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Quorum Health Corp (QHC)
Q3Â 2018 Earnings Conference Call
Nov. 07, 2018, 11:00 a.m. ET
Contents:
- Prepared Remarks
- Questions and Answers
- Call Participants
Prepared Remarks:
Operator
Good morning and welcome to Quorum Health Corporation's third quarter earnings conference call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will be given at that time. As a reminder, today's call is being recorded. Before we begin the call, I'd like to read the following disclosure statement.
This conference call may contain certain forward-looking statements, including all statements that do not relate solely to historical or current facts. These forward-looking statements are subject to a number of known and unknown risks, which are described in headings such as Risk Factors in the Company's Form 10-K filing, their current Form 10-Q 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 and today's discussion. The Company does not intend to update any of these forward-looking statements.
Quorum Health issued a press release yesterday afternoon with their financial statements and definitions and calculations of adjusted EBITDA and adjusted EBITDA adjusted for divestitures, including reconciliations to US GAAP measurements. A slide presentation is available on the Company's website to supplement today's call.
Results discussed today consolidate the results of Quorum's 27 owned or leased hospitals and the results of Quorum Health Resources. Same-facility information excludes the results of the 11 facilities that have been divested or closed since the spin-off through September 30, 2018.
In addition, the Company filed their quarterly report on Form 10-Q for the third quarter yesterday. All discussions today are supplemented by the press release, the earnings presentation on the Company's website and the Form 10-Q filed with SEC last night. All non-GAAP calculations discussed will exclude certain legal, professional and settlement costs, charges relating to the impairment of long-lived assets and goodwill, the net gain or loss on sale of hospitals, the net loss on the closure of hospitals, cost associated with the transition of the transition services agreement, or TSAs, transaction costs related to the spin-off, severance costs for the headcount reductions and executive changes as well as changes in estimates related to the collectability of patient accounts receivable. Please refer to the earnings presentation located on the Investor Relation section of the Company's website at www.quorumhealth.com. For a further description and calculation of adjusted EBITDA and adjusted EBITDA adjusted for divestitures.
With that, I'd like to turn the call over to Mr. Bob Fish, Quorum's President and Chief Executive Officer. Mr. Fish, you may proceed.
Robert Fish -- President and Chief Executive Officer
Thank you, Mike and good morning everyone. Thank you for joining us to discuss Quorum Health's third quarter 2018 financial and operating results. Joining me on the call this morning are Alfred Lumsdaine, our Chief Financial Officer; Marty Smith, our Chief Operating Officer and Dr. Shaheed Koury, our Chief Medical Officer. We will begin with some prepared remarks regarding our third quarter results and then open the call for your questions.
Overall, I am pleased with our financial and operating results for the quarter as well as the progress we're making on our strategic initiatives. We reported same-facility net operating revenue of $463.8 million, a 5.8% year-over-year increase. This increase in our same facility net operating revenue was driven by higher rates in acuity, the impact of the California Hospital Quality Assurance Fee program or HQAF, and the monetization of property tax credits in the State of Illinois. When normalized for HQAF and Illinois property tax credits, same facility net operating revenue increased 2.1% year-over-year. Adjusted EBITDA, adjusted for divestitures for the quarter came in at $42.8 million. As a percentage of same-facility net operating revenue, adjusted EBITDA adjusted for divestiture was 9.2% for the quarter compared to 8.7% for the third quarter of 2017.
Our improved margins are primarily the result of our focus on providing higher acuity services, driving efficiencies across our hospital operations, reducing corporate overhead and the impact of the California HQAF program. In terms of same-facility volumes, admissions were down 4.5% year-over-year, while adjusted admissions were down 2.1% for the same period. Finally, our same-facility all-payer case mix index increased 4.4% year-over-year, and same-facility net patient revenue per adjusted admission grew 5.2% on a normalized basis, again, primarily as a result of our focus on the right volume, at the right cost.
Going beyond the numbers, we made progress on several of our strategic initiatives during the third quarter. First, we continued to reduce our leverage by divesting non-core assets. As we announced last month, on September 30, we completed the divestiture of the McKenzie Regional Hospital. Subsequent to the end of the quarter, we paid down $10 million of debt, using proceeds from divestitures. Our target remains $165 million to $215 million in proceeds from divestitures before the end of 2019. As we've indicated, our goal is to reduce our leverage to under 6 times, doing this in order to execute a refinancing at significantly lower interest rates.
From an asset divestiture standpoint, we're continuing to make progress, despite some of the unique challenges we faced in divesting hospitals in our more rural markets. As of today, we have four LOIs covering five hospitals for a total potential proceed of approximately $105 million. Several of these current LOIs are likely to move to definitive agreement within the next 30 days. We would remind you that LOIs are non-binding agreements and should be viewed only as an indicator of interest, not as a barometer of our progress toward reaching our divestiture goal.
Turning to another key goal of improving our operating margins, we continue to see the expected impact from the margin improvement initiatives we put in place earlier this year. We're on track to accomplish our previously stated objective that will yield $30 million to $35 million of incremental annual EBITDA. $20 million to $25 million of this improvement will be achieved in 2018. The best measure of our focus on expense management is demonstrated by the 200 basis point decrease in same-facility operating expense, as a percentage of same-facility net revenue when compared to the first quarter of 2018.
Finally, I'd like to touch on the third initiative that of existing our transition -- exiting our transition service agreements. As you'll recall, we announced last quarter that the panel in our arbitration with CHS ruled that unless both parties agree to an early termination, Quorum can remain in the shared service center and information technology TSAs according to their initial terms through 2021. In early October, the second round of arbitration regarding financial claims with CHS was completed. A decision is expected from the arbitrators by the middle of January 2019. There is nothing further to add on the financial aspect to the arbitration until we receive a decision and we'll continue to keep you up to date on any developments.
You'll also recall that we previously agreed with CHS to exit the Eligibility Screening Services TSA, the Physician Practice Support TSA, and the Secondary Receivable Collection TSA. We exited the Eligibility Screening Services TSA at the end of the second quarter, and have since successfully taken all aspects of this agreement in-house, and implemented our own set of policies and procedures, appropriate for our portfolio of hospitals. The Physician Practice Support and Secondary Receivable Collection TSAs were exited on October 1. The exit of these TSAs has gone smoothly, and we're operating under new contracts with new vendors. As stated previously, we expect exiting these three TSAs will yield an incremental $8 million to $12 million in annual EBITDA.
Given our financial and operating results so far this year, we are reiterating our 2018 net operating revenue guidance range of $1.875 billion to $1.925 billion, and our full-year 2018 adjusted EBITDA adjusted for divestitures guidance range of $145 million to $165 million. As I mentioned at the start of the call, I'm very pleased with our results for the third quarter, the financial and operational improvements we've made, as well as the momentum we've been able to achieve.
With that, I will turn the call over to Marty for a discussion of our operations during the quarter.
Martin D. Smith -- Executive Vice President and Chief Operating Officer
Thanks, Bob. Good morning, everyone. As Bob mentioned, we continue to make good progress on our operational initiatives. On the heels of the changes we made early in the second quarter, our hospital leadership teams have continued their disciplined efforts to improve performance by focusing on more balanced approach to volume growth and margin improvement. On these efforts, we have seen the expected negative impact on volume, as Bob mentioned, and I will discuss momentarily, but they've also resulted in a lower run rate of operating expenses relative to the first quarter of the year and an overall improvement in our operating margins.
We continue to assess many aspects of our business, including physician productivity, individual service line profitability, improvements in payer mix, and overall expense management. As Bob mentioned, we exited our Physician Practice Support TSA at the beginning of October. Combined with the leadership changes we've made in our physician practice group we are seeing meaningful improvements in this area of our operations as well. As of the end of the third quarter, we have 149 mid-level providers and 296 physicians employed in our hospitals.
In terms of our same-facility operating results in the quarter, total admissions were down 4.5% year-over-year. Overall, the decline in our admissions was primarily the result of our margin improvement initiatives, specifically discontinuation of certain service lines, terminations of physicians and cancellations of Medicaid MCO contracts in select markets. We also saw a decline in admissions, resulting from certain volume shifting from inpatient to outpatient due to a year-over-year increase in our outpatient observations. This dynamic is reflected in the lower 2.1% year-over-year decline in our adjusted admissions. We also saw a 1.1% decline in year-over-year same-facility ER visits.
Similar to the admissions, the same-facility surgery volumes decreased by 5.2% year-over-year, again, primarily the actions of the margin improvement initiatives we put in place. We saw particular declines in OB/GYN, GI and general surgery, primarily the result of service line closures, physician terminations and/or Medicaid contract cancellations.
On the other hand, we continued to see higher acuity surgery volumes in neurosurgery, growth in vascular surgery, pulmonary procedures and orthopedic cases. This growth in these service lines has had a notable impact in our performance and improvement in our net revenue.
As a result of our focus on high acuity volumes, our overall case mix grew again in the third quarter compared to prior year, our net revenue per adjusted admission increased 9.2% overall in the quarter, and 5.2% when normalizing the California HQAF and the Illinois provider tax credits. Our focus on the right type of volume also continues to show positive impact on our payer mix. When normalizing again for California HQAF and Illinois property tax credits, managed care and commercial revenues, as a percent of our total patient revenues increased to 43.2%. This represents a 20 basis point sequential increase from the last quarter and an over 400 basis point increase from the prior year. Meanwhile, Medicaid and self-pay as a percent of total net patient revenue declined to 19.3% and 8.8% respectively.
Before I go ahead and turn the call over to Alfred, I would like to give a quick update on our Springfield, Oregon project. As you know, this is a multi-year, multi-phase project that started in 2015, and has been a major growth investment for us. As it stands today, the project is approximately 95% complete, the inpatient tower, the cath lab and the surgery expansion are now operational. The remaining major phases of this project (inaudible) unit, which is scheduled to open this month, and the opening of the new ED (ph) which will double the current capacity. The new ED is expected to be substantially operational by the end of this year.
I'll now turn the call over to Alfred for more detail on our financial results.
Alfred Lumsdaine -- Executive Vice President and Chief Financial Officer
Thanks, Marty, and good morning everyone. I'd like to take just a few minutes to take a deeper dive into some of the financial results for the quarter. Our same-facility net operating revenues of approximately $464 million were up almost 6% year-over-year from the approximately $439 million in Q3 of 2017. Revenues were positively impacted by approximately $9 million relating to the California HQAF program and $7 million relating to the monetization of Illinois property tax credits. These tax credits were recognized as a contra expense last year but as revenue in the current year from the adoption of ASC 606 in January of this year.
Normalized for these items, net operating revenues were up just over 2% from last year. Now turning to our expenses, same-facility salaries, wages and benefits at our hospitals were up 4% year-over-year. This is primarily as a consequence of the reversal of certain performance-based incentives for the first nine months of the year in the 2017 period. If we exclude this impact, our salaries, wages and benefits are up just 1% year-over-year, primarily from added service lines as well as more employee positions.
Same-facility supply expense at our hospitals decreased 2% as a result of fewer surgical procedures and the divestiture of an oncology clinic in Q2 of this year. Same-facility other hospital operating expenses increased approximately 14% year-over-year, primarily from the recognition of the Illinois property tax credits as a contra expense in the third quarter of 2017. When we normalize for this impact, same-facility other hospital operating expenses increased approximately 6% year-over-year, primarily from increased provider taxes in Illinois, Texas and California.
In summary, when normalized for the Illinois property tax credits as well as the reversal of the performance-based incentives in the third quarter of 2017, our same-facility hospital expenses grew less than 3% year-over-year during the quarter. This is a marked improvement from the year-over-year increases that we experienced in Q2 and Q1 of this year.
If we turn now to cash flow for the quarter, cash flow from operations improved to approximately $28 million, an increase of approximately $18 million compared to the third quarter of last year. This increase in our cash flow from operations is driven by improved financial results, continued focus on receivables collections and the timing of routine working capital items.
Capital expenditures for the quarter were approximately $10 million, a decline of approximately $5 million relative to the third quarter of last year. The majority of this decline relates to a reduction in the level of capital spending associated with the Springfield, Oregon Tower project that Marty just mentioned.
As it relates to cash flows for the full year, we continued to target to be around break-even in terms of free cash flow with capital expenditures expected to be in the $60 million range for the full year. This includes approximately $8 million remaining CapEx for the Springfield, Oregon project.
Next I'd like to make a few brief comments about our balance sheet. As Bob mentioned, our net debt at September 30 was $1.22 billion. This includes approximately $801 million outstanding on the term loan, which was reduced by $10 million subsequent to quarter-end. We have no amounts drawn on our ABL revolver at September 30.
Our EBITDA cushion for compliance purposes at September 30 was $33 million. Our compliance ratio at the end of the quarter as calculated under our credit agreement was 4.15 times.
Finally, I'd like to make a few quick comments regarding our expectations for the fourth quarter. We don't give quarterly guidance of course, but we would expect to see the same dynamics in the fourth quarter that we've seen year-to-date. This includes softer volumes more than offset by improved acuity and rate relative to last year. I'd also remind you that last year in the fourth quarter, we recorded an entire year's worth of revenue associated with the HQAF program. This resulted in $22.4 million in revenues and $16.5 million of EBITDA associated with the first three quarters of 2017 being recognized in the fourth quarter. This will notably distort the year-over-year comparisons for EBITDA, revenue and revenue derived metrics.
With that I'd like to turn the call back to Bob.
Robert Fish -- President and Chief Executive Officer
Thanks, Alfred. Before we open up the call for questions, I want to thank our physicians, our hospital leadership teams, our nurses and our teams at Quorum Health Resources and the corporate office for their dedication and hard work. We also thank you our shareholders for your support. We've made some (ph) great progress so far and will remain acutely focused on our strategic goals in the months to come.
With that, I'll open it up for questions.
Questions and Answers:
Operator
(Operator Instructions) Your first question comes from Zach Sopcak from Morgan Stanley.
Zachary Sopcak -- Morgan Stanley -- Analyst
Good morning and congrats on the quarter. A couple of questions first on the quarter. (inaudible) explained the trend pretty well. If I think about the rightsizing, I guess, of your volume, should we think about -- we're about two quarters into it, so it should be about two more quarters before kind of normalize to what you would expect your normal admissions growth to be?
Alfred Lumsdaine -- Executive Vice President and Chief Financial Officer
Thanks, Zach. I think that's a fair assumption. I think that would be consistent with our expectations.
Zachary Sopcak -- Morgan Stanley -- Analyst
Okay, great. And when I look at your case mix, so managed care and commercial is up over 400 basis points versus Q3 '17 and then another 300 basis points sequentially. I think you touched on it a little bit, but can you give any more color, is this kind of where you think you want to be and is this a function of the moves that you've made to improve your mix or is there something else going on more transient we should think about?
Alfred Lumsdaine -- Executive Vice President and Chief Financial Officer
Yeah, I think you're on the right track. I think clearly we have been focused, as Bob mentioned, on the right volumes and achieving the right mix. And that has been driven certainly, partially or significantly by the actions we've taken in terms of contracts that we've terminated or renegotiated, service lines that we've discontinued and that's resulted of course in higher acuity volumes at -- with a skewing toward payer mix that is more -- certainly more commercial. So I can't sit here and say definitively that we are where we want to be long term, every quarter is different, every situation is different. We clearly want to be doing services that we can make a reasonable margin on. So -- but I think what you're saying in terms of payer mix is certainly reflected in those actions. And Marty I don't know if you have any additional color to add.
Martin D. Smith -- Executive Vice President and Chief Operating Officer
I think two things I'll add. One, most of our case mix growth is being driven by surgery acuity. And so when you look at the two broke down between medical and surgical, you see an increase in our medical case mix but you see the biggest jump in increase on the surgery. So surgery is the primary factor. I also want to point out, we put in quite a bit of resources in and around coding, documentation, case management to ensure we're getting accurate information from our providers about procedures they are performing and being able to bill and handle those things more appropriately. So I do want to point out, we've got some nice resources here in terms of clinical coding and documentation that I think are having a positive impact on getting the right information for billing purposes.
Zachary Sopcak -- Morgan Stanley -- Analyst
Okay, great. Thank you. And a question -- I know it's early to ask about 2019, but I know you've talked about getting your debt below 6 times -- your debt-to-EBITDA ratio below 6 times in 2019 and you discussed the algorithm between paydown and EBITDA growth. Any changes to how you're thinking about that given your second quarter of solid performance in a row or should we think about a similar algorithm going forward?
Martin D. Smith -- Executive Vice President and Chief Operating Officer
No, I think obviously we will be back to you as we provide guidance to 2019. But I think for the last three months, we're continuing to think about it in the same way focused on both sides of the equation in terms of the numerator and denominator. If we can improve as we improve adjusted EBITDA, it's certainly one side of the lever, but we're equally intensely focused on the divestiture program and reducing our debt load to effect to get to that 6 times where we think we can affect the most favorable refinancing.
Zachary Sopcak -- Morgan Stanley -- Analyst
Okay. Great. Thanks. And last one and I'll control. I've got a question from a couple investors about your plan for refinancing and repricing looking forward as you continue to improve operations, if you could share at all?
Martin D. Smith -- Executive Vice President and Chief Operating Officer
I'm sorry, Zach, you broke up a little bit and I didn't pick up the question.
Zachary Sopcak -- Morgan Stanley -- Analyst
I'm sorry. If you could say at all what's your plans are for refinancing or repricing going forward?
Robert Fish -- President and Chief Executive Officer
Yeah, I think, kind of going to piggybacking off of the last answer, I think we continue to believe that we can most effectively get to a refinancing if we achieve that leverage ratio sustainably at 6 times or less that opens up we think the right investment opportunities and we continue to believe that there is opportunity for more than 300 basis points improvement in our interest debt profile, which would be extremely meaningful in terms of creating roughly $35 million of additional free cash flow.
Zachary Sopcak -- Morgan Stanley -- Analyst
Okay. Great. Thanks and congrats again for the quarter.
Robert Fish -- President and Chief Executive Officer
Thank you.
Operator
Your next question comes from Jason Adler from UBS.
Jason Adler -- UBS -- Analyst
Hi. Thank you for taking the questions. Just a couple on the potential asset sales. Are the five hospitals that are under LOI right now, are they profitable or unprofitable? And can you give us any sense of the magnitude, one way or the other?
Robert Fish -- President and Chief Executive Officer
I would say overall, we have some negative margin or low single-digit margin facilities in that five.
Jason Adler -- UBS -- Analyst
Okay. And then are there other hospitals after these five that you would look to divest? If you're successful at hitting your target, you're going to achieve those proceed goal. So, are there more to come after that? Or are you happy with the network after those five (ph)?
Alfred Lumsdaine -- Executive Vice President and Chief Financial Officer
There would be more to come after that. Of course we're obviously making an assumption that all five close, and as Bob mentioned LOIs, they do tend to come and go. We do expect some of these to move to definitive agreement in relatively short order. You've all five of those closed at the current expectation, we would be -- that would make a significant headway toward our goal of $165 million to $215 million, but we would still be short. So you can expect that we are continuing to have conversations on additional hospital to get to that $165 million to $215 million.
Jason Adler -- UBS -- Analyst
Okay, got it. And then the losses at McKenzie Regional during the quarter were considerable. Are those losses consistent with the previous quarters? How should we think about the losses coming out of the business now that that sales complete?
Alfred Lumsdaine -- Executive Vice President and Chief Financial Officer
Yeah, the losses are accelerated significantly because that was a closure and sale of the asset. So what you saw in the quarter is not indicative of the loss profile historically.
Jason Adler -- UBS -- Analyst
Okay. And then the last one for me. Just thinking about the steps to achieve that 6 times leverage goal, there's obviously the asset sales. You took out costs during the quarter and then you've got this $30 million to $35 million of cost savings. If you achieve all of those, do you envision being at that 6 times level? Or is there additional volume growth or revenue growth needed to get to that level in your mind?
Alfred Lumsdaine -- Executive Vice President and Chief Financial Officer
Yeah, good question and obviously we're not at the point of providing any 2019 guidance nor is that really embedded in your question. But, yeah, I think candidly, it's just kind of math, if you will. As we look at, we have much more control in the near-term over our cost profile. So as you saw, we've got the cost reduction program, we've talked about some of the other things we were doing such as the tailwind of that $8 million to $12 million benefit that we get essentially 2019 over 2018 from coming off of those three TSAs. So I would just say, obviously we're forecasting where we'll be in 2019 and we're not presuming dramatic volume growth of any kind to get to that 6 times leverage.
Jason Adler -- UBS -- Analyst
Okay. Thank you for taking the questions. Thanks.
Alfred Lumsdaine -- Executive Vice President and Chief Financial Officer
Thank you.
Operator
The next question comes from Elie Radinsky from Cantor Fitzgerald. Your line is open.
Elie Radinsky -- Cantor Fitzgerald -- Analyst
Yes, just the admission drop appears to be rather severe. What are you doing from a physician recruitment standpoint in order to bolster your admissions? And then clearly fixed -- large fixed cost assets leveraging admissions can go a long way to help your EBITDA here?
Alfred Lumsdaine -- Executive Vice President and Chief Financial Officer
Well, again, the point here was the reduction in volume was primarily in and around negative margin volume. So it was intentional on our part. If you look at across the board, the volume increases, we'll say 70% to 75% of those were (inaudible) as it relates to, again, intentional decision on our part to reduce our costs and improve our operating margin. We are still continuing to recruit physicians as we talked about on the last call. We'll recruit somewhere in the neighborhood of 60 providers this year which was basically our target. We will actually exceed our target this year. We're just making sure we're putting the right doctors in the right places at the right cost so that -- so that the overall process is accretive to the community hospital and keeping that hospital moving in the right operating margin direction so to speak.
Elie Radinsky -- Cantor Fitzgerald -- Analyst
Okay. And lastly, once you do this -- these five hospitals, let's say they move definitive agreement and you get $105 million for them, how much more is there to achieve your targets, in other words was how many hospitals were already sold to get you to that $195 million to $250 million number?
Alfred Lumsdaine -- Executive Vice President and Chief Financial Officer
Right. Well $165 million to $215 million is the target that we provided earlier this year. We have sold -- sold and closed the one hospital McKenzie since we provided that target, which has very small proceeds, but of course a larger loss profile. So to-date we've not made too much progress toward the $165 million to $215 million. Of course, if we close all or a significant number of these five, well, $105 million would make a significant dent in it. But we would still be gapped, call it roughly $60 million to $100 million of additional proceeds that we will need in order to get to that under 6 times leverage profile. And of course, that's the range necessarily because we don't know exactly which hospitals will end up being disposed (inaudible) profit profile of those, and that's what creates the range. But as we sit here today, we -- I would say, very little has changed from when we last spoke or even as we set that target in terms of what we'll need to do to reach that divestiture goal. I can't give you the number of hospitals because it really will just depend on which hospitals ultimately are divested.
Elie Radinsky -- Cantor Fitzgerald -- Analyst
Thank you very much.
Robert Fish -- President and Chief Executive Officer
Thank you.
Operator
Your next question comes from Rishi Parekh from Barclays.
Rishi Parekh -- Barclays -- Analyst
Good morning. Just one quick question. On the expectations with your rate decline of 300 basis points, I know you have a number of asset sales coming in, $100 million plus maybe another $60 million as you just mentioned, but how should we think about what needs to happen to get to that 300 basis points of cost of capital improvement? Just given the rates that we see in the market today, is it going to require either further equity, cash infusion, equitization of bonds or what's going to require to get to that 300 basis points of improvement?
Alfred Lumsdaine -- Executive Vice President and Chief Financial Officer
Yeah, thanks for the question. Rishi, I think fundamentally it's going to require that we get the rating agencies an upgrade, which will open up different investment pools which will put us into -- allow us to achieve that type of reduction. That's the best projection we have currently from -- in talking with our commercial bankers. Clearly it will require that we reduce our leverage profile, obtain those rating upgrades, which will make us much more marketable.
Operator
And that was our last question. At this time, I will turn the call back over to Mr. Bob Fish for closing comments.
Robert Fish -- President and Chief Executive Officer
Well, that's all we have for you today. Thanks very much for being on the call. We look forward to chatting with you between now and the next time we're together on our earnings call for next quarter. Thanks very much.
Operator
This concludes today's conference call. You may now disconnect.
Duration: 33 minutes
Call participants:
Robert Fish -- President and Chief Executive Officer
Martin D. Smith -- Executive Vice President and Chief Operating Officer
Alfred Lumsdaine -- Executive Vice President and Chief Financial Officer
Zachary Sopcak -- Morgan Stanley -- Analyst
Jason Adler -- UBS -- Analyst
Elie Radinsky -- Cantor Fitzgerald -- Analyst
Rishi Parekh -- Barclays -- Analyst
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