Community Health Systems, Inc. (CYH) Earnings Call Transcript & Summary

I want to thank everyone for joining us here today. It's my pleasure to be introducing Community Health Systems. Community is one of the largest hospital chains in the country. Presenting today, we have Tim Hingtgen, who is the CEO; and Kevin Hammons, who's the President and CFO.

So I guess I'm going to throw curveball at you and start off with a question you have heard all week, which is labor cost. So can you talk a little bit about what you're seeing in the market right now and how you're thinking labor costs might progress through the year?

Sure. Let me kick that one off. So as we came out of the first quarter coming into April, we did see -- or starting to see a decline both in the utilization of contract labor as well as the rate that we're paying, albeit slower than we had previously experienced with other surges of COVID, where the contract labor moved out of the system quite quickly after the surge, this one is moving out at a slower rate. If we go back and look at kind of the first quarter, our contract labor represented about 13% of our total labor spend for the quarter compared to the year ago period when it was 5% of our total labor spend. So a significant increase. As we look out ahead, and certainly, we don't have a crystal ball as to -- but we do see contract labor normalizing. As the rates come down, I think there's an equilibrium that we'll get to where it will be less advantageous for nurses to accept these travel positions or less attractive to accept the travel positions as that rate comes down and less incentive for them to do that. I would expect and we're projecting the fourth quarter to look more like that 5% of total labor -- being contract labor expense. Tim, I don't know if there's a few things you want to add to that?

Sure. We've actually been drilling at our working with our workforce to try to rebuild and when we saw some of the contractor trends emerge even in the earlier waves of COVID. We started our centralized nurse recruitment program. We've shared some of the details around that. But in the end of the first quarter, we had all of our hospitals covered by that service, which has been very impactful. We have net hiring gains, we've improved the retention rates, and we put a lot of energy into market adjustments and the things that it takes to achieve that equilibrium that we're after that Kevin mentioned, where contract labor, the differential with the inconvenience and being away from family and loved ones is no longer worth it. So getting people back home and part of the care team, we also announced some benefits enhancements, really focused on making sure that there's a benefit to being a core health care worker in a hospital health care system. We announced a couple of weeks ago a rather large and substantial enhancement to the benefit plan. About $40 million estimated spend on paying back student loans for our employees. We also have enhanced our tuition reimbursement programs. And we call it our Pathways program because we're going internally and working with even CNAs to make sure we put them on a pathway to a better career within our health care delivery system. And again, we're pleased with where we're at. Certainly we have not zeroed out the net loss of RNs through the waves of the pandemic, we like the progress we're seeing.

Yes. So that 5% number, how do we think about that number, kind of pre-pandemic, where was that?

Pre-pandemic contract labor ran 2% to 3% of our total labor. We've always had contract labor, and we'll likely have it. It helps with seasonality and so forth, just as you're volume ebbs and flows, so 2% to 3% on a historical basis.

So I think one of the things that we're all trying to wrestle with is how to think about what net-net happens to labor costs because you guys talked on the call about $190 million in Q1. And I guess Q1 last year was about $70 million. So basically, you're saying $190 million to $70 million by the end of the year. So you're going to have, if you just said, I guess, ratably a decline, something around $550 million, $600 million of contract labor costs, and it sounds like the number might be -- doing math on the fly is always dangerous. But like $120 million, $125 million normally. So how do we think about that $400 million of bolus of extra kind of contract labor there? Does that eventually come back into margin? Or the only way to get to 5% just to do the things you're talking about and build in a higher wages and say you only see half of that. How should we think about that conversion of contract into core? And then how much could be left over for margin?

Yes. I think a substantial portion is left over for margin. We are seeing a little higher wage inflation than we had previously seen, but also understanding that baseline of prior year that we had significant amounts of premium pay, over time, shift premiums as a result of the pandemic. We had special programs like sign-on bonuses and stay bonuses that are not like -- that we're not likely to see as much of going forward. We've projected, and I think we've said our assumption on labor cost inflation-wise, is about 4% this year. Currently, we're in the first quarter, a little higher than that. But as we anniversary some of those wage adjustments we made in the prior year, we don't expect to see that type of wage inflation throughout the full year. In terms of contract labor versus kind of the employed model in terms of rate, those contract labor rates are about 4x what an employee make. So there is a significant portion that will flow through to margin as that contract labor comes out.

Okay. That's great. And I guess, what gives you confidence that you will be at 5%. I guess you've kind of had a labor shortage getting into the recession [indiscernible] into COVID. And so it's been talking about burnout and all sorts of things. We talk more travel nursing interest because of the bill rates. The staffing companies seem to think that whatever that Q4 number is, is the new base and then it gets worse from there again slowly but surely. So how are you thinking about the long-term moderating off of this 4% to something a little bit lower?

Yes, I'll start that off, and it goes back to some of the things we just discussed in terms of creating an environment where all employees not just nurses feel valued and again, have opportunities to progress their careers within our health care systems so like they're part of something. There's a lot of surveys that have come out regarding burnout, early retirement. We're very focused on making sure we're addressing all those indicators that come out of those surveys, providing environments where employees really do want to be a part of that health care system. There has been, again, I think, a lot of traction around the initiatives that we referenced, again, the uptake on the student loan repayment. Those types of things are helpful. We're also going through a broader-based leadership training program for all of our directors to really augment the culture and making sure that employees do feel supported. They feel like they sort of can't speak up. We're also looking at advancing care delivery models where they feel that they're practicing, nurses are practicing at the highest level of their license, bringing in more extenders to help with that care delivery model. And then lastly, we're providing them with, I think, some technology, some augmented technology to help their jobs not be easier, but to get them ever extra layers of protection and overlaying AI on monitoring systems, that be on the OB service line, telemetry systems, just all those things creating an environment where people feel like they're really being supported.

And then how do you think about the other side of the equation, like the rate side of the equation. What's your ability to ultimately get rates that reflect the higher labor costs, higher inflation broadly?

Sure. So we are in process. Of course, 2022. We're fully contracted for rates, but we're already going after 2023. And basically, everything is on the table at this point, whether it's amending existing contracts, renegotiating a number of our contracts more than half or 1-year contract. So we have opportunities yet that we've not negotiated those for '23 and '24 so we can be pressing on those contracts for additional rate. In instances we have a multiyear contract, we're going back and trying to renegotiate those. And again, we're kind of -- everything is on the table for us right now.

So how much of like 2023 pricing do you think you could potentially affect.

It's a combination, I think, of both pricing as well as how much of that we'll actually capture. We've all heard recent stories on denials and managed care denials and the payers are denying commercial claims as well. So that the flow through of those payments, realization of those payments as well as rate. And I think it's a combination of those 2, and those are both part of our negotiations.

And then how do you think about the volume side of the equation? I mean, COVID has impacted volumes. I think a lot of times, we talk about, oh, are you back to pre-COVID levels, but the reality is you must have thought there was some growth in your core business. So even getting back to pre-COVID is not back to normal. So I guess how do you -- I guess maybe, first, the company has done so much around the portfolio rationalization that maybe it's a little bit hard for you to [indiscernible]. What you guys think core growth -- demand growth is in your markets? And then where are we, I guess, versus 2019, but then [indiscernible] versus where you would think 2022 should be?

I can't start. In terms of where we're at versus 2019, and we agree that, that's a relevant starting point we shared with everyone that our surgeries in the first quarter were on par with the first quarter of 2019, which we see as progress. We exited 2021 at about 97%, which was also relatively strong based upon our investments in capital -- service lines, growth initiatives, things along those lines, transfer center. So all those things, I think we're yielding the intended benefit. In terms of where we go next, we're still adding capacity in our core markets. We have de novo facilities that we're bringing online, expanding our access points, building a larger funnel to really start, I think, improving upon where the current core demand is. And all those things are taking root. We've always used our physician schedules as a key indicator as to what we could expect down the road in terms of more acute care, higher acuity business, particularly surgeries. And we're very pleased with our medical staff development results. We track our clinic visits on a daily basis. We have really good fill rates in our practices. So the underlying fundamentals still seem strong in terms of consumers reaching out once we clear the surge of COVID, coming in to regain some of that momentum on care that maybe was deferred. So we still feel the fundamentals are there. We still work very hard to make sure we're closing gaps in care and communicating with patients because sometimes -- it will not come back as quickly as perhaps we thought it would without those extra efforts. Did I miss anything, Kevin?

No, I think you summed that up really well. The one other point that I would make is we think of markets, and now that we've completed our portfolio realization program, we're in markets and a number are markets are in counties or adjacent to counties that have the largest population demographic growth over 100,000 in the country. So with that comes economic growth as well. So as we think about 2019, we also know our markets are growing. We expect to capture our share of that growth as well as the amounts we spent invested to take additional market share. So it gives us confidence. Now how quickly all that comes back? I'm not sure any of us know. I don't have a crystal ball. But inherently, we believe there's that deferred demand and that more of that business will come back.

I guess, let's say, if we get a normal environment, how would you be thinking about long-term volume growth in your markets?

Percentage-wise, I think it's probably 2% to 3%.

And I agree with Kevin, and that's where the way we focused on a stronger portfolio of hospitals, really building out health care delivery systems, not just focus on the hospitals, but all the ambulatory access, our ASC strategies, all of those items, physician practices. All those things really do matter to drive the acuity in the hospital setting itself. So a lot of our growth is baked into really building out those health care systems, doing a better job of connecting and managing the care with patients and providers so that our health care systems can take that market share.

That's helpful. So then like when we think about that trend line then, so if you were in 2019, okay. Then 2022, if your demand is growing 2% to 3%, then you've got 6% to 9%. Opportunity there. Is that the right way to think about it? Or has there been some changes around COVID where you say, you know what, we're not going to see as much volume in ER or other access points that you would have seen pre-COVID.

And I think as we went through every phase of the pandemic, and we saw volume come back relatively quickly after the couple of waves subsided, we thought that deferred care would really come back into the system more quickly. I think what we're seeing is there is some foregone care, meaning just care that it's not going to come back. It's cycled through routine colonoscopies, lab work, certain visits, obviously, the physician practices. So we've kind of had to isolate, okay, that's off the table in terms of what would have been something accretive to growth leading into normal times. But in terms of other areas where we see the growth of being able to pivot to areas where there's the opportunities, we now see that the deferred care is likely going to be sprinkled through because, as I said, our practices run pretty full schedule. So -- and unless we had a lot more physicians to bring in that deferred care more quickly, it's just going to be, I think, wave through the health care delivery system, that's our current theory. Some of that, I think, has foregone, but we still feel very, very opportunistic in terms of what's to come in subsequent quarters because people need orthopedic surgeries, they need cardiac procedures, deferred screenings that do cause, maybe, more advanced cancer is all the things that we certainly have been reading about. We see that starting to come through the system and the first quarter, we had very strong orthopedic case volumes, cardiac taste volumes. A lot of it weighted on the back end of the quarter in March. So we still have visibility that, that deferred care is there, and we do have the means and the mechanisms to bring it back into the system.

That's helpful. And I guess, I think one of the concerns that people have had for a while is that the biggest area is deferred care with lower acuity volumes. When you look at you're payer mix and the managed care results, it seems like Medicaid, Medicare would defer more heavily than commercial. So when volumes come back and it's lower acuity -- more likely lower acuity a little, more like government, how does that impact your thoughts about margins? And are those at the very least EBITDA dollar enhancing volumes to be coming back in the system?

Sure. So that volume, some of that lower acuity, lower payer mix volume that has typically been treated in the hospital-based emergency departments, we do think there's some structural change there, and some of that does not come back. Or if it does come back, it's going to come back in other sites of care. And we've invested pretty significantly in freestanding emergency rooms and urgent care centers and primary care clinics. And over a 2-year plus now pandemic, people have found other sites of care when needed. So we will capture some share of that in these other sites of care, and those are lower cost of care sites. So even though we may continue, we may capture that business back, we're doing so in a lower cost of care site, which is margin accretive compared to that pre-pandemic baseline. To your other point, it is additional EBITDA dollars. So it's still helpful. And as we continue to grow and leverage our fixed cost base in our markets, and we feel that there is an opportunity here for us to continue to grow out our existing markets and really leverage those fixed costs, that is also marginally accretive to us.

And the other thing I would add to that, and I think Kevin summed that up very well. But I would add that in terms of our access point expansion, we are really focused on building out a better commercial base of business where we place those. We rely on some really strong partnerships to help us identify where is the high-growth area, on typically commercially insured? How do we position ourselves for, again, at the top of the funnel? How those cases could migrate into our health care delivery systems for the long run? So we have to be more deliberate as to where we target commercial business to think overcome some of the structural changes or the change impairments that you referenced.

Because it's interesting, I get the question for all the hospital companies, it's not just you, but yours has a little bit more visibility because you've gone through this portfolio rationalization even doing so much around the investments and everything else. So when we think about your margin being 15%, I guess you're not only saying 15% is a good base, but 16s in the view over the next several years, what gives you confidence that, that 15% is really kind of 15%? Or what from the outside looking in, say, what is there we can point to that should give us that visibility that you have?

I think it's a balanced approach we're taking. So there's the organic growth that we've talked about and being in markets that are very favorable markets demographically and economically across the Southeast, Southwest United States. There's the capital investments that we're making as we target higher acuity services, as Tim just mentioned, the locations that we're putting those services. And as we continue to grow and have made some balance sheet corrections here and we're producing free cash flow, we're expanding our ability to also reinvest into further projects. And then there's our margin improvement program, which has also been very successful over the last couple of years, allowing us to hold kind of those nonlabor expenses. If you look back over the last 5 quarters, our nonlabor expenses on an absolute spend basis have remained flat. So not only have we stepped over inflation, but we've stepped over a number of these growth investments that we've made where we've opened up new access points and so forth. So I think balancing those 3 opportunities is what gives us confidence, and we think there's more opportunity, more runway on the margin improvement program and certainly more opportunities for investment.

Yes. And I guess when you think about that acuity dynamic, I mean, is there a way that you break out between like how much is service line driven acuity versus kind of COVID or lost volume type acuity?

I don't have an exact breakout of that right now.

I think to add on to what Kevin said in terms of how do we feel about margin progression down the road? Obviously, clearing the labor headwinds that are upon us, we're very active in that, as I explained, building a nursing pipeline with nursing college affiliations, things along those lines. Those are all good long-term plays for us beyond just the short-term things I mentioned. But the transfer center, the ACOs, all the things we've been investing in, the more we can -- and recruit doctors, the more we can identify those service line opportunities, recruit providers and invest the capital and the technology to drive them. As Kevin said, we have, in some cases, fixed assets that can take in that business without any capital and we get the improved margins just off the fixed cost leverage. So we see that in a number of our markets, where we are at capacity as we've shared, investing our capital to make sure that we are adding beds, adding procedural suites. All those things, I do believe are margin accretive in the long term, which helps us being full confident in the long-term margin profile.

So when we think about what you have for 2022, you've got what appears to be kind of a peak contract labor costs. You've already encompassed the $40 million investment around extra benefits, you're already taking a little bit higher wage costs. Do you think that pricing next year should start to get a little bit better? I mean is there any reason to think that next year shouldn't be a better year from a margin perspective than this year? Or are there still things kind of want to come and say, you know what, not quite ready to go there yet?

No, I would expect next year to be a better margin year. Yes. As we look at our kind of path forward and trajectory, and as we put out our near-term goals over 2 years and medium term over 4 years, we see a pretty steady trajectory in terms of margin growth into the out years. As we, again, continue to invest, continue to make improvements in our margin improvement program, continue to grab market share and get -- if you think about several of the investments that we've made throughout the pandemic, we've not fully realized the benefit from those investments because of the disruption from the pandemic. So we also have that opportunity that we believe will lead to further improvement and further margin expansion.

And if I could tag on to that, I think it's a great point, putting our capital in the right place as we talked about smart capital growth. I mean some really good markets, as Kevin pointed out, good demographics, good growth and a lot of the fastest-growing counties according to the U.S. Census Bureau. Those are all great. But with those investments that we've made, we did not want to lose momentum throughout this current labor surge either. That's why we deliberately did bring in that contract labor. We're building business with providers and building relationships with patients. We don't want to hand that back. So we're going to work through this labor environment, take great care of our patients and our communities. And again, continue that growth momentum going forward. That's our game plan.

And I guess the other thing that you guys have done, the portfolio rationalization has been great. The margin improvement, but the free cash flow and the balance sheet has significantly improved over the last couple of years. Can you just talk a little bit about kind of you're outlook there? I mean when I look at you're leverage targets over the next 4 years, felt to me kind of conservative because you're pretty much at the current one. And then if you're generating the free cash flow, it looks like you're generating now sustainably then why can't you be below 5x in a few years?

Coming out of the pandemic, there's still little volatility out here and not wanting to get too far out over our skis on this. So we're very focused on lowering that leverage, improving free cash flow. It's been top of mind for us. Given where we started a couple of years ago, we've made great progress to this point and probably have gotten to the point we're at quicker than we initially projected. But we have some goals out there. And trend-wise, still favorable, and we'll continue to push on that and see what some of the things that like contract labor that are still out in front of us that are less in our control. As we get past those, get passed if there are no more surges of COVID and then take it from there.

Kevin, if I could add on to that as well. I think the other balancing factor in that is we're reinvesting back in the business. So we have been very, again, focused on where we're spending our CapEx. Where we see opportunities, we want to have the cash to invest into those opportunities for the best long-term prospects for the organization and our stakeholders. So we still see plenty of opportunities out there as the environment normalizes. Our discussion on deferred care, bringing labor back into some new sense of normalcy, those things, we believe, will obviously open up more opportunities for us to invest in the portfolio. So the choice at that point, debt pay down or invest back in the business, and we're trying to take a moderated tone on that as well..

Because you're guidance for this year, like you're CapEx guidance is up somewhere between like 7% and 28%. So like can we look at those types of increases again in the future? Like is there still that type of opportunity? Or...

Yes. I absolutely believe there is. We are not -- the majority of that additional CapEx spend and the majority of our capital spend is in growth capital. We're not having to make up for maintenance capital that had been deferred. I think we have all along kept appropriate -- sending appropriate amounts of maintenance capital on our facilities. Now given where we are with free cash flow, we have an opportunity to really start to get more aggressive on some growth capital, and that's what we're doing. And I think there's opportunity for that to continue to increase in the future. Now right now, because of the labor backdrop, we have to be careful that we don't go out and spend on projects that we can't staff. I mean staffing is the long pole in the tent right now. So that's where we'll -- as we continue to look at opportunities and weigh the benefits and what's best for the company at the time, I think, between what could be debt pay down, what could be reinvesting in EBITDA growth, both of those have deleveraging benefits.

That's helpful. And I guess when you think about that excess cash, so you invest back in the business first, are we thinking -- you thinking about debt pay down and -- or could the deals be in future?

Right now, I don't see -- I think it's too early to talk about acquisitions at this point, but we are doing some things like investing in some joint ventures, expanding across the continuum of care with behavioral health with rehab, with LTAC services. And it's a lower cost entry point into the market to joint venture. It's also a speed to market by having a partner who that is their specialty and we can partner with them and really expand our brand and extend our services across continuum of care. So those are opportunities kind of that are ahead of us right now, at least where we're at with our cash flow. I think, again, as we continue to get past some of the current choppiness of labor and recovery from COVID, we'll get clear line of sight on that.

And I think versus opening up new markets, understanding the opportunities in our existing markets are there. Breaking [ down ] and a tower expansion in one of our Knoxville hospitals next week or the week after coming up here soon. So those will have time to build and then moderate the construction schedule to when we think staffing will normalize. We can go back on the offensive to taking market share in that particular health care delivery system. The Tucson market, we're opening up our fourth campus in that market. Hopefully, this quarter, again, all things equal, we should be ready to go with that. So that's kind of where we see, I think, the bigger buckets of cash going. Fortunately, for us, again, strong opportunities in access points, ASCs, somewhat freestanding EDs, urgent care, primary care, all those things, but they're relatively low dollar investments. They're really rounding out that delivery system. And as I said, just kind of an entry point into the larger scale offerings of a health care system. But again, the cash where we invested for bigger dollars will likely go into expanding out our existing markets.

Okay. And then, we -- one of the big issues facing, I guess, coverage generally in the U.S., I guess [ Tier 1 ] is Medicaid redeterminations. Is that actually like a positive for you at the end of the day from a shifting into commercial?

I'm sorry, I didn't...

The redetermination of the Medicaid.

Yes. Yes. I think that would be a positive.

And then how are you thinking about the ACA subsidies going away? How much of a headwind would that be if they can't extend that subsidy?

It could be a small headwind for us, but we don't see that as a real tremendous headwind. We also have opportunities where we have 4 of our 5 largest states have not expanded Medicaid yet, and there's more discussion of at least a couple of those states, actually expanding Medicaid, which would probably be a tailwind for us. So kind of on the balance. I mean, there's some puts and takes there, but I think ultimately it's a net positive.

Okay. Great. That's all we have time for. Thank you very much.

Thank you.