HCA Holdings' CEO Discusses Q2 2011 Results - Earnings Call Transcript

 |  About: HCA Holdings, Inc. (HCA)
by: SA Transcripts


Good day a welcome to the second quarter 2011 earnings release conference call. At this time I'd like to turn the conference over to Mr. Vic Campbell. Please go ahead sir.

Victor Campbell

Thank you operator. Good morning everyone. Mark Kimbrough, our chief investor relations officer, and I would like to welcome you on today's call, including those of you listening to our webcast. Here this morning with me are Chairman and CEO Richard Bracken, President and CFO Milton Johnson, and Sam Hazen, president of operations. And there are a number of other members of the HCA senior management team here with us today as well.

Before I turn the call over to Richard, let me remind everyone that should today's call contain any forward looking statements, they are based on management's current expectations. Numerous risks, uncertainties, and other factors may cause actual results to differ materially from those that might be expressed today. Many of the factors are listed in today's press release and in our various SEC filings.

Many of the factors that will determine the company's future results are beyond the ability of the company to control or predict. In light of the significant uncertainties inherent in any forward looking statements, you should not place undue reliance on those statements. The company undertakes no obligation to revise or update any forward looking statements whether as a result of new information or future events.

This morning's call is being recorded. Replay will be available later today. With that, I'll turn the call over to Richard.

Richard Bracken

All right. Thank you Vic, and good morning to all. We do appreciate your participation on our call this morning. Let me begin today by sharing with you some comments on the quarter.

Clearly, our results for the second quarter were very mixed. While it was a quarter marked by continued favorable patient volumes, stable expense management, and favorable cash flow, these positive trends were offset by an unfavorable service mix, negatively affecting earnings. These, of course are the issues that we will address this morning.

So let me start with volume. For the quarter, patient volumes, including our newly acquired facilities, were positive and continue to align with recent favorable trends. Reported admissions for the quarter were up 3.2% and reported equivalent admissions increased 3.4%. Similarly, on a same-facility basis, reported admissions and equivalent admissions grew 1.8% and 1.9% respectively.

We have now experienced 15 quarters in a row of positive equivalent admissions growth. On a year-over-year basis, reported admission and equivalent admission growth were also favorable at 2.6% and 3.6%.

Also, consistent with strong admission growth, we continued our favorable trends in same-facility emergency visit growth with a 4.5% growth rate for the second quarter and a 7.8% rate on a year to date basis.

And I think that you're generally aware that we believe this growth reflects not only favorable facility locations in areas with favorable growth dynamics, but also an operating agenda that seeks to improve the efficiency in which we process patients through our system. And we remain committed to this strategy as a way to not only improve efficiency but to improve the patient experience and clinical outcomes as well.

From an earnings perspective, however, the favorable volume performance that we did experience in the quarter did not convert to revenues as favorably as they previously have. We believe that this is primarily due to a shift that was experienced in service mix. That is, from more complex cases, significantly surgical cases, to less-acute medical cases.

Importantly, our same-facility cash revenue for equivalent admission increased only 1.2% in the second quarter, down from 2% growth in the first quarter of 2011. We believe this service mix shift accounts for the majority of variance in our quarterly earnings performance.

As a net result, our company reported revenues for the quarter totaling $8.06 billion, compared to $7.76 billion last year. Cash revenues, net revenue less bad debt, were up 4.6% for the quarter while same-facility cash revenue grew 3.1% in the quarter.

On the expense side of the equation, same-facility cash expenses for equivalent admission rose 2.9% for the quarter compared to the prior year. This was consistent with our expectations and reflective of the favorable expense trends in our facilities. And Milton and Sam are going to comment on all of this in more detail in just a moment.

So as we roll this up for the quarter, adjusted EBITDA totaled $1.42 billion, down 4.7% from the $1.49 billion we reported in the second quarter of the prior year. For the first 6 months of 2011, our adjusted EBITDA is $3.01 billion compared to $3.064 billion in the similar time period of the prior year. Our more favorable performance in Q1 has been offset by less favorable performance in Q2 of this year.

Given this performance, we felt it prudent to refine our overall 2011 guidance. Please recall that we had previously stated a goal of mid-single-digit growth in adjusted EBITDA for the full year. We are now refining that to 3-5% adjusted EBITDA growth.

Let me remind you that this guidance for 2011 excludes any impact from our previously announced HealthONE transaction in Denver as well as any subsequent acquisitions or divestitures or further debt restructuring opportunities, but continues to include anticipated reimbursements from CMS and Medicaid agencies related to the HITECH program.

It is contingent upon the successful rollout of our electronic health records initiative consistent with Stage One Meaningful Use requirements. And as you would expect, there is a significant amount of effort and investment underway to meet these standards and we remain optimistic relative to our ability to do so.

Our operating agenda remains robust. We remain committed to investing in necessary technologies, clinical management programs, and physician integration strategies to properly position our company for the future. Additionally, we will continue to develop our Parallon business solutions subsidy as a method of capitalizing on the core competencies that we have developed. We believe these major agendas will drive value for the organization in the future.

From a capital investment perspective, we made a couple of significant announcements during the quarter. First, on May 2, we completed our acquisition of the 473-bed Mercy Hospital in Miami. Mercy brings an annual revenue run rate of approximately $280 million to our East Florida division, which now inclusion 13 hospitals, 12 outpatient surgery centers, a regional laboratory, and numerous imaging facilities, physician practices, and medical education and training programs.

Additionally, on June 15 we announced a memorandum of understanding with the Colorado Health Foundation to purchase their approximate 40% equity ownership in our HealthONE joint venture in Denver for $1.45 billion.

Since 1995 we've been joint venture partners in this market. HealthONE is the largest healthcare system in the metro Denver area, with 7 hospitals, 12 ambulatory surgery centers, and more than 30 occupational medicine rehab and outpatient diagnostic clinics and we look forward to completing this transaction and to participating in an appropriate and comprehensive regulatory review process.

And so with that, let me turn the call to Milton.

Milton Johnson

Thank you and good morning. Hopefully everyone has had an opportunity to review the company's second quarter earnings release issued earlier today. Once again, we have included in today's release a supplemental schedule which provides a comparative view of our GAAP revenues and non-GAAP cash revenues in relation to the company to expense items. We believe this is a useful tool in analyzing the effects of uninsured volumes and discounts on our reported revenues and the provision for that account.

The company's second quarter results provide [inaudible] volume growth, good expense management and strong cash flow from operations. However, an unfavorable shift in service mix during the quarter resulted in lower patient acuity, which in turn research in lower revenue growth and earnings.

Net income in the second quarter totaled $229 million, or $0.43 per diluted share, which includes $75 million, or $0.08 per diluted share, of pre-tax loss on the retirement of $1.1 billion of debt called earlier in the quarter. This compares to $293 million in the second quarter of 2010, or $0.67 per diluted share. Results for 2010 include impairments of long-lived assets of $91 million, or $0.13 per diluted share.

Tax rate in the second quarter was approximately 39%, compared to 32% in the second quarter of 2010. The tax rate in the second quarter of 2010 was reduced due to certain tax settlements related to prior years.

As noted in the release this morning, shares used for computing our diluted earnings per share for the second quarter of 2011 increased 23% from the second quarter of last year to $538.6 million compared to $437.1 million last year, due primarily to the issuance of shares for the company's IPO in March of this year.

During the second quarter, same-facility admission increased 1.8%, while same-facility equivalent admissions increased 1.9% compared to the prior year. As noted in this morning's release, patient volumes in the quarter were driven by higher medical admits of 3.7% while our surgical admissions decreased 1.6%.

Consistent with recent quarters, we saw growth in volume from patients covered under governmental programs. Same-facility Medicare admissions and equivalent admissions increased 3.3% and 2.6% respectively, compared to the prior year second quarter.

Our same-facility Medicare admissions include both traditional and managed Medicare. Managed Medicare admissions increased 4.3% on a same-facility basis and represent 23.6% of our total Medicare admissions.

Same-facility managed care and other admissions declined 2.1% in the quarter with virtually all of the declines being in surgeries. However, same-facility managed care and other equivalent admissions were flat in the second quarter as compared to last year. This is the first quarter since 2007 we did not see a decline in managed care and other equivalent admission growth.

Same-facility uninsured admission increased 10.6% or 2,756 admits in the second quarter compared to the prior year. Same-facility uninsured admission represent 7.4% of total admits in the quarter, compared to 6.8% in the second quarter of 2010.

We did see a slowdown in Medicaid conversions from uninsured in the State of Texas. We believe this increased our uninsured growth in the quarter but we expect this affect to be temporary and should reverse later this year.

Same-facility total surgical volume in the quarter declined 1%, with inpatient surgeries down 1.5% and outpatient surgeries down 0.6%. Surgical softness is being driven by reduced elective surgeries, which declined 3.3% in the quarter. We also continue to see a shift in certain inpatient surgeries to outpatient settings, particularly in general surgery and gyn.

There has also been some movement of inpatient cases such as AICDs and pacemakers to cath labs as well as endovascular surgeons working in interventional radiology suites and cath labs rather than operating rooms.

Same-facility ER visits increased 4.5% in the second quarter as compared to last year. As Richard mentioned, we believe our ER strategy is effective on many fronts, including improving our admission growth.

Now a few comments on revenue. Same-facility cash revenues grew 3.1% in the second quarter. As a reminder, cash revenues is a non-GAAP financial measure, and represents reported revenue less the provision for [that account]. Our revenue growth was driven by same-facility equivalent admission growth of 1.9%, coupled with same-facility cash revenue per equivalent admission growth 1.2%. The unfavorable shift in service mix during the quarter was a primary driver of softer cash revenue per equivalent admission. Our same-facility case mix index increased just 0.4%.

Our revenue for the second quarter of 2011 included $39 million of Medicaid incentive revenues related to certain of our hospitals completing [inaudible] to their adoption of certain electronic health record technology.

The most significant contributor to the low cash revenue rate growth from a payer class standpoint was Medicare. Same-facility Medicare revenue per equivalent admission declined 1.3% compared to last year's second quarter and Medicare case mix index declined 1.2% compared to last year.

Our analysis found not only did Medicare case mix decline due to fewer surgical cases in the second quarter, but the medical cases had a lower case mix than medical cases during the second quarter of 2010. Comparing the second quarter of this year to the first quarter of this year, the change in Medicare revenue per equivalent admission growth rate yields an approximately $90 million negative impact on revenue growth.

Exploring further, we reported a 2.6% growth rate in Medicare revenue per equivalent admission in the first quarter of this year versus a 1.3% decline in the second quarter. The 390 basis point swing in growth rate accounts for approximately $90 million in Medicare revenue difference between the first and second quarter of this year.

We quantified this impact by multiplying our second quarter 2011 Medicare revenue by 3.9%. This reconciles a significant portion of our revenue change between the first and second quarters of this year. Same-facility managed care and other revenue per equivalent admission increased 4.9% compared to the prior year second quarter.

Medicaid same-facility revenue per equivalent admission increased 1.9%, excluding EPL. Same-facility charity care and uninsured discounts increased by $319 million in the second quarter compared to the prior year. During the second quarter, same-facility charity care discounts totaled $653 million, an increase of $57 million for the past year, while same-facility uninsured discounts totaled $1.33 billion, an increase of $262 million from the prior year.

We were generally pleased with expense management in the second quarter, as same-facility cash operating expense per equivalent admission increased 2.9% compared to the prior year. Cash operating expense is a non-GAAP financial measure, and is comprised of salaries and benefits, supplies, and other operating expenses.

Salary and benefit expense per equivalent admission increased 4.6% in the quarter on a same-facility basis. Hospital-only productivity performance as measured by man hours per equivalent admission showed an improvement of 1.2% while the company showed an unfavorable change of only 0.4% on a same-facility basis compared to the prior year.

Our wage rate increased 2.7% on a same-facility basis compared to the prior year. We incurred $24 million of cost related to the implementation of our electronic health records in the second quarter.

Supply costs per equivalent admission declined 0.4% on a same-facility basis, benefitting from our contract pricing established by our GPO, Health Trust Purchasing Group, and a decline in surgical volumes and numerous other supply saving initiatives.

Same-facility other operating expenses per equivalent admission increased 2% in the quarter, reflecting several small variances from prior year.

Adjusted EBITDA during the second quarter declined 4.7% to $1.42 billion, reflecting an adjusted EBITDA margin of 17.6%. On a cash revenues basis, the adjusted EBITDA margin was 19.5%, which compares to 21.4% in the second quarter of 2010.

The margin decline can be attributed primarily to lower revenue growth and increased physician employment expenses. Same-facility personnel costs associated with our physician management company increased to $243 million in the second quarter of the year, compared to $179 million in the second quarter of last year.

Bad debt plus charity and uninsured discounts as a percentage of revenue plus charity and uninsured discounts was 27.6% compared to 26.1% in the previous year's second quarter. We currently have 93% of our self-pay book reserved. Up front collections totaled $83 million, up 5.5% from the prior year.

Cash flows from operating activities increased to $748 million from $436 million in the second quarter of 2010. The increase was primarily due to reduction in the company's cash taxes due to recording of higher revenue deductions on uninsured accts and accelerated depreciation expense on certain capital expenditures.

Days in accounts receivable at the end of the second quarter were 45 days, which compares to 44 days June of 2010. Capital expenditures totaled $447 million in the second quarter, compared to $322 million last year, reflecting increases in routine and construction capital.

At June 30, 2011, the company's debt to adjusted EBITDA ratio was 4.36 times, compared to 4.31 times at March 31, 2011. At the end of the second quarter we had $2.854 billion of liquidity available under our senior secured credit facility.

As previously mentioned, during the quarter the company extended maturities of $594 million of our Term A to May of 2016 and $537 million of our Term A and $1.836 billion of our Term B to May of 2018. Also, the company completed an amendment to our cash flow and ABL credit agreements which will provide additional financing flexibility in the future.

As announced on our last earnings call, the company redeemed approximately $1.1 billion aggregate principal amount of certain issues of its high coupon senior secured notes on June 2, 2011. During the quarter, we also entered into an additional $1.5 billion of forward starting swaps. We now have an aggregate of $4.5 billion of swaps, which will commence in mid-November when our current $7.1 billion of swaps expires. The new swaps have an average 3.14 fixed rate versus LIBOR compared to the 4.85% average on our old swaps.

So with that, I'll turn the call over to Sam Hazen.

Sam Hazen

Good morning. I'm going to take a few minutes to speak to the performance across our operating divisions.

Again, in the second quarter, as we experienced in the first quarter, the operating performance across the company was very balanced and consistent with with respect to most volume metrics. Fourteen out of 16 divisions grew adjusted admissions on a year-over-year basis. Twelve out of 16 divisions had growth in inpatient admissions.

Of the four divisions that had declined, two were down less than 1%, one was down by almost 2%, and our London division was down because of the festivities around the royal wedding. All divisions once again had growth in emergency room visits for the quarter. As I shared in my comments last quarter, we have a comprehensive strategy across all of our markets to grow emergency room services. This strategy continues to yield solid results for us.

The one volume metric that showed inconsistent performance across the company was total surgeries. Only five divisions had growth in total surgeries, with no real geographical patter to this performance.

At this point, current period market share data is not available to understand all of the issues contributing to this performance, but some early observations indicate softness because of lingering effects of the economy, some incremental effects potentially from technology and drug enhancements, and some market share swings against us because of physician losses or competitor investments.

Obviously, we believe some of our divisions had share gains because of these same factors. The most recent market share data, which is year-end 2010, for most of the company's markets, shows our overall market share as stable to slightly up in most surgical service lines.

Our growth strategy for surgical services is built on adding physician capacity, improving physician service and convenience, increasing our operational efficiencies, investing in technology and facilities, developing and acquiring outpatient surgery centers, and deepening program capabilities such as adding trauma surgeries. We continually identify we appreciate your support to enhance these program elements and believe in total they position us well to compete for more share in surgical services.

Surgery is just one component, and obviously an important component, of overall intensity in our hospitals. Critical care services are another. For the quarter, the company had growth in admits and patient days in critical care services of 2.5% and 1.7% respectively. This is also the case in our neonatal intensive care units, where admits grew by 0.7% and patient days grew by 3.3%.

Unfortunately, the growth in these services was not sufficient to offset the revenue softness from surgery services and other declines in intensity of services rendered. It is important to understand that our hospitals have very sophisticated management systems to adjust their cost levels to variations and intensities.

Our scheduling and productivity systems are all geared to managing fluctuations in both census levels and acuity levels. This allows us to compensate some, but not entirely, for the associated revenue issues from lesser intensity.

Generally, the more intense the service, the higher the operating margin. Our management teams in our hospitals and surgery centers continue to execute a comprehensive agenda of both growth and operational initiatives while at the same time maintaining a tight grip on cost.

Finally, the financial performance across the three operating groups was generally consistent for the quarter. That concludes my comments, and I'll turn it back to Vic.

Victor Campbell

All right. Thank you very much. Operator, do you want to come back on and poll for questions?

Question-and-Answer Session


Yes sir. Thank you. [Operator instructions.] Our first question comes from the line of John Rex from JP Morgan.

John Rex - JP Morgan

I was wondering if you could just drill down a little further for us, specifically on the soft Medicare acuity. I say this mostly because the reads we've had so far from other segments, healthcare just showed a little more upward pressure on government program business in terms of cost trends. I'm wondering if there were any kind of share shifts or position losses that you could particularly point us to that maybe explain what you saw in your Medicare book.

Sam Hazen

We have certain markets where we know we have lost physician relationships, and that's generated some business loss, but we have other markets where we know we've picked up physician relationships and it is has seen our surgical volumes grow. And when I try to carry that across the whole portfolio, that's not the issue that I can point to in indicating that our surgical activity within the Medicare business was down.

We're really, at this particular point in time, not able to identify anything concrete and as I mentioned in my notes, our most recent data point on very objective data, which is the year end 2010 market share data for just about all of the company's markets, indicates that we in fact have picked up market share in surgical services.

So we don't know exactly if the market's shrunk in the second quarter in overall demand, or if we did in fact lose market share globally. We're just really without an important data point to understand that. But anecdotally, we don't think across the various divisions that that is in fact the case.

John Rex - JP Morgan

Okay, and I just want to confirm one thing on your guidance revision. I think last quarter you said your EBITDA guidance incorporated for Medicaid a 12% reduction in Florida, a 10% redundant in Texas. Would the revised guidance still accommodate those kind of Medicaid rate revisions?

Richard Bracken

It does include Florida and Texas, and I think we reported specifically on Florida that effective July 1, we saw a reduction take place of roughly $52 million on an annual basis. So we're looking for about half of that to take place in '11 and the other half in '12. Then Texas came about the time we were on the call. That takes effect September 1. We're estimating that's an annual reduction of somewhere around $25-30 million. So that would mean maybe $8-10 million coming in the last 4 months of '11. Both of those are in our revised guidance.


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

Darren Lehrich - Deutsche Bank

Thanks. Good morning everybody. I guess I just wanted to follow up a little bit more on the mix question and just get some confirmation from you as to whether or not you think there's any product mix shift going on here as well. We can understand the case mix numbers you've proved to us, but can you just maybe square for us what you're describing as somewhat of a flattish managed care growth. I think you said flat. I think at the same time you said down 2.1. So if you could just clarify those numbers. Is there something else inside the managed care book itself that you're also seeing here?

Milton Johnson

Just to clarify, the 2.1% decline is in managed care admissions, and the flat is equivalent admissions. And my comment was that for as long as we've been tracking back to '07, we've been seeing declines in the adjusted admission managed care book and had a flat number this quarter which obviously is a positive trend for us.

The case mix index of the managed care book for the second quarter was consistent with the first quarter, up about 1.8-1.9% over the prior year. So no big shift there. Our pricing on the managed care book for the second quarter was up 4.9% and I believe we were up a little over 5% in the first quarter.

So again, fairly similar trends in terms of pricing in managed care. The impact on earnings and our revenue for this quarter is primarily Medicare.


Our next question comes from the line of Tom Gallucci from Lazard Capital Markets.

Tom Gallucci - Lazard Capital Markets

Thanks for the color. Good morning. Just curious, now how do we think about going forward? You mentioned your guidance from an EBITDA perspective, but what are you assuming about the Medicare mix trend and is there anything more dramatic you can do on the cost side over and above the daily adjustments that you mentioned in your prepared remarks that you do on a regular basis?

Milton Johnson

On the revenue front, as we think about the rest of the year, we're seeing - this again is without HITECH revenues, which we've estimated again to be $290 million to $340 million - so excluding HITECH revenue, we would see our revenue growth in the 3-5% range for 2011. So we have, from our previous guidance, which was 5-6%, so we have brought our expectations on revenue down primarily as a result of the second quarter, but also factoring in some of the outlook for the second half of the year.

Richard Bracken

I think relative to the broader question, that how do we think about the business going forward, you had mentioned on the expense side of the equation, let me just kind of expand that a little bit. How do we think about the business going forward.

We absolutely believe that as we think about over time, years, that there's going to be increased pressure on the system to create more value for the healthcare dollar, and that this will translate into the day to day activities on our part to manage the costs as aggressively as we can. We have a robust cost management agenda. I've talked about this in the past.

And certainly, not only around management of variable cost, which Sam had talked about, but really in terms of overhead costs and reengineering the overall corporate support and shared service platform to bring overhead costs out of the company. We continue to do that in a very aggressive way, and pursue that.

But also the way we think about the future is, you know, how healthcare is provided in the future is going to change, and that we have to invest in the technologies and the infrastructure required to position the company appropriately. And that's what we're doing.

And we're taking on some serious investment of time and resources now to do so, whether it's in the technologies. We've talked a lot about the HER, the electronic health record, how to digitalize that. That's going to produce a lot of opportunities for us, we believe, as we go forward, but in all the clinical management of the business, as well as the Parallon Solutions to monetize some of these competencies.

We are acting, on a day to day basis, as if there will always be pressure on revenues and we think there are plenty of opportunities to respond to that. They're not even.

I would say on the Medicare case mix index, this is not a static number. But it doesn't move a lot, and it hasn't moved like we saw this quarter. So as Sam had mentioned, we need to wait and see what happens to this number. We weren’t expecting it obviously, but is this going to be a new number? It's just not knowable at this point in time.


We'll go to our next question, from Justin Lake from UBS.

Justin Lake - UBS

Just quickly on the same source surgical growth in the quarter. The numbers didn't look that materially different from what you reported in the first quarter on a same-store basis. I'm just wondering if there's any more color you can give us there, whether it was significantly different. And then maybe if you look back historically, when you see this kind of volatility on a quarter to quarter basis in surgeries, does it typically continue for two or three quarters and build up to the run rate, or do we think of this more as white noise?

Richard Bracken

You've got a good point. We've been seeing declines in our recent quarterly trends in our surgical volume. I think what's happened this quarter is that the overall intensity of the surgeries that we did have also appear to be lower than in prior quarters. And as I said in my comments, even in the Medicare book, even the medical admissions had a lower intensity than they did in the second quarter of last year. So all of those factors resulting in the lower revenue, on the Medicare book, in the quarter versus last quarter.


Our next question comes from the line of Ralph Giacobbe from Credit Suisse.

Ralph Giacobbe - Credit Suisse

Maybe a little bit more. Can you break down a little bit more of what you put into the complex surgical case bucket? And is there any way to quantify the average revenue for a medical case versus a complex surgical case?

Sam Hazen

Our case mix on Medicare is about 2.8 for Medicare surgical cases on average. Our medical case mix index is about 1.15. And so you can see the delta between that. Within each of those classes, though, this particular quarter, which we haven't seen historically much, there was declines in both sides of it.

So in other words, the surgical side dropped from where it was, and then the medical side dropped from where it was, and then we had a distribution between the two that was more medical as opposed to surgical as it relates to our trend. And the combination of those factors yielded the softer Medicare revenue that Milton referenced in his comments.

What goes into those surgical cases, just the higher end cases, and these are just sort of categories, obviously cardiovascular cases are particularly acute and yield a very high Medicare case mix. Total joint procedures in the orthopedic side of the equation also generate fairly large surgical case mix components.

Those are two examples of the type of cases that we typically see in our book of business on the Medicare side. And I don't have the exact statistics on each one of those in front of me, but we can get those to you.

Milton Johnson

I don't have the Medicare, but on cardiovascular surgeries, down 3.7%, and also had a 2% drop in general surgery as well.


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

Frank Morgan - RBC Capital Markets

I was curious if you could comment, based on where the trends are today, what you can do on the cost side. And maybe the reaction that you made on the cost side, how much of a flow through effect would you see from that in subsequent quarters if the mix of the business stays the same? And then secondly, with all these issues related to cardiology procedures and some of the higher procedures, how much of that do you really relate to recent doc recruiting of more medical and less surgical?

Milton Johnson

When you look at our cost trends, this year, we've been up on the same-facility basis about 2.8-2.9% for the first six months of the year. And we've done that, productivity, especially hospital only, has been improving.

But we have also continued to invest in the development of electronic health records, rolling out clinical qualify improvements programs as well. And we believe that those investments are central, especially with the HITECH incentive dollars available to us, primarily in the fourth quarter of this year.

So we continue to invest also in technology that again, over time, will allow us to operate the company more efficiently, not only from a quality standpoint but also from a cost standpoint. So I think from an overall standpoint, our cost is being managed pretty effectively considering the investments that we're making.

There's always opportunity to flex, with our volume changes and intensity changes, as Sam mentioned, but right now we continue to invest and will continue to invest primarily in electronic health records.

Sam Hazen

The second half of your question, I'm not sure I understood.

Frank Morgan - RBC Capital Markets

The notion of softness in the high acuity services, is it either you've lost positions that prove high acuity services recently? Or have you recruited an unusually high percentage of medical related specialties lately? Or is it a combination of both?

Sam Hazen

I don't know that I would say it's either. I don't think our recruitment efforts are excessively oriented toward medical type physicians, nor do I think we have lost any significant number of surgical positions. If anything, we tend to add more on the specialist side, I would submit, than we do on the medical side.

So our development of our physician medical staff, and our capacity, tends to be oriented toward procedures for surgeries and toward the higher-margin business. Our growth strategies are built around that, whether it's development of programs, adding new programs, and so forth. And so the orientation of our growth plan, and thus our physician development, is generally more toward the individuals who do procedures in our facilities.

Now we clearly have a primary care strategy with respect to physicians and other components of our network to feed those specialists and to reach into new markets, but I don't think I could sit here and call any disproportionate orientation toward any of those issues.


Your next question comes from the line of A.J. Rice from Susquehanna Financial Group

A.J. Rice - Susquehanna Financial Group

I wish I could think of a unique way to keep asking the same question, but I can't. Maybe just to ask you about cash deployment. You've got a bunch of debt that's callable later this year, maybe balance sheet management, that's high cost. What are the prospects for making some adjustments there?

You've also got the HealthONE deal. What's an update on when that might close, and what you might need for that, what that might mean for you?

And then I'm going to slip in a part B, which is obviously the Medicaid IT payments in the quarter were not expected at the beginning of the year. Are there other Medicaid IT incentive payments that you think you might get in the back half of the year beyond the Medicare?

Milton Johnson

As you saw in our quarter, we did have very, very strong cash flow generation, and we certainly believe we have some opportunity with our existing balance sheet to make some improvements and we'll be looking to do that based upon market conditions and taking advantage of the opportunities in the marketplace to restructure some existing debt and to reduce our interest cost going forward. So as the market opportunities present, I would expect that we would do that.

Richard Bracken

Sam, you want to give a HealthONE update?

Sam Hazen

We are anticipating that the HealthONE transaction will close sometime in the third quarter. We are in the final stages of developing definitive agreements. We will then proceed to the Colorado attorney general for his process, which is yet to be formalized. And we anticipate that the deal will make it through those proceedings and we should be in a position to close sometime in the middle part of the third quarter we think.

Richard Bracken

And finally, your HITECH question. Milton, you want to…

Milton Johnson

Sure. Our guidance remains on the revenue side the same as we gave in the first quarter: $290 million to $340 million. We did not anticipate the approximately $39 million of Medicaid HITECH that we had in the second quarter. But now we also would expect it third quarter, John, to have what, another …?


We expect another $37 million over the remainder of 2011 the year.

Milton Johnson

Okay, and that's included in our $290 million to $340 million annual guidance.


Your next question comes from the line of Christine Arnold from Cowen & Company.

Christine Arnold - Cowen & Company

Quick question on Texas UPL. I didn't happen to hear that number. What did that look like in the quarter? And then I may be wrong, but I think you were north of 5% managed care pricing in prior quarters, so it looked like it might have taken a step down this quarter. Am I misremembering? Or did managed care pricing take a bit of a step down?

Sam Hazen

Texas UPL, the EBITDA from the UPL program in the second quarter was $20 million less than in the second quarter of 2010. We had $457 million of EBITDA net in the UPL program versus $77 million a year ago.

The managed care pricing for the quarter, again 4.9%, slightly below our expectation. Our guidance for this year is 5-6%. I believe we were about 5.25%, 5.3%, if I memory is correct for the first quarter. So again, we're slightly under where we expected to be year to date on managed care, but just a few basis points.


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

Gary Lieberman - Wells Fargo

It sounds like from everything that you're saying - I guess Sam, specifically some of the comments that you made - it's entirely possible that this is sort of just the natural variation in the business and that you all wouldn’t be too surprised if it came back in subsequent quarters. Is that a fair way to summarize what you're saying and what you're thinking? Or is that maybe too optimistic?

Milton Johnson

One way I would maybe frame it, the 1.2% drop in our Medicare case mix index is there's nothing in our trends that gave us a heads up to expect that. If you look back over the years, from time to time, on a quarterly basis, you will see a decline in the case mix index for possibly any payer, but Medicare in particular.

Recent trends have been actually, entire case mix index, and so this 1.2% decline is the largest decline I've seen in a while. So it is unusual. But whether this is a single data point and we will see improvement, or whether this is starting a trend, we just have this data point, so it's hard for us to make that call at this point. But I will describe it as the magnitude of the decrease in a particular quarter as significant compared to recent trends or recent past declines.

Gary Lieberman - Wells Fargo

Have you had the chance to look back over the longer history and see if there are any similarities about the current quarter compared to maybe the last time that you did see something of this order of magnitude in the drop off of the case mix?

Milton Johnson

I do go back and look over some recent quarters and like I said, the typical movement in case mix index for Medicare has been an improving, or higher case mix index. So this is contrary to that typical trend. The decreases, when they did happen, were relatively small. So the magnitude of this change, and how sudden this change has happened, is not something that we could see coming in our trends.

Gary Lieberman - Wells Fargo

And then I guess is it just going to take another quarter, or will you be able to get some data mid-quarter that you would be able to share with us with an update maybe on more detail of what caused it?

Richard Bracken

I think we'll have to just monitor it as we go. We don't get into interim quarters reporting, and one month doesn't speak for a quarter very well. So my guess is we'll work our way through the quarter and have better guidance for you at that point.


Your next question comes from the line of Jake Hindelong from Ticonderoga Securities.

Jake Hindelong - Ticonderoga Securities

Good morning. Just going to try and find one other way to take an angle on the same question I guess. It sounds like lower acuity is factored into the second half outlook. Still, you're getting to 3.5% EBITDA growth. Did you have to make any cost assumptions or any changes to your cost assumptions, to get to that 3-5%?

Milton Johnson

Yes. We have factored in some cost improvements. We had already made some cost changes already in second quarter that we believe will carry through and benefit the remaining portion of the year. But also, the growth in EBITDA is going to be primarily in the first question based on our projection. And again, most of that growth is coming from the HITECH incentive payments that we expect to receive in the fourth quarter.


Your next question comes from the line of Gary Taylor from Citi.

Gary Taylor - Citi

The first one's going to be so fast, I'm going to ask two. The first one is could you just tell us the 2010 EBITDA number that you're using for your guidance of 3-5% growth? And then my real question is when you think about this year over year weakness, I guess, and the net revenue per adjusted admissions, how do you think about the comparison, and how strong the 2Q of 2010 was on that metric? Because if you look last year, you were still in the midst of making your accounting change of course. So you had weaker numbers, but the 2Q was by far the strongest quarter, so was there anything unusually good about the 2Q from acuity or mix or payer mix perspective that's influencing the year over year comp?

Victor Campbell

I'll take the easy one, the prior year EBITDA, $5.868 billion. And then Milton, you get the tougher one.

Milton Johnson

Gary, the only thing I can think of that changed was for the first part of last year we did benefit from what's called the Medicare 72-Hour Rule, which is basically allowing hospitals to unbundle billing for an outpatient, primarily an ER visit, if that patient is admitted within 72 hours of that visit. And we benefited about $8 million or so a month from that rule. That rule was appealed as of the end of June of 2010. So we did have that benefit. Again, that's about roughly $24 million a quarter. It was not something that we felt was material, although it is part of the difference in terms of year over year pickup with respect to the Medicare book. But other than that, I'm not aware of anything else.


Your next question comes from the line of John Ransom from Raymond James.

John Ransom - Raymond James

Can you just remind us why the bad debt number jumps around so much quarter to quarter? It was up a lot last year for example. Bad debt was materially higher in the second and third quarters and lower in the first quarter, lower in the first quarter. Could you tell us what your expectation is for bad debt for the back half of the year? Thanks.

Milton Johnson

There's a lot of movement and one reason we in our 10-Qs and 10-Ks we put so much disclosure around this issue, there is a lot of movement between what's written off as a bad debt, what could be written off above the line as charity or an uninsured discount. Primarily, what drives the variation in bad debt will be the amount of uninsured revenue that we have, and net revenue in any particular quarter. I'd say that would be the major factor. But then there's other changes again around these discounts and charity care, that would cause the variation. So I would ask all the investors to consider those adjustments and the bad debts in totality in looking at those trends, and we present it, I think, very clearly in all of our 10-Qs and 10-Ks to try and allow that information to be as clear as possible.


Your next question comes from the line of Adam Feinstein from Barclays Capital.

Adam Feinstein - Barclays Capital

Thanks for all of the details as always. Maybe just trying to think about, as you guys think about the disappointment in the quarter, how much of it was from all this mix shift stuff you've talked about. But at the same time, if we think about the uncompensated care coming in slightly higher, and the uninsured admits as a percentage of total, would you say that the mix issues were half?

And then on the mix issues, you spent a lot of time talking about that. But I was just curious, as you talked about the higher acuity cases, you mentioned cardio down 3.7%, but I just wanted to get a better sense for some of the other higher intensity surgeries like ortho and some of the other areas, just so we can put it in the right context.

Milton Johnson

Bad debt, yes, we did see a little uptick in our uninsured admissions compared to the recent trends. There was a slowdown in the state of Texas with some conversions that specifically happened from Medicaid payments from uninsured into Medicaid. Again, we think that that will work out over the rest of the year with some timing. That's, I think, a relatively modest impact on our quarter. I would not weight the increase in the uninsured volumes 50% of the problem at all. I would put much more of the weighting on this to the mix shift of service issue and primarily in the Medicare payer class is where the disappointment in this quarter would be based.

Victor Campbell

If you really look at that revenue differential Milton mentioned in his comments, if you look at what we did in the first quarter in the Medicare book, and if you would have had that same NRAA in the second quarter, that was an $85-90 million swing. You take that, put a margin on it, that's your differential for the quarter.

Milton Johnson

Yeah, surgical volumes in the quarter, I think I mentioned earlier that the drops - cardiovascular surgery down 3.7%. Neuro was basically flat. That's obviously a big one for us. Orthopedic surgery is up 2.4%. Women surgeries down almost 12%. But the biggest decline in terms of number of surgeries is general surgeries where we were down about 2.5%.


Your next question comes from the line of Doug Simpson from Morgan Stanley

Doug Simpson - Morgan Stanley

A lot of my questions have been answered. But maybe just to think through the quarter, how divergent were the trends from April to June? It sounds like you were able to offset some of this with the focus on costs. Just trying to understand kind of the June run rate. And then as we look to the back half of the year, how should we think about seasonality in EBITDA? Should it look like last year? Or do these dynamics impact it in any way?

Victor Campbell

Monthly trending - I know we saw this in all 3 months. I don't know if there was a material difference.

Milton Johnson

It was more material in May and June than it was in April.

Doug Simpson - Morgan Stanley

Okay, and then towards the second half of the year, as we think about EBITDA seasonality, what's a reasonable way to think about that relative to last year's seasonality?

Milton Johnson

As far as the percentage of EBITDA earned at any particular quarter, I don't know why this year would be different. Typically, the third quarter is the lowest EBITDA quarter. And I don't know why those ratios would change this year. Nothing comes to mind versus those prior year sort of ratios.

Doug Simpson - Morgan Stanley

So if we used last year and then added in the tech revenues, that would be appropriate.

Milton Johnson

Yeah, my comment was EBITDA, excluding of course any of the HITECH that we'd pull in.


Your next question comes from the line of Sheryl Skolnick from CRT Capital Group.

Sheryl Skolnick - CRT Capital Group

Thank you very much. I'm going to try to parse this out. As I'm sure you're aware, the stock is off 15.5%. My calculation, roughly under 4% decline in EBITDA versus expectations in the quarter. You were very clear in your guidance that first part of the year was going to be flat to down EBITDA, and that the mix shift was one of the greatest variables. If I recall your guidance correctly, deteriorating mix was one of the most significant risk that you faced.

So I'm going to ask the question this way, and sort of twofold. One, in your minds, you're clearly taking this seriously as you should. It's the second quarter out of the box. It's less than the Street expected, although I must confess not far off from my estimates, so maybe that's why I'm a little less concerned here.

But is this really the disaster the Street is making it out to be? And if you continue the current trends to the end of the year, would that be consistent with your guidance of EBITDA sort of going up in the neighborhood of 3-5% from the year inclusive of the HITECH payments, which is how I understand your guidance. In other words, basically flat to down EBITDA this year.

And lest we not forget, you did have, if I recall correctly, nearly 5% hit in your payments rate this year that we're absorbing, which is part of the reason for the decline. So the bottom line is to what extent, if we follow the trend through that you saw in the second quarter, for the rest of the year, would that be consistent with your guidance? And B, how much of a disaster is that?

Richard Bracken

Let me start with this one, and Milton, you can comment certainly on the forecast. Our forecast was our best thinking taking in all of these points on the 3-5% guidance. And relative to the bigger question, is it a disaster, I'm not sure I'd use that word. We were caught off guard like we said about the service mix being as much as it was.

We still think our company is very well positioned as an organization. In my comments I said that how we judged the quarter was - I used the word mix, because there were a lot of very strong trends in the quarter from an operation perspective. Volume continues to do well.

We believe this is a function of our executing our strategies. We like our strategies. We're not backing off our strategies. The investments we are making are expensive, putting this EHR in across 164-5 hospitals is a big expense for the company, and it's consuming a lot of energy and resources.

We're doing it because it's the right thing to do to position the company for the future. Likewise, in physician employment, integration, there is, as you know, a huge push by the medical community to seek employment with facilities and we are careful about how we do that, but it is expense now that we didn't have in the past.

These are appropriate investments to make for a company of our size, and our physicians, and our marketplace. And we're not backing off on it. We point to very strong cash production. We are able to handle this. We didn't like the quarter, clearly. We are looking to continue to manage expenses appropriately. We're looking to reengineer systems and as I think about it, our operating agenda today is the same as it was before the second quarter. It's spot on, and it's where we need to take the company.

Milton Johnson

Sheryl, your description of our new guidance I think is stated accurately, the 3-5% EBITDA growth is coming from HITECH dollars that we expect to receive, primarily in the first question. Absent HITECH, we would be flattish for this year would be our most recent guidance.

We did give guidance, you're correct, at flat to slightly down for the first, second, and third quarter of the year. I think what this 4.7% decline, when you factor in the Medicaid HITECH dollars in this quarter as well, it's down more than we expected. There's no doubt about that.

As Richard said, we're disappointed with it, but it is far from a disaster. It is something that we will continue to look at all of our operations, but it is below our expectation that we had coming in, but far from a disaster.

Victor Campbell

All right. I think at this point, we've gone a little beyond an hour, and I think I've heard almost every sell-sider get a pitch question. I apologize if we're missing anybody, but we're going to go ahead and call the meeting. Mark and I are here, obviously, all day, and please let us know if you need to talk about anything. Thank you very much for being on the call.

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