美國醫院公司 (HCA) 2005 Q2 法說會逐字稿

Good day everyone and welcome to today's HCA second quarter earnings release conference call.

Today's call is being recorded.

At this time for opening remarks and introductions, I would like to turn the call over to the Senior Vice President, Mr. Vic Campbell.

Please go ahead, sir.

Good morning everyone on today's call is as those of you listening on our webcast.

As you know, this morning we released our second quarter results.

They were $0.90 per diluted share, right in the middle of the previous guidance which we released on July 13.

With me this morning, as always, Jack Bovender, Richard Bracken, Milton Johnson, Mark Kimbrough, and then we have most of the senior management based here in Nashville as well to be here to answer any questions that might be on your minds.

Let me remind all of you that today's call will contain some forward-looking statements.

They are based on management's current expectations.

Numerous risks, uncertainties and other factors may cause actual results to differ materially from those expressed in these statements.

And these factors that we would like to you pay attention to are listed in our press release and are also included in our SEC filings.

Many of the factors that will determine our future results are beyond the ability of the Company to control or predict.

In light of the uncertainties inherent in forward-looking statements, you should not place undue reliance on the statements.

And we undertake no obligation to revise or update forward-looking statements as a result of new information or future events.

I want to remind you the call is being recorded.

A replay of the conference call will be available later in the day should you want to go back to it or refer others to the call.

I want to draw your attention to two items.

First, pages eight and nine of today's press release.

We included one of these pages in the first quarter and we have provided on page eight and nine, pages entitled Supplemental Non-GAAP Disclosures.

These provide a quarterly and a year-to-date comparison of our reported GAAP results to certain operating data that's been adjusted for the impact of the discount policy for the uninsured.

And you know we made changes in our discount policy effective January 1 to provide discounts for all uninsured regardless of their financial situation.

So as a result of that, the comparisons, in particular of cost as a percent of net revenues, are, to be able to compare them year over year, you need that non-GAAP adjustment.

So I draw your attention to, in particular, page eight and page nine.

And as we address costs and comparisons year over year, we will be using those adjusted numbers in our discussions.

Secondly, today's release did reference ten hospitals for which we have agreements to sell.

Jack will be discussing that.

These hospitals, as we mentioned in the first quarter, their results are not material to the overall financial results of the Company.

Therefore, they continue to be included in our consolidated report.

With that, I will turn the call over to Jack Bovender.

Thank you, Vic, and good morning everyone.

I realize we gave you a lot of information in numbers, both in our pre-release earlier in the month and this morning in our second quarter earnings release.

There were certainly a number of moving parts in our second quarter income statement , including gains on sale of assets, tax settlements, an increase in our accumulated depreciation reserve and a positive adjustment to our malpractice reserve.

Most of you have sifted through these numbers by now and have come to your own conclusions about what you consider the so-called run rate number is for the second quarter.

It was certainly our intention to give you enough information to draw your own conclusions about the ongoing performance of the Company.

However, I also think it is useful, indeed critical, to give you management's best take on how we think the Company did in light of all the so-called noise in the quarter.

While we reported this morning $0.90 of diluted earnings per share, or earnings per diluted share, this included $0.11 of gain from a favorable tax settlement and $0.04 of gain from the sale of assets.

On the other hand, we incurred an additional $0.04 in depreciation expense to adjust our accumulated depreciation reserves to assure all our hospitals were using a consistent depreciation policy, particularly as it relates to shorter lived equipment.

Quite simply, management does not include these items when it evaluates and assesses the Company's operations for the second quarter or forecasts its performance for the remainder of the year.

Many of you have discounted the effect of the $0.05 positive adjustment in the malpractice reserves, believing this is not part of our ongoing operation.

The plain facts related to this are, number one, we own a $2 billion insurance company, HCI.

The size and scope of this subsidiary is unique to HCA in the hospital industry.

Number two, owning such a company means that every year we may be required to recognize either positive or negative adjustments to malpractice reserves based upon actuarial experience.

Likewise, we may recognize investment gains or losses each year, all consistent with the operation of an insurance company.

Number three, last year in the second quarter, we had a positive adjustment of $0.07 in our malpractice reserves compared to $0.05 this quarter.

Number four, these positive adjustments to malpractice reserves are, to a large degree, reflective of the significant investment we have made in quality improvement and patient safety.

And number five, HCI charges our hospitals monthly premiums for malpractice coverage and these are naturally part of our ongoing cost structure.

Similarly, we view adjustments to HCI's malpractice reserves favorable or unfavorable as part of the Company's ongoing results.

What do I like most about this quarter?

Without a doubt, I am most proud of the exceptional performance of our management team in controlling expenses in a quarter where volumes were soft.

Richard will discussion operations in more detail later.

But I believe our operators from group presidents through hospital management teams have once again demonstrated they are exceptional managers even in the toughest environments.

What did I like least?

Obviously volumes were soft but even this, as Richard will discuss, is isolated and not universal throughout the Company.

As many of you are aware, the Company has recently signed definitive agreements to divest ten hospitals, five to LifePoint, and five to Capella, a new start-up hospital company here in Nashville, for a total valuation of $590 million, which of course is subject to working capital valuation and adjustments at the time of close.

We are pleased with the outcome of these divestitures and anticipate the transactions will be completed some time in the fourth quarter.

Finally, let me state this morning our view of the world has not changed.

We understand some individuals are more pessimistic and some more optimistic than our stated outlook for 2005 earnings.

However, let me assure you our guidance of $3.05 to $3.20 of earnings per diluted share for 2005, is our best assessment of our operating performance for this year.

With that, I will turn it over to Richard.

Thank, Jack, and good morning to all.

No doubt the second quarter produced some interesting operating results.

Since most of the key financial and operating metrics for the quarter were contained in our pre-release and the release that we issued this morning, in the interest of time I won't repeat all of that now.

Instead, let me share with you several observations and some additional information that I have about the quarter that might be helpful to you as you consider our results.

First, and as Jack referenced, let me reinforce the fact that we feel, despite softer inpatient growth rate in some markets and an increase in the level of bad debt expense, this was a solid quarter for us.

Many, in fact most, of our performance indicators continued with the positive trends that we have been reporting in recent quarters and were generally consistent with our expectations.

With respect to inpatient admissions, a significant portion of the variance was isolated to certain hospitals, or markets, or due to decisions that we've made and we don't feel that this necessarily signals a change in how we should view future performance.

Second, relative to the efficiency of our operations, I can't recall a time where we have performed better.

Labor management, even considering the productivity pressures that always accompany soft volumes, and other key cost indicators continue to improve over prior year's levels.

I continue to believe that our facility and corporate based operations teams have done an excellent job in managing their operations.

As I had mentioned on previous calls and once again held true for the second quarter, our infrastructure is now set at such a level that even small incremental increases in productive volumes efficiently transfer earnings to the bottom line.

This is why we are experiencing record levels of cash production even considering a more modest level of volume increases.

And third, as disappointing as the inpatient admission growth in some markets might have been for the second quarter, we remain very bullish about the location and positioning of our hospitals, the growth of our outpatient business, the quality of the programs and services that we provide, the relationships with our medical staff and managed care organizations and our overall operating strategies.

I guess the message, in short, is that we've achieved our earnings objectives despite some variances.

Now relative to some additional information concerning patient volumes, consider the following.

There continues to be fairly significant variability of monthly inpatient growth rates within the quarter.

Same facility admissions for the quarter were generally in line through May and then declined 1.5% in the month of June.

As I've said before, volume growth at a hospital or even a market is rarely smooth.

It's jerky and uneven, reflecting the realities and dynamics of the marketplace.

Same facility adjusted admissions, up 1.2% for the quarter, reflected stronger outpatient services growth and was much improved over prior year's second quarter rate of 0.9%.

Year-to-date through June, same facility equivalent admissions increased 1.7%.

As you would expect, growth rate varied widely across the Company.

Markets with particularly strong growth, say greater than 2% and as high as 12%, were Orlando, Georgia, New Orleans, Oklahoma City, Salt Lake City, Las Vegas, Austin and San Jose.

Markets which experienced unfavorable admission growth rates included Tampa, Houston and Kansas City.

It is very important to note that some of the variation in volume can directly be attributed to decisions that we have made.

For example, at certain facilities, we've closed distinct parts units as a reaction to the changing reimbursement climate for rehab programs or to create medical surgical capacity.

We've had to take action to curtail clinical privileges of our medical staff into quality questions.

Decisions such as these, while difficult, put pressure on near term growth rates but obviously make long-term sense for the Company.

But even these impacts in isolated markets can significantly affect our composite numbers.

For example, excluding rehab and skilled admissions from both the quarter and the prior year second quarter, admissions increased 70 basis points or, 2.4%.

Also, in one market, volume is slightly down as a result of our contracting strategy.

In this particular case, we renegotiated contracts that provided better rates but also allow for some expansion of the provider network.

So while patient growth rates may be down due to network expansions, earnings were up, a trade we are always willing to make.

As we analyze the mix of our volume for the quarter, it was noted that our surgical case load fared better than our medical case load.

Total surgical volume on a same facility basis was up 1.4% from the second quarter of the prior year.

Additionally, both inpatient and outpatient surgical volumes were up 30 basis points to 1.7% and 1.2% respectively.

Surgical volumes in our freestanding ambulatory centers were up 1.7% and hospital based outpatient surgeries increased 1%.

Obviously we are pleased with these growth rates in our outpatient lines of business.

To be sure, some volume loss in the quarter was due to competitive pressures in the marketplace.

And where it has occurred, we have taken action.

We have plans in place to respond and rebuild the business.

We continue to focus on offering a high quality and safe clinical service with an efficient and effective expense structure, which is obviously supported by quality physicians, competent and motivated employees and aggressive capital spending.

We are also committed to only pursue transactions structures that are safely within legal guidelines.

We are pleased to report that physician and employee satisfaction scores remain high at our hospitals, that the number of physicians that have been recruited to our markets this year, compared to the same period in the prior year, is up significantly and that an estimated 10% more medical office space, or almost 3 million square feet, is scheduled to come online in the next two years.

We are confident about our ability to compete in our markets from a cost, quality and service perspective.

A couple other thoughts before I turn the call to Milton to discuss the bad debt and some of the financial metrics.

I mentioned that our outpatient services volumes were strong for the quarter.

In addition, our development pipeline is robust for both ambulatory, surgery and imaging science.

We now operate 92 ASCs, ambulatory surgery centers, and are on track to development 12 to 14 centers through the end of 2006.

Relative to imaging centers, we continue to pursue a two-prong growth strategy which includes the acquisitions and development of freestanding, multi-modality imaging centers, as well as improvement of our existing hospital based operations.

Since the beginning of 2005, we've completed five acquisitions, adding 22 centers, and these centers are exceeding our pro forma assumptions both in terms of volumes and earnings.

We currently have nine potential acquisitions under review and are internally developing another 25 centers by the ends of '06.

Same facility outpatient imaging volumes were up 3.4% for the quarter.

From a cost perspective, other than bad debts, most key expense categories were in line or better than our expectations for the quarter.

Most notably, salaries, wages and benefits expressed as a percentage of revenue, adjusting for our new discount policy, was 39.4, down 60 basis points from last year's second quarter.

We benefited from productivity improvements, and reductions in contract labor costs, compared to the second quarter of 2004.

Supply costs, once again adjusting for the new discount policy, were 16.7% of revenue, generally consistent with first quarter trends.

Cash collections in the quarter were favorable as our focused efforts on improved point of service cash collections continues to exceed expectations.

Point of service collections were $68 million in the second quarter, up 52% from the same period in 2004.

We now estimate that we are collecting approximately 39% of available co-pays and deductibles at the time of service.

Also of importance, cash collected as a percent of net revenues less bad debt was 101% in the second quarter.

A couple of final comments.

We continue to enjoy progress in our Kansas City market.

In fact, the second quarter was the best quarter yet for the market and was $0.01 accretive.

As our management teams continue to improve internal processes, infuse capital and rebuild relationships, this market will respond and we are very optimistic about its future.

Finally, in the second quarter, there were some key developments on certain capital projects and while there has been progress on many projects this quarter, let me say that we officially started design work on two new hospitals, Methodist Stoanoke in San Antonio and Lee Summit in Kansas City, and also started work on a major replacement facility for our southwest Florida regional medical facility in Fort Myers as well as a new freestanding outpatient center in Peerland,Texas.

So with that, I'll give it to you.

Thank you, Richard, and good morning.

Our financial results for the second quarter included several items that I would like to briefly review.

First, our favorable tax settlement which resulted in a reduction of tax expense of 48 million, or $0.11 per diluted share.

In 1997, HCA acquired Value Health, a holding company whose subsidiaries operated four lines of businesses.

Three of these businesses, pharmacy benefit management, managed behavior healthcare and disease management, were sold in 1998, as HCA was in the midst of a major restructuring of its operations.

In connection with its dissemination of HCA's 1998 tax return, the IRS proposed adjustment to the loss in the sale of Value Health businesses.

The IRS claim has been included in our SEC filing since the 2001 Form 10-K.

During the second quarter, we reached a partial settlement with the IRS Appeals Division related to Value Health sales that resulted in settling this dispute without paying any additional tax.

Second, we recognized 29 million,or $0.04 per diluted share, of a previously deferred gain on the Company's sale of certain medical office buildings in October, 2003, to Healthcare Property Investors.

Due to HCA's continuing involvement with MODs related to certain contingent put and call rights, the Company recorded the deferred gain of 80 million.

During the second quarter, the Company renegotiated certain terms of the sales agreement that remedied the continuing involvement in most of the buildings, which resulted in the current recognition of 29 million and the amortization of a significant portion of the remaining gain over the applicable lease terms of the MODs in which HCA leased the space from HCT.

Third, we incurred additional depreciation expense of 30 million, or $0.04 per diluted share.

The additional depreciation resulted from an internal review of the depreciable lives of capitalized assets.

HCA's accounting policy for fixed assets utilized the AHA guidelines for depreciable life.

Generally these additional depreciation resulted from reclassifying certain high tech medical equipment from seven-year depreciable lives to four years depreciable lives.

The use of seven year depreciable lives does not consider to result in an improper allocation of cost but the judgment was made to, adjustment was made to attain consistent application of the Company's policy.

The adjustment to depreciation expense represents approximately 2% of the Company's annual depreciation expense.

Finally, the Company recognized a reduction in its estimated professional liability insurance reserves up 36 million or $0.05 per diluted share.

In the second quarter of 2004, the Company's earnings included a reduction of professional liability reserves of 59 million, or $0.07 per diluted share.

The malpractice reserve reduction, 36 million in 2005, and 59 million in 2004, reflects the recognition by external actuaries of improving frequency and severity claim trends at HCA.

HCA's data indicates a 3 to 4% annual decline in the frequency of claims since 2000.

Over that same period of time, HCA's average settlement values have remained relatively constant.

This declining frequency and moderation of severity can be attributed to HCA's risk management and patient safety initiatives, particularly in the areas of OB and emergency services, as well as tort reforms and in certain states such as Texas.

For example, OB claim frequency in 2004 is expected to be 40% less than in 2000.

New claims in Texas are down 40% from the pre-reform levels.

The improvement in professional liability expense reduces other operating expenses in the Company's income statement.

Adjusting the second quarter of 2005 operating results with a combination of a reduction in professional liability expense and the adjustment for earnings share discounts in the second quarter.

Other operating expenses represent 16.3% of net revenue, which is flat with 2004 after adjusting other operating expenses for the 59 million reduction recorded in the second quarter of 2004.

Next, turning to bad debt expense.

In the second quarter, same facility uninsured admissions increased 5.1% compared to the second quarter last year.

On a sequential basis, same facility uninsured admissions in the second quarter grew 8.1% over the first quarter of '05.

Reported bad debt expense as a percent of net revenue was 8.9%, after adjusting for uninsured discounts, 11.6%, compared to 11.3% in the second quarter of 2004.

Houston, our largest uninsured volume market, actually saw a drop of 12.5% in uninsured volume.

However, we saw growth in Tampa, Dade County and Las Vegas.

Generally we are pleased with the effectiveness of our bad debt action plans.

But as we have stated many times over the past few years, this is an issue that hospitals cannot eliminate without structural changes to deal with the number of uninsured individuals.

We do not believe in 2005 we will see a return to the growth rates in uninsured admissions we saw in late 2003 and early 2004.

We continue to have a stabilization of the inflexibility percentage based on our quarterly hindsight review.

It was approximately 30 basis points up this quarter over the previous quarter, the first quarter, and a continued improvement in a point of service collection.

Uninsured admissions in the second quarter were 5% of total admissions compared to 4.4% in the first quarter of '05 and 4.8% in the second quarter of 2004.

Although uninsured admissions continues to be a challenge cash flow from operations increased to 763 million in the second quarter, compared to 682 million in the same period last year.

Days in accounts receivable are 48.

Same facility net revenues rose 4.3%.

After adjusting revenue for uninsured discounts in the quarter, net revenue increased 7.5%.

Same facility inpatient revenues increased 8.5% and same facility outpatient revenues grew 7% after adjusting each for uninsured discounts.

Same facility net revenue per adjusted admission increased 3.1%.

After adjusting for uninsured discounts, net revenue per adjusted admission increased 6.2%.

Medicare revenue per adjusted admission increased by 6% over the second quarter of last year while managed care net revenue per adjusted admission increased 6.2%.

In conclusion, let me make a few comments regarding our earnings guidance assumptions.

As I stated in my comments last quarter, we expected our weighted-average share count to increase throughout the year due to stock option exercises.

We have increased our assumption regarding stock option exercises that raises our weighted-average share count for the year to 454 million, up 9 million shares from our original assumption.

Consistent with our original assumption, we continue to assume that adjusted admissions will grow in the 1 to 2% range.

We expect uninsured discounts will impact revenue by 180 million to 200 million per quarter, through the remainder of 2005.

Vic, at this point, I will turn the call back to you.

All right.

Milton, Richard, Jack, thank you very much.

Wendy, if we could bring you back for questions.

I would please ask because of the large number of people on the call that we each of you ask only one question at a time.

If you have a second one, please get back in the queue.

Okay Wendy?

[OPERATOR INSTRUCTIONS] We will take our first question from Darren Lehrich with Deutsche Bank.

Hi, good morning.

Can you hear me?

Just wanted to ask you a little bit more about your capital spending plans.

We've heard about a number of new projects you are starting and Jack, really just to get your sense for where we are in the cycle of spending with regard to recent order versus technology specifically and is there any more focus as you look over the next several years to spend more on technology than you have been spending and it gives a sense as to where we are on spending on bricks and mortar and if I could just get a little bit more perspective on what the MOB expansion projects are in the context of your overall MOB portfolio.

I just thought that 3 million square foot comment was interesting and I was hoping you could put a little more context around that.

Thank.

Let me start out in kind of a general way and then we will give you some breakdown on, as you said, bricks and mortar, technology and maybe expansion capital versus routine maintenance capital.

But generally speaking, we plan to spend, as we have consistently stated, somewhere around $1.6 billion in capital.

That is our first and best use of this exceptional cash flow that we've got.

We might see over the next couple of years that tick up somewhat, possibly to 1.7 to 1.8 billion, because we do have some, I think, great opportunities in the pipeline, both in terms of outpatient expansion, which Richard gave a good overview of, but also the construction of some new hospitals in our markets, in our existing markets, that we have under active evaluation at this time.

Richard, I don't know if you want to expand on?

Just a couple of general comments and then we can hit maybe some specific line items.

Our major capital spending strategy isn't going to change dramatically.

Jack mentioned it's going to be in the 1.6 to 1.8 billion range.

We are going to come in at 1.6 this year.

When we look out a year or two, there is some slight uptick in technology spending.

We are deploying pax units, radiology archiving systems, at almost all of our hospitals over the next two years.

There is some technology spend in our emergency department, et cetera, and it will bring the totals up some but I don't think materially.

The vast bulk of our capital spending continues to go in really adding capacity.

Our routine spending is generally pretty consistent at about 500 or so million and this tech component is probably 250 to 300.

So that kind of sizes it.

We have been, on the medical office building question, I will let Bruce from our real estate department to comment in a second, but we are very thoughtful about medical office building development on our campuses.

It has been historically and continues to be a very important strategic decision and investment that we make historically.

We would develop medical office buildings based on pre-leasing commitments when there was enough information.

Sometimes that slowed us down a little bit.

Now we are being a little bit more aggressive in developing these buildings before all the pre-leasing is totally in place and allows us to get these properties in the ground and supporting our organization a little more quickly.

But we have sort of been on the offensive in understanding where medical office capacity needs are and have stepped up the development pipeline.

Bruce?

I think the only thing I would add to that is some of the medical office building expansions associated with some of the new hospitals.

The other thing that we are doing, though, is we are starting to put more operating services in our medical office buildings such as imaging centers and surgery centers, to try to continue to link some of our other outpatient services back to our main campuses.

All right.

Thank you.

We'll move on to our next question with Gary Lieberman from Morgan Stanley.

Thanks.

Good morning.

I was hoping maybe you would update us a little bit on your thoughts on capital structure.

I think coming into the year, the thinking was that you would probably use some of the free cash flow to pay down debt a little bit.

With the sale of hospitals, you are coming into some more cash than maybe you expected at the beginning of the year, also with the share price backing off.

Have your thoughts changed in terms of what the right use for the free cash flow is right now?

All right.

Thank you, Gary.

David or Jack?

One of you?

Well, let's let David talk about where we are presently debt to cap.

And kind of our thoughts there and then I think I will deal then with Gary's implied question about what are we going to do with all this cash.

Good morning.

The debt to total cap financial targets for the Company has always been 55% and debt to EBITDA, sorry about that non-GAAP term, but anyway has been around two times.

At the end of the second quarter, we were 58% debt to cap, down from about 67% at the end of '04, and our debt to EBITDA is 2.2.

So basically, since the end of the year, we are almost back to our stated financial policy.

Gary, to your question about possible capital structure and use of that cash going forward.

I think it's an appropriate question at this point in time during the third quarter, specifically September every year, as I think many of you know, we go through an in-depth strategic planning process with our senior officers and with our Board of Directors.

That covers a lot of issues obviously, including estimates about operations for the coming year, in this case 2006, as well as any kind of internal management restructuring we think we need to do to be more responsive in our markets.

Looking at acquisitions and the possibility of what might be out there acquisition wise.

And capital structure, issues about how we use our cash in addition to acquisitions, items like share repurchase and dividend policy, and we will do that again this quarter.

We are not in a position to talk about what we might do as far as a share repurchase specifically, which I think is where your question is going.

But we obviously will look at that as one of the alternatives for use of cash.

I will say again what I have said many times in the past is that we are very focused on cash and how we can use that cash to increase total return to the shareholder and I think all of you can just look at our past history and know that we believe that share repurchase is from time to time an important part of that strategy as is dividends.

We will continue to evaluate that and we will go through the September process and I think we will have some more to talk about later in the year relative to use of the cash.

Gary, thank you.

We will move on to our next question and that will come from John Simplelum with ESW Capital.

Excuse me, who's that from?

Good morning, gentlemen.

Remember me?

Good morning, John.

I don't cover you guys as closely as I used to.

But I want to make sure I understand Jack's comments on the earnings.

You did $0.90.

You took $0.11 gains.

Now you are down to $0.79 cents.

Wait now. $0.04 gain, $0.04 loss.

So that kind of washes.

The question is, is $0.79 the run rate number?

I think consensus was $0.77 but if did you 79 and consensus was 77, the stock didn't act that way.

So the question I think becomes one of, what, how recurring or not is this change in your professional liability expense?

In other words, can we going forward assume that that line item will be less or maybe another way to ask the question is at this time next year, do we compare you against $0.79, $0.74, or something else?

Okay, John, a lot of parts to that.

It's a very complicated issue.

This day in time, we only can talk about GAAP numbers and we gave you, as I said earlier, enough information to do your own calculations on this.

But from management's standpoint, I think it's safe to say that three items mentioned early in the release, which was the sale of assets, the gain on sale of assets, the tax settlement and the increase in our accumulated depreciation reserves, we view as out of period numbers.

When it comes to the malpractice adjustments, those are going to occur on a year to year basis, as we said either positive or negative, and therefore I think by definition are part of the ongoing run rate of this Company, since we do have a very large captive insurance company that, according to the rules and regulations of how those are managed and accounted for, requires adjustments to reserves based upon actuarial review.

And so that's why we view those adjustments on a yearly basis as just part of the run rate of this Company.

And they are not totally predictable.

They've been positive for the last two years, I think reflecting what we have done on the quality and patient safety, in the quality and patient safety arena, and also some favorable malpractice or tort reform in certain states.

We can't predict what it will be next year or the year thereafter.

But it is part of the run rate of this Company and that's the way we view it from a management standpoint.

Welcome back by the way.

We will now take our next question from Christopher McFadden with Goldman Sachs.

Thanks, good morning.

It's actually Tim Leahy.

A question with regards to DRG recalibration.

It seems that there's a lot of momentum in Washington, both legislatively and just administratively from CMS, for this to go forward for fiscal 2007.

And I know that the federation and the AHA both are currently working on an analysis or a recently completed analysis on recalibration.

Just what are the implications for HCA and how are you thinking about it as we go into the back half of this legislative season?

All right, Tim.

Thank you very much.

I will ask Trish Lindler, who oversees all of our Medicare reimbursement, to address that.

Yes, Christopher, we are reviewing some of the DRG recalibration proposals.

We are looking at it primarily in terms of the med pack recommendations, APR, DRGs, cost weights, relative days, et cetera, so we think going forward, that it will likely be favorable to us.

We don't have exact numbers on that but we are keeping close contact with it.

I don't think, we will see the final rule for 2006 probably at the end of this week or the beginning of next week.

I don't know that CMS will tackle it for 2006 because they may in fact look at something for 2007.

It's obviously early, a lot of movement, but I think it is clear from my perspective in terms of legislation, highly unlikely, as you said, that we're going to see anything in '06, even in '07.

CMS is really struggling with this so it will be interesting.

Again, that first blush we are okay with it, but obviously lots of things could change.

We don't see it as having a material impact either way at this point.

Great.

Thank you.

Thank you.

We will now move to Jason Gurda with Bear Stearns.

Good morning.

Before I get on to my single question, I just want to clarify something you said earlier.

In your guidance for this year, which you reaffirmed of 305 to 320, what are you assuming that you reported for this quarter?

Thanks, Jason.

We are not giving, or breaking our guidance down on a quarterly basis, just on the annual basis.

Okay.

Fair enough.

But I think you can answer the question what you exclude from that guidance number, like, for instance, the gain on sale of assets.

Why don't you go through that?

Sure.

I mean, the tax, as we said in our guidance, we would carve out gain on sale of assets and tax settlement from our guidance.

When we, with respect, I think the issue is probably more targeted around the insurance assumption.

When we built our guidance for '05, our assumption, we were aware of the favorable trends we were seeing in a malpractice arena.

Did we have the number?

No, we had to wait for the actuarial report.

But certainly we were expecting some favorable results from that report.

We just didn't know the exact amount.

Thank you.

You had another question, Jason?

Please.

I was curious on the Medicare modernization Act, I think, promised a billion dollars to the hospital industry to cover uninsured emergency room expense.

Have you guys assessed that impact or how much you expect to receive and when you expect to receive funds from that?

Trish is sort of shaking her head as I am, too Jason, but you want to give him your thinking?

We are still awaiting some more definitive clarifications from CMS.

They have appointed a contractor to handle it, Trailblazers, but there's still a lot of unanswered questions about how we are to submit claims and what the actual payments will be.

Okay.

Thank you.

Again, it's one of the things that you would like to see it, sounds good, probably not terribly material, but thank you.

We'll now hear from Sheryl Skolnick from Fulcrum.

Thank you very much.

I would like to focus on the uninsured for a moment.

One of the things that was very interesting that you said last quarter was that recognition, for better for worse, hospitals are in fact the insurers of last resort for the uninsured and that you were taking some steps to do better case management and mitigate the impact on the hospitals while providing high quality care for the patients.

Can you update us on the progress as far as that's concerned?

And what I'm really getting at here is that it sounds like the uninsured are a fact of life.

We need to learn to live with it.

You've increased the point of service collection as one aspect, sort of better case management as another aspect.

But how much more room is there to mitigate the impact of it throughout your hospital system on the financial performance of the Company?

Sheryl, this is Beverly Wallace.

Yes, those action plans are still in place.

We implemented the plans last July and some of the hospitals came on early, some came on a little later in the process.

So we are still working through the structure of the case management but we believe long-term that will be a benefit not only for the uninsured but for all of our patient population.

And then on the front end collections, we continue to test and validate some technologies out there to get better intelligence around what the out-of-pocket will be for individuals and as you see to our numbers, we continue to improve year over year point of service collections.

So is the goal here to get the Company to the point where there is a certain immunity towards a fundamental level of uninsured heads in the beds?

I don't think we can predict that.

It's what shows up at our door and what level of care they need.

No, I understand that.

But what I'm saying is mitigating impact.

In other words, so that the stock market doesn't need to be hysterical if its 5% of your admissions.

That's what I'm getting at.

This is Richard.

Let me just mention a couple things.

The increase of self paid for the quarter was like 900 admissions.

If you think about the number of admissions that we have over the course of a quarter, we did a calculation, it's like one per hospital per month.

I mean so these aren't just like massive changes in what's happening at the hospital in terms of the patient volume.

It's costly, of course.

It's free care at its basic but it is sort of part of the dynamic of the marketplace and at these levels, where we have it at now, I mean we are handling it.

I think there is some tangible ways that's showing up in some other metrics.

For example, on observation days, you have seen a lot of observation day comments from the various companies.

In our case, observation days are up and half of its because of our case management, of better case management, around the self pay patients.

So we are working it as hard as we can, appropriately as we can.

At these levels, we can accommodate it.

That's great.

That's what I was trying to find out.

Thank you.

Sheryl, thank you.

From Merrill Lynch, we have A.J. Rice.

Hello everybody.

I was just going to ask on the initiatives in the supply management area, orthopedics in particular I guess, but even more broadly I know at one point you said you were going to update us this quarter where some of that stood, maybe ask for that.

All right.

A. J., thank you.

Jim Fitzgerald, you want to address that.

Yes.

Good morning, A.J.

How are you?

Good.

On the orthopedic side, I would first of all summarize where we are as being where we think we need to be according to our overall plan.

So we feel very comfortable where we are.

All of the corporate related work on contracting and the OIG gain sharing submission has been completed.

So much of the work now really is in operations.

That's going very well.

We've had each division with planning meetings with the three contracted vendors.

We have had extensive meetings with our surgeons communicating both the contractual piece of the plan as well as the gain sharing program.

At this point, we have over 50 surgeons that have signed up to participate in the program and we have already had at this point a handful of conversions.

But I would also say that again we are only about 45 days into this.

There has been an awful lot of training taking place with our surgeons and so I think we will have a better feel for the actual conversion numbers over the next 30 to 45 days.

But again, to summarize, I think we feel comfortable that we are where we need to be according to our plan.

Just real quick on that, is there any indication about when you would hear from the OIG and is it related to all the facilities?

And then I know we had a group down there, there was some comment about a cutoff date of buying from non-approved vendors or non-contracted vendors.

Can you remind us when that date is?

Yes.

We have until the end of the year to complete the conversions.

The OIG, there's no way to predict.

We have responded to some questions they have but at this point we don't have any idea when they may respond.

That's for all the facilities?

Yes.

Okay.

Thank a lot.

A. J., I would just add that orthopedic volumes were up 4%.

Up 4%.

Okay.

I think the 4% actually was since the program was initiated.

I don't know what the quarter was but so far the month of June when the program started.

A. J., thank you.

Now we have Glen Santangelo with CSFB.

I had a quick question about salaries, wages and benefits.

You showed some nice improvement in the quarter off of which you would think was relatively lower than expected admissions and you cited earlier in the call that you had some productivity gains.

Could you maybe just give us a little bit more clarity on what you mean by productivity gains?

Because I'm trying to assess how you did it and ultimately the sustainability of those types of improvements?

Thanks.

Thanks, Glen.

Richard, you want to start it?

Maybe I will let the group guys talk about it since they've, they work with divisions of the hospital.

But of course productivity is a measure of man hours per volume unit and quite frankly when I think about productivity, you think about your variable labor, that is, that labor that fluctuates with census levels or treatment levels, and then fixed labor which is independent of that.

Of course, you know we've been pretty conscious about managing our fixed labor levels in this Company through our passes, through our supply chain operations, regionalized supply chain operations, et cetera, and despite that, the major goal of this is to improve performance, it also has the effect in some cases of pulling fixed costs out of the system which was certainly a byproduct that we were trying to get.

So we've been able, in some cases, to pull fixed costs out of the system.

But most of the productivity management really comes in the management of the variable labor in the hospitals and this is really the hard work that the hospitals do with their clinical leadership and being sure they have the right number of employees based upon the acuity of the patient, on an as-needed basis.

If there are swings that basis they go up.

They have methods to add labor.

If there are decreases in volume or unanticipated decreases in volume, that they are able to flex and bring that cost out of the system.

And it's a day-to-day, shift-to-shift, focus that goes on.

It's a fundamental part of what our operations do in the field every day.

Charlie or Sam, either of you want to add a comment?

If you look at the specifics of our experience in the quarter, what you see is that the facilities that had challenges in terms of their volume were really holding their own with staffing.

That is they were managing down very nicely.

The facilities that had increases, in Georgia, in Orlando, were doing a great job of taking advantage of the volume increases and improving their productivity as that volume increase is occurring.

So the net of that produced really good results.

Charlie, thank you.

Glen, thank you.

Thanks.

We will now here from Ellen Wilson with Sanford Bernstein.

Yes, thanks.

A couple of follow up questions on bad debt.

Could you talk a bit more about the up-front cash collection initiatives, the dollars realized this quarter versus last, and kind of where you are in the roll-out to the facilities and then I have a related follow up.

All right.

Beverly, you want to address that?

Thanks Ellen.

On the up front collections, last quarter I think we reported that we had collected 33% of the available co-pays and deductibles and this quarter 39%.

We are working actually with three vendors, different vendors out there, to get better intelligence around what the out-of-pocket is from the patient at time of pre-registration.

That, coupled with some in-house technology that we are piloting, is really enhancing our ability to give the patient some evidence around what they owe on deductibles and co-pays and there in lies the ability to collect.

So I think, as we finalize rolling that out throughout the Company the rest of this year, we will continue to see enhancements in that area.

In terms of absolute dollars, if memory serves me it was like 63 million last quarter.

In absolute dollars this quarter?

Yes. 68 million this quarter.

Going to kind of what's your objective?

Our objective is to be north of 40% on a consistent basis.

Okay.

And then a very quick follow up.

Milton mentioned the uncollectability ratio, the reserve assumption.

Could you highlight that again?

You said 30 basis point change up kind of from what to what?

Yes, it moved up 30 basis points from where it was in the first quarter as far as uncollectability percentage.

So I think it moved up to about 78.8 from 78.5.

Okay.

Thank you.

Ellen, thank you.

Now we'll hear from Kemp Dolliver with SG Cowen.

Thanks.

Good morning.

A question related to the discussion regarding the rehab business.

Could you just, one, review the impact again and also talk about likely ongoing impacts since the threshold for qualification went up on July 1 and I imagine you are going to be dealing with this issue on an ongoing basis for at least the next few quarters.

Thank you.

Does anybody wants to volunteer there?

Sam or anyone?

This is Rick Shallcross, CFO of the Western Group.

We have a system where we monitor our compliance with the 50% criteria each month.

We manage the admissions very closely in each one of our units to make sure that we don't expect to fall below that threshold during their measurement period.

And we feel pretty good about where all of our units are right now.

We are not expecting any significant adverse outcome.

Thank you.

What was the rehab impact in the quarter?

We were down in the quarter, 1285 rehab admissions, which is about 20% of our rehab compared to last year.

Thank you.

I think we have time for one last question.

That last question will come from Adam Feinstein with Lehman Brothers.

Okay.

Thank you.

Slipped in under the gun there.

Just my question, one quick housekeeping question, and then a bigger question, could you just give the absolute dollars for malpractice in the quarter excluding the reserves?

And then just my follow-up question, just I think if I heard earlier on the call, you said your Medicare revenue per case was up over 6%.

Just wanted to get some more clarity there in terms of what was driving that.

Did your outpatient dollars move up another quarter, anything there, and should we look for similar growth in the future?

Thanks.

Right.

Milton, you want to address that?

Sure.

Adam, our insurance expense for the quarter was about $64 million versus about 38 million last year.

Of course, we had the bigger malpractice pick up last year.

Adam, that's about 100 million adding back that adjustment that was taken.

And on the malpractice, I'm sorry, on the Medicare net revenue per adjusted admission.

It was up 6% this quarter.

We did have a slight acuity increase, just under 1% acuity increase, in the Medicare payer class this quarter.

It's reflects pretty good surgical volumes for this quarter.

It did as well.

And should we look for that type of growth for the future in terms of the Medicare revenue?

Adam, as you know, those numbers move around quarter to quarter based on, as Richard was pointing out, the intensity of the service and it's hard for to us predict that going forward.

Obviously we are in a very good environment this year from a Medicare reimbursement standpoint from the increase.

But we wouldn't predict that we could keep that percent.

And was there any pick up from the out lier payments with the thresholds moving lower?

I believe our out lier payments in total were about 39 million this quarter.

That's up, I think, 3 million over first quarter.

Okay.

And year over year I think it was up about $11 million.

So we did pick up some.

But I think the big swing goes back to the patients that hit the hospitals.

If you go back to first quarter, I think Medicare NRAA was up in the 4-ish range.

Because it was, you had the higher flu season, you had you more medical patients this particular quarter, obviously more surgical patients.

So it will move around and it's kind of in the range of expectation.

With that, I want to thank Adam.

Thank all of you and we appreciate it very much.

Mark and I will be here all day to answer any questions you have.

Thank you.

Have a great day.

That concludes today's conference call.

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