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Edited Transcript of CYH earnings conference call or presentation 2-Aug-17 3:00pm GMT

Thomson Reuters StreetEvents

Q2 2017 Community Health Systems Inc Earnings Call

FRANKLIN Aug 12, 2017 (Thomson StreetEvents) -- Edited Transcript of Community Health Systems Inc earnings conference call or presentation Wednesday, August 2, 2017 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. - Senior Director of IR

* Thomas J. Aaron

Community Health Systems, Inc. - CFO and EVP

* Tim L. Hingtgen

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

* Wayne T. Smith

Community Health Systems, Inc. - Chairman and CEO

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Conference Call Participants

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* Albert J. Rice

UBS Investment Bank, Research Division - MD and Equity Research Analyst, Healthcare Facilities

* Anagha A. Gupte

Leerink Partners LLC, Research Division - MD, Healthcare Services and Senior Research Analyst

* Brian Gil Tanquilut

Jefferies LLC, Research Division - Equity Analyst

* Christian Douglas Rigg

Deutsche Bank AG, Research Division - Research Analyst

* Frank George Morgan

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

* Gary Paul Taylor

JP Morgan Chase & Co, Research Division - Analyst

* Kevin Mark Fischbeck

BofA Merrill Lynch, Research Division - MD in Equity Research

* Ralph Giacobbe

Citigroup Inc, Research Division - Director

* Sarah Elizabeth James

Piper Jaffray Companies, Research Division - Senior Research Analyst

* Stephen C. Baxter

Wolfe Research, LLC - Research 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 Second Quarter 2017 Conference Call. (Operator Instructions)

I will now turn the call over to Ross Comeaux, Vice President of Investor Relations. You may begin your conference.

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Ross W. Comeaux, Community Health Systems, Inc. - Senior Director of IR [2]

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Thank you, Mike. Good morning, and welcome to Community Health Systems' second quarter conference call. Before we begin the call, I'd like to read the following disclosure statement. This conference call may contain certain forward-looking statements, including all statements that do not relate solely to historical or current facts. These forward-looking statements are subject to a number of known and unknown risks, which are described in headings such as Risk Factors in our Annual Report 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 live broadcast of this conference call, a supplemental slide presentation has been posted to our website. We will be referring to those slides during this earnings call.

As a reminder, our discussion of our results excludes Quorum Health Corporation, the joint venture in Las Vegas that was sold to Universal Health Services, the company's home care division and the 11 hospitals divested in May. All calculations we will discuss also exclude discontinued operations, loss from early extinguishment of debt, impairment as well as gains or losses on the sale of businesses, expenses incurred related to divestitures, gain on sales of investments and unconsolidated affiliates, expenses related to government and other legal settlements and related costs, expenses related to employee termination costs and other restructuring charges, expense from fair value adjustments to the CVR agreement liability related to the HMA legal proceedings and related legal expenses. Included in our discussion of our results are the sale transactions that we closed effective June 30 and July 1.

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 and CEO [3]

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Thank you, Ross. And good morning, and welcome to our second quarter conference call. Tim Hingtgen, our President and Chief Operating Officer, is with me on the call today, along with Tom Aaron, our Executive Vice President and Chief Financial Officer.

For today's call, I'll provide some comments on our business, and then I'll talk about our outlook for the remainder of the year. After that, I will turn the call over to Tim, who will provide some additional detail around our operations. And then Tom will provide some more color on our second quarter financial results.

Overall, we were obviously not satisfied with our performance during the second quarter, as the quarter came in below our internal forecast. The biggest difference between our expectations and our second quarter results was volume, which drove lower-than-expected revenue. Tim and Tom will discuss more of the specifics of the quarter later in the call.

There were, however, a number of positives during the quarter. First, our cash flow from operations remained solid. Despite our second quarter EBITDA coming in lower than our forecast and below our first quarter 2017 performance, our cash flow from operations increased 8% sequentially to $261 million or 52% of EBITDA, which is consistent with our -- with prior years. And we expect to continue to deliver strong cash flow from operations into the back half of 2017.

Second, while some of our markets performed below our expectations, there were a number of our markets which we experienced solid year-over-year EBITDA growth. Our Grandview Hospital in Birmingham as well as our entire Northern Alabama network continues to perform well. Also, our Northwest health care network, which includes Tucson, Arizona and our Northwest health system network in Northwest Arkansas both had strong quarters. And there were another -- other examples of solid performance across our portfolio in other markets and individual hospitals, including improvement in a number of hospitals with solid performance in the state of Florida.

Third, we made progress in Fort Wayne. As you may have seen in the recent media reports, we have made leadership changes in that market, and we've committed additional capital and have started a number of new capital projects that will further strengthen the Lutheran hospitals moving forward. Despite recent changes in the market, we continue to experience good volume and revenue growth year-over-year at Lutheran Hospital and stable EBITDA performance.

Fort Wayne is another example of a strong market in our portfolio, and Lutheran Health Network is a great health care system. We're working on strategic ways to grow market share and continue -- and we continue to see good opportunity to expand access points in health services. The Lutheran team has a long history of delivering quality care for their patients and the community. And we continue to focus on quality improvements, patient experience and physician relationships.

Now I'd like to provide an update on our divestiture plan. As you're aware, we have announced plans to shift our portfolio to a smaller group of hospitals that are better positioned in their respective markets, with better demographics and volume growth, higher EBITDA margin and improved cash flow generation profile. This will also allow us to direct future investments in corporate resources to our most active -- attractive markets in regional networks, which should drive higher returns on invested capital.

On Page 8 of our supplemental slides, we've also included some key highlights on our divestiture plan. Since our last earnings call on May 2, we have announced the close of a number of transaction as well as definitive agreements. In addition to the 20 hospitals that we've closed to date, we also have 10 hospitals under definitive agreements.

Since our last earnings call, we announced definitive agreements to sell 103-bed Weatherford Regional Medical Center in Weatherford, Texas and 126-bed Highlands Regional Medical Center in Sebring, Florida to HCA. Adding up total hospital divestiture plan with 30 divestitures account for approximately $3.4 billion of annual revenues and mid-single-digit EBITDA margin.

Estimated gross proceeds from these divestitures, including working capital, are projected to generate approximately $1.95 billion. The multiple from our 30-hospital divestiture plan, including working capital, is 12x EBITDA, and we expect the transaction for these hospitals to close at the end of the third quarter.

As a sidelight, divestitures require huge amount of internal resources to effectively transition facilities to new owners. We're pleased with the progress we're making with our divestiture strategy, and we -- as we transition our portfolio to a smaller number of core markets.

As we mentioned, we continue to receive inbound inquiries from a number of parties interested in our assets. Last week, we disclosed that we're expanding our divestiture program. In addition to the 30 hospitals divestiture program, we're now pursuing the sale of transactions for hospitals accounting for at least $1.5 billion of net revenue and mid-single-digit EBITDA margins.

We continue to provide -- we will continue to provide updates as these transactions progress. The objective, as we have said before, is to have a portfolio of sustainable hospitals in growth markets and to reduce our debt to -- by 2018.

Before I move to guidance, I want to highlight some of the success we're seeing on the quality side. Quality remains a key strategic focus of our company, and we're continuing to see improvements under the leadership of Dr. Lynn Simon and her team. As it relates to CMS, hospital-acquired condition reduction program, we've seen a year-over-year decrease in HAC advanced since inception and have outperformed the national average each year.

Now I'd like to talk about full year 2017 guidance, and Tom will provide more detail later on the call. Our guidance includes the following: net revenues -- our operating revenue is expected -- divestitures are anticipated to be -- excluding divestitures, are anticipated to be $15.85 billion to $16.05 billion. Same-store hospital adjusted admissions is anticipated to decline 2%, down to 1%. Adjusted EBITDA is anticipated to be $1.825 billion to $2 billion. Income from operations per share is anticipated to be a negative $0.30 to a positive $0.40.

As it relates to our pending HMA legal matters, there has been no material change for several quarters. We continue to revalue the estimate liabilities covered by the CVR on a quarterly basis. Our current estimate, including probable legal fees, continues to reflect there will be no payment to CVR holders

Tim will now provide some comments on our operations, and then Tom will discuss our financials in more detail.

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

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Thank you, Wayne. As Wayne mentioned, we were not satisfied with our performance and results. And while we are confident that we're putting our strategies in place to enhance quality and patient satisfaction and drive better core hospital growth, our second quarter results came in below our expectations.

Starting on the volume side. We received reports from several markets that the environment in general was softer in the second quarter, based upon feedback from providers, other health care services and, in some cases, competitors. This was not across the portfolio but instead in select markets such as in the state of Tennessee.

On the flip side, our adjusted admissions performance in Florida was above our corporate average for the second consecutive quarter. So we're pleased with the progress we're seeing in a number of hospitals in Florida on both the admission and surgery front. We're seeing solid execution of our market-specific growth plans in the state, which are driven by strategic investments in both capital and medical staff development.

Across the portfolio, we are continuing to execute on broader strategies to drive better volume growth across our 4 hospital markets. We remain focused on our access point expansion strategy, with a solid development pipeline heading into 2018 which includes 13 freestanding ADEs, over 40 urgent and walking care centers and 9 ASC projects.

Additionally, we have been introducing a number of initiatives across our physician practices that we expect will improve our volume performance moving forward. Another goal, for example, has been targeted work with our affiliated primary care practices in a number of markets, focused on standardizing our scheduling templates and processes. These efforts have created incremental capacity and resulted in an overall lift in clinic volumes in our initial pilot markets. We've been expanding this to all of our primary care practice locations, and in the third quarter, we are scheduled to complete this rollout, which enabled growth in our employee practices into the second half of the year. We expect to implement the same framework on our specialist practices in the near future.

Standardizing these scheduling templates is a necessary precursor to the introduction of centralized scheduling, which we have now successfully launched in a number of markets. This consumer-focused initiative, which includes both telephonic and online scheduling functionality for our patients, has yielded improved volumes following each market's launch. Based upon these results, we have accelerated our rollout plan to add more sites in the back half of 2017. We intend to implement this functionality in both our larger and smaller markets, where we have a considerable number of employed primary care providers and specialists.

Another growth-focused area of investment is in our transfer center program or the management of inbound referrals to our hospitals and their EDs from both affiliated and nonaffiliated hospitals in a particular region. At present, in most of our markets, the call center phone lines are outsourced to contracted partners who specialize in this service. We are now in the process of migrating select markets to an in-house operation center to better leverage the size and scale of CHS.

We believe this transition to internal operations has multiple advantages. First, it will provide more real-time visibility into daily ED, bed management and case management operations at our affiliated facilities. It will also provide us improved data that will amplify our service line development strategies and related volume growth opportunities. And as important, the internal operations should improve the service to, and satisfaction of, the referring facilities and, in the end, better meet the patient needs within the markets we serve. Our first market transitions to our in-house service center is this month, and we will continue to migrate additional markets in the back half of the year.

Finally, I would like to provide a quick update on our high-opportunity hospital initiative. As a reminder, we started this framework in the fourth quarter of last year, where we identified an initial 15 hospitals that have historically operated at a higher EBITDA margin but had experienced some EBITDA decline in 2016. Following our initial in-depth operational assessment and focused strategic planning, we are seeing good results following execution of the resulting plans. On a year-to-date basis, we have seen EBITDA improve at 10 of these focus hospitals, and the group has seen positive year-over-year EBITDA growth.

On the expense side, we are continuing to build out our data analytics capabilities and reporting systems across the organization. These data and reporting tools have allowed our division operators to work with local market leaders on a more real-time basis so that costs are better managed in line with the individual hospital's current volume and revenue trends. We did see progress in the SWB line during the second quarter, and we are building out the same capability to help further improve our supply costs moving forward. We expect to see continued improvement on those 2 expense lines in particular from these efforts.

So in summary, we were not satisfied with our second quarter performance, but we see a number of opportunities to help drive both revenue growth and EBITDA margin improvement as we move forward.

And now let's turn it over to Tom.

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Thomas J. Aaron, Community Health Systems, Inc. - CFO and EVP [5]

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Thanks, Tim. As we've mentioned, our adjusted admission volumes were weaker than we anticipated, which had a negative flow-through to our EBITDA line. Adjusted EBITDA of $435 million was below our expectations. We did make some progress on our expenses during the second quarter but still see additional opportunities to improve our costs moving forward.

Now I will discuss the results of the second quarter. As a reminder, calculations discussed on this call exclude items Ross mentioned earlier and include the divestiture transactions that closed at the end of Q2.

On a same-store basis for the quarter, we noted the following. On a comparative second quarter 2017 versus 2016 basis, net revenues decreased $30 million or 0.7%. This was comprised of a 1.8% increase in net revenue per adjusted admissions and a 2.5% decrease in volume for adjusted admissions.

Our in-patient admissions declined 2.5%. Our ER visits were down 1.8%. Our surgeries were down 2.4%. During the second quarter, approximately 70% of our admissions decline was due from decreased OB volumes and increased observation days. The balance was primarily from decreased readmissions, in-patient surgeries and admissions related to the discontinuation of certain service lines, such as SNF.

In the second quarter, we recognized a BP revenue settlement of approximately $5 million. Looking out at the remainder of the year, we're not expecting material BP settlements in either the third quarter or the fourth quarters. Our net outpatient revenues before the provision for bad debts represents 56% of our revenues.

Consolidated revenue payer mix for the second quarter of 2017 compared to the second quarter of 2016 shows managed care and other increased 100 basis points, Medicare decreased 140 basis points, Medicaid increased 60 basis points and self-pay decreased 20 basis points. On a same-store basis, managed care and other increased 40 basis points, Medicare decreased 60 basis points, Medicaid increased 90 basis points and self-pay decreased 70 basis points. As a reminder, we include Medicare Advantage in our managed care and other accounts.

Consolidated uncompensated care, or care plus self-pay discounts plus bad debt expense, for the 3 months comparative periods has increased from 26.2% to 29% of adjusted net revenue, a 280-basis-point increase. Same-store increased from 27% to 29%, a 200 basis point increase.

Looking at our uncompensated care in the quarter, we experienced an increase due, in part, to the increases in self-pay volumes, patient co-pays and deductibles, increases in self-pay discounts as a percentage of net revenue and the self-serve hospitals that have lower bad debt as a percent of revenue.

For the second quarter, our bad debt as a percentage of net revenue before bad debt was up 90 basis points to 14.1% on a consolidated basis and was up 40 basis points same-store. It's worth noting that our 30 announced divestitures have a lower bad debt expense than our total corporate average, so the sale of these hospitals will cause some upward year-over-year movement on our consolidated bad debt expense line in the back half of 2017.

For the same-store expense items in the second quarter of 2017 compared to the second quarter of 2016, our salaries and benefits as a percentage of net operating revenues decreased approximately 10 basis points. The decrease was driven by hospitals' use of labor data that Tim just talked about as well as lower employee benefit expense.

Supplies expense as a percentage of net operating revenues for same-stores was flat. Increased implant costs were offset by savings in other supply areas.

We've made some progress on our salaries, wages and benefit and supply expense lines, but we see opportunities to reduce costs in both areas through the continuation of our focused initiative.

It's also worth noting that since 2015, despite a number of divestitures, our corporate costs have been reduced as a percentage of total net revenue.

Other operating expenses as a percentage of net operating revenue for same stores increased 180 basis points. Increases in the second quarter of 2017 -- I'm sorry, in the second quarter of 2017 were driven by a combination of higher medical specialist fees, certain purchase services, information systems expense, business taxes and malpractice insurance.

Our other operating expense line came in above expectations during the second quarter. We're working to better control this expense line item in the second half of the year.

In terms of our total operating spend, our same-store operating expenses were up 1.3% in the second quarter and 2.1% year-to-date. We expect our consolidated operating expense performance to improve as the company continues to execute on its 30-hospital divestiture plan. The divested hospitals' EBITDA contributions in Q1 and Q2 of 2017 were approximately $30 million and $15 million, respectively. The 10 remaining to-be-divested hospitals are not expected to contribute any Q3 2017 EBITDA.

Switching to cash flow. Our cash flows provided by operations were $261 million for the second quarter of 2017. This compares to cash flow from operations of $338 million during the second quarter of 2016. For the 6 months of 2017, our cash flows provided by operations were $503 million compared to $632 million.

Year-to-date, cash flow from operations declined year-over-year due to a few items. Cash flows attributable to divestitures was approximately $25 million. Reduction of timing of payments for payroll negatively impacted cash flows by approximately $135 million. The decrease in cash received from HITECH was roughly a $60 million reduction. Improvement in A/R days more than offset the changes in third-party settlements. Combined this, it was roughly a $150 million benefit to cash flow. Other decreases, including working capital changes, reduced cash flow by approximately $95 million.

Turning to CapEx. Our CapEx for the second quarter of 2017 was $128 million or 3.1% of our net revenue. Year-to-date, our CapEx is $274 million or 3.3% of net revenue compared to $407 million or 4.3% of net revenue through the first 6 months of 2016. The lower CapEx has been due to limited replacement hospital spending and more targeted CapEx, focused on our high-return core hospitals. Our CapEx is also being targeted towards additional access points that Tim mentioned, such as freestanding EDs and urgent care centers as well as service line buildout around cardiology, orthopedics and other high-acuity areas.

Moving to the balance sheet. At the end of the second quarter, we had approximately $14.7 billion of long-term debt, which is down approximately $100 million since the start of the year and approximately $1.9 billion from the end of 2015. We also had over $700 million of cash on the balance sheet at June 30. And as a reminder, we divested a number of hospitals after the close of our second quarter. So it's worth noting that we used a portion of those proceeds to pay down term loan debt in early July.

On Slide 17, we provided an update of our debt maturities as of July 7, which totaled approximately $14.25 billion of long-term debt.

With respect to our 20 closed hospitals, today, buyers have paid us $1.147 billion, of which we have used $951 million to pay down term loans.

As Wayne walked through earlier, we're pleased with the progress we're making with our 30-hospital divestiture plan. Our current divestiture plan is expected to generate approximately $1.95 billion of proceeds, with an estimated 10% of those proceeds coming from retained working capital.

The tax leakage from these divestitures is expected to be approximately 5%. We expect this current group of transactions to close during the third quarter of 2017, and these proceeds will be used to further -- for further debt reduction. And as Wayne mentioned, in response to continued interest in our hospitals, we recently expanded our divestiture program.

Beyond our announced 30, we're pursuing additional divestiture transactions for hospitals accounting for at least $1.5 billion net revenue and mid-single digit EBITDA margins. These proceeds will primarily be used to lower our debt.

On May 12, we completed a tack-on offering for $900 million of 6.25% senior secured notes due 2023 at an issue price of 101.75%. Net proceeds of the tack-on offering were used to prepay and fully extinguish our $700 million Term Loan A facility that was due January 2019. The only near-term debt maturities prior to 2019 is our $600 million accounts receivable facility that's due in November 2018, and we have renewed this several times in the past.

In terms of our bank covenants, our maximum senior secured net leverage ratio is 4.5x through December 31, 2019, and our minimum interest coverage ratio is 1.75 through the end of 2017, which will increase to 2.0 thereafter. We were in compliance with both covenants on June 30, 2017, with a secured net leverage ratio of 3.82 and an interest coverage ratio of 2.36. As of June 30, 2017, our EBITDA cushion on our secured net leverage ratio was 15%, and our EBITDA cushion on our interest coverage ratio was 26%.

For 2017, our full year guidance includes the following, and all amounts are adjusted for the timing of expected divestitures. Net operating revenues, less provision for doubtful accounts, are anticipated to be $15.85 billion to $16.05 billion. For full year 2017, our net revenue guidance was only slightly adjusted. While our adjusted admissions guidance range was lower, this was essentially offset by our 30 announced divestitures remaining in the portfolio slightly longer than anticipated. As a reminder, our 30 announced divestitures have an EBITDA margin that is well below our corporate average.

Adjusted EBITDA is anticipated to be $1.825 billion to $2.0 billion. Cash flow from operations is forecasted at $975 million to $1.125 billion. CapEx is expected to be $575 million to $725 million. HITECH is forecasted at $25 million to $30 million. Income from continuing operations per share is anticipated to be negative $0.30 to positive $0.40 based on weighted average diluted shares outstanding of 112 million to 113 million.

As we think about quarterly cadence for the back half of 2017, it's worth noting that the third quarter is typically our lowest quarter of the year in terms of revenue and EBITDA contribution. Also, we're expecting our remaining 10 divestitures that have not yet closed to be approximately breakeven from an EBITDA standpoint in the third quarter.

Wayne?

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

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At this point, we're ready to open up for questions. (Operator Instructions)

But as always, we're available to talk to you, and you can reach us at (615) 465-7000. Okay. Mike?

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Questions and Answers

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Operator [1]

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(Operator Instructions) The first question is from A.J. Rice from UBS.

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Albert J. Rice, UBS Investment Bank, Research Division - MD and Equity Research Analyst, Healthcare Facilities [2]

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I guess, it's a single question with 2 parts to it related to the divestiture program. Obviously, a lot of detail, Tom. It sounds like the divested assets in many ways underperformed the core business you're moving forward with. I guess, some of that could be because they were identified as divestitures, and people just took the eye off the ball. I guess, I would ask, how do you -- on this like $1.5 billion additional that you're looking at, how do you make sure, given that those aren't identified, that the entire portfolio doesn't sort of get distracted by whether or not they're part of the divestitures? How are you guys managing that? And then the other aspect of the divestiture question was, I know you're looking for a turnaround in operations, and you're balancing that against the divestiture program. Do you have in the back of your mind, where you were trying to get to with the financial metric whether it's debt-to-EBITDA or some other metric? And when you get to that, then you feel like, "Hey, I'm -- we're out of the woods. We can go forward from here with this level of leverage or this level of debt."

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

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So A.J., this is Wayne. In terms of the process for divestitures, we're much better today than we have been. This 30 has consumed a lot of time and effort and resources, but we've basically finished the 30. And -- but the next group, certainly, will not be that large. So it shouldn't be as big of a distraction as the 30 have been going forward. But we're getting outstanding prices for these facilities. It will ultimately help us end up where we want to go when it's all said and done. I don't know what that number might be, but I think what we think is that we will certainly improve our margins, improve our cash flow, get our debt-to-cap, to -- Tom?

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Thomas J. Aaron, Community Health Systems, Inc. - CFO and EVP [4]

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We're going to -- shooting to get below 6x, A.J., and then...

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Wayne T. Smith, Community Health Systems, Inc. - Chairman and CEO [5]

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In 2018. So I think we're on the right track. All the metrics, we've modeled those several times. All of our metrics look like the right idea. Good news is we're getting some performance out of Florida now, which we had not had before. We have a lot of outstanding markets. And as we continue to divest these low-margin hospitals and all of it this next round, which we believe we will continue to get very good rates on, it will be very helpful as well. You want to continue?

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Thomas J. Aaron, Community Health Systems, Inc. - CFO and EVP [6]

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I would say, A.J., the -- some of the fall-off there, when there's a longer delay between an announced and the closing, that's just a longer period of uncertainty. A lot of these hospitals are great assets. And I heard Sam Hazen talk last week about when he brings Tomball into their market that the margin is going to get up to their market margins. And we feel our buyers are going to achieve the same on these hospitals once they plug them in into their markets.

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Wayne T. Smith, Community Health Systems, Inc. - Chairman and CEO [7]

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And into their rate structure, which is [great].

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Operator [8]

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The next question is from Brian Tanquilut from Jefferies.

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Brian Gil Tanquilut, Jefferies LLC, Research Division - Equity Analyst [9]

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Wayne, just following up on your comments on the divestitures. I think, last quarter, you basically said we're kind of trying to shift more towards operation and execution rather than the divestiture focus. So -- and you've announced or discussed that you have $1.5 billion of revenue that you've got (inaudible), So what is your openness to selling bigger regions versus just being opportunistic and looking at one-off deals at this point?

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Wayne T. Smith, Community Health Systems, Inc. - Chairman and CEO [10]

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Well, I should probably note, very few of these are one-off deals. A lot of combined deals with a number of people. But we're trying to restructure this portfolio so that we get good properties in good markets and invest our capital, get good returns and get good growth. So we're being strategic about it, on how we think about our portfolio going forward. So far there hasn't been very many high-margin -- there hasn't been any high-margin hospitals to amount to anything (inaudible) and relatively low-margin hospitals once -- by and large, once it's all said and done. So I think that's the way that we're thinking about it. I'm not sure what the number is, but I can assure you that if you do the math on all this kind of going moving forward, it looks a lot better, and it's sustainable. And that's what we're trying to get to. So we can deploy our capital and go back into the growth mode sometime next year in terms of -- and you see from what Tim said, we are working hard on all of our operations. I don't know why we, nationwide, had a reduction in volume. I don't -- there's a lot of issues, a lot of reasons to think about in terms of a lot of different discussion about this. Everybody's got the same trend. But we're trying to buck that trend now. And particularly, we are doing it in a lot of good markets. And so we're excited about the opportunity, and we're not that far off in terms of turning the corner on all of this.

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Operator [11]

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Your next question is from Chris Rigg from Deutsche Bank.

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Christian Douglas Rigg, Deutsche Bank AG, Research Division - Research Analyst [12]

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I was just hoping to clarify some of the prepared comments on the contribution from the divested facilities. Were you -- did you say that the facility -- the 10 facilities that are not yet divested are expected to contribute 0 in the third quarter to EBITDA? Or did I hear you incorrectly?

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Thomas J. Aaron, Community Health Systems, Inc. - CFO and EVP [13]

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No, Chris. That was correct.

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Christian Douglas Rigg, Deutsche Bank AG, Research Division - Research Analyst [14]

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Okay. So does that mean if we sort of subtract the first half from the guidance, you get sort of an implied run rate of EBITDA core about $1.9 billion? Is that sort of fair, where you think you guys are on a pro forma basis at this point?

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Thomas J. Aaron, Community Health Systems, Inc. - CFO and EVP [15]

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Yes. I think if you utilize what I gave you on the contributions for Q1 and Q2 from all 30 of the divested hospitals, and then you take into consideration no contribution in the third quarter, that should give you a nice sequential start.

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Operator [16]

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Your next 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 [17]

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I guess, one other question I would have, just staying on that same subject. What do you think pro forma leverage will look like at year-end if you are successful with these new round of $1.5 billion of revenue of potential divestitures?

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Wayne T. Smith, Community Health Systems, Inc. - Chairman and CEO [18]

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It will take us more than 6 months for this next round. But there's some possibility that we might close a part of it by year-end, but it's probably into next year. Tom, you want to...

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Thomas J. Aaron, Community Health Systems, Inc. - CFO and EVP [19]

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Frank, we are -- we put that out just to give a heads-up to investors that we're continuing the process and that which would have been earlier than we had put out notice on these other 30. So we will update as we progress through those transactions, and we'll have a better feel for timing and so forth. But as Wayne said, right now, we're not anticipating anything by year-end. And we may be wrong on that, but we're not anticipating anything by year-end.

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Wayne T. Smith, Community Health Systems, Inc. - Chairman and CEO [20]

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But I can assure you, there's a lot of interest in the facilities that we talked -- that we have identified.

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Frank George Morgan, RBC Capital Markets, LLC, Research Division - MD of Healthcare Services Equity Research [21]

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Got you. And just as a follow-up there, in terms of just going back to Chris' question, the exit -- the year-end exit rate of EBITDA for the company, if you took the guidance that you updated today and then subtracted out those contributions in the first and second quarter, that effectively gets you to what the exit run rate at the end of the year would be for the company with these pending divestitures. Is that right?

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Thomas J. Aaron, Community Health Systems, Inc. - CFO and EVP [22]

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Right. From an EBITDA standpoint. That's correct, Frank.

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Operator [23]

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Your next question is from Ralph Giacobbe from Citi.

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Ralph Giacobbe, Citigroup Inc, Research Division - Director [24]

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So just -- you divested and bumped up, I guess, the additional divestitures. It referenced sort of roughly $5 billion of revenue. With all those assets at kind of mid-single-digit margins off the 2016 base, that's almost 30% of your revenue base, it would imply kind of a mid-teens margin on the nondivested piece. I guess, first, is that fair? And then just given the pressures that you've seen, can you give us a sense of what do you think the sustainable margin profile of whatever the existing hospitals you expect to retain will be?

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Thomas J. Aaron, Community Health Systems, Inc. - CFO and EVP [25]

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Yes. I think that what we put out before on the impact of the divestitures, we were using 2016 data. And looking at that, we had 170 basis points pickup from those divestitures. When we updated that for Q1 and Q2, it looks like about a 200 basis points improvement off the 2016 trailing 12 months. The only thing I would add there is, obviously, with this quarter, the results or operating performance consolidated has slipped. So when you talk about what you're going to improve off of that number was a little bit lower. So I think some of the initiatives, you can adjust for that for the 2017 performance, but then that's the lift coming at about 200 basis points from the 30 hospital divestitures.

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Operator [26]

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The next question is from Sarah James from Piper Jaffray.

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Sarah Elizabeth James, Piper Jaffray Companies, Research Division - Senior Research Analyst [27]

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It looks like same-store surgeries and ER visits decelerated in the second quarter. Can you talk about the drivers? And specifically, your peers have spoken to pressure on low-acuity volume. So I wanted to understand if community was seeing this pressure or if there is another driver.

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Tim L. Hingtgen, CHS/Community Health Systems, Inc. - President, COO & Director [28]

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Sure, this is Tim Hingtgen. I'll take that one. I'll start with the ED decline, and 90% of our ED volume decline was on the outpatient side, largely attributable to some of the industry dynamics, including urgent care growth, freestanding ED competition in select markets. Again, it was not across the board but in select markets. Also, from an in-patient admissions decline standpoint, that does correlate strongly with our observation increase that we've talked about as a key contributor to the admission decline in the second quarter. So for us, the strategies to combat that, obviously, as I said, are to build more access points, make sure we've got the right primary care basin in the markets to support the primary care needs of these patients. And then also, the transfer centers and service lines strategies that we've been working on for several quarters are certainly showing benefit in many of our core markets. We do extend that into those that are showing some of the softening. From a surgery standpoint, again, the majority of that is also on the outpatient side, about 80% of the decline. And more of that was attributable than we had expected in the divestiture markets. About 20% of the drop was in markets that are leaving the portfolio. We have had some ASC competition from non-joint venture, but also we've had some strategic decisions that we've made to invest in ASCs in core markets, which had moved some of the business out of the hospital operating environment into a nonconsolidating JV ASC. But we think that's the right thing for us to do in a long-term relative to where care is migrating. And then in select markets, we also had some decreases in GI and pain management procedures. Not necessarily in the highest revenue book of business, but losing 1 or 2 providers in a market can certainly drive up that debt comp relatively quickly. And then in some cases, we also had elective service lines discontinuations following a portfolio margin review of certain hospitals. So we think those are, frankly, good volume declines. Unfortunately, the volume declines in the second quarter certainly were greater than the number of hospitals that posted some pretty considerable volume increases. Wayne mentioned Grandview. We have a long list of core markets that had double-digit surgery increases with the successful recruitment and development of service lines that just got muddied out by the declines in some of those other markets.

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Operator [29]

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Your next question is from Gary Taylor from JPMorgan.

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Gary Paul Taylor, JP Morgan Chase & Co, Research Division - Analyst [30]

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I wanted to think about the potential impact of operating leverage as you divest those revenues heading into '18. And I was hoping you can give us some information on total annual corporate overhead and then how much you specifically look to bring that down in 2018. And then the final part of the question is, I believe, from Quorum's disclosure, they're paying about $16 million a quarter transition services, shared services support, et cetera, mostly under a 5-year agreement. So I wanted to make sure that those dollar amounts were pretty stable over that period, there weren't going to be any material contemplated changes in that revenue support for the corporate structure.

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Thomas J. Aaron, Community Health Systems, Inc. - CFO and EVP [31]

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Yes, Gary. So on that one, you're in the ballpark on QHC. We're not aware of any disruptions to that 5-year agreement. So that is correct. And secondly, on the annual corporate overhead, we are -- we're about right at 2%. And that is, as I mentioned earlier in my comments, that's actually declined as a percentage of net revenue. So we've done a lot of things with the QHC spin. That was about 200 corporate jobs that went with that. We've moved to shared service centers and become a lot more efficient on the revenue cycle in the HR area and other areas that we're looking at. So we'll continue to focus on that. We have moved our division structure for how we manage our hospitals down from 5 to 4, and that makes us more efficient. So we will continue like initiatives to make sure that we rightsize our corporate departments to the size of the company.

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Operator [32]

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The next question is from Ana Gupte from Leerink Partners.

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Anagha A. Gupte, Leerink Partners LLC, Research Division - MD, Healthcare Services and Senior Research Analyst [33]

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I just wanted to kind of -- you threw out a number of statistics on the payer mix and so on, along with your observation that 2Q has been somewhat of an inflection point in terms of worsening volumes. Can you talk about why you think that is beyond? Is it mostly peer pressure? Or is it mostly deductibles and consumers seeing the pressure on that, and so they're shying away from utilizing services? And it sounded like your Medicare volumes were down, but everything else, including MA, was up, which seems a little contradictory to some of what the other guys are saying.

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Tim L. Hingtgen, CHS/Community Health Systems, Inc. - President, COO & Director [34]

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Ana, this is Tim. I'll start off kind off addressing the observation question. I do want to point out, with the increase in observation, it was not widespread across the company. It was truly in a handful of markets that drove about 80% of the increase. And in those cases, it does seem as if the root cause was primarily payer pressure on the Medicare Advantage and, in some cases, the Medicaid managed lives in those select markets. So -- and in those cases, we're working very closely to make sure that if we don't have the same revenue differentials we do on an in-patient admission, that our cost structure is lining up with that new revenue reality. It's not necessarily material in every market. Where we do need to work on some contracting, we're in the throes of doing that as well.

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Thomas J. Aaron, Community Health Systems, Inc. - CFO and EVP [35]

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And then, Ana, just on the volumes, we provided, as you know, revenue by payer mix. When you look at it from a volume standpoint, overall Medicare was up, mostly in Medicare Advantage fee-for-service. Medicare was down. Self-pay was up. Medicaid was down. And managed care, which -- traditional manage care, which would include Blue Cross, was down for the quarter and 6 months.

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Operator [36]

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The next question is from Justin Lake from Wolfe Research.

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Stephen C. Baxter, Wolfe Research, LLC - Research Analyst [37]

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This is Steve Baxter on for Justin. I appreciate the commentary about the volume in your mind being the primary drag on results in the quarter. But margins were also clearly well below what The Street was expecting. Obviously, there's a lot going on with the divestitures. But I guess, can you give you some context around how margins in the quarter overall came in versus your expectations? And specifically -- go ahead.

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Tim L. Hingtgen, CHS/Community Health Systems, Inc. - President, COO & Director [38]

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Go ahead and finish your question.

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Stephen C. Baxter, Wolfe Research, LLC - Research Analyst [39]

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I was going to say specifically around the other OpEx line, which was up almost 200 basis points. Can you kind of break some of that out and provide some specificity? And then what's giving you confidence that's going to improve throughout the year?

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Thomas J. Aaron, Community Health Systems, Inc. - CFO and EVP [40]

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Will do. And Tim, chime in. But -- so looking at salaries, wages and benefits, we've been working hard at this for over 6 months. We feel like we got pretty good traction there on a same-store basis to get a decrease in that with decreased volumes. So felt good about that. We also felt very good because our hospitals did a great job by May of, really, getting a lot of that work done. So we had a very favorable June heading into third quarter, which we like. On the supply side, we had really good experience in the areas we're focused on, with the exception of implants. And that's partly due to our focus on the orthopedic that's driving some of that. But we know we can perform better on that supply line on the implants specifically. So we're going to go after that. Purchase services and others, one component of that are the medical specialist fees, which are hard to flex quickly when you have decreasing volume. But we are involved with getting into that and looking at how we use medical specialists and how we contract nationally for that. So we're focused on that. There were some other items in that. For example, what we pay in provider taxes is included in that. And as you know, what we put in, we get more than that out in the revenue side. So that was part of the increase. And then we had a very difficult comp on some other expenses there that we know will not occur for the rest of the year. So we feel good about that. So we're going to -- of all of those, the one we're really focused on are the medical specialist fees and -- as I mentioned, on the implants.

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Tim L. Hingtgen, CHS/Community Health Systems, Inc. - President, COO & Director [41]

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I'll add to what Tom said. We're putting a lot of energy into visibility into the supply line, the SWB line, at all of our hospitals. And then by exception, putting targeted resources to those that we have opportunity has been a core focus of ours. The other area where we're putting some good work into is the growth of cardiac services with our service line and acuity focus. But with that comes a higher implant expense. We've gone through a rather rigorous process to make sure we're getting preferential pricing and some rebate programs thrown in that as well.

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Operator [42]

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Our last question at this time is from Kevin Fischbeck from Bank of America Merrill Lynch.

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Kevin Mark Fischbeck, BofA Merrill Lynch, Research Division - MD in Equity Research [43]

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So this quarter, in your slide presentation, you didn't have a slide kind of comparing core community to core HMA. Just wanted to see what trends were going on there. And if that's not the right way to look at it, if there's any way to kind of slice the portfolio to kind of give us a sense of what you think the underlying growth of the real business is?

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Thomas J. Aaron, Community Health Systems, Inc. - CFO and EVP [44]

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Kevin, we've owned those over 3 years now. So we felt like let's move on. Run and cut those out separately. With that being said, when you look at some of those markets, Tim mentioned Florida, and Wayne mentioned Florida as being a strong state for us and largely influenced by HMA hospitals. Tennessee was not. So it just depends on the market, but we're looking at it as all CHS now.

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Operator [45]

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And I will now turn the call back over to Mr. Smith for closing comments.

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Wayne T. Smith, Community Health Systems, Inc. - Chairman and CEO [46]

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Thank you again for spending time with us this morning. We're very focused on our strategies we've outlined over the past several quarters. I want to specifically thank our management staff, hospital Chief Executive Officers, and hospital Chief Financial Officers, and Chief Nursing Officers and division operators for their continued focus on operating performance.

This concludes our call today. We look forward to updating you all on our progress throughout the year. Once again, if you have questions, you can always reach us at (615) 465-7000.

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Operator [47]

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