Quorum Health Corporation (NYSE:QHC) Q2 2019 Results Conference Call August 8, 2019 11:00 AM ET
Bob Fish - President and Chief Executive Officer
Alfred Lumsdaine - Chief Financial Officer
Marty Smith - Chief Operating Officer
Conference Call Participants
Elie Radinsky - Cantor Fitzgerald
Frank Morgan - RBC Capital
Moses Mutoko - Morgan Stanley
Good morning. And welcome to Quorum Health Corporation's Second Quarter 2019 Earnings Conference Call. At this time, all participants are in a listen only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time. As a reminder, today's call is being recorded. 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 the company's Form 10-K filing 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. The company does not intend to update any of these forward-looking statements.
Quorum Health issued a press release last evening with their financial statements and definitions and calculations of adjusted EBITDA and the same-facility adjusted EBITDA, including reconciliations to U.S. GAAP measures. A slide presentation is available on the company's Web site to supplement today's call. Results discussed today consolidate the results of Quorum's 26-owned or leased hospitals and the results of Quorum Health Resources. Same-facility information excludes the results of the 12 facilities that have been divested or closed since the spin-off through June 30, 2019.
In addition, the company filed their quarterly report on Form 10-Q last evening. All discussions today are supplemented by the press release, the earnings presentation on the company's Web site and the Form 10-Q. All non-GAAP calculations discussed will exclude certain legal, professional and settlement costs, charges related to the impairment of long-lived assets and goodwill, the net gain or loss on sale of hospitals, the net loss on the closure of hospitals, costs associated with the transition of the Transition Service Agreements or TSAs, change in actuarial estimates, severance costs for headcount reductions and executive changes. Please refer to the earnings presentation located in the Investor Relations section of the company's Web site at www.quorumhealth.com, for a further description and calculation of adjusted EBITDA and same-facility adjusted EBITDA and a reconciliation of these non-GAAP measures to net income, their most direct comparable GAAP measures.
With that, I would like to turn the call over to Mr. Bob Fish, Quorum's President.
Welcome. And thank you for joining us to discuss Quorum's second quarter 2019 financial and operating results. Joining me this morning is Alfred Lumsdaine, our Chief Financial Officer and Marty Smith, our Chief Operator Officer.
On the call today, I'll discuss highlights from the second quarter and provide an update on our strategic plan, before turning the call over to Marty to cover our second quarter operating results. Our same facility net operating revenue in the second quarter was $442.4 million, a decrease of 3.5% compared to the second quarter 2018. I note that 34% of this decline comes from the two hospitals, which will be sold or closed by the end of this year.
Same facility adjusted EBITDA was $37 million in the second quarter, a year-over-year decline of $3 million. This entire decline relates to the pending divestitures. While we experienced a decline in surgeries and admissions for the quarter on a year-over-year basis, our volumes improved sequentially due to reduced physician turnover and our ongoing initiatives to expand certain service lines in select markets. Our volumes for the quarter were also impacted by several planned service line closures.
Looking to the second half of 2019, we anticipate volumes will improve on a year-over-year basis as we complete the two pending divestitures, add or expand service lines in specific markets and continue to mitigate the impact of physician turnover.
Next, I'd like to discuss the progress we have made on our strategic initiatives. First, regarding our cost reduction initiatives. On our last call, we identified approximately $20 million of annual cost reduction opportunity in corporate costs and medical specialist fees. As planned, we have implemented these and other reductions, and expect to see corresponding benefits beginning in the third quarter. Second, I'd like to update you on our divestiture efforts. In the first half of year, we generated $12 million in proceeds from the divestiture of Scenic Mountain in Texas.
In June, we announced the sale of Watsonville in California. As we indicated in our press release yesterday, on July 18th, the local Community Health Trust exercised their Right of First Refusal on the transaction. Based upon the terms of the Right of First Refusal, the trust must match the terms of our existing APA and enter into a definitive agreement of their own. If no agreement is reached, the APA with Holston Healthcare will continue. This is resulted in a short extension of our timeline to close the transaction, but we still feel that we will close the sale by the end of the year. Also in June, we announced the planned closure of MetroSouth, which will be effective by the end of third quarter.
Third, we're making great progress on transitioning our remaining TSAs. We've begun implementation and are on track to go live with R1 by the end of calendar 2019 for end-to-end revenue cycle management services. This includes the transition of over 700 Quorum collogues to R1. We continue to expect to achieve $10 million in EBITDA improvement in the back half of this year as a consequence of this effort.
In addition, we've begun the process of transitioning responsibility for our IT services, provided under our IT TSA. The nature of this transition requires a staged hospital-by-hospital approach, and it will take until the first quarter of '21 to fully complete this transition. As noted in our release yesterday, we have made the decisions to remain with our current EHR provider MEDHOST. We believe remaining on the MEDHOST platform will provide for the most efficient and effective transition
We estimate capital expenditures associated with the MEDHOST transition will be approximately $60 million to $70 million beginning in 2019 and continuing through 2024. In short, we've made substantial progress toward transitioning our TSAs, and I'm appreciative of the hard work and collaboration that's occurring daily between the Quorum team and our counterparts at CHS, to ensure that these transitions will be as smooth as possible for both organizations.
A final comment about our progress against strategic goals. We've made good headway on divestitures year-to-date, and we're actively working on four more hospitals to be the best at this year, combined with the improvement and our profitability as we described. We expect to reach our goal of six times leverage on a run rate basis before the end of the year, which is an important milestone toward our refinancing. In short, we've made substantial progress this quarter and remain confident in achieving our full-year targets. I look forward to updating you throughout the second half of the year.
And now I'll turn the call over to Marty for a discussion of our operations in more detail.
Thanks, Bob and good morning, everyone. At a high level, our operating results this quarter can really be focused on individual trends at a few select hospitals. Most of our facilities are showing strong progress and performance relative to our expectations. While small select group of hospitals continue to work through their specific near-term issues, mostly related to independent provider turnover. This is especially true on the volume front. While our volumes, on a whole, are down year-over-year, we are seeing some positive underlying trends, particularly in surgeries across our portfolio. These trends give us confidence that we will see improvement in the second half of the year.
Our total same facility admissions were down 5.7% in the second quarter of 2019 compared to a year ago, and same facility adjusted admissions declined by 3.4% year-over-year. Same-facility admissions and adjusted admissions were impacted largely by our decision to close negative margin service lines over the last four quarters, and the impact of the announced closure of MetroSouth and Blue Island, Illinois.
There is a lingering impact of physician turnover that's being mitigated going forward in Marion, Illinois and Springfield, Oregon. We expect to see continued second half recovery on both of those fronts. This was also the case for our same facility surgical volume, which decreased 2.2% year-over-year but importantly, our surgical volumes improved almost 9% sequentially compared to the first quarter. You will recall in the first quarter that we had fourth facilities that were dragging on surgical volumes, first, due to our efforts to try and re-syndicate two underperforming ASCs in Illinois; and also, provide our turnover in GI services in Springfield, Oregon and orthopedics in Marion, Illinois. While there continues to be some lingering impact on volumes, our hospital teams have done an excellent job managing disruption in these markets and recruiting and backfilling physicians that were lost.
On the ASC front, we're actively assessing and talking to third-party partners to work with us on the re-syndication of the two facilities in Illinois. When you normalize the impact of these items, our same facility surgical volumes actually grew 4.9% year-over-year in the second quarter. Outside of lower acuity GI, which actually accounts for all our surgical volume declines in the quarter and ophthalmology and pain management declines. The recruitment and surgical volume initiatives at the hospital level led to good growth this quarter and higher acuity, E&C, general surgery, neurosurgery, urology, and orthopedics, which were all up to prior year.
Turning to the same facility ED business. We saw a 1% decrease year-over-year and a slight increase from the first quarter despite a nearly 3% reduction in ER volumes associated with the flu season in the first quarter of this year. We continue to make consistent progress, improving our mix over the past year. And we are still targeting continued improvement, going forward. As we discussed last quarter, we have a new team leading our managed care initiatives, and they've already been begun making progress and negotiating better rates. We've seen some improvement in rates in the first half of this year, and we expect to see a bigger lift in the second half of this year.
Finally, I want to provide a bit more detail on the cost reduction initiatives. As of the end of July, we have renegotiated nine medical specialist contracts, including emergency physicians, hospitalist and anesthesia provider contracts. We will recognize savings on these contracts beginning in the third quarter that will also ramp up into next year. We're also targeting continued to supply cost savings, particularly in our higher cost implant pricing. Corporate overhead costs will also decline in the second half of the year based on the actions that have already been taken.
In summary, I'm optimistic about the trajectory of our hospitals as a whole. And I'm proud of the efforts our hospital teams have put into positioning each market or success in terms of improved margin and volume. The decisions we've made, particularly around closing eight hospitals and service lines, are not easy but they're ultimately appropriate in the best interest of making each market sustainable.
With that, I'll turn the call over to Alfred, who will take a closer look at our second quarter financial results. Alfred?
Thanks, Marty and good morning, everyone. I'd like to start with an overview of our second quarter results, and then discuss expectations for the second half of this year. As Bob noted, same-facility net operating revenue of $442 million was down 4% year-over-year from $459 million in Q2 of 2018. This year-over-year decline was primarily driven by the same facility volume declines that Bob and Marty have already noted which impacted our revenues by nearly $15 million on a comparative basis.
Included in this year-over-year reduction is $6 million decline from the two hospitals that are pending divestiture. On a sequential quarter basis, same-facility net operating revenue improved by $10 million, or 2.3% in the second quarter of 2019, primarily as a result of increasing surgical volumes compared to the first quarter. Second quarter same facility net operating revenue also reflects the sequential improvement in self-pay patient collections from our secondary accounts receivable vendors, which as we've discussed previously, have ramped slower than we expected since the transition of these services under our TSA last July.
Moving on to expenses. Same facility salaries, wages and benefits, declined 5.1 percent year-over-year, primarily due to headcount reductions, as well as lower performance based benefit expenses. Same facility supply expense declined 1.8% year-over-year as a result of the lower volumes. Although, on per adjusted admission basis same facility supplies expense increased nearly 2% due to our focus on higher acuity service mix.
Our second quarter 2019 results include a $24 million benefit from actuarial adjustment on medical malpractice liability reserves that relates to prior years. Excluding this $24 million benefit, same facility other operating expenses in the second quarter decreased approximately 3.4% compared to the prior year. This decrease again was primarily related to the current year impact from the same medical malpractice actuarial adjustment, and I will discuss that in more detail in just a moment.
Moving on, our same facility adjusted EBITDA was approximately $37 million for the quarter compared to approximately $40 million in Q2 of 2018. As Bob has already noted, the $3 million decline in total company same facility adjusted EBITDA relative to 2018 matches the adjusted EBITDA decline from the two pending divestitures. Same facility adjusted EBITDA for the quarter was 8.3% of same facility net operating revenue.
Given our cost initiatives and the expected impact from our agreement with R1, we anticipate expansion in our same facility adjusted EBITDA margins through the second half of this year, particularly once the pending divestitures are completed. In terms of cash flow for the quarter, cash flow from operations was a use of $10 million compared to a benefit of $17 million in the second quarter of last year. This decline in cash flow from operations is primarily related to the timing of receipt of certain supplemental payments compared to the second quarter of 2018, as well as the timing of certain accrued liability payments in the second quarter of 2019.
We would expect to see improved cash flow from operations during the second half of the year as a result of normal timing of cash receipts and from payments, as well as improved profitability. For the full year, we expect to be slightly free cash flow positive. Capital expenditures in the second quarter were $12 million compared to $11 million in Q2 of 2018. This small increase in CapEx relates to increased spending on IT infrastructure as we begin the transition of our IT TSA.
Moving on to the balance sheet. Our net debt at June 30th was approximately $1.2 billion. This includes $778 million outstanding on the term loan and $42 million outstanding on the revolver. Cash and equivalents totaled $2 million. Our senior secured net leverage ratio calculated under our credit agreement was 4.85 times at June 30, 2019. While the cushion under our net leverage covenant was clearly quite high at the end of the quarter, we expect the cushion will expand as we go through the second half of the year in lock step with the anticipated improvement in operating results and the completion of the pending divestitures.
Next, I'd like to provide some more color on the adjustment to medical malpractice expense, and the corresponding reserve reduction that we recognized in the quarter. Cumulatively, this adjustment was for $29 million at our same facility hospitals with $5 million of this benefit relating to 2019. And as I previously mentioned, $24 million relating to prior periods. The adjustment itself results from a change in accounting estimate largely attributable to a greater reliance on the now more than three years of actual medical malpractice claims history since the company was found, as well as added consideration for industry trends. Ultimately, the change in estimate captures a declined and the frequency and severity of our med mal claims, which we attributed to both initiatives that we've implemented in the areas of patient safety, risk management and claims management, as well as certain external factors, such as tort reform in key states.
Moving on, I'd like to provide additional color on our revenue cycle management transition. In May, we announced that we've selected our R1 RCM for end-to-end revenue cycle management services. We're currently on track to complete the transition of our revenue cycle functions to R1 by your end. Additionally, R1 has committed extra resources to support near term collections, and to help to ensure seamless transition. We continue to expect that we'll realize a $10 million EBITDA benefit from our agreements with R1 over the second half of this year. And we continue to expect a substantial long-term benefit ramping to $5 million of incremental EBITDA in 2021. You'll note that we provide our expectations for the long-term benefit of our agreement with R1 slightly downward as a result of the two hospitals that are currently pending divestiture.
I'd also like to provide some additional comments on the announcement we made yesterday regarding our agreement with MEDHOST. We currently utilize the MEDHOST platform across almost all of our hospitals through our IT TSA. As we begin the process of transitioning IT services provided under our existing TSA, we've made the important decision to remain on the MEDHOST platform. The IT TSA transition will begin in earnest during the third quarter of 2019, and is expected to be complete by the end of the first quarter of 2021.
As Bob noted, we expect the total capital expenditures associated with the MEDHOST transition will be approximately $60 million to $70 million with this cash outlay spread over the next five years. This estimate includes all hospitals with the exception of the two pending divestitures, and could be lower depending on any divestitures that occur before MEDHOST has implemented at a hospital. As it relates to 2019, the anticipated impact on capital expenditures for the transition falls within the range of our previous expectations for the year.
One last topic I'd like to touch on before moving to guidance is the California Hospital Quality Assurance fee program or HQAF. As of the end of the second quarter, the fifth iteration of the HQAF program ended as scheduled. The State of California is expected to submit a waiver application to CMS for HQAF six by September 30th of this year, and approval is anticipated to take several months. Given the minimal changes between the fifth and sixth HQAF programs, we're optimistic that approval will take less time than in the past.
Nevertheless, until the CMS approval is received, we'll be unable to improve revenue associated with the HQAF program, which excluding our Watsonville hospital, represents approximately $2 million of EBITDA per quarter.
So moving on to our financial guidance. We're reaffirming our full year same facility adjusted EBITDA guidance range of $160 million to $180 million, while revising our same facility net operating revenue guidance to $1.55 billion to $1.6 billion. This guidance reflects the expected completion of the two pending divestitures, as well as the expected renewal of the HQAF program before the end of the year.
That concludes my prepared remarks. And I'd like to turn the call back to Bob for some closing comments.
Thanks, Alfred. Once again, I'd like to thank all my colleagues for their continued hard work and dedication. I'm very proud of the progress we've made and look forward to providing more updates as the year progresses. Operator, at this time, I'd like to open the call for questions.
[Operator Instructions] And your first question in the queue comes from line of Elie Radinsky with Cantor Fitzgerald. Please go ahead. Elie Radinsky, please unmute your line and go ahead.
So I just want to confirm the 6 times leverage that the company has placed out there for this year, or for the end of the year. So the midpoint of your EBITDA would be approximately 170, so that would -- time 6 would mean that you'd be slightly more than $1 billion of total debt outstanding at the end of the year? Is that correct?
Your math is correct. When Bob referred to our 6 times leverage target that would be on a run rate basis looking at the back half of the year, which is at the midpoint…
So I just want to confirm that the front half of the year, as you have put on your Slide Number 19, is approximately $60 million of EBITDA for the first two quarters. Where does it include other things, including other losses or something that is in addition to that $60 million?
The $60 million is correct. And of course, it includes the two pending divestitures, which if they close as anticipated by the end of the year would come out of our same facility adjusted EBITDA.
So that would, therefore, mean you're expecting to get approximately $110 million at the midpoint of your guidance absent any losses for those two facilities?
That $110 million would include those losses coming out of this business, so it's correct. Your understanding is correct.
And also the debt figure would include any cash proceeds that you may get from the additional I believe you said four facilities that you're planning on selling in addition to Watsonville, and the Scenic Mountain. Is that correct as well?
I just want to make sure my math is correct.
And your next question comes from the line Frank Morgan with RBC Capital. Please go ahead.
You mentioned some of the supplemental programs. I was just curious about the wage index adjustment. Can you help me with rural hospitals -- like how much of that's factored in and seems like that's an upside for most part, just kind of any hand-on size, magnitude of that particular payment? And then how much of that's factored in? Thanks.
Yes, I would suggest and Marty correct me. But it's not material in terms of how we're thinking about our guidance for this year.
Yes, you're correct in thinking. Frank, it would be net positive for us. But we've not factored it into the number at this point. Watsonville is actually a negative on that and they'll move out. So you take Watsonville out of the mix too and look at the rest of hospitals, it will be slightly positive. But again, we haven't included in these numbers.
Frank, we do not expect it to be material regardless…
Thank you [Operator instructions]. And we have a question from the line of Zack Sopcak with Morgan Stanley. Please go ahead.
Thank you for the time. This is Moses calling in for Zack Sopcak. Just a quick question on the physician turnover. Was this primarily at two facilities, or is this something that you've seen in several facilities? And you've talked about mitigating this. And just curious if you have any detail on how you're planning on going ahead with this and how does this impact your view on admissions for the second half of the year?
Yes, the color on that simply. It is really mitigating to the two hospitals that I've mentioned earlier, primarily Springfield, Oregon and Marion, Illinois. Springfield, Oregon actually is the bigger one where we lost independent GIs in the market who basically made a decision to leave their independent multi-specialty group and leave the market. That left us -- that'll happen in the fourth quarter of last year, which left us with about 600 GI surgery variants for first half of this year. They've mitigated some of that into the second quarter by some local services and they've got some recruitment initiatives that are ongoing and will, we think, have a better impact in the second half of the year. But if you look at their variants of surgeries in Q1 on GI, in Oregon, it was about 350. They mitigated it down to a variance of about 200 in the second quarter. So they're moving it in the right direction.
On the other one Marion, Illinois, its right the orthopedics, some orthopedics moved out of the market. We've now backfilled and they're going to be net positive for the second quarter and then going forward. So it's really primarily relegated to those two markets.
And my last question is on the $10 million benefit you expect from revenue cycle changes. Could you provide more color on that?
You can't really think of that $10 million as a split between $5 million of cost benefit of taking all of our costs that we're providing -- that it takes to provide RCM across the enterprise today. And having a lower price point in what we're paying R1 for the same set of services. And so that's a impact that we'll feel beginning in July and over the last half of the year. And then the remaining $5 million is expected from revenue cycle improvements in the back half of the year across the continuum of services. And that really begins beginning in October, so that's a fourth quarter impact on the revenue, expected revenue improvement versus the costs, which will be spread over the last six months.
[Operator Instructions] And it appears there are no further questions in the queue. I'll turn the call back over the presenters.
Thanks operator. Again, we'd like to thank everyone for their interest in Quorum. Have a great day.
And this concludes today's conference call. You may now disconnect.