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Executives

William Carpenter - President and Chief Executive Officer

David Dill - Chief Financial Officer

William Hoffman - Senior Vice President for Government Programs

Analysts

John Ransom - Raymond James & Associates

Darren Lehrich - Deutsche Bank

Ken Weakley - Credit Suisse

Tom Gallucci - Merrill Lynch

Christine Arnold - Morgan Stanley

Whit Mayo - Stevens Inc

Adam Feinstein - Lehman Brothers

Shelley Gnall - Goldman Sachs

Erik Chiprich - BMO Capital Markets

Gary Lieberman - Stanford Group

Matthew Ripperger - Citigroup

Bill Bonello - Wachovia

Gary Taylor - Banc of America

Sheryl Skolnick - CRT Capital Group

LifePoint Hospitals, Inc. (LPNT) Q3 2007 Earnings Call October 26, 2007 10:00 AM ET

Operator

Ladies and gentlemen, thank you for standing by and welcome to the LifePoint Hospitals Third Quarter 2007 Conference Call. During this presentation, all participants are in a listen-only mode. Afterwards, we will conduct a question-and-answer session (Operator Instructions). As a reminder, today's conference is being recorded on Friday, October 26th, 2007.

It's my pleasure to turn the conference over to Mr. William Carpenter, President and Chief Executive Officer of LifePoint Hospitals.

William Carpenter

Thank you, Pamela, and good morning. I'd like to welcome everyone, especially our stockholders, and also our employees, physicians and community leaders to today's call to discuss LifePoint Hospitals’ third quarter 2007 earnings.

On today's call we will be making forward-looking statements based upon management's current expectations. Numerous factors could cause our results to differ from these expectations. We outline those in our filings with the SEC and encourage you to review these filings. We also ask that you please review the cautionary language under the caption Important Legal Information in our press release.

The company undertakes no obligation to update or make any other forward-looking statements whether as a result of new information, future events or otherwise. Also, please visit our website for a link to various information and filings.

We filed our 10-Q for the third quarter last night simultaneously, with our press release, consistent with our past practice, this 10-Q provides detailed information, which should further assist you in understanding the results for the quarter ended September 30th, 2007.

On today's call, I'll begin by discussing certain key activities that are going on at the company and then David Dill will provide financial information about the quarter. After that, we'll open up the call for questions.

We recognize that many of you have back-to-back calls this morning. So, we'll do our best to move things along and to be concise and relevant in our remarks. We should be able to do so I think, unless, of course, you prove me wrong.

Let me note that Bill Gracey who is normally here with us, is not here this morning. Bill had a little outpatient surgery yesterday. Checked in with him this morning, he's doing great. I'm only disappointed that he doesn't live in one of our LifePoint communities. He does have good insurance but he's doing fine. He'll be here Monday. If there are any questions that you have that need Bill, he'll be in the office again next Monday. So let's get on to our quarter.

Really, when you reduce the third quarter to its simplest terms, our results can be defined  by good adjusted admission growth, along with solid expense management, including improved contract labor and a moderation in bad debts. I'm pleased this morning to be able to report results which are consistent with the expectations we set out on our last earnings release conference call.

These results reflect a lot of hard work by our hospital teams and corporate support personnel, as we continue to battle against the issues that face our industry generally and our company specifically.

In addition, I believe that our results are beginning to reflect in the very early stages, some of the strategic initiatives that we've been working on and that we're beginning to implement. As I have discussed over the past few months, we've been focusing a good bit of our company's efforts on five key areas, many of which you have heard us speak about on recent calls and at recent investor meetings.

Our five ongoing areas of focus are, 1) continuing to drive organic growth; 2) building on our strong heritage of excellent operations to maintain or improve operating margins at all our hospitals; 3) leveraging our scale to have our corporate center add increasing value in supporting our hospitals in areas like purchasing, revenue cycle and clinical quality; 4) getting back in the M&A game in a measured way, and 5) continuing to focus on retaining, developing and building our talent.

These areas of focus are of course in addition to our historical focus on operations and expense management. We're currently at varying stages of planned development and execution across each of these areas. This morning, I would like to highlight a couple of the initiatives that we're pursuing where the execution is a little bit further along.

With regard to organic growth, organic growth has always been a priority area for us. As we’ve highlighted on numerous occasions, physician recruiting has been a big part of this effort, and we're very pleased with our results. At this point in the year, we’ve met our goal of 167 recruited physicians as we have already signed 170, of which 96 have started.

Recently, we, like most in the industry, have experienced pressure on volume, but over the past few quarters, our growth and specifically adjusted admissions growth, has begun to pick up. Some of this is, we think, related to our significant emphasis on this initiative. This year our quarterly same store growth in adjusted admissions has ranged between 1.5% and 2% and was 1.9% in the third quarter. This improved performance has been driven in large part by a few important initiatives.

Recently, we focused on diagnostic imaging and outpatient surgery. One thing we've done was to make a significant group buy, since about this time last year, of 29 multi-slice CT scanners. At this point, we’ve deployed 21 of those, 16 of those are 64 slice units. Technology that's comparable with hospitals in any setting, urban or rural.

As a result, we have seen a significant increase in our outpatient CT volume. Outpatient CT revenue is up over 23%, with volumes up 17% in ‘07. This has been a very good investment for us and has contributed to our margins. We continue to believe that in many of our markets, there remains considerable opportunity to expand the scope of our services and thereby provide more care for our patients closer to home.

In the next year, you will see us make a concerted effort to streamline our outpatient processes for added patient and physician convenience. And, we'll continue to invest in new imaging technologies and advanced surgical capabilities.

In conjunction with this focus on growth, we’ve made a conscious decision to invest in targeted resources at the corporate office to assist our hospitals in maximizing market share for existing service lines and adding new lines of business.

These resources include dedicated folks in end-market business development, hospital marketing, physician referral development, enhancing surgical and imaging efficiency and service line analytics. On top of these efforts, as we’ve discussed previously, we're in the process of developing strategies for key service lines in a number of our local markets.

Initially, we will be focusing on our largest hospitals. The top eight of which represent over 40% of our total revenues. So far, we’ve conducted four of these intensive reviews, what I call deep dive reviews, to develop service line strategies. Through the remainder of this year, we'll be developing local market strategies as a result of our deep dive reviews.

Our hospital CEOs in these markets will be developing detailed growth plans, designed to enable us to grow our share in these markets, while focusing first on the most profitable services. Following the deep dives, we'll take the knowledge that we gained there and incorporate that into our strategy reviews at our other hospitals, as each of them develops more detailed growth plans for ‘08 and beyond. Again, focusing first on the most profitable service lines.

In connection with these strategies, we'll be recruiting key specialists and making targeted capital investments. We anticipate for example that these local market strategies will lead us to take actions that are designed to grow specialized services, such as cardiovascular, cancer care, including oncology, surgery and GI services, much of which involves cancer and emergency services.

We expect these efforts to lead to solid EBITDA growth over the next three years, as our volume in these high margin services ramps up. Throughout the year, we'll continue to share developments on this important topic. With regard to our corporate center, we have also been making some changes here where we have made some targeted investments in people who are bringing additional support and expertise to our hospitals, notably in areas like purchasing, revenue cycle and clinical quality.

We'll continue to focus our attention and resources in the hospitals, rather than in the corporate offices. We've been carefully adding people to our corporate team who will lead or oversee focused efforts across the hospitals. The goal here is to provide additional expertise in a leveraged way, supporting our hospitals without having to duplicate those resources in all our hospitals.

The results to date have been extremely positive on this. One key person whom we've added is Dr. Lanny Copeland, our Chief Medical Officer. Lanny joined LifePoint in August and since then has been focusing on improving core measures and thus, quality, across the company through education of our physicians and staff; strengthening physician relations through development of medical staff leadership; working with our medical staffs to help them better understand MS-DRGs and their impact on the hospitals, as well as serving as a resource for our administrative teams at each of our hospitals.

On a related note, I'm pleased to report that all of our hospitals received the full market basket update, based on having satisfied their core measure reporting requirements. In the area of purchasing, we have implemented our electronic data warehouse across all hospitals, which will allow our material managers to analyze our data at a level that has never been possible for our company in the past.

We have also added resources in the area of pharmacy and lab, where we have already achieved savings. And where we believe there is significant additional opportunity yet to be captured. With respect to revenue cycle, we have achieved approximately $12 million or 75% improvement year-over-year in up-front collections with approximately $5 million coming from our map program. We have a number of big hospitals, still scheduled to come on line in the map program and so we anticipate additional improvements here.

In addition, our passport program, which is a retrospective check on Medicaid eligibility, has been a big positive for us. With approximately $395 million in claims reviewed, resulting in actual cash recovered of over $1 million. While our corporate center enhancements to date have been extremely positive, we believe there's more opportunity to be captured as we roll out programs like these across our hospitals. And of course we'll continue to provide updates on this and our other strategic initiatives as we move ahead.

With respect to the IPPS rule change, as you are aware, on October 1st, CMS implemented a two year phase-in of Medicare severity weighted DRGs. This new classification system is designed to more precisely categorize the severity of illnesses and resource usage for Medicare patients.

As such, reimbursement funds will be redistributed from smaller, rural hospitals to larger, urban facilities. In the final rule, CMS also incorporated behavioral offset cuts of 1.2% for fiscal year 2008 and 1.8% for 2009 and 2010. As an industry, we were successful in having those reductions cut in half for the next two years.

To prepare for the implementation of MS-DRGs, we've been working on concurrent documentation improvement processes in preparation for the implementation of MS-DRGs.

We have a task force in place that has focused on communicating, educating and training employees affected by the change. We've taken precautions to ensure system readiness and accuracy. Ongoing education and support for our employees and physicians is occurring. And we're confident that our initial implementation efforts have been thorough and will lead to a successful transition to the new system.

David will provide information about the financial impact of the inpatient rule after he discusses the financial results of the third quarter, which I will ask him to do at this time.

David Dill

Thanks, Bill. It's been a busy quarter here at LifePoint. During my first 90 days, I've spent time in approximately 12 of our hospitals, which has been very valuable as I continue to learn both about the company and hospital industry.

In addition, I've spent time with many of the corporate departments here in Nashville to gain a better and deeper understanding of each of our key important processes. It is my pleasure to report our results for the quarter.

With respect to our results for the quarter, the same facility results in continuing operations results are the same due to us now operating the two hospitals acquired from HCA for a full 12 months. I would like to communicate our results today in the following manner.

First, consolidated financial results; second, volume; third, revenue; fourth, expense management; fifth, capital spending and cash flow and finally, changes in accounting and government reimbursement.

First, consolidated financial results. For the third quarter of 2007, revenues from continuing operations were $656.2 million, up 4.6% from $627.3 million for the same period a year ago.

Earnings before interest, taxes, depreciation, and amortization were $108.8 million for the quarter compared to $115.5 million from the prior year period and the related margins were 16.6%, compared to 18.4% from the third quarter of 2006.

Income from continuing operations for the quarter were $31.6 million, compared to $34 million for the same period a year ago or a decrease of 6.9%. Fully diluted EPS from continuing operations was $0.55 per share in the third quarter of 2007, compared to $0.60 a year ago or an 8.3% decrease.

For the first nine months of 2007, revenues from continuing operations were $1,971.7 million, up 11.5%, from $1,768.1 million for the same period a year ago.

Earnings before interest, taxes depreciation and amortization were $336.5 million for the first nine months of '07 compared to $330.4 million for the same period a year ago and the related margins were 17.1%, compared to 18.7% in 2006.

Income from continuing operations for the first nine months was $94.9 million, compared to $106.4 million for the same period a year ago, or a decrease of 10.8%. And finally, fully diluted EPS from continuing operations was $1.66 per share, for the first nine months of '07 compared to $1.89 a year ago or 12.2% decrease.

I would like to move to volume. Admissions from continuing operations were down 0.3% for the third quarter. However, adjusted admissions increased by approximately 1.9% as a result of strong outpatient gross revenue growth of 11.8%.

There were volume increases in outpatient imaging, lab, outpatient surgeries, and ER visits. During the quarter, our self-pay admissions were down 7% compared to the prior year, however, our self-pay adjusted admissions were up 6% due to a 13% outpatient self-pay revenue growth.

We saw total surgeries decline by 0.8% for the quarter. Inpatient surgeries were down 3.2% for the quarter; outpatient surgeries increased by 0.2%. ER visits increased by 3.6% during the quarter.

Third, revenue. As mentioned earlier, revenues increased 4.6% for the quarter this is being driven by adjusted admission volume growth of 1.9% and an increase in our revenue per adjusted admission of 2.7%.

Net revenue per adjusted admission increased approximately $180 to $6,757 during the quarter. This 2.7% increase in net revenue per adjusted admission was negatively impacted by approximately $2 million of net revenue declines related to lower prior year contractuals in 2007 and a re-class between bad debt and revenue of approximately $2.4 million related to our Lake Havasu ASC that I will discuss when I review our bad debt expense for the quarter.

These adjustments impacted net revenue per adjusted admission by 70 basis points for an adjusted growth of 3.4%. The revenue per adjusted admission growth slowed in the quarter, as a result of the outpatient adjustment factor growth of 2%, slower year-over-year growth in self-pay revenues and a decline in inpatient surgery volumes.

Self-pay revenues for the quarter were approximately $97.8 million, and represent a 4.4% increase over the prior year amount and a 1.9% increase over the previous quarter.

As a reminder, this does not include any amounts related to co-pays and deductibles as these amounts are reflected in our insured revenues. For the quarter, our self-pay revenues remained at just below 15% of our revenue.

The day sales outstanding have increased to approximately 44 days at the end of the quarter and have increased about 2 days, since the end of the second quarter. We typically see increases in our DSOs from the second quarter to the third quarter and this year was no exception.

Our allowance as a percent of gross AR has increased from approximately 50% at the end of the year to 59% at the end of the third quarter. This is being driven primarily from a slowdown in our write-offs during the period. I continue to feel comfortable with the consistency in the application of our policies to estimate our reserves and the allowances being applied to those revenues.

Four, expense management. Salaries, wages and benefits as a percent of net revenue came in at 39.6%, which was essentially flat versus the prior year. During the quarter, we did see improvement in contract labor. Same store contract labor was down approximately $500,000 from the same quarter a year ago and down $600,000 from the second quarter.

We continue to see improvements in our man-hours per adjusted admission with a decline of 1.3% from the prior year. However, we did see an offset to this productivity improvement. Our average hourly rate increased 5% versus the prior year. This is a result of adjusting our wage rates to stay competitive and an increase in the number of employed physicians in our markets.

Supplies as a percent of net revenue improved 50 basis points to 13.5% versus prior year of 14%. We saw improvement in our pharmacy cost combined with lower surgery related cost due to the inpatient surgery volume being down.

Other operating expenses increased 100 basis points to 18.3% of net revenue. We continue to see supply and demand pressures on professional fees, particularly related to anesthesiology services, hospitalists, ER physicians and ER call pay.

Bad debt expense for the quarter was $78.7 million compared to $67.8 million for the same period a year ago. As a percent of revenue, bad debt expense increased 120 basis points from the prior year, but decreased approximately 40 basis points from the second quarter.

As discussed earlier, we had a $2.4 million re-class from bad debt expense to contractual adjustments related to the Lake Havasu ASC. That re-class was necessary as a result of the final receipt of our provider numbers and after the provider numbers were received we went back and looked at how things had been recorded for the previous nine months and made the re-class during this quarter.

Absent this re-class, our bad debt expense would have been 12.4% of net revenue, our charity care for the quarter represented 0.8% of gross revenue or 1.8% of net revenues. For the quarter, our bad debt expense and charity care excluding the Lake Havasu ASC, approximated 13.8% of our revenues or $90.5 million.

As a result, we have provided approximately 92.5% of our self-pay revenues and if you adjust for the Lake Havasu re-class, the amount was approximately 95%. Of all the controllable expense items, our operators did an excellent job during the quarter and I want to thank them for their efforts.

Fifth, capital spending and cash flow. Our capital spending for the quarter was $38.5 million. For the first nine months of 2007, our spending has been $11.1 million and represents approximately 5.6% of our revenues for the year.

Based on our spending to date, combined with projects we plan to begin this year, we are now expecting to spend at or slightly below the low end of our range of our previously communicated guidance between $180 and $200 million.

Our cash flow from continuing operations for the quarter was $23.3 million, compared to $61.2 million for the same period a year ago. This decline in operating cash flow is a result of approximately $40 million of additional interest and tax payments paid during the quarter above our normal expected amounts. We expect to see these amounts normalize during the fourth quarter.

As of September 30th, we had total debt outstanding of approximately $1.517 billion and cash available on the balance sheet on $48.5 million.

And finally, the change in accounting and government reimbursement, there are two items I would like to share with you at this time that will impact our results in 2008. First, as many of you are aware, a current proposed accounting change, we increase our reported interest expense in two outstanding convertible debt instruments.

Currently, we estimate the range of additional non-cash interest expense that we would be required to reflect in our results of operations for 2008 under the current proposal to be $10 to $15 million net of income taxes.

This will impact GAAP fully diluted EPS by approximately $0.17 to $0.25 per share. The ultimate impact if implemented is highly dependent upon the fair value calculation of the instruments at the time those instruments were issued.

We are currently working on valuing these instruments and as we prepared to implement the new accounting standard. The company however, will continue to pay the lower cash coupon amount so there will be no cash flow impact from this change. The proposed accounting standard would also require us to restate all prior periods reported to reflect the change.

Second, as Bill alluded to in his prepared comments, effective October 1st of 2007, the new Medicare inpatient rates and changes went into effect. As a reminder, Medicare inpatient revenue represents between 20% and 25% of our consolidated revenues. Based on our current analysis, the market basket increase of approximately 3.3% maybe mostly or entirely offset by the impact of MS-DRGs, the behavioral offset and wage index changes.

In summary, the quarter developed as we had expected. Today we reconfirm our fourth quarter guidance of EBITDA in the range of $109 to $114 million and fully diluted EPS in the range of $0.55 to $0.60 per share.

With that, let me turn the call back over to Bill.

William Carpenter

Thank you, David and let me thank everyone at LifePoint for the way you've rallied this quarter, stayed focused on what we need to do and on the important work that we have left to do.

We appreciate how you've responded so well to the agenda that we set out for the company in the spirit of cooperation and focus that we're collectively bringing to this business. I'm also grateful to our shareholders for your continued support and for your interest in our company and its future.

I strongly believe that by staying focused on our strategic initiatives, we will achieve long-term success. The energy level and determination at LifePoint to fulfill our mission of making communities healthier and to improved performance has never been stronger.

As you know, industry headwinds are also stronger than ever. We've got a great team here. We understand the issues. And we're executing strategies to improve performance.

At this time, we are ready to take questions.

Questions-and-Answers Session

Operator

(Operator Instructions) Our first question comes from the line of John Ransom of Raymond James & Associates.

John Ransom - Raymond James & Associates

Hi, Good morning. Nice bounce back from the second quarter. The question I had was if you looked at year-over-year adjusted volumes and you strip out the uninsured, can you give us an idea of what the volume trend was with patients who have insurance cards, not the total number, but the kind of paid patient number for lack of a better term?

David Dill

The inpatient admission decline 0.3%, and we did talk about our self-pay admissions down about 7%. That only represents about a 150 or so admissions during the quarter. So, if you carve that, it has a very small impact on the overall number. It doesn’t even probably get us back to flat but it has a little bit of an impact.

John Ransom - Raymond James & Associates

So base is almost flat but what about adjusted admissions, if you carved out the uninsured from adjusted admissions. Do you have an idea of the volume trend there?

David Dill

It will go up a little bit but not much.

John Ransom - Raymond James & Associates

Okay. And then secondly, I'm going to torture Bill with his favorite topic. I know you have hired a new CEO up in Danville. Is there anything worth mentioning up there in terms of what you're looking for?

And is there any been any progress made that you can tell? I know you haven’t started yet but you could you update on us on that situation?

William Carpenter

Yes we really are seeing improvement at Danville. Incremental improvement. We've got the right guy coming there now; he'll start on Monday. We've got a new CFO we have got a new CNO. So we've got a team.

That's what we needed there, John we need leadership there in Danville in order to be able to execute the strategies that we have in place there. We've done an intensive review of all the systems at Danville.

We've had teams from our corporate office working very, very closely with the folks in Danville. So, we're making great progress as far as that goes. We're seeing our doctors becoming more involved with us in a proactive way, in a positive way, and I'm very, very pleased about that and I appreciate that. So, I feel like we're on the right trend in Danville. I look forward to Gerald getting there. I look forward to being there again, very, very soon, and supporting him.

One other thing I guess of some note, recently the Joint Commission has reconfirmed our full accreditation there. So, we got the official letter within the past couple of weeks. We were of course expecting that but it's always good to get that in-hand.

John Ransom - Raymond James & Associates

Sure.

William Carpenter

So positive things going on at Danville.

John Ransom - Raymond James & Associates

If Congress does repeal the whole hospital exemption as part of this year’s Medicare Bill. Is there a plan B for the Havasu market and does that concern you at all?

William Carpenter

We'll have to wait and see the way any bill comes through, of course. With respect to grandfathering, we'll make our plan B based on that.

We would expect there to be some grandfathering with respect to that. Some questions still exist with respect to future expansion capacity in that regard. So we'll continue to monitor it closely and we'll of course have plan B ready to go when and if there's a change.

Operator

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

Darren Lehrich - Deutsche Bank

Good morning, everyone. Few things here. I did want to talk a little bit more about the deep dive that you mentioned, Bill. You talked about some of the higher end services that you're evaluating but can you maybe just give us a sense for what are the key issues that you're seeing coming out of this process and I think you committed to doing six by the end of the year with your Board, so you've done four.

How do you feel about getting through the process? And then the corollary to this question really for David is just thinking about CapEx for next year, how might CapEx be impacted by some of these things? Thanks.

William Carpenter

Yes absolutely, Darren. We have done four of the deep dives so far. We will do seven by the end of the year. We're absolutely on track to do that. We're absolutely committed to making sure that those get done so that we see the impact from those in the next couple years.

This end market development work that we're doing is important in order to assist individual hospital management teams with service line expansion as they evaluate new programs and development there. I talked about surgical services. We're working very, very hard to assist surgery departments in becoming more efficient and responsive to patients and physicians’ needs with respect to quality and throughput, providing assistance to the emergency departments.

We're seeing returns there. We'll be assisting hospital emergency departments with patient wait times and throughput, as well. All of these things are patient satisfiers and physician satisfiers too. We've got to enhance the image of our hospitals.

We're seeing that. And so we're working hard to make sure that that comes through. That's going to be the result of improved quality. We know that. We just are constantly working on the quality aspects and Lanny Copeland is helping us, again very much in that regard.

With respect to capital projects, now I’ll turn over to David in just a second. We are committed to expediting our corporate review of capital projects that come out of the deep dives in order to more rapidly bring those new services to our patients and earnings for our shareholders.

One other thing I guess that's important, I would like to make sure that I don't forget to mention, is our commitment to physician referral relationships - it's more of a physician sales program. I don't really like to use that term, but that's what it is, a program that we're establishing at every hospital to make sure that we are responsive to what we're hearing from our physicians and working very closely with them.

David Dill

As it relates to the comments that we made earlier, even though the spending may come in at below the low end of that range, that's not indicative of us cutting back on any projects. In fact, we're pushing ahead.

It's only indicative of the amount of cash that we will spend this year, so anything that we don't spend this year would be built into our '08 cash flow numbers, so it's not a reduction of those projects. It's just more timing.

Darren Lehrich - Deutsche Bank

Thinking about CapEx for '08, if the range was going to be close to $200 million this year. Would that suggest that we should be higher than $200 million next year, just given all of these things coming out of this process?

I know you're not giving guidance at this point, but is that a fair assumption?

William Carpenter

We'll continue to invest back in our local markets. We won't be giving any guidance. We'll be looking at those as we go through the budgeting process.

Darren Lehrich - Deutsche Bank

Okay. And then just as far as the people side of things, Bill, just as it relates to these things that you're working on, where are you, what stage are you in building out all the teams necessary to accomplish what you're trying to do at the corporate office?

William Carpenter

They are basically there.

Darren Lehrich - Deutsche Bank

Okay.

William Carpenter

There are a couple of positions that we continue to consider, but basically our growth team is in place and working very closely with Joni Koford, in that regard. We have the dedicated people that I talked about with respect to our corporate center with respect to lab and pharmacy and those other physicians and so we are on the ground and moving ahead.

When I say those people are at the corporate office, they're employed at the corporate office. Those people are spending 99% of their time at the hospitals and we're seeing the returns already with respect to the feedback that I'm getting from the hospitals about the assistance that they're providing to each one of the hospitals.

Darren Lehrich - Deutsche Bank

Great. And then maybe one thing I could just clarify and I'll jump off here. As far as the revenue per adjusted admission numbers, I just want to make sure I'm thinking about this clearly, David. You mentioned $2 million was related to prior period contractuals and that was a negative and if I think about this re-class, basically the two sort of net out on the EPS line, if I'm thinking about it correctly.

But, I want to make sure I know what that $2 million was. I think I understand the re-class part of it.

David Dill

Let's break those down. On the Havasu re-class, there were items during the first nine or twelve months of operating net as we were waiting on provider numbers, where we had recorded some reserves against those revenues down in bad debt. As we received those provider numbers we re-classed those out of bad debt. So bad debt expense came down when we did that.

We put in offsetting debit up in revenue. So revenue came down as well. There wasn't any effect on the income statement. You combine that with a change in the prior year contractuals of about $2 million, you get a total impact of about $4.4 million of revenue when you look at the growth relative to the third quarter of '06. And that's how you get from the $2.7 million to the 3.4% on an adjusted basis.

Darren Lehrich - Deutsche Bank

Okay. And then just in terms of reconciling the bad debt ratio, what is a good go-forward at this point? Are you going to give us any thoughts about fourth quarter on that one?

David Dill

Well, you know, our guidance that we gave you back in June was 12% to 13%. Last quarter we were at 12.4%; on the face of our income statement this quarter it's 12%. I thought it was important to share with you the Havasu re-class that won't be going forward. Had that not been there, we would have been at about the same level in the third quarter that we were in the second. And certainly right in the midpoint of the range for guidance.

Operator

Continuing on, our next question comes from the line of Ken Weakley of Credit Suisse.

Ken Weakley - Credit Suisse

Thanks and good morning everyone. I wanted to ask about the profitability of the Medicare business. Based on what you said, on the one hand your market basket a 3.3% and you got the offsets on the three things you mentioned, MS-DRG, behavioral adjustments and wage.

So looks like you’re basically a net zero for the next two years. So I guess the question is how are you going to manage your cost per case on the Medicare side given that you effectively have zero percent pricing for two years?

If I assume an average profitability on your Medicare side, commensurate with what are you do on the company haul that would wipe off at least half of the profit margins. I'm trying to think of what's going to happen or how you're going to manage this process because from it’s my point of view it looks like it's a big negative.

William Carpenter

Are you talking at this point just about the inpatient business? Because we will receive [inaudible]

Ken Weakley - Credit Suisse

Yes, just the inpatient.

William Carpenter

Well, on our other Medicare business we'll probably see a 2% or 3% increase in '08. Market basket type stuff.

Ken Weakley - Credit Suisse

I understand. I was hoping just to get some color on just the inpatient side. Inpatient Medicare.

William Carpenter

I just wanted to make sure we were clear on inpatient versus outpatient. We'll focus in on inpatient. I would just reiterate similar to what Bill had said in previous calls. One of the needs we need to focus on the five key initiatives is that those pressures do occur in third-party reimbursement we going to have to do a better job of managing the expense side.

He talked about the operational assessments that we're doing and the transitional services division and the focus that they will be bringing to the under-performing hospitals in terms of just an increased operational focus. He talked about the things we're doing on the value added corporate center in terms of looking at our costs in different ways, in new ways, in terms of having more data available, utilizing technology.

We will become more standardized as an example to hopefully lower our cost per case, particularly in areas from a technology perspective. So we will just continue to focus on the five themes that we have in our strategic plan and that should hopefully help us mitigate some of this margin erosion over the next couple of years.

Ken Weakley - Credit Suisse

I was going to ask, is the average profitability of an inpatient Medicare patient dramatically different than the corporate-wide average? And secondly, I had asked about the cost per case, if you know that number, could you give us a sense of what the cost per case increases are?

David Dill

We're not going to disclose any profitability lines. It's too difficult as you allocate certain fixed costs to different product lines. Clearly, if you had over the years with revenue increases on the inpatient side going up in the year where we're not going to do an increase it will put pressure on the margin line in ‘08.

Ken Weakley - Credit Suisse

Last quarter you mentioned malpractice. I don't know if you discussed it in this quarter. Can you give us a sense of what the dynamics are there for your business in that regard?

David Dill

We can. Medical malpractice costs have historically run in about 1% of revenue, maybe a little bit more than that. Last quarter, the number was about 1.7% or 1.8% of revenue. We did expect that to come in during the third quarter.

Primarily as a result of some significant isolated cases that some reserves were either settled or reserves were required to be increased on. We did see that come in. This quarter I think the number was about 1.3% or 1.4%. Not all the way down to our historical levels but off what we saw in the second quarter.

William Carpenter

I just want to go back, just very briefly with respect to the reimbursement environment. We're also continuing to work very hard in our lobbying efforts on behalf of rural hospitals. I don't know what's going to happen in Congress toward the end of the year. There is a lot of uncertainty there currently. But I think it is likely that Congress will do a wrap up bill at the end of the year and it is possible.

We're certainly going to be working hard for some rural healthcare provisions that would be positive for us at that time. So in any event, we continue to be very active in that regard, you know, working operationally, as well as legislatively, in order to offset the impact of the new rules.

Ken Weakley - Credit Suisse

Would the provisions relate directly to the issues you've discussed on the MS-DRG side or would it be something just about getting better pricing or something?

David Dill

While we're lobbying with regard to that, we continue to make disparity a primary goal on behalf of rural hospitals. So there's opportunities, whether or not it's directly related to the IPPS rule, there are opportunities in other regards. Bill, do have you anything else to add to that?

William Carpenter

Yes. One of the other things too is the outlier pool. I think MedPAC is looking to see now whether the outlier pool is maybe set too high with the implementation of the MS-DRGs and we get very little in outlier payments. So if we could get that kind of redistributed over to the base rates that would be a pick up for us.

Ken Weakley - Credit Suisse

Outliers haven't always been the best strategy to generate pricing from what I've seen, but I understand. Thanks.

William Carpenter

Don't know how many questions are still in the queue. I do know there's pressure from another call behind this one. So we may limit it to one question going forward per caller and we'll try to be succinct in our answers as well so that we can cover as many as we can.

Operator

Certainly. Ladies and gentlemen, we'll be continuing on with our question-and-answer session. Please note, you are allowed one question. Therefore, our next question comes from the line of Tom Gallucci of Merrill Lynch.

Tom Gallucci - Merrill Lynch

Good morning. Thank you. On the topic of physician recruiting, one, I was wondering if you could give a little bit more color on the mix there in terms of specialists and what not. And then in number two, on inpatient admission trends, I guess the theory has been that new docs build their outpatient practices first and you’ve certainly seen growth there.

But I guess we're still waiting to see improved trend lines on the inpatient side. Do you have any visibility or color that you can add on that sort of concept as we look forward?

William Carpenter

It's still consistent with respect to the split between specialists and primary care doctors, Tom. We're still targeting and are recruiting about 60% on the specialist side and about 40% on the primary care side. We continue to focus on, as I said in my earlier comments, on increasing the outpatient high margin business and so that's consistent with our strategy.

But you're right. It does ramp up first in the operation side and then we'll see it start to roll into the inpatient side and particularly some of these speciality cases with respect to our efforts that we're making on surgical services. So don't know exactly, but see it coming in the next few quarters.

Operator

Continuing on, our next question comes from the line of Christine Arnold of Morgan Stanley.

Christine Arnold - Morgan Stanley

Good morning. Thanks for taking my question. Revenue per equivalent admission looks like it was up 3.4% excluding these re-class adjustments. Is that a good run rate going forward or should we anticipate, because next quarter IPPS is implemented, that this goes kind of sub-3% and what are you thinking there as a go forward?

David Dill

I think this should be a pretty good number going forward. If there's some uncertainty, obviously in this first quarter of implementing these MS-DRGs, so there may be a little bit of noise in the fourth quarter as we go through that that should normalize itself as we head into 2008.

Absent any changes on that, I expect it's a pretty good run rate. It was a big comp this quarter as we comped out of 2006. And just from a net revenue per adjusted admission of 6700, as you know, a lot of that is heavily dependent upon impatient and outpatient mix. So if one changes over the other could impact that number.

Operator

Our next question comes from the line of Whit Mayo of Stephens Inc.

Whit Mayo - Stephens Inc.

Thanks, good morning. Just any color you can provide a little bit more on the capital projects; what's changed between January and now that's either delayed your tabled, some of those spending projects.

And just more specifically, is this a function of the work you're doing in the deep dive and just any comments there would be helpful?

William Carpenter

No, really no change. With respect to capital projects, it's only about timing. We are pushing full speed ahead as far as getting projects that we think are good projects approved and getting them into the process.

So I think, as far as that goes, it's simply about timing. One thing that we have done is we have met sooner, following the deep dives, in order to make sure that we get approvals sooner with respect to projects that come out of those, because we do think there is great potential in those. So if anything, we've sort of accelerated our processes and I think it's just with respect to timing of this spend.

David Dill

There are a couple of big projects in a couple of hospitals that our operators aren’t completely sure on how much or how big the project needs to be as far as scope goes so it's really isolated in just a handful of projects.

Operator

Continuing on, our next question comes from the line of Mr. Adam Feinstein of Lehman Brothers.

Adam Feinstein - Lehman Brothers

Just back to the bad debt, you did a great job of managing through it this quarter. Obviously it moves around. Just as we think about it your un-insured receivables on the balance sheet started the year at 62.9%, looks like it's up to 69%, so a big increase. I know some of that was reflected in the second quarter in terms of the increase in the bad debt expense and I know the reserve has gone up on the balance sheet, maybe because of that.

But just seeing that, almost a 600 basis point increase in your uninsured receivables mix there, just thinking about the bad debt going forward, maybe just any additional comments and just David, I know you're still going through all of the hospitals but certainly, just as you thing about the accounting for the bad debt, just any updated thoughts in light of the trend that I just highlighted? Thank you.

David Dill

It's a good question. A couple things I will point out. If you look on the cash flow statement, our cash flow from operations were down considerably. If you look at the bottom of the cash flow statement, you’ll see that our tax payments were up.

Tax payments were up because of a slowdown in the write-offs that have happened. Even though we're reserving for those to the income statement, the allowance on the balance sheet has increased, as you pointed out, up substantially from 12/31 to September the 30th. What that is a result of is you're paying taxes on that revenue until you get those written off. In the fourth quarter of each year we go through a pretty extensive write-off process.

Now going back to your question, specifically if you look at that increase of 600, 700 basis points, all of that is reserved, I’ll share with you our number. Our allowance that we have as a percent of self-pay net AR was about 85% at the end of the fourth quarter of last year. That's increased now to about 89% at the end of the third quarter.

So, even though that increase is there, what that says is our reserves have gone up at a quicker rate. We have more self-pay net AR covered today through our allowances than we had at the end of last year.

So I feel extremely comfortable with all of our policies, the application of those policies and the consistency of the policies over the first 90 or 100 days here.

Operator

Continuing on, our next question comes from the line of Matthew Borsch of Goldman Sachs.

Shelley Gnall - Goldman Sachs

This is Shelley Gnall in for Matt Borsch. I would like to know, could you talk a little bit about the drivers, what contributed to the reduction in contract labor this quarter?

David Dill

Just management and management. This is something that we saw as we got toward the end of the second quarter. Most of our contract labor is spent out in our Western markets where we have significant volume growth.

We have another chunk of our contract labor that's spent across various of our other markets. As volumes slowed down in the month of June, as we saw it, our operators began to make changes in the utilization of contract labor. Those weren't reflected in the second quarter, because the changes really didn't happen until the end of the second quarter, first of the third quarter.

It is hard work but it is managing each of these dollars at the hospital level and that's where it comes from, matching up productivity and volume. I wish I could say it was anything other than management but that's what it is.

William Carpenter

I'm really pleased about the contract labor result this quarter. This is the first time in recent memory that we have reported year-over-year reduction in contract labor. That's significant. We've had sequential quarter-over-quarter reductions as we've been doing a good job of working on it, but year-over-year reduction in contract labor I think is a real testament to how hard our operators have worked on that.

I'm pleased about that. We also have a task force in place specifically focused on contract labor spending and the purpose of that is to make sure that we continue to see that play out over the course of the next several quarters but thanks to all of them for the hard work they've done on that.

Operator

We now have a question from the line of Erik Chiprich of BMO Capital Markets.

                       

Erik Chiprich - BMO Capital Markets

Good morning. Thanks for taking the call. You had mentioned M&A activity earlier in your remarks. I was curious if you could just expand on your plans what you’ve seen in the pipeline and if it’s internal or external forces that are keeping you on the sidelines right now. Thanks.

William Carpenter

Well, the pipeline is, I wouldn't say robust at the moment, but there are a number of deals we're looking at, there are a number of deals we've looked at and frankly have decided not to pursue. We are being very true to our strategy of not paying too much for any particular acquisition and making sure that it's one that will add incremental EBITDA to the company as we go forward.

So there are a couple of opportunities that frankly I'm very encouraged about and I have been out, personally, on these visits and look forward to that as we go further. We may see more deals. One thing that I believe may be the case, Erik, is that there may be some deals that are being held out there as the credit markets have been tight and that as the credit markets ease, we may see a little bit of a higher influx of deals. We just want to make sure that folks have the ability to borrow in order to buy their assets. So I hope that's helpful.

Operator

And continuing on, our next question comes from the line of Gary Lieberman of Stanford Group.

Gary Lieberman - Stanford Group

Good morning. Thanks. I was hoping you could discuss a little bit more the comments you made about the increase in the outpatient charges and I guess the impact it had on the self-pay adjusted admissions. Could you first talk about what kind of discounts are you offering to the self-pay outpatient patients?

David Dill

Well, that varies from market to market. Each of our facilities have their own charity policies and discount policies for uninsured. We do have some states where that is mandated by federal law, like Tennessee, but that does vary from market to market.

I think you asked the question in terms of the mix between inpatient and outpatient, we did see an overall 12%, 13% increase in our overall outpatient revenues, even though our inpatient revenues did decline related to our admission decline.

Operator

Continuing on, our next question comings from Matthew Ripperger of Citigroup.

Matthew Ripperger - Citigroup

Hi. Thanks very much. You commented that you've had good success with rolling out the map programs to some of the facilities. I just wanted to see if you could give a sense of how many facilities had you rolled that out to and what the potential opportunity is as you rolled out to the broader portfolios going forward?

David Dill

Sure. We currently have 38 facilities, I think, that are on the map program. We have another four or five who are on similar programs with a different vendor. I think we have about five or six facilities in the queue to hopefully start by the end of the year.

I think Bill shared a number of over $5 million year-to-date on net recoveries, several of those facilities remaining our larger hospitals. So, we should continue to see our map collections continue to increase.

William Carpenter

Being true to our plan of getting done this morning and giving people time to get to their next call, let's take a couple more calls and then wrap up.

Operator

Our next question, therefore, comes from the line of Bill Bonello of Wachovia.

Bill Bonello - Wachovia

Thanks. I'm just curious whether the changes to the Medicare inpatient payment system impact the method or amount that you'll be paid by any of your other payers?

William Carpenter

Well, Bill, it's possible; at this point, not. It's possible that other payers may take the approach that Medicare has taken. We've seen that in other cases in the past, but at this point, we don't see that being significant.

I'm going to ask Bill Hoffman, our Senior V.P. for Government Programs to chime in on that, however.

William Hoffman

Medicare was very, very specific that MS-DRGs only related to Medicare patients and they don't have like newborns or they don’t have maternity. We may see other payers pick it up. I don't know if we have at this point.

Operator

Our last question will therefore come from the line of Gary Taylor of Banc of America.

Gary Taylor - Banc of America

Just quickly, I don't think we talked much about supply expense this quarter. It looked like a great result. If my model is right, I think this is the first time in the history of the company it was down sequentially on a dollar basis into the third quarter. I think that's also true on an adjusted patient day basis. So, obviously you had some good results on the supply side. Can you just share what happened this quarter and what success we should be thinking about on a go-forward basis on supply costs?

David Dill

The 13.5%, it was a good quarter, it was a good result for us. As we talked about earlier in our communication, good management in some of the line items, but the biggest chunk relates to the over 3% drop in inpatient surgeries that we experienced on an absolute dollar amount, that's one of the big drivers of why the number came down.

As you think forward, I think, in the 13.5% to 14% range is a number to think about as we head into 2008.

William Carpenter

We can take one more.

Operator

On that note, our next question is from Sheryl Skolnick of CRT Capital Group.

Sheryl Skolnick - CRT Capital Group

I would like dovetail back a little bit about the MS-DRGs and let's put this in some sort of context.

First of all, I gather what you're saying is that there is some certainty with respect to the implementation and the accuracy, probably not just on your end, but also at the fiscal intermediate end.

So, the question that revolves not only what percentage of your revenue would be affected by this, but also what effect might it have on the timing of cash flow receipt, might we not see a delay in the fourth quarter?

And putting that in the context of when you'll be giving 2008 guidance, how much time do you need under the MS-DRG system in order to have good visibility on what your 2008 might look like given the pressures on top line, which are certainly not helped by the ongoing normal pressures of your costs?

David Dill

I want to start with the cash flow question first. Going back to our cash flow statement, cash flow was down. We talked about the reasons for that.

In addition, cash built up a little bit on the balance sheet we had $48.5 million of cash sitting there. We elected throughout the quarter as we developed cash flow knowing that we had an extra interest payment that needed to be made. We knew that coming out of the second quarter. We saw a slowdown in our write-offs in our AR accounts. So, we knew that we would have a tax impact in cash payments related to taxes would be up in the quarter. We expect those to normalize.

Given the tight credit markets, we elect to not pay debt off, but also hitting to this question directly, we saw the impact of this that would be coming down. When we implemented this in October, we did hold some of the bills that we dropped on the Medicare and patient side.

Happy to report that as of now, most of those bills have been sent. About 70% or 80% of those bills have been sent. We have a few hospitals that are on a different system. Those bills would be sent here in the coming days. So in the month of October we will definitely see a slow down in our cash payments; that assumes all of our files are ready to receive when we send them.

We know most are, some aren't ready to receive those. By the end of the fourth quarter, though, we fully expect to be caught up as it relates to cash flow based on what we know today. Now, as it relates to 2008 guidance it will take us some time. We're two, three weeks into this.

We do not have any trends yet that make us more or less comfortable with the work that our consultants have done over the course of the last two or three months as we get ready for the implementation that went effective October 1. By the time we get to the normal time of year we give guidance, we will know a lot more than we know today. We did feel it was prudent on this call to reflect it.

Based on what we see, based on all the work that our consultants have done and based upon our preliminary reviews that the 3.3% market basket increase gets primarily mostly mitigated through the three items that we talked about, wage index, behavioral offset, and just the affect of MS-DRGs. Having said all that, we have plenty of cash on hand to work our way through this. We're sitting here today with $50-$60 million of cash on the balance sheet through mid October.

We have a $300 million revolver; so while it's always a concern from our liquidity standpoint, we're not that concerned intra quarter and we feel like at the end of the fourth quarter we'll be in good shape.

William Carpenter

Just to be clear, we held those bills because we were instructed to. We have now, as David said, begun to drop those bills and so that should come along very well. We have done a lot of work to prepare for the implementation of the MS-DRGs and our folks have really dug in on this, from the quality side, from the revenue cycle folks, everybody has been very engaged in this in order to make sure that we mitigate any impact going forward. So thanks for that question.

Operator

Thank you, gentlemen. We'll return the presentation back to you once again for your concluding remarks.

William Carpenter

Thanks, again, very much, Pamela. I'm pleased with the results that we've been able to report, pleased to be within our expectation as we laid that out for you at the end of last quarter. I'm proud of this team. I'm proud of the team that we have in place, I'm proud of the strategy that we have.

I feel good about where we are. It's a tough industry right now. We all know that. But we also know this industry and we know our business and we know these hospitals inside and out. We are starting to see the benefit of the strategy. We're starting to see it play out across every single hospital.

There is no question that our folks at the corporate office and our folks in the field absolutely understand the direction that this company needs to be taking in order to be successful. We're going to stay after it. We're going to stay the course. We're going to intensify our focus on the strategy every single day.

If there are other questions that you have, please call us. We look forward to talking to you. If you need further clarification, call us. Dave and I will be here all day today. We'll be here all day Monday. On Tuesday and for a couple days next week, we're heading back out to the hospitals. We've been doing that a lot.

We've both been in the hospitals. Of course, Gracey is in the hospitals all the time. But we're going to make a swing next week and I think we'll be in three hospitals next week. So excited about that. That's where I like to be. Just making sure that everybody is absolutely focused and I assure you they are. Thank you again for your interest in LifePoint Hospitals.

Thank you for your interest in our strategy and what we're trying to accomplish here. We look forward to talking to you very, very soon.

Operator

Thank you, sir. Ladies and gentlemen, that does conclude the conference call for today. We thank you all for your participation and ask that you please disconnect. Thank you once again and have a wonderful weekend.

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Source: LifePoint Hospitals Q3 2007 Earnings Call Transcript
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