Nov 5, 2013
Executives
Thomas R. Rice - Senior Vice President of Investor Relations Trevor Fetter - Chief Executive Officer, President, Director and Member of Executive Committee Daniel J.
Cancelmi - Chief Financial Officer Keith B. Pitts - Vice-Chairman Phillip W.
Roe - Senior Vice President of Finance Britt T. Reynolds - President of Hospital Operations
Analysts
Albert J. Rice - UBS Investment Bank, Research Division Andrew Schenker - Morgan Stanley, Research Division Sheryl R.
Skolnick - CRT Capital Group LLC, Research Division Joshua R. Raskin - Barclays Capital, Research Division Justin Lake - JP Morgan Chase & Co, Research Division Ralph Giacobbe - Crédit Suisse AG, Research Division
Operator
Welcome to the Q3 2013 Tenet Healthcare Earnings Conference Call. My name is Vanessa, and I will be your operator for today's call.
[Operator Instructions] Please note that this conference is being recorded. And I will now turn the call over to Thomas Rice, Senior Vice President of Investor Relations.
Sir, you may begin.
Thomas R. Rice
Thank you, operator, and good morning, everyone. Tenet's management will be making forward-looking statements on this call.
These statements are qualified by the cautionary note on forward-looking statements contained in our Annual Report on Form 10-K. [Operator Instructions] At this time, I will turn the call over to Trevor Fetter, Tenet's President and CEO.
Trevor Fetter
Thank you, Tom, and good morning, everyone. To summarize the quarter, we achieved adjusted EBITDA of $288 million, well within our outlook range and an increase of more than 7% over the prior year.
As we projected, our inpatient utilization was soft. With virtually every company releasing Q3 earnings by now, it seems that most of the sector experienced similar conditions.
Within this challenging context, however, we delivered an improving volume trend. We reduced the decline in adjusted admissions to just 0.5%.
We also produced a 90-basis-point improvement in our admissions trend, holding the decline to 2.6% in the third quarter compared to 3.5% in the second quarter. This marks another quarter of sequential improvement during this difficult year.
Our focus on outpatient services continues to provide -- produce strong results. We grew outpatient visits by 3.5% and paying outpatient visits by an even stronger 3.7%.
This outpatient growth was significantly stronger than the already impressive 2.2% increase in paying outpatient visits we generated in the second quarter. We are continuing to achieve strong organic growth in our existing outpatient facilities and augmenting that growth through acquisitions.
We drove roughly half of our increase in outpatient visits through facilities we own for more than a year. And for yet another quarter, emergency services were a bright spot, with growth of 3.1%.
We achieved solid growth in all 3 of the higher acuity service lines we highlighted on our second quarter call: neurosurgery, orthopedic surgery and trauma. This helped to drive an increase in acuity of 1.5%.
We continued to drive pricing gains in the quarter, with increases in inpatient revenue per admission and per patient day of 2.8% and 2.0% respectively. We drove an even stronger increase in outpatient pricing, achieving an increase in revenue per visit of 3.5%.
We also maintained solid growth in commercial pricing, with increases in commercial managed care revenue per admission and per day of 2.3% and 3.4% respectively. We achieved even larger gains in commercial outpatient pricing.
We increased commercial outpatient revenue per visit by 3.7%. As some of you will remember, these increases are against a very tough comp in last year's third quarter.
These strong performances in outpatient volumes, ED volumes, acuity and pricing all contributed to our ability to drive a very strong 8.4% increase in revenues. Turning to a topic of great interest, I'd like to fill you in on our progress in exchange contracting and health reform related topics in general.
First, I'm very pleased with our exchange contracting, our position in the exchanges and the positioning of the managed care plans with which we've contracted. In exchange contracting, we had a primary goal of gaining market share in an important new market for commercially insured patients with products that have better benefit design features.
We quantified that goal based on the value of the portion of the commercial book that we thought might migrate to the exchanges. We met our goal for legacy Tenet, and the Vanguard hospitals exceeded that same metric.
Pricing was important in achieving that primary goal, and we're pleased that we achieved aggregate pricing that is very close to commercial. Our secondary goal was to be contracted with plans that were well positioned to succeed.
I'm very pleased that we are contracted in approximately 3/4 of all the exchange plans that are offered in our markets. Even better, we're contracted with 80% of the #1 or #2 lowest-priced silver plans.
We have a couple of contracts under negotiation currently that will push those statistics higher. Obviously, there's been a lot of attention given to the issues with the exchange technology, especially with the federal exchange.
We've been tracking the ease of accessing information and signing up for coverage in our markets. Across our entire geography, the wait times for call center assistance have been coming down steadily since October 1, and the problems with online access to the federal exchange website have been improving.
Please keep in mind that California is an important state for us, and in California, the exchange and enrollment efforts are well managed, well funded and working remarkably well. While there are plenty of problems with the federal exchange, we believe that those people who utilize hospital services and need health insurance the most will be the most persistent in their efforts to gain coverage.
The young invincibles are necessary for a balanced insurance risk pool, but they are not frequent hospital patients. Our patients are typically older and tend to have more serious or chronic conditions.
The mini-med insurance that they may have liked but now can't keep was of very little value to us. Just remember that hospitals have a very different perspective on this issue than other sectors of health care.
We're also doing a lot to help uninsured people enroll in insurance programs. We went live with a major outreach effort in October that is now active in all of our markets.
We are positioning our hospitals as trusted sources of information on how to obtain coverage and assistance with enrollment. The extent of what we're doing is calibrated depending on the number of uninsured people in each market who are eligible for coverage, the relative burden borne by our hospitals and the extent to which other organizations are conducting enrollment efforts.
We are using advertising, local community organizers, our patient access staff, our Conifer call center and partnerships with local community groups to identify, contact, educate and enroll the uninsured people in our markets. As you know, for many years, our Conifer medical eligibility teams have demonstrated consistent, strong performance in enrolling people in insurance programs for which they are eligible.
This new effort is a natural leveraging of that capability to capture the benefits of expanded coverage under the Affordable Care Act. Conifer's call center is experienced in these efforts and is the principal point of contact for individuals in our campaign.
We're using existing databases and Conifer's technology to do this in a highly effective and targeted way. In short, I'm very pleased with our exchange strategy and the outreach efforts and continue to be very enthusiastic about the benefits we'll see from health reform.
Let's now turn to our cost metrics. We held the growth in selected operating expenses per adjusted admission to 2.7%.
This metric excludes Conifer and incremental physician employment. We achieved a favorable cost variance to our forecast for the quarter.
This achievement is even more impressive given the strong surgical growth recorded in the quarter. Surgical growth is strongly correlated to the growth in supplies, which on a per adjusted admission basis we held to an increase of 3.4%.
Dan Cancelmi will provide a more detailed analysis of the relationship of surgeries to costs in a few minutes. One of the reasons for our impressive cost performance is that our Performance Excellence Program is having another great year.
We expect to meet or exceed our 2013 objective of $80 million in savings. Conifer continued to maintain tight control of our bad debt levels.
We reduced bad debt expense to 8.0% of revenues. That's a 50-basis-point improvement compared to last year's third quarter.
We maintained a stable self-pay collection rate of roughly 29%. Moving beyond bad debt expense to look at Conifer's broader impact on our financials, Conifer drove a $103 million revenue increase in the quarter.
This is an 84% increase in revenue. Total Conifer revenues in the quarter were $225 million.
On an annualized basis, Conifer has achieved a revenue run rate of $900 million, marking another important growth milestone. Conifer delivered EBITDA of $36 million in the quarter, a 50% increase over last year.
Conifer's operations are performing well and its sales pipeline is growing. I'm also very pleased that Vanguard's leader of revenue cycle, Neal Somaney, has joined Conifer, so the integration of Vanguard's operations into Conifer will move quickly.
Our other segments within Conifer are growing nicely. With some significant new customer wins, our value-based care business is now involved in some aspect of care management for more than 4 million people, and our patient communications business now has more than 180 hospitals and physician practices as customers.
In addition to Keith Pitts and Phil Roe, who are here with us today, I'm also delighted to report that all of Vanguard's market and hospital leaders joined Tenet. We have visited them in the markets and have had the market and regional leadership to Dallas multiple times.
I'm very pleased that this talented group of people joined us, and I'm very impressed with their capabilities and the strategies they are employing in our newly acquired markets. As I have visited our new markets and hospitals, I have been very positively impressed with the physical condition of the facilities, the innovative strategies and tactics that Vanguard has employed in improving performance, their quality programs, lean programs and physician strategies.
I'm very excited about the new company. In summary, last night's earnings release delivered additional robust evidence that our key business strategies are working effectively in driving significant growth.
However, the impact of soft utilization, especially in the commercial segment, presents a continuing challenge. We provided an updated outlook for our fourth quarter, which includes the expected EBITDA contribution from Vanguard.
Our fourth quarter outlook reflects the realities of softer volumes and the cost of assimilating new physicians into our organization. Now, I'll turn the floor over to our Chief Financial Officer, Dan Cancelmi.
Dan?
Daniel J. Cancelmi
Thank you, Trevor, and good morning, everyone. I want to take a few minutes to update everyone on the Vanguard integration, highlight a few notable items impacting our third quarter results and provide some additional color regarding our outlook for the fourth quarter.
I'd like to start off with an update on how the integration of the Vanguard facilities is going. Although certain of Vanguard markets are also encountering soft inpatient volume trends, as we become more familiar with the markets and facilities, we are more convinced of the strategic importance of these assets to our portfolio.
The closing of the transaction went extremely smoothly, and we were very pleased with our Day 1 readiness and subsequent plans to integrate the operations into our company. We're also gratified that key leaders in the Vanguard organization have chosen to join our team and will be instrumental in successfully growing these operations in the future.
From a synergy perspective, we have an intense daily focus on the successful execution of our strategies and have devoted significant internal and external resources to these efforts. We remain very optimistic about the upside value that we can capture over the next few years.
Turning to operating expenses, our cost management was very solid in the third quarter, including a favorable variance compared to our forecasted cost performance. Let me walk through our expenses during the quarter.
We use the term "hospital operations" to identify costs related to our clinical operations in both our hospitals and outpatient centers. This definition excludes our Conifer services business and the expenses related to an IPA, or independent physician association, in Southern California, with a multi-specialty network of over 400 physicians that we acquired in the third quarter.
Beginning in the fourth quarter when we include the results of Vanguard's health plans for the first time, we will also exclude the health plan expenses from our hospital operations cost metrics. Using this definition, labor expenses increased by $50 million, and supplies expenses were up by $11 million in the third quarter.
On a per adjusted admission basis, labor and supply grew by 5.5% and 3.4% respectively. The increases in both of these metrics are higher than we've seen in recent quarters, but they are consistent with the drivers of our growth strategies and our forecast.
Let me explain. Beginning with labor expense, more than half of the increase, or $28 million, is related to the expansion of our physician employment.
This growth reflects the increase in employed physicians since last September plus the expenses of their office staff. Labor costs have also increased due to insourcing certain physician practice management personnel that were previously paid through a third-party vendor and included in other operating expenses in Q3 of last year.
Also impacting labor costs was the fact that we provided our employees annual merit increases since the third quarter of 2012. In response to softer-than-anticipated inpatient volume levels, we did implement a series of actions in the third quarter that can be expected to have a favorable impact on labor costs going forward.
Turning to supplies. These costs on a per adjusted patient day and per adjusted patient admission basis were up 2.7% and 3.4%, respectively.
The increases were primarily due to a changing mix in surgical versus nonsurgical patients. Substantially, all of our third quarter admissions decline was in nonsurgical categories, which have a much lower supply cost per case.
A good example of this was a 3.8% decline in OB admissions, which accounted for 22% of our total admissions decline in the third quarter. As you know, OB is generally a very low consumer of supplies.
It's also important to note that within our surgical service lines, we are doing a good job controlling costs as well. As a result of our Performance Excellence Program initiatives, we drove a 2% decline in our supply costs for surgical case compared to the third quarter of last year.
At the same time, supply cost per nonsurgical admission also declined. These declines in surgical and nonsurgical supply costs make it clear that a service mix shift was a key driver of the increases in supply costs.
To summarize the increase in unit costs in the quarter, it's actually a very good story. First, the increase reflects a favorable mix shift related to our success in driving accelerated growth in surgeries.
Second, our surgery supply costs were actually declining on a per unit basis. Third, our selected operating expenses were favorable to our expectations.
And fourth, we implemented actions with regard to labor costs late in the quarter that can be expected to have an enhanced visibility going forward. Turning to our outpatient business, we are achieving our goals with regard to our outpatient growth strategies.
Over the last 5 years, we've grown our outpatient facilities from a total of 63 centers to today's 137, an increase of 117%. Adding Vanguard's 39 outpatient facilities brings us to a total of 176.
We expect that growth will continue as we have more than 20 additional projects in development, about 3/4 of which are either Urgent Care Centers or satellite emergency departments. And the acquisition pipeline remains strong.
And we are also optimistic about the outpatient development opportunities in Vanguard's markets. From a cash flow perspective, we did see an approximate 1 day increase in our days in AR from 51.4 days at June 30 to 52.6 days at September 30.
The increase in AR days was due in part to several factors impacting Medicare payments related to the transition to a different Medicare Administrative Contractor, or MAC, serving the company's hospitals. The change in our MAC was a result of CMS' periodic rebidding of MAC contracts, as required by law.
We are working collaboratively with the MAC and expect these issues to be sorted out fairly quickly. Also, our cash flows have been impacted by the fact that approximately $150 million of revenues related to the California Provider Fee program and the Texas uncompensated care 1115 waiver program have not been received by us as of September 30.
As we mentioned in our press release, our fourth quarter outlook for adjusted EBITDA is in the range of $400 million to $450 million. This outlook reflects assumptions for continuing soft inpatient volumes and payer mix and includes earnings from the Vanguard facilities for the first time.
Although Vanguard's earnings were not included in our Q3 results since the acquisition was not completed by the end of the quarter, Vanguard's operating results for the September quarter were in line with our expectations when we evaluated and priced the acquisition. In the fourth quarter, we anticipate Vanguard's operations to perform within our deal model assumptions.
In terms of other items impacting the fourth quarter, we expect to record approximately $30 million of HIT incentives. As a reminder, we expect the costs related to these system implementations to decline significantly in 2014, while the incentive payments are expected to remain at approximately 2013's levels.
Before leaving the topic of our fourth quarter outlook, I want to remind everyone that we provided all the detail you need to calculate net income for the quarter, including interest expense, depreciation, amortization and our projected share count in Tables 3 and 4 at the end of our earnings release. Let me now turn to the California Provider Fee program.
We recognized approximately $19 million of revenue in the third quarter under this program and expect to recognize a similar amount in the fourth quarter. As we stated in our press release, we recently received good news regarding the continuity of this program.
The California legislature recently approved and the governor signed into law an extension of this program for 3 years through 2016. Based on preliminary estimates, we expect to recognize approximately $475 million of revenues over the 3-year period.
Quarterly revenues will be about twice the size of the current program. Under the new program, approximately $140 million of revenues or about $35 million per quarter relate to calendar year 2014.
We will recognize approximately $115 million of revenues in calendar year 2013 under the current program. We do remain excited about the positive impact we anticipate from the Affordable Care Act.
Our optimism is based on the fact that our facilities located in markets with historical uninsured headwinds will now be able to take advantage of the tailwinds created by the ACA. Several important states we operate in have expanded or are in the process of expanding their Medicaid programs, including Arizona, California and Michigan, and we are pleased with the progress we've made negotiating exchange contracts.
As we mentioned before, these exchange products will be attractive to patients who currently don't have insurance and patients who currently have plans with very high deductibles and annual or lifetime caps as these exchange plans limit deductibles and have no annual or lifetime caps. In short, our geographic footprint has us strongly positioned to gain significant upside from expanded insurance coverage, and we have the tools and trained individuals in place to capture these benefits beginning on Day 1.
Finally, I'd like to point out that we continue to reduce our outstanding shares as we repurchased an additional 2.6 million shares in the third quarter. Since mid-2011, we've invested about $1.1 billion to repurchase 44 million shares.
These investments have reduced our fully diluted share count by about 30% since the beginning of the program. Our average price for these repurchases is just over $25 per share.
It's pretty clear that we created a lot of value for our shareholders with this program, which will conclude in the fourth quarter, as previously disclosed. In summary, our third quarter and year-to-date results provide solid evidence that our strategies are working effectively.
We are looking forward to the launching of the more meaningful aspects of the Affordable Care Act in 2014, and we believe we are well positioned to serve the health care needs of this expanded population of insured patients. Operator, please assemble the queue for our question-and-answer session.
Operator
[Operator Instructions] And we have our first question from A.J. Rice with UBS.
Albert J. Rice - UBS Investment Bank, Research Division
First of all, just to maybe try to drill down a little bit more on the fourth quarter guidance, I think if we took your previous legacy Tenet and most people's expectations for Vanguard, and then it looks like you're getting about $15 million more in HITECH Q3 to Q4, I think we have come in closer to something like $490 million to $520 million or something in EBITDA for the fourth quarter. I know you're singling out concern about soft volumes, and it sounds like a little bit on the commercial side, payer mix concerns.
Are those the 2 primary deltas that are -- where you come out within the updated guidance? Or is there anything else that we should be aware of that's a factor there?
Trevor Fetter
It's Trevor. A couple of comments there.
I mean, the short answer to your question is yes, those are the items. I think it's also worth pointing out that Vanguard had not issued any expectations for the fourth quarter, so whatever shortfall there is in our overall guidance that could be attributable to Vanguard is really a gap between our expectations today and what the Street's expectations were prior.
And so it's not as though Vanguard had a number out there. On the Tenet side, we were overly optimistic about volumes in particular, and the trend that we've seen throughout the year, although it may be in the middle of the pack in terms of the competitive environment, it's well below our expectations and business plans that formed the basis of our outlook.
And we have not seen reason to assume that, that is going to improve dramatically in the remainder of the fourth quarter.
Albert J. Rice - UBS Investment Bank, Research Division
Okay. Maybe my follow-up would just to ask you a conceptual question.
One of the things that have been a recurring theme and issue for Vanguard have been the commitment to the funding in Detroit and I guess in other markets too, and the impact that was having on cash flow in the next couple of years. There had been some discussion about -- that those returns could be maintained on those projects, but maybe some of that funding could be done off-balance sheet to improve the cash flow stream on the company.
Now, that that's sort of in your purview, are you guys open to that? Have you looked at that?
Is that something you might consider down the road?
Trevor Fetter
A.J., let me make first an overall comment about Detroit, then I'll ask Keith to comment on the nature of the investment and the expected flow and what sort of flexibility we have. Detroit was one of the areas where we did a very deep dive before the announcement of the acquisition, and of course, since then, it's been a real focus area for us.
We believe that there is significant upside in Detroit. Vanguard had seen this opportunity, and upon really investigating it, we would confirm their views.
There are a couple of things that I would just point out that people need to think about when they're thinking about Detroit. One is that there -- the health care economy in Detroit is very distinct from the overall economic environment of the city.
And so while you read plenty of stories about the blight in Detroit due to bankruptcy, but also the revitalization of downtown Detroit, the health care environment is a bit different, and we are the leading provider in Detroit. So we have a lot of confidence in the ability to generate strong returns and significant performance improvement in Detroit, and it's something we're particularly focused on here.
With respect to the capital deployment, I'm going to ask Keith to comment on that.
Keith B. Pitts
Thanks, Trevor. Thanks, A.J., for the question.
As you know, we had quite a few projects underway in Detroit and still do. We also have a brand-new hospital campus in New Braunfels under construction in north of San Antonio, which is a very large project.
In fact, if you look at our expenditures, almost half of them are in Texas and a little bit in Arizona markets, as well as half are in Detroit in terms of the construction in progress. We would anticipate the Texas projects are -- the expansion in North Central is just completing, and New Braunfels campus will open mid-calendar '14.
A lot of the Detroit things start opening in early to mid '14 onward through early '15. So a lot of things that are there are coming -- will be coming online.
We also have the flexibility in all of our capital commitments where it makes sense to use an off-balance sheet financing. For example, we want to build a big ambulatory building.
We have the ability to do that and count against capital commitments. So if you will, that's a financing mechanism.
As you know, we have a choice as to what financing mechanisms we want to do under all of our capital commitments with any hospitals we've ever made. So we feel very comfortable as we decided that.
We had a -- strategically, that was a better option for us in any case we can -- we have that avenue available.
Operator
And our next question comes from Andrew Schenker with Morgan Stanley.
Andrew Schenker - Morgan Stanley, Research Division
So just following up on the 4Q guidance, obviously, last quarter you updated your utilization guidance downwards. Are your expectations for the fourth quarter now still within the guidance you provided in 3Q?
Or are we expecting maybe even worse volumes for the year?
Trevor Fetter
Yes, so the short story is worse. But Dan Cancelmi, why don't you fill it a little of detail on that?
Daniel J. Cancelmi
Yes, so from an inpatient volume perspective, it's still within the range that we were evaluating when we put the guidance out in the summer. However, it's -- we had anticipated that there was going to be improvement in the inpatient volume, as well as some improvement in the mix, as we moved throughout the quarter.
And based on what we saw in the third quarter and what we have seen so far in October, we just think it's appropriate at this point to moderate the outlook for the fourth quarter. And again, it's an inpatient volume and mix issue.
So when -- there's other variables that you also have to take into consideration when you're looking out into the fourth quarter, including -- there are incremental HIT incentives out there, but there's also incremental costs associated with those incentives as we continue to roll out our program. So despite the fact that there is an approximately $15 million increase in the incentives in the fourth quarter, there's also about -- in the neighborhood of a $10 million increase in costs.
So net-net it's not a $15 million increase if you're looking at it on a sequential basis.
Andrew Schenker - Morgan Stanley, Research Division
Okay. And then changing direction here, and you obviously still need to digest Vanguard, which is closed, but can you maybe talk about your expectations for the M&A pipeline?
Obviously, there's still Emanuel outstanding. Any updates there and then Vanguard and Connecticut?
Trevor Fetter
Sure, one of the attributes we've gained through the combination of Vanguard is a robust pipeline and a talented team to join our existing team to work on that. So I'll ask Keith to comment on the pipeline.
He can also comment on Emanuel as well.
Keith B. Pitts
Thanks, Trevor. So Emanuel, we still are in regulatory review, but we do see, we think, the light at the end of the tunnel there soon so we should at least have a direction there after the regulatory there pretty soon.
In terms of Connecticut, we have 3 letters of intent. We are in the process of solving a handful of regulatory conflict issues, in that effect, all of the transactions there.
But we still feel very comfortable with the direction in Connecticut and working hastily to try to get those continue to make new filings. We are on the third transaction we announced, which is a partnership also with the [indiscernible] Health Systems.
We are just completing the due diligence process there and beginning the negotiations on a definitive agreement.
Operator
Our next question comes from Sheryl Skolnick with CRT Capital Group.
Sheryl R. Skolnick - CRT Capital Group LLC, Research Division
The color you've given us on the fourth quarter guidance, it's obviously the question of the day so I'm going to go back to it. Trevor and Dan, you indicated that perhaps we made some modeling errors relative to the real story at Vanguard, and I'm hoping that you can help us understand where we might be a little bit too aggressive.
Obviously, we didn't have the benefit of guidance just prior to putting these models together. So anything that you could give us I think would mitigate the pressures that we're seeing on your stock today and would enhance your investors' understanding of why you bought what you bought and what you intend to do with it.
So the question is this: certainly, for premium revenues, I can imagine that there might be some issues there, but anything else that you can give us in terms of parsing the guidance? Some are talking about shortfalls relative to expectations of $50 million to $100 million at the top end for the fourth quarter.
And so if you can sort of parse the shortfalls, given that there's some tailwinds and some headwinds, how much of it might be from misestimation of the Vanguard model versus core fundamental performance?
Trevor Fetter
Well, I think it's hard for me, too, and I wouldn't characterize it as modeling errors, maybe just difference in assumptions. But it's a little bit hard to understand.
It was in everybody's mind. But I think after reading some of the reports and getting back to the GAAP and guidance, what I would suggest pointing you toward is I think the -- there may have been a gap in understanding of how the impact of the health plan loss of business in Phoenix, particularly, affected Vanguard's earnings especially in the fourth quarter, and Dan can talk more about that as can Phil Roe, who is here.
So if you were to just be very broad about it, we'd probably say the expectation today relative to prior expectations on the Tenet side was overly optimistic by us, and that we obviously gave guidance for this implied guidance for the fourth quarter when we talked about the remaining half in August. And that is really driven by volumes and the mix of volumes and our continued investment in physician practices, which actually has ramped up in this second half.
And that's what's providing the gap relative to our expectations on the Tenet side. And on the Vanguard side, actually the operational story is better, but the health plan story probably provides the gap relative to the Street.
So Dan, do you want to explain that a little bit? And then we'll ask Phil to chime in as well.
Daniel J. Cancelmi
Sure. Yes, A couple of things on the Vanguard facilities.
As we mentioned, there have been inpatient headwinds in the Vanguard facilities, as well as ours. But that said, we have been tracking that, and when we modeled the transaction, we took those type of issues into consideration.
So there is obviously some inpatient volume pressure impacting the Vanguard numbers in the fourth quarter. And as Trevor mentioned, the health plan, the health plan operation, it's sort of a round number here.
But given the fact that the new contracts in place, the earnings impact of that is about $10 million on a quarterly basis from a normal run rate. Now I'm going to ask Phil to just comment upon that real briefly here in a second, but -- so you have about $10 million of pressure on the health plan side in the fourth quarter compared to what the normal sequential operations would have been.
In addition, there is some Medicare and Medicaid disproportionate share or DSH cut pressures sequentially in the fourth quarter. As you know, various reductions under the Affordable Care Act related to Medicare DSH as well as Medicaid DSH go into effect here in the fourth quarter.
And the impact on their operations is roughly in the -- it's in the $5 million neighborhood on a quarterly basis, so it's just another little bit of pressure that's impacting their quarterly results. But let me ask Phil to maybe just give a brief overview of the health plan operations so everyone has a good understanding of the dynamics related to that business.
Phillip W. Roe
Thanks, Dan. Sheryl, I'm sure you recall we went under the cap contract effective October 1.
The initial indications are that our membership will drop about 50%, it will be just under 100,000 lives post the cap. All of those are in Maricopa County.
We have made an intentional decision to communicate to our partners there with Arizona Medicaid that we're going to appropriately take care of the memberships that's in runoff and take care of those 98,000 to 100,000 lives that we continue to serve in Maricopa by being very conservative on our staffing and very conservative on our G&A while we take care of those runoff costs from the previous quarters. As a result of that, the December quarter, as Dan indicated, will likely be down $9 million to $10 million from -- on a sequential basis and from a year ago because we are keeping those G&A costs at a level that will allow us to adequately serve those members moving forward.
Sheryl R. Skolnick - CRT Capital Group LLC, Research Division
So that's extremely helpful. And so I can come up with $15 million of delta perhaps from my model or maybe from some Street expectations.
But I guess I'd like to go back to the Tenet guidance itself because my sense was that we were all pretty concerned that the -- about the guidance to begin with and got the sense that Tenet was trying very hard at the end of the second quarter to take the numbers down and be as conservative as it could be. It's not -- with all due respect, not the same as the first time that we've been in this situation with Tenet, where management's a little bit more optimistic, we find out, with 20/20 hindsight.
So I guess, I would ask and, again, respectfully here, how are you going to think about your guidance going forward so we don't have to replay this again?
Daniel J. Cancelmi
Sheryl, this is Dan. Listen, we're obviously disappointed that we've had to adjust the guidance for the fourth quarter.
We had assumed some improvement in our inpatient volume trends, and we've seen some of it in certain service lines where we've been making some nice investments. We -- it's just -- we just didn't see the growth that we were anticipating in other service lines.
Sheryl R. Skolnick - CRT Capital Group LLC, Research Division
Dan, do you know why? Do you know why you didn't see the growth?
Daniel J. Cancelmi
Well, we think there's -- when we look across our portfolio and say, okay, is this a market share issue or something else? We believe we're holding our own with market share.
Our ER volume is actually improving nicely. We're making investments in the business that we fully believe are going to pay off over time.
But what we've seen so far into the fourth quarter and what we saw in the third quarter -- Sheryl, I mean, we just concluded it was appropriate to moderate some of these assumptions in the fourth quarter. And we're trying to be as transparent and as timely as possible with our guidance as we look out over the next quarter.
And we also -- the payer mix that we saw in the third quarter and what we're seeing so far in the fourth quarter is just not as robust as we would have liked. So we certainly took that into consideration when we developed our outlook for the fourth quarter.
Operator
And we have our next question from Josh Raskin with Barclays.
Joshua R. Raskin - Barclays Capital, Research Division
Just in terms of the Vanguard transaction, I just want to make sure relative to expectations. I know you guys talked about $100 million to $200 million of synergies full run rate, with about half of that coming in, in the first year.
I will assume that's '14. Are you guys still confirming those synergies?
Daniel J. Cancelmi
Absolutely. We've continued to spend an incredible amount of time and energy on capturing these synergies, and we're certainly as confident, if not more confident, in the synergy opportunities that we have previously communicated.
Joshua R. Raskin - Barclays Capital, Research Division
Okay, and then I guess on that similar vein, still assuming first-year accretion net, I guess, even with revised operation expectations.
Daniel J. Cancelmi
When we -- obviously, we're not giving 2014 guidance at this time. We'll be addressing 2014 guidance early in the year.
And we'll obviously provide clear visibility on -- when we deliver our outlook at that point in time.
Joshua R. Raskin - Barclays Capital, Research Division
Okay. And then just getting back to the guidance for the fourth quarter in terms of the pressures, I guess, seen on both legacy Tenet and the Vanguard assets.
I guess, if you look at your guidance from last quarter implied a fourth quarter number of maybe 3 65 or so, it actually probably would have been a little bit higher if you look at the -- where the number came in for 3Q, but just assuming that 3 65, I'm curious what's your updated perspective on sort of a Tenet number would be. And I guess I'm a little questioning the commercial weakness in light of that trend in high deductible health plans.
I think in recent years we've seen commercial come in a little bit better on a sequential basis so in the fourth quarter. So I'm just curious specific to the commercial comments as well.
Daniel J. Cancelmi
Yes, Josh, this is Dan. In terms of -- we're one company now, and so I wouldn't -- you shouldn't expect us to report separately like a separate segment for Vanguard and a separate segment for the legacy Tenet business.
When we sat down and started really diving into the results for the quarter, the third quarter, as well as what we think the fourth quarter is going to look like, there's -- the improvement that we had anticipated from an inpatient volume perspective as well as a mix perspective, we just haven't seen it at the level across a broad enough category of service lines to continue -- to leave our guidance at its previous levels. And that's why we felt it was appropriate to regulate it at this point and moderate it based on some of the trends we have been seeing.
Joshua R. Raskin - Barclays Capital, Research Division
Okay. And just last question, I think you mentioned in your prepared remarks you had some labor initiatives that you were taking for savings in the fourth quarter.
Could you elaborate on what those are and the potential savings from that?
Daniel J. Cancelmi
Yes, we have -- obviously, as in reaction to our inpatient volume levels, as we do routinely, we evaluated our cost structure. And there were some actions that we took, and you'll see there will be some visibility into that as we move forward.
It's a normal routine type of cost analysis and efficiency that we always try to drive.
Operator
And our next question comes from Justin Lake with JPMorgan.
Justin Lake - JP Morgan Chase & Co, Research Division
So I want to take one swing myself at this Q4 issue. And the way I'm just looking at it, guys, is that you gave guidance for the fourth quarter at the midpoint.
If we just put a number around Vanguard, and also the Street was too optimistic, and instead of $140-ish million, it's $125 million, give or take, that would still leave the Tenet business at $300 million. And I'm looking at the $288 million number in the third quarter, and you will get some pickup from HITECH.
And Trevor, I mean, typically third quarter is the weakest quarter of the year, right?
Trevor Fetter
That's correct.
Justin Lake - JP Morgan Chase & Co, Research Division
So fourth quarter, we should see some seasonal improvement. Your guidance almost x HITECH for Tenet seems to -- that Tenet business seem to imply flat.
We know the third quarter was weak, so let's just say fourth quarter is still weak, wouldn't you still see some seasonal improvement? Or what are we missing here?
I mean, do you feel like you've now erred on the side of -- gotten more conservative versus optimistic before? Or do you feel like this is a reasonable number and why?
Trevor Fetter
Yes, I don't think you're missing anything, but Dan can fill in a little bit of blanks here.
Daniel J. Cancelmi
Let me try to address your sequential [indiscernible]. One thing I would want to point out, Justin, is on the HIT incentives, the HITECH incentives, as you pointed out, we will have incremental incentives in the fourth quarter, but we're also going to have incremental costs associated with that.
So we pointed out that there's about a $14 million, $15 million ramp from Q3 to Q4, but there's also going to be a ramp in the cost. And net-net, it's probably in the $5 million type of territory between the 2 quarters.
But also to your sequential point, yes, Q3 is typically the lowest volume quarter in the calendar year. And there's a couple of points of reference.
So last year from Q3 to Q4, we had about 420 additional admissions between Q3 and Q4. We had about 18,000 additional visits from Q3 to Q4.
When we modeled our outlook for Q4 this year, we did take that into consideration that there is typically a seasonal ramp in volume at those levels. And depending on the year, those numbers can move around a little bit.
But just from a ballpark perspective, I think that's what we saw last year. And we did take that into consideration when we built the outlook.
I know, and everyone is looking to see, what's the Tenet piece of this versus the Vanguard piece of it? And obviously, we're not going to continue to report separately because we don't have 2 different segments here.
But as we pointed out, there is inpatient -- the headwinds continue. There's not the improvement on the inpatient side that we would like to see.
We were pleased in some of the service lines and we pointed out, but it's not broad-based enough for us to retain our previous guidance. In addition to mix that we saw in the quarter, as well as what we've seen so far in October, we conclude it was appropriate to make the adjustment to the guidance.
Justin Lake - JP Morgan Chase & Co, Research Division
Okay. So you're saying that even with this guidance, this does assume a seasonal improvement from 3Q to 4Q that's typical of what you see in the last few years?
Daniel J. Cancelmi
No, when we modeled this, we built that into consideration, yes.
Justin Lake - JP Morgan Chase & Co, Research Division
Okay. And then on Vanguard, I think someone might have asked the question similar, so I apologize if I'm duplicating here.
But did you mention -- you had talked on the last -- on the Vanguard call about the accretion being single digits in Year 1 and double digits going forward. Is there any -- given what's happening here, is there any change to that view?
Daniel J. Cancelmi
Yes, we -- Justin, we're not commenting upon 2014 guidance at this point. We'll certainly get into all those details when we go through our 2014 numbers early in the year.
I would tell you, as I mentioned earlier, as we continue to learn more and more and become familiar with these assets, we were firmly convinced it was the right decision, and we become more confident as we evaluate the value opportunities related to synergies that are out there.
Justin Lake - JP Morgan Chase & Co, Research Division
But you did say it's in line with your acquisition model, right?
Daniel J. Cancelmi
Yes.
Justin Lake - JP Morgan Chase & Co, Research Division
Okay. So nothing off plan that you know of or anything that you want to point out to us?
Daniel J. Cancelmi
No.
Justin Lake - JP Morgan Chase & Co, Research Division
Okay. Then just lastly, on the share repurchase, you did a buyback in the quarter, which is great.
We're just hoping you'd think about -- tell us how the board is thinking about buybacks here given the current authorization should run out this quarter.
Trevor Fetter
Justin, it's Trevor. We've got to be quick here because we want to finish the call before 10 for HCA, and we would like to take one more question.
But just short story on the share buyback, the current program extends another 60 days, and we'll be evaluating what to do in 2014.
Operator
Our last question will be from Ralph Giacobbe with Crédit Suisse.
Ralph Giacobbe - Crédit Suisse AG, Research Division
Just hoping to understand mix maybe a little bit better. Can you give us a sense of where you were trending sort of for the first half of the year relative to the third quarter and maybe what you've seen so far in the fourth quarter in terms of deterioration, just from a payer mix perspective?
And then the second piece is just on acuity mix, how should we think about the outpatient growth sort of helping or hurting on the acuity side?
Daniel J. Cancelmi
Ralph, it's Dan. From a mix perspective, I wouldn't necessarily categorize it as a deterioration per se.
When we modeled our outlook for the second half of the year, we assumed improvement in inpatient volume levels as well as an improvement in the mix, and we're just not seeing it at the level that's robust enough to support the previous outlook assumptions related to inpatient volume levels as well as the mix related to that.
Ralph Giacobbe - Crédit Suisse AG, Research Division
Okay. And then on the acuity side?
Daniel J. Cancelmi
I think from an outpatient perspective, we're very pleased with our outpatient strategies. We're growing our surgical volume nicely.
The outpatient volume levels, from a visit perspective, it's about half-and-half organic, the other half through the various assets that we've been able to acquire over the past year. Nice results in terms of -- from a volume and earnings perspective, and we expect that to continue to grow.
Ralph Giacobbe - Crédit Suisse AG, Research Division
Okay. If I could squeeze in just one more.
Keith, can you talk a little bit more about your strategy around employing physicians? Obviously, it's sort of causing an increase on the cost side.
When and -- or if you expect pressures to abate, maybe what percentage you currently employ today and where that can get up to. And then just the last piece of that is just the -- I think you talked about insourcing.
I just wanted to get clarification exactly what -- where and what specialties you're insourcing.
Trevor Fetter
Okay. I'll ask Britt to answer that, Britt Reynolds, to address those 2 questions, be very concise.
We promised HCA we'd be done by now and apologize to everybody who has further questions, so you can call us a follow-up. Britt?
Real quick.
Britt T. Reynolds
Thanks, Trevor. In terms of insourcing, just to be very clear, the insourcing is relative to our management oversight and recruitment functions for the -- both recruitments, relocations and employments.
So it's not an insourcing of physicians but an insourcing of our entire program where it was contracted in the past, which gives us greater control and autonomy over that. Secondly, in terms of the headwinds on that, I think it's a convergence of a perfect storm in the sense that we have made decisions to constantly reinvest and doubled down in our physician alignment activities, including employment.
So in the third quarter, we have employed more physicians and recruited and relocated more physicians above those categories than in the first and second quarter combined and made a conscious decision to redouble our efforts and push that. We're seeing the fruits of that at a perfect storm time right now, when we're seeing an increase in cost.
And so that is the right strategy for the long term, and we believe -- we still believe that's the right strategy going forward. But it is going to be a drag for the next little bit.
Trevor Fetter
Okay. Thanks, everybody, and this concludes the call.
Operator
And thank you, ladies and gentlemen. That concludes today's conference.
Thank you for participating. You may now disconnect.