Community Health Systems Inc (CYH) 2012 Q3 法說會逐字稿

Good morning. 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.

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.

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

Welcome to our third quarter conference call. Larry Cash, our Chief 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 a 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 and 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 (sic -- see Presentation Slides "$453m") 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 for 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'd like to highlight some of the recent accomplishments. As we previously reported we acquired the assets of Memorial Health Systems in York, Pennsylvania on July 1. The 100 bed hospital and associated outpatient and ancillary services is located approximately 25 miles southeast of Harrisburg. [Trade on] revenue of approximately $100 million, with 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 a 225 bed Porter Regional Hospital in Valparaiso, Indiana in August. The environmentally 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. This small acute care hospital provides greatly expanded patient care areas along with increased patient privacy and security.

Physician recruiting continues to be one of our operating strengths and we're 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 of our 2011 (sic-see Press Release "2012") 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 that we recognized for 2010, only 18% of the eligible hospitals in the United States were recognized for 2011 and we're very proud of our efforts to improve quality of care in our markets.

Our work on CMS's existing quality benchmarks, core measures and H-caps have helped prepare us for the next phase of benchmarking. Value-based purchasing, the re-admission phase of value-based purchasing started on October 1. Our evidenced-based order set project is on schedule with approximately 120 standard sets in place for our most common admission conditions. This implementation will help us achieve stage II meaningful use.

Moving to an update on our more significant pending litigation into investigation matters, please note the following. In the New Mexico, Key Tam, 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 judges 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 in-patient admissions, we continue to cooperate with the government in this investigation. Third party review of a sample of medical records at a small number of hospitals is under way 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 requested another six months extension in the [Rurel] case to which we consented and the judge granted the request. Delaware State Court we discussed in July. The Delaware State Court case we discussed in July has been dismissed. There's nothing substantial to report for the other related cases investigations and I refer you to the legal proceedings 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 and compliance committee and selected senior management continue to be focused on these matters.

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

Thank you, Wayne. Before I get into the operating results for the quarter I want to briefly discuss seasonalities that affects the third quarter. Generally each quarter has the same number of weekdays. Leap day in 2012 changed that dynamic and there was one less weekday during the quarter, third quarter of 2012, compared to 2011 third quarter. As you all are aware, weekday volume can be significantly greater than weekend volume, one less weekday for this quarter translates into the following approximate reductions, 40 basis point reduction in admissions, a 60 basis point reduction in adjusted admissions and 130 basis point reduction in surgeries.

Our third quarter consolidated admissions increased 5% compared to the same period last year, adjusted admissions which factors in outpatient business increased 6.3%. Our same store admissions decreased 0.3% compared to the third quarter 2011. Our women's services have experienced declining volume with affect in the third quarter same store admissions were approximately 70 basis points. Same store adjusted admissions increased to 0.8% for the quarter. Debt revenues in the quarter increased 9% from $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 the ongoing Medicaid provider tax programs that started this year and also supplemental programs. For the third quarter, same store net revenue per adjusted admission increased 3.2%, versus the same period in 2011. We saw a decline in same store surgery in the third quarter of 2.8%, declining cases was primarily due to seasonality as I discussed earlier for third quarter 2012, with one fewer weekday and also fewer endoscopy procedures and women's service procedures. Same store emergency room visits increased 4.4%. Consolidated EBITDA was $477 million for the third quarter, versus $454 million for the same period a year ago, an increase of 5.2%.

On a same store basis, EBITDA was $481 million for the quarter, an increase of 3.9%. For the third quarter, EBITDA margin, consolidated basis is 4.9% (sic -- see Presentation Slides "14.9%") versus 15.4% for the prior year. This is a decrease primarily due to the low margins at our recently acquired facilities. Additionally, our HITECH incentives before expenses was approximately $10 million lower in the third quarter of 2011, or a 40 basis point reduction to EBITDA margin. Consolidated operating expenses, 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 to supply expense was up by continuing improvement in pharmacy and plant and expenses. On a year-to-date basis consolidated admissions increased 3.7%, consolidated adjusted admissions increased 6.7%. Same store admissions decreased 1.6%, the following contributed to the decrease. A lack of flu and respiratory, about 90 basis points, and lower admissions for women's services 40 basis points. Our hospitals over $50 million of annual revenue are faring better in terms of volume and year-to-date our same store adjusted admissions increased 1.1% (sic -- see Presentation Slides "1.3%").

Consolidated net revenue was $9.8 billion or an increase of 9.6%. Same store basis net revenue increased 4.3% for the first nine months. On a consolidated basis, net revenue per adjusted admission increased 4.6%, on a same store basis net revenue per adjusted admission increased 3%. Same store surgeries 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 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 the nine months ended September 30 was 15.3%, and same store margin for the 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 offset increases in other operating expenses.

Total A/R days were 60 September 30, 2012, an increase of four days from the end of 2011. The allowance for doubtful accounts was $2.199 billion or 51.3% as of September 30, 2012. The allowance for doubtful accounts and related contractions for self pay was approximately 84% of self pay receivables as of September 30, 2012. While same store self pay admissions and self pay revenue have increased because of the increase in admissions, the self pay revenue increased from the third quarter was approximately 400 basis points less than the year-to-date increase through June. Our self pay volume are generating fewer dollars for the quarter through the first half of the year.

Community Health Systems continues to have a favorable payer mix for the quarter ended September 30, 2012. Consolidated net revenue by payer 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 payer 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 a four day increase in A/R days. Our 2012 acquisitions increased A/R about $70 million, an increase in Medicaid about $25 million as well as the build-up in Medicaid supplemental provider programs of about $40 million.

We also had an increase in other assets due to increase in electronic health record receivables of about $30 million. Cash flow guidance remains $1.2 billion to $1.3 billion. Capital expenditures for the quarter ended were $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 for the quarter, [$92] million year-to-date. Our guidance for the year ranges from $750 million to $800 million.

Balance sheet cash at September 30, 2012 was $241 million. At the end of the quarter, the Company had available credit from the revolver of $700 million, and after outstanding letters of credit. Looking at the balance sheet, as of September 30, 2012, we had $1.226 billion in working capital. $16.2 billion in total assets, total outstanding debt as of September 30, 2012 was $9.572 billion, which approximately 88% is fixed. Our debt-to-capitalization at quarter end was approximately 78%.

At the end of the quarter, we were a party to a $3.550 billion in interest rate swap, bringing us down $200 million from the end of the second quarter and again, approximately 88% of our debt is fixed. The Company's been very active in the debt markets. During the third quarter we tendered for the remaining $934 million balance of our 8.875% bonds maturing in 2015. We issued a $1.2 billion of new debt with 7.125% coupon due in 2020, lowering the coupon, extending maturity. We completed an offering of $1.6 billion of 5.125% senior secured notes due in 2018. The Company used these proceeds to prepay a portion of certain term loans with an interest rate of approximately 2.5%, and the pay related fees and expenses. Our interest expense was increased due to all of our most recent financing activities we did in the latter part of 2000, third quarter 2012.

Some important points to note for both this earnings report and our 2012 guidance. Approximately $31 million of HITECH incentives were recognized in the third quarter, offsetting these incentive payments were approximately $12 million in operating expenses, and a depreciation expense increase of $11 million. While HITECH revenue was greater than anticipated, the associated operating expenses were greater by - - than the second quarter by approximately $9 million. Variances were due to accelerated deployment of Medicare and Medicaid in five locations. Updated cost to import information, two acquisitions were completed and greater physician incentives in one of our primarily larger multi specialty groups.

Please note we will be using Cerner platform in 15 to 20 of our facilities going forward, this move will be very cost effective for us. The California Medicaid Hospital Fee Program for managed care was included in our 2012 guidance. We're revising both EBITDA and EPS guidance to reflect the exclusion of this program 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 by $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 we did in September.

We have tightened our interest guidance range from 4.8% to 4.9%. We've lowered and tightened our EPS guidance to $3.80 to $3.95, reflecting the exclusion of the California Medicaid hospital fee program as well as the higher interest expense. And just as a reminder, there is seasonality in the fourth quarter compared to year-ago, with Christmas Eve and Christmas Day following on a Monday and Tuesday, rather than a weekend that they did in the fourth quarter of 2011.

Wayne will now provide a brief recap.

Thanks, Larry. Our results for the third quarter of 2012 further extend Community Health Systems consistent record of earnings growth. While our volumes have been constrained by the macroeconomic environment, we believe our results continue to demonstrate the underlying strength of our operating model.

With that I'll now open the call for questions. If you'd like to talk to us after the call you can reach us at (615) 465-7000.

(Operator Instructions)

Your first question comes from Tom Gallucci from Lazard Capital. Your line is open.

Good morning. This is Colleen Lang on for Tom.

Just on the volumes, Larry -- the decline of just 30 bps was a lot better than what we and many others were looking for, especially with the one fewer weekday. Can you talk about some of the drivers here? Were volumes as you had hoped, or were they better than what you were looking for?

Well, what we said is, the first half of the year we were down about 2% and we felt like we had an opportunity to be a little better in the second half of the year. We had a little bit of easier comps as a result of some of the reductions we've had in the third and fourth quarter of 2011. One of the drivers in the third quarter would be the fact that we didn't have any headwind as it related to lack of flu and respiratory, which helped us and that's probably been about 100 basis points.

We were pleased - - we hope we will continue to have decent volume activity. We also had good outpatient growth, the 0.8% of adjusted admissions was better than last quarter 0.5%. So we continue to have good outpatient growth and good revenue growth. We thought we would be better and so it pretty much came in line. We were aware that you're going to have some seasonality effect of, I think, the losing a weekday in September, becoming a weekend day. So pleased to see it come in about we sort of thought it would be.

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

I'll just add, we also continue to see a little bit better managed care admissions and adjusted admissions growth than the overall average. That's continued to happen. That helps our revenue growth.

Okay, great.

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 and existing markets? Thanks.

I think that was three or four questions, but I think the environment is still very good. There's a lot of hospitals for sale. There's a lot of opportunities. We're seeing on both sides of the street, there's some that have decent margins and some that have no margins. So I think that's the reason that we're being very selective about this. We're looking for opportunities that 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 thought the pricing was getting a little steep. So we're continuing to be disciplined but there are plenty of opportunities for us going forward. So you will see us continue to acquire in the future.

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

Hello. Thanks. Just quick question, Larry.

I'm sorry, 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?

Well, what we pointed out that Christmas Eve's on a Monday and Christmas is on a Tuesday. Last year that was a Saturday/Sunday. You had a little less volume on Friday before that weekend, a little less volume on Monday afterwards. So it's just something to make sure people are aware of that it does move around a little bit. There is a little bit of opportunity to get back that day you may have lost this quarter. I think lose that benefit now because of the way Christmas has moved forward a couple days, and so December could be a challenge.

Got you. 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?

The women's services were still down; we had a fewer less scope procedures also. We've been tracking hips and knees and they continue to look pretty good. We get some data from ourselves and other people. They were up 2.0% in the first quarter, 1.0% in the second quarter, up 5% or so in the third quarter. So a big number -- that's moved in the right direction. We didn't have -- I'll just add, we didn't have as much of an effect from Hurricane Isaac, it probably cost us very few admissions and surgeries, about $1 million of revenue. But fortunately, the other thing I would just add was our case mix for our in-patient surgeries went up about 240 basis points compared to year-to-date about 110 basis points. So what procedures we did have in-patient was a lot more intense procedures, so --

Okay. So the revenue number wasn't as big a decline as the --?

Correct, Josh, yes.

Okay. Got you. Thanks for taking the call.

Thanks, Josh.

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

Thanks. Hello, everybody. A couple questions.

First, obviously, on the physician recruitment number -- that's up 21% year-to-date versus prior year and it flattened out last year. So, A, what's led to the reacceleration, if I could ask, in the physician recruitment? And, B, when do you see those recruits actually starting to impact your admissions numbers and your volume -- overall volume numbers?

Yes, if you look at it, we have people who join our medical staff, some who do recruitment contracts. The recruitment contract numbers were relatively flat. What we're seeing is a lot of house-based physicians, and ER physicians and other specialists grow. The turnover stayed pretty good, so not every physician -- admitting physician -- always important to have the growth you've got. And then of course we've also had the very good success of adding the mid-level nurse practitioners and physician assistants.

So, I wouldn't want you to think because it's up -- the percentage you quoted that's going to necessarily drive a similar percentage of volume. Some of it's replacing the physicians we lost. We probably lost 700 or 800 physicians, so far. A lot of that growth is in house-based and radiology, et cetera. We're pretty happy where we are. But I wouldn't want you to think it's going to be a drop in volume increase that you described.

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

Yes, I think the best thing I'd say is we started out with about a little under $9 billion when we did the Triad deal, and it was due in 2014 and 2015. We started in September 30 or November of 2010 and started doing some of the term loans. So now we've got all but about $240 million of the July, 2014 term loan extended out to, generally, 2017. And we have pushed the bonds out from 2015 to 2019 and 2020. We also did a senior note 2018.

We gained a little bit more flexibility along the way. We refreshed our basket. We have bought a fair amount of stock back over time. We've probably got close to $50 million flexibility now that we can do, and we did not change a lot of the terms.

We did add the ability to do a spinoff of a small percentage of the Company, was one of the flexibilities we got if that got to be something that would be interesting to do. But I think that the best opportunity was the maturities now are much staggered out into 2016, 2017, 2018, 2019, and 2020. We also did an A/R securitization, which is cheaper than the cheapest rate we got. Hopefully, would add to that going forward a little bit, so that was a good feature.

And we also increased the revolver size a little bit.

Okay. And then just last question.

Your bad debt expense ratio was actually a little better than we were looking for. I did notice your administrative discounts ticked up. Is anything going on there that's worth highlighting or commenting on?

A.J., every couple of years, first of all, some states mandate discounts. We have to follow that. 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 a way we are creating out-patient, where the first few hundred dollars was not a subject now. All the self pay outpatient is substitute to it. So the discounts were up. And if you look at the uncompensated care, it is up about 170 basis points, I believe, on both year-to-date and the quarter. So while the bad debts were not uncompensated care, kept up with the growth in the business.

Okay. All right. Thanks a lot.

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

Good morning.

You talked about some adjustments for the fourth quarter, given the way the days fall out. But you also mentioned Isaac. So what about Sandy? I know you have a lot of hospitals in Pennsylvania. What are you seeing -- any impact there? Should we be mentally prepared for any kind of impact going into the quarter or going into the fourth quarter related to that?

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

To stay with it Frank -- we quantified what the Hurricane Isaac was; it wasn't that big -- $7 million. We'll keep accounting records. If it gets to be something we have to talk about, we'll talk about what it affects us. It is one of the better months of the quarter; it's a very good month, October, so it came in a month where a lot of our revenue and EBITDA was going to be earned.

I guess it's early enough in the quarter to the extent there was a deferral or elective surgery, you've still got plenty of time to get it back, right?

I would hope.

That's correct, yes.

All right.

Obviously, seems like with your adjusted admissions and your volume trends getting better here, working your way through that whole issue related to the 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 observation stays. Are any discussions, any thoughts on doing anything like that? Or is that something maybe you're already doing?

If you kind of go back to where we were in our -- I think we talked about this in terms of us being very strong in terms of implementing inter-qual, doing some outside reviews. I think we're in pretty good position overall. 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're seeing some stabilization.

I think we did acknowledge that we enhanced our concurrent review program in the last several quarters to help us, and our observations are still growing. But, fortunately, we're not having to call out one day's as reason for admission changes.

Okay. One more and I'll just hop off. You mentioned about the process being under way on the medical necessity-related area. I'm 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? Is it pretty much what you expected it was going to be? Any color you could add and I'll hop off. Thanks.

Not really. It's a long, arduous process. Fortunately, it's a relatively small number of hospitals and it just takes time to work your way through this when it's all said and done.

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

Thank you.

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

Thanks. Good morning, everybody.

So I just wanted to go back to your comments, Larry, just on the HITECH expense and the change in the guidance. Wondering if you can help us think about what's led to some of that? Is that just specific to this period? 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're seeing change there?

Yes, I think he we both increased the revenue side and the expense side. I think that it was 60 basis points, went to 80, now went to 80 to 90, and expenses went up from 0.3 to 0.5, to 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 few more facilities. I think we mentioned we did some acquisitions. I think we also got a lot of the training work got done in the third quarter. I wouldn't think that expenses would climb again in the fourth quarter; they would be more in line with where they were year-to-date for the fourth quarter. And I think that would fit with guidance. We've got the ability to do a little bit more than we thought we had done. We're doing a little bit more on the physician side than we had thought. And so we're a little bit ahead on the revenue but we're 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'll finish out, we're $73 million here right now, we're going to be somewhere $110 million to $120 million, thereabouts, for 2012; and I expect that number to be a little better for 2013. We have not published work and I know, Darren, you published $650 million to $750 million opportunity for us with our hospitals and our physicians. And you've done a lot of good math work on that, so we've got a lot of opportunity to get HITECH reimbursement, but we've got a lot of capital spend.

The Cerner move will help us going forward. But I think we would expect and intend to spend a fair amount of hardware and software next year.

Just on that point, 15 to 20 -- it sounds like some of your larger hospitals. So, how quickly will you start to turn the switch on with Cerner? And on what time line will this implementation be on? And any kind of broad thoughts on the relationship, what the capital commitment is, and what that means for future acquisitions and how Cerner might fit in?

Yes, Cerner will be who we will probably use for future acquisitions. We still have a good relationship; McKesson's helped us. We've got relationship with Health Care Management Systems and also with other companies. But Cerner will probably help us, assuming no system we work with is already in one of the hospitals we acquire.

But right now, I think we've targeted 15 to 20 hospitals. I don't know if we'll go into the specifics of how much that capital is. But we do think it's a cost effective move and allows us 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've met with them.

The switch is on.

Yes, the switch is on, as Wayne just said, and we'll be into it in 2013. It will be helpful for us in our efforts to get meaningful use and do acquisitions in 2013 and 2014.

Okay. That's great.

And then I'm sorry if I missed this in your comments, Wayne, but 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 how you framed that.

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

I just want to add, I may have misunderstood Frank's question a while ago. I thought he was talking about our efforts to put in 120 standardized sets, and so I answered the question more about HITECH, and stage two implementation. So I misunderstood his question. So I volunteered some information on a different answer than what was asked.

I wouldn't want to mischaracterize this as a positive or a negative. It's just part of the process.

Understood.

And then just the financial benefit that you get from the ruling, when will we see that? And --

It's just the cost of doing business, just the cost -- I mean, that's all. It's not enough money to even talk about very much.

Got it.

It's just part of the case.

Very good. Thanks.

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

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

We had about $1.7 billion roll off in 2012. We let most of it go to variable rate debt. Of course the $1.6 billion that we did, paid that down. We've got $1.1 billion floating off in 2013, and I think as we see today, looking at what's happening, we'll probably let all that float. We'll just have to watch and see where interest rates are going. I believe it's our advantage to let that rate, which is spelled out in our various disclosure, what the average interest rate is, so it will probably something we would let happen -- some of it at least in 2013. And I think we've got a little bit floating off in the fourth quarter -- $400 million or so -- we'll probably let that go to floating.

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

We'll watch it and just see, interest rates look like they're going to stay low. As long as they continue to look like they stay low we may let the 88% go down. We got down in the 70s. We're comfortable with that level. I think that's how we'll probably look at the future swaps.

Got it. Makes sense.

Maybe if you could just comment briefly on some of the recent acquisitions -- Tomball and Moses Taylor. Just curious how those are progressing now, and if they're EBITDA additive at this point? Just any commentary around the sequential improvement.

If you look at the hospitals that we had in non-same store, the margin was about 6% in the quarter, probably about 4% for the hospitals they had a year ago; so that's better, and we're probably about 4% to 5% year-to-date. So it got a little bit better, Moses Taylor got a little bit better. Tomball is doing good, it's still got some opportunity. I think they're all getting better now.

There's a lot of categories of expenses in our non-same stores -- acquisition and legal costs and legal reserves and other accounting adjustments there. But the pure financial statements of the hospitals for the most part got better in the third quarter versus the first half of the year. And I think they'll continue to get better looking at the projections that we expect to have and achieve for the year.

I think if you look at it, we've got about 12 or 13 hospitals, about $1.3 billion, $1.4 billion revenue. Still in single digit margins. It should help us in 2013 and again in 2014 as we manage those, and hopefully get a 200 basis point improvement in 2013 off those; maybe a little bit more.

Got it.

And 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?

Yes, the biggest change would be the provider tax change there. As you may remember, there was new programs in North Carolina, West Virginia, California [approvement]; and Indiana in the provider tax numbers lowered it. The malpractice expense is actually higher in the quarter and higher than a year ago to date. I think the provider tax expense is probably close to $40 million lower in the third quarter versus the second quarter.

Okay. And I guess, finally, Wayne, any update on Birmingham and the CON battle there? Just didn't know if there was any --?

Yes, we had a hearing on the 23rd at the Circuit Court level, and we're waiting for a ruling now. 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're making good progress. We will ultimately prevail and get that done.

I'm kind of hopeful that it will be, even if it does go to the State Supreme Court, that it would be somewhere around the first of the year that we would know one way or the other. If they don't hear it, it will be over with whenever the Circuit Court rules. So, we're encouraged and excited about the opportunity in Birmingham and I think we're making good progress.

Okay. So best case, maybe early 2013?

Yes. To get approval. Then it will be another two years after that before we would get it done.

Got it. But in terms of the actual construction beginning or re-beginning?

Yes, sometime after the first of the year.

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

Yes. York is the one that we bought on July 1. I think we got a four- to five-year commitment to do that one and that will start sometime in either 2013 or 2014. We've already got the land for that one; they bought it with the land. That's the only one that's on the approved for the Board, approved right now by the Board.

All right. Thanks a lot.

Your next question comes from Gary Taylor from Citigroup. Your line is open.

Good morning.

Good morning, Gary.

Couple questions. Most have been answered.

I just wanted to go back to, given that we're hearing a little more from some of your competitors about RACs and so forth, I didn't have a chance to go back and look at that big slide show from about 18 months ago, where you had kind of 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?

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 smaller critical access hospitals that haven't got it yet, maybe a couple other smaller ones, but I think most are there. I assume your question will get to be, are we having an increase in denial expense, as some people have said. 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' effect year-over-year; also the quarter is part of that 10 or 15 basis points versus the second quarter. It's a cost of doing business. We've worked hard at it. We have put a lot of programs in. We've got a centralized appeals unit. We've done a t lot of training, a lot of newsletters, a lot of efforts to try to make sure we do things right. But we are seeing an increase in RAC denials, and built into our operating assumptions; and the 20 basis points is probably might be a little bit more than we thought it would be. But it will probably finish out the year about that much.

Gary, the RAC work is just another operating issue for all of us now. And as Larry said, I think it's just part of doing business. 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 all the right things, and hopefully enhance, improve our documentation so that we have less denials when it's all said and done. But it is just part of doing business to stay in time.

Second question is on the one-day stays in 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 it as probably over-react, that may have not been the exact word you used at first. But now that we're six quarters past seeing some of that very intense pressure on your one-day stays and you've essentially anniversaried 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 came actually came back towards you as in-patient stays? Or is your experience really just that it went out, it went away, and we've just simply anniversaried it?

I think we developed a 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 a lot of things and we want to make sure that none of that existed here. So when it was all said and done, I think it's like anything else in terms of the way we think about managing this business, is that we analyze the problem and then we do what we think is the right thing to do to solve the problem.

And I think we're a little ahead of the curve as far as everyone else is concerned. And we feel pretty comfortable about the fact that we're getting good reviews of all of our admissions now to make sure that everything is appropriate, and because we do have enhanced review with RACs 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 when it's all said and done.

I think by the fact that we've not had to say anything about it, a lot of people may still have [engrossed]. We're not, so maybe we did overshoot it a little bit, maybe benefited by not having to talk about it. Probably technology, RAC reviews, change of practice, a lot more outpatient, will cause the one day in 2013 and 2014 to go down slightly. Fortunately, you'll get the outpatient business and you'll be able to benefit from that.

Last question. Who are you guys voting for next Tuesday?

That's a good question, Gary. You tell me who you're voting more and then I'll tell you who I'm voting for.

I won't vote next Tuesday. I already voted.

We're not really voters, we've already voted. I would tell you this -- and look, even though I went to Auburn, I certainly wouldn't make a prediction on the election. It's so close. But if it is a Romney win, you're going to test our ability to continue productivity and develop new strategies around reductions in cost and how we can better deliver it -- our care at a lesser cost. If President Obama is reelected, we'll be working more on the revenue side than we will on the cost side, although we'll continue to do that. So I think the strategies for the industry will change once we know who's going to be the new President.

Got it. Thank you.

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

Actually this is Joanna [Gatchet] filling in for Kevin today. Thanks for taking the question.

I'm sorry. We can't hear you. Can you speak up, please?

Can you hear me now?

Yes, thank you.

This is Joanna Gatchet on behalf of Kevin Fischbeck today. Most of our questions were asked but thanks for taking my question. I just want to confirm on the HITECH outlook -- it looks like the revenues and costs, the outlook, part of these [items] is higher. So does it mean that there's really no net change in profits from HITECH in your outlook?

Well, on the high end it went up 10 basis points on revenue and its operating expenses went up 10 basis points, and depreciation stayed about the same. So, it shouldn't have that big of an impact on it. On the low end it went up 20 basis points on revenue and 10 basis points, so there might be a small benefit -- but it's the low end. Hopefully, we'll work hard and it's our intent to get as much revenue and as much of this work done as we can. Hopefully, we'll come out at the high end.

Great. Thanks.

On just clarification on your volumes commentary -- definitely some improvement there versus first half of the year. Like you said you feel like all [vons] are stable now. So, can you now call it, you have reached a turning point in your markets in general in volumes?

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

Thank you so much. That's all from me.

Thank you.

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

Thank you for spending time with us this morning. Again, our thoughts and concerns are with all of you all here in the Northeast. Our consistent ability to drive revenue and achieve cost efficiencies in this environment demonstrates solid execution of our centralized operating platform. More specifically, we thank our Management team and staff, hospital Chief Executive Officers, 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, improving results.

Once again, if you have any questions you can reach us at (615) 465-7000.

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