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Health Management Associates Inc. (NYSE:HMA)

Q3 2011 Earnings Call

October 25, 2011 11:00 am ET

Executives

John Merriwether – Vice President of Financial Relations

Gary D. Newsome – President, Chief Executive Officer

Kelly E. Curry – Chief Financial Officer, Executive Vice President

Robert E. Farnham CPA – Senior Vice President, Finance

Analysts

Adam Feinstein – Barclays Capital

A.J. Rice – Susquehanna Financial Group.

John Ransom – Raymond James

Ralph Giacobbe – Crédit Suisse AG

Kevin Fischbeck – Bank of America Merrill Lynch

Jake Hindelong – Ticonderoga Securities

Gary Lieberman – Wells Fargo Securities, LLC

Justin Lake – UBS Investment Bank

John Rex – JPMorgan

Thomas Gallucci – Lazard Capital Markets LLC

Darren Lehrich – Deutsche Bank Securities Inc.

Jason Gurda – Leerink Swann

Operator

Good morning. My name is Jessica, and I will be your conference operator today. At this time, I’d like to welcome everyone to the Health Management Third Quarter 2011 Earnings Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. (Operator Instructions) Thank you.

John Merriwether, you may begin your conference.

John Merriwether

Thank you, Jessica. Good morning, I’m John Merriwether, Vice President of Financial Relations for Health Management Associates. I would like to welcome you to Health Management's third quarter 2011 earnings conference call.

Before we get started with the call, I would like to read our disclosure statement. This presentation contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended.

Forward-looking statements are subject to risks, uncertainties and assumptions and are identified by words such as expects, estimates, projects, anticipates, believes, could, prospects, promising and other similar words. All statements addressing operating performance, events or developments that Health Management expects or anticipates will occur in the future, including, but not limited to, projections of revenue, income or loss, capital expenditures, earnings per share, debt structure, bad debt expense, capital structure, repayment of indebtedness, other financial items, statements regarding the plans and objectives of management for future operations, statements regarding acquisitions, divestitures and other proposed or contemplated transactions, statements of future economic performance, statements of the assumptions underlying or relating to any of the foregoing statements, and other statements which are other than statements of historical fact are considered to be forward-looking statements.

Statements made throughout this presentation are based on current estimates of future events, and the company has no obligation to update or correct these estimates. Listeners are cautioned that any such forward-looking statements are not guarantees of future performance and involve risks and uncertainties and that actual results may differ materially as a result of these various factors.

In addition, adjusted EBITDA, as mentioned on this call, is defined as consolidated net income before discontinued operations, net gains or losses on sales of assets, net interest and other income, interest expense, income taxes, cost for acquisitions in government investigations, and depreciation and amortization.

On the call with me this morning are President and Chief Executive Officer, Gary Newsome; Chief Financial Officer, Kelly Curry; and Senior Vice President of Finance, Bob Farnham. Thank you for your attention, and I’ll now turn the call over to Gary.

Gary D. Newsome

Thanks, John, and good morning, everyone. Thank you for joining us to discuss another solid quarter as we report our strong results for the third quarter ended September the 30th, 2011.

For the third quarter from continuing operations and compared to the same quarter a year ago, Health Management reported net revenue growth of 12% to $1.4 million, adjusted EBITDA growth of 14.9% to $195.5 million, not including acquisition and government investigation cost of $9.3 million, income from continuing operations growth of 24.2% of $49.7 million, and diluted earnings per share or EPS growth of 21.4% to $0.17 per share.

Contributing to these outstanding and continuing operations financial results were admission increase of 4.9%, adjusted admissions increased to 7.6%, the emergency room visit increased of 5.5% and surgery increase of 4.8%.

For a continuing operations at hospitals we have owned and operated for one year or more, referred to the same hospital continuing operations compared to the prior year's third quarter, revenues increased 4.7%, adjusted EBITDA increased 7.6% to $216.6 million, resulting in a 40 basis point improvement and adjusted EBITDA margins to 16.5%, and surgeries were up 20 basis points. Recall that our same hospital surgery growth in the third quarter last year was among the best in the publicly traded space at 5.5%.

There are combination of outpatient services growth that continued declines in uninsured admissions, same hospital adjusted admissions grew nearly 1% in the third quarter compared to a year ago, while same hospital admissions declined 1.8%.

Excluding the declines in uninsured admissions of the same hospital facilities, same hospital admissions would have declined only 0.9% compared to the year ago quarter and same hospital adjusted admissions would have grown more than 1%.

As we have stated before, we believe our strong results reflect that continuing efforts to invest in innovation, recruit immediate physicians and deliver higher level services and these results further confirmed with the business we are attracting is good business.

The lack of cath labs to improve the economy continues to way, as we continue to see reluctance on the part of people to take time for more to address illnesses. Stability and physician business continues but patients are very varied of inpatient hospital business in what is their economic and employment situations.

Outpatient activity however remains constantly strong. Our focus is not wavered on our market share development initiative as we expect to continue to invest in innovation and capture market share for services that were previously not provided.

Likewise, our ERs are still a front door to our hospitals and addressing community needs through physician recruitment is crucial, but we will continue to implement our three prompt operating strategy.

Implicit in that operating strategy is a directed approach to cost control, to manage our expenses based on the volume and revenue we receive. We will continue to look for opportunities to improve our expenses controls.

We believe our results continue to illustrate in our operating approach and cost controls are successful. While opportunities for improvement exist at our same hospital facilities, the recently acquired facilities have the most opportunity as we seek to improve operating margins at these hospitals that the level of our same hospitals within four years.

As you recall, on September 30, 2011 a subsidiary of Health Management completed its acquisition of substantially all the assets at Mercy Health Partners, which was a subsidiary of Catholic Health Partners.

As a result, Health Management has acquired or leased all seven of Mercy`s hospitals, which include a total of 1,323 licensed beds as well as additional continuum-of-care services that are part of the Knoxville-based East Tennessee health system.

Also on September the 30th, the former Mercy System was renamed Tennova Healthcare. The new name represents Health Management’s commitment to building that fully integrated innovative health care system in the Knoxville area.

Most recent trailing 12-month revenues for the Tennova hospitals were about $600 million in the hospital integrations moving along as expected. We expect to achieve our first year return objective.

So when we look back to December 9 and review our acquisitions, we have added nearly $1.3 billion or 25% of acquisition revenue at very attractive prices, 25% increase of that. With the opportunity to take these acquisition hospitals with historically zero or low single-digit operating margins and grow then to the hospital to the Health Management same hospital average of middle teen margins, our story is very compelling.

The pipelines for partnering the hospitals hasn’t slowed down, and we are receiving opportunities to review literally on a weekly basis, consistent with the hospitals we have already chosen to partner with Health Management, potential partners are seeking us out for our operational expertise, our systems, capital resources and even more importantly our patient-centered approach and cultural fit. It is the combination of these operational attributes with our flexible partnership structures of assets purchased, long-term lease or joint venture that makes us believe we remain the partner of choice.

Thank you again for your attention. At this point, I would turn the call over to Kelly for a review of our quarter in a little more detail.

Kelly E. Curry

Thanks Gary and good morning to each of you. I will just summarize from the press release we issued last night for the third quarter ended September 30. Again, our third quarter net revenue grew 12%, adjusted EBITDA grew a strong 14.9%, income from continuing operations followed suit, increasing 24.2%, with our diluted EPS rising 21.4% after a 1.7% increase in the number of fully diluted shares outstanding.

During the third quarter, the company incurred approximately $9.3 million or $0.02 per diluted share of acquisition and investigation related costs. Excluding these acquisition and investigation related expenses, diluted earnings per share from continuing operations increased 35.7% to $0.19 as compared to $0.14 per diluted share for the same quarter a year ago.

For the fourth quarter ended December 31, 2011, we expect to incur approximately $4 million to $5 million of government investigation related expenses, and in addition, we expect approximately $10 million $11 million of restructuring costs associated with Tennova acquisition. Same hospital operations continue to perform very well. Compared to the prior year’s third quarter, net revenue increased 4.7% and net revenue per adjusted admission growth was strong, growing 3.8%.

For the fifth quarter in a row, we have seen a decline in uninsured patients seeking care at our same hospital facilities. Unemployment rates in our markets have held steady and in some markets, we have seen declines. Continuing same hospital uninsured admissions for the third quarter totaled 6.8% of total admissions, which is an 80 basis point decrease from the same quarter a year ago and again the fifth in a row.

As you know, there are three components that comprise our accounts for uninsured and underinsured patients; bad debt expense, uninsured discounts, and charity/indigent write-offs. These figures are consolidated and include acquisitions. Bad debt expense for the third quarter was $178.9 million, or 12.8% of net revenue, compared to $156.7 million or 12.5% of net revenue for the same period a year ago. Higher co-pay and deductibles are contributing to this increase.

Uninsured discounts for the third quarter were $227 million compared to $212.1 million a year ago. Health Management’s charity and indigent care write-offs were $24 million from both the third quarter in 2011 and 2010. The sum of bad debt expense, uninsured self-pay discounts and charity/indigent write-offs as a percent of the sum of net revenue, uninsured self-pay discount and charity/indigent write-offs, which helped management refers to as the uncompensated patient care percentage was 26% for the third quarter compared to 26.4% for the same quarter a year ago and a 25.8% for the second quarter ended June 30, 2011.

Our adjusted EBITDA from continuing operations for the third quarter was $195.5 million or 14% of net revenue, a jump of 14.9% and a $25.4 million increase over the prior year’s $170.2 million, not including the government investigation and acquisition related costs of $9.3 million.

Our same hospital basis adjusted EBITDA from continuing operations for the third quarter was $216.6 million for our 16.5% margin, compared to $201.2 million or 16.1% margin for the same quarter a year ago. This represents an improvement of 40 basis points or $15.4 million in a 7.6% increase for the third quarter this year. We continue to believe, as Gary said, we have more runway with regard to cost control opportunities.

Moving over to the balance sheet and the cash flow statement; total assets as of September 30, 2011 exceeded $5.6 billion for the first time and cash with $88.4 million. The balance in our accounts receivable net as of September 30, 2011 was $799.1 million and the balance in the allowance for doubtful accounts was $554.7 million.

Health Management’s days sales outstanding or DSO as of September 30 were 52 days, approximately two to three days of that number are related to our acquisitions and system conversions. Our cash collections continue to be strong and we are achieving our internal targets. For the third quarter, cash flow from continuing operating activities was strong at $175.5 million after cash, interest and tax payments aggregating $44 million.

Capital expenditures for the third quarter were $69.8 million. With regard to our debt covenants as of September 30, Health Management's total leverage ratio was 3.87, compared to requirement of a maximum of 4.5, and our interest coverage was 3.73 compared to requirement of having a minimum of 2.9; both of these ratios are well within requirements of Health Management's credit facilities.

Meaningful use reimbursement, which has been a hot topic in the industry for several quarters and hence we reported in the second quarter, Health Management systems are stage one compliant and our hospitals are eligible for HCIT funds. During the third quarter, Health Management's hospitals received a little less than $1.8 million of Medicaid HCIT fund and no Medicare HCIT fund. Our first wave of five hospitals passed the Medicare accreditation period with flying colors and they are eligible for Medicare HCIT payment, which we’d expect to receive either at the end of the fourth quarter or during the first quarter of 2012.

The second wave of 10 hospitals began their accreditation period on October 1. We are expecting to receive approximately $30 million of Medicare and Medicaid HCIT money in the fourth quarter in the December 31, 2011. None of the anticipated fourth quarter HCIT money have been recorded nor have those monies been included in our 2011 financial objectives.

So in review, fully diluted EPS from continuing operations grew to $0.17, which represents the significant 21.4% increase as compared to $0.14 per diluted share for the same quarter a year ago after a 1.7% increase in the number of fully diluted shares outstanding. Excluding the acquisition in government investigation related expenses of $9.3 million, as described earlier, diluted earnings per share from continuing operations increased 35.7% to $0.19 as compared to $0.14 per diluted share for the same quarter a year ago.

Same hospital adjusted admissions increased nearly 1%, same hospital surgeries were 0.02% compared to a peer group leading 5.5% growth for the same quarter a year ago. Same hospital net revenue increased 4.7% and same hospital net revenue per adjusted admission increased 3.8%. And same hospital adjusted EBITDA increased 7.6% to $216.6 million and same hospital adjusted EBITDA margin increased 40 basis point to 16.5%.

Thanks again for your attention. I'll turn the call back over to Gary.

Gary D. Newsome

Thanks, Kelly. We are very pleased with the results of the third quarter ended September 30. We believe we’ll continue to have opportunities to improve our operations under really tough economy. And we are affirming our 2011 annual diluted EPS objectives of between $0.76 and $0.80 for the year or roughly a 20% increase, and 2011 diluted EPS compared to 2010.

We continue to believe our objectives are achievable by maintaining our focus and discipline on cost containment and our three operating strategies, which is via emergency room operations, which is truly the front door to the hospitals, our position recruitment as we develop plans, as we expand services there, which is tied very nicely with our market service development initiatives throughout all of our markets.

We're encouraged by the dedicated efforts of our hospital associates, divisional leaders, home office associates and medical staffs. We believe our patient-centered approach to delivering healthcare is working to improve outcomes for our patients and provide an enjoyable workplace for our associates and physicians. Without our people, we couldn’t make the difference we do in the lives of our patients and I’m grateful to all of our associates and physicians for the tremendous efforts they give every single day. Special recognition is deserved for our 35 hospitals named as top performers on key quality measures according to the joint commission, the leading accreditor of the health care organizations in America.

From a universe of approximately 2,900 joint commission of accredit hospitals and critical access hospitals reporting core measured performance data, only 405 hospitals nationwide or 14% of the evaluated hospitals are in recognition as top performers. We are very proud of our 35 health management hospitals recognized as top performers representing 60% other than 59 hospitals self-management operated throughout the US 2010.

Health Management provides the people process as capital and expertise necessary for our hospitals and physician partners to fulfill their local missions of delivering superior healthcare services.

Our strategy of ensuring the most modern, high-quality care remains close to the citizens of our communities is gaining ever increasing reports. Health Management stands ready to enable America’s best local health care.

Thank you again for your attention this morning and I’ll now open the call for Q&A.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Adam Feinstein with Barclays Capital. Your line is now open

Adam Feinstein – Barclays Capital

Great, thank you. Good morning, everyone.

Gary D. Newsome

Good morning, Adam.

Kelly E. Curry

Good morning.

Adam Feinstein – Barclays Capital

So, everything looks very strong here, just a couple of things I just wanted to follow upon. There has been a lot of focus throughout the industry on mix, so I just wanted to get any update you guys may have in terms of just anything related to makes any changes you saw in other quarter and you know, if you can break out any sort of numbers just curious as in terms of just what the trends are there like, (inaudible) are stable. And I guess you know thinking about it from a community prospective and also from a commercial versus Medicaid versus Medicare. So, just any big picture comments there would be really helpful. And then, I just have a follow up question as well.

Gary D. Newsome

Okay, well on an acuity basis, we had our (inaudible) 1.354 as compared to 1.37 in the prior year, so its a fluctuation that would be within what we would expect to see, but what happened is within our Medicare mix of business, we saw fewer surgery cases that moved to medical cases, we had more medical cases in the quarter than we did prior year. At the engineering part of that is that, we saw an uptick in our surgery cases from commercial, which offset the decrease, although that's not reflected in the acuity figure, because that’s for the Medicare. Does that make sense?

Adam Feinstein – Barclays Capital

Yes, definitely.

Gary D. Newsome

Okay.

Adam Feinstein – Barclays Capital

Definitely.

Gary D. Newsome

Now, I’ll let Bob talk to you about mix.

Robert E. Farnham

Yeah, Adam just as I mentioned in last quarter, we’re seeing fewer cardiac related procedures. Pacemakers were down mid single digits as our defibrillators. Same thing is true with stents we were down probably mid-to-higher single digits on stent usage.

On the flip side of it though spine was up 3% or 4% for the quarter, and hips and knees were up a little bit as well, so it’s basically the same trend in cardiac this quarter as we really have seen in last year and half, net impact at the case mix a little bit as Kelly has said.

With regard to the payers we’ve been a lot pretty consistent this quarter. We said the last year, year and a half we’ve seen a little bit of a slippage in the commercial percentage of our total and it was down a little bit less this quarter than we’ve seen in a long-time probably 20 basis point as a percent of total admissions on a commercial side. And of course we mentioned about 80 basis points decrease in the uninsured, which is good thing and so that the 100 basis point difference there is increased in Medicare and Medicaid business. So that’s sort of how the surgery shook out with mix and then payer as well.

Adam Feinstein – Barclays Capital

Okay, great. Bob thanks. So then just maybe a follow-up question for Gary, so, with the Mercy deal you guys are seeing very about the opportunity there. You know this is the largest deal company has done, so may be if you could just talk a little bit more about the opportunity are there are any specific things about the market and just you know as you know think about it you know being a larger deal just is there anything different relative to things you guys have done the best?

Gary D. Newsome

It’s interesting. Although we officially took over October the 1, Adam we really have been on the ground in Knoxville with a team of operators and other expertise in terms of transitioning IP and other things for several months now. Really, from the time we announced the letter of intent, which has been excellent for us, because we’ve had a chance to get in and understand the market, the dynamics, the opportunities to really get close to the medical staff, which is quite extensive in a market like Knoxville and the surrounding areas. What’s great about all of that, we hit the ground running very strong on day one. The opportunities as you could imagine with three a very nice and from a service offering sophisticated hospitals, with opportunity there is no question about it to enhance in every situation there in the Knoxville market. And you add those outlined hospitals which are basically very – from the service offering, very complimentary because there will be a flow of patients for higher end services into the main hospitals there in the Knoxville market.

If you look at this, it’s really the opportunity to take a system and what I would call a system, a star of opportunity in Knoxville, not just in some of the Mercy hospitals to really look at the, collecting all the tremendous opportunities with the medical staffs, and to really tackle the service offerings in a way that’s never been done before, with the engagement we’ve had with the medical staff for several months now.

While we were very excited early on when we talked about this acquisition opportunity, our excitement has many fold increased after we had the opportunity to see the market, see the dynamics, look at the service offerings currently where we and strategic where our hospitals are located in Knoxville in particular are excellent. It’s in the growth opportunities, it’s in the growth market, and where people want to be, where doctors want to practice, and it’s a matter of doing the right things, giving the right tools, enhancing the right the correct services that we do there. Without giving any really the details, I can tell you that this is an excellent opportunity for us, and I think it really paved the way for us to continue to have opportunities in the future, because of this new transition we were able to achieve there.

Adam Feinstein – Barclays Capital

All right. Thank you.

Operator

So our next question comes from the line of A.J. Rice with Susquehanna Financials. Your line is now open.

A.J. Rice – Susquehanna Financial Group.

Thanks. Hello, everybody. Just because we finally got in, Kelly can you give us some indication on this [HITECH] payment. Can you give us more flavor about the $30 million in the fourth quarter is that just principally just Medicaid or you think you can get some Medicare money as well and what would that imply if you got that kind of step up in the fourth quarter to which you might be looking out in 2012.

Gary D. Newsome

Well, great question A.J. In terms of the quarter, most of that is Medicaid about $8 million or so would be related to the Medicare. And I’d tell you the truth, I don’t know whether we’ll see that in the fourth quarter or not for sure. You know that’s just matter of how quick they get their ducks in a row to do it. So but we definitely will see the Medicaid money and then, when we provide our objectives for fiscal year 2012, we’ll address you know what we think will be happening in 2012 with meaningful use, so you will get a number here and a little bit.

A.J. Rice – Susquehanna Financial Group.

And the Medicaid in the fourth quarter, is that covering a significant portion of portfolio or is it just.

Gary D. Newsome

Yeah, that’s covering a significant portion of the portfolio.

A.J. Rice – Susquehanna Financial Group.

Okay. Maybe just to have your comment on the pricing trends, because there are a lot of moving parts I know we had the Florida Medicaid cut go effective as a managed care rate. And frankly, what you’re seeing going into 2012, he just sort of gave us some flavor of within their context of that 3.8% were some of the components?

Gary D. Newsome

Well, I think Rice there are a lot of moving parts in there. That number one is, it’s that with respect to the rate cuts that we experienced in Florida, as we said at the time when we came back to reaffirm guidance on that, that we would mitigate against those by managing more efficiently, and that we have done to overcome. We’ve managed the situation.

In addition, 3.8 is really kind of a more normal run rate, we’ve seen some bumps in that figure because the growth in the outpatient that we’ve had and the additional surgery systems that we’ve added, because of the investments and technology we’ve made and innovation. So, the numbers bounce around a little bit, but that’s more typical of what we normally see and also we’re trying to through some of the big humps, and we still had a real tough comp on surgeries, and we came through that big hump, and frankly I think we came through it amazingly because not only that we come through a 5.5% comp that we actually grew it, so that was tremendous as of.

A.J. Rice – Susquehanna Financial Group.

That’s great. And let me just ask one final thing; obviously, there was two inquires right of JVs and the permits; is there any update on those even really mentioned in your prepared remarks.

Kelly E. Curry

Yeah. Well, not really I mean, what we did we are releasing the 10-Q today and we do expand our right up a little bit with respect to that, the reality is, now there is no more information to tell you that what we’ve already been saying, we basically what we’ve been doing and what was – the total was $4.5 million in the 9.3 which is related to legal expense was the cost of copy.

A.J. Rice – Susquehanna Financial Group.

Okay.

Kelly E. Curry

That’s what we are doing right now is we’re copying.

A.J. Rice – Susquehanna Financial Group.

Okay. All right, thanks a lot.

Kelly E. Curry

You’re welcome.

Operator

Your next question comes from the line of John Ransom with Raymond James. Your line is now open.

John Ransom – Raymond James

Good morning, I just wanted to know [Novant,] Mercy and HMA from a vocabulary, so maybe very careful to talk about Tennova.

Gary D. Newsome

Thanks John.

Kelly E. Curry

And Health Management.

John Ransom – Raymond James

Speaking of Tennova and just all of your acquisitions; should we model I think in given 2012 guidance, should we think about elevated CapEx over the next couple of years as you work through some of these systems that you bought; or do you think, okay it’s like we have.

Kelly E. Curry

Good, really good question. With respect to Tennova, we will be making some capital expenditures there, but three of those hospitals are brand new, so as far as tracking along within our usual 5% or so in net revenue type, we think we’ll stay pretty close to that as we go forward. One of the things about cap like health partners as apposed to some of the other circumstance we encounter is, is that they kept up with their maintenance capital, which is about 30% of your annual spend. So we don’t have that catch-up that we normally would on an acquisition, so the spending that we’ll be doing there will be related to expanding services, and as Gary was alluding earlier about the opportunities that we’ve identified in the marketplace in terms of how we need to coordinate and integrate our services amongst the seven facilities, which is hasn’t been done and when we do that we’ll be able to spend directly on that rather than going around replacing fire switches, boilers and air-conditioning chillers.

John Ransom – Raymond James

Great. In terms of Medicare high-tech monies, the formula looks at kind of a $1.5 million, $2 million per hospital; is that a good number to think about for you guys may be first quarter of 2012?

Kelly E. Curry

You mean looking ahead like for guidance for the next year?

John Ransom – Raymond James

Like guidance. It’s an innocent real question.

Kelly E. Curry

Well John, that would be inappropriate for me to comment on your reading of what the regulation say I think.

John Ransom – Raymond James

Have you guys hit all of the Medicare – when do you expected all the Medicare checklist parameters for meaningfully use phase I.

Kelly E. Curry

Well, we’ve already on the five hospitals that we tested. We passed with flying colors on all the checklist items. We know that our system works and that it works well. We are now rolling it out throughout our system and we will be doing that throughout the rest of this coming fiscal year. So we will be receiving those dollars over the next five years that they will be paid out.

John Ransom – Raymond James

Over the next five years?

Kelly E. Curry

Yeah, it’s a five year program for Medicare.

John Ransom – Raymond James

Okay. And then lastly…

Kelly E. Curry

So does your net present value affect that number, John.

John Ransom – Raymond James

I need my TI-35 calculator, but I don’t have it with me. This is the last question; what are your latest thoughts with your capital structure and the opportunity relative to the opportunity that you have?

Kelly E. Curry

Well, we’re carefully watching the markets. I’m sure you are well aware that circumstances in Europe have been kind of a hiccup to the market. It looks like we are moving through that, it looks like they are making progress over there, so we will continue to monitor and we take appropriate action as the opportunity presents itself to maximize the benefit to our capital structure as necessary.

John Ransom – Raymond James

All right. Thank you.

Kelly E. Curry

You’re welcome.

Gary D. Newsome

Thanks John.

Operator

Your next question comes from the line of Ralph Giacobbe with Credit Suisse. Your line is open.

Ralph Giacobbe – Crédit Suisse AG

Thanks. Good morning. Just on the surgery side; up 0.2%, any meaningful difference between inpatient and outpatient surgeries?

Gary D. Newsome

Well, obviously we’ve had, and I’ll let Bob give you a little more detail, but obviously our strategy is really been focused on growing the outpatient site and which is usually in the normalized market I think we have more of this a real pre-course of the inpatient surgeries and admissions, and of course we’re seeing some of that, but the reality is the growth that we’ve seen on the outpatient side continues to be very, very strong in surgery as well as other outpatient modalities. And this is really by design as we expand the services, recruit the right physicians and develop primary networks of the markets.

Robert E. Farnham

The inpatient surgeries have been slightly negative for the last couple quarters but as Gary have said the strength has really been on the outpatient side and that’s really carried today with the investments that we’ve made in market service development in conjunction with our recruiting. So, obviously the outpatient side has performed better as we’ve said all along that patients really will do anything really to avoid an inpatient stay and so if there is a choice they’re having something done on the outpatient side or deferring it.

Gary D. Newsome

Well to be just a little bit more specific; commercial patients have to basically be carried in it, okay, that’s quite because to spend a night. And Medicare patients are being careful too because their 401(k) has not performed right, so they don’t want to spend their deductable as quickly they might have in the past, so we’re still placing those kinds of circumstances with their current economy.

Ralph Giacobbe – Crédit Suisse AG

And then can you give us maybe an update on the transition from ProMed to MedHost and maybe just understand or help us understand the impact on DSO specifically from that transition?

Kelly E. Curry

Yeah, sure. We’re progressing very efficiently on that. We will be done around the end of the first quarter or shortly thereafter because we’re converting multiple facility at a time it's impacting our AR days because the process of converting over is essentially a five-day endeavor. So it's costing us a little bit in terms of, as we transfer the systems over a time period that we're losing in the process of doing that affects when we can crank to bill out.

Ralph Giacobbe – Crédit Suisse AG

Okay, that’s helpful, and just my last one; just in terms bad debt, I think you’d mentioned part of the reason it was up was increases to co-pays and deductibles, can you give us a little more detail, is it just the overall pool growing, what kind of growth rates are you seeing there? And maybe your collectability of that? And whether that's an issue or not?

Kelly E. Curry

You know, Ralph, what I would say about the quarter is that that's just a cyclical impact because our year-to-date is 12.4 versus 12.3. And in the third quarter, revenues are cyclical the bad debt calculation really are. So the percentage meter is up in the third quarter, so it’s really a function of that more than anything else.

Ralph Giacobbe – Crédit Suisse AG

Okay. So you’re seeing any increased co-pay deductible contribution...

Kelly E. Curry

We think that is, we’re seeing that, we didn’t see anymore in the third quarter than we’ve seen all year.

Ralph Giacobbe – Crédit Suisse AG

Okay, all right.

Kelly E. Curry

Which we anticipate with our when we gave the guidance since the beginning of the year and what we probably could say.

Ralph Giacobbe – Crédit Suisse AG

Okay, that’s helpful. Thank you

Kelly E. Curry

You’re welcome.

Operator

Your next question comes from the line of Kevin Fischbeck with Bank of America Merrill Lynch. Your line is now open.

Kevin Fischbeck – Bank of America Merrill Lynch

Okay, thanks. Just wanted to go through the guidance for a second here; so it sounds like your guidance does not include the two unusual items that you had in the quarter, that covers litigation costs, I guess in particular sounds like those might go on into next year, into next quarter as well. How are you factoring that into your guidance?

Kelly E. Curry

Well, actually the way we’re looking at it Kevin, I mean there is – I mean, you can decide as this make sense to you or not of course, but why we’re looking at it is the meaningful use more than offsets the – our acquisition cost that are related to bring on this number one largest acquisition we’ve got restructuring related cost and with respect to the legal cost that’s something we expect to go on for some period of time, we don’t know exactly how long. So that’s really included in our guidance and for – when we do guidance for the next year we’ll also include it.

Kevin Fischbeck – Bank of America Merrill Lynch

Okay. All right, so actually you made it takes it back so the number you’re using for Q3 in your guidance is $0.17 or $0.19?

Kelly E. Curry

We’re using $0.17

Kevin Fischbeck – Bank of America Merrill Lynch

Okay. All right. So that includes those costs and I guess it includes the cost from next quarter we are saying that, your guidance does not include the $30 million of Healthcare IT.

Kelly E. Curry

Yes.

Kevin Fischbeck – Bank of America Merrill Lynch

Why don’t you expect. But it does include the Healthcare IT billings you’ve gotten so far year-to-date?

Kelly E. Curry

Well, it’s $1.8 million or little less than that what we’ve got there, which is less than a $0.01.

Kevin Fischbeck – Bank of America Merrill Lynch

Okay, All right. And then I guess it’s a little early when you think about 2012 guidance are you going to include Healthcare IT payments at that point, do you have more visibility in that or is it still something you’ll probably talk about as a separate item?

Kelly E. Curry

I guess we’re going to be looking to you guys to see what our buyers is doing. We’ll follow the line of what everybody else is doing.

Kevin Fischbeck – Bank of America Merrill Lynch

Okay. And so far I guess only one company is really built it into their outlook but other companies yet to really weigh in on it. Okay, so that makes sense.

Kelly E. Curry

Well either way, we’re going to tell you what the number is okay and think it’s going to be…

Kevin Fischbeck – Bank of America Merrill Lynch

Okay. And it sounds like operationally the focus is going to be continue to be on a controlling cost. I mean can you give a little bit of on update on what exactly you’re seeing there as kind of the next line of initiatives to help you manage cost in this rate environment?

Kelly E. Curry

We’ve continue to tweak on our labor on a hospital-by-hospital basis that’s going to continue the supply let’s talked a lot over the last year and a half. Some initiatives are in place and some initiatives have some runway left to them. I can tell you on our GPO compliance high as its ever been, we talked about it at our Spinal Implants program, we brought a couple of more of our decisions on in that in the quarter and so we’re getting pretty much capitated vendor pricing company wide now.

I mentioned last quarter that we had some refreshes on our cardiac pricing from our three largest venders that was in the first quarter, middle of the first quarter. So that continues to benefit us. We’re now buying over 50% of our cardiac implants on both purchasing that saves us 5% to 10%. When we do that and that’s ongoing, our operating room we processing, we’ve taken that upper notch this year. So we’re saving more on that this year than we did last year and there are still opportunities there as well.

Our Trauma supplies, which is basically orthopedics outside of hips and knees are getting better contracting there with three of our larger vendors. So it actually increased the number of vendors there to get better pricing and HPG was part of that and that became a fact of just a few months ago.

So that will continue, I’ve talked about our HPG global sourcing program, that just went in fact this last quarter and we are beginning to see 15% to 20% savings on a number of items there and our drug cost rather a small portion of our supply line they’re doing a great job there with medication, use management in the areas of antibiotics and formularies our drug costs for just patient, they continue to be down over 5%, year-to-date. So all those things are in process, we still have some opportunities within a lot of those specific initiatives.

So we’re going to continue to take advantage of opportunities and look for ways to drive our supply cost down as a percent of that.

Kevin Fischbeck – Bank of America Merrill Lynch

Okay. Great, thanks.

Operator

Our next question comes from the line of Jake Hindelong with Ticonderoga Securities. Your line is now open.

Jake Hindelong – Ticonderoga Securities

Yeah, good morning. Just a couple of questions. First, is the Tennova third quarter cost a one time or is there going to be some incremental is broken out in the fourth quarter?

Kelly E. Curry

Yeah in my comments I’ve said that that cost have run $10 million to $11 million of restructuring cost that we expect in the fourth quarter and that would be more than offset against the meaningful use.

Jake Hindelong – Ticonderoga Securities

Great. Okay thanks, Kelly. And then as far as the of course the timing you’ve meaningful used payments are out of your control. But what is the lever that would either bringing that Medicare payment in to the fourth quarter or have it in the first quarter of next year?

Kelly E. Curry

We get the money and put it in the bank, in other words them showing up with the check, I can tell you that I can tell you that there are a lot of times Medicare, intermediaries or a little bit on the slow side of implementing things you required them to pay as opposed to how quick they are on things that require them to recover.

Jake Hindelong – Ticonderoga Securities

All right, all right, terrific. Thanks guys.

Kelly E. Curry

Thank you.

Operator

Your next question comes from the line of Gary Lieberman with Wells Fargo Securities. Your line is open.

Gary Lieberman – Wells Fargo Securities, LLC

Thanks. I was hoping maybe you guys talk a little bit about the physician recruitment environment, the mix of specialists versus general practitioners that you were recruiting and also the mix of docs employed versus non-employed that you’ve accrued?

Gary D. Newsome

Well, really the mix of physicians that we’ve recruited over the last couple of years has really been a 50/50 primary care to specialists and we see that trend continue. Number one is we want to continue to build our primary care network, our physicians that’s very important regardless of what happens into reform environment. We need to have a solid primary care environment, we need to fulfill the community need, where we have attrition, we also as we expand services, we need that type of support for services that we have had historically; not just on the specialist side, and we need primary care to support those efforts as we go forward.

We continue to see newer physicians that are coming out training, really looking for the employment model, either in employment model at the large existing group in a market places there are in some cases coming in to the Health Management physician network, which is the employment model that we have in many of our markets, but not all of our markets. We currently have around 1,000 providers that are employed. We see that continue to grow as far as our physician recruitment as we add.

We’ve added over the last couple of years over 600 physicians and see that trend continuing this with next year as well. But there is the new physicians coming in at least half or employ 50% are employed. We will see that trend changing in such…

Gary Lieberman – Wells Fargo Securities, LLC

Do you have a number for total recruited docs through the end of the third quarter?

Gary D. Newsome

End of the third quarter, a contract to be over 600 for the year.

Kelly E. Curry

Yeah.

Gary Lieberman – Wells Fargo Securities, LLC

Okay, great. Thanks a lot.

Operator

Our next question comes from the line of Justin Lake with UBS Securities. Your line is open.

Justin Lake – UBS Investment Bank

Thanks, good morning. First question just on the utilization side, we’ve seen there some evidence that doctors that may have picked up a bit later in the quarter also hearing that the birth rate might be up a bit, just curious if you seen this in terms of your business general and then maybe from your employed docs are seeing some of that. And whether that has led to any general pick up on the hospital side as you went through the quarter?

Gary D. Newsome

We’ve seen some increases in visits in our employed physician practices and part of that quite frankly as we mature these practices, they are going to get busy and busier. But even in practices that are mature, we’ve seen some increases. The reality is as Kelly had mentioned earlier, we mentioned several times, there is a tremendous reluctance for patients, we hear in time and time again from not only our employed physicians but independent physicians in the marketplace especially procedure based physicians that patients are at all cost avoiding, putting off any type of inpatient stay if they possibly can. And the reason for that they’re really worried about their employment status having been out of the market or out of – for any length of time, trying to recover from this type of surgical procedure. And we hear that, we heard that now for this entire year and we continue to hear more and more of that. So while we’re having, I think over time the economy will improve, I'm not going to predict win, but the fact that people are coming back to physicians’ offices in bigger numbers. I think again, as a precursor that there is so much pent up demand that eventually they’ll have to come back into the systems to some of these more higher-level procedures that were resolved in inpatient stays.

Justin Lake – UBS Investment Bank

Okay. When did you start seeing that pickup and any important magnitude as far as what the rate of change was in the third quarter?

Gary D. Newsome

Well, we've been seeing our same-store clinic practices have been seeing growing visits last several quarters. So people are going to the doctor that is helping to each other. What we also see is, we’re seeing that if you’re a runner, okay, and you’re coming because you knee is bothering you, and you’d say your family practice stop. And he says, well you know, I really need to refer you to an orthopedist. Well, the guy is saying, give me, get me a shot. And so, you (inaudible) to see the doctor, I’ll give you the shot to go see the doctor. So he’s given the shot and then referring, but the guy is not following up on the appointment.

Justin Lake – UBS Investment Bank

Got it.

Gary D. Newsome

I mean, that is up significantly, okay. That people are not following up on their appointments. They want to get it fixed, okay and then put it off.

Justin Lake – UBS Investment Bank

Got it. And any change in the birth rate that you’re seeing in the quarter?

Gary D. Newsome

Yeah. It's well, during up till this quarter, we had seen a decline. It’s come back to where it's not quite up, it's not that what we were seeing before, but it’s getting there.

Justin Lake – UBS Investment Bank

Got it. And last question, can you just walk us through the pair mix number I apologize, if you had said before, I missed it, and what you saw there in the quarter and specifically whether you saw any change in the trajectory of commercial volumes start to stabilize here at all?

Robert E. Farnham

It is Bob. I was saying earlier that over the last year and a half, we've seen a little bit of slippage in commercial and the slippage will actually last this quarter than I’ve seen in quite a while. I look at it on a part total basis and there was about 20 basis point slippage in the commercial admits part of total, and Kelly had mentioned that 80 basis point reduction in uninsured. So that 100 basis points flipped to Medicare and Medicaid government payers, and so that's what happened this quarter.

Justin Lake – UBS Investment Bank

And that 20 basis points was higher, looking back, and what was the number going back the last few quarters of your service [creditor]?

Robert E. Farnham

Yeah. Actually lower, we had been about 50 basis points to 100 basis points going back, last year, yeah and a half. So more stability this quarter than what we’ve seen over the last year, year and a half.

Justin Lake – UBS Investment Bank

Great. Thanks for all the color.

Operator

So our next question comes from the line of John Rex with JPMorgan. Your line is now open.

John Rex – JPMorgan

Thanks. I was wondering if you could just step us through Mercy again, kind of an updated view in terms of contribution year one, year two kind of how you expect that to come in those first couple of years and getting the trajectory and getting to your target margins?

Gary D. Newsome

Well, what we often see, John typically is that even where there is a positive EBITDA there, likely as a lot of non-recurring items that will be in there. So, we’re really talking about essentially a breakeven situation with the Tennova hospitals for our practical purpose. So as usual, what we would say is that we can get that to mid single digits or so in the first 12 months. We’ve got work to do on gas and services that we’ve identified, that will add additional opportunities for revenue growth and improve our results on margins. So that over the four years, we'll get to the 16% same store margin that we get on a same store unit.

John Rex – JPMorgan

Okay. But you still be looking for this to be a break-even in year one, even accommodating any other restructuring you incur?

Gary D. Newsome

I have more positive views in that first year. I would tell you then in the fourth quarter, it's going to be neutral to us.

John Rex – JPMorgan

Okay. So if you see some large contribution in here. Okay, great. Thank you.

Gary D. Newsome

Welcome.

Operator

So our next question comes from the line of Tom Gallucci with Lazard Capital Markets. Your line is now open.

Thomas Gallucci – Lazard Capital Markets LLC

Good morning. Thanks for all the information, maybe just a couple of quick ones following up. You mentioned the acquisition of Landscape is pretty active. How would you compare sort of the average that’s in there is a sort of a small deal that we see in the past or maybe something more or like to know where there any of those out there?

Gary D. Newsome

In fact, we see opportunities of all sizes. Obviously an acquisition like Tennova is fairly unique for anyone in the industry with seven hospitals in that type of concentric market. But we do see in the horizon big and small opportunities, some the more traditional that we’ve seen historically for Health Management and then some bigger ones as well.

I think really what’s exciting for us is our partnerships that we’ve had with some of the large not for profit providers out there. The success we’ve had in the other industry is very small and we (inaudible) these organizations are available to each other fairly easily and so our partnerships are really our best sales force out there in terms of newer partnerships coming down the road.

So we have in our pipeline, we are in discussions with opportunities with partners that I think are just outstanding for us, are unique, sets us apart and will really help us develop basis of operations, not too similar maybe from a Tennova acquisition maybe not for their scale, maybe [self], but it’s pretty exciting for us and we’re looking forward to the next year so and how all those things develop for us.

Thomas Gallucci – Lazard Capital Markets LLC

Did you see any buyers for your partnerships as you mentioned or outlet acquisitions or they are sort of a lot of both available out there?

Gary D. Newsome

There is actually a lot of both out there. There are some 100% acquisition opportunities as well as the partnerships. The partnerships really have a unique flavor for large established systems that have big hub of operations but then may have hospitals that are in communities, similar to the hospitals that we’ve operated historically. So there is a lot out there, but it’s really a mix of both.

Thomas Gallucci – Lazard Capital Markets LLC

Okay. And then just in managed care environment, over and above absolute weight are you seeing any changes in terms of how contracting is being done even more toward your incentive type payments on quality or trying any sort of global payments generally as you look further up?

Gary D. Newsome

Not really.

Thomas Gallucci – Lazard Capital Markets LLC

So it’s still pretty much the status quo when you’re getting sort of mid single digit price increases on typical contracting?

Gary D. Newsome

You know five to seven and probably closer to the seven. I don’t – I think where you’re seeing maybe some activity in that area is going to be in the more larger urban markets and maybe with them finally getting some maybe more reasonable ACO rules out there you might see that there is going to be opportunities that for different arrangement than the traditional.

Thomas Gallucci – Lazard Capital Markets LLC

And any comment on the reason issue where you know you’ve sort of been negatively disposed that in the past, Kelly. You said these are maybe a little bit more reasonable or any views on changes that maybe make the more reasonable?

Kelly E. Curry

We’re re-looking at it, because the rules are more reasonable it’s not ACOs, that I’ve been maybe not so excited about it, the rules that we talked with didn’t excite me, but we’re looking at them now, we’re looking at how we can make some sense out of it and we’re going to continue to do that, because moving to I mean certainly as we look at where Healthcare is going to in the future in some form of that.

Gary D. Newsome

Yeah this is, Gary. In reality, if you look at the ACO just a very high level what it helps bringing to the market plays as well as bundle payments or all those things. The things we’ve been doing over the last few years in terms of developing our markets, expanding our footprint, getting a wide variety of outpatient portals on to our system, these are all the right things to do. So we positioned ourselves very well to be able to tackle ACO environment, bundled payment environment whatever we have in each and every market is going to be a bit unique.

Thomas Gallucci – Lazard Capital Markets LLC

Okay. Thank you very much.

Gary D. Newsome

You’re welcome.

Operator

Your next question comes from the line of Darren Lehrich with Deutsche Bank. Your line is now open.

Darren Lehrich – Deutsche Bank Securities Inc.

Okay thanks, good morning everybody. Gary, I just wanted to follow-on on that. That last question just specifically on the CMMI bundled payment models; do you guys have any definitive plans to pursue them at this point. It seems like that the process is starting to play out right now?

Gary D. Newsome

Yeah, we do have a plan and it’s very market specific and that we’re very much engaged in the whole processes of understanding and deploying and participating as appropriate in these bundled payment arrangements, yes.

Darren Lehrich – Deutsche Bank Securities Inc.

Okay. And how many hospitals would you expect to participate there?

Kelly E. Curry

Well, we’re just looking at it from the standpoint that you know where does it make sense, what kind of opportunity, you know can we combine together for it to make sense for us in our operation. So obviously from your perspective Darren, you know one of the things, it doesn’t exercise much in Haynesville, Kentucky right.

Gary D. Newsome

It’s the larger markets that really makes the more sense.

Darren Lehrich – Deutsche Bank Securities

Sure, okay, and then if I could I just want to clarify two things that were brought up previously. The first is, just you know broadly on the investigations you know things for telling there will be a little more discloser in the queue here. But just the activity level in general and could you comment you know do you have any better sense for scope. It seems like 4 million to 5 million of legal and copying is still a fairly large number, so can you just put that in perspective relative to the activity on these matters.

Kelly E. Curry

Yeah in reality, the costs associated early on, we’ll go down over time and it will fluctuate. There will be fluctuations in that over time. We really don’t have an end point out there, but we do know that as far as what we’ve said and what we’ve disclosed is that has really ended very early stages of any type of data collection, the valuation of the data and cooperation with the government. I think that’s important you know very cooperative and I think we’re doing the right things in the process. But that cost will fluctuate up and down and over time that will tell us.

Darren Lehrich – Deutsche Bank Securities

And then last thing here, just you said 10 hospitals are rolling out for a meaningfully stage one. Is that sort of the right number per quarter over the next few quarters or does that number get bigger you know in 2012, just maybe put that 10 number and I guess you said five already have achieved it.

Gary D. Newsome

We’re lot more (inaudible) is that we’re rolling it out so that we know it’s that because what you don’t want to do is fail any of the screens. So we’re rolling it out right of late to see to make sure that we don’t have any (inaudible) part of the process you know is with the line of under data you bring into it. Okay, so you’re going to have those systems in place. As we get better and better kind of like doing the net house conversion we’ll be able to do more, but initially we’re just we’re going at it very right.

Darren Lehrich – Deutsche Bank Securities

Okay. I think where I was going with this was just if so, we go from 5 to 10 to 20 does expense associated with that you know change meaningfully. So you’re telling us $8 million in the quarter, but you know can you just frame the offsetting cost for that if there is much.

Gary D. Newsome

No, there is not. The cost is really not material relative to the money that we’re talking about it all.

Darren Lehrich – Deutsche Bank Securities

Okay

Gary D. Newsome

Our cost is because we were a very self development shop

Darren Lehrich – Deutsche Bank Securities

Great

Gary D. Newsome

You know we haven’t said what we’ve spend, but I’ve got to tell you we’ve had not a lot of money.

Darren Lehrich – Deutsche Bank Securities

Okay. That’s helpful thanks a lot.

Gary D. Newsome

You’re welcome

Operator

And we have time for one more question. Your final question comes from the line of Jason Gurda with Leerink Swann. Your line is now open.

Jason Gurda – Leerink Swann

Hey, thanks for the opportunity, but actually all my questions have been answered

Gary D. Newsome

Oh, outstanding. Thank you. Thanks for listening.

Robert E. Farnham

Thank you.

Kelly E. Curry

Thank you everyone.

Operator

And this concludes today’s conference call you may now disconnect.

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