Trevor Fetter - Tenet Healthcare Corp. Daniel J. Cancelmi - Tenet Healthcare Corp. Keith B. Pitts - Tenet Healthcare Corp. William H. Wilcox - United Surgical Partners International, Inc. Jason B. Cagle - United Surgical Partners International, Inc. J. Eric Evans - Tenet Healthcare Corp..

Whit Mayo - Robert W. Baird & Co., Inc. A.J. Rice - UBS Securities LLC Sheryl R. Skolnick - Mizuho Securities USA, Inc. Joshua Raskin - Barclays Capital, Inc. Chris Rigg - Deutsche Bank Securities, Inc. Kevin Mark Fischbeck - Bank of America Merrill Lynch Ralph Giacobbe - Citigroup Global Markets, Inc.

Brian Gil Tanquilut - Jefferies LLC Gary Lieberman - Wells Fargo Securities LLC Justin Lake - Wolfe Research LLC Gary P. Taylor - JPMorgan Securities LLC Ana A. Gupte - Leerink Partners LLC.

Good day, everyone, and welcome to the First Quarter 2017 Tenet Healthcare Earnings Conference Call. My name is Dana and I'll be you operator for today's call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. The slides referred to in today's call are posted on the company's website.

Please note the cautionary statement on forward-looking information included in the slides. I would now like to turn the call over to Trevor Fetter, Tenet's Chairman and Chief Executive Officer. Mr. Fetter, you may begin..

Great. Thanks, operator, and good morning, everyone. Thank you for joining us today. We've accomplished a lot in the past few months. In addition to generating solid first-quarter operating results, we took a number of important actions to improve the performance of our business and reduce complexity across the enterprise.

I'd like to walk you through some of those initiatives and accomplishments, which are outlined on slide 3. The most notable actions we announced are a new agreement with Humana, the purchase an additional interest in USPI, and a definitive agreement to sell our Houston hospitals to HCA.

We're committed to increasing growth in earnings and margins, and decreasing leverage and complexity, and these actions are tangible evidence of that commitment. Beginning with the first quarter results as outlined on slide 4, our performance in the quarter demonstrates our ability to deliver strong financial results in a soft volume environment.

Adjusted EBITDA of $527 million was at the top end of the outlook range that we provided in February. Our Ambulatory and Conifer segments delivered solid results. This includes same-facility system-wide revenue growth of more than 6% in our Ambulatory business, and third-party revenue growth of more than 11% at Conifer.

Our hospitals maintained strict cost control in the face of weak volumes, which enabled us to deliver our overall EBITDA results. Active expense management has long been a core skill for Tenet. We know how to do it, and we know how to do it well. This is not only a priority for our hospital operators, but also at USPI and Conifer.

Obviously we are disappointed with our volume performance. However, we believe the weakness is temporary, and we have strategies and initiatives in place that make it possible for us to meet our expectations for volumes for the year.

These include the service-line investments that we are making across our network and the expansion of access points in the communities that we serve. I'd also like to note that we faced a difficult comparison to last year, in part because of the impact of our out-of-network status with Humana.

We are pleased to have entered into a new contract that is in the best interest of both companies and our shared customers. The new three-year agreement includes all of our hospitals, outpatient centers, and employed physicians, which will become in-network providers with Humana during a phased-in process beginning June 1.

By October 1, this process will be complete. Our strategy at Tenet has always been to maintain collaborative relationships with commercial customers and to be in as many networks as possible to ensure access to our facilities.

This has created a strong managed care book of business, but we may go out of network from time to time if we can't reach acceptable agreements. The recent situation was very unusual and I'm glad to have resolved it. Overall, we have contracts covering 97% of our expected commercial revenue for 2017 and 82% for 2018.

As we work to create value in our business, we also want to simplify the Tenet enterprise. Over the last few years we completed several strategic transactions that align our business with industry trends, strengthened our growth prospects, and improved the long-term economics of our company.

These include the acquisitions of Vanguard and a majority stake in USPI, as well as a series of joint-venture transactions and divestitures. We have every confidence that these actions were the right ones for Tenet, but also recognize that some of them have created additional complexity.

I want you to know that we are committed to reducing that complexity, and also reducing risk across the enterprise. As part of this strategy, we are continuing to divest operations that are no longer core to our business.

Our exit of the health plan business is nearing completion with the divestitures of our health plans in Arizona and Michigan and the wind-down of additional operations. We've also completed the sale of most of our home health and hospice businesses that we planned to sell this year.

We also signed a definitive agreement for the sale of our hospitals in Houston, which we anticipate completing this summer.

Beyond these announcements, we made tangible progress on hospital divestitures in certain other markets, but in keeping with our practice of announcing definitive agreements, we aren't in a position to announce any additional hospital transactions today.

However, to set expectations, these other transactions are smaller in the aggregate than what we are realizing through the sale of Houston. Turning to USPI, as you know, we benefited from remarkable growth that our Ambulatory business has achieved since we acquired a majority stake two years ago.

The statistics on slides 11 and 12 provide a great snapshot of USPI's performance, and you can see not only the strength but also the consistency of those results, including nine consecutive quarters of growth in revenue, EBITDA, and EBITDA less NCI.

Not only is the ambulatory business well aligned with consumer trends, it has less exposure to government programs and uninsured patients than our acute care business. Its margins are higher and it requires less capital, yet the synergies with our acute care business make the two very complementary.

These are among the reasons that we are so pleased to have reached an agreement with Welsh Carson to accelerate our purchase of USPI. You can read more about the terms of the agreement in our earnings materials, but I wanted to take this opportunity to highlight a few key points which are summarized on slide 5.

Under the terms of the restructured agreement, we will increase our ownership in USPI to 80% by July 3. This is an NPV-positive transaction that we expect to fund with available liquidity. Our $711 million payment to Welsh Carson will reduce the redeemable non-controlling interest on our balance sheet by a similar amount.

I know that some of you view redeemable NCI as a form of debt when calculating our enterprise value, so this reduction is roughly $7 per share.

By deploying capital to fund this payment now, we are spending less to acquire USPI than we otherwise would, we're capturing earlier the value for Tenet shareholders that's created by the below-market multiple we're paying for USPI, and we're taking away what some of you have viewed as an overhang in the form of a pre-committed use of capital.

Establishing an 80% ownership position also creates value by enabling us to utilize our NOLs to reduce USPI's federal income taxes, which will help improve cash flow by roughly $50 million over the next two years.

We will continue to use internally-generated cash to allocate approximately $100 million to $150 million per year toward acquisition opportunities at USPI. By owning more of USPI, as that business segment grows organically and through acquisitions, more of the benefits of that growth will accrue sooner to our shareholders.

Looking ahead, we expect that we will complete our purchase of Welsh Carson's interest in USPI by July 2019. Our agreement provides us with the ability to buy the remainder in equal tranches over the next two years, with 7.5% in 2018 and another 7.5% in 2019. The remaining 5% is owned by Baylor.

As you think about the changes we're making to simplify Tenet, I want you to know that we remain committed to reducing our leverage and continue to target a debt-to-EBITDA ratio of 5 times or less by the end of 2019.

Our decision to accelerate our ownership stake in USPI, after taking into account the reduction in NCI and the tax benefits, advances both objectives. In addition to Houston and the sale of our health plans and home health and hospice businesses, we've made good progress towards the sale of additional hospital markets.

We feel very comfortable that these activities, once completed, combined with continued EBITDA growth, will enable us to drive down our leverage. Stepping back from the details for a moment, for the past several years we've pursued a strategy that included several basic elements.

The first element is to improve our hospital portfolio so that it contains a higher proportion of number-one and number-two market positions. That strategy drove our 2013 acquisition of Vanguard and the formation of joint ventures in Tucson and Birmingham.

Today, the number and percentage of our markets where we're number one or number two has never been higher, at around 75%, and we expect to be nearly 80% by this time next year. In other words, our hospital portfolio is stronger than ever.

The second element of our strategy has been to diversify Tenet into the ambulatory and business services segments through focused investments. Today, we've built leadership positions with USPI and Conifer.

Another way of looking at this is that the company generated nearly 100% of its revenues and nearly 90% of its EBITDA from acute care hospitals as recently as five years ago. Today the story is very different. In the last 12 months, our non-acute care hospital businesses represented roughly 15% of Tenet's revenues but nearly 40% of EBITDA.

As you know, while we've strategically repositioned the company's business portfolio, the complexity of the business model increased, and so did the leverage ratio. We're clearly focused on reducing both complexity and leverage while executing on our growth objectives within the businesses. Today's announcements demonstrate that focus.

And with that, I'll turn it over to Dan Cancelmi, our Chief Financial Officer.

Dan?.

Thank you, Trevor, and good morning, everyone. I'll start with a high-level summary of our financial results. We generated adjusted EBITDA of $527 million in the quarter, which was at the high end of our outlook range. Adjusted EPS was a loss of $0.27.

Same-hospital revenue per adjusted admission was up 3% on an apples-to-apples basis after adjusting for the California Provider Fee revenue. Adjusted EBITDA in our hospital segment was $309 million.

Revenue in the ambulatory segment increased 6.1% on a same-facility system-wide basis, and adjusted EBITDA less facility-level NCI increased 11.1% to $100 million. Conifer's EBITDA increased 3.2% to $65 million, and adjusted free cash flow was $9 million.

Turning to volumes which are summarized on slide 8, adjusted admissions decreased 2.5% on a same-hospital basis, and were down 0.8% excluding patients insured by Humana in both periods, and were about flat excluding the leap year impact. Regardless, it's clear that we face a challenging volume environment in the hospital business this quarter.

However, we expect improvement later in the year tied to our business strategies, recent capital investments, and returning to an in-network status with Humana. I also want to spend a minute on the California Provider Fee program.

In March, the state sent its application to CMS for their review, and we continue to anticipate approval of the program by CMS in the fourth quarter of this year. If you would like to understand how the California Provider Fee affected our growth rates and margins in Q1, simply add $57 million of revenue to our results in the first quarter.

As an example, if you do this math, revenue per adjusted admission is up 3%, and our EBITDA margins would've been 100 basis points higher in the first quarter. Slide 9 shows the calculation of our same-hospital revenue growth and revenue per adjusted admission growth after normalizing for the differences in the California Provider Fee revenues.

Turning to costs, total hospital segment cost per adjusted admission only increased 1.9%, which was below our full-year outlook range of 2.5% to 3.5%. We managed expenses well in response to the soft volume environment.

On slide 10, our total cost of uncompensated care increased to 21.8%, which is where we were in the first quarter of 2015 and up from 20.6% in the first quarter last year. The primary driver was a $34 million increase in self-pay revenue.

Moving to our Ambulatory business on slide 11, we delivered 6.1% same-facility system-wide revenue growth, with cases up 50 basis points and revenue per case up 5.6%. If we exclude patients that were insured by Humana in both periods, case growth would have been 2.4%. Importantly, all USPI's facilities will be back in network with Humana on June 1.

On slide 12, adjusted EBITDA less facility-level NCI increased 11.1%, which was in line with the growth that we are targeting this year. The results in the Ambulatory segment continue to benefit from strong organic growth and acquisitions.

USPI is working on a robust list of de novo developments and potential acquisitions this year, and we continue to anticipate deploying $100 million to $150 million this year on these opportunities. As you can see on slide 13, Conifer grew its revenue 4.4%, and revenue from third parties was up 11.5%. EBITDA for the quarter was $65 million.

Similar to last year, we anticipate Conifer's EBITDA being higher in the second half of the year relative to the first half due to performance-based incentive payments that Conifer can earn. Slides 14 and 15 provide the details of our outlook. We are making a technical adjustment to our outlook to reflect the change in accounting for pension expense.

This change has no effect on EPS, but it moves roughly $25 million out of SWB expense and places it into the other non-operating expense line. For the second quarter, we expect adjusted EBITDA of $550 million to $600 million and an adjusted loss of $0.10 to $0.20 per share.

Keep in mind that our EPS will be heavily weighted toward the fourth quarter due to the anticipated timing of the recognition of our 2017 California provider fee revenues. As Trevor discussed, we announced two meaningful transactions yesterday. Starting with Houston, we anticipate receiving net sales proceeds of approximately $725 million.

I thought you might find it helpful to know that these hospitals generated $575 million of revenue after bad debt last year, with an EBITDA margin of approximately 14%.

Our tax basis in Houston is around $250 million, so we will use roughly $500 million of our $1.7 billion NOL carryforward to offset most of the taxable gain, and we expect to complete this sale during the third quarter. Moving to our accelerated buy-up of USPI, we are now going to own 80% in July of this year, and expect to be at 95% in July, 2019.

By increasing our ownership stake to 80%, up from 56.3% today, our non-controlling interest expense will be reduced by approximately $30 million over the 12 months following the change. In the second half of this year, our non-controlling interest expense will be approximately $10 million lower than our prior expectations.

But this will be partially offset by higher NCI expense in the second quarter, so the effect in 2017 is around $5 million of a reduction in the NCI expense. Keep in mind that our outlook in the second half of the year had already incorporated the lower NCI expense for moving from 56.3% ownership to 69%.

So the $10 million is the incremental reduction in NCI as a result of increasing our ownership to 80%. Also, our balance sheet NCI will be reduced by about $700 million when we increase our USPI ownership to 80%. The payment this year to increase our USPI interest to 80% will be $711 million.

In 2018 and 2019, we expect the payments to be approximately $275 million to $325 million each year. More information on the USPI buy-up is provided on slide 5. The impact of both of these transactions will be reflected in the updated outlook that we plan on providing in our second quarter earnings release.

To summarize, our hospital operators performed well in the face of a tough volume environment and did a great job managing costs. The results of our Ambulatory segment continue to be very strong, and we were pleased with Conifer's results as well.

We remain on target to reduce leverage to 5 times debt-to-EBITDA by the end of 2019, and yesterday's announcement regarding Houston and USPI should help us achieve this goal. With that, I'll now ask the operator to assemble the queue for our Q&A session.

Operator?.

Thank you. We will now begin the question-and-answer session. And we'll take our first question from Whit Mayo with Robert Baird..

Hey. Thanks, guys.

Maybe just first starting with USPI, I think we totally get the decision to accelerate the ownership, but can you talk about why renegotiate the contract with Welsh, versus just buying the rollover piece left from last year, and calling all of the equity next year at 9.5 times? Just kind of wondering how you balanced all of the options?.

Yeah, I'll ask Keith to address that.

Keith?.

Yeah, we looked at several things. One is, they're buying today – given the growth that we've seen in the last few years and our growth guidance this year as well, we think the earlier ownership, the better we were able to start sheltering their taxes.

We're also trying to reduce some of the overhang on the allocation of free cash flow in 2018 through 2020, which we've done a significant amount here. We also were able to sort of lock in the dates, the times and the method of payments to be at our choice, fully, whether it was a put or a call.

And so there's a whole combination of factors there, and we were able to negotiate a good way where Welsh Carson continues to stay in some, but we're able to accelerate earlier the ownership..

That makes sense. And maybe my second question, just around the development opportunities within the Ambulatory division, I don't know if Bill is on or not, and I think Dan mentioned that there's been maybe a pickup in some de novo activity.

Is there anything driving that, or are these deals with existing hospital partners or are these new markets? Just any color around sort of like what you're seeing in the pipeline would be helpful..

Okay. Whit, this is Bill. We've seen, as we talked a little bit about last time, a big change in the amount of de novo opportunities and I think it's driven in part by the health system partner strategies, but also based on the fact that we have national relationships with managed care payers that we never had until we had the relationship with Tenet.

Combining those factors with just the market movements towards ambulatory has really created several opportunities. And the acquisition pipeline also continues to be quite robust..

I would just add with it, we at Tenet are also driving a very aggressive ambulatory strategy in our hospital market, as we've been doing since 2008, and find that the USPI platform is outstanding for developing everything from urgent care centers to surgery centers, and then we're also – we have a robust program in developing free-standing emergency departments, micro hospitals, et cetera..

Actually, I should've mentioned that..

Okay. Thanks, guys..

And we'll take our next question from A.J. Rice with UBS..

Thanks. Hello, everybody. Just to start off with, obviously one of the areas of outperformance, as you mentioned, Dan, was the growth – the moderate growth in controllable expenses, the 1.9% versus your target for the full year of 2.5% to 3.5%.

When you step back and look at that, is there anything in the underlying cost trend that is improving and allowed you to obtain that? Is this mostly just, the company saw and that they had the out of network situation with Humana and the leap day, and really ratcheted the cost? And does that make you think that you might be able to come in better than the 2.5% to 3.5% for the full year?.

Good morning, A.J. This is Dan. Yeah, we were certainly pleased with our cost performance. Our hospital teams did a really nice job responding to the softer volume environment. And really – I'll go through a few things and ask Eric to also weigh in. It's pretty much across the board.

We have various labor improvement initiatives that we've been focusing on, obviously, for several years. But we continue to look at consistent labor practices, premium pay. So we've done a really nice job managing labor.

We've also been really focused on our other operating expense spend, and looking for opportunities to rationalize some of that spend, leverage the company's size, and just continue to look for cost efficiencies. We've obviously completed some transactions in recent years.

Certainly the Vanguard transaction, the synergies we obtained there were very strong. And we continue to capture synergies related to our most recent acquisitions in Birmingham and Tucson. So that's working really well.

And from a supply chain perspective, our transition last year, bringing our procurement functions in-house, as well as transitioning to the HPG-GPO relationship, has really gone very well.

So we're certainly pleased, it helped us overcome some of the volume challenges that we saw in the quarter, and we're optimistic that we're going to continue to be able to drive efficiencies..

Yeah. Thanks, Dan. And A.J., I wouldn't add a lot to that, Dan covered a bunch, but on the labor side, we continue to really, I think, drive our Tenet operating system across the hospitals in a more concise way than we ever have, so we see standardization as a big opportunity. Top of license work, et cetera, at our hospitals, which is driving value.

Supply chain, the GPO integration continues to mature, and we continue to find savings there. We think there's still opportunity in our run rate to work on our supply chain costs. And I'd point out, I'd highlight a couple of areas.

Pharmacy is an area where we've really made great gains compared to prior years with some of the initiatives we've put in place in our hospitals, standardizing formularies, et cetera. So I'm really proud of the operators.

We think all of these changes obviously help with our cost structure going forward, when we expect that volumes will begin to strengthen..

Okay. And if I might just ask one follow-up on some of the investments that Dan referenced in the prepared remarks, investment in extending service lines, new service lines.

Can you just give us a sense of the order of magnitude of that? And I know there's been particular investment in building out the children's hospital in Texas, as well as in Detroit.

Any update on – so how these service line – different things are doing, and how they might impact your results over the remainder of the year?.

Sure. So, we have a number of pretty large investments that are coming online this year. I'd start with the hospital in my adopted city of El Paso that we opened in January. The Transmountain Campus is off to a good start.

Obviously, initially that will be a little bit of a cash burn, but we expect later in the year that that's going to turn positive for us.

We have three other major projects coming online between now and the end of the year, a new tower at Delray Medical Center, which is one of our busier hospitals, at a full occupancy rate in South Florida; a new tower at our Children's Hospital in Michigan; and then we had a third tower that actually opened towards the end of the last year at North Central Baptist in San Antonio.

So those are all pretty large investments that we expect will certainly strengthen those markets' position. The other thing I would say on the access point side, we had talked last quarter about the 15 free-standing EDs or microhospitals we have planned to add over the next 18 to 24 months. We're also adding urgent care centers.

And so those continue to come online over the next year or so; we have some already in the pipeline. So all of those we expect to help us as the year progresses in strengthening our volume performance..

Okay. Great. Thanks a lot..

We'll take our next question from Sheryl Skolnick with Mizuho..

Good morning, thank you. Can we focus on the non-controlling interest, please? It's confusing me, and I think probably some others. If we look at just the Ambulatory Care segment financials, so it's a two-part question. One is about the growth rate.

So why is it that the non-controlling interest net income seems to grow faster than the EBITDA? And I understand the difference in the size of the denominators, but I'm wondering whether there's something to do with the tax rates, or something there that's causing that disconnect? And second, because it's just – if the ownership levels are constant, I'm not quite sure why one should grow faster than the other.

And then second, can you just walk us through how the Welsh Carson NCI will work, giving us actual numbers? Because I think it's very important for us to understand what gets implicitly put back into the Tenet shareholder pool and comes out of the Welsh Carson ownership pool. Thank you..

Hi, Sheryl. This is Jason Cagle from USPI. I'll take the first one. You're right. The ownership levels don't change that dramatically, so that doesn't drive it.

But what does happen is with many of our facilities – about 300 of them, about two-thirds of those are unconsolidated, the rest are consolidated – and at any given month or quarter, there's going to be variation in which ones outperform versus which ones underperform.

And this quarter in particular, you can probably tell when you look at the system-wide revenue growth of 6.1% and consolidated revenue growth of 6.1%, but the earnings overall growing at a rate faster than that – combined with the fact that the equity in earnings, which represents the unconsolidated facilities, is growing at a rate slower than that, at about 8% -- that in this particular quarter, the consolidated facilities just outperformed, and that drove the NCI.

And that's something that, quarter by quarter, we're going to have our outperformers and our underperformers, and that's why you'll see some disparity between those two..

That's very helpful..

Sheryl, it's Dan. And on your second question, let me give you some numbers and hopefully make it clear. So as a result of buying up to 80%, beginning in July and for the next 12 months, this will result in a reduction of NCI expense, about $30 million for that 12-month period, July of this year through June of next year.

So about a $30 million reduction in NCI expense over the next 12 months, starting in the third quarter. So let's start off with that.

In terms of the numbers that we talked about in my prepared remarks, as well as what we had in our press release, by buying up to 80% in July, what that does is it results in an incremental reduction in NCI expense of $10 million compared to our previous guidance.

So we had always anticipated going up to 69% in the second quarter, okay? Now, we're going up another 11% to 80%. That results in about a $10 million reduction in NCI expense in the back half of this year relative to our prior expectations. Now, we also talked about this $5 million. So where's that coming from? Think of it this way.

That $10 million is reduced by the fact that we didn't buy up in April, which was our initial guidance this year. So a little bit of extra NCI expense in the second quarter, but we have $10 million reduction in NCI expense in the last 2 quarters of the year.

So, again, $30 million on an annual basis, roughly; $10 million additional reduction in the back half of this year..

Okay. That's helpful, but let me start at the beginning.

What's the total NCI for Welsh Carson before you go to 69%? What is it today, at the 56.3% ownership by Tenet?.

It's roughly $45 million..

Okay. It's confusing to people why that's such as a small number relative to the performance of USPI. That's part one.

Part two, so what you're saying is that we should raise our expectations by $5 million from the second quarter, but lower them by $10 million for the third quarter and fourth quarter?.

You should – the opposite, Sheryl. You should reduce NCI expense by $10 million in the back half of the year..

All right. I think....

Compared to....

Yeah.

Lower it in the third quarter and fourth quarter, raise it in the second quarter, because you're not going up to the 69% in the second quarter?.

That's correct..

Okay. All right.

And can we just go through why it's only $45 million if they own 39% of such an attractive enterprise?.

Well, when you go through and – first of all, that's on an after-tax basis..

Right..

And the NCI at the facility level, we don't pay taxes on that. So when you just go through the math, that's how you get to the net earnings that we pay taxes on. And as we pointed out, going to 80%, we are now going to be able to consolidate USPI's results in our consolidated federal tax return, which will reduce our cash tax payments..

Okay. That's kind of what I thought. That's great. Thank you. It's an interesting transaction. It's an interesting way to create some value. If you weren't going to pay down debt, investing in your fastest-growing, highest-margin portfolio seems like the right thing to do..

And we'll take our next question from Josh Raskin with Barclays..

Hi, thanks. Just want to confirm on the $100 million to $150 million of growth investment for USPI, just want to make sure of the timing.

It sounded like no impact on timing from some of these Welsh Carson payments? Should we assume that those will be ratable? And then, it sounded like there may be some opportunities to invest with health plans as opposed to health systems, and I want to just know if that's sort of a new initiative there as well?.

Hi, Josh. This is Bill. It's very difficult for us to predict the timing of the acquisitions. But as I said earlier that we've got a nice pipeline, and the transaction with Welsh Carson won't impact that at all. And as it relates to any major change in our strategy, we don't have that.

We've got plenty of opportunities within the Tenet enterprise, and also with our other health system partners..

Okay. Okay.

And then maybe more broadly on the outpatient, are you seeing more competition in your acute care hospital markets? Are you seeing competitors come in with new outpatient facilities, and maybe specifically what types of those facilities are you seeing most often?.

Hey, Josh. Yeah. This is Eric. That depends by market. I would say certainly in Texas and Arizona, we have seen increasing amounts of providers and urgent cares and free-standing ERs. With that said, we have our own strategies there that we think are going to be quite effective. And so we do see some increased competition.

One of the things you see more and more is the lower level ER visits are dropping and the higher level are increasing, which is kind of – aligns with our strategies. And our expectation is that in our core markets, we will be prepared to treat patients with the right care, in the right place, at the right price..

Okay. That's perfect. Thanks..

And we'll take our next question from Chris Rigg with Deutsche Bank..

Hi, good morning. Just wanted to get your big picture view, and not necessarily on the passage of a repeal and replace bill, but there's this dynamic in the market where as the news sort of ebbs and flows, the hospital stocks get whipped around. But then you step back, you sort of see smart buyers coming in to buy hospital assets.

And so, I guess I just would love to get your sense for, based upon what the current bill looks like – and it's still evolving – how would you think about that impacting your business over the short term, but then more importantly post-2020? Thanks..

Thanks, Chris. This is Trevor. We have noticed the phenomenon that you are speaking about, wherein there's a lot of speculation, obviously, that takes place, and I think that's evidenced by the volume of trading in some of the companies, et cetera, based on news flow.

I think that the distinction that you're drawing is between a short-term perspective based on news or rumors, and those of us who are operating the business who have a very long-term perspective.

And probably – I speak for many in the industry – we have a perspective about these businesses having a very permanent place in the healthcare system in the United States, probably an outcome of the legislative attempts and political rhetoric that is not as bad as many investors fear, and that it will take some time for that dust to settle.

Here we are now in May, and we still have not experienced the repeal, or the repeal and replace. There may be a vote in the House this week. We think that the efforts in the House to obtain more support from the right have potentially been offset by losing support of moderates. But we don't want to make a prediction about where the legislation will go.

Our industry has a particularly effective grassroots advocacy program, and while we're not advocating in favor or against any particular bill or legislation, we just tend to remind legislators of the importance of acute care hospitals to their communities and districts, not only for providing vital emergency services and healthcare, but also as a significant source of employment, job creation; let's not forget that through the last recession, healthcare jobs and education jobs were the only ones that were really resilient through that recession.

And also a significant source of capital spending. Eric mentioned the large capital projects that we've been undertaking. I would tell you that in response to the current uncertainty in the environment, we have scaled back our program of large, long-tailed capital investments. I've been speaking about this for a year and a half on these calls.

We've shortened our planning horizon, and we've redirected our efforts into other things other than large new towers, new hospital construction. That ultimately is not great for the economy, and I think that there are many in Washington who appreciate that..

Great. And then just one follow-up here, and hopefully it's quick. But when you talk about market share, being number one or two and seeing 75% now going to 80% by this time next year, should we think about that as just the acute care business, acute care hospitals, or does USPI also factor into the market share equation? Thanks..

Thank you for asking that clarifying question, because when we speak about that, we really are talking about the acute care markets. In many of USPI's markets, they will have the number one position in the Ambulatory business by virtue of partnering with the leading not-for-profit health system partners in those markets.

It's been a core strategy of USPI's since its inception. But in order to simplify the dialogue and reduce it to something that everybody I think can understand and also measure, because the statistics are readily available, when we refer to those number one or number two positions, we're really just talking about hospital markets..

Great. Thanks a lot..

We'll take our next question from Kevin Fischbeck with Bank of America Merrill Lynch..

Great. Thanks. I just wanted to see if I could get more color on what we would think about as kind of core hospital volume growth in Q1. I guess obviously down 80 basis points adjusting for Humana, then you've got leap year.

How much did flu add to the quarter? And then if you kind of add all that together, what did the core volume growth look like? And what was growing faster, what was growing slower?.

Yeah, so – this is Eric – I would answer that question a couple of ways. Obviously, if you want to address the core growth, I would take – if you adjust for Humana and leap year, you're basically at flat in-patient admissions. It's basically where it was, 1.8% adjusted for Humana down somewhere around flat. Still not where we want to be, obviously.

If you think going forward, we do expect improvement, we're seeing improvement and expect throughout the course of the year we will strengthen, with the fourth quarter being the strongest, based on the stuff I talked about earlier coming online. Also, Humana coming back in network, all of those things will be contributors going forward.

But the core growth we do expect to improve over the course of the year. And when you adjust it for the first year, it's flattish, adjusting for both Humana and leap year. With regards to flu, flu was up a bit, although just to put that in perspective, that's a fraction of the impact that the leap year day had on us. It was not really meaningful.

So it was up, but nothing that would actually be significant to talk about..

Okay. And then I guess the other thing that looked a little weird in the volume was the uninsured volume.

Different trends going on on the uninsured inpatient volume versus the outpatient volume, is there anything that you would you point to that would explain why outpatient uninsured volume was down while inpatient was up?.

Yes. It is a confusing trend, I think, with the outpatient dropping and the inpatient going up. I would say we have had periods of time across the past several years where certain markets would increase or decrease on the uninsured volume. We saw a particular increase in Texas, and we're not alone in that.

Certainly that's something that we're working to address. There's only so much we can do, obviously, on that, but we want to make sure that we're providing the right care in the right place for those patients. The uninsured volumes are up.

I mean, I think that on the outpatient side, I think some of that is probably due to lack of coverage and other issues they're facing, and so you end up with more inpatient admissions at a sicker state, and this goes back to kind of the whole idea of coverage and why we as an industry have been so focused on making sure people have coverage, so that we don't end up in situations where the only place they can access care is when they're really sick at the most expensive option..

Hi, Kevin. It's Dan. The decline in the uninsured on the outpatient side was predominantly in states that expanded their Medicaid programs..

Okay.

So, there, that's a coverage issue, but on the in-patient side, is that – I guess would there have been a similar decline in in-patient volume in those states, as well? I guess, does that mean that the states (45:25)?.

Yes. Yeah. On the in-patient side, the expansion states, the uninsured volumes were down. But on the in-patient side in the non-expansion states, particularly Florida and Texas, those volumes were up..

Okay. All right, thanks..

We'll take our next question from Ralph Giacobbe with Citi..

Thanks, good morning. I was hoping you could talk a little bit about payer mix, maybe help us on the pure commercial mix in terms of how that's trending. I think your stats include Medicare managed and managed Medicaid in there.

So I'm hoping you can strip that out, and at least sort of directionally point to what's going on with pure commercial?.

Hi, Ralph. It's Dan. Good morning. I would tell you, when we look at our volumes in the quarter as well as the mix, the key trend from a mix perspective, it was the growth in the in-patient uninsured. Which, as we mentioned in our remarks, it drove a $34 million increase in uninsured revenue. That should be the key takeaway.

As far as the mix of the other payers, nothing significant changes in those trends..

Okay. And then maybe can you help on the pricing yields? Just normalizing for the California provider fee, you mentioned you'd be about 3%. And you've been in that sort of 3% to 4% level for a bit now. Maybe just help us or remind us what some of the drivers are? As we know, government reimbursement is flat or up slightly.

So what rates are you getting on managed care? And maybe talk about acuity mix, perhaps, pushing that up as well? Thanks..

Yeah. So on the pricing side, so in aggregate, after you normalize for California, it was up 3% on a per-adjusted-admission basis, which is right in the middle of our range for the year of 2.5% to 3.5%. And revenue yield was good, commercial yield is still solid.

And as we've talked about in the past, mid-single-digits is what we're targeting from a commercial perspective, from a pricing point of view. And so we continue to be optimistic that we'll continue to be able to drive those type of yields.

From an acuity perspective, I would say, acuity was softer than recent quarters, particularly if you look back at the last year. But obviously we've been focusing on growing our higher complexity type of cases and service lines. So we expect that to grow as we move through the year, and flows into next year..

Okay. Thank you..

And we'll take our next question from Brian Tanquilut with Jefferies..

Hey, good morning, guys.

First question for me, how are you guys thinking about the potential benefit from the Florida LIP for this year, or for next year as well?.

Good morning, this is Dan. Certainly we were pleased to see the additional funding that's planned. So we should see some benefit from it; it won't be finalized until probably the summertime. So we'll see how it plays out, but obviously we're optimistic that we'll see a benefit from that..

And Dan, just to clarify, that's not in the guidance right now, right?.

That's correct..

Okay. And then second question, follow-up from me.

As we think about cash flows, you basically gave us your guidance for cash flows, but as you think about DSOs, flattish for the quarter, but qualitatively, anything you can share in terms of the progress that you're making, in terms of trying to break that down and drive cash flows for the rest of the year?.

Yeah. We did make some progress, Conifer made some progress. The DSOs were down about half a day. We put two metrics out there, we normalized the calculation for the fact that we don't have California provider fee revenues in the first quarter, but we did in the last year's numbers.

So we did make some improvement in the first quarter, and in April we also made improvement as well. So we're going to get it back. We're not there yet, and we still have more work to do, but we'll be working to get that back by the end of the year..

All right. Got it. Thanks, guys..

We'll go next to Gary Lieberman with Wells Fargo..

Good morning. Thanks for taking the question.

Can you tell us what market share position your hospitals in Houston were?.

Yeah, Gary, they were a distant – I don't know, 4th or 5th, depending on how you want to count it. Not close enough together to constitute a real network. Very fine hospitals, by the way. Obviously, HCA has a very strong network there..

Got it. And so the implied multiple is around 9 times, which is great for you guys. I assume that on a pro forma basis, HCA expects to get some revenue or cost synergies that'll drive the pro forma multiple down for them.

Are there other situations like that? I know you said that there probably aren't any other big deals, most of the others are going to be smaller.

But I'd just be interested to understand if there are other markets where that kind of dynamic might exist?.

Keith, do you want to speak to that?.

Sure. Thanks, Gary. First of all, we are still working on other opportunities where we have several hospitals under LOI and some in negotiation. There always will be a handful of markets where you have situations like that, where there's a strategic buyer versus a financial buyer and that has synergies.

And so, the real just question is, do they match up with the markets that we don't see the long-term opportunity in? But there are situations that's still similar to that in other places..

Okay. Great. Thanks very much..

We'll go next to Justin Lake with Wolfe Research..

Thanks. Good morning. Just to want follow up on that question there in terms of strategy. Trevor, you mentioned that you still see some opportunities, in terms of your hospital business and divesting some facilities that might make sense. But it's a smaller opportunity than what you just saw on the HCA sale.

Can you give us some size perspective – when you say smaller, is it smaller in revenues, is it smaller in EBITDA in terms of what you're selling? Or is it just smaller in terms of divesture dollars that you would expect to get in? And maybe you could talk about, are there still anymore JVs to do? Or beyond that, do you feel like this is your hospital business going forward?.

Well, thank you, Justin. I wasn't trying to convey any kind of specific guidance, except this is not news. So we have discussed for a long time a divestiture program.

It's just that because we don't announce actual transactions until we have a definitive agreement – I can tell you, and I did in the prepared remarks, that we have made good progress on several other divestitures. But in the aggregate, the amount is smaller than the Houston proceeds.

I'd rather not go farther than that, or be more specific on the nature of or identity of the transactions. That just doesn't serve anyone's purpose..

Got it.

And then secondly, in terms of cash flow, now that you have these proceeds, and you're actually spending a little bit more – you're spending materially more on the USPI, but can you tell us where you expect to end the year from a cash position?.

Justin, this is Dan. One thing I'd point on, this is merely an acceleration of the amount that we're paying to buy up USPI. It was always in our longer-term plans.

What I would say with that – not to dodge the question, but I'm not going to necessarily provide a spot estimate for our cash balance – but I would tell you that we're still on track to generate adjusted free cash flow, of $700 million at the midpoint, and our plan is also to get our leverage down to 5 times by the end of 2019..

All right. Thank you very much..

We'll go next to Gary Taylor with JPMorgan..

Hey, good morning. Thank you. I just want to come back, sorry to beat this to death, but just for modeling, make sure we've got the NCI correct. And I guess I wanted to understand it from the perspective of, for the year you guided midpoint about $400 million of P&L NCI.

I think you've contemplated roughly two-thirds of that would be actually cash distribution.

Is that about right?.

That's correct..

And so, if we pro forma this whole transaction to, you've now fully bought out Welsh Carson, you own 95% of USPI, the P&L NCI will go down by $45 million and the cash distribution will be unchanged, because Welsh Carson wasn't taking cash? Is that all correct?.

That's correct..

Okay. And then, so my one other question, just going back to the hospital side.

Excluding the California provider tax year-over-year change, which clearly isn't operational, where did you peg your same-store EBITDA growth or decline for 1Q of 2017 versus 1Q of 2016? And what's implied for same-store EBITDA in the hospital segment for the full year?.

So, in terms of our guidance for the first quarter for the hospital business, I would tell you that our hospitals' performance turned in better results than we anticipated. Again, cost control was very strong, and our revenue yield was solid as well. So that enabled us to achieve the high end of our outlook range.

So certainly there was a number of factors that impact the year-over-year comparison, whether it's a California provider fee, revenue of $57 million, and we had $25 million in Q1 last year related to our Georgia hospitals that we sold at the end of the first quarter last year.

And as Eric mentioned, we had some losses related to the new hospital that we opened in El Paso in January..

I guess, if I could just do one follow-up.

I mean, to us, it looks like same-store EBITDA is down, and that includes obviously the adverse self-paid mix, but for the full year of 2017, do you contemplate positive same-store EBITDA growth from the hospital segment? Is that embedded in the guidance, given all the moving parts?.

Yeah. So our guidance, we haven't moved off our guidance for the year, in terms of – we increased it by $25 million for the pension change, but there's been no change to our guidance..

I understand that, but did you ever tell us what your hospital same-store EBITDA growth expectation was, I guess is what I'm just trying to clarify? And maybe you just never provided that..

Yeah. Not necessarily for the current year, but we're targeting on a long-term basis is 3% to 5% growth in our hospital business. That's how you should be thinking of it. The issue with this year obviously is we had a couple of transactions that impacted the year-over-year comparison..

Fair enough. Okay, thanks..

Sure..

And we'll take our final question today from Ana Gupte with Leerink Partners..

Hi. Thanks for taking the question. Just one question I had was about USPI, and it makes a lot of sense what you're doing with all the secular trends on volumes going out of site, the hospital setting.

But as you think about and compare this business that you're going to get a full ownership stake in, that's maybe an OptumCare, and their business model is slightly different because they also get paid on the underwriting margin, and then their balance sheet and cash flows can fuel a lot of de novo.

How do you think about the long term? Do you think also – and I'd love to know if it is still driving from ED, free standing ED and the urgent care, if you're getting volumes in your in-patient sites? So is that kind of an earnings synergy? And then long term, is it better for this to reside under a hospital multiple or under a health line model?.

Okay. Thank you, Ana. And I want to be respectful of time, because HCA is beginning their call within a minute. So, let me just briefly say, obviously, there are major business model differences between United Healthcare and Tenet Healthcare.

The part about underwriting risk, we have a risk business with ACOs and other risk-oriented contracts, so it's very small.

For us, the synergies between the Ambulatory sector – segment and the Hospital segment are very significant, access point synergies in contracting both for revenues and for costs, and, to a greater extent in the future, integration of the physician experience across the platform, as Eric said, right care in the right place at the right price for the consumer.

And we think it's a smart strategy. We think it is the way that healthcare is going. It may differ from, say, United's strategy with Optum, for very important reasons, given the nature of the parent companies. But we think ours makes a lot of sense for us..

Terrific. Thank you very much..

Okay. And thank you, everybody, for participating in the call. Being that we've gone a little bit over time, we'll just say good-bye and look forward to seeing you on the next one..

Thank you, ladies and gentlemen. This concludes today's conference. Thank you for your participation. You may now disconnect..