Community Health Systems, Inc.
Q3 2014 Earnings Call Transcript

Published: 4 Nov 2014

[Operator:]

Good morning. My name is Jeremy, and I will be your conference operator today. At this time, I would like to welcome everyone to the Community Health Systems Third Quarter 2014 Conference Call [Operator Instructions] Thank you. I will now turn the call over to Mr. Mike Culotta, Vice President, Investor Relations. Please go ahead, sir.

[Michael J. Culotta:]

Thank you, Jeremy. Good morning, and welcome to Community Health Systems' Third Quarter Conference Call. Before we begin the call, I would like to read the following disclosure statements. This conference call may contain certain forward-looking statements, including all statements that do not relate solely to historical or current facts. These forward-looking statements are subject to a number of known and unknown risks, which are described in headings such as Risk Factors in our annual report on Form 10-K and other reports filed with the Securities and Exchange Commission. As a consequence, actual results may differ significantly from those expressed in any forward-looking statement in today's discussion. We do not intend to update any of these forward-looking statements. With that said, I would like to turn the call over to Mr. Wayne Smith, Chairman and Chief Executive Officer. Mr. Smith?

[Wayne T. Smith:]

Thank you, Mike. Good morning, and welcome to our third quarter conference call. Larry Cash, our President of Financial Services and Chief Financial Officer is on the call today; as well as David Miller, our President and Chief Operating Officer; and Dr. Lynn Simon, our President of Clinical Services and Chief Quality Officer. After market close yesterday, we issued an 8-K, including a press release, with our financial statements. For those of you listening to the live broadcast on this conference call, a supplemental slide presentation has been posted to our website. I'm extremely pleased with our financial and operational results that we were able to achieve this quarter. This is the second quarter that we have reported our combined operations with HMA for a full quarter. I think you will agree that our results are continuing to improve each quarter. We're accomplishing our goals as the year progresses. Our year-to-date results consolidate the results of Community Health Systems and CHS '14 facilities from and after January 27, 2014. The prior year third quarter and the year-to-date historical financial information includes that of CHS only. Same-store results reflect the HMA's performance for the full third quarter of 2013 and for the year-to-date performance from February 1 forward, for both 2013 and 2014, as well as for CHS for all 3 months and 9 months, respectively. For the third quarter, our net operating revenues increased 51% on a historical comparison, to $4.8 billion. Our adjusted EBITDA, as defined in our earnings presentation, increased 55% to $751 million. On a sequential quarter basis, our adjusted EBITDA grew $52 million. For the year-to-date comparison, our net operating revenues increased 43% on a historical basis, to $14 billion, while our adjusted EBITDA increased approximately 42% to $2 billion. On a sequential quarter basis, our adjusted EBITDA has gone from $541 million in the first quarter, to $699 million in the second quarter, to $751 million in the third quarter, or a cumulative growth rate of 17.8% over this time frame. Our quarter's adjusted EBITDA margins improved 50 basis points from a year ago, and 110 basis points sequentially. Adjusted earnings per share from continuing operations for the quarter was $1. This is a sequential quarter improvement of 35% and a 27% improvement over last year's third quarter. All calculations exclude the costs associated with HMA acquisition transition costs, government settlement and related reserves and CVR legal expenses and liability. Let's now discuss our volume trends. As we have said before, we should start seeing better trends and volumes as the year progresses and we did. So our same-store trends are as follows

[W. Larry Cash:]

Thank you, Wayne. We believe our same-store information for the third quarter we are providing is more meaningful and thus we'll commonly discuss same-store results for the third quarter. The same-store numbers for 2014 reflect the synergies previously discussed. All the comparisons will be to the third quarter 2013, focused on the same-store results, unless otherwise stated. Of course, the information we discuss excludes integration costs, the merger costs of HMA, the $3 million in government settlement that Wayne previously mentioned, the $77 million in legal expenses associated with the HMA, government litigation related to the contingent value rights of $8 million. Wayne has previously discussed our positive volume trends, so I'll focus on some other areas. We continue to see -- and we'll continue to see a shift to outpatient. Our outpatient revenue represents 55.8% of total patient revenues, compared to 54.9% in the third quarter 2013. Our price and the intensity we saw in our same-store revenue for adjusted admission after provision for bad debt increased 2.8%, which is up 110 basis points sequentially. Our consolidated impairments continues to show improvement, we saw a 70 basis point improvement in managed care and 120 basis point improvement in Medicaid, and a reduction in self-pay of 60 basis points. Our consolidated all-payer mix increased 1.1%, and just note that the Medicaid case mix was up 0.4% and managed care increased 2.4% and the Medicare increased 0.5%. On the expense front, all salaries and benefits declined 120 basis points percentage of revenue. The decline was the result of 1.9% productivity improvement. And we should continue to see improvements in this area as we continue to integrate our 2 organizations and further achieve the synergies we had previously estimated. So supply expenses declined approximately 10 basis points as a percentage of net revenue. We believe we will continue to see improvements in this area as we continue to increase our overall compliance in our group purchased organization, and a decrease to pricing, as it relates to both CHS '14 facilities and CHS facilities. Our other operating expenses declined 60 basis points, and we continue to see more improvement in this area as we work on our strategic sourcing initiative. As it relates to HITECH, we recognized $88 million, which is $4 million more in HITECH in the third quarter versus the second quarter. We also managed our operating expenses better. We believe in the fourth quarter, reimbursement of HITECH incentives will be between $50 million to $55 million, which is currently below the consensus. Related to legal contingencies and payments that may reduce the value of CVR rights, and which we recorded HMA prior to our acquisition as part of the purchase accounting for HMA, we have accrued or paid a total of $355 million. We adjust the fair value estimate each quarter as determined using the assistance of legal counsel and third-party valuation experts. In addition, these estimated liabilities from the date of acquisition through September 2014, we've incurred about $21 million in legal expenses, and these legal expenses now exceed the deductible of $18 million under the CVR agreement. Our CapEx for the year-to-date was $560 million or 4.1% of revenue, compared to $421 million or 4.4% for the 9 months ended September 30, 2013. Approximately $81 million was on replacement facilities in 2014. We'll focus on year-to-date amounts as it pertains to our cash flow from operations of $639 million. The following items have impacted our cash flow from operations. We have a negative impact of the HMA integration costs and legal fees, which is a CVR of $83 million. As you'll recall, $78 million was through the first 6 months. HMA investment banking fees and other related liabilities that were in accounts payable and accrued liabilities in the amount of $78 million, the government settlement and related costs of approximately $100 million. Adding these back and also tax in effective, which we didn't do in the second quarter, we have a cash flow of about $833 million. This $833 million compares to $561 million for the cash flow generated by both companies, or a 48% improvement. The items described above will not be included in our yearly guidance on cash flow of $1.6 billion and $1.8 billion, which it was previously. In addition, our cash interest paid is sequentially lower and the timing in our liabilities will create a larger cash flow in the fourth quarter. Also, we should receive over $100 million in HITECH incentives in the fourth quarter. We're expecting to receive another $85 million in tax refunds in the fourth quarter. Our patient receivables did increase due to system conversions by $75 million, an increase in some Medicare HMO activity of about $50 million and also an increase of $85 million receivables in hospitals we acquired, which we did not buy accounts receivable. Now let's turn our attention to the Affordable Care Act. As we said earlier, in the 3 years' time, we expect our self-pay admissions to decrease from 8% to 4% in 2016. This reduction in percentage is in line with our estimates made by the CEO. Approximately 55% of our self-pay population should be eligible for expanded Medicaid if all states expanded according to the data available. Through 9 months, we have noted same-store self-pay admissions as a percentage of total admissions in expansion states declined 390 basis points to 3.3%, and adjusted admissions declined 410 basis points to 3.8%. While Medicaid admissions increased 520 basis points to 24.3%, adjusted admissions increased 610 basis points to 26%. In expansion states, self-pay admissions decreased 56%, and our adjusted admissions decreased 53%. While Medicaid admissions increased 6,300 [ph] admissions or 20%, adjusted admissions increased about 27.5%. Self-pay emergency visits decreased 35% in expansion states and 4% in non-expansion states. We also experienced a 10% increase in Medicaid in-patient case mix index, which is compared to what was about 3% in the second quarter, and an approximately 20% increase in exchange case mix for -- over the previous year's self-pay case mix. Year-to-date, same-store adjusted admissions have declined 15%, 100 basis points in percentage of adjusted admissions. Over the last 3 quarters, the decline in self-pay mix and adjusted admissions [ph] increase in Medicaid expansion states has grown quarter-over-quarter. So we still continue to see the ramp-up in expansion states as we had originally projected. Take a look over the last 3 quarters, that the trend of uncompensated care has gone from 26.4% to 25.8%, and now at 25.4%. On a comparable basis, our uncompensated care in the quarter decreased 240 basis points and year-to-date it decreased 70 basis points. As you'll please recall from our last first quarter call, we've been monitoring certain payer patient visits with specific exchange identifications for 13 states or approximately 60% [ph] of our managed care business, we could identify are selected insurance companies, the exchange business in our hospitals. In these markets, patient visits were up about 28% from second quarter. From this information, we've attempted to estimate the company's ACA exchange benefit, including factoring in the normal migration of self-pay patients in non-expansion states and years. It's based on the various data points on Medicaid and exchange business, we believe that we recognized $80 million to $90 million from the Affordable Care Act for the first 9 months of 2014. We currently estimate that 50% of our exchange volume is previously uninsured. Now just to give you a few comments about how we're going to address the open enrollment period. We now have over 800 certified application counselors, compared to 400 last year. Half of these employees are located in our hospitals and half are at our internal eligibility company. Some of our specific outreach efforts are

[Wayne T. Smith:]

Thanks, Larry. We're very pleased with what we're accomplishing considering the challenges. Of course, with challenges comes opportunities. We have so many opportunities with

[Operator:]

[Operator Instructions] And your first question comes from A.J. Rice with UBS.

[Albert J. Rice:]

[indiscernible] and that you did clean, I guess, this quarter. And we take the $34 million of BNA, the $16 million of BP, the $25 million of California as a step-up. I guess you've got -- you're identifying HITECH at about $25 million and DSH at about $12 million as the back-off numbers. So it seems like there's 4 buckets left

[W. Larry Cash:]

Yes, A.J., it's Larry. Good question. You're correct, we've got -- the BNA is done, we expect to get the BP, about $14 million, the California provider tax. If you start at 751, that gets you to 826, there's going to be a little bit of a decline in HITECH in this quarter. We were able to get some of the work done in the third quarter, so that HITECH could drop $20 million or $25 million, that range or so. So -- excuse me, it's about $30 million to $35 million in incentives, but also expect to cut our expenses again, so that would offset some of that. And the -- well, everyone knew the DSH was going to come along. I think we'll continue to see the Affordable Care Act get a little bit better, maybe not quite as much from third to second, as you're done, but still get a little bit better than it got there. The synergies were probably around $125 million, we get another $40 million for stuff we're working on, that should help a little bit there. I think we've got 4 or 5 different things we're working on. One is the productivity, we'll probably continue to get better. We've got about $10 million, $11 million of benefit from some CapEx that we spent throughout the year that will not -- was not there in the third quarter and should help the fourth quarter. We've got the benefit -- physician practice is getting better, and I think our volume improvements, volume will probably be better year-over-year, which would help us. And I think we've also got the opportunities as it relates to the discontinued work on the basic organic of the company. If you look back the last couple of quarters, while we're not giving out same-store improvements or same-store specifically, we probably, in the second quarter, were better organically 5% to 7% and probably another 5% or so in this last quarter year-over-year. So I think we're continuing there. We feel like we can get it at a range, but there's a couple of headwinds, but there's plenty of tailwinds that should help us.

[Albert J. Rice:]

And just as a follow-up, as you think ahead to next year, I know, Dave, you've been working on a lot of things to grow the volumes. Can you give us an update on how much of that we've seen this year? How much is still ahead of the company in terms of these volume improvement initiatives?

[David L. Miller:]

Well, the -- we've been working on this now for a couple of quarters. We're seeing improvement. It's a little early, first, to certainly talk about in 2015, because when we get through the fourth quarter, we'll obviously do, give our guidance for 2015. But we're making progress and I think we'll continue to make progress. Assimilating HMA was a little bit of a distraction to start with, so I think we're back on track in terms of fundamentals and doing all the right things we need to do to grow the business.

[W. Larry Cash:]

Most of the things that took place started in the second quarter or the third quarter, and so, clearly, there'd be a full year benefit to that. But if you look at the other sort of appropriate tailwinds, the synergies probably has an opportunity to get a little bit better. The Affordable Care Act will still continue to grow. Wayne outlined a lot of states to expand, the expansion's going to be more, the penalty's going to be more. We're better prepared. The HMA hospitals would be better prepared. There's more managed care companies. We've got more contracts than we had before, and I think we're in good shape with our contracts. The organic improvement should be there for a full year. We've got a lot of expense improvements we're working on in service centers and central business offices and payroll and supply centers. So we will provide all the detail of that in February, but there's a lot of good things in that. And Wayne mentioned you've got the opportunity of the HMA margins. It probably is going to be a little bit better. At the end of the year, over 2013, but there's still more opportunity to work on that over and above the synergies.

[Wayne T. Smith:]

Even if the Republicans take the Senate, there seems to be good opportunity for us in 2015.

[Operator:]

Your next question comes from Justin Lake with JPMorgan.

[Justin Lake:]

You laid out a lot of the 2014 moving parts. I wanted to think about '15 and just if you could -- I know it's early, but maybe just talk to the known headwinds and tailwinds so that we've got a solid list there. And maybe just some color on how we should think about the incremental benefits from reform next year, as well as kind of core growth.

[W. Larry Cash:]

We'll just give some general commentary, because I mentioned a little bit, right, on the previous question. But the headwind is probably -- the HITECH's probably going to decrease a bit, but we're doing a pretty good job of offsetting expenses. So that's going to be a headwind. The BNA $36 million will not be there in 2015. The British Petroleum, I think would be another chance to recover some more money on that activity. The California provider tax should be there again in '15. A slight decrease in government updates overall. I mean -- and again, the tailwinds, the synergies, we had $275 million of synergies for Triad. Triad had 20 less hospitals than HMA and about $800 million less revenue and a smaller corporate office. So we're targeting $250 million right now, and as Wayne said, we'll revisit that in February. I think the ACA -- I think one of the maybe misconceptions is once you expand, you get your business early on. If you think about exchange, people will probably come to the hospital for admission once over 7 or 8 years, so there's clearly an upside to continue having this enrollment activity go on both in exchanges and similarly on Medicaid, so that should probably grow again over and above where we are now. You've got the organic improvements in volume that should take place, and I think we have a good shot of having positive volume in the fourth quarter. And then all the expense performance activities built around the service center initiatives and the sourcing supply chain initiatives. And also, we just completed centralizing all the payroll for the legacy hospitals. And then finally, you've probably got the opportunity of acquisitions. I mean, we bought a few hospitals midyear, a couple of small ones at the end of the year. We've got one in the first part of the year. Usually we improve the margins the first full year of 400 basis points, another couple of hundred basis points off that. So that will help. And then you've got the continue to get HMA back up to the 15% margin that we think we can get to.

[Justin Lake:]

And Larry, on the HMA, how much do you think you'd get next year that -- I think you said it's 200 basis points?

[W. Larry Cash:]

It's a little early, but I would think it would probably take just until '16 to get all that. So we'll probably, by the end of 2015, we'd be halfway there.

[Justin Lake:]

Okay. And then just a quick follow-up on the leverage comment you made. The 6x going to 4.5, and you said that's by 2016, right?

[W. Larry Cash:]

Yes, the end of 2016.

[Justin Lake:]

And so can you give us a breakdown in terms of -- obviously, that's a pretty significant decline in leverage. How should we think about that in terms of how much comes from EBITDA growth versus debt paydown?

[W. Larry Cash:]

Yes, we clearly have historically used EBITDA growth, but we'll have the ability, late in '15 and '16, to pay out some of the bonds that have become callable, and so that's probably something we'll look to. We probably will not pay any bank debt off of -- prior to that date, although we could change our mind about it. So I think it will be a combination of both. The majority of it has been pretty much all EBITDA growth. We've slowed down acquisitions, we're focused on HMA and I think we'll continue to see the EBITDA grow nicely. I mean, the $400 million, $500 million benefit of health care reform weren't there when we did the Triad deal, when we did a 1.5% over 1.5% improvement in a couple of years. I think we can easily get to the 2 with this, with both the opportunities from margin and the opportunities of the Affordable Care Act.

[Operator:]

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

[Kevin M. Fischbeck:]

I just wanted to -- you mentioned the elections being a basically kind of a tailwind as far as your view, because it kind of feels like it's something that might open up Republican or even Democratic governors to have a freer hand to expand Medicaid. But the markets seems to be focusing on the potential for Republicans to gain control of the Senate and maybe a Supreme Court decision to come down the pike. Just wanted to get your thoughts about what you thought -- you made a comment, Wayne about -- it didn't sound like you thought it'd be a headwind, but what you thought might happen around, legislatively, if Republicans take control. And then what you think a logical outcome from the Supreme Court might be if it was to somehow be a negative outcome if the states were kind of already prepared to find a workaround and keep things going. So just your thoughts there.

[Wayne T. Smith:]

Yes, Kevin. I think in talking to people, I think there's a -- if Republicans take the Senate, I think they'll do 2 or 3 things fairly quickly. I think they want to demonstrate that they can govern. So things like the Keystone Pipeline, trade agreements, they'll do those couple of things pretty quick. Then you get into the budget -- and probably the President would pass those first couple of things. Then you get into the budget and reconciliation, that's probably a veto item, when it's all said and done. I think there's a couple of things here at play that may be different than what we've been thinking. We have a presidential election coming up relatively soon. Mitch McConnell is going to want to be -- is going to want to have a leadership job for a long time instead of for only a couple of years. So Republicans have to think of a way to be kind and generous and helpful as it relates to health care reform, I think, is a big item. If you ever want to pass an immigration bill, you've got to figure out a way to work with people to do that. I think those things are different and I think the dynamics are different today because it's a short time to get to a presidential election. And if you're going to elect a Republican president, which all Republicans are going to want to do, they're going to have to compromise. Even the really difficult hardliners are going to have the figure out a way to compromise some so that we get some good legislation passed, but also so that the Republicans build up credibility with the minority base. So I don't think -- and by the way, I don't think -- I think Mitch McConnell has said this publicly, he now is not in favor of any kind of appeal process for the accountable care act -- Affordable Care Act.

[Kevin M. Fischbeck:]

Okay. And the Supreme Court, do you view that as a threat or...

[Wayne T. Smith:]

I'm sorry. What?

[Kevin M. Fischbeck:]

The Supreme Court subsidy issue?

[Wayne T. Smith:]

Yes, I don't really have much of an opinion about that, but other than the fact that the -- what I read is, in terms of what people are saying, that it's probably highly unlikely. But if that happens, I think most people think there's some kind of workaround in every state, some kind of conversion you can do that will be helpful.

[W. Larry Cash:]

There's going to be 8 million people in the areas already in the exchanges, a high percentage of those are going to be in non-expansion states. We've seen good success in Florida and Texas, I'm sure other people have also. It's going to be hard to think those states wouldn't want to continue to let these people have access to care. So it seems like even if it were to come down, you'd find some way to work around it, like some other state did an exchange for them or contract it out with somebody else.

[Wayne T. Smith:]

David [ph], since you're asking for political opinions, the last think I'd say is about Medicaid expansion. I think we think there's a good opportunity for Medicaid expansion in a lot of states kind of going forward, even in some of the states that have been most difficult. Again, I think it has to do with the presidential election, governors getting reelected. One of the reasons Rick Scott is having such a difficult time in Florida is because Charlie Crist is beating him up pretty bad over Medicaid expansion. So I think that's moving -- that will move forward after we get over these midterms.

[Kevin M. Fischbeck:]

And I guess, Larry, real quick. You mentioned that your reform estimate for the quarter is like $80 million to $90 million. And I think in the past, you've talked about this $400 million to $500 million benefit from reform, kind of being 1/3, 1/3, 1/3, in '14, '15 and '16, but you're already at a run rate that's more than half the way there. So just wanted to get your thoughts about how you're thinking about the timing of reform.

[W. Larry Cash:]

Well, 1/3 of $500 million will be $160 million. We're probably a little bit lower than that, based on where we are today. I think if you look at the states -- just go through them, Pennsylvania, there's probably about 1% benefit of consolidated EBITDA from expanding, Indiana is about 0.5%, and Utah and Missouri are probably -- and Wyoming are probably about 0.5%, Tennessee is probably 1.5% of our EBITDA. So I think you -- with those coming in, we should see another good year there. I do think that you will continue to see benefit from the exchange patients as they get coverage and use it, and it's not just the first year, so it's going to be build up. We're about 15% below our decrease in adjusted admissions. We're well on our way to get to the 50%. Hopefully we'll be a little bit above [ph] 15% by the end of the year and I think we'll see another good reduction next year of a similar amount. We'll outline how we're going to do the reform in February of 2015. Of course, our reform benefit is net of some reductions. Some people talk about a gross, so ours is a net number.

[Operator:]

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

[Whit Mayo:]

Larry, just first question, just on cash flow. It was a little soft in the quarter and your full year guidance would imply a fairly significant jump to get within your range. I know you called out a number of items that was a negative swing factor this quarter. But anything to consider going into the fourth quarter that gives you a lift and maybe just remind us when you fund your bond payments?

[W. Larry Cash:]

Yes, it's using $833 million, there's probably about -- I said over $100 million, there's probably about $125 million of HITECH incentives you're trying to get. There's an $85 million tax refund we'll get this quarter. Our A/R base went up a little bit. As you spend all this time and effort on conversions, they go up, they'll come back down, which is probably $75 million. We do have the benefit of the way the accrued payroll works, which is $140 million or so, the way we expect it to happen in the fourth quarter versus the third quarter. The interest accrual will be -- and interest payments is about $125 million. We'll probably get a little less money from some Texas supplemental programs. And then the normal cash flow would drive it somewhere in the neighborhood of $300 million to $400 million, which puts you nicely inside the $1.6 billion, $1.8 billion. I'd just point people to last year, we had -- we were $450 million or so in the third quarter. We got to $1.089 billion, so we had a really strong $700 million in the fourth quarter and I think we've got a good shot at doing that again.

[Whit Mayo:]

And second question for Wayne. Maybe if you could go back and talk about some of the regional network affiliations you've made with various retail pharmacy chains. We've seen a few things in the press. And what do you expect to get out of that? Is there any capital that gets exchanged in these partnerships? Just any color would be helpful.

[Wayne T. Smith:]

Yes, you've seen probably that we signed a deal with CVS. And our view of the world is changing a little bit in terms of access in these -- in our network markets in particular, and actually in all of our markets. We're either -- in the markets where we're the sole provider and we -- that hospital is the network or the basis for a network, which is a good thing for us, it's worked well for us through the years in terms of contract and all of the above. Having said that, access is becoming more and more important, primarily around the fact that we're going to have 25 million or so people insured that have not been insured before. Our perception is that's a group of people that are not going to spend a lot of time calling physician's offices, making appointments, waiting 2 hours in an office to see a physician. They're going to access care wherever they can, whether it's at Target or CVS or Walmart or wherever it might be. So we're pretty busy. That's -- one component of our market strategy is trying to figure out ways that we can develop opportunities in terms of access. Historically, when we looked at this before, the people that were doing that, the drugstores and the Walmart, they wanted us to put up capital, rent the space, provide the employees, do all of the above and they would take whatever the scripts or whatever else happens. And now it's really more about the fact that they're just looking for referrals from -- in terms of can they get access to a physician through us from those. So they don't require us to do anything much other than provide our availability of our network. It's building relationships with the patients long term and making sure those patients have good experiences. And we think that's one of the keys. And you add to that, the digital age and all the other things that we're working on is just one component of that.

[Operator:]

Your next question comes from the line of Josh Raskin from Barclays.

[Joshua R. Raskin:]

I just wanted to follow up on the efforts around the HMA facilities and make sure I got what you were saying right, Larry, that you guys didn't really have a chance, obviously, you closed that a little bit later. Did they have much of an outreach? I mean, obviously there was a lot going on at the end of the year last year. And would you expect the impact on the HMA legacy facilities to be higher in '15 on a relative basis than legacy CHS facilities?

[W. Larry Cash:]

They did not -- when we did due diligence, it was apparent that they weren't as focused. They had a lot of distractions going on. And of course, there's a lot of management turnover in the second, third quarter. I think we've got -- we've converted about 20 of their hospitals to our internal eligibility activity, and I think we've done the right hospitals, so that would be a good source, and I think, both on the Medicaid side. And clearly, there's the woodwork effect, which you get a little bit of benefit from that now so -- in the non-expansion states, and I think the exchange business could be very beneficial there. And we also probably helped them on some of the contracting. They had a few states that they were struggling with, with the exchange contract and I think we've done a better job, and we'll be more prepared for that. So I'm hopeful that most of it will be coming on exchange side. But there's also an opportunity, they've got some good hospitals. If Tennessee expands, they've got some good sites there. And if some of these other states expand, they would benefit from that. But I do think they were probably very, very underprepared for it, so it should be a benefit for us.

[Joshua R. Raskin:]

Okay. And then just any commentary on October volumes. I think you mentioned you'd expect a little bit of increase as we go into the fourth quarter. Do you have any color on admits or adjusted admits for October?

[W. Larry Cash:]

Well, we don't usually get into month-to-month, but we feel -- we believe it will be positive volume for the fourth quarter based on what we're seeing in the initiatives, and the work that David and Lynn are doing. I think we'll see some positive volume in the fourth quarter, but we won't go month-to-month.

[Operator:]

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

[Darren Perkin Lehrich:]

Two things I wanted to ask. Just first, as it relates to surgical trends, it looks like the year-over-year was just a little worse than in the second quarter. I'm just wondering if you can give us some flavor for inpatient/outpatient surgeries, how that looked in Q3? And whether you think some of the physician recruiting that you're catching up on with HMA or maybe some other investments might impact the rate of growth in surgeries going forward?

[Wayne T. Smith:]

Yes, I think our volume is getting better little by little. Some of this has to do with the economy in our markets. Unlike some of the larger markets, we have so many nonurban markets, it's taken a little while for them to recover. But it looks like they're stabilizing now. We had about a 1.3% growth in employment, unemployment is about 6.2% or something like that now. So it looks like it's being stabilized and we're beginning to see an improvement in terms of our surgical volumes. So hopefully we're own the right track there and it will continue to move forward. Our split, and Larry can speak to this, in terms of inpatient/outpatient revenue-wise is still relatively close. It's...

[W. Larry Cash:]

Yes, we were probably -- the inpatient surgery is down a little bit more than the outpatient. And as I said on the previous question, I think our adjusted admissions should be -- have a good chance staying positive for the fourth quarter, of what we know. As it relates to the second to the third quarter, I'll just remind people we did have a lot of bad weather in the first quarter and we did anticipate getting some recovery in the second quarter. Some of those surgeries, I feel about 25% of our volume dropped in the first quarter we thought was recoverable. So some of that, I think that's $3 million to $5 million of benefit that we thought we got in the second quarter from surgeries. So in essence, we were down 2%. Had it not been for the pickup from the first quarter, it actually had been sequential improvement in surgeries from the second to the third quarter.

[Darren Perkin Lehrich:]

Right. And then just the last thing I wanted to ask, it's been some time since you originally announced the Cleveland Clinic relationship. Is there any progress to note here? And where do you stand with that particular initiative?

[Wayne T. Smith:]

Well, we've done a little work with the Cleveland Clinic, but not a lot of work. And we still have a relationship, but it's not as big or as large a relationship as we once anticipated.

[Operator:]

Your next question comes from the line of Brian Tanquilut with Jefferies.

[Brian Tanquilut:]

Wayne, just a question on the volume trends. You guys clearly are expecting continued improvement, and you succeeded in driving that higher over the course of the year. As we look at the initiatives that you laid out and the comps that you're going to bump up against as we think about 2015, I mean, how do you look at that today without thinking about guidance, just from a more qualitative perspective?

[W. Larry Cash:]

Let me take that first, then Wayne can add to it. We've made progress every quarter. There's lots of activities around orthopedics, physician practices and other activities. We've got a project going on about telemedicine to help us that I've talked about on the road. So I think we'll continue to get better. Our employment has gotten better. It's probably averaged about 1% over the last 3 years, other markets maybe at 2%. We think there's more commercial business in our markets. Our managed care utilization was up, which is helpful. We're doing a good job on the physician recruiting, it takes a while to get them here. So I think we're pretty positive about it, without speaking specifically, seeing positive volume growth, adjusted admissions in 2015.

[Brian Tanquilut:]

Okay. And then, Larry, on the M&A timing, you mentioned that part of the reason you're adjusting the guidance was just delayed M&A. So should we think of that as just merely shifting over to 2015?

[W. Larry Cash:]

There was one of them that we were going to acquire, there was an HMA down in Florida that we decided it wasn't a good fit. And we're truly trying to buy stuff that makes good sense for us and our markets. So that would -- it was about $75 million and probably $10 million of EBITDA, that's gone, the rest of it is just timing. And the other thing in addition to hospitals, we've been doing a few outpatient deals and they got delayed a little bit, so we've got a big opportunity to continue to do outpatient physician deals. But the big one in Grand Rapids should be some time in the first half the year.

[Operator:]

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

[Frank G. Morgan:]

I think one of your big states, Texas, you called out. But I'm curious, being a non-expansion state, you mentioned the woodwork effect earlier, how much woodwork effect are you seeing there in terms of the decline in the uninsured volumes or a reduction in the increase? And then as you look toward 2015, a lot of insurers will be going into some of these states, like United. Have you negotiated with the Uniteds of the world? Are you in contract with them in all of those markets in places like Texas?

[W. Larry Cash:]

The woodwork effect, which we originally estimated at about $10 million, it's partly the flak [ph] on the run rate that may be a little bit less than there, but that's still going to be meaningful. Actually, I think what we've seen both in Texas and Florida a little bit more, it's change benefit. And of course, that's at a higher payment rate, so that's a good point, too. We do have about 30-some-odd contracts with United, we're not going to be in every location with them, but we are, have got 30 contracts in the exchange business. Of course, they didn't many last year. They're focused on larger markets, which in a lot of cases, we're not there. But we're pretty pleased with our relationship with them, they're a good managed care company.

[Frank G. Morgan:]

Okay. And then I think LifePoint called out issues surrounding collection rates on co-pays and deductibles, I think mainly on the commercial insurance side. But are you seeing any different trends in terms of collection rates because of higher out-of-pocket and co-pays?

[W. Larry Cash:]

If you go back and looked at it over the last couple of years, last year's, it looks like it's up about $40 on the average there. When you start out trying to collect it, maybe $70 from 2 years ago. I still think we're getting closer to 15%. I think 70%-plus of the exchange business is in the silver plan and there are subsidies there for those people. Most of the people buying it, 80-some-odd percent, 75%, have already got some form of subsidies. Clearly, it's a little harder to collect, but we've got our own collection company that do a good job under Mike Lynd and Jim Clark, and I think we'll continue to feel like we can collect most of it. But it has grown, but hadn't grown substantially.

[Frank G. Morgan:]

Okay. One final one, just RAC audit settlement payments. Are you -- were you inclined to participate in the settlement? If so, how much will that be? And then how much exposure do you have to the Texas Medicaid waiver programs that are now in dispute with CMS?

[W. Larry Cash:]

Somehow you got 4 questions in one there, Frank. Yes, we will participate. We'll probably -- it's probably a couple of A/R days. I don't think it's going to have a material effect on the income statement, on the -- see the other 2 questions.

[Frank G. Morgan:]

Just one on Texas Medicaid waiver.

[W. Larry Cash:]

Texas Medicaid. Yes, we've got a small amount of money in there, a few million dollars. So -- that we have got -- we don't have that reserved for our earnings, $2 million or $3 million, so I think we will ultimately collect that.

[Operator:]

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

[Ralph Giacobbe:]

I guess at this point, do you guys have a good estimate of what your success rate is, has been, at signing up people for Medicaid that have come through your doors and were eligible?

[W. Larry Cash:]

Yes, we're running 60%. I think we're somewhere over 80% right now. And I think we'll continue to see us get better at that. And it's probably a little bit better in the expansion states than it is in the non-expansion states, because more and more people are sort of taking it. So on a company-wide basis, I think we're up about 20%, probably better in the expansion states. And there's just some people that just don't want to participate. They don't want to fill out forms. The government's making it easier. We're getting better at it. I think we'll continue to do that. I think our statistics on our slide show some substantial progress with Medicaid volume growing faster than the drop in adjusted admissions. So we're pretty pleased with what effort we got. We think we'll have a good success going into 2015.

[Ralph Giacobbe:]

Okay. And then HITECH, you mentioned the headwind for next year. Can you help in terms of quantifying what the dollar amount of that would be?

[W. Larry Cash:]

It's somewhere in the neighborhood of $75 million to $100 million of incentives and then there's some offset of expenses that will eat up a lot of that, so it is a headwind. And over time, HITECH will wind down. The spending that we spend on HITECH, on capitalized software will wind down. And we think there's a great opportunity in this company outside of HITECH, but it's something that -- we've got 200 hospitals, so we're going to have a lot of HITECH and not spend money on them, like electronic health record, so we've got a lot of incentives out of. But it will probably be a little bit of a headwind next year, and it will be built into our guidance.

[Operator:]

And your last question comes from the line of Ana Gupte from Leerink Partners.

[Ana Gupte:]

I wanted to follow up on the acuity commentary you made earlier about Medicaid. I think you said the inpatient case mix is up 10% and you said the exchange is up 20%. What types of surgeries and procedures are these new members undertaking? So is this likely to show a continuous tailwind to 2015 and '16 for the same membership?

[W. Larry Cash:]

It's a good question. We early on -- as pointed out, that the Medicare case mix for Medicaid is very, very low, it's below 1. A lot of your Medicaid business that you have today is women and children. Now you're going to be seeing a bit -- a lot of adult males left out. A lot of it is your general surgery activity in the other care, which is a much higher case mix than the existing people. We estimated it would be up about 5% for the year. We weren't there in the second quarter, we're now up to 10% on the expansion states, so I think that will continue to be there. And I think I'd be surprised if we don't continue to see that stay at that level, maybe get a little better as more and more adult males take care of general surgery and other activity going on. As it relates to the exchange business, we're comparing it to what self-pay business was, because now they're coming in and taking -- adding more procedures, and this splits the self-pay business in itself. So we're glad to see the case mix of the Medicaid was up.

[Ana Gupte:]

And then just following up on the same point from -- for the exchange membership that you saw in the second quarter compared to -- or maybe in the first quarter compared to the second quarter, was there any difference in acuity in terms of those with more pre-existing conditions coming in earlier on and now as we're potentially getting to a less acute case mix?

[W. Larry Cash:]

The one thing I would comment is that we are seeing probably over 40% of our charges are inpatient exchange, and it probably was less than that through the first 6 months, so we are starting to see a little bit more inpatient admissions, and inpatient admissions did improve nicely over the second -- third quarter over second quarter. Although still a small number, so we are starting to see a bit more inpatient business. And I think as people who follow managed care understand, it's 70 or 80 admissions per thousand, this can take a while for 7 million or 8 million people to sort of generate themselves through the system as far as inpatient admissions. But outpatient is still 55%, 60%. But we did see a growth in inpatient charges, which also helped contribute to the case mix above the prior self-pay case mix.

[Ana Gupte:]

And one final one, again, just not on risk pools so much, but on the willingness of these exchange members, who don't have the kind of cost-sharing subsidies perhaps to undertake procedures and services. Are you seeing a reluctance and maybe some of them get to deductibles by the end of the year? And to what extent would you be willing, given exchange pricing looks pretty attractive, to just waive the deductible or deal with it as non-collectible?

[W. Larry Cash:]

Well, we do expect to collect deductible, that's something we do, We do give discounts for prompt payment. We do, do a little bit of outreach to try to let people know we're there. And then 5 months and a quarter and we do generally have an uptick in utilization. I don't know, this would be the first time we've had exchange business, we'll have to see. It's still a relatively small percentage of insured people. You've got 7 million, 8 million people out of 150 million people throughout the country, so it's not a meaningful percentage of the business throughout. But I would expect they would -- some of those will be there and we'd give them a prompt payment. I don't know if we're going to be waiving deductibles, per se, right now to get business.

[Wayne T. Smith:]

Thank you, again, for spending -- I'm sorry? Thank you, again, for spending time with us this morning. Our standardized and centralized operating platform, are helping moving the company forward as one and is achieving our goals. I want to specifically thank our management team and staff, hospital chief executive officers, hospital chief financial officers and chief nursing officers and division operators for their focus on operating performance for this challenging quarter. Once again, if you have any questions, you can always reach us at area code [phone]. Thank you.

[Operator:]

And this concludes today's conference call. You may now disconnect.