Community Health Systems Inc (CYH) 2012 Q2 法說會逐字稿

Good morning. My name is Candace, and I will be your conference operator today. At this time, I would like to welcome everyone to the Community Health Systems second quarter ending June 30, 2012, conference call. 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. Ms. Lib Schuler, Vice President of Investor Relations, you may begin your call.

Thank you, Candace. Good morning and welcome to Community Health Systems' second-quarter conference call. Before we begin the call, I would like to read the following disclosure statement.

This presentation contains forward-looking statements, including all statements that do not relate solely to historical or current facts. These forward-looking statements are subject to a number of known and unknown uncertainties and risks, which are described in heading 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-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.

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

For those of you listening to the live broadcast of this conference call on the web, a slide presentation accompanies our remarks. I would like to begin the call with some comments about the quarter, then turn it over to Larry, who will follow with additional detail of our financial results. Community Health Systems has delivered another quarter of solid financial operating results. The results are in spite of the continuing weakness in inpatient volume and challenges in the economy.

Net operating revenue for the quarter ended June 30, 2012, totaled $3.2 billion, compared to $3 billion for the same period last year, an increase of 8.1%. Consolidated EBITDA increased 4.9 -- 4.5% from $483 million to $462 million. Earnings per share from continuing operations was $0.93, versus $0.81 per share for the same period a year ago, an increase of 14.8%.

Net operating revenue for the six months ended June 30, 2011, was $6.5 billion and EBITDA was $1 billion, including certain unusual items. Earnings per share for the six months ended June 30, 2012, was $1.79, compared to $1.62 for the same period a year ago, an increase of over 10%.

With that, I would like to recap a few of the significant accomplishments for the quarter. The Company recruited 855 new physicians for the first six months of the year. This compares to 658 physicians recruited in the same period a year ago. Additionally, we have added 39 mid-level practitioners during the first six months of this year. Physician recruiting remains a very strong component of our operating strategy.

Our acquisition process has been very robust this year. We have acquired four facilities with trailing revenue of over $550 million. Our acquisition of assets in Memorial Hospital in New York -- in York, Pennsylvania, was completed on July 1, 2012. The assets include a 110-bed hospital, as well as other outpatient ancillary services. The price for the fixed assets was $45 million or 40% of trailing revenue of $115 million. The hospital's trailing margins, low single digits.

We have agreed to replace -- a replacement hospital will not start construction for several years. This is our seventeenth hospital in Pennsylvania. The seller has disclosed a letter of intent for a two-hospital system, with hospital located in Wheeling, West Virginia, and Martins Ferry, Ohio. This system has total of 636 licensed beds and trailing revenue of approximately $170 million. We continue to look for strategic opportunities and have a very strong and active pipeline.

As I mentioned last quarter, our safety patient organization has completed phase 1 of our high-reliability safety plan. We have initiated evidence-based order set standardization. This standardization will help us prepare for stage 2 of meaningful use, computerized physician order entry requirements.

The Company has updated the guidance provided in the first-quarter earnings release. We have increased the low end of our EBITDA by $5 million to $1.975 billion. We have also increased the low end of our 2012 EPS to 390 from 380 -- from $3.90 -- to $3.90 from $3.85. The high end of the range remains the same, and our 2012 EPS guidance ranges from $3.90 to $4.10.

I have little in the way of updates on pending litigation and investigation from what was discussed in April. In New Mexico qui tam case, both sides have fully briefed their motions for summary judgement. We are awaiting further scheduling from the District Court.

As to the group of investigations that involve medical necessity of inpatient admissions, we continue to cooperate by providing documents and making witnesses available, as well as participating in meetings with the government to discuss the cases.

We had hoped to be in the process on a probe audit we described in April, a third-party review of a sample of medical records at a small number of our hospitals. That review has not begun yet. We hope that review will begin soon and hopefully be underway by the time our next quarterly -- for our next quarterly update.

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

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

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

Thank you, Wayne. The second quarter of 2012 admissions increased 3% compared to the same period last year. Adjusted admissions, which factors in outpatient business, increased 5.7% for the same store. Admissions decreased 2% compared to second quarter of 2011 and a sequential improvement of 100 basis points from the first quarter of 2012. Unadjusted for Leap Day, they would have been down 3%.

We continued to see softer fluid respiratory-related volume during the quarter. Several items contributed to the Company's decrease, a lack of flu in respiratory,110 basis points, and lower admissions from women's services, that includes OB and GYN, were 50 basis points. Same-store adjusted admissions increased 0.5% for the quarter. The decline from the first quarter's due primarily to a decrease in both Medicare and self-pay adjusted admissions. The second quarter good outpatient equivalent admissions growth of 3.1%.

Net revenues in the second quarter increased 8.1% from $3.1 billion last year to $3.243 billion. On a same-store basis, net revenue increased 4.5% for the quarter. Physician practice growth continues to help contribute to the outpatient growth. Same-store surgery volume especially flat for the second quarter. There were three categories, cardiology, endoscopy, and skin, that accounted for 80% of decline from the strong first quarter in surgery growth. All these are up in the second quarter but in a slower rate of growth compared to the first quarter.

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

For the second quarter, same-store net revenue per adjusted admission increased 3.9% versus the same period in 2011, with a sequential increase of 3%. Our same-store Medicare case books increased to 0.5% versus last year at 0.6% sequentially. Consolidated EBITDA was $483 million for the second quarter versus $462 million for the same period a year ago, an increase of 4.5%. On a same-store basis, it was $490 million for the second quarter, an increase of 3.9%.

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

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

On a year-to-date basis, consolidated admissions increased 3.1%, and adjusted admissions increased 6.9%. Same-store admissions decreased 2.2%, and contributing to that was, again, the lack of flu in respiratory, 140 basis points, and lower admissions for women's services, 40 basis points. Same-store adjusted admissions 1.5%, and outpatient adjusted admissions increased a strong 5.5%.

Consolidated net revenue year to date was $6.5 billion, an increase of 9.8%. And our consolidated net revenue is affected by the B&A settlement and SSI recalculation that we discussed in the first quarter. On a same-store basis, net revenue increased 4.4% for the first six months. On a consolidated basis, net revenue per adjusted admission increased 2.8% and also increased 2.8% on a same-store basis.

Same-store surgeries increased 1.4%, with noted marked increases in cardiovascular, orthopedics, and oscopy procedures. Our same-store Medicare case mix for the six months ended June 30, 2012 was 0.6%. Consolidated EBITDA was $1.19 billion for the six months ended June 30, 2012. On a same-store basis, EBITDA was 3.7%. Same-store margin for the six months ended June 30 was also 15.6%, a decrease of 10 basis points compared to the same period in 2011.

For the first six months, consolidated operating expenses as a percentage of net revenue decreased 20 basis points from the prior year. The 80 basis points increased under operating results, offset by the increase in payroll and supplies, as well as the high-tech incentives, improvements in payroll and supplies. Same-store operating expenses increased by 10 basis points on a year-to-date basis.

We did see productivity of approximately 1% in payroll and supplies. Each improved 10 basis points on a year-to-date basis, and provider taxes increased about 90 basis points. Total A/R days were 58 at June 30, 2012, calculated with the net revenue less bad debt, an increase of 2 days from the end of 2011. Second-quarter A/R days were up four from the same quarter a year ago. The allowance for doubtful accounts was $2.105 billion or 50.5% at June 30, 2012. The allowance for doubtful accounts related to self-pay was approximately 84% of self-pay receivables.

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

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

Cash flow from operations was $295 million for the quarter. On a year-to-date basis, cash flow from operations was $483 million versus $585 million for 2011. The decrease is primarily due to the four-day increase in accounts receivable. About $40 million was due from the receivable growth from the three facilities acquired in 2012, about $35 million from the increase in Illinois Medicaid, and receivable related to the new Indiana Medicaid provider tax program, about $30 million.

Additionally, about $25 million in interest payments were made in the second quarter versus the third quarter [on debt due] 2019. As it relates to our overall use of cash, for the first six months, we have spent approximately $50 million for IT investments for 20 hospitals. Meaningful use incentives will begin in 2013, due to the accounting recognition that took place recently. Our cash flow guidance remains $1.2 billion to 1.3 billion. We have already received cash receipts for about 50% of the increases I described above on the receivables as of yesterday.

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

Balance sheet cash at June 30 was $115 million. At the end of the quarter, the Company had available credit from the revolver of $710 million after outstanding letters of credit. Looking at the balance sheet as of June 30, 2012, we had $1.98 billion in working capital and $15.9 billion in total assets. Total outstanding debt at June 30, 2012, was $9.325 billion, of which approximately 73% is fixed. Our debt to capitalization at quarter end was approximately 79%.

At the end of the quarter, we were party to a $3.75 billion in interest rate swaps, a decrease of $400 million from the end of the first quarter. Subsequent to the close of the quarter, the Company tendered a remaining $934 million balance for [7.8%] bonds maturing in 2015. We issued a $1.2 billion in new debt with 7.125% coupon due in 2020, both lowering the coupon and extending the maturity.

I would like to highlight a couple of items now. As Wayne stated, we increased the low end of EBITDA by $5 million EPS, $0.05. We would anticipate that our high-tech incentives would be down in the third quarter by approximately 50% compared to the third quarter of 2011. The EPS effect from this decrease would be approximately $0.12 in the third quarter of 2012. We lowered the high end of our CapEx guidance by approximately $50 million, and we also increased acquisition costs from $0.05 to $0.07 in the quarter from $0.04 to $0.06.

I would like to go back and say, in the first part, remember that our Medicaid revenue reductions were about 8% in 2011, maybe somewhere 2% to 3% in 2012. Obtaining two- to three-year Medicare tax provider tax programs will improve our Medicaid revenue. Medicaid provider tax programs that exist for two to three years often receive final approval after the effective date but are appropriately recognized as revenue when approvals become known and collection is deemed reasonable.

For 2012, the two significant states, Indiana, which has a two-year program through June 2013, and California, will have approximately 10 basis points of revenue and 7 basis point of expense in the first six months of 2012, compared to a projected 8 basis points of revenue and 5 basis points of expense in the second half of 2012. The Indiana benefit of EBITDA recognized in 2012 once it's approved that relates to 2011 was approximately $5 million.

For comparison purposes, we had Pennsylvania tax program EBITDA recognized in 2011 with a benefit of $4 million that relates to 2010, and the Pennsylvania program is still in existence in 2012. Also I want everyone to please note that the third quarter is unusually seasonally lower than any of the other four quarters. And Wayne will now provide a brief recap.

Thanks, Larry. We are pleased with our strong second-quarter performance and believe the prospects for continued growth are very favorable in light of the recent decisions surrounding healthcare reform. We are well-positioned to leverage these industry dynamics as the leading operator of hospitals in non-urban and mid-sized markets throughout the country. At this point, I will now open the call for questions.

(Operator Instructions). Your first question comes from Whit Mayo with Robert Baird. Your line is open.

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

West Virginia and North Carolina are relatively small. Indiana is the large one. Indiana will probably be $12 million to $14 million in the second quarter, which we would recognize as about $5 million applying to 2011. It was approved in the second quarter. It runs through June of 2013, that's the EBITDA benefit. Probably the revenue and expense that would apply to 2011 would probably be about $30 million of revenue and $25 million in expense, in addition to the provider tax programs and dish money was cut that would apply back to 2011.

What we were trying to say, it seems like there is some confusion about provider tax programs thinking they're a one-time payment. They are not. Indiana was approved, and then California was approved partially in 2012 in the second quarter. We tried to put what the revenue was in the second quarter and the expense, which the net difference would be your EBITDA benefit. For those two states which are the largest, Indiana and California, have about 10 basis points of revenue and 7 basis points expense in the first six months of 2012.

And the question we think people have is, how is the run rate of that affected going forward? And so we decided to put in what we project will happen in the next six months of 2012 so people will get comfortable that what they are looking at in EBITDA for the first six months of 2012 will probably -- likely repeat itself in the second six months of 2012. The revenue for these programs is probably about a little less than revenue, about 8 basis points of revenue in the second half of 2012, and the expense will be about 5 basis points, both differences being about 3 basis points of revenue. So the EBITDA contribution in the first half of '12 for Indiana and California will be pretty much about the same as the second half of 2012.

So the concern of the fact that the second quarter of 2012 is not a good representation of where earnings will be, is not correct when you look at Indiana and California. Indiana was approved and will continue all the way through June of 2013. And California, which was approved from the peak of service component, and there's another [manuscript] component that we believe will be proved in either the third or fourth quarter that will occur and they will run, I think, until 2013, I believe. It's a two-year program, I think. Or it could be, excuse me, June of 2013.

So we are trying just to put a flavor of what is happening now for the first six months and what is going to happen in the next six months. And we're also trying to disclose how much Indiana may apply to '11, which is about $5 million, approximately, similar to what happened in Pennsylvania last year. We had about a $4 million benefit in the first half of '11 which applied to 2010. These programs are approved. They are approved retroactive, and it's difficult to -- you can't recognize until it's done. When it happens -- we generally have said we have got a new provider tax program, and as long as it's going to continue, which most of all have to my knowledge, we never had a provider tax program totally be eliminated. It could happen in the future, but they are just a new way that the states are paying for Medicaid.

Larry, you certainly included this in our guidance.

It was in our guidance. It was in our internal budgets, and we have been telling people that -- could be around a 3% reduction, could be a 2%. One of the reasons for that is the new provider tax programs. And I think we've said that the two bigger ones this year are Indiana and California.

No, I think you have been pretty clear on that. I guess the other question, if you could spend a second on the cash flow, obviously a little weak. You named a couple items in your prepared remarks that help reconcile, but a little bit more color and guidance, because it certainly appears that there needs to be a nice little acceleration in the back half of the year. I don't think you really had any high-tech cash come in the door. Your bond payments may have moved from one quarter to the other. So spend a second reconciling that for us would be helpful.

For the first six months, it's down about $100 million. I think the receivables are up more than that. They are up about $112 million or so. We tried to name the Medicaid in Illinois, which is still there. I think it's $35 million. It's down a few million from the first quarter, but it's still there. The Indiana provider tax is about $30 million, which we've since received that money there. The other one was about $40 million, for some A/R tied to acquisitions.

The only acquisition of any size here is the York, and we'll probably have a little choppiness in receivables on it. It is a lot smaller than what we acquired in the first half of the year. There you had about $350 million to $400 million of revenue being acquired here. York is about. 25 of that size. We shouldn't have quite as big a challenge there. We are up $109 million on receivables. We collected $55 million of that yesterday, a very small amount in Illinois Medicaid, all of Indiana Medicaid provider tax, and all of the -- fair amount of the money is coming on acquisitions. The other thing was we moved our interest payment to the second quarter (inaudible) from the third quarter. That's a net about a $25 million hit actually in the quarter itself, so it's about a $60 million effect. But in the year to date, it's about a $25 million effect.

Those are the primary items there. There was a few other minor items, but those are the ones that reconciled the most. The reason we are comfortable about the cash flow guidance, there shouldn't be any outstanding provider tax programs we think at the end of the year. I would hope California gets done in the third quarter. The other thing was, we have had about $35 million of high-tech revenue that is still not received, and generally most of the high-tech would be recognized as we go along. Hopefully, we'll collect some of that, although we could replace it with some more receivables by the end of the year. Those are the primary reconciling items.

Okay. All right. Thanks a lot. I appreciate it.

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

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

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

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

Is there anything when you acquire the hospitals as it relates to high-tech payments? Have these hospitals already started the process of trying to meet meaningful use and try to recognize some of these dollars? Or is that something that you typically end up having to do once you get in there? And I will hop off, thanks.

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

Okay, thanks.

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

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

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

We're also continuing to see growth in observations, they are still growing 8% to 10%. That is still moving up about where you would expect it to be. I think from an admission perspective, the flu, which on a year-to-date basis is still down, and the OB-GYN, we had a couple of months there where the women in OB got a little better. Of course, it's a pretty high percentage of our business. That's about 14% of our admissions, and flu and respiratory is about 12%. And I think that's one reason why the non-urban hospitals have a higher percent. Those are at least -- one can be delayed or put off, and others, the ones you can possibly treat on an outpatient basis, or try to, from a flu and respiratory perspective.

I think we are getting better. We do have easier comps after what happened last year, so it's continuing to get better. I think our guidance negative 0.5 to positive 1.5, and we're pretty comfortable with where we are on a year-to-date basis there. We don't have specific admissions guidance, but I would expect it to have opportunity to get a little bit better. There's a very good physician recruitment which Wayne described in the first half of the year. We are continuing to work well with our core positions to try to do that, working on a various amount of elements to try to continue to improve it. But as we said earlier, it's a pretty tough economy. But I would think our volume metrics will continue to get a little bit better throughout the next -- second half of the year.

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

Sure. On the first issue, in terms of the probe study, there is nothing more to that than it's just the government works at their own pace, which nothing other has happened. There's been no other real issues. We are working cooperatively, and as we say, it's a relatively small number of hospitals. We would hope that that would get started very soon, in the next couple of months, and that it would go -- the process would go pretty quickly. So, there is no change. There is no bad news around that.

As it relates to the 60 Minute discussion that our friends in south Florida have been talking about, here is what I know. Last year, just right after the Tenet lawsuit which everybody knows was dismissed, we learned that 60 Minutes -- a producer was conducting some research about the same issues that were in the Tenet lawsuit. Nothing has come of that. We don't know any more than that. So until this started coming out again with HMA, we didn't know any more than that. I would say, though, I'm not the one that is going to predict what 60 Minutes is going to do or not do. They do whatever they're going to do. So, I don't have a clue. I can just tell you that the only time we heard any inquiry around us in terms of the research around us was around the Tenet lawsuit.

Okay. All right. Thanks a lot.

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

Thanks. Good morning. Larry, can you talk about the uptick in the bad debt, what's driving that between the uninsured or even out of pocket, and your comfort level with trends into the second half of the year?

Yes. The adjusted admissions were not quite as strong in the first quarter as the second quarter. Revenue was a little bit smaller percent, 13%, versus probably 13.4%, that may help a little bit going forward. But we do raise charges, which self-pay get a percentage of that, and that is partly accounting for some of our growth in bad debt. We have also had a little bit more emergency room use, especially, I would say, as self-pay can't find a place to go, they often go to the emergency room, we have some low-acuity visits there, which is probably up a little bit. It will cause bad debts to go up, because we haven't collected on much of that. The growth of the insurance, coinsurance and deductible has partly contributed and is part of the growth in rates. But we were ahead of it a year ago right now.

We don't have a specific bad debts guidance out there. We, in our own internal work, we don't anticipate it getting a lot better. We are doing some work in our collection company which does a pretty good job there trying to add some more resources, some more talent to it, and more speed or recovery. Get a lot of placements come in. Placements are down a little bit. Just think about where it would go, we generally don't ever predict a great reduction of bad debts. If the economy gets better and more people get insurance, it may happen, but probably for the next six months, bad debts will continue to be at a level pretty much where they are now, or maybe slightly better.

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

It's probably up a little bit more in the second. In the first six months, might have been 10% or so. I think what we would have done is if we don't have to talk about one-day stage, which means they are not creating one of the trends that we have to talk about, and so far this year, there's not been a negative trend or a positive trend that amounts to anything. They are small enough that we don't think it necessary to discuss it, which means that one-day stage are not a percentage of reconciling. I was trying to talk about adjusted admissions and the outpatient revenue and observation (inaudible) about what has grown.

Okay. Then my last one on the Medicaid side, you had talked about the minus two to three. Any preliminary thoughts, if you have any, on 2013? And then to further than, any just general thoughts on Medicaid expansion, your specific portfolio in your states post the Supreme Court ruling?

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

2013, just a couple of comments. Looking today, I think we have about three states that we could see a cut that will take place either in July or August. I think if I had to remember last year it was eight to 10 states that were going to have a little bit of a cut or had a recent cut, Illinois being one of them. Illinois is working to get an enhanced provider tax program and again, make sure people understand provider tax programs are a good thing. They give you Medicaid revenue and help the earnings and help offset cuts. So, we had a provider tax program in Illinois, which is, other than the fact that the state is not paying us right now for our business, we continue to have that, I believe, over five years.

Florida is about a 5.6% cut. It will cost us probably $700,000 over the next half a year. We've only got a couple of hospitals, and Louisiana has got a 3% to 4% cut in August, which is fairly small for us also. So I would say that at least what we know today, the second half of the year looks better than it did a year ago. And that would say that 2013 should look better than 2012 would. I would expect the programs that we have, these provider tax programs will all continue. They all generally continue and they provide good additions on Medicaid, which is a relatively lower payer, and that's why you are you allowed to get the type of Medicaid type of provider tax programs through CMS.

Okay. Great. Thanks, guys.

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

Okay. Thank you. Can you talk about the same-store margins in more detail? We're used to you guys seeing improvements in the margin year over year. Can you talk a little bit about what was going on there for the numbers, down in a little more detail? Is it purely a situation of the provider tax number? Outside of that it would have been up?

Provider tax is usually set off by provider tax revenue in most all cases. There is more revenue than there is tax. I would say that same-store -- our same-store bad debts, although it's on the -- it's probably up 70 basis points. That's probably hurt us a little bit. And then we also continue to employ physicians, and employment of physicians helps grow EBITDA, but it's a pretty challenge on EBITDA margins. So that perspective probably will continue, and so margins may not move up as much as long as you employ physicians.

The second thing in the quarter was supplies were relatively flat on same-store. I think that is the first time I've had to say that for quite a while. We are very comfortable that our Chief Purchases Officer will work on and our other people that work on there, the drugs were up a bit in the first quarter -- excuse me, second quarter. I think we will see some supply improvements in the second half of the year that we didn't see in the first half of the year. Payroll was managed really well in the first -- last quarter on a year-to-date basis, about 10 basis points. Both the quarter and the year to date are up -- are down about 10 basis points and bad debts in both situations. I think the year to date is up 80 to 90 basis points, and the quarter is up about 70. So that is what is probably hurting the margin, along with the growth of employed physicians, which makes it a challenge to keep your margins up.

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

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

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

I don't know. It really is tied to the unemployment rate, I think. When it's all said and done, it's an economy issue. And as long as you have 8% unemployment, I'm not sure that the volume is going to get much better. We went through this period where commercial enrollment was actually rising and then I think it has flattened out now. Until that starts again, I know the jobs numbers are there -- a little bit better, but I think that is the metric that will help us in terms of volume in the short term.

Clearly, on the longer term, in terms of health care reform, there is volume, both from the Medicare recipient and the Medicaid and the people who are uninsured. But right now, I think it really is based on the economy. We are seeing good volume on the outpatient. It's the inpatient now that is a little slower. So for us, I think we have identified our issues and I think we are back on track. I think our volume should continue to get a little better as time goes along, but not dramatically because of the fact that the economy is weak.

One of the good things, while we don't give individual statistics for every payer, I think recently we've given some direction why we are up 0.5% for adjusted admissions to managed care area. It's better than that. It's the best of the four categories and similar year to date our best growth in adjusted admissions is managed care and elders, which is encouraging that we're doing a good job. Most of that is outpatient. Of course, our self-pay admissions -- inpatient admissions have been dropping, at least on a year-to-date basis, worst than the Company average, but the adjusted admissions are growing a little bit. And I would clarify one thing. I think there was some comment, maybe confusion about managed care companies working for doctors and paying doctors differently for putting people in observation versus being admitted. That is generally, as I understand it -- Wayne and I have both been in managed care for several years, that is generally tied around managed care companies that may have a risk pool set up where doctors share in some of the savings. And I think your general fee for service doctors, which a lot of our case situations are affected by that type of activity, it's more around like Medicare advantage, HMOs or commercial HMOs, which there's more of that in Florida area than you'll generally find in our markets.

Okay. Great. That's helpful. Thanks.

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

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

I think it's a little more than 40 for the quarter, because year to date was 40.

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

Might have been 50 or 60.

Okay.

Generally, Gary, just to elaborate on that, you always start out the year -- what we do is start out the year a little higher, then you evaluate your claims coming in and get your payments and see how many claims are coming and how the settlements are taking place, and you get an actual report in the middle of the year. We got -- with that information we decided that we were probably a little overaccrued, and so we brought it down and we are disclosing it.

Typically, you said you'd do that in the third quarter, and this time, you did it in the second quarter because you had the information center?

We saw the activity and were pretty comfortable where our reserves were. And our reserves are continuing to climb, and they are still above where they were last year and are still above where they were at the end of the year. Last year, I think we had adjustment, and we may have had one in both the third and the fourth.

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

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

Okay. Great. Thanks for your thoughts.

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

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

We clearly have gotten probably 90% of our contracts completed for 2012, and we are well over 50% for 2013. There is not a lot of -- there is some pay for performance, but when you look at the level of dollars tied to it, it's still relatively small compared to overall managed care activity. And it is probably going to continue to grow. It's almost a small enough number it's not worth mentioning, but it will probably grow.

We don't have a lot of risk capitation. I would say it's probably in less than five markets, and it's a small percentage. It could be something that would grow if we got about 5% or 6% of our revenues in Medicare advantage. Most is in some form of fee for service arrangement there. Probably where we do have some risk sharing is in California, and that's where a lot of it would exist. But we are not in south Florida. We are not in Tampa. We are not in Las Vegas. We are not in New York and other big areas where you have a lot of your sharing-type contracts. But that could be something that we are willing to do, especially on commercial and we can work through it, but as yet, we haven't had that much, and we are still getting the 5% to 7%.

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

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

Okay. Great. Thanks for the color. And then, a quick housekeeping one, Larry. On the cash flow statement on the increase in other investments, I think it's a use of $162 million this year versus $75 million last year. Is that where you booked the high-tech investments?

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

Okay. Great. Thanks.

Your next question comes from Chris Rigg with Susquehanna. Your line is open.

Thanks for taking my question. You guys were pretty clear, but I just want to confirm. The guidance this year did not include -- or it did include the provider tax benefit that you guys received in the quarter and what you expect for the back half of the year, correct?

The guidance did include the Medicaid provider tax programs.

That would be an affirmative.

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

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

Well, I think the earnings increase, we raised the guidance $0.05. We raised EBITDA $5 million. We beat both the first quarter consensus, and we changed it a little bit then. And we also added a B&A, just so it would be tied to reported. And I think we had EBITDA in the first quarter, and then we also beat the second quarter consensus and also our internal number here. So, being a little ahead of that, and then we also did the refi, which helps a little bit, although some of that is offset by the fact we borrowed more money. So that's where the $0.05 comes from, some of the EBITDA increased. And we raised EBITDA guidance by $5 million at the end of the quarter, and we raised EPS $0.05, or $0.03 of the $0.05 would come from EBITDA improvement.

We knew probably the payroll management has been a little bit better. Supply management hasn't been quite as good. We're roughly pretty close to our plan. If you look at $5 million out of $1.970 billion, it's not quite -- it's a positive move. It wasn't a big percentage move. Then the EPS was $0.05 on top of a $3.85. And will have to start narrowing the range there but lowering it.

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

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

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

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

I think the guidance is down to 72% as it relates to that. We are getting closer to that for the year, and I think what we will continue to evaluate it. It doesn't appear there is a reason to swap more, as they have stayed fairly good, so we will continue to evaluate. But we could, by the end of the year or the fourth quarter, start putting some more swaps back on.

Okay. Thanks a lot.

Your next question comes from Matt Borsch with Goldman Sachs. Your line is open.

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

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

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

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

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

No, I think we are on the same track in terms of trying to make sure that we have got the proper infrastructure in place and demonstrating quality. We have been on this track now here for a good while. And we will continue down that road. That's why we started. You can see in it Pennsylvania, where we have 17 hospitals now. These markets can be a state, they can be a region, or they can be a city, when it's all said and done. We continue to think about infrastructure, which means clearly the provision of services in the area and getting size and -- in the area so that we can provide those -- that's consistent with our acquiring physician practices. We have acquired a number of large physician practices over the last couple of years.

I think the only thing that we will think about and adjust to now is -- and I think we will go slow with this in terms of the risk side of it, in terms of what kind of risk sharing business that we want to participate in. I know Larry just mentioned this earlier, and we're trying to figure out about how we can best do that. But I think that's going to go slow. I don't think we are going to jump all over that too quickly. But really, the basics of our business and our basic strategy has not changed. But we are continuing to think about what we might do differently as we go forward, and it will be a slow change, not a dramatic change.

Okay. Makes sense. Thanks a lot, guys.

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

We are pleased with our strong second quarter and believe the prospects for continued growth are very favorable in light of recent decisions surrounding healthcare reform. We are well positioned to leverage these industry dynamics as a leading operator of non-urban hospitals and mid-size hospitals. We specifically want to thank our management teams and staff, hospital chief executive officers, chief financial officers, chief nursing officers, and division operators for their excellent operating performance in the second quarter. We remain focused on our business strategy and improving our results. We appreciate your time this morning. If you have any questions, you can reach us at 615-465-7000.

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