LifePoint Health, Inc. (NASDAQ:LPNT) Q4 2017 Earnings Conference Call February 23, 2018 10:00 AM ET
Executives
Bill Carpenter – Chairman, Chief Executive Officer
Mike Coggin – Chief Financial Officer
David Dill – President, Chief Operating Officer
Analysts
Whit Mayo – Robert W. Baird
A.J. Rice – Credit Suisse
Peter Costa – Wells Fargo Securities
Ralph Giacobbe – Citi
Matt Larew – William Blair
Chris Rigg – Deutsche Bank
Ana Gupte – Leerink Partners
Matthew Borsch – BMO Capital Markets
Operator
Ladies and gentlemen, thank you for standing by and welcome to LifePoint Health, Fourth Quarter and Year End 2017 Earnings Conference Call.
On today’s call LifePoint will be making forward-looking statements based on management’s current expectations. Numerous factors could cause LifePoint’s results to differ from these expectations, and LifePoint has outlined these factors in its filings with the SEC. The company encourages you to review these filings.
LifePoint also asks that you please review the cautionary language under the caption Important Legal Information in the company’s Press Release issued this morning. The company undertakes no obligation to update or make any other forward-looking statements, whether as a result of new information, future events or otherwise. Also, please visit LifePoint’s website for links to various information and filings.
Importantly, non-GAAP financial information will be used on LifePoint’s call today. Comparable GAAP numbers, reconciliation, definitions and other information regarding this non-GAAP financial information are contained in the company’s earnings press release filed with the SEC and available on the company’s website.
[Operator Instructions].
As a reminder, this conference is recorded on Friday, February 23, 2018. It’s now my pleasure to turn the conference over to Bill Carpenter, Chairman and Chief Executive Officer of LifePoint Health. Please proceed sir.
Bill Carpenter
Great! Thank you, and welcome everyone to LifePoint Health’s Fourth Quarter and Year End 2017 Earnings Call. We hope you’ve had a chance to review the press release we issued earlier this morning and the supplement slides that were posted on our website.
I’ll begin by discussing the fourth quarter and year end 2017 results. Next I’ll hand the call over to Mike Coggin, our Chief Financial Officer to provide a closer look at our financial performance and discuss our 2018 guidance. David Dill our President and Chief Operating Officer will also provide some additional perspective on our operations. Following our prepared remarks, Mike, David and I will be available to answer your questions.
You saw our GAAP results this morning in our Press Release and a number of one-time items that impacted our results. Excluding these one-time items, our results were in line with our expectations and were as follows:
On a normalized basis for the fourth quarter, revenues from consolidated operations were approximately $1.563 billion. Adjusted EBITDA was approximately $181.9 million, and as a reminder, this excludes the expected benefit of $4 million of Medicare extended revenue and diluted earnings per share as adjusted were $0.77.
On a normalized basis for the full year 2017, our revenues from consolidated operations were approximately $6.364 billion. Adjusted EBITDA was approximately $745.7 million, also excluding the expected benefit of Medicare extenders and diluted earnings per share as adjusted were $3.63. Mike will go into detail regarding one-time items, but let me touch on a few of them briefly.
In preparing to adopt a new accounting standard required for all companies in the first quarter of this year, we are proactively implementing new systems to centralize and enhance our view of accounts receivable. This allows us to be more precise in our evaluation and resulted in a change in an accounting estimate during the quarter. This change did not impact our 2017 operating performance and has no impact on our 2018 guidance. In addition, we took a proactive step to further manage costs in 2018 and in the fourth quarter recognized approximately $5 million in severance costs associated with the reduction in force at our LifePoint Health Support Center.
Finally, we recorded a charge related to our existing hospital campus in Marquette, Michigan as we prepare to open our new campus next year. This is one of a number of investments we are making system wide to drive future growth.
Now, an update on the hospitals we’ve acquired since 2014. As we said before, the hospitals we bring into our system requires significant support in order to improve margins from low single digits to low double digits. We have a strong track record as disciplined operators in successfully achieving this transformation in about three years.
Throughout 2017, the classes of 2014 and 2015 continued to perform according to plan and in the fourth quarter the class of 2016 began to see both margin and EBITDA improvement that we expected. We expect this trajectory to continue in 2018. David will discuss some of the specifics shortly.
We are also pleased that the recently passed Federal budget includes funding for the Medicare dependant hospital and low volume adjustment extenders. These important programs will help to ensure our future success and provide critical support to the people who need it most in our communities. I’m proud to say that LifePoint played a significant leadership role in making this happen for rural hospitals across America.
As you know, we are disciplined in our approach to capital allocation and maintain what we believe to be an appropriate leverage profile. As a result, we expect the Tax Cuts and Jobs Act of 2017 to provide approximately $30 million in annual savings. We anticipate deploying these cash savings in a manner consistent with overall company strategies.
Also during the quarter we generated strong cash flows and remained disciplined in our allocation of capital. We repurchased stock in the fourth quarter and to-date we have substantially completed one of our existing authorizations ahead of its expiration in March. Our board previously authorized an additional $200 million share repurchase program, which is now available to us through April 2019.
On the regulatory front, we are very encouraged by the recent moves in Virginia towards expanding Medicaid. While we haven’t factored in any future Medicaid expansion in our guidance, we remain hopeful that this positive movement will gain momentum and other states will take advantage of the opportunity to provide healthcare coverage to their citizens.
We continue to be a leader in the delivery of healthcare services. As I indicated in January when we spoke at the JP Morgan conference, we periodically evaluate our operating priorities in order to adjust and lead though times of change and we are currently undergoing that type of review. We are confident in our positioning and the ongoing evolution of our strategy and we will take the necessary actions to remain a leader. Our quality program unique national and regional partnerships and network initiatives will keep LifePoint at the forefront. Our underlying performance in the fourth quarter shows the benefit of these strategies.
I’ll now turn the call over Mike to discuss our financial performance in greater detail, as well our guidance for 2018. Mike.
Mike Coggin
Thank you Bill and good morning everyone. As bill indicated, excluding the one-time non-operational items, our results for the fourth quarter were in line with our expectations. I will begin by explaining each of these items in more detail, followed by an in-depth review of our normalized financial results for the quarter. Finally, I will finish with a discussion of the key drivers and assumptions included in our 2018 guidance which we issued this morning.
Beginning with the one-time, non-operational items, first we recorded a $72.6 million change in an accounting estimate resulting in a loss of $1.15 per diluted share included in our provision for doubtful accounts. As Bill noted, in preparing to adopt the new accounting standard we are implementing new systems to centralize and enhance our view of accounts receivable, which allows us be more precise in our evaluation.
The $72.6 million charge was unrelated to our current year operating performance and has no impact on our 2018 guidance. We have taken the adjustment in the current quarter; therefore our historical financial statements have not been impacted by this change. Secondly, we incurred a $4.8 million charge or a loss of $0.08 per diluted share included in salary, wage and benefits or severance cost associated with the reduction in force at our LifePoint Health Support Center.
Next, we recognized total charges of $43.2 million or a loss of $0.69 per diluted share for the impairment of certain long life assets. Substantially all of this charge relates to our existing hospital campus in Marquette, Michigan as we plan to move into our new replacement hospital in early 2019.
Finally on December 22, 2017 the Tax Cut and Jobs Act was signed into law resulting in a reduction of the Federal Corporate Tax Rate from 35% to 21% beginning in 2018. Although the tax rate change has not effective until 2018, we revalued our differed tax positions in the fourth quarter considering the impact of the perspective federal tax rate change. As a result we reduced the book value of our net differed tax positions generating a benefit of $18 million or $0.45 per diluted share in the quarter.
Prospectively and I will cover in more depth, the discussion of our 2018 guidance, we project our 2018 effective tax rate will be approximately 24.5% and will result in incremental cash savings of approximately $30 million annually.
I’ll now review our normalized financial results for the quarter, which excludes the impact of these one-time non-operational items. Starting with volume, for the quarter same hospital admissions and equivalent admissions were down 2.4% and 0.1% respectively. Approximately half of the decline in the same hospital admissions resulted from a decrease in in-patient surgeries and the remaining decline was due primarily to fewer low-acuity medical admissions.
On a same hospital basis, emergency room visits were down 1.2% and outpatient surgeries were down 0.9% with a decline in total surgeries of 1.5% in the quarter. Consistent with the past several quarters, we experienced declines in self paid volumes during the fourth quarter of 2017. Same hospital self pay admissions were down approximately 9.7% and represented 4.3% of total admissions compared to 4.6% in the fourth quarter of 2016. Additionally, same hospital self pay emergency room visits were down approximately 5.8% and represented 11.7% of total emergency room visits compared to 12.2% in the fourth quarter of last year.
Consistent with recent quarters, our emergency room volume declines are concentrated in lower-acuity services. Our normalized same hospital revenues in the fourth quarter were $1.56 billion, down 0.6% from the same period last year. This decrease is a result of the previously discussed 0.1% decline in equivalent admissions and a 0.5% decline in our net revenue per equipment admission.
The 0.5% decline in net revenue per equivalent admission was primarily driven by reduced revenue associated with our recently transferred home health and hospice service lines to our partnership. The absence of Medicare extenders in the quarter and the continued pressures associated with payer mix exchanges, including greater managed Medicare penetration.
As a reminder, during 2017 we contributed 29 of our home health and hospice agencies to our recently formed post-acute partnership. Effective on the data of each of these contributions, we no longer include these operations in our consolidated results and account for our share of this partnership as an equity method investment. Excluding these contributions our revenue per equipment admission would have increased to approximately 0.5% in the fourth quarter. Our provision for bad debt on a normalized basis was 13.5% of revenue and consistent with the fourth quarter of 2016.
Turning to cost, on a normalized same hospital basis, salary, wage and benefits improved by 10 basis points to 47.6% of revenues as compared to 47.7% in the same quarter of the prior year. Our growth in certain higher acuity service lines such as oncology and other cancer related businesses created increased cost from supplies utilized with these services. However overall during the quarter we improved same hospital supply cost as a percentage of revenues by 20 basis points to 16.8%.
During the fourth quarter of 2017 our same hospital, other operating expenses increased 50 basis points to 24.1% of revenue as a result of several factors. First, while lowering the overall cost of the company and improving service we asked for certain hospital support departments in a number of our markets.
Next we incurred additional costs associated with implementation of new clinical IT systems in three of our markets. We also experienced higher physician subsidies within our professional fee arrangements. Finally, we incurred increases in certain non-income tax expenses. These increases were partially offset by favorable claims development under our Selfinsured Professional Liability Program.
Meaningful Use Income as reported in other income declined $8.8 million to $1.3 million in the fourth quarter of 2017 from $10.1 million in the same period of the prior year. Normalized EBITDA for the fourth quarter of 2017 was $181.9 million with a margin of 11.6% as compared to normalized EBITDA of $196.8 million and a 12.3% margin in the same quarter of the prior year.
When adjusting to exclude meaningful use income our normalized EBITDA margin was 11.6% for both periods. Both the fourth quarter normalized EBITDA of $181.9 million and the 11.6% margin were in line with the expectations we discussed in the third quarter and represent a sequential quarterly improvement of approximately $6 million and a margin improvement of 40 basis points when compared to the third quarter of 2017.
Our normalized diluted earnings per share were $0.77 in the quarter, down $0.30 compared to $1.07 in the same quarter of the prior year. Our normalized diluted earnings per share declined by approximately $0.13 from lower meaningful use income and approximately $0.14 as a result of a higher effective tax rate. The higher effective tax rate in the fourth quarter was primarily the result of the lower pre-tax net income, as well as the establishment of valuation allowances against specific differed state tax positions.
Cash flows from operations for the quarter were strong at $178.2 million as compared to $102.5 million in the same quarter of the prior year. Our full year cash flows from operations improved to $471.6 million as compared to $435.2 million in the prior year.
Our debt-to-EBITDA leverage ratio as of December 31, 2017 was 3.76 times on a net cash basis, well within our targeted range. Our net days in accounts receivable, including our fourth quarter change in accounting estimates were 51.9 days.
We invested $208 million in capital expenditures during the quarter, bringing the full year 2017 capital expenditures to $474.2 million. Also during the fourth quarter we repurchased 262,000 shares of our common stock for $14.7 million. Subsequent through December 31, 2017 and through yesterday we repurchased approximately 472,000 shares of our stock for $22.8 million. Accordingly as of today, we have approximately $207.2 million remaining under our current authorizations.
Turning to our 2018 guidance. On a consolidated basis we expect revenues to be in a range of $6.35 billion to $6.43 billion and adjusted EBITDA to be in a range of $725 million to $765 million. Finally, we expect diluted EPS to be in a range of $4 or $4.53 per share.
The following are some of the significant assumptions used in these guidance ranges: Starting with revenue, as a reminder effective October 1, 2017 we sold our hospital located in Conyers, Georgia and accordingly our 2018 guidance excludes approximately $100 million in revenues from this hospital that were recognized in 2017. On a same hospital basis we expect total revenue to be in a range of up 1.4% to up 2.7%.
Our revenue assumptions assume flat to slightly positive same hospital equivalent admissions and typical price and increases that are offset by expected reductions in our participation in certain Medicaid supplemental payment programs and projected payer mix shifts from commercial to governmental payers, including further penetration of managed Medicare in many of our markets.
Also built into our revenue assumptions is funding from the extenders which Congress passed in the first quarter of 2018. This includes the expected benefit not recorded in the fourth quarter of 2017 due to Congresses delay in approving these extenders.
Turning to cost assumptions, we continue to expect moderate pressure with salary wage and benefit and supply cost in 2018. Salary, wage and benefit rate pressures while less significant in some of our markets, are expected to increase in many of our larger markets as general economic conditions have improved.
Meaningfully impacting our 2018 guidance is an assumption related to expected pressures in other operating expenses. For example, our volume assumptions yield higher position subsidies under many of our professional fee arrangements. We also expect higher expenses associated with our professional liability programs, including medical malpractice and workers compensation programs.
Finally, we will incur additional operating costs in 2018 associated with the implementation of clinical IT systems at three of our hospitals. Furthermore we are not forecasting any meaningful use funding in 2018 resulting in a year-over-year EBITDA decline of approximately $10 million. We expect depreciation and amortization expense to remain flat next year at approximately $350 million. We expect capital expenditures to remain flat with 2017 and to be in a range of $475 million to $500 million before moderating beginning in 2019.
We expect interest expense in 2018 to be approximately $154 million, up $5 million over 2017 reflecting our assumption of increasing interest rates during 2018. Finally, we expect that the reduction to the federal corporate tax rate from 35% to 21% will resolve in an estimated 2018 effective tax rate of approximately 24.5%. When compared to our historical effective tax rate of approximately 38%, we estimate cash savings of approximately $30 million with a benefit to diluted EPS in a range of up $0.69 to up $0.78.
Consistent with our past approach, we have not included any estimates for impact for future share repurchases or potential acquisitions in 2018. Additional information regarding our fourth quarter and full year results is available by reviewing our SEC filings, including our 10K which we will file later today.
With that, I’ll turn the call over to David for some additional perspective on our operations.
David Dill
Thanks Mike. There are three areas that I would like to discuss in more detail: First, I’d like to talk about the class of 2016. We are pleased by the progress we saw during the quarter, creating momentum as we move into 2018. The margins for the class of 2016 improved by 350 basis points versus the previous quarter. In addition to the margin improvement, we saw equivalent admissions grow by 1.4% during the fourth quarter. These results show that our plans for the markets continue to work.
As we stated last quarter the typical margin improvement from low single digits to low double digits is primarily derived from several factors. Top line revenue growth is a result of targeted investments in growing service lines, coupled with disciplined cost management by using our size and scale. The integration and changes are led by our experienced operators who are focused on both the short term and long term success of each of these markets.
Second, I’d like to provide additional perspective on the guidance that Mike walked you through. The mid-point of our EBITDA guidance range is approximately $745 million. We expect margin improvement in our class of our 2016 acquisitions of approximately 250 basis points resulting in $20 million to $25 million of additional EBITDA. This assumption resulted in mid-single digit margins for this class in 2018, with our long term plan to expand the margins to low double digits through 2021. We expect the remainder of our hospitals EBITDA to grow at approximately 2% or $15 million to $20 million. This improvement is at a rate consistent with our expected revenue growth, therefore resulting in stable margins.
During 2018 this improvement will be offset by a few key items which include a $10 million reduction in EBITDA as we complete the final year of the incentives related to the meaningful use program. A $5 million impact associated with the implementation of a new clinical IT system in a few of our markets and a $20 million to $30 million headwind primarily related to the cost associated with position subsidies in certain insurance related programs. We expect the rate of these increases to subside in 2019.
Third, I am very excited about the work that we will be doing during the first half of 2018 to update our operating strategies across the entire organization, to ensure that we continue to be well positioned to capitalize on the evolving industry trends for the next five to seven years. This project in in-depth review will be focused on both long term and short term strategies to accelerate our growth into the future.
I’ll now turn the call back over to Bill for some closing remarks.
Bill Carpenter
Great! Thanks David and thank you Mike. We continue to focus on our strategic priorities, starting with a foundation of quality and service. We’ve set the bar high with the LifePoint National Quality Program and our hospitals and our people are working towards a designation as a Duke LifePoint National Quality Affiliate. 10 of our hospitals have achieved this designation at this point.
At the same time, we are growing the business, operating with discipline, reducing costs, developing high performing talent and buying back stock, all while protecting our solid balance sheet. We are also focused on taking new steps to adapt to the changing healthcare environment. We are confident our actions will have a positive financial impact on the company and ensure LifePoint Health continues to be a leader in healthcare.
Finally, I’d like to recognize our talented employees and providers who differentiate LifePoint as a leader in quality improvement in our communities. As you know, everything we do is built upon our delivery of high quality patient care and service. We are committed to enhancing shareholder value as we continue to fulfill our mission of making communities healthier.
With that, we’ll now take your questions.
Question-and-Answer Session
Operator
Thank you, sir. [Operator Instructions] Our first question comes from the line of Whit Mayo with Robert W. Baird. Please proceed.
Whit Mayo
Hi, thanks. Good morning. Bill, can we just start a little bit on the strategic review. Just want to hear a little bit more on what you guys are focused on, what you’re learning? Just any help into you know what we should expect out of this and when do you think you’ll have an update for us?
Bill Carpenter
Yeah, Whit thanks. I’ll tag team with David a little bit on this one, because he is taking a leadership role of course as this is an operational strategic review.
You know I think healthy companies spend time focused on their strategies and on what it takes to continue to be leaders. I think that they do that particularly in times of change. We’ve done this three time in the past 10 years and maybe one of the most instructive times was a point when the Affordable Care Act had just been past and we were thinking about how we operate in that new world order.
We’re seeing change now, we all are and we are at LifePoint and that change involves things like payer shifts, payer mix shifts and a move towards consumerism and value based care and we want to make sure that we are not reacting, but we are proactive and innovative as we think about dealing with that change. So that’s the reason that we’ve chosen to do this now.
I think it’s – the timing couldn’t be better and I am excited about what we’ll learn. We’ll go through this in the first half of the year and as we do that, I look forward to sharing our plans and I look forward to sharing the impact that we expect those plans to have on the company over the next several years.
David, I’m sure you’ll want to add something.
David Dill
Well, I think you said it well. You should expect us Whit us to do this. I think it’s very energizing for the company. We should wrap this up in the middle part of the year and you should expect to begin to hear from us on the results and our findings and our direction as we get into the summer months.
As I said in my prepared comments, this is not just focused on positioning us five to seven years out. We are acutely focused on both long term and short term strategies to help us accelerate our growth.
Whit Mayo
Okay, I mean we can talk a little bit more about this, but maybe just shifting to the other operating expenses. You mentioned, I think a tailwind in the fourth quarter from outsourcing certain functions. Can you talk a little bit more about that and then I heard an offset on subsidies and you obviously guided to a $20 million to $30 million headwind there. So just anymore color would be helpful. Thanks.
Mike Coggin
Sure Whit, this is Mike. So with regards to the fourth quarter and we talked a little bit about outsourcing, there are certain departments of the hospitals support services that we’ve outsourced. It’s creating a little bit of pressure on the contract service line item, inside of other operating expense.
That same pressure helps – you have a little bit of a benefit of salary, wage and benefits, so it’s somewhat neutralized there, although it’s much more efficient as we’ve outsourced it and so its created some level of – really some level of net benefit when you look at it across the company; that’s what we were refereeing to there.
David talked a little bit about some headwinds, some $20 million to $30 million of headwinds around position subsidies and our insurance programs and specifically what we’re talking about there. As you know with regards to position subsidies, volumes really impact position subsidies in any particular year. This has been a year where we’ve had to go through and really look at our contracts and rest and so what we’re saying from a headwind perspective is that there is a unique resetting that’s occurring in 2018, creating some additional costs on a proportionate basis that’s existing in ’18, that we don’t believe will repeat itself as we move into 2019. We’ll still see cost increases, but not at the same level.
With regards to the insurance programs and specifically medical malpractice, you know medical malpractice is part of any healthcare business and we’ve been involved with you know making sure our claims management is effective and we’ve had very good success in recent years, managing the development of our claims. That has had a benefit for us in the last few years and we believe that as we projected for 2018, that benefit that we’ve seen in the past several years won’t repeat itself creating somewhat of a little bit of a headwind.
So we don’t – similar to the position services piece and there is the position subsidy piece, we don’t expect that headwind to continue in 2019 and beyond. We see it as more of a one-time headwind that we see in 2018. Again, both of those are what’s really contributing to the $20 million to $30 million that David mentioned.
Whit Mayo
Okay, thanks Mike.
Operator
Thank you. Continuing on, our next question comes from A.J. Rice with Credit Suisse. Please proceed.
A.J. Rice
Hi everybody, thanks. Maybe first of all on the guidance and if I missed this, sorry, but can you talk about what your same store volume and pricing assumptions are embedded in the 2018 outlook.
Mike Coggin
Sure. So in terms of just overall revenue growth rate, on a same store basis the mid-point of that is about 2% and that 2% is roughly 175 basis points give or take, so it’s almost the complete portion of it on the rate side with volume being relatively flat.
When we think about pricing, we are seeing a stronger uptick on the Medicare side. We talked about the benefit of the extenders. We’ve talked about the benefits – well we haven’t talked about it here, but we’ve mentioned it previously that we’ll have some benefit the way the 340B Program wound down across the industry and how we’ve got a benefit through that for our outpatient rate. So Medicare is a little bit stronger.
Medicaid, on the supplemental payment programs is a declining component for us. That’s the part that’s pushing the rate down back to about 2% at the midpoint and then commercial is in line with our expectations. We’re getting a pretty good yield out of commercial pricing once again. So those are the items that contribute to that 2% total revenue increase at the mid-point.
A.J. Rice
Okay. Have you made any assumptions for growth related uptick in the first quarter or are you pretty much putting that on the sign?
Mike Coggin
We have – when we put this together, we have assumed everything that we know about through the process or through the point in time when we completed our guidance which was completing it as recently as the last couple of weeks. So we’ve assumed everything, including our view of any flu activity through now.
David Dill
A.J. this is Dave. The only thing I’ll add to that, we clearly are getting a lot of questions and there’s a lot of reports out there on the intensity of the flu season and we typically don’t discuss the current quarter volumes, but given the intensity of this flu season and the number of questions, we have seen higher intensity flu. We’ve seen through the first six weeks of the year, many of our volume indicators including admissions, adjust admissions, ER volumes turn positive.
This is the first six weeks. It’s still too early to talk about it in terms of the overall quarter, but clearly we’re seeing the benefit of those through the first half of this quarter that we’re currently in. We just want to make sure we share that with everybody today as well.
A.J. Rice
Sure. I guess this is a little while back on one of these calls, the comment I think was made that to really hold on to same store margins. You probably were looking really the need is for about 2%, 2.5% adjusted admissions growth. It sounds like in the guidance its sort of more flattish and you talked about a couple of headwinds that I guess would impact your margin adversely, which you got to overcome.
What’s the positive? I think if I heard David’s comments right, he’s saying you’re basically assume the same store revenue growth of 2% and same store EBITDA growth of 2% which would assume you’re holding your margin. So I guess I’m just trying to put that all together. Where are the positives coming from?
Mike Coggin
Yeah, so when you – I think you mentioned A.J. 2.5% – 2%, 2.5% volume growth, the whole margin flat. I think what we’ve said is 2%, 2.5% revenue growth rate, the whole margins flat, that’s roughly where we’re guiding to this year.
So you’re exactly right. The margin is in our core assets. If we put the class of 2016 over to the side, we talked about the incremental earnings of $20 million to $25 million that we’re expecting on that class, all the other hospitals we’re expecting to grow their EBITDA 2%. And so even in this environment with 2% revenue growth, a mixture and pricing and volume, we’re still able to achieve 2% EBITDA growth.
However, in this year there are a couple of unusual headwinds that we’re facing, that we have a high degree of confidence that they will subside in 2019 and coming off of a volume environment that the industry experienced in ’18 and a very similar assumption from a volume standpoint in 2018 that is resulting in some higher position subsidies as we reset some of these agreements and as a headwind that we’ve got this year. We’ve got it completely built into our guidance. If March volumes improved throughout the balance of the year, we should see some of these subsidies come down, but that’s the assumption that we made, built into our guidance.
A.J. Rice
Okay. Maybe just one last question. On the acquisitions, I know last year was a sort of a paused year and this year you still got – you’re making a big capital commitment to build out the market cap replacement hospital and you’re also doing this strategic review operationally. Does that mean that you’re sort of pulling back from the acquisition market again this year or would – do you think we’ll see anything on the acquisition front this year?
Bill Carpenter
Well A.J. we don’t have anything to announce at this moment. I am proud that LifePoint continues to be considered the buyer of choice for many community based hospitals and that’s because of our focus on quality and the size and scale that we bring to any new acquisition.
The pipeline is strong, but our strategy remains the same. We are highly selective in our acquisition candidates. We’ll move forward with opportunities that meet our criteria. We’ll continue to be opportunistic while maintaining the type of discipline you’ve seen from us last year.
When we buy our next hospital, I’ve said this before and I’ve said it here a lot. You should expect it to be strategic and compelling and so I guess that’s about all to say about that right now.
A.J. Rice
Right. So this year we’ll say you’re not proactively taking yourself out of the market this year while you do these other things?
Bill Carpenter
We are the buyer of choice for many community based hospitals and we should be a resource for them and I look forward to continuing to consider good opportunities. In the meantime, I can guarantee this; our operators led by David Dill are keeping their heads down and doing the hard work that we need to do to achieve value for our shareholders and to improve the operations of class 16 and these hospitals.
A.J. Rice
Okay. Alright, thanks a lot.
Operator
Thank you for your question. Continuing on, our next question comes from the line of Peter Costa with Wells Fargo Securities. Please proceed.
Peter Costa
Hi, guys. Thanks for the question. It seems like you know you had some nice improvement on the 2016 class in the fourth quarter and it seems like it should have been a little bit of a tailwind for you in the fourth quarter. I know it’s more in the first quarter, but it should have helped you in the fourth quarter, yet your same store or same hospital admissions are still down 2.4%, you know which the same as it was in the third quarter. I guess I’m wondering if there was something else that got worse in the quarter to drive that and then – you know how do you get confident that you’ll be able to be you know flat to slightly up in terms of volume in 2018.
Bill Carpenter
Yeah, we really didn’t see much of an impact of the flu in the fourth quarter. I mean ER volumes did improve a little bit. We saw a few higher intensity admissions, but not enough to change the overall admission statistics that were reported today.
The class of 2016 was really driven from not the flu, but much better and stronger sequential improvement in surgical volumes and other outpatient visits. So that drove more volume through the hospitals resulting in the margin improvement. It is more sustainable as opposed to kind of propped up for the flu. For us clearly seeing more flu in the first six weeks of this year, then we saw at the very tail end of December, which didn’t impact the quarter at all.
Peter Costa
So, let me try this again. I was thinking those were two separate items, the flu and the 2016 improvements, but both of those should have helped in the fourth quarter relative to the third quarter and yet your same store admits was down 2.4% in both quarters. So my question is, did something else get worse, because that number did not improve and if something else did get worse, how do you get confident that 2018 volumes will be flat to slightly up?
Bill Carpenter
Yeah, well if you take a look at our third quarter adjusted admissions, equivalent admissions, we were down 2.2% in the third quarter and down 0.1% in the fourth quarter. So while the in-patient statistic may look very similar from third to fourth quarter, much stronger growth in out-patient volumes across the company, but predominantly in the class of 2016 with very little of that being the flu.
Peter Costa
Okay, thanks.
Operator
Thank you. And our next question comes from the line of Ralph Giacobbe with Citi. Please proceed with your question.
Ralph Giacobbe
Thanks. First, can you give us the operating cash flow expectation for 2018 and then CapEx priorities and maybe how you look at returns on that capital given the stagnant growth we’ve seen of late. Thanks.
A – Mike Coggin
Hey Ralph, yeah this is Mike. I think you started out with operating cash flow. For the year we talked about operating cash flow coming in at $471 million this year. It was up from $435 million in 2016.
Operating cash flow in the fourth quarter was $178 million. That yielded a free cash flow number of minus 30 in the fourth quarter and basically flat on a year-to-date basis because of the level of CapEx that we’ve talked about.
As we look into 2018 we continue to see – you know from an operating cash flow we’ll see a little bit of benefit. We talked about $30 million coming from better taxes, the tax reform component will add probably $30 million to it and then CapEx will remain very consistent at the 475 number that we experienced in 2017.
I do want to point out that as we move into ’19, CapEx starts to moderate much less. ’18 continues to have a fairly significant spend with regards to the Marquette project. There were a couple of other large projects in there as well. There’s a few other projects in ’18 that are either close to finishing up or finishing up. Those related to places like Conemaugh in Johnstown, Pennsylvania where we’ve got a number of out-patient – we’ve got an out-patient project that just went online there. So we’ve got some of those projects that are finishing up.
We continue to look at our growth capital in the expectations of returns at an appropriate level, obviously above our weighted average cost of capital. The reason you haven’t seen that come through in terms of the returns at this point is because a large number of these growth projects are still online or still in process and haven’t been fully completed and fully realized. So you should start to see a lot of that be put into service as we move into the latter part of ’18 and then into 2019 as we talked about.
Bill Carpenter
I think that’s a very important part of the capital deployment over 2000 – really ’16 and ’17. Its going into a couple of large projects that haven’t come online yet, that will accelerate and drive growth for us. What we have been focusing on, the earlier question was around the MA program. One of the things we have been working on is continuing to build out markets and networks of hospitals.
In Conemaugh that we bought in 2014, we have built a network, built a health system, acquired an additional smaller acute care hospital within the market, building two state of the art multimillion dollar outpatient facilities that most that money has been spent, but the revenue generated off of that will come in the latter part of 2018 and then into 2019. We built clinically integrated networks in a few of our markets. At the Conemaugh we have over 300 physicians working together. So those are the type of things that we are doing from a capital deployment standpoint to grow and expand and strengthen our markets.
Ralph Giacobbe
Okay, all right that’s helpful. And then one more if I could. I just wanted to talk a little bit about the bad debt adjustment, how much of that was in ’17 and maybe over what period of time maybe all in, would that look back? What exactly was the issue? Was it the lack of collection on the uninsured? Was it out of pocket assumptions? Was it mainly recently acquired facilities? And what’s different around sort of your follow up process and estimation that gives you comfort sort of in ability to sort of capture and more appropriately estimate that? Thanks.
Bill Carpenter
Sure, yeah so in advance of the new revenue recognition standard, we made a decision to take a look at new systems that will allow us to get the information necessary to implement the standard. As part of that we implemented – we are in the process of implementing new systems in two different areas, one on a hospital side, one of our physician provider side, and as we implemented those systems, we gained new insight into our accounts receivable.
The information that’s coming out of these systems is at more disaggregated level, its more precise, it’s more accurate and as a result for the first time in this quarter, we realize that we needed to make this change in the estimate of our accounts receivable. We studied the impact, we deliberately and diligently focused on trying to evaluate the impact of the charge that we recorded in the quarter. In our prepared comments we made a statement that we have done so and there has be no impact from the operating performance of 2017. So definitely we don’t believe that’s its impacted ’17.
And if you just look at our accounts receivable you know at the beginning of the year and the end of the year and you look at days, everything is very comparable. There wasn’t a build out of accounts receivable that was adjusted in the current year.
So we studied it, there is no impact of ’17 and quite frankly there is impact on our 2018 guidance as a result of this adjustment. It goes back at some point in time and to your point, you know most of our accounts, our allowance for doubtful accounts always relates to a patient responsibility piece. This is no different.
Ralph Giacobbe
Okay, thank you.
Operator
Thank you. Our next question comes from the line of Matt Larew with William Blair. Please proceed with your question.
Matt Larew
Hi, good morning. You know forecasting EBITDA margin is roughly in line with ’17, but given improvements that you saw sequentially here in the class of 16 hospitals and expected in ’18, can you give us a sense for how company level EBITDA margins should trend throughout the year and what type of margin level you think you could hit exiting 2018?
Bill Carpenter
I’ll go with this and I think Dave may want to maybe add a couple of comments to it, but yeah. Our EBITDA margins on a normalized basis for 2017 were right at the 11.7%. This class of 16 David mentioned going from up $20 million to $25 million year-over-year, they are going to – on the face of that, they are going to generate about 40 basis points of margin improvement.
The other hospitals that we talked about, when you exclude the one time – kind of the one-time headwinds that we’ve compartmentalized at about $30 million, when you exclude that, their margin improvement year-over-year is about 20 basis points. Now meaningful use was a negative 20 basis points and the other items that we talked about did have a negative impact.
So I think as we progress, while we’ve got margins at the midpoint in ’18 of 11.7%, we will see margin progression as we move beyond ’18 and as we get outside of some of these one-time headwinds that we’ll experience in the calendar year 2018.
Matt Larew
Okay, thanks. And then second, I wondered if could you know just help us understand some of the more short term changes you’ve made at the class of 16 hospitals to improve performance in the context of the longer term changes still need to now hit that low double digit number, I think you said in 2021?
Bill Carpenter
Yeah, so some of the short term changes that we made are clearly in this volume environment and rate environment that we are in and have been focused on cost side of the income statements. So moving to our national contracts, more aggressively managing labor and productivity has been a key component. So we continue to see – our operators continue to focus on those two line items, and as we make the investments that are made and recruiting the doctors, we saw volumes, especially outpatient volumes strengthen from Q3 to Q4. That will be a component of the lift in 2018. But the progress that was made really in the back half of ’17 and that will carry us forward into ’18 have largely been on the backs for integration, executing our integration plan related to cost.
Mike Coggin
And I might add Matt that a number of the things we talked about in the third quarter with respect of the class of 16, those hard decisions we talked about, those are behind us. We’ve done those and so those, you know those are some of the short term things that I think you are probably thinking about as regards to class of 16.
Matt Larew
Okay, thanks guys.
Operator
Thank you. And our next question comes from the line of Chris Rigg with Deutsche Bank. Please proceed.
Chris Rigg
Good morning. I just wanted to ask about the trends in the surgical volumes, both in-patent and out-patient. Would you put the weakness there just to macro trends in your markets or are you seeing in your opening, increasing out migration services towards more urban oriented facilities, and just competitors generally?
A – Bill Carpenter
Yes, I’ll take that. Leaving the third quarter, we looked hard at the surgical volumes from a competitive standpoint. We called out really one market where we thought we had some real volume being lost to a competitor and that was predominantly in our Georgia market in Rockdale that we ended up divesting to Piedmont.
Outside of that, I think the majority of this is either some slower acuity procedures moving into some physician practices within the community, but the vast majority of it is I think just the general slowdown that we are all experiencing in surgical volumes for the course of 2017.
Chris Rigg
Great and then just on the – you talked about sort of wage pressure in some selective markets. Can you give us some color as to what type of wage inflation you are generally seeing given obviously we are in a pretty tight labor market right now.
Bill Carpenter
Sure, year. With regards to the wage pressure we have typically been able to not be pressured with wage pressure – with pressure in some of our smaller markets. In more of our real markets we don’t see it as significant.
In some of our larger markets, the more non-urban areas that we operate in, we have seen some of that pressure. It has been in the areas of – you know we’ve seen an increased contract labor, but it’s really on the rate side for the wages. We continue to mitigate that through the recruitment and retention plants that we have in every single one of our markets. So we are very focused on it. We are able to address it most of the time very successfully. But the pressure in some of the larger markets that we operate in continues to push us a little bit more, especially like we talked about earlier, as the economy improves we are seeing just some pressure in some of those larger locations.
Chris Rigg
Great. Thanks a lot.
Bill Carpenter
You’re welcome.
Operator
Thank you. Our next question comes from the line of Ana Gupte from Leerink Partners. Please proceed with your question.
Ana Gupte
Yeah, thanks, good morning. I appreciate you fitting me in. I was looking for some color on some of the components of volume. You know the first being ED volumes, you’ve seen from flu related admits and so on. It feels like at lest the decline has slowed down this quarter. But you are thinking about this structurally and other companies are investing a lot in Urgent Care and freestanding ED, as you look at your calculus in the rural markets as to how many admissions or what percentage of the ED visits translate to admissions and so on, I mean what calculus influences your decision? Perhaps it feels like not to invest that much in these ultimate access points and put you CapEx to work maybe in outpatient centers or other areas?
David Dill
We are clearly focused on bringing to the market the appropriate access points for patients to meet them where they want to be met. Through the course of 2017 the decline that we experienced in ER volumes was largely comprised, at least in the first half of the year with self pay ER volumes and in the second half of the year we started seeing Medicaid related volumes. So our Medicare volumes and our commercial volumes have been very stable through the course of 2017. So while there are urgent care centers in our market, we own and have built our own urgent care centers.
In fact fourth quarter 2017 we bought a couple of urgent care centers over North Carolina to round out the market and round out the networks. So this is kind of market-by-market driven. If we need to make investments, that’s a low capital investment that’s needed. But when we look at our overall volumes and the majority of this is our self pay volumes, remember we are still the only hospital in town and for patients that need care in a hospital or hospital based services, even if that originates in an urgent care center, it’s still coming to us for a higher level of care.
So its market-by-market driven, and we continue to make a significant portion of our investments from a capital standpoint in building out access points, not just urgent care type locations, but also larger, more complex, outpatient center like we’re doing up in Johnstown, Pennsylvania.
Ana Gupte
That’s very helpful.
Bill Carpenter
You know Ana, one thing I might just add to that, I don’t know it’s going to come exactly out of this strategic operational review that we are involved in currently. But I would be very surprised if it didn’t impact access points for consumers in our markets. So that’s an exciting opportunity that we still have open to us.
Ana Gupte
Got it, okay, very helpful. Thanks for the color. On the surgery side, a while ago they continued to decline. It does look like the decline slowed Q-over-Q and year-over-year on the inpatient surgery side and how much of that is related to high deductable health plans or seasonality or is something happening you think more broadly in bottoming out of surgeries? I mean I’m not saying that you are on the positive end, but at least the trends look like it, it’s positive and it was positive for [inaudible] as well. Any color on that?
Bill Carpenter
Well, I think if the questing is around the improvement that we saw, you are exactly right we saw an improvement as compared to the third quarter and the second quarter. And we saw improvements in the fourth quarter on the surgical volumes as we pointed out previously we are down 1.5 % in the fourth quarter. The third quarter was minus 3.4 and the second quarter was minus 4.4, so clearly an improvement. Whether it relates to high deductable plans people reaching their deductibles and then having surgeries, we think there is some of that that’s built in, in terms of the timing of it. But yeah, it’s part of the process and part of what we had expected when we put out guidance together for the fourth quarter.
And remember Ana, in the third quarter we did have a market that we talked about in class of 16. So the class of 16 has four hospitals in it, but these are large hospitals and it had a pretty significant impact in some surgical volumes being rearranged in the market for a short period of time. The stabilization of that leaving the quarter and volumes picking back up, we saw the surgical volumes and the class of 16 hospitals improve and its more than just seasonality improvement that happened in so we do think that points to the volume growth that we experienced in the class of 16 and the EBITDA improvement as well.
Ana Gupte
Okay, that’s helpful and encouraging on the volume growth on the 16 class, just one final follow up. Any color on your service line investment and/or physician or surgeon or other recruiting strategies and are you don’t anything new here with the operational and strategic review.
Bill Carpenter
You know it’s just continued execution. Every market is different. We won’t get into market by market what’s happening, but expanding higher intensity service lines in each of these communities is as an opportunity. We have an opportunity in every one of our markets, not just the class of 16. But in every one of our markets to continue to keep care close to home and fight the outmigration, and so that opportunity is there everywhere. Its more prominent in this class of 2016, but it’s just different service lines and different hospitals.
Ana Gupte
Thank you. I really appreciate the color.
Operator
Thank you. Due to time, we have time for one more question. This comes from the line of Matthew Borsch with BMO Capital Markets.
Matthew Borsch
Oh hi! Good morning. Thanks for squeezing me in. Could you just talk to any regional variation that you saw in the volumes in the fourth quarter, just so we can better understand where your volumes are moving relative to the flu for example?
A – Mike Coggin
Yeah, this is Mike. We did see some level of a little bit of a flu starting in the very tail end of the fourth quarter. We haven’t given it by region. It’s fair to say that it wasn’t across every one of our hospitals, but we did start to see it in a few of our different markets, but it’s not something that would be significant enough to even talk about in terms of this call. So nothing really from a – no really real regional variation that impacted us in the fourth quarter.
Bill Carpenter
Clearly what you can see when you – you’ll see case mix up for us, so if we just take a look at our medical admissions and just kind of draw a line between lower acuity and higher acuity. The lower acuity is where we continue to see pressure on the admission statistics as those patients move from in-patient to out-patient. Higher intensity cases, high case mix cases, we actually saw improve during the fourth quarter. So it’s not geographically, but clearly higher intensity cases growing and lower intensity cases shifting to out-patient.
Matthew Borsch
Just one more if I could. I think unless I misheard you I think you had mentioned it was somewhat lower than expected ER volumes. Does that fit into this whole mosaic that you’ve been putting together here?
David Dill
Well our ER volumes were down 1.2%. That was an improvement. That rate of decline has clearly improved from what we have been running in the third quarter and the fourth quarter, so it was an improvement. I think what we were talking about more specifically as we continue to see inside of ER visits, a decline on self pay patients. That’s been a trend for us that we’ve seen over the last year where fewer and fewer people that come to our emergency departments are self pay individuals.
So it was there and then we also talked about the change in the ED visits was really around lower acuity services, levels one, two and three type services versus the higher acuity and that is the trend that we have – that’s a consistent trend that we’ve seen throughout the year as well.
Matthew Borsch
Thank you.
David Dill
Your welcome.
Operator
Thank you, Mr. Borsch. Mr. Carpenter I’ll return the presentation to you once again for your concluding remarks. Thank you, sir.
Bill Carpenter
Right, thank you very much and thanks to all of you for participating in our fourth quarter and year end 2017 earnings call.
Our objectives for 2018 are clear. We are having margin improvement across all our hospitals, particularly our recently acquired hospitals where we have great opportunity; maintaining our operating discipline and effectively managing costs and utilizing our financial strength to achieve appropriate returns for our shareholders. We are doing all this while enhancing our position as a leader in quality. Our focus on quality to continue to differentiate LifePoint Health, attract high performing talent and create new opportunities for growth.
So thank you again for joining the call today and for your interest in LifePoint Health.
Operator
Thank you, Mr. Carpenter. Ladies and gentlemen, that does conclude the conference call for today. We thank you all for your participation and ask that you please disconnect your lines. Thank you once again. Have a great day.
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