FORM 10-K
Table of Contents

UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
 
 
 
Form 10-K
 
     
(Mark One)    
þ
  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
    For the year ended December 31, 2008
OR
o
  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
    For the transition period from          to          
 
Commission file number 001-15925
 
 
 
 
COMMUNITY HEALTH SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
 
     
Delaware
(State of incorporation)
  13-3893191
(IRS Employer
Identification No.)
4000 Meridian Boulevard
Franklin, Tennessee
(Address of principal executive offices)
  37067
(Zip Code)
 
Registrant’s telephone number, including area code:
(615) 465-7000
 
Securities registered pursuant to Section 12(b) of the Act:
 
     
Title of Each Class
 
Name of Each Exchange on Which Registered
 
Common Stock, $.01 par value   New York Stock Exchange
 
 
 
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  YES þ     NO o
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act.  YES o     NO þ
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  YES þ     NO o
 
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of the Form 10-K or any amendment to the Form 10-K. þ
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
 
Large accelerated filer þ Accelerated filer o Non-accelerated filer o Smaller reporting company o
(Do not check if a smaller reporting company)
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).  YES o     NO þ
 
The aggregate market value of the voting stock held by non-affiliates of the Registrant was $3,198,044,909. Market value is determined by reference to the closing price on June 30, 2008 of the Registrant’s Common Stock as reported by the New York Stock Exchange. The Registrant does not (and did not at June 30, 2008) have any non-voting common stock outstanding. As of February 1, 2009, there were 91,507,617 shares of common stock, par value $.01 per share, outstanding.
 
DOCUMENTS INCORPORATED BY REFERENCE
 
The information required for Part III of this annual report is incorporated by reference from portions of the Registrant’s definitive proxy statement for its 2009 annual meeting of stockholders to be filed with the Securities and Exchange Commission within 120 days after the end of the Registrant’s fiscal year ended December 31, 2008.
 


 

 
TABLE OF CONTENTS
 
FORM 10-K ANNUAL REPORT
 
COMMUNITY HEALTH SYSTEMS, INC.
Year ended December 31, 2008
 
             
        Page
 
  Business     1  
  Risk Factors     22  
  Unresolved Staff Comments     29  
  Properties     29  
  Legal Proceedings     34  
  Submission of Matters to a Vote of Security Holders     38  
 
PART II
  Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities     38  
  Selected Financial Data     40  
  Management’s Discussion and Analysis of Financial Condition and Results of Operations     41  
  Quantitative and Qualitative Disclosures about Market Risk     63  
  Financial Statements and Supplementary Data     64  
  Changes in and Disagreements with Accountants on Accounting and Financial Disclosure     119  
  Controls and Procedures     119  
  Other Information     119  
 
PART III
  Directors and Executive Officers of the Registrant     122  
  Executive Compensation     122  
  Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters     122  
  Certain Relationships and Related Transactions     122  
  Principal Accountant Fees and Services     122  
 
PART IV
  Exhibits and Financial Statement Schedules     122  
 EX-4.7
 EX-4.8
 EX-4.9
 EX-4.10
 EX-4.11
 EX-4.12
 EX-10.5
 EX-10.12
 EX-10.13
 EX-10.14
 EX-10.15
 EX-10.17
 EX-10.18
 EX-10.19
 EX-10.20
 EX-10.22
 EX-12
 EX-21
 EX-23.1
 EX-31.1
 EX-31.2
 EX-32.1
 EX-32.2


Table of Contents

 
PART I
 
Item 1.   Business of Community Health Systems, Inc.
 
Overview of Our Company
 
We are the largest publicly traded operator of hospitals in the United States in terms of number of facilities and net operating revenues. We were incorporated in 1996 as a Delaware corporation. We provide healthcare services through these hospitals that we own and operate in non-urban and selected urban markets throughout the United States. As of December 31, 2008, included in our continuing operations, are 118 hospitals that we owned or leased. These hospitals are geographically diversified across 28 states, with an aggregate of 17,245 licensed beds. We generate revenues by providing a broad range of general and specialized hospital healthcare services to patients in the communities in which we are located. Services provided by our hospitals include, but are not limited to, general acute care services, emergency room services, general and specialty surgery, critical care, internal medicine, obstetrics and diagnostic services. As part of providing these services we also own, outright or through partnerships with physicians, physician practices, imaging centers, and ambulatory surgery centers. Through our corporate ownership and operation of these businesses we provide: standardization and centralization of operations across key business areas; a strategic direction to expand and improve services and facilities at our hospitals; implementation of quality of care improvement programs; and assistance in the recruitment of additional physicians to the markets in which our hospitals are located. In a number of our markets, we have partnered with local physicians or not-for-profit providers, or both, in the ownership of our facilities. In addition to our hospitals and related businesses, we also own and operate home care agencies, including two home care agencies located in markets where we do not operate a hospital. Through our wholly-owned subsidiary, Quorum Health Resources, LLC, or QHR, we also provide management and consulting services to non-affiliated general acute care hospitals located throughout the United States. The home care agencies and the hospital management services businesses constitute operating segments that are not considered reportable segments since they do not meet the quantitative thresholds defined in Statement of Financial Accounting Standards, or SFAS, No. 131, “Disclosures about Segments of an Enterprise and Related Information.” The financial information for our reportable operating segments is presented in Note 14 of the Notes to our Consolidated Financial Statements included under Item 8 of this Report.
 
Our strategy has also included growth by acquisition. We target hospitals in growing, non-urban and select urban healthcare markets for acquisition because of their favorable demographic and economic trends and competitive conditions. Because these service areas have smaller populations, there are generally fewer hospitals and other healthcare service providers in these communities and generally a lower level of managed care presence in these markets. We believe that smaller populations support less direct competition for hospital-based services. Also, we believe that these communities generally view the local hospital as an integral part of the community.
 
Effective July 25, 2007, we completed our acquisition of Triad Hospitals, Inc., or Triad. Triad owned and operated 50 hospitals with 49 hospitals located in 17 states in non-urban and middle market communities and one hospital located in the Republic of Ireland. At December 31, 2008, 41 of the 50 hospitals acquired from Triad remain in our continuing operations. The acquisition of Triad also expanded our operations into five states where we previously did not own any facilities.
 
Throughout this Form 10-K, we refer to Community Health Systems, Inc., or Parent Company, and its consolidated subsidiaries in a simplified manner and on a collective basis, using words like “we” and “our.” This drafting style is suggested by the Securities and Exchange Commission, or SEC, and is not meant to indicate that the publicly traded Parent Company or any other subsidiary of the Parent Company owns or operates any asset, business, or property. The hospitals, operations, and businesses described in this filing are owned and operated, and management services provided, by distinct and indirect subsidiaries of Community Health Systems, Inc.


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Available Information
 
Our Internet address is www.chs.net and the investor relations section of our website is located at www.chs.net/investor/index.html. We make available free of charge, through the investor relations section of our website, annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K as well as amendments to those reports, as soon as reasonably practical after they are filed with the SEC. Our filings are also available to the public at the website maintained by the SEC, www.sec.gov.
 
We also make available free of charge, through the investor relations section of our website, our Governance Principles, our Code of Conduct and the charters of our Audit and Compliance Committee, the Compensation Committee and the Governance and Nominating Committee.
 
We have included the Chief Executive Officer and the Chief Financial Officer certifications regarding the company’s public disclosure required by Section 302 of the Sarbanes-Oxley Act of 2002 as Exhibits 31.1 and 31.2 of this report. We timely submitted to the New York Stock Exchange, or NYSE, the 2008 Annual CEO certification regarding our compliance with the NYSE’s corporate governance listing standards as required by NYSE Rule 303A.
 
Our Business Strategy
 
With the objective of increasing shareholder value, the key elements of our business strategy are to:
 
  •  increase revenue at our facilities;
 
  •  improve profitability;
 
  •  improve quality; and
 
  •  grow through selective acquisitions.
 
Increase Revenue at Our Facilities
 
Overview.  We seek to increase revenue at our facilities by providing a broader range of services in a more attractive care setting, as well as by supporting and recruiting physicians. We identify the healthcare needs of the community by analyzing demographic data and patient referral trends. We also work with local hospital boards, management teams, and medical staffs to determine the number and type of additional physician specialties needed. Our initiatives to increase revenue include:
 
  •  recruiting additional primary care physicians and specialists;
 
  •  expanding the breadth of services offered at our hospitals through targeted capital expenditures to support the addition of more complex services, including orthopedics, cardiovascular services, and urology; and
 
  •  providing the capital to invest in technology and the physical plant at the facilities, particularly in our emergency rooms, surgery departments, critical care departments, and diagnostic services.
 
Physician Recruiting.  The primary method of adding or expanding medical services is the recruitment of new physicians into the community. A core group of primary care physicians is necessary as an initial contact point for all local healthcare. The addition of specialists who offer services, including general surgery, OB/GYN, cardiovascular services, orthopedics and urology, completes the full range of medical and surgical services required to meet a community’s core healthcare needs. At the time we acquire a hospital and from time to time thereafter, we identify the healthcare needs of the community by analyzing demographic data and patient referral trends. As a result of this analysis, we are able to determine what we believe to be the optimum mix of primary care physicians and specialists. We employ recruiters at the corporate level to support the local hospital managers in their recruitment efforts. We have increased the number of physicians affiliated with us through our recruiting efforts, net of turnover, by approximately 686 in 2008, 440 in 2007 and 300 in 2006. The percentage of recruited or other physicians commencing practice with us that were specialists was over 50% in 2008. Although in recent years we have begun employing more physicians, most of our


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physicians are in private practice in their communities and are not our employees. We have been successful in recruiting physicians because of the practice opportunities afforded physicians in our markets, as well as lower managed care penetration as compared to larger urban areas.
 
Emergency Room Initiatives.  Approximately 55% of our hospital admissions originate in the emergency room. Therefore, we systematically take steps to increase patient flow in our emergency rooms as a means of optimizing utilization rates for our hospitals. Furthermore, the impression of our overall operations by our customers is substantially influenced by our emergency rooms since generally that is their first experience with our hospitals. The steps we take to increase patient flow in our emergency rooms include renovating and expanding our emergency room facilities, improving service and reducing waiting times, as well as publicizing our emergency room capabilities in the local community. We have expanded or renovated 13 of our emergency rooms during the past three years, including four in 2008. We have also implemented marketing campaigns that emphasize the speed, convenience, and quality of our emergency rooms to enhance each community’s awareness of our emergency room services.
 
One component of upgrading our emergency rooms is the implementation of specialized computer software programs designed to assist physicians in making diagnoses and determining treatments. The software also benefits patients and hospital personnel by assisting in proper documentation of patient records and tracking patient flow. It enables our nurses to provide more consistent patient care and provides clear instructions to patients at time of discharge to help them better understand their treatments.
 
Expansion of Services.  In an effort to better meet the healthcare needs of the communities we serve and to capture a greater portion of the healthcare spending in our markets, we have added a broad range of services to our facilities. These services range from various types of diagnostic equipment capabilities to additional and renovated emergency rooms, surgical and critical care suites and specialty services. For example, in 2008, we spent $108.7 million as a part of 27 major construction projects. The 2008 projects included new emergency rooms, cardiac cathertization labs, intensive care units, hospital additions, and ambulatory surgery centers. These projects improved various diagnostic and other inpatient and outpatient service capabilities. We continue to believe that appropriate capital investments in our facilities combined with the development of our service capabilities will reduce the migration of patients to competing providers while providing an attractive return on investment. We also employ a small group of clinical consultants at our corporate headquarters to assist the hospitals in their development of surgery, emergency services, critical care and cardiovascular services. In addition to spending capital on expanding services at our existing hospitals, we also build replacement facilities to better meet the healthcare needs of our communities. In 2008, three replacement hospitals were completed and opened: one in Clarksville, Tennessee (June 2008), one in Shelbyville, Tennessee (July 2008) and one in Petersburg, Virginia (August 2008). We spent approximately $374 million on these three replacement hospitals which includes expenditures by Triad prior to our acquisition of Triad.
 
Managed Care Strategy.  Managed care has seen growth across the U.S. as health plans expand service areas and membership in an attempt to control rising medical costs. As we service primarily non-urban markets, we do not have significant relationships with managed care organizations, including Medicare+Choice HMOs, now referred to as Medicare Advantage. We have responded with a proactive and carefully considered strategy developed specifically for each of our facilities. Our experienced corporate managed care department reviews and approves all managed care contracts, which are organized and monitored using a central database. The primary mission of this department is to select and evaluate appropriate managed care opportunities, manage existing reimbursement arrangements and negotiate increases. Generally, we do not intend to enter into capitated or risk sharing contracts. However, some purchased hospitals have risk sharing contracts at the time of our acquisition of them. We seek to discontinue these contracts to eliminate risk retention related to payment for patient care. We do not believe that we have, at the present time, any risk sharing contracts that would have a material impact on our results of operations.


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Improve Profitability
 
Overview.  To improve efficiencies and increase operating margins, we implement cost containment programs and adhere to operating philosophies that include:
 
  •  standardizing and centralizing our operations;
 
  •  optimizing resource allocation by utilizing our company-devised case and resource management program, which assists in improving clinical care and containing expenses;
 
  •  capitalizing on purchasing efficiencies through the use of company-wide standardized purchasing contracts and terminating or renegotiating specified vendor contracts;
 
  •  installing a standardized management information system, resulting in more efficient billing and collection procedures; and
 
  •  monitoring and enhancing productivity of our human resources.
 
In addition, each of our hospital management teams is supported by our centralized operational, reimbursement, regulatory and compliance expertise, as well as by our senior management team, which has an average of over 25 years of experience in the healthcare industry.
 
Standardization and Centralization.  Our standardization and centralization initiatives encompass nearly every aspect of our business, from developing standard policies and procedures with respect to patient accounting and physician practice management to implementing standard processes to initiate, evaluate and complete construction projects. Our standardization and centralization initiatives are a key element in improving our operating results.
 
  •  Billing and Collections.  We have adopted standard policies and procedures with respect to billing and collections. We have also automated and standardized various components of the collection cycle, including statement and collection letters and the movement of accounts through the collection cycle. Upon completion of an acquisition, our management information system team converts the hospital’s existing information system to our standardized system. This enables us to quickly implement our business controls and cost containment initiatives.
 
  •  Physician Support.  We support our newly recruited physicians to enhance their transition into our communities. We have implemented physician practice management seminars and training. We host these seminars bi-monthly. All newly recruited physicians are required to attend a three-day introductory seminar that covers issues involved in starting up a practice.
 
  •  Procurement and Materials Management.  We have standardized and centralized our operations with respect to medical supplies, equipment and pharmaceuticals used in our hospitals. We have a participation agreement with HealthTrust Purchasing Group, L.P., HealthTrust, a group purchasing organization, or GPO. HealthTrust is the source for a substantial portion of our medical supplies, equipment and pharmaceuticals. This agreement extends to March 2010, with automatic renewal terms of one year unless either party terminates by giving notice of non-renewal.
 
  •  Facilities Management.  We have standardized interiors, lighting and furniture programs. We have also implemented a standard process to initiate, evaluate and complete construction projects. Our corporate staff monitors all construction projects, and reviews and pays all construction project invoices. Our initiatives in this area have reduced our construction costs while maintaining the same level of quality and have shortened the time it takes us to complete these projects.
 
  •  Other Initiatives.  We have also improved margins by implementing standard programs with respect to ancillary services in areas including emergency rooms, pharmacy, laboratory, imaging, home care, skilled nursing, centralized outpatient scheduling and health information management. We have reduced costs associated with these services by improving contract terms and standardizing information systems. We work to identify and communicate best practices and monitor these improvements throughout the Company.


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  •  Internal Controls Over Financial Reporting.  We have centralized many of our significant internal controls over financial reporting and standardized those other controls that are performed at our hospital locations. We continuously monitor compliance with and evaluate the effectiveness of our internal controls over financial reporting.
 
Case and Resource Management.  Our case and resource management program is a company-devised program developed with the goal of improving clinical care and cost containment. The program focuses on:
 
  •  appropriately treating patients along the care continuum;
 
  •  reducing inefficiently applied processes, procedures and resources;
 
  •  developing and implementing standards for operational best practices; and
 
  •  using on-site clinical facilitators to train and educate care practitioners on identified best practices.
 
Our case and resource management program integrates the functions of utilization review, discharge planning, overall clinical management, and resource management into a single effort to improve the quality and efficiency of care. Issues evaluated in this process include patient treatment, patient length of stay and utilization of resources.
 
Under our case and resource management program, patient care begins with a clinical assessment of the appropriate level of care, discharge planning, and medical necessity for planned services. Once a patient is admitted to the hospital, we conduct a review for ongoing medical necessity using appropriateness criteria. We reassess and adjust discharge plan options as the needs of the patient change. We closely monitor cases to prevent delayed service or inappropriate utilization of resources. Once the patient attains clinical improvement, we encourage the attending physician to consider alternatives to hospitalization through discussions with the facility’s physician advisor. Finally, we refer the patient to the appropriate post-hospitalization resources.
 
Improve Quality
 
We have implemented various programs to ensure continuous improvement in the quality of care provided. We have developed training programs for all senior hospital management, chief nursing officers, quality directors, physicians and other clinical staff. We share information among our hospital management to implement best practices and assist in complying with regulatory requirements. We have standardized accreditation documentation and requirements. All hospitals conduct patient, physician, and staff satisfaction surveys to help identify methods of improving the quality of care.
 
Each of our hospitals is governed by a board of trustees, which includes members of the hospital’s medical staff. The board of trustees establishes policies concerning the hospital’s medical, professional, and ethical practices, monitors these practices, and is responsible for ensuring that these practices conform to legally required standards. We maintain quality assurance programs to support and monitor quality of care standards and to meet Medicare and Medicaid accreditation and regulatory requirements. Patient care evaluations and other quality of care assessment activities are reviewed and monitored continuously.
 
Grow Through Selective Acquisitions
 
Acquisition Criteria.  Each year we intend to acquire, on a selective basis, two to four hospitals that fit our acquisition criteria. Generally, we pursue acquisition candidates that:
 
  •  have a service area population between 20,000 and 400,000 with a stable or growing population base;
 
  •  are the sole or primary provider of acute care services in the community;
 
  •  are located in an area with the potential for service expansion;
 
  •  are not located in an area that is dependent upon a single employer or industry; and
 
  •  have financial performance that we believe will benefit from our management’s operating skills.


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In each year since 1997, we have met or exceeded our acquisition goals. Occasionally, we have pursued acquisition opportunities outside of our specified criteria when such opportunities have had uniquely favorable characteristics. In addition to two hospitals acquired from local governmental entities in 2007, we also acquired Triad, which, at the time of our acquisition, owned and operated 50 hospitals with 49 hospitals located in 17 states across the U.S. and one hospital located in the Republic of Ireland. Since our acquisition of Triad’s 50 hospital portfolio in July, 2007, we have primarily focused our efforts on integrating those hospitals, as opposed to pursuing further acquisition opportunities. In the fourth quarter of 2008, we completed an acquisition of a two hospital system located in Spokane, Washington, an acquisition we had been pursuing, and for which we were awaiting government approval, for almost a year. In 2009, in light of the current economic conditions, we intend to proceed cautiously with our acquisition strategy, anticipating closing on only two acquisitions during the year. One of these two anticipated acquisitions closed on February 1, 2009.
 
Disciplined Acquisition Approach.  We have been disciplined in our approach to acquisitions. We have a dedicated team of internal and external professionals who complete a thorough review of the hospital’s financial and operating performance, the demographics and service needs of the market and the physical condition of the facilities. Based on our historical experience, we then build a pro forma financial model that reflects what we believe can be accomplished under our ownership. Whether we buy or lease the existing facility or agree to construct a replacement hospital, we believe we have been disciplined in our approach to pricing. We typically begin the acquisition process by entering into a non-binding letter of intent with an acquisition candidate. After we complete business and financial due diligence and financial modeling, we decide whether or not to enter into a definitive agreement. Once an acquisition is completed, we have an organized and systematic approach to transitioning and integrating the new hospital into our system of hospitals.
 
Acquisition Efforts.  Most of our acquisition targets are municipal or other not-for-profit hospitals. We believe that our access to capital, ability to recruit physicians and reputation for providing quality care make us an attractive partner for these communities. In addition, we have found that communities located in states where we already operate a hospital are more receptive to us, when they consider selling their hospital, because they are aware of our operating track record with respect to our hospitals within the state.
 
At the time we acquire a hospital, we may commit to an amount of capital expenditures, such as a replacement facility, renovations, or equipment over a specified period of time. As an obligation under a hospital purchase agreement in effect as of December 31, 2008, we are required to build a replacement facility in Valparaiso, Indiana by April 2011. Also, as required by an amendment to a lease agreement entered into in 2005, we agreed to build a replacement hospital at our Barstow, California location. Estimated construction costs, including equipment costs, are approximately $269.0 million for these two replacement hospitals, of which approximately $8.5 million has been incurred to date. In addition, other commitments under purchase agreements in effect as of December 31, 2008, obligate us to spend approximately $266.8 million through 2013, for costs such as capital improvements, equipment, selected leases and physician recruiting.
 
Industry Overview
 
The Centers for Medicare and Medicaid Services, or CMS, reported that in 2007 total U.S. healthcare expenditures grew by 6.1% to $2.2 trillion. CMS also projected total U.S. healthcare spending to grow by 6.6% in 2008 and by an average of 6.7% annually from 2009 through 2017. By these estimates, healthcare expenditures will account for approximately $4.3 trillion, or 19.5% of the total U.S. gross domestic product, by 2017.
 
Hospital services, the market in which we operate, is the largest single category of healthcare at 30% of total healthcare spending in 2007, or $696.5 billion, as reported by CMS. CMS projects the hospital services category to grow by at least 6.4% per year through 2017. It expects growth in hospital healthcare spending to continue due to the aging of the U.S. population and consumer demand for expanded medical services. As hospitals remain the primary setting for healthcare delivery, CMS expects hospital services to remain the largest category of healthcare spending.


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U.S. Hospital Industry.  The U.S. hospital industry is broadly defined to include acute care, rehabilitation, and psychiatric facilities that are either public (government owned and operated), not-for-profit private (religious or secular), or for-profit institutions (investor owned). According to the American Hospital Association, there are approximately 4,900 inpatient hospitals in the U.S. which are not-for-profit owned, investor owned, or state or local government owned. Of these hospitals, approximately 41% are located in non-urban communities. We believe that a majority of these hospitals are owned by not-for-profit or governmental entities. These facilities offer a broad range of healthcare services, including internal medicine, general surgery, cardiology, oncology, orthopedics, OB/GYN, and emergency services. In addition, hospitals also offer other ancillary services including psychiatric, diagnostic, rehabilitation, home care, and outpatient surgery services.
 
Urban vs. Non-Urban Hospitals
 
According to the U.S. Census Bureau, 21% of the U.S. population lives in communities designated as non-urban. In these non-urban communities, hospitals are typically the primary source of healthcare. In many cases a single hospital is the only provider of general healthcare services in these communities.
 
Factors Affecting Performance.  Among the many factors that can influence a hospital’s financial and operating performance are:
 
  •  facility size and location;
 
  •  facility ownership structure (i.e., tax-exempt or investor owned);
 
  •  a facility’s ability to participate in group purchasing organizations; and
 
  •  facility payor mix.
 
We believe that non-urban hospitals are generally able to obtain higher operating margins than urban hospitals. Factors contributing to a non-urban hospital’s margin advantage include fewer patients with complex medical problems, a lower cost structure, limited competition, and favorable Medicare payment provisions. Patients needing the most complex care are more often served by the larger and/or more specialized urban hospitals. A non-urban hospital’s lower cost structure results from its geographic location, as well as the lower number of patients treated who need the most highly advanced services. Additionally, because non-urban hospitals are generally sole providers or one of a small group of providers in their markets, there is limited competition. This generally results in more favorable pricing with commercial payors. Medicare has special payment provisions for “sole community hospitals.” Under present law, hospitals that qualify for this designation can receive higher reimbursement rates. As of December 31, 2008, 25 of our hospitals were “sole community hospitals.” In addition, we believe that non-urban communities are generally characterized by a high level of patient and physician loyalty that fosters cooperative relationships among the local hospitals, physicians, employees and patients.
 
The type of third party responsible for the payment of services performed by healthcare service providers is also an important factor which affects hospital operating margins. These providers have increasingly exerted pressure on healthcare service providers to reduce the cost of care. The most active providers in this regard have been HMOs, PPOs, and other managed care organizations. The characteristics of non-urban markets make them less attractive to these managed care organizations. This is partly because the limited size of non-urban markets and their diverse, non-national employer bases minimize the ability of managed care organizations to achieve economies of scale as compared to economics of scale that can be achieved in many urban markets.
 
Hospital Industry Trends
 
Demographic Trends.  According to the U.S. Census Bureau, there are presently approximately 37.9 million Americans aged 65 or older in the U.S. who comprise approximately 12.6% of the total U.S. population. By the year 2030, the number of elderly is expected to climb to 72.1 million, or 19.3% of the total population. Due to the increasing life expectancy of Americans, the number of people aged 85 years and older is also expected to


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increase from 5.5 million to 8.7 million by the year 2030. This increase in life expectancy will increase demand for healthcare services and, as importantly, the demand for innovative, more sophisticated means of delivering those services. Hospitals, as the largest category of care in the healthcare market, will be among the main beneficiaries of this increase in demand. Based on data compiled for us, the populations of the service areas where our hospitals are located grew by 24.9% from 1990 to 2007 and are expected to grow by 6.2% from 2007 to 2012. The number of people aged 65 or older in these service areas grew by 24.4% from 1990 to 2007 and is expected to grow by 10.5% from 2007 to 2012.
 
Consolidation.  During recent years a significant amount of private equity capital has been invested into the hospital industry. Also, in addition to our own acquisition of Triad in 2007, consolidation activity, primarily through mergers and acquisitions involving both for-profit and not-for-profit hospital systems is continuing. Reasons for this activity include:
 
  •  excess capacity of available capital;
 
  •  valuation levels;
 
  •  financial performance issues, including challenges associated with changes in reimbursement and collectability of self-pay revenue;
 
  •  the desire to enhance the local availability of healthcare in the community;
 
  •  the need and ability to recruit primary care physicians and specialists;
 
  •  the need to achieve general economies of scale and to gain access to standardized and centralized functions, including favorable supply agreements and access to malpractice coverage; and
 
  •  regulatory changes.
 
As a result of recent changes in the global economic conditions, we anticipate seeing a decline in the trend of consolidation activity, including mergers and acquisitions.


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Selected Operating Data
 
The following table sets forth operating statistics for our hospitals for each of the years presented, which are included in our continuing operations. Statistics for 2008 include a full year of operations for 116 hospitals and partial periods for two hospitals acquired during the year. Statistics for 2007 include a full year of operations for 70 hospitals and partial periods for 45 hospitals acquired during the year. Statistics for 2006 include a full year of operations for 63 hospitals and partial periods for seven hospitals acquired during the year. Hospitals which have been sold and hospitals which are classified as held for sale are excluded from all periods presented.
 
                         
    Year Ended December 31,  
    2008     2007     2006  
    (Dollars in thousands)  
 
Consolidated Data
                       
Number of hospitals (at end of period)
    118       115       70  
Licensed beds (at end of period)(1)
    17,245       16,716       8,406  
Beds in service (at end of period)(2)
    15,063       14,446       6,753  
Admissions(3)
    663,328       459,046       307,964  
Adjusted admissions(4)
    1,196,602       842,368       570,969  
Patient days(5)
    2,808,247       1,923,547       1,264,256  
Average length of stay (days)(6)
    4.2       4.2       4.1  
Occupancy rate (beds in service)(7)
    52.0 %     52.2 %     54.3 %
Net operating revenues
  $ 10,840,098     $ 7,063,775     $ 4,180,136  
Net inpatient revenues as a % of total net operating revenues
    50.3 %     49.2 %     50.0 %
Net outpatient revenues as a % of total net operating revenues
    47.5 %     48.8 %     48.8 %
Net Income
  $ 218,304     $ 30,289     $ 168,263  
Net Income as a % of total net operating revenues
    2.0 %     0.4 %     4.0 %
Liquidity Data
                       
Adjusted EBITDA(8)
  $ 1,524,723     $ 814,980     $ 564,339  
Adjusted EBITDA as a % of total net operating revenues(8)
    14.1 %     11.7 %     13.5 %
Net cash flows provided by operating activities
  $ 1,057,281     $ 687,738     $ 350,255  
Net cash flows provided by operating activities as a % of total net operating revenues
    9.8 %     9.7 %     8.4 %
Net cash flows used in investing activities
  $ (665,471 )   $ (7,498,858 )   $ (640,257 )
Net cash flows provided by (used in) financing activities
  $ (304,029 )   $ 6,903,428     $ 226,460  
 
 
See pages 10 and 11 for footnotes.
 
                         
    Year Ended December 31,     (Decrease)
 
    2008     2007     Increase  
    (Dollars in thousands)        
 
Same-Store Data(9)
                       
Admissions(3)
    651,211       638,635       2.0 %
Adjusted admissions(4)
    1,174,600       1,149,284       2.2 %
Patient days(5)
    2,754,336       2,763,735          
Average length of stay (days)(6)
    4.2       4.3          
Occupancy rate (beds in service)(7)
    52.1 %     52.8 %        
Net operating revenues
  $ 10,620,627     $ 9,962,447       6.6 %
Income from operations
  $ 981,365     $ 621,983       57.8 %
Income from operations as a % of net operating revenues
    9.2 %     6.2 %        
Depreciation and amortization
  $ 487,637     $ 446,254          
Equity in earnings of unconsolidated affiliates
  $ 42,064     $ 48,796          


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(1) Licensed beds are the number of beds for which the appropriate state agency licenses a facility regardless of whether the beds are actually available for patient use.
 
(2) Beds in service are the number of beds that are readily available for patient use.
 
(3) Admissions represent the number of patients admitted for inpatient treatment.
 
(4) Adjusted admissions is a general measure of combined inpatient and outpatient volume. We computed adjusted admissions by multiplying admissions by gross patient revenues and then dividing that number by gross inpatient revenues.
 
(5) Patient days represent the total number of days of care provided to inpatients.
 
(6) Average length of stay (days) represents the average number of days inpatients stay in our hospitals.
 
(7) We calculated occupancy rate percentages by dividing the average daily number of inpatients by the weighted average of beds in service.
 
(8) EBITDA consists of net income (loss) before interest, income taxes, depreciation and amortization. Adjusted EBITDA is EBITDA adjusted to exclude discontinued operations, loss from early extinguishment of debt and minority interest in earnings. We have from time to time sold minority interests in certain of our subsidiaries or acquired subsidiaries with existing minority interest ownership positions. We believe that it is useful to present adjusted EBITDA because it excludes the portion of EBITDA attributable to these third party interests and clarifies for investors our portion of EBITDA generated by continuing operations. We use adjusted EBITDA as a measure of liquidity. We have included this measure because we believe it provides investors with additional information about our ability to incur and service debt and make capital expenditures. Adjusted EBITDA is the basis for a key component in the determination of our compliance with some of the covenants under our senior secured credit facility, as well as to determine the interest rate and commitment fee payable under the senior secured credit facility (although adjusted EBITDA does not include all of the adjustments described in the senior secured credit facility).
 
Adjusted EBITDA is not a measurement of financial performance or liquidity under generally accepted accounting principles. It should not be considered in isolation or as a substitute for net income, operating income, cash flows from operating, investing or financing activities, or any other measure calculated in accordance with generally accepted accounting principles. The items excluded from adjusted EBITDA are significant components in understanding and evaluating financial performance and liquidity. Our calculation of adjusted EBITDA may not be comparable to similarly titled measures reported by other companies.


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The following table reconciles adjusted EBITDA, as defined, to our net cash provided by operating activities as derived directly from our consolidated financial statements for the years ended December 31, 2008, 2007, and 2006 (in thousands):
 
                         
    Year Ended December 31,  
    2008     2007     2006  
 
Adjusted EBITDA
  $ 1,524,723     $ 814,980     $ 564,339  
Interest expense, net
    (651,925 )     (361,773 )     (94,411 )
Provision for income taxes
    (129,479 )     (41,828 )     (110,152 )
Deferred income taxes
    159,870       (39,894 )     (25,228 )
Income (loss) from operations of hospitals sold or held for sale
    5,316       (8,884 )     (6,873 )
Income tax (expense) benefit on the non-cash impairment and (gain) loss on sale of hospitals
    (6,357 )     5,298       1,378  
Depreciation and amortization of discontinued operations
    7,609       21,458       9,485  
Stock compensation expense
    52,105       38,771       20,073  
Excess tax benefits relating to stock based compensation
    (1,278 )     (1,216 )     (6,819 )
Other non-cash (income) expenses, net
    3,577       19,017       500  
Changes in operating assets and liabilities, net of effects of acquisitions and divestitures:
                       
Patient accounts receivable
    (57,437 )     131,300       (71,141 )
Supplies, prepaid expenses and other current assets
    (34,711 )     (31,977 )     (4,544 )
Accounts payable, accrued liabilities and income taxes
    119,596       125,959       52,151  
Other
    65,672       16,527       21,497  
                         
Net cash provided by operating activities
  $ 1,057,281     $ 687,738     $ 350,255  
                         
 
 
(9) Includes former Triad hospital’s data, as if we owned them as of January 1, 2007 (acquisition date was July 25, 2007) and other acquired hospitals to the extent we operated them during comparable periods in both years. We have restated our 2008 and 2007 financial statements and statistical results to reflect the reclassification in 2008 of one hospital owned by us during these periods, which is held for sale, to discontinued operations.
 
Sources of Revenue
 
We receive payment for healthcare services provided by our hospitals from:
 
  •  the federal Medicare program;
 
  •  state Medicaid or similar programs;
 
  •  healthcare insurance carriers, health maintenance organizations or “HMOs,” preferred provider organizations or “PPOs,” and other managed care programs; and
 
  •  patient directly.


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The following table presents the approximate percentages of net operating revenue received from Medicare, Medicaid, managed care, self-pay and other sources for the periods indicated. The data for the years presented are not strictly comparable due to the significant effect that hospital acquisitions have had on these statistics.
 
                         
Net Operating Revenues by Payor Source
  2008     2007     2006  
 
Medicare
    27.5 %     29.0 %     30.4 %
Medicaid
    9.1 %     10.3 %     11.1 %
Managed Care and other third party payors
    52.7 %     50.7 %     46.7 %
Self-pay
    10.7 %     10.0 %     11.8 %
                         
Total
    100.0 %     100.0 %     100.0 %
                         
 
As shown above, we receive a substantial portion of our revenue from the Medicare and Medicaid programs. Included in Managed Care and other third party payors is net operating revenue from insurance companies from which we have insurance provider contracts, Managed Care Medicare, insurance companies for which we do not have insurance provider contracts, worker’s compensation carriers, and non-patient service revenue, such as rental income and cafeteria sales.
 
Medicare is a federal program that provides medical insurance benefits to persons age 65 and over, some disabled persons, and persons with end-stage renal disease. Medicaid is a federal-state funded program, administered by the states, which provides medical benefits to individuals who are unable to afford healthcare. All of our hospitals are certified as providers of Medicare and Medicaid services. Amounts received under the Medicare and Medicaid programs are generally significantly less than a hospital’s customary charges for the services provided. Since a substantial portion of our revenue comes from patients under Medicare and Medicaid programs, our ability to operate our business successfully in the future will depend in large measure on our ability to adapt to changes in these programs.
 
In addition to government programs, we are paid by private payors, which include insurance companies, HMOs, PPOs, other managed care companies, employers, and by patients directly. Blue Cross payors are included in “Managed Care and other third party payors” line in the above table. Patients are generally not responsible for any difference between customary hospital charges and amounts paid for hospital services by Medicare and Medicaid programs, insurance companies, HMOs, PPOs, and other managed care companies, but are responsible for services not covered by these programs or plans, as well as for deductibles and co-insurance obligations of their coverage. The amount of these deductibles and co-insurance obligations has increased in recent years. Collection of amounts due from individuals is typically more difficult than collection of amounts due from government or business payors. To further reduce their healthcare costs, an increasing number of insurance companies, HMOs, PPOs, and other managed care companies are negotiating discounted fee structures or fixed amounts for hospital services performed, rather than paying healthcare providers the amounts billed. We negotiate discounts with managed care companies, which are typically smaller than discounts under governmental programs. If an increased number of insurance companies, HMOs, PPOs, and other managed care companies succeed in negotiating discounted fee structures or fixed amounts, our results of operations may be negatively affected. For more information on the payment programs on which our revenues depend, see “Payment” on page 17.
 
As of December 31, 2008, Indiana and Texas represented the only areas of geographic concentration. Net operating revenues as a percentage of consolidated net operating revenues generated in Indiana were 11.0% in 2008 and 7.7% in 2007. Net operating revenues as a percentage of consolidated net operating revenues generated in Texas were 13.4% in 2008, 13.0% in 2007 and 10.4% in 2006. As a result of our growth and expansion of services in other states, Pennsylvania no longer represents an area of geographic concentration, which it did as of December 31, 2007.
 
Hospital revenues depend upon inpatient occupancy levels, the volume of outpatient procedures, and the charges or negotiated payment rates for hospital services provided. Charges and payment rates for routine inpatient services vary significantly depending on the type of service performed and the geographic location of


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the hospital. In recent years, we have experienced a significant increase in revenue received from outpatient services. We attribute this increase to:
 
  •  advances in technology, which have permitted us to provide more services on an outpatient basis; and
 
  •  pressure from Medicare or Medicaid programs, insurance companies, and managed care plans to reduce hospital stays and to reduce costs by having services provided on an outpatient rather than on an inpatient basis.
 
Government Regulation
 
Overview.  The healthcare industry is required to comply with extensive government regulation at the federal, state, and local levels. Under these regulations, hospitals must meet requirements to be certified as hospitals and qualified to participate in government programs, including the Medicare and Medicaid programs. These requirements relate to the adequacy of medical care, equipment, personnel, operating policies and procedures, maintenance of adequate records, hospital use, rate-setting, compliance with building codes, and environmental protection laws. There are also extensive regulations governing a hospital’s participation in these government programs. If we fail to comply with applicable laws and regulations, we can be subject to criminal penalties and civil sanctions, our hospitals can lose their licenses and we could lose our ability to participate in these government programs. In addition, government regulations may change. If that happens, we may have to make changes in our facilities, equipment, personnel, and services so that our hospitals remain certified as hospitals and qualified to participate in these programs. We believe that our hospitals are in substantial compliance with current federal, state, and local regulations and standards.
 
Hospitals are subject to periodic inspection by federal, state, and local authorities to determine their compliance with applicable regulations and requirements necessary for licensing and certification. All of our hospitals are licensed under appropriate state laws and are qualified to participate in Medicare and Medicaid programs. In addition, most of our hospitals are accredited by the Joint Commission on Accreditation of Healthcare Organizations. This accreditation indicates that a hospital satisfies the applicable health and administrative standards to participate in Medicare and Medicaid programs.
 
Healthcare Reform.  The healthcare industry continues to attract much legislative interest and public attention. In recent years, an increasing number of legislative proposals have been introduced or proposed in Congress and in some state legislatures that would affect major changes in the healthcare system. The Obama administration has stated as a top priority its desire to reform the U.S. health care system with the goal of providing affordable, accessible health care for all Americans. Proposals that have been considered include cost controls on hospitals, insurance market reforms to increase the availability of group health insurance to small businesses, and mandatory health insurance coverage for employees. The “American Recovery and Reinvestment Act of 2009” has been signed into law providing for a temporary increase in the federal matching assistance percentage (FMAP), a temporary increase in federal Medicaid DSH allotments, subsidization of health insurance premiums (COBRA) for up to nine months, and grants and loans for infrastructure and incentive payments for providers who adopt and use health information technology. The costs of implementing this law and other proposals could be financed, in part, by reductions in payments to healthcare providers under Medicare, Medicaid, and other government programs. We cannot predict the course of future healthcare legislation, other changes the administration may seek to implement regarding healthcare or interpretations by the administration of existing governmental healthcare programs and the effect that any legislation change or interpretation may have on us.
 
Fraud and Abuse Laws.  Participation in the Medicare program is heavily regulated by federal statute and regulation. If a hospital fails substantially to comply with the requirements for participating in the Medicare program, the hospital’s participation in the Medicare program may be terminated and/or civil or criminal penalties may be imposed. For example, a hospital may lose its ability to participate in the Medicare program if it performs any of the following acts:
 
  •  making claims to Medicare for services not provided or misrepresenting actual services provided in order to obtain higher payments;


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  •  paying money to induce the referral of patients where services are reimbursable under a federal health program; or
 
  •  paying money to limit or reduce the services provided to Medicare beneficiaries.
 
The Health Insurance Portability and Accountability Act of 1996, or HIPAA, broadened the scope of the fraud and abuse laws. Under HIPAA, any person or entity that knowingly and willfully defrauds or attempts to defraud a healthcare benefit program, including private healthcare plans, may be subject to fines, imprisonment or both. Additionally, any person or entity that knowingly and willfully falsifies or conceals a material fact or makes any material false or fraudulent statements in connection with the delivery or payment of healthcare services by a healthcare benefit plan is subject to a fine, imprisonment or both.
 
Another law regulating the healthcare industry is a section of the Social Security Act, known as the “anti-kickback” statute. This law prohibits some business practices and relationships under Medicare, Medicaid, and other federal healthcare programs. These practices include the payment, receipt, offer, or solicitation of remuneration of any kind in exchange for items or services that are reimbursed under most federal or state healthcare program. Violations of the anti-kickback statute may be punished by criminal and civil fines, exclusion from federal healthcare programs, and damages up to three times the total dollar amount involved.
 
The Office of Inspector General of the Department of Health and Human Services, or OIG, is responsible for identifying and investigating fraud and abuse activities in federal healthcare programs. As part of its duties, the OIG provides guidance to healthcare providers by identifying types of activities that could violate the anti-kickback statute. The OIG also publishes regulations outlining activities and business relationships that would be deemed not to violate the anti-kickback statute. These regulations are known as “safe harbor” regulations. However, the failure of a particular activity to comply with the safe harbor regulations does not necessarily mean that the activity violates the anti-kickback statute.
 
The OIG has identified the following incentive arrangements as potential violations of the anti-kickback statute:
 
  •  payment of any incentive by the hospital when a physician refers a patient to the hospital;
 
  •  use of free or significantly discounted office space or equipment for physicians in facilities usually located close to the hospital;
 
  •  provision of free or significantly discounted billing, nursing, or other staff services;
 
  •  free training for a physician’s office staff including management and laboratory techniques (but excluding compliance training);
 
  •  guarantees which provide that if the physician’s income fails to reach a predetermined level, the hospital will pay any portion of the remainder;
 
  •  low-interest or interest-free loans, or loans which may be forgiven if a physician refers patients to the hospital;
 
  •  payment of the costs of a physician’s travel and expenses for conferences;
 
  •  payment of services which require few, if any, substantive duties by the physician, or payment for services in excess of the fair market value of the services rendered; or
 
  •  purchasing goods or services from physicians at prices in excess of their fair market value.
 
We have a variety of financial relationships with physicians who refer patients to our hospitals. Physicians own interests in a number of our facilities. Physicians may also own our stock. We also have contracts with physicians providing for a variety of financial arrangements, including employment contracts, leases, management agreements, and professional service agreements. We provide financial incentives to recruit physicians to relocate to communities served by our hospitals. These incentives include relocation, reimbursement for certain direct expenses, income guarantees and, in some cases, loans. Although we believe that we have structured our arrangements with physicians in light of the “safe harbor” rules, we cannot assure you that regulatory


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authorities will not determine otherwise. If that happens, we could be subject to criminal and civil penalties and/or exclusion from participating in Medicare, Medicaid, or other government healthcare programs.
 
The Social Security Act also includes a provision commonly known as the “Stark law.” This law prohibits physicians from referring Medicare patients to healthcare entities in which they or any of their immediate family members have ownership interests or other financial arrangements. These types of referrals are commonly known as “self referrals.” Sanctions for violating the Stark law include denial of payment, civil money penalties, assessments equal to twice the dollar value of each service, and exclusion from government payor programs. There are ownership and compensation arrangement exceptions to the self-referral prohibition. One exception allows a physician to make a referral to a hospital if the physician owns an interest in the entire hospital, as opposed to an ownership interest in a department of the hospital. Another exception allows a physician to refer patients to a healthcare entity in which the physician has an ownership interest if the entity is located in a rural area, as defined in the statute. There are also exceptions for many of the customary financial arrangements between physicians and providers, including employment contracts, leases, and recruitment agreements. From time to time, the federal government has issued regulations which interpret the provisions included in the Stark law. We strive to comply with the Stark law and regulations; however, the government may interpret the law and regulations differently. If we are found to have violated the Stark law or regulations, we could be subject to significant sanctions, including damages, penalties, and exclusion from federal health care programs.
 
Many states in which we operate also have adopted similar laws relating to financial relationships with physicians. Some of these state laws apply even if the payment for care does not come from the government. These statutes typically provide criminal and civil penalties as well as loss of licensure. While there is little precedent for the interpretation or enforcement of these state laws, we have attempted to structure our financial relationships with physicians and others in light of these laws. However, if we are found to have violated these state laws, it could result in the imposition of criminal and civil penalties as well as possible licensure revocation.
 
False Claims Act.  Another trend in healthcare litigation is the increased use of the False Claims Act, or FCA. This law makes providers liable for, among other things, the knowing submission of a false claim for reimbursement by the federal government. The FCA has been used not only by the U.S. government, but also by individuals who bring an action on behalf of the government under the law’s “qui tam” or “whistleblower” provisions and share in any recovery. When a private party brings a qui tam action under the FCA, it files the complaint with the court under seal, and the defendant will generally not be aware of the lawsuit until the government makes a determination whether it will intervene and take a lead in the litigation.
 
Civil liability under the FCA can be up to three times the actual damages sustained by the government plus civil penalties of up to $11,000 for each separate false claim submitted to the government. There are many potential bases for liability under the FCA. Although liability under the FCA arises when an entity knowingly submits a false claim for reimbursement, the FCA defines the term “knowingly” to include reckless disregard of the truth or falsity of the claim being submitted.
 
A number of states in which we operate have enacted state false claims legislation. These state false claims laws are generally modeled on the federal FCA, with similar damages, penalties, and qui tam enforcement provisions. An increasing number of healthcare false claims cases seek recoveries under both federal and state law.
 
Provisions in the Deficit Reduction Act of 2005, or DRA, that went into effect on January 1, 2007 give states significant financial incentives to enact false claims laws modeled on the federal FCA. Additionally, the DRA requires every entity that receives annual payments of at least $5 million from a state Medicaid plan to establish written policies for its employees that provide detailed information about federal and state false claims statutes and the whistleblower protections that exist under those laws. Both provisions of the DRA are expected to result in increased false claims litigation against health care providers. We have substantially complied with the written policy requirements.


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Corporate Practice of Medicine; Fee-Splitting.  Some states have laws that prohibit unlicensed persons or business entities, including corporations, from employing physicians. Some states also have adopted laws that prohibit direct or indirect payments or fee-splitting arrangements between physicians and unlicensed persons or business entities. Possible sanctions for violations of these restrictions include loss of a physician’s license, civil and criminal penalties and rescission of business arrangements. These laws vary from state to state, are often vague and have seldom been interpreted by the courts or regulatory agencies. We structure our arrangements with healthcare providers to comply with the relevant state law. However, we cannot assure you that governmental officials responsible for enforcing these laws will not assert that we, or transactions in which we are involved, are in violation of these laws. These laws may also be interpreted by the courts in a manner inconsistent with our interpretations.
 
Emergency Medical Treatment and Active Labor Act.  The Emergency Medical Treatment and Active Labor Act imposes requirements as to the care that must be provided to anyone who comes to facilities providing emergency medical services seeking care before they may be transferred to another facility or otherwise denied care. Sanctions for failing to fulfill these requirements include exclusion from participation in Medicare and Medicaid programs and civil money penalties. In addition, the law creates private civil remedies which enable an individual who suffers personal harm as a direct result of a violation of the law to sue the offending hospital for damages and equitable relief. A medical facility that suffers a financial loss as a direct result of another participating hospital’s violation of the law also has a similar right. Although we believe that our practices are in compliance with the law, we can give no assurance that governmental officials responsible for enforcing the law or others will not assert we are in violation of these laws.
 
Conversion Legislation.  Many states, including some where we have hospitals and others where we may in the future acquire hospitals, have adopted legislation regarding the sale or other disposition of hospitals operated by not-for-profit entities. In other states that do not have specific legislation, the attorneys general have demonstrated an interest in these transactions under their general obligations to protect charitable assets from waste. These legislative and administrative efforts primarily focus on the appropriate valuation of the assets divested and the use of the proceeds of the sale by the not-for-profit seller. While these reviews and, in some instances, approval processes can add additional time to the closing of a hospital acquisition, we have not had any significant difficulties or delays in completing the process. There can be no assurance, however, that future actions on the state level will not seriously delay or even prevent our ability to acquire hospitals. If these activities are widespread, they could limit our ability to acquire additional hospitals.
 
Certificates of Need.  The construction of new facilities, the acquisition of existing facilities and the addition of new services at our facilities may be subject to state laws that require prior approval by state regulatory agencies. These certificate of need laws generally require that a state agency determine the public need and give approval prior to the construction or acquisition of facilities or the addition of new services. As of December 31, 2008, we operated 54 hospitals in 16 states that have adopted certificate of need laws for acute care facilities. If we fail to obtain necessary state approval, we will not be able to expand our facilities, complete acquisitions or add new services in these states. Violation of these state laws may result in the imposition of civil sanctions or the revocation of a hospital’s licenses.
 
Privacy and Security Requirements of HIPAA.  The Administrative Simplification Provisions of HIPAA require the use of uniform electronic data transmission standards for healthcare claims and payment transactions submitted or received electronically. These provisions are intended to encourage electronic commerce in the healthcare industry. We believe we are in compliance with these regulations.
 
The Administrative Simplification Provisions also require CMS to adopt standards to protect the security and privacy of health-related information. The privacy regulations extensively regulate the use and disclosure of individually identifiable health-related information. If we violate these regulations, we could be subject to monetary fines and penalties, criminal sanctions and civil causes of action. We have implemented and operate continuing employee education programs to reinforce operational compliance with policy and procedures which adhere to privacy regulations. The HIPAA security standards and privacy regulations serve similar purposes and overlap to a certain extent, but the security regulations relate more specifically to protecting the integrity, confidentiality and availability of electronic protected health information while it is in our custody or


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being transmitted to others. We believe we have established proper controls to safeguard access to protected health information.
 
Payment
 
Medicare.  Under the Medicare program, we are paid for inpatient and outpatient services performed by our hospitals.
 
Payments for inpatient acute services are generally made pursuant to a prospective payment system, commonly known as “PPS.” Under PPS, our hospitals are paid a predetermined amount for each hospital discharge based on the patient’s diagnosis. Specifically, each discharge is assigned to a diagnosis-related group, commonly known as a “DRG”, based upon the patient’s condition and treatment during the relevant inpatient stay. For the federal fiscal year 2008 (i.e., the federal fiscal year beginning October 1, 2007), each DRG was assigned a payment rate using 67% of the national average cost per case and 33% of the national average charge per case and 50% of the change to severity adjusted DRG weights. Severity adjusted DRG’s more accurately reflect the costs a hospital incurs for caring for a patient and accounts more fully for the severity of each patient’s condition. For the federal fiscal year 2009, each DRG is assigned a payment rate using 100% of the national average cost per case and 100% of the severity adjusted DRG weights. DRG payments are based on national averages and not on charges or costs specific to a hospital. However, DRG payments are adjusted by a predetermined geographic adjustment factor assigned to the geographic area in which the hospital is located. While a hospital generally does not receive payment in addition to a DRG payment, hospitals may qualify for an “outlier” payment when the relevant patient’s treatment costs are extraordinarily high and exceed a specified regulatory threshold.
 
The DRG rates are adjusted by an update factor on October 1 of each year, the beginning of the federal fiscal year. The index used to adjust the DRG rates, known as the “market basket index,” gives consideration to the inflation experienced by hospitals in purchasing goods and services. DRG payment rates were increased by the full “market basket index”, for the federal fiscal years 2006, 2007, 2008 and 2009 or 3.7%, 3.4%, 3.3% and 3.6%, respectively. The Deficit Reduction Act of 2005 imposes a two percentage point reduction to the market basket index beginning October 1, 2007, and each year thereafter, if patient quality data is not submitted. We are complying with this data submission requirement. Future legislation may decrease the rate of increase for DRG payments, but we are not able to predict the amount of any reduction or the effect that any reduction will have on us.
 
In addition, hospitals may qualify for Medicare disproportionate share payments when their percentage of low income patients exceeds specified regulatory thresholds. A majority of our hospitals qualify to receive Medicare disproportionate share payments. For the majority of our hospitals that qualify to receive Medicare disproportionate share payments, these payments were increased by the Medicare Prescription Drug, Improvement and Modernization Act of 2003 effective April 1, 2004. These Medicare disproportionate share payments as a percentage of net operating revenues were 1.8%, 1.8% and 2.1% for the years ended December 31, 2008, 2007 and 2006, respectively.
 
Beginning August 1, 2000, we began receiving Medicare reimbursement for outpatient services through a PPS. Under the Balanced Budget Refinement Act of 1999, non-urban hospitals with 100 beds or less were held harmless through December 31, 2004 under this Medicare outpatient PPS. The Medicare Prescription Drug, Improvement and Modernization Act of 2003 extended the hold harmless provision for non-urban hospitals with 100 beds or less and for non-urban sole community hospitals with more than 100 beds through December 31, 2005. The Deficit Reduction Act of 2005 extended the hold harmless provision for non-urban hospitals with 100 beds or less that are not sole community hospitals through December 31, 2008; however, that Act reduced the amount these hospitals would receive in hold harmless payment by 5% in 2006, 10% in 2007 and 15% in 2008. Of our 118 hospitals in continuing operations at December 31, 2008, 31 qualified for this relief. The Medicare Improvements for Patients and Providers Act extends the hold harmless provision for non-urban hospitals with 100 beds or less, including non-urban sole community hospitals, through December 31, 2009, at 85% of the hold harmless amount. Of our 118 hospitals in continuing operations at December 31, 2008, 44 will qualify for this relief. The outpatient conversion factor was increased 3.7%


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effective January 1, 2006; however, coupled with adjustments to other variables within the outpatient PPS resulted in an approximate 2.2% to 2.6% net increase in outpatient PPS payments. The outpatient conversion factor was increased 3.4% effective January 1, 2007; however, coupled with adjustments to other variables with the outpatient PPS, an approximate 2.5% to 2.9% net increase in outpatient payments occurred. The outpatient conversion factor was increased 3.3% effective January 1, 2008; however, coupled with adjustments to other variables with the outpatient PPS, an approximate 3.0% to 3.4% net increase in outpatient payments occurred. The outpatient conversion factor was increased 3.6% effective January 1, 2009; however, coupled with adjustments to other variables with outpatient PPS, an approximate 3.5% to 3.9% net increase in outpatient payments is expected to occur. The Medicare Improvements and Extension Act of the Tax Relief and Health Care Act of 2006 imposes a two percentage point reduction to the market basket index beginning January 1, 2009, and each year thereafter, if patient quality data is not submitted. We intend to comply with this data submission requirement.
 
Skilled nursing facilities and swing bed facilities were historically paid by Medicare on the basis of actual costs, subject to limitations. The Balanced Budget Act of 1997 established a PPS for Medicare skilled nursing facilities and mandated that swing bed facilities must be incorporated into the skilled nursing facility PPS. For federal fiscal year 2006, skilled nursing facility PPS payment rates were increased by the full market basket of 3.1%; however coupled with adjustments to other variables within the skilled nursing facility PPS, an approximate 3.9% to 4.3% net increase in skilled nursing facility PPS payments occurred. Skilled nursing facility PPS rates were increased by the full SNF market basket index of 3.1%, 3.3% and 3.4% for the federal fiscal years 2007, 2008 and 2009, respectively.
 
The Department of Health and Human Services established a PPS for home health services (i.e. home care) effective October 1, 2000. The Medicare Prescription Drug, Improvement and Modernization Act of 2003 implemented a 0.8% reduction to the market basket increase to the home health agency PPS per episodic payment rate effective April 1, 2004 and for the federal fiscal years 2005 and 2006, and increased Medicare payments by 5.0% to home health services provided in rural areas from April 1, 2004 through March 31, 2005. The Deficit Reduction Act of 2005 extended the 5.0% increase to home health services provided in rural areas for an additional year effective January 1, 2006 and froze home health agency payments for 2006 at 2005 levels. The home health agency PPS per episodic payment rate increased by 0% on January 1, 2006 and 3.3% on January 1, 2007. The home health agency PPS per episodic payment rate increased by 3% on January 1, 2008; however, coupled with adjustments to other variables with home health agency PPS, an approximate 1.5% to 1.9% net increase in home health agency payments occurred. The home health agency PPS per episodic payment rate increased by 2.9% on January 1, 2009; however, coupled with adjustments to other variables with home health agency PPS, an approximate 0.2% net increase in home health agency payments is expected to occur. The Deficit Reduction Act of 2005 imposes a two percentage point reduction to the market basket index beginning January 1, 2007, and each year thereafter, if patient quality data is not submitted. We are complying with this data submission requirement.
 
Medicaid.  Most state Medicaid payments are made under a PPS or under programs which negotiate payment levels with individual hospitals. Medicaid is currently funded jointly by state and federal government. The federal government and many states are currently considering significantly reducing Medicaid funding, while at the same time expanding Medicaid benefits. We can provide no assurance that reductions to Medicaid fundings will not have a material adverse effect on our consolidated results of operations.
 
Annual Cost Reports.  Hospitals participating in the Medicare and some Medicaid programs, whether paid on a reasonable cost basis or under a PPS, are required to meet specified financial reporting requirements. Federal and, where applicable, state regulations require submission of annual cost reports identifying medical costs and expenses associated with the services provided by each hospital to Medicare beneficiaries and Medicaid recipients.
 
Annual cost reports required under the Medicare and some Medicaid programs are subject to routine governmental audits. These audits may result in adjustments to the amounts ultimately determined to be due to us under these reimbursement programs. Finalization of these audits often takes several years. Providers can appeal any final determination made in connection with an audit. DRG outlier payments have been and


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continue to be the subject of CMS audit and adjustment. The HHS OIG is also actively engaged in audits and investigations into alleged abuses of the DRG outlier payment system.
 
Commercial Insurance.  Our hospitals provide services to individuals covered by private healthcare insurance. Private insurance carriers pay our hospitals or in some cases reimburse their policyholders based upon the hospital’s established charges and the coverage provided in the insurance policy. Commercial insurers are trying to limit the costs of hospital services by negotiating discounts, including PPS, which would reduce payments by commercial insurers to our hospitals. Reductions in payments for services provided by our hospitals to individuals covered by commercial insurers could adversely affect us.
 
Supply Contracts
 
In March 2005, we began purchasing items, primarily medical supplies, medical equipment and pharmaceuticals, under an agreement with HealthTrust, a GPO in which we are a minority partner. Triad was also a minority partner in HeathTrust and we acquired their ownership interest and contractual rights in the acquisition. As of December 31, 2008, we have a 17.0% ownership interest in HealthTrust. By participating in this organization we are able to procure items at competitively priced rates for our hospitals. There can be no assurance that our arrangement with HealthTrust will continue to provide the discounts we expect to achieve.
 
Competition
 
The hospital industry is highly competitive. An important part of our business strategy is to continue to acquire hospitals in non-urban markets and select urban markets. However, other for-profit hospital companies and not-for-profit hospital systems generally attempt to acquire the same type of hospitals as we do. In addition, some hospitals are sold through an auction process, which may result in higher purchase prices than we believe are reasonable.
 
In addition to the competition we face for acquisitions, we must also compete with other hospitals and healthcare providers for patients. The competition among hospitals and other healthcare providers for patients has intensified in recent years. Our hospitals are located in non-urban and selected urban service areas. Those hospitals in non-urban service areas face no direct competition because there are no other hospitals in their primary service areas. However, these hospitals do face competition from hospitals outside of their primary service area, including hospitals in urban areas that provide more complex services. Patients in those service areas may travel to these other hospitals for a variety of reasons, including the need for services we do not offer or physician referrals. Patients who are required to seek services from these other hospitals may subsequently shift their preferences to those hospitals for services we do provide. Those hospitals in selected urban service areas may face competition from hospitals that are more established than our hospitals. Certain of these competing facilities offer services, including extensive medical research and medical education programs, which are not offered by our facilities. In addition, in certain markets where we operate, there are large teaching hospitals that provide highly specialized facilities, equipment and services that may not be available at our hospitals.
 
Some of our hospitals operate in primary service areas where they compete with another hospital. Some of these competing hospitals use equipment and services more specialized than those available at our hospitals and some of the hospitals that compete with us are owned by tax-supported governmental agencies or not-for-profit entities supported by endowments and charitable contributions. These hospitals can make capital expenditures without paying sales, property and income taxes. We also face competition from other specialized care providers, including outpatient surgery, orthopedic, oncology, and diagnostic centers.
 
The number and quality of the physicians on a hospital’s staff is an important factor in a hospital’s competitive advantage. Physicians decide whether a patient is admitted to the hospital and the procedures to be performed. Admitting physicians may be on the medical staffs of other hospitals in addition to those of our hospitals. We attempt to attract our physicians’ patients to our hospitals by offering quality services and facilities, convenient locations, and state-of-the-art equipment.


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Compliance Program
 
We take an operations team approach to compliance and utilize corporate experts for program design efforts and facility leaders for employee-level implementation. Compliance is another area that demonstrates our utilization of standardization and centralization techniques and initiatives which yield efficiencies and consistency throughout our facilities. We recognize that our compliance with applicable laws and regulations depends on individual employee actions as well as company operations. Our approach focuses on integrating compliance responsibilities with operational functions. This approach is intended to reinforce our company-wide commitment to operate strictly in accordance with the laws and regulations that govern our business.
 
Our company-wide compliance program has been in place since 1997. Currently, the program’s elements include leadership, management and oversight at the highest levels, a Code of Conduct, risk area specific policies and procedures, employee education and training, an internal system for reporting concerns, auditing and monitoring programs, and a means for enforcing the program’s policies.
 
Since its initial adoption, the compliance program continues to be expanded and developed to meet the industry’s expectations and our needs. Specific written policies, procedures, training and educational materials and programs, as well as auditing and monitoring activities have been prepared and implemented to address the functional and operational aspects of our business. Included within these functional areas are materials and activities for business sub-units, including laboratory, radiology, pharmacy, emergency, surgery, observation, home care, skilled nursing, and clinics. Specific areas identified through regulatory interpretation and enforcement activities have also been addressed in our program. Claims preparation and submission, including coding, billing, and cost reports, comprise the bulk of these areas. Financial arrangements with physicians and other referral sources, including compliance with anti-kickback and Stark laws, emergency department treatment and transfer requirements, and other patient disposition issues are also the focus of policy and training, standardized documentation requirements, and review and audit. Another focus of the program is the interpretation and implementation of the HIPAA standards for privacy and security.
 
We have a Code of Conduct which applies to all directors, officers, employees and consultants, and a confidential disclosure program to enhance the statement of ethical responsibility expected of our employees and business associates who work in the accounting, financial reporting, and asset management areas of our Company. Our Code of Conduct is posted on our website at www.chs.net/company_overview/code_conduct.html.
 
Employees
 
At December 31, 2008, we employed approximately 55,579 full-time employees and 22,755 part-time employees. Of these employees, approximately 2,010 are union members. We currently believe that our labor relations are good.
 
Professional Liability Claims
 
As part of our business of owning and operating hospitals, we are subject to legal actions alleging liability on our part. To cover claims arising out of the operations of hospitals, we maintain professional malpractice liability insurance and general liability insurance on a claims made basis in excess of those amounts for which we are self-insured, in amounts we believe to be sufficient for our operations. We also maintain umbrella liability coverage for claims which, due to their nature or amount, are not covered by our other insurance policies. However, our insurance coverage does not cover all claims against us or may not continue to be available at a reasonable cost for us to maintain adequate levels of insurance. For a further discussion of our insurance coverage, see our discussion of professional liability claims in “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
 
Environmental Matters
 
We are subject to various federal, state, and local laws and regulations governing the use, discharge, and disposal of hazardous materials, including medical waste products. Compliance with these laws and regulations


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is not expected to have a material adverse effect on us. It is possible, however, that environmental issues may arise in the future which we cannot now predict.
 
We are insured for damages of personal property or environmental injury arising out of environmental impairment for both above ground and underground storage tank issues under one insurance policy for all of our hospitals. Our policy coverage is $2 million per occurrence with a $25,000 deductible and a $10 million annual aggregate. This policy also provides pollution legal liability coverage for the former Triad hospitals.
 
Under a separate insurance policy, we are insured for onsite and offsite third party bodily injury, property damage and clean up costs including business interruption insurance coverage for actual losses or rental value resulting from pollution issues for all of our hospitals other than the former Triad hospitals. This policy coverage for pollution legal liability is $3 million per occurrence with a $100,000 deductible and a $6 million annual aggregate.


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Item 1A.   Risk Factors
 
The following risk factors could materially and adversely affect our future operating results and could cause actual results to differ materially from those predicted in the forward-looking statements we make about our business.
 
Our level of indebtedness could adversely affect our ability to raise additional capital to fund our operations, limit our ability to react to changes in the economy or our industry and prevent us from meeting our obligations under the agreements relating to our indebtedness.
 
We are significantly leveraged. The chart below shows our level of indebtedness and other information as of December 31, 2008. In connection with the consummation of our acquisition of Triad in July 2007, $7.215 billion senior secured financing under a new credit facility, or “New Credit Facility”, was obtained by our wholly-owned subsidiary, CHS/Community Health Systems, Inc. or CHS. CHS also issued 8.875% senior notes, or the “Notes”, having an aggregate principal amount of $3.021 billion. Both the indebtedness under the New Credit Facility and the Notes are senior obligations of CHS and are guaranteed on a senior basis by us and by certain of our domestic subsidiaries. We used the net proceeds from the Notes offering and the net proceeds of the $6.065 billion term loans under the New Credit Facility to pay the consideration under the merger agreement with Triad, to refinance certain of our existing indebtedness and the indebtedness of Triad, to complete certain related transactions, to pay certain costs and expenses of the transactions and for general corporate uses. As of December 31, 2008, a $750 million revolving credit facility and $200 million of our delayed draw term loan facility are available to us for working capital and general corporate purposes under the New Credit Facility, with $93.6 million of the revolving credit facility being set aside for outstanding letters of credit. During the fourth quarter of 2008, $100 million of the delayed draw term loan had been drawn down by us, reducing the delayed draw term loan availability from $300 million to $200 million at December 31, 2008. In January 2009, we drew down the remaining $200 million of the delayed draw term loan.
 
Also, in connection with the consummation of the acquisition of Triad, we completed an early repayment of the $300 million aggregate principal amount of 6.5% Senior Subordinated Notes due 2012 through a cash tender offer and consent solicitation.
 
         
    As of
 
    December 31, 2008  
    ($ in millions)  
 
Senior secured credit facility
       
Term loans
  $ 5,965.9  
Notes
    2,910.8  
Other
    90.7  
         
Total debt
    8,967.4  
         
Stockholder equity
    1,672.9  
         
 
The following table shows the ratio of earnings to fixed charges for the periods indicated:
 
                                         
    Year Ended December 31,  
    2004     2005     2006     2007     2008  
 
Ratio of earnings to fixed charges(1)
    3.87 x       3.79 x       3.37 x       1.22 x       1.47 x  
 
 
(1) There are no shares of preferred stock outstanding.
 
As of December 31, 2008, our $5.350 billion notional amount of interest rate swap agreements represented approximately 89.7% of our variable rate debt. On a prospective basis, a 1% change in interest rates on the remaining unhedged variable rate debt existing as of December 31, 2008, would result in interest expense fluctuating approximately $6.2 million per year.


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The New Credit Facility and/or the Notes contain various covenants that limit our ability to take certain actions, including our ability to:
 
  •  incur, assume or guarantee additional indebtedness;
 
  •  issue redeemable stock and preferred stock;
 
  •  repurchase capital stock;
 
  •  make restricted payments, including paying dividends and making investments;
 
  •  redeem debt that is junior in right of payment to the notes;
 
  •  create liens;
 
  •  sell or otherwise dispose of assets, including capital stock of subsidiaries;
 
  •  enter into agreements that restrict dividends from subsidiaries;
 
  •  merge, consolidate, sell or otherwise dispose of substantial portions of our assets;
 
  •  enter into transactions with affiliates; and
 
  •  guarantee certain obligations.
 
In addition, our New Credit Facility contains restrictive covenants and requires us to maintain specified financial ratios and satisfy other financial condition tests. Our ability to meet these restricted covenants and financial ratios and tests can be affected by events beyond our control, and we cannot assure you that we will meet those tests.
 
The counterparty to the interest rate swap agreements exposes us to credit risk in the event of non-performance. However, at December 31, 2008, we do not anticipate non-performance by the counterparty due to the net settlement feature of the agreements and our liability position with respect to all of our counterparties.
 
A breach of any of these covenants could result in a default under our New Credit Facility and/or the Notes. Upon the occurrence of an event of default under our New Credit Facility or the Notes, all amounts outstanding under our New Credit Facility and the Notes may become due and payable and all commitments under the New Credit Facility to extend further credit may be terminated.
 
Our leverage could have important consequences for you, including the following:
 
  •  it may limit our ability to obtain additional debt or equity financing for working capital, capital expenditures, debt service requirements, acquisitions and general corporate or other purposes;
 
  •  a substantial portion of our cash flows from operations will be dedicated to the payment of principal and interest on our indebtedness and will not be available for other purposes, including our operations, capital expenditures, and future business opportunities;
 
  •  the debt service requirements of our indebtedness could make it more difficult for us to satisfy our financial obligations;
 
  •  some of our borrowings, including borrowings under our New Credit Facility, are at variable rates of interest, exposing us to the risk of increased interest rates;
 
  •  it may limit our ability to adjust to changing market conditions and place us at a competitive disadvantage compared to our competitors that have less debt; and
 
  •  we may be vulnerable in a downturn in general economic conditions or in our business, or we may be unable to carry out capital spending that is important to our growth.


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Despite current indebtedness levels, we may still be able to incur substantially more debt. This could further exacerbate the risks described above.
 
We may be able to incur substantial additional indebtedness in the future. The terms of the indenture governing the Notes do not fully prohibit us from doing so. For example, under the indenture for the Notes, we may incur up to $7.815 billion pursuant to a credit facility or a qualified receivables transaction, less certain amounts repaid with the proceeds of asset dispositions. Our New Credit Facility provides for commitments of up to $7.115 billion in the aggregate. Our New Credit Facility also gives us the ability to provide for one or more additional tranches of term loans in aggregate principal amount of up to $600 million without the consent of the existing lenders if specified criteria are satisfied. If new debt is added to our current debt levels, the related risks that we now face could intensify.
 
If competition decreases our ability to acquire additional hospitals on favorable terms, we may be unable to execute our acquisition strategy.
 
An important part of our business strategy is to acquire two to four hospitals each year. However, not-for-profit hospital systems and other for-profit hospital companies generally attempt to acquire the same type of hospitals as we do. Some of these other purchasers have greater financial resources than we do. Our principal competitors for acquisitions have included Health Management Associates, Inc. and LifePoint Hospitals, Inc. On some occasions, we also compete with Universal Health Services, Inc. In addition, some hospitals are sold through an auction process, which may result in higher purchase prices than we believe are reasonable. Therefore, we may not be able to acquire additional hospitals on terms favorable to us.
 
If we fail to improve the operations of acquired hospitals, we may be unable to achieve our growth strategy.
 
Many of the hospitals we have acquired, had, or future acquisitions may have, significantly lower operating margins than we do and/or operating losses prior to the time we acquired or will acquire them. In the past, we have occasionally experienced temporary delays in improving the operating margins or effectively integrating the operations of these acquired hospitals. In the future, if we are unable to improve the operating margins of acquired hospitals, operate them profitably, or effectively integrate their operations, we may be unable to achieve our growth strategy. We acquired 50 hospitals in the Triad acquisition. In the past, we have not acquired this many hospitals at one time. We may still experience delays or difficulties in improving the operating margins or the operations of these acquired hospitals.
 
We may not be able to successfully integrate our acquisition of Triad or realize the potential benefits of the acquisition, which could cause our business to suffer.
 
We may not be able to combine successfully the operations of former Triad hospitals with our operations and, even if such integration is accomplished, we may never realize the potential benefits of the acquisition. The integration of former Triad hospitals with our operations requires significant attention from management and may impose substantial demands on our operations or other projects. In addition, Triad’s corporate officers did not continue their employment with us. The integration of Triad also involves a significant capital commitment, and the return that we achieve on any capital invested may be less than the return that we would achieve on our other projects or investments. Any of these factors could cause delays or increased costs of combining former Triad hospitals with us; and could adversely affect our operations, financial results and liquidity.
 
Certain of Triad’s joint venture partners have put or call rights, the exercise of which could affect our available cash and/or operating results. Triad entered into a number of joint venture transactions that entitle its joint venture partners to require Triad to purchase the partner’s interest or to require Triad to sell its interest to the partner. The consideration provided for in these contracts may not be at an advantageous amount vis-à-vis the consideration paid for the Triad acquisition. If these rights are exercised, we may be required to make unanticipated payments, our operations at certain facilities may be adversely affected, or we may be required to divest certain facilities.


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If we acquire hospitals with unknown or contingent liabilities, we could become liable for material obligations.
 
Hospitals that we acquire may have unknown or contingent liabilities, including liabilities for failure to comply with healthcare laws and regulations. Although we generally seek indemnification from prospective sellers covering these matters, we may nevertheless have material liabilities for past activities of acquired hospitals. In the case of the Triad acquisition, there was no indemnification provided given the fact that Triad was a public company and the acquisition was effective through a merger.
 
As a result of the Triad acquisition, on a consolidated basis, we are subject to all of the potential liabilities relating to the hospitals held by Triad, including liabilities relating to pending or threatened litigation matters, which, if adversely decided, could have a material adverse effect on our future results, operations and liquidity.
 
State efforts to regulate the construction, acquisition or expansion of hospitals could prevent us from acquiring additional hospitals, renovating our facilities or expanding the breadth of services we offer.
 
Some states require prior approval for the construction or acquisition of healthcare facilities and for the expansion of healthcare facilities and services. In giving approval, these states consider the need for additional or expanded healthcare facilities or services. In some states in which we operate, we are required to obtain certificates of need, known as CONs, for capital expenditures exceeding a prescribed amount, changes in bed capacity or services, and some other matters. Other states may adopt similar legislation. We may not be able to obtain the required CONs or other prior approvals for additional or expanded facilities in the future. In addition, at the time we acquire a hospital, we may agree to replace or expand the facility we are acquiring. If we are not able to obtain required prior approvals, we would not be able to acquire additional hospitals and expand the breadth of services we offer.
 
State efforts to regulate the sale of hospitals operated by not-for-profit entities could prevent us from acquiring additional hospitals and executing our business strategy.
 
Many states, including some where we have hospitals and others where we may in the future acquire hospitals, have adopted legislation regarding the sale or other disposition of hospitals operated by not-for-profit entities. In other states that do not have specific legislation, the attorneys general have demonstrated an interest in these transactions under their general obligations to protect charitable assets from waste. These legislative and administrative efforts focus primarily on the appropriate valuation of the assets divested and the use of the proceeds of the sale by the non-profit seller. While these review and, in some instances, approval processes can add additional time to the closing of a hospital acquisition, we have not had any significant difficulties or delays in completing acquisitions. However, future actions on the state level could seriously delay or even prevent our ability to acquire hospitals.
 
If we are unable to effectively compete for patients, local residents could use other hospitals.
 
The hospital industry is highly competitive. In addition to the competition we face for acquisitions and physicians, we must also compete with other hospitals and healthcare providers for patients. The competition among hospitals and other healthcare providers for patients has intensified in recent years. Our hospitals are located in non-urban service areas. In approximately 65% of our markets, we are the sole provider of general healthcare services. In most of our other markets, the primary competitor is a not-for-profit hospital. These not-for-profit hospitals generally differ in each jurisdiction. However, our hospitals face competition from hospitals outside of their primary service area, including hospitals in urban areas that provide more complex services. Patients in our primary service areas may travel to these other hospitals for a variety of reasons. These reasons include physician referrals or the need for services we do not offer. Patients who seek services from these other hospitals may subsequently shift their preferences to those hospitals for the services we provide.
 
Some of our hospitals operate in primary service areas where they compete with one other hospital. One of our hospitals competes with more than one other hospital in its primary service area. Some of these


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competing hospitals use equipment and services more specialized than those available at our hospitals. In addition, some competing hospitals are owned by tax-supported governmental agencies or not-for-profit entities supported by endowments and charitable contributions. These hospitals can make capital expenditures without paying sales, property and income taxes. We also face competition from other specialized care providers, including outpatient surgery, orthopedic, oncology and diagnostic centers.
 
We expect that these competitive trends will continue. Our inability to compete effectively with other hospitals and other healthcare providers could cause local residents to use other hospitals.
 
The failure to obtain our medical supplies at favorable prices could cause our operating results to decline.
 
We have a five-year participation agreement with a GPO. This agreement extends to March 2010, with automatic renewal terms of one year, unless either party terminates by giving notice of non-renewal. GPOs attempt to obtain favorable pricing on medical supplies with manufacturers and vendors who sometimes negotiate exclusive supply arrangements in exchange for the discounts they give. To the extent these exclusive supply arrangements are challenged or deemed unenforceable, we could incur higher costs for our medical supplies obtained through HealthTrust. These higher costs could cause our operating results to decline.
 
There can be no assurance that our arrangement with HealthTrust will provide the discounts we expect to achieve.
 
If the fair value of our reporting units declines, a material non-cash charge to earnings from impairment of our goodwill could result.
 
At December 31, 2008, we had approximately $4.166 billion of goodwill recorded on our books. We expect to recover the carrying value of this goodwill through our future cash flows. On an ongoing basis, we evaluate, based on the fair value of our reporting units, whether the carrying value of our goodwill is impaired. If the carrying value of our goodwill is impaired, we may incur a material non-cash charge to earnings.
 
The current turmoil in the financial markets and weakness in macroeconomic conditions globally continue to be challenging and we cannot be certain of the duration of these conditions and their potential impact on our stock price performance. If a further decline in our market capitalization and other factors resulted in the decline in our fair value, it is reasonably likely that a goodwill impairment assessment prior to the next annual review, in the fourth quarter of 2009, would be necessary. If such an assessment is required, an impairment of goodwill may be recognized. A non-cash goodwill impairment charge would have the effect of decreasing our earnings or increasing our losses in the period the impairment is recognized. The amount of such effect on earnings and losses is dependent on the size of the impairment charge.
 
Risks related to our industry
 
If federal or state healthcare programs or managed care companies reduce the payments we receive as reimbursement for services we provide, our net operating revenues may decline.
 
In 2008, 36.6% of our net operating revenues came from the Medicare and Medicaid programs. In recent years, federal and state governments made significant changes in the Medicare and Medicaid programs, including the Medicare Prescription Drug, Improvement and Modernization Act of 2003. Some of these changes have decreased the amount of money we receive for our services relating to these programs.
 
In recent years, Congress and some state legislatures have introduced an increasing number of other proposals to make major changes in the healthcare system including an increased emphasis on the linkage between quality of care criteria and payment levels such as the submission of patient quality data to the Secretary of Health and Human Services. In addition, CMS conducts ongoing reviews of certain state reimbursement programs. Federal funding for existing programs may not be approved in the future. Future federal and state legislation may further reduce the payments we receive for our services. The Obama administration has stated as a top priority its desire to reform the U.S. healthcare system with the goal of providing affordable, accessible health care for all Americans. Proposals that have been considered include


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cost controls on hospitals, insurance market reforms to increase the availability of group health insurance to small businesses, and mandatory health insurance coverage for employees. The “American Recovery and Reinvestment Act of 2009” has been signed into law providing for a temporary increase in the federal matching assistance percentage (FMAP), a temporary increase in federal Medicaid DSH allotments, subsidization of health insurance premiums (COBRA) for up to nine months, and grants and loans for infrastructure and incentive payments for providers who adopt and use health information technology. The costs of implementing this law and other proposals could be financed, in part, by reductions in payments to healthcare providers under Medicare, Medicaid, and other government programs. We cannot predict the course of future healthcare legislation, other changes the administration may seek to implement regarding healthcare or interpretations by the administration of existing governmental healthcare programs and the effect that any legislation change or interpretation may have on us.
 
In addition, insurance and managed care companies and other third parties from whom we receive payment for our services increasingly are attempting to control healthcare costs by requiring that hospitals discount payments for their services in exchange for exclusive or preferred participation in their benefit plans. We believe that this trend may continue and our inability to negotiate increased reimbursement rates or maintain existing rates may reduce the payments we receive for our services.
 
If we fail to comply with extensive laws and government regulations, including fraud and abuse laws, we could suffer penalties or be required to make significant changes to our operations.
 
The healthcare industry is required to comply with many laws and regulations at the federal, state, and local government levels. These laws and regulations require that hospitals meet various requirements, including those relating to the adequacy of medical care, equipment, personnel, operating policies and procedures, maintenance of adequate records, compliance with building codes, environmental protection and privacy. These laws include the Health Insurance Portability and Accountability Act of 1996 and a section of the Social Security Act, known as the “anti-kickback” statute. If we fail to comply with applicable laws and regulations, including fraud and abuse laws, we could suffer civil or criminal penalties, including the loss of our licenses to operate and our ability to participate in the Medicare, Medicaid, and other federal and state healthcare programs.
 
In addition, there are heightened coordinated civil and criminal enforcement efforts by both federal and state government agencies relating to the healthcare industry, including the hospital segment. The ongoing investigations relate to various referral, cost reporting, and billing practices, laboratory and home care services, and physician ownership and joint ventures involving hospitals. For example, the Department of Justice has alleged that we and three of our New Mexico hospitals have caused the state of New Mexico to submit improper claims for federal funds in violation of the Civil False Claims Act. For a further discussion of this matter, see “Legal Proceedings.”
 
In the future, different interpretations or enforcement of these laws and regulations could subject our current practices to allegations of impropriety or illegality or could require us to make changes in our facilities, equipment, personnel, services, capital expenditure programs, and operating expenses.
 
A shortage of qualified nurses could limit our ability to grow and deliver hospital healthcare services in a cost-effective manner.
 
Hospitals are currently experiencing a shortage of nursing professionals, a trend which we expect to continue for some time. If the supply of qualified nurses declines in the markets in which our hospitals operate, it may result in increased labor expenses and lower operating margins at those hospitals. In addition, in some markets like California, there are requirements to maintain specified nurse-staffing levels. To the extent we cannot meet those levels, the healthcare services that we provide in these markets may be reduced.


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If we become subject to significant legal actions, we could be subject to substantial uninsured liabilities or increased insurance costs.
 
In recent years, physicians, hospitals, and other healthcare providers have become subject to an increasing number of legal actions alleging malpractice, product liability, or related legal theories. Even in states that have imposed caps on damages, litigants are seeking recoveries under new theories of liability that might not be subject to the caps on damages. Many of these actions involve large claims and significant defense costs. To protect us from the cost of these claims, we maintain professional malpractice liability insurance and general liability insurance coverage in excess of those amounts for which we are self-insured, in amounts that we believe to be sufficient for our operations. However, our insurance coverage does not cover all claims against us or may not continue to be available at a reasonable cost for us to maintain adequate levels of insurance. The cost of malpractice and other professional liability insurance increased in 2006 by 0.1%, decreased in 2007 by 0.1% and decreased in 2008 by 0.2% as a percentage of net operating revenue. If these costs rise rapidly, our profitability could decline. For a further discussion of our insurance coverage, see our discussion of professional liability insurance claims in “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
 
If we experience growth in self-pay volume and revenue, our financial condition or results of operations could be adversely affected.
 
Like others in the hospital industry, we have experienced an increase in our provision for bad debts as a percentage of net operating revenue due to a growth in self-pay volume and revenue. Although we continue to seek ways of improving point of service collection efforts and implementing appropriate payment plans with our patients, if we experience growth in self-pay volume and revenue, our results of operations could be adversely affected. Further, our ability to improve collections for self-pay patients may be limited by statutory, regulatory and investigatory initiatives, including private lawsuits directed at hospital charges and collection practices for uninsured and underinsured patients.
 
Currently, the global economies, and in particular the United States, are experiencing a period of economic uncertainty and the related financial markets are experiencing a high degree of volatility. This current financial turmoil is adversely affecting the banking system and financial markets and resulting in a tightening in the credit markets, a low level of liquidity in many financial markets and extreme volatility in fixed income, credit, currency and equity markets. This uncertainty poses a risk as it could potentially lead to higher levels of uninsured patients, result in higher levels of patients covered by lower paying government programs and/or result in fiscal uncertainties at both government payors and private insurers.
 
This Report includes forward-looking statements which could differ from actual future results.
 
Some of the matters discussed in this Report include forward-looking statements. Statements that are predictive in nature, that depend upon or refer to future events or conditions or that include words such as “expects,” “anticipates,” “intends,” “plans,” “believes,” “estimates,” “thinks,” and similar expressions are forward-looking statements. These statements involve known and unknown risks, uncertainties, and other factors that may cause our actual results and performance to be materially different from any future results or performance expressed or implied by these forward-looking statements. These factors include the following:
 
  •  general economic and business conditions, both nationally and in the regions in which we operate;
 
  •  our ability to successfully integrate any acquisitions or to recognize expected synergies from such acquisitions, including facilities acquired from Triad;
 
  •  risks associated with our substantial indebtedness, leverage and debt service obligations;
 
  •  demographic changes;
 
  •  changes in, or the failure to comply with, governmental regulations;
 
  •  legislative proposals for healthcare reform;


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  •  potential adverse impact of known and unknown government investigations and Civil False Claims Act litigation;
 
  •  our ability, where appropriate, to enter into or maintain managed care provider arrangements and the terms of these arrangements;
 
  •  changes in inpatient or outpatient Medicare and Medicaid payment levels;
 
  •  increases in the amount and risk of collectability of patient accounts receivable;
 
  •  increases in wages as a result of inflation or competition for highly technical positions and rising supply costs due to market pressure from pharmaceutical companies and new product releases;
 
  •  liabilities and other claims asserted against us, including self-insured malpractice claims;
 
  •  competition;
 
  •  our ability to attract and retain, without significant employment costs, qualified personnel, key management, physicians, nurses and other healthcare workers;
 
  •  trends toward treatment of patients in less acute or specialty healthcare settings, including ambulatory surgery centers or specialty hospitals;
 
  •  changes in medical or other technology;
 
  •  changes in GAAP;
 
  •  the availability and terms of capital to fund additional acquisitions or replacement facilities;
 
  •  our ability to successfully acquire additional hospitals and complete the sale of hospitals held for sale;
 
  •  our ability to obtain adequate levels of general and professional liability insurance; and
 
  •  timeliness of reimbursement payments received under government programs.
 
Although we believe that these statements are based upon reasonable assumptions, we can give no assurance that our goals will be achieved. Given these uncertainties, prospective investors are cautioned not to place undue reliance on these forward-looking statements. These forward-looking statements are made as of the date of this filing. We assume no obligation to update or revise them or provide reasons why actual results may differ.
 
Item 1B.  Unresolved Staff Comments
 
None
 
Item 2.   Properties
 
Corporate Headquarters
 
We own our corporate headquarters building located in Franklin, Tennessee.
 
Hospitals
 
Our hospitals are general care hospitals offering a wide range of inpatient and outpatient medical services. These services generally include internal medicine, surgery, cardiology, oncology, orthopedics, OB/GYN, diagnostic and emergency room services, laboratory, radiology, respiratory therapy, physical therapy, and rehabilitation services. In addition, some of our hospitals provide skilled nursing and home care services based on individual community needs.


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For each of our hospitals owned or leased as of December 31, 2008, including the two hospitals classified as held for sale and included in discontinued operations, the following table shows its location, the date of its acquisition or lease inception and the number of licensed beds:
 
                     
              Date of
   
        Licensed
    Acquisition/Lease
  Ownership
Hospital
 
City
  Beds(1)     Inception   Type
 
Alabama
                   
LV Stabler Memorial Hospital
  Greenville     72     October, 1994   Owned
South Baldwin Regional Medical Center
  Foley     112     June, 2000   Leased
Cherokee Medical Center
  Centre     60     April, 2006   Owned
Dekalb Regional Medical Center
  Fort Payne     134     April, 2006   Owned
Trinity Medical Center
  Birmingham     560     July, 2007   Owned
Flowers Hospital
  Dothan     235     July, 2007   Owned
Medical Center Enterprise
  Enterprise     131     July, 2007   Owned
Gadsden Regional Medical Center
  Gadsden     346     July, 2007   Owned
Crestwood Medical Center
  Huntsville     150     July, 2007   Owned
Alaska
                   
Mat-Su Regional Medical Center
  Palmer     74     July, 2007   Owned
Arizona
                   
Payson Regional Medical Center
  Payson     44     August, 1997   Leased
Western Arizona Regional Medical Center
  Bullhead City     139     July, 2000   Owned
Northwest Medical Center
  Tucson     300     July, 2007   Owned
Northwest Medical Center Oro Valley
  Oro Valley     144     July, 2007   Owned
Arkansas
                   
Harris Hospital
  Newport     133     October, 1994   Owned
Helena Regional Medical Center
  Helena     155     March, 2002   Leased
Forrest City Medical Center
  Forrest City     118     March, 2006   Leased
Northwest Medical Center — Bentonville
  Bentonville     128     July, 2007   Owned
Northwest Medical Center — Springdale
  Springdale     222     July, 2007   Owned
Willow Creek Women’s Hospital(2)
  Johnson     64     July, 2007   Owned
California
                   
Barstow Community Hospital
  Barstow     56     January, 1993   Leased
Fallbrook Hospital
  Fallbrook     47     November, 1998   Operated(3)
Watsonville Community Hospital
  Watsonville     106     September, 1998   Owned
Florida
                   
Lake Wales Medical Center
  Lake Wales     154     December, 2002   Owned
North Okaloosa Medical Center
  Crestview     110     March, 1996   Owned
Georgia
                   
Fannin Regional Hospital
  Blue Ridge     50     January, 1986   Owned
Trinity Hospital of Augusta
  Augusta     231     July, 2007   Owned
Illinois
                   
Crossroads Community Hospital
  Mt. Vernon     55     October, 1994   Owned
Gateway Regional Medical Center
  Granite City     416     January, 2002   Owned
Heartland Regional Medical Center
  Marion     92     October, 1996   Owned
Red Bud Regional Hospital
  Red Bud     31     September, 2001   Owned
Galesburg Cottage Hospital
  Galesburg     173     July, 2004   Owned


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              Date of
   
        Licensed
    Acquisition/Lease
  Ownership
Hospital
 
City
  Beds(1)     Inception   Type
 
Vista Medical Center East/West
  Waukegan     407     July, 2006   Owned
Union County Hospital
  Anna     25     November, 2006   Leased
Indiana
                   
Porter Hospital
  Valparaiso     301     May, 2007   Owned
Bluffton Regional Medical Center
  Bluffton     79     July, 2007   Owned
Dupont Hospital
  Fort Wayne     131     July, 2007   Owned
Lutheran Hospital
  Fort Wayne     432     July, 2007   Owned
St. Joseph’s Hospital
  Fort Wayne     191     July, 2007   Owned
Dukes Memorial Hospital
  Peru     25     July, 2007   Owned
Kosciusko Community Hospital
  Warsaw     72     July, 2007   Owned
Lutheran Musculoskeletal Center(4)
  Fort Wayne     39     July, 2007   Owned
Kentucky
                   
Parkway Regional Hospital
  Fulton     70     May, 1992   Owned
Three Rivers Medical Center
  Louisa     90     May, 1993   Owned
Kentucky River Medical Center
  Jackson     55     August, 1995   Leased
Louisiana
                   
Byrd Regional Hospital
  Leesville     60     October, 1994   Owned
Northern Louisiana Medical Center
  Ruston     159     April, 2007   Leased
Women & Children’s Hospital
  Lake Charles     88     July, 2007   Owned
Mississippi
                   
Wesley Medical Center
  Hattiesburg     211     July, 2007   Owned
River Region Health System
  Vicksburg     341     July, 2007   Owned
Missouri
                   
Moberly Regional Medical Center
  Moberly     103     November, 1993   Owned
Northeast Regional Medical Center
  Kirksville     115     December, 2000   Leased
Nevada
                   
Mesa View Regional Hospital
  Mesquite     25     July, 2007   Owned
New Jersey
                   
Memorial Hospital of Salem County
  Salem     140     September, 2002   Owned
New Mexico
                   
Mimbres Memorial Hospital
  Deming     49     March, 1996   Owned
Eastern New Mexico Medical Center
  Roswell     162     April, 1998   Owned
Alta Vista Regional Hospital
  Las Vegas     54     April, 2000   Owned
Carlsbad Medical Center
  Carlsbad     112     July, 2007   Owned
Lea Regional Medical Center
  Hobbs     234     July, 2007   Owned
Mountain View Regional Medical Center
  Las Cruces     168     July, 2007   Owned
North Carolina
                   
Martin General Hospital
  Williamston     49     November, 1998   Leased
Ohio
                   
Affinity Medical Center
  Massillon     432     July, 2007   Owned
Oklahoma
                   
Ponca City Medical Center
  Ponca City     140     May, 2006   Owned
Claremore Regional Hospital
  Claremore     81     July, 2007   Owned

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              Date of
   
        Licensed
    Acquisition/Lease
  Ownership
Hospital
 
City
  Beds(1)     Inception   Type
 
Deaconess Hospital
  Oklahoma City     313     July, 2007   Owned
SouthCrest Hospital
  Tulsa     180     July, 2007   Owned
Woodward Regional Hospital
  Woodward     87     July, 2007   Owned
Oregon
                   
McKenzie-Willamette Medical Center
  Springfield     114     July, 2007   Owned
Pennsylvania
                   
Berwick Hospital
  Berwick     101     March, 1999   Owned
Brandywine Hospital
  Coatesville     175     June, 2001   Owned
Jennersville Regional Hospital
  West Grove     59     October, 2001   Owned
Easton Hospital
  Easton     254     October, 2001   Owned
Lock Haven Hospital
  Lock Haven     59     August, 2002   Owned
Pottstown Memorial Medical Center
  Pottstown     226     July, 2003   Owned
Phoenixville Hospital
  Phoenixville     138     August, 2004   Owned
Chestnut Hill Hospital
  Philadelphia     164     February, 2005   Owned
Sunbury Community Hospital
  Sunbury     92     October, 2005   Owned
South Carolina
                   
Marlboro Park Hospital
  Bennettsville     102     August, 1996   Leased
Chesterfield General Hospital
  Cheraw     59     August, 1996   Leased
Springs Memorial Hospital
  Lancaster     231     November, 1994   Owned
Carolinas Hospital System — Florence
  Florence     420     July, 2007   Owned
Mary Black Memorial Hospital
  Spartanburg     209     July, 2007   Owned
Tennessee
                   
Lakeway Regional Hospital
  Morristown     135     May, 1993   Owned
Regional Hospital Of Jackson
  Jackson     154     January, 2003   Owned
Dyersburg Regional Medical Center
  Dyersburg     225     January, 2003   Owned
Haywood Park Community Hospital
  Brownsville     62     January, 2003   Owned
Henderson County Community Hospital
  Lexington     45     January, 2003   Owned
McKenzie Regional Hospital
  McKenzie     45     January, 2003   Owned
McNairy Regional Hospital
  Selmer     45     January, 2003   Owned
Volunteer Community Hospital
  Martin     100     January, 2003   Owned
Heritage Medical Center
  Shelbyville     60     July, 2005   Owned
Sky Ridge Medical Center
  Cleveland     351     October, 2005   Owned
Gateway Medical Center
  Clarksville     270     July, 2007   Owned
Texas
                   
Big Bend Regional Medical Center
  Alpine     25     October, 1999   Owned
Cleveland Regional Medical Center
  Cleveland     107     August, 1996   Leased
Scenic Mountain Medical Center
  Big Spring     150     October, 1994   Owned
Hill Regional Hospital
  Hillsboro     92     October, 1994   Owned
Lake Granbury Medical Center
  Granbury     59     January, 1997   Owned
South Texas Regional Medical Center
  Jourdanton     67     November, 2001   Owned
Laredo Medical Center
  Laredo     326     October, 2003   Owned
Weatherford Regional Medical Center
  Weatherford     99     November, 2006   Leased
Abilene Regional Medical Center
  Abilene     231     July, 2007   Owned

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              Date of
   
        Licensed
    Acquisition/Lease
  Ownership
Hospital
 
City
  Beds(1)     Inception   Type
 
Brownwood Regional Medical Center
  Brownwood     196     July, 2007   Owned
College Station Medical Center
  College Station     150     July, 2007   Owned
Navarro Regional Hospital
  Corsicana     162     July, 2007   Owned
Presbyterian Hospital of Denton
  Denton     255     July, 2007   Owned
Longview Regional Medical Center
  Longview     131     July, 2007   Owned
Woodland Heights Medical Center
  Lufkin     149     July, 2007   Owned
San Angelo Community Medical Center
  San Angelo     171     July, 2007   Owned
DeTar Healthcare System
  Victoria     308     July, 2007   Owned
Cedar Park Regional Medical Center
  Cedar Park     77     December, 2007   Owned
Utah
                   
Mountain West Medical Center
  Tooele     35     October, 2000   Owned
Virginia
                   
Southern Virginia Regional Medical Center
  Emporia     80     March, 1999   Owned
Southampton Memorial Hospital
  Franklin     105     March, 2000   Owned
Southside Regional Medical Center
  Petersburg     300     August, 2003   Owned
Washington
                   
Deaconess Medical Center
  Spokane     388     October, 2008   Owned
Valley Hospital and Medical Center
  Spokane Valley     123     October, 2008   Owned
West Virginia
                   
Plateau Medical Center
  Oak Hill     25     July, 2002   Owned
Greenbrier Valley Medical Center
  Ronceverte     122     July, 2007   Owned
Wyoming
                   
Evanston Regional Hospital
  Evanston     42     November, 1999   Owned
                     
Total Licensed Beds at December 31, 2008
        17,932          
                     
 
 
(1) Licensed beds are the number of beds for which the appropriate state agency licenses a facility regardless of whether the beds are actually available for patient use.
 
(2) In 2008, we segregated this entity from Northwest Medical Center — Bentonville for reporting purposes.
 
(3) We operate this hospital under a lease-leaseback and operating agreement. We recognize all operating statistics, revenue and expenses associated with this hospital in our consolidated financial statements.
 
(4) In 2008, we segregated this entity from Lutheran Hospital for reporting purposes.
 
The real property of substantially all of our wholly-owned hospitals are encumbered by mortgages under the New Credit Facility.

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The following table lists the hospitals owned by joint venture entities in which we do not have a consolidating ownership interest, along with our percentage ownership interest in the joint venture entity as of December 31, 2008. Information on licensed beds was provided by the majority owner and manager of each joint venture. A subsidiary of HCA Inc. is the majority owner of Macon Healthcare LLC, a subsidiary of Universal Health Systems Inc. is the majority owner of Summerlin Hospital Medical Center LLC and Valley Health System LLC and the Share Foundation is the other 50% owner of MCSA LLC.
 
                     
Joint Venture
 
Facility Name
  City   State   Licensed Beds  
 
Macon Healthcare LLC
  Coliseum Medical Center (38%)   Macon   GA     250  
Macon Healthcare LLC
  Coliseum Psychiatric Center (38%)   Macon   GA     60  
Macon Healthcare LLC
  Coliseum Northside Hospital (38%)   Macon   GA     103  
Summerlin Hospital Medical Center LLC
  Summerlin Hospital Medical Center (26.1%)   Las Vegas   NV     281  
Valley Health System LLC
  Desert Springs Hospital (27.5%)   Las Vegas   NV     286  
Valley Health System LLC
  Valley Hospital Medical Center (27.5%)   Las Vegas   NV     404  
Valley Health System LLC
  Spring Valley Hospital Medical Center (27.5%)   Las Vegas   NV     210  
Valley Health System LLC
  Centennial Hills Medical Center (27.5%)   Las Vegas   NV     165  
MCSA LLC
  Medical Center of South Arkansas (50%)   El Dorado   AR     166  
 
Item 3.   Legal Proceedings
 
From time to time, we receive various inquiries or subpoenas from state regulators, fiscal intermediaries, the Centers for Medicare and Medicaid Services and the Department of Justice regarding various Medicare and Medicaid issues. In addition, we are subject to other claims and lawsuits arising in the ordinary course of our business. We are not aware of any pending or threatened litigation that is not covered by insurance policies or reserved for in our financial statements or which we believe would have a material adverse impact on us; however, some pending or threatened proceedings against us may involve potentially substantial amounts as well as the possibility of civil, criminal, or administrative fines, penalties, or other sanctions, which could be material. Settlements of suits involving Medicare and Medicaid issues routinely require both monetary payments as well as corporate integrity agreements. Additionally, qui tam or “whistleblower” actions initiated under the civil False Claims Act may be pending but placed under seal by the court to comply with the False Claims Act’s requirements for filing such suits.
 
Community Health Systems, Inc. Legal Proceedings
 
In May 1999, we were served with a complaint in U.S. ex rel. Bledsoe v. Community Health Systems, Inc., subsequently moved to the Middle District of Tennessee, Case No. 2-00-0083. This qui tam action sought treble damages and penalties under the False Claims Act against us. The Department of Justice did not intervene in this action. The allegations in the amended complaint were extremely general, but involved Medicare billing at our White County Community Hospital in Sparta, Tennessee. By order entered on September 19, 2001, the U.S. District Court granted our motion for judgment on the pleadings and dismissed the case, with prejudice. The qui tam whistleblower (also referred to as a “relator”) appealed the district court’s ruling to the U.S. Court of Appeals for the Sixth Circuit. On September 10, 2003, the Sixth Circuit Court of Appeals rendered its decision in this case, affirming in part and reversing in part the district court’s decision to dismiss the case with prejudice. The court affirmed the lower court’s dismissal of certain of plaintiff’s claims on the grounds that his allegations had been previously publicly disclosed. In addition, the appeals court agreed that, as to all other allegations, the relator had failed to include enough information to meet the special pleading requirements for fraud under the False Claims Act and the Federal Rules of Civil


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Procedure. However, the case was returned to the district court to allow the relator another opportunity to amend his complaint in an attempt to plead his fraud allegations with particularity. In May 2004, the relator in U.S. ex rel. Bledsoe filed an amended complaint alleging fraud involving Medicare billing at White County Community Hospital. We then filed a renewed motion to dismiss the amended complaint. On January 6, 2005, the District Court dismissed with prejudice the bulk of the relator’s allegations. The only remaining allegations involve a small number of charges from 1997 and 1998 at White County. After further motion practice between the relator and the United States Government regarding the relator’s right to participate in a previous settlement with the Company, the District Court again dismissed all claims in the case on December 13, 2005. On January 9, 2006, the relator filed a notice of appeal to the U.S. Court of Appeals for the Sixth Circuit and on September 6, 2007, the Court of Appeals issued its opinion affirming in part, reversing in part (and in doing so, reinstating a number of the allegations claimed by the relator), and remanding the case to the District Court for further proceedings. The relator filed a motion for rehearing. That motion for rehearing was denied. The relator amended his complaint to conform to the decision of the Court of Appeals and we filed an answer. A case management conference was held August 18, 2008. The parties have exchanged initial written discovery. Relator has recently filed a pleading stating “Relator Sean Bledsoe has a potentially fatal brain tumor that has severely affected Relator’s long-term and short-term memory...” The court has now ordered that a mandatory settlement conference be stayed until Relator and wife can be deposed. We will continue to vigorously defend this case.
 
In August 2004, we were served a complaint in Arleana Lawrence and Robert Hollins v. Lakeview Community Hospital and Community Health Systems, Inc. (now styled Arleana Lawrence and Lisa Nichols vs. Eufaula Community Hospital, Community Health Systems, Inc., South Baldwin Regional Medical Center and Community Health Systems Professional Services Corporation) in the Circuit Court of Barbour County, Alabama (Eufaula Division). This alleged class action was brought by the plaintiffs on behalf of themselves and as the representatives of similarly situated uninsured individuals who were treated at our Lakeview Hospital or any of our other Alabama hospitals. The plaintiffs allege that uninsured patients who do not qualify for Medicaid, Medicare or charity care are charged unreasonably high rates for services and materials and that we use unconscionable methods to collect bills. The plaintiffs seek restitution of overpayment, compensatory and other allowable damages and injunctive relief. In October 2005, the complaint was amended to eliminate one of the named plaintiffs and to add our management company subsidiary as a defendant. In November 2005, the complaint was again amended to add another plaintiff, Lisa Nichols and another defendant, our hospital in Foley, Alabama, South Baldwin Regional Medical Center. After a hearing held on June 13, 2007, on October 29, 2007 the Circuit Court ruled in favor of the plaintiffs’ class action certification request. On summary judgment, the Circuit Court dismissed the case against Community Health Systems, Inc. only. All other parties remain. We disagree with the certification ruling and pursued our automatic right of appeal to the Alabama Supreme Court. Briefs have now been filed and oral argument requested. We are vigorously defending this case.
 
On March 3, 2005, we were served with a complaint in Sheri Rix v. Heartland Regional Medical Center and Health Care Systems, Inc. in the Circuit Court of Williamson County, Illinois. This alleged class action was brought by the plaintiff on behalf of herself and as the representative of similarly situated uninsured individuals who were treated at our Heartland Regional Medical Center. The plaintiff alleges that uninsured patients who do not qualify for Medicaid, Medicare or charity care are charged unreasonably high rates for services and materials and that we use unconscionable methods to collect bills. The plaintiff seeks recovery for breach of contract and the covenant of good faith and fair dealing, violation of the Illinois Consumer Fraud and Deceptive Practices Act, restitution of overpayment, and for unjust enrichment. The plaintiff class seeks compensatory and other damages and equitable relief. The Circuit Court Judge granted our motion to dismiss the case, but allowed the plaintiff to re-plead her case. The plaintiff elected to appeal the Circuit Court’s decision in lieu of amending her case. Oral argument was heard on this case on January 9, 2008. On June 16, 2008, the Appellate Court upheld the dismissal of the consumer fraud claim but reversed dismissal of the contract claim. We filed a Petition for Leave of Appeal to the Illinois Supreme Court which was denied. The case has now been remanded and we are evaluating our position concerning discovery and possible dispositive motions. We are vigorously defending this case.


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On April 8, 2005, we were served with a first amended complaint, styled Chronister, et al. v. Granite City Illinois Hospital Company, LLC d/b/a Gateway Regional Medical Center, in the Circuit Court of Madison County, Illinois. The complaint seeks class action status on behalf of the uninsured patients treated at Gateway Regional Medical Center and alleges statutory, common law, and consumer fraud in the manner in which the hospital bills and collects for the services rendered to uninsured patients. The plaintiff seeks compensatory and punitive damages and declaratory and injunctive relief. Our motion to dismiss has been granted in part and denied in part and discovery has commenced. Gateway Regional Medical Center v. Holman is a companion case to the Chronister action, seeking counterclaim recovery on a collections case. Holman has been stayed pending the outcome of the Chronister action. We have refiled our motion to dismiss in light of subsequent favorable Illinois Appellate court decisions on the consumer fraud issues. We are vigorously defending these cases.
 
On February 10, 2006, we received a letter from the Civil Division of the Department of Justice requesting documents in an investigation they are conducting involving the Company. The inquiry relates to the way in which different state Medicaid programs apply to the federal government for matching or supplemental funds that are ultimately used to pay for a small portion of the services provided to Medicaid and indigent patients. These programs are referred to by different names, including “intergovernmental payments,” “upper payment limit programs,” and “Medicaid disproportionate share hospital payments.” The February 10th letter focused on our hospitals in 3 states: Arkansas, New Mexico, and South Carolina. On August 31, 2006, we received a follow up letter from the Department of Justice requesting additional documents relating to the programs in New Mexico and the payments to the Company’s three hospitals in that state. We have provided the Department of Justice with the requested documents. In a letter dated October 4, 2007, the Civil Division notified us that, based on its investigation to date, it preliminarily believes that we and these three New Mexico hospitals have caused the State of New Mexico to submit improper claims for federal funds, in violation of the Civil False Claims Act. The DOJ asserted that these allegedly improper claims and payments began in 2000 and may be ongoing, but provided no information about the amount of any improper claims or the possible damages or penalties it may seek. After a meeting between us and the DOJ held in November 2007, by letter dated January 22, 2008, the Civil Division notified us that they continued to believe that the False Claims Act had been violated and had calculated that the three hospitals received ineligible federal participation payments from August 2000 to June 2006 of approximately $27.5 million. The Civil Division advised us that if they proceeded to trial, they would seek treble damages plus an appropriate penalty for each of the violations of the False Claims Act. Discussions are continuing with the Civil Division in an effort to resolve this matter. On May 28, 2008, we received a letter from the Office of the U.S. Attorney for the state of New Mexico requesting additional information. The Company responded to and subsequently met with the government on October 30, 2008 and in January 2009 we provided additional information. We continue to believe that we have not violated the Federal False Claims Act in the manner described in the government’s letter of January 22, 2008. However, in February 2009 we were informed by the Department of Justice that it intends to pursue litigation in this matter.
 
In August 2006, our facility in Petersburg, Virginia (Southside Regional Medical Center) was notified of the pendency of a federal False Claims Act case styled U.S. ex rel. Vuyyuru v. Jadhav et al. filed in the Eastern District of Virginia. In addition to naming the hospital, Community Health Systems Professional Services Corporation, our management subsidiary, has also been named. The suit alleges that Dr. Jadhav, Southside Regional Medical Center, and other healthcare providers performed medically unnecessary procedures and billed federal healthcare programs and also alleges that the defendants defamed Dr. Vuyyuru in the process of terminating his medical staff privileges. Almost all of the allegations pre-date our acquisition of this facility and the seller’s successor-in-interest has agreed to indemnify the Company and its affiliates. A motion to dismiss the case has been granted and the relator’s appeal of the ruling to the U.S. Court of Appeals for the Fourth Circuit was denied. We will no longer refer to this case in future filings unless there is further litigation.
 
On August 28, 2007, Texas Health Resources of Arlington, Texas, or THR, notified us of its decision to exercise a call right to acquire our 80% interest in the limited partnership that owns Presbyterian Hospital of Denton, Texas, together with certain land and buildings that we own in Denton (including rights under a lease for such land and buildings). We acquired these interests in connection with the Triad acquisition. This call


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right became exercisable under the terms of the limited partnership agreement by reasons of our acquisition of Triad. Shortly after we initiated efforts to set the purchase price, which is determined by various formulas set forth in the limited partnership agreement and related documents, THR filed suit in Texas state court seeking injunctive and declaratory relief to extend the 90-day closing date and to set the purchase price. We removed the case to Federal District Court. Pursuant to the limited partnership agreement, the closing was to occur on or before November 26, 2007. The closing did not occur on November 26, 2007, as THR failed to properly tender adequate closing consideration. The case proceeded with discovery and motions. On February 12, 2009, the parties announced the execution of a settlement agreement, pursuant to which we will transfer our partnership interests on or before March 31, 2009 to THR or an affiliate. We will no longer refer to this case in future filings.
 
On June 12, 2008, two of our hospitals received letters from the U.S. Attorney’s Office for the Western District of New York requesting documents in an investigation they are conducting into billing practices with respect to kyphoplasty procedures performed during the period January 1, 2002, through June 9, 2008. On September 16, 2008, one of our hospitals in South Carolina also received an inquiry. Kyphoplasty is a surgical spine procedure that returns a compromised vertebrae (either from trauma or osteoporotic disease process) to its previous height, reducing or eliminating severe pain. We have been informed that similar investigations have been initiated at unaffiliated facilities in Alabama, South Carolina, Indiana and other states. We believe that this investigation is related to a recent qui tam settlement between the same U.S. Attorney’s office and the manufacturer and distributor of the Kyphon product, which is used in performing the kyphoplasty procedure. We are cooperating with the investigation by collecting and producing material responsive to the requests. At this early stage, we do not have sufficient information to determine whether our hospitals have engaged in inappropriate billing for kyphoplasty procedures. We are continuing to evaluate and discuss this matter with the government.
 
Triad Hospitals, Inc. Legal Proceedings
 
Triad, and its subsidiary, Quorum Health Resources, Inc. are defendants in a qui tam case styled U.S. ex rel. Whitten vs. Quorum Health Resources, Inc. et al., which is pending in the Southern District of Georgia, Brunswick Division. Whitten, a long-term employee of a two hospital system in Brunswick and Camden, Georgia sued both his employer and Quorum Health Resources, Inc. and its predecessors, which had managed the facility from 1989 through September 2000; upon his termination of employment, Whitten signed a release and was paid $124,000. Whitten’s original qui tam complaint was filed under seal in November 2002 and the case was unsealed in 2004. Whitten alleges various charging and billing infractions, including charging for routine equipment supplies and services not separately billable, billing for observation services that were not medically necessary or for which there was no physician order, billing labor and delivery patients for durable medical equipment that was not separately billable, inappropriate preparation of patients’ histories and physicals, billing for cardiac rehabilitation services without physician supervision, performing outpatient dialysis without Medicare certification, and performing mental health services without the proper staff assignments. In October 2005, the district court granted Quorum’s motion for summary judgment on the grounds that his claims were precluded under his severance agreement with the hospital, without reaching two other arguments made by Quorum, which included that a prior settlement agreement between the hospital and the federal government precluded the claims brought by Whitten as well as the doctrine of prior public disclosure. On appeal to the 11th Circuit Court of Appeals, the court reversed the findings of the district court regarding the severance agreement, but remanded the case to the district court for findings on Quorum’s other two defenses. Limited discovery has been conducted and renewed motions by Quorum to dismiss the action and to stay further discovery were filed in September 2007. On August 5, 2008, our motion to dismiss was denied. Discovery is continuing and a motion for summary judgment will be filed. The pre-trial order is due March 13, 2009 and any trial would be anticipated for May 2009. We continue to believe that the relator’s claims are without merit and will continue to vigorously defend this case.
 
In a case styled U.S. ex rel. Bartlett vs. Quorum Health Resources, Inc., et al., pending in the Western District of Pennsylvania, Johnstown Division, the relator alleges in his second amended complaint, filed in January 2006 (the first amended complaint having been dismissed), that Quorum conspired with an unaffiliated


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hospital to pay an illegal remuneration in violation of the anti-kickback statute and the Stark laws, thus causing false claims to be filed. A renewed motion to dismiss that was filed in March 2006 asserting that the second amended complaint did not cure the defects contained in the first amended complaint. In September 2006, the hospital and one of the other defendants affiliated with the hospital filed for protection under Chapter 11 of the federal bankruptcy code, which imposed an automatic stay on proceedings in the case. Relators entered into a settlement agreement with the hospital, subject to confirmation of the hospital’s reorganization plan. The District Court conducted a status conference on January 30, 2009 and has indicated it will convene another conference with the Bankruptcy Court in the near future. We believe that this case is without merit and should the stay be lifted, will continue to vigorously defend it.
 
Item 4.   Submission of Matters to a Vote of Security Holders
 
No matters were submitted to a vote of security holders during the fourth quarter of the year ended December 31, 2008.
 
PART II
 
Item 5.   Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
 
We completed an initial public offering of our common stock on June 14, 2000. Our common stock began trading on June 9, 2000 and is listed on the New York Stock Exchange under the symbol CYH. At February 2, 2009, there were approximately 46 record holders of our common stock. The following table sets forth, for the periods indicated, the high and low sale prices per share of our common stock as reported by the New York Stock Exchange.
 
                 
    High     Low  
 
Year Ended December 31, 2007
               
First Quarter
  $ 39.05     $ 33.28  
Second Quarter
    41.72       34.86  
Third Quarter
    44.50       30.39  
Fourth Quarter
    37.50       27.70  
Year Ended December 31, 2008
               
First Quarter
  $ 36.85     $ 29.79  
Second Quarter
    40.05       32.40  
Third Quarter
    36.81       28.24  
Fourth Quarter
    28.38       10.47  


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Corporate Performance Graph
 
The following graph sets forth the cumulative return of the Company’s common stock during the five year period ended December 31, 2008, as compared to the cumulative return of the Standard & Poor’s 500 Stock Index (S&P 500) and the cumulative return of the Dow Jones Healthcare Index. The graph assumes an initial investment of $100 in our common stock and in each of the foregoing indices and the reinvestment of dividends where applicable.
 
(PERFORMANCE GRAPH)
 
                                                             
      12/31/2003     12/31/2004     12/31/2005     12/31/2006     12/31/2007     12/31/2008
Community Health Systems
    $ 100.00       $ 104.89       $ 144.24       $ 137.40       $ 138.68       $ 54.85  
Dow Jones Health Care Index
    $ 100.00       $ 103.21       $ 110.30       $ 116.20       $ 124.07       $ 93.95  
S&P 500
    $ 100.00       $ 108.99       $ 112.26       $ 127.55       $ 132.06       $ 81.23  
                                                             
 
We have not paid any cash dividends since our inception, and do not anticipate the payment of cash dividends in the foreseeable future. Our New Credit Facility limits our ability to pay dividends and/or repurchase stock to an amount not to exceed $400 million in the aggregate (but not in excess of $200 million unless we receive confirmation from Moody’s and S&P that dividends or repurchases would not result in a downgrade, qualification or withdrawal of the then corporate credit rating). The indenture governing our Notes also limits our ability to pay dividends and/or repurchase stock. As of December 31, 2008, the amount of permitted dividends and/or stock repurchases permitted under the indenture was $399 million.
 
The following table contains information about our purchases of common stock during the three months ended December 31, 2008:
 
                                 
                Total Number
       
                of Shares
    Maximum
 
                Purchased as
    Number of
 
    Total
    Average
    Part of
    Shares that May
 
    Number of
    Price
    Publicly
    Yet be Purchased
 
    Shares
    Paid per
    Announced
    Under the Plans
 
Period
  Purchased     Share     Plans(a)     or Programs(a)  
 
October 1, 2008 — October 31, 2008
    2,500,000     $ 20.73       2,500,000       1,983,000  
November 1, 2008 — November 30, 2008
    1,319,609       11.75       1,319,609       663,391  
December 1, 2008 — December 31, 2008
    450,000       12.43       450,000       213,391  
                                 
Total
    4,269,609       17.08       4,269,609       213,391  


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(a) On December 13, 2006, we commenced an open market repurchase program for up to 5,000,000 shares of our common stock not to exceed $200 million in purchases. This purchase program will conclude at the earlier of three years or when the maximum number of shares have been repurchased. During the year ended December 31, 2008, we repurchased 4,786,609 shares, which is the cumulative number of shares repurchased under this program, at a weighted-average price of $18.80 per share. This repurchase plan follows a prior repurchase plan for up to five million shares which concluded on November 8, 2006. We repurchased 5,000,000 shares at a weighted average price of $35.23 per share under this earlier program.
 
Item 6.   Selected Financial Data
 
The following table summarizes specified selected financial data and should be read in conjunction with our related Consolidated Financial Statements and accompanying Notes to Consolidated Financial Statements. The amounts shown below have been adjusted for discontinued operations. We have restated our 2008 and 2007 financial statements to reflect the reclassification in 2008 of one hospital owned by us during these periods, which is held for sale, to discontinued operations.
 
Community Health Systems, Inc.
Five Year Summary of Selected Financial Data
 
                                         
    Year Ended December 31,  
    2008     2007(1)     2006     2005     2004  
    (In thousands, except share and per share data)  
 
Consolidated Statement of Operations Data
                                       
Net operating revenues
  $ 10,840,098     $ 7,063,775     $ 4,180,136     $ 3,576,117     $ 3,042,880  
Income from operations
    983,574       478,726       385,057       398,463       332,767  
Income from continuing operations
    206,658       57,714       177,695       188,370       158,009  
Net income
    218,304       30,289       168,263       167,544       151,433  
Earnings per common
share — Basic:
                                       
Income from continuing operations
  $ 2.21     $ 0.62     $ 1.87     $ 2.13     $ 1.65  
Income (Loss) on discontinued operations
    0.13       (0.30 )     (0.10 )     (0.24 )     (0.07 )
                                         
Net Income
  $ 2.34     $ 0.32     $ 1.77     $ 1.89     $ 1.58  
                                         
Earnings per common
share — Diluted:
                                       
Income from continuing operations
  $ 2.19     $ 0.61     $ 1.85     $ 2.00     $ 1.58  
Income (Loss) on discontinued operations
    0.13       (0.29 )     (0.10 )     (0.21 )     (0.07 )
                                         
Net Income
  $ 2.32     $ 0.32     $ 1.75     $ 1.79     $ 1.51  
                                         
Weighted-average number of shares outstanding
                                       
Basic
    93,371,782       93,517,337       94,983,646       88,601,168       95,643,733  
Diluted(2)
    94,288,829       94,642,294       96,232,910       98,579,977 (4)     105,863,790 (3)
                                         
Cash and cash equivalents
  $ 220,655     $ 132,874     $ 40,566     $ 104,108     $ 82,498  
Total assets
    13,818,254       13,493,643       4,506,579       3,934,218       3,632,608  
Long-term obligations
    10,611,419       10,334,904       2,207,623       1,932,238       2,030,258  
Stockholders’ equity
    1,672,865       1,710,804       1,723,673       1,564,577       1,239,991  


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(1) Includes the results of operations of the former Triad hospitals from July 25, 2007, the date of acquisition.
 
(2) See Note 12 to the Consolidated Financial Statements, included in item 8 of this Form 10-K.
 
(3) Included 8,582,076 shares related to the convertible notes under the if-converted method of determining weighted average shares outstanding.
 
(4) Included 8,385,031 shares related to the convertible notes under the if-converted method of determining weighted average shares outstanding.
 
Item 7.   Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
You should read this discussion together with our consolidated financial statements and the accompanying notes to consolidated financial statements and “Selected Financial Data” included elsewhere in this Form 10-K.
 
Executive Overview
 
We are the largest publicly traded operator of hospitals in the United States in terms of number of facilities and net operating revenues. We provide healthcare services through these hospitals that we own and operate in non-urban and selected urban markets. We generate revenue primarily by providing a broad range of general hospital healthcare services to patients in the communities in which we are located. We currently have 118 general acute care hospitals included in continuing operations. In addition, we own four home care agencies, located in markets where we do not operate a hospital and through our wholly-owned subsidiary, Quorum Health Resources, LLC (“QHR”), we provide management and consulting services to non-affiliated general acute care hospitals located throughout the United States. We are paid for our services by governmental agencies, private insurers and directly by the patients we serve.
 
Since our acquisition of Triad on July 25, 2007 and throughout most of 2008, we have focused our efforts toward integrating the former Triad hospitals and realigning our hospital portfolio. As such we have put less effort toward the pursuit of additional acquisitions. During this time we have sold seven of the hospitals acquired from Triad and seven hospitals owned by us prior to our acquisition of Triad. These hospitals have been classified in discontinued operations for the years ended December 31, 2008, 2007 and 2006 to the extent the hospitals were owned by us during the respective periods. Two additional hospitals acquired from Triad have been classified as held for sale and are also included in discontinued operations during the respective periods of our ownership.
 
During 2008, with the exception of acquiring the outstanding minority interests in two of our hospitals, our only hospital acquisition was a two hospital system located in Spokane, Washington, an acquisition we had been pursuing and for which we were awaiting government approval since 2007.
 
Currently, the global economies, and in particular the United States, are experiencing a period of economic uncertainty and the related financial markets are experiencing a high degree of volatility. This current financial turmoil is adversely affecting the banking system and financial markets and resulting in a tightening in the credit markets, a low level of liquidity in many financial markets and extreme volatility in fixed income, credit, currency and equity markets. A risk associated with this uncertainty is that it could potentially lead to higher levels of uninsured patients, result in higher levels of patients covered by lower paying government programs and/or result in fiscal uncertainties at both government payors and private insurers.
 
As a result of our current levels of cash, available borrowing capacity, long term outlook on our debt repayments and our continued projection of our ability to generate cash flows, we do not anticipate a significant impact on our ability to invest the necessary capital in our business over the next twelve months. However, we do believe it to be prudent that we pursue our strategy of acquiring hospitals very cautiously and therefore we anticipate only completing two acquisitions in 2009. On February 1, 2009, we completed one of


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our anticipated acquisitions for 2009 with the acquisition of Siloam Springs Memorial Hospital (74 licensed beds), located in Siloam Springs, Arkansas, from the City of Siloam Springs.
 
In the quarter ended June 30, 2008, we were informed that we would not receive the full amount of previously estimated reimbursements under certain Indiana Medicaid programs. The reductions are due partly to the state not receiving a federal waiver for one of its programs and partly as a result of changes to its disproportionate share program which were different from what had previously been communicated to us. This represents an approximately $8.0 million reduction in expected payments from these programs on an annual basis.
 
Self-pay revenues represented approximately 10.7% of our net operating revenues in 2008 compared to 10.0% in 2007. The value of charity care services relative to total net operating revenues decreased to 3.5% in 2008 from 4.6% in 2007. Uninsured and underinsured patients continue to be an industry-wide issue, and we anticipate this trend will continue into the foreseeable future. However, we do not anticipate a significant amount of continuing deterioration resulting from our self-pay business as evidenced by the lack of relative growth in business from self-pay patients over the prior year.
 
Operating results and statistical data for the year ended December 31, 2008, include comparative information for the operations of the acquired Triad hospitals from July 25, 2007, the date of acquisition. Same-store operating results and statistical data include the hospitals acquired in the Triad acquisition as if they were owned by us from January 1 through July 24, 2007 and all other hospitals as owned throughout both periods. For the year ended December 31, 2008, we generated $10.840 billion in net operating revenues, a growth of 53.5% over the year ended December 31, 2007, and $218.3 million of net income, an increase of 620.7% over the year ended December 31, 2007. For the year ended December 31, 2008, admissions at hospitals owned throughout both periods increased 2.0% and adjusted admissions increased 2.2%.
 
We believe there continues to be ample opportunity for growth in substantially all of our markets by decreasing the need for patients to travel outside their communities for health care services. Furthermore, we continue to strive to improve operating efficiencies and procedures in order to improve our profitability at all of our hospitals.
 
Acquisitions and Dispositions
 
Effective November 14, 2008, we acquired from Willamette Community Health Solutions all of its joint venture interest in MWMC Holdings, LLC, which indirectly owns and operates McKenzie-Willamette Medical Center of Springfield, Oregon. This acquisition resulted from a put right held by Willamette Community Health Solutions in connection with the 2003 transaction establishing the joint venture. The purchase price for this minority interest was $22.7 million in cash. Physicians affiliated with Oregon Healthcare Resources, Inc. continue to own a minority interest in the hospital.
 
Effective October 1, 2008, we completed the acquisition of Deaconess Medical Center (388 licensed beds) and Valley Hospital and Medical Center (123 licensed beds) located in Spokane, Washington, from Empire Health Services. The total consideration for these two hospitals was approximately $182.6 million, of which $149.2 million was paid in cash and $33.4 million was assumed in liabilities.
 
Effective June 30, 2008, we acquired the remaining 35% equity interest in Affinity Health Systems, LLC, which indirectly owns and operates Trinity Medical Center (560 licensed beds) in Birmingham, Alabama, from Baptist Health Systems, Inc. of Birmingham, Alabama (“Baptist”), giving us 100% ownership of that facility. The purchase price for this minority interest was $51.5 million in cash and the cancellation of a promissory note issued by Baptist to Affinity Health Systems, LLC in the original principal amount of $32.8 million.
 
Effective March 1, 2008, we sold Woodland Medical Center (100 licensed beds) located in Cullman, Alabama; Parkway Medical Center (108 licensed beds) located in Decatur, Alabama; Hartselle Medical Center (150 licensed beds) located in Hartselle, Alabama; Jacksonville Medical Center (89 licensed beds) located in Jacksonville, Alabama; National Park Medical Center (166 licensed beds) located in Hot Springs, Arkansas; St. Mary’s Regional Medical Center (170 licensed beds) located in Russellville, Arkansas; Mineral Area Regional Medical Center (135 licensed beds) located in Farmington, Missouri; Willamette Valley Medical


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Center (80 licensed beds) located in McMinnville, Oregon; and White County Community Hospital (60 licensed beds) located in Sparta, Tennessee, to Capella Healthcare, Inc., headquartered in Franklin, Tennessee. The proceeds from this sale were $315 million in cash.
 
Effective February 21, 2008, we sold THI Ireland Holdings Limited, a private limited company incorporated in the Republic of Ireland, which leased and managed the operations of Beacon Medical Center (122 licensed beds) located in Dublin, Ireland, to Beacon Medical Group Limited, headquartered in Dublin, Ireland. The proceeds from this sale were $1.5 million in cash.
 
Effective February 1, 2008, we sold Russell County Medical Center (78 licensed beds) located in Lebanon, Virginia to Mountain States Health Alliance, headquartered in Johnson City, Tennessee. The proceeds from this sale were $48.6 million in cash.
 
As of December 31, 2008, we had two hospitals classified as held for sale and included in discontinued operations.
 
Sources of Revenue
 
The following table presents the approximate percentages of net operating revenue derived from Medicare, Medicaid, managed care and other third party payors, and self-pay for the periods indicated. The data for the years presented are not strictly comparable due to the significant effect that hospital acquisitions have had on these statistics.
 
                         
    Year Ended December 31,  
    2008     2007     2006  
 
Medicare
    27.5 %     29.0 %     30.4 %
Medicaid
    9.1 %     10.3 %     11.1 %
Managed care and other third party payors
    52.7 %     50.7 %     46.7 %
Self pay
    10.7 %     10.0 %     11.8 %
                         
Total
    100.0 %     100.0 %     100.0 %
                         
 
Net operating revenues include amounts estimated by management to be reimbursable by Medicare and Medicaid under prospective payment systems and provisions of cost-based reimbursement and other payment methods. In addition, we are reimbursed by non-governmental payors using a variety of payment methodologies. Amounts we receive for treatment of patients covered by these programs are generally less than the standard billing rates. We account for the differences between the estimated program reimbursement rates and the standard billing rates as contractual adjustments, which we deduct from gross revenues to arrive at net operating revenues. Final settlements under some of these programs are subject to adjustment based on administrative review and audit by third parties. We account for adjustments to previous program reimbursement estimates as contractual adjustments and report them in the periods that such adjustments become known. Adjustments related to final settlements were insignificant to both net operating revenue and net income in the years ended December 31, 2008, 2007 and 2006. In the future, we expect the percentage of revenues received from the Medicare program to increase due to the general aging of the population.
 
The payment rates under the Medicare program for inpatient acute services are based on a prospective payment system, depending upon the diagnosis of a patient’s condition. These rates are indexed for inflation annually, although the increases have historically been less than actual inflation. Reductions in the rate of increase in Medicare reimbursement may cause our net operating revenue growth to decline.
 
In addition, specified managed care programs, insurance companies, and employers are actively negotiating the amounts paid to hospitals. The trend toward increased enrollment in managed care may adversely effect our net operating revenue growth.


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Results of Operations
 
Our hospitals offer a variety of services involving a broad range of inpatient and outpatient medical and surgical services. These include orthopedics, cardiology, occupational medicine, diagnostic services, emergency services, rehabilitation treatment, home care and skilled nursing. The strongest demand for hospital services generally occurs during January through April and the weakest demand for these services occurs during the summer months. Accordingly, eliminating the effect of new acquisitions, our net operating revenues and earnings are historically highest during the first quarter and lowest during the third quarter.
 
The following tables summarize, for the periods indicated, selected operating data.
 
                         
    Year Ended December 31,  
    2008     2007     2006  
    (Expressed as a percentage
 
    of net operating revenues)  
 
Consolidated(a):
                       
Net operating revenues
    100.0       100.0       100.0  
Operating expenses(b)
    (86.3 )     (88.9 )     (86.5 )
Depreciation and amortization
    (4.6 )     (4.4 )     (4.3 )
                         
Income from operations
    9.1       6.7       9.2  
Interest expense, net
    (6.0 )     (5.1 )     (2.2 )
Loss from early extinguishment of debt
          (0.4 )      
Minority interest in earnings
    (0.4 )     (0.2 )     (0.1 )
Equity in earnings of unconsolidated affiliates
    0.4       0.4        
                         
Income from continuing operations before income taxes
    3.1       1.4       6.9  
Provision for income taxes
    (1.2 )     (0.6 )     (2.6 )
                         
Income from continuing operations
    1.9       0.8       4.3  
Income (loss) on discontinued operations, net of tax
    0.1       (0.4 )     (0.3 )
                         
Net income
    2.0       0.4       4.0  
                         
 
                 
    Year Ended December 31,  
    2008     2007  
    (Expressed in percentages)  
 
Percentage increase from prior year(a):
               
Net operating revenues
    53.5 %     69.0 %
Admissions
    44.5       49.1  
Adjusted admissions(c)
    42.1       47.5  
Average length of stay
          2.4  
Net Income(d)
    620.7       (82.0 )
Same-store percentage increase from prior year(a)(e):
               
Net operating revenues
    6.6 %     4.2 %
Admissions
    2.0       (1.1 )
Adjusted admissions(c)
    2.2       0.3  
 
 
(a) Pursuant to SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” we have restated our 2008 and 2007 financial statements to reflect the reclassification in 2008 of one hospital owned by us during these periods, which is held for sale, to discontinued operations. Our statistical results have also been restated to reflect the aforementioned reclassification.


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(b) Operating expenses include salaries and benefits, provision for bad debts, supplies, rent, and other operating expenses.
 
(c) Adjusted admissions is a general measure of combined inpatient and outpatient volume. We computed adjusted admissions by multiplying admissions by gross patient revenues and then dividing that number by gross inpatient revenues.
 
(d) Includes income (loss) on discontinued operations.
 
(e) Includes former Triad hospitals during the comparable periods and other acquired hospitals to the extent we operated them during comparable periods in both years.
 
Year Ended December 31, 2008 Compared to Year Ended December 31, 2007
 
Net operating revenues increased by 53.5% to $10.840 billion in 2008, from $7.064 billion in 2007. On a combined basis, the hospitals acquired in the Triad acquisition and growth from those hospitals owned throughout both periods contributed $3.557 billion of the increase and $219 million was contributed by other hospitals acquired in 2008. On a same-store basis, including the former Triad hospitals as if they were owned by us as of January 1, 2007, this represents an increase in same-store net revenue of 6.6%. The increase from hospitals that we owned throughout both periods was attributable to volume increases, rate increases, payor mix and the acuity level of services provided.
 
On a consolidated basis inpatient admissions increased by 44.5% and adjusted admissions increased by 42.1%. With respect to consolidated admissions, approximately 50.5% were contributed from newly acquired hospitals, including those hospitals acquired from Triad, and 49.5% were contributed by hospitals we owned throughout both periods. On a same-store basis, which includes the hospitals acquired from Triad, as if we owned them both years, admissions increased by 2.0% during the year ended December 31, 2008.
 
Operating expenses, excluding depreciation and amortization, as a percentage of net operating revenues, decreased from 88.9% in 2007 to 86.3% in 2008. Salaries and benefits, as a percentage of net operating revenues, decreased from 40.7% in 2007 to 39.9% in 2008, primarily as a result of efficiency improvements realized at hospitals owned throughout both periods. These improvements were partially offset by an increase in the number of employed physicians as well as an increase in salaries for certain IT employees who were previously treated as leased employees with related expense previously being included in other operating expense. Provision for bad debts, as a percentage of net revenues, decreased from 12.5% in 2007 to 11.2% in 2008, due primarily to $70.1 million of additional bad debt expense recorded as a change in estimate to increase the allowance for doubtful accounts in 2007. Supplies, as a percentage of net operating revenues, increased from 13.2% in 2007 to 14.0% in 2008, primarily the result of the acquisition of the former Triad hospitals whose higher acuity of services resulted in higher supply costs than our other hospitals taken collectively, offsetting improvements from greater utilization of and improved pricing under our purchasing program. Rent and other operating expenses, as a percentage of net operating revenues, decreased from 22.5% in 2007 to 21.2% in 2008, primarily as a result of the hospitals acquired from Triad having lower rent expense as a percentage of net operating revenues. As part of our acquisition of Triad, we acquired minority ownership interests in several hospitals. Our percentage of ownership interests in these joint ventures provided earnings of 0.4% of net operating revenues during both of the years ended December 31, 2008 and 2007. Prior to the Triad acquisition, we did not have any material minority investments in joint ventures.
 
Income from continuing operations margin increased from 0.8% in 2007 to 1.9% in 2008. Net income margins increased from 0.4% in 2007 to 2.0% in 2008. The increase in these margins is reflective of the impact of the net decrease in expenses, as a percentage of net revenue, discussed above.
 
Depreciation and amortization increased from 4.4% of net operating revenues in 2007 to 4.6% of net operating revenues in 2008.
 
Interest expense, net, increased by $290.1 million from $361.8 million in 2007, to $651.9 million in 2008. The primary reason for the increase in interest expense is the increase in our average outstanding debt during the year ended December 31, 2008, as compared to the year ended December 31, 2007, resulting in an additional $299.2 million of interest expense. Interest expense for the year ended December 31, 2008 includes


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a full year of interest expense from borrowings under our New Credit Facility and the issuance of Notes in connection with the acquisition of Triad in 2007. Since 2008 was a leap year, one additional day in the year resulted in $1.8 million of the increase in interest expense. A decrease in our effective interest rate during the year ended December 31, 2008, as compared to the year ended December 31, 2007, resulted in a decrease in interest expense of $10.9 million.
 
The net results of the above mentioned changes resulted in income from continuing operations before income taxes increasing $236.6 million from $99.5 million in 2007 to $336.1 million for 2008.
 
Provision for income taxes from continuing operations increased from $41.8 million in 2007 to $129.5 million in 2008 due to the increase in income from continuing operations before income taxes. Our effective tax rates were 38.5% and 41.8% for the years ended December 31, 2008 and 2007, respectively. The decrease in our effective tax rate is primarily a result of a decrease in our effective state tax rate.
 
Net income was $218.3 million in 2008 compared to $30.3 million for 2007, an increase of 620.7%. The increase in net income is reflective of the impact of the net decrease in expenses discussed above, including the effect of the change in estimate that increased bad debt expense in 2007.
 
Year Ended December 31, 2007 Compared to Year Ended December 31, 2006
 
Net operating revenues increased by 69.0% to $7.064 billion in 2007, from $4.180 billion in 2006. This increase was net of a $96.3 million reduction to net operating revenues as a result of the change in estimate to increase contractual allowances recorded in the fourth quarter of 2007. On a combined basis, the hospitals acquired in the Triad acquisition and growth from those hospitals owned throughout both periods contributed $2.458 billion of that increase and $426 million was contributed by other hospitals acquired in 2007. On a same-store basis, including the former Triad hospitals during the comparable periods, this represents an increase in same-store net revenue of 4.2%. The increase from hospitals that we owned throughout both periods was attributable to volume increases, rate increases, payor mix and the acuity level of services provided.
 
On a consolidated basis inpatient admissions increased by 49.1% and adjusted admissions increased by 47.5%. With respect to consolidated admissions, approximately 34% were contributed from newly acquired hospitals, including those hospitals acquired from Triad, and 66% were contributed by hospitals we owned throughout both periods. On a same-store basis, which includes the hospitals acquired from Triad, as if we owned them from August 1 through December 31 of both periods, admissions decreased by 1.1% during the year ended December 31, 2007.
 
Operating expenses, excluding depreciation and amortization, as a percentage of net operating revenues, increased from 86.5% in 2006 to 88.9% in 2007. Salaries and benefits, as a percentage of net operating revenues, increased from 39.8% in 2006 to 40.7% in 2007, primarily as a result of an increase in stock compensation expense, incurring duplicate salary costs related to the acquisition of Triad for certain corporate overhead positions not yet eliminated and an increase in the number of employed physicians. These increases have offset improvements realized at hospitals owned throughout both periods. Provision for bad debts, as a percentage of net revenues, increased from 12.4% in 2006 to 12.5% in 2007, due primarily to $70.1 million of additional bad debt expense recorded as a change in estimate to increase the allowance for doubtful accounts. Supplies, as a percentage of net operating revenues, increased from 11.7% in 2006 to 13.2% in 2007, primarily from the acquisition of hospitals from Triad whose higher acuity of services and lower purchasing program utilization resulted in higher supply costs than our other hospitals taken collectively and from other recent acquisitions for which we have yet to fully integrate into our purchasing program, offsetting improvements at hospitals owned throughout both periods from greater utilization of and improved pricing under our purchasing program. Rent and other operating expenses, as a percentage of net operating revenues, decreased from 22.6% in 2006 to 22.5% in 2007, primarily as a result of the hospitals acquired from Triad having lower rent expense as a percentage of net operating revenues. As part of our acquisition of Triad, we acquired minority ownership interests in several hospitals. These investments provided earnings of 0.4% of net operating revenues during the year ended December 31, 2007. Prior to the Triad acquisition, we did not have any material minority investments in joint ventures.


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Income from continuing operations margin decreased from 4.3% in 2006 to 0.8% in 2007. Net income margins decreased from 4.0% in 2006 to 0.4% in 2007. The decrease in these margins is reflective of the impact of the net increase in expenses, as a percentage of net revenue, discussed above and the increase in interest expense and loss on early extinguishment of debt associated with the acquisition of Triad.
 
Depreciation and amortization increased from 4.3% of net operating revenues in 2006 to 4.4% of net operating revenues in 2007.
 
Interest expense, net, increased by $267.4 million from $94.4 million in 2006, to $361.8 million in 2007. An increase in the average debt balance in 2007 as compared to 2006 of $3.583 billion, due primarily to the additional borrowings to fund the Triad acquisition and repay our previous outstanding debt, accounted for a $245.9 million increase in interest expense. An increase in interest rates due to an increase in LIBOR during 2007, as compared to 2006, accounted for $21.5 million of the increase.
 
The net results of the above mentioned changes plus a $27.3 million loss from early extinguishment of debt incurred in connection with the financing of the Triad acquisition, resulted in income from continuing operations before income taxes decreasing $188.3 million from $287.8 million in 2006 to $99.5 million for 2007.
 
Provision for income taxes from continuing operations decreased from $110.2 million in 2006 to $41.8 million in 2007 due to the decrease in income from continuing operations before income taxes. Our effective tax rates were 41.8% and 38.3% for the years ended December 31, 2007 and 2006, respectively. The increase in our effective tax rate is primarily a result of an increase in valuation allowances. As a result of the additional interest expense expected to be incurred, we determined that certain of our state net operating losses will expire before being utilized and accordingly established appropriate valuation allowances.
 
Net income was $30.3 million in 2007 compared to $168.3 million for 2006, a decrease of 82%. The decrease in net income is reflective of the impact of the net increase in expenses discussed above, including the effect of the change in estimate that increased bad debt expense in 2007.
 
Liquidity and Capital Resources
 
2008 Compared to 2007
 
Net cash provided by operating activities increased $369.5 million from $687.7 million for the year ended December 31, 2007 to $1.057 billion for the year ended December 31, 2008. This increase is due to an increase in cash flow from net income of $188.0 million, increases in cash flows from other assets of $29.1 million and a net increase in non-cash expenses of $350.2 million, of which $174.1 million was related to depreciation and $199.8 million related to deferred income taxes. These cash flow increases were offset by decreases in cash flows from supplies, prepaid expenses and other current assets of $2.7 million, accounts receivable of $188.7 million and accounts payable, accrued liabilities and income taxes of $6.4 million. The decrease in income taxes was primarily a result of a prior year prepaid tax position which was used to offset taxes owed during the current year.
 
The use of cash in investing activities decreased $6.833 billion from $7.499 billion in 2007 to $665.5 million in 2008, as a result of the acquisition occurring in 2007. The purchase of property and equipment in 2008 increased $169.4 million from $522.8 million in 2007 to $692.2 million in 2008. This increase reflects the increased number of hospitals owned by us after the acquisition of Triad. We anticipate being able to fund future routine capital expenditures with cash flows generated from operations.
 
In 2008, our net cash provided by financing activities decreased $7.207 billion from $6.903 billion in 2007 to a net cash used in financing activities of $304.0 million in 2008, primarily due to borrowings under our New Credit Facility and issuance of Notes in connection with the acquisition of Triad in 2007. During the fourth quarter of 2008, $100 million of delayed draw term loans had been drawn by us.
 
In 2008, we used $90.0 million for the repurchase of 4,786,609 shares of our outstanding common stock on the open market. We believed this to be a prudent use of cash as a result of the severely depressed stock price under the current economic conditions. Our New Credit Facility limits our ability to pay dividends and/


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or repurchase stock to an amount not to exceed $400 million in the aggregate (but not in excess $200 million unless we receive confirmation from Moody’s and S&P that dividends or repurchases would not result in a downgrade, qualification or withdrawal of the then corporate credit rating). The indenture governing our Notes also limits our ability to pay dividends and/or repurchase stock. As of December 31, 2008, the amount of permitted dividends and/or stock repurchases permitted under the indenture was $399 million.
 
With the exception of some small principal payments of our term loans under our New Credit Facility, representing less than 1% of the outstanding balance each year through 2013, the term loans under our New Credit Facility mature in 2014 and our Notes are not due until 2015. We believe this five to six year period before final maturity allows sufficient time for the current financial environment to improve and permits us to make favorable changes, including refinancing, to our debt structure. Furthermore, we do not anticipate the need to use funds currently available under our New Credit Facility for purposes of funding our operations, although these funds could be used for the purpose of making further acquisitions or for restructuring our existing debt. Furthermore, we anticipate we will remain in compliance with our debt covenants and thus it would not be necessary to exercise the cures available to us in our existing debt agreements.
 
As described in Notes 6, 9 and 15 of the Notes to Consolidated Financial Statements, at December 31, 2008, we had certain cash obligations, which are due as follows (in thousands):
 
                                         
                            2015
 
    Total     2009     2010-2012     2013-2014     and thereafter  
 
Long Term Debt
  $ 6,015,529     $ 22,730     $ 148,787     $ 5,821,263     $ 22,749  
Senior Notes
    2,910,831                         2,910,831  
Interest on Bank Facility and Notes(1)
    2,947,815       487,993       1,454,945       864,943       139,934  
Capital Leases, including interest
    58,972       10,589       16,553       5,865       25,965  
                                         
Total Long-Term Debt
    11,933,147       521,312       1,620,285       6,692,071       3,099,479  
Operating Leases
    842,523       159,954       339,486       137,514       205,569  
Replacement Facilities and Other Capital Committments(2)
    527,320       110,683       383,615       18,022       15,000  
Open Purchase Orders(3)
    93,257       93,257                    
Financial Interpretation No. 48 obligations, including interest and penalties
    18,211       6,454       11,757              
                                         
Total
  $ 13,414,458     $ 891,660     $ 2,355,143     $ 6,847,607     $ 3,320,048  
                                         
 
 
(1) Estimate of interest payments assumes the interest rates at December 31, 2008 remain constant during the period presented for the New Credit Facility, which is variable rate debt. The interest rate used to calculate interest payments for the New Credit Facility was LIBOR as of December 31, 2008 plus the spread. The Notes are fixed at an interest rate of 8.875% per annum.
 
(2) Pursuant to purchase agreements in effect as of December 31, 2008 and where certificate of need approval has been obtained, we have commitments to build the following replacement facilities and the following capital commitments. As required by an amendment to our lease agreement entered into in 2005, we agreed to build a replacement hospital at our Barstow, California location by November 2012. As part of an acquisition in 2007, we agreed to build a replacement hospital in Valparaiso, Indiana by April 2011. Construction costs, including equipment costs, for these two replacement facilities are currently estimated to be approximately $269.0 million of which approximately $8.5 million has been incurred to date. In addition as a part of an acquisition in 2004, we committed to spend $90.0 million in capital expenditures within eight years in Phoenixville, Pennsylvania, and as part of an acquisition in 2005, we committed to spend approximately $64 million within seven years and an additional $15 million with no set completion


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date related to capital expenditures at Chestnut Hill Hospital in Philadelphia, Pennsylvania. As of December 31, 2008, we have incurred to date approximately $53.6 million and $17.0 million for the capital expenditures at Phoenixville, Pennsylvania and Chestnut Hill, Pennsylvania, respectively. As part of an acquisition in 2008, we committed to spend $100.0 million within five years related to capital expenditures at Deaconess Hospital and Valley Hospital and Medical Center, both in Spokane, Washington. As of December 31, 2008, we have incurred to date approximately $11.3 million related to this commitment.
 
(3) Open purchase orders represent our commitment for items ordered but not yet received.
 
As more fully described in Note 6 of the Notes to Consolidated Financial Statements at December 31, 2008, we had issued letters of credit primarily in support of potential insurance related claims and specified outstanding bonds of approximately $93.6 million.
 
Our debt as a percentage of total capitalization remained consistent at 84% for both December 31, 2008 and 2007.
 
2007 Compared to 2006
 
Net cash provided by operating activities increased $337.4 million from $350.3 million for the year ended December 31, 2006 compared to $687.7 million for the year ended December 31, 2007. This increase is due to an increase in cash flow from changes in accounts receivable of $202.4 million, increases in cash flows from accounts payable, accrued liabilities and income taxes of $73.8 million, and an increase in non-cash expenses of $231.6 million, of which $143.8 million was related to depreciation. These cash flow increases were offset by decreases in cash flows from supplies, prepaid expenses and other current assets of $27.4 million, decreases in cash flows from other assets and liabilities of $5.0 million and a decrease in net income of $138.0 million.
 
The use of cash in investing activities increased $6.859 billion from $640.3 million in 2006 to $7.499 billion in 2007, as a result of the acquisition of Triad for $6.836 billion.
 
In 2007, our net cash provided by financing activities increased $6.677 billion from $226.5 million in 2006 to $6.903 billion in 2007 from our New Credit Facility and issuance of Notes in connection with the acquisition of Triad.
 
Capital Expenditures
 
Cash expenditures for purchases of facilities were $161.9 million in 2008, $7.018 billion in 2007 and $384.6 million in 2006. Our expenditures in 2008 included $149.1 million for the purchase of two hospitals and $12.8 million for the purchase of physician practices and a home care agency. Our expenditures in 2007 included $6.865 billion for the purchase of Triad, $133.7 million for the purchase of two additional hospitals, $3.4 million for the purchase of physician practices, $7.7 million for equipment to integrate acquired hospitals and $8.5 million for the settlement of acquired working capital. Our expenditures in 2006 included $334.5 million for the purchase of the eight hospitals acquired in 2006, $21.8 million for the purchase of three home care agencies and physician practices, $21.5 million for information systems and other equipment to integrate the hospitals acquired in 2006 and $6.8 million for the settlement of acquired working capital.
 
Excluding the cost to construct replacement hospitals and a de novo hospital, our cash expenditures for routine capital for 2008 totaled $569.4 million compared to $344.1 million in 2007, and $207.7 million in 2006. Costs to construct replacement hospitals and a de novo hospital totaled $122.8 million in 2008, $178.7 million in 2007 and $16.8 million in 2006.
 
Pursuant to hospital purchase agreements in effect as of December 31, 2008, as part of an acquisition in 2007, we agreed to build a replacement hospital in Valparaiso, Indiana by April 2011. Also as required by an amendment to a lease agreement entered into in 2005, we agreed to build a replacement facility at Barstow Community Hospital in Barstow, California. Estimated construction costs, including equipment costs, are approximately $269 million for these two replacement facilities. We expect total capital expenditures of approximately $600 to $650 million in 2009 (which includes amounts which are required to be expended pursuant to the terms of hospital purchase agreements), including approximately $593 to $640 million for


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renovation and equipment cost and approximately $7 to $10 million for construction and equipment cost of the replacement hospitals.
 
Capital Resources
 
Net working capital was $1.071 billion at December 31, 2008 compared to $1.105 billion at December 31, 2007, a decrease of $34 million. This decrease in working capital is due to increases in accounts payable of $16.4 million and accrued liabilities of $21.6 million, decreases in other current assets of approximately $100.1 million and deferred income taxes of $21.9 million and the net reduction in all other working capital assets and liabilities of $15.1 million. This decrease in working capital was offset by an increase in working capital attributable to the acquisition of Deaconess Medical Center and Valley Hospital and Medical Center, which provided additional working capital of $17.7 million at December 31, 2008. In addition, an increase in cash of $85.3 million and accounts receivable of $38.1 million also offset the decrease in working capital.
 
In connection with the consummation of the Triad acquisition in July 2007, we obtained $7.215 billion of senior secured financing under a New Credit Facility with a syndicate of financial institutions led by Credit Suisse, as administrative agent and collateral agent. The New Credit Facility consists of a $6.065 billion funded term loan facility with a maturity of seven years, a $300 million delayed draw term loan facility (reduced from $400 million) with a maturity of seven years and a $750 million revolving credit facility with a maturity of nine years. During the fourth quarter of 2008, $100 million of the delayed draw term loan had been drawn down by us reducing the delayed draw term loan availability to $200 million at December 31, 2008. In January 2009, we drew down the remaining $200 million of the delayed draw term loan. The revolving credit facility also includes a subfacility for letters of credit and a swingline subfacility. The New Credit Facility requires us to make quarterly amortization payments of each term loan facility equal to 0.25% of the initial outstanding amount of the term loans, if any, with the outstanding principal balance of each term loan facility payable on July 25, 2014.
 
The term loan facility must be prepaid in an amount equal to (1) 100% of the net cash proceeds of certain asset sales and dispositions by us and our subsidiaries, subject to certain exceptions and reinvestment rights, (2) 100% of the net cash proceeds of issuances of certain debt obligations or receivables based financing by us and our subsidiaries, subject to certain exceptions, and (3) 50%, subject to reduction to a lower percentage based on our leverage ratio (as defined in the New Credit Facility generally as the ratio of total debt on the date of determination to our EBITDA, as defined, for the four quarters most recently ended prior to such date), of excess cash flow (as defined) for any year, commencing in 2008, subject to certain exceptions. Voluntary prepayments and commitment reductions are permitted in whole or in part, without premium or penalty, subject to minimum prepayment or reduction requirements.
 
The obligor under the New Credit Facility is CHS/Community Health Systems, Inc., or CHS, a wholly-owned subsidiary of Community Health Systems, Inc. All of our obligations under the New Credit Facility are unconditionally guaranteed by Community Health Systems, Inc. and certain existing and subsequently acquired or organized domestic subsidiaries. All obligations under the New Credit Facility and the related guarantees are secured by a perfected first priority lien or security interest in substantially all of the assets of Community Health Systems, Inc., CHS and each subsidiary guarantor, including equity interests held by us or any subsidiary guarantor, but excluding, among others, the equity interests of non-significant subsidiaries, syndication subsidiaries, securitization subsidiaries and joint venture subsidiaries.
 
The loans under the New Credit Facility bear interest on the outstanding unpaid principal amount at a rate equal to an applicable percentage plus, at our option, either (a) an Alternate Base Rate (as defined) determined by reference to the greater of (1) the Prime Rate (as defined) announced by Credit Suisse or (2) the Federal Funds Effective Rate (as defined) plus one-half of 1.0%, or (b) a reserve adjusted London interbank offered rate for dollars (Eurodollar rate) (as defined). The applicable percentage for term loans is 1.25% for Alternate Base Rate loans and 2.25% for Eurodollar rate loans. The applicable percentage for revolving loans was initially 1.25% for Alternate Base Rate revolving loans and 2.25% for Eurodollar revolving loans, in each case subject to reduction based on our leverage ratio. Loans under the swingline subfacility bear interest at the rate applicable to Alternate Base Rate loans under the revolving credit facility.


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We have agreed to pay letter of credit fees equal to the applicable percentage then in effect with respect to Eurodollar rate loans under the revolving credit facility times the maximum aggregate amount available to be drawn under all letters of credit outstanding under the subfacility for letters of credit. The issuer of any letter of credit issued under the subfacility for letters of credit will also receive a customary fronting fee and other customary processing charges. We were initially obligated to pay commitment fees of 0.50% per annum (subject to reduction based upon on our leverage ratio), on the unused portion of the revolving credit facility. For purposes of this calculation, swingline loans are not treated as usage of the revolving credit facility. With respect to the delayed draw term loan facility, we were also obligated to pay commitment fees of 0.50% per annum for the first nine months after the close of the New Credit Facility and 0.75% per annum for the next three months thereafter. Thereafter, we are obligated to pay a commitment fee of 1.0% per annum. In each case, the commitment fee is based on the unused amount of the delayed draw term loan facility. We also paid arrangement fees on the closing of the New Credit Facility and pay an annual administrative agent fee.
 
The New Credit Facility contains customary representations and warranties, subject to limitations and exceptions, and customary covenants restricting our and our subsidiaries’ ability to, among other things and subject to various exceptions, (1) declare dividends, make distributions or redeem or repurchase capital stock, (2) prepay, redeem or repurchase other debt, (3) incur liens or grant negative pledges, (4) make loans and investments and enter into acquisitions and joint ventures, (5) incur additional indebtedness or provide certain guarantees, (6) make capital expenditures, (7) engage in mergers, acquisitions and asset sales, (8) conduct transactions with affiliates, (9) alter the nature of our businesses, (10) grant certain guarantees with respect to physician practices, (11) engage in sale and leaseback transactions or (12) change our fiscal year. We and our subsidiaries are also required to comply with specified financial covenants (consisting of a leverage ratio and an interest coverage ratio) and various affirmative covenants.
 
Events of default under the New Credit Facility include, but are not limited to, (1) our failure to pay principal, interest, fees or other amounts under the credit agreement when due (taking into account any applicable grace period), (2) any representation or warranty proving to have been materially incorrect when made, (3) covenant defaults subject, with respect to certain covenants, to a grace period, (4) bankruptcy events, (5) a cross default to certain other debt, (6) certain undischarged judgments (not paid within an applicable grace period), (7) a change of control, (8) certain ERISA-related defaults and (9) the invalidity or impairment of specified security interests, guarantees or subordination provisions in favor of the administrative agent or lenders under the New Credit Facility.
 
As of December 31, 2008, there was approximately $950 million of available borrowing capacity under our New Credit Facility, of which $93.6 million was set aside for outstanding letters of credit and $200 million was available under the delayed draw term loan facility (which was borrowed in January 2009). We believe that these funds, along with internally generated cash and continued access to the bank credit and capital markets, will be sufficient to finance future acquisitions, capital expenditures and working capital requirements through the next 12 months and into the foreseeable future.
 
During the year ended December 31, 2008, we repurchased on the open market and cancelled $110.5 million of principal amount of the Notes. This resulted in a net gain from early extinguishment of debt of $2.5 million with an after-tax impact of $1.6 million.


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As of December 31, 2008, we are currently a party to the following interest rate swap agreements to limit the effect of changes in interest rates on a portion of our long-term borrowings. On each of these swaps, we received a variable rate of interest based on the three-month London Inter-Bank Offer Rate (“LIBOR”), in exchange for the payment by us of a fixed rate of interest. We currently pay, on a quarterly basis, a margin above LIBOR of 225 basis points for revolving credit and term loans under the New Credit Facility.
 
                                 
    Notional
    Fixed
             
    Amount
    Interest
    Termination
    Fair Value
 
Swap #
  (In 000’s)     Rate     Date     (In 000’s)  
 
1
  $ 100,000       3.9350 %     June 6, 2009     $ (975 )
2
    100,000       4.3375 %     November 30, 2009       (2,147 )
3
    200,000       2.8800 %     September 17, 2010       (3,846 )
4
    100,000       4.9360 %     October 4, 2010       (5,632 )
5
    100,000       4.7090 %     January 24, 2011       (6,327 )
6
    300,000       5.1140 %     August 8, 2011       (25,737 )
7
    100,000       4.7185 %     August 19, 2011       (7,645 )
8
    100,000       4.7040 %     August 19, 2011       (7,609 )
9
    100,000       4.6250 %     August 19, 2011       (7,408 )
10
    200,000       4.9300 %     August 30, 2011       (16,510 )
11
    200,000       3.0920 %     September 18, 2011       (7,118 )
12
    100,000       3.0230 %     October 23, 2011       (3,432 )
13
    200,000       4.4815 %     October 26, 2011       (14,788 )
14
    200,000       4.0840 %     December 3, 2011       (12,949 )
15
    100,000       3.8470 %     January 4, 2012       (5,908 )
16
    100,000       3.8510 %     January 4, 2012       (5,919 )
17
    100,000       3.8560 %     January 4, 2012       (5,934 )
18
    200,000       3.7260 %     January 8, 2012       (11,150 )
19
    200,000       3.5065 %     January 16, 2012       (9,924 )
20
    250,000       5.0185 %     May 30, 2012       (25,375 )
21
    150,000       5.0250 %     May 30, 2012       (15,337 )
22
    200,000       4.6845 %     September 11, 2012       (19,262 )
23
    100,000       3.3520 %     October 23, 2012       (5,080 )
24
    125,000       4.3745 %     November 23, 2012       (10,932 )
25
    75,000       4.3800 %     November 23, 2012       (6,668 )
26
    150,000       5.0200 %     November 30, 2012       (16,905 )
27
    100,000       5.0230 %     May 30, 2013       (12,247 )
28
    300,000       5.2420 %     August 6, 2013       (40,561 )
29
    100,000       5.0380 %     August 30, 2013       (12,762 )
30
    50,000       3.5860 %     October 23, 2013       (3,297 )
31
    50,000       3.5240 %     October 23, 2013       (3,160 )
32
    100,000       5.0500 %     November 30, 2013       (13,262 )
33
    200,000       2.0700 %     December 19, 2013       161  
34
    100,000       5.2310 %     July 25, 2014       (15,376 )
35
    100,000       5.2310 %     July 25, 2014       (15,376 )
36
    200,000       5.1600 %     July 25, 2014       (30,033 )
37
    75,000       5.0405 %     July 25, 2014       (10,809 )
38
    125,000       5.0215 %     July 25, 2014       (17,895 )


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The New Credit Facility and/or the Notes contain various covenants that limit our ability to take certain actions including; among other things, our ability to:
 
  •  incur, assume or guarantee additional indebtedness;
 
  •  issue redeemable stock and preferred stock;
 
  •  repurchase capital stock;
 
  •  make restricted payments, including paying dividends and making investments;
 
  •  redeem debt that is junior in right of payment to the notes;
 
  •  create liens without securing the notes;
 
  •  sell or otherwise dispose of assets, including capital stock of subsidiaries;
 
  •  enter into agreements that restrict dividends from subsidiaries;
 
  •  merge, consolidate, sell or otherwise dispose of substantial portions of our assets;
 
  •  enter into transactions with affiliates; and
 
  •  guarantee certain obligations.
 
In addition, our New Credit Facility contains restrictive covenants and requires us to maintain specified financial ratios and satisfy other financial condition tests. Our ability to meet these restricted covenants and financial ratios and tests can be affected by events beyond our control, and we cannot assure you that we will meet those tests. A breach of any of these covenants could result in a default under our New Credit Facility and/or the Notes. Upon the occurrence of an event of default under our New Credit Facility or the Notes, all amounts outstanding under our New Credit Facility and the Notes may become due and payable and all commitments under the New Credit Facility to extend further credit may be terminated.
 
We believe that internally generated cash flows, availability for additional borrowings under our New Credit Facility of $950 million (consisting of a $750 million revolving credit facility and $200 million of our delayed draw term loan facility) and our ability to add up to $300 million of borrowing capacity from receivable transactions (including securitizations) and continued access to the bank credit and capital markets will be sufficient to finance acquisitions, capital expenditures and working capital requirements through the next 12 months. We believe these same sources of cash flows, borrowings under our credit agreement as well as access to bank credit and capital markets will be available to us beyond the next 12 months and into the foreseeable future. On December 22, 2008, we filed a universal automatic shelf registration statement on Form S-3ASR that will permit us, from time to time, in one or more public offerings, to offer debt securities, common stock, preferred stock, warrants, depositary shares, or any combination of such securities. The shelf registration statement will also permit our subsidiary, CHS, to offer debt securities that would be guaranteed by us, from time to time in one or more public offerings. The terms of any such future offerings would be established at the time of the offering.
 
Off-balance sheet arrangements
 
Excluding the hospital whose lease terminated in conjunction with our sale of interests in the partnership holding the lease and whose operating results are included in discontinued operations, our consolidated operating results for the years ended December 31, 2008 and 2007, included $282.0 million and $275.6 million, respectively, of net operating revenue and $18.4 million and $22.7 million, respectively, of income from operations, generated from seven hospitals operated by us under operating lease arrangements. In accordance with accounting principles generally accepted in the United States of America, the respective assets and the future lease obligations under these arrangements are not recorded in our consolidated balance sheet. Lease payments under these arrangements are included in rent expense and totaled approximately $16.7 million and $15.2 million for the years ended December 31, 2008 and 2007, respectively. The current terms of these operating leases expire between June 2010 and December 2019, not including lease extension options. If we allow these leases to expire, we would no longer generate revenue nor incur expenses from these hospitals.


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In the past, we have utilized operating leases as a financing tool for obtaining the operations of specified hospitals without acquiring, through ownership, the related assets of the hospital and without a significant outlay of cash at the front end of the lease. We utilize the same operating strategies to improve operations at those hospitals held under operating leases as we do at those hospitals that we own. We have not entered into any operating leases for hospital operations since December 2000.
 
As described more fully in Note 15 of the Notes to Consolidated Financial Statements, at December 31, 2008, we have certain cash obligations for replacement facilities and other construction commitments of $527.3 million and open purchase orders for $93.3 million.
 
Joint Ventures
 
We have sold minority interests in certain of our subsidiaries or acquired subsidiaries with existing minority interest ownership positions. Triad implemented this strategy to a greater extent than we did, and in conjunction with the acquisition of Triad, we acquired 19 hospitals containing minority ownership interests ranging from less than 1% to 35%. As of December 31, 2008, 22 of our hospitals were owned by physician joint ventures, of which one also had a non-profit entity as a partner. In addition, five other hospitals had non-profit entities as partners. During 2008, we sold minority interests in six of our hospitals for total consideration of $80.0 million. These minority interest positions represent ownership positions in the hospitals ranging from less than 1% to 40%. Effective June 30, 2008, we acquired the remaining 35% equity interest in Affinity Health Systems, LLC which indirectly owns and operates Trinity Medical Center (560 licensed beds) in Birmingham, Alabama, from Baptist, giving us 100% ownership of that facility. The purchase price to acquire this interest was $51.5 million in cash and the cancellation of a promissory note issued by Baptist to Affinity Health Systems, LLC in the original principal amount of $32.8 million. Effective November 14, 2008, we acquired from Willamette Community Health Solutions all of its joint venture interest in MWMC Holdings, LLC, which indirectly owns and operates McKenzie-Willamette Medical Center of Springfield, Oregon. This acquisition resulted from a put right held by Willamette Community Health Solutions in connection with the 2003 transaction establishing the joint venture. The purchase price to acquire this interest was $22.7 million in cash. Physicians affiliated with Oregon Health Resources, Inc. continue to own a minority interest in the hospital. Minority interests in equity of consolidated subsidiaries was $325.2 million and $366.1 million as of December 31, 2008 and December 31, 2007, respectively, and the amount of minority interest in earnings was $40.1 million and $15.2 million for the years ended December 31, 2008 and 2007, respectively.
 
Reimbursement, Legislative and Regulatory Changes
 
Legislative and regulatory action has resulted in continuing change in the Medicare and Medicaid reimbursement programs which will continue to limit payment increases under these programs and in some cases implement payment decreases. Within the statutory framework of the Medicare and Medicaid programs, there are substantial areas subject to administrative rulings, interpretations, and discretion which may further affect payments made under those programs, and the federal and state governments might, in the future, reduce the funds available under those programs or require more stringent utilization and quality reviews of hospital facilities. Additionally, there may be a continued rise in managed care programs and future restructuring of the financing and delivery of healthcare in the United States. These events could cause our future financial results to decline.
 
Inflation
 
The healthcare industry is labor intensive. Wages and other expenses increase during periods of inflation and when labor shortages occur in the marketplace. In addition, our suppliers pass along rising costs to us in the form of higher prices. We have implemented cost control measures, including our case and resource management program, to curb increases in operating costs and expenses. We have generally offset increases in operating costs by increasing reimbursement for services, expanding services and reducing costs in other areas. However, we cannot predict our ability to cover or offset future cost increases.


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Critical Accounting Policies
 
The discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amount of assets and liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities at the date of our consolidated financial statements. Actual results may differ from these estimates under different assumptions or conditions.
 
Critical accounting policies are defined as those that are reflective of significant judgments and uncertainties, and potentially result in materially different results under different assumptions and conditions. We believe that our critical accounting policies are limited to those described below. For a detailed discussion on the application of these and other accounting policies, see Note 1 in the Notes to the Consolidated Financial Statements.
 
Third Party Reimbursement
 
Net operating revenues include amounts estimated by management to be reimbursable by Medicare and Medicaid under prospective payment systems and provisions of cost-reimbursement and other payment methods. In addition, we are reimbursed by non-governmental payors using a variety of payment methodologies. Amounts we receive for treatment of patients covered by these programs are generally less than the standard billing rates. Contractual allowances are automatically calculated and recorded through our internally developed “automated contractual allowance system.” Within the automated system, excluding the former Triad hospitals, actual Medicare DRG data, coupled with all payors’ historical paid claims data, is utilized to calculate the contractual allowances. This data is automatically updated on a monthly basis. For the former Triad hospitals, regardless of payor or method of calculation, contractual allowances are determined through a process wherein contractual allowance adjustments are reviewed and compared to actual payment experience. All hospital contractual allowance calculations are subjected to monthly review by management to ensure reasonableness and accuracy. We account for the differences between the estimated program reimbursement rates and the standard billing rates as contractual allowance adjustments, which we deduct from gross revenues to arrive at net operating revenues. The process of estimating contractual allowances requires us to estimate the amount expected to be received based on payor contract provisions. The key assumption in this process is the estimated contractual reimbursement percentage, which is based on payor classification and historical paid claims data. Due to the complexities involved in these estimates, actual payments we receive could be different from the amounts we estimate and record. If the actual contractual reimbursement percentage under government programs and managed care contracts differed by 1% from our estimated reimbursement percentage, net income for the year ended December 31, 2008 would have changed by approximately $24.1 million, and net accounts receivable would have changed by $39.1 million. Final settlements under some of these programs are subject to adjustment based on administrative review and audit by third parties. We account for adjustments to previous program reimbursement estimates as contractual allowance adjustments and report them in the periods that such adjustments become known. Contractual allowance adjustments related to final settlements were insignificant to both net operating revenue and net income in each of the years ended December 31, 2008, 2007 and 2006.
 
Allowance for Doubtful Accounts
 
Substantially all of our accounts receivable are related to providing healthcare services to our hospitals’ patients. Collection of these accounts receivable is our primary source of cash and is critical to our operating performance. Our primary collection risks relate to uninsured patients and outstanding patient balances for which the primary insurance payor has paid some but not all of the outstanding balance, with the remaining outstanding balance (generally deductibles and co-payments) owed by the patient. At the point of service, for patients required to make a co-payment, we generally collect less than 15% of the related revenue. For all procedures scheduled in advance, our policy is to verify insurance coverage prior to the date of the procedure. Insurance coverage is not verified in advance of procedures for walk-in and emergency room patients.


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We estimate the allowance for doubtful accounts by reserving a percentage of all self-pay accounts receivable without regard to aging category, based on collection history, adjusted for expected recoveries and, if present, anticipated changes in trends. For all other payor categories we reserve 100% of all accounts aging over 365 days from the date of discharge. The percentage used to reserve for all self-pay accounts is based on our collection history. We believe that we collect substantially all of our third-party insured receivables which include receivables from governmental agencies. During the quarter ended December 31, 2007, in conjunction with our ongoing process of monitoring the net realizable value of our accounts receivable, as well as integrating the methodologies, data and assumptions used by the former Triad management, we performed various analyses including updating a review of historical cash collections. As a result of these analyses, we noted deterioration in certain key cash collection indicators.
 
The primary key cash collection indicator that experienced deterioration during the fourth quarter of 2007 was “cash receipts as a percentage of net revenue less bad debts.” This indicator decreased to the lowest percentage experienced by us since the quarter ended September 30, 2006. Further analysis indicated the primary causes of this deterioration were a continuing increase in the volume of indigent non-resident aliens, an increase in the number of patients qualifying for charity care and a greater than expected impact of the removal of participants from TennCare (Tennessee’s state provided Medicaid program) which increased the number of uninsured patients with limited financial means receiving care at our eight Tennessee hospitals. During the fourth quarter of 2007, due to the deteriorating cash collections and the desire to standardize processes with those of the former Triad hospitals, we undertook a detailed programming effort to develop data around the deteriorating classes of accounts receivable needed to update its historical cash collections percentages as well as enable it to estimate how much of certain self-pay categories ultimately convert to Medicaid, charity and indigent programs. Triad’s processes for establishing contractual allowances and allowances for bad debts related to accounts classified as Medicaid — pending, charity — pending and indigent non-resident alien included inputs and assumptions based on the historical percentage of these accounts which ultimately qualified for specific government programs or for write-off as charity care.
 
We used these new inputs and assumptions regarding Medicaid — pending, charity — pending, and indigent non-resident alien in conjunction with the new data developed in the fourth quarter of 2007 as described above to evaluate the reliability of accounts receivable and to revise our estimate of contractual allowances for estimated amounts of self-pay accounts receivable that will ultimately qualify as charity care, or that will ultimately qualify for Medicaid, indigent care or other specific governmental reimbursement, resulting in an increase to our contractual reserves of $96.3 million as of December 31, 2007. Previous estimates of uncollectible amounts for such receivables were included in our bad debt reserves for each period.
 
Furthermore, in updating the historical collection statistics of all our hospitals, we also took into account a detailed study of the historical collection information for the hospitals acquired from Triad. The updated collection statistics of the hospitals acquired from Triad also showed subsequent deterioration in cash collections similar to those experienced by the other hospitals that we own. Therefore, we also standardized the processes for calculating the allowance for doubtful accounts of the hospitals acquired from Triad to that of our other hospitals which, along with the allowance percentages determined from the new collection data, resulted in the recording of an additional $70.1 million of allowance for bad debts as of December 31, 2007.
 
The resulting impact of the above, net of taxes, for the year ended December 31, 2007 was a decrease to income from continuing operations of $105.4 million. We believe this lower collectability was primarily the result of an increase in the number of patients qualifying for charity care, reduced enrollment in certain state Medicaid programs and an increase in the number of indigent non-resident aliens. Collections are impacted by the economic ability of patients to pay and the effectiveness of our collection efforts. Significant changes in payor mix, business office operations, economic conditions or trends in federal and state governmental healthcare coverage could affect our collection of accounts receivable. The process of estimating the allowance for doubtful accounts requires us to estimate the collectability of self-pay accounts receivable, which is primarily based on our collection history, adjusted for expected recoveries and, if available, anticipated changes in collection trends. Significant change in payor mix, business office operations, economic conditions, trends in federal and state governmental healthcare coverage or other third party payors could affect our estimates of accounts receivable collectability. If the actual collection percentage differed by 1% from our


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estimated collection percentage as a result of a change in expected recoveries, net income for the year ended December 31, 2008 would have changed by $11.5 million, and net accounts receivable would have changed by $18.7 million. We also continually review our overall reserve adequacy by monitoring historical cash collections as a percentage of trailing net revenue less provision for bad debts, as well as by analyzing current period net revenue and admissions by payor classification, aged accounts receivable by payor, days revenue outstanding, and the impact of recent acquisitions and dispositions.
 
Our policy is to write-off gross accounts receivable if the balance is under $10.00 or when such amounts are placed with outside collection agencies. We believe this policy accurately reflects our ongoing collection efforts and is consistent with industry practices. We had approximately $1.5 billion at December 31, 2008 and 2007, being pursued by various outside collection agencies. We expect to collect less than 3%, net of estimated collection fees, of the amounts being pursued by outside collection agencies. As these amounts have been written-off, they are not included in our gross accounts receivable or our allowance for doubtful accounts. Collections on amounts previously written-off are recognized as a reduction to bad debt expense when received. However, we take into consideration estimated collections of these future amounts written-off in evaluating the reasonableness of our allowance for doubtful accounts.
 
All of the following information is derived from our hospitals, excluding clinics, unless otherwise noted.
 
Patient accounts receivable from our hospitals represent approximately 95% of our total consolidated accounts receivable.
 
Days revenue outstanding was 53 days at December 31, 2008 and 54 days at December 31, 2007. Our target range for days revenue outstanding is from 52 to 58 days.
 
Total gross accounts receivable (prior to allowance for contractual adjustments and doubtful accounts) was approximately $5.458 billion as of December 31, 2008 and approximately $4.692 billion as of December 31, 2007. The approximate percentage of total gross accounts receivable (prior to allowance for contractual adjustments and doubtful accounts) summarized by aging categories is as follows:
 
                 
    As of December 31,  
    2008     2007  
 
0 – 60 days
    59.8 %     61.2 %
60 – 150 days
    19.0 %     18.8 %
151 – 360 days
    16.2 %     15.3 %
Over 360 days
    5.0 %     4.7 %
                 
Total
    100.0 %     100.0 %
 
The approximate percentage of total gross accounts receivable (prior to allowances for contractual adjustments and doubtful accounts) summarized by payor is as follows:
 
                 
    As of December 31,  
    2008     2007  
 
Insured receivables
    67.0 %     66.7 %
Self-pay receivables
    33.0 %     33.3 %
                 
Total
    100.0 %     100.0 %
 
For the hospital segment, the combined total of the allowance for doubtful accounts and related allowances for other self-pay discounts and contractuals, as a percentage of gross self-pay receivables, was approximately 80% at December 31, 2008 and 79% at December 31, 2007. If the receivables that have been written-off, but where collections are still being pursued by outside collection agencies, were included in both the allowances and gross self-pay receivables specified above, the percentage of combined allowances to total self-pay receivables would have been approximately 88% at December 31, 2008 and 89% at December 31, 2007.


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Goodwill and Other Intangibles
 
Goodwill represents the excess of cost over the fair value of net assets acquired. Goodwill arising from business combinations is accounted for under the provisions of Statement of Financial Accounting Standards (SFAS) No. 141 “Business Combinations” and SFAS No. 142, “Goodwill and Other Intangible Assets” and is not amortized. SFAS 142 requires goodwill to be evaluated for impairment at the same time every year and when an event occurs or circumstances change that, more likely than not, reduce the fair value of the reporting unit below its carrying value. SFAS No. 142 requires a two-step method for determining goodwill impairment. Step one is to compare the fair value of the reporting unit with the unit’s carrying amount, including goodwill. If this test indicates the fair value is less than the carrying value, then step two is required to compare the implied fair value of the reporting unit’s goodwill with the carrying value of the reporting unit’s goodwill. We have selected September 30th as our annual testing date.
 
We estimate the fair value of the related reporting units using both a discounted cash flow model as well as an EBITDA multiple model. These models are both based on our best estimate of future revenues and operating costs and are reconciled to our consolidated market capitalization. The cash flow forecasts are adjusted by an appropriate discount rate based on our weighted average cost of capital. Historically our valuation models did not fully capture the fair value of our business as a whole, as they did not consider the increased consideration a potential acquirer would be required to pay, in the form of a control premium, in order to gain sufficient ownership to set policies, direct operations and control management decisions. However, because our models have indicated value significantly in excess of the carrying amount of assets in our reporting units, the additional value from a control premium was not a determining factor in the outcome of step one of our impairment assessment.
 
As indicated above, in addition to the annual impairment analysis, we are required to evaluate goodwill for impairment whenever an event occurs or circumstances change such that it is more likely than not that an impairment may exist. In light of this requirement, we have considered whether the decline in our market capitalization between September 30, 2008 and December 31, 2008 has, more likely than not, resulted in the existence of an impairment and have concluded that the decline in our market capitalization did not, more likely than not, result in the existence of an impairment. In making this conclusion, we gave consideration to the valuation of hospitals in which we sold equity interests during periods subsequent to September 30, 2008, currently proposed hospital equity sale transactions, our proposed purchase price for a hospital which we anticipate closing on the acquisition in the first half of 2009, the increase in our stock price since December 31, 2008 and our average stock price over the trailing 3 month, 6 month and 1 year periods. We also considered the fact that the decline in our stock price has not been related to a decline in our operating performance and that any near term credit tightening within the financial markets could be overcome by us through the substantial amount of cash flows being generated by us, as well as, the borrowing capacity available to us through our existing credit facilities. The current turmoil in the financial markets and weakness in macroeconomic conditions globally continue to be challenging and we cannot be certain of the duration of these conditions and their potential impact on our stock price performance. If a further decline in our market capitalization and other factors resulted in the decline in our fair value, it is reasonably likely that a goodwill impairment assessment prior to the next annual review, in the fourth quarter of 2009, would be necessary. If such an assessment is required, an impairment of goodwill may be recognized. A non-cash goodwill impairment charge would have the effect of decreasing our earnings or increasing our losses in the period the impairment is recognized. The amount of such effect on earnings and losses is dependent on the size of the impairment charge. Such a change, however, would be a non-cash charge and therefore would not impact our compliance with covenants contained in our New Credit Facility.
 
Impairment or Disposal of Long-Lived Assets
 
In accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”, whenever events or changes in circumstances indicate that the carrying values of certain long-lived assets may be impaired, we project the undiscounted cash flows expected to be generated by these assets. If the projections indicate that the reported amounts are not expected to be recovered, such amounts are reduced to


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their estimated fair value based on a quoted market price, if available, or an estimate based on valuation techniques available in the circumstances.
 
Professional Liability Claims
 
As part of our business of owning and operating hospitals, we are subject to legal actions alleging liability on our part. We accrue for losses resulting from such liability claims, as well as loss adjustment expenses that are out-of-pocket and directly related to such liability claims. These direct out-of-pocket expenses include fees of outside counsel and experts. We do not accrue for costs that are part of our corporate overhead, such as the costs of our in-house legal and risk management departments. The losses resulting from professional liability claims primarily consist of estimates for known claims, as well as estimates for incurred but not reported claims. The estimates are based on specific claim facts, our historical claim reporting and payment patterns, the nature and level of our hospital operations, and actuarially determined projections. The actuarially determined projections are based on our actual claim data, including historic reporting and payment patterns which have been gathered over an approximate 20-year period. As discussed below, since we purchase excess insurance on a claims-made basis that transfers risk to third party insurers, the liability we accrue does not include an amount for the losses covered by our excess insurance. Since we believe that the amount and timing of our future claims payments are reliably determinable, we discount the amount we accrue for losses resulting from professional liability claims using the risk-free interest rate corresponding to the timing of our expected payments.
 
The net present value of the projected payments was discounted using a weighted-average risk-free rate of 2.6%, 4.1% and 4.6% in 2008, 2007 and 2006, respectively. This liability is adjusted for new claims information in the period such information becomes known to us. Professional malpractice expense includes the losses resulting from professional liability claims and loss adjustment expense, as well as paid excess insurance premiums, and is presented within other operating expenses in the accompanying consolidated statements of income.
 
Our processes for obtaining and analyzing claims and incident data are standardized across all of our hospitals and have been consistent for many years. We monitor the outcomes of the medical care services that we provide and for each reported claim, we obtain various information concerning the facts and circumstances related to that claim. In addition, we routinely monitor current key statistics and volume indicators in our assessment of utilizing historical trends. The average lag period between claim occurrence and payment of a final settlement is between 4 and 5 years, although the facts and circumstances of individual claims could result in the timing of such payments being different from this average. Since claims are paid promptly after settlement with the claimant is reached, settled claims represent less than 1.0% of the total liability at the end of any period.
 
For purposes of estimating our individual claim accruals, we utilize specific claim information, including the nature of the claim, the expected claim amount, the year in which the claim occurred and the laws of the jurisdiction in which the claim occurred. Once the case accruals for known claims are determined, information is stratified by loss layers and retentions, accident years, reported years, geography, and claims relating to the acquired Triad hospitals versus claims relating to our other hospitals. Several actuarial methods are used against this data to produce estimates of ultimate paid losses and reserves for incurred but not reported claims. Each of these methods uses our company-specific historical claims data and other information. This company-specific data includes information regarding our business, including historical paid losses and loss adjustment expenses, historical and current case loss reserves, actual and projected hospital statistical data, a variety of hospital census information, employed physician information, professional liability retentions for each policy year, geographic information and other data.
 
Based on these analyses we determine our estimate of the professional liability claims. The determination of management’s estimate, including the preparation of the reserve analysis that supports such estimate, involves subjective judgment of the management. Changes in reserving data or the trends and factors that influence reserving data may signal fundamental shifts in our future claim development patterns or may simply reflect single-period anomalies. Even if a change reflects a fundamental shift, the full extent of the change


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may not become evident until years later. Moreover, since our methods and models use different types of data and we select our liability from the results of all of these methods, we typically cannot quantify the precise impact of such factors on our estimates of the liability. Due to our standardized and consistent processes for handling claims and the long history and depth of our company-specific data, our methodologies have produced reliably determinable estimates of ultimate paid losses.
 
Although we have not historically maintained and presented our claims data in this manner, we are providing the following table to present the amounts of our accrual for professional liability claims and approximate amounts of our activity for each of the respective years listed (excludes premiums for excess insurance coverage) (in thousands):
 
                         
    Year Ended December 31,  
    2008     2007     2006  
 
Accrual for professional liability claims, January 1
  $ 300,184     $ 104,161     $ 88,371  
                         
Liability acquired through acquisition:
                       
Gross liability acquired
          197,453        
Discount of liability acquired
          (26,309 )      
                         
Discounted liability acquired
          171,144        
                         
Expense (income) related to(1):
                       
Current accident year
    110,010       73,039       43,441  
Prior accident years
    (15,826 )     7,158       3,146  
Expense (income) from discounting
    11,499       (1,040 )     3,667  
                         
Total incurred loss and loss expense
    105,683       79,157       50,254  
                         
Paid claims and expenses related to:
                       
Current accident year
    (688 )     (701 )     (574 )
Prior accident years
    (54,600 )     (53,577 )     (33,890 )
                         
Total paid claims and expenses
    (55,288 )     (54,278 )     (34,464 )
                         
Accrual for professional liability claims, December 31
  $ 350,579     $ 300,184     $ 104,161  
                         
 
 
(1) Total expense, including premiums for insured coverage, was $65.7 million in 2006, $99.7 million in 2007 and $130.4 million in 2008.
 
The increase in current accident year claims expense in each respective year from 2006 to 2008 is consistent with the increase in net operating revenues during the respective periods. Income/expense related to prior accident years reflects changes in estimates resulting from the filing of claims for prior year incidents, claim settlements, updates from litigation, and our ongoing investigation of open claims. Expense/income from discounting reflects the changes in the weighted-average risk-free interest rate used and timing of estimated payments for discounting in each respective year.
 
We are primarily self-insured for these claims; however, we obtain excess insurance that transfers the risk of loss to a third-party insurer for claims in excess of our self-insured retentions. Our excess insurance is underwritten on a claims-made basis. For claims reported prior to June 1, 2002, substantially all of our professional and general liability risks were subject to a $0.5 million per occurrence self-insured retention and for claims reported from June 1, 2002 through June 1, 2003, these self-insured retentions were $2.0 million per occurrence. Substantially all claims reported after June 1, 2003 and before June 1, 2005 are self-insured up to $4 million per claim. Substantially all claims reported on or after June 1, 2005 are self-insured up to $5 million per claim. Management on occasion has selectively increased the insured risk at certain hospitals based upon insurance pricing and other factors and may continue that practice in the future. Excess insurance for all hospitals has been purchased through commercial insurance companies and generally covers us for liabilities in excess of the self-insured retentions and up to $100 million per occurrence for claims reported on


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or after June 1, 2003 and up to $150 million per occurrence for claims occurred and reported after January 1, 2008.
 
Effective January 1, 2008, the former Triad Hospitals are insured on a claims-made basis as described above and through commercial insurance companies as described above for substantially all claims occurring on or after January 1, 2002 and reported on or after January 1, 2008. Substantially all losses for the former Triad hospitals in periods prior to May 1999 were insured through a wholly-owned insurance subsidiary of HCA, Inc., or HCA, Triad’s owner prior to that time, and excess loss policies maintained by HCA. HCA has agreed to indemnify the former Triad hospitals in respect of claims covered by such insurance policies arising prior to May 1999. After May 1999 through December 31, 2006, the former Triad hospitals obtained insurance coverage on a claims incurred basis from HCA’s wholly-owned insurance subsidiary with excess coverage obtained from other carriers that is subject to certain deductibles. Effective for claims incurred after December 31, 2006, Triad began insuring its claims from $1 million to $5 million through its wholly-owned captive insurance company, replacing the coverage provided by HCA. Substantially all claims occurring during 2007 were self-insured up to $10 million per claim.
 
Income Taxes
 
We must make estimates in recording provision for income taxes, including determination of deferred tax assets and deferred tax liabilities and any valuation allowances that might be required against the deferred tax assets. We believe that future income will enable us to realize these deferred tax assets, subject to the valuation allowance we have established.
 
On January 1, 2007, we adopted the provisions of the FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes.” The total amount of unrecognized benefit that would affect the effective tax rate, if recognized, is approximately $10.5 million as of December 31, 2008. It is our policy to recognize interest and penalties accrued related to unrecognized benefits in our consolidated statement of operations as income tax expense. During the year ended December 31, 2008, we decreased liabilities by approximately $0.8 million and recorded $0.2 million in interest and penalties related to prior state income tax returns through our income tax provision from continuing operations and which are included in our FASB Interpretation No. 48 liability at December 31, 2008. A total of approximately $1.2 million of interest and penalties is included in the amount of FASB Interpretation No. 48 liability at December 31, 2008. During the year ended December 31, 2008, we released $7.5 million for income taxes and $1.8 million for accrued interest of our FASB Interpretation No. 48 liability, as a result of the expiration of the statute of limitations pertaining to tax positions taken in prior years relative to state tax positions.
 
We believe it is reasonably possible that approximately $5.3 million of our current unrecognized tax benefit may be recognized within the next twelve months as a result of a lapse of the statute of limitations and settlements with taxing authorities.
 
We or one of our subsidiaries file income tax returns in the U.S. federal jurisdiction and various state jurisdictions. We have extended the federal statute of limitations for Triad for the tax periods ended December 31, 1999, December 31, 2000, April 30, 2001, June 30, 2001, December 31, 2001, December 31, 2002 and December 31, 2003. With few exceptions, we are no longer subject to state income tax examinations for years prior to 2003. During 2007, we agreed to a settlement with the Internal Revenue Service, or IRS, Appeals Office with respect to the 2003 tax year. We have since received a closing letter with respect to the examination for that tax year. The settlement was not material to our results of operations or consolidated financial position.
 
The IRS has concluded an examination of the federal income tax returns of Triad for the short taxable years ended April 27, 2001, June 30, 2001 and December 31, 2001, and the taxable years ended December 31, 2002 and 2003. On May 10, 2006, the IRS issued an examination report with proposed adjustments. Triad filed a protest on June 9, 2006 and the matter was referred to the IRS Appeals Office. Representatives of the former Triad hospitals met with the IRS Appeals Office in April 2007 and reached a tentative settlement. Triad has since received a closing letter with respect to the examination for those tax years. The settlement was not material to our results of operations or consolidated financial position. In December 2008, we were notified by


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the IRS of its intent to examine the federal tax return of Triad for the tax periods ended December 31, 2005 and ended July 25, 2007. We believe the results of this examination will not be material to our results of operations or consolidated financial position.
 
Recent Accounting Pronouncements
 
In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS No. 157”), which defines fair value, provides a framework for measuring fair value, and expands disclosures required for fair value measurements. SFAS No. 157 applies to other accounting pronouncements that require fair value measurement; it does not require any new fair value measurements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007, and was adopted by us as of January 1, 2008. The adoption of this statement has not had a material effect on our consolidated results of operations or consolidated financial position.
 
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities — Including an Amendment of FASB Statement No. 115” (“SFAS No. 159”). SFAS No. 159 expands the use of fair value accounting but does not affect existing standards that require assets or liabilities to be carried at fair value. SFAS No. 159 permits an entity, on a contract-by-contract basis, to make an irrevocable election to account for certain types of financial instruments and warranty and insurance contracts at fair value, rather than historical cost, with changes in the fair value, whether realized or unrealized, recognized in earnings. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007. We adopted SFAS No. 159 as of January 1, 2008 and did not elect to re-measure any assets or liabilities. The adoption of this statement has not had a material effect on our consolidated results of operations or consolidated financial position.
 
In December 2007, the FASB issued SFAS No. 141(R), “Business Combinations” (“SFAS No. 141(R)”). SFAS No. 141(R) replaces SFAS No. 141 and addresses the recognition and accounting for identifiable assets acquired, liabilities assumed, and noncontrolling interests in business combinations. This standard will require more assets and liabilities to be recorded at fair value and will require expense recognition (rather than capitalization) of certain pre-acquisition costs. This standard will also require any adjustments to acquired deferred tax assets and liabilities occurring after the related allocation period to be made through earnings. Furthermore, this standard requires this treatment of acquired deferred tax assets and liabilities also to be applied to acquisitions occurring prior to the effective date of this standard. SFAS No. 141(R) is effective for fiscal years beginning after December 15, 2008 and is required to be adopted prospectively with no early adoption permitted. We will begin applying SFAS No. 141(R) in the first quarter of 2009. We do not currently have on our consolidated balance sheet any material deferred costs related to prospective acquisitions that would be required to be expensed upon the adoption of SFAS No. 141(R). Any outstanding deferred costs will be expensed in 2009 for any acquisitions that are not closed by December 31, 2008. Furthermore, the impact of SFAS No. 141(R) on our consolidated results of operations and consolidated financial position in future periods will be largely dependent on the number of acquisitions we pursue; however, it is not anticipated at this time that such impact will be material.
 
In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements” (“SFAS No. 160”). SFAS No. 160 addresses the accounting and reporting framework for noncontrolling ownership interests in consolidated subsidiaries of the parent. SFAS No. 160 also establishes disclosure requirements that clearly identify and distinguish between the interests of the parent company and the interests of the noncontrolling owners and that require minority ownership interests to be presented separately within equity in the consolidated financial statements. SFAS No. 160 is effective for fiscal years beginning after December 15, 2008, and will be adopted by us in the first quarter of 2009. We are currently assessing the potential impact that SFAS No. 160 will have on our consolidated results of operations and consolidated financial position.
 
In February 2008, the FASB issued FASB Statement of Position No. 157-2, “Effective Date of FASB Statement No. 157” (“FSP 157-2”). FSP 157-2 deferred the effective date of the provisions of SFAS No. 157 for all non-financial assets and non-financial liabilities to fiscal years beginning after November 15, 2008, and


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will be adopted by us in the first quarter of 2009. We are currently assessing the potential impact of SFAS No. 157 for non-financial assets and non-financial liabilities on our consolidated results of operations and consolidated financial position.
 
In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities” (“SFAS No. 161”). SFAS No. 161 expands the disclosure requirements for derivative instruments and for hedging activities in order to provide additional understanding of how an entity uses derivative instruments and how they are accounted for and reported in an entity’s financial statements. The new disclosure requirements for SFAS No. 161 are effective for fiscal years beginning after November 15, 2008, and will be adopted by us in the first quarter of 2009.
 
Item 7A.   Quantitative and Qualitative Disclosures about Market Risk
 
We are exposed to interest rate changes, primarily as a result of our New Credit Facility which bears interest based on floating rates. In order to manage the volatility relating to the market risk, we entered into interest rate swap agreements described under the heading “Liquidity and Capital Resources”. We do not anticipate any material changes in our primary market risk exposures in 2009. We utilize risk management procedures and controls in executing derivative financial instrument transactions. We do not execute transactions or hold derivative financial instruments for trading purposes. Derivative financial instruments related to interest rate sensitivity of debt obligations are used with the goal of mitigating a portion of the exposure when it is cost effective to do so.
 
A 1% change in interest rates on variable rate debt in excess of that amount covered by interest rate swaps would have resulted in interest expense fluctuating approximately $13 million in 2008, $14 million in 2007 and $4 million in 2006.


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Item 8.   Financial Statements and Supplementary Data.
 
Index to Financial Statements
 
         
    Page
 
Community Health Systems, Inc. Consolidated Financial Statements:
       
    65  
    66  
    67  
    68  
    69  
    70  


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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
To the Board of Directors and Stockholders of
Community Health Systems, Inc.
Franklin, Tennessee
 
We have audited the accompanying consolidated balance sheets of Community Health Systems, Inc. and subsidiaries (the “Company”) as of December 31, 2008 and 2007, and the related consolidated statements of income, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2008. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
 
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
 
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Community Health Systems, Inc. and subsidiaries as of December 31, 2008 and 2007, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2008, in conformity with accounting principles generally accepted in the United States of America.
 
As discussed in Note 8 to the consolidated financial statements, the Company adopted Statement of Financial Accounting Standards No. 157, Fair Value Measurements (“SFAS No. 157”) effective January 1, 2008, which changed the Company’s definitions of fair value, framework for measuring fair value, and disclosures for fair value measurements.
 
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of December 31, 2008, based on the criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 26, 2009 expressed an unqualified opinion on the Company’s internal control over financial reporting.
 
/s/ Deloitte & Touche LLP
 
Nashville, Tennessee
February 26, 2009


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COMMUNITY HEALTH SYSTEMS, INC. AND SUBSIDIARIES
 
CONSOLIDATED STATEMENTS OF INCOME
 
                         
    Year Ended December 31,  
    2008     2007     2006  
    (In thousands, except share and per share data)  
 
Net operating revenues
  $ 10,840,098     $ 7,063,775     $ 4,180,136  
                         
Operating costs and expenses:
                       
Salaries and benefits
    4,326,526       2,875,795       1,661,619  
Provision for bad debts
    1,208,687       885,653       518,861  
Supplies
    1,518,987       935,812       487,778  
Other operating expenses
    2,073,713       1,422,972       855,596  
Rent
    229,526       153,695       91,943  
Depreciation and amortization
    499,085       311,122       179,282  
                         
Total operating costs and expenses
    9,856,524       6,585,049       3,795,079  
                         
Income from operations
    983,574       478,726       385,057  
Interest expense, net of interest income of $7,057, $8,181, and $1,779 in 2008, 2007 and 2006, respectively
    651,925       361,773       94,411  
(Gain) loss from early extinguishment of debt
    (2,525 )     27,388       4  
Minority interest in earnings
    40,101       15,155       2,795  
Equity in earnings of unconsolidated affiliates
    (42,064 )     (25,132 )      
                         
Income from continuing operations before income taxes
    336,137       99,542       287,847  
Provision for income taxes
    129,479       41,828       110,152  
                         
Income from continuing operations
    206,658       57,714       177,695  
Discontinued operations, net of taxes:
                       
Income (loss) from operations of hospitals sold and held for sale
    5,316       (8,884 )     (6,873 )
Gain (loss) on sale of hospitals and partnership interests
    9,580       (2,594 )     (2,559 )
Impairment of long-lived assets of hospitals held for sale
    (3,250 )     (15,947 )      
                         
Income (loss) on discontinued operations
    11,646       (27,425 )     (9,432 )
                         
Net income
  $ 218,304     $ 30,289     $ 168,263  
                         
Earnings per common share — basic:
                       
Income from continuing operations
  $ 2.21     $ 0.62     $ 1.87  
Income (loss) on discontinued operations
  $ 0.13     $ (0.30 )   $ (0.10 )
                         
Net income
  $ 2.34     $ 0.32     $ 1.77  
                         
Earnings per common share — diluted:
                       
Income from continuing operations
  $ 2.19     $ 0.61     $ 1.85  
Income (loss) on discontinued operations
  $ 0.13     $ (0.29 )   $ (0.10 )
                         
Net income
  $ 2.32     $ 0.32     $ 1.75  
                         
Weighted-average number of shares outstanding:
                       
Basic
    93,371,782       93,517,337       94,983,646  
                         
Diluted
    94,288,829       94,642,294       96,232,910  
                         
 
See notes to consolidated financial statements.


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COMMUNITY HEALTH SYSTEMS, INC. AND SUBSIDIARIES
 
CONSOLIDATED BALANCE SHEETS
 
                 
    December 31,  
    2008     2007  
    (In thousands, except share data)  
 
ASSETS
Current assets:
               
Cash and cash equivalents
  $ 220,655     $ 132,874  
Patient accounts receivable, net of allowance for doubtful accounts of $1,102,900 and $1,033,516 in 2008 and 2007, respectively
    1,613,959       1,533,798  
Supplies
    272,937       262,903  
Prepaid income taxes
    92,710       99,417  
Deferred income taxes
    91,875       113,741  
Prepaid expenses and taxes
    72,900       70,339  
Other current assets (including assets of hospitals held for sale of $40,853 and $118,893 at December 31, 2008 and 2007, respectively)
    240,014       339,826  
                 
Total current assets
    2,605,050       2,552,898  
                 
Property and equipment:
               
Land and improvements
    508,690       463,373  
Buildings and improvements
    4,480,999       4,166,888  
Equipment and fixtures
    2,093,241       1,679,979  
                 
      7,082,930       6,310,240  
Less accumulated depreciation and amortization
    (1,213,871 )     (797,666 )
                 
Property and equipment, net
    5,869,059       5,512,574  
                 
Goodwill
    4,166,091       4,247,714  
                 
Other assets, net of accumulated amortization of $158,532 and $100,556 in 2008 and 2007, respectively (including assets of hospitals held for sale of $172,870 and $362,546 at December 31, 2008 and 2007, respectively)
    1,178,054       1,180,457  
                 
Total assets
  $ 13,818,254     $ 13,493,643  
                 
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
               
Current maturities of long-term debt
  $ 29,462     $ 20,710  
Accounts payable
    529,429       492,693  
Deferred income taxes
    6,740        
Accrued liabilities:
               
Employee compensation
    427,688       403,598  
Interest
    152,228       153,832  
Other (including liabilities of hospitals held for sale of $106,856 and $67,606 at December 31, 2008 and 2007, respectively)
    388,423       377,102  
                 
Total current liabilities
    1,533,970       1,447,935  
                 
Long-term debt
    8,937,984       9,077,367  
                 
Deferred income taxes
    460,793       407,947  
                 
Other long-term liabilities
    887,445       483,459  
                 
Minority interests in equity of consolidated subsidiaries
    325,197       366,131  
Commitments and contingencies
               
Stockholders’ equity:
               
Preferred stock, $.01 par value per share, 100,000,000 shares authorized; none issued
           
Common stock, $.01 par value per share, 300,000,000 shares authorized; 92,483,166 shares issued and 91,507,617 shares outstanding at December 31, 2008 and 96,611,085 shares issued and 95,635,536 shares outstanding at December 31, 2007
    925       966  
Additional paid-in capital
    1,197,944       1,240,308  
Treasury stock, at cost, 975,549 shares at December 31, 2008 and 2007
    (6,678 )     (6,678 )
Unearned stock compensation
           
Accumulated other comprehensive income (loss)
    (295,575 )     (81,737 )
Retained earnings
    776,249       557,945  
                 
Total stockholders’ equity
    1,672,865       1,710,804  
                 
Total liabilities and stockholders’ equity
  $ 13,818,254     $ 13,493,643  
                 
 
See notes to consolidated financial statements.


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COMMUNITY HEALTH SYSTEMS, INC. AND SUBSIDIARIES
 
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
 
                                                                                 
                                        Accumulated
    Retained
             
                Additional
                Unearned
    Other
    Earnings
             
    Common Stock     Paid-in
    Treasury Stock     Stock
    Comprehensive
    (Accumulated
             
    Shares     Amount     Capital     Shares     Amount     Compensation     Income (Loss)     Deficit)     Total        
                      (In thousands, except share data)                          
 
BALANCE, December 31, 2005
    94,539,837     $ 945     $ 1,208,930       (975,549 )   $ (6,678 )   $ (13,204 )   $ 15,191     $ 359,393     $ 1,564,577          
Comprehensive income (loss):
                                                                               
Net income
                                              168,263       168,263          
Net change in fair value of interest rate swaps, net of tax benefit of $931
                                        (1,654 )           (1,654 )        
Net change in fair value of available for sale securities
                                        562             562          
                                                                                 
Total comprehensive income (loss)
                                                    (1,092 )     168,263       167,171          
Adjustment to adopt FASB statement No. 158, net of tax benefit of $5,465
                                        (8,301 )           (8,301 )        
Repurchases of common stock
    (5,000,000 )     (50 )     (176,265 )                                   (176,315 )        
Issuance of common stock in connection with the exercise of options
    867,833       9       14,564                                     14,573          
Issuance of common stock in connection with the conversion of convertible debt
    4,074,510       41       137,157                                     137,198          
Tax benefit from exercise of options
                4,750                                     4,750          
Share-based compensation
    544,314       5       20,068                                     20,073          
Reclassification of unearned stock compensation
                (13,257 )                 13,204                   (53 )        
                                                                                 
BALANCE, December 31, 2006
    95,026,494     $ 950     $ 1,195,947       (975,549 )   $ (6,678 )   $     $ 5,798     $ 527,656     $ 1,723,673          
Comprehensive income (loss):
                                                                               
Net income
                                              30,289       30,289          
Net change in fair value of interest rate swaps, net of tax benefit of $51,223
                                        (91,063 )           (91,063 )        
Net change in fair value of available for sale securities
                                        237             237          
Adjustment to pension liability, net of tax of $496
                                        3,291             3,291          
                                                                                 
Total comprehensive income (loss)
                                                    (87,535 )     30,289       (57,246 )        
Issuance of common stock in connection with the exercise of options
    321,535       3       8,362                                     8,365          
Tax benefit from exercise of options
                (2,760 )                                   (2,760 )        
Share-based compensation
    1,263,056       13       38,759                                     38,772          
                                                                                 
BALANCE, December 31, 2007
    96,611,085     $ 966     $ 1,240,308       (975,549 )   $ (6,678 )   $     $ (81,737 )   $ 557,945     $ 1,710,804          
Comprehensive income (loss):
                                                                               
Net income
                                              218,304       218,304          
Net change in fair value of interest rate swaps, net of tax benefit of $112,915
                                        (200,737 )           (200,737 )        
Net change in fair value of available for sale securities
                                        (2,613 )           (2,613 )        
Adjustment to pension liability, net of tax of $7,262
                                        (10,488 )           (10,488 )        
                                                                                 
Total comprehensive income (loss)
                                                    (213,838 )     218,304       4,466          
Repurchases of common stock
    (4,786,609 )     (48 )     (90,141 )                                   (90,189 )        
Issuance of common stock in connection with the exercise of options
    281,831       3       1,803                                     1,806          
Cancellation of restricted stock for tax withholdings on vested shares
    (310,806 )     (3 )     (5,455 )                                   (5,455 )        
Tax benefit from exercise of options
                (672 )                                   (672 )        
Share-based compensation
    687,665       7       52,101                                     52,105          
                                                                                 
BALANCE, December 31, 2008
    92,483,166     $ 925     $ 1,197,944       (975,549 )   $ (6,678 )   $     $ (295,575 )   $ 776,249     $ 1,672,865          
                                                                                 
 
See notes to consolidated financial statements.


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COMMUNITY HEALTH SYSTEMS, INC. AND SUBSIDIARIES
 
CONSOLIDATED STATEMENTS OF CASH FLOWS
 
                         
    Year Ended December 31,  
    2008     2007     2006  
    (In thousands)  
 
Cash flows from operating activities:
                       
Net income
  $ 218,304     $ 30,289     $ 168,263  
Adjustments to reconcile net income to net cash provided by operating activities:
                       
Depreciation and amortization
    506,694       332,580       188,771  
Deferred income taxes
    159,870       (39,894 )     (25,228 )
Stock-based compensation expense
    52,105       38,771       20,073  
Excess tax benefits relating to stock-based compensation
    (1,278 )     (1,216 )     (6,819 )
(Gain) loss on early extinguishment of debt
    (2,525 )     27,388        
Minority interest in earnings
    40,101       15,996       2,795  
Impairment on hospitals held for sale
    5,000       19,044        
(Gain) loss on sale of hospitals and partnership interest, net
    (17,687 )     3,954       3,937  
Other non-cash expenses, net
    3,577       19,017       500  
Changes in operating assets and liabilities, net of effects of acquisitions and divestitures:
                       
Patient accounts receivable
    (57,437 )     131,300       (71,141 )
Supplies, prepaid expenses and other current assets
    (34,711 )     (31,977 )     (4,544 )
Accounts payable, accrued liabilities and income taxes
    119,596       125,959       52,151  
Other
    65,672       16,527       21,497  
                         
Net cash provided by operating activities
    1,057,281       687,738       350,255  
                         
Cash flows from investing activities:
                       
Acquisitions of facilities and other related equipment
    (161,907 )     (7,018,048 )     (384,618 )
Purchases of property and equipment
    (692,233 )     (522,785 )     (224,519 )
Proceeds from disposition of hospitals and other ancillary operations
    365,636       109,996       750  
Proceeds from sale of property and equipment
    13,483       4,650       4,480  
Increase in other assets
    (190,450 )     (72,671 )     (36,350 )
                         
Net cash used in investing activities
    (665,471 )     (7,498,858 )     (640,257 )
                         
Cash flows from financing activities:
                       
Proceeds from exercise of stock options
    1,806       8,214       14,573  
Stock buy-back
    (90,188 )           (176,316 )
Deferred financing costs
    (3,136 )     (182,954 )     (2,153 )
Excess tax benefits relating to stock-based compensation
    1,278       1,216       6,819  
Redemption of convertible notes
                (128 )
Proceeds from minority investors in joint ventures
    14,329       2,351       6,890  
Redemption of minority investments in joint ventures
    (77,587 )     (1,356 )     (915 )
Distribution to minority investors in joint ventures
    (46,890 )     (6,645 )     (3,220 )
Borrowings under Credit Agreement
    131,277       9,221,627       1,031,000  
Repayments of long-term indebtedness
    (234,918 )     (2,139,025 )     (650,090 )
                         
Net cash (used in) provided by financing activities
    (304,029 )     6,903,428       226,460  
                         
Net change in cash and cash equivalents
    87,781       92,308       (63,542 )
Cash and cash equivalents at beginning of period
    132,874       40,566       104,108  
                         
Cash and cash equivalents at end of period
  $ 220,655     $ 132,874     $ 40,566  
                         
 
See notes to consolidated financial statements.


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COMMUNITY HEALTH SYSTEMS, INC. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
1.   Business and Summary of Significant Accounting Policies
 
Business.  Community Health Systems, Inc. is a holding company and operates no business in its own name. On a consolidated basis, Community Health Systems, Inc. and its subsidiaries (collectively the “Company”), own, lease and operate acute care hospitals in non-urban and select urban markets. As of December 31, 2008, included in its continuing operations, the Company owned or leased 118 hospitals, licensed for 17,245 beds in 28 states. As of December 31, 2008, Indiana and Texas represent the only areas of geographic concentration. Net operating revenues generated by the Company’s hospitals in Indiana, as a percentage of consolidated net operating revenues, were 11.0% in 2008 and 7.7% in 2007. Net operating revenues generated by the Company’s hospitals in Texas, as a percentage of consolidated net operating revenues, were 13.4% in 2008, 13.0% in 2007 and 10.4% in 2006. As a result of the Company’s growth and expansion of services in other states, Pennsylvania no longer represents an area of geographic concentration, which it did as of December 31, 2007.
 
Use of Estimates.  The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates under different assumptions or conditions.
 
Principles of Consolidation.  The consolidated financial statements include the accounts of the Company, its subsidiaries, all of which are controlled by the Company through majority voting control, and variable interest entities for which the Company is the primary beneficiary. All significant intercompany accounts and transactions have been eliminated. Certain of the subsidiaries have minority stockholders. The amount of minority interest in equity is disclosed separately on the consolidated balance sheets and minority interest in earnings is disclosed separately on the consolidated statements of income.
 
Cost of Revenue.  The majority of the Company’s operating expenses are “cost of revenue” items. Operating costs that could be classified as general and administrative by the Company would include the Company’s corporate office costs at the Company’s Franklin, Tennessee offices and former offices in Brentwood, Tennessee and Plano, Texas, which were $149.9 million, $133.4 million and $88.9 million for the years ended December 31, 2008, 2007 and 2006, respectively. Included in these amounts is stock-based compensation of $52.1 million, $38.8 million and $20.1 million for the years ended December 31, 2008, 2007 and 2006, respectively.
 
Cash Equivalents.  The Company considers highly liquid investments with original maturities of three months or less to be cash equivalents.
 
Supplies.  Supplies, principally medical supplies, are stated at the lower of cost (first-in, first-out basis) or market.
 
Marketable Securities.  The Company accounts for marketable securities in accordance with the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 115, “Accounting for Certain Investments in Debt and Equity Securities.” The Company’s marketable securities are classified as trading or available-for-sale. Available-for-sale securities are carried at fair value as determined by quoted market prices, with unrealized gains and losses reported as a separate component of stockholders’ equity. Trading securities are reported at fair value with unrealized gains and losses included in earnings. Interest and dividends on securities classified as available-for-sale or trading are included in net operating revenue and were not material in all periods presented. Accumulated other comprehensive income (loss) included an unrealized loss of $2.6 million at December 31, 2008 and an unrealized gain of $0.2 million at December 31, 2007, related to these available-for-sale securities.


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COMMUNITY HEALTH SYSTEMS, INC. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
Property and Equipment.  Property and equipment are recorded at cost. Depreciation is recognized using the straight-line method over the estimated useful lives of the land and improvements (2 to 15 years; weighted average useful life is 14 years), buildings and improvements (5 to 40 years; weighted average useful life is 24 years) and equipment and fixtures (4 to 18 years; weighted average useful life is 8 years). Costs capitalized as construction in progress were $196.4 million and $457.5 million at December 31, 2008 and 2007, respectively. Expenditures for renovations and other significant improvements are capitalized; however, maintenance and repairs which do not improve or extend the useful lives of the respective assets are charged to operations as incurred. Interest capitalized in accordance with SFAS No. 34, “Capitalization of Interest Cost,” was $22.1 million, $19.0 million and $3.0 million for the years ended December 31, 2008, 2007 and 2006, respectively. Net property and equipment additions included in accounts payable decreased $7.9 million for the year ended December 31, 2008, and increased $21.4 million and $16.9 million for the years ended December 31, 2007 and 2006, respectively.
 
The Company also leases certain facilities and equipment under capital leases (see Note 9). Such assets are amortized on a straight-line basis over the lesser of the term of the lease or the remaining useful lives of the applicable assets.
 
Goodwill.  Goodwill represents the excess cost over the fair value of net assets acquired. Goodwill arising from business combinations is accounted for under the provisions of SFAS No. 141, “Business Combinations” (“SFAS No. 141”), and SFAS No. 142, “Goodwill and Other Intangible Assets” (“SFAS No. 142”), and is not amortized. SFAS No. 142 requires goodwill to be evaluated for impairment at the same time every year and when an event occurs or circumstances change such that it is reasonably possible that an impairment may exist. The Company has selected September 30th as its annual testing date.
 
Other Assets.  Other assets consist of costs associated with the issuance of debt, which are included in interest expense over the life of the related debt using the effective interest method, and costs to recruit physicians to the Company’s markets, which are deferred and amortized in amortization expense over the term of the respective physician recruitment contract, which is generally three years. Long-term assets held for sale at December 31, 2008 and 2007 are also included in other assets.
 
Third-Party Reimbursement.  Net patient service revenue is reported at the estimated net realizable amount from patients, third party payors and others for services rendered. Net operating revenues include amounts estimated by management to be reimbursable by Medicare and Medicaid under prospective payment systems, provisions of cost-reimbursement and other payment methods. Approximately 36.6% of net operating revenues for the year ended December 31, 2008, 39.3% of net operating revenues for the year ended December 31, 2007 and 41.5% of net operating revenues for the year ended December 31, 2006, are related to services rendered to patients covered by the Medicare and Medicaid programs. Revenues from Medicare outlier payments are included in the amounts received from Medicare and were approximately 0.55% of net operating revenues for 2008, 0.42% of net operating revenues for 2007, and 0.44% for 2006. In addition, the Company is reimbursed by non-governmental payors using a variety of payment methodologies. Amounts received by the Company for treatment of patients covered by such programs are generally less than the standard billing rates. The differences between the estimated program reimbursement rates and the standard billing rates are accounted for as contractual adjustments, which are deducted from gross revenues to arrive at net operating revenues. These net operating revenues are an estimate of the net realizable amount due from these payors. The process of estimating contractual allowances requires the Company to estimate the amount expected to be received based on payor contract provisions. The key assumption in this process is the estimated contractual reimbursement percentage, which is based on payor classification and historical paid claims data. Due to the complexities involved in these estimates, actual payments the Company receives could be different from the amounts it estimates and records. Final settlements under certain of these programs are subject to adjustment based on administrative review and audit by third parties. Adjustments to the estimated billings are recorded in the periods that such adjustments become known. Adjustments to previous program


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COMMUNITY HEALTH SYSTEMS, INC. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
reimbursement estimates are accounted for as contractual allowance adjustments and reported in the periods that such adjustments become known. Adjustments related to final settlements were insignificant to both net operating revenue and net income in each of the years ended December 31, 2008, 2007 and 2006.
 
Amounts due to third-party payors were $87.9 million and $91.4 million as of December 31, 2008 and 2007, respectively, and are included in accrued liabilities-other in the accompanying consolidated balance sheets. Amounts due from third party payors were $73.6 million and $90.8 million as of December 31, 2008 and 2007, respectively, and are included in other current assets in the accompanying consolidated balance sheets. Substantially all Medicare and Medicaid cost reports are final settled through 2006.
 
Net Operating Revenues.  Net operating revenues are recorded net of provisions for contractual allowance of approximately $26.433 billion, $16.718 billion and $10.024 billion in 2008, 2007 and 2006, respectively. Net operating revenues are recognized when services are provided and are reported at the estimated net realizable amount from patients, third party payors and others for services rendered. Also included in the provision for contractual allowance shown above is the value of administrative and other discounts provided to self-pay patients eliminated from net operating revenues which was $458.6 million, $266.0 million and $100.3 million for the years ended December 31, 2008, 2007 and 2006, respectively. In the ordinary course of business, the Company renders services to patients who are financially unable to pay for hospital care. Included in the provision for contractual allowance shown above is the value (at the Company’s standard charges) of these services to patients who are unable to pay that is eliminated from net operating revenues when it is determined they qualify under the Company’s charity care policy. The value of these services was $380.2 million, $322.2 million and $214.2 million for the years ended December 31, 2008, 2007 and 2006, respectively. In the fourth quarter of 2007, in conjunction with an analysis of the net realizable value of accounts receivable, which included updating the Company’s analysis of historical cash collections, as well as conforming estimation methodologies with those of the hospitals acquired from Triad Hospitals, Inc. (“Triad”), the Company revised its methodology whereby the Company has revised its estimate of contractual allowances for estimated amounts of self-pay accounts receivable that will ultimately qualify as charity care, or that will ultimately qualify for Medicaid, indigent care or other specific governmental reimbursement. Previous estimates of uncollectible amounts for such receivables were included in the Company’s bad debt reserves for each period. The impact of these changes in estimates decreased net operating revenue approximately $96.3 million for the year ended December 31, 2007.
 
Allowance for Doubtful Accounts.  Accounts receivable are reduced by an allowance for amounts that could become uncollectible in the future. Substantially all of the Company’s receivables are related to providing healthcare services to its hospitals’ patients.
 
The Company experienced a significant increase in self-pay volume and related revenue, combined with lower cash collections during the quarter ended September 30, 2006. The Company believes this trend reflected an increased collection risk from self-pay accounts, and as a result the Company performed a review and an alternative analysis of the adequacy of its allowance for doubtful accounts. Based on this review, the Company recorded a $65.0 million increase to its allowance for doubtful accounts to maintain an adequate allowance for doubtful accounts as of September 30, 2006. The Company believed that the increase in self-pay accounts was a result of economic trends, including an increase in the number of uninsured patients, reduced enrollment under Medicaid programs such as TennCare, and higher deductibles and co-payments for patients with insurance.
 
In conjunction with recording the $65.0 million increase to the allowance for doubtful accounts, the Company changed its methodology for estimating its allowance for doubtful accounts effective September 30, 2006, as follows: The Company reserved a percentage of all self-pay accounts receivable without regard to aging category, based on collection history adjusted for expected recoveries and, if present, other changes in trends. For all other payor categories, the Company reserved 100% of all accounts aging over 365 days from the date of discharge. Previously, the Company estimated its allowance for doubtful accounts by reserving all


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COMMUNITY HEALTH SYSTEMS, INC. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
accounts aging over 150 days from the date of discharge without regard to payor class. The Company believes its revised methodology provided a better approach to reflect changes in payor mix and historical collection patterns and to respond to changes in trends.
 
During the quarter ended December 31, 2007, in conjunction with the Company’s ongoing process of monitoring the net realizable value of its accounts receivable, as well as integrating the methodologies, data and assumptions used by the former Triad management, the Company performed various analyses including updating a review of historical cash collections.
 
The primary key cash collection indicator that experienced deterioration during the fourth quarter of 2007 was “cash receipts as a percentage of net revenue less bad debts.” This percentage decreased to the lowest percentage experienced by the Company since the quarter ended September 30, 2006. Further analysis indicated the primary causes of this deterioration were a continuing increase in the volume of indigent non-resident aliens, an increase in the number of patients qualifying for charity care and a greater than expected impact of the removal of participants from TennCare (Tennessee’s state provided Medicaid program) which increased the number of uninsured patients with limited financial means receiving care at the Company’s eight Tennessee hospitals. During the fourth quarter of 2007, due to the deteriorating cash collections and desire to standardize processes with those of the former Triad hospitals, the Company undertook a detailed programming effort to develop data around the deteriorating classes of accounts receivable needed to update its historical cash collections percentages as well as enable it to estimate how much of certain self-pay categories ultimately convert to Medicaid, charity and indigent programs. Triad’s processes for establishing contractual allowances and allowances for bad debts related to accounts classified as Medicaid — pending, charity — pending and indigent non-resident alien included inputs and assumptions based on the historical percentage of these accounts which ultimately qualified for specific government programs or for write-off as charity care.
 
The Company used these new inputs and assumptions regarding Medicaid — pending, charity — pending, and indigent non-resident alien in conjunction with the new data developed in the fourth quarter of 2007 as described above to evaluate the realizability of accounts receivable and to revise the Company’s estimate of contractual allowances for estimated amounts of self-pay accounts receivable that will ultimately qualify as charity care, or that will ultimately qualify for Medicaid, indigent care or other specific governmental reimbursement, resulting in an increase to the Company’s contractual reserves of $96.3 million as of December 31, 2007. Previous estimates of uncollectible amounts for such receivables were included in the Company’s bad debt reserves for each period.
 
Furthermore, in updating the historical collection statistics of all its hospitals, the Company also took into account a detailed study of the historical collection information for the hospitals acquired from Triad. The updated collection statistics of the hospitals acquired from Triad also showed subsequent deterioration in cash collections similar to those experienced by the other hospitals that the Company owns. Therefore, the Company also standardized the processes for calculating the allowance for doubtful accounts of the hospitals acquired from Triad to that of its other hospitals which, along with the allowance percentages determined from the new collection data, resulted in the recording of an additional $70.1 million of allowance for bad debts as of December 31, 2007.
 
The resulting impact of the above, net of taxes, for the year ended December 31, 2007 was a decrease to income from continuing operations of $105.4 million. The Company believes this lower collectability was primarily the result of an increase in the number of patients qualifying for charity care, reduced enrollment in certain state Medicaid programs and an increase in the number of indigent non-resident aliens. Collections are impacted by the economic ability of patients to pay and the effectiveness of the Company’s collection efforts. Significant changes in payor mix, business office operations, economic conditions or trends in federal and state governmental healthcare coverage could affect the Company’s collection of accounts receivable. The process of estimating the allowance for doubtful accounts requires the Company to estimate the collectability of self-pay accounts receivable, which is primarily based on its collection history, adjusted for expected recoveries


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COMMUNITY HEALTH SYSTEMS, INC. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
and, if available, anticipated changes in collection trends. Significant change in payor mix, business office operations, economic conditions, trends in federal and state governmental healthcare coverage or other third party payors could affect the Company’s estimates of accounts receivable collectability.
 
The Company believes the revised methodology provides a better approach to estimating changes in payor mix, continued increases in charity and indigent care as well as the monitoring of historical collection patterns. The revised accounting methodology and the adequacy of resulting estimates will continue to be reviewed by monitoring accounts receivable write-offs, monitoring cash collections as a percentage of trailing net revenues less provision for bad debts, monitoring historical cash collection trends, as well as analyzing current period net revenue and admissions by payor classification, aged accounts receivable by payor, days revenue outstanding, and the impact of recent acquisitions and dispositions.
 
Physician Income Guarantees.  The Company enters into physician recruiting agreements under which it supplements physician income to a minimum amount over a period of time, typically one year, while the physician establishes themselves in the community. As part of the agreements, the physicians are committed to practice in the community for a period of time, typically three years, which extends beyond their income guarantee period. The Company accounts for these agreements in accordance with FASB Staff Position No. 45-3, “Application of FASB Interpretation No. 45 to Minimum Revenue Guarantees Granted to a Business or Its Owners,” (“FIN 45-3”). FIN 45-3 requires that an asset and liability for the estimated fair value of minimum revenue guarantees be recorded on new agreements entered into on or after January 1, 2006. Adjustments to the ultimate value of the guarantee paid to physicians are recognized in the period that the change in estimate is identified. The Company amortizes such costs over the life of the agreement. As of December 31, 2008 and 2007, the unamortized portion of these physician income guarantees was $49.1 million and $45.7 million, respectively.
 
Concentrations of Credit Risk.  The Company grants unsecured credit to its patients, most of whom reside in the service area of the Company’s facilities and are insured under third-party payor agreements. Because of the economic diversity of the Company’s facilities and non-governmental third-party payors, Medicare represents the only significant concentration of credit risk from payors. Accounts receivable, net of contractual allowances, from Medicare were $256.6 million and $302.1 million as of December 31, 2008 and 2007, respectively, representing 9.4% and 11.8% of consolidated net accounts receivable, before allowance for doubtful accounts, as of December 31, 2008 and 2007, respectively.
 
Professional Liability Claims.  The Company accrues for estimated losses resulting from professional liability. The accrual, which includes an estimate for incurred but not reported claims, is based on historical loss patterns and actuarially-determined projections and is discounted to its net present value. To the extent that subsequent claims information varies from management’s estimates, the liability is adjusted when such information becomes available.
 
Accounting for the Impairment or Disposal of Long-Lived Assets.  In accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (“SFAS No. 144”), whenever events or changes in circumstances indicate that the carrying values of certain long-lived assets may be impaired, the Company projects the undiscounted cash flows expected to be generated by these assets. If the projections indicate that the reported amounts are not expected to be recovered, such amounts are reduced to their estimated fair value based on a quoted market price, if available, or an estimate based on valuation techniques available in the circumstances.
 
Income Taxes.  The Company accounts for income taxes under the asset and liability method, in which deferred income tax assets and liabilities are recognized for the tax consequences of “temporary differences” by applying enacted statutory tax rates applicable to future years to differences between the financial statement carrying amounts and the tax bases of existing assets and liabilities. The effect on deferred taxes of a change


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COMMUNITY HEALTH SYSTEMS, INC. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
in tax rates is recognized in the consolidated statement of income during the period in which the tax rate change becomes law.
 
Comprehensive Income (Loss).  Comprehensive income (loss) is the change in equity of a business enterprise during a period from transactions and other events and circumstances from non-owner sources.
 
Accumulated Other Comprehensive Income (Loss) consists of the following (in thousands):
 
                                 
                      Accumulated
 
    Change in Fair
    Change in Fair
    Adjustment
    Other
 
    Value of Interest
    Value of Available
    to Pension
    Comprehensive
 
    Rate Swaps     for Sale Securities     Liability     Income (Loss)  
 
Balance as of December 31, 2006
  $ 13,315     $ 784     $ (8,301 )   $ 5,798  
2007 Activity, net of tax
    (91,063 )     237       3,291       (87,535 )
                                 
Balance as of December 31, 2007
  $ (77,748 )   $ 1,021     $ (5,010 )   $ (81,737 )
                                 
2008 Activity, net of tax
    (200,737 )     (2,613 )     (10,488 )     (213,838 )
                                 
Balance as of December 31, 2008
  $ (278,485 )   $ (1,592 )   $ (15,498 )   $ (295,575 )
                                 
 
Segment Reporting.  SFAS No. 131, “Disclosures About Segments of an Enterprise and Related Information” (“SFAS No. 131”), requires that a public company report annual and interim financial and descriptive information about its reportable operating segments. Operating segments, as defined, are components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and in assessing performance. SFAS No. 131 allows aggregation of similar operating segments into a single reportable operating segment if the businesses have similar economic characteristics and are considered similar under the criteria established by SFAS No. 131.
 
Prior to the acquisition of Triad, the Company aggregated its operating segments into one reportable segment as all of its operating segments had similar services, had similar types of patients, operated in a consistent manner and had similar economic and regulatory characteristics. In connection with the Triad acquisition, certain aspects of the Company’s organizational structure and the information that is reviewed by the chief operating decision maker have changed. As a result, management has determined that the Company now operates in three distinct operating segments, represented by the hospital operations (which includes the Company’s acute care hospitals and related healthcare entities that provide inpatient and outpatient health care services), the home care agencies operations (which provide outpatient care generally in the patient’s home), and the hospital management services business (which provides executive management and consulting services to independent acute care hospitals). SFAS No. 131 requires (1) that financial information be disclosed for operating segments that meet a 10% quantitative threshold of the consolidated totals of net revenue, profit or loss, or total assets; and (2) that the individual reportable segments disclosed contribute at least 75% of total consolidated net revenue. Based on these measures, only the hospital operations segment meets the criteria as a separate reportable segment. Financial information for the home care agencies and management services segments do not meet the quantitative thresholds defined in SFAS No. 131 and are therefore combined with corporate into the all other reportable segment.
 
The financial information from 2006 has been presented in Note 14 to reflect this change in the composition of the Company’s reportable operating segments.
 
Derivative Instruments and Hedging Activities.  In accordance with SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” (“SFAS No. 133”), as amended, the Company records derivative instruments (including certain derivative instruments embedded in other contracts) on the consolidated balance sheet as either an asset or liability measured at its fair value. Changes in a derivative’s fair value are recorded each period in earnings or other comprehensive income (“OCI”), depending on whether the derivative is designated and is effective as a hedged transaction, and on the type of hedge transaction. Changes in the fair value of derivative instruments recorded


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