ITEM 1. BUSINESS
OVERVIEW
Province Healthcare Company owns and operates acute-care hospitals in attractive non-urban markets throughout the United States. The Company currently owns or leases 11 general acute care hospitals in seven states with a total of 808 licensed beds. The Company also provides management services to 51 primarily non-urban hospitals in 17 states with a total of 3,505 licensed beds. At all of their hospitals, the Company provides a wide range of both inpatient and outpatient services, along with a variety of locally-needed specialty services such as skilled nursing units and a range of rehabilitation care. The Company seeks to acquire hospitals that are either the sole or primary health care provider in the community, and then develop that facility into the hub of health care delivery for the area. After acquiring a hospital, the Company works with the local leadership team to improve the hospital's operating performance and to expand the range and scope of services provided to the community.
The Company's objective is to be the leading provider of high quality health care in selected non-urban markets. Accordingly, there is a specific target market for potential acquisitions, generally defined as follows: (i) the facility has a minimum service area population of 20,000 with a stable or growing employment and economic base; (ii) the facility is the sole or primary provider of health care services in the community; (iii) the facility has annual net patient revenue of at least $12.0 million; and (iv) the facility has the potential to benefit from the expertise and resources provided by Province. The Company's goal is to acquire annually two to four of the approximately 1,100 hospitals that fit the acquisition profile.
Following the acquisition of a hospital, the Company begins to implement a number of proven policies and procedures designed to improve the efficiency of the hospital's operations and maximize its financial performance. The Company's operating strategy is built on four foundational points: (i) expand the range and scope of services available in the local market to better serve the community and increase market share; (ii) improve hospital operations by implementing appropriate expense controls, maintaining appropriate staffing levels through the facility, reducing supply costs, and renegotiating certain vendor contracts; (iii) recruit additional physicians to the community, both general practitioners and specialty physicians; and (iv) form strong relationships with local employers and regional tertiary health care providers to help insure the position of the local hospital as the focal point for the delivery of health care in the community.
Prior to its 1996 recapitalization and merger with PHC of Delaware, Inc. ("PHC"), the Company operated under the name Brim, Inc. ("Brim"). The current operations of the Company include the operations of Brim and PHC. Brim and its predecessors have provided health care services, including managing and operating non-urban hospitals, since the 1970s. PHC was founded in February 1996 by Golder, Thoma, Cressey, Rauner Fund IV, L.P. and Martin S. Rash
to acquire and operate hospitals in attractive non-urban markets. In December 1996, Brim was recapitalized (the "Recapitalization"). Subsequently, PHC merged with a subsidiary of Brim in a transaction accounted for as a reverse acquisition (the "Merger"). In connection with the Recapitalization, Mr. Rash and Richard D. Gore were elected as the senior management of the Company.
The Company's management team has extensive experience in acquiring poorly performing non-urban hospitals and improving their financial operations. Prior to co-founding PHC, Mr. Rash was the Chief Operating Officer of Community Health Systems, Inc. ("Community"), which acquires and operates non-urban hospitals. During Mr. Rash's tenure, Community acquired many non-urban hospitals and owned or leased 36 hospitals as of December 31, 1995. Mr. Gore was previously employed as Vice President and Controller of Quorum Health Group, Inc., which owns, operates and manages acute care hospitals. John M. Rutledge, the Company's Chief Operating Officer, was previously employed as a Regional Vice President/Group Director at Community. James Thomas Anderson, the Company's Senior Vice President of Acquisitions and Development, was previously a Vice President/Group Director at Community. Both Mr. Rutledge and Mr. Anderson reported directly to Mr. Rash while at Community.
THE NON-URBAN HEALTH CARE MARKET
According to United States Census Bureau statistics, just over a third of the people in the United States lives in counties with a population of less than 150,000. In these non-urban areas, hospitals are typically the primary resource for health care services, and in many cases the local hospital is the only provider of acute care services. As of October 1996, there were approximately 1,500 non-urban hospitals in the country, of which more than 1,100 were owned by not-for-profit or governmental entities.
The Company believes that these non-urban areas provide attractive markets. Because of the smaller population base, these areas generally only have one or two hospitals in each market, resulting in less competition. The resulting strong market position of the hospital(s) in these markets also limits the entry of alternate providers, such as outpatient surgery centers, rehabilitation facilities, or diagnostic imaging centers. The demographic characteristics and relative strength of the local hospital makes non-urban markets historically less attractive to HMOs and other forms of managed care. The Company also believes that non-urban communities generally are characterized by a high level of patient and physician loyalty that fosters a cooperative relationship between the hospital, physicians, patients, and the community.
While the non-urban health care market presents numerous opportunities, these hospitals recently have come under considerable pressure. The not-for-profit and governmental entities that typically own and operate these hospitals often have limited access to the capital required to keep pace with the rapid advances in medical technology and to make ongoing capital improvements. These hospitals also frequently lack the depth and range of management resources and expertise needed to control expenses, recruit needed physicians, and expand the range of programs and services. Additionally, the health care environment is extremely dynamic, with rapidly changing
regulations and laws. Collectively, this combination of factors may result in poor operating performance, a decline in the range of services available locally, a physician community that feels it cannot provide appropriate levels of care, and a community perception of subpar quality of care. As a result patients, by choice or physician direction, leave the community for care. This out migration often leads to a further downward spiral, both economically and through community perception, further limiting the hospital's ability to address the issues that initially led to these pressures.
As a result of these issues, not-for-profit and governmental hospitals increasingly are looking to sell or lease these hospitals to entities like the Company, that have the capital resources and the management expertise to better serve the community. The Company believes that a significant opportunity for consolidation exists in the non-urban health care market.
BUSINESS STRATEGY
The Company's objective is to be the leading provider of high quality health care services in selected non-urban markets. The key elements of the Company's strategy are to:
Acquire Hospitals in Attractive Non-Urban Markets. The Company seeks to acquire hospitals that are the sole or primary provider of health care services in their markets and that present the opportunity to increase profitability and local market share. Approximately 1,100 non-urban hospitals fit the Company's acquisition profile, and the Company's goal is to acquire two to four such hospitals each year.
Expand Breadth of Services to Increase Local Market Share. The Company seeks to provide additional health care services and programs in response to community needs. These services may include specialty inpatient services, outpatient services, home health care and mental health clinics. The Company also may make capital investments in technology and the physical plant to further improve both the quality of health care and the reputation of the hospital in the community. By providing a broader range of services and a more attractive care setting, the Company believes it can reduce patient migration and increase hospital revenues.
Improve Hospital Operations. Following the acquisition of a hospital, the Company augments local management with appropriate operational and financial managers and installs its standardized information system. The local management team implements appropriate expense controls, manages staffing levels according to patient volumes, reduces supply costs by requiring strict compliance with the Company's supply arrangements, and renegotiates certain vendor contracts.
Recruit Physicians. The Company believes that recruiting physicians to local communities is key to increasing the quality and breadth of health care. The Company works with the local hospital board, management and medical staff to determine the number and type of additional physicians needed in the community. The Company's corporate physician recruiting staff then assists the local management team in identifying and recruiting specific physicians to the community to meet those needs.
Develop Health Care Networks. The Company forms networks to address local employers' integrated health care needs and to solidify the position of the Company's hospitals as the focal point of their respective community's health care delivery system. As part of its efforts to develop these networks, the Company seeks relationships with regional tertiary care providers.
ACQUISITION PROGRAM
The Company's goal is to acquire two to four hospitals each year that are the sole or primary providers of health care services in attractive non-urban markets. The Company acquires hospital operations by purchasing hospitals or by entering into long-term leases. The Company targets acquisition candidates that: (i) have a minimum services area population of 20,000 with a stable or growing employment base; (ii) are the sole or primary providers of health care services in the community; (iii) have annual net patient revenue of at least $12.0 million; and (iv) have financial performance that will benefit from management's proven operating skills. There are approximately 1,100 hospitals in the United States that meet the Company's target criteria.
In addition to responding to requests for proposals from entities that are seeking to sell or lease a hospital, the Company proactively identifies acquisition targets. Also, the Company seeks to acquire selected hospitals to which it already provides contract management services. The Company also identifies attractive markets and hospitals and initiates meetings with hospital systems, comprised of one or more urban tertiary care hospitals and a number of non-urban hospitals, to discuss acquiring non-urban hospitals or operating them through a joint venture. Such joint ventures allow the health system to maintain an affiliation for providing tertiary care to the non-urban hospitals without the management responsibility.
The Company believes that it generally takes six to 12 months between the hospital owner's decision to accept offers and the consummation of a sale or lease. After a potential acquisition has been identified, the Company undertakes a systematic approach to evaluating and closing the transaction. The Company begins the acquisition process with a thorough due diligence review of the target hospital. The Company utilizes its dedicated teams of experienced personnel to conduct a formalized review of all aspects of the target's operations, including Medicare reimbursement, purchasing, fraud and abuse compliance, litigation, capital requirements, and environmental issues. During the course of its due diligence review, the Company prepares an operating plan for the target hospital, identifies opportunities for operating efficiencies and physician recruiting needs, and assesses productivity and management information systems. Throughout the process, the Company works closely with community leaders in order to enhance both the community's understanding of the Company's philosophy and abilities and the Company's knowledge of the needs of the community.
The competition to acquire non-urban hospitals is intense, and the Company believes that often the acquiror will be selected for a variety of reasons, not exclusively on the basis of price. The Company believes it is well positioned to compete for acquisitions for several reasons. The Company's management team has extensive experience in acquiring and operating previously under-performing non-urban hospitals. The Company also benefits from access to capital, strong
financial and operating systems, a national purchasing organization, and training programs. The Company believes its strategy of increasing access to, and quality of, health care in the communities served by its hospitals aligns its interests with those of the communities. The Company believes that the alignment of interests with the community, the Company's reputation for providing market-specific, high quality health care, and its focus on physician recruiting enable the Company to compete successfully for acquisitions.
During 1996, PHC purchased Memorial Mother Frances Hospital in Palestine, Texas and leased Starke Memorial Hospital in Knox, Indiana, and Brim leased Parkview Regional Hospital in Mexia, Texas. In August 1997, the Company leased Colorado River Medical Center. The Company provided management services to Parkview Regional Hospital and Colorado River Medical Center prior to their respective acquisitions.
On May 1, 1998, Province acquired Havasu Samaritan Regional Hospital in Lake Havasu City, Arizona, and on June 11, 1998, the Company acquired Elko General Hospital in Elko, Nevada. In December 1998, the Company exercised its option to purchase General Hospital in Eureka, California, which it had leased since 1986. In June 1998, the Company entered into a Lease and Management Agreement for Moosa Memorial Hospital (also known as Eunice Regional Medical Center) in Eunice, Louisiana, which the Company had managed since March 1998. The Company managed this hospital until the acquisition closed on February 22, 1999. Each of the six hospitals acquired by the Company, and three of the hospitals acquired by Brim prior to the Merger, have been acquired from not-for-profit or governmental entities.
HOSPITAL OPERATIONS
Following the acquisition of a hospital, the Company implements its systematic policies and procedures to improve the hospital's operating and financial performance. The Company implements an operating plan designed to reduce costs by improving operating efficiency and increasing revenue through the expansion of the breadth of services offered by the hospitals and the recruitment of physicians to the community. The Company also plans to form health care networks with employers in the community and regional tertiary care hospitals. Management believes that the long-term growth potential of a hospital is dependent on the Company's ability to add appropriate health care services and effectively recruit physicians.
Each hospital management team is comprised of a chief executive officer, chief financial officer and chief nursing officer. The Company believes that the quality of the local management team at each hospital is critical to the hospital's success, because the management team is responsible for implementing the elements of the Company's operating plan. The operating plan is developed by the local management team in conjunction with the Company's senior management team and sets forth revenue enhancement strategies and specific expense benchmarks. The Company has implemented a performance-based compensation program for each local management team based upon the achievement of the goals set forth in the operating plan.
While the local management team is responsible for the day-to-day operations of the hospitals, the Company's corporate staff provides support services to each hospital, including
physician recruiting, corporate compliance, reimbursement, standardized information systems, human resources, accounting, cash management and other finance activities, tax and insurance support. Financial controls are maintained through utilization of standardized policies and procedures. The Company promotes communication among its hospitals so that local expertise and improvements can be shared throughout the Company's network.
As part of the Company's efforts to improve access to high quality health care in the communities it serves, the Company adds appropriate services at its hospitals. Services and care programs added may include specialty inpatient services, such as cardiology, skilled nursing, rehabilitation and subacute care, and outpatient services such as same-day surgery. The Company also provides home health care services. Management believes the establishment of quality emergency room departments, obstetrics and gynecological services are particularly important, because they are often the most visible and needed services provided to the community. The Company also makes capital investments in technology and facilities to increase the quality and breadth of services available in the communities. By increasing the services provided at the Company's hospitals and upgrading the technology used in providing such services, the Company believes that it improves the quality of care and the hospitals' reputation in each community, which in turn may increase patient census and revenue.
To achieve the operating efficiencies set forth in the operating plan, the Company (i) evaluates existing hospital management; (ii) adjusts staffing levels according to patient volumes using best demonstrated practices by department; (iii) capitalizes on purchasing efficiencies and renegotiates certain vendor contracts; and (iv) installs a standardized management information system. The Company also enforces strict protocols for compliance with the Company's supply contracts. All of the Company's owned and leased hospitals currently purchase supplies and certain equipment pursuant to an arrangement between the Company and a large investor-owned hospital company. Vendor contracts also are evaluated, and based on cost comparisons, such contracts are either renegotiated or terminated. The Company prepares for the transition of management information systems to its standardized system prior to the completion of an acquisition, so that the newly-acquired hospital can typically begin using the Company's management information systems immediately following completion of the acquisition.
The Company works with local hospital boards, management and medical staff to determine the number and type of additional physicians needed in the community. The Company's corporate staff then assists the local management team in identifying and recruiting specific physicians to the community to meet those needs. The majority of physicians who relocate their practices to the communities served by the Company's hospitals are identified by the Company's internal physician recruiting staff, which is supplemented by the efforts of independent recruiting firms. When recruiting a physician to a community, the Company generally guarantees the physician a minimum level of revenue during a limited initial period and assists the physician with his or her transition to the community. The Company requires the physician to repay some or all of the amounts expended for such assistance in the event the physician leaves the community within a specified period. The Company prefers not to employ physicians, and relocating physicians rarely become employees of the Company.
Owned and Leased Hospitals
The Company currently owns or leases and operates 11 general acute care hospitals in California, Texas, Arizona, Colorado, Indiana, Nevada and Louisiana, with a total of 808 licensed beds. Nine of the Company's 11 hospitals are the only hospital in the town in which they are located. The owned and leased hospitals represented 88.8% and 92.3% of the Company's net operating revenues for the years ended December 31, 1997 and 1998, respectively.
The Company's hospitals offer a wide range of inpatient medical services such as operating/recovery rooms, intensive care units, diagnostic services and emergency room services, as well as outpatient services such as same-day surgery, radiology, laboratory, pharmacy services and physical therapy. The Company's hospitals also frequently provide certain specialty services which include skilled nursing, rehabilitation and home health care services. The Company's hospitals do not provide highly specialized surgical services such as organ transplants and open heart surgery and are not engaged in extensive medical research or educational programs.
The following table sets forth certain information with respect to each of the Company's owned and leased hospitals as of March 26, 1999:
- ---------------- (1) The lease expires in April 2014 and is subject to a five-year renewal term. The Company has a right of first refusal to purchase the hospital. (2) The lease expires in July 2012, and is subject to three five-year renewal terms. The Company has a right of first refusal to purchase the hospital. (3) The Company contractually has agreed to construct a replacement facility within 36 months of the acquisition date. This facility was acquired on June 11, 1998. (4) The lease expires in June 2008, and is subject to a five-year renewal option. The Company contractually has agreed to construct a replacement facility upon the hospital reaching a pre-determined level of net patient revenue; the existing lease would automatically terminate at the time the replacement hospital commences operations. (5) The lease had an expiration date of December 2000. The Company exercised its option to purchase the hospital in December 1998. (6) Includes a 20-bed skilled nursing facility. (7) The hospital is owned by a partnership of which a subsidiary of the Company is the sole general partner (with a 1.0% general partnership interest) and another subsidiary of the Company has a 94.0% limited partnership interest, subject to an option by the other limited partner to acquire an additional 5.0% interest. (8) Includes a 66-bed skilled nursing facility. (9) The lease expires in December 2002, and is subject to a ten-year renewal option. The Company has the option to purchase the hospital at any time prior to termination of the lease, subject to regulatory approval. (10) The lease expires in January 2011, and is subject to two five-year renewal terms. The Company has a right of first refusal to purchase the hospital. (11) The lease expires in September 2016, and is subject to two ten-year renewal options. The Company has a right of first refusal to purchase the hospital.
Colorado Plains Medical Center is located approximately 70 miles northeast of Denver and is the only hospital in town. The hospital is the only rural-based Level III trauma center in Colorado, and one of only 10 such rural centers in the United States. In 1997, Colorado Plains completed an $8.5 million expansion project that included expansion of surgery, recovery, emergency room and radiology facilities as well as a new entrance. The hospital provides home health services, and opened an inpatient rehabilitation unit in September 1998. The closest competing hospitals are located approximately 50 miles away. Colorado Plains is a sole community provider as designated under Medicare and has a service area population of approximately 43,000.
Colorado River Medical Center is located approximately 100 miles south of Las Vegas, Nevada and is the only hospital in town. The hospital purchased two home health agencies and opened an inpatient cardiac rehabilitation unit in August 1998. The hospital's primary competitor is located approximately 20 miles away. Colorado River is a sole community provider as designated under Medicare and has a service area population of approximately 47,000.
Elko General Hospital is located approximately 290 miles from Reno, Nevada and 225 miles from Salt Lake City, Utah, and is the largest hospital between those two cities. The Elko region has experienced rapid population growth over the last five years, with gold mining and gaming being the primary industries. The Company acquired this hospital on June 11, 1998 and expects to construct and open a replacement hospital facility within 36 months of the acquisition date. Elko is a sole community provider as designated under Medicare and has a service area population of approximately 65,000.
Eunice Regional Medical Center is located in Eunice, Louisiana and is the only hospital in town. The hospital is located 45 miles northeast of LaFayette, Louisiana and 70 miles west of Baton Rouge. The nearest competitor is located approximately 15 miles away. The hospital previously was managed by the Company. The hospital's service area population is approximately 20,000.
General Hospital is located approximately 300 miles north of San Francisco. The hospital also operates an ambulatory surgery center and a home health agency that are located near the hospital. The Company recently completed a renovation of General Hospital's obstetrical unit and opened a rehabilitation unit in September 1998. There is one other hospital in Eureka, and two small hospitals located 15 and 20 miles away. The nearest tertiary care hospitals are located approximately 160 miles away. General Hospital's service area population is approximately 122,000.
Havasu Samaritan Regional Hospital is located approximately 180 miles from Phoenix, Arizona and 130 miles from Las Vegas, Nevada, and is the only hospital in town. The hospital is located in the 16th fastest growing county in the United States, according to United States Census Bureau statistics. The Company acquired this hospital on May 1, 1998. The hospital currently provides general acute care, skilled nursing care, radiation, oncology and diagnostic services, including the recent addition of a cardiac catheterization lab. Havasu is a sole community provider as designated under Medicare and has a service area population of approximately 70,000.
Memorial Mother Frances Hospital is located approximately halfway between Dallas and Houston, and approximately 50 miles from Tyler, Texas. The hospital provides home health care, and operates rural health clinics. Recently 10 beds were added to its inpatient rehabilitation unit, thereby expanding unit capacity to 22 beds. Memorial Mother Frances Hospital has a relationship with a tertiary care hospital in Tyler. The hospital's primary competitor also is located in Palestine. The hospital's service area population is approximately 104,000.
Ojai Valley Community Hospital is located approximately 85 miles northeast of Los Angeles and is the only hospital in town. Along with its 50-bed acute care hospital, Ojai Valley has a 66-bed skilled nursing facility. In 1997, Ojai Valley purchased a home health business and opened a rural health clinic in a neighboring town. The hospital's primary competitors are located 18 to 20 miles away, but due to the geography and traffic conditions, such hospitals are 30 to 60 minutes away by vehicle. The hospital's service area population is approximately 30,000.
Palo Verde Hospital is located in southeast California near the Arizona border. It is 120 miles east of Palm Springs, California and is the only hospital in town. The hospital provides home health care, and opened an outpatient physical therapy department in 1998. The hospital's primary competitors are one small hospital located 45 miles away and two large hospitals located
approximately 100 miles away. Palo Verde Hospital is a sole community provider as designated under Medicare and has a service area population of approximately 20,000 that increases substantially during the winter months due to a seasonal inflow of residents.
Parkview Regional Hospital is located approximately 40 miles east of Waco, Texas and is the only hospital in town. In 1997, the hospital completed a $5.7 million expansion and renovation project which included a new emergency room and new radiology, surgery and inpatient rehabilitation departments. The hospital's primary competitors are hospitals located 35 to 40 miles away. The hospital's service area population is approximately 40,000.
Starke Memorial Hospital is located approximately 50 miles from South Bend, Indiana and is the only hospital in town. Starke Memorial's primary competitors are two large hospitals, located approximately 30 and 35 miles away. The hospital's service area population is approximately 25,000.
The Company also owns a 48,000 square foot office building in Portland, Oregon and leases approximately 26,600 square feet of office space for its corporate headquarters in Brentwood, Tennessee under a seven-year lease that expires on March 31, 2005 and contains customary terms and conditions.
Operating Statistics
The following table sets forth certain operating statistics for the Company's owned or leased hospitals for each of the periods presented.
(1) Average length of stay is calculated based on the number of patient days divided by the number of admissions. (2) Adjusted patient days have been calculated based on an industry-accepted revenue-based formula (multiplying actual patient days by the sum of gross inpatient revenue and gross outpatient revenue and dividing the result by gross inpatient revenue for each hospital) to reflect an approximation of the volume of service provided to inpatients and outpatients by converting total patient revenues to equivalent patient days.
(3) Percentages are calculated by dividing average daily census by average licensed beds. (4) Percentages are calculated by dividing average daily census by average beds in service.
Sources of Revenue
The Company receives payments for patient care from private insurance carriers, federal Medicare programs for elderly and disabled patients, HMOs, preferred provider organizations ("PPOs"), state Medicaid programs, the Civilian Health and Medical Program of the Uniformed Services ("CHAMPUS"), employers and patients directly. See "Item 7. Management's Discussion and Analysis of Results of Operations and Financial Condition."
The following table sets forth the percentage of the patient days of the Company's owned and leased hospitals (excluding the 66-bed skilled nursing facility at Ojai Valley Community Hospital) from various payors for the periods indicated. The data for the periods presented are not strictly comparable because of the significant effect that acquisitions have had on the Company. See "Item 7. Management's Discussion and Analysis of Results of Operations and Financial Condition."
All percentages in the table above exclude the 66-bed skilled nursing facility at Ojai Valley Community Hospital. Substantially all of the patient days at the Ojai Valley skilled nursing facility are provided by Medicaid. The Ojai Valley skilled nursing facility utilization is as follows:
Quality Assurance
The Company's hospitals implement quality assurance procedures to ensure a consistently high level of care. Each hospital has a medical director who supervises and is responsible for the quality of medical care provided. In addition, each hospital has a medical advisory committee comprised of physicians who review the professional credentials of physicians applying for medical staff privileges at the hospital. Medical advisory committees also review and monitor surgical outcomes along with procedures performed and the quality of the logistical, medical and
technological support provided to the physician. The Company surveys all of its patients either during their stay at the hospital or subsequently by mail to identify potential areas of improvement. All of the Company's hospitals are accredited by the Joint Commission on Accreditation of Health Care Organizations.
Regulatory Compliance Program
The Company has developed a corporate-wide compliance program overseen by a Vice President of Corporate Compliance. The Company's compliance program focuses on all areas of regulatory compliance, including physician recruitment, reimbursement and cost reporting practices, billing, health information management, laboratory and home health care operations. The Company has conducted on-site compliance training for all of the employees at its owned hospitals, corporate and management company entities. The Company also maintains a toll-free hotline to permit employees to report compliance concerns on an anonymous basis. The Company regularly monitors its corporate compliance program to respond to developments in health care regulation and the industry.
MANAGEMENT SERVICES
The Company's management services division provides comprehensive management services to 51 primarily non-urban hospitals in 17 states with a total of 3,505 licensed beds. These services are provided under three to five-year contracts with the Company. The Company generally provides a chief executive officer, who is an employee of the Company, and may also provide a chief financial officer. The Company typically does not employ other hospital personnel. The Company provides a continuum of solutions to the problems faced by these hospitals through services which may include instituting new financial and operating systems and various management initiatives, such as establishing a local or regional provider network to efficiently meet a community's health care needs. Management believes the Company's contract management business provides a competitive advantage in identifying and developing relationships with suitable acquisition candidates and in understanding the local markets in which such hospitals operate. This division represented 10.7% and 7.7% of net operating revenue for the years ended December 31, 1997 and 1998, respectively. PHC did not provide management services until its acquisition of Brim on December 18, 1996.
COMPETITION
The primary bases of competition among hospitals in non-urban markets are the quality and scope of medical services, strength of referral network, location, and, to a lesser extent, price. With respect to the delivery of general acute care services, most of the Company's hospitals face less competition in their immediate patient service areas than would be expected in larger communities. While the Company's hospitals are generally the primary provider of health care services in their respective communities, its hospitals face competition from larger tertiary care centers and, in some cases, other non-urban hospitals. Some of the hospitals that compete with the Company are owned by governmental agencies or not-for-profit entities supported by endowments
and charitable contributions, and can finance capital expenditures on a tax-exempt basis.
The Company faces competition for acquisitions primarily from for-profit hospital management companies as well as not-for-profit entities. Some of the Company's competitors have greater financial and other resources than the Company. Increased competition for the acquisition of non-urban acute care hospitals could have an adverse impact on the Company's ability to acquire such hospitals on favorable terms.
EMPLOYEES AND MEDICAL STAFF
As of March 1, 1999, the Company had 2,785 "full-time equivalent" employees, including 32 corporate personnel and 139 management company personnel. The remaining employees, most of whom are nurses and office personnel, work at the hospitals. The Company considers relations with its employees to be good.
The Company typically does not employ physicians and, as of March 1, 1999, the Company employed only 12 practicing physicians. Certain of the Company's hospital services, including emergency room coverage, radiology, pathology and anesthesiology services, are provided through independent contractor arrangements with physicians.
GOVERNMENT REIMBURSEMENT
Medicare payments for acute hospital services are based on a prospective payment system ("PPS"). Under PPS, a hospital receives a fixed amount for inpatient hospital services based on the established fixed payment amount per discharge for categories of hospital treatment known as diagnosis related groups ("DRGs"). DRG payments do not consider a specific hospital's costs, but are national rates adjusted for area wage differentials. Psychiatric services, long-term care, rehabilitation, pediatric services, certain designated research hospitals and distinct parts of rehabilitation and psychiatric units within hospitals are currently exempt from PPS and are reimbursed on a cost-based system, subject to specific reimbursement caps (known as TEFRA limits). For the year ended December 31, 1998, the Company had five units reimbursed under the TEFRA methodology.
For several years, the percentage increases to the DRG rates have been lower than the percentage increases in the cost of goods and services purchased by general hospitals. The index used to adjust the DRG rates is based on the cost of goods and services purchased by hospitals as well as those purchased by non-hospitals (the "Market Basket"). The historical Market Basket rates of increase were 1.5%, 2.0% and 2.5% for federal fiscal years 1997, 1998 and 1999, respectively. However, the Balanced Budget Act of 1997 (the "1997 Act") set the DRG rate of increase for federal fiscal year 1998 at zero percent. The 1997 Act set the DRG rates of increase for future federal fiscal years at rates that will be based on the Market Basket rates less reduction factors of 1.9% in 1999, 1.8% in 2000, and 1.1% in 2001 and 2002. The Company anticipates that future legislation may further decrease the rates of increase for DRG payments, but does not know the amount of the final reduction.
Outpatient services provided by general hospitals are reimbursed by Medicare at the lower of customary charges or approximately 90% of actual cost, subject to additional limits on the reimbursement of certain outpatient services. The 1997 Act mandated the implementation of a PPS for Medicare outpatient services by January 1, 1999. This outpatient PPS system will be based on a system of Ambulatory Payment Categories ("APCs"). Each APC will represent a bundle of outpatient services and each APC will be assigned a fully prospective reimbursement rate. Because implementing regulations with respect to outpatient PPS have not been promulgated, the Company is not able to predict the full impact of this provision of the 1997 Act. The Health Care Financing Administration ("HCFA") has announced that the implementation of outpatient PPS will be delayed until January 1, 2000 or later.
Each state has its own Medicaid program that is funded jointly by such state and the federal government. Federal law governs how each state manages its Medicaid program, but there is wide latitude for states to customize Medicaid programs to fit local needs and resources. As a result, each state Medicaid plan has its own payment formula and recipient eligibility criteria. The Company's current operations are in states that have historically had well-funded Medicaid programs with adequate payment rates.
The Company owns or leases four hospitals in California. The Medicaid program in California, known as Medi-Cal, reimburses hospital inpatient cost on one of three methods: (i) cost-based, subject to various limits known as MIRL/Peer Group limits; (ii) negotiated rates per discharge or per diems for hospitals under contract; or (iii) managed care initiatives, where payment rates tend to be capitated and networks must be formed. Three of the Company's four California hospitals are cost-based for Medi-Cal and the other is paid under the negotiated contract method. None of the Company's cost-based hospitals is currently subject to a MIRL/Peer Group limit, because its cost per discharge has historically been below the limit. There can be no assurance that this will remain the case in the future. Medi-Cal currently has a managed care initiative that is primarily targeted at urban areas. The Company does not expect that Medi-Cal will begin rural managed care contracting in the near future.
Medicare has special payment provisions for "Sole Community Hospitals" or SCHs. An SCH is generally the only hospital in at least a 35-mile radius. Colorado Plains, Colorado River, Elko, Havasu and Palo Verde qualify as SCHs under Medicare regulations. Special payment provisions related to SCHs include a higher DRG rate, which is based on a blend of hospital-specific costs and the national DRG rate; and a 90% payment "floor" for capital cost. In addition, the CHAMPUS program has special payment provisions for hospitals recognized as SCHs for Medicare purposes.
The Medicare, Medicaid and CHAMPUS programs are subject to statutory and regulatory changes, administrative rulings, interpretations and determinations, requirements for utilization review and new governmental funding restrictions, all of which may materially increase or decrease program payments as well as affect the cost of providing services and the timing of payment to facilities. The final determination of amounts earned under the programs often requires many years, because of audits by the program representatives, providers' rights of appeal and the
application of numerous technical reimbursement provisions. Management believes that adequate provision has been made for such adjustments. Until final adjustment, however, significant issues remain unresolved and previously determined allowances could become either inadequate or more than ultimately required.
HEALTH CARE REFORM, REGULATION AND LICENSING
Certain Background Information
Health care, as one of the largest industries in the United States, continues to attract much legislative interest and public attention. Medicare, Medicaid, and other public and private hospital cost-containment programs, proposals to limit health care spending, proposals to limit prices and industry competitive factors are among the many factors that are highly significant to the health care industry. In addition, the health care industry is governed by a framework of federal and state laws, rules and regulations that are extremely complex and for which the industry has the benefit of only limited regulatory or judicial interpretation. Although the Company believes it is in compliance in all material respects with such laws, rules and regulations, if a determination is made that the Company was in violation of such laws, rules or regulations, its business, financial condition and results of operations could be materially adversely affected.
There continue to be federal and state proposals that would, and actions that do, impose more limitations on government and private payments to providers such as the Company and proposals to increase co-payments and deductibles from program and private patients. The Company's facilities also are affected by controls imposed by government and private payors designed to reduce admissions and lengths of stay. Such controls, including what is commonly referred to as "utilization review," have resulted in fewer of certain treatments and procedures being performed. Utilization review entails the review of the admission and course of treatment of a patient by a third party. Utilization review by third-party peer review organizations ("PROs") is required in connection with the provision of care paid for by Medicare and Medicaid. Utilization review by third parties is also required under many managed care arrangements.
Many states have enacted, or are considering enacting, measures that are designed to reduce their Medicaid expenditures and to make certain changes to private health care insurance. Various states have applied, or are considering applying, for a federal waiver from current Medicaid regulations to allow them to serve some of their Medicaid participants through managed care providers. These proposals also may attempt to include coverage for some people who presently are uninsured, and generally could have the effect of reducing payments to hospitals, physicians and other providers for the same level of service provided under Medicaid.
Certificate of Need Requirements
Some states require approval for purchase, construction and expansion of health care facilities, including findings of need for additional or expanded health care facilities or services. Certificates of Need ("CONs"), which are issued by governmental agencies with jurisdiction over
health care facilities, are at times required for capital expenditures exceeding a prescribed amount, changes in bed capacity or services and certain other matters. However, Texas and California, states in which the Company operates six of its 11 hospitals, do not currently require CONs for hospital construction or changes in the mix of services. The Company is unable to predict whether it will be able to obtain any CON that may be necessary to accomplish its business objectives in any jurisdiction where such CON is required.
Anti-Kickback and Self-Referral Regulations
Sections of the Anti-Fraud and Abuse Amendments to the Social Security Act, commonly known as the "anti-kickback" statute (the "Anti-kickback Amendments"), prohibit certain business practices and relationships that might affect the provision and cost of health care services reimbursable under Medicare and Medicaid, including the payment or receipt of remuneration for the referral of patients whose care will be paid for by Medicare or other government programs. Sanctions for violating the Anti-kickback Amendments include criminal penalties and civil sanctions, including fines and possible exclusion from government programs such as the Medicare and Medicaid programs. Pursuant to the Medicare and Medicaid Patient and Program Protection Act of 1987, the U.S. Department of Health and Human Services has issued regulations that create safe harbors under the Anti-kickback Amendments ("Safe Harbors"). A given business arrangement that does not fall within a Safe Harbor is not per se illegal; however, business arrangements of health care services providers that fail to satisfy the applicable safe harbor criteria risk increased scrutiny by enforcement authorities. The "Health Insurance Portability and Accountability Act of 1996," which became effective January 1, 1997, broadened the scope of certain fraud and abuse laws, such as the Anti-kickback Amendments, to include all health care services reimbursed under a federal program or state healthcare programs.
The Company provides financial incentives to recruit physicians into the communities served by its hospitals, including payments of relocation expenses and minimum cash collection guarantees, and structures these incentives so as to fall within a proposed safe harbor for physician recruitment. However, the proposed safe harbor for physician recruitment has never been finalized. Although the Company is not subject to the Internal Revenue Service Revenue Rulings and related authority addressing recruitment activities by tax-exempt facilities, management believes that such IRS authority tends to set the industry standard for acceptable recruitment activities. The Company believes that its recruitment policies are being conducted in accordance with the IRS authority and industry practice.
The Company also enters into certain leases with physicians and is a party to one joint venture with physicians. The Company believes that these arrangements do not violate the Anti-kickback Amendments. There can be no assurance that regulatory authorities who enforce the Anti-kickback Amendments will not determine that the Company's physician recruiting activities or other physician arrangements violate the Anti-kickback Amendments or other federal laws. Such a determination could subject the Company to liabilities under the Social Security Act, including exclusion of the Company from participation in Medicare and Medicaid.
There is increasing scrutiny by law enforcement authorities, the Office of Inspector General ("OIG") of the Department of Health and Human Services ("HHS"), the courts, and Congress of arrangements between health care providers and potential referral sources to ensure that the arrangements are not designed as a mechanism to exchange remuneration for patient care referrals and opportunities. Investigators also have demonstrated a willingness to look behind the formalities of a business transaction to determine the underlying purpose of payments between health care providers and potential referral sources. Enforcement actions have increased, as evidenced by recent highly publicized enforcement investigations of certain hospital activities. To its knowledge, the Company is not currently the subject of any investigation that is likely to have a material adverse effect on its business, financial condition or results of operations. There can be no assurance that the Company and its hospitals will not be the subject of investigations or inquiries in the future.
In addition, provisions of the Social Security Act prohibit physicians from referring Medicare and Medicaid patients to providers of a broad range of designated health services with which the physicians or their immediate family members have ownership or certain other financial arrangements (the "Stark Laws"). A person making a referral, or seeking payment for services referred, in violation of the Stark Laws would be subject to the following sanctions: (i) civil money penalties of up to $15,000 for each service; (ii) assessments equal to twice the dollar value for each service; and/or (iii) exclusion from participation in the Medicare Program (which can subject the person or entity to exclusion from participation in state health care programs). Further, if any physician or entity enters into an arrangement or scheme that the physician or entity knows or should know has the principal purpose of assuring referrals by the physician to a particular entity, and the physician directly makes referrals to such entity, then such physician or entity could be subject to a civil money penalty of up to $100,000. Many states have adopted or are considering similar legislative proposals, some of which extend beyond the Medicaid program, to prohibit the payment or receipt of remuneration for the referral of patients and physician self-referrals regardless of the source of the payment for the care. The Company's contracts with physicians on the medical staff of its hospitals and its participation in and development of joint ventures and other financial relationships with physicians could be adversely affected by these amendments and similar state enactments.
The Company is unable to predict the future course of federal, state and local regulation or legislation, including Medicare and Medicaid statutes and regulations. Further changes in the regulatory framework or in the interpretation of these laws, rules and regulations could have a material adverse effect on the Company's business, financial condition and results of operations.
Environmental Regulations
The Company's health care operations generate medical waste that must be disposed of in compliance with federal, state and local environmental laws, rules and regulations. The Company's operations, as well as the Company's purchases and sales of facilities, also are subject to various other environmental laws, rules and regulations.
Health Care Facility Licensing Requirements
The Company's health care facilities are subject to extensive federal, state and local legislation and regulation. In order to maintain their operating licenses, health care facilities must comply with strict standards concerning medical care, equipment and hygiene. Various licenses and permits also are required in order to dispense narcotics, operate pharmacies, handle radioactive materials and operate certain equipment. The Company's health care facilities hold all required governmental approvals, licenses and permits. All licenses, provider numbers and other permits or approvals required to perform the Company's business operations are held by subsidiaries of the Company. All of the Company's hospitals are fully accredited by the Joint Commission on Accreditation of Health Care Organizations.
Utilization Review Compliance and Hospital Governance
The Company's health care facilities are subject to and comply with various forms of utilization review. In addition, under the Medicare PPS, each state must have a PRO to carry out a federally mandated system of review of Medicare patient admissions, treatments and discharges in hospitals. Medical and surgical services and practices are extensively supervised by committees of staff doctors at each health care facility, are overseen by each health care facility's local governing board, the primary voting members of which are physicians and community members, and are reviewed by the Company's quality assurance personnel. The local governing boards also help maintain standards for quality care, develop long-range plans, establish, review and enforce practices and procedures and approve the credentials and disciplining of medical staff members.
Governmental Developments Regarding Sales of Not-for-Profit Hospitals
In recent years, the legislatures and attorneys general of several states have shown a heightened level of interest in transactions involving the sale of non-profit hospitals. Although the level of interest varies from state to state, the trend is to provide for increased governmental review, and in some cases approval, of transactions in which not-for-profit corporations sell a health care facility. Attorneys general in certain states, including California, have been especially active in evaluating these transactions. Although the Company has not yet been affected adversely as a result of these trends, such increased scrutiny may increase the difficulty or prevent the completion of transactions with not-for-profit organizations in certain states in the future.
California Seismic Standards
California recently adopted a law requiring standards and regulations to be developed to ensure hospitals meet seismic performance standards. Within three years after adoption of the standards by the California Building Standards Commission, owners of subject properties are to evaluate their facilities and develop a plan and schedule for complying with the standards. The Commission has adopted evaluation criteria, and in 1998 adopted the retrofit standards. The Company will be required to conduct engineering studies of its California facilities to determine whether and to what extent modifications to its facilities will be required. In order to comply with the seismic standards, the Company could incur significant capital costs. These costs may, in turn, have a material adverse effect on the Company's financial condition or results of operations.
PROFESSIONAL LIABILITY
As part of its business, the Company is subject to claims of liability for events occurring as part of the ordinary course of hospital operations. To cover these claims, the Company maintains professional malpractice liability insurance and general liability insurance in amounts that management believes to be sufficient for its operations, although some claims may exceed the scope of the coverage in effect. The Company also maintains umbrella coverage. At various times in the past, the cost of malpractice and other liability insurance has risen significantly. Therefore, there can be no assurance that such insurance will continue to be available at a reasonable price for the Company to maintain adequate levels of insurance.
Through its typical hospital management contract, the Company attempts to protect itself from such liability by requiring the hospital to maintain certain specified limits of insurance coverage, including professional liability, comprehensive general liability, worker's compensation and fidelity insurance, and by requiring the hospital to name the Company as an additional insured party on the hospital's professional and comprehensive general liability policies. The Company's management contracts specifically provide for the indemnification of the Company by the hospital against claims that arise out of the actions of the hospital employees, medical staff members and other personnel who are not employees of the Company. However, there can be no assurance the hospitals will maintain such insurance or that such indemnities will be available.
ITEM 2.
ITEM 2. PROPERTIES
Information with respect to the Company's hospital facilities and other properties can be found in Item 1 of this Report under the caption, "Business - Hospital Operations - Owned and Leased Hospitals."
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
The Company is, from time to time, subject to claims and suits arising in the ordinary course of business, including claims for damages for personal injuries, breach of management
contracts or for wrongful restriction of or interference with physician's staff privileges. In certain of these actions, plaintiffs request punitive or other damages that may not be covered by insurance. The Company is currently not a party to any proceeding which, in management's opinion, would have a material adverse effect on the Company's business, financial condition or results of operations.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock is quoted on the Nasdaq National Market ("Nasdaq") under the symbol "PRHC." The Company's Common Stock began publicly trading on February 11, 1998. From February 11, 1998 through December 31, 1998, the high and low sales prices for the Company's Common Stock as reported by Nasdaq, were as follows:
As of March 26, 1999, there were approximately 251 record holders of the Company's Common Stock.
The Company historically has retained and currently intends to retain all earnings to finance the development and expansion of its operations and, therefore, does not anticipate paying cash dividends or making any other distributions on its shares of Common Stock in the foreseeable future. Furthermore, the Company's credit facilities contain restrictions on the Company's ability to pay dividends. The Company's future dividend policy will be determined by its Board of Directors on the basis of various factors, including the Company's results of operations, financial condition, business opportunities, capital requirements and such other factors as the Board of Directors may deem relevant.
ITEM 6.
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The following table sets forth selected consolidated financial data of (i) the Company's predecessor (Brim) as of and for each of the two years ended December 31, 1995, and as of December 18, 1996 and for the period January 1, 1996 to December 18, 1996, and (ii) the Company as of December 31, 1996, 1997 and 1998, and for the period February 2, 1996 to December 31, 1996 and the years ended December 31, 1997 and 1998. The selected financial information for the predecessor and the Company has been derived from the audited consolidated financial statements of the predecessor and the Company. The selected consolidated financial data are qualified by, and should be read in conjunction with, "Item 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION
The following discussion should be read in conjunction with the Company's consolidated financial statements and related notes thereto included elsewhere in this Report.
OVERVIEW
Province Healthcare Company is a health care services company focused on acquiring and operating hospitals in attractive non-urban markets in the United States. As of December 31, 1998, the Company operated ten general acute care hospitals in six states with a total of 723 licensed beds, and managed 52 hospitals in 17 states with a total of 3,574 licensed beds.
PHC of Delaware, Inc., a subsidiary of the Company, was founded in February 1996 by Golder, Thoma, Cressey, Rauner Fund IV, L.P. ("GTCR Fund IV") and Martin S. Rash to acquire and operate hospitals in attractive non-urban markets. PHC acquired its first hospital, Memorial Mother Frances Hospital ("Memorial Mother Frances") in Palestine, Texas, in July 1996 and acquired Starke Memorial Hospital ("Starke") in Knox, Indiana, in October 1996.
In December 1996, a subsidiary of Brim, Inc. merged with PHC in a transaction in which Brim issued Junior Preferred Stock and Common Stock in exchange for all of the outstanding common stock of PHC, and PHC became a wholly-owned subsidiary of Brim. Because the PHC shareholders became owners of a majority of the outstanding shares of Brim after the Merger, PHC was considered the acquiring enterprise for financial reporting purposes and the transaction was accounted for as a reverse acquisition. Therefore, the historical financial statements of PHC replaced the historical financial statements of Brim, the assets and liabilities of Brim were recorded at fair value as required by the purchase method of accounting, and the operations of Brim were reflected in the operations of the combined enterprise from the date of acquisition. Because PHC had been in existence for less than a year at December 31, 1996, and because Brim had been in existence for several years, PHC is considered the successor to Brim's operations.
On February 4, 1998, the Company merged with and into Province Healthcare Company, a Delaware corporation, to change the Company's name and jurisdiction of incorporation and to make certain other changes to the Company's authorized capitalization.
IMPACT OF ACQUISITIONS AND DIVESTITURES
An integral part of the Company's strategy is to acquire non-urban acute care hospitals. See "Item 1. Business - Business Strategy." Because of the financial impact of the Company's recent acquisitions, it is difficult to make meaningful comparisons between the Company's financial statements for the fiscal periods presented. In addition, due to the relatively small number of owned and leased hospitals, each hospital acquisition can materially affect the overall operating margin of the Company. Upon the acquisition of a hospital, the Company typically takes a number of steps to lower operating costs. See "Item 1. Business - Hospital Operations." The impact of such actions may be offset by cost increases to expand services, strengthen medical staff and improve market position. The benefits of these investments and of other activities to improve operating margins generally do not occur immediately. Consequently, the financial performance of a newly-acquired hospital may adversely affect overall operating margins in the near term. As the Company makes additional hospital acquisitions, the Company expects that this effect will be mitigated by the expanded financial base of existing hospitals and the allocation of corporate overhead among a larger number of hospitals.
In February 1996, Brim acquired Parkview Regional Hospital by entering into a 15-year operating lease agreement with two five-year renewal terms, and by purchasing certain assets and assuming certain liabilities for a purchase price of $1.8 million. In December 1996, Brim sold its senior living business (see "-Discontinued Operations") and certain assets related to three medical office buildings.
In July 1996, PHC purchased certain assets and assumed certain liabilities of Memorial Mother Frances for a purchase price of $23.2 million in a transaction resulting in PHC owning 95.0% of the hospital. In October 1996, PHC acquired Starke Memorial by assuming certain liabilities and entering into a capital lease agreement, and by purchasing certain assets for a purchase price of $7.7 million. In December 1996, a subsidiary of Brim and PHC merged in a transaction which has been accounted for as a reverse acquisition (i.e., the acquisition of Brim by PHC).
In August 1997, the Company acquired Colorado River Medical Center ("Colorado River"), in Needles, California (formerly Needles Desert Communities Hospital) by purchasing certain assets, assuming certain liabilities, and entering into a fifteen-year lease agreement, with three five-year renewal options, for a purchase price of approximately $6.3 million.
In May 1998, the Company acquired Havasu Samaritan Regional Hospital ("Havasu") in Lake Havasu City, Arizona, for approximately $107.5 million. In June, 1998, the Company acquired Elko General Hospital ("Elko") in Elko, Nevada for a purchase price of approximately
$23.3 million. To finance these acquisitions, the Company borrowed $106.0 million and $22.0 million, respectively, under its revolving credit facility.
All the acquisitions described above were accounted for as purchase business combinations, and the results of operations of the hospitals have been included in the results of operations of the Company from the purchase dates forward.
The December 31, 1996 results of operations of the Company include five months of operations for Memorial Mother Frances, three months of operations for Starke Memorial, and 13 days of operations for Brim. Brim's operations consisted of five owned/leased hospitals and a hospital management company operation. In the discussion that follows, Memorial Mother Frances, Starke Memorial and Brim are referred to as the "1996 Acquisitions."
The December 31, 1997 results include twelve months of operations for the 1996 Acquisitions, plus five months of operations for Colorado River.
The December 31, 1998 results include twelve months of operations for the 1996 Acquisitions and Colorado River, plus eight months of operations for Havasu and six and one-half months of operations for Elko. In the discussion that follows, Colorado River, Havasu and Elko are referred to as the "1997 and 1998 Acquisitions."
On February 22, 1999, the Company entered into a "special services agreement" for the lease of Eunice Regional Medical Center, an 85-bed general acute care hospital located in Eunice, Louisiana. The Company purchased certain assets, assumed certain liabilities, and entered into a ten-year lease agreement, with one five-year renewal option. The transaction was accounted for as a purchase business combination, with a purchase price of approximately $1.7 million.
RESULTS OF OPERATIONS
The following table presents, for the periods indicated, information expressed as a percentage of net operating revenue. Such information has been derived from the consolidated statements of operations of the Company included elsewhere in this report. The results of operations for the periods presented include hospitals from their acquisition dates, as previously discussed.
(1) Operating expenses represent expenses before interest, minority interest, loss on sale of assets, income taxes, depreciation and amortization.
(2) EBITDA represents the sum of income before income taxes, interest, minority interest, depreciation and amortization, and loss on sale of assets. Management understands that industry analysts generally consider EBITDA to be one measure of the financial performance of a company that is presented to assist investors in analyzing the operating performance of the Company and its ability to service debt. Management believes that an increase in EBITDA level is an indicator of the Company's improved ability to service existing debt, to sustain potential future increases in debt and to satisfy capital requirements. However, EBITDA is not a measure of financial performance under generally accepted accounting principles and should not be considered an alternative (i) to net income as a measure of operating performance or (ii) to cash flows from operating, investing, or financing activities as a measure of liquidity. Given that EBITDA is not a measurement determined in accordance with generally accepted accounting principles and is thus susceptible to varying calculations, EBITDA, as presented, may not be comparable to other similarly titled measures of other companies.
Hospital revenues are received primarily from Medicare, Medicaid and commercial insurance. The percentage of revenues received from the Medicare program is expected to increase due to the general aging of the population. The payment rates under the Medicare program for inpatients are based on a PPS, based upon the diagnosis of a patient. While these rates are indexed for inflation annually, the increases have historically been less than actual inflation. In addition, states, insurance companies and employers are actively negotiating the amounts paid to hospitals as opposed to their standard rates. The trend toward managed care, including health maintenance organizations, preferred provider organizations and various other forms of managed care, may affect the hospitals' ability to maintain their current rate of net revenue growth.
Net operating revenue is comprised of: (i) net patient service revenue from the Company's owned and leased hospitals; (ii) management and professional services revenue; and (iii) other revenue.
Net patient service revenue is reported net of contractual adjustments and policy discounts. The adjustments principally result from differences between the hospitals' customary charges and payment rates under the Medicare and Medicaid programs. Customary charges generally have increased at a faster rate than the rate of increase for Medicare and Medicaid payments. Operating expenses of the
hospitals primarily consist of salaries and benefits, purchased services, supplies, provision for doubtful accounts and other operating expenses (principally consisting of utilities, insurance, property taxes, travel, freight, postage, telephone, advertising, repairs and maintenance).
Management and professional services revenue is comprised of fees from management and professional consulting services provided to third-party hospitals pursuant to management contracts and consulting arrangements, plus reimbursable expenses. Operating expenses for the management and professional services business primarily consist of salaries and benefits and reimbursable expenses.
YEAR ENDED DECEMBER 31, 1998 COMPARED TO YEAR ENDED DECEMBER 31, 1997
Net operating revenue increased from $170.5 million in 1997, to $238.9 million in 1998, an increase of $68.4 million or 40.1%. Revenue generated by hospitals owned during both periods increased $5.2 million, or 3.4% in 1998. The increase in revenue generated by hospitals owned during both periods is primarily the result of higher volumes and price increases, partially offset by increased managed care and charity care discounts and the effects of the Balanced Budget Act of 1997 (the "1997 Act"). (See "Item 1. Business - Government Reimbursement.") Cost report settlements and the filing of cost reports during the year resulted in positive revenue adjustments of $3.3 million (2.2% of net patient service revenue) in 1997 and $4.0 million (1.8% of net patient service revenue) in 1998. The remaining increase of $63.2 million was primarily attributable to the 1997 and 1998 Acquisitions.
Operating expenses increased from $146.7 million in 1997, to $196.8 million in 1998, an increase of $50.1 million or 34.2%. Operating expenses were 86.0% of net operating revenue in 1997, compared to 82.4% in 1998. The increase in operating expenses of hospitals owned during both periods resulted from volume increases, increased services and change in case mix, offset by decreased expenses in home health as a result of the 1997 Act and decreased expenses from the closing of two geriatric psychiatric units. The majority of the increase in operating expenses was attributable to the 1997 and 1998 Acquisitions.
EBITDA was $23.8 million, or 14.0% of net operating revenue in 1997, compared to $42.1 million, or 17.6% of net operating revenue in 1998. The increase is primarily the result of the 1997 and 1998 Acquisitions.
Depreciation and amortization expense was $7.6 million, or 4.4% of net operating revenue in 1997, compared to $13.4 million, or 5.6% of net operating revenue in 1998. The increase in depreciation and amortization resulted from the 1997 and 1998 Acquisitions and increased capital expenditures. Interest expense as a percent of net operating revenue decreased from 4.8% in 1997 to 4.4% in 1998.
Net income was $4.1 million, or 2.4% of net operating revenue in 1997, compared to $10.0 million, or 4.2% of net operating revenue in 1998.
YEAR ENDED DECEMBER 31, 1997 COMPARED TO PERIOD FROM FEBRUARY 2, 1996 (PHC'S INCEPTION) TO DECEMBER 31, 1996
Net operating revenue was $170.5 million in 1997, compared to $17.3 million in 1996, an increase of $153.2 million. This increase is principally the result of a full year's operations for the 1996 Acquisitions. Cost report settlements and the filing of cost reports resulted in no revenue adjustments in 1996 and positive revenue adjustments of $3.3 million (2.2% of net patient service revenue) in 1997.
Operating expenses were $16.8 million, or 97.2% of net operating revenue in 1996, compared to $146.7 million, or 86.0% of net operating revenue in 1997, principally as a result of a full year of operations for the 1996 Acquisitions.
EBITDA was $0.5 million, or 2.8% of net operating revenue in 1996, compared to $23.8 million, or 14.0% of net operating revenue in 1997, principally as a result of a full year of operations for the 1996 Acquisitions.
Depreciation and amortization expense was $1.3 million, or 7.6% of net operating revenue in 1996, compared to $7.6 million, or 4.4% of net operating revenue in 1997. Interest expense was $1.0 million, or 5.7% of net operating revenue in 1996, compared to $8.1 million, or 4.8% of net operating revenue in 1997. This increase resulted primarily from $52.7 million in new bank debt incurred in connection with the recapitalization of Brim, and an increase of $10.0 million in bank debt during 1997 to fund the acquisition of Colorado River and the buyout of the operating lease at Ojai.
Net loss was $1.6 million, or 9.1% of net operating revenue in 1996, compared to net income of $4.1 million, or 2.4% of net operating revenue in 1997.
LIQUIDITY AND CAPITAL RESOURCES
Working capital increased from $21.4 million at December 31, 1997 to $50.7 million at December 31, 1998. The ratio of current assets to current liabilities was 1.8 to 1.0 at December 31, 1997 and 3.5 to 1.0 at December 31, 1998.
In February 1998, the Company completed its initial public offering of 5,405,000 shares of common stock. In connection with the offering, the Series B redeemable junior preferred stock was converted into common stock at the public offering price. The net proceeds from the offering were used to reduce the balance of the outstanding term and revolving credit loans ($39.6 million), redeem the outstanding balance of the Series A redeemable senior preferred stock plus accrued dividends ($22.7 million) and repurchase a portion of the common stock that was issued upon conversion of the Series B junior preferred stock ($14.9 million).
In July 1998, the Company completed its public offering of 2,685,500 shares of common stock at an offering price of $26.00 per share. The net proceeds from the offering of approximately $65.7 million primarily were used to reduce amounts outstanding on the revolving line of credit.
In March 1998, the Company amended and restated its Credit Agreement and increased the size of its credit facility to $260.0 million. The total amount outstanding under the credit facility increased from $82.0 million at December 31, 1997 to $127.0 million at December 31, 1998. The increase resulted primarily from the borrowings to finance the Havasu and Elko acquisitions, offset by a reduction in debt from application of stock offering proceeds. The loans under the Credit Agreement bear interest at the adjusted base rate or at the adjusted LIBOR rate, plus in each case, a margin depending on the amount of the Company's outstanding indebtedness.
The Credit Agreement contains limitations on the Company's ability to incur additional indebtedness (including contingent obligations), sell material assets, retire, redeem or otherwise reacquire its capital stock, acquire the capital stock or assets of another business, and pay dividends. The Credit Agreement also requires the Company to maintain a specified net worth and meet or exceed certain coverage, leverage, and indebtedness ratios. Indebtedness under the Credit Agreement is secured by substantially all assets of the Company. The Credit Agreement obligates the Company to pay certain commitment fees, based upon amounts borrowed and available for borrowing, during its term.
Interest rate swap agreements are used to manage the Company's interest rate exposure under the Credit Agreement. In 1997, the Company entered into an interest rate swap agreement, which effectively converted for a three-year period $35.0 million of floating-rate borrowings to fixed-rate borrowings. In 1998, the Company entered into an interest rate swap agreement, which effectively converted for a five-year period $45.0 million of floating-rate borrowings to fixed-rate borrowings. The Company secured a 6.27% fixed interest rate on the 1997 swap agreement, and a 5.625% fixed interest rate on the 1998 swap agreement.
Cash used in operations increased from $0.8 million in 1997 to $4.1 million in 1998, primarily due to a large increase in accounts receivable, primarily at newly-acquired hospitals. Cash used in investing activities increased from $18.2 million in 1997 to $146.4 million in 1998, relating primarily to the Havasu and Elko acquisitions and capital expenditures. Net cash provided by financing activities increased from $12.0 million in 1997 to $148.5 million in 1998, primarily as a result of the initial public offering and the follow-on public offering and the application of the proceeds, and borrowings related to the Havasu and Elko acquisitions.
Capital expenditures, excluding acquisitions, were $15.6 million in 1997 and $15.5 million in 1998. Capital expenditures for the owned hospitals may vary from year to year, depending on facility improvements and service enhancements. The management services business does not require significant capital expenditures. The Company expects to make capital expenditures in 1999 of approximately $15.1 million, exclusive of any acquisitions of businesses or construction projects. These expenditures will be funded through cash provided by operating activities and borrowings under the revolving credit agreement.
IMPACT OF YEAR 2000
GENERAL DESCRIPTION OF THE YEAR 2000 ISSUE AND THE NATURE AND EFFECTS OF THE YEAR 2000 ON INFORMATION TECHNOLOGY (IT) AND NON-IT SYSTEMS
The following discussion is designated as Year 2000 readiness disclosure for purposes of the Year 2000 Information Readiness and Disclosure Act.
Some older computer programs and systems were written using two digits rather than four to define the applicable year. As a result, those computer programs have time-sensitive software that recognizes a date using "00" as the year 1900 rather than the year 2000. Certain of the Company's computer hardware and software, facility equipment (e.g., communications equipment, environmental controls such as heating and air conditioning systems, and elevators), and medical equipment that are date sensitive, may contain programs with the Year 2000 problem. If uncorrected, the problem could result in computer system and program failures or equipment and medical device malfunctions that could result in a disruption of business operations or affect patient diagnosis and treatment.
STATUS OF PROGRESS IN BECOMING YEAR 2000 COMPLIANT, INCLUDING TIMETABLE FOR COMPLETION OF EACH REMAINING PHASE.
The Company's plan to resolve the Year 2000 issue involves the following four phases: assessment, remediation, testing, and implementation. The Company has replaced the majority of its key financial and operational systems as a part of its systems consolidation in the normal course of business. This replacement has been a planned approach during the last two years to enhance or better meet its functional business and operational requirements. In addition to the replacement program, some of the Company's software and hardware is being modified so that its computer systems will function properly with respect to dates in the year 2000 and thereafter.
The Company is currently working with outside consultants, who are visiting each of the owned hospitals to determine the depth of the problem as it relates to devices that are attached to the Company's information systems. The purpose is twofold: (i) They are testing the hospital computer networks to identify problem areas relative to the communications of the information system hardware, the network servers and various devices attached to the network. This phase is focused on identifying conflict/problem areas and recommending solutions to address these problems; and (ii) They are evaluating each personal computer for hardware and software related Year 2000 issues. The result of this process will be a report that will document a physical layout of the network, any potential or existing network problems, and an inventory of each system with its potential Year 2000 problems.
In the area of medical equipment, the Company is working with a consultant to identify issues impacting medical equipment items/systems. This process will be completed in three phases: (i) identification of medical equipment items/systems impacted by Year 2000 issues; (ii) evaluation of such medical equipment; and (iii) Year 2000 resolution. The Company has completed Phase I of this process and has completed 80% of Phase II. Management believes that this process will substantially address its Year 2000 issues, and anticipates a completion date no later than June 30, 1999.
NATURE AND LEVEL OF IMPORTANCE OF THIRD PARTIES AND THEIR EXPOSURE TO THE YEAR
The Company relies heavily on third parties in operating its business. In addition to its reliance on software, hardware and other equipment vendors to verify Year 2000 compliance of their products, the Company also depends on (i) fiscal intermediaries that process claims and make payments on behalf of the Medicare program, (ii) insurance companies, HMOs and other private payors, (iii) utilities that provide electricity, water, natural gas and telephone services and (iv) vendors of medical supplies and pharmaceuticals used in patient care. As part of its Year 2000 strategy, the Company has been working with its major vendors and has received assurances such vendors are addressing the Year 2000 issue. The Company has received assurances from four of its largest vendors that their software modules are fully compliant with software releases completed by the end of 1998. At this point, there have been no identified problems associated with this portion of the systems. Failure of these third parties to resolve their Year 2000 issues could have a material adverse effect on the Company's results of operations and ability to provide health care services.
The Company uses various third-party software products to perform electronic billing to Medicare, Medicaid, and certain other third-party payors. These electronic billing systems allow for a direct electronic interface with the computer systems of third-party payors, including Medicare and Medicaid. This direct interface allows the individual electronic bills to be edited on-line so that they can be successfully uploaded to the host system. In addition, certain Medicare intermediaries transmit remittance advice data back to the Company through these same electronic billing systems. The remittance advice data transmitted back to the Company determines the amount of payment that a particular hospital will receive for a particular remittance advice. In addition, most of the Company's hospitals receive electronic funds transfer from the Medicare intermediaries.
Reimbursement under the Medicare program is administered by HCFA. HCFA employs more than 60 carriers and intermediaries to process Medicare fee-for-service claims throughout the United States. There are several hundred different computer systems involved in the every day work of HCFA, its carriers and intermediaries. HCFA, under its internal Year 2000 compliance program, identified 99 mission critical systems, 25 that are directly managed by HCFA and 74 that are managed by outside carriers and intermediaries. These 99 systems contain more than 50 million lines of computer code that require re-writing to ensure Year 2000 compliance. In a public statement on its web page, HCFA has stated that the major HCFA forms, utilized for claims submission by the Company, are Year 2000 compliant. This includes both paper and electronic claims submission. There can be no assurance that HCFA's mission critical systems, which most directly affect the Company, will be compliant in time to prevent disruptions to the Medicare payments received by the Company. Moreover, HCFA has announced the delayed implementation of certain new regulations as well as the possible postponement of scheduled rate increases while its resources are re-directed towards Year 2000 compliance. While certain members of Congress have taken strong exception to HCFA's announcement to delay rate increases, it is possible that rate increases that were scheduled
to take effect on October 1, 1999, could be delayed until December 31, 1999 or later.
COSTS
The Company is utilizing both internal and external resources to complete the Year 2000 modifications. The Company believes that the Year 2000-related remediation costs incurred through December 31, 1998 have not been material to its results of operations.
During 1998, the majority of the costs related to Year 2000 were in the area of consulting services to assess the impact of Year 2000, and to inventory the existing information technology and medical equipment to determine the level of Year 2000 compliance. During 1998, approximately $50,000 of direct cost was incurred as part of this assessment. The costs of Year 2000 software compliance were included in standard software maintenance agreements with the Company's major vendors. No additional costs were incurred to modify this software over and above those amounts incurred as part of the normal business process.
During 1999, the consulting services have continued relative to the assessment of the Year 2000 project. The Company expects consulting costs related to medical equipment compliance to be $160,000 in the first quarter of 1999, and $60,000 in the second quarter of 1999. Assessment costs related to information technology compliance are expected to be $30,000 in the first quarter of 1999, and $50,000 in the second quarter of 1999, and have been included in the information systems budget. These costs will be expensed as incurred, and have been included in the Company's 1999 internal budget.
Based upon a review of completed hospital assessments, the Company expects approximately $2,000,000 in remediation/replacement capital expenditures for both information technology and medical equipment, which is approximately 67% of the total information systems capital budget for 1999. These funds are part of a contingency budget. There can be no guarantee that actual costs and results will not differ materially from those anticipated. No significant information systems projects have been delayed due to the Year 2000 project.
By utilizing external consultants for the assessments associated with Year 2000, the Company has achieved independent verification and validation processes to assure the reliability of risk and cost estimates.
RISK AND CONTINGENCY PLANS
Management of the Company believes it has an effective program in place to resolve the Year 2000 issue in a timely manner. As noted above, the Company has not yet completed all necessary phases of the Year 2000 program, but expects to complete the program no later than June 30, 1999. In the event that the Company does not complete any additional phases, the Company may be unable to diagnose or treat patients, bill for patient services or collect and apply payments from patients or third party payors. In addition, disruptions in the economy generally resulting from Year 2000 issues could materially adversely affect the Company. The amount of potential liability and lost revenue cannot be reasonably estimated at this time.
The Company believes that the most reasonably likely worst case Year 2000 scenario is that some of its material third party payors will not be Year 2000 compliant, and will have difficulty processing and paying the Company's bills, thereby possibly affecting the Company's cash flows. The Company intends to develop a contingency plan to address this scenario. It is expected that such a plan would involve establishing procedures whereby the Company would revert to manual billing processes. In addition, the plan would involve ensuring the Company's access to additional capital through, for example, its revolving credit facility.
The Company intends to complete its initial contingency plan by June 30, 1999. Each of the Company's owned hospitals has a disaster plan that will be reviewed as a part of the Company's overall contingency planning process, to assure that each plan includes contingency planning for the Year 2000 issues. However, failure by third parties to resolve their own Year 2000 issues may render each hospital's contingency plan ineffective.
The foregoing assessment is based on information currently available to the Company. The Company will revise its assessment as it continues to implement its Year 2000 strategy. The Company can provide no assurances that applications and equipment the Company believes to be Year 2000 compliant will not experience difficulties, or that the Company will not experience difficulties obtaining resources needed to make modifications to or replace the Company's affected systems and equipment. Failure by the Company or third parties on which it relies to resolve Year 2000 issues could have a material adverse effect on the Company's results of operations and its ability to provide health care services. Consequently, the Company can give no assurances that issues related to the Year 2000 will not have a material adverse effect on the Company's financial condition or results of operations.
The Company has established and distributed a set of guidelines and strategies for each of its managed hospitals to use in evaluating and planning for making their facilities Year 2000 compliant. The Company intends to monitor the progress of the response by the hospitals it manages to the Year 2000 problem. The Company does not believe that it is responsible for ensuring Year 2000 compliance by its managed hospitals. Ultimately, responsibility for implementing the individual Year 2000 compliance plan at each managed hospital rests with each managed hospital's board; the Company can only implement the boards' recommendations at their direction.
GENERAL
The federal Medicare program accounted for approximately 60.3% and 57.8% of hospital patient days in 1997 and 1998, respectively. The state Medicaid programs accounted for approximately 13.1% and 11.1% of hospital patient days in 1997 and 1998, respectively. The payment rates under the Medicare program for inpatients are prospective, based upon the diagnosis of a patient. The Medicare payment rate increases have historically been less than actual inflation.
Both federal and state legislators are continuing to scrutinize the health care industry for the purpose of reducing health care costs. While the Company is unable to predict what, if any, future health reform legislation may be enacted at the federal or state level, the Company expects continuing pressure to limit expenditures by governmental health care programs. The 1997 Act imposed certain limitations on increases in the inpatient Medicare rates paid to acute care hospitals. Payments for Medicare outpatient services provided at acute care hospitals and home health services historically have been paid based on costs, subject to certain limits. The 1997 Act requires that the payment for those services be converted to a prospective payment system, which will be phased in over time. The 1997 Act also includes a managed care option that could direct Medicare patients to managed care organizations. Further changes in the Medicare or Medicaid programs and other proposals to limit health care spending could have a material adverse impact upon the health care industry and the Company.
The Company's acute care hospitals, like most acute care hospitals in the United States, have significant unused capacity. The result is substantial competition for patients and physicians. Inpatient utilization continues to be affected negatively by payor-required pre-admission authorization and by payor pressure to maximize outpatient and alternative health care delivery services for less acutely ill patients. The Company expects increased competition and admission constraints to continue in the future. The ability to respond successfully to these trends, as well as spending reductions in governmental health care programs, will play a significant role in determining the ability of the Company's hospitals to maintain their current rate of net revenue growth and operating margins.
The Company expects the industry trend in increased outpatient services to continue because of the increased focus on managed care and advances in technology. Outpatient revenue of the Company's owned or leased hospitals was approximately 44.5% and 43.5% of gross patient service revenue in 1997 and 1998, respectively.
The complexity of the Medicare and Medicaid regulations, increases in managed care, hospital personnel turnover, the dependence of hospitals on physician documentation of medical records and the subjective judgment involved complicates the billing and collections of accounts receivable by hospitals. There can be no assurance that this complexity will not negatively impact the Company's future cash flows or results of operations.
The federal government and a number of states are rapidly increasing the resources devoted to investigating allegations of fraud and abuse in the Medicare and Medicaid programs. At the same
time, regulatory and law enforcement authorities are taking an increasingly strict view of the requirements imposed on providers by the Social Security Act and Medicare and Medicaid regulations. Although the Company believes that it is in material compliance with such laws, a determination that the Company has violated such laws, or even the public announcement that the Company was being investigated concerning possible violations, could have a material adverse effect on the Company.
The Company's historical financial trend has been impacted favorably by its success in acquiring acute care hospitals. While the Company believes that trends in the health care industry described above may create possible future acquisition opportunities, there can be no assurances that it can continue to maintain its current growth rate through hospital acquisitions and successfully integrate the hospitals into its system.
The Company intends to acquire additional acute care facilities, and is actively seeking out such acquisitions. There can be no assurance that the Company will not require additional debt or equity financing for any particular acquisition. Also, the Company continually reviews its capital needs and financing opportunities and may seek additional equity or debt financing for its acquisition program or other needs.
The Company's owned hospitals accounted for 95.2%, 88.8% and 92.3% of the Company's net operating revenue in 1996, 1997 and 1998, respectively. The Company currently owns four hospitals in California, which accounted for 33.4% of 1998 net operating revenue. This concentration of results of operations in this market increases the risk that adverse developments at these facilities, or in the economic, regulatory or industry environment in California, could have a material adverse effect on the Company's operations or financial condition.
The preparation of financial statements in conformity with generally accepted accounting principles requires the Company to make estimates and assumptions that affect the amounts reported in its financial statements. Resolution of matters, for example, final settlements with third party payors, may result in changes from those estimates. The timing and amount of such changes in estimates may cause fluctuations in the Company's quarterly or annual operating results.
IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
As of January 1, 1998, the Company adopted Statement of Financial Accounting Standards ("SFAS") No. 130, Reporting Comprehensive Income. Statement 130 establishes new rules for the reporting and display of comprehensive income and its components. The Company had no items of other comprehensive income, and accordingly, adoption of the statement had no effect on the consolidated financial statements.
Effective January 1, 1998, the Company adopted SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information.
Statement 131 established standards for reporting of information about operating segments. In excess of 90% of the Company's assets, revenues and income are derived from one segment, the ownership and operation of acute care hospitals. Accordingly, segment disclosures are not presented in these financial statements.
In June 1998, SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, was issued, and is required to be adopted in years beginning after June 15, 1999. The Company expects to adopt the new Statement effective January 1, 2000. The Statement will require the Company to recognize all derivatives on the balance sheet at fair value. Derivatives that are not hedges must be adjusted to fair value through income. If a derivative is a hedge, depending on the nature of the hedge, changes in the fair value of the derivative will either be offset against the change in fair value of the hedged asset, liability, or firm commitment through earnings, or recognized in other comprehensive income until the hedged item is recognized in earnings. The ineffective portion of a hedge derivative's change in fair value will be immediately recognized in earnings. The Company does not anticipate that the adoption of this Statement will have a significant effect on its results of operations or financial position.
INFLATION
The health care industry is labor intensive. Wages and other expenses increase, especially during periods of inflation and labor shortages. In addition, suppliers pass along rising costs to the Company in the form of higher prices. The Company has generally been able to offset increases in operating costs by increasing charges for services, expanding services, and implementing cost control measures to curb increases in operating costs and expenses. In light of cost containment measures imposed by government agencies and private insurance companies, the Company is unable to predict its ability to offset or control future cost increases, or its ability to pass on the increased costs associated with providing health care services to patients with government or managed care payors, unless such payors correspondingly increase reimbursement rates.
SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
Certain statements contained in this discussion, including without limitation, statements containing the words "believes," "anticipates," "intends," "expects," and words of similar import, constitute forward-looking statements. Such forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause the actual results, performance or achievements of the Company or industry results to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. Such factors include, among others, the following: general economic and business conditions, both nationally and in regions where the Company operates; demographic changes; the effect of existing
or future governmental regulation and federal and state legislative and enforcement initiatives on the Company's business, including the 1997 Act; changes in Medicare and Medicaid reimbursement levels; the Company's ability to implement successfully its acquisition and development strategy and changes in such strategy; Year 2000 compliance; the availability and terms of financing to fund the expansion of the Company's business, including the acquisition of additional hospitals; the Company's ability to attract and retain qualified management personnel and to recruit and retain physicians and other health care personnel to the non-urban markets it serves; the effect of managed care initiatives on the non-urban markets served by the Company's hospitals and the Company's ability to enter into managed care provider arrangements on acceptable terms; the effect of liability and other claims asserted against the Company; the effect of competition in the markets served by the Company's hospitals; and other factors referenced in this Report. Certain of these factors are discussed in more detail elsewhere in this Report. Given these uncertainties, prospective investors are cautioned not to place undue reliance on such forward-looking statements. The Company disclaims 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.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's primary market risk involves interest rate risk. The Company's interest expense is sensitive to changes in the general level of U. S. interest rates. To mitigate the impact of fluctuations in U. S. interest rates, the Company generally expects to maintain a substantial percent of its debt as fixed rate in nature by entering into interest rate swap transactions. The interest rate swap agreements, entered into in 1997 and 1998, are contracts to exchange periodically fixed and floating interest rate payments over the life of the agreements. The floating-rate payments are based on LIBOR and fixed-rate payments are dependent upon market levels at the time the swap agreement was consummated. The interest rate swap agreements do not constitute positions independent of the underlying exposures. The Company does not hold or issue derivative instruments for trading purposes and is not a party to any instruments with leverage features. The swap agreements allow the counterparty a one-time option at the end of the initial term to cancel the agreement or extend the swaps for an incremental time period. The Company is exposed to credit losses in the event of nonperformance by the counterparties to its financial instruments. The counterparties are creditworthy financial institutions, and the Company expects the counterparties to fully satisfy their contract obligations. The Company received a weighted average rate of 5.72% and 5.67%, and paid a weighted average rate of 6.27% and 6.14% on its interest rate swap agreements, for the years ended December 31, 1997 and 1998, respectively.
At December 31, 1998, the carrying amount of the Company's total debt of $134.3 million approximated fair value. The Company had $128.7 million of variable rate debt outstanding at December 31, 1998, with
interest rate swaps in place to offset the variability of $80.0 million of this balance. At this borrowing level, a hypothetical 10% adverse change in interest rates, considering the effect of the interest rate hedge agreements, would have an unfavorable impact on the Company's net income and cash flows of approximately $0.3 million. A hypothetical 10% adverse change in interest rates on the fixed-rate debt would not have a material impact on the fair value of such debt.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The response to this item is submitted in a separate section of this report.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information with respect to the executive officers and directors of the Company is incorporated by reference from the Company's Proxy Statement relating to the Annual Meeting of Shareholders to be held on May 20, 1999. Such Proxy Statement will be filed with the Commission not later than 120 days subsequent to December 31, 1998.
Information with respect to compliance with Section 16(a) of the Securities Exchange Act of 1934 is incorporated by reference from the Company's Proxy Statement relating to the Annual Meeting of Shareholders to be held on May 20, 1999.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
Information with respect to the compensation of the Company's executive officers is incorporated by reference from the Company's Proxy Statement relating to the Annual Meeting of Shareholders to be held on May 20, 1999, except that the Comparative Performance Graph and the Compensation Committee Report on Executive Compensation included in the Proxy Statement are expressly not incorporated herein by reference. Such Proxy Statement will be filed with the Commission not later than 120 days subsequent to December 31, 1998.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information with respect to the security ownership of certain beneficial owners of the Company's Common Stock and management is incorporated by reference from the Company's Proxy Statement relating to the Annual Meeting of Shareholders to be held on May 20, 1999. Such Proxy Statement will be filed with the Commission not later than 120 days subsequent to December 31, 1998.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information with respect to certain relationships and related transactions between the Company and its executive officers and directors is incorporated by reference from the Company's Proxy Statement relating to the Annual Meeting of Shareholders to be held on May 20, 1999. Such Proxy Statement will be filed with the Commission not later than 120 days subsequent to December 31, 1998.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, CONSOLIDATED FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) (1) and (2) LIST OF FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES
The Consolidated Financial Statements and Financial Statement Schedules of the Company required to be included in Part II, Item 8 are indexed on Page and submitted as a separate section of this Report.
(a) (3) EXHIBITS
EXHIBIT NUMBER DESCRIPTION OF EXHIBIT - ------ ----------------------
2.1 Agreement and Plan of Merger, dated as of December 16, 1996, between Brim, Inc. ("Brim") and Carryco, Inc. (a)
2.2 Plan and Agreement of Merger, dated as of December 17, 1996, between Brim, Principal Hospital Company ("PHC") and Principal Merger Company (a)
2.3 Agreement and Plan of Merger, dated as of November 27, 1996, between Brim, Brim Senior Living, Inc., Encore Senior Living, L.L.C. and Lee Zinsli (a)
2.4 Amended and Restated Agreement and Plan of Merger, dated as of January 15, 1998, between Principal Hospital Company and Province Healthcare Company ("Province") (a)
3.1 Amended and Restated Certificate of Incorporation of Province (a)
3.2 Amended and Restated Bylaws of Province (a)
4.1 Form of Common Stock Certificate (a)
4.2 Amended and Restated Credit Agreement, dated as of March 30, 1998, among Province, First Union National Bank, as Agent and Issuing Bank, and various lenders thereto (b)
EXHIBIT NUMBER DESCRIPTION OF EXHIBIT - ------ ----------------------
4.3 Participation Agreement, dated as of March 30, 1998, among Province, as Construction Agent and Lessee, various parties as Guarantors, First Security Bank, National Association, as Owner Trustee, various banks party thereto, as Holders, various banks party thereto, as Lenders, and First Union National Bank, as Agent (b)
4.4 First Amendment to Credit Agreement and Waiver, dated as of November 20, 1998, among Province, First Union National Bank, as Agent and Issuing Bank, and various lenders thereto *
10.1 Investment Agreement, dated as of November 21, 1996, between Brim, Golder, Thoma, Cressey, Rauner Fund IV, L.P. ("GTCR Fund IV") and PHC (a)
10.2 First Amendment to Investment Agreement, dated as of December 17, 1996, between Brim, GTCR Fund IV and PHC (a)
10.3 Form of Investment Agreement Counterpart (a)
10.4 Employment Agreement, dated as of December 17, 1996, by and between A.E. Brim and Brim (a)
10.5 Stockholders Agreement, dated as of December 17, 1996, by and among Brim, GTCR Fund IV, Leeway & Co., First Union Corporation of Virginia, AmSouth Bancorporation, Martin S. Rash ("Rash"), Richard D. Gore ("Gore"), PHC and certain other stockholders (a)
10.6 First Amendment to Stockholders Agreement, dated as of July 14, 1997, by and among the Company, GTCR Fund IV, Rash, Gore and certain other stockholders (a)
10.7 Registration Agreement, dated as of December 17, 1996, by and among Brim, PHC, GTCR Fund IV, Leeway & Co., First Union Corporation of Virginia, AmSouth Bancorporation and certain other stockholders (a)
10.8 Senior Management Agreement, dated as of December 17, 1996, between Brim, Rash, GTCR Fund IV, Leeway & Co. and PHC (a)
10.9 First Amendment to Senior Management Agreement, dated as of July 14, 1997, between the Company, Rash and GTCR Fund IV (a)
EXHIBIT NUMBER DESCRIPTION OF EXHIBIT - ------ ----------------------
10.10 Senior Management Agreement, dated as of December 17, 1996, between Brim, Gore, GTCR Fund IV, Leeway & Co. and PHC (a)
10.11 First Amendment to Senior Management Agreement, dated as of July 14, 1997, between the Company, Gore and GTCR Fund IV (a)
10.12 Lease Agreement, dated December 16, 1985, as amended, by and between Union Labor Hospital Association and Brim Hospitals, Inc. (a)
10.13 Lease Agreement, dated October 1, 1996, by and between County of Starke, State of Indiana, and Principal Knox Company (a)
10.14 Lease Agreement, dated December 1, 1993, by and between Palo Verde Hospital Association and Brim Hospitals, Inc. (a)
10.15 Lease Agreement, dated May 15, 1986, as amended, by and between Fort Morgan Community Hospital Association and Brim Hospitals, Inc. (a)
10.16 Lease Agreement, dated April 24, 1996, as amended, by and between Parkview Regional Hospital, Inc. and Brim Hospitals, Inc. (a)
10.17 Lease Agreement and Annex, dated June 30, 1997, by and between The Board of Trustees of Needles Desert Communities Hospital and Principal-Needles, Inc. (a)
10.18 Corporate Purchasing Agreement, dated April 21, 1997, between Aligned Business Consortium Group and PHC (a)
10.19 Principal Hospital Company 1997 Long-Term Equity Incentive Plan (a)
10.20 Lease Agreement, dated December 17, 1996, between Brim and Encore Senior Living, L.L.C. (a)
EXHIBIT NUMBER DESCRIPTION OF EXHIBIT - ------ ----------------------
10.21 First Amendment to Securities Purchase Agreement, dated as of December 31, 1997, between PHC and Leeway & Co. (a)
10.22 Second Amendment to Senior Management Agreement, dated as of October 15, 1997, between the Company, Rash, GTCR Fund IV (a)
10.23 Second Amendment to Senior Management Agreement, dated as of October 15, 1997, between the Company, Gore and GTCR Fund IV (a)
10.24 Second Amendment to Stockholders Agreement, dated as of December 31, 1997, between the Company, GTCR Fund IV, Rash, Gore and certain other stockholders (a)
10.25 Asset Acquisition Agreement and Escrow Instructions, dated March 22, 1994, between THC-Seattle, Inc., Community Psychiatric Centers, Brim Fifth Avenue, Inc. and Brim Hospitals, Inc. (a)
10.26 Bill of Sale and Assignment, dated July 9, 1997, by Nationwide Health Properties, Inc. in favor of Brim Hospitals, Inc. (a)
10.27 Asset Purchase Agreement, dated July 12, 1996, between Memorial Hospital Foundation-Palestine, Inc. and Palestine Principal Healthcare Limited Partnership (a)
10.28 Agreement of Limited Partnership, dated July 17, 1996, between Principal Hospital Company, Palestine-Principal, Inc. and Mother Frances Hospital Regional Healthcare Center. (a)
10.29 Lease Agreement, dated as of March 30, 1998, between First Security Bank, National Association, as Owner Trustee, and Province Healthcare Company, as Lessee (b)
10.30 Asset Purchase Agreement, dated April 29, 1998, between Province Healthcare Company, PHC-Lake Havasu, Inc. and Samaritan Health System (c)
10.31 Asset Purchase Agreement, dated June 8, 1998, between Province Healthcare Company and the County of Elko (d)
10.32 Amendment to the Province Healthcare Company Long-Term Equity Incentive Plan, effective March 24, 1998 (e)
10.33 Province Healthcare Company Employee Stock Purchase Plan, effective March 24, 1998 (e)
21.1 Subsidiaries of the Registrant *
EXHIBIT NUMBER DESCRIPTION OF EXHIBIT - ------ ----------------------
23.1 Consent of Ernst & Young LLP *
27.1 Financial Data Schedule - 1998 (for SEC use only) *
27.2 Financial Data Schedule - 1997 (for SEC use only) *
(a) Incorporated by reference to the exhibits filed with the Registrant's Registration Statement on Form S-1, Registration No. 333-34421.
(b) Incorporated by reference to the exhibits filed with the Registrant's Quarterly Report on Form 10-Q, for the quarterly period ended March 31, 1998, Commission File No. 0-23639.
(c) Incorporated by reference to the exhibits filed with the Registrant's Current Report on Form 8-K, dated May 14, 1998, Commission File No. 0-23639.
(d) Incorporated by reference to Exhibit 10.26 filed with the Registrant's Registration Statement on Form S-1, Registration No. 333-56663.
(e) Incorporated by reference to the exhibits filed with the Registrant's Proxy Statement on Schedule 14A, dated May 11, 1998, Commission File No. 0-23639.
(*) Filed herewith
EXECUTIVE COMPENSATION PLANS AND ARRANGEMENTS
The following is a list of all executive compensation plans and arrangements filed as exhibits to this Annual Report on Form 10-K:
EXHIBIT NUMBER EXHIBIT - ------ -------
10.4 Employment Agreement, dated as of December 17, 1996, by and between A.E. Brim and Brim (a)
10.19 Principal Hospital Company 1997 Long-Term Equity Incentive Plan (a)
10.32 Amendment to the Province Healthcare Company Long-Term Equity Incentive Plan, effective March 24, 1998 (e)
10.33 Province Healthcare Company Employee Stock Purchase Plan, effective March 24, 1998 (e)
- -------------------- (a) Incorporated by reference to exhibits filed with the Registrant's Registration Statement on Form S-1, Registration No. 333-34421
(e) Incorporated by reference to the exhibits filed with the Registrant's Proxy Statement on Schedule 14A, dated May 11, 1998, Commission File No. 0-23639
(b) REPORTS ON FORM 8-K
None.
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.
Province Healthcare Company By: /s/ Brenda B. Rector Brenda B. Rector Vice President and Controller
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.
Name Title Date ---- ----- ----
/s/ Martin S. Rash President and Chief Executive March 30, 1999 Martin S. Rash Officer, Director
/s/ Richard D. Gore Executive Vice President and March 30, 1999 Richard D. Gore Chief Financial Officer
/s/ Bruce V. Rauner Director March 30, 1999 Bruce V. Rauner
/s/ Joseph P. Nolan Director March 30, 1999 Joseph P. Nolan
/s/ A. E. Brim Director March 30, 1999 A. E. Brim
/s/ Michael T. Willis Director March 30, 1999 Michael T. Willis
/s/ David L. Steffy Director March 30, 1999 David L. Steffy
PROVINCE HEALTHCARE COMPANY FORM 10-K - ITEM 8 AND ITEM 14 (A) (1) AND (2)
INDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE
The following financial statements are included as a separate section of this report:
The following financial statement schedule is included as a separate section of this report.
Schedule II - Valuation and Qualifying Accounts S-1
All other schedules for which provision is made in the applicable accounting regulation of the Securities and Exchange Commission are not required under the related instructions or are inapplicable and, therefore, have been omitted.
REPORT OF INDEPENDENT AUDITORS
Board of Directors Province Healthcare Company
We have audited the accompanying consolidated balance sheets of Province Healthcare Company (formerly known as Principal Hospital Company) and subsidiaries as of December 31, 1997 and 1998, and the related consolidated statements of operations, changes in common stockholders' equity (deficit), and cash flows for the period February 2, 1996 (date of inception) to December 31, 1996 and the years ended December 31, 1997 and 1998. Our audits also included the financial statement schedule listed in the Index at Item 14(a). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. 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 financial statements referred to above present fairly, in all material respects, the consolidated financial position of Province Healthcare Company and subsidiaries as of December 31, 1997 and 1998, and the consolidated results of their operations and their cash flows for the period February 2, 1996 to December 31, 1996 and the years ended December 31, 1997 and 1998, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
Ernst & Young LLP
Nashville, Tennessee February 19, 1999, except for Note 17, as to which the date is February 22, 1999
PROVINCE HEALTHCARE COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
See accompanying notes.
PROVINCE HEALTHCARE COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
See accompanying notes.
PROVINCE HEALTHCARE COMPANY
CONSOLIDATED STATEMENTS OF CHANGES IN COMMON STOCKHOLDERS' EQUITY (DEFICIT) (DOLLARS IN THOUSANDS)
See accompanying notes.
PROVINCE HEALTHCARE COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
See accompanying notes.
PROVINCE HEALTHCARE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1998
1. ORGANIZATION
The Company (formerly Principal Hospital Company (PHC) until February 4, 1998) was founded on February 2, 1996. The Company is engaged in the business of owning, leasing and managing hospitals in non-urban communities, principally in the northwestern and southwestern United States.
As discussed in Note 3, on December 18, 1996, a subsidiary of Brim, Inc. (Brim) and PHC merged in a transaction in which Brim issued junior preferred and common stock to PHC. As the PHC shareholders became owners of a majority of the outstanding shares of Brim after the merger, PHC was considered the acquiring enterprise for financial reporting purposes and the transaction was accounted for as a reverse acquisition. Therefore, the historical financial statements of PHC replaced the historical financial statements of Brim, the assets and liabilities of Brim were recorded at fair value as required by the purchase method of accounting, and the operations of Brim were reflected in the operations of the combined enterprise from the date of acquisition. As PHC was in existence for less than a year at December 31, 1996, and because Brim has been in existence for several years, PHC is considered the successor to Brim's operations. Brim, the predecessor company and surviving legal entity, changed its name to Principal Hospital Company on January 16, 1997.
On February 4, 1998, the Company merged with a wholly-owned subsidiary in order to change its jurisdiction of incorporation to Delaware and change its name to Province Healthcare Company. In the Merger, the Company exchanged 1.83 shares of its no par common stock for each share of the subsidiary's $0.01 par value common stock. All common share and per share data included in the consolidated financial statements and footnotes thereto have been restated to reflect this reincorporation.
2. ACCOUNTING POLICIES
BASIS OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company, its majority-owned subsidiaries and partnerships in which the Company or one of its subsidiaries is a general partner and has a controlling interest. All significant intercompany accounts and transactions have been eliminated in consolidation.
RECLASSIFICATIONS
Certain reclassifications have been made to the prior year financial statements to
conform to the 1998 presentation. These reclassifications had no effect on net income.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.
CASH EQUIVALENTS
Cash equivalents include all highly liquid investments with an original maturity of three months or less when acquired. The Company places its cash in financial institutions that are federally insured and limits the amount of credit exposure with any one financial institution.
PATIENT ACCOUNTS RECEIVABLE
The Company's primary concentration of credit risk is patient accounts receivable, which consist of amounts owed by various governmental agencies, insurance companies and private patients. The Company manages the receivables by regularly reviewing its accounts and contracts and by providing appropriate allowances for uncollectible amounts. Significant concentrations of gross patient accounts receivable at December 31, 1997 and 1998, consist of receivables from Medicare of 36% and 35%, respectively, and Medicaid of 12% and 12%, respectively. Concentration of credit risk relating to accounts receivable is limited to some extent by the diversity and number of patients and payors.
INVENTORIES
Inventories are stated at the lower of cost, determined by the first-in, first-out method, or market.
PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment are stated on the basis of cost. Routine maintenance and repairs are charged to expense as incurred. Expenditures that increase values, change capacities or extend useful lives are capitalized. Depreciation is computed by the straight-line method over the estimated useful lives of the assets, which range from 3 to 40 years. Amortization of equipment under capital leases is included in the provision for depreciation.
INTANGIBLE ASSETS
Intangible assets arising from the accounting for acquired businesses are amortized using the straight-line method over the estimated useful lives of the related assets which range
from 5 years for management contracts to 15 to 35 years for cost in excess of net assets acquired.
At December 31, 1997 and 1998, cost in excess of net assets acquired totaled $55,653,000 and $147,654,000, respectively, and accumulated amortization totaled $2,029,000 and $5,637,000, respectively. Management contracts are included in other noncurrent assets. At December 31, 1997 and 1998, management contracts totaled $1,200,000 and accumulated amortization totaled $249,000 and $489,000, respectively.
OTHER ASSETS
Deferred loan costs are included in other noncurrent assets and are amortized over the term of the related debt by the interest method. At December 31, 1997 and 1998, deferred loan costs totaled $3,083,000 and $4,487,000, respectively, and accumulated amortization totaled $916,000 and $1,637,000, respectively.
RISK MANAGEMENT
The Company maintains self-insured medical and dental plans for employees. Claims are accrued under these plans as the incidents that give rise to them occur. Unpaid claim accruals are based on the estimated ultimate cost of settlement, including claim settlement expenses, in accordance with an average lag time and past experience. The Company has entered into a reinsurance agreement with an independent insurance company to limit its losses on claims. Under the terms of this agreement, the insurance company will reimburse the Company a maximum of $900,000 on any individual claim. These reimbursements are included in salaries, wages and benefits in the accompanying consolidated statements of operations.
The Company is insured for professional liability based on a claims-made policy purchased in the commercial insurance market. The provision for professional liability and comprehensive general liability claims includes estimates of the ultimate costs for claims incurred but not reported, in accordance with actuarial projections based on past experience. Management is aware of no professional liability claims whose settlement, if any, would have a material adverse effect on the Company's consolidated financial position or results of operations.
OTHER NONCURRENT LIABILITIES
Other noncurrent liabilities consist primarily of insurance liabilities, supplemental deferred compensation liability, and deferred income taxes.
PATIENT SERVICE REVENUE
Net patient service revenue is reported at the estimated net realizable amounts from patients, third-party payors, and others for services rendered, including estimated retroactive adjustments under reimbursement agreements with third-party payors. Estimated settlements under third-party reimbursement agreements are accrued in the period the related services are rendered and adjusted in future periods as final settlements are determined.
MANAGEMENT AND PROFESSIONAL SERVICES
Management and professional services is comprised of fees from management and professional services provided to third-party hospitals pursuant to management contracts and consulting arrangements. The base fees associated with the hospital management contracts are determined in the initial year of the contract on an individual hospital basis. In certain contracts, the Company is entitled to a yearly bonus based on the performance of the managed hospital. The base fee, which is fixed, is based on a fair market wage and is not dependent on any bonus structure. The management contracts are adjusted yearly based on an agreed upon inflation indicator. The reimbursable expenses relate to salaries and benefits of Company employees that serve as executives at the managed hospitals. The salaries and benefits of these employees are legal obligations of, and are paid by, the Company and are reimbursed by the managed hospitals. Fees are recognized as revenue as services are performed. The Company does not maintain any ownership interest in and does not fund operating losses or guarantee any minimum income for these managed hospitals. The Company does not have any guarantees to these hospitals, except for two managed hospitals for which the Company has guaranteed the hospitals' long-term debt of $690,000.
STOCK BASED COMPENSATION
The Company, from time to time, grants stock options for a fixed number of common shares to employees. The Company accounts for stock option grants in accordance with Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and accordingly, recognizes no compensation expense for the stock option grants when the exercise price of the options equals, or is greater than, the market price of the underlying stock on the date of grant.
INTEREST RATE SWAP AGREEMENTS
The Company enters into interest rate swap agreements as a means of managing its interest rate exposure. The differential to be paid or received is recognized over the life of the agreement as an adjustment to interest expense.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
Effective January 1, 1998, the Company adopted Statement of Financial Accounting Standards ("SFAS") No. 130, Reporting Comprehensive Income. Statement No. 130 established new rules for the reporting and display of comprehensive income and its components. The Company had no items of other comprehensive income, and accordingly, adoption of the Statement had no effect on the consolidated financial statements.
Effective January 1, 1998, the Company adopted SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information. Statement No. 131 established standards for the reporting of information about operating segments. In excess of 90% of the Company's assets, revenues and income are derived from one segment, the ownership and operation of acute care hospitals. Accordingly, segment disclosures are not presented in these financial statements.
In June 1998, SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, was issued, and is required to be adopted in years beginning after June 15, 1999. This Statement requires all derivatives to be recorded on the balance sheet at fair value. This results in the offsetting changes in fair values or cash flows of both the hedge and the hedged item being recognized in earnings in the same period. Changes in fair value of derivatives not meeting the Statement's hedge criteria are included in income. The Company expects to adopt the new Statement January 1, 2000. The Company does not expect the adoption of this Statement to have a significant effect on its results of operations or financial position.
3. ACQUISITIONS
MEMORIAL MOTHER FRANCES HOSPITAL
In July 1996, the Company purchased certain assets totaling $26,394,000 and assumed certain liabilities totaling $3,211,000 of Memorial Mother Frances Hospital for a purchase price of $23,183,000. Cost of the acquisition approximated net assets acquired.
STARKE MEMORIAL HOSPITAL
In October 1996, the Company acquired Starke Memorial Hospital by purchasing certain assets totaling $458,000, assuming certain liabilities totaling $211,000, and entering into a capital lease agreement, for a purchase price of approximately $7,742,000. The cost in excess of net assets acquired is being amortized over 20 years.
BRIM, INC.
In December 1996, a subsidiary of Brim merged with PHC. Brim was engaged in the business of owning, leasing and managing hospitals in non-urban communities primarily in the northwestern and southwestern United States. In exchange for their shares in PHC, the PHC shareholders received 14,403 shares of newly-designated redeemable junior preferred stock and 2,757,947 shares of newly designated common stock of Brim. The Company purchased certain assets totaling $89,625,000 and assumed certain liabilities totaling $140,424,000 for a purchase price of approximately $1,594,000. The acquisition of Brim resulted in cost in excess of net assets acquired of $52,393,000, which is being amortized over a period ranging from 20 to 35 years.
As discussed in Note 1, the merger was accounted for as a reverse acquisition under the purchase method of accounting and, for accounting purposes, PHC was considered as having acquired Brim. The historical financial statements of PHC became the historical financial statements of Brim and include the results of operations of Brim from the effective date of the merger, December 18, 1996.
COLORADO RIVER MEDICAL CENTER
In August 1997, the Company acquired Colorado River Medical Center by purchasing certain assets totaling $70,000, assuming certain liabilities totaling $121,000, and entering into a capital lease agreement, for a purchase price of approximately $6,293,000. Cost in excess of net assets acquired in the acquisition totaled approximately $1,047,000 and is being amortized over 15 years.
HAVASU SAMARITAN REGIONAL HOSPITAL
In May 1998, the Company acquired Havasu Samaritan Regional Hospital in Lake Havasu City, Arizona, for approximately $107,467,000. To finance this acquisition, the Company borrowed $106,000,000 under its revolving credit facility. Cost in excess of net assets acquired in the acquisition totaled approximately $76,474,000 and is being amortized over 35 years.
ELKO GENERAL HOSPITAL
In June 1998, the Company acquired Elko General Hospital in Elko, Nevada, for a purchase price of approximately $23,251,000. To finance this acquisition, the Company borrowed $22,000,000 under its revolving credit facility. Cost in excess of net assets acquired in the acquisition totaled approximately $14,331,000 and is being amortized over 35 years. The allocation of the purchase price has been determined based upon currently available information and is subject to further refinement, pending the final settlement of the working capital acquired. The Company has committed to spend at least $30,000,000 on a replacement facility within thirty-six months of the acquisition close date.
OTHER INFORMATION
In accordance with its stated policy, management of the Company evaluates all acquisitions independently to determine the appropriate amortization period for cost in excess of net assets acquired. Each evaluation includes an analysis of factors such as historic and projected financial performance, evaluation of the estimated useful lives of buildings and fixed assets acquired, the indefinite lives of certificates of need and licenses acquired, the competition within local markets, and lease terms where applicable.
The foregoing acquisitions were accounted for using the purchase method of accounting. The operating results of the acquired companies have been included in the accompanying consolidated statements of operations from the respective dates of acquisition.
The following pro forma information reflects the operations of the entities acquired in 1996, 1997 and 1998, as if the respective transactions had occurred as of the first day of the fiscal year immediately preceding the year of the acquisitions (in thousands, except per share data):
The pro forma results of operations do not purport to represent what the Company's results would have been had such transactions in fact occurred at the beginning of the periods presented or to project the Company's results of operations in any future period.
The Company has minority ownership in various health care related businesses. These investments are accounted for by the equity method. The assets, liabilities and results of operations of these businesses are not material to the consolidated financial statements.
4. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consist of the following (in thousands):
Assets under capital leases were $23,619,000 and $17,374,000, net of accumulated amortization of $2,684,000 and $3,957,000 at December 31, 1997 and 1998, respectively. Interest is capitalized in connection with construction projects at the Company's facilities. The capitalized interest is recorded as part of the asset to which it relates and is amortized over the asset's estimated useful life. In 1997 and 1998, respectively, $223,000 and $288,000 of interest cost was capitalized.
5. LONG-TERM OBLIGATIONS
Long-term obligations consist of the following (in thousands):
In connection with the Brim merger in 1996, the Company repaid its outstanding debt and reported a $262,000 loss on early retirement, net of taxes of $167,000, as a result of the write off of related deferred financing costs.
As a result of the reverse acquisition of Brim, the Company assumed a $100 million Credit Agreement of Brim, consisting of a revolving credit facility in an amount of up to $65,000,000 and a term loan in the amount of $35,000,000. There were $47,000,000 of borrowings outstanding under the revolving credit agreement and $35,000,000 under the term loan at December 31, 1997. The Company repaid the $35,000,000 term loan in 1998 using proceeds from its initial public offering.
In March 1998, the Company amended and restated its Credit Agreement to consist of a revolving credit agreement in the amount of $260,000,000. At December 31, 1998, the Company had $127,000,000 outstanding under its revolving line of credit and borrowing availability of $133,000,000.
The loans under the Credit Agreement bear interest, at the Company's option, at the adjusted base rate or at the adjusted LIBOR rate. The interest rate ranged from 6.78% to 9.50% during 1998. The Company pays a commitment fee, which varies from one-quarter to one-half of one percent of the unused portion, depending on the Company's compliance with certain financial ratios. The Company may prepay the principal amount outstanding under the revolving credit agreement at any time before the maturity date of March 30, 2003.
The Credit Agreement contains limitations on the Company's ability to incur additional indebtedness (including contingent obligations), sell material assets, retire, redeem or otherwise reacquire its capital stock, acquire the capital stock or assets of another business, and pay dividends. The Credit Agreement also requires the Company to maintain a specified net worth and meet or exceed certain coverage, leverage, and indebtedness ratios. Indebtedness under the Credit Agreement is secured by substantially all assets of the Company.
During 1997, as required by the credit facility, the Company entered into an interest rate
swap agreement, which effectively converted for a three-year period $35,000,000 of floating-rate borrowings to fixed-rate borrowings. On September 4, 1998, the Company entered into an interest rate swap agreement, which effectively converted for a five-year period $45,000,000 of floating rate borrowings to fixed-rate borrowings. These interest rate swap agreements are used to manage the Company's interest rate exposure. The agreements are contracts to periodically exchange floating interest rate payments for fixed interest rate payments over the life of the agreements. The Company secured a 6.27% fixed interest rate on the 1997 swap and a 5.63% rate on the 1998 swap. These agreements expose the Company to credit losses in the event of non-performance by the counterparties to its financial instruments. The Company anticipates that the counterparties will fully satisfy their obligations under the contracts.
Aggregate maturities of long-term obligations at December 31, 1998, excluding capital leases, are as follows (in thousands):
6. MANDATORY REDEEMABLE PREFERRED STOCK
Redeemable preferred stock consists of the following:
The 20,000 outstanding shares of Series A redeemable senior preferred stock and a warrant to purchase 253,228 shares of common stock were issued in December 1996 by Brim for cash of $20,000,000. Issuance costs totaled $892,000. Series A redeemable preferred stock paid
cumulative preferential dividends which accrued on a daily basis at the rate of 11% and were payable in cash when and as declared by the board of directors.
Of the 32,295 outstanding shares of Series B redeemable junior preferred stock at December 31, 1997, 28,540 were issued in December 1996 by Brim and 3,755, were issued in July 1997. Issuance costs totaled $1,282,000 and $50,000 for the December 1996 and July 1997 issues, respectively. Series B redeemable junior preferred stock paid cumulative preferential dividends which accrued on a daily basis at the rate of 8% and were payable in cash when and as declared by the board of directors.
In connection with its initial public offering of common stock, the Company redeemed all of the outstanding shares of Series A preferred stock and all accrued and unpaid dividends thereon; and converted into common stock all of the outstanding shares of Series B preferred stock, plus accrued and unpaid dividends thereon.
7. STOCKHOLDERS' EQUITY
COMMON STOCK
Prior to the merger with Brim, the capital stock of PHC consisted of Class A Common Stock, and Class B Common Stock. All of the Class A and Class B Common Stock was exchanged by the PHC shareholders in the merger with Brim for 14,403 shares of Brim junior preferred stock and 2,757,947 shares of Brim common stock as more fully discussed in Note 3.
In May 1997, the Company declared a three-for-one stock split of the outstanding common stock and common stock options and warrant. All common share and per share data included in the accompanying consolidated financial statements and footnotes have been restated to reflect this stock split.
In February 1998, the Company merged with a wholly-owned subsidiary in order to change its jurisdiction of incorporation to Delaware and change its name to Province Healthcare Company. In the Merger, the Company exchanged 1.83 shares of its no par common stock for each share of the subsidiary's $0.01 par value common stock. All common share and per share data included in the consolidated financial statements and footnotes have been restated to reflect this reincorporation. As a result of the reincorporation, $2,053,000 was reclassified from common stock to additional paid-in-capital upon conversion from no par to $0.01 par value Common Stock.
In February 1998, the Company closed its initial public offering of 5,405,000 shares of common stock at an offering price of $16.00 per share. In connection with the offering, the Series B redeemable junior preferred stock was converted into common stock at the public offering price of the common stock. The net proceeds from the offering were used to redeem the outstanding balance of the Series A redeemable senior preferred stock plus accrued dividends, reduce the balance of the outstanding term and revolving credit loans, and repurchase a portion of the
common stock which was issued upon conversion of the Series B redeemable junior preferred stock.
In July 1998, the Company completed its public offering of 2,685,500 shares of common stock at an offering price of $26.00 per share. The net proceeds from the offering of approximately $65,700,000 were used primarily to reduce debt.
STOCK OPTIONS
The Company follows Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (APB 25) and related Interpretations in accounting for its employee stock options. Under APB 25, when the exercise price of the Company's employee stock options equals the market price of the underlying stock on the date of grant, no compensation expense is recognized.
In March 1997, the Company's Board of Directors approved the 1997 Long-Term Incentive Plan (the Plan). Under the Plan, options to purchase shares may be granted to officers, employees, and directors. The options have a maximum term of ten years and vest in five equal annual installments. Options are generally granted at not less than market price on the date of grant.
The following is a summary of option transactions during 1997 and 1998:
At December 31, 1997, 37,736 options were exercisable, with a vesting schedule based on employment date.
The following table summarizes information concerning outstanding and exercisable options at December 31, 1998:
At December 31, 1998, the Company had options representing 415,506 shares available for future grant.
Pro forma information regarding net income and earnings per share is required by SFAS No. 123, Accounting for Stock Based Compensation, and has been determined as if the Company had accounted for its employee stock options under the fair value method of that Statement. The fair value for these options was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted-average assumptions for 1997 and 1998, respectively: risk-free interest rate of 6.41% and 5.28%; dividend yield of 0%; volatility factor of the expected market price of the Company's common stock of .563 and .640; and a weighted-average expected life of the option of 5 years. The estimated weighted average fair values of shares granted during 1997 and 1998, using the Black-Scholes option pricing model, were $2.90 and $12.80, respectively.
The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options.
For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting period. The Company's pro forma information is as follows (in thousands, except for per share information):
EMPLOYEE STOCK PURCHASE PLAN
In May 1998 the Company's Board adopted, and in June 1998 the stockholders approved, the Province Healthcare Company Employee Stock Purchase Plan (the "ESSP"). Under the Plan, employees may purchase shares of common stock at 85% of market price on the first day of the year or 85% of market price on the last day of the year, whichever is lower. The shares are purchased each year with funds withheld from employees through payroll deductions from January 1 through December 31. A total of 250,000 shares of Common Stock have been reserved for issuance under the ESSP. Participation in the Plan commenced in January 1998.
WARRANT
In connection with the reverse acquisition of Brim (see Note 3), the Company assumed a warrant that had been issued by Brim to purchase 253,228 shares of Brim's common stock for $15,447. On September 12, 1997, the warrant, was exercised.
8. PATIENT SERVICE REVENUE
The Company has agreements with third-party payors that provide for payments to the Company at amounts different from its established rates. A summary of the payment arrangements with major third-party payors follows:
- Medicare--Inpatient acute care services rendered to Medicare program beneficiaries are paid at prospectively determined rates per diagnosis related group ("DRG"). These DRG rates vary according to a patient classification system that is based on clinical, diagnostic, and other factors. Inpatient nonacute services, certain outpatient services and medical education costs related to Medicare beneficiaries are paid based on a cost reimbursement methodology subject to various cost limits. The Company is reimbursed for cost-based services at a tentative rate, with final settlement determined after submission of annual cost reports by the Company and audits thereof by the Medicare fiscal intermediary. The Company's classification of patients under the Medicare program and the appropriateness of their admission are subject to an independent review. The majority of the Company's Medicare cost reports have been audited by the Medicare fiscal intermediary through December 31, 1996.
- Medicaid--Inpatient services rendered to the recipients under the Medi-Cal program (California's medicaid program) are reimbursed either under contracted rates or reimbursed for cost reimbursable items at a tentative rate with final settlement determined after submission of annual cost reports by the Company and audits thereof by Medi-Cal. The Company owns or leases four hospitals in California, and its Medi-Cal cost reports have been audited by the Medi-Cal fiscal intermediary through December 31, 1996. The Medicaid programs of the other states in which the Company owns or leases hospitals are prospective payment systems which generally do not have retroactive cost report settlement procedures.
- Other--The Company also has entered into payment agreements with certain commercial insurance carriers, health maintenance organizations and preferred provider organizations. The basis for payment to the Company under these agreements includes prospectively determined rates per discharge, discounts from established charges, and prospectively determined daily rates.
Approximately 62% and 57% of gross patient service revenue for the years ended December 31, 1997 and 1998, respectively, are from participation in the Medicare and state-sponsored Medicaid programs.
The Company owns or leases four hospitals in California, which accounted for 40.9% of net operating revenue in 1997 and 33.4% in 1998. Three of these hospitals were acquired in the Company's merger with Brim, and only thirteen days of operations were included in 1996 results of operations.
Final determination of amounts earned under the Medicare and Medicaid programs often occur in subsequent years because of audits by the programs, rights of appeal and the application of numerous technical provisions. Differences between original estimates and subsequent revisions (including final settlements) are included in the statements of operations in the period in which the revisions are made, and resulted in increases in net patient service revenue of $788,000 for the predecessor company in 1996, and $3,260,000 and $4,050,000 for the Company in 1997 and 1998, respectively. The amount of the revisions that occurred in the fourth quarter of 1997 and 1998 totaled $2,400,000 and $650,000, respectively.
9. INCOME TAXES
The provision for income tax expense (benefit) attributable to income (loss) before extraordinary item consists of the following amounts (in thousands):
The differences between the Company's effective income tax rate of 33.8%, 47.2% and 44.2% before extraordinary item for 1996, 1997 and 1998, respectively, and the statutory federal income tax rate of 34.0% for 1996 and 1997 and 35.0% for 1998 are as follows (in thousands):
The components of the Company's deferred tax assets and liabilities are as follows (in thousands):
In the accompanying consolidated balance sheets, net current deferred tax assets and net noncurrent deferred tax liabilities are included in prepaid expenses and other, and other liabilities, respectively.
The Company had Federal net operating loss carryforwards (NOLs) of approximately $714,000 at December 31, 1997 and 1998 related to a subsidiary. These NOLs will expire beginning in 2009. Due to restrictions on the use of the NOLs, management believes there is a risk they may expire unused, and accordingly, has established a valuation reserve against the tax benefit of the NOLs. Management believes it is more likely than not that the remaining deferred tax assets, will ultimately be realized through future taxable income from operations.
During 1997, the Internal Revenue Service finalized its examination of the predecessor company's federal income tax returns for the 1993 and 1994 years. Finalization of the examination had no impact on the financial condition or results of operations of the Company. The IRS is currently engaged in an examination of the predecessor company's federal income tax returns for 1995 and 1996. Finalization of the examination is not expected to have a significant impact on the financial condition or results of operations of the Company.
10. EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted earnings per share (in thousands, except per share data):
Diluted loss per share amounts for 1996 and 1997 have been calculated using the same denominator as used in the basic loss per share calculation, as the inclusion of dilutive securities in the denominator would have an anti-dilutive effect.
11. LEASES
During 1998, the Company entered into a five-year $35,000,000 End Loaded Lease Financing agreement to provide a financing option for future construction of medical office buildings on the campuses of its owned/leased hospitals, and may be used for the construction of a replacement facility at one of its owned hospitals. The interest rate and facility fee rate are substantially the same as the Company's revolving line of credit (see Note 5). All lease payments are guaranteed by the Company. At December 31, 1998, the entire $35,000,000 was available under the ELLF agreement.
The Company leases various buildings, office space and equipment. The leases expire at various times and have various renewal options. These leases are classified as either capital leases or operating leases based on the terms of the respective agreements.
Future minimum payments at December 31, 1998, by year and in the aggregate, under capital leases and noncancellable operating leases with terms of one year or more consist of the following (in thousands):
12. LITIGATION
The Company is involved in litigation arising in the ordinary course of business. In the opinion of management, after consultation with legal counsel, these matters will be resolved without material adverse effect on the Company's consolidated financial position or results of operations.
13. RETIREMENT PLANS
The Company sponsors defined contribution employee benefit plans which cover substantially all employees. Employees may contribute a percentage of eligible compensation subject to Internal Revenue Service limits. The plans call for the Company to make matching contributions, based on either a percentage of employee contributions or a discretionary amount as determined by the Company. Contributions by the Company to the plans totaled $988,000 and $1,340,000 for the years ended December 31, 1997 and 1998, respectively.
The Company sponsors a nonqualified supplemental deferred compensation plan for selected management employees. As determined by the Board of Directors, the Plan provides a benefit of 1% to 3% of the employee's compensation. The participant's amount is fully vested, except in those instances where the participant's employment terminates for any reason other than retirement, death or disability, in which case the participant forfeits a portion of the employer's contribution depending on length of service. Plan expenses totaled $98,000 and $197,000 for the years ended December 31, 1997 and 1998, respectively.
14. FAIR VALUES OF FINANCIAL INSTRUMENTS
Cash and Cash Equivalents -- The carrying amount reported in the balance sheets for cash and cash equivalents approximates fair value.
Accounts Receivable and Accounts Payable -- The carrying amount reported in the balance sheets for accounts receivable and accounts payable approximates fair value.
Long-Term Debt -- The carrying amount reported in the balance sheets for long-term obligations approximates fair value. The fair value of the Company's long-term obligations is estimated using discounted cash flow analyses, based on the Company's current incremental borrowing rates for similar types of borrowing arrangements.
Interest rate swap agreements -- The fair value of the Company's interest rate swap agreements is $575,000 at December 31, 1998, based on quoted market prices for similar debt issues.
15. PRO FORMA FINANCIAL INFORMATION (UNAUDITED)
The unaudited pro forma condensed consolidated statement of operations for the year ended December 31, 1998 gives effect to (i) the conversion of junior preferred stock into common stock at the initial public offering ("IPO") price of $16.00 per share; (ii) the sale of common stock in the IPO in February 1998, and the application of net proceeds thereof to the repurchase of certain shares of common stock, the redemption of senior preferred stock and the repayment of debt; and (iii) the sale of common stock at $26.00 per share in a public offering completed in July 1998, and the application of net proceeds thereof to reduce debt; as if all such transactions had been completed as of January 1, 1998.
16. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
Quarterly financial information for the years ended December 31, 1997 and 1998 is summarized below (in thousands, except per share data):
17. SUBSEQUENT EVENT
On February 22, 1999, the Company entered into a "special services agreement" for the lease of Eunice Regional Medical Center, an 85-bed general acute care hospital, located in Eunice, Louisiana. The Company purchased certain assets, assumed certain liabilities, and entered into a ten-year lease agreement, with a five-year renewal option. The transaction was accounted for as a purchase business combination, with a purchase price of approximately $1,669,000. The Company is obligated under the lease to construct a replacement facility (currently estimated to cost approximately $20,000,000) at such time as the net patient revenue of the hospital reaches a pre-determined level. The lease will terminate at the time the replacement hospital commences operations.
REPORT OF INDEPENDENT AUDITORS
Board of Directors Brim, Inc.
We have audited the accompanying consolidated statements of income and cash flows of Brim, Inc. and subsidiaries for the period January 1, 1996 to December 18, 1996. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing standards. 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 audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated results of operations and cash flows of Brim, Inc. and subsidiaries for the period January 1, 1996 to December 18, 1996 in conformity with generally accepted accounting principles.
Ernst & Young LLP
Nashville, Tennessee April 30, 1997, except for the second paragraph of Note 10, as to which the date is February 4, 1998
BRIM, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF INCOME FOR THE PERIOD JANUARY 1 TO DECEMBER 18, 1996 (IN THOUSANDS)
See accompanying notes.
BRIM, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS FOR THE PERIOD JANUARY 1 TO DECEMBER 18, 1996 (IN THOUSANDS)
BRIM, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS (CONTINUED) FOR THE PERIOD JANUARY 1 TO DECEMBER 18, 1996 (IN THOUSANDS)
See accompanying notes.
BRIM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 18, 1996
1. ORGANIZATION AND ACCOUNTING POLICIES
Brim, Inc. and its subsidiaries (Brim or the Company) are engaged in the business of owning, leasing and managing hospitals in non-urban communities principally in the northwestern and southwestern United States. As more fully described in Note 2, the Company consummated a leveraged recapitalization on December 18, 1996. Immediately thereafter, as more fully described in Note 10, a subsidiary of the Company merged with Principal Hospital Company (PHC) in a transaction accounted for as a reverse acquisition of Brim by PHC. These accompanying financial statements are presented on the historical cost basis after the leveraged recapitalization but prior to the reverse acquisition. The reverse acquisition resulted in a new basis of accounting such that Brim's assets and liabilities were recorded at their fair value in PHC's consolidated balance sheet upon consummation of the reverse acquisition. Brim, the predecessor company, was renamed Principal Hospital Company on January 16, 1997. PHC is considered the successor company of Brim.
BASIS OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company, its majority-owned subsidiaries and partnerships in which the Company or one of its subsidiaries is a general partner and has a controlling interest. All significant intercompany accounts and transactions have been eliminated in consolidation.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.
RISK MANAGEMENT
The Company maintains self-insured medical and dental plans for employees. Claims are accrued under these plans as the incidents that give rise to them occur. Unpaid claim accruals are based on the estimated ultimate cost of settlement, including claim settlement expenses, in accordance with an average lag time and past experience. The Company has entered into reinsurance agreements for certain plans with independent insurance companies to limit its losses on claims. Under the terms of these agreements, the insurance companies will reimburse the Company based on the level of reinsurance which ranges from $30,000 per
individual claim up to $1,000,000. These reimbursements are included in salaries, wages and benefits in the accompanying consolidated statements of income.
The Company is insured for professional liability based on a claims-made policy purchased in the commercial insurance market. The provision for professional liability and comprehensive general liability claims include estimates of the ultimate costs for claims incurred but not reported, in accordance with actuarial projections based on past experience. Management is aware of no potential professional liability claims whose settlement, if any, would have a material adverse effect on the Company's consolidated results of operations.
PATIENT SERVICE REVENUE
Net patient service revenue is reported at the estimated net realizable amounts from patients, third-party payors, and others for services rendered, including estimated retroactive adjustments under reimbursement agreements with third-party payors. Estimated settlements under third-party reimbursement agreements are accrued in the period the related services are rendered and adjusted in future periods as final settlements are determined.
Approximately 61% of gross patient service revenue for the period January 1 to December 18, 1996, is from participation in the Medicare and state-sponsored Medicaid programs.
MANAGEMENT AND PROFESSIONAL SERVICES
Management and professional services is comprised of fees from management and professional consulting services provided to third-party hospitals pursuant to management contracts and consulting arrangements. The base fees associated with the hospital management contracts are determined in the initial year of the contract on an individual hospital basis. In certain contracts, the Company is entitled to a yearly bonus based on the performance of the managed hospital. The base fee, which is fixed, is based on a fair market wage and is not dependent on any bonus structure. The management contracts are adjusted yearly based on an agreed upon inflation indicator. The substantial majority of management and professional services revenue consists of the management fees earned under the hospital management contracts and reimbursable expenses. The reimbursable expenses relate to salaries and benefits of Company employees that serve as executives at the managed hospitals. The salaries and benefits of these employees are legal obligations of, and are paid by, the Company and are reimbursed by the managed hospitals. Fees are recognized as revenue as services are performed. Reimbursable expenses are included in salaries, wages and benefits in the accompanying consolidated statements of income. Management and professional services revenue, excluding reimbursable expenses, was $9,329,000 for the period January 1 to December 18, 1996. The Company does not maintain any ownership interest in and does not fund operating losses or guarantee any minimum income for these managed hospitals. The Company does not have any guarantees to these hospitals, except for one managed hospital for which the Company has guaranteed the hospital's long-term debt of $500,000.
STOCK BASED COMPENSATION
The Company, from time to time, grants stock options for a fixed number of common shares to employees. The Company accounts for stock option grants in accordance with APB Opinion No. 25, Accounting for Stock Issued to Employees, and accordingly, recognizes no compensation expense for the stock option grants when the exercise price of the options equals, or is greater than, the market price of the underlying stock on the date of grant.
2. RECAPITALIZATION
On December 18, 1996, Brim was recapitalized pursuant to an Investment Agreement dated November 21, 1996, by and between Brim and Golder, Thoma, Cressey, Rauner Fund IV, L.P. (GTCR Fund IV), and PHC. The basic elements of the recapitalization of the Company included the following: GTCR Fund IV and other investors purchased new shares of the Company's common and preferred stock; the Company sold its senior living business and entered into a new credit facility to, along with the proceeds from the sale of the new shares, provide financing for the redemption of a portion of the pre-existing common and preferred stock; this pre-existing common and preferred stock was redeemed; and certain pre-existing debt was repaid. The recapitalization was accounted for as such and, accordingly, did not result in a new basis of accounting.
The principal elements of the recapitalization included the following:
- Brim sold for cash its two wholly-owned subsidiaries engaged in senior living activities for a gross sales price of $19.7 million (see Note 6), and sold for cash certain real estate properties for a price of $406,500 plus assumption of debt of approximately $800,000 (see Note 3).
- GTCR Fund IV purchased 1,051,476 shares, Mr. Martin Rash purchased 16,886 shares, Mr. Richard Gore purchased 31,477 shares, two banks purchased 15,737 shares, and Leeway & Co., a subsidiary of AT&T, purchased 615,082 shares of Brim newly-designated common stock for cash of approximately $1.1 million. Messrs. Rash and Gore purchased 295,011 shares of Brim newly-designated common stock for notes of $179,956.
- Through a series of transactions, Brim pre-transaction shareholders who were to remain shareholders after the recapitalization received 3,580 shares of newly-designated junior preferred stock and 586,884 shares of Brim newly-designated common stock with a value of approximately $4.0 million in exchange for their common stock of Brim.
- GTCR Fund IV purchased 6,414 shares, Mr. Rash purchased 103 shares, Mr.
Gore purchased 192 shares, two banks purchased 96 shares and Leeway & Co. purchased 3,752 shares of newly-designated redeemable junior preferred stock for cash of approximately $10.6 million.
- Leeway & Co. purchased 20,000 shares of newly designated redeemable senior preferred stock and was issued a warrant to purchase 253,228 shares of newly-designated common stock for total cash consideration of $20.0 million. A value of $139,000 was assigned to the warrant.
- Brim entered into a $100.0 million credit facility with First Union National Bank and borrowed $35.0 million under the term loan portion of the facility, and $37.0 million under the $65.0 million revolving credit portion of the facility.
- The outstanding common stock of all Brim shareholders who were not to remain as shareholders after the recapitalization was exchanged for redeemable junior preferred stock. The preferred stock was then redeemed for cash of approximately $42.3 million, and outstanding stock options were settled for cash of approximately $8.0 million.
- Brim redeemed pre-existing Series A preferred stock held by General Electric Credit Corporation for cash of approximately $29.9 million.
- Existing Brim debt of $5.4 million was paid.
- An aggregate of approximately $6.5 million was deposited into escrow accounts for possible breaches of representations and warranties that were made in connection with the recapitalization. Escrow funds not used for settlement of breaches within 18 months of the recapitalization will be released to the redeemed Brim shareholders.
The common stock ownership subsequent to the recapitalization consists of a 22.5% interest held by certain of the pre-recapitalization Brim shareholders and 77.5% held by the new investors.
Total financing fees and legal, accounting and other related costs of the recapitalization amounted to approximately $14,231,000. Costs totaling $8,951,000 were charged to operations at the date of the recapitalization, consisting of cash paid to buy-out stock options of $7,995,000 and transaction-related costs of $956,000. Costs of $2,321,000 associated with the sale of common and preferred stock were allocated to retained earnings (deficit) as to the common stock, and were netted against the proceeds as to the preferred stock. Financing costs of $2,959,000 associated with the credit facility with First Union National Bank were recorded as deferred loan costs.
3. ACQUISITIONS AND DIVESTITURES
In February 1996, the Company acquired Parkview Regional Hospital by entering into a 15-year operating lease agreement with two five-year renewal terms and by purchasing certain assets totaling $3,092,000 and assuming certain liabilities totaling $1,329,000, for a purchase price of $1,763,000. The operating results of Parkview have been included in the accompanying consolidated statement of income from the date of acquisition. Accordingly, the accompanying consolidated statement of income for the period January 1 to December 18, 1996 includes the results of approximately 10 months of operations of Parkview.
In December 1996, the Company sold its senior living business (see Note 6) and certain assets related to three medical office buildings. The assets related to three medical office buildings were sold to a limited liability company for $406,500 plus assumption of debt of approximately $800,000. The accounting basis for the sale was fair market value and a pre-tax gain of approximately $94,000 was recognized on the sale. The members of the limited liability company were officers and employees of the Company prior to the recapitalization who collectively owned 75% of the Company's fully diluted common stock prior to the recapitalization.
The following pro forma information related to continuing operations reflects the operations of the entity acquired in 1996 as if the transaction had occurred as of the first day of the period presented (in thousands):
The pro forma results of continuing operations do not purport to represent what the Company's results of continuing operations would have been had such transactions in fact occurred at the beginning of the years presented or to project the Company's results of operations in any future period.
The Company has minority interests in various health care related businesses. These investments are accounted for by the equity method. The results of operations of these businesses are not material to the consolidated financial statements.
4. PATIENT SERVICE REVENUE
The Company has agreements with third-party payors that provide for payments to the Company at amounts different from its established rates. A summary of the payment arrangements with major third-party payors follows:
- Medicare--Inpatient acute care services rendered to Medicare program beneficiaries are paid at prospectively determined rates per diagnosis. These
rates vary according to a patient classification system that is based on clinical, diagnostic, and other factors. Inpatient nonacute services, certain outpatient services and medical education costs related to Medicare beneficiaries are paid based on a cost reimbursement methodology. The Company is reimbursed for cost reimbursable items at a tentative rate with final settlement determined after submission of annual cost reports by the Company and audits thereof by the Medicare fiscal intermediary. The Company's classification of patients under the Medicare program and the appropriateness of their admission are subject to an independent review. The Company's Medicare cost reports have been audited by the Medicare fiscal intermediary through December 31, 1993.
- Medicaid--Inpatient and outpatient services rendered to Medicaid program beneficiaries are reimbursed either under contracted rates or reimbursed for cost reimbursable items at a tentative rate with final settlement determined after submission of annual cost reports by the Company and audits thereof by Medicaid. The Company's Medicaid cost reports have been audited by the Medicaid fiscal intermediary through December 31, 1993.
- Other--The Company also has entered into payment agreements with certain commercial insurance carriers, health maintenance organizations and preferred provider organizations. The basis for payment to the Company under these agreements includes prospectively determined rates per discharge, discounts from established charges, and prospectively determined daily rates.
Final determination of amounts earned under the Medicare and Medicaid programs often occur in subsequent years because of audits by the programs, rights of appeal and the application of numerous technical provisions. Adjustments from finalization of prior year cost reports from both Medicare and Medicaid resulted in an increase in patient service revenue of $788,000 for the period January 1 to December 18, 1996.
5. INCOME TAXES
The provision for income tax expense (benefit) attributable to income from continuing operations consists of the following amounts (in thousands):
The differences between the Company's effective income tax rate of 30.2% from
continuing operations for 1996, and the statutory federal income tax rate of 34.0% are as follows (in thousands):
The Internal Revenue Service is in the process of finalizing its examination of the Company's federal income tax returns for the 1995 year. Finalization of the examination is not expected to have a significant impact on the results of operations of the Company.
6. DISCONTINUED OPERATIONS
During November 1996, the Company adopted a plan to sell its senior living business to companies whose shareholders included unrelated third parties and certain shareholders, officers, and employees of Brim. The sale of the senior living business was accomplished in the following separate transactions: (i) the sale of assets used in connection with the senior living business through the merger of Brim Senior Living, Inc. with a Delaware limited liability company and (ii) the sale of Meridian Senior Living, Inc. The sale of assets used in connection with the senior living business was to a limited liability company for $15 million. The accounting basis for the sale was fair market value and a pre-tax gain of $11.4 million was recognized on the sale. The limited liability company was owned 65% by an unrelated third party and 35% by officers and shareholders of the Company prior to the recapitalization who collectively owned 61% of the Company's fully diluted common stock prior to the recapitalization. The sale of the outstanding common stock of Meridian Senior Living, Inc., a wholly-owned subsidiary, was to an unrelated third party for $4.7 million. The accounting basis for the sale was fair market value and a loss of $2.4 million was recognized on the sale. Subsequent to the sale to the unrelated third party, certain individuals who were officers and stockholders of the Company prior to the recapitalization became limited partners with the unrelated third party and collectively held a 14% limited partnership interest. These individuals owned approximately 60% of the Company's fully diluted common stock prior to the recapitalization.
The senior living business segment was sold on December 18, 1996. Revenue from this business segment was $18,598,000 for the period January 1 to December 18, 1996. Income from operations was $537,000, net of taxes, for the period January 1, 1996 to December 18, 1996. The gain on the disposal of this business segment was $5,478,000, net of taxes.
For financial reporting purposes, the results of operations and cash flows of the
discontinued businesses are included in the consolidated financial statements as discontinued operations. The income (loss) from discontinued operations is summarized as follows (in thousands):
7. LEASES
The Company leases various buildings, office space and equipment. The leases expire at various times and have various renewal options. These leases are classified as either capital leases or operating leases based on the terms of the respective agreements.
Future minimum payments at December 18, 1996, by year and in the aggregate, under noncancellable operating leases with terms of one year or more consist of the following (in thousands):
8. CONTINGENCIES
The Company is involved in litigation and regulatory investigations arising in the ordinary course of business. In the opinion of management, after consultation with legal counsel, these matters will be resolved without material adverse effect on the Company's consolidated financial position or results of operations.
9. RETIREMENT PLANS
The Company sponsors defined contribution employee benefit plans which cover substantially all employees. Employees may contribute a percentage of eligible compensation subject to Internal Revenue Service limits. The plans call for the Company to make matching
contributions, based on either a percentage of employee contributions or a discretionary amount as determined by the Company. Contributions by the Company to the plans totaled $385,000 for the period January 1 to December 18, 1996.
In January 1995, the Company adopted a nonqualified supplemental deferred compensation plan for selected management employees. As determined by the Board of Directors, the Plan provides a benefit of 1% to 3% of the employee's compensation. The participant's amount is fully vested, except in those instances where the participant's employment terminates for any reason other than retirement, death or disability, in which case the participant forfeits a portion of the employer's contribution depending on length of service. Plan expense totaled $95,000 for the period January 1 to December 18, 1996.
10. SUBSEQUENT EVENTS
Immediately after the recapitalization discussed in Note 2, a subsidiary of the Company was merged into PHC and the Company was renamed Principal Hospital Company. In exchange for their shares in PHC, the PHC shareholders received newly-issued redeemable junior preferred stock and common stock of the Company. While the Company was the legal acquirer, the merger was accounted for as a reverse acquisition of the Company by PHC.
On May 8, 1997, the Company declared a three-for-one stock split of the outstanding common stock and common stock options and warrant to shareholders of record on May 8, 1997. On February 4, 1998, Principal Hospital Company merged with a wholly-owned subsidiary in order to change its jurisdiction of incorporation to Delaware and change its name to Province Healthcare Company (Province). In the Merger, Province exchanged 1.83 shares of its no par common stock for each share of the subsidiary's $0.01 par value common stock. All common share data included in the footnotes to the consolidated financial statements have been restated to reflect the stock split and the reincorporation.
PROVINCE HEALTHCARE COMPANY AND SUBSIDIARIES
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS (In thousands)
(1) Allowances as a result of acquisitions.
(2) Uncollectible accounts written off, net of recoveries.
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