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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC  20549

 

Form 10-K

 

x       Annual report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the fiscal year ended December 31, 2012

 

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.)

 

1445 Ross Avenue, Suite 1400
Dallas, TX 75202

(Address of principal executive offices, including zip code)

 

(469) 893-2200
(Registrant’s telephone number, including area code)

 


 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class

 

Name of each exchange on which registered

Common stock

 

New York Stock Exchange

7 3¤8% Senior Notes due 2013

 

New York Stock Exchange

9 7¤8% Senior Notes due 2014

 

New York Stock Exchange

9 1¤4% Senior Notes due 2015

 

New York Stock Exchange

6 7¤8% Senior Notes due 2031

 

New York Stock Exchange

 

Securities registered pursuant to Section 12(g) of the Act: None

 


 

Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes x No o

 

Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No x

 

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 has submitted electronically and posted on its corporate website every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months. Yes x No o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x

 

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company (as defined in Exchange Act Rule 12b-2).

 

Large accelerated filer x

 

Accelerated filer o

 

 

 

Non-accelerated filer o

 

Smaller reporting company 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 June 30, 2012, there were 104,123,502 shares of common stock, $0.05 par value, outstanding (as adjusted to reflect a one-for-four reverse stock split in October 2012). The aggregate market value of the shares of common stock held by non-affiliates of the Registrant as of June 30, 2012, based on the split-adjusted closing price of the Registrant’s shares on the New York Stock Exchange on Friday, June 29, 2012, was approximately $1,400,757,470. For the purpose of the foregoing calculation only, all directors and the executive officers who were SEC reporting persons of the Registrant as of June 30, 2012 have been deemed affiliates. As of January 31, 2013, there were 104,285,643 shares of common stock outstanding.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the Registrant’s definitive proxy statement for the 2013 annual meeting of shareholders are incorporated by reference into Part III of this Form 10-K.

 

 

 



Table of Contents

 

TABLE OF CONTENTS

 

 

 

Page

PART I

 

Item 1.

Business

1

Item 1A.

Risk Factors

20

Item 1B.

Unresolved Staff Comments

26

Item 2.

Properties

26

Item 3.

Legal Proceedings

26

Item 4.

Mine Safety Disclosures

26

 

 

 

PART II

 

Item 5.

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

27

Item 6.

Selected Financial Data

29

Item 7.

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

30

Item 7A.

Quantitative and Qualitative Disclosures About Market Risk

79

Item 8.

Financial Statements and Supplementary Data

80

 

Consolidated Financial Statements

83

 

Notes to Consolidated Financial Statements

88

 

Supplemental Financial Information

122

Item 9.

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

123

Item 9A.

Controls and Procedures

123

Item 9B.

Other Information

123

 

 

 

PART III

 

Item 10.

Directors, Executive Officers and Corporate Governance

124

Item 11.

Executive Compensation

124

Item 12.

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

124

Item 13.

Certain Relationships and Related Transactions, and Director Independence

124

Item 14.

Principal Accounting Fees and Services

124

 

 

 

PART IV

 

Item 15.

Exhibits and Financial Statement Schedules

125

 

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PART I.

 

ITEM 1. BUSINESS

 

OVERVIEW

 

Tenet Healthcare Corporation (together with our subsidiaries, referred to herein as “Tenet,” the “Company,” “we” or “us”) is an investor-owned health care services company whose subsidiaries and affiliates as of December 31, 2012 primarily operated 49 hospitals, 117 outpatient centers and Conifer Health Solutions (“Conifer”), which provides business process solutions to more than 600 hospital and other clients nationwide.

 

With respect to our hospitals and outpatient facilities, we seek to offer superior quality and patient services to meet community needs, to make capital and other investments in our facilities and technology to remain competitive, to recruit and retain physicians, to expand our outpatient business, and to negotiate favorable contracts with managed care and other commercial payers. With respect to business process services, we provide comprehensive operational management for revenue cycle functions, including patient access, health information management, revenue integrity and patient financial services. We also offer patient communications solutions to optimize the relationship between providers and patients. In addition, our management services offerings have expanded to support value-based performance through clinical integration, financial risk management and population health management. For financial reporting purposes, our business lines are classified into two separate reportable business segments — hospital operations and other, and Conifer.

 

We are committed to providing the communities our hospitals, outpatient centers and other health care facilities serve with high quality, cost-effective health care while growing our business, increasing our profitability and creating long-term value for our shareholders. Our operating strategies for accomplishing this mission in the complex and competitive health care industry are discussed in detail in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, of this report. In general, we anticipate the continued acceleration of major industry trends we have seen emerge over the last several years, and our strategies reflect the belief that: (1) consumers will increasingly select services and providers based on quality and cost; (2) physicians will seek strategic partners with whom they can align clinically and financially; (3) more procedures will shift from the inpatient to the outpatient setting; (4) demand will grow as a result of an improved economy, shifting demographics and the expansion of coverage under the Patient Protection and Affordable Care Act as amended by the Health Care and Education Reconciliation Act of 2010 (the “Affordable Care Act”); and (5) payer reimbursements will be constrained and further shift to being more closely tied to performance on quality and service metrics. We believe that our strategies and the acceleration of these trends will allow us to achieve our operational and financial targets. We adjust our strategies as necessary in response to changes in the economic and regulatory climates in which we operate and the results achieved by our various efforts.

 

OPERATIONS

 

HOSPITAL OPERATIONS

 

At December 31, 2012, our subsidiaries operated 49 hospitals, including three academic medical centers, a children’s hospital and a critical access hospital, with a total of 13,216 licensed beds, serving primarily urban and suburban communities in 10 states. Of those hospitals, 44 were owned by our subsidiaries and five were owned by third parties and leased by our subsidiaries. In addition, at December 31, 2012, our subsidiaries operated a long-term acute care hospital and owned or leased and operated 30 medical office buildings, all of which were located on, or nearby, our hospital campuses. Our subsidiaries also operated 117 free-standing and provider-based outpatient centers in 11 states at December 31, 2012, including diagnostic imaging centers, ambulatory surgery centers and urgent care centers, among others.

 

We seek to operate our hospitals and outpatient centers in a manner that positions them to compete effectively in an evolving health care environment. From time to time, we also: build new hospitals and outpatient centers; make strategic acquisitions of hospitals, outpatient businesses, physician practices, and other health care assets and companies; and enter into joint venture arrangements or affiliations with health care businesses — in each case in markets where we believe our operating strategies can improve performance and create shareholder value. In particular, we believe that growth by strategic acquisitions, when and if opportunities are available, can supplement the growth we believe we can generate organically in our existing markets. During the year ended December 31, 2012, we made the following acquisitions: (1) a diagnostic imaging center; (2) an oncology center; (3) an urgent care center; (4) a health plan; (5) a cyberknife center in which we previously held a noncontrolling interest; (6) a majority interest in nine ambulatory surgery centers (in one of which we previously held a noncontrolling interest); (7) 20 physician practice entities; and (8) a physician practice management company in which we previously held a noncontrolling interest. We also sometimes decide to sell, consolidate or close certain facilities to eliminate duplicate services or excess capacity or because of changing market conditions or other factors. In May 2012, we sold Diagnostic Imaging Services, Inc., our former

 



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diagnostic imaging center business in Louisiana, and, in August 2012, we sold our Creighton University Medical Center in Nebraska.

 

Our hospitals classified in continuing operations for financial reporting purposes generated in excess of 95% of our net operating revenues before provision for doubtful accounts for all periods presented in our Consolidated Financial Statements. Factors that affect patient volumes and, thereby, the results of operations at our hospitals and related health care facilities include, but are not limited to: (1) the business environment, economic conditions and demographics of local communities; (2) the number of uninsured and underinsured individuals in local communities treated at our hospitals; (3) seasonal cycles of illness; (4) climate and weather conditions; (5) physician recruitment, retention and attrition; (6) advances in technology and treatments that reduce length of stay; (7) local health care competitors; (8) managed care contract negotiations or terminations; (9) any unfavorable publicity about us, which impacts our relationships with physicians and patients; (10) changes in health care regulations and the participation of individual states in federal programs; and (11) the timing of elective procedures.

 

Each of our general hospitals offers acute care services, operating and recovery rooms, radiology services, respiratory therapy services, clinical laboratories and pharmacies; in addition, most offer intensive care, critical care and/or coronary care units, physical therapy, and orthopedic, oncology and outpatient services. A number of our hospitals also offer tertiary care services such as open-heart surgery, neonatal intensive care and neurosciences. Three of our hospitals — North Shore Medical Center, St. Louis University Hospital and Hahnemann University Hospital — offer quaternary care in areas such as heart, liver, kidney and bone marrow transplants. St. Christopher’s Hospital for Children provides tertiary and quaternary pediatric services, including bone marrow and kidney transplants, as well as burn services. Sierra Medical Center, Good Samaritan Medical Center and North Shore Medical Center offer gamma-knife brain surgery; and Brookwood Medical Center, North Shore Medical Center, Saint Francis Hospital and St. Louis University Hospital offer cyberknife radiation therapy for tumors and lesions nearly anywhere in the body, including in the brain, lung, neck and spine, that may have been previously considered inoperable or inaccessible by traditional radiation therapy. In addition, our hospitals will continue their efforts to deliver and develop those outpatient services that can be provided on a quality, cost-effective basis and that we believe will meet the needs of the communities served by the facilities.

 

Many of our hospitals also offer a wide range of clinical research studies, giving patients access to innovative care. We are dedicated to helping our hospitals participate in medical research that is consistent with state and federal regulations and provides good clinical practice guidelines. Current clinical research programs relate to a wide array of ailments, including cardiovascular disease, pulmonary disease, musculoskeletal disorders, neurological disorders, genitourinary disease and various cancers, as well as medical device studies. By supporting clinical research, our hospitals are actively involved in medical advancements that can lead to improvements in patient safety and clinical care.

 

Each of our acute care hospitals is accredited by the Joint Commission (formerly, the Joint Commission on Accreditation of Healthcare Organizations) or the American Osteopathic Association (in the case of one hospital). With such accreditation, our hospitals are deemed to meet the Medicare Conditions of Participation and are eligible to participate in government-sponsored provider programs, such as the Medicare and Medicaid programs.

 

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The following table lists, by state, the hospitals owned or leased and operated by our subsidiaries as of December 31, 2012:

 

Hospital

 

Location

 

Licensed
Beds

 

Status

 

Alabama

 

 

 

 

 

 

 

Brookwood Medical Center

 

Birmingham

 

631

 

Owned

 

 

 

 

 

 

 

 

 

California

 

 

 

 

 

 

 

Desert Regional Medical Center(1)

 

Palm Springs

 

387

 

Leased

 

Doctors Hospital of Manteca

 

Manteca

 

73

 

Owned

 

Doctors Medical Center

 

Modesto

 

461

 

Owned

 

Fountain Valley Regional Hospital & Medical Center

 

Fountain Valley

 

400

 

Owned

 

John F. Kennedy Memorial Hospital

 

Indio

 

156

 

Owned

 

Lakewood Regional Medical Center

 

Lakewood

 

172

 

Owned

 

Los Alamitos Medical Center

 

Los Alamitos

 

167

 

Owned

 

Placentia Linda Hospital

 

Placentia

 

114

 

Owned

 

San Ramon Regional Medical Center(2)

 

San Ramon

 

123

 

Owned

 

Sierra Vista Regional Medical Center

 

San Luis Obispo

 

164

 

Owned

 

Twin Cities Community Hospital

 

Templeton

 

122

 

Owned

 

 

 

 

 

 

 

 

 

Florida

 

 

 

 

 

 

 

Coral Gables Hospital

 

Coral Gables

 

245

 

Owned

 

Delray Medical Center

 

Delray Beach

 

493

 

Owned

 

Good Samaritan Medical Center

 

West Palm Beach

 

333

 

Owned

 

Hialeah Hospital

 

Hialeah

 

378

 

Owned

 

North Shore Medical Center

 

Miami

 

357

 

Owned

 

North Shore Medical Center — FMC Campus

 

Lauderdale Lakes

 

459

 

Owned

 

Palm Beach Gardens Medical Center(3)

 

Palm Beach Gardens

 

199

 

Leased

 

Palmetto General Hospital

 

Hialeah

 

360

 

Owned

 

Saint Mary’s Medical Center

 

West Palm Beach

 

464

 

Owned

 

West Boca Medical Center

 

Boca Raton

 

195

 

Owned

 

 

 

 

 

 

 

 

 

Georgia

 

 

 

 

 

 

 

Atlanta Medical Center

 

Atlanta

 

460

 

Owned

 

North Fulton Regional Hospital(3)

 

Roswell

 

202

 

Leased

 

South Fulton Medical Center(4)

 

East Point

 

338

 

Owned

 

Spalding Regional Hospital

 

Griffin

 

160

 

Owned

 

Sylvan Grove Hospital(5)

 

Jackson

 

25

 

Leased

 

 

 

 

 

 

 

 

 

Missouri

 

 

 

 

 

 

 

Des Peres Hospital

 

St. Louis

 

143

 

Owned

 

St. Louis University Hospital

 

St. Louis

 

356

 

Owned

 

 

 

 

 

 

 

 

 

North Carolina

 

 

 

 

 

 

 

Central Carolina Hospital

 

Sanford

 

137

 

Owned

 

Frye Regional Medical Center(3)

 

Hickory

 

355

 

Leased

 

 

 

 

 

 

 

 

 

Pennsylvania

 

 

 

 

 

 

 

Hahnemann University Hospital

 

Philadelphia

 

496

 

Owned

 

St. Christopher’s Hospital for Children

 

Philadelphia

 

189

 

Owned

 

 

 

 

 

 

 

 

 

South Carolina

 

 

 

 

 

 

 

Coastal Carolina Hospital

 

Hardeeville

 

41

 

Owned

 

East Cooper Medical Center

 

Mount Pleasant

 

140

 

Owned

 

Hilton Head Hospital

 

Hilton Head

 

93

 

Owned

 

Piedmont Medical Center

 

Rock Hill

 

288

 

Owned

 

 

 

 

 

 

 

 

 

Tennessee

 

 

 

 

 

 

 

Saint Francis Hospital

 

Memphis

 

519

 

Owned

 

Saint Francis Hospital — Bartlett

 

Bartlett

 

196

 

Owned

 

 

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Hospital

 

Location

 

Licensed
Beds

 

Status

 

Texas

 

 

 

 

 

 

 

Centennial Medical Center

 

Frisco

 

118

 

Owned

 

Cypress Fairbanks Medical Center

 

Houston

 

181

 

Owned

 

Doctors Hospital at White Rock Lake

 

Dallas

 

218

 

Owned

 

Houston Northwest Medical Center(6)

 

Houston

 

430

 

Owned

 

Lake Pointe Medical Center(7)

 

Rowlett

 

112

 

Owned

 

Nacogdoches Medical Center

 

Nacogdoches

 

153

 

Owned

 

Park Plaza Hospital

 

Houston

 

444

 

Owned

 

Providence Memorial Hospital

 

El Paso

 

508

 

Owned

 

Sierra Medical Center

 

El Paso

 

351

 

Owned

 

Sierra Providence East Medical Center

 

El Paso

 

110

 

Owned

 

 


(1)         Lease expires in 2027.

(2)         In January 2013, we announced that we were creating a joint venture partnership with John Muir Health, a not-for-profit integrated system of doctors, hospitals and other health care services in the San Francisco Bay area, through which John Muir Health will invest approximately $100 million to acquire a 49% ownership interest in San Ramon Regional Medical Center.

(3)         The current lease terms for Palm Beach Gardens Medical Center, North Fulton Regional Hospital and Frye Regional Medical Center expire in February 2014, but may be renewed through at least February 2039, in each case subject to certain conditions contained in the respective leases. In February 2013, we exercised our options under the leases to purchase the hospitals.

(4)         Effective January 1, 2013, South Fulton Medical Center was consolidated with Atlanta Medical Center and renamed Atlanta Medical Center — South Campus.

(5)         Designated by the Centers for Medicare and Medicaid Services (“CMS”) as a critical access hospital. Although it has not sought to be accredited, the hospital participates in the Medicare and Medicaid programs by otherwise meeting the Medicare Conditions of Participation. The current lease term for this facility expires in December 2016, but may be renewed through December 2046, subject to certain conditions contained in the lease.

(6)         Owned by a limited liability company in which a Tenet subsidiary owned an 86.61% interest at December 31, 2012 and is the managing member.

(7)         Owned by a limited liability company in which a Tenet subsidiary owned a 94.59% interest at December 31, 2012 and is the managing member.

 

As of December 31, 2012, the largest concentrations of licensed beds in our hospitals were in Florida (26.4%), Texas (19.9%) and California (17.7%). Strong concentrations of hospital beds within market areas help us contract more successfully with managed care payers, reduce management, marketing and other expenses, and more efficiently utilize resources. However, these concentrations increase the risk that, should any adverse economic, regulatory, environmental or other condition occur in these areas, our overall business, financial condition, results of operations or cash flows could be materially adversely affected.

 

The following table presents the number of hospitals operated by our subsidiaries, as well as the total number of licensed beds at those facilities, at December 31, 2012, 2011 and 2010:

 

 

 

December 31,

 

 

 

2012

 

2011

 

2010

 

Total number of facilities(1)

 

49

 

50

 

50

 

Total number of licensed beds(2)

 

13,216

 

13,453

 

13,428

 

 


(1)              Includes all general hospitals and our critical access facility, as well as one facility at December 31, 2011 and 2010 that is classified in discontinued operations for financial reporting purposes as of December 31, 2012.

(2)              Information regarding utilization of licensed beds and other operating statistics can be found in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, of this report.

 

CONIFER

 

Our Conifer subsidiary provides a number of services primarily to health care providers to assist them in generating sustainable improvements in their operating margins, while also enhancing patient, physician and employee satisfaction. At December 31, 2012, Conifer provided one or more of the business process services described below to more than 600 Tenet and non-Tenet hospital and other clients nationwide.

 

Revenue Cycle Management—Conifer provides comprehensive operational management for patient access, health information management, revenue integrity and patient financial services, including:

 

·            centralized insurance and benefit verification, financial clearance, pre-certification, registration and check-in services;

 

·            financial counseling services, including reviews of eligibility for government health care programs, for both insured and uninsured patients;

 

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·            productivity and quality improvement programs, revenue cycle assessments and optimization recommendations, and Joint Commission and other preparedness services;

 

·            coding and compliance support, billing assistance, auditing, training, and data management services at every step in the revenue cycle process;

 

·            accounts receivable management, third-party billing and collections; and

 

·            ongoing measurement and monitoring of key revenue cycle metrics.

 

These revenue cycle management solutions assist hospitals and other health care organizations in improving cash flow, increasing revenue, and advancing physician and patient satisfaction.

 

Patient Communications Services—Conifer offers customized patient communications solutions to optimize the relationship between providers and patients. Conifer’s trained customer service representatives provide direct, 24-hour, multilingual support for (1) physician referrals, calls regarding maternity services and other patient inquiries, (2) community education and outreach, (3) scheduling and appointment reminders, and (4) employee recruitment. Conifer also coordinates and implements mail-based marketing programs to keep patients informed of screenings, seminars and other events and services, as well as conducts patient quality and satisfaction surveys to provide valuable feedback to its clients. In addition, Conifer provides clinical admission reviews that are intended to provide evidence-based support for physician decisions on patient status and reduce staffing costs.

 

Management Services—Conifer’s service offerings have recently expanded to support value-based performance through clinical integration, financial risk management and population health management, all of which support hospitals, physicians, accountable care organizations, health plans and employers in improving the cost and quality of health care delivery, as well as patient outcomes. Conifer assists clients in building clinically integrated networks that provide predictive analytics and quality measures across the care continuum. In addition, Conifer helps clients improve both the cost and quality of care by aligning and managing financial incentives among health care stakeholders through risk modeling and management for various payment models. Conifer also offers clients tools and analytics to improve quality of care and provide care management support of patients with chronic diseases by identifying high-risk patients and monitoring clinical outcomes.

 

In May 2012, Conifer entered into a 10-year agreement with Catholic Health Initiatives (“CHI”) to provide revenue cycle services for over 50 of CHI’s hospitals. As part of this agreement, CHI received a minority ownership interest in Conifer. In addition, in October 2012, Conifer acquired InforMed, LLC (“InforMed”), an information management and services company with extensive health care data and proprietary technology. In November 2012, Conifer also acquired a hospital revenue cycle management business.

 

We began reporting Conifer as a separate business segment for financial reporting purposes in the three months ended June 30, 2012. The loss of Conifer’s key customers, primarily Tenet and CHI, in the future could have a material adverse impact on the segment. Financial and other information about our Conifer business segment is provided in the Consolidated Financial Statements included in this report.

 

REAL PROPERTY

 

Description of Real Property—The locations of our hospitals and the number of licensed beds at each hospital at December 31, 2012 are set forth in the table beginning on page 3. At December 31, 2012, our subsidiaries also operated 30 medical office buildings, all of which were located on, or nearby, our hospital campuses. Of those medical office buildings, 23 were owned by our subsidiaries and seven were owned by third parties and leased by our subsidiaries.

 

Our corporate headquarters are located in Dallas, Texas. We have other corporate administrative offices in Anaheim, California and Coral Springs, Florida. One of our subsidiaries leases our corporate headquarters space under an operating lease agreement that expires in December 2019. Other subsidiaries lease the space for our offices in Anaheim and Coral Springs under operating lease agreements. Conifer’s headquarters are located in Frisco, Texas, and it also maintains offices in Anaheim and Encino, California, Boca Raton and St. Petersburg, Florida, Atlanta, Georgia (which office we are planning to close in 2013) and St. Louis, Missouri. One of Conifer’s subsidiaries leases its headquarters space under two operating lease agreements that expire in March and October 2014, respectively. In February 2013, Conifer entered into a new lease to consolidate its headquarters in one building; that lease, which is expected to be accounted for as a capital lease, is scheduled to commence in February 2014 and expire in February 2030. Other Conifer subsidiaries lease the space for its regional offices under operating lease agreements. We

 

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believe that all of our properties, including the administrative and medical office buildings described above, are suitable for their intended purposes.

 

Obligations Relating to Real Property—As of December 31, 2012, we had approximately $6 million of outstanding loans secured by property and equipment. In addition, from time to time, we lease real property to third-party developers for the construction of medical office buildings. Under our current practice, the financing necessary to construct the medical office buildings encumbers only the leasehold and not our fee interest in the real estate. In years past, however, we have at times subordinated our fee interest and allowed our property to be pledged as collateral for third-party loans. We have no contractual obligation to make payments on these third-party loans, but our property could be subject to loss in the case of default by the lessee.

 

Regulations Affecting Real Property—We are subject to a number of laws and regulations affecting our use of, and purchase and sale of, real property. Among these are California’s seismic standards, the Americans with Disabilities Act, and various environmental laws and regulations.

 

The State of California has established standards intended to ensure that all hospitals in the state withstand earthquakes and other seismic activity without collapsing or posing the threat of significant loss of life. To date, we have spent a total of approximately $28 million to comply with the requirements under California’s seismic regulations. We do not expect to incur material additional costs, however, because all of our general acute care hospitals in California are now in compliance with the current seismic requirements. In addition to safety standards, over time, hospitals must also meet performance standards meant to ensure that they are generally capable of providing medical services to the public after an earthquake or other disaster. Ultimately, all general acute care hospitals in California must meet these seismic performance standards by 2030 to remain open. We expect to meet California’s seismic performance standards by the 2030 deadline; however, we are unable to estimate the cost of compliance at this time.

 

The Americans with Disabilities Act generally requires that public accommodations, including hospitals and other health care facilities, be made accessible to disabled persons. Through December 31, 2012, we spent approximately $50 million on corrective work to improve disability access at our facilities, and we expect to spend approximately $70 million more on such improvements over the next three years pursuant to the terms of a negotiated consent decree.

 

Our properties are also subject to various federal, state and local environmental laws, rules and regulations, including with respect to asbestos abatement and the treatment of underground storage tanks, among other matters. We believe it is unlikely that the cost of complying with such laws, rules and regulations will have a material effect on our future capital expenditures, results of operations or competitive position.

 

INTELLECTUAL PROPERTY

 

Conifer relies on a combination of patent, trademark, copyright and trade secret laws and contractual terms and conditions to protect its intellectual property rights, and has sought patent protection for one of its key innovations. Legal standards relating to the validity, enforceability and scope of protection of patents can be uncertain. We do not know whether our pending patent application will result in the issuance of a patent or whether the examination process will require us to further narrow our claims. Our patent application may not result in the grant of a patent with the scope of the claims that we seek, if at all, or the scope of the granted claims may not be sufficiently broad to protect our technology. Any patents that may be granted in the future from pending or future applications may be opposed, contested, circumvented, designed around by a third party or found to be invalid or unenforceable. Third parties may develop technologies that are similar or superior to our proprietary technologies, duplicate or otherwise obtain and use our proprietary technologies, or design around patents owned or licensed by us. Conversely, if our technology is found to infringe any patent or other intellectual property right held by a third party, we could be prevented from providing our service offerings and could be subject to significant damage awards.

 

We also rely in some circumstances on trade secrets to protect our technology. We control access to and the use of our application capabilities through a combination of internal and external controls. We also license some of our software through agreements that impose specific restrictions on customers’ ability to use the software, such as prohibiting reverse engineering and limiting the use of copies.

 

On occasion, we incorporate third-party commercial or open source software products into our technology platform. Although we prefer to develop our own technology, we periodically employ third-party software in order to simplify our development and maintenance efforts, provide a “commodity” capability, support our own technology infrastructure or test a new capability.

 

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MEDICAL STAFF AND EMPLOYEES

 

General—Our hospitals are staffed by licensed physicians who have been admitted to the medical staffs of individual hospitals. Under state laws and other licensing standards, hospital medical staffs are generally self-governing organizations subject to ultimate oversight by the hospital’s local governing board. Members of the medical staffs of our hospitals also often serve on the medical staffs of hospitals not owned by us. Members of our medical staffs are free to terminate their affiliation with our hospitals or admit their patients to competing hospitals at any time. Although we operate some physician practices and, where permitted by law, employ some physicians, the overwhelming majority of the physicians who practice at our hospitals are not our employees. However, nurses, therapists, lab technicians, facility maintenance workers and the administrative staffs of hospitals normally are our employees. We are subject to federal minimum wage and hour laws and various state labor laws, and maintain a number of different employee benefit plans.

 

Our operations depend on the efforts, abilities and experience of the physicians on the medical staffs of our hospitals, most of whom have no contractual relationship with us. It is essential to our ongoing business that we attract and retain an appropriate number of quality physicians in all specialties on our medical staffs. Although we had a net overall gain in physicians added to our medical staffs in each of the last three years, in some of our markets, physician recruitment and retention are still affected by a shortage of physicians in certain sought-after specialties and the difficulties that physicians can experience in obtaining affordable malpractice insurance or finding insurers willing to provide such insurance. Other issues facing physicians, such as proposed decreases in Medicare payments, are causing them to consider alternatives, including leaving private practice for employed physician arrangements, relocating their practices or retiring sooner than expected.

 

We continue to take steps to successfully attract and retain key employees, qualified physicians and other health care professionals. One of our initiatives is our Physician Relationship Program, which is centered on 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. In general, the loss of some or all of our key employees or the inability to attract or retain sufficient numbers of qualified physicians and other health care professionals could have a material adverse effect on patient volumes and, thereby, our business, financial condition, results of operations or cash flows.

 

The number of our employees (of which approximately 24% were part-time employees) at December 31, 2012 was as follows:

 

Hospital operations(1)

 

53,877

 

Conifer

 

4,225

 

Administrative offices

 

1,062

 

Total

 

59,164

 

 


(1)              Includes employees whose employment related to the operations of our general hospitals, critical access facility, long-term acute care hospital, outpatient centers, physician practices and other health care operations.

 

At December 31, 2012, the largest concentrations of our employees (excluding employees in our administrative offices) were in those states where we had the largest concentrations of licensed hospital beds, as shown in the table below:

 

 

 

% of Employees

 

% of Licensed Beds

 

Florida

 

22.0

%

26.4

%

California

 

20.6

%

17.7.

%

Texas

 

16.9

%

19.9

%

 

Union Activity and Labor Relations—As of December 31, 2012, approximately 29% of our employees were represented by various labor unions. These employees — primarily registered nurses and service and maintenance workers — were located at 25 of our hospitals, the majority of which are in California and Florida. We have no expired contracts at this time; however, we are in the process of negotiating new contracts where employees have recently chosen union representation. At this time, we are unable to predict the outcome of the negotiations, but increases in salaries, wages and benefits could result from these agreements. Furthermore, there is a possibility that strikes could occur during the negotiation process, which could increase our labor costs and have an adverse effect on our patient admissions and net operating revenues. Ongoing organizing activities by labor unions could increase our level of union representation in 2013.

 

Shortage of Experienced Nurses and Mandatory Nurse-Staffing Ratios—In addition to union activity, factors that adversely affect our labor costs include the nationwide shortage of experienced nurses and the enactment of state laws regarding nurse-staffing ratios. Like others in the health care industry, we continue to experience a shortage of experienced nurses in certain key specialties and geographic areas. In addition, state-mandated nurse-staffing ratios in California affect not only our labor costs,

 

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but, if we are unable to hire the necessary number of experienced nurses to meet the required ratios, they may also cause us to limit patient admissions with a corresponding adverse effect on our net operating revenues. We continually monitor our nurse-staffing ratios in California in an effort to achieve full compliance with the state-mandated nurse-staffing ratios there. Nurse-staffing ratio legislation has been proposed in, but not yet enacted by, Congress and other states besides California in which we operate hospitals, including Florida and Pennsylvania. In 2009, Texas passed the Hospital Safe Staffing Law, which mandates the creation of nurse staffing committees at Texas hospitals and outlines each hospital’s responsibility to adopt, implement and enforce an official nurse staffing plan, but does not mandate staffing ratios. Also in 2009, the Missouri Department of Health and Senior Services adopted hospital nursing services regulations that are similar to the Texas requirements with respect to nurse staffing.

 

We cannot predict the degree to which we will be affected by the future availability or cost of nursing personnel, but we expect to continue to experience salary, wage and benefit pressures created by the shortage of experienced nurses throughout the country and state-mandated nurse-staffing ratios, particularly in California. In response, we have increased our efforts to recruit and retain experienced nurses and also to address workforce development with local schools of nursing. We expect that 25 of our hospitals will participate in the VersantTM RN Residency Program in 2013 by providing an 18- to 22-week residency program for new nursing school graduates to help ease the transition from student to professional practicing nurse, give nurses evidence-based experience and skills needed to increase their competency and confidence, reduce first-year nurse turnover and decrease the use of contract labor.

 

COMPETITION

 

HEALTH CARE SERVICES

 

Overall, our hospitals, outpatient centers and other health care businesses operate in competitive environments, primarily at the local level. Generally, other hospitals and outpatient centers in the local communities we serve provide services similar to those we offer, and, in some cases, competing facilities are more established or newer than ours. Furthermore, competing facilities (1) may offer a broader array of services to patients and physicians than ours, (2) may have larger or more specialized medical staffs to admit and refer patients, (3) may have a better reputation in the community, or (4) may be more centrally located with better parking or closer proximity to public transportation. We also face increased competition from specialty hospitals (some of which are physician-owned) and unaffiliated freestanding outpatient centers for market share in high margin services and for quality physicians and personnel. Furthermore, some of the hospitals that compete with our hospitals are owned by government agencies or not-for-profit organizations. These tax-exempt competitors may have certain financial advantages not available to our facilities, such as endowments, charitable contributions, tax-exempt financing, and exemptions from sales, property and income taxes. In addition, in certain markets in which we operate, large teaching hospitals provide highly specialized facilities, equipment and services that may not be available at our hospitals.

 

Another major factor in the competitive position of a hospital or outpatient facility is the ability to negotiate contracts with managed care plans. Our future success depends, in part, on our ability to retain and renew our managed care contracts and enter into new managed care contracts on terms favorable to us. Other health care providers may impact our ability to enter into acceptable managed care contractual arrangements or negotiate increases in our reimbursement and other favorable terms and conditions. For example, some of our competitors may negotiate exclusivity provisions with managed care plans or otherwise restrict the ability of managed care companies to contract with us.

 

Moreover, state laws that require findings of need for construction and expansion of health care facilities or services (as described in “Health Care Regulation and Licensing — Certificate of Need Requirements” below) may also have the effect of restricting competition. In addition, in those states that do not have certificate of need requirements or that do not require review of health care capital expenditure amounts below a relatively high threshold, competition in the form of new services, facilities and capital spending is more prevalent.

 

Our strategies are designed to help our hospitals remain competitive. Broadly speaking, we attract physicians by providing high-quality care to our patients and otherwise creating an environment within which physicians prefer to practice. One of our specific initiatives is our Physician Relationship Program, which is centered on 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 targeted capital spending in order to address specific needs or growth opportunities of our hospitals, which is expected to have a positive impact on their volumes. We have also sought to include all of our hospitals and an increased number of our affiliated physicians in the affected geographic area or nationally when negotiating new managed care contracts, which may result in additional volumes at facilities that were not previously a part of such managed care networks. In addition, we have completed clinical service line market demand analyses and profitability assessments to determine which services are highly valued that can be emphasized and marketed to improve our operating results. This Targeted Growth Initiative (“TGI”) has resulted in some reductions in unprofitable service lines in several locations. However, the

 

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de-emphasis or elimination of certain unprofitable service lines as a result of our TGI analyses will allow us to dedicate more resources on services that are in higher demand and are more profitable. We have also increased our focus on operating our outpatient centers with improved accessibility and more convenient service for patients, as well as increased predictability and efficiency for physicians.

 

Our Commitment to Quality and Medicare Performance Improvement initiatives are further helping position us competitively. We continually work with physicians to implement the most current evidence-based medicine techniques to improve the way we provide care, while using labor management tools and supply chain initiatives to reduce variable costs. We believe the use of these practices will promote the most effective and efficient utilization of resources and result in shorter lengths of stay, as well as reductions in redundant ancillary services and readmissions for hospitalized patients. As a result of our efforts, our CMS Hospital Compare Core Measures scores have consistently exceeded the national average since the end of 2005, and the major national commercial payers have recognized our achievements relative to quality. In general, we believe that quality of care improvements may have the effect of reducing costs, increasing payments from Medicare and certain managed care payers for our services, and increasing physician and patient satisfaction, which may improve our volumes.

 

Further, each hospital has a local governing board, consisting primarily of community members and physicians, that develops short-term and long-term plans for the hospital to foster a desirable medical environment. Each local governing board also reviews and approves, as appropriate, actions of the medical staff, including staff appointments, credentialing, peer review and quality assurance. While physicians may terminate their association with our hospitals at any time, we believe that by striving to maintain and improve the quality of care at our hospitals and by maintaining ethical and professional standards, we will attract and retain qualified physicians with a variety of specialties.

 

REVENUE CYCLE MANAGEMENT SOLUTIONS

 

Our Conifer subsidiary faces competition from existing participants and new entrants to the revenue cycle management market. In addition, the internal revenue cycle management staff of hospitals and other health care providers, who have historically performed many of the functions addressed by our services, in effect compete with us. Moreover, providers who have previously made investments in internally developed solutions sometimes choose to continue to rely on their own resources. We also currently compete with several categories of external participants in the revenue cycle market, most of which focus on small components of the hospital revenue cycle, including:

 

·            software vendors and other technology-supported revenue cycle management business process outsourcing companies;

 

·            traditional consultants, either specialized health care consulting firms or health care divisions of large accounting firms; and

 

·            large, non-healthcare focused business process outsourcing and information technology outsourcing firms.

 

We believe that competition for the revenue cycle management and other services Conifer provides is based primarily on: (1) knowledge and understanding of the complex public and private health care payment and reimbursement systems; (2) a track record of delivering revenue improvements and efficiency gains for hospitals and other health care providers; (3) the ability to deliver solutions that are fully integrated along each step of the revenue cycle; (4) cost-effectiveness, including the breakdown between up-front costs and pay-for-performance incentive compensation; (5) reliability, simplicity and flexibility of the technology platform; (6) understanding of the health care industry’s regulatory environment; (7) sufficient infrastructure; and (8) financial stability.

 

To be successful, Conifer must respond more quickly and effectively than its competitors to new or changing opportunities, technologies, standards, regulations and customer requirements. Existing or new competitors may introduce technologies or services that render Conifer’s technologies or services obsolete or less marketable. Even if Conifer’s technologies and services are more effective than the offerings of its competitors, current or potential customers might prefer competitive technologies or services to Conifer’s technologies and services. Furthermore, increased competition may result in pricing pressures, which could negatively impact Conifer’s margins, growth rate or market share.

 

HEALTH CARE REGULATION AND LICENSING

 

AFFORDABLE CARE ACT

 

The Affordable Care Act was enacted to change how health care services in the United States are covered, delivered and reimbursed. The primary goal of this comprehensive legislation is to extend health coverage to millions of uninsured legal

 

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U.S. residents through a combination of private sector health insurance reforms and public program expansion. To fund the expansion of insurance coverage, the legislation contains measures designed to promote quality and cost efficiency in health care delivery and to generate budgetary savings in the Medicare and Medicaid programs. We are unable to predict the full impact of the Affordable Care Act on our future revenues and operations at this time due to the law’s complexity, the limited amount of implementing regulations and interpretive guidance, uncertainty regarding the ultimate number of uninsured patients who will obtain insurance coverage, uncertainty regarding future negotiations with payers, and gradual or potentially delayed implementation. However, we expect that several provisions of the Affordable Care Act, including those described below, will have a material effect on our business.

 

Health Insurance Market Reforms—The Affordable Care Act contains provisions requiring most Americans to maintain, and employers to provide, “minimal essential” health insurance coverage. For individuals who are not exempt from this “individual mandate,” and who do not receive health insurance through an employer or government program, the means of satisfying the requirement is to purchase insurance from a private company. Beginning in 2014, those who do not comply with the individual mandate must make a “shared responsibility payment” to the federal government in the form of a tax penalty. In June 2012, the U.S. Supreme Court upheld the individual mandate following the appeal of a lawsuit first filed in federal district court by 26 states, several individuals and the National Federation of Independent Business challenging the constitutionality of various provisions of the Affordable Care Act.

 

The law also establishes a number of health insurance market reforms, including bans on lifetime limits and pre-existing condition exclusions, new benefit mandates, and increased dependent coverage. Specifically, group health plans and health insurance issuers offering group or individual coverage (“Plans”):

 

·                    may not establish lifetime limits or, beginning January 1, 2014, annual limits on the dollar value of benefits;

 

·                    may not rescind coverage of an enrollee, except in instances where the individual has performed an act or practice that constitutes fraud or makes an intentional misrepresentation of material fact;

 

·                    must reimburse hospitals for emergency services provided to enrollees without prior authorization and without regard to whether a participating provider contract is in place; and

 

·                    must continue to make dependent coverage available to unmarried dependents until age 26 (coverage for the dependents of unmarried adult children is not required) effective for health plan policy years beginning on or after September 23, 2010 (for Plans that offer dependent coverage).

 

It is not clear what impact, if any, the increased obligations on managed care payers and other payers imposed by the Affordable Care Act will have on our commercial managed care volumes and payment rates.

 

In addition, the Affordable Care Act calls for states to establish health insurance exchanges, which are government-regulated organizations that provide a competitive market for buying health insurance. Health insurance exchanges will offer individuals a choice of different health plans, certifying plans that participate and providing information to help consumers better understand their options. States have the option of operating their own exchanges or partnering with the federal government to run an exchange. States choosing neither option will default to a federally facilitated exchange. All exchanges, regardless of how they are administered, must be ready to begin enrolling consumers into coverage on October 1, 2013 and must be fully operational on January 1, 2014.

 

Public Program Reforms—The Affordable Care Act expands eligibility under existing Medicaid programs to non-pregnant adults with incomes up to 138% of the federal poverty level beginning in 2014. Further, the law permits states to create federally funded, non-Medicaid plans for low-income residents not eligible for Medicaid. However, the Affordable Care Act also contains a number of provisions designed to reduce Medicare and Medicaid program spending by significant amounts, including:

 

·                    negative adjustments to the annual input price index, or “market basket,” updates for Medicare’s inpatient, outpatient, long-term acute and inpatient rehabilitation prospective payment systems, which began in 2010, as well as additional “productivity adjustments,” which began in 2011; and

 

·                    reductions to Medicare and Medicaid disproportionate share hospital payments beginning in federal fiscal year (“FFY”) 2014 as the number of uninsured individuals declines.

 

Any reductions to our reimbursement under the Medicare and Medicaid programs by the Affordable Care Act could adversely affect our business and results of operations to the extent such reductions are not offset by increased revenues from providing care to previously uninsured individuals.

 

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The Affordable Care Act, as enacted, penalized states that refused to comply with Medicaid expansion with the possibility of losing 100% of their federal Medicaid funding. However, the U.S. Supreme Court struck down that provision in June 2012 following the appeal of the lawsuit discussed above challenging the constitutionality of various provisions of the Affordable Care Act. The expansion of the Medicaid program in each state will require state legislative action and the approval by CMS of a state Medicaid plan amendment. There is no deadline for a state to undertake expansion and qualify for the enhanced federal funding available under the Affordable Care Act. We cannot provide any assurances as to whether or when the states in which we operate might choose to expand their Medicaid programs.

 

The Affordable Care Act also contains a number of provisions intended to improve the quality and efficiency of medical care provided to Medicare and Medicaid beneficiaries. For example, the legislation expands payment penalties based on a hospital’s rates of hospital-acquired conditions (“HACs”). Medicare has designated selected diagnoses as HACs. These are conditions that would otherwise potentially result in a higher payment for an inpatient hospital discharge, but will not result in a higher payment if the condition is acquired during hospitalization (i.e., was not present on admission), as the case will be paid as though the secondary diagnosis is not present. Effective July 1, 2011, the Affordable Care Act likewise prohibits the use of federal funds under the Medicaid program to reimburse providers for medical assistance provided to treat HACs. Beginning in FFY 2015, hospitals that fall into the top 25% of national risk-adjusted HAC rates for all hospitals in the previous year will also receive a 1% reduction in Medicare payment rates. For discharges occurring during FFYs beginning on or after October 1, 2012, hospitals with excessive readmissions for certain conditions will receive reduced Medicare payments for all inpatient admissions. Separately, under a Medicare value-based purchasing program that was launched in FFY 2013, hospitals that satisfy certain performance standards will receive increased payments for discharges during the following fiscal year. These payments will be funded by decreases in payments to all hospitals for inpatient services. For discharges occurring during FFY 2014 and after, the performance standards must assess hospital efficiency, including Medicare spending per beneficiary. In addition, the Affordable Care Act directed CMS to launch a national pilot program to study the use of bundled payments to hospitals, physicians and post-acute care providers relating to a single admission to promote collaboration and alignment on quality and efficiency improvement; implementation of the pilot program is currently ongoing through the Center for Medicare and Medicaid Innovation within CMS, which has the authority to develop and test new payment methodologies designed to improve quality of care and lower costs.

 

In addition, the Affordable Care Act contains provisions relating to recovery audit contractors (“RACs”), which are third-party organizations under contract with CMS that identify underpayments and overpayments under the Medicare program and recoup any overpayments on behalf of the government. The Affordable Care Act expanded the RAC program’s scope to include Medicaid claims and required all states to enter into contracts with RACs.

 

Other Provisions—The Affordable Care Act contains a number of other additional provisions, including provisions relating to the Medicare and Medicaid anti-kickback and anti-fraud and abuse amendments, Section 1877 of the Social Security Act (commonly referred to as the “Stark” law), and qui tam or “whistleblower” actions, each of which is described in detail below, as well as provisions regarding:

 

·                    the creation of an Independent Payment Advisory Board that will make recommendations to Congress regarding additional changes to provider payments and other aspects of the nation’s health care system; and

 

·                    new taxes on manufacturers and distributors of pharmaceuticals and medical devices used by our hospitals, as well as a requirement that manufacturers file annual reports of payments made to physicians.

 

Many of the law’s provisions will not take effect until 2014, while others became effective immediately or have become effective more recently. Many provisions also will require the federal government and individual state governments to interpret and implement the new requirements. In particular, we are unable to predict the timing and impact of changes resulting from actions individual states have taken or might take with respect to expanding Medicaid coverage at this time. Because of the many variables involved, we are unable to predict with certainty the net effect on us of the expected increase in revenues and expected decrease in bad debt expense from providing care to previously uninsured and underinsured individuals, the reductions in Medicare and Medicaid spending, and numerous other provisions in the law that may affect us. In addition, even after implementation of the Affordable Care Act, we may continue to experience a high level of bad debt expense and have to provide uninsured discounts and charity care due to the failure of states to expand Medicaid coverage as originally contemplated by the Affordable Care Act and for undocumented aliens who will not be permitted to enroll in a health insurance exchange or government health care program. Moreover, we are unable to predict the future course of federal, state and local health care regulation or legislation, including Medicare and Medicaid statutes and regulations. Further changes in the regulatory framework affecting health care providers could have a material adverse effect on our business, financial condition, results of operations or cash flows.

 

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ANTI-KICKBACK AND SELF-REFERRAL REGULATIONS

 

Medicare and Medicaid anti-kickback and anti-fraud and abuse amendments codified under Section 1128B(b) of the Social Security Act (the “Anti-kickback Statute”) prohibit certain business practices and relationships that might affect the provision and cost of health care services payable under the Medicare and Medicaid programs and other government programs, including the payment or receipt of remuneration for the referral of patients whose care will be paid for by such programs. Specifically, the law prohibits any person or entity from offering, paying, soliciting or receiving anything of value, directly or indirectly, for the referral of patients covered by Medicare, Medicaid and other federal health care programs or the leasing, purchasing, ordering or arranging for or recommending the lease, purchase or order of any item, good, facility or service covered by these programs. In addition to addressing other matters, as discussed below, the Health Insurance Portability and Accountability Act of 1996 (“HIPAA”) also amended Title XI (42 U.S.C. Section 1301 et seq.) to broaden the scope of fraud and abuse laws to include all health plans, whether or not payments under such health plans are made pursuant to a federal program. Moreover, the Affordable Care Act amended the Anti-kickback Statute to provide that knowledge of the law or the intent to violate the law is not required.

 

Sanctions for violating the Anti-kickback Statute include criminal and civil penalties, as well as fines and possible exclusion from government programs, such as Medicare and Medicaid. In addition, under the Affordable Care Act, submission of a claim for services or items generated in violation of the Anti-kickback Statute constitutes a false or fraudulent claim and may be subject to additional penalties under the federal False Claims Act (“FCA”). Furthermore, it is a violation of the federal Civil Monetary Penalties Law to offer or transfer anything of value to Medicare or Medicaid beneficiaries that is likely to influence their decision to obtain covered goods or services from one provider or service over another. Many states have statutes similar to the federal Anti-kickback Statute, except that the state statutes usually apply to referrals for services reimbursed by all third-party payers, not just federal programs.

 

The federal government has also issued regulations that describe some of the conduct and business relationships that are permissible under the Anti-kickback Statute. These regulations are often referred to as the “Safe Harbor” regulations. The fact that certain conduct or a given business arrangement does not meet a Safe Harbor does not necessarily render the conduct or business arrangement illegal under the Anti-kickback Statute. Rather, such conduct and business arrangements may be subject to increased scrutiny by government enforcement authorities and should be reviewed on a case-by-case basis.

 

Although we seek to structure our business relationships to avoid any activity that could be construed to violate the Anti-kickback Statute and similar laws, new payment structures, such as accountable care organizations and other arrangements involving combinations of hospitals, physicians and other providers who share payment savings could potentially be seen as implicating such laws. In addition to the sanctions described above, any determination by a federal or state agency or court that we have violated any of these laws could give Conifer’s customers the right to terminate our services agreements with them. Moreover, any violations by and resulting penalties or exclusions imposed upon Conifer’s customers could adversely affect their financial condition and, in turn, have a material adverse effect on Conifer’s business and results of operations.

 

The Stark law generally restricts referrals by physicians of Medicare or Medicaid patients to entities with which the physician or an immediate family member has a financial relationship, unless one of several exceptions applies. The referral prohibition applies to a number of statutorily defined “designated health services,” such as clinical laboratory, physical therapy, radiology, and inpatient and outpatient hospital services. The exceptions to the referral prohibition cover a broad range of common financial relationships. These statutory, and the subsequent regulatory, exceptions are available to protect certain permitted employment relationships, relocation arrangements, leases, group practice arrangements, medical directorships, and other common relationships between physicians and providers of designated health services, such as hospitals. A violation of the Stark law may result in a denial of payment, required refunds to patients and the Medicare program, civil monetary penalties of up to $15,000 for each violation, civil monetary penalties of up to $100,000 for “sham” arrangements, civil monetary penalties of up to $10,000 for each day that an entity fails to report required information, and exclusion from participation in the Medicare and Medicaid programs and other federal programs. In addition, the submission of a claim for services or items generated in violation of the Stark law may constitute a false or fraudulent claim, and thus be subject to additional penalties under the FCA. Many states have adopted self-referral statutes similar to the Stark Law, some of which extend beyond the related state Medicaid program to prohibit the payment or receipt of remuneration for the referral of patients and physician self-referrals regardless of the source of the payment for the care. Our participation in and development of joint ventures and other financial relationships with physicians could be adversely affected by the Stark law and similar state enactments.

 

The Affordable Care Act also made changes to the “whole hospital” exception in the Stark law, effectively preventing new physician-owned hospitals after March 23, 2010 and limiting the capacity and amount of physician ownership in existing physician-owned hospitals. As revised, the Stark law prohibits physicians from referring Medicare patients to a hospital in which they have an ownership or investment interest unless the hospital has physician ownership and a Medicare provider agreement as of March 23, 2010 (or, for those hospitals under development at the time of the Affordable Care Act’s enactment, as of

 

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December 31, 2010). A physician-owned hospital that meets these requirements will still be subject to restrictions that limit the hospital’s aggregate physician ownership percentage and, with certain narrow exceptions for hospitals with a high percentage of Medicaid patients, prohibit expansion of the number of operating rooms, procedure rooms or beds. The legislation also subjects a physician-owned hospital to reporting requirements and extensive disclosure requirements on the hospital’s website and in any public advertisements. As of December 31, 2012, two of our hospitals are owned by joint ventures that include some physician owners and are subject to the limitations and requirements in the Affordable Care Act on physician-owned hospitals.

 

In accordance with our ethics and compliance program, which is described in detail under “Compliance and Ethics” below, we have policies and procedures in place concerning compliance with the Anti-kickback Statute and the Stark law, among others. In addition, our ethics and compliance, law and audit services departments systematically review a substantial number of our arrangements with referral sources to determine the extent to which they comply with our policies and procedures and with the Anti-kickback Statute, the Stark law and similar state statutes.

 

HEALTH INSURANCE PORTABILITY AND ACCOUNTABILITY ACT

 

Title II, Subtitle F of the Health Insurance Portability and Accountability Act mandates the adoption of specific standards for electronic transactions and code sets that are used to transmit certain types of health information. HIPAA’s objective is to encourage efficiency and reduce the cost of operations within the health care industry. To protect the information transmitted using the mandated standards and the patient information used in the daily operations of a covered entity, HIPAA also sets forth federal rules protecting the privacy and security of protected health information (“PHI”). The privacy and security regulations address the use and disclosure of individually identifiable health information and the rights of patients to understand and control how their information is used and disclosed. The law provides both criminal and civil fines and penalties for covered entities that fail to comply with HIPAA.

 

To receive reimbursement from CMS for electronic claims, health care providers must use HIPAA’s electronic data transmission (transaction and code set) standards when transmitting certain health care information electronically. Our electronic data transmissions are compliant with current standards. In January 2009, CMS published a final rule changing the formats used for certain electronic transactions and requiring the use of updated standard code sets for certain diagnoses and procedures known as ICD-10 code sets. At this time, use of the ICD-10 code sets is not mandatory until October 1, 2014. Nonetheless, we have begun modifying our payment systems and processes to prepare for ICD-10 implementation. Although use of the ICD-10 code sets will require significant administrative changes, we believe that the cost of compliance with these regulations has not had and is not expected to have a material adverse effect on our business, financial condition, results of operations or revenues. However, we may experience a short-term adverse impact on our cash flows due to claims processing delays related to payer implementation of the new code sets. Furthermore, the Affordable Care Act requires the U.S. Department of Health and Human Services (“HHS”) to adopt standards for additional electronic transactions and to establish operating rules to promote uniformity in the implementation of each standardized electronic transaction.

 

Under HIPAA, covered entities must establish administrative, physical and technical safeguards to protect the confidentiality, integrity and availability of electronic PHI maintained or transmitted by them or by others on their behalf. The covered entities we operate are in material compliance with the privacy, security and National Provider Identifier requirements of HIPAA. In addition, most of Conifer’s customers are covered entities, and Conifer is a business associate to many of those customers under HIPAA as a result of its contractual obligations to perform certain functions on behalf of and provide certain services to those customers. As a business associate, Conifer’s use and disclosure of PHI is restricted by HIPAA and the business associate agreements Conifer is required to enter into with its covered entity customers.

 

In 2009, HIPAA was amended by the Health Information Technology for Economic and Clinical Health (“HITECH”) Act to impose certain of the HIPAA privacy and security requirements directly upon business associates of covered entities and significantly increase the monetary penalties for violations of HIPAA. Regulations that took effect in late 2009 also require business associates such as Conifer to notify covered entities, who in turn must notify affected individuals and government authorities, of data security breaches involving unsecured PHI. Since the passage of the HITECH Act, enforcement of HIPAA violations has increased. A knowing breach of the HIPAA privacy and security requirements made applicable to business associates by the HITECH Act could expose Conifer to criminal liability, and a breach of safeguards and processes that is not due to reasonable cause or involves willful neglect could expose Conifer to significant civil penalties and the possibility of civil litigation under HIPAA and applicable state law.

 

In May 2011, the Office for Civil Rights of HHS proposed new regulations to implement changes to the HIPAA requirements set forth in the HITECH Act that state that covered entities and business associates must account for disclosures of PHI to carry out treatment, payment and health care operations if such disclosures are through an electronic health record. The proposed regulations seek to expand the scope of the requirements under the HITECH Act and create a new patient right to an “access report,” which would be required to list every person who has accessed, for any reason, PHI about the individual

 

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contained in any electronic designated record set. Because our hospitals currently utilize multiple, independent modules that may meet the definition of “electronic designated record set,” our ability to produce an access report that satisfies the proposed regulatory requirements would likely require new technology solutions to map across those multiple record sets. It is our understanding that many providers have expressed significant concerns to CMS regarding the access report requirement created by the proposed rule. On January 17, 2013, HHS issued final regulations modifying the requirements set forth in the HITECH Act. While we anticipate that we will be in full compliance with the new regulations before the compliance date of September 23, 2013, the new regulations do not address the proposed “access report” requirement. Because we cannot predict the requirements of the final rule regarding access reports, we are unable to estimate the costs of compliance, if any, at this time.

 

We have developed a comprehensive set of policies and procedures in our efforts to comply with HIPAA, and similar state privacy laws, under the guidance of our ethics and compliance department. Hospital and Conifer compliance officers and information security officers are responsible for implementing and monitoring compliance with our HIPAA privacy and security policies and procedures at our hospitals and Conifer. We have also created an internal web-based HIPAA training program, which is mandatory for all employees. Based on existing regulations and our experience with HIPAA to this point, we continue to believe that the ongoing costs of complying with HIPAA will not have a material adverse effect on our business, financial condition, results of operations or cash flows.

 

GOVERNMENT ENFORCEMENT EFFORTS AND QUI TAM LAWSUITS

 

Both federal and state government agencies continue heightened and coordinated civil and criminal enforcement efforts against the health care industry. The operational mission of the Office of Inspector General (“OIG”) of HHS is to protect the integrity of the Medicare and Medicaid programs and the well-being of program beneficiaries by: detecting and preventing waste, fraud and abuse; identifying opportunities to improve program economy, efficiency and effectiveness; and holding accountable those who do not meet program requirements or who violate federal laws. The OIG carries out its mission by conducting audits, evaluations and investigations and, when appropriate, imposing civil monetary penalties, assessments and administrative sanctions. Although we have extensive policies and procedures in place to facilitate compliance in all material respects with the laws, rules and regulations affecting the health care industry, if a determination is made that we were in material violation of such laws, rules or regulations, our business, financial condition, results of operations or cash flows could be materially adversely affected.

 

Health care providers are also subject to qui tam or “whistleblower” lawsuits under the federal False Claims Act, which allows private individuals to bring actions on behalf of the government, alleging that a hospital or health care provider has defrauded a government program, such as Medicare or Medicaid. If the government intervenes in the action and prevails, the defendant may be required to pay three times the actual damages sustained by the government, plus mandatory civil penalties for each false claim submitted to the government. As part of the resolution of a qui tam case, the party filing the initial complaint may share in a portion of any settlement or judgment. If the government does not intervene in the action, the qui tam plaintiff may continue to pursue the action independently. There are many potential bases for liability under the FCA. Liability often arises when an entity knowingly submits a false claim for reimbursement to the federal government. The FCA defines the term “knowingly” broadly. Though simple negligence will not give rise to liability under the FCA, submitting a claim with reckless disregard to its truth or falsity constitutes a “knowing” submission under the FCA and, therefore, will qualify for liability. The Fraud Enforcement and Recovery Act of 2009 expanded the scope of the FCA by, among other things, creating liability for knowingly and improperly avoiding repayment of an overpayment received from the government and broadening protections for whistleblowers. Under the Affordable Care Act, the knowing failure to report and return an overpayment within 60 days of identifying the overpayment or by the date a corresponding cost report is due, whichever is later, constitutes a violation of the FCA. Further, the Affordable Care Act expands the scope of the FCA to cover payments in connection with health insurance exchanges if those payments include any federal funds. Qui tam actions can also be filed under certain state false claims laws if the fraud involves Medicaid funds or funding from state and local agencies. Like other companies in the health care industry, we are subject to qui tam actions from time to time; however, we are unable to predict the future impact of such actions on our business, financial condition, results of operations or cash flows.

 

HEALTH CARE FACILITY LICENSING REQUIREMENTS

 

In order to maintain their operating licenses, health care facilities must comply with strict governmental standards concerning medical care, equipment and cleanliness. Various licenses and permits also are required in order to dispense narcotics, operate pharmacies, handle radioactive materials and operate certain equipment. Our health care facilities hold all required governmental approvals, licenses and permits material to the operation of their business.

 

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UTILIZATION REVIEW COMPLIANCE AND HOSPITAL GOVERNANCE

 

In addition to certain statutory coverage limits and exclusions, federal laws and regulations, specifically the Medicare Conditions of Participation, generally require health care providers, including hospitals that furnish or order health care services that may be paid for under the Medicare program or state health care programs, to ensure that claims for reimbursement are for services or items that are (1) provided economically and only when, and to the extent, they are medically reasonable and necessary, (2) of a quality that meets professionally recognized standards of health care, and (3) supported by appropriate evidence of medical necessity and quality. The Social Security Act established the Utilization and Quality Control Peer Review Organization program, now known as the Quality Improvement Organization (“QIO”) program, to promote the effectiveness, efficiency, economy and quality of services delivered to Medicare beneficiaries and to ensure that those services are reasonable and necessary. CMS administers the QIO program through a network of QIOs that work with consumers, physicians, hospitals and other caregivers to refine care delivery systems to ensure patients receive the appropriate care at the appropriate time, particularly among underserved populations. The QIO program also safeguards the integrity of the Medicare trust fund by reviewing Medicare patient admissions, treatments and discharges, and ensuring payment is made only for medically necessary services, and investigates beneficiary complaints about quality of care. The QIOs have the authority to deny payment for services provided and recommend to HHS that a provider that is in substantial noncompliance with certain standards be excluded from participating in the Medicare program.

 

Medical and surgical services and practices are extensively supervised by committees of staff doctors at each of our health care facilities, are overseen by each facility’s local governing board, the members of which primarily are community members and physicians, and are reviewed by our clinical quality personnel. The local hospital governing board also helps maintain standards for quality care, develop short-term and long-range plans, and establish, review and enforce practices and procedures, as well as approves the credentials, disciplining and, if necessary, the termination of privileges of medical staff members.

 

CERTIFICATE OF NEED REQUIREMENTS

 

Some states require state approval for construction, expansion and closure of health care facilities, including findings of need for additional or expanded health care facilities or services. Certificates of need, which are issued by governmental agencies with jurisdiction over health care facilities, are at times required for capital expenditures exceeding a prescribed amount, changes in bed capacity or services, and certain other matters. As of December 31, 2012, we operated hospitals in seven states that require a form of state approval under certificate of need programs applicable to those hospitals. We are unable to predict whether we will be required or able to obtain any additional certificates of need in any jurisdiction where they are required, or if any jurisdiction will eliminate or alter its certificate of need requirements in a manner that will increase competition and, thereby, affect our competitive position. In those states that do not have certificate of need requirements or that do not require review of health care capital expenditure amounts below a relatively high threshold, competition in the form of new services, facilities and capital spending is more prevalent.

 

ENVIRONMENTAL MATTERS

 

Our health care operations are subject to a number of federal, state and local environmental laws, rules and regulations that govern, among other things, our disposal of solid waste, as well as our use, storage, transportation and disposal of hazardous and toxic materials (including radiological materials). Our operations also generate medical waste that must be disposed of in compliance with laws and regulations that vary from state to state. In addition, although we are not engaged in manufacturing or other activities that produce meaningful levels of greenhouse gas emissions, our operating expenses could be adversely affected if legal and regulatory developments related to climate change or other initiatives result in increased energy or other costs. We could also be affected by climate change and other environmental issues to the extent such issues adversely affect the general economy or result in severe weather or climate change events affecting the communities in which our facilities are located. At this time, based on current climate conditions and our assessment of existing and pending environmental rules and regulations, as well as treaties and international accords relating to climate change, we do not believe that the costs of complying with environmental laws and regulations, including regulations relating to climate change issues, will have a material adverse effect on our future capital expenditures, results of operations or cash flows.

 

Consistent with our commitment to meet the highest standards of corporate responsibility, we have formed a sustainability committee consisting of corporate and hospital leaders to regularly evaluate our environmental outcomes and share best practices among our hospitals and other facilities. In 2012, we published our second annual sustainability report, using the industry-standard Global Reporting Initiative framework. In addition, we are a sponsor of the Healthier Hospitals Initiative and will work with each of our hospitals in adopting components of the initiative’s agenda, which focuses on improvements in (1) sustainability governance, (2) the provision of healthier foods, (3) energy consumption, (4) waste generation, (5) the use of

 

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safer chemicals and (6) purchasing decisions. We are committed to report the results of our sustainability efforts on an annual basis.

 

REGULATIONS AFFECTING CONIFER

 

DEBT COLLECTION ACTIVITIES

 

The federal Fair Debt Collection Practices Act (“FDCPA”) regulates persons who regularly collect or attempt to collect, directly or indirectly, consumer debts owed or asserted to be owed to another person. Certain of the accounts receivable handled by Conifer’s debt collection agency subsidiary, Syndicated Office Systems, LLC (“SOS”), are subject to the FDCPA, which establishes specific guidelines and procedures that debt collectors must follow in communicating with consumer debtors, including the time, place and manner of such communications. Further, the FDCPA prohibits harassment or abuse by debt collectors, including the threat of violence or criminal prosecution, obscene language or repeated telephone calls made with the intent to abuse or harass. The FDCPA also places restrictions on communications with individuals other than consumer debtors in connection with the collection of any consumer debt and sets forth specific procedures to be followed when communicating with such third parties for purposes of obtaining location information about the consumer. In addition, the FDCPA contains various notice and disclosure requirements and prohibits unfair or misleading representations by debt collectors. Finally, the FDCPA imposes certain limitations on lawsuits to collect debts against consumers. Debt collection activities are also regulated at state level. Most states have laws regulating debt collection activities in ways that are similar to, and in some cases more stringent than, the FDCPA.

 

In certain situations, the activities of SOS are also subject to the Fair Credit Reporting Act (“FCRA”), which regulates consumer credit reporting and which may impose liability on us to the extent that the adverse credit information reported on a consumer to a credit bureau is false or inaccurate. State law, to the extent it is not preempted by the FCRA, may also impose restrictions or liability on us with respect to reporting adverse credit information.

 

The U.S. Federal Trade Commission has the authority to investigate consumer complaints relating to the FDCPA and the FCRA, and to initiate or recommend enforcement actions, including actions to seek monetary penalties. State officials typically have authority to enforce corresponding state laws. In addition, affected consumers may bring suits, including class action suits, to seek monetary remedies (including statutory damages) for violations of the federal and state provisions discussed above.

 

In July 2010, the President signed the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) into law. Under the Dodd-Frank Act, a new Consumer Financial Protection Bureau (“CFPB”) was formed within the U.S. Federal Reserve to promulgate regulations to promote transparency, simplicity, fairness, accountability and equal access in the market for consumer financial products or services, including debt collection services. The legislation gives significant discretion to the CFPB in establishing regulatory requirements and enforcement priorities. At this time, we cannot predict the extent to which the operations of SOS could be affected by these developments.

 

CREDIT CARD ACTIVITIES

 

Conifer accepts payments by credit cards from patients of its customers. Various federal and state laws impose privacy and information security laws and regulations with respect to the use of credit cards. If Conifer fails to comply with these laws and regulations or experiences a credit card security breach, its reputation could be damaged, possibly resulting in lost business, and it could be subjected to additional legal or financial risk as a result of non-compliance.

 

COMPLIANCE AND ETHICS

 

General—Our ethics and compliance department maintains our multi-faceted, values-based ethics and compliance program, which is designed to (1) help staff in our corporate and Conifer offices, hospitals, outpatient centers and physician practices meet or exceed applicable standards established by federal and state laws and regulations, as well as industry practice, and (2) monitor and raise awareness of ethical issues among employees and others, and stress the importance of understanding and complying with our Standards of Conduct. The ethics and compliance department operates with independence — it has its own operating budget; it has the authority to hire outside counsel, access any Tenet document and interview any of our personnel; and our chief compliance officer reports directly to the quality, compliance and ethics committee of our board of directors.

 

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Program Charter—Following the expiration of our five-year Corporate Integrity Agreement (the “CIA”) with the OIG in September 2011, the quality, compliance and ethics committee of our board of directors approved an updated Quality, Compliance and Ethics Program Charter intended to continue certain of the safeguards implemented by the CIA and, among other things:

 

·                    support and maintain our present and future responsibilities with regard to participation in federal health care programs; and

 

·                    further our goals of (1) fostering and maintaining the highest ethical standards among all employees, officers and directors, physicians practicing at Tenet facilities and contractors that furnish health care items or services, and (2) valuing our compliance with all state and federal laws and regulations as a foundation of our corporate philosophy.

 

The primary focus of our quality, compliance and ethics program is compliance with the requirements of Medicare, Medicaid and other federally funded health care programs. Pursuant to the terms of the charter, our ethics and compliance department is responsible for the following activities: (1) annually assessing, critiquing and (as appropriate) drafting and distributing company policies and procedures; (2) developing, providing and tracking ethics training for all employees, directors, contractors and agents; (3) developing, providing and tracking job-specific training to those who work in clinical quality, coding, billing, cost reporting and referral source arrangements; (4) developing, providing and tracking annual training on ethics and clinical quality oversight to the members of each hospital governing board; (5) creating and disseminating the company’s Standards of Conduct and obtaining certifications of adherence to the Standards of Conduct as a condition of employment; (6) maintaining and promoting Tenet’s Ethics Action Line, which allows confidential reporting of issues on an anonymous basis and emphasizes Tenet’s no retaliation policy; (7) responding to and resolving all compliance-related issues that arise from the Ethics Action Line and compliance reports received from our facilities, hospital compliance officers or any other source; (8) ensuring that appropriate corrective and disciplinary actions are taken when non-compliant conduct or improper contractual relationships are identified; (9) monitoring and measuring the Company’s adherence to all applicable Tenet policies and legal and regulatory requirements related to federal health care programs; (10) directing an annual screening of individuals for exclusion from federal health care program participation as required by federal regulations; (11) maintaining a database of all arrangements involving the payment of anything of value between Tenet and any physician or other actual or potential source of health care business or referrals to or from Tenet; and (12) overseeing annual audits of clinical quality, referral source arrangements, outliers, charging, coding, billing and other compliance risk areas as may be identified from time to time.

 

Standards of Conduct—All of our employees, including our chief executive officer, chief financial officer and principal accounting officer, are required to abide by our Standards of Conduct to advance our mission that our business be conducted in a legal and ethical manner. The members of our board of directors and many of our contractors are also required to abide by our Standards of Conduct. The standards reflect our basic values and form the foundation of a comprehensive process that includes compliance with all corporate policies, procedures and practices. Our standards cover such areas as quality patient care, compliance with all applicable laws and regulations, appropriate use of our assets, protection of patient information and avoidance of conflicts of interest.

 

As part of the program, we provide annual training sessions to every employee, as well as our board of directors and certain physicians and contractors. All employees are required to report incidents that they believe in good faith may be in violation of the Standards of Conduct, and are encouraged to contact our 24-hour toll-free Ethics Action Line when they have questions about the standards or any ethics concerns. All reports to the Ethics Action Line are kept confidential to the extent allowed by law, and employees have the option to remain anonymous. Incidents of alleged financial improprieties reported to the Ethics Action Line or the ethics and compliance department are communicated to the audit committee of our board of directors. Reported cases that involve a possible violation of the law or regulatory policies and procedures are referred to the ethics and compliance department for investigation. Retaliation against employees in connection with reporting ethical concerns is considered a serious violation of our Standards of Conduct, and, if it occurs, it will result in discipline, up to and including termination of employment.

 

Availability of Documents—The full text of our Quality, Compliance and Ethics Program Charter, our Standards of Conduct, and a number of our ethics and compliance policies and procedures are published on our website, at www.tenethealth.com, under the “Ethics and Compliance” caption in the “About” section. A copy of our Standards of Conduct is also available upon written request to our corporate secretary. Information about how to contact our corporate secretary is set forth under “Company Information” below. Amendments to the Standards of Conduct and any grant of a waiver from a provision of the Standards of Conduct requiring disclosure under applicable Securities and Exchange Commission (“SEC”) rules will be disclosed at the same location as the Standards of Conduct on our website.

 

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PROPERTY AND PROFESSIONAL AND GENERAL LIABILITY INSURANCE

 

Property Insurance—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 periods April 1, 2011 through March 31, 2012 and April 1, 2012 through March 31, 2013, we have coverage totaling $600 million per occurrence, after deductibles and exclusions, with annual aggregate sub-limits of $100 million each for floods and earthquakes and a per-occurrence sub-limit of $100 million for windstorms with no annual aggregate. With respect to fires and other perils, excluding floods, earthquakes and windstorms, the total $600 million limit of coverage per occurrence applies. Deductibles are 5% of insured values up to a maximum of $25 million for floods, California earthquakes and wind-related claims, and 2% of insured values for New Madrid fault earthquakes, with a maximum per claim deductible of $25 million. Other covered losses, including fires and other perils, have a minimum deductible of $1 million.

 

Professional and General Liability Insurance—As is typical in the health care industry, we are subject to claims and lawsuits in the ordinary course of business. The health care industry has seen significant increases in the cost of professional liability insurance due to increased litigation. In response, we formed and maintain captive insurance companies to self-insure a substantial portion of our professional and general liability risk. Claims in excess of our self-insurance retentions are insured with commercial insurance companies.

 

For the policy period June 1, 2011 through May 31, 2012, our hospitals generally have a self-insurance retention of $5 million per occurrence for all claims incurred. Our captive insurance company, The Healthcare Insurance Corporation (“THINC”), retains $10 million per occurrence coverage above our hospitals’ $5 million self-insurance retention level. The next $10 million of claims in excess of these aggregate self-insurance retentions of $15 million per occurrence are 65% reinsured by THINC with independent reinsurance companies, with THINC retaining 35% or a maximum of $3.5 million. Claims in excess of $25 million are covered by our excess professional and general liability insurance policies with major independent insurance companies, on a claims-made basis, subject to an aggregate limit of $175 million.

 

For the policy period June 1, 2012 through May 31, 2013, our hospitals generally have a self-insurance retention of $5 million per occurrence for all claims incurred. THINC retains $10 million per occurrence coverage above our hospitals’ $5 million self-insurance retention level. The next $10 million of claims in excess of these aggregate self-insurance retentions of $15 million per occurrence are 80% reinsured by THINC with independent reinsurance companies, with THINC retaining 20% or a maximum of $2 million. Claims in excess of $25 million are covered by our excess professional and general liability insurance policies with major independent insurance companies, on a claims-made basis, subject to an aggregate limit of $175 million.

 

If the aggregate limit of any of our professional and general liability policies is exhausted, in whole or in part, it could deplete or reduce the limits available to pay any other material claims applicable to that policy period. Any losses not covered by or in excess of the amounts maintained under insurance policies will be funded from our working capital.

 

In addition to the reserves recorded by our captive insurance subsidiaries, we maintain reserves, including reserves for incurred but not reported claims, for our self-insured professional liability retentions and claims in excess of the policies’ aggregate limits, based on actuarial estimates of losses and related expenses. Also, we provide standby letters of credit to certain of our insurers, which can be drawn upon under certain circumstances, to collateralize the deductible and self-insured retentions under a selected number of our professional and general liability insurance programs.

 

EXECUTIVE OFFICERS

 

Information about our executive officers, as of February 15, 2013, is as follows:

 

Name

 

Position

 

Age

Trevor Fetter

 

President and Chief Executive Officer

 

53

Britt T. Reynolds

 

President of Hospital Operations

 

47

Daniel J. Cancelmi

 

Chief Financial Officer

 

50

Audrey T. Andrews

 

Senior Vice President and General Counsel

 

46

Cathryn H. Fraser

 

Senior Vice President, Human Resources

 

48

 

Mr. Fetter was named Tenet’s president in November 2002 and was appointed chief executive officer and a director in September 2003. From March 2000 to November 2002, he was chairman and chief executive officer of Broadlane, Inc., a provider of cost management services to hospitals that was founded by Tenet and several other major health care providers. From October 1995 to February 2000, he served in several senior management positions at Tenet, including chief financial officer. Mr. Fetter began his career in investment banking with Merrill Lynch and later spent seven years in financial executive positions in the entertainment industry with Metro-Goldwyn-Mayer, Inc. He holds an M.B.A. from Harvard Business School and a

 

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bachelor’s degree in economics from Stanford University. He is a member of the board of directors of The Hartford Financial Services Group, Inc. and a member of The Business Roundtable. Mr. Fetter served as chair of the Federation of American Hospitals from 2009 to 2010 and remains a director.

 

Mr. Reynolds was appointed president of hospital operations in January 2012. From December 2008 through December 2011, he served as senior vice president and division president of Health Management Associates, Inc. (“HMA”), overseeing HMA’s largest division, with 20 hospitals and related facilities in seven states. Prior to joining HMA, Mr. Reynolds served as a multi-facility divisional vice president of Community Health Systems, Inc. from December 2002 to December 2008, primarily in the northeast, midwest and southeast. Mr. Reynolds holds an M.B.A. from Baker University in Baldwin City, Kansas, and a bachelor’s degree in psychology from the University of Louisville. He is a Fellow of the American College of Healthcare Executives (FACHE).

 

Mr. Cancelmi was appointed Tenet’s chief financial officer in September 2012. He previously served as senior vice president from April 2009, principal accounting officer from April 2007 and controller from September 2004. Mr. Cancelmi was a vice president and assistant controller at Tenet from September 1999 until his promotion to controller. He joined the company as chief financial officer of Hahnemann University Hospital. He has also held various positions at PricewaterhouseCoopers, including in the firm’s National Accounting and SEC office in New York City. Mr. Cancelmi is a certified public accountant who holds a Bachelor of Science degree in accounting from Duquesne University in Pittsburgh. He is also a member of the American Institute of Certified Public Accountants.

 

Ms. Andrews was appointed senior vice president and general counsel in January 2013. From July 2008 until that appointment, she served as senior vice president and chief compliance officer and, prior to that, served as vice president and chief compliance officer from November 2006. She joined Tenet in 1998 as hospital operations counsel. Ms. Andrews holds a J.D. and a bachelor’s degree in government, both from the University of Texas at Austin. She is a member of the board of directors of the Federation of American Hospitals and is the vice chair of that organization’s Legal and Operational Policy Committee. She is also a member of the Health Care Compliance Association, the American and Texas Bar Associations, and the American Health Lawyers Association.

 

Ms. Fraser joined Tenet as senior vice president, human resources, in September 2006. From June 2000 to September 2006, she served as a management consultant with McKinsey & Co. Inc., the international consulting firm. In that role, Ms. Fraser counseled senior executives at a number of large companies on organizational design, talent management and retention strategies, recruiting and related human resources topics. Prior to her work with McKinsey, Ms. Fraser served as a vice president of Sabre Holdings Inc., a major provider of travel product distribution and technology solutions for the travel industry, from 1994 to 2000. She has also worked for American Airlines and General Motors Acceptance Corp. Ms. Fraser holds an M.B.A. from the University of Michigan and a bachelor’s degree in business administration from the University of Washington in Seattle. She is a board member of Workforce Solutions of Greater Dallas and the JKU Foundation, a family non-profit foundation. Ms. Fraser also serves as a volunteer on various committees in the City of Coppell, Texas.

 

COMPANY INFORMATION

 

Tenet Healthcare Corporation was incorporated in the State of Nevada in 1975. We file annual, quarterly and current reports, proxy statements and other documents with the SEC under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Our reports, proxy statements and other documents filed electronically with the SEC are available at the website maintained by the SEC at www.sec.gov.

 

Our website, www.tenethealth.com, also offers, free of charge, access to our annual, quarterly and current reports (and amendments to such reports) and other filings made with, or furnished to, the SEC as soon as reasonably practicable after such documents are submitted to the SEC. The information found on our website is not part of this or any other report we file with or furnish to the SEC.

 

Inquiries directed to our corporate secretary may be sent to Corporate Secretary, Tenet Healthcare Corporation, P.O. Box 139003, Dallas, Texas 75313-9003 or by e-mail at CorporateSecretary@tenethealth.com.

 

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 Exchange Act, each as amended. 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

 

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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:

 

·                  Changes in health care and other laws and regulations;

 

·                  Economic conditions;

 

·                  Adverse litigation or regulatory developments;

 

·                  Competition;

 

·                  Our success in implementing our business development plans and integrating newly acquired assets;

 

·                  Our ability to hire and retain health care professionals;

 

·                  Our ability to meet our capital needs, including our ability to manage our indebtedness;

 

·                  Our ability to grow our Conifer business segment; and

 

·                  Other factors and risks 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 this report. Should one or more of the risks and uncertainties described in this 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 any obligation to 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.

 

ITEM 1A. RISK FACTORS

 

Our business is subject to a number of risks and uncertainties — many of which are beyond our control — that may cause our actual operating results or financial performance to be materially different from our expectations. If one or more of the events discussed in the following risks were to occur, actual outcomes could differ materially from those expressed in or implied by any forward-looking statements we make in this report or our other filings with the SEC, and our business, financial condition, results of operations or liquidity could be materially adversely affected; furthermore, the trading price of our common stock could decline and our shareholders could lose all or part of their investment.

 

If we are unable to enter into and maintain managed care contractual arrangements on acceptable terms, if we experience material reductions in the contracted rates we receive from managed care payers or if we have difficulty collecting from managed care payers, our results of operations could be adversely affected.

 

We currently have thousands of managed care contracts with various health maintenance organizations and preferred provider organizations. The amount of our managed care net patient revenues during the year ended December 31, 2012 was $5.4 billion, which represented approximately 57% of our total net patient revenues before provision for doubtful accounts. Approximately 63% of our managed care net patient revenues for the year ended December 31, 2012 was derived from our top ten managed care payers. In the year ended December 31, 2012, our commercial managed care net inpatient revenue per admission from our acute care hospitals was approximately 79% higher than our aggregate yield on a per admission basis from government payers, including managed Medicare and Medicaid insurance plans. In addition, at December 31, 2012, approximately 52% of our net accounts receivable were due from managed care payers.

 

Our future success depends, in part, on our ability to retain and renew our managed care contracts and enter into new managed care contracts on terms favorable to us. Other health care providers may impact our ability to enter into acceptable managed care contractual arrangements or negotiate increases in our reimbursement and other favorable terms and conditions. For example, some of our competitors may negotiate exclusivity provisions with managed care plans or otherwise restrict the ability of managed care companies to contract with us. Furthermore, managed care payers are continuing to demand discounted fee structures, and the trend toward consolidation among these payers tends to increase their bargaining power. In some cases, commercial managed care payers rely on all or portions of Medicare’s severity-adjusted diagnosis-related group system to

 

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determine payment rates, which could result in decreased reimbursement from some of these payers if levels of payments to health care providers or payment methodologies under the Medicare program are changed. Other changes to government health care programs, such as the increased obligations on managed care payers imposed by the Affordable Care Act, may negatively impact commercial managed care volumes and payment rates from managed care payers. Any material reductions in the contracted rates we receive for our services, coupled with any difficulties in collecting receivables from managed care payers, could have a material adverse effect on our financial condition, results of operations or cash flows.

 

We cannot predict with certainty the effect that the Affordable Care Act may have on our business, financial condition, results of operations or cash flows.

 

The Affordable Care Act was enacted to change how health care services in the United States are covered, delivered and reimbursed. The expansion of health insurance coverage under the law may result in a material increase in the number of patients using our facilities who have either private or public program coverage. On the other hand, the Affordable Care Act provides for significant reductions in the growth of Medicare spending and reductions in Medicare and Medicaid disproportionate share hospital payments. A substantial portion of both our patient volumes and, as result, our revenues is derived from government health care programs, principally Medicare and Medicaid. Reductions to our reimbursement under the Medicare and Medicaid programs by the Affordable Care Act could adversely affect our business and results of operations.

 

In June 2012, the U.S. Supreme Court upheld the Affordable Care Act’s individual mandate and struck down its penalties for states that refused to comply with Medicaid expansion provisions. We remain unable to predict with certainty the full impact of the Affordable Care Act on our future revenues and operations at this time due to the law’s complexity and the limited amount of implementing regulations and interpretive guidance, as well as our inability to foresee how individuals and businesses will respond to the choices available to them under the law. Furthermore, many of the provisions of the Affordable Care Act that expand insurance coverage will not become effective until 2014 or later. In addition, the Affordable Care Act will result in increased state legislative and regulatory changes in order for states to participate in Medicaid expansion and the grants and other incentive opportunities under the law, and we are unable to predict the timing and impact of changes resulting from actions individual states have taken or might take with respect to expanding Medicaid coverage at this time.

 

In general, there is significant uncertainty with respect to the positive and negative effects the Affordable Care Act may have on reimbursement, utilization and the future designs of provider networks and insurance plans (including pricing, provider participation, coverage, co-pays and deductibles), and the multiple models that attempt to predict those effects may differ materially from our expectations.

 

Further changes in the Medicare and Medicaid programs or other government health care programs could have an adverse effect on our business.

 

For the year ended December 31, 2012, approximately 23% of our net patient revenues before provision for doubtful accounts were related to the Medicare program, and approximately 8% of our net patient revenues before provision for doubtful accounts were related to various state Medicaid programs, in each case excluding Medicare and Medicaid managed care programs. In addition to the changes affected by the Affordable Care Act, the Medicare and Medicaid programs are subject to: other statutory and regulatory changes, administrative rulings, interpretations and determinations concerning patient eligibility requirements, funding levels and the method of calculating payments or reimbursements, among other things; 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, which could in turn adversely affect our overall business, financial condition, results of operations or cash flows. Any material adverse effects resulting from future reductions in payments from government programs could be exacerbated if we are not able to manage our operating costs effectively.

 

Moreover, the economic downturn has increased budget pressures on most states, and these budget pressures have resulted, and likely will continue to result, in decreased spending for Medicaid programs in many states. Most states began a new fiscal year on July 1, 2012 and, although most addressed projected shortfalls in their final budgets, some states are still facing budget gaps. Increased Medicaid enrollment due to the economic downturn, limits on the ability of states to reduce Medicaid eligibility criteria enacted as part of the Affordable Care Act, budget gaps and other factors could result in future reductions to Medicaid payments or additional taxes on hospitals. Some states are considering proposals that would result in such reductions.

 

In general, 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 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 condition, results of operations or cash flows.

 

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Our business continues to be adversely affected by a high volume of uninsured and underinsured patients, as well as declines in commercial managed care patients.

 

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 increased burdens of co-payments and deductibles due to changes in their health care plans. As a result, we continue to experience a high level of uncollectible accounts, and, unless our business mix shifts toward a greater number of insured patients as a result of the Affordable Care Act or otherwise, the trend of higher co-payments and deductibles reverses, or the economy improves and unemployment rates decline, we anticipate this high level of uncollectible accounts to continue or increase. In addition, even after implementation of the Affordable Care Act, we may continue to experience bad debts and have to provide uninsured discounts and charity care for undocumented aliens who are not permitted to enroll in a health insurance exchange or government health care program.

 

Over the past several years, we have experienced declines in our commercial managed care volumes, which in the aggregate generate substantially higher yields than Medicare and Medicaid volumes. The declines in our commercial managed care volumes are due, in part, to the related effects of higher unemployment and reductions in commercial managed care enrollment. In addition, we believe that the growth in high-deductible health plans has adversely impacted commercial managed care volumes.

 

Our hospitals, outpatient centers and other health care businesses operate in competitive environments, and competition is one reason increases in patient volumes have been constrained.

 

Overall, our hospitals, outpatient centers and other health care businesses operate in competitive environments, and we believe increases in patient volumes have been constrained, in part, by competition for market share in high margin services and for quality physicians and personnel. Generally, other hospitals and outpatient centers in the local communities we serve provide services similar to those we offer, and, in some cases, competing facilities are more established or newer than ours. Furthermore, competing facilities (1) may offer a broader array of services to patients and physicians than ours, (2) may have larger or more specialized medical staffs to admit and refer patients, (3) may have more favorable contracts with managed care plans, (4) may have a better reputation in the community, or (5) may be more centrally located with better parking or closer proximity to public transportation. We also face increased competition from specialty hospitals (some of which are physician-owned) and unaffiliated freestanding outpatient centers for market share in high margin services and for quality physicians and personnel. Furthermore, some of the hospitals that compete with our hospitals are owned by government agencies or not-for-profit organizations. These tax-exempt competitors may have certain financial advantages not available to our facilities, such as endowments, charitable contributions, tax-exempt financing, and exemptions from sales, property and income taxes. In addition, in certain markets in which we operate, large teaching hospitals provide highly specialized facilities, equipment and services that may not be available at our hospitals. If competing health care providers are better able to attract patients, recruit and retain physicians, expand services or obtain favorable managed care contracts at their facilities, our patient volume levels may suffer.

 

If we are unable to recruit and retain an appropriate number of quality physicians on the medical staffs of our hospitals, our business may suffer.

 

The success of our business depends in significant part on the number, quality and specialties of the physicians on the medical staffs of our hospitals, the admitting practices of those physicians and maintaining good relations with those physicians. Although we operate some physician practices and, where permitted by law, employ some physicians, physicians are often not employees of the hospitals at which they practice and, in many of the markets we serve, most physicians have admitting privileges at other hospitals in addition to our hospitals. Such physicians may terminate their affiliation with our hospitals or admit their patients to competing hospitals at any time. In some of our markets, physician recruitment and retention are affected by a shortage of physicians in certain sought-after specialties and the difficulties that physicians can experience in obtaining affordable malpractice insurance or finding insurers willing to provide such insurance. Other issues facing physicians, such as proposed decreases in Medicare payments, are causing them to consider alternatives, including leaving private practice for employed physician arrangements, relocating their practices or retiring sooner than expected. If we are unable to attract and retain sufficient numbers of quality physicians by providing adequate support personnel, technologically advanced equipment and hospital facilities that meet the needs of those physicians and their patients, physicians may be discouraged from referring patients to our facilities, admissions may decrease and our operating performance may decline.

 

Our labor costs could be adversely affected by competition for staffing, the shortage of experienced nurses and labor union activity.

 

Our hospital operations depend on the efforts, abilities and experience of our management and medical support personnel, including nurses, pharmacists and lab technicians, as well as our employed physicians. We compete with other health care providers in recruiting and retaining physicians and qualified management responsible for the daily operations of our hospitals. In addition, like others in the health care industry, we continue to experience a shortage of experienced nurses in certain

 

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key specialties and geographic areas. As a result, from time to time, we may be required to enhance wages and benefits to recruit and retain experienced nurses or hire more expensive temporary or contract personnel. Furthermore, state-mandated nurse-staffing ratios in California affect not only our labor costs, but, if we are unable to hire the necessary number of experienced nurses to meet the required ratios, they may also cause us to limit patient admissions with a corresponding adverse effect on our net operating revenues. In general, our failure to recruit and retain qualified management, experienced nurses and other medical support personnel, or to control labor costs, could have a material adverse effect on our business, financial condition, results of operations or cash flows.

 

Increased labor union activity is another factor that could adversely affect our labor costs. At December 31, 2012, approximately 29% of our employees were represented by various labor unions. These employees — primarily registered nurses and service and maintenance workers — were located at 25 of our hospitals, the majority of which are in California and Florida. We have no expired contracts at this time; however, we are in the process of negotiating new contracts where employees have recently chosen union representation. At this time, we are unable to predict the outcome of the negotiations, but increases in salaries, wages and benefits could result from these agreements. Furthermore, there is a possibility that strikes could occur during the negotiation process, which could increase our labor costs and have an adverse effect on our patient admissions and net operating revenues. Ongoing organizing activities by labor unions could increase our level of union representation in 2013; to the extent a greater portion of our employee base unionizes, it is possible our labor costs could increase materially.

 

Conifer’s future success also depends in part on our ability to attract, hire, integrate and retain key personnel. Competition for the caliber and number of employees we require at Conifer is intense. We may face difficulty identifying and hiring qualified personnel at compensation levels consistent with our existing compensation and salary structure. In addition, we invest significant time and expense in training Conifer’s employees, which increases their value to competitors who may seek to recruit them. If we fail to retain our Conifer employees, we could incur significant expenses in hiring, integrating and training their replacements, and the quality of Conifer’s services and its ability to serve its customers could diminish, resulting in a material adverse effect on that segment of our business.

 

Our licensed hospital beds are heavily concentrated in certain market areas in Florida, Texas and California, which makes us sensitive to economic, regulatory, environmental and other conditions in those areas.

 

As of December 31, 2012, the largest concentrations of licensed beds in our hospitals were in Florida (26.4%), Texas (19.9%) and California (17.7%). These concentrations increase the risk that, should any adverse economic, regulatory, environmental or other condition occur in these areas, our overall business, financial condition, results of operations or cash flows could be materially adversely affected.

 

Furthermore, a natural disaster or other catastrophic event could affect us more significantly than other companies with less geographic concentration, and the property insurance we obtain may not be adequate to cover our losses. In the past, hurricanes have had a disruptive effect on the operations of our hospitals in Florida and Texas and the patient populations in those states. Our California operations could be adversely affected by a major earthquake or wildfires in that state.

 

Our business and financial results could be harmed by violations of existing regulations or compliance with new or changed regulations.

 

Our business is subject to extensive federal, state and local regulation relating to, among other things, licensure, conduct of operations, privacy of patient information, ownership of facilities, physician relationships, addition of facilities and services, and reimbursement rates for services. The laws, rules and regulations governing the health care industry are extremely complex and, in certain areas, the industry has little or no regulatory or judicial interpretation for guidance. If a determination is made that we were in violation of such laws, rules or regulations, we could be subject to penalties or liabilities or required to make significant changes to our operations. In addition, Conifer’s failure to comply with the laws and regulations applicable to it could result in reduced demand for its services, invalidate all or portions of some of Conifer’s services agreements with its customers, or give customers the right to terminate Conifer’s services agreements with them, among other things, any of which could have an adverse effect on Conifer’s business. Even a public announcement that we are being investigated for possible violations of law could have a material adverse effect on our business, financial condition or results of operations, and our business reputation could suffer. Furthermore, health care, as one of the largest industries in the United States, continues to attract much legislative interest and public attention. We are unable to predict the future course of federal, state and local regulation or legislation, including Medicare and Medicaid statutes and regulations. Further changes in the regulatory framework affecting health care providers could have a material adverse effect on our business, financial condition, results of operations or cash flows.

 

We are also required to comply with various federal and state labor laws, rules and regulations governing a variety of workplace wage and hour issues. From time to time, we have been and expect to continue to be subject to regulatory proceedings and private litigation concerning our application of such laws, rules and regulations.

 

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The failure to comply with debt collection and consumer credit reporting regulations could subject Conifer’s SOS subsidiary to fines and other liabilities, which could harm Conifer’s reputation and business, and could make it more difficult for Conifer to retain existing customers or attract new customers.

 

The Fair Debt Collection Practices Act regulates persons who regularly collect or attempt to collect, directly or indirectly, consumer debts in default that are owed or asserted to be owed to another person. Certain of the accounts receivable handled by SOS, Conifer’s debt collection agency subsidiary, are subject to the FDCPA. Many states impose additional requirements on debt collection communications, and some of those requirements may be more stringent than the federal requirements. Moreover, regulations governing debt collection are subject to changing interpretations that may be inconsistent among different jurisdictions. SOS could incur costs or could be subject to fines or other penalties under the FDCPA, the Fair Credit Reporting Act and the Federal Trade Commission Act if it is determined to have mishandled protected information. We or Conifer’s customers could be required to report such breaches to affected consumers or regulatory authorities, leading to disclosures that could damage Conifer’s reputation, making it more difficult to retain existing customers or attract new customers, or otherwise harm Conifer’s business.

 

We could be subject to substantial uninsured liabilities or increased insurance costs as a result of significant legal actions.

 

We are subject to medical malpractice lawsuits, class action lawsuits and other legal actions in the ordinary course of business. Some of these actions may involve large demands, as well as substantial defense costs. Even in states that have imposed caps on damages, litigants are seeking recoveries under new theories of liability that might not be subject to such caps. Our professional and general liability insurance does not cover all claims against us, and it may not continue to be available at a reasonable cost for us to maintain at adequate levels, as the health care industry has seen significant increases in the cost of such insurance due to increased litigation. We cannot predict the outcome of current or future legal actions against us or the effect that judgments or settlements in such matters may have on us or on our insurance costs. Additionally, all professional and general liability insurance we purchase is subject to policy limitations. If the aggregate limit of any of our professional and general liability policies is exhausted, in whole or in part, it could deplete or reduce the limits available to pay any other material claims applicable to that policy period. Any losses not covered by or in excess of the amounts maintained under insurance policies will be funded from our working capital. Furthermore, one or more of our insurance carriers could become insolvent and unable to fulfill its or their obligations to defend, pay or reimburse us when those obligations become due. In that case or if payments of claims exceed our estimates or are not covered by our insurance, it could have a material adverse effect on our business, financial condition, results of operations or cash flows.

 

Conifer operates in a highly competitive industry, and its current or future competitors may be able to compete more effectively than Conifer does, which could have a material adverse effect on Conifer’s business, revenue, growth rate and market share.

 

We intend to continue expanding Conifer’s revenue cycle management, patient communications services and management services businesses by marketing these services to non-Tenet hospitals and other health care-related entities. However, the market for Conifer’s solutions is highly competitive, and we expect competition may intensify in the future. Conifer faces competition from existing participants and new entrants to the revenue cycle management market (including software vendors and other technology-supported revenue cycle management outsourcing companies, traditional consultants and information technology outsourcing firms), as well as from the internal staffs of hospitals and other health care providers who, as described above, handle these processes internally. To be successful, Conifer must respond more quickly and effectively than its competitors to new or changing opportunities, technologies, standards, regulations and customer requirements. Moreover, existing or new competitors may introduce technologies or services that render Conifer’s technologies or services obsolete or less marketable. Even if Conifer’s technologies and services are more effective than the offerings of its competitors, current or potential customers might prefer competitive technologies or services to Conifer’s technologies and services. Furthermore, increased competition may result in pricing pressures, which could negatively impact Conifer’s margins, growth rate or market share.

 

Our business could be negatively impacted by security threats, catastrophic events and other disruptions affecting our information technology and related systems.

 

As a provider of health care services, we rely on our information technology in the day-to-day operation of our business to process, transmit and store sensitive or confidential data, including electronic health records, other protected health information, and financial, payment and other personal data of patients, as well as to store our proprietary and confidential business performance data. Our centralized information technology delivery model supports all of our hospitals, outpatient centers and other health care businesses, including Conifer. We utilize a diversified data and voice network, along with technology systems for billing, supply chain, clinical information systems and labor management. Although we have redundancies and other measures

 

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designed to protect the security and availability of the data we process, transmit and store, our information technology and infrastructure is vulnerable to computer viruses, attacks by hackers or breaches due to employee error or malfeasance. Furthermore, our network and technology systems are subject to disruption due to events such as a major earthquake, fire, telecommunications failure, terrorist attack or other catastrophic event. Any such breach or system interruption could result in the unauthorized disclosure, misuse or loss of confidential, sensitive or proprietary information, could negatively impact our ability to conduct normal business operations (including the collection of revenues), and could result in potential liability and damage to our reputation, any of which could have a material adverse effect on our business, financial position, results of operations or cash flows.

 

The economic downturn and other economic factors have impacted, and may continue to impact, our business, financial condition and results of operations.

 

We continue to be impacted by a number of industry-wide challenges, including constrained growth in patient volumes and high levels of bad debt. We believe factors associated with the economic downturn — including higher levels of unemployment, reductions in commercial managed care enrollment, and patient decisions to postpone or cancel elective and non-emergency health care procedures — have impacted our volumes and affected our ability to collect outstanding receivables. If industry trends or general economic conditions worsen, we may not be able to sustain future profitability, and our liquidity and ability to repay our outstanding debt may be harmed.

 

Furthermore, the availability of liquidity and credit to fund the continuation and expansion of many business operations worldwide has been limited in recent years. Our ability to access the capital markets on acceptable terms may be severely restricted at a time when we would like, or need, to access those markets, which could have a negative impact on our growth plans, our flexibility to react to changing economic and business conditions, and our ability to refinance existing debt. The economic downturn or other economic conditions could also adversely affect the counterparties to our agreements, including the lenders under our senior secured revolving credit facility, causing them to fail to meet their obligations to us.

 

Trends affecting our actual or anticipated results may require us to record charges that would adversely affect our results of operations.

 

As a result of factors that have negatively affected our industry generally and our business specifically, we have been required to record various charges in our results of operations. Our impairment tests presume stable, improving or, in some cases, declining operating results in our hospitals, which are based on programs and initiatives being implemented that are designed to achieve the hospitals’ most recent projections. If these projections are not met, or if in the future negative trends occur that impact our future outlook, future impairments of long-lived assets and goodwill may occur, and we may incur additional restructuring charges. Future restructuring of our operating structure that changes our goodwill reporting units could also result in future impairments of our goodwill. Any such charges could adversely affect our results of operations.

 

The amount and terms of our current and any future debt could, among other things, adversely affect our ability to raise additional capital to fund our operations and limit our ability to react to changes in the economy or our industry.

 

As of December 31, 2012, we had approximately $5.3 billion of total long-term debt, as well as approximately $154 million in standby letters of credit outstanding under our senior secured revolving credit facility, which is collateralized by patient accounts receivable of all of our wholly owned acute care and specialty hospitals. From time to time, we expect to engage in additional capital markets, bank credit and other financing activities depending on our needs and financing alternatives available at that time.

 

The terms and conditions in our credit agreement and the indentures governing our outstanding senior notes and senior secured notes, as well as our payment obligations under these agreements, could have important consequences to our business and to holders of our securities, including the following:

 

·                    Our credit agreement and the indentures contain, and any future debt obligations may contain, covenants that, among other things, restrict our ability to pay dividends, incur additional debt and sell assets. Our credit agreement also requires us to maintain a financial ratio relating to our ability to satisfy certain fixed expenses, including interest payments. The indentures contain covenants that, among other things, restrict our ability and the ability of our subsidiaries to incur liens, consummate asset sales, enter into sale and lease-back transactions or consolidate, merge or sell all or substantially all of our or their assets. If we do not comply with these obligations, it may cause an event of default, which, if not cured or waived, could require us to repay the indebtedness immediately.

 

·                    We may be more vulnerable in the event of a deterioration in our business, in the health care industry or in the economy generally, or if federal or state governments set further limitations on reimbursement under the Medicare or Medicaid programs.

 

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·                    We may be required to dedicate a substantial portion of our cash flow to the payment of principal and interest on our indebtedness, which could reduce the amount of funds available for our operations, capital expenditures or acquisitions.

 

We have the ability to incur additional indebtedness in the future, subject to the restrictions contained in our credit agreement and the indentures governing our outstanding senior notes and senior secured notes. If new indebtedness is added to our current debt levels, the related risks that we now face could intensify.

 

The utilization of our tax losses could be substantially limited if we experience an ownership change as defined in the Internal Revenue Code.

 

Because of net operating losses we have experienced for federal income tax purposes, at December 31, 2012, we had federal net operating loss (“NOL”) carryforwards of approximately $1.5 billion pretax available to offset future taxable income. Our ability to utilize NOL carryforwards to reduce future taxable income may be limited under Section 382 of the Internal Revenue Code if certain ownership changes in our Company occur during a rolling three-year period. These ownership changes include purchases of common stock under share repurchase programs, the offering of stock by us, the purchase or sale of our stock by 5% shareholders, as defined in the Treasury regulations, or the issuance or exercise of rights to acquire our stock. If such ownership changes by 5% shareholders result in aggregate increases that exceed 50 percentage points during the three-year period, then Section 382 imposes an annual limitation on the amount of our taxable income that may be offset by our NOL carryforwards or tax credit carryforwards at the time of ownership change. The limitation may affect the amount of our deferred income tax asset and, depending on the limitation, a significant portion of our NOL carryforwards or tax credit carryforwards could expire before we are able to use them. In such an event, our business, financial condition, results of operations or cash flows could be adversely affected.

 

We believe that we have not experienced an ownership change under Section 382 of the Internal Revenue Code as of February 15, 2013; however, the amount by which our ownership may change in the future could be affected by purchases and sales of stock by 5% shareholders, purchases of common stock under share repurchase programs and new issuances of stock by us, should we choose to do so.

 

ITEM 1B. UNRESOLVED STAFF COMMENTS

 

None.

 

ITEM 2. PROPERTIES

 

The disclosure required under this Item is included in Item 1, Business, of this report.

 

ITEM 3. LEGAL PROCEEDINGS

 

For information regarding material pending legal proceedings in which we are involved, see Note 15 to our Consolidated Financial Statements, which is incorporated by reference.

 

ITEM 4. MINE SAFETY DISCLOSURES

 

Not applicable.

 

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PART II.

 

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

 

Common Stock. Our common stock is listed on the New York Stock Exchange (“NYSE”) under the symbol “THC.” On October 11, 2012, our common stock began trading on the NYSE on a split-adjusted basis following a one-for-four reverse stock split we announced on October 1, 2012. Every four shares of our issued and outstanding common stock were exchanged for one issued and outstanding share of common stock, without any change in the par value per share, and our authorized shares of common stock were proportionately decreased from 1,050,000,000 shares to 262,500,000 shares. No fractional shares were issued in connection with the stock split. The following table sets forth, for the periods indicated, the high and low sales prices per share of our common stock on the NYSE, as adjusted to reflect the reverse stock split:

 

 

 

High

 

Low

 

Year Ended December 31, 2012

 

 

 

 

 

First Quarter

 

$

24.20

 

$

18.36

 

Second Quarter

 

22.56

 

17.32

 

Third Quarter

 

25.76

 

17.24

 

Fourth Quarter

 

33.86

 

22.86

 

Year Ended December 31, 2011

 

 

 

 

 

First Quarter

 

$

30.20

 

$

26.28

 

Second Quarter

 

30.80

 

23.56

 

Third Quarter

 

26.16

 

16.08

 

Fourth Quarter

 

21.20

 

13.84

 

 

On February 15, 2013, the last reported sales price of our common stock on the NYSE composite tape was $40.10 per share. As of that date, there were 4,297 holders of record of our common stock. Our transfer agent and registrar is Computershare. Shareholders with questions regarding their stock certificates, including inquiries related to exchanging or replacing certificates or changing an address, should contact the transfer agent at (866) 229-8416.

 

Cash Dividends on Common Stock. We have not paid cash dividends on our common stock since the first quarter of fiscal 1994. We currently intend to retain future earnings, if any, for the operation and development of our business and, accordingly, do not currently intend to pay any cash dividends on our common stock. Our board of directors will evaluate our future earnings, results of operations, financial condition and capital requirements in determining whether to pay any cash dividends in the future. Our senior secured revolving credit agreement contains provisions that limit the payment of cash dividends on our common stock if we do not meet certain financial ratios.

 

Equity Compensation. Refer to Item 12, Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters, of this report for information regarding securities authorized for issuance under our equity compensation plans.

 

Stock Performance Graph. The following graph shows the cumulative, five-year total return for our common stock compared to three indices, each of which includes us. The Standard & Poor’s 500 Stock Index includes 500 companies representing all major industries. The Standard & Poor’s Health Care Composite Index is a group of 52 companies involved in a variety of healthcare-related businesses. Because the Standard & Poor’s Health Care Composite Index is heavily weighted by pharmaceutical and medical device companies, we believe that at times it may be less useful than the Hospital Management Peer Group Index included below. We compiled this Peer Group Index by selecting publicly traded companies that have as their primary business the management of acute care hospitals and that have been in business for all five of the years shown. These companies are: Community Health Systems, Inc. (CYH), Health Management Associates, Inc. (HMA), Tenet Healthcare Corporation (THC) and Universal Health Services, Inc. (UHS).

 

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Performance data assumes that $100.00 was invested on December 31, 2007 in our common stock and each of the indices. The data assumes the reinvestment of all cash dividends and the cash value of other distributions. Stock price performance shown in the graph is not necessarily indicative of future stock price performance.

 

COMPARISON OF FIVE YEAR CUMULATIVE TOTAL RETURN

 

 

 

 

12/07

 

12/08

 

12/09

 

12/10

 

12/11

 

12/12

 

Tenet Healthcare Corporation

 

$

100.00

 

$

22.64

 

$

106.10

 

$

131.69

 

$

100.98

 

$

159.79

 

S&P 500

 

$

100.00

 

$

63.00

 

$

79.67

 

$

91.67

 

$

93.61

 

$

108.59

 

S&P Health Care

 

$

100.00

 

$

77.19

 

$

92.40

 

$

95.08

 

$

107.18

 

$

126.35

 

Peer Group

 

$

100.00

 

$

42.88

 

$

110.05

 

$

136.84

 

$

99.60

 

$

142.39

 

 

Repurchase of Common Stock. In October 2012, we announced that our board of directors had authorized the repurchase of up to $500 million of our common stock through a share repurchase program expiring in December 2013. Under the program, shares may be purchased in the open market or through privately negotiated transactions in a manner consistent with applicable securities laws and regulations, including pursuant to a Rule 10b5-1 plan maintained by the Company. Shares will be repurchased at times and in amounts based on market conditions and other factors. Purchases during the year ended December 31, 2012 are shown in the table in Note 2 to our Consolidated Financial Statements, which table is incorporated by reference.

 

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ITEM 6. SELECTED FINANCIAL DATA

 

OPERATING RESULTS

 

The following tables present selected consolidated financial data for Tenet Healthcare Corporation and its wholly owned and majority-owned subsidiaries for the years ended December 31, 2008 through 2012:

 

 

 

Years Ended December 31,

 

 

 

2012

 

2011

 

2010

 

2009

 

2008

 

 

 

(In Millions, Except Per-Share Amounts)

 

Net operating revenues:

 

 

 

 

 

 

 

 

 

 

 

Net operating revenues before provision for doubtful accounts

 

$

9,904

 

$

9,371

 

$

8,992

 

$

8,785

 

$

8,368

 

Less: Provision for doubtful accounts

 

785

 

717

 

727

 

684

 

618

 

Net operating revenues

 

9,119

 

8,654

 

8,265

 

8,101

 

7,750

 

Operating expenses:

 

 

 

 

 

 

 

 

 

 

 

Salaries, wages and benefits

 

4,257

 

4,015

 

3,830

 

3,781

 

3,707

 

Supplies

 

1,552

 

1,548

 

1,542

 

1,534

 

1,477

 

Other operating expenses, net

 

2,147

 

2,020

 

1,857

 

1,831

 

1,852

 

Electronic health record incentives

 

(40

)

(55

)

 

 

 

Depreciation and amortization

 

430

 

398

 

380

 

373

 

357

 

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

 

19

 

20

 

10

 

27

 

16

 

Litigation and investigation costs, net of insurance recoveries

 

5

 

55

 

12

 

31

 

41

 

Operating income

 

749

 

653

 

634

 

524

 

300

 

Interest expense

 

(412

)

(375

)

(424

)

(445

)

(418

)

Gain (loss) from early extinguishment of debt

 

(4

)

(117

)

(57

)

97

 

 

Investment earnings

 

1

 

3

 

5

 

 

22

 

Net gain on sales of investments

 

 

 

 

15

 

139

 

Income from continuing operations, before income taxes

 

334

 

164

 

158

 

191

 

43

 

Income tax benefit (expense)

 

(125

)

(61

)

977

 

23

 

25

 

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

 

$

209

 

$

103

 

$

1,135

 

$

214

 

$

68

 

Basic earnings per share attributable to Tenet Healthcare Corporation common shareholders from continuing operations

 

$

1.77

 

$

0.58

 

$

9.09

 

$

1.67

 

$

0.54

 

Diluted earnings per share attributable to Tenet Healthcare Corporation common shareholders from continuing operations

 

$

1.70

 

$

0.56

 

$

8.03

 

$

1.63

 

$

0.54

 

 

The operating results data presented above is not necessarily indicative of our future results of operations. Reasons for this include, but are not limited to: overall revenue and cost trends, particularly the timing and magnitude of price changes; fluctuations in contractual allowances and cost report settlements and valuation allowances; managed care contract negotiations, settlements or terminations and payer consolidations; changes in Medicare and Medicaid regulations; Medicaid funding levels set by the states in which we operate; the timing of approval by the Centers for Medicare and Medicaid Services (“CMS”) of Medicaid provider fee revenue programs; trends in patient accounts receivable collectability and associated provisions for doubtful accounts; fluctuations in interest rates; levels of malpractice insurance expense and settlement trends; the timing of when we meet the criteria to recognize electronic health record incentives; 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 deferred tax asset valuation allowance activity; changes in estimates of accruals for annual incentive compensation; the timing and amounts of stock option and restricted stock unit grants to employees and directors; gains or losses from early extinguishment of debt; and changes in occupancy levels and patient volumes. Factors that affect patient volumes and, thereby, the results of operations at our hospitals and related health care facilities include, but are not limited to: the business environment, economic conditions and demographics 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; advances in technology and treatments that reduce

 

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length of stay; local health care competitors; managed care contract negotiations or terminations; any unfavorable publicity about us, which impacts our relationships with physicians and patients; changes in health care regulations and the participation of individual states in federal programs; and the timing of elective procedures.

 

BALANCE SHEET DATA

 

 

 

December 31,

 

 

 

2012

 

2011

 

2010

 

2009

 

2008

 

 

 

(In Millions)

 

Working capital (current assets minus current liabilities)

 

$

918

 

$

542

 

$

586

 

$

689

 

$

760

 

Total assets

 

9,044

 

8,462

 

8,500

 

7,953

 

8,174

 

Long-term debt, net of current portion

 

5,158

 

4,294

 

3,997

 

4,272

 

4,778

 

Total equity

 

1,218

 

1,492

 

1,819

 

697

 

147

 

 

CASH FLOW DATA

 

 

 

Years Ended December 31,

 

 

 

2012

 

2011

 

2010

 

2009

 

2008

 

 

 

(In Millions)

 

Net cash provided by operating activities

 

$

593

 

$

497

 

$

472

 

$

425

 

$

208

 

Net cash used in investing activities

 

(662

)

(503

)

(420

)

(125

)

(274

)

Net cash provided by (used in) financing activities

 

320

 

(286

)

(337

)

(117

)

1

 

 

ITEM 7. 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 (“MD&A”), 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 our financial information may be analyzed, and to provide information about the quality of, and potential variability of, our financial condition, 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, per admission, per adjusted admission, per patient day, per adjusted patient day and per visit amounts). All current and prior period amounts related to shares, share prices and earnings per share have been restated to give retrospective presentation for the reverse stock split described in Note 2 to the accompanying Consolidated Financial Statements. In the three months ended June 30, 2012, we began reporting Conifer Health Solutions (“Conifer”) as a separate reportable business segment. Our core business is Hospital Operations and other, which is focused on owning and operating acute care hospitals and outpatient facilities. We also operate revenue cycle management, patient communications services and management services businesses under our Conifer subsidiary. MD&A, which should be read in conjunction with the accompanying Consolidated Financial Statements, includes the following sections:

 

·                  Management Overview

·                  Sources of Revenue

·                  Results of Operations

·                  Liquidity and Capital Resources

·                  Off-Balance Sheet Arrangements

·                  Recently Issued Accounting Standards

·                  Critical Accounting Estimates

 

MANAGEMENT OVERVIEW

 

RECENT DEVELOPMENTS

 

Agreement to Acquire Hospital—In February 2013, we announced the signing of a definitive agreement to acquire Emanuel Medical Center, a 209-bed hospital in Turlock, California. The acquisition is subject to customary approvals and other closing conditions, but is expected to be completed in the second quarter of 2013.

 

Issuance of New Notes; Repurchase of Outstanding NotesIn February 2013, we sold $850 million aggregate principal amount of 41¤2% senior secured notes, which will mature on April 1, 2021. We will pay interest on the 41¤2% senior secured notes semi-annually in arrears on April 1 and October 1 of each year, commencing on October 1, 2013. We used a portion of the proceeds from the sale of the notes to purchase approximately $645 million aggregate principal amount outstanding of our 10% senior secured notes due 2018 in a tender offer and to call approximately $69 million of the remaining aggregate principal amount outstanding of those notes. The remaining net proceeds will be used for purchases of our other outstanding senior secured notes through public or privately negotiated transactions and for general corporate purposes,

 

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including strategic acquisitions and the repayment of indebtedness and drawings under our senior secured revolving credit facility.

 

Joint Venture with John Muir HealthIn January 2013, we announced the creation of a joint venture partnership between our San Ramon Regional Medical Center and John Muir Health, a not-for-profit integrated system of doctors, hospitals and other health care services in the San Francisco Bay area. Through this partnership, John Muir Health will invest approximately $100 million to acquire a 49% ownership interest in San Ramon Regional Medical Center.

 

STRATEGY AND TRENDS

 

We are committed to providing the communities our hospitals, outpatient centers and other health care facilities serve with high quality, cost-effective health care while growing our business, increasing our profitability and creating long-term value for our shareholders. We believe that our success in increasing our profitability depends in part on our success in executing the strategies and managing the trends discussed below.

 

Core Business StrategyOur business is focused on providing high quality care to patients through our hospitals and outpatient centers, and providing business process solutions for health care providers through our Conifer business. With respect to our hospitals and outpatient facilities, we seek to offer superior quality and patient services to meet community needs, to make capital and other investments in our facilities and technology to remain competitive, to recruit and retain physicians, to expand our outpatient business, and to negotiate favorable contracts with managed care and other commercial payers. With respect to business process services, we provide comprehensive operational management for revenue cycle functions, including patient access, health information management, revenue integrity and patient financial services. We also offer patient communications solutions to optimize the relationship between providers and patients. In addition, our management services offerings have expanded to support value-based performance through clinical integration, financial risk management and population health management.

 

Development StrategiesWe remain focused on opportunities to increase our hospital and outpatient revenues through organic growth and acquisitions, and to expand our Conifer business.

 

From time to time, we build new hospitals, make strategic acquisitions of hospitals and enter into joint venture arrangements or affiliations with health care businesses — in each case in markets where we believe our operating strategies can improve performance and create shareholder value. We recently signed a definitive agreement to acquire the Emanuel Medical Center in Turlock, California. In addition, we are creating a joint venture partnership with John Muir Health, a not-for-profit integrated system of doctors, hospitals and other health care services in the San Francisco Bay area, through which John Muir Health will invest approximately $100 million to acquire a 49% ownership interest in San Ramon Regional Medical Center.

 

Historically, our outpatient services have generated significantly higher margins for us than inpatient services. During the year ended December 31, 2012, we derived approximately 34% of our net patient revenues from outpatient services. By expanding our outpatient business, we expect to increase our profitability over time. We believe that growth by strategic acquisitions, when and if opportunities are available, can supplement the growth we believe we can generate organically in our existing markets. We continually evaluate collaboration opportunities with outpatient facilities, health care providers, physician groups and others in our markets to maximize effectiveness, reduce costs and build clinically integrated networks that provide quality service across the care continuum.

 

We intend to continue expanding Conifer’s revenue cycle management, patient communications services and management services businesses by marketing these services to non-Tenet hospitals and other health care-related entities. Conifer provides services to more than 600 Tenet and non-Tenet hospital and other clients nationwide. We believe this business has the potential over time to generate high margins and improve our results of operations. In May 2012, Conifer entered into a 10-year agreement with Catholic Health Initiatives (“CHI”) to provide revenue cycle services for over 50 of CHI’s hospitals. As part of this agreement, CHI received a minority ownership interest in Conifer. In addition, in October and November 2012, Conifer acquired an information management and services company and a hospital revenue cycle management business, respectively. Our service offerings have also recently expanded to support value-based performance through clinical integration, financial risk management and population health management, which are integral parts of the health care industry’s movement toward accountable care organizations (“ACOs”) and similar risk-based or capitated contract models. In addition to hospitals, other clients for these services include health plans, self-insured employees and other entities.

 

Commitment to QualityWe have made significant investments in the last decade in equipment, technology, education and operational strategies designed to improve clinical quality at our hospitals and outpatient centers. As a result of our efforts, our CMS Hospital Compare Core Measures scores have consistently exceeded the national average since the end of 2005, and the major national commercial payers have also recognized our achievements relative to quality. These designations are expected to become increasingly important as the commercial market moves to narrow networks and other methods designed to

 

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encourage covered individuals to use certain facilities over others. Through our Commitment to Quality and Medicare Performance Improvement initiatives, we continually work with physicians to implement the most current evidence-based medicine techniques to improve the way we provide care, while using labor management tools and supply chain initiatives to reduce variable costs. We believe the use of these practices will promote the most effective and efficient utilization of resources and result in shorter lengths of stay, as well as reductions in redundant ancillary services and readmissions for hospitalized patients. In general, we believe that quality of care improvements may have the effect of reducing costs, increasing payments from Medicare and certain managed care payers for our services, and increasing physician and patient satisfaction, which may improve our volumes.

 

Realizing HIT Incentive Payments and Other BenefitsBeginning in the year ended December 31, 2011, we achieved compliance with certain of the health information technology (“HIT”) requirements under the American Recovery and Reinvestment Act of 2009 (“ARRA”); as a result, we recognized approximately $55 million of electronic health record (“EHR”) incentives related to Medicaid ARRA HIT in 2011 in our consolidated statement of operations. In addition, we recognized approximately $40 million of Medicare and Medicaid EHR incentives in our consolidated statement of operations in the year ended December 31, 2012. These incentives partially offset the operating expenses we have incurred and continue to incur to invest in HIT systems. Furthermore, we believe that the operational benefits of HIT, including improved clinical outcomes and increased operating efficiencies, will contribute to our long-term ability to grow our business.

 

General Economic ConditionsWe believe that high unemployment rates and other adverse economic conditions are continuing to have a negative impact on our bad debt expense levels and patient volumes. However, as the economy recovers, we expect to experience improvements in these metrics relative to current levels.

 

Improving Operating LeverageWe are experiencing an increase in our adjusted patient admissions that we believe is primarily attributable to our focus on physician alignment and satisfaction, targeted capital spending on critical growth opportunities for our hospitals, emphasis on higher demand clinical service lines (including outpatient lines), focus on expanding our outpatient business, the implementation of new payer contracting strategies, and improved quality metrics at our hospitals. Increases in patient volumes have been constrained by the slow pace of the current economic recovery, increased competition, utilization pressure by managed care organizations, the effects of higher patient co-pays and deductibles, and demographic trends. We continue to pursue integrated contracting models that maximize our system-wide skills and capabilities in conjunction with our strong market positions to accommodate new payment models. We are also committed to a clinical alignment strategy, which includes an emphasis on physician employment and on innovative arrangements with payers, physicians and other providers. For example, during 2012, we successfully completed our first year of operation of an ACO in Northern California with roughly 7,000 Blue Shield members as part of an integrated health care delivery system designed to compete with offerings from other providers in the local market. In several other markets, we have formed clinical integration organizations, which are collaborations with independent physicians and hospitals to develop ongoing clinical initiatives designed to control costs and improve the quality of care delivered to patients. These achievements provide a foundation for negotiating with plans under an ACO structure or other risk-sharing model.

 

Impact of Affordable Care ActWe anticipate that we will benefit over time from the provisions of the Patient Protection and Affordable Care Act as amended by the Health Care and Education Reconciliation Act of 2010 (“Affordable Care Act”) that will extend insurance coverage through Medicaid or private insurance to a broader segment of the U.S. population. Although we are unable to predict the precise impact of the Affordable Care Act on our future results of operations, and while there will be some reductions in reimbursement rates, which began in 2010, we anticipate, based on the current timetable for implementing the law, that we should begin to receive reimbursement for caring for uninsured and underinsured patients as early as 2014.

 

Our ability to execute on these strategies and manage these trends is subject to a number of risks and uncertainties that may cause actual results to be materially different from expectations. For information about these risks and uncertainties, see the Forward-Looking Statements and Risk Factors sections in Part I of this report.

 

RESULTS OF OPERATIONS—OVERVIEW

 

Our results of operations have been and continue to be influenced by industry-wide and company-specific challenges, including constrained volume growth, lower patient acuity levels for certain patient service lines, and high levels of bad debt, that have affected our revenue growth and operating expenses. We believe our results of operations for our most recent fiscal quarter best reflect recent trends we are experiencing with respect to volumes, revenues and expenses; therefore, we have provided below information about these metrics for the three months ended December 31, 2012 and 2011 for all of our continuing operations hospitals, excluding the results of our Creighton University Medical Center, which has been reclassified to discontinued operations.

 

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Three Months Ended December 31,

 

Admissions, Patient Days and Surgeries

 

2012

 

2011

 

Increase
(Decrease)

 

Total admissions

 

125,290

 

125,347

 

 

%

 

Adjusted patient admissions(1)

 

199,304

 

193,631

 

2.9

 

%

 

Paying admissions (excludes charity and uninsured)

 

116,611

 

116,763

 

(0.1

)

%

 

Charity and uninsured admissions

 

8,679

 

8,584

 

1.1

 

%

 

Admissions through emergency department

 

77,465

 

76,151

 

1.7

 

%

 

Paying admissions as a percentage of total admissions

 

93.1%

 

93.2%

 

(0.1

)

%

(2)

Charity and uninsured admissions as a percentage of total admissions

 

6.9%

 

6.8%

 

0.1

 

%

(2)

Emergency department admissions as a percentage of total admissions

 

61.8%

 

60.8%

 

1.0

 

%

(2)

Surgeries — inpatient

 

34,511

 

35,419

 

(2.6

)

%

 

Surgeries — outpatient

 

63,534

 

55,781

 

13.9

 

%

 

Total surgeries

 

98,045

 

91,200

 

7.5

 

%

 

Patient days — total

 

580,426

 

589,848

 

(1.6

)

%

 

Adjusted patient days(1)

 

915,584

 

902,762

 

1.4

 

%

 

Average length of stay (days)

 

4.63

 

4.71

 

(1.7

)

%

 

Average licensed beds

 

13,216

 

13,119

 

0.7

 

%

 

Utilization of licensed beds(3)

 

47.7%

 

48.9%

 

(1.2

)

%

(2)

 


(1)    Adjusted patient days/admissions represents actual patient days/admissions adjusted to include outpatient services by multiplying actual patient days/admissions by the sum of gross inpatient revenues and outpatient revenues and dividing the results by gross inpatient revenues.

(2)    The change is the difference between the amounts shown for the three months ended December 31, 2012 compared to the three months ended December 31, 2011.

(3) Utilization of licensed beds represents patient days divided by number of days in the period divided by average licensed beds.

 

Total admissions were flat in the three months ended December 31, 2012 compared to the three months ended December 31, 2011. Total surgeries increased by 7.5% in the three months ended December 31, 2012 compared to the same period in 2011, comprised of a 13.9% increase in outpatient surgeries partially offset by a 2.6% decrease in inpatient surgeries. Our emergency department admissions increased 1.7% in the three months ended December 31, 2012 compared to the same period in the prior year. We believe the current economic conditions continue to have an adverse impact on the level of elective procedures performed at our hospitals, which constrained the overall change in our total admissions. Charity and uninsured admissions increased 1.1% in the three months ended December 31, 2012 compared to the three months ended December 31, 2011.

 

 

 

Three Months Ended December 31,

 

Outpatient Visits

 

2012

 

2011

 

Increase
(Decrease)

 

Total visits

 

1,053,499

 

982,083

 

7.3

 

%

 

Paying visits (excludes charity and uninsured)

 

941,658

 

884,421

 

6.5

 

%

 

Charity and uninsured visits

 

111,841

 

97,662

 

14.5

 

%

 

Emergency department visits

 

399,711

 

363,230

 

10.0

 

%

 

Surgery visits

 

63,534

 

55,781

 

13.9

 

%

 

Paying visits as a percentage of total visits

 

89.4%

 

90.1%

 

(0.7

)

%

(1)

Charity and uninsured visits as a percentage of total visits

 

10.6%

 

9.9%

 

0.7

 

%

(1)

 


(1)    The change is the difference between the amounts shown for the three months ended December 31, 2012 compared to the three months ended December 31, 2011.

 

Total outpatient visits increased 71,416 or 7.3%, in the three months ended December 31, 2012 compared to the three months ended December 31, 2011. All four of our regions reported increased outpatient visits in the three months ended December 31, 2012, with the strongest growth occurring in our California region.

 

Outpatient surgery visits increased by 13.9% in the three months ended December 31, 2012 compared to the same period in 2011. Charity and uninsured outpatient visits increased by 14.5% in the three months ended December 31, 2012 compared to the three months ended December 31, 2011.

 

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Three Months Ended December 31,

 

Revenues

 

2012

 

2011

 

Increase
(Decrease)

 

Net operating revenues

 

$

2,331

 

$

2,172

 

7.3

%

Revenues from the uninsured

 

$

165

 

$

157

 

5.1

%

Net inpatient revenues(1)

 

$

1,544

 

$

1,499

 

3.0

%

Net outpatient revenues(1)

 

$

821

 

$

736

 

11.5

%

 


(1)     Net inpatient revenues and net outpatient revenues are components of net operating revenues. Net inpatient revenues include self-pay revenues of $71 million and $72 million for the three months ended December 31, 2012 and 2011, respectively. Net outpatient revenues include self-pay revenues of $94 million and $85 million for the three months ended December 31, 2012 and 2011, respectively.

 

Net operating revenues increased by $159 million, or 7.3%, in the three months ended December 31, 2012 compared to the same period in 2011. Net operating revenues in the three months ended December 31, 2012 included $72 million of Medicaid disproportionate share hospital (“DSH”) and other state-funded subsidy revenues compared to $60 million in the same period in 2011.

 

In addition to certain of the factors discussed above, net patient revenues increased by 5.8% in the three months ended December 31, 2012 compared to the same period in 2011 primarily as a result of managed care pricing improvement and increased outpatient volumes.

 

 

 

Three Months Ended December 31,

 

Revenues on a Per Admission, Per Patient Day and Per Visit Basis

 

2012

 

2011

 

Increase
(Decrease)

 

Net inpatient revenue per admission

 

$

12,323

 

$

11,959

 

3.0

%

Net inpatient revenue per patient day

 

$

2,660

 

$

2,541

 

4.7

%

Net outpatient revenue per visit

 

$

779

 

$

749

 

4.0

%

Net patient revenue per adjusted patient admission(1)

 

$

11,866

 

$

11,543

 

2.8

%

Net patient revenue per adjusted patient day(1)

 

$

2,583

 

$

2,476

 

4.3

%

 


(1)    Adjusted patient days/admissions represents actual patient days/admissions adjusted to include outpatient services by multiplying actual patient days/admissions by the sum of gross inpatient revenues and outpatient revenues and dividing the results by gross inpatient revenues.

 

Net inpatient revenue per patient day and per admission increased 4.7% and 3.0%, respectively, in the three months ended December 31, 2012 compared to the same period in 2011. This pricing increase reflects improved terms in our contracts with commercial managed care payers, as well as the increase in DSH and other state-funded subsidy revenues described above, partially offset by an adverse shift in payer mix. The 4.0% increase in net outpatient revenue per visit was primarily due to the improved terms of our managed care contracts, partially offset by the provision of lower acuity services by outpatient centers we acquired in the past several years, as well as an unfavorable shift in our total outpatient payer mix.

 

 

 

Three Months Ended December 31,

 

Provision for Doubtful Accounts

 

2012

 

2011

 

Increase
(Decrease)

 

Provision for doubtful accounts

 

$

200

 

$

181

 

10.5

 

%

 

Provision for doubtful accounts as a percentage of net operating revenues before provision for doubtful accounts

 

7.9%

 

7.7%

 

0.2

 

%

(1)

Collection rate on self-pay accounts(2)

 

28.9%

 

27.7%

 

1.2

 

%

(1)

Collection rate on commercial managed care accounts

 

98.0%

 

98.2%

 

(0.2

)

%

(1)

 


(1)    The change is the difference between the amounts shown for the three months ended December 31, 2012 compared to the three months ended December 31, 2011.

(2)    Self-pay accounts receivable are comprised of both uninsured and balance after insurance receivables.

 

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Provision for doubtful accounts increased by $19 million, or 10.5%, in the three months ended December 31, 2012 compared to the same period in 2011. The increase in provision for doubtful accounts primarily related to the increase in uninsured patient volumes in the three months ended December 31, 2012 compared to the three months ended December 31, 2011, partially offset by the impact of a 120 basis point improvement in our collection rate on self-pay accounts. Our self-pay collection rate, which is the blended collection rate for uninsured and balance after insurance accounts receivable, was approximately 28.9% at December 31, 2012 and 27.7% at December 31, 2011.

 

 

 

Three Months Ended December 31,

 

Selected Operating Expenses

 

2012

 

2011

 

Increase
(Decrease)

 

Hospital Operations and other

 

 

 

 

 

 

 

 

Salaries, wages and benefits

 

$

1,010

 

$

955

 

5.8

 

%

Supplies

 

388

 

381

 

1.8

 

%

Other operating expenses

 

506

 

480

 

5.4

 

%

Total

 

$

1,904

 

$

1,816

 

4.8

 

%

Conifer

 

 

 

 

 

 

 

 

Salaries, wages and benefits

 

$

81

 

$

59

 

37.3

 

%

Other operating expenses

 

37

 

14

 

164.3

 

%

Total

 

$

118

 

$

73

 

61.6

 

%

Total

 

 

 

 

 

 

 

 

Salaries, wages and benefits

 

$

1,091

 

$

1,014

 

7.6

 

%

Supplies

 

388

 

381

 

1.8

 

%

Other operating expenses

 

543

 

494

 

9.9

 

%

Total

 

$

2,022

 

$

1,889

 

7.0

 

%

Rent/lease expense(1)

 

 

 

 

 

 

 

 

Hospital Operations and other

 

$

39

 

$

34

 

14.7

 

%

Conifer

 

3

 

3

 

 

%

Total

 

$

42

 

$

37

 

13.5

 

%

Hospital Operations and other

 

 

 

 

 

 

 

 

Salaries, wages and benefits per adjusted patient day(2)

 

$

1,103

 

$

1,058

 

4.3

 

%

Supplies per adjusted patient day(2)

 

424

 

422

 

0.5

 

%

Other operating expenses per adjusted patient day(2)

 

553

 

532

 

3.9

 

%

Total per adjusted patient day

 

$

2,080

 

$

2,012

 

3.4

 

%

Salaries, wages and benefits per adjusted patient admission(2)

 

$

5,068

 

$

4,932

 

2.8

 

%

Supplies per adjusted patient admission(2)

 

1,947

 

1,968

 

(1.1

)

%

Other operating expenses per adjusted patient admission(2)

 

2,538

 

2,479

 

2.4

 

%

Total per adjusted patient admission

 

$

9,553

 

$

9,379

 

1.9

 

%

 


(1)    Included in other operating expenses.

(2)    Adjusted patient days/admissions represents actual patient days/admissions adjusted to include outpatient services by multiplying actual patient days/admissions by the sum of gross inpatient revenues and outpatient revenues and dividing the results by gross inpatient revenues.

 

Total selected operating expenses, which is defined as salaries, wages and benefits, supplies and other operating expenses, increased by 3.4% and 1.9% on a per adjusted patient day and per adjusted patient admission basis, respectively, in the three months ended December 31, 2012 compared to the three months ended December 31, 2011. The increase on a per adjusted patient admission basis was lower than the increase on a per adjusted patient day basis due in part to the impact of our focus on reducing average length of stay.

 

Salaries, wages and benefits per adjusted patient admission increased by 2.8% in the three months ended December 31, 2012 compared to the same period in 2011. This increase is primarily due to an increase in the number of physicians we employ, annual merit and contractual wage increases for our employees, increased contract labor costs, increased annual incentive compensation expense, increased health benefits costs and increased employee-related costs associated with our HIT implementation program, partially offset by a decrease in overtime expense.

 

Salaries, wages and benefits expense for our Conifer segment increased by 37.3% in the three months ended December 31, 2012 compared to the three months ended December 31, 2011 due to an increase in employee headcount as a result of the growth in Conifer’s business primarily attributable to the new CHI partnership and Conifer’s two recent business acquisitions.

 

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Supplies expense per adjusted patient admission decreased by 1.1% in the three months ended December 31, 2012 compared to the three months ended December 31, 2011. Supplies expense was favorably impacted by lower pharmaceutical costs and a decline in orthopedic costs due to renegotiated prices, partially offset by increased costs of implants and surgical supplies.

 

Other operating expenses per adjusted patient admission increased by 2.4% in the three months ended December 31, 2012 compared to the same period in 2011. This change is primarily due to increased costs of contracted services, increased systems implementation costs primarily related to our HIT implementation program, increased consulting and legal expenses, costs related to agreements to fund indigent care services by certain of our Texas hospitals beginning in the three months ended December 31, 2012, and increased rent and lease expenses, partially offset by decreased malpractice expense and decreased physician relocation expenses. In the 2012 period, we also recognized a $3 million gain on the sale of land and buildings. Malpractice expense in the 2012 period includes a favorable adjustment of approximately $1 million due to a 14 basis point increase in the interest rate used to estimate the discounted present value of projected future malpractice liabilities compared to an unfavorable adjustment of approximately $1 million as a result of an eight basis point decrease in the interest rate in the 2011 period.

 

Other operating expenses for our Conifer segment increased by 164.3% in the three months ended December 31, 2012 compared to the three months ended December 31, 2011 primarily due to additional operating expenses related to the new CHI partnership and Conifer’s two recent business acquisitions.

 

The table below shows the pre-tax and after-tax impact on continuing operations for the three months and years ended December 31, 2012 and 2011 of the following items:

 

 

 

Three Months Ended
December 31

 

Years Ended
December 31,

 

 

 

2012

 

2011

 

2012

 

2011

 

 

 

(Expense) Income

 

Impairment of long-lived assets and goodwill, and restructuring charges

 

$

(7

)

$

(2

)

$

(19

)

$

(20

)

Litigation and investigation costs

 

(2

)

(31

)

(5

)

(55

)

Loss from early extinguishment of debt

 

(4

)

(117

)

(4

)

(117

)

Pre-tax impact

 

$

(13

)

$

(150

)

$

(28

)

$

(192

)

Total after-tax impact

 

$

(8

)

$

(95

)

$

(18

)

$

(121

)

Diluted per-share impact of above items

 

$

(0.08

)

$

(0.88

)

$

(0.17

)

$

(1.00

)

Diluted earnings per share, including above items

 

$

0.52

 

$

(0.55

)

$

1.70

 

$

0.56

 

 

LIQUIDITY AND CAPITAL RESOURCES OVERVIEW

 

Cash and cash equivalents were $364 million at December 31, 2012, an increase of $281 million from $83 million at September 30, 2012.

 

Significant cash flow items in the three months ended December 31, 2012 included:

 

·                  Capital expenditures of $148 million;

 

·                  Interest payments of $88 million;

 

·                  Payments on reserves for restructuring charges and litigation costs of $7 million;

 

·                  $173 million of payments to acquire various outpatient, physician practice, information management and revenue cycle management businesses;

 

·                  $175 million of net repayments of borrowings under our revolving credit facility;

 

·                  $100 million of payments to repurchase common stock;

 

·                  $161 million of payments to retire a portion of our 73/8% senior notes due 2013; and

 

·                  $800 million of proceeds from the issuance of our 43/4% senior secured notes due 2020 ($500 million) and 63/4% senior notes due 2020 ($300 million).

 

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Net cash provided by operating activities was $593 million in the year ended December 31, 2012 compared to $497 million in the year ended December 31, 2011. Key negative and positive factors contributing to the change between the 2012 and 2011 periods include the following:

 

·                  $81 million of proceeds in the 2012 period related to our continuing operations from the Medicare Rural Floor Budget Neutrality Adjustment settlement described below;

 

·                  Income tax payments of $13 million in the year ended December 31, 2012 compared to $10 million in the year ended December 31, 2011;

 

·                  Higher payments on reserves for restructuring charges and litigation costs of $19 million; and

 

·                  $3 million less cash used in operating activities from discontinued operations.

 

SOURCES OF REVENUE

 

We receive revenues for patient services from a variety of sources, primarily managed care payers and the federal Medicare program, as well as state Medicaid programs, indemnity-based health insurance companies and self-pay patients (that is, 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 before provision for doubtful accounts for our general hospitals, expressed as percentages of net patient revenues before provision for doubtful accounts from all sources:

 

 

 

Years Ended December 31,

 

Net Patient Revenues from:

 

2012

 

2011

 

2010

 

Medicare

 

23.4

%

23.1

%

23.7

%

Medicaid

 

8.4

%

9.0

%

8.6

%

Managed care

 

57.4

%

57.2

%

56.6

%

Indemnity, self-pay and other

 

10.8

%

10.7

%

11.1

%

 

Our payer mix on an admissions basis for our general hospitals, expressed as a percentage of total admissions from all sources, is shown below:

 

 

 

Years Ended December 31,

 

Admissions from:

 

2012

 

2011

 

2010

 

Medicare

 

28.9

%

29.6

%

29.9

%

Medicaid

 

12.2

%

12.8

%

13.0

%

Managed care

 

48.8

%

47.9

%

47.8

%

Indemnity, self-pay and other

 

10.1

%

9.7

%

9.3

%

 

GOVERNMENT PROGRAMS

 

The Medicare program, the nation’s largest health insurance program, is administered by the Centers for Medicare and Medicaid Services of the U.S. Department of Health and Human Services (“HHS”). 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 poor and most vulnerable individuals.

 

The Affordable Care Act was enacted to change how health care services in the United States are covered, delivered and reimbursed. One key provision of the Affordable Care Act is the individual mandate, which requires most Americans to maintain “minimum essential” health insurance coverage. For individuals who are not exempt from the individual mandate, and who do not receive health insurance through an employer or government program, the means of satisfying the requirement is to purchase insurance from a private company. Beginning in 2014, those who do not comply with the individual mandate must make a “shared responsibility payment” to the federal government in the form of a tax penalty. Another key provision of the Affordable Care Act is the expansion of Medicaid coverage. The current Medicaid program offers federal funding to states to assist pregnant women, children, needy families, the blind, the elderly and the disabled in obtaining medical care. The Affordable Care Act, as enacted, expanded the scope of the Medicaid program, increased the number of individuals the states must cover and penalized states that refused to comply with Medicaid expansion with the possibility of losing 100% of their federal Medicaid funding. However, the U.S. Supreme Court struck down the Medicaid expansion provision in June 2012 following the appeal of a lawsuit first filed in federal district court by 26 states, several individuals and the National Federation

 

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of Independent Business challenging the constitutionality of various provisions of the Affordable Care Act. The expansion of the Medicaid program in each state will require state legislative action and the approval by CMS of a state Medicaid plan amendment. There is no deadline for a state to undertake expansion and qualify for the enhanced federal funding available under the Affordable Care Act. We cannot provide any assurances as to whether or when the states in which we operate might choose to expand their Medicaid programs. We anticipate that health care providers will benefit over time from provisions of the Affordable Care Act that will extend insurance coverage through Medicaid, state-sponsored, federally funded, non-Medicaid plans for low-income residents not eligible for Medicaid, and private insurance to a broader segment of the U.S. population. However, the Affordable Care Act also contains a number of provisions designed to significantly reduce Medicare and Medicaid program spending, including: (1) negative adjustments to the annual market basket updates for Medicare inpatient, outpatient, long-term acute and inpatient rehabilitation prospective payment systems, which began in 2010, as well as additional “productivity adjustments” that began in 2011; and (2) reductions to Medicare and Medicaid disproportionate share hospital payments beginning in federal fiscal year (“FFY”) 2014 as the number of uninsured individuals declines. We are unable to predict the full impact of the Affordable Care Act on our future revenues and operations at this time due to the law’s complexity, the limited amount of implementing regulations and interpretive guidance, uncertainty regarding the ultimate number of uninsured patients who will obtain insurance coverage, uncertainty regarding future negotiations with payers, and gradual or potentially delayed implementation. Furthermore, we are unable to predict what action, if any, Congress might take with respect to the Affordable Care Act or the actions individual states might take with respect to expanding Medicaid coverage as originally contemplated by the Affordable Care Act.

 

In addition to the changes affected by the Affordable Care Act, the Medicare and Medicaid programs are subject to statutory and regulatory changes, administrative and judicial 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, 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 condition, results of operations or cash flows.

 

Medicare

 

Medicare offers its beneficiaries different ways to obtain their medical benefits. One option, the Original Medicare Plan, is a fee-for-service payment system. The other option, called Medicare Advantage (sometimes called “Part C” or “MA Plans”), includes health maintenance organizations (“HMOs”), preferred provider organizations (“PPOs”), private fee-for-service Medicare special needs plans and Medicare medical savings account plans. The major components of our net patient revenues, including our general hospitals and other operations, for services provided to patients enrolled in the Original Medicare Plan for the years ended December 31, 2012, 2011 and 2010 are set forth in the following table:

 

 

 

Years Ended December 31,

 

Revenue Descriptions

 

2012

 

2011

 

2010

 

Medicare severity-adjusted diagnosis-related group — operating

 

$

1,109

 

$

1,126

 

$

1,148

 

Medicare severity-adjusted diagnosis-related group — capital

 

98

 

100

 

104

 

Outliers

 

51

 

44

 

47

 

Outpatient

 

522

 

462

 

441

 

Disproportionate share

 

217

 

214

 

211

 

Direct Graduate and Indirect Medical Education(1)

 

96

 

97

 

96

 

Other(2)

 

66

 

70

 

52

 

Adjustments for prior-year cost reports and related valuation allowances

 

109

 

 

(15

)

Total Medicare net patient revenues

 

$

2,268

 

$

2,113

 

$

2,084

 

 


(1)    Includes Indirect Medical Education revenue earned by our children’s hospital under the Children’s Hospitals Graduate Medical Education Payment Program administered by the Health Resources and Services Administration of HHS.

(2)    The other revenue category includes inpatient psychiatric units, inpatient rehabilitation units, one long-term acute care hospital, other revenue adjustments, and adjustments related to the estimates for current-year cost reports and related valuation allowances.

 

A general description of the types of payments we receive for services provided to patients enrolled in the Original Medicare Plan is provided below. Recent regulatory and legislative updates to the terms of these payment systems and their estimated effect on our revenues can be found below under “Regulatory and Legislative Changes.”

 

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Acute Care Hospital Inpatient Prospective Payment System

 

Medicare Severity-Adjusted Diagnosis-Related Group Payments—Sections 1886(d) and 1886(g) of the Social Security Act (the “Act”) set forth a system of payments for the operating and capital costs of inpatient acute care hospital admissions based on a prospective payment system (“PPS”). Under the inpatient prospective payment system (“IPPS”), Medicare payments for hospital inpatient operating services are made at predetermined rates for each hospital discharge. Discharges are classified according to a system of Medicare severity-adjusted diagnosis-related groups (“MS-DRGs”), which categorize patients with similar clinical characteristics that are expected to require similar amounts of hospital resources. CMS assigns to each MS-DRG a relative weight that represents the average resources required to treat cases in that particular MS-DRG, relative to the average resources used to treat cases in all MS-DRGs.

 

The base payment amount for the operating component of the MS-DRG payment is comprised of an average standardized amount that is divided into a labor-related share and a nonlabor-related share. Both the labor-related share of operating base payments and the base payment amount for capital costs are adjusted for geographic variations in labor and capital costs, respectively. Using diagnosis and procedure information submitted by the hospital, CMS assigns to each discharge an MS-DRG, and the base payments are multiplied by the relative weight of the MS-DRG assigned. The MS-DRG operating and capital base rates, relative weights and geographic adjustment factors are updated annually, with consideration given to: the increased cost of goods and services purchased by hospitals; the relative costs associated with each MS-DRG; and changes in labor data by geographic area. Although these payments are adjusted for area labor and capital cost differentials, the adjustments do not take into consideration an individual hospital’s operating and capital costs.

 

Outlier Payments— Outlier payments are additional payments made to hospitals on individual claims for treating Medicare patients whose medical conditions are costlier to treat than those of the average patient in the same MS-DRG. To qualify for a cost outlier payment, a hospital’s billed charges, adjusted to cost, must exceed the payment rate for the MS-DRG by a fixed threshold established annually by CMS. A Medicare administrative contractor (“MAC”) calculates the cost of a claim by multiplying the billed charges by a cost-to-charge ratio that is typically based on the hospital’s most recently filed cost report. Generally, if the computed cost exceeds the sum of the MS-DRG payment plus the fixed threshold, the hospital receives 80% of the difference as an outlier payment.

 

Under the Act, CMS must project aggregate annual outlier payments to all PPS hospitals to be not less than 5% or more than 6% of total MS-DRG payments (“Outlier Percentage”). The Outlier Percentage is determined by dividing total outlier payments by the sum of MS-DRG and outlier payments. CMS annually adjusts the fixed threshold to bring projected outlier payments within the mandated limit. A change to the fixed threshold affects total outlier payments by changing: (1) the number of cases that qualify for outlier payments; and (2) the dollar amount hospitals receive for those cases that still qualify for outlier payments.

 

Medicare Rural Floor Budget Neutrality Adjustment Settlement—In April 2012, we entered into an industry-wide settlement (the “Medicare Budget Neutrality Settlement”) with HHS, the Secretary of HHS and CMS that corrects Medicare payments made to providers for inpatient hospital services for a number of prior periods. The Balanced Budget Act of 1997 created the “rural floor,” which is intended to ensure that the wage-adjusted IPPS rates for providers in urban areas in a state are not lower than the wage-adjusted IPPS rates for rural providers in the same state. Congress required that the rural floor adjustment, which would otherwise increase aggregate IPPS payments, be administered in a budget neutral manner. CMS included a rural floor budget neutrality adjustment in annual IPPS updates to the base payment rate; however, it did so in a manner that went beyond what was required to achieve budget neutrality. Our 2012 settlement with the government, which is included in adjustments for prior-year cost reports and related valuation allowances in the table above, resulted in a net favorable adjustment in the three months ended March 31, 2012 of approximately $84 million, of which $75 million related to continuing operations (revenues of $81 million less $6 million of legal fees). Substantially all of the cash proceeds to which the Company is entitled under the settlement were received during the three months ended June 30, 2012.

 

Disproportionate Share Hospital Payments—In addition to making payments for services provided directly to beneficiaries, Medicare makes additional payments to hospitals that treat a disproportionately high share of low-income patients. DSH payments are determined annually based on certain statistical information defined by CMS and are calculated as a percentage add-on to the MS-DRG payments. During 2012, 43 of our hospitals in continuing operations qualified for DSH payments. The primary method for a hospital to qualify for DSH payments is based on a complex statutory formula that results in a DSH percentage that is applied to payments based on MS-DRGs. The hospital-specific DSH percentage is equal to the sum of the percentage of Medicare inpatient days attributable to patients eligible for both the Traditional Medicare Plan (“Part A”) and Supplemental Security Income (“SSI”) percentage, and the percentage of total inpatient days attributable to patients eligible for Medicaid but not Medicare Part A. Hospitals receive interim DSH payments that are reconciled in the annual cost report. CMS develops and distributes the hospital-specific SSI percentages, typically one year after the close of the federal fiscal year; however, the release of the SSI percentages was delayed several years as CMS examined and refined the underlying data, in

 

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particular the data supporting CMS’ policy of including Medicare Advantage days in the calculation of the SSI ratio. During this time, CMS instructed the MACs to suspend the settlement of cost reports pending the completion of its review of the SSI data. The FFY 2007 SSI ratios previously issued by CMS generally included the Medicare Advantage days for teaching hospitals only. CMS initiated a data collection effort intended to ensure that the SSI ratios include the Medicare Advantage days for non-teaching hospitals as well. Since 2009, we have estimated the impact of including the Medicare Advantage days of our non-teaching hospitals using internal estimates of the SSI ratios. We accrued approximately $49 million in reserves for potential SSI adjustments in prior reporting periods, including $6 million in 2011. During the three months ended March 31, 2012, CMS released revised SSI ratios for FFYs 2006 and 2007, and SSI ratios for FFYs 2008 and 2009, which, according to CMS, include the Medicare Advantage days; based on these ratios, we increased the aforementioned reserves by approximately $2 million related to our hospitals in continuing operations and approximately $4 million related to our hospitals in discontinued operations. During the three months ended September 30, 2012, CMS released the SSI ratios for FFY 2010, which also include the Medicare Advantage days, and removed the aforementioned suspension on issuing cost report settlements. Based on these ratios, we increased the aforementioned reserves by approximately $3 million related to our hospitals in continuing operations and decreased the reserves by approximately $1 million related to our hospitals in discontinued operations. During the three months ended December 31, 2012, we received cost report settlements previously held in abeyance due to the aforementioned moratorium, resulting in a cash outflow of approximately $20 million, substantially all of which is related to the SSI percentages. We expect to be required to pay the remainder of the estimated liability related to the SSI percentages during 2013.

 

The Medicare DSH statutes and regulations have been the subject of various administrative appeals and lawsuits, and our hospitals have been participating in these appeals, including challenges to the inclusion of Medicare Advantage days in the SSI ratios. These types of appeals generally take several years to resolve, particularly for multi-hospital organizations, because of CMS’ administrative appeal rules. During the three months ended December 31, 2012, the federal district court in the District of Columbia ruled that the Secretary of HHS failed to follow the Administrative Procedures Act when promulgating the regulation requiring the inclusion of the Medicare Advantage days in the SSI ratios. The court remanded the matter to the Secretary and vacated the regulation it found to be improperly promulgated. Subsequently, the Secretary appealed the district court’s order to the court of appeals. The Company’s DSH appeals are still pending; however, the outcome of the aforementioned case could influence the disposition of our appeals. We cannot predict the timing or outcome of our DSH appeals; however, a favorable outcome of our appeals could have a material impact on our future revenues and cash flows. We are also not able to predict what additional action the Secretary might take with respect to the regulation vacated by the district court.

 

Direct Graduate and Indirect Medical Education Payments—The Medicare program provides additional reimbursement to approved teaching hospitals for additional expenses incurred by such institutions. This additional reimbursement, which is subject to certain limits, including intern and resident full-time equivalent (“FTE”) limits, is made in the form of Direct Graduate Medical Education (“DGME”) and Indirect Medical Education (“IME”) payments. During 2012, 12 of our hospitals in continuing operations were affiliated with academic institutions and were eligible to receive such payments. Medicare rules permit teaching hospitals to enter into Medicare Graduate Medical Education Affiliation Agreements for the purpose of applying the FTE limits on an aggregate basis, and some of our teaching hospitals have entered into such agreements.

 

Hospital Outpatient Prospective Payment System

 

Under the outpatient prospective payment system, hospital outpatient services, except for certain services that are reimbursed on a separate fee schedule, are classified into groups called ambulatory payment classifications (“APCs”). Services in each APC are similar clinically and in terms of the resources they require, and a payment rate is established for each APC. Depending on the services provided, hospitals may be paid for more than one APC for an encounter. CMS periodically updates the APCs and annually adjusts the rates paid for each APC.

 

Inpatient Psychiatric Facility Prospective Payment System

 

The inpatient psychiatric facility prospective payment system (“IPF-PPS”) applies to psychiatric hospitals and psychiatric units located within acute care hospitals that have been designated as exempt from the hospital inpatient prospective payment system. The IPF-PPS is based on prospectively determined per-diem rates and includes an outlier policy that authorizes additional payments for extraordinarily costly cases.

 

Inpatient Rehabilitation Prospective Payment System

 

Rehabilitation hospitals and rehabilitation units in acute care hospitals meeting certain criteria established by CMS are eligible to be paid as an inpatient rehabilitation facility (“IRF”) under the IRF prospective payment system (“IRF-PPS”).

 

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Payments under the IRF-PPS are made on a per-discharge basis. A patient classification system is used to assign patients in IRFs into case-mix groups. The IRF-PPS uses federal prospective payment rates across distinct case-mix groups.

 

To be paid under the IRF-PPS, each hospital or unit must demonstrate on an annual basis that at least 60% of its total population had either a principal or secondary diagnosis that fell within one or more of the qualifying conditions designated in the Medicare regulations governing IRFs. As of December 31, 2012, all of our rehabilitation units were in compliance with the required 60% threshold.

 

Physician Services Payment System

 

Medicare pays for physician and other professional services based on a list of services and their payment rates, called the Medicare Physician Fee Schedule (“MPFS”). In determining payment rates for each service on the fee schedule, CMS considers the amount of work required to provide a service, expenses related to maintaining a practice, and liability insurance costs. The values given to these three types of resources are adjusted by variations in the input prices in different markets, and then a total is multiplied by a standard dollar amount, called the fee schedule’s conversion factor, to arrive at the payment amount. Medicare’s payment rates may be adjusted based on provider characteristics, additional geographic designations and other factors. The conversion factor updates payments for physician services every year according to a formula called the sustainable growth rate (“SGR”) system. This formula is intended to keep spending growth (a function of service volume growth) consistent with growth in the national economy. However, in the last several years, Congress has specified an update outside of the SGR formula. Because of budget neutrality requirements, these payment updates have largely been funded by payment reductions to other providers, including hospitals.

 

Cost Reports

 

The final determination of certain Medicare payments to our hospitals, such as DSH, DGME, IME and bad debt expense, are retrospectively determined based on our hospitals’ cost reports. The final determination of these payments often takes many years to resolve because of audits by the program representatives, providers’ rights of appeal, and the application of numerous technical reimbursement provisions.

 

For filed cost reports, we adjust the accrual for estimated cost report settlements based on those cost reports and subsequent activity, and record a valuation allowance against those cost reports based on historical settlement trends. The accrual for estimated cost report settlements for periods for which a cost report is yet to be filed is recorded based on estimates of what we expect to report on the filed cost reports and a corresponding valuation allowance is recorded as previously described. Cost reports must generally be filed within five months after the end of the annual cost report reporting period. After the cost report is filed, the accrual and corresponding valuation allowance may need to be adjusted.

 

Medicaid

 

Medicaid programs and the corresponding reimbursement methodologies are administered by the states and vary from state to state and from year to year. Estimated revenues under various state Medicaid programs, excluding state-funded managed care Medicaid programs, constituted approximately 8.4%, 9.0% and 8.6% of net patient revenues at our continuing general hospitals for the years ended December 31, 2012, 2011 and 2010, respectively. We also receive DSH payments under various state Medicaid programs. For the years ended December 31, 2012, 2011 and 2010, our revenues attributable to DSH payments and other state-funded subsidy payments were approximately $283 million, $255 million and $178 million, respectively.

 

Several states in which we operate have recently faced budgetary challenges that resulted in reduced Medicaid funding levels to hospitals and other providers. Because most states must operate with balanced budgets, and the Medicaid program is generally a significant portion of a state’s budget, states can be expected to adopt or consider adopting future legislation designed to reduce their Medicaid expenditures. The economic downturn has increased budget pressures on most states, and these budget pressures have resulted, and likely will continue to result, in decreased spending for Medicaid programs in many states. In addition, some states are implementing delays in issuing Medicaid payments to providers. Increased Medicaid enrollment due to the economic downturn, budget gaps and other factors could result in future reductions to Medicaid payments, payment delays or additional taxes on hospitals.

 

As an alternative means of funding provider payments, several states in which we operate have adopted or are considering adopting broad-based provider taxes to fund the non-federal share of Medicaid programs. Most states have introduced provider fee arrangements, which are intended to enhance funding or partially mitigate reduced Medicaid funding levels to hospitals and other providers.

 

In September 2011, the Governor of California signed legislation that created a hospital fee program to provide supplemental Medi-Cal payments to hospitals retroactive to July 1, 2011 and expiring on December 31, 2013 (the “30-Month

 

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Program”). During the three months ended June 30, 2012, the Governor of California signed the state’s 2012/2013 budget, which included a change to the fee program. This legislative change and approval by CMS of the fee-for-service supplemental payment and assessment portions of the 30-Month Program in June 2012 enabled us to record $72 million of net revenues related to the 30-Month Program in 2012, of which $42 million had not been received as of December 31, 2012. We recorded $91 million of net revenues from similar California hospital fee programs during the year ended December 31, 2011. We expect the managed care portion of the 30-Month Program to be approved in 2013. Based on the most recent California Hospital Association estimates, the 30-Month Program could result in approximately $187 million of net revenues for our California hospitals. At such time as CMS approves the managed care portion of the fee program, we expect to: (1) make a one-time adjustment to record the retroactive impact of the additional revenues net of assessments; and (2) record the remaining net revenues for the program years ratably over the remaining term of the program. We cannot provide any assurances regarding the final approval of the managed care portion of the 30-Month Program by CMS or the timing or amount of the payments we may ultimately receive or be required to make.

 

The State of Georgia adopted an amended budget for the state fiscal year ended June 30, 2012 that included additional funding for payments to private hospitals from the Indigent Care Trust Fund (“ICTF”), the state’s disproportionate share program. As a result, we recognized ICTF revenues of approximately $14 million in 2012. During 2011, we recorded $13 million of ICTF revenues. We cannot provide any assurances regarding the amount, if any, of ICTF payments we might receive in 2013.

 

During the three months ended June 30, 2012, we received notification of our net revenues under a North Carolina hospital fee program retroactive to January 1, 2011 through September 30, 2012. As a result, we recognized $17 million of net revenues from this program during 2012. This program has no sunset date.

 

Based on an audit of Missouri’s 2005-2007 Medicaid plan years, we had recorded a liability of approximately $10 million as of September 30, 2012 related to estimated Medicaid DSH overpayments. We formally challenged the recovery of the overpayment and, during the three months ended December 31, 2012, we settled the matter for $1.5 million. As a result, we recognized a favorable adjustment to net operating revenues of approximately $8 million during the three months ended December 31, 2012.

 

During the three months ended December 31, 2012, certain of our Texas hospitals began to participate in the Texas 1115 demonstration waiver approved by CMS in December 2011 to replace the state’s Upper Payment Limit program. The waiver term covers state fiscal years September 1, 2012 through August 31, 2016, is funded by intergovernmental transfer payments from local government entities, and includes two funding pools — Uncompensated Care and Delivery System Reform Payment. We recognized $15 million of revenues associated with this 1115 waiver program during the three months ended December 31, 2012, which we have not yet received. Separately, during the same period we incurred $13 million of expenses related to funding indigent care services by certain of our Texas hospitals. The state is also negotiating with local government entities the amount of intergovernmental transfer funding that will be provided for the state’s Medicaid DSH program. In 2012, we recognized $32 million in revenues from the Texas 1115 waiver and DSH programs. We cannot provide any assurances as to the ultimate amount of revenues that our hospitals may receive from these programs in 2013.

 

Because we cannot predict what actions the federal government or the states may take under existing legislation and future legislation to address budget gaps or deficits, we are unable to assess the effect that any such legislation might have on our business, but the impact on our future financial position, results of operations or cash flows could be material.

 

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Medicaid-related patient revenues recognized by our continuing general hospitals from Medicaid-related programs in the states in which they are located, as well as from Medicaid programs in neighboring states, for the years ended December 31, 2012, 2011 and 2010 are set forth in the table below:

 

 

 

Years Ended December 31,

 

 

 

2012

 

2011

 

2010

 

Hospital Location

 

Medicaid

 

Managed
Medicaid

 

Medicaid

 

Managed
Medicaid

 

Medicaid

 

Managed
Medicaid

 

California

 

$

198

 

$

148

 

$

221

 

$

127

 

$

137

 

$

111

 

Florida

 

178

 

61

 

184

 

60

 

194

 

55

 

Georgia

 

85

 

38

 

88

 

40

 

87

 

40

 

Pennsylvania

 

72

 

209

 

91

 

195

 

53

 

161

 

Missouri

 

70

 

5

 

52

 

5

 

81

 

6

 

Texas

 

67

 

123

 

64

 

114

 

66

 

109

 

North Carolina

 

40

 

 

23

 

 

26

 

 

South Carolina

 

34

 

25

 

40

 

22

 

61

 

20

 

Alabama

 

31

 

 

29

 

 

26

 

 

Tennessee

 

8

 

29

 

10

 

30

 

9

 

27

 

 

 

$

783

 

$

638

 

$

802

 

$

593

 

$

740

 

$

529

 

 

Regulatory and Legislative Changes

 

Recent regulatory and legislative updates to the Medicare and Medicaid payment systems are provided below.

 

Payment and Policy Changes to the Medicare Inpatient Prospective Payment System

 

Under Medicare law, CMS is required to annually update certain rules governing the IPPS. The updates generally become effective October 1, the beginning of the federal fiscal year. On August 1, 2012, CMS issued the Changes to the Hospital Inpatient Prospective Payment Systems for Acute Care Hospitals and Fiscal Year 2013 Rates (“Final Rule”). The Final Rule includes the following payment and policy changes:

 

·                  A market basket increase of 2.6% for MS-DRG operating payments for hospitals reporting specified quality measure data (hospitals that do not report specified quality measure data would receive an increase of 0.6%); CMS is also making certain adjustments to the estimated 2.6% market basket increase that result in a net market basket update of 2.8%, including the following adjustments to the market basket index:

 

·                  Market basket index and productivity reductions required by the Affordable Care Act of 0.1% and 0.7%, respectively;

 

·                  A reduction of 1.9% to permanently remove the remaining portion of the estimated 3.9% documentation and coding adjustment resulting from the conversion to MS-DRGs based on CMS’ analysis of FFY 2008 and FFY 2009 claims data; and

 

·                  Restoration of a 2.9% reduction that was required to complete the recovery in FFY 2012 of the estimated MS-DRG documentation and coding overpayments for FFYs 2008 and 2009;

 

·                  A 0.97% net increase in the capital federal MS-DRG rate; and

 

·                  A decrease in the cost outlier threshold from $22,385 to $21,821.

 

CMS projects that the combined impact of the payment and policy changes in the Final Rule will yield an average 2.6% increase in payments for hospitals in large urban areas (populations over 1 million). Using the impact percentages in the Final Rule as applied to our IPPS payments for the 12 months ended September 30, 2012, the estimated annual impact for all changes in the Final Rule on our hospitals is an increase in our Medicare inpatient revenues of approximately $40 million. Because of the uncertainty regarding other factors that may influence our future IPPS payments by individual hospital, including admission volumes, length of stay and case mix, we cannot provide any assurances regarding our estimate.

 

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Payment Changes to the Medicare Inpatient Psychiatric Facility Prospective Payment System

 

On August 2, 2012, CMS issued a notice updating the prospective payment rates for the Medicare inpatient psychiatric facility (“IPF”) PPS for FFY 2013 (“IPF-PPS Notice”). The IPF-PPS Notice includes the following payment and policy changes:

 

·                  A net payment increase for IPFs of 1.9%, which reflects a market basket index increase of 2.7%, reduced by a productivity adjustment of 0.7% and an additional 0.1%, both as required by the Affordable Care Act, as well as other adjustments, including a budget neutrality reduction; and

 

·                  An increase in the outlier threshold from $7,340 to $11,600.

 

At December 31, 2012, 11 of our general hospitals operated inpatient psychiatric units reimbursed under the IPF-PPS. CMS projects that the combined impact of the payment and policy changes included in the IPF-PPS Notice will yield an average 0.8% increase in payments for all IPFs (including psychiatric units in acute care hospitals) and an average 0.2% increase in payments for psychiatric units of acute care hospitals located in urban areas for FFY 2013. Using the urban psychiatric unit impact percentage as applied to our IPF-PPS payments for the 12 months ended September 30, 2012, the annual impact of all payment and policy changes in the IPF-PPS Notice on our IPF-PPS psychiatric units may result in an estimated increase in our Medicare revenues of approximately $1 million. Because of the uncertainty associated with various factors that may influence our future IPF-PPS payments, including legislative action, admission volumes, length of stay and case mix, we cannot provide any assurances regarding our estimate of the impact of the aforementioned changes.

 

Payment Changes to the Medicare Inpatient Rehabilitation Facility Prospective Payment System

 

On July 25, 2012, CMS issued a notice that further implements certain provisions of the Affordable Care Act and updates the prospective payment rates for the Medicare inpatient rehabilitation facility prospective payment system for FFY 2013 (“IRF-PPS Notice”). The IRF-PPS Notice includes the following payment changes:

 

·                  A net payment increase for IRFs of 1.9%, which reflects a market basket index increase of 2.7%, reduced by a productivity adjustment of 0.7% and an additional 0.1%, both as required by the Affordable Care Act, as well as other adjustments, including a budget neutrality reduction; and

 

·                  A decrease in the outlier threshold for high cost outlier cases from $10,660 to $10,466.

 

The IRF-PPS Notice also notes that the Affordable Care Act requires the Secretary of HHS to establish a quality reporting program for IRFs, and that IRFs that fail to comply with the quality data submission requirements, beginning in FFY 2014, will experience a 2% reduction in the annual payment update.

 

At December 31, 2012, eight of our general hospitals operated inpatient rehabilitation units. CMS projects that the payment changes in the IRF-PPS Notice will result in an estimated total increase in aggregate IRF payments of 2.1%. This estimated increase includes an average 2.2% increase for rehabilitation units in hospitals located in urban areas for FFY 2013. Using the urban rehabilitation unit impact percentage as applied to our Medicare IRF payments for the 12 months ended September 30, 2012, the annual impact of the payment changes in the IRF-PPS Notice may result in an estimated increase in our Medicare revenues of less than $1 million. Because of the uncertainty associated with various factors that may influence our future IRF payments, including legislative action, admission volumes, length of stay and case mix, and the impact of compliance with IRF admission criteria, we cannot provide any assurances regarding our estimate of the impact of these changes.

 

Payment and Policy Changes to the Medicare Outpatient Prospective Payment System

 

On November 1, 2012, CMS released the Final Changes to the Hospital Outpatient Prospective Payment System (“OPPS”) and Calendar Year (“CY”) 2013 Payment Rates (“Final OPPS Rule”). The Final OPPS Rule includes the following payment and policy changes:

 

·                  A net update to OPPS payments equal to the estimated market basket of 1.8%, which takes into account a projected hospital IPPS market basket percentage increase of 2.6%, minus an estimated productivity adjustment of 0.7% and a 0.1% adjustment, both of which are necessary to comply with certain provisions of the Affordable Care Act; and

 

·                  The continuation of a budget neutral reduction in payments for non-cancer OPPS hospitals to fund an increase in OPPS payments to cancer hospitals mandated under the Affordable Care Act.

 

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CMS projects that the combined impact of the payment and policy changes in the Final OPPS Rule will yield an average 1.9% increase in payments for all hospitals and an average 2.0% increase in payments for hospitals in large urban areas (populations over one million). According to CMS’ estimates, the projected annual impact of the payment and policy changes in the Final OPPS Rule on our hospitals is an $11 million increase in Medicare outpatient revenues. Because of the uncertainty associated with factors that may influence our future OPPS payments by individual hospital, including patient volumes and case mix, we cannot provide any assurances regarding this estimate.

 

Changes to the Medicare Physician Fee Schedule

 

On November 1, 2012, CMS issued the CY 2013 Medicare Physician Fee Schedule final rule detailing Medicare physician payment policies for 2013. The rule confirmed that, unless Congress intervened, Medicare’s physician payments were scheduled to decrease in January 2013 by 26.5%. The American Taxpayer Relief Act of 2012, which was enacted on January 2, 2013, includes a provision to avert the 26.5% reduction for 2013. For additional information, see the disclosure regarding the American Taxpayer Relief Act of 2012 below.

 

Medicare Prepayment Reviews

 

The Improper Payments Information Act of 2002, amended by the Improper Payments Elimination and Recovery Act of 2010, requires the heads of federal agencies, including HHS, to annually review programs it administers to:

 

·                  Identify programs that may be susceptible to significant improper payments;

 

·                  Estimate the amount of improper payments in those programs;

 

·                  Submit those estimates to Congress; and

 

·                  Describe the actions the agency is taking to reduce improper payments in those programs.

 

CMS has identified the Medicare Fee-For-Service (“FFS”) program as a program at risk for significant erroneous payments. In 2010, the Medicare FFS paid claims error rate was estimated to be 10.5%, or approximately $34 billion in improper payments. As a result, in addition to the Recovery Audit Contractor (“RAC”) program, which currently performs post-payment claims reviews, CMS has recently established initiatives to prevent improper payments before a claim is processed. These initiatives include:

 

·                  A significant increase in the number of prepayment claims reviews performed by MACs; and

 

·                  A three-year demonstration project that expands the scope of the RAC program to include prepayment reviews in 11 states; these reviews, which commenced in August 2012, are initially focusing on inpatient claims, in particular short stays.

 

Claims selected for prepayment review are not subject to the normal Medicare FFS payment timeframe. Furthermore, prepayment claims denials are subject to administrative and judicial review. The degree to which our Medicare FFS claims are subjected to prepayment reviews, the extent to which payments are denied, and our success in overturning denials could have a material adverse effect on our cash flows and results of operations.

 

Affordable Care Act

 

The Affordable Care Act was enacted to change how health care services in the United States are covered, delivered and reimbursed through expanded coverage of uninsured individuals, reduced growth and other reductions in Medicare program spending, and the establishment of programs where reimbursement is tied to quality and integration. In addition, the law reforms certain aspects of health insurance, expands existing efforts to tie Medicare and Medicaid payments to performance and quality, and contains provisions intended to strengthen fraud and abuse enforcement. The expansion of health insurance coverage under the Affordable Care Act may result in a material increase in the number of patients using our facilities who have either private or public program coverage. On the other hand, the Affordable Care Act provides for significant reductions in Medicare market basket updates and reductions in Medicare and Medicaid DSH payments. Given that approximately 31.8% of our net patient revenues in 2012 were from Medicare and Medicaid, reductions to these programs may significantly impact us and could offset any positive effects of the Affordable Care Act.

 

We are unable to predict the full impact of the Affordable Care Act on our future revenues and operations at this time due to the law’s complexity, the limited amount of implementing regulations and interpretive guidance, uncertainty regarding the ultimate number of uninsured patients who will obtain insurance coverage and uncertainty regarding future negotiations with payers.

 

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