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Tenet Healthcare Corp. (NYSE:THC)

Q2 2009 Earnings Call

August 04, 2009; 10:00 am ET

Executives

Trevor Fetter - President & Chief Executive Officer

Steve Newman - Chief Operating Officer

Biggs Porter - Chief Financial Officer

Tom Rice - Senior Vice President of Investor Relations

Analysts

Shelley Gnall - Goldman Sachs

Ralph Giacobbe - Credit Suisse

Sheryl Skolnick - CRT Capital Group

Adam Feinstein - Barclays Capital

Kevin Fischbeck - Banc of America

Darren Lehrich - Deutsche Bank

Rob Hawkins - Stifel Nicolaus

A.J. Rice - Soleil Securities

John Ransom - Raymond James & Associates

Whit Mayo - Robert Baird

Erin Blum - Goldman Sachs

Operator

Hello and welcome to the Tenet Healthcare conference call. All participants will be in a listen-only mode. There will be an opportunity for to you ask questions at the end of today’s presentation. (Operator Instructions)

Now I would like to turn the conference over to Tom Rice. Sir, please begin.

Tom Rice

Thank you, operator and good morning everyone. Welcome to Tenet Healthcare’s conference call for the second quarter ended June 30, 2009. A set of slides has been posted to the Tenet website to which management will refer during this call.

Tenet’s management will be making forward-looking statements on this call. These statements are based on management’s current expectations and are subject to risks and uncertainties that may cause these forward-looking statements to be materially incorrect.

Management cautions you not to rely on and makes no promises to update any forward-looking statements. Management will be referring to certain financial measures, including adjusted EBITDA, which are not calculated in accordance with generally accepted accounting principles, or GAAP.

Management recommends that you focus on the GAAP numbers as the best indicator of financial performance. During the question-and-answer portion of this call, callers are requested to limit themselves to one question and one follow up question.

At this time, I will turn the call over to, Trevor Fetter, President and CEO. Trevor.

Trevor Fetter

Thanks, Tom. Good morning everybody. We’re going to keep our remarks fairly brief this morning as we believe our second quarter results speak for themselves. I’m very pleased with the 5.5% growth that we generated in total company revenues and 51% growth we generated in adjusted EBITDA in the quarter.

With second quarter EBITDA of $246 million, adjusted EBITDA for the first half of the year is $524 million. We’re raising the outlook for 2009 for a second time to a new range of $810 million to $875 million. This is an increase of $50 million of the previous range of $760 million and $825 million.

While our performance has been quite strong in both the first and second quarters, we’re still concerned about the potential for rising bad debt in the second half of the year. While much of the strength in the first half of the year can be credited to solid revenue growth, excellent cost control and prompt response to volume fluctuations in each of our hospitals, we’re also seeing some encouraging volume growth in important segments of our business like outpatient. Our outpatient business was particularly strong in the second quarter, same hospital outpatient business were up 4.5% and we achieved our first quarter of positive growth in commercial outpatient visits since we started disclosing this data a few years back.

Other measures of the volume mix were strong as well including at 3.5% growth in outpatient surgeries. Beyond increases in ER visits, we believe that growth in our outpatient business is being driven by our operational improvement initiatives and increased capital investments in this area as well as at least three other factors.

First, much of our growth in outpatient volumes is being generated by continuing growth of our active medical staff. We found that the first surge in volumes from these new physicians tends to be in the outpatient side. As the relationship with their Tenet hospital matures overtime, that growth tends to evolve into a greater number of inpatient referrals. With continuing growth in the number of new physicians, the initial pickup in outpatient volumes is much more visible.

Second, the physician relationship program reps that we have dedicated to the outpatient business are clearly having an impact. This is especially true in our growing imaging business where we’ve seen the benefit of a focused marketing strategy.

Finally, the competitive environment in the outpatient industry is increasingly favorable for us. Many competitors who are standalone or physician owned centers are in various forms of financial distress causing them to under invest in new technology and to cut staff.

Since our outpatient business generates higher margins than inpatient, this contributes to our earnings growth. Conversely, commercial managed care admissions remained under pressure in the second quarter declining by 5.7%. Given that we previously reported a 7% decline through end of May, it’s fair for you to conclude that June was stronger for us in terms of commercial managed care admissions.

With a cautionary warning about reading too much into a single month’s data, I’m pleased to tell that we saw relative improvement continue through July with just a 2.3% decline in commercial managed care admissions and 0.8% increase in commercial outpatient visits for the first 28 days.

Total same hospital admissions grew 1.3%, paying admissions grew 0.8% and outpatient visits grew 4.7% during the first 28 days of July. So while we discourage anyone from placing too much emphasis on data for time periods less than a full quarter it’s always encouraging when the most recent data does indicate evidence of improving trends.

The sustainability of strong earnings momentum, that we achieved in the first half will be critically dependent on our ability to maintain tight cost controls and avoid a spike in bad debt. While we have limited control over what happens with bad debt expense in the second half, we do have a number of initiatives in place to position ourselves in front of the issue. While we are unlikely to be completely immune to further deterioration in the economy and potentially higher levels of unemployment in our markets, our early action in this area leave us well positioned.

I also want to point out that we ended the quarter with a strengthened cash position. At June 30, we had $758 million in cash on our balance sheet. While we’ve had some sizable cash outflows since the end of the quarter, we’re pleased that our strong earnings performance from the quarter is being efficiently converted into cash.

One other point about cash, we find ourselves essentially flat in terms of adjusted free cash flow at mid year and since the first quarter is very significant in terms of cash consumption, we view this mid year breakeven status as a very important milestone for us. Additionally in July, we repurchased $68 million face value of debt for $60 million. I don’t have much to add about healthcare reform beyond what you’ve heard in the popular press and it’s still too early to make definitive statements about the likely outcome.

I can only remind you that by virtue of our geographic footprint with major exposures to Florida and Texas, Tenet has borne a disproportional impact from the cost of providing healthcare to the rising numbers of the uninsured. So if healthcare reform succeeds in providing coverage to a large segment of today’s uninsured population, this will be very helpful to us.

To quickly summarize, I feel good about the progress that we’ve made this year. We’re heading into the second half of 2009 with positive momentum. The strong cost culture is solidly in place, and we have a healthy growth trend on the outpatient side. Continuing macroeconomic weakness could surprise us in any number of ways, but that should not cause you to lose sight of the progress that we’ve made.

It’s now clear that our earnings performance is significantly stronger than we anticipated at the beginning of the year. Our rapid and effective response to a changing environment is driving this earnings growth in a modestly different way than we had anticipated. We’re building on accelerated growth in our outpatient business achieving very effective cost controls and successfully restraining the expected growth in bad debt expense.

Tenet is a much stronger company than it was just one year ago. Our strategic initiative to set the stage for further earnings growth should we get some favorable changes relative to recent trends and finally see some lift from commercial admissions and some abatement from the cost burden of providing healthcare for the uninsured.

With that, let me now turn the floor over to Steve Newman, to add some color on our cost efficiencies and volume growth. Steve.

Steve Newman

Thank you, Trevor. Good morning, everyone. As Trevor mentioned, we derived much of the improvement in our second quarter results from continued progress and cost control. In past quarters, we’ve talked about the ongoing development of cost management systems that we have implemented at each of our hospitals. Our performance in the second quarter clearly demonstrates, that these initiatives are producing positive results.

Let’s take a look at our cost line items to better understand what I mean. Our same hospital SW&B per adjusted patient day increased by just 0.9% in the quarter, this was helped by a 29% decline in our overtime and contract labor expenses. Three factors contributed to this positive result.

First, a 26% improvement in employee turnover and a 29% improvement in registered nurse turnover compared to Q2, 2008. Second, the continuation of an uncertain economic environment, which has added nurses to the available workforce, intends to keep employees with their present employer.

Third, better staffing and position control systems. As a result of these factors, as well as the other reductions we made as part of our broader cost initiatives, SW&B as a percent of net revenue fell to 42.7% in the quarter. That’s down from 44.1% last year.

Let me expand for a moment on the point I made about better staffing and position control systems. We’ve developed several proprietary systems which provide hospital department heads and A teams a more sophisticated approach to managing labor productivity.

The web based staffing matrices allow managers the ability to set staffing for their departments based upon expected levels of activity. The web based physician control system optimizes manager’s hiring of the appropriate skill mix on a full or part-time basis.

Daily monitoring reports support the department heads at maintaining actual staffing at or below preset targets. Dedicated corporate labor management specialists work with their assigned hospitals to enhance the leaders understanding and use of these new tools.

At the end of each pay period, a summary of the labor management for each hospital is produced for regional and corporate management review. I personally review the reports for each hospital at least twice a month and more frequently if a negative variance has been detected.

At 17.8% of net revenue, supply expense was flat, which is remarkable when you consider the 1.5% increase in surgeries, including a 3.5% increase in same-store outpatient surgeries. We reduced malpractice expense by 29% or $11 million in the quarter, further extending our recent trend of significant year-over-year declines.

As you know since 2003, we’ve had a tremendous effort behind improving clinical quality. The continued expansion of our patient safety initiative should help keep downward pressure on our malpractice expense going forward. All of this combined to produce a great result. Total same-hospital controllable operating expenses on a unit cost basis were up only 0.3%, compared to Q2 2008.

Turning to volumes; given that our TGI service lines target high-value elective surgeries it is understandable that TGI inpatient volumes declined in the second quarter. We are confident, however that our TGI service lines remain the right service lines and demand for these services will return as the economy recovers.

We’re pleased that in last Friday’s CMS update, the additions to rates for targeted service lines appear to be a net positive for us, especially in orthopedic and spinal surgery. To build the targeted service lines further, we are also aggressively implementing our business-to-business and direct-to-consumer marketing activities to both the commercial and Medicare populations.

Now, let me quickly bring you up to-date on the growth of our medical staff in the quarter. Net of attrition, we added 173 physicians to our active medical staff in the second quarter, putting us at 34% of our annual target. That’s slightly behind where I’d like to be at this point in the year, but I think our goal of adding 1,000 active staff physicians net of attrition is still achievable.

The physicians we’ve added to our active medical staff continue to refer significant volumes to our hospitals and outpatient facilities. The physicians of the class of 2007 actively practicing in our hospital today referred an average of 8.6 admissions in the second quarter 2009. This is an 18% year-over-year increase in admissions by this group of physicians.

Commercial admissions from this class were up as well, increasing a robust 15%, and as Trevor mentioned, our relationships with new physicians tend to mature earlier on the outpatient side. Referred outpatient visits by the physicians in the class of 2007 increased 2.7% year-over-year.

Additionally, the physicians of the class of 2008 continue their ramping up of inpatient admissions and referrals to our outpatient facilities in the second quarter of 2009. There are two takeaways from these observations.

First, our physician relationship program is having a very positive impact on our patient volumes, and second the surge in outpatient volumes is a continuation of the pattern we’ve observed in which new physicians build the early phases of their relationships with Tenet facilities primarily on the outpatient side. The initial outpatient referral predominance is one of several factors which have contributed to our positive outpatient growth over the last three quarters.

With that, let me now turn the floor over to Tenet’s Chief Financial Officer, Biggs Porter. Biggs.

Biggs Porter

Thank you, Steve. Good morning, everyone. Since our second quarter financials have been in the public demand for almost a week, I will not review them this morning. I will point out to however one-time, which you’ll see a greater detail on in our 10-Q filed this morning. That is that this quarter’s results would have been even stronger were it not for a $23 million charge, $16 million of which was retroactive to 2007 and 2008 related to the new methodology deployed on the determination by CMS of the Supplemental Security Income ratio adjustment to Medicare reimbursement.

We have said that there will always be adjustments to our cost reports, but this charge was definitely unusual. Even with that adjustment, we believe our results for the quarter year-to-date demonstrate that our strategies for improving our performance are succeeding even in a tough commercial admissions environment and that pressure from the economy otherwise has been largely muted.

Now I want to take a few minutes to examine the revisions to our 2009 outlook and discuss the added outlook detail we provided on our slides for today’s call. I will focus on the changes in our assumptions and the issues we see is the drivers that imbibe the remaining sources of opportunity and risk.

To that end, let me draw your attention to our revised assumptions as detailed on slide 20 and our new EBITDA walk forward on slide 21. As you already know, we have raised our 2009 EBITDA outlook by $50 million. We have basically left our revenue outlook unchanged with an expected continuation of the second quarter trends on volume for the remainder of the year including strong performance we are experiencing on outpatient.

As we have discussed before, there’s been a year-to-date shift to outpatient, which although does not benefit the top line, does enhance profitability because it is the higher margin business. We have made favorable adjustments in the walk forward for operating expense and bad debt reflecting our strong performance to-date. Also, at the top of slide 21, you can see that we have reflected the reclassification of NorthShore hospital in Slidell, Louisiana to discontinued operations, which had a positive effect of $7 million on the walk forward.

In addition to the shift to outpatient, we had another great quarter in terms of cost efficiency, reflecting our cost initiatives, improved cost flexing in response to day-to-day fluctuation of volumes and lower contract labor and overtime. We expect to be able to sustain our improvements that are cost efficiency as we continue through the year.

Because we use broad rounded off ranges on our presentation of our outlook assumptions, as reflected on slide, the amount of change to operating expense and bad debt in our outlook appears larger than it really is. If you look at slide 21, you will see at the upper end of the range, we’ve adjusted bad debt by $35 million and cost by $8 million.

Through six months, our bad debt expense ratio has averaged 7.2% with the second quarter at a higher 7.5%. This performance is significantly better than the 8.3% to 9.3% level we have factored into our prior outlook. Having said that, with unemployment high both nationally in many of our important markets, risk remains that we could see rising numbers of the uninsured and further deterioration in collection rates.

We’re now expecting the second half of the year for bad debt to be in the range of 8.4% to 9.8% putting the full year in the range of 7.8% to 8.5%. The other risks we have been watching are the potential for accelerating declines in the commercial inpatient volumes attributable to individuals losing their courage during the recession and any reductions in state Medicaid funding.

Having said that, in keeping with the conservatism we applied earlier in the year, even the upper end of our outlook range provides for second half decline relative to the first half driven by the negative effects of the recession on each of these metrics. Conversely, there is upside to our outlook ranges, if bad debt remains stable and commercial volume trends moderate as indicated may be possible when looking at July’s statistics. I always have to caution though that, while encouraging, one month does not establish a trend.

Briefly on the topic of pricing, I want to emphasize we have good visibility in the commercial pricing. At this point in the year, we have over 95% of our price negotiated for 2009, 57% for 2010 and 44% for 2011. We’re also pleased with the final IPPS rates announced on Friday by CMS.

This eliminates a critical element of pressure on fourth quarter of 2010 Medicare pricing as it results in a $30 million improvement in the fiscal year 2010 rates relative to the rates proposed in May. The effects of this and other elements of government pricing are further laid out in our 10-Q.

Turning to the cash outlook, we had a very good quarter in converting our profitability to cash. We also received a $49 million early payment in retirement of the bonds due to us from a Dallas area hospital authority. This is one of the items in our cash initiatives we had been pursuing for this year.

The largest single initiative remaining is a sale of our MOBs which we are now marketing on single or market grouping basis, which we have not included in our forecast for this year. Our revised cash flow walk forward is provided on slides 22 and 23.

You will note that net-net we have lowered our December 2009 cash balance outlook, but that it is because the improvement from cash flows from operations has been offset by the use of cash in the retirement of debt as reflected in the net financing activities lying on the walk forward.

This includes the third quarter repurchase of $68 million of face value of debt as Trevor mentioned earlier. You’ll also note that forecasted adjusted negative free cash flow for the year is now in the neighborhood of $100 million. Drilling into our results for the quarter, it should be noted that despite the economy, our days in accounts receivable is down 48 at June 30.

The cash walk forward assumes that this goes back up to 58 year end. This may also improve conservative if we continue our trends of reducing cycle times and billing and improvement and cash collections at the point of service. The offsetting risk is of course the timeliness of payment from self pay a balance after as we proceed through the year.

So in summary, a strong quarter on outpatient cost control and cash flow, bad debt pressures from the economy have remained slight relative to our earlier expectation, the negative effects of the economy on commercial volumes have been offset by the positive trend on outpatient, which may be a strong indicator of future growth and we are confident in our strategies but remain conservative in our outlook only for those things outside of our control.

With that, let me turn it over to the operator for questions. Operator.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question is from Shelly Gnall of Goldman Sachs.

Shelley Gnall - Goldman Sachs

Hi, great thank you. So, I guess my one question is there was a shelf registration filed on fairly recently, it seem to imply you’re looking for greater financial flexibility. I guess my question is what sorts of things might you be interested with doing with greater financial flexibility and any thoughts on what time horizon you could be looking at?

Trevor Fetter

The shelf registration is something we just thought was good business practice to have on file with the SEC. It had been some years since the company had one, but there was the ability to put it back in place this year, restores our status, which is important to us. So it’s just a good business practice to put it out there in a same way. It’s a good business practice to have a line of credit. So that capital can be accessed that way.

In terms of uses of it, it is very broad. So it can be used for a variety of things over the long term. In terms of near term, I won’t speculate. I don’t want to speculate as to any particular point in time. As we said in the past, we want to improve our performance we want to reduce our leverage overtime, and keep flexibility and be opportunistic.

Shelley Gnall - Goldman Sachs

Just as a follow-up, have you spoken to a target leverage range you hope to get through eventually?

Trevor Fetter

Yes. We may or may not have spoken to it previously, but on a net debt basis, we would want our leverage over the long term to get down to about four times EBITDA.

Shelley Gnall - Goldman Sachs

Thanks.

Operator

Our next question is from Ralph Giacobbe of Credit Suisse; please go ahead.

Ralph Giacobbe - Credit Suisse

Thanks, good morning. I just want to go back and I know you’ve tried to sort of explain in the walkthroughs. Again, sort of you’ve done over $500 million in EBITDA in the first half of the year and the guidance does imply a fairly steep drop off even when considering sort of higher bad debt.

So I mean, besides higher bad debt and some of the potential volume falloff from the commercial side. Any other main variables that we need to think about in the second half of the year, maybe if you can give us even your Medicaid expectations for the back half?

Trevor Fetter

Okay. In terms of second half versus first half. First I would point out is that, first half typically from a seasonal standpoint has higher volume. So volume in the second half is by about 1% lower. In terms of Medicaid, the biggest single thing would be dish is biased towards the first half. That’s not due to any specific reductions, but rather just the timing of when awards are made. It’s about $20 million variable on dish between the first half and second half.

With lower volume, cost performance typically also falls off in the second half just because the fixed cost ratios and the absorption issues resulting from the 1% lower volume. Another factor would be malpractice, which although we said as we go through the year quarter-to-quarter, we expect to be lower than last year.

Clearly, the first two quarters were much lower reflecting more substantial adjustments year-over-year or quarter-over-quarter than we would expect in the second half. So the improvement in malpractice here is more front-end loaded.

Bad debt gets affected not only by our conservatism with respect that might happen with collections, but also is affected by seasonality. The third quarter being a lower revenue quarter, typically draws higher bad debt as a percentage of revenue, so that’s another factor to consider.

On the other hand, offsetting that, net-net between commercial inpatient and outpatient growth, we would expect some positive probability, not a big one second half over first half by virtue of the outpatient growth.

Ralph Giacobbe - Credit Suisse

Okay and then just my one follow-up. Just noticed in the last couple of months, you’ve had new CEOs takeover at several of your hospitals. Can you just help us maybe anything going on there? Are these new fills you wanted to make, is it sort of back filling positions where the existing management team had left and should we expect any of these going forward, and is this at all concerning?

Steve Newman

This is Steve Newman. That’s a very good observation. We talked in our prior calls about some underperformance in some of our hospitals and specifically in the Southern States region. So we’ve made some changes there. We’re delighted with these particular changes, which I think should improve the performance of those facilities going forward.

We took one of our outstanding CEOs from a California hospital and announced this week that she was going to one of our Southern States region hospitals, and we were able to acquire a CEO from our former USC University Hospital to fill that slot at Fountain Valley in California. So, I think all in all, we’re continuing to upgrade our talent at the CEO level, which should provide the sort of boost we need to improve performance in those particular hospitals.

Ralph Giacobbe - Credit Suisse

Okay. Great, thank you.

Operator

Our next question is from Sheryl Skolnick of CRT Capital Group; please go ahead.

Sheryl Skolnick - CRT Capital Group

Good morning, everyone. When I looked at your press releases for this quarter I must confess I almost didn’t have anything to ask because there’s so little hair on it. So, that’s a backhanded way of saying nice job.

Can you confirm that or talk to, in my larger question talk to a sense that I have that there’s more sort of ordinary hospital issues and less sort of drama and angst and whether or not you believe your results might therefore be more predictable and we might avoid the usual difficult seasonality in the third quarter as a result?

Trevor Fetter

I don’t recall there ever being drama and angst. So, I’d have to argue with your characterization of the past, but I guess it’s absolutely true. We’ve knocked off quite a number of things on the to-do list. I mean just recent ones that come to mind include the Peoples Health Network that HMO we had in New Orleans, several REIT hospitals.

Getting the money on this Metrocrest bond thing was huge and I’m sure I’m forgetting a whole number of them in addition to the litigation issue. So, we’ve really, if you look back at the past several years, we’ve cut the number of hospitals in half.

We cut the revenues by about a quarter. We cut the headquarters staff by about half. The activities have been reduced and so, today you have so much greater of a focus on normal operations in the future than on solving little issues that were lingering around from before.

So, at least inside the company, it’s a very different balance and it’s awfully nice. We’d always kind of separated the people who are working on the going forward from the, who are people working on cleaning up the past, but today everybody’s working on moving forward.

Sheryl Skolnick - CRT Capital Group

That’s fair enough and thank you. I have a couple of nips that need I think to be clarified if I could. Biggs, did I understand you correctly to say that if we added back the adjustment for the supplemental security income treatment that your EBITDA this quarter would have been $16 million higher.

Biggs Porter

If you add back just the retroactive portion, yes $16 million.

Sheryl Skolnick - CRT Capital Group

So the ops generated to 262, not 246?

Biggs Porter

Yes.

Sheryl Skolnick - CRT Capital Group

That’s nice.

Biggs Porter

The charge in total was $23 million, but $16 million of that was retroactive. So, that’s the easier one to add back.

Sheryl Skolnick - CRT Capital Group

Right, that’s because it’s very clearly prior period, but and so, okay. So, then that’s pretty significant and then that would actually make the sequential conservatism, I guess even more apparent and then I have two other little nits, if you might indulge me.

One is a question about why Stephen, you might believe that the company is trailing your goal with respect to recruited physicians? And then a little bit of an understanding of, where the uninsured trend in July is relative to the trend you experienced in the second quarter?

Steve Newman

Sheryl, let me do the first part of the question and I’ll let Biggs do the second part. We’ve noticed some very significant differences in the attitude of our loyal medical staff in their groups, mainly located around our campuses in the country.

I think it is probably a reasonable and rational approach, but our goals in our prior two years in terms of adding active medical staff, net of attrition were affected by succession planning in many of these multi physician practices. With the economic downturn in many of these markets and nationally, we’ve seen a reluctance on the part of these physicians to proceed with succession planning even as they’re aging.

I think largely that is the factor that has caused us to be at 34% of our goal rather than 40% of our goal, which would be the more likely number in comparison to prior years, but we believe that we will go ahead and redirect in the marketplace those physicians that have practices that don’t have active staff privileges, make up a lot of progress in third and fourth quarter toward our goal of being the third consecutive year of adding 1,000 physicians net of attrition.

Sheryl Skolnick - CRT Capital Group

Great, thank you. Biggs, the uninsured July trends, obviously, you had positive uninsured admissions in July, right?

Biggs Porter

Uninsured is a negative charity as positive. The net of the two is positive.

Sheryl Skolnick - CRT Capital Group

Is it any better or worse than it was in the second quarter?

Biggs Porter

Second quarter.

Sheryl Skolnick - CRT Capital Group

Which was two percentage on average?

Biggs Porter

It’s close to the same.

Sheryl Skolnick - CRT Capital Group

Okay. So is there anything we should be concerned about there, in particular, I’m thinking about any exposure to swine flu that might crop up in the third quarter, because the third quarter can be a very dangerous quarter for your investors and those of us who work with the securities of your company. So I’m trying to identify those kinds of risks and see what the company’s thoughts are ahead of time.

Biggs Porter

In terms of swine flu, one thing to consider is I’m not sure those are the most expensive of cases that come in. So even if there’s a statistical increase, that may not result in a significant increase from a, or decrease in the P&L performance for the quarter. Otherwise, I think some overseeing is there’s been some anniversarying of some of our initiatives, right care, right place, and the eligibility program where we have people in our larger emergency departments, like counseling people getting them qualified for government programs.

So some of the benefits on that on a year-over-year basis are now a little bit more matured. There’s no other driving I think driving consideration other than just monitoring what the effects of the economy are and whether or not that changes the trends as we go through time.

Sheryl Skolnick - CRT Capital Group

Great. Okay. Thank you and Stephen, the Medicare performance initiative is being rolled out as we speak. Is it generating any kind of improvements? Can we see that anywhere yet?

Steve Newman

We are on schedule having moved it to the next stage of hospitals, as we shared in the last earnings call and on investor day. We are seeing what I would call at this point anecdotal evidence of decrease in variable costs. I guess the one thing I would highlight is our observation that the engagement and embracing of this by our physicians really positively exceeded our ambitious expectations.

They are very willing to participate. They are learning a lot about their own practice, how it relates to national best practices, how they relate to physicians, their colleagues within the institution and I think we’ve made a very good calculation that the externalities, pressures on physicians, are really helping us do this at this time. So we’ll be back to you when we have some quantitative data on the Medicare performance initiative, but we are on track moving forward.

Sheryl Skolnick - CRT Capital Group

That’s excellent. Thank so you much. It will be nice to stop talking about Tenet as a turnaround, sounds like we’re almost there.

Steve Newman

Thank you, Sheryl.

Operator

Our next question is from Adam Feinstein of Barclays Capital; please go ahead.

Adam Feinstein - Barclays Capital

Alright, thank you. Good morning, everyone.

Steve Newman

Good morning.

Adam Feinstein - Barclays Capital

Just a few questions here, everything was pretty straightforward, but I just wanted to follow-up on a couple of things. So I guess first just with the Managed Care side, you had mentioned that you’ve already finalized a significant number of contracts for 2010 and 2011. We’re just curious in terms of what the overall tone is like? It seems like the Managed Care companies are struggling more than they were in the past.

I’m just curious in terms of whether you’re seeing any change in terms of the contracts and some terms of overall rate increases, contract language, anything like that? So just wanted to get a general sense in terms of what’s going on with the specific contracts.

Steve Newman

Thank you, Adam. This is Steve.

Adam Feinstein - Barclays Capital

Hey, Steve.

Steve Newman

Our tone with the Managed Care partners is positive. We’re focused on terms and conditions of the contracts as well as yield year-over-year. We’re moving toward contract simplification, auto adjudication and things that make it easier for us to process and as well as easier for them to process, therefore helping us in the revenue cycle in decreasing their overall costs.

We’ve been paying visits to some of the large national and regional payers, some mid-contract some of them are very interested mid-contract in adding some pay-for-performance attributes for next year to our agreements, so largely I would say that the relationships are positive.

We have a couple of large contracts that are in process for a 1-1-10 effective date and you’ll be seeing press releases on those after we secure them, but all-in-all, we’re providing very good value to the payers.

When we go to visit them, one of the things they say is that in terms of denials for appropriateness of admissions, they’re amongst our best customers and the fact that we use InterQual across the company really puts us in a good position in terms of utilization. So, I’d say the tone is positive and we look forward to updating you in the future.

Trevor Fetter

If I just were to summarize that in one perspective. We’re not giving guidance for 2010 yet, but at this point in time, we don’t expect any follow-off in terms of what we’re able to achieve net realization on managed care next year versus this year.

Adam Feinstein - Barclays Capital

Great. Okay, good. I appreciate the details there. Just for a follow-up question, just on the outpatient growth that was probably a big driver. I know you guys have a lot of initiatives in place, but just the outpatient surgery growth was very strong and then there was some comment in your slide presentation about margins being up significantly on the outpatient side.

So just wanted to get some more details there in terms of how we should think about that. Was the margin expansion within outpatient greater than the overall company, so just wanted to just think about the details there with respect to the outpatient surgeries as well as just the margin growth you highlighted.

Steve Newman

Well, from the standpoint of margin expansion, two things. Certainly, outpatient is a higher margin business, so even without those margins, if you are expanding within the outpatient area as we see a shift from inpatient to outpatient, that’s a positive just based upon a constant mix.

In this case, with the intensity going up on the outpatient at the same time, there’s a little bit of an incremental positive effect above and beyond a shift of an average inpatient to an average outpatient. Somewhat offsetting that is the fact that on the inpatient side what we’ve lost is commercial, which is also a higher value, higher margin activity. So that’s why we say roughly the two have offset.

We have lower revenue, but it’s shifted over to the outpatient side where there’s higher profitability. So, it’s just a mixed bag you have to get into the payer mix as well as the broader mix between inpatient and outpatient, but certainly everything on outpatient that’s been happening has been in the positive direction. We don’t give explicitly the margin rate on one versus the other, but as I said, outpatient is definitely much higher.

Adam Feinstein - Barclays Capital

The surgeries as well was there anything unusual there, so should we look for a continued growth rate within outpatient surgeries?

Trevor Fetter

Adam, I think that we have a lot of activities focused on growing our outpatient surgeries. I think we’re making it easier for patients to register. We’re making it easier for our physicians to schedule cases there and it’s a big focus and we should continue with the growth in outpatient surgeries.

Adam Feinstein - Barclays Capital

Very good. Great quarter.

Operator

Our next question is from Kevin Fischbeck of Banc of America; please go ahead.

Kevin Fischbeck - Banc of America

Okay, thank you. I wanted to follow-up on the point earlier about the bad debt impact and the change in the guidance. Can you go over again, why you took down the guidance for bad debt by $5200 million and you’re saying the actual impact to EBITDA is not the $50 million increase? Can you go over that again?

Biggs Porter

The range is on the first chart, which shows our outlook assumptions. They’re broad ranges, what we didn’t take on the upper end of the range for the walk forward is a series of spot estimates building to the upper end of EBITDA range for each of the line items. On those spot estimates for the walk forward, we reduced the bad debt by the lesser number. So it’s somewhat giving rounded ranges on one chart versus giving a spot estimate on the other. So the spot estimate’s the lower number.

Kevin Fischbeck - Banc of America

The spot estimate has the low end of your revenue guidance in it?

Biggs Porter

You can try to be increasingly scientific if you want in terms of trying to work through it. I think as we look at it, the bad debt dollars and the risks associated with it are not so much tied to the revenue line as they’re tied to the collectibility. So we’re looking at more from a whole dollar risk standpoint relative to collectability as opposed to what revenue may be driving bad debt.

Kevin Fischbeck - Banc of America

Okay and then I wanted to get a little color. I guess there was a protest by the SEIU regarding some of the changes that you guys made to the benefit designs. Any thoughts there on how that might impact your ability to manage labor costs going forward, any resolution to that?

Trevor Fetter

Fist of all that sort of activity is really nothing unusual. I think the whole thing is immaterial, actually.

Kevin Fischbeck - Banc of America

Okay, great. Thanks.

Operator

Our next question is from Darren Lehrich of Deutsche Bank; please go ahead.

Darren Lehrich - Deutsche Bank

Thanks. Good morning, everyone. I have a couple of things here. I wanted to just ask you a little bit more about the cost trends that you’re experiencing in the context of some of the actions you took late last year, given the performance that you’ve had thus far this year.

Again I wanted to get your comments on how we should think about that really heading into 2010? Now we know that the Medicare rates will be a little bit better. You’ve been able to hold the line in costs. Clearly, we don’t know what the mix is going to do in the next several quarters?

Trevor, I’d just be looking to get your comments on some of the actions that you’ve taken and whether you think 2010 will be the year that you start to loosen a little bit in relation to those things like 401(k) match and the like. So just hoping to get some high level comments there.

Trevor Fetter

Okay. Well, it’s good questions. Obviously, the sustainability question that should be in everyone’s minds, and what makes it very difficult to answer crisply is that if you look at every trend that is evident in our performance not only second quarter, but the first half of the year, there are initiatives that have also been in place for some time to affect us.

Whether it’s malpractice coming down or whether it is costs over all the SW&B trends, the outpatient growth. Whatever, you go through all of it, and there’s nothing where we can say we have a controlled experiment here where we’ve changed nothing from one year to the next and the entire change in whatever metric is something that must be a result of outside factors. So it’s a combination of outside factors and inside factors.

As to your specific question, what we had on that one cost item, which by the way is a small number in relation to the total impact that we’ve had on costs. Just as an example, we did not say that this was a permanent cut, nor did we say it was a temporary cut. We just said we have to change this 401(k) matching during this difficult period of time, and then reevaluate it as we go forward.

We have not gotten a tremendous amount of negative feedback from our employees about that. I think people are much more concerned today with job security and health benefits and things like that than they are necessarily with 401(k). Just to put the fact out there, we went from a 3% match to 1.5% match.

So, it was not a dramatic change, but I think we’re evaluating all of the things. I would suggest though, that there are a number of areas in which we’ve become more efficient. We’ve saved costs and those we expect to be able to continue.

Darren Lehrich - Deutsche Bank

Okay. That’s great and then I guess another question I have that relates to your volumes and whether you can give us some commentary here about regional disparities and if you’re seeing any correlation at all at this point to the unemployment trends. I know your commentary before has been, that you haven’t on this, but can you just update us on your thinking there.

Steve Newman

Darren, that previous observation still pertains. There’s not a direct correlation volume on inpatient or outpatient basis with the local unemployment rates. We do obviously operate in some areas that are well over 13% in terms of the unemployment rate.

I would have to say that across the company, just as our performance in cost management has become more consistent, same has become true in terms of our volumes. Almost every region in the company and market was up in outpatient in the quarter, and the regions were pretty close in terms of their total inpatient admissions as well as the commercial managed care.

So, I would say some of the disparities that you’ve heard from us in regional and market differences a year, year and a half ago have really dissipated, and our performance is much more consistent both in volumes as well as cost management across the company.

Darren Lehrich - Deutsche Bank

Great and I guess I’ll sneak one last one in there. Just if you can let us know if you’ve had any material business wins in your Conifer division and if there’s any update there from what we got I guess, a couple of months ago?

Steve Newman

Actually, we’re very pleased with how the business is developing. We’ve announced publicly the business wins where the other party is willing to have an announcement made. Some customers, as you can imagine would prefer not to have that publicized, but any kind of sales business in healthcare has a difficult sales cycle.

It’s a big transaction that we seek when we are seeking to provide revenue cycle services through Conifer, but we’re very pleased with how that business, which is really, run behind a Chinese wall. We’re very pleased with how that is developing.

Darren Lehrich - Deutsche Bank

Your revenue run rate there now is what?

Steve Newman

It’s something we don’t disclose.

Darren Lehrich - Deutsche Bank

Okay. Thanks very much.

Steve Newman

Okay.

Operator

Our next question is A.J. Rice of Soleil Securities. Please go ahead.

A.J. Rice - Soleil Securities

Hello everybody, just a couple quick things here. I think that I heard you say that the pressure on commercial lines had moderated in June and July, was your early read. If I heard you right. Have you been able to assess whether that’s a Tenet specific dynamic? Is that something that’s happening across your markets or even if you just, would you attributes it more to anniversarying, starting to anniversarying some of the pressure from last year? Maybe a little more color on that, if I heard you right.

Trevor Fetter

Sure, and A.J. it’s nice to have you back, hear you again on the call. The commercial thing is really an area that’s frustrating, because there’s very little data that we can measure against. We would love to know, for example, exactly what is happening in every one of our markets in terms of the commercial enrollment and so forth.

You get some data from the payers; you get some data from certain states. There’s generally a lag. You don’t really get reliable data from other hospital systems and very few people disclose that, and those who do don’t disclose it regularly. So, it’s been a tough one for us.

That’s why we can tell you our trends relative to a sequential improvement, meaning less of a decline that took place later in the second quarter and then into the first 28 days of July, 28 days being that comparable period one year to the next. So, I don’t know that I would sit here and declare that there is a trend, because obviously, there’s a lot going on in terms of employment and payer pricing and shifts to drive that, but at least our own experience in Tenet without reference to anything else except our prior performance is looking a little bit better here in June and July versus the way it looked a little bit earlier.

Tom Rice

The other thing I wanted to ask about is that repurchase of the $68 million in face value bonds below face. Is that, can you give us a little history on that and whether that was just an opportunistic purchase or do you see that as something that you may become more active on for the rest of the year and look at again next year?

Biggs Porter

I think it was just an opportunistic purchase. Trevor mentioned that we received the money in from the Metrocrest Hospital authority, the Dallas Area Hospital Authority I referred to in my comments that and other actions had certainly built up our cash position. We felt like it was opportunistic to go back to go out and purchase some amount of debt in the open market, but it’s not a part of a broader program or something that I would say we intend to keep doing.

We will always evaluate where we are in the future relative to our cash position. We intend to generate cash. As we do that, we will look to retire debt with it whether that’s in 2013 or otherwise.

Tom Rice

Okay. It sounds good.

Operator

Our next question is from Rob Hawkins of Stifel Nicolaus. Please go ahead.

Rob Hawkins - Stifel Nicolaus

Thank you. I wanted to take a look at maybe at controllable expenses. For the last eight quarters, you guys have been able to grow revenue faster than the controllable expenses. Obviously, we can see what’s happening with the economy this year. I guess ex the economy, it looks like you guys were able to keep a spread between revenue growth and controllable expenses of about 250, almost 300 basis points. Now it’s bigger than 400.

As you think about unemployment, obviously we’re at a peak here, we hope soon, and it’s going to slowly work its way down. How do you think about that spread, say, next year and then like, let’s say, we get back to an economy where unemployment’s normalized? What do you think that spread is that you guys can keep? I’m trying to figure out, relative to the kind of $180 million, $150 million change you guys made this year, maybe where that goes?

Trevor Fetter

It’s a great question, difficult to answer since we’re not putting out any guidance for 2010, but I would just say going back to an earlier question. So for example, clearly a weak economy, a number of companies in different industries and our own industry have reported that they’re seeing declines in turnover. We saw decline in employee turnover as well, which is very helpful to cost, but we had programs in place to address turnover for a couple of years.

We were engaging in a greater level of management training, front line training, better recruitment processes, better ongoing processes, and so forth. So I can’t sit here and tell you how much of our improvement in turnover, which has led to lower costs is due to the economy being rough and people hunkering down inside their jobs and not being as eager to switch jobs versus success in those initiatives that we’ve taken.

I would say that we are taking every advantage we can of the current economic environment to make sure that those initiatives are successful and they stick, but it’s premature to make a prediction about whether that spread what you’ve very correctly noticed, it’s been a big driver of our margin expansion, how sustainable that is. We’re working hard to make it as sustainable as it can be.

Biggs Porter

Since you mentioned the $180 million, or $188 million, the items in there are ones which are more or less discrete actions which we were able to take that are very sustainable. We did talk about 401(k), which could always be reevaluated overtime.

At this point in time, it doesn’t seem to be a particular pressure point, but those are sort of step function initiatives, which are separately captured as opposed to the general process initiatives of improving our staffing efficiency in the hospital and having day-to-day management visibility against a set of standards that we operate against to drive down costs on very much a recurring basis.

There are some effects possibly positive ex of the economy in there that we think there are they can’t be clearly differentiated, but certainly the processes we’ve established are ones which could continue. So I would look at the $180 million and think of repeatability of that in the same context as those things which are driven by the economy from a reduced turnover standpoint.

The $180 million should be largely sustainable. Only a small portion of it really appears to be at risk overtime, but the process efficiencies we talked about are outside of that and the turnover effects are outside of that.

Rob Hawkins - Stifel Nicolaus

Okay and then I guess if follow up maybe for Dr. Newman. I guess the physician recruiting would probably be one of the biggest drivers in out performance you’ve had for the last quarters.

What’s been the secret I guess to ramping up physicians earlier? Is that approach sustainable? Is there a factor related to either you mentioned how the other physicians are not willing to I guess succeed or retire. Is it that or the economy have something to do with this?

Steve Newman

It’s an excellent point and certainly one of the critical elements in our more recent success. We’ve identified the best practice within the company, on boarding new physicians.

This was in one of our central region hospitals and it consists of finding a mentor for each new physician that’s added to the medical staff and a very standardized, routinized list of activities and education programs we put those physicians through as they join the staff in terms of orienting them to our both facilities as well as physician colleagues that they could refer to or receive referrals from.

With that standardization, we’ve rolled that out to each hospital in terms of our business development activity, so our physician relationship program reps have an additional responsibility of making sure that newly added physician to the staff gets that on boarding and largely is responsible and accountable for that taking place in the first six months after they join the medical staff. So, I think we’ve sort of found the secret sauce in that particular area and we’re able to do that in a more consistent fashion.

Rob Hawkins - Stifel Nicolaus

Great thanks. I appreciate the color. I’ll jump back in the queue. That’s a great practice.

Operator

Our next question is from John Ransom of Raymond James; please go ahead.

John Ransom - Raymond James & Associates

Hi, good morning is there any reason to think that labor costs won’t decline sequentially due to the seasonality last year, they ticked up a little bit sequentially, but this year, I would expect they might be down some?

Steve Newman

From a gross standpoint with lower volumes we will flex the staff to reduce costs in the third quarter. However, if you are looking at it on a unit cost or an adjusted patient day basis, they would probably go up in the third quarter because of lower efficiency on lower volumes.

John Ransom - Raymond James & Associates

I’m just looking at the absolute dollar numbers from the second quarter.

Steve Newman

Absolute dollars should go down.

John Ransom - Raymond James & Associates

Okay and then my second question is I know you’re not giving 2010 guidance but let’s assume that the better results hold and you do a little bit better in the back half than what you’re forecasting. How much of that will be eaten up next year in terms of higher CapEx? Is there a CapEx backlog that’s building that you’ve had to defer as you’ve gone through the cash flow negative cycle?

Steve Newman

No. We’re not going to give exclusive guidance for 2010, but we don’t see at this point in time that CapEx has to go up over the near term. I’ve said most recently that over the longer term, we may have some moderate increase associated with healthcare IT in terms of getting the systems to the point where we can satisfy the requirements for the incentives to start to kick in several years from now or a few years from now.

So we may have some acceleration of that spending, which might affect us and move capital spending up slightly, but you might still only be talking about $500 million versus $400 million to $450 million. So, that’s not to be taken as real guidance for the future but just indicator that near term we don’t see any real pressure to increase, but as we start to go out a couple years, we could have it.

John Ransom - Raymond James & Associates

So, I guess my point would be, I mean last year your labor costs went up sequentially by about $21 million and last year you had a weakening of commercial volumes into the third quarter. Now, you’re having a strengthening of commercial volumes in July and you think your labor costs might be down sequentially. It makes your EBITDA guidance look pretty conservative in light of those two factors?

Steve Newman

It will certainly, if July is a trend. If the strengthening of commercial for July is a trend for the quarter, then we would outperform our assumptions with respect to commercial volumes for the remainder of the year. So, it is a July’s performance on its own is favorable to our assumptions.

John Ransom - Raymond James & Associates

Okay. Thank you.

Operator

Our next question is from Whit Mayo of Robert Baird; please go ahead.

Whit Mayo - Robert Baird

Thanks, good morning. Just wanted to ask one more question on the cost trends, maybe ask it a different way. Trevor, I thought your comments around the cost culture was pretty interesting and probably pretty important.

It’s hard to not have a positive takeaway on the surface when we look at the trends and the turnover volumes and really hear your enthusiasm, but maybe can you talk about that in context of the physician and the physician satisfaction scores in the quarter kind of what you’re seeing? Maybe you could just expand upon that a little bit, it would be helpful?

Trevor Fetter

The trends have all continued to be good. Now, Steve, when is the most recent physician satisfaction survey?

Steve Newman

Fourth quarter ‘08.

Trevor Fetter

Yes. So, we’re doing it once a year now and so, it’s not like we have a quarter-to-quarter benchmark, but as of the most recent data for physicians and employees, also the satisfaction continued trending up, same thing for patients, by the way. So, I think we’re being very careful.

Obviously, it’s difficult when you’re trying to espouse some serious cost control at the same time that the EBITDA growth is so great, but, that is part of the thing that all of us need to do, which is to keep all this in context, which is still today, it’s nice to have a $4 stock rather than a $1 stock, but it’s a lot lower than it was even a year and a half ago or year ago and we continue to see this erosion in commercial managed care.

There’s a lot of very concerning trends out there and we’ve just got to do our best to continue marching forward on a growth path.

Whit Mayo - Robert Baird

Okay, that’s fair and I guess my second question, just wanted to go back to, I don’t know if this was asked already, but go to some of the comments that you had about B2B and consumer marketing initiatives, I think on slide 16. Maybe Dr. Newman, can you expand on that some? Just would be helpful to understand, maybe some of the details on what you’re doing, I guess potentially is new and does this augment some of the other initiatives that you have in place currently?

Steve Newman

Sure. We’re really doing a number of things in business development that are at least innovative from our perspective. All the way down to redoing our hospital websites to do two things. One, make it easier for the staff within the hospital to keep the content very updated and timely, all the way to search engine optimization. So, that they come up earlier, when patients search for hospitals in their zip code or regional market area.

With respect to business-to-business, once again we’ve identified some best practices in our hospitals, all the way from worksite wellness programs to onsite clinics for certain school systems, some public school systems, as well as parochial school systems, and really trying to become the number one top of mind provider for inpatient and outpatient services, when those employees covered by commercial managed care need to access a service.

We’ve expanded our database marketing, and that surrounds seminars and screenings done in our local markets. So we’ve used our business intelligence at a corporate level to assist the local hospitals in terms of growing their business.

Whit Mayo - Robert Baird

Okay, that’s helpful. Thanks a lot.

Operator

The next question is from Erin Bloom of Goldman Sachs; please go ahead.

Erin Blum - Goldman Sachs

Hi, I just wanted to check if you made any changes to your assumptions on bad debt and similarly for charity?

Trevor Fetter

I’m sorry, what was any change…

Erin Blum - Goldman Sachs

Yes, for 2Q, did you make any changes in…?

Trevor Fetter

Matrix did we change the bad debt matrix not significantly.

Erin Blum - Goldman Sachs

Is the same true for discounts and charities?

Trevor Fetter

No change there.

Erin Blum - Goldman Sachs

Okay, thanks.

Operator

At this time we show no further questions. I would like to turn the conference back over to Trevor Fetter.

Trevor Fetter

Thank you for participating in today’s conference call and we’ll see you next quarter.

Operator

The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect your lines.

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Source: Tenet Healthcare Corp. Q2 2009 Earnings Call Transcript
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