Ross 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..

A.J. Rice - UBS Securities LLC Brian Gil Tanquilut - Jefferies LLC Chris Rigg - Deutsche Bank Securities, Inc. Frank Morgan - RBC Capital Markets LLC Ralph Giacobbe - Citigroup Global Markets, Inc. Sarah E. James - Piper Jaffray & Co. Gary P. Taylor - JPMorgan Securities LLC Ana A.

Gupte - Leerink Partners LLC Stephen Baxter - Wolfe Research LLC Kevin Mark Fischbeck - Bank of America Merrill Lynch.

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 2017 Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there'll be a question-and-answer session. Thank you.

I will now turn the call over to Ross Comeaux, Vice President of 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'd like to read the following disclosure statement. This conference call makes contain certain forward-looking statements, including all statements that do not relate solely to historical or current facts.

These forward-looking statements are subject to a number of known and unknown risks, which are described in headings such as Risk Factors in our Annual Report on Form 10-K and other reports filed with or furnished to the Securities and Exchange Commission.

As a consequence, actual results may differ significantly from those expressed in any forward-looking statements in today's discussion. We do not intend to update any of these forward-looking statements. Yesterday afternoon, we issued a press release with our financial statements and definitions and calculations of adjusted EBITDA and adjusted EPS.

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

As a reminder, our discussion of our results excludes Quorum Health Corporation, the joint venture in Las Vegas that was sold to Universal Health Services, the company's home care division and the 11 hospitals divested in May.

All calculations we will discuss also exclude discontinued operations, loss from early extinguishment of debt, impairment as well as gains or losses on the sale of businesses, expenses incurred related to divestitures, gain on sales of investments and unconsolidated affiliates, expenses related to government and other legal settlements and related cost, expenses related to employee termination costs and other restructuring charges, expense from fair value adjustments to the CVR agreement liability related to the HMA legal proceedings and related legal expenses, including our discussion of our results or the sale transactions that we closed effective June 30 and July 1.

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

Smith?.

net operating revenues excluding divestitures are anticipated to be $15.85 billion to $16.05 billion. Same-store hospital adjusted admissions is anticipated to decline 2% down to 1%. Adjusted EBITDA is anticipated to be $1.825 billion to $2 billion. Income from operations per share is anticipated to be a negative $0.30 to a positive $0.40.

As it relates to our pending HMA legal matters, there is no material change for several quarters. We'll continue to revalue the estimated liabilities covered by the CVR on a quarterly basis. Our current estimate, including probable legal fees, continues to reflect there will be no payment to CVR holders.

Tim will now provide some comments on our operations and then Tom will discuss our financials in more detail..

Thank you, Wayne. As Wayne mentioned, we were not satisfied with our performance and results. And while we are confident that we're putting the right strategies in place to enhance quality and patient satisfaction and drive better core hospital growth, our second quarter came in below our expectations.

Starting on the volume side, we received reports from several markets that the environment in general was softer in the second quarter based upon feedback from providers, other healthcare services and, in some cases, competitors. This was not across the portfolio, but instead in select markets such as in the state of Tennessee.

On the flip side, our adjusted admission performance in Florida was above our corporate average for the second consecutive quarter. So we are pleased with the progress we're seeing at a number of hospitals in Florida on both the admission and surgery front.

We're seeing solid execution of our market-specific growth plans in the state, which are driven by strategic investments in both capital and medical staff development. Across the portfolio, we are continuing to execute our broader strategies to drive better volume growth across our four hospital markets.

We remain focused on our access point expansion strategy with a solid development pipeline heading into 2018, which includes 13 freestanding EDs, over 40 urgent and walk-in care centers, and 9 ASD projects.

Additionally, we have been introducing a number of initiatives across our physician practices that we expect will improve our volume performance moving forward. Another goal, for example, has been targeted work with our affiliated primary care practices in a number of markets, focused on standardizing our scheduling templates and processes.

These efforts have created incremental capacity and resulted in overall lift in clinic volumes in our initial pilot markets.

We've been expanding this to all of our primary care practice locations, and in the third quarter, we are scheduled to complete this roll-out, which should enable growth in our employed practices into the second half of the year. We expect to implement the same framework in our specialist practices in the near future.

Standardizing these scheduling templates are the necessary precursor to the introduction of centralized scheduling, which we have now successfully launched in a number of markets.

This consumer-focused initiative, which includes both telephonic and online scheduling functionality for our patients, has yielded improved volumes following each market's launch. Based upon these results, we've accelerated our roll-out plan to add more sites in the back half of 2017.

We intend to implement this functionality in both our larger and smaller markets where we have a considerable number of employed primary care providers and specialists.

Another growth focused area of investment is in our transfer center program or the management of inbound referrals to our hospitals and their EDs from both affiliated and non-affiliated hospitals in a particular region. At present, in most of our markets, the call center phone lines are outsourced to contracted partners who specialize in the service.

We are now in the process of migrating select markets to an in-house operation center to better leverage the size and scale of CHS. We believe this transition to internal operations has multiple advantages. First, it will provide more real-time visibility into daily ED, bed management and case management operations at our affiliated facilities.

It will also provide us improved data that will amplify our service line development strategies and related volume growth opportunities. And of importance, the internal operation should improve the service to and satisfaction of the referring facilities, and in the end, better meet the patient needs within the markets we serve.

Our first market transitions to our in-house service center this month and we will continue to migrate additional markets in the back half of the year. Finally, I would like to provide a quick update on our high-opportunity hospital initiative.

As a reminder, we started this framework in the fourth quarter of last year where we identified an initial 15 hospitals that have historically operated at a higher EBITDA margin but had experienced some EBITDA decline in 2016.

Following our initial in-depth operational assessment and focused strategic planning, we are seeing good results following execution of the resulting plans. On a year-to-date basis, we have seen EBITDA improve at 10 of these focused hospitals, and the group has seen positive year-over-year EBITDA growth.

On the expense side, we are continuing to build out our data analytics capabilities and reporting systems across the organization.

These data and reporting tools have allowed our division operators to work with local market leaders on a more real-time basis, so that costs are better managed in line with the individual hospitals' current volume and revenue trends.

We did see progress in the SWB line during the second quarter and we're building out the same capability to help further improve our supply costs moving forward. We expect to see continued improvement on those two expense lines in particular from these efforts.

So, in summary, we were not satisfied with our second quarter performance, but we see a number of opportunities to help drive both revenue growth and EBITDA margin improvement as we move forward. And now, I'll turn it over to Tom..

On a comparative second quarter 2017 versus 2016 basis, net revenues decreased $30 million or 0.7%. This was comprised of a 1.8% increase in net revenue for adjusted admissions and a 2.5% decrease in volume for adjusted admissions. Our inpatient admissions declined 2.5%. Our ER visits were down 1.8%. Our surgeries were down 2.4%.

During the second quarter, approximately 70% of our admissions decline was due from decreased OB volumes and increased observation days. The balance was primarily from decreased readmissions, inpatient surgeries and admissions related to the discontinuation of service lines such as SNF.

In the second quarter, we recognized a BP revenue settlement of approximately $5 million. Looking out the remainder of the year, we're not expecting material BP settlements in either the third or the fourth quarters. Our net outpatient revenues, before the provision for bad debts, represents 56% of our revenues.

Consolidated revenue payor mix for the second quarter of 2017 compared to the second quarter of 2016 shows managed care and other increased 100 basis points, Medicare decreased 140 basis points, Medicaid increased 60 basis points and self-pay decreased 20 basis points.

On a same-store basis, managed care and other increased 40 basis points, Medicare decreased 60 basis points, Medicaid increased 90 basis points and self-pay decreased 70 basis points. As a reminder, we include Medicare Advantage in our managed care and other account.

Consolidated uncompensated care, or care plus self-pay discounts plus bad debt expense, for the three months' comparative periods has increased from 26.2% to 29% of adjusted net revenue, a 280-basis-point increase. Same-store increased from 27% to 29%, a 200-basis-point increase.

Looking at our uncompensated care in the quarter, we experienced an increase due in part to the increases in self-pay volumes, patient co-pays and deductibles, increases in self-pay discounts as a percentage of net revenue and the sale of certain hospitals that have lower bad debt as a percent of revenue.

For the second quarter, our bad debt as a percentage of net revenue before bad debt was up 90 basis points to 14.1% on a consolidated basis and was up 40 basis points same-store. It's worth nothing that our 30 announced divestitures have a lower bad debt expense than our total corporate average.

So the sale of these hospitals will cost some upward year-over-year movement on our consolidated bad debt expense lined in the back half of 2017.

For the same-store expense items in the second quarter of 2017 compared to the second quarter of 2016, our salaries and benefits as a percentage of net operating revenues decreased approximately 10 basis points. The decrease was driven by our hospitals' use of labor data that Tim just talked about, as well as lower employee benefit expense.

Supplies expense as a percentage of net operating revenues for same-stores was flat. Increased implant costs were offset by savings and other supply areas. We made some progress on our salaries, wages and benefit and supply expense lines, but we see opportunities to reduce costs in both areas through the continuation of our focused initiatives.

It's also worth noting that since 2015, despite a number of divestitures, our corporate costs have been reduced as a percentage of total net revenue. Other operating expenses as a percentage of net operating revenue for our same-stores increased 180 basis points.

Increases in the second quarter of 2017 were driven by a combination of higher medical specialist fees, certain purchase services, information systems expense, business taxes and malpractice insurance. Our other operating expense line came in above expectations during the second quarter.

We're working to better control this expense line item in the second half of the year. In terms of our total operating spend, our same-store operating expenses were up 1.3% in the second quarter and 2.1% year-to-date.

We expect our consolidated operating expense performance to improve as the company continues to execute on its 30-hospital divestiture plan. The divested hospitals' EBITDA contributions in Q1 and Q2 of 2017 were approximately $30 million and $15 million respectively.

The 10 remaining to-be-divested hospitals are not expected to contribute any Q3 2017 EBITDA. Switching to cash flow, our cash flows provided by operations were $261 million for the second quarter of 2017. This compares to cash flow from operations of $338 million during the second quarter of 2016.

For the six months of 2017, our cash flows provided by operations were $503 million compared to $632 million. Year-to-date cash flow from operations declined year-over-year due to a few items. Cash flows attributable to divestitures was approximately $25 million reduction.

The timing of payments for payroll negatively impacted cash flows by approximately $135 million. The decrease in cash received from HITECH was roughly a $60 million reduction. Improvement in AR days more than offset the changes in third-party settlements. Combined, this was roughly $150 million benefit to cash flow.

Other decreases, including working capital changes, reduced cash flow by approximately $95 million. Turning to CapEx. Our CapEx for the second quarter of 2017 was $128 million or 3.1% of our net revenue. Year-to-date, our CapEx is $274 million or 3.3% of net revenue, compared to $407 million or 4.3% of net revenue through the first six months of 2016.

The lower CapEx has been due to limited replacement hospital spending and more targeted CapEx, focused on our high return in core hospitals.

Our CapEx is also being targeted towards additional access points that Tim mentioned, such as freestanding EDs and urgent care centers, as well as service line build-out around cardiology, orthopedics and other high acuity areas. Moving to the balance sheet.

At the end of the second quarter, we had approximately $14.7 billion of long-term debt, which is down approximately $100 million since the start of the year and approximately $1.9 billion from the end of 2015.

We also had over $700 million of cash on the balance sheet at June 30, and as a reminder, we divested a number of hospitals after the close of our second quarter. So it's worth noting that we used a portion of those proceeds to pay down term loan debt in early July.

On slide 17, we provide an update of our debt maturities as of July 7, which totaled approximately $14.25 billion of long-term debt. With respect to our 20 closed hospitals, to-date buyers have paid us $1.147 billion, of which we have used $951 million to pay down term loans.

As Wayne walked through earlier, we're pleased with the progress we're making with our 30-hospital divestiture plan. Our current divestiture plan is expected to generate approximately $1.95 billion of proceeds, with an estimated 10% of those proceeds coming from retained working capital.

The tax leakage from these divestitures is expected to be approximately 5%. We expect this current group of transactions to close during the third quarter of 2017 and these proceeds will be used for further debt reduction. And as Wayne mentioned, in response to continued interest in our hospitals, we recently expanded our divestiture program.

Beyond our announced 30, we're pursuing additional divestiture transactions for hospitals accounting for at least $1.5 billion of net revenue and mid-single-digit EBITDA margins. These proceeds will primarily be used to lower our debt.

On May 12, we completed a tack-on offering for $900 million of 6.25% senior secured notes due 2023 at an issue price of 101.75%. Net proceeds of the tack-on offering were used to prepay and fully extinguish our $700 million term loan A facility that was due January 2019.

The only near-term debt maturities prior to 2019 is our $600 million accounts receivable facility that's due in November 2018 and we have renewed this several times in the past. In terms of our bank covenants, our maximum senior secured net leverage ratio is 4.5 times through December 31, 2019.

And our minimum interest coverage ratio is 1.75 through the end of 2017, which will increase to 2.0 thereafter. We were in compliance with both covenants on June 30, 2017 with a secured net leverage ratio of 3.82 and an interest coverage ratio of 2.36.

As of June 30, 2017, our EBITDA cushion on our secured net leverage ratio is 15% and our EBITDA cushion on our interest coverage ratio is 26%. For 2017, our full-year guidance includes the following, and all amounts are adjusted for the timing of expected divestitures.

Net operating revenues, less provision for doubtful accounts, are anticipated to be $15.85 billion to $16.05 billion. For full-year 2017, our net revenue guidance was only slightly adjusted.

While our adjusted admissions guidance range was lowered, this was essentially offset by our 30 announced divestitures remaining in the portfolio slightly longer than anticipated. As a reminder, our 30 announced divestitures have an EBITDA margin that is well below our corporate average.

Adjusted EBITDA is anticipated to be $1.825 billion to $2.0 billion. Cash flow from operations is forecasted at $975 million to $1.125 billion. CapEx is expected to be $575 million to $725 million. HITECH is forecasted at $25 million to $30 million.

Income from continuing operations per share is anticipated to be negative $0.30 to positive $0.40, based on weighted average diluted shares outstanding of 112 million to 113 million.

As we think about quarterly cadence for the back half of 2017, it's worth nothing that the third quarter is typically our lowest quarter of the year in terms of revenue and EBITDA contribution. Also, we're expecting our remaining 10 divestitures that have not yet closed to be approximately break-even from an EBITDA standpoint in the third quarter.

Wayne?.

At this point, we're ready to open up for questions. We will limit everyone to one question so several of you have time on this call. But, as always, we're available to talk to you and you can reach us at area code 615-465-7000. Okay.

Mike?.

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

Hi, everybody. I guess it's a single question with two parts to it related to the divestiture program. Obviously, a lot of detail, Tom. It sounds like the divested assets in many ways underperformed the core business you're moving forward with.

I guess, some of that could be because they were identified as divestitures and people just took the eye off the ball.

I guess I would ask, on this like $1.5 billion additional that you're looking at, how do you make sure, given that those aren't identified, that the entire portfolio doesn't sort of get distracted by whether or not they're part of the divestitures? How are you guys managing that? And then the other aspect of the divestiture question was, I know you're looking for a turnaround in operations and you're balancing that against the divestiture program.

Do you have in the back of your mind where you were trying to get to with the financial metric, whether it's debt-to-EBITDA or some other metric? And when you get to that then you feel like, hey, we're out of the woods, we can go forward from here with this level of leverage or this level of debt?.

So, A.J., this is Wayne. In terms of the process for divestitures, we're much better today than we have been. This 30 has consumed a lot of time and effort and resources, but we've basically finished the 30. But the next group certainly will not be that large. So it shouldn't be as big a distraction as the 30 have been going forward.

But we're getting outstanding prices for these facilities. It will ultimately help us end up where we want to go when it's all said and done.

I don't know what that number might be, but I think what we think is that we will certainly improve our margins, improve our cash flow, get our debt to cap to – Tom?.

We're shooting to get below 6 times, A.J. And then....

In 2018. So I think we're on the right track. We've model this several times. All of our metrics look like the right idea. Good news is we're getting some performance out of Florida now, which we had not had before. We have a lot of outstanding markets.

And as we continue to divest these low-margin hospitals and all of it this next round, which we believe we will continue to get very good rates on, it will be very helpful as well.

You want to continue on that?.

I would say, A.J., some of the falloff there, when there's a longer delay between an announced and the closing, that's just a longer period of uncertainty. A lot of these hospitals are great assets and I heard Sam Hazen talk last week about when he brings Tomball into their market, the margins are going to get up to their market margins.

And we feel our buyers are going to achieve the same on these hospitals once they plugged them in into their markets..

Yeah. And into their rate structure, which is really....

Okay. Great. Thanks a lot..

Thank you..

The next question is from Brian Tanquilut from Jefferies..

Hey. Good morning, guys. Wayne, just following up on your comments on the divestitures. I think last quarter, you basically said we're kind of trying to shift more towards operation and execution rather than the divestiture focus. And you've announced or discussed that you have $1.5 billion of revenue that you've gotten offers for.

So what is your openness to selling bigger regions versus just being opportunistic and looking at one-off deals at this point?.

Well, as you probably know, very few of these are one-off deals. A lot of them are combined deals with a number of people. But we're trying to restructure this portfolio so that we get good properties and good markets and invest our capital, get good returns and get good growth.

So we're being strategic about it in how we think about our portfolio going forward. So far, there hasn't been very many high-margin – there hasn't been any high-margin hospitals to amount to anything in this. They all have been relatively low-margin hospitals, by and large, once all said and done.

So I think that's the way that we're thinking about it. I'm not sure what the number is, but I can assure you that if you do the math on all of this kind of going forward, it looks a lot better and it's sustainable. And that's where we're trying to get to.

So we can deploy our capital and go back into growth mode sometime next year, and you see from what Tim said, we are working hard on all of our operations. I don't know why we, nationwide, had a reduction in volume. There's a lot of issues and a lot of reasons to think about in terms of a lot of different discussion about this.

Everybody's got the same trend. But we're trying to buck that trend now, and particularly we are doing it in a lot of good markets. And so we're excited about the opportunity and we're not that far off in terms of turning the corner on all this..

Sounds good. Thanks, Wayne..

Your next question is from Chris Rigg from Deutsche Bank..

Good morning. We're just hoping to clarify some of the prepared comments on the contribution from the divested facilities.

Did you say that the 10 facilities that are not yet divested are expected to contribute $0 in the third quarter to EBITDA, or did I hear you incorrectly?.

No, Chris, that was correct..

Okay. So, does that mean if we sort of subtract the first half from the guidance, you get sort of an implied run rate of EBITDA core about $1.9 billion.

Is that sort of fair where you think you guys are on a pro forma basis at this point?.

Yeah. I think if you utilize what I gave you on the contributions for Q1 and Q2 from all 30 of the divested hospitals and then you take into consideration no contribution in the third quarter, that should give you a nice sequential start..

Okay. Thanks a lot..

Your next question is from Frank Morgan from RBC Capital Markets..

Good morning. I guess one other question I would have staying on that same subject.

What do you think pro forma leverage will look like at year-end if you are successful with this new round of $1.5 billion of revenue of potential divestitures?.

It'll take us more than six months for this next round. But there's some possibility that we might close part of it by year-end. But it's probably into next year. Tom, do you want to....

Yeah. Frank, we put that out just to give a heads up to investors that we're continuing the process and that which would have been earlier than we had put out notice on these other 30. So we will update as we progress through those transactions and we'll have a better deal for timing and so forth.

But, as Wayne said, right now we are not anticipating anything by year-end, and we may be wrong on that but we're not anticipating anything by year-end..

But I can assure you there's a lot of interest in the facilities that we have identified..

Got you. And just as a follow up there, in terms of just going back to Chris's question, the year-end exit rate of EBITDA for the company.

If you took the guidance that you updated today and then subtracted out those contributions in the first quarter and second quarter, that effectively gets you to what the exit run rate at the end of the year would be for the company with these pending divestitures.

Is that right?.

Right. From an EBITDA standpoint, that's correct, Frank..

Okay..

Frank, for an Alabama guy, your math is pretty good..

Oh, my goodness. Okay. Thank you..

Your next question is from Ralph Giacobbe from Citi..

Thanks. So, you divested and bumped up I guess the additional divestitures in reference sort of roughly $5 billion of revenue with all those assets at kind of mid-single-digit margins off the 2016 base. That's almost 30% of your revenue base and would imply kind of a mid-teens margins on the non-divested piece.

I guess, first, is that fair? And then, just given the pressures that you've seen, can you give us a sense of, I don't know, what do you think the sustainable margin profile of whatever the existing hospitals you expect to retain will be?.

Yeah. I think that what we put out before on the impact of the divestitures, we were using 2016 data. And looking at that, we had 170 basis points pickup from those divestitures. When we updated that for Q1 and Q2, it looks like about a 200 basis points improvement after the 2016 trailing 12 months.

The only thing I would add there is obviously with this quarter, our operating performance consolidated has slipped. So, when you talk about what you're going to improve off of that number was a little bit lower. So I think some of the initiatives, you can adjust for that for the 2017 performance.

But then the lift coming at about 200 basis points from the 30 hospital divestitures..

Okay. All right. Thank you..

The next question is from Sarah James from Piper Jaffray..

Thank you. It looks like same-store surgeries and ER visits decelerated in the second quarter. Can you talk about the drivers? And specifically, your peers have spoken to pressure on low acuity volume. So I wanted to understand if Community was seeing this pressure or if there's another driver..

Sure. This is Tim Hingtgen. I'll take that one. I'll start with the ED decline, and 90% of our ED volume decline was on the outpatient side, largely attributable to some of the industry dynamics, including urgent care growth, freestanding ED competition in select markets. Again, it was not across the board, but in select markets.

Also, from an inpatient admission decline standpoint, that does correlate strongly with our observation increase that we've talked about as a key contributor to the admission decline in the second quarter.

So, for us, the strategy to combat that, obviously, as I said are to build more access points, make sure we've got the right primary care base in the markets to support the primary care needs of these patients.

And then also, the transfer centers and service line strategy that we've been working on for several quarters are certainly showing benefit in many of our core markets. We do expand that into those that are showing some of the softening. From a surgery standpoint, again, the majority of that is also on the outpatient side, about 80% of the decline.

And more of that was attributable than we had expected in the divestiture markets. About 20% of the drop was in markets that are leaving the portfolio.

We have had some ASD competition from non-joint venture, but also we've had some strategic decisions that we made to invest in ASDs in core markets, which has moved some of the business out of the hospital operating environment into a non-consolidating JV ASD.

But we think that's the right thing for us to do in the long-term relative to WorkCare's migrating. And then in select markets, we also had some decreases in GI and pain management procedures. Not necessarily the highest revenue book of business, but losing one or two providers in a market can certainly drive up that stat comp relatively quickly.

And then, in some cases, we also had elective service line discontinuations following a portfolio margin review of certain hospitals. So we think those are, frankly, good volume declines. Unfortunately, the volume declines in the second quarter certainly were greater than the number of hospitals that posted some pretty considerable volume increases.

Wayne mentioned Grandview. We have a long list of core markets that had double-digit surgery increases with the successful recruitment and development of service line. They just got muddied out by the declines in some of those other markets..

Your next question is from Gary Taylor from JPMorgan..

Hi. Good morning. I wanted to think about the potential impact of operating leverage as you divest revenues heading into 2018.

And I was hoping you can give us some information on total annual corporate overhead? And then how much you specifically look to bring that down in 2018? And then the final part of the question is, I believe from Quorum's disclosure, they're paying about $16 million a quarter transition services, shared services support, et cetera, mostly under a five-year agreement.

So I wanted to make sure that those dollar amounts were pretty stable over that period. There aren't going to be any material contemplated changes in that revenue support for the corporate structure..

Yeah, Gary. So, on that one, you're in the ballpark on QHC. We're not aware of any disruptions to that five-year agreement. So, that is correct. And secondly, on the annual corporate overhead, we're about right at 2%. And as I mentioned earlier in my comments, that's actually declined as a percentage of net revenue.

So we've done a lot of things with the QHC spend. That was about 200 corporate jobs that went with that. We've moved to shared service centers and become a lot more efficient on the revenue cycle and the HR area and other areas that we're looking at. So we'll continue to focus on that.

We have moved our division structure for how we manage our hospitals down from five to four, and that make us more efficient. So we will continue like initiatives to make sure that we rightsize our corporate departments to the size of the company..

The next question is from Ana Gupte from Leerink Partners..

Thanks. Good morning. I just wanted to find out – you threw out a number of statistics on the payor mix and so on, along with your observation that 2Q has been somewhat of an inflection point in terms of worsening volumes.

Can you talk about why you think that is beyond – is it mostly payor pressure or is it mostly deductibles and consumers seeing the pressure on that and so they're shying away from utilizing services? And it sounded like your Medicare volumes were down but everything else, including MA, was up, which seems a little contradictory to some of what the other guys are seeing..

Ana, this is Tim. I'll start off kind of addressing the observation question. I do want to point out, with the increase in observations, it was not widespread across the company. It was truly in a handful of markets that drove about 80% of the increase.

And in those cases, it does seem as if the root cause was primarily payor pressure on the Medicare Advantage and, in some cases, the Medicaid managed lives in those select markets.

And in those cases, we're working very closely to make sure that if we don't have the same revenue differentials we do on an inpatient admission, that our cost structure is lining up with that new revenue reality. It's not necessarily material in every market. Where we do need to work on some contracting, we're in the throes of doing that as well..

And then, Ana, just on the volumes, we provided, as you know, revenue by payor mix. When you look at it from a volume standpoint, overall, Medicare was up. Mostly in Medicare Advantage fee-for-service, Medicare was down. Self-pay was up, Medicaid was down.

And traditional managed care, which would include Blue Cross, was down for the quarter and six months..

The next question is from Justin Lake from Wolfe Research..

Hi. This is Steve Baxter on for Justin. I appreciate the commentary about the volume in your mind being the primary drag on results in the quarter. But margins were also clearly well below what the Street was expecting. Obviously, there's a lot going on with the divestitures.

But I guess could you give some context around how margins in the quarter overall came in versus your expectations and specifically....

Sure..

Go ahead..

Go ahead and finish your question..

I was going to say specifically around the other OpEx line, which was up almost 200 basis points..

Okay..

Can you kind of break some of that out and provide some specificity and what's giving you confidence that's going to improve throughout the year?.

Will do, and Tim, chime in. So, looking at salaries, wages and benefits, we've been working hard at this for over six months. We feel like we got pretty good traction there on a same-store basis to get a decrease in that with decreased volume. So, felt good about that.

We also felt very good because our hospitals did a great job by May of really getting a lot of that work done. And so we had a very favorable June heading into third quarter, which we like. On the supply side, we had really good experience in the areas we're focused on, with the exception of implants.

And that's partly due to our focus on the orthopedic. It's probably driving some of that. But we know we can perform better on that supply line, on implants specifically. So we're going to get after that. Purchase services and others, one component of that are the medical specialist fees, which are hard to flex quickly when you have decreasing volume.

But we are involved with getting into that and looking at how we use medical specialists and how we contract nationally for that. So we're focused on that. There were some other items in that, for example, what we pay in provider taxes is included in that and, as you know, what we put in, we get more than that out on the revenue side.

So, that was part of the increase. And then we had a very difficult comp on some other expenses there that we know will not occur for the rest of the year. So we feel good about that. So, of all of those, the one we're really focused on are the medical specialist fees and, as I mentioned, on the implants..

And I'll echo what Tom said. Putting a lot of energy into, visibility into these supply lines, SWB lines, at all of our hospitals and then by exception putting targeted resources to those that we have opportunity has been a core focus of ours.

The other area where we're putting some good work into is the growth of cardiac services with our service line and acuity focus. But with that comes a higher implant expense. We've gone through a rather rigorous process to make sure we're getting preferential pricing, and it's a rebate program surrounding that as well..

Our last question at this time is from Kevin Fischbeck from Bank of America Merrill Lynch..

Great. Thanks. So this quarter, in your slide presentation, you didn't have a slide kind of comparing core Community to core HMA. Just wanted to see what trends were going on there and if that's not the right way to look at it.

If there's any other way to kind of slice the portfolio to kind of give us a sense of what you think the underlying growth of the real business is?.

Thanks, Kevin. We've owned those over three years now. So we felt like let's move on, run and cut those out separately. With that being said, when you look at some of those markets, Tim mentioned Florida and Wayne mentioned Florida, has been a strong state for us and largely influenced by HMA hospitals.

Tennessee was not, so it just depends on the market. But we're looking at it as all CHS now..

And I will now turn the call back over to Mr. Smith for closing comments..

Thank you, again, for spending time with us this morning. We are very focused on our strategies we outlined over the past several quarters.

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 operating performance. This concludes our call today. We look forward to updating you all on our progress throughout the year.

Once again, if you have questions, you can always reach us at area code 615-465-7000..

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