Community Health Systems (CYH) Wayne T. Smith on Q2 2016 Results - Earnings Call Transcript

| About: Community Health (CYH)

Community Health Systems, Inc. (NYSE:CYH)

Q2 2016 Earnings Call

August 03, 2016 11:00 am ET


Ross W. Comeaux - Director-Investor Relations, Community Health Systems, Inc.

Wayne T. Smith - Chairman & Chief Executive Officer

W. Larry Cash - Chief Financial Officer, Director & President-Financial Services


A. J. Rice - UBS Securities LLC

Jason Plagman - Jefferies LLC

Gary Lieberman - Wells Fargo Securities LLC

Joshua Raskin - Barclays Capital, Inc.

Ralph Giacobbe - Citigroup Global Markets, Inc. (Broker)

Andrew Schenker - Morgan Stanley & Co. LLC

Chris Rigg - Susquehanna Financial Group LLLP

Kevin Mark Fischbeck - Bank of America Merrill Lynch

Tejus Ujjani - Goldman Sachs & Co.


Good morning. My name is Mike and I will be your Conference Operator today. At this time, I would like to welcome everyone to the Community Health Systems 2016 Second Quarter Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers remarks there will be a question-and-answer session.

I will now turn to call over to Mr. Ross Comeaux, Director of Investor Relations. You may begin your conference.

Ross W. Comeaux - Director-Investor Relations, Community Health Systems, Inc.

Thank you, Mike. Good morning and welcome to Community Health Systems' second quarter conference call. Before we begin the call, I'd like to read the following disclosure statement.

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 or Form 10-K and other reports filed with or furnished to the Securities and Exchange Commission.

As a consequence, actual results may differ significantly from those expressed in any forward-looking statements in today's discussion. We do not intend to update any of these forward-looking statements.

Yesterday afternoon, we issued a press release with our financial statements and definitions and calculations of adjusted EBITDA and adjusted EPS. For those of you listening to live broadcast of this conference call, a supplemental slide presentation has been posted to our website. We will be referring to those slides during this earnings call.

Our results consolidate the results of Community Health Systems and April 2016 acquisition of an 80% interest in a 20-bed Physicians' Specialty Hospital in Fayetteville, Arkansas. As a reminder, our results include approximately a month's worth of results from Quorum Health Corporation and our joint venture in Las Vegas that was sold to Universal Health Services.

All calculations we will be discussing exclude discontinued operations, loss from early extinguishment of debt, impairment of long-lived assets, expenses incurred related to the Company's spin-off of Quorum Health Corporation, impairment of goodwill, expenses related to the HMA legal settlements and related costs, expense from fair value adjustments related to HMA legal proceedings, accounted for a fair value underlying the CVR agreement, and related legal expenses.

With that said, I'd like to turn the call over to Mr. Wayne Smith, Chairman and Chief Executive Officer. Mr. Smith?

Wayne T. Smith - Chairman & Chief Executive Officer

Thank you, Ross, and welcome aboard. This is Ross's first conference call. Good morning, and welcome to our second quarter conference call. Larry Cash, our President of Financial Services and Chief Financial Officer is with me on the call today, along with David Miller, our President and Chief Operating Officer, and Dr. Lynn Simon, our President of Clinical Services and Chief Quality Officer.

We are obviously not satisfied with our performance this quarter. However, we did make some progress during the second quarter with the spin of Quorum and additional divestitures that are underway. As you know, there have been some recent acquisitions and divestitures, so this makes the comparison to our prior quarters challenging.

As a result, on the call today, we will discuss a number of our metrics on a same-store basis. These same-store metrics exclude the one-month contribution from Quorum and the Las Vegas joint venture, both of which closed early in the second quarter.

Same-store also excludes results from our joint venture with Indiana University Health and our joint venture for Physicians' Specialty Hospital in Fayetteville, Arkansas. The spin of Quorum Health Corporation was completed during the quarter.

This was a major transaction and the spin took much longer to complete than we had originally expected, in part because of market conditions early in the year. The inevitable result of prolonged transaction period is that considerable resources were required and directed toward the preparation for the new company.

We worked to minimize distraction as much as possible, but the workload during the first four months of the year and the immediate period following transaction close was not typical for our management group.

Our division and corporate team leaders were focused on readiness of the new company while also maintaining their CHS responsibilities and job functions. Some operational initiatives for the remaining CHS facilities did not move forward as quickly as we had planned because of the delayed transaction.

Once the spin was completed, we realigned our operating divisions, matching experience and expertise with the market need and opportunity. We reduced the number of operating divisions from six to five. We promoted Tim Hingtgen to the newly created position of Executive Vice President of Operations, and named a new division president to take Tim's place. It took some time to organize around the new division structure, but we are now seeing momentum build as we look to the rest of 2016 and 2017.

While preparation for the spin was one factor that impacted our operations, we still see significant benefits from the separation. We've used proceeds from the transaction to reduce some of our debt. With a smaller portfolio, we have increased our ability to focus more sharply on the potential of our most attractive markets and regional networks. And QHC is positioned for long-term success and growth.

I now want to touch on our performance during the second quarter, and Larry will provide much more detail in a minute. The second quarter, the primary difference between our performance and our internal projection was the net revenue line, which came in approximately $115 million below our internal projection which includes recent acquisitions.

The lower than forecasted revenues without significant expense reductions negatively impacted our adjusted EBITDA performance this quarter. Our volumes at the former HMA hospitals continue to remain weaker than at CHS legacy hospitals.

I now want to provide an update of our near-term initiatives. First, we have made considerable progress on rationalizing our portfolio and reducing our leverage. On April 29, 2016, we completed the spin of Quorum Health Corporation. As we have previously mentioned, the transaction generated $1.2 billion in net proceeds.

Also under our portfolio rationalization strategy, we talked about divesting a number of other hospitals that would lead us to moving toward a more substantial high margin group of hospitals. We completed the sale of Las Vegas joint venture and received proceeds of $445 million in early May 2016.

Back on our last earnings call in early May, we were working on three different divestiture transactions. Two of these were for a total of 10 hospitals and the other was for non-hospital operations. 2015, these 10 hospitals accounted for approximately $1 billion of annual revenue, drove mid-single digit margins, and were expected to generate estimated proceeds of approximately $530 million.

Some of the transactions that we were working on at the time of our last earnings report have changed. Today, we are working on a total of five divestiture transactions, which include a total of 12 hospitals and also non-hospital operations that generate about $1.45 billion in revenue and mid-single digit EBITDA margins. The estimated proceeds from these transactions are approximately $850 million, with closing expected late in 2016. That summarizes our deleveraging progress through the midpoint of 2016.

As we mentioned on our last earnings call, eliminating these assets will allow for future investments that can be committed to our most attractive markets and regional networks where we have an opportunity to improve access points, outpatient services, market density to support our acute care business, recruit the right physicians who can establish successful practices and enhance the quality of care in our communities, improve our cash flow, further invest in profitable health services, and gain market share over the near- and long-term for sustainable results.

Second, we are making progress on a number of our strategic initiatives. While we just talked about a number of the divestitures we are making as we continue to reshape our portfolio, building out our outpatient capabilities remain a strategic priority.

During the third quarter of 2016, we plan to open two additional surgery centers in Mississippi and another surgery center in Florida. Our pipeline for potential surgery center locations is getting stronger and we expect to open or acquire additional locations over the next couple of quarters. We are also focused on increasing our access points and strengthening our regional networks.

In the first quarter, we added three new freestanding emergency departments, two of which are located in existing regional networks. These freestanding emergency departments are in Tucson, Arizona; Spokane, Washington; and Cedar Park, Texas, and are off to a good start.

During the back half of 2016, we will open two additional freestanding emergency departments, one in our Indiana regional network in Fort Wayne and one in New Mexico. Post these openings, we will have 10 freestanding emergency department. As you know, we strengthened our Indiana and Northwest Health Arkansas networks through two separate transactions early this year.

In March, we acquired 80% interest in a joint venture for La Porte Hospital, Starke Hospital and an ambulatory surgery center in Valparaiso, all of which strengthened our successful Indiana network providers. In April, we acquired an 80% interest in Physicians' Specialty Hospital in Fayetteville, Arkansas.

On the physician side, as we indicated last quarter, we are monitoring the pace at which we are employing and recruiting new physicians. Our current efforts are focused on adding the right physicians in our most critical areas while focusing on productivity improvements for our existing physician practices.

In terms of physicians commencing employment at CHS, we experienced a 16% year-over-year increase in the first half of 2015, a 42% increase in the second half of 2015, a 32% increase in the first half of 2016. Following that growth, we are projecting a 40% year-over-year decrease in employed physicians commencing employment in the second half of 2016.

Physicians typically take 18 to 24 months to reach full utilization, so we expect utilization to continue to improve for physician recruited in 2014 and 2015. Based on our analysis of physician utilization by their start dates, we are seeing progress across employed physician categories as they continue to ramp up at our hospitals.

On a total physician recruited basis, we recruited 4,100 new physicians in 2015. Through the midpoint of 2016, we have recruited 1,800 physicians.

On the expense side, we have a number of ongoing expense reduction initiatives that started in the second quarter. Our labor costs were lower in June than the first two months of the quarter, and we expect the benefit of all these programs to help drive EBITDA leverage over subsequent quarters.

Turning to our quality initiatives, our Company remains intently focused on quality across the organization. At our CHS legacy hospitals through the first quarter of 2016, we have lowered our serious safety event rate by 74.5% compared to the baseline in April 2013. For our HMA hospitals, their baseline was established in June of 2015. For the first three quarters, we've achieved a 20.8% serious safety rate reduction through the end of the first quarter of 2016. We are seeing similar reduction in serious safety event rates at our HMA hospitals as we did in our CHS legacy hospitals over a comparable time span.

Switching back to the quarter and our full-year guidance, here's some of the second quarter's key metrics. On a same-store basis, adjusted admissions decreased 0.6%. Surgeries were up 1.2%. Adjusted to exclude certain non-typical expenses, such as expenses in connection with the QHC spin-off, cash flow from operations was $345 million in the second quarter and totaled $642 million in the first half of the year. That compares to adjusted cash flow from operations of $588 million for the first half of 2015. Larry will provide more detail on this in a minute.

Adjusted EBITDA was $563 million, and Larry also will provide more detail on the factors impacting our results in just a minute. Adjusted EPS was $0.09. We are revising our guidance as follows: net operating revenues less provision for doubtful accounts are anticipated to be $17.7 billion to $18.3 billion. Same-store hospital adjusted admission growth is anticipated to be 0.5% to 1.2%. Adjusted EBITDA is anticipated to be $2.4 billion to $2.550 billion.

Income from operations per share is anticipated to be $1.40 to $1.90 based on weighted average diluted shares outstanding of 111 million to 112 million. As it relates to our pending HMA legal matter, there has been no material change since our last earnings call. We continue to revalue the estimated liability coverage on the CVRs on a quarterly basis. Our current estimate, including probable legal fees continue to reflect. There is no payment to the CVR holders.

Larry will now discuss our results further and provide you additional detail and information. Larry?

W. Larry Cash - Chief Financial Officer, Director & President-Financial Services

Thank you, Wayne. Now we will discuss results for the second quarter. As a reminder, calculations discussed in this call exclude the items noted earlier. On a same-store basis for the quarter note to file in the second quarter 2015 versus 2016, net revenue is up 5.3% or – was up $53 million and 1.2%. This is comprised of 1.8% increase in net revenue per adjusted admission and a 0.6% decrease in volume our adjusted admissions. Our inpatient admissions declined 2.1%, and about 50% of the decline was related to flu and respiratory. Our ER visits were down 0.1% and our surgeries increased 1.2%, primarily due to outpatient growth.

Let me describe some of the same-store trends between the former HMA hospitals and their legacy facilities. For the second quarter 2015 versus second quarter 2016, the former HMA facilities experienced a 3.4% decrease in admission, which compares to a 1.4% decline, and to the legacy facilities a 1.2% decrease in adjusted admissions for HMA compares to a 0.3% decrease in legacy. A 1.4% decrease in net revenue per adjusted admission this compares to a 3.4% increase at legacy facilities. And the surgeries cases decreased 3.3%, while legacy experienced a 3.1% growth in surgeries. And a decrease in net revenue of 2.6% compared to 3.2% increase in the legacy facilities.

As it relates to HMA volumes, we decided to go back and look at the 56 hospitals that have been owned since January of 2012. We have reduced the rate at which these volumes have declined each year. We expect to continue to see this progress at these hospitals HMA owned since 2012 and also giving treatments to the ones that were acquired after 2012.

Going back from 2013 compared to 2012, admissions were down 7% and in 2014 to 2013, they were down 4%. 2015 to 2014, they are down 3% or down about 3% for the first 6 months. Adjusted admissions were down 4% from 2013 to 2012, 1% in both 2014 to 2013 and 2015 to 2014, and almost flat for the first half of 2016. Again, this is for 56 hospitals they've owned since 2012.

Our net outpatient revenues before the provision of bad debts currently represent 57% of our revenues. Our consolidated revenue – payer mix for second quarter compared to second quarter of 2015 shows managed care up 70 basis points, Medicare decreased 70%, Medicaid decreased 50%, and self-pay increased 50 basis points.

Compared to the year-to-date consolidated payer mix, managed care was up 50 basis points. Again, the second quarter was better. And Medicare decreased 30 basis points and Medicaid decreased 30 basis points and self-pay increased only 10 basis points. For same-store expense items, our salaries and benefits as a percent of net operating revenue for same-stores increased 160 basis points. Of this increase, approximately 45% relates to physician practices.

Also, the salaries required provide the transitional service agreements for QHC were approximately 8% of this increase, and our self-insurance costs were up about 30 basis points during the quarter. We expect this increase to moderate in the back half of 2016 and expect the full year to be relatively flat year-over-year.

Overall, our salary growth exceeded the revenue growth for the quarter. And as Wayne said, the month of June payroll expenses were 3% lower in the first two months. And as a percentage of net revenue, they were 130 basis points better in June. This lower payroll run rate as we exit the quarter should help subsequent quarters.

Supply expense as a percentage of net operating revenue for same-store increased 90 basis points due to drugs and clinic costs and other charge on supplies. We experienced an increase in our inpatient surgical case mix and the growth in selected outpatient procedures, which have higher supply costs.

Other operating expenses as a percentage of net revenue for the same-store increased 70 basis points. This increase in the second quarter decreased sequentially from the first quarter. Increases in the second quarter 2016 versus the second quarter 2015 occurred in the information systems, outsourced services, medical specialist fees, and training and education.

Consolidated adjusted EBITDA for the second quarter was approximately $80 million below our internal projection. As Wayne stated earlier, our actual revenue was approximately $115 million lower than projected. Volume was approximately 1.7% below our internal projection, and actual net revenue per adjusted admission approximately 0.8% below our projection.

On our first quarter call, we discussed eight hospitals in Florida and two in Tennessee that impacted our EBITDA performance. In the first quarter, these 10 hospitals contributed approximately $40 million to our consolidated year-over-year decline. During the second quarter, nine of these hospitals contributed $30 million of our year-over decline, with one hospital breaking even. HITECH contributed about $24 million of the year-over-year decline.

When you look at our internal projections, eight of these 10 hospitals we mentioned contributed 35% of the decline compared to our internal projection. I like to share a comparison, which is on slide 13, that might help you understand the trend line in our performance.

From the fourth quarter of 2015 to the first quarter of 2016, our reported adjusted EBITDA declined about 9%, from $696 million to $633 million. For comparison purposes for the second quarter, the $633 million for the first quarter can be normalized by excluding the EBITDA attributable to QHC and UHS and including the pro forma EBITDA attributable to our recent acquisitions.

Once you adjust for these numbers, the first quarter number would be $585 million. This $585 million compares to reported second quarter adjusted EBITDA of $633 million, and this shows a decline of about 4% or $22 million. This decline was not anticipated, but it does at least show an improvement in the decline in the results from previous quarter-over-quarter performance.

Our cash flows provided by operations were $338 million compared to $565 million quarter. In the first half, our reported cash flow was $632 million. It has increased 25% over the prior year, but you need to exclude certain government settlements-related expenses, acquisition or duration expenses, and the payment (21:32) liability from our results in the cash flow from operations of $345 million in the second quarter and be $642 million in the first half of 2016.

This compares to an adjusted cash flow from operations of $588 million for the first six months of 2015. And so during the first half, the adjusted cash flow from operation was up 9% or about $54 million. While there is not much change on a year-over-year basis, there are a few items worth noting.

The timing of payments was partially offset by timing of increased accounts payable. And combined these items contributed about $90 million of cash flow. The slower growth in accounts receivable contributed about $50 million improvement, and we are being affected by some growth in acquisition receivables negatively. And HITECH incentive payments increased about $40 million. Our cash flow from operations for 2016 is $1.3 billion to $1.4 billion.

Let me update the uses of the $1.2 billion of proceeds we received from the spin of Quorum, which included $190 million to pay down a term loan F due in 2018; $900 million on the tender offer on 5.125% senior secured notes due August 15, 2018; $75 million of open market purchases of 8% unsecured senior notes due 2019; and $23 million in the recovery of direct expenses related to the QHC spin.

Moving on to the balance sheet, from the close of the first quarter 2016 to the end of the second quarter 2016, we lowered our long-term debt by $1.560 billion. As Wayne stated earlier, we are currently working on 5 transactions that could result in approximately $850 million of incremental proceeds. We are targeting a late 2016 close for these transactions and we expect a substantial portion of these proceeds to be used for further debt reduction.

Turning to CapEx, our CapEx for the second quarter 2016 was $183 million or 4% and year-to-date it's $407 million or 4.2%. During the first half of 2015, we'd spent $474 million or 4.8% of net revenue. And just as a reminder, we spent $80 million on a replacement facility in the first half of 2015. Our CapEx guidance is $725 million to $875 million for 2016.

Referencing slide 19, which is a bridge – a walkthrough of this 2000 (sic) [2016] adjusted EBITDA bridge. We start with the current run rate which we arrive at by backing out our HITECH and doubling our year-to-date performance. And now we'll walk through some headwinds/tailwinds we expect for balance of the year. The divestitures that were done in the first half of the year will reduce the run rate annualized EBITDA by $95 million in the second half primarily Quorum and Las Vegas.

And annual HITECH incentives that will add back to the midpoint of the guidance of $65 million since it was backed out. We expect better physician practice performance to generate $55 million improvement in the back half.

For the remainder of the year, we believe our payer mix revenue per adjusted admission and volume improvements will improve EBITDA by approximately $50 million. Our health information management or coding centralization efforts should drive an EBITDA improvement of approximately $25 million. Our supply chain payroll and revenue cycle pretty much on target is expected to deliver another $5 million benefit for the remainder of 2016.

We expect expense reduction improvements of $80 million in the second half of the year which is about 1% of our expenses. In the second half contributions from acquisitions are estimated at $20 million. And we expect to have some reimbursement reductions of about $20 million. Additional reductions in the second half of the year are a headwind.

Our updated EBITDA guidance changes are reflected in the 2016 EBITDA bridge as of August 2 when you compare the first quarter to this, the changes are we've got a current run rate less spin-off of QHC and joint venture and expected divestitures and acquisition a decrease of $70 million. We've reduced the expected benefit from volume payer mix and rates up $50 million, and we've reduced the expected improvements from physician practices by $50 million.

As mentioned in the press release and on slide eight, as of June 30, 2016, we recorded a non-cash charge for the impairment of goodwill and other long-lived assets. We recorded a write-down of $1.4 billion to goodwill for the company's hospital reporting unit.

As of June 30, a combination of a decline in our stock price from an adjusted $21.93 at December 31 to approximately $12 now, a decline in the fair value of our debt, and the lower than expected earnings performance contributed to the decrease in the applied fair value of assets and led to the non-cash charge.

We also recorded a write-down of $169 million for certain hospitals we expect to divest as part of some gains. We only recorded the write-downs for underperforming low margin hospitals we recorded an impairment (27:24). And it should be noted these impairment charges do not have any impact on the calculation of our financial ratio or covenants under our credit facility. Wayne?

Wayne T. Smith - Chairman & Chief Executive Officer

Thanks, Larry. Overall, this was a challenging quarter, especially with separate distractions. However, we are pleased to now have the Quorum spin behind us and we are excited about our new divisional leadership. We believe we have the key pieces in place to effectively execute on our strategy, and our entire management team is intensely focused on improving the fundamentals of the company.

Before we take your questions, there are some promising achievements I'd like to highlight. Inpatient orthopedic volume increased approximately 4% during the second quarter. Following the Quorum spin, we now have 35 hospitals which have implemented our standard orthopedic program. We have 12 new programs which are expected to come online by the end of the year.

Looking at our rehab and psych business on a year-over-year same-store basis, rehab admissions were up about 5% during the second quarter. Total psych admissions were up 5% and psych patient days were up 9%.

Total psych admissions were up 4% and psych patient days were up 7% on a year-over-year basis. We are continuing to invest in our access points. We are working on a number of potential ambulatory surgery center and urgent treatment center opportunities, which could close in the back half of the year. Combined, these opportunities increase our ambulatory surgery centers by 10% to 15% and our urgent care centers by 5% to 10%. There are other successes.

But at this point, Mike, we are ready to open up the call for questions. We will limit everyone to one question, so several of you will have an opportunity to get on the call. But as always, we are available to talk to you and you can reach us at area code 615-465-7000. Mike?

Question-and-Answer Session


Your first question is from A.J. Rice from UBS.

A. J. Rice - UBS Securities LLC

Hi, everybody. Larry, just maybe to go through the bridge on page 19 of your slide deck a little more. You have three big swing factors that will make a big difference in your ability to hit the back half of the year outlook: the physician practice improvement expectations of $55 million, the payer mix volume improvement of $50 million, and the expense reduction of $80 million. Can you just give us some sense of how much do you think you've already taken the steps to realize that? What needs to be done to realize some of those gains? Is there other dynamics comparison-wise versus last year or some other aspect that gives you confidence you can – that those numbers are achievable?

W. Larry Cash - Chief Financial Officer, Director & President-Financial Services

Yes, I think we said earlier we've made some changes in some of the physician practices that weren't performing quite as well and I think that is something that has been accomplished through the end of the second quarter. You'll get some benefit in the third quarter and the fourth quarter also.

I think Wayne referenced a 40% decline in employed physicians, which will help and that's – we pretty well know the number of physicians that'll come on and there's clearly a loss factor of our salaries versus benefit. Of the $55 million, probably 40% is revenue. We've got some new approaches there related to Medicare wellness and also some work with some star rating for managed care and some other features we put in place, that we tested it in certain locations. So based on those tests, we think those are achievable.

The expenses relates to the productivity improvements. We've also made some efforts around better collection activity, which will be beneficial. It's not 100% locked up, but all the actions are outlined and we know who's responsible for them. They are underway and I think we feel reasonably comfortable that that could be achieved and there's a lot of talented people working on that.

If you go down to the volume improvements, we were 0.4% year-to-date, a little help, maybe, from the leap day the first part. But again, the flu was pretty weak in both first and second quarter, so we shouldn't have that drop out. And we do expect that if you take the midpoint of the guidance of 0.4% to 1.2%, that shows we've got some opportunity there. We have done a refresh of our annual projections for all of our hospitals in order of volume opportunity is. And based on what that's been projected, we think we see some good opportunity to generate an extra probably $125 million to $150 million of revenue versus what we did the first quarter, which will help EBITDA.

Our managed care team has identified a good listing of managed care increases that will receive some delay from the first quarter due for some other reasons in the second half of the year. And I think that's going to be very helpful to get to the $50 million.

The other item of the $80 million – again, we made some progress in June, but it doesn't show up as well because of the challenges to the results of the first couple months in the quarter. We think that will carry in the third quarter and the fourth quarter, we've had all the – all hospitals' divisions have projected out some expense reductions. And we've taken some leeway to bring those down and we'll be monitoring those. And so it's one of the things we must do is try to lower expenses. Historically, we've been pretty good at managing expenses and it didn't happen for us this last quarter or the first quarter (32:54) focused on making sure that happens.

That's just what I add – you didn't ask about it – there's probably a chance of supply chain revenue cycle improvement is on target. We're working hard to get maybe a little bit better than was originally there. So that $5 million might have some upside activity. And we'll look to also try to get a little bit better results out of acquisitions we've done. That's pretty much what we'd modeled.

The final thing – I don't think that the reimbursement reductions that came out yesterday will have any effect on our $20 million that's clearly a headwind.


The next question is from Brian Tanquilit with Jefferies. Your line is open.

Jason Plagman - Jefferies LLC

Hey, guys. It's Jason Plagman on for Brian. So on the decline in employed physicians, how much impact will that have on the revenue run rate?

W. Larry Cash - Chief Financial Officer, Director & President-Financial Services

I don't think that the decline of employed physicians in the second half of the year will be that meaningful. It generally takes 18 to 24 months. One of the things that's created a challenge for us was the large number of physicians that were recruited back in 2015, which we had a challenge. The productivity was slower. We got those to become more productive and I think we've got plenty of physicians out in the marketplace now.

And we have to measure how that may affect 2017, but I think that we got enough employed physicians. We got a lot of market share opportunity we can go after. And I don't think anybody wants to employ physicians in all cases to do it. If we need a new service and these employed physicians, that's one we do. But there's a lot of existing physicians there that have plenty of room to continue to grow. Wayne, you want to add anything to that.

Wayne T. Smith - Chairman & Chief Executive Officer

No. I think that's covers it enough. Lynn Simon is here in the room and that's the area that she manages. But I think we're on-track with her employee physicians in this all about productivity making sure that we had the most productive physician in the right spots. Lynn, you want to add anything? Okay. Good.

Let's go to next question, please.


The next question is from Gary Lieberman with Wells Fargo. Your line is open.

Gary Lieberman - Wells Fargo Securities LLC

Good morning. Thanks for taking the question. I guess, as you think about the trends over the last three or four quarters, where do you feel like you are in achieving some of the improvements that you've set out here to get and how confident do you think you can get them in the rest of the year?

W. Larry Cash - Chief Financial Officer, Director & President-Financial Services

Yeah. If you take the bridge, I'm very confident we can do a better job on expenses. This is something we've done over the years. And I think we are pretty focused as a company to do that. I think we reorganized for the physician practices little over year ago and I think we're starting to see some traction on that.

The results were a little bit better in the second quarter than they were the first quarter. Thanks to the volume improvements that we've done and physicians brought in a year ago, be beneficial to managed care results, should be there. Over the last couple of years, we have last year or so benefited a fair amount from the Affordable Care Act. Bad debts seem to be relatively stable. (36:11). So that's probably something we've got to keep in mind. I think we got synergies, pretty good synergies, last year. There was some small amount of synergies this quarter. We will continue to get activity.

I think if you look at the – main thing we've got to do is do a better job and we're – expenses the last half of the year, and I think we'll continue to work on that. And also get a little bit better. We have got a bit better comps, so from a comp perspective we need to grow our volume, but primarily I think the expenses in some of the physician practices will help us a lot in the second half of the year. And again that second half of the year will set you up nicely for next year, because you will get a full benefit of that for the whole year if we execute correctly on that.


The next question is from Joshua Raskin with Barclays. Your line is open.

Joshua Raskin - Barclays Capital, Inc.

Hi. Thanks. Good morning. Question on the physician practices again. I sort of hate to harp on this. But in the past, I think you said that the remedy for some of the HMA weakness has been they just didn't do a great job on the physician recruiting side. Now it sounds like you guys are slowing down the physician recruiting because of the short-term losses. I just want to kind of juxtapose how do you get to where you want to be long term? And then you mentioned improved productivity on the existing physicians. And how was that accomplished? Are there compensation schedules that you guys can implement that change the way physicians behave, et cetera?

Wayne T. Smith - Chairman & Chief Executive Officer

I might just say that we have talked about this for a good while in terms of the lack of physician recruitment to a number of HMA facilities, particularly in Florida. We recruited pretty hard, as you said, and the numbers were pretty strong last year. When we did that we also brought on a number of physicians that are working their way forward, that we are getting productivity out of and we should continue to see that improve going forward. I think that's what Larry was trying to communicate when he said our adjusted admissions at HMA have gone down from negative 4% to basically flat.

Along the way though, there are physicians that are not that productive, so we have been looking and we have a lot of metrics now that we use to determine productivity, centralized scheduling and things that we're putting in place to make sure that we get productivity. So I think we're on the right track and the two – this is what happens oftentimes, when you recruit and then we have other physicians that were in place that we need to work on, but I think what Lynn has done in terms of managing our physician practices has brought a lot of discipline to the area, and I think we're now beginning to see progress from that.

W. Larry Cash - Chief Financial Officer, Director & President-Financial Services

If you look at the employed physicians that we're bringing in – that we brought in, we clearly had about three times more physicians in 2015 than 2014, and the legacy was relatively flat. Rolling into 2016, the legacy hospitals are slightly above 10% and HMA hospitals are still ahead of a year ago, but we don't need to bring in as much. We had an all-out effort, maybe a little too much of an all-out effort, to bring a lot of physicians in 2015 a record year for us for our internal recruiting efforts.

And I think it's appropriate for us now we've got the physicians, to let them mature in the marketplace and get to productivity in the – so it's not as if slowing down is a bad thing. It's probably the right thing to do.


The next question is from Ralph Jacoby with Citi. Your line is open.

Ralph Giacobbe - Citigroup Global Markets, Inc. (Broker)

Thanks, good morning. When I look at same-store revenue, it's been in that 1% to 2% range for the last four or five quarters. So I guess how much of this is just having to reaccelerate the topline below that or beyond that low single digit range?. I certainly appreciate cost savings opportunities, but I guess will we see that come through if revenue trends don't accelerate, and maybe help us, what you need from the topline perspective, what's embedded in guidance to just kind of hold the line on margin? Thanks.

W. Larry Cash - Chief Financial Officer, Director & President-Financial Services

Yeah, I think we have started out the year, I think it could be somewhere in the neighborhood around 3% same-store revenue growth and we're not there for the first couple of periods. One other thing that is different is we have had much better surgical growth driving some revenue growth in our legacy facilities; a bunch of HMA facilities. So there is lot of effort to try to recapture some of the surgery business, the HMA had once upon a time the big loss. So that's one thing we probably got to do.

The second thing from a revenue perspective is continue to do a good job of the managed care penetration, managed care contracting. We've got in some new managed care contracts in Florida in the last three to four months that will be helpful. We're doing a pretty good job of trying to make sure that we grow our managed care revenue payer mix which will help the growth there. I think we also have done a decent job as it relates to looking at our appropriate coding and make sure that's done right. So I think that's an area that we've made some progress on.

But clearly, the legacy facilities are running better, and are up almost 4% year-to-date and 3.2% for the quarter, just bringing the HMA facilities to flat would help tremendously grow that business. So I think that's one to focus there. All the programs we do here, we talked about around orthopedic programs, or bariatric surgery programs, or cardiology programs all the HMA facilities are overtime getting participated in that, we should get some benefit from it. But you are right, we did also – while we are working diligently to get the cost back in line, we have to continue to focus on getting the revenue back up in 3% range, where we've have gotten the legacy hospitals so far this year.

Wayne T. Smith - Chairman & Chief Executive Officer

And improve our margin on the way.

W. Larry Cash - Chief Financial Officer, Director & President-Financial Services

And of course the margin in itself, both the QHC leaving and the Universal which is helpful, and in the divestitures, that at least we got to talk about today, our margins will go up 100 basis points once that's done, and of course, the QHC spin is done, that will help the cash flow of the company.


The next question is from Andrew Schenker with Morgan Stanley. Your line is open.

Andrew Schenker - Morgan Stanley & Co. LLC

Hi, thanks, good morning. Just real quick, think about the sale of the 12 hospitals now, I'm just trying to better understand how that compares with the expectations last quarter when you highlight the 10, it seems like you are giving a much better rate for the two extra hospitals, is this just because these two – and what I mean by as – before you were looking for about $ 530 million on $1 billion of revs, now you're thinking about $850 million on $1.45 billion revs so those new hospitals you're getting much better rates for, is this just a more profitable, or is this just you've restructured the portfolio or the offering. It sounds like to maybe find better strategic buyers, so just thinking about what's changed in that package? Thank you.

W. Larry Cash - Chief Financial Officer, Director & President-Financial Services

Yeah. The 10 hospitals, there are some of the 10 that are in the 12, but there is not all of the 10 in there, and as we continue to look at which facilities, we had a transaction that we started with a LOI that's not going to go forward. So we have to restructure that. So you've got a different makeup of hospitals, you are correct. The revenue, the price of these is closer than on 60% of revenue versus to the other one was 50%, 53% of revenue.

Margins are relative to close on the two and it's just a different makeup of the hospitals, but clearly that the first set of hospitals had a couple of more challenging facilities in there, so now we're not in the 12, but as Wayne said, there are still some other de-leveraging opportunities so the makeup is a little bit differently and as a result the price compared to revenue is a little bit differently. And I think these are all transactions that will help us to deliver and also helped the margin of company going forward.

Wayne T. Smith - Chairman & Chief Executive Officer

Yeah. I think that's important thing is that these will definitely after it's de-leverage and our margin should improve and its consistent with our view that we're looking for sustainable markets that we can grow and spend our capital and to enhance our facilities.

W. Larry Cash - Chief Financial Officer, Director & President-Financial Services

Generally, when we describe these transactions, we generally have a pretty good confident level that we've got a letter of intent that's going to generally go forward but we have one letter of intent and the original intent that didn't go forward.


The next question is from Chris Rigg from Susquehanna Financial.

Chris Rigg - Susquehanna Financial Group LLLP

Good morning. Larry, thanks for providing the sort of volumes trends in the HMA hospitals over the last few years. Is there anything you can share margin wise there, how the trends have been? And then I guess more importantly, you're seeing diminishing declines in the volume pressure there. Do you think we're near inflection point there or it's still too early to call? Thanks a lot.

W. Larry Cash - Chief Financial Officer, Director & President-Financial Services

It's 56 or somewhere in the mid-60s of hospitals and so that tells you that the ones that devolve after January 12, have been more challenging and some of those remain challenging. I think we would expect hopefully by the end of the year, we'll be at a point where we don't have to talk about HMA next year. We've owned it a while, we've worked on it. And we're seeing progress, it's a group of 60 some odd hospitals, some do better than others. We had a little bit more challenge in Florida with some other competition there and other stuff. But I'm hopeful that this – we did this to sort of say look, it started out in a pretty difficult environment when you compare it to 2013 and 2012 and all the challenges they've had in 2013 once they went through, including our purchase and the changeover of the Board. And so there has been results and then we will keep working on trying to get the results, we got to also get the revenue growth out of there. The one things that is not heading as fast as you want to is surgeries, so to work on the surgical growth.


The next question is from Kevin Fischbeck from Bank of America Merrill Lynch.

Kevin Mark Fischbeck - Bank of America Merrill Lynch

Hi, Great. Just want to go through, because you are doing a lot of transactions and divestitures. So, I wanted to see if you could help us level set what the core business looks like in 2016. So we can kind of think about what the basis to grow off for 2017, I know in your guidance bridge you exclude EBITDA from divestitures. But I guess, if we took out the EBITDA that actually was included in the numbers, I don't know, I am coming up with something maybe like $130 million. Do you know what that number to take out of 2013 from I guess both the revenue and an EBITDA, so we think about a clean 2016 and the base for 2017 growth?

W. Larry Cash - Chief Financial Officer, Director & President-Financial Services

Yeah, if you take the $2.480 billion, I think what you got to back out is $95 million and then whatever you end up selling, if you sell $1.450 billion at a 5% margin of $70 some odd million roughly if it's a 5% margin, 6% a little bit higher. But I think the known right now is the $95 million that we think we got to back out, as a result of what the bankers and the QHC ended most of the ones we are selling – now keep in mind divestitures stay in the income statement even after you sell them, the income statement you no longer separate it and so it's a little bit more difficult. That's why we went to a same-store. And left out all the stuff we sold, even though it may have owned it for a month or two. But I think the run rate would be somewhere in the neighborhood of $2.480 billion less $95 million plus whatever earnings are of the ones we sell and we will provide as time goes on. But right now 5% is a reasonably good proximity of what the margins are over time.


We have time for one more question. The last question is from Matthew Borsch from Goldman Sachs.

Tejus Ujjani - Goldman Sachs & Co.

Hi. this is Tejus Ujjani on for Matt. Thanks for taking the question. You called out surgery volume strength of 1.2%. Was hoping you could just break that out in terms of inpatient versus outpatient. And then also any trends in acuity across both.

W. Larry Cash - Chief Financial Officer, Director & President-Financial Services

Yeah, the outpatient growth was positive and the inpatient growth was negative so we do not have positive inpatient growth and that's been the way for the past couple of quarters. Lot of it's moving to outpatient especially some in orthopedics. Orthopedics had good outpatient growth and then we also had good growth in neurology, all of which have a pretty high implant cost which has driven from our supplier cost, but our surgical growth has been predominantly outpatient.


There are no further questions at this time. I will turn the call back over to the presenters.

Wayne T. Smith - Chairman & Chief Executive Officer

Thank you again for spending time with us this morning. We are very focused on our strategies, we've outlined earlier. You will see us improve as we always have done historically. We want to specifically thank our management team, staff, hospital chief executive officers, hospital chief financial officers, and chief nursing officers, and division operators for their continued focus on operations performance.

Once again, if you have a question, you can always reach us at area code 615-465-7000. Thank you.


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

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