Tenet Healthcare Corp (THC) 2006 Q1 法說會逐字稿

Good morning and welcome to Tenet Healthcare's conference call for the quarter ending March 31, 2006. 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. The 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. Those forward-looking statements are based on 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 Form 10-K and its quarterly reports on Form 10-Q, to which you are referred. Management cautions you not to rely on and makes no promises to update any of the forward-looking statements.

Management will be referring to certain financial measures and statistics, including measures such as EBITDA, that are not calculated in accordance with generally accepted accounting principles or GAAP. The term EBITDA is defined as earnings before interest, taxes, depreciation and amortization. Management recommends that you focus on the GAAP numbers as the best indicator of financial performance, but is providing these alternative measures as a supplement to aid in analysis of the Company. Reconciliation between non-GAAP measures and related GAAP measures can be found in the press release issued this morning on the Company's website. Detailed quarterly financial and operating data is available on First Call and on the following websites -- tenethealth.com, businesswire.com and companyboardroom.com.

During the question-and-answer portion of the call, callers are requested to limit themselves to one question and one follow-up question. At this time, I will turn the call over to Trevor Fetter, President and CEO. Mr. Fetter, please proceed.

Thank you, operator, and good morning, everyone. I trust that you have had an opportunity to review the press release we issued this morning with our first-quarter results. I will start by giving you an overview of the quarter, and then our Chief Operating Officer, Reynold Jennings, will provide some commentary on volumes.

I hope that you have seen our press release regarding the action yesterday evening by the Inspector General of HHS to exclude our hospital at San Diego from federal health programs. The IG made that announcement after we had prepared our remarks for this morning, but Peter Urbanowicz, our General Counsel, and I will be prepared to answer your questions about that matter during our Q&A.

The predominant themes in the quarter continued to be weak volumes, strong pricing and good cost control. Three years ago, we had isolated but severe problems in pricing and clinical quality, and we had widespread problems in cost control, litigation, investigations, governance, labor relations and relations with uninsured patients. Since that time, we have either resolved or are far along in resolving each one of those issues. But as we have been fixing the original problems, we confronted two new challenges affecting the entire industry -- bad debts and weak volumes. Today, bad debts appear to be stabilizing, while weak volumes remain our number-one concern.

As we worked to resolve the problems that we faced three years ago, we built a solid foundation for the future. We are fighting the volume challenge with the same energy and creativity that we brought to the problems we faced at the end of 2002, and our success in these areas demonstrates that when our team sets out to fix something, we fix it. I'm confident that we will do the same with volumes.

Let me turn to the results for the quarter. We generated net income from continuing operations of $15 million or $0.03 per share and EBITDA of $216 million for the quarter, for a margin of 8.9%. We use two different metrics to describe results in our earnings release, continuing operations and same hospital. Both measures are important, but I'm going to refer primarily to same-hospital numbers in my comments, as I believe those are of the greatest interest to you. Same-hospital numbers are continuing operations excluding the six hospitals impacted by Hurricane Katrina. Operations in the Gulf Coast region are still sufficiently impaired that to include them in the discussion distorts the performance of our core business.

On a same-hospital basis, our EBITDA margin was 9.5%, a 50 basis point increase from last year's first quarter. We identified five distinct items in our press release that had a net favorable contribution of $1 million. We broke these out so that you could decide which of these items should be included in your individual assessments of our current earnings. These items include litigation and investigation costs, impairment and restructuring charges, costs related to Katrina, our unusual tax position and favorable adjustments on prior-year cost report settlements. As we have discussed in previous quarters, we also had a reversal of some temporary spikes in bad debt expense from the last half of 2005, which we estimate added about $5 million or $0.01 per share to earnings this quarter. I will take you through the details on bad debt trends in just a few minutes.

As you know, the first quarter is typically our strongest of the year. The $0.03 we earned from continuing operations is above the consensus estimates for the quarter, but at this point we are not going to refine or confirm the outlook for 2006 that we had issued in March. Our practice has been to issue an outlook only once a year, and after only one quarter it would be premature to refine or confirm it.

Drilling down into the specifics of the quarter, let's start with volumes. The decline in volumes drives the outcome of virtually every other performance metric, and starting with volumes is the only way to place the quarter's results in context. Same-hospital admissions climbed by 3.3% relative to last year's first quarter. Nearly a third of the decline results from the deliberate elimination of service lines or operating entities. The more serious impact on earnings came from the 5.3% decline in same-hospital commercial managed care volumes.

Our activity rose by 1.25% from last year's first quarter and by more than 0.5% from Q4 2005. This was driven by increases in acuity in several of our service lines. In cardiology, we had volume losses in the less intense procedures. Cardiology volume was down 5%, but case mix was flat. In orthopedic and spine surgery, volumes were up nearly 3% and case mix was up 2%. In pulmonary medicine, volume was down by 6%, but case mix was up by 6%. And in general surgery, volume was down by 4% and case mix was up 2%. These were the drivers of the increase in acuity for the quarter.

Let's turn to pricing, where we achieved very strong results for the third consecutive quarter. We recorded a 7.7% increase in same-hospital compact-adjusted net inpatient revenue per admission. On the outpatient side, the comparable metric increased by 11.9%. While the acuity helped slightly, these aggregate increases are especially impressive, as they helped offset the adverse shift in our payer mix away from commercial managed care patients and toward managed Medicare and Medicaid.

The real strength becomes visible when we narrow our focus to just the commercial managed care piece of our business. For commercial managed care, net inpatient revenue per admission increased by 11.8% on a same-hospital basis. Our managed care team has done an excellent job of fixing our pricing problems and putting our hospitals on solid ground in pricing and contract terms. The missing piece is volume, and that is why Tenet's profit growth is critically dependent on volume growth. When we rebuild commercial managed care volumes, these impressive pricing gains will be reflected on the bottom line.

If we had generated the same commercial managed care volumes in the first quarter of 2006 as in the first quarter of 2005, we would have retained additional revenues of about $50 million, with 50 to 60% of that adding to EBITDA for the quarter. We estimate that retaining the managed care volume we lost over the past year would have added 110 to 125 basis points to our EBITDA margin.

Despite the recent declining volumes in commercial managed care, our aggregate portfolio yield on our inpatient business increased by 6.1% compared to the first quarter of 2005. You will recall that in our fourth quarter, we reported a year-over-year increase of 9.7% for our aggregate portfolio yield, so on a sequential basis our improvement moderated a bit. We expect the moderation to continue as we reach the anniversary of some of these strong quarters. These pricing increases offset the volume declines to create 3.1% growth in revenues on a same-hospital compact-adjusted basis.

We also continued to do a great job on cost control. Same-hospital controllable costs per adjusted patient day actually declined by 2.8% from Q4 2005 to Q1 2006. On a year-over-year basis, our controllable operating expense per adjusted patient day rose by 5.2%. Not surprisingly, the line item with the greatest increase was supply expense, which increased 6.2%.

Despite a comparatively more severe decline in volumes, our growth rate in unit controllable costs of 5.2% is below our peers and further demonstrates the favorable impact of our discipline in cost control, which is now hardwired throughout the Company. Given what we have accomplished in pricing and costs, we have set the stage for strong growth in income when we generate growth in volumes.

Let's move on to bad debt. On a same-hospital compact-adjusted basis, our bad debt ratio was 12.9% for the quarter, an increase of 110 basis points from a year ago, but a decline of 140 basis points from the 14.3% that we reported last quarter. You will recall in the past two quarters, we isolated the impact of some systems conversions issues, which caused a temporary increase in bad debt expense. We told you that as we collected these delayed billings, we expected our bad debt ratio to show a temporary decline, reversing the earlier increase. This quarter, we collected the remainder of these amounts, which reduced the first quarter's bad debt ratio by roughly 20 basis points, adding an estimated $5 million to EBITDA.

Another trend in bad debt was that more of our uninsured patients were classified as charity. In part, this is due to the elimination of the adult medically indigent program in Tennessee and the elimination of funding for undocumented immigrants in the California County where Doctors Medical Center of Modesto is located. The elimination or reduction of similar funds in Missouri and Georgia will continue to limit the uninsured, low-income population from eligibility and further increases our charity care.

I'm highlighting this growth in charity partly because I don't want anyone to conclude that we're making more progress on reducing bad debt than is actually the case. The other reason to highlight this change is to follow up on my comments last quarter about cost shifting. Last quarter, I talked about cost shifting from employer to employee. Well, here's another stark example of cost shifting -- state and county governments simply deciding not to compensate hospitals for the care that we're providing to their residents whom we have a federal mandate to care for. I think it's outrageous, and you have got to wonder when this situation is going to reach a breaking point.

The number of charity inpatients increased by 30% from last year's first quarter on a same-hospital basis to over 2,800 patients. Total uncompensated inpatient care volume, defined as uninsured self-pay and charity, rose 8% on a same-hospital basis since the first quarter of last year. It's a rough estimate, but we think that the total uncompensated care that we provide these people is costing us about $0.25 billion per year. That's cost, not charges or foregone revenues, which of course would be considerably higher. Since hospitals are the primary sector of the health-care economy that is bearing the responsibility for these costs, again I have got to ask the question of when this situation reaches a breaking point and gains sufficient attention in federal, state and local governments.

We also had a very active quarter on the quality front. The major national managed care companies recognized in Tenet's advances in quality by continuing to award our hospitals Centers of Excellence designations for an ever-growing number of service lines.

Last quarter, we spoke in great detail about the United Healthcare designations. This quarter, I would like to spend some time telling you about our CIGNA designations. CIGNA's policy is to reevaluate all service line designations on an annual basis. This year, they expanded the number of service lines to 29 from 19, while simultaneously raising the volumes required to be eligible. In 2005, 41 Tenet hospitals earned 95 service line designations as Centers of Excellence from CIGNA. As of today, Tenet hospitals had achieved a 56% increase in Centers of Excellence designations, bringing our total CIGNA designations to 149. To receive these designations requires the hospitals to receive three stars from CIGNA on both patient outcomes and cost efficiency, offering significant advantages to both the patient and the payer.

In addition to these designations, 11 of our hospitals were named CIGNA certified hospitals for bariatric surgery. Because CIGNA awarded only 88 of these certifications across the country, Tenet's hospitals represent one-eighth of the national total. We hope that these certifications, along with the government's recent decision to cover some bariatric procedures, will influence other payers to cover these surgeries going forward.

We have got a number of initiatives to improve quality and grow volume. Our efforts to gain these Centers of Excellence designations are at the heart of these strategies. To benefit from the cost efficiencies associated with these designations, some of the managed care payers are offering to reduce deductibles or eliminate copays. When you factor these incentives into the equation, the ability to link quality and efficiency to higher patient volumes becomes very real and very exciting.

Two and a half years ago, I declared that quality would be our strategy because it was the right thing to do, period. But as these quality designations and plan designs intersect with consumerism, Tenet's investments in quality should show greater economic returns as well.

Let's now turn to cash flow. Cash flow used by operating activities was negative 321 million in the quarter. Including capital expenditures of 117 million, free cash flow was negative 438 million.

While our cash consumption was large, it's important to note that there were several unusual items adversely impacting cash this quarter. First, payments towards restructuring, litigation costs and settlements and discontinued operations totaled $183 million. This includes a $145 million payment to settle a securities class-action lawsuit and a $7 million payment to settle with Florida's Attorney General.

Second, we paid 97 million in the quarter to fund the entire 2005 401(k) matching contribution. This is substantially more than we paid a year ago, because the Q1 2005 funding represented only half the total 2004 contribution. We decided to change the timing of our funding in May 2004 for contributions for the period beginning July 1, 2004, which were then funded in the first quarter of 2005. We made this change to reduce costs, and we estimate that this change will save nearly 15 to $20 million annually, due to employee turnover and eligibility.

Third, our interest payments on long-term debt were $123 million. There were additional payments of $29 million this quarter compared to the prior year, due to the additional debt that we issued in January 2005 and the timing of our interest payments. The first quarter typically has a high cash burn, given the timing of our expenditures. If you look at 2005, for example, you'll see that cash flow improved in subsequent quarters during the year. Unrestricted net cash at the end of March was $975 million. In addition, we had another 263 million in cash that is restricted as collateral for standby letters of credit.

Now, before I turn the floor over to Reynold, I would like to call your attention to a series of organizational changes that we have made over the past few weeks. We appointed one of our senior operations executives to lead a group to execute our outpatient growth strategy. We also restructured our regional operations in Florida and the southern states to better enable our regional leaders to focus on global market business development. I'm proud that we have been able to retain and recognize talented people from within the organization, and we have been able to recruit fresh talent from other fine companies.

With that as an overview, let me turn things over to Reynold for a deeper look at some of the volume-building efforts that are underway in our hospitals.

Thanks, Trevor, and good morning. I would like to begin by commenting on Tenet's inpatient volumes in the first quarter. As Trevor mentioned, we saw a continuation of the aggregate volume decline we have experienced in recent quarters. Embedded in these numbers, however, is a more complex and positive story. 15 of our hospitals actually had strong year-over-year growth in patient volumes, and 11 more had volumes about even with their first-quarter results last year. In other words, 26 hospitals or about 40% of our portfolio delivered reasonably good results in the quarter. The hospitals with the strongest growth were in Birmingham, Atlanta, Omaha, St. Louis, Memphis, the Carolinas and parts of Florida. Since many of these are historically among our strongest-margin hospitals, we see this as good news.

On the other side of the coin, 14 of our hospitals or about 20% of the portfolio accounted for about 90% of our aggregate year-over-year decline in volumes. This group included hospitals in Florida, California and Texas.

Let me give you some detail about what affected these hospitals in the quarter. In Florida, the combination of a warm winter in the Northeast and extensive damage from Hurricane Wilma seriously reduced tourism in the state, as well as the number of snowbirds who usually spend the winter there. These factors, along with the weaker-than-normal flu season, resulted in fewer admissions at five of our Florida hospitals. Also, hurricane damage to condo projects forced some mostly elderly residents who live in the communities served by two of our hospitals to find temporary housing outside the area. However, we believe that situation will reverse itself shortly.

In California, our targeted growth initiatives planned deemphasis of certain service lines accounted for about half of the volume decline there. We attribute the other half to our decision at to California hospitals to reject the unacceptably low capitation rates in a new contract offered by two large medical groups.

In Texas, two hospitals released in Dallas accounted for 24% of the volume decline in that state. Business at those hospitals, Trinity and RHD Memorial, has been hurt this year by the uncertainty generated (indiscernible) their owner, the Metrocrest Hospital Authority, sought competitive bids to manage them once our lease expires in 2007. The balance of our volume decline in Texas was primarily the result of stiff competition from four new and maturing hospitals in Dallas and Houston.

So, to summarize, I would say our volume results are for the first quarter show that a significant portion of our portfolio is doing pretty well, especially in light of the general challenges faced by all hospitals these days. Our overall volume weakness is basically caused by 14 hospitals with very specific issues, and we are aggressively tackling those situations.

Let me now move to our position sales and service program which we launched last year. The results continue to be very encouraging. Our hospital management teams have had face-to-face meetings with about 11,000 of our 13,000 targeted doctors. And as a result, we have identified about 1,600 individual opportunities for service improvement at our hospitals. Based on this experience, we have learned that there is nothing more positive in building and cementing relationships with our doctors than asking them to tell us about issues they have with a hospital and then taking quick action to resolve them. The physicians continue to express appreciation for the visits by our local hospital management teams and the efforts being made to respond to their needs.

On our last call, I gave you some examples of the service improvement opportunities we have identified, all of which fall into three categories -- first, those that are easy to understand and resolve; second, those that can be resolved but will take some time; and, thirdly, those for which we don't yet have a solution. Thematically, these opportunities fall into seven broad categories -- one, process improvement and throughput; two, customer service; three, modernization of our physical plants; three, marketing, advertising and community outreach; four, physician recruitment; six, effective communication between hospital administration and physicians; and, seven, the scheduling, registration and pricing of outpatient services.

Some components of our Commitment to Quality initiative are already implementing significant improvements in critical service areas, such as the emergency department in surgery. With the additional information we now have as a result of our physician visits, we are focused on improving other areas within the hospital and also boosting the spirit of collaboration with our physicians.

With regard to boosting that spirit of collaboration, let me give you three rather simple examples. First, physicians in one of our Houston hospitals told us that our outpatient order forms were difficult to use. We immediately worked with the physicians to redesign the forms and added carbonless copies to save both time and cost.

Second, physicians in East Texas told us that a specialty group at a competing hospital was breaking up, and that gave our hospital leaders the opportunity to recruit two of those physicians to our hospital.

And third, we found that the primary care physicians and endocrinologists in our El Paso hospitals were looking for educational opportunities in bariatric surgery. They were delighted when we quickly gave them copies of our new clinical service manual focused specifically on bariatric procedures.

These examples should make it clear that not all physician-friendly improvements need to be expensive. And as an indication of how well our hospital managers are embracing the value of the physician visitation program, I can tell you that our data clearly shows that the hospitals with the greatest volume challenges also happen to be the ones most actively using the program software tracking tool that we have implemented. I'm optimistic that we have much more value to harvest from this program.

Now, let me talk about the operational effect of local hospital management stability. Of the 14 hospitals I spoke of that drove the lion's share of our aggregate volume decline in the first quarter, three were being managed by an interim Chief Executive Officer, and three others were being managed by newly-hired permanent CEOs. We lost six experienced hospital CEOs in December of 2005, all of whom left because they had been recruited by larger, well-known hospital systems. I see that loss as a bittersweet consequence of our accomplishments in public quality scores, cost control and data-enriched decision-making. Tenet's progress in these and other operational enhancement initiatives have made many of our hospital executives the target of executive search firms.

We are redoubling our efforts to retain our top talent, and one way we are doing that is by making sure our experienced hospital CEOs have a career ladder with us. Fortunately, we have been able to replace our hospitals' departing hospital executives with well-qualified internal candidates in almost half the cases. In addition, our external recruiting efforts have brought us some very good managers from other companies and hospital systems. I'm excited about both the internal and external candidates' enthusiasm for being a part of our future.

Before I turn it back over to Trevor, let me mention that the end of the first quarter, we had virtually completed the latest wave of our targeted growth initiative. This involved 11 hospitals including the remaining two in California, five in Florida, two in the Central Northeast and two in Texas.

With that, I will hand it back over to Trevor.

Thank you, Reynold. Operator, we are ready now to begin the Q&A.

(OPERATOR INSTRUCTIONS). Oksanna Butler, Citigroup.

Well, since you offered to do so, I was going to ask you about Alvarado. What is the status there? What do you envision would be the next steps? And perhaps you could tell us to what extent does this indicate that you are really far from an agreement with the government?

I'm going to ask Peter Urbanowicz, our General Counsel, to address that. Peter?

As you know, two trials in San Diego both ended in mistrials, after both juries deadlocked on whether anyone at Alvarado intended to violate the law regarding physician relocation agreements. We think that the OIG's proposed action is unfair and unwarranted. Nothing in the hospital's practice of recruiting physicians to Eastern San Diego County warrants a forced sale or closure of the hospital, especially given the lack of any evidence that any physician compromised his or her medical judgment when referring a patient to Alvarado.

Since the second mistrial was declared in April, we have been attempting in good faith to resolve the Alvarado matter with the federal government, as we have been working on resolving all the broader issues. I hope that the US Attorney shares our view that a third trial would serve no useful purpose, and that this case should be resolved and dismissed.

It is unfortunate that the OIG announcement did not recognize the jobs of hundreds of health-care workers at Alvarado and access to care for East San Diego County. I spoke yesterday afternoon with several leading doctors on our medical staff at Alvarado, and they are very upset that the OIG would propose this action without even consulting them or anyone else in the San Diego health-care community. And the think it's interesting that this action by the OIG should come more than four years after they first opened their investigation of Alvarado, and after two very long trials that both ended in mistrials.

The OIG is using what is known as its permissive exclusion authority. I'm aware of only one other case, in the early '90s, where the OIG tried to exercise this permissive exclusion authority. It's more typical to ask a hospital to enter into a corporate integrity agreement. The OIG's notice gives us 30 days to present information to demonstrate that exclusion is unwarranted. And once the OIG receives that information from Alvarado, it will reconsider again whether to continue to pursue exclusion of the hospital. If a decision to exclude is pursued by the OIG, the hospital would have the right to appeal the decision in a civil administrative proceeding before an Administrative Law Judge. We obviously hope that the OIG will reverse that position before then. In the meantime, Alvarado is going to continue to treat Medicare and Medicaid patients during that time period.

Despite this unfortunate action by the OIG and this notice yesterday, we are going to continue to discuss an overall resolution with the Department of Justice on a global basis, as we have been doing, and we hope to reach an equitable result. We have said for some time that a negotiated settlement is in everybody's interest, but it has to be fair for all parties, especially for employees and shareholders. So that's a long way of saying we are continuing to discuss things. I think a negotiated settlement makes a great deal of sense for everyone's perspective, and that is what we're going to continue to work towards.

And just as a follow-up, can you just tell us, then, what the Company's options would be here? I think you indicated in your press release you might close the hospital or be forced to sell it. Is this a hospital that was quite profitable? My impression was that it was fairly profitable.

As you know, there's three different things that could go on here. One is, obviously, the US Attorney could try to pursue a third case, a third case in criminal court. We certainly hope that does not happen. I don't think that's in anyone's interest. The second possibility is a civil settlement of all Alvarado-related matters. That is certainly something that can occur. The third thing that could happen -- and it's separate and apart from anything with the Justice Department -- is an exclusion of the hospital after a proceeding or, if that can be can't be worked out, a closure of the hospital.

A.J. Rice, Merrill Lynch.

I just wanted to ask a two-part question related to cash flow and liquidity. Trevor, you mentioned and referred to -- and it's obviously in your notes -- about the 263 million of restricted cash. Can you just give us some sense of -- is that something we should just ignore or can you get access to? And then, if you look at your cash flow from ops after CapEx this quarter, I understand the seasonal and one-time issues you highlighted. Can you give us some flavor -- when you put out earlier in the year that you thought you did 200 to 300 million use of cash flow from ops after CapEx this year, are you at the end of the first quarter on track with that? Is it about where you expected, or are you a little bit behind?

I'll start with the credit line piece. That restricted cash supports letters of credit that back up Workers' Compensation insurance, different programs like that that tend to be statutory, in different states where we operate. And you may remember a couple years ago, we had a bank credit facility that we terminated, because we had all this cash and we were not drawing on the facility but we were paying fees to keep it alive. And given the liquidity position that we have had, we felt it was inefficient to pay banks, essentially, to issue those letters of credit, so instead, we cash-collateralized them.

I would expect that at some point in the future, if we have a more normal type of capital structure, perhaps following some sort of overall settlement, that we would not continue to use that much cash to collateralize those letters of credit. Instead, we would enter into some more traditional financing type arrangement with banks to cover that. I don't think you should think it's a permanent thing, but you shouldn't think it will go away until we have sort of a permanent capital structure in place.

Then, on the issue of cash flow, the way I would think about it is if you take the amounts that we spent on litigation and discontinued operations, and you assume that that's part of the resolution of our issues -- and in fact, that shareholder litigation was one of the most major issues we faced, from a dollar point of view, since in theory, the claims could have totaled something like $18 billion. So that expenditure, I would suggest that you could characterize as being unusual.

And then, this 401(k) -- I know that's a bit of a complicated subject, but we have pursued numerous cost reduction initiatives for the past few years. And one of them was this initiative to reduce the cost of matching our 401(k). So we essentially front-loaded all of the matches into the beginning of the year. You could take that amount, which was roughly 100 million, and annualize it, if you wanted to create something that was comparable to other quarters or comparable to companies that match every payroll period as opposed to once a year. And I think, if you make those adjustments, that gets you to about $100 million of positive cash flow from operations. And then, our outlook for capital expenditures called for about 550 to 650 million a year. We spent less than a quarter of that in the quarter, so you can make whenever adjustments you want to there.

But I think you would conclude, if you looked at both the cash flow from operations number or the free cash flow number, after making those adjustments to normalize some of these timing-related expenditures, that we had come in with about $100 million of positive cash flow from operations, about negative 50 on an adjusted basis of negative free cash flow. And I think if you compare that to the outlook that we issued in March, it's pretty much on track.

Adam Feinstein, Lehman Brothers.

This is actually [Raj Kumar] filling in for Adam Feinstein. My question is related to the labor contract. In 2003, Tenet signed a labor contract that [provided a payment] for prenegotiated (indiscernible) benefit. I believe this agreement is set to expire in 2006 or it had already expired. Can you give us some details on how the renegotiation of the labor contract is going? And are you expecting any significant changes to the terms of the contract?

What you are referring to is the waiver peace accord that we entered into in about the spring of 2003. It was a four-year contract, actually, so it expires around a year from now. And then, there are contracts under that blanket agreement with different unions, depending on which unions have unionized our hospitals. This activity was primarily in California. So we have until the end of the year, really, to negotiate a new agreement or not with the labor unions.

I think it has been important for us to have good labor relations the past three years, and our intention is to seek a reasonable extension of the peace accord. But we have not had, yet, substantive discussions with the labor unions about this. I think that the appropriate time to be doing that probably is over the next several months.

Glen Santangelo, Credit Suisse.

Just two questions, if I could. I wanted to talk about volumes a little bit. And I appreciate the detail, and you kind of highlighted California and Texas and Florida as being the reason for the weakness. Could you just kind of go over Texas again? Because I didn't catch all that. And then, secondly, could you maybe just give us a little bit more color on the commercial managed care admission? They were down over 5% this quarter, which is the first quarter we have seen a drop-off that big. If you could maybe give us some color geographically what's going on, and maybe what you're doing to address the split of physicians, that would be helpful.

First of all, in Texas, Texas is a non-CON state. So anybody wants to build a hospital or an outpatient service can do that, if they think that's a good business idea. So, over the last three or four years, there have been two brand-new hospitals built in North Houston and three brand-new hospitals in North Dallas. And like all new hospitals, they typically start out a little bit slow, dealing strictly with the emergency room volume that comes in, and then they work on developing their medical staff. And so it's not only us, but others in those particular areas, other for-profit and not-for-profit hospitals, typically lose a section of your medical staff to any new hospitals until the doctors find out whether that is productive for their practice or not.

So over the past 12 months, all four of those hospitals were beginning to get into the second or third year of operation, in which they are more specific about their strategies and their plans. The doctors are beginning to see more information and make a concrete decision about whether using that hospital more or less is in their best decision to do that. So that's why Texas is unique in that particular standpoint.

On the issue of the commercial drop, again, in all the data and information that we have looked at, it is the continuing litany of numerous things, some of which I talked about earlier on, as well as 15 or 20 other things I've talked about over the last six quarters that are an influence by a particular hospital or a particular geographic area.

So, again, there's no more color that I can give you that would be more specific than all the things we've continually talked about. And we feel good that the physician sales and visitation program, the five-year capital plan, the enhanced acquisition of diagnostic and clinical equipment and those other things, the target growth initiative are all the right things in combination to eventually make a turn on this.

I also believe strongly, as I've said many times before, is that it takes a new hospital CEO about 18 months to earn the confidence of the medical staff at large or, particularly, doctors who use more than one hospital. And so, as I indicated in December, that was a setback for us. And again, those six hospitals were a key part of the hospitals experiencing the volume drop. So I wish I can give you any more definition, but I think I've done a good job of covering all the multitude of essentials that are going to affect this.

If I could just ask one last question on the outpatient side, obviously the Company continued to have soft results there. Should I think about the weakness geographically similar to the inpatient admissions, or is there something unique about the outpatient side that's contributing to the softness?

On the outpatient side, again, closing or selling our home health-care entities over a two-year period of time, as well as closing down a lot of Workers' Comp clinics, predominantly in Florida, was a major part of the bulk of our volume decrease. We were extremely pleased last year that the outpatient surgery volumes planed off from a two-year drop, and that gives us a lot of confidence that some of the things that we're doing are beginning to stabilize that and make progress. And as I indicated, we put out a press release the other day naming Steve Corbeil, one of our regional Senior Vice Presidents, as the individual who is going to start building and heading up a focus in outpatient services. And so we think we will have a lot more exciting things to talk to you about in the future.

Todd Corsair, BS.

With respect to to your Philadelphia market, with the movement of Mr. Corbeil out of that region and into his new position, is that market which -- my understanding is it has not really been considered one of your core markets historically. Is that something that you guys potentially continue to be evaluating for potential divestiture?

We are always evaluating all of our markets for performance. We've been working intently with all of our hospitals that have failed to meet our expectations of minimum margins and returns on capital and things like that. And Philadelphia has been a very challenging market. It's a market that is dominated by two managed care payers. Collectively, they have about 80% of the market. They pay some of the lowest rates that we are paid in the nation. It has high labor costs, heavily unionized. It is it tough market. I left out malpractice, which is very challenging in Pennsylvania.

But I'm not going to make any comment about any acquisition or divestiture plans on this conference call. I will just tell you it's no secret that that has been one of our most challenging markets. We do have some fine hospitals in Philadelphia. We're very proud of the work that they do. Two of the hospitals that we have there are academic medical centers affiliated with the Drexel University College of Medicine. One of our hospitals there, St. Christopher's Hospital for Children, is one of about two dozen children's hospitals in the United States, and it's the only one that we own. These are outstanding hospitals. There's nothing wrong with them; it's just a very challenging market.

I think you guys had commented in recent quarters that operators in those markets had actually achieved some improvements in operating results. Does that continue to be the case?

We had some very significant challenges in Philadelphia. The Philadelphia market, prior to 2003, was profitable but almost entirely on outlier payments. And once we voluntarily suspended taking the outlier payments and they changed the rules, the market became unprofitable overnight. We have improved our performance there, and we have also invested in that market, and we continue -- like I said, we work with all of the hospitals that we have, the ones that Reynold has identified as being underperforming, to improve their performance.

And this one will just be for Peter. In terms of our thinking about the potential for a more global -- some kind of a global resolution to the Company's legal issues, is it possible that the action which the OIG is taking here for the release last night, that that type of action could be instituted without buy-in for people at the most senior levels of the Department of Justice?

Well, you have to recognize, Todd, that this is a different agency than the Department of Justice. The Department of Justice tries cases on behalf of the United States. It's the one that's in charge of, through its US Attorney, the case in San Diego. This action is by a branch of the Department of Health and Human Services, the agency that actually runs the Medicare and Medicaid programs. So their actions are separate and different than what the Department of Justice does, and they can do whatever they want to do, separate and apart from the Justice Department. And I think that's what you see is going on here.

We will leave it up to you to decide whether it's a coincidence or not.

Right. Clearly, different branches of the same tree, but would suspect that there is likely communication between the two agencies within the government. So no opinion on whether there's any kind of coordination there?

No comment. You have asked four questions, so your time is up.

Darren Lehrich, Deutsche Bank.

I want to just clarify something with regard to your cash balances. I believe you have said previously on calls that your cash balances, at least at last year's time, would be sufficient to settle any government settlement within a reasonable amount, I think were your words. And with your cash balances now roughly 400 million below where they were at that point, I just want to confirm that that statement still holds up.

And my real question here really is for Reynold. I'm just trying to understand a little bit better how your outpatient initiative is going to be different than the TenetCare initiative that I think we launched a few years ago. Just maybe compare and contrast what you're doing today versus what you had launched several years ago.

I don't recall specifically, offhand, what I might have said about the cash last year being sufficient to fund a government settlement, but I will assume you are correct on that. As Peter said, we continue to work towards some resolution of these issues -- some of which are under litigation, some of which have never been litigated, like the whole outlier matter -- to reach a fair and appropriate settlement. And I think that it's important for all parties to recognize that Tenet's financial position has deteriorated in the past year. Clearly, Katrina alone was a significant negative turning point for the Company.

But I'm not going to make some sort of a prediction about what a settlement amount might be, how it might relate to our cash position. I would only say that our objective is to reach a fair settlement and move on from that fair settlement in a manner in which we have not imperiled the Company, in which we have sufficient liquidity for our operations and sufficient capital to invest appropriately in our hospitals.

Many analysts have commented on the levels of investment that we have been making in the hospitals. I think you'll notice that we have increased those levels of investment lately. Whether you measure it on a per-bed basis or on an aggregate basis, we are investing healthy amounts in our hospitals. We're doing it in a far more targeted way. I spoke about that at length in the last quarter, about how we are investing in equipment and service lines as opposed to simply new towers and wings in our infrastructure. But we need to have capital for all these things, for resolution of the past issues, for ongoing liquidity and to invest in the success of our company going forward. And that's our objective. And I can't give you some prediction as to whether we will meet that objective or not.

And on the outpatient?

Yes, on outpatient --

I would like to call Steve Corbeil up, because he's there with us, to answer that question. But as Steve comes up, I'd like two correct to questions back, which is Steve is still managing our hospitals in Philadelphia, St. Louis and Memphis, Tennessee. But in reconstituting the former southern states region, we proactively did that for a number of reasons that were in our press release, but also to make sure that Steve had adequate time to provide leadership to this new, important [view on] outpatient.

So with that, Steve Corbeil?

Thank you, Reynold. Darren, you had asked about how this is going to be fundamentally different from our TenetCare model before. But put in context, this is currently a very large part of Tenet's business, approaching 30% of our net revenue. And clearly, by all indications, this is where our business is going, the growth primarily being driven by technology and payers.

So we really went to build upon the success we've had in TenetCare. For the most part, those models and those centers that we currently have have performed very, very well. The difference, I think, is going to be is that our focus will be for a broad array of outpatient services, not just limited to ASEs or endoscopy centers or even imaging centers. There's a lot of growth in other related type outpatient centers.

I also think that what's different here is that we're going to leverage what we have done in our Commitment to Quality and expand that into our outpatient side of our business and also use the disciplined, targeted growth. As we've started to use targeted growth at our inpatient side and outpatient, we really one to, again, fully apply targeted growth as we focus on those outpatient businesses.

So there is a lot in the pipeline right now. We have about 20 projects that we're evaluating. The whole reason we formed the group was to accelerate these projects and get them to market as quickly as we can.

John Ransom, Raymond James.

If you looked at your portfolio today, what, roughly, percentage of hospitals that you own now would you consider to be performing at acceptable levels? And what percentage would you consider to be below your target?

We're having trouble hearing the introduction. Is that you, John?

Yes.

We can hear the question real good, but we can't really hear the name of the person that well, so we will get that fixed by the name time.

John Ransom, Raymond James.

Yes. Again, as I said last earnings call is that right now, I've got about 15 hospitals that the managers and I are working on, and which we believe that we have got to find a way to move their volumes and earnings up to something that's more reasonable and makes a fair contribution. Outside of those 15, we're seeing a lot of good signs of progress in several dimensions on the revenue, pricing, cost control and volume side. And so this, as I sit here today, that number is still pretty much close to about 15 that cause me to stay awake at night and figure out what is the next solution, and how do we speed up the resolution of certain issues they have -- again, many of which are specific to their locale.

And would that roughly correlate to what percentage of hospitals can carry themselves from a free cash flow standpoint? So you would have 45 that might be cash flow positive and 15 that are cash strained? Is that a good way to think about it, or is it (multiple speakers)?

Yes. Again, I think we have been pretty clear that the first goal when you're doing a turnaround is that a hospital be able to meet its five-year business plan and capital needs and then, secondarily, make a fair contribution to interest on debt and corporate overhead.

And then, my second question is, looking at your physician composition, I know the rural hospital guys make a big deal about how many physicians they have recruited and their net physician adds. Have you guys looked at that? Is it as relevant for an urban hospital chain with as many splitter physicians? And how would you characterize your overall physician staff, numerically? Have you been able to grow that over the past couple of years? Are you still fighting some of the perception issues from legacy management?

Well, that's a pretty broad question. But in general, yes, it is very important to us because if you have approximately 13,000 doctors, whether they use one hospital or several hospitals, again, they are aging. They are making trade-off decisions based on malpractice risk about what things they will get credentialed to do. They have health problems. They move.

And so, again, for a company our size, replenishing at least about 400 physicians a year is the minimum order of the day. And again, we have been more conservative than some of the other companies on relocating doctors from outside the area into our hospital area, and that number is about one-fourth of what it historically had been three or four years ago.

But the thing we're really concentrating on right now is that, for example, last year we had 1,000 doctors who voluntarily joined our medical staff of their own voluntary desire. And so again, as we do the physician sales and service calls, the first thing we want to go to is what do we have to do to make those 1,000 doctors more of a core loyal physician who selects our hospital for most of the services that they need for their patients?

Is the net number growing or shrinking or stable? That was my question.

Which number?

The physicians on staff.

The core group of doctors who admit to mostly our hospitals showed, I think, year over year 2005 over 2004, about a 200 drop, roughly in that neighborhood, out of the 3,700 physicians that we reported constitute the core group. Again, those factors I mentioned, which is health problems, aging, getting out of certain services and letting hospital [list admit] and those kind of things are a lot of the issues that grow that particular change.

And then, finally, just a quick numbers question. I know Trevor talked about $100 million. As we calculate it, you have 321 million in reported cash flow from ops. If you add back 145 million for shareholder, 30 million for other settlements, add back three-fourths of your 401(k) payments of 73 million, and then 8 million from discontinued ops, you get a $65 million cash burn. And then you subtract 92 million of CapEx. I get about $157 million cash burn in the quarter, so that kind of normalizes out at a 600 million cash burn for the year. That seems high. It looks like your payables dropped a lot more than normal, but I just wondered what we are missing. And I'll stop there. Thank you.

You know what? What I did was I took the actual numbers, and the only things I adjusted for were to normalize 401(k) and the interest. And I didn't hear whether you normalized the interest or not. And I separated out the discontinued operations and so forth. The accounts payable activity, we would assume we would be growing payables throughout the year, because some of these cash payments are front-loaded, so then you are accruing constantly throughout the year. So you are creating working capital in that way. That may be the difference. I didn't really follow every number that you had, but I think that maybe the big difference in the assumption.

So you normalize -- you did some manual adjustment to normalize the payable trend? Is that what you're saying?

Yes.

We did not have a way to do that.

And I would say, look at last year for those trends, to see how that works. And obviously, something like the 401(k) was not as extreme last year.

One other comment to your last question to Reynold. We talked in previous quarters about our Commitment to Quality initiatives. One of the things was more rigorous credentialing standards, and I think that may have also contributed to some, I don't know how many, of the drop in physicians that Reynold mentioned.

Miles Highsmith, Wachovia Securities.

Just a technical question, first. Maybe, Peter, this is for you. Just sort of looking at the -- back to the OIG, looking at some of the language, it was mentioned that post the 30-day period, if OIG decided to move forward and proposed exclusion, that Alvarado would have the right to an administrative appeal. Just wondering if you could sort of talk to us about that option and what the steps might be that are associated with that.

And then, secondly, just kind of a general question getting back to bad debt. Knowing that the total uncompensated care is up pretty significantly year over year, sort of going back to the allowance for doubtful as a percent of growth -- I know this bounces around. I'm sort of in the 26 range, down from year end at 28%. And again, even though that bounces around, sort of down from 30% at the end of March last year. And my sense would have been that it was some uninsured volumes outpacing the overall admissions, that we might have seen that more stable. Just kind of wondering if you could piece some of that together and kind of help me understand what I'm missing here.

Peter is going to address the Alvarado question, but I have to say I was thoroughly confused by your other questions. Once Peter finishes Alvarado, we will try to get you to restate that second question and see if we can answer that.

On the timing on an exclusion proceeding, the IG -- the letter is the very first preliminary step in an exclusion, a permissive exclusion proceeding. And the 30 days is to present preliminary evidence on our part on why it is not appropriate to do an exclusion in this case, which we have said we think this is highly unusual to do something like this, and it's certainly not warranted in a case like this, especially after two juries have been locked and there have been two mistrials.

After that period of time, once they get that information, the IG can do a couple of things. One, they can decide to continue with their exclusion proceeding or they drop it. If they pursue it, the hospital has the right to a hearing before the Administrative Law Judge. Those are individuals who work for the Department of Health and Human Services. And you go through a hearing; it's like another trial. And then, after that, there's another level of review. It's called the Departmental Appeals Board. It's also part of the Department of Health and Human Services. And after that, an excluded party always has the right to go to a federal court for further appeal.

All that being said, this is something that takes quite a long period of time. And our position all along is that this has gone on for three years. It's really time to resolve the issues at Alvarado and move on. Just the notion of putting an exclusion notice out there is something of a death sentence for the hospital and really unwarranted, given the factual circumstances out there.

And as a practical matter, you can't really operate under that cloud, because physicians and patients and employees just don't know if, at any moment, the hospital is going to have to cease taking Medicare patients that day.

So now, back to your other question. Can you try that again?

Sure, sorry, I kind of rambled. I guess the core of the question is, even though I know it bounces around, why is the allowance for doubtful so much lower than it has been in previous periods, and sort of declining over the last four to five quarters? Just trying to get a sense -- has there been a change in the quality of your receivables portfolio? And I guess I'm just wondering, because I'm seeing the uninsured admission trends sort of outpacing the negative overall admission trend. I guess the core question is, why are we seeing a 400 basis point drop in the allowance as a percent of gross AR?

I think what we're going to have to do is get back to you on that. We have not made any accounting policy changes or anything that would obviously make it many different. And I think, if you could call Tom and follow up with him after the call on that question, we will try to shed some light on that.

The obvious place that we would look first would be the adjustments we make for the compact with the uninsured. That tends to distort all these numbers, whereas we give you the percentage of revenues on a compact-adjusted basis, but the balance sheet is presented on an actual basis. And while we are in transition, I think for another three quarters, before we have completely anniversaried the implementation of the compact, I think you are going to have some of those distortions on the balance sheet. That's what I suspect is the case, but please call Tom for a more definitive answer.

David Common, JPMorgan.

Just following up on this Alvarado situation, as you point out, if there is a risk that the hospital could have to cease taking Medicare patients at any time, can you end up in some sort of crazy between a rock and a hard place, where the state or someone else weighs in to say that the facility cannot, in fact, be closed, and you have to continue doing health-care pro bono, as it were?

Well, this whole matter has been full of surprises, and I suppose that's another one that could theoretically occur, although that would be extremely unusual.

I think that's really something that the local community needs to weigh in on as part of this process as well. I think the people in San Diego, especially the doctors and the patients, should indicate how that hospital should function and how essential it is to East County San Diego. One of the doctors on the staff is the President of the San Diego Medical Society, and they are extremely concerned, because this hospital operates a very essential emergency room for the people of East San Diego County. And so there's a lot of public policy concerns that ought to go into a decision to suggest closing a hospital, especially a hospital in an area of town that really has no other access to care.

Sheryl Skolnick, CRT Capital.

I want to thank you very much for all of the very detailed explanation. My first question should be a quick one, and that is, can you update us on the CFO search? And my second question is related to the cash flows that I believe you got from insurance settlements for Redding and 36 million of the proceeds from Katrina settlements. Where were they on the income statement? I think I know where Katrina was, but I don't think I can find the Redding settlement. And generally, can you speak to the issue of how you think you are doing with respect to getting more of the potential $250 million available for New Orleans? And then, the final question is, last quarter you were quite eloquent, Trevor, discussing the concerns you have about the rise in self-pay portion of insured bills from higher deductible plans. Is that also still an issue for you this quarter?

I think I wrote quickly enough to capture those areas, but I only got three. I thought there were four. But I will just start with the CFO search. We have been very deliberate on this; it's obviously a very important decision for us. We're not ready to make an announcement or a prediction on it, just to say that in the absence of having a permanent CFO named, we have been doing just fine. We have a strong bench in finance. We have a group of capable people who have been here for a long time. I have some degree of familiarity with the subject matter myself, and so I wanted to make sure that we get this right. And beyond that, I don't really have anything to say about it.

On the cash from insurance, the reason that you have not seen it on the income statement is that we have had a practice that we, I think, believe have disclosed on previous conference calls that we don't book it until we actually receive it, with the exception of this Redding one, I guess.

And on the Katrina insurance, I think we have recovered $100 million so far just out of interest. That approximates what our costs were in the rescue and supporting employees in that area and doing minimum required repairs to some of the facilities there. We obviously are pursuing larger amounts from the insurance company, since the damage is substantially greater than that.

And on Redding, this amount that we have in our 10-Q is really the first recovery along from the Redding claims that we have made.

So, as I look at that total potential pool of insurance recoveries that you are pursuing -- not that any of it is guaranteed, I understand, but that you are pursuing -- does that leave about another 150 million, potentially, to be pursued from Katrina and another 300 or so? Or is it 200 or so, from Redding?

Well, I can't make a prediction about that. What you do on the math is take the amounts that we paid out in Redding, assume that we are making a malpractice claim for the most substantial amount that we can, minus the deductibles, and subtract this 45 million. I think that if you do that math, that gets you to about 200 million in Redding.

And on Katrina, obviously, we have tremendous damage that occurred as well as business interruption to what was a significant market for the Company. So that's one that is the subject of negotiations, hopefully not litigation, with the insurance carriers as we move forward. And what we have gotten to date is sort of what we have been able to negotiate with carriers. You know that works. They are all separate, you know.

So there is the opportunity to get additional capital cash into the Company if you are successful in pursuing this? That's kind of what I was --

Yes.

-- still getting at. Okay. (Multiple speakers) As we consider the cash position of the Company, you don't want us to think that charity care is solved. I don't want to overestimate your -- a liquidity problem; I want an understanding of how much might also come in that is not immediately obvious.

Right. Exactly. And I will tell you two things I have learned about insurance. One is, whatever coverage you think you have, good luck in trying to collect on it. The second is it's a long and arduous process of having the insurance carriers assess the damage, then negotiate about exactly how they are going to deal with it. It's very frustrating. Just like the residents of New Orleans are struggling through this on their homes, we are struggling through it with respect to our hospitals. We are not giving up, and we believe that we have excellent claims remaining.

And the last question was on the self-pay AR portion of insured claims. Is that still rising?

Yes. And let me just say I try to get on a different soapbox each quarter, so that's why I let that one rest. But Steve Mooney, who is head of our revenue cycle, is here. Do you want to make a couple of comments, Steve?

Yes. I think you remember from Trevor's prepared remarks last quarter, he mentioned that we were about flat on the volume but about 17% on the inpatient side. This quarter, we didn't see the same trend on the inpatient side. We actually were about 8% down on volume and about 7% down on dollars, in the inpatient.

On the outpatient side, it's a different story. We actually saw a decline on volume by about 2% of the copays [and doubles] coming through but an increase, about 11.3%, on the dollars. And more alarming was those dollars above $1,000. We actually increased those patients by 14.2% and actually in dollars by about 28.6%. So overall, for the total inpatient/outpatient, we declined about 3% on volume and about 1.4% on total dollars. So it's still an alarming trend for us.

Gary Taylor, Banc of America Securities.

One quick question on the Redding insurance settlement of 45 million. I understand that's in discontinued ops on the income statement. But that is included in your cash from ops of the negative 321?

No.

That's excluded? So that appears somewhere down below?

It's because we have not yet received the cash.

Oh, okay, just recorded the recovery?

Yes.

So it will show up in cash from ops (multiple speakers)?

It just had to do with the fact that we were making this deal at the time that we were preparing the 10-Q. So that's why you have that gap. Normally, we would not have had that. [It occurred] within a quarter.

My last question, and I had to jump on the call late, so if you covered this, you can just shut me down. I continue to read the stats and the impressive stats you disclose about the growth in your commercial yields per inpatient admission and overall inpatient yields. And then, obviously, when we look at overall net revenue per adjusted admission, the growth is moving in your direction but it's not nearly as strong. And I guess I'm trying to understand, is that suggesting that there's more pricing pressure on the outpatient side, or is that indicative of just mix changes? Or what would be causing the differential to be as wide as it is?

I'll answer the question even though the operator, when she read that forward-looking statement thing, also said if you jump on the call late you can't ask any questions. That's a new thing that we've added to the disclosure language.

But the difference primarily -- first of all, I read the transcripts of most of the other conference calls. We break out a lot of statistics that I don't see elsewhere, so I hope that that is helpful, although I know it can also be confusing. The big difference typically between the yield statistics that we represent on commercial, whether it's inpatient or outpatient, and then down to these aggregate yields has to do with the growth of managed Medicare and Medicaid, where obviously the types of price increases that you're able to get are associated with aggregate increases in those government programs, not with what you're able to negotiate, as you do on commercial. So that generally will account for the difference as you move down from the highest statistic to the lowest statistic.

And generally, on outpatient reimbursement, your rate increases are positive and in the mid single digits? Is that fair?

No, the outpatient has actually been stronger than the inpatient, but the reason is we started in a position of -- and you know, because you have followed the story for a long time, this is a three-year process of completely restructuring our portfolio of managed care contracts and pricing in the Company. And a blanket observation I would make is prior to 2003, the Company had focused entirely on inpatient pricing and driving it largely through gross charges. So, when we began this multi-year process of restructuring the contract, we started with high inpatient prices but low outpatient prices, and the low outpatient prices below where they should have been. So that's one of the reasons that you have been seeing that stronger pricing growth in outpatient.

Thank you. I would like to turn the floor back over to management for any closing remarks.

Thank you, operator. This concludes the call, and we will see you next quarter.

Thank you. This concludes today's Tenet call. You may disconnect your lines at this time, and have a wonderful day.