環球健康 (UHS) 2009 Q2 法說會逐字稿

Good morning. My name is Candace, and I will be your conference operator today. At this time, I would like to welcome everyone to the 2000 -- I'm sorry -- second quarter 2009 earnings release conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question-and-answer session. (Operator Instructions) Thank you. Mr. Filton, you may begin your conference.

Thank you. Good morning, I'm Steve Filton. Alan Miller, our CEO is also joining us this morning. Welcome to this review of Universal Health Services results for the second quarter ended June 30, 2009. As discussed in our press release last night, the Company recorded adjusted net income per diluted share of $1.44 for the quarter representing a 36% increase over the adjusted net income per diluted share earned during the second quarter of 2008 as calculated on the supplemental schedules included with last night's press release. Combined with our better than expected first quarter earnings, we earned adjusted net income of $2.81 per diluted share during the six months ended June 30, 2009, representing a 24% increase over the adjusted net income per diluted share earned during the first six months of 2008. During this conference call, we will be using words such as believes, expects, anticipates, estimates and similar words that represent forecast projections and forward-looking statements. For anyone not familiar with the risks and uncertainties inherent in these forward-looking statements, I recommend a careful reading of the section on risk factors and forward-looking statements and risk factors in our Form 10k for the year ended December 31, 2008.

We would like to highlight just a couple of developments in business trends before opening the call up to questions. On a same facility basis in our acute care division, revenues increased 2.9% during the second quarter of 2009. Adjusted admissions to our hospitals owned for more than a year were up 3.1% for the quarter. We remind you that in 2009, our Centennial Hills hospital in Las Vegas was included in our same store comparisons and while we continue to believe it has cannibalized some of its volume from our existing facilities, overall adjusted admissions in the Las Vegas market are up 3.5% in the second quarter. On a same facility basis, revenue per adjusted admission was basically flat with last year's quarter, due mainly to a difficult comparison. Q2 '08 revenue per adjusted admission was up 7% and a significant increase in charity care. We define operating margins as operating income or net revenue less salaries, wages and benefits, other operating expenses, supplies expense and provision for doubtful accounts divided by net revenues.

On a same-facility basis, operating margins for our acute care hospitals increased to 16.8% during the second quarter of 2009 from 14.7% during the second quarter of 2008. The margin improvement results mainly from the significant cost controls and was realized throughout the acute care portfolio. Our acute care hospitals provided charity care and uninsured discounts based on charges and established rates amounting to $181 million and $159 million(Sic-see press release) during the three month periods ended June 30, 2009 and 2008, respectively. On a same facility basis, revenues in our behavioral health division increased 4.0% during the second quarter of 2009. Adjusted admissions to our behavioral health facilities owned for more than a year increased 1.0% during the second quarter and revenue per adjusted admission rose 3.0% over the comparable prior year quarter. The adjusted admission comparison is a difficult one as adjusted admissions rose 8% in the second quarter of 2008. Operating margins for our behavioral health hospitals owned for more than a year increased to 26.3% during the quarter ended June 30, 2009 as compared to 25.1% during the comparable prior year period.

Our cash flow from operating activities was approximately $145 million during the second quarter of 2009 as compared to $67 million in the second quarter of 2008. At June 30, 2009, our ratio of debt to total capitalization was 35.5% and the ratio of debt to EBITDA was 1.7 times. We spent $105 million on capital expenditures during the second quarter. Included in our capital expenditures were the construction costs related to a new bed tower at our Summerland facility in Las Vegas and the 220-bed Texoma replacement hospital, both of which are scheduled to be completed in late 2009 and a new 171-bed hospital in Palmdale California, which is scheduled to be opened in the second quarter of 2010. Approximately half of our total capital spending in the first six months of 2009 related to the to these three project. At the end of the second quarter, we completed the acquisition of Centennial Peaks hospital, a 72-bed behavioral facility in Louisville, Colorado. Our new behavioral facility in Fayetteville Arkansas is scheduled to open in the third quarter. We also have multiple project to say add capacity to our busiest behavioral facilities. We opened a total of 119 new behavioral health beds during the first half of 2009 and anticipate opening a total of approximately 600 new beds in our existing behavioral health facilities in 2009 and 2010 combined. We will be pleased to answer your questions at this time.

(Operator Instructions) Your first question comes from the line of Shelley Gnail.

Hi, thanks for taking my question. Dave, my first question, just from a high level, can you talk about whether you're seeing a divergence in trend in your markets where there is a county hospital such as Las Vegas versus where the UHS hospital serves that function?

I think it's a bit of a mixed bag, Shelley, but I do think that having a county hospital or something like that in the market certainly spreads the burden of treating the uninsured. But in a market like Las Vegas, for instance, where there is a county hospital, one of our hospitals, Valley hospital essentially shares the campus with the county hospital and clearly, we've seen our pair mix. I think weaken at Valley more so than the other hospitals, and I think that's a function of the county hospital cutting back on some services, et cetera. But in markets like McAllen or Manatee or Aiken where essentially we play the role of the county hospital and historically have done so. We've certainly seen pair mix weaken in those markets probably a little bit more than we have in markets like GW where we don't necessarily play that same role.

Have you seen that trend spike in any of those markets yet?

I think it's fair to say obviously in the quarter, we saw, as I discussed in my opening remarks, a $22 million increase in charity care in the quarter. I think it's fair to say that that increase was felt throughout the portfolio. It was not centered or focused in one particular market, and it's a trend that we see throughout the portfolio.

Okay, great. Thanks. And then just a quick question on the acute care revenue per adjusted admission. I understand it was a tough comp, but can you talk a little bit about -- are you seeing changes in CMI or any other drivers that have impacted that number?

Well again, not to be repetitive, but I think that the main driver that suppresses the acute care revenue per adjusted admission is that charity care number. I think if you take out that $22 million increase, you get to a revenue increase probably more along the lines of what most of us expected. So I think that's the main driver. We're seeing case mix or acuity increase very incrementally, increasing I would say on average over the past couple years maybe by 1%, 1.5% a year, but no other significant changes like that.

Okay. Thank you.

Your next question comes from the line of AJ Rice.

Thanks. Hi, everybody. A couple quick questions if I could ask. First of all, maybe a bigger picture. You guys raised the guidance for the year. Obviously, strong outperformance, at least relative to consensus expectations in the current quarter, but you don't give quarterly guidance, so it's a little hard to know. When you look at year numbers and the way they lay out, are you -- the raise in guidance, my sense is it just reflects what's already happened, the strong outperformance in both the first and second quarter and that you're basically leaving the back half of the year relatively unchanged with where where you were previously. Is that the right interpretation of what you've done with the guidance?

I think that's relatively fair, AJ. As we said in the first quarter, our own internal estimates were a little bit ahead of the street, although frankly not as much in the second quarter as they were in the first,. But our expectations, I think, for the most part, are that we largely meet our own internal guidance for the back half of the year. I think that the factors that sort of go into that thinking are the big increase we saw in charity care in the second quarter and the uncertainties about what that implies for the back half of that year. Will that number continue to rise? Will it sort of stay at those levels? We certainly don't, frankly, expect charity care and bad debt to come down in the back half of the year. As we discussed in the first quarter, we got a big boost from the turn around at Centennial in the first half of the year and mechanically, it will not be possible to replicate that sort of outperformance over last year and the second half of the year. And thirdly, as everybody who follows the company knows, the last two years, the second half of the year has definitely been more difficult,, noticeably so. So I think those were the three major factors that went into what we would describe as a cautious approach to guidance for the balance of the year.

Okay, and then the other question I'll ask now is on your use of your cash flow. Obviously, it looks like you had a very strong cash flow number in the second quarter. You mainly paid down debt, closed one behavioral health acquisition right at the end of the quarter. Give us some flavor for how much powder you really need for possible acquisitions. What does the acquisition market look like out there? And then, do you think in the back half of the year you'll become more aggressive on the share repurchase or any other use of cash dividend or whatever.

AJ, I think as you've heard us say in these calls before, our expectation has been and I would say that it continues to be that given the environment that we're in, given some of the other uncertainties, given the particular challenges that our not-for-profit peers, or at least many of our not-for-profit peers face, our expectation is that there will be a greater number of M&A opportunities and a higher quality of M&A opportunities. But in fairness, I think for the most part, those opportunities have not yet materialized in a great way. I think that our second quarter use of cash reflects the fact that as you described it, I think we were trying to mostly keep our powder dry for those sorts of opportunities, but given our own performance, we certainly feel like buying back our stock remains an attractive and compelling investment and we're happy to do that. If it appears that we're not going to have other opportunities for our cash, as you point out, mostly, we've been paying down debt in the last quarter or two and frankly, we're paying down revolver debt which is -- we're borrowing at pretty low rates, LIBOR plus 60 basis points, so we don't feel an urgent need to do more of that necessarily.

Okay. Thanks a lot.

Your next question comes from the line of Gary Lieberman.

Thanks. Good morning. If you could give a little bit more detail around some of the expense items. It looks like some of the market expansion you had was due to controlling your expenses and maybe you could talk about what you've been able to do and what you expect to continue to be able to do throughout the rest of the year on the expense side.

I think continuing the commentary that we made in the first quarter on this subject, Gary, I think like many of our peers in the fall of last year anticipating a significant weakening of the overall economy, our operators began a very comprehensive initiative to look at our costs structure and infrastructure throughout both of our businesses and to reduce any cost that we could that would not compromise our quality of care. And I think , obviously the results in the first half of '09 reflect the fact that they've been very successful in doing that. Obviously, they did so in an environment where we're seeing less inflation or more disinflation, however you want to characterize it, than we've seen in quite some time, and I do think that lack of inflation is a significant difference in this downturn that we're experiencing now and the one that we experienced earlier in the decade. So what I think the two -- the two dynamics together, our very proactive response as well as the disinflationary environment have allowed us to very successfully reduce costs, again, really both pervasively functionally meaning in salaries, in supplies, in other operating expenses as well as geographically across the portfolio, meaning that we're not necessarily cutting costs only in a particular market. We're really doing it across both acute care and behavioral portfolios and across all geographies. We've been very successful doing it. I think in some ways, the performance in the second quarter is even more impressive because in the second quarter, we had to overcome this very significant increase in charity care. So we could get in and talk about specifics, what we've done in terms of deferring pay raises and asking for reductions in fees from vendors, et cetera, but all I can tell you it's been a very pervasive and

Okay, and focusing on that other expense line, it's pretty clear and intuitive, the decreases from salaries and benefits and supplies, but within that other line which is a little bit less clear in terms of some of the things that might be in that, you do feel comfortable that some of that will continue throughout the rest of the year and was there anything one time that might not recur in the second quarter?

Obviously, other than the one item that we disclosed which was a reduction in malpractice expense of approximately $23 million pretax, which is on that other operating expense line and which is not included in our $1.44 adjusted EPS for the quarter, no, I don't think there's anything unusual. I know a number of analysts commented to me that other operating expenses are coming in below their model, more so than either of the other lines. I can tell you that in our own modeling, we're having the same benefit on that other operating expense line that we are in salaries and wages. Although I understand the idea that people didn't necessarily expect a lot of improvement on that other operating expense line, we've always characterized it as including more fixed and semi fixed expenses than either salaries or supplies. But I think it's, again, it's a reflection both of our efforts and of the disinflationary environment that we've been able to reduce the sorts of things that you have on that line, marketing expenses and physician payments and utilities and insurance and taxes and again, across the board, we've even had success in reducing those fixed and semi fixed costs.

Okay, great. Thanks for the color.

Your next question comes from the line of Adam Feinstein.

Okay. Thank you, good morning. Maybe just to talk a little bit more about some of the key markets, just wanted to get an update on Vegas. It sounds like you guys have done a good job advancing through what's been a difficult environment there. So just wanted to get some color in terms of what you're seeing.

Well, just on on overall basis, Adam, I would say that one of the interesting things I think about this quarter is that our strong performance and our excess to budget, if you will, was felt really throughout both portfolios. You know and in the past, many times a strong performance in a quarter was very focused on any particular market whether it was Vegas or McAllen or vice-versa where some weakness was felt in a particular market. But I think largely because so much of the excess of budget was related to cost controls and items within our control, it was felt,again, much more ratably throughout the portfolio and most of our markets were ahead, very few markets were behind, and really only a handful of anything were materially behind. As far as Vegas goes, I know people look at the minority interest line as a proxy for Vegas performance and usually, that's not a bad way of doing things. You can see that our minority interest expense is up for the quarter. It implies that we're slightly ahead in Vegas, we're ahead in GW, those are our two big markets that contribute to that line. And again, you've read, as we have, the discouraging news that comes out almost daily about the Vegas market and the over arching dynamics of the economy in Vegas, the fact that we're ahead in Vegas of last year and been so throughout this difficult economic period is, I think, a testament to our operators in that market who have done all the things I just described. All of our operators are doing, but I think it's even more of a challenge in that market.

And just to follow-up question with respect to Vegas. With the Centennial Hills hospital just -- are you continuing to see a pretty big ramp up there, and you had called out earlier in the year in terms of what the incremental benefit would be this year, but just curious whether you think it's going to be better than what you had said at the start of the year?

Right. Well at the start of the year we talked about the fact that our guidance presumed $14 million or $15 million dollar EBITDA turnaround just at Centennial Hills and in fairness, we're pretty much there after six months. I think we think that Centennial will continue to improve in the back half of the year, but as I indicate I think in my comments to AJ, we certainly won't be able to replicate that sort of improvement in the back half of the year, mostly because of what happened last year. We had, especially in the first quarter of last year, actual start up and operating losses, so the turnaround was very significant in the first quarter, but Centennial has -- I know Alan has commented on in many of our calls, really since Centennial opened in January of '08, just continues to exceed our performance every period and we're just very enthusiastic about not only its performance in its first 18 months of operation, but it's long-term prospects, I think are even more encouraging.

And then just final question, maybe one for Alan here, curious to get your thoughts in terms of health care reform. I know it changes every day in terms what have we're hearing out of Washington, but just curious to get your thoughts in terms of what you see happening?

Adam, as I've spoken on the air and I've written, the big thing to look at is the public option. The public option, to me, is clearly socialized medicine in two steps. It will decimate the insurance companies, the 1,300 insurance companies, so there's plenty of competition in the insurance companies now. That seems to be weakening a little bit, but to me, that's part -- most of the game. The other thing is 80% of Americans are satisfied with their health care and they're really working on 20%. And the other thing that I think is coming clear is that the 47% of uninsured is now down to 45.7%. People have moved into the SHIP program, couple of million people off the insurance roles. So as people are finding out more and more about it, it's becoming less and less compelling, I think.

Right.

And the last thing I'll say, without getting into more details, but I am familiar with -- pretty -- very familiar with it, I think that it's positive for our industry because what they're talking about is increasing coverage and that's got to be helpful in charity, as Steve talked about, and bad debt. So I think it's a positive for us. How this thing goes forward, I would guess that it's so important to the Democrats to pass something that something will probably get passed by the end of the year, but I think it's going to be not bad for us.

Okay, great. Thank you.

Your next question comes from the line of Ralph Giacobbe.

Thanks, good morning. I just want to back to the guidance to Steve for the back half of the year, maybe more specific on the pricing side in terms of government reimbursement, what's embedded into your expectations on that. I think in the previous call, you had said sort of a 0% to 1% increase in the fourth quarter. Wondering if that's still consistent or if you've been more conservative there. And even on the Medicaid side, given fiscal budgets, many of which start in the midpoint of the year, any changes to your thoughts there?

Well, sure, Ralph. I guess just a couple of overarching comments first. To me, the performance in the first six months from a revenue perspective is a fairly decent proxy for what our expectations would be for the balance of the year. So to me, same store net revenue growth, 2% to 2.5 % in acute and maybe 3% to 4% in behavioral seems reasonable in thinking about the performance in the back half of the year. As far as the specific question, I think you're asking about Medicare rates. The IPPS rate is still -- the final IPPS rate is still scheduled to come out by the end of August. We mentioned in our first quarter call that our '09 guidance had presumed that that would be a 0.5% or 0.6% increase. Obviously, the preliminary rule that is out there has a minus 0.5% increase. That's a couple of million for us in the quarter. I don't think enough to make us sort of think any differently about our guidance. We have not really seen any new Medicaid changes in the second quarter. We certainly note that any number of states are struggling with state budget issues. It's entirely possible that another state or two will try and deal with the issue in the back half of the year. But again, I think our general notion is that Medicaid rates will not change dramatically, at least dramatically enough for make us to think differently about the guidance. So I think our general thought is more of the same in the back half of the year and repeating what I had said in response to a question before, probably the most difficult part of the revenue equation to predict is what happens to uncompensated care. We presume that the increase we saw in the second quarter will continue to be a trend, but the magnitude of that trend has been difficult for us to predict in the past and certainly difficult for the industry to predict.

Okay. And then any swine flu impact in the quarter or any you could see?

I think that the impact of the swine flu was probably most notably seen just in our level of ER visits. I know at least one of our peers yesterday discussed a fairly big uptake in ER visits and I think our ER visits were up in the upper single digits in the quarter. And while I don't think that's exclusively related to the swine flu, it certainly was evident that in some of our markets like south Texas where the swine flu is fairly prevalent, we did see a big uptick in ER visits. For the most part, it was limited to ER visits. We saw very few actual admissions from those visits, et cetera. So I think at the end of the day, the impact on profitability in the quarter was fairly minimal, but again, it was -- I think probably contributed both to the increase in ER visits and the increase in charity care in the quarter.

Okay. And then any notable changes in maybe the distribution of receivables by aging buckets at all that you noticed?

No. I think if you note our days and receivables are down into the low 40s in quarter. That's probably about as low as I can recall. I think we had a particularly good cash collection quarter. I would say maybe $20 million of those cash collections were a little unusual in the sense that we probably collected about $12 million or $13 million of stale dated Illinois Medicaid that had been aging quite a bit during the quarter, and that's actually fairly typical of what happens in Illinois seasonally. We collected about $6 million or $7 million on our construction contract which tends to bounce around each quarter, but even if you discount that $20 million or put it on the side, we had a very strong cash collection quarter. I don't think we're seeing any sort of significant deterioration in our aging. I think we're being very timely about our recognition of bad debt and charity care adjustments, et cetera. So I think in that sense, we feel like we're tracking any changes in our payor mix very careful and very closely.

Okay. Then just my last one. Any change to that -- to your uninsured or charity care policies in terms the upfront discounting?

No. We have a 20% uninsured discount for anyone who comes to our hospitals with no insurance, and that policy has been in place now for several years. So no changes to our actual discounting policies or to our accounting policies.

Okay. Thank you.

Your next question comes from the line of Darren Lehrich.

Thanks, good morning, everyone. I just wanted to follow up on the uninsured discussion. What was the uninsured patient admission growth, if you could just share with us the statistics?

Yes, Darren, so our adjusted acute admissions for the quarter were up 3% or so, and I think our self-pay or uncompensated admissions were up close to twice that, between 5.5% and 6%.

Okay. And then related to the $181 million of charity plus discounts, are you able to separate that out for us at all just to -- so we can get a sense for what is the charity number discrete from the discount number?

The charity number is 148 and the uninsured discount is $33 million in the quarter.

Okay. And I think Ralph asked this question, but you answered it with regard to the discount policy not changing. As it relates to the charity policy changing, I'm sure that -- or charity numbers changing, I'm sure that relates to the uninsured growth, but is there any discussion at all internally about whether you're maybe allocating too much to charity and not pursuing collection? Could you just help me think about the absolute dollar growth in that bucket?

I think, Darren, actually, from an uninsured discount policy, we actually have one of the lower uninsured discount rates in the industry. And I think that the reason we do so is that in a number of markets, I think south Texas comes it mind, we have some relatively wealthy uninsured patients. Sometimes they are Mexican nationals who come to our hospitals and we're conscious of the fact that -- and these are relatively rare cases, but certainly feel like those people are more than capable of paying their bills and we're not looking to give them a discount more significant than they really need or deserve. So no, I think we're sort of very focused on the idea that if somebody meets our charity care guidelines, which are usually triggered off of federal poverty levels, they are really are not going to be able to pay their bills and we recognize them as charity care. We don't attempt to collect those, but people who don't meet those criteria, I think we aggressively try to collect those bills.

Okay. And then, Steve, the acute care bad debt, rough math would suggest it's about 12%. Can you give us a spot number?

Yes, just give me a second. It is 12%, Darren.

Okay. Very good. And then I guess a question for Alan. First of all, the New Yorker article that spurred a lot of discussion nationally and I'm just curious to get your perspective on that story. You're a big provider of health care services, obviously, in south Texas and how you think that story is resonating in the market.

I'm certainly aware that it's gotten a lot of readership in Washington. It's been discussed off and on, but basically, the article relates to doctors. I mean, the doctors are the one that do the charging. They order the tests, and I just think it's part of the mix in what's happening now and I don't think that it's going to -- it's not doing anything on its own. I think it's used for people who make a point out of certain -- would like to control costs escalating a little more, but it's directed to the doctors and actually, I think our competitors were -- did most of the talking and were quoted and I think that they may perhaps be a little sorry about the openness that they gave to the reporters.

And just commentary about McAllen. Steve, it sounds like the results were pretty broad based, but you had a turnaround in that market specifically as well. Can you comment as to how that turnaround is progressing?

Sure. And I think to your point, Darren, we have made the comment certainly over the last quarter and maybe even over the most recent quarters that McAllen has been rebounding in a fairly significant way and has been well ahead of the prior year in some of the previous quarters. In the second quarter, that performance tempered a little bit. We have disclosed that the physician hospital did open some new capacity towards the end of the first quarter and that has had some impact on us. In addition, while I think that is a market that has been slow to feel the weakening economy effects, I think we're starting to see that more and more in that market, which obviously is affecting everybody. So again, McAllen's performance was tempered a little bit in the second quarter, but it still remains ahead in the prior year, still remains markedly ahead of where we were a couple of years ago, still is generating operating margins that are now at least equal to if not better than the acute care averages.

Okay, fair enough. And then my last question, would love to get some more details on the medical malpractice accrual or reversal you were able to take. Can you just help us think about the circumstances there and whether you think there's any sustainability at all to the medical malpractice levels you're accruing now?

Sure, Darren. The last favorable medical malpractice adjustment or accrual reversal that we recorded was back, I believe, in the second quarter of 2007, and I think that, frankly, the dynamics that we discussed at that time are still equally as relevant. We talked about the favorable impact of tort reform in a number of important states for us, Nevada, Texas, Florida. I think that if nothing -- the intervening two years reinforced that notion of how important that notion is. We talked about our focused attention on some very high risk service lines like OB, and again, the intervening performance in the two years since then has just reinforced the notion that we have successfully reduced the number and amounts of claims in those -- that particular high risk area and in some others. And then finally, I think that -- this is more of an internal issue, but our hospitals have gotten an lot better about very timely reporting of malpractice claims, so we don't need to have as much as a cushion in our malpractice accrual for the incurred but not reported claim.. So we think it's sustainable. We've actually tried to work with our actuary to -- because quite frankly, our preference would be not to record in essence an inflated malpractice number and then every two years have to back off the accrual. We'd rather record a more accurate number on a current basis. So trying to provide data that is responsive to our actuary's needs so that going forward, we'd hopefully see some sort of modest reduction in the current malpractice expense that we record, which would reflect our favorable performance. So I suspect that we'll see a couple million dollars of benefit if the back half of the year from what we would have expected, and I think we're likely to see, absent any significant changes from where we are now, a slightly lower rate of accrual in 2010.

Great. Very helpful. Thanks.

Your next question comes from the line of Kevin Fischbeck.

Okay, thank you. Question here on Vegas. You did a good job talking about the trends so far. It sounds like the quarter was pretty solid. I just want to get a little bit more of a sense from you what your near term outlook is there, and you didn't particularly highlight Vegas as an issue for keeping the second half of the year guidance somewhat in line, except maybe to the extent that you -- that it applies to the general concept about uncompensated care increasing. Just want to get your thoughts about where you think Vegas will be trending over the next six to 12 months.

To some degree, Kevin, the question was asked and answered. I think that your point is well taken. As I said in my opening remarks, we're cautious about the impacts of the economy and increased charity care and certainly Vegas, both because of its size and importance so us as both because it has experienced -- as you reported and pointed out on any number of occasions, particularly weaker economy. We do have concerns about Vegas. We've seen generally, I would say for probably a year now, the same sorts of trends in Vegas which are relatively strong volumes, market share improvements, et cetera, on the part of our hospitals. But definitely a weakening payor mix, and I think our expectation is that those are the trends that we're likely to see continuing. So I would just sort of reinforce the idea that some of our caution in the back half of the year and in our back half of the year guidance is definitely related to those trends in the Vegas market.

Okay. Then you mentioned earlier in response to another question to that -- the operator did a good job kind of offsetting those trends. What in particular would you cite as the things that the managers are able to do to work against the settlements.

Again, I think that that -- it could be an extremely lengthy conversation, and actually an interesting one in some form, probably not this one. But I think that we have taken advantage of the disinflationary environment and as I've said before, we've deferred some salary or merit increases. Certainly when we've given merit increases or negotiated, we don't have many union contracts but as we've negotiated union labor contracts, we've negotiated them at rates lower than we would have otherwise expected. We have some productivity reporting tools and management tools that I think allow us to be a little bit more labor efficient. We have talked at some length in previous calls about switching our GPO back in April of '08. I think we have clearly gotten a benefit from that in the -- in significant millions of dollar range. As well as further benefit from asking vendors to reduce price increases or hold prices flat, et cetera. We've -- I think I alluded before, cut down some of our physician payments. We've reduced discretionary marketing and business development expenses. We have gone back to, I would say, every third party vendor that we do business with and in -- ask for rate reductions or fee reductions and I would say in most cases have got be those. So the only think I would reinforce is the comment that I made before, the efforts are across the board in both divisions and they are very comprehensive, very pervasive, literally down to the level of every single payment that we make.

Okay. That seems to be a theme throughout the industry, that companies are taking advantage of the disinflationary environment. Is the thought process, as you're looking at 2010, that if the economy continues to be weak, bad debt, uncompensated care will probably rise, but you will have a similar opportunity to do this again next year or (inaudible) is going to be less because you've done a lot of the easy stuff this year?

There's nothing easy about it. I think what you've seen is just the quality of management, and Steve tried to detail all of the different things that a manager does, but he couldn't hope to catch it all because they're making decisions every day, and the thing that we've seen is that it's across the board. It's in both divisions. The margins are up in both divisions, and I think it's a testament to the quality of the management and their capability and their adaptability into taking advantage of every opportunity they have, and that will continue. And I'm just very pleased, and I think all of the shareholders should be with what's been accomplished in a very difficult setting.

Clearly, the company and the group has done a pretty good job -- better than expected job on the margin side this year. One last question. The -- going back to the acquisitions. It seems like the company, in the last couple of years, anyway, has been focusing more on the behavioral side when doing acquisitions rather than the acute care side. Can you give us some thoughts about why that was and going forward, (inaudible) looking at more details, do you have any thoughts about why it might be more focused to one or two divisions?

Sure, Kevin. I think to some degree, this is just the law of numbers. We have found, I think, over the past few years that competition for acute acquisitions has just been greater, just because there are just more companies both the large, both publicly held and privately held companies, the smaller private companies and some of the start up acute care companies. But in any particular acute care acquisition, we may have found ourselves bidding against 10 or 12 qualified buyers including some not-for-profits in individual local situations, and I think that that had the effect of bidding up prices on acute care acquisitions. I think one of the reasons why we have said in the last few quarters that we expect that situation to change for the better is that as you're well aware, I think any number of those previous bidders are on the sidelines because of the amount of leverage they've taken on or other issues that they may have specific to their companies. On the behavioral side, the number of bidders for properties has, just by definition, been last. Certainly psych solutions has been an aggressive competitor for most M&A opportunities, and there have been a couple of start up venture funded companies over the last few years. But at the end of the day, I think we always find ourselves bidding against less competitors on the behavioral side that we have on the acute side. So I think that has been the explanation over the last few years. I think both the number of acute opportunities is likely to change as we move forward just because so many of our not-for-profit peers have struggled with financial challenges, decline this their endowment values, increases in their pension obligations, increased capital costs and financing costs. All those things I think have challenged any number of not-for-profits who may decide that sale of their assets is the most appropriate course for them. So I think that that balance may change going forward, but I think it remains to be seen.

Great, thanks.

Your next question comes from the line of Frank Morgan.

Good morning. Two questions here. First, on the managed care pricing outlook, could you talk a little bit about how managed care contracting is looking and what percentage of your contracts you have got locked in. And then secondly, an update on dis outlook for Texas and South Carolina? Actually I've got a third one, too. What were your surgical volumes, both in and outpatient in the quarter? Thanks.

Surgical questions -- I'm going to backwards on the questions, Frank and if I forget, then you'll have to remind me. surgical volumes were a little shy of our overall admission growth, with inpatient surgeries being a little stronger than outpatient and again, at least in my own mind, that sort of being a logical progression because the outpatient surgeries may be a little bit more elective or discretion and in this environment, not a surprise to me that you would see a little more softness in a those outpatient procedures. As far as dispro goes, we -- the two states where we get the most disproportion share historically have been Texas and South Carolina. We do not have those numbers yet. Although we don't expect a dramatic -- certainly any dramatic unfavorable changes in Texas, South Carolina has actually changed their methodology and mechanisms a little bit, so I think they're incorporating more of the disproportionate share pool in your regular Medicaid payments. But at the end of the day, I don't think we anticipate much of a change in the economics. And as I promised, I now have forgotten your first question.

Managed care.

Managed care. We made the comment, Frank, I think in the last few quarters that our dynamics with managed care providers haven't changed much, both in terms of contracted rate increases that we're getting, in terms of the terms of the contract, both tenure and other terms in terms of utilization review. We're seeing -- I think you saw the acute care length of stay down a tenth of a day in the second quarter compared to last year, and that probably reflects a little more attention to utilization review on the part of some managed care payors, but the reality is I don't think that number has a lot of room to be reduced, so I don't expect major changes this that regard. So I think it has largely been kind of a status quo environment. These are our managed care contracts. As far as what we have got locked in for next year, I think at this point, Frank, it's probably over half between our multiyear contracts and the contracts that we have in place.

Any commentary on kind of the price rate increase there on the 2010?

I think we're still in that rage we've been quoting for some time now, which is in that 6% to 8% range.

Okay. Thanks.

Your next question comes from the line of Whit Mayo.

Hey, thanks. Have a third acquisition question. Sounds like the quality of transaction certainly isn't there for you guys, but just would be curious, I think certainly we've seen a lot of activity emerge on the distressed side, but would be interested on your opinion and observations for, what do transactions look like right now, the books that are coming across your desk? Are these hospitals with five weeks of working capital left? I just would like to have an idea of what you're seeing.

Whit, I think there are those kinds of opportunities out there. I would say that generally, again, I don't think you can ever completely generalize, but when a hospital is really significantly distressed, it's significantly distressed for a reason. And for the most part, those are not the properties we're anxious to step in and save somebody from bankruptcy or whatever because I think the upside in those situations is probably fairly minimal. I think historically, the deals have a that have been attractive to us have been those where a relatively strong, well positioned not-for-profit perhaps has been mismanaged, undermanaged, faces some significant capital commitment that they're looking for a buyer to come in and help them satisfy. We feel in many of those cases that there are both operating and revenue enhancement improvements to be accomplished, et cetera. So that's more of, I think, the profile of an acquisition that we would be interested in and not these, again, severely distressed properties.

That makes sense. And secondly, when you talk to your regional operators and you look broadly across your portfolio of assets now, are you seeing more opportunities at this point to make what I would call more offensive investments with capital spending than maybe, let's say a year ago? Obviously, a lot of the spending over the past couple years has been more defensive. So how do we think about the nature of the dollars that you're putting into your hospitals right now?

Well, I think you've characterized it properly, Whit. So much of the capital that we've spent over the last four or five years, particularly to me as a financial person has been frustrating because we've had to invest capital just to stay even to keep pace with our peers and the ability to earn a reasonable return on those sorts of investments is difficult, because if everybody in a market upgrades to a 64-slice CT, then nobody in the market really benefits, no market share changes, et cetera, and only the manufacturer of the 64-slice CT really benefits. I do think that is two phenomenon. We discussed this a little bit in first quarter, that is likely to take over over the next few years. I don't think we will need to spend nearly as much money just to keep pace, and that's a good thing, I believe. And then secondly, where we do spend money to your point, I do think we are going to do so in situations where there's a real opportunity for us to gain a competitive advantage, whether that's the recruitment of a physician or the redirection of a business or greater efficiencies. Whatever it may be, I do think that opportunity for competitive advantage and earning a return or more likely earning a return on the capital we invest is going to increase over the next few years.

Are there any markets that just stand out to you as having those characteristics? Is there one you say clearly we have a lot of opportunities right knew to take market share?

No. I think it's been a pretty pervasive reaction, Whit, that other than large projects that were already well underway, that most of our peers, both for-profit and not-for-profit have really scaled back their capital commitments. Again, it certainly varies, the magnitude varies by market. But I would say it's a -- this is a fairly valid generalization that capital spending has been cut back except for the most routine maintenance capital type of items.

Thanks a lot. Thank you.

Your next question comes from the line of David Bachman.

Hey, good morning. Thanks for squeezing me in here. I just want to circle back quickly to the other operating expense line, make sure I'm understanding there. So if look at what we did in the second quarter, add back that $23 million of pretax, looks like there's still, just on a straight dollar basis, down about $12 million or $13 million from 2Q of '08. Is that kind of fairly representative of the ongoing savings that you might be seeing there?

Well, and I know Kevin Fischbeck asked a similar question. I think it's a little hard to predict what we'll be able to continue to save and sustain because I think a lot of that relates to what happens to the overall inflationary environment, et cetera. But I'll sort of reiterate or reinforce the idea that there's nothing unusual other than what we've already disclosed in those numbers. There's no one time reductions, et cetera. So again, I know a number of analysts have told me that the other operating expense line is the line that we did better than, more than any other, I'll repeat what I said before. Internally we did sort of equally as well on a ratable basis in salaries and supplies and other operating expenses. So it was nothing in the other operating expense performance that was a particular surprise to us and therefore, we're going to continue all the efforts that Alan described and I've described before. We're certainly going to be as diligent in the last -- in the future quarters as we have in the last couple of quarters.

Okay. So there's just some more leverage off of that line perhaps than a number of us have been thinking.

And I conceded before, David, that historically, I think we would have acknowledged that that was not a line where we thought there was a lot of leverage, so again, we've had some success there and to Alan's point, getting success on that line really reinforces what a good job the operators have done.

Great. Okay. Just a couple other quick questions here. In terms of charity and bad debt and how that trended through the quarter, was that pretty much straight line trend or were you seeing anything towards the end of the quarter that kind of gave you more caution about how that might be trending moving forward.

I think we saw things, the uncompensated volumes trend up at the end of the quarter. I don't like to draw too many conclusions from a month or two's worth of results. Obviously, it seems sort of intuitive and logical that given what's happening in the economy, that those number would trend up, and that's in fact what we saw. But again, we'd like to get another couple of months and certainly some quarters under our belt to really see what direction this is moving.

Okay. That's fair enough. And then, Alan has spoken in the past about -- you've spoken about Cobra and the Cobra uptake in the subsidies, part of the stimulus package. Any update there on your view on the benefit of Cobra moving forward here?

The challenge that we have, and I've said it before, is that it's really impossible for us to define the Cobra impact when a patient comes to our hospital and shows us an insurance card, we have no way of knowing whether they're paying for that insurance through their active employment or Cobra premiums. It looks exactly the same to us, so it's really impossible to know. Some people have suggested to me that some Cobra benefits may be retroactive in the sense that what the law allows is for people to pay for their Cobra premiums and then go back for six months and get that coverage. So it's possible that there is some benefit to be had in the next few quarters, et cetera, but it's almost impossible for us to A, define what it is or even to define what we've felt so far.

Okay, great. Thanks.

Your next question comes from the line of Erin Blum.

Thank you, my questions have all been answered.

Your next question comes from the line of Christine Arnold.

Hi there. Two questions. First, I'm trying to triangulate what you all are saying with what we're hearing from the managed care companies, I'm going to throw out a couple observations we've heard from managed care companies are see if it jives with what you're seeing. Managed care companies, multiple managed care companies are saying that they are seeing an increase in acuity and that in many cases, they're seeing the insured population deteriorate, i.e. , they're sicker than the uninsured population. Can you comment on whether you think you're seeing that trend

In response to some questioner earlier in the call, Christine, I did say that in general, we've seen our case mix and other measures of acuity increasing over the last few years, but a a fairly gradual and incremental way. I would say on average, we've been up over the last two years maybe 1.5 % a year in terms of acuity which, at least from my perspective, is not terribly dramatic. I don't know if the managed care companies of implying that the increases they are seeing are more dramatic than that.

They are, but you're not seeing it.

No.

Okay, all right. And then on the behavioral health side, it looks like your kind of gross revenue is rising at a pretty healthy pace, but the net revenue growth is lagging gross revenue growth. Could you help me understand what might account for that?

Yes. The reality, Christine, is that gross revenue number is largely an artifice That number will be whatever we make it. We could increase prices and it would probably have little effect on that revenue. We could increase prices and it would have very little effect on that revenue. It is a very small percentage of our patients whose payments to us, either on their own or through their insurance company are really based on gross revenue charges. So frankly, the spread on the acute side between gross and net is a lot larger than it is on the behavioral side. All I can say about behavioral revenue is that for the six months, at least internally, it is almost spot on, our net revenues are almost spot on with what our estimates were. So I think we're very much tracking behavioral revenue to what our expectations were.

Okay. So you're not seeing an increase in denials of behavioral health claims or the insurer or the Medicaid program kind of downcoding what you've done? It's just --

No, and the reality is, Christine, all that would show up in net revenue. So if those things were happening, you would see that showing up in net revenue and net revenue would frankly be falling short of our expectations. And so no, I don't think we're seeing that.

Okay, thanks.

You have a question from the line of Justin Lake.

Thanks. Just a follow-up on what Christine is talking about, here. Just about every managed care company in the states is talking about going back to hospitals and trying to work out why they're seeing this upcoding. Are you seeing managed care coming to you looking to take a second look at bills?

Yes Justin, I think one thing that's worth noting is that that the vast majority of our managed care contracts, and I can't speak to other companies or other hospitals, but the vast majority of our managed care contracts are -- usually have some per diem basis to them and they're not based on acuity, so -- and there's really no coding involved. So they're paying us X dollars per day and therefore, it's the number of days and the length of stay that's the critical driving issue. And I talked a little bit before about managed care companies having an incremental effect on reducing length of stay a little bit. But very few of our managed care contracts are coding sensitive, so the -- by definition, the answer to your question is no, we're not seeing our managed care companies coming back and discussing that issue, because that's not what's driving our managed care payments.

Okay. And you still feel confident, despite what's going on with FOS and the deflationary environment out there, that 6% to 8%? There's really no change in tone in managed care contracting for 2009 and even beyond.

I think what we've said, or what I've said up to now is there hasn't been. Again, predicting what the managed care companies' behavior is going to be in the future is difficult for me to do, but certainly the observation is that up to now, it has largely been business as usual in our negotiations with the managed care companies.

Then just my quarterly cash flow question. Just thinking about next year, it continues to look like your cash flow is going to be -- your free cash flow, I should say, is going to materially appreciate once you get through this last bolus of CapEx. Can you run through how you expect those numbers to look and specifically, confirm that you're not -- there's nothing in the pipeline that's changed as far as kind of your CapEx expectation for spending next year as far as big projects?

Sure, Justin. I think -- I did make comments in my opening remarks that almost half of what we've spent on capital in the first six months has been on these three large projects, Summerland, Palmdale and Texoma. And while Texoma and Summerland should be open by the end of the year, some of those spending from those projects will slip over into 2010. Certainly, the Palmdale project will continue into 2010, and obviously, the spending will continue as well. But after those projects are done, sort of using your term, there's a very significant bolus of capital spending that will fall off. And I think I said in the first quarter call that if our annual rate of capital spending has been in the $350 million to $400 million dollar range for the last couple of years, I would think by the back half of 2010, that rate will at least drop to about $275 million or so, certainly drop by a about a $100 million annually once these projects fall off.

Great, and use of that cash? You've been paying down debt which seems like a -- do you think that's run its course and you'll get more aggressive with share repurchases if there's no M&A to be done?

I think that's pretty much the comments that I made earlier in the call, and I think that's a fair characterization of our thinking at this point.

Great. Sorry to make you go through that again. Thanks, guys.

No problem.

And at this time, sir, we have no further questions.

Okay. We'd like to thank everybody for their time, and we look forward to talking with everybody next quarter.

Ladies and gentlemen, this concludes today's conference call. You may now disconnect.