MedCath Corp. F2Q08 (Qtr End 03/31/08) Earnings Call Transcript

MedCath Corp.(MDTH)

F2Q08 (Qtr End 03/31/08) Earnings Call

May 7, 2008 9:00 am ET

Executives

Ed French - President and CEO

Art Parker - Senior and Interim CFO

Phil Mazzuca - COO

Analysts

Whit Mayo - Stephens, Inc.

Eric Chiprich - BMO Capital Markets

Sid Eric - Deutsche Bank

Bill Bonello - Wachovia Securities

David Bachman - Longbow Research

Rob Hawkins - Stifel Nicolaus

Nikhil Sathe - JPMorgan

David Nierenberg - Nierenberg Investment Management

Presentation

Operator

Welcome to the MedCath Corporation conference call. Today, management will discuss the company's operating results for its second fiscal year quarter ended March 31, 2008.

Parts of this announcement contain forward-looking statements that involve risks and uncertainties.

Although management believes that these forward-looking statements are based on reasonable assumptions, these assumptions are inherently subject to significant economic, regulatory, and competitive uncertainties and contingencies that are difficult or impossible to predict accurately and are beyond its controls including but not limited to legislative changes, which would affect the healthcare industry as a whole. Actual results could differ materially from those projected in these forward-looking statements.

MedCath does not assume any obligation to update these statements in a news release or otherwise should material, facts, or circumstances change in any way that will affect their accuracy.

These various risks and uncertainties are described in detail in Risk Factors in the company's annual report or Form 10-K for the year ended September 30, 2007, filed with the Securities and Exchange Commission on December 14, 2007. A copy of this form including exhibits is available on the Internet site of the commission at www.sec.gov.

These risks and uncertainties include among others the impact of healthcare reform initiatives, possible reductions or changes in reimbursements from government or third-party payers that would decrease revenue, a negative finding by a regulatory organization with oversight of one of the facilities and changes in the medical or other technology and reimbursement rates for new technologies.

After management's prepared remarks, there will be a question-and-answer session. (Operator Instructions).

I would now like to turn the call over to Ed French, President and CEO. Please go ahead, sir.

Ed French

Julianne, thank you and good morning everyone. Thanks for joining the call. This morning we have employees and physicians, investors, analysts and other friends of the company joining us and we appreciate your participation.

Joining the call today with me are Phil Mazzuca, our Chief Operating Officer and Art Parker, our interim Chief Financial Officer.

Given the changes that we've communicated and will communicate herewith today, I am affirmed in our strategy of diversifying our company through bed additions and new services being the one that is valid and timely.

The operating results for the quarter indicate that we are seeing a trend in the cardiovascular business away from the heavy inpatient procedures that dominated the business as recently as a few years ago to one that increasingly relies on care being performed on an outpatient basis or that is being completed less intensively. That's a trend we have seen in other disciplines in healthcare.

Due to these fundamental industry changes, we are diversifying toward a volume and revenue mix that increasingly relies on expanded high acuity services in addition to cardiology business. This has been a strategy that we have been pursuing for over two years now and that has manifest in our earlier announcements with the expansion of Texsan Heart Hospital in San Antonio, expansion and conversion to a general acute care service mix for Louisiana Medical Center and Heart Hospital and the construction of a new hospital in Kingman, Arizona, the Hualapai Mountain Medical Center.

We have another announcement that is imminent regarding the major expansion of one of our hospitals in a high-growth market. This material expansion is in a location that has a lead-time for developing a project that's longer than others due to state review procedures, but it is material to our long-term growth and earnings expansion.

Combined, these projects including the imminent announcement will add 58% capacity, 34% coming online over the next two years.

Our strategy will continue our leading position in cardiovascular care but will strengthen our business by providing services that are currently not such to the variability of cardiovascular services. This strategy was undertaken over two years ago and executed through rationalization of assets and planned expansions of others.

We will accrete our average bed size from 61, two years ago to 90 within two years and over 100 within 3.5 years without any acquisitions. We will have gone from one hospital over 100 beds and one acute care hospital two years ago to five hospitals over 100 beds, four of which are diversified acute care services two years from now.

With the expansion to be announced within the next several days, we will have expanded another hospital to more than 100 beds and to a diversified acute care hospital when that expansion is complete.

While we didn't anticipate the procedure mix changes we've seen over the past year, the major pushes beyond our strategy were to better use our fixed asset base for marginal cost growth and to do so through diversifying services and be less single product dependent.

In retrospect, it's fortuitous that we had the benefit of executing on that plan in advance of the change that we've seen in cardiology procedure mix over the past year or so. The evolution of our company is well underway as envisioned and communicated over the past two years.

I am pleased this quarter with the performance we had from an operating efficiency perspective as we experienced improvement in labor and supply and resource use on both adjusted patient day and adjusted admission bases. Evidencing that was an early and continuing effort in our evolution.

That said we are facing some industry trends that are directly affecting our revenues including lower inpatient procedures especially open hearts and stents, a move to outpatient services in some of our markets and higher charity care. We believe that these are trends of the business and require us to be more conservative in our near-term outlook. As such we already lowered our guidance for fiscal 2008 to reflect what we think our revenue and earnings will be for the year.

I need to be clear that I believe our strategic directions noted above, the additional cardiology business with an aging population and continued service development mix is a company that is properly positioned for demonstrable long-term success through growth.

We also had some key announcements in the quarter since we last spoke. We announced the $11 million expansion of our Texsan Heart Hospital located in San Antonio whereby we will double the capacity of that hospital from 60 to 120 beds at roughly 20% of the hospital's original cost.

We also announced that we entered into a managed care agreement with Blue Cross/Blue Shield in the San Antonio market that's going to allow us to provide services to over 200,000 enrollees in the various Blue Cross plants.

MedCath Partners was active in the quarter entering into two new ventures, one in New Jersey and one in the fast-growing market of Yuma, Arizona. Combined these ventures will add approximately $0.07 to our annual earnings.

We also announced our plans to divest Dayton Heart Hospital which we anticipate will be a transaction that closes within the next week. Dayton Heart Hospital is one of our earlier hospitals and we enjoyed a long and beneficial relationship with our good physician partners there.

As both we and our partners look at the changing landscape in Dayton as it relates to lower than national average growth rates and the changing environment that required we expand or divest, we felt it was the right time for us to divest the hospital, thus making it easier for the physician partners to better align with the eventual acquirer. Dayton is a 47-bed hospital with shell space for an additional 47 beds that we had intended to expand in fiscal year 2009.

However, after being approached by the acquirer, Good Samaritan, we and our doctors decided it was in our best interest to divest rather than engaged an expanded medical staff development in that market to diversify services. We will receive about $32.5 million in net cash from the transaction, after tax and after liquidation of the accounts receivables that we'll maintain post closing.

We have also added three new board members since we last talked and I want to welcome the addition of Pam Bailey, Ed Casas, and Woody Grossman to the MedCath Board. All are uniquely qualified to provide leadership and counsel to the management team and we are excited about their being engaged and look forward to their involvement.

I also want to use this opportunity to say thanks to Ed Gilhuly and Adam Clammer for the many years of service and leadership that they provided to MedCath in the early years of our development and supporting our evolution, as they had both announced their intentions to resign and their resignation in fact, from the board due to other business interests.

Let me now turn this call over to Art to discuss the financial results for the quarter. Art?

Art Parker

Thank you, Ed. In our review of the quarter, we will make reference to adjusted EBITDA which is a measure used by management to measure operating performance and to allocate capital. Adjusted EBITDA and similar metrics are commonly used in the healthcare industry as an indicator of performance and are also used as a measure of debt capacity and ability to service debt.

Adjusted EBITDA should not be used as a measure of financial performance as defined under Generally Accepted Accounting Principles. The calculation of adjusted EBITDA excludes many items in its calculation and as a non-GAAP measure is susceptible to varying calculations. Adjusted EBITDA as presented by us may not be similar to other companies' definition and calculation.

Our press release issued and posted on our website prior to this call provides reconciliation from income from continuing operations, a GAAP financial measure to adjusted EBITDA which you may find helpful in your review of our quarterly results.

As we discussed on previous conference calls, we completed the recapitalization of our Harlingen Medical Center in the fourth quarter ended September 30, 2007, and now account for Harlingen Medical Center as an equity investment. In the second quarter of 2007, we owned a majority of Harlingen Medical Center and consolidated its results into our financial results.

Today's earnings release provides supplemental information to share pro forma results for last year's second quarter as if we accounted for Harlingen Medical Center as an equity investment in that quarter.

In addition, we had certain unusual items occur in both quarters, the impact of which we detailed in today's earnings release. As such, as I review the quarter, I will compare our normalized second quarter of 2008 results to normalized second quarter of 2007 results, accounting for Harlingen Medical Center as an equity investment.

I wanted to begin my financial review by addressing specific questions that we have been receiving from an institutional investor since we preannounced our preliminary second quarter results and revised our 2008 outlook.

First, we have been asked about the details regarding the financial impact of the trends that we experienced in the quarter. During the quarter, we experienced a shift in procedures from same-facility inpatient to outpatient primarily in stent and cath procedures.

For the quarter we performed approximately 23% of our drug eluting stents on an outpatient basis versus 16.8% last year and 14% of our bare metal stents outpatient versus 11.5% last year. We estimate that the move to outpatient stent and cath procedures impacted our net revenue approximately $1.1 million this quarter.

Also impacting our same-facility revenue this quarter was a decline in our Case Mix Index as we saw a 1.3% drop in our overall Case Mix Index and a 2.9% decrease in our Medicare Case Mix Index. We estimate the lower CMI impacted our new revenue an additional $1.5 million, of which approximately $500,000 of this reduction was due to the introduction of MSDRGs this fiscal year.

Our same-facility earnings this quarter were also impacted by higher uncompensated care expense, which includes charity care discounts and bad debt expense. During the quarter, charity care discounts reduced our net revenue $4.1 million in comparison to the second quarter of the prior year of $1.2 million.

A number of these patient accounts qualifying for charity care this quarter have been reserved for in prior periods in accordance with our bad debt policy. The increase in charity discounts this quarter reflects our attempts to more appropriately apply our charity care policy across our company as we are experiencing an increase in the number of individuals applying and qualifying for charity discounts.

Importantly, gross self-pay revenue was down 10.8% versus prior year second quarter in both self-pay inpatient admissions and outpatient visits were also down versus prior quarter. As such, the majority of the increase in total uncompensated care expense this quarter was related to the aging of account balances.

Despite the increase in aging, our collection activity in the quarter was solid and our hospital division DSAs fell two days from 57 days at December 31, 2007, to 55 days at March 31, 2008. Our business offices continued this trend in April with collections for the month exceeding 100% of their collection goal.

I also wanted to address questions we have received regarding our revised 2008 outlook. Our initial guidance was provided in November of 2007, concurrent with our release of our fourth quarter 2007 results. At that time, we provided net revenue guidance of $685 million to $700 million; adjusted EBITDA guidance of $110 million to $114 million; and income from continuing operations of $32.8 million to $34.3 million.

We revised that guidance two weeks ago to count for the disposition of our Dayton Heart Hospital and to reflect our views on the current operating environment. Importantly, our revised guidance excludes Dayton Heart Hospital for the entire year as it is accounted for as an asset held for sale for the year-to-date period beginning with our March 31, 2008, reporting period.

For the year, we anticipate adjusted admissions to increase approximately 5% to 5.5%, consistent with our year-to-date rate of 5.5% and our plans for the remainder of the year. We anticipate revenue per adjusted admission will be down 1.5% to 2.5% versus the prior year, which also reflects the current operating environment.

We anticipate that our second half adjusted EBITDA and adjusted EBITDA margin will exceed what we experienced during the first half of the year, reflecting the seasonal strength of the third quarter, new bed additions in Arkansas, new managed care contract in San Antonio and cost saving initiatives that we have throughout the organization.

The final question that I wanted to answer relates to capital formation decisions that we have upcoming, primarily related to our senior notes. As many know, we have $102 million outstanding under a senior notes issue that we incurred in July 2004. The notes are callable for the first time this July.

As we discussed in the past, it is our preference to repurchase these notes at their call date, assuming we can do so with a financing solution that works for us by lowering our cost of debt and at the same time provides us with financing flexibility to support our development and growth plans. We are monitoring the financing markets to determine if such a financing solution exists for us at this time and we will provide more insight to our plans and the market conditions for us as we continue to seek a solution that meets our goals.

With that said, I wanted to cover a couple of other areas before turning over to Phil to review the operating performance and strategies. For the share buyback, so far we have expended $44.4 million of our $59 million authorized program repurchasing shares and have acquired approximately 1.9 million shares. We ended the quarter with approximately 20 million weighted average diluted shares and 19.5 million actual shares outstanding. Capital expenditures in the quarter totaled $13 million, of which $4.6 million was related to our development activities.

Regarding the balance sheet liquidity and leverage, the balance sheet total cash equaled $85.3 million at quarter end, of which $53.1 million is held at certain hospitals primarily within our development projects in Louisiana and Kingman, Arizona. Importantly, these funds are earmarked for a capital expenditure and working capital needs of those projects and are not available for corporate use. We ended the quarter with $150.4 million in debt.

Net revenue on a payer mix basis, for the total company Medicare was 38.7% in the second quarter of fiscal 2008, compared with 40.2% in the second quarter of 2007. Payer mix within the hospital division on a same-facility, net revenue basis, Medicare was 41.8% this quarter versus 43.5% prior year. Medicaid was 6.6% this quarter versus 4% prior year. Commercial and other was 43.8% versus 43.4%. And self-pay revenue was 7.8% versus 9.1%.

I will now turn the call over to Phil.

Phil Mazzuca

Thank you, Art. As in past quarters, I will spend a few minutes providing you with an update on where we are related to achieving our primary operating objectives and the current and future benefits of these objectives.

From a volume perspective, adjusted admissions in the quarter were up 4.6%, although admissions were down 0.9% versus prior year quarter. Admissions were somewhat impacted by the inpatient to outpatient conversion, as evidenced by the shift in some stent volumes. Additionally, we experienced a 2.9% decline in open heart surgery cases.

Our overall stent volume was flat for the quarter, although total drug eluting stent volumes were up 4.1% versus the prior year quarter. Although we are early into the third quarter, drug eluting stent volumes continue to trend up over the prior quarter and open heart procedures continue to demonstrate decline versus prior year quarter.

We have identified opportunities in our markets to increase inpatient cardiology and cardiovascular volumes through expanded EP and surgical programs, as well as the recruitment of additional cardiologists and CV surgeons to our markets during the past few months and continued recruitment pipeline for the remainder of the calendar year.

We are also pursuing new sources of high acuity inpatient revenue through non-[MPC] product lines such as bariatrics, orthopedics, neurology, and neurosurgery, which are starting to come online in a few of our markets.

We have also started to develop primary care networks in some of our markets to support our diversification strategy. I will provide more information as to this strategy in the next few quarters.

As Art mentioned, from an outpatient basis, our outpatient visits remain strong, increasing 11.9% for the quarter over prior year quarter. ER visits were also up 3.9% for the same period. Outpatient surgeries were up 38.6% versus prior year quarter.

We have engaged a strategy and most of our markets increased visibility of our emergency departments and outpatient services product line capabilities through marketing campaigns and outreach programs.

As we continue to develop and implement our diversification and expansion strategies at many of our facilities, and focus on expanding our outpatient market share, we should continue to see increases in our outpatient revenue and expansion of product lines, such as general surgery, outpatient bariatric surgery, ENT, GYN surgery, and other procedural-based high acuity product lines.

From an efficiency standpoint, one of our objectives for fiscal year 2008 focuses on continuing to lower supply costs, through a combination of contract negotiations for certain high-cost medical devices and continuing to pursue the opportunities identified through our GPO arrangement with Broadlane.

During the quarter, on a same-facilities basis, supplier expense was down 4.2% for adjusted admission versus prior year quarter. We continue to make good progress related to medical device contracts and we continue to achieve incremental savings related to our GPO contract, which was effective July 1st.

As we continue to implement our supply initiatives, we believe that we will continue to be successful in achieving our projected run rate of several million in annualized savings for the fiscal year.

We continued to show good progress on the implementation of our management engineering initiatives that we have discussed in previous quarters. The impact from a paid man-hours basis for the quarter equated to a 2% reduction in paid man-hours per adjusted admission and a 5% reduction per adjusted patient day on a same-facilities basis.

Our contract labor expense during the quarter declined 9.7% versus prior year quarter, due to our efforts in replacing contract labor with permanent full-time and part-time staff.

I described this initiative in past quarters and the associated increase in orientation hours, which is paying off. Our orientation hours continue to exceed prior periods as we continue this focus on reducing contract labor. However, it will decline over time as positions are filled and contract labor is replaced. We will continue to execute on opportunities from a productivity standpoint and results of our continued efforts will be discussed in future quarters.

Our managed care initiatives have continued to result in gaining access to additional covered lines. Ed described our new contract with Blue Cross in San Antonio, which was effective April 1st. We continue to focus on new relationships with managed care providers in our markets and our close to executing an important contract in one of our markets in the next few weeks.

Our diversification strategy has helped us in accessing some of these new contracts. Due to our capabilities in handling a broader spectrum of patients, as well as our continued recognition for quality outcomes and customer satisfaction as evidenced by HealthGrades, Thomson, HCAHPS reporting and other sources in many of our markets.

We continue to experience improved pricing on legacy contracts and our average increase during the quarter ran in the mid to high single digits. For the year we continue to expect to see managed care pricing increases of 5 to 7% on the average.

I will now turn the call back over to Ed.

Ed French

Well Phil. Thank you. Julianne, we are ready to take calls at this time.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Your first question is from the line of Whit Mayo with Stephens, Inc.

Whit Mayo - Stephens, Inc.

Hey good morning guys.

Ed French

Hi Whit.

Whit Mayo - Stephens, Inc.

Just on the volumes again, we have been seeing this trend for several quarters now. It feels like almost a year now of the shift from inpatient to outpatient. Can you talk a little bit more about the payer behavior behind this and what is driving it?

Ed French

Whit, I think probably you saw the-- going back a year and a half, two years ago, the genesis of it in one of our markets where the professional review organization for Medicare patients was trying to identify some patients that could be served on outpatient basis based on comorbidity and DRG specific contribution. And so that is probably when we started seeing some of the movement. And it has been in various locations since then.

Whit Mayo - Stephens, Inc.

Okay. I mean should we see this to be a little bit more pronounced over the coming quarters just as you re-contract with some payers and secure additional contracts? Just kind of help us understand the moving pieces there?

Ed French

Yes, realistically I think we ought to expect it to continue to-- not all patients will be able to be served on an outpatient basis, but I think there are some. And there is no reason to think that would not continue.

Whit Mayo - Stephens, Inc.

Okay, okay, that is helpful. And just secondly, it has been reported that Catholic Healthcare West and Cigna are in some disputes over some contracting terms in Phoenix. Just, have you been able to pick up any of their heart business down there? I know it is early and just Ed, I know you are familiar with this situation, as much as anyone, so just any color on kind of, how you look at the market dynamics there?

Ed French

Good insights Whit, because yes we are-- visible to end market with a nice presence obviously in Arizona Heart Hospital. And from the get go, we have been very attuned to that. And you can be sure that our folks who are on the ground offering support to physicians to have a place to practice medicine if they need to admit Cigna patients somewhere. And also reaching out to CHW if they need a partner and helping in some way or another with marketing their services and being able to support their doctors.

So our folks are very much engaged in that and I cannot attribute though any growth -- any material growth to that. I think time will tell. It has only been about a week now I think Whit.

Whit Mayo - Stephens, Inc.

Yes.

Ed French

So we will see what happens. The other curiosity of course is whether this is a long-term thing. Conventional wisdom would have it that these guys are still at the table talking and they still may come up with a solution before too much time passes. And so we do not know what that means, but in the meantime we are making hay while we can, at least trying to.

Whit Mayo - Stephens, Inc.

Okay, that was great. And Art just you mentioned and we have seen a press release and that you have added a couple new Directors to the Board, can you help us understand the implications there in thinking about the June quarter and any additional option expense that we need to be modeling?

Art Parker

Yes, good question Whit. As we think about option expense for the quarter, we will have the options related to the three new directors be fully expensed in the quarter. We will also have some employee options from some new hires in the quarter. And then we will have sort of the consistent share-based comp. My estimate at this point is we will see $750,000 to $1 million in expense related to those option grants and the restricted shares.

Whit Mayo - Stephens, Inc.

That is all pretax right?

Art Parker

Yes, that is all pretax.

Whit Mayo - Stephens, Inc.

Okay, okay that is very helpful. And also can we get the revenue for MedCath Partners in the quarter?

Art Parker

Yes. Hold on one second. Whit I will-- if you have another question, go ahead.

Whit Mayo - Stephens, Inc.

No that was it. I just wanted to get the number there and the spot number for the number of contracts, management contracts you have. Well, I can get that offline. Thanks guys. I appreciate it.

Ed French

Thanks Whit.

Operator

Your next question is from the line of Eric Chiprich with BMO Capital Markets.

Eric Chiprich - BMO Capital Markets

Thanks for taking the question. Just a couple housekeeping things. I am not sure if you guys broke out the revenues based on outpatient versus the inpatient for the hospital division?

Art Parker

We did not. I will be glad to give that to you Eric. I have it from a percentage standpoint, it was about 77%-- I am sorry, about 73% of gross revenue this quarter was on the inpatient side versus 77% for the prior quarter.

Eric Chiprich - BMO Capital Markets

Got you. And then also on the tax rate, looks like that has moved around a little bit. Can you just refresh us in what you think that will-- what a good rate is going forward?

Art Parker

Yes it did, we got a benefit this quarter of about $420,000 that lowered the rate. That was relative to some deferred asset tax benefits that we received in quarter relative to some exercise of some stock options in the quarter. I think that about 38 to 39% is where we end up for the year.

Eric Chiprich - BMO Capital Markets

Okay. And then to follow-up on Whit's question, I was curious can you talk a little bit about the trends in the shift to the outpatient stenting. Is that something that occurred gradually throughout the second quarter, ramped up towards the end? Or and can you talk about what are your expectations going forward through the rest of the year? I mean is this something that can get to 30% of stent volumes are done outpatient -- I was just kind of trying to get a feel of kind of what your impression is for where the market's going?

Ed French

Eric this is Ed. Phil spoke to the percentage of movement that we have seen and the answer is I do not think it would be as dramatic as you suggested. But we have seen this going back a couple years. So it is not something that has just happened this quarter. But we have seen it accrete enough with that we thought we would at least throw the figures out, so that should be aware that something we believe is here to stay. That it is not just an episodic change. And so we would expect to see that to continue.

And Phil, do you have those figures in front of you? By the way, we are not in the same location today. I am on location at Bankers conference with Deutsche Bank in Boston and Phil's down in Charlotte with Art. Phil, do you have those figures in front of you?

Phil Mazzuca

Give me one second.

Ed French

I think it was like 23% versus 17% the procedures that have…

Phil Mazzuca

Yes it was 23% this quarter versus 16.8% last year quarter for drug eluting and 14% this quarter and 11.5% last quarter for bare metal.

Eric Chiprich - BMO Capital Markets

Great. And then just some clarity. I know you talked about another major expansion is-- [acute] hospital. Is that part of the initial 135-bed expansion project that you guys had talked about previously or is this something in addition to that?

Ed French

It is new. It is new and I discussed previously, more substantial than 47 beds including new bricks and mortar to an existing asset.

Eric Chiprich - BMO Capital Markets

Okay. And so these-- this 135 plus this new project now or is that the remainder of the 135-bed expansion is kind of I guess not potentially coming on line now?

Ed French

Well no 130 beds included a 28 plus the 60 beds that we have planned at Texsan the 28 Arkansas, 60 Texsan. And we have another 47 beds that we are going to put in at Dayton. Now Dayton is being sold, so those 47 potential will go away. But this-- we have other assets where we continue to have business plan development to look at expansion. So I am not ready to say yet that we are not going to expand 47 beds somewhere else next year, as we already have said we plan on doing. So that is still on the table. That said though, we have an announcement to make that will be in addition to that a material number of beds.

Eric Chiprich - BMO Capital Markets

Okay, thanks for the clarity. I will get back in the queue.

Ed French

Thanks Eric.

Operator

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

Ed French

Morning Rob. Are you there?

Operator

Rob, your line is open.

Ed French

That was an easy question Rob. We are ready for the next one Julianne.

Operator

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

Sid Eric - Deutsche Bank

Hi, good morning guys. It is actually [Sid Eric] calling in for Darren. I guess with the progress that you are making with the commercial contracting, is it reasonable to assume going forward, that the commercial revenue mix should meaningfully change from here? I guess it appeared somewhat flat year-over-year and I just wanted to get a sense from you guys as to where that number could go?

Ed French

Phil?

Phil Mazzuca

Yes I believe it will improve as we continue to execute on these new managed care contracts.

Sid Eric - Deutsche Bank

Okay. And in terms of the Arkansas beds, I think a bunch came online in January. Could you just give us an update as to how those beds have performed since coming online?

Art Parker

Yes this is Art. You are right. They did come online at end of January, so we had them for a couple months in the quarter. And felt very good about them in the quarter, relative to our expectation. Obviously we anticipate as with any new bed opening that there will be a ramp-up period. But they were in line with our expectations.

Ed French

I can tell you for April we have seen about a 10% increase in average daily census at Arkansas. So we feel pretty good but we still have significant capacity that we have opportunity to fill.

Sid Eric - Deutsche Bank

Great. Thanks very much.

Operator

Your next question is from the line of Bill Bonello with Wachovia.

Bill Bonello - Wachovia Securities

I wanted to follow-up on a couple of the questions that were asked earlier. We are not certain we got an answer. One would be on the sequential change in the drug eluting stent inpatient versus outpatient. You talked about what happened year-over-year but I guess I am still not clear on whether you saw a meaningful change between last quarter and this quarter in volume in total or in inpatient versus outpatient mix?

Phil Mazzuca

Total stent volume was actually I believe flat, but drug eluting stent volume-- the total drug eluting stent volume was up 4%-- I believe it was 4.3%. As far as inpatient to outpatient, we did see an increase from inpatient to outpatient. Those numbers we gave were quarter-over-quarter.

Bill Bonello - Wachovia Securities

Right your-- by that was quarter-over-quarter sequentially or quarter-over-quarter, year-over-year?

Phil Mazzuca

No that was for year-over-year.

Bill Bonello - Wachovia Securities

Right. I am trying to figure out sequentially whether you saw a big move from inpatient to outpatient?

Ed French

Bill, I do not know that we did. I do not have any figures in front of me but I think it has just been a continuing thing over the last couple of years.

Bill Bonello - Wachovia Securities

Okay. I guess my second question is just to sort of going back to the change in guidance. I guess I am still not clear on what it was that you expected to happen -- a couple months ago when you reaffirmed guidance that you now believe is going to be different. Given that this trend in inpatient to outpatient has been occurring all along, it strikes me that you probably did not assume that that was going to suddenly stop when you gave your initial guidance?

Art Parker

Bill there is a couple things inside of that that I think that we have seen over this first half of the year as we experienced operating data coming through. First of all, on the open heart side, on the CABG side, that has been down. And in addition to that as far as the reduction on the inpatient side is lower as well. I mean, I think when you think about sort of our pricing views on the year then versus now, I mean that change is reflective in the fact, that we have had a movement away from or some decreases on the CABG side, as well as overall in inpatient side.

Bill Bonello - Wachovia Securities

Okay. And are you sort of saying that the CABG decreases in particular were I guess unexpected then?

Art Parker

Yes, I think that we had anticipated for the year that we would be flat year-over-year in CABG volumes. And we were down in the first quarter and then we had some reductions in this quarter as well.

Bill Bonello - Wachovia Securities

And can you just once again elaborate on why you think that is?

Art Parker

I mean-- Ed I do not know if you have any commentary around that?

Ed French

There are multiple reasons. We have got one market where the medical group has had some disruption regarding its cardiovascular surgery program. They are in the process of recruiting another surgeon who has actually committed in coming on I think June or July.

I also wonder, and as we talk about some of the procedure mixes, perhaps changing where they have been historically. I am also wondering if we are going to see hearts not continuously decrease but not grow back to where they have been only because the bottom line is drug eluting stents do work and their increased that drugs and all the research we've seen in the past says that we should expect to see lower cardiovascular surgeries because of those.

So I think we are resigned to the fact that there will continue to be increase in cardiovascular surgeries but the rate at which they will be captured from new patients will probably be less than they have been historically.

Bill Bonello - Wachovia Securities

Okay. And that is something that is sort of being reinforced I guess. It sounds like by Q1 and Q2 results that you feel a little more strongly about that than maybe you had previously?

Ed French

That is right.

Bill Bonello - Wachovia Securities

Okay. And then, just again to revisit another question, I just want to make sure I understand what you're saying about the bed counts versus what you had been saying in the past, because just to be sure, it sounds like in the initial 135, you had included additional beds in Dayton?

Ed French

Yes.

Bill Bonello - Wachovia Securities

And how many-- that was 47?

Ed French

47.

Bill Bonello - Wachovia Securities

Okay. And, so what you are saying now is you are not taking the bed count down by 47, and be able to announce something that still happens next year, but we just do not know at this point?

Ed French

Well first of all as regards to 47 beds, we are not taking it down. We have something going on in every market in terms of growth expectations. So, we have other possibilities for expansion besides Dayton and we have contemplated that. What we originally gave you was the beds that were unfilled as shelf space. We have other beds that have other opportunities for development in hospitals, none of which we are prepared to speak to now, but which we expect to nurture and still in '09 bring on 47 new beds.

In addition to that, we are going to announce next several days, perhaps as early as next week, an expansion, when I say imminent I mean that we've got a project. We just need to make sure all of our constituents are communicated with in the market and we get the press release prepared. They will announce an even larger addition to an existing asset and new bricks and mortar in a market that will continue to diversify away from-- in addition to I should say hearts. We will still grow the heart business, but we are going to grow non-heart business, non MBC5, exponentially quicker.

Bill Bonello - Wachovia Securities

Okay. And then, just the last question and I apologize if I missed this on the call but just again on the change in the payer mix and particularly the decrease in the Medicare as a percent. Is that predominantly related to what you are seeing in the procedure mix or is there more to it than that?

Art Parker

There is really two things. One is change in procedure mix. The second is a movement from Medicare to Medicare HMO.

Bill Bonello - Wachovia Securities

Okay and the Medicare, the MA is being counted in the commercial?

Art Parker

That is correct.

Bill Bonello - Wachovia Securities

And why do you think we saw such a big uptick in Medicaid? Was that actually a real increase or was it just that it did not decrease in line with some of the other stuff?

Art Parker

I think that was a real increase that we saw Bill. I mean, I think it is just more economically driven than anything.

Bill Bonello - Wachovia Securities

Okay, alright. Thank you very much.

Art Parker

Bill let me just follow-up on a couple things that you asked as I was able to get the data here. Outpatient drug eluting stents were 21%, drug eluting stent volume in the first quarter of '08. Bare metal stents were 12% on an outpatient basis. While I am catching up on some data here, MedCath Partners had $11.3 million in revenue in the quarter.

Bill Bonello - Wachovia Securities

Can you give that bare metal one more time? Sorry I did not take it fast enough.

Art Parker

12%.

Bill Bonello - Wachovia Securities

Thank you.

Operator

Your next question is from the line of David Bachman with Longbow Research.

David Bachman - Longbow Research

Hey, good morning. I think a lot of questions have been answered but maybe one for Phil here. Even though it looks like you're continuing to make progress on the supply expense, I guess given the weakness in some of those I guess more supply intensive service lines, I would expected that to maybe have come in even a bit lower. Am I just kind of misunderstanding or can you give me a little bit more color on supplies?

Phil Mazzuca

Our focus on supplies are in two areas. One is the reduction in supplies per adjusted admission. As far as the amount of supplies and the second is the cost per supply. And our focus actually is on-- is really on reduction of costs for supply. And we have had a couple new contracts in the quarter where we have actually reduced pricing on some of the CRM devices. As far as the cost intensity, our total stent volume was flat, even though inpatient stents were down. So, we would not see a reduction in cost for stents and actually our drug eluting stent volume itself, the total volume was up. Drug eluting stents as you know are more costly than bare metal stents. So, I think that the supply expense is consistent with what we are seeing. I believe our AICDs were-- let me take a quick look at this. Our AICDs were actually, pacers were actually up 2.3%. So we did see some of our EP supply pricing go up or volumes go up.

David Bachman - Longbow Research

Okay great. That is helpful. And then Art, I appreciate you giving the above the revenue line charity care numbers and you mentioned that there's an effort to be a little bit more systematic across the different hospitals and how that's being applied. Can you just give us a bit more color on the decision-making process there? And anything that may have-- that is changing on the ground in terms of the charity care and bad debt decision making?

Art Parker

David thank you. On the ground I think the, sort of the best color I can give you is that we are having and experiencing as we work through collection efforts with past patient accounts, more people ask for and qualify underneath our charity care policy. And it is something that we want to be more uniform and systematic as a company in applying. And we have a charity care policy that is based on the national poverty guidelines and applies. It applies uniformly throughout our hospitals. And, it is something that just overall for this quarter we saw an increase too.

From a bad debt standpoint, nothing has changed on the ground relative to that. Our accounting policies are very firm and in place as it relates to recognizing bad debt as it comes through from self pay or from many other financial class that may have a component of bad debt tied to it.

David Bachman - Longbow Research

Okay and just one last question on the tax rate. You said 38 to 39%. That would kind of be the average for the year taking into account where the first two quarters have come in. Am I understanding that correctly?

Art Parker

That is correct.

David Bachman - Longbow Research

Okay, great. Thank you.

Operator

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

Rob Hawkins - Stifel Nicolaus

Good, can you hear me?

Ed French

Hey Rob, welcome back.

Rob Hawkins - Stifel Nicolaus

I am sorry about that. I guess as my age approaches your demographic these things are bound to happen. I hit this generic versus the mute button. I really had just one question. And I want to probe a little bit further in kind of the inpatient, outpatient, where you spent kind of the earlier part of the conversation. You mentioned a lot of this started with the peer review organizations, the PROs. Can you remind me first, are those set up kind of in the same ten Medicare districts or are they kind of spread out or more fragmented than that?

Ed French

I do not how many we have in Texas? Phil do you know?

Phil Mazzuca

I could not tell you the number Ed.

Ed French

The answer is I do not know how many are out there. But they are spread out. There are several. You mentioned ten Rob?

Rob Hawkins - Stifel Nicolaus

Yeah. I guess the real question is that are you seeing them spread kind of PRO to PRO to PRO, kind of the way we've seen stuff like the rack system or some of the other things where-- they can be starting to kind of follow?

Ed French

Yeah. I think that is fair. There are different PROs serving most of our hospitals. And so, that-- yeah I would say that is probably pretty factory characterization. Over the last couple years, we have seen some migration. That is why we have seen some of the shift.

Rob Hawkins - Stifel Nicolaus

Okay. Well that helps to understand some of the volume shifts a little. And then, kind of following on that, how is that changing your outlook on outpatients for cardiac services both in your hospitals and then for the partner services? And then, how is it also changing your outlook as you move more to general acute care, how is that changing what you do on an outpatient basis in general that's kind of non-cardiology?

Ed French

I hear three questions here. As regards to Partners. Perhaps you do not know, that is fine. I want to make sure I get all of them. So if I fail, please remind me. As regards to Partners because we have material projects, Cape Cod, Sun City, and we've added new ones now in Wilmington, North Carolina, a very large one and Yuma, Arizona. Obviously we are affected there as we are anywhere else.

In fact, Partners is down in its revenue and it has been because of that primarily, because of the large hospital operations that are seeing also similar shift and in some cases a declining volume. So, what is interesting about that is -- that is a microcosm of what we have seen as well. So that is an industry trend as I said in my comments earlier.

But that said though, its variable. So it is not a downward trend. We think in our MedCath's Partners operations it has flattened out, bottomed out and we are seeing some gains in now this month. So, I think you get through the shift and as we did drug eluting stents going back a year and a half ago, you reach a valley and then they start to normalize and reach some kind of expectation for growth. So that is Partners.

As regards to the hospital outpatient activity, as we've said we think we'll continue to see some movement not from my perspective not alarming movement from outpatient and-- inpatient and outpatient because frankly a lot of our patients are sick and they need the attention of the inpatient staff and the recovery period. But that said there will continue to be some and we would expect that.

And, we would expect continued growth in non-MDC5 outpatient. That is the thrust of our marketing efforts in all of our markets. We have got the technology and we have, if you consider our percentage of business, typically 30% of our business-- correction our outpatient conversion ratio maybe 30% in a typical heart hospital. But, the typical acute care hospital, that ratio could be as high as 60, 70 or 80%, sometimes more, sometimes a little less.

So we would expect to continue to see growth in outpatient business in our hospitals, not because we're seeing overwhelming movement inpatient, outpatient but because we're also seeing marketing growth for new services coming into the hospital that heretofore went to our competitors.

Rob Hawkins - Stifel Nicolaus

I know I have asked my fair share of questions. I just want to follow on that comment. Is it-- I mean you guys are doing a nice job of differentiating yourselves as the high acuity player, how might those outpatient-- what kind of higher acuity services might you guys be doing on an outpatient versus the average hospital in your market because of this, on the non-MDC stuff? I mean should we be looking for Da Vinci robots? I mean what should we be expecting along those lines?

Ed French

Well first of all we are adding neurosciences in some of our hospitals. We do spines now. And we are going to add MRIs to our acute care operations. So that will support neurosurgery and other neurosciences patients, neurology for example. And, as we have MRIs that are available for other patients as well. So to us it is incremental. So we have-- being able to handle an orthopedic patient for MRIs just as effective as anybody else. So that is access to new markets.

Bariatrics is a new high-end service that is going to have some diagnostic work ups for patients before they come into the hospital. And the service itself is high acuity from an operative standpoint as we know. I think, the other growth we may see-- may see some additional diagnostic casts. And the reason I say that is part because I believe we are going to be pronounced. They have already been about 25% this year. And I think, a lot of freestanding Part B programs may be doing less business there that may convert to the hospital environment. That also represents an opportunity for us with Partners because we are beautifully positioned to work with not-for-profit hospitals or other investor-owned hospitals that are not in our competing markets to help integrate some of these Part B freestanding units with hospitals under our management model. Kind of a tangential answer and I apologize for it. But I hope --

Rob Hawkins - Stifel Nicolaus

No, no that is what I am looking for. I mean, this is good color because I think this could be-- this might become little story that is kind of interesting for the future.

Ed French

It is exciting, trust it's exciting.

Phil Mazzuca

I think to add on to that Ed, in most of our hospitals we do have OR capacity. And as we talked about this last quarter, our outpatient surgery volume has increased dramatically and we still have significant capacity to add additional types of outpatient OR cases to our existing assets.

Ed French

Phil that is a good point. And neuroscience is one that leans that to. And we have spine programs in at least three of our hospitals now. In fact one of our heart hospitals just a couple months ago did its first spine procedure. And we expect to see that continue to increase in volume. So, again it is an exciting moment for us frankly.

Rob Hawkins - Stifel Nicolaus

Thanks so much for taking my call again. Sorry for dropping the call earlier.

Operator

(Operator Instructions) Your next question-- I am sorry.

Ed French

Julianne, let me-- before we go I do not want to forget this point. Bill Bonello asked a question and he had a comment buried within it. And I am not sure that I reacted properly because I want our listeners to understand this. He had mentioned that in the context of an imminent decision we may make that might come on next year, the question was, does the 47 beds for Dayton go away or not? I want to clarify that the new-- the new announcement we will make will not be for expansion for next year. It will take materially longer than that because of the review processes in the state in which it is located. But, we are commencing with extending all the A&E, filing the plans and going through the review process, but they will not be on next year. We will give more color on that in our announcement. Thank you Julianne, go ahead.

Operator

Your next question is from the line of Andreas Dirnagl with JPMorgan.

Nikhil Sathe - JPMorgan

This is actually Nikhil Sathe for Andreas. I just had a quick question. If you guys could maybe sort of add some color on the legislative issue? A big part of your strategy is increasing that capacity. I mean if this legislation goes through, part of it is sort of restrictions, some undertaking your bed capacity and expansion project? I know you guys are doing a lot to sort of alleviate that potential issue? Can you maybe just add some more color on it? Thanks.

Ed French

Andreas I will be glad to. Let me draw distinction again between our hospitals and those that are numbering around 200 other surgical specialty hospitals primarily. We have only one hospital with more than 40% physician ownership and very, very few doctors owning more than 2% individually. The other hospitals had significantly more physician ownership on average. So the angst about legislation is less ours than theirs. Because we can live with the 40%. We can live with the 2% if that is what comes our way.

But let us presume that that is where legislation winds up being. The worst case for us is we buy down to 40% for one hospital and we take the few with over 2% ownership and we get their shares distributed. For the projects that are completed or underway, the question then is how materially are they underway? Will there be some allowance for those? And the worst case scenario, if they are not allowed, what do are we do?

In all these expansion projects, we have an arrangement with our physicians, an understanding with our physicians as well as an arrangement that if the projects are disallowed because they are not licensed and operational at the time the legislation might happen, then we can rework the arrangement with the doctors. In other words, we would abandon the economic partnership, take down our doctor's equity at fair market value and we would then keep in place our shared governance partnership.

So, the things that materially bring the doctors our way would still continue. That is their participation in management, participation in leadership, participation in the governance of the organization. They would just not have ongoing economic interest in the operation. Now, some believe mistakenly that our success depends upon having these economic relationships with physicians. I disavow that.

We have about a third of our business coming from doctor partners and there is no suggestion that that business, any of it would go away because doctors do not have economic interest. A doctor has-- our doctors have on average $50,000 interest in our hospital in each or any hospital in which they participate. I cannot imagine any of our doctors is going to move their business or practice, stay with us if they do not want to be there to either preserve that $50,000 investment on average or to see it grow. And while that is the average, note that the preponderance of our doctors have much less than $50,000 invested per doctor.

So, there is not such significant economic engagement to cause them to change their behavior to come to us or change their behavior to leave us that goes away. It might have been a vehicle in some markets for some groups to become engaged because it got the doctors interest aligned with us in the front end. But, now that they are there, the relationships are right.

Again, sorry for another tangential answer, but my opinion is the legislation is out there. I believe it will happen at some time. And if happens, we can adapt. And we are not concerned about it. While we prefer to keep things as they are, the reality is they probably will not stay and that's-- if they do not, they do not.

Nikhil Sathe - JPMorgan

Okay, thanks for the clarification.

Ed French

You are welcome.

Operator

Your next question is from the line of David Nierenberg with Nierenberg Investment Management Company.

David Nierenberg - Nierenberg Investment Management

Hey guys.

Ed French

Morning David. It is early for you out there.

David Nierenberg - Nierenberg Investment Management

Very early, very early. It strikes me that as the number of hospitals that you own and operate has shrunk to seven, given that plus given the changes-- the trends between outpatient and inpatient, between bare metal and drug eluting stents, CABG volumes and so forth and a small share count that the task of your giving accurate guidance is incredibly difficult because you have both the law of small numbers and a large number of moving parts.

My counsel to you therefore is prospectively that you give serious consideration to providing less rich data and less guidance because I feel that the trivia is crowding out understanding of the tremendous progress that this company has made over a multi-year period and will continue to make over a multi-year period on three important dimensions.

First there has been an enormous improvement over the years in the quality and liquidity of your balance sheet to the extent that on a pretax, pre pay-off basis, for instance the addition of the cash from the Dayton Hospital sale will bring you just about to a zero net debt position even after the repurchases you've been doing. Secondly, since you and Phil joined the company there has been a huge and continuing improvement in EBITDA margins and tremendous cost reduction programs across the board. And third, as you said in your opening comments, tremendous growth prospects over a multi-year basis, the opportunity organically to add 58% in bed count. And while all these great things have been happening Ed, your share price has kind of done a round trip into the mid teens. So the capital markets do not seem to be understanding the enormous value that has been added over the past several years.

Therefore, two suggestions. First continue the share repurchase program as long as you can and use the potential for retirement or renegotiation of your debt to enlarge and extend it because if the public markets wants to sleep than I would like to own more and more of this company as you retire more shares. And second, again, think about how much guidance you really need to give if people are missing the main point.

Ed French

David, advice well taken. Thank you. Appreciate your support and I frankly do not disagree with anything you said.

Operator

Your next question is a follow-up question from the line of Whit Mayo with Stephens, Inc.

Whit Mayo - Stephens, Inc.

Sorry guys, just one quick one. Just any early read on the IPPS proposal and how that will impact you guys?

Art Parker

Whit, this is Art. Yes, we have taken a look at the proposal and do not see anything that concerns us in the proposal as it relates to either the weight changes or the labor updates in that. Based on sort of an early read, my sense is it would be in the 2% range accretive to us.

Whit Mayo - Stephens, Inc.

Great. Thanks guys.

Ed French

Thanks Whit.

Operator

There are no further questions at this time. Mr. French, do you have any closing remarks?

Ed French

Julianne, thank you. I really appreciate all of you joining us this morning. Thanks for the stimulating discussion. We appreciate you following the company and supporting us.

Operator

Thank you for participating in today's conference call. You may now disconnect.

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