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Community Health Systems (NYSE:CYH)

Q3 2012 Earnings Call

October 31, 2012, 12:00 pm ET

Executives

Lizbeth Schuler - VP, Investor Relations

Wayne Smith - Chairman, President & CEO

Larry Cash - EVP & CFO

Analysts

Colleen Lang - Lazard Capital

Joshua Raskin - Barclays

A.J. Rice - UBS

Frank Morgan - RBC Capital Markets

Darren Lehrich - Deutsche Bank

Whit Mayo - Robert Baird

Gary Taylor - Citigroup

Operator

Good morning. My name is Michelle, and I will be your conference operator today. At this time, I would like to welcome everyone to the Community Health Systems Third Quarter 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)

I would now like to turn the call over to Ms. Schuler, Vice President of Investor Relations. Please go ahead.

Lizbeth Schuler

Thank you, Michelle. Good morning, and welcome to Community Health Systems’ third quarter conference call. Before we begin the call, I would like to read the following disclosure statement.

This presentation contains forward-looking statements including all statements that do not relate solely to historical or current facts. These forward-looking statements are subject to a number of known and unknown uncertainties and risks, which are described in headings such as Risk Factors in our Annual Report on Form 10-K and other reports filed with the Securities and Exchange Commission. As a consequence, actual results may differ significantly from those expressed in any forward-looking statements in today's presentation. We do not intend to update any of these forward-looking statements.

With that said, I would like to turn the call over to Mr. Wayne Smith, Chairman, President and Chief Executive Officer. Mr. Smith?

Wayne Smith

Thank you, Liz. Good morning. First, before we get started, let me express our sincere concern regarding the damage from Hurricane Sandy and please note that our hearts and prayers are with everyone who is over through very devastating storm.

Welcome to our third quarter conference call. Larry Cash, our Executive Vice President and Chief Financial Officer is with me on the call today. After the market closed yesterday, we issued an 8-K, including the press release with our financial statements. For those of you listening to the live broadcast of this conference call on our website, a slide presentation accompanies our remarks. I would like to begin the call with some comments about the quarter then turn the call over to Larry, who will provide additional comments on our financial results.

Community Health Systems has delivered another solid financial and operating quarter results in spite of continuing challenges in the economy. Net operating revenues for the quarter ended September 30, 2012, totaled $3.2 billion compared to $2.9 billion for the same period last year, an increase of 9%. Consolidated EBITDA increased 5.2% from $553 million to $477 million excluding the loss of early extinguishment of debt. Earnings per share from continuing operations was $0.86 versus $0.86 per share in the same period a year ago.

Net operating revenue for the nine months ended September 30, 2012, was $9.8 billion. EBITDA was $1.5 billion. Excluding the early extinguishment of debt earnings per share from continuing operations for the nine months ended September 30, 2012 was $3.08 compared to $2.49 for the same period a year ago.

With that, I would like to highlight some of the recent accomplishments. As we previously reported, we acquired the assets to Memorial Health Systems in York, Pennsylvania on July 1st. The 100 bed hospital and associated outpatient ancillary services is located approximately 25 miles Southeast of Harrisburg. Trading revenues approximately $100 million to low single-digit margin. We continue to be very selective and we have a full pipeline of acquisition prospects.

The company has completed construction of several replacement hospitals. We opened 225 bed Porter Regional Hospital at Valparaiso, Indiana in August. The environmentally conscience hospital is located on 104 acres and features all private rooms and state-of-the-art patient care technology. We also recently opened Barstow Community hospital in Barstow, California. Just small acute care hospital provide greatly expanded patient care areas along with increased patient privacy security.

Physician recruiting continues to be one of our operating strengths and we are very proud of our success in this area. The company recruited 1,644 new physicians for the first nine months compared with 1,362 physicians recruited for the same period a year ago.

The company is updating guidance. We have tightened the range for our 2011 EPS guidance to $3.80 to $3.95 as adjusted for the items described in our third quarter 8-K filing.

For 2011, the company had 50 hospitals recognized as top performers on key quality measures by the joint commission. This is up from 41 recognized 2010. Only 18% of the eligible hospitals in the United States were recognized for 2011 and we are very proud of our efforts to improve quality of care in our markets.

Our work on CMS is existing quality benchmarks co-measures in HCAHPS have helped prepare us for the next phase of benchmarking. Value-based purchasing, the re-admission phase of value based purchasing started on October 1st. Our evidence based order set project is on schedule at approximately 120 standards sets in place for our most common admission conditions. This implementation will help us achieve stage two of meaningful use.

Moving to an update on our more significant pending litigation and diversification matters, please note the following: In the next New Mexico key town, the Federal District Court upheld the recommendations of the magistrate judge and has imposed sanctions against CMS and the Department of Justice for failure to preserve documents needed to support our defense of the case. The judge ruling gives us access to certain privileged documents held by the government as well as an opportunity to recover some of our legal expenses.

As for the group of investigations that involve medical necessity of inpatient admissions, we continue to cooperate with the government in this investigation. Third-party review of sample of medical records and a small number of hospitals is underway and will take several months to complete. We continue to provide documents in response to the request issued by the Department of Justice.

The government request is another six months extension and the real case to which we can send in as the Judge (inaudible) request. The Delaware State Court case we discussed in July has been dismissed. There is nothing substantial to report for the other related cases and investigations and I refer you to the legal proceeding section of our Form 10-Q for the details of the updates. As has been the case in the past 18 months, our Board of Directors, the Audit Compliance Committee and selected senior management continue to be focused on these matters.

At this point, I would like to turn the call over to Larry Cash to provide you with a summary of our financial results.

Larry Cash

Thank you, Wayne. Before I get into the operating results for the quarter, I am going to briefly discuss seasonalities that affects our third quarter. Generally, each quarter has the same number of week days, a leave day and 2012 changed that dynamic and there was one less week day during the third quarter of 2012 compared to 2011 third quarter.

You should be all aware that week day volume could be significantly greater than weekend volume, one less weekday for this quarter translates into following approximate projections. 40 basis points reductions in admissions or 60 basis point reduction in adjusted admissions and a 130 basis points reduction in surgeries.

Our third quarter consolidated admissions increased 5% compared with the same period of last year. Adjusted admissions which factors in outpatients business increased 6.3%. Our same-store admissions decreased three-tenths of 1% compared to the third quarter of 2011. Our women’s services have experienced decline in volume with affect in the third quarter same-store admissions of approximately 70 basis points. Same-store adjusted admissions increased 0.8% for the quarter.

Net revenues in the quarter increased 9% to $2.945 billion last year to $3.212 billion. On a same-store basis net revenue increased 4% for the quarter; the third quarter had a benefit from ongoing Medicaid provider tax program we started this year and also supplemental programs.

For the third quarter, same-store net revenue for adjusted admissions increased 3.2% versus the same period of 2011. We saw a decline in same-store surgeries in the third quarter of 2.8% decline in cases was primarily due to seasonality I spoke earlier for the third quarter of 2012 of one few weekday, and also a fewer in hospital procedures and women service procedures.

Same-store (inaudible) visits 4.4%. Consolidated EBITDA was $477 million for the third quarter versus $454 million for the same period a year ago and increased 5.2%. On a same-store basis EBITDA was $481 million for the quarter and increased to 3.9%. For the third quarter, EBITDA margin on consolidated basis was 4.9% versus 15.4% for the prior year, this was decrease primarily due to low margins of regional facilities.

Additionally, our HITECH incentives before expenses was approximately $10 million lower than the third quarter of 2011, a 40 basis points reduction to EBITDA margin. Consolidated operating expenses as a percentage of net revenues increased 50 basis points in the third quarter of 2011, primarily due to our recent acquisitions and a decrease in HITECH incentives.

On a same store basis, total operating expenses were flat year-over-year from improvements in payroll and supplies, introduction and supply expense followed by our continued improvement in pharmacy and plants and expenses. On a year-to-date basis, consolidated admissions increased 3.7%, consolidated adjusted admissions increased 6.7%. Our same store admissions decreased 1.6% contributed to the decrease. A lack of fluid respiratory about 90 basis points and lower admissions for women's services by 40 basis points.

Our hospitals earned over 50 million in annual revenue are faring better in terms of volume, and year-to-date our same store adjusted admissions increased 1.1%. Consolidated net revenue was $9.8 billion, an increase to 9.6%. On a same store basis net revenue increased 4.3% for the first nine months. On a consolidated basis, net revenue for adjusted admissions increased 4.6%. On a same store basis net revenue per adjusted admissions increased 3%.

Our same store [searches] were flat year-to-date and same store emergency room visits were up 4.5%. Our same store Medicare case mix for the nine months ended September 30, 2012 increased to 0.6%. Consolidated EBITDA was $1.496 billion for the nine months ended September 30, 2012. On a same store basis EBITDA increased 3.8%, consolidated EBITDA margin for nine months ended September 30 was 15.3% and same store margin for same period was 15.6% down 10 basis points.

For the first nine months, consolidated operating expenses as a percentage of net revenue increased 10 basis points from the prior year, decreases in payroll of 10 basis points and supplies of 30 basis points offsetting versus lower operating expenses. Total A/R days were 60 at September 30, 2012, an increase of four days from the end of 2011. The allowance for doubtful accounts is $2.199 billion or 51.3% at September 30, 2012. The allowance for doubtful accounts and related contractuals for self pay was approximately 84% of self-pay receivables at September 30, 2012.

While same store self pay admissions and self pay revenue have increased because of the increased conditions of self pay revenue increased for the third quarter was approximately 400 basis points less than a year-to-date increase through June. Our self pay volume generated fewer dollars for the quarter in first half of the year.

Community Health Systems continues to have a favorable payor mix for the quarter and early 2012, consolidated net revenue by payor source was Medicare 25.8%, Medicaid 10.5%, managed care and other 50.4% and self-pay 12.3%. On a year-to-date basis, the payor mix is as follows; Medicare, 25.9%, Medicaid, 9.9%; managed care and other, 51%; and self pay, 13.2%.

Cash flow from operations was $295 million for the quarter, an increase of 26%. On a year-to-date basis, cash flow from operations was $778 million versus $820 million for 2011. The difference is due to four day increase in A/R days, our 2012 acquisitions increased A/R about $70 million and increased our Medicaid about $25 million, as well as a build up in Medicaid settlement provided programs by about $40 million. We also had an increase in other assets due to increase in electronics health record receivables for about 30 million. Cash flow (inaudible) and 200 million to 1 billion and 300 million.

Capital expenditures for the quarter ended versus 171 million or 5.3% of net revenue. Year-to-date capital expenditures were [558] million or 5.7%, replacement hospital expenditures were approximately 44 million per quarter (inaudible) year-to-date. Our guidance for the year ranges from 750 million to 800 million.

Balance sheet cash in September 30, 2012 was 241 million. At the end of the quarter, company had available credit for the revolver of (inaudible) after (inaudible) credit. A look at the balance sheet as of September 30, 2012, we had 1.226 billion in working capital. 16.2 billion of assets. Total outstanding debt as of September 30, 2012 was 9.572 billion, of which approximately 88% is fixed. Our debt-to-capitalization for the quarter is approximately 78%.

At the end of the quarter, we were probably 3.550 billion in interest bearing [swap] (inaudible) down to [1 billion] in the second quarter, and again approximately 88% of debt is fixed. The company has been very active in the debt markets. During the third quarter, we tendered for remaining 934 million balance of our 7% or 8% bonds which mature in 2015. We issued 1.2 billion of new debt with 7.125%. Coupon deal in 2020 lowered the coupons and extended the material.

We completed an offer of 1.600 billion or 5.125% senior secured notes during 2018. The company used these proceeds to prepay a portion of certain term loans of potentially (inaudible) approximate 2.5% and the pay related to these expenses. Our interest expense work increased due to all of our most recent financing activity that we did in latter part of 2012 third quarter of ‘12.

So the important points to note for both this (inaudible) report and our 2012 guidance; approximately 31 million of HITECH incentives were recognized in the third quarter, offsetting these incentive finance for approximately 12 million in operating expenses and depreciation expense increased 11 million. While HITECH revenue was greater than anticipated, dissociating operating expenses were greater than the second quarter by approximately 9 million.

As appearances were due to (inaudible) deployment of Medicare and Medicaid in five locations, updated cost for information two acquisitions were completed and greater physician incentives in primarily larger multi specialty groups. Please note we will be using [standardized] platform in 15 to 20 of our facilities going forward this (inaudible) very cost effective for us.

The California Medicaid hospital fee program for managed care was included in our 2012 guidance. We are advising both EBITDA and EPS guidance reflect the exclusion of this programs since we do not believe the program will be approved by CMS as of 2012. This lowers our EBITDA by 10 million and our EPS $0.07. We now expect annual interest to be approximately 10 million higher due to the issuance of the 5.125% senior secured notes and our recent extension with it in September. We have tied our interest guidance (inaudible) from 4.8 to 4.9%. We have lowered and tightened our EPS guidance to 380 to 395 reflecting the exclusion of the California Medicaid Hospital Fee program (inaudible) as well as the higher interest expense

Just as the remainder, there is seasonality in the fourth quarter compared to year ago with Christmas Eve and Christmas Day following on Monday and Tuesday and rather than a weekend that they did in the fourth quarter of 2011 and Wayne will now provide a brief recap.

Larry Cash

Thanks, Larry. I was also at the third quarter of 2012 further extend Community Health Systems, system record of earnings growth. While our volumes have been constraint by the macroeconomic environment, we believe our results continue to demonstrate underlying strength of our operating model. With that I will now open the call for questions, if you would like to talk with us at, or you can reach us at 615-465-7000.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Tom Gallucci from Lazard Capital Markets. Your line is open.

Colleen Lang - Lazard Capital

Hey, good morning, this is Colleen Lang in for Tom. Just on the volumes Larry the decline at just 30 beds was a lot better than but we and many others were looking for especially with the once in a weekday. Can you talk about some of the drivers here where volumes as you had hoped and were they better then what you were looking for?

Larry Cash

Well, what we said in the first half of the year, we were down about 2% and we felt like we are getting a opportunity to be a little better. In the second half of the year we had a little bit easier comps as result to some of the deductions we had in the third and fourth quarter 2011. One of the drivers in the third quarter would the fact that we didn’t have any headwinds as related to lack of flue respiratory [chapters] next part be around 100 basis points.

We are hopeful to continue to have a decent volume activity; we also had good at out-patient growth, the [0.8%] of adjusted admissions was better in last quarter 0.5%, so we continue to have good (inaudible) growth and good revenue growth. We thought it would be better and so pretty much came in line, we were aware, you are going to have some seasonality effect of, I got to think the loosening a weekday in September and coming at weekend day. So it was pleased to see it coming about (inaudible) we sort of thought it would be.

Wayne Smith

The other thing here is of course is we are not seeing volatility in our volume that we did before, it seems to be a little more stable so that's helpful.

Larry Cash

And I will just add. We also continue to see a little bit better managed care admissions and adjusted admissions grow than the overall average and that's continuing to have in and perhaps our revenue growth.

Colleen Lang - Lazard Capital

And then just quickly what are your views on the M&A environment in terms of the quality of assets up for sale and recent pricing and what's your priority in terms of new markets versus expanding in existing markets? Thanks.

Wayne Smith

I think there was three or four questions. But I think the environment is still very good. There is a lot of hospitals for sale; there is a lot of opportunities. I think we are seeing on both sides of the street, there are some that have decent margins and some that have no margins. So I think that's the reason that we are being very selective about this. We are looking for opportunities to help us enhance our networks and our infrastructure across the country. We have turned down I think more than 20 opportunities now. We just withdrew from one that we were looking at because it didn't quite fit for us and we felt the pricing was getting a little steep. So we are continuing to be disciplined but there are plenty of opportunities for us going forward. So you will see us continue to acquire one in the future.

Operator

Your next question comes from Joshua Raskin from Barclays. Your line is open.

Joshua Raskin - Barclays

Just quick question Larry, could you, I think you talked about the fourth quarter seasonality of days, is there going to be an impact there that reverses some of this, is that what you said?

Larry Cash

Yeah, what we pointed out that first, this is on a, first to see it’s on a Monday; first it’s on Tuesday (inaudible), Saturday and Sunday. You had a little less volume on Friday before the weekend little less volume on Monday afterwards. So it’s just going something I'm not sure people are aware of that it does maybe round a little bit. There is a little bit of opportunity to get back that day or loss this quarter but not if you lose that benefit now because of the way Christmas has move forward a couple of days. So December it could be down.

Joshua Raskin - Barclays

And then just on the surgeries I think you said 130 bps was the impact on surgeries in the quarter from having one less weekday and obviously that's probably much more impacted weekday versus weekend. But outside of that on the 2.8% same-store number, were there any other specific factors you can point to or anything else that you saw?

Larry Cash

The women services were still down and we had a few or less scope procedures also. We've been tracking hips and knees and they continue to look pretty good. We get some data from our sales and other people. They were up a couple of percent in the first quarter, and percent in the second quarter and up 5% or so in the third quarter so a big number. That's moved in the right direction. We didn't have, I would just add, we didn't have as much of an effect of Hurricane Isaac to get (inaudible) very, very few admissions and surgeries, about a $1 million in revenue, but fortunately the other thing I will just add was our case mix for our inpatient surgeries, [didn't] have it went up about 240 basis points compared with a year-to-date about 110. So what procedures we did have inpatient was a lot more intense procedures.

Joshua Raskin - Barclays

Okay, so the revenue number wasn't as big a decline as…

Larry Cash

That’s correct, Josh. Yes.

Operator

Your next question comes from A.J. Rice from UBS. Your line is open.

A.J. Rice - UBS

Couple of questions, first obviously on the physician recruitment number, that’s up 21% year-to-date versus prior year and then it flattened out last year. So, A, what's led to the re-acceleration if I am going to ask in physician recruitment and B, when do you see those recruits actually starting to impact your admissions numbers and your volume, overall volume numbers?

Larry Cash

If you look at it, we have people who joined our medical staff when some new do recruitment contracts. Our recruitment contract numbers are relatively flat. What we're seeing is lot of house based physicians and [ER] physicians and other specialists grow but the turnover state pretty good. So not every physician, admitting physicians always support and have the growth you got and then of course also we have a very good success of having the mid-level of nurse practitioners or some physician in systems. So everyone should think the cost is up, 50% you quoted. That’s going to necessarily drive a similar percentage of volume, somewhat replacing the physicians we lost, we probably lost 700 or 800 physicians so far and a lot of that growth was in house based and radiology etcetera. We are pretty happy where we are but I wouldn’t want to you to think it's going to be (inaudible) volume increase as you described.

A.J. Rice - UBS

Larry, you articulated a bunch of different refinancing activity and pushing maturities out. Can you just sort of give us a sense of where you are at over the next few years on your updated maturity schedule and then in the refinancing process, have you guys gained any more flexibility or are there any changes in terms that we should be aware of in either direction other than just the rates?

Larry Cash

Yeah, I think the best thing I would say is we started out with about a little $9 billion when we did a trial (inaudible) it was 14 and 15. We started at September 30 or November 2010 and started doing some of the term loans. So, now we got all at about $240 million of the July 2014 term loan extended out to January 2017 and we have pushed the bonds out from ‘15 to ’18 and ‘19 and ’20 and we also did a senior note of 2018. We gained a little bit more flexibility along the way.

We refreshed our basket; we have [bottom] for amount of stock back overtime. We have probably got close to $50 million flexibility now that we can do and we did not change a lot of returns. We do have the ability to do a spin off over small percentage of the company was (inaudible) the flexibilities we got to be something that would be interesting to do, but I think that the best opportunity was maturities now a much staggered out in the ‘16, ‘17, ‘18, ‘19 and ’20. We also did an AR securitization which is cheaper than the cheapest rate we have got. Hopefully, it would add to that going forward little bit so that was a good teacher.

Wayne Smith

And we are going to (inaudible) revolver size a little bit.

A.J. Rice - UBS

Okay. And then just last question your bad debt expense ratio was actually little better than we were looking for do you know as your administrative discounts ticked up, there is anything going on there that’s what you are highlighting or commenting on?

Larry Cash

Yeah, every couple of years, first of all some stage mandate discounts and that we have to follow that and every couple of years we look at our self pay discounts and we agreed in the second quarter, late in the second quarter to increase the discount throughout the company. We also had our way of recruiting outpatient for first [$300], it’s not subject now, all the self payout patients to substitute. So the discounts for and if you look at the uncompensated care that it is up about 170 basis points. I believe on both year-to-date and in the quarter. So while the bad debts were not uncompensated care kept up with the growth from the business.

Operator

Your next question comes from Frank Morgan from RBC Capital Markets. Your line is open.

Frank Morgan - RBC Capital Markets

Good morning, you talk about some adjustments for the fourth quarter given away the days fall out. But you also mentioned Isaac. So, what about sandy I mean I know you have a lot of hospitals in Pennsylvania. What are you seeing any impact there or should we be mentally prepared for any kind of impact going into the quarter or going into the fourth quarter related to that?

Wayne Smith

I don't think so. We have got about 21 or 22 or 23 hospitals in that area, all of which are operational, none of which had any significant damage. We had a couple of power outages but it really will depend on the population based in those areas and what happens around that population base. And I think we are probably removed from it that we will see, sort of business is usual in most to those markets but we are certainly available and we haven't lost anytime and haven’t closed in facilities over. So it’s a little hard to say right now but we could have a slight reduction based on the weather.

Larry Cash

To state with it Frank, we quantify what the Hurricane Isaac was, it wasn’t that big $7 million, we will keep accounting records and (inaudible) to be something we have to talk about. We will talk what it affects the city, it is the one of the better months of the quarter, it’s a very good month of October. So it came in a month where lot of our revenue and EBITDA was (inaudible).

Frank Morgan - RBC Capital Markets

But again, its early enough in the quarter to the extent there was a deferral, elective surgeries; still you have got plenty of time to get it back, right?

Wayne Smith

That's correct, yeah.

Frank Morgan - RBC Capital Markets

Okay, all right, and obviously it seems like with your adjusted admissions and your volume trends getting better here, working your way through that whole issue related to one day versus observation. But we’ve heard some people comment about making either clinical adjustments of care they deliver or maybe even contractual adjustments with regard to the issue of observations or any discussions, any thoughts on doing anything like that or is that something maybe you are already doing?

Wayne Smith

Well, I would, if we kind of go back to where we were and I think we talked about this in terms of us being very strong in terms of implementing inter quo and doing some outside reviews, I think we are in a pretty good position overall there. And I think some people are just now getting around to do the things that we did last year and I think that maybe one of the reasons we are seeing some stabilization.

Larry Cash

I think we did announced that we have enhanced our concurrent review program in the last several quarters to help us and our observations are still growing, but unfortunately we are not having to call out one day as a reason for admission changes.

Frank Morgan - RBC Capital Markets

Okay, one more and I will just hop off, you mentioned about the process being underway on the medical necessity related area, I am just curious, is there any details you can provide us or explain to us about how that process is going and what the timing is and is it pretty much what you expected it was going to be and any color you can add and I will hop off? Thanks.

Wayne Smith

Not really, you know it’s a long arduous process. Fortunately it’s a relatively small number of hospitals and it would be just work your way through this when all is said and done.

Larry Cash

And I think, so this is stage two and we still have a lot of work to do on stage one. You know we've got most of our hospitals now done from Medicaid, a small number done for Medicare stage one, so we've still got a lot to do.

Operator

The next question comes from Darren Lehrich from Deutsche Bank.

Darren Lehrich - Deutsche Bank

So I just wanted to go back to your comments Larry, just on the HITECH expense and the change in the guidance, I am wondering if you can help us think about what's led to some of that, is that just specific to this period or are you expecting as this continues to roll out that ratio between the income and the expense to be closer; just want to get some broad comments on what you are seeing change there?

Larry Cash

Yeah, I think we both increased the revenue side and the expense side, I think that’s 60 basis points and went to 80 now and it went to 80 to 90 and expenses went up from 0.3 to 0.5 and 0.4 to 0.6. So the expenses went up generally in line there. The low end looks a little bit differently. We are doing a more facilities; I think I mentioned we did some acquisitions. I think we also got a little bit of the, a lot of training work got done in the third quarter. I wouldn’t think that as expenses climb again in the fourth quarter they would be more in line where they were year-to-date for the fourth quarter and I think inside the guidance. We've got to do a little bit more than we thought we had done and we are doing a little bit more on physician side than we thought and so we are a little bit ahead on the revenue, but we are also spending more money.

Going into 2013 I think we said on the last call, that we would expect our HITECH reimbursement to be a little better next year; we will finish out, we were at $73 million here right now; we are going to be somewhere at $110 million to $120 million or thereabout for 2012 and I expect that number to be a little better for 2013. We have not done published work and I know Darren you published $650 million to $750 million opportunity for us for hospital and our physicians and you've done a lot of good math work on that and so we've got a lot of opportunities at HITECH reimbursement, but we've got a lot of capital spend that certainly will help us going forward, but I think with respect to spend a fair amount of hardware and software next year.

Darren Lehrich - Deutsche Bank

Yeah, and then just on that point, just, you know, 15 to 20, it sounds like, some of your larger hospitals, so how quickly will you start to turn the switch on with Cerner; on what timeline will this implementation be on in any kind of broad thoughts on the relationship with the capital commitment is and how would that means for future acquisitions and how Cerner might fit in?

Larry Cash

Cerner will be, we will probably used for future acquisitions. We still have a good relationship because it helped us. We got relationship with Healthcare Management System and also with other companies and Cerner will probably help us. So no real system we work with is already in one of the hospitals we acquire, but right now we're targeting 15 to 20 hospitals. I don't know if we're going to the specific segments of where capital is, but we do think it's a cost effective movement that allow to spend less money for those hospitals and then it should allow us to spend less money for acquisitions at least that’s our guidance right now. We're getting started on it. We met with them and….

Wayne Smith

The switch is on.

Larry Cash

Yeah, switch is on and Wayne just said it will be into it in 2013, it will be helpful for us and for our efforts to get meaningfully use and do acquisitions in ‘13 and ‘14.

Darren Lehrich - Deutsche Bank

Okay, that’s great and then I am sorry if I missed this in your comments, Wayne, but I guess, I just wanted to come back to your litigation update. What is the favorable ruling exactly in New Mexico and what exactly does it mean, maybe I just missed on how you frame that?

Wayne Smith

Well, the case is a baker case and you can go back and read the legal proceedings on that, but basically what has happened here is that the government did not provide or misplaced or did something with the some of the information that’s needed for us to defend the case and the court’s decided that it was problematic and after they sanctioned the government and levied fine which would reimburse us for our cost in terms of us trying to determine how to get that information I guess is best way to say.

Larry Cash

And I may have misunderstood Franks question a while ago, I probably just talked about our efforts to put in 120 standardized sets and so I answered the question more about HITECH in stage 2 implementation. So I misunderstood his question, so I volunteer for this information on a different answer that was asked.

Wayne Smith

And I wouldn’t want to mischaracterize this as a positive or negative it’s just part of the process.

Darren Lehrich - Deutsche Bank

Understood and just the financial benefit that you get from the ruling when we will see that…

Larry Cash

It’s just the cost of doing business just a cost I mean that’s not enough money to even talk about very much it’s just kind of case.

Operator

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

Whit Mayo - Robert Baird

Larry it looks like you’ve have got about 90% of your debt fixed now which is pretty high relative to your peers and where you have been, immediately you do have some swaps rolling off. How are you thinking about managing that fixed versus variable rate exposure in this environment.

Larry Cash

We had about 1.7 billion roll off in ‘12 and we like most of the (inaudible) variable rate debt close to 1.6 billion that we did pay that down. You got a 1.1 billion floating off in 2013 and I think as we see today in looking at what happening you probably will know that. So we just have to watch and see where interest rates are going. I believe that (inaudible) that rate we just spread out in our various disclosure what the average interest rate is. So we probably something will not happen, some of released in 2013 and like we got little bit flown off in the fourth quarter we probably $400 million or so, we probably let that go flowing.

Whit Mayo - Robert Baird

Okay. So no intension on re-swapping any of those swaps as they roll for now?

Larry Cash

Yeah we’ll watch it and you will see interest looks like they are going to stay low as long as they continue to look like they’d stay low. We may left the 88% for down, we got down on the 70s, and we are confident with that level and I think that's how we probably look at the future swaps.

Whit Mayo - Robert Baird

Got it, makes sense. Maybe if you can just comment briefly on some of the recent acquisitions Tomball and Moses Taylor. Just curious how those are progressing now and if there are EBITDA additive at this point. Any commentary around the sequential improvement?

Larry Cash

Yeah, if you look at the hospitals that we had in non-same store. The margin was about 6% in the quarter and probably about 4% for the hospitals, we had a year ago. So that's better and were probably about 4% or 5% year-to-date. So the (inaudible) the better. Moses Taylor got a little bit better, Tomball is doing good, it’s still got some opportunity. I think they are all getting better now. There is a lot of categories of expenses in our non-same store acquisition and legal cost and daily reserves and other accounting adjustment therapy. But the pure financial statements are the hospitals for the most part got better than third quarter versus the first half of the year, and I think it they will continue to get better looking at projections, that we expect and have and achieved for the year. I think if you look at it we got about 12 or 13 hospitals, about 1.3 billion, 1.4 billion of revenue, still on single digit margin should have us in 2013 and we get in 14 as we manage those and hopefully and get a couple of 100 basis points improvement in ’13 of those maybe a little bit more.

Whit Mayo - Robert Baird

Got it. Looking at your other operating expenses, the number was down and I know you didn't have a lot of provider fee programs helping you this quarter. But just any other accrual items to talk about that could potentially be influencing that number.

Larry Cash

Yeah, the biggest change would be the provider tax change there that as you may remember the new programs in North Carolina, West Virginia, California, approvement in to Indiana in the provider tax numbers lowered its malpractice expenses are higher in the quarter and higher a year ago. Today I think that the provider tax expense is probably close to $40 million lower in the third quarter versus the second quarter.

Whit Mayo - Robert Baird

Okay. Finally Wayne any update on Birmingham and the CON battle there just to note there's any…

Wayne Smith

Yeah, we had a hearing on the 23 at the Circuit Court level and we are waiting for a ruling now and if we get a favorable ruling there then the question will be whether the State Supreme Court would hear the case or not, I wouldn't speculate about that. But I think we are making good progress, and we will ultimately prevail and get that done. I'm hopeful that we will be, even if it does go to the State’s Supreme Court it would be somewhere around the first of the year that we would know one way or the other. And if we don't hear it then it will be over with whatever the Circuit Court rules. So we are encouraged and excited about the opportunity in Birmingham and I think we are making good progress.

Whit Mayo - Robert Baird

Okay, so best case maybe early 2013.

Wayne Smith

Yes. To get approval and then there will another two years after that before we get it done.

Whit Mayo - Robert Baird

Got it. But in terms of the actual construction beginning or rebegining.

Wayne Smith

Yeah some time around first of the year.

Whit Mayo - Robert Baird

And one last one is any other replacement projects on the white board at this point in time or is - and maybe if you could only comment on the ones that have opened or will open soon.

Larry Cash

Yeah New York is the one that we bought on July 1, I think we got a four to five year commitment to do that and that will start sometime likely in the ’13 or ’14. We've already got the land so that went about with the land. That's only one that's unapproved for Board, approved by now by the Board.

Operator

The next question comes from Gary Taylor from Citigroup.

Gary Taylor - Citigroup

Couple of questions. Most have been answered. I just want to go back to given that we are hearing a little more from some of your competitors about [RAC] and so forth. I didn't have a chance to go back and look at that slide show from about 18 months ago where you had walked through your RAC experience thus far. But I thought I would just circumvent that and just ask you how many states that you operate in have you actually seen RAC activity, I believe it is a national program now but not every state has seen these guys come in. So is there an easy answer to that question.

Larry Cash

I believe it’s in most situations now. I think there's a pre-review program that just got started. But most of our facilities, there might be some of the smaller and [critical access] hospitals that haven't got it and maybe a couple of other small ones. But I think most were there. So (inaudible) and I presume your question we get to be or we haven't got an increase in [denial] expense. As some people have said, but the answer to that question is yes the quarter is up over the last quarter. It's up over year-to-date. If you look at it on a percentage of total revenue, it's about 20 basis points affect year-over-year, also the quarter it’s probably that 10 or 15 basis points versus the second quarter. It's a cost driven business. We worked hard at it. We would have put a lot programs in, we got a centralized unit in it. We've done a lot, training, a lot of newsletters, lot of efforts to try to make sure we do things right but we're seeing an increase in [rack] now since built in our operating assumptions and the 20 basis points is probably, it might be a little bit more we thought it would be but probably finish up that year, finish up the year by that much.

Wayne Smith

Gary, the rack work is just another operating issue for all of us now. And so as I said, I think it's just part of doing business and we're going to live with this for a long time to come and it's an operating issue that we have to learn how to make sure we're doing the right things and hopefully enhance and improve our documentation so that we have a less denials since it is just part of doing business of staying there.

Gary Taylor - Citigroup

Second question is on the one day stays and observation, I guess, kind of being the first to go through that in a major way and I know at one point Wayne you had characterized this, you probably overreact to that I mean, that [had] been the exact word you used it at first but now that we're six quarters past, seeing some of that very intense pressure on your one day stays and you potentially (inaudible) that with very normal looking patient volume metrics at this point, is your experience that there was kind of an overreaction and some of that actually came back towards you within patient stays or is your experience really just that it went out, it went away and we have just simply (inaudible).

Wayne Smith

I think we developed process which included a number of changes and enhancements to our documentation and our reviews all that process I think we did overreact. I think we were very strong in terms of our reaction because as you recall we were accused of lot of things and we want to make sure that none of that existed here. So I think it’s like anything else in terms of the way we think about managing this business is that we analyze a problem and then we do what we think is the right thing to do to solve the problem I think we a little ahead of the curve as far as everyone else is concerned and we feel pretty comfortable about the fact that we are getting good reviews of all of our admissions now to make sure that everything is appropriate and because we do have enhanced review with [racks] and everybody else. So, I don’t think anybody in this industry was doing anything inappropriate. I think this is just a matter of judgment and physician documentation was also.

Larry Cash

And I think matter of fact, we have not had the same thing about it. A lot of people may have still haven’t growth and we did overshoot a little bit and may be benefited to not having to talk about it. Probably, technology, rack reviews, change of practice a lot more outpatient will call us the one day in 2013 and ‘14 and go down slightly. Fortunately you will get the outpatient business and you will be able to benefit from that.

Gary Taylor - Citigroup

Last question are you guys voting for next Tuesday?

Wayne Smith

That’s a good question Gary and you know you tell me who you are voting for and I will tell you who I am voting for.

Larry Cash

I won’t vote next Tuesday I have already voted.

Wayne Smith

We are [not] really voters we have already voted, I would tell you this and I would, even though I went perhaps certainly wouldn’t make prediction on the election, but it’s so close, if it is a Romney win, you are going to test our ability to continue productivity and develop new strategies around reductions and cost product and how we can better deliver it, our care at a lesser cost. If the President Obama, as we elected, we will be working more on the revenue side, I think than we will on the cost side, we will continue to do that. So I think the strategies for the industry will change once we know who is going to be the new president.

Operator

And your final question for the day comes from Kevin Fischbeck from Bank of America Merrill Lynch. Your line is open.

Unidentified Analyst

Good morning, actually this is Joan (inaudible) sitting in for Kevin today. Thanks for taking the question.

Wayne Smith

Sorry we can't hear you, could you speak up, please.

Unidentified Analyst

Can you hear me now?

Wayne Smith

Yes, thank you.

Unidentified Analyst

Most of the questions were asked but thanks for taking my question. I just want to confirm on the HITECH outlook, it looks like the revenues and cost the outlook is the point of this items is higher, so does it mean that the (inaudible) already going to change in profits from HITECH in your outlook?

Larry Cash

Well, in the high end went up 10 basis points on revenue and its offering consensus 110 basis points and really depreciation state about the same. So it shouldn’t have that big impact on it. On the lower end it went up 20 basis points on the revenue and 10 basis points, so it might be a small benefit but it’s up to low end hopefully we will work hard and our intend to get as much revenue and as much of work done as we can. Hopefully we will come out at the high end.

Unidentified Analyst

And then on just clarification on your volumes commentary, there's definitely some improvement there versus first half of the year and like you said, you feel like all volumes are stable now so can you now call it, you have future turning point in your markets in general on volumes?

Larry Cash

Well, our guidance is on adjusted admissions, its 0.5% to negative 1.5% and I think we are at 1.1% I believe on a year-to-date basis. And I think 1.3% and so we are near to high end of the guidance right now and I would hope that we continue to stay at the high end of the guidance on adjusted admissions basis.

Operator

That is all the questions I have in queue. Mr. Smith, I turn the call back over to you for closing remarks.

Wayne Smith

Thank you for spending time with us this morning. Again, our thoughts and concerns are with all of you, all here in the north east. Our consistent ability to drive revenue and achieve cost efficiencies in this environment to demonstrate solid execution of our centralized operating platform and I want to specifically thank our management team and staff, hospital chief executive officers, also chief financial officers, chief nursing officers and division operators for their excellent operating performance for the third quarter. We remain focused on our business strategy and improving results. Once again, if you any questions you can reach us at 615-465-7000.

Operator

This concludes today's conference call. You may now disconnect.

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