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Health Management Associates Inc. (NYSE:HMA)

Q3 2008 Earnings Call

October 28, 2008 11:00 am ET

Executives

John Merriweather - VP of Financial Relations

Gary Newsome - President and CEO

Robert Farnham - CFO and SVP

Analysts

Jason Gurda - Leerink Swan

Sudeep Singh - Deutsche Bank

Justin Lake - UBS

Adam Feinstein - Barclays Capital

Gary Lieberman - Stanford Group

Sheryl Skolnick - CRT Capital Group

Robert Hawkins - Stifel Nicolaus

Ralph Giacobbe - Credit Suisse

A.J. Rice - Soleil Securities

Operator

My name is [Burnice] and I will be your conference operator today. At this time, I would like to welcome everyone to the HMA third quarter 2008 earnings call. All lines have been placed on mute to prevent any background noise.

After the speaker's remarks, there will be a question and answer session. (Operator Instructions) Thank you. Mr. Merriweather, you may begin your conference call.

John Merriweather

I'm John Merriweather, Vice President of Financial Relations for HMA. I would like to welcome you to our third quarter 2008 Earnings Call. Before we get started with the call, I need to read our disclosure statement.

Certain statements contained in this presentation, including without limitation, statements containing the words believes, anticipates, intends, expects, optimistic, objectives and words of similar import constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.

These statements may include projections of revenue, income or loss, capital expenditures, capital structure or other financial items, statements regarding the plans and objectives of management for future operations, statements of future economic performance, statements of the assumptions underlying or relating to any of the foregoing statements and other statements, which are other then statements of historical facts.

Statements made throughout this presentation are based on current estimates of future events and the company has no obligation to update or correct these estimates. Listeners are cautioned that any such forward-looking statements are not guarantees of future performance and involve risks and uncertainties, and that actual results may differ materially as a result of these various factors.

In addition, EBITDA, as mentioned on this call today, is defined as earnings before interest, income taxes, depreciation, amortization, gains on sales of assets, refinancing and debt modification costs and minority interests. I will refer you to the HMA earnings press release issued earlier this morning for a disclosure statement regarding EBITDA as a non-GAAP financial measure. On the call this morning is the Chief Executive Officer, Gary Newsome and Chief Financial Officer, Bob Farnham.

Thank you for your attention and I'll turn the call over to Gary.

Gary Newsome

Thank you, John, and thank you all for joining us today to discuss HMA's third quarter results. It is a pleasure to speak with you for the first time as CEO of HMA. Bob Farnham will walk you through the numbers shortly, but first I would like to take a few minutes to reflect on why I rejoined HMA, what I have observed and learned since I arrived and how our team will go about improving HMA's operational and financial performance.

First, a little about my background, which should shed some light on why I'm here today. I spent my entire business career in hospital operations. Beginning with Humana in the 1980s, and most recently as Division President of Community Health Systems, I had the opportunity to work with some of the most talented people in the industry.

My years with Community were a wonderful experience that prepared me for what I'm doing now. In between Humana and Community, I spent five years here at HMA as Divisional Vice President of Group Operations, as well as Assistant Vice President of Group Operations and as Hospital CEO.

These were also great years for me professionally. So this is a sweet homecoming for me. I'm excited to be back working with the great people of this company, including many colleagues from my first tenure. Returning to HMA to become CEO and apply what I have learned over the past 25 years in hospital operations was an opportunity that I really couldn't pass up.

That's because HMA has an excellent hospital portfolio in several highly attractive markets. It is great people at the executive level, in particular, Kelly Curry, Bob Farnham, and Tim Parry and throughout the organization including relationships with world class physicians. And I have a great respect for the company's culture and commitment to excellence in quality of care.

I have long believed from afar that while there is a strong foundation at HMA, there are opportunities to improve operations and increase the company's value. What I have seen since returning to the company fully validates that belief. My first six weeks have been busy.

I have taken upon myself a full review of the company's operations, which is helping me get my arms around the company. I have visited with all of the hospital CEOs, some of whom I have known for many years. I have also visited hospitals in eight of our 15 states, where I have met with many physicians employed by and affiliated with our company. The time I spent listening and learning have been very, very helpful.

With the help of my colleagues, I have identified many of HMA's strengths and some additional opportunities. Among our strengths are good hospitals and strong markets, good overall resource management, strong leaders at all levels of the organization and a strong foundation in principles. Opportunities include physician relations. We can have a greater depth of operational discipline, corporate structure and resources and we need to be more disciplined in our oversight of operating platform and strategy.

One additional topic, I would like to address is our balance sheet which I see is, both, a strength and an opportunity. HMA's current risk exposure is limited, given that we are locked in at attractive fixed rates with a weighted average of approximately 6.4% and no near-term maturities.

Further, we have paid down 13% of total debt this year and we will continue to deleverage the company. As a result, I believe that we have significant operating leverage to improve EBITDA and EPS. My philosophy in general is to ensure that the fundamentals of the hospital operations are being addressed, and we won't waiver from that here at HMA. We also are not going to fix what isn't broken.

That said, our mission and our vision will remain the same, to lead the hospital industry in quality and customer satisfaction. HMA has made significant progress on quality and patient, physician and employee satisfaction scores in a very short period of time. Going forward, we will recognize that each market has its own unique set of opportunities and challenges and so our strategy will be modified to incorporate a more markets specific approach in certain issues.

These include physician employment, joint ventures and outpatient services. At the same time, there are certainly areas of our business that will benefit from a more disciplined and focused operational approach, which will allow us to maximize cost savings and operational synergies.

Examples include marketing and physician recruitment. With that in mind, I have identified three broad areas where we will focus in order to improve our operations and derive value and we need to do this in a timely fashion without sacrificing long-term results.

The first area is patient volumes, where I believe we can make significant progress by improving emergency room operations. In that respect, we need to improve standard metrics toward our goal of achieving the highest quality care in the ER, implement a disciplined management approach, provide better education and training tools for our personnel and upgrade our hardware and systems where required.

The second area is to increase physician recruitment and retention, which we will accomplish through a structured approach to accelerating recruitment and accelerating initiatives. The third is market development, and we'll accomplish this through a broad base focused on inpatient opportunities, outpatient strategies, imaging, surgery, occupational medicine and urgent care. That's our plan.

I believe that by focusing on and successfully improving these hospital operations fundamentals, HMA will produce tangible results, which we’ll be able to see within the next six to twelve months. It is not very complex, but is going to require a lot of work by our corporate and hospital level management teams and everyone associated with HMA. I am very confident that we are up to the task.

The healthcare has historically been an area that has weathered recession better than other industries, and I believe that is still the case. Despite more uninsured people today than during the last recession, I believe that operationally we can still make the necessary progress to increase value.

As I said before, HMA has a very strong foundation and is headed in the right direction. I'm very excited to be back at HMA and eager to apply what I have learned during my career in hospital operations to enhance the value of our company for our employees, patients, physicians and shareholders.

I look forward to productive ongoing discussions with all of you. In the next several months, we'll look for opportunities to speak about our company and hospital industry in general. At this point, I'll turn over the call to Bob Farnham for a review of our third quarter financial results. Bob?

Robert Farnham

Earlier this morning, we announced the results for the third quarter ended September 30, 2008. For the third quarter, HMA reported diluted earnings per share from continuing operations excluding refinancing costs of $0.07. HMA also reported net revenue of $1.891 billion, and earnings before interest, refinancing and debt modification costs, income taxes, depreciation and amortization, gains and losses on sales of assets and minority interest of $141.9 million

Income from continuing operations was $10.4 million or $0.04 per diluted share, and net income was $6.4 million or $0.02 per diluted share. Continuing hospital adjusted admissions decreased 1.0% for the third quarter, while admissions from continuing operations decreased 3.3% compared to the same quarter a year ago. A decline in uninsured admissions contributed approximately 0.6% of the 3.3% decrease in continuing hospital admissions.

Continuing hospital emergency room visits declined 1.3%, and surgeries declined 2.6% compared to the same quarter a year ago. Pricing in the third quarter showed a 4.4% increase in continuing hospital net revenue per adjusted admissions relative to the same period a year ago, which contributed to a continuing hospital net revenue increase of 3.4%.

Our EBITDA from continuing operations for the third quarter was 160.1million, and the corresponding hospital EBITDA margin from continuing operations was 14.8%. During the quarter, the company's operations were negatively impacted by approximately $3.3 million, or almost 1 penny per diluted share, which represented 2.1million of lost revenue and actual expenses incurred, attributable to two hurricanes and one tropical storm affecting over a dozen hospitals in Florida and Mississippi, as well as $1.2 million of compensation expense attributable to the company's recent CEO change during the quarter.

For the nine months ended September 30, 2008, HMA reported diluted EPS from continuing operations excluding refinancing costs and gains on sales of assets of $0.32. HMA also reported net revenue of $33.398 billion, and EBITDA of $486.8 million. Income from continuing operations was $194.3 million, or $0.79 per diluted share, and net income was $152.7 million, or $0.62 per diluted share. Continuing hospital adjusted admissions decreased 0.5% for the nine month period, while admissions from continuing operations decreased 2.3% compared to the same period a year ago.

A decline in uninsured admissions contributed approximately 0.5 of the 2.3% decrease in continuing hospital admissions. Continuing hospital emergency room visits increased 1.6% for the nine month period, and surgeries declined 0.9% compared to the same period a year ago. HMA also saw a 4.0% increase in continuing hospital net revenue per adjusted admission relative to the same nine month period a year ago, which contributed to a continuing hospital net revenue increase of 3.5%. Likewise, EBITDA from continuing operations for the nine month period was $554.0 million, and the corresponding hospital EBITDA margin from continuing operations was 16.8%.

Turning to bad debt and the uninsured, which remains a prominent industry issue affecting operating returns; for the third quarter in a row, our uninsured patient volumes declined compared to the same period a year ago. Continuing hospital uninsured admissions for the third quarter totaled approximately 7.0 of total admissions, which is down 60 basis points from the same quarter a year ago. There are three components that comprise how HMA accounts for the uninsured and underinsured patients; bad debt expense, uninsured discounts, and charity and indigent write offs.

Bad debt expense for the third quarter was $124.2 million or 11.5% of net revenue, compared to $122.7 million or 11.8% of net revenue for the same period a year ago. Since February of 2007, HMA has given a 60% discount to uninsured patients for non-elective services. Uninsured discounts for the third quarter were $149.8 million, compared to $152.8 million for the same quarter a year ago.

HMA's charity and indigent care write-offs for the third quarter were $25.5 million compared to $16.5 million for the same period a year ago. To accurately compare how HMA accounts for the uninsured, it is necessary to review all three components together. Therefore the sum of bad debt expense, uninsured discounts, and charity/indigent care write offs as a percent of the sum of net revenue uninsured discounts, and charity/indigent care write-offs was 23.8% for the third quarter, compared to 24.0% for the same quarter a year ago.

One year ago, we began increasing awareness to our emergency room patients of our expectations. We visibly acknowledged the discount we offered to the uninsured, and we clearly explained payment responsibilities and our collection process following a screening for truly emergent care. I believe our success in implementing these emergency room initiatives continue to have a positive effect on our uninsured volumes.

Moving over to the balance sheet and cash flow statement, total assets are more than $4.5 billion. The balance in accounts receivable net as of September 30, 2008 was $639.2 million, and the balance in the allowance for doubtful accounts was $459.4 million.

Year-to-date, cash flow from continuing operating activities was $376.1 million after cash interest and cash tax payments aggregating $141.4 million. For the quarter, cash flow from continuing operating activities was $89.8 million after cash interest and cash tax payments aggregating $58 million.

Lastly, HMA's days sales outstanding or DSOs as of September 30, 2008, were 53 days, representing no change from September 30 of 2007.

During the second quarter, HMA utilized the net proceeds from a private placement of $250 million of 3.75% senior subordinated convertible notes due 2028 together with additional cash on hand to repurchase in the open market approximately $292 million of HMA's 4.375% convertible senior subordinated notes due 2023 leaving approximately $282.7 million of the 4.375% convertible senior subordinated notes outstanding as of June 30, 2008. On August 1, 2008, holders of HMA's 4.375% convertible notes exercised their rights and HMA repurchased $282.5 million or 99.9% of the outstanding convertible notes.

Between HMA's repurchases of the 4.375% convertible senior subordinated notes due 2023 and HMA's repayment of the Term B loan under the February 16, 2007 credit facility with Bank of America, and HMA's repayment of miscellaneous other debt, HMA will have reduced its net debt by approximately $500 million or 13% of total debt by year-end December 31, 2008. Substantially all of HMA's debt is fixed rate with a total weighted average of 6.4%, and HMA's first significant debt maturity occurs in February of 2014.

To review the third quarter results, compared to the same period last year, and net of an approximate 0.6% decline in uninsured admissions, same hospital admissions from continuing operations decreased 2.6%, adjusted admissions and surgeries declined 1.0% and 2.6%, respectively.

Net revenue per adjusted admission from continuing operations increased 4.4%, contributing to a net revenue increase of 3.4%. EBITDA margins from continuing operations were 14.8%, bad debt expense was 11.5% of net revenue, cash flow from operations for the quarter was $89.8 million.

For the third time in as many quarters, same hospital uninsured admissions declined compared to the same quarter a year ago with same hospital uninsured admissions representing 7.0% of total admissions. Lastly, by December 31, of 2008, HMA will have repaid approximately $500 million of net debt or 13% of its total debt.

Thank you for your attention, and I'll now turn the call back over to Gary.

Gary Newsome

Thanks, Bob. Before we open up the call for Q&A, I would like to reiterate how proud and excited I am to be back at HMA in my new role. The mission and vision will remain the same as we strive to lead the hospital industry in quality and patient satisfaction metrics. Going forward, we will recognize that each market has its own unique set of opportunities and challenges. And so our strategy will be modified to incorporate a more market specific approach for certain issues.

There is a strong foundation here to build upon. Good hospitals in strong markets, good overall resource management, strong leaders at all levels of the organization, and a strong foundation in principles and there are areas of opportunities, physician relations. We can have a greater depth of operational discipline, corporate structure and resources, and we need more disciplined oversight of operating platform strategy.

With that in mind, I have identified three broad areas where we will focus in order to improve our operations and derive value, and we need to do this in a timely fashion without sacrificing long-term results; emergency room operations, physician recruitment and retention and market specific development.

This is the right time for me to be in the role of HMA and leverage my 25 years of operating experience into tangible operating results. We have an experienced team that is capable of executing the operational discipline required to achieve our mission, realize our vision and then increase the value of HMA.

Thank you again for your attention this morning. I will now open the call up for Q&A.

Question-and-Answer Session

Operator

Thank you. (Operator instructions) Your first question comes today from Jason Gurda from Leerink Swan.

Gary Newsome

Hello?

Jason Gurda - Leerink Swan

Hello. Can you hear me?

Gary Newsome

Yes, Jason.

Jason Gurda - Leerink Swan

I want to just first start off with congratulations, Gary.

Gary Newsome

Thank you.

Jason Gurda - Leerink Swan

Wanted to see if I know it is still early, but if you had any timeline in mind for, based on your initial assessment of where we are, when we could start to see improvements in volume trends.

Gary Newsome

We are very fortunate to have the structure we have at HMA that we are able to move and make the necessary changes. Specifically, for example, in the emergency room, there is a huge opportunity there for us to drive volume appropriately into our hospitals and that requires time, training, execution, requires some equipment and some things we need to do there. In six to 12 months, we should see results of our efforts as we go forward.

Jason Gurda - Leerink Swan

Okay. Then I was curious if anyone had an update on what was happening in North Carolina? The last quarter, you had talked about the issue with volumes being down significantly as physicians were upset with the Novant deal or at least not being notified about it in advance. Has there been any changes there?

Gary Newsome

In North and South Carolina, the situation is really stabilized there. Admissions in that market have improved with the exception of one market, one hospital. The physicians that were involved in that are settled. We think we have a great communication vehicle with those medical staff members, and seem to have stabilized throughout.

Jason Gurda - Leerink Swan

Okay. Then one last question, just for you, Bob. If you would give us an update on where you are with any debt covenants?

Robert Farnham

Sure, Jason. We are in compliance with all of our debt covenants. We will report that formally to our banks, as required in a couple of weeks. We are comfortable with where those covenants and the requirements going forward. I think we did point out the reductions in debt that we have made during the quarter. We actually paid down about $294 million in debt. We will by year end pay down close to $500 million.

So, I think that, as we look here through the balance of the year and then into 2009, our improved operations, as well as continued pay downs on debt that we feel comfortable not only with where we are today and through the end of the year but also going forward into 2009.

Jason Gurda - Leerink Swan

Okay. Thank you.

Gary Newsome

Thank you.

Operator

Our next question comes from Darren Lehrich, Deutsche Bank.

Sudeep Singh - Deutsche Bank

Hi, this is actually Sudeep calling in for Darren. We just had one question here about your budget process; just curious to hear about the timing; when does it start, when does it typically end, and how do you think that process is going to be different this year relative to what you have done in previous years?

Gary Newsome

It is a fairly comprehensive budgeting process that we have changed somewhat this year, and we will continue to evolve over time. We are in the process of the budget presentation by facility throughout the month of November, finalizing the budget which will then be reviewed and approved by the Board of Directors early in December.

Sudeep Singh - Deutsche Bank

In terms of just expectations about, given the impact of the overall economy, how do you think the budget process and just what you are envisioning on how that would change relative to the overall economy and maybe if you would talk about how you envision some of the changes going into 2009?

Gary Newsome

In the process, again, we are in the process of budgeting, looking at 2009, once that process is done in our budgeting, we will be able to communicate early in January of 2009the expectations for that year.

Darren Lehrich - Deutsche Bank

Okay, great. Thanks a lot.

Operator

Our next question comes from Justin Lake, UBS.

Justin Lake - UBS

Thank you. Just wanted to get a little more granularity around the bad debt numbers in the quarter; I thought they look pretty much in line, but the DSOs were up. I am wondering if you are seeing anything there as far as our cash collections that you could tell us about, and I apologize if I missed it. Maybe just an update on what you are seeing as far as co-pay levels and indigent care?

Robert Farnham

Sure. This is Bob. We mentioned that this is the third quarter in a row that we saw a reduction in our uninsured business. It was 7.0% this year versus 7.6% a year ago. That equates to roughly 620 or so decrease in uninsured admits year-over-year. Sequentially, we were up probably about 150 admissions or so in uninsured. Sequentially, I think that is probably why we saw a little bit of an uptick.

We were 11.2% bad debt expense in the first quarter, 11.3 the second quarter, and now 11.5% this quarter, and now we are 11.3% year-to-date. But, really it continues to be good news on the uninsured front. Just looking across all of our States, I counted up, we had reductions in the level of uninsured in like 13 out of 15 States. So some of what I mentioned earlier, the initiatives with regard to the emergency room and how we are handling the uninsured continues to be positive.

You asked about cash collections. That is one of the things I look at with regard to the uninsured, just exactly where our cash collections are, and then where our self pay AR is as well. It is really collections, on both pure uninsured and from our collection agencies, that have really been in a very narrow band, really 1 million, 1.5 million, one side or the other of an average.

So the collections really, they are hanging in there. I think we are still collecting between 55% and 57% of our co-pays and deductibles. I think that is probably least industry average. We will work to get those closer to 60% if we can, but I think the good news is there, we have not lost ground over the last year.

So all in all, continues to be a pretty good track record so far for this year on bad debt expense, and really just with the trend that I see really of reductions in almost all of our states, do not really expect any big surprises here over the next couple of quarters, unless the economy really turns south. Even in Florida, we had a reduction in the uninsured. So it is really stable on that front and it will continue to be so unless the economy really does significantly worsen here over the next six months.

Justin Lake - UBS

Was there anything behind the DSO increase?

Robert Farnham

No, I think that normally if you look back historically, it normally bumps up between the June quarter and the September quarter as volumes do begin to trend up and you see more of that in the latter part of the quarter. I think that it is just normal that DSOs trend up a little bit in September versus June. No, nothing unusual there to report.

Justin Lake - UBS

Okay, great. During your initial commentary, I heard you mentioned some of the opportunities that you see within HMA and specifically around the Emergency Room productivity and flow through and we just wanted to, given your prior experience, is there anything you can tell us as far as the comparability there as far as maybe what the potential is, for instance if you were to close the gap between HMA and your former employer on some of those metrics that we hear about all the time?

Gary Newsome

You know one of the things great about HMA and my previous experience is that the tool used in the emergency room is very similar. From that standpoint, my experience with improving the overall operations in the emergency room, there is very little curve from my perspective, and laying out the expectation and understanding what needs to happen in the emergency room in terms of improving the quality experience, driving the right type of disposition of the patients appropriately in the ER.

I think, we will have improvement in that metric and in that arena. The emergency room continues to be a significant portal into our hospitals, and that is true for the industry. Such being that front door, for lack of a better word, into our healthcare system, it is important to have the best possible processes in place, so that we have quality experience, quality care, risk avoidance and appropriate disposition of those patients.

We have opportunity in HMA to improve those metrics, and that is where a lot of our focus will be early on, but we have other areas, too. We have some opportunities in physician recruitment and market development and some very attractive markets that will help us as we go along.

Justin Lake - UBS

Okay, great. Thank you very much.

Operator

Our next question comes from Adam Feinstein from Barclays Capital.

Adam Feinstein - Barclays Capital

Yes. Thank you. Good morning, everyone. Let’s say congratulations to Gary and good luck in your new role.

Gary Newsome

Thank you, Adam.

Adam Feinstein - Barclay's Capital

Just, I have three broad areas of questions for you, similar to your three broad areas of focus. One, I just wanted to just get some feedback. In the last quarter, company outlined a number of things that impacted volumes. It was a question asked earlier about the Carolinas. I was just curious about some of the other things that you had talked about last quarter in terms of whether some of the same issues continued in the other quarter.

I was also interested in Florida. So just wanted to get a feedback in terms of some of the issues you highlighted last quarter. Second, just curious if you are looking to exit any markets or it is that something that will be something you are evaluating? Then third, just curious in terms of whether you have seen any significant changes in trends so far in the fourth quarter. I know it is early but just curious, just with so much going on in the economy. So those are the areas, if...

Gary Newsome

Adam, just looking, you mentioned the Carolinas again. The relationship with Novant is progressing very well, and I think we have great opportunities in that market to work with them in a partnership. As I stated earlier, we have improved results there from a volume standpoint in the quarter with the exception of one market and that market is rebuilding and we have confidence that will move forward as well.

From that standpoint, Florida, you mentioned Florida. It is interesting about Florida. We see and we have information from the State of Florida the Chamber of Commerce that while there are challenges in the state, there continues to be a positive influx of people into the state and what is interesting about the demographic of those individuals coming to the state, now more than ever, you can imagine is the fact that they are older seniors that are well insured or have Medicare. So from that standpoint, the state continues to grow in terms of population. Of course having the concentration that we do here, we see that as stabilizing for us going forward.

As far as markets from an exit standpoint, we will evaluate that as we go forward. Obviously, in the last six weeks, I have had a lot of items I have looked at. Of course, I have looked at the different markets and the opportunities and challenges and we will continue to evaluate as we go forward on the whether or not we should exit any market.

Adam Feinstein - Barclays Capital

Okay. The economy has been so horrible thus far this month, so not necessarily looking for a point on type of number, but just any significant change in trend that you have seen thus far in the first part of the quarter or things have been pretty much similar to what you saw in Q3?

Gary Newsome

Adam, it is really early in the quarter. We need to keep our head down and focus on what we are doing to really start making probably any predictions on that.

Adam Feinstein - Barclays Capital

Sure. Okay. Let me ask a follow-up question. Last quarter, and you alluded just a little bit in your comments early, Gary, just in terms of the physician recruiting, you think the company said that it was a little bit behind plan for the year. Can you just provide some more details in terms of what you are doing there?

I know part of your, one of the areas of focus you outlined was to improve upon that, but just do you have any specific details that you can give us as you think about that? I know, and company was talking about employing more doctors in the last couple of years you have been something have been talking about but just curious in terms of any specific details about the recruitment in terms of what is going on and what may change in the future.

Gary Newsome

Well, Adam, I think we have been behind on the physician recruitment front for some time and I think that really opens up an opportunity for us. We have at present discipline around how we approach physician recruitment in the company and we are in the process of doing that now.

To be able to really streamline the process, measure our effectiveness in that process and be able to source physicians across the company versus very isolated by market. That would give us the opportunity to identify the best physicians and identify the best location for those physicians as we put structure around the whole process.

Adam Feinstein - Barclays Capital

Okay. Thank you very much. Good luck.

Operator

Our next question comes from Gary Lieberman, Stanford Group.

Gary Lieberman - Stanford Group

Thanks, good morning. Not sure if you said, but, was there any continued damage or continued impact from any of the hurricanes going into the fourth quarter?

Robert Farnham

Going into the fourth quarter Gary, no. The two hurricanes, the Tropical Storm Fay was all in August and September. There was no structural damage to any of the hospitals. Most of the damage, if you will, was some trees down, clean up and that thing. There was a good part of our surgeries and what not that could be rescheduled and was but then, there is always a component that is and but no, there was no continuing impact going into the fourth quarter.

Gary Lieberman - Stanford Group

Concerning the stock price; I mean, it seems like the stock is trading less on the operating performance and more about fears of debt or your ability to repay your debt and not violate any covenants.

What comments can you make or comfort if any can you give us that you feel based on the operations and how the business looks out albeit given an uncertain economy that you are going to be able to not to violate the debt covenants and to run in any problems?

Robert Farnham

Sure, I will take a stab at that, Gary and Gary can fill in for me. I think we talked about a couple of very large opportunities that we have going forward. Gary is, he has been and will be very instrumental in these and one is the emergency room and another is in physician recruiting.

I would also point out to a couple of the initiatives that we have had ongoing and first in that is our initiative to improve quality. Our improvements in patient quality and physician and patient satisfaction should lead to improved volumes because the government is reporting scores of the year in arrears and we did not implement our program until really December or January 1 of this year.

We are living with lower scores right now. The good news is that in a few more quarters, those improved scores will come through. So not only our physicians but also our patients who are increasingly looking at quality metrics to make their decisions on where they go for care, that benefit will accrue to us in 2009.

I think also, there was another benefit from the capital expenditures we are making. We have been very focused over this last year on our CapEx spending and making in areas that will not only improve our satisfactions, but also make us more competitive, and improve market share.

For example, we have probably renovation and expansion projects in about 10 of our markets that will serve to increase the number of private rooms that we have to offer in those markets. In many markets, this has become a standard of care and this will allow us to compete more effectively in those markets.

In addition to that, we have a number of facilities, markets, where we have identified that we are going to create centers of excellence in cardiology and orthopedics and Gary has also had a hand in determining some of those as well.

So I think, there is a number of areas for us; the emergency room, recruiting, capital expenditures, and quality. I think all of those together should provide a good opportunity for us to increase volumes in 2009, even despite the challenges that we have in this market.

Gary Lieberman - Stanford Group

Okay. That is helpful. Thank you.

Operator

Our next question comes from Sheryl Skolnick from CRT Capital Group.

Sheryl Skolnick - CRT Capital Group

Hi Gary, it is Sheryl Skolnick. Congratulations on your first call and I hope it is one of many more with better news for everyone's sake. I have a couple of questions that I need to go through. First of all, can you Bob, help me to understand exactly what debt you will pay down when and is your term loan fixed because of a swap arrangement? Because my understanding is, it is LIBOR plus 175. That is the quick one, but...

Robert Farnham

Yes. Absolutely after the latter question. Basically, all of our term B loan is...

Sheryl Skolnick - CRT Capital Group

Is swap?

Robert Farnham

Is fixed by virtue of a swap.

Sheryl Skolnick - CRT Capital Group

Okay.

Robert Farnham

Then, we have scheduled roll-offs from that fixed swap, and those will represent the majority of our pay downs.

Sheryl Skolnick - CRT Capital Group

Okay.

Robert Farnham

We have over $100 million of debt that rolls off of that fixed rate swap in 2009. That is certainly what we plan to pay down on through free cash flow in 2009.

Sheryl Skolnick - CRT Capital Group

Okay. In 2008 and the balance of it, you said you did the 294 in third quarter, are you talking about roughly another $206 million of pay down in the fourth, or you are talking about the accumulation of the 294 in the third plus other debt that was paid down prior to that? I am having trouble coming up with the $500 million by December 31.

Robert Farnham

Sure. If you look at the June cash flow statement.

Sheryl Skolnick - CRT Capital Group

Yes.

Robert Farnham

We had paid down a net of $194 million.

Sheryl Skolnick - CRT Capital Group

Okay. Right.

Robert Farnham

Then this quarter, we paid down $294 million.

Sheryl Skolnick - CRT Capital Group

Okay.

Robert Farnham

Which was 282 on the convert...

Sheryl Skolnick - CRT Capital Group

Yes.

Robert Farnham

Another $12 million on the term B and miscellaneous other.

Sheryl Skolnick - CRT Capital Group

Okay.

Robert Farnham

So that brings us to about 488.

Sheryl Skolnick - CRT Capital Group

Okay. So now you would do another 12.

Robert Farnham

Which ties into the September 30 cash flow statement, and then there will probably be another twelve or so in the fourth quarter to get you to 500.

Sheryl Skolnick - CRT Capital Group

Okay. That is helpful. That was a number I came up with, but I wanted to make sure that that was correct. Then, especially given where your bank debt and your first lien 6 and 8 notes have been trading as if they are not secured, but you are not allowing them. I would like to understand too if I might to, to change subjects.

We did not really get a good feel for whether the same trends that existed in the second quarter adversely affecting volume affected volumes in the third, nor do I really understand some of the specific things that you are going to do going forward that might be different under you, Gary, versus under Berk before with respect to driving volumes through better physician satisfaction, recruitment, retention, because that seems to me to be the key.

I mean, the old debt monitor was to prevent out migration, but you always went out and recruited docs. So, you buy it, you fix it, you grew it, and then you did it again. So now you are in the fixed mode, which means driving volumes through better doc relationship. I am lacking in the specifics here. Are you going to put in a Chief Medical Officer for the company? Are you going to have a Chief Quality Officer for the company? Are there going to be physician leadership groups established? Does none of that matter, and is it all just local relationships, is it all centralized recruiting, is it all diversified community based recruiting? What is it that will work for HMA specifically please?

Robert Farnham

Sure Sheryl, I will start off and then Gary can follow-up. Just with regard to the volume trends, volumes are trended better this quarter than they did in the second quarter. Admissions were down 3.8% in the second quarter, were down 3.3% this quarter, so things have improved, and it is been fairly broad based.

As I said before with the uninsured, we have made progress with the uninsured in like 13 to 15 markets. Generally speaking, volumes have improved in just about all of our markets, even in Florida.

I think I said after the second quarter, that Florida admissions were down over 4%. This quarter they were down about the company average of 3.3%. So, admissions in Florida did improve in the face of a reduction in the uninsured as well in Florida.

Mississippi is our other biggest market. Mississippi did a little better than it did last quarter as well. North Carolina was a little bit better as well, but for the one hospital in North Carolina. So I mean, as I look across all of our markets, generally speaking, all of the markets did a little bit better on volumes, not only in total admits, but on net paying admit.

Sheryl Skolnick - CRT Capital Group

Okay so, not that I am a fan of sequential comparisons, but given that third quarter is usually seasonally a worse quarter than second, I will let it go by this time. But, I understand your point.

So, would it be fair to say that the issues you had in the second quarter did not get worse in the third quarter, but maybe got a little bit better in the third quarter? So physician departures or other things that would lead to patients going someplace else, is that fair?

Robert Farnham

Yes, that is fair. I would say yes on the admission front. Yes, that is true. Surgeries were off a little bit more this quarter than they were in the second quarter. Most of that decrease though probably was in Florida, and I think some of that is a result of the economy, particularly on the outpatient side, we are seeing fewer surgeries because the economy, people are postponing. So with the exception of surgeries, in a couple of markets, like Florida, yes, I would say the trends are better.

Sheryl Skolnick - CRT Capital Group

Okay. Then, if I could move to the other, broader question of understanding how specifically you are going to address these key issues, especially with respect to physicians driving volumes?

Gary Newsome

Sheryl just, all the drivers that really influence physicians, their decision to come to a market or stay in a market or to use our facilities, all those drivers have to do around the quality experience of the patients, the experience personally they have in the facility and all those metrics are improving in our facilities. We have great resources geared and dedicated to that process in every market and we are seeing results. Sheryl, I appreciate your calls, we are going to move onto the next caller.

Operator

Our next question comes from Rob Hawkins, Stifel Nicolaus.

Robert Hawkins - Stifel Nicolaus

Good morning, thanks. I want to talk a little bit of the cash flow trends. They have been very strong this year, and I know, I do not want to suggest you would cut CapEx, but I am curious because a lot of the private equity providers try to look at this in terms of accelerating cash flow. I mean, roughly, hospitals spend about 5% to 6% of revenues on CapEx, could you cut it back to 2% to 3% of revenues and still get all the ER improvements and some of the things that you wanted to do for a couple of years to accelerate debt repayment?

Robert Farnham

I can tell you that historically what the industry has seen is if you start to get down into that something less than 5% approaching to 4%, it is going to affect the operations and volumes long-term. So I think that is why the average for the industry is 5% to 7%. We expect that we will be in that 5% to 6% range, probably closer to 6%. We believe that that is where we need to be, particularly with some of the investments.

I mentioned earlier, we are adding patient towers in a number of markets, we are adding floors. We are spending money on centers of excellence for orthopedics, cardiology and so these are the investments we feel like we need to make to grow our volumes and increase market share.

So, I hear what you are saying and believe me, we are being as prudent as we ever have been with regard to the deployment of capital and you will see that, if you looked at our cash flow statement through September, that we have, in fact, spent less through September this year than we did last year. So, we are being very judicious about where and when we deploy capital and we will continue to be. I just, I really do not see it going below 5% for us.

Robert Hawkins - Stifel Nicolaus

All right, fair enough. Then the surgeries and ER visit trends during the quarter, I may have missed this. I suspect some of that was related to the hurricane trends on a normalized basis. I mean is there anything going on within the industry that you are starting to see surgeries slow down that was not just seasonal or more market specific.

Robert Farnham

Obviously, the hurricanes did impact volumes in surgery a little bit but not to a significant extent. I think overall the economy is having more impact on the surgeries, particularly on the outpatient side. Those tend to be the ones that, if somebody can defer, a knee procedure or something like that. In this economy, people are having to spend more out of pocket with deductibles and co-insurance than they used to. So, the economy is really affecting the utilization more so than anything else.

Robert Hawkins - Stifel Nicolaus

All right, thanks, I will jump back in the queue.

Operator

Our next question comes from Ralph Giacobbe from Credit Suisse.

Ralph Giacobbe - Credit Suisse

Thanks, just a few questions. So, we have had a couple of quarters that are obviously the negative 3% volume trends and I think you mentioned earlier we will probably have to see improvements or we will not see meaningful improvements for another six to 12 months. So, I was just wondering the sustainability the margins should the volumes continue at current levels?

Gary Newsome

Really, I think from our standpoint, we are seeing improvements as we go forward. The structure and basically the cost structure of the company is in very good position. We feel very strongly as we continue to marginally improve our volumes. We will continue to perform well financially.

Ralph Giacobbe - Credit Suisse

Maybe can you just talk about some of your markets and maybe what the current environment is doing to some of your not-for-profit competitors. Are you seeing any changes in some your markets?

Gary Newsome

Obviously, as mentioned earlier, the economy is affecting all healthcare providers. Anecdotally, our competitors in certain markets are seeing soft volumes in certain areas. That is a trend I think we see throughout. I think, on the very positive side, is for example in focusing on the front door of the hospital in one area and physician recruitment and development, we can continue to improve our position and be able to take advantage of the opportunities going forward.

Ralph Giacobbe - Credit Suisse

Okay and then just one last one. It just looked like supply costs in SWB were a little bit higher than expected. Just, given the negative volume trends, can you maybe talk about what is driving that pressure? Is it just a matter of not being able to adjust the staff appropriately on the SWB side and maybe what could plain the supply increase given that you have had the surgery number go down?

Gary Newsome

Sure. We have made a conscious decision to improve nursing throughout all of our hospitals for both physician and patient satisfactions. So, we have made investments in staffing in that regard and that means we have hired more RNs. So, we have a higher mix of RNs in our hospitals delivering patient care than we did have a year ago. So that is probably most of the reason for the increase in salaries and benefits. We have also, though, added other case managers and some of those kinds of folks that also not only improve quality, but also throughput at the hospital level.

You mentioned supplies expense. Supply expense was 13.6% for the quarter; that was compared to 13.0% last year. It is not that this year's supply expense is 13.6% as high; supply expense year-to-date is also 13.6%. It is really just that last year's was abnormally low. Last year's year-to-date through the third quarter was 13.5%. So, just looking at it for the year to date, 13.6% this year versus 13.5% is pretty consistent. We have done a good job on supplies.

With surgeries down, we did do a few less knees and hips, but other areas such as the implants and what not were up. We are beginning to see an increase in drug-eluting stents again with the advent of the newer second generation stents. We did about the same number of procedures this year that we did last year, but drug-eluting stents were up about 15% and their amount were down about the same 15%.

So, pricing on supplies should be pretty consistent through the end of the year is what I am hearing from our supply people and as well as our group purchasing organization. We should expect to see some inflationary increases next year. At this point, supply expense seems pretty stable.

Ralph Giacobbe - Credit Suisse

Okay. Thank you.

Operator

Our final question comes today from A.J. Rice, Soleil Securities.

A.J. Rice - Soleil Securities

Thanks. Hello everybody. First Gary, as you laid out your areas of focus, your initiatives for physician recruitment you also mentioned market-specific development. I wonder if you could slush out how wide or narrow that initiative is, and what are some of the specific things you are looking at doing there?

Then the other question I had was related to the debt situation. you are on a debt to EBITDA borrowing less than five times, if I have calculated it right. What is the objective? I mean, I know near-term the focus is on paying down debt. Do you have a goal for where you would like to see that be over the next 12 to 18 to 24 months? Maybe just give us some perspective on managing that side of the balance sheet from here?

Robert Farnham

Sure AJ, I will answer that last part of the question and Gary can answer the first part. We are actually at about 5.35 on our debt to EBITDA leverage at September 30 on a requirement of 5.7. So we are okay with regard to our covenant there. Our interest coverage was actually at 2.52 on a requirement of 2.4. I heard you would mention about 5.0 on the debt to EBITDA. Maybe you are giving us credit for our cash balance and...

A.J. Rice - Soleil Securities

Right; right.

Robert Farnham

In the calculation, we do not get credit for our cash balance, but...

A.J. Rice - Soleil Securities

Do you have a goal for that overtime? Or are you focused on getting it down to a certain level over the next 12 to 24 months?

Robert Farnham

Yes, we have, as I talked earlier about even though we have a swap on the term B, we have anywhere from $100 to $200 million rolling off of that over the next couple of years. And, I would like to see us get down into the 4.0 range, maybe even a little bit less. That is where I would like to see us get to in the next couple of years.

A.J. Rice - Soleil Securities

Okay.

Robert Farnham

Which is not that unreasonable; that is just really another little over turn.

A.J. Rice - Soleil Securities

Right. Exactly. Okay. Gary, on the market-specific development initiative?

Gary Newsome

Sure. From the standpoint of the market-specific development, each of our markets are very unique as is true for all healthcare markets. Rather than take a global shot at strategies, we are looking at each market from a unique standpoint. What we found is, there is really some great opportunities to, for example on the inpatient side, to expand services, and specifically to expand the intensity of services through enhanced technology equipment, physician recruitment on the surgical side.

We have that opportunity in several markets. From an outpatient standpoint, we have the opportunity to reach out into the community and have a greater presence from the healthcare system standpoint, in order to expand the portals into our hospital in a very wide angle from the standpoint of outpatient.

For example, in imaging, looking for opportunities possibly in outpatient surgery centers, either standalone or joint venture with physicians, and then there is obviously the opportunity for occupational medicine and urgent care. All of these provide access points into our healthcare system in each market, which gives us a broader base and exposure, and obviously will drive business into the facility.

The other part is the relationship with physicians. Obviously, we are going to continue to employ physicians where that is necessary in the markets. We will continue to, in certain markets where it makes sense, to do joint ventures with the physicians, which will allow us to move that forward with them. So, there are some specific things we can do in each market and they are very unique to each.

A.J. Rice - Soleil Securities

Okay. Great. Thanks a lot.

Robert Farnham

You are welcome. Thank you.

Gary Newsome

Okay. Burnice that is going to do it. Thanks everybody for being on the call, and have a great day.

Operator

This concludes today’s conference. You may now disconnect.

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Source: Health Management Associates Inc. Q3 2008 Earnings Call Transcript
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