Quorum Health Corporation (QHC) Q1 2020 Earnings Conference Call November 8, 2019 11:00 AM ET
Bob Fish - President and CEO
Alfred Lumsdaine - CFO
Marty Smith - COO
Conference Call Participants
Anton Hie - RBC Capital Markets
Good morning. And welcome to Quorum Health Corporation's Third 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 statement 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 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 24-owned or leased hospitals and results of Quorum Health Resources. Same-facility information excludes the results of the 14 facilities that have been divested or closed since the spin-off through September 30, 2019.
In addition, the company filed their quarterly report on Form 10-Q last night. 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 relating 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 a Transition Service Agreements or TSAs, change in actuarial estimates and 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 or loss, their most direct comparable GAAP measures.
With that, I would like to turn the call over to Mr. Bob Fish, Quorum's President and Chief Executive Officer. Mr. Fish, you may proceed.
Thanks operator, good morning and thanks for joining us on today’s call. With me this morning are Alfred Lumsdaine, our Chief Financial Officer; and Marty Smith, our Chief Operator Officer.
On the call today, I'll discuss results from our third quarter and provide information on our revenue cycle and divestitures, before turning the call over to Marty to cover third quarter operating results and Alfred for financial results and a discussion of updated guidance. Despite the soft results which I’ll discuss further in a moment, I'm pleased with many aspects of the progress we’ve made operationally during the third quarter.
Same-facility net operating revenue in the third quarter was $378.6 million, a decrease of 2.7% compared to the third quarter 2018. Same facility adjusted EBITDA was $30.6 million. These results were negatively affected by the timing of two items; first, compared to the prior year quarter we were unable to recognize $2 million in revenue from the California hospital quality assurance e-program at our hospital in Barstow. We received the needed information in October of this year and will recognize these revenues in the fourth quarter of 2019.
Second; compared to the prior year quarter, our EBITDA results were negatively by $4.2 million as a result of a change in the timing for recognizing proceeds from the sale of property tax credits in the state of Illinois. Normalized for these timing items, our same facility net operating revenue declined by approximately 1.1% year-over-year, which I’ll describe in greater detail in a moment.
In terms of underlying volume, our results for the quarter reflect a year-over-year increase in adjusted admissions for the first time in six quarters, as well as continued strengthening in patient acuity. In particular, we experienced growth in our outpatient surgeries which were up 2.5%. Despite these positive trends, we experienced an estimated $8 million impact during the quarter, from a deterioration in our revenue cycle performance ahead of the transition of revenue cycle responsibilities to R1 RCM, which began October 1.
As of that day, we completed the transition of our backend revenue cycle functions and are on track to complete the full end to end transition by January of 2020. This deterioration in our revenue cycle activities began. Prior to the third quarter of this year, but accelerated as we get closer to the October 1 transition date.
We continue to remain confident in the improvement that R1's revenue cycle capabilities will bring to our business and expect that the negative impact we see in the third quarter results or normalize or even exceed few quarters. This recovery is an addition to the expected annual EBITDA improvement of $45 million by 2021 which we have discussed previously.
Moving on, I'd like to discuss the progress we have made on divestitures. In most terms, we’ve announced at the end of the quarter, the sale of Watsonville Community Hospital on September 30, for $39 million in net cash proceeds, plus $5 million in a note receivable. We used the cash proceeds from this transaction to pay down our term loan facility.
During the quarter, we also made the difficult position to close MetroSouth Medical Center in Blue Island, Illinois. Closing hospital is decision of last resort and we’re convinced however that it was the best solution for the company as a whole and we continue to work with a number of parties to determine the optimal use of the physical plan to benefit the Blue Island Community.
While we don’t currently anticipate completing additional divestitures this year, we’re actively working on up to four more potential divestitures that could transact by the end of the first quarter of next year.
With that, I’ll turn the call over to Marty for a review of our operations. Marty?
Thanks, Bob and good morning, everyone. At a high level, volume and expense operating results came in as expected. As Bob mentioned adjusted admissions increased 0.2% year-over-year and net patient revenue per adjusted admission declined 2.7% year-over-year.
While net revenue per adjusted admission decline compared to the third quarter of 2018. When normalized for the estimated impact of the revenue cycle deterioration ahead of the transition, and the timing of recognizing revenue for both the sale of property tax credits in Illinois and the California HQAF program, net revenue per adjusted admission would have increased approximately 0.7% year-over-year primarily due to both inpatient and outpatient increases in acuity.
Our same facility admissions during the third quarter declined 5.9% year-over-year. The majority of this decline is attributable to our decision to close some select OB services lines, some continued shift in services from inpatient to outpatient and an overall, continued decline in Medicaid volume. As a percentage of our volume Medicaid was down approximately 210 basis points prior year.
Same facility surgery volumes decreased 1% due to declines in, GI primarily in one market, surgery volumes associated with the closed OVG van services, and select termination of some employed surgeons. We have been able to mitigate the impact of this with the continued growth of other service lines and new surgeon recruitment.
Turning to our same facility ED visits, we saw a 0.4% decrease year-over-year in visits but a 260 basis points improvement in the percentage of admissions from the ER. Overall, our emergency room volumes on a quarter-over-quarter basis this year have been very stable. Our volume in acuity trends are reflective of the strategic decisions to term select Medicaid MCOs, to rationalize negative margin service lines and underperforming physicians which began in the second quarter of 2018.
We have successfully reduced negative margin volumes and improved the overall acuity of our service lines. As we move forward, we expect to see targeted year-over-year volume growth as we continue to strategically focus on growth drivers, as well as the underlying profitability of our service lines. 2019, has been a stronger year for provider equipment, with 81 providers signed year-to-date which is 20 ahead of prior year to three quarters.
Finally, I’d like to provide some color on our expense initiatives and trends during the quarter. As we have noted on previous calls, we have implemented various initiatives to reduce our cost by over $20 million annually. These initiatives include reducing corporate overhead expense, lowering our cost associated with medical specialists, terminating surgeons and underperforming physicians and lowering our supply cost.
As of the end of October, we have renegotiated 13 medical specialist contracts since the beginning of 2019, including emergency physicians, hospitalist and anesthesia provider contracts. Ten of those contracts are now active, and three more will take effect in Q4. We expect the impact of these savings initiatives to be utilized beginning in Q4 and expect an incremental $5 million in cost savings relative to the third quarter.
With that, I’ll turn the call now over to Alfred for a closer look at our third quarter financial results. Alfred?
Thanks Marty. Good morning everyone. I’ll start with an overview of the third quarter financial results and then discuss the revised expectations for the year. Same-facility net operating revenue of $379 million was down approximately 3% year-over-year from $389 million in Q3 of 2018. A large piece of this year-over-year decline was driven by the two timing items Bob mentioned, first our inability to recognize revenue associated with the California HQAF VI program and second, a change in the timing of recognition for the sale of property tax credits in Illinois.
Combined these two timing items resulted in more than $6 million of the decrease in same facility net operating revenue year-over-year. In addition as Bob mentioned, our third quarter revenues were impacted by an estimated $6 million that we associate with deterioration and the collectability of self pay accounts receivable, which we attribute to disruption ahead of the transition of revenue cycle functions to R1 RCM beginning October 1 of this year.
I’ll note that, although this financial impact accelerated as we approached the October 1 transition date, we can’t say a smaller impact that was present in our results during the first two quarters of the year. And the total is more than $15 million for all of 2019, through the end of the third quarter compared to the same period in 2018.
Moving on to expenses, same facility salaries, wages and benefits were generally flat year-over-year. That’s a result of normal wage growth that was mostly offset by employee health benefit cost reductions attributable to plan design changes.
Same facility supply expenses increased 6.5% year-over-year that’s primarily a result of the acuity increases that Marty mentioned particularly as it relates to outpatient services. Same facility other operating expenses increased just over 1% year-over-year, primarily from some small increases in contract labor and purchase services.
In summary, same facility adjusted EBITDA was $31 million compared to $42 million in Q3 of 2018 or a decrease of $11 million. And as I’ve noted this decline is more than accounted for in the estimated $8 million deterioration in our revenue cycle, our inability to recognize the benefit from the California HQAF VI program revenues. And then the more than $4 million impact from the timing of recognizing the property tax credit sale in Illinois.
So, in terms of cash flow for the quarter, our cash flow from operations was $25 million compared to $28 million in the third quarter of last year. Cash flow from operations during the quarter included $7 million of cash costs that are associated with the closure of MetroSouth. Capital expenditures in the third quarter were approximately $10 million which is comparable to Q3 of last year.
Our free cash flow for the quarter, similarly reflects the impact that we attribute to the deterioration from revenue cycle management activities. Although we’ve seen, our cash collections improve significantly during the month of October from September levels, we would now expect free cash flow for the full year to come in slightly negative.
Moving on to the balance sheet, our net debt at September 30, was approximately $1.2 billion. This includes $778 million outstanding on the term loan, and $25 million outstanding on the revolver. Cash and cash equivalents totaled $44 million and that reflects the cash proceeds from the sale of Watsonville at the end of September.
Our senior secured net leverage ratio calculated under our credit agreement was 4.49 times at September 30, 2019. We anticipated being fully in compliance with our credit agreement covenants through the end of this year.
As we look to 2020 and the step down of the secured leverage covenant that occurs at the end of the first quarter, as we noted in our release, we plan to engage with our secured debt holders to try and ensure we remain in compliance and have sufficient flexibility within our credit agreement during this important inflection period for the business.
Moving to our financial guidance, we are revising our full year same facility adjusted EBITDA guidance from a range of $160 million to $180 million to a range of $140 million to $155 million. In addition, we are revising our same facility net operating revenue guidance from a range of $1.55 billion to $1.6 billion to a range of $1.525 billion to $1.575 billion.
Our guidance reflects the previously communicated expected $5 million revenue benefit in the fourth quarter, from the R1 transition, as well as approximately $5 million in expected cost reductions in the fourth quarter from a number of ongoing expense initiatives at our hospitals and corporates that Marty mentioned.
The size of the same facility adjusted EBITDA guidance range represents uncertainty as to the precise timing of the expected improvement in revenue cycle performance from the deterioration we experienced thus far in 2019. However, our discussions with R1 give us confidence that the deterioration is temporal and can be fully recovered from in the coming quarters.
That concludes our prepared remarks, with that operator. I’ll open the call for any questions.
[Operator Instructions] Our first question is from the line of Frank Morgan from RBC Capital Markets. Your line is open.
Hey guys. This is Anton on for Frank. Just, I think if I am not mistaken you mentioned that Medicaid volumes are down a bit. Can we talk about kind of what may have driven that, is it service line closures or what’s really behind that?
Yeah. It is really a combination of two things both of the items kind of working in tandem. We did term primarily in Illinois some Medicaid MCO’s and we continue to kind of rationalize that portfolio just because it’s either ability to pay timely payment, increase in denials all the things associated with some of those struggles.
And a lot of the Medicaid volume was embedded into some of the service lines or physician terminations that had. But in particular OB service lines. And then there were few select markets where we had some negative margin volume just coming out of surgical programs in certain markets where we turn providers at some point in the second half of 2018 and that’s still kind of going through 2019.
Okay, and I guess so that comes back to some of the managed care. If I remember right you guys have put in some additional resources to get managed care negotiated rates better and is that kind of come back to that?
Some of that. I mean, we put in some new managed care resources in the first parse of this year. And so there’s still a lot of work going on in that area and there’s still lot of analysis on the Medicaid MCOs and short stays. With some of that activity was done in the prior just to rate coming on board with us.
Okay, and then how about just overall commercial rate renegotiations?
Overall that continues to be very positive for us. I think we’ve done a nice job when securing teams, secure some rate that are favorable and using our strength in certain areas to continue to bring good plan design going forward.
What we really encourage is a lot of our plans have been touched in a number of years. And so, there are some opportunities there. And Rick and his team have done an outstanding job for us.
Okay. And then back on the RCM. I know there’s collections issue I mean, you say it seems better that you’ve moved over on to the R1 platform is that -- are you kind of back to where you were before this sort of deterioration or do you think it’s improved from even there, prior to the deterioration?
Yeah. So, I’ll speak to it in two pieces Anton. There’s -- we’ve long talked about the expected improvement and Bob noted it in his comments about the $45 million at raw material that we expect to see from a flow through. And of course, as I mentioned on the call today with same deterioration in revenue cycle feudality, particularly profound in the third quarter, the closer we got to transition date.
Our conversations with R1 give us confidence, we can fully recover from that deterioration. But your question is how quickly. I think it would be -- it’s going to be -- it would be early for me to speculate. We see good process data as I mentioned. We’ve seen collections significantly improve from September.
Although September was a very low month of course, so yeah we think it’s going to take a few quarters in our conversations with R1. So and then again it goes to the width of the range of same facility adjusted EBITDA for the year, because it’s difficult to predict just how quickly.
And we’ll likely never be able to chase out what was the expected improvement versus what’s kind of, I’ll call the recovery piece it allow, looks the same as it happens but from where we are, of course we would expect to achieve more than $45 million that we quoted because of the -- in pervious calls because of the deterioration that we’ve seen. I hope that makes sense but the short answer is we think it’s going to take a few quarters.
Okay, I think I got it. Thanks.
There are no further questions at this time. I will now turn the call back to Mr. Bob Fish. Please go ahead.
Thanks operator. Again thanks for joining the call everyone. And we appreciate your interest in Quorum Health. Everyone have a great day.
This concludes today’s conference call. Thank you all for joining. You may now disconnect.