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Edited Transcript of CYH earnings conference call or presentation 6-Aug-19 3:00pm GMT

Q2 2019 Community Health Systems Inc Earnings Call

FRANKLIN Aug 12, 2019 (Thomson StreetEvents) -- Edited Transcript of Community Health Systems Inc earnings conference call or presentation Tuesday, August 6, 2019 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Ross W. Comeaux

Community Health Systems, Inc. - VP of Investor Relation

* Thomas J. Aaron

Community Health Systems, Inc. - Executive VP & CFO

* Tim L. Hingtgen

CHS/Community Health Systems, Inc. - President, COO & Director

* Wayne T. Smith

Community Health Systems, Inc. - Chairman & CEO

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Conference Call Participants

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* Albert J. William Rice

Crédit Suisse AG, Research Division - Research Analyst

* Anthony Husni Makdessi

JP Morgan Chase & Co, Research Division - Research Analyst

* Bradley Thomas Bowers

BofA Merrill Lynch, Research Division - Research Analyst

* Brian Gil Tanquilut

Jefferies LLC, Research Division - Equity Analyst

* Frank George Morgan

RBC Capital Markets, LLC, Research Division - MD of Healthcare Services Equity Research

* Joshua Richard Raskin

Nephron Research LLC - Research Analyst

* Ralph Giacobbe

Citigroup Inc, Research Division - Director

* Stephen Vartan Tanal

Goldman Sachs Group Inc., Research Division - Equity Analyst

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Presentation

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Operator [1]

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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 2019 Q2 Conference Call. (Operator Instructions) I will now turn the call over to Mr. Ross Comeaux, Vice President of Investor Relations. You may begin your conference.

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Ross W. Comeaux, Community Health Systems, Inc. - VP of Investor Relation [2]

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Thank you, Mike. Good morning, and welcome to Community Health Systems Second Quarter 2019 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 on 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 the broadcast of this conference call, a supplemental slide presentation has been posted to our website. We will refer to those slides during this earnings call. All calculations we discuss also exclude: gain or loss from early extinguishment of debt; impairment expense as well as gains or losses on the sale of businesses; expenses incurred related to divestitures; expenses related to employee termination, benefits and other restructuring charges; expenses from government and other legal settlements and related costs; expenses from settlement, fair value adjustments and legal expenses related to cases covered by the CVR; expenses to record a valuation allowance recorded for a promissory note received for the sale of hospitals in 2017; an expense to record a change in estimate for our professional liability claims accrual.

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

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Wayne T. Smith, Community Health Systems, Inc. - Chairman & CEO [3]

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Thank you, Ross. Good morning, and welcome to our second quarter 2019 conference call. With us on the call today is Tim Hingtgen, President and Chief Operating Officer; Tom Aaron, Executive Vice President and Chief Financial Officer; and Dr. Lynn Simon, President, Clinical Operations and Chief Medical Officer. On the call today, I'll provide some comments across the organization as well as on our performance during the quarter. Then I'll turn the call over to Tim, who will provide an update on operations, and then Tom will provide some details on the financial results.

Looking to the second quarter. We're pleased with the progress we made and the performance. We're continuing to strengthen the company across multiple fronts. Our strategic initiatives, which we have been rolling out over the past couple of quarters, are working and helping to drive improved performance. And the company is making positive strides across all of our strategic imperatives, including safety and quality, operational excellence, connected care and our competitive position. We're also seeing great execution by market leaders across the portfolio as they deliver on their strategic plans, capitalize on their specific market opportunities and advance and improve their market position.

Looking at our same-store volumes and our net revenue, we continue to see sequential improvements. And it's worth noting that our second quarter volume and net revenue growth marked our strongest performance since the first quarter of 2015. Let me say that again. It's worth noting that our second quarter volume and net revenue growth marked our strongest performance since the first quarter of 2015. During the second quarter, on a year-over-year basis, our same-store admissions increased 2.3%. Our adjusted admissions grew 1.8%. Our surgeries were up 3.4% And finally, our same-store net revenue was up 4.9%. So we're pleased to see our same-store volumes continue to improve and we expect to continue to deliver strong volume and net revenue performance going forward. Tim will provide some additional thoughts on our patient volumes in a minute.

Our adjusted EBITDA came in at $402 million. We're pleased to see that our adjusted EBITDA increased sequentially despite the second quarter being a wider volume than the first quarter. And our EBITDA margin, 12.2%, improved 70 basis points year-over-year and 60 basis points sequentially. During the quarter, we also made a number of improvements across our expenses, and we have identified substantial expense opportunities for the back half of 2019 and into 2020, which will continue to help us improve our margins and our EBITDA. Tim will talk more about how -- more about this and how we will leverage the expense opportunities and improve our margins and cash flow. Overall, we're confident about our outlook and our opportunities as we move through the second half of 2019.

Following a number of divestitures over the past 2 years, the company now has a stronger portfolio of assets. Today, our hospitals are in more substantial markets with better population growth, better economic growth and lower unemployment, providing an opportunity for improved growth potential. And with a greater portion of our resources and investments focused on the smaller and stronger portfolio, coupled with the continued execution across our initiatives, we expect to drive improved results in the back half of 2019 and beyond. We also believe the stronger portfolio will help the company deliver both improved cash flow performance and lower our leverage ratio. Our current divestiture plan anticipates the completion of divestitures of at least $2 billion of net revenue with single -- with mid-single-digit EBITDA margins. Total estimated gross proceeds, excluding working capital, is expected to be approximately $1.3 billion.

Through the end of the second quarter of 2019 as part of the plan, we closed divestitures accounting for approximately $1.5 billion of net revenue, generating $550 million of gross proceeds. These divestitures consisted of low single-digit margin EBITDA hospitals. During the third quarter, we closed divestitures for Tennova - Lebanon in Tennessee, College Station in Texas. We've announced definitive agreements to sell Bluefield Regional Medical Center, West Virginia, Heart of Florida Regional Medical Center in Davenport, Florida, Lake Wales Medical Center in Florida, all of which are expected to close during the third quarter. And we expect our third quarter divestitures to generate approximately $200 million in proceeds.

Tom will provide more details on our full year 2019 guidance and on the call -- on the call, but our EBITDA guidance remains unchanged. Adjusted EBITDA is anticipated to be $1.625 billion to $1.725 billion.

Now I'd like to turn the call over to Tim for additional comments.

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Tim L. Hingtgen, CHS/Community Health Systems, Inc. - President, COO & Director [4]

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Thank you, Wayne. We're pleased with our same-store volume and net revenue performance, which continues to show solid year-over-year growth as well as sequential improvements. As Wayne mentioned earlier, we have a stronger group of hospitals today. And these more sustainable hospitals and markets are benefiting from the strategic initiatives we have invested in over the past several quarters: growth CapEx in our key markets, medical staff investments consistent with the advanced strategic planning, the leveraging of data analytics across the organization, the shift to our regional management model to the majority of our markets and other factors, which have positioned the company for enhanced EBITDA growth and margin improvement going forward, specifically, our operating initiatives, including the transfer program, accountable care organizations or ACOs, inpatient investments, access points, patient connectivity, our service line enhancements and others, are helping to drive improved performance.

On today's call, I will talk about our volumes in more detail, share the latest on a few of our strategic initiatives that are helping to drive volume growth, and then I will walk through a number of expense management opportunities we expect to realize in the near term. First, starting with our volumes. Our same-store admissions increased 2.3%. The increase in volumes was seen across a number of different geographies and markets. In terms of individual service lines, we drove growth across cardiovascular, neurology, orthopedics and spine and other targeted specialties. Surgeries grew 3.4% due to an increase across orthopedics, GI and other categories. After a couple of negative growth quarters, ER visits were up 2.4%. We believe this strength is due in part to our targeted service line development, which is supported by our transfer center, enhanced clinical and EMS outreach programs and our freestanding emergency department growth. We continue to invest both in our hospital-based ERs as well as alternative settings of care, such as urgent care and walk-in care centers and freestanding EDs. During the second quarter, we opened our 13th freestanding ED in our Santa Rosa, Florida market, north of Pensacola. We've also been pleased with the development and growth of our primary care provider base and practice locations, posting double-digit growth in traditional primary care visits during the quarter. Looking forward, we have a strong pipeline of additional on-demand care access points in the development, which are designed to provide consumers with conveniently located health care services and connect them with our health care systems, providers and services. Same-store net revenue increased 4.9% with comparable growth in both the inpatient and outpatient side. So overall, we were pleased with our volume performance and remain focused on driving this momentum going forward due to leveraging of our initiatives and the continued execution by our local market leadership teams.

In terms of our transfer program, as I mentioned in the past, the program helps to manage the inbound referrals to CHS hospitals from both CHS-affiliated and nonaffiliated hospitals in a particular area. The program has provided a number of benefits including: one, more real time visibility into daily emergency department, bed management and case management operational performance; and two, improved data capture aligned from our targeted service line development strategies and aligned physician hiring in each particular market. Looking at our same-store hospitals that have utilized our transfer and access program for more than a year, CHS inbound transfers increased 17% year-over-year and also picked up momentum sequentially despite the second quarter historically being a lighter volume quarter. The payer mix across CHS inbound transfers has also been favorable as commercial mix grew faster than total Medicare and all other care categories. During the second quarter, we competed the planned rollout of our transfer and access program in our 56th hospital, which now includes hospitals in 18 distinct markets. Due to the success we're seeing from this initiative, we now plan to leverage this capability in additional markets with plans to expand the program into another 9 hospitals by the end of 2019, which we expect will help drive incremental growth going forward. While today I wanted to highlight the success we're seeing from the transfer program, we're also experiencing continued progress across all of our strategic volume growth initiatives.

Now, I would like to provide an update on our supply chain and purchased service initiatives. As a reminder, we have reorganized our supply chain organizational structure and added experienced supply chain executives to lead this focus and drive expense savings. Through these efforts, we're enhancing our technology across the company to more efficiently procure supplies and services. And our new strategy, focused on stronger national contracting, is providing good results.

In terms of commodity supply products, our clinician-led teams have launched more than 50 supply categories designed to identify products that offer the best quality, safety and overall value. We are seeing quick adoption from this program, and we'll continue to launch new categories to drive incremental savings. On the physician preference side, we've deployed physician-led advisory committees to assist with the selection of clinical physician-preference items. We implemented the first category late in the first quarter, which will lead to approximately 30% savings on that particular implant. And we executed 2 additional physician-preference item categories that started provided savings in July. Combined, these 3 categories will lead to over $40 million of estimated annual savings, and we expect to implement the same strategy with other specialty categories throughout the remainder of 2019. We deployed a similar strategy across certain purchased service categories, and we expect these focused efforts to drive meaningful savings over the coming quarters.

In addition to our ongoing supply chain transformation, our management team initiated a strategic cost-reduction program during the quarter, focused on corporate, shared services and hospital administrative costs. The program will include ongoing expansion of the vendor-spend reduction initiatives, which I just mentioned, along with reorganizations of certain nonclinical areas, technology-led process improvements and real estate and other cost-reduction efforts. Many program activities are underway and are expected to produce savings over the next several quarters. Adding all of this together, as we look forward, we expect to deliver improved same-store EBITDA growth and improved EBITDA margin performance.

Tom?

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Thomas J. Aaron, Community Health Systems, Inc. - Executive VP & CFO [5]

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Thank you, Tim, and good morning, everyone. Now we'll discuss second quarter on a same-store and quarter-over-quarter basis. As a reminder, calculations discussed on this call exclude items Ross mentioned earlier.

During the second quarter of 2019, net revenues increased 4.9%. This was comprised of a 1.8% increase in adjusted admissions and 3.1% increase in net revenues for adjusted admission. During the second quarter, our net outpatient revenues were 53% of our net operating revenues. And as Tim mentioned earlier, we drove similar mid-single-digit same-store net revenue growth on both the inpatient and outpatient side. Consolidated revenue payer mix for the second quarter of 2019 compared to second quarter of 2018 shows managed care and other, which includes Medicare Advantage, increased 120 basis points, Medicare Fee-for-Service decreased 170 basis points, Medicaid increased 20 basis points and self-pay increased 30 basis points.

Looking at our same-store adjusted admissions by payer. Our managed care, Medicare Advantage and self-pay volumes were up while our Medicare Fee-for-Service and Medicaid volumes decreased. During the second quarter of 2019, the sum of consolidated charity care, self-pay discounts and uncollectible revenue increased from 31% to 31.8% of adjusted net revenue year-over-year, an 80 basis point increase.

For the same-store expense items, our salaries and benefits as a percent of net operating revenue was flat. Supplies expense as a percent of net operating revenue for same-store decreased 20 basis points as lower commodity spend more than offset increased implant volume related to surgery growth. Other operating expense as a percentage of net operating revenue for our same stores increased 80 basis points due to higher IT subscription fees, vendor-related expenses and insurance costs. Malpractice expense incurred in the second quarter was higher even after excluding the increase to expense from the change in estimate for our professional liability claims accrual.

Looking at the P&L. On a consolidated basis, other operating expense decreased 30 basis points on an adjusted basis. While we expect to drive improvements on other operating expense line going forward, we have experienced increased IT subscription fees as we have utilized more cloud computing technology across our company. This shift lowers ongoing IT capital expenditures and SWB expense, but the technology fees for the cloud increases other operating expenses. That said, we're focused on driving expense improvements across the 3 primary expense lines.

As Tim mentioned, we have now completed national contracting for 3 physician-preference categories with more to follow later in the year. This contracting effort will include both supply chain and purchased service opportunities. Through all these initiatives, we expect to see incremental improvements going forward.

Switching to cash flow. Cash flows provided by operations were $265 million for the first half of 2019. This compares to cash flow from operations of $94 million in the first half of 2018. Looking at the year-over-year increase, there are few items worth noting versus the prior period. We have lower interest payments from timing due to our recent refinancing activity, contributing approximately $176 million more this year. This was offset from higher cash outflow from malpractice claims payment of approximately $72 million. Other year-over-year increases and decreases, including working capital changes, contributed approximately $67 million during the first half of the year.

Turning to CapEx. Our CapEx for the first half of 2019 was $212 million or 3.2% of net revenue. During the first half of 2018, our CapEx was $295 million or 4.1% of net revenue. We continue to make investments toward high-growth opportunities in key markets, and we remain focused on generating good returns on our capital spend.

Moving to the balance sheet. At the end of the second quarter, we had approximately $13.4 billion of long-term debt with current maturities of long-term debt of $206 million. From a liquidity perspective, at the end of the second quarter, we had approximately $207 million of cash on the balance sheet, approximately $235 million in undrawn revolver capacity, ABL borrowing capacity, $500 million of first lien borrowing capacity and approximately $200 million in anticipated Q3 divestiture proceeds. Our first lien net debt leverage ratio financial covenant under our credit facility is currently 5.25:1. As of June 30, 2019, our first lien net debt leverage ratio is approximately 4.96:1. We expect the first lien net debt leverage ratio to decrease going forward from a combination of additional debt paydown and EBITDA growth.

In terms of the capital structure, we're focused on the execution of our strategic initiatives which we expect to drive improved same-store EBITDA growth, allowing the company to deleverage and drive better cash flow.

Before I move to guidance, I want to reiterate some of Wayne and Tim's earlier comments on the business. Overall, we had a good start to 2019. We have a stronger second quarter compared to our first quarter. We're pleased with our continuous volume improvements, and many of our initiatives are on track and expanding. As we think about the second half of the year, we expect to deliver a stronger second half of the year than the first. As Tim mentioned, we expect to drive additional supply costs and other expense savings across the company. In the final 2020 inpatient rate -- Medicare inpatient rates will benefit our Medicare and Medicare Advantage inpatient revenues starting in the fourth quarter.

Now, I will walk through our full year 2019 guidance. As a reminder, our 2019 guidance contemplates future divestitures and does not reflect refinancing activities. Our updated guidance includes the following. Same-store adjusted admission growth is anticipated to be up 0.5% to up 1.5%. We increased our full year range by 50 basis points due to strong volume start to the year. For 2019, net operating revenues are anticipated to be $12.9 billion to $13.2 billion after adjusting for expected divestitures. Adjusted EBITDA is anticipated to be $1.625 billion to $1.725 billion. Net income per share is anticipated to be negative $2 to negative $1.65 based on weighted average diluted shares outstanding of 114 million to 114.5 million. Cash flow from operations is forecast at $550 million to $650 million. CapEx is expected to be at $450 million to $550 million.

Wayne, I'll return the call back to you.

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Wayne T. Smith, Community Health Systems, Inc. - Chairman & CEO [6]

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Thanks, Tom. And at this point, operator, we're ready to open up the questions. (Operator Instructions) But as always, we're available to talk to you, and you can reach us at (615) 465-7000.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question is from Frank Morgan from RBC Capital Markets.

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Frank George Morgan, RBC Capital Markets, LLC, Research Division - MD of Healthcare Services Equity Research [2]

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That was good color in terms of the volume side, but I would just want to go back to the pricing one more time and your outlook for the second half of the year. Any incremental impacts from state government programs that you can think of that might affect that? And then also just -- you mentioned the final PPS little bit. Just curious about the rural wage adjustments, how much of an impact that would be for you.

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Thomas J. Aaron, Community Health Systems, Inc. - Executive VP & CFO [3]

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Yes, Frank. So in the second quarter, we had a couple that kind of recur in the second quarter in various states. So we had expected those to be recurring in the second quarter. We had -- on the supplemental programs, we had just a few that were outside but not significant dollars involved with those.

With -- on your question about the finalized Medicare rates, so we benefited from that, especially on the wage index. We have approximately 40 hospitals that were able to benefit being in the lower quartile and stepping up. So overall, we handicapped that. When you look at the Medicare Fee-for-Service and the Medicare Advantage impact to that at approximately $80 million per year run rate, that will start on October 1.

Also the proposed outpatient rules came out. And one thing that looks like for certain in that, is that the wage index calculation, our benefit from that will be in the outpatient as well when that's finalized. But just looking at what is proposed right now, that's about $40 million benefit on Medicare and Medicare Advantage. That would be starting on January 1 in what's a pretty strong payment environment.

Just looking at the horizon on the other supplemental programs, I think the main one we called out this year was New Mexico Medicaid, which we're dealing with. There's been a new program put in there that should offset that, and then we don't see any other dramatic changes in the market. One other item to call out, and I think we talked about this before, Virginia did a Medicaid expansion. And we're clearly seeing the impact of that movement from self-pay to Medicaid in that state, and so that has been a benefit for us from that standpoint.

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Operator [4]

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Your next question comes from Albert Rice from Credit Suisse.

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Albert J. William Rice, Crédit Suisse AG, Research Division - Research Analyst [5]

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It's A.J. Anyway, you guys have spent a lot of time talking about the initiatives that are driving the volume growth, and obviously, you're probably getting some help as well from the divestitures, I would think, on the same-store numbers. But the strength you're seeing, any thought about what the underlying market trends are? Are you seeing any underlying strengthening in your markets, either on the medical, surgical or in any payer class, particularly, that will be worth highlighting? Or is it mostly just you grabbing share or keeping share within your portfolio given your transfer initiative and so forth?

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Wayne T. Smith, Community Health Systems, Inc. - Chairman & CEO [6]

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A.J., it's Wayne. I think -- we think based on our -- all of our initiatives, that -- and I think we can begin to demonstrate this, that we're getting market share across-the-board in our markets. It's working. Obviously, getting rid of some of those facilities that were not performing as well has been helpful to us, but part of it is market share. Tim might address some of the initiatives we have, but they're absolutely working.

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Tim L. Hingtgen, CHS/Community Health Systems, Inc. - President, COO & Director [7]

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Right. As far as the sector itself, obviously we want to grow commensurate with the sector. But we believe the volume growth in the markets were due to, again, a stronger core, strong strategic plans. We've talked about this for the last several years and in terms of multiyear strategic plans, recruiting the right doctors. Normally, we have visibility into opportunities through our transfer center data. In other words, where we weren't able to accept transfers because we didn't have the specialist to the service line or the capital or the equipment, we've since invested in that and really have seen strong growth, as I pointed out, on a same-store and a sequential basis to that initiative and those investments.

The EDs were a strong performer for us this quarter. We called out the last couple of quarters some macro trends, where some of that lower acuity business was moving into our urgent care, walk-in care and primary care practices. This quarter, we did see, we think through our direct-to-your-physician outreach programs, including EMS liaisons, perhaps better partnership with EMS providers. I'm showing some preference for our networks in the markets, driving that market share improvement that Wayne just referenced. We still saw growth in our urgent care, walk-in care centers and primary care practices even with that ED growth.

So in general, we believe the strategic initiatives and the -- really, the day-to-day focus, the regional president model, where we have regional presidents working more closely with hospital CEOs on a daily basis, is expediting the execution on those investments we made in the strategies.

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Wayne T. Smith, Community Health Systems, Inc. - Chairman & CEO [8]

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And I will end this with one of the things I said earlier that our second quarter volume and net revenue is as strong as we've had since 2015. So I think we're making really good progress. This is not just a [blown up] period. It's strong progress.

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Thomas J. Aaron, Community Health Systems, Inc. - Executive VP & CFO [9]

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And A.J., just going back to the previous question. Strong payer mix also helped on our net revenue per adjusted admission in the quarter.

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Operator [10]

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Your next question comes from Josh Raskin from Nephron Research.

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Joshua Richard Raskin, Nephron Research LLC - Research Analyst [11]

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Question around CapEx as you kind of think into 2020. I know you guys aren't giving guidance. But just directionally, these would be the $500 million or so that you'll spend in 2019, how should we think about that number? And then within the sort of the totality of that number, the mix between outpatient development and then maybe some of the inpatient initiatives that you guys are making would be helpful.

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Thomas J. Aaron, Community Health Systems, Inc. - Executive VP & CFO [12]

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All right. So Josh, thanks for the question. When we look at our CapEx and where we are this year, a couple of things to call out. One, we do have, with the divestitures going on with to-be divested hospitals, it's slightly lower. We have a savings there that's been reflected in our year-to-date spend. Going forward, as we discontinue the divestiture program, we're going to see that go back up to the, I'd say, traditional levels, which has been around 4%.

We've also mentioned we've got 3 kind of hospital replacement projects or newer hospital. We got a new hospital, replacement hospital in La Porte, Indiana, that's underway. We've got a community hospital going in the Tucson market. And we just broke ground in Fort Wayne with a replacement hospital for St. Joseph's. That's not going to be as much spend in '19, but that should start picking up in 2020. And so some of the years where we've had, and we put this in our slide, more replacement hospital spend, I think we'll get closer to those trends.

One other item worth noticing in our IT spend, and I mentioned the cloud, that we're using more IT services on the cloud. When we do that, we spend generally less on IT, SWB. And we -- the cost of purchasing additional servers, maintaining that with patches and so forth and software decreases. So IT spend for IT CapEx has been down a little bit.

But I think those are probably going to be the major drivers as we look to 2020. And Tim, you want to talk about the inpatient/outpatient and where our spend has historically been and where it might be going?

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Tim L. Hingtgen, CHS/Community Health Systems, Inc. - President, COO & Director [13]

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Sure. That's a good point, Tom. Josh, to follow up on that, the outpatient CapEx spend is certainly ongoing. We like the access point deployment strategy, as I've referenced a few moments ago. Obviously, in most cases, that's a lower investment expense versus some of the larger acute care investments. We've also had good investments in service line strategy. When we recruit the neurosurgeons, orthopedic surgeons, robotic technology, all those items are coming out of that CapEx spend.

We do have great facilities, a lot of capacity to really take advantage of across the markets we serve where we don't have that capacity. We have expanded operating rooms. We've put on new beds. We're still really focused on making sure where there's a demand, we have the investments going into those markets to further grow our market share, our competitive position and our earnings.

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Operator [14]

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Your next question comes from Brian Tanquilut from Jefferies.

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Brian Gil Tanquilut, Jefferies LLC, Research Division - Equity Analyst [15]

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Congratulations on the quarter. My question for Tom. As I think about what Wayne was talking about, $200 million of expected divestiture procedures come up -- proceeds coming up, sorry, how are we thinking about redeploying that? Is that all going to go towards debt paydown? And what's the margin profile or EBITDA profile of those assets to be divested?

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Thomas J. Aaron, Community Health Systems, Inc. - Executive VP & CFO [16]

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So what we're looking at, Brian, is we look at this program we're under right now. We're talking about mid-single-digit overall. The hospitals that we complete in 2018 and so far in 2019 have been in the lower single digits. Many of those -- not many -- but several of those have been negative EBITDA even.

So the -- when you look at the proceeds to revenue, that's been fairly low on these. Some of the ones that we have to round out the program were going to be more in the single digits, closer to the mid or just above mid. And the proceeds as a relative to revenue should be increasing with those. So I think that's been the profile.

So far, it's very much to our advantage. When we divest those, we save on our free cash flow. Our EBITDA margins typically pick up. And as you've seen, we have had some benefit on our volume growth as well with struggling hospitals now sold with, in many cases, strategic buyers where they have other opportunities. So that has been what we've done up to this point, what we plan to do with the rest of the year.

On the proceeds, I mean it's really all fungible. We've got a lot of liquidity. We've got $200 million cash on the balance sheet. We've got about $235 million in untapped revolver. We've got ABL capacity, $500 million of first lien capacity and the divestiture proceeds. So we put that together. We do see a better free cash flow second half of the year compared to the first. And so I think we'll just, at least, come in. We'll just have to look at the most appropriate use to determine exactly what we do with those.

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Operator [17]

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Your next question comes from Ralph Giacobbe from Citigroup.

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Ralph Giacobbe, Citigroup Inc, Research Division - Director [18]

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You had consolidated margin, up 70 basis points with same facility margin down 60 bps on a strong 4.9% revenue. I was hoping you can reconcile that for us.

And then you did talk about sort of a better second half. I was hoping you could just help on the visibility there. You certainly called out the savings around, I think, the supply expense. Maybe a little bit more in terms of actual numbers around those savings around national contracting.

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Thomas J. Aaron, Community Health Systems, Inc. - Executive VP & CFO [19]

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All right. Thanks, Ralph. So on the same-store versus consolidated, I think on the same-store, I think the SWB and the supplies are pretty straightforward. That same-store, I think, works pretty well looking at that as well as consolidated.

The other operating expenses sometimes gets clunky with allocations that we have to recreate the allocations from -- especially when we're in a divestiture mode. We also look at consolidated on that. We think that matters quite a bit. With that being said, we still think we have lots of opportunities in that area to improve other operating expenses.

Just one of the few things that are moving in that space with -- especially look at this quarter, we have the malpractice charge that's included. We also had a note write-off that's included in those. We have had, as we called out, more IT subscription fees as we've gone to cloud. But again, consolidated is still an appropriate way to look at those as well, and we do feel like we're improving our ability to start taking that down.

As we look towards the second half of the year, so just some of the items that Tim raised, on the supply chain, he mentioned that 3 of those categories going into the third quarter now fully in place with physician-preference items. That's really important especially as -- with our service line focus. We expand procedures there, high-cost procedures, and we've got better contracting.

Tim also mentioned we're going to roll that out to purchased service categories. So we're already underway with that. We've contracted some, but there's a lot of work to do on those to not only get the benefit of national contracting but also get arrangements where we can adjust the arrangement through the divesture program. That's really important for us.

And then just more broadly looking, we think on the -- from our benefits standpoint, without really impacting the impact on our employees, but things like dependent verification, other sorts of things, new -- looking at PBM strategies and new PBM strategies that we can have improvements there, that, that will likely be first of 2020. But we think those are going to be consequential.

And then more broadly, we've talked in prior quarters about -- we've gone from a division structure to more of a regional. And I think Tim can speak to how we have opportunities to expand that.

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Tim L. Hingtgen, CHS/Community Health Systems, Inc. - President, COO & Director [20]

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Sure. Thanks, Tom. In terms of our opportunities on the regional model, looking at how we build out stronger networks where we have hospitals in closer geography, we believe there is an opportunity to put targeted resources, gain those efficiencies on those targeted resources, whether it be on the top line or the expense line, improvement opportunities we see out there, again, putting the same standardized centralized playbook to work but on more of a regional model for the company.

The other thing I would point out in terms of improving our leverage on the improved volumes, we've invested heavily on a year-to-date basis on medical staff development, physician recruitment, physician practices. And we do see the contribution of those investments having some room left to move to improve margin as we move forward, get more efficient on those practice ramp-ups, also looking at opportunities where we can gain synergies across our physician practices, leveraging some of the same resources within a market to drive better efficiencies. So all those things together, we believe, will help us drive improved leverage going forward.

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Thomas J. Aaron, Community Health Systems, Inc. - Executive VP & CFO [21]

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And then Ralph, I'll just add that for the second half of 2019, like we said, we're locked in on a few supply categories that are going to be helping. We're going to be adding more of those. A lot of the items that -- a lot of these supplies will be still showing up as improvements in Q1, Q2 of 2020. And I think a lot of the other purchased services and regionalization opportunities Tim mentioned, I think will be fully in place by then. So this is something that it's going to be a continuous practice for us, but we do think we have a lot of opportunities with what's been identified.

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Operator [22]

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Your next question comes from Gary Taylor from JPMorgan.

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Anthony Husni Makdessi, JP Morgan Chase & Co, Research Division - Research Analyst [23]

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This is Anthony Makdessi on for Gary. Just one quick clarification, looking about the $70 million add-back for the med mal. I know you had cited that most of it is related to prior years and prior divested hospitals. Any sense of the breakdown of that $70 million would be helpful. And then a real question is kind of how you guys are thinking about the 2022 [maturity] to this point. I know it's still a ways away, but it's definitely a big payment that's coming up.

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Thomas J. Aaron, Community Health Systems, Inc. - Executive VP & CFO [24]

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So Anthony, on the malpractice, we regularly -- it's a major estimate that we've had, and other peer companies have on the malpractice accruals. So we look at activity with respect to paid losses and individual case reserves that we're setting up on those. So based on the observations that we had that occurred during 2019 and we studied that with actuarial help, we identified areas. These are primarily for data loss prior to 2016. So these are older claims in the development, and they just happen to be -- many of those are divested hospitals. And they're also -- many of those relate to more difficult venues that we are -- in many cases, we're out of or we have significantly limited our exposure. And then certain service lines in that as well are ones that we've also trimmed down our exposures to those.

So again, those were primarily in older years. And you might have picked up on the comment I made, if you exclude that charge that we carved out, our malpractice outside of that, we still increase similar to how we've done in the first couple of quarters here just based on experience and be reflective of some of our more recent years.

With respect to the 2022, our -- as you can tell from our comments today and our responses, we are -- we're laser focused on getting the operational improvements in place, finishing the divestitures, growing our business and our same store. And we think that, that is the best way to put ourselves in optimal position when it's the appropriate time to deal with the 2022s.

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Operator [25]

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

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Bradley Thomas Bowers, BofA Merrill Lynch, Research Division - Research Analyst [26]

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Yes. This is Brad Bowers on for Kevin. I appreciate the color on the Q3 divestitures of about $200 million. That still leaves about $500 million, $550 million left in the divestiture program. So I was wondering if you could give some color on the timing of that and if that's where you think your portfolio would shake out after that $500 million, $550 million or if you'd think that there would be opportunities to divest even more after that.

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Wayne T. Smith, Community Health Systems, Inc. - Chairman & CEO [27]

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So just in terms of where we think we are in terms of divestitures, we're coming to an end in terms of our divestiture program. We've done really well. We've got great prices. As you can tell, it's been very helpful to our operations and our volume. But that program is coming to an end, and we will announce the end of it here in the relatively near future.

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Thomas J. Aaron, Community Health Systems, Inc. - Executive VP & CFO [28]

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And then just, Brad, on the timing, as I mentioned before, these are likely going to be better-margin hospitals and what we've divested before. It's going to -- that will drive better proceeds. And I think this is probably looking like we should see some activity in the third quarter as far as announcing definitive agreements likely closing some time maybe later in the fourth quarter by the time we wrap up.

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Operator [29]

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Your next question comes from Stephen Tanal from Goldman Sachs.

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Stephen Vartan Tanal, Goldman Sachs Group Inc., Research Division - Equity Analyst [30]

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Maybe just to follow up on that. So it sounds like, Wayne, you were pretty clear about having divested hospitals of about $1.5 billion of revenue through 2Q. And then the hospitals that you guys expect to close in 3Q, since the Medicare cost report, it would suggest it's north of $500 million. So it seems like the program is probably done with this quarter, at least the $2 billion, and I guess you framed gross proceeds as being $750 million. So just trying to really understand that versus the $1.3 billion. Maybe there's more hospitals that you just mentioned sort of closing at 4Q that got you there, could understand that.

And then just one question on sort of the operating numbers. I guess I'm just not clear why you're all lowering cash flow guidance. First, that seemed okay. I get there are some favorable items that maybe were a little unusual. But anything to note on the back half just from a cash generation perspective?

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Thomas J. Aaron, Community Health Systems, Inc. - Executive VP & CFO [31]

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Yes. So Steve, just on that latter question there, the cash flow, it's really with respect to the increased activities on payments on professional liability claims that we've seen so far in 2019. And adjusting for that, there's not really other material changes other than that. So that's the -- on that question.

The other piece on the -- with respect to the divestitures, as we get into the higher-margin hospitals, those are going to drive higher proceeds from us. Generally, this -- we saw this in 2017 and '18 and '19 so far. The hospitals with the lower margins, especially with strategic buyers, were getting astronomical multiples on those. Imagine negative EBITDA hospitals that we're getting proceeds on, the math on that. So -- and generally, what we see as you increase the EBITDA margins on the sold assets, those EBITDA multiples come down to what you're normally might see around the 10x plus or minus. And so I -- when we talk about the remaining portfolio, I think we're going to see more assets, better -- slightly higher margins that's going to drive the multiples at a more -- the reasonable range of what we've seen in the last 1.5 years.

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Operator [32]

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I will now turn the call back over to CHS for closing comments.

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Wayne T. Smith, Community Health Systems, Inc. - Chairman & CEO [33]

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Thank you for spending time with us this morning. We, as we outlined on today's call, we're very encouraged with all the progress during the first of 2019 first half. Moving forward, we're focused on continued execution on the strategies we discussed today's call, and we're looking forward to a strong back half of 2019.

We want to specifically thank our management team and staff, hospital chief executive officers, hospital chief financial officers, chief nursing officers, division operators for their continued focus on operating performance and quality.

This concludes our call today. We look forward to updating you on all of our progress later in the year. Once again, if you have any questions, you can always reach us, area code (615) 465-7000. Thank you.

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Operator [34]

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