10-K 1 d10k.htm UNIVERSAL HEALTH SERVICES INC--FORM 10-K Universal Health Services Inc--Form 10-K
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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

 

(MARK ONE)

 

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

 

For the fiscal year ended December 31, 2008

 

OR

 

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

 

For the transition period from                             to                             

 

Commission File No. 1-10765

 

UNIVERSAL HEALTH SERVICES, INC.

(Exact name of registrant as specified in its charter)

 

Delaware   23-2077891

(State or other jurisdiction of

incorporation or organization)

  (I.R.S. Employer Identification Number)

UNIVERSAL CORPORATE CENTER

367 South Gulph Road

P.O. Box 61558

King of Prussia, Pennsylvania

 

 

19406-0958

(Zip Code)

(Address of principal executive offices)  

 

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

 

 

 

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

 

Title of each Class   Name of each exchange on which registered
Class B Common Stock, $.01 par value   New York Stock Exchange

 

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

Class D Common Stock, $.01 par value

(Title of each Class)

 

 

 

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  ¨

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.

Yes  ¨          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 (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes  x          No  ¨

 

Indicate by check mark 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 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. ¨


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Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act (check one):

Large accelerated filer  x  Accelerated filer  ¨   Non-accelerated filer  ¨  Smaller reporting company  ¨

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes  ¨          No  x

 

The aggregate market value of voting stock held by non-affiliates at June 30, 2008 was $2.94 billion. (For the purpose of this calculation, it was assumed that Class A, Class C, and Class D Common Stock, which are not traded but are convertible share-for-share into Class B Common Stock, have the same market value as Class B Common Stock. Also, for purposes of this calculation only, all directors, officers subject to Section 16(b) of the Securities Exchange Act of 1934, and 10% stockholders are deemed to be affiliates.)

 

The number of shares of the registrant’s Class A Common Stock, $.01 par value, Class B Common Stock, $.01 par value, Class C Common Stock, $.01 par value, and Class D Common Stock, $.01 par value, outstanding as of January 31, 2009, were 3,328,404, 45,780,143, 335,800 and 22,269, respectively.

 

DOCUMENTS INCORPORATED BY REFERENCE:

Portions of the registrant’s definitive proxy statement for our 2009 Annual Meeting of Stockholders, which will be filed with the Securities and Exchange Commission within 120 days after December 31, 2008 (incorporated by reference under Part III).

 

 

 


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UNIVERSAL HEALTH SERVICES, INC.

2008 FORM 10-K ANNUAL REPORT

 

TABLE OF CONTENTS

 

PART I

Item 1

  

Business

   4

Item 1A

  

Risk Factors

   17

Item 1B

  

Unresolved Staff Comments

   24

Item 2

  

Properties

   25

Item 3

  

Legal Proceedings

   28

Item 4

  

Submission of Matters to a Vote of Security Holders

   31
PART II

Item 5

  

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

  

32

Item 6

  

Selected Financial Data

   35

Item 7

  

Management’s Discussion and Analysis of Operations and Financial Condition

   36

Item 7A

  

Quantitative and Qualitative Disclosures about Market Risk

   72

Item 8

  

Financial Statements and Supplementary Data

   73

Item 9

  

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

   73

Item 9A

  

Controls and Procedures

   73

Item 9B

  

Other Information

   74
PART III

Item 10

  

Directors and Executive Officers of the Registrant

   74

Item 11

  

Executive Compensation

   74

Item 12

  

Security Ownership of Certain Beneficial Owners and Management

   74

Item 13

  

Certain Relationships and Related Transactions

   74

Item 14

  

Principal Accounting Fees and Services

   74
PART IV

Item 15

  

Exhibits, Financial Statement Schedules

   75

SIGNATURES

   80

 

Exhibit Index

 

This Annual Report on Form 10-K is for the year ended December 31, 2008. This Annual Report modifies and supersedes documents filed prior to this Annual Report. Information that we file with the SEC in the future will automatically update and supersede information contained in this Annual Report. In this Annual Report, “we,” “us,” “our” and the “Company” refer to Universal Health Services, Inc. and its subsidiaries.

 

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PART I

 

ITEM 1. Business

 

Our principal business is owning and operating, through our subsidiaries, acute care hospitals, behavioral health centers, surgical hospitals, ambulatory surgery centers and radiation oncology centers. As of February 26, 2009, we owned and/or operated or had under construction, 26 acute care hospitals (including 1 new facility currently being constructed) and 101 behavioral health centers located in 32 states, Washington, D.C. and Puerto Rico. As part of our ambulatory treatment centers division, we manage and/or own outright or in partnerships with physicians, 9 surgical hospitals and surgery and radiation oncology centers located in 6 states and Puerto Rico.

 

Net revenues from our acute care hospitals, surgical hospitals, surgery centers and radiation oncology centers accounted for 74%, 74% and 75% of our consolidated net revenues in 2008, 2007 and 2006, respectively. Net revenues from our behavioral health care facilities accounted for 25% of our consolidated net revenues during each of 2008, 2007 and 2006. During each of 2008 and 2007, approximately 1% of our consolidated net revenues were recorded in connection with two construction management contracts pursuant to the terms of which we: (i) built a newly constructed acute care hospital for an unrelated third party that was completed during the first quarter of 2008, and; (ii) are building a newly constructed acute care hospital for an unrelated party that is scheduled to be completed during the fourth quarter of 2009.

 

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

 

We are a Delaware corporation that was organized in 1979. Our principal executive offices are located at Universal Corporate Center, 367 South Gulph Road, P.O. Box 61558, King of Prussia, PA 19406. Our telephone number is (610) 768-3300.

 

Available Information

 

Our website is located at http://www.uhsinc.com. Copies of our annual, quarterly and current reports that we file with the SEC, and any amendments to those reports, are available free of charge on our website. The information posted on our website is not incorporated into this Annual Report. Our Board of Directors’ committee charters (Audit Committee, Compensation Committee and Nominating & Governance Committee), Code of Business Conduct and Corporate Standards applicable to all employees, Code of Ethics for Senior Financial Officers and Corporate Governance Guidelines are available free of charge on our website. Copies of such reports and charters are available in print to any stockholder who makes a request. Such requests should be made to our Secretary at our King of Prussia, PA corporate headquarters. We intend to satisfy the disclosure requirement under Item 5.05 of Form 8-K relating to amendments to or waivers of any provision of our Code of Ethics for Senior Financial Officers by promptly posting this information on our website.

 

In accordance with Section 303A.12(a) of the New York Stock Exchange Listed Company Manual, we submitted our CEO’s certification to the New York Stock Exchange in 2008. Additionally, contained in Exhibits 31.1 and 31.2 of this Annual Report on Form 10-K, are our CEO’s and CFO’s certifications regarding the quality of our public disclosures under Section 302 of the Sarbanes-Oxley Act of 2002.

 

Our Mission

 

Our mission and objective is to provide superior healthcare services that patients recommend to families and friends, physicians prefer for their patients, purchasers select for their clients, employees are proud of, and investors seek for long-term results. To achieve this, we have a commitment to:

 

   

service excellence

 

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continuous improvement in measurable ways

 

   

employee development

 

   

ethical and fair treatment

 

   

teamwork

 

   

compassion

 

   

innovation in service delivery

 

Business Strategy

 

We believe community-based hospitals will remain the focal point of the healthcare delivery network and we are committed to a philosophy of self-determination for both the company and our hospitals.

 

Acquisition of Additional Hospitals.    We selectively seek opportunities to expand our base of operations by acquiring, constructing or leasing additional hospital facilities. We are committed to a program of rational growth around our core businesses, while retaining the missions of the hospitals we manage and the communities we serve. Such expansion may provide us with access to new markets and new healthcare delivery capabilities. We also continue to examine our facilities and consider divestiture of those facilities that we believe do not have the potential to contribute to our growth or operating strategy.

 

Improvement of Operations of Existing Hospitals and Services.     We also seek to increase the operating revenues and profitability of owned hospitals by the introduction of new services, improvement of existing services, physician recruitment and the application of financial and operational controls.

 

We are involved in continual development activities for the benefit of our existing facilities. Applications to state health planning agencies to add new services in existing hospitals are currently on file in states which require certificates of need, or CONs. Although we expect that some of these applications will result in the addition of new facilities or services to our operations, no assurances can be made for ultimate success by us in these efforts.

 

Quality and Efficiency of Services.     Pressures to contain healthcare costs and technological developments allowing more procedures to be performed on an outpatient basis have led payors to demand a shift to ambulatory or outpatient care wherever possible. We are responding to this trend by emphasizing the expansion of outpatient services. In addition, in response to cost containment pressures, we continue to implement programs at our facilities designed to improve financial performance and efficiency while continuing to provide quality care, including more efficient use of professional and paraprofessional staff, monitoring and adjusting staffing levels and equipment usage, improving patient management and reporting procedures and implementing more efficient billing and collection procedures. In addition, we will continue to emphasize innovation in our response to the rapid changes in regulatory trends and market conditions while fulfilling our commitment to patients, physicians, employees, communities and our shareholders.

 

In addition, our aggressive recruiting of top-notch physicians and developing provider networks help to establish our facilities as an important source of quality healthcare in their respective communities.

 

2008 Acquisition and Divestiture Activities

 

Acquisitions:

 

During 2008, we spent $23 million on the acquisition of businesses and real property, including the following:

 

   

the acquisition of a 76-bed behavioral health facility located in Lawrenceville, Georgia, and;

 

   

the acquisition of previously leased real property assets of a behavioral health facility located in Nevada.

 

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Divestitures:

 

During 2008, we received $82 million from the divestiture of assets and businesses, including the following:

 

   

the sale of the assets and operations of Central Montgomery Medical Center, a 125-bed acute care facility located in Lansdale, Pennsylvania;

 

   

the sale of our ownership interest in a third-party provider of supply chain services, and;

 

   

the sale our ownership interest in an outpatient surgery center and certain other real property assets.

 

Hospital Utilization

 

We believe that the most important factors relating to the overall utilization of a hospital include the quality and market position of the hospital and the number, quality and specialties of physicians providing patient care within the facility. Generally, we believe that the ability of a hospital to meet the health care needs of its community is determined by its breadth of services, level of technology, emphasis on quality of care and convenience for patients and physicians. Other factors that affect utilization include general and local economic conditions, market penetration of managed care programs, the degree of outpatient use, the availability of reimbursement programs such as Medicare and Medicaid, and demographic changes such as the growth in local populations. Utilization across the industry also is being affected by improvements in clinical practice, medical technology and pharmacology. Current industry trends in utilization and occupancy have been significantly affected by changes in reimbursement policies of third party payors. We are also unable to predict the extent to which these industry trends will continue or accelerate. In addition, hospital operations are typically subject to certain seasonal fluctuations, such as higher patient volumes and net patient service revenues in the first and fourth quarters of the year.

 

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The following table sets forth certain operating statistics for hospitals operated by us for the years indicated. Accordingly, information related to hospitals acquired during the five-year period has been included from the respective dates of acquisition, and information related to hospitals divested during the five year period has been included up to the respective dates of divestiture.

 

    2008     2007     2006     2005     2004  

Average Licensed Beds:

         

Acute Care Hospitals—U.S. & Puerto Rico (1)

  6,101     5,962     5,617     5,707     6,496  

Behavioral Health Centers

  7,658     7,348     6,607     4,849     4,225  

Acute Care Hospitals—France (2)

  —       —       —       667     1,588  

Average Available Beds (3):

         

Acute Care Hospitals—U.S. & Puerto Rico (1)

  5,249     5,110     4,783     5,110     5,592  

Behavioral Health Centers

  7,629     7,315     6,540     4,766     4,145  

Acute Care Hospitals-France (2)

  —       —       —       662     1,588  

Admissions:

         

Acute Care Hospitals—U.S. & Puerto Rico (1)

  268,207     262,147     246,429     261,402     286,630  

Behavioral Health Centers

  129,553     119,730     111,490     102,683     94,743  

Acute Care Hospitals—France (2)

  —       —       —       37,262     94,536  

Average Length of Stay (Days):

         

Acute Care Hospitals—U.S. & Puerto Rico (1)

  4.5     4.5     4.4     4.5     4.7  

Behavioral Health Centers

  16.1     16.8     16.6     14.1     13.0  

Acute Care Hospitals—France (2)

  —       —       —       4.6     4.7  

Patient Days (4):

         

Acute Care Hospitals—U.S. & Puerto Rico (1)

  1,200,672     1,172,130     1,095,375     1,179,894     1,342,242  

Behavioral Health Centers

  2,085,114     2,007,119     1,855,306     1,446,260     1,234,152  

Acute Care Hospitals—France (2)

  —       —       —       172,084     442,825  

Occupancy Rate—Licensed Beds (5):

         

Acute Care Hospitals—U.S. & Puerto Rico (1)

  54 %   54 %   53 %   57 %   56 %

Behavioral Health Centers

  74 %   75 %   77 %   82 %   80 %

Acute Care Hospitals—France (2)

  —       —       —       71 %   76 %

Occupancy Rate—Available Beds (5):

         

Acute Care Hospitals—U.S. & Puerto Rico (1)

  62 %   63 %   63 %   63 %   66 %

Behavioral Health Centers

  75 %   75 %   78 %   83 %   81 %

Acute Care Hospitals—France (2)

  —       —       —       71 %   76 %

 

(1) The acute care facilities located in Puerto Rico were divested by us during the first quarter of 2005 and Central Montgomery Medical Center located in Pennsylvania was divested during the fourth quarter of 2008. The statistical information for these facilities is included in the above information through the respective divestiture dates.
(2) The facilities located in France were divested by us during the second quarter of 2005 and the statistical information for these facilities is included in the above information through the divestiture date.
(3) “Average Available Beds” is the number of beds which are actually in service at any given time for immediate patient use with the necessary equipment and staff available for patient care. A hospital may have appropriate licenses for more beds than are in service for a number of reasons, including lack of demand, incomplete construction, and anticipation of future needs
(4) “Patient Days” is the sum of all patients for the number of days that hospital care is provided to each patient.
(5) “Occupancy Rate” is calculated by dividing average patient days (total patient days divided by the total number of days in the period) by the number of average beds, either available or licensed.

 

Sources of Revenue

 

We receive payments for services rendered from private insurers, including managed care plans, the federal government under the Medicare program, state governments under their respective Medicaid programs and directly from patients. See Item 7. Management’s Discussion and Analysis of Operations and Financial Condition—Sources of Revenue for additional disclosure. Other information related to our revenues, income and other operating information for each reporting segment of our business is provided in Note 11 to our Consolidated Financial Statements, Segment Reporting.

 

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Regulation and Other Factors

 

Overview:    The healthcare industry is subject to numerous laws, regulations and rules including among others those related to government healthcare participation requirements, various licensure and accreditations, reimbursement for patient services, health information privacy and security rules, and Medicare and Medicaid fraud and abuse provisions (including, but not limited to, federal statutes and regulations prohibiting kickbacks and other illegal inducements to potential referral sources, false claims submitted to federal health care programs and self-referrals by physicians). Providers that are found to have violated any of these laws and regulations may be excluded from participating in government healthcare programs, subjected to significant fines or penalties and/or required to repay amounts received from government for previously billed patient services. Although we believe our policies, procedures and practices comply with governmental regulations, no assurance can be given that we will not be subjected to additional governmental inquiries or actions, or that we would not be faced with sanctions, fines or penalties if so subjected. Even if we were to ultimately prevail, a significant governmental inquiry or action under one of the above laws, regulations or rules could have a material adverse impact on us.

 

Licensing, Certification and Accreditation:    All of our hospitals are subject to compliance with various federal, state and local statutes and regulations and receive periodic inspection by state licensing agencies to review standards of medical care, equipment and cleanliness. Our hospitals must also comply with the conditions of participation and licensing requirements of federal, state and local health agencies, as well as the requirements of municipal building codes, health codes and local fire departments. Various other licenses and permits are also required in order to dispense narcotics, operate pharmacies, handle radioactive materials and operate certain equipment.

 

All our eligible hospitals have been accredited by the Joint Commission. All of our acute care hospitals and most of our behavioral health centers are certified as providers of Medicare and Medicaid services by the appropriate governmental authorities.

 

If any of our facilities were to lose its Joint Commission accreditation or otherwise lose its certification under the Medicare and Medicaid programs, the facility may be unable to receive reimbursement from the Medicare and Medicaid programs and other payors. We believe our facilities are in substantial compliance with current applicable federal, state, local and independent review body regulations and standards. The requirements for licensure, certification and accreditation are subject to change and, in order to remain qualified, it may become necessary for us to make changes in our facilities, equipment, personnel and services in the future, which could have a material adverse impact on operations.

 

Certificates of Need:    Many of the states in which we operate hospitals have enacted certificates of need (“CON”) laws as a condition prior to hospital capital expenditures, construction, expansion, modernization or initiation of major new services. Failure to obtain necessary state approval can result in our inability to complete an acquisition, expansion or replacement, the imposition of civil or, in some cases, criminal sanctions, the inability to receive Medicare or Medicaid reimbursement or the revocation of a facility’s license, which could harm our business. In addition, significant CON reforms have been proposed in a number of states that would increase the capital spending thresholds and provide exemptions of various services from review requirements. In the past, we have not experienced any material adverse effects from those requirements, but we cannot predict the impact of these changes upon our operations.

 

Conversion Legislation:    Many states have enacted or are considering enacting laws affecting the conversion or sale of not-for-profit hospitals to for-profit entities. These laws generally require prior approval from the attorney general, advance notification and community involvement. In addition, attorney generals in states without specific conversion legislation may exercise discretionary authority over these transactions. Although the level of government involvement varies from state to state, the trend is to provide for increased governmental review and, in some cases, approval of a transaction in which a not-for-profit entity sells a health care facility to a for-profit entity. The adoption of new or expanded conversion legislation and the increased review of not-for-profit hospital conversions may limit our ability to grow through acquisitions of not-for-profit hospitals.

 

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Utilization Review:    Federal regulations require that admissions and utilization of facilities by Medicare and Medicaid patients must be reviewed in order to ensure efficient utilization of facilities and services. The law and regulations require Peer Review Organizations (“PROs”) to review the appropriateness of Medicare and Medicaid patient admissions and discharges, the quality of care provided, the validity of diagnosis related group (“DRG”) classifications and the appropriateness of cases of extraordinary length of stay. PROs may deny payment for services provided, assess fines and also have the authority to recommend to HHS that a provider that is in substantial non-compliance with the standards of the PRO be excluded from participating in the Medicare program. We have contracted with PROs in each state where we do business to perform the required reviews.

 

Self-Referral and Anti-Kickback Legislation

 

The Stark Law:    The Social Security Act includes a provision commonly known as the “Stark Law.” This law prohibits physicians from referring Medicare and Medicaid patients to entities with which they or any of their immediate family members have a financial relationship, unless an exception is met. These types of referrals are known as “self-referrals.” Sanctions for violating the Stark Law include civil penalties up to $15,000 for each violation, up to $100,000 for sham arrangements, up to $10,000 for each day an entity fails to report required information and exclusion from the federal health care programs. There are a number of exceptions to the self-referral prohibition, including an exception for a physician’s ownership interest in an entire hospital as opposed to an ownership interest in a hospital department unit, service or subpart. There are also exceptions for many of the customary financial arrangements between physicians and providers, including employment contracts, leases and recruitment agreements that adhere to certain enumerated requirements.

 

We monitor all aspects of our business and have developed a comprehensive ethics and compliance program that is designed to meet or exceed applicable federal guidelines and industry standards. Nonetheless because the law in this area is complex and constantly evolving, there can be no assurance that federal regulatory authorities will not determine that any of our arrangements with physicians violate the Stark Law.

 

Anti-kickback Statute:    A provision of the Social Security Act known as the “anti-kickback statute” prohibits healthcare providers and others from directly or indirectly soliciting, receiving, offering or paying money or other remuneration to other individuals and entities in return for using, referring, ordering or recommending or arranging for such referrals or orders of services or other items covered by a federal or state health care program.

 

The anti-kickback statute contains certain exceptions, and the Office of the Inspector General of the Department of Health and Human Services (“OIG”) has issued regulations that provide for “safe harbors,” from the federal anti-kickback statute for various activities. These activities, which must meet certain requirements, include (but are not limited to) the following: investment interests, space rental, equipment rental, practitioner recruitment, personnel services and management contracts, sale of practice, referral services, warranties, discounts, employees, group purchasing organizations, waiver of beneficiary coinsurance and deductible amounts, managed care arrangements, obstetrical malpractice insurance subsidies, investments in group practices, freestanding surgery centers, donation of technology for electronic health records and referral agreements for specialty services. The fact that conduct or a business arrangement does not fall within a safe harbor or exception does not automatically render the conduct or business arrangement illegal under the anti- kickback statute. However, such conduct and business arrangements may lead to increased scrutiny by government enforcement authorities.

 

Although we believe that our arrangements with physicians have been structured to comply with current law and available interpretations, there can be no assurance that all arrangements comply with an available safe harbor or that regulatory authorities enforcing these laws will determine these financial arrangements do not violate the anti-kickback statute or other applicable laws. Violations of the anti-kickback statute may be punished by a criminal fine of up to $25,000 for each violation or imprisonment, however, under 18 U.S.C. Section 3571, this fine may be increased to $250,000 for individuals and $500,000 for organizations. Civil money penalties

 

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may include fines of up to $50,000 per violation and damages of up to three times the total amount of the remuneration and/or exclusion from participation in Medicare and Medicaid.

 

Similar State Laws:    Many of the states in which we operate have adopted laws that prohibit payments to physicians in exchange for referrals similar to the anti-kickback statute and the Stark Law, some of which apply regardless of the source of payment for care. These statutes typically provide criminal and civil penalties as well as loss of licensure. In many instances, the state statutes provide that any arrangement falling in a federal safe harbor will be immune from scrutiny under the state statutes. However, in most cases, little precedent exists for the interpretation or enforcement of these state laws.

 

These laws and regulations are extremely complex and, in many cases, we don’t have the benefit of regulatory or judicial interpretation. It is possible that different interpretations or enforcement of these laws and regulations could subject our current or past practices to allegations of impropriety or illegality or could require us to make changes in our facilities, equipment, personnel, services, capital expenditure programs and operating expenses. A determination that we have violated one or more of these laws, or the public announcement that we are being investigated for possible violations of one or more of these laws (see “Legal Proceedings”), could have a material adverse effect on our business, financial condition or results of operations and our business reputation could suffer significantly. In addition, we cannot predict whether other legislation or regulations at the federal or state level will be adopted, what form such legislation or regulations may take or what their impact on us may be.

 

If we are deemed to have failed to comply with the anti-kickback statute, the Stark Law or other applicable laws and regulations, we could be subjected to liabilities, including criminal penalties, civil penalties (including the loss of our licenses to operate one or more facilities), and exclusion of one or more facilities from participation in the Medicare, Medicaid and other federal and state health care programs. The imposition of such penalties could have a material adverse effect on our business, financial condition or results of operations.

 

Federal False Claims Act and Similar State Regulations:    A current trend affecting the health care industry is the increased use of the federal False Claims Act, and, in particular, actions being brought by individuals on the government’s behalf under the False Claims Act’s qui tam, or whistleblower, provisions. Whistleblower provisions allow private individuals to bring actions on behalf of the government by alleging that the defendant has defrauded the Federal government.

 

When a defendant is determined by a court of law to be liable under the False Claims Act, the defendant must pay three times the actual damages sustained by the government, plus mandatory civil penalties of between $5,500 to $11,000 for each separate false claim. There are many potential bases for liability under the False Claims Act. Liability often arises when an entity knowingly submits a false claim for reimbursement to the federal government. In addition, a number of states have adopted their own false claims provisions as well as their own whistleblower provisions whereby a private party may file a civil lawsuit on behalf of the state in state court.

 

Other Fraud and Abuse Provisions:    The Social Security Act also imposes criminal and civil penalties for submitting false claims to Medicare and Medicaid. False claims include, but are not limited to, billing for services not rendered, billing for services without prescribed documentation, misrepresenting actual services rendered in order to obtain higher reimbursement and cost report fraud. Like the anti-kickback statute, these provisions are very broad.

 

Further, the Health Insurance Portability and Accountability Act of 1996 (“HIPAA”) broadened the scope of the fraud and abuse laws by adding several criminal provisions for health care fraud offenses that apply to all health benefit programs, whether or not payments under such programs are paid pursuant to federal programs. HIPAA also introduced enforcement mechanisms to prevent fraud and abuse in Medicare. There are civil penalties for prohibited conduct, including, but not limited to billing for medically unnecessary products or services.

 

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HIPAA Administrative Simplification and Privacy Requirements:    The administrative simplification provisions of HIPAA require the use of uniform electronic data transmission standards for health care claims and payment transactions submitted or received electronically. These provisions are intended to encourage electronic commerce in the health care industry. HIPAA also established new federal rules protecting the privacy and security of personal health information. The privacy and security regulations address the use and disclosure of individual health care information and the rights of patients to understand and control how such information is used and disclosed. Violations of HIPAA can result in both criminal and civil fines and penalties.

 

Compliance with the electronic data transmission standards became mandatory in October 2003. However, during the following year HHS agreed to allow providers and other electronic billers to continue to submit pre-HIPAA format electronic claims for periods after October 16, 2003, provided they can show good faith efforts to become HIPAA compliant. Since this exception expired, we believe that we have been in compliance with the electronic data transmission standards.

 

We were required to comply with the privacy requirements of HIPAA by April 14, 2003. We believe that we were in material compliance with the privacy regulations by that date and remain so, as we continue to develop training and revise procedures to address ongoing compliance. The HIPAA security regulations require health care providers to implement administrative, physical and technical safeguards to protect the confidentiality, integrity and availability of patient information. We were required to comply with the security regulations by April 20, 2005 and believe that we have been in substantial compliance to date.

 

Environmental Regulations:    Our healthcare operations generate medical waste that must be disposed of in compliance with federal, state and local environmental laws, rules and regulations. Infectious waste generators, including hospitals, face substantial penalties for improper disposal of medical waste, including civil penalties of up to $25,000 per day of noncompliance, criminal penalties of up to $50,000 per day, imprisonment, and remedial costs. In addition, our operations, as well as our purchases and sales of facilities are subject to various other environmental laws, rules and regulations. We believe that our disposal of such wastes is in material compliance with all state and federal laws.

 

Corporate Practice of Medicine:    Several states, including Florida, Nevada and Texas, have passed legislation that prohibits corporations and other entities from employing physicians and practicing medicine for a profit or that prohibit certain direct and indirect payments or fee-splitting arrangements between health care providers that are designed to induce or encourage the referral of patients to, or the recommendation of, particular providers for medical products and services. Possible sanctions for violation of these restrictions include loss of license and civil and criminal penalties. In addition, agreements between the corporation and the physician may be considered void and unenforceable. These statutes vary from state to state, are often vague and have seldom been interpreted by the courts or regulatory agencies. We do not expect this legislation to significantly affect our operations. Many states have laws and regulations which prohibit payments for referral of patients and fee-splitting with physicians. We do not make any such payments or have any such arrangements at this time.

 

EMTALA:    All of our hospitals are subject to the Emergency Medical Treatment and Active Labor Act (“EMTALA”). This federal law generally requires hospitals that are certified providers under Medicare to conduct a medical screening examination of every person who visits the hospital’s emergency room for treatment and, if the patient is suffering from a medical emergency, to either stabilize the patient’s condition or transfer the patient to a facility that can better handle the condition. Our obligation to screen and stabilize emergency medical conditions exists regardless of a patient’s ability to pay for treatment. There are severe penalties under EMTALA if a hospital fails to screen or appropriately stabilize or transfer a patient or if the hospital delays appropriate treatment in order to first inquire about the patient’s ability to pay. Penalties for violations of EMTALA include civil monetary penalties and exclusion from participation in the Medicare program. In addition, an injured patient, the patient’s family or a medical facility that suffers a financial loss as a direct result of another hospital’s violation of the law can bring a civil suit against the hospital.

 

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The federal government broadly interprets EMTALA to cover situations in which patients do not actually present to a hospital’s emergency room, but present for emergency examination or treatment to the hospital’s campus, generally, or to a hospital-based clinic that treats emergency medical conditions or are transported in a hospital-owned ambulance, subject to certain exceptions. EMTALA does not generally apply to patients admitted for inpatient services. The government also has expressed its intent to investigate and enforce EMTALA violations actively in the future. We believe that we operate in substantial compliance with EMTALA.

 

Health Care Industry Investigations:    We are subject to claims and suits in the ordinary course of business, including those arising from care and treatment afforded by our hospitals and are party to various government investigations and litigation. Please see Item 3. Legal Proceedings included herein for disclosure related to: (i) Investigation of South Texas Health System affiliates; (ii) Litigation and Administrative Appeal of CMS’s Attempt to Terminate Medicare Participation of Two Rivers Psychiatric Hospital, and: (iii) Investigation of Virginia Behavioral Health Facilities.

 

We monitor all aspects of our business and have developed a comprehensive ethics and compliance program that is designed to meet or exceed applicable federal guidelines and industry standards. Because the law in this area is complex and constantly evolving, governmental investigation or litigation may result in interpretations that are inconsistent with industry practices, including ours. Although we believe our policies, procedures and practices comply with governmental regulations, no assurance can be given that we will not be subjected to inquiries or actions, or that we will not be faced with sanctions, fines or penalties in connection with the investigations. Even if we were to ultimately prevail, the government’s inquiry and/or action in connection with these matters could have a material adverse effect on our future operating results.

 

Our substantial Medicare, Medicaid and other governmental billings may result in heightened scrutiny of our operations. It is possible that governmental entities could initiate additional investigations or litigation in the future and that such matters could result in significant penalties as well as adverse publicity. It is also possible that our executives and/or managers could be included as targets or witnesses in governmental investigations or litigation and/or named as defendants in private litigation.

 

Revenue Rulings 98-15 and 2004-51:    In March 1998 and May 2004, the IRS issued guidance regarding the tax consequences of joint ventures between for-profit and not-for-profit hospitals. As a result of the tax rulings, the IRS has proposed, and may in the future propose, to revoke the tax-exempt or public charity status of certain not-for-profit entities which participate in such joint ventures or to treat joint venture income as unrelated business taxable income to them. The tax rulings have limited development of joint ventures and any adverse determination by the IRS or the courts regarding the tax-exempt or public charity status of a not-for-profit partner or the characterization of joint venture income as unrelated business taxable income could further limit joint venture development with not-for-profit hospitals, and/or require the restructuring of certain existing joint ventures with not-for-profits.

 

State Rate Review:    Some states where we operate hospitals have adopted legislation mandating rate or budget review for hospitals or have adopted taxes on hospital revenues, assessments or licensure fees to fund indigent health care within the state. In the aggregate, state rate reviews and indigent tax provisions have not materially, adversely affected our results of operations.

 

Compliance Program:    Our company-wide compliance program has been in place since 1998. Currently, the program’s elements include a Code of Conduct, risk area specific policies and procedures, employee education and training, an internal system for reporting concerns, auditing and monitoring programs, and a means for enforcing the program’s policies.

 

Since its initial adoption, the compliance program continues to be expanded and developed to meet the industry’s expectations and our needs. Specific written policies, procedures, training and educational materials and programs, as well as auditing and monitoring activities have been prepared and implemented to address the

 

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functional and operational aspects of our business. Specific areas identified through regulatory interpretation and enforcement activities have also been addressed in our program. Claims preparation and submission, including coding, billing, and cost reports, comprise the bulk of these areas. Financial arrangements with physicians and other referral sources, including compliance with anti-kickback and Stark laws and emergency department treatment and transfer requirements are also the focus of policy and training, standardized documentation requirements, and review and audit.

 

Medical Staff and Employees

 

Our facilities had approximately 39,500 employees on December 31, 2008, of whom approximately 27,900 were employed full-time. Our hospitals are staffed by licensed physicians who have been admitted to the medical staff of individual hospitals. With a few exceptions, physicians are not employees of our hospitals and in a number of our markets, may have admitting privileges at other hospitals in addition to ours. Approximately 70 physicians are employed either directly by certain of our acute care facilities or affiliated by group practices structured as 501A corporations. Members of the medical staffs of our hospitals also serve on the medical staffs of hospitals not owned by us and may terminate their affiliation with our hospitals at any time. We employ approximately 170 psychiatrists within our behavioral health division. Each of our hospitals are managed on a day-to-day basis by a managing director employed by us. In addition, a Board of Governors, including members of the hospital’s medical staff, governs the medical, professional and ethical practices at each hospital.

 

Approximately 2,000 of our employees at six of our hospitals are unionized. At Valley Hospital Medical Center, unionized employees belong to the Culinary Workers and Bartenders Union, the International Union of Operating Engineers and the Service Employees International Union (“SEIU”). Nurses and technicians at Desert Springs Hospital are represented by the SEIU. Registered nurses at Auburn Regional Medical Center located in Washington, are represented by the United Staff Nurses Union, the technical employees are represented by the United Food and Commercial Workers, and the service employees are represented by the SEIU. At The George Washington University Hospital, unionized employees are represented by the SEIU or the Hospital Police Association. Registered Nurses, Licensed Practical Nurses, certain technicians and therapists, pharmacy assistants, and some clerical employees at HRI Hospital in Boston are represented by the SEIU. At Pennsylvania Clinical Schools, unionized employees are represented by the AFL-CIO. We believe that our relations with our employees are satisfactory.

 

Competition

 

The health care industry is highly competitive. In recent years, competition among healthcare providers for patients has intensified in the United States due to, among other things, regulatory and technological changes, increasing use of managed care payment systems, cost containment pressures and a shift toward outpatient treatment. In all of the geographical areas in which we operate, there are other hospitals that provide services comparable to those offered by our hospitals. In addition, some of our competitors include hospitals that are owned by tax-supported governmental agencies or by nonprofit corporations and may be supported by endowments and charitable contributions and exempt from property, sale and income taxes. Such exemptions and support are not available to us.

 

In some markets, certain of our competitors may have greater financial resources, be better equipped and offer a broader range of services than us. Certain hospitals that are located in the areas served by our facilities are specialty or large hospitals that provide medical, surgical and behavioral health services, facilities and equipment that are not available at our hospitals. The increase in outpatient treatment and diagnostic facilities, outpatient surgical centers and freestanding ambulatory surgical also increases competition for us.

 

During the past several years, the operating results of our acute care facilities located in the McAllen/Edinburg, Texas market have been pressured by continued intense hospital and physician competition as a physician-owned hospital in the market has eroded a portion of our higher margin business, including cardiac

 

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procedures. Additional newly constructed inpatient capacity and expansion of certain services at the physician owned hospital is expected to be completed and opened during the first quarter of 2009 which may further erode our future patient volumes and results of operations. In response to these competitive pressures, we have undertaken significant capital investment in the market, including two newly constructed facilities that were completed and opened during 2006 as follows: (i) Edinburg Children’s Hospital, a 120-bed children’s facility, and; (ii) South Texas Behavioral Health Center, a 134-bed replacement behavioral health facility. However, we expect that our future patient volumes, net revenues and profitability will continue to be unfavorably impacted as a result of this increased competitor capacity and expansion of services. A continuation of increased provider competition in this market and other markets in which we operate, as well as potential future capacity added by us and others, could result in additional erosion of the patient volumes, net revenues and financial operating results of our facilities.

 

The number and quality of the physicians on a hospital’s staff are important factors in determining a hospital’s success and competitive advantage. Typically, physicians are responsible for making hospital admissions decisions and for directing the course of patient treatment. We believe that physicians refer patients to a hospital primarily on the basis of the patient’s needs, the quality of other physicians on the medical staff, the location of the hospital and the breadth and scope of services offered at the hospital’s facilities. We strive to retain and attract qualified doctors by maintaining high ethical and professional standards and providing adequate support personnel, technologically advanced equipment and facilities that meet the needs of those physicians.

 

In addition, we depend on the efforts, abilities, and experience of our medical support personnel, including our nurses, pharmacists and lab technicians and other health care professionals. We compete with other health care providers in recruiting and retaining qualified hospital management, nurses and other medical personnel. Our acute care and behavioral health care facilities are experiencing the effects of a shortage of skilled nursing staff nationwide, which has caused and may continue to cause an increase in salaries, wages and benefits expense in excess of the inflation rate. In addition, in some markets like California, there are requirements to maintain specified nurse-staffing levels. To the extent we cannot meet those levels, we may by required to limit the healthcare services provided in these markets which would have a corresponding adverse effect on our net operating revenues.

 

Many states in which we operate hospitals have CON laws. The application process for approval of additional covered services, new facilities, changes in operations and capital expenditures is, therefore, highly competitive in these states. In those states that do not have CON laws or which set relatively high levels of expenditures before they become reviewable by state authorities, competition in the form of new services, facilities and capital spending is more prevalent. See “Regulation and Other Factors.”

 

Our ability to negotiate favorable service contracts with purchasers of group health care services also affects our competitive position and significantly affects the revenues and operating results of our hospitals. Managed care plans attempt to direct and control the use of hospital services and to demand that we accept lower rates of payment. In addition, employers and traditional health insurers are increasingly interested in containing costs through negotiations with hospitals for managed care programs and discounts from established charges. In return, hospitals secure commitments for a larger number of potential patients. Generally, hospitals compete for service contracts with group health care service purchasers on the basis of price, market reputation, geographic location, quality and range of services, quality of the medical staff and convenience. The importance of obtaining contracts with managed care organizations varies from market to market depending on the market strength of such organizations.

 

A key element of our growth strategy is expansion through the acquisition of additional hospitals in select markets. The competition to acquire hospitals is significant. We face competition for acquisition candidates primarily from other for-profit health care companies, as well as from not-for-profit entities. Some of our competitors have greater resources than we do. We intend to selectively seek opportunities to expand our base of operations by adhering to our disciplined program of rational growth, but may not be successful in accomplishing acquisitions on favorable terms.

 

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Relationship with Universal Health Realty Income Trust

 

At December 31, 2008, we held approximately 6.6% of the outstanding shares of Universal Health Realty Income Trust (the “Trust”). We serve as Advisor to the Trust under an annually renewable advisory agreement pursuant to the terms of which, we conduct the Trust’s day-to-day affairs, provide administrative services and present investment opportunities. In addition, certain of our officers and directors are also officers and/or directors of the Trust. Management believes that it has the ability to exercise significant influence over the Trust, therefore we account for our investment in the Trust using the equity method of accounting. We earned an advisory fee from the Trust, which is included in net revenues in the accompanying consolidated statements of income, of approximately $1.6 million during 2008 and $1.4 million during each of 2007 and 2006. Our pre-tax share of income from the Trust was $900,000 during 2008 and $1.5 million during 2007 and is included in net revenues in the accompanying consolidated statements of income for each year. Our pre-tax share of income from the Trust was $2.3 million in 2006, of which $1.4 million is included in net revenues and the remaining $900,000 was recorded as a reduction to our hurricane related expenses and is included in “income/(loss) from discontinued operations, net of income taxes”. The carrying value of this investment was $8.9 million and $9.9 million December 31, 2008 and 2007, respectively, and is included in other assets in the accompanying consolidated balance sheets. The market value of this investment was $25.9 million at December 31, 2008 and $27.9 million at December 31, 2007, based on the closing price of the Trust’s stock on the respective dates.

 

Total rent expense under the operating leases on the hospital facilities with the Trust was $16.1 million during each of 2008 and 2007 and $16.0 million during 2006. In addition, certain of our subsidiaries are tenants in several medical office buildings owned by limited liability companies in which the Trust holds non-controlling ownership interests.

 

The Trust commenced operations in 1986 by purchasing certain properties from us and immediately leasing the properties back to our respective subsidiaries. Most of the leases were entered into at the time the Trust commenced operations and provided for initial terms of 13 to 15 years with up to six additional 5-year renewal terms. Each lease also provided for additional or bonus rental, as discussed below. The base rents are paid monthly and the bonus rents are computed and paid on a quarterly basis, based upon a computation that compares current quarter revenue to a corresponding quarter in the base year. The leases with our subsidiaries are unconditionally guaranteed by us and are cross-defaulted with one another.

 

Pursuant to the terms of the leases with the Trust, we have the option to renew the leases at the lease terms described above by providing notice to the Trust at least 90 days prior to the termination of the then current term. In addition, we have rights of first refusal to: (i) purchase the respective leased facilities during and for 180 days after the lease terms at the same price, terms and conditions of any third-party offer, or; (ii) renew the lease on the respective leased facility at the end of, and for 180 days after, the lease term at the same terms and conditions pursuant to any third-party offer. We also have the right to purchase the respective leased facilities at the end of the lease terms or any renewal terms at the appraised fair market value. In addition, during 2006, as part of the overall exchange and substitution transaction relating to Chalmette Medical Center (“Chalmette”) which was completed during the third quarter of 2006, as well as the early five year lease renewals on Southwest Healthcare System-Inland Valley Campus (“Inland Valley”), Wellington Regional Medical Center (“Wellington”), McAllen Medical Center and The Bridgeway (“Bridgeway”), the Trust agreed to amend the Master Lease to include a change of control provision. The change of control provision grants us the right, upon one month’s notice should a change of control of the Trust occur, to purchase any or all of the four leased hospital properties at their appraised fair market value purchase price.

 

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The table below details the renewal options and terms for each of our four hospital facilities leased from the Trust:

 

Hospital Name

   Type of Facility    Annual
Minimum
Rent
   End of Lease Term    Renewal
Term
(years)

McAllen Medical Center

   Acute Care    $ 5,485,000    December, 2011    20 (a)

Wellington Regional Medical Center

   Acute Care    $ 3,030,000    December, 2011    20 (b)

Southwest Healthcare System, Inland Valley Campus

   Acute Care    $ 2,648,000    December, 2011    20 (b)

The Bridgeway

   Behavioral Health    $ 930,000    December, 2014    10 (c)

 

(a) We have four 5-year renewal options at existing lease rates (through 2031).
(b) We have two 5-year renewal options at existing lease rates (through 2021) and two 5-year renewal options at fair market value lease rates (2022 through 2031).
(c) We have two 5-year renewal options at fair market value lease rates (2015 through 2024).

 

Executive Officers of the Registrant

 

The executive officers, whose terms will expire at such time as their successors are elected, are as follows:

 

Name and Age

  

Present Position with the Company

Alan B. Miller (71)

   Chairman of the Board, President and Chief Executive Officer

Steve G. Filton (51)

   Senior Vice President, Chief Financial Officer and Secretary

Debra K. Osteen (53)

   Senior Vice President

Michael Marquez (55)

   Senior Vice President

Marc D. Miller (38)

   Senior Vice President and Director

 

Mr. Alan B. Miller has been Chairman of the Board, President and Chief Executive Officer since inception. Prior thereto, he was President, Chairman of the Board and Chief Executive Officer of American Medicorp, Inc. He currently serves as Chairman of the Board, Chief Executive Officer and President of Universal Health Realty Income Trust. Mr. Miller also serves as a Director of Penn Mutual Life Insurance Company. He is the father of Marc D. Miller, Senior Vice President and Director.

 

Mr. Filton was elected Senior Vice President and Chief Financial Officer in 2003 and he was elected Secretary in 1999. He had served as Vice President and Controller since 1991.

 

Ms. Osteen is responsible for our Behavioral Health Care facilities and was elected Senior Vice President in 2005 and Vice President in 2000. She has served in various capacities related to our Behavioral Health Care facilities since 1984.

 

Mr. Marquez was elected Senior Vice President and co-head of our Acute Care Hospitals in 2007 and was elected Vice President in 2004. He has served in various capacities related to our acute care division and most recently served as Vice President of our Western Region Acute Care Hospitals from 2000 to 2007.

 

Mr. Marc D. Miller was elected Senior Vice President and co-head of our Acute Care Hospitals in 2007. He was elected a Director in May, 2006 and Vice President in 2005. He has served in various capacities related to our acute care division since 2000. He was elected to the Board of Trustees of Universal Health Realty Income Trust in December, 2008. He is the son of Alan B. Miller, our Chief Executive Officer, President and Chairman of the Board.

 

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ITEM 1A. Risk Factors

 

We are subject to numerous known and unknown risks, many of which are described below and elsewhere in this Annual Report. Any of the events described below could have a material adverse effect on our business, financial condition and results of operations. Additional risks and uncertainties that we are not aware of, or that we currently deem to be immaterial, could also impact our business and results of operations.

 

A significant portion of our revenues is produced by a small number of our facilities, which are concentrated in Texas and Nevada.

 

We have a majority ownership interest in five acute care hospitals in the Las Vegas, Nevada market. The five hospitals, Valley Hospital Medical Center, Summerlin Hospital Medical Center, Desert Springs Hospital, Spring Valley Medical Center and Centennial Hills Hospital Medical Center (opened in January 2008), on a combined basis, contributed 22% in 2008, 21% in 2007, and 21% in 2006 of our consolidated net revenues. On a combined basis, after deducting an allocation for corporate overhead expense, these facilities generated 20% in 2008, 27% in 2007, and 25% in 2006 of our earnings before income taxes and interest expense.

 

In addition, South Texas Health System, which includes McAllen Medical Center, McAllen Heart Hospital, South Texas Behavioral Health Center, located in McAllen, Texas, and Edinburg Regional Medical Center and Edinburg Children’s Hospital, located in Edinburg, Texas, operate within the same market. On a combined basis, these facilities contributed 7% in 2008, 7% in 2007, and 8% in 2006 of our consolidated net revenues. On a combined basis, after deducting an allocation for corporate overhead expense, these facilities generated 3% in 2008, had a pre-tax loss of 3% in 2007, and generated 1% in 2006 of our earnings before income taxes and interest expense.

 

The significant portion of our revenues derived from these facilities makes us particularly sensitive to regulatory, economic, environmental and competition changes in Texas and Nevada. Any material change in the current payment programs or regulatory, economic, environmental or competitive conditions in these states could have a disproportionate effect on our overall business results.

 

Our revenues and results of operations are significantly affected by payments received from the government and other third party payors.

 

We derive a significant portion of our revenue from third party payors, including the Medicare and Medicaid programs. Changes in these government programs in recent years have resulted in limitations on reimbursement and, in some cases, reduced levels of reimbursement for health care services. Payments from federal and state government programs are subject to statutory and regulatory changes, administrative rulings, interpretations and determinations, requirements for utilization review, and federal and state funding restrictions, all of which could materially increase or decrease program payments, as well as affect the cost of providing service to patients and the timing of payments to facilities. We are unable to predict the effect of future policy changes on our operations. In addition, the uncertainty and fiscal pressures placed upon federal and state governments as a result of, among other things, the substantial deterioration in general economic conditions, the funding requirements from the federal government’s stimulus package, the ongoing military engagements in Iraq and Afghanistan, the War on Terrorism and the relief efforts related to hurricanes and other disasters, may affect the availability of taxpayer funds for Medicare and Medicaid programs. If the rates paid or the scope of services covered by government payors are reduced, there could be a material adverse effect on our business, financial position, results of operations.

 

We receive a large concentration of our Medicaid revenues from Texas and significant amounts from Nevada, Florida, California, Washington, DC and Illinois. These states, as well as most other states in which we operate, have reported significant budget deficits that, for all except Texas at this time, have resulted in a reduction of Medicaid funding for 2009. We can provide no assurance that reductions to Medicaid revenues, particularly in these states, will not have a material adverse effect on our business, financial condition and results of operations.

 

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In addition to changes in government reimbursement programs, our ability to negotiate favorable contracts with private payors, including managed care providers, significantly affects the revenues and operating results of our hospitals. Private payors, including managed care providers, increasingly are demanding that we accept lower rates of payment.

 

We expect continued third party efforts to aggressively manage reimbursement levels and cost controls. Reductions in reimbursement amounts received from third party payors could have a material adverse effect on our financial position and our results of operations.

 

An increase in uninsured and underinsured patients in our acute care facilities or the deterioration in the collectibility of the accounts of such patients could harm our results of operations.

 

Collection of receivables from third-party payors and patients is our primary source of cash and is critical to our operating performance. Our primary collection risks relate to uninsured patients and the portion of the bill that is the patient’s responsibility, which primarily includes co-payments and deductibles. We estimate our provisions for doubtful accounts based on general factors such as payor mix, the agings of the receivables and historical collection experience. We routinely review accounts receivable balances in conjunction with these factors and other economic conditions that might ultimately affect the collectibility of the patient accounts and make adjustments to our allowances as warranted. Significant changes in business office operations, payor mix, economic conditions or trends in federal and state governmental health coverage could affect our collection of accounts receivable, cash flow and results of operations. If we experience unexpected increases in the growth of uninsured and underinsured patients or in bad debt expenses, our results of operations could be harmed.

 

Fluctuations in our operating results quarter to quarter earning and other factors may result in decreases in the price of our common stock.

 

The stock markets have experienced volatility that has often been unrelated to operating performance. These broad market fluctuations may adversely affect the trading price of our common stock and, as a result, there may be significant volatility in the market price of our common stock. If we are unable to operate our hospitals as profitably as we have in the past or as our stockholders expect us to in the future, the market price of our common stock will likely decline as stockholders could sell shares of our common stock when if becomes apparent that the market expectations may not be realized.

 

In addition to our operating results, many economic and seasonal factors outside of our control could have an adverse effect on the price of our common stock and increase fluctuations in our quarterly earnings. These factors include certain of the risks discussed herein, demographic changes, operating results of other hospital companies, changes in our financial estimates or recommendations of securities analysts, speculation in the press or investment community, the possible effects of war, terrorist and other hostilities, adverse weather conditions, the level of seasonal illnesses, managed care contract negotiations and terminations, changes in general conditions in the economy or the financial markets, or other developments affecting the health care industry.

 

Our hospitals face competition for patients from other hospitals and health care providers.

 

The health care industry is highly competitive and competition among hospitals and other health care providers for patients and physicians has intensified in recent years. In all of the geographical areas in which we operate, there are other hospitals that provide services comparable to those offered by our hospitals. Some of our competitors include hospitals that are owned by tax supported governmental agencies or by nonprofit corporations and may be supported by endowments and charitable contributions and exempt from property, sales and income taxes. Such exemptions and support are not available to us.

 

In some markets, certain of our competitors may have greater financial resources, be better equipped and offer a broader range of services than we. The number of inpatient facilities, as well as outpatient surgical and

 

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diagnostic centers, many of which are fully or partially owned by physicians, in the geographic areas in which we operate has increased significantly. As a result, most of our hospitals operate in an increasingly competitive environment.

 

During the past several years, the operating results of our acute care facilities located in the McAllen/Edinburg, Texas market have been pressured by continued intense hospital and physician competition as a physician-owned hospital in the market has eroded a portion of our higher margin business, including cardiac procedures. Additional newly constructed inpatient capacity and expansion of certain services at the physician owned hospital is expected to be completed and opened during the first quarter of 2009 which may further erode our future patient volumes and results of operations. In response to these competitive pressures, we have undertaken significant capital investment in the market, including two newly constructed facilities that were completed and opened during 2006 as follows: (i) Edinburg Children’s Hospital, a 120-bed children’s facility, and; (ii) South Texas Behavioral Health Center, a 134-bed replacement behavioral health facility. However, we expect that our future patient volumes, net revenues and profitability will continue to be unfavorably impacted as a result of this increased competitor capacity and expansion of services. A continuation of increased provider competition in this market and other markets in which we operate, as well as potential future capacity added by us and others, could result in additional erosion of the patient volumes, net revenues and financial operating results of our facilities.

 

If our competitors are better able to attract patients, recruit physicians and other healthcare professionals, expand services or obtain favorable managed care contracts at their facilities, we may experience a decline in patient volume and our business may be harmed.

 

Our performance depends on our ability to recruit and retain quality physicians.

 

Typically, physicians are responsible for making hospital admissions decisions and for directing the course of patient treatment. As a result, the success and competitive advantage of our hospitals depends, in part, on the number and quality of the physicians on the medical staffs of our hospitals, the admitting practices of those physicians and our maintenance of good relations with those physicians. Physicians generally are not employees of our hospitals and, in a number of our markets, physicians have admitting privileges at other hospitals in addition to our hospitals. They may terminate their affiliation with us at any time. If we are unable to provide high ethical and professional standards, adequate support personnel or technologically advanced equipment and facilities that meet the needs of those physicians, they may be discouraged from referring patients to our facilities and our results of operations may decline.

 

It may become difficult for us to attract an adequate number of physicians to practice in certain of the non-urban communities in which our hospitals are located. Our failure to recruit physicians to these communities or the loss of physicians in these communities could make it more difficult to attract patients to our hospitals and thereby may have a material adverse effect on our business, financial condition and results of operations.

 

Our performance depends on our ability to attract and retain qualified nurses and medical support staff and we face competition for staffing that may increase our labor costs and harm our results of operations.

 

We depend on the efforts, abilities, and experience of our medical support personnel, including our nurses, pharmacists and lab technicians and other health care professionals. We compete with other health care providers in recruiting and retaining qualified hospital management, nurses and other medical personnel.

 

The nationwide shortage of nurses and other medical support personnel has been a significant operating issue facing us and other health care providers. This shortage may require us to enhance wages and benefits to recruit and retain nurses and other medical support personnel or require us to hire expensive temporary personnel. In addition, in some markets like California, there are requirements to maintain specified nurse-staffing levels. To the extent we cannot meet those levels, we may by required to limit the healthcare services provided in these markets which would have a corresponding adverse effect on our net operating revenues.

 

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We cannot predict the degree to which we will be affected by the future availability or cost of attracting and retaining talented medical support staff. If our general labor and related expenses increase we may not be able to raise our rates correspondingly. Our failure to either recruit and retain qualified hospital management, nurses and other medical support personnel or control our labor costs could harm our results of operations.

 

We depend heavily on key management personnel and the departure of one or more of our key executives or a significant portion of our local hospital management personnel could harm our business.

 

The expertise and efforts of our senior executives and key members of our local hospital management personnel are critical to the success of our business. The loss of the services of one or more of our senior executives or of a significant portion of our local hospital management personnel could significantly undermine our management expertise and our ability to provide efficient, quality health care services at our facilities, which could harm our business.

 

We may be subject to liabilities from claims brought against our facilities and governmental investigations.

 

We are subject to medical malpractice lawsuits, product liability lawsuits, governmental investigations and other legal actions in the ordinary course of business. Some of these actions may involve large claims, as well as significant defense costs (See Item 3-Legal Proceedings for disclosure regarding ongoing governmental investigations). We cannot predict the outcome of these lawsuits or investigations or the effect that findings in such lawsuits or investigations may have on us. All professional and general liability insurance we purchase is subject to policy limitations. We believe that, based on our past experience and actuarial estimates, our insurance coverage is adequate considering the claims arising from the operations of our hospitals. While we continuously monitor our coverage, our ultimate liability for professional and general liability claims could change materially from our current estimates. If such policy limitations should be partially or fully exhausted in the future, or payments of claims exceed our estimates or are not covered by our insurance, it could have a material adverse effect on our operations.

 

Our growth strategy depends on acquisitions, and we may not be able to continue to acquire hospitals that meet our target criteria. We may also have difficulties acquiring hospitals from not-for-profit entities due to regulatory scrutiny.

 

Acquisitions of hospitals in select markets are a key element of our growth strategy. We face competition for acquisition candidates primarily from other for-profit health care companies, as well as from not-for-profit entities. Some of our competitors have greater resources than we do. Also, suitable acquisitions may not be accomplished due to unfavorable terms.

 

In addition, many states have enacted, or are considering enacting, laws that affect the conversion or sale of not-for-profit hospitals to for-profit entities. These laws generally require prior approval from the state attorney general, advance notification and community involvement. In addition, attorney generals in states without specific conversion legislation may exercise discretionary authority over such transactions. Although the level of government involvement varies from state to state, the trend is to provide for increased governmental review and, in some cases, approval of a transaction in which a not-for-profit entity sells a health care facility to a for-profit entity. The adoption of new or expanded conversion legislation, increased review of not-for-profit hospital conversions or our inability to effectively compete against other potential purchasers could make it more difficult for us to acquire additional hospitals, increase our acquisition costs or make it difficult for us to acquire hospitals that meet our target acquisition criteria, any of which could adversely affect our growth strategy and results of operations.

 

Further, the cost of an acquisition could result in a dilutive effect on our results of operations, depending on various factors, including the amount paid for the acquisition, the acquired hospital’s results of operations, allocation of the purchase price, effects of subsequent legislation and limits on rate increases.

 

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We may fail to improve or integrate the operations of the hospitals we acquire, which could harm our results of operations and adversely affect our growth strategy.

 

We may be unable to timely and effectively integrate the hospitals that we acquire with our ongoing operations. We may experience delays in implementing operating procedures and systems in newly acquired hospitals. Integrating a new hospital could be expensive and time consuming and could disrupt our ongoing business, negatively affect cash flow and distract management and other key personnel. In addition, acquisition activity requires transitions from, and the integration of, operations and, usually, information systems that are used by acquired hospitals. In addition, some of the hospitals we acquire had significantly lower operating margins than the hospitals we operate prior to the time of our acquisition. If we fail to improve the operating margins of the hospitals we acquire, operate such hospitals profitably or effectively integrate the operations of acquired hospitals, our results of operations could be harmed.

 

If we acquire hospitals with unknown or contingent liabilities, we could become liable for material obligations.

 

Hospitals that we acquire may have unknown or contingent liabilities, including but not limited to, liabilities for failure to comply with applicable laws and regulations. Although we typically attempt to exclude significant liabilities from our acquisition transactions and seek indemnification from the sellers of such hospitals for these matters, we could experience difficulty enforcing those obligations or we could incur material liabilities for the past activities of hospitals we acquire. Such liabilities and related legal or other costs and/or resulting damage to a facility’s reputation could harm our business.

 

State efforts to regulate the construction or expansion of health care facilities could impair our ability to expand.

 

Many of the states in which we operate hospitals have enacted CON laws as a condition prior to hospital capital expenditures, construction, expansion, modernization or initiation of major new services. Our failure to obtain necessary state approval could result in our inability to complete a particular hospital acquisition, expansion or replacement, make a facility ineligible to receive reimbursement under the Medicare or Medicaid programs, result in the revocation of a facility’s license or impose civil or criminal penalties on us, any of which could harm our business.

 

In addition, significant CON reforms have been proposed in a number of states that would increase the capital spending thresholds and provide exemptions of various services from review requirements. In the past, we have not experienced any material adverse effects from those requirements, but we cannot predict the impact of these changes upon our operations.

 

If we fail to comply with extensive laws and government regulations, we could suffer civil or criminal penalties or be required to make significant changes to our operations that could reduce our revenue and profitability.

 

The health care industry is required to comply with extensive and complex laws and regulations at the federal, state and local government levels relating to, among other things:

 

   

hospital billing practices and prices for services;

 

   

relationships with physicians and other referral sources;

 

   

adequacy of medical care and quality of medical equipment and services;

 

   

ownership of facilities;

 

   

qualifications of medical and support personnel;

 

   

confidentiality, maintenance and security issues associated with health-related information and patient medical records;

 

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the screening, stabilization and transfer of patients who have emergency medical conditions;

 

   

licensure and accreditation of our facilities;

 

   

operating policies and procedures, and;

 

   

construction or expansion of facilities and services.

 

Among these laws are the False Claims Act, HIPAA, the federal anti-kickback statute and the Stark Law. These laws, and particularly the anti-kickback statute and the Stark Law, impact the relationships that we may have with physicians and other referral sources. We have a variety of financial relationships with physicians who refer patients to our facilities, including employment contracts, leases and professional service agreements. We also provide financial incentives, including minimum revenue guarantees, to recruit physicians into communities served by our hospitals. The OIG has enacted safe harbor regulations that outline practices that are deemed protected from prosecution under the anti-kickback statute. A number of our current arrangements, including financial relationships with physicians and other referral sources, may not qualify for safe harbor protection under the anti-kickback statute. Failure to meet a safe harbor does not mean that the arrangement necessarily violates the anti-kickback statute, but may subject the arrangement to greater scrutiny. We cannot assure that practices that are outside of a safe harbor will not be found to violate the anti-kickback statute.

 

These laws and regulations are extremely complex and, in many cases, we don’t have the benefit of regulatory or judicial interpretation. In the future, it is possible that different interpretations or enforcement of these laws and regulations could subject our current or past practices to allegations of impropriety or illegality or could require us to make changes in our facilities, equipment, personnel, services, capital expenditure programs and operating expenses. A determination that we have violated one or more of these laws, or the public announcement that we are being investigated for possible violations of one or more of these laws (see Item 3-Legal Proceedings), could have a material adverse effect on our business, financial condition or results of operations and our business reputation could suffer significantly. In addition, we cannot predict whether other legislation or regulations at the federal or state level will be adopted, what form such legislation or regulations may take or what their impact on us may be. See Item 1 Business—Self-Referral and Anti-Kickback Legislation.

 

If we are deemed to have failed to comply with the anti-kickback statute, the Stark Law or other applicable laws and regulations, we could be subjected to liabilities, including criminal penalties, civil penalties (including the loss of our licenses to operate one or more facilities), and exclusion of one or more facilities from participation in the Medicare, Medicaid and other federal and state health care programs. The imposition of such penalties could have a material adverse effect on our business, financial condition or results of operations.

 

We are subject to uncertainties regarding health care reform.

 

An increasing number of legislative initiatives have been introduced or proposed in recent years that would result in major changes in the health care delivery system on a national or a state level. Among the proposals that have been introduced are price controls on hospitals, insurance market reforms to increase the availability of group health insurance to small businesses, requirements that all businesses offer health insurance coverage to their employees and the creation of government health insurance plans that would cover all citizens and increase payments by beneficiaries. We cannot predict whether any of the above proposals or other proposals will be adopted and, if adopted, no assurances can be given that their implementation will not have a material adverse effect on our business, financial condition or results of operations.

 

If the number of uninsured patients treated by our subsidiary hospitals increase, our results of operations may be harmed.

 

In accordance with our internal policies and procedures, as well as EMTALA, we provide a medical screening examination to any individual who comes to one of our hospitals while in active labor and/or seeking medical treatment (whether or not such individual is eligible for insurance benefits and regardless of ability to

 

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pay) to determine if such individual has an emergency medical condition. If it is determined that such person has an emergency medical condition, we provide such further medical examination and treatment as is required to stabilize the patient’s medical condition, within the facility’s capability, or arrange for transfer of such individual to another medical facility in accordance with applicable law and the treating hospital’s written procedures. If the number of indigent and charity care patients with emergency medical conditions we treat increases significantly, our results of operations may be harmed.

 

Controls designed to reduce inpatient services may reduce our revenues.

 

Controls imposed by third-party payors designed to reduce admissions and lengths of stay, commonly referred to as “utilization review,” have affected and are expected to continue to affect our facilities. Utilization review entails the review of the admission and course of treatment of a patient by managed care plans. Inpatient utilization, average lengths of stay and occupancy rates continue to be negatively affected by payor-required preadmission authorization and utilization review and by payor pressure to maximize outpatient and alternative health care delivery services for less acutely ill patients. Efforts to impose more stringent cost controls are expected to continue. Although we cannot predict the effect these changes will have on our operations, significant limits on the scope of services reimbursed and on reimbursement rates and fees could have a material adverse effect on our business, financial position and results of operations.

 

We are subject to significant corporate regulation as a public company and failure to comply with all applicable regulations could subject us to liability or negatively affect our stock price.

 

As a publicly traded company, we are subject to a significant body of regulation, including the Sarbanes-Oxley Act of 2002. While we have developed and instituted a corporate compliance program based on what we believe are the current best practices in corporate governance and continue to update this program in response to newly implemented or changing regulatory requirements, we cannot provide assurance that we are or will be in compliance with all potentially applicable corporate regulations. For example, we cannot provide assurance that, in the future, our management will not find a material weakness in connection with its annual review of our internal control over financial reporting pursuant to Section 404 of the Sarbanes-Oxley Act. We also cannot provide assurance that we could correct any such weakness to allow our management to assess the effectiveness of our internal control over financial reporting as of the end of our fiscal year in time to enable our independent registered public accounting firm to state that such assessment will have been fairly stated in our Annual Report on Form 10-K or state that we have maintained effective internal control over financial reporting as of the end of our fiscal year. If we fail to comply with any of these regulations, we could be subject to a range of regulatory actions, fines or other sanctions or litigation. If we must disclose any material weakness in our internal control over financial reporting, our stock price could decline.

 

Different interpretations of accounting principles could have a material adverse effect on our results of operations or financial condition.

 

Generally accepted accounting principles are complex, continually evolving and may be subject to varied interpretation by us, our independent registered public accounting firm and the SEC. Such varied interpretations could result from differing views related to specific facts and circumstances. Differences in interpretation of generally accepted accounting principles could have a material adverse effect on our financial position or results of operations.

 

We continue to see rising costs in construction materials and labor. Such increased costs could have an adverse effect on the cash flow return on investment relating to our capital projects.

 

The cost of construction materials and labor has significantly increased. As we continue to invest in modern technologies, emergency rooms and operating room expansions, the construction of medical office buildings for physician expansion and reconfiguring the flow of patient care, we spend large amounts of money generated from our operating cash flow or borrowed funds. In addition, we have commitments with unrelated third-parties

 

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to build newly constructed facilities with a specified minimum number of beds and services. Although we evaluate the financial feasibility of such projects by determining whether the projected cash flow return on investment exceeds our cost of capital, such returns may not be achieved if the cost of construction continues to rise significantly or the expected patient volumes are not attained.

 

A worsening of the economic and employment conditions in the United States could materially affect our business and future results of operations.

 

Our patient volumes, revenues and financial results depend significantly on the universe of patients with health insurance which to a large extent is dependent on the employment status of individuals in our markets. A continuation or worsening of economic conditions may result in a continued increase in the unemployment rate which will likely increase the number of individuals without health insurance. As a result, our facilities may experience a decrease in patient volumes, particularly in less intense, more elective service lines, or a significant increase in services provided to uninsured patients. These factors could have a material unfavorable impact on our future patient volumes, revenues and operating results.

 

The deterioration of credit and capital markets may adversely affect our access to sources of funding and we cannot be certain of the availability and terms of capital to fund the growth of our business when needed.

 

We require substantial capital resources to fund our acquisition growth strategy and our ongoing capital expenditure programs for renovation, expansion, construction and addition of medical equipment and technology. We believe that our capital expenditure program is adequate to expand, improve and equip our existing hospitals. We cannot predict, however, whether financing for our growth plans and capital expenditure programs will be available to us on satisfactory terms when needed, which could harm our business.

 

To fund all or a portion of our future financing needs, we rely on borrowings from various sources including fixed rate, long-term debt as well as borrowings pursuant to our revolving credit facility and accounts receivable securitization program. If any of the lenders were unable to fulfill their future commitments, our liquidity could be impacted, which could have a material unfavorable impact our results of operations and financial condition.

 

In addition, the degree to which we are, or in the future may become, leveraged, our ability to obtain financing could be adversely impacted and could make us more vulnerable to competitive pressures. Our ability to meet existing and future debt obligations, depends upon our future performance and our ability to secure additional financing on satisfactory terms, each of which is subject to financial, business and other factors that are beyond our control. Any failure by us to meet our financial obligations would harm our business.

 

In addition, global capital markets have experienced volatility that has tightened access to capital markets and other sources of funding. In the event we need to access the capital markets or other sources of financing, there can be no assurance that we will be able to obtain financing on acceptable terms or within an acceptable time. Our inability to obtain financing on terms acceptable to us could have a material unfavorable impact on our results of operations, financial condition and liquidity.

 

ITEM 1B. Unresolved Staff Comments

 

None.

 

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ITEM 2. Properties

 

Executive Offices

 

We own an office building with approximately 100,000 square feet available for use located on 11 acres of land in King of Prussia, Pennsylvania.

 

Facilities

 

The following tables set forth the name, location, type of facility and, for acute care hospitals and behavioral health care facilities, the number of licensed beds:

 

Acute Care Hospitals

 

Name of Facility

  

Location

   Number
of Beds
   Real
Property
Ownership
Interest

Aiken Regional Medical Centers

   Aiken, South Carolina    183    Owned

Aurora Pavilion

   Aiken, South Carolina    47    Owned

Auburn Regional Medical Center

   Auburn, Washington    149    Owned

Centennial Hills Hospital Medical Center (1)

   Las Vegas, Nevada    165    Owned

Corona Regional Medical Center

   Corona, California    240    Owned

Desert Springs Hospital (1)

   Las Vegas, Nevada    286    Owned

Doctors’ Hospital of Laredo

   Laredo, Texas    180    Owned

Fort Duncan Regional Medical Center

   Eagle Pass, Texas    101    Owned

The George Washington University Hospital (2)

   Washington, D.C.    371    Owned

Lakewood Ranch Medical Center

   Bradenton, Florida    120    Owned

Lancaster Community Hospital

   Lancaster, California    117    Owned

Manatee Memorial Hospital

   Bradenton, Florida    319    Owned

Northern Nevada Medical Center

   Sparks, Nevada    100    Owned

Northwest Texas Healthcare System

   Amarillo, Texas    404    Owned

The Pavilion at Northwest Texas Healthcare System

   Amarillo, Texas    85    Owned

Palmdale Regional Medical Center (10)

   Palmdale, California    171    Owned

South Texas Health System (4)

        

Edinburg Regional Medical Center

   Edinburg, Texas    127    Owned

Edinburg Children’s Hospital

   Edinburg, Texas    86    Owned

McAllen Medical Center (3)

   McAllen, Texas    441    Leased

McAllen Heart Hospital

   McAllen, Texas    60    Owned

South Texas Behavioral Health Center

   McAllen, Texas    134    Owned

Southwest Healthcare System

        

Inland Valley Campus (3)

   Wildomar, California    122    Leased

Rancho Springs Campus

   Murrieta, California    96    Owned

Spring Valley Hospital Medical Center (1)

   Las Vegas, Nevada    210    Owned

St. Mary’s Regional Medical Center

   Enid, Oklahoma    245    Owned

Summerlin Hospital Medical Center (1)

   Las Vegas, Nevada    281    Owned

Texoma Medical Center

   Denison, Texas    174    Owned

TMC Behavioral Health Center

   Denison, Texas    60    Owned

Valley Hospital Medical Center (1)

   Las Vegas, Nevada    404    Owned

Wellington Regional Medical Center (3)

   West Palm Beach, Florida    158    Leased

 

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Behavioral Health Care Facilities

 

Name of Facility

  

Location

   Number
of Beds
   Real
Property
Ownership
Interest

Academy at Canyon Creek

   Springville, Utah    128    Owned

Alabama Clinical Schools

   Birmingham, Alabama    80    Owned

Anchor Hospital

   Atlanta, Georgia    102    Owned

Arbour Counseling Services

   Rockland, Massachusetts    —      Owned

The Arbour Hospital

   Boston, Massachusetts    118    Owned

Arbour Senior Care

   Rockland, Massachusetts    —      Owned

Arbour-Fuller Hospital

   South Attleboro, Massachusetts    82    Owned

Arbour-HRI Hospital

   Brookline, Massachusetts    68    Owned

Ascent Therapeutic Adventure Program

   Naples, Idaho    120    Owned

Boulder Creek Academy

   Bonners Ferry, Idaho    100    Owned

The Bridgeway (3)

   North Little Rock, Arkansas    114    Leased

Bristol Youth Academy

   Bristol, Florida    80    Owned

Carmichael NPS

   Carmichael, California    —      Leased

The Carolina Center for Behavioral Health

   Greer, South Carolina    89    Owned

Cedar Grove Residential Treatment Center

   Murfreesboro, Tennessee    34    Owned

Cedar Ridge

   Oklahoma City, Oklahoma    36    Owned

Cedar Ridge Residential Treatment Center

   Oklahoma City, Oklahoma    80    Owned

Center for Change

   Orem, Utah    58    Owned

Central Florida Behavioral Hospital

   Orlando, FL    120    Owned

Clarion Psychiatric Center

   Clarion, Pennsylvania    74    Owned

Coastal Harbor Treatment Center

   Savannah, Georgia    132    Owned

Community Behavioral Health

   Memphis, Tennessee    50    Leased

Compass Intervention Center

   Memphis, Tennessee    88    Owned

Cottonwood Treatment Center

   S. Salt Lake City, Utah    82    Leased

Del Amo Hospital

   Torrance, California    166    Owned

Dover Behavioral Health

   Dover, Delaware    52    Owned

Elmira NPS

   Elmira, California    —      Leased

Fairmount Behavioral Health System

   Philadelphia, Pennsylvania    185    Owned

Forest View Hospital

   Grand Rapids, Michigan    62    Owned

Foundations Behavioral Health

   Doylestown, Pennsylvania    114    Leased

Foundations for Living

   Mansfield, Ohio    84    Owned

Glen Oaks Hospital

   Greenville, Texas    54    Owned

Good Samaritan Counseling Center

   Anchorage, Alaska    —      Owned

Grand Terrace NPS

   Grand Terrace, California    —      Owned

Hampton Behavioral Health Center

   Westhampton, New Jersey    100    Owned

Hartgrove Hospital

   Chicago, Illinois    136    Owned

Hemet NPS

   Hemet, California    —      Owned

Hermitage Hall

   Nashville, Tennessee    112    Owned

Highlands Behavioral Health System

   Highlands Ranch, Colorado    86    Owned

The Hope Program

   Fountain, Florida    32    Owned

The Horsham Clinic

   Ambler, Pennsylvania    146    Owned

Hospital San Juan Capestrano

   Rio Piedras, Puerto Rico    108    Owned

Jacksonville Youth Center

   Jacksonville, Florida    —      Owned

Keys of Carolina

   Charlotte, North Carolina    60    Owned

Keystone Newport News

   Newport News, Virginia    108    Owned

KeyStone Center

   Wallingford, Pennsylvania    140    Owned

King George School

   Sutton, Vermont    90    Owned

 

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Name of Facility

  

Location

   Number
of Beds
   Real
Property
Ownership
Interest

La Amistad Behavioral Health Services

   Maitland, Florida    80    Owned

Lakeside Behavioral Health System

   Memphis, Tennessee    290    Owned

Laurel Heights Hospital

   Atlanta, Georgia    122    Owned

Lincoln Trail Behavioral Health System

   Radcliff, Kentucky    116    Owned

McDowell Center for Children

   Dyersburg, Tennessee    31    Owned

Marion Youth Center

   Marion, Virginia    48    Owned

The Meadows Psychiatric Center

   Centre Hall, Pennsylvania    101    Owned

Meridell Achievement Center

   Austin, Texas    112    Owned

Midwest Center for Youth and Families

   Kouts, Indiana    76    Owned

Mountain Youth Academy

   Mountain City, Tennessee    60    Owned

Natchez Trace Youth Academy

   Waverly, Tennessee    85    Owned

North Star Hospital

   Anchorage, Alaska    74    Owned

North Star Bragaw

   Anchorage, Alaska    34    Owned

North Star DeBarr Residential Treatment Center

   Anchorage, Alaska    60    Owned

North Star Palmer Residential Treatment Center

   Palmer, Alaska    29    Owned

Northwest Academy

   Bonners Perry, Idaho    120    Owned

Nueces County JJAEP NPS

   Corpus Christi, Texas    —      Owned

Oak Plains Academy

   Ashland City, Tennessee    90    Owned

Old Vineyard Behavioral Health

   Winston-Salem, North Carolina    111    Owned

Parkwood Behavioral Health System

   Olive Branch, Mississippi    112    Owned

The Pavilion

   Champaign, Illinois    77    Owned

Peachford Behavioral Health System of Atlanta

   Atlanta, Georgia    224    Owned

Pembroke Hospital

   Pembroke, Massachusetts    115    Owned

Pennsylvania Clinical Schools

   Coatesville, Pennsylvania    114    Owned

Provo Canyon School

   Provo, Utah    266    Owned

Rancho Cucamonga NPS

   Rancho Cucamonga, California    —      Owned

The Ridge Behavioral Health System

   Lexington, Kentucky    110    Owned

Rivendell Behavioral Health Services of Arkansas

   Benton, Arkansas    77    Owned

Rivendell Behavioral Health Services of Kentucky

   Bowling Green, Kentucky    125    Owned

Riverside NPS

   Riverside, California    —      Owned

River Crest Hospital

   San Angelo, Texas    80    Owned

River Oaks Hospital

   New Orleans, Louisiana    126    Owned

Rockford Center

   Newark, Delaware    92    Owned

Roxbury

   Shippensburg, Pennsylvania    84    Owned

St. Louis Behavioral Medicine Institute

   St. Louis, Missouri    —      Owned

Spring Mountain Sahara

   Las Vegas, Nevada    30    Owned

Spring Mountain Treatment Center

   Las Vegas, Nevada    82    Owned

Steele Canyon NPS

   El Cajon, California    —      Leased

Stonington Institute

   North Stonington, Connecticut    72    Owned

SummitRidge

   Lawrenceville, Georgia    76    Owned

Talbott Recovery Campus

   Atlanta, Georgia    —      Owned

Timberlawn Mental Health System

   Dallas, Texas    144    Owned

Turning Point Care Center

   Moultrie, Georgia    59    Owned

Turning Point Youth Center

   St. Johns, Michigan    60    Owned

Two Rivers Psychiatric Hospital

   Kansas City, Missouri    105    Owned

Upper East TN Juvenile Detention Facility

   Johnson City, Tennessee    10    Owned

Vallejo NPS

   Vallejo, California    —      Leased

Victorville NPS

   Victorville, California    —      Leased

Westwood Lodge Hospital

   Westwood, Massachusetts    133    Owned

Wyoming Behavioral Institute

   Casper, Wyoming    90    Owned

 

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Surgical Hospitals, Ambulatory Surgery Centers and Radiation Oncology Centers

 

Name of Facility

  

Location

        Real
Property
Ownership
Interest

Cancer Institute of Nevada (6) (8)

   Las Vegas, Nevada       Owned

Cancer Care Institute of Carolina

   Aiken, South Carolina       Owned

Cornerstone Regional Hospital (9)

   Edinburg, Texas       Leased

OJOS/Eye Surgery Specialists of Puerto Rico (6)

   Santurce, Puerto Rico       Leased

Northwest Texas Surgery Center (6)

   Amarillo, Texas       Leased

Palms Westside Clinic ASC (9)

   Royal Palm Beach, Florida       Leased

Surgery Center at Wellington (7)

   West Palm Beach, Florida       Leased

Surgery Center of Midwest City (5)

   Midwest City, Oklahoma       Leased

Temecula Valley Day Surgery and Pain Therapy Center (7)

   Murrieta, California       Leased

 

(1) Desert Springs Hospital, Summerlin Hospital Medical Center, Valley Hospital Medical Center, Spring Valley Hospital Medical Center and Centennial Hills Hospital Medical Center are owned by limited liability companies (“LLCs”) in which we hold controlling, majority ownership interests of approximately 72%. The remaining minority ownership interests in these facilities are held by unaffiliated third-parties. All hospitals are managed by us. Centennial Hills Hospital Medical Center, a newly constructed facility, was completed and opened in January, 2008.
(2) We hold an 80% ownership interest in this facility through a general partnership interest in limited partnership. The remaining 20% ownership interest is held by an unaffiliated, third-party.
(3) Real property leased from the Trust.
(4) In October, 2007, the license for Edinburg Regional Medical Center, Edinburg Children’s Hospital, McAllen Medical Center, McAllen Heart Hospital and South Texas Behavioral Health Center were consolidated under one license operating as the South Texas Health System.
(5) We own general and limited partnership interests in a limited partnership that owns and operates this center.
(6) We own a majority interest in a LLC that owns and operates this center.
(7) We own minority interests in LLCs that own and operate these centers which are managed by unaffiliated third-parties.
(8) Real property is owned by a limited partnership or LLC that is majority owned by us.
(9) We own non-controlling ownership interests of approximately 50% in the entities that operate these facilities.
(10) New acute-care facility currently under construction and scheduled to be completed and opened by early 2010.

 

We own or lease medical office buildings adjoining some of our hospitals. We believe that the leases on the facilities, medical office buildings and other real estate leased or owned by us do not impose any material limitation on our operations. The aggregate lease payments on facilities leased by us were $41 million in 2008, $39 million in 2007 and $35 million in 2006.

 

ITEM 3. Legal Proceedings

 

We are subject to claims and suits in the ordinary course of business, including those arising from care and treatment afforded by our hospitals and are party to various other litigation, as outlined below.

 

Investigation of South Texas Health System affiliates:

 

We and our South Texas Health System affiliates, which operate McAllen Medical Center, McAllen Heart Hospital, Edinburg Regional Medical Center and certain other affiliates, were served with a subpoena dated November 21, 2005, issued by the Office of Inspector General of the Department of Health and Human Services

 

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(“OIG”). At that time, the Civil Division of the U.S. Attorney’s office in Houston, Texas indicated that the subpoena was part of an investigation under the False Claims Act regarding compliance with Medicare and Medicaid rules and regulations pertaining to the employment of physicians and the solicitation of patient referrals from physicians from January 1, 1999 to the date of the subpoena, related to the South Texas Health System. Documents were produced on a rolling basis pursuant to this subpoena and several additional requests, including an additional March 9, 2007 subpoena, beginning in January of 2006. On February 16, 2007, our South Texas Health System affiliates were served with a search warrant in connection with what we were advised was a related criminal Grand Jury investigation concerning the production of documents. At that time, the government obtained various documents and other property related to the facilities. Follow-up Grand Jury subpoenas for documents and witnesses and other requests for information were subsequently served on South Texas Health System facilities and certain employees and former employees.

 

We have received notification from the U.S. Department of Justice (“DOJ”) that, at this time, the DOJ will not be pursuing criminal prosecutive action against Universal Health Services, Inc. or our South Texas Health System affiliates. The DOJ is still investigating whether or not any individuals independently obstructed justice as it relates to the civil subpoena dated November 21, 2005. Our representatives have been advised that the Civil Division of the U.S. Attorney’s office in Houston, Texas is continuing its investigation in connection with the civil subpoena dated November 21, 2005 issued by the OIG. Our legal representatives continue to meet with representatives of the Civil Division to discuss the status of this matter. We understand that, based on those discussions and its investigations to date, the government is focused on certain arrangements entered into by the South Texas Health System affiliates which, the government believes, may have violated Medicare and Medicaid rules and regulations pertaining to payments to physicians and the solicitation of patient referrals from physicians and other matters relating to payments to various individuals which may have constituted improper payments. We are cooperating with the investigations and are responding to the matters raised with us. We have been negotiating a possible settlement of this matter with the government. We expect to continue our discussions with the government to attempt to resolve this matter in a manner satisfactory to us and the government. During 2008, we recorded a pre-tax charge of $25 million to establish a reserve in connection with this matter. However, there is no assurance that a settlement can be reached, and, should a settlement be reached, we are unable at this time to determine the ultimate settlement amount. Should we be unable to ultimately reach a settlement, we are unable at this time to determine the extent of the total financial and/or other exposure to us in connection with this matter

 

Litigation and Administrative Appeal of CMS’s Attempt to Terminate Medicare Participation of Two Rivers Psychiatric Hospital:

 

In late September, 2008, the Centers for Medicare and Medicaid Services (“CMS”) issued a decision to terminate the participation in the Medicare program of Two Rivers Psychiatric Hospital (“Two Rivers”), a behavioral health facility operated by one of our affiliates in Kansas City. This decision was issued after state surveyors found Two Rivers to be allegedly out of compliance with the conditions of participation required for the Medicare program. Two Rivers filed an administrative appeal with the U.S. Department of Health and Human Services, Departmental Appeals Board, Civil Remedies Division, seeking review of that decision. In order to prevent CMS from terminating the facility from the program prior to a hearing in the administrative appeal, Two Rivers filed a complaint in the U.S. District Court for the Western District of Missouri against the Secretary, U.S. Department of Health and Human Services, seeking a temporary restraining order and preliminary injunction against CMS’ proceeding with the termination. The Court issued a temporary restraining order in favor of Two Rivers, preventing CMS from terminating Two Rivers from the Medicare program and referring the case to a magistrate judge for a settlement conference prior to a hearing on the preliminary injunction motion. On December 12, 2008, CMS and Two Rivers entered into a settlement agreement under which CMS rescinded its termination action and Two Rivers withdrew the administrative appeal and stipulated to a dismissal of the federal court action. The settlement agreement provides, among other terms, that Two Rivers would retain a monitor for six months to: (a) evaluate Two Rivers’ systems for compliance with the Medicare conditions of participation; (b) make recommendations to Two Rivers based on the evaluation; (c) provide

 

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monthly reports to CMS and Two Rivers; and (d) notify CMS if conditions at Two Rivers present a serious threat to patient safety, health or welfare. The settlement agreement also provides that CMS and the Missouri state survey agency will resurvey Two Rivers on or before six and at twelve months after monitoring is initiated. Although Two Rivers is no longer being terminated by CMS from participation in the Medicare program, there is no assurance that during or after the monitoring period a new termination action would not be initiated by CMS should Two Rivers be found to be out of compliance with conditions of participation in Medicare, which could have a material adverse effect on us.

 

Investigation of Virginia Behavioral Health Facilities:

 

In late 2007 and again recently, the Office of Inspector General for the Department of Health and Human Services (“OIG”) issued subpoenas to two of our facilities, Marion Youth Center and Mountain Youth Academy, seeking documents related to the treatment of Medicaid beneficiaries at the facilities. We believe that the OIG is investigating whether claims for reimbursement submitted by those facilities to the Virginia Medicaid program were supported by adequate documentation of the services provided.

 

On August 4, 2008, the Office of the Attorney General for the Commonwealth of Virginia issued a subpoena to Keystone Newport News, another of our facilities. We believe the Office of Attorney General is investigating whether Keystone Newport News complied with various Virginia laws and regulations, including documentation requirements.

 

In response to these subpoenas, we have been producing the requested documents on a rolling basis and we are cooperating with the investigations in all respects. We also have met with representatives of the OIG, the Virginia Attorney General, the United States Attorney for the Western District of Virginia, and the United States Department of Justice Civil Division to discuss a possible resolution of this matter. There is no assurance that we will be able to satisfactorily negotiate a resolution to this issue. At this time we are unable to evaluate the extent of any potential financial and/or other exposure in connection with this matter.

 

Ethridge v. Universal Health Services et. al:

 

In June, 2008, we and one of our acute care facilities, Lancaster Community Hospital, were named as defendants in a wage and hour lawsuit in Los Angeles County Superior Court. This is a purported class action lawsuit alleging that the hospital failed to provide sufficient meal and break periods to certain employees. We have denied liability and are defending the case vigorously which has not yet been certified as a class action by the court. Given the early stage of this case and the uncertainty of the nature, legal viability and extent of the claims, we are unable to determine the extent of potential financial exposure at this time. Further, some of the issues in this lawsuit may have been settled by a previous settlement related to a previously filed class action wage and hour suit against the hospital.

 

The healthcare industry is subject to numerous laws and regulations which include, among other things, matters such as government healthcare participation requirements, various licensure and accreditations, reimbursement for patient services, and Medicare and Medicaid fraud and abuse. Government action has increased with respect to investigations and/or allegations concerning possible violations of fraud and abuse and false claims statutes and/or regulations by healthcare providers. Providers that are found to have violated these laws and regulations may be excluded from participating in government healthcare programs, subjected to fines or penalties or required to repay amounts received from the government for previously billed patient services. We monitor all aspects of our business and have developed a comprehensive ethics and compliance program that is designed to meet or exceed applicable federal guidelines and industry standards. Because the law in this area is complex and constantly evolving, governmental investigation or litigation may result in interpretations that are inconsistent with industry practices, including ours. Although we believe our policies, procedures and practices comply with governmental regulations, from time to time, we are subjected to inquiries or actions with respect to

 

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our facilities. There is no assurance that we will not be faced with sanctions, fines or penalties in connection with such inquiries or actions, including with respect to the investigations and other matters discussed above. Even if we were to ultimately prevail, such inquiries and/or actions could have a material adverse effect on us.

 

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

 

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

 

No matter was submitted during the fourth quarter of the fiscal year ended December 31, 2008 to a vote of security holders.

 

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PART II

 

ITEM 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

 

Our Class B Common Stock is traded on the New York Stock Exchange. Shares of our Class A, Class C and Class D Common Stock are not traded in any public market, but are each convertible into shares of our Class B Common Stock on a share-for-share basis.

 

The table below sets forth, for the quarters indicated, the high and low reported closing sales prices per share reported on the New York Stock Exchange for our Class B Common Stock for the years ended December 31, 2008 and 2007.

 

     2008    2007
     High-Low Sales Price    High-Low Sales Price

Quarter:

     

1st

   $  54.46-$46.73    $  60.19-$55.17

2nd

   $ 65.00-$54.84    $ 63.00-$56.87

3rd

   $ 65.08-$56.03    $ 62.30-$48.76

4th

   $ 53.17-$32.44    $ 53.80-$48.45

 

Number of shareholders of record as of January 31, 2009, were as follows:

 

Class A Common

   11   

Class B Common

   344   

Class C Common

   5   

Class D Common

   139   

 

Stock Repurchase Programs

 

During 1999, 2004, 2005, 2006 and 2007, our Board of Directors approved stock repurchase programs authorizing us to purchase up to an aggregate of 21.5 million shares of our outstanding Class B Common Stock on the open market at prevailing market prices or in negotiated transactions off the market. There is no expiration date for our stock repurchase programs. The following schedule provides information related to our stock repurchase programs for each of the three years ended December 31, 2008:

 

    Additional
Shares Authorized
For Repurchase
  Total number
of shares
purchased(a)
  Average
price paid
per share
for forfeited
restricted
shares
  Total
Number
of shares
purchased
as part of
publicly
announced
programs
  Average
price paid

per share
for shares
purchased
as part of
publicly
announced
program
  Aggregate
purchase
price paid
(in thousands)
  Maximum
number of
shares that
may yet be
purchased
under the
program

Balance as of
January 1, 2006

              3,603,320

2006

  5,000,000   6,536,240   $ 0.01   6,527,155   $ 53.68   $ 350,372   2,076,165

2007

  5,000,000   1,462,537   $ 0.01   1,451,073   $ 51.06   $ 74,091   5,625,092

2008

  —     3,293,568   $ 0.01   3,268,318   $ 45.71   $ 149,404   2,356,774
                                 

Total for three year period ended December 31, 2008

  10,000,000   11,292,345   $ 0.01   11,246,546   $ 51.03   $ 573,867  
                               

 

(a.) Includes 9,085, 11,464 and 25,250 restricted shares that were forfeited by former employees pursuant to the terms of our restricted stock purchase plan during 2006, 2007 and 2008, respectively.

 

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During the period of October 1, 2008 through December 31, 2008, we repurchased the following shares:

 

     Additional
Shares
Authorized
For
Repurchase
   Total
number of
shares
purchased(a)
   Average
price paid
per share
for forfeited
restricted
shares
   Total
Number
of shares
purchased
as part of
publicly
announced
programs
   Average
price paid
per share
for shares
purchased
as part of
publicly
announced
program
   Aggregate
purchase
price paid
(in thousands)
   Maximum
number of
shares that
may yet be
purchased
under the
program

October, 2008

   —      —        N/A    —      $ N/A    $ N/A    3,571,098

November, 2008

   —      626,665    $ 0.01    624,165    $ 39.56    $ 24,692    2,946,933

December, 2008

   —      590,159      N/A    590,159    $ 34.36    $ 20,276    2,356,774
                                        

Total October through December

   —      1,216,824    $ 0.01    1,214,324    $ 37.03    $ 44,968   
                                      

 

(a.) Includes 2,500 restricted shares that were forfeited by former employees pursuant to the terms of our restricted stock purchase plan.

 

Dividends

 

During the two years ending December 31, 2008, dividends per share were declared and paid as follows:

 

     2008    2007

First quarter

   $ .08    $ .08

Second quarter

   $ .08    $ .08

Third quarter

   $ .08    $ .08

Fourth quarter

   $ .08    $ .08
             

Total

   $ .32    $ .32
             

 

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Stock Price Performance Graph

 

The following graph compares the cumulative total stockholder return on our common stock with the cumulative total return on the stock included in the Standard & Poor’s 500 Index and a Peer Group Index during the five year period ended December 31, 2008. The graph assumes an investment of $100 made in our common stock and each Index as of January 1, 2004 and has been weighted based on market capitalization. Note that our common stock price performance shown below should not be viewed as being indicative of future performance.

 

Companies in the peer group, which consist of companies in the S&P 400 Health Care Facilities Index (in which we are also included), the S&P 500 Health Care Facilities Index and the S&P 600 Health Care Facilities Index, are as follows: Community Health Systems, Inc., HCA Inc. (included through December, 2005), Health Management Associates, LifePoint Hospitals, Inc., Province Healthcare Company (included through December, 2004 and acquired by LifePoint Hospitals, Inc. during 2005), Tenet Healthcare Corporation and Triad Hospitals, Inc. (included through December, 2006 and acquired by Community Health Systems in 2007).

 

COMPARISON OF FIVE YEAR CUMULATIVE TOTAL RETURN

(The Company, S&P 500 and Peer Group)

 

LOGO

 

Company Name / Index

   2003    2004    2005    2006    2007    2008

Universal Health Services, Inc

   $ 100.00    $ 83.40    $ 88.16    $ 105.18    $ 97.71    $ 72.14

S&P 500 Index

   $ 100.00    $ 110.88    $ 116.33    $ 134.70    $ 142.10    $ 89.53

Peer Group

   $ 100.00    $ 90.47    $ 88.71    $ 87.96    $ 68.85    $ 32.98

 

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ITEM 6. Selected Financial Data

 

The following table contains our selected financial data for, or as the end of, each of the five years ended December 31, 2008. You should read this table in conjunction with the consolidated financial statements and related notes included elsewhere in this report and in Part II, Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

Selected Financial Data

 

    Year Ended December 31  
    2008     2007     2006     2005     2004  

Summary of Operations (in thousands)

         

Net revenues

  $ 5,022,417     $ 4,683,150     $ 4,124,692     $ 3,706,618     $ 3,342,886  

Income from continuing operations

  $ 192,941     $ 170,642     $ 159,200     $ 157,034     $ 164,158  

Net income

  $ 199,377     $ 170,387     $ 259,458     $ 240,845     $ 169,492  

Net margin

    4.0 %     3.6 %     6.3 %     6.5 %     5.1 %

Return on average equity

    13.0 %     11.3 %     18.9 %     19.4 %     14.4 %

Financial Data (in thousands)

         

Cash provided by operating activities

  $ 463,100     $ 348,495     $ 169,239     $ 425,426     $ 392,880  

Capital expenditures, net (1)

  $ 354,537     $ 339,813     $ 341,140     $ 241,412     $ 230,760  

Total assets

  $ 3,742,462     $ 3,608,657     $ 3,277,042     $ 2,858,709     $ 3,022,843  

Long-term borrowings

  $ 990,661     $ 1,008,786     $ 821,363     $ 637,654     $ 852,229  

Common stockholders’ equity

  $ 1,543,850     $ 1,517,199     $ 1,402,464     $ 1,205,098     $ 1,220,586  

Percentage of total debt to total capitalization

    39 %     40 %     37 %     35 %     42 %

Operating Data—Acute Care Hospitals (2)

         

Average licensed beds

    5,452       5,292       4,947       4,884       4,940  

Average available beds

    5,145       4,985       4,658       4,559       4,311  

Inpatient admissions

    263,536       256,681       240,451       236,753       228,454  

Average length of patient stay

    4.5       4.5       4.4       4.4       4.5  

Patient days

    1,182,894       1,149,399       1,069,890       1,036,366       1,020,817  

Occupancy rate for licensed beds

    59 %     60 %     59 %     58 %     56 %

Occupancy rate for available beds

    63 %     63 %     63 %     62 %     65 %

Operating Data—Behavioral Health Facilities

         

Average licensed beds

    7,658       7,348       6,607       4,849       4,225  

Average available beds

    7,629       7,315       6,540       4,766       4,145  

Inpatient admissions

    129,553       119,730       111,490       102,683       94,743  

Average length of patient stay

    16.1       16.8       16.6       14.1       13.0  

Patient days

    2,085,114       2,007,119       1,855,306       1,446,260       1,234,152  

Occupancy rate for licensed beds

    74 %     75 %     77 %     82 %     80 %

Occupancy rate for available beds

    75 %     75 %     78 %     83 %     81 %

Per Share Data

         

Net income from continuing operations—basic

  $ 3.81     $ 3.20     $ 2.92     $ 2.82     $ 2.85  

Net income from continuing operations—diluted

  $ 3.80     $ 3.18     $ 2.83     $ 2.66     $ 2.67  

Net income—basic

  $ 3.94     $ 3.19     $ 4.76     $ 4.33     $ 2.94  

Net income—diluted

  $ 3.93     $ 3.18     $ 4.56     $ 4.00     $ 2.75  

Dividends declared

  $ 0.32     $ 0.32     $ 0.32     $ 0.32     $ 0.32  

Other Information (in thousands)

         

Weighted average number of shares outstanding—basic

    50,611       53,381       54,557       55,658       57,653  

Weighted average number of shares and share equivalents outstanding—diluted

    50,776       53,569       57,908       62,647       64,865  

 

(1) Amounts include non-cash capital lease obligations, if any.
(2) Excludes statistical information related to divested facilities and facilities held for sale.

 

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ITEM 7. Management’s Discussion and Analysis of Operations and Financial Condition

 

Overview

 

Our principal business is owning and operating, through our subsidiaries, acute care hospitals, behavioral health centers, surgical hospitals, ambulatory surgery centers and radiation oncology centers. As of February 26, 2009, we owned and/or operated or had under construction, 26 acute care hospitals (including 1 new facility currently being constructed) and 101 behavioral health centers located in 32 states, Washington, D.C. and Puerto Rico. As part of our ambulatory treatment centers division, we manage and/or own outright or in partnerships with physicians, 9 surgical hospitals and surgery and radiation oncology centers located in 6 states and Puerto Rico.

 

Net revenues from our acute care hospitals, surgical hospitals, surgery centers and radiation oncology centers accounted for 74%, 74% and 75% of our consolidated net revenues in 2008, 2007 and 2006, respectively. Net revenues from our behavioral health care facilities accounted for 25% of our consolidated net revenues during each of 2008, 2007 and 2006. During each of 2008 and 2007, approximately 1% of our consolidated net revenues were recorded in connection with two construction management contracts pursuant to the terms of which we: (i) built a newly constructed acute care hospital for an unrelated third party that was completed during the first quarter of 2008, and; (ii) are building a newly constructed acute care hospital for an unrelated party that is scheduled to be completed during the fourth quarter of 2009.

 

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

 

Forward-Looking Statements and Risk Factors

 

This Annual Report contains “forward-looking statements” that reflect our current estimates, expectations and projections about our future results, performance, prospects and opportunities. Forward-looking statements include, among other things, the information concerning our possible future results of operations, business and growth strategies, financing plans, expectations that regulatory developments or other matters will not have a material adverse effect on our business or financial condition, our competitive position and the effects of competition, the projected growth of the industry in which we operate, and the benefits and synergies to be obtained from our completed and any future acquisitions, and statements of our goals and objectives, and other similar expressions concerning matters that are not historical facts. Words such as “may,” “will,” “should,” “could,” “would,” “predicts,” “potential,” “continue,” “expects,” “anticipates,” “future,” “intends,” “plans,” “believes,” “estimates,” “appears,” “projects” and similar expressions, as well as statements in future tense, identify forward-looking statements.

 

Forward-looking statements should not be read as a guarantee of future performance or results, and will not necessarily be accurate indications of the times at, or by which, such performance or results will be achieved. Forward-looking information is based on information available at the time and/or our good faith belief with respect to future events, and is subject to risks and uncertainties that could cause actual performance or results to differ materially from those expressed in the statements. Such factors include, among other things, the following:

 

   

our ability to comply with existing laws and government regulations and/or changes in laws and government regulations;

 

   

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

 

   

an increase in the number of uninsured and self-pay patients treated at our acute care facilities that unfavorably impacts our ability to satisfactorily and timely collect our self-pay patient accounts;

 

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

 

   

the outcome of known and unknown litigation, government investigations, and liabilities and other claims asserted against us, including the government’s ongoing investigations of our South Texas Health Systems affiliates and other matters as disclosed in Item 1. Legal Proceedings;

 

   

the potential unfavorable impact on our business of continued deterioration in national, regional and local economic and business conditions, including a continuation or worsening of unfavorable credit market conditions;

 

   

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

 

   

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

 

   

our ability to attract and retain qualified personnel, nurses, physicians and other healthcare professionals and the impact on our labor expenses resulting from a shortage of nurses and other healthcare professionals;

 

   

demographic changes;

 

   

our ability to successfully integrate and improve our recent acquisitions and the availability of suitable acquisitions and divestiture opportunities;

 

   

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

 

   

our ability to continue to obtain capital on acceptable terms, including borrowed funds, to fund the future growth of our business;

 

   

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

 

   

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

 

   

the ability to obtain adequate levels of general and professional liability insurance on current terms;

 

   

changes in our business strategies or development plans;

 

   

fluctuations in the value of our common stock, and;

 

   

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

 

Given these uncertainties, risks and assumptions, you are cautioned not to place undue reliance on such forward-looking statements. Our actual results and financial condition could differ materially from those expressed in, or implied by, the forward-looking statements.

 

Forward-looking statements speak only as of the date the statements are made. We assume no obligation to publicly update any forward-looking statements to reflect actual results, changes in assumptions or changes in other factors affecting forward-looking information, except as may be required by law. All forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by this cautionary statement.

 

Critical Accounting Policies and Estimates

 

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires us to make estimates and assumptions that affect the amounts reported in our consolidated financial statements and accompanying notes.

 

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A summary of our significant accounting policies is outlined in Note 1 to the financial statements. We consider our critical accounting policies to be those that require us to make significant judgments and estimates when we prepare our financial statements, including the following:

 

Revenue recognition:    We record revenues and related receivables for health care services at the time the services are provided. Medicare and Medicaid revenues represented 36%, 37% and 38% of our net patient revenues during 2008, 2007 and 2006, respectively. Revenues from managed care entities, including health maintenance organizations and managed Medicare and Medicaid programs accounted for 46%, 44% and 41% of our net patient revenues during 2008, 2007 and 2006, respectively.

 

We report net patient service revenue at the estimated net realizable amounts from patients and third-party payors and others for services rendered. We have agreements with third-party payors that provide for payments to us at amounts different from our established rates. Payment arrangements include prospectively determined rates per discharge, reimbursed costs, discounted charges and per diem payments. Estimates of contractual allowances under managed care plans are based upon the payment terms specified in the related contractual agreements. We closely monitor our historical collection rates, as well as changes in applicable laws, rules and regulations and contract terms, to assure that provisions are made using the most accurate information available. However, due to the complexities involved in these estimations, actual payments from payors may be different from the amounts we estimate and record.

 

We estimate our Medicare and Medicaid revenues using the latest available financial information, patient utilization data, government provided data and in accordance with applicable Medicare and Medicaid payment rules and regulations. The laws and regulations governing the Medicare and Medicaid programs are extremely complex and subject to interpretation and as a result, there is at least a reasonable possibility that recorded estimates will change by material amounts in the near term. Certain types of payments by the Medicare program and state Medicaid programs (e.g. Medicare Disproportionate Share Hospital, Medicare Allowable Bad Debts and Inpatient Psychiatric Services) are subject to retroactive adjustment in future periods as a result of administrative review and audit and our estimates may vary from the final settlements. Such amounts are included in accounts receivable, net, on our Consolidated Balance Sheets. The funding of both federal Medicare and state Medicaid programs are subject to legislative and regulatory changes. As such, we can not provide any assurance that future legislation and regulations, if enacted, will not have a material impact on our future Medicare and Medicaid reimbursements. Adjustments related to the final settlement of these retrospectively determined amounts did not materially impact our results in 2008 or 2007 and favorably impacted our 2006 after-tax operating results by $5 million ($8 million pre-tax). If it were to occur, each 1% adjustment to our estimated net Medicare revenues that are subject to retrospective review and settlement as of December 31, 2008, would change our after-tax net income by approximately $1 million.

 

We provide care to patients who meet certain financial or economic criteria without charge or at amounts substantially less than our established rates. Because we do not pursue collection of amounts determined to qualify as charity care, they are not reported in net revenues or in accounts receivable, net. Our acute care hospitals provided charity care and uninsured discounts, based on charges at established rates, amounting to (amounts include uninsured discounts mentioned above and data related to an acute care facility that is reflected as discontinued operations) $614 million, $562 million and $443 million during 2008, 2007 and 2006, respectively.

 

At our acute care facilities, Medicaid pending accounts comprise the large majority of our receivables that are pending approval from third-party payors but we also have smaller amounts due from other miscellaneous payors such as county indigent programs in certain states. Approximately 5% or $36 million as of December 31, 2008 and 5% or $31 million as of December 31, 2007 of our accounts receivable, net, were comprised of Medicaid pending accounts.

 

Our patient registration process includes an interview of the patient or the patient’s responsible party at the time of registration. At that time, an insurance eligibility determination is made and an insurance plan code is

 

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assigned. There are various pre-established insurance profiles in our patient accounting system which determine the expected insurance reimbursement for each patient based on the insurance plan code assigned and the services rendered. Certain patients may be classified as Medicaid pending at registration if we are unable to definitively determine if they are currently Medicaid eligible without further evaluation. When a patient is registered as Medicaid eligible or Medicaid pending, our patient accounting system records net revenues for services provided to that patient based upon the established Medicaid reimbursement rates pending ultimate disposition of the patient’s Medicaid eligibility.

 

Based on historical hindsight information related to Medicaid pending accounts, we estimate that approximately 58% or $21 million of the $36 million Medicaid pending accounts receivable as of December 31, 2008 will subsequently qualify for Medicaid reimbursement. Approximately 58% or $18 million of $31 million total Medicaid pending accounts receivable as of December 31, 2007 subsequently qualified for Medicaid pending reimbursement and were therefore appropriately classified at the patient’s registration. Additional charity reserves of $13 million during each of 2008 and 2007 were established to cover the Medicaid Pending patients that failed to qualify for the Medicaid program based on historical conversion rates. Based on general factors as discussed below in Provision for Doubtful Accounts, our facilities make estimates at each financial reporting period to reserve for amounts that are deemed to be uncollectible. Such estimated uncollectible amounts related to Medicaid pending, as well as other accounts receivable payor classifications, are considered when the overall individual facility and company-wide reserves are developed.

 

Below are the Medicaid pending receivable agings as of December 31, 2008 and 2007 (amounts in thousands):

 

     2008    %    2007    %

Under 60 days

   $ 13,554    37.9    $ 11,916    38.2

61-120 days

     8,309    23.3      7,963    25.6

121-180 days

     4,283    12.0      3,450    11.1

Over 180 days

     9,585    26.8      7,836    25.1
                       

Total

   $ 35,731    100.0    $ 31,165    100.0
                       

 

Provision for Doubtful Accounts:    Collection of receivables from third-party payors and patients is our primary source of cash and is critical to our operating performance. Our primary collection risks relate to uninsured patients and the portion of the bill which is the patient’s responsibility, primarily co-payments and deductibles. We estimate our provisions for doubtful accounts based on general factors such as payor mix, the agings of the receivables and historical collection experience. We routinely review accounts receivable balances in conjunction with these factors and other economic conditions which might ultimately affect the collectibility of the patient accounts and make adjustments to our allowances as warranted. At our acute care hospitals, third party liability accounts are pursued until all payment and adjustments are posted to the patient account. For those accounts with a patient balance after third party liability is finalized or accounts for uninsured patients, the patient is sent at least two statements followed by a series of collection letters. If the patient is deemed unwilling to pay, the account is written-off as bad debt and transferred to an outside collection agency for additional collection effort. Patients that express an inability to pay are reviewed for write-off as potential charity care. Our accounts receivable are recorded net of established charity care reserves of $83 million as of December 31, 2008 and $81million as of December 31, 2007 (including additional charity care reserves of $13 million established during each of 2008 and 2007, as discussed above in Revenue recognition).

 

Uninsured patients that do not qualify as charity patients are extended an uninsured discount of at least 20% of total charges. During the collection process the hospital establishes a partial reserve in the allowance for doubtful accounts for self-pay balances outstanding for greater than 60 days from the date of discharge. All self-pay accounts at the hospital level are fully reserved if they have been outstanding for greater than 90 days from the date of discharge. Third party liability accounts are fully reserved in the allowance for doubtful accounts when the balance ages past 180 days from the date of discharge. Potential charity accounts are fully reserved when it is determined the patient may be unable to pay.

 

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On a consolidated basis, we monitor our total self-pay receivables to ensure that the total allowance for doubtful accounts provides adequate coverage based on historical collection experience. At December 31, 2008 and December 31, 2007, accounts receivable are recorded net of allowance for doubtful accounts of $163 million and $121 million, respectively.

 

Approximately 93% during 2008, 93% during 2007 and 94% during 2006, of our consolidated provision for doubtful accounts, was incurred by our acute care hospitals. Shown below is our payor mix concentrations and related aging of our billed accounts receivable, net of contractual allowances, for our acute care hospitals as of December 31, 2008 and 2007:

 

As of December 31, 2008:                    
(amounts in thousands)    0-60 days    61-120 days    121-180 days    Over 180 days

Medicare

   $ 49,254    $ 3,993    $ 1,091    $ 4,830

Medicaid

     29,072      16,049      9,409      22,858

Commercial insurance and other

     187,273      53,539      21,600      44,670

Private pay

     70,174      38,510      24,921      34,645
                           

Total

   $ 335,773    $ 112,091    $ 57,021    $ 107,003
                           

 

As of December 31, 2007:                    
(amounts in thousands)    0-60 days    61-120 days    121-180 days    Over 180 days

Medicare

   $ 51,426    $ 3,656    $ 1,128    $ 2,937

Medicaid

     27,884      16,769      8,174      16,530

Commercial insurance and other

     185,540      58,332      23,286      36,381

Private pay

     65,244      28,050      20,241      29,381
                           

Total

   $ 330,094    $ 106,807    $ 52,829    $ 85,229
                           

 

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

 

For the years of 1998 through 2001, most of our subsidiaries were covered under commercial insurance policies with PHICO, a Pennsylvania based insurance company that was placed into liquidation in February, 2002. As a result, although PHICO continued to be liable for claims on our behalf that were related to 1998 through 2001, we began paying the claims upon PHICO’s liquidation. Since that time, although we preserved our right to receive reimbursement from the PHICO estate, we were not previously able to assess the probability of collection or reasonably quantify our share of the liquidation proceeds. In January, 2009, a court order from the Commonwealth Court of Pennsylvania was executed in connection with the partial liquidation of the PHICO estate. As a result, during the fourth quarter of 2008, based upon our share of the undisputed and resolved claims made against the PHICO estate as of a specified date and as approved by the liquidator to the court, we recorded a $10 million reduction to our professional and general liability self-insured claims expense. These liquidation proceeds were received during the first quarter of 2009.

 

During the second quarter of 2007, based upon the results of a reserve analysis, we recorded an $18 million (pre-minority interest) reduction to our prior year reserves for professional and general liability self-insured

 

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claims. This favorable change in our estimated future claims payments was partially due to the favorable impact of medical malpractice tort reform experienced in several states in which we operate as well as a decrease in obstetrical-related claims due to a company-wide patient safety initiative in this high-risk specialty. Adjustments to our prior year reserves for professional and general liability self-insured claims did not have a material impact on our financial statements during 2006.

 

Based upon the results of workers’ compensation reserves analyses, we recorded reductions to our prior year reserves for workers’ compensation claims amounting to $4 million during 2008 (recorded during the fourth quarter) and $5 million during 2007 ($2 million recorded during the second quarter of 2007 and $3 million recorded during the fourth quarter of 2007). Adjustments to our prior year reserves for workers’ compensation claims did not have a material impact on our financial statements during 2006.

 

Although we are unable to predict whether or not our future financial statements will include adjustments to our prior year reserves for self-insured general and professional and workers’ compensation claims, given the relatively unpredictable nature of the these potential liabilities and the factors impacting these reserves, it is reasonably likely that our future financial results may include material adjustments to prior period reserves.

 

Below is a schedule showing the changes in our general and professional liability and workers’ compensation reserves during the three years ended December 31, 2008 (amount in thousands):

 

     General and
Professional
Liability
    Workers’
Compensation
    Total  

Balance at January 1, 2006 (a)

   $ 216,459     $ 45,329     $ 261,788  

Plus: accrued insurance expense, net of commercial premiums paid

     59,752       16,704       76,456  

Less: Payments made in settlement of self-insured claims

     (31,591 )     (13,265 )     (44,856 )

Plus: Liabilities assumed at acquisition

     176       668       844  
                        

Balance at January 1, 2007 (a)

     244,796       49,436       294,232  

Plus: accrued insurance expense, net of commercial premiums paid

     49,177       14,954       64,131  

Less: Payments made in settlement of self-insured claims

     (37,960 )     (15,648 )     (53,608 )
                        

Balance at January 1, 2008 (a)

     256,013       48,742       304,755  

Plus: accrued insurance expense, net of commercial premiums paid (b)

     56,904       16,509       73,413  

Less: Payments made in settlement of self-insured claims

     (41,807 )     (16,754 )     (58,561 )
                        

Balance at December 31, 2008 (a)

   $ 271,110     $ 48,497     $ 319,607  
                        

 

(a) Net of expected recoveries from various state guaranty funds in connection with a commercial general and professional insurance company’s (PHICO) liquidation in 2002 (see Professional and General Liability Claims and Property Insurance).
(b) Excludes the impact of the $10 million recovery from the liquidation of the PHICO estate, as discussed above.

 

In addition, we also maintain self-insured employee benefits programs for employee healthcare and dental claims. The ultimate costs related to these programs include expenses for claims incurred and paid in addition to an accrual for the estimated expenses incurred in connection with claims incurred but not yet reported.

 

Long-Lived Assets:    We review our long-lived assets, including amortizable intangible assets, for impairment whenever events or circumstances indicate that the carrying value of these assets may not be recoverable. The assessment of possible impairment is based on our ability to recover the carrying value of our asset based on our estimate of its undiscounted future cash flow. If the analysis indicates that the carrying value is not recoverable from future cash flows, the asset is written down to its estimated fair value and an impairment loss is recognized. Fair values are determined based on estimated future cash flows using appropriate discount rates.

 

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Goodwill:    Goodwill is reviewed for impairment at the reporting unit level on an annual basis or sooner if the indicators of impairment arise. Our judgments regarding the existence of impairment indicators are based on market conditions and operational performance of each reporting unit. We have designated September 1st as our annual impairment assessment date and performed an impairment assessment as of September 1, 2008 which indicated no impairment of goodwill. Future changes in the estimates used to conduct the impairment review, including profitability and market value projections, could indicate impairment in future periods potentially resulting in a write-off of a portion or all of our goodwill.

 

Income Taxes:    Deferred tax assets and liabilities are recognized for the amount of taxes payable or deductible in future years as a result of differences between the tax bases of assets and liabilities and their reported amounts in the financial statements. We believe that future income will enable us to realize our deferred tax assets net of recorded valuation allowances relating to state net operating loss carryforwards.

 

We operate in multiple jurisdictions with varying tax laws. We are subject to audits by any of these taxing authorities. During 2008, the estimated liabilities for uncertain tax positions (including accrued interest and penalties) were increased in the amount of approximately $2 million due to tax positions taken in the current and prior years. Also during 2008, the estimated liabilities for uncertain tax positions (including accrued interest and penalties) were reduced due to the lapse of the statute of limitations resulting in a net income tax benefit of approximately $1 million. During 2007, the estimated liabilities for uncertain tax positions (including accrued interest and penalties) were reduced due to the lapse of the statue of limitations and the conclusions of income tax audits of varying taxing authorities resulting in a net income tax benefit of approximately $2 million. Our tax returns have been examined by the Internal Revenue Service (IRS) through the year ended December 31, 2002. The IRS has recently commenced an audit for the tax year ended December 31, 2006. We believe that adequate accruals have been provided for federal, foreign and state taxes.

 

Accounting for Uncertainty in Income Taxes:    Effective January 1, 2007, we adopted the provisions of FASB issued Interpretation No. 48 (“FIN 48”), Accounting for Uncertainty in Income Taxes. As a result of the implementation of FIN 48, we recognized a $12 million decrease in the liability for unrecognized tax benefits. This decrease in the liability resulted in an increase to the January 1, 2007 balance of retained earnings of approximately $12 million. As of January 1, 2007, after the implementation of FIN 48, our unrecognized tax benefits were approximately $6 million. The amount at implementation that would favorably affect the effective tax rate and provision for income taxes was approximately $4 million, approximately $3 million of which was recorded during 2007. The balance at December 31, 2008 and 2007, if subsequently recognized, that would favorably affect the effective tax rate and provision for income taxes is approximately $2 million and $1 million, respectively.

 

Recent Accounting Pronouncements:    For a summary of recent accounting pronouncements, please see Note 13 to the Consolidated Financial Statements as included in this Report on Form 10-K for the year ended December 31, 2008.

 

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Results of Operations

 

The following table summarizes our results of operations, and is used in the discussion below, for the years ended December 31, 2008, 2007 and 2006 (dollar amounts in thousands):

 

    Year Ended December 31,  
    2008     2007     2006  
    Amount   % of
Revenues
    Amount     % of
Revenues
    Amount     % of
Revenues
 

Net revenues

  $ 5,022,417   100.0 %   $ 4,683,150     100.0 %   $ 4,124,692     100.0 %

Operating charges:

           

Salaries, wages & benefits

    2,133,181   42.5 %     2,004,995     42.8 %     1,765,162     42.8 %

Other operating expenses

    1,044,278   20.8 %     982,614     21.0 %     921,836     22.3 %

Supplies expense

    694,477   13.8 %     666,320     14.2 %     547,915     13.3 %

Provision for doubtful accounts

    476,745   9.5 %     410,543     8.8 %     343,383     8.3 %

Depreciation & amortization

    193,635   3.9 %     180,557     3.9 %     161,097     3.9 %

Lease & rental expense

    69,882   1.4 %     67,867     1.4 %     63,574     1.5 %
                                       
    4,612,198   91.8 %     4,312,896     92.1 %     3,802,967     92.2 %
                                       

Income before interest expense, hurricane insurance recoveries in excess of expenses, minority interests & income taxes

    410,219   8.2 %     370,254     7.9 %     321,725     7.8 %

Interest expense, net

    53,207   1.1 %     51,626     1.1 %     32,558     0.8 %

Hurricane insurance recoveries in excess of expenses

    —     —         —       —         (770 )   0.0 %

Minority interests in earnings of consolidated entities

    40,693   0.8 %     43,361     0.9 %     37,519     0.9 %
                                       

Income before income taxes

    316,319   6.3 %     275,267     5.9 %     252,418     6.1 %

Provision for income taxes

    123,378   2.5 %     104,625     2.3 %     93,218     2.2 %
                                       

Income from continuing operations

    192,941   3.8 %     170,642     3.6 %     159,200     3.9 %

Income/(loss) from discontinued operations, net of income taxes

    6,436   0.2 %     (255 )   0.0 %     100,258     2.4 %
                                       

Net income

  $ 199,377   4.0 %   $ 170,387     3.6 %   $ 259,458     6.3 %
                                       

 

Year Ended December 31, 2008 as compared to the Year Ended December 31, 2007:    Net revenues increased 7% or $339 million to $5.02 billion during 2008 as compared to $4.68 billion during 2007. The increase was attributable to:

 

   

a $250 million or 6% increase in net revenues generated at our acute care hospitals and behavioral health care facilities owned during both periods (which we refer to as “same facility”);

 

   

$114 million of other combined increases in revenues including revenues generated at Centennial Hills Hospital Medical Center (“Centennial Hills Hospital”) which opened during the first quarter of 2008 and behavioral health care facilities opened or acquired during 2008 and 2007, and;

 

   

$25 million of other combined net decreases in revenues resulting primarily from decreased revenue earned during 2008 in connection with construction management contracts pursuant to the terms of which we are building/have built newly constructed acute care hospitals for an unrelated third party.

 

Income before income taxes increased $41 million to $316 million during 2008 as compared to $275 million during 2007 due to the following:

 

   

an increase of $54 million at our acute care facilities as discussed below in Acute Care Hospital Services exclusive of the $25 million unfavorable pre-tax provision for settlement recorded during

 

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2008 in connection with the investigation of our South Texas Health System affiliates, as discussed in Item 3. Legal Proceedings, and exclusive of the $14 million favorable pre-tax effect recorded during 2007 from the reduction to our prior year reserves for professional and general liability claims, as discussed above in Self-Insured Risks;

 

   

an increase of $26 million at our behavioral health care facilities as discussed below in Behavioral Health Services exclusive of the $2 million favorable pre-tax effect recorded during 2007 from the reduction to our prior year reserves for professional and general liability self-insured claims, as discussed above in Self-Insured Risks;

 

   

a decrease of $25 million resulting from the provision for settlement recorded during 2008 to establish a reserve in connection with the government’s investigation of our South Texas Health System affiliates, as discussed in Item 3. Legal Proceedings;

 

   

an increase of $10 million resulting from the reduction to our professional and general liability expense recorded during 2008 in connection with the expected receipt of liquidation proceeds from the PHICO estate, as discussed above in Self-Insured Risks;

 

   

a decrease of $16 million (after minority interest) resulting from favorable pre-tax effect recorded during 2007 from the reduction to our prior year reserves for professional and general liability self-insured claims, as discussed below, and;

 

   

a decrease of $8 million from other combined net unfavorable changes.

 

Net income increased $29 million to $199 million during 2008 as compared to $170 million during 2007 due to the following:

 

   

the $41 million increase in income before income taxes, as discussed above, and;

 

   

an unfavorable change of $19 million in the provision for income taxes resulting primarily from the tax provision on the $41 million increase in income before income taxes. Contributing to the increase in the income tax provision was an increase in the effective state income tax rate during 2008, as compared to 2007, and;

 

   

an increase of $7 million due primarily to the after-tax gain realized during 2008 on the sale of a 125-bed acute care hospital located in Pennsylvania.

 

Year Ended December 31, 2007 as compared to the Year Ended December 31, 2006:    Net revenues increased 14% or $558 million to $4.68 billion in 2007 as compared to $4.12 billion during 2006. The increase was attributable to:

 

   

a $314 million or 8% increase in net revenues generated at our acute care hospitals and behavioral health care facilities owned during both periods (which we refer to as “same facility”);

 

   

$174 million of other combined increases in revenues resulting from the acute care facility and behavioral health care facilities acquired during 2007 and 2006, and;

 

   

$70 million of other combined net increases in revenues resulting primarily from the revenues earned during 2007 in connection with a construction management contract pursuant to the terms of which we built a newly constructed acute care hospital for an unrelated third party.

 

Income before income taxes increased $23 million to $275 million during 2007 as compared to $252 million during 2006 due to the following:

 

   

an increase of $10 million at our acute care facilities as discussed below in Acute Care Hospital Services exclusive of the $14 million favorable pre-tax effect resulting from the reduction recorded during 2007 to our prior year reserves for professional and general liability claims, as discussed above in Self-Insured Risks;

 

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an increase of $16 million at our behavioral health care facilities as discussed below in Behavioral Health Services exclusive of the $2 million favorable pre-tax effect resulting from the reduction recorded during 2007 to our prior year reserves for professional and general liability self-insured claims, as discussed above in Self-Insured Risks;

 

   

an increase of $16 million (after minority interest) resulting from the reduction recorded during 2007 to our prior year reserves for professional and general liability self-insured claims, as discussed above in Self-Insured Risks, and;

 

   

a decrease of $19 million due to an increase in interest expense.

 

Net income decreased $89 million to $170 million during 2007 as compared to $259 million during 2006 due to the following:

 

   

the $23 million increase in income before income taxes, as discussed above;

 

   

an after-tax decrease of $101 million resulting from the hurricane insurance recoveries, in excess of expenses, recording during 2006 ($168 million before minority interest and income taxes);

 

   

a net unfavorable change of $11 million in the provision for income taxes resulting primarily from the tax provision on the $23 million increase in income before income taxes. Contributing to the increase in the income tax provision was an increase in the effective state income tax rate during 2007 as compared to 2006.

 

Effective July 1, 2006, the pharmacy services for our acute care facilities were brought in-house from an outsourced vendor. As a result of this change, during the period of January through June of 2007, we experienced an increase to supplies expense of approximately $56 million, an increase to salaries, wages and benefits expense of approximately $22 million and a decrease to other operating expense of approximately $82 million. The transition of our pharmacy services favorably impacted our pre-tax income by approximately $4 million during 2007. As a percentage of our consolidated net revenues for the year ended December 31, 2007, as shown above, the transition of the pharmacy services increased supplies expense by 120 basis points, increased salaries, wages and benefits expense by 40 basis points and decreased other operating expenses by 170 basis points.

 

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Acute Care Hospital Services

 

Year Ended December 31, 2008 as compared to the Year Ended December 31, 2007:

 

The following table summarizes the results of operations for our acute care facilities on a same facility basis and is used in the discussions below for the years ended December 31, 2008 and 2007 (dollar amounts in thousands):

 

     Year Ended
December 31, 2008
    Year Ended
December 31, 2007
 

Acute Care Hospitals—Same Facility Basis

   Amount    % of
Revenues
    Amount    % of
Revenues
 

Net revenues

   $ 3,582,575    100.0 %   $ 3,419,108    100.0 %

Operating charges:

          

Salaries, wages and benefits

     1,370,424    38.3 %     1,334,937    39.0 %

Other operating expenses

     664,469    18.5 %     645,463    18.9 %

Supplies expense

     598,643    16.7 %     589,613    17.2 %

Provision for doubtful accounts

     429,997    12.0 %     381,718    11.2 %

Depreciation and amortization

     145,812    4.1 %     146,924    4.3 %

Lease and rental expense

     47,524    1.3 %     47,066    1.4 %
                          
     3,256,869    90.9 %     3,145,721    92.0 %
                          

Income before interest expense, minority interests and income taxes

     325,706    9.1 %     273,387    8.0 %

Interest expense, net

     4,361    0.1 %     3,757    0.1 %

Minority interests in earnings of consolidated entities

     41,332    1.2 %     40,005    1.2 %
                          

Income before income taxes

   $ 280,013    7.8 %   $ 229,625    6.7 %
                          

 

On a same facility basis during 2008, as compared to 2007, net revenues at our acute care hospitals increased $163 million or 5%. Income before income taxes increased $50 million or 22% to $280 million or 7.8% of net revenues during 2008 as compared to $230 million or 6.7% of net revenues during 2007.

 

Inpatient admissions to these facilities increased 0.1% during 2008, as compared to 2007, while patient days increased 0.8%. The average length of patient stay at these facilities was 4.5 days in each of the years 2008 and 2007. The occupancy rate, based on the average available beds at these facilities, was 64% during 2008 and 63% during 2007. Our same facility inpatient volumes were negatively impacted during 2008, as compared to 2007, by the: (i) opening of the previously disclosed, newly constructed capacity at the physician-owned competitor hospital in McAllen, Texas, and; (ii) the opening of our newly constructed Centennial Hills Hospital. Since Centennial Hills Hospital is a newly opened facility, it is not included in our same facility basis results during 2008. However, we believe a portion of the patient volume at Centennial Hills Hospital during 2008 would have been treated at our previously existing hospitals in the Las Vegas, Nevada market which are included in our same facility basis results.

 

Our same facility net revenues were favorably impacted by an increase in prices charged to private payors including health maintenance organizations and preferred provider organizations. On a same facility basis, net revenue per adjusted admission (adjusted for outpatient activity) at these facilities increased 4.8% during 2008, as compared to 2007, and net revenue per adjusted patient day increased 4.1% during 2008, as compared to 2007.

 

We continue to experience an increase in uninsured patients throughout our portfolio of acute care hospitals which in part, has resulted from an increase in the number of patients who are employed but do not have health insurance. We provide care to patients who meet certain financial or economic criteria without charge or at amounts substantially less than our established rates. Because we do not pursue collection of amounts determined to qualify as charity care, they are not reported in net revenues or in accounts receivable, net. Our acute care hospitals provided charity care and uninsured discounts, based on charges at established rates, amounting to (includes data for an acute care facility reflected as discontinued operations) $614 million during 2008 and $562 million during 2007. An increase in the level of uninsured patients to our facilities and the resulting adverse

 

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trends in the provision for doubtful accounts and charity care provided, could have a material unfavorable impact on our future operating results.

 

The following table summarizes the results of operations for all our acute care operations during 2008 and 2007. Included in these results, in addition to the same facility results shown above, are: (i) the 2008 financial results for Centennial Hills Hospital located in Las Vegas, Nevada which was opened during the first quarter of 2008; (ii) the unfavorable impact resulting from the $25 million provision for settlement recorded during 2008 to establish a reserve in connection with the government’s investigation of our South Texas Health System affiliates, as discussed in Item 3. Legal Proceedings, and; (ii) the favorable effect recorded during 2007 from the reduction to our prior year reserves for professional and general liability self-insured claims, as mentioned above in Self-Insured Risks (amounts in thousands):

 

     Year Ended
December 31, 2008
    Year Ended
December 31, 2007
 

All Acute Care Hospitals

   Amount    % of
Revenues
    Amount    % of
Revenues
 

Net revenues

   $ 3,669,504    100.0 %   $ 3,410,368    100.0 %

Operating charges:

          

Salaries, wages and benefits

     1,413,963    38.5 %     1,336,970    39.2 %

Other operating expenses

     707,758    19.3 %     634,142    18.6 %

Supplies expense

     613,944    16.7 %     589,911    17.3 %

Provision for doubtful accounts

     443,289    12.1 %     381,718    11.2 %

Depreciation and amortization

     153,744    4.2 %     146,924    4.3 %

Lease and rental expense

     49,383    1.3 %     47,368    1.4 %
                          
     3,382,081    92.2 %     3,137,033    92.0 %
                          

Income before interest expense, minority interests and income taxes

     287,423    7.8 %     273,335    8.0 %

Interest expense, net

     4,361    0.1 %     3,757    0.1 %

Minority interests in earnings of consolidated entities

     38,827    1.0 %     40,239    1.2 %
                          

Income before income taxes

   $ 244,235    6.7 %   $ 229,339    6.7 %
                          

 

During 2008, as compared to 2007, net revenues at our acute care hospitals increased 8% or $259 million to $3.67 billion. The increase in net revenues was attributable to:

 

   

a $163 million increase at same facility revenues, as discussed above;

 

   

$93 million of revenues generated at Centennial Hills Hospital, and;

 

   

a net increase of $3 million resulting from other combined revenue changes.

 

Income before income taxes increased $15 million to $244 million or 6.7% of net revenues during 2008 as compared to $229 million or 6.7% of net revenues during 2007. The increase in income before income taxes at our acute care facilities resulted from:

 

   

a $50 million increase at our acute care facilities on a same facility basis, as discussed above;

 

   

a decrease of $25 million resulting from the provision for settlement recorded during 2008 to establish a reserve in connection with the government’s investigation of our South Texas Health System affiliates, as discussed in Item 3. Legal Proceedings;

 

   

a decrease of $14 million (after minority interest) resulting from the favorable pre-tax effect recorded during 2007 to our prior year reserves for professional and general liability self-insured claims attributable to our acute care facilities, as discussed above in Self-Insured Risks, and;

 

   

$4 million of other combined net increases.

 

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Year Ended December 31, 2007 as compared to the Year Ended December 31, 2006:

 

The following table summarizes the results of operations for our acute care facilities on a same facility basis and is used in the discussions below for the years ended December 31, 2007 and 2006 (dollar amounts in thousands):

 

     Year Ended
December 31, 2007
    Year Ended
December 31, 2006
 

Acute Care Hospitals—Same Facility Basis

   Amount    % of
Revenues
    Amount    % of
Revenues
 

Net revenues

   $ 3,261,872    100.0 %   $ 3,023,917    100.0 %

Operating charges:

          

Salaries, wages and benefits

     1,261,043    38.6 %     1,160,446    38.4 %

Other operating expenses

     615,109    18.9 %     653,968    21.6 %

Supplies expense

     566,474    17.4 %     478,270    15.8 %

Provision for doubtful accounts

     364,254    11.2 %     322,292    10.7 %

Depreciation and amortization

     142,238    4.4 %     131,616    4.4 %

Lease and rental expense

     44,498    1.4 %     42,742    1.4 %
                          
     2,993,616    91.8 %     2,789,334    92.2 %
                          

Income before interest expense, hurricane insurance recoveries in excess of expenses, minority interests and income taxes

     268,256    8.2 %     234,583    7.8 %

Interest expense, net

     3,458    0.1 %     1,619    0.1 %

Minority interests in earnings of consolidated entities

     40,005    1.2 %     34,316    1.1 %
                          

Income before income taxes

   $ 224,793    6.9 %   $ 198,648    6.6 %
                          

 

On a same facility basis during 2007, as compared to 2006, net revenues at our acute care hospitals increased $238 million or 8%. Income before income taxes increased $26 million or 13% to $225 million or 6.9% of net revenues during 2007 as compared to $199 million or 6.6% of net revenues during 2006.

 

Inpatient admissions to these facilities increased 2.6% during 2007, as compared to 2006, while patient days increased 2.4%. The average length of patient stay at these facilities was 4.4 days in each of the years 2007 and 2006. The occupancy rate, based on the average available beds at these facilities, was 63% during each of 2007 and 2006.

 

Our same facility net revenues were favorably impacted by an increase in prices charged to private payors including health maintenance organizations and preferred provider organizations. On a same facility basis, net revenue per adjusted admission (adjusted for outpatient activity) at these facilities increased 3.1% during 2007, as compared to 2006, and net revenue per adjusted patient day increased 3.3% during 2007, as compared to 2006.

 

The pharmacy services for our acute care facilities were brought in-house from an outsourced vendor effective July 1, 2006. As a result of this change, during the period of January through June of 2007, our acute care facilities experienced an increase to supplies expense of approximately $56 million, an increase to salaries, wages and benefits expense of approximately $22 million and a decrease to other operating expenses of approximately $82 million. The transition of our pharmacy services favorably impacted the pre-tax income of our acute care facilities by approximately $4 million during 2007. As a percentage of our 2007 same facility acute care net revenues, as shown above, the transition of the pharmacy services increased supplies expense by 170 basis points, increased salaries, wages and benefits expense by 70 basis points and decreased other operating expenses by 250 basis points. Since this transition occurred on July 1st of 2006, the same facility acute care financial statements for the six month periods of July 1st through December 31st of 2007 and 2006 were comparably stated.

 

We provide care to patients who meet certain financial or economic criteria without charge or at amounts substantially less than our established rates. Because we do not pursue collection of amounts determined to

 

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qualify as charity care, they are not reported in net revenues or in accounts receivable, net. Our acute care hospitals provided charity care and uninsured discounts, based on charges at established rates, amounting to (includes data for an acute care facility reflected as discontinued operations) $562 million during 2007 and $443 million during 2006.

 

The following table summarizes the results of operations for all our acute care operations during 2007 and 2006. Included in these results, in addition to the same facility results shown above, are: (i) the financial results for the Texoma Healthcare System that was acquired on January 1, 2007; (ii) the prior period effect of a favorable adjustment recorded during 2007 to reduce our reserves for professional and general liability self-insured claims (as discussed above); (iii) the net hurricane related expenses and insurance recoveries; (iv) the prior year portion of recording or reserving of Medicaid supplemental payments and cost reports settlements, and; (v) the write-down of the carrying-value of an investment in a joint-venture (dollar amounts in thousands).

 

     Year Ended
December 31, 2007
    Year Ended
December 31, 2006
 

All Acute Care Hospitals

   Amount    % of
Revenues
    Amount     % of
Revenues
 

Net revenues

   $ 3,410,368    100.0 %   $ 3,039,775     100.0 %

Operating charges:

         

Salaries, wages and benefits

     1,336,970    39.2 %     1,160,446     38.2 %

Other operating expenses

     634,142    18.6 %     663,996     21.8 %

Supplies expense

     589,912    17.3 %     478,270     15.7 %

Provision for doubtful accounts

     381,718    11.2 %     322,292     10.6 %

Depreciation and amortization

     146,924    4.3 %     131,616     4.3 %

Lease and rental expense

     47,368    1.4 %     42,781     1.4 %
                           
     3,137,034    92.0 %     2,799,401     92.1 %
                           

Income before interest expense, hurricane insurance recoveries in excess of expenses, minority interests and income taxes

     273,334    8.0 %     240,374     7.9 %

Interest expense, net

     3,757    0.1 %     1,619     0.1 %

Hurricane recoveries in excess of expenses

     —      —         (770 )   0.0 %

Minority interests in earnings of consolidated entities

     40,239    1.2 %     34,316     1.1 %
                           

Income before income taxes

   $ 229,338    6.7 %   $ 205,209     6.8 %
                           

 

During 2007, as compared to 2006, net revenues at our acute care hospitals increased 12% or $371 million to $3.41 billion. The increase in net revenues was attributable to:

 

   

a $238 million increase at same facility revenues, as discussed above;

 

   

$157 million of revenues generated during 2007 by the Texoma Healthcare System, and;

 

   

a $24 million net decrease in revenues resulting from the recording of various retroactive portions of supplemental Medicaid reimbursements (occurred during 2006) or related reserves (occurred during 2007) and settlement of prior year Medicare cost reports (occurred during 2006).

 

Income before income taxes increased $24 million to $229 million or 6.7% of net revenues during 2007 as compared to $205 million or 6.8% of net revenues during 2006. The increase in income before income taxes at our acute care facilities resulted from:

 

   

a $26 million increase at our acute care facilities on a same facility basis, as discussed above;

 

   

an increase of $14 million (after minority interest) representing the portion of the reduction recorded during 2007 to our prior year reserves for professional and general liability self-insured claims attributable to our acute care facilities, as discussed above in Self-Insured Risks;

 

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a $24 million net decrease resulting from the unfavorable changes resulting from the recording of various retroactive portions of supplemental Medicaid reimbursements (occurred during 2006) or related reserves (occurred during 2007) and settlement of prior year Medicare cost reports (occurred during 2006);

 

   

a $3 million decrease due to the write-down of the carrying-value of an investment in a joint-venture during 2007,

 

   

a $10 million increase due to 2006 including a $10 million provision recorded in connection with a wage and hour lawsuit in California, and;

 

   

$1 million of other combined favorable changes including the pre-tax income generated during 2007 by the Texoma Healthcare System and the pre-opening losses sustained at our newly constructed Centennial Hills Hospital Medical Center that was completed and opened during the first quarter of 2008.

 

Behavioral Health Care Services

 

Year Ended December 31, 2008 as compared to the Year Ended December 31, 2007:

 

The following table summarizes the results of operations for our behavioral health care facilities, on a same facility basis, and is used in the discussions below for the years ended December 31, 2008 and 2007 (dollar amounts in thousands):

 

     Year Ended
December 31, 2008
    Year Ended
December 31, 2007
 

Behavioral Health Care Facilities—Same Facility Basis

   Amount    % of
Revenues
    Amount    % of
Revenues
 

Net revenues

   $ 1,225,948    100.0 %   $ 1,139,634    100.0 %

Operating charges:

          

Salaries, wages and benefits

     603,227    49.2 %     565,901    49.7 %

Other operating expenses

     227,113    18.5 %     213,224    18.7 %

Supplies expense

     70,926    5.8 %     66,973    5.9 %

Provision for doubtful accounts

     32,014    2.6 %     27,955    2.5 %

Depreciation and amortization

     28,610    2.3 %     27,650    2.4 %

Lease and rental expense

     16,218    1.3 %     16,204    1.4 %
                          
     978,108    79.8 %     917,907    80.6 %
                          

Income before interest expense, minority interests and income taxes

     247,840    20.2 %     221,727    19.4 %

Interest expense, net

     277    0.0 %     335    0.0 %

Minority interests in earnings of consolidated entities

     —      —         361    0.0 %
                          

Income before income taxes

   $ 247,563    20.2 %   $ 221,031    19.4 %
                          

 

On a same facility basis during 2008, as compared to 2007, net revenues at our behavioral health care facilities increased 8% or $86 million to $1.23 billion during 2008 as compared to $1.14 billion during 2007. Income before income taxes increased $27 million or 12% to $248 million or 20.2% of net revenues during 2008 as compared to $221 million or 19.4% of net revenues during 2007.

 

Inpatient admissions at these facilities increased 6.4% during 2008, as compared to 2007 while patient days increased 3.2%. The average length of patient stay at these facilities was 16.0 days during 2008 and 16.5 days during 2007. The occupancy rate, based on the average available beds at these facilities, was 75% during each of 2008 and 2007.

 

On a same facility basis, net revenue per adjusted admission at these facilities increased 1.4% during 2008, as compared to 2007, and net revenue per adjusted patient day increased 4.5% during 2008, as compared to 2007.

 

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The following table summarizes the results of operations for all our behavioral health care facilities for 2008 and 2007, including newly acquired or recently opened facilities (amounts in thousands):

 

     Year Ended
December 31, 2008
    Year Ended
December 31, 2007
 

All Behavioral Health Care Facilities

   Amount    % of
Revenues
    Amount     % of
Revenues
 

Net revenues

   $ 1,251,116    100.0 %   $ 1,146,078     100.0 %

Operating charges:

         

Salaries, wages and benefits

     619,484    49.5 %     572,279     49.9 %

Other operating expenses

     234,908    18.8 %     215,365     18.8 %

Supplies expense

     72,768    5.8 %     67,514     5.9 %

Provision for doubtful accounts

     32,688    2.6 %     27,907     2.4 %

Depreciation and amortization

     29,796    2.4 %     27,807     2.4 %

Lease and rental expense

     16,654    1.3 %     16,531     1.4 %
                           
     1,006,298    80.4 %     927,403     80.9 %
                           

Income before interest expense, minority interests and income taxes

     244,818    19.6 %     218,675     19.1 %

Interest expense, net

     293    0.1 %     411     0.0 %

Minority interests in losses of consolidated entities

     —      —         (1,627 )   (0.1 %)
                           

Income before income taxes

   $ 244,525    19.5 %   $ 219,891     19.2 %
                           

 

During 2008, as compared to 2007, net revenues at our behavioral health care facilities (including newly acquired and recently opened facilities), increased 9% or $105 million to $1.25 billion during 2008 as compared to $1.15 billion during 2007. The increase in net revenues was attributable to:

 

   

a $86 million increase in same facility revenues, as discussed above, and;

 

   

$19 million of revenues generated at facilities recently acquired or opened.

 

Income before income taxes increased $25 million or 11% to $245 million or 19.5% of net revenues during 2008, as compared to $220 million or 19.2% of net revenues during 2007. The increase in income before income taxes at our behavioral health facilities was attributable to:

 

   

a $27 million increase at our behavioral health facilities on a same facility basis, as discussed above;

 

   

a decrease of $2 million resulting from the favorable pre-tax effect recorded during 2007 from the reduction to our prior year reserves for professional and general liability self-insured claims attributable to our behavioral health care facilities, as discussed above in Self-Insured Risks, and;

 

   

a $4 million decrease resulting primarily from the aggregate net loss, net of aggregate income, incurred at facilities acquired or opened during 2008 and 2007.

 

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Year Ended December 31, 2007 as compared to the Year Ended December 31, 2006:

 

The following table summarizes the results of operations for our behavioral health care facilities, on a same facility basis, and is used in the discussions below for the years ended December 31, 2007 and 2006 (dollar amounts in thousands):

 

     Year Ended
December 31, 2007
    Year Ended
December 31, 2006
 

Behavioral Health Care Facilities—Same Facility Basis

   Amount     % of
Revenues
    Amount     % of
Revenues
 

Net revenues

   $ 1,105,011     100.0 %   $ 1,028,776     100.0 %

Operating charges:

        

Salaries, wages and benefits

     546,567     49.5 %     513,325     49.9 %

Other operating expenses

     206,013     18.6 %     192,559     18.7 %

Supplies expense

     64,025     5.8 %     60,819     5.9 %

Provision for doubtful accounts

     27,372     2.5 %     20,507     2.0 %

Depreciation and amortization

     25,189     2.3 %     22,126     2.2 %

Lease and rental expense

     16,166     1.5 %     16,218     1.6 %
                            
     885,332     80.1 %     825,554     80.2 %
                            

Income before interest expense, minority interests and income taxes

     219,679     19.9 %     203,222     19.8 %

Interest expense, net

     232     0.0 %     274     0.0 %

Minority interests in earnings (losses) of consolidated entities

     (1,627 )   (0.1 %)     (949 )   (0.0 %)
                            

Income before income taxes

   $ 221,074     20.0 %   $ 203,897     19.8 %
                            

 

On a same facility basis during 2007, as compared to 2006, net revenues at our behavioral health care facilities increased 7% or $76 million to $1.11 billion during 2007 as compared to $1.03 billion during 2006. Income before income taxes increased $17 million or 8% to $221 million or 20.0% of net revenues during 2007 as compared to $204 million or 19.8% of net revenues during 2006.

 

Inpatient admissions and patient days at these facilities each increased 4.3% during 2007, as compared to 2006. The average length of patient stay at these facilities was 16.7 days during each of 2007 and 2006. The occupancy rate, based on the average available beds at these facilities, was 77% and 78% during 2007 and 2006.

 

On a same facility basis, net revenue per adjusted admission at these facilities increased 3.2% during 2007, as compared to 2006, and net revenue per adjusted patient day increased 3.1% during 2007, as compared to 2006. The increase in net revenues at our behavioral health care facilities during 2007, as compared to 2006, partially resulted from a scheduled increase in the Medicare prospective payment system rates.

 

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The following table summarizes the results of operations for all our behavioral health care facilities for 2007 and 2006, including newly acquired facilities (amounts in thousands):

 

     Year Ended
December 31, 2007
    Year Ended
December 31, 2006
 

All Behavioral Health Care Facilities

   Amount     % of
Revenues
    Amount     % of
Revenues
 

Net revenues

   $ 1,146,078     100.0 %   $ 1,028,967     100.0 %

Operating charges:

        

Salaries, wages and benefits

     572,279     49.9 %     513,979     49.9 %

Other operating expenses

     215,365     18.8 %     193,397     18.8 %

Supplies expense

     67,514     5.9 %     61,027     5.9 %

Provision for doubtful accounts

     27,907     2.4 %     20,507     2.0 %

Depreciation and amortization

     27,807     2.4 %     22,154     2.2 %

Lease and rental expense

     16,531     1.4 %     16,240     1.6 %
                            
     927,403     80.9 %     827,304     80.4 %
                            

Income before interest expense, minority interests and income taxes

     218,675     19.1 %     201,663     19.6 %

Interest expense, net

     411     0.0 %     274     0.0 %

Minority interests in earnings (losses) of consolidated entities

     (1,627 )   (0.1 %)     (949 )   (0.1 %)
                            

Income before income taxes

   $ 219,891     19.2 %   $ 202,338     19.7 %
                            

 

During 2007, as compared to 2006, net revenues at our behavioral health care facilities (including newly acquired facilities), increased 11% or $117 million to $1.15 billion during 2007 as compared to $1.03 billion during 2006. The increase in net revenues was attributable to:

 

   

a $76 million increase in same facility revenues, as discussed above, and;

 

   

$41 million of revenues generated at facilities acquired and/or opened during 2007 and 2006.

 

Income before income taxes increased $18 million or 9% to $220 million or 19.2% of net revenues during 2007, as compared to $202 million or 19.7% of net revenues during 2006. The increase in income before income taxes at our behavioral health facilities was attributable to:

 

   

a $17 million increase at our behavioral health facilities owned for more than a year, as discussed above;

 

   

a $2 million increase representing the portion of the reduction recorded during 2007 to our prior year reserves for professional and general liability self-insured claims attributable to our behavioral health care facilities, as discussed above in Self-Insured Risks, and;

 

   

a $1 million decrease resulting from the aggregate net loss (net of aggregate income) generated at facilities acquired and/or opened during 2007 and 2006.

 

Sources of Revenue

 

Overview:    We receive payments for services rendered from private insurers, including managed care plans, the federal government under the Medicare program, state governments under their respective Medicaid programs and directly from patients.

 

Hospital revenues depend upon inpatient occupancy levels, the medical and ancillary services and therapy programs ordered by physicians and provided to patients, the volume of outpatient procedures and the charges or negotiated payment rates for such services. Charges and reimbursement rates for inpatient routine services vary depending on the type of services provided (e.g., medical/surgical, intensive care or behavioral health) and the geographic location of the hospital. Inpatient occupancy levels fluctuate for various reasons, many of which are beyond our control. The percentage of patient service revenue attributable to outpatient services has generally increased in recent years, primarily as a result of advances in medical technology that allow more services to be provided on an outpatient basis, as well as increased pressure from Medicare, Medicaid and private insurers to

 

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reduce hospital stays and provide services, where possible, on a less expensive outpatient basis. We believe that our experience with respect to our increased outpatient levels mirrors the general trend occurring in the health care industry and we are unable to predict the rate of growth and resulting impact on our future revenues.

 

Patients are generally not responsible for any difference between customary hospital charges and amounts reimbursed for such services under Medicare, Medicaid, some private insurance plans, and managed care plans, but are responsible for services not covered by such plans, exclusions, deductibles or co-insurance features of their coverage. The amount of such exclusions, deductibles and co-insurance has generally been increasing each year. Indications from recent federal and state legislation are that this trend will continue. Collection of amounts due from individuals is typically more difficult than from governmental or business payers and we continue to experience an increase in uninsured and self-pay patients which unfavorably impacts the collectibility of our patient accounts thereby increasing our provision for doubtful accounts and charity care provided.

 

The significant portion of our revenues derived from these facilities makes us particularly sensitive to regulatory, economic, environmental and competition changes in Texas and Nevada. Any material change in the current payment programs or regulatory, economic, environmental or competitive conditions in these states could have a disproportionate effect on our overall business results.

 

The following tables show the approximate percentages of net patient revenue during the past three years (excludes sources of revenues for all periods presented for divested facilities which are reflected as discontinued operations in our Consolidated Financial Statements) for: (i) our Acute Care and Behavioral Health Care Facilities Combined; (ii) our Acute Care Facilities, and; (iii) our Behavioral Health Care Facilities. Net patient revenue is defined as revenue from all sources after deducting contractual allowances and discounts from established billing rates, which we derived from various sources of payment for the years indicated.

 

     Percentage of Net
Patient Revenues
 

Acute Care and Behavioral Health Care Facilities Combined

   2008     2007     2006  

Third Party Payors:

      

Medicare

   24 %   24 %   25 %

Medicaid

   12 %   13 %   13 %

Managed Care (HMO and PPOs)

   46 %   44 %   41 %

Other Sources

   18 %   19 %   21 %
                  

Total

   100 %   100 %   100 %
                  

 

     Percentage of Net
Patient Revenues
 

Acute Care Facilities

   2008     2007     2006  

Third Party Payors:

      

Medicare

   27 %   27 %   29 %

Medicaid

   9 %   9 %   10 %

Managed Care (HMO and PPOs)

   47 %   46 %   41 %

Other Sources

   17 %   18 %   20 %
                  

Total

   100 %   100 %   100 %
                  

 

     Percentage of Net
Patient Revenues
 

Behavioral Health Care Facilities

   2008     2007     2006  

Third Party Payors:

      

Medicare

   16 %   15 %   15 %

Medicaid

   22 %   26 %   25 %

Managed Care (HMO and PPOs)

   42 %   41 %   43 %

Other Sources

   20 %   18 %   17 %
                  

Total

   100 %   100 %   100 %
                  

 

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Medicare:    Medicare is a federal program that provides certain hospital and medical insurance benefits to persons aged 65 and over, some disabled persons and persons with end-stage renal disease. All of our acute care hospitals and many of our behavioral health centers are certified as providers of Medicare services by the appropriate governmental authorities.

 

Amounts received under the Medicare program are generally significantly less than a hospital’s customary charges for services provided. Since a substantial portion of our revenues will come from patients under the Medicare program, our ability to operate our business successfully in the future will depend in large measure on our ability to adapt to changes in this program.

 

Under the Medicare program, for inpatient services, our general acute care hospitals receive reimbursement under the inpatient prospective payment system (“IPPS”). Under the IPPS, hospitals are paid a predetermined fixed payment amount for each hospital discharge. The fixed payment amount is based upon each patient’s diagnosis related group (“DRG”). Every DRG is assigned a payment rate based upon the estimated intensity of hospital resources necessary to treat the average patient with that particular diagnosis. The DRG payment rates are based upon historical national average costs and do not consider the actual costs incurred by a hospital in providing care. This DRG assignment also affects the predetermined capital rate paid with each DRG. The DRG and capital payment rates are adjusted annually by the predetermined geographic adjustment factor for the geographic region in which a particular hospital is located and are weighted based upon a statistically normal distribution of severity. While we generally will not receive payment from Medicare for inpatient services, other than the DRG payment, a hospital may qualify for an “outlier” payment if a particular patient’s treatment costs are extraordinarily high and exceed a specified threshold.

 

DRG rates are adjusted by an update factor each federal fiscal year, which begins on October 1. The index used to adjust the DRG rates, known as the “hospital market basket index,” gives consideration to the inflation experienced by hospitals in purchasing goods and services. Generally, however, the percentage increases in the DRG payments have been lower than the projected increase in the cost of goods and services purchased by hospitals. For federal fiscal years 2008, 2007 and 2006, the update factors were 3.3%, 3.4% and 3.7%, respectively. For 2009, the update factor is 3.6%. Hospitals are allowed to receive the full basket update if they provide the Centers for Medicare and Medicaid Services (“CMS”) with specific data relating to the quality of services provided. We have complied fully with this requirement and intend to comply fully in future periods.

 

In August 2006, CMS finalized new provisions for the hospital IPPS for the upcoming federal fiscal year, which included a significant change in the manner in which it determines the underlying relative weights used to calculate the DRG payment amount. For federal fiscal year 2007, CMS began to phase-in the use of hospital costs rather than hospital charges for the DRG relative weight determination. This change is to phase-in ratably over three years with full phase-in to be completed in federal fiscal year 2009.

 

On August 1, 2007, CMS issued a final rule revising Medicare payment and policy under the hospital IPPS for federal fiscal year 2008. These changes, which were first proposed in April 2007, will restructure the inpatient DRGs to account more fully for the severity of patient illness. Specifically, the final rule creates 745 new severity-adjusted DRGs to replace the current 538 DRGs. As a result, payments are expected to increase for hospitals serving more severely ill patients and decrease for those serving patients who are less severely ill. The new severity-adjusted DRGs were phased in over two years starting October 1, 2007 and will be fully phased during the federal fiscal year ending September 30, 2009. The new severity adjusted DRGs have resulted in an approximate 2 percent increase in to our inpatient Medicare DRG reimbursement as compared to the prior DRG system.

 

The August, 2007 final rule also includes important provisions to ensure that Medicare no longer pays for the additional costs of certain preventable conditions (including certain infections) acquired in the hospital. The reporting of hospital acquired conditions, also referred to as Present on Admission (POA) codes, became effective on October 1, 2007. Further, CMS implemented Medicare DRG payment reductions for certain

 

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preventable conditions beginning on October 1, 2008. We do not expect this payment change for preventable conditions to have a material impact on our results of operations. In addition, the rule expanded the list of publicly reported quality measures that hospitals would need to report in calendar year 2008 in order to qualify for the full market basket update in federal fiscal year 2009 and reduces Medicare’s payment when a hospital replaces a device that is supplied to the hospital at no or reduced cost.

 

In September, 2007, the “TMA, Abstinence Education, and QI Programs Extension Act of 2007” legislation took effect and will scale back cuts in hospital reimbursement that CMS was set to impose under the final rule for the Inpatient Prospective Payment System (“IPPS”) for federal fiscal year 2008. CMS planned on reducing the standardized amount by 1.2% in 2008 and 1.8% in 2009 to account for expected changes in coding practices by hospitals in response to the CMS implementation of the new Medicare-Severity Diagnosis Related Group system for inpatient hospitals. The new law cuts these reductions by 0.6% in 2008 and 0.9% in 2009. In federal fiscal years 2010 to 2012, the new law also requires CMS to make an adjustment to the Medicare standardized amount in these years to reflect the removal of actual aggregate payment increases or decreases for documentation and coding adjustments that occurred during federal fiscal years 2008 and 2009 as compared to the initial CMS estimates of the MS-DRG coding and documentation change impact of 0.6% and 0.9%, respectively. We are unable to predict the impact of this CMS adjustment on the revenues and operating results of our acute care hospitals.

 

In July, 2008, CMS published the final IPPS 2009 payment rule which provides for a 3.6% market basket increase to the base Medicare DRG blended rate. When statutorily mandated budget neutrality factors and annual geographic wage index updates are considered, we estimate our overall increase from the final rule in federal fiscal year 2009 will approximate 3.7% to 4.2%.

 

Outpatient services were traditionally paid at the lower of customary charges or on a reasonable cost basis. The Balanced Budget Act of 1997 established the outpatient prospective payment system for outpatient hospital services provided on or after August 1, 2000 (“OPPS”). Under the OPPS, CMS pays for hospital outpatient services on a rate-per-service basis that varies according to the ambulatory payment classification (“APC”) group to which the service is assigned. The OPPS rate is an unadjusted national payment amount that includes the Medicare payment and the beneficiary co-payment. Special payments under the OPPS may be made for certain new technology items and services through transitional pass-through payments and special reimbursement rates.

 

On November 1, 2007, CMS released a final rule with comment period updating the hospital OPPS. The rule is effective for those services furnished in calendar year 2008, by general acute care hospitals, inpatient rehabilitation facilities, inpatient psychiatric facilities and long-term acute care hospitals. CMS estimates that hospitals will receive an overall average increase of 3.8 percent in Medicare payments for outpatient services in 2008, after accounting for the annual market basket update and other factors that typically affect the level of payments. Changes in the final rule including providing larger payment bundles for certain OPPS services which will, in CMS’s estimation, provide hospitals with more flexibility in managing their resources. The rule also updates the payment rates for the revised ambulatory surgical center payment system, beginning in 2008.

 

We operate inpatient rehabilitation hospital units that treat Medicare patients with specific medical conditions which are excluded from the Medicare IPPS DRG payment methodology. Inpatient rehabilitation facilities (“IRFs”) must meet a certain volume threshold each year for the number patients with these specific medical conditions, often referred to as the “75 Percent Rule.” The Medicare, Medicaid and SCHIP Extension Act of 2007 (“MMSEA”) included a favorable permanent decrease of the IRF “75 Percent Rule” qualifying threshold to 60% from the current threshold of 65%. Medicare payment for IRF patients is based on a prospective case rate based on a CMS determined Case-Mix Group classification and is updated annually by CMS. The MMSEA includes provisions that provide IRF’s with a zero percent increase in Medicare rates for federal fiscal year 2009.

 

Psychiatric hospitals have also traditionally been excluded from the IPPS. However, on January 1, 2005, CMS implemented a new PPS (“Psych PPS”) for inpatient services furnished by psychiatric hospitals under the

 

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Medicare program. This system replaced the cost-based reimbursement guidelines with a per diem Psych PPS with adjustments to account for certain facility and patient characteristics. The Psych PPS also contained provisions for outlier payments and an adjustment to a psychiatric hospital’s base payment if it maintains a full-service emergency department. The new system was phased-in over a three-year period and was fully implemented for our behavioral health facilities by June 30, 2008. Also, CMS has included a stop-loss provision to ensure that hospitals avoid significant losses during the transition. In May 2006, CMS published its annual increase to the federal component of the Psych PPS per diem rate. This increase includes the effects of market basket updates resulting in a 4.5% increase in total payments for Rate Year 2007, covering the period of July 1, 2006 to June 30, 2007. The market basket was increased by 3.2% for the period of July 1, 2007 through June 30, 2008. In addition, according to the May, 2008 CMS notice, the market basked increase is 3.2% for the period of July 1, 2008 through June 30, 2009.

 

Medicaid:    Medicaid is a joint federal-state funded health care benefit program that is administered by the states to provide benefits to qualifying individuals who are unable to afford care. Most state Medicaid payments are made under a PPS-like system, or under programs that negotiate payment levels with individual hospitals. Amounts received under the Medicaid program are generally significantly less than a hospital’s customary charges for services provided. In addition to revenues received pursuant to the Medicare program, we receive a large portion of our revenues either directly from Medicaid programs or from managed care companies managing Medicaid. All of our acute care hospitals and most of our behavioral health centers are certified as providers of Medicaid services by the appropriate governmental authorities.

 

We receive a large concentration of our Medicaid revenues from Texas and significant amounts from Nevada, Florida, California, Washington, DC and Illinois. These states, as well as most other states in which we operate, have reported significant budget deficits that, for all except Texas at this time, have resulted in the reduction of Medicaid funding for 2009. We can provide no assurance that reductions to Medicaid revenues, particularly in the above-mentioned states, will not have a material adverse effect on our future results of operations. Furthermore, many states are currently working to effectuate further significant reductions in the level of Medicaid funding due to significant state budget deficits also projected for 2010, which could adversely affect future levels of Medicaid reimbursement received by our hospitals. Conversely, on February 17, 2009, the American Recovery and Reinvestment Act of 2009 was signed into law and contained various Medicaid provisions that will impact our hospitals including the following: (i) temporary increases to Medicaid funding through enhanced federal matching assistance percentages (“FMAPs”) for a 27 month period retroactive to October 1, 2008 through December 31, 2010 with all states receiving a FMAP increase of 6.2% and also receiving a bonus FMAP increase contingent on the increased level of a state’s unemployment rate; (ii) a temporary increase of 2.5% in the federal Medicaid disproportionate share hospital allotment for both federal fiscal years 2009 and 2010, and; (iii) states will be required to maintain effort on Medicaid eligibility consistent with requirements prior to passage of this law. Due to the indirect nature of the enhanced Medicaid federal funding contained within the American Recovery and Reinvestment Act of 2009, we are unable to determine the impact of these Medicaid changes on our future results of operations.

 

In February, 2005, a Texas Medicaid State Plan Amendment went into effect for Potter County that expands the supplemental inpatient reimbursement methodology for the state’s Medicaid program. This state plan amendment was approved retroactively to March, 2004. In connection with this program, we earned revenues of $21 million during 2008, $21 million during 2007 and $22 million during 2006. At this time, the local hospital district in Potter County continues to fund the program’s inter-governmental transfers (“IGTs”). The failure of the hospital district to make future IGTs at a level consistent with 2008 levels will reduce revenues in connection with this program to approximately $8 million during 2009. If during 2009 the hospital district makes IGTs consistent with 2008, we believe we would be entitled to revenues of approximately $18 million during 2009.

 

In July, 2006, CMS retroactively approved to June 11, 2005, an amendment to the Texas Medicaid State Plan which permits the state of Texas to make supplemental payments to certain hospitals located in Hidalgo, Maverick and Webb counties. Our four acute care hospital facilities located in these counties are eligible to receive these

 

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supplemental Medicaid payments. This program was subject to final state rule making procedures and the local governmental agencies providing the necessary funds on an ongoing basis through inter-governmental transfers to the state of Texas. In connection with this program, we earned revenues of $9 million during 2008, $11 million during 2007 (before $9 million reduction recorded during 2007 to establish a reserve for the 2006 and 2005 supplemental payments, as discussed below) and $13 million during 2006. At this time, we believe we will be entitled to revenues of approximately $9 million during 2009 in connection with this program.

 

As part of the CMS routine retroactive review of a new Texas Medicaid state plan amendment (“SPA”) that pertains to the Medicaid supplemental payment programs for Hidalgo and Webb counties, CMS previously indicated that certain IGTs related to this retroactive SPA approval may have been ineligible for federal matching dollars which were used to fund the programs. In the anticipation of a possible CMS retroactive IGT ineligibility determination, we recorded a charge of $9 million during 2007 to establish a reserve for potential CMS action related to these Medicaid supplemental payments applicable to state fiscal years 2005 and 2006. In April, 2008, we received notification that the $9 million of retroactive Medicaid supplemental payment were deemed ineligible for federal matching dollars. These funds will be recouped by the Texas Health and Human Services Commission (“THHSC”) as an offset to future IGTs during state fiscal year 2009.

 

In October, 2007, we were notified by the THHSC that CMS deferred approximately 25% of the federal financial participation (“FFP”) on Medicaid supplemental payments made to private hospitals during the second calendar quarter of 2007 pursuant to two SPAs approved by CMS in July and September of 2006. This deferral applies to our acute care hospitals that operate in Hildalgo, Maverick and Webb counties. In April, 2008, we received notification from THHSC that a settlement agreement has been reached with CMS and that both CMS and THHSC intend to remove the supplemental payment deferral status. THHSC has resumed its distribution of supplemental payments in August, 2008 at levels consistent with pre-deferral amounts. We estimate that our hospitals in these counties will be entitled to supplemental payment reimbursements of approximately $7 million annually.

 

In September 2005, legislation in Texas went into effect that ensures that some form of Medicaid managed care will exist in every Texas county. In addition, the Texas STAR+PLUS program, which provides an integrated acute and long-term care Medicaid managed care delivery system to elderly and disabled Medicaid beneficiaries in the Harris County service area will be expanded to seven additional service areas. Such actions could have a material unfavorable impact on the reimbursement our Texas hospitals receive.

 

We operate two freestanding psychiatric hospitals in the Dallas, Texas region that operated under the Lone Star Select II prospective per diem payment program. We were notified by the Commission that this per diem payment program terminated on August 31, 2006. These affected facilities were paid on a TEFRA cost based payment system for September and October of 2006. Effective November 1, 2006, the Commission’s payment for these hospitals is based on a prospective per diem rate based on a prior year cost report.

 

As directed by Texas Senate Bill 10, the HHSC is currently drafting a Medicaid Reform Waiver (“Waiver”) proposal that would create a newly established Healthcare Opportunity Pool that requires CMS’s approval prior to implementation. The overall Waiver program design will be budget neutral on a statewide basis but individual hospitals, including those owned and operated by us, could be either favorably or adversely impacted. Although, at this time, we are unable to estimate the impact of the Waiver program on our future operating results, we can give no assurance that this Waiver program will not have a material adverse effect on our future results of operations. HHSC has yet to receive CMS’s approval for this waiver and it’s uncertain as to when, or if, this Waiver program will be implemented by HHSC.

 

Managed Care:    A significant portion of our net patient revenues are generated from managed care companies, which include health maintenance organizations, preferred provider organizations and managed Medicare (referred to as Medicare Part C or Medicare Advantage) and Medicaid programs. In general, we expect the percentage of our business from managed care programs to continue to grow. The consequent growth in managed care networks and the resulting impact of these networks on the operating results of our facilities vary

 

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among the markets in which we operate. Typically, we receive lower payments per patient from managed care payors than we do from traditional indemnity insurers, however, during the past few years we have secured price increases from many of our commercial payors including managed care companies.

 

Tricare:    In April, 2008, the Department of Defense (“DoD”) issued a proposed rule that would change the payment methodology for outpatient services that, if enacted, could significantly decrease payment for these services. In December, 2008, the DoD issued a final rule that basically adopted the current Medicare payment Outpatient Prospective Payment System for services provided to Tricare outpatients with a limited phase-in for certain emergency and clinic services. Based upon our estimates, payments to us for these services could be reduced by as much as $4 million in 2009 and by $6 million annually in 2010 and thereafter. The effective date of this final rule is projected to be May, 2009.

 

Commercial Insurance:    Our hospitals also provide services to individuals covered by private health care insurance. Private insurance carriers typically make direct payments to hospitals or, in some cases, reimburse their policy holders, based upon the particular hospital’s established charges and the particular coverage provided in the insurance policy. Private insurance reimbursement varies among payors and states and is generally based on contracts negotiated between the hospital and the payor.

 

Commercial insurers are continuing efforts to limit the payments for hospital services by adopting discounted payment mechanisms, including predetermined payment or DRG-based payment systems, for more inpatient and outpatient services. To the extent that such efforts are successful and reduce the insurers’ reimbursement to hospitals and the costs of providing services to their beneficiaries, such reduced levels of reimbursement may have a negative impact on the operating results of our hospitals.

 

As mentioned above, the American Recovery and Reinvestment Act of 2009 was signed into law in February, 2009. This law contains a federal health care provision that provides a 65% subsidy for COBRA continuation premiums for up to nine months for workers who have been involuntarily terminated, including their families. We are unable to determine the impact of this provision on our future results of operations.

 

Other Sources:    Our hospitals provide services to individuals that do not have any form of health care coverage. Such patients are evaluated, at the time of service or shortly thereafter, for their ability to pay based upon federal and state poverty guidelines, qualifications for Medicaid or other state assistance programs, as well as our local hospital’s indigent and charity care policy. Patients without health care coverage who do not qualify for Medicaid or indigent care write-offs are offered substantial discounts in an effort to settle their outstanding account balances. In addition, effective January 1, 2006, we implemented a formal uninsured discount policy for our acute care hospitals which had the effect of lowering both our provision for doubtful accounts and net revenues during 2006 and 2007 but did not materially impact net income in either year.

 

State Medicaid Disproportionate Share Hospital Payments:    Hospitals that have an unusually large number of low-income patients (i.e., those with a Medicaid utilization rate of at least one standard deviation above the mean Medicaid utilization, or having a low income patient utilization rate exceeding 25%) are eligible to receive a disproportionate share hospital (“DSH”) adjustment. Congress established a national limit on DSH adjustments. Although this legislation and the resulting state broad-based provider taxes have affected the payments we receive under the Medicaid program, to date the net impact has not been materially adverse.

 

Upon meeting certain conditions and serving a disproportionately high share of Texas’ and South Carolina’s low income patients, five of our facilities located in Texas and one facility located in South Carolina received additional reimbursement from each state’s DSH fund. The Texas and South Carolina programs have been renewed for each state’s 2009 fiscal years (covering the period of September 1, 2008 through August 31, 2009 for Texas and October 1, 2008 through September 30, 2009 for South Carolina). Included in our financial results was an aggregate of $42 million during 2008, $41 million during 2007 and $43 million during 2006. Failure to renew these DSH programs beyond their scheduled termination dates, failure of our hospitals that currently receive DSH payments to qualify for future DSH funds under these programs, or reductions in reimbursements, could have a material adverse effect on our future results of operations.

 

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In February 2003, the Office of the Inspector General of the Department of Health and Human Services published a report indicating that Texas Medicaid may have overpaid Texas hospitals for DSH payments. To date, no actions to follow up on this report have had any material impact on our Texas hospitals.

 

Sources of Revenues and Health Care Reform:    Given increasing budget deficits, the federal government and many states are currently considering additional ways to limit increases in levels of Medicare and Medicaid funding, which could also adversely affect future payments received by our hospitals. In addition, the uncertainty and fiscal pressures placed upon the federal government as a result of, among other things, the ongoing military engagement in Iraq, the War on Terrorism, economic recovery stimulus packages, responses to natural disasters, such as Hurricane Katrina, the continuing expansion of a Medicare drug benefit and the federal budget deficit in general may affect the availability of federal funds to provide additional relief in the future. We are unable to predict the effect of future policy changes on our operations.

 

In addition to statutory and regulatory changes to the Medicare and each of the state Medicaid programs, our operations and reimbursement may be affected by administrative rulings, new or novel interpretations and determinations of existing laws and regulations, post-payment audits, requirements for utilization review and new governmental funding restrictions, all of which may materially increase or decrease program payments as well as affect the cost of providing services and the timing of payments to our facilities. The final determination of amounts we receive under the Medicare and Medicaid programs often takes many years, because of audits by the program representatives, providers’ rights of appeal and the application of numerous technical reimbursement provisions. We believe that we have made adequate provisions for such potential adjustments. Nevertheless, until final adjustments are made, certain issues remain unresolved and previously determined allowances could become either inadequate or more than ultimately required.

 

Finally, we expect continued third-party efforts to aggressively manage reimbursement levels and cost controls. Reductions in reimbursement amounts received from third-party payors could have a material adverse effect on our financial position and our results of operations.

 

Other Operating Results

 

Combined net revenues from our surgical hospitals, ambulatory surgery centers and radiation oncology centers were $29 million during 2008 and $34 million in each of 2007 and 2006. In connection with construction management contracts pursuant to the terms of which we are building/have built newly constructed acute care hospitals for an unrelated third party, we earned revenues of $64 million during 2008, $83 million during 2007 and $13 million during 2006. Combined income before income taxes earned in connection with the revenues mentioned above was $11 million during 2008, $9 million during 2007 and $5 million during 2006.

 

Interest expense was $53 million during 2008, $52 million during 2007 and $33 million during 2006. In June, 2008, we issued an additional $150 million of senior notes (the “Notes”) which formed a single series with the original Notes issued in June, 2006 (see Note 4—Long Term Debt). Other than their date of issuance and initial price to the public, the terms of the Notes issued in June, 2008 are identical to, and trade interchangeably with, the Notes which were originally issued in June, 2006. The proceeds from this issuance were used to repay outstanding borrowings pursuant to our revolving credit agreement and accounts receivable securitization program. During 2008, as compared to the 2007, the combined average outstanding borrowings on the above-mentioned debt instruments increased $84 million. The increase in the combined average outstanding borrowings were offset by a decrease in the combined average annual interest rate of 0.9% during 2008 as compared to 2007. The $19 million increase in interest expense during 2007, as compared to 2006, was due primarily to a $345 million increase in our average outstanding borrowings under our revolving credit and demand notes and accounts receivable securitization program. For additional disclosure, see Note 4 to the Consolidated Financial Statements—Long Term Debt.

 

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Below is a schedule of our interest expense during 2008, 2007 and 2006 (amounts in thousands):

 

     2008     2007     2006  

Revolving credit & demand notes

   $ 12,597     $ 23,396     $ 5,825  

$200 million, 6.75% Senior Notes due 2011

     13,510       13,510       13,500  

7.125% Senior Notes due 2016 (a.)

     24,012       17,899       8,956  

Accounts receivable securitization program

     4,653       2,879       —    

Convertible debentures, 5.00%

     —         —         7,791  

Other combined, including interest rate swap expense, net

     7,198       4,232       1,667  

Capitalized interest on major construction projects

     (7,899 )     (9,230 )     (3,403 )

Interest income

     (864 )     (1,060 )     (1,778 )
                        

Interest expense, net

   $ 53,207     $ 51,626     $ 32,558  
                        

 

(a.) In June, 2006, we issued $250 million of senior notes (the “Notes”) which have a 7.125% coupon rate and mature on June 30, 2016. Interest on the Notes is payable semiannually in arrears on June 30 and December 30 of each year. In June, 2008, we issued an additional $150 million of Notes which formed a single series with the original Notes issued in June, 2006. Other than their date of issuance and initial price to the public, the terms of the Notes issued in June, 2008 are identical to, and trade interchangeably with, the Notes which were originally issued in June, 2006.

 

The effective tax rate was 39.0% during 2008, 38.0% during 2007 and 36.9% during 2006. The increase in our effective tax rate during 2008 as compared to 2007 and 2007 as compared to 2006 resulted primarily from increases in the effective state income tax rate.

 

Discontinued Operations

 

During 2008, we sold a 125-bed acute care hospital located in Pennsylvania and commenced divestiture considerations for the real property of our four acute care facilities located in Louisiana that were severely damaged and closed during 2005 as a result of damage sustained from Hurricane Katrina. The operating results and gain on divestiture for the facility located in Pennsylvania, as well as the hurricane insurance recoveries in excess of expenses recorded during 2006 in connection with our facilities located in Louisiana, are reflected as “Income/(loss) from discontinued operations, net of income taxes” in the Consolidated Statements of Income for each period presented.

 

The following table shows the results of operations of these facilities, on a combined basis, for all facilities reflected as discontinued operations (amounts in thousands):

 

     Year Ended December 31,  
     2008     2007     2006  

Net revenues

   $ 58,467     $ 67,887     $ 66,823  

(Loss)/income before hurricane recoveries in excess of expenses, minority interests, gain on divestitures and income taxes

   $ (2,996 )   $ (398 )   $ 1,371  

Hurricane insurance recoveries in excess of expenses

     —         —         167,229  

Minority interests in earnings of consolidated entities

     —         (13 )     (8,762 )

Gain on divestiture

     13,413       —         —    
                        

Income/(loss) from discontinued operations, before income taxes

     10,417       (411 )     159,838  

Income tax (expense)/benefit

     (3,981 )     156       (59,580 )
                        

Income/(loss) from discontinued operations, net of income taxes

   $ 6,436     $ (255 )   $ 100,258  
                        

 

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Professional and General Liability Claims and Property Insurance

 

Effective January 1, 2008, most of our subsidiaries became self-insured for malpractice exposure up to $10 million per occurrence, as compared to $20 million per occurrence in the prior year. We purchased several excess policies through commercial insurance carriers which provide for coverage in excess of $10 million up to $195 million per occurrence and in the aggregate. However, we are liable for 10% of the claims paid pursuant to the commercially insured coverage in excess of $10 million up to $60 million per occurrence and in the aggregate.

 

Our estimated liability for self-insured professional and general liability claims is based on a number of factors including, among other things, the number of asserted claims and reported incidents, estimates of losses for these claims based on recent and historical settlement amounts, estimate of incurred but not reported claims based on historical experience, and estimates of amounts recoverable under our commercial insurance policies. While we continuously monitor these factors, our ultimate liability for professional and general liability claims could change materially from our current estimates due to inherent uncertainties involved in making this estimate. Given our significant self-insured exposure for professional and general liability claims, there can be no assurance that a sharp increase in claims asserted against us will not have a material adverse effect on our future results of operations.

 

As of December 31, 2008, the total accrual for our professional and general liability claims was $272 million ($271 million net of expected recoveries from state guaranty funds) of which $42 million is included in other current liabilities. As of December 31, 2007, the total accrual for our professional and general liability claims was $258 million ($256 million net of expected recoveries from state guaranty funds), of which $32 million is included in other current liabilities. As a result of a commercial insurer’s liquidation in 2002, we became liable for unpaid claims related to our facilities, some of which remain outstanding as of December 31, 2008. The reserve for the estimated future claims payments for these outstanding liabilities is included in the accrual for our professional and general liability claims as of December 31, 2008.

 

For the years of 1998 through 2001, most of our subsidiaries were covered under commercial insurance policies with PHICO, a Pennsylvania based insurance company that was placed into liquidation in February, 2002. As a result, although PHICO continued to be liable for claims on our behalf that were related to 1998 through 2001, we began paying the claims upon PHICO’s liquidation. Since that time, although we preserved our right to receive reimbursement from the PHICO estate, we were not previously able to assess the probability of collection or reasonably quantify our share of the liquidation proceeds. In January, 2009, a court order from the Commonwealth Court of Pennsylvania was executed in connection with the partial liquidation of the PHICO estate. As a result, during the fourth quarter of 2008, based upon our share of the undisputed and resolved claims made against the PHICO estate as of a specified date and as approved by the liquidator to the court, we recorded a $10 million reduction to our professional and general liability self-insured claims expense. Since we received these liquidation proceeds during the first quarter of 2009, the $10 million reimbursement from the PHICO estate is included in accounts receivable, net, as of December 31, 2008. We are also entitled to receive reimbursement from state guaranty funds for certain claims paid by us. Included in other assets was $1 million as of December 31, 2008 and $2 million as of December 31, 2007 related to estimated expected recoveries from various state guaranty funds in connection with payment of these claims.

 

Effective April 1, 2008, we have commercial property insurance policies covering catastrophic losses resulting from windstorm damage up to a $1 billion policy limit per occurrence. Losses resulting from non-named windstorms are subject to a $250,000 deductible. Losses resulting from named windstorms are subject to a 5% deductible based upon the declared value of the property. In addition, we have commercial property insurance policies covering catastrophic losses resulting from earthquake and flood damage, each subject to aggregated loss limits (as opposed to per occurrence losses.). Our earthquake limit is $250 million, except for facilities in Alaska, California and the New Madrid (which includes certain counties located in Arkansas, Illinois, Kentucky, Mississippi, Missouri and Tennessee) and Pacific Northwest Seismic Zones which are subject to a $100 million limitation. The earthquake limit in Puerto Rico is $25 million. Earthquake losses are

 

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subject to a $250,000 deductible for our facilities located in all states except California, Alaska, Washington and Puerto Rico where earthquake losses are subject to a 5% deductible based upon the declared value of the property. Flood losses have a $250,000 deductible except in FEMA designated flood zones A and V (which are located in certain sections of Florida, Oklahoma and Texas) in which case the losses are subject to a $500,000 deductible. Due to an increase in property losses experienced nationwide in recent years, the cost of commercial property insurance has increased. As a result, catastrophic coverage for earthquake and flood has been limited to annual aggregate losses (as opposed to per occurrence losses). Given these insurance market conditions, there can be no assurance that a continuation of these unfavorable trends, or a sharp increase in uninsured property losses sustained by us, will not have a material adverse effect on our future results of operations.

 

Effects of Inflation and Seasonality

 

Seasonality—Our business is typically seasonal, with higher patient volumes and net patient service revenue in the first and fourth quarters of the year. This seasonality occurs because, generally, more people become ill during the winter months, which results in significant increases in the number of patients treated in our hospitals during those months.

 

Inflation—Although inflation has not had a material impact on our results of operations over the last three years, the healthcare industry is very labor intensive and salaries and benefits are subject to inflationary pressures as are rising supply costs which tend to escalate as vendors pass on the rising costs through price increases. Our acute care and behavioral health care facilities are experiencing the effects of a shortage of skilled nursing staff nationwide, which has caused and may continue to cause an increase in salaries, wages and benefits expense in excess of the inflation rate. Although we cannot predict our ability to continue to cover future cost increases, we believe that through adherence to cost containment policies, labor management and reasonable price increases, the effects of inflation on future operating margins should be manageable. However, our ability to pass on these increased costs associated with providing healthcare to Medicare and Medicaid patients is limited due to various federal, state and local laws which have been enacted that, in certain cases, limit our ability to increase prices. In addition, as a result of increasing regulatory and competitive pressures and a continuing industry wide shift of patients into managed care plans, our ability to maintain margins through price increases to non-Medicare patients is limited.

 

Liquidity

 

Year ended December 31, 2008 as compared to December 31, 2007:

 

Net cash provided by operating activities

 

Net cash provided by operating activities was $463 million during 2008 as compared to $348 million during 2007. The net increase of $115 million, or 33%, was primarily attributable to the following:

 

   

a favorable net change of $49 million due to an increase in net income plus or minus the adjustments to reconcile net income to net cash provided by operating activities (depreciation and amortization, gains on sales of businesses and assets and provision for settlements);

 

   

a favorable change of $35 million in accounts receivable;

 

   

an unfavorable change of $22 million in other receivables consisting of: (i) a $12 million unfavorable change in receivables recorded in connection with two construction management contracts pursuant to the terms of which we are building/built newly constructed acute care hospitals for an unrelated third party, and; (ii) a $10 million unfavorable change resulting from the receivable recorded during the fourth quarter of 2008 in connection with the proceeds received in 2009 from the liquidation of the PHICO estate, as discussed above;

 

   

a favorable change of $30 million in other working capital accounts due primarily to the timing of accrued payroll and accounts payable disbursements;

 

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a favorable change of $26 million in other assets and deferred charges which included the receipt during 2008 of a previously outstanding $9 million deposit held by our pharmacy supply distributor and a $5 million reduction in the long-term receivables related to the construction management contracts mentioned above, and;

 

   

$3 million of other combined net unfavorable changes.

 

Days sales outstanding (“DSO”):    Our DSO are calculated by dividing our annual net revenue by the number of days in the year. The result is divided into the accounts receivable balance at the end of the year to obtain the DSO. Without adjustment, our DSO were 46 days in 2008, 48 days in 2007 and 52 days in 2006. After adjusting our respective year-end accounts receivable balances for the items mentioned below, our adjusted DSO were 44 days in 2008, 48 days in 2007 and 47 days in 2006. Our adjusted DSO were calculated by reducing our respective year-end accounts receivable balances for the following: (i) the PHICO liquidation and construction management receivables as of December 31, 2008; (ii) the construction management receivables as of December 31, 2007, and; (iii) the construction management receivables and the $45 million of combined receivables related to the Texas upper payment limit and disproportionate share hospital receivables, which were paid to us during 2007, as of December 31, 2006.

 

Net cash used in investing activities

 

Net cash used in investing activities was $297 million during 2008 as compared to $450 million during 2007.

 

2008:

 

The $297 million of net cash used in investing activities during 2008 consisted of $355 million spent on capital expenditures, $82 million received from the sale of assets and businesses, $23 million spent on the acquisition of assets and businesses and $1 million of other combined net uses of cash.

 

2008 Capital Expenditures:

 

During 2008, we spent $355 million to finance capital expenditures, including the following:

 

   

construction costs related to the newly constructed Centennial Hills Hospital, a 165-bed acute care hospital in Las Vegas, Nevada which was completed and opened during the first quarter of 2008;

 

   

construction costs related to the newly constructed Palmdale Regional Medical Center, a 171-bed acute care hospital in Palmdale, California that is scheduled to be completed and opened in 2010;

 

   

construction costs related to a major expansion of the emergency, imaging and women’s services at our Southwest Healthcare System hospitals located in Riverside County, California;

 

   

construction costs related to a newly constructed 220-bed replacement acute care hospital in Denison, Texas that is scheduled to be completed and opened in 2010;

 

   

construction costs related to various other projects at certain of our acute care facilities including an emergency room and imaging expansion at Wellington Regional Medical Center located in Florida and expansion of the operating rooms at Valley Hospital Medical Center in Nevada;

 

   

construction costs related to multiple projects in process to add capacity to our busiest behavioral health facilities, and;

 

   

capital expenditures for equipment, renovations and new projects at various existing facilities.

 

2008 Divestiture of Assets and Businesses:

 

During 2008, we received $82 million from the divestiture of assets and businesses, including the following:

 

   

the sale of the assets and operations of Central Montgomery Medical Center, a 125-bed acute care facility located in Lansdale, Pennsylvania;

 

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the sale of our ownership interest in a third-party provider of supply chain services, and;

 

   

the sale of certain real property assets.

 

2008 Acquisitions of Assets and Businesses:

 

During 2008, we spent $23 million on the acquisition of businesses and real property, including the following:

 

   

the acquisition of a 76-bed behavioral health care facility located in Lawrenceville, Georgia, and;

 

   

the acquisition of previously leased real property assets of a behavioral health facility located in Nevada;

 

Also during 2008, we spent a combined $2 million to purchase/repurchase minority ownership interests in two outpatient surgery centers. We also received $2 million of net settlement proceeds related to a prior year acquisition.

 

2007:

 

The $450 million of net cash used in investing activities during 2007 consisted of $340 million spent on capital expenditures, $102 million spent on the acquisition of businesses and real property, $15 million spent to purchase minority ownership interests in majority owned businesses and $7 million received for the sale of vacant property.

 

2007 Capital Expenditures:

 

During 2007, we spent $340 million to finance capital expenditures, including the following:

 

   

construction costs related to Centennial Hills Hospital;

 

   

construction costs related to major renovation at our Manatee Memorial Hospital in Bradenton, Florida which was completed and opened during the second quarter of 2007;

 

   

construction costs related to a newly constructed Palmdale Regional Medical Center;

 

   

construction costs related to the expansions at Southwest Healthcare System, Wellington Regional Medical Center and Valley Hospital Medical Center;

 

   

construction costs related to multiple projects in process to add capacity to our busiest behavioral health facilities, and;

 

   

capital expenditures for equipment, renovations and new projects at various existing facilities.

 

2007 Acquisitions of Businesses:

 

During 2007, we spent $102 million on the acquisition of businesses and real property, including the following:

 

   

the acquisition of certain assets of Texoma Healthcare System located in Texas, including a 153-bed acute care hospital, a 60-bed behavioral health hospital, a 21-bed freestanding rehabilitation hospital and TexomaCare, a 34-physician group practice structured as a 501A corporation;

 

   

the acquisition of previously leased real property assets of a behavioral health facility located in Ohio;

 

   

the acquisition of a 52-bed behavioral health facility located in Delaware;

 

   

the acquisition of a 102-bed behavioral health facility located in Pennsylvania, and;

 

   

the acquisition of a 78-bed behavioral health facility located in Utah.

 

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Also during 2007, we spent $15 million to acquire the remaining 10% minority ownership interest in a limited liability company (“LLC”) that owns Methodist Hospital and Lakeland Medical Pavilion located in Louisiana that were severely damaged and closed as a result of Hurricane Katrina. In addition, we received $7 million of combined cash proceeds in connection with the sale of vacant property located in Texas and Kentucky.

 

Net cash provided by/used in financing activities

 

Net cash used in financing activities was $177 million during 2008 as compared to $102 million of net cash provided by financing activities during 2007.

 

2008:

 

The $177 million of net cash used in financing activities consisted of the following:

 

   

generated $150 million of net proceeds (net of financing costs) from the issuance of additional senior notes which have a 7.25% coupon rate and are scheduled to mature on June 30, 2016;

 

   

spent $167 million for debt repayments consisting primarily of repayments pursuant to our accounts receivable securitization program, revolving credit facility and short-term, on-demand credit facility;

 

   

spent $149 million to repurchase 3.27 million shares of our Class B Common Stock;

 

   

spent $16 million to pay an $.08 per share quarterly dividend;

 

   

received $2 million of capital contributions from minority members of joint-ventures, and;

 

   

generated $2 million from the issuance of shares of our Class B Common Stock pursuant to the terms of employee stock purchase plans.

 

2007:

 

The $102 million of net cash provided by financing activities consisted of the following:

 

   

generated $183 million of proceeds generated from borrowings pursuant to our accounts receivable securitization program;

 

   

spent $9 million for debt repayments, including net debt repayments pursuant to our revolving credit facility;

 

   

spent $74 million to repurchase 1.45 million shares of our Class B Common Stock;

 

   

spent $17 million to pay an $.08 per share quarterly dividend;

 

   

received $17 million of capital contributions from minority members consisting primarily of capital contributions received from a third-party for their share of costs related to Centennial Hills, and;

 

   

generated $2 million from the issuance of shares of our Class B Common Stock pursuant to the terms of employee stock purchase plans.

 

Year ended December 31, 2007 as compared to December 31, 2006:

 

Net cash provided by operating activities

 

Net cash provided by operating activities was $348 million during 2007 as compared to $169 million during 2006. The $179 million net increase was primarily attributable to the following:

 

   

a favorable net change of $23 million due primarily to: (i) a favorable $45 million change due to an increase in net income plus or minus the adjustments to reconcile net income to net cash provided by

 

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operating activities (depreciation and amortization, accretion of discount on convertible debentures, gains on sales of assets and businesses, hurricane insurance recoveries and hurricane related expenses), and; (ii) an unfavorable $21 million change in accrued insurance expense, net of commercial premiums paid, resulting primarily from the previously mentioned $18 million reduction to our prior year reserves for professional and general liability self-insured claims recorded during 2007;

 

   

a favorable change of $74 million in accounts receivable, which includes: (i) the favorable change resulting from the collection during 2007 of $45 million of Texas upper payment limit and disproportionate share hospital receivables outstanding as of December 31, 2006; (ii) a favorable change of $18 million resulting from the collection during 2007 of Medicaid supplemental payment program escrow accounts for our Texas hospitals that were funded during 2006, and; (iii) $11 million of other combined favorable changes;

 

   

a favorable change of $121 million in accrued and deferred income taxes resulting from: (i) the $84 million of income tax payments made during 2006 that related to 2005 federal income taxes that were deferred pursuant to an Internal Revenue Service granted postponement of income tax payments to companies that owned Hurricane Katrina-affected businesses in the most severely damaged parishes of Louisiana; (ii) the income tax provision of approximately $6 million recorded during 2007 on the $18 million reduction to our accrual for general and professional liability claims ($16 million after minority interest), and; (iii) $31 million of other combined favorable changes;

 

   

an unfavorable change of $45 million in other working capital accounts due primarily to the timing of certain accrued payroll and accounts payable disbursements;

 

   

a favorable change of $8 million in receivables recorded in connection with two construction management contracts pursuant to the terms of which we built/are building newly constructed acute care hospitals for an unrelated third party, and;

 

   

$2 million of other combined net unfavorable changes.

 

Hurricane insurance proceeds received:    During 2006, we reached an agreement with our insurance carrier to settle all claims related to damage sustained at our facilities located in Louisiana as a result of Hurricane Katrina. Including amounts collected from our other insurance carriers in 2005 and 2006, we received total insurance proceeds of $264 million ($189 million received during 2006 and $75 million received during 2005). We allocated the total insurance proceeds received to “investing activities” and “operating activities” on our consolidated statements of cash flows based upon the percentage of our total insurance claim that related to recovery of property losses and the recovery of all other losses. Of the $189 million of hurricane insurance proceeds received during 2006, $44 million is included in net cash provided by operating activities and the remaining $145 million is included in net cash provided by investing activities.

 

Income taxes:    As a result of Hurricane Katrina, the Internal Revenue Service (“IRS”) granted a postponement of payment relief to companies that owned Hurricane Katrina-affected businesses in the most severely damaged parishes of Louisiana. Since four of our facilities were severely damaged and closed as a result of Hurricane Katrina (and remain closed), we qualified for the income tax postponement until the third quarter of 2006. During 2006, we paid $263 million of income taxes, $84 million of which related to 2005 federal income taxes that were previously deferred pursuant to the above mentioned IRS postponement. As of December 31, 2006, no income tax payments remained deferred pursuant to the IRS postponement.

 

Net cash used in investing activities

 

Net cash used in investing activities was $450 million during 2007 as compared to $278 million during 2006. The factors contributing to the $450 million of net cash used in investing activities during 2007 are detailed above.

 

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2006:

 

The $278 million of net cash used in investing activities during 2006 consisted of $341 million spent on capital expenditures and $82 million spent on the acquisition of businesses, less the $145 million of hurricane insurance proceeds received as a result of damage sustained from Hurricane Katrina, as discussed above:

 

2006 Capital Expenditures:

 

During 2006, we spent $341 million to finance capital expenditures, including the following:

 

   

construction costs related to Centennial Hills Hospital;

 

   

construction costs related to major renovation at our Manatee Memorial Hospital;

 

   

construction costs related to the newly constructed Palmdale Regional Medical Center;

 

   

construction costs related to the newly constructed 120-bed children’s facility in Edinburg, Texas which was completed and opened during 2006;

 

   

construction costs related to the newly constructed 134-bed replacement behavioral health facility in McAllen, Texas which was completed and opened during 2006;

 

   

construction costs related to the newly constructed 104-bed acute care hospital in Eagle Pass, Texas which was completed and opened during 2006;

 

   

construction costs related to multiple projects in process to add capacity to our busiest behavioral health facilities, and;

 

   

capital expenditures for equipment, renovations and new projects at various existing facilities.

 

2006 Acquisitions of Businesses:

 

During 2006, we spent $82 million on the acquisition of businesses, including the following:

 

   

the assets of two closed behavioral health care facilities located in Florida and Georgia which were/are being renovated and reopened/scheduled to be reopened either during 2008 (Florida) or during 2009 (Georgia);

 

   

acquisition of a 128-bed behavioral health facility in Utah;

 

   

acquisition of the assets of an 86-bed behavioral health facility in Colorado which was renovated and opened in 2007;

 

   

acquisition of a medical office building in Nevada, and;

 

   

acquisition of a 77-bed behavioral health care facility located in Kentucky.

 

Net cash provided by/used in financing activities

 

Net cash provided by financing activities was $102 million during 2007 as compared to $116 million during 2006. The factors contributing to the $102 million of net cash provided by financing activities during 2007 are detailed above.

 

2006:

 

The $116 million of net cash provided by financing activities consisted of the following:

 

   

generated $249 million of net proceeds (net of underwriting discount) from the issuance of $250 million of senior notes which have a 7.125% coupon rate and will mature on June 30, 2016;

 

   

generated $245 million of net proceeds from additional borrowings pursuant to our revolving credit facility and our short term, on-demand credit facility;

 

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spent $35 million for repayments of debt consisting primarily of $31 million spent on the redemption of a portion of our outstanding convertible debentures that were due in 2020 prior to our exercise of our call option in June of 2006;

 

   

spent $350 million to repurchase approximately 6.5 million shares of our Class B Common Stock;

 

   

spent $17 million to pay quarterly cash dividends of $.08 per share;

 

   

received $17 million of capital contributions from a third-party minority member for their share of costs related to Centennial Hills, and;

 

   

generated $7 million of net cash from other financing activities.

 

2009 Expected Capital Expenditures:

 

During 2009, we expect to spend approximately $350 million to $400 million on capital expenditures, including approximately $220 million related to expenditures for capital equipment, renovations, new projects at existing hospitals and completion of major construction projects in progress at December 31, 2008. We believe that our capital expenditure program is adequate to expand, improve and equip our existing hospitals. We expect to finance all capital expenditures and acquisitions with internally generated funds and/or additional funds, as discussed below.

 

Capital Resources

 

Credit Facilities and Outstanding Debt Securities

 

We have an $800 million, unsecured non-amortizing revolving credit agreement, as amended, (“Credit Agreement”) which is scheduled to expire on July 28, 2011. In April, 2007, the Credit Agreement was amended to increase commitments from $650 million to $800 million. The Credit Agreement includes a $100 million sub-limit for letters of credit. The interest rate on the borrowings is determined, at our option, as either: (i) the one, two, three or six month London Inter-Bank Offer Rate (“LIBOR”) plus a spread of 0.33% to 0.575%; (ii) the higher of the Agent’s prime rate or the federal funds rate plus 0.50%, or; (iii) a competitive bid rate. A facility fee ranging from 0.07% to 0.175% is required on the total commitment. The applicable margins over LIBOR and the facility fee are based upon our credit ratings from Standard & Poor’s Ratings Services and Moody’s Investors Service, Inc. At December 31, 2008, the applicable margin over the LIBOR rate was 0.50% and the facility fee was 0.125%. There are no compensating balance requirements. As of December 31, 2008, we had $303 million of borrowings outstanding under our revolving credit agreement and $434 million of available borrowing capacity, net of $63 million of outstanding letters of credit. Outstanding borrowings pursuant to a short-term, on-demand credit facility which can be refinanced through available borrowings under the terms of our Credit Agreement are classified as long-term on our balance sheet. There were no borrowings outstanding under the short-term on-demand credit facility at December 31, 2008.

 

In August, 2007, we entered into a $200 million accounts receivable securitization program (“Securitization”) with a group of conduit lenders and liquidity banks. The patient-related accounts receivable (“Receivables”) for substantially all of our acute care hospitals serve as collateral for the outstanding borrowings. The interest rate on the borrowings is based on the commercial paper rate plus a spread of .35%. The initial term of this Securitization was 364 days and the term can be extended for incremental 364 day periods upon mutual agreement of the parties. The facility was extended for a second 364-day term in August, 2008. The Securitization has a term-out feature that can be exercised by us if the banks do not extend the Securitization which would extend the maturity date to August, 2010. Under the terms of the term-out provision, the borrowing rate would be the same as our Credit Agreement rate. Outstanding borrowings which can be refinanced through available borrowings under the terms of our Credit Agreement are classified as long-term on our balance sheet. We have accounted for this Securitization as borrowings under SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities”. We maintain effective control over the Receivables since, pursuant to the terms of the Securitization, the Receivables are sold from certain of our subsidiaries to special purpose entities that are wholly-owned by us. The wholly-owned special purpose entities

 

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use the Receivables to collateralize the loans obtained from the group of third-party conduit lenders and liquidity banks. The group of third-party conduit lenders and liquidity banks do not have recourse to us beyond the assets of the wholly-owned special purpose entities that securitize the loans. As of December 31, 2008, we had $70 million of borrowings outstanding pursuant to this program and $130 million of available borrowing capacity.

 

On June 30, 2006, we issued $250 million of senior notes (the “Notes”) which have a 7.125% coupon rate and mature on June 30, 2016. Interest on the Notes is payable semiannually in arrears on June 30 and December 30 of each year. In June, 2008, we issued and additional $150 million of Notes which formed a single series with the original Notes issued in June, 2006. Other than their date of issuance and initial price to the public, the terms of the Notes issued in June, 2008 are identical to and trade interchangeably with, the Notes which were originally issued in June, 2006.

 

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

 

The average amounts outstanding during 2008, 2007 and 2006 under the revolving credit, demand notes and accounts receivable securitization program were $431 million, $435 million and $90 million, respectively, with corresponding effective interest rates of 3.9%, 6.0% and 6.4% including commitment and facility fees. The maximum amounts outstanding at any month-end were $566 million in 2008, $531 million in 2007 and $352 million in 2006. The effective interest rate on our revolving credit, demand notes and accounts receivable securitization program, including the respective interest expense/income on designated interest rate swaps, was 4.4% in 2008, 5.9% in 2007 and 6.4% in 2006.

 

On June 23, 2006, we exercised our right to redeem our convertible debentures due in 2020 (the “Debentures”) at a price of $543.41 per $1,000 principal amount of Debenture. The aggregate issue price of the Debentures was $250 million or $587 million aggregate principal amount at maturity. The Debentures were issued at a price of $425.90 per $1,000 principal amount of Debenture. The Debentures’ yield to maturity was 5% per annum, .426% of which was cash interest. The Debentures were convertible at the option of the holders into 11.2048 shares of our common stock per $1,000 of Debentures. We had the right to redeem the Debentures any time on or after June 23, 2006 at a price equal to the issue price of the Debentures plus accrued original issue discount and accrued cash interest to the date of redemption. During the second quarter of 2006, approximately 10% of the Debentures were redeemed or repurchased. We spent an aggregate of approximately $31 million to either redeem Debentures at a price of $543.41 per $1,000 principal amount of Debenture or repurchase Debentures on the open market. In late June of 2006, approximately 90% of the holders converted their Debentures into 5.9 million shares of our Class B Common Stock. In connection with this conversion, we reclassified approximately $288 million of long-term debt to capital in excess of par.

 

Our total debt as a percentage of total capitalization was 39% at December 31, 2008 and 40% at December 31, 2007.

 

Our revolving credit agreement includes a material adverse change clause that must be represented at each draw. The facility also requires compliance with maximum debt to capitalization and minimum fixed charge coverage ratios. We are in compliance with all required covenants as of December 31, 2008. We also believe that we would remain in compliance if the full amount of our commitment was borrowed.

 

The fair value of our long-term debt at December 31, 2008 and 2007 was approximately $924 million and $1.05 billion, respectively.

 

We expect to finance all capital expenditures and acquisitions, pay dividends and potentially repurchase shares of our common stock utilizing internally generated and additional funds. Additional funds may be obtained through: (i) the issuance of equity; (ii) borrowings under our existing revolving credit facility or through refinancing the existing revolving credit agreement, and/or; (iii) the issuance of other long-term debt. There can be no assurance that such additional funds will be available in the preferred amounts or from the preferred sources.

 

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Contractual Obligations and Off-Balance Sheet Arrangements

 

As of December 31, 2008, we were party to certain off balance sheet arrangements consisting of standby letters of credit and surety bonds. Our outstanding letters of credit and surety bonds as of December 31, 2008 totaled $79 million consisting of: (i) $63 million related to our self-insurance programs; (ii) $14 million related pending appeals of legal judgments, and; (iii) $2 million of other debt guarantees related to public utilities and entities in which we own a minority interest.

 

Obligations under operating leases for real property, real property master leases and equipment amount to $145 million as of December 31, 2008. The real property master leases are leases for buildings on or near hospital property for which we guarantee a certain level of rental income. We sublease space in these buildings and any amounts received from these subleases are offset against the expense. In addition, we lease four hospital facilities from the Trust with terms expiring in 2011 and 2014. These leases contain up to four 5-year renewal options.

 

The following represents the scheduled maturities of our contractual obligations as of December 31, 2008:

 

     Payments Due by Period (dollars in thousands)

Contractual Obligation

   Total    Less than
1 year
   2-3
years
   4-5
years
   After
5 years

Long-term debt obligations (a)

   $ 999,369    $ 8,708    $ 579,338    $ 2,028    $ 409,295

Estimated future interest payments on debt outstanding as of December 31, 2008 (b)

     284,880      58,150      97,920      57,200      71,610

Construction commitments (c)

     179,945      158,099      21,846      —        —  

Purchase and other obligations (d)

     136,843      32,027      46,572      46,894      11,350

Operating leases (e)

     145,356      40,258      62,452      28,726      13,920

Estimated future defined benefit pension plan and other retirement plan payments (f)

     233,958      7,393      9,747      10,853      205,965
                                  

Total contractual cash obligations

   $ 1,980,351    $ 304,635    $ 817,875    $ 145,701    $ 712,140
                                  

 

(a) Includes capital lease obligations.
(b) Assumes that all debt outstanding as of December 31, 2008, including borrowings under our revolving credit agreement and accounts receivable securitization program remain outstanding until the final maturity of the debt agreements at the same interest rates which were in effect as of December 31, 2008. We have the right to repay borrowings, upon short notice and without penalty, pursuant to the terms of the revolving credit agreement, demand note and accounts receivable securitization program.
(c) Estimated cost to complete construction of: (i) a new 171-bed acute care facility located in Palmdale, California, and; (ii) a new 220-bed replacement acute care facility in Denison, Texas. We are required to build the facility in Palmdale, California pursuant to an agreement with a third-party. As of December 31, 2008, we have spent $137 million in connection with the construction of this facility which we expect to be completed and opened in 2010. In connection with our January, 2007 acquisition of certain assets of Texoma Healthcare System, we are committed to build a 220-bed replacement acute care facility in Denison, Texas within three years of the closing date. As of December 31, 2008, we have spent $27 million in connection with construction of this replacement facility. In addition to the projects mentioned above, we had various other projects under construction as of December 31, 2008 with estimated additional cost to complete and equip of approximately $220 million. Because we can terminate substantially all of the related construction contracts at any time without paying a termination fee, these costs are excluded from the above table except for the amounts contractually committed to a third-party.
(d)

Consists of: (i) a $125 million related to a long-term contract with a third-party to provide certain data processing services and laboratory information system and order management technology for our acute care facilities; (ii) a $10 million liability for physician commitments recorded in connection with the adoption of FASB issued Interpretation No. 45-3, “Application of FASB Interpretation No. 45 to Minimum Revenue

 

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Guarantees Granted to a Business or Its Owners” (“FIN 45-3”), and; (iii) a $2 million commitment payable over a four-year period in connection with the William & Mary Funding. See Note 1 to the Consolidated Financial Statements for additional disclosure related to FIN 45-3.

(e) Reflects our future minimum operating lease payment obligations related to our operating lease agreements outstanding as of December 31, 2008 as discussed in Note 7 to the Consolidated Financial Statements. Some of the lease agreements provide us with the option to renew the lease and our future lease obligations would change if we exercised these renewal options.
(f) Consists of $218 million of estimated future payments related to our non-contributory, defined benefit pension plan (estimated through 2086), as disclosed in Note 10 to the Consolidated Financial Statements, and $16 million of estimated future payments related to another retirement plan liability. Included in our other non-current liabilities as of December 31, 2008 was a $38 million liability recorded in connection with the non-contributory, defined benefit pension plan and an $11 million liability recorded in connection with the other retirement plan.

 

As of December 31, 2008, the total accrual for our professional and general liability claims was $272 million ($271 million net of expected recoveries from state guaranty funds) of which $42 million is included in other current liabilities and $230 million is included in other non-current liabilities. We exclude the $272 million for professional and general liability claims from the contractual obligations table because there are no significant contractual obligations associated with these liabilities and because of the uncertainty of the dollar amounts to be ultimately paid as well as the timing of such amounts. Please see Professional and General Liability Claims and Property Insurance above for additional disclosure related to our professional and general liability claims and reserves.

 

ITEM 7A. Quantitative and Qualitative Disclosures about Market Risk

 

Our interest expense is sensitive to changes in the general level of interest rates. To mitigate the impact of fluctuations in domestic interest rates, a portion of our debt is fixed rate accomplished by either borrowing on a long-term basis at fixed rates or by, from time to time, entering into interest rate swap transactions. From time to time, we may enter into interest rate swap agreements that require us to pay fixed and receive floating interest rates or to pay floating and receive fixed interest rates over the life of the agreements. We may also, from time to time, enter into treasury locks (“T-Locks”) to protect from a rise in the yield of the underlying treasury security for a forecasted bond issuance.

 

During the fourth quarter of 2007, we entered into two interest rate swaps whereby we pay a fixed rate on a total notional principal amount of $150 million and receive 3-month LIBOR. Each of the two interest rate swaps has a notional principal amount of $75 million. The fixed rate payable on the first interest rate swap is 4.7625% and matures on October 5, 2012. The fixed rate payable on the second interest rate swap is 4.865% and the maturity date is October, 17, 2011. The notional amount of the second interest rate swap reduces to $50 million on October 18, 2010.

 

As of December 31, 2006, we had no U.S. dollar denominated interest rate swaps. During the second quarter of 2006, in connection with the issuance of the $250 million of senior notes (“Notes”) which have a 7.125% coupon rate and mature on June 30, 2016, we entered into T-Locks, with an aggregate notional amount of $250 million, to lock in the 10-year treasury rate underlying the bond issuance. These T-Locks, which were designated as cash flow hedges, were unwound during the second quarter of 2006 resulting in a $3 million cash payment to us which has been recorded in accumulated other comprehensive income (net of income taxes) and is being amortized over the life of the 10-year Notes.

 

The table below presents information about our long-term financial instruments that are sensitive to changes in interest rates as of December 31, 2008. For debt obligations, the table presents principal cash flows and related weighted-average interest rates by contractual maturity dates. The fair value of long-term debt was determined based on market prices quoted at December 31, 2008, for the same or similar debt issues.

 

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Maturity Date, Fiscal Year Ending December 31

(Dollars in thousands)

 

     2009     2010     2011     2012     2013     Thereafter     Total  

Long-term debt:

              

Fixed rate:

              

Debt

   $ 2,295     $ 2,080     $ 202,814     $ 985     $ 1,043     $ 403,995     $ 613,212  

Average interest rates

     7.0 %     7.0 %     7.0 %     7.1 %     7.1 %     7.1 %     7.1 %

Variable rate:

              

Debt

   $ 6,413     $ 994     $ 373,450     $ —       $ —       $ 5,300     $ 386,157  

Average interest rates

     3.6 %     5.8 %     2.8 %     —         —         2.1 %     2.8 %

Interest rate swaps:

              

Notional amount

     —       $ 25,000     $ 50,000     $ 75,000       —         —       $ 150,000  

Average interest rates

     —         4.9 %     4.9 %     4.8 %     —         —         4.8 %

 

As calculated based upon our variable rate debt outstanding as of December 31, 2008 that is subject to interest rate fluctuations, each 1% change in interest rates would impact our pre-tax income by approximately $2 million.

 

ITEM 8. Financial Statements and Supplementary Data

 

Our Consolidated Balance Sheets, Consolidated Statements of Income, Consolidated Statements of Common Stockholders’ Equity, and Consolidated Statements of Cash Flows, together with the reports of PricewaterhouseCoopers LLP and KPMG LLP, independent registered public accounting firms, are included elsewhere herein. Reference is made to the “Index to Financial Statements and Financial Statement Schedule.”

 

ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

 

None.

 

ITEM 9A. Controls and Procedures.

 

As of December 31, 2008, under the supervision and with the participation of our management, including our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), we performed an evaluation of the effectiveness of our disclosure controls and procedures as defined in Rule 13a-15(e) or Rule 15d-15(e) of the Securities Exchange Act of 1934, as amended. Based on this evaluation, the CEO and CFO have concluded that our disclosure controls and procedures are effective to ensure that material information is recorded, processed, summarized and reported by management on a timely basis in order to comply with our disclosure obligations under the Securities Exchange Act of 1934, as amended, and the SEC rules thereunder.

 

Changes in Internal Control Over Financial Reporting

 

There have been no significant changes in our internal control over financial reporting or in other factors during the fourth quarter of 2008 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

Management’s Report on Internal Control Over Financial Reporting

 

Management is responsible for establishing and maintaining an adequate system of internal control over our financial reporting. In order to evaluate the effectiveness of internal control over financial reporting, as required by Section 404 of the Sarbanes—Oxley Act, management has conducted an assessment, including testing, using

 

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the criteria on Internal Control—Integrated Framework, issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Our system of internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation and fair presentation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness of internal control over financial reporting to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

Based on its assessment, management has concluded that we maintained effective internal control over financial reporting as of December 31, 2008, based on criteria in Internal Control—Integrated Framework, issued by the COSO. The effectiveness of the Company’s internal control over financial reporting as of December 31, 2008 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm as stated in their report which appears herein.

 

ITEM 9B Other Information

 

None.

 

PART III

 

ITEM 10. Directors, Executive Officers and Corporate Governance

 

There is hereby incorporated by reference the information to appear under the captions “Election of Directors”, “Section 16(a) Beneficial Ownership Reporting Compliance” and “Corporate Governance” in our Proxy Statement, to be filed with the Securities and Exchange Commission within 120 days after December 31, 2008. See also “Executive Officers of the Registrant” appearing in Item I hereof.

 

ITEM 11. Executive Compensation

 

There is hereby incorporated by reference the information to appear under the caption “Executive Compensation” in our Proxy Statement to be filed with the Securities and Exchange Commission within 120 days after December 31, 2008.

 

ITEM 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

 

There is hereby incorporated by reference the information to appear under the caption “Security Ownership of Certain Beneficial Owners and Management” in our Proxy Statement, to be filed with the Securities and Exchange Commission within 120 days after December 31, 2008.

 

ITEM 13. Certain Relationships and Related Transactions, and Director Independence

 

There is hereby incorporated by reference the information to appear under the captions “Certain Relationships and Related Transactions” and “Corporate Governance” in our Proxy Statement, to be filed with the Securities and Exchange Commission within 120 days after December 31, 2008.

 

ITEM 14. Principal Accounting Fees and Services.

 

There is hereby incorporated by reference the information to appear under the caption “Relationship with Independent Auditor” in our Proxy Statement, to be filed with the Securities and Exchange Commission within 120 days after December 31, 2008.

 

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PART IV

 

ITEM 15. Exhibits, Financial Statement Schedules

 

(a) Documents filed as part of this report:

 

(1) Financial Statements:

 

See “Index to Financial Statements and Financial Statement Schedule.”

 

(2) Financial Statement Schedules:

 

See “Index to Financial Statements and Financial Statement Schedule.”

 

(3) Exhibits:

 

3.1 Registrant’s Restated Certificate of Incorporation, and Amendments thereto, previously filed as Exhibit 3.1 to Registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 1997, are incorporated herein by reference.

 

3.2 Bylaws of Registrant, as amended, previously filed as Exhibit 3.2 to Registrant’s Annual Report on Form 10-K for the year ended December 31, 1987, is incorporated herein by reference.

 

3.3 Amendment to the Registrant’s Restated Certificate of Incorporation previously filed as Exhibit 3.1 to Registrant’s Current Report on Form 8-K dated July 3, 2001 is incorporated herein by reference.

 

4.1 Form of Indenture dated January 20, 2000, between Universal Health Services, Inc. and J.P. Morgan Trust Company, National Association (as successor to Bank One Trust Company, N.A.), Trustee previously filed as Exhibit 4.1 to Registrant’s Registration Statement on Form S-3/A (File No. 333-85781), dated February 1, 2000, is incorporated herein by reference.

 

4.2 Supplemental Indenture between Universal Health Services, Inc. and J.P. Morgan Trust Company, National Association, dated as of June 20, 2006, previously filed as Exhibit 4.2 to Registrant’s Registration Statement on Form S-3 (File No. 333-135277) dated June 23, 2006, is incorporated herein by reference.

 

4.3 Form of 6 3/4 % Notes due 2011, previously filed as Exhibit 4.1 to Registrant’s Current Report on Form 8-K dated November 13, 2001, is incorporated herein by reference.

 

4.4 Form of Debt Security, previously filed as Exhibit 4.1 to Registrant’s Registration Statement on Form S-3 (File No. 333-135277) dated June 23, 2006, is incorporated herein by reference.

 

4.5 Form of 7.125% Notes due 2016, previously filed as Exhibit 4.1 to Registrant’s Current Report on Form 8-K dated June 30, 2006, is incorporated herein by reference.

 

4.6 Officer’s Certificate relating to the 7.125% Notes due 2016, previously filed as Exhibit 4.1 to Registrant’s Current Report on Form 8-K dated June 30, 2006, is incorporated herein by reference.

 

4.7 Form of Note, previously filed as Exhibit 4.1 to the Company’s Current Report on Form 8-K dated May 30, 2008, is incorporated herein by reference.

 

4.8 Officers’ Certificate, previously filed as Exhibit 4.2 to the Company’s Current Report on Form 8-K dated May 30, 2008, is incorporated herein by reference.

 

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10.1* Employment Agreement, dated as of December 27, 2007, by and between Universal Health Services, Inc. and Alan B. Miller, previously filed as Exhibit 10.1 to Registrant’s Current Report on Form 8-K dated December 27, 2007, is incorporated herein by reference.

 

10.2 Advisory Agreement, dated as of December 24, 1986, between Universal Health Realty Income Trust and UHS of Delaware, Inc., previously filed as Exhibit 10.2 to Registrant’s Current Report on Form 8-K dated December 24, 1986, is incorporated herein by reference.

 

10.3 Agreement, dated December 3, 2008, to renew Advisory Agreement, dated as of December 24, 1986, between Universal Health Realty Income Trust and UHS of Delaware, Inc.

 

10.4 Form of Leases, including Form of Master Lease Document for Leases, between certain subsidiaries of the Registrant and Universal Health Realty Income Trust, filed as Exhibit 10.3 to Amendment No. 3 of the Registration Statement on Form S-11 and Form S-2 of Registrant and Universal Health Realty Income Trust (Registration No. 33-7872), is incorporated herein by reference.

 

10.5 Corporate Guaranty of Obligations of Subsidiaries Pursuant to Leases and Contract of Acquisition, dated December 24, 1986, issued by Registrant in favor of Universal Health Realty Income Trust, previously filed as Exhibit 10.5 to Registrant’s Current Report on Form 8-K dated December 24, 1986, is incorporated herein by reference.

 

10.6* Universal Health Services, Inc. Executive Retirement Income Plan dated January 1, 1993, previously filed as Exhibit 10.7 to Registrant’s Annual Report on Form 10-K for the year ended December 31, 2002, is incorporated herein by reference.

 

10.7* 2002 Executive Incentive Plan, previously filed as Exhibit 10.17 to Registrant’s Annual Report on Form 10-K for the year ended December 31, 2002, is incorporated herein by reference.

 

10.8 Asset Purchase Agreement dated as of February 6, 1996, among Amarillo Hospital District, UHS of Amarillo, Inc. and Universal Health Services, Inc., previously filed as Exhibit 10.28 to Registrant’s Annual Report on Form 10-K for the year ended December 31, 1995, is incorporated herein by reference.

 

10.9 Agreement of Limited Partnership of District Hospital Partners, L.P. (a District of Columbia limited partnership) by and among UHS of D.C., Inc. and The George Washington University, previously filed as Exhibit 10.1 to Registrant’s Quarterly Report on Form 10-Q for the quarters ended March 30, 1997, and June 30, 1997, is incorporated herein by reference.

 

10.10 Contribution Agreement between The George Washington University (a congressionally chartered institution in the District of Columbia) and District Hospital Partners, L.P. (a District of Columbia limited partnership), previously filed as Exhibit 10.3 to Registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 1997, is incorporated herein by reference.

 

10.11* Deferred Compensation Plan for Universal Health Services Board of Directors and Amendment thereto, previously filed as Exhibit 10.22 to Registrant’s Annual Report on Form 10-K for the year ended December 31, 2002, is incorporated herein by reference.

 

10.12 Valley/Desert Contribution Agreement dated January 30, 1998, by and among Valley Hospital Medical Center, Inc. and NC-DSH, Inc. previously filed as Exhibit 10.30 to Registrant’s Annual Report on Form 10-K for the year ended December 31, 1997, is incorporated herein by reference.

 

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10.13 Summerlin Contribution Agreement dated January 30, 1998, by and among Summerlin Hospital Medical Center, L.P. and NC-DSH, Inc., previously filed as Exhibit 10.31 to Registrant’s Annual Report on Form 10-K for the year ended December 31, 1997, is incorporated herein by reference.

 

10.14* Amended and Restated 1992 Stock Option Plan, previously filed as Exhibit 10.33 to Registrant’s Annual Report on Form 10-K for the year ended December 31, 2000, is incorporated herein by reference.

 

10.15 Credit Agreement dated as of March 4, 2005, by and among Universal Health Services, Inc., JPMorgan Chase Bank, N.A., as Administrative Agent, Bank of America, N.A., as Syndication Agent and ABN Amro Bank N.V., Sun Trust Bank and Wachovia Bank, National Association, as Co-Documentation Agents, previously filed as Exhibit 10.1 to the Registrant’s Current Report on Form 8-K, dated March 8, 2005, is incorporated herein by reference.

 

10.16* Amended and Restated Universal Health Services, Inc. Supplemental Deferred Compensation Plan dated as of January 1, 2002, previously filed as Exhibit 10.29 to Registrant’s Annual Report on Form 10-K for the year ended December 31, 2002, is incorporated herein by reference.

 

10.17* Second Amended and Restated 2001 Employees’ Restricted Stock Purchase Plan, previously filed as Exhibit 99.2 to the Company’s Current Report on Form 8-K dated May 22, 2008, is incorporated herein by reference.

 

10.18* Universal Health Services, Inc. Employee Stock Purchase Plan, previously filed as Exhibit 4.1 to Registrant’s Registration Statement on Form S-8 (File No. 333-122188), dated January 21, 2005 is incorporated herein by reference.

 

10.19* Amended and Restated Universal Health Services, Inc. 2005 Stock Incentive Plan, previously filed as Exhibit 99.1 to the Company’s Current Report on Form 8-K dated May 22, 2008, is incorporated herein by reference.

 

10.20* Form of Stock Option Agreement, previously filed as Exhibit 10.4 to Registrant’s Current Report on Form 8-K, dated June 8, 2005, is incorporated herein by reference.

 

10.21* Form of Stock Option Agreement for Non-Employee Directors, previously filed as Exhibit 10.2 to Registrant’s Current Report on Form 8-K, dated October 3, 2005, is incorporated herein by reference.

 

10.22* Restricted Stock Purchase Agreement by and between Universal Health Services, Inc. and Alan B. Miller, Chairman of the Board, President and Chief Executive Officer of the Company, previously filed as Exhibit 10.1 to Registrant’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2005, is incorporated herein by reference.

 

10.23 Sale and Purchase Agreement of the Médi-Partenaires Group, dated April 21, 2005, among UHS International, Inc., Santé et Loisirs, CMS Staff, SF Staff, MP staff and Financiere Opale, previously filed as Exhibit 10.1 to Registrant’s Current Report on Form 8-K, dated April 28, 2005, is incorporated herein by reference.

 

10.24 Ownership Interest Purchase Agreement, dated as of October 3, 2005, among Harbinger Private Equity Fund I, L.L.C., Keystone Group Kids, Inc., Michael Lindley, Marty Weber, Ameris Healthcare Investments, LLC, Rainer Twiford, Al Smith, Mike White, Rodney Cawood, Buddy Turner, Jeff Cross, Gail Debiec, Brad Gardner, Brad Williams, Don Wert, Rob Minor, Mike McCulla, Jim Shaheen, Rob Gaeta, and Universal Health Services, Inc., previously filed as Exhibit 10.1 to Registrant’s Current Report on Form 8-K, dated October 11, 2005, is incorporated herein by reference.

 

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10.25* Universal Health Services, Inc., Executive Incentive Plan, previously filed as Exhibit 10.2 to Registrant’s Current Report on Form 8-K, dated April 1, 2005, is incorporated herein by reference.

 

10.26 Amendment No. 1 to the Credit Agreement by and among Universal Health Services, Inc., JPMorgan Chase Bank, N.A., as Administrative Agent, Bank of America, N.A., as Syndication Agent and ABN Amro Bank N.V., Sun Trust Bank and Wachovia Bank, National Association, as Co-Documentation Agents, dated June 28, 2006, previously filed as Exhibit 10.1 to the Registrant’s Current Report on Form 8-K, dated August 1, 2006, is incorporated herein by reference.

 

10.27* Description of Contribution Agreement relating to Mr. Alan Miller, previously filed as Exhibit 10.1 to the Registrant’s Current Report on Form 8-K, dated July 26, 2006, is incorporated herein by reference.

 

10.28* Universal Health Services, Inc. Restricted Stock Purchase Agreement dated as of March 15, 2006, by and between Universal Health Services, Inc. and Alan B. Miller, previously filed as Exhibit 10.1 to Registrant’s Current Report on Form 8-K, dated March 21, 2006, is incorporated herein by reference.

 

10.29 Amendment No. 1 to the Master Lease Document, between certain subsidiaries of Universal Health Services, Inc. and Universal Health Realty Income Trust, dated April 24, 2006, previously filed as Exhibit 10.29 to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2006, is incorporated herein by reference.

 

10.30 Amendment No. 2 to the Credit Agreement, dated as of April 13, 2007 by and among the Company, JP Morgan Chase Bank, N.A., as Administrative Agent, Bank of America, N.A., as Syndication Agent and ABN Amro Bank, N.V., Sun Trust Bank and Wachovia Bank, National Association, as Co-Documentation Agents and other lenders named therein, previously filed as Exhibit 10.1 to the Registrant’s Current Report on Form 8-K dated April 13, 2007, is incorporated herein by reference.

 

10.31 Credit and Security Agreement, dated as of August 31, 2007, previously filed as Exhibit 10.1 to the Registrant’s Current Report on Form 8-K dated September 6, 2007, is incorporated herein by reference.

 

10.32 Form of Receivables Sale Agreement, dated as of August 31, 2007, previously filed as Exhibit 10.2 to the Registrant’s Current Report on Form 8-K dated September 6, 2007, is incorporated herein by reference.

 

10.33 Form of Performance Undertaking, dated as of August 31, 2007, previously filed as Exhibit 10.3 to the Registrant’s Current Report on Form 8-K dated September 6, 2007 is incorporated herein by reference.

 

10.34 Underwriting Agreement by and among Banc of America Securities LLC, as representative of the underwriters named in Schedule II, and Universal Health Services, Inc., dated May 29, 2008, previously filed as Exhibit 1.1 to the Company’s Current Report on Form 8-K dated May 30, 2008, is incorporated herein by reference.

 

11 Statement regarding computation of per share earnings is set forth in Note 1 of the Notes to the Consolidated Financial Statements.

 

21 Subsidiaries of Registrant.

 

23.1 Consent of Independent Registered Public Accounting Firm-PricewaterhouseCoopers LLP.

 

23.2 Consent of Independent Registered Public Accounting Firm-KPMG LLP.

 

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

 

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

 

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

 

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

 

* Management contract or compensatory plan or arrangement.

 

Exhibits, other than those incorporated by reference, have been included in copies of this Annual Report filed with the Securities and Exchange Commission. Stockholders of the Company will be provided with copies of those exhibits upon written request to the Company.

 

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SIGNATURES

 

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

UNIVERSAL HEALTH SERVICES, INC.
By:  

/S/    ALAN B. MILLER        

Alan B. Miller

Chairman of the Board, President

and Chief Executive Officer

 

February 26, 2009

 

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.