Ross W. Comeaux - Community Health Systems, Inc.

Wayne T. Smith - Community Health Systems, Inc.

Tim L. Hingtgen - Community Health Systems, Inc.

Thomas J. Aaron - Community Health Systems, Inc.

Frank George Morgan - RBC Capital Markets LLC A. J.

Rice - Credit Suisse Securities (USA) LLC Brian Gil Tanquilut - Jefferies LLC Ana A. Gupte - Leerink Partners LLC Joshua Raskin - Nephron Research LLC Gary P.

Taylor - JPMorgan Securities LLC Kevin Mark Fischbeck - Bank of America Merrill Lynch Sarah E. James - Piper Jaffray & Co.

Thank you, Mike. Good morning and welcome to Community Health Systems first quarter conference call.

Before we begin the call, I'd like to read the following disclosure statement. This conference call may contain certain forward-looking statements, including all statements that do not relate solely to historically or current facts.

These forward-looking statements are subject to a number of known and unknown risks, which are described in headings such as Risk Factors in our annual report on Form 10-K and other reports filed with or furnished to Securities and Exchange Commission. As a consequence, actual results may differ significantly from those expressed in any forward-looking statements in today's discussion.

We do not intend to update any of these forward-looking statements. Yesterday afternoon, we issued a press release with our financial statements and definitions and calculations of adjusted EBITDA and adjusted EPS.

For those of you listening to the live broadcast of this conference call, a supplemental slide presentation has been posted to our website. We will refer to those slides during this earnings call.

As a reminder, we've adopted the new revenue recognition standard in ASC 606 on January 1, 2018. One take from this new standard is that the majority of what was previously classified as provision for bad debt are now reflected as implicit price concessions, and therefore included as a reduction to net operating revenues in 2018, which we have characterized as the provision for uncollectible revenue on a go-forward basis.

As such, the numbers we will discuss include comparisons of net revenue after the provision for uncollectible revenue in 2018 and 2017. All calculations we will discuss also exclude the discontinued operations, loss from early extinguishment of debt, impairment expense, as well as gains and losses on the sale of businesses, expenses incurred related to divestitures, expenses related to the government and other legal settlements and related costs, expenses related to employee termination benefits and other restructuring charges, expense from fair value adjustments to the CVR agreement liability related to the HMA legal proceedings, and related legal expenses.

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

Mr. Smith?

Thank you, Ross. Good morning and welcome to our first quarter conference call.

Tim Hingtgen, our President and Chief Operating Officer, is with me on the call today along with Tom Aaron, our Executive Vice President and Chief Financial Officer. On today's call, I will provide some comments on the company, as well as our performance during the quarter.

Then I'll turn the call over to Tim, who will discuss some additional detail around our operations, and then Tom will provide more color on our first quarter financial results. Overall, our first quarter results were a good start to 2018.

We still have plenty of work to do, but we expect to build on this performance as we move through the remainder of 2018. During the first quarter, similar to our performance in the fourth quarter of 2017, we drove improved net revenue performance year-over-year.

Our same-store net revenue was up 1.6% versus the prior year and net revenue per adjusted admission was up 3.5%. Adjusted EBITDA was $440 million for the first quarter and was up sequentially, and our adjusted EBITDA margin of 11.9% was improved on both a sequential and a year-over-year basis.

So, we've made some good strategic and operational progress during the quarter, and we believe we are well-positioned to drive further improvements during the remainder of 2018. On the quality side, we continue to make strong advances, as enhancing the quality and safety of care for our patients and communities is a core strategy.

And one quality metric that we continuously track is Serious Safety Event Rates, or SSER. Through the end of 2017, our Serious Safety Event Rate showed an overall 82% reduction from the baseline set in 2013 for our legacy hospitals and 68% reduction since the baseline set in 2015 for the HMA hospitals.

As a company, we have been investing in service line enhancements across our portfolio, such as neurology, cardiovascular, and other high acuity areas of care. During the first quarter of 2018, our Porter Hospital in Valparaiso, Indiana was the first hospital in the nation to be recognized by an American College of Cardiology's Accreditation Services for atrial fibrillation with EPS Accreditation, Version 3.

The hospital met or exceeded a number of criteria and has organized a team of doctors, nurses, clinicians, and other administrative staff to support efforts leading to better patient education, improved patient outcomes, and more effective and efficient disease control for AFib. We were pleased to see Porter get recognized as the first in the country with this achievement.

As you know, while we've been investing in a number of strategies to drive core operational growth, we have also been working on divestitures. These divestitures are helping to transition our focus to our most sustainable markets and ones that are positioned for improved growth.

For 2018, we continue to expect to close hospital divestitures by the end of 2018 that account for approximately $2 billion of net revenue in the full year of 2017 and had mid single-digit EBITDA margin. In 2018, we expect these divestitures to generate approximately $1.3 billion of gross proceeds, which does not include the retention of net working capital.

And beyond this group of divestitures I just mentioned, we're continuing to work to optimize and strengthen our portfolio. And with the reduced portfolio of hospitals we're continuing to proactively manage our corporate cost.

In terms of the 2018 guidance, our guidance is unchanged and includes the following. Net operating revenues, adjusted for expected divesture timing, are anticipated to be $13.6 billion to $13.9 billion.

Adjusted EBITDA is anticipated to be around $1.55 billion to $1.65 billion. With that, I'll turn the call over to Tim for some additional comments.

Thank you, Wayne. Similar to what we experienced in the fourth quarter, we drove better same-store net revenue growth and good EBITDA margin performance compared to the second and third quarters of 2017.

So overall, we had a good first quarter. We've also been executing on a number of initiatives that support our company's strategic imperatives, which include safety and quality that Wayne just touched on, along with operational excellence, connected care, and competitive position.

Along these lines, on our fourth quarter earnings call, we talked about a number of initiatives that are intended to drive improved performance in 2018, which include the opening of a number of outpatient access points with a solid pipeline of projects in various stages of development, targeted capital investments in core markets including service line enhancements, expansion of our proprietary in-house transfer and access center service to more of our markets, the launch of our ACO program in early 2018, the ongoing rollout of enhanced capabilities to better connect patients across the continuum of care, the leveraging of our data analytics technologies across the organization, further implementation of centralized and online scheduling across our affiliated physician practices, and strong strategic medical staff development in the first quarter, with a 6% increase in providers commencing practice and a strong group of newly signed recruiting physicians that will start practice in subsequent quarters. All of these programs are on track and are intended to help drive better growth in operations in 2018 and beyond.

Switching to the volume side, we were not satisfied with our overall volume performance this quarter, although we had a number of markets posting very strong gains, clearly demonstrating that when executed well, our development strategies can drive the expected growth and improvement in competitive position. As we continue to focus on implementing strategies that are appropriate for every market's unique growth and development opportunities, we do expect our volume trends to improve during the remainder of the year.

First, it's worth noting that we did not see a material impact from the flu. While we did see higher volumes from the flu during the first half of the quarter, flu diagnosis was weak during the second half.

As such, looking at the flu on a year-over-year basis, it was a relatively nonevent in terms of our performance. Overall, during the first quarter, we continued to see an increase in observation days, softer OB volume, and some shift to outpatient.

We also discontinued some lower-margin business in select markets, such as skilled nursing, pediatrics, and other lower acuity service lines, which was a headwind in our first quarter admissions and, in some cases, surgical volumes. But we believe this will benefit our margins over time.

Additionally, we believe the calendar impacted our volume performance towards the end of the quarter. As we think about our volumes for the remainder of the year, we expect them to improve versus our experience this quarter based on the initiatives that I just walked through.

Turning to our expenses, we continue to be pleased with our hospitals' improved efficiency on the SWB side, despite year-over-year wage rate increases in the low 3% range. Our hospital leadership drove improvements on that expense line on both a year-over-year and sequential basis.

And we are continuing to utilize our labor analytics tools, which allow our hospitals clear insights to right-size their labor utilization around higher or lower volumes and in relation to various staffing best practices. Looking at our supply expense, our drug and pharmacy costs remain well-managed, while higher implant costs have been a headwind as we expand our growth opportunities and business into higher acuity service lines.

We are continuing to leverage recent data enhancements and we implemented a company-wide coordinated supply formulary approach to support our hospitals' utilization of this data. We expect to drive improved supply expense efficiency during 2018 and 2019.

Before I hand the call over to Tom, I wanted to emphasize that we are seeing ongoing progress on a number of areas across the company and expect the strategies and initiatives that we have deployed to deliver even better performance moving forward. Tom?

Thank you, Tim. Now I'll discuss the first quarter on a quarter-over-quarter basis.

As a reminder, calculations discussed on this call exclude items Ross mentioned earlier. On a same-store basis for the quarter, we noted the following.

On a comparative first quarter of 2017 versus 2018 basis, net revenues increased 1.6%. This is comprised of a 3.5% increase in net revenues for adjusted admissions and a 1.9% decrease in adjusted admissions.

Our inpatient admissions declined 3.4%, our ER visits were up 0.1%, our surgeries decreased 2.7%. Overall, we are pleased with our net revenue per adjusted admission performance.

On a year-over-year basis, we benefited from improved acuity, better Medicare rates, and a stronger portfolio of hospitals. Our net outpatient revenues after the provision for uncollectible revenue was 51% of our revenues.

Our 51% outpatient revenue this quarter is lower than our reported numbers in 2017, in part from our outpatient revenue last year being reported before bad debt. During the quarter, our net outpatient revenue is down approximately 10 basis points, owing to strong inpatient revenue performance.

Consolidated revenue per mix for the first quarter of 2018 compared to first quarter of 2017 shows managed care and other, which includes Medicare Advantage, increased 110 basis points, Medicare Fee-For-Service increased 50 basis points, Medicaid decreased 70 basis points, self-pay decreased 90 basis points. Looking at our adjusted admissions per payer class, our managed care, Medicare Fee-For-Service, and Medicaid volumes were down, while our Medicare Advantage and self-pay volumes were up.

During the first quarter of 2018, the sum of consolidated charity care, self-pay discounts, and uncollectible revenue for the three-month comparative periods has increased from 27.1% to 29.8% of adjusted net revenue, a 270-basis-point increase. With the same-store expense items, our salaries and benefits as a percent of net operating revenues for same stores decreased approximately 80 basis points.

This decrease was driven primarily by improved FTE management. Supplies expenses as a percent of net operating revenues for same stores increased 10 basis points, driven by higher implant cost.

Other operating expenses as a percent of net operating revenues for same stores increased 190 basis points. The increase was driven primarily by higher medical specialist fees, purchased services, business taxes, and insurance.

The other operating expense line has been a drag on our performance. We're currently looking at multiple strategies to lower our vendor expense, including in-house of certain services and other strategies.

Switching to cash flow, our cash flows provided by operations were $106 million for the first quarter of 2018. This compares to cash flow from operations of $242 million during the first quarter of 2017.

In terms of the year-over-year decrease, there were two items worth noting versus the prior quarter. Cash from the shareholder derivative settlement in 2017 contributed approximately $40 million.

Prior year cash flow collections from accounts receivable were approximately $75 million higher last year, including $40 million related to state supplemental programs. Other decreases, including working capital changes, reduced cash flow by approximately $20 million.

It's worth noting that our cash flow from operations is typically lower in the first quarter than the second quarter. As such, we expect our cash flow from operations to improve in the second quarter.

Turning to CapEx, our CapEx for the first quarter of 2018 was $170 million, or 4.6% of net revenue. During the first quarter of 2017, our CapEx was $146 million, or 3.3% net revenue.

We're continuing to invest our capital towards high growth opportunities in our markets, such as additional access points as well service line build-outs around cardiology, orthopedics, and other high acuity areas. Moving to the balance sheet.

At the end of the first quarter, we had approximately $13.85 billion of long-term debt, with current maturities of long-term debt of $37 million. At the end of the first quarter, we had approximately $425 million of cash on the balance sheet.

We expect our ongoing divestiture plan to reduce our total debt moving forward. As it relates to our pending HMA legal matters, there's been no material change for several quarters.

We continue to revalue the estimated liabilities covered by the CVRs on a quarterly basis. Our current estimate, including probable legal fees, continues to reflect that there will be no payment to the CVR holders.

We continue to make good progress on the execution of our refinancing strategy through the completion of important transactions. The main objective of our refinancing strategy is to extend maturities, align management to fully implement major operating initiatives, and optimize its portfolio through smart divestitures.

As previously noted on February 26, we amended our credit facility to modify the financial maintenance covenants by removing the EBITDA-to-interest coverage ratio and replacing the senior secured net debt to EBITDA ratio with the first-lien net debt to EBITDA ratio. We also reduced the extended revolving credit commitments to $650 million.

On March 23, we amended our credit agreement to modify our ability to retain asset sale proceeds, and instead apply them to prepayments of term loans based on pro forma first-lien leverage. Increased junior secured debt capacity permit asset-based loan that could replace the existing asset-backed securitization and reduce first-lien and current capacity.

On April 3, 2018, we terminated the $600 million asset-backed securitization receivable facility and replaced it with a $1 billion asset-based loan revolving credit facility. Concurrent with this action, we also reduced our credit facility revolver to $425 million.

At the end of the first quarter, we had $538 million outstanding on the new ABL and nothing drawn on the revolver. With these completed amendments and actions, and given our $4.4 billion of additional secured debt capacity, we have the tools in place to address debt coming due in 2019 and 2020.

As we discussed in a separate press release last night, we intend to launch tender offers involving the exchange of up to $1.925 billion of the 8% senior unsecured notes due 2019 and up to $1.2 billion of the 7.125% senior unsecured notes due 2020. Such exchanges would involve new second-lien notes issued in an aggregate amount not to exceed $3.125 billion.

To the extent that all of the outstanding 2019 notes and 2020 notes are tendered in the exchange offers, then the company could include some of the 6.875% senior unsecured notes due 2022 up to an aggregate amount of $3.125 billion among all such exchanges. In anticipation of a potential transaction, the company and certain large institutional investors that are holders of the 2019 note, the 2020 notes, have held private discussions and agreed in principle to participate in the contemplating exchange offers at amounts greater than 70% aggregate principal of the 2019 notes, amounts greater than 55% aggregate principal of the 2020 notes and, if included, amounts greater than 55% of the aggregate principal of the 2022 notes.

In addition to those large institutional investors, other investors that are holders of the 2019 notes, 2020 notes, and 2022 notes could also participate in such contemplated debt exchanges. Importantly, we have no obligation to commence any of those exchange offers.

Further, there can be no assurance that the exchange offers will be commenced or consummated. While we have not yet done so, if the company were to decide to commence any exchange offers, then the company would issue an offering memorandum.

Following completion of the potential exchange, we may seek to extend or refinance term loan G, which is due on December 2019. For 2018, we've reaffirmed our full-year guidance, which includes the following.

For 2018, net operating revenues less provision for uncollectible revenue are anticipated to be $13.6 billion to $13.9 billion after adjusting for the timing of the expected divestitures. Adjusted EBITDA is expected to be $1.55 billion to $1.65 billion, again, after adjusting for timing of expected divestitures.

And we expect HITECH incentives to be close to zero compared to $28 million in 2017. Before I turn the call over to Wayne, I wanted to briefly talk about second quarter 2018 as you update your models.

As a reminder, during the second quarter of 2017, our adjusted EBITDA was $435 million. Last year, divestitures that are no longer in our portfolio contributed approximately $15 million in the second quarter, while HITECH and BP settlements contributed approximately $22 million to our results.

Adjusting for this comparability, our second quarter 2017 EBITDA would have been approximately $400 million. Wayne?

Thank you, Tom. At this point, operator, we're ready to open it up for questions.

We respectfully ask that you ask only one question so that everyone will have a chance to get on the call. But as always, we're available to talk to you anytime.

You can reach us at area code 615-465-7000.

Good morning. Yeah, I was hoping you could talk a little bit about your assumptions for volume growth that you currently have.

Certainly seems like – I just want to break out how much of that's related to, say, this transfer center initiative that you have going on versus how much of it's related just specifically to divesting additional hospitals, divesting weaker volume hospitals. So any color on that would be greatly appreciated.

Thanks.

Sure. Tim, would you?

Sure. I'll kick that one off.

Thanks, Frank, for the question. In terms of our volume initiatives, certainly the transfer centers, which is really a supporting mechanism of our overall acuity and service line strategy, is a big component of that.

But we have other major strategies that are underway, which will certainly drive further growth as we proceed into the year. One thing I want to point out is our medical staff development success.

Already on board, we have about 225 non-same store doctors who were in the ramp-up phases, which means for us less than two years in practice. So we still have some runway there for growing along those service line strategies.

We also have, in total, 400 non-same store physicians, which would include primary care physicians. So we see great progress and opportunity in developing those physicians who have not been with us for an extended period of time.

We also have centralized and online scheduling initiatives, which will drive that practice growth, also deploying certain online scheduling capabilities for our hospitals in the upcoming quarters. The other thing I want to point out is the access point strategy.

We did bring two new freestanding EDs online in the latter part of last year. We have two more, where they've come online in the first half of this year.

And we have roughly two to three more that should be online by the end of the year as well. So our freestanding EDs are performing well.

They are driving incremental volume growth for us in our target markets. We also see the ASC development strategies that are working well for us.

Urgent care and walk-in care deployment is very solid. So we just felt really good about the strategic initiatives that we have underway to drive the continued growth.

And, Frank, I think one point I would add on to that with respect to transfer centers. We first rolled those out in the first markets during the fourth quarter of 2017.

At this point, we're almost at 50% of the markets we intend to roll those out and should make great progress in 2018 on those. Tim, do you mind commenting on the ACOs, because that's another important part of our long-term strategy in terms of growth?

Certainly. Last year, we spent a considerable amount of time and energy ramping up our ACO strategy, which is basically live in all of our affiliated markets through 15 specific ACOs through the Medicare Fee-For-Service program.

Those are developing very nicely. We believe there's good opportunities to improve, not just growth, but retention of patients through the continuum of care across the network with those employed and independent providers in our markets.

We got our first batch of data just a couple weeks ago. We're working through that with those physicians.

Through this whole process, we believe we can better leverage our relationships, if you will, with doctors, communicating on what's important for their patients, how we can build out our networks to retain more of the care within our networks.

Hi, everybody. Thanks for the question.

Maybe I'll ask about the same-store pricing metrics, up 3.5%. That was obviously a good number and we've seen that from some of the others as well.

I wonder if there's any chance to parse out some of the dynamics behind that. I know there's the 340B Program is probably helping.

I know there's a reference to more acuity and behind that, are you seeing more high acute patients or are you seeing just the lower acute's been pushed out into the outpatient setting? What's driving that?

And then, the third thing I could think of other than just outright prices is I don't know if there's anything about the accounting change for bad debt that may have some impact on the way the pricing metrics looks and then the outright pricing. So just drill down a little bit, if you don't mind, on that 3.5% increase.

A. J., this is Tom.

So, a few things going on there. One is, when you look at fourth quarter, we were up about 2.7% then, and we called out some of the initiatives we had on the service lines.

We have also been more focused on just broadly more high acuity services and less focused on some of the lower acuity. So, intentionally, getting out of some of those lower acuity services.

The impact of divestitures had some impact on that. And then, you're right, effective January 1, the benefit of 340B being reduced and sticking in the Medicare outpatient rates helped us as well.

When we look at the rev rec and the accounting that we followed on that, we have tracked that. And as we mentioned in the fourth quarter, we restated all of our prior periods internally to make sure that we have the data for our same-store hospitals and we've monitored that, and we do not see any pickup coming out of that.

That's been pretty steady with the amounts we've previously reported.

So one of the other things that we don't want to miss here is the quality of our portfolios continues to improve. You see in the fourth quarter and you can see it this quarter as well.

So we think we're making significant progress in terms of the sustainability of our portfolio. Tim?

Yeah. On the acuity side, I'll just give a little more color on that.

We continue to focus on orthopedics and spine. We've referenced that as one of the drivers of our implant costs.

We'll work to get that in line with revenues here in the near term. Our cardiac and vascular service lines are an area of strong focus, both through additional physician recruitment, building stronger networks in terms of our name networks, and then also expanding into higher acuity services within the cardiac or cardiovascular service line, like TAVR.

We're up to eight programs now on the company, which is a net increase of three quarter-over-quarter. So really methodical and determined decisions to go into higher acuity services like that are driving the case mix index.

And, A. J., we called out last year the divestitures, the 2017 divestitures.

When we looked at their pricing, they were about 400 basis points lower than our ongoing portfolio. So, I think divestiture program 2017, we see the same dynamics when we look at the divestitures in 2018 maybe not as extreme, but we do see that same dynamic.

Hey. Good morning, guys.

I guess, just a question for Wayne or Tim. As you think about the growth outlook for volumes and, obviously, it's been challenged, how are you thinking about the ability to generate leverage or incremental margin expansion without really seeing an acceleration in volume?

Or, I guess, the other way I was thinking of asking the question is, the gains that you saw on the cost side this quarter, I mean, is there incremental stuff that you can squeeze out or have we pretty much rolled out the initiatives for cost cuts this year?

So as we continue to work on our portfolio and improve the quality of our portfolio, we continue to see a lot of good opportunities. We had a number of hospitals this past quarter that had high volume growth, over 5% volume growth, had good margins, all the above.

And I think Tim mentioned this earlier in terms of our execution on that. We're getting there on all those.

I think there certainly is opportunity for margin expansion. We have margin that's less than 12%.

And I can add just a few more comments to that on the service line strategies themselves, Tom mentioned this a few seconds ago, but we are exiting certain service lines that are, in some cases margin negative, in some cases just margin dilutive. And when we have a network strategy, a lot of these are smaller hospitals around the major tertiary care centers, we can gain greater efficiencies.

We're intending on keeping most of the volume within the network. But in some cases, it may just be worth letting it go to drive margin, if the care is available somewhere else within that community.

So we're very concerted and focused on doing that across the portfolio, strengthening what will be the remaining portfolio in the end. We, on the cost side, do not concede that we're done looking at cost controls or opportunities.

We've referenced supply expense. Tom mentioned medical specialist fees.

We are making progress on those lines, but we still see there is more work to be done and we're committed to that.

We actually think that we're playing offense here, and then we've a lot of opportunities left in terms of our portfolio. Okay?

Yeah, hi. Thanks.

Good morning. On the SWB improvements that you had, can you give us some more color on if there was workforce reduction, where that came from?

How that ties into your physician recruiting strategy and the impact on volumes? And also if you've factored in any bonus payments and so on for docs and the ACOs and stuff for the rest of the year in your guidance?

So, Ana, on the SWB, I think that's what you're talking about. We called out last year that we started leveraging labor analytics and it basically moving us to where we can put into every department of every hospital their labor utilization from the prior day that can be to them in the morning.

We contrast that to where we were. We're working on payroll, which was dated and there's debating data and so forth.

Our hospital leaders have done a great job getting that data out, so that they can own their labor management. We help them with benchmarks.

And it's really something where they can manage that themselves. We've looked at the hospitals that have been on that tool for longer periods of time.

We know there's a tail of improvement and we know we still have some tail on that with some of the hospitals that just came online in the fourth quarter. So we think that we can continue to leverage that, and that goes in all directions to hire more, to be smarter with contract labor and overtime and so forth.

So we do think we've got runway with that and we will certainly leverage that going forward in 2018.

Go ahead. I'm sorry.

Just on the ACO question, the first payments with success under the modeling of the ACOs, to my understanding, would not be until 2019.

Hi. Thanks.

Good morning. I wanted to ask about the tender that was launched last night and, I guess, you gave some statistics on institutional investor interest in terms of where you guys are today.

I guess, couple of questions around timing. When would you expect to have some sort of decision?

And then secondarily, what are sort of the factors that are helping you decide whether or not to go forward? It sounds like you haven't really made up your mind.

And then lastly, is there any sort of pricing sensitivity or proceeds discussion, et cetera, that you could give that's helpful?

Sure, Josh. So, the process, I mean, we're actively looking at this.

And as we had mentioned before, we're trying to be very proactive, so we're looking at this currently. The process, once we launch that, that process will go for 20 business days.

There is an early exchange benefit to anybody who exchanges the notes during the first 10 business days. So we expect to see most of the activity on those 10 business days.

And then we will complete that and complete the exchange of those notes. And as I mentioned before, we'd like to move on to the term loan G to extend or refinance those once that is done.

There was a lot of work done and we mentioned that we've been in discussion with some of the investors on that, and we think that we incorporated their feedback into the offer that we intend to put out. And again, we're replacing unsecured with second lien.

It's an improvement on coupon with what they have. It reduces the second-lien capacity from $4.4 billion to $3.125 billion, which we think is attractive for those holders.

And so we think what we've contemplated and what we put out last night is going to be attractive to the 2019 holders and the 2020 holders.

Hi. Good morning.

Just following up on that note, I wanted to make sure I understand. The new indentures, how much incremental first-lien/second-line capacity would be allowed after this exchange?

Is there any?

So, Gary, we are sitting with, right now, $4.4 billion secured capacity and roughly $500 million plus a little bit on first lien. With this exchange offer, if that goes out, we're going to be reducing that secured capacity to the second-lien portion to the $3.125 billion we're going to use to exchange the notes.

And we're going to give up on being able to use second-lien on the remaining portion of that. We could use third-lien down the road on that.

But that's one of the covenants that we're intending to put into that. Again, that should be beneficial to the noteholders that take the exchange.

Going forward, so we have the $500 million first lien. Just keep in mind, we've got the CVR liability out there, roughly $250 million, $260 million is our best estimate right now.

At some point in time that is going to be settled. And we also have our first lien to net-debt ratio.

It's currently 5.52:1. That reduces to 5:1 on July 1, 2018; 4.75:1 on January 1, 2019; then down to 4.5:1 on January 1, 2020; and then down to 4.25 on January 1, 2020.

So we do have first-lien capacity, we think will be helpful for the CVR. It is going to be decreasing.

It also gives us the liquidity we need on some of the strategic investments and just for liquidity. Thanks for the question.

All right, great. Thanks.

I just wanted to dig in a little bit more to some of these volume initiatives, because you guys had outlined a bunch of initiatives, but you've been talking about a number of initiatives really for couple of years now to try to improve volume. So we really haven't seen the last couple of rounds of initiatives play into volume improvement.

So what gives you the confidence that these ones are going to take or going to be more impactful?

I'll start with the answer to that one. Thanks, Kevin.

Our optimism comes for the reasons I mentioned previously. These are all initiatives that have to kind of play in tandem.

Transfer centers don't stand alone without service line and capital investments, which can't be driven without suitable strategic physician recruitment and development, which is well underway. So again, looking from the starting point of when we implemented the initiatives to where we're at today, we're seeing great growth and progress in so many markets that have fully embraced them and executed them in a strong way.

As we said earlier, the markets that are more mature on these key initiatives are seeing growth rates in the mid single-digit to double-digit. So we believe that we're certainly on the right path here.

Thank you. So I appreciate the broad comments that you've made on some of the cost and operational improvement initiatives.

But I'm wondering if you could go a little bit more into detail of how you're wanting to bring down operating expense. So maybe give us a range of how much potential you see there to really move that ratio and what some of the larger opportunities are.

Okay. So, Sarah, I'll take that.

The SWB, we've talked about the labor analytics that we're leveraging in the facilities. I think we'll continue to benefit from that.

We're also broadly looking at, on the benefit side, to make sure we're smart with our benefits. We're taking advantage of our drug spend, for example.

And we have some initiatives there that we think are going to be helpful maybe as soon as next quarter. On the supply side, Tim touched on that, where we've done really well with drug cost in 2017.

So far 2018, the implant costs are going up. Really just towards the latter part of last year, we're getting more data with our supply spend and we are really for the first time trying to leverage the data and help the hospitals make better decisions on what they procure.

And this is in non-physician preference item. So, these are items we're working closely with panels at the hospitals.

Ultimately, we will try to get into physician preference items, where we think we can incentivize the local markets to be smart on their vendor selections and get some benefit from that. On the purchase services, other operating expense, we talked about medical specialist fees.

Tim mentioned, we have some contract initiated a few years ago that kicked in – subsidies started to kick in, in 2017. We're revisiting those on a market-by-market basis.

We're also looking at some broader contracting strategies on those. And we know we're making progress, but we're also finding the headwind of other subsidies that are kicking in.

What Tim described as far as making decisions about service lines, medical specialist fees come into play on those as well. So we're probably more aggressive looking at those than we've been in the past.

We'll continue that. There's a slew of other costs that are associated with us shrinking our size from divestiture.

So we basically sold about 20% of our revenue last year. We got $2 billion of revenue that we've targeted for this year.

This company over the years has grown through acquisition and leveraged its cost structure. We didn't have a lot of repetitions as to how we shrink cost.

We are getting better, that I think we're better positioned right now to take a look at how we reduce our cost. We are involved in a lot of PSA agreements with some of the buyers and that we transition out from a few months to maybe up to a year.

And we want to make sure that we're managing all of our costs, our labor costs and our purchase services, smartly as we reduce those – with those. I will say with our corporate costs, we have been exceptionally well through three quarters of 2017.

We were on par or slightly below where we were in 2015 and 2016. With additional divestitures coming out, we're just having to get more focused on that and we are continuing to take actions to manage our purchase service spend that's generated by corporate and in our corporate costs, so that's more manageable.

And like I said, I think we're better positioned now than we were before to manage that on the 2018 divestitures.

Thank you again for your time this morning. We're very focused on the strategies we have outlined today.

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

We look forward to updating you on all of our progress throughout the year. Once again, if you have a question, you can reach us at area code 615-465-7000.