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Edited Transcript of QHC earnings conference call or presentation 13-Apr-17 2:00pm GMT

Thomson Reuters StreetEvents

Q4 2016 Quorum Health Corp Earnings Call

BRENTWOOD May 4, 2017 (Thomson StreetEvents) -- Edited Transcript of Quorum Health Corp earnings conference call or presentation Thursday, April 13, 2017 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Michael Culotta

Quorum Health Corporation - EVP & CFO

* Tom Miller

Quorum Health Corporation - President & CEO

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Conference Call Participants

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* Jailendra Singh

UBS - Analyst

* Chris Rigg

Deutsche Bank - Analyst

* Sheryl Skolnick

Mizuho Securities - Analyst

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Presentation

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Operator [1]

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Good morning, my name is Kelly and I will be your conference operator today. At this time I would like to welcome everyone to the Quorum Health fourth-quarter 2016 earnings conference call. (Operator Instructions). Thank you. And I will now turn the call over to Michael Culotta, Executive Vice President and Chief Financial Officer. Mr. Culotta, you may begin your conference.

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Michael Culotta, Quorum Health Corporation - EVP & CFO [2]

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Thank you, Kelly. Good morning and welcome to Quorum Health's fourth-quarter conference call. Before we begin the call I would 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 and our Form 10-K filing and other reports filed with or furnished to the Securities and Exchange Commission.

As a consequence actual results may differ significantly from those expressed in any forward-looking statement in today's discussion. We do not intend to update any of these forward-looking statements.

We previously issued a press release on March 29, 2017 with our unaudited financial statements and definitions and calculations of adjusted EBITDA and adjusted EBITDA adjusted for divestitures, including reconciliations to US GAAP measurements. We have included a slide presentation to supplement today's discussions.

As you know, our results consolidate the results of the 36 owned or leased hospitals and the results of Quorum Health Resources. Our same facility information excludes the Sandhills facility in Hamlet, North Carolina sold on December 1, 2016. Our Barrow facility in Winder, Georgia was sold on December 31, 2016 and is included in same store since the results were for the full quarter.

All calculations we will be discussing exclude impairment of long-lived assets and goodwill, expenses incurred related to the spinoff of Quorum Health Corporation, certain legal, professional and settlement costs, net loss on sale of hospitals, severance costs for post spin headcount reductions, the change in estimate relating to the collectability of patient accounts receivable and the adjusted EBITDA of divested facilities and related entities.

Please refer to the slide presentation for a further description and calculation of adjusted EBITDA adjusted for divestitures. The Company has also completed the negotiations of amending the credit agreement and the ABL credit agreement. Further details of these changes are described in detail in our Form 10-K. With that I would like to turn the call over to Mr. Tom Miller, President and Chief Executive Officer. Tom.

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Tom Miller, Quorum Health Corporation - President & CEO [3]

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Thank you, Mike, and good morning and welcome to Quorum Health's fourth-quarter 2016 conference call. With me today is Marty Smith, our Executive Vice President of Operations; Dr. Shaheed Koury, our Senior Vice President and Chief Medical Officer; and Mike Culotta, our Executive Vice President and Chief Financial Officer.

Mike and I have some brief comments today covering the fourth-quarter and yearend results, our financial guidance and our focus on improvements as we continue to move forward as a public Company. We will then open up the call for your questions.

As you know, during 2016 we divested two strategic facilities: Barrow in Georgia and Sandhills in North Carolina. The adjusted EBITDA for these two facilities represented a negative $9.1 million in the quarter or approximately 66% of the negative $13.7 million for the entire group of assets we had targeted to divest in 2016.

For the year these two facilities represented negative EBITDA of approximately $18.9 million or approximately 57% of the negative EBITDA of $33 million of the entire group of assets that we had targeted to divest in 2016.

In addition, we completed the sale of our hospital in Centre, Alabama on March 31, 2017. This hospital represented an adjusted EBITDA loss of approximately $900,000 in the fourth quarter of 2016 and approximately $2.5 million for the year. Our net proceeds on all of these sales have approximated $18 million and all proceeds have gone to reduce our debt.

Presently we have an asset purchase agreement on our hospital in Augusta, Georgia and letters of intent on an additional four hospitals. We expect to consummate the sale of the Augusta facility in the second quarter. Please review slides 2 and 3.

We are evaluating additional facilities for potential divestiture. These hospitals have low-single-digit to negative margins. We are in the very early stages for seeking interested parties. We believe these facilities do not meet our future strategy of our Company. We are very focused on reducing our leverage and moving to a profitable operating Company.

We will use all of the divestiture proceeds to pay down our secure term loans as we did last quarter and the first quarter of 2017. We estimate with all the sales that we will be able to pay down approximately $20 million of debt, that is approximately 25% of our total debt -- I'm sorry, $200 million in debt which will be about 25% of our total debt.

To strengthen our remaining core hospitals we continue to recruit our physicians and our previously discussed strategic specialty areas and expand our services. Please refer to slides 2 and 6. We have 137 physicians and advanced practitioners that commenced in 2016, an increase of 23% over 2015. Through March 31, 2017 another 36 have commenced. This compares to only 18 a year ago through March 31, 2016.

We remain focused on increasing access points in our markets at reasonable costs. We acquired three outpatient diagnostic centers; opened an urgent care center in the first quarter of 2017; we have an urgent care center planned for the late second quarter 2017; we have expanded behavioral health services in selected markets and we are set to open a new unit later this year.

In addition, our expansion project in Springfield, Oregon is progressing with new patient rooms and additional operating and capacity set to open mid-2017. Additionally, in an effort to reduce transfers to larger out of market hospitals and increase [security], we opened four intensive care units and increased the coverage to specialty physicians in multiple hospitals.

Overall we have seen that intensity growth as demonstrated in our case mix index. Our same facility Medicare case mix index increased 5.2% in the fourth quarter and 3% for the year. Additionally our all payer case mix increased 3.6% for the year predominantly in surgical cases.

As you will hear more detail from Mike, we are working hard to improve our cost efficiency. Regarding our various outsourcing agreements, we are in negotiations to transition the billing and collection cycle agreements with a timeline that would avoid any disruptions.

We believe we will experience lower costs, higher collection rates and better patient satisfaction as someone from the community will be there to address our patients' questions and needs. We are working to make this transition happen and look forward to working with our former parent on accomplishing this initiative. Please review slides 4 and 5.

Our adjusted EBITDA adjusted for divestitures was $40 million for the quarter and for the year it was $182 million. As outlined on slide 7, we have multiple near-term initiatives to improve hospitals. The first step is to continue to divest negative to low margin operations and reduce leverage.

We will focus on restructuring our portfolio to hospitals that could improve in market share and contribute to our operations and strategy. We will concentrate on our market demographics, payer mix and targeted physician specialties that will increase access to care in our communities.

We are focused on better alignment of cost and business strategies as we reduce our portfolio, improve labor staffing at our operations and improve performance of underperforming physician practices. We will continue to concentrate on reducing supply costs and other operating costs while additionally working to improve profitability at QHR and assess business lines that are not meeting specific needs.

For further segments we have reduced our capital expenditure projects by $20 million in 2017 compared to the expenditures in 2016. As we work on these initiatives we will also continue to focus on high quality standards.

I continue to believe in the opportunities we see before us, our strategies to achieve our long-term objectives for growth. We remain very focused on our mission: leading in safety, quality performance and patient experience; investing in resources and services to improve access to local care; valuing the input of physicians, nurses and other professionals; attracting and retaining engaged professionals who share our vision; and being a good community citizen. Our vision is to improve the health of every community we serve.

Thank you. And now here is Mike to discuss the fourth-quarter results.

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Michael Culotta, Quorum Health Corporation - EVP & CFO [4]

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Thank you, Tom. Tom has previously mentioned our adjusted EBITDA adjusted for the divestitures. In addition, on slide 8, we have included those that we are in the process of selling or have sold. Tom has also previously mentioned the one we sold in the first quarter of 2017, another one under an asset purchase agreement, and the others under letters of intent.

In addition, in the first quarter of 2017, we have identified others that we will also be selling that are not included in the numbers above. The new group represented another $1.9 million in losses during the fourth quarter. One of these facilities lost $3.6 million for the year in 2016. The others have low-single-digit margins for the year.

In addition we have included slide 9 for the adjusted EBITDA adjusted for divestitures, reconciliation and bridge for your review. As we have previously stated in prior earnings calls, some of our larger items relate to the volume and rate impacts; changing corporate office versus prior management allocations resulting from the spin out; increases in medical specialist fees; differences in GSA costs compared to previous intercompany charges from the former parent; changes in electronic health records reimbursement; and rebates and administrative fees reimbursement that declined due to the change in ownership.

In addition, on a sequential basis the large difference in other operating expenses related to the Illinois income tax credits and the New Mexico Gross receipts tax, all of these are described in detail in the Form 10 in the Management's Discussion & Analysis section where we included a Q4 to Q4 comparison and a sequential quarter comparison.

Let me review some items relating to revenue. As of December 31, 2016 the Company recorded a change in estimate of $22.8 million to reduce the net realizable value of patient accounts receivable. A portion of this change in the estimate impacted contractual allowances relating to delays associated with collections on Illinois Medicaid accounts.

The remaining $11.4 million of the change in estimate impacted the provision for bad debts in the consolidated and combined statements of income. This change in estimate related to an assessment of the collectability of the Company's managed care and commercial accounts receivable aged greater than one year and was based on the Company's review of historical cash collections for these accounts.

We have slides 11 and 12 to further explain the change in net operating revenue and the provision for bad debt. We have also provided a slide with a description of our DSOs and the makeup of those DSOs. Please review slide 13.

Our purpose here was to help explain why our DSOs are high compared to our peers other than our former parent. As you can see, Illinois Medicaid over 180 days represents about two days and the accounts receivable to former parents internal collection agency represents another 10 days.

On the volumes we went back and recalculated certain volume metrics relating to the original group of hospitals divested and to be divested and also the additional hospitals we will be divesting.

Slides 14 and 15 give information on the original group of divested and to be divested facilities, including all facilities on a year comparison. The admissions and adjusted admissions would improve about 90 to 120 basis points. On a quarter comparison the improvement would be around 60 to 170 basis points.

Other items to note in volume trends were that weather- and flu-related cases were down 9.3% for the quarter and 7.2% for the year. Also one day stays and observations were both down 3.4% and 10.1% respectively for the quarter. Other volume trends were down as you can see from our press release, including surgery cases which were down 4.5% for the quarter and 4.1% for the year.

Turning to expenses, we have included slides 16 and 17 for your review on the changes in salaries and benefits, supplies and other operating expenses. In addition, the Form 10-K also has further detail regarding the fourth-quarter of 2016 compared to 2015.

But briefly, salaries and wages and benefits increased due to the corporate office salaries and benefits shifting from a management fee allocation to actual cost. Corporate office salaries and benefits accounted for approximately $11 million of the increase. Of this $2.8 million is stock-based compensation.

Just as points of reference, the corporate office costs since the spinoff were $38 million of which $28.1 million was salaries and benefits and of which $7.4 million was stock-based compensation. The management fee for the first four months of the year was $11.8 million. This combined total of $49.8 million for 2016 compares to the 2015 management fees of $36.5 million or about $13.3 million difference. If you analyze the $38 million the difference is $20.5 million.

Supplies expense as a percentage of net patient revenues increased over 220 basis points in the quarter. Our overall rebates declined $2.7 million from a year ago as a result of not being an equity partner in the GPO. The HealthTrust purchase group organization has been very gracious in spending time with us and we are in the process of getting some higher rebates in 2017 and beyond. We will be signing a new agreement with them.

In addition, we wrote off $1.2 million in obsolete inventory in the fourth quarter. Other operating expense increased only $1.3 million in the quarter but increased 270 basis points to 31.8% as a percentage of net operating revenues for the quarter.

There was a $9.7 million decline in management fees offset by an increase in medical specialist fees of $6.9 million and increases in other areas such as taxes and insurance and repairs and maintenance. High-tech accounted for a reduction in reimbursement of approximately $2.6 million.

As previously announced, our fourth-quarter results also include updated long-lived impairment charges. In the second quarter we reported a total impairment charge in our long-lived assets and goodwill for $250.4 million. Of this amount $50.4 million was directly related to certain long-lived assets and the other $200 million was an estimate for goodwill.

In the fourth quarter we completed step two of the goodwill impairment testing and adjusted and reclassified the $200 million impairment estimate. We ultimately impaired the long-lived asset [to] $82.7 million and reduced the goodwill impairment estimate by $80 million.

Based on results in the fourth quarter at certain facilities we reported an additional impairment of $38.8 million. The total long-lived asset impairment charges on 18 of our [field] facilities since 2012 were $193.5 million and $125 billion in goodwill. See slide 18 which further explains this very complicated accounting treatment.

In November 2016 California voters approved a state constitutional amendment measure that extends indefinitely the statute that imposes fees on hospitals within California to obtain federal matching funds. Revenues generated from these fees provide funding for the nonfederal share of supplement of payments to California hospitals that serve California's Medicaid or Medi-Cal and uninsured patients.

For the year ended December 31, 2016 we recognized $34 million of revenues net of provider taxes from our participation in this California program. The current program expired on December 31, 2016 and, although we currently anticipate CMS will approve the program later this year, to date CMS has not approved a new program.

Consistent with the first four phases of the California program, we will not recognize any revenues under the new program until CMS completes the approval process. In addition, the program's funding levels are based in part on Medi-Cal's utilization. As a result, changes in coverage of individuals under the Medi-Cal program could affect the revenues and cash flows of our California hospitals under subsequent phases of the program.

Accordingly we are unable to predict the actual amount of revenues our hospitals may receive from or the timing of CMS' approval of the program including its impact on our 2017 results. At this time we believe the net impact in 2017 will be approximately $21 million. We further believe it will be approved by CMS in the fourth quarter. We refer to slide 19 in our presentation.

We estimated that the Affordable Care Act provided us with a modest benefit to revenues in 2016 of approximately 0.5% net of government reimbursement cuts. The estimate is comprised of approximately $8 million for the exchanges and approximately $28 million for Medicaid offset by approximately $26 million of Medicare cuts. Please see slide 20.

Net cash provided by operations for the quarter was $20.3 million and for the year was $81.1 million. If you will note the accounts payable and accrued liabilities increased as a result of the increased and accrued interest expense of $19.9 million. The year-over-year change was impacted by $30 million of legal payments in 2015 with no corresponding payments in 2016.

Capital expenditures including software for the quarter were $25.5 million and for the year was $87.2 million. Of our capital expenditures for the year approximately $38.5 million was spent on the Oregon project. We have spent approximately $48.9 million over the life of this project.

The net secured leverage ratio for the quarter on a trailing 12-month basis is approximately 3.93 times. Our consolidated EBITDA cushion is $28 million and our secured debt cushion is $125.8 million. In addition, we had no borrowings under our revolver or our ABL at December 31, 2016.

I now refer to slide 21, which further explains our rationale for seeking an amendment under our credit and ABL facilities. This was a product of several items including the new FASB accounting standards update number 2014-15, presentation of financial statements going concern.

We have experienced losses since the spinoff, further deterioration in our facilities divested and to be divested, increases in the timing of sales of such facilities, and the inability to approve revenue related to the California Hospital Quality Assurance Fund. The Company has obtained the amendments necessary to alleviate substantial doubt about its ability to continue as a going concern.

Our guidance is as follows and we refer to slide 22. We expect operating revenues for the year ended December 31, 2017 to range between $2.05 billion and $2.1 billion; adjusted EBITDA to range from $150 million to $170 million; adjusted EBITDA adjusted for divestitures to be in the range of $170 million to $200 million; CapEx is estimated to be $60 million to $70 million.

We have headwinds on the California Hospital Quality Assurance Fee program of approximately $13 million; lower reimbursement on electronic health records incentives of $7 million; and related to New Mexico Gross receipts tax refunds of $2.3 million.

We have non-cash items included in our expenses of approximately $10 million to $13 million of stock-based compensation and other non-cash benefits and approximately $25 million to $28 million of non-cash self-insurance reserves. All of these items are add backs under the credit agreement.

In addition, remember that we estimate the California Hospital Quality Assurance Fee will be recorded all in the fourth quarter and is estimated to be approximately $21 billion. Tom.

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Tom Miller, Quorum Health Corporation - President & CEO [5]

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Thanks, Mike. As you can see, we are making progress on divesting underperforming facilities with the goal of reducing debt by $200 million. We are in negotiations we believe will improve our billing and collection processes and are identifying every opportunity to improve cash flow, decrease unbilled write offs and missed billing opportunities.

We continue to evaluate productivity at all levels and will continue to adjust as we see variability in volumes to be fiscally responsible. As we work on our portfolio our team continually assesses hospitals that we believe do not meet the long-term goals of our strategies. We are also strengthening our core hospitals by growing our access points and outpatient services to better serve our communities.

With all of these I want to remind you again our steadfast commitment to quality and our internally created executive quality dashboard to track and emphasize continuous improvement. This measure already indicates a 6.1% improvement for our hospitals in 2016.

Additionally, we continue to see improvements in our serious safety events with an 86% reduction through the fourth quarter 2016 from our baseline in 2013. We are proud of our quality improvements and we continue this focus.

In closing I want to thank our physicians, our leadership teams at our facilities and all of our nurses and support staff with the encouragement and enthusiasm we have received. We thank you for your support. With that, Kelly, we are ready to take questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions). A.J. Rice, UBS.

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Jailendra Singh, UBS - Analyst [2]

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Hi, thanks, this is Jailendra Singh filling in for A.J. First a quick clarification on the California supplemental payments assumed in 2017 outlook. So are you saying that the $13 million decline is all driven by an expected decline in overall funding and not driven by any sale of hospital in this state?

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Michael Culotta, Quorum Health Corporation - EVP & CFO [3]

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It is based on a calculation. For example, this particular period was based on the base year of 2013 compared to a previous year of 2010. So it is just based on that estimate at this point in time and that was the information that we receive from the California Hospital Association. We are looking into that to make sure that allocation is correct.

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Tom Miller, Quorum Health Corporation - President & CEO [4]

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And just to clarify it, it would take the allocation from $34 million in 2016 to $21 million in 2017 going forward for the next three years.

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Jailendra Singh, UBS - Analyst [5]

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Okay, got it. And then can you talk about your volume expectations for 2017 and any color you can provide about the trends thus far in 2017.

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Michael Culotta, Quorum Health Corporation - EVP & CFO [6]

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One, we don't give any cadence of based on the volume trends is point in time and it is a little early right now; we are still in the process of closing the books. So at this point in time we would not be giving any information on 2017. But there was a little bit more of a flu that we saw in the first quarter than we did see in the fourth quarter. So we would say that.

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Tom Miller, Quorum Health Corporation - President & CEO [7]

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And just in addition to that, I think our physician recruitment activities have really been very successful associated with it. We had 75 providers start in the fourth quarter 2016 and first quarter of 2017, that is 75 commencements of providers who are actually seeing patients. We anticipate that would have an effect going forward.

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Jailendra Singh, UBS - Analyst [8]

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Got it, okay. And then finally just one high level question. Of course since the spinoff last year the Company had been focused on the divestitures of these underperforming hospitals and which you guys expect to complete over the next 12-15 months. Can you guys talk about the next phase for Quorum Health in terms of initiatives or areas you are planning to focus to grow top-line volumes either via expansion initiatives, JVs, M&A, etc.?

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Tom Miller, Quorum Health Corporation - President & CEO [9]

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As we look forward to our future growth -- and I think we identified when we first came out that it would take us about 18 months on these first eight hospitals and we are ahead of track on those. We are looking at additional assets to make sure that our debt structure is aligned and that is why we are looking at a few additional hospitals associated with that.

As we go forward, every day we work on volume growth, we work on expanding services. One of the key areas I think we identified was we are generally in underserved areas. And so, we have been focusing on recruiting doctors for these underserved areas because in our hospitals one doctor makes a big difference associated with it.

And we had identified in the specialty areas that we were underserved in regard to orthopedics, general surgery, gastroenterology and cardiology. We recruited 19 of those providers in 2016, which makes a big impact. We have focused on our intensity of services -- we were able to take our Medicare case mix in the fourth quarter of 2016 and move it above 1.4, which was our goal for the year was to get that case mix up which represents the intensity. And part of that is opening up four ICUs in our hospitals that were closed down so that we could take care of the sicker patients.

So, we will continue to re-focus our hospitals toward what are the opportunities in the community, what are the growth opportunities, where are the specialty needs and grow the intensity of the patients that we take care of as well as having the providers take care of the patients that are coming to our emergency room. So we will continue to do that. And we think there is great opportunity associated with that.

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Jailendra Singh, UBS - Analyst [10]

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Okay, great. Thanks a lot.

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Operator [11]

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Chris Rigg, Deutsche Bank.

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Chris Rigg, Deutsche Bank - Analyst [12]

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Just wanted to come back to slide 2 and the $200 million of proceeds you guys are targeting. When we think about the facilities that you have either divested already or have under definitive agreement or letters of intent, how much of the $200 million is captured in what you guys sort of have very good visibility on?

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Michael Culotta, Quorum Health Corporation - EVP & CFO [13]

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Chris, right now, based on what we have under letters of intent, we are probably somewhere in about 20% to 25% of that number. Some of the additional hospitals that we have included are some larger hospitals that would make up a larger bulk of the number.

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Chris Rigg, Deutsche Bank - Analyst [14]

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Okay, great. And then on the DSOs, I guess what -- you took a write off at the end of the year. So the 68 days in total, you guys feel very confident that you will get that money through the tour at some point. And can you give us just a general sense, particularly on the money tied up with the CHS collection agency, when you think that might come through the door?

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Michael Culotta, Quorum Health Corporation - EVP & CFO [15]

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Well, when you are in a collection agency a lot of those are time payments, things that will take place. So it will be over a longer period of time. But based on everything that we've seen and reviewed we believe we are very comfortable with the net realizable value there.

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Chris Rigg, Deutsche Bank - Analyst [16]

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Okay, great. And then I understand the reluctancy to not comment on volumes sort of intra-quarter, but we are already a couple weeks into April here. And I guess even if you don't want to comment on the full quarter, is there anything you can provide with regard to even just January and February, just to give us some sense for how things have tracked thus far into the year?

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Michael Culotta, Quorum Health Corporation - EVP & CFO [17]

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No, we would really like to wait until we close out the books and records. Because, as you know, a lot of things like, for example, adjusted admissions is based on your gross inpatient/gross outpatient revenue. And as we are going through all those cycles now with the closing of the books, all that will be impacted by that. So we just want to stay away from first quarter at this point in time.

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Chris Rigg, Deutsche Bank - Analyst [18]

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Okay, I got it. And then finally, just on the ACA impact. When you talk about $36 million of gross benefits in 2016 and then you talk about $26 million of reimbursement cuts, is that $26 million of reimbursement cuts -- maybe this is obvious -- just in 2016 or is that the cumulative impact of what has happened thus far?

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Michael Culotta, Quorum Health Corporation - EVP & CFO [19]

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It is the cumulative roll up. So -- and remember that all started I think roughly I want to say around 2010. So as you were getting like -- for example, all of those cuts kept cutting into the wage index, etc. So yes, that is a cumulative number rollup of all of those cuts that have taken place.

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Chris Rigg, Deutsche Bank - Analyst [20]

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Okay, great. Thanks a lot.

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Operator [21]

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Sheryl Skolnick, Mizuho.

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Sheryl Skolnick, Mizuho Securities - Analyst [22]

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Thank you very much and I will apologize where I am; phone connections are too great and the power goes off at the worst possible time, so I missed the last about 5 or 10 minutes of your -- 5 minutes or so of your comments. So if you said this I apologize.

First of all, thank you for holding this call. And clearly not the way you wanted to start the year, but diligence I'm sure will prevail. And the attempts and efforts you are making in correcting the operations and improving them as the ongoing assets, it is that part of what you said resonates with me is the right thing to do. But I do have a couple of questions going backwards.

First of all, can you clarify -- I think in your comments -- in your press release and 10-K comments you mentioned on the credit agreement revisions and amendments that there was some change in definition of add backs to the consolidated EBITDA. If there were could you please go through those for us?

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Michael Culotta, Quorum Health Corporation - EVP & CFO [23]

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Yes, Sheryl, there were. Some of the add backs that were included in there, for example, is roughly about -- I want to say about $5.1 million to $5.4 million per quarter to get credit for not being able to accrue the California provider program. So that was part of it.

In addition, another item that was an add back was for the hospitals that are losing money we had put in approximately a number of about nine hospitals that were looking to divest and we estimated those losses, those are also an add back that is taking place.

And then also some savings as we bring in the billing offices, but those numbers are basically minor. Then we also adjusted for the net senior secured leverage ratio, it steps down -- technically it was stepping down to 4.25 -- well, at the beginning of Q3 and we moved that up to give us a little bit more room and time to sell these facilities.

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Sheryl Skolnick, Mizuho Securities - Analyst [24]

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Okay. So as I recall correctly, under the prior definition you couldn't add back those losses from the to-be-sold assets until they were actually sold, is that correct?

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Michael Culotta, Quorum Health Corporation - EVP & CFO [25]

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That is correct. And under the new agreement it would give us that add back during the quarters. However, you would then adjust that back to 103 -- section 103 of the credit agreement to make the adjustment for whatever actually occurred for those facilities once we sell those.

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Sheryl Skolnick, Mizuho Securities - Analyst [26]

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Okay, so you pro forma it at first and then you retroactively or you cumulatively adjust it at the time it is sold?

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Michael Culotta, Quorum Health Corporation - EVP & CFO [27]

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Yes, what would take place is -- let's just use an example and say that the estimate is $1 million a quarter, so let's just go with that. And so, we would have that $4 million. But then let's say what actually happens once the hospital is sold that the number is either $3 million or $5 million. You (multiple speakers) adjust to that number and reverse out the old number.

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Sheryl Skolnick, Mizuho Securities - Analyst [28]

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Right, okay. And then you would do that. I got it, okay. If we could just turn back to the AR adjustments for a second. So, I understand on the contractual allowances for Illinois that is somewhat out of your hands, Illinois is Illinois. But on the commercial and managed-care collections, can you give us any kind of color on whether or not you needed to change your current estimate of collectability as opposed to making adjustments for a lack of collectability of old managed-care and commercial receivables?

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Michael Culotta, Quorum Health Corporation - EVP & CFO [29]

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I would say it is probably getting to be a little bit more current. There was some of it that was old but some of it is the denials. We started seeing a growth in commercial or I should say managed-care. And as we were digging into it we were noticing some higher denial factors that are taking place.

We haven't technically given up on all of that, we are still working on old denials and trying to improve that whole entire process. But again, part of that was basically what we were seeing some of the stuff currently.

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Sheryl Skolnick, Mizuho Securities - Analyst [30]

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Okay. So when you are making your estimates of collectability of these receivables today, just to fine-tune this, are you taking into account that higher denial rate? Or are you assuming that higher denial rate won't prevail?

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Michael Culotta, Quorum Health Corporation - EVP & CFO [31]

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No, we are assuming the higher denial rate. So going forward we will be adjusting to that, but at the same time we are extremely -- we brought in a separate group of people that are helping with the denials so that we can try to keep those at bay. But at the same time we are using a higher denial factor until we see debt improve.

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Sheryl Skolnick, Mizuho Securities - Analyst [32]

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Right. So that is an appropriately conservative way to look at it. You assume the higher denial rate but you work your tail off to make sure it doesn't get realized, got it, okay. Okay. And then as you look at this expanded group of assets that you are selling, did I hear you correctly in saying that one of them lost money and the others are low margin?

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Michael Culotta, Quorum Health Corporation - EVP & CFO [33]

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Several of them lost money in the -- one definitely lost throughout the entire 2016. A couple of them lost in the fourth quarter but were low margin for the full year. Does that make sense?

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Sheryl Skolnick, Mizuho Securities - Analyst [34]

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Yes, it does. And then as we think about the business going forward two questions arise. One, the seasonal pattern -- I know you don't want to comment on first-quarter, I don't blame you. But the seasonal pattern that we saw -- you were kind enough to give us the fully stated quarters -- in 2016, will that be a good guide for us in estimating quarterlies for 2017?

Or does the factor -- excluding all the charges on a pro forma or adjusted basis? Or does the fact that there was basically a restart of the Company mid-year make that a less than optimal way of estimating the pattern?

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Michael Culotta, Quorum Health Corporation - EVP & CFO [35]

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I think one of the things to really take a look at is when you take a look there is a pattern there when you go through it. Don't forget in the third quarter -- and if I am going off the reservation here bring me back in.

But if you look in the third quarter, don't forget, one of the unusual items, don't forget, is we sold the tax credits in Illinois for about $8 million, we had the New Mexico gross receipts tax of $2.3 million. So that lowered the taxes and licenses line item for that particular quarter.

Now going forward we will continue to get that $8 million from Illinois. So that will still come in in the third quarter. In addition, what we did is point out that we will not be able to record the California, so all of that will accrue -- if it all comes in, which we believe it will with CMS, it will come in in the fourth quarter.

I do want to state something very interesting here though, even though that number is $21 million, remember California is usually running about 15 to 18 months behind in their payment. So technically that amount doesn't impact our cash flow, it actually is really bizarre. We expect in the third or fourth quarter to get $33 million in cash from California that related to prior year programs. So even though the number is $21 million the cash coming in for 2017 is actually higher if that makes any sense.

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Sheryl Skolnick, Mizuho Securities - Analyst [36]

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It sure does.

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Michael Culotta, Quorum Health Corporation - EVP & CFO [37]

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So, and then again don't forget in your volumes -- and again I don't want to talk about the first quarter. But let's remember February 29 -- you had a leap year last year. So you did have that one year, and I'm talking off the top of my head. I thought that accounted for about 3% but I could be wrong.

But again, as Tom has mentioned, we brought on quite a lot of physicians, we are seeing some good things in that area. And I will probably just leave it at that if that makes any sense. Did I answer your question?

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Sheryl Skolnick, Mizuho Securities - Analyst [38]

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You did, absolutely. And I will pop back on if -- and get back into queue if there are no other questions after me, but I am sure there are. Thank you so much.

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Michael Culotta, Quorum Health Corporation - EVP & CFO [39]

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Sheryl, Sheryl, are you still there?

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Sheryl Skolnick, Mizuho Securities - Analyst [40]

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Yes, I am here.

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Michael Culotta, Quorum Health Corporation - EVP & CFO [41]

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Nobody else is in the queue, so if you have another question or two.

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Sheryl Skolnick, Mizuho Securities - Analyst [42]

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Oh, really, okay. All right. So when we -- so talking about the businesses going forward, just you have done a lot of work just going through the slides and your commentary about the recruiting that you have done, opening the urgent care centers in these markets as well as the investments in Oregon, we got that.

But as these doctors that you are bringing on, is it the usual kind of 12 to 18 months to really ramp up on volumes that we typically see in these situations? Or is there some reason we should believe that they could accelerate just because there is I think you refer to once, Tom, of pent up demand.

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Tom Miller, Quorum Health Corporation - President & CEO [43]

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Yes, Sheryl, I would tell you that, perhaps as we had the opportunity to announce what the first quarter was, you will see -- you could possibly see the impact of recruitment associated with that.

But I think that what we have always felt like is we are seeing patients in our emergency room and we are transferring them out to other facilities. One of our hospitals was transferring 60 patients a month out to another facility. And we had nothing close by to keep them and we had no specialists that we could hold them in our communities. We believe that is where our great opportunity is.

I think as you look at our primary service area -- and again, 80% some of our hospitals are sole community hospitals in their individual primary area. Our market share is only around 33% in our primary service area. What a great opportunity for us to bring an orthopedist into the community, introduce them to every doctor, introduce them in the community to have an impact.

In many of our hospitals one doctor makes tremendous impact associated with it. And we have 75 doctors who have commenced practices in the fourth quarter and in the first quarter of 2017. We do believe that the startup associated with these patients, since they don't have competitors, they are not competing against a group of 20 orthopedists in a community, they are the orthopedist. And it is a different situation than you would see in many of our markets.

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Sheryl Skolnick, Mizuho Securities - Analyst [44]

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I'm glad I asked. Okay. So you might be able to mitigate the start-up losses early on by having some real volume from capturing those transfers, so I have got that. And then on the CapEx, you made a comment that the 2017 CapEx you expect to be $20 million less, is that related to the completion of Oregon?

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Tom Miller, Quorum Health Corporation - President & CEO [45]

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It is not. It is just -- we have committed about $98 million I think in 2016, although cash flow we show about $80 million-$88 million. We are lowering that number down in the $70 million range associated with that and that is just a belief of us being fiscally responsible.

I mean, we have to be fiscally responsible for the cash flow that we bring in. Our goal, Sheryl, I think we told you, we were positive cash flow at the end of 2016. Our goal is to continue to have a positive cash flow for our Company. We think that is vital. And our spend on capital needs to reflect what the cash flow is for our Company.

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Sheryl Skolnick, Mizuho Securities - Analyst [46]

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Yes. And then finally on the guidance. So, the way I thought about this was that if I looked at your fourth-quarter run rate and I took the add back for the assets that you sold and you got to around $40 million and I got to $160 million, that would get you to the midpoint of the $150 million to the $170 million of the part one of your guidance.

Is that the right way to think about that guidance, that that is sort of the midpoint is kind of the run rate from the fourth quarter and then the upper end is doing better?

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Michael Culotta, Quorum Health Corporation - EVP & CFO [47]

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Basically what we did is on the lower end, the $150 million to $170 million, actually includes the facilities to be divested for the period of time from January 1 to the point in time that we believe they will be sold, our estimate based on what they will be sold. The $170 million to $200 million is the add back for the period of time for those losses.

So, when we went and looked at it looking at the run rate, similar to what you did, depending on how you look at it you would have to -- because Q3 would have had the $8 million in it, we have the add back relating to the $8 million. Depending on how you do the run rate you would also have the adjustment relating to the California provider program.

And so, that is how we came up with that range of numbers just making sure from that regard. And then adding back any positive that we had, any changes we are doing with cost-saving measures and then also for the positive on the revenue side.

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Sheryl Skolnick, Mizuho Securities - Analyst [48]

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Okay. All right. And then the physicians that you are hiring, sorry to jump back and forth a little bit. But the physicians that you are hiring, are you able to attract to these communities more seasoned professionals? Or are they -- is it still or is it just more of the new grads who are looking for positions and maybe getting some help paying off their loans?

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Tom Miller, Quorum Health Corporation - President & CEO [49]

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Sheryl, I would say that is a combination. We still get -- we will get individuals out of the military who are more seasoned, we'll get new graduates who want to start up their own practice associated with it. So I wouldn't tell you there is any one consistency between those two; I think it is variable.

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Sheryl Skolnick, Mizuho Securities - Analyst [50]

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Okay. Because we were a little bit concerned with immigration rules being what they are that it might adversely affect rural markets. And that is one of the factors that I was a little concerned about. Are you experiencing any of that so far or are you still okay?

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Tom Miller, Quorum Health Corporation - President & CEO [51]

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I can only speak to our results. We are up 23% in physician commencements from 2015 to 2016. We have hit new records in regard to fourth quarter and first quarter 2017 in regard to what we have recruited. And so, I think from our standpoint anything could change (multiple speakers).

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Sheryl Skolnick, Mizuho Securities - Analyst [52]

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Yes, well, we know that. And then just while we are on the docs, the numbers that you are giving us, is that gross or net of attrition? And if so, if it is net of attrition -- if it is not net of attrition what has attrition been?

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Tom Miller, Quorum Health Corporation - President & CEO [53]

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Sheryl, those are gross numbers; it is very difficult for us to get to the net numbers. Mike, I don't know if you have any specific numbers associated with that. We are not seeing -- we've worked very diligently with our doctors to try to reengage them in our facilities. We still have doctors who leave for whatever reasons, whether it is health or retirement associated with that. But we are seeing positive growth associated in these categories.

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Sheryl Skolnick, Mizuho Securities - Analyst [54]

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Right. So the net number is still positive though, that you are confident in?

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Tom Miller, Quorum Health Corporation - President & CEO [55]

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It is, yes.

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Sheryl Skolnick, Mizuho Securities - Analyst [56]

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By the time all is said and done, whatever recruiting you have done you still ended up with a higher headcount of qualified physicians and specialists especially in your markets?

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Tom Miller, Quorum Health Corporation - President & CEO [57]

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Absolutely.

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Sheryl Skolnick, Mizuho Securities - Analyst [58]

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Okay, that is fair. And then, again I apologize for bouncing around, but certain things occur to me as I go on. And I really appreciate having this almost private audience, this is phenomenal.

On the CapEx number, so I understand the prudence of trying to make sure and maintain positive cash flows, especially given the degree of leverage and the focus that I have on free cash flow and that it be positive so you can sustain the business. And given that the scale is still fairly small, so that is even more important.

But some companies measure this as a percentage of revenues. And if my math is correct your percentage of revenue is substantially below the peer group for CapEx. Two questions: one, is that the right way to look at it?

And two, if it is, are you concerned at all that you are perhaps at this juncture able to either -- I hesitate to say under invest, but maybe it is a little bit of under investing to sustain the enterprise along a positive free cash flow basis?

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Michael Culotta, Quorum Health Corporation - EVP & CFO [59]

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I think, Sheryl, the big thing to look at there is we would probably be normal within our peer group. But remember, with the number of divestitures we have, it just doesn't make a whole lot of sense to be investing in potentially facilities that we are getting very close to selling from that regard. Now we are not going to shortchange quality by any stretch of the imagination, but we have to be frugal also in what we are doing.

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Sheryl Skolnick, Mizuho Securities - Analyst [60]

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Yes, yes. No, I don't disagree with that at all. And then the final question that I have for you. So you are at 36 hospitals as of the end of the quarter, that makes 35 now because you have closed in 3-31 on one sale, right. You have 9 more to go, so by my math, if I can do simple math, that is 26 hospitals remaining in the core base. Is that right?

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Tom Miller, Quorum Health Corporation - President & CEO [61]

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That would be right.

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Sheryl Skolnick, Mizuho Securities - Analyst [62]

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Okay. Didn't you have one pending in Texas as an acquisition?

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Tom Miller, Quorum Health Corporation - President & CEO [63]

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Sheryl, we had announced that we had a letter of intent to purchase that. We are still working with that hospital to look at our relationship and how it might change. The hospital has changed a little bit over its time and so we are still looking at how we can have a positive relationship with it even if it is not a full acquisition.

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Sheryl Skolnick, Mizuho Securities - Analyst [64]

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Okey-doke, I got that. And so, my question then becomes 26 hospitals is a small scale; it is a little hard to get leverage off of that. I am going to presume that there is still going to be some concentration in key markets that make sense. But how concerned should we be at the small scale?

And I hesitate almost to bring this up. But at some point don't you have to add to that base to get appropriate leverage given the kind of necessary and sophisticated work you are doing in bringing the AR back under your own control and not relying on someone else's collection agency, etc., etc.?

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Michael Culotta, Quorum Health Corporation - EVP & CFO [65]

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Let me throw something out there. We talked about these facilities, these facilities that we are talking about that we have sold and will be selling range anywhere from about $33 million to $38 million in negative EBITDA. And then when you tack on the CapEx associated with it, throw in another $15 million, you are throwing out a whole lot of negative cash flow just in those facilities.

And so, I hear what you are saying from the standpoint -- and I will let Tom follow up with that. But the first and foremost thing we have got to do is get and really concentrate on the hospitals that are doing very, very well, that are very profitable, have a lot of potential to grow. And take those that are draining us of the cash and getting those off. So, I think with that (multiple speakers).

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Tom Miller, Quorum Health Corporation - President & CEO [66]

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Yes and I will just add, Sheryl, our priority -- and we have not been shy in saying this and we are absolutely committed to this -- is to right size our assets, right size our portfolio to be able to build upon. And we have to do that first, that is our number one priority and we are still focused on that.

We are just completing -- coming close to completing our first year of operation. And our goal was to get our assets in line and we are still focused on that. And, Mike is right, we are showing about $15 million, maybe $20 million less than last year, but a lot of that has to do with not spending money on hospitals that are for sale.

And we are still investing where we need to invest to make sure they are a safe facility. But you don't do the growth opportunities. My goal is never to miss an opportunity for growth.

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Sheryl Skolnick, Mizuho Securities - Analyst [67]

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Well, I hear that and I certainly can agree with you that getting rid of the hospitals -- sorry to them -- but that are causing such a drain on the Company's cash flows at this moment is prudent. Repositioning the portfolio according to what current management of these assets, this Company thinks is wise given these growth opportunities is also prudent.

It is almost as if we are in that difficult transition time where you are going to be small. And when you are small anything that goes right gets magnified but so does the other. That we should be aware that there could be very significant volatility in results as a result of either timing differences, the way you gave guidance in step one for when you might sell these things, how much you might get, how much debt you might be able to pay, etc.

But never mind the fact that it is going to end up being a relatively small base of high-performing hospitals. It is just I think prudent for us to think about it as a year in which there could be high volatility even though the strategy is pursuing positive -- in a positive direction. Is that fair?

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Tom Miller, Quorum Health Corporation - President & CEO [68]

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Sheryl let me just -- yes, I think it is fair. Let me remind you first of all we are part of HealthTrust Purchasing Group's [pharma] supply expenses, we get the value. And that tends to be 17% to 18% of our overall cost associated with it. So we get the value of companies like ACA with the same purchasing price. So it is a great value that we have.

Wages, wages are unique to every market. There is no national I am going to save money because I am larger or smaller; it is unique to every single market. And we believe we are competitive but we are also fiscally responsible. And we are going to stay fiscally responsible associated with that.

And I believe that, yes, by having the right assets that allow us a strong base we will be able to grow both at our current hospitals and as we go forward in the future.

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Sheryl Skolnick, Mizuho Securities - Analyst [69]

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Excellent, that is very fair and I appreciate all this time you have given me. Thank you so much. I think a lot of folks' questions have -- I hope a lot of folks' questions have been answered, this is very helpful.

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Michael Culotta, Quorum Health Corporation - EVP & CFO [70]

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Thanks, Sheryl.

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Operator [71]

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A.J. Rice, UBS.

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Jailendra Singh, UBS - Analyst [72]

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This is Jailendra Singh again for A.J. Just one quick clarification I needed. So, for Barrow and Sandhills hospitals, on page 2 today you are highlighting that the proceeds were around like $14 million. And I think on the third-quarter earnings call you indicated expectations for $25 million of proceeds on those two hospitals. What is the disconnect?

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Michael Culotta, Quorum Health Corporation - EVP & CFO [73]

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Yes, I think part of that is -- and I thought that meant the three, but maybe it was the two, but I thought it was the three. The other part of that related to as the receivables are being collected, and again that takes a longer period of time. So at that point in time we had included also the amount that we would get potentially from the receivables, that is the difference and that process is still ongoing.

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Jailendra Singh, UBS - Analyst [74]

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Okay, all right, thanks a lot.

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Operator [75]

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That completes our last question. I will now turn the call back over to Mr. Miller for closing remarks.

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Tom Miller, Quorum Health Corporation - President & CEO [76]

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Kelly, thank you again. I want to thank all of you for being on the call and your interest in Quorum Health. We do believe we have a great story to tell, we believe we have great associates working for us. We believe we have engaged our doctors going forward. And we believe as we execute our strategy that we will be a successful Company going forward. So we thank you for your time. Thank you, Kelly.

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Operator [77]

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And this concludes today's conference call. You may now disconnect.