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Health Management Associates, Inc. (NYSE:HMA)

Q3 2012 Earnings Call

October 23, 2012 11:00 a.m. ET

Executives

John Merriwether - VP, Financial Relations

Gary Newsome - President and CEO

Kelly Curry – CFO

Bob Farnham – SVP Finance

Analysts

A.J. Rice – UBS

Kevin Fischbeck – Bank of America

Darren Lehrich - Deutsche Bank

John Ransom - Raymond James

Whit Mayo - Robert Baird

Ralph Giacobbe - Credit Suisse

Gary Leiberman - Wells Fargo

Operator

Operator

Good morning, my name is Rob, and I will be your conference operator today. At this time, I would like to welcome everyone to the Health Management Third Quarter 2012 Earnings 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. Health Management Associate, John Merriwether, you may begin your conference.

John Merriwether 

Thanks, Rob, and good morning everyone. I’m John Merriwether, Vice President of Financial Relations for Health Management Associates. I'd like to welcome you to Health Management's third quarter 2012 earnings conference call.

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

Forward-looking statements are subject to risk, uncertainties and assumptions and are identified by words such as expect, estimates, projects, anticipates, believes, intends, plans, may, continue, should, could and other similar words. All statements addressing operating performance, events, or developments To Health Management Associates Inc. expects or anticipates will occur in the future, including but not limited to incurrence of indebtedness projections of revenue income or loss. Capital expenditures, earnings per-share, debt structure, the provision for doubtful accounts, capital structure, retainment of indebtedness, the amount and timing of funds under the meaningful use measurement, standard of various ACIT incentive programs. Other financial items and operating statistics, statements regarding the plans and objectives of management for future operations, innovations or market service development, statements regarding acquisitions, joint ventures, divestitures and other proposed, or contemplated transactions, including with unlimited statements regarding the potential for future acquisitions and proceed benefits of acquisitions, statements of future economic performance, statements regarding legal proceedings and other loss contingency’s, statements regarding market risk exposures, statements regarding the effects, interpretations, were recently enacted for future healthcare laws and regulations, statements and the assumptions underline related to any of the [inaudible] statements, or statements which are other than statements of historical factor can be considered to be forward-looking statements.

In addition, adjusted EBITDA, as mentioned on this call, is defined as consolidated net income before discontinued operations, net gains, losses on sales of the assets, net interest and other income, interest expense, income taxes and depreciation and amortization.

On the call with me this morning are President and Chief Executive Officer, Gary Newsome; Chief Financial Officer, Kelly Curry; and Senior Vice President - Finance, Bob Farnham.

Thank you for your attention. I will turn the call over to Gary.

Gary Newsome -

Thanks John. Good morning everyone. Thank you for joining us to discuss another solid quarter. We are very pleased with the results of the third quarter. Let me share with you some reasons why we are so pleased.

Our Same Hospital EBITDA increases have led the publically traded hospital industry for the past several quarters and are again strong. Indeed Same Hospital adjusted EBITDA increased to $249.6 million this period. And while I’m happy with our financial results, I’m most excited about how we are achieving them.

We are accomplishing great things by remaining resolutely focused on delivering excellent care. Evidence of our efforts are paying off. The joint commission just recently recognized 41 of our hospitals as top performers and key quality indicators. That is 65% of our hospitals recognized at the top versus 18% nationally. [inaudible] were drivers to, of our success are first, our continued investment and outpatient services to capture market shifts to that channel, and second our remaining very disciplined on managing cost, a strength of ours that will serve us well as the highly challenging healthcare environment continues for the foreseeable future.

We are now a company of 70,000 hospitals spread across 15 states, with more than 45,000 associates and 10,000 physicians on staff. We now touch more than 3.5 million patient lives a year, and continue to grow. It is this skill of our operation that allows us to deliver on our mission to enable and increasingly save great local healthcare.

We welcome you here today to discuss our solid third quarter results. If it weren’t for the collective strength of the company’s associates and physicians. We are able to leverage this strength to give our hospitals and physicians what they need to serve their patients well. We are able to provide the local communities, the people, processes, capital on expertise necessary to deliver great care when they’re faced with markets reality’s that we’re seeing today.

Quite frankly, if Health Management hadn’t historically partnered with many of our communities, there’s a high likelihood that many of the hospitals would no longer exist, or certainly provide much less comprehensive local care.

We feel great about investing to local hospitals, we’re saving jobs. We are delivering high quality care locally near where people and families live. We believe we have made, and will continue to make a difference in local communities across the country. Certainly our 35 year track record proves that.

As we continue to improve this already great company, we are more than confident we will be highly successful going forward. I’m very bullish on our prospects as a company, and the industry as a whole. Healthcare is a complex industry, we all know that. However, it will get only more complex as varies facets of the Affordable Care Act take hold.

We are currently executing on strategies to not only weather the industry change and the on-going effects of a [inaudible] economy, but to use our scale, financial strength, and financial discipline to significantly grow the company.

We believe we are starting to see inpatient volumes moderate as unemployment rates stabilize. Although our Same Hospital admissions decline 6.4% in the quarter, our investment in and focus on outpatient services significantly blunted the impact that Same Hospital adjusted admission declined just 2.2%.

Absent three specific contributing factors, adjusted admissions growth would have likely been flat. The three issues are as follows, one, the impact of declining uninsured admissions. Two, the extended impact of hurricane Isaac in late August, specifically on our hospitals in Florida, and more specifically in our hospitals in Mississippi. In fact, our Mississippi hospital declined in the quarter as it relates to these challenges, really affect 1% of our adjusted admission decline in the quarter. And three, the effect of operation stays over 24 hours, which is being addressed.

We recognize the challenge to the inpatient volumes. To some extent, like the economy and weather, the inpatient issue is a macro issue out of our control. But let me be clear, we are aggressively making up the difference by adding outpatient services, and maintaining effective cost controls, and we continue to focus on operating initiatives that have generated our consistent results today, emergency room operations, physician recruitment, and market service development. The blocking and tackling is still effective.

And finally, before I turn over the call to Kelly, let me leave you with some good news inherent in the economy and the industry uncertainty. There’s no doubt that the pain is extremely acute on some very attractive facilities that are without the scale, a support system necessary for long-term survival. It’s an attractive market, and our strong balance sheet and cost discipline will allow us to selectively capitalize on this strategic acquisition and partnership opportunities before us.

With that, I’ll turn the call over to Kelly, to review the financial results we reported to you last night.

Kelly Curry

Thanks, Gary, and good morning to each of you. As you know, we issued our earnings press release last night for the third quarter. For the third quarter for continuing operations and compared to the same quarter a year ago, Health Management reported net revenue growth of 18.1% to $1 billion, 440 million, and adjusted EBITDA growth of 26.95 to $236.4 million.

Compared to same quarter a year ago diluted EPS from continuing operations for the third quarter increased 5.9% to $0.18, excluding the impact of the interest rate swap accounting, our mark-to-market adjustments, HIT payments is offset by Medicaid payment rate reductions. Overall diluted EPS from continuing operations was $0.17.

Contributing to the solid results, where admission increase of 4%, adjusted admission increase of 10.4%, and emergency room visit increase of 20.9%, and a surgery increase of 19.1%. For continuing operations at hospitals we have owned and operated for one year or more, referred to as our hospital continuing operations, compared to the prior year’s third quarter, net revenue increased 4.5%, net revenue per adjusted admission grew a strong 6.9%, adjusted EBITDA increased 14.2% to $259.6 million, resulting in a 180 basis point improvement in our EBITDA to 20.4%.

Excluding approximately $20.3 million of our HIT incentive payments, net of the $3.9 million of Medicaid rate reductions for the third quarter of 2012, and 1.7 million of HIT incentive payments for the third quarter of 2011. Same Hospital adjusted EBITDA increased 6% to 239.3 million. In addition, surgeries and emergency room visits were up eight tenth percent and 4.2% respectively.

While outpatient volume growth in the third quarter of 2012 continued to improve, inpatient admissions saw declines and as Gary had mentioned, the weather impacted volumes and financial results.

Hurricane Isaac affected hospitals in Florida and Mississippi in late August for several days. Although the hurricane effects did not result in significant structural damage to any of our hospitals, the slow moving storm in [inaudible], several of our communities for multiple days. The resulting power outages and travel restrictions closed school systems and many local businesses, forcing our hospitals to close certain departments, cancel procedures and test.

While volumes were and still are being rescheduled, the duration of this storm significantly affected our Mississippi and to some extent, our southwestern Florida hospitals. The impact have reduced ER activity, lost admissions, procedures and testing, was approximately $4 million or $0.01 per diluted share.

For the ninth quarter in a row, or more than two years now, we have seen decline of uninsured patients seeking care at our Same Hospital facilities. Our markets unemployment rates have improved compared to last year, but we still lag the national average about 60 to 70 basis points.

We believe there needs to be significant improvement in the employment rate, coupled with insurance coverage, before we experience sustaining, sustainable meaningful, commercial inpatient volume growth.

Continuing Same Hospital uninsured admissions for the third quarter total 7.3% of total admissions, which is a 10 basis point increase – excuse me, decrease from the same quarter a year ago.

As you know, there are three components that comprise our accounts for uninsured and under insured patients, provision for doubtful accounts, uninsured discounts, and charity/indigent write-offs. These figures are consolidated and do include our acquisitions.

Our provision for the doubtful accounts for the third quarter was 224.1 million or 13.5% of net revenue, compared to 178 million or 12.8% of net revenue for the same period a year ago. Year-to-date our provision for doubtful accounts as a percentage of net revenue is 12.7% and at the low end of our 2012 objective of between 12.5 and 13.5% of net revenue.

Uninsured self-paid discounts for the third quarter were 334.7 million compared to 227 million a year ago. Health Management’s charity/indigent write-offs for the third quarter were 28.1 million compared to 24 million for the prior year. The sum of the provision for doubtful accounts, uninsured discounts and charity/indigent write-offs, as a percent of the sum of net revenue, uninsured discounts, and charity/indigent write-offs, which help management refers to as the uncompensated patient care percentage was 29% for the third quarter, compared to 26.1% for the same quarter a year ago, and 27.2% for the second quarter ended June 30.

The effect of new acquisitions, the increase and uninsured ER volumes and the effect of price increases contributed to this increase in uncompensated care. Our adjusted EBITDA from continuing operations for the third quarter was 236.4 million, or 16.4% of net revenue, an increase of 50.1 million or 26.9% over the prior year’s 186.3 million.

Adjusted EBITDA from continuing operations for the third quarter ended September 30, include approximately 20.3 of HIT incentive payments, net of approximately 3.9 million of Medicaid program payment reductions. Adjusted EBITDA from continuing operations for the third quarter last year included approximately 1.7 million of HIT payments.

On a Same Hospital basis, adjusted EBITDA from continuing operations for the third quarter grew to 259.6 million for a 20.4% margin, compared to 227.3 million or a 18.6 margin for the same period a year ago. This represents a 180 basis points, $32.3 million or 14.2% increase for the third quarter of this year.

As with consolidated adjusted EBITDA, Same Hospital EBITDA includes HIT incentive payment and Medicaid payment reductions, excluding the 20.3 million of HIT incentive payment, offset by the 3.9 million – 3.9 million of Medicaid rate adjustments for the third quarter of 2012, and the 1.7 million of HIT incentive payments for the third quarter, Same Hospital adjusted EBITDA increased 6% to 239.3 million.

Moving over to the balance sheet and cash flow statement, our total asset at September 30 were just over $6.3 billion. The balance and accounts receivable, net as of September 30 was 972.1 million, and the balance in the allowance for doubtful accounts was 715.5 million.

Health Management’s day sale outstanding as of September 30, were 53 days or 1 day higher than the 52 days reported at September 30 prior year. We have yet to receive all the government tie in notices for the INTEGRIS hospitals during the third quarter, and the buildup of AR is affecting our day sales outstanding by approximately 2 days.

Our cash collections continue to be strong, and we are achieving our internal targets. For the third quarter, cash flow from continuing operating activities was 167.1 million after cash interest and tax payments aggregating 119.8 million. Again, cash flow from operations was negatively affected by the collection of AR associated with the INTEGRIS tie in notices. We do expect to receive the notices in the fourth quarter of 2012.

Our capital expenditures for the third quarter were 88.2 million. With regard to our debt covenants as of September 30, Health Management’s total leverage ratio was 3.6 and our interest coverage ratio was 4.2. These ratios compared to our total leverage ratio maximum of 5.5 and an interest coverage ratio minimum of 3.25 as of September 30. As you can see, we are well within those requirements.

We have now reported three strong quarters of financial results for 2012. As we move closer to the end of the year, we were able to update some of our annual objectives. We are updating our 2012 adjusted EBITDA range for the year ending December 31, to be between 875 and 915 million.

We are also updating our diluted EPS from continuing operations range for the year ending December 31, to be between 80 and $0.85. Our adjusted EBITDA objective range didn’t change materially, so the prime reason for the narrowing is a result of increased fixed expenses which is depreciation amortization associated with two new replacement hospitals.

Please remember this diluted EPS range for 2012 does not include approximately 103 to 107 million or $0.26 to $0.27 per diluted share of impact expected from interest rates swap accounting and the mark-to-market adjustments. Nor does it include approximately 90 to 100 million or 23 to $0.25 per related share of anticipated HIT incentive payments.

We are also updating our 2012 Same Hospital admissions objective range. We now expect Same Hospital admission for 2012 to decline between 3 and 5%. However, we are affirming our 2012 annual Same Hospital adjusted admissions objective range, which we expect to be between plus 1 and minus 1%.

In closing, to review our third quarter results, diluted EPS from continuing operations increased 5.9% to $0.18 excluding the impact of our interest rate swap account, the mark-to-market adjustment, and HIT payments, net of Medicaid payment rate reductions.

Same Hospital surgeries were up eight tenth of a percent and emergency room visits were up 4.2%. Same hospital net revenue increased 4.5% and same hospital net revenue for adjusted admission increased 6.9%.

Same Hospital adjusted EBITDA increased 14.2% to 259.6 million, resulting in 180 basis point improvement in margin to 20.4%. Excluding approximately 20.3 million of HIT payments, reduced for the impact of the 3.9 million of Medicaid payment rate reduction, for the third quarter of 2012, and 1.7 million of HIT incentive payments for the third quarter of 2011, Same Hospital adjusted EBITDA increased 6% to 239.3 million. Our cash flow from operations totaled 167.1 million.

Thanks again for your attention, and I’ll turn the call back over to Gary.

Gary Newsome

Thanks, Kelly. Now I was really excited in my comments earlier, I was talking about the number of hospitals we had, and I think I said 70,000. Well we only have 70. But I am pretty excited about where were going in terms of our growth opportunities there.

Before we open it up for questions, I did want to update you on a topic. We discussed a little in the second quarter call back in July. Coincidently as they did before our last earnings call in July, a Pennsylvania newspaper in Carlisle, Pennsylvania has published another article this morning, discussing a possibility of a 60 minute segment this fall.

The potential segment has not aired, and we do not know the timing of the airing or if it will air at all. The segment would likely focus on emergency room operations, but we can’t be certain. I am confident that our emergency room operations are appropriately evaluating and treating our patients.

So to determine a 60 minute segment is [inaudible], we will update you with additional information. As I mentioned earlier, our mission is to provide the people, processes, capital and expertise necessary for our hospitals and physician partners to fulfill the local missions, of delivering superior healthcare services.

We give our associates and physicians what they need to succeed. And you know what? They are succeeding. Earlier I mentioned that 64% of our eligible hospitals were recognized by the joint commission as top performers on key quality measures in 2000 – as 2012 report on quality and safety.

The joint commission is just the latest outside group to recognize the quality and safety of the Health Management hospitals. Fortune Magazine named Health Management one of the worlds most admired companies in healthcare medical facilities earlier this year. Within that category, Health Management was named number one company in quality, of product and services, and in social responsibility.

U.S. News and World Report named two Health Management hospital, our Sparks hospital, our Sparks health system in fact in Fort Smith, Arkansas, and Riverview Regional Medical Center in Gadsden, Alabama as two of the best regional hospital in the United States. And Health Management hospitals as a group scored 98.6 out of 100 for [inaudible] to a set of core process – care processes called core measures, developed by the centers of Medicare and Medicaid services in 2010.

And all this is very important because it’s number one, the right thing to do. And number two, our reimbursement to a certain extent will be tied to these quality and service metrics.

As I said before, I’m as proud of our associates and this recognition that they’ve earned. I’m also equally excited about what we believe the future holds for us. So the most exciting opportunities that lie ahead of Health Management are the acquisition and partnership opportunities. Our pipeline remains very active. We’ve established great relationship with nationally recognized healthcare systems like [inaudible], and Orlando Health right here in Florida. University of Mississippi Medical Center in Mississippi, and then INTEGRIS healthcare in Oklahoma. Likewise Tennova Healthcare in east Tennessee continues to exceed our expectations. These successes are bringing new opportunities as hospitals seek a strategic partner like Health Management, who in these uncertain times can provide access to capital, meaningful use compliant systems and effective operating expertise.

We are confident that the continued effects of a weak economy and the complexities of the Affordable Care Act will continue to generate partnership opportunities. By remaining focused on delivering high quality healthcare, successfully implementing our operating initiatives and effectively integrating our partnership opportunities, we are confident we can achieve our objectives.

We will continue to enable and save America’s best local healthcare. Thank you again for your attention. I’ll now open the call for questions.

Question-and-Answer Session

Operator

(Operator instructions). And your first question comes from the line of A.J. Rice – UBS. A.J. are you there?

A.J. Rice – UBS

Same store revenues for adjusted admissions increased 6.9%. I wonder if we could get a little more flavor on that. It seems like a lot of times when your inpatient admission number is down, this number seems to jump up. Is this – is there an acuity element of this. Is there a change in what you’re seeing on the pricing side? Maybe there’s a payer mix, I just wondered if you’d flush it out a little more for us?

Kelly Curry – CFO

There was a little bit of a delay before the line opened up A.J., so what I got from your question was, you asked about a net revenue projected admission increase, is that all of it?

A.J. Rice – UBS

That’s right, sorry.

Kelly Curry – CFO

Yes, actually there was and we had a very strong acuity increase. Our Medicare acuity increased from 1.36 to 1.41 or 500 bases points, or 3.6%, a big growth. As we’ve been saying people are coming in sick. And as we said before, and we know it’s true, as we’ve continued to expand our menu of services, as well as access the services for outpatient procedures, we’re seeing a higher acuity, can’t measure it, but we do know that we are treating a broader an array, and we are doing so in all – frankly across the country in outpatient procedures, which is also impacting that. So, actually I would lean – I know what you’re saying about how the numbers move, but actually I would lean further in this case to the fact that we’re just seeing a lot higher increases in acuity.

A.J. Rice – UBS

Okay.

Gary Newsome – President and CEO

Hi, this is Gary. I just wanted to put a little flavor on that as well. This is really a demonstration of what we’re doing from - Kelly mentioned it, but I want to emphasize our service development these hospitals and our physician recruitment. You know we’ve been raising the bar in terms of the level of service we’re offering in all of our hospitals, and as we do that we’re going to get a higher intensity patient into our hospitals.

A.J. Rice – UBS

Okay.

Bob Farnham – SVP – Finance

This is Bob, A.J. You know we reported surgeries were up by .8%, but on the outpatient side surgeries were up almost 3 ½ %. And the mix on those surgeries was very well, very good. As Gary just mentioned, we focused on market service development and it’s been particularly true in orthopedics, hips, knees, and shoulders. As a group we’re up about 10% for the quarter. Spine was up by 8%. So, we’ve had a focus on those particular services that are higher intensity and that’s fed into the net revenue per adjusted admission as well.

A.J. Rice – UBS

Okay. Then maybe looking at a different area, if I look at where there’s a variance relative to our forecast on the – above the EBITA line, it was mainly on other operating expense, and my sense is that this is being skewed by the acquired facilities. Can you step back and A: Is that right, and B: Is there anything going in other operating expenses. Is that physician recruitment cost, investment in IT, is there something that we should call out and be aware of that’s happening on the other operating expense line?

Kelly Curry – CFO

Well some of it A.J. is attributable to – which impacts operating more than it does our SWB, but we have adjusted some of our contractual relationships for some of the services in our hospital. For instance: Like dietary and that sort of thing, and that’s had some impact, replacing that as in in-house service to going to out-house for it.

And in addition, I mean we have had a little higher, which we’ve said that we’re dealing with, but we have had, and continue to have, you know a little bit of increased legal cost associated, and that’s also in the figures.

And then – lastly, we do have the new acquisitions which are impacting that.

A.J. Rice – UBS

I guess I’m just – if I could brush a little on the acquisitions, what is – is it just that they naturally are running a higher cost Gary, or is there something going on there.

Gary Newsome – President and CEO

No, no, it’s always true, but it’s more noticeable on a consolidated basis because of the size of the acquisition that we did. Where it might not have been so obvious in the past, you know.

A.J. Rice – UBS

Okay. And just the last question I’ll ask you. You did reference a sort of continuing pressure with the short inpatient stays, moving to outpatient observation status. I think you’re saying at this point that that’s mostly a commercial pressure point as opposed to Medicare pressure point? I want to make sure of that. And then do you see a time when your anniversary at some point time here in the next few quarters, or is that something that’s going to be ongoing for a while?

Kelly Curry – CFO

It’s not just commercial patients. It’s Medicare advantage as well. In fact in the AARP magazine this month, they wrote a large article on this exact point talking about people that are covered on Medicare Advantage going into the hospital, being in the hospital for three days, eating hospital food, wearing hospital gown, on a hospital floor being treated by nurses and hospitalist, and then getting out of the hospital and going to rehab care and finding out that they weren’t in the hospital. Which means they have to pay for it. So, I think this entire subject, you know frankly the implications of this activity are going to end up being debated nationally I think because, you know, I mean we’ve had situations, you know talk about doing the right thing. I mean we’ve has situations, we have an individual that’s 80 years old show up in our ER, and not able to get an admission because they only have pneumonia in one lung, and we’re supposed to send this patient home, you know. I mean that’s ridiculous. And that’s the kind of ridiculous stuff that we’re seeing.

So, as to whether or not at anniversary’s, I think you know really this entire issue is going to come to – going to come to a head because I think there’s going to be some debates on this relative to whether or not this is the right way for Medicare patients as well as managed care patients, because it’s happening with managed care also.

A.J. Rice – UBS

Okay, all right thanks.

Operator

Your next question comes from the line of Kevin Fischbeck. Your line is open.

Kevin Fischbeck – Bank of America

Thanks. I just wanted to get more into the volume numbers. You know, it’s good color there on the – some of those issues, but you know, it looks like your guidance assumes that, you know, Q3 was more of an aberration and that Q4, there’s some improvement off of that. Is it just difficult comps in Q3 that we’re going against or what gives you visibility to see some improvement next quarter. And I guess in the past you’ve talked about kind of a U from a volume perspective. Can you talk about visibility in where you are in that turnaround?

Kelly Curry – CFO

Yeah, Kevin, you know the comp was part of it. But the reality in the quarter, you know, as I mentioned in my comments earlier, the Mississippi, this Hurricane Isaac really affected volumes in Florida and the Western Coast of Florida and we saw that several days, a lot of school closing, businesses closing. But in Mississippi, it hung in there for a long time and literally the decline in Mississippi resulted in at least a full point of our adjusted admissions down for the quarter.

So we don’t expect Hurricane Isaac to happen again or any hurricane hopefully in the month of November. We’re getting to the end of the hurricane season and it has been fairly benign, but – and there’s a lot of other things we have that gives us confidence in keeping our range where it is at this point.

Gary Newsome – President, CEO

Yeah, we – as we’ve shown and indicated, I mean, up until really this aberration that we talked about, we’ve been running a flat adjusted admissions year to date, and so we think that that’s pretty reasonable because we know what we’ve done related to services in terms of market service development. We know what we’ve done in terms of expanding access of the menu of services, so we think that as we look forward, we’re going to see that return to what we would expect.

And in addition to that, you’re correct, we have said U and I think what I said was in the past that we were entering the leg of the U. I don’t know where we are in the U and it might not be a U that would get an A-plus from a first grade teacher in writing either. It could be a little lousy leg on the other side too in terms of what the turn is because to some extent, I think we have a mute dynamic in what we’ve seen in inpatient admissions that had aired since we’ve had this recession.

Kelly Curry - CFO

Kevin, just a little more color on that, you know, we – you know, as far as our confidence in that, you know, we did see a decline, particularly in surgeries as it related to the hurricane and you know, we’re – we started seeing those coming back though it was much later in the quarter and it’s strictly into the fourth quarter quite frankly, so that gives us a lot of confidence.

Kevin Fischbeck – Bank of America

Okay, so that’s due to the hurricane disruption, now you think we’re kind of out of the numbers at this point into Q4?

Kelly Curry – CFO

Yeah, we don’t budget for hurricanes and we sort of can’t predict them.

Kevin Fischbeck – Bank of America

Okay, and then as far as the U goes, so it sounds like you kind of feel like the headwinds to volumes are normalizing but I think maybe to a comment you made earlier, that you really are looking for a rebound in employment before that U starts to pick up, is that the way to think about it?

Kelly Curry – CFO

Exactly.

Kevin Fischbeck – Bank of America

Okay. And then just one question on the pricing side. You know, you talked a couple times about the Medicaid headwinds and just to clarify what you’re talking about there as far as about $4 million in the quarter, is that – are the ones that you’re singling out there, are those when those are actual Medicaid reductions year over year or do you include things where the rate of increase is less than inflation.

Kelly Curry – CFO

No, no, it’s the same one I’ve been – well, you know, Kevin, you would remember that, you know, before we got to this stage, they either wouldn’t pay [inaudible] if they did, they pay reduced rates, and that’s what the states have done because they knew that the government was going to – or the federal government, federal dollars would be going to pay HIT money for state Medicaid programs so it gave the states an opportunity to call back some money at a rate to go towards the general budget and that’s what they’ve done. And that’s been – and we’ve been saying all year long that that’s been costing us about $4 million a quarter and it’s going to cost us $4 million a quarter next quarter as well.

But we view that that was really HIT money that should apply to our normal operations as opposed to HIT. So just being consistent with what I said to begin with.

Kevin Fischbeck – Bank of America

Okay, so since most state budgets are kind of July 1, you know, September 1, do we – should we expect somewhat of a headwind in the first half of next year as well?

Kelly Curry – CFO

I would imagine. We’re still – we’re still looking at the things. I mean, there’s – in Mississippi, they’ve made a significant change in payment there. However, they – when they did the change, they failed to calculate – it was supposed to be budget neutral but they didn’t run the calculation to see that it would be and now they’ve discovered and it’s really not and – because every hospital in the state’s banging on the governor’s door. And so they’re going to go back in and make some adjustments, we know that. That’s the only state we really know about right now. We do know that, you know, in Florida, Governor Scott has talked about going through a DRG system. And frankly, we’re fine with that, you know, it’s just – it’s managing the transition is the key on that. But I don’t expect that will happen until maybe his next term in office.

So all in all, right now, we’re just waiting for things to settle a little bit to find out exactly what’s going to happen in Mississippi.

Kevin Fischbeck – Bank of America

So Mississippi was moving from a DRG to a per-diem rate, is that – and they just didn’t get the rate correct?

Kelly Curry – CFO

Yes.

Kevin Fischbeck – Bank of America

Okay.

Kelly Curry – CFO

They just didn’t quite get it figured accurately, correct.

Kevin Fischbeck – Bank of America

Okay, great. Thanks for your help.

Operator

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

Darren Lehrich - Deutsche Bank

Can you hear me okay?

Gary Newsome – President, CEO

Yes.

Darren Lehrich - Deutsche Bank

Okay, great. Sorry, there’s some feedback in the line. I just wanted to confirm in the pricing number, did you see any provider fees from any of your states in that 6.9% number? I just want to confirm whether…

Kelly Curry – CFO

No.

Darren Lehrich - Deutsche Bank

…that – so no. And then I think earlier in the year you had talked about the potential to get some Medicare settlement dollars I the second half of the year. Is that still a possibility? Should we be thinking about that for the fourth quarter?

Gary Newsome – President, CEO

Well, actually we – that’s related to the rural floor issue. That’s being dealt with. We don’t know whether for sure it’s going to be in the fourth quarter or perhaps the first quarter next year. We’re still working on it. We do know that based on what’s been settled in the past, we should definitely be expecting to settle it soon and [inaudible] and also that we are [inaudible] yet.

Darren Lehrich - Deutsche Bank

Okay, but that – so that wouldn’t be in the fourth quarter outlook, nor would it…

Gary Newsome – President, CEO

Can’t say for sure.

Darren Lehrich - Deutsche Bank

Okay.

Gary Newsome – President, CEO

It could be next quarter. They kind of went at this – they did – they kind of went at it and they did, I think, three of them. And then they accounted a hiatus and they’re supposed to be going back to it. You know, who knows, you know, the government manages on an actual case basis, so – which means that if they keep stuff in float, it works for them.

Darren Lehrich - Deutsche Bank

And then just on that point, I guess, you did tweak your HIT income number slightly lower for this calendar year. I just want to understand, did you lower that because of anticipated delays in payments from the government or is there slower out-of-station on your end with the systems? I just want to understand, you know, what’s driving the meaningful use change?

Gary Newsome – President, CEO

It’s where we’re tightening up the book entry. We’re still probably going to get $120 million of cash, it’s just tightening up the book number that will be booked for this year.

Darren Lehrich - Deutsche Bank

Okay. So that’s just the difference between what you can accrue and what you expect?

Gary Newsome – President, CEO

Yes, based on the renewals and not only do you have – not only is it based on the cost reporting period there, it’s based on the cost report being sustainably complete and that’s, you know, of course, subject to – also to the auditor’s review. So that’s just our expectation of what for sure that we would expect to be done. But cash wise, we think it’s going to come in where we thought it was to begin with.

Darren Lehrich - Deutsche Bank

Great. Okay.

Kelly Curry – CFO

And we’re well on track with your attestations as far as our end.

Darren Lehrich - Deutsche Bank

Okay, great, that’s helpful. And then just the last thing, I just wanted to come back to the impact from the shift to observations. Obviously this is something we’ve been hearing about for a long time and I know you guys have been talking about it for many quarters. I just want to be clear, in terms of the trend, it looks like maybe the impact was a little bit more, or has been running a little bit higher and so is there something new or different in terms of your process that’s caused that to happen? Is there, you know, some other externality, you know, from any of your math that’s causing this to change? I just want to understand the, you know the continued shift there. I know you can’t predict when it’s going to normalize, but what’s really changed?

Gary Newsome – President, CEO

In reality, Medicare Advantage is really one of the biggest drivers of – especially observation stays greater than 24 hours, which is inconsistent with the definition of observation stays by CMS. So that is something that we think gets reconciled over time, not just for us, but for the industry and so we have seen some of that pressure. And as you know, as good as Medicare Advantage – Medicare and Medicare Advantage, then commercial payers tend to follow suit too.

You know, we’re addressing that in a variety of ways, including our processes. We have been working out – it’s really an education process for our caregivers, our case management physicians. It’s also an opportunity for us as we refine agreements with third-party payers to improve that – improve that whole relationship going forward.

Kelly Curry – CFO

And as Gary mentioned, I mean, we all have to do our managed care contracting and also we’re doing a lot of steps system wise with it. This year we’ll have our investor day and you guys will get to see what we’re doing along the lines to improve our documentation to deal with some of these issues that are coming up because, you know, you learn – you also learn through this process, you know.

Darren Lehrich - Deutsche Bank

And do you – or just the last thing here in the – the collections piece, obviously with more outpatient, you know, there’s for the fee-for-service population, a lot more out-of-pocket, so is that having any impact at all on the bad debt numbers we’re seeing in this quarter?

Kelly Curry – CFO

It’s having some, but as you know, because as I indicated, you know, number one, in the third quarter, as you are well familiar with, Darren, it’s always a quarter that it upticks because of the way the revenues flow. You always have an uptick in percentage. So it’s there and it’s historical. But our year-to-date provisions as a percentage of net revenue is 12.7%, which is well within range of the guidance that we gave and what we expect. And yeah, the – there are some new challenges in the area, but we, frankly, have been dealing with that at the front end when we’ve been given our objectives and we’ll update our objectives at the beginning of the year like we usually do.

Darren Lehrich - Deutsche Bank

Okay. Thanks a lot.

Kelly Curry – CFO

You’re welcome.

Operator

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

John Ransom - Raymond James

Hi. A lot of questions were asked. I guess I’m going to ask about the acquisition environment. There was a lot of talk about that 6 to 9 months ago but news seems to be – the news flow seems to be a little light other than just stuff that’s out [inaudible]. Can you comment on that? Is it still tracking? Is it delayed? Is it as good as you thought it was? That would be great to get an update.

Gary Newsome – President, CEO

Actually, John, that’s a very good question.

John Ransom - Raymond James

Well, thank you.

Gary Newsome – President, CEO

Well, you always ask good questions. But that’s a particularly good one I think.

Kelly Curry – CFO

All you’all ask good questions.

John Ransom - Raymond James

Kelly, it’s way too late for you to be playing nice. It’s way too late for that.

Gary Newsome – President, CEO

But we’ve had – we could have announced several deals throughout this year, but we have chosen not to pursue certain deals because of a variety, we were very strict in the model and the way we look at acquisitions. The opportunities are – the pipeline is rich. That’s the best way I can describe it.

There’s a lot of activity there, the fact that there hasn’t been a lot in terms of communication of an announcement is because as you would want us to be, you want us to be very strategic in our acquisitions and that’s exactly what we’re doing. And you know, there will be some communication pretty soon, I think, in terms of our acquisition process and it will be very pleasing for everyone when they hear it.

John Ransom - Raymond James

And just kind of on that point, talk about some of the recent ones. Are we seeing, for example, year-over-year EBITDA growth in Knoxville and say in [inaudible] and some of the recent ones? How are they tracking? I know you gave the same story with a number, but I’m just curious how you’re year-over-year EBITDA is tracking at some of the more recently acquired hospitals?

Gary Newsome – President, CEO

John, we are thrilled with our new acquisitions, absolutely thrilled. There are great markets, great results and you know, and it’s really fundamentally doing the things that we do well that have improved these markets. As I mentioned earlier, you know, Tennova, [Inaudible], the – all of these are doing very, very well.

And one thing on your other question, John, is that you have to remember that when you’re talking about – and you’re in Florida and you saw what’s going on in Ocala. That’s the process that, you know, I first visited that hospital, you know, like almost 2 ½ years ago. So when you’re talking about a community that’s making an important decision like this, you know, they take time and it’s appropriate that they do because this is something they’re going to do once and they sure want to do the right thing for the community. So net effects are the length of time involved can fluctuate during the process of going through dealing with them on potential acquisitions.

John Ransom - Raymond James

Okay. Thank you.

Operator

Your next question comes from the line of Whit Mayo from Robert Baird. Your line is open.

Whit Mayo - Robert Baird

Hey, can you hear me?

Gary Newsome – President, CEO

We can.

Whit Mayo - Robert Baird

Hey. Great, thanks. Just a couple questions. I guess first, to start off, the two replacement hospitals that you discussed, are both of those open now and I guess the corollary question to that is you know, the D&A number in the third quarter, is that a good starting point moving into the fourth quarter?

Bob Farnham – SVP, Finance

This is Bob. The one replacement hospital, Monroe, Georgia, we opened up first quarter of this year. The second replacement hospital, which is in Poplar Bluff, Missouri, will probably open up in the first quarter of 2013, but what we have to do for accounting purposes is make sure that the remaining book value on that hospital, the existing hospital is reduced down to basically just about zero except for what we can transfer into the new hospital. So between those two items, we’ve seen depreciation increase about $6 million this year, this quarter over last quarter and that’s going to be true. It was true last quarter. I mentioned it last quarter, it will be true for the last really three quarters for the year. That’s driving part of the increase in depreciation. But acquisitions too is a big, big component largely because of Tennova and INTEGRIS that we closed in April as well. Those two are probably up about $10.5 million for this quarter versus last year. So between those two items, that’s probably about 60 to 65% of the increase in depreciation.

I also mentioned last quarter that we are taking advantage of historic low interest rates and as existing leases finish out, we are replacing those – that equipment with newer, longer-term capitalized leases, taking advantage of those interest rates. So you’re seeing a shift, a little bit of a shift out of rent expense, which has been down sequentially now a couple quarters in a row. So we’re seeing a little bit of shift there that’s contributing to the increase in depreciation. And then finally, it’s just really, you know the full year of depreciation on our CapEx that we acquired last year and some depreciation on our current year CapEx as well.

Whit Mayo - Robert Baird

Okay, that’s helpful. Are there any more replacement projects that are planned at this point that we need to be aware of?

Gary Newsome – President, CEO

No, no. No.

Whit Mayo - Robert Baird

Other question I had was just talking to a lot of our industry contacts in the past few weeks, it sounds like there was a pretty meaningful slowdown in volumes through September and I know you don’t comment too much on month-to-month trends, but just was wondering if you would kind of comment on the calendar this quarter and sort of curious how the months progress for you through the third quarter, just any general high-level comments would be helpful.

Gary Newsome – President, CEO

You know, Whit, one of the things we didn’t mention, but I think it’s important in the quarter is we have two fewer workdays in the quarter and particularly late in the quarter, this September actually. So that, you know, that definitely effects volume in our hospitals, it affects inpatient and outpatient because doctors are not in their offices on the weekends typically. So that – if you trend that – if you look at the volume year over year, trended over an number of years, when you have a month that has two days that are fewer in terms of workday, it can impact and did impact us this year and I imagine it probably did across the whole sector.

Whit Mayo - Robert Baird

Any way to size up what you think that headwind could have been on a percentage basis?

Kelly Curry - CFO

I haven’t done the calculation, Whit. If I was just guessing, Whit, it’s the difference that’s left to get us to even.

Whit Mayo - Robert Baird

Yeah.

Kelly Curry – CFO

Real scientific math there.

Gary Newsome – President, CEO

It is significant when you have that type of – we can certainly do that and get back to whoever would want to know that answer.

Whit Mayo - Robert Baird

Okay. Well, considering Kelly’s answer there, I might ask Bob to answer this one to get more scientific math. But can you remind us…

Gary Newsome – President, CEO

2%.

Whit Mayo - Robert Baird

Okay. And just remind us as we move into the fourth quarter, you know, remind us what the Medicare update is for either – I still hear a lot of concerns from investors about the rural cuts and how you’ll be impacted there. So if you could just remind us on some of the changes that would be helpful.

Gary Newsome – President, CEO

Well, the Medicare increase before sequestration was about 2.5% and then we know that sequestration is not happening, they said so last night, so but if you 2% sequestration does happen, you know, we’ve looked at a cross section of our hospitals and we’re probably going to be up maybe about ½ a percent.

Whit Mayo - Robert Baird

Got it.

Gary Newsome – President, CEO

On Medicare.

Whit Mayo - Robert Baird

Okay. Well, that’s helpful. Thanks a lot, guys.

Gary Newsome – President, CEO

Thanks, Whit.

Operator

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

Ralph Giacobbe - Credit Suisse

Thanks. Good morning. Can you give us what maybe short-stay was down in the quarter and what observation was up, percentage basis?

Kelly Curry – CFO

Well, observations are running at about 3%.

Ralph Giacobbe - Credit Suisse

Up 3?

Kelly Curry – CFO

Yeah. They’re running about 3%. I don’t know the short-stay number off the top of my head, but every time I look at it, it’s about average.

Ralph Giacobbe - Credit Suisse

And then I guess when we look at the pricing strength, does the short-stay observation dynamic, you know, is there anything to attribute to the pricing to that and I guess just generally, is that shift a headwind or tailwind to pricing?

Kelly Curry - CFO

It does not help our revenue for [inaudible] at all. In fact, it’s a drain on it. I guess it’s a headwind.

Ralph Giacobbe - Credit Suisse

Okay. And then can you give us maybe what – break out sort of what Medicare volume versus Medicaid versus commercial in the quarter?

Kelly Curry – CFO

It’s pretty – it’s been pretty consistent. I’m going to guess commercial as a percent of total may have been down 50 basis points and you know where we saw the shift was into managed Medicare. So it’s been – it’s tracking pretty consistent with prior periods.

Ralph Giacobbe - Credit Suisse

And just remind me, Managed Medicare is – do you put that in the Medicare bucket or do you put that in the commercial bucket?

Kelly Curry – CFO

Medicare bucket. Commercial. I’m sorry. Commercial. Commercial bucket.

Ralph Giacobbe - Credit Suisse

So managed Medicare is in commercial?

Kelly Curry – CFO

Correct. Yes.

Ralph Giacobbe - Credit Suisse

Okay. All right, that’s all I had. Thank you.

Operator

Ladies and gentlemen, we have time for one more question. The question comes from the line of Gary Leiberman from Wells Fargo. Your line is open.

Gary Leiberman - Wells Fargo

Thanks. I think most of my questions have been answered. I guess just going back to – it looked like your ER growth was fairly strong, so was there any negative impact from any of the press last quarter or was that a non-issue?

Gary Newsome – President, CEO

In fact, in our ER regards, we haven’t had any effect of the negative presses as far as that’s concerned. You know, the things we’re doing in our markets, you know, market service development and especially when we’re enhancing services and putting higher equity services, we’re getting higher equity patients coming into our emergency room. So all that’s good as we look at it. And the fact that our uninsured admissions continue to trend down is also positive as it relates to that. So the type of business we’re getting in our emergency room is good business.

Gary Leiberman - Wells Fargo

Okay, and then maybe just going back to the question on depreciation, so just to be clear, will you expect D&A to continue next quarter kind of at the pace of this quarter? Kind of the 92 million or more like what it was in the second quarter at sort of the $86 million level?

Gary Newsome – President, CEO

I think probably 91, 92 million is probably a better – a better, more accurate number.

Gary Leiberman - Wells Fargo

Okay, and then on the run as we think about 2013, it will moderate from there or do you think it’s going to continue at that level?

Gary Newsome – President, CEO

It’s probably going to continue at that level and maybe even a little higher than that as we have the full year impact of this year’s CapEx.

Gary Leiberman - Wells Fargo

Okay, that’s – and then I guess maybe my final question, just to wrap up, is in terms of shift in capital expenditures as you head into next year, kind of what was the overall percentage that you expect to spend on HCIT this year and as you head into next year, how do you think that trends?

Gary Newsome – President, CEO

We spend minimal money on HIT to get ourselves in position and we are well on track for the next round. Our capital percentage will be, as we always say, it runs about 5% of net revenue, it has run a little higher this year because this replacement in Poplar Bluff was originally a leased hospital, now we are – we own it, so that’s reflected in our CapEx percentage, but it’s going to go back to being around the 5% figure.

Gary Leiberman - Wells Fargo

Okay, great. Thanks a lot.

Operator

This concludes our question-and-answer session.

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