MedCath Corporation F1Q09 (Qtr End 12/31/08) Earnings Call Transcript

MedCath Corporation (MDTH)

F1Q09 Earnings Call

February 5, 2009 10:00 am ET

Executives

Edwin French - Chief Executive Officer, President

Jeffrey L. Hinton - Chief Financial Officer and Executive VP

Analysts

Darren Lehrich – Deutsche Bank

Whit Mayo – Robert W. Baird and Company

Rob Hawkins – Stifel Nicolaus

David Nierenberg – Nierenberg Investments

David Bachman – Longbow Research

Presentation

Operator

Welcome to the MedCath Corporation conference call. Today, management will discuss the company’s operating results for its first fiscal quarter ended December 31, 2008. Parts of this announcement contain forward-looking statements that involve risks and uncertainties. Although management believes that these forward-looking statements are based on reasonable assumptions, these assumptions are inherently subject to significant economic, regulatory, and competitive uncertainties and contingencies that are difficult or impossible to predict accurately and are beyond its control including, but not limited to, legislative changes, which would affect the healthcare industry as a whole.

Actual results could differ materially from those projected in these forward-looking statements. MedCath does not assume any obligation to update these statements in a news release or otherwise should material facts or circumstances change in ways that will affect their accuracy. These various risks and uncertainties are described in detail in risk factors in the company’s Annual Report or Form 10-K for the year ended September 30, 2008, filed with the Securities and Exchange Commission on December 15, 2008. A copy of this form including exhibits is available on the Internet site of the Commission at www.sec.gov.

These risks and uncertainties include, among others, the impact of healthcare reform initiatives, possible reductions or changes in reimbursements from government or third party payers that would decrease revenue, a negative finding by a regulatory organization with oversight of one of the facilities, and changes in medical or other technology and reimbursement rates for new technologies. In management’s review of the quarter, they will make reference to adjusted EBITDA, which is a measure used by management to measure operating performance and to allocate capital. Adjusted EBITDA and similar metrics are commonly used in the healthcare industry as an indicator of performance and are also used as a measure of debt capacity and ability to service debt. Adjusted EBITDA should not be used as a measure of financial performance as defined under Generally Accepted Accounting Principles. The calculation of adjusted EBITDA excludes many items in its calculation, and as a non-GAAP measure, is susceptible to varying calculations. Adjusted EBITDA, as presented by MedCath, may not be similar to those other companies’ definition and calculation.

MedCath’s press release issued and posted on its website prior to this call, provides a reconciliation from income from continuing operations, a GAAP financial measure to adjusted EBITDA, which you may find helpful in your review of MedCath’s quarterly results.

After management’s prepared remarks, there will be a question-and-answer session. I would now like to turn the call over to Edwin French, President and CEO.

Edwin French

Good morning everyone and welcome to our quarterly conference call. Thanks to the employees, physicians, investors, analysts, and other friends of MedCath for joining us on this call. With me today is Jeffrey Hinton, the Chief Financial Officer.

Let me begin by updating you on the progress that we have made towards transforming MedCath from mostly a single-service dependent company to a company that provides a diverse array of high acuity services within our existing markets and new market growth. This quarter’s results reflect the first full quarter of our 60-bed expansion of the Texan Heart Hospital of which we have 15 beds online at this time treating cardiovascular and bariatric patients. All in all, 60 beds are completed and operational by simply adding movable equipment and staff.

In addition, we now have had 28 additional beds at Arkansas Heart Hospital based for about a year, allowing us to capture additional cardiovascular share in that market. In May, we plan to open our expansion of the Louisiana Medical Center Heart Hospital in Lacombe, Louisiana, opening the first 39 beds of that 119-bed capacity expansion. We have another 39 beds finished in addition to that ready for use by also simply adding movable equipment and staff, and have one unfinished shelled floor for future expansion.

Our new Hualapai Mountain Medical Center in Kingman, Arizona, continues to progress according to our plans, and we intent to open 70 beds of this 106-capacity hospital in October. Once we open Hualapai, we would have expanded our consolidated bed capacity of nearly 47% over less than 2 years, the vast majority of which supports our goal of diversifying our revenue potential and earnings by adding more high acuity non-cardiovascular services while we continue to grow cardiovascular, of course.

We have considered and are pursuing acquisition opportunities and new joint ventures to continue to advance our transformation and our strategic goals. We are also in touch with several other providers in many of our communities exploring ways of joint venturing with a focus on adding new consolidating revenue except in our partner’s division, where new ventures are likely to be a minority.

We have endeavored over the past few years to build assets that offer greater franchise value because of the facility and/or service expansion. Talks are underway that support the interest and the exploration of the what ifs of potential market consolidation and/or expansions as well as new markets. Of course, whether or not if these come to fruition is a matter of discussion and coming to terms with potential partners, but we are spending lots of time on this effort and are encouraged about the potential.

This quarter, we completed the disposition of our previously announced joint venture in Cape Cod, Massachusetts. This venture is now accounted for as a discontinued operation and would have provided $2.6 million in revenue, about $700,000 in adjusted EBITDA, and $0.01 per share to our EPS from continuing operations had it consolidated in the quarter. We realized an enterprise multiple of 6.9 times the adjusted EBITDA less minority interest on this disposition, so it is consistent with our past dispositions that provided higher valuation multiples than we are been seeing applied in the market today.

This quarter, we also continued to affirm our strength in providing quality health care that is valued by patients, physicians, and all of us involved in MedCath. The Lewin Group provided it’s 8^th annul comparative study of our hospital outcomes to peer hospitals, meaning all those Medicare participating hospitals that have an open heart program consistent with prior year results, this annual study, demonstrates that our hospital has continued to treat patients suffering from heart disease with lower length of stay, reduced mortality, and a higher case mix index.

We also continue to discharge our patients more frequently to home than peer hospitals consistent with the past analysis. This is a direct benefit to our peers and of course a direct benefit to patients and families. In addition, 5 of our hospitals were ranked in the top 100 hospitals for cardiovascular care by Thomson Reuters. It is a remarkable achievement. MedCath hospitals account for less than 1% of the US Heart Programs, but now we count for 5% of the top cardiovascular hospitals. We are extremely proud of that distinction.

The SCHIP passed this week without any specialty hospital legislation attached. We expect this to come up again in another bill or on its own, so it is still a good time to reinforce what I have said before. Our transformation strategy allows us to continue to grow in a way that is not impeded by any legislation that limits doctor ownership of new hospital ventures. We think there is too much focus on wanted adversity we might experience with legislation. My belief is that giving finality to legislation removes ambiguity. After all, we would, of course prefer less legislation. We would also rather have something we could live with to get this thing behind us than to continue to have it as an overhang, but whatever form legislation emerges again, we hope the Congress can choose some success in having protections for projects that are materially under way and we could have a Certificate of Occupancy within a reasonable period of time following potential legislation. Regardless of the legislation, we expect to continue to encourage and maintain support physician involvement in the future via our shared governance and joint decision programs and processes and consider that a material differentiate in our dealings with our doctors.

We are not actively involved in communicating with healthcare politics on this issue at this time, however. This is much speculation regarding what will happen to hospital reimbursement under any new healthcare package that may come from capital hill. Though it is much too early to speculate as to what a product might look like when the stimulus bills are concluded, I could see something coming to which that would include a broad-based coverage and support to ensure ideas of which we have been hearing regarding possibly extending COBRA coverage, some payments subsides for COBRA and participation perhaps in a Medicare look-alike for employed and/or otherwise insured or uninsured over age 55.

This should take some pressure off the public expectation of inordinate rise and uninsured exposure that might be existing in the healthcare industry. We might also see a single payer standard or standards that would develop as an outgrowth of investment in IT infrastructure that we will need to include a protocol and application standardization so that we can have portability of data from which outcomes data and treatment plans may emanate and with more intensity that we have seen than we have in today’s disjoint system. It is not a big leap of faith to believe at some point access, payments, diagnostic, and treatment standards will be increasingly standardized, but the consumers will still be free to choose providers based on convenience and quality. This will not easy or quick.

I would hope that complication by and among the health facilities will still allow for innovation and differentiation and the potential for profits based on efficiency, market-share gains based on quality of service, and with payment incentives to match, but no matter the infrastructure or solutions for national heath policy, they will likely be slow in developing and even slower to execute, so I will be surprised that we find anything meaningful that changes our delivery systems to give us any visibility as to the ultimate effect.

Our first quarter results are in line with the expectation, something we are extremely pleased with this quarter. Sequentially, our hospitals experienced improved operations and better revenue and improved earnings. This is attributable to our efforts to improve case mix through market share and market expansion efforts. During the quarter, we benefited from an increase in drug-eluting stent volumes that we up 33% year over year, and we are 51% of our stent procedures versus 48% in the September quarter.

We also experienced growth in our electrophysiology lines with ICDs and pacers up 15% and 17% respectively. Our outpatient business continued to grow of about 16.3% year over year. Surgeries were mixed during the quarter with open heart procedures down 5.9% and outpatient surgeries up 47%. Of course, the higher cost implantables means higher supply costs and that compresses the margins somewhat versus surgical procedures, and we solved some of that in this period.

Our results were affected by the continuation of operating challenges that our Arizona Heart Hospital in Phoenix that experienced lower volume revenue and earnings during the quarter and in past quarters. We are collaborating with our physician partners and others to determine the best course of action at this facility which could range from a revision of the operating agreement that governs the hospital to recasting and reforming a partnership. We anticipate that this will take several quarters to effect as we look to determine the best strategies and the dialogue in collaboration with our partners there. We should not interpret this to mean that we are willing to vacate this market, rather we prefer a strategic re-alignment and management solution with our partners, but we are not excluding any potential that helps us maximize this asset value for all the partners and ultimately MedCath shareholders since we own the preponderance of that asset.

Before turning the call over to Jeff, I wanted to publicly thank John McKinnon for his 8 years of service to MedCath as a member of our board of directors. John has been a trusted confidant and advisor to the board to my predecessors and me. He has been a mature, reasoned, and well-informed counsel, and we are indeed better off for his wisdom, coming from his distinguished business and academic career and his leadership example. We wish John all the best for a meaningful and fulfilled retirement and thank him for his service.

With that, I will now turn the call over to Jeff.

Jeffrey L. Hinton

I will begin my commentary by focusing on 3 items that I believe are most relevant to understanding our quarterly results. First, I would like to reconcile our reported EPS from a loss on continuing operations of $0.08 per share to an adjusted income of $0.18 per share for the quarter. Our reported loss includes a $0.22 negative impact, related to the loss on debt re-financing that we incurred as part of our senior notes re-purchase and closing of our new credit facility. As a reminder, we closed this transaction during the first quarter and re-purchased our notes in December. As such, we only benefited for 2 weeks in the quarter with the lower interest expense. We anticipate that in the second quarter, our interest expense will be approximately $1.5 million or $0.04 to $0.05 per share, lower than we experienced in the first quarter. Also, the transaction is approximately $0.19 accretive per share annually based on current LIBOR.

EPS this quarter also includes $0.01 per share in pre-opening expenses that we incurred at our Hualapai Mountain Medical Center and $0.03 per share related to the cost of granting options to our board of directors. So, beginning with the loss of $0.08, adding back $0.22 for the debt re-financing costs, $0.01 for pre-opening expenses, and $0.03 for stock options equals the $0.18. Importantly, the $0.18 does not include $0.01 of contribution from our Cape Cod as venture as that venture was divested effective December 31, 2008, at a gain of $6.6 million which along with the quarterly EBITDA of $0.7 million is reflected net of tax in discontinued operations.

Secondly, we experienced sequential adjusted EBITDA and margin growth due predominantly to improved net revenue for adjusted admission. Our adjusted admissions were down approximately 1% sequentially, mostly attributable to the one hospital that I discussed earlier. However, net revenue per adjusted admission in our hospital division was up 4.2% driving a sequential increase in net revenue for the company of 3.2%. Our net revenue grew due to a 17% increase in ICD procedures as I mentioned, an increase in the mix of drug-eluting stent procedures from 48% to 51% of total stent procedures, and a $2.2 million reduction in charity care. Total uncompensated care, which is a combination of charity care and bad debt expense, totaled 8.5% of hospital division quarterly revenue before charity care, down from 10.4% last quarter and 9.2% year over year.

The sequential reduction in total uncompensated care was $2.6 million, slightly better than we expected at the time of our last earnings call due to improved point-of-service cash collections, better qualification procedures for assistance in concert with our third-party vendors, and fewer qualifying charity applications. On the year-over-year basis, commercial mix held steady this quarter versus the first quarter of 2008, and our self-pay admissions mix was 2.2% versus 2.4% in the prior year quarter. Our CMI was up 1% year over year due to the increase in drug-eluting stents and EP services in the quarter. Overall our revenue for adjusted admission was up 4.3% year over year.

Finally, we had another quarter of very strong operating cash flow. Our cash flow from continuing operation totaled $18.2 million, and our adjusted free cash flow which is cash flow from operating activities adjusted for a 6-month bond interest payment on our now retired senior notes and less maintenance CapEx was $14.4 million. Our hospital division DSO ended the quarter at 51 days, roughly the same as Q4 2008. We have also rolled out technology enhancements through to our registration and collection processes at our Austin Heart Hospital and plan to roll out the same enhancements to two additional hospitals this month.

We ended the quarter with a net debt of $76 million. Cash was $56.9 million, of which $36.1 million resides at our hospital subsidiaries. We ended the quarter with $11.2 million outstanding on our revolver and has since reduced that to $5 million. We are currently borrowing at LIBOR plus 300 basis points or 3.3% on our revolver and our $75 million term loan. The rate adjusts every 30 days based on one-month LIBOR and we can lock into a higher rate or enter into a LIBOR swap at any time. Capital expenditures totaled $30 million during the quarter, $23.7 million related to our construction projects not open and $6.3 million related to maintenance capital.

With that, I will turn the call back over to Ed.

Edwin French

Thank you very much Jeff. We are open for questions at this time.

Question-And-Answer Session

Operator

(Operator instructions) Your first question comes from the line of Darren Lehrich - Deutsche Bank.

Darren Lehrich - Deutsche Bank

I have a couple of questions here. I just wanted to dig a little bit deeper into the pricing number that you talked about, and we can see up a little over 4%, but I hear you rate that your case mix was up 1.1%, and if so, can you just flush out a little bit more for us where the pricing is coming from and what kind of rates are you seeing for your annual updates from commercial manage care payers.

Jeffrey L. Hinton

First of all, the single biggest component in the net revenue for adjusted admit increase is going to be charity care. As you recall, charity care goes above the line and it otherwise reduces your net revenue, so sequentially that improvement was $2.2 million. In terms of the managed care contract renewals that we are seeing, it is in the mid single digits, probably 5% to 7%, when they come up for renewal. A lot of the contracts are set for annual increases and those that have been preset will adjust at around 3% to 4%.

Darren Lehrich - Deutsche Bank

Where do you think your Medicare rates are coming out for the fiscal year?

Jeffrey L. Hinton

That would be around 2%.

Darren Lehrich - Deutsche Bank

I was wondering if you could just comment a little bit more with regard to your medical supply costs. I know you were trying to de-emphasize some research in one of your facilities, and I am just wondering if you were successful in accomplishing that, and maybe if you just talked a little bit more about the underlying trend itself?

Edwin French

Darren, the principal contributors to the supply costs this quarter were drug-eluting stents, up 17.7%, while bare metal was down 21.5% versus prior year and of the total being 51% versus 38% prior year, AICD is up 15% and pacer is 9%. These are all high cost items. Those are the major drivers for the supply costs. The other asset that we talked about where we have some research primarily are intraluminal grafts that portents an opportunity is something we are still working on and that has not been achieved yet. It is part of the transformation of Arizona Hospital, and that is where we do a lot of research, so we are working on that as a part of our improvement plan.

Darren Lehrich - Deutsche Bank

I can understand your comment here about some of the product line growth, but I was really looking at it more on a sequential basis, there was quite an improvement on that line item, so I don’t think you had that kind of growth in ICDs and some of these other high-cost implant items last quarter, so may be if you can just flush that out a little bit more please?

Jeffrey L. Hinton

We had, you may recall, last quarter the million dollar cost report settlement, and so that would have also not flown through the current course in that revenue calculation, so that is the other next biggest piece there.

Operator

Your next question comes from the line of Whit Mayo – Robert W. Baird and Company.

Whit Mayo – Robert W. Baird and Company

Just going back to the uncompensated care/charity care for a second, that was down nicely, and if I recall, I think last quarter, you felt that we would continue to see some pressure on those lines, so can you talk a little more about more mitigating initiatives you have put into place within your hospital, just any additional color would be helpful, and did you change any of your charity care policies in any of the markets, and if you could maybe just comment a little bit on the mix within Pheonix and the payer mix, maybe did you see any impact from that at all?

Jeffrey L. Hinton

Well let me first of all address the total uncompensated care issue. The total uncompensated care again was down $2.6 million, and $2.2 million of that was reduction in charity care, and there were no changes in the policy there. We have had a much greater focus on point-of-service cash collections, and we are working with our third party vendor to better qualify and add experience with better qualifications for Medicaid during the quarter, and frankly we are just getting fewer charity applications returned to us, and we are pretty determined to require those and to have written documentation for anyone that goes into charity care, and we just think that the collection of all those efforts have resulted in this improvement. In terms of the technology enhancements, it has been too early to see the results of that since Austin went live with them in mid December, probably were not fully operational until a couple of weeks ago, so we have two additional hospitals that we are targeting moving forward, but here is the end result of those technology enhancements. With any hospital, we are going to be linking directly with the health plan, the five major health plans within each market. We will have access to co-pay and deductible specifics that we have not had in the past, giving us a greater ability to estimate the ultimate patient responsibility. We will also be linked into credit-rating agencies. We will have credit scores and certain information on available credit line such as credit cards, and all of that, we think much better equips us to increase our point-of-service cash. I would like to say we have this product through at least half of our hospitals by the end of this quarter that will really show some improvement by the last half of this year.

Whit Mayo – Robert W. Baird and Company

I don’t want to pin you down too much on what you’re seeing quarter to date, but just any sense for whether or not the charity care trends that you experience in December have continued throughout, at least, what you have seen so far this quarter.

Jeffrey L. Hinton

There hasn’t been a change noticed. The one thing that we have seen from tracking this month to month, I would say there is a little more pressure on the self-paid piece, that is at 2.2% of our admits. Collection is not quite as strong there as I’m looking at the trend. However, we are also seeing an improvement that offsets that in the self-paid portion of commercially insured claims, so when you roll it all together, I would describe it as stable.

Edwin French

We usually don’t talk about market specifics, but if you asked the question that I mentioned Arizona, we have not seen any adverse shift at all in terms of bad debt charity load.

Whit Mayo – Robert W. Baird and Company

Just on the options expense, there was $0.03 in the quarter. I think Jeff you mentioned that there were some director grants, and I know you have changed your policy there, but just any thoughts on just what we should expect each quarter going forward.

Edwin French

Well we are addressing that whole issue of the stock option plan now with the compensation committee and the board and the reason being is that there are deficiencies with what we now have. We don’t have any senior management holding requirements. We may not have the right plan for retention and for recruitment potential. It is not an annual plan. There is no systematic and organized review, so we are going through and exploration. By next quarter, we will be in a better position to talk about where that is going to lead us. I think we will be able to offer some visibility frankly that has been difficult to come by in the past, so that will be expectation for that.

Whit Mayo – Robert W. Baird and Company

Okay, is it safe though that something in the $0.01 to $0.03 range is reasonable though to thing about?

Edwin French

Can’t predict right now, but I would say I don’t see anything that is going to be inordinately different from what our history has been, if that helps at all.

Whit Mayo – Robert W. Baird and Company

Jeff, can we get a spot number for your cash and debt, just post re-financing. I think you mentioned you paid some of your term down, and how do we think about your priorities for cash going forward?

Jeffrey L. Hinton

Well in term of our priorities this year with the completion of Hualapai Mountain and the Louisiana Medical Center, that will consume the majority of our free cash flow and those being the new capital projects. I think right now, we would expect to end the year with somewhere around $65 million in availability under our credit lines and our cash capability.

Whit Mayo – Robert W. Baird and Company

Maybe just a number for your debt right now after you have paid down some of your term and paid down your high yield note?

Jeffrey L. Hinton

Total net debt was $76 million and I think the revolving credit facility was 11.2 at year end in addition to the $75 million term load, and that 11.2 was paid down to 5, so we have reduced that difference.

Whit Mayo – Robert W. Baird and Company

I guess maybe just one final question for Ed. You commented earlier that you were pretty pleased with how the quarter played out for you guys, also nice sequential improvement which is really encouraging, but maybe if we could just get some comments around how the quarter met with your internal budget, whether or not this was pretty much in line with what you guys were truly expecting, and maybe just some comments about how you feel about the progress quarter to date?

Edwin French

We are pleased with the quarter, and it did meet our expectations, so no disappointments on this end at all regarding the company’s performance.

Operator

Your next question comes from the line of Rob Hawkins – Stifel Nicolaus.

Rob Hawkins – Stifel Nicolaus

I got the expectation that may be this inpatient-outpatient shift was bottoming, but the number really kind of show that the inpatient costs are dropping off still sequentially and it looks like from the drug-eluting stent, percentage has gone from 48% to 51% where pre the big articles and all that stuff a few years ago, those numbers were, I believe, in the 70s to 80% proportionally. Do you think we have peaked here on drug-eluting, and where do you think we are going to be bottoming on, kind of this inpatient shift and how that starts changing, because it does seem to kind of drag a little bit on the revenue growth?

Edwin French

A couple of questions there, Rob, one the bare-metal and drug-eluting, don’t know where it’s going to go, we have certainly bottomed out for us, something just below 40% of the total, and our high was around 85% to 88%, some of the other non-profit organizations and other hospitals were actually higher than that in terms of their drug-eluting stent penetration in total. I don’t know where it’s going to go, but there has been no research of late that suggests that drug-eluting stent is not efficacious. Contrarily, the last report we heard about 6 or 7 months ago was I believe a Canadian study that said indeed longitudinal benefit of drug eluting stent is firm and that is where we start to see the depreciation in the drug-eluting stent volume as the percent of that total, so I don’t know how high it could go. We are not making any projections that it is going to go higher than this, but if it does, that will be a pleasant thing from a net revenue standpoint.

Now, with regard to inpatient and outpatient conversion, I think we are seeing it migrate in most of our facilities. We have a couple of those that are subjected to the rollout as the feds take a look at where the potential is, so we are of course trying to be in front of that, anticipating where it is going to be. Focusing on documentation because a lot of what happens is when a patient comes in to the hospital, if we have got proper documentation to show that we have an urgent intervention, the patient will quality for one-night stay, so we are making sure the documentation is comporting with the patient condition and what we are actually doing, and so we are paid commensurately, so I think that will help.

Now, while we are also going to respond to that, is we have a system wide effort underway to do a throughput analysis and proactively look at process re-engineering, and we have started to roll that out in one hospital. We are now gathering information and setting up the process plans at all the other hospitals, and we would expect within another quarter to begin to see some result from that effort and it is a material result. I am not ready to quantify it, because you will remember the figure, but I can tell you that it would be material, but we are very focused on that, so that is how we want to catch up with what has already happened quickly to get in front of those that may be have not converted as they might in the future, but there are only a couple of hospitals that really have not going thought the transformation yet from inpatient to outpatient to the extent that they potentially could.

Rob Hawkins – Stifel Nicolaus

I think I understand that, if I were to say it back, is the process engineering will help you, I guess, ID may be the one-night stay versus the other patients. Is that correct?

Edwin French

What the process of engineering will help us do is look at our portfolio, identify where we can re-engineer how we manage the throughput for those patients to better normalize the result. I will give you an example. Within our company, I can tell you there is probably about 35% to 40% spread between the better performers on throughput management and those that have the potential to improve, and what we want to do is close that gap. We would like to have a deviation that is much narrower than 35% or 40% in practice. To the extent that we do that, we will pick up some savings. We have got to keep in mind just to manage your expectations that because a patient is classified as outpatient, does not mean that there is disproportionate reduction of costs because we still have the implant costs, we got labor cost, and if the patient is with us for 15 hours instead of 20, all we take off is 5 hours of incremental labor costs connected with it, but still, there is 5 hours we want to find if that happens to be figure or for this one hour or whatever it is, so we are not talking about exponential reduction in costs because of classification changes, but we are talking about difference obviously in the top line because revenue is different between these two patients.

Rob Hawkins – Stifel Nicolaus

I guess from the numbers then you’re talking with the managed care renewals and the preset rates and kind of where managed Medicare is coming out, since you guys are saving these guys so much money in this shift and doing this, why can’t that parley into better rate increases for you guys?

Edwin French

I don’t know that it is not helping us achieve the mid digit rates that Jeff mentioned. Those were still pretty strong renewal rates.

Rob Hawkins – Stifel Nicolaus

It just seems like with your value proposition on the quality and all this stuff, you would get kind of above average rates.

Edwin French

I’m on your side. I vote for that, but I will take part of it frankly. We have got one program amount 22, lets take Phoenix, Arizona; our ability to leverage that footprint for rates is different than when in another market like Arkansas or perhaps other markets where we have a much larger foot print compared to the community, so it is all about a market by market opportunity and it is going to vary by markets, but on average, we still get the single digits on new rates. I think that is a reflection of the quality because we are in contracts that we have not been in before many of our markets, and we are in those contracts to a large measure because of the quality and because of physician participation that we have, so I think we are accomplishing much in terms of gaining access, getting good rates, and it is the quality, it is the accessibility, and I think it is our effectiveness as well that allows us to invite these managed care payers and with some success negotiation.

Jeffrey L. Hinton

On the point of the topic, I don’t mention this to be indicative of the entire managed care arena, because it is not, but certainly there were some contracts that we accepted 2 or 3 years ago, just to get in to panels, and we took in the rates that were quite dissatisfactory, just to break through and on some of those outliers right now, we can and are getting 20% or better rate improvements, because that is more in line with the rest of our population. Just don’t expect that that is what we have across the board; that is not indicative of the overall experience.

Rob Hawkins – Stifel Nicolaus

I can understand and the reticence to go to a smaller facility some times.

Edwin French

We just want to be clear that we are not disappointed with our success with managed care contracts and access. We are pleased with the results on both those fronts.

Rob Hawkins – Stifel Nicolaus

I am just saying I think my expectation would be that you would be at the higher end of this 5-7 range or better, given what the value proposition is?

Edwin French

We are working hard to be there. We agree with you.

Operator

Your next question comes from the line of David Nierenberg - Nierenberg Investments.

David Nierenberg - Nierenberg Investments

It has been a while since we have seen you hit expectations, so congratulations and maybe your days in the penalty box are coming to an end.

Edwin French

That would be a pleasant relief, wouldn’t it?

David Nierenberg - Nierenberg Investments

Coinciding that with another element of closure on SCHIP yesterday, so that’s good. I had one number of questions and then some broader ones if I may. The only number question I have today is guys is that looking at your other operating expense line, it looked like it bulged a bit versus last year, although it did come down a bit sequentially. Is that happening because of the impact on the P&L of added capacity or is there something else going on?

Jeffrey L. Hinton

Well, we invested roughly $1 million dollars more in development this quarter than prior periods to promoting our new emergency room accreditations because we have accredited chest pain centers in virtually all of our assets now, so without their promoting emergency rooms and the access to them we hope it is going to improve because of the promotion. We have also started new programs in bariatrics in four markets, so we are doing some promotion there. We have had new print media and billboards, and it is all dedicated to advertising development promotion. We also added update in professional liability company wide of about $650,000 over prior periods, and we also have added a new primary care network in Louisiana to support that asset, and we came out of the shoot last quarter with it, so we had about $300,000 of cost we picked up for the quarter. I think a lot of that was timing, so David, that will constitute what you have seen in the other expenses.

David Nierenberg - Nierenberg Investments

So, overwhelmingly it relates to efforts to drive volume growth.

Jeffrey L. Hinton

Absolutely, all of it except professional liability is dedicated toward doing just that.

David Nierenberg - Nierenberg Investments

I said I had non-financial questions. The first is I think that this is your first quarter, Ed, with a flatter organizational structure without a chief operating officer between you and the hospitals, so I wanted to get a sense for how that is going.

Edwin French

I really enjoy what we are doing now, because we are doing a couple of things. One, we have also removed a layer of financial support that existed between our Charlotte Service Center, that in other words is our corporate office, and the hospitals and Jeff is intimately involved with all of our hospital CFOs directly, and of course, directly supervising the central business office and all of the other activities supporting revenue cycle management, decision support as well as traditional financial efforts. Likewise, since we have no chief operating officer, I am spending a lot of time with the CEOs of the hospitals and COOs, and I will tell you, it is giving us more focus. We are small enough that we can do that and I really believe that that is going to add some value in fine-tuning some of the disparity among hospitals and operating on revenue cycle performances, narrow the performance gaps, and continue to help us put more discipline, so it is working fine David.

David Nierenberg - Nierenberg Investments

Is it a coincidence that the quarter that you got your arms around everything is the quarter when we have gone from having two problem hospitals to only one?

Edwin French

The answer is yes. That certainly has contributed.

David Nierenberg - Nierenberg Investments

I think you should claim victory yet.

Edwin French

No question that is a contribution.

David Nierenberg - Nierenberg Investments

The other thing I wanted to ask you about qualitatively is now that you have added capacity in several markets, tell us looking at Arkansas and San Antonio for instance, what are you guys doing to fill the new beds? How is it going relative to expectations?

Edwin French

Arkansas has had an up-tick in admissions and adjusted admissions, and they are meeting our expectations. Let’s face the reality, around the country, we have some pressure to varying degrees now, and we are going to continue to have some on electives. I don’t know what that fully means for us. I think less impact for us than other acute care hospitals that maybe have more discretionary admissions, but we are going to see some effect, and we have seen some of that in our numbers, and Arkansas is an example where there is going to be some of that. We have not had a big impact there, but it is meeting our expectations. Now Texan has actually had a nice up-tick in admissions. The mix does not yet really reflect the procedure base that we want it to reflect as we continue to diversify because we want to take up more high-end procedure stuff to diversify from Cardiology, but Texan is I think going to be fine for meeting our expectations. It certainly is in admissions so far.

David Nierenberg - Nierenberg Investments

Last question is you noted that one of your directors is retiring. It appeared from reading the proxy that that director must be retiring because he served on every single one of your board committees, so you must have worked him to death. What plans do you have, if any, to replace him?

Edwin French

We are going to be doing a search for a replacement and that search is underway now, and we hope to name a replacement in the next I would say quarter perhaps.

David Nierenberg - Nierenberg Investments

Again congrats on getting out of the penalty box. It is nice to see the sequential improvement.

Operator

Your next question comes from the line of David Bachman - Longbow Research

David Bachman – Longbow Research

A few questions last year, did you give any number around CABGs, open hearts, for the quarter, and if not, could you?

Edwin French

We certainly can. The open hearts for the quarter for the division was down 5.9%.

David Bachman – Longbow Research

Down 5.9%?

Edwin French

Yeah, 5.9% open hearts, down, and I think I mentioned that in the script as well. The overall surgical procedures were up 47% outpatient procedures; overall inpatient surgical procedure which includes open heart up 2.8%.

David Bachman – Longbow Research

On the inpatient side, can you give any color on kind of where the growth was there? I guess I am kind of interested in what you’re seeing in some of the non-cardiac areas on the inpatient side?

Edwin French

What we are seeing on the inpatient side is a migration from discharges from a year ago of about 78% being for MDC-5 to about the low 75% this year, so 280 basis point change. On the inpatient revenue side, we’ve seen a change from about roughly 84% to a little over 81%, so about 250 to 260 basis point change, so we are seeing some migration. Remember that most of the beds that we are adding are just now beginning to be for the non-cardiology additions, Texan being the first of those, and we have not opened Louisiana yet and Hualapai comes on later, so we are beefing up the medical staffs with the addition of the primary care doctors in Louisiana as I mentioned, and other specialists in anticipation of that, but I think once we see Texan continuing to build, it is diversification of staff, and open Louisiana beds and the new emergency room, we will start to see this change materially.

David Bachman – Longbow Research

On that note, I wanted to ask about the emergency department business, and just overall what you are seeing in terms of volume trends or admissions coming through the emergency room? Any update on how that is going?

Edwin French

The admissions coming through emergency room are consistent with what we have had in prior periods. We have not seen a lot of movement in that. The ER visits themselves are up. We are up for the quarter just about 100 basis points from the prior period and that is an area, I think, because of our this year undertaking the initiatives to do this past 12 months, the accredited chest pain centers and to promote those, where we are going to see some gains, and the admissions that we see coming through the emergency room are material because we are talking mid 20s typically, of the percent of ER patients that wind up being admitted and that is higher now than the average acute care hospital which will typically run maybe around 16% to 18%, so as we expand our emergency room in Louisiana and as we add new one at Hualapai and as we promote ERs, I could see the admission capture from ER visits dropping a bit, but the absolute number is coming up because we will have more admissions through the ER.

David Bachman – Longbow Research

Just another numbers question in terms of sort of a run rate on bad debt expense going forward and sort of where that settled out in the first quarter, a decent guess at where we may be throughout the year.

Jeffrey L. Hinton

That’s a good description, a decent guess, but there are a couple of moving pieces again as I am looking at the monthly trends here, a little more pressure on self pay, a little better result on the self-pay portion of commercial insurance, and right now it is hard to determine that one is going to push the other around.

David Bachman – Longbow Research

Just one last question for Ed. You had mentioned early in the script on JV opportunities and talking with people. Can you just kind of give us a sense of, in this sort of economic environment that providers are dealing with, the nature of those conversations, what sorts of tie-ups or relationships are people discussing and just an update on what you’re hearing on that front?

Edwin French

That’s an insightful question. We can probably spend an inordinate amount of time talking about that, because the economy has changed in our markets a large part, because providers have had their challenges with auction rate securities, and access to debt markets and the price of it, but one of the things that I think though that may portents opportunity is some of these folks may be more motivated now to talk about market transactions than they might have been in the past, so I am thinking of one market where a not-for-profit has announced that they may hold up to 5 years expansion of a facility that they wanted to build in the market, so the question we have to ask ourselves is if there is an opportunity to use our balance sheet and our visibility to work with them to help them achieve their objective sooner than they might without us being a participant. It is a curiosity. It is that kind of a question that we are looking to get answered all over the country in all of our markets with varying degrees of interest, but I would say that, that in most of the markets where we want to talk to somebody, we are gaining access, and we have conversations underway, but in all these they have in common is that we have told them that we are interested in potentials that would allow for us to consolidate earnings.

We are amenable to selling our equity and assets so that they may own a piece of it and as long as we have a consolidating management agreement, that meets our objectives, and so in those cases we are talking about expansion of access to heart programs put through consolidation perhaps, expansion to other acute care beds, perhaps. We are also looking at acquisitions. We have looked at some hospitals. We have done diligence in a couple of settings, in-depth diligence in one, and said no to that one because of what we believed would be an inordinate amount of effort to try to get a return our invested capital that just wouldn’t likely be a payoff that our investors would appreciate, so we have others that we have approached, investor owned, and non-profit. We have talked with every banker who would listen to us and who wants to do business with us and told them the best way to get a job with us is to bring us a deal, and so a lot of bankers are looking. We get calls periodically from them to go in our NDA, to look at deals, so we will take a poke at any hospital’s financial though an NDA if at first blush it looks like it might be something that fits our demographic expectation as to population, the number of hospitals, the market, and our ability to have a flourishing heart program if we are there and at least 100 beds and those kinds of criteria. Sorry, a little tangential about that David, but I hope gives you a nutshell of what you’re looking for.

David Bachman – Longbow Research

I appreciate all that color and that’s it from me; just nice work on the quarter and continuing to move things in the right direction.

Operator

Your next question is a followup from the line of Rob Hawkins – Stifel Nicolaus

Rob Hawkins – Stifel Nicolaus

Just wanted to maybe ask one question following on some of the questioning along David Nierenberg’s line and that is related to the margins. You showed pretty dramatic significant margin improvement this quarter, and you know really good expense control. Kind of given where the inpatient’s going and kind of what you have talked about how the margins and this progress you’re making on the process re-engineering, where do you think you guys can take margins this year?

Edwin French

Regarding admissions first, let me put into perspective that one hospital we talked about Arizona, if we just look at where it was a year ago versus what happed this year, that accounts for all of our deficit in inpatient admissions, so that puts it in perspective right there and that would push the margin up, and had we had that level of admission right, we would have had it materially accretive margin, so I think that once we get that hospital turned and as we see growth in Louisiana, and as we continue to get the right procedure mix and patient population growing in Texan, those are going to be the materially creative opportunities for us as a company. I’m avoiding this question specifically and dancing around it because you’re going to want to know what the percentage is, I don’t know what to tell you. Our objective a year and a half ago was that we would achieve a 16% EBITDA. Is it realistic for us to come back and expect that in the foreseeable future? No. Is it going to accrete to where it is? We believe absolutely it will. I would really just let it go with that without stating that I am going to give you guidance on that.

Rob Hawkins – Stifel Nicolaus

I won’t ask that one. I will ask another difficult one, though and that would be you mentioned the process for Arizona, and it sounds to me like you are going through a re-syndication Can you give us any sense, of kind of where the process stands now and a time line of that, say a quarter, a couple of quarters? Can you be a little more specific?

Edwin French

I would expect by the next quarterly call, we ought to have a definitive plan in place, something that we can speak to that says here is what we’re doing, here’s how we want to get there. We have engaged our partners in the dialogue. We are engaging a banker to help us figure out what it means to maximize the potential. It could be in any number of forms that excluded recapitalizing, doing something with our partners under the right circumstances. We have not excluded brining in others to consolidate in that market. I won’t say we have excluded selling the hospital, but I will tell you right now, its at the bottom of list of things we would want to do or believe we need to do, I should add, so we’ve not excluded any possibility and we are exploring every one. Our bottom line being we want to enhance, and we are going to enhance value to all of our partners, doctors, and you.

Operator

At this time, there are no further questions.

Edwin French

Thank you very much folks for joining the call. We appreciate your interest in following MedCath. We look forward to the next call, and we hope we will have something similar to report.

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