Good day, and welcome to the Tennant 3Q 2018 Earnings Call. As a reminder, today's call is being recorded. At this time, I would like to turn the call over to Brendan Strong, Vice President of Investor Relations. Please go ahead.
Good morning. 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. In addition, please note that certain statements made during our discussion today constitute forward looking statements. These statements relate to future events, including, but not limited to, statements with respect to our business outlook and forecasts, our future earnings and financial position.
Forward looking statements represent management's current expectations based on currently available information as to the outcome and timing of future events, but by their nature address matters that are uncertain. Actual results and plans could differ materially from those expressed in any forward looking statement. For more information, please refer to our risk factors discussed in Tenet's most recent Form 10 ks and subsequent SEC filings. Tennant assumes no obligation to update any forward looking statements or other information that speak as of their respective dates, and you are cautioned not to put undue reliance on these forward looking statements. I'll now turn the call over to Ron Rittenmeyer, Tenet's Executive Chairman and Chief Executive Officer.
Ron?
Thanks, Brandon, and good morning and thanks for joining us. Before Dan dives into the details, I thought I'd take a few minutes and put the quarter into context from my perspective. As you saw in the materials we posted yesterday afternoon, adjusted EBITDA came in within the range we projected, but at the lower end of the range. While EPS was $0.29 which was above the higher end of our range and above consensus of $0.13 My view as CEO is that we had a solid quarter in Conifer and USPI and we fell short in hospital operations. There are several puts and takes that impacted the overall number and we've added some detail this time in our presentation materials on Slides 56 to summarize the larger items impacting year over year comparability and Dan will spend some time on that.
First, allow me to take a few minutes though and add some color to those comments and statistics. On a normalized basis, adjusted EBITDA grew 2.8% this quarter. Ambulatory grew adjusted EBITDA less facility level NCI by 11.5%. Conifer improved its margins over 200 basis points this quarter. The Hospital segment, while up for the year, declined 2.9% in the 3rd quarter.
Make no mistake, growth and operational excellence are my top priorities as it relates to hospital operations. While we had some headwinds in older malpractice settlements this quarter, as well as an impact from prior hospital divestitures, our growth is not acceptable. When we look at the quarter, 14 to 21 markets had positive adjusted admissions, which we believe follows the trends we see in outpatient services. We also noted that we had a shift into a greater number of observation cases from inpatient cases, which has a negative impact on admissions and suggests we're not really losing share, but rather having a shift in share and we're looking into that deeper. Detroit, which has been a topic discussed in the past remains a headwind, but we have noted improvements and we expect these trends to continue.
Detroit remains a very important market and we do see improvements in emissions and are noting that the environment has begun to stabilize. We remain confident that Detroit is a very good market for Tennant. And while our expectations is that volume challenges will persist in Detroit as we rebuild this market for the next several quarters, we believe we're on a path to restore organic growth in Detroit. As I said, I and my team are not satisfied with our growth. And while we have noted we have seen a shift to observation in outpatients from inpatients and some headwinds in a few markets, we are not stating excuses versus what we see as opportunities to make appropriate corrections.
We have increased marketing efforts at the local level with the marketing programs tailored to the specific market and community. In Detroit, for example, it is built on a theme of a community built on care. This campaign uses our employees, physicians, nurses, etcetera to drive this message at the grassroots level using radio, billboards, bus wraps, speaking at community events, speaking in local churches. Each hospital has a tailored program directed to its community and the services needed. This is a clear departure from our past and we are expanding in selected markets to position us as a much stronger part of the community.
We have focused our resources on a hospital by hospital basis, on service lines, growth strategies, quality, weekly performance reviews among other items. We're going to support this with appropriate amounts of capital and further build out of our outpatient offerings with new micro hospitals, off campus EDs and urgent care centers as I've stated in the past. In our Ambulatory segment, USPI's financial performance was strong in this quarter with adjusted EBITDA less facility level up 11.5%. This was driven by solid performance, both in the surgical and non surgical areas of the business. Overall, a great quarter and we feel very good about their position in the market and as part of our overall portfolio.
Conifer has improved its margins over 200 basis points this quarter and this should continue. The team has done a tremendous job improving their structure the dramatic improvement in Conifer's margin underscores the value we've created in a very short period of time. I continue to be pleased with the improvements in Conifer's performance and we continue to develop a stronger commercial engine to develop additional revenue opportunities in the future. In terms of portfolio activities since we last spoke, we completed the sale of Aspen Healthcare in the UK in August. We continue to target the Chicago closing and the remaining health plan for the Q4.
Last week, USPI formed a new joint venture with Integris and the HPI Community Hospital Group in Oklahoma City. As part of this transaction, USPI now has an ownership position in 2 additional surgical hospitals, bringing our total number of surgical hospitals to 23. USPI also announced a joint venture with a new healthcare partner, Tower Health, to expand access to care for patients in Southeastern Pennsylvania. We have deployed roughly $130,000,000 on the ambulatory acquisitions through the Q3 and will be between $225,000,000 $250,000,000 by the end of the year. This will provide a nice tailwind to USPI's growth in 2019.
Now, I'd like to take a second and talk about the Conifer process. Over the last year, we have made significant progress at Conifer. We made a number of changes within the business that has enabled us to substantially improve performance, including driving adjusted EBITDA growth of 32% year to date. At the same time, we have invested time and energy into the exploration of a potential sale of the business. We are now down to a very few viable participants.
And while I realize many believe we should have accomplished this faster, our commitment to the shareholders is to do it right. This process has been very deliberate and has raised other opportunities that we are now actively evaluating for Conifer that could deliver more value to our shareholders than an outright sale. That includes strategic alternatives such as a merger, a tax efficient spin off or even a combination of alternative transactions. And by the way, while this has taken some time, the improvement in Conifer's performance from when this started to today has been worth the investment as we did not allow this time to go to waste. We need to close out this process and I believe we are now in the late stages.
By taking the time to construct a new contract for Tennant and Confer and explore in detail the options I mentioned, the final decision will be the right one for Conifer and our shareholders. Before I conclude, I'd like to also provide a few thoughts on 2018, some early perspective on 2019 for the enterprise. We are going to lower our EBITDA outlook for 2018 to reflect the challenges that we faced in the hospital segment this quarter and which we expect will continue somewhat into the Q4. Even with this, based on where we are with our business planning process, we expect to grow adjusted EBITDA in the 3% to 5% range in 2019, which positions us to deliver results in 2019 that are consistent with consensus expectations. And we expect to deliver 4% to 6% EBITDA growth at Conifer.
We have more work to do over the next months to finalize our business planning process for 2019 and we'll provide our full outlook when we release our Q4 results in February. With that, I'm going to turn it over to Dan and I'll have some closing comments. Dan?
Thank you, Ron, and good morning, everyone. We generated 577,000,000 dollars of adjusted EBITDA in the quarter below the level that we wanted to achieve, but within our range of expectations. As outlined on Slide 5, on a normalized basis, we grew EBITDA 2.8% this quarter and we anticipate delivering 8% to 10% normalized EBITDA growth this year. Adjusted EPS was $0.29 and was above the high end of our range for the quarter with lower NCI offsetting the lower EBITDA. Our Hospital segment delivered $312,000,000 of EBITDA, which was up $43,000,000 year over year, but down 2.9% after you normalize for the items listed on Slide 6.
Ambulatory EBITDA was $184,000,000 a year over year increase of 15.7% and EBITDA less facility level NCI was $116,000,000 up 11.5%. Conifer's EBITDA rose to $81,000,000 with margins up 2 10 basis points. And adjusted free cash flow was 5 $12,000,000 in the 1st 9 months of this year, a $200,000,000 improvement over last year. Turning to hospital volumes, which are summarized on Slide 7, adjusted admissions were up 0.3% and admissions were down 2.1%. As we discussed on our earnings call last quarter, we have closed various sub scale margin dilutive services at a number of hospitals.
This lowered adjusted admissions 30 basis points and admissions by 40 basis points. Continued softness in Detroit also lowered our admissions and adjusted admissions by 70 basis points. After normalizing for Detroit and service line closures, adjusted admissions were up 1.3% and admissions were down 1.0% this quarter. Revenue per adjusted admission increased 5.7% or 3.6% if you adjust for the California provider fee revenue. Overall, cost per adjusted admissions increased 3.9% this quarter.
SWMB only increased 0.9% and supply expense was up 4.6%. Similar to recent quarters, supply costs were up due to acuity growth, including strong growth in high intensity cardiovascular procedures. Other operating expenses were up 9.5% per adjusted admission, primarily due to increased malpractice expense and about $20,000,000 of losses on risk based contracts in California. These items were partially offset by a $16,000,000 gain from the sale of an asset. As shown on Slide 6, we anticipate our losses on these risk based contracts will be smaller going forward with about a $5,000,000 loss in the 4th quarter and even lower on a quarterly basis in 2019.
As you think about these three items impacting other operating expenses, we did not forecast the $20,000,000 of losses on risk based contracts or the $16,000,000 gain on asset sale. Also malpractice expense was about $30,000,000 more than we had anticipated in our Q3 forecast, which was a key reason why our results were lower than we had anticipated this quarter. Moving to our ambulatory business on Slide 8, USPI's growth remains strong with surgical revenue up 6.6% this quarter. Cases were up 4% and revenue per case increased 2.5%. Starting in the Q3, these growth rates now exclude Aspen, which we sold in August.
In the non surgical business, which consists of USPI's urgent care and imaging centers, revenue growth was strong again this quarter, up 9 point 4%. As shown on Slide 9, adjusted EBITDA less facility level NCI increased 11.5% consistent with the 11% growth that we anticipate for the full year. As Ron mentioned, we expect USBI to deploy $225,000,000 to $250,000,000 on acquisitions this year, providing a strong foundation for USBI's continued growth next year. Moving to Conifer on Slide 10. As a result of divestitures by Tenet and other customers, Conifer's revenue was down 7.5% this quarter.
Despite this, margins improved 2 10 basis points, resulting in EBITDA of $81,000,000 which was in line with our expectations. And margins should be up by more than 300 basis points in the Q4 compared to last year. We remain confident in Conifer's value proposition and long term growth prospects. We expect additional margin improvement at Conifer next year, leading to EBITDA growth of 4% to 6% in 2019. Turning to Slides 11 through 13, you will note that we lowered the midpoint of our full year adjusted EBITDA outlook by $50,000,000 This is due to a $60,000,000 $60,000,000 reduction for the hospital segment, primarily due to the risk based contract losses and additional malpractice expense, partially offset by $10,000,000 increase in the ambulatory segment.
Our outlook on Conifer's EBITDA has not changed. Turning to cash flows, we lowered our range for adjusted free cash flow to $600,000,000 to $800,000,000 reflecting the reduction in EBITDA and a change in the timing of anticipated payments from the provider fee programs in California and Michigan. In the Q4, we expect to realize approximately $100,000,000 of proceeds from divestitures we anticipate investing about $100,000,000 to $125,000,000 for ambulatory acquisitions. We paid off another $38,000,000 of debt this quarter and expect to retire another $30,000,000 through open market repurchases in the 4th quarter. And our leverage ratio at the end of the quarter was 5.70.
In summary, our hospital results did not meet our expectations. However, USPI and Conifer delivered strong results. Companywide, we anticipate normalized EBITDA growth of 8% to 10% this year. And finally, for 2019, we expect to grow EBITDA in the 3% to 5% range from our 2018 outlook range. Let me now turn the call back to Ron.
Thanks, Dan. In closing, I'd like to make a few comments that I believe are relevant to where we are as a company. This year we made some noteworthy strides, most of which are outlined on Slide 14. First, we lowered our rates of hospital acquired infections by evaluating, implementing standardized, proven and effective methods for preventing infections. Since January, we've seen an 18% decline in this area and we've improved our patient experience score by 70 basis points with 7 of our 9 groups delivering improved levels of patient experience.
In expense management, we obviously have instituted a much sharper approach and we are operating with more discipline and rigor. If you recall, we started with $150,000,000 reduction, then we later identified an additional $100,000,000 We are on track deliver the full annualized run rate of $250,000,000 by the end of the year. Our portfolio is also improving. Since last November, we've exit non core operations, including divesting 8 hospitals and related outpatient centers, 9 facilities in the UK, additional home health and hospice assets and other non core businesses. We've also closed 4 OB programs, 5 behavioral health programs, all of which were subscale and margin dilutive.
At the same time, we built or bought 30 outpatient centers, including urgent care centers, off campus EDs and surgery centers in prime locations. And we completed our buy up of USPI to 95%, still lowering our leverage ratio. Governance of the company has improved, 50% of our board is new since around this time last year and we've added important experience and fresh perspective as well as improving diversity. We amended our bylaws to include a special meeting right, adding an important shareholder friendly provision to our policies and practices. And we will have and will continue to engage frequently with shareholders and solicit their feedback on a wide range of topics, including strategy, performance and governance.
We've enhanced our leadership team Since last November in the top corporate leadership ranks across the enterprise, we've transitioned or realigned roles and responsibilities. We eliminated roles that were duplicative and we've eliminated entire management layers. We changed our positions due to performance and we've taken our best people and promoted them. This is happening in our corporate functions and throughout our operation. To provide a little context, we've transitioned approximately 20% of our corporate leaders and 1 third of our hospital leaders.
These may not be the names and faces you know, but they are the people that I and the members of my team count on to deliver results. And today, we announced a very important promotion at USPI. Brett Broadnax has been named CEO of USPI succeeding Bill Wilcox, who will continue his role as Chairman of USPI and a Vice Chairman of Tennant. Brett was part of the original USPI team joining the company from Baylor in 1999. He's earned deep respect from physicians and health systems and also internally from his colleagues, given his work to shape the company's culture of top notch service and quality.
I'm confident that USPI will continue to thrive under Brett's leadership. And Bill has done a terrific job at USPI, drove incredible performance and built its legacy. We're very grateful to him for his many years of service and I look forward to his guidance and contribution in his role as Vice Chairman of Tennant as we work to integrate our operations and instill a stronger culture of performance. As we look into the balance of the year and moving to 2019, we are prioritizing growth initiatives with each area of the business. As summarized on Slide 15, we're going market by market.
In our hospital business, we're leveraging what works well and addressing areas for improvement and making changes that are needed. USPI, we are positioned to serve the seasonal increase in demand for surgical services in the last 2 months of this year and we're adding to our portfolio through acquisitions and joint ventures. And at Conifer, we have delivered tremendous value. Right now, we are focused on top line growth, expanding our client base and improving client services. So net, I expect us to continue improving and addressing admissions, quality, service and to provide the returns we should be expected to achieve.
It is not without headwinds, but they are not an excuse, but rather an opportunity. Not easily overcome in many cases, but they are also not going to stop the improvements we're making. So with that, I'll close this section and operator, we can turn it over for questions now. Thank you.
Thank We will take our next question from Ralph Giacobbe of Citi. Please go ahead. Your line is open.
Thanks. Good morning. Hopefully we could start with some of the spin factors in the quarter, the risk based contracts first. Can you give us a sense of maybe the revenue contribution from these arrangements? How long will contracts run?
Your ability to exit? And then sort of the what happened I guess in the quarter for you to take the losses?
Good morning, Ralph. This is Dan. Let me address that. The risk based business that we're referring to where these losses emanated from is in Southern California. And we've had that business for a number of years and it's been a solid business.
Just a little bit of background on it. Generally speaking, the business, it's an IPA related type business, negotiates and enters into contracts with plans and then manages the population of lives, whether they're cared for at a hospital, including some of our hospitals or physician offices or other care settings. Based on the claims experience that we've seen this year. There's been a deterioration in the claims trends and could be attributable to a number of different things that you can imagine. These are risk based capitation related contracts where you're paid fixed amount for each life per member per month.
And between the some of the higher acuity that's been incurred, specialty mix and other items such as ESRD type of patients, they tend to drive incremental claim dollars. And that's what we've seen. And so based on where we're at with our experience this year, we had to address this in the quarter and that was the driver of the about the $20,000,000 of losses. We are fully evaluating the business on a going forward basis, evaluating all the contracts. We're we can if it makes sense, we will terminate contracts if necessary.
But we're evaluating the business, see if it makes sense going forward. And if it doesn't, we will exit that business and sell it.
Okay. And can you give us a sense of the revenue, Vince?
It's about $100,000,000 or so. Okay.
That's helpful. And then, you attributed some of the lower outlook to, I guess, your payer mix expectations. I just wanted to get a little more details there as the pricing study even ex the California provider fee looked pretty healthy. So I just wanted a little more context on sort of payer mix and what's driving those pressures or if you can help flush out what you're seeing there?
Yes. So let me I'll address the pair Meg, but let me provide a little context. So in terms of the reduction in the hospital segment outlook, it's largely attributable to as we mentioned in our release to these losses related to these contracts that risk based plan as well as incremental malpractice expenses we've encountered. As well as some there is a portion related to payer mix, the trends there. As you may have noticed uninsured volumes are up higher than we obviously would prefer and just some of the mix between commercial book of business as well.
So we're on it. We have a number of different growth strategies at each and every hospital and all the markets Where we need to make leadership changes, we're doing that. But based on where we're at right now with some of the trends that we felt it was prudent to adjust the guidance at this point.
Okay. All right. Thank
We will now take our next question from Anne Hynes of Mizuho Securities. Please go ahead. Your line is open.
Hi, thanks. Ron, you mentioned that part of the Conifer sale, you reworked your contract with Conifer and Tennant. Can you go into a little bit of detail about what was changed to try to get that process, the sale process or a strategic process moving forward?
Well, the contract on between Tennant and Conifer doesn't really move the process forward. I mean, we have to have a new contract. This one expires the one we've got. We could renew the current one on a month over month basis. Basis.
But the reality is we spent a lot of time on that contract developing that during the process. And so we're going forward with that contract. At this point, I'm not comfortable talking about that publicly given where we are. So I would just say that the contract clearly has the things in it you would expect. We've looked at pricing and adjusted pricing appropriately and we consider all that as we look forward on Conifer's performance.
We've also put in a series of standards that they have to achieve, heavy focus on cash and some other areas that we expect them to perform to. I think we have also in the last year really done a much better job of closing the gap between Conifer's performance and the things that we measure. We have really begun the shift from Conifer measuring what they think is good performance versus we expect to measure in QM by the clients. So good performance needs to be defined by the customer, not by Conifer. And there was, I think, a little mix there that we needed to fix and we've done that in this process.
So all I would say is the contract is very balanced. It's arm's length like it's supposed to be. And I think it provides Conifer with upside and it provides the tenant with the appropriate protections to get its cash collected and for them to execute the mission that they're supposed to be doing. And I think that's probably the best way I could describe it at this point.
All right. Thanks. And any update on potential divestiture program? It's something that you've highlighted a lot in past presentations.
Other than I mentioned in the thing that we're getting close to finalizing the ones that we publicly have talked about. We're not going to publicly announce divestitures going forward. I would tell you that there is a divestiture program always in play. We're always looking at our operations. We're always looking at whether or not they still strategically fit.
I know that sounds like a lot of words, but it is the kiss of death to start telling you we're in a divest hospital A, B or C or this type of business because then we as we've proven in the past, performance is very difficult obviously to maintain when you've made those statements. It's hard to retain staff, doctors, etcetera. And unless you have a deal signed, it's almost impossible ball to catch. So I don't want to create more turmoil to that. I think we've done that in the past.
I don't think that's a good business posture for us going forward. But I would tell you that there is an active view where we continually go look at profitability. Just take a look at the service lines we've closed. We've been reasonably aggressive this year of taking out service lines that are margin dilutive. We are going to continue to look at our assets, whether it's at USPI or at Tenet on the basis of whether or not they're still providing the type of return we want Or is it better to move some of those assets, bring cash in, pay down debt and or redeploy to other assets?
So that's a process that I guess the only way I'd say is a reasonably active and ongoing effort that we continually work at. And we evaluate every call we get when people call in asking us if expressing an interest to see if that interest makes better sense than what we're actually doing. So it's kind of the glib comment that everything's for sale to some degree. I mean, you do what you need to go do. And I think the only concern I got in is just mentioning locations that we're actively looking at just because I think it is a bite.
You get a big bite later if you're not careful with that. So that's the best I can give you.
Thanks.
Sure. We will now take our next question from Josh Raskin of Nephron. Please go ahead. Your line is open.
Hi, this is Rachna on for Josh and thanks for the question. Ron, you highlighted a number of ongoing initiatives to improve hospital operations. So how should we think about CapEx spend for 2019? Also could you give us a timeframe to fully stabilize the Detroit assets?
Good morning. This is Dan. Let me address the capital expenditures. Certainly, we're talking about this year for 2018 on a consolidated basis, estimated capital expenditures of $650,000,000 In terms of next year, we haven't obviously gone out with that level of detail yet. But I would say that capital will probably be in that neighborhood next year.
We're obviously focusing our capital on from a hospital perspective on high acuity service lines, increasing patient access sites, freestanding EDs, micro hospitals, urgent care business, all again to drive additional access points to improve our hospitals' patient care in our markets and drive growth in the hospital business. Certainly, we'll continue to invest capital in the USPI business. As we mentioned in our remarks, we'll probably invest about $225,000,000 to $250,000,000 this year. The pipeline is very, very strong in the surgical business. And so we will come out with exactly where we think we'll be next year in the USPI and when we on our February call.
But certainly, the levels that we've been investing over the past several years of $125,000,000 $150,000,000 certainly will be at least at those levels. And depending on the opportunities that arise, I mean, we could be a little north of that. Conifer, certainly, it's a low capital type of business. So I wouldn't expect any material change in the type of capital that we've been investing in Conifer over the past several years.
Yes. The only thing I'd add to that is that the capital is not free and we are going to be very diligent going forward on spending money where we get a return. There are some things you always have there's some amount of capital for maintenance and things you have to do, which we will always do and make sure we're putting the type of the focus on our preventive maintenance that means we're spending those dollars appropriately. But beyond that, this is really going to be a focus on greater return, certainly in the hospital business, better returns and then the stuff Dan talked about. So I think that's
the only other color I'd add.
Yes. This is Eric Evans. Josh, your Detroit question, a couple of things to follow-up on there. Clearly, we Ron mentioned earlier, we've seen stabilization there. You guys know we finalized our Wayne State agreement.
And our focus there is really a lot of the basics we just heard about from a business planning perspective. We are investing heavily and increasing our access points and our connection with the community. That's everything from meeting the physician community need that there is there to bring in the right physician specialist primary care to meet the community need as well as urgent care center access points. So we just actually approved our 16th for the City of Detroit. We've got a big marketing plan, as Rob mentioned, in Detroit that we're also doing in other markets.
And we have look, we have some of the premier assets in the State of Michigan in our Detroit Medical Center. The Children's Hospital of Michigan is the premier children's hospital in the state. The Rehab Institute of Michigan is a really renowned asset. And so our job is to take the investments we've made in our acute assets and make sure that we are using those to attract the best docs and the best staff. And we're very, very focused on that.
And as Ron mentioned, we expect to return to an organic growth number in Detroit in the second half of twenty nineteen.
Okay, good. Thank you.
We will now take our next question from A. J. Rice of Credit Suisse. Please go ahead. Your line is open.
Thanks. Hi, everybody. First, maybe to just get you to talk a little more about your 2019 outlook. Obviously, 3% to 5% growth for this business would seem on the surface to be pretty straightforward and a reasonable range. But you've got a lot of moving parts.
Obviously, we've been talking about Detroit. You've got your annualized savings of the $250,000,000 that you're exiting the year at. You've got divestitures in Chicago and the health plan out in the West. And then you got annualizing the acquisitions, which you already mentioned, USPI among other things that are headwinds and tailwinds. When you think about some of those, maybe if there's some big ones to highlight, is the 3% to 5% growth, what is really the assumption about the core businesses, the assumption of growth there versus the 3% to 5% headline number?
Good morning, A. J. This is Dan. Let me address that. When we think about next year, we feel good about what we think we can deliver.
Let me go through some pieces and just to give you a sense of how we're thinking about the math. In terms of let's start with the about USPI's ability to continue to grow at the levels that we've seen recently. We'll obviously get into more minutiae when we put out the specific guidance, but we feel very, very good about the USPI assets and the continued growth there. In terms of Conifer, as we've mentioned in our prepared remarks, we think growth there should be 4% to 6% next year. So you can do the math on that and see where Conifer were at least what our initial thinking is for Conifer next year.
And you're right about the cost reduction initiatives. We're on track for our $250,000,000 realizing that. As we've pointed out, we're going to realize about $195,000,000 or $200,000,000 this year. So there's another $50,000,000 rolling into next year as well. And so when you just look at those pieces, you get to that 3% to 5% growth.
But listen, on the hospital business, we are optimistic that we have good opportunities to grow our hospital business next year. We obviously have had some issues this year that we've been addressing, but there are a lot of opportunities where you have those type of issues and that creates opportunities as well. And that's obviously that's what we're targeting. We think certainly with continued strong cost management as well as we feel very good in terms of from a pricing next year. We have next year is already about 80% contracted from a commercial book of business.
So we feel real good about our pricing there. In terms of Medicare, you've obviously seen the recent updates there. It's about 2% next year. So we have good sense where Medicare obviously at. Outpatients just came in at about 1% for us next year.
So cost management, pricing, we feel real good about. We obviously have work to do to grow volumes in the hospital business and that's what we're targeting and that's that will be incremental to those other items I mentioned, the USPI growth, the Conifer growth as well as the growth that would come from additional cost actions.
Okay, great. Let me just for the follow-up go back to the commentary around Conifer. I guess as you guys have broadened the discussion about what you might consider, I think my focus maybe and I think maybe some of the investment community has been more on, okay, what kind of dollars can you realize upfront from this transaction? I mean, I think it's made me think about there is this aspect of you're going to probably have an ongoing relationship with whoever whatever happens here, you're going to they're going to be collecting your dollars and your revenue cycle management. I wonder if you could flush out a little bit, you talked about the contract.
Is that contract in stone or could a new buyer or a new entity if it's a spin off whatever rework the contract? Is there potential some of the people that you're talking to might actually be able to do things that Conifer can't do for you on their own and that that could get potentially incorporated in the contract? And I'm sure there's a trade off between upfront and ongoing fee payments. And how do you is that on the table? How do you think about that?
This is Ron. You kind of answered most of those questions, but I'll throw it out this way. The contract is never in stone, right? The contract is written. It's fundamentally in stone.
It's would we consider as tenant extending the contract longer? Sure. I mean, it depends on what the deal is when we finally cut it and where we plan to go with that deal and how that plays out. So yes, we would consider certain things. I mean, clearly, we're not going to start over and because we have an agreement with Conifer, it's a very it's a commercial agreement.
It's a great it's a good agreement for both sides. So, it's based on a premise they got to deliver and if they deliver, they get paid. If they deliver above expectations, they get higher return. If they deliver and miss expectations, they get a penalty that hurts. There's a reason for that, right?
Because collecting our cash is very important. I mean, we're married to them, we're going to get a divorce, but we still got to live with them. So they are a major part of our life going forward. It's not optional at this stage. So part of the sale anticipates that a long term contract would go with it.
And that's the only that's the value in the deal. So I think though you've got to be flexible. We're far enough along that I don't think the things you're bringing up are truly major concerns at this stage that I would worry about, because most of that stuff has been discussed and has been talked about. There are nuances to it, but I don't think that that is a strong point. So that Yes.
I was thinking more
in terms of an opportunity maybe. Is there are there entities that would look at this or swaying construction where maybe they can
do more than Conifer
can do on their own?
Yes. Well, sure. I mean, that's part of theoretically, that's part of the deal. I mean, listen, when you're in a negotiation, everybody the guy you're negotiating with OE seals, he can give you more. And that's why his price should be lower.
And we just want him to stand against that and support it. So you're kind of getting into negotiating tactics here of how we where we've been. But look at the end of the day, we know the value of the company. This is something I've spent a lot of time in my life doing. And every both sides have to stand behind what they're saying.
So you can't promise something that doesn't have some skin in it. Otherwise, there's no reason to promise it, right? So, but we I think we've made very good progress here and I feel confident that we have those things bracketed at this stage.
Okay. Thanks a lot.
We will now take our next question from Sarah James of Piper Jaffray. Please go ahead. Your line is open.
Thank you. You mentioned that you're looking deeper into the shift in share from inpatient to outpatient. So I wanted to understand how you're tracking that. Is there a way that you can identify the shift to outpatient for specific patients or surgical categories? And then once you're able to track it, can you talk about how you could utilize that information to benefit growth?
Good morning. This is Eric. So the shift from inpatient to outpatient is a couple of things we mentioned. So I'll break it into a couple of buckets. The first bucket is this quarter we saw an increase in our observation patients, which is a patient that is basically it's a head in a bed in a hospital that is not classified as an inpatient.
And so that is something that's moved around. We see it move from time to time. We had more of an expansion of those types of observation patients this quarter than we've seen, and we're looking at that very closely to make sure that we classify the patients in the right level of acuity. And we're confident we have them there. We're just trying to make sure we understand whether this is just a shift for the quarter.
Typically, we see markets that are up and down and they pretty much cancel each other out. We have a normal trend. It was a little different this quarter. So that is one that we look at very closely. The second part of that question is just in general the shift from inpatient to outpatient.
And one of the great things about having USPI is that we can work very closely together on making sure that we manage that shift with our medical staffs, with our communities, so that when a patient wants to go to a different setting or we have a technology opportunity that we do that in the lockstep with each other and an opportunity to earn that business. And so we do see that as an opportunity. And every year, as you know, the ASC list gets updated with procedures that were used to be only done in hospitals that are now done in the ASC setting. And Brett and I will coordinate very closely on that to ensure that we're well positioned as that business leaves the hospitals to number 1, earn the business in the outpatient setting and then number 2, that we're planning thoughtfully about how we bring in high acuity business in the hospitals that backfills that. So
it's a movement that's been happening for
a long time and it's one that we have to work very closely with in our markets to make sure that we deal with appropriately.
Got it. And just to clarify, when you talk about backfilling the high acuity and inpatient, consumers are increasingly relying on ratings and reviews to select where they seek treatment for high acuity items. So how is Tenet evolving their investments to attract share gain in high acuity? So specifically, I'm thinking across hiring decisions, CapEx and marketing spend. Thanks.
Yes, it's a great question. I mean, clearly, consumerism is taking more hold in healthcare, which is exactly why we have to work so closely with USPI and make sure we meet the patient where they want to be treated. This is a big part of our urgent care center strategy. It's a big part of our branding strategy in each local market, how we market high end service lines. And then of course, as Ron touched on, our constant push for improvement in outcomes and in our patient experience, which we are making progress on, We're very, very focused on that.
And we do believe that the increased transparency is driving and the increased deductibles is driving a lot more power to the consumer. The good news for us is with the premier ambulatory provider in USPI and with our market positions in the markets we're left in, we feel very, very well positioned to deliver on that going forward.
Thank you.
We'll now take our next question from Ana Gupte of Leerink Partners. Please go ahead. Your line is open.
Hey, thanks. Good morning. Yes, so the first question I had was on the bridge that you have to get to the adjusted hospital EBITDA. It's like it come up with 1400 in your deck, but you don't account for the malpractice, which is obviously clearly it feels like a one timer and then you haven't any adjustment for Detroit. Can you give us a sense for what the magnitude of those 2 are?
I would think that the adjusted EBITDA would be higher if you took those into account on the baseline?
Dan, let me address that. Yes, we did not include the malpractice as a separate line on that schedule or Slide 6. As I mentioned in my remarks though, the incremental malpractice costs in the 3rd quarter were roughly about $30,000,000 that were not in our guidance for the quarter. So you could do the math if you want to also add that into your analysis. Again, dollars 30,000,000 over and above what we had factored into our Q3 guidance when we last talked in August.
Okay. So it'd be $14,000,000 in which case roughly there, which would then the EBITDA would I guess the headline story would have been more positive. Your stock is trading down pretty dramatically. I think, I mean, the feedback from investors is that there was a miss, but if you take that out, it looks a lot better than the headline suggests. Is that fair?
Yes. As I mentioned, there was $30,000,000 of incremental malpractice to settle various older claims, some of which were older than 5 years old. And we went through the various components that contributed to the adjustment to our guidance. Malpractice was certainly part of it as well as the risk based contract losses of about $20,000,000
Okay. Okay, that's helpful. Thanks. Then on the pricing growth and the 2019 expectation that you have, you say the pricing growth is sustainable because on a net basis inpatient is outweighing the outpatient. You're incorporating the bad debt issues in there.
When you look at after your portfolio rationalization, where
is your capacity utilization at this point? And to
what degree would the service in the in in the inpatient setting? And are you seeing any kind of improvement in commercial relative to the other segments?
So this is Eric. I'd answer a couple of those questions. So first of all, when we look forward, capacity utilization still remains we have in our remaining markets, we have plenty of capacity to support obviously our growth perspectives and our capacity utilization is a little higher in the markets that we're keeping obviously than the ones we're getting rid of. But I would say that from a go forward perspective, when you think about pricing, we're continuing to focus on high acuity items or high acuity service lines. And so you're seeing that growth show up in the revenue.
It's the same thing we're seeing in our ERs. If you look at the level 1 and 2 visits, they're down slightly. The level 4 and 5 are up about 3%. So we continue to expect that acuity is going to drive a fair part of that along with the managed care agreement terms that we've already negotiated. So feel good about the pricing.
From a service line perspective, if you look at the markets we're in, that we have that we remain in, because of the markets we divested, our market share is up approximately 6 points in those markets. We feel better positioned than ever. 80% of those markets were number 1 or 2 in, And we're working very closely with Brett to not just be looking at the inpatient market share, but really be thinking about kind of what does the healthcare system look like in a market. And we think that positions us well to again grow the high acuity in our hospitals and also grow overall outpatient volume in the USPI assets.
Got it. Thanks for the color.
We will now take our next question from John Ransom of Raymond James. Please go ahead. Your line is open.
Hi. At the risk of having Ron get mad at me, I'm going to ask this question. So please be gentle. The thing that I'm struggling with a little bit is when you talk to potential buyers about Conifer, how do you also preserve your flexibility on divestitures without sacrificing too much value? I mean, I assume it could be as simple as a payout over one price today and a price 5 years down the road, but how should we think about that?
Really good to hear from you, John. I appreciate the comment or question. It's a good question. And that's an interesting it is an interesting question. It's a negotiation point.
We've had buyers that obviously want to approach it with you've got a guarantee never to do a divestiture, so we can't do that. Right. There's realism here. You've got to you said you try to set some floor, some reasonable numbers, some projection based on what you know today and what you believe will happen during. But the other argument is then how do you deal with acquisitions?
If we have an acquisition of some business or we USPI rolls into that portfolio and gets handled through Conifer, do they then pay us for that, right? They probably won't. They would just add it to their volume and etcetera, and we negotiate a price. So the ins and the outs are, to me just kind of part of what an outsourcing contract does. In my experience and again different industries to some degree, ins and outs are just part of the business because Conifer's job is to take the base that it owns, which is in terms of its customer base, which is primarily us in CHI and some others and then build on that.
And it's going to potentially lose clients over time if they divest a piece of their business and it's going to benefit every time a client acquires a piece of business. So, I don't we don't spend a lot of time on this because that's sort of the position we take that the ins and outs are part of a normal outsourcing process. And if you look at outsourcing as an industry, that's typically how it's thought of. I have found on the hospital side since I've been here that it's viewed a little differently because people want security. And the problem in outsourcing is there is no security.
Security is only in really performance execution and proving that you can handle more business and going out and looking for every bit of that. So I don't see it as a major point of turning somebody on or off. I think that we try to be frank about what's already in the pipeline to be divested, what we know and we make those adjustments. But short of that, because by the way, when we divest a hospital, it's up to Conifer to win that business. And usually there's some transitional period of a year, maybe 2 years in a divestiture.
It gives them 2 years to prove that they can do that business or not. Conifer has lost some of that in the past, but they've also retained some of it. So again, I think that's just part of negotiation. I don't know if that answers your question, but the best way I can think of saying it.
That's interesting about the 2 year transition. So that helps.
Well, summer a year. I mean, it could be less. Depends on who's buying it, right?
Right. My other question would be, not to beat the dead horse of Detroit too much, but you guys talked about turning the corner. How much of that in your opinion was the getting the physician issue settled with the university? And how much of that is just kind of catching up on some deficiencies and just Management 101?
Again, hard question. I think the university thing, right or wrong, the loss of doctors, the whole thing we went through feeds the base of the problem, right? Now your question would be, okay, so when that's going on, what happened with Management 101? Did they do the right things at all times? The answer is probably they didn't do the right thing at all times.
They did is in some cases, I think they did a darn good job, other cases they probably missed a few balls. So it's a combination. But having said that, we made some major changes. We're totally I think we have a great guy leading it in Tony Tedeschi. He's a doctor.
He does a great job. He has rallied the organization very well up there. So I'm comfortable with that. But you've got to go back out in the community and rebuild your issue and rebuild what you're doing. That's our whole change in how we're approaching marketing as a company.
We were totally into just digital marketing and the problem is in downtown Detroit, digital marketing is probably not as effective as putting things on buses and billboards and other kind. And so we've expanded our we brought in people now that look at marketing more as a consumer business and I think that's really what's helped. So it's really a combination of all of it. Eric, do you want to do you have any other thought?
No, I mean, I think you covered it well. I mean, ultimately, Detroit Medical Center is a core foundational piece of the Detroit community. And we while we had some struggles this year and certainly there were distractions, we feel very confident in our ability to make that a vibrant part of the company. And the investments we're making, we've announced a growth there in orthopedics downtown and in partnership with a lot of community leaders. We have continued to invest in our core strategic service lines, including the last part of our children's hospital tower opening up this week.
And so we have a lot of pieces in place to turn the story around.
We see
it stabilizing and we again see this
And the marketing effort, just the theme of a community of care, I mean, has really begun to resonate, we believe in the community. And the fact that we're doing outreaches at every aspect when you think of the inner city community, I mean, it's important that we do that outreach where the inner city community exists and not just in a digital environment where they may not even see it. So we and we're doing a major drive on signing up Medicare, Medicaid and that's had a positive, a tremendously positive influence in the last couple of weeks. So I think, Holl, it's good. Did you have something else you want?
Okay.
Thanks so
much. Thank you. Sure. We will take our final question from Matthew Gillmor of Robert Baird. Please go ahead.
Your line is open.
Hey, thanks. I did want to ask about the ambulatory business. The growth trends there were obviously very good. I know the comp got a little easier from a case perspective. Can you talk about the trends in that business?
Were there any particular geography or specialty that was driving the stronger growth in the quarter? And then you talked about the confidence with the 4th quarter ramp. Is that based on just the normal seasonality? Are you seeing something from a volume perspective in October that's part of the confidence?
This is Bill, Wilcox. We continue to see positive trends both in the organic and the inorganic opportunities through de novos and also through mergers and acquisitions. And as Dan mentioned that the pipeline is as strong as it's ever been. I think the contributing factors to that are that many health system partners or many health systems and potential partners are really focused on developing ambulatory strategies. And then on the independent surgery centers, of which there's a large number, many of those owners are looking for some strategic stability that would come through, affiliating with a company like ours.
In terms of the Q4, we always as we become more and more cyclical and more dependent on the particularly the November, December volumes, it's always a time for us to make certain that we have expanded our surgical schedules and operating days as much as possible. We're working very closely with our physicians and our nurses to be able to do that. And we're confident that we're going to end the year with strong volumes as we have in the last 3 or 4 years.
Got it. Thanks, Bill. I'll leave it there.
All right. Thanks very much, Matt. That's going to conclude our call today. And if anybody has any follow-up questions, please give me a call. Thanks.