1. Tenet’s Q1 2007 Earnings Call Prepared Remarks
May 8, 2007
Trevor Fetter, President and Chief Executive Officer
Thank you, operator, and good morning, everyone.
I intend to keep my comments relatively brief this morning, so you can hear from our new chief
operating officer, Dr. Steve Newman, on our operating strategies, and from Biggs Porter on the
financial aspects of the quarter. Also, please remember that we will discuss our operating
strategy in greater detail in less than a month at our upcoming Investor Day on June 5 here in
Dallas. The meeting will also be available via live webcast at www.tenethealth.com.
In addition to providing further insight into our strategies at Investor Day, we’ll share specific
examples of the impact our initiatives are having on performance. You’ll hear from the
individuals leading the initiatives as well as from some of the operators who are implementing
them. Again, the date is June 5.
Before I turn things over to Steve and Biggs, let me offer my own thoughts and provide some
context to the quarter.
I see a good deal of evidence that our turnaround strategies are working. I remain confident that
we are on the right course, even though our performance likely will not improve in a straight
line. As I’ll discuss in a minute, we have some regions and hospitals that are not improving
according to our plans or as rapidly as other regions. That is what held us back in the quarter.
To put volumes in context, our admissions decline in the first quarter, while still a decline, was
less than the decline a year ago. While the breakeven in pre-tax income from continuing
operations was essentially even with last year, it’s difficult to make a blanket statement about the
quarter without getting into a detailed discussion. Biggs will do that in his remarks because it’s
important you understand all of the drivers.
As you recall, we launched a series of initiatives to build a more sustainable foundation for the
company at the same time that we worked to resolve our legacy issues and rebuild the trust and
confidence among our physician base. These efforts were grounded in our Commitment to
Quality. As we started earning external recognition for clinical quality, we focused on
developing strategies to leverage this distinctiveness into growth. These strategies fell under the
umbrella of our Targeted Growth Initiative, or “TGI.”
There is continuing evidence that these strategies are producing their intended results.
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2. Our California Region continued its strong fourth quarter results into the first quarter, with a 0.9
percent increase in admissions. Our Texas Region, which followed California in our phased
rollout of TGI, increased admissions year-over-year by 2.9 percent, excluding the two Dallas
hospitals that we will stop operating this summer.
The one region in which we continue to struggle is Florida where, among other factors, we have
been hit hard by new competition in cardiology. You may recall that a few years ago the
Certificate of Need regulations in the state were relaxed. Three of our hospitals gained new
competitive threats, and one of our hospitals gained an opportunity to compete with a new
program of its own. In addition to opening new and competing heart programs, certain of our
competitors are also engaging in aggressive physician employment strategies.
The success of our Commitment to Quality is directly visible in the differential volume growth
which distinguishes our service lines earning the coveted Centers of Excellence designations. In
Q1, the delta in year-over-year volumes between hospitals with and without United Healthcare
Centers of Excellence designations in cardiology is 10 percentage points. Hospitals with Centers
of Excellence designations were down 1 percent in volume and hospitals without the
designations were down 11 percent. While the absolute growth was negative, the relative
difference still demonstrates the value of pursuing these designations through excellent clinical
quality.
Our performance was also affected by a number of unique situations, such as USC University
Hospital in Los Angeles, where volumes have been soft due to instability within the medical
school. I also mentioned Florida a minute ago, where the decline in just cardiology volumes
represents more than half of the total declines in admissions we saw nationwide in the first
quarter. If you add the admissions impact of these two items and exclude the two Dallas
hospitals we will stop operating this summer, the negative impact from basically five hospitals
accounts for more than 80 percent of the decline in admissions company-wide in the quarter.
Now, I’d prefer to be reporting a quarter where all of our regions and hospitals were performing
more consistently, but I believe that the negative drivers I just mentioned are isolated instances
that should not be mistaken as flaws in our overall strategy, nor should investors conclude that
the weakness in volumes is company-wide. Twenty-six of our 55 go-forward hospitals generated
positive growth in admissions. The strategy that we set back in 2003 is sound. It requires that
we maintain and enhance our commitments to quality, service and volume-building activities.
Here to talk more about these items is Dr. Steve Newman, Steve.
Dr. Stephen Newman, Chief Operating Officer
Thank you, Trevor, and good morning everyone.
This was my first quarter as chief operating officer. I have spent virtually all of my time fine-
tuning the turnaround strategies we’ve initiated over the past few years and making sure our
operators are focusing their efforts only on the levers that drive improved performance. After
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3. visiting our hospitals in six states in the first quarter, it’s clear to me that we have the right
strategies to get the job done. But what’s needed now is a much more consistent level of
excellence in implementing these strategies across our entire system.
At our annual management conference in Dallas last month, I told our hospital teams the only
priorities that really matter right now are these:
1. Continue to improve the quality of our excellent clinical care;
2. Grow inpatient and outpatient volumes and revenues consistent with our Targeted
Growth Initiative;
3. Retain and recruit the best employees and physicians; and
4. Improve cost management each day.
I called these my “prescription for success” at Tenet. And I told our hospital leaders that these
four priorities – and only these four – should guide everything they do every day. My most
critical assignment right now is to assure that our hospital leaders are not distracted from
executing our turnaround strategies. I intend to remove anything that gets in their way. I also
intend to make sure we have the appropriate level of rigor and a real sense of urgency at every
level in the organization. With enhanced focus and increased accountability, I expect to see
noticeable improvement in both our quality and earnings metrics in the months ahead.
We are already seeing the benefit of this effort in some of our first quarter results. Let me share
with you some of the highlights.
California
Since I was the regional leader in California until the end of the year, I am particularly pleased
with the continuing recovery in that region during the first quarter. If we exclude USC
University Hospital’s results from California’s performance, California’s admissions were up 0.9
percent in the first quarter. In large measure, we can credit the second part of my prescription I
just told you about for the California recovery; that is, a tight focus on growing volumes
consistent with our Targeted Growth Initiative. You will recall that TGI is our initiative to use a
rigorous, evidence-based approach to decide which services to emphasize and which to de-
emphasize at each hospital.
As Trevor mentioned, admissions are down at USC. Since USC has been a very successful
hospital for us in the past, its downturn has a ripple effect on other aggregate company metrics,
including pricing. We remain hopeful that this situation will be resolved favorably.
Texas
Moving on to the Texas Region, we saw a strong recovery in the first quarter with admissions up
2.9 percent when RHD and Trinity are excluded. This resulted from multiple factors:
1. The implementation of our Targeted Growth Initiative, which we launched about 18
months ago in Texas and which is now maturing in most hospitals.
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4. 2. Over the last 18 months, we have hired five new chief executive officers at our Texas
hospitals. These enthusiastic leaders have now had sufficient time to settle into their jobs
and develop the kinds of productive working relationships with their physicians that are
critical to growing market share and improving financial performance.
3. We’ve made progress with our physician alignment strategies in Texas. Our initiative to
develop an effective physician employment model in Texas appears to be yielding early
positive results. For instance, we’ve established primary care clinics at four locations as
part of our newly created Cypress Fairbanks Health Network in Houston. This is helping
us to secure a loyal base of primary care physicians and, in some selective cases,
specialists as well.
We have learned many lessons from our own past mistakes, and those of others, with regard to
physician employment. We are not purchasing any existing physician practices, for example,
and we are adding productivity targets and incentives for meeting quality metrics to our
physician employment agreements.
I should caution you about the sustainability of this rate of improvement in Texas. The gain in
key operating statistics in Texas exceeded our own first quarter expectations. Obviously, we
can’t be sure the current rate will continue, but we’ve been working on the Texas issue for some
time, and we are optimistic that the improvement we’ve seen will continue even if the rate of
progress begins to slow at some point.
The good news here is that our turnaround in Texas is clearly linked to consistent execution of
our strategies. That bodes well for the entire company over time.
Florida
In Florida, our hospitals continued to experience soft admissions in the first quarter. We believe
this, in part, resulted from fewer “snow birds” making their annual trek south during the winter
months, as well as loss of year-round population in some areas. In Palm Beach County, where
we have our largest cluster of hospitals, we’ve lost some market share in cardiology and in
managed care in general. We believe the diversion of a significant portion of our cardiovascular
business to new open-heart surgery competitors is primarily responsible for this noticeable drop
in both Medicare and commercial managed care business at our hospitals.
We’re taking multiple actions in Florida to address the recent softness. Since I became chief
operating officer in January, I have made three trips there to assess the situation and meet with
our hospital managers. We are currently completing the implementation of several new
strategies to stem the loss of volumes in Florida and we are confident there are significant
opportunities for us in cancer, neurology and neurosurgery, as well as the cardiovascular services
where we have traditionally been very strong.
For example, we recently started an open-heart surgery program at Palmetto General Hospital in
Dade County. In the first quarter of 2007, we performed 25 open-heart surgeries and 280
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5. percutaneous cardiac interventions at Palmetto. The good news is that all of this volume is
incremental new business that we couldn’t capture previously.
In addition, we recently undertook an analysis of the demographic data regarding our physicians
in Florida in order to better understand the factors causing our weaker admissions. The analysis
shows a worrisome aging of the primary care base, especially for our Palm Beach hospitals. As
they pass a certain age, physicians see fewer patients in their offices and scale back the number
of hospital patients they render care to. The malpractice climate in Florida has been a barrier to
the recruitment of private, primary care physicians who are necessary to meet community needs.
We are embarking on new strategies to recruit new, younger primary care physicians, similar to
our recent physician employment efforts in Texas.
In addition, we are more aggressively implementing our physician sales and service program in
Florida, and we are beginning to see the impact it can have on growing our patient volumes.
However, these efforts take time, and you should not expect us to reverse our loss of Florida
volumes quickly. I have also made it a top priority to augment our marketing and business
development efforts in Florida by recruiting experienced business development directors and
PSSP coordinators at all of our hospitals. We have also deployed more marketing resources and
increased our Florida advertising budgets.
The bottom line in Florida is that we’ve implemented a variety of turnaround strategies, but they
are less mature than in other regions. We are now focused intensely on consistent execution of
these strategies and improvement in physician relations as we rebuild our market share in the
state.
PSSP
Part of the third element of my “prescription for success” that I mentioned earlier is a focus on
recruiting and retaining physicians. We have described PSSP, our principal initiative in this
area, in earlier calls. And I can tell you that we’re still seeing improved referral patterns from the
physicians that have been our primary focus so far. As we gain more experience and improve
our focus, we are providing new tools to help our people. For example, today we are launching
our volume-building workshops for hospital chief executive officers. These intensive, one-day
education programs consist of didactic and role-playing modules focused on interactions with
physicians. The workshops are being held for Texas CEOs today, but over the next 120 days we
will roll them into every region.
In addition, we now develop lists of all physicians within the zip codes that define a hospital’s
market. And we have begun calling on high-prospect physicians that are not affiliated with our
hospitals. This is in addition to those physicians that have long-standing relationships with Tenet
hospitals, but may have diminished their referrals or become inactive members of our medical
staff. When we meet with non-Tenet physicians, we not only explain the culture change and new
investments at the hospital and at Tenet, but we also work collaboratively with them to get them
properly credentialed by the local hospital medical staffs.
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6. As we dig deeper into our prospect lists, we are continuing to generate the kinds of satisfying
results we have shared with you on earlier calls. We added just over 1,100 physicians to our
focus list in the first quarter. Most of those on the list who had already affiliated with us had
been referring far fewer patients than they had in the past. But in the first quarter, we saw an
increase of 13.6 percent, or 560 admissions, from these physicians compared to their admissions
to our hospitals in the first quarter of 2006. When you recall that Tenet’s goal for admissions
growth for 2007 is approximately 6,000 incremental admissions, it’s clear that PSSP continues to
make a meaningful contribution towards this goal.
We also have refined PSSP to put priority on visiting physicians that have received quality
designations by the managed care plans. Some of these physicians may not currently have or use
admitting privileges at a Tenet hospital, but they are on our focus list because there is a
geographic match. For example, Aetna has a strategy of identifying physicians, rather than
hospitals, as the primary focus of its quality strategy. Aetna offers financial incentives to its
members to use these doctors based on their patterns of utilization and quality outcomes. While
our reward for targeting these physicians may take longer than other parts of our PSSP initiative,
we believe this approach holds significant promise over the longer term.
Centers of Excellence
The first element of my “prescription for success” is a focus on improving clinical quality. As
you know, one aspect of our strategy for growth is to gain quality centers of excellence
designations for our hospitals from the managed care payers. In the first quarter, we again saw a
dramatic differential in admissions between our hospitals that have designated centers of
excellence and those that don’t. Although both rates were still negative in the quarter, our COE
hospitals saw cardiology admissions decline by only 1 percent, while our non-COE hospitals
were down almost 11 percent.
The issue comes into better focus if we exclude Florida where, as I mentioned earlier, some of
our cardiology programs have experienced significant declines due to new competitors.
Not counting Florida, our centers of excellence hospitals were actually up 4.5 percent in
cardiology admissions, while the non-COE hospitals declined by 7.1 percent. In other words,
there is even a wider growth gap between COE and non-COE cardiology programs of almost
1,200 basis points. That evidence is what gives us confidence that our quality strategy is playing
an increasingly important role in generating our future growth.
Unions
Let me conclude with a brief comment on our ongoing union negotiations. As many of you
know, some of our employees in California, and at three hospitals in Florida, have been working
under a month-by-month extension of our contract with the Service Employees International
Union that expired at the end of 2006. We’ve also been negotiating with the California Nurses
Association since last October on a new wage agreement for CNA-affiliated nurses at some of
our hospitals in California. The existing CNA agreement also expired at the end of 2006 and our
unionized nurses have been working under a month-by-month extension. We have not yet been
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7. able to reach a new agreement with either union. We remain optimistic that we’ll be able to do
so. But in the meantime, it’s possible that you may hear about some union activities or see some
negative media coverage as we continue these tough negotiations.
With that, I’d like to turn it over to Biggs Porter, our chief financial officer, Biggs.
Biggs Porter, Chief Financial Officer
Thank you Steve and good morning everyone.
I’ll start my review of the quarter with a look at patient volumes.
When we issued our outlook for admissions growth of 0.5 to 1.5 percent for 2007 two months
ago, we expected to see a reversal of the rate of decline and then for volumes to build gradually
through 2007, versus prior year quarters, as our strategies to drive profitable growth take further
hold.
As it is, there was a year-over-year decline of 1.7 percent in the first quarter, or even in the more
relevant metric of 1.4 percent after excluding the two Dallas hospitals to be divested this
summer. This is neither stellar nor acceptable, but there is still some moderation in the statistics
as last quarter’s decline in commercial managed care admissions, excluding the two Dallas
hospitals, was 3.1 percent for the quarter compared to 3.2 percent in the fourth quarter.
Growth in admissions in the outlook range of 50 to 150 basis points requires an incremental
2,800 to 8,400 admissions for the year. Excluding the two hospitals to be divested in Dallas, the
first quarter decline was 2,090 admissions, so our outlook range remains an achievable objective.
I will talk more about this later, but I want everyone to remember that, while volume growth is
critical for us to achieve our long term earnings potential, we can continue to improve our results
over the near and intermediate term through price, cost and cash flow focus as well.
Turning to revenues, net operating revenues grew by 3.1 percent, reflecting soft volumes, but
helped by reasonably good pricing. We saw good growth of 8.1 percent in managed care
revenues, which was driven, in part, by the continued migration from traditional Medicare and
Medicaid programs to managed programs.
Revenues were affected by favorable cost report settlements of almost $12 million in the quarter,
down from just over $27 million in last year’s first quarter. While cost report settlements and
adjustments from them may continue, we can’t say at what value.
Cost control
Total controllable operating expenses were up 4.1 percent, but the more important measure was
the measure of unit costs which rose by 6.3 percent, which, although we may have made some
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8. progress, still reflected higher staffing expense and fixed cost absorption than what we believe is
necessary for our current volumes. This is not just about headcount, but also the effects of
higher than desired turnover and higher contract labor cost. I will talk more about that in a
moment when I speak to the full-year expectations and our actions to mitigate the risk of volume
shortfalls.
I should also note that we had reductions in length of stay of 2 percent and this correspondingly
drives cost per day.
Supply costs actually declined in the quarter by 0.7 percent. While it’s true that this cost item
tends to move with patient volumes, and part of the decline was clearly the result of a decline in
surgeries, this kind of result is still quite extraordinary given the otherwise steady adverse impact
of the high rate of medical inflation.
“Other Operating Expenses” rose by 8.8 percent. This line item includes the costs of increased
medical fees, including the increased burden of ED on-call payments as well as subsidies to
hospital based physician groups, especially anesthesiologists, who are in short supply. We also
had some significant costs for systems development recorded here and malpractice expense
increased to $49 million from $43 million a year ago. There were a few adverse awards or
settlements during the quarter, which contributed to the increase in malpractice expense. While
we cannot say with certainty, this may be an anomaly for the quarter. Rising rents also
contributed to the increase, along with a decline in the amount of overhead costs allocated to
discontinued operations. These costs were partially offset by a $7 million gain on the sale of a
medical office building.
To say it again, as I mentioned in my fourth quarter remarks, we are continuing to carry staff
costs in excess of our immediate, current needs. We have facility-level plans in place to realign
staffing to current volumes. We also have specific targeted reductions in baseline overhead costs
and discretionary overhead spending, which should have a positive effect on the profitability of
future quarters.
Bad debt
Bad debt as a percent of net operating revenues came in at 6.2 percent, compared to 5.5 percent
in the first quarter a year ago and 5.7 percent in the fourth quarter.
If we exclude the two Dallas hospitals to be divested this summer, bad debt would have been 6
percent.
More importantly, after normalizing fourth quarter of last year for the effect on bad debt expense
of improved collections, the first quarter shows a fairly stable bad debt situation. We continue to
deploy our bad debt reduction strategies to mitigate risk in this area or, hopefully, to yield net
improvement over time.
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9. Pricing
Net inpatient revenue per patient day rose by 3.6 percent while net outpatient pricing per visit
increased by a much stronger 11 percent. One factor contributing to this was the relative mix
change toward higher priced commercial managed care volumes.
As we’ve said many times in past quarters, pricing metrics can be somewhat misleading in that
they are significantly impacted by the particular type of patient presenting themselves at a
specific hospital. The decline of volumes at USC provides an interesting example of this. If we
exclude USC from both last year’s and this year’s first quarters in calculating the increase in net
inpatient revenue per patient day, the increase would have been 4.6 percent rather than the 3.6
percent reported number.
Those of you who have followed Tenet closely over the last few years will notice that we have
reduced the amount of detail we are disclosing this quarter on some of our commercial pricing
metrics. It has gotten to the point that the disclosure of this type of detailed information has
become counterproductive in our on-going negotiations with managed care payors.
The fact is that, while we have received steady increases in most of our markets, we still have a
number of markets where our information on competitors’ pricing indicates that Tenet is being
underpaid. Our pricing objective remains to achieve rate parity across all our plans, in all of our
facilities and in all of our markets. On this basis, we still have several markets and contracts
which need to have greater-than-average increases to obtain rate parity.
Cash flow
We ended the quarter with $584 million in cash, down $200 million from year-end. Adjusted
free cash flow used in continuing operations was $272 million. Adjusted free cash flow is a non-
GAAP term we define and reconcile to GAAP in the release.
Discontinued operations provided $17 million in cash, primarily due to the on-going collection
of accounts receivable from sold hospitals.
Excluding this cash from disc ops, as well as payments against reserves of $7 million and a small
tax payment of $2 million, cash used in continuing operations would have been $162 million.
Note that this $162 million included the combined $96 million annual funding of our 401(k)
match and incentive compensation.
It should be noted that shortly after the end of the first quarter, we received the tax refund of
$171 million, which we have previously disclosed as being expected around this time.
It is worth noting that our focus on cash flow is increasing. We have always had cash related
targets, but the more comprehensive measure of free cash flow has been added to our balance
scorecard metrics in 2007.
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10. Total company capital expenditures were $111 million in the quarter, of which $110 million was
in continuing operations. These capital investments included $11 million for the construction of
our new East Side Hospital in El Paso and $35 million related to the $150 million of bolus
capital we authorized for commitment last year. This brings our total spending on the bolus to
about $75 million, with the remainder in the pipeline.
The deployment of our bolus capital has been slower than we anticipated due to long lead times
in regulatory approvals and moving from the placing of an order to the final installation,
including any construction and site preparation activities. We otherwise find ourselves walking
the fine line of ensuring value generating expenditures are executed expeditiously and applying
good discipline to more mundane capital activities.
Adjusted EBITDA and our outlook
Adjusted EBITDA was $189 million for the first quarter for a margin of 8.3 percent. The
reconciliation of this number to the GAAP definition of net income is provided in the earnings
release we issued this morning. This number included $6 million of negative EBITDA for
Trinity and RHD, which will be discontinued by year-end and are not in our 2007 outlook for
continuing operations. It also included a number of other items reflected in our earnings release.
In late February, we provided an outlook for 2007 which put adjusted EBITDA in the range $700
to $800 million. While the first quarter was somewhat weaker than we had anticipated in terms
of patient volumes, we saw many signs that our growth strategies are gaining traction, but were
held back by Florida and USC.
As a result, it is entirely too early to start refining our outlook for 2007, or even commenting on
whether it is more likely that we will be at the high or low end of the range.
Since I know some of you struggled to reconcile our 2007 outlook, I’m going to take a moment
to give you a sample walk forward. The purpose of doing this is not to give you specific new
line item guidance, but to show you how the variables operate and to communicate the types of
actions we are engaged in to mitigate risk or give us upside. As I said earlier, I want to
emphasize that near-term performance is not all about volumes.
If you assume normalized adjusted EBITDA for the first quarter was around $180 million, then
annualized you would have $720 million. Using around $180 million for this purpose seems
reasonable after eliminating the $6 million of losses at RHD and Trinity and the $7 million gain
on sale of the MOB, and normalizing for cost reports, malpractice expense and dish payments.
This is subjective and I recognize everyone will have to draw their own conclusions about this
starting point.
The question then becomes one of how do you get a model to work from the $720 million level
to say the middle of our outlook or higher. Here is one bridge to that result:
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11. First, we should add back to the annualized figure above the detail plans we have to reduce
overhead and staffing costs over the next three quarters relative to first quarter expense levels.
These efficiencies aggregate to over $50 million for the rest of this year.
Second, we have initiatives with a potential to significantly contribute to 2007 results. These
include:
• Additional staffing reductions at the hospitals
• DRG documentation corrective actions to increase recovery to the level we are entitled
• Similarly improve our ED coding to ensure services and severity are all properly captured
• Charge capture and other revenue-related initiatives
• Improved denial management
• Improved bad debt expense from our bad debt initiatives
• Continued success in improving costs on medical devices
• Further reductions in consulting and other overhead spending
The list of our action plans is in fact longer, but I will stop here as the remaining items become
increasingly finite.
Now, let’s assume a starting point at the conservative end of our outlook for admissions. I am
not leading you to this as an assumption, but it will be a good way to show how the variables
work. In order to have admissions and visits for the year at 0.5 percent and 2 percent growth,
respectively, our remaining quarters need to have admissions growth over the prior year quarter’s
of 1.2 percent, and outpatient visit growth of 3.3 percent. Since the first quarter has higher
admissions than average for the year, this would result in equivalent admissions of 2.2 percent
below the first quarter. At first quarter average pricing and mix, this would result in lower
average quarterly revenue of $50 million for the next three quarters compared to the run-rate we
achieved in the first quarter, or $150 million, in the aggregate for the next three quarters. You
may recall that we believe the incremental margin on each admission is 40 percent, other
variables remaining constant. Versus our first quarter, this would suggest a reduction in
quarterly income for the next three quarters of an aggregate $60 million versus the first quarter,
so $150 million times 40 percent for $60 million. Although our merit increases are not until the
fourth quarter, let’s assume that, absent mitigating actions on our part, our cost and pricing move
at the same rate of growth for the remainder of the year, so that the $60 million is a logically
produced number.
Using this data set and assuming we only capture just over $30 million from the initiatives
above, we would be around the middle of our outlook. If you start with a different normalized
EBITDA number for the first quarter and hold the same volume assumptions, it just changes how
much I would say we have to achieve of our initiatives in order to hit the middle of the range.
We are actively pursuing the full capture of the initiatives, which are of much higher potential
value than what I used a moment ago, and also performance much better than the admissions
data I used above. If we are successful, then there is upside or additional mitigation of volume
risk.
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12. I have said before that our objective is to have a balanced outlook with offsetting risks and
opportunities, with good risk mitigation and opportunity capture plans. There is a lot of the year
and risk left ahead of us, but I believe we still have that balance. Of course, in the end, it is our
performance that matters.
Q and A
With that we can turn to Q and A. Operator, could you please provide the instructions for our
callers to wish to ask a question.
[END]
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