ARDENT HEALTH SERVICES LLC - 10-Q Quarterly Report

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q


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

		For the quarterly period ended June 30, 2004

		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 333-110117

Ardent Health Services LLC

(Exact Name of Registrant as Specified in its Charter)


Delaware		62-1862223
(State or Other Jurisdiction of		(I.R.S. Employer
Incorporation or Organization)		Identification Number)


One Burton Hills Blvd., Suite 250
Nashville, TN		37215
(Address of Principal Executive Offices)		(Zip Code)

Registrant’s telephone number, including area code: (615) 296-3000

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act: None

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 x No o

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

As of August 12, 2004, there were 69,981,650 of the registrant’s common units outstanding (all of which are privately owned and are not traded on any public market).

PART I
FINANCIAL INFORMATION

Item 1. Financial Statements (Unaudited)

ARDENT HEALTH SERVICES LLC AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

(Dollars in thousands)


	Three Months Ended						Six Months Ended
	June 30,						June 30,
	2004			2003			2004			2003
Revenues:
Net patient service revenue	$	180,144		$	152,196		$	369,987		$	299,973
Premium revenue		157,596			145,575			312,802			288,328
Other revenue		19,473			20,103			40,093			38,957

Total net revenues		357,213			317,874			722,882			627,258
Expenses:
Salaries and benefits		142,055			126,657			288,321			250,201
Professional fees		35,890			32,407			66,013			62,068
Claims and capitation		75,096			67,640			146,317			135,132
Supplies		41,825			37,719			83,812			74,586
Provision for doubtful accounts		15,976			12,290			33,333			23,206
Interest, net		7,042			4,780			13,541			8,459
Change in fair value of interest rate swap agreements		2,624			—			1,389			—
Depreciation and amortization		11,713			7,314			22,529			14,641
Loss (gain) on divestitures		—			310			—			(618	)
Other		29,773			29,545			62,185			56,596

Total expenses		361,994			318,662			717,440			624,271

Income (loss) from continuing operations before income taxes		(4,781	)		(788	)		5,442			2,987
Income tax expense (benefit)		(1,780	)		(302	)		2,123			1,199

Income (loss) from continuing operations, net		(3,001	)		(486	)		3,319			1,788
Discontinued operations:
Loss from discontinued operations		(144	)		(724	)		(444	)		(835	)
Gain on divestitures of discontinued operations		3,622			250			3,622			949

Income (loss) from discontinued operations before income taxes		3,478			(474	)		3,178			114
Income tax expense (benefit)		1,441			(200	)		1,332			44

Income (loss) from discontinued operations, net		2,037			(274	)		1,846			70

Net income (loss)		(964	)		(760	)		5,165			1,858
Accrued preferred dividends		2,203			2,017			4,377			3,964

Net income available for (loss attributable to) common members	$	(3,167	)	$	(2,777	)	$	788		$	(2,106	)

See accompanying notes to unaudited condensed consolidated financial statements.

ARDENT HEALTH SERVICES LLC AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

(Dollars in thousands)


	June 30,			December 31,
	2004			2003
ASSETS
Current assets:
Cash and cash equivalents	$	122,711		$	89,762
Accounts receivable, less allowance for doubtful accounts of $64,806 at June 30, 2004 and $42,438 at December 31, 2003		135,039			116,515
Premiums receivable		10,890			14,733
Inventories		16,973			16,759
Deferred income taxes		30,697			27,792
Prepaid expenses and other current assets		37,247			31,514
Assets held for sale		—			3,336
Income tax receivable		2,453			2,128

Total current assets		356,010			302,539
Property, plant and equipment, net		366,597			365,321
Goodwill		75,529			75,529
Other intangible assets		45,866			48,289
Deferred income taxes		5,654			5,682
Other assets		19,015			20,644

Total assets	$	868,671		$	818,004

LIABILITIES AND MEMBERS’ EQUITY
Current liabilities:
Current installments of long-term debt	$	2,170		$	2,082
Accounts payable		54,011			53,301
Medical claims payable		44,259			45,751
Accrued salaries and benefits		48,493			44,692
Accrued interest		9,473			10,133
Unearned premiums		3,194			15,399
Other accrued expenses and liabilities		22,445			25,771

Total current liabilities		184,045			197,129
Long-term debt, less current installments		258,439			259,361
Other long-term liabilities		6,541			6,573
Self-insured liabilities		32,018			21,920

Total liabilities		481,043			484,983
Redeemable preferred units and accrued dividends, $3.43 unit price, $3.43 per unit redemption value; authorized, issued, and outstanding: 28,141,807 units		116,308			111,931
Members’ equity:
Authorized: 80,532,766 units at June 30, 2004 and 69,961,407 units at December 31, 2003; issued and outstanding: 68,107,299 units at June 30, 2004 and 56,998,444 units at December 31, 2003		273,773			224,331
Accumulated deficit		(2,453	)		(3,241	)

Total members’ equity		271,320			221,090

Total liabilities and members’ equity	$	868,671		$	818,004

See accompanying notes to unaudited condensed consolidated financial statements.

ARDENT HEALTH SERVICES LLC AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(Dollars in thousands)


	Six Months Ended
	June 30,
	2004			2003

Cash flows from operating activities:
Income from continuing operations, net	$	3,319		$	1,788
Adjustments to reconcile income from continuing operations, net, to net cash provided by (used in) operating activities, net of acquisitions and divestitures:
Provision for doubtful accounts		33,333			23,206
Change in fair value of interest rate swap agreements		1,389			—
Depreciation and amortization		22,529			14,641
Gain on divestitures		—			(618	)
Amortization of deferred financing costs		1,019			2,378
Deferred income taxes		(3,753	)		(6,110	)
Changes in operating assets and liabilities:
Accounts receivable		(52,121	)		(22,936	)
Other current assets		(1,669	)		777
Income tax receivable (payable)		(325	)		6,003
Accounts payable and accrued expenses		(13,004	)		(12,971	)
Self-insured liabilities		10,633			4,147
Medical claims payable		(1,492	)		5,241

Net cash provided by (used in) operating activities		(142	)		15,546
Net cash provided by (used in) discontinued operations		(1,253	)		211
Cash flows from investing activities:
Investments in acquisitions, less cash acquired		—			(194,117	)
Purchases of property, plant and equipment, net		(20,288	)		(27,431	)
Proceeds from divestitures		5,972			6,311
Other		505			2,584

Net cash used in investing activities		(13,811	)		(212,653	)
Cash flows from financing activities:
Change in revolving line of credit		—			(11,443	)
Proceeds from long-term debt		—			148,500
Payments on long-term debt		(1,047	)		(29,804	)
Debt financing costs paid		(784	)		(4,587	)
Proceeds from issuance of common and preferred units		49,986			11,487
Common unit issuance costs		—			(1,982	)

Net cash provided by financing activities		48,155			112,171

Net increase (decrease) in cash and cash equivalents		32,949			(84,725	)
Cash and cash equivalents, beginning of period		89,762			113,859

Cash and cash equivalents, end of period	$	122,711		$	29,134

See accompanying notes to unaudited condensed consolidated financial statements.

ARDENT HEALTH SERVICES LLC AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

June 30, 2004

1. Basis of Presentation and Organization

Ardent Health Services LLC is a holding company whose affiliates own and operate hospitals and related health care entities. The term “affiliates” includes direct and indirect subsidiaries of Ardent Health Services LLC and partnerships and joint ventures in which such subsidiaries are partners. At June 30, 2004, these affiliates owned and operated seven acute care hospitals (including one inpatient rehabilitation hospital), 20 behavioral hospitals, and other related health care businesses. The fully integrated health care delivery system in Albuquerque, New Mexico (the “Lovelace Sandia Health System”) comprises five of the seven acute care hospitals and includes an approximately 164,000 member health plan (the “Lovelace Health Plan” or the “Health Plan”), approximately 335 employed physicians, 15 primary care clinics and a full service reference laboratory. The terms “Ardent” or the “Company,” as used in this Quarterly Report on Form 10-Q, refer to Ardent Health Services LLC and its affiliates unless stated otherwise or indicated by context.

The unaudited condensed consolidated financial statements have been prepared in conformity with U.S. generally accepted accounting principles for interim financial reporting and in accordance with Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and notes required by U.S. generally accepted accounting principles for complete financial statements.

In the opinion of management, the unaudited condensed consolidated financial statements reflect all material adjustments (consisting of normal recurring items) necessary for a fair presentation of the financial position and the results of operations for the periods presented. The results of operations for the periods presented are not necessarily indicative of the expected results for the year ending December 31, 2004. The interim unaudited condensed consolidated financial statements should be read in connection with the audited consolidated financial statements as of and for the year ended December 31, 2003, included in the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission.

The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the accompanying unaudited condensed consolidated financial statements and notes. Actual results could differ from those estimates.

Certain prior year amounts have been reclassified to conform to the current year presentation. Additionally, certain prior year amounts have been reclassified due to accounting for discontinued operations in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 144, Accounting for the Impairment and Disposal of Long-Lived Assets. Refer to Note 3 for further discussion.

As none of the Company’s common units are publicly held, no earnings per share information is presented in the accompanying unaudited condensed consolidated financial statements. The majority of the Company’s expenses are “cost of revenue” items.

2. Recently Issued Accounting Standards

In May 2003, the Financial Accounting Standards Board (the “FASB”) issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity (“SFAS No. 150”). SFAS No. 150 requires issuers to classify as liabilities, or assets in some circumstances, three classes of freestanding financial instruments that embody obligations of the issuer. Generally, SFAS No. 150 was effective for financial instruments entered into or modified after May 31, 2003 and was otherwise effective for interim periods beginning after June 15, 2003. For mandatorily redeemable financial instruments, as defined by SFAS No. 150, the statement is effective for fiscal periods beginning after December 15, 2003. Prior to being amended, the Company’s mandatorily redeemable preferred units would have been reflected as a liability effective January 1, 2004. However, in January 2004, the

holders of the Company’s common units and mandatorily redeemable preferred units voted to delete the mandatory redemption feature of the preferred units. Therefore, the application of SFAS No. 150 did not have a material effect on the Company’s financial position or results of operations.

In December 2003, the FASB issued Interpretation No. 46 (revised December 2003), Consolidation of Variable Interest Entities (“FIN46R”). FIN46R replaces Interpretation No. 46, Consolidation of Variable Interest Entities, an interpretation of ARB No. 51, which was issued in January 2003. FIN46R addresses the consolidation by business enterprises of variable interest entities as defined within FIN46R. The Company must immediately apply the provisions of FIN46R to variable interests in variable interest entities created after December 31, 2003. The Company must apply the provisions of FIN46R to all other variable interests in variable interest entities by January 1, 2005. The application of FIN46R did not have and is not expected to have a material effect on the Company’s financial position or results of operations.

3. Acquisitions, Divestitures and Joint Venture

Acquisitions

Acquisitions are accounted for using the purchase method of accounting as prescribed by SFAS No. 141, Business Combinations, and the results of operations are included in the accompanying unaudited condensed consolidated statements of operations from the respective dates of acquisition.

Effective January 1, 2003, the Company acquired Lovelace Health Systems, Inc. (“Lovelace”) in Albuquerque, New Mexico from CIGNA Health Plan (“Cigna”). The aggregate purchase price of $209.4 million plus acquisition costs was paid in cash and was financed with debt issued in 2003 and equity issued in 2002. In conjunction with the acquisition, certain post-closing items have resulted in a dispute with Cigna related to a net worth settlement provision. The dispute, when resolved, could result in a change to the purchase price. The Company expects the dispute to be resolved during 2004.

Effective October 8, 2003, the Company acquired the 146-bed Northwestern Institute of Psychiatry (renamed Brooke Glen), a private behavioral health services facility in Fort Washington, Pennsylvania, for $7.7 million, plus acquisition costs. The purchase price was paid in cash and funded from the proceeds of $225.0 million senior subordinated notes issued in August 2003.

Subsequent to June 30, 2004, the Company completed certain previously announced acquisitions. Refer to Note 9 for further discussion.

Divestitures

Effective April 1, 2004, the Company sold a behavioral hospital for consideration of approximately $6.1 million, which resulted in a pretax gain of $3.6 million recorded during the three months ended June 30, 2004. The hospital’s results of operations, including gain on divestiture, and net assets are included in income from discontinued operations and assets held for sale, respectively, for the periods presented in the accompanying unaudited condensed consolidated financial statements in accordance with SFAS No. 144.

For the six months ended June 30, 2003, the Company recorded pretax gains of $949,000, which included pretax gains of $250,000 recorded during the three months ended June 30, 2003, from the sale of one behavioral hospital and recoveries of fully reserved items related to a behavioral hospital sold in 2002. The hospitals were identified as held for sale under SFAS No. 144, under which the results of operations and related gains on divestitures are included in income from discontinued operations in the accompanying unaudited condensed consolidated statements of operations.

For the six months ended June 30, 2003, the Company also recorded pretax gains of $618,000, which included a pretax loss of $310,000 recorded during the three months ended June 30, 2003, from the sales of two behavioral hospitals. The hospitals were previously identified as held for sale under SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of (“SFAS No. 121”), under which the net gains are recorded in the accompanying unaudited condensed consolidated statements of operations as gains on divestitures and the historical results of operations and financial position are not reclassified as discontinued operations.

Joint Venture

On June 9, 2004 the Company entered into a letter of intent with Ochsner Clinic Foundation to partner in the ownership of Summit Hospital in Baton Rouge, Louisiana. The Company has solely owned Summit Hospital since July 2001, and accordingly consolidates the accounts and results of operations of the hospital. Subject to closing conditions, the transaction is expected to be completed by the fall of 2004, at which time management expects to account for the Company’s noncontrolling interest in Summit Hospital as an equity-method investment.

Pro Forma Results of Operations

The pro forma effect of the Company’s acquisitions and divestitures on the Company’s results of operations for the periods prior to the respective transaction dates was not significant for the periods presented. Refer to the unaudited Pro Forma Condensed Consolidated Financial Statements included elsewhere in this Form 10-Q for further discussion.

4. Long-Term Debt and Financing Arrangements

Long-term debt includes the following (in thousands):


	June 30,			December 31,
	2004			2003
Senior subordinated notes (interest at 10.0%)	$	225,000		$	225,000
Subordinated debt (interest at 10.2%), net of unamortized discount of $3.8 million and $4.0 million at June 30, 2004 and December 31, 2003, respectively		32,209			31,996
Bank facilities (interest on revolving line of credit at LIBOR plus 3.75%)		—			—
Notes payable		2,316			3,157
Other		1,084			1,290

Total long-term debt		260,609			261,443
Less current installments		(2,170	)		(2,082	)

Long-term debt, less current installments	$	258,439		$	259,361

Subsequent to June 30, 2004, the Company borrowed an additional $300.0 million of senior secured term debt in connection with the acquisition of Hillcrest HealthCare System and increased its senior secured revolving line of credit to $150.0 million. Refer to Note 9 for further discussion.

Interest Rate Swap Agreements

In September 2003, the Company entered into four interest rate swap agreements with financial institutions to convert a notional amount of $80.0 million of the $225.0 million fixed-rate borrowings under the 10.0% senior subordinated notes into floating-rate borrowings. The swap agreements mature in $40.0 million increments on August 15, 2006 and August 15, 2008. The floating interest rate is based on six month LIBOR plus a margin and is determined for the six months ended in arrears on semi-annual settlement dates of February 15 and August 15.

As the interest rate swap agreements do not qualify for hedge accounting under the provisions of SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, changes in the fair value of the Company’s interest rate hedging arrangements are recognized each period in earnings. The fair value of the swap obligations was a liability of $831,000 at June 30, 2004 and is included in other accrued expenses and liabilities in the accompanying unaudited condensed consolidated balance sheet. On August 5, 2004, the Company terminated its interest rate swap agreements, resulting in a payment of $267,000, which was the fair market value of the related liability.

5. Stock-Based Compensation


	Three Months Ended						Six Months Ended
	June 30,						June 30,
	2004			2003			2004			2003
Net income (loss), as reported	$	(964	)	$	(760	)	$	5,165		$	1,858
Less total unit-based employee compensation expense determined under fair-value based method for all awards, net of tax		(345	)		(313	)		(696	)		(541	)

Pro forma net income (loss)	$	(1,309	)	$	(1,073	)	$	4,469		$	1,317

The effect of applying SFAS No. 123 for providing pro forma disclosure is not likely to be representative of the effect on reported net income for future years.

The weighted average fair values of the Company’s options granted during the three months ended June 30, 2004 and 2003 were $1.63 and $1.36, respectively. The weighted average fair values of the Company’s options granted during the six months ended June 30, 2004 and 2003 were $1.57 and $1.37, respectively. The fair value of each option grant is estimated on the date of grant using a minimum value option pricing model. The weighted average assumptions used for grants are as follows:


	Three Months Ended						Six Months Ended
	June 30,						June 30,
	2004			2003			2004			2003
Risk-free investment interest rate		4.6	%		3.6	%		4.3	%		3.7	%
Expected life in years		10			10			10			10
Expected dividend yield		—			—			—			—

6. Segment Information

The Company’s acute care hospitals and related health care businesses are similar in their activities and the economic environments in which they operate (i.e., urban and suburban markets). Accordingly, the Company’s reportable operating segments consist of (1) acute care hospitals and related health care businesses, (2) the Lovelace Health Plan and (3) behavioral hospitals. The “Other” segment column below consists of centralized services including information services, reimbursement, accounting, taxation, legal, internal audit and risk management as well as the Company’s wholly-owned insurance subsidiary.

Total net revenue within the consolidated acute care services segment prior to January 1, 2004 excludes patient service revenue for services provided to the Lovelace Health Plan members. During 2003, the Health Plan did not qualify as a separate operating segment in accordance with the criteria set forth by SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information. However, beginning on January 1, 2004, the Company managed the Health Plan as a separate operating segment and the acute care services segment excluded the operations of the Health Plan and included patient service revenue related to services rendered at the Company’s acute care hospitals to its Health Plan members. The Company’s management believes this allows them to better manage the businesses within the Company and make better financial and operational decisions. As a result of this change in the Company’s management of these operations, the Health Plan business is a separate reportable segment in 2004. However, due to system limitations, it is impractical to restate the Company’s segment information for the three months and six months ended June 30, 2003 to correspond with this change in reportable segments. For purposes of comparability, the Company’s segment information for the three months and six months ended June 30, 2004 includes the consolidated acute care services segment consistent with the basis of segmentation in effect prior to January 1, 2004.

Adjusted EBITDA represents income from continuing operations, net, before interest, change in fair value of interest rate swap agreements, depreciation and amortization and income tax expense. Adjusted EBITDA for the Company’s segment information is presented because the Company’s management uses it as a measure of segment performance and as a useful indicator with which to allocate resources among segments. Additionally, the Company’s management believes it is a useful measure of its liquidity. Adjusted EBITDA for the Company on a consolidated basis, subject to certain adjustments, is also used as a measure in certain of the covenants in the Company’s senior secured credit facility and the indenture governing its subsidiary’s 10.0% Senior Subordinated Notes due 2013. Adjusted EBITDA should not be considered in isolation from, and is not intended as an alternative measure of, net income or cash flow from operations, each as determined in accordance with accounting principles generally accepted in the United States. Adjusted EBITDA is not necessarily comparable to similarly titled measures used by other companies.

The following is a financial summary by business segment for the periods indicated (in thousands):


	For the Three Months Ended June 30, 2004
								Consolidated
	Acute		Lovelace					Acute		Behavioral
	Care		Health					Care		Care
	Services		Plan		Eliminations			Services		Services		Other			Eliminations			Total
Total net revenues	$	183,792	$	161,152	$	(60,741	)	$	284,203	$	74,042	$	—		$	(1,032	)	$	357,213
Adjusted EBITDA		7,756		7,485		—			15,241		11,984		(10,627	)		—			16,598
Segment assets		448,125		87,919		—			536,044		142,309		190,318			—			868,671
Goodwill		64,169		—		—			64,169		11,360		—			—			75,529
Other identifiable intangible assets		—		45,866		—			45,866		—		—			—			45,866
Capital expenditures		4,932		1,902		—			6,834		2,369		1,766			—			10,969

								For the Three Months Ended June 30, 2003
								Consolidated		Behavioral
								Acute Care		Care
								Services		Services		Other			Eliminations			Total
Total net revenues								$	249,666	$	68,809	$	—		$	(601	)	$	317,874
Adjusted EBITDA									8,332		13,008		(10,034	)		—			11,306
Segment assets									478,779		127,176		72,742			—			678,697
Goodwill									62,990		11,360		—			—			74,350
Other identifiable intangible assets									48,350		—		—			—			48,350
Capital expenditures									14,257		1,851		3,467			—			19,575

	For the Six Months Ended June 30, 2004
								Consolidated
	Acute		Lovelace					Acute		Behavioral
	Care		Health					Care		Care
	Services		Plan		Eliminations			Services		Services		Other			Eliminations			Total
Total net revenues	$	380,393	$	319,730	$	(122,860	)	$	577,263	$	147,969	$	—		$	(2,350	)	$	722,882
Adjusted EBITDA		25,669		14,370		—			40,039		23,566		(20,704	)		—			42,901
Capital expenditures		6,684		3,614		—			10,298		4,897		5,093			—			20,288

								For the Six Months Ended June 30, 2003
								Consolidated		Behavioral
								Acute Care		Care
								Services		Services		Other			Eliminations			Total
Total net revenues								$	493,328	$	135,484	$	—		$	(1,554	)	$	627,258
Adjusted EBITDA									17,613		26,147		(17,673	)		—			26,087
Capital expenditures									20,793		2,905		3,733			—			27,431

The following is a reconciliation of Adjusted EBITDA to cash flows from operating activities (in thousands):


	Three Months Ended						Six Months Ended
	June 30,						June 30,
	2004			2003			2004			2003
Net cash provided by (used in) operating activities	$	24,153		$	6,173		$	(142	)	$	15,546
Changes in working capital items and other		(29,191	)		(6,385	)		1,615			(13,828	)
Income (loss) from discontinued operations, net		2,037			(274	)		1,846			70

Income (loss) from continuing operations, net		(3,001	)		(486	)		3,319			1,788
Interest, net		7,042			4,780			13,541			8,459
Change in fair value of interest rate swap agreements		2,624			—			1,389			—
Depreciation and amortization		11,713			7,314			22,529			14,641
Income tax expense (benefit)		(1,780	)		(302	)		2,123			1,199

Adjusted EBITDA	$	16,598		$	11,306		$	42,901		$	26,087

7. Members’ Equity

The Company entered into a subscription agreement with Welsh, Carson, Anderson and Stowe IX, L.P. (“WCAS”) and FFC Partners II, L.P. (“Ferrer Freeman”) on December 11, 2002, pursuant to which WCAS and Ferrer Freeman have the right, under certain circumstances, in WCAS’s discretion, to purchase up to an aggregate of $165.0 million of the Company’s common units at a purchase price of $4.50 per common unit. The subscription agreement was amended in February 2003 to add BancAmerica Capital Investors I, L.P. (“BAC”) as a purchaser of up to an additional $10.0 million of common units at the same purchase price per common unit. Pursuant to the subscription agreement, as amended, WCAS, Ferrer Freeman and BAC had invested a total of $116.7 million at December 31, 2003, and had the right, under certain circumstances, at WCAS’s discretion, to invest up to an additional $58.3 million.

In a series of transactions beginning on June 30, 2004, WCAS, Ferrer Freeman and BAC exercised the right to invest an additional $58.3 million, pursuant to the subscription agreement. On June 30, 2004, the Company issued 11,111,109 common member units to WCAS and related investors for $50.0 million, or $4.50 per common unit. Such transaction is reflected in the Company’s financial position at June 30, 2004. On July 2, 2004, the Company issued 1,851,851 common member units to Ferrer Freeman and BAC for $8.3 million, or $4.50 per common unit. Such transaction was recorded subsequent to June 30, 2004 and is not reflected in the Company’s financial position at June 30, 2004. The Company used the majority of the proceeds to fund, in part, the acquisition of Hillcrest HealthCare System. Refer to Note 9 for further discussion of the acquisition.

8. Commitments and Contingencies

Capital Expenditure Commitments

In connection with the acquisitions in the Albuquerque market, the Company has committed to the previous owners to invest $80.0 million in capital expenditures in the Albuquerque market through 2008. The Company had invested $58.9 million through June 30, 2004. In connection with the acquisition of Hillcrest HealthCare System, the Company committed to invest approximately $100.0 million in capital expenditures in the Tulsa market over the next five years.

Net Revenue

The Medicare and Medicaid regulations and various managed care contracts under which the discounts from the Company’s standard charges must be calculated are complex and are subject to interpretation and adjustment. The Company estimates the allowance for contractual discounts on a payor-specific basis given its interpretation of the applicable regulations or contract terms. However, the services authorized and provided and resulting reimbursements are often subject to interpretation. These interpretations sometimes result in payments that differ

from the Company’s estimates. Additionally, updated regulations and contract renegotiations occur frequently necessitating continual review and assessment of the estimation process by management.

The Company has recently received notice from a state Medicaid program that certain amounts paid by the program to one of the Company’s behavioral hospitals in prior years were paid in error and that the Company owes the amounts back to the program. The Company believes that it has fully complied with both the applicable laws and previous agreements established with the program during previous years and that final resolution of these disputed amounts will not have a material adverse effect on the Company’s business, results of operations or financial position.

The final determination of amounts earned under Medicare and Medicaid programs often does not occur until fiscal years subsequent to submission of claims due to audits by the administering agency, rights of appeal and the application of numerous technical provisions. Differences between original estimates and subsequent revisions, including final settlements, are included in the results of operations of the period in which the revisions are made. Adjustments to estimated settlements resulted in increases to net patient service revenue of $1.7 million and $668,000 for the three months ended June 30, 2004 and 2003, respectively, and $2.1 million and $1.1 million for the six months ended June 30, 2004 and 2003, respectively.

Litigation and Regulatory Matters

From time to time, claims and suits arise in the ordinary course of the Company’s business. In certain of these actions, plaintiffs request punitive or other damages against the Company that may not be covered by insurance. The Company does not believe that it is a party to any proceeding that, in management’s opinion, would have a material adverse effect on the Company’s business, financial condition or results of operations.

Acquisitions

The Company has acquired and plans to continue to acquire businesses with prior operating histories. Acquired companies may have unknown or contingent liabilities, including liabilities for failure to comply with health care laws and regulations, such as billing and reimbursement, fraud and abuse and anti-kickback laws. The Company has from time to time identified certain past practices of acquired companies that do not conform to its standards. Although the Company institutes policies designed to conform such practices to its standards following completion of acquisitions, there can be no assurance that the Company will not become liable for the past activities of these acquired facilities that may later be asserted to be improper by private plaintiffs or government agencies. Although the Company generally seeks to obtain indemnification from prospective sellers covering such matters, there can be no assurance that any such matter will be covered by indemnification, or if covered, that such indemnification will be adequate to cover potential losses and fines.

9. Subsequent Events

Acquisitions

Effective August 1, 2004, the Company completed its previously announced transaction with Molina Healthcare, Inc. to transfer approximately 30,000 commercial members of Cimarron Health Plan (“Cimarron”) to the Lovelace Health Plan, which is part of Lovelace Sandia Health System, Inc., for approximately $16.0 million, plus additional contingent consideration of up to $3.5 million subject to the satisfaction of certain conditions. The Company funded the transaction with available cash on hand.

On August 12, 2004, the Company completed its previously announced acquisition of Hillcrest HealthCare System (“Hillcrest”) in Tulsa, Oklahoma. The Company acquired substantially all of the net operating assets of Hillcrest for $326.3 million, including preliminary working capital, subject to customary adjustments. The acquisition consisted primarily of two metropolitan Tulsa hospitals and related health care entities, as well as six regional hospitals acquired or intended to be acquired through long-term operating agreements. In connection with the Hillcrest acquisition, the Company committed to invest approximately $100.0 million in capital expenditures in the Tulsa market over the next five years. The aggregate purchase price of the acquisition was paid in cash and financed, in part, with the $58.3 million of proceeds invested by WCAS, Ferrer Freeman, BAC and related investors pursuant to the aforementioned subscription agreement with the Company and cash on hand. The remaining purchase price was financed through an additional borrowing of senior secured term debt on August 12, 2004 in the principal amount of $300.0 million, as further discussed below.

The Company is currently in the process of allocating the respective purchase prices of the Cimarron and Hillcrest acquisitions to the fair market value of assets acquired and liabilities assumed, subject to working capital adjustments, valuation of fixed assets, and identification and valuation of identifiable intangible assets.

In connection with the Company’s recent acquisitions, the Company’s management began evaluating its information systems in the acute care segment, primarily related to patient accounting and clinical information systems, to determine the feasibility of moving to a single operating platform across its acute care hospitals. Management has evaluated the carrying amounts of the related information system assets for recoverability and does not believe any indicators of impairment exist. However, should events, changes in circumstances or other indicators of potential impairment exist in the future, the Company may be required to record impairment charges on long-lived assets, which could have a material adverse effect on its results of operations and financial condition.

Long-term Debt

On August 12, 2004, the Company amended its August 2003 Credit Agreement to, among other things, increase its $125.0 million revolving line of credit to a $150.0 million revolving line of credit and add $300.0 million of additional borrowing available under an add-on term loan (“Term Loan B”). The Company also retained the $200.0 million of incremental term loans available, under certain conditions, under the existing August 2003 Credit Agreement. Concurrent with the amendment, the Company received $300.0 million through borrowings of the amount available under Term Loan B. Interest on Term Loan B is payable quarterly at an interest rate of either LIBOR plus 2.25% or a base rate plus 1.25%. Principal payments of 0.25% of the original principal borrowed on Term Loan B are to be paid quarterly, with the remaining principal to be paid at maturity. Term Loan B matures August 12, 2011. The revolving line of credit bears interest initially at LIBOR plus 2.50%. The interest on the revolving line of credit is payable on the outstanding principal balance on the last day of the selected interest period. The principal amount of the revolving line of credit is to be paid in full on August 19, 2008. The Company has not incurred borrowings under the revolving line of credit or incremental term loans as of August 16, 2004; other than standby letters of credit totaling $10.4 million that reduce the amount available under the revolving line of credit.

The Company continues to pay a commitment fee ranging from 0.50% to 0.75% of the average daily amount of availability under the revolving credit facility and other fees based on the applicable LIBOR margin on outstanding standby letters of credit. The August 2003 Credit Agreement, as amended, contains various financial covenants including requirements for the Company to maintain a minimum interest coverage ratio, a total leverage ratio, a senior leverage ratio, a minimum net worth of the health maintenance organization affiliates and a capital expenditures maximum. The August 2003 Credit Agreement, as amended, also restricts certain activities of the Company, including its ability to incur additional debt, declare dividends, repurchase stock, engage in mergers or acquisitions and sell assets. The August 2003 Credit Agreement, as amended, is guaranteed by the Company and its material and future affiliates, other than Lovelace Sandia Health System, Inc. and the Company’s captive insurance affiliate, and is secured by substantially all of the Company’s existing and future property and assets and capital stock of all of the Company’s affiliates.

In connection with the merger of the Company’s New Mexico affiliates on October 1, 2003, Lovelace Sandia Health System, Inc. (the surviving entity) issued a $70.0 million intercompany note to Ardent Health Services, Inc. The Company was required to maintain a pledge of the intercompany note in favor of the lenders of the Company’s August 2003 Credit Agreement and the holders of the Company’s $225.0 million senior subordinated notes. On July 12, 2004, the August 2003 Credit Agreement was amended to, among other things, reduce the pledge required to be maintained by the Company to $43.0 million, upon which the intercompany note was also amended to reduce the principal amount of the note to $43.0 million.

Divestitures

Effective July 31, 2004, the Company sold its Lovelace Home Health operations for $200,000 in cash, subject to certain adjustments, which is expected to result in a minimal gain. The entity was identified as held for sale during the three months ended June 30, 2004. Accordingly, the entity’s results of operations are included in income (loss) from discontinued operations for all periods presented in the accompanying unaudited condensed consolidated statements of operations.

10. Financial Information for the Company and Its Subsidiaries

The Company’s $225.0 million senior subordinated notes are fully and unconditionally guaranteed on a joint and several basis by all of the Company’s material subsidiaries except for entities comprising Lovelace Sandia Health System, Inc. and RIVID Insurance Company Ltd., the Company’s wholly-owned captive insurance subsidiary.

The Company conducts substantially all of its business through its subsidiaries. Presented below are condensed consolidating balance sheets as of June 30, 2004 and December 31, 2003, condensed consolidating statements of operations for the three months and six months ended June 30, 2004 and June 30, 2003 and condensed consolidating statements of cash flows for the six months ended June 30, 2004 and June 30, 2003 for the Company and its subsidiaries. The information segregates the parent company (“Ardent Health Services LLC”), the issuer of the senior subordinated notes (“Ardent Health Services, Inc.”), the combined Subsidiary Guarantors, the combined Non-Guarantors (the entities comprising Lovelace Sandia Health System, Inc. and RIVID Insurance Company Ltd.), and eliminations. The issuer and each of the Subsidiary Guarantors and Non-Guarantors are 100% owned, directly or indirectly, by Ardent Health Services LLC.

ARDENT HEALTH SERVICES LLC AND SUBSIDIARIES
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
Three Months Ended June 30, 2004
(Dollars in thousands)


							Subsidiary			Non-						Condensed
	Parent			Issuer			Guarantors			Guarantors			Eliminations			Consolidated

Revenues:
Net patient service revenue	$	—		$	—		$	92,907		$	87,237		$	—		$	180,144
Premium revenue		—			—			—			157,586			10			157,596
Other revenue		(964	)		7,096			17,342			11,004			(15,005	)		19,473

Total net revenues		(964	)		7,096			110,249			255,827			(14,995	)		357,213
Expenses:
Salaries and benefits		—			—			65,991			76,090			(26	)		142,055
Professional fees		—			—			11,832			30,501			(6,443	)		35,890
Claims and capitation		—			—			—			75,818			(722	)		75,096
Supplies		—			—			12,436			29,389			—			41,825
Provision for doubtful accounts		—			—			6,009			9,967			—			15,976
Interest, net		—			5,436			216			1,390			—			7,042
Change in fair value of interest rate swap agreements		—			2,624			—			—			—			2,624
Depreciation and amortization		—			—			5,441			6,272			—			11,713
Other		—			—			5,324			24,921			(472	)		29,773

Total expenses		—			8,060			107,249			254,348			(7,663	)		361,994

Income (loss) from continuing operations before income taxes		(964	)		(964	)		3,000			1,479			(7,332	)		(4,781	)
Income tax expense (benefit)		—			—			(1,780	)		—			—			(1,780	)

Income (loss) from continuing operations, net		(964	)		(964	)		4,780			1,479			(7,332	)		(3,001	)
Discontinued operations:
Income (loss) from discontinued operations		—			—			3,894			(416	)		—			3,478
Income tax expense (benefit)		—			—			1,572			(131	)		—			1,441

Income (loss) from discontinued operations, net		—			—			2,322			(285	)		—			2,037

Net income (loss)		(964	)		(964	)		7,102			1,194			(7,332	)		(964	)
Accrued preferred dividends		2,203			—			—			—			—			2,203

Net income available for (loss attributable to) common members	$	(3,167	)	$	(964	)	$	7,102		$	1,194		$	(7,332	)	$	(3,167	)

ARDENT HEALTH SERVICES LLC AND SUBSIDIARIES
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
Six Months Ended June 30, 2004
(Dollars in thousands)


					Subsidiary		Non-						Condensed
	Parent		Issuer		Guarantors		Guarantors			Eliminations			Consolidated

Revenues:
Net patient service revenue	$	—	$	—	$	185,053	$	184,934		$	—		$	369,987
Premium revenue		—		—		—		312,802			—			312,802
Other revenue		5,165		17,134		39,377		24,419			(46,002	)		40,093

Total net revenues		5,165		17,134		224,430		522,155			(46,002	)		722,882
Expenses:
Salaries and benefits		—		—		130,226		158,144			(49	)		288,321
Professional fees		—		—		22,893		56,540			(13,420	)		66,013
Claims and capitation		—		—		—		148,011			(1,694	)		146,317
Supplies		—		—		24,362		59,450			—			83,812
Provision for doubtful accounts		—		—		11,615		21,718			—			33,333
Interest, net		—		10,580		214		2,747			—			13,541
Change in fair value of interest rate swap agreements		—		1,389		—		—			—			1,389
Depreciation and amortization		—		—		10,093		12,436			—			22,529
Other		—		—		8,191		54,940			(946	)		62,185

Total expenses		—		11,969		207,594		513,986			(16,109	)		717,440

Income (loss) from continuing operations before income taxes		5,165		5,165		16,836		8,169			(29,893	)		5,442
Income tax expense		—		—		2,123		—			—			2,123

Income (loss) from continuing operations, net		5,165		5,165		14,713		8,169			(29,893	)		3,319
Discontinued operations:
Income (loss) from discontinued operations		—		—		4,088		(910	)		—			3,178
Income tax expense (benefit)		—		—		1,650		(318	)		—			1,332

Income (loss) from discontinued operations, net		—		—		2,438		(592	)		—			1,846

Net income (loss)		5,165		5,165		17,151		7,577			(29,893	)		5,165
Accrued preferred dividends		4,377		—		—		—			—			4,377

Net income available for common members	$	788	$	5,165	$	17,151	$	7,577		$	(29,893	)	$	788

ARDENT HEALTH SERVICES LLC AND SUBSIDIARIES
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
Three Months Ended June 30, 2003
(Dollars in thousands)


							Subsidiary			Non-						Condensed
	Parent			Issuer			Guarantors			Guarantors			Eliminations			Consolidated

Revenues:
Net patient service revenue	$	—		$	—		$	83,897		$	68,299		$	—		$	152,196
Premium revenue		—			—			—			145,575			—			145,575
Other revenue		(760	)		3,725			5,432			9,566			2,140			20,103

Total net revenues		(760	)		3,725			89,329			223,440			2,140			317,874
Expenses:
Salaries and benefits		—			—			54,057			72,600			—			126,657
Professional fees		—			—			13,103			21,391			(2,087	)		32,407
Claims and capitation		—			—			—			67,640			—			67,640
Supplies		—			—			10,173			27,546			—			37,719
Provision for doubtful accounts		—			—			4,428			7,862			—			12,290
Interest, net		—			4,485			(152	)		447			—			4,780
Depreciation and amortization		—			—			2,396			4,918			—			7,314
Loss on divestitures		—			—			310			—			—			310
Other		—			—			1,791			27,806			(52	)		29,545

Total expenses		—			4,485			86,106			230,210			(2,139	)		318,662

Income (loss) from continuing operations before income taxes		(760	)		(760	)		3,223			(6,770	)		4,279			(788	)
Income tax expense (benefit)		—			—			(302	)		—			—			(302	)

Income (loss) from continuing operations, net		(760	)		(760	)		3,525			(6,770	)		4,279			(486	)
Discontinued operations:
Income from discontinued operations		—			—			291			(765	)		—			(474	)
Income tax expense (benefit)		—			—			91			(291	)		—			(200	)

Income (loss) from discontinued operations, net		—			—			200			(474	)		—			(274	)

Net income (loss)		(760	)		(760	)		3,725			(7,244	)		4,279			(760	)
Accrued preferred dividends		2,017			—			—			—			—			2,017

Net income available for (loss attributable to) common members	$	(2,777	)	$	(760	)	$	3,725		$	(7,244	)	$	4,279		$	(2,777	)

ARDENT HEALTH SERVICES LLC AND SUBSIDIARIES
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
Six Months Ended June 30, 2003
(Dollars in thousands)


						Subsidiary			Non-						Condensed
	Parent			Issuer		Guarantors			Guarantors			Eliminations			Consolidated

Revenues:
Net patient service revenue	$	—		$	—	$	165,705		$	134,268		$	—		$	299,973
Premium revenue		—			—		—			288,328			—			288,328
Other revenue		1,858			9,513		16,489			18,400			(7,303	)		38,957

Total net revenues		1,858			9,513		182,194			440,996			(7,303	)		627,258
Expenses:
Salaries and benefits		—			—		106,481			143,720			—			250,201
Professional fees		—			—		24,772			41,612			(4,316	)		62,068
Claims and capitation		—			—		—			135,132			—			135,132
Supplies		—			—		20,012			54,574			—			74,586
Provision for doubtful accounts		—			—		8,829			14,377			—			23,206
Interest, net		—			7,655		968			(164	)		—			8,459
Depreciation and amortization		—			—		4,703			9,938			—			14,641
Loss (gain) on divestitures		—			—		(618	)		—			—			(618	)
Other		—			—		7,150			49,551			(105	)		56,596

Total expenses		—			7,655		172,297			448,740			(4,421	)		624,271

Income (loss) from continuing operations before income taxes		1,858			1,858		9,897			(7,744	)		(2,882	)		2,987
Income tax expense		—			—		1,199			—			—			1,199

Income (loss) from continuing operations, net		1,858			1,858		8,698			(7,744	)		(2,882	)		1,788
Discontinued operations:
Income (loss) from discontinued operations		—			—		1,316			(1,202	)		—			114
Income tax expense (benefit)		—			—		501			(457	)		—			44

Income (loss) from discontinued operations, net		—			—		815			(745	)		—			70

Net income (loss)		1,858			1,858		9,513			(8,489	)		(2,882	)		1,858
Accrued preferred dividends		3,964			—		—			—			—			3,964

Net income available for (loss attributable to) common members	$	(2,106	)	$	1,858	$	9,513		$	(8,489	)	$	(2,882	)	$	(2,106	)

ARDENT HEALTH SERVICES LLC AND SUBSIDIARIES

CONDENSED CONSOLIDATING BALANCE SHEET

June 30, 2004
(Dollars in thousands)


						Subsidiary			Non-					Condensed
	Parent			Issuer		Guarantors			Guarantors		Eliminations			Consolidated

ASSETS
Current assets:
Cash and cash equivalents	$	—		$	—	$	94,918		$	27,793	$	—		$	122,711
Accounts receivable, net		—			—		63,491			71,548		—			135,039
Premiums receivable		—			—		—			10,890		—			10,890
Inventories		—			—		6,723			10,250		—			16,973
Deferred income taxes		—			—		26,122			4,575		—			30,697
Prepaid expenses and other current assets		—			—		17,185			20,062		—			37,247
Assets held for sale		—			—		—			—		—			—
Income tax receivable		—			—		2,453			—		—			2,453

Total current assets		—			—		210,892			145,118		—			356,010
Property, plant and equipment, net		—			—		156,479			210,118		—			366,597
Goodwill		—			—		13,073			62,456		—			75,529
Other intangible assets		—			—		—			45,866		—			45,866
Deferred income taxes		—			—		5,654			—		—			5,654
Other assets		387,628			655,040		271,783			3,660		(1,299,096	)		19,015

Total assets	$	387,628		$	655,040	$	657,881		$	467,218	$	(1,299,096	)	$	868,671

LIABILITIES AND MEMBERS’ AND STOCKHOLDERS’ EQUITY
Current liabilities:
Current installments of long-term debt	$	—		$	—	$	2,013		$	157	$	—		$	2,170
Accounts payable		—			—		25,124			28,887		—			54,011
Medical claims payable		—			—		—			44,259		—			44,259
Accrued salaries and benefits		—			—		24,379			24,114		—			48,493
Accrued interest		—			9,455		18			—		—			9,473
Unearned premiums		—			—		(106	)		3,300		—			3,194
Other accrued expenses and liabilities		—			831		11,337			10,277		—			22,445

Total current liabilities		—			10,286		62,765			110,994		—			184,045
Long-term debt, less current installments		—			257,209		853			377		—			258,439
Other long-term liabilities		—			—		6,541			—		—			6,541
Self-insured liabilities		—			—		27,699			4,319		—			32,018
Note payable to Parent		—			—		(72,353	)		72,353		—			—
Due to (from) Parent		—			—		(9,088	)		9,088		—			—

Total liabilities		—			267,495		16,417			197,131		—			481,043
Redeemable preferred units and accrued dividends		116,308			—		—			—		—			116,308
Members’ and stockholder’s equity:
Capital stock		—			—		—			150		(150	)		—
Common units		273,773			—		—			—		—			273,773
Additional paid in capital		—			370,320		594,405			262,254		(1,226,979	)		—
Retained earnings (accumulated deficit)		(2,453	)		17,225		47,059			7,683		(71,967	)		(2,453	)

Total members’ and stockholder’s equity		271,320			387,545		641,464			270,087		(1,299,096	)		271,320

Total liabilities and members’ equity	$	387,628		$	655,040	$	657,881		$	467,218	$	(1,299,096	)	$	868,671

ARDENT HEALTH SERVICES LLC AND SUBSIDIARIES

CONDENSED CONSOLIDATING BALANCE SHEET

December 31, 2003
(Dollars in thousands)


							Subsidiary		Non-						Condensed
	Parent			Issuer			Guarantors		Guarantors			Eliminations			Consolidated
ASSETS
Current assets:
Cash and cash equivalents	$	—		$	—		$	49,919	$	39,843		$	—		$	89,762
Accounts receivable, net		—			—			59,743		56,772			—			116,515
Premiums receivable		—			—			—		14,733			—			14,733
Inventories		—			—			6,523		10,236			—			16,759
Deferred income taxes		—			—			23,217		4,575			—			27,792
Prepaid expenses and other current assets		—			—			16,966		14,548			—			31,514
Assets held for sale		—			—			3,336		—			—			3,336
Income tax receivable		—			—			2,128		—			—			2,128

Total current assets		—			—			161,832		140,707			—			302,539
Property, plant and equipment, net		—			—			154,095		211,226			—			365,321
Goodwill		—			—			13,072		62,457			—			75,529
Other intangible assets		—			—			—		48,289			—			48,289
Deferred income taxes		—			—			5,682		—			—			5,682
Other assets		333,021			528,109			261,617		6,174			(1,108,277	)		20,644

Total assets	$	333,021		$	528,109		$	596,298	$	468,853		$	(1,108,277	)	$	818,004

LIABILITIES AND MEMBERS’ AND STOCKHOLDERS’ EQUITY
Current liabilities:
Current installments of long-term debt	$	—		$	—		$	1,931	$	151		$	—		$	2,082
Accounts payable		—			—			26,175		27,126			—			53,301
Medical claims payable		—			—			—		45,751			—			45,751
Accrued salaries and benefits		—			—			23,429		21,263			—			44,692
Accrued interest		—			10,133			—		—			—			10,133
Unearned premiums		—			—			—		15,399			—			15,399
Other accrued expenses and liabilities		—			—			9,423		16,348			—			25,771

Total current liabilities		—			10,133			60,958		126,038			—			197,129
Long-term debt, less current installments		—			256,996			1,908		457			—			259,361
Other long-term liabilities		—			—			6,573		—			—			6,573
Self-insured liabilities		—			—			10,255		11,665			—			21,920
Note payable to Parent		—			(71,412	)		—		71,412			—			—
Due to (from) Parent		—			—			3,228		(3,228	)		—			—

Total liabilities		—			195,717			82,922		206,344			—			484,983
Redeemable preferred units and accrued dividends		111,931			—			—		—			—			111,931
Members’ and stockholders’ equity:
Capital stock		—			—			—		150			(150	)		—
Common units		224,331			—			—		—			—			224,331
Additional paid in capital		—			320,332			484,587		262,254			(1,067,173	)		—
Retained earnings (accumulated deficit)		(3,241	)		12,060			28,789		105			(40,954	)		(3,241	)

Total members’ and stockholders’ equity		221,090			332,392			513,376		262,509			(1,108,277	)		221,090

Total liabilities and members’ equity	$	333,021		$	528,109		$	596,298	$	468,853		$	(1,108,277	)	$	818,004

ARDENT HEALTH SERVICES LLC AND SUBSIDIARIES
CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS
Six Months Ended June 30, 2004
(Dollars in thousands)


							Subsidiary			Non-					Condensed
	Parent			Issuer			Guarantors			Guarantors			Eliminations		Consolidated
Net cash provided by (used in) operating activities	$	—		$	(9,561	)	$	27,402		$	(17,983	)	$	—	$	(142	)
Net cash provided by (used in) discontinued operations		—			—			(1,253	)		—			—		(1,253	)
Cash flows from investing activities:
Purchases of property, plant and equipment, net		—			—			(11,712	)		(8,576	)		—		(20,288	)
Proceeds from divestitures		—			—			5,972			—			—		5,972
Other		—			—			(2,010	)		2,515			—		505

Net cash provided by (used in) investing activities		—			—			(7,750	)		(6,061	)		—		(13,811	)
Cash flows from financing activities:
Payments on long-term debt		—			—			(973	)		(74	)		—		(1,047	)
Debt financing costs paid		—			(784	)		—			—			—		(784	)
Intercompany advances, net		—			—			(11,126	)		11,126			—		—
Contributions from Parent		(49,986	)		10,345			39,641			—			—		—
Note payable to Issuer		—			—			(942	)		942			—		—
Proceeds from the issuance of common units		49,986			—			—			—			—		49,986

Net cash provided by (used in) financing activities		—			9,561			26,600			11,994			—		48,155

Net increase (decrease) in cash and cash equivalents		—			—			44,999			(12,050	)		—		32,949
Cash and cash equivalents, beginning of period		—			—			49,919			39,843			—		89,762

Cash and cash equivalents, end of period	$	—		$	—		$	94,918		$	27,793		$	—	$	122,711

Supplemental cash flow information:
Cash paid for interest	$	—		$	10,239		$	653		$	2,747		$	—	$	13,639
Cash paid for income taxes		—			—			6,658			—			—		6,658
Preferred unit dividends accrued		4,377			—			—			—			—		4,377

ARDENT HEALTH SERVICES LLC AND SUBSIDIARIES
CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS
Six Months Ended June 30, 2003
(Dollars in thousands)


							Subsidiary			Non-					Condensed
	Parent			Issuer			Guarantors			Guarantors			Eliminations		Consolidated

Net cash (used in) provided by operating activities	$	—		$	(5,277)		$	14,176		$	6,647		$	—	$	15,546
Net cash provided by discontinued operations		—			—			211			—			—		211
Cash flow from investing activities:
Investments in acquisitions, less cash acquired		—			—			—			(194,117	)		—		(194,117	)
Purchases of property, plant and equipment, net		—			—			(11,779	)		(15,652	)		—		(27,431	)
Transfer of assets		—			—			6,570			(6,570	)		—		—
Proceeds from divestitures		—			—			6,311			—			—		6,311
Other		—						2,414			170			—		2,584

Net cash provided by (used in) investing activities		—			—			3,516			(216,169	)		—		(212,653	)
Cash flows from financing activities:
Proceeds from (payments on) revolving line of credit, net		—			—			(11,443	)		—			—		(11,443	)
Proceeds from long-term debt		—			148,500			—			—			—		148,500
Payments on long-term debt		—			—			(29,772	)		(32	)		—		(29,804	)
Debt financing costs paid		—			(4,587	)		—			—			—		(4,587	)
Intercompany advances, net		—			—			(62,380	)		62,380			—		—
Contributions from (distributions to) Parent		(9,505	)		(138,636	)		(11,394	)		159,535			—		—
Proceeds from the issuance of common units		11,487			—			—			—			—		11,487
Preferred and common unit issuance costs		(1,982	)		—			—			—			—		(1,982	)

Net cash provided by (used in) financing activities		—			5,277			(114,989	)		221,883			—		112,171

Net increase (decrease) in cash and cash equivalents		—			—			(97,086	)		12,361			—		(84,725	)
Cash and cash equivalents, beginning of period		—			—			102,853			11,006			—		113,859

Cash and cash equivalents, end of period	$	—		$	—		$	5,767		$	23,367		$	—	$	29,134

Supplemental cash flow information:
Cash paid for interest	$	—		$	2,074		$	1,561		$	—		$	—	$	3,635
Cash paid for income taxes		—			—			734			—			—		734
Noncash common units issued		4,639			—			—			—			—		4,639
Preferred unit dividends accrued		3,964			—			—			—			—		3,964

ARDENT HEALTH SERVICES LLC AND SUBSIDIARIES

PRO FORMA CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Introduction

Effective July 31, 2004, the Company sold its Lovelace Home Health operations and certain related assets in Albuquerque, New Mexico to Heritage Home Healthcare in an arms’ length transaction for $200,000 in cash. Effective April 1, 2004, the Company sold the operations and certain assets of Northern Indiana Hospital, a behavioral hospital in Plymouth, Indiana. The following balance sheet narrative as of June 30, 2004 gives effect to the Lovelace Home Health business disposition as if the transaction had been completed as of June 30, 2004. The following results of operations narrative for the six months ended June 30, 2004 and unaudited condensed consolidated statements of operations for the year ended December 31, 2003 give effect to the business dispositions by the Company as if the transactions had been completed on January 1, 2003.

The following narratives and unaudited pro forma condensed consolidated statements of operations presented herein do not intend to represent what the Company’s financial position or results of operations would have been had such transactions occurred at the beginning of the periods presented or to project the Company’s results of operations in any future period. The following pro forma information should be read in conjunction with the Company’s audited consolidated financial statements included in its Annual Report on Form 10-K for the year ended December 31, 2003 and its unaudited condensed consolidated financial statements included elsewhere in this Form 10-Q.

Balance Sheet as of June 30, 2004

The unaudited condensed consolidated balance sheet as of June 30, 2004 included elsewhere in this Form 10-Q already gives effect to the disposition of Northern Indiana Hospital and includes $33,000 of net property, plant and equipment that was included in the sale of its Lovelace Home Health operations.

Pro Forma Results of Operations for the Six Months Ended June 30, 2004

The accompanying unaudited pro forma condensed consolidated statement of operations for the six months ended June 30, 2004 reflects the results of operations of the Lovelace Home Health and Northern Indiana Hospital as discontinued operations. For the six months ended June 30, 2004, income (loss) from discontinued operations includes the following (dollars in thousands):


						Total
	Lovelace			Northern		Discontinued
	Home Health			Indiana		Operations
Total net revenues	$	1,937		$	2,742	$	4,679
Total expenses		2,846			2,277		5,123

Income (loss) from discontinued operations		(909	)		465		(444	)
Gain on divestitures of discontinued operations		—			3,622		3,622

Income (loss) from discontinued operations before income taxes		(909	)		4,087		3,178
Income tax expense (benefit)		(318	)		1,650		1,332

Income (loss) from discontinued operations, net	$	(591	)	$	2,437	$	1,846

ARDENT HEALTH SERVICES LLC AND SUBSIDIARIES
PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS


(a)	Adjustment to exclude interest expense allocated to the disposed businesses but not directly attributable to the disposition.

(b)	Adjustment to exclude management fees allocated to the disposed businesses that are eliminated upon consolidation.

(c)	Adjustment to give effect to the income tax effect of pro forma adjustments.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

The following discussion and analysis of financial condition and results of operations should be read in conjunction with our unaudited condensed consolidated financial statements and related notes appearing elsewhere in this report and the more detailed discussion contained in Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in our Annual Report on Form 10-K for the year ended December 31, 2003.

Forward Looking Statements

This Quarterly Report on Form 10-Q includes forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 which are intended to be covered by the safe harbors created under that Act. These statements are based on our current estimates and expectations. Forward-looking statements may include words such as “may,” “will,” “plans,” “estimates,” “anticipates,” “believes,” “expects,” “intends” and similar expressions. These forward-looking statements are subject to various factors, risks and uncertainties that could cause actual outcomes and results to be materially different from those projected or assumed. These factors, risks and uncertainties include, without limitation, possible changes in the Medicare and Medicaid programs that may limit reimbursement to health care providers and insurers; a possible reduction of profitability of our Health Plan caused by lower enrollment; our failure to maintain satisfactory relationships with providers or our ability to effectively price our health care premiums or manage medical costs; the geographic concentration of our operations, particularly in Albuquerque, New Mexico and Tulsa, Oklahoma; the availability, cost and terms of malpractice insurance coverage; claims and legal actions relating to professional liabilities or other matters exceeding the scope of our liability coverage; the highly competitive nature of the health care business, including the competition to recruit and retain physicians and other health care personnel and the ability to retain qualified management; the potential adverse impact of government investigations or “qui tam” lawsuits brought under the False Claims Act or other whistleblower statutes; our ability to integrate newly acquired facilities and improve their operations and realize the anticipated benefits of the acquisitions; our ability to acquire hospitals and other related health care entities that meet our target criteria; our ability to manage and integrate our information systems effectively; any reduction in payments to health care providers by government and commercial third-party payors, as well as cost-containment efforts of insurers and other payors; uncertainty associated with compliance with HIPAA and other privacy laws and regulations; the restrictions and covenants in our credit facility and debt instruments and the potential lack of adequate alternative financing; changes in, or violations of, federal, state or local regulation affecting the health care industry; the possible enactment of Federal or state health care reform; changes in general economic conditions and those factors, risks, and uncertainties described in our Annual Report on Form 10-K under the caption “Risk Factors” and from time to time in our filings with the Securities and Exchange Commission (the “SEC”). We can give no assurance that the forward-looking statements included in this report will prove to be accurate. In light of the significant uncertainties inherent in the forward-looking statements included herein, you should not regard the inclusion of such information as a representation by us or any other person that our objectives and plans will be achieved. We undertake no obligation to publicly release any revisions to any forward-looking statements contained in this report.

Executive Overview

2004 Operations Summary

During the three months and six months ended June 30, 2004, we have continued to achieve positive results, including:

• increased admissions and patient days over prior year periods in both our acute care and behavioral segments, including on a same facility basis;

• increased net patient service revenue per adjusted admission and patient day over prior year periods in both the consolidated acute care and behavioral segments;

• progress towards finalizing the previously announced Hillcrest and Cimarron acquisitions, which were completed subsequent to June 30, 2004;

• increased Health Plan revenue, successful retention of plan members and effective management of the cost of medical care; and

• certification by the Centers for Medicare and Medicaid Services (“CMS”) in May 2004 of our Brooke Glen behavioral hospital, which will allow for increased access to patient admissions in future periods.

However, we continue to face certain challenges, including:

• continued deterioration in the collectability of self-pay accounts due to industry-wide trends, which continues to negatively impact our bad debt expense;

• integration of the recently completed Hillcrest and Cimarron acquisitions, including integration of disparate information systems;

• continued labor pricing and recruitment pressures brought on by the nationwide nursing shortage; and

• continued challenges in managing our general and professional liability and workers compensation risks in a cost-effective manner.

Revenues

We generate revenue predominantly through three sources: the provision of patient care at our acute care and behavioral facilities; premiums charged to our Health Plan membership; and other health care services. We evaluate the growth of our revenue in many ways. In our acute care segment, we utilize admissions and adjusted admissions, which are volume measures, and revenue per adjusted admission, which is a pricing and acuity measure. However, it has been difficult to utilize revenue per adjusted admission due to the historical treatment of revenues associated with our Health Plan members who receive health care services at our acute care hospitals, which is discussed below under net patient service revenue. In our behavioral care segment, we utilize patient days, adjusted patient days and average length of stay, measures of volume and acuity, as well as revenue per patient day and adjusted patient day, measures of pricing and acuity.

The following is an analysis of our revenue from each source (in thousands):


	Three Months Ended June 30,								Six Months Ended June 30,
	2004				2003				2004				2003
Net patient service revenue	$	180,144	50.4	%	$	152,196	47.9	%	$	369,987	51.2	%	$	299,973	47.8	%
Premium revenue		157,596	44.1			145,575	45.8			312,802	43.3			288,328	46.0
Other revenue		19,473	5.5			20,103	6.3			40,093	5.5			38,957	6.2

Total net revenues	$	357,213	100.0	%	$	317,874	100.0	%	$	722,882	100.0	%	$	627,258	100.0	%

Net Patient Service Revenue

Our net patient service revenue is primarily derived from Medicare and Medicaid programs and managed care contracts. These revenues are net of contractual adjustments and policy discounts, which represent the difference between our hospitals’ established charges and the payment rates under the Medicare and Medicaid programs and managed care programs. The percentage of our net patient service revenue from Medicare and Medicaid programs and managed care programs (expressed in patient days) was as follows:


	Three Months Ended June 30,												Six Months Ended June 30,
	2004						2003						2004						2003
	Acute			Behavioral			Acute			Behavioral			Acute			Behavioral			Acute			Behavioral
Medicare		40.6	%		8.9	%		44.0	%		9.0	%		40.9	%		9.2	%		43.7	%		8.9	%
Medicaid		5.6			38.4			6.2			34.3			5.6			36.8			6.1			34.5
Managed care		43.9			28.3			38.1			29.6			44.4			29.2			39.1			30.1
Other payors		9.9			24.4			11.7			27.1			9.1			24.8			11.1			26.5

		100.0	%		100.0	%		100.0	%		100.0	%		100.0	%		100.0	%		100.0	%		100.0	%

Other payors primarily include state and local governments, commercial payors, workers’ compensation and self pay patients.

Net patient service revenue within our consolidated acute care services segment prior to January 1, 2004 excludes revenue for services provided to our Health Plan members. During 2003, the Health Plan did not qualify as a separate operating segment in accordance with the criteria set forth by SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information. However, beginning on January 1, 2004, we managed the Health Plan as a separate operating segment and our acute care services segment excludes the operations of the Health Plan and includes net patient service revenue related to services rendered at our acute care hospitals to our Health Plan members. We believe this allows us to better manage the businesses within our company and make better financial and operational decisions. As a result of this change in how we managed these operations, our Health Plan business is a separate reportable segment in 2004. However, due to system limitations it is impractical to restate our segment information for prior periods to correspond with this change in our reportable segments.

The final determination of amounts earned under Medicare and Medicaid programs often does not occur until fiscal years subsequent to submission of claims due to audits by the administering agency, rights of appeal and the application of numerous technical provisions. Differences between original estimates and subsequent revisions, including final settlements of cost reports, are included in the results of operations of the period in which the revisions are made. We did not assume any of the cost report settlements under these programs for our acquisitions for dates prior to our purchases. Adjustments to estimated settlements resulted in increases to net patient service revenue of $1.7 million and $668,000 for the three months ended June 30, 2004 and 2003, respectively, and $2.1 million and $1.1 million for the six months ended June 30, 2004 and 2003, respectively.

We recently received notice from a state Medicaid program that certain amounts paid by the program to one of our behavioral hospitals in prior years were paid in error and that we owe the amounts back to the program. We believe that we have fully complied with both the applicable laws and previous agreements established with the program during previous years and that final resolution of these disputed amounts will not have a material adverse effect on our business, results of operations or financial position.

Recent Behavioral Hospital Trends

The Medicare, Medicaid and SCHIP Balanced Budget Refinement Act of 1999 (“BBRA of 1999”) required CMS to develop an inpatient psychiatric per diem effective for the federal fiscal year beginning October 1, 2002. On November 28, 2003, CMS proposed a rule to implement a prospective payment system (“PPS”) for psychiatric hospitals and units. This new system will replace the current inpatient psychiatric payment system. The proposed rule designates that PPS under the new system will be effective for cost reports beginning on or after April 1, 2004. CMS has not issued a final rule for the inpatient psychiatric PPS to accomplish the proposed effective date of April 1, 2004. According to CMS’ recent notice on Proposed Changes to the Hospital Inpatient Prospective Payment Systems and Fiscal Year 2005 Rates, CMS is still in the process of analyzing public comments and developing a final rule related to this new system. The effective date of this new system would occur five months following publication of the final rule. The plan is scheduled to be implemented through a three year transition, ultimately phasing into 100% PPS (year one: 75% cost/25% PPS; year two: 50% cost/50%

PPS; year three: 25% cost/75% PPS; year four: 100% PPS). We cannot predict the date the final rule will be published, the actual effective date of the final rule, or whether the final rule will mirror provisions of the proposed rule or its ultimate impact on our results of operations.

Charity Care and Contemplated Revisions to Policies

In February 2004, CMS and the Office of Inspector General issued guidance that hospitals have the ability under Medicare regulations to provide relief to uninsured and under-insured patients who cannot afford their hospital bills and to Medicare beneficiaries who cannot afford their Medicare cost sharing amounts. Beginning in August 2004, we implemented a pilot charity care policy that provides discounts to uninsured and under-insured patients. The policy requires facility personnel to first determine if a patient has insurance or can qualify for state or locally funded programs. If not, facility personnel seek to qualify the patient for charity care. The policy considers income level, family size and the total annual family medical bills. Discounts are applied on a sliding scale depending on income and family size. We began the program at a pilot hospital and plan to evaluate its results and eventually implement the policy throughout all of our facilities. Implementation of this policy could result in decreased net patient service revenue with a commensurate offsetting decrease to the provision for doubtful accounts.

Premium Revenue

Our premium revenue is derived from our Health Plan in New Mexico. We offer a portfolio of health plan products to private and public purchasers. Premium revenue is comprised of premiums we receive from our Health Plan members, for which we then are responsible for the costs of health care services provided to those members. Because our Health Plan is part of our integrated health care delivery network in New Mexico, we ultimately provide many of those health care services to our Health Plan members.

Although premium revenue was 44.1% and 43.3% of total net revenues for the three months and six months ended June 30, 2004, respectively, expanding our presence in the managed care business is not one of our primary growth strategies. One of our key growth strategies is to expand through the selective acquisition of acute care and behavioral hospitals in targeted markets. Effective August 1, 2004, we completed the previously announced transaction with Molina Healthcare, Inc. to transfer approximately 30,000 commercial members of Cimarron Health Plan to our Health Plan in New Mexico. The transaction provided a strategic opportunity to expand our current Health Plan services in the Albuquerque market and increase the integrated delivery system’s access to these members; however, we do not generally plan to acquire additional health plans unless these plans are tangential parts of the hospitals or systems that we acquire. The Health Plan is an important part of our integrated delivery system in Albuquerque, and we expect to ultimately provide a higher proportion of health care services to the former Cimarron commercial members as a result of transferring them to our Health Plan. As we expand into new targeted markets over time, we anticipate that Health Plan revenues will become a smaller percentage of our total net revenues.

Other Revenue

We also derive revenue from our commercial laboratory, retail pharmacies within our hospitals, provider network access and medical management services through our Health Plan, and educational services through our behavioral segment.

Accounts Receivable Collection Risks and Resulting Increased Provision for Bad Debts

We are susceptible to the industry-wide trend of increased collection risk on uninsured self-pay patients as well as insured patients whose employers have required them to pay higher deductibles and co-payments. This increase in uninsured self-pay patients has caused deterioration in our accounts receivable, primarily related to the uninsured self-pay patients, which has resulted in increased write-offs and a larger provision for doubtful accounts as a percentage of total net revenues. The increase in self-pay accounts receivable results from a combination of factors including general economic weakness, higher levels of patient deductibles and co-insurance, continuing state budget struggles resulting in reductions of Medicaid enrollees and an increase in uninsured patients who may not qualify for charity care programs. We have implemented policies and procedures designed to accelerate upfront cash collections as well as to continue to focus on cash collection efforts after

discharge. However, we believe that increased bad debts will remain a prevalent trend in the hospital industry during the foreseeable future.

Our self-pay amounts due from patients were $39.4 million and our total allowance for doubtful accounts was $64.8 million at June 30, 2004. The valuation allowance related to the self-pay portion of our business is substantially greater than any other payor and is based upon our historical collection rates. Our total allowance for doubtful accounts exceeds self-pay amounts due from patients primarily due to our billing systems not currently tracking co-payments and deductibles due from patients for which collection of the primary payor accounts has not occurred. Therefore, our accounts receivable agings reflect certain co-payments and deductibles as due from third-party payors until those third-party payors have made payment, at which time the co-payments and deductibles due from patients are reclassified to self-pay.

Our total allowance for doubtful accounts represented approximately 164.6% and 152.0% of self-pay amounts due from patients at June 30, 2004 and December 31, 2003, respectively. The increase in our allowance for doubtful accounts and related provision for doubtful accounts is primarily the result of increased allowances on self-pay accounts as a result of deterioration in the estimated collectability of such accounts. Our accounts receivable has increased due to a corresponding increase in net patient service revenue and an increase in days sales outstanding, which were 67 days and 59 days as of June 30, 2004 and December 31, 2003, respectively.

The increase in days sales outstanding is primarily related to changes in how we manage the acute care activity within the Lovelace Sandia Health System. Beginning on January 1, 2004, we managed the Health Plan as a separate operating segment and our acute care services segment excludes the operations of the Health Plan and includes net patient service revenue related to services rendered at our acute care hospitals to our Health Plan members. We believe this allows us to better manage the businesses within our company and make better financial and operational decisions. As a result of this change in how we managed these operations, we began adjudicating claims for services provided to our Health Plan members. The adjudication of our Health Plan claims, coupled with increased adjusted admissions and patient days, significantly increased the volume of claims that our business office was required to process and resulted in a build up of accounts receivable during the six months ended June 30, 2004. We expect to decrease our days sales outstanding during the remainder of 2004 as we continue to increase our business office personnel to adjust to the increased volumes and enhance our collection processes.

Our Business Strategy

Key elements of our business strategy include the following:

• Physician Recruiting and Retention. We strive to recruit both primary and specialty care physicians who can provide quality services that we believe are currently needed in the communities we serve. We similarly seek to recruit new physicians (primarily psychiatrists) to our behavioral hospitals to provide services to our patients. This reflects our strategy to expand capacity and more importantly our service lines at our facilities. Additionally, we strive to retain our physicians by maintaining strong relationships with them, by enhancing the scope and quality of services at our hospitals, and by constantly improving our hospitals’ work environment. We believe that as we continue to strengthen our position in each of our markets, we will further improve our ability to attract and retain quality physicians. An example of our retention efforts is the use of a program we refer to as Physician Leadership Councils, or PLCs. PLCs generally consist of leading physicians in our communities who provide their ideas and recommendations to the management of each facility on improving its operations. We use PLCs to develop and maintain strong relationships with members of the medical staffs at each of our acute care hospitals. Generally, PLCs meet with our hospital management teams on a regular basis to discuss operating and strategic issues, serve as a sounding board for the medical community at each hospital and enable our local management teams to communicate on a regular basis with the medical staff. PLCs also actively participate in the strategic planning process of each of our acute care hospitals.

• Acquisitions. An integral part of our business strategy is the continued selective acquisitions of acute care hospitals in urban and suburban markets and behavioral hospitals. To accomplish this, we selectively seek acquisition opportunities in markets with populations over 100,000 and growth rates above the national

average, either through the acquisition of a network of hospitals and other health care facilities or a single well-positioned facility, where we generally can improve operating performance and profitability. For example, in August 2004, we completed the previously announced acquisition of Hillcrest HealthCare System in Tulsa, Oklahoma for $326.3 million, including preliminary working capital, subject to customary adjustments. We have generally acquired relatively underperforming acute care hospitals where we believe we can improve their operational performance, profitability and their financial systems and internal controls. After we acquire a hospital, we implement a number of measures designed to increase revenues, lower operating costs and improve their financial systems and internal controls. We also may make significant investments in the acquired hospital to expand services, strengthen the medical staff, improve our market position overall and integrate the acquired hospital’s systems into our systems.

• Capital Expenditures. Upon acquisition of a health care system or a single facility, we generally invest substantial capital in those new markets. For example, upon the acquisition of the facilities now comprising Lovelace Sandia Health System, we committed to invest $80.0 million of capital into those facilities in the Albuquerque market over a five-year period. Through June 30, 2004, we had invested approximately $58.9 million and we anticipate completing our commitment during 2004. As part of the Hillcrest acquisition, we have committed to invest approximately $100.0 million in capital expenditures in the Tulsa market over the next five years. See “Liquidity and Capital Resources” below for additional discussion of our capital expenditures.

Our ability to realize the benefits of these strategies will be affected by a number of important factors, including factors described under the captions, “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Known Legislative, Industry and Economic Trends” contained in our Annual Report on Form 10-K for the year ended December 31, 2003.

Acquisitions, Divestitures and Joint Venture

2003 Acquisitions

Effective January 1, 2003, we acquired Lovelace Health Systems, Inc. in Albuquerque, New Mexico, for $209.4 million, plus acquisition costs. Lovelace Health Systems, Inc. included Lovelace Medical Center, a 201 bed acute care hospital, and the Lovelace Health Plan, a health maintenance organization. We financed the acquisition of Lovelace Health Systems, Inc. through a combination of $112.5 million of bank debt, $36.0 million of subordinated debt and the balance from the proceeds of the sale of equity securities. Results of operations for the year ended December 31, 2003 include an entire year of operations for this system. Effective October 1, 2003, we completed the merger of Sandia Health System (previously acquired in 2002) and Lovelace Health Systems, Inc. The merged entity is named Lovelace Sandia Health System, Inc., and is part of Lovelace Sandia Health System, the second largest integrated health care delivery system in Albuquerque, New Mexico.

Effective October 8, 2003, we acquired the 146-bed Northwestern Institute of Psychiatry (renamed Brooke Glen), a private behavioral health services facility located in Fort Washington, Pennsylvania, for $7.7 million, plus acquisition costs. The purchase price was paid in cash and funded from the proceeds of our $225.0 million senior subordinated notes issued in August 2003. Results of operations for the year ended December 31, 2003 include approximately three months of operations for this facility.

2004 Acquisitions

Effective August 1, 2004, we completed the previously announced transaction with Molina Healthcare, Inc. to transfer approximately 30,000 commercial members of Cimarron Health Plan to the Lovelace Health Plan, which is part of Lovelace Sandia Health System, Inc., for approximately $16.0 million, plus additional contingent consideration of up to $3.5 million subject to the satisfaction of certain conditions. We funded the transaction with available cash on hand.

On August 12, 2004, we completed the previously announced acquisition of Hillcrest HealthCare System in Tulsa, Oklahoma. We acquired substantially all of the net operating

assets of Hillcrest for $326.3 million, including preliminary working capital, subject to customary adjustments. The acquisition consisted primarily of two metropolitan Tulsa hospitals and related health care entities, as well as six regional hospitals acquired or intended to be acquired through long-term operating agreements. In connection with the Hillcrest acquisition, we committed to invest approximately $100.0 million in capital expenditures in the Tulsa market over the next five years.

The aggregate purchase price of the Hillcrest acquisition was paid in cash and financed, in part, with the $58.3 million of proceeds invested by WCAS, Ferrer Freeman, BAC and related investors pursuant to the subscription agreement with us, as discussed in Note 7 to the accompanying unaudited condensed consolidated financial statements. The remaining purchase price was financed through an additional borrowing of senior secured term debt on August 12, 2004 in the principal amount of $300.0 million, as further discussed in “Capital Resources”.

In connection with our recent acquisitions, management began evaluating its information systems in the acute care segment, primarily related to patient accounting and clinical information systems, to determine the feasibility of moving to a single operating platform across the acute care hospitals. We have evaluated the carrying amounts of the related information system assets for recoverability and do not believe any indicators of impairment exist. However, should events, changes in circumstances or other indicators of potential impairment exist in the future, we may be required to record impairment charges on long-lived assets, which could have a material adverse effect on our results of operations and financial condition.

2003 Divestitures

For the six months ended June 30, 2003, we recorded pretax gains of $949,000, which included pretax gains of $250,000 recorded during the three months ended June 30, 2003, from the sale of one behavioral hospital and recoveries of fully reserved items related to a behavioral hospital sold in 2002. The hospitals were identified as held for sale under SFAS No. 144, under which the results of operations and related gains on divestitures are included in income from discontinued operations in the accompanying unaudited condensed consolidated statements of operations.

For the six months ended June 30, 2003, we also recorded pretax gains of $618,000, which included a pretax loss of $310,000 recorded during the three months ended June 30, 2003, from the sales of two behavioral hospitals. The hospitals were previously identified as held for sale under SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of, under which the net gains are recorded in the accompanying unaudited condensed consolidated statements of operations as gains on divestitures and the historical results of operations and financial position are not reclassified as discontinued operations.

2004 Divestitures

Effective April 1, 2004, we sold a behavioral hospital for consideration of approximately $6.1 million, which resulted in a pretax gain of $3.6 million that was recorded during the three months ended June 30, 2004. The hospital’s results of operations, including gain on divestiture, and net assets are included in income from discontinued operations and assets held for sale, respectively, for the periods presented in the accompanying unaudited condensed consolidated financial statements in accordance with SFAS No. 144.

Effective July 31, 2004, we sold our Lovelace Home Health operations and certain related assets for $200,000 in cash, subject to certain adjustments, which is expected to result in a minimal gain. The entity was identified as held for

sale during the three months ended June 30, 2004. Accordingly, the entity’s results of operations are included in income from discontinued operations for all periods presented in the accompanying unaudited condensed consolidated statements of operations.

2004 Joint Venture

On June 9, 2004 we entered into a letter of intent with Ochsner Clinic Foundation to partner in the ownership of Summit Hospital in Baton Rouge, Louisiana. We have solely owned Summit Hospital since July 2001, and accordingly consolidate the accounts and results of operations of the hospital. Subject to closing conditions, the transaction is expected to be completed by the fall 2004, at which time we expect to account for our noncontrolling interest in Summit as an equity-method investment. In addition to income recorded from our equity investment, we expect to receive management fees pursuant to our continued management of the hospital.

Critical Accounting Policies

A summary of significant accounting policies is disclosed in Note 1 to the Consolidated Financial Statements contained in our Annual Report on Form 10-K for the year ended December 31, 2003. Our critical accounting policies are further described under the caption “Critical Accounting Policies” in Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in our Annual Report on Form 10-K for the year ended December 31, 2003. There have been no significant changes in the nature of our critical accounting policies or the application of those policies since December 31, 2003.

Results of Operations

The following table sets forth for the periods indicated selected results of operations data expressed in dollar terms and as a percentage of total net revenues (dollars in thousands).


	Three Months Ended												Six Months Ended
	June 30, 2004						June 30, 2003						June 30, 2004					June 30, 2003
CONSOLIDATED	Amount			%			Amount			%			Amount		%			Amount			%
Revenues:
Net patient service revenue	$	180,144			50.4	%	$	152,196			47.9	%	$	369,987		51.2	%	$	299,973			47.8	%
Premium revenue		157,596			44.1			145,575			45.8			312,802		43.3			288,328			46.0
Other revenue		19,473			5.5			20,103			6.3			40,093		5.5			38,957			6.2

Total net revenues		357,213			100.0	%		317,874			100.0	%		722,882		100.0	%		627,258			100.0	%
Expenses:
Salaries and benefits		142,055			39.8			126,657			39.8			288,321		39.9			250,201			39.9
Professional fees		35,890			10.0			32,407			10.2			66,013		9.1			62,068			9.9
Claims and capitation		75,096			21.0			67,640			21.3			146,317		20.2			135,132			21.5
Supplies		41,825			11.7			37,719			11.9			83,812		11.6			74,586			11.9
Provision for doubtful accounts		15,976			4.5			12,290			3.9			33,333		4.6			23,206			3.7
Interest, net		7,042			2.0			4,780			1.5			13,541		1.9			8,459			1.3
Change in fair value of interest rate swap agreements		2,624			0.7			—			—			1,389		0.2			—			—
Depreciation and amortization		11,713			3.3			7,314			2.3			22,529		3.1			14,641			2.4
Loss (gain) on divestitures		—			—			310			0.1			—		—			(618	)		(0.1	)
Other		29,773			8.3			29,545			9.3			62,185		8.6			56,596			9.0

Income (loss) from continuing operations before income taxes		(4,781	)		(1.3	)		(788	)		(0.3	)		5,442		0.8			2,987			0.5
Income tax expense (benefit)		(1,780	)		(0.5	)		(302	)		(0.1	)		2,123		0.3			1,199			0.2

Income (loss) from continuing operations, net		(3,001	)		(0.8	)		(486	)		(0.2	)		3,319		0.5			1,788			0.3
Discontinued operations:
Income (loss) from discontinued operations		3,478			0.9			(474	)		(0.1	)		3,178		0.4			114			—
Income tax expense (benefit)		1,441			0.4			(200	)		—			1,332		0.2			44			—

Income (loss) from discontinued operations, net		2,037			0.5			(274	)		(0.1	)		1,846		0.2			70			—

Net income (loss)		(964	)		(0.3	)		(760	)		(0.3	)		5,165		0.7			1,858			0.3
Accrued preferred dividends		2,203			0.6			2,017			0.6			4,377		0.6			3,964			0.6

Net income available for (loss attributable to) common members	$	(3,167	)		(0.9	%)	$	(2,777	)		(0.9	%)	$	788		0.1	%		$(2,106	)		(0.3	%)


	Three Months Ended												Three Months Ended
	June 30, 2004												June 30, 2003
	Acute		Lovelace					Consolidated					Consolidated
CONSOLIDATED ACUTE CARE	Care		Health					Acute Care					Acute Care
SERVICES SEGMENT	Services		Plan		Eliminations			Services		%			Services		%
Revenues:
Net patient service revenue	$	164,702	$	—	$	(53,502	)	$	111,200		39.1	%	$	87,702		35.1	%
Premium revenue		—		157,586		—			157,586		55.4			145,575		58.3
Other revenue		19,090		3,566		(7,239	)		15,417		5.5			16,389		6.6

Total net revenues		183,792		161,152		(60,741	)		284,203		100.0			249,666		100.0
Expenses:
Salaries and benefits		86,430		4,867		(247	)		91,050		32.0			84,531		33.9
Professional fees		18,598		10,333		—			28,931		10.2			22,179		8.9
Claims and capitation		—		135,590		(60,494	)		75,096		26.4			67,640		27.1
Supplies		37,782		74		—			37,856		13.3			34,007		13.6
Provision for doubtful accounts		14,810		—		—			14,810		5.2			10,820		4.3
Other		18,416		2,803		—			21,219		7.5			22,157		8.9

Adjusted EBITDA	$	7,756	$	7,485	$	—		$	15,241		5.4	%	$	8,332		3.3	%


	Six Months Ended												Six Months Ended
	June 30, 2004												June 30, 2003
	Acute		Lovelace					Consolidated					Consolidated
CONSOLIDATED ACUTE CARE	Care		Health					Acute Care					Acute Care
SERVICES SEGMENT	Services		Plan		Eliminations			Services		%			Services		%
Revenues:
Net patient service revenue	$	339,382	$	—	$	(107,220	)	$	232,162		40.2	%	$	173,091		35.1	%
Premium revenue		—		312,802		—			312,802		54.2			288,328		58.4
Other revenue		41,011		6,928		(15,640	)		32,299		5.6			31,909		6.5

Total net revenues		380,393		319,730		(122,860	)		577,263		100.0			493,328		100.0
Expenses:
Salaries and benefits		178,828		9,853		(543	)		188,138		32.6			167,177		33.9
Professional fees		33,011		19,451		—			52,462		9.1			43,734		8.9
Claims and capitation		—		268,634		(122,317	)		146,317		25.3			135,132		27.4
Supplies		75,818		140		—			75,958		13.2			67,228		13.6
Provision for doubtful accounts		30,040		—		—			30,040		5.2			20,030		4.0
Other		37,027		7,282		—			44,309		7.7			42,414		8.6

Adjusted EBITDA	$	25,669	$	14,370	$	—		$	40,039		6.9	%	$	17,613		3.6	%

Selected Operating Statistics

The following table sets forth certain operating data for each of the periods presented:


	Three Months Ended					Six Months Ended
	June 30,					June 30,
	2004			2003		2004			2003
Acute Care Operating Data:
Actual and Same Facilities for 2004 (1):
Number of hospitals (end of period)		7			7		7			7
Number of licensed beds (end of period)(2)		1,263			1,269		1,263			1,269
Total delivery system admissions(3) (4)		8,424			8,034		17,004			16,170
% Change		4.9	%				5.2	%
Total delivery system adjusted admissions (AA) (4)(5)		20,073			18,579		39,842			36,755
% Change		8.0	%				8.4	%
Average length of stay (days)(6)		5.0			5.4		5.3			5.5
Net patient service revenue/AA(7)	$	8,205			—	$	8,518			—
Behavioral Operating Data:
Actual (1):
Number of hospitals (end of period)		20			19		20			19
Number of licensed beds (end of period) (2)		1,999			1,853		1,999			1,853
Admissions (3)		9,197			8,290		18,694			16,620
% Change		10.9	%				12.5	%
Adjusted Admissions (5)		9,697			8,760		19,710			17,552
% Change		10.7	%				12.3	%
Patient days(8)		125,810			122,874		252,682			241,503
% Change		2.4	%				4.6	%
Adjusted patient days (APD) (5)		132,657			129,844		266,422			255,042
% Change		2.2	%				4.5	%
Net patient service revenue/APD	$	520		$	497	$	517		$	498
% Change		4.5	%				3.9	%
Average length of stay (days)(6)		13.7			14.8		13.5			14.5
Same Facilities for 2004 (1):
Number of hospitals (end of period)		19			19		19			19
Number of licensed beds (end of period) (2)		1,853			1,853		1,853			1,853
Admissions (3)		9,028			8,290		18,314			16,620
% Change		8.9	%				10.2	%
Adjusted Admissions (5)		9,529			8,760		19,332			17,552
% Change		8.8	%				10.1	%
Patient days(8)		123,878			122,874		248,095			241,503
% Change		0.8	%				2.7	%
Adjusted patient days (5)		130,734			129,844		261,887			255,042
% Change		0.7	%				2.7	%
Net patient service revenue/APD	$	520		$	497	$	517		$	498
% Change		4.8	%				4.1	%
Average length of stay (days)(6)		13.7			14.8		13.5			14.5
Health Plan Operating Data:
Health Plan members (end of period)		164,461			167,749		164,461			167,749

(1)

The segment operating data excludes statistics for discontinued operations. Same facility statistics exclude the operations of facilities that were either acquired or divested subsequent to January 1, 2003.

(2)		Licensed beds are those beds for which a facility has been granted approval to operate from the applicable state licensing agency.

(3)		Represents the total number of patients admitted (for a period in excess of 23 hours) to our hospitals and is used by management and certain investors as a general measure of inpatient volume.

(4)		Total delivery system includes all operating data at our owned hospitals prior to elimination of services rendered to our Health Plan members.

(5)		Adjusted admissions and adjusted patient days are used by management and certain investors as a general measure of combined inpatient and outpatient volume. Adjusted admissions/patient days are computed by multiplying admissions/patient days (inpatient volume) by the sum of gross inpatient revenue and gross outpatient revenue and then dividing the resulting amount by gross inpatient revenue. The adjusted admissions/patient days computation “equates” outpatient revenue to the volume measure (admissions/patient days) used to measure inpatient volume resulting in a general measure of combined inpatient and outpatient volume.

(6)		Represents the average number of days admitted patients stay in our hospitals.

(7)		Net patient service revenue and related admissions and adjusted admissions operating data within the consolidated acute care services segment prior to January 1, 2004 excludes revenue and related operating data for services provided to the Lovelace Health Plan members. Due to system limitations, it is impracticable to restate net patient service revenues and related operating data for the three months and six months ended June 30, 2003 for purposes of comparability. Excluding Health Plan members, admissions and adjusted admissions were 6,185 and 13,155, respectively, for the three months ended June 30, 2004 and 12,596 and 26,305, respectively, for the six months ended June 30, 2004.

(8)		Represents the total number of days that patients stayed in our hospitals over the period.

Three Months Ended June 30, 2004 Compared to Three Months Ended June 30, 2003

Total Net Revenues. The $39.3 million increase in total net revenues, a 12.4% increase over the three months ended June 30, 2003, was due to a combination of an increase of $34.5 million in total net revenues from our consolidated acute care services segment, and an increase of $5.2 million in total net revenues from our behavioral care services segment.

The $34.5 million, or 13.8%, increase in our consolidated acute care total net revenues was primarily due to increases of $23.5 million in net patient service revenue and $12.0 million in premium revenues. Net patient service revenue increased due to an increase in patient volumes (including new services and the expansion of existing services) and pricing increases. Total delivery system adjusted admissions increased 8.0% during the three months ended June 30, 2004. Premium revenue increased primarily due to an increase in pricing as membership remained relatively flat.

The $5.2 million, or 7.6%, increase in our behavioral care total net revenues was attributed to $941,000 in total net revenues from the acquisition of Brooke Glen effective October 8, 2003, as well as a $4.4 million increase in our same facility behavioral care total net revenues. Adjusted patient days contributed by Brooke Glen totaled 1,896 during the three months ended June 30, 2004. Since the acquisition in October 2003, we have experienced a delay in obtaining our Medicare certification at Brooke Glen. This delay has had a negative impact on our 2004 total net revenues and results of operations. In May 2004, we received CMS certification of Brooke Glen, which will allow for increased access to patient admissions and improved results of operations in future periods. The $4.4 million increase in same facility behavioral care total net revenues was predominantly related to increases in patient volumes, pricing, expansion of existing services and intensity of services. Adjusted admissions on a same facility basis increased 8.8%. Adjusted patient days on a same facility basis increased 0.7%.

Salaries and Benefits. Salaries and benefits were 39.8% of total net revenues for each of the three months ended June 30, 2004 and 2003. Salaries and benefits in our consolidated acute care services segment were 32.0% of total net revenues for the three months ended June 30, 2004, compared to 33.9% of total net revenues for the three months ended June 30, 2003. The improvement in our consolidated acute care salaries and benefits as a percentage of total net revenues was primarily due to the growth in our markets and the related economies of scale. Lovelace was acquired on January 1, 2003. Due to the size of this acquisition, its integration and the related synergies and economies of scale were not immediately recognized, but occurred throughout 2003. Salaries and benefits in our behavioral care services segment were 57.2% of total net revenues for the three months ended June 30, 2004, compared to 54.1% of total net revenues for the three months ended June 30, 2003. On a same facility basis, salaries and benefits as a percentage of total net revenues were 55.3% and 54.2% for the three months ended June 30, 2004 and 2003, respectively, in our behavioral care services segment. These increases, on a same facility basis, were primarily attributable to wage inflation brought on by nursing labor pressures due to

the national shortage of nurses. The overall increase incremental to the aforementioned same facility increases was primarily related to the delay in obtaining our Medicare certification at Brooke Glen, which resulted in a significantly higher than average staffing ratio on low volumes.

The remainder of our salaries and benefits relate to costs not allocated to our reportable operating segments, which include centralized services such as information services, reimbursement, accounting, taxation, legal, internal audit and risk management. Salaries and benefits not allocated were $8.6 million during the three months ended June 30, 2004, or 2.4% of total net revenues, compared to $4.9 million during the three months ended June 30, 2003, or 1.5% of total net revenues. The increase in unallocated salaries and benefits relates to the growth of our centralized services as we continued to enhance these areas in connection with beginning to implement the internal control requirements of the Sarbanes-Oxley Act and preparing for future growth. We anticipate our centralized services costs to continue to increase in total during 2004 as we continue to grow and integrate recent acquisitions. However, as a percentage of total net revenues, we expect these costs to decline during 2004.

During the three months ended June 30, 2004 our consolidated acute care services segment was able to successfully manage the delivery of health care services with proper staffing and utilization. However, we have been negatively impacted by the industry-wide shortage of nurses, which has caused labor pricing pressures and some level of dependence on contracted labor. Should we be unable in the future to provide adequate nursing coverage at our facilities, our future operating results could be negatively impacted through increased salaries and wages and contract labor.

Professional Fees. Professional fees include amounts paid to non-employed physicians, third-party contractors and legal, accounting and banking firms. Professional fees were 10.0% of total net revenues for the three months ended June 30, 2004, compared to 10.2% of total net revenues for the three months ended June 30, 2003. Professional fees in our consolidated acute care services segment were 10.2% of total net revenues for the three months ended June 30, 2004, compared to 8.9% of total net revenues for the three months ended June 30, 2003. Professional fees in our behavioral care services segment were 11.1% of total net revenues for the three months ended June 30, 2004, compared to 11.0% of total net revenues for the three months ended June 30, 2003. On a same facility basis, professional fees as a percentage of total net revenues were 10.9% and 10.8% for the three months ended June 30, 2004 and 2003, respectively, in our behavioral care services segment.

The increase in our consolidated acute care professional fees as a percentage of total net revenues is due to the growth within our markets, to increased costs related to outsourcing certain claims administration functions at our health plan and to increased costs associated with information systems implementation. The increase in our same facility behavioral care professional fees as a percentage of total net revenues was due primarily to the increase in patient admissions. As a percentage of revenues, we expect our professional fees to decline slightly in future periods as a result of synergies and benefits from economies of scale expected to be achieved from our recent acquisitions.

The remainder of our professional fees relate to costs not allocated to our reportable operating segments. Professional fees related to our centralized services, including information services, legal and accounting, were approximately $3.2 million and $3.5 million for the three months ended June 30, 2004 and 2003, respectively. Beginning in 2004, we allocated such costs to our reportable operating segments.

In connection with becoming a public reporting entity in January, 2004, we began the process of evaluating our business processes and related internal controls in order to satisfy the internal control requirements of the Sarbanes-Oxley Act. The implementation of the requirements of the Sarbanes-Oxley Act has and will continue to require significant effort from our employees as well as our professional advisors. We expect our professional fees to continue to increase in the near term related to our Sarbanes-Oxley implementation.

Claims and Capitation. Claims and capitation expense was 21.0% of total net revenues for the three months ended June 30, 2004, compared to 21.3% of total net revenues for the three months ended June 30, 2003. Before eliminations, our medical care ratio, the claims and capitation costs as a percentage of premium revenue, was 86.0% during the three months ended June 30, 2004. Prior to 2004, we did not record patient revenue within our acute care facilities or claims and capitation expense on the Lovelace Health Plan for health plan members who

received services within our integrated Lovelace Sandia Health System network. Beginning January 1, 2004, we began to present the Lovelace Health Plan as a separate reportable segment.

Supplies. Supply costs were 11.7% of total net revenues for the three months ended June 30, 2004, compared to 11.9% of total net revenues for the three months ended June 30, 2003. Supply costs in our consolidated acute care services segment were 13.3% of total net revenues for the three months ended June 30, 2004, compared to 13.6% of total net revenues during the three months ended June 30, 2003. Supply costs in our consolidated acute care services segment include the pharmaceutical costs of our retail pharmacies, which were 90.7% of retail pharmacy revenue. Supply costs in our behavioral care services segment were 5.2% of total net revenues for the three months ended June 30, 2004, compared to 5.3% of total net revenues for the three months ended June 30, 2003. On a same facility basis, supply costs as a percentage of total net revenues were also 5.2% and 5.3% for the three months ended June 30, 2004 and 2003, respectively, in our behavioral care services segment.

Provision for Doubtful Accounts. The provision for doubtful accounts was 4.5% of total net revenues during the three months ended June 30, 2004, compared to 3.9% of total net revenues during the three months ended June 30, 2003. The provision for doubtful accounts in our consolidated acute care services segment was 5.2% of total net revenues during the three months ended June 30, 2004, compared to 4.3% of total net revenues during the three months ended June 30, 2003. The provision for doubtful accounts in our behavioral care services segment was 1.6% of total net revenues during the three months ended June 30, 2004, compared to 2.1% of total net revenues during the three months ended June 30, 2003. On a same facility basis, provision for doubtful accounts as a percentage of total net revenues was 2.0% and 2.2% during the three months ended June 30, 2004 and 2003, respectively, in our behavioral care services segment.

The increase in days sales outstanding is primarily related to changes in how we manage the acute care activity within the Lovelace Sandia Health System. Beginning on January 1, 2004, we managed the Health Plan as a separate operating segment and our acute care services segment excludes the operations of the Health Plan and includes net patient service revenue related to services rendered at our acute care hospitals to our Health Plan members. We believe this allows us to better manage the businesses within our company and make better financial and operational decisions. As a result of this change in how we managed these operations, we began adjudicating claims for services provided to our Health Plan members. The adjudication of our Health Plan claims, coupled with increased adjusted admissions and patient days, significantly increased the volume of claims that our business office was required to process and resulted in a build up of accounts receivable. We expect to decrease our days sales outstanding during the remainder of 2004 as we continue to increase our business office personnel to adjust to the increased volumes and enhance our collection processes.

The decrease in the provision for doubtful accounts in our behavioral care services segment is primarily attributable to receiving our Medicare certification at Brooke Glen, which has allowed for improved collections on accounts that were previously estimated as uncollectable due to the delay in certification. On a same facility basis, the provision for doubtful accounts remained relatively consistent at 2.0% and 2.2% of total net revenues for the three months ended June 30, 2004 and 2003, respectively.

Interest and Change in Fair Value of Interest Rate Swap Agreements. Interest expense and change in fair value of interest rate swap agreements increased to $9.7 million, in aggregate, for the three months ended June 30, 2004 compared to $4.8 million for the three months ended June 30, 2003. Our long-term debt balance was $260.6 million at June 30, 2004, compared to $176.3 million at June 30, 2003. Our weighted average interest rate on our outstanding debt increased due to our senior subordinated notes and subordinated debt (issued in August 2003) having interest rates at 10.0% and 10.2%, respectively.

In conjunction with our $225.0 million senior subordinated notes, we entered into four interest rate swap agreements which converted $80.0 million of the $225.0 million fixed-rate 10.0% borrowings to floating-rate borrowings. Our interest rate swap agreements did not qualify for hedge accounting under the provisions of SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities; therefore, we have recognized the changes in fair value of the swaps in earnings. At June 30, 2004, the fair value of our interest rate swap agreements was a liability of $831,000. On August 5, 2004, we terminated our interest rate swap agreements, resulting in a payment of $267,000, which was the fair market value of the related liability.

Depreciation and Amortization. Depreciation and amortization expense increased to $11.7 million for the three months ended June 30, 2004 from $7.3 million for the three months ended June 30, 2003. Depreciation and amortization in our Albuquerque market increased $1.5 million during the three months ended June 30, 2004. In addition, depreciation not allocated to our reportable operating segments increased $2.1 million during the three months ended June 30, 2004, which was predominantly related to the information systems build out to support our centralized services and public reporting structure. Our capital expenditures for the three months ended June 30, 2004 and 2003 totaled $11.0 million and $19.6 million, respectively. The capital expenditures during the 2003 fiscal year were $87.0 million. These capital expenditures contributed to the increase in depreciation as the respective assets became utilized and depreciable.

Gain on Divestitures. Our gain on divestitures for the three months ended June 30, 2003 was related to the sale of a behavioral hospital in Oregon that was previously identified for sale under SFAS No. 121.

Other Operating Expenses. Other operating expenses consist of insurance costs (primarily general and professional liability), non-income taxes (various states in which we operate have gross receipts taxes or premium taxes), utilities, rents and leases, repairs and maintenance and other operating expenses. Other operating expenses were 8.3% of total net revenues during the three months ended June 30, 2004, compared to 9.3% of total net revenues during the three months ended June 30, 2003. Other operating expenses in our consolidated acute care services segment were 7.5% of total net revenues during the three months ended June 30, 2004, compared to 8.9% of total net revenues during the three months ended June 30, 2003. Other operating expenses in our behavioral care services segment were 8.6% of total net revenues during the three months ended June 30, 2004, compared to 8.1% of total net revenues during the three months ended June 30, 2003. On a same facility basis, other operating expenses as a percentage of total net revenues were 8.2% and 8.1% during the three months ended June 30, 2004 and 2003, respectively, in our behavioral care services segment.

The decrease in our consolidated acute care services segment other operating expenses as a percentage of total net revenues was due to the growth within our markets and related economies of scale. The behavioral care segment other operating expenses have remained relatively constant.

The remainder of our other operating expenses relate to costs not allocated to our reportable operating segments. Other operating expenses not allocated were $2.2 million during the three months ended June 30, 2004 compared to $1.8 million during the three months ended June 30, 2003. These costs predominantly relate to our centralized services, specifically our lease costs for our corporate and information services facilities, which increased as we grew our infrastructure. We anticipate these costs to decline as a percentage of total net revenues during 2004 as we complete the build out of our public reporting structure.

We expect to see continued increases in the cost of insurance, especially for general and professional liability, as the market has fewer competitors and remains depressed. We have offset the pace of increases through the establishment of a wholly-owned captive insurance subsidiary that now insures our professional and general liability risk for claims up to $2.0 million, subject to a $500,000 deductible per claim. In addition, we purchased excess insurance coverage with independent third-party carriers for claims totaling up to $75.0 million per occurrence and in the aggregate.

Income Tax Expense. Our income tax effective rate from continuing operations was 37.2% for the three months ended June 30, 2004 compared to 38.3% for the three months ended June 30, 2003. The change primarily relates to our state income tax rates.

Net Income from Continuing Operations. Net loss from continuing operations increased to $3.0 million for the three months ended June 30, 2004 from $486,000 for the three months ended June 30, 2003, primarily as a result of proportionately higher increases in certain operating expenses compared to total net revenues, most notably the $4.9 million increase in interest expense and change in fair value of interest rate swap agreements and the $4.4 million increase in depreciation and amortization.

Income (Loss) from Discontinued Operations. Income from discontinued operations was $3.5 million for the three months ended June 30, 2004 compared to a loss of $474,000 for the three months ended June 30, 2003. For the three months ended June 30, 2004 we recorded a gain on divestitures of $3.6 million associated with the divestiture of a behavioral hospital effective April 1, 2004.

Accrued Preferred Dividends. Our accrued preferred dividends amount to 8.0% of the principal amount and accrued unpaid dividends outstanding on our redeemable preferred units. Effective January 2004, we amended the terms of the preferred units such that the mandatory redemption date of August 19, 2014 was deleted, thereby removing the mandatory redemption feature. Had we not amended the preferred units, effective January 1, 2004 we would have been required to account for the preferred units as a liability and record the dividends as interest expense.

Six Months Ended June 30, 2004 Compared to Six Months Ended June 30, 2003

Total Net Revenues. The $95.6 million increase in total net revenues, a 15.2% increase over the six months ended June 30, 2003, was due to a combination of an increase of $83.9 million in total net revenues from our consolidated acute care services segment, and an increase of $12.5 million in total net revenues from our behavioral care services segment.

The $83.9 million, or 17.0%, increase in our consolidated acute care total net revenues was primarily due to increases of $59.1 million in net patient revenue and $24.5 million in premium revenues. Net patient revenue increased due to an increase in patient volumes (including new services and the expansion of existing services) and pricing increases. Total delivery system adjusted admissions increased 8.4% during the six months ended June 30, 2004. Premium revenue increased primarily due to an increase in pricing as membership remained relatively flat.

The $12.5 million, or 9.2%, increase in our behavioral care total net revenues was attributed to $2.2 million in total net revenues from the acquisition of Brooke Glen effective October 8, 2003, as well as a $10.2 million increase in our same facility behavioral care total net revenues. Adjusted patient days contributed by Brooke Glen totaled 4,587 during the six months ended June 30, 2004. Since the acquisition in October 2003, we experienced a delay in obtaining our Medicare certification at Brooke Glen. This delay has had a negative impact on our 2004 total net revenues and results of operations. In May 2004, we received CMS certification of Brooke Glen, which will allow for increased access to patient admissions and improved results of operations in future periods. The $10.2 million increase in same facility behavioral care total net revenues was predominantly related to increases in patient volumes, pricing, expansion of existing services and intensity of services. Adjusted admissions on a same facility basis increased 10.1%. Adjusted patient days on a same facility basis increased 2.7%.

Salaries and Benefits. Salaries and benefits were 39.9% of total net revenues for each of the six months ended June 30, 2004 and 2003. Salaries and benefits in our consolidated acute care services segment were 32.6% of total net revenues for the six months ended June 30, 2004, compared to 33.9% of total net revenues for the six months ended June 30, 2003. The improvement in our consolidated acute care salaries and benefits as a percentage of total net revenues was primarily due to the growth in our markets and the related economies of scale. Lovelace was acquired on January 1, 2003. Due to the size of this acquisition, its integration and the related synergies and economies of scale were not immediately recognized, but occurred throughout 2003. Salaries and benefits in our behavioral care services segment were 57.0% of total net revenues for the six months ended June 30, 2004, compared to 54.6% of total net revenues for the six months ended June 30, 2003. On a same facility basis, salaries and benefits as a percentage of total net revenues were 55.3% and 54.7% for the six months ended June 30, 2004 and 2003, respectively, in our behavioral care services segment. These increases on a same facility basis, were primarily attributable to wage inflation brought on by nursing labor pressures due to the national shortage of nurses. The overall increase incremental to the aforementioned same facility increases was primarily related to the delay in obtaining our Medicare certification at Brooke Glen, which resulted in a significantly higher than average staffing ratio on low volumes.

Salaries and benefits not allocated were $15.9 million during the six months ended June 30, 2004, or 2.2% of total net revenues, compared to $9.0 million during the six months ended June 30, 2003, or 1.4% of total net revenues. The increase in unallocated salaries and benefits relates to the growth of our centralized services as we continued to enhance these areas in connection with beginning to implement the internal control requirements of the Sarbanes-Oxley Act and preparing for future growth. We anticipate our centralized services costs to continue to increase in total during 2004 as we continue to grow and integrate recent acquisitions. However, as a percentage of total net revenues, we expect these costs to decline during 2004.

During the six months ended June 30, 2004 our consolidated acute care services segment was able to successfully manage the delivery of health care services with proper staffing and utilization. However, we have been negatively impacted by the industry-wide shortage of nurses, which has caused labor pricing pressures and some level of dependence on contracted labor. Should we be unable in the future to provide adequate nursing coverage at our facilities, our future operating results could be negatively impacted through increased salaries and wages and contract labor.

Professional Fees. Professional fees were 9.1% of total net revenues for the six months ended June 30, 2004, compared to 9.9% of total net revenues for the six months ended June 30, 2003. Professional fees in our consolidated acute care services segment were 9.1% of total net revenues for the six months ended June 30, 2004, compared to 8.9% of total net revenues for the six months ended June 30, 2003. Professional fees in our behavioral care services segment were 11.1% of total net revenues for the six months ended June 30, 2004, compared to 10.7% of total net revenues for the six months ended June 30, 2003. On a same facility basis, professional fees as a percentage of total net revenues were 10.8% and 10.5% for the six months ended June 30, 2004 and 2003, respectively, in our behavioral care services segment.

The increase in our consolidated acute care professional fees as a percentage of total net revenues was due to the growth within our markets, to increased costs related to outsourcing certain claims administration functions at our health plan and to increased costs associated with information systems implementation. The increase in our same facility behavioral care professional fees as a percentage of total net revenues was due primarily to the increase in patient admissions. As a percentage of revenues, we expect our professional fees to decline slightly in future periods as a result of synergies and benefits from economies of scale expected to be achieved from our recent acquisitions.

The remainder of our professional fees relate to costs not allocated to our reportable operating segments during 2003. Professional fees related to our centralized services, including information services, legal and accounting, were approximately $6.7 million and $5.9 million for the six months ended June 30, 2004 and 2003, respectively. Beginning in 2004, we allocated such costs to our reportable operating segments. In connection with becoming a public reporting entity in January, 2004, we began the process of evaluating our business processes and related internal controls in order to satisfy the internal control requirements of the Sarbanes-Oxley Act. The implementation of the requirements of Sarbanes-Oxley Act has and will continue to require significant effort from our employees as well as our professional advisors. We expect our professional fees to continue to increase in the near term related to our Sarbanes-Oxley implementation.

Claims and Capitation. Claims and capitation expense was 20.2% of total net revenues for the six months ended June 30, 2004, compared to 21.5% of total net revenues for the six months ended June 30, 2003. Before eliminations, our medical care ratio, the claims and capitation costs as a percentage of premium revenue, was 85.9% during the six months ended June 30, 2004. Prior to 2004, we did not record patient revenue within the acute care hospitals or claims and capitation expense on the Lovelace Health Plan for health plan members who received services within our integrated Lovelace Sandia Health System network. Beginning January 1, 2004, we began to present the Lovelace Health Plan as a separate reportable segment.

Supplies. Supply costs were 11.6% of total net revenues for the six months ended June 30, 2004, compared to 11.9% of total net revenues for the six months ended June 30, 2003. Supply costs in our consolidated acute care services segment were 13.2% of total net revenues for the six months ended June 30, 2004, compared to 13.6% of total net revenues during the six months ended June 30, 2003. Supply costs in our consolidated acute care services segment include the pharmaceutical costs of our retail pharmacies, which were 81.4% of retail pharmacy revenue. Supply costs in our behavioral care services segment were 5.2% of total net revenues for the

six months ended June 30, 2004, compared to 5.3% of total net revenues for the six months ended June 30, 2003. On a same facility basis, supply costs as a percentage of total net revenues were also 5.2% and 5.3% for the six months ended June 30, 2004 and 2003, respectively, in our behavioral care services segment.

Provision for Doubtful Accounts. The provision for doubtful accounts was 4.6% of total net revenues during the six months ended June 30, 2004, compared to 3.7% of total net revenues during the six months ended June 30, 2003. The provision for doubtful accounts in our consolidated acute care services segment was 5.2% of total net revenues during the six months ended June 30, 2004, compared to 4.0% of total net revenues during the six months ended June 30, 2003. The provision for doubtful accounts in our behavioral care services segment was 2.2% of total net revenues during the six months ended June 30, 2004, compared to 2.3% of total net revenues during the six months ended June 30, 2003. On a same facility basis, provision for doubtful accounts as a percentage of total net revenues was 2.3% and 2.5% during the six months ended June 30, 2004 and 2003, respectively, in our behavioral care services segment.

As previously discussed, we have experienced an increase in self-pay amounts due from patients and a deterioration in the collectability of such amounts, which has resulted in an increase in our provision for doubtful accounts as a percentage of total net revenues. Our accounts receivable has increased due to a corresponding increase in net patient service revenue and an increase in days sales outstanding, which were 67 and 59 as of June 30, 2004 and December 31, 2003, respectively.

Interest and Change in Fair Value of Interest Rate Swap Agreements. Interest expense and change in fair market value of interest rate swap agreements increased to $14.9 million, in aggregate, for the six months ended June 30, 2004 from $8.5 million for the six months ended June 30, 2003. Our long-term debt balance was $260.6 million at June 30, 2004, compared to $176.3 million at June 30, 2003. Our weighted average interest rate on our outstanding debt increased due to our senior subordinated notes and subordinated debt (issued in August 2003) having interest rates at 10.0% and 10.2%, respectively.

Depreciation and Amortization. Depreciation and amortization expense increased to $22.5 million for the six months ended June 30, 2004 from $14.6 million for the six months ended June 30, 2003. Depreciation and amortization in our Albuquerque market increased $2.4 million during the six months ended June 30, 2004. In addition, depreciation not allocated to our reportable operating segments increased $4.0 million during the six months ended June 30, 2004, which was predominantly related to the information systems build out to support our centralized services and public reporting structure. Our capital expenditures for the six months ended June 30, 2004 and 2003 totaled $20.3 million and $27.4 million, respectively. The capital expenditures during the 2003

fiscal year were $87.0 million. These capital expenditures contributed to the increase in depreciation as the respective assets became utilized and depreciable.

Gain on Divestitures. Our gain on divestitures for the six months ended June 30, 2003 was related to the sale of a behavioral hospital in Oregon that was previously identified for sale under SFAS No. 121.

Other Operating Expenses. Other operating expenses consist of insurance costs (primarily general and professional liability), non-income taxes (various states in which we operate have gross receipts taxes or premium taxes), utilities, rents and leases, repairs and maintenance and other operating expenses. Other operating expenses were 8.6% of total net revenues during the six months ended June 30, 2004, compared to 9.0% of total net revenues during the six months ended June 30, 2003. Other operating expenses in our consolidated acute care services segment were 7.7% of total net revenues during the six months ended June 30, 2004, compared to 8.6% of total net revenues during the six months ended June 30, 2003. Other operating expenses in our behavioral care services segment were 8.6% of total net revenues during the six months ended June 30, 2004, compared to 8.2% of total net revenues during the six months ended June 30, 2003. On a same facility basis, other operating expenses as a percentage of total net revenues were 8.2% during each of the six months ended June 30, 2004 and 2003, in our behavioral care services segment.

The remainder of our other operating expenses relate to costs not allocated to our reportable operating segments. Other operating expenses not allocated were $5.2 million during the six months ended June 30, 2004 compared to $3.0 million during the six months ended June 30, 2003. These costs predominantly relate to our centralized services, specifically our lease costs for our corporate and information services facilities, which increased as we grew our infrastructure. We anticipate these costs to decline as a percentage of total net revenues during 2004 as we complete the build out of our public reporting structure.

Income Tax Expense. Our income tax effective rate from continuing operations was 39.0% for the six months ended June 30, 2004 compared to 40.1% for the six months ended June 30, 2003. The change primarily relates to our state income tax rates.

Net Income from Continuing Operations. Net income from continuing operations increased to $3.3 million for the six months ended June 30, 2004 from $1.8 million for the six months ended June 30, 2003, primarily as a result of the increase in total net revenues while effectively managing the utilization of our resources.

Income from Discontinued Operations. Income from discontinued operations was $3.2 million and $114,000 for the six months ended June 30, 2004 and 2003, respectively. For the six months ended June 30, 2004, we recorded a gain on divestitures of $3.6 million associated with the divestiture of a behavioral hospital effective April 1, 2004. For the six months ended June 30, 2003, we recorded pretax gains of $949,000 from the sale of another behavioral hospital and recoveries of fully reserved items related to a behavioral hospital sold in 2002.

Liquidity and Capital Resources

Liquidity

We require capital principally for the acquisition of additional acute care and behavioral hospitals, the expansion of the services provided through our existing facilities, improvements to these facilities, including designing and implementing new information systems, and for debt service. Historically, we have financed our capital requirements, including our acquisitions, through a combination of cash flows from operations, borrowings under credit facilities and proceeds from the issuance of subordinated debt and equity securities.

Sources and Uses of Cash

Our cash and cash equivalents were $122.7 million at June 30, 2004, compared to $89.8 million at December 31, 2003, an increase of $32.9 million primarily related to proceeds from the issuance of common units. A more detailed discussion on specific sources and uses of cash is set forth below.


	Three Months						Six Months
	Ended June 30,						Ended June 30,
	2004			2003			2004			2003
Statement of cash flows information:
Cash flows provided by (used in) operating activities	$	24,153		$	6,173		$	(142	)	$	15,546
Cash flows used in investing activities		(3,590	)		(18,520	)		(13,811	)		(212,653	)
Cash flows provided by (used in) financing activities		49,239			(8,032	)		48,155			112,171

Cash flows used in operating activities were $142,000 for the six months ended June 30, 2004, compared to cash flows provided by operating activities of $15.5 million for the six months ended June 30, 2003. Our cash flows used in operating activities were negatively impacted primarily by a $52.1 million increase in accounts receivable. The increase in accounts receivable relates to the previously discussed increase in our days sales outstanding, which increased from 59 days at December 31, 2003 to 67 days at June 30, 2004. The increase in days sales outstanding equates to approximately $16.6 million. The remaining increase is due primarily to an increase in net patient service revenue, which resulted in a corresponding increase in accounts receivable.

Cash flows used in investing activities decreased to $13.8 million for the six months ended June 30, 2004, compared to $212.7 million for the six months ended June 30, 2003. Our total cash spent for the six months ended June 30, 2004 related to capital expenditures was $20.3 million. During the six months ended June 30, 2003, we spent $194.1 million on acquisitions, primarily to acquire Lovelace Health System, Inc.

Cash flows provided by financing activities were $48.2 million in 2004, compared to cash flows provided by financing activities of $112.2 million in 2003. We financed our Lovelace acquisition primarily from our credit facilities, which were paid in full from the proceeds of our senior subordinated notes and equity issued in 2002.

Restrictions on Cash Flows

Lovelace Sandia Health System, Inc., our wholly-owned subsidiary, includes, in addition to hospitals and other health care facilities, the Lovelace Health Plan. Lovelace Sandia Health System, Inc. is therefore subject to certain restrictions on its ability to pay dividends or make other distributions to us by state insurance company laws and regulations. These laws and regulations require Lovelace Sandia Health System, Inc. to give notice to the New Mexico Department of Insurance prior to paying dividends or making distributions to us. Lovelace Sandia Health System, Inc. has paid dividends of $25.0 million to our affiliates since its acquisition. As of June 30, 2004, cash and cash equivalents at Lovelace Sandia Health System, Inc. were $21.9 million. In addition, Lovelace Sandia Health System, Inc. is subject to state-imposed net worth-based capital requirements that effectively limit the amount of funds it has available to distribute to us. As of June 30, 2004, Lovelace Sandia Health System, Inc. is required to maintain a net worth of approximately $34.8 million (based on the unaudited annual statement filing with the State of New Mexico), as well as a minimum requirement of $610,000 in cash or short-term government instruments. Actual net worth exceeded the requirement by $10.3 million and, subject to the requirements, may be available to us. On July 12, 2004, Lovelace Sandia Health System, Inc.’s intercompany note was reduced from $70.0 million to $43.0 million with a corresponding increase to net worth. Refer to “Capital Resources” for further discussion. This additional net worth will provide, in part, the additional capital required in connection with our acquisition of approximately 30,000 commercial members of Cimarron Health Plan. In addition, as part of Lovelace Health Plan’s participation in the Medicaid Salud! program for New Mexico, Lovelace Sandia Health System, Inc. is required to maintain a cash reserve of at least 3.0% of the annual capitated payments per member for each month of the first year of the

contract. As of June 30, 2004, Lovelace Sandia Health System, Inc. maintained a balance of $3.4 million to meet these two required reserve amounts.

As a result of the consolidation and merger of our New Mexico operations in October 2003, all of our operations in New Mexico (other than the operations of AHS S.E.D. Medical Laboratories, Inc.) are owned by Lovelace Sandia Health System, Inc. and are subject to the restrictions and requirements described above.

Cash Requirements

During the three months and six months ended June 30, 2004, there were no material changes in our contractual obligations presented in our 2003 Annual Report on Form 10-K. In connection with the Hillcrest acquisition in August 2004, we borrowed an additional $300.0 million of senior secured term debt under the August 2003 Credit Agreement, as amended, as further discussed in “Capital Resources”, and assumed or replaced certain operating and capital leases of Hillcrest. We also committed to invest approximately $100.0 million in capital expenditures in the Tulsa market over the next five years.

Letters of Credit

We are required to issue letters of credit for the benefit of our insurers related to our workers’ compensation and professional liability insurance coverage. As of June 30, 2004, we had issued $7.1 million of standby letters of credit which were secured by the collateral of our August 2003 Credit Agreement. In connection with the Hillcrest acquisition and related amendment to the August 2003 Credit Agreement, we issued an additional $3.3 million of standby letters of credit on August 12, 2004.

Capital Expenditures (including Capital Commitments)

Capital expenditures, excluding amounts paid for acquisitions, were $11.0 million and $19.6 million for the three months ended June 30, 2004 and 2003, respectively, and $20.3 million and $27.4 million for the six months ended June 30, 2004 and 2003, respectively. Generally, the facilities and equipment at the hospitals we have acquired were in good condition; however, we have invested, and will continue to invest, significant funds into facility improvements and service enhancements undertaken by our hospitals. Excluding Hillcrest, we expect to make total capital expenditures in our existing facilities of approximately $60.0 million during 2004. We expect to fund these expenditures through cash provided by operating activities and borrowings under our bank facility.

As previously discussed, we have committed to invest $80.0 million of capital expenditures in the Albuquerque market through 2008, of which $58.9 million has been invested through June 30, 2004. We expect that the remaining $21.1 million will be invested in the Albuquerque market during the remainder of 2004 as we continue to upgrade financial and clinical systems, expand service lines and refurbish and retool facilities.

On August 12, 2004, we completed the previously announced acquisition of Hillcrest in Tulsa, Oklahoma. We acquired substantially all of the net operating assets of Hillcrest for $326.3 million, including preliminary working capital, subject to customary adjustments. The acquisition consisted primarily of two metropolitan Tulsa hospitals and related health care entities, as well as six regional hospitals acquired or intended to be acquired through long-term operating agreements. In connection with the Hillcrest acquisition, we committed to invest approximately $100.0 million in capital expenditures in the Tulsa market over the next five years.

The aggregate purchase price of the Hillcrest acquisition was paid in cash and financed, in part, with the $58.3 million of proceeds invested by WCAS, Ferrer Freeman and BAC pursuant to the subscription agreement with us and further discussed in Note 7 to the accompanying unaudited condensed consolidated financial statements. The remaining purchase price was financed through an additional borrowing of senior secured term debt borrowed on August 12, 2004 in the principal amount of $300.0 million, as further discussed in “Capital Resources”.

Our August 2003 Credit Agreement described below contains provisions that limit annual capital expenditures. We increased this limit in conjunction with the August 2003 Credit Agreement, as amended, to provide for forecasted capital expenditures, including the $100.0 million capital expenditure commitment related to the recently completed Hillcrest acquisition. We believe our forecasted and committed capital expenditures will be sufficient to meet our quality and growth objectives while allowing us to expand our service lines and complete our implementation of clinical and information systems; however, there can be no assurance that we will be able to obtain the financing required to provide for forecasted capital expenditures.

Capital Resources

Long-term Debt and Capital

On August 19, 2003, we received $225.0 million through the issuance of 10.0% senior subordinated notes due on August 15, 2013. We used the proceeds from the offering to repay all amounts outstanding under our then existing credit facilities of $155.2 million plus accrued interest. On March 1, 2004, we exchanged all of our outstanding 10.0% senior subordinated notes due August 15, 2013, for 10.0% senior subordinated notes due August 15, 2013, that have been registered under the Securities Act of 1933, as amended. Terms and conditions of the exchange offer were as set forth in the registration statement on Form S-1 filed with the Securities and Exchange Commission that became effective on January 28, 2004. Interest on the senior subordinated notes is payable semi-annually on February 15 and August 15. We may redeem the senior subordinated notes, in whole or in part, at any time before August 15, 2008, at the principal amount plus a premium and accrued and unpaid interest. We may redeem the senior subordinated notes after August 15, 2008, at redemption prices ranging from 105.0% to 100.0%, plus accrued and unpaid interest. Additionally, at any time prior to August 15, 2006, we may redeem up to 35.0% of the principal amount of the senior subordinated notes with the net cash proceeds of one or more sales of our capital stock at a redemption price of 110.0% plus accrued and unpaid interest to the redemption date; provided that at least 65.0% of the aggregate principal amount of the senior subordinated notes originally issued on August 19, 2003 remains outstanding after each such redemption and the redemption occurs within 90 days of the date of closing of the equity offering.

Payment of the principal and interest of the senior subordinated notes is subordinate to amounts owed for our existing and future senior indebtedness. The senior subordinated notes are guaranteed, fully and unconditionally, jointly and severally, on an unsecured senior subordinated basis by all of our material subsidiaries (the “Subsidiary Guarantors”), other than Lovelace Sandia Health System, Inc. and our captive insurance subsidiary. We are subject to certain restrictive covenants under the Indenture governing the senior subordinated notes. We have designated certain of our immaterial affiliates as unrestricted subsidiaries under the indenture governing the senior subordinated notes. None of these unrestricted subsidiaries carry on any significant business or conduct any operations and, as a result, they are not material to our business, financial condition or results of operations.

On August 19, 2003, concurrent with the issuance of the senior subordinated notes, we replaced our existing credit agreement with the August 2003 Credit Agreement with a syndicate of banks and other institutional lenders. The August 2003 Credit Agreement consisted of a $125.0 million revolving line of credit, subject to a borrowing base, including a swing-line loan of $10.0 million and an incremental term loan under which we were permitted to request term loans of up to $200.0 million. The August 2003 Credit Agreement contained various financial covenants including requirements to maintain a minimum interest coverage ratio, a total leverage ratio, a senior leverage ratio, a minimum net worth of the health maintenance organization subsidiaries, and a capital expenditures maximum. At June 30, 2004, we were in compliance with all such covenants. The August 2003 Credit Agreement also restricted certain of our activities including our ability to incur additional debt, declare dividends,

repurchase stock, engage in mergers and acquisitions and sell assets.

On August 12, 2004, we amended our August 2003 Credit Agreement to, among other things, increase our $125.0 million revolving line of credit to a $150.0 million revolving line of credit and add $300 million of additional borrowing available under an add-on term loan (“Term Loan B”). We also retained the $200.0 million of incremental term loans available, under certain conditions, under the existing August 2003 Credit Agreement. Concurrent with the amendment, we received $300.0 million through borrowings of the amount available under Term Loan B. Interest on Term Loan B is payable quarterly at an interest rate of either LIBOR plus 2.25% or a base rate plus 1.25%. Principal payments of 0.25% of the original principal borrowed on Term Loan B are to be paid quarterly, with the remaining principal to be paid at maturity. Term Loan B matures August 12, 2011. The revolving line of credit bears interest initially at LIBOR plus 2.50%. The interest on the revolving line of credit is payable on the outstanding principal balance on the last day of the selected interest period. The principal amount of the revolving line of credit is to be paid in full on August 19, 2008. We have not incurred borrowings under the revolving line of credit or incremental term loans as of August 16, 2004; other than standby letters of credit totaling $10.4 million that reduce the amount available under the revolving line of credit.

We continue to pay a commitment fee ranging from 0.50% to 0.75% of the average daily amount of availability under the revolving credit facility and other fees based on the applicable LIBOR margin on outstanding standby letters of credit. The August 2003 Credit Agreement, as amended, contains various financial covenants including requirements for us to maintain a minimum interest coverage ratio, a total leverage ratio, a senior leverage ratio, a minimum net worth of the health maintenance organization subsidiaries and a capital expenditures maximum. The August 2003 Credit Agreement, as amended, also restricts certain of our activities, including our ability to incur additional debt, declare dividends, repurchase stock, engage in mergers or acquisitions and sell assets. The August 2003 Credit Agreement, as amended, is guaranteed by us and our material and future subsidiaries, other than Lovelace Sandia Health System, Inc. and our captive insurance subsidiary, and is secured by substantially all of our existing and future property and assets and capital stock of all of our subsidiaries.

In connection with the merger of our New Mexico subsidiaries on October 1, 2003, Lovelace Sandia Health System, Inc. (the surviving entity) issued a $70.0 million intercompany note to Ardent Health Services, Inc. Interest accrues at a rate equal to the greater of (i) our base rate plus 4.0% or (ii) 6.0%. Interest is payable on demand. Principal is payable on the later of November 19, 2008 or 30 days after the maturity date of our incremental term loan, if any. We were required to maintain a pledge of the intercompany note in favor of the lenders of our August 2003 Credit Agreement and the holders of the senior subordinated notes. Effective January 1, 2004, the intercompany note was transferred to a subsidiary of Ardent Health Services, Inc. On July 12, 2004, the August 2003 Credit Agreement was amended to, among other things, reduce the pledge required to be maintained by the Company to $43.0 million, upon which the intercompany note was also amended to reduce the principal amount of the note to $43.0 million.

Interest Rate Swap Agreements

In September 2003, we entered into four interest rate swap agreements with large financial institutions which converted a notional amount of $80.0 million of the senior subordinated notes to floating-rate borrowings. The swap agreements mature in $40.0 million increments on August 15, 2006 and August 15, 2008. The floating interest rate is based on six month LIBOR plus a margin and is determined for the six months ended in arrears on semi-annual settlement dates of February 15 and August 15. The swap agreements do not qualify for hedge accounting, thus changes in the fair value of our interest rate hedging arrangements are recognized each period in earnings. All earnings adjustments resulting from changes in the fair values of the interest rate swaps are non-cash charges or credits and do not impact cash flows from operations or operating income. There may be periods with significant non-cash increases or decreases to our earnings relating to the change in the fair value of the interest rate swap agreements. The fair value of the swap obligations was a liability of $831,000 at June 30, 2004. On August 5, 2004, we terminated our

interest rate swap agreements, resulting in a payment of $267,000, which was the fair market value of the related liability.

Availability of Capital Resources

We believe that the cash flows generated by our operations, together with amounts available under our August 2003 Credit Agreement, as amended, and cash on hand will be sufficient to meet our operating and capital needs for at least the next twelve months.

At June 30, 2004, we had borrowing capacity of $117.9 million on our revolving line of credit and, in certain circumstances, $200.0 million on our term loans. In connection with our acquisition of Hillcrest on August 12, 2004, we amended our credit facility to, among other things, accommodate an additional $25.0 million borrowing capacity on our revolving line of credit and add $300.0 million of additional borrowing available under an add-on term loan. Concurrent with the amendment, we borrowed the $300.0 million available under our Term Loan B to fund, in part, the Hillcrest acquisition, after which we have borrowing capacity of $139.6 million on our revolving line of credit and, in certain circumstances, $200.0 million on our term loans. We intend to acquire additional hospitals and are actively seeking acquisitions that fit our corporate growth strategy. These acquisitions may, however, require financing in addition to the capital on hand and future cash flows from operations. We continually assess our capital needs and may seek additional financing, including debt or equity, as considered necessary to fund potential acquisitions or for other corporate purposes. We anticipate that our acquisition strategy will necessitate the funding of future acquisitions through use of our amended credit facility and use of other financing means that may not be available to us at those times. We expect to finance our future acquisitions in large part through additional borrowings; however, there can be no assurance that we will be able to obtain future financing or financing on terms favorable to us.

Recently Issued Accounting Standards

A discussion of recently issued accounting pronouncements and their effect on our financial position and results of operations can be found in Note 2 to our unaudited condensed consolidated financial statements.

Seasonality

We typically experience higher patient volumes in the first and fourth quarters of each year. We typically experience such seasonal volume peaks because more people generally become ill during the winter months, which in turn results in significant increases in the number of patients we treat during those months.

Inflation

The health care industry is labor intensive. Wages, contract labor and other expenses increase during periods of inflation and when shortages in marketplaces occur. In addition, our supply costs and insurance costs are subject to inflation as the respective vendors pass along their increased costs to us in the form of higher prices. Our ability to pass on these increased costs is limited because of increasing regulatory and competitive pressures. Accordingly, inflationary pressures could have a material adverse effect on our results of operations.

Item 4. Controls and Procedures.

We conducted an evaluation, under the supervision of our chief executive officer and chief financial officer, of the effectiveness as of June 30, 2004 of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)). Based on this evaluation, our chief executive officer and chief financial officer have concluded that our disclosure controls and

procedures were effective as of June 30, 2004.

There was no change in our internal control over financial reporting during our last fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

As previously disclosed, we have identified certain matters with respect to period-end closing processes, including matters related to the lack of timely and accurate review and reconciliations of account balances. We also are in the initial phases of our efforts to comply with the internal control requirements of Section 404 of the Sarbanes-Oxley Act. Additionally, an integral part of our business strategy is the continued selective acquisitions of acute care and behavioral hospitals. Many of our acquisition targets may not have systems of internal control over financial reporting that would comply with the internal control requirements of Section 404 of the Sarbanes-Oxley Act. Based on the matters previously identified, our continued efforts to comply with the internal control requirements of Section 404 of the Sarbanes-Oxley Act and our acquisition strategy, we anticipate that we will identify additional weaknesses and deficiencies in our internal control over financial reporting. We have implemented and will continue to implement action plans to remedy any deficiencies or weaknesses identified.

PART II
OTHER INFORMATION

Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities

During the three months ended June 30, 2004, certain holders of the Company’s common units exercised their right to purchase 11,111,109 common units at $4.50 per unit pursuant to a subscription agreement between the Company and such holders. These transactions were exempt from registration pursuant to, among other things, Section 4(2) and Regulation D under the Securities Act of 1933, as amended (the “Securities Act”). In addition, an employee of the Company exercised options to purchase 2,500 common units at $3.43 per unit. This transaction was exempt from registration pursuant to, among other things, Rule 701 under the Securities Act.

Item 6. Exhibits and Reports on Form 8-K.

(a) Exhibits: The following exhibits are filed with this report.


Exhibit No.		Description
2.1		Asset Purchase Agreement, dated as of May 11, 2004, between Hillcrest HealthCare System and Ardent Health Services, Inc.

2.2		Assets Purchase Agreement, dated as of July 20, 2004, between Heritage Home Healthcare and Lovelace Sandia Health System, Inc.

3.1		Certificate of Formation of Ardent Health Services LLC, as filed with the Delaware Secretary of State on June 1, 2001 (Incorporated by reference to Exhibit 3.1 to the Registrant’s Registration Statement on Form S-1, File No. 333-110117)

3.2		Limited Liability Company Agreement of Ardent Health Services LLC, including Amendment No. 1 thereto (Incorporated by reference to Exhibit 3.2 to the Registrant’s Registration Statement on Form S-1, File No. 333-110117)

3.3		Amendment No. 2 to Limited Liability Company Agreement of Ardent Health Services LLC (Incorporated by reference to Exhibit 3.3 to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2003)

10.1		First Amendment to Credit Agreement dated as of December 31, 2003 among Ardent Health Services, Inc., as Borrower, Ardent Health Services LLC and certain of its subsidiaries as Guarantors, Bank One, NA, as Administrative Agent, Swing Line Lender and L/C Issuer and the Lenders party thereto

10.2		Second Amendment to Credit Agreement dated as of July 12, 2004 among Ardent Health Services, Inc. as Borrower, Ardent Health Services LLC and certain of its subsidiaries as Guarantors, Bank One, NA, as Administrative Agent, Swing Line Lender and L/C Issuer and the other Lenders party thereto

10.3		Second Amended and Restated Intercompany Promissory Note dated July 12, 2004 issued by Lovelace Sandia Health System, Inc. in favor of Ardent Medical Services, Inc.

10.4		Employment Agreement, dated as of July 1, 2004, between AHS Management Company, Inc. and David T. Vandewater

10.5		Amended and Restated Employment and Consulting Agreement, dated as of June 7, 2004, between AHS Management Company, Inc. and Vernon S. Westrich

31.1		Certification of CEO pursuant to Rule 13a-14(a)/15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

31.2		Certification of CFO pursuant to Rule 13a-14(a)/15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

32.1		Certification of CEO pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

32.2		Certification of CFO pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

(b) Reports on Form 8-K During the Quarter Ended June 30, 2004

On April 7, 2004, the Company filed a Current Report on Form 8-K, pursuant to Item 4, regarding changes in the Company’s certifying accountant.

On May 4, 2004, the Company furnished a Current Report on Form 8-K, pursuant to Item 12, regarding the Company’s press release announcing its financial results for the first quarter ended March 31, 2004.

On May 12, 2004, the Company filed a Current Report on Form 8-K, pursuant to Item 5, relating to the Company’s execution of a definitive agreement to acquire Hillcrest HealthCare System in Tulsa, Oklahoma.

EXHIBIT INDEX


Exhibit No.		Description
2.1		Asset Purchase Agreement, dated as of May 11, 2004, between Hillcrest HealthCare System and Ardent Health Services, Inc.

2.2		Assets Purchase Agreement, dated as of July 20, 2004, between Heritage Home Healthcare and Lovelace Sandia Health System, Inc.

3.1		Certificate of Formation of Ardent Health Services LLC, as filed with the Delaware Secretary of State on June 1, 2001 (Incorporated by reference to Exhibit 3.1 to the Registrant’s Registration Statement on Form S-1, File No. 333-110117)

3.2		Limited Liability Company Agreement of Ardent Health Services LLC, including Amendment No. 1 thereto (Incorporated by reference to Exhibit 3.2 to the Registrant’s Registration Statement on Form S-1, File No. 333-110117)

3.3		Amendment No. 2 to Limited Liability Company Agreement of Ardent Health Services LLC (Incorporated by reference to Exhibit 3.3 to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2003)

10.1		First Amendment to Credit Agreement dated as of December 31, 2003 among Ardent Health Services, Inc., as Borrower, Ardent Health Services LLC and certain of its subsidiaries as Guarantors, Bank One, NA, as Administrative Agent, Swing Line Lender and L/C Issuer and the Lenders party thereto

10.2		Second Amendment to Credit Agreement dated as of July 12, 2004 among Ardent Health Services, Inc. as Borrower, Ardent Health Services LLC and certain of its subsidiaries as Guarantors, Bank One, NA, as Administrative Agent, Swing Line Lender and L/C Issuer and the other Lenders party thereto

10.3		Second Amended and Restated Intercompany Promissory Note dated July 12, 2004 issued by Lovelace Sandia Health System, Inc. in favor of Ardent Medical Services, Inc.

10.4		Employment Agreement, dated as of July 1, 2004, between AHS Management Company, Inc. and David T. Vandewater

10.5		Amended and Restated Employment and Consulting Agreement, dated as of June 7, 2004, between AHS Management Company, Inc. and Vernon S. Westrich

31.1		Certification of CEO pursuant to Rule 13a-14(a)/15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

31.2		Certification of CFO pursuant to Rule 13a-14(a)/15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

32.1		Certification of CEO pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

32.2		Certification of CFO pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002


		Page
		No.
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited):
Condensed Consolidated Statements of Operations for the Three Months and Six Months ended June 30, 2004 and 2003	3
Condensed Consolidated Balance Sheets as of June 30, 2004 and December 31, 2003	4
Condensed Consolidated Statements of Cash Flows for the Six Months ended June 30, 2004 and 2003	5
Notes to Condensed Consolidated Financial Statements	7
Pro Forma Condensed Consolidated Financial Statements	25
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	27
Item 4. Controls and Procedures	50
PART II OTHER INFORMATION
Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities	52
Item 6. Exhibits and Reports on Form 8-K	52
Signature	53
Exhibit Index	54
Ex-2.1 Asset Purchase Agreement, dated as of May 11, 2004
Ex-2.2 Asset Purchase Agreement, dated as of July 20, 2004
Ex-10.1 First Amendment to Credit Agreement
Ex-10.2 Second Amendment to Credit Agreement
Ex-10.3 Second Amended and Restated Intercompany Promissory Note
Ex-10.4 Employment Agreement
Ex-10.5 Amended and Restated Employment and Consulting Agreement
EX-31.1 SECTION 302 CEO CERTIFICATION
EX-31.2 SECTION 302 CFO CERTIFICATION
EX-32.1 SECTION 906 CEO CERTIFICATION
EX-32.2 SECTION 906 CFO CERTIFICATION


			Historical			Lovelace			Northern			Pro Forma			Pro Forma
			Ardent			Home Health			Indiana			Adjustments			Ardent

Revenues:
	Net patient service revenue		$	640,920		$	(4,648	)	$	(9,039	)	$	—		$	627,233
	Premium revenue			592,293			—			—			—			592,293
	Other revenue			86,461			(23	)		(159	)		—			86,279

		Total net revenues		1,319,674			(4,671	)		(9,198	)		—			1,305,805
Expenses:
	Salaries and benefits			531,893			(5,550	)		(5,120	)		—			521,223
	Professional fees			127,295			(381	)		(998	)		—			125,916
	Claims and capitation			272,872			—			—			—			272,872
	Supplies			149,063			(297	)		(571	)		—			148,195
	Provision for doubtful accounts			52,749			(254	)		(393	)		—			52,102
	Interest, net			22,155			(31	)		(386	)		281	(a)		22,019
	Change in fair value of interest rate swap agreements			(558	)		—			—			—			(558	)
	Depreciation and amortization			35,742			(81	)		(182	)		—			35,479
	Impairment of long-lived assets and restructuring costs			2,913			—			—			—			2,913
	Loss on divestitures			61			—			—			—			61
	Other			119,472			(1,278	)		(1,303	)		711	(b)		117,602

		Total expenses		1,313,657			(7,872	)		(8,953	)		992			1,297,824

	Income (loss) from continuing operations before income taxes			6,017			3,201			(245	)		(992	)		7,981
	Income tax expense (benefit)			2,312			1,216			(93	)		(372	)(c)		3,063

	Income (loss) from continuing operations, net		$	3,705		$	1,985		$	(152	)	$	(620	)	$	4,918


	ARDENT HEALTH SERVICES LLC

	By:	/s/ R. Dirk Allison
		R. Dirk Allison
		Executive Vice President and Chief Financial Officer
		(Principal Financial Officer, Chief Accounting Officer and Authorized Signatory)