Good day, ladies and gentlemen, and welcome to the Q4 2009 Tenet Healthcare earnings conference call. My name is Kiernan [ph] and I will be your operator for today. At this time, all participants are in listen-only mode. Later we will conduct a question-and-answer session towards the end of the conference. (Operator Instructions).
I would now like to turn the conference over to your host for today, Mr. Thomas Rice, Senior Vice President. You may proceed.
Thank you operator, and good morning everyone. 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 those forward-looking statements to be materially incorrect.
Management cautions you not to rely on and makes no promises to update any of the forward-looking statements. During the Q&A portion of the 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, Tenet's President and CEO. Trevor.
Thank you Tom, and good morning everyone. I'm very pleased with our results for 2009. Recession made it a difficult year to navigate, but we focused on the basics and delivered very solid progress. Tenet's EBITDA was $982 million and through 33% increase over 2008. We extended for a fifth year Tenet's strong record of growth in EBITDA and EBITDA margin. Our EBITDA in 2009 was more than twice what Tenet generated in 2004 when we had 40% more hospitals than we have today.
Our adjusted free cash flow improved by almost $400 million to a positive $165 million. While adjusted free cash flow excludes our payments to the Department of Justice, worth noting that we will make the last of these payments in August bringing our contract to begin generating positive absolute free cash flow and marking another important milestone for the company.
I would like to begin by begin you a summary of how we generated these results. One of the most important objectives was to control costs and we did that very well. We made serious cost cuts in virtually all areas of our business. This showed out in our results every quarter. We had dramatic reductions and fully termed (inaudible) use of contract labor.
For several years, we've been working hard to review turnover. Having achieved solid gains in 2009, we took actions to maintain them. In Q4 we decided to make a $60 million [ph] discretionary contribution to the 401K accounts of our employees who are not eligible to participate in our incentive compensation plans. We also provided non-executive employees with merit increases above the rate inflation. I mention these actions in order to point out that we've made investments in keeping our employee retention and satisfaction high. We also met our objectives with regard to price. Mixed shifts that occurred in 2009 making pricing increases less obvious but they are very real. Health insurers recognized the value in retaining access to the quality care that Tenet hospitals are able to provide their members. We've been able to negotiate appropriate pricing increase. So with costs and pricing being few parameters more or less under our direct control, we may have significantly exceeded all our performance objectives in these areas.
Turning to measures by which we have less direct control. We had a much better year with regard to bad debt expense than anyone might have projected last January. The following picture however was mixed. We were very pleased with the 3.4% and year-over-year growth in Tenet hospital outpatient business, because March is generally higher on the outpatient side, this growth helps us to expand overall margin.
Tenet Hospital admissions were down $0.06% year-over-year, but total admissions were up by $0.2% basically flat. One area of disappointment in 2009 was commercial admission which declined for the year by 4.7%. We have anecdotal evidence these declines are consistent with the commercial volume declines are affiliated positions (inaudible). We hear from our health plan customers that they saw declines at similar rate.
Continued weakness in economy appears to be the main driver of this segment of the business. We have a large group of initiatives to gain market share, but the environment for commercial admission is very tough. Unfortunately the trend does not improve so far this year with year-over-year comparison somewhat weaker than what we saw in Q4, it's pretty clear that we're off to a slow start for the year as far as volume is concerned.
Our outlook in overall volumes to be flat and commercial volumes down 3%. The silver lining to the strong commercial volumes story but we achieved very strong earnings improvement in 2009 in spite of it. The changes we made to our cost structure have enhanced the potential profitability in operating leverage of the company. For example, if we can generate even modest volume increases going forward, we believe we are well positioned to achieve significant growth in earnings and cash flow.
Let me now turn this to highlight our comments on our outlook for 2010. As you went through this morning's press release, we are projecting growth and adjusted EBITDA someplace between flat and up 7%. I'd like to highlight a few of the assumptions driving these numbers.
First in order to optimize the financial impact of the health information technology provision in last year's stimulus bill, we expect to incur incremental clinical information technology expenses of about $40 million in 2010. As we've said in the past, we had already planned to make these investments, but now to qualify to the government's incentive payments we will accelerate their implementation.
The adverse impact of these expenditures on 2010 EBITDA is largely a timing issue, this is because there is an 18 month mismatch between the early expense of the program and the revenue recognition to begin no later than early 2012. What impacted this initiative is truly significant when you consider that it reduces our expected EBITDA growth rate by 4 percentage points. These expenses will improve an important part of our business and are designed to meaningful enhance patient care and long-term profitability. People have more to say about this program and how it advances our Medicare performance initiative.
All things considered we see 2010 as a transition year. Will be a year of significant technology investments, potential risks from increasing bad debts, state Medicare (inaudible) and hopefully the tail end of recession due to weakness in commercial volumes. Even after taking all the upside and downside risks into account, we expect that the profitability growth of up to 7% and expect to generate more than $100 million in adjusted free cash flow. In other word, our outlook for pre cash flow will well be positive in 2010 even including the burden of the cash outflow for our final DOJ payment.
To summarize, I feel very good about the progress we made in 2009. We are heading in to 2010 strongly positioned to deal with the challenges confronting the industry. Before I turn things over to Steve, let me tell you about some changes to our investor relations program this year. Instead of holding our annual investor day in Dallas, we decide to be more visible and accessible on the road. We intend to visit various cities in order to meet with more of you in person and we plan to participate in a few more conferences in five years. We've also decided to shorten our quarterly pre-announcement acquire period in order to accommodate more of your requests for meeting. I'll be anxious to get your feedback throughout the year as to whether this is a better approach. In the mean time let my now turn things over to Steve Newman. Steve?
Thank you Trevor and good morning everyone. I would like to touch on four topics important to both short and long term success. Our medical staff development activities, our health information technology initiatives, the status of our Medicare performance initiative and an update on our volume building activities through innovations and marketing.
We believe that the vast majority of new physicians joining our medical staffs are doing so as a result of value proposition of having high quality, efficiently operated in patient and outpatient services. This value proposition is supplemented through the activities of our mid 3000 practice resources joint venture which I'll talk more about later.
As I mentioned on a previous call, we have focused more effort on attracting high quality hard working productive physicians and assimilating them more effectively in to our medical staffs and hospitals. As a result, we are seeing tangible benefits from our more focused efforts.
Let's turn to review the recent progress we've made in medical staff development. In 2009 we attracted 855 active staff physicians net of attrition. 249 of these physicians net of attrition joined us in the fourth quarter. We accomplished this through a variety of means although the overwhelming focus on the redirection of existing physicians. If necessary to meet demonstrated community need, we relocate certain physicians in a particular specialty, but relocations generally represent less than 10% of our growth in medical staff. Physician employment represents an even smaller share of our growth because we're utilizing this tactic very selectively. Due to our improved assimilation process and because of the improvement of the facilities and services we provide to physicians, a class of 2009 is among the most productive classes we've ever assembled.
While the class of '08 has been extremely productive, the class of '09 is already outperforming them on several measures while maintaining a commitment to our quality standards. Compared to the class of '08, these new '09 physicians are averaging 46% more total admissions, 27% more commercial admissions and 32% more commercial outpatient visits. This productivity data is based upon Q4 performance only, and therefore we expect even greater productivity gains from the class of '09 as their relatively young relationships mature over the next 12 months.
We believe on our improvements in quality, efficiency, service and other initiatives will strengthen our relationship with these and future physicians.
Let's turn to a brief discussion on health, information, technology or HIT. HIT is the glue that joins the existing strategies we've shared with you over the last three years. By the end of 2010, 19 of our hospitals will have begun installing advanced clinical systems. These activities will result in each hospital having a computerized physician order entry system, CPOE and an electronic health record at the completion of deployment. The implementation at each hospital is expected to take 16 to 21 months depending upon its existing systems. It's this 16 to 21 month implementation period which is the determinant of Trevor's earlier statement that we expect to earn the first of the incentive payments by early 2012.
While this hospital based program is proceeding, we will simultaneously deploy our position office HIT plant. This plant utilizes the resources of our joint venture, net [ph] 3000 practice resources. We will deploy a suite of products that includes an office based electronic health record and patient health record e-prescribing technology and electronic data interchange capabilities for claim submissions. These new initiatives have been designed to dovetail smoothly with our existing systems.
First, the computerized position or a entry system will contain over 600 standardized order sets. A number of these sets were developed to execute our Medicare performance initiative. This CPOE will allow us to accelerate the standardization of care in our hospitals both improving clinical outcomes and driving down variable costs at the bedside.
Second, the broad implementation of HIT will eliminate redundancy and increase the efficiency of care, this brings with it staffing efficiencies and will accelerate our efforts to optimize labor and supply costs. These clinical systems all will provide us with improved patient safety and clinical outcomes, further advancing our long standing commitment to quality.
Finally, the HIT offering will position practices will more tightly align our affiliated positions with our hospitals. It's an effective sales tool for our physician relationship program representatives since our hospitals will be able to provide advanced IT systems to help physicians improve their practice efficiencies and obtain office based financial incentives under the ARRA high tech funding program.
Next I want to offer a couple of comments on Phase I of our Medicare performance initiative rollout. Our MPI teams are currently deployed in 16 hospitals. We expect to have completed Phase I of MPI at 42 hospitals by the end of December 2010 with all hospitals being completed by the end of Q1 2011. As you know, Phase I focuses on the development of a customized list of 5 DRGs in each hospital where we identify the largest opportunity that decreased variable cost while improving clinical outcomes.
It is important to remember that simultaneously we have ongoing resource utilization initiatives such as medication use management and standardization programs in cardiac rhythm management devices and orthopedic and spinal implants. We expect these combined programs to yield $28 to $32 million of cost savings in 2010. Additionally, all of the savings from the progress made through these initiatives this year will not be fully visible until 2011 due to the timing of the rollout and the phased-in adoption of the clinical delivery system changes.
I continue to be excited about the prospects for MPI and our early results strengthened my confidence. Finally turning to volume growth, we remain excited about our many initiatives designed to capture incremental market share, I'm particularly enthusiastic about our business-to-business initiatives in Texas and Florida which take advantage of the employer channel to capture patients covered by commercial insurance. We also are enjoying increasing success in our direct mail marketing initiatives as we expand our use of variable dynamic printing to customize our mail drops.
These programs are data intensive and include active and precise monitoring of the reactions of patients we know are covered by commercial insurance.
We are using more internet marketing and are employing search engine optimization strategies to target select and receptive populations focused on both wellness and specific disease management. These initiatives are all designed to gain market share. With that let me now turn the call over to Tenet's Chief Financial Officer, Biggs Porter. Biggs?
Thank you Steve and good morning everyone. As both and Steve and Trevor discussed despite the dramatic decline in discretionary consumer spending experienced in most sectors of the economy, Tenet's admissions exhibited only a modest decline while outpatient extended its trend of vigorous growth with an increase of 3.5% in the fourth quarter.
Flu provided us with a modest boost to our volume statistics, but because of a slow margin value contributed little incremental to the bottom line.
Commercial volumes were weaker than expected in the fourth quarter with declines of 5.3% in commercial admissions and 3.9% in commercial outpatient visits. As our pricing remained strong, even these softer volumes resulted in solid same hospital revenue growth of 3.5%. This pricing growth included a 2.8% increase in patient revenue from commercial managed care demonstrating continued pricing growth given the context of declining commercial volumes.
As most of you know, we do not disclose a specific number for our commercial pricing increase, but I will note that our pricing increase in the fourth quarter was our strongest quarter in 2009. After making some minor tweaks to normalize our revenue reflecting prior cost report adjustments and a favorable one-time item in 2008, revenue growth was even stronger 3.7%.
Cost control continues to contribute to wider margins, with controllable operating expense growing by just 2.7% and even a more restrained 2.5% on a per adjusted patient day basis.
Even these modest increases would have been still better had we not elected to make a discretionary increase in our 401(k) match to employees who are not eligible for incentive compensation. That added $16 million to SW&B. Without this discretionary expense item the increased controllable cost for APD would have been 1.6%.
We only make discretionary contribution such as this in the future if we add substantial increases in year-over-year profitability or if necessary to meet competitive pressures. Supplies expense increased by 1.9% per APD, a larger increase than we've seen recently. This was driven by increased usage of high-cost pharmaceuticals and biologics as well continued growth in the use of implantable devices.
As growth in the usage of implantable devices is highly correlated with growth in higher margin procedures, this growth in supply cost is not entirely unwelcome. Other operating expense increased by $11 million or 2.2% per APD. This increase was in part due to lower cost allocations for information systems and business office costs and discontinued operations, which require the absorption of some of those costs by continuing operations.
Malpractice expense declined by $4 million continuing a favorable trend we're seeing throughout 2009. We will continue to drive on this, but for actuarial reasons, we don't forecast net reductions year-over-year in 2010. Although at a rising risk-free interest-rate environment, it is possible.
Bad debt expense rose by $12 million as the bad debt ratio increased by 30 basis points to 7.9%. This was in our area where despite continuing employment weakness in many of our markets, we outperformed our earlier expectations. This increase was impacted by higher pricing as well as a 240 basis point decline in our soft pay collection rate during the course of the year, but was helped by decline in uninsured volumes.
Sequentially, however our collection rate was substantially unchanged from the third quarter. Turning to cash and cash flow; we ended the year with $690 million in cash, a decline of $41 million from September 30, but somewhat higher than the $525 million to $660 million, we had projected in our 2009 outlook.
Among other items, our cash position was impacted by higher than anticipated capital expenditures, which came in at a $192 million including an acceleration of HIT CapEx of $18 million and $58 million in an early tax payment otherwise scheduled for 2010 which will save us interest cost between now and what was otherwise a June projected payment date.
We also saw a benefit of $25 million with another improvement in our accounts receivables. Days outstanding declined to 46 days at year end, down from 47 days at September 30. Since we started the year at 50 days, this was a significant improvement during the course of the year.
Let me now turn to our outlook for 2010. We have provided a fair amount of detail on our 2010 outlook, in both our press release and slides we posted to the Tenet website this morning. The headline is that we expected adjusted EBITDA to be in a range of $985 million to $1.05 billion. This range includes at both ends incremental HIT expense in 2010 of approximately $40 million as I will discuss more in a moment.
Without that spending our range for 2010 for adjusted EBITDA would have been $1.025 billion to $1.090 billion. We've considered numerous variables representing both risks and opportunities setting the range of adjusted EBITDA. These include variables related to state funding and the continued unknowns related to the economy.
In absolute terms these variables create a potentially broader set of outcomes that was expressed in our outlook range. We presume that neither everything bad nor everything good happens in setting the adjusted EBITDA range, but we have considered continued adverse mix shift away from commercial and higher bad debt expense in even the upper end of the range.
At the middle of the range, we would expect commercial inpatient volumes to be in the range of a negative 3% year-over-year in 2010 which still represents a recovery from the declines we recently experienced.
The lower end of the range, all other things equal could accommodate greater commercial volume declines, increases in the uninsured, lower state funding and/or additional declines in the collectability of self pay and balanced after accounts.
Our outlook assumes total admissions will be approximately flat to growth of plus or minus 50 basis points. We continue to remain conscious on the outlook for commercial volume growth and our outlook assumes that it will be premature to expect the eventual recovery and commercial admissions to occur in 2010. Our assumptions are more considerably more robust on the outpatient side, but we are assuming growth of 3% to 4% and significantly greater stability in terms of payer mix.
We assume pricing increases of 2% to 3% in inpatient revenue per admission and somewhat stronger 3% to 4% increase in outpatient revenue per visit with a greater visibility in pricing growth on the outpatient side being helped by our assumption of stable payer mix on outpatients.
These assumptions would afford us 2010 revenue growth of 4% to 6% in line to modestly stronger than a same-hospital net revenue growth to 4.3% we recorded in 2009. As we disclosed our third quarter 10-Q, we had potential to receive as much a $60 million in annual revenues attributable to 2010 from the California provider fee legislation. This is one of the many variables we consider to setting our range. In fact it could be a greater amount if retroactive treatment is deemed appropriate by CMS.
Controllable operating expenses are assumed to grow by 4% to 6%. This growth is significantly impacted by $40 million in incremental expense for clinical information technology spending. This HIT spending is tied to our plans to comply with the American Recovery and Reinvestment Act or ARRA and we expect this investment to qualify us for significant incentive payments starting in either late 2011 or early 2012.
As we said last fall, this spending is consistent with out existing plans to invest in HIT in order to qualify for as much of the federal incentive payments by achieving meaningful use of milestones as we can achieve, we elected their spending. We believe this increased spending on HIT should be considered as in such as non-recurring and its EBITDA effects in 2010 and 2011 as beginning of 2012 and in future years anticipate there will be incentive revenue and operational other benefits which will offset this incremental experience.
Although we are very far along in our scheduling of the work, we are continuing to work the schedule against the requirements as they evolve, so it is possible we will see further change including in the timing of expense.
Without that $40 million in incremental accelerated HIT expense, we assume 2010 outlook growth and controllable operating expenses will decline by a little over 50 basis points to 3.5% to 5.5%. Although we will continuously work on cost improvement and expect to yield on these efforts in 2010 including in our supplies and Medicare performance initiatives the incremental savings from these in 2010 will be more modest than the approximately $188 million we achieved on our various initiatives in 2009.
We assume bed debt expense to be in the range of 7.8% to 8.8% of net operating revenues. This would be a modest increase at the lower end of the range to a significant increase at the higher end, relative to the 7.7% recorded in 2009. But also note that this range encompasses the 8% total company bad debt ratio with which we ended the year. In terms of dollars, this would be an increase of roughly $30 million to $140 million relative to the $697 million of bad debt expense recorded in 2009.
Turning to the outlook for cash, we provide the details on slide 25 on the web. A few comments on the major items. We are looking for capital expenditures in a range of $475 million to $525 million, a $20 million to $70 million increase over the $455 million in CapEx in continuing operation in 2009. Included in this outlook is approximately $7 million in HIT CapEx, a $20 million increase over the aggregate $50 million in HIT capital expenditures in May 2009.
This HIT requirement is a principal reason for raising our CapEx outlook for 2010. Based on our above assumptions, we expect adjusted free cash flow from continuing operations in a range of $105 million to $125 million. I will remind you that free cash flow in 2010 will include the final $73 million we will pay as a part of our government settlement.
Retirement and obligation this year clears the runway for increasing positive free cash flow in the future. These assumptions would result in a cash position at December 31, 2010, in a range of $630 million to $700 million. The question frequently arises as to what we believe we can achieve in EBITDA margin over time.
For the near term, the effect of the economy on state funding, commercial volumes and account collectability continues to create an uncertain environment, making it difficult to create a timetable and scope for improvement. Over the intermediate to longer term, federal funding is also certain to contain pressures which we must offset through our others efforts.
The highest target we put out for our sales when we first gave intermediate term guidance three years ago was 13%, but we also said that does not necessarily represent a ceiling. Irrespective of geographic and business mix consideration relative to our peers, we have excess capacity and a high fixed cost base. Stabilizing commercial volumes as the economy improves and achieving aggregate growth therefore are one key to our continued margin improvements as we go forward.
We also expect our MPI and other cost control initiatives, an increasing emphasis on higher margin outpatient business organically or through continuous selective acquisitions to contribute measurably to EBITDA margin over the next 2 to 3 years. How fast these efforts fall to the bottom line will depend significantly on the externalities I have already described.
In summary in 2009, we were able to accomplish the following key elements of performance. We constrained growth and bad debt expense, a strong outpatient volume growth, which mitigated the revenue impact of softer commercial admissions, had solid revenue growth, excellent cost control and strong cash flow. We remain confident that our initiatives to drive revenue growth, reduce costs and drive increasingly positive bottom-line and free cash flow will be successful.
The raises we've assumed in 2010 for pricing revenues and adjust EBITDA allow for effects either partially or totally out of our control related to the recession. But having said that, the value of our initiatives are clearly demonstrated in 2009, creating a step function increase in our profitability and cash flow and providing a strong foundation for future growth. With that, I'll ask the operator to open the floor for questions. Operator?
(Operator Instructions). Our first question is going to come from the line of Shelley Gnall of Goldman Sachs.
Shelley Gnall - Goldman Sachs
I guess my first question is, and I do have a follow up, but the unemployment rate in your key markets actually looked like it improved in December. So I'm just wondering, what are your thoughts reflected in guidance for sort of macro trends in your markets? And is the high end of guidance reflecting some sort of improvement in overall unemployment rates?
I think that the unemployment rates as we've seen don't have a big effect on our uninsured volumes. We do think that it is contributing to the overall softness in commercial volumes and as we said commercial enrollments have declined over the last year or so, so there is a correlation there.
But I think that broadly speaking, we will see our markets behaving largely as the national markets are with stabilizing unemployment levels. Outside of the effects on volumes, there is also a positive effect on that, potentially with respect to our collections or bad debt expense experienced because what we've seen is historically although there's not a great correlation between unemployment and uninsured volumes, there is a correlation between unemployment and our collection rates.
So as unemployment has stabilized, we would expect our collection rates to stabilize. It remains a risk and let's see how truly that plays out in 2010, but that would create some potential for us to move further up in our outlook range if in fact collection rates are stable.
Shelley Gnall - Goldman Sachs
Okay, and then just to be clear, if your unemployment situation in your markets actually improves, would that be upside to your guidance range?
I would say it would move us up in the range. Keep in mind that at the middle of the range we assume that there were commercial volume losses year-over-year of a negative 3% and so any improvement off of that as a result of greater employment will move us up in the range.
Shelley Gnall - Goldman Sachs
Then on the other operating expenses, when you back out the healthcare technology operating costs, it looks like you are guiding to 3.5% to 5.5% for controllable operating expense growth in 2010. That's certainly more cost inflation than you'd expect to see in a deflationary environment, so why have we moved meaningfully away from this sort of deflationary environment that benefited operating costs in 2009?
Well, 2009 benefited significantly from the $108 million of cost reductions we put in place effectively at the beginning of the year which every quarter positively affected what otherwise would be seen as a normal rate of inflation. We are still targeting cost reductions in 2010. Steve mentioned the approximately $30 million from MPI and other supply-related initiatives which we expect to contribute to beating what otherwise would be inflationary cost pressure, they just aren't of the same magnitude as what we were able to accomplish in 2009 on more of a step function type basis.
Shelley Gnall - Goldman Sachs
So your operating costs are now seeing inflation back to the historical 3% to 5% range, is that fair to say?
That's where we are starting out with respect to this outlook, yes.
Our next question comes from the line of Darren Lehrich of Deutsche Bank
Darren Lehrich - Deutsche Bank
A couple of things here. I guess I just wanted to start out with the $40 million of expenditure related to your healthcare IT initiatives and just the philosophy around expensing that versus capitalizing that. We're seeing definitely some divergence within the peer group about how to treat those types of expenses and would love to get your thoughts on how you are thinking about it. It would appear that you're expensing virtually all of the implementation costs, but can you just, can you just walk us through that?
We are not expensing all of the implementation costs, there's a substantial amount of capital being spent next year, $70 million as we indicated in the release and in my comments. I can't speak to everybody else's accounting policy. I can only speak to our own. We interpret the accounting standards on this is certainly as we think is appropriate but the incremental cost that we are taking to the bottom line, are projecting to take to the bottom line are largely training costs, planning data conversion costs and then to the extent we bring up our production environment prior to being fully utilized, that also falls to the bottom line as an unabsorbed cost.
So those are the three elements of cost hitting expense next year which as I said is a two-year phenomenon, by the time we get out to 2012, it should be offset by -- that incremental expense will be offset by incentive dollars and beyond that by operational benefits.
Darren Lehrich - Deutsche Bank
And is there any additional risk element that you're embedding into guidance as it relates to potential implementation problems that you may have or anything like that, any thoughts there?
Well, the $40 million represents a best estimate, we would hope at the end of the day that it ends up being conservative, but I'm not going to promise that.
Darren Lehrich - Deutsche Bank
Let me just ask a question related to volume growth and the medical staff growth has been very good. Dr. Newman's been talking about some of those trends and we've obviously seen very good outpatient growth. I'm just wondering if PRP is going to change at all with regard to how the focus is.
It seems like or my sense is at least that you've been focusing a great deal of attention on improving the outpatient access points for your referring physicians. Is there a chance that you may have missed some inpatient opportunities as that process has rolled out? Can you just give us some comments there?
Well Darren, I think you are right. I think that we continue to learn how to improve the efficacy of our physician relationship program. There are a couple of things we are doing to upscale that function and make it more effective in terms of capturing our target which is more commercial managed care inpatient volume.
Number one, we are arming those PRP reps with items that we say are in their goody bag which is the tools and techniques to help the physicians practice more efficiently and effectively. We mentioned earlier the deployment of our office-based HIT suite. That will once again attract not only physicians affiliated with our hospitals today, but those that are not affiliated that have a high book of commercial managed care business today.
I think the second thing we have learned is how to improve our targeting. It's fascinating that a significant amount of the value leak is occurring in physicians that are not our most frequent admitters. Over time, our referring physicians especially our primary care physicians, don't come to the hospital as frequently as they used to. So in addition to deploying hospital that are full time within the facility to take those referrals, we have to strengthen our outreach to those doctors who we don't see walking around the hospitals very frequently.
Additionally, we are improving the assimilation of those new to staff by introducing them to their referral sources, so I do believe that we have an opportunity to improve the output and efficacy of our physician relationship program and we will go after those value leaks that today are causing us to not have increase in commercial managed care admissions.
Our next question comes from the line of Adam Feinstein of Barclays Capital.
Brendan Strong - Barclays Capital
This is actually Brendan Strong [ph] dialing in on Adam's behalf today. Just had a couple questions here on guidance. And really the first one is as you think about 2009, you guys did a really, really good job managing your costs and then it looks like EBITDA for the year ended up coming in a lot better than what you had initially expected or even what you had expected as recently as the third quarter call.
And so you ended up paying out this extra 401(k) match. Is there any way to think about that as really like a one-time item this quarter, unless EBITDA for 2010 ends up being just much higher than you're currently expecting?
But if you're asking on the 401(k) match, was it a one-time item? Yes, as I said in my comments, it should be considered a one-time item. We're going to repeat that if we have some substantial increases in future earnings or if competitive pressures should cause us to increase or make it further discretionary 401(k) match in the future. It's not in the 2010 outlook.
Brendan [ph], just one clarification to where we're making that announcement today and we're setting the expectation for employees of what they have just said that this is not something that is a permanent match, but it's a match that would – it’s an additional contribution that would be made again only if our performance in 2010 were substantially greater than in 2009.
So we've left ourselves that flexibility and we called it out so that you could make your own judgment as to whether to treat that as a you know one-time item or not and just one last point of clarification, that contribution was made only to the accounts of employees who are not a part of the incentive compensation plan.
Brendan Strong - Barclays Capital
Biggs, just one other question. On the tax rate, you guys are assuming a 40% tax rate for 2010, but you got the significant NOL there. I was just trying to understand that a little bit better. I mean ultimately do you think your taxes end up coming in a lot lower than what you're including in guidance? Just any color would be helpful around that.
The 40% represents on a normalized basis what we think we would have is an effective tax rate, federal and state combined. As it is, the only thing that we are effectively paying at this point in time on current income is state taxes, which have been running more in the $15 million to $20 million kind of level on an annual basis.
So that's if you will the state effects and then the federal effects at this point of course have been offset by the NOL. We would expect that NOL is going to start to demonstrate its value as we go into future and produce taxable income and we are happy. On the one hand, you don't want to be a taxpayer, on the other hand, we will be happy to be in a position in which we are generating taxable income and start to utilize the value of that NOL.
Brendan Strong - Barclays Capital
Just to clarify there though, let's say for example, when you end up reporting first quarter results, do you think you will be reporting like a 40% tax rate on the income statement, or do you think it would end up being lower than that?
No, in terms of reported basis in the first quarter, we would anticipate still just having state taxes effectively flowing through to the bottom-line.
Our next question comes from the line of Sheryl Skolnick of CRT Capital Group.
Sheryl Skolnick - CRT Capital Group
First of all, I don't understand why you're giving it, to follow up on that one, I don't understand with the NOL, why you bother to confuse us with the 40% tax rate when the NOL is roughly $2.5 billion and (inaudible) considerable amount of income for the next several years positively impacting your cash flow. I think it just confuses the issue and makes for estimates versus guidance comparisons to be negative, which I don't think you need.
The second thing is, where I'm coming out on this quarter was that the right read is, I think you'll confirm, given the $16 million of discretionary payments that were not, certainly not expected in my model, that the earnings power of the company in the fourth quarter from an EBITDA perspective was much stronger than anticipated. I guess we're all sitting here with the stock down 9%, a little bit disappointed that the 2010 commentary sounds so funereal.
Now, recognizing that it's your job to be prudent and it's your job to be conservative, it's a little troubling to have the answer to the question, why are you assuming your costs going up 3% to 5%, or are you assuming a return to inflationary trends be positive when the articulation of where those pressures are hasn't been precise. So I would ask for a better articulation of that.
The second issue around that is if you are rolling out Medicare performance initiatives this year and you're not rolled out to all the hospitals and your supply initiatives are only partially rolled out, the ones that go hand in glove with that, aren't there additional costs in your numbers that would show up in the other operating expense related to the Medicare performance initiative that you haven't enumerated?
I think that -- taking the last piece first, the Medicare performance issue will effect the number of items of performance, wherever cost is incurred is potentially we're able to drive it down by reducing variability length to stay improving, staffing as a result of that and our supplies and everything else. So there is certainly going to be effects more broadly than just looking at supplies which is something that's typically been focused on when you talk about the MPI effort. Back to the broader question on inflationary pressures, we did give a relatively normal looking merit increase in the fourth quarter, we talked about that when we issued our third quarter outlook, so there is built-in inflationary pressure on SW&B, and as Trevor mentioned, it was above what the rate of inflation has been. Union contracts also provide for some set increases which are not tied to inflationary measures and so the estimated beeline is not going to move literally with inflation or the absence of it for 2010.
On the supply side, certainly we expect to be able to continue to drive down cost using MPI and our other initiatives, but when you look at it across the entirety of our cost, that $30 million that Steve mentioned could get somewhat muted by the numerator denominator effect, the sizes of our number.
Sheryl Skolnick - CRT Capital Group
Okay. I guess where I'm going with this is, some of this is that you just did such a good job in 2010 that it's hard to repeat the performance, but you have other initiatives that you're spending money on in 2009 and 2010 that will begin to show results in 2010. And I'm a little bit concerned because I would think that the employment situation hasn't gotten that much better that your retention rates should still be strong and improving the programs you have on labor retention and around reducing turnover should be strong and improving, your contract labor costs control should be strong and improving. Your other operating expenses I think have been historically low. Obviously there's some twisting around of that because of the new IT initiatives and some costs associated with that, which you've articulated in detail.
But I can't help feeling, and I'd be okay with this, I mean it's your job to be conservative, but I can't help feeling that there's still a lot going on that would suggest separate and apart from labor where, yes, calling that out is important, the pressures probably shouldn't be above an inflation rate where we're not really in an inflationary environment. So I think I know the answer which is that this is your first look at 2010 guidance and someone, someplace told you to set it conservatively. I think that was right, but I'd kind of like an answer to that question.
One area where we are possibly being sure I mentioned in my comments is malpractice expense. We grow systematically malpractice expense down during 2009 repeatedly making actuarial adjustments for favorable experience. At this point in time, we're not forecasting similar reductions to occur in 2010 that so our guidance does not embed a continued reduction in malpractice. Having said that, we certainly have all of our efforts aimed in that direction, and that is one of the things that would influence the other cost category and is one area where we may prove to be conservative.
Secondly as I said in an environment of rising risk free and in this case discount rates, there is also a favorable impact on malpractice expense. It doesn't affect the cash piece of it, but it would affect expense piece of it, and we haven't presumed that into our forecast as well, but that as we know, based upon the actions of last week, that is very feasible to happen over the course of this year and if that does and that would provide lift as well. So, I mean there are areas of conservatism, but I'm not going to go so far as to lay it out and say yes, this is a conservative number and it's not a reasonable estimate on our part, it obligation to go ahead and get a reasonable estimate.
Sheryl Skolnick - CRT Capital Group
And then I'll also keep in mind that if we had backed the $40 million, it's still substantially higher than it used to be, so maybe I should stop complaining the EBITDA I mean. I guess then the other thing, I have to go back to on the physician recruitment and relationships, there were some mention on the third quarter call Steve, that there you stepped back and you took a look at the physicians recruited in the program through third quarter and felt that you needed to make some adjustments in terms of the appropriateness of those recruits and their commitment to generate volumes. Now you're telling us in the fourth quarter that the volumes in the class of 2009 are comparing favorably to 2008. Should we not be concerned about that? Have you addressed those issues? Do you have the right roadmap going forward and what would be your outlook for position recruitment for 2010?
Well Sheryl I think you are exactly right. I think that the statistics I gave about the productivity of the class of '09 compared to the class of '08 was only for the date range of Q4 which means we have been able to make a mid course correction and how we focus those PRP reps. I think one of the issues that we identified and we alluded to in the Q3 call was we may not have worked on the on boarding and the assimilation process of doctors that join the staff as well as we could have. I think by focusing the PRP reps on those new recruits as well as those that have not yet joined staff and then subdividing the ones that have joined by the ones that put a minority of their work at the hospital will increase our yield in terms of total referred inpatient and outpatient volume as well as commercial managed care. So we are learning. We have changed things as a result of the observations we shared with you in Q3 conference call and I think we're making progress. Overtime I think the goal will be to actually add fewer physicians who each contribute more in terms of meaningful inpatient and outpatient volumes that meet our community need and prevent patients from have to out migrate from our service area, so that for 2010, we'll probably target 800 to 900 active staff physicians net of attrition. So, I think you're right. I think we have made changes. We continue to improve that targeting; we improve our business intelligence at the hospital level, so that those PRP reps will know which physicians to call on and they have work plans that are defined for them a week in advance.
Sheryl Skolnick - CRT Capital Group
Okay. I guess in summary, if I can, am I supposed to take away from this that you're doing your job and giving guidance at the beginning of a very uncertain environment, by not overreaching, by trying to make it, I'll say maybe not in your words, as conservative as is reasonable to make it? But that the actual earnings power of the Company could be as much as going up by $100 million in EBITDA and that there's significant progress having been made despite the reduction in commercial managed care trends? Is that fair?
That's the part where we can as I said earlier, we're not going to say that our range is not reasonable, that yes there is essentially greater earnings power, than what reflect is looking at the range by virtue of the non-recurring hit from HIT and the fact that it is uncertain environment that's going to hold us back for a limited period of time here, but we expected as the economy recovers, that our results return to a more steep upward trajectory.
Our next question comes from the line of Jason Gurda of Leerink Swann. You may proceed.
Jason Gurda - Leerink Swann
Wanted to ask about your accounts receivable, looks like DSOs have been coming down every quarter this year. What's been driving that? Is there a point where you expect that to level off, how does that tie in also with your current bad debt expensing policy?
Well we haven't changed our bad debt expensing policy, we continue to reserve at the point of discharge for whatever our historic collection experience has been. So, there is no reflection of a change in policy and the days in receivable. The clutching rate overall has diminished on the 18 months look back basis over the course of the last couple of years declining down to the third quarter at roughly 30% and then it stayed relatively flat in the fourth quarter which is a positive sign. But what has improved overtime was our upfront collection. So collecting more at point of service has been one of the contributors to our accounts receivable improvements as well as the fact that we substantially improved our process for integrating with the payers. We have much more electronic exchange of information, quicker adjudication of bills etcetera with our managed care payers which enables us to collect more timely, we've also been driving down the discharge but not since the payer time cycle, so we get bills out the door faster, we get paid faster. That's been a systematic approach over the last year. We have routine so called cash is king calls, with all of our hospitals where we go over those kinds of metrics talk about cycle times on the receivable side, also look at inventories which isn't part of your question to make sure that we're driving down those as well.
So, it's a very conservative effort between what happens within conifer and what happens within our hospitals on everything associated with cycle time process, upfront collections which have been driving down receivables balances.
And we obviously been very successful, one thing we're worried about in 2009 in a recessionary environment was the fact that it will go the other way that we would have people paying us more slowly and to an extent that has happened. It's been offset as if by the increasing point of service collections. If you look at 2010, we're not projecting in our guidance that we continue to decline days in receivables but that's certainly something that we're going to go try to accomplish as we continue to refine the process or reduce cycle times.
Jason Gurda - Leerink Swann
Okay and as your upfront collections continue to improve, is that putting downward pressure on the bad debt expense each quarter?
It does have a favorable impact, how much is hard to say because the question is are you collecting from the same people faster or are you collecting from people otherwise wouldn't have paid and it's going to be sum of both, but it's very difficult to measure one versus the other.
Jason Gurda - Leerink Swann
And then just a final follow-up question is on the California issue that you're or at least California is waiting to hear back from CMS, do you have an expected timeframe on that?
It's the middle of the year and since you bring that up, I know from reading you're earlier this morning and some others that there's some questions or interpretational issues as to what we've actually reflected in our outlook for that. So if you will, I'll take this as an opportunity to clarify and the release said that we had $35 million of upstate cuts outside of California which will potentially offset or partially offset by the receipt of up to $60 million the California provider fee.
The California provider fee is one of many risks and opportunities included to setting the range. So we look at every risk, every opportunity, we look at the probability with the currents as a basis for determining what kind of range of outcomes we should expect for the year. So in this case, effectively what's included in the range for the California provider fee for other things we deem to be risk and opportunities are factored numbers. So, if I was doing a walk forward in the middle of our range, I would use $30 million as the amount to include for the California provider fee. So not the full amount, but a factored amount; and you get there but you're saying it was approved prospectively or it's a probabilistic outcome along with others considered to setting the range, and so it's not I think appropriate people could conclude that we've put $60 million into all levels of the range for the California provider fee and that our outlook is conditional upon $60. The bottom line of all that is that when and if the provider fees approved we has had might be towards more in the middle of the year, we would not want analyst to immediately add the gross value of that fee to our outlook range. We'll need reassess the range against all our areas of performance, all the risk and opportunities, cost, revenue, volume or otherwise in assessing how that provider fee would have affected the range that was up or down or what.
Jason Gurda - Leerink Swann
So just to clarify what you said, the mid-point of the guidance, assuming nothing else changed, let's just assume all the other states come in fine. The mid-point of the guidance range was how much from the California private program, $30 million?
The next question comes from the line of Ralph Giacobbe of Credit Suisse. You may proceed.
Ralph Giacobbe - Credit Suisse
In the press release you talked about certain regions showing better volume trends. What about within a commercial bucket. You've seen any better or maybe potential positive trends in any regions or is the managed care pressure basically similar across the board?
Ralph, I think we've seen some variability in commercial managed care. I think that there is some correlation with unemployment but it's not an extremely strong correlation with unemployment. Within certain micro-markets we see strength for example, a strong place, might be Atlanta, strong place maybe Palm Beach County relative to our other facilities. But in general, the decline is fairly broad based with occasional points of rightness within the group of 49 hospitals.
Ralph Giacobbe - Credit Suisse
Okay. And then just following on that, any more detail, I think you mentioned a certain initiative to gain share in Texas and Florida specifically around commercial, any more color on that?
Specifically, a great example of business-to-business initiative in Florida is the relationship with Bank Atlantic whereby we provide on-site screenings for their employees, education programs, flu shots, things of that nature on site. We're doing that with a number of other large regional employers in many of our markets. We've had a similar issue and initiative in several of our Texas markets which are proving to be very effective in opening that channel to accessing commercial managed care patients at the business level rather than simply focusing on physician referrals for commercial managed care. Our commercial payers are actually helping us with this, encouraging us to do this, because in our meetings with them, they tell us that we are high quality provider. From the assessments they give, we are in their centers of excellence designation program and to the extent they are not able to do our hard storage [ph] they certainly help us in those connections with businesses.
Next question comes from the line of Gary Lieberman of Wells Fargo.
Gary Lieberman - Wells Fargo
I just needed to follow up on the last question regarding the commercial admissions. You've talked about this in the past, but is it your sense that you're losing share or is it that your sense of the markets that you're in, everybody's seeing it across the board decrease? What's sort of the dynamic that you think is going on there?
From our discussion Gary with a number of the large payer leadership teams as well as large regional teams, we don't think we're loosing share. That maybe true in a couple of isolated incidents but our volumes in commercial managed care are pretty consistent but there are losses in the markets in which we operate across the country. That said, we're not satisfied with shrinking commercial volumes even if the universe of addressable are contestable patients shrinking and that's why I mentioned our upscaled efforts to take market share in commercial market share to access the other channels by which we can get the patients other than simply referrals from positions. So, we are focused on taking market share and growing commercial managed care even in a shrinking environment.
Gary Lieberman - Wells Fargo
Okay, and then just one housekeeping item. Not sure if you gave it, but do you have the compact discounts in the quarter?
We don't track those effectively anymore, it's all just embedded into our routine.
The next question comes from the line of Kemp Dolliver of Avondale Partners. You may proceed.
Kemp Dolliver - Avondale Partners
Question relates to the stimulus bill spending on HCIT and you're going to spend about $110 million this year between capital and operating expenses. So as you look down the road to 2012 and beyond, what is your thinking with regard to how much of that you'll ultimately recoup?
Well I would refer you to the 10-K we break out what the total project is expected to be over slight [ph] and what the incentive dollars are expected to be and then above and beyond that, we expect to have operational benefits which we haven't quantified. So, it leaves you short of being able to totally answer your question as to what the economic effects are, but I'll go back to say this was something we were going to do anyway, so we felt like it had value anyway. We're just accelerating. So, since we thought it had a value anyway, we felt like the economics are there for executing this program just on different time tables.
Kemp Dolliver - Avondale Partners
Great, and my other question relates to expenses. You've mentioned with regard to the uptick in expense growth in 2010 versus 2009 the absence of a large cost reduction program and probably a little bit more generous wage increases. But it strikes me when I do the math that the overall costs or approach to costs discipline, is still probably where it was a year ago. Is that fair or is the mindset that the profitability in the business environment's a little bit better than what you thought a year ago, so at the margin, there are some things you're willing to do that you might not have done this time last year?
I would say we're not relaxing on anything. Our discipline in terms of cost management is now very engrained and we are seeing continued success in terms of how the hospitals are managing staffing and in flexing appropriately and avoiding contract labor and overtime, and just being on a day-to-day basis much more effective than we were a few years ago as a result of all the processes we've installed.
So nothing is changed along those regards. We always even last year we had to make decisions about, these are something that we should be investing in for the future, and so it's not say that there is zero dollars being invested for the future discretionarily even in 2009, there were some, but it's going to stay something that we're can be conservative with respect to and day-to-day it's a matter of being absolutely diligent with respect to cost control.
Our next question comes from the line of Justin Lake of UBS.
Justin Lake - UBS
Just first question around, you made some comments around the fourth quarter being particularly strong on the commercial pricing side. Can you give us a little more color there around what was particularly strong there, maybe just talk the difference between pricing and mix?
Well, we don't give out literally what our price increases are because it ends up being used against us negatively in our negotiations because everybody wants to be at average, so we stopped giving that information a few years ago. There was some lift in commercial managed care, case management index, some lift in acuity. We've talked about that over the last several months that even though volumes were down, there was a positive shift in terms of patient mix, it's strictly quantified, but that has been a positive, that's been a trend over the last almost 9 months I think.
Justin Lake - UBS
So you're not saying basically that your contracting has gotten significantly better in the last quarter or two?
No the contract has stayed on the path we talked about previously. Our rate of increases, nothing changed significantly in the fourth quarter and as we said before, the pure rate increases for 2010, we expect it to be in line with what we experienced in 2009 as well.
Justin Lake - UBS
One last question, typically you'll give us a little bit of visibility into what you've seen the first month of the quarter. Is there anything you could tell us about January particularly on the commercial volume side?
As Trevor mentioned earlier and as I have said in the past we want to try to work our way away from giving that information because as often as not it ends up being different from what the full quarter view. So we've decided at this point in time not to give specific stats but Trevor did mention that the first quarter was starting out somewhat softer than what we ended the fourth quarter with and that would be with respect to commercial volumes.
Our final question will comes from the line of Whit Mayo of Robert Baird.
Whit Mayo - Robert Baird
Just wanted to follow up on that last question, Biggs. Just any issues to think about with weather in the first quarter and just any perspective around that?
I don't think that we have any particular insights about the first quarter, whether it was weather-driven, I have heard that with respect to retailers, but I wouldn't want to speculate. All we want to say is that the trends are a little bit in my opening comments at least the trends year-to-date are a little bit weaker than the fourth quarter and we are off to a slow start in terms of volumes for the year, but then to remind you that our guidance for 2010 assumed flat volumes and down 3% on commercial.
Whit Mayo - Robert Baird
Just wanted to clarify the comments that you made about self pay collection rates. Just wasn't sure if you said that it was down sequentially or flat sequentially?
It's effectively flat sequentially third quarter to fourth quarter.
I just want to make a couple of closing comment before we concluded the call. 2009 was clearly a very important year for us. It was a watershed in many respects. We showed very strong improvement in EBITDA and continuing a trend that is going on for a number of years. We made major changes to the cost structure which we are not letting up on, we did very well on pricing, we continued to have visibility into pricing long into future and we made major progress in strengthening our medical staff.
We think those improvements are sustainable and represent a foundation for the future, but sitting here early in 2010 it's a very challenging year for which to forecast. I think many of your questions and comments have pointed that out. I will just say we faced over the past several years much larger challenges and we have been able to overcome them and we have confidence as we enter 2010 and look forward to spending more time in person with you and as I mentioned having a higher degree of visibility out there than we have had in prior years.
So thanks to everybody for participating. Take a little bit of a break before your next call and operator this concludes the call for us. Thank you.
Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect and have a great day.
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