Universal Health Services, Inc - Form 10-K
Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

FORM 10-K

 


 

(MARK ONE)

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

 

For the fiscal year ended December 31, 2004

 

OR

 

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

 

For the transition period from              to             

 

Commission File No. 1-10765

 


 

UNIVERSAL HEALTH SERVICES, INC.

(Exact name of registrant as specified in its charter)

 


 

Delaware   23-2077891

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification Number)

 

UNIVERSAL CORPORATE CENTER

367 South Gulph Road

P.O. Box 61558

King of Prussia, Pennsylvania

  19406-0958
(Address of principal executive offices)   (Zip Code)

 

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

 


 

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

 

Title of each Class


 

Name of each exchange on which registered


Class B Common Stock, $.01 par value   New York Stock Exchange

 

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

Class D Common Stock, $.01 par value

(Title of each Class)

 


 

Indicate by check mark whether the registrant (1) has filed all reports to be filed by Section 13 or 15(d) of the Securities and Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.     Yes  x    No  ¨

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  x

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act)    Yes  x    No  ¨

 

The number of shares of the registrant’s Class A Common Stock, $.01 par value, Class B Common Stock, $.01 par value, Class C Common Stock, $.01 par value, and Class D Common Stock, $.01 par value, outstanding as of January 31, 2005, were 3,328,404, 54,046,996, 335,800 and 27,336, respectively.

 

The aggregate market value of voting stock held by non-affiliates at June 30, 2004 $2,475,482,221.03 (For the purpose of this calculation, it was assumed that Class A, Class C, and Class D Common Stock, which are not traded but are convertible share-for-share into Class B Common Stock, have the same market value as Class B Common Stock.)

 

DOCUMENTS INCORPORATED BY REFERENCE:

 

Portions of the registrant’s definitive proxy statement for our 2005 Annual Meeting of Stockholders, which will be filed with the Securities and Exchange Commission within 120 days after December 31, 2004 (incorporated by reference under Part III).

 


 

 


Table of Contents

UNIVERSAL HEALTH SERVICES, INC.

2004 FORM 10-K ANNUAL REPORT

 

TABLE OF CONTENTS

 

PART I     

Item 1

   Business    4

Item 2

   Properties    20

Item 3

   Legal Proceedings    24

Item 4

   Submission of Matters to a Vote of Security Holders    25
PART II     

Item 5

   Market for the Registrant’s Common Equity and Related Stockholder Matters    26

Item 6

   Selected Financial Data    26

Item 7

   Management’s Discussion and Analysis of Financial Condition and Results of Operations    27

Item 7A

   Quantitative and Qualitative Disclosures About Market Risk    55

Item 8

   Financial Statements and Supplementary Data    57

Item 9

   Changes in and Disagreements with Accountants on Accounting and Financial Disclosure    57

Item 9A

   Controls and Procedures    57
PART III     

Item 10

   Directors and Executive Officers of the Registrant    59

Item 11

   Executive Compensation    59

Item 12

   Security Ownership of Certain Beneficial Owners and Management    59

Item 13

   Certain Relationships and Related Transactions    59
PART IV     

Item 14

   Principal Accounting Fees and Financial Services    59

Item 15

   Exhibits, Financial Statement Schedules, and Reports on Form 8-K    60

SIGNATURES

   65

 

This Annual Report on Form 10-K is for the year ended December 31, 2004. This Annual Report modifies and supersedes documents filed prior to this Annual Report. Information that we file with the SEC in the future will automatically update and supersede information contained in this Annual Report. In this Annual Report, “we,” “us,” “our” and the “Company” refer to Universal Health Services, Inc. and its subsidiaries.

 

You should carefully review all of the information contained in this Annual Report, and should particularly consider any risk factors that we set forth in this Annual Report and in other reports or documents that we file from time to time with the SEC. In this Annual Report, we state our beliefs of future events and of our future financial performance. In some cases, you can identify those so-called “forward-looking statements” by words such as “may,” “will,” “should,” “expects,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “potential,” or “continue” or the negative of those words and other comparable words. You should be aware that those statements are only our predictions. Actual events or results may differ materially. In evaluating those statements, you should specifically consider various factors, including the risks outlined below. Those factors may cause our actual results to differ materially from any of our forward-looking statements.

 

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Factors Affecting Future Operations

 

Factors that may cause our actual results to differ materially from any of our forward-looking statements presented in this Annual Report include, but are not limited to:

 

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

 

    industry capacity, demographic changes, existing laws and government regulations and changes in or failure to comply with laws and governmental regulations;

 

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

 

    liability and other claims asserted against us;

 

    liabilities arising out of shareholders’ suits which have been commenced against us and certain of our officers and directors;

 

    the continuing high number of governmental inquiries, investigations and administrative and legal actions being taken against health care providers, which, if directed at us or one of our facilities, could significantly increase costs and expenses;

 

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

 

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

 

    our ability to attract and retain qualified personnel, including nurses, and our ability to recruit physicians to provide services at our facilities;

 

    our ability to successfully integrate our recent acquisitions;

 

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

 

    our ability to finance growth on favorable terms;

 

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

 

    our acute care facilities continue to experience an increase in uninsured and self-pay patients which unfavorably impacts the collectibility of our patient accounts;

 

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

 

    we have experienced a significant increase in professional and general liability and property insurance expense caused by unfavorable pricing and availability trends of commercial insurance and as a result, we have assumed a greater portion of our liability risk and consequently, there can be no assurance that a continuation of these unfavorable trends, or a sharp increase in claims asserted against us, which are self-insured, will not have a material adverse effect on our future results of operations, and;

 

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

 

Given these uncertainties, prospective investors are cautioned not to place undue reliance on such forward-looking statements. We disclaim any obligation to update any such factors or to publicly announce the result of any revisions to any of the forward-looking statements contained herein to reflect future events or developments.

 

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PART I

 

ITEM 1. Business

 

We are a Delaware corporation that was organized in 1979.

 

Our principal business is owning and operating, through our subsidiaries, acute care hospitals, behavioral health centers and ambulatory surgery and radiation oncology centers. As of March 1, 2005, we operated 44 acute care hospitals and 49 behavioral health centers located in 23 states, Washington, DC, Puerto Rico and France. As part of our ambulatory treatment centers division, we manage and own outright or in partnership with physicians, 12 surgery and radiation oncology centers located in 7 states and Puerto Rico. Subsequent to December 31, 2004, we executed a definitive agreement to sell two acute care hospitals located in Puerto Rico. The sales, which are subject to customary regulatory approvals, are expected to be completed by March 31, 2005.

 

Services provided by our hospitals include:

 

    general surgery

 

    internal medicine

 

    obstetrics

 

    emergency room care

 

    radiology

 

    oncology

 

    diagnostic care

 

    coronary care

 

    pediatric services

 

    behavioral health services

 

We provide capital resources as well as a variety of management services to our facilities, including central purchasing, information services, finance and control systems, facilities planning, physician recruitment services, administrative personnel management, marketing and public relations.

 

Our principal executive offices are located at 367 South Gulph Road, King of Prussia, PA 19406. Our telephone number is (610) 768-3300. Universal Health Services, Inc. has a web site at http://www.uhsinc.com. Copies of the annual, quarterly and current reports we file with the SEC, and any amendments to those reports, are available on our web site. The information posted on our web site is not incorporated into this Annual Report.

 

We selectively seek opportunities to expand our base of operations by acquiring, constructing or leasing additional hospital facilities. Such expansion may provide us with access to new markets and new health care delivery capabilities. We also seek to increase the operating revenues and profitability of owned hospitals by the introduction of new services, improvement of existing services, physician recruitment and the application of financial and operational controls. Pressures to contain health care costs and technological developments allowing more procedures to be performed on an outpatient basis have led payors to demand a shift to ambulatory or outpatient care wherever possible. We are responding to this trend by emphasizing the expansion of outpatient services. In addition, in response to cost containment pressures, we continue to implement programs designed to improve financial performance and efficiency while continuing to provide quality care, including more efficient use of professional and paraprofessional staff, monitoring and adjusting staffing levels and equipment usage, improving patient management and reporting procedures and implementing more efficient billing and collection procedures. We also continue to examine our facilities and consider divestiture of those facilities that we believe do not have the potential to contribute to our growth or operating strategy.

 

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

 

Recent and Proposed Acquisition and Divestiture Activities

 

Subsequent to December 31, 2004, we signed a definitive agreement to sell two acute care facilities in Puerto Rico: Hospital San Pablo, a 430-bed acute care hospital located in Bayamon and Hospital San Pablo del Este, a 180-bed acute care hospital in Fajardo. The sale proceeds will be approximately $120 million in cash plus the value of certain components of working capital. The sale is subject to customary regulatory approvals and we expect the closing to occur by March 31, 2005. The operating results of these facilities are reflected as “Income/(loss) from discontinued operations, net of income tax” in the Consolidated Statements of Income for the year ended December 31, 2004.

 

During 2004, we spent approximately $163 million on acquisitions to acquire the following:

 

    a 90% controlling ownership interest in a 54-bed acute care hospital located in New Orleans, Louisiana, (operations subsequently merged with the operations of a 306-bed acute care hospital located in East New Orleans, Louisiana);

 

    a 50-bed acute care facility, a 20-bed acute care facility and the remaining 65% ownership interest (35% previously acquired) in the rea1 estate assets of a 198-bed acute care facility located in France, all of which were acquired by an operating company in which we own an 80% controlling ownership interest;

 

    a 63-bed behavioral health hospital, partial services, a school, group homes and detox services located in Stonington, Connecticut;

 

    a 112-bed behavioral health facility in Savannah, Georgia;

 

    a 77-bed behavioral health facility in Benton, Arkansas;

 

    the operations of an 82-bed behavioral health facility in Las Vegas, Nevada;

 

    a 72-bed behavioral health facility in Bowling Green, Kentucky, and;

 

    an outpatient surgery center in Edinburg, Texas and an outpatient surgery center located in New Orleans, Louisiana.

 

In addition, in late December, 2003, we funded $230 million (which was included in other assets on our consolidated balance sheet as of December 31, 2003) for the combined purchase price of the following acute care facilities which we acquired effective January 1, 2004:

 

    a 90% controlling ownership interest in a 306-bed facility located in East New Orleans, Louisiana;

 

    a 228-bed facility located in Corona, California;

 

    a 112-bed facility located in San Luis Obispo, California (this facility was sold during the second quarter of 2004), and;

 

    a 65-bed facility located in Arroyo Grande, California (this facility was sold during the second quarter of 2004).

 

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During 2004, in conjunction with our strategic plan to sell two recently acquired acute care hospitals in California as well as certain other under-performing assets, we sold the operations and/or property of the following acute care facilities and surgery and radiation therapy centers for combined cash proceeds of approximately $81 million:

 

    a 112-bed hospital located in San Luis Obispo, California (sold in second quarter of 2004);

 

    a 65-bed hospital located in Arroyo Grande, California (sold in second quarter of 2004);

 

    a 136-bed leased hospital in Shreveport, Louisiana (sold in second quarter of 2004);

 

    a 106-bed hospital located in La Place, Louisiana (sold in second quarter of 2004);

 

    a 160-bed pediatric and surgery hospital located in Rio Piedras, Puerto Rico (sold in third quarter of 2004), and;

 

    ownership interests in five outpatient surgery centers located in Ponca City, Oklahoma (sold in second quarter of 2004), New Albany, Indiana (sold in third quarter of 2004), Hammond, Louisiana (sold in third quarter of 2004), Littleton, Colorado (sold in the first quarter of 2004) and St. George, Utah (sold in the fourth quarter of 2004) and a radiation therapy center located in Madison, Indiana (sold in first quarter of 2004).

 

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Bed Utilization and Occupancy Rates

 

The following table shows the historical statistical information for the hospitals operated by us for the years indicated. Accordingly, information related to hospitals acquired during the five-year period has been included from the respective dates of acquisition, and information related to hospitals divested during the five year period has been included up to the respective dates of divestiture. Also included for all years presented, is the statistical information related to two acute care facilities located in Puerto Rico that we expect to sell by March 31, 2005, as discussed above.

 

     2004

    2003

    2002

    2001

    2000

 

Average Licensed Beds:

                              

Acute Care Hospitals - U.S & Puerto Rico

   6,496     5,804     5,813     5,514     4,980  

Behavioral Health Centers

   4,225     3,894     3,752     3,732     2,612  

Acute Care Hospitals – France (1)

   1,588     1,433     1,083     720     —    

Average Available Beds (2):

                              

Acute Care Hospitals - U.S & Puerto Rico

   5,592     4,955     4,802     4,631     4,220  

Behavioral Health Centers

   4,145     3,762     3,608     3,588     2,552  

Acute Care Hospitals - France (1)

   1,588     1,433     1,083     720     —    

Admissions:

                              

Acute Care Hospitals - U.S & Puerto Rico

   286,630     266,207     266,261     237,802     214,771  

Behavioral Health Centers

   94,743     87,688     84,348     78,688     49,971  

Acute Care Hospitals - France (1)

   94,536     82,364     63,781     38,627     —    

Average Length of Stay (Days):

                              

Acute Care Hospitals - U.S & Puerto Rico

   4.7     4.7     4.7     4.7     4.7  

Behavioral Health Centers

   13.0     12.2     11.9     12.1     12.2  

Acute Care Hospitals - France (1)

   4.7     5.0     5.0     4.7     —    

Patient Days (3):

                              

Acute Care Hospitals - U.S & Puerto Rico

   1,342,242     1,247,882     1,239,040     1,123,264     1,017,646  

Behavioral Health Centers

   1,234,152     1,067,200     1,005,882     950,236     608,423  

Acute Care Hospitals - France (1)

   442,825     409,860     319,100     180,111     —    

Occupancy Rate—Licensed Beds (4):

                              

Acute Care Hospitals - U.S & Puerto Rico

   56 %   59 %   58 %   56 %   56 %

Behavioral Health Centers

   80 %   75 %   73 %   70 %   64 %

Acute Care Hospitals - France (1)

   76 %   78 %   81 %   69 %   —    

Occupancy Rate—Available Beds (4):

                              

Acute Care Hospitals - U.S & Puerto Rico

   66 %   69 %   71 %   66 %   66 %

Behavioral Health Centers

   81 %   78 %   76 %   73 %   65 %

Acute Care Hospitals – France (1)

   76 %   78 %   81 %   69 %   —    

(1) The facilities located in France are owned by an operating company that is 80% owned by us.
(2) “Average Available Beds” is the number of beds which are actually in service at any given time for immediate patient use with the necessary equipment and staff available for patient care. A hospital may have appropriate licenses for more beds than are in service for a number of reasons, including lack of demand, incomplete construction, and anticipation of future needs.
(3) “Patient Days” is the sum of all patients for the number of days that hospital care is provided to each patient.
(4) “Occupancy Rate” is calculated by dividing average patient days (total patient days divided by the total number of days in the period) by the number of average beds, either available or licensed.

 

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The number of patient days of a hospital is affected by a number of factors, including the number of physicians using the hospital, changes in the number of beds, the composition and size of the population of the community in which the hospital is located, general and local economic conditions, variations in local medical and surgical practices and the degree of outpatient use of the hospital services. Current industry trends in utilization and occupancy have been significantly affected by changes in reimbursement policies of third party payors. A continuation of such industry trends could have a material adverse impact upon our future operating performance. We have experienced growth in outpatient utilization over the past several years. We are unable to predict the rate of growth and resulting impact on our future revenues because it is dependent upon developments in medical technologies and physician practice patterns, both of which are outside of our control. We are also unable to predict the extent to which other industry trends will continue or accelerate.

 

Sources of Revenue

 

We receive payments for services rendered from private insurers, including managed care plans, the federal government under the Medicare program, state governments under their respective Medicaid programs and directly from patients. All of our acute care hospitals (located in the U.S. and Puerto Rico) and most of our behavioral health centers are certified as providers of Medicare and Medicaid services by the appropriate governmental authorities. The requirements for certification are subject to change, and, in order to remain qualified for such programs, it may be necessary for us to make changes from time to time in our facilities, equipment, personnel and services. The costs for recertification are not material as many of the requirements for recertification are a part of our internal quality control processes. If a facility loses certification, it will be unable to receive payment for patients under the Medicare or Medicaid programs. Although we intend to continue in such programs, there is no assurance that we will continue to qualify for participation.

 

The sources of our hospital revenues are charges related to the services provided by the hospitals and their staffs, such as radiology, operating rooms, pharmacy, physiotherapy and laboratory procedures, as well as basic charges for the hospital room and related services such as general nursing care, meals, maintenance and housekeeping. Hospital revenues depend upon the occupancy for inpatient routine services, the extent to which ancillary services and therapy programs are ordered by physicians and provided to patients, the volume of outpatient procedures and the charges or negotiated payment rates for such services. Charges and reimbursement rates for inpatient routine services vary depending on the type of bed occupied (e.g., medical/surgical, intensive care or behavioral health) and the geographic location of the hospital.

 

Our patient registration process includes an interview of the patient or the patient’s responsible party at the time of registration. At that time, an insurance eligibility determination is made and an insurance plan code is assigned. There are various pre-established insurance profiles in our patient accounting system which determine the expected insurance reimbursement for each patient based on the insurance plan code assigned and the services rendered. Our acute care hospitals identify patient co-pay and deductible amounts through insurance card review and insurance eligibility/benefit inquiries. These inquiries are completed during the scheduling and pre-admission process and at the time of actual patient registration. For non-emergent patients, hospitals attempt to collect co-pay and deductible amounts from the patient at the end of the registration process. As required under federal EMTALA regulations, for patients provided medical treatment in the emergency room, the hospital attempts collection of patient co-pay and deductible amounts after the completion of the medical treatment.

 

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McAllen Medical Center located in McAllen, Texas and Edinburg Regional Medical Center located in Edinburg, Texas operate within the same market. On a combined basis, these two facilities contributed 9% in 2004, 11% in 2003 and 12% in 2002, of our consolidated net revenues and 10% in 2004, 16% in 2003 and 19% in 2002, of our consolidated earnings before income taxes (after deducting an allocation for corporate overhead). We have a majority ownership interest in four acute care hospitals in the Las Vegas, Nevada market. These four hospitals, Valley Hospital Medical Center, Summerlin Hospital Medical Center, Desert Springs Hospital and Spring Valley Medical Center, on a combined basis, contributed 17% in 2004, 16% in 2003 and 17% in 2002 of our consolidated net revenues and 12% in 2004, 13% in 2003 and 16% in 2002 of our consolidated earnings before income taxes (after deducting an allocation for corporate overhead).

 

The following table shows the approximate percentages of net patient revenue, defined as revenue from all sources after deducting contractual allowances and discounts from established billing rates, which we derived from various sources of payment for the years indicated (excludes sources of revenues for all periods presented for five acute care facilities, three of which have been divested, and two which are expected to be divested, and are therefore reflected as discontinued operations in our consolidated financial statements).

 

     Percentage of Net Patient Revenues

 
     2004

    2003

    2002

    2001

    2000

 

Third Party Payors:

                              

Medicare

   28.6 %   30.4 %   31.5 %   30.7 %   31.6 %

Medicaid

   11.3 %   11.0 %   10.9 %   11.4 %   12.7 %

Managed Care (HMO and PPOs)

   40.5 %   40.2 %   39.6 %   35.5 %   32.7 %

Other Sources

   19.6 %   18.4 %   18.0 %   22.4 %   23.0 %
    

 

 

 

 

Total

   100 %   100 %   100 %   100 %   100 %
    

 

 

 

 

 

Note 11 to our consolidated financial statements included in this annual report contains our revenues, income and other operating information for each reporting segment of our business.

 

Regulation and Other Factors

 

A significant portion of our revenue is derived from federal and state healthcare programs, including Medicare and Medicaid (excluding managed Medicare and Medicaid programs), which accounted for 40%, 41% and 42% of our net patient revenues during 2004, 2003 and 2002, respectively. Under the statutory framework of the Medicare and Medicaid programs, many of our operations are subject to administrative rulings, interpretations and discretion that may affect payments made under either or both of such programs as well as by other third party payors. Management believes that adequate provision has been made for any adjustment that might result therefrom.

 

The federal government makes payments to participating hospitals under its Medicare program based on various formulas. For inpatient services, our general acute care hospitals are subject to a prospective payment system (“PPS”) under which the hospitals are paid a predetermined amount per admission. The payment is based upon a diagnostic related group (“DRG”), for which payment amounts are adjusted to account for geographic wage differences. For outpatient services, both general acute and behavioral health hospitals are paid under an outpatient prospective payment system (“OPPS”) according to ambulatory procedure codes (“APC”) that group together services that are comparable both clinically and with respect to the use of resources, as adjusted to account for certain geographic wage differences.

 

Prior to January 1, 2005, behavioral health facilities, which are generally excluded from the inpatient services PPS, were reimbursed on a reasonable cost basis by the Medicare program (“TEFRA Payment”), but were generally subject to a per discharge ceiling, calculated based on an annual allowable rate of increase over the hospital’s base year amount under the Medicare law and regulations. Capital-related

 

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costs were exempt from this limitation. The discharge ceiling is higher for those hospitals that were excluded from PPS before October 1, 1997. Congress required the Centers for Medicare and Medicaid Services (“CMS”) to develop a per diem PPS for inpatient services furnished by behavioral health hospitals under the Medicare program (“Psych PPS”). On November 15, 2004, CMS published final regulations that implement Psych PPS, which is effective beginning on an inpatient psychiatric facility’s first cost reporting period beginning on or after January 1, 2005. This new system will generally become effective for most UHS hospitals on January 1, 2005. The federal prospective rate is a base prospective per diem rate and is adjusted for individual hospital demographic factors including: geographic location, resident teaching program status and licensed emergency room department status. The base per diem rate is also adjusted for patient specific demographic factors including: patient age, medical diagnosis and the existence of certain comorbid medical conditions. The base per diem rate is paid based on sliding scale payment adjustment factors wherein a provider will receive an increased per diem for day one of the patient stay and the per diem payment will decrease during the patient hospital stay based on a published CMS sliding scale. Psych PPS will be implemented over a four year period with Year 1 having a blended Medicare payment rate based on seventy-five percent (75%) TEFRA payment and twenty-five percent (25%) Psych PPS payment. For PPS transition Years 2, 3 and 4, the blended rate is 50% TEFRA and 50% Psych PPS, 25% TEFRA and 75% Psych PPS, 0% TEFRA and 100% Psych PPS, respectively. We believe the implementation of inpatient Psych PPS will have a favorable affect on our future results of operations, however, due to the four-year phase-in period, we do not believe the favorable affect will have a material impact on our 2005 results of operations.

 

There are also a number of other more general federal regulatory trends and factors affecting our business. Federal legislation continues to call for the government to trim the growth of federal spending on Medicare and Medicaid, including reductions in the future rate of increases to payments made to hospitals, to reduce the amount of payments for outpatient services, bad debt expense and capital costs. In federal fiscal year 2004, hospitals were receiving full market basket inflation adjustment for services paid under the inpatient PPS (inpatient PPS update of the market basket is 3.4% in fiscal year 2004), although CMS estimates that for the same time period, Medicare payment rates under OPPS were to increase, for each service, by an average of 4.5%. Under the Medicare Modernization Act of 2003, which was signed into law in November 2003, the update was restored to the full market basket for fiscal year 2004; however, for fiscal years 2005 through 2007, operating updates equal to the market basket will be granted only to those hospitals that submit data on the ten quality indicators established by CMS. Our hospitals intend to submit the required quality data to CMS. In addition, in February, 2003, the federal fiscal year 2003 omnibus spending federal legislation included approximately $800 million in increased spending for hospitals. More specifically, $300 million of this amount was targeted for rural and certain urban hospitals effective for the period of April, 2003 through September, 2003. Certain hospitals of ours were eligible for and received the increased Medicare reimbursement resulting from this legislation which amounted to approximately $3 million during 2004 and 2003. For federal fiscal year 2005, CMS will increase the inpatient Medicare unadjusted standard base rate by a full market basket increase of 3.3.%, absent any legislative action by Congress. However, this Medicare payment increase will be mitigated by changes in other factors that directly impact a hospital’s DRG payment including, but not limited to, annual Medicare wage index updates, expansion of the DRG transfer payment policy and the annual recalibration of DRG relative payment weights.

 

Certain Medicare inpatient hospital cases with extraordinarily high costs in relation to other cases within a given DRG may receive an additional payment from Medicare (“Outlier Payments”). In general, to qualify for the additional Outlier Payments, the gross charges associated with an individual patient’s case must exceed the applicable DRG plus a threshold established annually by CMS. In the federal 2004 fiscal year, the unadjusted Outlier Payment threshold decreased from $33,560 to $31,000. In the federal 2005 fiscal year, the threshold will be reduced to $25,800. In June, 2003, CMS issued a final rule that

 

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changed the formula for determining outlier payments in an effort to promote more accurate spending for outlier payments to hospitals. These changes to the Outlier Payment methodology resulted in a decrease in the overall Outlier Payments received by us during the 2004 federal fiscal year as compared to the prior year. Our total Outlier Payments were less than 0.5% of our consolidated net revenues in 2004 and 2003, less than 1% in 2002 and we expect outlier payments to be less than 0.5% in 2005.

 

Within certain limits, a hospital can manage its costs, and to the extent this is done effectively, a hospital may benefit from the DRG system. However, many hospital operating costs are incurred in order to satisfy licensing laws, standards of the Joint Commission on Accreditation of Healthcare Organizations (“JCAHO”) and quality of care concerns. In addition, hospital costs are affected by the level of patient acuity, occupancy rates and local physician practice patterns, including length of stay and number and type of tests and procedures ordered. A hospital’s ability to control or influence these factors which affect costs is, in many cases, limited.

 

On August 1, 2003, CMS published regulations that made certain changes to the inpatient PPS. Among the changes made by this new rule, as amended, is an expansion of the definition of when the discharge of a hospital patient must be considered a transfer for Medicare payment purposes. Under the rule, a discharge results in a transfer if the patient discharge is assigned to one of thirty DRGs in federal fiscal year 2005. The rule also addresses other issues that may impact us, including certain changes to the DRG classifications and updates to the wage index. We do not believe that this rule will have a material adverse impact on our future results from operations.

 

On September 9, 2003, CMS published a final rule clarifying policies relating to the responsibilities of Medicare-participating hospitals in treating individuals with emergency medical conditions who are presented to a hospital under the provisions of the Emergency Medical Treatment and Labor Act (“EMTALA”). The clarifications in the final rule relate to, among other areas, seeking prior authorization from insurers for services, emergency patients presented at off-campus outpatient clinics that do not routinely provide emergency services, the applicability of the EMTALA provisions to hospital inpatients and outpatients, the circumstances under which physicians must serve on hospital medical staff “on-call” lists, and the responsibilities of hospital-owned ambulances. We do not believe that this new rule will have a material adverse impact on our future results from operations.

 

In addition to revenues received pursuant to the Medicare program, we receive a large portion of our revenues either directly from Medicaid programs or from managed care companies managing Medicaid with a large concentration of our Medicaid revenues received from Texas, Pennsylvania and Massachusetts. We can provide no assurance that reductions to Medicaid revenues, particularly in the above-mentioned states, will not have a material adverse effect on our future results of operations. Furthermore, we can provide no assurances that future reductions to federal and/or state budgets that contain certain further reductions or decreases in the rate of increase of Medicare and Medicaid spending, will not adversely affect our future operations.

 

In 1991, the Texas legislature authorized the LoneSTAR Health Initiative, a pilot program in two areas of that state, to establish for Medicaid beneficiaries a healthcare delivery system based on managed care principles. The program is now known as the STAR program, which is short for State of Texas Access Reform. Since 1995, the Texas Health and Human Services Commission (the “Commission”), with the help of other Texas agencies such as the Texas Department of State Heath Services, formerly known as the Texas Department of Health, has rolled out STAR Medicaid managed care pilot programs in several geographic areas of the state. Under the STAR program, the Commission either contracts with health maintenance organizations in each area to arrange for covered services to Medicaid beneficiaries, or contracts directly with healthcare providers and oversees the furnishing of care in the role of the case

 

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manager. Two carve-out programs are the STAR+PLUS program, which provides long-term care to elderly and disabled Medicaid beneficiaries in the Harris County service area, and the NorthSTAR program, which furnishes behavioral health services to Medicaid beneficiaries in the Dallas County service area. The Commission has also sought a waiver to extend a limited Medicaid benefits package to low income persons with serious mental illness. The waiver is limited to individuals residing in Harris County or the NorthSTAR service areas. As a result of the passage of Texas House Bill 2292, which passed in the 2003 legislative session, the Commission conducted an analysis and cost-effectiveness study of the managed care models in use to determine how a statewide rollout should be implemented. As a result of this study, the Commission created a framework for expanding Medicaid managed care in Texas. Under this proposal, set to go into effect in September 2005, some form of Medicaid managed care will exist in every Texas county and the STAR+PLUS program will be expanded to seven additional service areas. Such actions could have a material unfavorable impact on the reimbursement the Texas hospitals receive.

 

Upon meeting certain conditions, and serving a disproportionately high share of Texas’ and South Carolina’s low income patients, five of our facilities located in Texas and one facility located in South Carolina became eligible and received additional reimbursement from each state’s disproportionate share hospital (“DSH”) fund. To qualify for DSH funds in Texas, the facility must have either a disproportionate total number of inpatient days for Medicaid patients, a disproportionate percentage of all inpatient days that are for Medicaid patients, or a disproportionate percentage of all inpatient days that are for low-income patients. Included in our financial results was an aggregate of $39.3 million in 2004, $27.8 million in 2003 and $33.0 million in 2002 related to DSH programs. In February 2003, the United States Department of Health and Human Services Office of Inspector General (“OIG”) published a report indicating that Texas Medicaid may have overpaid Texas hospitals for DSH payments. During 2004, the Commission implemented rules which offset negative Medicaid shortfalls in the hospital-specific cap formula, and included third-party and upper payment limit payments in the shortfall calculation. These changes resulted in reduced payments to our hospitals located in Texas that have significant Medicaid populations. The Texas and South Carolina programs have been renewed for each state’s 2005 fiscal years and we expect the DSH reimbursements to be no less than the amounts received during each state’s 2004 fiscal years. Failure to renew these DSH programs beyond their scheduled termination dates (June 30, 2005 for South Carolina and August 31, 2005 for Texas), failure of our hospitals that currently receive DSH payments to qualify for future DSH funds under these programs, or reductions in reimbursements, could have a material adverse effect on our future results of operations.

 

In May, 2004, the state of Texas submitted a Medicaid state plan amendment to the Centers for Medicaid Services (“CMS”) requesting CMS’s approval to expand the Texas supplemental inpatient reimbursement methodology. In July, 2004, CMS approved the submitted state plan amendment retroactive to the May, 2004 submission date. With the CMS approval, the Texas Health and Human Services Commission (“HHSC”) published a proposed rule change in the Texas Register in October, 2004 to incorporate the state plan amendment changes in the Texas Administrative Code regulation. After expiration of the public comment period, the final rule, with language identical to that contained in the proposed rule, was published in the Texas Register on February 18, 2005. The general provisions of this supplemental payment methodology, which is governed by federal statute and regulations, includes: (i) matching federal dollars to the state for certain qualifying Medicaid expenditures; (ii) the federal government permitting the state to use the inter-governmental transfer of funds between state and local entities, and; (iii) subjecting supplemental payments made to hospitals to federally mandated limits. Included in our 2004 financial results was $6.2 million of incremental revenue earned pursuant to the provisions of this program. During 2005, assuming the program remains unchanged, we expect to earn approximately $12 million of incremental revenue in connection with this program. In Pennsylvania, several of our behavioral health hospitals were notified that $2.6 million in state Medicaid DSH monies

 

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paid for the state fiscal year 2004 will require repayment to the state. This repayment is the result of a change in the calculation of the hospital specific DSH cap formula as it relates to the handling of a hospital’s negative Medicaid payment shortfall. The repayment of these Pennsylvania Medicaid DSH monies have been reflected in our operating results for 2004. We expect this change to the DSH calculation and the resulting adverse financial impact to remain in place in 2005 and forward.

 

Approximately 40% of our net patient revenues, during each of the last three years, were generated from managed care companies, which include health maintenance organizations, preferred provider organizations and managed Medicare and Medicaid programs. In general, we expect the percentage of our business from managed care programs to continue to grow. The consequent growth in managed care networks and the resulting impact of these networks on the operating results of our facilities vary among the markets in which we operate. Typically, we receive lower payments per patient from managed care payors than we do from traditional indemnity insurers, however, during the past few years, we have secured price increases from many of our commercial payors including managed care companies.

 

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

 

The federal physician self-referral and payment prohibitions (codified in 42 U.S.C. Section 1395nn, Section 1877 of the Social Security Act) generally forbid, absent qualifying for one of the exceptions, a physician from making referrals for the furnishing of any “designated health services,” for which payment may be made under the Medicare or Medicaid programs, to any “entity” with which the physician (or an immediate family member) has a “financial relationship.” The legislation was effective January 1, 1992 for clinical laboratory services (“Stark I”) and January 1, 1995 for ten other designated health services (“Stark II”). Stark I and Stark II are collectively referred to as the Stark Law. A “financial relationship” under Stark I and II includes any direct or indirect compensation arrangement with an entity for payment of any remuneration, and any direct or indirect ownership or investment interest in the entity. The legislation contains certain exceptions including, for example, where the referring physician has an ownership interest in a hospital as a whole or where the physician is an employee of an entity to which he or she refers. The Stark Law prohibitions include specific reporting requirements providing that each entity providing covered items or services must provide certain information concerning its ownership, investment, and compensation arrangements. In August 1995, CMS published a final rule regarding physician self-referrals for clinical lab services (Stark I). On March 26, 2004, CMS published its final rule regarding physician self referrals for the ten other designated health services (Stark II), which became effective on July 26, 2004. The Stark II final rule added new exceptions to the general prohibition, but also narrowed some of the previously existing exceptions. Penalties for violating Stark I and Stark II include denial of payment for any services rendered by an entity in violation of the prohibitions, civil money penalties of up to $15,000 for each offense, and exclusion from the Medicare and Medicaid programs.

 

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The federal anti-kickback statute (codified in 42 U.S.C. Section 1320a-7b(b)) prohibits individuals and entities from knowingly and willfully soliciting, receiving, offering or paying any remuneration to other individuals and entities (directly or indirectly, overtly or covertly, in cash or in kind):

 

1. in return for referring an individual to a person for the furnishing or arranging for the furnishing of any item or service for which payment may be made under a federal or state health care program; or,

 

2. in return for purchasing, leasing, ordering or arranging for or recommending purchasing, leasing, or ordering any goods, facility, service or item for which payment may be made under a federal or state health care program.

 

Starting in 1991, the Inspector General of the Department of Health and Human Services (“HHS”) issued regulations which provide for “safe harbors” from the federal anti-kickback statute; if an arrangement or transaction meets each of the standards established for a particular safe harbor, the arrangement will not violate the statute. If an arrangement does not meet the safe harbor criteria, it may be subject to scrutiny under its particular facts and circumstances to determine whether it violates the federal anti-kickback statute. Safe harbors include protection for certain limited investment interests, space rental, equipment rental, personal service/management contracts, sales of a physician practice, referral services, managed care payment arrangements, employees, discounts and group purchasing arrangements, among others. The criminal sanctions for a conviction under the anti-kickback statute include imprisonment, fines, or both. Civil sanctions include exclusion from federal and state healthcare programs.

 

Many states, including Texas, have also enacted similar illegal remuneration statutes that apply to healthcare services reimbursed by private insurance, not just those reimbursed by a federal or state health care program. In many instances, the state statutes provide that any arrangement falling in a federal safe harbor will be immune from scrutiny under the state statutes.

 

We do not anticipate that the Stark Law, the anti-kickback statute or similar state law provisions will have material adverse effects on our operations. However, in consideration of the current health care regulatory atmosphere, we cannot provide any assurance that federal or state authorities would not attempt to challenge one or more of our business dealings in consideration of one of these federal or state provisions, or that if challenged, the authorities might not prevail.

 

Several states, including Florida and Nevada, have passed legislation which limits physician ownership in medical facilities providing imaging services, rehabilitation services, laboratory testing, physical therapy and other services. This legislation is not expected to significantly affect our operations. Many states have laws and regulations which prohibit payments for referral of patients and fee-splitting with physicians. We do not make any such payments or have any such arrangements.

 

All hospitals are subject to compliance with various federal, state and local statutes and regulations and receive periodic inspection by state licensing agencies to review standards of medical care, equipment and cleanliness. Our hospitals must comply with the conditions of participation and licensing requirements of federal, state and local health agencies, as well as the requirements of municipal building codes, health codes and local fire departments. In granting and renewing licenses, a department of health considers, among other things, the physical buildings and equipment, the qualifications of the administrative personnel and nursing staff, the quality of care and continuing compliance with the laws and regulations relating to the operation of the facilities. State licensing of facilities is a prerequisite to certification under the Medicare and Medicaid programs. Various other licenses and permits are also required in order to dispense narcotics, operate pharmacies, handle radioactive materials and operate

 

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certain equipment. All our eligible hospitals have been accredited by JCAHO. JCAHO reviews each hospital’s accreditation once every three years. The review period for each state’s licensing body varies, but generally ranges from once a year to once every three years.

 

The Social Security Act and regulations thereunder contain numerous provisions which affect the scope of Medicare coverage and the basis for reimbursement of Medicare providers. Among other things, this law provides that in states which have executed an agreement with the Secretary of HHS, Medicare reimbursement may be denied with respect to depreciation, interest on borrowed funds and other expenses in connection with capital expenditures which have not received prior approval by a designated state health planning agency. Additionally, many of the states in which our hospitals are located have enacted legislation requiring certificates of need (“CON”) as a condition prior to hospital capital expenditures, construction, expansion, modernization or initiation of major new services. Failure to obtain necessary state approval can result in the inability to complete an acquisition or change of ownership, the imposition of civil or, in some cases, criminal sanctions, the inability to receive Medicare or Medicaid reimbursement or the revocation of a facility’s license. We have not experienced and do not expect to experience any material adverse effects from those requirements.

 

Health planning statutes and regulatory mechanisms are in place in many states in which we operate. These provisions govern the distribution of healthcare services, the number of new and replacement hospital beds, administer required state CON laws, contain healthcare costs, and meet the priorities established therein. Significant CON reforms have been proposed in a number of states, including increases in the capital spending thresholds and exemptions of various services from review requirements. We are unable to predict the impact of these changes upon our operations.

 

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

 

Our healthcare operations generate medical waste that must be disposed of in compliance with federal, state and local environmental laws, rules and regulations. In 1988, Congress passed the Medical Waste Tracking Act (42 U.S.C.§ 6992). Infectious waste generators, including hospitals, now face substantial penalties for improper arrangements regarding disposal of medical waste, including civil penalties of up to $25,000 per day of noncompliance, criminal penalties of up to $50,000 per day, imprisonment, and remedial costs. The comprehensive legislation establishes programs for medical waste treatment and disposal in designated states. The legislation also provides for sweeping inspection authority in the Environmental Protection Agency, including monitoring and testing. We believe that our disposal of such wastes is in material compliance with all state and federal laws.

 

Medical Staff and Employees

 

Our hospitals are staffed by licensed physicians who have been admitted to the medical staff of individual hospitals. With a few exceptions, physicians are not employees of our hospitals. During the first quarter of 2005, McAllen Medical Center affiliated itself with a company employing approximately

 

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10 physicians. Members of the medical staffs of our hospitals also serve on the medical staffs of hospitals not owned by us and may terminate their affiliation with our hospitals at any time. Each of our hospitals are managed on a day-to-day basis by a managing director employed by us. In addition, a Board of Governors, including members of the hospital’s medical staff, governs the medical, professional and ethical practices at each hospital. Our facilities had approximately 37,000 employees on December 31, 2004, of whom approximately 25,000 were employed full-time.

 

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

 

Competition

 

In all geographical areas in which we operate, there are other hospitals which provide services comparable to those offered by our hospitals, some of which are for profit entities, some of which are owned by governmental agencies and supported by tax revenues, and others of which are owned by nonprofit corporations and may be supported to a large extent by endowments and charitable contributions. Such support is not available to our hospitals. Certain of our competitors have greater financial resources, are better equipped and offer a broader range of services than us. Outpatient treatment and diagnostic facilities, outpatient surgical centers and freestanding ambulatory surgical centers also impact the healthcare marketplace. In recent years, competition among healthcare providers for patients has intensified in the United States due to, among other things, regulatory and technological changes, increasing use of managed care payment systems, cost containment pressures and a shift toward outpatient treatment.

 

In addition, certain hospitals which are located in the areas served by our facilities are special service hospitals providing medical, surgical and behavioral health services that are not available at our hospitals or other general hospitals. The competitive position of a hospital is to a large degree, dependent upon the number and quality of staff physicians. Although a physician may at any time terminate his or her affiliation with a hospital, our hospitals seek to retain doctors of varied specializations on their staffs and to attract other qualified doctors by improving facilities and maintaining high ethical and professional standards. In addition, in certain markets including McAllen, Texas, the site of one of our largest acute care facilities, competition from other healthcare providers, including physician owned facilities, has increased and additional inpatient capacity at a physician owned hospital opened in late 2004 which may further erode our higher margin business, including cardiac procedures. A continuation of the increased provider competition in the markets in which our hospital facilities operate, including McAllen, Texas, could have a material adverse effect on our future results of operations.

 

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General and Professional Liability

 

Due to unfavorable pricing and availability trends in the professional and general liability insurance markets, our subsidiaries have assumed a greater portion of the hospital professional and general liability risk as the cost of commercial professional and general liability insurance coverage has risen significantly. As a result, effective January 1, 2002, most of our subsidiaries were self-insured for malpractice exposure up to $25 million per occurrence. We purchased umbrella excess policies for our subsidiaries through several commercial insurance carriers for coverage in excess of $25 million per occurrence with a $75 million aggregate limitation. Given these insurance market conditions, there can be no assurance that a continuation of these unfavorable trends, or a sharp increase in claims asserted against us, will not have a material adverse effect on our future results of operations.

 

Our estimated liability for professional and general liability claims is based on a number of factors including, among other things, the number of asserted claims and reported incidents, estimates of losses for these claims based on recent and historical settlement amounts, estimate of incurred but not reported claims based on historical experience, and estimates of amounts recoverable under our commercial insurance policies. While we continuously monitor these factors, our ultimate liability for professional and general liability claims could change materially from our current estimates due to inherent uncertainties involved in making this estimate.

 

For the period from January 1, 1998 through December 31, 2001, most of our subsidiaries were covered under commercial insurance policies with PHICO, a Pennsylvania based insurance company that was placed into liquidation during the first quarter of 2002. As a result of PHICO’s liquidation, we recorded a $40 million pre-tax charge during 2001 to reserve for PHICO claims that could become our liability, however, we are entitled to receive reimbursement from state insurance guaranty funds, other commercial insurers and/or PHICO’s estate for a portion of certain claims ultimately paid by us.

 

As of December 31, 2004, the total accrual for our professional and general liability claims was $204.1 million ($172.5 million net of expected recoveries), of which $28.0 million is included in other current liabilities. As of December 31, 2003, the total accrual for our professional and general liability claims was $190.8 million ($147.7 million net of expected recoveries), of which $35.0 million is included in other current liabilities. Included in other assets was $31.6 million as of December 31, 2004 and $43.0 million as of December 31, 2003, related to estimated expected recoveries from various state guaranty funds, insurance companies and other sources in connection with PHICO related professional and general liability claims payments.

 

Relationship with Universal Health Realty Income Trust

 

At December 31, 2004, we held approximately 6.7% of the outstanding shares of Universal Health Realty Income Trust (the “Trust”). We serve as Advisor to the Trust under an annually renewable advisory agreement. Pursuant to the terms of this advisory agreement, we conduct the Trust’s day-to-day affairs, provide administrative services and presents investment opportunities. In addition, certain of our officers and directors are also officers and/or directors of the Trust. Management believes that it has the ability to exercise significant influence over the Trust, therefore we account for our investment in the Trust using the equity method of accounting. Our pre-tax share of income from the Trust was $1.6 million in 2004, $1.6 million during 2003 and $1.4 million during 2002, and is included in net revenues in the accompanying consolidated statements of income. The carrying value of this investment was $9.5 million and $9.4 million at December 31, 2004 and 2003, respectively, and is included in other assets in the accompanying consolidated balance sheets. The market value of this investment was $25.2 million at December 31, 2004 and $23.4 million at December 31, 2003.

 

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As of December 31, 2004, we leased five hospital facilities from the Trust with terms expiring in 2006 through 2009. These leases contain up to five 5-year renewal options. In addition, certain of our subsidiaries are tenants in several medical office buildings owned by limited liability companies in which the Trust holds non-controlling ownership interest.

 

On December 31, 2004, we completed the purchase of the real estate assets of the Virtue Street Pavilion, located in Chalmette, Louisiana, from the Trust. The purchase was completed pursuant to the exercise of an option granted to us under our previous lease for the facility. The purchase price for the facility was $7.3 million and was determined, in accordance with the terms of the lease, based upon independent appraisals obtained by both us and the Trust.

 

During the third quarter of 2004, we exercised the five-year renewal option on a behavioral health hospital leased from the Trust which was scheduled to expire in December, 2004. The lease was renewed at the same lease terms. During 2002, we exercised the five-year renewal option on an acute care hospital leased from the Trust which was scheduled to expire in March, 2003. The renewal rate on this facility was based upon the five-year Treasury rate on March 29, 2003 plus a spread.

 

During 2003, we sold four medical office buildings located in Las Vegas, Nevada, for combined cash proceeds of $12.8 million, to limited liability companies, in which the Trust holds non-controlling majority ownership interests. The sale of these medical office buildings resulted in a pre-minority interest and pre-tax gain of $3.1 million ($1.4 million after minority interest expense and after-tax) which is included in our 2003 results of operations. Tenants of these buildings include certain of our subsidiaries.

 

Future minimum lease payments to the Trust are included in Note 7. Total rent expense under these operating leases was $17.4 million in 2004, $17.4 million in 2003 and $17.2 million in 2002. As of December 31, 2004, the aggregate fair market value of our facilities leased from the Trust is not known, however, the aggregate original purchase price paid by the Trust for these properties was $101.3 million (excluding the Virtue Street Pavilion). Pursuant to the terms of the leases with the Trust, we have the option to purchase the respective leased facilities at the end of the lease terms or any renewal terms at the appraised market value. In addition, we have rights of first refusal to: (i) purchase the respective leased facilities during and for 180 days after the lease terms at the same price, terms and conditions of any third-party offer, or; (ii) renew the lease on the respective leased facility at the end of, and for 180 days after, the lease term at the same terms and conditions pursuant to any third-party offer. The terms of the leases also provide that in the event we discontinue operations at the leased facility for more than one year, or elect to terminate a lease prior to the expiration of its term for prudent business reasons, we are obligated to offer a substitution property. If the Trust does not accept the substitution property offered, we are obligated to purchase the leased facility back from the Trust at a price equal to the greater of its then fair market value or the original purchase price paid by the Trust.

 

We received an advisory fee from the Trust of $1.5 million in 2004, $1.5 million in 2003 and $1.4 million in 2002 for investment and administrative services provided under a contractual agreement which is included in net revenues in the accompanying consolidated statements of income.

 

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Executive Officers of the Registrant

 

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

 

Name and Age


  

Present Position with the Company


Alan B. Miller (67)    Director, Chairman of the Board, President and Chief Executive Officer
Steve G. Filton (47)    Senior Vice President, Chief Financial Officer and Secretary
O. Edwin French (58)    Senior Vice President
Debra K. Osteen (49)    Vice President
Richard C. Wright (57)    Vice President

 

Mr. Alan B. Miller has been Chairman of the Board, President and Chief Executive Officer since inception. Prior thereto, he was President, Chairman of the Board and Chief Executive Officer of American Medicorp, Inc. He currently serves as Chairman of the Board, Chief Executive Officer and Trustee of the Trust. Mr. Miller also serves as a Director of Penn Mutual Life Insurance Company and Broadlane, Inc. (an e-commerce marketplace for healthcare supplies, equipment and services).

 

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

 

Mr. French joined us in October 2001, as Senior Vice President, responsible for the Acute Care Hospital Division. He had served as President and Chief Operating Officer of Physician Reliance Network from 1997 to 2000, as Senior Vice President of American Medical International from 1992 to 1995, as Executive Vice President of Samaritan Health Systems of Phoenix from 1991 to 1992 and as Senior Vice President of Methodist Health Systems, Inc. in Memphis from 1985 to 1991.

 

Ms. Osteen was elected Vice President in January 2000, responsible for the Behavioral Health Services facilities. She has served in various capacities related to our Behavioral Health Services facilities since 1984

 

Mr. Wright was elected Vice President in May 1986. He has served in various capacities since 1978 and currently heads the Development function.

 

We make available, free of charge, our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments, if any, to those reports through our Internet website as soon as reasonably practicable after they have been electronically filed with or furnished to the SEC. Our Internet address is http://www.uhsinc.com. Additionally, we have adopted corporate governance guidelines, a Code of Business Conduct and Corporate Standards applicable to all our employees, officers and directors, a Code of Ethics for Senior Financial Officers and new charters for each of the Audit

 

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Committee, Compensation Committee and Nominating and Governance Committee of our Board of Directors. These documents are also available on our Internet website under the “Investor Relations” hyperlink. Copies of these documents are also available in print to any stockholder who requests a copy. We intend to satisfy the disclosure requirement under Item 10 of Form 8-K relating to amendments to or waivers from any provision of our Code of Ethics for Senior Financial Officers by posting this information on our Internet website. Our website address is listed above.

 

ITEM 2. Properties

 

Executive Offices

 

We own an office building with 68,000 square feet available for use located on 11 acres of land in King of Prussia, Pennsylvania.

 

Facilities

 

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

 

Acute Care Hospitals

 

Name of Facility


  

Location


   Number
of Beds


   Real Property
Ownership
Interest


Aiken Regional Medical Centers

   Aiken, South Carolina    225    Owned

Auburn Regional Medical Center

   Auburn, Washington    149    Owned

Central Montgomery Medical Center

   Lansdale, Pennsylvania    150    Owned

Chalmette Medical Center (1)

        195     

Chalmette Medical Center (4)

   Chalmette, Louisiana         Leased

Virtue Street Pavilion

   Chalmette, Louisiana         Owned

Corona Regional Medical Center

   Corona, California    228    Owned

Desert Springs Hospital (2)

   Las Vegas, Nevada    346    Owned

Doctors’ Hospital of Laredo

   Laredo, Texas    180    Owned

Edinburg Regional Medical Center

   Edinburg, Texas    169    Owned

Fort Duncan Medical Center

   Eagle Pass, Texas    77    Owned

The George Washington University Hospital (3)

   Washington, D.C.    371    Owned

Hospital San Pablo (14)

   Bayamon, Puerto Rico    430    Owned

Hospital San Pablo del Este (14)

   Fajardo, Puerto Rico    180    Owned

Lakewood Ranch Medical Center

   Bradenton, Florida    120    Owned

Lancaster Community Hospital

   Lancaster, California    117    Owned

Manatee Memorial Hospital

   Bradenton, Florida    319    Owned

McAllen Medical Center (5)

        633     

McAllen Medical Center (4)

   McAllen, Texas         Leased

McAllen Heart Hospital

   McAllen, Texas         Owned

Methodist Hospital (13)

        360     

Methodist Hospital

   New Orleans, Louisiana         Owned

Lakeland Medical Pavilion

   New Orleans, Louisiana         Owned

Northern Nevada Medical Center (3)

   Sparks, Nevada    100    Owned

Northwest Texas Healthcare System

   Amarillo, Texas    447    Owned

Southwest Healthcare System (10)

        176     

Inland Valley Campus

   Wildomar, California         Leased

Rancho Springs Campus

   Murrieta, California         Owned

Spring Valley Hospital Medical Center (2)

   Las Vegas, Nevada    176    Owned

St. Mary’s Regional Medical Center

   Enid, Oklahoma    277    Owned

Summerlin Hospital Medical Center (2)

   Las Vegas, Nevada    274    Owned

Valley Hospital Medical Center (2)

   Las Vegas, Nevada    409    Owned

Wellington Regional Medical Center (4)

   West Palm Beach, Florida    143    Leased

 

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Médi-Partenaires (Paris/Bordeaux)

 

Name of Facility (11)


  

Location


   Number
of Beds


  

Real Property

Ownership
Interest


Clinique Ambroise Paré

   Toulouse, France    198    Owned

Clinique Bon Secours

   Le Puy en Velay, France    96    Owned

Clinique d’Aressy

   Pau, France    179    Owned

Clinique Bercy

   Charenton le Pont, France    92    Owned

Clinique du Louvre

   Paris, France    20    Owned

Clinique du Trocadéro

   Paris, France    50    Owned

Clinique Montréal

   Carcassonne, France    125    Owned

Clinique Notre Dame

   Thionville, France    73    Owned

Clinique Pasteur

   Bergerac, France    96    Owned

Clinique Richelieu

   Saintes, France    73    Owned

Clinique Saint Augustin

   Bordeaux, France    155    Owned

Clinique Villette

   Dunkerque, France    117    Owned

Hôpital Clinique Claude Bernard

   Metz, France    224    Owned

Polyclinique St. Jean

   Montpellier, France    102    Owned

 

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Behavioral Health Centers

 

Name of Facility


  

Location


   Number
of Beds


  

Real

Property

Ownership
Interest


Anchor Hospital

   Atlanta, Georgia    84    Owned

The Arbour Hospital

   Boston, Massachusetts    118    Owned

The Bridgeway (4)

   North Little Rock, Arkansas    70    Leased

The Carolina Center for Behavioral Health

   Greer, South Carolina    66    Owned

Clarion Psychiatric Center

   Clarion, Pennsylvania    74    Owned

Community Behavioral Health

   Memphis, Tennessee    50    Leased

Coastal Harbor Treatment Center

   Savannah, Georgia    112    Owned

Del Amo Hospital

   Torrance, California    166    Owned

Fairmount Behavioral Health System

   Philadelphia, Pennsylvania    180    Owned

Forest View Hospital

   Grand Rapids, Michigan    62    Owned

Fuller Memorial Hospital

   South Attleboro, Massachusetts    82    Owned

Glen Oaks Hospital

   Greenville, Texas    54    Owned

Good Samaritan Counseling Center

   Anchorage, Alaska    —      Owned

Hampton Hospital

   Westhampton, New Jersey    100    Owned

Hartgrove Hospital

   Chicago, Illinois    128    Owned

The Horsham Clinic

   Ambler, Pennsylvania    146    Owned

Hospital San Juan Capestrano

   Rio Piedras, Puerto Rico    108    Owned

HRI Hospital

   Brookline, Massachusetts    68    Owned

KeyStone Center (6)

   Wallingford, Pennsylvania    119    Owned

La Amistad Behavioral Health Services

   Maitland, Florida    54    Owned

Lakeside Behavioral Health System

   Memphis, Tennessee    204    Owned

Laurel Heights Hospital

   Atlanta, Georgia    102    Owned

The Meadows Psychiatric Center

   Centre Hall, Pennsylvania    101    Owned

Meridell Achievement Center

   Austin, Texas    112    Owned

The Midwest Center for Youth and Families

   Kouts, Indiana    58    Owned

North Star Children’s Hospital

   Anchorage, Alaska    34    Owned

North Star Counseling Centers

   Anchorage, Alaska    —      Owned

North Star Hospital

   Anchorage, Alaska    74    Owned

Palmer Residential Treatment Center

   Palmer, Alaska    29    Owned

Parkwood Behavioral Health System

   Olive Branch, Mississippi    112    Owned

The Pavilion

   Champaign, Illinois    52    Owned

Peachford Behavioral Health System of Atlanta

   Atlanta, Georgia    184    Owned

Pembroke Hospital

   Pembroke, Massachusetts    115    Owned

Provo Canyon School

   Provo, Utah    242    Owned

Ridge Behavioral Health System

   Lexington, Kentucky    110    Owned

Rivendell Behavioral Health Services of Arkansas

   Benton, Arkansas    77    Owned

Rivendell Behavioral Health Services of Kentucky

   Bowling Green, Kentucky    72    Owned

River Crest Hospital

   San Angelo, Texas    80    Owned

River Oaks Hospital

   New Orleans, Louisiana    126    Owned

Rockford Center

   Newark, Delaware    72    Owned

Roxbury (6)

   Shippensburg, Pennsylvania    48    Owned

St. Louis Behavioral Medicine Institute

   St. Louis, Missouri    —      Owned

Spring Mountain Treatment Center

   Las Vegas, Nevada    82    Leased

Stonington Institute

   North Stonington, Connecticut    63    Owned

Talbott Recovery Campus

   Atlanta, Georgia    —      Owned

Timberlawn Mental Health System

   Dallas, Texas    124    Owned

Turning Point Care Center (6)

   Moultrie, Georgia    59    Owned

Two Rivers Psychiatric Hospital

   Kansas City, Missouri    80    Owned

Westwood Lodge Hospital

   Westwood, Massachusetts    133    Owned

 

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Ambulatory Surgery Centers

 

Name of Facility


  

Location


  

Real

Property

Ownership

Interest


OJOS/Eye Surgery Specialists of Puerto Rico (8)

   Santurce, Puerto Rico    Leased

Goldring Surgical Center

   Las Vegas, Nevada    Leased

Northwest Texas Surgery Center (8)

   Amarillo, Texas    Leased

Providence Surgical and Medical Center (7)

   Laredo, Texas    Leased

Surgery Center at Wellington (9)

   West Palm Beach, Florida    Leased

Surgery Center of Midwest City (7)

   Midwest City, Oklahoma    Leased

Surgery Center of Springfield (7)

   Springfield, Missouri    Leased

Surgical Arts Surgery Center (8)

   Reno, Nevada    Leased

Surgical Center of South Texas

   Edinburg, Texas    Owned

 

Radiation Oncology Centers

 

Name of Facility


  

Location


    

Auburn Regional Center for Cancer Care

   Auburn, Washington    Leased

Cancer Institute of Nevada (8)(12)

   Las Vegas, Nevada    Owned

Carolina Cancer Center

   Aiken, South Carolina    Owned

 

Specialized Women’s Health Center

 

Name of Facility


  

Location


    

Renaissance Women’s Center of Edmond (8)(12)

   Edmond, Oklahoma    Owned

(1) Includes Chalmette Medical Center, a 118-bed medical/surgical facility and The Virtue Street Pavilion, a 77-bed facility consisting of a physical rehabilitation unit, skilled nursing and inpatient behavioral health services.
(2) Desert Springs Hospital, Summerlin Hospital Medical Center, Valley Hospital Medical Center and Spring Valley Hospital Medical Center are owned by limited liability companies (“LLC) in which we hold controlling, majority ownership interests of approximately 72%. The remaining minority ownership interests in these facilities are held by unaffiliated third-parties. All hospitals are managed by us.
(3) General partnership interest in limited partnership.
(4) Real property leased from the Trust.
(5) Real property of McAllen Medical Center is leased from the Trust. During 2000, we purchased the assets of an 80-bed non-acute care facility located in McAllen, Texas. Although the real property of the non-acute facility is not leased from the Trust, the license for this facility is included in McAllen Medical Center’s license.

 

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(6) Addictive disease facility.
(7) Each facility is owned in partnership form. We own general and limited partnership interests in a limited partnership.
(8) We own a majority interest in a LLC.
(9) We own a minority interest in a LLC that owns and operates this center.
(10) Southwest Healthcare System consists of the Inland Valley Campus in Wildomar, California and the Rancho Springs Campus in Murrieta, California.
(11) All facilities located in France are owned by an operating company in which we own an 80% equity interest.
(12) Real property is owned by a limited partnership or LLC that is majority owned by us.
(13) In January, 2004, we purchased a controlling 90% ownership interest in a LLC (10% ownership interest held by a third-party) that owns the assets and operations of Methodist Hospital, a 306-bed acute care facility located in New Orleans, Louisiana, and in February, 2004 this LLC purchased the assets and operations of Lakeland Medical Pavilion, a 54-bed acute care facility located in New Orleans.
(14) Subsequent to December 31, 2004, we executed a definitive agreement to sell these two acute care hospitals located in Puerto Rico. The sales, which are subject to regulatory approval, are expected to be completed by March 31, 2005.

 

Some of these facilities are subject to mortgages, and substantially all the equipment located at these facilities is pledged as collateral to secure long-term debt. We own or lease medical office buildings adjoining some of our hospitals.

 

We believe that the leases or liens on the facilities, medical office buildings and other real estate leased or owned by us do not impose any material limitation on our operations.

 

The aggregate lease payments on facilities leased by us were $36.8 million in 2004, $37.9 million in 2003 and $33.8 million in 2002.

 

ITEM 3. Legal Proceedings

 

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

 

Lawsuits:

 

In December 2003, one of our subsidiaries, McAllen Hospitals, L.P., was named as a defendant in a case filed in the District Court of Hidalgo County, Texas, 275th Judicial District, under the caption Rio OB-Gyn Partners Ltd. v. McAllen Hospitals, L.P., Cause No. C-3128-03-E. The plaintiff is a physician group which claims that McAllen and its agents committed fraud or negligent misrepresentation in promising to build an OB-Gyn hospital and inducing the plaintiff to cancel an agreement with another party to build a competing OB-Gyn hospital.

 

On or about March 22 through March 26, 2004 two purported class action Complaints were filed against us and certain of our officers and directors in the United States District Court for the Eastern District of Pennsylvania alleging that defendants violated Section 10(b) of the Exchange Act and Rule 10b-5 promulgated thereunder by disclosing materially false and misleading information or failing to disclose material information necessary to make other disclosure not misleading or to correct prior disclosure with respect to our financial condition and operations. A claim is asserted against the individual defendants under section 20(a) of the Exchange Act alleging that because they controlled the Company, they should be held liable for damages caused by the Company’s violation of section 10(b) and Rule 10b-5 thereunder. Plaintiffs seek, on behalf of a purported class of purchasers of our common stock during a class period from July 21, 2003 through February 27, 2004, unspecified money damages, restitution, attorneys’ fees and reimbursement of expenses.

 

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Pursuant to an Order of the Court, these two cases were consolidated into one action captioned: In re Universal Health Services, Inc. Securities Litigation, Case No. CV-04-01233-JP. Subsequently, the plaintiffs filed an Amended Consolidated Class Action Complaint. The defendants have moved to dismiss that complaint. The motion to dismiss has been fully briefed and oral argument was held on March 9, 2005.

 

On July 6, 2004, we were served with a complaint filed in the United States District Court for the Eastern District of Pennsylvania captioned “Eastside Investors LLP, derivatively and on behalf of nominal defendant, Universal Health Services, Inc., v. Alan B. Miller, Robert Hotz, Anthony Pantaleoni and Steve G. Filton.” Plaintiff subsequently filed an amended complaint which dropped Messrs Hotz and Pantaleoni as defendants. Plaintiff purports to assert claims derivatively on behalf of the Company against our officers and directors seeking to recover on behalf of the Company unspecified damages to redress alleged breaches of fiduciary duty, abuses of control and gross mismanagement by the individual defendants. The complaint also seeks equitable relief and attorneys’ fees. We are named as a nominal defendant in that action. The Court has granted the parties’ joint motion in the derivative action asking that the Defendants’ time to respond to the complaint be extended until after the decision on the motion to dismiss the class action complaint. That motion is pending.

 

On August 5, 2004, we were named, together with our subsidiary Valley Hospital Medical Center, Inc., as defendants in a lawsuit filed in Clark County, Nevada, under the caption Deborah Louise Poblocki v. Universal Health Services, Inc., et al., No. 04-A-489927-C. The plaintiff alleges that we overcharged her and other similarly situated patients who lacked health insurance. The complaint seeks class action treatment.

 

The complaint, filed by plaintiff individually and on behalf of other unnamed class members, alleges that Valley Hospital Medical Center charged her “unconscionable rates” because it charged her, an uninsured outpatient, more than it charged insured patients and more than the cost of the services provided. She claims that this alleged conduct violates state civil RICO laws as well as other state statutory and common law. We filed a notice of removal to federal court, and plaintiff filed a motion to remand back to state court. The court has not yet ruled on plaintiff’s motion.

 

In October, 2004, one of our subsidiaries, Aiken Regional Medical Centers, Inc., received a complaint filed in state court in South Carolina (Case No. 04-CP-02-1275). The complaint, filed by the plaintiff individually and on behalf of other unnamed, putative class members, alleges that Aiken breached its contract with the plaintiff (and other putative plaintiffs), or in the alternative Aiken was unjustly enriched, by virtue of billing and collecting full hospital charges from the plaintiff and other putative class members.

 

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

 

No matter was submitted during the fourth quarter of the fiscal year ended December 31, 2004 to a vote of security holders.

 

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PART II

 

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

 

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

 

Number of shareholders of record as of January 31, 2005, were as follows:

 

Class A Common

   11

Class B Common

   428

Class C Common

   5

Class D Common

   163

 

During 1998 and 1999, our Board of Directors approved stock repurchase programs authorizing us to purchase up to 12 million shares of our outstanding Class B Common Stock on the open market at prevailing market prices or in negotiated transactions off the market. In November, 2004, an additional 2 million shares were approved for repurchase. During the year ended December 31, 2004, we purchased 559,481 shares at an average price of $42.07 per share or $23.5 million in the aggregate. Since inception of the stock purchase program in 1998 through December 31, 2004, we purchased a total of 11,437,404 shares at an average purchase price of $25.76 per share or $294.6 million in the aggregate. As of December 31, 2004, the maximum number of shares that may yet be purchased under the program is 2,562,596 shares.

 

2004 period


   Total
number of
shares
purchased


   Number of
shares
purchased as
part of
publicly
announced
programs


  

Average
price paid

per share


   Aggregate
purchase
price paid
(in thousands)


   Maximum
number of
shares that
may yet be
purchased
under the
program


October, 2004

   346,000    346,000    $ 41.33    $ 14,300    641,540
    
  
  

  

  

November, 2004

   77,500    77,500    $ 41.86    $ 3,244    2,564,040
    
  
  

  

  

December, 2004

   1,444    1,444    $ 47.33    $ 68    2,562,596
    
  
  

  

  

Total October through December

   424,944    424,944    $ 41.45    $ 17,612    2,562,596
    
  
  

  

  

 

Dividends

 

During the fourth quarter of 2003, we announced the initiation of quarterly cash dividends, commencing with the fourth quarter of 2003. During the two years ending December 31, 2004, dividends per share were declared as follows:

 

     2004

   2003

First quarter

   $ .08      —  

Second quarter

   $ .08      —  

Third quarter

   $ .08      —  

Fourth quarter

   $ .08    $ .08
    

  

Total

   $ .32    $ .08
    

  

 

ITEM 6. Selected Financial Data

 

Year Ended December 31


   2004

    2003

    2002

    2001

    2000

 

Summary of Operations (in thousands)

                                        

Net revenues

   $ 3,938,320     $ 3,391,506     $ 2,991,919     $ 2,582,423     $ 1,985,913  

Net income

   $ 169,492     $ 199,269     $ 175,361     $ 99,742     $ 93,362  

Net margin

     4.3 %     5.9 %     5.9 %     3.9 %     4.7 %

Return on average equity

     14.4 %     20.0 %     19.6 %     12.8 %     13.7 %

Financial Data (in thousands)

                                        

Cash provided by operating activities

   $ 392,880     $ 376,775     $ 331,259     $ 297,543     $ 174,821  

Capital expenditures, net (1)

   $ 230,905     $ 224,370     $ 207,627     $ 160,748     $ 115,751  

Total assets

   $ 3,022,843     $ 2,772,730     $ 2,329,137     $ 2,168,589     $ 1,742,377  

Long-term borrowings

   $ 852,229     $ 868,566     $ 680,514     $ 718,830     $ 548,064  

Common stockholders’ equity

   $ 1,220,586     $ 1,090,922     $ 917,459     $ 807,900     $ 716,574  

Percentage of total debt to total capitalization

     42 %     45 %     43 %     47 %     43 %

Operating Data – Acute Care Hospitals in U.S.

                                        

Average licensed beds

     5,645       4,792       4,801       4,502       3,972  

Average available beds

     4,860       4,119       3,966       3,795       3,388  

Hospital admissions

     251,655       227,932       224,286       196,234       171,900  

Average length of patient stay

     4.6       4.5       4.5       4.6       4.6  

Patient days

     1,150,882       1,032,348       1,013,395       896,874       790,219  

Occupancy rate for licensed beds

     56 %     59 %     58 %     55 %     54 %

Occupancy rate for available beds

     65 %     69 %     70 %     65 %     64 %

Operating Data - Behavioral Health Facilities

                                        

Average licensed beds

     4,225       3,894       3,752       3,732       2,612  

Average available beds

     4,145       3,762       3,608       3,588       2,552  

Hospital admissions

     94,743       87,688       84,348       78,688       49,971  

Average length of patient stay

     13.0       12.2       11.9       12.1       12.2  

Patient days

     1,234,152       1,067,200       1,005,882       950,236       608,423  

Occupancy rate for licensed beds

     80 %     75 %     73 %     70 %     64 %

Occupancy rate for available beds

     81 %     78 %     76 %     73 %     65 %

Operating Data - Acute Care Hospitals in France (2)

                                        

Average licensed beds

     1,588       1,433       1,083       720       —    

Average available beds

     1,588       1,433       1,083       720       —    

Hospital admissions

     94,536       82,364       63,781       38,627       —    

Average length of patient stay

     4.7       5.0       5.0       4.7       —    

Patient days

     442,825       409,860       319,100       180,111       —    

Occupancy rate for licensed beds

     76 %     78 %     81 %     69 %     —    

Occupancy rate for available beds

     76 %     78 %     81 %     69 %     —    

Per Share Data

                                        

Net income - basic (3)

   $ 2.94     $ 3.45     $ 2.94     $ 1.67     $ 1.55  

Net income - diluted (3)

   $ 2.75     $ 3.20     $ 2.74     $ 1.60     $ 1.50  

Other Information (in thousands)

                                        

Weighted average number of common shares - basic (3)

     57,653       57,688       59,730       59,874       60,220  

Weighted average number of common shares and equivalents - diluted (3)

     64,865       65,089       67,075       67,220       64,820  

Common Stock Performance

                                        

Market price of common stock High - Low, by quarter (4)

                                        

1st

   $ 56.51 - $43.97     $ 46.58 - $34.99     $ 43.00 - $37.80     $ 50.69 - $38.88     $ 24.50 - $18.25  

2nd

   $ 46.55 - $42.53     $ 45.48 - $34.77     $ 51.90 - $42.31     $ 46.75 - $37.82     $ 35.03 - $24.50  

3rd

   $ 46.10 - $42.04     $ 52.00 - $39.76     $ 51.40 - $41.90     $ 52.60 - $42.65     $ 42.81 - $31.91  

4th

   $ 48.51 - $39.87     $ 54.30 - $44.34     $ 56.20 - $43.00     $ 48.60 -$38.25     $ 55.88 - $38.63  

(1) Amount includes non-cash capital lease obligations.
(2) The facilities located in France are owned by an operating company that is 80% owned by us.
(3) In April 2001, the Company declared a two-for-one stock split in the form of a 100% stock dividend which was paid in June 2001. All classes of common stock participated on a pro rata basis. The weighted average number of common shares and equivalents and earnings per common and common equivalent share for all years presented have been adjusted to reflect the two-for-one stock split.
(4) These prices are the high and low closing sales prices of the Company’s Class B Common Stock as reported by the New York Stock Exchange (all periods have been adjusted to reflect the two-for-one stock split in the form of a 100% stock dividend paid in June, 2001). Class A, C and D Common Stock are convertible on a share-for-share basis into Class B Common Stock.

 

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Table of Contents

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

 

Overview

 

Our principal business is owning and operating, through our subsidiaries acute care hospitals, behavioral health centers and ambulatory surgery and radiation oncology centers. As of March 1, 2005, we operated 44 acute care hospitals and 49 behavioral health centers located in 23 states, Washington, DC, Puerto Rico and France. As part of our ambulatory treatment centers division, we manage and own outright or in partnership with physicians, 12 surgery and radiation oncology centers located in 7 states and Puerto Rico. Subsequent to December 31, 2004, we executed a definitive agreement to sell two acute care hospitals located in Puerto Rico. The divestitures, which are subject to customary regulatory approvals, are expected to be completed by March 31, 2005.

 

Net revenues from our acute care hospitals (including the facilities located in France) and our ambulatory and radiation oncology centers accounted for 82%, 82% and 81% of consolidated net revenues in 2004, 2003 and 2002, respectively. Net revenues from our behavioral health care facilities accounted for 18%, 18% and 19%, of consolidated net revenues in 2004, 2003 and 2002, respectively.

 

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

 

Forward-Looking Statements and Risk Factors

 

The matters discussed in this report as well as our news releases issued from time to time include certain statements containing the words “believes”, “anticipates”, “intends”, “expects” and words of similar import, which constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause industry results and/or our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. Such factors include, among other things, the following:

 

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

 

    industry capacity, demographic changes, existing laws and government regulations and changes in or failure to comply with laws and governmental regulations;

 

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

 

    liability and other claims asserted against us;

 

    liabilities arising out of shareholders’ suits which have been commenced against us and certain of our officers and directors;

 

    the continuing high number of governmental inquiries, investigations and administrative and legal actions being taken against health care providers, which, if directed at us or one of our facilities, could significantly increase costs and expenses;

 

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

 

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

 

    our ability to attract and retain qualified personnel, including nurses, and our ability to recruit physicians to provide services at our facilities;

 

    our ability to successfully integrate our recent acquisitions;

 

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

 

    our ability to finance growth on favorable terms;

 

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

 

    our acute care facilities continue to experience an increase in uninsured and self-pay patients which unfavorably impacts the collectibility of our patient accounts;

 

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

 

    we have experienced a significant increase in professional and general liability and property insurance expense caused by unfavorable pricing and availability trends of commercial insurance and as a result, we have assumed a greater portion of our liability risk and consequently, there can be no assurance that a continuation of these unfavorable trends, or a sharp increase in claims asserted against us, which are self-insured, will not have a material adverse effect on our future results of operations, and;

 

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

 

Given these uncertainties, prospective investors are cautioned not to place undue reliance on such forward-looking statements. We disclaim any obligation to update any such factors or to publicly announce the result of any revisions to any of the forward-looking statements contained herein to reflect future events or developments.

 

Critical Accounting Policies and Estimates

 

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

 

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

 

Revenue Recognition: We record revenues and related receivables for health care services at the time the services are provided. We have agreements with third-party payors that provide for payments to us at amounts different from our established rates. Payment arrangements include prospectively determined rates per discharge, reimbursed costs, discounted charges and per diem payments. We report net patient service revenue at the estimated net realizable amounts from patients, third-party payors and others for services rendered. Medicare and Medicaid revenues represented 40%, 41% and 42% of our net patient revenues during 2004, 2003 and 2002, respectively. Revenues from managed care entities, including health maintenance organizations and managed Medicare and Medicaid programs, accounted for 40% of our net patient revenues during each of the years ended December 31, 2004, 2003 and 2002.

 

Laws and regulations governing the Medicare and Medicaid programs are extremely complex and subject to interpretation and as a result, there is at least a reasonable possibility that recorded estimates will change by material amounts in the near term. We estimated certain Medicare and Medicaid revenues using the latest available financial information, patient utilization data, government provided data and in

 

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accordance with applicable Medicare and Medicaid payment rules and regulations. Certain types of payments by the Medicare program and state Medicaid programs are subject to retroactive adjustment in future periods. We accrue for the estimated amount of these retroactive adjustments in the period when the services subject to retroactive settlement are recorded. Such amounts are included in accounts receivable, net, on our consolidated balance sheets. These revenues (e.g. Medicare Disproportionate Share Hospital, Medicare Allowable Bad Debts and Inpatient Psychiatric Services) are subject to retrospective review and final settlement by the Medicare program. Adjustments related to the final settlement of these retrospectively determined amounts did not materially impact our operating results in 2004, 2003 and 2002. A 1% adjustment to our estimated net revenues recorded in connection with Medicare revenues that are subject to retrospective review and settlement as of December 31, 2004, would change our after-tax net income by approximately $1.6 million. The large majority of the revenues generated by the acute care hospitals owned by our France subsidiary are paid by the government based on predetermined rates established in May of each year and consist of a per diem payment and per procedure rate plus reimbursement for certain supplies.

 

We provide care to patients who meet certain financial or economic criteria without charge or at amounts substantially less than our established rates. Because we do not pursue collection of amounts determined to qualify as charity care, they are not reported in net revenues or in accounts receivable, net. Our acute care hospitals located in the U.S. provided charity care, based on charges at established rates, amounting to $294.7 million, $241.2 million and $186.2 million during 2004, 2003 and 2002, respectively.

 

At our acute care facilities located in the U.S., Medicaid Pending accounts comprise the large majority of our receivables that are pending approval from third-party payors but we also have smaller amounts due from other miscellaneous payors such as county indigent programs in certain states. Approximately 5% or $26.0 million as of December 31, 2004 and 4% or $20.7 million as of December 31, 2003 of our accounts receivable, net, were comprised of Medicaid Pending accounts.

 

Our patient registration process includes an interview of the patient or the patient’s responsible party at the time of registration. At that time, an insurance eligibility determination is made and an insurance plan code is assigned. There are various pre-established insurance profiles in our patient accounting system which determine the expected insurance reimbursement for each patient based on the insurance plan code assigned and the services rendered. Certain patients may be classified as Medicaid Pending at registration if we are unable to definitively determine if they are Medicaid eligible. When a patient is registered as Medicaid eligible or Medicaid Pending, our patient accounting system records net revenues for services provided to that patient based upon the established Medicaid reimbursement rates pending ultimate disposition of the patient’s Medicaid and eligibility.

 

Based on historical information related to Medicaid Pending accounts, we estimate that approximately 63% or $16.3 million of the $26.0 million Medicaid Pending accounts receivable as of December 31, 2004 will subsequently qualify for Medicaid Pending reimbursement. Approximately 60% or $12.5 million of the $20.7 million Medicaid Pending accounts receivable as of December 31, 2003, subsequently qualified for Medicaid reimbursement and were therefore appropriately classified at the patient’s registration. The majority of the remaining accounts that ultimately did not qualify for Medicaid reimbursement were subsequently reclassified as self-pay or charity care accounts. Based on general factors as discussed below in Provision for Doubtful Accounts, our facilities make estimates at each financial reporting period to reserve for amounts that are deemed to be uncollectible. Such estimated uncollectible amounts related to Medicaid Pending, as well as other accounts receivable payor classifications, are considered when the overall individual facility and company-wide reserves are developed. Related specifically to accounts classified as Medicaid Pending, our facilities establish reserves for such accounts based on agings of the receivables, historical collection experience and

 

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conversion rates (i.e. the above mentioned percentages of Medicaid Pending amounts that ultimately qualify for Medicaid reimbursement). Based on this methodology, our analyses indicated that we had adequate reserves established as of December 31, 2004 and 2003 for accounts that will not/did not ultimately qualify for Medicaid reimbursement (or county indigent program reimbursement) and were therefore reclassed to self-pay or charity care.

 

Below are the Medicaid Pending receivable agings as of December 31, 2004 and 2003 (amounts in thousands):

 

    

December 31,

2004


  

December 31,

2003


     Amount

   %

   Amount

   %

Under 60 days

   $ 9,125    35.2    $ 7,820    37.9

61-120 days

     6,023    23.2      5,455    26.4

121-180 days

     3,817    14.7      3,008    14.6

Over 180 days

     6,999    26.9      4,373    21.1
    

  
  

  

Total

   $ 25,964    100.0    $ 20,656    100.0
    

  
  

  

 

Provision for Doubtful Accounts: Collection of receivables from third-party payors and patients is our primary source of cash and is critical to our operating performance. Our primary collection risks relate to uninsured patients and the portion of the bill which is the patient’s responsibility, primarily co-payments and deductibles. We estimate our provisions for doubtful accounts based on general factors such as payor mix, the agings of the receivables and historical collection experience. We routinely review accounts receivable balances in conjunction with these factors and other economic conditions which might ultimately affect the collectibility of the patient accounts and make adjustments to our allowances as warranted. At our acute care hospitals, third party liability accounts are pursued at the hospital level until all payment and adjustments are posted to the patient account. For those accounts with a patient balance after third party liability is exhausted, the patient is sent at least two statements followed by a series of three collection letters. If the patient is deemed unwilling or unable to pay, the account is written off as bad debt and transferred to an outside collection agency for additional collection effort. Self-pay receivables are outsourced to several early out collection agencies under contract with the hospital. The collection vendor must make at least three patient contacts and send three statements from the date of placement. If the patient fails to respond or express a willingness to pay, the account is returned to the hospital and subsequently written off as bad debt and transferred to an outside agency for additional collection effort.

 

During the collection process the hospital establishes a partial reserve in the allowance for doubtful accounts for self-pay balances outstanding for greater than 60 days from the date of discharge. All self-pay accounts at the hospital level are fully reserved if they become outstanding for greater than 90 days from the date of discharge. Third party liability accounts are fully reserved in the allowance for doubtful accounts when the balance ages past 180 days from the date of discharge. On a consolidated basis, we monitor our total self-pay receivables to ensure that the total allowance for doubtful accounts provides adequate coverage based on historical collection experience. Significant changes in business office operations, payor mix, economic conditions or trends in federal and state governmental health coverage could affect our collection of accounts receivable, cash flow and results of operations. At December 31, 2004 and 2003, accounts receivable are recorded net of allowance for doubtful accounts of $71.4 million and $56.4 million, respectively.

 

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Approximately 93% during 2004, 94% during 2003 and 91% during 2002, of our consolidated provision for doubtful accounts, was incurred by our acute care hospitals located in the U.S. Shown below is our payor mix concentrations and related aging of accounts receivable for our acute care hospitals located in the U.S. as of December 31, 2004 and 2003 (excludes facilities reflected as discontinued operations in our consolidated financial statements):

 

As of December 31, 2004:

                           
(amounts in thousands)    0-60 days

   61-120 days

   121-180 days

   Over 180 days

Medicare

   $ 53,040    $ 6,346    $ 2,053    $ 5,508

Medicaid

     18,582      11,912      8,177      19,650

Commercial insurance and other

     144,029      48,958      18,871      38,488

Private pay

     48,107      8,419      5,693      6,965
    

  

  

  

Total

   $ 263,758    $ 75,635    $ 34,794    $ 70,611
    

  

  

  

As of December 31, 2003:

                           
(amounts in thousands)    0-60 days

   61-120 days

   121-180 days

   Over 180 days

Medicare

   $ 47,569    $ 5,765    $ 2,138    $ 4,234

Medicaid

     18,149      10,037      5,684      8,058

Commercial insurance and other

     118,168      42,668      14,782      25,088

Private pay

     36,240      15,922      10,230      4,456
    

  

  

  

Total

   $ 220,126    $ 74,392    $ 32,834    $ 41,836
    

  

  

  

 

Self-Insured Risks: We provide for self-insured risks, primarily general and professional liability claims and workers’ compensation claims, based on estimates of the ultimate costs for both reported claims and claims incurred but not reported. Estimated losses from asserted and incurred but not reported claims are accrued based on our estimates of the ultimate costs of the claims, which includes costs associated with litigating or settling claims, and the relationship of past reported incidents to eventual claims payments. All relevant information, including our own historical experience, the nature and extent of existing asserted claims and reported incidents, and independent actuarial analyses of this information, is used in estimating the expected amount of claims. We also consider amounts that may be recovered from excess insurance carriers, state guaranty funds and other sources in estimating our ultimate net liability for such risk. We also maintain a self-insured workers’ compensation program. Adjustments to our prior period, self-insured general and professional and workers’ compensation reserve estimates did not have a material impact on our financial statements during 2004, 2003 or 2002.

 

Below is a schedule showing the changes in our general and professional liability and workers’ compensation reserves during the three years ended December 31, 2004 (amount in thousands):

 

     General and
Professional
Liability


    Workers’
Compensation


    Total

 

Reserve balance at January 1, 2002 (a)

   $ 105,591     $ 12,403     $ 117,994  

Plus: accrued insurance expense, net of commercial premiums paid

     45,880       12,436       58,316  

Less: payments made in settlement of self-insured claims

     (22,302 )     (8,832 )     (31,134 )

Balance at acquisition of acquired facility

     2,015       1,672       3,687  
    


 


 


Balance at January 1, 2003 (a)

     131,184       17,679       148,863  

Plus: accrued insurance expense, net of commercial premiums paid

     48,154       18,590       66,744  

Less: payments made in settlement of self-insured claims

     (31,594 )     (11,808 )     (43,402 )
    


 


 


Balance at January 1, 2004 (a)

     147,744       24,461       172,205  

Plus: accrued insurance expense, net of commercial premiums paid

     58,272       19,984       78,256  

Less: payments made in settlement of self-insured claims

     (33,482 )     (13,371 )     (46,853 )
    


 


 


Balance at December 31, 2004 (a)

   $ 172,534     $ 31,074     $ 203,608  
    


 


 



(a) Net of expected recoveries from various state guaranty funds, insurance companies and other sources in connection with PHICO related professional and general liability claims payments.

 

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

 

Long-Lived Assets: In accordance with SFAS No.144, “Accounting for the Impairment or Disposal of Long-Lived Assets”, we review our long-lived assets, including amortizable intangible assets, for impairment whenever events or circumstances indicate that the carrying value of these assets may not be recoverable. The assessment of possible impairment is based on our ability to recover the carrying value of our assets based on our estimate of its undiscounted future cash flow. If the analysis indicates that the carrying value is not recoverable from future cash flows, the asset is written down to its estimated fair value and an impairment loss is recognized. Fair values are determined based on estimated future cash flows using appropriate discount rates.

 

Goodwill: In accordance with SFAS No. 142, “Goodwill and Other Intangible Assets”, we ceased amortizing goodwill as of January 1, 2002. Goodwill is reviewed for impairment at the reporting unit level as, defined by SFAS No. 142, on an annual basis or sooner if the indicators of impairment arise. Our judgments regarding the existence of impairment indicators are based on market conditions and operational performance of each reporting unit. We have designated September 1st as our annual impairment assessment date and performed an impairment assessment as of September 1, 2004, which indicated no impairment of goodwill. Future changes in the estimates used to conduct the impairment review, including profitability and market value projections, could indicate impairment in future periods potentially resulting in a write-off of a portion or all of our goodwill.

 

Income Taxes: Deferred tax assets and liabilities are recognized for the amount of taxes payable or deductible in future years as a result of differences between the tax bases of assets and liabilities and their reported amounts in the consolidated financial statements. We believe that future income will enable us to realize our deferred tax assets and therefore no valuation allowances have been recorded.

 

We operate in multiple jurisdictions with varying tax laws. We are subject to audits by any of these taxing authorities. Our tax returns have been examined by the Internal Revenue Service through the year ended December 31, 2002. We believe that adequate accruals have been provided for federal and state taxes.

 

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Results of Operations

 

The following table summarizes our results of operations, and is used in the discussion below, for the years ended December 31, 2004, 2003 and 2002 (dollar amounts in thousands):

 

     Year Ended December 31,

 
     2004

    2003

    2002

 
     Amount

    % of
Revenues


    Amount

   % of
Revenues


    Amount

  

% of

Revenues


 

Net revenues

   $ 3,938,320     100.0 %   $ 3,391,506    100.0 %   $ 2,991,919    100.0 %

Operating charges:

                                        

Salaries, wages & benefits

     1,607,103     40.8 %     1,355,047    40.0 %     1,193,258    39.9 %

Other operating expenses

     916,542     23.2 %     778,656    23.0 %     717,805    24.0 %

Supplies expense

     546,801     13.9 %     449,225    13.2 %     376,755    12.6 %

Provision for doubtful Accounts

     307,163     7.8 %     252,644    7.4 %     218,947    7.3 %

Depreciation & amortization

     155,514     4.0 %     130,039    3.8 %     109,246    3.6 %

Lease & rental expense

     70,433     1.8 %     59,479    1.8 %     56,943    1.9 %
    


 

 

  

 

  

       3,603,556     91.5 %     3,025,090    89.2 %     2,672,954    89.3 %
    


 

 

  

 

  

Income before interest expense, minority interests & income taxes

     334,764     8.5 %     366,416    10.8 %     318,965    10.7 %

Interest expense, net

     43,405     1.1 %     37,855    1.1 %     34,096    1.1 %

Minority interests in earnings of consolidated entities

     20,216     0.5 %     22,265    0.7 %     19,716    0.7 %
    


 

 

  

 

  

Income before income taxes

     271,143     6.9 %     306,296    9.0 %     265,153    8.9 %

Provision for income taxes

     101,137     2.6 %     114,217    3.3 %     97,306    3.3 %
    


 

 

  

 

  

Income from continuing operations

     170,006     4.3 %     192,079    5.7 %     167,847    5.6 %

(Loss) Income from discontinued operations, net of income taxes

     (514 )   0.0 %     7,190    0.2 %     7,514    0.3 %
    


 

 

  

 

  

Net income

   $ 169,492     4.3 %   $ 199,269    5.9 %   $ 175,361    5.9 %
    


 

 

  

 

  

 

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Year Ended December 31, 2004 as compared to the Year Ended December 31, 2003: Net revenues increased 16% to $3.94 billion in 2004 as compared to $3.39 billion in 2003. The $547 million increase during 2004, as compared to 2003, was primarily attributable to:

 

    a $153 million or 5% increase in net revenues generated at acute care hospitals (located in the U.S. and France) and behavioral health care facilities owned during both years (which we refer to as “same facility”), and;

 

    $387 million of revenues generated at acute care hospitals acquired or opened in the U.S. and France and behavioral health facilities acquired at various times during 2003 and 2004 (excludes revenues generated at these facilities one year after the 2003 opening or acquisition).

 

Income before income taxes decreased $35 million to $271 million during 2004 as compared to $306 million during 2003. The decrease in income before income taxes during 2004, as compared to 2003, resulted primarily from: (i) a $50 million decrease at our acute care facilities (as discussed below in Acute Care Hospital Services); (ii) a $9 million increase at our behavioral health care facilities (as discussed below in Behavioral Health Services); (iii) an $8 million increase at our acute care hospitals located in France (as discussed below in International and Other Operating Results); (iv) a $6 million decrease due to an increase in interest expense (as discussed below in Other Operating Results); (v) an $11 million increase due to a cumulative reduction to compensation expense in 2004 resulting from the reversal of expense related to restricted shares granted to our Chief Executive Officer that were contingent on an earnings threshold which was not achieved, and; (vi) a $7 million decrease resulting from other combined net unfavorable changes.

 

Net income decreased $30 million during 2004, as compared to 2003, due to: (i) the $35 million decrease in income before income taxes, as discussed above; (ii) partially offset by a $13 million decrease in income taxes resulting from the tax benefit on the decrease in income before income taxes, and; (iii) an $8 million unfavorable change in income/loss from discontinued operations, net of income taxes (as discussed below in Discontinued Operations).

 

Year Ended December 31, 2003 as compared to the Year Ended December 31, 2002: Net revenues increased 13% to $3.39 billion in 2003 as compared to $2.99 billion in 2002. The $400 million increase during 2003, as compared to 2002, was primarily attributable to:

 

    a $234 million or 8% increase in net revenues generated at our same facility acute care hospitals (located in the U.S. and France) and behavioral health care facilities;

 

    $91 million of revenues generated at acute care hospitals acquired or opened in the U.S. and France and behavioral health facilities acquired at various times during 2002 and 2003 (excludes revenues generated at these facilities one year after opening or acquisition).

 

    $61 million of other increases in net revenues consisting primarily of $29 million from reclassifying certain supply costs incurred by our French hospitals and a $20 million increase resulting from favorable exchange rate changes. Beginning January 1, 2003, we began recording as revenues and supplies expense, the cost of certain medical devices which are billed to patients of our French hospitals. Previously, these amounts were recorded net in our consolidated financial statements. During the year ended December 31, 2002, these amounts were approximately $15 million. The change in accounting presentation had no impact on previously reported operating income or net income.

 

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Income before income taxes increased $41 million to $306 million during 2003 as compared to $265 million during 2002. The increase in income before income taxes during 2003, as compared to 2002, resulted primarily from: (i) a $25 million increase at our acute care facilities (as discussed below in Acute Care Hospital Services); (ii) a $27 million increase at our behavioral health care facilities (as discussed below in Behavioral Health Services); (iii) a $4 million decrease due to an increase in interest expense (as discussed below in Other Operating Results), and; (iv) an $7 million decrease resulting from other combined net unfavorable changes.

 

Net income increased $24 million during 2003, as compared to 2002, due to the $41 million increase in income before income taxes, as discussed above, partially offset by a $17 million increase in income taxes resulting primarily from the income tax expense on the increase in income before income taxes.

 

Acute Care Hospital Services

 

Year Ended December 31, 2004 as compared to the Year Ended December 31, 2003: The following table summarizes the results of operations for our acute care facilities located in the U.S. on a same facility basis and is used in the discussions below for the years ended December 31, 2004 and 2003 (dollar amounts in thousands):

 

    

Year Ended

December 31, 2004


   

Year Ended

December 31, 2003


 

Acute Care Hospitals – Same Facility Basis


   Amount

   % of
Revenues


    Amount

   % of
Revenues


 

Net revenues

   $ 2,576,360    100.0 %   $ 2,499,549    100.0 %

Operating charges:

                          

Salaries, wages and benefits

     941,721    36.5 %     895,803    35.9 %

Other operating expenses

     601,800    23.3 %     571,564    22.9 %

Supplies expense

     375,262    14.6 %     347,760    13.9 %

Provision for doubtful accounts

     241,317    9.4 %     238,075    9.5 %

Depreciation and amortization

     107,347    4.2 %     100,047    4.0 %

Lease and rental expense

     41,376    1.6 %     41,233    1.6 %
    

  

 

  

       2,308,823    89.6 %     2,194,482    87.8 %
    

  

 

  

Income before interest expense, minority interests and income taxes

     267,537    10.4 %     305,067    12.2 %

Interest expense, net

     233    0.0 %     248    0.0 %

Minority interests in earnings of consolidated entities

     15,939    0.6 %     16,953    0.7 %
    

  

 

  

Income before income taxes

   $ 251,365    9.8 %   $ 287,866    11.5 %
    

  

 

  

 

On a same facility basis during 2004, as compared to 2003, net revenues at our acute care hospitals located in the U.S. increased $76.8 million or 3.1%. Income before income taxes decreased $36.5 million or 12.7% to $251.4 million or 9.8% of net revenues during 2004 as compared to $287.9 million or 11.5% of net revenues during 2003. The factors contributing to the decrease in income before income taxes at these facilities are discussed below. Inpatient admissions to these facilities decreased 0.9% during 2004, as compared to 2003, while patient days decreased 1.6%. The average length of patient stay at these facilities was 4.5 days in both 2004 and 2003. The occupancy rate, based on the average available beds at these facilities, was 65.5% during 2004, as compared to 68.7% during 2003. Our same facility net revenues were favorably impacted by an increase in prices charged to private payors including health

 

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maintenance organizations and preferred provider organizations. On a same facility basis, net revenue per adjusted admission (adjusted for outpatient activity) at these facilities increased 2.8% during 2004, as compared to 2003, and net revenue per adjusted patient day increased 3.4% during 2004, as compared to 2003.

 

The following table summarizes the results of operations for all our acute care facilities located in the U.S. (including newly acquired and built facilities) and is used in the discussion below for the years ended December 31, 2004 and 2003 (amounts in thousands):

 

    

Year Ended

December 31, 2004


   

Year Ended

December 31, 2003


 

All Acute Care Hospitals


   Amount

   % of
Revenues


    Amount

   % of
Revenues


 

Net revenues

   $ 2,897,719    100.0 %   $ 2,499,550    100.0 %

Operating charges:

                          

Salaries, wages and benefits

     1,089,042    37.6 %     895,803    35.8 %

Other operating expenses

     683,373    23.6 %     571,611    22.9 %

Supplies expense

     412,751    14.2 %     340,764    13.6 %

Provision for doubtful accounts

     285,779    9.9 %     238,074    9.5 %

Depreciation and amortization

     119,998    4.1 %     100,047    4.0 %

Lease and rental expense

     47,856    1.7 %     41,272    1.7 %
    

  

 

  

       2,638,799    91.1 %     2,187,571    87.5 %
    

  

 

  

Income before interest expense, minority interests and income taxes

     258,920    8.9 %     311,979    12.5 %

Interest expense, net

     302    0.0 %     248    0.0 %

Minority interests in earnings of consolidated entities

     13,463    0.4 %     16,953    0.7 %
    

  

 

  

Income before income taxes

   $ 245,155    8.5 %   $ 294,778    11.8 %
    

  

 

  

 

During 2004, as compared to 2003, net revenues at our acute care hospitals located in the U.S. (including newly acquired and built facilities), increased $398.2 million or 15.9%. The increase in net revenues was attributable to a $76.8 million increase in same facility revenues and $318.6 million of revenues generated at facilities acquired or opened during 2003 and 2004 (excludes revenues generated at these facilities one year after the 2003 opening or acquisition). Income before income taxes decreased $49.6 million or 16.8% to $245.2 million or 8.5% of net revenues during 2004 as compared to $294.8 million or 11.8% of net revenues during 2003. The $49.6 million decrease in income before income taxes at our acute care facilities (including newly acquired and built facilities), resulted primarily from a $36.5 million decrease at our acute care facilities owned for more than a year, including a $20.9 million decrease experienced at our acute care facility in McAllen, Texas, as discussed below. Also contributing to the decrease were losses experienced at our newly opened Lakewood Ranch Hospital in Florida (opened during the third quarter of 2004) and Methodist Hospital in Louisiana which was acquired in January, 2004.

 

Unfavorably impacting the income before income taxes at our acute care hospitals located in the U.S. during 2004, as compared to 2003 (on a same facility and all facility basis), were the following factors:

 

    decreasing inpatient admission attributable in part to a slower economy which has induced lower health care consumption trends in many of our markets. Unfavorable economic conditions are more prevalent in certain markets such as Amarillo, Texas and Auburn, Washington;

 

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    a continuation of an increase in uninsured and self-pay patients which unfavorably impacts the collectibility of our patient accounts thereby increasing our provision for doubtful accounts and charity care provided;

 

    the emergence of recent trends indicating the erosion of some business, including surgeries and better paying, higher acuity patients, in certain markets such as McAllen, Texas and Aiken, South Carolina as a result of increased hospital and physician competition;

 

    an increase in salaries, wages and benefits expense as a percentage of net revenues partially due to decreasing inpatient admission trends and severance payments related to reductions in staffing levels, and;

 

    an increase in supplies expense partially due to the higher costs for orthopedic implants and high cost cardiology supplies.

 

As mentioned above, income before income taxes at our acute care facility located in McAllen, Texas decreased $20.9 million during 2004, as compared to 2003. Admissions and patient days declined at this facility during 2004, as compared to 2003, due to intense hospital and physician competition. We expect the competitive pressures in the market to remain and potentially intensify. The physician-owned hospital in the market added new inpatient capacity in late 2004 which has the potential to further erode our higher margin business, including cardiac procedures. As competition in this market has increased, wage rates and physician recruiting costs have risen, exacerbating the profitability decline.

 

We believe that the slowing economy has accelerated health benefit design changes in which employers shift costs to employees in the form of higher cost sharing. Since these changes may continue to have a noticeable effect on health care consumption going forward, we expect the unfavorable patient volume and provision for doubtful accounts trends to continue to pressure future results of operations until there is a notable strengthening of the overall labor market. In response to the market share erosion in certain of our markets, we have undertaken a program of facility renovation/expansion and physician recruitment in several markets.

 

Year Ended December 31, 2003 as compared to the Year Ended December 31, 2002:

 

The following table summarizes the results of operations for our acute care facilities located in the U.S. on a same facility basis and is used in the discussions below for the years ended December 31, 2003 and 2002 (dollar amounts in thousands):

 

    

Year Ended

December 31, 2003


   

Year Ended

December 31, 2002


 

Acute Care Hospitals – Same Facility Basis


   Amount

   % of
Revenues


    Amount

   % of
Revenues


 

Net revenues

   $ 2,486,031    100.0 %   $ 2,287,780    100.0 %

Operating charges:

                          

Salaries, wages and benefits

     889,611    35.8 %     820,196    35.8 %

Other operating expenses

     567,528    22.8 %     537,480    23.5 %

Supplies expense

     345,472    13.9 %     324,724    14.2 %

Provision for doubtful accounts

     237,259    9.5 %     196,280    8.6 %

Depreciation and amortization

     98,936    4.0 %     84,847    3.7 %

Lease and rental expense

     41,132    1.7 %     41,086    1.8 %
    

  

 

  

       2,179,938    87.7 %     2,004,613    87.6 %
    

  

 

  

Income before interest expense, minority interests and income taxes

     306,093    12.3 %     283,167    12.4 %

Interest expense, net

     248    0.0 %     304    0.0 %

Minority interests in earnings of consolidated entities

     17,262    0.7 %     17,186    0.8 %
    

  

 

  

Income before income taxes

   $ 288,583    11.6 %   $ 265,677    11.6 %
    

  

 

  

 

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On a same facility basis during 2003, as compared to 2002, net revenues at our acute care hospitals located in the U.S. increased $198.3 million or 8.7%. Income before income taxes at these facilities increased $22.9 million or 8.6% to $288.6 million or 11.6% of net revenues during 2003 as compared to $265.7 million or 11.6% of net revenues during 2002. Inpatient admissions and patient days to these facilities increased 1.1% and 1.4%, respectively, during 2003, as compared to 2002. The average length of patient stay at these facilities was 4.5 days in both 2003 and 2002. The occupancy rate, based on the average available beds at these facilities, was 68.7% during 2003, as compared to 70.0% during 2002. Our same facility net revenues were favorably impacted by an increase in prices charged to private payors including health maintenance organizations and preferred provider organizations. On a same facility basis, net revenue per adjusted admission at these facilities increased 6.4% during 2003, as compared to 2002, and net revenue per adjusted patient day increased 6.1% during 2003, as compared to 2002.

 

The following table summarizes the results of operations for all our acute care facilities located in the U.S. (including newly acquired and built facilities) and is used in the discussion below for the years ended December 31, 2003 and 2002 (amounts in thousands):

 

    

Year Ended

December 31, 2003


   

Year Ended

December 31, 2002


 

All Acute Care Hospitals


   Amount

   % of
Revenues


    Amount

   % of
Revenues


 

Net revenues

   $ 2,499,550    100.0 %   $ 2,292,417    100.0 %

Operating charges:

                          

Salaries, wages and benefits

     895,803    35.8 %     818,484    35.7 %

Other operating expenses

     571,611    22.9 %     537,669    23.5 %

Supplies expense

     340,764    13.6 %     324,728    14.2 %

Provision for doubtful accounts

     238,074    9.5 %     198,278    8.6 %

Depreciation and amortization

     100,047    4.0 %     84,847    3.7 %

Lease and rental expense

     41,272    1.7 %     41,129    1.8 %
    

  

 

  

       2,187,571    87.5 %     2,005,135    87.5 %
    

  

 

  

Income before interest expense, minority interests and income taxes

     311,979    12.5 %     287,282    12.5 %

Interest expense, net

     248    0.0 %     304    0.0 %

Minority interests in earnings of consolidated entities

     16,953    0.7 %     17,016    0.7 %
    

  

 

  

Income before income taxes

   $ 294,778    11.8 %   $ 269,962    11.8 %
    

  

 

  

 

During 2003, as compared to 2002, net revenues at our acute care hospitals located in the U.S. (including newly acquired and built facilities), increased $207.1 million or 9.0%. The increase in net revenues was primarily attributable to a $198.3 million increase in same facility revenues, discussed above, and revenues generated at a newly constructed facility which was opened in the fourth quarter of 2003. Income before income taxes increased $24.8 million or 9.2% to $294.8 million or 11.8% of net revenues during 2003 as compared to $270.0 million or 11.8% of net revenues during 2002.

 

Favorably impacting the operating margins at our acute care hospitals located in the U.S. during 2003, as compared to 2002, was a decrease in other operating expenses (to 22.9% of net revenues during 2003, as compared to 23.5% in 2002) resulting primarily from decreased pharmacy costs resulting from a new outsourcing agreement that commenced during the third quarter of 2002. Also during 2003, supplies expense at our acute care facilities decreased to 13.6% of net revenues, as compared to 14.2%

 

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during 2002, due primarily to the elimination of supply intensive, uneconomic service lines at several hospitals. Unfavorably impacting the operating margins at our acute care hospitals was an increase in the provision for doubtful accounts which increased to 9.5% during 2003 as compared to 8.6% during 2002.

 

Acute Care Hospital Services-General

 

The federal government makes payments to participating hospitals under its Medicare program based on various formulas. For inpatient services, our general acute care hospitals are subject to a prospective payment system (“PPS”) under which the hospitals are paid a predetermined amount per admission. The payment is based upon a diagnostic related group (“DRG”), for which payment amounts are adjusted to account for geographic wage differences. For outpatient services, both general acute and behavioral health hospitals are paid under an outpatient prospective payment system (“OPPS”) according to ambulatory procedure codes (“APC”) that group together services that are comparable both clinically and with respect to the use of resources, as adjusted to account for certain geographic wage differences.

 

A significant portion of the revenue generated at our acute care facilities located in the U.S. is derived from federal and state healthcare programs, including Medicare and Medicaid (excluding managed Medicare and Medicaid programs), which accounted for 40%, 42% and 44% of our net patient revenues during 2004, 2003 and 2002, respectively. Under the statutory framework of the Medicare and Medicaid programs, many of our operations are subject to administrative rulings, interpretations and discretion that may affect payments made under either or both of such programs as well as by other third party payors. Management believes that adequate provision has been made for any adjustment that might result therefrom.

 

Approximately 39% in 2004, 38% in 2003 and 38% in 2002, of the net patient revenues at our acute care facilities located in the U.S. were generated from managed care companies, which include health maintenance organizations, preferred provider organizations and managed Medicare and Medicaid programs. Typically, we receive lower payments per patient from managed care payors than we do from traditional indemnity insurers, however, during the past few years, we have secured price increases from many of our commercial payors including managed care companies.

 

Upon meeting certain conditions, and serving a disproportionately high share of Texas’ and South Carolina’s low income patients, five of our facilities located in Texas and one facility located in South Carolina became eligible and received additional reimbursement from each state’s disproportionate share hospital (“DSH”) fund. To qualify for DSH funds in Texas, the facility must have either a disproportionate total number of inpatient days for Medicaid patients, a disproportionate percentage of all inpatient days that are for Medicaid patients, or a disproportionate percentage of all inpatient days that are for low-income patients. Included in our financial results was an aggregate of $39.3 million in 2004, $27.8 million in 2003 and $33.0 million in 2002 related to DSH programs. In February 2003, the United States Department of Health and Human Services Office of Inspector General (“OIG”) published a report indicating that Texas Medicaid may have overpaid Texas hospitals for DSH payments. During 2004, the Commission implemented rules which offset negative Medicaid shortfalls in the hospital-specific cap formula, and included third-party and upper payment limit payments in the shortfall calculation. These changes resulted in reduced payments to our hospitals located in Texas that have significant Medicaid populations. The Texas and South Carolina programs have been renewed for each state’s 2005 fiscal years and we expect the DSH reimbursements to be no less than the amounts received during each state’s 2004 fiscal years. Failure to renew these DSH programs beyond their scheduled termination dates (June 30, 2005 for South Carolina and August 31, 2005 for Texas), failure of our hospitals that currently receive DSH payments to qualify for future DSH funds under these programs, or reductions in reimbursements, could have a material adverse effect on our future results of operations.

 

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In May, 2004, the state of Texas submitted a Medicaid state plan amendment to the Centers for Medicaid Services (“CMS”) requesting CMS’s approval to expand the Texas supplemental inpatient reimbursement methodology. In July, 2004, CMS approved the submitted state plan amendment retroactive to the May, 2004 submission date. With the CMS approval, the Texas Health and Human Services Commission (“HHSC”) published a proposed rule change in the Texas Register in October, 2004 to incorporate the state plan amendment changes in the Texas Administrative Code regulation. After expiration of the public comment period, the final rule, with language identical to that contained in the proposed rule, was published in the Texas Register on February 18, 2005. The general provisions of this supplemental payment methodology, which is governed by federal statute and regulations, includes: (i) matching federal dollars to the state for certain qualifying Medicaid expenditures; (ii) the federal government permitting the state to use the inter-governmental transfer of funds between state and local entities, and; (iii) subjecting supplemental payments made to hospitals to federally mandated limits. Included in our 2004 financial results was $6.2 million of incremental revenue earned pursuant to the provisions of this program. Although we can provide no assurance that this program will remain in place, we expect to earn on an incremental basis (assuming the program remains unchanged), approximately $12 million during 2005 in connection with this program. In Pennsylvania, several of our behavioral health hospitals were notified that $2.6 million in state Medicaid DSH monies paid for the state fiscal year 2004 will require repayment to the state. This repayment is the result of a change in the calculation of the hospital specific DSH cap formula as it relates to the handling of a hospital’s negative Medicaid payment shortfall. Our 2004 financial statements include a $2.6 million reserve established for the expected repayment of the Pennsylvania DSH funds. We expect this change to the DSH calculation and the resulting adverse financial impact to remain in place in 2005 and beyond.

 

Behavioral Health Care Services

 

Year Ended December 31, 2004 as compared to the Year Ended December 31, 2003:

 

The following table summarizes the results of operations for our behavioral health care facilities, on a same facility basis, and is used in the discussions below for the years ended December 31, 2004 and 2003 (dollar amounts in thousands):

 

    

Year Ended

December 31, 2004


   

Year Ended

December 31, 2003


 

Behavioral Health Care Facilities – Same Facility Basis


   Amount

   % of
Revenues


    Amount

   % of
Revenues


 

Net revenues

   $ 656,336    100.0 %   $ 612,404    100.0 %

Operating charges:

                          

Salaries, wages and benefits

     313,827    47.8 %     288,555    47.1 %

Other operating expenses

     133,623    20.3 %     129,400    21.1 %

Supplies expense

     40,391    6.2 %     37,011    6.0 %

Provision for doubtful accounts

     20,573    3.1 %     13,748    2.3 %

Depreciation and amortization

     14,919    2.3 %     13,665    2.3 %

Lease and rental expense

     8,496    1.3 %     8,755    1.4 %
    

  

 

  

       531,829    81.0 %     491,134    80.2 %
    

  

 

  

Income before interest expense, minority interests and income taxes

     124,507    19.0 %     121,270    19.8 %

Interest expense, net

     12    0.0 %     82    0.0 %

Minority interests in earnings of consolidated entities

     672    0.1 %     668    0.1 %
    

  

 

  

Income before income taxes

   $ 123,823    18.9 %   $ 120,520    19.7 %
    

  

 

  

 

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On a same facility basis during 2004, as compared to 2003, net revenues at our behavioral health care facilities increased $43.9 million or 7.2%. Income before income taxes increased $3.3 million or 2.7% to $123.8 million or 18.9% of net revenues during 2004 as compared to $120.5 million or 19.7% of net revenues during 2003. Favorably impacting the income before income taxes at our behavioral health hospitals during 2003 was the reversal of $4 million of previously established bad debt reserves which were reversed as a result of a certain payor’s emergence from Chapter 11 bankruptcy protection. Inpatient admissions to these facilities increased 5.9% during 2004, as compared to 2003, while patient days increased 6.4%. The average length of patient stay at these facilities was 12.3 days during 2004 and 12.2 days during 2003. The occupancy rate, based on the average available beds at these facilities, was 80.4% during 2004, as compared to 77.7% during 2003. Our same facility net revenues were favorably impacted by an increase in prices charged to private payors including health maintenance organizations and preferred provider organizations. On a same facility basis, net revenue per adjusted admission (adjusted for outpatient activity) at these facilities increased 2.4% during 2004, as compared to 2003, and net revenue per adjusted patient day increased 1.5% during 2004, as compared to 2003.

 

The following table summarizes the results of operations for all our behavioral health care facilities (including newly acquired facilities) and is used in the discussion below for the years ended December 31, 2004 and 2003 (amounts in thousands):

 

    

Year Ended

December 31, 2004


   

Year Ended

December 31, 2003


 

All Behavioral Health Care Facilities


   Amount

   % of
Revenues


    Amount

   % of
Revenues


 

Net revenues

   $ 698,772    100.0 %   $ 612,404    100.0 %

Operating charges:

                          

Salaries, wages and benefits

     337,888    48.3 %     288,555    47.1 %

Other operating expenses

     141,392    20.2 %     129,400    21.1 %

Supplies expense

     42,940    6.1 %     37,011    6.0 %

Provision for doubtful accounts

     20,664    3.0 %     13,748    2.3 %

Depreciation and amortization

     15,849    2.3 %     13,665    2.3 %

Lease and rental expense

     9,551    1.4 %     8,755    1.4 %
    

  

 

  

       568,284    81.3 %     491,134    80.2 %
    

  

 

  

Income before interest expense, minority interests and income taxes

     130,488    18.7 %     121,270    19.8 %

Interest expense, net

     12    0.0 %     82    0.0 %

Minority interests in earnings of consolidated entities

     672    0.1 %     668    0.1 %
    

  

 

  

Income before income taxes

   $ 129,804    18.6 %   $ 120,520    19.7 %
    

  

 

  

 

During 2004, as compared to 2003, net revenues at our behavioral health care facilities (including newly acquired facilities), increased $86.4 million or 14.1%. The increase in net revenues was attributable to a $43.9 million increase in same facility revenues and $42.5 million of revenues generated at facilities acquired during 2004 or 2003. Income before income taxes increased $9.3 million or 7.7% to $129.8 million or 18.6% of net revenues during 2004, as compared to $120.5 million or 19.7% of net revenues during 2003.

 

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Year Ended December 31, 2003 as compared to the Year Ended December 31, 2002:

 

The following table summarizes the results of operations for our behavioral health care facilities, on a same facility basis, and is used in the discussions below for the years ended December 31, 2003 and 2002 (dollar amounts in thousands):

 

    

Year Ended

December 31, 2003


   

Year Ended

December 31, 2002


 

Behavioral Health Care Facilities – Same Facility Basis


   Amount

   % of
Revenues


    Amount

   % of
Revenues


 

Net revenues

   $ 591,562    100.0 %   $ 565,585    100.0 %

Operating charges:

                          

Salaries, wages and benefits

     278,184    47.0 %     266,111    47.1 %

Other operating expenses

     126,793    21.4 %     130,365    23.0 %

Supplies expense

     35,898    6.1 %     34,010    6.0 %

Provision for doubtful accounts

     13,626    2.3 %     20,113    3.6 %

Depreciation and amortization

     12,438    2.1 %     12,173    2.2 %

Lease and rental expense

     8,652    1.5 %     8,718    1.5 %
    

  

 

  

       475,591    80.4 %     471,490    83.4 %
    

  

 

  

Income before interest expense, minority interests and income taxes

     115,971    19.6 %     94,095    16.6 %

Interest expense, net

     82    0.0 %     12    0.0 %

Minority interests in earnings of consolidated entities

     668    0.1 %     490    0.1 %
    

  

 

  

Income before income taxes

   $ 115,221    19.5 %   $ 93,593    16.5 %
    

  

 

  

 

On a same facility basis during 2003, as compared to 2002, net revenues at our behavioral health care facilities increased $26.0 million or 4.6%. Income before income taxes increased $21.6 million or 23.1% to $115.2 million or 19.5% of net revenues during 2003 as compared to $93.6 million or 16.5% of net revenues during 2002. Favorably impacting the income before income taxes at our behavioral health hospitals during 2003 was the reversal of $4 million of previously established bad debt reserves which were reversed as a result of a certain payor’s emergence from Chapter 11 bankruptcy protection. Inpatient admissions to these facilities increased 2.9% during 2003, as compared to 2002, while patient days increased 2.7%. The average length of patient stay at these facilities was 11.9 days during 2003 and 2002. The occupancy rate, based on the average available beds at these facilities, increased to 77.7% during 2003, as compared to 76.4% during 2002. On a same facility basis, net revenue per adjusted admission and adjusted patient day at these facilities each increased 3.3% during 2003, as compared to 2002.

 

The following table summarizes the results of operations for all our behavioral health care facilities (including newly acquired facilities) and is used in the discussion below for the years ended December 31, 2003 and 2002 (amounts in thousands):

 

    

Year Ended

December 31, 2003


   

Year Ended

December 31, 2002


 

All Behavioral Health Care Facilities


   Amount

   % of
Revenues


    Amount

   % of
Revenues


 

Net revenues

   $ 612,404    100.0 %   $ 565,585    100.0 %

Operating charges:

                          

Salaries, wages and benefits

     288,555    47.1 %     266,111    47.1 %

Other operating expenses

     129,400    21.1 %     130,365    23.0 %

Supplies expense

     37,011    6.0 %     34,010    6.0 %

Provision for doubtful accounts

     13,748    2.3 %     20,113    3.6 %

Depreciation and amortization

     13,665    2.3 %     12,173    2.2 %

Lease and rental expense

     8,755    1.4 %     8,718    1.5 %
    

  

 

  

       491,134    80.2 %     471,490    83.4 %
    

  

 

  

Income before interest expense, minority interests and Income taxes

     121,270    19.8 %     94,095    16.6 %

Interest expense, net

     82    0.0 %     12    0.0 %

Minority interests in earnings of consolidated entities

     668    0.1 %     490    0.1 %
    

  

 

  

Income before income taxes

   $ 120,520    19.7 %   $ 93,593    16.5 %
    

  

 

  

 

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During 2003, as compared to 2002, net revenues at our behavioral health care facilities (including newly acquired facilities), increased $46.8 million or 8.3%. The increase in net revenues was attributable to a $26.0 million increase in same facility revenues and $20.8 million of revenues generated at facilities acquired during 2003. Income before income taxes increased $26.9 million or 28.8% to $120.5 million or 19.7% of net revenues during 2003 as compared to $93.6 million or 16.5% of net revenues during 2002.

 

Behavioral Health Care Services-General

 

Prior to January 1, 2005, behavioral health facilities, which are generally excluded from the inpatient services PPS, were reimbursed on a reasonable cost basis by the Medicare program (“TEFRA Payment”), but were generally subject to a per discharge ceiling, calculated based on an annual allowable rate of increase over the hospital’s base year amount under the Medicare law and regulations. Capital-related costs were exempt from this limitation. The discharge ceiling is higher for those hospitals that were excluded from PPS before October 1, 1997. Congress required the Centers for Medicare and Medicaid Services (“CMS”) to develop a per diem PPS for inpatient services furnished by behavioral health hospitals under the Medicare program (“Psych PPS”). On November 15, 2004, CMS published final regulations that implement Psych PPS, which is effective beginning on an inpatient psychiatric facility’s first cost reporting period beginning on or after January 1, 2005. This new system will generally become effective for most of our hospitals on January 1, 2005. The federal prospective rate is a base prospective per diem rate and is adjusted for individual hospital demographic factors including: geographic location, resident teaching program status and licensed emergency room department status. The base per diem rate is also adjusted for patient specific demographic factors including: patient age, medical diagnosis and the existence of certain co-morbid medical conditions. The base per diem rate is paid based on sliding scale payment adjustment factors wherein a provider will receive an increased per diem for day one of the patient stay and the per diem payment will decrease during the patient hospital stay based on a published CMS sliding scale. Psych PPS will be implemented over a four year period with Year 1 having a blended Medicare payment rate based on seventy-five percent (75%) TEFRA payment and twenty-five percent (25%) Psych PPS payment. For PPS transition Years 2, 3 and 4, the blended rate is 50% TEFRA and 50% Psych PPS, 25% TEFRA and 75% Psych PPS, 0% TEFRA and 100% Psych PPS, respectively. We believe the implementation of behavioral health impatient PPS will have a favorable affect on our future results of operations, however, due to the four-year phase-in period, we do not believe the favorable affect will have a material impact on our 2005 results of operations.

 

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A significant portion of the revenue generated at our behavioral health care facilities is derived from federal and state healthcare programs, including Medicare and Medicaid (excluding managed Medicare and Medicaid programs), which accounted for 38%, 36% and 35% of our net patient revenues during 2004, 2003 and 2002, respectively.

 

Approximately 48% in 2004, 51% in 2003 and 48% in 2002, of the net patient revenues at our behavioral health care facilities were generated from managed care companies, which include health maintenance organizations, preferred provider organizations and managed Medicare and Medicaid programs. Typically, we receive lower payments per patient from managed care payors than we do from traditional indemnity insurers, however, during the past few years, we have secured price increases from many of our commercial payors including managed care companies.

 

International and Other Operating Results

 

Combined net revenues from our international and other operating entities including outpatient surgery centers, radiation centers and an 80% ownership interest in an operating company that owns fourteen hospitals in France, increased to $332 million during 2004 as compared to $265 million during 2003 and $126 million during 2002. The increases in combined net revenues of $67 million during 2004, as compared to 2003, was primarily attributable to an increase in the same facility revenues generated at our French facilities, as discussed below, and $26 million of revenues attributable to the acquisition of two additional hospitals by our France subsidiary during the first quarter of 2004. The increases in combined net revenues of $139 million during 2003, as compared to 2002, was primarily attributable to $130 million of increased revenues from our French subsidiary consisting of: (i) $54 million of revenues generated at newly acquired facilities; (ii) a $29 million increase from reclassifying certain supply costs incurred by our French hospitals (change in accounting presentation that had no impact on net income); (iii) a $20 million increase resulting from a favorable change in the foreign currency exchange rate; (iv) a $18 million increase resulting from an additional month of revenues recorded during 2003 to convert this subsidiary to a December 31st year-end, and; (v) a $9 million increase in revenues on a same facility basis.

 

Combined income before income taxes from the international and other operating entities was $17.0 million during 2004, $10.0 million during 2003 and $8.7 million during 2002. The $7.0 million increase during 2004, as compared to 2003, was due to increased income generated at the facilities located in France.

 

On a same facility basis at our hospitals located in France (excluding the effects of changes in the foreign currency exchange rate and the additional month of results recorded during 2003), net revenues increased $32 million or 14% during 2004, as compared to 2003, and 8% during 2003 (excluding the effects of changes in the foreign currency exchange rate, the additional month of results recorded during 2003 and the supply cost reclass mentioned above), as compared to 2002. Inpatient admissions to our facilities located in France increased 0.1% during 2004, as compared to 2003, and decreased 2.0% during 2003, as compared to 2002. Patient days at these facilities decreased 0.8% during 2004, as compared to 2003, and decreased 0.7% during 2003, as compared to 2002. On a same facility basis, the average length of stay at these facilities decreased to 4.9 days during 2004, as compared to 5.0 days during 2003. Also on a same facility basis, the average length of stay at our facilities located in France was 5.1 days during 2003 as compared to 5.0 days during 2002. The occupancy rate, based on the average available beds at these facilities, was 78% during both 2004 and 2003 and 81% during 2002. The large majority of the revenues generated by our hospitals located in France are paid by the government based on predetermined rates established in May of each year and consist of a per diem payment and per procedure rate plus reimbursement for certain supplies.

 

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Prior to the fourth quarter of 2003, our French subsidiary was included on the basis of the year ended November 30th. During the fourth quarter of 2003, we recorded an additional month of financial results to convert this subsidiary to a December 31st year-end. The additional month of financial results increased net revenues by approximately $18 million, or 0.5% of our consolidated net revenues for the year ended December 31, 2003. The effect on our consolidated net income resulting from this adjustment was approximately $500,000 during the year ended December 31, 2003.

 

During the third quarter of 2004, our 121-bed acute care hospital located in West Palm Beach, Florida sustained property damage from a hurricane. As a result, we recorded a pre-tax charge of $2.3 million during the quarter ended September 30, 2004 to reflect the impact of the property write-down which is not covered by our insurance due to deductibles.

 

Interest expense was $43.4 million during 2004, $37.9 million during 2003 and $34.1 million during 2002. The increase during 2004, as compared to 2003, was due primarily to the increased average borrowings incurred to finance the acquisition, during the first quarter of 2004, of three acute care facilities located in the U.S. and two located in France, the acquisition during the second quarter of 2004 of five behavioral health care facilities and the construction costs related to the opening of two newly constructed acute care facilities which opened during the fourth quarter of 2003 and the third quarter of 2004.

 

The effective tax rate was 37.3% during 2004, 37.3% during 2003 and 36.7% during 2002. The increase during 2003, as compared to 2002, was due primarily to 2002 including a tax credit for which we are no longer eligible.

 

Discontinued Operations

 

During 2004, in conjunction with our strategic plan to sell two recently acquired acute care hospitals in California as well as certain other under-performing assets, we sold the operations and/or property of the following acute care facilities and surgery and radiation therapy centers for combined cash proceeds of approximately $81 million:

 

    a 112-bed hospital located in San Luis Obispo, California (sold in second quarter of 2004);

 

    a 65-bed hospital located in Arroyo Grande, California (sold in second quarter of 2004);

 

    a 136-bed leased hospital in Shreveport, Louisiana (sold in second quarter of 2004);

 

    a 106-bed hospital located in La Place, Louisiana (sold in second quarter of 2004);

 

    a 160-bed pediatric and surgery hospital located in Rio Piedras, Puerto Rico (sold in third quarter of 2004), and;

 

    ownership interests in five outpatient surgery centers located in Ponca City, Oklahoma (sold in second quarter of 2004), New Albany, Indiana (sold in third quarter of 2004), Hammond, Louisiana (sold in third quarter of 2004), Littleton, Colorado (sold in the first quarter of 2004) and St. George, Utah (sold in the fourth quarter of 2004) and a radiation therapy center located in Madison, Indiana (sold in first quarter of 2004).

 

In addition, subsequent to December 31, 2004, we completed and executed a definitive agreement to sell two acute care hospitals located in Puerto Rico. The sales, which are subject to customary regulatory approvals, are expected to be completed by March 31, 2005.

 

The operating results of all these facilities, as well as gains, net of losses, resulting from the divestitures are reflected as “Income/(loss) from discontinued operations, net of income tax” in the Consolidated Statement of Income for the year ended December 31, 2004. These transactions resulted in a combined pre-tax gain of approximately $5.4 million ($3.4 million after-tax) which is included in “Income/(loss) from discontinued operations, net of income tax” in the Consolidated Statement of Income for the year ended December 31, 2004.

 

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The following table shows the results of operations, on a combined basis, for all facilities reflected as discontinued operations for the years ended December 31, 2004, 2003 and 2002.

 

     Year Ended December 31,

 
     2004

    2003

    2002

 
           (000s)        

Net revenues

   $ 219,553     $ 252,060     $ 266,979  
    


 


 


Income (loss) from operations

   $ (6,191 )   $ 1,655     $ 9,736  

Gains, net

     5,382       14,623       —    

Provision for asset impairment

     —         (13,742 )     —    

Recovery of provision for judgment/closure costs

     —         8,867       2,182  
    


 


 


Income (loss) from discontinued operations, pre-tax

     (809 )     11,403       11,918  

Income tax (provision)/benefit

     295       (4,213 )     (4,404 )
    


 


 


Income (loss) from discontinued operations, net of income tax expense

   $ (514 )   $ 7,190     $ 7,514  
    


 


 


 

Included in our results for the year ended December 31, 2003 were the following items: (i) the reversal of an accrued liability amounting to $8.9 million pre-tax ($5.6 million after-tax), including $1.9 million of accrued interest, resulting from a favorable Texas Supreme Court decision which reversed an unfavorable 2000 jury verdict and 2001 appellate court decision; (ii) a combined pre-tax net gain of $14.6 million ($8.7 million after-tax and after minority interest expense) realized on the disposition of an investment in a health-care related company and sales of radiation therapy centers, medical office buildings and an outpatient surgery center, and; (iii) a pre-tax $13.7 million provision for asset impairment ($8.7 million after-tax) resulting from the write-down of the carrying value of a 160-bed acute care pediatric hospital located in Puerto Rico to its estimated fair value.

 

Included in our results during the year ended December 31, 2002 was a $2.2 million pre-tax recovery of provision for closure cost ($1.4 million after-tax) resulting from the sale of the real estate of a women’s hospital that was written down to its estimated fair value during 2000.

 

Professional and General Liability Claims

 

Due to unfavorable pricing and availability trends in the professional and general liability insurance markets, our subsidiaries have assumed a greater portion of the hospital professional and general liability risk as the cost of commercial professional and general liability insurance coverage has risen significantly. As a result, effective January 1, 2002, most of our subsidiaries were self-insured for malpractice exposure up to $25 million per occurrence. We purchased umbrella excess policies for our subsidiaries through several commercial insurance carriers for coverage in excess of $25 million per occurrence with a $75 million aggregate limitation. Given these insurance market conditions, there can be no assurance that a continuation of these unfavorable trends, or a sharp increase in claims asserted against us, will not have a material adverse effect on our future results of operations.

 

Our estimated liability for professional and general liability claims is based on a number of factors including, among other things, the number of asserted claims and reported incidents, estimates of losses for these claims based on recent and historical settlement amounts, estimate of incurred but not reported claims based on historical experience, and estimates of amounts recoverable under our commercial insurance policies. While we continuously monitor these factors, our ultimate liability for professional and general liability claims could change materially from our current estimates due to inherent uncertainties involved in making this estimate.

 

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For the period from January 1, 1998 through December 31, 2001, most of our subsidiaries were covered under commercial insurance policies with PHICO, a Pennsylvania based insurance company that was placed into liquidation during the first quarter of 2002. As a result of PHICO’s liquidation, we recorded a $40 million pre-tax charge during 2001 to reserve for PHICO claims that could become our liability, however, we are entitled to receive reimbursement from state insurance guaranty funds, other commercial insurers and/or PHICO’s estate for a portion of certain claims ultimately paid by us.

 

As of December 31, 2004, the total accrual for our professional and general liability claims was $204.1 million ($172.5 million net of expected recoveries), of which $28.0 million is included in other current liabilities. As of December 31, 2003, the total accrual for our professional and general liability claims, was $190.8 million ($147.7 million net of expected recoveries), of which $35.0 million is included in other current liabilities. Included in other assets was $31.5 million as of December 31, 2004 and $43.0 million as of December 31, 2003, related to estimated expected recoveries from various state guaranty funds, insurance companies and other sources in connection with PHICO related professional and general liability claims payments.

 

Effects of Inflation and Seasonality

 

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

 

Inflation — Although inflation has not had a material impact on our results of operations over the last three years, the healthcare industry is very labor intensive and salaries and benefits are subject to inflationary pressures as are rising supply costs which tend to escalate as vendors pass on the rising costs through price increases. Our acute care and behavioral health care facilities are experiencing the effects of a shortage of skilled nursing staff nationwide, which has caused and may continue to cause an increase in salaries, wages and benefits expense in excess of the inflation rate. In addition, due to unfavorable pricing and availability trends in the professional and general liability insurance markets, the cost of commercial professional and general liability insurance coverage has risen significantly. As a result, our subsidiaries have assumed a greater portion of the hospital professional and general liability risk. Given these insurance market conditions, there can be no assurance that a continuation of these unfavorable trends, or a sharp increase in claims asserted against our subsidiaries, will not have a material adverse effect on our future results of operations.

 

Although we cannot predict our ability to continue to cover future cost increases, we believe that through adherence to cost containment policies, labor management and reasonable price increases, the effects of inflation on future operating margins should be manageable. However, our ability to pass on these increased costs associated with providing healthcare to Medicare and Medicaid patients is limited due to various federal, state and local laws which have been enacted that, in certain cases, limit our ability to increase prices. In addition, as a result of increasing regulatory and competitive pressures and a continuing industry wide shift of patients into managed care plans, our ability to maintain margins through price increases to non-Medicare patients is limited.

 

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Liquidity

 

Year ended December 31, 2004 as compared to December 31, 2003:

 

Net cash provided by operating activities

 

Net cash provided by operating activities was $393 million during 2004 as compared to $377 million during 2003. The 4% or $16 million increase was primarily attributable to:

 

    a favorable change of $37 million in other working capital accounts due primarily to timing of accrued payroll, other accrued expenses and accounts payable disbursements;

 

    an unfavorable change of $11 million due to a decrease in net income plus or minus the adjustments to reconcile net income to net cash provided by operating activities (depreciation and amortization, accretion of discount on convertible debentures, gains on sales of assets and businesses, property write-down due to hurricane, reversal of restricted stock grant amortization, provision for asset impairment and recovery of provision for judgment);

 

    an unfavorable change of $19 million in accounts receivable, partially due to an $8 million increase in accounts receivable at an acute care facility acquired during 2004, due in part to billing delays for Medicaid claims, and a $6 million increase in accounts receivable due to the revenues recorded during 2004 in connection with the Texas Medicaid supplemental payment methodology, as discussed above in Acute Care Hospital Services-General.

 

    $9 million of other net favorable changes.

 

Our annual days sales outstanding, or DSO, are calculated by dividing our annual net revenue by the number of days in the year. The result is divided into the accounts receivable balance at the end of the year to obtain the DSO. Our DSO were 52 days in 2004, 50 days in 2003 and 52 days in 2002.

 

Net cash used in investing activities

 

Net cash used in investing activities was $320 million during 2004 as compared to $480 million during 2003. During 2004, we spent $231 million to finance capital expenditures and an additional $170 million on the acquisition of newly acquired businesses and real estate assets, including the following:

 

    2004 capital expenditures

 

    Construction costs related to the new Lakewood Ranch Hospital, a 120-bed acute care facility located in Manatee County, Florida which opened during the third quarter of 2004;

 

    Purchase of land for potential future construction of a new acute care facility located in Las Vegas, Nevada;

 

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

 

    2004 Acquisitions of businesses and real estate assets

 

    a 90% controlling ownership interest in a 54-bed acute care hospital located in New Orleans, Louisiana, (operations subsequently merged with the operations of a 306-bed acute care hospital located in East New Orleans, Louisiana);

 

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    a 50-bed acute care facility, a 20-bed acute care facility and a the remaining 65% ownership interest (35% previously acquired) in the rea1 estate assets of a 198-bed acute care facility located in France, all of which were acquired by an operating company in which we own an 80% controlling ownership interest;

 

    a 63-bed behavioral health hospital, partial services, a school, group homes and detox services located in Stonington, Connecticut;

 

    a 112-bed behavioral health facility in Savannah, Georgia;

 

    a 77-bed behavioral facility in Benton, Arkansas;

 

    the operations of an 82-bed behavioral health facility in Las Vegas, Nevada;

 

    a 72-bed behavioral health facility in Bowling Green, Kentucky, and;

 

    an outpatient surgery center in Edinburg, Texas and an outpatient surgery center located in New Orleans, Louisiana.

 

In addition, in late December, 2003, we funded $230 million (which was included in other assets on our consolidated balance sheet as of December 31, 2003) for the combined purchase price of the following acute care facilities which we acquired effective January 1, 2004:

 

    a 90% controlling ownership interest in a 306-bed facility located in East New Orleans, Louisiana;

 

    a 228-bed facility located in Corona, California;

 

    a 112-bed facility located in San Luis Obispo, California (this facility was sold during the second quarter of 2004), and;

 

    a 65-bed facility located in Arroyo Grande, California (this facility was sold during the second quarter of 2004).

 

During 2005, we expect to spend approximately $275 million on capital expenditures, including expenditures for capital equipment, renovations and new projects at existing hospitals and completion of major construction projects in progress at December 31, 2004. We believe that our capital expenditure program is adequate to expand, improve and equip our existing hospitals. We expect to finance all capital expenditures and acquisitions with internally generated funds and borrowed funds. Additional funds may be obtained either through refinancing the existing revolving credit agreement and/or the commercial paper facility and/or the issuance of equity or long-term debt.

 

During 2004, in conjunction with our strategic plan to sell two recently acquired acute care hospitals in California as well as certain other under-performing assets, we sold the operations and/or property of the following acute care facilities and surgery and radiation therapy centers for combined cash proceeds of approximately $81 million:

 

    a 112-bed hospital located in San Luis Obispo, California (sold in second quarter of 2004);

 

    a 65-bed hospital located in Arroyo Grande, California (sold in second quarter of 2004);

 

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    a 136-bed leased hospital in Shreveport, Louisiana (sold in second quarter of 2004);

 

    a 106-bed hospital located in La Place, Louisiana (sold in second quarter of 2004);

 

    a 160-bed pediatric and surgery hospital located in Rio Piedras, Puerto Rico (sold in third quarter of 2004), and;

 

    ownership interests in five outpatient surgery centers located in Ponca City, Oklahoma (sold in second quarter of 2004), New Albany, Indiana (sold in third quarter of 2004), Hammond, Louisiana (sold in third quarter of 2004), Littleton, Colorado (sold in the first quarter of 2004) and St. George, Utah (sold in the fourth quarter of 2004) and a radiation therapy center located in Madison, Indiana (sold in first quarter of 2004).

 

The operating results of all these facilities, as well as gains, net of losses, resulting from the divestitures are reflected as “Income/(loss) from discontinued operations, net of income tax” in the Consolidated Statement of Income for the year ended December 31, 2004. These transactions resulted in a combined pre-tax gain of approximately $5 million ($3 million after-tax) which is included in “Income/(loss) from discontinued operations, net of income tax” in the Consolidated Statement of Income for the year ended December 31, 2004.

 

During 2003, we spent $224 million to finance capital expenditures and an additional $281 million on the acquisition of newly acquired facilities, including the following:

 

    2003 Capital Expenditures

 

    Completion of the newly constructed Spring Valley Hospital;

 

    Construction costs related to the new Lakewood Ranch Hospital, a 120-bed acute care facility located in Manatee County, Florida.;

 

    Completion of a 90-bed addition to our Northwest Texas Hospital;

 

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

 

    2003 Acquisitions

 

    The North Star Hospital and related treatment centers;

 

    Three acute care facilities located in France;

 

    Three acute care facilities in California, Corona Regional Medical Center, French Medical Center and Arroyo Grande Community Hospital, all of which are ownership effective as of January 1, 2004;

 

    The acquisition of a 90% controlling ownership interest in Pendleton Methodist Hospital in Louisiana, which is ownership effective January 1, 2004, and;

 

    The acquisition of a behavioral health facility located in Alaska and an outpatient surgery center located in Oklahoma.

 

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During 2003, we received total cash proceeds of $25 million for the sale of five radiation therapy centers, two medical office buildings (which were sold to limited liability companies that are majority owned by Universal Health Realty Income Trust), an outpatient surgery center and the disposition of our investment in a healthcare related company. These transactions resulted in a combined pre-tax gain of $15 million ($9 million after minority interest expense and income taxes) which is included in “Income/(loss) from discontinued operations, net of income tax” in the Consolidated Statement of Income for the year ended December 31, 2003.

 

Net cash provided by/used in financing activities

 

During 2004, net cash used in financing activities amounted to $75 million as compared to $121 million of net cash provided by financing activities during 2003. The $75 million of net cash used in financing activities during 2004 consisted of the following: (i) $108 million of debt repayments, $100 million of which were used to repay borrowings under the terms of our commercial paper credit facility which expired on its scheduled maturity date in October of 2004; (ii) $72 million of additional borrowings, $58 million of which were borrowed under our revolving credit facility; (iii) $24 million spent during 2004 to repurchase 559,481 shares of our Class B Common Stock on the open market; (iv) $19 million spent during 2004 to pay cash dividends of $.08 per share ($.32 for the year), and; (v) $4 million of other net cash provided by financing activities.

 

The $121 million of net cash provided by financing activities during 2003 consisted of the following: (i) $175 million of additional borrowings, borrowed primarily under our revolving credit facility, to finance the acquisitions mentioned above; (ii) $54 million spent during 2003 to repurchase 1.4 million shares of our Class B Common Stock on the open market; (iii) $5 million spent during the fourth quarter of 2003 to pay an $.08 per share quarterly cash dividend, and; (iv) $5 million of other net cash provided by financing activities.

 

Year ended December 31, 2003 as compared to December 31, 2002:

 

Net cash provided by operating activities

 

Net cash provided by operating activities was $377 million during 2003 as compared to $331 million during 2002. The 14% or $46 million increase was primarily attributable to:

 

    a favorable change of $34 million due to an increase in net income plus or minus the adjustments to reconcile net income to net cash provided by operating activities (depreciation and amortization, accretion of discount on convertible debentures, losses on foreign exchange and debt extinguishment, gains on sales of assets and businesses and recovery of provision for judgment);

 

    a favorable change of $28 million in accrued and deferred income taxes due primarily to the timing of income tax payments and the favorable effect of “bonus” depreciation and tax benefits on increased capital expenditures;

 

    a favorable change of $24 million in accounts receivable (partially due to the prior year containing unfavorable changes due to the timing of Medicare settlements and the increased patient volume and revenue at the George Washington University Hospital which opened during the third quarter of 2002);

 

    an unfavorable change of $44 million in other working capital accounts due primarily to timing of accrued compensation payments and accounts payable disbursements;

 

    $4 million of other net favorable changes in working capital.

 

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Net cash used in investing activities

 

Net cash used in investing activities increased to $480 million during 2003 as compared to $202 million during 2002. As mentioned above, during 2003, we spent $224 million to finance capital expenditures and an additional $281 million on the acquisition of newly acquired facilities. During 2002, we spent $3 million to acquire a majority interest in an outpatient surgery center located in Puerto Rico and $207 million to finance capital expenditures, including the following:

 

    Construction costs related to the completion of the new George Washington University Hospital located in Washington, D.C. which opened in August, 2002;

 

    Construction costs related to a 56-bed patient tower at Auburn Regional Medical Center located in Auburn, Washington which opened in January, 2003;

 

    Construction costs related to the first phase of the newly constructed Spring Valley Hospital located in Las Vegas, Nevada;

 

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

 

During 2002, we received total cash proceeds of $8 million resulting from the sale of real estate related to a women’s hospital and radiation oncology center both of which were closed in a prior year and written down to their estimated net realizable values. The sale of the real property of the women’s hospital resulted in a $2 million recovery of closure costs, which is included in “Income/(loss) from discontinued operations, net of income tax” in the Consolidated Statement of Income for the year ended December 31, 2002, as is the net gain on the sale of the assets of the radiation therapy center which did not have a material impact on the 2002 results of operations.

 

Net cash provided by/used in financing activities

 

During 2003, net cash provided by financing activities amounted to $121 million (as mentioned above) as compared to $135 million of net cash used in financing activities during 2002. The $135 million of net cash used in financing activities during 2002 consisted of the following: (i) $67 million of net repayments of debt ($106 million of repayments, the majority of which reduced outstanding borrowings under our Revolver, less $39 million of additional borrowings consisting primarily of new borrowings pursuant to the terms of our France subsidiary’s debt facility); (ii) $77 million spent during 2002 to repurchase 1.7 million shares of our Class B Common Stock, and; (iii) partially offset by $9 million of other net cash provided by financing activities.

 

Capital Resources

 

Credit Facilities and Outstanding Debt Securities

 

During 2004 the Company was a party to a $400 million unsecured non-amortizing revolving credit agreement with a scheduled maturity date of December 13, 2006. The agreement included a $50 million sub-limit for letters of credit of which $2 million was available at December 31, 2004. The interest rate on borrowings was determined at our option at the prime rate, certificate of deposit rate plus.925% to 1.275%, Euro-dollar plus .80% to 1.150% or a money market rate. A facility fee ranging from .20% to .35% is required on the total commitment. The applicable margins over the certificate of deposit, the Euro-dollar rates and the facility fee are based upon the leverage ratio. At December 31, 2004, the applicable margins over the certificate of deposit and the Euro-dollar rate were 1.125% and 1.00%

 

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respectively, and the commitment fee was .25%. There are no compensating balance requirements. At December 31, 2004, we had $91 million of unused borrowing capacity available under this Credit Agreement.

 

Subsequent to year-end, on March 4, 2005, we terminated the $400 million revolving credit agreement described above and replaced it with a $500 million unsecured non-amortizing revolving credit agreement, which expires on March 4, 2010. The agreement includes a $75 million sub-limit for letters of credit. The interest rate on borrowings is determined at our option at the prime rate, LIBOR plus a spread of .32% to .80% or a money market rate. A facility fee ranging from .08% to .20% is required on the total commitment. The applicable margins over LIBOR and the facility fee are based upon our debt ratings by Standard & Poor’s Ratings Group and Moody’s Investor Services Inc. At December 31, 2004, the applicable margins over the LIBOR rate would have been .50% and the commitment fee would have been .125%. There are no compensating balance requirements.

 

During 2003, our majority-owned subsidiary in France entered into a senior credit agreement denominated in Euros, which provides for a total commitment of 90 million Euros. The loan, which is non-recourse to us, matures on December 4, 2009. The committed amount available under this credit agreement amortizes to zero over the life of the agreement and decreased by 5 million Euros to 85 million Euros on December 31, 2004. Interest on the loan is determined at our option and can be based on the one, two, three and six month EURIBOR plus a spread of 2.00% to 2.50%. The spread in effect at December 31, 2004 was 2.25%. As of December 31, 2004, the interest rate was 4.48% (including the spread of 2.25%) and the effective interest rate including the effects of the designated interest rate swaps and the spread of 2.25% was 4.42%. As of December 31, 2004, there were 55.6 million Euros ($75.2 million) of debt outstanding, and 29.4 million Euros ($39.8 million) of unused borrowing capacity, pursuant to the terms of this agreement.

 

During 2004, the $100 million commercial paper credit facility, which was fully collateralized by a portion of our acute care patient accounts receivable, expired on its scheduled maturity date of October 20, 2004 and we elected not to renew the program.

 

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

 

We issued discounted Convertible Debentures in 2000, which are due in 2020 (“Debentures”). The aggregate issue price of the Debentures was $250 million or $587 million aggregate principal amount at maturity. The Debentures were issued at a price of $425.90 per $1,000 principal amount of Debenture. The Debentures’ yield to maturity is 5% per annum, .426% of which is cash interest. The interest on the bonds is paid semiannually in arrears on June 23 and December 23 of each year. The Debentures are convertible at the option of the holders into 11.2048 shares of the our common stock per $1,000 of Debentures, however, we have the right to redeem the Debenture any time on or after June 23, 2006 at a price equal to the issue price of the Debentures plus accrued original issue discount and accrued cash interest to the date of redemption.

 

Our total debt as a percentage of total capitalization was 42% at December 31, 2004 and 45% at December 31, 2003. Covenants relating to long-term debt require maintenance of a minimum net worth, specified debt to total capital and fixed charge coverage ratios. We are in compliance with all required covenants as of December 31, 2004.

 

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The average amounts outstanding during 2004, 2003 and 2002 under the revolving credit and demand notes and commercial paper program were $272.1 million, $116.5 million and $140.3 million respectively, with corresponding effective interest rates of 2.6%, 3.3% and 5.1% including commitment and facility fees. The maximum amounts outstanding at any month-end were $370 million in 2004, $304.8 million in 2003 and $170 million in 2002.

 

The effective interest rate on our revolving credit, demand notes and commercial paper program, including the respective interest expense and income incurred on designated interest rate swaps which are now expired, was 4.1%, 6.6% and 6.3% during 2004, 2003 and 2002, respectively. Additional interest expense recorded as a result of our U.S. dollar denominated hedging activity was $4.1million in 2004, $4.6 million in 2003 and $4.2 million in 2002. There are no longer any domestic interest rate swaps outstanding.

 

Covenants relating to long-term debt require specified leverage and fixed charge coverage ratios. We are in compliance with all required covenants as of December 31, 2004.

 

The fair value of our long-term debt at December 31, 2004 and 2003 was approximately $932 million and $1.00 billion, respectively.

 

We expect to finance all capital expenditures and acquisitions with internally generated funds and additional funds. Additional funds may be obtained either through (i) the issuance of equity; (ii) additional borrowings under our existing revolving credit facility or through refinancing the existing revolving credit agreement, and/or; (iii) the issuance of other long-term debt.

 

Contractual Obligations and Off-Balance Sheet Arrangements

 

As of December 31, 2004, we were party to certain off balance sheet arrangements consisting of operating leases and standby letters of credit and surety bonds. Our outstanding letters of credit and surety bonds, as of December 31, 2004, totaled $58 million consisting of: (i) $45 million related to our self-insurance programs, and; (ii) $7 million consisting primarily of collateral for outstanding bonds of an unaffiliated third party and public utility, and; (iii) $6 million of debt guarantees related to entities in which we own a minority interest.

 

Obligations under operating leases for real property, real property master leases and equipment amount to $96.5 million as of December 31, 2004, as disclosed in Note 7 to our consolidated financial statements. The real property master leases are leases for buildings on or near hospital property for which we guarantee a certain level of rental income. We sublease space in these buildings and any amounts received from these subleases are offset against the expense. In addition, we lease five hospital facilities from Universal Health Realty Income Trust with terms expiring in 2006 through 2009. These leases contain up to five 5-year renewal options.

 

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The following represents the scheduled maturities of our contractual obligations as of December 31, 2004:

 

Contractual Obligation


   Payments Due by Period (dollars in thousands)

 
   Total

   Less than
1 year


  

2-3

years


  

4-5

years


  

After

5 years


 

Long-term debt—fixed (a)

   $ 597,660    $ 16,718    $ 46,952    $ 27,390    $  506,600 (b)

Long-term debt—variable

     271,535      250      261,085      —        10,200  

Accrued interest

     2,645      2,645      —        —        —    

Construction commitments(c)

     40,000      —        40,000      —        —    

Purchase obligation (d)

     155,891      19,463      40,519      40,543      55,366  

Operating leases

     96,452      38,003      40,270      9,844      8,335  
    

  

  

  

  


Total contractual cash obligations

   $ 1,164,183    $ 77,079    $ 428,826    $ 77,777    $ 580,501  
    

  

  

  

  



(a) Includes capital lease obligations
(b) Amount is presented net of discount on Convertible Debentures of $287,031
(c) Estimated cost of completion on the construction of a new 100-bed acute care facility in Eagle Pass, Texas.
(d) Consists of $135.8 million minimum obligation pursuant to a contract that expires in 2012, that provides for certain data processing services at our acute care and behavioral health facilities, and a $20.0 million commitment payable over a five-year period for a clinical application license fee.

 

ITEM 7A. Quantitative and Qualitative Disclosures about Market Risk

 

Our interest expense is sensitive to changes in the general level of interest rates. To mitigate the impact of fluctuations in domestic interest rates, a portion of our debt is fixed rate accomplished by either borrowing on a long-term basis at fixed rates or by entering into interest rate swap transactions. Our interest rate swap agreements are contracts that require us to pay fixed and receive floating interest rates or to pay floating and receive fixed interest rates over the life of the agreements. The floating-rates are based on LIBOR and the fixed-rate is determined at the time the swap agreement is consummated.

 

As of December 31, 2004 we had no U.S. dollar denominated interest rate swaps. During the fourth quarter of 2004, we terminated three interest rate swaps. We terminated one fixed rate swap with a notional principal amount of $125 million, which was scheduled to expire in August 2005. Under the terms of the swap, we paid a fixed rate of 6.76% and received a floating rate equal to three month LIBOR. We also terminated two floating rate interest rate swaps having a notional principal amount of $60 million in which we received a fixed rate of 6.75% and paid a floating rate equal to 6 month LIBOR plus a spread. The initial term of these swaps was ten years and they were both scheduled to expire on November 15, 2011. For the years ended December 31, 2004, 2003 and 2002, we received weighted average rates of 3.2%, 3.1% and 3.5%, respectively, and paid a weighted average rate on its domestic interest rate swap agreements of 5.5% in 2004, 5.5% in 2003 and 5.7% in 2002.

 

As of December 31, 2004, a majority-owned subsidiary of ours had two interest rate swaps and two interest rate caps denominated in Euros. The total notional amount of the two interest rate swaps is 27.5 million Euros ($37.2 million based on the end of period currency exchange rate) and will mature on June 30, 2005. Our subsidiary pays an average fixed rate of 4.35% and receives six month EURIBOR. The effective floating rate for these swaps as of December 31, 2004 was 1.45%. The notional amount of the interest rate cap currently outstanding is 17.5 million Euros ($23.7 million), the strike price is 3.5% and the cap matures on June 30, 2005. The other interest rate cap is a forward starting cap that takes effect on June 30, 2005 upon the expiration of the currently outstanding interest rate swaps and caps. The notional amount of the cap begins at 45.0 million Euros ($60.9 million) and reduces to 38.0 million Euros ($51.4 million) on December 30, 2005. The strike price is 3.3625% and the cap matures on December 29, 2006.

 

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The interest rate swap and cap agreements do not constitute positions independent of the underlying exposures. We do not hold or issue derivative instruments for trading purposes and are not a party to any instruments with leverage features. In the event of nonperformance by the counter-parties to these financial instruments, we are exposed to credit losses. The counter-parties are creditworthy financial institutions, rated A or better by Moody’s Investor Services and we anticipate that the counter-parties will be able to fully satisfy their obligations under the contracts.

 

The table below presents information about our derivative financial instruments and other financial instruments that are sensitive to changes in interest rates, including long-term debt and interest rate swaps as of December 31, 2004. For debt obligations, the table presents principal cash flows and related weighted-average interest rates by contractual maturity dates. For interest rate swap agreements, the table presents notional amounts by maturity date and weighted average interest rates based on rates in effect at December 31, 2004. The fair values of long-term debt and interest rate swaps were determined based on market prices quoted at December 31, 2004, for the same or similar debt issues.

 

Maturity Date, Fiscal Year Ending December 31

(Dollars in thousands)

 

     2005

    2006

    2007

    2008

    2009

    Thereafter

    Total

 

Long-term debt:

                                                        

Fixed rate—Fair value

   $ 16,718     $ 25,065     $ 21,887     $ 20,889     $ 6,501     $ 568,979 (a)   $ 660,039  

Fixed rate—Carrying value

   $ 16,718     $ 25,065     $ 21,887     $ 20,889     $ 6,501     $ 506,600     $ 597,660  

Average interest rates

     5.4 %     5.6 %     4.5 %     4.5 %     4.5 %     5.7 %     5.6 %

Variable rate long-term debt

   $ 250     $ 261,085     $ 0     $ 0     $ 0     $ 10,200     $ 271,535  

Interest rate swaps:

                                                        

Euro denominated Swaps and Cap:

                                                        

Pay fixed/receive variable notional amount

   $ 37,200                                             $ 37,200  

Fair value

   $ (397 )                                                

Average pay rate

     4.35 %                                                

Average receive rate

    
 
6 Month
EURIBOR
 
 
                                               

Interest rate caps

   $ 23,700                                             $ 23,700  

Forward starting interest rate cap

                   $ 51,437                             $ 51,437  

Average strike price

     3.5 %     3.36 %                                        

Fair Value

   $ 1     $ (524 )                                        

(a) The fair value of our 5% Convertible Debentures (“Debentures”) at December 31, 2004 is $343.5 million, however, we have the right to redeem the Debentures any time on or after June 23, 2006 at a price equal to the issue price of the Debentures plus accrued original issue discount and accrued cash interest to the date of redemption. On June 23, 2006 the amount necessary to redeem all Debentures would be $319 million. If the Debentures could be redeemed at the same basis at December 31, 2004 the redemption amount would be $300 million. The holders of the Debentures may convert the Debentures to our Class B stock at any time. If all Debentures were converted, the result would be the issuance of 6.6 million shares of our Class B Common Stock.

 

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ITEM 8. Financial Statements and Supplementary Data

 

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

 

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

 

None

 

ITEM 9A. Controls and Procedures.

 

As of December 31, 2004, under the supervision and with the participation of our management, including our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), an evaluation of the effectiveness of our disclosure controls and procedures was performed. Based on this evaluation, the CEO and CFO have concluded that our disclosure controls and procedures are effective to ensure that material information is recorded, processed, summarized and reported by management on a timely basis in order to comply with our disclosure obligations under the Securities and Exchange Act of 1934 and the SEC rules thereunder. There have been no significant changes in our internal controls or in other factors during the fourth quarter of 2004 that have materially affected, or are reasonably likely to materially affect, our internal controls.

 

Management’s Report on Internal Control over Financial Reporting

 

Management is responsible for establishing and maintaining an adequate system of internal control over financial reporting for the Company. In order to evaluate the effectiveness of internal control over financial reporting, as required by Section 404 of the Sarbanes-Oxley Act, management has conducted an assessment, including testing, using the criteria in Internal Control – Integrated Framework, issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s system of internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation and fair presentation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness of internal control over financial reporting to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

Based on its assessment, management has concluded that the Company maintained effective internal control over financial reporting as of December 31, 2004, based on criteria in Internal Control – Integrated Framework, issued by the COSO. Facilities acquired during 2004, as identified in Note 2 to the consolidated financial statements, have been excluded from management’s assessment. Management’s assessment of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2004, has been audited by KPMG LLP, an independent registered public accounting firm, as stated in their report which is included herein.

 

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Report of Independent Registered Public Accounting Firm

 

The Board of Directors and Stockholders

Universal Health Services Inc.:

 

We have audited management’s assessment, included in the accompanying Management’s Report on Internal Control over Financial Reporting, that Universal Health Services Inc. maintained effective internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Universal Health Service Inc.’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit.

 

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

 

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

In our opinion, management’s assessment that Universal Health Services Inc. maintained effective internal control over financial reporting as of December 31, 2004, is fairly stated, in all material respects, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Also, in our opinion, Universal Health Services Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).

 

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Facilities acquired during 2004, as identified in Note 2 to the accompanying consolidated financial statements, have been excluded from management’s assessment. Our audit of internal control over financial reporting of Universal Health Services Inc. also excluded an evaluation of the internal control over financial reporting of those facilities acquired during 2004.

 

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Universal Health Services Inc. and subsidiaries as of December 31, 2004 and 2003, and the related consolidated statements of income, common stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2004, and our report dated March 14, 2005, expressed an unqualified opinion on those consolidated financial statements.

 

/s/ KPMG LLP

 

Philadelphia, Pennsylvania

March 14, 2005

 

PART III

 

ITEM 10. Directors and Executive Officers of the Registrant

 

There is hereby incorporated by reference the information to appear under the caption “Election of Directors” in our Proxy Statement, to be filed with the Securities and Exchange Commission within 120 days after December 31, 2004. See also “Executive Officers of the Registrant” appearing in Part I hereof.

 

ITEM 11. Executive Compensation

 

There is hereby incorporated by reference the information to appear under the caption “Executive Compensation” in our Proxy Statement to be filed with the Securities and Exchange Commission within 120 days after December 31, 2004.

 

ITEM 12. Security Ownership of Certain Beneficial Owners and Management

 

There is hereby incorporated by reference the information to appear under the caption “Security Ownership of Certain Beneficial Owners and Management” in our Proxy Statement, to be filed with the Securities and Exchange Commission within 120 days after December 31, 2004.

 

ITEM 13. Certain Relationships and Related Transactions

 

There is hereby incorporated by reference the information to appear under the caption “Certain Relationships and Related Transactions” in our Proxy Statement, to be filed with the Securities and Exchange Commission within 120 days after December 31, 2004.

 

ITEM 14. Principal Accounting Fees and Financial Services.

 

There is hereby incorporated by reference the information to appear under the caption “Relationship with Independent Auditor” in our Proxy Statement, to be filed with the Securities and Exchange Commission within 120 days after December 31, 2004.

 

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PART IV

 

ITEM 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K

 

(a) 1. and 2. Financial Statements and Financial Statement Schedule.

 

See Index to Financial Statements and Financial Statement Schedule.

 

(b) Reports on Form 8-K

 

  1) Report on Form 8-K dated October 22, 2004, furnished under Item 2.02, Results of Operations and Financial Condition, reporting that we issued a press release announcing our financial results for the quarter ended September 30, 2004.

 

  2) Report on Form 8-K dated November 29, 2004, filed under Item 1.02, Termination of a Material Agreement, announcing that we had terminated an interest rate swap agreement with JPMorgan Chase Bank, N.A. and Bank of America, N.A.

 

  3) Report on Form 8-K dated December 22, 2004, filed under Item 1.01, Entry into a Material Definitive Agreement and Item 1.02, Termination of a Material Definitive Agreement, announcing that our board of directors voted to freeze our Deferred Compensation Plan for UHS Board of Directors and to terminate our 1996 Employee Stock Purchase Plan

 

  4) Report on Form 8-K dated December 28, 2004, filed under Item 8.01, Other Events, announcing an expected earnings shortfall for the quarter ended December 31, 2004.

 

(c) Exhibits

 

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

 

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

 

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

 

4.1 Indenture dated as of June 23, 2000 between Universal Health Services, Inc. and Bank One Trust Company, N.A., previously filed as Exhibit 10.1 to Registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2000, is incorporated herein by reference.

 

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

 

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

 

10.1 Amended and Restated Employment Agreement, dated as of November 14, 2001, by and between Universal Health Services, Inc. and Alan B. Miller, previously filed as Exhibit 10.1 to Registrant’s Annual Report on Form 10-K for the year ended December 31, 2002, is incorporated herein by reference.

 

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

 

10.3 Agreement, effective January 1, 2005, to renew Advisory Agreement, dated as of December 24, 1986, between Universal Health Realty Income Trust and UHS of Delaware, Inc.

 

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

 

10.5 Share Option Agreement, dated as of December 24, 1986, between Universal Health Realty Income Trust and Registrant, previously filed as Exhibit 10.4 to Registrant’s Current Report on Form 8-K dated December 24, 1986, is incorporated herein by reference.

 

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

 

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

 

10.8 Sale and Servicing Agreement dated as of November 16, 1993 between Certain Hospitals and UHS Receivables Corp., previously filed as Exhibit 10.16 to Registrant’s Annual Report on Form 10-K for the year ended December 31, 1993, is incorporated herein by reference.

 

10.9 Amendment No. 2 dated as of August 31, 1998, to Sale and Servicing Agreements dated as of various dates between each hospital company and UHS Receivables Corp., previously filed as Exhibit 10.1 to Registrant’s Quarterly Report on Form 10-Q for the quarter ended September 30, 1998, is incorporated herein by reference.

 

10.10 Servicing Agreement dated as of November 16, 1993, among UHS Receivables Corp., UHS of Delaware, Inc. and Continental Bank, National Association, previously filed as Exhibit 10.17 to Registrant’s Annual Report on Form 10-K for the year ended December 31, 1993, is incorporated herein by reference.

 

10.11 Pooling Agreement dated as of November 16, 1993, among UHS Receivables Corp., Sheffield Receivables Corporation and Continental Bank, National Association, previously filed as Exhibit 10.18 to Registrant’s Annual Report on Form 10-K for the year ended December 31, 1993, is incorporated herein by reference.

 

10.12 Amendment No. 1 to the Pooling Agreement dated as of September 30, 1994, among UHS Receivables Corp., Sheffield Receivables Corporation and Bank of America Illinois (as successor to Continental Bank N.A.) as Trustee, previously filed as Exhibit 10.1 to Registrant’s Quarterly Report on Form 10-Q for the quarter ended September 30, 1994, is incorporated herein by reference.

 

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10.13 Amendment No. 2, dated as of April 17, 1997 to Pooling Agreement dated as of November 16, 1993, among UHS Receivables Corp., a Delaware corporation, Sheffield Receivables Corporation, a Delaware corporation, and First Bank National Association, a national banking association, as trustee, previously filed as Exhibit 10.2 to Registrant’s Quarterly Report on Form 10-Q for the quarter ended March 30, 1997, is incorporated herein by reference.

 

10.14 Form of Amendment No. 3, dated as of August 31, 1998, to Pooling Agreement dated as of November 16, 1993, among UHS Receivables Corp., Sheffield Receivables Corporation and U.S. Bank National Association (successor to First Bank National Association and Continental Bank, National Association) previously filed as Exhibit 10.17 to Registrant’s Annual Report on Form 10-K for the year ended December 31, 1998 is incorporated herein by reference.

 

10.15 Agreement, dated as of August 31, 1998, by and among each hospital company signatory hereto, UHS Receivables Corp., a Delaware Corporation, Sheffield Receivables Corporation and U.S. Bank National Association, as Trustee, previously filed as Exhibit 10.2 to Registrant’s Quarterly Report on Form 10-Q for the quarter ended September 30, 1998, is incorporated herein by reference.

 

10.16 Guarantee dated as of November 16, 1993, by Universal Health Services, Inc. in favor of UHS Receivables Corp., previously filed as Exhibit 10.19 to Registrant’s Annual Report on Form 10-K for the year ended December 31, 1993, is incorporated herein by reference.

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

10.26 Employee’s Restricted Stock Purchase Plan, previously filed as Exhibit 10.1 on Registrant’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2001, is incorporated herein by reference.

 

10.27 Amendment No. 1 to the Universal Health Services, Inc. 2001 Employees’ Restricted Stock Purchase Plan, previously filed as Exhibit 10.1 on Registrant’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2002, is incorporated herein by reference.

 

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

 

10.29 Amended and Restated 2001 Employees’ Restricted Stock Purchase Plan, previously filed as Exhibit 4.1 to Registrant’s Registration Statement on Form S-8 (File No. 333-119143), dated September 21, 2004.

 

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

 

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

 

22 Subsidiaries of Registrant.

 

23.1 Consent of Independent Registered Public Accounting Firm.

 

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

 

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

 

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

 

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

 

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

 

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SIGNATURES

 

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

 

UNIVERSAL HEALTH SERVICES, INC.
By:  

/s/    ALAN B. MILLER


   

Alan B. Miller

President

 

March 14, 2005

 

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

 

Signatures


  

Title


 

Date


/s/ ALAN B. MILLER


   Chairman of the Board, President
    and Director (Principal Executive Officer)
  March 14, 2005
Alan B. Miller         

/s/ ANTHONY PANTALEONI


   Director   March 14, 2005
Anthony Pantaleoni         

/s/ ROBERT H. HOTZ


   Director   March 14, 2005
Robert H. Hotz         

/s/ JOHN H. HERRELL


   Director   March 14, 2005
John H. Herrell         

/s/ JOHN F. WILLIAMS, JR., M.D.


   Director   March 14, 2005
John F. Williams, Jr., M.D.         

/s/ LEATRICE DUCAT


   Director   March 14, 2005
Leatrice Ducat         

/s/ ROBERT A. MEISTER


   Director   March 14, 2005
Robert A. Meister         

/s/ STEVE FILTON


   Senior Vice President, Chief
    Financial Officer and Secretary
  March 14, 2005
Steve Filton         

 

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UNIVERSAL HEALTH SERVICES, INC.

 

INDEX TO FINANCIAL STATEMENTS

AND FINANCIAL STATEMENT SCHEDULE

 

Consolidated Financial Statements:     

Report of Independent Registered Public Accounting Firm on Consolidated Financial Statements and Schedule

   67

Consolidated Statements of Income for the three years ended December 31, 2004

   68

Consolidated Balance Sheets as of December 31, 2004 and 2003

   69

Consolidated Statements of Common Stockholders’ Equity for the three years ended December 31, 2004

   70

Consolidated Statements of Cash Flows for the three years ended December 31, 2004

   71

Notes to Consolidated Financial Statements

   72

Supplemental Financial Statement Schedule II: Valuation and Qualifying Accounts

   103

 

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Report of Independent Registered Public Accounting Firm

 

The Board of Directors and Stockholders

Universal Health Services Inc.:

 

We have audited the consolidated financial statements of Universal Health Services Inc. and subsidiaries (the Company) as listed in the accompanying index. In connection with our audits of the consolidated financial statements, we also have audited the financial statement schedule listed in the accompanying index. These consolidated financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule based on our audits.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Universal Health Services Inc. and subsidiaries as of December 31, 2004 and 2003, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2004, in conformity with U.S. generally accepted accounting principles. Also in our opinion, the related financial statement schedule referred to above, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.

 

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Universal Health Services Inc.’s internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated March 14, 2005, expressed an unqualified opinion on management’s assessment of, and the effective operation of, internal control over financial reporting.

 

/s/ KPMG LLP

 

Philadelphia, Pennsylvania

March 14, 2005

 

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UNIVERSAL HEALTH SERVICES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

 

     Year Ended December 31,

     2004

    2003

   2002

     (in thousands, except per share data)

Net revenues

   $ 3,938,320     $ 3,391,506    $ 2,991,919

Operating charges:

                     

Salaries, wages and benefits

     1,607,103       1,355,047      1,193,258

Other operating expenses

     916,542       778,656      717,805

Supplies expense

     546,801       449,225      376,755

Provision for doubtful accounts

     307,163       252,644      218,947

Depreciation and amortization

     155,514       130,039      109,246

Lease and rental expense

     70,433       59,479      56,943
    


 

  

       3,603,556       3,025,090      2,672,954
    


 

  

Income before interest expense, minority interests and income taxes

     334,764       366,416      318,965

Interest expense, net

     43,405       37,855      34,096

Minority interests in earnings of consolidated entities

     20,216       22,265      19,716
    


 

  

Income before income taxes

     271,143       306,296      265,153

Provision for income taxes

     101,137       114,217      97,306
    


 

  

Income from continuing operations

     170,006       192,079      167,847

(Loss) income from discontinued operations, net of income tax (benefit) expense of ($295) during 2004, $4.2 million during 2003 and $4.4 million during 2002

     (514 )     7,190      7,514
    


 

  

Net income

   $ 169,492     $ 199,269    $ 175,361
    


 

  

Basic earnings (loss) per share:

                     

From continuing operations

   $ 2.95     $ 3.33    $ 2.81

From discontinued operations

     (0.01 )     0.12      0.13
    


 

  

Total basic earnings per share

   $ 2.94     $ 3.45    $ 2.94
    


 

  

Diluted earnings (loss) per share:

                     

From continuing operations

   $ 2.76     $ 3.09    $ 2.63

From discontinued operations

     (0.01 )     0.11      0.11
    


 

  

Total diluted earnings per share

   $ 2.75     $ 3.20    $ 2.74
    


 

  

Weighted average number of common shares - basic

     57,653       57,688      59,730

Add: Shares for conversion of convertible debentures

     6,577       6,577      6,577

Weighted average number of common share equivalents

     635       824      768
    


 

  

Weighted average number of common shares and equivalents - diluted

     64,865       65,089      67,075
    


 

  

 

The accompanying notes are an integral part of these consolidated financial statements.

 

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UNIVERSAL HEALTH SERVICES, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

 

     December 31,

 
     2004

    2003

 
     (dollar amounts in thousands)  
Assets                 

Current assets:

                

Cash and cash equivalents

   $ 33,125     $ 34,863  

Accounts receivable, net

     552,538       503,929  

Supplies

     60,729       61,736  

Deferred income taxes

     —         25,271  

Other current assets

     29,663       19,992  

Assets of facilities held for sale

     132,870       —    
    


 


Total current assets

     808,925       645,791  
    


 


Property and Equipment

                

Land

     204,733       169,285  

Buildings and improvements

     1,236,081       1,120,313  

Equipment

     706,111       658,932  

Property under capital lease

     51,075       44,540  
    


 


       2,198,000       1,993,070  

Accumulated depreciation

     (819,218 )     (774,938 )
    


 


       1,378,782       1,218,132  

Construction-in-progress

     69,284       86,209  
    


 


       1,448,066       1,304,341  

Other assets:

                

Goodwill

     619,064       442,504  

Deferred charges

     14,416       15,832  

Other, including deposits on acquisitions of $230 million in 2003

     132,372       364,262  
    


 


       765,852       822,598  
    


 


     $ 3,022,843     $ 2,772,730  
    


 


Liabilities and Stockholders’ Equity                 

Current liabilities:

                

Current maturities of long-term debt

   $ 16,968     $ 10,871  

Accounts payable

     190,181       178,824  

Accrued liabilities

                

Compensation and related benefits

     93,524       78,060  

Interest

     2,645       2,508  

Taxes other than income

     19,202       25,268  

Other

     113,564       85,599  

Current federal and state income taxes

     12,455       14,623  

Deferred income taxes

     10,001       —    

Liabilities of facilities held for sale

     11,116       —    
    


 


Total current liabilities

     469,656       395,753  
    


 


Other noncurrent liabilities

     243,617       216,094  

Minority interests

     186,543       159,554  

Long-term debt

     852,229       868,566  

Deferred income taxes

     50,212       41,841  

Commitments and contingencies

                

Common stockholders’ equity:

                

Class A Common Stock, voting, $.01 par value; authorized 12,000,000 shares: issued and outstanding 3,328,404 shares in 2004 and 3,328,404 shares in 2003

     33       33  

Class B Common Stock, limited voting, $.01 par value; authorized 150,000,000 shares: issued and outstanding 54,058,695 shares in 2004 and 54,376,706 shares in 2003

     541       544  

Class C Common Stock, voting, $.01 par value; authorized 1,200,000 shares: issued and outstanding 335,800 shares in 2004 and 335,800 shares in 2003

     3       3  

Class D Common Stock, limited voting, $.01 par value; authorized 5,000,000 shares: issued and outstanding 27,401 shares in 2004 and 31,259 shares in 2003

     —         —    

Capital in excess of par, net of deferred compensation of $1,659 in 2004 and $9,456 in 2003

     21,231       42,480  

Cumulative dividends

     (23,272 )     (4,644 )

Retained earnings

     1,220,186       1,050,694  

Accumulated other comprehensive income

     1,864       1,812  
    


 


       1,220,586       1,090,922  
    


 


     $ 3,022,843     $ 2,772,730  
    


 


 

The accompanying notes are an integral part of these consolidated financial statements.

 

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UNIVERSAL HEALTH SERVICES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMMON STOCKHOLDERS’ EQUITY

For the Years Ended December 31, 2004, 2003, and 2002

(in thousands)

 

     Class A
Common


    Class B
Common


    Class C
Common


    Class D
Common


   Capital in
Excess of
Par Value


    Cumulative
Dividends


    Retained
Earnings


   Accumulated
Other
Comprehensive
Income (Loss)


    Total

 

Balance, January 1, 2002

   $ 38     $ 556     $ 4     —      $ 137,400       —       $ 676,064    $ (6,162 )   $ 807,900  

Common Stock

                                                                    

Issued/(converted) including tax benefits from exercise of stock options

     (5 )     14       (1 )   —        6,558       —         —        —         6,566  

Repurchased

     —         (17 )     —       —        (76,598 )     —         —        —         (76,615 )

Amortization of deferred compensation

     —         —         —       —        15,396       —         —        —         15,396  

Stock option expense

     —         —         —       —        1,379       —         —        —         1,379  

Comprehensive income:

                                                                    

Net income

     —         —         —       —        —         —         175,361      —         175,361  

Foreign currency translation adjustments

     —         —         —       —        —         —         —        (719 )     (719 )

Adjustment for settlement amounts reclassified into income (net of income tax effect of $2,387)

     —         —         —       —        —         —         —        4,073       4,073  

Unrealized derivative losses on cash flow hedges (net of income tax effect of $4,783)

     —         —         —       —        —         —         —        (8,161 )     (8,161 )

Minimum pension liability (net of income tax effect of $4,525)

     —         —         —       —        —         —         —        (7,721 )     (7,721 )
    


 


 


 
  


 


 

  


 


Subtotal - comprehensive income

     —         —         —       —        —         —         175,361      (12,528 )     162,833  
    


 


 


 
  


 


 

  


 


Balance, January 1, 2003

     33       553       3     —        84,135       —         851,425      (18,690 )     917,459  

Common Stock

                                                                    

Issued/(converted) including tax benefits from exercise of stock options

     —         5       —       —        8,998       —         —        —         9,003  

Repurchased

     —         (14 )     —       —        (54,304 )     —         —        —         (54,318 )

Amortization of deferred compensation

     —         —         —       —        3,651       —         —        —         3,651  

Dividends paid ($.08 per share)

     —         —         —       —        —         (4,644 )     —        —         (4,644 )

Comprehensive income:

                                                                    

Net income

     —         —         —       —        —         —         199,269      —         199,269  

Foreign currency translation adjustments

     —         —         —       —        —         —         —        15,660       15,660  

Adjustment for settlement amounts reclassified into income (net of income tax effect of $2,901)

     —         —         —       —        —         —         —        4,950       4,950  

Unrealized derivative losses on cash flow hedges (net of income tax effect of $935)

     —         —         —       —        —         —         —        (1,596 )     (1,596 )

Minimum pension liability (net of income tax effect of $873)

     —         —         —       —        —         —         —        1,488       1,488  
    


 


 


 
  


 


 

  


 


Subtotal - comprehensive income

     —         —         —       —        —         —         199,269      20,502       219,771  
    


 


 


 
  


 


 

  


 


Balance, January 1, 2004

     33       544       3     —        42,480       (4,644 )     1,050,694      1,812       1,090,922  

Common Stock

                                                                    

Issued/(converted) including tax benefits from exercise of stock options

     —         3       —       —        11,730       —         —        —         11,733  

Repurchased

     —         (6 )     —       —        (23,528 )     —         —        —         (23,534 )

Amortization of deferred compensation

     —         —         —       —        1,153       —         —        —         1,153  

Reversal of amortization of deferred compensation

                                  (10,604 )                            (10,604 )

Dividends paid ($.08 per share)

     —         —         —       —        —         (18,628 )     —        —         (18,628 )

Comprehensive income:

                                                                    

Net income

     —         —         —       —        —         —         169,492      —         169,492  

Foreign currency translation adjustments (net of tax effect of $7,761)

     —         —         —       —        —         —         —        (1,558 )     (1,558 )

Adjustment for settlement amounts reclassified into income (net of income tax effect of $3,168)

     —         —         —       —        —         —         —        5,529       5,529  

Unrealized derivative losses on cash flow hedges (net of income tax effect of $504)

     —         —         —       —        —         —         —        (879 )     (879 )

Minimum pension liability (net of income tax effect of $1,662)

     —         —         —       —        —         —         —        (3,040 )     (3,040 )
    


 


 


 
  


 


 

  


 


Subtotal - comprehensive income

     —         —         —       —        —         —         169,492      52       169,544  
    


 


 


 
  


 


 

  


 


Balance, December 31, 2004

   $ 33     $ 541     $ 3     —      $ 21,231     $ (23,272 )   $ 1,220,186    $ 1,864     $ 1,220,586  
    


 


 


 
  


 


 

  


 


 

The accompanying notes are an integral part of these consolidated financial statements.

 

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UNIVERSAL HEALTH SERVICES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

     Year Ended December 31,

 
     2004

    2003

    2002

 
     (in thousands)  

Cash Flows from Operating Activities:

                        

Net income

   $ 169,492     $ 199,269     $ 175,361  

Adjustments to reconcile net income to net cash provided by operating activities:

                        

Depreciation & amortization

     166,677       144,466       124,794  

Accretion of discount on convertible debentures

     12,088       11,408       10,903  

Gains on sales of assets and businesses, net of losses

     (5,382 )     (14,623 )     —    

Property write-down due to hurricane damage

     2,318       —         —    

Reversal of restricted stock grant amortization

     (10,604 )     —         —    

Provision for asset impairment

     —         13,742       —    

Recovery of provision for judgment

     —         (8,867 )     —    

Changes in assets & liabilities, net of effects from acquisitions and dispositions:

                        

Accounts receivable

     (29,552 )     (10,530 )     (34,987 )

Accrued interest

     (388 )     (1,182 )     640  

Accrued and deferred income taxes

     37,857       35,189       7,347  

Other working capital accounts

     16,452       (20,490 )     23,679  

Other assets and deferred charges

     6,576       11,517       (5,113 )

Other

     (15,853 )     (6,810 )     (5,972 )

Minority interest in earnings of consolidated entities, net of distributions

     11,796       344       7,425  

Accrued insurance expense, net of commercial premiums paid

     78,256       66,744       58,316  

Payments made in settlement of self-insurance claims

     (46,853 )     (43,402 )     (31,134 )
    


 


 


Net cash provided by operating activities

     392,880       376,775       331,259  
    


 


 


Cash Flows from Investing Activities:

                        

Property and equipment additions, net

     (230,760 )     (224,370 )     (206,838 )

Proceeds received from merger, sales or dispositions of assets and businesses

     81,291       25,376       8,369  

Acquisition of businesses and deposits on acquisitions

     (162,930 )     (281,268 )     (3,000 )

Purchase of assets previously leased

     (7,320 )     —         —    
    


 


 


Net cash used in investing activities

     (319,719 )     (480,262 )     (201,469 )
    


 


 


Cash Flows from Financing Activities:

                        

Additional borrowings

     72,629       175,033       39,311  

Reduction of long-term debt

     (108,860 )     (13,164 )     (106,439 )

Capital contributions from minority member

     —         14,541       5,908  

Issuance of common stock

     3,072       3,152       2,947  

Repurchase of common shares

     (23,534 )     (54,318 )     (76,615 )

Dividends paid

     (18,628 )     (4,644 )     —    

Net cash received for termination of interest rate swaps

     422       —         —    
    


 


 


Net cash (used in) provided by financing activities

     (74,899 )     120,600       (134,888 )
    


 


 


(Decrease) Increase in cash and cash equivalents

     (1,738 )     17,113       (5,098 )

Cash and cash equivalents, beginning of period

     34,863       17,750       22,848  
    


 


 


Cash and cash equivalents, end of period

   $ 33,125     $ 34,863     $ 17,750  
    


 


 


Supplemental Disclosures of Cash Flow Information:

                        

Interest paid

   $ 31,180     $ 27,576     $ 23,203  
    


 


 


Income taxes paid, net of refunds

   $ 63,542     $ 81,919     $ 94,412  
    


 


 


 

The accompanying notes are an integral part of these consolidated financial statements.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

1) BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Our principal business is owning and operating, through our subsidiaries acute care hospitals, behavioral health centers and ambulatory surgery and radiation oncology centers. As of March 1, 2005, we operated 44 acute care hospitals and 49 behavioral health centers located in 23 states, Washington, DC, Puerto Rico and France. As part of our ambulatory treatment centers division, we manage and own outright or in partnership with physicians, 12 surgery and radiation oncology centers located in 7 states and Puerto Rico. Subsequent to December 31, 2004, we executed a definitive agreement to sell two acute care hospitals located in Puerto Rico. The sales, which are subject to customary regulatory approvals, are expected to be completed by March 31, 2005.

 

Net revenues from our acute care hospitals (including the facilities located in France) and our ambulatory and radiation oncology centers accounted for 82%, 82% and 81% of consolidated net revenues in 2004, 2003 and 2002, respectively. Net revenues from our behavioral health care facilities accounted for 18%, 18% and 19%, of consolidated net revenues in 2004, 2003 and 2002, respectively.

 

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

 

The more significant accounting policies follow:

 

A) Principles of Consolidation: The consolidated financial statements include the accounts of our majority-owned subsidiaries and partnerships controlled by us or our subsidiaries as the managing general partner. All significant intercompany accounts and transactions have been eliminated.

 

B) Revenue Recognition: We record revenues and related receivables for health care services at the time the services are provided. We have agreements with third-party payors that provide for payments to us at amounts different from our established rates. Payment arrangements include prospectively determined rates per discharge, reimbursed costs, discounted charges and per diem payments. We report net patient service revenue at the estimated net realizable amounts from patients, third-party payors and others for services rendered. Medicare and Medicaid revenues represented 40%, 41% and 42% of our net patient revenues during 2004, 2003 and 2002, respectively. Revenues from managed care entities, including health maintenance organizations and managed Medicare and Medicaid programs, accounted for 40% of our net patient revenues during each of the years ended December 31, 2004, 2003 and 2002.

 

Laws and regulations governing the Medicare and Medicaid programs are extremely complex and subject to interpretation and as a result, there is at least a reasonable possibility that recorded estimates will change by material amounts in the near term. We estimated certain Medicare and Medicaid revenues using the latest available financial information, patient utilization data, government provided data and in accordance with applicable Medicare and Medicaid payment rules and regulations. Certain types of payments by the Medicare program and state Medicaid programs are subject to retroactive adjustment in future periods. We accrue for the estimated amount of these retroactive adjustments in the period when the services subject to retroactive settlement are recorded. Such amounts are included in accounts receivable, net, on our consolidated balance sheets. These revenues (e.g.; Medicare Disproportionate Share Hospital, Medicare Allowable Bad Debts and Inpatient Psychiatric Services) are subject to

 

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retrospective review and final settlement by the Medicare program. Adjustments related to the final settlement of these retrospectively determined amounts did not materially impact our operating results in 2004, 2003 and 2002. The large majority of the revenues generated by the acute care hospitals owned by our France subsidiary are paid by the government based on predetermined rates established in May of each year and consist of a per diem payment and per procedure rate plus reimbursement for certain supplies.

 

We provide care to patients who meet certain financial or economic criteria without charge or at amounts substantially less than our established rates. Because we do not pursue collection of amounts determined to qualify as charity care, they are not reported in net revenues or in accounts receivable, net. Our acute care hospitals located in the U.S. provided charity care, based on charges at established rates, amounting to $294.7 million, $241.2 million and $186.2 million during 2004, 2003 and 2002, respectively.

 

C) Provision for Doubtful Accounts: Collection of receivables from third-party payors and patients is our primary source of cash and is critical to our operating performance. Our primary collection risks relate to uninsured patients and the portion of the bill which is the patient’s responsibility, primarily co-payments and deductibles. We estimate our provisions for doubtful accounts based on general factors such as payor mix, the agings of the receivables and historical collection experience. We routinely review accounts receivable balances in conjunction with these factors and other economic conditions which might ultimately affect the collectibility of the patient accounts and make adjustments to our allowances as warranted. Patient accounts receivable are written-off when reasonable collection efforts have been exhausted and the account is deemed uncollectible, as defined by our policies and procedures. Significant changes in business office operations, payor mix, economic conditions or trends in federal and state governmental health coverage could affect our collection of accounts receivable, cash flow and results of operations. At December 31, 2004 and 2003, accounts receivable are recorded net of allowance for doubtful accounts of $71.4 million and $56.3 million, respectively.

 

D) Concentration of Revenues: Our four majority-owned facilities operating in the Las Vegas market contributed on a combined basis 17%, 16% and 17% of our consolidated net revenues during 2004, 2003 and 2002, respectively. Two facilities located in the McAllen/Edinburg, Texas market contributed, on a combined basis, 9%, 11% and 12% of our consolidated net revenues during 2004, 2003 and 2002, respectively.

 

E) Cash and Cash Equivalents: We consider all highly liquid investments purchased with maturities of three months or less to be cash equivalents.

 

F) Property and Equipment: Property and equipment are stated at cost. Expenditures for renewals and improvements are charged to the property accounts. Replacements, maintenance and repairs which do not improve or extend the life of the respective asset are expensed as incurred. We remove the cost and the related accumulated depreciation from the accounts for assets sold or retired and the resulting gains or losses are included in the results of operations.

 

We capitalize interest expense on major construction projects while in process. We capitalized $1.5 million, $3.6 million and $4.6 million of interest related to major construction in projects in 2004, 2003 and 2002, respectively.

 

Depreciation is provided on the straight-line method over the estimated useful lives of buildings and improvements (twenty to forty years) and equipment (three to fifteen years). Depreciation on capital leases is provided on a straight-line method over the shorter of the lease term or estimated useful life of the buildings and equipment. Depreciation expense was $143.1 million, $119.2 million and $99.4 million in 2004, 2003 and 2002, respectively.

 

G) Long-Lived Assets: In accordance with SFAS No.144, “Accounting for the Impairment or Disposal of Long-Lived Assets”, we review our long-lived assets, including amortizable intangible assets,

 

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for impairment whenever events or circumstances indicate that the carrying value of these assets may not be recoverable. The assessment of possible impairment is based on our ability to recover the carrying value of our assets based on our estimate of its undiscounted future cash flow. If our analysis indicates that the carrying value is not recoverable from future cash flows, we recognize an impairment loss and write the long-lived asset down to its estimated fair value. We determine the fair values based on estimated future cash flows using appropriate discount rates.

 

H) Goodwill: In accordance with SFAS No. 142, “Goodwill and Other Intangible Assets”, we ceased amortizing goodwill as of January 1, 2002. Goodwill is reviewed for impairment at the reporting unit level, as defined by SFAS No. 142, on an annual basis or sooner if the indicators of impairment arise. Our judgments regarding the existence of impairment indicators are based on market conditions and operational performance of each reporting unit. We have designated September 1st as our annual impairment assessment date and performed an impairment assessment as of September 1, 2004, which indicated no impairment of goodwill. Future changes in the estimates used to conduct the impairment review, including profitability and market value projections, could indicate impairment in future periods potentially resulting in a write-off of a portion or all of our goodwill.

 

Changes in the carrying amount of goodwill for the two years ended December 31, 2004 were as follows (in thousands):

 

     Acute Care
Hospital
Services


    Behavioral
Health
Services


   Other

    Total
Consolidated


 

Balance, January 1, 2003

   $ 307,938     $ 54,450    $ 47,932     $ 410,320  

Goodwill acquired during the period

     942       2,386      16,768       20,096  

Goodwill divested during the period

     —         —        (860 )     (860 )

Adjustments to goodwill (a)

     —         —        12,948       12,948  
    


 

  


 


Balance, January 1, 2004

     308,880       56,836      76,788       442,504  

Goodwill acquired during the period

     122,500       79,955      20,399       222,854  

Goodwill divested during the period

     (14,968 )     —        (1,286 )     (16,254 )

Goodwill of facilities held for sale

     (37,010 )     —        —         (37,010 )

Adjustments to goodwill (a)

     —         —        6,970       6,970  
    


 

  


 


Balance, December 31, 2004

   $ 379,402     $ 136,791    $ 102,871     $ 619,064  
    


 

  


 



(a) Consists of the foreign currency translation adjustment on goodwill recorded in connection with our 80% ownership interest in an operating company that owns acute care facilities in France.

 

I) Other Assets: Included in other assets are estimates of expected recoveries from various state guaranty funds, insurers and other sources in connection with PHICO related professional and general liability claims payments amounting to $31.5 million and $43.0 million at December 31, 2004 and 2003, respectively (see Note 8). Actual recoveries may vary from these estimates due to the inherent uncertainties involved in making such estimates. Other assets at December 31, 2003 also include $230 million of deposits on acquisitions, which were consummated on January 1, 2004.

 

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As of December 31, 2004 and 2003, other intangible assets, net of accumulated amortization, were not material.

 

J) Self-Insured Risks: We provide for self-insured risks, primarily general and professional liability claims and workers’ compensation claims, based on estimates of the ultimate costs for both reported claims and claims incurred but not reported. Estimated losses from asserted and incurred but not reported claims are accrued based on our estimates of the ultimate costs of the claims, which includes costs associated with litigating or settling claims, and the relationship of past reported incidents to eventual claims payments. All relevant information, including our own historical experience, the nature and extent of existing asserted claims and reported incidents, and independent actuarial analyses of this information, is used in estimating the ultimate cost to settle claims. We also consider amounts that may be recovered from excess insurance carriers, state guaranty funds and other sources in estimating our ultimate net liability for such risks.

 

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

 

Our estimated self-insured reserves are reviewed and changed, if necessary, at each reporting date. The amounts of the changes are recognized currently as additional expense or as a reduction of expense.

 

K) Income Taxes: Deferred tax assets and liabilities are recognized for the amount of taxes payable or deductible in future years as a result of differences between the tax bases of assets and liabilities and their reported amounts in the consolidated financial statements. We believe that future income will enable us to realize our deferred tax assets and therefore no valuation allowances have been recorded.

 

We operate in multiple jurisdictions with varying tax laws. We are subject to audits by any of these taxing authorities. Our tax returns have been examined by the Internal Revenue Service and various state authorities through the year ended December 31, 2002 with no material adjustments. We believe that adequate accruals have been provided for federal and state taxes.

 

L) Other Noncurrent Liabilities: Other noncurrent liabilities include the long-term portion of our professional and general liability, workers’ compensation reserves and pension liability.

 

M) Minority Interest: As of December 31, 2004 and 2003, the $186.5 million and $159.6 million, respectively, minority interest liability consists primarily of: (i) a 27.5% outside ownership interest in four acute care facilities located in Las Vegas, Nevada; (ii) a 20% outside ownership in an acute care facility located in Washington D.C.; (iii) a 20% outside ownership interest in an operating company that owns fourteen hospitals in France, and; (iv) a 10% outside ownership in two acute care facilities located in Louisiana.

 

In connection with the four acute care facilities located in Las Vegas, the outside owners have certain “put rights” that may require the respective limited liabilities companies (“LLCs”) to purchase the minority member’s interests upon the occurrence of: (i) certain specified financial conditions falling below established thresholds; (ii) breach of the management contract by the managing member (a subsidiary of ours), or; (iii) if the minority member’s ownership percentage is reduced to less than certain thresholds.

 

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In connection with the fourteen hospitals located in France, the minority owners have certain “put rights” that, if exercised, would require us to purchase up to 100% of the shares, through March 31, 2009, at a multiple of the subsidiary’s earnings before interest, taxes, depreciation and amortization, as defined. We also have certain “call rights” that would allow us to purchase all the minority owners’ shares pursuant to this formula at any time through December 31, 2009.

 

With respect to the first quarter of 2004 acquisitions of two acute care facilities located in Louisiana by a LLC, in which we own a 90% controlling interest, the minority member has certain “put rights” which can be exercised at any time within 180 days of the third, fifth, tenth or fifteenth anniversary of the closing dates, or at any time if certain determinations are made as specified in the agreement. These put rights, if exercised, would require the LLC to purchase the minority member’s interest at a price that is the greater of: (i) a fixed amount as stipulated in the agreement that approximates the minority member’s interest in each facility, or; (ii) the minority member’s interest multiplied by the annualized net revenue of each facility for the 12 month period ending on the date of exercise of the put right. We also have certain “call rights” that would allow the LLC to purchase the minority member’s shares which can be exercised at any time within 180 days of the third, fifth, tenth or fifteenth anniversary of the closing dates, or at any time if certain determinations are made as specified in the agreement. These call rights allow the LLC to purchase the minority member’s interest at a price that is the greater of: (i) a fixed amount as stipulated in the agreement that approximates the minority member’s interest in each facility, plus a premium, or; (ii) the minority member’s percentage interest multiplied by the annualized net revenue of each facility plus a premium for the 12 month period ending on the date of exercise of the call right.

 

N) Comprehensive Income: Comprehensive income or loss is recorded in accordance with the provisions of SFAS No.130, “Reporting Comprehensive Income”. SFAS No.130 establishes standards for reporting comprehensive income and its components in financial statements. Comprehensive income (loss), is comprised of net income, changes in unrealized gains or losses on derivative financial instruments, foreign currency translation adjustments and the minimum pension liability.

 

O) Accounting for Derivative Financial Investments and Hedging Activities: We manage our ratio of fixed to floating rate debt with the objective of achieving a mix that management believes is appropriate. To manage this risk in a cost-effective manner, we, from time to time, enters into interest rate swap agreements, in which we agree to exchange various combinations of fixed and/or variable interest rates based on agreed upon notional amounts.

 

We account for our derivative and hedging activities using SFAS 133, “Accounting for Derivative Instruments and Hedging Activities,” as amended by SFAS No. 149, which requires all derivative instruments, including certain derivative instruments embedded in other contracts, to be carried at fair value on the balance sheet. For derivative transactions designated as hedges, we formally document all relationships between the hedging instrument and the related hedged item, as well as its risk-management objective and strategy for undertaking each hedge transaction.

 

Derivative instruments designated in a hedge relationship to mitigate exposure to variability in expected future cash flows, or other types of forecasted transactions, are considered cash flow hedges. Cash flow hedges are accounted for by recording the fair value of the derivative instrument on the balance sheet as either an asset or liability, with a corresponding amount recorded in accumulated other comprehensive income (“AOCI”) within shareholders’ equity. Amounts are reclassified from AOCI to the income statement in the period or periods the hedged transaction affects earnings.

 

We use interest rate swaps in our cash flow hedge transactions. The interest rate swaps are designed to be highly effective in offsetting changes in the cash flows related to the hedged liability. For derivative instruments designated as cash flow hedges, the ineffective portion of the change in expected cash flows of the hedged item are recognized currently in the income statement.

 

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Derivative instruments designated in a hedge relationship to mitigate exposure to changes in the fair value of an asset, liability, or firm commitment attributable to a particular risk, such as interest rate risk, are considered fair value hedges under SFAS 133. Fair value hedges are accounted for by recording the changes in the fair value of both the derivative instrument and the hedged item in the income statement.

 

For hedge transactions that do not qualify for the short-cut method, at the hedge’s inception and on a regular basis thereafter, a formal assessment is performed to determine whether changes in the fair values or cash flows of the derivative instruments have been highly effective in offsetting changes in cash flows of the hedged items and whether they are expected to be highly effective in the future.

 

P) Foreign Currency: One of our subsidiaries operates in France, whose currency is denominated in Euros. Our French subsidiary translates its assets and liabilities into U.S. dollars at the current exchange rates in effect at the end of the fiscal period. Any resulting gains or losses are recorded, net of the income tax effect, in accumulated other comprehensive income (loss) in the accompanying consolidated balance sheet.

 

The revenue and expense accounts of the France subsidiary are translated into U.S. dollars at the average exchange rate that prevailed during the period. Therefore, the U.S. dollar value of the French subsidiary’s operating results may fluctuate from period to period due to changes in exchange rates.

 

Q) Stock-Based Compensation: At December 31, 2004, we have a number of stock-based employee compensation plans, which are more fully described in Note 5. We account for these plans under the recognition and measurement principles of APB Opinion No.25, “Accounting for Stock Issued to Employees,” and related Interpretations. No compensation cost is reflected in net income for most stock option grants, as all options granted under the plan had an original exercise price equal to the market value of the underlying common shares on the date of grant. The following table illustrates the effect on net income and earnings per share if we had applied the fair value recognition provisions of FASB Statement No.123, “Accounting for Stock-Based Compensation”, to stock-based employee compensation. We recognize compensation cost related to restricted share awards over the respective vesting periods, using an accelerated method.

 

    

Twelve Months Ended

December 31,


 
     2004

    2003

    2002

 
     (in thousands, except per share data)  

Income from continuing operations

   $ 170,006     $ 192,079     $ 167,847  

Add/(deduct): total stock-based compensation expenses included in net income, net of tax (provision)/benefit of ($3.4) million, $1.4 million and $6.3 million in 2004, 2003 and 2002, respectively. (a)

     (5,779 )     2,412       10,691  

Deduct: total stock-based employee compensation expenses determined under fair value based methods for all awards, net of tax of $24,000, $5.2 million and $11.0 million in 2004, 2003 and 2002, respectively. (a)

     (41 )     (8,916 )     (18,894 )
    


 


 


 

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Twelve Months Ended

December 31,


     2004

    2003

   2002

     (in thousands, except per share data)

Pro forma net income from continuing operations

     164,186       185,575      159,644

Income from discontinued operations, net of income tax

     (514 )     7,190      7,514
    


 

  

Pro forma net income

   $ 163,672     $ 192,765    $ 167,158
    


 

  

Basic earnings (loss) per share, as reported:

                     

From continuing operations

   $ 2.95     $ 3.33    $ 2.81

From discontinued operations

     (0.01 )     0.12      0.13
    


 

  

Total basic earnings per share, as reported

   $ 2.94     $ 3.45    $ 2.94
    


 

  

Basic earnings (loss) per share, pro forma:

                     

From continuing operations

   $ 2.85     $ 3.22    $ 2.67

From discontinued operations

     (0.01 )     0.12      0.13
    


 

  

Total basic earnings per share, pro forma

   $ 2.84     $ 3.34    $ 2.80
    


 

  

Diluted earnings (loss) per share, as reported:

                     

From continuing operations

   $ 2.76     $ 3.09    $ 2.63

From discontinued operations

     (0.01 )     0.11      0.11
    


 

  

Total diluted earnings per share, as reported

   $ 2.75     $ 3.20    $ 2.74
    


 

  

Diluted earnings (loss) per share, pro forma

                     

From continuing operations

   $ 2.67     $ 2.99    $ 2.51

From discontinued operations

     (0.01 )     0.11      0.11
    


 

  

Total diluted earnings per share, pro forma

   $ 2.66     $ 3.10    $ 2.62
    


 

  


(a) The 2004 “total stock-based compensation expense included in net income, net of tax (provision)/benefit”, and “total stock-based employee compensation expenses determined under fair value based methods for all awards, net of tax”, include a $6.7 million after-tax ($10.6 million pre-tax) reversal of compensation expense recorded in prior years in connection with a restricted stock grant that was cancelled.

 

In December, 2004, the FASB issued FASB Statement No. 123R, Share-Based Payment, which requires all companies to measure compensation cost for all share-based payments, including employee stock options, restricted share plans, performance-based awards, share appreciation rights and employee share purchase plans at fair value. Statement 123R replaces FASB Statement No. 123, Accounting for Stock-Based Compensation,which was originally issued in 1995, and supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees. SFAS 123R will be effective for public companies for interim periods beginning after June 15, 2005. Retroactive application of the requirements of SFAS 123 (not SFAS 123R) to the beginning of the fiscal year that includes the effective date or all periods presented would be permitted, but not required. We will be required to apply SFAS 123R beginning on July 1, 2005, which will be reflected in our financial statements for the quarter ending September 30, 2005. Although we have not yet determined our valuation methodology, beginning on July 1, 2005, using the Black-Scholes option pricing model, we expect to record expense related to currently outstanding stock options (assuming no cancellations) of $1.7 million for the period of July 1, 2005 through December 31, 2005 ($3.6 million for the entire year of 2005), $2.1 million during 2006, $739,000 during 2007 and $51,000 during 2008. The stock-based compensation expense determined under a fair value method, specifically related to stock options, was $9.2 million and $10.6 million for the years ended December 31, 2004 and 2003, respectively. These pro forma amounts may not be representative of future expense amounts since the estimated fair value of the stock options is amortized to expense over the vesting period, and additional options may be granted in future years.

 

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R) Earnings per Share: Basic earnings per share are based on the weighted average number of common shares outstanding during the year. Diluted earnings per share are based on the weighted average number of common shares outstanding during the year adjusted to give effect to common stock equivalents.

 

The following table sets forth the computation of basic and diluted earnings per share, for the periods indicated:

 

     Twelve Months Ended December 31,

     2004

    2003

    2002

     (in thousands, except per share data)

Basic:

                      

Income from continuing operations

   $ 170,006     $ 192,079     $ 167,847

Less: Dividends on unvested restricted stock, net of taxes

     (111 )     (28 )     —  
    


 


 

Income from continuing operations - basic

   $ 169,895     $ 192,051     $ 167,847

Income (loss) from discontinued operations

     (514 )     7,190       7,514
    


 


 

Net income – basic

   $ 169,381     $ 199,241     $ 175,361
    


 


 

Weighted average number of common shares - basic

     57,653       57,688       59,730

Basic earnings (loss) per share:

                      

From continuing operations

   $ 2.95     $ 3.33     $ 2.81

From discontinued operations

   $ (0.01 )   $ 0.12     $ 0.13
    


 


 

Total basic earnings per share

   $ 2.94     $ 3.45     $ 2.94
    


 


 

Diluted:

                      

Income from continuing operations

   $ 170,006     $ 192,079     $ 167,847

Less: Dividends on unvested restricted stock, net of taxes

     (111 )     (28 )     —  

Add: Debenture interest, net of taxes

     9,240       8,799       8,451
    


 


 

Income from continuing operations - diluted

   $ 179,135     $ 200,850     $ 176,298

Income (loss) from discontinued operations

     (514 )     7,190       7,514
    


 


 

Net income - diluted

   $ 178,621     $ 208,040     $ 183,812
    


 


 

Weighted average number of common shares

     57,653       57,688       59,730

Assumed conversion of discounted convertible debentures

     6,577       6,577       6,577

Net effect of dilutive stock options and grants based on the treasury stock method

     635       824       768
    


 


 

Weighted average number of common shares and equivalents - diluted

     64,865       65,089       67,075

Diluted earnings (loss) per share:

                      

From continuing operations

   $ 2.76     $ 3.09     $ 2.63

From discontinued operations

   $ (0.01 )   $ 0.11     $ 0.11
    


 


 

Total diluted earnings per share

   $ 2.75     $ 3.20     $ 2.74
    


 


 

 

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S) Fair Value of Financial Instruments: The fair values of our registered debt, interest rate swap agreements and investments are based on quoted market prices. The fair values of other long-term debt, including capital lease obligations, are estimated by discounting cash flows using period-end interest rates and market conditions for instruments with similar maturities and credit quality. The carrying amounts reported in the consolidated balance sheets for cash, accounts receivable, accounts payable, and short-term borrowings approximates their fair values due to the short-term nature of these instruments. Accordingly, these items have been excluded from the fair value disclosures included elsewhere in these notes to consolidated financial statements.

 

T) Use of Estimates: The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

 

U) Reclassifications: Certain prior period amounts have been reclassified to conform to the current period presentation.

 

V) Recent Accounting Pronouncements: On September 30, 2004, the Emerging Issues Task Force (“EITF”) affirmed its previous consensus regarding Issue 04-8, “The Effect of Contingently Convertible Debt on Diluted Earnings Per Share”. The guidance in this Issue requires that contingently convertible instruments be included in diluted earnings per share computations (if dilutive) regardless of whether the market price trigger has been met. The effective date of this consensus is for reporting periods ending after December 15, 2004. Retroactive restatement of earnings per share amounts is required for contingent convertible debt issuances that are outstanding at the effective date. This pronouncement had no effect on our financial statements.

 

On December 15, 2003, the FASB issued an Exposure Draft, “Earnings Per Share, an Amendment of FASB Statement No. 128” (the “Amendment”). The proposed Amendment requires, in part, that for contracts that can be settled in either cash or shares, issuing entities should assume share settlement for purposes of computing diluted earnings per share. The FASB subsequently decided that retroactive restatement of earnings per share is not required for those contracts that are appropriately modified prior to the effective date of the Amendment. This Amendment was effective for reporting periods ending after December 15, 2004. This pronouncement had no effect on our financial statements.

 

In December 2003, the FASB issued FASB Interpretation No. 46 (revised December 2003), “Consolidation of Variable Interest Entities,” which addresses how a business enterprise should evaluate whether it has a controlling financial interest in an entity through means other than voting rights and accordingly should consolidate the entity. FIN 46R replaces FASB Interpretation No. 46, Consolidation of Variable Interest Entities, which was issued in January 2003. We were required to apply FIN 46R to variable interests in variable interest entities (“VIEs”) created after December 31, 2003. For variable interests in VIEs created before January 1, 2004, the Interpretation will be applied beginning on January 1, 2005. As of December 31, 2004, we do not have any interests in entities that would be considered variable interest entities.

 

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2) ACQUISITIONS AND DIVESTITURES

 

2005:

 

Subsequent to December 31, 2004, we signed a definitive agreement to sell two acute care facilities in Puerto Rico: Hospital San Pablo, a 430-bed acute care hospital located in Bayamon and Hospital San Pablo del Este, a 180-bed acute care hospital in Fajardo. The sale proceeds will be approximately $120 million in cash plus the value of certain components of working capital. The sale is subject to customary regulatory approvals and we expect the closing to occur by March 31, 2005. The operating results of these facilities are reflected as “Income/(loss) from discontinued operations, net of income tax” in the Consolidated Statements of Income for the years ended December 31, 2004, 2003 and 2002.

 

Year ended December 31, 2004:

 

During 2004, we spent approximately $163 million on acquisitions to acquire the following:

 

    a 90% controlling ownership interest in a 54-bed acute care hospital located in New Orleans, Louisiana, (operations subsequently merged with the operations of a 306-bed acute care hospital located in East New Orleans, Louisiana);

 

    a 50-bed acute care facility, a 20-bed acute care facility and a the remaining 65% ownership interest (35% previously acquired) in the rea1 estate assets of a 198-bed acute care facility located in France, all of which were acquired by an operating company in which we own an 80% controlling ownership interest;

 

    a 63-bed behavioral health hospital, partial services, a school, group homes and detox services located in Stonington, Connecticut;

 

    a 112-bed behavioral health facility in Savannah, Georgia;

 

    a 77-bed behavioral health facility in Benton, Arkansas;

 

    the operations of an 82-bed behavioral health facility in Las Vegas, Nevada;

 

    a 72-bed behavioral health facility in Bowling Green, Kentucky, and;

 

    an outpatient surgery center in Edinburg, Texas and an outpatient surgery center located in New Orleans, Louisiana.

 

In addition, in late December, 2003, we funded $230 million (which was included in other assets on our consolidated balance sheet as of December 31, 2003) for the combined purchase price of the following acute care facilities which we acquired effective January 1, 2004:

 

    a 90% controlling ownership interest in a 306-bed facility located in East New Orleans, Louisiana;

 

    a 228-bed facility located in Corona, California;

 

    a 112-bed facility located in San Luis Obispo, California (this facility was sold during the second quarter of 2004), and;

 

    a 65-bed facility located in Arroyo Grande, California (this facility was sold during the second quarter of 2004).

 

The aggregate net purchase price of the facilities was allocated on a preliminary basis to assets and liabilities based on their estimated fair values as follows:

 

    

Amount

(000s)


 

Working capital, net

   $ 31,000  

Property, plant & equipment

     165,000  

Goodwill

     223,000  

Other assets

     5,000  

Debt

     (10,000 )

Other liabilities

     (21,000 )
    


Cash purchase price for 2004 acquisitions

     393,000  

Less: Cash deposits made in 2003

     (230,000 )
    


Cash paid in 2004 for acquisitions

   $ 163,000  
    


 

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Assuming these acquisitions occurred on January 1, 2004, proforma net revenues for the year ended December 31, 2004 would have been $3.96 billion and the proforma effect on our income from continuing operations, income from continuing operations per basic and diluted share, net income and net income per basic and diluted share was immaterial. Assuming these acquisitions occurred on January 1, 2003, our 2003 proforma net revenues would have been approximately $3.67 billion and our proforma income from continuing operations would have been $197.1 million and proforma income from continuing operations per basic and diluted share would have been $3.42 and $3.16, respectively, and proforma net income would have been $204.3 million and proforma net income per basic and diluted share would have been $3.54 and $3.27, respectively.

 

During 2004, in conjunction with our strategic plan to sell two recently acquired acute care hospitals in California as well as certain other under-performing assets, we sold the operations and/or property of the following acute care facilities and surgery and radiation therapy centers for combined cash proceeds of approximately $81 million:

 

    a 112-bed hospital located in San Luis Obispo, California (sold in second quarter of 2004);

 

    a 65-bed hospital located in Arroyo Grande, California (sold in second quarter of 2004);

 

    a 136-bed leased hospital in Shreveport, Louisiana (sold in second quarter of 2004);

 

    a 106-bed hospital located in La Place, Louisiana (sold in second quarter of 2004);

 

    a 160-bed pediatric and surgery hospital located in Rio Piedras, Puerto Rico (sold in third quarter of 2004), and;

 

    ownership interests in five outpatient surgery centers located in Ponca City, Oklahoma (sold in second quarter of 2004), New Albany, Indiana (sold in third quarter of 2004), Hammond, Louisiana (sold in third quarter of 2004), Littleton, Colorado (sold in the first quarter of 2004) and St. George, Utah (sold in the fourth quarter of 2004) and a radiation therapy center located in Madison, Indiana (sold in first quarter of 2004).

 

The operating results of all these facilities, as well as gains, net of losses, resulting from the divestitures are reflected as “Income/(loss) from discontinued operations, net of income tax” in the Consolidated Statements of Income for the years ended December 31, 2004, 2003 and 2002. These transactions resulted in a combined pre-tax gain of approximately $5 million ($3 million after-tax) which is included in “Income/(loss) from discontinued operations, net of income tax” in the Consolidated Statement of Income for the year ended December 31, 2004.

 

Shown below is a schedule of results of operations, on a combined basis, for all facilities reflected as discontinued operations for the years ended December 31, 2004, 2003 and 2002.

 

Year Ended December 31, 2003:

 

During 2003, we spent $281 million to acquire the assets and operations of: (i) a 108-bed behavioral health system in Anchorage and Palmer, Alaska; (ii) three acute care facilities located in France which were acquired by an operating company that is 80% owned by us; (iii) three acute care facilities located in California, all of which were ownership effective January 1, 2004, as discussed above; (iv) the acquisition, which was also ownership effective January 1, 2004, of a 90% controlling ownership interest in a 306-bed acute care facility located in East New Orleans, Louisiana, and; (v) the acquisition of a behavioral health facility located in Alaska and an outpatient surgery center located in Oklahoma.

 

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The aggregate net purchase price of the facilities was allocated to assets and liabilities based on their estimated fair values as follows:

 

     Amount
(000s)


 

Working capital, net

   $ (2,000 )

Property, plant & equipment

     38,000  

Goodwill

     20,000  

Other assets

     6,000  

Debt

     (6,000 )

Other liabilities

     (5,000 )
    


Cash purchase for 2003 acquisitions

     51,000  

Cash deposits made for 2004 acquisitions

     230,000  
    


Total cash paid in 2003 for acquisitions

   $ 281,000  
    


 

The pro forma effect of these acquisitions (excluding the acquisitions that were ownership effective January 1, 2004) on our net revenues, net income and basic and diluted earnings per share for the years ended December 31, 2003 and 2002 were immaterial.

 

During 2003, we received total cash proceeds of $25 million for the sale of five radiation therapy centers, two medical office buildings (which were sold to limited liability companies that are majority owned by Universal Health Realty Income Trust), an outpatient surgery center and the disposition of our investment in a healthcare related company. The operating results of these facilities, as well as gains, net of losses, resulting from the divestitures are reflected as “Income/(loss) from discontinued operations, net of income tax” in the Consolidated Statement of Income for the year ended December 31, 2003. These transactions resulted in a combined pre-tax gain of approximately $15 million ($9 million after minority interest expense and income taxes) which is included in “Income/(loss) from discontinued operations, net of income tax” in the Consolidated Statement of Income for the year ended December 31, 2003.

 

Year Ended December 31, 2002:

 

During 2002, we spent $3 million to acquire a majority ownership interest in the assets and operations of a surgery center located in Puerto Rico. In addition, effective January 1, 2002, we acquired the assets and operations of: (i) a 150-bed acute care facility located in Lansdale, Pennsylvania, and; (ii) a 117-bed acute care facility located in Lancaster, California. Included in other assets at December 31, 2001 were $70 million of deposits related to the acquisition of these two facilities.

 

The aggregate net purchase price of the facilities was allocated to assets and liabilities based on their estimated fair values as follows:

 

     Amount
(000s)


 

Working capital, net

   $ 14,000  

Property and equipment

     32,000  

Goodwill

     34,000  

Debt

     (3,000 )

Other liabilities

     (4,000 )
    


Total cash purchase price

     73,000  

Less: cash deposits made in 2001

     (70,000 )
    


Cash paid for 2002 acquisitions

   $ 3,000  
    


 

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The pro forma effect of these acquisitions on our net revenues, net income and basic and diluted earnings per share for the year ended December 31, 2002 was immaterial.

 

During 2002, the we received net proceeds of $8 million resulting from the sale of real estate related to a women’s hospital and a radiation oncology center, both of which were closed in a prior year and written down to their estimated net realizable values. The sale of the real estate of the women’s hospital resulted in a $2.2 million gain which is included in “Income/(loss) from discontinued operations, net of income tax” in the Consolidated Statement of Income for the year ended December 31, 2002. The gain on the sale of the radiation center was not material.

 

The goodwill acquired during the last three years as presented above, is expected to be fully deductible for income tax purposes.

 

The following table shows the results of operations, on a combined basis, for all facilities reflected as discontinued operations for the years ended December 31, 2004, 2003 and 2002.

 

     Year Ended December 31,

 
   2004

    2003

    2002

 
           (000s)        

Net revenues

   $ 219,553     $ 252,060     $ 266,979  
    


 


 


Income (loss) from operations

   $ (6,191 )   $ 1,655     $ 9,736  

Gains, net

     5,382       14,623       —    

Provision for asset impairment

     —         (13,742 )     —    

Recovery of provision for judgment/closure costs

     —         8,867       2,182  
    


 


 


Income (loss) from discontinued operations, pre-tax

     (809 )     11,403       11,918  

Income tax (provision)/benefit

     295       (4,213 )     (4,404 )
    


 


 


Income (loss) from discontinued operations, net of income tax expense

   $ (514 )   $ 7,190     $ 7,514  
    


 


 


 

3) FINANCIAL INSTRUMENTS

 

Fair Value Hedges: As of December 31, 2004, we had no fair value hedges outstanding. During November 2004 we terminated two fair value hedges. They were floating rate swaps with a notional principal amount of $60 million in which we received a fixed rate of 6.75% and paid a floating rate equal to 6 month LIBOR plus a spread. The term of these swaps were ten years and were scheduled to expire on November 15, 2011. We received a termination payment of $4.3 million. As a result of the termination, during 2004, we recorded a decrease of $4.3 million in other assets. The basis adjustment of $4.3 million on the hedged interest-bearing instrument will be treated as a premium and amortized as interest income over the expected remaining life of the interest bearing instrument using the effective-yield method.

 

Cash Flow Hedges: As of December 31, 2004, we had no domestic cash flow hedges outstanding. During November 2004 we terminated one fixed rate swap with a notional principal amount of $125 million, which was scheduled to expire in August 2005. We paid a termination amount of $3.8 million. As the previously hedged forecasted transactions are still probable of occurring, the net loss of $3.8 million remained in accumulated other comprehensive income as of the date of the termination, and is being reclassified into earnings in the same period during which the hedged transaction was forecasted to occur. We paid a fixed rate of 6.76% and received a floating rate equal to three month LIBOR.

 

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As of December 31, 2004, one of our majority-owned subsidiaries had two interest rate swaps denominated in Euros. The total notional amount of these two interest rate swaps is 27.5 million Euros ($37.2 million based on the end of period currency exchange rate) and the swaps mature on June 30, 2005. We pay an average fixed rate of 4.35% and receive six month EURIBOR. The effective floating rate for these swaps as of December 31, 2004 was 1.45%. This same majority owned subsidiary also had two interest rate caps, one that was effective as of December 31, 2004 and another that becomes effective at a future date. The notional amount of the interest rate cap currently outstanding is 17.5 million Euros ($23.7 million), the strike price is 3.5% and the cap matures on June 30, 2005. The other interest rate cap is a forward starting cap that takes effect on June 30, 2005 upon the expiration of the currently outstanding interest rate swaps and caps. The notional amount of the cap begins at 45.0 million Euros ($60.9 million) and reduces to 38.0 million Euros ($51.4 million) on December 30, 2005. The strike price is 3.3625% and the cap matures on December 29, 2006.

 

During the year ended December 31, 2004, we recorded in accumulated other comprehensive income (“AOCI”), pre-tax losses of $4.5 million ($2.9 million after-tax) to recognize the change in fair value of all derivatives that are designated as cash flow hedging instruments. The gains or losses are reclassified into earnings as the underlying hedged item affects earnings, such as when the forecasted interest payment occurs. During the years ended December 31, 2004, 2003 and 2002, we also recorded charges to earnings of $525,000 ($334,000 after-tax), $431,000 ($272,000 after-tax), and $169,000 ($107,000 after-tax) respectively, to recognize the ineffective portion of its cash flow hedging instruments.

 

4) LONG-TERM DEBT

 

A summary of long-term debt follows:

 

     December 31,

 
     2004

    2003

 
     (000s)  

Long-term debt:

                

Notes payable and Mortgages payable (including obligations under capitalized leases of $14,613 in 2004 and $13,943 in 2003) and term loans with varying maturities through 2009; weighted average interest at 6.0% in 2004 and 6.2% in 2003 (see Note 7 regarding capitalized leases)

   $ 18,560     $ 19,861  

Non-recourse term loan (denominated in Euros)

     75,242       51,876  

Revolving credit and demand notes

     261,085       204,830  

Commercial paper

     0       100,000  

Revenue bonds:

                

Interest at floating rates of 1.98% and 1.122% at December 31, 2004 and 2003, respectively, with varying maturities through 2015

     10,200       10,200  

5.00% Convertible Debentures due 2020, net of the unamortized discount of $287,031 in 2004 and $299,119 in 2003

     299,961       287,873  

6.75% Senior Notes due 2011, net of the unamortized discount of $68 in 2004 and $82 in 2003, and fair market value adjustment of $4,217 in 2004 and $4,879 in 2003.

     204,149       204,797  
    


 


       869,197       879,437  

Less-Amounts due within one year

     (16,968 )     (10,871 )
    


 


     $ 852,229     $ 868,566  
    


 


 

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During 2004 the Company was a party to a $400 million unsecured non-amortizing revolving credit agreement with a scheduled maturity date of December 13, 2006. The agreement included a $50 million sub-limit for letters of credit of which $2 million was available at December 31, 2004. The interest rate on borrowings was determined at our option at the prime rate, certificate of deposit rate plus .925% to 1.275%, Euro-dollar plus .80% to 1.150% or a money market rate. A facility fee ranging from .20% to .35% is required on the total commitment. The applicable margins over the certificate of deposit, the Euro-dollar rates and the facility fee are based upon the leverage ratio. At December 31, 2004, the applicable margins over the certificate of deposit and the Euro-dollar rate were 1.125% and 1.00% respectively, and the commitment fee was .25%. There are no compensating balance requirements. At December 31, 2004, we had $91 million of unused borrowing capacity available under this Credit Agreement.

 

Subsequent to year-end, on March 4, 2005, we terminated the $400 million revolving credit agreement described above and replaced it with a $500 million unsecured non-amortizing revolving credit agreement, which expires on March 4, 2010. The agreement includes a $75 million sub-limit for letters of credit. The interest rate on borrowings is determined at our option at the prime rate, LIBOR plus a spread of .32% to .80% or a money market rate. A facility fee ranging from .08% to .20% is required on the total commitment. The applicable margins over LIBOR and the facility fee are based upon our debt ratings by Standard & Poor’s Ratings Group and Moody’s Investor Services, Inc. At December 31, 2004, the applicable margins over the LIBOR rate would have been .50% and the commitment fee would have been .125%. There are no compensating balance requirements.

 

During 2003, our majority-owned subsidiary in France entered into a senior credit agreement denominated in Euros, which provides for a total commitment of 90 million Euros. The loan, which is non-recourse to us, matures on December 4, 2009. The committed amount available under this credit agreement amortizes to zero over the life of the agreement and decreased by 5 million Euros to 85 million Euros on December 31, 2004. Interest on the loan is at our option and can be based on the one, two, three and six month EURIBOR plus a spread of 2.00% to 2.50%. The spread in effect at December 31, 2004 was 2.25%. As of December 31, 2004, the interest rate was 4.48% (including the spread of 2.25%) and the effective interest rate including the effects of the designated interest rate swaps and the spread of 2.25% was 4.42%. As of December 31, 2004, there were 55.6 million Euros ($75.2 million) of debt outstanding, and 29.4 million Euros ($39.8 million) of unused borrowing capacity, pursuant to the terms of this agreement.

 

During 2004, the $100 million commercial paper credit facility, which was fully collateralized by a portion of our acute care patient accounts receivable, expired and we elected not to renew the program.

 

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

 

We issued discounted Convertible Debentures in 2000, which are due in 2020 (“Debentures”). The aggregate issue price of the Debentures was $250 million or $587 million aggregate principal amount at maturity. The Debentures were issued at a price of $425.90 per $1,000 principal amount of Debenture. The Debentures’ yield to maturity is 5% per annum, .426% of which is cash interest. The interest on the bonds is paid semiannually in arrears on June 23 and December 23 of each year. The Debentures are convertible at the option of the holders into 11.2048 shares of the our common stock per $1,000 of Debentures, however, we have the right to redeem the Debenture any time on or after June 23, 2006 at a price equal to the issue price of the Debentures plus accrued original issue discount and accrued cash interest to the date of redemption.

 

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The average amounts outstanding during 2004, 2003 and 2002 under the revolving credit and demand notes and commercial paper program were $272.1 million, $116.5 million and $140.3 million respectively, with corresponding effective interest rates of 2.6%, 3.3% and 5.1% including commitment and facility fees. The maximum amounts outstanding at any month-end were $370 million in 2004, $304.8 million in 2003 and $170 million in 2002.

 

The effective interest rate on our revolving credit, demand notes and commercial paper program, including the respective interest expense and income incurred on designated interest rate swaps which are now expired, was 4.1%, 6.6% and 6.3% during 2004, 2003 and 2002, respectively. Additional interest expense recorded as a result of our U.S. dollar denominated hedging activity was $4.1million in 2004, $4.6 million in 2003 and $4.2 million in 2002. There are no longer any domestic interest rate swaps outstanding.

 

Covenants related to long-term debt require specified leverage and fixed charge coverage ratios. We are in compliance with all required covenants as of December 31, 2004.

 

The fair value of our long-term debt at December 31, 2004 and 2003 was approximately $932 million and $1 billion respectively.

 

Aggregate maturities follow:

 

     (000s)

 

2005

   $ 16,968  

2006

     286,150  

2007

     21,887  

2008

     20,889  

2009

     6,501  

Later

     803,831  
    


Total

   $ 1,156,226  

Less: Discount on Convertible Debentures

     (287,031 )
    


Net Total

   $ 869,195  
    


 

Included in the aggregate maturities shown above, are maturities related to the Euro denominated debt ($75.2 million in the aggregate) which mature as follows: $10.9 million in 2005; $16.7 million in 2006; $20.4 million in 2007; $20.8 million in 2008 and $6.4 million in 2009.

 

5) COMMON STOCK

 

During the fourth quarter of 2003, we announced the initiation of quarterly cash dividends, commencing with the fourth quarter of 2003. Cash dividends of $.32 per share ($18.6 million in the aggregate) were declared and paid during 2004. Cash dividends of $.08 per share ($4.6 million in the aggregate) were declared and paid during 2003.

 

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During 1998, 1999 and 2004, our Board of Directors approved stock purchase programs authorizing us to purchase up to fourteen million shares of our outstanding Class B Common Stock on the open market at prevailing market prices or in negotiated transactions off the market. Pursuant to the terms of these programs, we purchased 1,713,787 shares at an average purchase price of $44.71 per share ($76.6 million in the aggregate) during 2002, 1,360,321 shares at an average purchase price of $39.93 ($54.3 million in the aggregate) during 2003 and 559,481 shares at an average purchase price of $42.07 ($23.5 million in the aggregate) during 2004. Since inception of the stock purchase program in 1998 through December 31, 2004, we have purchased a total of 11,437,404 shares at an average purchase price of $25.76 per share ($294.6 million in the aggregate).

 

At December 31, 2004, 15,227,849 shares of Class B Common Stock were reserved for issuance upon conversion of shares of Class A, C and D Common Stock outstanding, for issuance upon exercise of options to purchase Class B Common Stock, for issuance upon conversion of our discounted Convertible Debentures and for issuance of stock under other incentive plans. Class A, C and D Common Stock are convertible on a share for share basis into Class B Common Stock.

 

As discussed in Note 1, we account for stock-based compensation using the intrinsic value method in APB No. 25, Accounting for Stock Issued to Employees. The fair value of each option grant was estimated on the date of grant using the Black-Scholes option-pricing model with the following range of assumptions used for the sixteen option grants that occurred in 2004, 2003 and 2002:

 

Year Ended December 31,


   2004

  2003

  2002

Volatility

   46%-48%   50%-53%   53%-57%

Interest rate

   3%-4%   2%-3%   3%-4%

Expected life (years)

   3.8   3.8   3.7

Forfeiture rate

   6%   5%   4%

Dividend yield

   .7%   —     —  

 

Stock options to purchase Class B Common Stock have been granted to our officers, key employees and directors under various plans.

 

Information with respect to these options is summarized as follows:

 

Outstanding Options


  

Number

of Shares


    Average
Option
Price


  

Range

(High-Low)


Balance, January 1, 2002

   3,817,969     $ 31.14    $ 42.65 - $11.85

Granted

   320,500     $ 41.76    $ 51.40 - $39.96

Exercised

   (470,385 )   $ 24.34    $ 42.41 - $11.85

Cancelled

   (74,000 )   $ 35.02    $ 43.50 - $20.22
    

 

  

Balance, January 1, 2003

   3,594,084     $ 32.89    $ 51.40 - $11.85

Granted

   461,900     $ 40.72    $ 50.70 - $38.50

Exercised

   (685,749 )   $ 25.11    $ 43.50 - $11.85

Cancelled

   (188,250 )   $ 36.86    $ 44.00 - $11.85
    

 

  

Balance, January 1, 2004

   3,181,985     $ 35.47    $ 51.40 - $11.85

Granted

   51,200     $ 45.72    $ 54.88 - $43.08

Exercised

   (839,087 )   $ 18.20    $ 43.63 - $11.85

Cancelled

   (77,813 )   $ 41.18    $ 50.70 - $22.28
    

 

  

Balance, December 31, 2004

   2,316,285     $ 41.66    $ 54.88 - $22.28
    

 

  

 

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Outstanding options at December 31, 2004:

 

Number of Shares


    

Average Option

Price


    

Range

(High-Low)


    

Contractual

Life


59,360

     $29.70      $34.00-$22.28      0.4

2,131,025

     $41.62      $44.00-$37.80      1.5

125,900

     $49.75      $54.88-$45.14      3.7

                    

2,316,285

                    

                    

 

All stock options were granted with an exercise price equal to the fair market value on the date of the grant. Options are exercisable ratably over a four-year period beginning one year after the date of the grant. The options expire five years after the date of the grant. The outstanding stock options at December 31, 2004 have an average remaining contractual life of 1.63 years. At December 31, 2004, options for 1,807,577 shares were available for grant. At December 31, 2004, options for 1,432,110 shares of Class B Common Stock with an aggregate purchase price of $59.7 million (average of $41.66 per share) were exercisable.

 

During the third quarter of 2002, we restructured certain elements of our long-term incentive compensation plans in response to changes in regulations relating to such plans. Prior to the third quarter of 2002, we loaned employees funds (“Loan Program”) to pay the income tax liabilities incurred upon the exercise of their stock options. Advances pursuant to the Loan Program were secured by full recourse promissory notes that were forgiven after three years, if the borrower remained employed by us. If the forgiveness criteria were not met, the employee was required to repay the loan at the time of separation.

 

During the third quarter of 2002, this Loan Program was terminated. As a replacement long-term incentive plan, the Compensation Committee of the Board of Directors approved the issuance of 217,510 shares (net of cancellations) of restricted stock at $51.15 per share ($11.1 million in the aggregate) to various officers and employees pursuant to the Company’s 2001 Employees’ Restricted Stock Purchase Plan (“Restricted Stock”). The number of shares and the current value of the Restricted Stock issued to each employee were based on the estimated benefits lost by that employee as a result of the termination of the Loan Program. The Restricted Stock is scheduled to vest ratably on the third, fourth and fifth anniversary dates of the award. Included in the Restricted Stock granted was 319,490 restricted shares issued to the Chief Executive Officer (“CEO”) which were also scheduled to vest ratably on the third, fourth and fifth anniversary dates of the award if we achieved a 14% cumulative increase in our diluted earnings per share during the two-year period ended December 31, 2004, as compared to December 31, 2002. Since the earnings contingency threshold was not achieved, these shares of restricted stock have been cancelled and the previously recorded compensation expense related to this restricted stock grant through December 31, 2003, amounting to $10.6 million ($6.7 million after-tax), was reversed during 2004.

 

In connection with the Loan Program, it was our policy to charge compensation expense for the loan forgiveness over the employees’ estimated service period or approximately six years on average. As of December 31, 2004, we had approximately $1.7 million of loans outstanding in connection with the Loan

 

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Program (approximately $688,000 of which was loaned to officers), all of which was charged to compensation expense through that date. In addition, as of July 1, 2002, we had recorded an additional accrual of approximately $16.0 million related to the estimated benefits earned under the Loan Program for which loans had not yet been extended. As a result of the termination of the Loan Program, this accrued liability was adjusted by reducing compensation expense by $16.0 million during 2002 (the majority of which was recorded during the third quarter of 2002) since we do not have any future obligations related to the benefits that employees might have been entitled to if the Loan Program had continued.

 

Since the Restricted Stock awards were primarily intended to replace the benefits that had been earned under the Loan Program, a portion of the awards was attributable to services rendered by employees in prior periods. Accordingly, in connection with the issuance of the Restricted Stock awards during 2002, during the third quarter of 2002 we recorded approximately $14.1 million of compensation expense which represented the prior service portion of the expense related to the Restricted Stock awards. During the fourth quarter of 2002, an additional $1.2 million of compensation expense was recorded related to the Restricted Stock awards. The remaining expense associated with the Restricted Stock awards (estimated at $1.7 million, net of cancellations, as of December 31, 2004) will be recorded over the vesting periods of the awards (through the third quarter of 2007), assuming the recipients remain employed by us.

 

In addition to the stock option plan we have the following stock incentive and purchase plans: (i) a Stock Ownership Plan whereby eligible employees (officers of the Company are no longer eligible) may purchase shares of Class B Common Stock directly from the Company at current market value and the Company will loan each eligible employee 90% of the purchase price for the shares, subject to certain limitations, (loans are partially recourse to the employees), and; (ii) a 2001 Restricted Stock Purchase Plan which allows eligible participants to purchase shares of Class B Common Stock at par value, subject to certain restrictions (no shares issued during 2004 and 6,081 shares issued during 2003). The reserve for this plan was increased by 600,000 shares during 2004. We have reserved 2.1 million shares of Class B Common Stock for issuance under these various plans (excluding terminated plans) and have issued 1.3 million shares pursuant to the terms of these plans (excluding terminated plans) as of December 31, 2004, none of which became fully vested during 2004 or 2003 and 38,432 of which became fully vested during 2002.

 

Subject to shareholder approval, a 2005 Employee Stock Purchase Plan has been established, which will allow eligible employees to purchase shares of Class B Common Stock at a ten percent discount. The plan has 1 million shares of Class B Common Stock reserved for issuance.

 

In connection with the long-term incentive plans described above, we recorded net compensation expense of $1.2 million in 2004, (excluding the $10.6 million pre-tax reduction to compensation expense resulting from the reversal of expense associated with the cancellation of a restricted stock grant, as discussed above), $4.8 million in 2003 and $3.6 million in 2002.

 

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6) INCOME TAXES

 

Components of income tax expense/(benefit) from continuing operations are as follows:

 

    

Year Ended December 31,

(000s)


 
     2004

   2003

   2002

 

Currently payable

                      

Federal

   $ 42,702    $ 79,835    $ 90,336  

Foreign

     19,396      2,838      2,688  

State

     4,843      7,055      8,026  
    

  

  


       66,941      89,728      101,050  

Deferred

                      

Federal and foreign

     32,131      22,501      (3,440 )

State

     2,065      1,988      (304 )
    

  

  


       34,196      24,489      (3,744 )
    

  

  


Total

   $ 101,137    $ 114,217    $ 97,306  
    

  

  


 

We account for income taxes under the provisions of Statement of Financial Accounting Standards No. 109, “Accounting for Income Taxes,” (SFAS 109). Under SFAS 109, deferred taxes are required to be classified based on the financial statement classification of the related assets and liabilities which give rise to temporary differences. Deferred taxes result from temporary differences between the financial statement carrying amounts and the tax bases of assets and liabilities. The components of deferred taxes are as follows:

 

     December 31, (000s)

 
     2004

    2003

 

Deferred income tax assets:

                

Self-insurance reserves

   $ 67,628     $ 62,210  

Compensation accruals

     22,469       23,523  

Other deferred tax assets

     3,844       7,044  
    


 


     $ 93,941     $ 92,777  

Less: Valuation Allowance

     —         —    

Net deferred income tax assets

     93,941       92,777  

Deferred income tax liabilities:

                

Doubtful accounts and other reserves

     (26,531 )     (19,069 )

Repatriation of foreign earnings, including foreign withholding taxes

     (10,400 )     —    

Depreciable and amortizable assets

     (117,223 )     (90,278 )
    


 


Net deferred income tax liability

   $ (60,213 )   $ (16,570 )
    


 


 

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A reconciliation between the federal statutory rate and the effective tax rate is as follows:

 

    

Year Ended

December 31,


 
     2004

    2003

    2002

 

Federal statutory rate

   35.0 %   35.0 %   35.0 %

State taxes, net of federal income tax benefit

   1.4     2.0     1.9  

Other items

   0.9     0.3     (0.2 )
    

 

 

Effective tax rate

   37.3 %   37.3 %   36.7 %
    

 

 

 

The net deferred tax assets and liabilities are comprised as follows:

 

     December 31, (000s)

 
     2004

    2003

 

Current deferred taxes

                

Assets

   $ 34,691     $ 48,544  

Liabilities

     (44,692 )     (23,273 )
    


 


Net deferred taxes-current

     (10,001 )     25,271  

Noncurrent deferred taxes

                

Assets

     67,011       48,437  

Liabilities

     (117,223 )     (90,278 )
    


 


Net deferred taxes-noncurrent

     (50,212 )     (41,841 )
    


 


Total deferred taxes

   $ (60,213 )   $ (16,570 )
    


 


 

The assets and liabilities classified as current relate primarily to the allowance for uncollectible patient accounts and the current portion of the temporary differences related to self-insurance reserves. Under SFAS 109, a valuation allowance is required when it is more likely than not that some portion of the deferred tax assets will not be realized. Realization is dependent on generating sufficient future taxable income. Although realization is not assured, we believe it is more likely than not that all the deferred tax assets will be realized. Accordingly, we have not provided a valuation allowance. The amount of the deferred tax asset considered realizable, however, could be reduced if estimates of future taxable income during the carry-forward period are reduced.

 

The American Jobs Creation Act (AJCA) was signed into law on October 22, 2004. AJCA provides for a deduction of 85% of certain foreign earnings that are repatriated in accordance with the requirements of AJCA. The Company may elect to apply this provision to qualifying repatriations during the year ending December 31, 2005. The Company is in the process of evaluating the amount of foreign earnings that could be repatriated along with the related amount of deferred tax liability associated with this repatriation arising from the American Jobs Creation Act. The range of potential repatriation that the Company is considering is between $0 and $25 million with the resultant tax impact to be between $0 and a $7.5 million benefit. Although the Company expects to complete its repatriation review during 2005, if a decision is made to repatriate foreign earnings subsequent to the date of the financial statements but prior to their issuance, the effect of such a decision would be consistent with the resultant tax impact mentioned above.

 

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7) LEASE COMMITMENTS

 

Certain of our hospital and medical office facilities and equipment are held under operating or capital leases which expire through 2009 (See Note 9). Certain of these leases also contain provisions allowing us to purchase the leased assets during the term or at the expiration of the lease at fair market value.

 

A summary of property under capital lease follows:

 

    

Year Ended

December 31,


 
     2004

    2003

 
     (000s)  

Land, buildings and equipment

   $ 51,075     $ 44,540  

Less: accumulated amortization

     (28,409 )     (25,695 )
    


 


     $ 22,666     $ 18,845  
    


 


 

Future minimum rental payments under lease commitments with a term of more than one year as of December 31, 2004, are as follows:

 

Year


  

Capital

Leases


  

Operating

Leases


     (000s)

2005

   $ 5,879    $ 38,003

2006

     6,286      30,149

2007

     1,324      10,121

2008

     277      6,530

2009

     254      3,314

Later Years

     5,445      8,335
    

  

Total minimum rental

   $ 19,465    $ 96,452
           

Less: Amount representing interest

     4,851       
    

      

Present value of minimum rental commitments

     14,614       

Less: Current portion of capital lease obligations

     5,181       
    

      

Long-term portion of capital lease obligations

   $ 9,433       
    

      

 

Capital lease obligations of $4.7 million in 2004, $100,000 in 2003 and $9.5 million in 2002 were incurred when we entered into capital leases for new equipment or assumed capital lease obligations upon the acquisition of facilities.

 

8) COMMITMENTS AND CONTINGENCIES

 

Due to unfavorable pricing and availability trends in the professional and general liability insurance markets, our subsidiaries have assumed a greater portion of the hospital professional and general liability

 

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risk as the cost of commercial professional and general liability insurance coverage has risen significantly. As a result, effective January 1, 2002, most of our subsidiaries were self-insured for malpractice exposure up to $25 million per occurrence. We purchased umbrella excess policies for our subsidiaries through several commercial insurance carriers for coverage in excess of $25 million per occurrence with a $75 million aggregate limitation. Given these insurance market conditions, there can be no assurance that a continuation of these unfavorable trends, or a sharp increase in claims asserted against us, will not have a material adverse effect on our future results of operations.

 

Our estimated liability for professional and general liability claims is based on a number of factors including, among other things, the number of asserted claims and reported incidents, estimates of losses for these claims based on recent and historical settlement amounts, estimate of incurred but not reported claims based on historical experience, and estimates of amounts recoverable under our commercial insurance policies. While we continuously monitor these factors, our ultimate liability for professional and general liability claims could change materially from our current estimates due to inherent uncertainties involved in making this estimate.

 

For the period from January 1, 1998 through December 31, 2001, most of our subsidiaries were covered under commercial insurance policies with PHICO, a Pennsylvania based insurance company that was placed into liquidation during the first quarter of 2002. As a result of PHICO’s liquidation, we recorded a $40 million pre-tax charge during 2001 to reserve for PHICO claims that could become our liability, however, we are entitled to receive reimbursement from state insurance guaranty funds, other commercial insurers and/or PHICO’s estate for a portion of certain claims ultimately paid by us.

 

As of December 31, 2004, the total accrual for our professional and general liability claims was $204.1 million ($172.5 million net of expected recoveries), of which $28.0 million is included in other current liabilities. As of December 31, 2003, the total accrual for our professional and general liability claims, was $190.8 million ($147.7 million net of expected recoveries), of which $35.0 million is included in other current liabilities. Included in other assets was $31.6 million as of December 31, 2004 and $43.0 million as of December 31, 2003, related to estimated expected recoveries from various state guaranty funds, insurance companies and other sources in connection with PHICO related professional and general liability claims payments.

 

As of December 31, 2004, we had outstanding letters of credit and surety bonds totaling $58 million consisting of: (i) $45 million related to our self-insurance programs; (ii) $7 million consisting primarily of collateral for outstanding bonds of an unaffiliated third party and public utility, and; (iii) $6 million of debt guarantees related to entities in which we own a minority interest.

 

We have a long-term contract with a third party that expires in 2012, to provide certain data processing services for our acute care and behavioral health facilities.

 

In December 2003, one of our subsidiaries, McAllen Hospitals, L.P., was named as a defendant in a case filed in the District Court of Hidalgo County, Texas, 275th Judicial District, under the caption Rio OB-Gyn Partners Ltd. v. McAllen Hospitals, L.P., Cause No. C-3128-03-E. The plaintiff is a physician group which claims that McAllen and its agents committed fraud or negligent misrepresentation in promising to build an OB-Gyn hospital and inducing the plaintiff to cancel an agreement with another party to build a competing OB-Gyn hospital.

 

On or about March 22 through March 26, 2004 two purported class action Complaints were filed against us and certain of our officers and directors in the United States District Court for the Eastern District of Pennsylvania alleging that defendants violated Section 10(b) of the Exchange Act and Rule

 

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10b-5 promulgated thereunder by disclosing materially false and misleading information or failing to disclose material information necessary to make other disclosure not misleading or to correct prior disclosure with respect to our financial condition and operations. A claim is asserted against the individual defendants under section 20(a) of the Exchange Act alleging that because they controlled the Company, they should be held liable for damages caused by the Company’s violation of section 10(b) and Rule 10b-5 thereunder. Plaintiffs seek, on behalf of a purported class of purchasers of our common stock during a class period from July 21, 2003 through February 27, 2004, unspecified money damages, restitution, attorneys’ fees and reimbursement of expenses.

 

Pursuant to an Order of the Court, these two cases were consolidated into one action captioned: In re Universal Health Services, Inc. Securities Litigation, Case No. CV-04-01233-JP. Subsequently, the plaintiffs filed an Amended Consolidated Class Action Complaint. The defendants have moved to dismiss that complaint. The motion to dismiss has been fully briefed and oral argument was held on March 9, 2005.

 

On July 6, 2004, we were served with a complaint filed in the United States District Court for the Eastern District of Pennsylvania captioned “Eastside Investors LLP, derivatively and on behalf of nominal defendant, Universal Health Services, Inc., v. Alan B. Miller, Robert Hotz, Anthony Pantaleoni and Steve G. Filton.” Plaintiff subsequently filed an amended complaint which dropped Messrs Hotz and Pantaleoni as defendants. Plaintiff purports to assert claims derivatively on behalf of the Company against our officers and directors seeking to recover on behalf of the Company unspecified damages to redress alleged breaches of fiduciary duty, abuses of control and gross mismanagement by the individual defendants. The complaint also seeks equitable relief and attorneys’ fees. We are named as a nominal defendant in that action. The Court has granted the parties’ joint motion in the derivative action asking that the Defendants’ time to respond to the complaint be extended until after the decision on the motion to dismiss the class action complaint. That motion is pending.

 

On August 5, 2004, we were named, together with our subsidiary Valley Hospital Medical Center, Inc., as defendants in a lawsuit filed in Clark County, Nevada, under the caption Deborah Louise Poblocki v. Universal Health Services, Inc., et al., No. 04-A-489927-C. The plaintiff alleges that we overcharged her and other similarly situated patients who lacked health insurance. The complaint seeks class action treatment.

 

The complaint, filed by plaintiff individually and on behalf of other unnamed class members, alleges that Valley Hospital Medical Center charged her “unconscionable rates” because it charged her, an uninsured outpatient, more than it charged insured patients and more than the cost of the services provided. She claims that this alleged conduct violates state civil RICO laws as well as other state statutory and common law. We filed a notice of removal to federal court, and plaintiff filed a motion to remand back to state court. The court has not yet ruled on plaintiff’s motion.

 

In October, 2004, one of our subsidiaries, Aiken Regional Medical Centers, Inc., received a complaint filed in state court in South Carolina (Case No. 04-CP-02-1275). The complaint, filed by the plaintiff individually and on behalf of other unnamed, putative class members, alleges that Aiken breached its contract with the plaintiff (and other putative plaintiffs), or in the alternative Aiken was unjustly enriched, by virtue of billing and collecting full hospital charges from the plaintiff and other putative class members.

 

We believe that the claims asserted against us in the proceedings described above are without merit and we deny all allegations of violations of law and any liability to the above named plaintiffs. The

 

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individual defendants also believe that the claims asserted against them in these proceedings are without merit. There can be no assurance, however, as to the outcome or timing of the resolution of these proceedings. We therefore are unable to estimate the amount or potential range of any loss that may arise out of these proceedings. The range of possible resolutions could include determinations and judgments against us or settlements that could require substantial payments by us that could have a material adverse effect on our financial condition, results of operations and cash flows.

 

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

 

We have maintained for several years the Universal Health Services, Inc. Stock Purchase Plan (the “Plan”) which is designed to encourage stock ownership among our employees. While the Plan has, since its adoption, exclusively used shares purchased on the open market through our third party administrator, the offering of shares under the Plan may have failed to comply with the registration requirements of federal securities laws. We filed a registration statement on SEC Form S-8 registering 1,087,726 of our Class B Common Stock on October 25, 2004, covering the remaining shares in the Plan. As a result, certain participants who purchased shares under the Plan prior to registration may be entitled to rescission rights or other remedies under the Securities Act of 1933, as amended. We cannot predict the extent to which any such rescission rights may be exercised or the impact of any possible regulatory action pertaining to such sales under the Plan. We do not believe, however, that any consequences arising from such sales under the Plan will have a material adverse effect on our financial position or results of operations.

 

The healthcare industry is subject to numerous laws and regulations which include, among other things, matters such as government healthcare participation requirements, various licensure and accreditations, reimbursement for patient services, and Medicare and Medicaid fraud and abuse. Government action has increased with respect to investigations and/or allegations concerning possible violations of fraud and abuse and false claims statutes and/or regulations by healthcare providers. Providers that are found to have violated these laws and regulations may be excluded from participating in government healthcare programs, subjected to fines or penalties or required to repay amounts received from government for previously billed patient services. While management believes its policies, procedures and practices comply with governmental regulations, no assurance can be given that we will not be subjected to governmental inquiries or actions.

 

9) RELATED PARTY TRANSACTIONS

 

At December 31, 2004, we held approximately 6.7% of the outstanding shares of Universal Health Realty Income Trust (the “Trust”). We serve as Advisor to the Trust under an annually renewable advisory agreement. Pursuant to the terms of this advisory agreement, we conduct the Trust’s day-to-day affairs, provide administrative services and presents investment opportunities. In addition, certain of our officers and directors are also officers and/or directors of the Trust. Management believes that it has the ability to exercise significant influence over the Trust, therefore we account for our investment in the Trust using the equity method of accounting. Our pre-tax share of income from the Trust was $1.6 million in 2004, $1.6 million during 2003 and $1.4 million during 2002, and is included in net revenues in the accompanying consolidated statements of income. The carrying value of this investment was $9.5 million and $9.4 million at December 31, 2004 and 2003, respectively, and is included in other assets in the accompanying consolidated balance sheets. The market value of this investment was $25.2 million at December 31, 2004 and $23.4 million at December 31, 2003.

 

As of December 31, 2004, we leased five hospital facilities from the Trust with terms expiring in 2006 through 2009. These leases contain up to five 5-year renewal options. In addition, certain of our subsidiaries are tenants in several medical office buildings owned by limited liability companies in which the Trust holds non-controlling ownership interest.

 

On December 31, 2004, we completed the purchase of the real estate assets of the Virtue Street Pavilion, located in Chalmette, Louisiana, from the Trust. The purchase was completed pursuant to the exercise of an option granted to us, under the previous lease for the facility. The purchase price for the facility was $7.3 million and was determined, in accordance with the terms of the lease, based upon independent appraisals obtained by both us and the Trust.

 

During the third quarter of 2004, we exercised the five-year renewal option on a behavioral health hospital leased from the Trust which was scheduled to expire in December, 2004. The lease was renewed

 

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at the same lease terms. During 2002, we exercised the five-year renewal option on an acute care hospital leased from the Trust which was scheduled to expire in March, 2003. The renewal rate on this facility was based upon the five-year Treasury rate on March 29, 2003 plus a spread.

 

During 2003, we sold four medical office buildings located in Las Vegas, Nevada, for combined cash proceeds of $12.8 million, to limited liability companies, in which the Trust holds non-controlling majority ownership interests. The sale of these medical office buildings resulted in a pre-minority interest and pre-tax gain of $3.1 million ($1.4 million after minority interest expense and after-tax) which is included in our 2003 results of operations. Tenants of these buildings include certain of our subsidiaries.

 

Future minimum lease payments to the Trust are included in Note 7. Total rent expense under these operating leases was $17.4 million in 2004, $17.4 million in 2003 and $17.2 million in 2002. As of December 31, 2004, the aggregate fair market value of our facilities leased from the Trust is not known, however, the aggregate original purchase price paid by the Trust for these properties was $101.3 million (excluding the Virtue Street Pavilion). Pursuant to the terms of the leases with the Trust, we have the option to purchase the respective leased facilities at the end of the lease terms or any renewal terms at the appraised market value. In addition, we have rights of first refusal to: (i) purchase the respective leased facilities during and for 180 days after the lease terms at the same price, terms and conditions of any third-party offer, or; (ii) renew the lease on the respective leased facility at the end of, and for 180 days after, the lease term at the same terms and conditions pursuant to any third-party offer. The terms of the leases also provide that in the event we discontinue operations at the leased facility for more than one year, or elect to terminate a lease prior to the expiration of its term for prudent business reasons, we are obligated to offer a substitution property. If the Trust does not accept the substitution property offered, we are obligated to purchase the leased facility back from the Trust at a price equal to the greater of its then fair market value or the original purchase price paid by the Trust.

 

We received an advisory fee from the Trust of $1.5 million in 2004, $1.5 million in 2003 and $1.4 million in 2002 for investment and administrative services provided under a contractual agreement which is included in net revenues in the accompanying consolidated statements of income.

 

In connection with a long-term incentive compensation plan that was terminated during the third quarter of 2002, we had $1.7 million as of December 31, 2004 and $4.6 million as of December 31, 2003, of gross loans outstanding to various employees of which $1.7 million as of December 31, 2004 and $3.6 million as of December 31, 2003 were charged to compensation expense through that date. Included in the amounts outstanding were gross loans to our officers amounting to $688,000 as of December 31, 2004 and $2.8 million as of December 31, 2003 (see Note 5).

 

Our Chairman and Chief Executive Officer is member of the Board of Directors of Broadlane, Inc. In addition, the Company and certain members of executive management own approximately 6% of the outstanding shares of Broadlane, Inc. as of December 31, 2004. Broadlane, Inc. provides contracting and other supply chain services to us and various other healthcare organizations.

 

A member of our Board of Directors and member of the Executive Committee is Of Counsel to the law firm used by us as our principal outside counsel. This Board member is also the trustee of certain trusts for the benefit of the Chief Executive Officer and his family. This law firm also provides personal legal services to our Chief Executive Officer.

 

We invested $3.3 million for a 25% ownership interest in an information technology company that provides laboratory information system and order management technology to many of our acute care hospitals. During 2004, we also committed to pay this company a license fee totaling $25.3 million over a five-year period.

 

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10) PENSION PLAN

 

We maintain contributory and non-contributory retirement plans for eligible employees. Our contributions to the contributory plan amounted to $13.3 million, $11.6 million and $7.2 million in 2004, 2003 and 2002, respectively. The non-contributory plan is a defined benefit pension plan which covers employees of one of our subsidiaries. The benefits are based on years of service and the employee’s highest compensation for any five years of employment. Our funding policy is to contribute annually at least the minimum amount that should be funded in accordance with the provisions of ERISA.

 

The following table shows the reconciliation of the defined benefit pension plan as of December 31, 2004 and 2003:

 

     (000s)

 
     2004

    2003

 

Change in benefit obligation:

                

Benefit obligation at beginning of year

   $ 70,030     $ 61,627  

Service cost

     1,041       1,072  

Interest cost

     4,302       4,092  

Benefits paid

     (4,996 )     (2,163 )

Actuarial loss

     5,573       5,402  
    


 


Benefit obligation at end of year

   $ 75,950     $ 70,030  

Change in plan assets:

                

Fair value of plan assets at beginning of year

   $ 50,540     $ 42,918  

Actual return on plan assets

     4,293       10,114  

Benefits paid

     (4,996 )     (2,163 )

Administrative expenses

     (555 )     (329 )
    


 


Fair value of plan assets at end of year

   $ 49,282     $ 50,540  

Reconciliation of funded status

                

Funded status of the plan

   $ (26,668 )   $ (19,490 )

Unrecognized actuarial loss

     19,469       14,753  
    


 


Net amount recognized

     (7,199 )     (4,737 )
    


 


Total amounts recognized in the consolidated balance sheets consist of:

                

Accrued benefit liability

   $ (21,786 )   $ (14,622 )

Accumulated other comprehensive income

     14,587       9,885  
    


 


Net amount recognized

   $ (7,199 )   $ (4,737 )
    


 


Accumulated other comprehensive (income)/loss attributable to change in additional minimum liability recognition

   $ (4,702 )   $ (2,361 )

Additional year end information for Pension Plan

                

Projected benefit obligation

   $ 75,950     $ 70,030  

Accumulated benefit obligation

     71,068       65,162  

Fair value of plan assets

     49,282       50,540  

 

     (000s)

 
     2004

    2003

    2002

 

Components of net periodic cost (benefit)

                        

Service cost

   $ 1,041     $ 1,071     $ 986  

Interest cost

     4,302       4,092       3,856  

Expected return on plan assets

     (3,948 )     (3,353 )     (4,459 )

Recognized actuarial loss

     1,068       1,506       —    
    


 


 


Net periodic cost

   $ 2,463     $ 3,316     $ 383  
    


 


 


 

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     2004

    2003

 

Measurement Dates

            

Benefit obligations

   12/31/2004     12/31/2003  

Fair value of plan assets

   12/31/2004     12/31/2003  
     2004

    2003

 

Weighted average assumptions as of December 31

            

Discount rate

   5.75 %   6.25 %

Expected long-term rate of return on plan assets

   8.00 %   8.00 %

Rate of compensation increase

   4.00 %   4.00 %

Weighted-average assumptions for net periodic benefit cost calculations

            

Discount rate

   6.25 %   6.75 %

Expected long-term rate at return on plan assets

   8.00 %   8.00 %

Rate of compensation increase

   4.00 %   4.00 %

 

The accumulated benefit obligation was $71,068 and $65,162 as of December 31, 2004 and 2003, respectively. The accumulated benefit obligations of the plan exceeded the fair value of plan assets as of December 31, 2004 and 2003. In 2004 and 2003, the accrued pension cost is included in non-current liabilities in the accompanying consolidated balance sheets.

 

To develop the expected long-term rate of return on plan assets assumption, we considered the historical returns and the future expectations for returns for each asset class, as well as the target asset allocation of the pension portfolio.

 

Information with respect to estimated future benefit payments and plan assets follows:

 

Estimated Future Benefit Payments (000s)

      

2005

   $ 3,138

2006

     3,371

2007

     3,608

2008

     3,845

2009

     4,080

2010-2014

     24,427

 

Plan Assets

            
     2004

    2003

 

Asset Category

            

Equity securities

   74 %   74 %

Fixed income securities

   26 %   26 %
    

 

Total

   100 %   100 %
    

 

 

Investment Policy, Guidelines and Objectives have been established for the defined benefit pension plan. The investment policy is in keeping with the fiduciary requirements under existing federal laws and managed in accordance with the Prudent Investor Rule. Total portfolio risk is regularly evaluated and compared to that of the plan’s policy target allocation and judged on a relative basis over a market cycle. The following asset allocation policy and ranges have been established in accordance with the overall risk and return objectives of the portfolio:

 

     Policy

    As of 12/31/04

    Permitted Range

 

Total Equity

   70 %   74 %   50-80 %

Total Fixed Income

   30 %   26 %   20-50 %

 

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In accordance with the investment policy, the portfolio will invest in high quality, large and small capitalization companies traded on national exchanges, and investment grade securities. The investment managers will not write or buy options for speculative purposes; securities may not be margined or sold short. The manager may employ futures or options for the purpose of hedging exposure, will not purchase unregistered sectors, private placements, partnerships or commodities.

 

11) SEGMENT REPORTING

 

Our reportable operating segments consist of acute care hospital services (includes hospitals located in the U.S. and excludes hospitals reported as discontinued operations), behavioral health care services and international acute care hospital services consisting of fourteen hospitals located in France. The “Other” segment column below includes centralized services including information services, purchasing, reimbursement, accounting, taxation, legal, advertising, design and construction, and patient accounting as well as the operating results for our other operating entities including outpatient surgery and radiation centers. Also included in the Other segment column for all periods presented are the combined assets of $132.9 million, $200.0 million and $210.2 million as of December 31, 2004, 2003 and 2002, respectively, related to the acute care facilities reflected as discontinued operations on our Consolidated Statements of Income. The chief operating decision making group for our acute care hospital services, behavioral health care services and international acute care hospital services is comprised of the President and Chief Executive Officer, and the lead executives of each operating segment. The lead executive for each operating segment also manages the profitability of each respective segment’s various facilities. The operating segments are managed separately because each operating segment represents a business unit that offers different types of healthcare services or operates in different healthcare environments. The accounting policies of the operating segments are the same as those described in the summary of significant accounting policies included in this Annual Report on Form 10-K for the year ended December 31, 2004.

 

2004


   Acute Care
Hospital
Services


   Behavioral
Health
Services


   International

   Other

    Total
Consolidated


     (Dollar amounts in thousands)

Gross inpatient revenues

   $ 6,732,660    $ 1,238,131    $ 217,402    $ —       $ 8,188,193

Gross outpatient revenues

   $ 2,544,891    $ 177,360    $ 58,139    $ 100,536     $ 2,880,926

Total net revenues

   $ 2,897,719    $ 698,772    $ 291,396    $ 50,433     $ 3,938,320

Income/(loss) before income taxes

   $ 245,155    $ 129,804    $ 15,185    $ (119,001 )   $ 271,143

Total assets

   $ 1,961,252    $ 417,331    $ 319,807    $ 324,453     $ 3,022,843

Licensed beds

     5,645      4,225      1,588      —         11,458

Available beds

     4,860      4,145      1,588      —         10,593

Patient days

     1,150,882      1,234,152      442,825      —         2,827,859

Admissions

     251,655      94,743      94,536      —         440,934

Average length of stay

     4.6      13.0      4.7      —         6.4

 

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2003


   Acute Care
Hospital
Services


   Behavioral
Health
Services


   International

   Other

    Total
Consolidated


     (Dollar amounts in thousands)

Gross inpatient revenues

   $ 5,658,490    $ 1,091,885    $ 191,659    $ —       $ 6,942,034

Gross outpatient revenues

   $ 1,985,040    $ 156,115    $ 24,502    $ 108,716     $ 2,274,373

Total net revenues

   $ 2,499,550    $ 612,404    $ 228,231    $ 51,321     $ 3,391,506

Income/(loss) before income taxes

   $ 294,778    $ 120,520    $ 7,094    $ (116,096 )   $ 306,296

Total assets

   $ 1,608,345    $ 302,694    $ 234,594    $ 627,097     $ 2,772,730

Licensed beds

     4,792      3,894      1,433      —         10,119

Available beds

     4,119      3,762      1,433      —         9,314

Patient days

     1,032,348      1,067,200      409,860      —         2,509,408

Admissions

     227,932      87,688      82,364      —         397,984

Average length of stay

     4.5      12.2      5.0      —         6.3

 

2002


   Acute Care
Hospital
Services


   Behavioral
Health
Services


   International

   Other

    Total
Consolidated


     (Dollar amounts in thousands)

Gross inpatient revenues

   $ 4,893,198    $ 979,824    $ 82,166    $ —       $ 5,955,188

Gross outpatient revenues

   $ 1,657,418    $ 149,604    $ 10,230    $ 74,803     $ 1,892,055

Total net revenues

   $ 2,292,417    $ 565,585    $ 97,937    $ 35,980     $ 2,991,919

Income/(loss) before income taxes

   $ 269,962    $ 93,593    $ 7,331    $ (105,733 )   $ 265,153

Total assets

   $ 1,237,368    $ 259,010    $ 150,276    $ 682,483     $ 2,329,137

Licensed beds

     4,801      3,752      1,083      —         9,636

Available beds

     3,966      3,608      1,083      —         8,657

Patient days

     1,013,395      1,005,882      319,100      —         2,338,377

Admissions

     224,286      84,348      63,781      —         372,415

Average length of stay

     4.5      11.9      5.0      —         6.3

 

12) QUARTERLY RESULTS (unaudited)

 

The following tables summarize the quarterly financial data for the two years ended December 31, 2004:

 

     (000s, except per share amounts)

2004


   First
Quarter


   Second
Quarter


   Third
Quarter


   Fourth
Quarter


Net revenues

   $ 982,576    $ 982,560    $ 978,348    $ 994,836

Income before income taxes

   $ 72,395    $ 74,731    $ 62,165    $ 61,852

Income from continuing operations

   $ 45,582    $ 47,068    $ 39,237    $ 38,119

Net income

   $ 46,183    $ 48,289    $ 37,846    $ 37,174

Earnings per share - basic

   $ 0.80    $ 0.84    $ 0.65    $ 0.64

Earnings per share - diluted

   $ 0.74    $ 0.78    $ 0.62    $ 0.61

 

Net revenues in 2004 include $39.3 million of additional revenues received from Medicaid disproportionate share hospital (“DSH”) funds in Texas and South Carolina. Of this amount, $10.5 million was recorded in the first quarter, $7.1 million in the second quarter, $8.7 million in the third quarter and $13.0 million in the fourth quarter. These amounts were recorded in periods that we met all

 

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of the requirements to be entitled to these reimbursements. Included in our results during the first quarter is $2.8 million of pre-tax ($1.7 million or $.02 per diluted share, net of taxes) South Carolina DSH revenue attributable to a prior period. Included in our third quarter results is a $2.3 million pre-tax property write-down ($1.5 million or $.02 per diluted share net of taxes) resulting from property damage caused by a hurricane. Included in our fourth quarter results is $11.6 million pre-tax reversal of previously recorded stock grant amortization expense ($7.3 million or $.11 per diluted share net of taxes) related to restricted shares granted to our Chief Executive Officer that were contingent on an earnings threshold which was not achieved.

 

     (000s, except per share amounts)

2003


   First
Quarter


   Second
Quarter


   Third
Quarter


   Fourth
Quarter


Net revenues

   $ 831,990    $ 840,149    $ 832,080    $ 887,287

Income before income taxes

   $ 82,751    $ 80,878    $ 70,216    $ 72,451

Income from continuing operations

   $ 52,178    $ 50,649    $ 44,005    $ 45,247

Net income

   $ 52,790    $ 50,950    $ 49,061    $ 46,468

Earnings per share – basic

   $ 0.91    $ 0.88    $ 0.86    $ 0.81

Earnings per share - diluted

   $ 0.84    $ 0.82    $ 0.79    $ 0.75

 

Net revenues in 2003 include $27.8 million of additional revenues received from Medicaid disproportionate share hospital (“DSH”) funds in Texas and South Carolina. Of this amount, $6.3 million was recorded in the first quarter, $7.0 million in the second quarter, $8.1 million in the third quarter and $6.4 million in the fourth quarter. These amounts were recorded in periods that we met all of the requirements to be entitled to these reimbursements. Included in our results during the third quarter is a $7.8 million pre-tax gain ($4.4 million, net of taxes and minority interest expense) recorded on the sale of three radiation therapy centers and three medical office buildings. Included in our results during the fourth quarter is a net pre-tax increase to income of $1.9 million ($1.2 million or $.02 per diluted share, net of taxes) consisting of the following: (i) a pre-tax increase of $8.8 million ($5.6 million or $.08 per diluted share, net of taxes) resulting from the reversal of an accrued liability (including accrued interest) due to a favorable Texas Supreme Court decision which reversed an unfavorable 2000 jury verdict and 2001 appellate court decision; (ii) a pre-tax increase of $6.8 million ($4.3 million or $.07 per diluted share, net of taxes) resulting from a gain realized on the disposition of an investment in a health-care related company, and; (iii) a pre-tax charge of $13.7 million ($8.7 million or $.13 per diluted share, net of taxes) resulting from the write-down of the carrying value of an acute care pediatric hospital located in Puerto Rico to its estimated realizable value.

 

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UNIVERSAL HEALTH SERVICES, INC AND SUBSIDIARIES

 

SCHEDULE II—VALUATION AND QUALIFYING ACCOUNTS

 

    

Balance

at
beginning
of

Period


  

Additions


  

Write-Off of
Uncollectible
Accounts


   

Assets

divested or
transferred

to

facilities
held-for- sale


   

Balance
at End of
Period


     

Charges

to Costs
and
Expenses


  

Acquisitions
of

Business


      
     (000s)

Description

                                           

ALLOWANCE FOR DOUBTFUL ACCOUNTS RECEIVABLE:

                                           

Year ended December 31, 2004

   $ 56,371    $ 307,163    $ 14,448    $ (302,071 )   $ (4,530 )   $ 71,381
    

  

  

  


 


 

Year ended December 31, 2003

   $ 59,144    $ 263,724    $ 293    $ (266,790 )     —       $ 56,371
    

  

  

  


 


 

Year ended December 31, 2002

   $ 61,108    $ 231,362    $ 6,260    $ (239,586 )     —       $ 59,144
    

  

  

  


 


 

 

Included in the charges to costs and expenses are $11,080 and $12,415 for 2003 and 2002, respectively, related to assets divested or transferred to facilities held-for-sale.

 

103

Agreement, effective January 1, 2005, to renew Advisory Agreement

Exhibit 10.3

 

December 31, 2004

 

Mr. Alan B. Miller

President

UHS of Delaware, Inc.

367 South Gulph Road

King of Prussia, PA 19406

 

Dear Alan:

 

The Board of Trustees of Universal Health Realty Income Trust, at their December 1, 2004 meeting, authorized the renewal of the current Advisory Agreement between the Trust and UHS of Delaware, Inc. (“Agreement”) upon the same terms and conditions.

 

This letter constitutes the Trust’s offer to renew the Agreement, until December 31, 2005, upon the same terms and conditions. Please acknowledge UHS of Delaware’s acceptance of this offer by signing in the space provided below and returning one copy of this letter to me.

 

Sincerely,

/s/ Charles F. Boyle


Vice President, Chief Financial Officer and Controller

 

cc: Warren J. Nimetz, Esq.

Cheryl K. Ramagano

 

Agreed to and Accepted:

 

UHS OF DELAWARE, INC.

 

By:  

/s/ Alan B. Miller


    President
Amended and Restated 2001 Employees' Restricted Stock Purchase Plan

Exhibit 10.29

 

AMENDED AND RESTATED

2001 EMPLOYEES’ RESTRICTED STOCK PURCHASE PLAN

 

1. Purpose. The purpose of this 2001 Employees’ Restricted Stock Purchase Plan (the “Plan”), is to secure for Universal Health Services, Inc. (the “Company”) the benefits of the additional incentive resulting from the ownership of its Shares of Class B Common Stock, par value $.01 per share (the “Shares”), by selected employees of, and consultants to, the Company or its subsidiaries (for convenience such persons are hereinafter collectively referred to as “employees”) who are important to the success and the growth of the business of the Company and its subsidiaries, and to help the Company and its subsidiaries secure and retain the services of such persons.

 

2. Restricted Stock Committee. The Plan will be administered by the compensation committee of the Company’s Board of Directors (the “Board”), or such other committee of directors designated by the Board (the “Committee”), provided that all of said designated directors qualify as “non-employee directors” (within the meaning of Rule 16b-3(b)(3) under the Securities Exchange Act of 1934, as amended) and as “outside directors” (within the meaning of Treas. Reg. Section 1.162-27(e)(3)).

 

3. Shares Subject to Plan. Subject to the adjustment provisions of paragraph 9, the number of shares of Class B Common Stock which may be issued or sold under the Plan shall not exceed 1,200,000.

 

Shares sold under the Plan may be Shares of the Company’s authorized and unissued Shares of Class B Common Stock, Shares of the Company’s issued Shares of Class B Common Stock held in the Company’s treasury, or both. Should any Shares sold pursuant to the Plan be repurchased by the Company, such Shares shall again become available for sale hereunder. Subject to adjustment under paragraph 9, the number of shares of Class B Common Stock which may be issued or sold under the Plan to any employee during any calendar year shall not exceed 400,000.

 

4. Employees Eligible. Shares may be sold pursuant to the Plan to all employees and consultants of the Company and its subsidiaries (including officers of the Company or any of its subsidiaries whether or not they are also directors of the Company or any of its subsidiaries). For purposes of the Plan, “subsidiary” shall mean a “subsidiary corporation” as defined in Section 424 of the Internal Revenue Code of 1986, as amended. In making determinations as to whom Shares should be sold, the Committee shall take into consideration an employee’s present and potential contribution to the success of the Company and its subsidiaries and such other factors as the Committee may deem proper and relevant.

 

5. Purchase of Shares, Price and Delivery of Payment. Subsequent to a determination by the Committee that Shares shall be sold pursuant to the Plan, the Company or a subsidiary shall deliver to the employee a letter advising him of such determination. Within 30 days of the date of such letter, the employee must complete


the Restricted Stock Purchase Agreement enclosed therewith and return it to the Company along with payment in full by cash or check. The price of each Share sold pursuant to the Plan shall be the par value thereof at the time of sale. Prior delivery by an employee to the Company of a completed Restricted Stock Purchase Agreement and payment in full for the Shares, the Committee may, at its discretion, revoke its decision to sell Shares to an employee.

 

6. Restrictions. All Shares sold pursuant to the Plan shall be sold subject to a Restricted Stock Purchase Agreement which gives the Company the right to repurchase all or a portion of such Shares, for an amount equal to the price paid by the employee, in the event that his employment terminates for any reason during the period set forth in such Restricted Stock Purchase Agreement. Each employee shall also be required to agree that all Shares purchased by him pursuant to the Plan are purchased for investment purposes and not for the purpose of resale or other distribution thereof.

 

Notwithstanding the foregoing, in the event that an employee of the Company or one of its subsidiaries who has purchased Shares under the plan terminates his employment with such employer and immediately commences employment with the Company or a different subsidiary thereof, such event shall not be treated as a termination of employment under the Plan, and the Company’s repurchase rights with respect to such Shares shall not be affected. Upon the termination of employment in such cases, the Restricted Stock Purchase Agreement entered into between such employee and his employer shall be cancelled and, upon the commencement of employment with his new employer, the employee and his new employer shall enter into a new Restricted Stock Purchase Agreement.

 

6A. Performance-Based Awards. The provisions of this paragraph 6A will apply to awards under the Plan that are intended to generate “qualified performance-based compensation” within the meaning of Section 162(m) of the Internal Revenue Code of 1986, as amended (the “Code”). Awards made under this paragraph will be interpreted and construed accordingly.

 

(a) Shares issued or sold pursuant to this paragraph 6A shall be subject to such performance-based conditions as the Committee deems appropriate, consistent with the requirements of this paragraph and Section 162(m) of the Code. A performance condition established by the Committee in connection with a sale or issuance of Shares pursuant to this paragraph must be (1) objective, so that a third party having knowledge of the relevant facts could determine whether the condition is met, (2) prescribed in writing by the Committee before the beginning of the applicable performance period or at such later date (when fulfillment is substantially uncertain) as may be permitted under Section 162(m) of the Code, and (3) based on one or more of the following performance criteria:

 

(i) attainment of certain target levels of, or a specified percentage increase in, revenues, income before income taxes and extraordinary items, net income, earnings before income tax, earnings before interest, taxes, depreciation and amortization or a combination of any or all of the foregoing;


(ii) attainment of certain target levels of, or a percentage increase in, after-tax or pre-tax profits;

 

(iii) attainment of certain target levels of, or a specified increase in, operational cash flow;

 

(iv) achievement of a certain level of, reduction of, or other specified objectives with regard to limiting the level of increase in, all or a portion of, the Company’s bank debt or other long-term or short-term public or private debt or other similar financial obligations of the Company, which may be calculated net of such cash balances and/or other offsets and adjustments as may be established by the Committee;

 

(v) attainment of a specified percentage increase in earnings per share or earnings per share from continuing operations;

 

(vi) attainment of certain target levels of, or a specified increase in return on capital employed or return on invested capital;

 

(vii) attainment of certain target levels of, or a percentage increase in, after-tax return on stockholders’ equity;

 

(viii) attainment of certain target levels of, or a specified increase in, economic value added targets based on a cash flow return on investment formula;

 

(ix) attainment of certain target levels in the fair market value of the shares of the Company’s Common Stock; and

 

(x) growth in the value of an investment in the Company’s Common Stock assuming the reinvestment of dividends.

 

If and to the extent permitted under Section 162(m) of the Code, performance conditions may be determined without regard to (or adjusted for) changes in accounting methods, corporate transactions (including, without limitation, dispositions and acquisitions) and other similar types of events or circumstances occurring during the applicable performance period. The Committee may not delegate any responsibility with respect to the establishment or certification of the achievement of performance conditions to which awards covered by this paragraph are subject.


(b) Upon the expiration of the performance period applicable to a performance-based award, the Committee will certify in writing the extent to which the performance conditions applicable to the award and any other material terms were in fact achieved and the percentage of such award that has been earned.

 

(c) No sale or issuance of Shares pursuant to this paragraph 6A may be made on or after the date of the first meeting of stockholders of the Company (or any adjournment or postponement thereof) in 2009.

 

7. Transferability. No Shares subject to repurchase by the Company may be sold, assigned, transferred, disposed of, pledged or otherwise hypothecated, by the purchase of such Shares. Any attempt to do any of the foregoing shall cause the immediate forfeiture of such Shares.

 

8. Right to Terminate Employment or Service. Nothing in the Plan or in any Restricted Stock Purchase Agreement shall confer upon any employee the right to continue in the employment of the Company or affect the right of the Company to terminate the employee’s employment at any time, subject, however, to the provisions of any agreement of employment between the Company and the employee.

 

9. Adjustment Upon Changes in Capitalization, etc. In the event of one or more stock splits, reverse stock splits, stock dividends, reclassifications, recapitalizations or any other change in the character or amount of the Company’s Shares, the number, kind and purchase price of Shares which may thereafter be sold under the Plan and the number of Shares that may be issued or sold to any individual employee during any calendar year shall be adjusted as determined by the Board, in its sole discretion, to give effect thereto, and all new, substituted or additional securities to which any employee may become entitled by reason of his ownership of Shares previously purchased or issued pursuant to the Plan shall be subject to the terms of the Plan and the Restricted Stock Purchase Agreement under which such Shares were purchased or issued.

 

10. Amendment or Termination of Plan. The Board of Directors shall have the authority to amend or terminate the Plan at any time; provided, however, that no such amendment or termination shall adversely affect the rights of any employee with respect to Shares previously sold hereunder. Notwithstanding the above, no amendment to the Plan will become effective without the approval of the company’s stockholders which would increase the number of shares which may be issued under the Plan if and to the extent such approval is necessary or desirable to comply with applicable law or exchange requirements.

 

11. Expiration of the Plan. Unless sooner terminated by the Board of Directors, shares may be sold under the Plan at any time and from time to time, prior to March 7, 2010. Any Shares sold under the Plan that remain outstanding on or after such expiration date shall remain subject to the terms of the Plan until any restrictions thereon have lapsed or they have been repurchased by the Company.


12. Effective Date of Plan. The Plan shall become effective on March 7, 2001, subject, nevertheless, to approval by the Stockholders representing at least a majority of the Common Stock votes of the Company present or represented at the 2001 Annual Meeting of Stockholders.

Subsidiaries of Registrant

Exhibit 22

 

Name of Subsidiary


  

Judisdiction of Incorporation


ASC Property Management, Inc.

   Louisiana

ASC of Aiken, Inc.

   Delaware

ASC of Brownsville, Inc.

   Delaware

ASC of Corona, Inc.

   California

ASC of East New Orleans, Inc.

   Delaware

ASC of Las Vegas, Inc.

   Nevada

ASC of Louisiana, Inc.

   Louisiana

ASC of Midwest City, Inc.

   Oklahoma

ASC of Palm Springs, Inc.

   California

ASC of Puerto Rico, Inc.

   Delaware

ASC of Reno, Inc.

   Nevada

ASC of Springfield, Inc.

   Missouri

ASC of St. George, Inc.

   Utah

ASC of Wellington, Inc.

   Florida

Aiken Regional Medical Centers, Inc.

   South Carolina

Alliance PPO, Inc.

   Texas

Ambulatory Surgery Center of Brownsville, L.P.

   Delaware

Ambulatory Surgical Center of Aiken, L.L.C.

   South Carolina

Arbour Elder Services, Inc.

   Massachusetts

Arbour Health Systems Foundation, Inc.

   Massachusetts

Arkansas Surgery Center of Fayetteville, Limited Partnership

   Arkansas

Auburn Regional Medical Center, Inc.

   Washington

Behavioral Healthcare Alliance, LLC

   Kentucky

Bon Secours SCI

   France

Bowling Green Radiation Therapy Associates, L.L.P.

   Kentucky

CSJ SAS

   France

Capitol Radiation Therapy, L.L.P.

   Kentucky

Central Montgomery Medical Center, L.L.C.

   Pennsylvania

Chalmette Medical Center, Inc.

   Louisiana

Choate Health Management, Inc.

   Massachusetts

Choate Integrated Behavioral Healthcare Corporation

   Massachusetts

Choate Mental Health Center, Inc.

   Massachusetts

Cie Financiere & Immobiliere Medicale SAS

   France

Clinique Ambroise Pare SA

   France

Clinique Bon Secours SA

   France

Clinique Investissement SAS

   France

Clinic Management Services GIE

   France

Clinique Pasteur SA

   France

Clinique Paul Doumer SA

   France

Clinique Richelieu SAS

   France

Clinique Saint Augustin SAS

   France

Clinique de Bercy SAS

   France

Clinique du Louvre SA

   France

Community Behavioral Health, L.L.C.

   Delaware

Comprehensive Occupational and Clinical Health, Inc.

   Florida

Contemporary Physician Services, Inc.

   Texas

Del Amo Hospital, Inc.

   California

District Hospital Partners, L.P.

   District of Columbia

Doctors’ Hospital of Shreveport, Inc.

   Louisiana

Edinburg Ambulatory Surgical Center, Inc.

   Texas

Edinburg Holdings, Inc.

   Delaware

Edinburg Surgery Center, L.P.

   Delaware

Eye Surgery Specialists of Puerto Rico, L.L.C.

   Delaware

Forest View Psychiatric Hospital, Inc.

   Michigan


Name of Subsidiary


  

Judisdiction of Incorporation


Fort Duncan Medical Center, Inc.

   Delaware

Fort Duncan Medical Center, L.P.

   Delaware

Frontline Behavioral Health, Inc.

   Delaware

Frontline Children’s Hospital, L.L.C.

   Delaware

Frontline Counseling Centers, LLC

   Delaware

Frontline Hospital, LLC

   Delaware

Frontline Residential Treatment Center, LLC

   Delaware

Glen Oaks Hospital, Inc.

   Texas

Gulph Mills Insurance Limited

   Nevada

HRI Clinics, Inc.

   Massachusetts

HRI Hospital, Inc.

   Massachusetts

Health Care Finance & Construction Corp.

   Delaware

Hôpital Clinique Claude Bernard SA

   France

Immobilere de la Clinique Richelieu SAS

   France

La Amistad Residential Treatment Center, Inc.

   Florida

Lakewood Ranch Imaging Center, L.L.C.

   Florida

Lakewood Ranch Medical Center Auxiliary, Incorporated

   Florida

Lancaster Hospital Corporation

   California

Laredo ASC, Inc.

   Texas

Laredo Holdings, Inc.

   Delaware

Laredo Providence Management, L.L.C.

   Texas

Laredo Regional Medical Center, L.P.

   Delaware

Laredo Regional, Inc.

   Delaware

Maison de Sante Pasteur SA

   France

Manatee Memorial Hospital, L.P.

   Delaware

McAllen Edinburg Health Care Network Physician Hospital Organization

   Texas

McAllen Heart Hospital, L.P.

   Texas

McAllen Holdings, Inc.

   Delaware

McAllen Hospitals, L.P.

   Delaware

McAllen Medical Center Foundation

   Texas

McAllen Medical Center Physicians, Inc.

   Texas

McAllen Medical Center, Inc.

   Delaware

Medi-Partenaires SAS

   France

Meridell Achievement Center, Inc.

   Texas

Merion Building Management, Inc.

   Delaware

Nevada Preferred Professionals, Inc.

   Nevada

Nevada Radiation Oncology Center-West, L.L.C.

   Nevada

Northern Nevada Ambulatory Surgical Center, L.L.C.

   Nevada

Northern Nevada Medical Center, L.P.

   Delaware

Northwest Texas Healthcare System, Inc.

   Texas

Northwest Texas Surgical Hospital, L.L.C.

   Texas

Nouvelle Clinique Villette SA

   France

Oasis Health Systems, L.L.C.

   Nevada

Pendleton Methodist Hospital, L.L.C.

   Delaware

Plaza Surgery Center Limited Partnership

   Nevada

Polyclinique Saint Jean Sarl

   France

Professional Probation Services, Inc.

   Georgia

Professional Surgery Corporation of Arkansas

   Arkansas

Providence ASC Management, L.L.C.

   Texas

Providence Hospital Real Estate, L.P.

   Texas

Providence Hospital, L.P.

   Texas

Pueblo Medical Center, Inc.

   Nevada

RCW of Edmond, Inc.

   Oklahoma


Name of Subsidiary


  

Judisdiction of Incorporation


Radiation Therapy Associates of California, L.L.C.    California

Radiation Therapy Medical Associates of Bakersfield, Professional Corporation

   California
Relational Therapy Clinic, Inc.    Louisiana
Renaissance Women’s Center of Austin, L.L.C.    Texas
Renaissance Women’s Center of Edmond, L.L.C.    Oklahoma
Ridge Outpatient Counseling, L.L.C.    Kentucky
River Crest Hospital, Inc.    Texas
River Oaks, Inc.    Louisiana
SCI Ambroise Paré    France
SCI Fonciere G    France
SCI Gravelle Bercy    France
SCI Saint-Augustin    France
Sante Finance SAS    France
Santé Investissement SCS    France
Sante Partenaires S.a.r.l.    Luxembourg
Socrate Sarl    France
Sparks Family Hospital, Inc.    Nevada
St. Louis Behavioral Medicine Institute, Inc.    Missouri
Ste D’Exploitation de la Clinique Montreal SA    France
Ste D’Exploitation de la Clinique Notre Dame SAS    France

Ste Nouvelle D’Exploitation de la Clinique Cardiologique D’Aressy SAS

   France
Stonington Behavioral Health, Inc.    Delaware
Summerlin Hospital Medical Center, L.L.C.    Delaware
Summerlin Hospital Medical Center, L.P.    Delaware
Surgery Center Property, L.L.C.    Delaware
Surgery Center at Wellington, L.L.C.    Florida
Surgery Center of Midwest City, L.P.    Delaware
Surgery Center of New Orleans East, L.L.C.    Delaware
Surgery Center of Springfield, L.P.    Delaware
Surgery Center of Waltham, Limited Partnership    Massachusetts
The Arbour, Inc.    Massachusetts
The Bridgeway, Inc.    Arkansas
The Friends of Wellington Regional Medical Center, Inc.    Florida
The Pavilion Foundation    Illinois
Tonopah Health Services, Inc.    Nevada
Trenton Street Corporation    Texas
Turning Point Care Center, Inc.    Georgia
Two Rivers Psychiatric Hospital, Inc.    Delaware
UHS Advisory, Inc.    Delaware
UHS Behavioral Health Services, L.L.C.    Massachusetts
UHS Broadlane Holdings L.P.    Delaware
UHS Good Samaritan, L.L.C.    Delaware
UHS Health Partners S.a.r.l.    Luxembourg
UHS Holding Company, Inc.    Nevada
UHS International, Inc.    Delaware
UHS Ireland Limited    Ireland
UHS Las Vegas Properties, Inc.    Nevada
UHS Managed Care Operations, L.L.C.    Pennsylvania
UHS Midwest Center for Youth and Families, Inc.    Indiana
UHS Receivables Corp.    Delaware
UHS Recovery Foundation, Inc.    Pennsylvania
UHS of Anchor, L.P.    Delaware


Name of Subsidiary


  

Judisdiction of Incorporation


UHS of Benton Day School and Treatment Program, Inc.

   Delaware

UHS of Benton, Inc.

   Delaware

UHS of Bowling Green, Inc.

   Delaware

UHS of Bradenton, Inc.

   Florida

UHS of D.C., Inc.

   Delaware

UHS of Delaware, Inc.

   Delaware

UHS of Eagle Pass, Inc.

   Delaware

UHS of Fairmount, Inc.

   Delaware

UHS of Fayetteville, Inc.

   Arkansas

UHS of Fuller, Inc.

   Massachusetts

UHS of Georgia Holdings, Inc.

   Delaware

UHS of Georgia, Inc.

   Delaware

UHS of Greenville, Inc.

   Delaware

UHS of Hampton Learning Center, Inc.

   New Jersey

UHS of Hampton, Inc.

   New Jersey

UHS of Hartgrove, Inc.

   Illinois

UHS of Indiana, Inc.

   Indiana

UHS of Indianapolis, Inc.

   Indiana

UHS of Lakeside, Inc.

   Delaware

UHS of Lakewood Ranch, Inc.

   Florida

UHS of Laurel Heights, L.P.

   Delaware

UHS of Manatee, Inc.

   Florida

UHS of New Orleans, Inc.

   Louisiana

UHS of Odessa, Inc.

   Texas

UHS of Oklahoma, Inc.

   Oklahoma

UHS of Parkwood, Inc.

   Delaware

UHS of Peachford, L.P.

   Delaware

UHS of Pennsylvania, Inc.

   Pennsylvania

UHS of Provo Canyon, Inc.

   Delaware

UHS of Puerto Rico, Inc.

   Delaware

UHS of Ridge, Inc.

   Delaware

UHS of River Parishes, Inc.

   Louisiana

UHS of Rockford, Inc.

   Delaware

UHS of Savannah, L.L.C.

   Delaware

UHS of Spring Mountain, Inc.

   Delaware

UHS of Talbot, L.P.

   Delaware

UHS of Timberlawn, Inc.

   Texas

UHS of Waltham, Inc.

   Massachusetts

UHS of Westwood Pembroke, Inc.

   Massachusetts

UHS-Corona, Inc.

   Delaware

UHS-Lakeland Medical Center, L.L.C.

   Delaware

UHSMS, Inc.

   Delaware

Universal Community Behavioral Health, Inc.

   Pennsylvania

Universal HMO, Inc.

   Nevada

Universal Health Network, Inc.

   Nevada

Universal Health Recovery Centers, Inc.

   Pennsylvania

Universal Health Services of Cedar Hill, Inc.

   Texas

Universal Health Services of Concord, Inc.

   California

Universal Health Services of Palmdale, Inc.

   Delaware

Universal Health Services of Rancho Springs, Inc.

   California

Universal Probation Services, Inc.

   Georgia

Universal Treatment Centers, Inc.

   Delaware

Valley Health System, L.L.C.

   Delaware

Valley Hospital Medical Center, Inc.

   Nevada


Name of Subsidiary


  

Judisdiction of Incorporation


Valley Surgery Center, L.P.

   Delaware

Victoria Regional Medical Center, Inc.

   Texas

Vista Diagnostic Center, L.L.C.

   Nevada

Wellington Physician Alliances, Inc.

   Florida

Wellington Regional Diagnostic Center, L.L.C.

   Florida

Wellington Regional Health & Education Foundation, Inc.

   Florida

Wellington Regional Medical Center Incorporated

   Florida
Consent of Independent Registered Public Accounting Firm

Exhibit 23.1

 

CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

To the Board of Directors of Universal Health Services, Inc.:

 

We consent to the incorporation by reference in the Registration Statements (File Nos. 333-119925, 333-119143, 333-112332, 333-46384, 33-49428, 33-51671, 33-63291, 333-13453, 333-63926, 333-112332 and 333-122188) on Form S-8 and the Registration Statements (File Nos. 333-46098, 333-85781, 333-59916) on Form S-3 of Universal Health Services, Inc. our reports dated March 14, 2005, with respect to the consolidated balance sheets of Universal Health Services, Inc. as of December 31, 2004 and 2003, and the related consolidated statements of income, common stockholders’ equity and cash flows for each of the years in the three-year period then ended, and related financial statement schedule, management’s assessment of the effectiveness of internal control over financial reporting as of December 31, 2004 and the effectiveness of internal control over financial reporting as of December 31, 2004, which reports appear in the December 31, 2004 annual report on Form 10-K of Universal Health Services, Inc.

 

Our report dated March 14, 2005, on management’s assessment of the effectiveness of internal control over financial reporting and the effectiveness of internal control over financial reporting as of December 31, 2004, contains an explanatory paragraph that states facilities acquired during 2004, as identified in Note 2 to the consolidated financial statements, have been excluded from management’s assessment. Our audit of internal control over financial reporting of Universal Health Services Inc. also excluded an evaluation of the internal control over financial reporting of facilities acquired during 2004.

 

/s/ KPMG LLP

 

Philadelphia, Pennsylvania

March 14, 2005

Section 302 CEO Certification

Exhibit 31.1

 

CERTIFICATION - Chief Executive Officer

 

I, Alan B. Miller, certify that:

 

1. I have reviewed this annual report on Form 10-K of Universal Health Services, Inc.;

 

2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;

 

3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;

 

4. The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal controls over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and we have:

 

a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervison to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;

 

b) designed such internal controls over financial reporting, or caused such internal controls over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principals;

 

c) evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report, based on such evaluation;


d) disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

 

5. The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):

 

a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

 

b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls over financial reporting.

 

Date: March 16, 2005

 

/s/ Alan B. Miller


President and Chief Executive Officer

Section 302 CFO Certification

Exhibit 31.2

 

CERTIFICATION-Chief Financial Officer

 

I, Steve Filton, certify that:

 

1. I have reviewed this annual report on Form 10-K of Universal Health Services, Inc.;

 

2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;

 

3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;

 

4. The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal controls over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and we have:

 

a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervison to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;

 

b) designed such internal controls over financial reporting, or caused such internal controls over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principals;

 

c) evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report, based on such evaluation; and


d) disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

 

5. The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):

 

a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize

 

b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls over financial reporting.

 

Date: March 16, 2005

 

/s/ Steve Filton


Senior Vice President and Chief

Financial Officer

Section 906 CEO Certification

EXHIBIT 32.1

 

CERTIFICATION PURSUANT TO

18 U.S.C. SECTION 1350,

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

 

In connection with the Annual Report of Universal Health Services, Inc. (the “Company”) on Form 10-K for the year ended December 31, 2004, as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Alan B. Miller, President and Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. § 1350, as adopted pursuant to § 906 of the Sarbanes-Oxley Act of 2002, and to the best of my knowledge, that:

 

(1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

 

(2) The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company at the end of, and for the period covered by, the Report.

 

/s/ Alan B. Miller


President and Chief Executive Officer

March 16, 2005

 

A signed original of this written statement required by Section 906 has been provided to Universal Health Services, Inc. and will be retained and furnished to the Securities and Exchange Commission or its staff upon request.

Section 906 CFO Certification

EXHIBIT 32.2

 

CERTIFICATION PURSUANT TO

18 U.S.C. SECTION 1350,

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

 

In connection with the Annual Report of Universal Health Services, Inc. (the “Company”) on Form 10-K for the year ended December 31, 2004, as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Steve Filton, Senior Vice President and Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. § 1350, as adopted pursuant to § 906 of the Sarbanes-Oxley Act of 2002, and to the best of my knowledge, that:

 

(1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

 

(2) The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company at the end of, and for the period covered by, the Report.

 

/s/ Steve Filton


Senior Vice President and Chief

Financial Officer

March 16, 2005

 

A signed original of this written statement required by Section 906 has been provided to Universal Health Services, Inc. and will be retained and furnished to the Securities and Exchange Commission or its staff upon request.