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Edited Transcript of CYH earnings conference call or presentation 30-Oct-18 3:00pm GMT

Q3 2018 Community Health Systems Inc Earnings Call

FRANKLIN Nov 6, 2018 (Thomson StreetEvents) -- Edited Transcript of Community Health Systems Inc earnings conference call or presentation Tuesday, October 30, 2018 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 and COO

* 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

* Anagha A. Gupte

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

* Bryan William Ross

Jefferies LLC, Research Division - Equity Associate

* Frank George Morgan

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

* Joshua Richard Raskin

Nephron Research LLC - Research Analyst

* Kevin Mark Fischbeck

BofA Merrill Lynch, Research Division - MD in Equity Research

* Patrick Thomas Feeley

Barclays Bank PLC, Research Division - Research Analyst

* Ralph Giacobbe

Citigroup Inc, Research Division - Director

* Sarah Elizabeth James

Piper Jaffray Companies, Research Division - Senior Research Analyst

* 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 2018 Q3 Conference Call. (Operator Instructions)

I will now turn the call over to Mr. Ross Comeaux. 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 third 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 refer to those slides during this earnings call.

All calculations we will discuss also exclude: discontinued operations, 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 government and other legal settlements and related costs; expenses related to employee termination benefits and other restructuring charges; expense from settlement and fair value adjustments on the CVR; agreement liability related to the HMA legal proceedings; and related legal expenses.

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

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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 third quarter conference call. With us on the call today is Tim Hingtgen; our President and Chief Operating Officer; Tom Aaron, our Executive Vice President and Chief Financial Officer; and Dr. Lynn Simon, our President of Clinical Operations and Chief Medical Officer.

Similar to the last earnings call, I have some general comments on the company as well as our performance during the quarter, then I'll turn the call over to Tim, who will discuss our core operations. And Tom will provide more color on our third quarter financial results.

Overall, during the past few quarters, we have strengthened our company from a combination of core operational improvements, execution across our strategic imperatives and progress from our divestiture program. All these investments are focused on reinforcing our competitive position within the markets, which is positioning the company well for the future sustainable same-store growth.

During this time, we have improved our quality and safety through the reduction of our Serious Safety Event rates, invested in service line development across our hospitals; opened a number of new access points with more in the pipeline, built out and expanded our transfer center here in Franklin, Tennessee; launched our ACO program in early 2018; implemented, centralized an online scheduling across our physician practices, along with other patient engagement technology to connect patients across a continuum of care; and leveraged our data analytics capabilities to help manage expenses across the organization.

We view these investments as meaningful drivers of growth and margin improvement moving forward. And while we have seen early success, we expect to see additional benefits from our initiatives in the future. Tim will provide more detail on some of the progress later in the call.

Now I'd like to discuss some highlights from our third quarter earnings performance. Our same-store net revenue performance was up 3.2%. On the pricing, net revenue per adjusted admission was up 4% during the third quarter. Our adjusted EBITDA came in at $372 million, and our adjusted EBITDA margin of 10.8% was up 180 basis points year-over-year.

In terms of cash flow, our cash flow from operations was $346 million in the third quarter compared to $114 million last year. Adding to this -- adding all of this together, we are pleased with our continuing progress and financial performance during the third quarter and we believe our strategic initiatives are working and we are well positioned to drive additional growth moving forward.

Our portfolio of rationalization strategy is allowing us to focus on sustainable markets and shift more of our resources to hospitals and networks with improved market position, higher growth potential and better profitability. On the divestiture side, early in the fourth quarter, we announced that we completed the divestiture of AllianceHealth Deaconess in Oklahoma City. And we previously announced definitive agreements with the divestiture of Sparks Health System and Mary Black Health System, both of which include 2 hospitals.

From time to time and after considering other strategic options, we have decided to close certain hospitals. At the end of the fourth quarter 2018, we expect to complete the planned closure of 2 additional hospitals, Physicians Regional Medical Center in Knoxville, Tennessee and Lakeway Regional Hospital in Morristown, Tennessee. Importantly, these hospitals' service lines will be integrated into our existing CHS network hospitals in East Tennessee, which will further strengthen the market's competitive position and growth potential.

Excluding these 2 hospitals closures, the completion of the Deaconess divestiture and the 4 hospitals currently under definitive agreement, our year-to-date same-store admissions would have improved 90 basis points. Our adjusted admissions would have improved 50 basis points, and our surgeries would improve 40 basis points. And excluding these hospitals from the third quarter 2018 performance, our same-store adjusted admissions and surgeries would have been positive.

Moving forward, we expect our remaining divestitures to provide additional benefits to our core portfolio. Our current divestiture plan calls for the divestiture of hospitals that accounted for at least $2 billion of net revenue in the full year of 2017 and mid-single-digit EBITDA margin. We expect these divestitures to generate approximately $1.3 billion of gross proceeds, which does not include the retention in network capital. We expect to close the remainder of these divestitures in 2018 and 2019. And as we move forward, we will continue to improve our operations and optimize and strengthen our portfolio.

So in summary, over the past several quarters, we have invested in and executed on a number of operational strategies, some of which are early in their respective rollout. We believe these strategies are already strengthening our core same-store portfolio of hospitals, with more benefits to come as these initiatives continue to be implemented and fortified. And we expect these strategies will help the company continue to drive further growth moving forward.

Now I'll turn the -- over to Tim for an operational update.

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

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Thank you, Wayne. As Wayne mentioned, we have made a great deal of progress with a number of operational initiatives, which we believe will help pave the way for additional growth moving forward.

In terms of volume for the quarter, as Wayne mentioned, the 7 hospitals that we expect to exit the portfolio in the fourth quarter of this year have been a drag on our same-store volume performance. During the third quarter, approximately 60% of our same-store admissions decline was due to these 7 hospitals. The balance of the decline stemmed from fewer deliveries, mirroring the natural trend of lower childbirths; the select service line closures and select -- I'm sorry, and short length of stay Medicare total knee replacement cases shifting from inpatient to outpatient status.

Overall, we expect our volumes to improve from not only the portfolio rationalization that Wayne mentioned, but also from our core operational strategies. We expect that these strategies, coupled with our continued focus on expense management, will help drive improved same-store net revenue and EBIT growth over the next 6 to 12 months.

Switching back to the third quarter, I believe we delivered good results. Our same-store net revenue growth was up 3.2%, which was similar to our performance during the second quarter. Our net revenue per adjusted admission was up 4% as we continue to benefit from our investments in higher-intensity service lines, physician recruitment into surgical and procedural specialties and from select closure of lower-acuity services in some markets that typically had minimal volume and were margin dilutive. Along these lines, our CMI increased across each payer class during the third quarter. It's also worth noting that in contrast to full year 2016 and 2017, the Medicare and Medicaid environment has been more stable. And at this point, we expect the environment to remain stable moving into 2019.

Now I'll provide a few highlights from some of our operational initiatives. First, we continue to focus on our high-opportunity networks. As we've outlined in the past, this program targeted 5 high-priority networks with a combined 28 hospitals that had been impacted in 2017 by slower top line and EBITDA growth due to various factors. Through a combination of increased managerial focus and dedicated resources over the past few quarters, these networks are generally showing improved performance. Looking at year-to-date results, EBITDA is up 17% across these 5 markets. And excluding the hospitals we closed during the fourth quarter, admissions from the remaining group are positive and surgeries are up 2%. So we have been pleased with this improvement, and we anticipate further momentum in these networks moving forward.

Another strategy that we launched at the start of 2018 is our Accountable Care Organization, or ACO, initiative. Nearly all of our CHS-affiliated hospitals are enrolled in 1 of our 15 ACOs, allowing us to partner with more than 4,000 providers to better coordinate care in our communities. Through these ACOs, we've been coordinating care for approximately 250,000 traditional Medicare patients.

This initiative has allowed us to better integrate and align with physicians and advance our value-based care capabilities. And as we prepare for 2019, we have achieved a 97% retention rate of independent primary care physicians who initially joined our ACOs in 2017. And more independent physicians have signed on for this upcoming year with over 150 new primary care providers for the 2019 program year. We're seeing a number of benefits from our ACOs, including a lowering of the hospital readmission rate for our ACO patients year-to-date, which points to better quality and care coordination.

In terms of our transfer center and access program, we began in-sourcing this effort toward the back end of 2017. As we continue to roll this function out in a number of markets, we are gaining greater visibility into operational and growth opportunities as well as ways to strengthen specific service lines. We have now implemented the transfer center support in approximately 70% of our plan markets, adding 3 markets and a combined 7 hospitals since the second quarter. More markets will be added this quarter and into 2019.

We are also allowing directors to provider outreach, or DPOs, with our access center team. And in many markets, we have EMS coordinators and outreach employees to drive enhanced growth. This program is also helping us better align patient demand with medical staff development and hiring. For instance, to date, we have expanded our capabilities in areas such as cardiology and surgical specialties through successful physician recruitment.

Another area of ongoing investment is on the outpatient side as we open new care locations and deploy technology and navigation programs to connect with our patients across the care continuum. In terms of access points, we have recently added new primary care locations and providers, freestanding EDs, urgent care and walk-in clinics, ASCs and we made other outpatient investments in our core markets. And while we and the hospital industry have seen some lower-acuity patient shift out of the ED setting, we have seen solid growth across our outpatient care settings. On a year-over-year basis, during the third quarter, we experienced 12% growth in our urgent care and walk-in care facilities and 9% visit growth across our primary care providers.

In summary, I've been pleased with our progress during the first 3 quarters of the year. Overall, the strategies we are implementing are driving improved performance across our core portfolio. And as we intensify our focus on our strategies and key operational initiatives, we have also invested in our human capital where we are attracting and retaining top talent focused on the development of higher-performing hospital leadership teams and on continued strengthening of position employee engagement. So overall, while we are confident that we have strengthened our company across a number of important areas, we remain focused on the opportunities to drive further improvement over the coming quarters.

With that, let me turn the call over to Tom.

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

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Thank you, Tim. Now I will discuss the third quarter on a quarter-over-quarter basis. As a reminder, calculations discussed on this call exclude items Ross mentioned earlier. On a same-store basis for the quarter, we noted the following: on a comparative third quarter 2018 versus 2017 basis, net revenues increased 3.2%. This is comprised of a 4% increase in net revenues per adjusted admissions and a 0.8% decrease in adjusted admissions. Our inpatient admissions declined 2.3%. Our ER visits decreased 1.7%. Our surgeries increased 0.3%.

Similar to the past few quarters, we delivered strong net revenue per adjusted admission performance. On a year-over-year basis, we benefited from improved acuity across all payers, better Medicare rates and a stronger portfolio of hospitals, following the close of a number of divestitures. Our net operating revenues after provision for uncollectible revenue was 53% of our revenues, up 50 basis points. On a same-store basis, net outpatient revenue was 53% of our revenues and increased 80 basis points. Consolidated revenue payer mix for the third quarter of 2018 compared to the third quarter of 2017 shows managed care and other increased 70 basis points, which includes Medicare Advantage. Medicare fee-for-service decreased 140 basis points. Medicaid increased 10 basis points. Self-pay increased 60 basis points.

Based on our adjusted admissions per payer class, our managed care, Medicare fee-for-service and Medicaid volumes were down, while our Medicare Advantage and self-pay volumes were up. For the third quarter, the sum of consolidated care self-pay discounts and uncollectible revenue for the 3 months comparative periods has increased from 30.9% to 32.3% of adjusted net revenue, 140 basis point increase. Same-store uncollectible revenue is up 60 basis points from 31.5% to 32.1%. For the same-store expense items, our salaries and benefits as a percentage of net operating revenues for our same stores decreased approximately 50 basis points. The decrease was primarily driven by improved FTE management. Supplies expense as a percentage of net operating revenues for same stores decreased 30 basis points, driven by lower commodity supply and pharmaceutical spend, which offset higher in-plan expense. Our other operating expense as a percent of net operating revenues for the same stores increased 70 basis points. The increase was driven by higher medical specialist fees, certain purchased services, information systems expense and insurance costs.

In terms of our same-store expense management, we are pleased with our performance on the SWB and supplies expense lines. However, we still see opportunities for more efficiency across the organization. Specifically, on supplies, over the past few months, we've organized teams that enhance our data capabilities, all with the focus of driving savings across our supply expense line. And while we have seen improvements in the last 2 quarters, we expect to deliver additional savings in 2019.

Switching to cash flows. Our cash flows provided by operations year-to-date were $440 million. This compares to cash flow from operations of $617 million during the first 9 months of 2017. In Q3, our cash flow from operations was $346 million compared to $114 million in the prior year. In terms of the year-over-year decrease through September 30, the primary difference is due to the prior year cash flow collections from accounts receivable being approximately $190 million higher than last year, mostly due to divestitures.

As we've mentioned last quarter, cash flow from patient receivables benefited from lower same-store net revenue growth prior year-to-date, while current year-to-date patient receivables were negatively impacted by stronger same-store net revenue growth. Additionally, we closed a number of large divestitures earlier in the year in 2017, which contributed to our cash flow from patient receivables last year versus fewer divestiture closings year-to-date in 2018.

Turning to CapEx. Our CapEx year-to-date was $413 million or 3.9% of net revenue. During the first 9 months of 2017, our CapEx was $428 million or 3.5% of net revenue. As Wayne and Tim both mentioned earlier, we're continuing to invest capital in a number of high-growth areas across our core markets.

Moving to the balance sheet. At the end of the third quarter, we had approximately $13.54 billion of long-term debt, with current maturities of long-term debt of $35 million. At the end of the third quarter, we had approximately $335 million of cash on the balance sheet. We expect our divestiture plan to further reduce our debt moving forward. As Wayne mentioned, we expect to close additional divestitures during the fourth quarter of 2018 and in 2019.

Year-to-date 2018, we've completed the divestitures of 9 hospitals from our divestiture plan, accounting for approximately $650 million of net revenue in 2017 and generating approximately $235 million in total proceeds.

Before I move to guidance, I'd like to comment on our HMA legal matters. On September 25, 2018, we announced a global resolution and settlement agreement ending the U.S. Department of Justice investigation and settling key TAM lawsuits that were initiated and pending and known to the company before the company's acquisition of HMA in January of 2014. We were obviously pleased to make this announcement as this legal matter had been ongoing for a number of years, and it also ends uncertainties around the amount and timing of the payment.

At the date of the HMA acquisition, the company previously recorded an estimated liability at fair value of the remaining underlying claims that are covered by the CFR -- CVR agreement in connection with these claims as part of the acquired assets and liabilities. The liability has been adjusted as of September 30, 2018, to take into account the settlement amount contemplated by the global settlement agreement, including interest of $266 million, and has been classified as a current liability in other accrued liabilities on the condensed consolidated balance sheet at September 30, 2018. The settlement amount will be paid by the company in the fourth quarter of 2018. Our current estimate includes probable legal fees to be claimed by related counsel continues to reflect that there will be no payment to the CVR holders.

For 2018, our full year guidance includes the following: same-store adjusted admission growth is anticipated to be down 1% to flat. For 2018, net operating revenues less provision for doubtful accounts are anticipated to be $14 billion to $14.2 billion. Adjusted EBITDA is anticipated to be $1.6 billion to $1.65 billion. Cash flow from operations is forecasted at $550 million to $650 million. CapEx is expected to be $500 million to $575 million. We expect HITECH incentives to be close to 0. Interest expense is expected to be approximately 7.0% of net revenue for the year. Income from continuing operations per share is anticipated to be negative $2.25 to $2.10 based on the weighted average diluted shares outstanding of approximately 113 million.

Wayne?

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

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Thanks, Tom. At this point, operator, we're ready to open it up to questions. (Operator Instructions) But as always, we're available to talk to you, and you can reach us at any time 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 comes from the line of 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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I appreciate the additional color on the volume of the business, excluding the divestitures. But I'm curious, could you also give us a little color on maybe what the revenue run rate or the cash flow EBITDA run rate would be also adjusted for those divestitures?

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

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Yes, Frank. So on the -- historically, we've gone back when we talked about divestiture programs and we've looked at prior years on anticipated divestitures and margin improvement. And I think if you take a look at broadly, not just the ones that we've just described being the announced divestitures, but if you look at the broad divestiture program, we're going to be pretty consistent with what we've previously guided on margin improvement. We -- going forward, we do think that, that is starting to pan out when we look at our consolidated results this quarter, up 1.8% EBITDA margin. We think the divestitures had a strong influence on that improvement as well as some of the initiatives we've got on the volume and growth side. So -- we'll just guide you to that. One other thing, Frank, I'd point out is we've talked about the divestitures, $2 billion of revenue -- at least $2 billion of revenue, $1.3 billion of proceeds. Also, the closures, mentioning those might be helpful. Now that's about, if you look at 2017 revenue, that's about a run rate of around $300 million in revenue for those closures. That includes the one previously closed in Kennett, Missouri and then the 2 we just talked about in East Tennessee.

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Wayne T. Smith, Community Health Systems, Inc. - Chairman & CEO [4]

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So Frank, this should take us down the road of mid-teen margins in a year, 18 months or somewhere out in the future, but not-too-distant future. But we're making good progress.

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Operator [5]

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Your next question comes from the line of A.J. Rice from Credit Suisse.

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Albert J. William Rice, Crédit Suisse AG, Research Division - Research Analyst [6]

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Maybe just sort of a multipart question about your finances. Strong cash flow trends in the quarter, definite improvement, obviously, over the first half of the year. Is there anything unusual in there? I know you talked about the divestitures a little bit in your prepared remarks, but I just want to single that out. And now you've got the $266 million payment in the fourth quarter. Maybe talk about your sources of liquidity to make that payment and then also whether you have to get any approvals from any of your lenders to do that. And then finally, just where you're at on the covenants, if you don't mind?

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

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That's more than one question, A.J.

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Albert J. William Rice, Crédit Suisse AG, Research Division - Research Analyst [8]

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It's all about finances.

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Wayne T. Smith, Community Health Systems, Inc. - Chairman & CEO [9]

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Same categories.

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Thomas J. Aaron, Community Health Systems, Inc. - Executive VP & CFO [10]

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I'm still writing those down. It's okay, A.J., let me take a swing at this. First of all, on the cash flows, we did not have any unusual amounts influencing our cash flows from operations. I think mostly we spent a lot of time Q2 talking about the impact of divestitures and the acceleration of the interest payments and the fact that would not be recurring. And that did, in fact, play out, focused on our receivables and our payables as well. So no unusual items on that. With respect to the $266 million, we -- looking at this, we have $335 million cash on the balance sheet. We've got $425 million undrawn on the revolver and about $450 million available on the ABL. We anticipated this settlement, so we made sure we had lots of liquidity for this. We did use about just over $200 million of our ABL. A substantial portion of that has been paid already in October and then the rest with cash. And then there's some just final math that will be paid in the fourth quarter as well. Likely, the small amounts will be paid in cash. Because a lot of this was anticipated and included in the refinancing, we did not have to get approvals from any of our lenders to fund this. And then with respect to the covenants, we have a first lien coverage covenant. We're at -- 5 is our covenant. We were at 4.6 in Q3. And as you probably know, that steps down with first quarter of 2019 to 4.75. We like the fact that we're already under that with expected improvements.

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Wayne T. Smith, Community Health Systems, Inc. - Chairman & CEO [11]

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And I just want to add real quick that we're very happy to have the HMA matter over with. It's been a long haul, and that has been a little bit of a distraction. But generally speaking, we're very happy and pleased to have that concluded. Thank you.

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Operator [12]

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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 [13]

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Wanted to understand a little bit more around the decision process on closing the facilities and the potential impact there. I assume those are money losers at this point, but I don't want to be presumptuous. I know you gave the revenue number. And how do you think about that factoring into your existing networks in terms of volumes? And is it one of these scenarios where we shut the hospital down, but we don't necessarily lose all of the volumes. And again, this has actually become EBITDA-enhancing as part of that process?

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Tim L. Hingtgen, CHS/Community Health Systems, Inc. - President and COO [14]

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This is Tim. I'll go ahead and give you some updates on those decisions. Overall, first of all, the hospitals that are closing are a drag on the market, on the Knoxville market. So with that being said, we've been investing in some capital expansion project sets, some of the remaining facilities in that network to take on the service lines, the capacity, the physicians that we think will strength us for the long run. So for instance, expanding our orthopedics capacity, building out OB capacity, cardiac capacity and some of the stronger network performers that's taking place. And by the first part of next year, those projects will be in a much better space to take on the volumes and the closure of the larger Knoxville hospital. So it does strengthen us overall. It strengthens our underlying volume trends in the market. It strengthens the EBITDA profile, cash flows through the market. So we feel real good about that consolidation decision.

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Thomas J. Aaron, Community Health Systems, Inc. - Executive VP & CFO [15]

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And Josh, I would just add that as we look longer term, bigger picture, we are -- it's been mostly spin transaction and divestitures to date. But this is an important part about trying to accelerate and make sure we get down to the right portfolio of hospitals, profitable strong cash flow that put us in the best position as soon as possible to start looking at our balance sheet options. So we're happy with the progress we're making on this. And as Tim mentioned, especially in situations like this where we're able to capture some of those services.

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Wayne T. Smith, Community Health Systems, Inc. - Chairman & CEO [16]

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And this has no reflection on the employees or the physicians. These are a good group of people. They're well qualified. They do excellent work. It's a market share issue for us and how we can best consolidate in the market. Morristown is particularly sensitive to me, since in 1974, I was the first trainee there when I was working at Humana. So I hate to see that one close, but this is the right decision. And these are good people that work in these facilities.

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Operator [17]

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Your next question comes from Brian Tanquilut from Jefferies.

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Bryan William Ross, Jefferies LLC, Research Division - Equity Associate [18]

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This is Bryan Ross on for Brian Tanquilut. I just had a question on the rev per adjusted admission, very strong again at 4%. Can you provide any more detail on the moving parts there? I guess, just thinking about overall acuity payer mix, 340B, other factors in terms of the magnitude on that measure? And you spoke about the admissions growth, ex the planned divestitures and closures. Is there any difference on the rev per adjusted admission metric for that for the core facilities?

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

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Yes. So let me start, Bryan, talking about that stat you mentioned. Our net revenue per adjusted admission was up 3% this quarter. I'm going to back up to the fourth quarter of 2017. That's when we started seeing the benefits of service line focus going for a higher-acuity service line that start flowing through our case mix and our net revenue per adjusted admission. For several years before that, we had been around 2% on that statistic. Fourth quarter, that started stepping up to 2.7%. Effective January 1, the Medicare outpatient rates, we got the benefit of the 340B, which gave us about a 4% increase in that area. That translated to maybe 40 or 50 basis points on net revenue per adjusted admission. So that will carry through the fourth quarter, just that these will. And then we might have had a little bit of onetime with respect to the hurricanes last year, impacted our payer mix more towards self-pay. We had to cancel surgeries, especially in Florida and -- which was higher payment. So we were -- some of that would have been due to that. But I think where we were, if you look at the fourth quarter last year and where we've been in Q1 and Q2, is probably more of a normalized on that stat.

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Operator [20]

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Your next question comes from the line of Ana Gupte from Leerink Partners.

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Anagha A. Gupte, Leerink Partners LLC, Research Division - MD of Healthcare Services & Senior Research Analyst [21]

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The question was on the mid-teens margin expansion goal that you're setting for the 12 to 18 months. Can you give us a sense for what portion of that is coming from the markets that you're in and the contract rates you're likely to get there now on other volume trends, top line trends versus just OpEx efficiencies and the like and how that plays into your physician strategy, which haven't heard about that for a bit now.

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Thomas J. Aaron, Community Health Systems, Inc. - Executive VP & CFO [22]

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Sure, Ana. So I think there's 2 parts. That one is, when we look at these core markets that we're going to be operating when we're done with the divestiture program, when we look back historically on what they've done from a volume standpoint, much better volume statistics than what we've presented, even same-store more recently, because we still have divestitures to go. They also have a better history of their net revenue per adjusted admission. They have more relevance in their market, and they're able to achieve better rates from their payers in those markets. So they've got a history of that as well. So we think that's a good indicator of where we're going to be with those hospitals once we've wound down. We know that from our expense management that we've been be able to achieve so much on SWB, and we've started on supplies. Going forward, we have some opportunities with -- if we're getting breadth and we're getting volume, we're pretty comfortable we could grow EBITDA at those hospitals as we have in the past. And we still have a lot of hospitals are showing great EBITDA growth and volume growth as well. So we're going to -- that's going to be a bigger portion of our portfolio going forward. The other thing it does is, just pulling out the divestitures, that's been a drag on our margin. It's been a drag on our free cash flow. And so we are doing everything we can to expedite that, the newer twist to that with the closures, 3 hospital closures that we have now announced. So we are really focused on accelerating that, getting that done, getting the divestitures done at the right price. So I think those are the 2 bigger contributors to that. But I want to emphasize, we do believe, on our core hospitals, we are going to be growing our EBITDA margin on those based on history and everything we've seen to date.

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Tim L. Hingtgen, CHS/Community Health Systems, Inc. - President and COO [23]

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Ana, another contributor would be we are expanding capacity in some of our higher-margin markets. Those projects are underway. We believe we can grow more market share in those markets, which will obviously grow the margin for the company in total. In terms of our medical staff development and physician recruitment strategy, we've been very strategic in our focus on this, being very careful not to over-recruit, but to really put in the right physician to drive the right service line strategy in our remaining -- permanent remaining portfolio markets. We've invested heavily in primary care development. We're up a good number of primary cares in their startup phase this year. I mentioned earlier, really having strong growth in primary care business will certainly help us drive our market share, our market performance across the portfolio. More importantly, it will drive more of the higher-acuity service lines that we're building out in our hospitals. We have a great deal of -- a great number of doctors in startup, as I said, over 200 doctors that are new to the markets that we serve. We are very focused on ramping them up as quickly as possible to improve our competitive position in the market, but also as I said, to drive those service line strategies. And then I also mentioned the ACO. Short of having to recruit every doctor new to our market, we've been very focused on better alignment strategies with the independent physicians in the communities. And a 97% retention rate of the primary cares who've signed on initially, adding another 150 this year, we believe we are building a healthcare community with providers to drive our core portfolio growth.

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Operator [24]

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Your next question comes from Sarah James from Piper Jaffray.

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Sarah Elizabeth James, Piper Jaffray Companies, Research Division - Senior Research Analyst [25]

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Breaking into some of the pieces for the margin expansion, you mentioned that you thought you had additional savings opportunities in 2019 for supply expense. So can you help us understand the scale of that additional opportunity versus what you've already recognized through your programs and for the progress this year on both the commodities and the pharmaceutical savings. Should we think about that more as related to negotiation with vendors on price point? Or is it more of utilization management?

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Thomas J. Aaron, Community Health Systems, Inc. - Executive VP & CFO [26]

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Okay, Sarah, thanks for the question. There's probably on the supply side, and I want to hit on purchased services as well, but supply side, there's probably 2 components of that. One is, we buy a lot of our supplies through HPG or GPO. And if you look at it this way for any item, there might be 20 to 40 items under contract. We want to -- using our data analytics, we want to put the person who's requesting the item, we want to put information in front of them. So instead of looking at the 20 to 40, picking from those, we point them to the maybe the 2 best items, highest quality, lowest-price items on that list so that they -- upfront, they make the right choice on that select item. So that's one piece, and you might want to look at that as nonphysician preference items, but just being better with that. And then we can do that with data similar to what we've been able to do with labor. The second piece of that is when we're looking at implants, it's been the one item that we've called out quite a bit. We do have the ability of getting better information on prices at our hospital, who's using which vendors and so forth, to better organize our consumption and the market share by certain vendors and to negotiate off of that. And you could even have some negotiation without that, but we think that's where you're really optimize that and that's what we're looking to do. We have -- with the help of Cardinal Health, we've been able to do this on drug spend and point towards better purchasing decisions on the drug side that's helped quite a bit with our supplies to date. But we, again, leveraging data on both of those areas of supply, we think we have significant improvement there. I think we had 30 basis points for the quarter that's coming off another quarter where we had some improvement. And we still think that most are still to come on the supply side. Using purchased services and procurement strategy, we think we can improve in that area as well. So you think about maybe dietary, security, maintenance at our facilities, we do have the ability to better contract those, get more competitive bidding going on, better national contracts. And we think there's some opportunity in that space in the procurement area as well.

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Operator [27]

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Your next question comes from Ralph Giacobbe from Citigroup.

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Ralph Giacobbe, Citigroup Inc, Research Division - Director [28]

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Can you maybe give us a sense of why you think -- or what's driving the pushout of the timing of some of the divestitures? Is it just slimmer number of buyers than what you thought? Or are you far apart in negotiation? And I guess, are you still confident that all the identified divestitures will happen and maybe should expectations for proceeds change?

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Thomas J. Aaron, Community Health Systems, Inc. - Executive VP & CFO [29]

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All right, Ralph. So we're still very confident in the at least $2 billion and want to point out, we're still getting significant inbound interest in the proceed amount there. When we look at, especially compared to last year when we divested 30 hospitals, one, we had 2 very large individual transactions, Steward was 8 hospitals and then in Pennsylvania, 5 hospitals last year in single transactions. We don't -- we're not dealing with transactions of that size with so many hospitals. We still have very strong strategic buyers that are involved. In most cases, we've got 2 options at least with the strategic buyers of some of the bigger hospitals in the bigger market plays. And we see those -- some of those it's just a newer transaction for some of those buyers. They're hiring new counsel; they're getting advisers involved with that. So that is just taking a little more time. We've got one transaction, it's just structured slightly differently, so that we're working a little bit longer on those. And I would say, there are some smaller hospitals involved in this. And you can tell the ones we closed earlier were smaller transactions. The hospitals that we have closed so far, we talked about being mid-single digit as a portfolio of this year's divestitures. The ones we've closed on so far are the lower performers in that. And so if you look at the proceeds relative to revenues, those aren't very high. However, the proceeds relative to the EBITDA are extremely high on those. So I think going forward, you're going to see higher proceeds to revenue numbers. And on the EBITDA multiples, maybe slightly lower. But we're confident we're going to get those done. Those will push back. We'll get those done in the fourth quarter of 2018 and then into 2019.

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Wayne T. Smith, Community Health Systems, Inc. - Chairman & CEO [30]

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The only thing I would add to that is that most of these acquisitions are geographic specific in that they're somewhat in that area that has an interest to add to their portfolio or to their network. So we don't really -- even though there are a number of people selling hospitals today, there's not any competition around this, except for the fact that there are a lot of not-for-profits and other people that are interested in our properties. So it's still going well.

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

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From everything we're hearing, the kind of broad provider strategy about having better market share helps them with their rate and other operational areas. That's still true, and so that's still going to drive demand for our hospitals.

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Operator [32]

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

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Kevin Mark Fischbeck, BofA Merrill Lynch, Research Division - MD in Equity Research [33]

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Can you talk a little bit about what you see as kind of the core growth of demand for services in your markets? I think over the last 5-plus years, it really seems like the urban-focused hospitals have been seeing a lot stronger core demand in their markets than the nonurban companies. I just want to get your sense of kind of what you think the core growth is there and how much of that is going to be based upon you just getting your fair share of that core growth versus maybe the growth being a little bit lower and you have to gain market share to be growing volumes organically?

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

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Sure, Kevin. This is Tim. I'll kick off the answer to that. Overall, with the portfolio rationalization that has been under way, we have seen a shift in our market profile to more of the, I'll say, suburban or smaller urban markets. As a matter of fact, our average population has grown. We've kind of shared this with some folks who visit us in the last couple of months, some of the road shows that are -- mid-tier market, if you will, is about 180,000 -- our 50th largest market has a population of 180,000. So getting larger, it helps to drive those service lines, development strategies, faster growing. We see improved dynamics across employment indicators and population growth indicators and overall demographics in those markets. So when you look at what's left in the portfolio when we're through the rationalization, we do believe we have a group of assets in markets that we can really deploy the strategic initiatives I've been walking through in terms of service line development, transfer centers, primary care development, access point. All those things will grow and drive the market shares to drive the margins and the earnings going forward.

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Thomas J. Aaron, Community Health Systems, Inc. - Executive VP & CFO [35]

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Yes. And just one piece I would add to Tim's point about our 50th largest market. When we are looking at post these planned divestitures, we're only going to have 6 hospitals that are going to be in combined service areas of 50,000 or less. So very few hospitals that are in rural. We do have some very successful rural hospitals, by the way, that we intend on keeping and operating. But we're going to be less in that area and more in markets Tim mentioned.

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Operator [36]

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Your next question comes from the line of Patrick Feeley from Barclays.

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Patrick Thomas Feeley, Barclays Bank PLC, Research Division - Research Analyst [37]

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In the past, you've talked about these -- the total pool of assets slated for divestitures having negative free cash flow. Is there any way to quantify the free cash flow from these assets year-to-date? Or alternatively, what do you think the free cash flow profile of the company is once these sales are fully done?

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Thomas J. Aaron, Community Health Systems, Inc. - Executive VP & CFO [38]

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Patrick, we called out the 2017 divestitures, and this is divested in 2017. So we're looking at free cash flow from those hospitals in 2016, and those were negative $250 million that we've talked about. The portfolio we're talking about for the 2018, the $2 billion in revenue and 1.3 of proceeds, those hospitals are going to be less than that. This is not from a negative free cash flow. It is the same level, plus it's going to be fewer -- it's only $2 billion of revenue versus $3.4 billion. So it's going to be less than that. But it is a meaningful number for us. We are already starting to see the impact on our free cash flow as we project out our free cash flow. We like what we're seeing. As that has come out, to operate those hospitals, some of these had very open campuses that don't require a lot of CapEx. So we're seeing that improvement. And we would anticipate that we continue to benefit from that -- from the divestitures and the closures.

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Operator [39]

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Our last question comes from Steve Tanal with Goldman Sachs.

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Stephen Vartan Tanal, Goldman Sachs Group Inc., Research Division - Equity Analyst [40]

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Just wanted to ask one about the working capital improvement. Good outcome this quarter. Was there anything unusual that helped the performance there? Or can you all run the business at these levels going forward?

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Thomas J. Aaron, Community Health Systems, Inc. - Executive VP & CFO [41]

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Well -- so on the working capital, there were no real unusual items in there. We have -- we do have some things like interest payments that will be -- it's a little heavier in the second and fourth quarter than we do have in the third. We are going to have, as we've discussed already, the CVR settlement that's going to be in the fourth quarter. But -- and the other thing that played out that we called, Steve, out in the second quarter, we had some divestitures that closed just 1 month before the quarter end. And compared to the prior year, we had the Steward transaction, 8 hospitals closed 2 months prior to quarter end. When it's closing a month before quarter end, we pay all the payables immediately. And it takes time to collect the receivables, and we've retained working capital. And so that influenced the second quarter as well as we mentioned, the acceleration of the interest payment. Going forward, though, as I mentioned on Patrick's call, free cash flow does improve quite a bit once we complete divestitures and closures. We're already seeing the impact of that. We continue to project that. So we do think that we're going to get an improvement in our core hospital free cash flow. And the only other thing I would say going forward is just the timing of divestitures and when those fall, just like they did in the second quarter, those could impact it one direction or the other going forward. But from the core, we do like the -- our trajectory for free cash flow.

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Operator [42]

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I'll now turn the call back over to Mr. Smith for closing comments.

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Wayne T. Smith, Community Health Systems, Inc. - Chairman & CEO [43]

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Thank you again for spending time with us today. We're focused on the strategies that we've outlined. We want to specifically thank our management team and staff, Hospital Chief Executive Officers, Hospital Chief Financial Officers and Chief Nursing Officers and Division Operators for their continued focus on operation performance and quality.

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

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Operator [44]

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