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Community Health Systems (NYSE:CYH)

Q2 2012 Earnings Call

July 26, 2012 11:00 am ET

Executives

Lizbeth R. Schuler - Vice President of Investor Relations

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

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

Analysts

Whit Mayo - Robert W. Baird & Co. Incorporated, Research Division

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

Albert J. Rice - UBS Investment Bank, Research Division

Ralph Giacobbe - Crédit Suisse AG, Research Division

Kevin M. Fischbeck - BofA Merrill Lynch, Research Division

Gary Lieberman - Wells Fargo Securities, LLC, Research Division

Colleen Lang - Lazard Capital Markets LLC, Research Division

Christian Rigg - Susquehanna Financial Group, LLLP, Research Division

Brian Zimmerman

Operator

Good morning. My name is Candace, and I will be your conference operator today. At this time, I would like to welcome everyone to the Community Health Systems Second Quarter Ending June 30, 2012 Conference Call. [Operator Instructions] Ms. Lizbeth Schuler, Vice President of Investor Relations, you may begin your call.

Lizbeth R. Schuler

Thank you, Candace. Good morning, and welcome to Community Health Systems' Second Quarter Conference Call. Before we begin the call, I would like to read the following disclosure statement.

This presentation contains forward-looking statements including all statements that do not relate solely to historical or current facts. These forward-looking statements are subject to a number of known and unknown uncertainties and risks, which are described in headings such as risk factors in our annual report on Form 10-K and other reports filed with the Securities and Exchange Commission. As a consequence, actual results may differ significantly from those expressed in any forward-looking statements in today's presentation. We do not intend to update any of these forward-looking statements. With that said, I'd like to turn the call over to Mr. Wayne Smith, Chairman, President and Chief Executive Officer. Mr. Smith?

Wayne T. Smith

Thank you, Liz. Good morning. Our Executive Vice President and Chief Financial Officer, Larry Cash, is with me on the call today. The purpose of this call is to review our financial and operating results for the second quarter and 6 months ended June 30, 2012. After market closed yesterday, we issued an 8-K, including the press release with our financial statements.

For those of you listening to the live broadcast of this conference call on the web, a slide presentation accompanies our remarks. I would like to begin the call with some comments about the quarter then turn it over to Larry, who will follow with additional detail of our financial results.

Community Health Systems has delivered another quarter of solid financial and operating results. The results are in spite of the continuing weakness in inpatient volume and challenges in the economy.

Net operating revenues for the quarter ended June 30, 2012, totaled $3.2 billion compared to $3 billion for the same period last year, an increase of 8.1%. Consolidated EBITDA increased 4.5% from $483 million to $462 million. Earnings per share from continuing operations was $0.93 versus $0.81 per share for the same period a year ago, an increase of 14.8%.

Net operating revenue for the 6 months ended June 30, 2011, was $6.5 billion, and EBITDA was $1 billion, including certain unusual items.

Earnings per shares from continuing operations for the 6 months ended June 30, 2012, was $1.79 compared to $1.62 for the same period a year ago, an increase of over 10%.

With that, I'd like to recap a few of the significant accomplishments for the quarter. The company recruited 855 new physicians for the first 6 months of the year, this compares to 658 physicians recruited in the same period a year ago. Additionally, we've added 39 mid-level practitioners during the first 6 months of this year. Physician recruiting remains a very strong [indiscernible] of our operating strategy.

Our acquisition process has been very robust this year. We've acquired 4 facilities with trailing revenue over $550 million. Our acquisition of assets in Memorial Hospital in York, Pennsylvania was completed on July 1, 2012. The assets include a 110-bed hospital as other, as well as other outpatient ancillary services.

The price for the fixed assets was $45 million or 40% of trailing revenue of $115 million. The hospital's trading margin is below single digits. We've agreed to replace. A replacement hospital will not start construction for several years, and this is our 17th hospital in Pennsylvania.

The seller has disclosed a letter of intent for 2 hospital system with hospitals located in Wheeling, West Virginia and Martins Ferry, Ohio. This system has a total of 636 licensed beds and trailing revenue of approximately $170 million.

We continue to look for strategic opportunities and have a very strong and active pipeline.

As I mentioned last quarter, our patient safety organization has completed Phase I of our high reliability safety plan. We have initiated Evidence Based Order Set standardization. This standardization will help us prepare for stage 2 of meaningful use to produce computerized physician order entry requirements.

The company's updating guidance provided the first quarter earnings release. We have increased the lower end of our EBITDA about $5 million to $1.975 billion. We've also increased the low end of our 2012 EPS to $3.90 from $3.85. The high end of the range remains the same, and our 2012 EPS guidance ranges from $3.90 to $4.10.

I have little in the way of updates on pending litigation investigation from what was discussed in April. In the New Mexico qui tam case, both sides have fully briefed their motions for summary judgment. We're waiting for their scheduling from the District Court. As for the group of investigations that involve medical necessity of inpatient admissions, we continue to cooperate by providing documents and making witnesses available, as well as participating in meetings with the government to discuss the cases. We had hoped to be in the process on the probe audit we described in April. A third-party review of a sample of medical records at a small number of our hospitals. That review has not begun yet. We hope that, that review will begin soon and hopefully, it will be underway by the time our next quarterly -- for the next quarterly update.

There's nothing to report with respect to the SEC's investigation or the Texas Attorney General. An additional lawsuit has been filed in the Delaware Chancery Court. This shareholder lawsuit, refers to as the Delaware 220 suit, seeks production of documents beyond what was already been provided to the plaintiffs in the shareholder revenue of action case that's pending in Tennessee. The Delaware 220 suit will move relatively quickly and the trial has been scheduled for the end of September, and the Tennessee consolidated shareholders derivative action, we have filed a motion to dismiss.

You also recall, that there's a consolidated shareholder class-action lawsuit pending in Tennessee on July 30, in accordance with our agreed schedule. Plaintiff filed an amended complaint. We will be filing a motion to dismiss this lawsuit. It almost goes without saying, but there's I would say anyway, that we are vigorously defending each of these private plaintiff lawsuits.

Our Board of Directors, the Audit Compliance committee and selected senior management will continue to be focused on these matters. So at this point, I'd like to turn the call over to Larry Cash to provide you summary of our financial results.

W. Larry Cash

Thank you, Wayne. The second quarter 2012 admissions increased 3% compared to the same period last year. Adjusted admissions, which factors in outpatient business, increased 5.7%. For the same-store, admissions decreased 2% compared to the second quarter 2011 and a sequential improvement of 100 basis points from the first quarter of 2012 when adjusted for late data [ph] it had been down 3%.

We continue to see softer flu and respiratory related volume during the quarter. Several items contributed to the company's decrease, lack of flu and respiratory, 110 basis points and lower admissions from women's services includes OB/GYN, 50 basis points.

Our same-store adjusted admissions increased 0.5% for the quarter, but flat from the first quarter due primarily to the decrease in both Medicare and self-pay adjusted admissions.

The second quarter had good outpatient improvement in admissions growth of 3.1%.

Net revenues in the second quarter increased 8.1% from $3,001,000,000 last year to $3,243,000,000. On a same-store basis, this net revenue increased 4.5% for the quarter. Physician practice growth continues to help contribute to the outpatient growth.

Same-store surgery volume was basically flat for the second quarter, 3 categories: cardiology, endoscopy and skin accounted for 80% of the decline from a strong first quarter surge of growth. All these categories are up in the second quarter, but in a slower rate of growth compared to the first quarter.

As expected and disclosed and included in our guidance and internal budgets, we recognized several new provider tax programs in the second quarter with Indiana being the most significant. We also booked a fee-for-service portion of the California provider tax similar to what was supported in the second quarter of 2011.

For the second quarter, same-store net revenue per adjusted admission increased 3.9% versus the same period in 2011, a sequential increase of 3%.

Our same-store Medicare case mix increased to 0.5% versus last year at 0.6% sequentially. Consolidated EBITDA was $483 million for the second quarter versus $462 million for the same period a year ago, an increase of 4.5%. And on a same-store basis, that was $490 million for the second quarter, an increase of 3.9%.

After second quarter consolidated EBITDA margins, 14.9% versus 15.4%. The decrease is due to low margins of acquired facilities, and same store EBITDA margin decreased 10 basis points compared to 15.7 compared to the quarter ended June 30, 2011.

Consolidated operating expenses as a percentage of net revenues increased 50 basis points in the second quarter 2012, primarily due to the recent acquisitions, as well as an increase in provider tax, partially offset by HITECH incentives. Our same-store operating expenses for the second quarter increased by 10 basis points, a 60 basis point improvement in payroll plus the HITECH, partially offset the increase in other offering due to the increase in provider taxes primarily.

On a year-to-date basis, consolidated admissions increased 3.1%, and adjusted admissions increased 6.9%. Our same store admissions decreased 2.2% and contributing to that was again the lack of flu and respiratory, 140 basis points and lower admissions for women's services by 40 basis points.

Same-store adjusted admissions increased 1.5%, and outpatient adjusted admissions increased a strong 5.5%.

Consolidated net revenue year-to-date was $6.5 billion, an increase of 9.8%, and our consolidated net revenues affected by the BNA settlement and SSI recalculation that we discussed in the first quarter. On a same-store basis, net revenue increased to 4.4% for the first 6 months.

On a consolidated basis, net revenue per adjusted admission increased 2.8% and also increased 2.8% on a same-store basis. Same-store surgeries increased 1.4%, with a noted marked increases in cardiovascular, orthopedics, endoscopic procedures. Our same-store Medicare case mix for the 6 months ended June 30, 2012, is 0.6%. Consolidated EBITDA was $1,019,000,000 for the 6 months ended June 30, 2012. On a same-store basis, EBITDA increased 3.7%.

And same-store margin for the 6 months ended June 30 was also 15.6% compared to a decrease of 10 basis points compared to the same period in 2011.

After the first 6 months, consolidated operating expenses as a percentage of net revenue decreased 20 basis points from the prior year. The 80 basis point increase under operating was offset by the increase in payroll and supplies, as well as HITECH incentives, improvements in payroll and supplies. Same-store operating expenses increased by 10 basis points on a year-to-date basis. We did see productivity of approximately 1%, and payroll and supplies each grew 10 basis points on a year-to-date basis, and provider taxes increased about 90 basis points.

Total A/R days were 58 at June 30, 2012, calculated with the net revenue less bad debt, an increase of 2 days from the end of 2011. The second quarter A/R days were up 4 from the same quarter a year ago. The allowance for doubtful accounts is $2,105,000,000 or 50.5% at June 30, 2012. The allowance for doubtful accounts and related contractuals for self pay was approximately 84% of self-pay receivables.

We continue to have a favorable payor mix quarter in June 30, 2012, net revenue by payor source was as follows: Medicare, 25.4%; Medicaid, 10.6%; managed care, 51% and self-pay revenue, 13%. On a year-to-date basis, payor mix is Medicare, 26%, Medicaid, 9.6%; managed care and other, 51.2%; and self pay, 13.2%.

Embedded in our guidance is an overall Medicaid decrease for calendar year 2012 of approximately 2% to 3% compared to a decrease of approximately 8% for 2011 and the ongoing unmet Medicaid provider tax program, which usually 2 to 3 years helped us reduce the Medicaid reductions in 2011 to 2% to 3% in 2012.

Cash flow from operations was $295 million for the quarter. On a year-to-date basis, cash flow from operations was $483 million versus $585 million for 2011. The decrease is primarily due to a four-day increase in accounts receivable and about $40 million was due from receivable growth for the 3 facilities acquired in 2012, about $35 million from increase in Illinois Medicaid and the receipt were related to new Indiana Medicaid provider tax program of about $30 million. Additionally, about $25 million of interest payments were made in the second quarter versus the third quarter from the due debt 2019. As it relates to the overall use of cash, for the first 6 months, we spent approximately $50 million for IT investments for 20 hospitals. Meaningful use incentives will begin in 2013 due to accounting recognition that took place recently.

Our cash flow guidance remains $1,200,000,000 to $1,300,000,000. We have already received cash receipts for about 50% of the increases I described above in the receivables as of yesterday.

Total capital expenditures in the quarter just ended $198 million or 5.8% of net revenue. Year-to-date, total capital expenditures were $387 million or 5.9%. Replacement hospitals expenditures were approximately $30 million for the quarter and $71 million year-to-date. Our CapEx guidance will now range from $800 million to $850 million, a reduction of $50 million on the high end.

Our balance sheet cash at June 30 was $115 million. And the end of the quarter, the company had available credit from the revolver of $710 million after outstanding letters of credit. We have the balance sheet as of June 30, 2012, we had $1,098,000,000 in working capital and $15.9 billion in total assets. Total outstanding debt at June 30, 2012, was $9.325 billion of which approximately 73% was fixed. Our debt-to-capitalization at quarter end is approximately 79%.

At the end of the quarter, we were party to $3,750,000,000 in interest rate swaps, a decrease of $400 million from the end of the first quarter. Subsequent to the close of the quarter, the company tendered for the remaining [indiscernible] balance 7/8 of a percent [ph] bonds to mature in 2015. We issued a 1.2 billion in new debt, with a 7.125% coupon due in 2020 both lowering the coupon and extending maturity.

I'd like to highlight a couple of items now [indiscernible] stated we increased the low-end EBITDA by $5 million EPS, $0.05. We would anticipate that our HITECH incentives will be down in the third quarter by approximately 50% compared to the third quarter 2011. The EPS is expected to decrease to be approximately $0.12 in the third quarter 2012.

We lowered the high-end of our CapEx guidance by approximately $50 million. We also increased acquisition costs from $0.05 to $0.07 in the quarter from $0.04 to $0.06. I'd like to go back and say first of all, remember that our Medicaid revenue reductions were about 8% in 2011 that will be somewhere 2% to 3% in 2012. Attaining a 2- to 3-year Medicare provider tax program will improve our Medicaid revenue.

Medicaid provider tax programs for 2 to 3 years often receive final approval after effective date or appropriately recognized as revenue when approvals become known and collections deemed reasonable. For 2012, the 2 significant states Indiana, which is a 2-year program, through June 2013, and California will have approximately 10 basis points of revenue and 7 basis points of expense in the first 6 months of 2012 compared to a projected 8 basis points of revenue and 5 basis points of expense in the second half of 2012.

The Indiana benefit of EBITDA recognized in 2012, once it's approved, as it relates to 2011, was approximately $5 million. For comparison purposes, we had Pennsylvania recognize [indiscernible] provider tax program, EBITDA recognized in 2011, with a benefit of $4 million as it relates to 2010 and the Pennsylvania program is still in existence in 2012.

I also wanted -- please note that the third quarter is unusually seasonally lower than any of the 4 quarters and Wayne will now provide a brief recap.

Wayne T. Smith

Thanks, Larry. We are pleased with our strong second quarter performance and believe our prospects for continued growth are very favorable in light of the recent decisions surrounding health care reform. We are well-positioned to leverage these industry dynamics as the leading operator of hospitals [indiscernible] as markets [indiscernible]. At this point, we'll now open the call for questions.

Question-and-Answer Session

Operator

[Operator Instructions] And your first question comes from Whit Mayo with Robert Baird.

Whit Mayo - Robert W. Baird & Co. Incorporated, Research Division

Larry, can we just go back just for a second to the provider fee payments in the quarter? I kind of got lost with the discussion around basis points but maybe if you could size up the impact again in the quarter and maybe get a sense of what sort of in period, out of period, what is recurring this year versus last year, just to maybe frame up the impact a little better for us?

W. Larry Cash

Yes, the West Virginia and North Carolina are roughly small. Indiana is the large one and Indiana probably will be $12 million to $14 million in the second quarter, which we would recognize as about $5 million applied into 2011. It was approved in second quarter. It runs through June of 2013, that's the EBITDA benefit, probably the revenue and expense that would apply in 2011 will probably be about $30 million of revenue and $25 million of expense. In addition to the provider tax programs in this money was cut that would apply back to 2011. What we were trying to say it seems like there's some confusion about provider tax programs, thinking they're a onetime payment, they are not -- Indiana was approved and then California was approved partially in 2012 in the second quarter. And we try to put what the revenue was in the second quarter and the expense, which the net difference would be your EBITDA benefit. Those 2 states which are the largest, Indiana and California, will have about 10 basis points of revenue and 7 basis points of expense in the first 6 months of 2012. And the question that we think people have is how's the run rate of that affected going forward? And so we decided to put in what we project will happen in the next 6 months of 2012, so people will get comfortable that what they're looking at in EBITDA for the first 6 months of 2012 will probably come likely to repeat itself in the second 6 months of 2012. The revenue for these programs are probably about a little less than revenue, about 8 basis points of revenue in the second half of 2012, and the expense will be about 5 basis points, both differences being about 3 basis points of revenue. So the EBITDA contribution in the first half of '12 for Indiana and California will be pretty much about the same as the second half of 2012. So the concern or the fact that the second quarter 2012 is not a good representation for earnings. It's not correct when you look at Indiana and California. Indiana was approved, it will continue all the way through to June 2013, and California, which was approved on a fee-for-service component, and there's another managed care component that we believe will be proved either the third or fourth quarter, that will occur and it will run I think, until 2013. I believe it's a 2-year program, I think. It could be June 2013. We're trying just to put a flavor of what's happening now for the first 6 months and what's going to happen in the next 6 months. And we are also trying to disclose how much Indiana may apply to '11, which is about $5 million approximately. Similar to what happened in Pennsylvania last year, we had about a $4 million benefit in the first half of '11, which applied to 2010. These programs are approved. They are approved retroactive, and it's difficult to -- you can't recognize until it's done. When it happens we generally said we're going to do the provider tax program. And as long as it's going to continue, which most of them all have to my knowledge, we never had a provider tax program totally be eliminated. It could happen in the future, but they're just a new way that the states are paying for Medicaid.

Whit Mayo - Robert W. Baird & Co. Incorporated, Research Division

And Larry, you certainly included this in our guidance.

W. Larry Cash

It's in our guidance. It's in our internal budgets. We've been telling people that it will be around a 3% reduction, it could be a 2% and one of the reasons for that is these provider tax programs. And I think we said that the 2 bigger ones this year are Indiana and California. So...

Whit Mayo - Robert W. Baird & Co. Incorporated, Research Division

Yes, no, I think you've been very clear on that. And I guess maybe the other question, just if you could spend maybe a second on the cash flow obviously, a little weak, you named a couple of items in your prepared remarks that helped to reconcile but maybe, just a little bit more color and guidance because I mean, it certainly appears that there needs to be a nice little acceleration in the back half of the year. I don't think you really had any HITECH cash come in the door. Your bond payments may have moved from 1 quarter to the other so maybe just spend a second reconciling that for us would be helpful.

W. Larry Cash

Yes, for the first 6 months, it's down about $100 million. I think the receivables are up more than that, they're up about $112 million or so. I would try to name Medicaid in Illinois, which is still there. I think it's $35 million, it's down a few million from the first quarter but it's still there. The Indiana provider tax is about $30 million, which we since received that money there and the other one was about $40 million and some A/R that tied to the acquisitions. The only acquisition of any size here is in York so we'll probably have a little choppiness in receivables from it. It's a lot smaller than what we acquired in the first half of the year. There we had about $350 million to $400 million of revenue being acquired. Here, York is about 1/4 or 1/3 -- 1/4 of that size so we shouldn't have quite as big a challenge there. We were up $109 million on receivables. We collected about $55 million of that yesterday, a little bit in -- a very small amount, Illinois Medicaid are reasonable. All of Indiana Medicaid provider tax and all of the fair amount of money is coming on acquisitions. The other thing was we moved our interest payment to the second quarter from the notes from the third quarter, that's a net, about $25 million shift. Actually in the quarter itself, it's about a $60 million effect but in the year-to-date, it's about a $25 million effect. Those are the primary items there. There was a few other minor items for those who wants to reconcile the most. The reason we're comfortable about the cash flow guidance, a, there shouldn't be any outstanding provider tax programs, we think. At the end of the year, I would hope California gets done in the third quarter. The other thing was we've had about $35 million of HITECH revenue still not received and generally most of the HITECH would be recognized as they go along. Hopefully, we'll collect some of that, although we could replace it with some more receivables by the end of the year. Those are the primary reconciling items.

Operator

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

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

On the acquisition front, you commented about some of the lower margins on those assets. But I'm curious, could you give us a little additional color on perhaps how these acquisition integrations are going? Is there anything that changes in the timing? And are there any specific markets or any of these acquisitions that you could call out that might have hospital-specific issues that need to be fixed, or any of these have market-specific issues that need to be fixed?

Wayne T. Smith

Yes, I would say these acquisitions, they're fine, they're going to be fine. They're just a little slower than we've had in the past. And obviously, some of them, because of the pressure they've been under, that hospitals we acquired in the past were not under the same kinds of pressures that people have been under this day and time. So without going to specific hospitals, I think we should see improvements in them in the latter part of the year. I would tell you that also that we have turned down, I think, 20-plus acquisition opportunities so far this year.

W. Larry Cash

I would think that the second half of the year will be better for all of the acquisitions that we've gotten on same-store today. We expect it all to be better in the supply area, expense management and also volume.

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

Is there anything, when you acquire these hospitals, is there, as it relates to HITECH payments, I mean, have these hospitals already kind of started the process of trying to meet meaningful use and try to recognize some of these dollars or is that something you typically end up having to do once you get in there?

W. Larry Cash

Yes, Frank, it varies. I think one of the ones that we acquired in the first quarter had done some work and I think we'll probably receive the HITECH there. For the most part, we're coming in where we have to do some work to try to get the HITECH dollars. One of the reasons that our IT spending is up, we're both converting systems like we used to do and we're also trying to do the HITECH so we will have to spend some money on IT hardware and capitalized software. But I think these are all facilities that we will we expect to get the HITECH meaningful use money for stage 1 for all the acquisitions.

Operator

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

Albert J. Rice - UBS Investment Bank, Research Division

I had a couple of questions, if I could ask. First of all, just maybe flesh out a little more obviously, you're seeing the inpatient volumes, the negative trend gradually moderate and then -- but you're seeing some moderation in the outpatients growth, more in line with what others have been posting, I guess. What -- any other commentary behind that? I know you've done a lot of improvement on physicians and maybe is their practice maturing, is that having any impact? And what do you see as the prospects, as you get in the back half of the year, for the inpatient number to at least flatten out on a year-over-year basis?

W. Larry Cash

Yes, I think first of all, the adjusted admissions were a little slower in the second quarter and the first quarter. There was a little benefit from late days and adjusted admissions in the first quarter. That primarily is tied to outpatient OR. If you look at the way it's calculated on gross revenue our outpatient OR revenue wasn't quite as strong in the first quarter. The factor was up about 5% in the first quarter. It's probably about 2%, that's what drove a fair amount of that and it also was Medicare, which is good. A lot of it was self pay adjusted admissions. So having a little self pay adjusted admissions might help in the future from a bad debt perspective.

We're also continuing to see growth in observations are still growing 8% to 10%. So that's still moving up about where you'd expect it to be. I think from an admission perspective, the flu, which on a year-to-date basis, is still down and the OB/GYN. We had a couple of months there, where the women and OB got a little better. Of course, it's a pretty high percentage for our business. That's about 14% of our admissions, flu and respiratory is about 12% and I think that's one of the reason why the non urban hospitals have a higher percent. Those were at least -- one could be delayed or put off, others ones you can possibly accrete on an outpatient basis or try to from a flu respiratory perspective. I think we're getting better. We do have easier comps as a result of what happened last year. So it should just continue to get better. I think our guidance is negative 0.5% to a positive 1.5% and we're pretty comfortable where we are. On a year-to-date basis, there, we don't have specific admissions guidance, but I would expect it to continue to have opportunity to be a little bit better. There's a very good position recruitment which Wayne described in the first half of the year. We continue to work well for our employed physicians, try to do that working on a various amount of ailments to try to continue to improve. But as I said earlier, it's a pretty tough economy, but I would think our volume metrics will continue to get a little bit better throughout the next second half of the year.

Albert J. Rice - UBS Investment Bank, Research Division

Okay. And I appreciate all comments about the updatings on the federal inquiry and all of that. I guess, 2 questions related to that. One is the postponing of starting the sampling, I guess, probing, is that just normal course of back and forth with the government or is there anything more behind that, that's going on? And then, second, there's really been some discussion about media looking at the industry, I guess your name was mentioned as one of the people on this posting of the Academy of Emergency Medicine letter, it sounds like that's been out there for a while. But you have any thoughts or comments about any of that stuff?

Wayne T. Smith

Sure. On the first issue, in terms of the probe study, there's nothing more to that and it's just the government works at their own pace, which nothing other has happened, there's been no other real issues. We're working cooperatively and as we said, it's a relatively small number of hospitals. We would hope that, that would get started very soon in the next couple of months and it would go, the process would go pretty quickly. So that's -- there's no change, there's no bad news or anything around that. And as it relates to the 60 Minutes discussion that our friends in South Florida have been talking about, here's what I know. Last year, just right after the Tenet lawsuit, which everybody knows was dismissed, we learned that 60 Minutes, a producer was conducting some research about the same issues there were in the Tenet lawsuit. Nothing has come of that. We don't know any more than that. And so, until they start coming out again, with HMA, we didn't know any more than that. I would say, though, I'm not one that's going to predict what 60 Minutes is going to do or not do. They do whatever they're going to do so I don't have a clue. I could just tell you that the only time we heard any inquiry around us in terms of the research around us was around the Tenet lawsuit.

Operator

Your next question comes from Ralph Giacobbe with Crédit Suisse.

Ralph Giacobbe - Crédit Suisse AG, Research Division

Larry, can you talk a little bit maybe about the uptick in the bad debt, maybe what's driving that between through the uninsured or even maybe out-of-pocket and maybe your comfort level with trends kind of into the second half of the year?

W. Larry Cash

Yes, the adjusted admissions were not quite as strong in the first quarter as the second quarter and the revenue was a little bit smaller percent, 13%, versus 13.4%, which might help a little bit going forward but we do raise charges with self pay, get a percentage of that and that's part of the accounting for some of our growth in bad debt. We've also had a little bit more emergency room use, especially I'd say, the self pay, can't find a place to go, they often go to the emergency room. We have some low accretive business there which was probably up a little bit. It's going to cause bad debts to go up because we haven't collected on much of that. And the growth of the insurance, coinsurance and deductible was just part of contributing. I'd say the biggest thing is probably the growth in rates but we were ahead of a year ago right now. We don't have a specific bad debts guidance out there. We have done our own internal work, we don't anticipate it getting a lot better. We are doing some work in our collection company, which -- a pretty good job. They're trying to add some more resources and more talent to it and more speed of recovery. We had a lot placements come in and probably the placements was down a little bit but just think about where we go, we generally don't ever predict a great reduction of bad debts. As economy gets better, more people get insurance. It may happen but probably for the next 6 months, bad debts will continue to be at a level pretty much where they are now, maybe slightly better.

Ralph Giacobbe - Crédit Suisse AG, Research Division

Okay. And then, anything more to call out on the kind of 1 day in observation? I think you had mentioned that observation, did you say was up 8%? Any way to help quantify sort of what that impact was to sort of the inpatient number and/or maybe where that trend -- that observation trend has been over the last couple of quarters?

W. Larry Cash

It's probably up a little bit more [indiscernible] in the first 6 months I think 10% or so. I think what we have done is if we don't have to talk about 1 day stays, which means we are not creating one of the trends that we have to talk about. So far this year, there has been a negative trend or a positive trend, not anything, they're small enough that we don't think it's necessary to discuss it, which means 1 day stays are not a significant reconciling item at this point in time. I was trying to comment about adjusted admissions, outpatient revenue and observations [indiscernible].

Ralph Giacobbe - Crédit Suisse AG, Research Division

Okay. And then just my last one just on kind of the Medicaid side, you sort of talked about the minus 2% to 3% and any preliminary thoughts if you have any, on sort of 2013? And then sort of further that, any just general thoughts on kind of Medicaid expansion, maybe your specific portfolio and your states sort of post the Supreme Court ruling?

Wayne T. Smith

I think it's way too early in terms of trying to fare through the Medicaid expansion. I actually think that some of these states that are now trying to make a determination about whether they will participate or not will probably change their mind as time goes on. I know in Tennessee, I think it's about $13 billion for the state of Tennessee, that's a lot of money to reject from the government. So I don't -- no one knows what the answer is going to be yet, and some of it is closely related in terms of how the election goes but I would think that when it's all said and done, the vast majority of the states would participate in Medicaid expansion.

W. Larry Cash

On 2013, just a couple of comments. Looking today, I think we got about 3 states until we can see a cut that will take place either in July or August. I think if I had to remember last year, it was 8 to 10 states that were going to have a little bit of a cut or had a recent cut. Illinois had been one of them. Illinois is also working to get an enhanced provider tax program. And again, make sure people understand provider tax programs are a good thing. They give you Medicaid revenue, that'd be earnings that help offset cuts. So -- and we've had a provider tax program in Illinois, which is other than the fact that the state's not paying us right now for our business, we continue to have that probably for 5 years. Florida, it's about 5.6% cut. It's going to cost us probably $700,000 for the next half of the year, we've only got a couple of hospitals, and Louisiana has got a 3% to 4% cut, which in August, which is fairly small for us also. So I would say that at least what we know today, the second half of the year looks better than a year ago, and I would say that 2013 should look better than maybe 2012 would. I expect the programs that we have, these provider tax programs will all continue, they all generally continue to provide additions on Medicaid, which is a real low payor and that's why you're allowed to get the type of Medicaid provider tax programs through CMS.

Operator

Your next question comes from Kevin Fischbeck with Bank of America.

Kevin M. Fischbeck - BofA Merrill Lynch, Research Division

Can you guys talk a little bit about the same-store margins in more detail? I mean, we're used to see you guys being -- improvements in the margin year-over-year. Can you talk a little bit about what was going on there with the numbers down, in a little more detail? Is it just purely a situation of the provider tax number, outside of that, it would've been up?

W. Larry Cash

No, provider tax is usually all set off by provider tax revenue in most all cases. If there's more revenues than there's tax. I'd say that from the same-store, our same-store bad debts, although it's probably up 70 basis points, that probably hurt us a little bit. And then we also continue to employ physicians and employing those physicians helps us grow EBITDA but it's a pretty challenge on EBITDA margins. So that perspective is probably will continue so margins may not move up as much as long as you employ physicians. The second thing in the quarter was supplies were relatively quiet on the same-store. I think it's the first time I've had to say that for quite a while. We were very comfortable that our Chief Purchasing Officer were worked on and other people that worked on air [ph] to drugs were up a little bit in the first quarter -- excuse me, in the second quarter. And I think we'll see some supply improvements in the second half the year that we didn't see in the first half of the year. Our payroll was managed really well in the first -- last quarter on a year-to-date basis, about 10 basis points. So both the quarter and year-to-date are up -- are down about 10 basis points and bad debts in both situations. I think year-to-date is up 80 to 90 basis points and the quarter's up about 70 so that's what's probably hurting the margin along the growth of the employed physicians, which makes the challenge to keep your margins up.

Kevin M. Fischbeck - BofA Merrill Lynch, Research Division

Okay. And then the malpractice number, that was 40 basis points better. Is that like a reversal of an accrual or is this a good run rate that you were able to secure better rates?

W. Larry Cash

What it is, is we have a little bit less claims coming in and if you go back last year in 2011, we had a favorable adjustment I think, in the third or fourth quarter. We did a little bit earlier review here and it's a little bit lower there, which we probably may have over accrued a little bit in the first half of '11 and now we adjusted it in the third or fourth quarter of '11. Now we're doing that a little sooner. We'll do another review. We do a review every quarter, and we have certain actuarial reviews to do and looking at claims and ranges, and we feel comfortable that there could be a 40 basis points year-to-date adjustment in June that would lower our malpractice expense. It's still a good number where it's running right now and I expect it to probably in the second half of the year, to be close to where we are first half of the year.

Kevin M. Fischbeck - BofA Merrill Lynch, Research Division

Okay. And then I guess, the last question. You talked a little bit about volumes so far. I mean, one of your competitors who reported earlier talked about kind of reaching the bottom of the U in volumes. I mean, do you have any comments there about really what you're seeing there at the ground level? And where your comfort level is about kind of feeling where we are? Or are we getting close to a trough here?

Wayne T. Smith

I don't know. It's really tied to the unemployment rate. I think when it's all said and done, it's part of the -- it's an economy issue. And as long as you have 8% unemployment, I'm not sure the volumes are going to get much better. We went through this period where commercial enrollment was actually rising and then I think it's kind of flattened out now. Until that starts again -- I know that jobs numbers today are a little bit better but I think that's the metric that will help us in terms of volume on the short term. Clearly, on the longer term, in terms of health care reform, there's volume both from Medicare recipients and the Medicaid and the people who are uninsured. But right now, I think it really is based on the economy. We are seeing good volume on the outpatient, it's the inpatient now that's a little slower. So for us, I think we've identified our issues and I think we're back on track, and I think our volume should continue to get a little better as time goes along but not dramatically because of the fact that the economy is weak.

W. Larry Cash

Yes, one of the good things while we don't give individual statistics for every payor I think recently we've given some direction why we're up 0.5% for adjusted admissions to managed care area, it's better than that, it's the best of the 4 categories. And similarly, year-to-date, our best growth in adjusted admissions is managed care and other, which is encouraging that we're doing a good job. And most -- a lot of that is outpatient. And then of course, our self pay admissions, inpatient admissions have been dropping at least on a year-to-date basis, worse than the company average. But the adjusted admissions are growing a little bit and I just would clarify one thing, I figure that some -- maybe a confusion about managed care companies working with doctors and doctors differently for putting people on observation versus being admitted. That's truly, as I understand it, Wayne, I've now been [ph] in managed care for several years, that's generally tied around the managed care companies that may have risk pools set up where doctors share in some of the savings that I think you're generally fee-for-service doctors, which a lot of our case situation is affected by that type of activity. It's more around Medicare Advantage, decapitated [ph] HMOs or commercial HMOs, which are more [ph] in the Florida area than you generally find in our market.

Operator

Your next question comes from Gary Lieberman with Wells Fargo Securities.

Gary Lieberman - Wells Fargo Securities, LLC, Research Division

Larry, maybe if you could just clarify one of the points you just mentioned. You said there was a 40 basis points adjustment to malpractice in June. So is that a 40 basis point benefit for the quarter or was that just a June benefit?

W. Larry Cash

I think it's a little bit more than 40 for the quarter. Its year-to-date was 40.

Gary Lieberman - Wells Fargo Securities, LLC, Research Division

Okay. So it's 40 more than -- how much was it in the quarter?

W. Larry Cash

It might have been 50 or 60.

Gary Lieberman - Wells Fargo Securities, LLC, Research Division

Okay.

W. Larry Cash

And generally, Gary, just to elaborate on that, you always start out the year, what we do is start off the year a little higher then you evaluate your claims coming in and get your payments and see how many clients are coming and how to sell once you're taking place and you get an actual report in the middle of the year. And we've got -- with that information, we decided that we're probably a little over prudent so we brought it down, and we're disclosing it.

Gary Lieberman - Wells Fargo Securities, LLC, Research Division

Okay. And typically, you said you do that in the third quarter and this time, you just did it in the second quarter because you had the information there?

W. Larry Cash

Yes, we saw the activity and we're pretty comfortable where our reserves were, our reserves have continued to climb, and they're still above where they were last year and they're still above where they were at the end of the year. And last year, I think we had an adjustment, may have had one in both the third and the fourth.

Gary Lieberman - Wells Fargo Securities, LLC, Research Division

Okay. And then, can we get your thoughts on what you're hearing from DC with the election coming up and what the chances are, I guess, in a lame-duck session of addressing the sequestration cuts that are scheduled to get implemented in January?

Wayne T. Smith

Yes, I have another trip coming to -- going to Washington here on the first. But I think just to start with the election, I think this election is way too tight for anybody to call. It'll probably be down to the wire before some -- before you can get a clear picture and maybe not until -- then you get a clear picture of who's going to win. So all these -- anything from there is basically speculation in terms of everything from Republicans doing reconciliation to -- I would tell you there's a lot of conversation now and there's some support on the sequester that if there's a change for the military component of it, then there should be some change for the health care as well, not just to leave health care out there by themselves to take the cuts. So I don't know where all that's going. I think probably, you may not know anything about that during the lame-duck. It may go into January before some of these problems are solved. I think it's just way too early to tell, and lots of things can happen in a relatively short period of time here.

Operator

Your next question comes from Tom Gallucci with Lazard Capital Markets.

Colleen Lang - Lazard Capital Markets LLC, Research Division

This is Colleen Lang on for Tom. I'm just curious about your thoughts on managed care negotiations and the tone of negotiations. And if you could just remind us what percent of your contracts at this point have some sort of pay for performance requirements or include risk sharing?

W. Larry Cash

Yes, we've clearly gotten probably 90% of our contracts completed for 2012, and we're well over 50% for 2013. There's not a lot of -- there's some pay for performance, but when you look at the level of dollars tied to it, it's still relatively pretty small compared to overall managed care activity and it's probably going to continue to grow so it's almost a small enough number that's not worth mentioning, but it would probably grow. We don't have a lot of risk capitation. I'd say it's probably in less than 5 markets and it's a small percentage. It could be something that would grow. We got about 5% or 6% of our revenues from Medicare Advantage. Most of it is in some form of fee-for-service arrangement there. Probably, where we do have some risk sharing is in California and that's where a lot of it would exist. But we are not in South Florida, not in Tampa, we're not in Las Vegas, we're not in New York or other big areas where they have a lot of risk sharing type contracts. But that could be something that we're willing to do, especially on commercial. We can work through. But just as yet, we haven't had that much and we're still getting the 5% to 7%.

Wayne T. Smith

Yes, I would think that even though there's a lot of conversation around risk sharing, I would think if you look at the development of the risk throughout the country in terms of capitation, it's not that large across the country. There are certain markets that are pretty well saturated. So I think this process is going to take a lot longer than some people think. And I think it will -- we, as providers, need to have some understanding of actuarial science before we get too far down the road. I think that's going to take a little while for all that to develop. I just don't think it's going to happen overnight. And then, I don't -- when you get to the exchanges and all that, it's a totally different matter. So...

W. Larry Cash

Colleen, the other thing probably pertinent is looking at all the ACOs that are existing or announced to be in existence. I think we've got about 3% of our primary population that's near an ACO that can be a competitor. If you look at the secondary, it adds another percent to it. So it's a roughly small percent. We've got probably 20 million people in our population service areas. So I don't think we're going to see a lot of ACOs being that competitive. If they are, then we have to think different about it or arrange differently, but at least starting out, it don't look likely to be that much of a competitive threat for us.

Colleen Lang - Lazard Capital Markets LLC, Research Division

And then, just a quick housekeeping one, Larry. On the cash flow statement, on the increase in other investments, I think it's a use of $162 million this year versus the $75 million last year, is that where you booked the HITECH investment?

W. Larry Cash

Most of that is HITECH, it's position recruitment and it's also the other system conversions we do. And I just would point out that it's pretty big year-over-year. It's about the same amount we said in the second half of the year and clearly, there's -- we understand we've got to spend a fair amount of money on both capitalized software, and the hardware is up in CapEx because it's a hardware piece of equipment, fixed asset, the software capitalization's down there. And as I mentioned [indiscernible] spent probably $50 million on IT that we've got to work through for 20 facilities, which would benefit for 2013. We spent a lot of dollars for capitalized software so far, and we'll get the benefit of that. In HITECH, we've still got probably another $50 million to $60 million of HITECH reimbursement to get, and we'd probably work on 50 hospitals to get probably $60 million of the high ups [ph] or 40% on [indiscernible] $60 million [ph] probably to go the second half of the year at the high end. So I would think you'll probably see a fair amount of HITECH spending going but you'll also start seeing some HITECH reimbursements start to come in a little faster. Not to give specific guidance but just thinking where we are right now I would expect our HITECH incentives to be as we know today, higher in 2013 than they're going to be in 2012.

Operator

Your next question comes from Chris Rigg with Susquehanna.

Christian Rigg - Susquehanna Financial Group, LLLP, Research Division

You guys were pretty clear but I just want to confirm. So the guidance this year did not include or did include the provider tax benefit that you guys received in the quarter and what you expect for the back half of the year. Correct?

W. Larry Cash

The guidance did include the Medicaid provider tax program.

Wayne T. Smith

That would be an affirmative.

W. Larry Cash

For 2012, it is always included. Guidance has always included anything we generally have knowledge of, and we acknowledge that early on the conference calls that we're down 8% Medicaid in 2011 and will be down around 3% in 2012, now 2% to 3% and one of the reasons was new provider tax programs that would incur in 2012 and in the extensions at California which we've got a portion of that equal to what we sort of got in dollars in the second quarter 2011. And it's also in our internal budgets, so when we started out the guidance for 2012 in October, it was in there. When we put it out in February, it was in there. When we put out in April, it was in there, when we put it out today, it's there and the second half of the year it will be pretty close to the first half of the year for the 2 large states, California and Indiana from a EBITDA.

Christian Rigg - Susquehanna Financial Group, LLLP, Research Division

Well, that was very clear. And so I guess, the real point of my question is can you then help us understand where the outperformance is or has been relative to your prior expectations and what's driving the earnings increase?

W. Larry Cash

Well, I think the earnings increased, we raised the guidance $0.05, we raised it about $5 million. We beat both the first quarter consensus and we changed it a little bit then, and we also added the D&A just so it would be tied to reported and I think we were ahead of EBITDA in first quarter, and then we also beat the second quarter consensus and also our internal number here. So being a little bit ahead of that and then we also did the refi, which helps a little bit although some of that is offset by the fact that we borrowed more money, so that's where the $0.05 comes from, some of the EBITDA increase and we raised EBITDA guidance by $5 million at the end of the quarter, and we raised the EPS $0.05. So $0.03 of the $0.05 would come from the EBITDA improvement. We do -- probably the payroll management did a little bit better, supply management hasn't been quite as good. We're roughly pretty close to our plan. If you look at the $5 million out of $1 billion it applied to [ph] it's a positive move, it wasn't a big percentage move, then the EPS was $0.05 on top of the 3 85. And we actually are narrowing the range or about lower in the...

Wayne T. Smith

And we're getting small increases in intensity and outpatient businesses has done pretty well and so we're getting a little pricing as well and we are operating as Larry just said, from an expense standpoint, we are operating well. So compared to where we -- how we were having to operate last year, we are back on track and able to focus on the business so we feel pretty confident about where we're going.

Christian Rigg - Susquehanna Financial Group, LLLP, Research Division

Okay. And then on the capital expenditures, you brought that down $50 million. Is that sort of an absolute reduction or was there -- has something been delayed to next year?

W. Larry Cash

Well, there's probably something been delayed. We are probably doing a little bit better job in spending our CapEx and maybe we'll be a little closer to the low end instead of the high end when all said and done. There was a replacement facility we'd allocated some money to that we thought we might start this year, but it looks like it's going to be pushed off to next year. It's tied up with a CON fight so that would be probably a high percentage of that $50 million.

Christian Rigg - Susquehanna Financial Group, LLLP, Research Division

Okay. And then on the swaps and floating rate debt, are you going to -- at this point, do you envision continuing to let the swaps roll off or are you going to put some more on in the back half of the year?

W. Larry Cash

I think the guidance was down to about 72% as it relates to that, so we're getting closer to that for the year. And I think that we'll continue to evaluate it. It doesn't appear there's a reason to swap more. They stayed fairly good so we'll continue to buy that but we could, by the end of the year or fourth quarter, start putting some more swaps back on.

Operator

Your next question comes from Matt Borsch with Goldman Sachs.

Brian Zimmerman

This is Brian Zimmerman in for Matt. Considering now you've acquired 4 hospitals this year and your guidance is for 4 to 5, how are you viewing acquisitions in the back half of the year? Has anything changed in your pipeline or are you just going to focus on integrating the deals you've already completed?

Wayne T. Smith

I think we feel pretty good about where we -- we've had a pretty robust year. We've got a letter of intent on a West Virginia, Ohio system. So one of the things we continually do is look at our pipeline and think about our pipeline all the time. And if it strategically makes sense, we do what we think is the appropriate thing. I would tell you again that we've been -- even though sometimes it doesn't seem this way, we have been highly selective in terms of the properties that we've acquired because there's so many properties out there. We mentioned earlier that we've turned down about 20-plus possibilities for acquisitions this year. So I think we're fairly disciplined, and we'll continue to be disciplined. I think we're in pretty good shape for this year. It's a little hard to judge these things, but probably anything that we're working on now certainly would not occur in 2013 in terms of getting it closed.

Brian Zimmerman

Okay, that's helpful. And then what sort of number of total position recruitment should we think about for 2012? Last year, we saw an acceleration in the back half of the year, are you expecting that kind of acceleration again this year?

W. Larry Cash

We think there's an acceleration. We didn't put a goal out on physician recruitment, we've done that every year for 12 years and thought we'd just continue to recruit compared to a year ago. So we're ahead of the year ago right now, and the best quarter is usually is the third quarter, that's when a lot of residents come out so we should have another good quarter in the third quarter, then the fourth quarter will probably be -- might be comparable to it was a year ago. The other thing Wayne mentioned was we did a good job in nurse practitioners and physician assistants in bringing them in and that's helpful in the overall market. But I think we'll have a good year. So far it's off to a good year and I expect the third quarter will be strong also.

Brian Zimmerman

Okay. And then my last question is, you've touched on it bit from other questions but with the Supreme Court decision now in the rearview mirror, has anything changed regarding your strategy or operations now that the picture is maybe a little bit clearer?

Wayne T. Smith

No, I think we're on the same track in terms of trying to make sure that we've got the proper infrastructure in place and demonstrating quality. I mean, we've been on this track now here for a good while, and we'll continue down that road. That's why we started and you can see it in Pennsylvania, where we're at 17 hospitals now. These markets can be a state, they can be a region or they can be a city, when it's all said and done. So we continue to think about infrastructure and which means clearly, provision of services in the area and getting size in areas. So we can provide the service that's also consistent with our acquiring physician practices. We've acquired a number of large physician practices over the last couple of years. So I think the only thing that we will think about and adjust to now is, and I think we'll go slow with this is, in terms of the risk side of it, in terms of what kind of risk sharing business that we want to participate in, I know Larry just mentioned this earlier and we're trying to figure out how we can best do that. But I think that's going to go slow. I don't think we're going to jump all over that too quickly. So -- but really, the basics of our business and our basic strategy has not changed but we're continuing to think about what we might do differently as we kind of go forward, and it will be a slow change, not a dramatic change.

Operator

This now concludes the Q&A session. I will now turn the call back to our presenters.

Wayne T. Smith

We are pleased with our strong second quarter and believe our prospects for continued growth are very favorable in light of recent decisions surrounding health care reform. We are well-positioned to leverage the industry dynamics as the leading operator of non urban hospitals and midsize hospitals and markets. We specifically want to thank our management teams and staff, hospital Chief Executive Officers, Chief Financial Officers, Chief Nursing Officers, and vision operators for their excellent operating performance in the second quarter. We remain focused on our business strategy and improving results. We appreciate your time this morning. If you have any questions, you can reach us at (615) 465-7000.

Operator

And this concludes today's conference call. You may now disconnect.

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