Michael J. Culotta - Vice President - Investor Relations, Community Health Systems, Inc. Wayne T. Smith - Chairman & Chief Executive Officer W. Larry Cash - CFO, Director & President-Financial Services.

A.J. Rice - UBS Securities LLC Sarah James - Wedbush Securities, Inc. Frank G. Morgan - RBC Capital Markets LLC Whit Mayo - Robert W. Baird & Co., Inc. (Broker) Dana Nentin - Deutsche Bank Securities, Inc. Andrew Schenker - Morgan Stanley & Co. LLC Gary Lieberman - Wells Fargo Securities LLC Brian Gil Tanquilut - Jefferies LLC Joanna S.

Gajuk - Bank of America Joshua R. Raskin - Barclays Capital, Inc. Brian Michael Wright - CRT Capital Group LLC Matthew Richard Borsch - Goldman Sachs & Co. Chris D. Rigg - Susquehanna Financial Group LLLP Ana A. Gupte - Leerink Partners LLC Miles L. Highsmith - RBC Capital Markets LLC.

Good morning. My name is Mike, and I will be your conference operator today. At this time, I would like to welcome everyone to the Community Health Systems Second Quarter 2015 Earnings Release Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session.

I will now turn the call over to Mr. Michael Culotta, Vice President, Investor Relations. You may begin your conference..

Thank you, Mike. Good morning, and welcome to Community Health Systems second 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 risk, which are described in headings such as Risk Factors in our Annual Report on Form 10-K and other reports filed with or furnished to the Securities and Exchange Commission.

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

After the market closed yesterday, we issued an 8-K, including a press release of 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.

As you know, our results consolidate the results of Community Health Systems and the former HMA facilities from and after January 27, 2014, the date of acquisition. The same-store volume and financial results reflect the HMA's performance from January 1, for both 2014 and 2015 as well as for CHS.

Further our same-store for the second quarter also includes the two acquisitions that were completed on April 1, 2014, Sharon Regional in Pennsylvania and Munroe Regional in Florida.

All calculations we will be discussing exclude the cost associated with the government settlements and related cost, expenses related to the loss from early extinguishment of debt, the impairment of long-lived assets, and the CVR legal expenses and liability. With that said, I would like to turn the call over to Mr.

Wayne Smith, Chairman and Chief Executive Officer. Mr.

Smith?.

Thank you, Mike. Good morning and welcome to our second quarter conference call. Larry Cash, our President, Financial Services and Chief Financial Officer, is on the call today; as well as David Miller, our President and Chief Operating Officer; and Dr. Lynn Simon, our President of Clinical Services and Chief Quality Officer.

I'm very pleased with our financial and operating results we were able to achieve this quarter, but before we get further into the details of the quarter, we disclosed in an 8-K filed yesterday that we have a plan to create a new publicly traded company we named Quorum Health Corporation.

This is also – there is also a slide deck that is in the 8-K and posted to our website with this information. We're preparing a Form 10 registration statement for the tax-free spinout of 38 hospitals representing 3,635 beds in 16 states.

Quorum Health Resources, a leading hospital management and consulting services company, will also be included in the new company. These facilities will be predominantly non-urban. For calendar year 2014, we estimate that Quorum Health had approximately $2.1 billion in net revenue – operating revenue, and approximately $255 million in adjusted EBITDA.

All results are unaudited. As you can see from our key highlights, this creates a new publicly traded company with attractive portfolio of high-quality hospitals, streamlined management structure, independent access to capital markets.

Quorum is expected to have an enhanced ability to drive growth by capitalizing on acquisition opportunities consistent with its portfolio, developing facility-specific operating strategies aligned with its communities' needs, and better leveraging its management and consulting capabilities; improves CHS's profitable growth profile by allowing it to focus on large markets and invest in strengthening its regional healthcare networks while maintaining the benefit of scale from being one of the largest hospital companies in the country; provides stockholders with an opportunity to realize the unique growth potential of two focused healthcare companies that are each better positioned to pursue their distinct business strategies.

The distribution is intended to qualify as tax-free to CHS shareholders for best federal income tax purposes. We expect this transaction to close some time in the first quarter. Our existing credit agreement has a carve out for a spinout transaction for up to 15% of our trailing four-quarter adjusted EBITDA without having to seek any approvals.

We'll use the cash from this transaction to pay down certain secured indebtedness. We'll be naming the executive leadership team when we file the Form 10. I think you will agree that this is a great opportunity for both companies.

I'm also very excited to announce that in October of this year, Trinity Medical Center, Birmingham, will relocate to its new home, Grandview Medical Center. Grandview Medical Center is a 1 million square foot hospital, 372 beds, 30 operating rooms, it sits on 32-acre campus, and there is an adjacent 200,000 square foot physician office building.

We were able to construct and equip this hospital for approximately $730,000 per bed and the national comparable construction cost is approximately $1.3 million per bed. This site is located in Alabama's largest metropolitan area. Grandview will be one of the most technologically advanced and modern hospitals in the country.

The hospital already has made a significant and positive impact on the community in terms of construction, jobs downstream, revenue, and economic development benefits that result in a major capital project.

Most importantly, Grandview Medical Center and its affiliated clinics and outpatient services will provide comprehensive high-quality healthcare services for residents of Birmingham and the broader region. We're very proud to be opening this spectacular hospital in October 2015. Let's give a quick overview of the quarter.

Our adjusted EBITDA grew $69 million or 9.9% from the second quarter of 2014 to $769 million. Adjusted EBITDA margins grew a strong 110 basis points to 15.8%. Sequentially adjusted EBITDA grew $54 million, or 7.6%, and margin of 15.8% grew 120 basis points. Our reported cash flow provided by operations, very strong at $565 million this quarter.

Our adjusted earnings per share was $1.14 compared to $0.74, our growth over 54%. As always, we're focused on physician recruiting. Physician recruiting is very important to the expansion of services that are provided at our facilities.

There were 1,778 physicians that recruited to our active medical staffs across all of our facilities for the first half of the year. This compares to 1,403 physicians recruited in the first half of 2014 or a 26% increase. We've stated on the last earnings call and have assigned operational oversight of our employed physician practices to Dr.

Lynn Simon and her team. They're proceeding in centralizing and standardizing our posted physician practice management with good opportunities for improvement. Remember that we have over 3,250 employed physicians out of our 22,200 active medical staff.

In addition, as you recall, there was virtually no physician recruiting taking place at HMA over the last several quarters before acquisition. We continue to drive recruiting in those facilities and this is increasing, but we still have many opportunities in this area. But let me assure you, we're focused on this.

As we've stated before, this is an area that we have upside for our company. We achieved $50 million in incremental synergies this quarter and $100 million in incremental synergies this year. We estimate that we will still achieve our revised cumulative guidance of at least $275 million of incremental synergies for this year.

We've just recently announced that we would not be proceeding with the acquisition of Metro Health in Wyoming, Michigan. Definitive agreement was cancelled on August 3. We will continue to stay focused on the midsize urban markets as we take our company forward.

In addition, we're concentrating heavily on name branding and developing comprehensive health services in our 11 networks, and we'll be looking at other hospital networks as we continue this strategy. Turning our attention to the Affordable Care Act, it is an understatement to state that we were very pleased with the recent Supreme Court ruling.

We truly hope that both federal and state legislatures will understand the importance of having healthcare expanding to those less fortunate and will get politics out of the equation.

We continue to work very hard with the Federation of American Health Systems, our DC trade organization, and on monitoring and educating our state legislators on the positives with the Act.

We still continue to hope that governors and state legislators in non-expansion states will strongly consider the numerous positive impacts of expanding Medicaid, and we hope they understand there are citizens that are not eligible for healthcare with existing specific state Medicaid programs.

We continue to remain very active in our states with respect to hospital associations, trade groups, including active lobbyists. We still believe other states will ultimately expand over time. Next to update you on pending legal matters.

Regarding our pending legal matters, we continue to proceed with our discussions in cooperation with the civil division and criminal division of the Department of Justice in an effort to resolve the open HMA matters. We continue to reevaluate the estimated liabilities covered by the CVR on a quarterly basis.

I remind you that these expenses and accruals have different financial statement treatment than under the CVR agreement. Our current estimate including probable legal fees continue to reflect that there will be no payment to the CVR holders.

As it relates to our 2015 guidance, we're adjusting the low end of our adjusted EPS to $3.65 from $3.40 and adjusting the high end to $4.10 from $4.05. Larry will now discuss further our results, the effects of Affordable Care Act, and provide you with other information on 2015 guidance.

Larry?.

Thank you, Wayne. We believe our same-store information we are providing is more meaningful and thus we'll predominantly discuss same-store results for the quarter, excluding items noted earlier. Our same-store net operating revenues increased 2.2%, with net operating revenues per adjusted admission increasing 2.4%.

Our volumes of adjusted admissions declined slight 0.2%, or about 1,180 adjusted admissions. ED visits were up 4% and surgeries were roughly flat. Actually our CHS legacy hospitals had both increases in adjusted admissions and surgeries where our HMA CHS 14 facilities had declines in both adjusted admissions and surgeries.

We should note that our same-store Medicaid adjusted admissions increased 8.4% and self-pay adjusted admissions declined 25%. On a total patient revenue basis before bad debts, Medicaid increased 4.4% while self-pay declined 4.9%.

Our payer mix continues to improve as we saw a 60 basis point improvement in managed care, a 40 basis point improvement in Medicaid, and a reduction in self-pay of 90 basis points. The overall case mix increased 2% while Medicaid case mix increased 3.3% and Medicare increased – case mix increased 1.7%.

The Medicaid case mix in states that expanded in 2014 increased 4.4%. In the two most recent states that expanded, Indiana and Pennsylvania, Medicaid case mix increased 5.9%. This compares to only a 2.2% case mix in non-expansion states. We'll continue to see the shift to outpatient setting.

Our outpatient revenue represents 57.6% of our total patient revenues compared to 56.5% in the second quarter of 2014, or 110 basis point shift. We achieved good expense management in the quarter. Our salaries and benefits as a percent of net operating revenue declined 100 basis points as a percent of net operating revenue to 45.4%.

Our overall hours declined 1.4%, which continue monitoring productivity. In addition, we have as previously discussed, there's a natural drop in payroll taxes from the first quarter throughout the remainder of the year. Supplies expense declined 10 basis points to 15.4%.

We continue to increase our overall compliance in our group purchased organization and increase our pricing. Other operating expenses declined 40 basis points to 22.3% of net operating revenue. As it relates to HITECH incentives on a consolidated basis, we recognized $55 million this quarter compared to $84 million in last year's second quarter.

The second quarter HITECH reimbursement was actually right on the number we had budgeted for the quarter. On a year-to-date basis, we recognized $81 million of HITECH incentives compared to $124 million last year at this time. Another item we'd like to call your attention is to equity and earnings of unconsolidated affiliates.

As you know, we're involved in two hospital ventures. One is with HCA in Macon, Georgia; and on e with – the other is with PHS in Las Vegas, Nevada. The large increase is predominantly from our ownership in Las Vegas hospitals. Our cash flow operations were $565 million for the quarter and $504 million for the year.

Our adjusted cash flow for the six months were $588 million. The adjusted cash flows provided by operations have been adjusted for government settlements and related expenses of $104 million and acquisition, integration expenses and the payment of old HMA government liability of $29 million. We did tax effect these items.

This compares to adjusted cash flow provided by operations of $637 million for June last year. We have a slide we'll refer to on our adjusted cash flow calculations. Couple of items to note related to our large differences between the two six months period.

This year there was debt outstanding for the full period and the impact on cash flow relative to interest payments was $125 million this year. This interest expense relates to the HMA acquisition in late January of 2014 and was built in our guidance.

Remember our payments on interest are higher in each of the first quarters and third quarters by approximately $140 million. We received a tax refund of $80 million in last year's first quarter. We also received refunds in 2014 of $15 million in the third quarter and in the fourth quarter of $86 million.

We don't expect any significant tax refunds this year. Another item of note is improvement in accounts receivable collections. Our cash provided for accounts receivable collections improved $80 million from a year ago and we've made some strong improvements in this area. We are reconfirming our year-end cash flow generated by operations guidance.

This last three years, 66% of our cash flow provided by operations has been in the second half of the year. Our cash flow used in investments of our assets for six months were down approximately $179 million compared to a year ago.

Our CapEx was $474 million at 4.8% of revenue, approximately $80 million was on the Birmingham, Alabama replacement facility, and once the Birmingham facility opens we'll have additional interest expense of approximately $4 million and depreciation expense of $3 million in the fourth quarter.

We are lowering our guidance on capital expenditures to $950 million to $1.1 billion. This reduces the range by $100 million to $150 million for 2015. Now let's turn our attention to the Affordable Care Act. The following information is hospital data only for the comparative second quarters.

Self-pay adjusted admissions as a percentage of total adjusted admissions declined by 150 basis points to 4.6%. Self-pay adjusted admissions decreased 24%. In expansion states, the decline was 49%. The biggest percentage decline were from Indiana and Pennsylvania.

Medicaid adjusted admissions as a percentage of total adjusted admissions increased 130 basis points to 19.5%. Medicaid adjusted admissions increased 6.7% with majority increase coming from facilities in expansion states. In expansion states, the increase was 10.3%.

We need to point out the significant declines in self-pay trends and increase in Medicaid trends. Sequentially for Indiana and Pennsylvania combined from the first quarter self-pay adjusted admissions declined 76%, while Medicaid adjusted admissions increased 30%. Actually Medicaid adjusted admissions in all expansion states increased 9% sequentially.

As it relates to monitoring the exchanges, we have sufficient information. We noted an increase in patient visits of approximately 77% this quarter compared to second quarter a year ago. And sequentially the patient visits were up approximately 17%.

Self-pay emergency department visits decreased 22.7% in expansion states, and 5.6% in non-expansion states. In Indiana and Pennsylvania, self-pay ED visits declined 28% from a year ago. Charity care and self-pay discounts plus bad debts for the six months comparative periods has declined from 26.4% to 24% or a 240 basis point decline.

Based on the various data points on Medicaid and exchange business, we believe we've recognized some accumulated benefit through June 30, 2015 in the amount of approximately $140 million from the Affordable Care Act, which is in line for our overall 2015 guidance. We should continue to see some higher benefits as the year progresses.

This compares to an approximately $165 million in 2014. For 2015, we continue to estimate we'll receive incremental benefits before deductions within our guidance range. We're adjusting the guidance to lower our range on net operating revenues, less provision for bad debts to $2.3 billion.

We are also adjusting our guidance to lower upper range of adjusted EBITDA of $3.165 billion. These adjustments reflect that there will be no hospital acquisitions in 2015 versus the two hospitals that were in the original guidance.

As it to relates to EBITDA expectations for the third quarter, historically the third quarter for our industry has been the lowest quarter of the year and generally declines from second quarter.

Wayne?.

We're very pleased with what we've accomplished this year and what we hope to accomplish throughout 2015 and beyond. We're very pleased to be working on a new spinout company, Quorum Health Corporation, and believe this will provide tremendous shareholder value. We have so many opportunities with the continuation of the rollout of Affordable Care Act.

There are opportunities for growth in the former HMA assets and other recent acquisitions, the opening of Grandview, our opportunities to delever our balance sheet, our operation and clinical initiatives, our focus on our strategy going forward with emphasis on large markets and future developing of our networks.

We'll continue to work on volume initiatives that help – that should help us achieve organic growth and grow market share.

We've laid a great foundation for our platform, and as always, we continue to focus on enhancing quality, building stronger physician relationships, including increasing physician recruiting and doing what's right for our patients. I'd like to thank our physicians, nurses and support staff for all their tremendous support this quarter.

With that, we'd like to open up the call for comments. In an effort to keep more calls – get more calls in, we'd ask that you limit yourself to one question, so others can have time. If you have any further follow-up questions, as always, we're here to take your calls. You can reach us at area code 615-465-7000..

The first question is from A.J. Rice with UBS..

Hello, everybody. And thanks for the question. Just real quick. Maybe just to have you step back and make any comments you'd care to on the disparity we continue to see between the volume trends in the urban markets versus the non-urban markets. I think that was again pronounced this quarter.

I know those investments in outpatient you guys are doing, and your outpatient is a significant percentage, maybe more so than anybody else, I think possibly, of your revenues, the mix of the patients, the economy, the reform benefits.

Do you think we will see that divergence close at some point in the future? Or do you think it's just the nature of the markets, particularly on the in-patient side that the urbans will grow faster than the non-urban?.

Yeah. Just on top, A.J., I think the issue in the non-urban markets really is an economic issue more than anything else. I mean, there are opportunities for us now to enhance the services in our non-urban markets, which should help the growth, but the real issue is employment.

And as time goes forward, I think, we will see improved employment in those markets, which would be helpful. Also, I think as it relates to our spend, this is one of the things that the new company will be able to focus on in terms of really enhancing improving the level of services and recruiting physicians in those non-urban markets..

Yeah. I might just add that if you go back a few years ago, our unemployment growth was like 50 basis points in 2013, and 2014 it was 80 basis points. Recently, it's 150 basis points, so we've got better in our markets, but that's still much different than you're seeing in urban markets.

And clearly the commercial enrollment follows employment, so we're seeing good managed care growth from managed care as a payer mix. But our employment growth was still lagging a little bit better. The unemployment has come down, but the employment growth was still a bit less.

You will always have a little bit more of a movement from the in-patient to outpatient in these smaller markets that are non-urban markets because of the change in technology and the activity going on, and there's a lot more medical admissions, higher percentage of medical admissions of your DRGs than surgical.

And that's the type of medical admissions now being treated on an outpatient basis..

The next question is from Sarah James with Wedbush Securities..

Thank you. You mentioned one of the motivators here was independent access to capital.

So can you speak a little bit more on how capital deployment decisions were made in the past? Was there one segment that was generating a higher ROIC and so this new structure will give that lower-returning entity an additional avenue to access capital, or were returns similar on a ROIC basis? And related to that, how should we think about the long-term growth profile of each separate entity?.

Strategically, I think if you look at our capital deployment over the years, we've been deploying capital in our larger markets even though we have not had any real capital issues in our smaller markets, but because of the rate of growth we have not probably enhanced the deployment of capital in the small markets.

I think you will see this in the spinout that there's an opportunity to really focus on some new services that might be available in those markets in terms of telemedicine and some of those other kinds of things they can really focus on.

Not that that we have done anything, we've got – the capital that we have deployed now in the spin markets, we'll continue to make sure that all that happens, but I think there'll be greater opportunities for the future..

I just would add generally the margin will improve when the Quorum Health Corporation hospitals are removed. You can see that from the information provided so far. And actually when you look at capital allocations, the higher margins would generally get a little bit more of the capital because there's a little bit surer return.

There's generally a little bit more managed care business that would be there. And I think when you look at that we would allocate it. We'll be providing three years of audited financial statements in the Form 10 and it would show that the capital probably is a little less in 2014 than the overall company.

And clearly the other thing, just when it comes to looking at stuff, you will see a situation that on the acquisitions, we haven't been buying any hospitals in non-urban markets..

Larry, could you just comment a minute on our return on investment and how we look at that?.

Yeah..

Because that's fairly important to this (25:52).

Yeah. When you look at that, we – and the acquisitions we do or the capital we do, we do a 3 year to 5 year projection out, and we'd monitor the larger projects inside the company. We're doing a much better job now of looking at the returns we get on the projects that we monitor, and that's on the capital side.

On the side of the acquisitions, to do a four-year or five-year model looking at both being first year pre-tax profitable and then also what the multiple is and what the internal rate of return is..

The next question is from Frank Morgan with RBC Capital Markets..

Certainly your growth profile should improve, at least on the RemainCo part of the business.

I wonder could you share any kind of pro forma numbers for us, maybe what your admissions and adjusted admissions would have been on a pro forma basis for what will be the RemainCo going forward? And then also when you look – you commented on HMA in terms of its weaker relative performance.

Is that more of a capital-related issue there or is it more of an operational-related issue where it's more program or service lines?.

That's two questions, Frank..

Hey, Frank. The first one is we'll provide all that in the Form 10, we're still finalizing the audit and we did get comfortable that we gave the revenue of $2.1 billion and EBITDA of $255 million. From there, you can see that the margins of the remaining hospitals are higher when you do the math.

But clearly we'll provide all of that on what the performance of those hospitals are. I would just point out that the 16 states – that nine of those states have expanded Medicaid, so that's been helpful in those states..

The next question is from Whit Mayo with Robert W. Baird..

Hey. Thanks. Larry, can you maybe just go back to Quorum and just talk about how you plan on capitalizing that company? Just curious what the right leverage is. And any reason you might be thinking about refinancing on this portfolio? We've seen some attractive rates out there on some other companies..

Yeah. The plan on this would be that they'll go do a bit road show themselves and that management team will raise financing, and it'll be attractive financing. It'd probably be – haven't decided on a capital structure. It'd be a mix of banks and bonds probably, so similar to what we've done with HMA. Still to be decided and it should be attractive.

We have not set up on the leverage, we did disclose that the tax basis is $1.270 billion, which would put – if you just did all of that, would put the leverage somewhere around 5%. You can do that math on that at $255 million.

But that still remains to be seen and we'll continue to watch also how well they do this year, and what the tax basis may be at the end of 2013 (sic) [2015]. But they'll go out and borrow money themselves..

The next question is from Dana Nentin with Deutsche Bank..

Great. Thanks for taking the question. At Q1 you had talked about Pennsylvania Medicaid expansion getting off to a slow start, but I guess, it's seen sequential improvements exiting the quarter.

I guess can you provide any color on how that trended in Q2? And then also looking at Q2 of last year, what that looks like on a gross basis, because I believe it was previously reported net in terms of reform benefit?.

Yeah. On a gross basis and that's how we're going to report it, I think the Q2 was $80 million versus the first quarter was $60 million. And I think we were somewhere in the $40 million range last year as I remember correctly. And then the businesses were up substantially.

We clearly didn't have as much of a benefit in Indiana and Pennsylvania, and I think we called out a while ago a pretty good increase in the quarter in Pennsylvania.

I think, the bullet was from the first quarter self-pay adjusted admissions declined 76% and Medicaid adjusted admissions in Indiana and Pennsylvania increased 30%, and so we had good results from that activity. And they're a contributor of the $20 million growth in gross healthcare reform benefit growing from $60 million to $80 million..

The next question is from Andrew Schenker with Morgan Stanley..

Good morning. So thinking about your same-store adjusted admissions growth, you've kept that 0% to 2%.

Thinking that the comps actually get a little bit more difficult in the second half of the year, is there any drivers or programs you have in place that you think could help drive those volumes more positive, so keep you in the middle of the range or towards the high-end of the range? Specifically, any impact on the legacy HMA facilities that are clearly still a drag on growth? Thank you..

Yeah. I'd say the big driver there would be the physician recruitment would do a lot better. If you sort of just look and we don't like to do a lot of separations of HMA versus the company, but a year ago we only had about 7% of overall internal recruiting was HMA hospitals. This year it's 35% for people starting.

That's about what you'd expect it to be. So our physician recruiting is starting to be much more resulting from that activity. There's a lot of focus here on all the programs we've got going on, and we feel comfortable we'll do better. We were positive in the first and the second quarter of – fourth quarter and the first – 2014, and the first quarter.

So we do not have that kind of success in the second quarter and the physician recruitments will be real strong in the third quarter, and a lot of that will be the HMA hospitals. The other thing, I think, not directly addressing your question is we probably were a little bit short on volume.

We've had some good revenue per unit growth in the HMA hospitals. We closed the gap again. They're well above the company average now in revenue per adjusted admissions for the quarter. And we're now – I think, one time we were $1,000 and were $600 or $700 short there, and they'll never be as much.

So we're doing a good job of growing the revenue per adjusted admission.

When you think about the volume for the quarter, just want to make one comment about sequentially, our adjusted admissions were up 40 basis points sequentially, our outpatient adjusted admissions are actually up 5%, so we had good outpatient growth and you can do the math there looking at the first quarter and the second quarter.

So I'm hopeful that we will continue to have good results. We did have a little bit of a challenge in the second quarter of 2014. I think people may remember we had a lot of weather effects in our hospitals in Indiana, Pennsylvania and Ohio, Illinois.

And we had some surgery growth, probably 1% or 2% of our surgery growth in the second quarter of 2014 we think came from the delayed services. And everyone may remember the economy bounced back a little bit in the second quarter. So I think that also created a challenge for the comparison..

The next question is from Gary Lieberman with Wells Fargo..

Good morning. Thanks for taking the question.

I guess on HMA and the volumes there, would you characterize it more sort of a recruitment issue on the physician part? Or is there sort of still this behavioral change amongst the existing physicians which seemed like existed maybe a year or a year-and-a-half ago?.

I think, Gary, the main issue here is lack of recruitment. It just takes a while to go through this process and get people lined up and get them working. So, I think, fundamentally it's a numbers issue as opposed to a principle issue or a cultural issue or any of those kinds of things.

I think it's just basically we need to continue to very strong recruiting to make this work..

And just a little bit of – remind people of history in 2013, they substantially missed what they expect to accomplish. They had declining same-store revenue, declining same-store revenue per adjusted admissions, increasing bad debts, increasing payroll, increasing other operating expenses and declining margins.

We've done a pretty good job on the expense side, we've gotten synergies. We're now got them participating in healthcare reform. We're increasing the revenue per unit. We're doing a better job on managed care contracting and over time we'll do a better job on adjusted admissions.

But we did start with some challenges and we made good progress on it, but we've just got more progress to do..

Great. Thanks..

The next question is from Brian Tanquilut with Jefferies..

Hey. Good morning, guys. Larry, if you don't mind just talking us through your views on margin expansion, I know that you guys were preparing for potentially adverse ruling on the SCOTUS and then the HMA moving parts on margins.

So if you don't mind just walking us through what you guys are doing and where you see that going over the next year to three years?.

Yeah. Looking out, we've got a couple of centralized projects which will be very helpful in the company. We just finished centralized payroll for the CHS hospitals which was helpful. We'll be doing that for the HMA hospitals.

We're well under our way of doing a centralized business office that's going to give us good results, both collecting and lower cost perspective. We're working on supply chain initiative which we've had some good benefits this year. We got some more benefits in the second half of the year that will do a carryover for next couple years.

You're going to get the benefit of the Healthcare Reform. You'll get another enrollment period. The penalty will go from $350 to $700 next year, more people know about it.

There's more managed care companies coming in, and we've got good participants in those managed care companies so that benefit will continue to be there, and there ought to be sequential reductions in uninsured, hopefully some more states will expand Medicaid.

Utah looks like its maybe got a possibility and maybe Alaska, both small markets, but at least it's a positive if they do follow through with that.

Then you go to the HMA margin which was down 11% or 12% when we bought it, and I talked about the challenges they had in 2013 with the leadership turnover and the lack of focus that may have taken place at that point in time.

We probably improved it 50 basis points in 2014, and we probably got another 50 basis points to 70 basis points so far this year that we got, and we've got more opportunity to go as we continue to work on the volume initiatives and trying to do a better job of getting the recruitment activity that Wayne talked about.

I think, we will do a very job of getting the margins back up with synergies and healthcare reform, and also the volume growth activities and get them back up in the mid-teens..

Thank you..

The next question is from Kevin Fischbeck with Bank of America..

Good morning. This is actually Joanna Gajuk filling in for Kevin today. Thanks for taking the question.

So just briefly, coming back to the guidance and reduction in the CapEx, can you just talk about reasons for that?.

Well, we often look at the beginning of the year how we're going to operate and if you look over the history of us, we generally have brought the guidance down to be either near the low end or even below the low end. And so, it's a strategy we'll plan early to do it. And once we get throughout the year, we'll look at projects.

We've got lots of opportunities on capital to do it. We are putting our capital in the markets that we think we get the best return. We're doing a good of taking the projects, and so I think, we decided we'd spend less money this year, so this is really a good time to lower it, it will help our cash flow, help our leverage.

We are trying to delever, so I think that was the reason we did it, but we did start off a little higher spending in 2015 than we had in 2014, and now we've brought it back down to a level more in line with that..

So they are not particular projects that you are giving up?.

No. No. There's a handful of projects that will be done. Some of it's routine, and we also probably a little less money on replacement hospitals, but $100 million to $150 million will not affect our ability to be successful with that kind of reduction..

And then on the comments around the reform, and I guess going forward, any updates on your view around the additional states potentially expanding Medicaid, how you feel about Tennessee or even Florida or any other states that you think are -who should be next sort of on that Medicaid expansion front? Thanks..

We've believed all along that the states will continue to think and consider expanding Medicaid. We think the benefits are very strong in terms of the opportunities for states. It's good for the health of the people.

It's good for economic development, all of the above for people to have healthcare coverage, so we believe that ultimately the states, every state will expand Medicaid..

And I think I said earlier there's more activity going on in Utah and Alaska right now, are the two states relatively small, but it'd be good to get two more states. I think this year, we had the most states expanding in Indiana and Pennsylvania from a size benefit, and then we saw that coming through in the second quarter.

Hopefully it will continue..

Great, thanks. That's all from me for now. Thank you..

Thanks..

The next question is from Joshua Raskin with Barclays..

Hi, thanks. Good morning. I appreciate you taking the question.

Also on CapEx, and I want to make sure I got it right, Larry, did you – do you guys have sort of a target investment? You know, it sounds like you've got this one-year to three-year plan on your capital expenditures, but is there a way, just like a rule of thumb in terms of dollars of CapEx and what sort of incremental EBITDA returns you look for on those?.

Yeah, if you look at it, we try spend around 5% of revenue, and I think, we're spending a little less than that, we're at 4.8% right now, I think we spent a little less last year. It goes up a little bit more when you do a replacement hospital, but that's there.

About 1.5% of revenue is probably routine, and the other, we expect to get a four to five multiple off of that in the first couple of years.

We run out, mostly if it's a large expansion in a hospital or a large piece of equipment, we run both the existing hospital and the benefit of the new item and do a review there and then we monitor that for probably about 18 months after the project opens to see if we've got the revenue and EBITDA benefit there.

I think right now, if I remember correctly, we had targeted somewhere in the neighborhood of $60 million to $80 million benefit in the 2015 year off the capital we either spent in 2014 or spent in 2015 and we got some of that benefit coming in the second half of the year.

If it's a substantial project, let's say, over $50 million, it will probably get reviewed at a higher level at the board, but most of them fall under that amount.

And then we do review annually with the board the projects of any size, and we monitor every quarter projects, our treasurer department, see if we get gets results; and if not, we will try to get some plans in place to improve that. And we've done a much better job of getting more of our EBITDA in a multiple of four off of the debt we're spending..

So is the math right on $100 million of CapEx is somewhere in the ballpark of $15 million-ish of EBITDA. I don't know if that's for two or three..

That would be about right, and of course, some of these projects ill simply be done the next year. But yes, there could be some – some of that would be out of routine, and some would be out of a project item. And hopefully we pick the ones where we probably got a little bit lower result than – a better result..

Right. Okay. Perfect. Thanks..

The next question is from Brian Wright with Sterne Agee CRT..

Thanks. Good morning.

A couple of – so just wanted to understand kind of the thought process on the timing of why Quorum spin-out kind of now? And then just when we look at the hospitals within the Quorum, maybe I'm wrong, but it only looks like a couple of them are HMA, so just thought process on the hospitals in there versus not?.

Yeah. Timing-wise, obviously, this is kinds of things that take a long time to work on, and a lot of security around not letting this leak. So, we've been working on this for a good while. A couple of good things are that the Affordable Care Act in terms of the Supreme Court, that was a good sign that we should go forward.

And then secondly, our timing really is more around trying to get this done at the end of the year in the first quarter, just from an operational standpoint. So, there are four HMA hospitals in this group. I would remind you that this is a very good strong company. It will be; it's $2.1 billion in revenue, $255 million in EBITDA.

It's spread out in 16 states, nine of those states have expanded Medicaid. This is a high-quality group of hospitals, 74% of them or 28 of them are top performers in the Joint Commission. So the metrics here are very good, 84% are sole providers.

And if you compare these facilities and this spin-out to the prior spin-outs, the Triad and LifePoint, I think you will find – the margin is about the same, but the revenue is substantially greater and EBITDA is substantially greater.

So, we think this should be a very successful company going forward with a lot of opportunity, particularly with focus on those markets..

Great. Thank you..

The next question is from Matt Borsch with Goldman Sachs..

Yeah.

Just following up on that same theme relative to Quorum, can you just address what are the different capabilities, strategies or skill sets that you think Quorum needs versus the existing company that causes you to differentiate it?.

Yeah. I think our focus over the last year, 18 months, have been on larger networks. And because of the Affordable Care Act and exchanges, we feel like that we've got to be a much broader system now and look at larger markets to get market share and make sure that we do all the right things.

What it requires in smaller markets is a lot of attention to individual items and individual physician recruiting, more hands-on work in terms of the market, a lot to develop the market in terms of extending the market.

So, we just think that by having more resources in place to do that, and there's a lot of development in terms of technology that will work well in smaller markets, but we might not have an interest in that in larger markets. We don't want to divert our attention to – and we haven't bought any smaller markets.

We haven't bought any – these hospitals average about $50 million in revenue. We haven't been buying those unless they're synergistic to our network. So a couple things, one is that the skill set is a little different. The other thing is that this is a huge opportunity. There are a lot of smaller hospitals out there that are for sale.

If we look at our Quorum management business, last year they lost five or six hospitals to contracts on hospitals they were managing. Those were acquired by not-for-profits. Maybe one was acquired by a for-profit.

We think there's a huge opportunity here by having these two together in terms of actual acquisitions by working with our Quorum management to identify really strong good targets for the future. So, it's a business that requires a lot of attention and a lot of focus on the particular markets.

And the second part of that is the opportunity for acquisition in terms of growth. So, we think it will be a very strong company..

Makes sense. Thank you..

Matt, I might just add one thing. There's also some very good challenging services in the area of payroll processing, collections, eligibility screening and (46:30) and IT that we'll be providing to Quorum Health Corporation, which would allow them to focus on operations and improving their revenue and volume and expense management..

Got it. The scale-sensitive activity that you'll maintain..

Yes..

Thank you..

The next question is from Chris Rigg with SIG..

Good morning. Thanks for taking my question. Larry, I know we've talked in not too recent past about sort of an intermediate debt leverage target of sort of 4.5 times. Does the spin impact at all? And I know we'd also talked about potentially some divestitures.

Should we still think about seeing some, you guys selling some hospitals in the residual community portfolio? Thanks..

Well, the second question. There's always a responsibility to look at your portfolio, and there may be some that don't fit. And there's another local buyer that would find a better value for that. So that's just our responsibility to think about indeed. And when that comes up, we will always do that.

There's no books floating around at hospitals, but there are some that we'd possibly do that on. We'll have to wait and see what the final debt there is. I mean we are very focused on deleveraging in the mid-4%s.

We're focused on trying to continue to improve the operations and the margins and EBITDA growth, as you will notice this year that we're not going to buy any hospitals which will help our leverage there for end of this year and also some into next year. So, I think we're very focused on it.

We'll see exactly how much debt we end up allocating to the Quorum Health, and then revisit the mid-4%s target..

Yeah. I would just say that post this Quorum transaction, I think the Quorum facilities in that company will be a strong company. And I think we're very well-positioned with the facilities that we own to move forward..

Yeah, our margin were improved and then, of course, we have some of our own focus activities that we can spend and – working on those 160 hospitals. So hopefully, we'll do a better job on that. And we would also expect some Medicaid expansion activity next year..

Great. Thanks a lot..

Thanks..

Your next question is from Ana Gupte with Leerink..

Yeah. Thanks. Good morning.

So the first one was just again on the payer consolidation that's ongoing, as you've considered your own core entity and now the spin-off of Quorum, how do you see these two entities positioned against changing (49:01)?.

I'll start off and Wayne will have a comment I'm sure also. Clearly, the sole provider markets are helpful when you're the only hospital in town. And if you're in there, you'll probably end up with some margins or business.

And so, I do think that from that perspective, one of the things that's left in 160 hospitals, there's a large number of those hospitals remember were networked. They're important to markets they operate in. And you're going to have several thousand – a couple thousand physicians there employed.

You're going to have a lot of physician office practices and surgery centers and urgent care centers that are important to that. I think we've done a pretty good job of working through prior mergers and we'll see how these mergers, once done, how they fall out, but I think we'll do well.

And one of the focus here is having a good healthcare regional network inside of Community Health after the spin-off of Quorum Health, and this being a sole provider in 84% of the markets should help on the managed care side. I don't think our managed care rates are what you would call exorbitant, and I think that also helps..

Well, we also have been a consolidator through the last number of years and this is an opportunity for us to sort of rationalize in one respect, and we will continue to improve in terms of our market share by having attention to these larger markets.

But this is also an opportunity for us to be able to expand and grow by having two companies, and it's an opportunity for our shareholders to do well. We think there is clearly a space for smaller hospitals in the hospital industry. There's a lot of acquisition opportunity here.

This company starts out at a lower base, so it has an opportunity to grow faster. So, we think this is the right idea for both of these organizations going forward..

And just as a follow-up on that, in that 4% to 6% contracting rates for commercial, are you seeing it trend more lower toward the lower end of the range, or is it beginning to again trend up? There's been some buzz in the marketplace that there is more pressure from hospitals on managed care, and one of your peers today talked about commercial pricing as a driver of the better revenue per admission that they saw..

We're in the 4% to 6% range. I think you'll see that our slides show that our managed care percent of business is up over a year ago, both on a quarter basis and it's also up real nice on a year-to-date basis, so we're improving our managed care revenue. Thank you..

Thanks..

We have time for one more question. The last question is from Miles Highsmith with RBC..

Hi. Good morning, guys. You mentioned the credit agreement carve out and the ability to do this transaction via that. I just wanted to confirm as it relates to the bonds, that they're not being issues there.

I assume it would be a restricted pay or asset sale carve-out that would allow you to do this, and just want to confirm that you would not have to go to bondholders in connection with this? Thanks..

That's correct..

I will now turn the call over to Mr. Smith for closing remarks..

Thank you again for spending time with us this morning. Our standardized and centralized operating platform will help in moving this company forward as one. We're excited about the opportunities for this year and beyond. We all were especially excited about the future of Quorum Health Corporation.

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 focus on our operating performance. Once again, if you have any questions you can always reach us, area code 615-465-7000. Thank you very much..

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