of $49 million and $58 million for the three months ended June 30, 2006 and 2005, respectively, and $92 million and $102 million for the six months ended June 30, 2006 and 2005, respectively.

NOTE 10.  CLAIMS AND LAWSUITS

During the past several years, we have been subject to a significant number of claims and lawsuits. Also during the past several years, we became the subject of federal and state agencies’ civil and criminal investigations and enforcement efforts, and received subpoenas and other requests from those agencies for information relating to a variety of subjects. Some of these matters were resolved in 2005 and 2004, and many of them have recently been resolved, as described below and in our Annual Report. Our recent settlements include the following:

1.                                       Global Civil Settlement with the United States of America—On June 28, 2006, we, on behalf of our predecessors and current and former affiliates, divisions, and direct and indirect subsidiaries, along with several specified subsidiaries and 165 hospitals, entered into a Civil Settlement Agreement with the United States of America. The settlement concludes several previously disclosed governmental investigations, including: (a) an inquiry by the U.S. Attorney’s Office for the Central District of California into our receipt of certain Medicare outlier payments prior to 2003; (b) investigations by U.S. Attorneys in Los Angeles and San Francisco, California, El Paso, Texas, New Orleans, Louisiana, St. Louis, Missouri and Memphis, Tennessee into physician financial relationships; (c) an inquiry by the U.S. Attorney’s Office in New Orleans into services provided by Peoples Health Network, an unconsolidated New Orleans health plan management services provider in which one of our subsidiaries holds a 50% membership interest; and (d) an investigation by the U.S. Attorney’s Office for the Central District of California into coding, billing and cost reporting relating to the Comprehensive Cancer Center at our Desert Regional Medical Center in Palm Springs, California. The settlement also brings to a close civil litigation regarding Medicare coding that the U.S. Department of Justice (“DOJ”) first filed against the Company in January 2003 and various sealed qui tam, or whistleblower, actions brought by private citizens on behalf of the government concerning allegedly excessive or inappropriate claims to government health care programs, including Medicare. Although we specifically deny the allegations outlined by the government in the Civil Settlement Agreement, we agreed to reach a full and final settlement as described in the agreement to avoid the delay, uncertainty, inconvenience and expense of protracted litigation.

Under the Civil Settlement Agreement, we agreed to pay to the United States: (a) $450 million, plus interest accruing at a simple rate of 4.125% from November 1, 2005, within 10 days after the effective date of the settlement agreement; and (b) $275 million, plus interest accruing at a simple rate of 4.125% from November 1, 2005, in quarterly installments from November 1, 2007 through August 1, 2010. We recorded a charge of $711 million for the settlement in the three months ended June 30, 2006, reflecting the payments described above ($725 million), plus interest ($20 million), that were in excess of an accrual of $34 million recorded in a prior period. In addition, we agreed to waive, and not assert any claim for, certain Medicare disproportionate share and outlier payments to which we may be entitled from government health care programs, which payments are valued by the government at $175 million. We had not recorded these payments pending resolution of various issues and the uncertainty that the payments would ever be received.

We further agreed to continue to cooperate with the government in connection with any investigation the government may pursue into the actions of individuals, including former executive officers and employees of the Company, relating to the matters described in the Civil Settlement Agreement. The government has agreed that if it pursues

14




TENET HEALTHCARE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

claims that result in judgments against or settlements with any individuals in connection with matters covered by the settlement agreement, and a court determines that the individuals are entitled by law to indemnification from the Company or its subsidiaries for all or any portion of those judgment or settlement amounts, then the government will seek to recover from the individuals only those amounts that, in the aggregate, total no more than $75 million.

2.                                       Settlement of Criminal Case Concerning Physician Relationships—On May 17, 2006, we announced that we had reached a civil settlement with the U.S. Attorney for the Southern District of California to resolve the criminal case against Alvarado Hospital Medical Center, Inc. and Tenet HealthSystem Hospitals, Inc. (both Tenet subsidiaries). In two separate trials, both of which ended in mistrials, the government alleged that the defendants made illegal use of physician relocation, recruitment and consulting agreements. As part of the civil settlement, we denied the government’s allegations. We agreed to the civil settlement, which included a payment of $21 million to resolve potential civil claims by the government, to avert a third criminal trial, as well as potential civil liabilities that could have resulted. We recorded the payment as a charge in discontinued operations in the three months ended June 30, 2006. In order to conclude the settlement, we agreed to the demand of the Office of Inspector General of the U.S. Department of Health and Human Services to sell or close Alvarado Hospital Medical Center by February 5, 2007 or have the hospital face exclusion from federal health care programs.

3.                                       Settlement of Securities Class Action Lawsuit and State Shareholder Derivative Litigation—On January 12, 2006, we announced that we had reached agreements in principle to settle the federal securities class action lawsuit and shareholder derivative litigation entitled In Re Tenet Healthcare Corporation Securities Litigation and In Re Tenet Healthcare Corporation Derivative Litigation, which were pending in U.S. District Court in Los Angeles and California Superior Court in Santa Barbara, respectively. The Company agreed to settled the securities class action for $215 million in cash and, in March 2006, we paid $140 million (which we recorded as a charge in the three months ended December 31, 2005) toward that amount; our insurance for directors and officers contributed the remaining $75 million. All funds will be disbursed to certain purchasers of Tenet securities according to a distribution plan approved by the federal court. On May 26, 2006, we received final court approval of the settlement. Also in March 2006, we paid a $5 million award of attorneys’ fees in connection with the settlement of the shareholder derivative litigation, which we recorded as a charge during the three months ended March 31, 2006. The shareholder derivative settlement received final court approval on May 4, 2006; however, a notice of appeal of the settlement was filed on July 6, 2006.

4.                                       Settlement of Pricing Litigation— On March 10, 2005, we announced the settlement of a pricing case in California that is nationwide in effect and, on August 8, 2005, we received final court approval of the settlement. Plaintiffs had alleged, on behalf of themselves and a purported class consisting of certain uninsured, self-insured and Medicare patients, that they had paid excessive or unfair prices for prescription drugs or medical products or procedures at hospitals or other medical facilities owned by us or our subsidiaries. The settlement has two primary components: (a) injunctive relief governing our conduct prospectively for a period of four years; and (b) retrospective relief, including restitution and discounting of outstanding unpaid bills, for covered patients who were treated at our hospitals during the settlement class period (June 15, 1999 to December 31, 2004). We have also agreed to make a $4 million charitable contribution to a health-care-related charity specified by plaintiffs’ counsel. As part of the settlement, we have made no admission of wrongdoing, and we continue to deny the allegations made by plaintiffs in these actions. A notice of appeal of the judgment approving the settlement was filed in the California Court of Appeal by objectors to the settlement. However, the objectors subsequently agreed to withdraw their notice of appeal, and the appeal was dismissed in late June 2006. The nationwide settlement is now effective. In addition to the California coordinated cases, similar class actions were filed in Tennessee, Louisiana, Florida, South Carolina, Pennsylvania, Texas, Missouri and Alabama. Some of these actions were dismissed following final approval of the nationwide settlement in the California action. Subsequently, we reached an agreement in principle with the plaintiffs in the South Carolina actions, who had appealed the nationwide settlement, to settle their cases. Now that the appeal has been dismissed and the nationwide settlement is effective, we expect the remaining actions to be dismissed to the extent that the claims in those cases fall within the scope of the release provided in the settlement. At June 30, 2006, we had an accrual of $23 million as an estimated liability to address the resolution of the pricing litigation.

Currently pending legal proceedings and investigations that are not in the ordinary course of business are set forth below. Where specific amounts are sought in any pending legal proceeding, those amounts are disclosed. For all other matters, where the possible loss or range of loss is reasonably estimable, an estimate is provided. Where no estimate is provided, the possible amount of loss is not reasonably estimable at this time.

 

15




TENET HEALTHCARE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1.                                       Texas Qui Tam Action—We are defending a qui tam action in Texas that alleges violations of the federal False Claims Act by our hospitals in El Paso arising out of: (a) alleged violations of the federal anti-kickback statute in connection with certain unspecified financial arrangements with physicians; and (b) the alleged manipulation of the hospitals’ charges in order to increase outlier payments.  The DOJ has filed a statement of interest joining our motion to dismiss this matter.

2.                                       Civil RICO Case—We have been named as a defendant in a civil case in federal district court in Miami filed as a purported class action by Boca Raton Community Hospital, principally alleging that Tenet’s past pricing policies and receipt of Medicare outlier payments violated the federal Racketeer Influenced and Corrupt Organizations (RICO) Act, causing harm to the plaintiffs.

3.                                       Brockovich Lawsuit—Plaintiff Erin Brockovich, purportedly on behalf of the United States of America, filed a civil complaint in Los Angeles Superior Court on June 2, 2006, alleging that we inappropriately received reimbursement from Medicare for treatment given to patients whose injuries were caused as a result of medical error or neglect. Plaintiff is seeking damages of twice the amount that defendants were allegedly obligated to pay or reimburse Medicare in connection with the treatment in question, plus interest, together with plaintiff’s costs and fees, including attorneys’ fees.

4.                                       Shareholder Derivative Actions and Securities Matter—A consolidated shareholder derivative action is pending in federal district court in California against certain current and former members of our board of directors and former members of senior management. The Company is also named as a nominal defendant. The shareholder plaintiffs allege various causes of action on behalf of Tenet and for our benefit, including breach of fiduciary duty, insider trading and other causes of action. We anticipate that this matter will be dismissed now that the state court in Santa Barbara has approved the settlement of the state derivative litigation, as described above.

In addition, on May 26, 2006, a purported Tenet shareholder filed a derivative action against certain law firms and individual attorneys who represented shareholders in the now-settled California state derivative litigation, current and former directors and executive officers of Tenet, and the law firm and individual attorneys who represented Tenet in the state derivative litigation and currently represent the Company in the above-described federal derivative litigation. The complaint alleged that defendants breached their fiduciary duty to Tenet in connection with the settlement of the state derivative action. Plaintiff sought unspecified damages, punitive damages, costs and attorneys’ fees. On August 4, 2006, the matter was dismissed without prejudice pursuant to the stipulation of the parties. In that stipulation, plaintiff indicated that he will immediately file a compliant containing virtually identical claims against largely the same defendants in California state court.

On June 6, 2006, four purported Tenet shareholders who opted out of the settlement of the federal securities class action lawsuit described above filed a civil complaint in federal court in California against the Company, certain former officers of the Company and KPMG LLP (“KPMG”), the Company’s independent registered public accounting firm. Plaintiffs allege that the Company, KMPG and certain former executives are liable for securities fraud under Section 10(b) of and Rule 10b-5 under the Securities Exchange Act of 1934, and that each of the former executive defendants are liable for control person liability pursuant to Section 20(a) of the Exchange Act. Plaintiffs seek an undisclosed amount of compensatory damages and reasonable attorneys’ fees and expenses.

5.                                       SEC Investigation—The SEC is conducting a formal investigation of whether the disclosures in our financial reports relating to Medicare outlier reimbursements and stop-loss payments under managed care contracts were misleading or otherwise inadequate, and whether there was any improper trading in our securities by certain of our current and former directors and officers. The SEC served a series of document requests and subpoenas for testimony on the Company, certain of our current and former employees, officers and directors, and our independent registered public accounting firm. On April 27, 2005, we announced that we had received a “Wells Notice” from the staff of the SEC in connection with this investigation, and that we had been informed that Wells Notices had also been issued to certain former senior executives of the Company who left their positions in 2003 and 2002. A Wells Notice indicates that the SEC’s staff intends to recommend that the agency bring a civil enforcement action against the recipients for possible violations of federal securities laws. Recipients of Wells Notices have the opportunity to respond before the SEC’s staff makes its formal recommendation on whether any action should be brought. We submitted a response on May 13, 2005.

16




TENET HEALTHCARE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

As previously disclosed, the SEC is also investigating allegations made by a former employee that inappropriate contractual allowances for managed care contracts may have been established at three California hospitals through at least fiscal year 2001. At the request of the audit committee of our board of directors, the board’s independent outside counsel, Debevoise & Plimpton LLP (“Debevoise”), conducted an investigation of these allegations utilizing the forensic accounting services of Huron Consulting Group (“Huron”). This investigation was expanded and included determining whether similar issues might have affected other Tenet hospitals during the periods mentioned in the allegations and any other pertinent periods. Debevoise and Huron have completed their investigation and presented the results of their findings to the audit committee. Based on these findings, the audit committee determined that it was necessary to restate our previously reported financial statements. The restated financial statements were presented in our Annual Report and the restatement adjustments were described in Note 2 to the Consolidated Financial Statements in the Annual Report. We are continuing to cooperate with the SEC with respect to its investigation, including responding to subsequent requests for voluntary production of documents, as well as a subpoena request for documents dated October 6, 2005, and have provided regular updates to the SEC as to the progress of the investigation.

6.                                       Wage and Hour Actions—We are the defendant in a proposed class action lawsuit alleging that our hospitals violated certain provisions of the California Labor Code and applicable California Industrial Welfare Commission Wage Orders with respect to (a) meal breaks, (b) rest periods, (c) the payment of compensation for meal breaks and rest periods not taken, (d) the payment of compensation and appropriate premiums for overtime (including the California Differential payments described below), (e) “rounding off” practices for time entries on timekeeping records and (f) the information shown on pay stubs. Plaintiffs are seeking back pay, statutory penalties and attorneys’ fees, and seek to certify this action on behalf of virtually all nonexempt employees of our California subsidiaries. Two other proposed class actions pending in Southern California involve allegations regarding unpaid overtime. The lawsuits allege that our pay practices since 2000 for California-based 12-hour shift employees violate California overtime laws by virtue of the alleged failure to include certain payments known as Flexible (or California) Differential payments in the regular rate of pay that is used to calculate overtime pay. Plaintiffs in both cases are seeking back pay, statutory penalties and attorneys’ fees. We have recorded an accrual of $24 million ($18 million in the three months ended June 30, 2006 and $6 million in prior periods) as an estimated liability for the wage and hour actions and other unrelated employment matters.

7.                                       IRS Dispute—In May 2003, the Internal Revenue Service (“IRS”) completed an examination of our federal income tax returns for fiscal years ended May 31, 1995, 1996 and 1997 and issued a Revenue Agent’s Report. During 2005, we resolved several disputed issues with the IRS and paid approximately $8 million, which was comprised of $23 million of tax plus accrued interest of approximately $15 million less prior payments of $30 million. Among these issues was a disputed adjustment with respect to the timing of the recognition of income for tax purposes pertaining to Medicare and Medicaid net revenues, which we resolved by agreeing to spread the impact of the disputed adjustment over fiscal years ended May 31, 1995 through May 31, 2002.

After the settlement, the IRS issued a statutory notice of tax deficiency for $67 million in the fourth quarter of 2005 related to the remaining disputed items for fiscal years May 31, 1995, 1996 and 1997. In March 2006, we filed a petition to contest the tax deficiency notice through formal litigation in Tax Court. Interest expense (approximately $75 million through June 30, 2006, before any federal or state tax benefit) will continue to accrue until the case is resolved. The principal issues that remain in dispute include the deductibility of a portion of the civil settlement we paid to the federal government in 1994 related to our discontinued psychiatric hospital business and the computation of depreciation expense with respect to certain capital expenditures incurred during the foregoing fiscal years. We presently cannot determine the ultimate resolution of the remaining disputed items. We believe we have adequately provided for all probable tax matters, including interest, related to those disputed items.

The IRS has commenced an examination of our tax returns for fiscal years ended May 31, 1998 through the seven-month transition period ended December 31, 2002. We presently cannot determine the ultimate resolution of this examination. We believe we have adequately provided for all probable tax matters, including interest, related to all periods ended after May 31, 1997.

8.                                       Investigation by Louisiana Attorney General’s Office—In connection with an investigation into patient deaths that occurred at various hospitals and nursing homes following Hurricane Katrina, the Louisiana Attorney General’s Office conducted a review of events that occurred during the hurricane at two Tenet hospitals in New Orleans. The

17




TENET HEALTHCARE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

hospitals, Memorial Medical Center and Lindy Boggs Medical Center, have both been closed since September 2, 2005 because of damage from the hurricane. On October 1, 2005, representatives of the Louisiana Attorney General’s Office conducted a search of Memorial’s campus pursuant to a search warrant issued by an Orleans Parish state judge on September 30, 2005. Certain records and other materials were removed, including materials from an independently owned long-term acute care facility on Memorial’s campus, which is managed and operated under separate license by LifeCare Holdings Inc., which is not affiliated with us. The Attorney General’s Office also issued subpoenas to Tenet and Memorial requesting documents pertaining to the matters under investigation and events occurring at the hospital during and after the hurricane. In addition, the Attorney General subpoenaed certain individuals he wanted to question on these matters, including a number of Tenet employees. Subsequently, we learned in mid-July 2006 that the Louisiana Attorney General had referred the findings of his ten-month investigation to the New Orleans District Attorney. The Attorney General’s Office also announced that it had issued arrest warrants for two nurses who were employees of Memorial and one doctor on the medical staff there, alleging that they may have administered pain medication that hastened the deaths of four patients of LifeCare’s facility in the aftermath of the hurricane. These individuals have not yet been charged.

In addition to the matters described above, our hospitals are subject to claims and lawsuits in the ordinary course of business. The largest category of these relates to medical malpractice. Two recently filed medical malpractice cases involve former patients of Memorial Medical Center and Lindy Boggs Medical Center in New Orleans.  In each case, family members allege, on behalf of themselves and a purported class of other patients and their family members, damages as a result of injuries sustained during Hurricane Katrina.

Also, we and our subsidiaries are from time to time engaged in disputes with managed care payers. For the most part, we believe the issues raised in these contract interpretation and rate disputes are commonly encountered by other providers in the health care industry.

Further, our hospitals are routinely subject to sales and use tax audits and personal property tax audits by the state and local government jurisdictions in which they do business. The results of the audits are frequently disputed, and such disputes are ordinarily resolved by administrative appeals or litigation.

We cannot predict the likelihood of future claims or inquiries; however, we expect that new matters may be initiated against us from time to time. The results of claims, lawsuits and investigations also cannot be predicted, and it is possible that the ultimate resolution of these matters, individually or in the aggregate, may have a material adverse effect on our business (both in the near and long term), financial position, results of operations or cash flows. Although we defend ourselves vigorously against claims and lawsuits and cooperate with investigations, these matters (1) could require us to pay substantial damages or amounts in judgments or settlements, which individually or in the aggregate could exceed amounts, if any, that may be recovered under our insurance policies where coverage applies and is available, (2) cause us to incur substantial expenses, (3) require significant time and attention from our management, and (4) could cause us to close or sell hospitals or otherwise modify the way we conduct business.

We record reserves for claims and lawsuits when they are probable and reasonably estimable. For matters where the likelihood or extent of a loss is not probable or cannot be reasonably estimated, we have not recognized in the accompanying Condensed Consolidated Financial Statements all potential liabilities that may result. If adversely determined, the outcome of some of these matters could have a material adverse effect on our business, liquidity, financial position or results of operations.

18




TENET HEALTHCARE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

The table below presents reconciliations of the beginning and ending liability balances in connection with legal settlements and related costs recorded during the six months ended June 30, 2006 and 2005:

 

 

 

 

Additions Charged To:

 

 

 

 

 

 

 

 

 

Balances at
Beginning
of Period

 

Costs of
Litigation and
Investigations

 

Other
Accounts (1)

 

Cash
Payments

 

Other (2)

 

Balances at
End of
Period

 

Six months ended June 30, 2006

 

 

 

 

 

 

 

 

 

 

 

 

 

Continuing operations

 

$

308

 

$

744

 

$

 

$

(649

)

$

(75

)

$

328

 

Discontinued operations

 

5

 

(24

)

 

(21

)

45

 

5

 

 

 

$

313

 

$

720

 

$

 

$

(670

)

$

(30

)

$

333

 

Six Months Ended June 30, 2005

 

 

 

 

 

 

 

 

 

 

 

 

 

Continuing operations

 

$

40

 

$

19

 

$

 

$

(19

)

$

83

 

$

123

 

Discontinued operations

 

 

 

5

 

 

 

5

 

 

 

$

40

 

$

19

 

$

5

 

$

(19

)

$

83

 

$

128

 


(1)          The discontinued operations charge was recorded as an adjustment to net operating revenues within income (loss) from operations of asset group.

(2)          Other items include the funding of $75 million from our insurance carriers for the settlement of the securities class action, which is included in receivable for insurance recoveries in the Condensed Consolidated Balance Sheet as of December 31, 2005, and $45 million in insurance recoveries related to the Redding Medical Center settlement in December 2004, which is included in receivable for insurance recoveries in the Condensed Consolidated Balance Sheet as of June 30, 2006.

For the six months ended June 30, 2006 and 2005, we recorded net costs of $720 million and $24 million, respectively, in connection with significant legal proceedings and investigations, including $(24) million and $5 million in the six months ended June 30, 2006 and 2005, respectively, that were reflected in discontinued operations. The 2006 payments consisted primarily of the June 30, 2006 global civil settlement payment ($470 million, including $20 million in interest), the settlement of the Alvarado case ($21 million), the settlement of the securities class action ($140 million), attorneys’ fees associated with the state shareholder derivative settlement ($5 million), our February 2006 settlement with the Florida Attorney General ($7 million), and legal and other costs to defend ourselves in other ongoing lawsuits and investigations.

 

NOTE 11.  INCOME TAXES

Income taxes in the six months ended June 30, 2006 included the following: (1) a $247 million income tax benefit ($171 million recorded as a current income tax receivable and $76 million as a non-current deferred tax asset) to record the tax effects of the Civil Settlement Agreement with the United States of America; (2) income tax expense of $1 million in continuing operations to increase the valuation allowance for our deferred tax assets; (3) an income tax benefit of $7 million in continuing operations reflecting changes in tax contingency reserves; (4) an income tax benefit of $53 million in discontinued operations to decrease the valuation allowance; (5) an income tax benefit of $2 million in discontinued operations reflecting changes in tax contingency reserves; and (6) an income tax benefit of $1 million in cumulative effect of change in accounting principle to decrease the valuation allowance. A tax benefit has been recorded with respect to the amounts being paid pursuant to the Civil Settlement Agreement because such amounts represent a repayment of revenues previously reported in taxable income.  Under the Internal Revenue Code, we may recover taxes paid in previous years because the amounts paid pursuant to the Civil Settlement Agreement are attributable to amounts previously reported in taxable income and because we had an apparent unrestricted right to such revenues when recorded in prior periods.

Income taxes in the six months ended June 30, 2005 included the following: (1) an $8 million income tax benefit in continuing operations to reduce the valuation allowance for our deferred tax assets; (2) a $17 million income tax benefit in continuing operations reflecting changes in tax contingency reserves; (3) income tax expense of $16 million in discontinued operations to increase the valuation allowance; and (4) a $9 million benefit in discontinued operations reflecting changes in tax contingency reserves.

In May 2003, the Internal Revenue Service completed an examination of our federal income tax returns for fiscal years ended May 31, 1995, 1996 and 1997 and issued a Revenue Agent’s Report. During 2005, we resolved several disputed issues with the IRS and paid approximately $8 million, which was comprised of $23 million of tax plus accrued interest of approximately $15 million less prior payments of $30 million. Among these issues was a disputed adjustment with respect to the timing of the recognition of income for tax purposes pertaining to Medicare and Medicaid net revenues, which we

19




TENET HEALTHCARE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

resolved by agreeing to spread the impact of the disputed adjustment over fiscal years ended May 31, 1995 through May 31, 2002.

After the settlement, the IRS issued a statutory notice of tax deficiency for $67 million in the fourth quarter of 2005 related to the remaining disputed items for fiscal years May 31, 1995, 1996 and 1997. In March 2006, we filed a petition to contest the tax deficiency notice through formal litigation in Tax Court. Interest expense (approximately $75 million through June 30, 2006, before any federal or state tax benefit) will continue to accrue until the case is resolved. The principal issues that remain in dispute include the deductibility of a portion of the civil settlement we paid to the federal government in 1994 related to our discontinued psychiatric hospital business and the computation of depreciation expense with respect to certain capital expenditures incurred during the foregoing fiscal years. We presently cannot determine the ultimate resolution of the remaining disputed items. We believe we have adequately provided for all probable tax matters, including interest, related to those disputed items.

The IRS has commenced an examination of our tax returns for fiscal years ended May 31, 1998 through the seven-month transition period ended December 31, 2002. We presently cannot determine the ultimate resolution of this examination. We believe we have adequately provided for all probable tax matters, including interest, related to all periods ended after May 31, 1997.

NOTE 12.  EARNINGS PER COMMON SHARE

The table below is a reconciliation of the numerators and denominators of our basic and diluted earnings per common share calculations for income (loss) from continuing operations for the three and six months ended June 30, 2006 and 2005.  Income (loss) is expressed in millions and weighted average shares are expressed in thousands.

 

 

Income
(Loss)
(Numerator)

 

Weighted
Average
Shares
(Denominator)

 

Earnings
(Loss)
Per-Share
Amount

 

Three Months Ended June 30, 2006:

 

 

 

 

 

 

 

Loss to common shareholders for basic earnings per share

 

$

(447

)

470,608

 

$

(0.95

)

Effect of dilutive securities

 

 

 

 

Loss to common shareholders for diluted earnings per share

 

$

(447

)

470,608

 

$

(0.95

)

Three Months Ended June 30, 2005:

 

 

 

 

 

 

 

Loss to common shareholders for basic earnings per share

 

$

(9

)

468,758

 

$

(0.01

)

Effect of dilutive securities

 

 

 

 

Loss to common shareholders for diluted earnings per share

 

$

(9

)

468,758

 

$

(0.01

)

 

 

 

 

 

 

 

 

Six Months Ended June 30, 2006:

 

 

 

 

 

 

 

Loss to common shareholders for basic earnings per share

 

$

(448

)

470,338

 

$

(0.95

)

Effect of dilutive securities

 

 

 

 

Loss to common shareholders for diluted earnings per share

 

$

(448

)

470,338

 

$

(0.95

)

Six Months Ended June 30, 2005:

 

 

 

 

 

 

 

Income available to common shareholders for basic earnings per share

 

$

2

 

468,403

 

$

 

Effect of dilutive securities

 

 

1,232

 

 

Income available to common shareholders for diluted earnings per share

 

$

2

 

469,635

 

$

 

 

All potentially dilutive securities were excluded from the calculation of diluted loss per share for the three and six months ended June 30, 2006 and the three months ended June 30, 2005 because we reported a loss from continuing operations in each of those periods. In circumstances where we have a loss from continuing operations, the effect of stock options and other potentially dilutive securities is anti-dilutive, that is, losses have the effect of making the diluted loss per share from operations less than the basic loss per share from continuing operations.  Had we generated income from continuing operations in these periods, the effect (in thousands) of employee stock options, restricted stock units and deferred compensation units on the diluted shares calculation would have been an increase in shares of 1,371 and 1,024 for the three and six months ended June 30, 2006, respectively, and 1,565 for the three months ended June 30, 2005.

Stock options (in thousands) whose exercise price exceeded the average market price of our common stock and, therefore, would not have been included in the computation of diluted shares if we had generated income from continuing

20




TENET HEALTHCARE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

operations were 39,339 and 37,407 for the three months ended June 30, 2006 and 2005, respectively, and 39,497 for the six months ended June 30, 2006. Stock options (in thousands) of 41,408 had exercise prices that exceeded the average market price of our common stock and, therefore, were not included in the computation of diluted shares for the six months ended June 30, 2005.

 

NOTE 13.  RECENTLY ISSUED ACCOUNTING STANDARDS

The following summarizes noteworthy recently issued accounting standards:

·                  In June 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109” (“FIN 48”).  FIN 48 clarifies the circumstances in which a tax benefit may be recorded with respect to uncertain tax positions.  The Interpretation provides guidance for determining whether tax benefits may be recognized with respect to uncertain tax positions and, if recognized, the amount of such tax benefits that may be recorded.  Under the provisions of FIN 48, tax benefits associated with a tax position may be recorded only if it is more likely than not that the claimed tax position will be sustained upon audit.  FIN 48 applies to tax benefits claimed with respect to any uncertain tax position in any taxable year for which the statute of limitations for assessment of a tax deficiency has not expired, which generally includes our taxable years ended May 31, 1995 and later.  FIN 48 is effective for us on January 1, 2007.  At this time, we cannot estimate the impact of FIN 48 on our consolidated financial statements, although the estimated impact, when determined, may be material.

21




TENET HEALTHCARE CORPORATION

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

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

INTRODUCTION TO MANAGEMENT’S DISCUSSION AND ANALYSIS

The purpose of this section, Management’s Discussion and Analysis of Financial Condition and Results of Operations, is to provide a narrative explanation of our financial statements that enables investors to better understand our business, to enhance our overall financial disclosures, to provide the context within which financial information may be analyzed, and to provide information about the quality of, and potential variability of, our results of operations and cash flows. Unless otherwise indicated, all financial and statistical information included herein relates to our continuing operations, with dollar amounts expressed in millions (except per-share amounts). This information should be read in conjunction with the accompanying Condensed Consolidated Financial Statements. It includes the following sections:

·                  Executive Overview

·                  Forward-Looking Statements

·                  Outlook

·                  Sources of Revenue

·                  Results of Operations

·                  Liquidity and Capital Resources

·                  Off-Balance Sheet Arrangements

·                  Critical Accounting Estimates

EXECUTIVE OVERVIEW

SIGNIFICANT CHANGES AND INITIATIVES

During 2006, we continue to focus on the execution of our turnaround strategies. We are dedicated to improving our patients’, shareholders’ and other stakeholders’ confidence in us. We believe we will do that by providing quality care and generating positive growth and earnings at our hospitals.

Key developments include:

·                  Joint Venture Buyout—In 2004, we announced our intention to divest the two hospitals comprising the Encino-Tarzana Regional Medical Center, which we owned and operated in a joint venture with HCA, Inc. On July 28, 2006, we purchased from HCA: (1) a 25% interest in the joint venture; and (2) the real property comprising the Encino campus of the medical center, for an aggregate purchase price of $28 million. Prior to the transaction, we owned the other 75% interest in the joint venture, while the Encino campus real property was wholly owned by HCA. We anticipate that this transaction will facilitate our ability to divest these hospitals. The Tarzana campus continues to be leased from an affiliate of Health Care Property Investors, Inc.

·                  Settlement Reached over Katrina Insurance Claims—On July 6, 2006, we announced a $340 million settlement had been reached with our property insurers regarding claims related to the physical damage and business interruption we sustained as a result of Hurricane Katrina. We received $240 million on July 5, 2006, in addition to the $100 million previously received, in full resolution of our claims. With the settlement, we have avoided a protracted resolution process fraught with the disagreements and differences over interpretation that can occur in insurance claims of this magnitude and complexity. As provided in our insurance contracts, we have the flexibility to apply these funds to meet our overall capital needs.

·                  Global Civil Settlement—On June 28, 2006, we entered into a broad civil settlement agreement with the U.S. Department of Justice and other federal agencies that concluded several previously disclosed governmental investigations, including inquiries into our receipt of certain Medicare outlier payments before 2003, physician financial arrangements and Medicare coding issues.  Under the terms of the settlement, we will pay $725 million, plus interest, over a four-year period and waive our right to pursue receipt of $175 million in unrecorded Medicare payments for past services.  We also agreed to enter into a multi-year Corporate Integrity Agreement with the government within 90 days of the effective date of the settlement.

22




TENET HEALTHCARE CORPORATION

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

·                  Strategic Divestitures Announced—Also in June 2006, we announced our strategic plan to divest 10 underperforming hospitals in order to enhance our future profitability, provide funds to expand capital investments at our remaining hospitals and help fund our global civil settlement with the federal government. In addition to Gulf Coast Medical Center in Biloxi, Mississippi, which we sold in June 2006, Alvarado Hospital Medical Center, which we agreed to divest as part of our settlement with the U.S. Attorney in San Diego, as discussed below, and other hospitals currently held for sale or already sold, these 10 hospitals are reported in discontinued operations for all periods presented in this report. The 10 hospitals to be divested include four in the New Orleans area — Kenner Regional Medical Center, Lindy Boggs Medical Center, Meadowcrest Hospital and Memorial Medical Center — because of uncertainties in the New Orleans market and the need for health care consolidation in the aftermath of Hurricane Katrina. On July 18, 2006, we announced that we signed a definitive agreement to sell Kenner, Meadowcrest and Memorial to a local New Orleans operator. We also decided to divest three of our five hospitals in Philadelphia — Graduate Hospital, Roxborough Memorial Hospital and Warminster Hospital.  Three of our Florida hospitals — Hollywood Medical Center, Parkway Regional Medical Center and Cleveland Clinic Hospital — are also part of the divestiture plan. The divestitures are expected to be complete by mid-2007.

·                  Settlement with the U.S. Attorney in San Diego—In May 2006, we reached a civil settlement with the U.S. Attorney in San Diego to resolve the long-running criminal case regarding physician relocation agreements at Alvarado Hospital Medical Center. After two separate federal juries were unable to reach a verdict on the charges, we agreed to pay a settlement of $21 million to avoid a third trial and potential civil liabilities. The settlement requires us to sell or close the hospital or have the hospital face exclusion from federal health care programs.  As such, the hospital is included in discontinued operations for all periods presented in this report.

·                  New Chief Financial Officer—We announced in May 2006 that Biggs Porter would join Tenet as chief financial officer effective June 5. He previously served as vice president and corporate controller of a major aerospace company and defense contractor. He also served as that company’s principal accounting officer. Earlier in his career, Mr. Porter was a financial executive with several large companies.

·                  Construction Approved—Our application for a certificate of need to build a 100-bed hospital in Fort Mill, South Carolina was approved in May 2006. The approval is subject to appeal by the other applicants, and we expect the appeal process to take up to two years or longer.  Once construction begins, the hospital is expected to take up to 24 months to complete at an estimated cost of $125 million.  We also received approval for a 140-bed replacement hospital for East Cooper Medical Center in Mt. Pleasant, South Carolina at an estimated cost of $160 million.  Opening of the replacement hospital is expected in early 2009.

SIGNIFICANT CHALLENGES

The settlements discussed above and other legal settlements in the first quarter of 2006 have resolved several material threats to our company and should help us move forward in our turnaround strategy. However, there are still significant challenges, both company-specific and industry-wide, that will impact the timing of our turnaround. Below is a summary of these items:

Company-Specific Challenge

Volumes—We believe the reasons for declines in our volumes include, but are not limited to, increased competition, physician attrition, managed care contract negotiations or terminations, and the impact of our litigation and government investigations. We are taking a number of steps in addition to the settlement of litigation and government investigations to address the problem of volume decline. The most important of these is centered around understanding the needs of physicians who admit patients both to our hospitals and to our competitors’ hospitals and responding to those needs with changes and improvements in our hospitals and operations. We have accelerated capital spending for the remainder of 2006 in order to address specific needs of our hospitals, which is expected to have a positive impact on their volumes. We are also completing clinical service line market demand analysis and profitability assessments to determine which services are highly valued that can be emphasized and marketed to improve results.

Our Commitment to Quality initiative, which we launched in 2003, should further help position us to competitively meet the volume challenge.  We are working with physicians to implement the most current evidence-based techniques to improve the

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TENET HEALTHCARE CORPORATION

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

way we provide care. Our hospitals have improved substantially in quality metrics reported by the government and have been recognized by several managed care companies for their quality of care.  We believe that these improvements will have the effect of increasing physician and patient satisfaction, potentially improving volumes as a result.

Significant Industry Trends

Bad Debt—Like other organizations in the health care industry, we continue to provide services to a high volume of uninsured patients and more patients than in prior years with an increased burden of co-payments and deductibles as a result of changes in their health care plans. Although the discounting components of our Compact with Uninsured Patients (“Compact”) have reduced and are expected to continue to reduce our provision for doubtful accounts recorded in our Condensed Consolidated Financial Statements, they are not expected to mitigate the net economic effects of treating uninsured or underinsured patients. We continue to experience a high level of uncollectible accounts.  Our collection efforts have improved, and we continue to focus, where applicable, on placement of patients in various government programs such as Medicaid. However, unless our business mix shifts toward a greater number of insured patients or the trend of higher co-payments and deductibles reverses, we anticipate this high level of uncollectible accounts to continue.

Cost Pressures—Labor and supply costs remain a significant cost pressure facing us as well as the industry in general.  We have slowed the rates of increase in both labor and supply costs and have been able to contain our unit cost growth below the rate of medical inflation. Maintaining this level of cost control in an environment of declining patient volume and increasing labor union activity will continue to be a challenge.

RESULTS OF OPERATIONS—OVERVIEW

Our net patient revenue for this quarter compared to the same quarter of the prior year reflects the progress we have made in restructuring our operations to focus on a smaller group of general hospitals. Our turnaround timeframe is influenced by industry trends and a company-specific volume challenge that continues to negatively affect our revenue growth and operating expenses. In addition, our turnaround timeframe was influenced by the impact of Hurricane Katrina.  Our future profitability depends on volume growth, reimbursement levels and cost control. Below are some of the financial highlights for the three months ended June 30, 2006 compared to the three months ended June 30, 2005:

·                  Net inpatient revenue per patient day and per admission increased by 10.1% and 8.0%, respectively, due primarily to the effect of newly negotiated levels of reimbursement from our managed care contracts.  Patient days were down 4.5% and admissions were down 2.7%.

·                  Net outpatient revenue per visit increased 4.5%, while outpatient visits declined 6.0%. The increase in revenue per visit is due primarily to higher emergency room volume relative to total visits and the effect of newly negotiated levels of reimbursement from our managed care contracts.

·                  Favorable net adjustments for prior-year cost reports and related valuation allowances, primarily related to Medicare and Medicaid, of $4 million in the current quarter compared to similar adjustments in the prior-year quarter that netted to a favorable $7 million.

·                  Litigation and investigation costs increased to $728 million for the current quarter compared to $11 million in the prior-year quarter due to settlements of several cases.

·                  Loss per diluted share from continuing operations was $0.95 in the current quarter compared to loss per diluted share of $0.02 in the prior-year quarter.

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TENET HEALTHCARE CORPORATION

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

The table below shows the pretax and after-tax impact on continuing operations for the three and six months ended June 30, 2006 and 2005 of the following items:

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2006

 

2005

 

2006

 

2005

 

 

 

(Expense) Income

 

Impairment and restructuring charges, net of insurance recoveries

 

$

(27

)

$

4

 

$

(56

)

$

(5

)

Costs of litigation and investigations

 

(728

)

(11

)

(744

)

(19

)

Hurricane insurance recoveries, net of costs

 

13

 

 

10

 

 

Loss from early extinguishment of debt

 

 

 

 

(15

)

Pretax impact

 

$

(742

)

$

(7

)

$

(790

)

$

(39

)

Deferred tax asset valuation allowance

 

$

(2

)

$

(10

)

$

(1

)

$

8

 

Reduction in estimated tax exposures

 

$

7

 

$

17

 

$

7

 

$

17

 

Total after-tax impact

 

$

(474

)

$

2

 

$

(502

)

$

 

Diluted per-share impact of above items

 

$

(1.01

)

$

 

$

(1.07

)

$

 

Diluted earnings (loss) per share, including above items

 

$

(0.95

)

$

(0.02

)

$

(0.95

)

$

 

 

LIQUIDITY AND CAPITAL RESOURCES—OVERVIEW

Net cash used in operating activities was $641 million in the six months ended June 30, 2006 compared to net cash provided by operating activities of $700 million in the six months ended June 30, 2005. The principal reasons for the change were:

·                   an additional $622 million in payments during the six months ended June 30, 2006 compared to the six months ended June 30, 2005 for legal settlements and related costs comprised primarily of the global civil settlement with the federal government ($470 million), the settlement of the securities class action lawsuit and state shareholder derivative litigation ($145 million) and our February 2006 settlement with the Florida Attorney General ($7 million);

·                   an income tax refund of $537 million received in March 2005;

·                   an unfavorable change of $137 million in cash used by discontinued operations due to the impact of Hurricane Katrina on operating cash flows, payment of the Alvarado settlement ($21 million) and lower collections on accounts receivable in the current period than in the prior-year period due to a majority of account collections occurring shortly after hospital divestiture dates and a greater number of divestitures occurring in 2004;

·                   an additional $44 million of 401(k) matching contributions due to a full year of contribution matching in the six months ended June 30, 2006 compared to six months of contribution matching in the six months ended June 30, 2005 (effective July 1, 2004, we changed to an annual matching of employee 401(k) plan contributions for participants actively employed on December 31, as opposed to matching such contributions each pay period); and

·                   an additional $28 million of interest expense payments in 2006 due to debt issuances in January 2005.

Purchases of property and equipment were $243 million and $224 million during the six months ended June 30, 2006 and 2005, respectively.  Proceeds from the sales of facilities, investments and other assets during the six months ended June 30, 2006 and 2005 aggregated $30 million and $117 million, respectively.

In January 2005, we sold $800 million of unsecured 9¼% senior notes. The net proceeds from the sale of the senior notes were approximately $773 million after deducting discounts and related expenses. We used a portion of the proceeds in February 2005 for the early redemption of the remaining $400 million aggregate principal amount outstanding on our senior notes due in 2006 and 2007, and the balance of the proceeds for general corporate purposes. Our next scheduled maturity of senior notes is now in 2011. From time to time, we expect to engage in various capital markets, bank credit and other financing activities depending on our needs and financing alternatives available at the time.

 

We are currently in compliance with all covenants and conditions in our letter of credit facility and the indentures governing our senior notes. (See Note 5 to the Condensed Consolidated Financial Statements.) At June 30, 2006, we had approximately $191 million of letters of credit outstanding under the letter of credit facility, which were fully collateralized by $263 million of restricted cash on our Condensed Consolidated Balance Sheet. In addition, we had $568 million of unrestricted cash and cash equivalents on hand as of June 30, 2006.

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TENET HEALTHCARE CORPORATION

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

FORWARD-LOOKING STATEMENTS

The information in this report includes “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. All statements, other than statements of historical or present facts, that address activities, events, outcomes, business strategies and other matters that we plan, expect, intend, assume, believe, budget, predict, forecast, project, estimate or anticipate (and other similar expressions) will, should or may occur in the future are forward-looking statements. These forward-looking statements represent management’s current belief, based on currently available information, as to the outcome and timing of future events. They involve known and unknown risks, uncertainties and other factors—many of which we are unable to predict or control—that may cause our actual results, performance or achievements, or health care industry results, to be materially different from those expressed or implied by forward-looking statements. Such factors include, but are not limited to, the following risks, many of which are described in detail in Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2005 (“Annual Report”):

·                  A reduction in the payments we receive from managed care payers as reimbursement for the health care services we provide and difficulties we may encounter collecting from managed care payers;

·                  Changes in the Medicare and Medicaid programs or other government health care programs, including modifications to patient eligibility requirements, funding levels or the method of calculating payments or reimbursements;

·                  The volume of uninsured and underinsured patients, and our ability to satisfactorily and timely collect our patient accounts receivable;

·                  Competition;

·                  The ultimate resolution of claims, lawsuits and investigations;

·                  Our ability to attract and retain employees, physicians and other health care professionals, and the impact on our labor expenses from union activity and the shortage of nurses in certain specialties and geographic regions;

·                  The geographic concentration of our licensed hospital beds;

·                  Changes in, or our ability to comply with, laws and government regulations;

·                  The cost and future availability of insurance, as well as the effects of insurance policy limits;

·                  Trends affecting our actual or anticipated results that lead to charges adversely affecting our results of operations;

·                  Our relative leverage and the amount and terms of our indebtedness;

·                  Our ability to identify and execute on measures designed to save or control costs;

·                  The availability and terms of debt and equity financing sources to fund the needs of our business;

·                  Changes in our business strategies or development plans;

·                  The impact of natural disasters, including our ability to reopen facilities affected by such disasters;

·                  Technological and pharmaceutical improvements that increase the cost of providing, or reduce the demand for, health care;

·                  Various factors that may increase the cost of supplies;

·                  National, regional and local economic and business conditions;

·                  Demographic changes; and

·                  Other factors and risk factors referenced in this report and our other public filings.

When considering forward-looking statements, a reader should keep in mind the risk factors and other cautionary statements in our Annual Report. Should one or more of the risks and uncertainties described above, elsewhere in this report or in Item 1A, Risk Factors, of our Annual Report occur, or should underlying assumptions prove incorrect, our actual results and plans could differ materially from those expressed in any forward-looking statements. We specifically disclaim all responsibility to publicly update any information contained in a forward-looking statement or any forward-looking statement in its entirety and, therefore, disclaim any resulting liability for potentially related damages.

All forward-looking statements attributable to us are expressly qualified in their entirety by this cautionary statement.

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TENET HEALTHCARE CORPORATION

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

OUTLOOK

As described in “Significant Changes and Initiatives” in the Executive Overview above, this quarter we announced a broad settlement with the U.S. Department of Justice and other federal agencies of a number of matters that had been under investigation since 2003.  With this global settlement and the previously announced settlements of the criminal case involving Alvarado Hospital Medical Center, civil pricing litigation, a securities lawsuit and shareholder derivative litigation, and several matters with the Florida Attorney General, as well as certain other legal matters, we have now resolved the majority of the lawsuits and investigations related to legacy issues that had been ongoing for the past several years.

During this quarter, we also announced plans to divest 10 hospitals in order to enhance our future profitability and provide funds to expand capital spending in our remaining hospitals.  Additionally, we recently disclosed plans to open two new hospitals – one in El Paso, Texas and one in Fort Mill, South Carolina.

We believe that the resolution of significant legal matters, along with the divestiture of underperforming hospitals and enhanced spending in our remaining hospitals, improve our ability to focus on the initiatives that we have implemented, including our Commitment to Quality, to help meet both the company-specific and industry-wide challenges of volume decline, bad debt and cost pressures, as described above.  We remain in a turnaround situation and believe overcoming these challenges will continue to take time.

SOURCES OF REVENUE

We receive revenues for patient services from a variety of sources, primarily, the federal Medicare program, state Medicaid programs, managed care payers (including preferred provider organizations and health maintenance organizations), indemnity-based health insurance companies, and self-pay patients (patients who do not have health insurance and are not covered by some other form of third-party arrangement).

The table below shows the sources of net patient revenues for our general hospitals, expressed as percentages of net patient revenues from all sources:

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

 

 

2006

 

2005

 

Increase
(Decrease) (1)

 

2006

 

2005

 

Increase
(Decrease) (1)

 

Medicare

 

26.8

%

27.3

%

(0.5

)%

27.5

%

27.6

%

(0.1

)%

Medicaid

 

9.5

%

8.5

%

1.0

%

9.0

%

8.3

%

0.7

%

Managed care (2)

 

52.2

%

49.8

%

2.4

%

51.7

%

50.1

%

1.6

%

Indemnity, self-pay and other

 

11.5

%

14.4

%

(2.9

)%

11.8

%

14.0

%

(2.2

)%

 


(1)               The change is the difference between the 2006 and 2005 amounts shown.

(2)               Includes Medicare Advantage managed care and Medicaid managed care.

The decrease in indemnity, self-pay and other net patient revenues during 2006 is due primarily to the implementation of the discounting components of the Compact. Our payer mix on an admissions basis for our general hospitals, expressed as a percentage of total admissions from all sources, is shown below:

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

Admissions from:

 

2006

 

2005

 

Increase
(Decrease)

 

2006

 

2005

 

Increase
(Decrease)

 

Medicare

 

32.4

%

33.3

%

(0.9

)%

33.2

%

34.3

%

(1.1

)%

Medicaid

 

13.2

%

13.5

%

(0.3

)%

13.2

%

13.3

%

(0.1

)%

Managed care

 

45.6

%

44.8

%

0.8

%

45.1

%

44.2

%

0.9

%

Indemnity, self-pay and other

 

8.8

%

8.4

%

0.4

%

8.5

%

8.2

%

0.3

%

 

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TENET HEALTHCARE CORPORATION

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

GOVERNMENT PROGRAMS

The Medicare program, the nation’s largest health insurance program, is administered by the Centers for Medicare and Medicaid Services (“CMS”) of the U.S. Department of Health and Human Services. Medicare is a health insurance program primarily for individuals 65 years of age and older, certain younger people with disabilities, and people with end-stage renal disease, and is provided without regard to income or assets. Medicaid is a program that pays for medical assistance for certain individuals and families with low incomes and resources, and is jointly funded by the federal government and state governments. Medicaid is the largest source of funding for medical and health-related services for the nation’s poorest and most vulnerable populations.

These government programs are subject to statutory and regulatory changes, administrative rulings, interpretations and determinations, requirements for utilization review, and federal and state funding restrictions, all of which could materially increase or decrease payments from these government programs in the future, as well as affect the cost of providing services to our patients and the timing of payments to our facilities. We are unable to predict the effect of future government health care funding policy changes on our operations. If the rates paid by governmental payers are reduced, if the scope of services covered by governmental payers is limited, if we are required to pay substantial settlement amounts pertaining to government programs, or if we, or one or more of our subsidiaries’ hospitals, are excluded from participation in the Medicare or Medicaid program or any other government health care program, there could be a material adverse effect on our business, financial position, results of operations or cash flows.

Medicare

Medicare offers beneficiaries different ways to obtain their medical benefits. One option, the Traditional Medicare Plan, is a fee-for-service payment system. The other option, called Medicare Advantage (formerly Medicare + Choice), includes managed care, preferred provider organization, private fee-for-service and specialty plans. The major components of our net patient revenues for services provided to patients enrolled in the Traditional Medicare Plan for the three and six months ended June 30, 2006 and 2005 are set forth in the table below:

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

Revenue Descriptions

 

2006

 

2005

 

2006

 

2005

 

Diagnosis-related group – operating

 

$

315

 

$

316

 

$

662

 

$

664

 

Diagnosis-related group – capital

 

32

 

32

 

66

 

68

 

Outlier

 

19

 

18

 

41

 

34

 

Outpatient

 

95

 

93

 

189

 

187

 

Disproportionate share

 

52

 

50

 

106

 

102

 

Direct Graduate and Indirect Medical Education

 

27

 

25

 

53

 

52

 

Psychiatric, rehabilitation and skilled nursing facilities and other (1)

 

31

 

31

 

47

 

62

 

Adjustments for prior-year cost reports and related valuation allowances

 

6

 

9

 

30

 

14

 

Total Medicare net patient revenues

 

$

577

 

$

574

 

$

1,194

 

$

1,183

 

 


(1)             The other revenue category includes one prospective payment system (“PPS”)-exempt cancer hospital, one long-term acute care hospital, other revenue adjustments, and adjustments related to the current-year cost reports and related valuation allowances.

Medicaid

Medicaid programs are funded by both the federal government and state governments. These programs and the reimbursement methodologies are administered by the states and vary from state to state and from year to year. Estimated payments under various state Medicaid programs, excluding state funded managed care programs, constituted approximately 9.0% and 8.3% of our net patient revenues for the six months ended June 30, 2006 and 2005, respectively. These payments are typically based on fixed rates determined by the individual states.

 

We also receive disproportionate-share payments under various state Medicaid programs. For the three months ended June 30, 2006 and 2005, our revenue attributable to disproportionate-share payments and other state-funded subsidies was approximately $55 million and $22 million, respectively. For the six months ended June 30, 2006 and 2005, this revenue

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TENET HEALTHCARE CORPORATION

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

was approximately $71 million and $39 million, respectively. The increase in revenue is primarily attributable to additional funding provided by certain states, which was made available in part by additional annual state provider taxes on certain of our hospitals.

Many states in which we operate are facing budgetary challenges that pose a threat to Medicaid funding levels to hospitals and other providers. We expect these challenges to continue; however, we cannot predict the extent of the impact of the states’ budget reductions, if any, on our hospitals. Also, new Medicaid programs or any changes to existing programs could materially impact Medicaid payments to our hospitals.

Regulatory and Legislative Changes

There have been no material changes to the information in our Annual Report about the Medicare and Medicaid programs, except as set forth below:

Payment and Policy Changes to the Medicare Inpatient Prospective Payment System

Under Medicare law, CMS is required annually to update certain rules governing the inpatient prospective payment system (“IPPS”). The updates generally become effective October 1, the beginning of the federal fiscal year (“FFY”). On August 1, 2006, CMS issued the IPPS final rule for FFY 2007 (“Final Rule”). The Final Rule includes the following payment policy changes:

·                   A market basket increase of 3.4% for diagnosis-related group (“DRG”) operating payments for hospitals reporting specified quality measure data;

·                   An increase of market basket minus 2.0% for hospitals not supplying quality measure data;

·                   A 1.6% increase in the capital federal rate;

·                   A three-year transition to change the methodology CMS uses for calculating the DRG relative weights from a charge basis to estimated hospital costs;

·                   A move toward a more complete severity adjustment by adding 20 new groups to the current DRG system; and

·                    An 8.2% increase in the cost outlier threshold from $23,600 to $25,530.

CMS projects that the combined impact of the payment and policy changes in the Final Rule will yield an average 3.5% increase in payments for hospitals in large urban areas (populations over 1 million). Due to the unusual circumstances imposed by the order of the Court of Appeals for the Second Circuit in its decision in Bellevue Hospital Center v. Leavitt, which related to the application of 100% of the occupational mix to the wage index, CMS was not able to provide the final FFY 2007 occupational mix adjusted wage index tables, payment rates or impacts in the Final Rule. Because the wage data affect the calculation of the outlier threshold, as well as the outlier offset and budget neutrality factors that are applied to the standardized amounts, CMS was able to provide only tentative figures in the Final Rule. According to CMS, these tentative amounts will be revised once the occupational mix adjusted wage index is finalized and published prior to October 1, 2006. Using the tentative impact percentage in the Final Rule for hospitals in large urban areas applied to our Medicare IPPS payments for the nine months ended June 30, 2006 (annualized), the annual impact for all changes in the Final Rule on our hospitals in continuing operations may result in an estimated increase in our Medicare revenues of approximately $53 million. Because of the uncertainty regarding the payment rates, index adjustments, outlier threshold and impact percentages in the Final Rule and other factors that may influence our future IPPS payments, including admission volumes, length of stay and case mix, we cannot provide any assurances regarding our estimate.

Proposed Payment and Policy Changes to the Medicare Outpatient Prospective Payment System

On August 8, 2006, CMS issued the Proposed Changes to the Hospital Outpatient Prospective Payment System and Calendar Year 2007 Payment Rates (“OPPS Proposed Rule”). The OPPS Proposed Rule includes the following payment and policy proposals:

·      A 3.4% inflation update in Medicare payment rates for hospital outpatient services paid under the outpatient prospective payment system (“OPPS”) for hospitals that report quality measures; hospitals not reporting quality measures would receive an update equal to the OPPS update of 3.4% minus 2.0%;

·      A move towards the use of additional quality measures that are specifically appropriate for hospital outpatient care, as such measures are developed;

·      An expanded number of payment levels for services in outpatient clinics and emergency departments from three to five to match the levels for physician services; and

·      A revision to the OPPS ambulatory payment classification structure for drug administration services, allowing hospitals to be paid separately for additional hours of infusion, in addition to the initial hour of infusion.

CMS projects that the combined impact of the proposed payment and policy changes in the OPPS Proposed Rule will yield an average 3.0% increase in payments for all hospitals, and an average 3.0% increase in payments for hospitals located in large urban areas (populations over one million). Applying the large urban hospital impact percentage from the OPPS Proposed Rule to our Medicare outpatient payments for the six months ended June 30, 2006 (annualized), the annual impact of all changes on our hospitals in continuing operations may result in an estimated increase in our Medicare revenues of approximately $11 million. Because of the uncertainty regarding the modifications to the proposed payment policies contained in the OPPS Proposed Rule, and other factors that may influence our future OPPS payments, including volumes and case mix, we cannot provide any assurances regarding this estimate.

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TENET HEALTHCARE CORPORATION

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

Payment and Policy Changes to the Medicare Inpatient Psychiatric Facility Prospective Payment System (“IPF-PPS”)

On May 9, 2006, CMS issued the Final Rule for the Medicare Inpatient Psychiatric Facility Prospective Payment System for FFY 2007 (“IPF-PPS Rule”). The IPF-PPS Rule, which applies beginning July 1, 2006, includes the following payment and policy changes:

·                  A market basket increase of 4.5%; and

·                  An increase to the fixed dollar loss threshold amount for outlier payments from $5,700 to $6,200.

 

At June 30, 2006, 15 of our general hospitals in continuing operations operated inpatient psychiatric units. CMS projects that the combined impact of the proposed payment and policy changes will yield an average 4.0% increase in payments for all inpatient psychiatric facilities (including psychiatric units in acute care hospitals), and an average 2.4% increase in payments for psychiatric units of acute care hospitals located in urban areas. Applying the psychiatric unit impact percentage to our Medicare IPF-PPS payments for the twelve months ended June 30, 2006, the annual impact of all changes on our hospitals’ psychiatric units in continuing operations may result in an estimated increase in our Medicare revenues of approximately $1 million. Because of the uncertainty of the factors that may influence our future IPF-PPS payments, including admission volumes, length of stay and case mix, we cannot provide any assurances regarding this estimate.

Payment and Policy Changes to the Medicare Inpatient Rehabilitation Facility Prospective Payment System (“IRF-PPS”)

On August 1, 2006, CMS issued the Final Rule for the Inpatient Rehabilitation Facility Prospective Payment System for FFY 2007 (“IRF-PPS Rule”). The IRF-PPS Rule includes the following payment policy changes:

·                  An increase to the inpatient rehabilitation facility payment rate equal to the market basket of 3.3%;

·                  A 2.6% reduction in the standard payment to offset the effect of changes in coding, which, according to CMS, do not reflect real changes in patient acuity;

·                  A one-year extension of the 75% admission criteria rule phase-in period to conform to section 5005 of the Deficit Reduction Act of 2005. The current 60% compliance threshold will be extended for cost reporting periods that start on or after July 1, 2006 and before July 1, 2007; and

·                  An increase in the outlier threshold for high cost outlier cases from $5,129 to $5,534.

At June 30, 2006, we operated two inpatient rehabilitation hospitals, and 14 of our general hospitals in continuing operations operated inpatient rehabilitation units. CMS projects that the combined impact of the payment and policy changes in the IRF-PPS Rule will yield an average 0.8% increase in payments for all inpatient rehabilitation facilities (including rehabilitation units in acute care hospitals), an average 0.9% increase in payments for rehabilitation hospitals located in urban areas and an average 0.7% increase in payments for rehabilitation units of hospitals located in urban areas. Applying the urban hospital and unit impact percentages from the IRF-PPS Rule to our Medicare IRF-PPS payments for the nine months ended June 30, 2006 (annualized), the annual impact of all changes on our rehabilitation hospitals and units in continuing operations may result in an estimated increase in our Medicare revenues of approximately $1 million. Because of the uncertainty of the factors that may influence our future IRF-PPS payments, including admission volumes, length of stay and case mix, and the impact of compliance with the inpatient rehabilitation facility admission criteria, we cannot provide any assurances regarding this estimate.

PRIVATE INSURANCE

Managed Care

We currently have thousands of managed care contracts with various health maintenance organizations (“HMOs”) and preferred provider organizations (“PPOs”). HMOs generally maintain a full-service health care delivery network comprised of physician, hospital, pharmacy and ancillary service providers that HMO members must access through an assigned “primary care”

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TENET HEALTHCARE CORPORATION

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

physician. The member’s care is then managed by his or her primary care physician and other network providers in accordance with the HMO’s quality assurance and utilization review guidelines so that appropriate health care can be efficiently delivered in the most cost-effective manner. HMOs typically provide no benefit or reimbursement to their members who use non-contracted health care providers.

PPOs generally offer limited benefits to members who use non-contracted health care providers. PPO members who use contracted health care providers receive a preferred benefit, typically in the form of lower co-payments or deductibles. As employers and employees have demanded more choice, managed care plans have developed hybrid products that combine elements of both HMO and PPO plans.

The amount of our net patient revenue under managed care contracts during the six months ended June 30, 2006 and 2005 was $2.2 billion and $2.1 billion, respectively, and it is anticipated to be approximately $4.5 billion for our continuing operations in 2006. Approximately 59% of our managed care net patient revenues during 2006 was derived from our top ten managed care payers. At June 30, 2006 and December 31, 2005, approximately 55% and 58%, respectively, of our net accounts receivable related to continuing operations were due from managed care payers.

The table below shows the managed care admissions by type for our general hospitals, expressed as percentages of total managed care admissions:

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

 

 

2006

 

2005

 

Increase
(Decrease)

 

2006

 

2005

 

Increase
(Decrease)

 

Non-governmental

 

64.4

%

67.9

%

(3.5

)%

64.5

%

67.6

%

(3.1

)%

Governmental

 

35.6

%

32.1

%

3.5

%

35.5

%

32.4

%

3.1

%

 

A majority of our managed care contracts are “evergreen” contracts. Evergreen contracts extend automatically every year, but may be renegotiated or terminated by either party after giving 90 to 120 days notice. National payers generate approximately 42% of our total net managed care revenues, although these agreements are often negotiated on a local or regional basis. The remainder comes from regional or local payers. During the twelve-month period ended June 30, 2006, we renewed or renegotiated managed care contracts representing approximately 80% of our annual managed care revenues.

 

Generally, managed care plans prefer fixed, predictable rates in their contracts with health care providers. Managed care plans seeking to pay fixed and predictable rates frequently pay for hospital services on a capitation, DRG or per diem basis. Capitation is the least common of the three fixed payment methods. Under capitation, the hospital is paid a fixed amount per HMO member each month for all the hospital care of a specific group of members. Managed care plans also pay hospitals a fixed fee based upon the DRG assigned to each patient. The DRG is a health care industry code that is based upon the patients’ diagnosis at time of discharge. HMOs and PPOs may also reimburse hospitals on a “per day” or “per diem” basis. Under a per diem payment arrangement, the hospital is reimbursed a fixed amount for every day of hospital care delivered to a member. Per diem payment arrangements generally represent less financial risk to a hospital than capitation payment arrangements because the amount paid varies with the number of days of care provided to each patient. The financial risk of per diem agreements is further mitigated by the fact that most contracts with per diem payment arrangements also contain some form of “stop-loss” provision that allows for higher reimbursement rates for difficult medical cases where the hospital’s billed charges exceed a certain threshold amount. The majority of our managed care contracts are per diem and DRG contracts with stop-loss payment components as well.

Significant progress has been made to transition key managed care payers to contracts that use fixed, predictable market-based per diems and/or DRG methodology and that are less dependent on stop-loss payments, and that provide for market-based rate escalators and terms and conditions designed to help us reduce our provision for doubtful accounts.

In the past, our managed care policy was developed and implemented almost exclusively at the local hospital or regional level. However, we now have a team at the corporate level to develop a strategy to support our hospitals in their managed care relationships and provide a more consistent message to payers that will focus on performance management and assessment.

Our approach to managed care is built around the development of key competencies in the following areas: (1) strategy, policy and initiatives; (2) individualized key payer strategies; (3) managed care economics; (4) regional

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TENET HEALTHCARE CORPORATION

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

contracting support for our hospital regions; and (5) centralized data base management, which enhances our ability to effectively model contract terms and conditions for negotiations, and improves the efficiency and accuracy of our billing procedures.

Indemnity

An indemnity-based agreement generally requires the insurer to reimburse an insured patient for health care expenses after those expenses have been incurred by the patient, subject to an increasing number of policy conditions and exclusions. Unlike an HMO member, a patient with indemnity insurance is free to control his or her utilization of health care and selection of health care providers.

SELF-PAY PATIENTS

Self-pay patients are patients who do not qualify for government programs payments, such as Medicare and Medicaid, and who do not have some form of private insurance, and are, therefore, responsible for their own medical bills. A significant portion of our self-pay patients is being admitted through our hospitals’ emergency departments and often require high-acuity treatment. High-acuity treatment is more costly to provide and, therefore, results in higher billings, which are the least collectible of all accounts. We believe our level of self-pay patients has been higher in the last two years than previous periods due to a combination of broad economic factors, including reductions in state Medicaid budgets, increasing numbers of individuals and employers who choose not to purchase insurance, and an increased burden of co-payments and deductibles to be made by patients instead of insurers.

Self-pay accounts pose significant collectibility problems. At June 30, 2006 and December 31, 2005, approximately 7% and 6%, respectively, of our net accounts receivable related to continuing operations were due from self-pay patients. A significant portion of our provision for doubtful accounts relates to self-pay patients. We are taking multiple actions in an effort to mitigate the effect on us of the high level of uninsured patients and the related economic impact. These initiatives include conducting detailed reviews of intake procedures in hospitals facing the greatest pressures, and enhancing and updating intake best practices for all of our hospitals. Hospital-specific reports detailing collection rates by type of patient were developed to help the hospital management teams better identify areas of vulnerability and opportunities for improvement. Also, we have completely redesigned our self-pay collection workflows, enhanced technology and improved staff training in an effort to increase collections.

Over the longer term, several other initiatives we have previously announced should also help address this challenge. For example, our Compact, which is discussed in Note 2 to the Condensed Consolidated Financial Statements, is enabling us to offer lower rates to uninsured patients who historically have been charged standard gross charges.

We also provide charity care to patients who are financially unable to pay for the health care services they receive. Most patients who qualify for charity care are charged a per diem amount for services received, subject to a cap. Except for the per diem amounts, our policy is not to pursue collection of amounts determined to qualify as charity care; therefore, we do not report these amounts in net operating revenues or in provision for doubtful accounts. For the three months ended June 30, 2006 and 2005, $138 million and $140 million of charity care gross charges were excluded from net operating revenues and provision for doubtful accounts, respectively.  Charity care gross charges for the six months ended June 30, 2006 and 2005 were $301 million and $281 million, respectively.

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TENET HEALTHCARE CORPORATION

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

RESULTS OF OPERATIONS

The following two tables show a summary of our net operating revenues, operating expenses and operating income (loss) from continuing operations, both in dollar amounts and as percentages of net operating revenues, for the three and six months ended June 30, 2006 and 2005:

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2006

 

2005

 

2006

 

2005

 

Net operating revenues:

 

 

 

 

 

 

 

 

 

General hospitals

 

$

2,144

 

$

2,081

 

$

4,316

 

$

4,225

 

Other operations

 

51

 

61

 

89

 

116

 

Net operating revenues

 

2,195

 

2,142

 

4,405

 

4,341

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Salaries, wages and benefits

 

963

 

986

 

1,944

 

1,979

 

Supplies

 

398

 

388

 

809

 

786

 

Provision for doubtful accounts

 

128

 

140

 

249

 

294

 

Other operating expenses

 

497

 

475

 

977

 

931

 

Depreciation

 

76

 

74

 

152

 

151

 

Amortization

 

6

 

5

 

12

 

9

 

Impairment and restructuring charges, net of insurance recoveries

 

27

 

(4

)

56

 

5

 

Hurricane insurance recoveries, net of costs

 

(13

)

 

(10

)

 

Costs of litigation and investigations

 

728

 

11

 

744

 

19

 

Loss from early extinguishment of debt

 

 

 

 

15

 

Operating income (loss)

 

$

(615

)

$

67

 

$

(528

)

$

152

 

 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2006

 

2005

 

2006

 

2005

 

Net operating revenues:

 

 

 

 

 

 

 

 

 

General hospitals

 

97.7

%

97.2

%

98.0

%

97.3

%

Other operations

 

2.3

%

2.8

%

2.0

%

2.7

%

Net operating revenues

 

100.0

%