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Community Health Systems, Inc. (NYSE:CYH)

Q1 FY08 Earnings Call

April 30, 2008, 10:30 AM ET

Executives

Wayne Smith - Chairman, President and CEO

W. Larry Cash - EVP and CFO

Analysts

Justin Lake - UBS

Thomas Gallucci - Merrill Lynch

Adam Feinstein - Lehman Brothers

Kenneth Weakley - Credit Suisse

Shelley Gnall - Goldman Sachs

Gary Lieberman - Stanford Group

Darren Lehrich - Deutsche Bank

Robert Hawkins - Stifel Nicolaus

David Bachman - Longbow Research

Operator

Good morning. My name is Brandy, and I will be your conference operator today. At this time, I would like to welcome everyone to the first quarter ending March 31, 2008 conference call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions]. Thank you.

I would now like to turn the call over to Wayne Smith, Chairman, President and Chief Executive Officer. Please go ahead, sir.

Wayne Smith - Chairman, President and Chief Executive Officer

Thank you. Good morning and welcome to Community Health Systems quarterly conference call. With me on the call today is Larry Cash, our Executive Vice President and Chief Financial Officer. Purpose of this call is to review our financial and operating results for the first quarter ended March 31, 2008.

We issued a press release after the market closed yesterday, that included our financial statements. For those of you listening to the live broadcast of this conference call on website, a slide presentation accompanies our prepared remarks.

I’d like to begin the call with some comments about the quarter and an update on our integration progress and then turn the call over to Larry, who will follow with the comments on our financial results.

But before I begin, I’d like to read the following statement. Statements contained in this conference call regarding expected operating results, acquisition, transactions and other events are forward-looking statements that involve risk and uncertainties. Actual future events or results may differ materially from these statements.

Such forward-looking statements are made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995 and made based on management’s current expectations or beliefs as well as assumptions made by, and information currently available to management.

These are summarized under the caption Risk Factors in the documents filed by Community Health Systems, Inc., with the Securities and Exchange Commission, including the company’s annual report on Form 10-K, and current reports on Form 8-K. These filings identify important risk factors and other uncertainties that cause actual results to differ from those contained in the forward-looking statements.

In our reported results, the prior year first quarter 2007 consolidated results reflect Legacy hospitals only. Our same store results included July 25, 2007 acquisition as well as the legacy CHS for the first quarter for both years 2008 and 2007.

With that we are very, very pleased with Community Health Systems solid financial performance for the first quarter 2008 with a strong revenue growth and successful expense management.

Net operating revenues for the quarter ended March 31, 2008 totaled $2.7 billion compared to $1.2 billion for the same period last year. EBITDA was $383 million, income from operations was $51.5 million with earnings per share from continuing operations of $0.54 per share.

With that, I’d like to review some of the key accomplishments for the quarter. As you know, by February influenza was widespread across the country and remained a strong admission force throughout the second week in all of… in March.

Our same-store admissions benefited from this strong flu benefit for the first quarter were up 3.8%, Same-store adjusted admissions also increased 3.8% for the same quarter. The same-store net revenues increased 5.7%.

We completed the sale of nine facilities to Capella Healthcare, effective March 1 for an aggregate purchase price of $315 million, we continue to work towards the purchase of a two-hospital system in Spokane, Washington. The target settlement for that acquisition is now sometime in the fourth quarter due to delays in the Certificate of Need process.

The operations of the hospital have deteriorated and we have negotiated in lower price as we stated the focuses over the next 12 months will be to improve our current hospital portfolio.

We recruited 206 new physicians for the first quarter, compared to the 156, same period last year, over 60% of those physicians were specialists. Our outlook for 2008 with a… is a target of 900 physicians. We achieved approximately $35 million, or 24% of our targeted synergies of the $145 million of 2008 and we continue to be one track.

We’re reconfirming the guidance that was provided in February 2008 with minor changes in the third and fourth quarter projection range for income from continued operations. The 2008 projection range remains $2.25 to $2.45. There is no update to the status of the Federal Governments investigation three of our New Mexico hospitals allegedly improper receipt of federal participation payments.

With that, I’d like to turn the call over to Larry to provide you summary of our financial results.

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

Thank you, Wayne. The financial and operating results for the first quarter reflected our solid expansion of our operating staff assisted by the increased volume. Our consolidated admissions were 177,280 in the first quarter and the consolidated adjusted admissions were 310,251.

Same-store admissions increased 3.8% and our same-store self-pay admissions, as a percent of admissions, increased 20 basis points. Flu-related admissions represent approximately 120 basis points of increase and additional day in February represent another 120 basis points.

Excluding the flu and the extra day, admissions would have increased 1.4% for the quarter. We also had a negative effect from the Easter falling in the first quarter as well as some service closures and a statistical classification. Had these events not occurred, admission would have increased approximately 50 basis points or 1.9%. Same-store adjusted admissions also increased 3.8%.

Our net revenues in the first quarter increased to 136% compared to the same period last year or $2.7 billion versus $1.2 billion. On a same-store basis, net revenue increased 5.7% with inpatient revenue up 7.3% and outpatient revenue up 4.6%. The outpatient growth was slow somewhat due to reduction in physician clinic revenue, approximately 1.7%. Same-store revenue increased to $110 million or 4.3% sequentially.

Some points to make regarding revenue are as follows, as one would expect with the high flu volume, our same-store surgery volume was down 0.9% for the quarter. Same-store net revenue per adjusted admission increased just 1.9% due to lower intensity of the flu cases. Our Medicare case mix declined for the quarter by approximately 1.8%. And finally, of course, this is indicative of the less severe nature of the flu patients.

Same-store revenue growth was also affected by an implementation in the discount policy in the legacy Tennessee hospitals in the third quarter 2007. This impacted revenue and revenue per adjusted admission by approximately 40 basis points.

Our discounts policies were implemented into other legacy CHS facilities in the first quarter of 2008, and affected revenue growth and revenue per adjusted admission by approximately 60 basis points. Same-store revenue will increase 6.7% and same-store revenue per adjusted admission would have increased 2.9% without the change in the discount policy.

We have continued to deliver good EBITDA growth of a 125% increase $213 million from $170 million to $383 million. On a same-store basis EBITDA increased $38 million or 11% from $340 million to $379 million for the quarter. For the first quarter EBITDA margin on a consolidated basis was 14%, a decrease of 70 basis points from year ago. The same-store EBITDA margin improved 80 basis points to 14.4% compared to the quarter ended March 31, 2007.

For the first quarter our non same-store margin was 4.9%. The de novo, Cedar Park Regional Medical Center outside of Austin, Texas, has contributed to the lower than average performance in the non same-store, due to its start-up costs and reduced margin by approximately 400 basis points. The credit margin before acquisition of the non same-store hospitals was approximately 3%.

In the first quarter, consolidated operating expenses as percentage of revenue were up 70 basis points, due somewhat to the non same-store acquisitions, specifically Cedar Park. Also consolidated payroll benefits of bad debt decreased 20 basis points. Supplies increased 260 basis points. On a sequential basis, there was a 30 basis point increase in supplies, which is consistent with historical results from the fourth and first quarter.

Other operating expenses including rent decreased to 100 basis points. On a same-store basis total operating expenses improved 80 basis points driven by improvements in payroll benefits and supplies and other operating expenses offset by the increase in bad debt. Same-store operating expense per adjusted admission increased only 1% or 100 basis points with very, very good cost controls in the quarter.

Triad historically had lower combined bad debt and charity in CHS, with higher discounts. Our consolidated self-pay revenue, as a percentage of total revenue declined 200 basis points, due somewhat to an implementation to discount policies, I previously discussed, when discussed revenue.

Our consolidated bad debt is 10.9% for the first quarter versus 11.1% for prior period a year ago.

And of course, bad debts were less due to increased self-pay discounts. Charity decreased to 110 basis points and administrative discounts increased to 130 basis points. Our combined consolidated bad debt charity care and administrative self-pay discounts, as a percent of adjusted revenue are up 10 basis points for the quarter, 17.5% versus 17.4% for a year ago.

Our 2008 guidance for bad debt ranges from 11.2% to 11.7% of net revenue. Consolidated cash receipts were over $103 million we collected that revenue for the last 12 months ending March 31, 2008. Consolidated AR days were 54 at March 31, 2008, unchanged from December 31, 2007.

The allowance for doubtful accounts was $1.37 billion or 39% at March 31, 2008 of our total net accounts receivable. For the hospital segment, the allowance for doubtful accounts and related contractual allowance for self-pay were approximately 82% of the self-pay receivables at March 31, 2008.

Community Health Systems continues to have a favorable payer mix. For the quarter in March 31, 2008, consolidated net revenue by payer source was broken down as follow, Medicare 28.5%, Medicaid 8.3%, Managed Care and others 52.6% and self-pay 10.6%. Our cash flow from operation for the first quarter was $8.9 million versus a $120 million for the first quarter of 2007.

The first quarter cash flow was impacted by the following, we made our first semi-annual interest payment of $126 million on our high yield debt yield debt, reducing cash flow by approximately $62 million. We also funded prior year annual benefits in the amount of $49 million and added $18 million more health claim payments in 2008 versus 2007 due to some pre-funding in the fourth quarter 2006.

Additionally to the large volume in February, March compared to prior periods, our accounts receivable increased approximately $100 million generally in the zero to sixty day aging category were to increased in $67 million more than 2007.

These forecast provided us, total $196 million compared to the 2007 cash flow. These decreases were also of primarily increase in non-cash depreciation. The last six months cash flow from operations totaled $291 million. Our 2008 guidance for net cash provided by operating activities remains at $750 million to $800 million.

Total capital expenditure for the quarter just ended were $137 million, or about 5% of revenue. Replacement hospital expenditures including that amount were $58 million, or 2.1% of revenue. Our capital expenditure guidance for 2008 remains $775 million to $800 million, or approximately 7% of net revenue for a $140 million related to replacement hospitals.

Balance sheet cash at March 31 was approximately $164 million. At the end of the quarter, the company had available credit of over $1 billion. We believe that we have sufficient availability to fill our capital expenditure requirements.

Looking at the balance sheet at March 31 2008, we had $1.3 billion in working capital and approximately $13.3 billion in total assets. Total outstanding debt at March 31 2008 was $8.9 billion of which 84% is fixed. Our debt to capitalization at the quarter end was also 84%.

We did payoff approximately $100 million in our bank term-loan debt during the first quarter, and additionally we retired $63 million for high-yield bonds, which caused us to incur early distinguish of debt charge of $1.3 billion and this retirement should generate future interest savings.

At the end of the quarter, we reported to $4.450 billion in the interest rate swap agreements, an increase of $575 million for end of the year. At March 31, 2008, again our fixed rate debt is at 84%, and these agreements limit the effect of changes in interest rates on a portion of our long-term borrowings.

I would like to briefly discuss our minority interest as well as our equity earnings with the unconsolidated subsidiaries. Our minority interest and earnings was $9.7 million in the first quarter versus $0.2 million in the first quarter a year ago.

As of March 31, 2008, 19 of our hospitals were owned by our physician joint ventures, of which two also had some not-for-profit entities as partners. In addition, six other hospitals had not-for-profit entities to partners.

We recognized about $12.9 million in equity and earnings of unconsolidated subsidiaries in the first quarter. These earnings are attributable to our minority unconsolidated positions and joint ventures for subsidiaries of the university. Universal Health Systems in Las Vegas, Nevada, HCA, in Macon, Georgia and the local foundation in El Dorado, Arkansas.

Wayne will now provide a brief recap.

Wayne Smith - Chairman, President and Chief Executive Officer

Thanks, Larry. First quarter marks a very strong start to 2008 with $2.7 billion in quarterly revenues. We have consistently recorded double-digit revenue growth since the beginning of June 2000 and we’re gone public in June 2000, 31 consecutive quarters. And we expect our growth to continue as we improve hospital operation, enhance services, recruit physicians stem out migration.

With that I will now open the call for our questions and answer period and if you would like to talk to us after the call, you can reach us at area code 615-465-7000.

Question and Answer

Operator

[Operator Instructions] Your first question comes from Justin Lake with UBS.

Justin Lake - UBS

Thanks, good morning. Couple of questions, just first on commercial pricing, can you talk a little bit about what you are seeing for managed care, specifically. There has been a lot of chatter in the market that we might be seeing an inflection point here as far as our hospital negotiations.

Are you seeing anything there that you kind of point to as far as managed care’s willingness to give up price or your ability to get better price from them and maybe talk to what those points are?

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

Yeah, this is Larry. Our guidance has been 5% to 7%, and we pretty much think we are staying in that range of 5% to 7%. We do have some anticipated synergies in $145 million for managed care, which I think were achieved for the year and talking to our managed care directors, they feel pretty confident about we will be within that range and I think that’s been our range for a while. So, I wouldn’t think that we would expect to be lot any outside that range right now.

Wayne Smith - Chairman, President and Chief Executive Officer

But one of the things that’s helped us in terms of managed care if you recall, is the fact that we’ve been able to consolidate our operations in individual states and having one manager over that particular state as opposed to the way Triad did it by individual hospital and that’s given us a little advantage currently in terms of working through our contracts.

Justin Lake - UBS

Great. And when you sit down with your counterpart, someone who is going to plan, and you talk about a certain pool of revenue, for instance that, you’re putting together community in Triad and you’re talking to, trying to get your rates obviously closer to Triad’s are getting a better rate on that total pool.

Is there any thing that you’re seeing from the employer community or the plan that’s changed as far as your ability to get them to move closer to that higher rate? And within that 5% to 7% is there, do you feel like you’re moving towards the higher end of that range from maybe, five to six. Is there any movement within that range that you can talk about?

Wayne Smith - Chairman, President and Chief Executive Officer

Yes, nothing has changed as far as we can see currently in terms of there is no big trend changes or any of those kinds of things that we’re hearing about. I’ll let Larry to.

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

Yeah, I’ll just add that, we’re probably renegotiating a little higher number of contracts say in a first quarter than we would added a year ago because of having more contracts since we had 4300 contracts down the work there which is about double. So, we got more work and more activity.

There is a good overlap of activity there basically we have about the same top, same five high payers. But I think if we can stay in the 5% to 7%, and again 65% of the markets are still sole providers, which helps you get some of your contracts you got to give, because if you don’t have a contract there, you should be able to pay charges.

Wayne Smith - Chairman, President and Chief Executive Officer

Just to conclude this part of this conversation is that, we’re not having any difficulty getting contracts that we want. We’re not having trouble renewing or renegotiating or any of those kinds of things and we’re doing fine.

Justin Lake - UBS

Great, and then I’ll just touch on the volume side. And as you kind of axed out some of the one time items, you did a good job of kind of explaining in your presentation. It sounds like same-store volumes were in the 1.5% to 2% range.

Wayne Smith - Chairman, President and Chief Executive Officer

That’s correct.

Justin Lake - UBS

Can you tell us, it looks like surgeries were down maybe you can just give us an idea of what kind of volume you’re seeing there as far as maybe by payer mix, and then is it more medical? And what maybe you can kind of just walk us through, do you expect that to continue, are you are seeing it continue in April and was there anything you kind of point us to as to what’s driving that?

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

Well, if you look at, answer your first question, first. We’ll be about 2%. Clearly Medicare was probably, some of the Medicare’s now been classified as managed care. So Managed care a percent of admissions is actually above the 3.8% looking at that perspective. But some of that’s probably Medicare fee for service.

Medicare was little less and self-pay was up a little bit. I think we were up 20 basis points percentage growth more than 3.8% in total. We generally don’t talk about quarterly volume. We get asked that and we just have elected not to talk about each quarter or each week, clearly we’ll benefit in April as a result of Easter, being in March, and that should help April well.

Justin Lake - UBS

Thanks, and just one clarification, I will jump off on the commercial side. Larry, you did break out the fact that a bunch of Medicare is now being classified as commercial due to the growth in Medicare Advantage. Can you give me an idea of what the commercial growth is, how it looks ex, the Medicare advantage?

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

Well, what I have here is the total Managed care and other was greater than 3.8% and we have not broken out the Medicare any further than that.

Justin Lake - UBS

Okay. So, it’s added and we just don’t know much?

Wayne Smith - Chairman, President and Chief Executive Officer

Justin, just to conclude again this conversation about volume, and we’re the first ones to say don’t really, you can’t really count on the flu, you never know when it’s going to come or not come all those kinds of things and changes is imperious. Larry’s great about making sure everybody understands it, when there is a leap year or Easter, how those things falls. Having said all that, we had almost 2% same-store volume growth. It’s a very positive as I think for us currently and you look which is strong for the quarter.

Justin Lake - UBS

Absolutely. Thanks for all the commentary.

Operator

Your next question comes from the line of Tom Gallucci with Merrill Lynch.

Thomas Gallucci - Merrill Lynch

Good morning. Just a couple of quick topics, I guess the first on synergies. It seems to be maybe going little faster than initially anticipated. Can you talk about, maybe some of the specifics there and is it just faster or maybe can we expect a little bit bigger synergy ultimately too?

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

We didn’t change our guidance, so we kept at $145 million and the look by us because of the some reductions in the corporate overhead came little faster than we originally thought, been on there and we’d probably guided in the second quarter, and now we’re get some of that in the first quarter. A lot of activities in corporate office and productivity and supplies and we’ve made some benefits in some of the other areas. But I think we’ll stick with now for $145 million.

Thomas Gallucci - Merrill Lynch

Okay. And I guess Larry, in your prepared remarks you mentioned, some pressure due to doctor clinic type revenue, can you expand on that a little bit?

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

Yeah, there was a large, Triad had acquired a large multi-specialty clinic in that fourth quarter of 2006, it’s in a same-store hospital. So it’s been showing up from the same-store revenue and that’s how clinic revenue is done that sort of anniversaried itself. So, it’s a positive to see the clinic revenue is slowing down, that slow down, our patient revenue down about 1.7% I believe. And it’s sort of a positive to see clinic revenue not growing. Also that probably effected the overall revenue growth about 90 basis points, I didn’t add that into it. So we really will be somewhere in the 3% to 4% if you adjusted for that.

Thomas Gallucci - Merrill Lynch

Great and then on the Empire deal, looks like you get the little better price may be its pushed out a little bit in terms of the timing. Where is sort of some of the dynamics that lead to that and does it change your longer term expectations at all there?

Wayne Smith - Chairman, President and Chief Executive Officer

Just in terms of the dynamics of this, the state is taking inordinate long period of time to go through this process which it is going to need. So that’s really extended this a great deal. And one of the things that we’re always concerned about as we talk about divestitures is when you talk about selling a hospital, the things that happen in the market. The dynamics in the market are fairly detrimental to that facility until someone gets in and starts making the right decisions and move forward quickly.

Those are the kinds of things that are happening in that market. So we were successful in renegotiating and reducing the price by $16 million. So we think now that things are moving forward, that it will close sometime in the fourth quarter. I don’t know if you want to add anything.

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

Yeah. I’ll just say, we’re still pretty positive about it being a really good acquisition and just that the results did slip a little bit in 2007 versus 2006, but this should be a good facility for us once it closes.

Thomas Gallucci - Merrill Lynch

Okay, thank you.

Wayne Smith - Chairman, President and Chief Executive Officer

Thank you.

Operator

Your next question comes from the line of Adam Feinstein with Lehman Brothers.

Adam Feinstein - Lehman Brothers

Okay, thank you. Good morning. Just, I guess, to follow-up to the synergy question from earlier, this maybe… just wanted to think about it a little bit different. So you guys have now achieved 25% of the ‘08 synergies and if we include what you had in 2007, it’s about 35% of among the total.

As we think about the integration of Triad and not just talking about synergies, as we think about just the process and things such as integrating the systems and such. How far along are we within the process here?

I don’t know if there’s a way to think about it, but just curious to get your thoughts in terms of just the overall integration process with synergies being a part of that but other things also.

Wayne Smith - Chairman, President and Chief Executive Officer

Let me just speak to the integration process and then Larry can talk about the synergy detail again. Adam, I think we really made a lot of good progress. We’re in an operating mode now.

We are back to doing the things that we have done historically in terms of working hard on expense management, looking for revenue growth opportunities, recruiting physicians, doing all the things that we’ve been doing in the last 10 years.

This acquisition feels a lot like the acquisitions that we’ve done through the years. There’s just a lot more of them in terms of the kinds of things that we need to do to make this hospital successful.

As a couple things that have helped us along the way that we talk about publicly is that we didn’t have to do a big systems change to start with nor a supply system change to start with but those two things have helped us a lot in terms of moving this forward.

So we are making really good progress. We’re now back to working on perfecting the things that we do in term of our standardized centralized business processes and procedures and getting physicians in place and looking for all these opportunities.

So we feel pretty good about that and we are not having any turnovers as I’ve said over a thousand times. We’ve not had any major doctor issues or meltdowns or any of those kinds of things.

So all that is going better than we expected, and by the way we continue, this will set Larry up to answer your question for you. By the way, we continue to find great opportunities. The more we work on this, the better opportunities that we see.

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

To just add a little bit to that the areas of the corporate office… it’s got done a bit quicker and I think we’re making some progress in productivity. We’re real productive in this quarter. Supplies is probably one we made some progress, there’s a lot of opportunities in supplies to speak specifically and our Chief Purchasing Officer will do a good job the next three quarters improving our supply synergies to other areas, managed care, home health case management, HIM, marketing IT.

All have got annual goals that they have accepted and we measure on site and we feel real good about the $145 million. Wayne alluded to other areas. There’s other areas in revenue management, ER management, physician recruitment, opportunities to do better job there.

And I think as we do those we’ll see some benefits of that too, and we’ll continue to monitor how we do but $145 million looks pretty good right now for achieving that in 2008.

Wayne Smith - Chairman, President and Chief Executive Officer

And the most encouraging thing so far for us, are not only the opportunities in the market it’s the management we have in place around this country. Our management throughout our hospitals and our division management really stepped up to the process and that’s why we are having good success now and making good progress.

Adam Feinstein - Lehman Brothers

Okay, just a follow-up question here, and thanks for the details there. Just around the accounts receivable, you saw the build-up, it makes sense with the volumes picking up the way they did in February, just curious if you’ve already seen improvement there? And then just also on the AR Larry, but you said self-pay… I guess your allowance is now 82% of your self-pay AR, and that’s up from 76 last quarter, just curious, if you think about that number staying at that level I guess, to just your outlook in terms of how you think about the reserve as a percentage of self-pay AR. Thank you

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

I checked yesterday, and we’ve actually done a pretty good job of late. We will talk about that since it’s a specific. We’ve done a pretty good job of April cash collections through yesterday and our investible cash has gone up quite well. So, it is moving down, I didn’t expect to have a real good second quarter from cash flow perspective. As it relates to the 82, that’s on hospital segment, Adam we decided it a little differently.

Most of our receivables that are show up in our Q our hospitals having clinics or some that were there and it’s about 82%. It’s fair to count what the hospital segment would have been at the end of the year, last time we disclosed the total company. So, we’re pretty comfortable, it’s going to be somewhere in the high 70s%, low 80s% range there. Our collection company here is doing very good job.

We are starting to get some accounts from the Triad hospitals merged into our collection company and that started in March, and we’ll see some good results there. We’re done a pretty good job on deductibles and coinsurance keeping our collections up, and a pretty good overall recovery rates. So, I think we’re in a pretty good shape from bad debt reserve right now.

Adam Feinstein - Lehman Brothers

Okay, thank you very much

Operator

Your next question comes from Ken Weakley with Credit Suisse.

Kenneth Weakley - Credit Suisse

Thanks and good morning everyone. Wayne, I was curious, if you could maybe look forward, with some of thoughts about the slowing economy, how labor cost and bad debts may be change relative to expectations depending upon the stay of the economy?

Wayne Smith - Chairman, President and Chief Executive Officer

Ken, I don’t know. I mean people have different views about this, but from my perspective, I think our unemployment rate in our markets is about 5.3%. Historically it’s been 5.2% to 5.3%. We maybe up to 5.4% now. It would take a pretty big sea change of unemployment for it to really adversely affect our markets in terms of, and you know, better than I do, when you do have a big lay-off in a market or a big change in payer mix. And we saw this in Tennessee a couple years ago, when 200,000 people were disenrolled from Medicaid here. We had a big uptick in our bad debt of course.

I think incrementally those small changes in unemployment rate don’t really have much of an adverse effect on us, and you can see that we had really good productivity in our wages and salaries this quarter. So, we continue to have opportunities to make progress there. But I think it has to be a pretty major change in a particular market to have a big impact. And then the other side of this is that we continue to see so many opportunities in terms of market share opportunities.

We still are only getting about half of the available volume that’s in our markets and we have a lot of physician recruiting opportunities. So, all those things would offset any of these smaller incremental issues, having said that, we had really good volume, 2% growth in volume, couple of other issues about the flu and leap year. So I am not too terribly concern unless there is a major change and by the way if you had a big issue in a community, it’s a community issue not a company wide issue. So…

Kenneth Weakley - Credit Suisse

I understand. I would think that a slowing economy could actually help out the labor margins. Is there any validity to that thinking that maybe turnover starts to actually drop considerably on the nursing side and your labor cost actually to start to improve as a percent?

Wayne Smith - Chairman, President and Chief Executive Officer

There is clearly a possibility, but again incrementally, it’s a relatively small number when you look at it market-by-market and across the company. It’s a

Kenneth Weakley - Credit Suisse

Okay.

Wayne Smith - Chairman, President and Chief Executive Officer

It’s a pretty small and besides there is always demand for nurses.

Kenneth Weakley - Credit Suisse

Yeah.

Wayne Smith - Chairman, President and Chief Executive Officer

So, you maybe right that over a longer period of time, if unemployment goes up, people have to have stability in their jobs.

Kenneth Weakley - Credit Suisse

Okay. And Larry can you offer some color on the severity adjusted DRGs? What impact it may have had relative to last year either in pricing or on profitability of the Medicare and patient business?

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

Yeah. Let me make one comment. If you go back a couple of years, when the unemployment rate actually went up from around 4.2% to 5.7% and that’s when it really happened. January 2001 to 2002, that’s when you start seeing all the volume going up and so, its going to take a lot more now in part to side volume activity.

The MSDRGs were originally all in. We still think we are going to get somewhere around of 2%. Medicare increased both sides of the company. We benefited from the Triad facilities it would be a little bit higher than the Legacy CHS hospitals.

I think we are still feeling pretty good about that. We’ve done some work to try to make sure that our estimates are right, and so far they look pretty good. As far as the behavioral adjustment we’ve made some, we’re always working, trying to do a good job on coding. Some of our synergies are in the HIM area, so we made a little progress in that. But I think we still believe we’ll get the overall Medicare increase of about 2%.

Kenneth Weakley - Credit Suisse

Okay. And there is one last question if I could. You have a target of 900 docs. What’s your net addition on a yearly basis? In other words, how many are losing?

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

Well, we lose about 5%, 4% to 5% a year, is about 12,000 physicians. So, if we’re losing 5%, it would be 2,000.

Kenneth Weakley - Credit Suisse

Thank you.

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

Net drop.

Kenneth Weakley - Credit Suisse

Okay.

Operator

Your next question comes from Matthew Borsch with Goldman Sachs.

Shelley Gnall - Goldman Sachs

Hi, thanks. This is Shelley Gnall in for Matt Borsch this morning. Just as a follow-up on a couple of Justin’s comment. Can you clarify was flu actually displacing surgical cases during the quarter?

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

Well, surgery was down and we have said alternate. Our experience has been, when you have a really large flu season, you had one in 2005, had one in the first quarter of March 2009, I mean, growth like 16% March of 1999.

You just have less surgery. It’s a phenomenon there and so to some extent it could happen. It’s got lot to do with, when you have this type of flu, I am sure a lot of people had the flu on the call listing and so it slows down surgery.

Wayne Smith - Chairman, President and Chief Executive Officer

Having said that, we don’t know of anything either competitively or systemically that adversely affect our surgeries in the first quarter, it seems to be more about mix than anything else.

Shelley Gnall - Goldman Sachs

Well, because I was giving my follow-up. Was there any reduced demand for specific types of surgery? It doesn’t sound like there was.

Wayne Smith - Chairman, President and Chief Executive Officer

But not that we can tell.

Shelley Gnall - Goldman Sachs

Okay, great. And then just a quick question on the self-pay mix, it looks like its two basis points sequentially. Any thoughts thereon what’s driving that?

Wayne Smith - Chairman, President and Chief Executive Officer

Well, it’s spread throughout. And we got 115 hospitals. That’s probably in 10 or 15 hospitals. It’s not a big number; it’s like 700 to 800 admissions our of 170,000 admission. So, it is too tensed, it’s not a big percentage increase.

And we’ve often said, we respect self-pay, may be grow just a little faster than the overall admissions grow, we didn’t have that happening last year. But this 2% increase doesn’t seem to alarm us. It’s what we think we have going forward.

Shelley Gnall - Goldman Sachs

And then overall, it looks like you payer mix generally, actually looks a little bit better year-over-year, I mean I am wondering, does that reflect some of the recent divestitures?

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

It helps on that, also when you look at year-over-year Triad had a lower margin that we’ve had, even though they had much higher revenue for just admission by 9,000. We were somewhere in 7,000 range. That’s some of the comparison year-over-year, that’s as reported. So we don’t look quite as good when you put in Triad, the Triad will help our payer mix going forward.

Shelley Gnall - Goldman Sachs

Okay, great. Thank you.

Operator

Your next question comes from the line of Gary Lieberman with Stanford.

Gary Lieberman - Stanford Group

Thanks. Good morning. I guess just to, maybe stay with a little bit of theme from the last question on the total uncompensated care claims, looks like your levels were pretty stable on a year-over-year basis and down from last year.

I guess in terms of framing maybe the risk on the uncompensated care side is the cure risks that the uninsured admissions pick back up faster than they have been growing or is it a lack of ability to collect on the co-payer, the deductible side, what’s the biggest risk to the uncompensated care trends going forward?

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

Well, historically bad debts have been about 70% related to pure self-pay and I think that’s stayed in our trend and 30% deductibles for co-insurance. Our guidance is 11.2% to 11.7% and we feel really good, I want to finish the year with a 10.9%, and also the 17.5% was actually up sequentially compared to 17.4% where I just see CHS only. If you look sequentially it was 16.8%, so it was up a little bit and we still had a pretty good quarter.

So I think we feel pretty comfortable that bad debts shouldn’t derail us to make in what out there is our guidance especially knowing that we’ve got 11.2 to 11.7 versus 10.9%. One other thing we do a lot of always remember that the bad debts, maturing discounts or gross dollars, we saw looking that revenue less bad debts, and operating expenses less bad debts. In this past quarter revenue just was up 5.3%, operating expenses were up 4.3%. So we had real good operating management their.

Gary Lieberman - Stanford Group

Okay. And then just one quick follow up on the portfolio, any thoughts on additional divestures or are you guys pretty happy with what the portfolio looks like at this point?

Wayne Smith - Chairman, President and Chief Executive Officer

I think we’re in pretty good shape now. We made good progress early on and making determinations about what we needed to work on to get done the Capella deal, happened very quickly, as we said, we would get a fair number of down to start with. I think we’re in pretty good shape now, and I think really the job here now is continuous operation and operations improvement, I think that’s what we have both on the acquisition and the divesture side.

I think our focus really now is on improvement and there is a lot of opportunity for improvement. That’s not to say though if somebody wants to offer a great price rate particular facility and then we are certainly we consider that. But I think all in all we feel like we have a pretty stable portfolio with a lot of opportunity for growth.

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

Garry, one point about that, if you go back and look at our first quarter, we saw some CHS legacy hospitals since the first quarter of 2007, the revenue actually dropped $50 million for those hospitals, the EBITDA stayed the same, and we increased our EPS $0.03. So the deleveraging is working because we’re still under right assets and getting a good price for it and that’s sort of indicates it.

Gary Lieberman - Stanford Group

Great, thanks a lot.

Operator

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

Darren Lehrich - Deutsche Bank

Thanks, good morning everyone. So just as far as the quarterly guidance goes, you came in towards the upper end here in the first quarter and if I am hearing you correct, it sounds like the volumes were probably a little ahead of what you would have expected given the seasonal impact of flu and you probably got a little bit ahead with regard to the corporate office that are winding down in Plano.

So, I guess I am just wondering if there was anything that went against you in the quarter such that, that didn’t translate to more earnings. Can you just help me square that question? Was there more startup losses in Cedar Park, was there something on supply cost side that didn’t go your way? Just, if you can help me understand that.

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

Only one thing I’d say is, is the Cedar Park had started out a little bit higher of loss EBITDA wise than we anticipated and what we budgeted, it should get better by the year. What the change in the guidance was, we were 2.25 or 2.45 where this is the second full quarter of owing the Triad assets.

We just felt it is appropriate to leave the range the same. We didn’t change the revenue-to-EBITDA, the EPS-to-revenue, our admission guidance and if you look at it the admissions were real strong in the first quarter. What we’ve said of the people is we will look out for the second quarter and make some adjustments.

The other couple of things was Spokane did move from the third quarter and the fourth quarter. That affects about $75 I mean the revenue and maybe $8 million or $10 million of EBITDA, possibly and then you also, a little bit of accretion. And then we do think the Medicare increase may not be quite as positive as we thought it would be.

Earlier, I think, we thought it might be 30.5%, now I think it might be less than that for the fourth quarter. Those are events in the future. But we feel pretty good about where we are and have good quarter and we will see where second quarter takes us when we revisit our annual guidance.

Gary Lieberman - Stanford Group

Okay. That’s helpful and just on Spokane, Wayne is there anything you can do leading up to the close of that sale? I mean, you have got QHR. Is that an asset for you to help stabilize operations out there? Is there just anything you can do in the interim given the length of time it still is that you plan to close?

Wayne Smith - Chairman, President and Chief Executive Officer

Not really. We generally don’t get too terribly involved in a facility until we own it. Because you never know, you never own until you own it, until actually it is closed. So we are pretty careful about not trying to get in control or take steps.

We are getting good information on a quarterly basis we think now they have a, on a monthly basis, I am sorry. We think now they have a good operating team in place that they have employed and they are doing the right things now, but it did risk for about six months or so.

But we are still encouraged. It’s over $300 million in the revenue, the purchase price is about half that when it is all said and done. So it should work extremely well. It’s over 500 beds, there’s two facilities, that’s great a community, Spokane is a great community with good growth and sort of fits our opportunity list in terms of a midsized market, so we are very encouraged about it, just taking an inordinate amount of time to get this done.

Gary Lieberman - Stanford Group

Yes. Okay. And then on the synergy, I know you have talked a lot about that. I guess my one question would be related to supply cost. Is there anything specific or, are there any processes that you are looking to change over the next several quarters on that particular line?

It seemed like that was one of the major opportunities, and probably a lot of your guidance I think it rest on success there, So can you just flush that out a little bit?

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

Yeah. If you look at the area there, it is, lot of opportunities and the drug opportunity we made some progress I think it was drugs little bit better in the CHS ‘07 hospitals in the first quarter and historically that’s a very good opportunity. We got some opportunity, probably in the food and stents and stuff as that. I think you will see us make some progress going forward. The first quarter was up a little bit, but I think you will see us do better as the quarters go on, unless we have a lot of surgical growth which would even be better.

So, I think the main thing we are putting a lot of focus on right now is drug formulary and trying to drive our drug costs down. If you go back, CHS has the last four, five years improved drug costs as a percentage revenue 20 basis points to 30 basis points. I think we can make a similar type progress in the CHS ‘07 hospitals.

Gary Lieberman - Stanford Group

Okay, that’s great. My last question, Larry, just as it relates to your swaps. Is there anything you have to say about what you might do with swaps and whether you unwind any of them prematurely just to take advantage of the interest rate environment? I think you’ve been evaluating that.

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

Yeah, I think we have evaluated our internal analysis and also external analysis was probably with the kind of volatility going on, not a good idea to try to unwind the swaps and pay cost for it. LIBOR now is about 2.9 and we are going to reset here in the 1st of May and it was in the low 3s when we had it back it in February.

We will watch it and see what happens today. Instead of activity, we could do some more swaps and we are pretty comfortable with 84% of fixed, and we still lease as $1.5 billion of variable debt, but I think from a perspective of going forward, interest should help us. And I think the rates we got are somewhere comparable to what most people would expect to see for the age of the category of swaps we got, and we will probably wait and see what happens after this next rate decrease, hopefully today.

Gary Lieberman - Stanford Group

Great, okay. Thanks very much.

Operator

Your next question comes from the line of Rob Hawkins with Stifel Nicolaus.

Robert Hawkins - Stifel Nicolaus

Thanks. The surgery volumes getting back to that, it’s been down not only for you guys but also for everybody else. Is any of this related to medical management as we’re seeing more and more shifts from straight Medicare fee for service to Medicare managed care?

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

I don’t think in our markets. I think most of the growth of Medicare has been in the Medicare fee per service in PPOs, I don’t think it’s gone that much in the HMOs where you could see some redirection or some slowing down of surgeries. And I think I would expect that we’ll have reasonable surgery performance going forward, but it was a little lower this quarter.

Historically, as you’ll have a pretty big flu season, you have little less surgery growth. You do have some minor surgeries and moving into the doctors offices, and that’s probably going to continue and we can all surgeries. So, some of that movements is to less intense surgeries to doctors offices.

Robert Hawkins - Stifel Nicolaus

Okay. Your physician recruiting was very strong for the quarter. You haven’t changed any guidance on that. You are up 32% year-over-year, but 17% is still kind of what you expect to grow physician recruits by. First of all, why so many in the first quarter, usually kind of see, I guess more starting in the latter part of the year?

And then what’s going on with the mix year? You are trying to target some things over other things; can you give a little color on that?

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

Yes, as you probably recall one of the things, when we talked about this transaction when we got into it, one of the things that we were little surprised about was the fact that there was not an organized effort in the Triad hospitals in terms of physician recruiting. And that’s a benefit that, we didn’t really think about all that much when we did this, we thought lot more on own expense improvement.

Having said that, we have ramped up our organization here in terms of corporate office staff quite a bit, and we’re beginning to see result that we also have identify a lot of really good locations and opportunities across the country, particularly in the Triad facilities that we have acquired.

So, there is just a lot of opportunity for physician recruiting. And the good news is that we had sort of the mechanism in place to make that happen. We’ve been the most consistent and the most successful in terms of recruiting physicians over the last seven or eight or nine years, of course and all we need had to do was to incrementally improve on that or increase that process and that’s kind of what is happen.

And we found the lot more opportunities, so we’ve known about we know practically every person who is finishing a plenty of program across the country or transitory or those kinds of things. So, I think that it’s just our process working and I think, we have confidence that we should continue to be able to have a very strong year in terms of physician recruiting, which will be very helpful to us, by the way.

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

From our numbers perspective, of course we’re comparing some of the CHS and Triad for the first quarter to just CHS last year, because I didn’t track the physician recruitment, why would we do that? You’re right, and if we have really strong third quarter we’ll have to visit and see what that number is and we didn’t have a pretty good start in the first quarter.

Robert Hawkins - Stifel Nicolaus

In terms of mix of these docs, primary care, hospitalist, a lot of specialists, diagnostics?

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

More 60%, 70% specialists more than primary care.

Robert Hawkins - Stifel Nicolaus

Okay, thank you. I’ll jump back in queue.

Operator

Your final question comes from the line of David Bachman with Longbow Research.

David Bachman - Longbow Research

Great, thanks for sneaking me in here. A follow-up question on the physician recruitment, obviously that’s been a strong point for you’ll for sometime. Can you just give us little bit more color how you tie, just how you think of that in terms of the incremental benefit of specialist let say or the ratio of your, the physicians that are recruiting to your capacity. Can you just provide a little more color on that?

Wayne Smith - Chairman, President and Chief Executive Officer

Let me get a start and tell you how we work on the process. We do it by individual hospital. We make determination based on the composition of the medical staff, based on the level of services, the types of physicians we need for each one of those hospitals. We go through a fairly detailed process to get there, which includes everything from succession planning if you want to call it that, age analysis for doctors, demographics in the market in terms of growth, new opportunities that we see.

All the above to try to make a determination, we’ve been doing that with our facilities for a long, long time. We have just been through all that process with the Triad facilities and again that we had a very good result in terms of understanding the needs, identifying the needs by our facility.

Then Larry is going to tell you here in the second thing, when you do population work, you can very easily determine the numbers of surgeons you need and all those kinds of things which we put in that calculation. But more importantly after we do that, then we have a pretty disciplined standardized, organized process in terms of how we go about looking for and recruiting physicians and tying those physicians to those communities so that our turnover rate as Larry mentioned earlier 4%, 5% which is fairly low and as a lot of it has to do with the work that we do on the front-end to try and find some relationship with that physician with that community.

With that Larry you want to?

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

Yeah. There is about 20 physicians for every 10,000 people. We run about every 10,000 people slightly less than, so there is a lot of opportunity in these markets now. And some of the where there is competition that may be working at another hospital, and we do have acted, but we got a large percentage of our markets being a sole provider. So it’s been something we’ve been really good at over years, and think, we’ll continue to be good at it. And when you got half the population out there, you could add that many more doctors. So there is a lot of recruiting opportunity.

Wayne Smith - Chairman, President and Chief Executive Officer

And the market share opportunity for us is continues to be very strong, organically in our market. So that also drives the opportunity for physician recruiting.

David Bachman - Longbow Research

Okay. Great, thanks. Once again, you’re now proving yourself to be very capable operators. I guess, my final question is, when it comes to things that you all can control, I think that we have a pretty comfort level. What’s out there in your operating environment that is outside your control that gives you pause, as you look at over the next nine, twelve, eighteen months?

Wayne Smith - Chairman, President and Chief Executive Officer

Politics, and I think the government think that, you always have to be most concerned about in this industry is reimbursement, talk about it all the time. But who knows what’s’ going to happen politically over the next few months and then longer term. I don’t think we’re going, I think we’re pretty stable for a couple of years because it will take a long time to make major changes.

But it’s not clear to me what the democratic strategy, and certainly it’s not clear to me, what the republican strategy is in terms of the overall, in terms of healthcare going forward. I think that’s the thing that will keep us a little bit on the edge all the time, in terms of conversations about different ways of solving the uninsured problem. The uninsured problem clearly rose up, its reimbursement in the uninsured problem is the one that, is of greatest concern to everyone.

David Bachman - Longbow Research

So if healthcare reform means finding a new way to shift cost around, how that plays out is a big concern?

Wayne Smith - Chairman, President and Chief Executive Officer

Yeah.

David Bachman - Longbow Research

Okay, that’s it for me. Thank you very much.

Operator

We have reached the allotted time for questions. I will turn the call back to Mr. Smith, for any closing remarks.

Wayne Smith - Chairman, President and Chief Executive Officer

Thank you. Thanks for spending time with us this morning. Our strategic objective is cleared, delivered consistent results. I’m sure that our hospitals achieve a position as a dominant healthcare provider in our respective markets. We’re very pleased with the trends in our business. We look forward to another successful year at Community Health Systems.

We want to specifically thank our management team, and staff, and hospital Chief Executives, and Chief Financial Officers and Chief Nursing Officers, and Division Operators, for their excellent operating performance of the first quarter. We continue to remain focused on our business strategy and improving results. Once again, if you have any question, you can reach us at area code 615-465-7000.

Operator

This concludes today’s first quarter ending March 31st, 2008, conference call. You may now disconnect.

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Source: Community Health Systems, Inc. Q1 2008 Earnings Call Transcript
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