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Health Management Associates, Inc. (HMA)

Q1 2009 Earnings Call Transcript

April 28, 2009 11:00 am ET

Executives

John Merriwether – VP, IR

Gary Newsome – President and CEO

Bob Farnham – SVP and CFO

Analysts

A.J. Rice – Soleil Securities

John Ransom – Raymond James

Frank Morgan – RBC Capital Markets

Adam Feinstein – Barclays Capital

Shelley Gnall – Goldman Sachs

Darren Lehrich – Deutsche Bank

Jason Gurda – Leerink Swann

John Rex – JPMorgan

Justin Lake – UBS

David Bachman – Longbow Research

Rob Hawkins – Stifel Nicolaus

Operator

Good morning. My name is Niva, and I will be your conference operator today. At this time, I would like to welcome everyone to the HMA first quarter 2009 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question-and-answer session. (Operator instructions). Thank you. Mr. Merriwether, you may begin the conference.

John Merriwether

Thank you, Niva. Good morning, everyone. I'm John Merriwether, Vice President of Financial Relations for Health Management Associates. I would like to welcome you to HMA's first quarter 2009 earnings conference call.

Before we get started with the call I would like to read our disclosure statement. Certain statements contained in this presentation including without limitations, 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 of 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 than statements of historical fact.

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 is defined as earnings before interest, income, taxes, depreciation, and amortization, gains and losses on sales of assets, gains on the early extinguishment of debt and write-offs and deferred financing costs. I will refer you to HMA's earnings press release issued last night, April 27, 2009, for a disclosure statement regarding EBITDA as a non-GAAP financial measure.

On the call with me this morning is Chief Executive Officer, Gary Newsome; and Chief Financial Officer, Bob Farnham. Thank you again for your attention, and now I'll turn the call over to Gary.

Gary Newsome

Thank you, John, and good morning everyone and thank all of you for joining us today to discuss the results for HMA's first quarter 2009. I'm going to provide you with an update on where we are operationally, starting with the initiatives we have been implementing, and Bob Farnham will provide you with additional details on the financial results shortly.

The first quarter marks significant improvement for HMA as we return to positive EBITDA growth and improved our operating margin as compared to prior year. Admissions declined just 2/10th of a percent and adjusted admissions grew 1/10th of a percent during the quarter compared to prior year.

As you are aware, last year's first quarter ended March 31st, 2008, contained one extra day for leap year, compared to this year's first quarter ended March 31st, 2009. When we account for the leap year effect, flu, and respiratory volumes this quarter compared to the same quarter last year, adjusted admissions and admissions for the quarter actually grew approximately 2%. We're very pleased with this progress in improving volumes, and we believe this is a direct result of the initiatives we are implementing.

We continue to focus on three main operation – operating initiatives. Emergency room operations, physician recruitment, and retention, and market service development, while closely managing our resource consumption. We are making progress in each of these areas and the initial traction we witnessed in the fourth quarter of 2008 has continued and gained momentum in the first quarter of 2009.

We discussed the divisional reorganization on previous calls and this relocation of leaders has proven to be an effective as senior management meets more frequently with the operations leaders. As a result we have been more productive about both operational opportunities and challenges.

We have spent a great deal of time over the past six months to assess patient flow, ER systems both hardware and software, employee and physician training and culture. You heard me say this before many times that the ER is the other front door to the hospital with typically 50% to 60% of admissions for HMA and the hospital industry coming from this department.

Right on schedule as of March 31st, we have completed the hardware and software upgrades for our clinical guideline driven ER patient system called ProMed. As you know this tool is designed by ER professionals that we used to improve patient flow, quality and the delivery of care in the ER.

By improving our patient flow and quality and better documenting the care we are delivering, we believe we can provide the best care for our ER patients. Based on our initial results we believe that we can reduce the time the patient spends in the ER and subsequently increase patient satisfaction. Ultimately, improving patient satisfaction should improve volumes.

We have also been able to reduce the number of transfers from our ERs with the cooperation of our attending physicians. The training of our ER staff and physicians is an ongoing process, and we have established committees at several levels of the organization to improve communication across the system.

We have just completed our first ever ER Director Symposium that provided a venue for all our hospital ED directors to meet one another, share ideas and receive education on a myriad of ER topics from both internal and external experts.

We believe the volume improvements we have seen this quarter and in the fourth quarter 2008 are partially attributable to our focus on the ER operations. An integral part of providing the healthcare service our community need is having enough physicians to meet those needs which makes physician recruitment, our second area focus.

As I mentioned previously, during the fourth quarter we put a structure in place and established a disciplined approach where we measure every component of the physician recruitment process. We now track key metrics of contract related flow, scheduling the contract signing, and we now have the ability to better source physicians across the HMA system.

We have a great opportunity here to fulfill the needs of our communities better than we ever have. Again, the momentum we experienced in the fourth quarter of 2008 carried over to the first quarter of 2009, as we added 144 physicians to our medical staff this year compared to 92 physicians in the same quarter last year. We are on our way to our 2009 goal of adding 600 physicians to our medical staffs.

For these recruited physicians to really hit their stride with HMA, it's necessary that we continue to enhance the level of services we provide, and that is the third area focus of our hospitals. As I mentioned before this is an area that takes little time to develop. But there are opportunities in our hospitals to expand existing services and add new ones without compromising our resource consumption.

By recruiting specialists, for example, and reviewing where service lines like orthopedics, neurology, and cardiology are currently operating, we have an opportunity to highlight these product lines and utilize tool kits to improve quality, distinguish ourselves and become regarded as a center of excellence by our patients, which then generates even more volume.

Likewise, we have seen an increase in the development of outpatient centers for diagnostics and surgery in recent years, and we believe we have an opportunity to create more partnerships, both in our primary markets and in outlying areas where the need exists, allowing us to expand our footprint.

And lastly, market development includes expansion into occupational medicine in urgent care centers. We have just recently collaborated on an urgent care center near Sebastian, Florida with the third party, clearing the landscape is changing for where and how patients seek healthcare, and we must better position ourselves to address that change.

By focusing on these areas, which are natural extensions of the hospital setting, we have an opportunity to add to the continuum of care we provide. It's another great opportunity for us.

As you can see, we have not deviated or will not deviate from the operational plan we set forth in late 2008. We're beginning to see the positive results. The economy continues to be the wild card. We have seen some increases in our bad debt experience as a result of the economy, but we were prepared for that with the cost reductions we put in place at the beginning of the year. We recognize that more cost reductions may be needed, but we are encouraged by the enthusiasm of our employees, physicians and our improving patient volumes.

All said along that despite the current economic times, I believe HMA has unique opportunities to grow. And if you recall when I rejoined the company in September 2008, we spoke about beginning to see tangible results from our initiatives in 6 months to 12 months, and based on this, these first quarter results, we are on schedule. I'd like to thank you for your attention.

At this point I would like to turn it over to Bob Farnham for the quarter results.

Bob Farnham

Thanks, Gary, and good morning, everyone. Last night we announced the results for the first quarter ended March 31st, 2009. For the first quarter, HMA reported net revenue of 1,188 billion and EBITDA of 183.4 million. Income from continuing operations was $54.1 million and net income attributable to HMA stockholders was $46 million or $0.19 per diluted share. Included in diluted EPS for the quarter ended March 31st, 2009 was a $16.7 million gain from the early extinguishment of debt.

Results for the prior year's first quarter ended March 31st, 2008 included a $203.3 million gain on the sale of a 27% interest in seven hospitals to Novant Health. Excluding these gains, diluted EPS from continuing operations for both quarters would have been $0.15 as shown in the tables of the press release we issued yesterday.

For the first quarter, continuing hospital adjusted admissions reflecting total admissions adjusted for outpatient volumes, increased 0.1%, while admissions from continuing operations decreased 0.2% compared to the same period a year ago. When we take into account the effect of having one less day in the first quarter of 2009 compared to the first quarter of 2008, because of the leap year, continuing hospital adjusted admissions and admissions grew approximately 1%.

Pricing in the first quarter showed a 3.0% increase in continuing hospital net revenue per adjusted admission, relative to the same period a year ago, which contributed to a continuing hospital net revenue increase of 3.1%.

Our EBITDA from continuing operations for the first quarter was 214.1 million or an 18.0% operating margin compared to 206.8 million or a 17.9% operating margin for the same period a year ago.

I need to mention two accounting pronouncements we had to adopt this quarter, which impacted current and prior periods reported numbers. SFAS No. 160 titled “Non-controlling interest in financial statements” required us to reclass the majority of our minority interest which had been reported in the balance sheet as another long-term liability, down to the equity portion of the balance sheet on the theory that the ownership really represents an equity position the company also requires a change in the presentation of minority interest in the income statement.

The other pronouncement, APB No. 14-1, accounting for convertible debt instruments that may be settled in cash upon conversion, required us to fair value our convertible bonds as of the issuance date and then credit a portion of the bond proceeds to equity for a corresponding increase in bond discount, which has the effect of increasing the amortization of bond discount in all income periods presented since the issuance of the bonds. The impact of the accounting change was an increase of approximately $1 million of amortization expense included in interest expense in both the first quarter periods presented.

Also required was an allocation of the gain on the repurchase of the convertible bonds between income and debt discount. The economic or real gain on the $98.6 million of convertible bonds purchased during the quarter was $39.2 million, of which $16.7 million was recognized as a gain in the financial statements. Both accounting changes will be explained in more detail on our Form 10-Q.

With the prospects for a rapidly improving economy dwindling, uncompensated care and uninsured patient volumes continue to be issues for the hospital industry and HMA. Continuing hospital uninsured admissions for the first quarter totaled approximately 6.4% of total admissions, which is a 20 basis point increase from the same quarter a year ago. There are three components that compromise how we account for our uninsured and underinsured patients. Bad debt expense, uninsured discounts, and charity and indigent write-offs.

Bad debt expense for the first quarter was 144.0 million or 12.1% of net revenue compared to 129.0 million or 11.2% of net revenue for the same period a year ago. Uninsured discounts for the first quarter were 159.6 million compared to 153.4 million for the same period a year ago.

HMA's charity and indigent care write-offs for the first quarter were 21.8 million compared to 18.1 million for the same period a year ago. To accurately compare our HMA accounts for the uninsured it's necessary to review all three components together. Therefore, the sum of bad debt expense, uninsured discounts, and charity and indigent write-offs as a percent of the sum of net revenue, uninsured discounts and charity and indigent write-offs was 23.8% for the first quarter compared to 22.7% for the same quarter a year ago.

We continue to apply initiatives in the ER to ensure that our emergency room patients understand their financial responsibilities. Likewise, we are continuing to assess whether emergent care is required. And if it isn't, we are requesting payment upfront for services or referring non-emergent patients to a more appropriate and economical setting for them to receive their care.

As Gary mentioned earlier, despite an increase in bad debt expense, HMA increased its EBITDA and operating margin during the first quarter. EBITDA from continuing hospital operations for the first quarter was 214.1 million compared to 206.8 million for the same period a year ago. Likewise, operating margins increased 10 basis points to 18.0% for the first quarter compared to the same period a year ago.

Contributing to this margin improvement was a reduction in continuing hospital salaries, wages, and benefits. Continuing hospital salaries, wages, and benefits, as a percent of net revenue, was 37.3% for the first quarter or 180 basis points less than the 39.1% reported for the same period a year ago.

We will continue to review all expense control line items to ensure we are operating as efficiently as possible while improving the quality of care that we are delivering.

Moving over to the balance sheet and cash flow statement, total assets as of March 31st, 2009 exceeded $4.5 billion and the balance sheet cash at March 31st was approximately $103 million. The balance in accounts receivable net as of March 31st, 2009 was 674.9 million and the balance in the allowance for doubtful accounts was 455.3 million.

HMA's Days Sales Outstanding or DSOs, as of March 31st, were 50 days, up one day from March 31st, 2008 and flat compared to December 31st of 2008.

For the quarter, cash flow from continuing operating activities was $116.7 million after cash interest and cash tax payments aggregating 54.9 million. Capital expenditures for the first quarter were $65.2 million as compared to $46.8 million for the first quarter of 2008. We are finishing up on a few projects from 2008, but we do not anticipate this run rate for CapEx to continue for the full year. Our objective for 2009 is to spend between 4% and 5% of net revenue on capital expenditures.

During the first quarter, HMA repurchased in the open market, at a discount, $98.6 million of its 3.75% convertible senior subordinated notes through 2028. As a result, HMA recorded a $16.7 million gain on the early extinguishment of that debt. In addition, HMA repaid $29.8 million of the term B loan due in 2014 as well as other miscellaneous debt, bringing our total debt repayment during the first quarter 2009 to approximately $126 million, recall that our debt reduction objective for 2009 was a minimum of $150 million for the year.

We expect to continue to repurchase the 3.75% convertible subordinated notes in the open market on an opportunistic basis. Since January 1st, of 2008, HMA has reduced its indebtedness by 650.9 million, representing approximately 17.2% of its outstanding debt as of January 1st, 2008.

Regarding loan covenants, as of March 31st, 2009, our debt to EBITDA ratio was 4.87, on a maximum requirement of 5.50 times, and the interest coverage ratio was 2.69 times on a minimum requirement of 2.50 times. We expect both of these covenants to improve through the rest of the year.

To review the first quarter's results, compared to the same period last year hospital adjusted admissions from continuing operations increased 0.1%, and admissions from continuing operations decreased 0.2%. And when adjusted for the leap year effect, adjusted admissions and admissions increased by approximately 1%.

Net revenue per adjusted admission from continuing operations increased 3.0%, contributing to a net revenue increase of 3.1%. EBITDA from continuing operations increased to 214.1 million and EBITDA margins from continuing operations increased to 18.0%.

And lastly, HMA repaid approximately $126 million of debt during the first quarter and 650.9 million or approximately 17% of its total debt outstanding since January 1st of 2008. Thank you for your attention.

And now I'll turn the call back over to Gary.

Gary Newsome

Thanks Bob. Before we open up the call for Q&A, I would like to acknowledge the hard work and dedication of our employees and physicians in the delivery of high quality care to the communities we serve. I would also like to reiterate how pleased we are with the results of the first quarter 2009, and how excited we are for our prospects for the remainder of the year. The mission and vision remain the same as we continue to make strides toward our goal to lead the hospital industry in quality and patient satisfaction metrics. As we continue to see tangible progress as we said we would 6 months to 12 months after we began our operating initiatives, as we focus on three broad areas that are key to our future success, that being the ER operations, physician recruitment and retention and market development. I would like to thank you again for your attention this morning, and I'll now open up the call for Q&A.

Question-and-Answer Session

Operator

Thank you. (Operator instructions). Our first question comes from A.J. Rice of Soleil Securities. Please go ahead.

A.J. Rice – Soleil Securities

Hello, everybody. Thanks. Couple of questions just to follow up, maybe even on your last comments there, Gary. You have seen now stabilization for two quarters in your admissions and I guess your comps on the admission front get easier as you progress into the middle of the year compared to what you were dealing with last year. It seems like most of what we have seen so far is from the initiatives in the ER, do you perceive we have seen the benefit of the ramped up – physician recruitment or how much has that impacted the results thus far and how much of that still in front of us? And then also on the service line expansion, the market development, has any of that yet really impacted results, or is that something still in front of us as well?

Gary Newsome

A.J., ER is really just a portion of the improvement that we've seen so far. The physician recruitment that we were able to do in the fourth quarter, to a limited extent is providing results for us today. And it will continue to provide even more positive results as the year progresses. We are seeing some improvement minimal at this time from service line enhancement in certain markets and that also will continue to drive forward in a bigger way as the year progresses. But the ER is – as I mentioned, in our last call, many times, as I met with many of you is that the ER initiatives are real time they're today, and while we're improving that, we still have a lot of room for improvement even there. So it's really a multi-front approach and we're getting results from all those, and it will improve the mix of that improvement will improve as we go along.

A.J. Rice – Soleil Securities

Okay. And then maybe Bob on the wages and benefits improvement. Clearly, that was a big bright spot in the quarter. I know there are several different initiatives that you guys have taken on, holding down some wage increases in light of the weak economy, changes in benefits. I think there was some streamlining of staff, you have seen a reduction in turnover. Can you give us a flavor for how each of those dynamics played into the improvements you saw and then maybe looking out for the rest of the year is there any incremental benefit from some of those items?

Bob Farnham

Sure, A.J. Last year, we saw a decrease in admissions in the second quarter and third quarter, and really with the – Gary coming on board, we took a hard look at the volumes in each of our market, and made some necessary adjustments with regard to our staffing, and we did that late in the fourth quarter, it was on a hospital-by-hospital basis. We also communicated to all of our employees that there would be no merit increases in 2009, and that we would also temporarily suspend our employer 401K match. And we really did that – and lot of other companies have done that as well, but that was really to help ensure our success with our objectives in 2009 and really not knowing the full impact of the economy in where unemployment was going to top out, so at some point, we will reinstate 401K employer match. At some point we'll have to give out merit increases as well. But I don't think we're going to change anything that we've done so far, with – our salaries and – and benefits is really just one component of all of our expense line items, and we are going to make sure that we manage all of our expenses to the level of our revenue. That's probably, frankly, something we didn't do after the first quarter last year, and we're going to continue to do that this year through the rest of the year as – as we have in the first quarter.

A.J. Rice – Soleil Securities

How about just turnover rate? Is that stable year-to-year or what was the trend there?

Bob Farnham

I think our turnover is down somewhat overall. I think our employees surveys are showing that employees are happier than they were when we took the survey year and a half ago. So I think we're seeing increased employee satisfaction, and of course with the job market the way it is, that doesn't encourage people jumping from job to job. So – I mean, we did make a conscious effort last year to improve the mix – our skill mix. We added more RNs to the mix in our hospitals and I think overall that has improved employee morale, the satisfaction of the RNs, the physicians are happier, the patients are happier. So I think overall our turnover is down just a bit, I don't have the exact number, but I do know it's down a bit.

Gary Newsome

A.J. this is Gary, just one more comment on – that decision to – on the salary increases and the 401K, very difficult decisions to make, but we've communicated very thoroughly throughout the organization that we would hope that our staff's employees would want their leadership of the company be wise stewards and manage in uncertain time in a way that preserves jobs, and our feedback from our employees with that message has been very positive. Now we know that there is a limited life, and as the economy – when it improves and things change and the stability of the outlook just nationally happens, we have the flexibility to make changes. So we did communicate clearly that the expectation was for the year 2009, but we still have the flexibility.

A.J. Rice – Soleil Securities

Okay. That sounds great. Thanks a lot.

Operator

The next question comes from John Ransom of Raymond James. Please go ahead.

John Ransom – Raymond James

Hi, good morning. Looking at your different states, what state would you say right now is the most difficult in terms of achieving some growth objectives?

Bob Farnham

John, this is Bob. That's a good question, I – I think we had a couple of challenges in a few facilities a year, year and a half ago. We had a challenge in our Texas market. We had two facilities there. We closed one. We had some challenges in Pennsylvania that we are working our way through and are doing better there. We had some challenges, shortly after Novant transaction with the integration of our physicians. But we recovered basically in all of those markets. I wouldn't single out any market right now more than another market. With regard to our book of business, it still continues to be rather mixed. With regard to admissions, we had increases in admissions in seven states, and we had some decreases in about nine. That's how the 15 work out, so there isn't one – one state that, that I would say is at risk certainly so. I think we have opportunities to expand business in all of our markets, and that's – that's where we're looking at a lot of our service lines, and trying to mine some opportunities there.

Gary Newsome

John, this is Gary. I think it's important to realize the initiatives we put in place companywide bearing fruit across every state. And that's great for us. Additionally, our two largest states, Florida and Mississippi, should benefit from the stimulus funding and should stabilize especially from Medicaid funds and such. So we feel good about that.

John Ransom – Raymond James

Right. I guess my second question specifically about Florida. Do you think that your – you can grow your operating earnings in Florida over the next two years? It seems like some of your competitors are still – I know HCA, for example, said their uninsured admits were up 10% in Florida. Just looking at the economic stats, well, maybe it's not getting worse or badly it's still a tough state to grow in. Is that a state that's going to continue to hold you back? Or do you think you got some opportunity to grow there.

Gary Newsome

John, this is Gary. I'll let Bob tell if he needs to on this one. It's – actually – again, I don't want to sound like a broken record, but the initiatives we put in place are bearing fruit in Florida and all of the other states and we believe that there are opportunities to continue to improve performance in Florida. It's – our recruitment efforts are a great example of the opportunities we have in Florida and we're aggressively pursuing those.

Bob Farnham

Actually, John, we had a pretty good first quarter here in Florida. I have said at a couple of the conferences, Florida has been a concern for a lot of people, but, the first quarter – we had a pretty good season here in Florida. I mean, we did see an increase in uninsured in Florida, but we had a much bigger increase overall in total admissions. So in Florida, for the first quarter, we actually had an increase in paying business. So things seem to be fairly stable in Florida.

John Ransom – Raymond James

That's great. Thank you.

Operator

Next question comes from Frank Morgan of RBC Capital Markets. Please go ahead.

Frank Morgan – RBC Capital Markets

Good morning. On the subject of Florida and Mississippi, could you be a little more specific about what total volume growths were like. You just mentioned Florida, if you could also mention Mississippi in terms of what the total volume growth was like and how that compared to your growth in the uninsured?

Bob Farnham

I don't want to give out specific numbers, but I can tell you that in Mississippi as well as Florida, we had positive growth in admissions, in total admissions. We also had some growth in uninsured, but in both states, the total admits grew more than the growth in uninsured, so we had net positive growth in paying business, if you will, in both states, so we're pleased with the performance of both of our two biggest states.

Frank Morgan – RBC Capital Markets

Okay. One more question on the pricing growth. I was hoping to get a little more detail in terms of the components of that revenue per adjusted admission growth. The kind of trends you are seeing, how much of your managed care book is locked in for say, next year, and how much of a shift you're seeing from fee for service over to managed Medicare and Medicaid? Thanks.

Bob Farnham

Obviously at this point there's probably 80 plus percent of our pricing locked in for 2009 and we have been doing more multi-year contracts over the last year or so, so I would say, we probably have 50, maybe – maybe not as much as 60%, but easily 50% of our pricing locked in for 2010, so we're in pretty good shape there. With regard to the mix of business, seeing pretty much a similar trend to what we saw last year, we saw about a 1% shift in business for the year. That's consistent with what we saw here in the first quarter as a percent of total admissions, commercial business was down.8%. Medicare, Medicaid and managed Medicare, Medicaid was up 0.6%, and of course, we mentioned self-pay was up 0.2%. So down 0.8% in commercial, up 0.6% in Medicare, Medicaid, up 0.2% in self-pay. So that's how the mix broke down and the shift was for the quarter.

Operator

The next question comes from Adam Feinstein of Barclays Capital.

Adam Feinstein – Barclays Capital

Okay. Thank you. Good morning, everyone. Very good numbers here, just – maybe just to start off on the guidance, so, clearly, bad debt expense is an unknown variable here, you guys are keeping your guidance intact. But should we think about the components being slightly different, meaning maybe bad debt will be a little bit higher but it seems like lot of the operating costs are running lower, so as you are thinking about the rest of 2009, do you think that's the right way to think about it?

Gary Newsome

From our overall guidance, Adam, we feel comfortable where we are across the board, and from – part of that is we put in to motion a very good operational plan and it's – we're starting obviously to get the traction as we said we would in 6 months to 12 months after implementation. And our goal is to keep our focus and execute on our plan and through that we believe we're going to do very, very well. There is some headwinds in the economy. We know that there's some – probably some flexibility on the bad debt side, but we are managing our cost, our expense side. We still have opportunity to do that as we go forward to make sure that we mitigate any of those changes.

Adam Feinstein – Barclays Capital

Okay. And then with respect to – sounds like you guys have had success in recruiting doctors. You may have given it out here, did you give an actual number? I know on your last call you said your goal for the year was to recruit 600 net new adds in 2009. But did you give a net number for the quarter?

Bob Farnham

We did not give that out. We added 144 physicians for the quarter.

Adam Feinstein – Barclays Capital

Okay. And is that net adds, Bob, or is that before any turnover?

Bob Farnham

That's – that's gross adds.

Adam Feinstein – Barclays Capital

Okay. And what about turnover, I guess since that's part of it here, and one of the things you guys have been focusing on, what's been the trend there?

Bob Farnham

The net number is probably about 100.

Gary Newsome

Adam I think one thing you need to realize is that this is really not the peak recruitment season for physicians. That's really later in the year as – there's a lot of reasons for that, schools are out, programs are finished, physicians are ready to start practice, and also for even physicians in existing practices who are having to relocate their families, we see that more second quarter, third quarter, and even fourth quarter than we do the first.

Adam Feinstein – Barclays Capital

Okay. Good point there. Alright. And then just with the ER, I know you guys have made that another area of focus, one of your peers the other day was talking about opportunities there where they have been changing their coding. Is that part of your strategy also? I know in light of what you talked to us has been more process, but just curious in terms of ER coding. Is that an area of opportunity also?

Gary Newsome

Actually, the whole process that we have, the flow, the quality initiatives, and the billing side of the component is all part of our initiatives in the ER. And while we may not subscribe to the program that you mentioned, necessarily, we are getting the same results through the process that we have.

Adam Feinstein – Barclays Capital

Okay. Great. And then just my final question, do you have an allowance or doubtful accounts number, Bob, on the balance sheet?

Bob Farnham

I do. I did mention that. At the end of March, it was 455.3 million.

Adam Feinstein – Barclays Capital

Thank you very much.

Operator

Next question comes from Shelley Gnall of Goldman Sachs. Please go ahead.

Shelley Gnall – Goldman Sachs

Hi, thanks. My questions are little bit on the deflationary environment. It sounds like you're operating in right now. As we think about your managed care, as you are renegotiating rates for 2010, and maybe this is more appropriate for 2011, but is it the case that because we're in a deflationary environment right now, is that impacting your rate negotiation?

Bob Farnham

It is beginning to, Shelley. I can tell you I talk to our managed care people all the time and I think where we're seeing it is on one-year contracts or – or in the first year of a three year contract. What I'm hearing is rather than getting a 7% to 8% first year increase on a contract, we're getting 6% to 7%, still getting a 5% or 6% increase in year two and three. That's still pretty consistent. Where we are seeing a little bit of pressure though is the first year rate increase, say, on a three-year contract. That's probably, maybe down 1%. That's, that's what I'm hearing back from the managed care folks, on a – on a – on a more regular basis now, so – little bit of impact, but not significant.

Shelley Gnall – Goldman Sachs

Yes, okay. That makes good sense. And then as we think about your ED admissions rate, as you continue to sort of focus on improving your admissions through the ED and as that rate increases, are you concerned at all that that could raise your profile to the payers as being a – sort of a higher cost hospital?

Bob Farnham

The higher cost hospital? I – I don't think so. I mean, everything that we have done in the emergency room is to improve patient flow, quality, delivery of care, patient satisfactions are better. Our quality metrics, some of which get reported to – to Medicare are improved, and – and so I think it's – managed care payers are willing to pay more for higher quality, so I think this is what – what CMS and managed care payers and the government is pushing for, so, I think we're on the right track with everything that we've done, and our hire quality should support higher payments, and that's certainly a position that we're going to take as we renegotiate our contracts going forward.

Shelley Gnall – Goldman Sachs

Okay. Great. Thank you.

Operator

Next question is from Darren Lehrich of Deutsche Bank. Please go ahead.

Darren Lehrich – Deutsche Bank

Thanks. Good morning, everyone. Just one question here about the balance sheet and your cash flow. Can you just remind us now what you're targeting for cash flow from operations and what we should expect the net debt balances to be exiting this year?

Bob Farnham

Sure. Cash flow from operations, we talked about a number in the – 350, maybe a little bit more, million dollar range. CapEx in the – the middle of the 4% to 5% of net revenue range that we talked about is probably in the order of – of $200 million, maybe 2.25, so, we're looking at free cash flow of probably 150 to maybe – maybe as much as $180 million is what we talked about at the beginning of the year. And we said essentially that we are going to use almost all of our free cash flow to pay down debt. And that's why I said we expect to pay down a minimum of $150 million of principal amount of debt and we're well on our way to doing that, we paid down $126 million at face in the first quarter, so we're well on the way to accomplishing that $150 million goal. Our total debt at the end of March was about $3.2 billion. We'll have schedule reductions of another $25 million or $30 million through the balance of the year, but obviously we're going to – we're going to pay down more than that. So at the end of the year, our total long-term debt should be – probably – excuse me – we were at $3.1 million at the end of March. So we – we could be – we could be somewhere between 3.0 and 3.050 by the end of the year.

Darren Lehrich – Deutsche Bank

Okay. I mean, I guess, the question I'll ask then is given what you've done thus far in terms of de-leveraging, and the $126 million of face that you paid down, I mean, do you care to update us at all on the deleveraging? It would seem that there would be more than what you have laid out.

Bob Farnham

Sure. I mean, I said $150 million at face. We're – what we actually paid to – to reduce that $150 million of face was about $87 million, so we – we could end up the year reducing debt by $200 million of face. So – that's – we're easily going to get through and complete 150. Could we be at 200? It's possible. It may, it probably will depend on how much more we buy back of the convert, but I do have to keep in mind that after the end of the year, I will have to pay the term B bondholders 50% of my excess cash flow, so that may temper a little bit, what – how much I buy back of the convert here through the balance of the year.

Darren Lehrich – Deutsche Bank

Sure. Okay. And then just my last question just on the operations piece, you talked, Gary, about lot of the ED initiatives. Besides just tracking the emergency room visits, which you do disclose, are there any other disclosures that you think you want to make to us here and going forward just as it relates to the progress that you're getting out of that initiative. It's – it's obviously been a key focus.

Gary Newsome

There are so many components that we measure in the emergency room, there is so many things that we measure, it all drives a higher quality experience for our patient and better satisfaction. There's a lot of data and it probably would not be meaningful without a baseline comparison just out there on its own from that standpoint, but we probably won't give any more specific other – other than what we have on the ER process. It's an internal process that we monitor very closely. In fact, we review these reports, are reviewed daily at each facility, the division Presidents are monitoring those throughout the week. In our weekly meetings we review the data as part of our weekly meeting with the division Presidents, and we look at other – all of our initiatives, we – in the weekly meeting we look at our initiatives on the physician recruitment front and development and market development, specific to each market, and I think those are more meaningful as we go forward as we are able to report our successes in those areas.

Darren Lehrich – Deutsche Bank

Okay. That's great. And then my last thing just relative to the readmission discussion that's being held at a national level. Where are you in your markets, just kind of in aggregate on readmission trends?

Bob Farnham

I – Darren, I don't have that off the top of my head. Obviously we are going to look at that kind of related to what the government is talking about, about bundling, and readmission rates. I just – I don't have that handy at this point in time.

Gary Newsome

We – we do and have been looking at that from a diagnosis cat – per diagnosis category. We – we're – all of our quality initiatives are in place to address those as we go forward. It's part of our ongoing quality project. And we do have those numbers; we just don't have them in front of us right now.

Darren Lehrich – Deutsche Bank

Sure. Okay. Thanks a lot.

Operator

Next question comes from Jason Gurda of Leerink Swann. Please go ahead.

Jason Gurda – Leerink Swann

Good morning. Thank you. You had mentioned earlier that Florida volumes were up in the quarter. Do you have a sense whether you are gaining market share there or is the overall market firming up?

Gary Newsome

Based on our certain markets, the one we have in Florida, we believe there's two components. Florida continues to grow as a state not at the rate that it has historically, obviously, but it continues to grow. So we – we do see some volume related to growth in the state, but because of our initiatives, and doing the right things of – in our ER recruitment of physicians and then also this market development strategy, we are gaining market share. I think that's a great opportunity for us.

Jason Gurda – Leerink Swann

Okay. And then looking at some of your initiatives that you have applied to improve volumes, would you attribute firming up in volumes that you have seen, I guess the last two quarters relative to, particularly the summer as to some of your more recent initiatives? Or is there some benefit coming from some of the legacy initiatives like improving physician satisfaction and patient satisfaction scores?

Gary Newsome

I believe that there's some benefit obviously from a physician relationships or physician satisfaction. Our patient satisfaction obviously will continue to help us drive volume. There's no question about it. We – one thing about our recent initiatives, we can measure that. It's a measurable component, easier to measure, but we think it's a combination of all of the initiatives we have out there.

Jason Gurda – Leerink Swann

Okay. And the last question is if I could get your year-over-year change in case mix?

Bob Farnham

Sure. It was 1.36 for this quarter, this year and 1.34 last year. That's Medicare case mix index.

Jason Gurda – Leerink Swann

Okay. Thank you.

Operator

Your next question is from John Rex of JPMorgan. Please go ahead.

John Rex – JPMorgan

Thanks. Just two quick ones. First one, to circle back on the guidance on the bad debt – outlook for the year, just as you think about kind of where we are with unemployment, the way it's trending and seemingly at least for a lot of guys seem a lagged effect, and that actually impacted bad debt expense, so can I look at you guys already at the high end of your guidance range for the year, kind of what are the offsetting factors that you see in terms of – whether it's your markets and probably both of these your markets and your initiatives that are going to keep that in check and from going throughout the year as kind of that lag – as that lag effect has some impact?

Bob Farnham

Sure, John, yes, when – and I said this before when – when we put together our – our 2009 plan, unemployment on a national level was probably about 7.2%. We have run about a half percent higher than the national average because of unemployment in Florida and Mississippi. Where we have our highest concentrations of hospitals, and we did assume that employment would average – unemployment would average close to about 9% and we thought if we could keep our uninsured volumes in 2009 close to what we experienced in 2008 that we could see bad debt expense is stay in the 11.5% to 12% range and we did run 11.7% in the fourth quarter, so that's seemed reasonable and appropriate to us.

However, as you know, that national unemployment now is around 9% and we're probably at 9.5% overall as a company, so unemployment is and will likely to continue to be higher in the short-term and there is some relationship between unemployment and the uninsured. Is it direct? And is there a time lag there? It is somewhat – it's probably more indirect than direct. It's not a given that when somebody becomes uninsured that they will automatically need health care services, but obviously the longer that they are unemployed, the higher likelihood they will need healthcare services. But I think – you asked about mitigating circumstances, there have been a couple of things, SCHIP program has been expanded by the government. That's a good thing.

With regard to the stimulus package, there have been money is included in that for the states for the Medicaid programs. So we're not hearing as much of a – as much talk in states about adjusting down Medicaid rates. And yes, the government picking up 60% of the tab for Cobra, should provide a benefit to us. It's hard to say how many patients, potential patients will take advantage of Cobra. I think there's a number of mitigating factors and circumstances out there that, that should help, help with the uninsured volumes.

John Rex – JPMorgan

And do you think you could handle, say, you were up another 1500 BIPS in unemployment as you get out? Do you think you could still handle and keep your bad debt expense in this range? Or would you assume at that point that would be pushing it above your 12%?

Bob Farnham

Well, again, it's going to get back to the volume of the uninsured, if we can, keep the uninsured volumes, flat to up just a bit, I think we can keep it close to 12%. It's going to depend on what happens in a lot of our markets. I can tell you that for example, with regard to the auto industry, there aren't any of our markets, they are impacted by the American automobile industry, so that's a good thing. And so we're just going to have to follow the economy and the trends and unemployment as they relate to our markets and see what impact that, that has on us. The longer that the – the downturn in the economy and the recession goes on, the more impact it will have on deductibles and co-pays. We have seen little bit of deterioration in that, but – but not a great deal. So – but like I said, there's a lot of mitigating factors that should help with, with our bad debt expense. But if we can keep the volume of uninsured relatively flat I think we'll have some success in holding it around 12%.

John Rex – JPMorgan

Okay. And just – can you tell me what you embedded in your 4Q for inpatient PPS update factor?

Bob Farnham

We figured between 2.5% and 3% sort of similar to what we have been seeing in the last couple of years.

John Rex – JPMorgan

That will mark a basket but did you offset that for some kind of coding creep factor?

Bob Farnham

A little bit of coding creep factor, but we figured we could offset that as we have for the last year, with better documentation, and higher price mix index.

John Rex – JPMorgan

Okay. So – but you would more look for kind of a net – the 4Q is more kind of a net of a 2.5 to 3?

Bob Farnham

Somewhere between 2.5 and 3. As high as 3, but more likely mid-2s.

John Rex – JPMorgan

Okay. Thank you.

Operator

The next question comes from Justin Lake of UBS. Please go ahead.

Justin Lake – UBS

Thanks. Covered a lot, so I just got one question left here. Just wanted to see if you could give us a little bit more color around the benefits that you outlined on the – on the salary and wage side? So specifically what was the benefit in the quarter from discontinuing that 401K match and also eliminating the merit pay increases?

Bob Farnham

Well, we didn't give detail on those. I can tell you that you can look at your financial statement footnotes and we paid about $15 million in employer 401K match last year. That's in our footnotes, so that's – that's $3 million or $4 million benefit for the quarter. It's a little harder to assign dollars to merits. Some merit increases are given out earlier in the year, other hospitals do that throughout the year. So it's a little harder to start the dollar in each of those items. But I think the biggest – biggest impact came from adjusting the FTEs at each hospital.

Gary Newsome

In reality, Justin, – this is Gary, it's – we're managing our resources across the board including our staffing to our volume more appropriately.

Justin Lake – UBS

No, that – that's clear. I just wanted to see if there is any protocol. So basically the second piece, these merit increases, you're going to actually see kind of a year-over-year benefit, not just in the first quarter, but going forward because – because of the fact that they don't just all come out one on one.

Gary Newsome

That's true.

Justin Lake – UBS

Okay. Just kind of bigger than a bread box, is it in the – as far as merit increase that you platform last year, were they kind of in the ballpark of that 401K or less or more? And that's all I got.

Bob Farnham

It's probably in the ballpark, maybe a little bit more. I mean, you can – even a 2% merit increase on a $1 billion of payroll, I mean, you can figure out on an annual basis what that is.

Justin Lake – UBS

Perfect. Thanks a lot, guys.

Operator

Our next question comes from David Bachman of Longbow Research. Please go ahead.

David Bachman – Longbow Research

Great day and thanks for squeezing in another question here. Staying on the expense front, if you just look out over the rest of the year relative to where you guys came in here on the first quarter, so – where – where will we sort of expect things to remain static and where might there be more opportunity whether it's in supply cost or other operating expenses to try to bring in expenses even a little bit more than where they were in the first quarter?

Gary Newsome

We – we are looking at every area – every operating expense line, and we do have opportunities as we go forward from outside service agreements and other contractual relationships that we have, even better performance in terms of our compliance with purchasing agreements. And there are several opportunities for us as we go forward, and we will take advantage of all of those as they present.

David Bachman – Longbow Research

Okay. And then just one question on the outpatient book of business. Just a little bit more color there on just sort of the overall volume trends in the outpatient front. I guess I'm just trying to – to look past adjusted admissions and sort of the revenue influence there to just get a better handle on what's outpatient volumes are doing?

Gary Newsome

One of the areas that we believe our outpatient volume has a lot of opportunity in reality, and as we recruit our physicians and get them in place, that's going to really help us in our outpatient surgeries and diagnostic testing across the board, as well as we expand this footprint that we have talked about, surgery centers, and imaging centers, and urgent care centers. So all of these components will help us as we go forward, and as they develop and mature on the outpatient volume side. We have opportunities in our markets to do that and that's an exciting piece of it.

David Bachman – Longbow Research

Okay. That's all I got. Thanks.

Gary Newsome

Just one more caller.

Operator

We have time for one more call. Our last call – our last question is from Rob Hawkins of Stifel Nicolaus. Please go ahead.

Rob Hawkins – Stifel Nicolaus

Thanks. I would like to ask again some questions little bit down the labor line again. What were your FTE per bed numbers – I don't know, say a year ago, and – and what kind of a percent change did you guys get out of it and then what's the opportunity or I guess how would you characterize like how mature or how far along you are in the process there?

Bob Farnham

I don't have any FTE numbers per bed with me. I can tell you that, we – obviously we have less FTEs today than we did a year ago. I mean we started out last year as I mentioned earlier changing our skill mix and so, for example, we may have replaced three LPN type employees with two RNs, kind of thing. So – so we have improved our skill mix. We did that throughout the year, so – and we talked about that throughout the year that there are – our salaries, wages and benefits were higher because we did change the skill mix at the hospital level. So that happened through most of last year, and then toward the end of the year, we looked at our volumes in each of our markets, and adjusted our FTEs accordingly, and that's something we will – we will continue to do based on – on volumes here through the balance of the year. But with regard to a specific FTE numbers, I don't have those and generally we have not provided those in the past. We – we're going to – we're going to – staff based on our volume and (inaudible).

Rob Hawkins – Stifel Nicolaus

Okay. And then just finally, you guys already have a pretty significant self-pay discount built in, but what kind of eligibility enrollment, processes and the structure do you have in place at the hospitals to kind of handle Medicaid enrollment, SCHIP, Cobra, and some of these things right now, and is there still some room to go on that as well?

Bob Farnham

Yes, we educate our business offices on an ongoing basis based on any changes in the regulations or requirements, so – I mean, that's something we do. I can tell you that charity and indigent care guidelines in lot of cases, most of our hospitals look at state guidelines, but in a lot of cases refer to the – the Federal poverty levels, and anything under 200% of Federal poverty level is certainly a guideline they look at. But we educate each of our medical offices – business offices on an ongoing basis. For example, on the Cobra, we make sure that our business offices know that the government is willing to pay for Cobra, and so, if we have a patient that is unemployed, and say, they are unemployed, we find out when it was they became unemployed, and if they had insurance, if they could get insurance, and that the government would pay for some of that. So it's a continual educational process, and we're working as hard as we ever have on a state-by-state basis, and I would tell you that we're – probably our conversion rate on qualifying patients per Medicaid is probably a little bit better today than it was a year, year and a half ago, and we do that through a combination of employees, consultants, and state workers as well. So, it's an ongoing educational process that we try to stay on top of to qualify for payment, through any program, as best we can.

Rob Hawkins – Stifel Nicolaus

You are not outsourcing – you mentioned some consultants that's more on the educational side? You are not outsourcing to other services to help you with this?

Bob Farnham

We outsource – sometimes we outsource helping us qualify patients for Medicaid. Sometimes there are employees that do that. Sometimes they are outside consultants. Even in some cases, state workers that we help pay the salary cost on.

Rob Hawkins – Stifel Nicolaus

Alright. Thank you. I'll jump off the line. Thanks for taking the call.

Bob Farnham

Thank you.

John Merriwether

Great, that's going to do it everybody. Thanks very much for your attention this morning, and have a great day.

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Source: Health Management Associates, Inc. Q1 2009 Earnings Call Transcript
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