Tenet Healthcare Corp (THC) 2003 Q1 法說會逐字稿

Good morning and welcome to Tenet Healthcare calendar 2003 First Quarter Earnings Conference Call for the quarter ending March 31, 2003. Tenet is pleased that you have accepted their invitation to participate in this call. Please note that this call is being recorded by Tenet and will be available on replay. This call is also available to all investors on the web, both live and archived.

Tenet's management will be making forward-looking statements on this call today. Those forward-looking statements are based management's current expectations and are subject to risks and uncertainties that may cause those forward-looking statements to be materially incorrect. Certain of those risks and uncertainties are discussed in Tenet's filings with the Securities and Exchange Commission, including the company's annual report on Form 10K and it's quarterly report on Form 10Q of which you are referred.

Management cautions you not to rely on and makes no promises to update any of these forward-looking statements. Management will be referring to certain financial measures and statistics, including measurements such as EBITDA, adjustments earnings and adjustments revenues that are not calculated in accordance with generally accepted accounting principals or GAAP.

Management recommends that you focus on the GAAP numbers as the best indicator of financial performance providing these alternative measures as a supplement to aid in analysis of the company. Reconciliations between non-GAAP measures and related GAAP measures can be found in the press release issued this morning and on the company's website.

Detailed quarterly financial and operating data is available on First Call and the following websites: Tenethealth.com., Businesswire.com and Companyboardroom.com. At this time, I would like to turn the call over to Mr. Jeffrey Barbakow, Tenet's Chairman and Chief Executive Officer.

Thank you and good morning, and thanks to all of you for joining us. We reported earnings only a month ago and have already reported 2/3 of the period covered by this quarter. But there are many new accounting and reporting features in the quarter we are reporting today that make it difficult to compare with previous reports.

It is the first quarter we are reporting for the new calendar fiscal year. It is the first quarter in which we expense options, and we are restating prior periods as if we had already expensed them. This decision to divest a group of hospitals requires a restatement of prior results for discontinued operations.

We recorded the impairment charge that we told you about last month; and, of course, it is the first quarter in which we experienced the full impact of reduced outlier revenues. There are a number of ways to look at results for the quarter. On a GAAP basis, including the impairments, we reported a loss of 4 cents per share compared to a profit of 55 cents in the year-ago quarter.

Excluding the impact of discontinued operations and impairments, earnings per share would be 34 cents, 57 cents with the drop largely due to the decline in outlier revenues. If we look at the quarter, excluding discontinued operations, impairments and all outlier revenues in both years, earnings per share would be 32 cents versus 33 cents -- very little change at all.

We are not about to suggest that there was very little change in our earnings, but I think this comparison does demonstrate that the decline was largely due to the loss of outlier revenues and charges related to the restructuring we are in the midst of. We said in our last call that this would be a transitional year and that we would make a number of changes to our business, our management and our governance.

Some of these actions have and will continue to impact our near-term financial performance. On our last call, I described the steps we are taking to improve corporate governance, including staggering the board and separating the Chairman and CEO positions. We've imposed stricter standards of independence which go well beyond proposed New York Stock Exchange requirements.

As former Chairman and CEO of Deloitte Touche Tohmatsu -- I'm missing a page here -- Ed Kangus joined our board -- Excuse me for one second. Okay. We've implemented a minimum number of ownership requirements for all directors and senior executives, as well as a requirement for holding shares after option exercises to insure their personal interests are aligned with shareholder interests.

As part of our recent initiatives, the board decided to appoint four new independent directors. The board's four longest serving directors, including myself, will step down and retire from the board. And as a part of this board restructuring, new chairpersons will be named to the audit, compensation and nominating committees. We're making good progress in bringing in new blood to the board.

Tenet recently announced the election of Edward A. Kangus and Robert C. Nakasone as Directors. As former Chairman and CEO of Deloitte Touche Tohmatsu, Ed brings great experience in the areas of accounting and finance to our board. In addition, Tenet will benefit from Bob Nakasone's experience in running a major international company.

Bob is the former Chief Executive Officer of Toys "R" Us, which has more than $11 billion in annual sales in over 1500 retail stores. We expect to name additional independent directors shortly. All of these actions underscore our commitment to shareholder focus governance, improving performance and restoring investor confidence. We're gratified that third parties have noticed the steps we are taking.

In fact, reflecting the changes we have made, Institutional Shareholder Services, ISS, recently rated Tenet's corporate governance better than 98.8% of the companies in the S&P 500 index and top among companies in the healthcare equipment and services group. Now, let me ask Trevor Fetter to review our operational performance during this quarter.

Thanks, Jeff. First, I want to give you a brief overview of the quarter. For the three months ended March 31, we achieved net operating revenues of $3.45 billion, which was 2.3% above net operating revenues for the year-ago quarter ended March 31, 2002. That loss for the quarter was $20 million, or 4 cents per share, compared with net income of $278 million or 55 cents a share in the year-ago quarter.

As we described in the press release, this quarter's lower earnings reflect the impact of impairments of long life assets totaling $187 million, restructuring charges of $9 million, and a $61 million loss from discontinued operations. These are items directly related to previously announced actions to sharpen our strategic focus, address the outlier issue, and reduce costs. The reduction in outlier revenues continues to have an impact on virtually every year-over-year comparison.

And while we recognize that our results should stand on their own, as we move through the balance of 2003, we will continue to provide comparative data without outlier revenues because it provides a useful apples to apples comparison. For example, this quarter we had outlier revenues of $18 million versus $197 million in the year-ago quarter.

We expect outlier revenues to continue at approximately their current level in future quarters. Although, as you know, the outlier rules are in the process of being changed for the precise amount under the final rule may vary from our current run rates. What's much more important is to look at some of the operating trends inside the business.

Starting with revenues, same facility revenue per admission, if we exclude all outlier revenues in both years, increased 5.8%. And same facility revenue per day increased 6.7%. Patient volume also remains strong relative to the industry. Same facility admissions increased by 1.8% in the quarter.

This is a bit better than the preliminary number we provided a month ago, which still included the facilities to be divested. This 1.8% growth excludes the assets held for sale, and it is the method we will be using for reporting admissions going forward. Like other companies, we were affected by the light flu season.

If pulmonary admissions had simply been flat with last year, same store admissions would have been up by about 3%. I don't want to make too much of this, however, because flu-related volumes are always going to fluctuate. The recent negative publicity has been most intense in California, but we see no evidence that it has affected overall volumes other than at a few facilities.

I know there's been a lot of discussion and speculation in the last few weeks about what has happened to industry volumes. I've already mentioned inpatient volume. Tenet's growth is well within the normal range of variation. Same-store outpatient visits increased by 4/10 of 1%. Which is nothing robust, but same-store emergency room visits were up 2.5%, outpatient surgeries were up 1.1%, and inpatient surgeries up a strong 2.9%.

All in all it was a solid quarter for volumes, especially given the circumstances. As I say each quarter, you will need to remember that our hospitals are local businesses in communities throughout 16 states. Their strength is based primarily on the quality of services they provide, the manner in which they provide those services, their physical plant and the investments we make in equipment and facilities. It is those local positions that matter the most.

Speaking of the service we provide, I'm pleased that customer satisfaction continues to rise. There is no question that this is a key driver of our business and in many respects, our primary lever in maintaining a competitive advantage.

As we've discussed, as part of our Target 100 program, we regularly survey patients to gauge their satisfaction with the care we provide. The surveys, which include inpatient and outpatient participants, are conducted post-discharge by an independent third party. Patients rate each hospital on a scale of 1 to 10, with 10 being the highest in eight different categories, including nursing, physicians and food and nutrition. Perhaps the most important question is whether the patient would be willing to return to that particular facility.

In March, 84% of patients rated our hospitals either a 9 or 10 on this 10-point scale. This is consistent with our rankings from last fall and slightly better than the rankings from a year ago. These are good results, but we're challenging our hospitals to do even better by achieving 9s and 10s across-the-board.

In fact, our program aspires to achieve 100% satisfaction among not only patients but physicians and employees as well. That's the 100 in Target 100.

We are confident we can achieve high levels of satisfaction while operating more efficiently. Toward that end, we are making good progress in executing the cost reduction initiatives that we announced in March and expect to realize the full benefit of the $100 million in savings by year-end as planned.

We've implemented changes in corporate policies in the areas of travel and business meetings. We've eliminated or drastically cut back several corporate departments. We've improved nurse contract labor sourcing and reorganized our human resources marketing communications and business development function. In total, we're in the process of eliminating over 300 positions.

We do not feel that our current level of margins is acceptable. They reflect the full impact of reduced outlier revenues, but virtually no cost reductions yet. While we have begun to execute on our cost reduction program, it will have an increasingly positive effect on margins as the year progresses.

Since we announced the original $100 million in cost cuts since March, we've moved aggressively to identify additional savings in the areas of overhead cost, purchase services and supply chain costs. We expect to announce this next phase of cost reduction initiatives to our employees and to you this summer.

We view the cost reduction program as an ongoing process and as we find additional savings beyond those which we have identified thus far, we will take steps to realize them. One reason we need to continuously look for further cuts is that some costs will go up no matter what we save in other areas. Our announced sale of nonstrategic hospitals is also proceeding well, and Stephen will provide an update on that process in a moment.

Now turning to margins, Jeff has already mentioned the ways that the basis of presentation and accounting has changed with this new fiscal period, which makes it very difficult to compare the March 2003 quarter with the February 2003 quarter. To do so would require all kinds of complex reconciliations under the new Regulation G.

We believe the more meaningful comparison is the March quarter of 2003, compared to the same quarter of 2002. The loss of outlier revenues was by far the biggest contributor to the increase in expense ratios and decline in margins.

So I'd like to focus on the changes after eliminating all outlier revenues in both years. You will find several pages in our release today entitled, "Additional Supplemental Non-GAAP Disclosures Data Excluding Outlier Revenues." It's a pretty awkward name, but these are key schedules and I would draw your attention to those pages.

Salary and benefit expense increased from 42.1% to 42.6% of adjusted revenues, primarily reflecting higher benefit costs and continuing wage inflation. While option expense is reflected in both years, if you compare Tenet to other companies, you should be aware that expensing options cost 1.1 percentage points of margin.

In this analysis, supplies expense declined by 1/10 of a point. Bad debt expense increased from 7.1% to 8.0% consistent with an upward trend that we have seen recently. Other operating expense increased from 20.4% to 21.2% of revenues in this analysis and almost all of the increase, 7/10 out of the 8/10 of increase, was due to higher medical malpractice expense, which we discussed at length on our last call.

As I stated earlier, we are not satisfied with our current level of margins. As of this point, they reflect the full impact of reduced outlier revenues but virtually none of the benefits of our cost reductions. Changing gears slightly, as you know, two weeks ago we announced an important multiyear agreement with two powerful unions, the SEIU and AFSCME.

With 1.5 million members, of which 755,000 are healthcare employees, SEIU is the largest healthcare union in California and nationally. AFSCME represents another 360,000 healthcare professionals, 15,000 of whom are in California. I'd like to briefly review this agreement.

Fundamentally, the agreement provides stable and predictable wage costs at our California hospitals, as well as three Florida hospitals, for the next four years and guarantees no SEIU or AFSCME strikes for years to come. With only about 8% of our workforce currently represented by unions, Tenet has been the only large multihospital system in California that is primarily nonunion.

As you know, we have been the target of a corporate and organizing campaigns by several unions in California, which had become contentious, costly and disruptive. This agreement radically changes those dynamics for the better.

The contract standards provide for set wage increases each year. For nurses, it's 8% in the first year and 7% in following years. For other employee groups, it's a bit lower, beginning at 6% or 7% in the first year and dropping to 5% in subsequent years. These rates are consistent with Tenet's recent practice. And given the nursing shortage, we have had to compete with the wage and benefit packages being offered by competing hospitals both union and nonunion. We think these rates are similar to where the market will be.

As I mentioned, during the last year we have been the target of a corporate campaign by the unions in California. They have mounted very sophisticated, negative public relations campaigns against the company and against our hospitals in local markets. They have also sparked some of the scrutiny that we've endured from Sacramento.

In some hospitals where the unions won elections, it has become very contentious. For example, we are now six months into a nurse strike by the California Nurses Association at our San Pablo hospital, which is disruptive and costly. We expect that there will be additional advantages to Tenet from this labor accord, particularly in terms of being able to join forces with these unions to address important healthcare legislation that is under consideration at both the state and federal levels.

Employees in each facility will have the ability to vote as to whether they will join a union or not. And let me be clear, Tenet has not chosen a union for our employees.

To the contrary, we have simply provided an orderly mechanism for employees to choose whether or not they want to join a union. If they choose to join one of the unions that are in our peace accord, then they will know in advance what the terms of an agreement will look like.

While we cannot estimate how much of our total labor costs will be covered by the contracts going forward, this contract will provide stable and predictable wage costs, significantly less disruption-related costs and competitive packages and an appealing work environment for those employees who desire union representation. In short, we believe this was a critical step as we aggressively move to address the challenges that we face across our business.

Finally, before I turn the call over to Stephen, I'd like to comment on our ongoing work in the area of managed care contracting. While we have nothing new to announce since our earnings call last month, we are pleased with the progress that we are making in a challenging environment.

None of the statistics that we gave you last month have changed materially, such as weighted days to expiration, contracts under negotiation or other measures of our managed care portfolio. We are still working through renegotiations and renewals of contracts on a regional basis, contract by contract.

For the last three quarters, each quarter about 30% of the annual managed care revenue have been under some form of renegotiation. As we complete negotiations on some contracts, others open up for renewal or negotiation.

I mentioned at the outset that the company's quarter-over-quarter increase in same store net revenues per patient day, excluding outliers, was 6.7%. Please keep in mind that an important part of the company's approach, prior to November 2002, was to achieve price increases by increasing gross charges.

Because we changed this approach in November 2002, you won't see the full effect on a year-over-year basis of our current practice negotiating for price increases until we get past November 2003. So although each quarter's revenue growth per unit of service is increasingly indicative of the company's pricing trends, the first quarter to fully reflect this new environment will not occur until the first quarter of 2004.

In other words, you will have to wait until the first quarter of 2004 to see the full impact of the negotiations that we've been concluding in 2003. We are also continuing to work to resolve the company's outstanding litigation and investigation issues. And there is nothing new to report today, but Christi Sulzbach is here to address any questions in this area and we will keep you informed as these matters unfold.

Let me now turn the call over to Stephen Farber for a more thorough discussion of the financial issues. Stephen?

Thanks, Trevor and good morning. I will spend most of my time today talking about cash flow. It was a complicated quarter and there are plenty of moving parts.

My plan is to go piece by piece to not only explain the quarter but also make it clear which elements are likely to be repeated and which are simply part of the transitional period that we are working through. Let me start with operating cash flow.

Net cash provided by operating activities in the quarter was $224 million as compared to $610 million in the year-ago quarter. Five key items accounted for the majority of this significant decline in operating cash flow.

The first and most significant is the loss of outlier revenue, as Trevor and Jeff have both already mentioned. In the prior year quarter, we received $197 million of outlier revenues, and in this quarter we had $18 million, a decline of $179 million. So nearly half of the reduction in operating cash flow was driven by this change.

While the new outlier rules have yet to be finalized, we do not expect much change from current levels of accrual. So the current level of contribution, or something close to it, will likely continue going forward.

Second, there was a $101 million reduction in other current liabilities from March 31, '02, to March 31, '03. Approximately half of this was driven by the company's payroll cycle.

In the recent quarter there was an additional payroll cycle versus the prior year, resulting in a lower accrual of about $50 million. The rest of the change was primarily driven by health insurance, other insurance and other benefit accruals, totaling a $48 million negative change.

While these numbers are fairly significant, they are standard accounting treatments of basic items that tend to balance out over a series of quarters and are not an area of concern. This $101 million change, combined with the $179 million outlier change, explains roughly 3/4 of the difference in operating cash flow.

The next item is cash taxes. Cash taxes increased from $158 million in the prior period to $215 million in the current period. This accounted for $56 million of the operating cash flow difference. But there is more of a story here.

To start, the entire tax payment during the quarter of $215 million related to closing out the 12/31 fiscal period. So the entire $215 million payment related to earnings in calendar 2002, even though the payment was made in 2003.

As a result, cash flow for this year will be lower than it would normally be on a current run rate basis. This is one of the many timing impacts resulting from our change in fiscal year. Going forward, we still expect our book tax rate to be about 39%; but because of all the restructuring activities, asset sales and various charges, we expect our cash taxes to move around significantly from quarter-to-quarter until we get through this transitional period.

The fourth key item that impacted operating cash flow is accounts receivable. Net accounts receivable increased by $143 million in the quarter, which was $35 million more than the increase in the prior year quarter. There is a lot to discuss with this number, so bear with me as I go through it.

From a days outstanding perspective, when calculated straight from our books, it will appear that DSOs have jumped from 67.2 days as of the December balance sheet to 71.3 days at the end of March. These calculations, however, include the impact of eliminating the revenues of discontinued operations from the equation, while the receivables from these hospitals remain on the balance sheet.

Tenet is not selling the working capital with the hospitals that are being sold but instead, consistent with our usual practice, will work the balances off after the sales are complete. Taking out these receivables related to discontinued operations, days outstanding increased from 62.8 days in the December quarter to 66.4 days in the March quarter, an increase of 3.6 days.

Roughly 1/3 of this increase in days was due to growth in managed care accounts receivable and about 2/3 was from growth in AR from Medicare. Now, we have spoken many times about the managed care component of working capital growth, which is straight-forward and well understood. The Medicare growth is somewhat unique and extremely complicated, but I will try to explain the basics of how it works.

During the recent quarter we filed an unusually large number of Medicare cost reports relating to prior periods. Under normal circumstances, many of these reports would have been filed prior to 12/31/02, as cost reports are typically due within five months of the end of a fiscal year. However, CMS extended the filing deadlines for many providers' reports, not just Tenet, due to systems issues at CMS and a backlog and requested that we wait to submit some of these filings until recently.

When a cost report is filed, in some ways it is like a tax return. On some we owe money and must make payment at that time. On others, we are due money from the government and a tentative settlement is not paid until later.

This cost report activity constituted 1.8 days of the 3.6-day change in DSOs. In April and May the remainder of the catch-up should be completed, and there may be additional impact resulting from this in the June quarter. Once this process is complete, we will return to our normal five-month filing schedule going forward as we are all caught up and the CMS systems problems have been resolved.

The final item of meaningful change in operating cash flow is payables. While payables did increase by $39 million in the quarter, this was $51 million less than the March 2002 quarter. These five items, changes in outlier payments, other current liabilities, cash taxes, accounts receivable and accounts payable, when considered in aggregate, total roughly $440 million, as compared to the $386 million decline in operating cash flow between periods. A long list of smaller items made up the difference.

I want to briefly comment on one other cash flow item: cash interest. Cash interest for the period was $21 million, which was lower than it will be going forward. The billion dollars of bonds that we issued in January skewed the cash outflow from interest during the period and going forward with our current capital structure, calendar Q1 and Q3 should have cash interest of about $60 million per quarter. And Q2 and Q4 should have cash interest of about $90 million per quarter resulting, again, from the current capital structure that we have in place.

Switching to capital expenditures. For the quarter, CAPEX was $220 million compared to $218 million for the prior year's quarter. When I first became CFO late last year, we were almost halfway through a fiscal year in which our company was planning for a nearly $1.1 billion of capital expenditures for the period ending this May. Changing a capital plan in progress is a very tough thing to do as contractual or other commitments were already in place for much of this program.

For example, if a building is partially completed, it usually makes sense to finish the project. Or if a commitment has been made to a medical staff or community to install new equipment or make other investments, it can disrupt key relationships to change plans after announcement.

That being said, we have worked very aggressively over the past six months and managed to trim this level by at least $150 million already and are intending to reduce this to a $700 million run rate level within the coming 12 months. Let's now move to share repurchase.

With net cash provided from operating activities of $224 million and capital spending of $220 million, we generated only a few million dollars this quarter for share repurchases under our board resolution formula for the repurchase of stock. As previously announced, during the March quarter, we repurchased 6 million shares for approximately $110 million.

During the past month, for the period April 14 to May 12, we repurchased an additional 5.7 million shares of stock for approximately $85 million under a previously-announced 10B51 program. The total repurchases for the year through May 12 were approximately $200 million and pretty close to 12 million shares.

As mentioned in our press release this morning, as of May 12 we had approximately $35 million of total repurchase capacity remaining under the formula, including the small contribution from this quarter. This amount will be used to repurchase shares in the coming weeks.

Going forward, the June results will determine the next financial allocation under the formula. With respect to the original board authorization to repurchase 30 million shares, subject to the formula-driven financial allocation, as of May 12 we had 18.3 million shares remaining.

Now for an update on the divestiture program. Since the last earnings call, we have continued to move forward with our sales program. We have received bids from a large variety of interested parties and are in the process of working through all the bids and selecting the final bidders with whom we will negotiate definitive agreements.

The process is on track and we expect most of the sales to be completed by the end of the calendar year, if not sooner. I also want to mention that tomorrow we'll be filing our 10K for the seven-month transition period ending December 2002 and our 10Q for the quarter ending March 2003.

When reading the 10K, just bear in mind that in conformance with generally accepted accounting principals with GAAP, the financials do not reflect expensing of options or the reclassification to discontinue operations of the hospitals held for sale since these decisions were made after December 31, the end of that period.

For my final point, let me just say that the transition from an old fiscal year to our new calendar year is complicated and can be confusing. We are trying to provide you with all the necessary information for you to understand what is happening in our business and to update your models.

To that end, in our press release today we provided several additional pages of financials and statistics for calendar 2002 restated by quarter. These numbers are unaudited but reflect the key changes we have discussed. This information can also be found on our website. And with that, let's open it up for questions. Operator?

Thank you. Ladies and gentlemen, to ask a question, press star 1. If your question has been answered, press star 2.

We would ask that as a courtesy to the many listeners who do have questions, that you limit yourself to one question. After your question has been answered, you may re-enter the queue with another question, which Tenet will address, time permitting.

Our first question comes from A.J. Rice of Merrill Lynch. Your question, please.

A.J., you there?

Mr. Rice, do you have a question at this time? Our next question comes from Gary Lieberman of Morgan Stanley. Your question, please.

Thanks. Can you hear me okay?

Yes.

Just to get a little bit of clarification on the volume numbers. In the call last month you talked about the quarter having volume growth of 1.1%, and I realize that that includes the hospitals that you plan to sell. And I just want to understand the numbers that you put out in the press release today, the 1.2% and the 1.8%. Are you, in fact, saying that the volumes are stronger than the 1.1% you talked about last month? Just help me out there.

Yeah, Gary. The 1.1 and 1.2 are on a consistent basis and because of the date on which we reported, we didn't have the absolutely final numbers at that time. So that is the difference in 1.1 and 1.2.

Difference between 1.2 and 1.8 is excluding the divested facilities. So naturally you can deduce from that that the performance of the divested facilities was substantially below the average of the rest of the company.

Great. Thanks a lot.

All right. Our next question is from Mr. A.J. Rice with Merrill Lynch. Your question, please.

Thanks a lot. Sorry about that a minute ago. I know that when you guys had reported a month or so ago, you talked about the fact that you were in the midst of this bottoms-up budgeting process looking ahead for the rest of the year. I guess you haven't made any comments about that on today's call.

Where does that stand? And is there any update on the rest -- the outlook for the rest of the year in light of the one additional quarter, a month's worth of information?

Sure, A.J. Good morning. It's Stephen. You know, we're continuing to work through the budgeting process. We, in fact, have meetings scheduled for late this month and early next month to review the hospitals -- or the budgets on a hospital-by-hospital basis.

It will take a couple of weeks to get through that number of facilities. And then we have to go through the consolidation process during the course of June. So the process itself should be completed sometime in late June and will likely be disclosed on the Q2 earnings call.

Okay. Okay. And just maybe if I could ask a follow-up on your comments with respect to volumes. I guess in Trevor's comments he's talking -- he gave us some numbers about the -- if you had normalized for the pulmonary volume year-over-year, I guess mainly flu-related type stuff.

Is it your general sense that other than that you really didn't see -- you're not yet seeing anything that would suggest to you that there's some unusual -- I mean, certainly there's been a lot of talk about co-pay, changes, economy, war-related issues and a whole litany of things that people have talked about. Can you guys point to any of that as having an impact in the March quarter?

You know, A.J., it's, of course, on all those types of theories, it's impossible to isolate them. You can't tell who didn't show up at the door because of the war or weather or any of these types of things. So the numbers are what they are.

They are decent numbers. I'm sure that all of those factors that have been mentioned, either by other companies or by analysts, play some role in determining admissions; but it's not something that, you know, that we decided was necessary for us to focus on this call.

Okay. All right. Thanks a lot.

Our next question comes from Adam Feinstein of Lehman Brothers. Your question, please.

Great. Thank you. My question is just a comment on guidance. And then just in the context of, you know, what's the deal you guys reached with the labor unions, I guess, a week ago? Are you making any thought process here about higher labor costs going forward? And do you believe you will see more, I guess, the nurses join the union over the next couple of years? Thank you.

Adam, with respect to the union deal and labor costs, you know, I wanted to make it clear that we've always been in a competitive environment for labor. So our own practices with respect to wage increases and benefits has been designed to be competitive to make sure that we have the best possible people that we can have in the hospitals, that we're successful in recruiting and retaining them.

So we believe that we were at the market in California and the market is largely defined by facilities that are unionized. As I mentioned, we were the last nonunionized facility. So the built-in increases to wages, as part of our union agreement, are not inconsistent with what the company's practice has been during the past few years.

Okay. And then, I guess, you know, just -- so with that, the guidance you guys gave out was $1.35 to $1.60. Is that still the same guidance, then?

Well, Adam, just to qualify that guidance from a month ago, to put it in the same context as it was cast a month ago, that was what we called preliminary guidance at the time. It was taking all the things that had happened since we had issued formal guidance on December 3rd.

All of these accounting changes, restructuring, cost cuts, you name it, and adjusting those aggregate numbers down to that range. We have not since December 3 updated the operating guidance, which underlies all of those items, and that will not be updated until we complete the budget process over the next six weeks or so, like I just answered for A.J.

Great, thank you.

Thank you.

Our next question comes from Jay Leopold of Legg Mason Funds. Your question, please.

Good morning. I wanted to focus in on your cash flow from operations. You gave a variety of explanations of why they declined sequentially, or maybe it was year-over-year. But I wanted to focus in on what's possibly normalized cash flow given 34 cents in earnings?

For instance, the outlier payments, you wouldn't make any adjustment to because it will continue as is. $101 million, you probably would want to back out, cash taxes, maybe back out the whole thing, maybe only part of it. But you have to go through the items with an eye of trying to give us an idea of normalized cash flow operations?

Yeah. You know, I'm not under -- since we're not updating cash flow guidance until we update overall guidance, I probably can't add up the numbers for you but I can certainly walk through the components individually and give a sense of what it might be without the unusual effects of this transitional period.

Okay.

You know, you are right on the outlier piece; that's going to be whatever it's going to be going forward. In terms of the $101 million swing in other current liabilities, you know, the reality is every quarter we have some sorts of swings in the broader working capital section, whether it's a pea or other current liabilities or any of these areas.

There were some particularly different things this quarter in other current liabilities, like the extra payroll period, but that happens sometimes. And when you have a $5 billion payroll, having an extra payroll period in a quarter, you know, has an impact. So those will swing around and there's -- there are literally dozens and dozens of constituent parts. So that's fairly random how that comes out.

If I were to take out the entire 101, would I be going too far in the other direction?

If you were to combine that 101 and any movement in payables, because that's fairly random, as well, based on CAPEX timing -- and we've talked about this a bit in the last couple quarters -- where you tend to get pretty big swings in payables throughout the year and it all just depends on when projects are getting done and when checks are being cut.

You know, those together really do vary quarter by quarter. It is tough for me to say if it should be higher or lower. The swing in other operating expense was fairly high this quarter. What we saw in the swing in payables was lower than it has been for the past couple of quarters.

So, you know, those are the toughest parts to predict; but they're also routine things as opposed to, you know, something like growth and accounts receivable is more of a focus issue. Whereas, if you have a swing in payables, that's something that's very much within the company's control or whether you have a payroll cycle.

Those are issues that are to a great extent self-correcting and just become issues of timing. Whereas, some of the other cash flow issues are ones where there needs to be focus because we actually have an ability to influence them over the long run.

Moving on through the cash taxes, like I said, the $215 million of cash taxes for this period all related to last year and it certainly was, you know, significantly higher than the book tax accrual this quarter and would be much higher than any sort of cash tax that could be imputed from the various ranges of estimates for our performance for this year.

I would like to -- our cash taxes on a normalized basis, without all these other things going on, should be just a little bit lighter than our book tax accrual. We tend to create some deferred taxes, but not a tremendous amount. So if we're accruing book taxes at 39% of whatever pretax income we actually earned on a normalized basis, I would accrue cash taxes a little lighter than that.

Clearly this quarter was heavy and those also tend to not be completely flat throughout the year. They tend to accelerate as you move towards the third and fourth quarter. So Q1 and Q2 typically would be a lighter tax payment. Q3 and Q4, for any company, would typically be a heavier tax payment. As far as the accounts receivable, you know, we have seen over the past couple quarters, a day or two growth per quarter NAR.

There was the unusual issue of the Medicare settlements this time. And I did comment that we expected for the June quarter, the sort of the completion of that catch-up in Medicare cost report filings. But it's too early to know what impact that will have, but it could be something to similar to what we saw this time. It is -- we are certainly doing everything that we can to try and manage the accounts receivable as efficiently at possible.

But it would have to be your judgment and others' judgment as to how successful we will be on that over this transitional period. And as far as -- and I think the only other item really was this comment that I made with respect to cash interest payments, and I think I pretty much gave the numbers there about what that would be on a normalized basis.

Were there any restructuring costs?

You know, there certainly will be. That's what makes the transitional period very difficult to predict on an ongoing basis. Because you do have outflows. And we're going to have, particularly over the next few quarters, outflows relating to severance payments for people who are terminated, early lease termination costs. When we sell these hospitals, there will be some negatives and positives.

We will get cash that comes in the door, but will have some internatl, underlying cost that we'll have to pay. But at same time, we'll be working off their accounts receivable and I think they have net working capital of around $100 million when you net it all out. So that will be an inflow later this year as we work that off in addition to whatever proceeds we receive. So it's one of those years where there's just so many moving parts, it does get to be very, very difficult to predict with any accuracy.

Thank you.

Sure.

Our next question comes from Sheryl Skolnick of Fulcrum Global Partners. Your question, please.

Hi. And I am going to follow up on a couple of the cash flow statements, and I want to thank you for trying to go through this as clearly as you did. On the Medicare -- well, there's two areas. First, the Medicare and then the second is with respect to the managed care. And I want to focus on those two.

Let me start, actually, with managed care. The $52 million was the number that you gave us in the February quarter of a lack of cash flow that you otherwise would have expected that you attributed to, as I think the words were, managed care payer slowing down principally in California, slowing down the rate of payment. What's happened with that?

That number for the whole quarter, Sheryl, is $64 million.

Uh-huh.

So we didn't see a whole lot more.

$12 million sequentially in March. Okay. But is that still an issue?

You know, I would be surprised if it is not. It's one of those things where we get, you know, the updated numbers every month. March happened to be okay, but the fact is there are a lot of payers out there who are continuing to push back very hard and we continue to push back very hard.

So it's, you know, I would not be surprised. And I think I've said it over the previous couple of quarters, that I would not be surprised if we continue to have some slippage on that front, but we're doing everything we can to offset it.

Okay. And then with the Medicare, with the cost report filings and your comparing it to tax returns makes a lot of sense. But you said that there was approximately a five-month delay.

So that means that somewhere between July and September you would normally have filed these things and experienced a cash flow impact? Forgive me for saying this, but why is it that we're hearing about it in May of 2003 when it's related to 2002 cost reports?

Yeah, there are a couple of reasons. First, I mean, this category is incredibly complicated; so let me try and give you my best explanation.

There were a number of reports -- I believe there were about 80 cost reports related to 2001 and 2002 -- which CMS requested that we not submit, that we hold off on submitting, because they had systems issues and basically work flow issues where they were just so backed up there was no utility in submitting the cost reports so they would just sit there.

Uh-huh.

So that was part of what was behind that. The other thing is that cost reports are typically due five months after the end of the hospital's fiscal year.

Uh-huh.

For Medicare purposes, not all of our hospitals have the same fiscal year.

Uh-huh.

Approximately half of our hospitals have a May 31 fiscal year; the other half of our hospitals are evenly spread, pretty much, over the last few months of the calendar year.

Uh-huh.

And some of that is work flow on our part and work flow on CMS's part in terms of balance out, you know, the work throughout the year.

Uh-huh.

So these filings over the past few months were all related to the resolution of the CMS issues and their ability to then receive those reports.

Okay. But these cost reports would more normally have been filed in what month, if CMS was willing to accept them?

There would have been some that would have been filed in 2001 and some that would have been filed at different points during 2002.

Did you give the total amount of the difference in cash flow year-over-year as a result of this?

The total amounts -- you know, I've got the number for this quarter, Sheryl.

Yeah, that's fine.

For this quarter, it was $71 million. This is, in fact, a new study that I had had my staff do. It had not been looked at in the prior year.

Okay.

So I don't have the number for last year; but I do know that the cost report slippage, or the acceleration of the filings this year, was a $71 million impact.

Right. And that must have been done in March, because we didn't talk about this at the February quarter.

There was a small amount in February, there was a big chunk that went in March, there's another big chunk that's not in these numbers that went in April, and there's another piece that's supposed to go in sort of later this month.

Okay. All right. So rather than badger you on all of this, I guess where I'm getting to, and I guess the bigger question is, it sounds like the June quarter is going to be very tough with respect to free cash flow, as well, as the March quarter was. It's disturbing to see the drop-off so steep sequentially from February to March.

And I guess I have to ask the question: Is it really prudent to be going out there when cash is clearly dear and hard to come by from operations during this transition period -- you listed a number of ways we're going to have to see shareholders money be spent in order to restructure the company for the future. Is it prudent for you to be going out and buying back stock?

Well, the way that the program is currently set up, we did contemplate that to the extent that we don't have free cash flow defined as, under GAAP, defined as operating cash flow less CAPEX --

Uh-huh.

-- proceeds to the extent that we can only use that money for buying back stock. To some extent it is a self-balancing effort. So for instance, during this quarter we only generated, I think, $9 million on that basis per share repurchase.

Uh-huh.

And when we combine it to the $35 million that we have to repurchase shares with over the next couple of months until we release the joins earnings, it is a combination of that $9 million or $11 million, I forget the exact number, plus the little bit that's left over from prior periods. So we will have another chance to look and see how cash flow performed during the June quarter prior to any material amount of additional shares being repurchased.

I guess that's some safeguard. But it still doesn't get to the issue of, your balance sheet appears to be getting tighter and tighter. There are all of these issues, and I have to ask the question: Isn't it a little bit smarter to just take a hiatus from this and conserve what little cash is being generated from operations? I guess at some point you will answer that.

Sheryl, it's certainly open for a consideration.

Okay. I'll let someone else ask more questions. Thank you so much.

Sure.

Our next question comes from John Mason [sic] of Raymond James. Your question, please.

Hi. This is John Ransom. I just had a question about stock options and stock option expense. Can you give us the adjusted stock options expense number for 2002? And I apologize if it's buried in this release somewhere.

That's fine. Let me look that up. Do you have a same question? Or can we ask a second question?

I guess more of a philosophical question.

It was $37 million during the prior year first quarter.

What was it for the year?

Give me a second. Hold on one second. Why don't we come back to that, if that's okay. Someone is looking it up, and we will give the number once we get to the right page. We could save time and get on to the next question.

Sure, just a question philosophical question about stock options. I mean, looking at your latest filings, your stock options are certainly pretty far out of the money. You get another 50 million shares, I guess, to issue under your current option agreements.

Why do you want to drink this hemlock of, you know, expensing options that are 60% out of the money. Why not a reconsideration of that whole process? Thanks.

That wasn't a question it was just a comment.

It's a question. I mean, is there any consideration about the use of stock options since you're carrying a pretty heavy penalty for options that are pretty far out of the money that, you know, are also kind of a noncash expense?

Correct. You know, there are -- it is fairly bizarre how the calculation is required to be done where the most out of the money options that we have, there is a series of options that was granted a couple years ago at about $41. The book expense for those options is about $18.5 per option that's being amortized over a three-year period.

Those constitute a disproportionate amount of the option expense; and yet they are the, you know, the least worthwhile options on a current value basis, but that's just the way the mechanics work. We undertook the decision to send stock options. The board undertook it, basically, upon multiple requests from our core shareholders who had requested that we begin to expense stock options so that it would be a, you know, from a governance perspective.

Well, I mean, again, the philosophical question: Since you're now having to carry this expense around, and it sets you up differently than your peers, why not rebase the whole thought process around incentives toward straight cash payments? Maybe for something like generating free cash flow or something like that, as opposed to having out of the money stock options to store your financials?

Well, you know that same question could probably be asked of any company that has adopted stock option expensing. And I think there is a very broad philosophical debate about the topic as a whole. I think there's an article in the journal every day or two about --

Oh, I mean, I understand the difficulty with valuing options.

Sure.

But it would seem to me if, you know, if you've got options that are 60, 70% out of the money that have very low value or likelihood of having value realized in our lifetime, why not just rethink that whole -- I mean, it's not providing any incentive to anybody. I mean a $40 option is not making anybody get up and go work harder tomorrow. And I just wonder why -- why if we're having the expenses, why don't we rethink the whole incentive process?

Listen, you've raised some very, very good points. We've gone through this, we will continue to think about it. I don't think we're going to change the approach that we've suggested and gone public with at this point in time. But you raise some very valid points as it relates to us and not necessarily philosophically. It's pretty practical.

I've got the number for you for the --

Okay.

-- yeah, the number for the entire [INAUDIBLE] calendar '02 was $149 million.

If we're doing apples to apples margin comparisons, we essentially need to add that back to get EBITDA, true EBITDA, compared [INAUDIBLE]. Thank you.

Yes. Thanks.

Our next question comes from Lee Cooperman of Omega Advisors. Your question, please.

Good afternoon or whatever. I feel a little bit like that old man in "Moonstruck" when he was around the dinner table. He said he was confused. Speaking for myself, I've never been too concerned about any one quarter's earnings, but rather very concerned about earning power and normalized earnings.

In that regard, you folks were on a road show from December 3 to December 6 last year with a 69-page handout with very specific detail in earnings and cash flow projections. Five months have gone by since that time, and now what I'm hearing is you can't provide any guidance because you're in some kind of budgeting process.

And I don't understand that. And the reason I don't understand it is you're making a very bold statement regarding the valuation of your company by virtue of channeling significant resources into stock repurchase. And it seems to me, I don't think a company's management, the board, can make intelligent, you know, decision on stock repurchase unless you have a view of earnings, earning power, asset value, et cetera.

And I don't want to find out, you know, a year or two years from now, just as we found out about these outlier payments being inappropriate, that we bought back a lot of stock that was overvalued and not undervalued. The only way that makes sense is if people are selling you back the stock and reducing their ownership in the company as you're buying back stock.

So I really call upon you say either to say that the outlook has deteriorated since December and things are much more uncertain, and if we had to do over again we wouldn't have provided the guidance that we provided in December in this 69-page handout, or share with us your kind of view of what this institution, this company is capable of doing in the way of normalized revenues, normalized EBITDA, normalized net income, normalized free cash flow, so we have a basis upon which to judge a management's performance going forward. Okay?

And Number 2, the intelligence of your stock repurchase program. I just don't understand how you can't talk about guidance when you're buying back all this stock. You have to have a view internally of what things are going to look like or you shouldn't being buying stock back. It's irresponsible. So, you know, and I'd like a real specific answer, if possible.

That is a question, not a statement.

It is a question, exactly. Why are you buying back all the stock as opposed to giving me a 50, 60 cent dividend which you could always eliminate at any time?

See, the trouble with the stock repurchase, you can't eliminate that. Once you buy it back, you've spent the money. In the form of a dividend, if you turn out that things deteriorate, that don't improve, you can always eliminate the dividend.

Now Lee, Lee, Lee, the way that we have the stock repurchase program set up, it gives us the same exact ability to shut it off as you would have --

No, no, no, no, no, no, no, no! The average common stock yields less than 2%. You buy back a share of stock you're buying back 50 years of dividends for every share you buy back. Okay? That's number one.

But, Lee, your comment was that -- your comment was that from a cash flow perspective, if we find that we are in not as good of a position going forward, we would have been somehow better off by having paid a dividend than by having bought back a share of stock. And if it's the same exact amount of dollars going out the door to do either, and if they both are truly discretionary, then they should be equivalent.

The idea of stock repurchase, pure and simple, is to buy back an asset that sells at a substantial discount to its value. If the asset was fully valued or overvalued only a fool would be buying back stock. You'd be playing a game.

So what I'm saying is to determine that it's appropriate to buy back stock, you have to have a view of what this group of hospitals is capable of earning when you take out the costs that you take out and you run the business the way the business should be run. You know, on Page 61 of your 69-page handout, fiscal 2004, originally you gave revenues of $15.4 million EBITDA, $2.4 billion EBITDA of a billion 8, pretax a billion 6, then it goes 950 million, earnings per share of $2 plus or minus 10%. And, you know, I don't need that degree of specificity but I -- and I'm not saying you're wrong in buying back stock. What I'm saying is the inconsistency is the unwilling -- you're kind of hiding behind this budgeting process even though we're 5.5 months past the meeting in December where you didn't have a problem giving out a 69-page handout.

So a rational person would probably conclude that things have gotten kind of, not nearly going along the path that you anticipated and you're not prepared to give any guidance because things are highly uncertain, which I think doesn't sit with this, you know, mindless buying back of stock with our free cash flow. I want you to buy back stock because the stock is significantly undervalued relative to what the collection of assets is worth. And so, you know, this is what I'm asking you to comment on.

You guys get all of these options, you get fancy compensation, which I hope that you wind a up earning and deserving. I'm on your team, I'm your partner, I'm an investor with you. But what I want to know is how do I evaluate you? What should you be earning a couple years out when we go through this restructuring process and we get our costs down and we're doing the proper job?

Lee, Lee, there's nothing I would like more than to be able to give you an accurate prediction of what we expect to do next year. But like I said for the last two quarters, I am personally unwilling to do that unless I have a bottom up, hospital-level budget process that is based on business plans that have been veted and accepted for those individual hospitals to comprise the budget. That will be the basis for the guidance I would give you.

Okay. And I'm going to relent here by just telling you, it is a very bad answer you're giving me.

Why?

You're spending hundreds of millions of dollars on stock repurchase and when you're telling me you don't know what the business could earn. It's inconsistent. You have to --

Although, Lee, again, and I'm not meaning to argue. The amount of shares repurchased this year was about $195 million, is what has been repurchased during the course of this year.

And in terms of the overall credit quality of the company, the company's credit has been fairly stable. We have a $1.5 billion credit line that's is completely undrawn, our liquidity is intact, and I think that the level of repurchases have been prudent in the context of our recent experiment.

That's not -- I really apologize to everybody on the phone. I'm not looking to monopolize this call. That's not the criteria.

The criteria for stock repurchase is are you buying something for a discount to its true value? The idea that we have the cash in the company to buy back stock, that's not relevant, because the cash could be given to the shareholders in the form of a dividend.

If you wind up buying back all this stock and you turn that over to overpay, I would have been infinitely better off as an ongoing shareholder to get my money in the form of a dividend and I can go out and buy some other security that is undervalued. So I would beg to differ. The decision to buy back stock has to be a decision made by the board with the support or the recommendation of management that, listen, we sit back and we look at the hospitals. Our reproductive costs to the hospitals is $30 a share, $40 a share, $25 a share.

In a normal economic environment when we get our costs down, et cetera, and we kick out these outlier issues, this business ought to earn a couple of bucks a share. And we're worth 13 or 14 times earnings and we're worth $25 and the ability to buy back stock at a significant discount, because the market doesn't believe in our ongoing earning power, gives us this opportunity. I'm not hearing you saying that.

What I'm hearing you saying is, frankly, all wrong about the attitude and why you buy back stock. And I'm sorry to give you a lecture, but I think I know what I'm talking about.

We thank you for the comment. Lee, you and I have talked a lot about this.

As to dividends versus stock buyback, you know, if we use the $200 million as akin to 50 cents a share and the divident philosophy -- I won't get into what's better at this point in time or disagree or agree with you as to -- as to the timing of the budgeting process, I think you know why we have to do it in that manner. Again, we've discussed this very fully; and on this next call and next quarter, we will be able to answer this.

As to whether we believe this stock is cheap at this point in time, the answer is, yes. We're not doing something just out of, you know, without thinking through some of the things that you have already told us, either on this call or offline. We totally agree with what you're saying. I don't think we'd be going out and spending $1, let alone $200 million, as a board, if we didn't believe that was true.

What you want are the specifics. We will give you the specifics in the next meeting. We totally understand and we appreciate your comments.

Okay. Well, the only frustration is you gave a 69-page handout in December, five months ago [INAUDIBLE] was so vague on everything. It doesn't seem to make any sense.

We get you.

Okay.

We totally understand.

We'll talk to you offline.

And we do appreciate it.

Once again, ladies and gentlemen, to ask a question, please key star 1. Our next question comes from Walter Branson of [INAUDIBLE] Capital.

Thank you. I do have a question! [ Laughter ] And the question is could you give us a status update on your plan to give private payers a managed care rate and maybe some insight as to what the impact of that might be on revenues and EBITDA if it goes through?

The status is that we have made the appropriate submissions to receive the regulatory approval to do so. We announced the policy some months ago, and at that time I believe we had given an estimate of what the impact on revenues would be.

Yeah. Yeah. The revenue impact should be fairly small. The net receipts from this group of people is well below a couple hundred million dollars. It does depend on how -- there are a lot of different ways of calculating it. But we think that the impact is sort of in the, you know, 20, $30 million range. So not terribly material.

And there should be some savings that offset that, but we're going to have to wait until we get into the actual implementation once we get the regulatory approvals to see what that is. For instance, you know, saving the money on some of the collections efforts from these people and that sort of process simplification.

Okay, thank you.

Sure.

We've got a couple of more calls that are online. I think we'll take those and then conclude this morning's session.

Our next question comes from Brad Leonard of ETG. Your question, please?

Yeah. This is just a comment on the stock repurchases. I mean, you said that you think the stock is cheap and you wouldn't have been buying it back if you didn't think so. But how many shares have you purchased in the last two years at significantly higher prices?

Do we have the number?

Yes, we have the number. We'll get you the number.

I mean it was a lot. You bought a lot. I have a filing here. You dig through them, but what do you think the values were? I mean, if you thought it was okay to buy it back at 40 or 50 --

Listen. We are where we are. The reason we bought back stock in prior years -- prior to the outlier, prior to the November and October dates -- really related to different things. We were offsetting the options that were exercised at that point in time.

I think you have to look at the post-October period. We can give you all the numbers, if you want it, but I think you're asking a more major question.

Well, I am. And I can find the numbers, that's not even -- the question is, you didn't know what was going on necessarily then or you wouldn't have been buying stuff at 40 and $50 a share blindly.

That's absolutely right. As everyone knows, all the circumstances relating to the company have changed since October.

Well, so, I mean, it is what it is; but it just, I guess the credibility of when you should be buying it is up in the air.

Thank you for your comment.

Yeah.

We'll go to the next question now.

Our final question comes from Jason [INAUDIBLE]. Your question, please.

This is Ryan Schafer, actually. Going back to admissions, you reported 2.5% same facility growth in the February quarter and 1.8 in the March quarter. I'm wondering if you could you give us the admissions growth on a monthly basis, kind of starting in December through February?

You know, we were in a position because we changed the fiscal year. But, in fact, you know, we made some disclosures about monthly admissions. But we'd really prefer not to do that. If you follow the industry closely, you will see that there's a high degree of volatility.

The rest of the companies in the industry have reported March quarters with, that are generally weaker than what we've reported; and we just don't believe it serves a useful purpose to talk about monthly admissions because it doesn't -- give you a sufficient idea of any sort of trend. So beginning with this March quarter, we're really just not going to talk about monthly admissions. Our next report on admissions growth would be for the June quarter.

Was December particularly strong at all? Could you at least say.

Yes. We acknowledged on one of the many earnings calls we've had since November, that the December month was particularly strong. This, by the way, I think is consistent. It's been confirmed by most of the other public companies in this industry. December was strong. January and February were weaker.

And that was a proving trend kind of throughout the January through February?

Yes. And I think that, again, if you look back at all the research reports that have been published and comments from other companies, it's all very consistent in terms of the directional trends. Our March numbers are, as I mentioned, stronger than they, you know, other companies in the industry have reported.

Are you seeing the same kind of currently, the same kind of trend?

Well, but that would be a monthly admissions question.

Okay. Fair enough. Thank you. [ Laughter ]

Okay.

Listen, we thank you all for your time this morning. I think we're done with the queue at this point in time. There are no other questions. If you have any, please do call us at any point. And thank you. We will talk to you all soon.

Ladies and gentlemen, this concludes your conference call for today. You may all disconnect, and thank you for your participation.