Review of Revenue Recognition Issues at Hospitals and Other Healthcare Facilities (10/8/02) ? 2002 by the Center for Financial Research and Analysis, Inc. (CFRA)

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Review of Revenue Recognition Issues at Hospitals and Other Healthcare Facilities, 10/8/02 This educational piece reviews revenue recognition for hospitals, healthcare facilities, and other companies that obtain reimbursement from Medicare, Medicaid , and managed care and other health plans. CFRA believes that the amount of revenue that such companies recognize in a given period involves significant estimates and could enable a company to its boost revenue and earnings through management discretion. Typically, hospitals and such companies recognize revenue upon completion of the performance of its services. In order to standardize billing, the hospital or company will bill, and thus recognize, a gross amount of revenue (which is not presented on the income statement). Such gross billing and revenue recognition is based on the list price of the services – an amount the hospitals and the companies seldom, if ever, anticipate receiving. On the income statement, the hospital or company presents net revenue which is composed of the gross revenue amount less a “contractual allowance reserve”. Generally, the contractual allowance reserve represents the Company’s estimate, based on its payors’ history, of the gross list revenue which the hospital or company does not expect to collect. Thus, revenue is presented on the income statement at the estimated net realizable amount from patients, third-party and government payors, and others. In addition, accounts receivable are also presented net of the contractual allowance reserve, indicating the net realizable value of the accumulated revenue recognized. The resulting accounts receivable balance is also netted against a bad debt reserve (allowance for doubtful accounts) which relates to the actual amount the Company believes it will collect in cash from the receivable. Since the initial contractual allowance has already been taken out of the receivable balance, the allowance for doubtful accounts primarily relates to the portion of the account that must be paid by the individual as well as uninsured accounts. CFRA is especially concerned about the significant estimates involved in the recognition of such revenue since it could be used to provide hospitals and companies with a tool to boost revenue and earnings in any given period. Even a slight change in estimates could significantly impact the amount of revenue the hospital or company recognizes in a period without any change in the amount billed to clients. It is this degree of discretion which leads us to be concerned about this method of recognizing revenue. A possible scenario in which a bank or company could boost earnings in a quarter through such accounting would be to simply reduce its estimate of the contractual allowance reserve. By simply reducing this estimate, revenues, gross profits, and net income are increased in the period of the change. Receivables are also increased by this change. As the new estimate is an aggressive one, the hospital or company would not collect the full amount of the receivable and could write such uncollectible receivable down through special charges (reducing income on a non-recurring basis) or a future increase in the allowance for doubtful accounts (reducing income in a future period). ? 2002 by the Center for Financial Research and Analysis, Inc. (CFRA), 11140 Rockville Pike, Suite 640, Rockville, MD, 20852; Phone: (301) 984-1001; www.cfraonline.com. ALL RIGHTS RESERVED. This research report may not be reproduced, stored in a retrieval system, or transmitted, in whole or in part, in any form or by any means, without the prior written permission of CFRA. The information in this report was based on sources believed to be reliable and accurate, principally consisting of required filings submitted by the Company to the Securities and Exchange Commission; but no warranty can be made. No data or statement is or should be construed to be a recommendation for the purchase, retention, or sale of the securities of the company mentioned.

Review of Revenue Recognition Issues at Hospitals and Other Healthcare Facilities (10/8/02) ? 2002 by the Center for Financial Research and Analysis, Inc. (CFRA)

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As a result, for companies which use such accounting, CFRA closely monitors the accounts involved in these transactions. Clearly, watching the contractual allowance reserve (if disclosed, it often is not, particularly on a quarterly basis) as a percentage of revenue is one way to detect a drop in the estimates. On this note, otherwise unexplained increases in the gross margin should be questioned. In addition, the days sales outstanding (DSO) of such companies could indicate a buildup of uncollectible receivables. Furthermore, special charges that involve receivable write-offs or increases in reserves for bad debts and uncollectible accounts can indicate such aggressive revenue recognition has been used and the allowance for doubtful accounts as a percentage of gross receivables should be reviewed for large increases. Table 1a exhibits a basic revenue transaction for a hospital while Table 1b displays the same transaction with a $5 million reduction to the contractual allowance reserve and a subsequent $5 million special charge addition to allowance for doubtful accounts taken in a future period. As shown, net income is increased by $4 million in the period of the reduction in the contractual allowance reserve. Table 1a: Basic Hospital Revenue Transaction Income Statement Gross Revenue 200 Less: Contractual Allowance Reserve (10) Net Revenue 190 COGS (100) SG&A (20) Taxes (20) Net Income 50 Balance Sheet Gross Accounts Receivable 200 Less: Contractual Allowance Reserve (10) Less: Allowance for Doubtful Accounts ( 5) Net Accounts Receivable 185 Prior Period Allowance for Doubtful Accounts 4 Plus: Additions to Provision for Bad Debts 6 Less: Write-offs (5) Current Period Allowance for Doubtful Accounts 5 Table 1 b: Reduction in Contractual Allowance Reserve and Future Charge to Allowance for Doubtful Accounts Income Statement Gross Revenue 200 Less: Contractual Allowance Reserve (5) Net Revenue 195 COGS (100) SG&A (20) Taxes (21) Net Income 54 Balance Sheet Gross Accounts Receivable 200 Less: Contractual Allowance Reserve (5) Less: Allowance for Doubtful Accounts (5) Net Accounts Receivable 190

Review of Revenue Recognition Issues at Hospitals and Other Healthcare Facilities (10/8/02) ? 2002 by the Center for Financial Research and Analysis, Inc. (CFRA)

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In Future Quarter: Prior Period Allowance for Doubtful Accounts 4 Plus: Additions to Provision for Bad Debts 6 Plus: Special Charge 5 Less: Write-offs (5) Current Period Allowance for Doubtful Accounts 10 Gross Accounts Receivable 200 Less: Contractual Allowance Reserve (5) Less: Allowance for Doubtful Accounts (10) Net Accounts Receivable 185