Community Health Systems, Inc.
Q2 2013 Earnings Call Transcript

Published: 30 Jul 2013

[Operator:]

Good morning. My name is Tiffany, and I will be your conference operator today. At this time, I would like to welcome everyone to the Community Health Systems Conference Call. [Operator Instructions] Lizbeth Schuler, Vice President of Investor Relations, you may begin your conference.

[Lizbeth R. Schuler:]

Thank you, Tiffany. Good morning, and welcome to Community Health Systems' Conference Call. Before we begin the call, I would like to read the following disclosure statements. And please bear with me, this is a bit lengthy. Certain statements contained in this communication may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements include, but are not limited to, statements regarding the expected timing of the completion of the merger; the benefits of the merger, including future financial and operating results; the combined company's plans, objectives, expectations and other statements that are not historical facts. Such statements are based on views and assumptions of the management of CHS and HMA and are subject to significant risks and uncertainties. Actual future events or results may differ materially from these statements. Such differences may result from the following factors

[Wayne T. Smith:]

Thank you, Liz. Good job. Welcome and thanks for joining us this morning. We released our second quarter earnings report after the market closed. We also issued a press release announcing a definitive agreement has been reached to purchase Health Management Associates. The purpose of this call this morning is twofold

[W. Larry Cash:]

Thank you, Wayne. Second quarter 2013 admissions decreased 5.1% compared to the same period last year. Adjusted admissions, which factors in outpatient business, decreased 1.8%. Our same-store admissions decreased 5.7% compared to the second quarter 2012. Our sole community hospitals volume continues to track with a significant larger decline than our mid-sized markets. The calendar seasonality accounted for approximately 30% of their client in admissions and 50% of their client admissions in the first quarter of 2013. The following specifics have contributed to the decrease in admissions in the second quarter

[Wayne T. Smith:]

Thanks, Larry. While we're disappointed in our results for the second quarter, we continue to believe that prospects for our industry are very favorable due to the implementation of health care reform. We have always been dedicated to accuracy and transparency in our reporting and communications to our stockholders, employees and stakeholders. And today's report is further evidence of that objective. I'd just like to just pause for about 30 seconds, give you a chance to get your slides up and then we'll start to -- and talk about the transaction. So now that we've concluded our financial presentation, I'd like to move to the combination of Community Health Systems and Health Management Associates, a combination that was approved unanimously by both CHS and HMA's board. This merger will create the largest for-profit hospital system in the United States in terms of number of facilities with a total of 206 hospitals. Starting on Slide 3, the transaction summary. The company is acquiring HMA for an aggregate purchase price of approximately $7.6 billion, plus a contingency value right of up to $270 million. Total consideration before the contingent value right will be approximately $13.78, a 25% premium to the company's unaffected price of $11.04 on May 24 of this year. Total consideration would be made up of $10.50 cash, and 0.06942 shares of CHS stock valued on July 29 at $3.28. The CVR that would represent an additional $1. We'll describe the CVR more fully later in the presentation. The company would expect approximately $150 million to $180 million of synergies over the next 2 to 3 years. There is no financing condition for this transaction, and we have committed financing from Bank of America Merrill Lynch and Crédit Suisse. Slide 4. We view this transaction as unique and transformative strategic opportunity. HMA has excellent hospitals. The ability to integrate these facilities in our organizational will enhance our already rich and diverse hospital portfolio. HMA's geographic footprint is complementary to ours. We operate in 15 of the same states, but their hospitals are largely in different markets, which provides us an opportunity for us to expand into new communities. Our organizations share a commitment to quality. A total of 91 of our combined 206 hospitals, almost half of them were recognized by the joint commission as top performers in key quality measures. Considering only about 600 U.S. hospitals achieved that status last year, you can clearly see that we are both focused on initiatives that drive quality and strong clinical results. Clearly, there are opportunities to share best practices for quality, benefit from economies of scale and produce synergies and operating efficiencies in this transaction. These are all things that are increasingly important during this dynamic period of change in our industry. And we believe this transaction positions the organization through health care reform. Finally, we would expect a mutual effect on earnings per share in the first year, following the close of the transaction. We also expect the transaction to be significantly accretive to earnings per share thereafter. Slide 5. HMA has demonstrated a very strong trajectory of both revenue and EBITDA growth since 2008. Slide 6. Community Health Systems has solid long-term results with a compounded annual growth rate for revenue of 22% and EBITDA of 20%. We have a proven operating platform and a solid history of performance. The implementation of health care reform will continue to further our success. Slide 7. On a pro forma basis, the company will have over $18 billion in annual revenue and over 31,000 beds in 29 states. 80% or 60% of CHS hospitals were sole providers. 50% or 70% of HMA hospitals are sole providers. On a combined basis, we will have 63% of our portfolio as sole providers in their respective markets. Slide 8. HMA has a very attractive portfolio, primarily in the Southeastern United States, with a concentration of 23 hospitals in Florida, 10 hospitals in Mississippi, 7 in Oklahoma. The company also operates approximately 470 clinics throughout the U.S. Slide 9. The HMA hospitals enhanced some of the states, where CHS already has a presence. We bring 2 hospitals for their 23 hospitals in Florida; 3 hospitals to the 10 hospitals in Mississippi, 3 hospitals to the 7 hospitals in Oklahoma. They bring 3 hospitals to our 17 in Pennsylvania. 9 hospitals to our 11 hospitals in Tennessee. This represents a very strong geographic fit and presents a great opportunity to further advance our state and network strategy, similar to what we are currently creating in Pennsylvania with Commonwealth Health in Indiana with the Lutheran Health Network. This is especially true in their pro forma networks in Florida, Mississippi, Oklahoma and Tennessee. Combined, the company will operate 1,000 clinics across our markets. Slide 10. More importantly, we will have 13 states with revenue greater than $500 million. Our combined 5 states have approximately $9 billion in revenue and represent approximately 48% of our total revenue. Currently, our top 5 states represent 50% of our revenue and for HMA, over 70% of their revenue. Slide 11. Improving quality of care. CHS has been focused on quality and patient safety. We had 20 straight quarters of in-patient core measure improvements and 15 straight quarters of outpatient core measure care improvements. The company has also achieved significant reductions in readmission rates, almost 20% reduction and a 16% reduction in all hospital-acquired conditions. This demonstrates our ability to quickly adapt to changes in measurement criteria. Last year, we made over 1 million calls to [indiscernible] patients who had been discharged from one of our facilities. And this year, we have added in-patient discharge calls, which are shown to improve compliance and discharge instructions and help drive better overall quality. Slide 12. One of the things that I'm most proud of is the solid relationship that we have with our medical staffs and employee physicians. We have approximately 17,000 physicians on our medical staff, 2,500 employed physicians. Our latest patient satisfaction -- physician satisfaction survey, 91% of our physicians said they would recommend their facility to their family or friends. Overall, satisfaction rates were 89%. Incidentally, our employee be satisfaction is also very strong. Our strategic alliances with the Cleveland Clinic continues to gain momentum. The health care landscape is changing very quickly, and this collaboration allows us to identify synergies and develop solutions for challenges facing health care providers. We're actively working together and combining our resources and expertise in areas such as clinical services, physician alignment integration, as well as other hospital operations and cost reduction. In addition, of HMA's 71 hospitals, will serve to make this alliance even stronger and more meaningful. Slide 14. HMA has entered into several affiliation agreements, including the University of Florida, University of Mississippi and INTEGRIS in Oklahoma. Slide 15. The company has acquired over 50 hospitals since January 2000 in addition to the 50 or so hospitals we acquired in the Triad transaction. We believe that the Triad transaction was the most successful large acquisition in this industry. Our success with that integration has demonstrated our abilities and prepared us for another sizable acquisition. Our ability to grow through acquisition focus on network development, clinical excellence and value is the foundation on which we will build further success in this new health care environment. Slide 16. Our hospital acquisition strategy has generated excellent results. In the acquisition years 2002 through to 2011, we've expanded margins by approximately 650 basis points. The Triad acquisition had initial margin around 11% or 12%. Today, those hospitals are above 15%. We believe that our physician recruitment, judicial capital spending, effective cost management enabled us to improve these facilities. Slide 17. As you can see on -- I'm sorry, Slide 17. As you can see from Slide 14, both CHS and HMA have been very acquisitive over the last 4 years, with 33 acquisitions between the 2 companies, a total of $2.7 billion of acquired revenue. Clearly, this represents an opportunity for margin improvement over the next several years. Slide 18. Improving hospital operations through our standardize and centralized management approach has been the hallmark of our success over the years. We believe that this growth was successful with Triad, and will clearly benefit our acquisition of HMA. Essentially, our standardize processing systems enabled us -- enable consistent performance across all the markets, provide proven process improvement and more importantly, generate quality improvements. We do have -- the company has a strong experienced management team with a dedicated bench strength throughout our operations. Almost 95% of our current management team helped with the Triad acquisition in 2007. With that, I'd like to turn the rest of this presentation, and I'll be back, the rest of the presentation to Larry to start on Slide 20. Larry?

[W. Larry Cash:]

Yes, on Slide 20, the acquisition of Triad was very successful for approximately $275 million in synergies realized in 2.5 years. We recruited over 2,400 physicians in Triad hospitals and our focused capital expenditure efforts on high return on investment projects. Additionally, we improved all the operating expense categories. We're able to significantly delever our debt to EBITDA within 2.5 years. As Wayne said, our margins are over 15% today. Slide 21. As with the Triad acquisition, this company expects to realize approximately $150 million to $180 million of synergies within the first 2.5 years. The expectation is approximately 45% or $80 million will be realized in the first year. These synergies will come from overhead reduction, revenue cycle management, supply management and case management. For instance, we believe that the HMA Medicare length of stay is about 60% higher than CHS and for efforts of Dr. Lynn Simon, who runs our efforts, he should be a good synergy for us. We expect the transaction to breakeven EPS in year 1 and meaningfully accretive thereafter. Pro forma debt to EBITDA, would start off in the mid 5s, return to current levels in the 12 to 18 months. We will delever similar to the Triad acquisition, especially with the benefit of health care reform in 2014 through 2016 and the improvements in the recent acquisitions that Wayne discussed. Concerning contingent value rights. Our effort here is to give recognition to contingent liabilities as a function, something like an unfunded escrow. HMO shareholders receive about $1 per share in cash, less 90% of the losses post the CHS deductable of $18 million. We value the transaction established with CVR takes in account the legal proceedings described in HMA's public filings. We will also certify legal expenses, fees, fines and settlement amounts relating to HMA's existing litigation with the Department of Justice, SEC and related litigation claims. The first $18 million of cost related will not reduce the CVR payment amount after the first $18 million. This CVR payment amount would be reduced by 90% of such losses. The CVR would be settled in cash after the CVR payment date, which is the final resolution of all existing litigation. Our strategy for health care reform has been straight forward, demonstrate quality in our market, enhance productivity and manage resources, deliver infrastructure necessary to implement HITECH and reform and participation in managed-care networks. We anticipate about 14 million newly insured patients in 2014, and the combination of CHS and HMA will make us stronger and better prepared for reform. The company has been very proactive with regard to reform, identifying the uninsured in our markets and development plan to contact these folks through outreach and marketing efforts to make sure they know about insurance availability. About 8% of our adjusted admissions are self-pay, 80% of our states are in the federal exchange. We think there would be something like nationally, 25 million insured in 2016 and 28 states are now have an exchange contracts. So all states we operate in have an exchange contract.

[Wayne T. Smith:]

Thank you, Larry. It's now my pleasure to introduce Bill Schoen, Chairman of HMA. Bill has served as a Chariman since 1986. Bill, welcome.

[William J. Schoen:]

Thanks, Wayne. You and I have believed in the strategic logic of combining up the companies for some time, I would say, for years. I'm delighted we've made it happen and to be here with you today to speak with our investors about this compelling transaction, which you presented so powerfully. As you know, the HMA Board of Directors has been engaged in a various serious and productive conversation about the future of health care in our company. The industry is changing dramatically, more dramatically than I can think about, since really 1983. It was the last big change when we went into DRG. Our focus has been on how to maximize the value of our stockholders investments by capitalizing on new opportunities and growing our business while continuing to provide the highest quality of care for our patients and the communities we serve. Late last year, we decided to formalize this process and commenced a review of the strategic options available to our company, including possible transformative transactions. Together, with our advisers, we reviewed a wide range of options. Everything was on the table, including remaining independent and potential transaction with other strategic parties. The transaction we announced today represents the successful completion of that process. It is consistent with our objective to maximize shareholder value and achieve scale in an evolving operating environment. The Discussion between Wayne and I started late last year in 2012. Strategic combination of HMA and CHS springs together 2 outstanding companies, with complementary hospital portfolios that can create an even greater company focused on suburban or rural communities. In my view, this is truly a case of the whole being greater than the sum of its parts. In the transaction our shareholders will receive substantial value for their shares. I would like to take a moment to walk through the components of the value proposition as CHS has defined it. The cash and stock considerations represent a 25% premium over the unaffected price of HMA's shares prior to our adoption of a shareholder rights plan in late May, an 8.3 multiple of trailing cash flow, which is higher than the multiple paid in the most recent industry transaction, and a significant premium to what we believe would be the unaffected trading price of our shares, taking into account our revised guidance. Specifically, our stockholders will receive an immediate cash payment of $10.50 per share, stock in the combined company that will allow them to participate in the future growth of a true industry leader. And also, the contingent value rights could yield an additional cash consideration of up to $1 per share, depending on the outcome of certain legal proceedings we are addressing and are described in our public filings. I believe -- the board believes that the total consideration of $13.78, based on yesterday's closing price of CHS stock, plus the potential of $1 through the CVR, is a very attractive offering for our stockholders, particularly as this includes an ongoing ownership stake in the combined company. During the months, my colleagues and I will be working very closely with Wayne and his team to plan a thorough and thoughtful integration of our companies so that we are ready to capitalize on the excellent opportunity available to us beginning on day one. Our goal will be to make the transition as seamless as possible for our constituencies. We will also be taking the time to speak with our shareholders about the transaction and the exciting value creation opportunities it presents. Before I conclude, I want to briefly comment on the reasons our companies are in business. Our patients, HMA was built on an unwavering dedication to leading the industry in the quality of care and customer satisfaction, with an emphasis on continual improvement. CHS' share commitment to these values is what makes this combination possible. I truly believe we have found the right partner and that this transaction will benefit the great communities we serve. I'd like to now turn the call back to Wayne.

[Wayne T. Smith:]

Thank you, Bill. I would direct your attention back to Slide 24. While this announcement represents the first step, there are many more required steps to complete this transaction. We need regulatory approval, Hart-Scott-Rodino, as well as required state and local approvals. HMA shareholders must approve the transaction. It requires a 70% vote for a vote. Should the transaction not be completed, there will be the usual breakup fee. Approximately 60% of our stock is owned by HMA shareholders also. We believe that our Triad experience will be most hopeful in the integration process. Finally, we anticipate closing this transaction sometime towards the latter part of the first quarter of 2014. So Slide 25, the final slide. In conclusion, we firmly believe that the combination of these 2 companies will create shareholder value in a meaningful way over the next several years. It provides a strategic opportunity to create a larger company with a diverse portfolio that is well-positioned to benefit from the changes in health care. This transition clearly gives us an increased scale, a complementary geographic fit, strong market presence and diversification. It presents us with network opportunities, synergies and a very attractive profile. The entire management team is excited about the company integration efforts and we look forward to getting to know the HMA management team and working with HMA physicians and employees to advance quality health care in all the communities we serve. We appreciate you joining us this morning, and we will now open the call for questions.

[Operator:]

[Operator Instructions] Your first question comes from the line of Gary Lieberman with Wells Fargo Securities.

[Gary Lieberman:]

Congratulations on the deal. Can you talk maybe a little bit more about the synergies and where you expect the primary synergies to come from?

[W. Larry Cash:]

Yes, I'd say you got the overhead reduction. There's a couple of hundred million dollars of overhead reduction there, and you got the supply management, which there will be some supply activity when you put 2 companies together. I mentioned, the case management and length of stay opportunities we think we see. A couple of -- for instance, our case mix, it's slightly a little bit under ours and I'd like to say is above it. A couple of areas about revenue cycle management. We got our internal collection agency, which does a very good job at an effective rate of about half what external vendor rates with 500 people. They collected $250 million last year. We've got eligibility screen services, which is -- over 200 employees takes care of 80 of our hospitals. I believe HMA outsources that. I think we do it for about 1/3 less than we do at external costs. That would be an opportunity. That's also an opportunity on health care reform a group they help us and grow people from Medicaid. Then you got -- it's clearly a large percentage of your overlap of audit fees and [indiscernible] insurance and insurance cost and things of that nature, but that's a pretty good description where I think the synergies will come from.

[Wayne T. Smith:]

Yes, Gary, I also want to make sure that people understand that we're sensitive to all the employees in this organization, including corporate office. And we will have a process we will work through whatever might happen in terms of the future and how we might design the organization going forward.

[Gary Lieberman:]

Do you think there are any potential synergies on any of the legal issues that are affecting both companies? It would seem like there's at least some similarity between the 2 and do you think there's any advantage or any opportunity to consolidate the issues of both companies into one matter?

[W. Larry Cash:]

One of the things we'd do on the CVR is we keep a separate effort of how that's happening and separate legal expenses, there could be a small amount but not anything significant.

[Operator:]

Your next question comes from the line of Ralph Giacobbe with Crédit Suisse.

[Ralph Giacobbe:]

Just want to make sure I'm thinking about the contingent value correctly. Is the breakeven sort of $320 million roughly? Am I thinking about that right? So anything above that, shareholders wouldn't receive anything below that and it just gets scaled down based on what the fine is?

[W. Larry Cash:]

That's in the ballpark, $300 million and $310 million. It's in the ballpark. 10% of the co-insurance of $268 million will be $26 million, $27 million deductible, $18 million in the $268 million is the number of shares, that's around $300 million to $310 million.

[Wayne T. Smith:]

And, Ralph, again, the losses are defined as legal expenses, fees, fines, settlements, all the above.

[Ralph Giacobbe:]

Right. Anything below that, again, it is just scaled ratably? Is that the way to think about it? So if there's 0 essentially, then that will be $1?

[W. Larry Cash:]

No, if it's 0, there'll be no money left. There's no -- if there's...

[Wayne T. Smith:]

0...

[W. Larry Cash:]

If it's 0, you're correct.

[Ralph Giacobbe:]

Right. And if it gets scaled up, the $1 is basically prorated based on whatever that finance?

[W. Larry Cash:]

Yes, the $1 would go down.

[Ralph Giacobbe:]

Yes, okay, all right. And then again, on that contingent value rate, is there a timeframe around this? I mean, I know you've said it seems like it's going to be settled with final resolution of all existing litigation. My guess is that, that could take many, many years. I just want to understand if there are other parameters around that, that we need to think about in terms of timeframe?

[W. Larry Cash:]

No, the final resolution would be determined when all existing litigation is resolved.

[Wayne T. Smith:]

No timeframe.

[Ralph Giacobbe:]

Okay. And just my one, if I could sneak it in. Do you expect any divestitures from the deal, any markets where there could be concerns around share?

[Wayne T. Smith:]

Too early to talk about that.

[Operator:]

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

[Colleen Lang:]

This is Colleen Lang in for Tom this morning. Larry and Wayne, how did you factor reform within your analysis in looking at the company and the return you expect to see from the deal? And also, are you comfortable with where HMA is on the reform preparation front?

[W. Larry Cash:]

Well, on the preparation, I think they've done some activities. They've got managed care contracts, just like we've got. They got a really good presence in Florida. I know they put up a slide deck, which we've factored some -- we saw that, had availability to it. It was a little bit different than most people think. They had it higher in the first year, they've been winding down, we think. We usually reform or something that starts a little slower and builds up over 3 years. And we did our own estimates of what we thought reform would be and we'll talk more about that as the year progresses, both for ourselves and HMA. But I think the thought process would be as high as it was in 2014. It's a little more than without it would be.

[Colleen Lang:]

Okay, great. And then have you assumed any refinancing for HMA's existing debt balance?

[W. Larry Cash:]

We got committed financing for all of it. So we will attempt to use that committed financing as best going forward, both their debt and our debt.

[Operator:]

Your next question comes from the line of Kevin Fischbeck with Bank of America Merrill Lynch.

[Kevin M. Fischbeck:]

I just wanted to go back to the synergies for a second. When you -- the numbers that you guys are targeting, is that a realized number over 18 months or is that the run rate number you expect to be at in month 18?

[W. Larry Cash:]

By 2.5 years, with September run rate of $180 million if you go back to the -- what we did with the prior situation. I believe, we had $24 million in the first 6 months, then $145 million the next year and $105 million in year 2009 for a total of $275 million. By that time, you have a run rate of $275 million. In this situation, we have a run rate of $180 million.

[Kevin M. Fischbeck:]

Okay, all right. So it's a run rate number until -- okay, that's very helpful. And then when you say that the deal will be single-digit accretive in year one x amortization, did you mean single-digit EPS accretive or single-digit percentage accretive?

[W. Larry Cash:]

Single-digit EPS accretive in the low-single digits.

[Kevin M. Fischbeck:]

Okay. And then actually, maybe just more to the point, I guess, what is the amortization then that you're assuming in that calculation?

[W. Larry Cash:]

It's going to be a somewhere in the $20 million to $30 million range depending on the final appraisals to get done and how much goes to mixed assets, usually very little goes to equipment and then some will go to land and some will go to building and of course, some will go to goodwill. And we'll carve that amount out, let people know what that effect is. And on a cash EPS, it should be single-digit accretive the first year.

[Kevin M. Fischbeck:]

Okay. And just to make sure that $20 million to $30 million is an annualized number, figure?

[W. Larry Cash:]

That's right.

[Kevin M. Fischbeck:]

All right. And then maybe just last question here. As far as the decision around cash and stock, I don't know, it sounds like based upon Bill's comments, that maybe that was something HMA wanted. But just your thought about the decision to include some stock and your views around leverage and anything you can provide color there?

[Wayne T. Smith:]

Yes. Well, absent the leverage piece of this, we thought it worked well and HMA thought it worked well to have a cash payment, as well as an opportunity to participate in the growth of this company going forward since it will be a very large company with a lot of opportunity introduced. Just the early synergies are just one part of this in terms of the thought process around network developments and an opportunity for cost savings going forward. So we thought that was a good way because we couldn't get the value any higher than we thought it currently is, we thought it would be s good way for people to participate in the future.

[W. Larry Cash:]

And there's also a lot of overlap of shareholders.

[Wayne T. Smith:]

Yes. I think it's 60%. Do you want to talk about leverage?

[W. Larry Cash:]

Yes, the leverage will start out in the mid-5s, and then we'll work our way to over 6.5, and we'll work our way down to 5 in a couple of years and we'll continue work it down. You got the benefits of health care reform, which will clearly help anybody's company leverage, or should -- in '14 and '15. So it should work it's way back down in about 18 months or so of what it is now and then continue to improve from there.

[Operator:]

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

[Frank G. Morgan:]

A couple of questions. First, did you say what the actual breakup fee is? And then secondly, I was hoping you could discuss the biggest difference in the synergy opportunities that you see with HMA versus what you saw at Triad because I believe Triad actually had lower margins. And then any revenue synergies that you see?

[Wayne T. Smith:]

Yes. Let me just say that all of that will be in the proxy, I guess. So the breakup fees and all the above. That's usual. It's just the usual. We've been there today, Rachel's [ph] telling me it is today, it will be out today.

[Lizbeth R. Schuler:]

We'll file our 8-K.

[Wayne T. Smith:]

Yes. When we file our 8-K today, Frank, all that will be in there. And it is -- 2 or 3 parts to this. I'm not being evasive, there's just 2 or 3 parts to it. And then the other thing I would think -- one of the things, I think, is a little different here, and then Larry can talk more about the synergies, but this really is a -- Triad was a much more of an expense opportunity, this is a revenue opportunity in terms of us building and working with physicians and networks to enhance the revenue here. So it's a little different challenge, but one of the things that we think is very helpful is that, and that's why I mentioned it in our slides, that we have a great working relationship with our physicians across the country and a lot of experience in doing this. And they're more than willing -- our physicians are more than willing to help us with HMA physicians so that we work on together how we can develop our networks and get -- enhance payments and all of the above.

[W. Larry Cash:]

Yes. If you back to look at the $275 million, it was a little over 10% of that was partly related to managed care negotiations. Triad had a good approach, they generally focused on large accounts. We focused on all of them. We got a really good group of managed care people. We'll work with the good staff we got down at HMA and come up with a good team to work with managed care. I think as we mentioned, we got the good overlap as it relates to Florida and Tennessee and Mississippi and Oklahoma and some other good situations like that. Pennsylvania got some over that side. So I think it'll be helpful, but I would think most of our synergy thought process is on the effective cost management to try and to effectively and appropriately reduce duplicate costs and services and trying to improve the supply management and also case management. We've got a lot of activity we got going on inside the company to supply us some efforts and that efforts will probably help the HMA synergies also.

[Wayne T. Smith:]

One of the things, Frank, of course, is if you see this happening across the industry in terms of HCA and Tenet as well in terms of the way everybody is looking at how we can get more synergies and that's not built into this in terms of over the long haul, all the possibilities once you scale this and have size, you can do a lot more things.

[Frank G. Morgan:]

Okay. And then one final. Just on de-leveraging that Larry referenced. That's basically purely from EBITDA growth. There's not any real divestitures either of your assets or their assets that's contemplated, is that correct?

[W. Larry Cash:]

The de-leveraging is just with EBITDA growth and of course, a lot of asset sales after taxes aren't that -- they're helpful but not as much as it is to grow EBITDA. And of course, as Wayne pointed out, we've got 2 companies who've got a lot of good acquisitions in the last 2 years. So you got both the normal growth, the health care reform growth and the improvement of the recent acquisitions for both companies should help the de-leveraging.

[Operator:]

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

[Albert J. Rice:]

A couple of questions, if I could ask. First, on the -- in the press release, there's a reference when you talk about the contingencies to closing the deal. It says the absence of adverse developments. What is that referring to?

[W. Larry Cash:]

That's a standard legal term. It's pretty most all deals to try to make sure something really, really adverse happen, which is unusually unlikely to happen that...

[Wayne T. Smith:]

Something catastrophic.

[Albert J. Rice:]

But it's nothing more than a just traditional material adverse change?

[W. Larry Cash:]

That's right.

[Albert J. Rice:]

All right. Second, I wondered if you could comment on how much due diligence you guys were able to do around the government issues at HMA? Obviously -- and I assume you were aware of the subpoenas -- extra subpoenas they disclosed today. Any comments about that broadly?

[Wayne T. Smith:]

Yes, we were certainly aware of that, and we've done a fair amount of work. You'll just have to read about it in their releases in terms of the details of that. We obviously cannot talk about that, but I think we have a pretty good understanding.

[Albert J. Rice:]

Okay. And then maybe the last question, broadly, I mean, if you look at HMA's performance in the last 18 months, obviously, there's been pressure in especially small secondary market hospitals and rural hospitals on volumes, which we all know about. And then they've had issues around some of the adverse publicity on the investigations, and then maybe there's other company-specific things. Can you give us maybe a little bit of your view on what it takes to get HMA back on track and the kind of numbers that we've historically associated with them and you?

[Wayne T. Smith:]

Well, first, I think you have to -- everybody in this industry is having issues, particularly all of us who operate in non-urban markets. I mean, this is a residual problem of the economy for sure. And then there's changes going on the delivery system for copays and deductibles and all of the above. So we have to adjust to that -- and there's a movement to outpatient, of course. We have to adjust to that. I think one of the things that -- clearly, we need help from health care reform, and we need the economy to get better kind of going forward. But I think there are number of things that we think we can do in terms of case management, resource management, that we could bring to HMA hospitals that would be helpful to them in terms of trying to understand -- better understand the process from an educational standpoint, which we think could be helpful in terms of the volumes. A lot of this is around the economy and hopefully, in 2014, we're going to get some help.

[W. Larry Cash:]

A.J., just to mention, again, I don't have all our numbers committed to knowledge, but I think their just admissions that were down about 2% in the second quarter and about 4% year-to-date. So that's encouraging to see that it was better. Just like ours, it was down 2.6%, and year-to-date, it was down 4%. So which is a little bit better, and a lot of the in-patient admissions is moving to outpatient and you just got to make sure you got the appropriate rate for or the appropriate cost structure for that business.

[Operator:]

Your next question comes from the line of Gary Taylor with Citigroup.

[Gary P. Taylor:]

Maybe as a little bit of a follow-on to A.J.'s question. I mean, more specifically, HMA announced a pretty material EBITDA miss versus expectations, lowered their EBITDA guidance for -- on the annual basis for the second time in a couple of quarters. So I guess essentially, their EBITDA run rate's going to become your EBITDA run rate as you close this transaction and inherit the business. What's kind of your view on where their current 2013 EBITDA guidance is as you head into 2014? Do you have concerns that that's aggressive or comfortable, or it's conservative enough given the recent performance?

[W. Larry Cash:]

Well, the guidance was $850 million to $900 million, down from, I think, somewhere like $978 million on the low end before that. Clearly, we're aware of that. Clearly, we've done our own models, our models. We were aware of what the second quarter was trending to be -- it was down a few million dollars than what we thought it would be, and then we factored that into our improvements. They had an improvement plan for the rest of the year, which we saw. We took the knowledge of that and reviewed that and came up with our assumptions, which are pretty close to what's in the revised guidance. So I think we're comfortable with the work we did and the answer we used and the work such that we'd have a good idea what the run rate was at the end of '13 going into 2014.

[Gary P. Taylor:]

Any view yet on whether the possibility of sort of a parallel government settlement? Any view yet on whether the government would be amenable to having that kind of parallel discussion? Or is it too premature to comment at all?

[Wayne T. Smith:]

We can't comment on that at all, Gary, unfortunately. But let me go back to your first question in terms of their runway. That's how we got to the value of this company after we did all our work and all our due diligence, see what they were producing. That's how we got there, of course. The math is pretty straightforward.

[W. Larry Cash:]

I think Bill said that the discussion's been going on since late last year. We did a fair amount of review of data. We had a lot of data available in the data room. We had meetings with their management and also did a lot of work from there and formed our own opinion of what 2013 would be, and we're very comfortable of what that opinion was. And it ties pretty much closely with the range of EBITDA guidance they put out.

[Gary P. Taylor:]

Last question, Larry, you mentioned committed financing for the transaction. Does this include taking out all of their notes as well? Or is there any possibility that you wouldn't have to take out some of those notes? Or is it the synergies?

[W. Larry Cash:]

There's always a possibility, but what we've got is committed financing to address both their debt in our capital structures as it relates to our credit agreements. And so we want to make sure we had plenty of flexibility to operate going forward and be a mix of bank and bonds.

[Operator:]

Your next question comes from the line of John (sic) [Josh] Raskin with Barclays.

[Joshua R. Raskin:]

So a question, I guess, in 2014 expectations. And you guys, as you said, have done a lot of diligence on current operating trends, et cetera. So I'm just curious directionally, where you thought HMA's core book of business was going in '14. And then maybe specifically, I just want to make sure I understood. Did you say, Larry, that you thought their reform slide that they published in their SEC document a week or two ago, did you say that was -- that seemed too high for '14 but would ramp up higher in '15 and '16? I just want to make sure I got that right.

[W. Larry Cash:]

Yes, that was some consultant work, which we got and we had to form our own opinion. And I think most people believe health care reform would be a little lower. And of course, I think that work was done in February, I believe, in 2013. And so -- and then it was disclosed as such. So we got that and we did our own works and we're doing our work for ourselves and make some adjustments to that. We think health care reform's going to be a benefit end of 3 years, but just the years which is going to be different in our thought. I think it's a little too early for us to sort of talk about '14. You've got to have the reform benefits, you'd hope to stabilize some of the volume challenges. They've got some cost improvements going on right now. And to make sure those continue there for the run rate, we've got our own cost improvement plans. But I think as we said, this would be pretty close to neutral -- it could be close to neutral EPS. We'll give more color on that as we continue to do more work. But I do think '14 should be a good year, but I'd say the better years would be '15 and '16.

[Joshua R. Raskin:]

So just to clarify, when you say 2014 should be a good year, I guess relative to the 8 75 midpoint this year, does a good year mean a growth year next year?

[W. Larry Cash:]

I think there expects to be some growth next year, yes.

[Joshua R. Raskin:]

Okay. And then just a second question, it sounds like the conversation started late last year. I'm just curious in terms of timing. Obviously, there's been all sorts of industry pressures and company-specific pressures in the second quarter for HMA. So why now? What was the impetus to announce a transaction as opposed to maybe seeing where operations went the next couple of months?

[Wayne T. Smith:]

Well, this has been going on for a good while. We've had a lot of conversations with HMA. I've had a lot of conversation with Bill Schoen over the last number of months. So this has been the word for a while. And look, this is -- it's opportunistic as well. And now's a good -- I mean, this industry is having a very difficult time, if you haven't noticed, in terms of all of our earnings. And so this is an opportunity for us to scale, get synergies, improve our geographic presence. So it's a great opportunity for us. So we didn't specifically think of it in terms of doing it today. I mean, when we worked on it, it could've happened earlier, matter of fact, I thought it was going to happen a lot earlier, and it could have happen later. But it's just when we got our work done.

[W. Larry Cash:]

And that's the point I had made, we did finish our work here with this sort of [indiscernible] and what time it would happen. It's clearly a good time to do it with health care reform ahead of you.

[Wayne T. Smith:]

Correct.

[Operator:]

Your next question comes from the line of Whit Mayo with Robert Baird.

[Whit Mayo:]

Keeping everybody busy, Wayne. How do you think of some of the joint ventures that HMA has? You've historically not been one that has constructed a lot of the nonprofit JVs, the way that maybe HMA has. And I think in fact, you actually unwound somewhat at Triad, so just kind of curious on your thoughts with those deals and maybe if they are just dissimilar from the Triad joint ventures?

[Wayne T. Smith:]

Our basic premise is, we have a number of joint ventures. They are well constructed. We will just have to review them, and things that work are great, things that don't work, we'll have to deal with it.

[W. Larry Cash:]

I just would add a couple on Triad, when they unwound they had to put which they put it to their -- and they're very good joint venture down in Texas with another not-for-profit that's working pretty well. And we've got a lot of physician joint ventures just like they've got.

[Whit Mayo:]

Okay. And then maybe also just on their IT systems, they've been on their PULSE System for a long time. And I guess the question is can you operate HMA on their existing IT infrastructure with a normal level of CapEx? Or you think there's anything that you need to do to maybe spend some money to run them the way that you'd like to? And I guess, that's maybe a broader question outside of just the IT spend.

[Wayne T. Smith:]

Yes, there's 2 parts to the IT question, and one has to do with the basic operating system and the other has to do with the development piece of this. HMA has done a lot of creative work in terms of developing a number of pieces for the future that are very interesting, have very good potential we think, but the operating system needs work. So we'll have to work on that. Larry, do you want to say more about that?

[W. Larry Cash:]

Yes, I think we met, Wayne and I and some others, met with their IT sectors, did a nice presentation, understood what they got going on. We reviewed a lot of work done by Ernst & Young and [indiscernible] Financial, et cetera, and I think we're pretty comfortable of where they are and there's work to get done, as Wayne said. But I mean, we factored in some extra costs that's likely to be spent over the couple of years. I'd just go back to the Triad. Triad was under a big system conversion. We changed that around to not follow through with the Pro arrangement [ph]. We stuck with McKesson. McKesson's in a lot of our hospitals now. We still got McKesson [indiscernible] Cerner. I think IT is an evolving area and you need to be flexible based on the size of the hospitals and the systems you got. And I think we'll be very successful working with what HMA's got underway.

[Wayne T. Smith:]

They have really great talent in the IT area. We're hopeful we can take the talent and the things they developed and use that with our system and use our operating system with that talent too, for all our hospitals. So I think it is an opportunity even though there is some costs associated with it.

[Whit Mayo:]

Is there a good way to think about what the pro forma CapEx level would be of the combined company?

[W. Larry Cash:]

Well, I just -- they've been spending in the range of about 5% of revenue. We've been spending -- we've got a project or 2 on replacement. They've got no replacement hospitals to do right now. We've looked at what projects they got underway, and I think you generally would see us generally spend around 5% of CapEx, plus replacement hospitals. And we -- this year, we spent a little less last year, we spent a little less this year. And as long as their revenue is a little -- not growing, I would think we'd spend 5% or less.

[Whit Mayo:]

Got it. And maybe one last one quickly for either Bill or Wayne, you'll probably just point me to the proxy later. But any comments on the go shop or what process is going to be run between now and whenever this is finalized?

[William J. Schoen:]

I will just point you to the proxy. You will see all the details about this. There is a breakup fee and all of the above.

[Operator:]

Your next question comes from the line of Andrew Schenker with Morgan Stanley.

[Andrew Schenker:]

So you've recently pushed out your expectations for smaller acquisitions to just 1 this year. I mean, how does the deal impact your acquisition strategy in the near term? And similarly, HMA has been very active in pursuing single hospitals, small-system acquisitions, does the deal change that strategy as well?

[Wayne T. Smith:]

No, no, it -- we have a number of acquisition opportunities. We have to be careful about this. But we've said all along that we're looking for strategic opportunities, and we're not -- that's why we haven't closed anything this year. We're being careful about price and opportunity. So we're going to be very disciplined about this. But we do have a number of really good opportunities in terms of future acquisitions, so we'll continue to pursue those.

[W. Larry Cash:]

I just should add, we were aware of all the HMA activities, and we factored in the Ocala [ph], a good transaction just required by [indiscernible], the other one down into Florida. They were working on some outpatient surgery centers from that perspective, just like we are. And we got left [indiscernible] to finish what they've done and also the ones that we've got underway.

[Wayne T. Smith:]

Let me add something to Whit Mayo's question about there is no go shop in this agreement. And you'll see it in the merger agreement in, I think the 8-K will be filed today, so you'll be able to read about that.

[Andrew Schenker:]

Okay, great. And just a couple of housekeeping ones here. Are there -- you mentioned amortization expense. Are there any other costs for implementation deal costs that you're factoring into your accretion estimates in year 1?

[W. Larry Cash:]

Well, generally, when you look at accretion dilution, you do have some mergers & acquisition. But the accounting rule is changing. Bankers' fees, lawyer fees will be expensed, and when I talk about accretion, I'm leaving those kind of items out as onetime costs.

[Andrew Schenker:]

Okay, good. And then just on the CVR, just to make sure I understand, you do call out legal expenses and fees, does that include the ongoing legal expenses they're incurring currently without a settlement or as they work towards one? And maybe what is the kind of run rate there for HMA today on those expenses?

[W. Larry Cash:]

It does include that. It's somewhere in the $20 million plus range, and it depends on how active they are. But I think, expect it to be a little bit lower this year on legal expenses, but they incurred some more legal expenses that I thought they were going to. But active -- existing legal expenses, to the extent they continue, would be an offset to the value of CVR.

[Operator:]

Your next question comes from the line of Darren Lehrich with Deutsche Bank.

[Darren P. Lehrich:]

I just wanted to follow up on the CVR. Larry, will you be establishing a reserve then at the outset of this transaction related to a potential settlement?

[W. Larry Cash:]

Well, there'll be other liability recorded because the money is either going to be spent paying for losses, legal fees, or eventually, a payment to the shareholders. Yes, there'd be other liabilities established in the books and the financials and you'll value that on a quarterly basis as to its expected fair value at the time. And we will separate or also reflect the type of expenses that are ongoing -- future ongoing expenses, that will be reflected also.

[Darren P. Lehrich:]

Okay. And then just as we think about the CVR and the level that you've set it at, how does that color your view about your exposure? Is that a good way to think about it because the issues are relatively similar? Can you maybe just comment on how do we think about it?

[Wayne T. Smith:]

Let me say this one thing, Larry. First, you need to go read their proxy and then read ours, and you'll see what their issues are and then you'll make -- you can make your own determination about that.

[W. Larry Cash:]

And especially, if you look at the legal proceedings, there are some -- they got issues, and we've got some issues that are somewhat different. It has no bearing on our perception of ours. We don't have an estimate there today. We didn't have one at the end June, and we're still working through. We did, I think, put out some good information last night in the press release, and Wayne referred to it today, of where we are. But I think that this estimate work was clearly for their issues and our just trying to set up a contingent liability. There's no accounting support for that contingent liability, there's no -- there'd be no estimate booked had there not been a CVR booked in this transaction.

[Darren P. Lehrich:]

Okay. And then as far as HMA's performance goes, it would seem that there was about $100 million of cost savings that they had embedded, including some consolidated business activities. And I'm just wondering, as you look at the numbers relative to the consensus, is the fact that they haven't really moved fast on some of that, the main reason for the shortfall? Maybe just some flavor for what they've been talking about on this cost savings relative to what we saw this second quarter?

[W. Larry Cash:]

I believe their press release called out $25 million of cost savings they recognized, but they've had some other expenses offsetting that. I think you'd also got the issue that we have to sort of look through are the cost savings short-term in nature or longer term in run rate. We had a fair amount of cost savings in the first quarter that didn't carry into the second quarter the way we hoped it could, and we're starting some things now on cost savings which we hope are longer term in nature. But sometimes, you can put expenses off and they come back at a later date. So we're comfortable of where the range is and we're comfortable where we sort of pay for 2013, $1 billion [indiscernible] of our assessment or the growth for 2014 with the synergies and the other things that we talked about that could be a very good transaction. We're excited about the transaction. I think it'd help the company immensely if we can get this done.

[Darren P. Lehrich:]

Okay. And then just last thing, Wayne. In terms of the Cleveland Clinic relationship, are you -- would you be able to carry that into the HMA portfolio? Any just commentary about how you brought Cleveland Clinic into this potential transaction?

[Wayne T. Smith:]

Yes, as we look at our networks and then we've got -- we'll have a number of sites where we have significant presence, this works great for the Cleveland Clinic in terms of us identifying those hospitals that they have for everything, cardiovascular work to physician alliance. So I think we're on the right track here. We have -- not only we have great quality standards, but we also have an organization that has the absolute best quality standards in the country. And then we overlay that on significant networks. I think we're well-positioned for the future in terms of health care reform.

[Operator:]

Our next question comes from the line of Chris Rigg with Susquehanna.

[Christian Rigg:]

Actually, I just wanted to come back to some of the core business trends here just to make sure I fully understand what's going on. On Slide 8 in the initial presentation, where you talked about the employed physician involuntary turnover, it looks like that stepped up a little bit in the second quarter. Can you give us a sense for what's going on there?

[W. Larry Cash:]

Yes, when you look at -- it's up just a little bit on a quarter basis and not quite as much on a year-to-date basis. It's not up a great deal. As you looked at physicians who left after our review of them, some of them had started in the first quarter a year ago and had more volume in the second quarter. I would hope that we will, by the end of the year, not have to have the effect on that we've talked about to try to replace them. But I think it's got more to do to the timing of the physicians, and there was more of them working the entire second quarter of 2012 than there were in the first quarter, 2012.

[Wayne T. Smith:]

We, like everyone else, are adjusting and we didn't adjust fast enough in the second quarter. But adjusting in terms of productivity. And that's what's happening in this industry, it's shrinking in terms of making sure that people are the most productive that -- so that we don't carry extra costs.

[Christian Rigg:]

Right. And then -- and I know this one's, again, on the core business but applies to HMA as well. It might be somewhat difficult to answer. But when you look at sort of the uptake in high-deductible health plans and how that's impacting commercial utilization, I mean, how -- are you guys really seeing a noticeable difference at this point that you think you will see a bump in the fourth quarter? Or any material change in seasonality? Any color would be helpful.

[W. Larry Cash:]

It does look like some of the high deductible plans give you a little bit more benefit in the fourth quarter and if you look at our deductibles, we were able to identify where we had some deductible increases that affected our MRIs and CAT scans and things of that nature. In the second quarter, our deductibles dollar lines were up a little bit, but not up a substantial amount, and I think we just got to continue to monitor it. I would hope that we would see a little bit better result. When it comes back to the dollar deductibles, were about 14% a year ago and they're about 14% -- a little over 14% now, and are 14.3% or 14.3% a year ago. But we did see that where you have the deductibles increasing that you would have a little bit slower CAT scans and MRIs.

[Operator:]

We have time for one last question. John Ransom from Raymond James.

[John W. Ransom:]

Could you -- Larry, could you give us an estimate of HITECH EBITDA for both companies, '13 and '14? Do you have that number?

[W. Larry Cash:]

Our number is 160. I thought their number was $85 million, I believe, for 2014 -- 2013. We don't have '14 out yet. We wish to have another good year, I think they dropped down a little bit in the '14...

[Joanna Gajuk:]

I'm just curious, as good as you are with numbers, how did you think about that EBITDA? Did you think about it as an add-on to enterprise value? Or did you think that was something worth paying a multiple for?

[W. Larry Cash:]

Well, you've got to look at what other industries or what other transactions happen, and they had HITECH in it. And then if you look at other transactions, were less than what the 8.3% is here. And you could carve it out on other transactions or clearly, the sectors that trade a little bit lower. So we sort of thought about it both ways.

[John W. Ransom:]

So I guess, as I'm thinking about the transaction, if we take the 7.6% and we add the 260, let's say, for either the settlement or for the extra dollar, it looks like a $7.9 billion deal for run rate EBITDA of about $800 million that you strip out HITECH for HMA? So I mean with that as kind of the a starting base, I know you've got the synergies, but how else should we think about that $800 million number to adjust for '14 other than reform assumptions? Is that -- how much legal cost should we take out and what other adjustments shall we make for that number, do you think?

[W. Larry Cash:]

Yes, I think we'll provide more color as time goes on. I think a couple other things you have to think about when it comes to HITECH, you also got expenses. With HITECH, it probably wouldn't be there in their conversion costs, expenses and software. HITECH, you got to roll forward a little bit with HITECH, John. We spent a lot of money, we're going to get some money back from the government. And I think over time, we'll see some benefits. It should help us be productive and have all this records and order sets and things of that nature. People just sort of think about it as a vacuum for next year or two. And it should, with the assistance money you're spending, give you some operating efficiencies. And I think you also got to think about the value of health care reform and value of being larger in certain states or all similar states as us. So we're comfortable that this was a good price. It was an 8.3 multiple with HITECH in it, and it was based off the last, I got to say, off the last 6 months -- the last 12 months earnings.

[John W. Ransom:]

And then just 1 other thing, as you think about HMA, how much pure corporate overhead do you think can be taken out? And how do we think about -- is the net IT spend going to go up or down on those assets? Because they in-source their IT. A lot of their IT, as you know, had a lot of programmers. How do we think about those 2 pieces?

[Wayne T. Smith:]

Yes, when you look at corporate overhead, there's IT, there's some regional business offices, there's some corporate expenses, there's some corporate long-term incentive numbers and we just have to go through that. We'll provide more color over time. But there is a portion of the corporate that relates to long-term incentives in which in some will stay and some will be eliminated. Thank you, all, for joining us. I want to direct this both to the HMA employees and physicians, as well as ours. We appreciate all the good work you've done. Let me also express my appreciation to all the people who have been working on this transaction over the last number of weeks. You all have done a fabulous job of getting us together. We have a long way to go. There's a lot of hurdles to get over to get this done. We're confident that we'll get there. We certainly think strategically, this is the right opportunity for us as a company and the right opportunity for HMA, their shareholders and their employees. So thank you very much for what you've done. And we still remain focused on our business strategy and improving our own results. So if you need to talk to us, you can reach us at area code [phone]. Thank you.

[Operator:]

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