Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message| ()  

Executives

Lizbeth R. Schuler - Vice President of Investor Relations

Wayne T. Smith - Chairman, Chief Executive Officer and President

W. Larry Cash - Chief Financial Officer, Executive Vice President and Director

Analysts

Joshua R. Raskin - Barclays Capital, Research Division

Ralph Giacobbe - Crédit Suisse AG, Research Division

Kevin M. Fischbeck - BofA Merrill Lynch, Research Division

Gary Lieberman - Wells Fargo Securities, LLC, Research Division

Albert J. Rice - UBS Investment Bank, Research Division

Darren P. Lehrich - Deutsche Bank AG, Research Division

Frank G. Morgan - RBC Capital Markets, LLC, Research Division

Justin Lake - JP Morgan Chase & Co, Research Division

Community Health Systems (CYH) Q3 2013 Earnings Call October 31, 2013 11:00 AM ET

Operator

Good morning, my name is Melissa, and I will be your conference operator today. At this time, I would like to welcome everyone to the Community Health Systems' Third Quarter 2013 Conference Call. [Operator Instructions] I would now like to turn the call over to Ms. Lizbeth Schuler, Vice President, Investor Relations. You may begin your conference.

Lizbeth R. Schuler

Thank you, Melissa. Good morning, and welcome to Community Health Systems' conference call. Before we begin the call, I would like to read the following disclosure statements.

This presentation may contain certain forward-looking statements, including all statements that do not relate solely to historical or current facts. These forward-looking statements are subject to a number of known and unknown uncertainties and risks, which are described in headings such as Risk Factors in our Annual Report on Form 10-K and other reports filed with the Securities and Exchange Commission. As a consequence, actual results may differ significantly from those expressed in any forward-looking statements in today's presentation. We do not intend to update any of these forward-looking statements.

With that said, I would like to turn the call over to Mr. Wayne Smith, Chairman, President and Chief Executive Officer. Mr. Smith?

Wayne T. Smith

Thank you, Liz. Good morning, and welcome to our third quarter conference call. Larry Cash, our Executive Vice President and Chief Financial Officer, is also on the call today. After the markets closed yesterday, we issued an 8-K, including a press release with our financial statements. For those of you listening to the live broadcast of this conference call on our website, a slide presentation accompanies our remarks. I'd like to begin the call with some comments about the quarter, and then turn the call over to Larry, who will provide additional details on our financial results.

We are pleased with our results for the third quarter of 2013 during what has continued to be a very challenging operating environment for health care providers. Our net operating revenues improved slightly over the prior year period on both a consolidated and same-store basis in spite of ongoing volume weaknesses. We've also realized a benefit of our cost management initiatives and we remain focused on driving operating efficiencies across our hospital system.

We are currently in negotiations with the Department of Justice about resolving its claims in connection with the department's investigation in the company's short-stay hospital admissions for the years 2005 to 2010, as well as their investigation in our hospital in Laredo, Texas. Based on those negotiations, which are not final, we believe that a reserve of $98 million is sufficient to cover the federal government's claims for Medicare admissions, certain claims specifically related to our hospital in Laredo, Texas and on other related legal expenses. This reserve does not include the claims in the investigation arising from TRICARE, Medicaid or a third-party expense. Please note that this is a tentative agreement with the government, and we'll not be able to take any other questions concerning this matter. I would say that I'd tell you that the Department of Justice is well aware of our public disclosure on this. Purpose of this discussion, I will exclude this reserve when discussing the third quarter operating results.

Net operating revenues for the quarter ended September 30, 2013, totaled $3.2 billion. Consolidated EBITDA was $473 million. Earnings per share from continuing operations were $0.69. Net operating revenue for the 9 months ended September 30, 2013, was $9.7 billion. EBITDA was $1.4 billion. Earnings per share from continuing operations for the 9 months ended September 30, 2013, were $1.86.

With that, I'd like to highlight some of the recent accomplishments. We've been very busy on the acquisition front. As you know, in August, we announced exclusive negotiations with Akron General, a health system in Akron, Ohio. This system has 3 separate facilities with 625 beds and trailing revenue of approximately $575 million. Sharon Regional Health System in Sharon, Pennsylvania announced in late August that it executed a letter of intent for the sale of its assets to a subsidiary of Community Health Systems. The system has a 258-bed community hospital and 22 satellite centers throughout Mercer and the large counties. Trailing revenue is approximately $155 million. This would be our 18th hospital in Pennsylvania. Finally, Metro Health announced in mid-September that it expects to explore strategic equity partnership with us. Metro Health Hospital located in Grand Rapids, Michigan, has 208 beds and was opened in 2007. Trailing annual revenue is approximately $300 million. This would be our first hospital in Michigan. These 3 potential acquisitions represent over $1 billion in additional revenue. We continue to be very selective and have a full pipeline of acquisition prospects.

I'd like to address the HMA acquisition. As we reported in our October 9 press release, we did receive a second request for additional information from the Federal Trade Commission. A second request is a standard part of the review process that was anticipated. Also the SEC has notified us that they're not reviewing our Registration Statement. The company and HMA amended their merger agreement on September 24, 2013, to allow the new HMA Board of Directors to retain additional financial advisors to assist them in evaluating the merger. Once this evaluation has been completed, the company expects to have the Registration Statement on Form S-4 declared effective by the SEC. HMA will proceed with the proxy mailings and the shareholder vote. As we have stated before, we expect the transaction to be completed in the first quarter of 2014.

Position recruiting continues to be one of our operating strength. And so we're very proud of our success in this area of the company, recruiting 1,670 -- 1,617 new physicians for the first 9 months. System-wide, there's approximately 17,000 physicians affiliated with our hospitals. Based on our financial performance in the third quarter, the company is updating the guidance for 2013. We are targeting a range of our 2013 EPS guidance to $2.85 to $3.10.

We have seen positive reimbursement from a value-based purchasing year-over-year of approximately 25%. Our readmission reduction program also reflects an improvement of 2%. Finally, our Cleveland Clinic Quality Alliance and Heart & Vascular assessment at selected hospitals is progressing on target. For 2012, the company had 63 hospitals recognized as top performers on the key quality measures by the Joint Commission. This is up from 50 hospitals that were recognized in 2011. Only 30% of the eligible hospitals in the United States were recognized for 2012. And we're proud of our efforts to improve the quality of care in our markets.

At this point, I'd like turn the call over to Larry Cash to provide you a summary of our financial results.

W. Larry Cash

Thank you, Wayne. First, the third quarter results. Consolidated and same-store are identical as all of our hospitals are now considered same-store. And I'll discuss the consolidated operations for the quarter and year-to-date, excluding the $98 million reserve that Wayne just described for the period of 2005 to 2010.

Third quarter admissions 2013 decreased 6.8% compared to the same period last year. As previously reported, our small hospitals continued to experience a lower volume than our larger facilities and adjusted admissions decreased at 3.9%. What contributed to this decline in admissions in the third quarter? About 20% of the decline, related to the lack of flu and respiratory; the EHR system conversions of both hospitals and physician practices to achieve HITECH incentives account for 15%; reduction in cardiology cases, primarily low intensity of 20%; lower readmissions, both Medicare and managed care of 15%; a decline of admissions from OB, women's services, 10%. We also had some service closures of about 5%. I'd just note that the involuntary termination of physicians anniversary-ed during the quarter.

Net revenues in the third quarter increased slightly from $3,212,000,000 last year to $3,218,000,000. On a same-store basis, net revenue increased to 0.2% for the quarter. Before bad debt, it was up by 2%. And again, after bad debt, it's 0.2%. As we mentioned, the volumes in physician offices' conversions from paper records to electronic medical records reduced physician practice debt revenue by approximately $10 million during the quarter. And we converted 800 providers in the third quarter, and we'll convert approximately 1,800 providers in 2013.

For the third quarter, same-store net revenue per adjusted admission increased 4.3% versus the same period 2012. And we also -- same-store surgeries in the third quarter declined 0.5%, a much slower rate of decline than in the first and second quarters, just small improvements due primarily to orthopedic cases. Same-store emergency room visits decreased 1.6%. Our same-store Medicare case mix increased 4% versus last year. Our all-payer case mix increased 2.7% in the third quarter.

Our consolidated EBITDA was $473 million for the third quarter versus $477 million the same period a year ago. Expenses associated with the HMA acquisition were approximately $4 million. And a strike cost at one of our hospitals was about $2 million. Excluding those, it would have been $479 million. For the quarter, EBITDA margin on a consolidated basis is 14.7% versus 14.9% a year ago. Consolidated operating expenses as a percentage of revenue increased 20 basis points in the third quarter, primarily due to the increase in our operating expenses. And this is offset by the increase of HITECH incentives. The increase in other operating expenses includes the expenses associated with the HMA acquisition and the strike in one of our facilities. Wages and benefits increased 40 basis points compared to 190 basis points in quarter 2 [indiscernible] quarter 3 [ph].

For the year-to-date basis, consolidated admissions decreased 5.4% and consolidated adjusted admissions decreased 3.1%. Same-store admissions decreased 6.2%. Again, what contributed to that? Similar to the quarter, decreased cardiology, primarily lower-intensity cases, about 15%; lower admissions for women's services, 15%; the lack of flu and respiratory, 15%; service closures and the seasonality in the first quarter, 15%; readmissions, 10%; involuntary physician turnover, 10%; and system conversions, 5%. Same-store adjusted admissions were down 3.9%. Our revised guidance for calendar 2013 now ranges from minus 4.5% to minus 3.5%.

Consolidated net revenues year-to-date were $9.8 billion, a slight increase from a year ago. Year-to-date revenue was reduced by approximately $20 million because of the physician office EHR conversions. Same-store revenue for bad debt was up 1%. And after bad debt, it was up 0.2%. On a consolidated basis, net revenue per adjusted admission increased 3.3%. And on a same-store basis, net revenue per adjusted admission increased 4.4%. Same-store surgeries are down year-to-date 2.8% and emergency room visits are down 1%. Our same-store Medicare case mix for the 9 months increased 3.2% and our same-store all-payer year-to-date case mix increased 3%. Consolidated EBITDA was up $1,381,000,000 for the 9 months ended September 30, 2013. And on a same-store basis, $1,398,000,000. Consolidated EBITDA margin was 14.1% and same-store was 14.4%, down 60 basis points.

For the first 9 months, consolidated operating expenses as a percentage of net revenue increased 120 basis points. Payroll increased 120 basis points. Also supplies and other operating grant [ph] increased 10, offset by improvement in HITECH incentives. And same-store operating expenses increased 60 basis points with payroll up about 80 basis points. We still expect to see improvements that were discussed at the end of the second quarter of $40 million to $60 million in the second half of the year. We've achieved at least $20 million of savings in the third quarter. And it's amidst decline of approximately $33 million from the second quarter.

Total AR days were 66 at September 30, 2013, an increase of 8 days at the end of 2012. The increase in AR days is due to the growth in state supplemental Medicaid programs of about 2 days and also some system conversions related to HITECH of about 2 days. The allowance for doubtful accounts was $2,391,000,000 or 51% at September 30, 2013. And the allowance for doubtful accounts and related contractuals for self-pay was approximately 84% of our self-pay receivables at September 30, 2013.

Community Health Systems continues to have a favorable payer mix. In the quarter ended, consolidated net revenue by payer source was as follows: Medicare, 24.2%; Medicaid, 10.5%; managed care, 51.4%; and self-pay, 13.9%. On a year-to-date basis: Medicare is 25%; Aid is 9.9%; managed care is 51.4%; and self-pay is 13.7%.

Some commentary about health care marketplaces and exchanges. 134 of our 135 hospitals in all 29 states are participating in health care insurance exchanges and we have approximately 400 contracts. 128 of our 135 hospitals, 95%, have 2 or more deals. On the health care insurance exchanges, 83% of CH hospitals have a contract with the lowest-cost bronze plan and 75% have contracts with the lowest-cost silver plan. 89% of our hospitals have a contract with the first- or second-lowest bronze plan and 92% have a contract with the first- or second-lowest silver plan. These type of arrangements help to [indiscernible] us when the exchange activity picks up.

Cash flow from operations was $132 million for the quarter. On a year-to-date basis, it's $441 million versus $778 million. The year-to-date variance has to do with a much higher cash outflow for AP, $146 million of timing of some compensation-related liabilities, $85 million increase in taxes due to a refund received last year of $28 million. And also 2012 cash flow included a $45 million benefit from a favorable BNA settlement.

Total capital expenditure in the quarter just ended were $126 million or 3.9% of net revenue. And year-to-date, capital expenditures were $421 million or 4.3%. Replacement hospital expenditures were approximately $5 million for the quarter and $42 million year-to-date. Our guidance for the year ranges from 75 -- excuse me, $750 million to $800 million, down $25 million. Balance sheet cash is $144 million. At the end of the quarter, the company had available credit revolver of $644 million.

Looking at the balance sheet. As of September 30, we had about $1,398,000,000 [ph] working capital and $16.7 billion in assets. Total outstanding debt was $9,549,000,000, which approximately 77% is fixed. And our debt-to-capitalization ratio is 75%. At the end of the quarter, we were party to $2,400,000,000 in interest rate swaps, a decrease of $400 million from the end of the second quarter. We did place 2 forward starting interest rate swaps totaling $400 million effective July 25, 2014, from a maturity of $900 million of swaps that day [ph].

Some other important things to note both in this earnings report and our 2013 guidance. Approximately $65 million of HITECH incentives were recognized in the third quarter. This pretty much matched what was in our internal budget that we did the first part of the year. Offsetting these incentive payments were approximately $27 million of expenses, including $17 million for depreciation. The HITECH incentives increased in the third quarter versus preceding quarters because of some updated cost reported information resulted in increase in Medicare base, which allows to get higher incentives. Earlier recognition and a little bit of a catch-up incentives previously estimated during the first half of the year also pulling some in the fourth quarter. Also we did additional physician incentives in the third quarter. We believe the HITECH incentives will be approximately $155 million to $165 million. And we also have a slight increase in HITECH expenses for guidance.

Our revenue is approximately $10 million lower in the quarter due to our physician EMR system conversions, and we've done about, by the end of the year, 1,800 providers, who will undergo systems conversions and probably cost us for the year of around $20 million. Lowered and tightened our EPS guidance of $2.85 to $3.10, reflecting our performance of the third quarter, including the acquisition expenses primarily associated with HMA transaction, which had previously been left out of our guidance at the end of the third quarter, and is now included in our guidance for 2013 and the strike at one of our facilities and also investment [ph] of the fact of the 2-midnight rule that went into effect October 1.

Our acquisition spends guidance was $0.05 to $0.07 negative effect on EPS. And we've increased it to $0.15 to $0.17 effect on EPS. The 2-midnight rule, again effective October 1, and we believe the negative effect for the fourth quarter will be approximately $5 million. Also we are on our target for our $40 million to $60 million expense improvements that we discussed during the second quarter conference call. [indiscernible], we achieved about $20 million in the third quarter with an absolute reduction of $33 million from the second quarter.

As a reminder, our fourth quarter presents a very tough comp. In terms of volume, the fourth quarter had some flu and respiratory business with same-store adjusted admissions increasing 2.3%. Wayne will now provide a brief recap.

Wayne T. Smith

Thanks, Larry. While our results for the third quarter 2013 have been constrained by the macroeconomic environment, we believe these results continue to demonstrate the underlying strength of our operating model. With that, I will now open the call for questions. If you'd like to talk to us after the call, you can reach us at area code (615) 465-7000.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Joshua Raskin from Barclays.

Joshua R. Raskin - Barclays Capital, Research Division

Appreciate you guys can't give any more detail around the settlement, but just maybe a procedural question. I was curious if you were working in connection with HMA and the government was sort of thinking about those cases together or if everything was just done completely separately.

Wayne T. Smith

No, that's totally separate.

Joshua R. Raskin - Barclays Capital, Research Division

Okay. And then maybe just talking about 2014. I know it's early and obviously visibility is a little lower this year than you've seen in the past. But I'm just curious if there's any of the key variables that you guys are monitoring that would change the outlook. And then maybe anything specific in 2013 in terms of like an aggregate sort of onetime items number that we should be thinking about that won't recur for next year.

Wayne T. Smith

Larry, why don't you talk about the things that adversely affected volume this quarter and this year that probably will not repeat itself in 2014.

W. Larry Cash

Yes. I think we did a little bit in the official disclosure, some of the EHR systems conversions, primarily of what we did in the second quarter of about 10 hospitals, and clearly affected our volume in the third quarter. And we think that should improve the per share amount of 2014. We also are -- most of our hospitals are now through Stage 1. We've got 1,800 physicians this year and had some last year. So it shouldn't have that kind of disruption [indiscernible] a lot of HITECH incentives reduced some capital. On that, we probably have another year spending on the HITECH activity. But it shouldn't grow about probably another year of spending. And we should expect our HITECH to be as good as -- in '14 as good as 2013. You've got the sequester, which started in April. We should have got that quarter, the first quarter one there. You have the benefit of expenses. We did a pretty a good job. Since long time ago, we did a pretty good job in the first quarter of achieving expectations when some people did and didn't. In the second quarter, we did not. We made the adjustments and did a good job, I think, as a lot of people commented on expenses. Improving in the third quarter and also [indiscernible], I expect our intensity to continue to increase. I think we'll continue to have a little bit of challenge around short-stay admissions declining as a result of RACs and reviews from managed care. You do have the 2-midnight rule. We've made an estimate, other people have not made it. So we'll continue to monitor that because we did think of something we want to point out, that could affect '14. I think the big advantage in '14 will be health care reform, and we're well positioned for that. We've got over 450 certified application counselors. We've got our own internal organization out there in 22 of our states and 83 of our hospitals. And we've already -- I know of 11 states that expanded Medicaid. We've already got a Medicaid person that's joined effective January 14 in each of those 11 states. So while it's slow, we're starting to see good progress on that. I think that expense management will help us going there. Bad debts have been up, and I think you'll see bad debts as you probably start the process of enrolling people and trying to manage that activity. And we'll do a lot of work to try to do outreach efforts. But I think you'll see that effort help 2014, probably won't see the full benefits until 2016.

Joshua R. Raskin - Barclays Capital, Research Division

That's very comprehensive. The only thing left on my list was M&A cost. Would you expect those to come down? Obviously, HMA, one probably larger than what you would typically expect.

W. Larry Cash

Yes. What we generally do is we'll always finish on transactions underway. There might be a good transaction or 2. But HMA is closed, so we probably will not be quite as active going forward after that. So expect acquisitions and also some of the acquisition expenses that we have for HMA, we'll have to comment about what those are going to be at the date of the transaction. But other than that, I'd expect it's going to have to slow down.

Operator

Your next question comes from the line of Ralph Giacobbe from Crédit Suisse.

Ralph Giacobbe - Crédit Suisse AG, Research Division

Just wanted to go back to the sort of the volume side. Any geographies to point to that maybe had any type of disproportionate impact, one? And then two, just in terms of the EHR system conversions, just want to make share I understand exactly what's going on there. Is there just sort of stricter guidelines that's not allowing you to sort of admit patients? And it looked like for the year-to-date, had a small impact. Obviously, big impact in 3Q. So is it risk sort of accelerates into fourth quarter in the beginning of '14?

W. Larry Cash

No. This is nothing more than our ability to try to get as much HITECH incentives as we could and finish each one. And we went to a very good system in the second quarter in our efforts to put 10 hospitals in. And about 8 weeks, we took on a challenge. It's a little too much for us and it created some efforts, where we could identify some loss volume in the third quarter. I think it's coming back, and we've made some corrections that we didn't make early in the prior process. I don't think that had an effect in 2014. It might have some effect in the fourth quarter. I think the other question that you had was about the geography. All 5 divisions are down. There's a little bit of difference, but I think all 5 divisions are down. The hospitals that are...

Wayne T. Smith

Small hospitals.

W. Larry Cash

Small hospitals have fluttered down more than the rest of the hospitals. There's probably 40 small hospitals under $50 million of revenue. And I think we're down lower in the markets where we did these systems conversions, which we think will correct itself sometime this quarter or early next quarter.

Ralph Giacobbe - Crédit Suisse AG, Research Division

Okay. And then you noted the settlement, or I guess, the reserve was solely related to investigations related to Medicare and sort of noted Medicaid, TRICARE and some other things were not included. Can you give us any sense? Or can you size the scope of those other pieces outstanding?

Wayne T. Smith

No, I think we've said about all we can say about that. You can figure that out pretty quickly in terms of how much Medicaid business, how much TRICARE business we have. But I think we've said everything that we can say about that.

Ralph Giacobbe - Crédit Suisse AG, Research Division

Okay, fair enough. And if I could squeeze one more in. Just in terms of, Larry, I think you went through the numbers, and there were a lot of numbers there in terms of the exchanges and how you were positioned. I guess, the one data point I wanted to sort of repeat or make sure I had was what percentage are you contracted with the lowest or second-lowest cost plans?

W. Larry Cash

Yes. Let me -- I haven't committed to memory. I may refer back to my notes. [indiscernible] range. But on the lowest-cost plan, 83% of our hospitals have a contract to the lowest-cost bronze plan and 75% with the lowest-cost silver plan. When you look at the 2 first- and second-lowest cost plans, we're 89% and we're 92% with a contract with the first- or second-lowest silver plan. And where it's not 100%, our managed care executives have done an outstanding job of working on this on a short period of time. They're [indiscernible] one back, looking to see who may have a little bit lower price in the market with some of the people we've got. And in some cases, we're the only hospital in town, so it probably won't matter. In some cases, when they try to go get contracts to keep building on these percentages, this should help us immensely because most people do believe that the price will be what a lot of people look at on exchanges. And being in the low-cost plans would help us a great deal.

Wayne T. Smith

I would think most people would say that at this point in time, we're about as well positioned as you can be in terms of exchanges.

Ralph Giacobbe - Crédit Suisse AG, Research Division

Just last thing, what's the percentage discount off the commercial rate? Can you give us a sense of that?

W. Larry Cash

Yes, it's in the 5% to 10% range, some a little bit lower, some a little bit less, some at the commercial rate. So we're fairly well positioned about it. But we've always said it'd be close to commercial rates.

Operator

Your next question comes from the line of Kevin Fischbeck from Bank of America.

Kevin M. Fischbeck - BofA Merrill Lynch, Research Division

Can you talk a little bit about the health care reform outreach that you're doing in your markets, what you're setting up as far as getting word out to the uninsured, what you're doing as far as counselors in your hospitals? And then I'm not sure if you saw the HHS guidance yesterday, that these qualified health plans are not actually federal programs so that hospitals would be able to pay the premiums or subsidize the premiums for people. Any thought about how you might participate along those lines?

W. Larry Cash

Yes, I think I said earlier, we have 450 certified application counselors or CACs. And they work on -- as people come to the hospital, they work on both Medicaid and they'll also be working on the exchange activity. We have about 83 of our hospitals in a company, Eligibility Screening Services, which has done a good job of qualifying people for Medicaid historically. It'd be one of our synergies for the HMA transaction. They're set up in about 22 of our states. And we have actually enrolled someone -- really challenging, but we enrolled somebody in 16 of those states in the exchanges that are there. And we've got somebody enrolled in all 11 states that are effective for January 1. Outreach effort, we did target -- based on the 500,000 people individual uninsured business, we send out about 60,000 targeted mailings. We had another one scheduled and we delayed that to the website. It's working better, so there would be another 100,000 go out. And these are people we think would be the most likely to do it. We've got about a lot of full-page articles. And 100 of our hospitals have done mailings of articles to do, and [indiscernible] have been mailed.

We've had 100 media points of coverage, which have been captured either in print or TV, radio. I think we had 175,000 instances of displaying on Google and Facebook, about 1,000 clicks on actual ads. This is our search efforts. We've had 250 speaking events, lunches, and learnings about it, at trying to be ready for the marketplace, and these include our HealthyWomen program, Senior Circle program with our partner for our outreach efforts. We've had 150 community events, health payers, that's been hosted by our hospitals. And then again, there's $5 million of government money that's been allocated to our type of markets for community centers and we're well aware of those. So as Wayne said earlier, we put a very concentrated effort to try to be ready for it, and hopefully, we'll see the benefits as the next few months roll.

Kevin M. Fischbeck - BofA Merrill Lynch, Research Division

Okay. And then just anything about the potential to actually help subsidize premiums for uninsured?

W. Larry Cash

Yes, that's a question that -- we saw that and it's interpreted. I think we would use that carefully. I mean, you have to make sure you use it for the -- appropriate for the people. We do have a fair amount of foundations that we set up through acquisitions that we would encourage our local management to talk to them about doing that so we don't get in a habit of doing it. But it is something that's probably on our radar screen that we will consider doing selectively, probably not throughout the whole company.

Kevin M. Fischbeck - BofA Merrill Lynch, Research Division

Okay, that makes sense. And then just want to go to the cost side. I think last quarter, Tenet made some comments that although their volumes were weak, they did not really try to bring down the cost because they thought that cutting it too much would have some potential longer-term business implications. Just one of the things that we're focused on is, obviously, the 2014 opportunity. I wasn't sure if there was some sense like that, in a situation of weak volumes, you're going to pull back on certain things given the situation, and when the backdrop is a little bit better, some of those costs might come back into the system next year. How do you think about that? Is this operating at a good run rate? Or do you think that whatever health reform benefit we think about next year, $30 million of that, $40 million to $60 million comes back next year?

Wayne T. Smith

You always have to adjust the volume when it's up and when it's down. So even if you do get volume, you certainly will bring some of that back. But generally speaking, I think we're in pretty good shape. I don't think we have done anything that would, in any way, jeopardize our patients. That's certainly, our highest concern is that we maintain our very high quality. As you have seen, we had 63 hospitals as the top performers in The Joint Commission. So I think we're in pretty good shape, but I think we will continue to look and adjust our cost. But I think as time goes forward, we'll have to look to other areas that we have to spend a lot of time on. In the past, historically, hospitals have adjusted their staffing. Now, everybody's moving to try to consolidate expenses in other areas, and so that will be a big initiative for us in the future.

W. Larry Cash

Kevin, [indiscernible] nice work on health care reform. And clearly, as you point out, that about 8% of our business is adjust -- self-pay adjusted admissions and it's going to take a few years to reduce that. And we think we can get something like a 50% reduction over a few years. We did go out and have, since the last conference call, some studies done by pretty reputable consulting firms which have done work for other companies, and they've selected 5 of our hospitals and thought that we could send -- in those 5 hospitals spread around, they got about 5%, 5.5% self-pay admissions, and they believe it could be 2%, which sort of supports our theory of cutting the adjusted admissions in half. So you're already getting that business. So you already got the cost for it. And that's what's going to happen, is they're going to come back in. And clearly, we're doing a lot of outreach on high-utilizers, on people that use our facilities. So -- and I think you've written about how people who need it, who probably are used to the emergency room, would be the ones to be part of that first. So I think you're going to get a lot of your business, which you already got. You do stand a chance as people get insurance over the next couple of years, that the utilization would go up. We'd probably average about 50 admissions per 1,000 now in our markets out of self-pay. You'd probably see somewhere in the 70s, so that's probably going to tick up over time. But I don't think we would have to have a substantial staffing increase for a few percentage increase in adjustment.

Wayne T. Smith

The other component of this, of course, is that outpatient is moving pretty quickly. And in terms of our revenue base, about 55%. So we could move to outpatient, that changes the dynamics around staffing as well.

Operator

Your next question comes from the line of line Gary Lieberman from Wells Fargo.

Gary Lieberman - Wells Fargo Securities, LLC, Research Division

Yes, interested in your thoughts on the slow opening of the exchanges. What you think the impact is going to be, if any, as we head into next year?

Wayne T. Smith

I think, and Larry can comment on this, but I think this has created a lot of uncertainty in the marketplace around the exchanges currently. But I clearly think it will get fixed. I don't know if it will get fixed by the end of this month or not, but if takes a few months, it takes a few months to fix it. But I think this whole issue around exchanges will be resolved sometime in the relative near future. And then things will continue to -- and things will start to move forward. I would hope that based on where we are and how well we're positioned in exchanges, that if you get this fixed in certainly 2014, we should find -- should have some impact around enrollment.

W. Larry Cash

Even if our cost efforts that we have underway, we allocated some extra staffing and cost, all this outreach effort, which probably cost us $1 million or $2 million additional cost throughout the year. I do think -- we are monitoring, especially our own internal organization, and we're glad to see that we got some, in all 11 states, we've got some Medicaid enrolls starting January. We are probably seeing a little effect from the woodwork effect, Gary, which I think you've written about. I don't -- I think it's too early. You also wrote about presumptive billing, and I think it's a little too early to see that. We'll focus on that also. I do think that -- it's been very frustrating, because we had everybody else psyched up for the exchanges to work well, and people get enrolled and we've been trying to monitor it. So it's been a big disappointment to see it be so difficult. But then I think that same energy will be there in 6 weeks or 8 weeks when it does get fixed, and once it's fixed, it should still give people ample time to enroll. Clearly, I would assume there'll be some adjustments in the open enrollment period for the fact that it's gotten started slowly.

Gary Lieberman - Wells Fargo Securities, LLC, Research Division

Have you made any changes to your charity care or discount policies as you head into next year?

W. Larry Cash

Not specifically for this. It's a very good question. We'll have to think about how to address that because some of the people will be getting insurance. And our care-to-care policy is if you don't have insurance, you're eligible. But if you have some form of insurance, you're not generally eligible for charity. So we may have to address the people who have 200% under poverty level, federal poverty level, how we handle trying to collect money from them because they are working in that activity. But we have not made any changes yet. That's a good question.

Gary Lieberman - Wells Fargo Securities, LLC, Research Division

Okay. And then maybe finally, any more color on what the impact of the 2 midnight rule is? And how it is kind of exactly a net negative to EBITDA?

W. Larry Cash

Yes, I think you got certain requirements, some certification and documentation. And patients -- the doctors have to think they're going to be there 2 midnights before they admit them. And looking to No. 1 day admissions that you have. There's a belief that some of those, possibly, that have been in observation, we'll continue to monitor it. But we made an estimate of about $5 million for the quarter. First of all, just to give transparency, it's an estimate. Hopefully, it would be less than that. But at least we put that forth and we'll have to try to work through it. It would probably continue to have a little bit effect on this transition. Wayne just referred to inpatient volume going to outpatient, and it's happening to us. It's happening to everybody. And we'll continue to monitor that and try to make sure we do the correct thing, but also take care of the patients in a correct setting.

Operator

Your next question comes from the line of A.J. Rice from UBS.

Albert J. Rice - UBS Investment Bank, Research Division

Just to clarify on the comment around the cost reduction activity. You guys had laid out a cost reduction program of $40 million to $60 million I think in the second quarter. How much of that have you -- do you feel like you've got in place at this point? And how much is still left for fourth quarter?

W. Larry Cash

It's at least $20 million, and clearly, we used a fair amount of that is around staffing. There were some staffing adjustments made into the second month of the quarter, so that will be there for the full month of the quarter, and I think we'll hit somewhere within $40 million to $60 million, and hopefully, get higher into the range. But we hit at least $20 million. Now the absolute dollar of expense -- the best way to see what's happened to expenses is look at the income statement. In the second quarter to the third quarter, expenses dropped $33 million, disregarding HITECH and equity investments, and that sort of shows that the $20 million, at least $20 million, was a good estimate.

Albert J. Rice - UBS Investment Bank, Research Division

Okay. And then you mentioned in your prepared remarks about the acquisition pace picking up, and clearly, it has. It seems like in some of those deals, you may have gotten some help from the Cleveland Clinic, I was -- relationship. I was wondering, were they actually formally involved with you in pursuing some of those deals? And is there any update on the status on what you're doing with them?

Wayne T. Smith

Yes, we -- they have been involved in some of these transactions, of course. Ohio is an important state to them. And they've been working with us in terms of the kinds of things that our agreement is around in terms of quality alliance and cardiovascular, and they will be doing the same kinds of things in these facilities. Our relationship is going along fine. We're doing assessments now. This just takes a while to do this. We're doing assessments on 5 or 6 hospitals. And as time goes along, we'll start putting these things in place. So I think we're making good progress and if the relation is developing and maturing, and hopefully, there'll be other things that will come out of this in the future.

Albert J. Rice - UBS Investment Bank, Research Division

Okay. My last one, I guess, would be, I think you mentioned in the prepared remarks that your -- the deal with HMA is on-track. Obviously, now they've got a new Board. Any comment that can be made about whether the dialogue is -- how the dialogue is? Your enthusiasm towards the deal. Is it sort of the same as it was? I know you don't have any particular outs anyway. But I just wanted -- if you're -- you feel like there's the same opportunity you thought a few months back. And then is there any update on timing?

Wayne T. Smith

Yes, I don't think there's any change, in our view, of the transaction in terms -- as far as we think HMA's got good facilities, good opportunities, there's a lot of synergy in the markets and across the board. So I think we're still enthusiastic about the transaction. I would tell you, though, as you might expect, and this is -- will be great -- no great surprise, but if you change a Board and you change management, it's very disruptive to an organization. So this -- it's moving along at a good pace and we'll have more to say about that in the future. But hopefully, we're on track, as I said earlier, to close this in the first quarter.

W. Larry Cash

And I'd just add A.J., we -- and there's 2 banks that have been doing the fairness opinion. We've had reversed due diligence of them on our calls and kept them informed of what's going on in our company. I think that's gone well. And I know there's some heightened concern about how HMAs operating today. And I just want to just say that it's a lot of turmoil, a lot of changes, a lot of organizational changes and staffing changes. When we bought Triad, they had a firm estimate out the Street of what they were going to achieve. By the time we took over, it was lower by 10% and we did a great job of improving that to the quarter. So to get going, we got $275 million synergies, took the margin of 11% and 12% to 15%. And we're looking at HMA as an effort. It's going to take more than just a quarter or 2 or -- and we work very hard, and we see this is a good asset we can improve. But clearly, there seems to be a high concern on a quarter-by-quarter basis, but we were looking at it more from an opportunity for us over a longer period of time.

Wayne T. Smith

Yes, it's really our operating systems and our processes and procedures that are important here when all is said and done for us to assimilate this group of facilities.

Operator

Your next question comes from the line of Darren Lehrich from Deutsche Bank.

Darren P. Lehrich - Deutsche Bank AG, Research Division

Just a few things here. You've talked a lot in the last couple of years just about the impact of the smaller hospitals on the overall volume picture. I'm wondering if you can just maybe just give us a little commentary on what you think you need to be doing in some of these markets. Whether some of the service closure that you've been disclosing relates more to those types of facilities you can right size the capacity? Maybe just help us think about the strategy, I guess, in trying to manage through what's going on in some of these smaller markets?

Wayne T. Smith

Yes, one thing, Darren, is -- and you know, as we think about where we are in terms of our, historically, our standalone hospitals are our hospitals or individual markets that have been a strong asset as far as negotiating and all of the above. Now, we're thinking that we have to make sure they're part of a broader network so that they're inclusive and not excluded. And we've done the things that we think are really good things in terms of demonstrating quality, but we have to continue to work hard to recruit physicians. We have to think about outpatient services in these markets that we have not really thought a lot about in the past, and enhancing our outpatient services. So strategically, we've been working pretty hard and trying to figure out all the things that we need to do to make sure that our smaller markets are successful. And of course, this is an uphill battle because we've got all the issues around racks and observations and readmissions, and then the managed care companies are a lot more aggressive now than they have been around utilization. So all these things are factored in as we kind of move forward. And then at the same time, putting in meaningful use, as Larry has said, it's as little bit of disruptor as well.

W. Larry Cash

Yes, and just to add a little bit there. If you think about the small hospitals, they have a higher percentage of low-acuity business, flu, respiratory, a higher percentage of women's services, the same thing. It seems like we're talking about it every quarter and that continues to move out of the inpatient over to outpatient, or it's not happening. With the OB women's services, it's clearly been down for 3-plus years now. So having a higher percent of that drives the volume down. I think if you sort of look at 2014, some of the benefit here is this will be a big benefit for these smaller markets where, a, there's be some outreach efforts, there'll be new activities in emergency rooms, and the people that are uninsured, some of the populations, I think about 40% of our markets have had a little bit of declining population. There's a little bit more unemployment in those locations. So I think health care reform, in itself, will be very helpful to some of these small locations and help us be able to turn there. Some of them have pretty good margins, some of them don't have quite as good margins, but some of them have been there, and all we had to do was find what works in the markets that are doing better and try to make -- try to put that in place in the others.

Darren P. Lehrich - Deutsche Bank AG, Research Division

Yes. That's helpful commentary. Two other things I just wanted to ask. You mentioned the productivity that you lost as a result of some of that conversions. I guess, I'm really just trying to understand how that played into the quarter and in what areas operationally? And maybe just size it for us in terms of the numbers of hospitals you, I guess, pushed a little harder to move some of these conversions up?

W. Larry Cash

It was 10 locations in the second quarter. We worked very, very quickly to get done. We all made a conscious decision to do it. We all thought we executed flawlessly, and we were all wrong. So as a result, we lost some admissions and now, we're...

Wayne T. Smith

Good news is we enhanced our Meaningful Use. Bad news is we cratered our admissions.

W. Larry Cash

And it's quite evident. It didn't take a great CPA to calculate that we lost business from it. But we did it, and now, we're trying to recover from it. And it's a good system. And we decided to work better with that system. On the physicians, it's a little different. I mean, there's been lots of studies, the 20% to 30% productivity for up to 6 months, sometimes longer, sometimes a little bit shorter. And our analysis, and we just had to go doctor-by-doctor so we could understand it because we had not talked about it because we were seeing physicians. I think our primary care offices, which are down a little bit in the second quarter, were down more in the third quarter. Some of these physicians we converted, we'll be glad to get this electronic calculation done. I think we're up to over 2,000 doctors will be done by end of the year, so we're making progress on that perspective that are employed, and we shouldn't have to have as many to do in 2014 for that purpose. And we quantified the drop in revenue versus the preceding quarter or preceding year for these doctors. And the drop-in visits and the end result is, and we quantified how much that it was in our physician practice area, and it's about $10 million. It would probably be as much as $20 million by the end of the year. The fourth quarter should be less than the third quarter. There tends to be less doctors converted into fourth quarter. But we did get Meaningful Use incentives but we paid a little price for it.

Darren P. Lehrich - Deutsche Bank AG, Research Division

Got it. And then last thing here, just you mentioned the $2 million of straight costs in your prepared remarks. I guess I'd be looking for just an update whether that has been resolved. And maybe a broader comment, how you're feeling about labor relations in your markets. We've seen strikes come and go. But is there anything else building around labor conflict that we should be thinking about in the next few quarters?

Wayne T. Smith

I don't think so. I think our labor relations are relatively good. We are going to have conflicts. The hospital industry has been under distress for a good while now in terms of volumes in the economy. And we've done and made a lot of acquisitions that have labor unions. We don't have any issues whatsoever. We treat our employees that are part of a union the same way we treat everybody else when it's all said and done. Unfortunately, we just have to negotiate these contracts, and sometimes, there are things in these contracts that are not as helpful in terms of productivity. And I don't think they're a distractor but I don't think they're a major issue kind of going forward. And we've made good progress across the country in terms of resolving any labor issues that we might have. But that's not to say that we won't continue to have them in the future.

Darren P. Lehrich - Deutsche Bank AG, Research Division

And this one, is it done?

W. Larry Cash

That was a third quarter event. It's not anticipated for the fourth quarter.

Operator

Your next question comes from the line of Frank Morgan from RBC Capital Markets.

Frank G. Morgan - RBC Capital Markets, LLC, Research Division

Just a quick one on Texas. Did you highlight or did you receive any Texas DSH payment, Medicaid DSH payment. I know that was highlighted by one of your competitors on the DSH program in Texas.

Wayne T. Smith

We did get some money. We've been accruing some money we've got that we didn't have accrued for. One way to look at Texas, you got uncompensated care, you got DSH money and you got UPL money. If you look at it year-over-year, we're down about $10 million, even with the money we got on the uncompensated care. So you may or may not remember, I think I mentioned it at the beginning of the year, we could have about a $20 million reduction in Texas Medicaid, primarily built around the UPL program. I think that may be closer to $10 million for the end of the year. But we clearly got a little bit of money. But net-net, third quarter of '13 versus third quarter of '12, our Texas Medicaid was down by $10 million.

Frank G. Morgan - RBC Capital Markets, LLC, Research Division

Okay. And then on that subject of the -- some of the headwinds from the readmissions, I'm just curious, the readmissions penalties, are there any particular subset of markets where that's more pronounced? Is that a smaller market or a more rural focus? Or is that -- do you see any difference in terms of where that is popping up as a volume headwind?

W. Larry Cash

As I remember, we had a higher amount of readmissions in our smaller markets than we did in the larger markets. So it would be a little more of a smaller market effect. The numbers we gave were clearly the company-wide effect. But I think our smaller markets had a little bit higher readmission percentage.

Wayne T. Smith

And no good deed goes unpunished. We've done a good job with the readmissions, and that's cost us.

Frank G. Morgan - RBC Capital Markets, LLC, Research Division

Okay. And do you kind of feel like that's now stabilized at a new normalized rate in terms of what that impact is on volume?

W. Larry Cash

If you look at the Medicare rules, I think we lost $7 million in 2013, and the penalty is 1%. I think next year, we're going to lose $6 million, and the penalty doubles. So I think we made progress on that. I would not expect us to continue to see our drop of readmissions. Once you put a program in place, it sort of affects all your business. You don't necessarily continue to try to have that decline continue, but we've done a good job. Our quality area has done a good job of work on readmissions.

Frank G. Morgan - RBC Capital Markets, LLC, Research Division

Okay. So in terms of just making sure we don't extrapolate something out too far, the readmissions issue probably does not continue to extrapolate out. You -- the headwinds that you saw in the EHR with your practices, that probably doesn't get worse. And then I think you said the strike impact, this was a onetime item in the third quarter. You don't expect to see that going forward?

W. Larry Cash

That's all correct. I mean, I think that we made progress in all those items. And actually, the EHR and the physicians, I would hope we don't have to worry about doing those calculations in 2014 because most of the physicians have gone through EHR, and hopefully, it's to be working smoothly.

Wayne T. Smith

The issue around unions, I think there was a press conference in Wilkes-Barre -- or Scranton, sorry, yesterday, where a union notice -- gave us a notice of strike some time in the future. So we may have 1 here and there.

Operator

Our last question of the day comes from the line of Justin Lake from JPMorgan.

Justin Lake - JP Morgan Chase & Co, Research Division

First, just a quick follow-up on HMA. Wayne, is there any date that you know of when HMA shareholders are expected to vote, or to vote to start on the acquisition?

Wayne T. Smith

No. You have to get through all of these other filings first before you can notify the shareholders of the potential date for a vote. So I think, we think we're on track to get all these done by end of the first quarter. So if there's something else that comes up, we'll keep you posted. But I don't -- there's no specific date yet.

W. Larry Cash

I think the fairness opinion is supposed to be done by November 19, I believe. That's progressing. And I think I said earlier, Justin, we talked to the 2 banks of ours on the reversed due diligence, which is part of it. So I'll send that's the next advantage for the fairness opinion to be presented to the new Board.

Justin Lake - JP Morgan Chase & Co, Research Division

And how long after that opinion's presented would the votes start in your mind?

W. Larry Cash

You have to go back and update the proxy filings with the SEC and that could take a few days to do that. And then once it becomes effective, it starts after that.

Justin Lake - JP Morgan Chase & Co, Research Division

And would...

W. Larry Cash

[indiscernible]

Wayne T. Smith

[indiscernible] with the FTC as well.

W. Larry Cash

And the FTC.

Justin Lake - JP Morgan Chase & Co, Research Division

Got it. And then, Wayne, maybe you could just speak to -- obviously, you've gone through some settlement discussions here, got an idea of where the government heads at. I know you've done your due diligence that you can on HMA's investigation. And I'm wondering if you could share with us any -- can we read through any kind of similarities to what HMA's going through right now?

Wayne T. Smith

Every one of these investigations at each company are totally different and you can look -- go back and look at the history of these settlements and look at some of the other companies, and look at us, and look at the latest settlements around the country in terms of size and the components. One thing we found out is every one of these are different. They have different issues. HMA's issues are not exactly the same issues as ours, even though some components are the same. So I don't think you can extrapolate or make any judgment about HMA related to our settlement.

Justin Lake - JP Morgan Chase & Co, Research Division

Okay, great. And then last question, just wanted to get your thoughts on volumes. And specifically, as we've looked over a number of quarters, there seems to be a real bifurcation, even excluding the likely impact of these investigations. But the bifurcation in terms of volumes from rural markets to urban markets or suburban markets. And given you own both, I'm just curious to hear whether you've seen a material difference between your rural facilities and your suburban facilities, first? And then if you can talk -- if you have, what you think the drivers are and when you think they might abate?

Wayne T. Smith

Let me just -- and then Larry can talk about the details of this. Let me just tell you a couple of overriding issues, I think, are important. We're all -- and I said this earlier, we've got -- all have had issues with the RACs and the observations. Clearly, there are more -- as Larry said earlier, there's less acuity in smaller facilities and less sophisticated, complicated cases. Readmissions, obviously, are an issue and that may be impacting smaller facilities more. Commercial utilization is a lot more aggressive now, and co-pays and deductibles, all of the above. I also think GDP is growing at 2% and we're 18% of GDP. It's hard. And we've been growing about twice as fast as GDP, but it's very hard to move the needle here in terms of the 18% now. I think there's an underlying -- overall underlying economy issue that affects smaller markets faster than it does larger markets. So I may be in the minority about that, but I think when the economy does better, these markets will do better and they have historically.

W. Larry Cash

We've got 40 small hospitals under $50 million. Probably about 40% of those probably have population declines over -- all 40% could make it there, but those 40 up[ph]. And if you look at our markets above 50 million, I think they're doing a little bit better population growth. And I think you'll note that the markets or the companies that do better have the best population growth, so that's what drives the point that if you're in a market with better population growth, you'll do a little bit better than somebody who doesn't. I think the co-payment, the deductible issue...

Wayne T. Smith

Population growth, does that anything to do with the economy?

W. Larry Cash

[indiscernible] population growth. Actually, it's the birth rate, too. The copayments and deductibles, we're seeing it come a little bit more in our markets. I think I commented earlier in the year that we had the biggest increase in co-payments and deductibles this January in our major employers throughout the company [indiscernible] the last 3 years. I think you talk to people who have been operating in urban markets, they probably have had it sooner than we got it, so you probably got that happening in the last couple of years. And I think that has some effect in co-payments, especially on diagnostic testing, radiology work and things of that nature. So -- but the volume was down. Good thing for us is the case mix was up, the surgeries are better, the revenue looked pretty good and expenses were controlled well.

Operator

I now turn the call back over to Mr. Smith for closing comments.

Wayne T. Smith

Thank you for spending time with us this morning. Our consistent ability to drive revenues, achieve cost efficiencies in this environment demonstrates solid execution of our centralized operating platform. We want to specifically thank our management team and staff, hospital Chief Executive Officers, Chief Financial Officers and our Chief Nursing Officers and division operators for the focus on our operating performance for the third quarter.

Once again, if you have any questions, you can reach us at area code (615) 465-7000.

Operator

Ladies and gentlemen, this does conclude today's conference call. You may now disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Community Health Systems Management Discusses Q3 2013 Results - Earnings Call Transcript
This Transcript
All Transcripts