Tenet Healthcare Corp (THC) 2006 Q3 法說會逐字稿

Good morning, and welcome to Tenet Healthcare's conference call for the third quarter ended September 30th, 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 and makes no promises to update any of the forward-looking statements.

Management will be referring to certain financial measures and statistics, including measure such as EBITDA, which are not calculated in accordance with Generally Accepted Accounting Principles, or GAAP. 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 1 question and 1 follow-up question. At this time, I would like to turn the call over to Trevor Fetter, President and CEO. Mr. Fetter, please proceed.

Thank you, operator, and good morning. I'm going to focus my remarks on the 2 headwinds that we've been fighting all year, weak volumes and unprecedented high levels of bad debt expense. Let me start by giving you my perspective on these problems at a high level. 2 trends that affect hospital volumes and bad debt expense have been taking place in the health benefits area. People have health coverage that is less comprehensive, and they bear a responsibility for a higher out of pocket portion of the cost of their healthcare. The weak volumes and higher bad debt expense across our industry have been in evidence now for a little bit more than 3 years. Over that same period of time, there have been 3 related trends in employee benefits. First, fewer small employers, defined as companies that employ under 200 people, are offering health benefits at all. The percentage of small employers offering benefits has dropped from around 65% to 60%. Fortunately, employer-based health insurance in large firms is still high. 98% of firms that employ more than 200 people offer health benefits, and that percentage has been either 98% or 99% for each of the past 3 years. But most of the job growth in this country, 84% to be exact, has been occurring in small firms during the 3 year period I'm talking about. As more people join small employers, and those employers stop offering health benefits, more people become uninsured.

The second trend is that the percentage of employees of all firms, regardless of size, who are covered by employer-based health benefits has dropped from 62% to 59%. This is due to a variety of factors, such as employees not choosing to take the coverage that is offered to them, as well as firms structuring their workforce with an increasing percentage of part time workers who don't qualify for benefits. It's very important to remember that 80% of the uninsured have at least 1 family member who has a job. So these people have jobs, they just don't have insurance. It's either because they've chosen not to pay for the employee benefit, or they can't afford to pay for it and still meet basic needs, or because their employer effectively does not offer it to them.

The third trend is that in response to rising costs, employers of all sizes have steadily reduced the portion of health costs paid by the company, and have shifted those costs towards the employee. Traditionally, the split between the employer portion and the employee portion was 80/20. That ratio has changed just in the past 2 years, it was 78/22 in 2005, and estimated to be 77/23 in 2006. While this may not sound like a big shift, as employers are generally thought to be moving towards 75/25 shift -- or 75/25 split over the next few years, this has resulted in double-digit percentage increases in health premiums to employees in each of the past 3 years. These increases far exceed the percentage increases in wages generally, so it encourages employees to select the least expensive options or to drop coverage. The least expensive plans typically have the highest deductible and co-pays. Tenet is actually on both sides of this problem. In the spirit of full disclosure, as a large employer, we've been pursuing these and other strategies to control our own benefit costs.

So these 3 trends affect hospitals in ways that we can't completely quantify. First, they may have the effect of suppressing volume, because of the increasing cost to the patient. Second, when the patient does get treated, the financial burden is one that they choose not to pay, or cannot afford to pay. The bottom line is that a cost that has traditionally been borne by employers, is now being shifted onto employees, who shift it onto doctors and hospitals. In the simplest terms, we ultimately collect $0.97 of every $1 we bill to insurance companies, $0.60 of what we bill to insured individuals, and only $0.08 of what we bill to uninsured individuals who don't qualify for charity care. These collection rates show the dramatic effect on Tenet's earnings that can be caused by trends in employee benefits designs that I mentioned earlier.

On top of this, there's an additional factor suppressing industry volumes for which we don't have hard data to provide statistics, but we see the impact in subtle ways. Managed care companies have been clamping down on utilization of medical services. The industry term is "increased medical management." This has tended to go in cycles during the past 10 years, but for the last 2 to 3 years, managed care payers have been reverting to tougher controls on approving care, which suppresses hospital admissions and length of hospital stays. At Tenet, our Commitment to Quality initiatives have placed us ahead of this trend. For example, when we adopted InterQual admission standards and American Heart Association and American College of Cardiology appropriateness criteria beginning 3 years ago, we were effectively preventing admissions for medical services that the managed care companies might later disapprove under tighter medical management standards.

Let me tell you what we're doing to mitigate the industry factors that I just spoke about. In the area of bad debt, in addition to initiatives that we've previously discussed, we have enhanced our collection processes and intake procedures by refining our self-pay segmentation, introducing new easy to understand patient billing statements, and creating a new letter that we send to managed care patients with their estimated balance due. September was the first full month in which we sent the letter to patients with balance after insurance, and that alone generated an additional $1 million in cash in the month. We also completed our center for patient access, or [CPASS] pilot with very impressive results. The results demonstrate an increase in the percentage of scheduled preregistered patients financially cleared before service, from 70% to over 95%. Although it's too early to see the results on denials and bad debt expense, we expect it to be positive.

We've talked at length in prior calls about what we're doing to grow patient volumes. Although Q3 was weak, I'm pleased to say that Q4 is off to a good start. Admissions increased 1.2% in October. Our preliminary information suggests that commercial managed care admissions grew in the month by 0.6%, so the admissions growth was not driven entirely by the uninsured. Now please remember, this is only 1 month of volume data. We have not yet closed the books for the month. Also to give you some context, in October, 2005, admissions declined by 3.1% versus October, 2004, for these same hospitals. Normally, we would not report on 1 month's data, but we thought we should bring October's admission results to your attention, because it represents a very substantial change from the results in the third quarter. A part of our reasoning was that if this were a 400 basis point swing in the wrong direction, we also would have disclosed it.

We've laid a foundation for growing volumes with the following categories of actions. First, resolving the legal overhang that clouded the Company's future. Second, injecting capital into our hospitals and making commitments to our physicians and communities that we will keep these hospitals competitive. Third, actively managing our service lines through our Targeted Growth initiative. Fourth, employing classic sales techniques through our Physician Sales and Service Program to draw attention to these investments and ask physicians for their support. Fifth, driving better managed care contracting through the strategic use of data and information systems, and through participating aggressively in the payer's quality designation programs. And sixth and most importantly, differentiating our hospitals on quality and service. I'm confident that this approach will work and it will be sustainable. Reynold will cover the volume topic in detail in a few moments.

Turning to quality, those of you who have followed us for at least 3 years know that our strategy is to differentiate our hospitals on quality and service. You have been patiently waiting for proof that quality and economics go hand in hand. The first results we were able to report were the CMS Hospital Compare ratings. At our investor day, I went into detail on this, and the presentation is still on our website. Suffice it to say that our improvement trajectory is steeper than the national average, our performance compares favorably to some of the finest hospitals in the country, and our quality ratings are ahead of our peer companies. The next results we reported were the numbers of Centers of Excellence designations we received from major payers. Our UnitedHealthcare Centers of Excellence designations were 5 times the national average rate of designation. Now we're able to compare volumes in those hospitals with Centers of Excellence-designated services to see what it means in terms of volume to differentiate a hospital on quality.

Cardiology DRGs are the most mature of these programs. In the first 9 months of the year, our UnitedHealthcare Centers of Excellence hospitals grew cardiology volumes by 11%. This growth is incredibly strong. During the same 9 months, cardiology volumes from United in our non-Centers of Excellence designated hospitals were up 3%. To place this in context, our cardiology volumes across all payers in the first 9 months of the year were down 5%. Total cardiology admissions from just managed care payers were down 3%, which is in the range of the overall admissions decline. So, in a service line that was down more than overall admissions, through our managed care contracting strategies, we achieved 2% better volume managed care. That's the difference between negative 5% and negative 3%. We achieved growth of 6% with UnitedHealthcare overall, and when we obtained the UnitedHealthcare Centers of Excellence designations, we grew cardiology volumes by 11%. And again, that's for the first 9 months of 2006.

We knew at the outset, that pursuing distinctive quality would be the right thing for our patients. These statistics show that it's also the right thing for the economic well being of our hospitals. And with that as an overview, I'll turn the call over to Reynold Jennings for a more thorough explanation of our operating performance in the quarter. Reynold?

Thank you, Trevor, and good morning, everyone. I want to focus my comments this morning on 2 issues which are central to your understanding of how our performance improvement plan is coming together. These topics are, first, an update on the results of our Physician Sales and Service Program, which we refer to as PSSP. And secondly, the issues which have led to delayed earnings recoveries in 3 important markets: Houston, Texas; Palm Beach and Broward Counties, Florida; and certain California markets. In addition, I'll provide a brief update on our plans for growing our outpatient business. Before reporting the progress on PSSP, however, I want to place this initiative in context. There are numerous previously-reported strategies which are being implemented across our Company to put us back on a sustainable growth path. PSSP is only 1 of these programs. I like to think about these efforts as supporting our objectives in the short, the middle, and the long-term. In this regard, I define short-term as those initiatives which we can complete in the next 6 to 12 months.

In addition to PSSP, this includes our Targeted Growth Initiative, which is already two-thirds of the way through its analytical phase, and more than one-third through its implementation. Most of you are aware that TGI resulted in some self-inflicted volume losses in its early stages of implementation in California. Except for Florida, where we expect to exit some businesses, we are not seeing so far material self-inflicted admissions declines in southern states, Texas, or our central northeast markets, including Philadelphia, as TGI is rolled out in these markets. Our incremental capital expenditure program, the approximate $150 million of the $800 million in capital commitments that we have targeted for 2006, I also put under the heading of short-term. It is natural to be interested in whether these recent investments have generated incremental admissions, but this is an impossible question to answer with acceptable accuracy. If we call on a physician to communicate that we've just installed a long-desired piece of clinical equipment, and then see incremental admissions from that doctor, should those admissions be credited to PSSP or our CapEx program? Obviously, when you've got the types of interrelated strategies that we're executing, it's extremely difficult to make that type of distinction.

Turning to our midterm strategies, which we define as those we can complete within 12 to 24 months, we also have a number of interrelated efforts going on. During this time frame, we will move into the volume-building phase of TGI, particularly in California and Florida. This means we will be adding to, or expanding the service lines TGI identified as addressing local market demand. In this time frame, we will also be moving aggressively into the building phase of our outpatient program. We introduced this to you at Investor Day, and I'll be exploring this program in more detail in just a few minutes. But within this midterm 12 to 24 month time frame, you should expect considerable activity on this front. In addition, we are developing some physician alignment strategies, including joint ventures and targeted physician employment strategies, which can be expected to contribute to our growth over the next 12 to 24 months. So that no one gets the wrong idea when I say targeted physician employment, you can be sure that this targeting will be done with laser-like precision. I'm not talking about a massive program with regard to physician employment. In passing I should note that the number of employed physicians we have today is only 10% higher than we had 4 years ago.

Longer term, looking out 24 to 36 months, still more initiatives will come into play. Including the new capacity that we're adding in El Paso, where we have already broken ground, Brookwood, USC University Hospital, North Fulton, and Spalding, where we are completing existing projects, and other hospitals where we are actively seeking state agency permission to build. I hope that brief overview gives you some sense of the many fronts across which we are acting to grow our business. And why the careful layering and interconnectivity will take about 3 years to establish the correct foundation for sustainable growth.

As a program generating immediate benefits, Physician Sales and Service, or PSSP, certainly deserves all the attention it has received, but it needs to be viewed in the context of these other programs with which it forms an interrelated whole. With that said, lets turn our attention to the performance of PSSP in the third quarter. From a management perspective, the fundamental question we want to answer is whether PSSP is generating an adequate yield from our physician visits, and making a meaningful contribution to our growth strategy. Consequently, just as we did with other systems in quality, managed care, and patient financial services, we are evolving our PSSP management and information systems to help us answer that critical question. I'm anticipating that many of you have a number of questions which would require us to cut the data in a number of creative ways. But remember, our goal at the macrolevel is to assess the efficacy of the initiative as a whole. At the the micro or hospital level, this data is tracked by each physician, but it cannot currently be rolled up to the corporate level, based on various scenarios one would want to analyze. So the data that I present to you will reflect that limitation.

First as a benchmark, let me review the PSSP data that I shared with you at the end of the second quarter. At that time, we looked at the results of our concentration on 1,300 physicians of the total that we visited in the first half of 2006, and noted that these physicians increased their admissions by about 1,200 admissions in the second quarter relative to the first. Because the seasonality component is so dramatic in Florida when comparing admissions between the first and second quarters, no Florida physicians were included in this analysis. Given additional time to refine our data collection and analysis, we can now express this data on a year-over-year comparable quarter basis, so that seasonality is not a factor. Also, taking a sequential quarterly view at the macro or individual hospital level would be misleading, since the third quarter is a peak vacation time for physicians, and the fourth quarter has the major holiday and religious observance impacts on individual physician activity. So let me give you the admissions yield resulting from all of the 2,900 physicians we visited in the third quarter who were active in either the third quarter of '05 or '06.

Our admission from these physicians were up by 1.5% in the third quarter of '06 versus third quarter of '05. By contrast, this means that admissions from the roughly 6,550 physicians we did not visit declined by 3,850 admissions, or 6.5%. Let me make a few observations about this data. First, these 2,900 physicians come from all of our markets, including Florida. Second, some of these physicians were visited for the first time in the third quarter, and some were among the 1,300 physicians on which we concentrated in the first half of '06. Third, admissions growth varied significantly across our markets. California and Florida again showed admissions declines from these physicians, while at the other end of the spectrum, our central northeast market achieved a growth of just over 10%. And lastly, some physician visits occurred very late in the quarter and therefore, had little time to respond with incremental referrals.

We've also tracked the outpatient business we've received from the 2,900 physicians we visited in the third quarter, and they increased by 2.5% in the third quarter of '06 versus third quarter of '05. This stronger outpatient growth confirms our earlier observation that outpatient referrals tend to precede the inpatient business. Then if the outpatient experience is satisfactory, the inpatient business tends to follow. So that tells you the results achieved in the third quarter from the physicians we visited in the third quarter. Taking this data, and adding it to the results that I shared with you in August when we released our second quarter results, creates a reasonably convincing impression that PSSP can be effective in creating an immediate and meaningful increase in referrals.

Now I need to warn you that there is some imprecision in this data. Physician actions are not always readily trackable. One problem is the whole issue of hospitalist, which carries the potential that a visited doctor starts to send you increased volume, but that business shows up under a different doctor's name. This issue is compounded when doctors move patients to their physician partners within a doctor group. But even with these difficulties, the power of PSSP to move the needle is clearly visible.

So what about the longer term impact of PSSP? When we examined the ongoing behavior of the physicians we visited in the first half of the year, we unfortunately found that their third quarter admissions declined by 1,523, or 1.8%. That's comparing admissions in the third quarter of '06 to admissions in the third quarter of '05. But to place this result in context, the 4,600 physicians who were not visited in the first half of the year had a decline in admissions of 3,252, or 5.4% in the third quarter. So at a minimum, PSSP was able to create an improvement in the growth rate of admissions by 360 basis points. In addition, I will note below some examples of unique, local competition that suggests a major portion of the admissions decline had a rationale unassociated with our PSSP sales and service efforts.

As we've come up on the learning curve with PSSP, we saw a need for more formal sales training, a need to maintain local focus, and a need to constantly enhance our systems data capture and the ability for quicker, deeper analytical review. To get at the first 2 needs, we hired John Landino, as previously reported. John is going through a carefully structured education program at headquarters and at selected hospitals. His work products will be designed by the end of the year, and he will be full speed in January. On the last need, it took several months to refine the other systems that I referred to above. So we believe it will take most of next year to get the PSSP system to the same level of operability.

As of now, we are working on improving the third visit to a physician, which after listening and then solving service problems is what I call closing the sale. If we are convinced if we convince the physician that we're moving the hospital in a positive direction, then in a direct statement, ask for increase business, make it specifically clear that their support is necessary for further progress. It's salesmanship 101, but you've got to close the sale. In each of these visits, we also work to develop a solid relationship with the physician's office manager. This individual can be incredibly important to the direction of patient flow, and it is critical to identify and address any issues at this level. The focus needs to be maintained on attention to detail and rigorous and timely follow-up.

I'd like to turn your attention now to a couple of markets where our turnaround efforts are lagging our initial expectations. The first of these markets is Palm Beach and North Broward Florida. While all of Florida has felt the economic effects of last year's hurricanes, the effect has been magnified in the Palm Beach and North Broward market. In the winter months, these 2 counties have some of the most attractive demographics in Florida, or any other state for that matter. These 2 markets are more dependent on higher income individuals with multiple options for their living arrangements than other Florida markets. So fears of another bad hurricane season in 2006, which frankly didn't materialize, and decisions to stay up north while repairs triggered by last year's storms were completed, hit this market hard. As a result, Tenet's volumes in this market have yet to rebound from the declines of 2005. In the aftermath of a very quiet 2006 hurricane season, we are hopeful that the population statistics will soon return to normal levels. This will go a long way towards restoring the profitability of our hospitals in this market.

We also took a hit in Palm Beach on the issue of call pay for emergency department coverage. In retrospect, it is clear that our refusal to provide an appropriate, timely response to this issue was costly. We tried to hold the line on this cost issue, but ultimately our competitors caved in. In the course of holding out, it is clear that we alienated some physicians. The solution is in place, but we have yet to win back any physicians we lost over this issue.

Moving to Texas, Houston has a different set of issues. The same high projected growth rate that makes Houston a high potential market for Tenet, makes Houston equally attractive for the significant investment the Houston market has seen in facilities, with physician equity participation, as well as investments by the not-for-profits. These investments are made easier by the relatively light regulatory environment in Texas. The analytical phase of our Targeted Growth Initiative was recently completed in Houston. We believe these actions will help put us on a trajectory to intermediate term enhancements to profitability. In the longer term, even if we merely retain a position near our current market share, the anticipated growth in demographics should bolster Tenet's longer-term performance in Houston.

And then lastly, 4 hospitals contributed to most of our shortfall in California, with TGI and risk-based IPA contracts, the same drivers of shortfall as previously reported in the first 2 quarters. The net volume impact of TGI continues to be negative at this point in the implementation of the program. Given that California led the other regions in implementing TGI, this was not an unexpected result from their analytic data. However, given that California completed TGI in the first quarter of '06, the expectation is for a net positive impact by the latter part of 2007.

Let me switch gears now and bring you up to date on our outpatient strategy. At this summer's Investor Day, we told you we were in the process of evaluating over 30 projects, which were in various stages of development. That list has since been expanded to over 60 projects, that are also in various stages of analysis or development. Most of the surgery center projects are structured as joint ventures. At this point, we have identified 11 projects to which we are committed and should be completed in 2007. 4 of our commitments are to ambulatory surgery centers and 7 are to diagnostic imaging centers. While we have some urgent primary care projects also under analysis, we have not yet committed to any of these projects. These free-standing outpatient projects will require a commitment of approximately $40 million in capital expenditures over the next year, including something in the neighborhood of $5 million in the current quarter. I expect this level of investment will grow considerably by 2008.

In closing, let me iterate a point I emphasized several times in previous calls, which is we expected our progress across these many fronts to be anything but linear during the foundation period. However, we believe the sum total of our interconnecting operational strategies and initiatives to be the correct ones to land us in a -- at an appropriate place in the next 2 to 3 years. Let me now turn the floor over to Biggs Porter, Tenet's Chief Financial Officer. Biggs?

Thank you, Reynold, and good morning, everyone. I want to offer some additional color on third quarter results, and then provide some comments on the challenges [we face] going forward and our actions to mitigate their impact. Begin with earnings, we reported a loss from continuing operations of $30 million or $0.06 per share. We also listed 5 items in the press release this morning which have a net favorable impact of $0.02 per share on continuing operations, and provided the details on these so you can draw your own conclusions on our underlying profitability for the quarter. Adjusted EBITDA for the quarter was $108 million for a margin of 5.1%. On volumes, Trevor and Reynold both explored various aspects of our results for patient volumes, so I won't have a lot to add. While PSSP continues to suggest that volume declines can be reversed if given an appropriate focus, then the results of our COE hospitals are clearly impressive. The aggregate reality is that admissions were down 3.3% and commercial managed care admissions declined by 6.3%. Clearly, industry headwinds are generating formidable challenges, and the successful reversal of the declines in our volume picture is likely to take time and be subject to considerable volatility.

Most of you estimated a more favorable third quarter than we did ourselves, but we missed our own expectations, as well. Having said that, with the absence of hurricanes, our fourth quarter is traditionally stronger, and we remain confident that the fourth quarter will generate an improvement in our admissions trend. With the higher volumes, we also expect better mix, as the seasonal fourth quarter volume growth is not normally driven by the uninsured. One of the greater uncertainties remains Florida, which although we have not had hurricanes this year, is still suffering the longer-term effects of last year's property loss and displacement of both the seasonal and permanent population.

With respect to pricing, we achieved gains in pricing consistent with our expectations. As we stated on prior calls, we expected that these gains in managed care pricing would gradually moderate as prior-year comps become more challenging. In the third quarter this was the case, with the higher comps being the biggest factor in restraining our growth rate and pricing. While commercial managed care outpatient revenue per visit increased 7.2% over the prior-year quarter, managed care net revenue per inpatient admission was up 3.9%. I want to take a few minutes to explore this increase more thoroughly, as there are a large number of factors which impacted this outcome, including business mix, average length of stay, a modest decline in our case mix index, and changes in admission patterns across regions and hospitals which occurred in the quarter. Let me take these issues one at a time.

One of the reasons for the smaller increase in managed care pricing than you have recently seen at Tenet is the continuing mix change between government programs and commercial managed care within the managed care portfolio. Commercial inpatient base rates were actually up 9.2% from a year ago. But a year ago almost 83% of our managed care revenues came from the commercial piece of the business, while in this year's third quarter the percentage from commercial declined to 79%. This changing business mix had a significant dilutive effect on our pricing progress. If the third quarter's mix this year had been the same as last year, revenues this year would have been higher than reported by $35 million.

The second impact in our pricing results was a significant drop in stop loss payments. Stop loss payments were $72 million in the third quarter, a decline of $19 million, or 21% from the $91 million reported in last year's third quarter. As we have discussed previously, the primary driver is the change we instituted in our approach to structuring our managed care contracts, which shifted our payments toward base rates and away from stop loss. As a result of this approach, negotiating our contracts, we now receive stop loss payments on 4.6% of our commercial managed care admissions. We believe this ratio is typical for the industry. The decline in stop loss is also one of the reasons we were successful in maintaining solid growth rates in our base rates, which as I just mentioned, were up 9.2% in the quarter. Within the commercial managed care portfolio, average length of stay declined from 4.01 days in the third quarter of 2005, to 3.94 in the current quarter. These shorter stay times had a negative effect on revenue per admission by approximately 200 basis points. In addition, we experienced a 1.6% decline in our case mix index from the second quarter. This reflects a normal seasonal decline, and therefore has minimal impact on our year-over-year pricing metrics, but still makes it incrementally difficult to achieve a strong quarter from a pricing perspective.

Lastly, the relatively larger decline in volumes in some of our Southern California hospitals, where Tenet tends to have its highest pricing, also restrained the advance in our pricing metrics for the quarter. This was influenced by the TGI implementation, which continues to roll out in those markets. This litany of [inaudible] factors illustrates a point we have made repeatedly; that pricing metrics can be surprisingly volatile given their inherent sensitivity to the specific patients who show up at which hospitals, and the precise nature of their medical conditions.

With respect to bad debt, the increase in bad debt was higher than we anticipated and a definite disappointment. Compact-adjusted bad debt was 16.4% in the third quarter versus 14.9% a year ago, and 14.2% in the second quarter of this year. On a reported basis, which excludes the Compact adjustments, bad debt was 7.4% in the third quarter versus 5.8% in the second quarter, or an increase of $29 million. I'm going to focus on the sequential quarter-to-quarter increase, as we feel that at this point, it provides more meaningful comparison by avoiding the distortion of the Compact adjustments.

Before getting into the specifics of the increase, I thought it would be helpful to review Tenet's accounting treatment for bad debt expense. Tenet recognizes bad debt expense by writing down self-paid accounts receivable, including accounts due from patients with insurance, or balance after accounts, to our net realizable value. Self-insured patients are reserved for at the point of discharge. Balance after amounts are reserved once we receive the EOB from the carrier, about a 30-day lag. Trevor told you earlier that we collect $0.97 of every $1 we bill to insurance companies, $0.60 of what we bill to insured individuals, and only $0.08 of what we bill to uninsured individual that don't qualify for charity care. This reflects collections made within 2 years, including collections made at the point of service. We are reserving for these levels at the point of discharge, or in the case of balance after, upon the receipt of the EOB from the carrier. This level of additional reserving is generally sufficient to provide for adequate coverage of the receivables as they age, fit to use as a composite of our collection history. In instances where it does not, because of greater or lesser than normal aging receivables, we increase or decrease the reserve. Typically, the balance after bad debt exhibits a seasonal high in the first quarter, when individuals have not yet met their deductibles, which gradually decline in later quarters.

With that being said, let me now review the reasons behind the approximate $29 million increase in reported bad debt expense for Q3 '06 over Q2 '06. Approximately one-third of the increase resulted from increased self-pay volumes. An additional third was the result of a deterioration in the aging of managed care receivables. This aging was in the over 360 day category. These older balances relate to an earlier time period before we introduced enhanced contract language and defined better adjudication procedures. The remainder was from various other unusual factors, including primarily the resolution of older outstanding managed care accounts, which increased both bad debt expense and revenues in an offsetting manner, and to a lesser extent, an increase in self-pay accounts assigned to our collection agency and other miscellaneous items. There were no material changes to our geographic concentrations in bad debt. Texas and Florida continue to report percentages higher than other markets. We have spoken previously about our efforts to mitigate the growth in bad debt expense, and Trevor has just referred to these kind of actions as well, so I'm not going to reiterate. I will, however, emphasize that we are actively working this area in an effort to combat the industry challenge.

On cost efficiency, solid cost management continues to contribute to our performance. Despite declining volumes and the adverse impact this has on operating leverage, controllable operating expense per equivalent patient day grew by just 3.5% in the quarter. Our performance on controlling the growth in supplies expense was truly outstanding. Again on a per equivalent patient day basis, which neutralizes the impact of declining volumes, supplies expense was up only 1.3%, an impressive testament to a variety of programs we have introduced to control what can otherwise be a runaway cost item.

With respect to capital expenditures, capital expenditures for continuing operations in the third quarter were $133 million, a little below what we had anticipated. Recall however, that much of the clinical technology investments we expect to make this year have relatively long lead times, so not much of the increment we announced at the end of June was completed in the first 90 days. We expect a significant step up in spending to be apparent in our fourth quarter numbers, although it is very possible, if not likely, that we will fall short of the $700 million cash expenditure for continuing operations yet anticipated. Our best estimate for the fourth quarter is 250 to $300 million, which will bring total 2007 CapEx up to approximately $650 million. As I said last quarter, any variance should be considered timing in nature, as we still plan on committing $800 million this year. As we have said before, on many items the lead time is significant, and we're also taking the time to ensure we achieve the best pricing and complete the necessary financial analysis. I should note that we have received very positive feedback from our physicians with regard to our investment plans. Although we wouldn't normally comment on capital spending in discontinued operations, for the third quarter, this includes a capital expenditure for the buyout of our joint venture partner at Encino-Tarzana in order to facilitate our exit of the business.

Turning now to cash, current quarter cash flow from operations was $200 million, and unrestricted cash on hand was $809 million at September 30 of this year. This still leave us in position to have approximately $1 billion or more in cash at year end. The primary drivers for the fourth quarter are the federal income tax payments of approximately $110 million, capital spending of 250 to $300 million, proceeds from asset sales of about $80 million, the release of restricted cash, fourth quarter EBITDA, and year end accrual and other working capital changes.

I will give a few words on taxes. As announced last week, the Company received a Revenue Agent's Report or RAR, which affected the Company's tax accounts and NOL carry forward. Tax accounting is not simple by any means, but to be brief, 2 things happen when you receive an RAR. First, you assess the position of the agent relative to what you have reserved, and secondly, you assess the effects of the RAR on your NOL and its recoverability under GAAP. The net effects of these are assigned to continuing and discontinued operations. The net effect for us was as indicated in the results for the quarter, with the only cash effect being that we have decided to pay the amounts not in dispute of $85 million plus interest in the fourth quarter. We had adequately provided for that amount and for what we believe to be the ultimate resolution of other matters in dispute, but assumed payment would not occur until conclusion of any appeals. After taking into account the affect of the RAR, the Company's net operating loss carry forward from 2004, 2005 is approximately $1.3 billion.

Now turning to our outlook. Last week, we indicated that we believe we would still achieve adjusted EBITDA for the year in the range of 670 to $770 million, although it was unlikely that we would be in the upper end of the range. I will elaborate. I have discussed our bad debt and admissions results for the quarter. As I noted earlier, we expect improved volumes in the fourth quarter from seasonal drivers alone. Any further success in our PSSP and other strategies will further support this. Year-to-date, we have experienced admissions declines of 2.9%. We believe that in the fourth quarter we can have slightly positive admission growth, which would be in line with our prior outlook for the full year, and would support achievement of the middle of our range. October admissions to date have been consistent with this outlook for the fourth quarter, but I have to caution that 1 month does not a quarter make, and admissions are not the only financial variable. Also, our outpatient business statistics are not final for October, and although improving, it appears they may lag in patient growth. Improved admissions should be accompanied by a better mix and improved bad debt as a percentage of revenues, as well. If on the contrary, we were to assume admissions declines, and uninsured and bad debt experience continued at the rate experienced in the third quarter, we would be around the lower end of the range for Q4.

I know many of you are likely to ask about 2007 and our intermediate term outlook. We are still in the planning process, and would expect not to give any current outlook for 2007 and beyond, until we release earnings for the full year 2006. Every quarter gives us better insight into our prospects, and the degree to which our strategies are taking hold. Our fourth quarter will give us one more piece of information, and be a key indicator of how some of our markets are responding, particularly Florida. If you ask if bad debts, uninsured and admission trends represent real risks to our intermediate outlook, I will have to say yes. However, we not only look at the risks and mitigation, but also the opportunities, and are going to drive on those. Reynold has already talked about some of these, but they include right-sizing of our overhead costs to reflect the loss of business space due to dispositions, reduced third party contracting costs as some of our current initiatives mature, outpatient expansion, adjusting the FTE levels of our hospitals which are above industry benchmarks,and this includes some of our better performing hospitals, further leveraging of our initiatives to consolidate our buying power, denial management, length of stay reduction, leveraging clinical product development to improve not just quality, but also efficiency, and reductions in malpractice expense enabled by our quality initiative. I could go on and on. The point is that it is not all just about PSSP, TGI, and bad debts.

There are a number of things we are doing to improve our performance that we either act as mitigators of the external pressures or hopefully create upside. I'm not going to give you specific targets for each of these, or for those I haven't mentioned. We also should expect the benefits of these actions to be realized over time, and for our results to fluctuate on the short-term. I just want to be clear that there are a number of levers we are going to pull to improve our results.

Finally, before we move to Q&A, since I missed our last Investor Day, I can't wait to schedule the next one. So at this time, I would like to announce that we are going to hold our next Investor Day on June 5th, 2007. Let me now ask the operator to poll our callers for the Q&A session. Operator?

[OPERATOR INSTRUCTIONS] Glen Santangelo, Credit Suisse.

Trevor, just a couple of questions. Thanks for the outlook on the admissions in terms of October, but could you give us a little bit more sense for what's driving those managed care admissions? You had been in negative territory in the range down to 6% to 7% the past couple of quarters, and now you're in positive territory. That's a 700 basis point swing in the growth rate. Could you give us a little bit more of an explanation as to maybe what's driving that trend change?

I'll ask Reynold to give you that insight.

Sure. Again, if you reflect on my comments, what we're hopefully pointing out, both in the releases as well as my comments, that a significant number of our hospitals are now in positive growth territory, a significant number are holding their own and not experiencing significant declines, and then we have a group that have the local factors that I gave some highlights on. When we look at the managed care volume drops, those drops are very consistent into those local hospitals with those local issues. And so again, we would hope that we're giving you enough information to indicate it's not a consistent, pervasive problem over our base of 57 hospitals. But again, contributory to those specific, unique issues. Be that, IPA group contracts in California, elective closing of TGI products, which also have a heavy managed care load in that, and the hurricane leftover issues down in Florida, and the Houston issue.

So just to be clear, you're saying that the bulk of the inflection point in the admissions came from a limited number of hospitals versus the entire network?

That's correct.

Okay. How about on the outpatient side? Are you seeing -- you saw a nice trend change this quarter from where you had been the past couple of quarters. Is October a continuing of that trend change? Or any type of visibility on the outpatient side?

Well, as Biggs mentioned a while ago, the October outpatient numbers are not looking as aggressive as the inpatient. However, I would like to go back to our TGI analysis, which is a large portion of the bleed off is now down to outpatient year-over-year comparisons, in which a lot of outpatient services in California with either low margins or negative margins were closed, as well as in the last earnings call, I highlighted workers' comp clinics down in Florida that we closed. So those will continue to bleed off pretty much into the third quarter of next year on an outpatient basis. And again, all of our data seems to indicate that the thousands of outpatient business that we're losing are lower net revenue visits, which would seem to go hand in hand with our TGI-focused effort.

Okay. Thanks. And Reynold, just if I could ask 1 more question and then I'll hop off. I think Biggs talked about the expanded CapEx plans are being well received by the physicians. Here you are in year 1, and you are kind of, due to some timing issues, you're not spending as much on CapEx as you thought. Could you give us some feedback as to what you're hearing from admissions, and how soon you think some of this expanded CapEx can translate into some incremental admissions?

Sure. The expanded CapEx, which is really good for us, be that CT scanners, MRI scanners, cath labs, high net revenue, high margin services, pretty much because of the effort we made on the front end, which is the correct effort to get additional savings through our group buying process, means that a lot of that technology will not be installed and ready to start making a contribution until probably halfway through the second quarter, into the third quarter of next year. We have reported some quick wins that we had gotten with some lower cost items that are easy to order and easy to get in within a 4 to 6 week period of time. But our assessment in talking to our local managers is again, the combination of the incremental announcement on top of the government settlement was well received, and the fact that we made the commitment and the doctors know exactly when the delivery time and installation time is of their specific hospital's equipment, has served us well. And we're not seeing any concerns expressed that it's taking too long. They understand that we're saving money by going through the appropriate bidding processes, and they're supportive with us on that part of the process.

Okay. Thanks for the comment.

[OPERATOR INSTRUCTIONS] . Adam Feinstein, Lehman Brothers.

Just a quick question here I guess is on the pricing. I appreciate all of the details. But just as we think about the stop loss payments and just your comments, Trevor, about just the mix shift you guys are seeing in terms of this shift away from the commercial managed care, I guess the question is, we've been seeing this same thing for the last several quarters, and we really haven't seen pricing move down to the extent in the current quarter. So my question is, why won't that continue for the next several quarters? It just seems like we've been seeing that same trend. And I understand your comments about the length of stay, but the stop loss payments were down about 18% last quarter, and you were still able to get a higher aggregate number, so just trying to reconcile that. Any feedback would be great. Thank you.

I'll ask Bob Yungk, our Head of Managed Care to address that question. Adam, thanks.

Good morning, Adam. Basically, if you look to the individual yield per day on the net revenue per admit, the actual net revenue per admit per day was up 5.8%. And that actually was well within the expected range from our standpoint, on what we previously received. The difference here is that the average length of stay, which is a unique thing for the quarter that we saw, was down about -- had an impact of about 200 basis points. So if, in fact, the average length of stay would have remained constant, it would have been very consistent with the type of numbers that we've seen in previous quarters.

And I guess just a follow-up then. In that guidance you guys gave in terms of the margins getting back to 11% to 13% over the next few years, you had mentioned before mid-single digit pricing. But what were your assumptions about average length of stay and any comments there?

Well, we had assumed over time there would be some reduction in length of stay, but that primarily would have had an affect on the Medicare, not the managed care environment. But I think that the pricing that we gave was as you said.

Okay, thank you.

Darren Lehrich, Deutsche Bank.

Question here with regard to margins. I guess the longer term margin outlook you established over the summer might seem like a little bit of a stretch in light of the bad debt environment you're operating in. I just want to make sure I'm understanding what you're saying about what you'll be telling us after year end. Are you still supporting or confirming that long-term 11% to 13% margin forecast? Or is that something you plan to update and change after fourth quarter?

Well, at this point in time, we're not speaking to that outlook. We are saying we will readdress it after the fourth quarter when we release earnings. So I think you'll have to wait then to see what our current planning process produces. You're right, bad debt and admissions create pressures, as I indicated. But we're also focused on what the mitigators are. But while we're in the planning process, it's inappropriate for us to say what the outcome of that is going to be.

Okay. So just to be clear here, all the things that you laid out in your June 29th press release as it relates to longer term outlook is now withheld? Just so I'm clear in terms of what you're saying. Because you spent a lot of time going through your mid-term and long-term outlook, and it sounds to me like you're withdrawing that?

Well, we're not -- I'll say it a little differently. We're not changing it, we're not altering it. But I'm also not going to comment on it. I'm not going to confirm it, if you want to use those terms, because I think that we are in the planning process, and we're going to wait and see what that planning process produces, giving consideration to the fact that there are pressures here. But that is not to suggest that we're believing it's going to be different either.

Very well. Okay. Thank you.

Sheryl Skolnick, CRT Capital Group.

Okay. Well, I'm going to go back to Darren's question, because I want to make this absolutely, perfectly clear. If I recall your guidance from July, you gave us very broad time frames. You gave us intermediate term, you didn't define it. And you said sometime at the end of that, you might get to 11% to 13% EBITDA on some revenue that we might be able to predict would have better volumes, would have better market share, would have better revenue metrics, so long as bad debt didn't eat it all up and take it away. So it was nebulous. I don't think you ever defined whether it was 2008 or 2009. I think we all sort of thought the intermediate term was probably 2008, but I don't think you ever said that. So you gave yourself an awful lot of breathing room there. Are you saying now that you're going through a more specific process so that you might give us better visibility on what the components of the year are? Are you saying that you don't think 11% to 13% range of EBITDA margin sometime over the intermediate term, however long that is, is achievable? What specifically are you saying? Because if you say you're not going to comment on it, you're not going to confirm you're guidance, you've just told us you're not going to make it. And I just want to make sure that's exactly what you mean.

My last statement was that I was not suggesting that we weren't going to make it. But that I wasn't going to confirm today. We're in a planning process. And at the conclusion of that planning process, we will give you an updated expectation for 2007 and for the intermediate years. The intermediate years were expressed as 2 to 3 years out, that was 2008, 2009. We did say 11% to 13% in that time period. And you're right, that was a relatively broad reference point. At this point in time, it would be foolish to say that bad debt experience, recent experience, and admissions recent experience didn't put pressure on those numbers. So clearly reacting to that additional pressure to say we have to consider that, but we also are going to consider the things that we can do to go and offset it. And I listed out some of those in my script. So we have a number of considerations. We're currently engaged in the planning process. And at the conclusion of that planning process, we will give you insight into our outlook into the future. I am not saying we will not achieve 11 to 13, I'm just not confirming it as of today.

Okay, that's helpful. If I could ask a follow-up question, here. This quarter you were actually, as you kind of mentioned, you actually had positive free cash flow from combined operations of discontinued and continued, plus discontinued and continued CapEx. So when we take that, you actually did $30 million of positive free cash flow, which was a pleasant surprise. But as we go forward through the next little period, can we expect you to actually sign the credit facility? Can we expect you to actually need the credit facility? To use it, to draw it down?

We do expect to execute the credit facility in the fourth quarter, and have the release of the unrestricted cash associated with it.

Right.

Do we expect it to draw on it? No.

Great. Well, I want to thank you for answering all of the other 10 questions I had already. Thanks a lot.

Tom Gallucci, Merrill Lynch.

Just 2 quick ones. I guess 1 for Trevor. And then 1 more strategically within the Houston market. I guess you've obviously made a fair number of divestitures, or are working on some currently. With the latest results, are you just as committed to the kind of portfolio of continuing operations as you've defined it in the past at this point? Or is there a possibility that we could see some more tweaking to the portfolio longer term? And then within Houston, the issues I think that were mentioned in your prepared remarks, seemed to be fairly -- I don't know, difficult to turn around in the short-term when you're talking about equity participation by doctors and investments by not-for-profits. So can you maybe get into a little bit more detail on what you can do in that market to turn things around a bit? Thanks.

Thanks, Tom. I'll take the first part first. Nothing has changed our opinion about the core hospitals that we have. We're still committed to working with them. Obviously, we actively manage our portfolio. We look constantly at the prospects of all of our hospitals. But we laid out at our Investor Day remains our current outlook. And as for Houston, I'll ask Reynold to comment.

Sure. On Houston, there are 2 new hospitals into their second and third year of operation in north Houston, and a third one about to open up in the next probably 3 or 4 months. The 2 north are not joint ventured. The third one about to open is joint ventured. When you look at the 3 assets we have down there, one of them had really lagged in its capital investment over a period of time. And we've made a significant investment along with our TGI analytics and our market share data analysis, and many of those projects are just now starting to come online. So we think our competitive position in one of those hospitals, which actually competes somewhat with 2 of the new ones, but also has a significant market to the south of it, that the new ones don't cover, that we can re-enhance volumes there starting into the midpoint of next year.

One of the other hospitals, we actually 2 years ago, thought we had solidified that hospital when we were able to recruit almost a 40 doctor group from the medical complex. And based on internal issues with that particular group, they are having some internal partnership issues, and the 40-man group is now a 15-man group, all primary care doctors. And so again, we're still happy to have the 15, but we also need to take advantage of some specialty referral opportunities in that particular hospital off of the primary care base, again, which TGI has pointed out to us, and we'll be working on that. The third hospital is one which is doing well in volume, but is closer to the new joint venture hospital that's about to open up. And on that one, that is the first one out of the chute on a primary care employed doctor strategy, and over the next 3 to 4 years, we will be employing somewhere in the neighborhood of 20 primary care physicians in decentralized sites away from the hospital campus, to protect our referral base from the physician equity hospital, which will be about 5 to 7 miles away. Any follow-up question to that?

Operator, next question.

Christopher McFadden, Goldman Sachs.

This is [Shelly Nall] in for Chris McFadden. I would like to visit the PSSP initiative. Anecdotally, can you tell us some of the reasons the splitter physicians are giving for not increasing referrals? Reynold had mentioned solving service problems in some markets. Are these contributing factors?

As we reported several quarters, again, the plight that we saw at the time we initiated the PSSP initiative, was that the whole splitter group had decreased over a 2.5 year period from an average admission of somewhere in the 15 per year basis, to somewhere near the 10 or 11 basis. And our anecdotal information from visiting with those physicians was that they were concerned about the media issues swirling around Tenet, and our survivability, and future government settlement, and those kind of issues. We anticipated that again, given 2.5 years, when doctors create certain behavior patterns, you do not change those overnight. But again, part of the sales effort is the more sales calls we make, and the more we answer questions, and the more that we get them, particularly, to try out some outpatient services, we get over time a better chance of winning those doctors back over that we've lost.

Okay, thank you.

Gary Taylor, Banc of America.

First question, I think if I'm interpreting the cash flow statement correctly, there was $161 million of insurance recoveries, and that was this quarter. Is that right?

The Katrina recoveries were this quarter, yes.

So all that 161 is in the cash from ops this quarter?

Yes.

Okay. And when you give your self-pay percent of net revenue, actually it's 12.6%, but you say self-pay, indemnity, and other, can you tell us what the self-pay percentage is, roughly?

Why don't we -- let's take that question, and we'll see if we can -- or is there some clarification you want?

Well, I guess I'm trying to work into -- are you implying on your reserving policy then, since you say you collect on average $0.08 on the $1 on post discounts, or post Compact uninsured revenue, are you suggesting at time of service you're booking $0.92 on the $1 into your bad debt allowance?

Yes. At the time of discharge, we reserve down to the $0.08 of recoverability. So a 92% reserve.

So I guess what I'm trying to do -- obviously, if you take the 12.6 times your $2 billion and change of revenue this quarter, that would 267 of revenue in that book at this quarter. So since indemnity and other is in there, it's hard to figure out if that amount is really being reserved. But you gave your analysis on the impact of self-pay volumes quarter-over-quarter. I'm not sure we have the data to do that. But when we look year-over-year, the number of uninsured patients, I think, went up 600? And if you assume the typical cost -- average cost for those patients, you're talking about maybe a $6 million year-over-year direct cost increase to take care of those patients. Yet your bad debt year-over-year went up $42 million from continuing ops? So it seems to suggest that there's not 92% on the dollar being taken at time of service. Either that, or a year ago there was a higher collection assumption. Does that make sense, what I'm looking at?

I don't think we've changed -- I'm having a little trouble following you, Gary, I apologize. We haven't changed our assumptions. There really hasn't been any change in our rate of collection over the last year. We have had an increase in the dollars we're having to reserve, because the volume has gone up. The amount of uninsured and the amount of deductibles has gone up. But the collection rate has not varied. So I'm not sure I can answer your question directly. It's maybe one of those things where, within the limits of Reg FD, if you call, we can try to walk you through the numbers.

And then finally, can you give us your balance sheet allowance for -- against your gross AR? Or are we going to have to wait for the Q for that?

The Q is out. So you should be able to see it.

All right, thank you.

[inaudible]

Thank you very much for taking my question. I have 1 follow-up each on the Florida and California markets you mentioned earlier. In Florida, you talked about an issue where you said you alienated some physicians and there was an issue related to call pays I didn't fully understand what you were referring to. Can you elaborate on that?

Sure. Be glad to. The national movement for private physicians to request call pay to be on standby and come to the emergency room when called, originated in California about 3 years ago, and then moved pretty quickly from there to the Florida market. Again, we took the position, since our neighboring mostly not-for-profit hospitals were coming up with extremely different approaches and ways to do that, we felt it was more prudent on our part to wait and see how the market settled down, how many hospitals did that, and was there a commonality associated with it. At the end of the day, there was not a commonality. So we picked what we thought was the most prudent, cost effective way of securing coverage, particularly for certain specialty doctors that are needed to coverage the emergency department. But again, we were probably as much as 8 to 14 months, depending on the hospital location, behind the not-for-profit hospital down the street putting their system in. And again, I alluded to the fact that some doctors decided to move on down the street and secure that agreement with that hospital. And so they're under an arrangement with a local hospital down the street. So that's what I was referring to.

And this is in Palm Beach market? This was pretty much all hospitals in southeast Florida.

Okay. And then in California, you said that 4 hospitals were still affected by the declining volume due to Targeted Growth Initiatives. And you mentioned that California was the first market where you implemented those initiatives. So if that was the first market, shouldn't you be seeing improvements by now? And is this a surprise versus your prior expectations? Or am I missing something? No. On the analytic tools we had there, we found that the quickest result was to diminish or stop doing many services, and we previously talked about those. OB programs, [inaudible] programs, [SNIF] programs, and then a whole litany of outpatient activity. And again, the other issue in some of those 4 hospitals really has to do with the fact that we previously announced that there are 2 very large IPA doctor groups who accept downstream risk contracts from the insurance companies. And at the last negotiation we went through, their price point was one that was not financially productive for us. And so again, as we started a process back in 2004, we're not going to take volume just for volume's sake. We want to take volume that we actually make a margin on. So we proactively decided to do that.

Now in the meantime, in gearing up for the next round of negotiations, we're hopeful that we can find the right inflection points to figure out how to arrive at the right price and actually make a reasonable margin in those 2. But one of those large medical groups is in the desert, and therefore affects our large hospital there. And the other group is in Orange and L.A. County, and affects 2 of our hospitals there. And then 1 of the 4 is really the last one left in which a significant amount of TGI activity is still bleeding off. It's pretty much run its inpatient course in all of the other 16 hospitals in California. But this one, again, we had numerous things to deal with. And again, the margins of that hospital has been reflecting a really nice growth in-line with our analytical expectations, that we've been doing a lot of business both inpatient and outpatient, that are actually harming our margins at that particular hospital. So we're actually happy to see that volume decline.

And you started the TGI initiatives in California when again?

The idea for the pilot originated in about the fall of '04. The models, test pilot started in early '05. And the last 2 hospitals were [inaudible] in the first quarter of '06.

And then all the other markets really came in after the settlement, or -- ?

Yes, yes. We had all of our efforts to finish up California. And then starting this year in '06, we did have Texas as the next major location. And we should be completely through with Texas at the end of this year. And in Florida, we should be at least 50% to 60% through by the end of this year. And then in the central northeast southern states, that will be the last one that we roll into. However, from our previous analytics, we also knew we were approaching this in the manner where we got the best yield by going region by region in the direction that I just indicated, California to Texas to Florida, then to the rest of the hospitals.

Okay. Thank you very much.

Sheryl Skolnick, CRT Capital Group.

You touched on a number of the issues. But I would just -- I would like to go back to a couple of just little details. First of all, I noticed that while you had good cost control on labor, especially in in view -- it appears, especially in view on the decline in admissions, your labor costs were less than I thought they would probably be. Your SG&A or your other operating expense appeared to be a little higher. The disclosures you gave us in the press release were that rent was stable and malpractice was down. So what was up?

There's really no single -- this is Biggs, Sheryl. There's really no single explanation. The category of expense is probably well described as other, because there's a lot of things in there. So it is not lend itself to easy explanation. But having said that, year-over-year, there are increases in outside contracting and consulting fees. There's also in this account the allocations, really, those credits that we make to our discontinued operations, and those are down. So those are the 2 biggest things. But there's a number of drivers, none of which really, if you will, make up the explanation.

Okay. And I guess one larger question for Trevor is, when you first prereleased this quarter, it really did look like this was, in short, a disaster for those of us who were looking for maybe some more initial, if not consistent, progress on the turnaround. Now that we're looking at it and looking at more of the detail, it certainly seems like we have a better -- I think, I have a better sense of what's going right, what's going wrong, and what's not going at all. But just -- I guess what I'm curious from you is, do you believe that the Company is turning? Do you see this quarter as a signal of anything particularly meaningful that we should either be concerned about or excited about? And just to ask you for your read as the CEO of what you see is going on in this Company, and whether your investors should be comfortable that it's turning, or uncomfortable that it's not?

Okay, thanks, Sheryl. Well, look. One observation I would make, because I think that as we have reported over the past few years, investors have tended to react in an overly enthusiastic way to good news, and an overly pessimistic way to bad news. We prereleased largely because of the receipt of that Revenue Agent's Report and the impact that it would have on cash flow. And as we -- I would not have necessarily anticipated the reaction to the prerelease that it generated. But as I look at the business overall, I'm very encouraged by trends on the initiatives that we have undertaken. So whether that is the continued progress on the Commitment to Quality, which was really our first major initiative that we undertook back in the summer of 2003, or the more recent we have made as a result of the Targeted Growth Initiative, or the Physician Sales and Service Program. As we look at these initiatives, number 1, they are working. So there's nothing that we have launched that we're abandoning because it isn't working. And number 2, as we gain time and experience with some of these. For example, the statistics I quoted about UnitedHealthcare Centers of Excellence designations in cardiology, we see that they are working and they are working well. So we made this initiative in quality, and it has had a strong impact on volume and economics. Obviously, that's a higher margin service line. So I think we're doing the right thing.

What continues to be difficult, obviously, is those headwinds that we face in the way of pressure on admissions and bad debt, not only are important variables to our business, they also are the least predictable elements that we have. So where we have things under much greater control, such as costs and clinical quality, we've done very well. Where things are less under our control, like bad debt expense and mix of patients coming in, so forth, it is taken longer to figure out how to mitigate some of those trends. And of course, volumes is subject to a wide variety of factors. But as I sit here today, I think our hospitals are better positioned than they ever have been. Certainly we have made very real and lasting improvements in the fundamental quality of what we do in the hospitals. So I sit here today very encouraged about where we stand, even though it is a difficult industry environment. Maybe one of the most difficult ones we've seen. Certainly the most difficult one I've seen in 11 years of being in this business. I hope that gives you a sense, and answers your question. But as I think I've said before in other quarters, I would like to see more quarters go past. I would like us to get through this business planning cycle and see what the fourth quarter and what the first quarter of '07 are looking like before we can really declare a trend to be in place.

Can I ask a follow-up question, please, and I know you're indulging me on this one. I want to go back to the third, the third, the third, breakdown of the sequential $29 million increase in bad debt, which I guess is Gary's 42 billion [sic] increase year-over-year. Is there any way to break down that 42 million increase on the basis of being contributed to by movement in the Compact and how that impacts the year-over-year comparison, the self-pay volume increase, which was clearly the 600 admissions that Gary was talking about. So if that's a third of 29, if I can do that math, it's a little over $9 million of it, of the sequential increase. And then a third of the deterioration in the really old, troubled managed care receivables that I guess finally went over 365 and you had to write-off. And then the third one, which was other unusual items. Is there any way to break down the year-over-year change that way and give us how much of the 42 million was -- can be broken down into maybe 4 buckets, the Compact and these other 3 things?

I'm thinking, Sheryl, whether we can do that for you or not. Last year's third quarter, I think, also had some anomaly in it. So you have to normalize that out, too. One of the reasons we went to the sequential was because when you start to do it on a Compact-adjusted basis, you start comparing numbers which have assumptions in them which don't necessarily reflect reality. And so much has changed between last year and this year, that it seemed more reasonable to look at it from a second quarter/third quarter standpoint, because it's a relatively comparable baseline, and you can easily see that there was a spike, and it's easy to define what that spike was. If you're going back to last year, there's nothing else that I would point out, aware of as being significantly unusual this quarter versus the quarter of last year. So I'm not sure I can help you out any more. The only thing we're aware of was, as I indicated, the charges associated with the aging of the managed care receivables and the relatively unusual items which are largely offset by adjustments to revenue.

Okay. But of the increase that you did talk about sequentially, am I right that a little bit -- that approximately 9 or 10 million was due to the increase in self-pay volume? And is that how we should think about the fourth quarter, too? That another 9 or 10 million from the aging of managed care receivable doesn't recur, or it does?

Well I think that, obviously, it depends upon what happens with self-pay volumes in the fourth quarter. But the only thing that I would point out as being unusual or nonrecurring that actually hit the bottom line is that aging of the managed care accounts.

Right. Which was roughly -- it was also about a third. So we'd get that back as we look sequentially.

Yes -- .

As offset by whatever assessment we make of the growth of self-pay.

Correct. We don't see that managed care expense, that additional reserve, repeating itself. We've looked at what's aging in the buckets that are slightly newer, and we don't see the same characteristics. That doesn't say it can't happen. But at this point in time, it looks to be unusual.

Excellent. Thanks so much for the indulgence.

Kemp Dolliver, Cowen and Company.

I saw on the 10-Q that you have requested arbitration with regard to the USC dispute. Any sense as to when that process will move forward?

Hi, Kemp, this is Peter Urbanowicz. Yes, we did file a motion to compel arbitration in that case. Both the ground lease agreement and the operating and development agreement with the university require arbitration of disputes that we have them. So we've asked the judge to invoke arbitration. There's actually a hearing tomorrow in Los Angeles before the judge on our motion to compel arbitration. So either tomorrow or some point therefore we should have a decision for judge as to whether we arbitrate this dispute or whether it gets heard in state court in Los Angeles.

Great. Thank you.

Okay, operator, I think that concludes the call.

Yes, sir, I would like to turn the floor back over to management for any closing remarks.

Well, we don't have any closing remarks. I don't think there are any more questions. So we'll see you in a few months on the next call.

Thank you. This concludes today's third quarter earnings conference call. You may now disconnect your lines at this time, and have a wonderful day.