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

Hi, everyone. I'm A.J. Rice, the health care service analyst at UBS. And we will have next up, Community Health Systems. Happy to have Kevin Hammons, our Chief Executive Officer at Community; and Jason Johnson, Chief Financial Officer.

So we're about 10 months into the year at this point, a little over 10. What has sort of been some of the takeaways for you so far, Kevin? Surprises? Challenges?

Sure. It's been a little bit of an unusual year. Started off the year I think with a lot of optimism, consumer confidence is high. First quarter was strong in terms of volumes. And then we ran into the second quarter where I think we saw a lot of disruption. Consumer confidence dropped off pretty significantly, more disruption out of Washington that started concerns about inflation, impact of tariffs and so forth. So then when we get to the third quarter, a lot of that consumer confidence, it kind of hit the trough, it started to stabilize a little bit. We've seen some recovery in the third quarter. And hopefully, that continues on for the remainder of the year.

Yes. So you mentioned a little bit about the macro backdrop. I know volumes moderated for you and for the industry, it looked like in the second quarter, but seemed to rebound a bit in the third quarter. What's your latest thinking overall as to what's happening with respect to volumes? And do you think the bit of moderation we've seen has been sort of behind us, and we'll see a pickup as we exit the year?

I do think we're certainly stabilized now. I would expect the volumes probably, particularly in the surgery area, remain a little bit soft. We're seeing that across the industry. And at this point, it's still too early to tell for the fourth quarter, and we've not put out anything specific about the fourth quarter. But I would expect surgeries to remain soft through the rest of the year. A lot of the softness really cause -- or we're seeing in the elective outpatient area amongst commercially insured patients, which suggest to us that it's more of an economic decision. And it's probably just deferred care. And it's yet to be seen whether that deferred care comes back in Q4 or in early 2026.

One of the managed care companies yesterday was sort of hypothesizing that there is some shift to scheduling people that would normally get an outpatient procedure, say, 8:00, 10:00 in the morning, be discharged at the end of the day via AI and things like that. Some hospitals are now scheduling those procedures from the afternoon. So they're not off of anesthesia yet, so they end up being an overnight stay. Is that -- have you -- is that anything that resonates with you?

No. I've never heard that one yet.

Okay. It seemed like an odd one, but it definitely created a little buzz yesterday. The ACA subsidies is a big focus. Obviously, we've had the announcement over the weekend of the deal, and it seems like there's not a provision to extend the subsidies on there. Can you just remind us a little bit about your exposure to the exchanges? Have you given any sense of what you think it might mean if these subsidies don't get extended?

Yes. So our exchange business represents less than 5% of our net revenue. So really limited amount of exposure and not all of those patients are receiving subsidies, only a subset of those patients are actually receiving subsidies. And if you think about the patients that really are getting subsidized for their health insurance premiums, we're also not likely to be collecting co-pays and deductibles either from those patients. So we're already kind of absorbing that piece, and there are also higher utilizers of emergency room visits. So I think our exposure is pretty limited. I think we have less exposure than some of the other providers, and that's probably more of a geographic issue than anything. Okay. Now I do want to point out and we're thinking information is coming out, probably hourly or every 30 minutes out of Washington. But it does sound like part of the deal to reopen the government, there will be a vote on the extended tax credits here in mid-December. It looks like they'll take that up, and we'll have another vote at that.

Right. So a couple of things to follow on that. There had been some discussion of perhaps people would realize when they see there'll be open enrollment, their coverage is going to be prohibitive next year, and they might rush to get procedures done to the end of the year, given your earlier comments on surgery volumes, are you seeing anything that would suggest that type of activities happening or not really?

We've not seen that yet. I think it's a real possibility if those individuals are really paying attention to what their premium, their situation is for next year. That said, we haven't really seen that yet, at least kind of through the third quarter and maybe into the early parts of October.

And the other flip side of it is while it looks a little less likely or a lot less likely that we'll have these subsidies extended given the weekend dynamics. But if we did have some 11th hour reprieve and there was something, do you have a mechanism? What happens for people that have -- maybe there's an extended open enrollment or something? Can you access those people and tell the ones that maybe have dropped off, "hey, you can sign up again or whatever"?

We do. So we have a group, we call it Eligibility Screening Services. It's actually a subsidiary that we own that work with our patients as they present to the hospital as they schedule appointments, if they don't have insurance, our ESS group will work with them to make sure that they get signed up or qualify under whether it's charity program, Medicaid, health exchange, any type of service out there in some instances, in some communities if there's a foundation that will help cover uninsured, we'll get them connected with them. And they'll work with patients not only in our emergency rooms, but also patients scheduling inpatient services. And separately, we work with patients even in our clinics to make sure that they get it connected with any available insurance coverage.

Okay. And so that happens maybe when you're engaging with them before they come in not so much when they show up in the emergency room or when they show up in the emergency room, you can still help them?

We can still help them when they show up in the emergency room. So it's both. We can connect with them in the emergency room, if that's where they show up when they're scheduling, if it's a prescheduled procedure. We don't have a roster of just kind of blanketing the community to help with that. But we do -- when the patient comes to us, then that's when we can get involved and help them out.

We'll also contact them post discharge, if for some reason, we were not able to get with them at their time -- services with emergent or new...

Right. Sure. And you can get them signed up then. Maybe just a minute on the expense side. There's been a lot of chatter about professional fees the last two years. I think you were up in the third quarter, about 4%. Any -- what's the updated thinking on that? I know you've taken some steps to bring some in-house over the last year or so. What is the trend for professional fees look like?

SP59283275 I think our professional fees are up, I think, it's 7% same-store for the full year. And we're guiding to 8% to 10%. And I think we'll end up in that another area. And if you think about the professional fee trend, it started with ED and hospitalists. We were able to in-source quite a few of those kind of the big bang because one of the companies we're using to provide those services went under, we assumed the contract last year. So now a lot of the pressures come from anesthesia, I think half of the increase is anesthesia and radiology is increasing quickly. It's been more challenging to find opportunities to in-source a significant number of those. So it's a bit by the ones or if not able to in-source negotiating better contracts with those groups. So we do think that it will be a continued headwind.

Similar to next year, what you're seeing this year, 8% to 10%?

Yes. Probably so.

Just remind us what percent of cost revenues, labor, is that roughly? What's the best way to do...

At the mid-spec fees?

Professional fees.

Yes, it's about 5.4%, I think, of revenues.

Yes. Okay. And maybe more broadly, obviously, labor is the biggest cost item generally, what's happening with nursing and wage increases and so forth?

We are, I think, at 4% of the wage increase for nurses, which is what we're guiding towards. And I think that's probably what will continue around that amount for the foreseeable future over the next 12 months or so probably around that. Contract labors well managed. I think we've managed the utilization rates are down well down from the peak during COVID.

Are you at about the same place you were pre-COVID?

Yes, probably more like the 2019.

Okay. All right. So that probably is going to stabilize at the current level in your mind?

Yes, I don't think there's any reason to expect any significant increase on that.

From time to time, there's an area of focus under supply expense as an opportunity. Is there anything that's front burner these days?

Yes. So we are -- have an equity ownership and GPO -- so the more that we can make sure that we're spending on contract, obviously, the better for us. We implemented an ERP that we finished and January 1 of this year. So there's still opportunity there with the ERP. We have access to more data to ensure contract compliance, inventory management, also an area that we're trying to make sure that we focused on built shared services around that. So the supplies is -- I think there's still opportunities there to...

Is the inventory management more focused on commodity supplies? Or is it in implants?

It's mostly in the commodity supplies, talking about that. Yes.

Yes, if I could just maybe add a little more color. So we went from having created the company over a lot of acquisitions for a lot of years. We had multiple systems in place, not unusual for health care systems built this way. When we put our ERP in, we now have a single integrated system across finance, supply chain, HR payroll, all integrated. All of our hospitals now have a single instance of item masters and vendor masters and so forth. So we have information that we can aggregate much easier, much quicker that will give us kind of a business decision support tool. We can see how many of an individual item we're purchasing across the entire organization within a moment's notice versus having to manually kind of gather information that you might get after 6 weeks, and suddenly, it's information stale. So I think it gives us, a great deal, more insight. We're also in the process of putting that in, moved all of those functions into a shared service environment versus all the purchasing decisions being made locally at each hospital. So that will also give us the opportunity to leverage our scale, be able to take advantage of more bulk buy on commodities also as we think about moving physicians on some of the implant higher-cost items, having the insight and the ability to control that better with our workflows should be meaningful to us.

When did you put that in place?

We kicked it off almost four years ago, but beginning January 1 of this year is fully operational across our entire enterprise.

Do you have a target for a reduction in working capital and what that might mean from a cash flow perspective?

We do. We think, from a savings perspective, it was, I believe, $20 million to $40 million this year. We think we'll be able to increase that $30 million to $50 million next year.

Okay. And then I think the other thing is as your financial position continues to strengthen. There's an expectation you might step up capital spending as well. Can you give us a little bit of thoughts on where that spending might be directed? What might it mean for the company's growth?

We don't have any -- we recently -- last year, we completed two bed tower expansions, one in a hospital in Foley, Alabama and one in Knoxville area. So we don't have any replacement hospitals or major inpatient additions of projects into next year. So more focus on outpatient growth, more -- you should get a quicker return capital efficient. So I think next year probably looks more similar this year. We're still working on our -- we haven't released guidance, but in terms of what we'll spend, still trying to make sure that we are free cash flow positive that in the future, as we continue to decrease our leverage and generate more free cash flow, we'll certainly be looking for the increase in our capital spend.

A lot of discussion at the conference about AI, and that's the buzzword. Are you -- is that investment priority in any way? What are some areas where you might think that would be applicable for a hospital business?

It certainly is. There are a lot of opportunities. We're already using AI in our revenue cycle area. We're using it to do some coding for appeal letters. Those are some areas where we've built some AI. There's also, with a number of the products that we already purchased, AI being built in. So our ERP is Oracle. And there's a lot of AI built into Oracle, and we're in the process of now that we're up and using Oracle, looking at all the different AI components and how we can integrate those into our workflows.

Okay. I know it's sometimes hard to envision how this applies revenue cycle management generally. So what -- is there a couple of specific things that you can say this is how it's changed, and this is what it's doing for us?

Yes. I think there are one area, and this is in the clinical space, but using AI, we're -- as we gather clinical information about patients who are at risk for sepsis using AI, it can actually inform the physicians earlier in the care process that the patient has indicators of potential sepsis and allows us to actually dose medication and our sepsis rate and sepsis mortality has decreased significantly as a result of that. And the AI component of that is looking at all that information in the background and then notifying physicians that, "hey, this patient is at risk" and it does that much quicker than what may otherwise be done by humans. In the appeals letter process in the revenue cycle, the AI tools are actually reviewing the records. We get denial and it can generate an appeals letter. And AI generated appeals letter that we can -- we still have a human review it but at least the construction of the letter itself or production of the letter itself is much quicker. So it's tools, then somebody can review it and decide -- we then decide whether...

So it's more of a focus on the appeal as opposed to just getting a clean claim to begin with. Is that where you're seeing the opportunity?

Correct. Currently.

Interesting. And I guess, maybe from a finance perspective, a general leisure perspective, there's account reconciliation opportunities to use AI rather than individuals actually complete...

So what would be an example of that, maybe?

I mean this is pretty detailed here, but even like reconciling bank reconciliations, where you've got two sources, you get the bank and the ledger and doing all the matching, just continue to auto reconcile using AI.

Which can help reduce costs and speed up time and reduce costs.

Experience. Analysis.

Right. Interesting. Okay. The government shutdown seems like its coming to an end. Was there anything that impacted your business in any way?

No, we did not see any material impacts to our business during the shutdown. I mean, claims continue to get paid and even some of the things we're more worried about that are much longer down the road, there did not seem to be any kind of slowdown or impact to those.

So you've got a couple of potentially important supplemental payment programs that are out there, I think Indiana, Florida, Georgia. Any thoughts on those? They sound like they were probably held up because of the...

They may have been held up. I mean we never know when the approval process is coming through. Certainly, they did not get approved over the last 40 days during the shutdown. I still think there's opportunity. We hope that they'll get approved before the end of the year. And as long as we're recognizing it, if they get approved by the end of the year, we can still recognize it in the quarter.

Right. And any way to size what those might be?

Sure. Florida is relatively small because it's just an adjustment to the existing program. Similarly, Georgia, we only have one hospital. I think each of those states is probably in the $10 million to $15 million range each. Indiana, there's been -- our understanding is a lot of back and forth between CMS and the state around the structure of that program. They're working through that. We don't know what the final structure of the program will be. So there's no way that we really have to size what that opportunity is.

Every once in a while, we find there's one not on their radar screen. Are there any other states that you're watching that are particularly relevant?

Not for us. We have some opportunities. We still believe in Alabama and Arkansas probably not with the provider tax programs because they were not applied for prior to the one Big Beautiful Bill. But we do believe there's other opportunities for those states to leverage federal funding, maybe in some other structures. There's work going on. We're talking with the state Medicaid directors and the governor's offices, but those are further down the road, nothing currently.

Okay. Some chatter about the Medicaid work requirements that are part of the One Big Beautiful Bill. I think that goes after more the expansion population. So maybe that's a limited impact on you guys, but just any -- what's your thought about that?

It is limited to the states that expanded Medicaid. However, we've had a little bit of experience Arkansas had previously put in work requirements as has Georgia. And we -- when those states did that, we did not see any real impact to Medicaid. And my suspicion is we won't see a material impact to Medicaid reimbursement as a result.

It's because those tend to be healthier people that aren't utilizing hospital services that much.

Yes. Okay. Divestitures have been an ongoing part of the story as well. You've recently announced three hospitals in Pennsylvania, [indiscernible] and one hospital in Tennessee to Vanderbilt. Do you want to provide -- if you don't mind some context around that and what's happening?

Sure. Happy to do that. So the Pennsylvania hospitals, total purchase price around $35 million, plus we'll give up some lease liabilities. So I think the actual valuation is closer to $50 million. And those are essentially breakeven from an EBITDA perspective. So high multiple, not really losing any EBITDA as a result. So that one was a deal that we had tried to get done last year, financing fell through by the buyer. This deal that we've recently signed still subject to financing. But this group does have another hospital in Sharon, Pennsylvania. They have operations. They own another hospital in Pennsylvania, and we're relatively confident that they'll be able to get this one across the finish line. Clarksville, a much bigger deal, $600 million for our 80% ownership being purchased by Vanderbilt. Vanderbilt is our joint venture partner so they already own the other 20%.

What is the EBITDA headwind from that one roughly?

Roughly, that one was, I believe, in the $60 million to $70 million range. But with it being a joint venture, we also had minority interest. So net-net, it's roughly -- or net of noncontrolling interest, it's in the range of 12x multiple.

And you did a transaction with LabCorp, maybe describe that as well?

Yes. We -- so we sold our outreach lab services, not a core component of our business to LabCorp. We'll be closing on that here in the fourth quarter, roughly $190 million purchase price for that lab business which will -- they'll take over, we'll be outsourcing then all the lab work to them.

Does that create an EBITDA headwind at all or?

Because it wasn't a stand-alone business and not core to our business, we really don't have an EBITDA kind of estimate. It was really more based on a volume play in revenue play, but it should not be a material EBITDA impact.

So your total proceeds from divestitures are going to end up being what, just under $1 billion or something?

Yes. So we also, in the fourth quarter, we collected roughly $90 million, which was a contingent purchase price from the sale of our Cleveland, Tennessee Hospital last year. That deal included this contingent purchase price adjustment after Tennessee's state-directed payment program got approved. So we collected that cash. So that's $90 million, about $190 million for LabCorp, $600 million for Clarksville and then, call it, $35 million for Pennsylvania. The Clarksville deal not likely to close until Q1. But here in the next short period of time, approaching $1 billion of incoming...

Yes. Pretax, there will be 15%, 20%, maybe in taxes.

Yes. That's right.

And you've done the refinancing, they got rid of your maturities, it went out to 2029. So what's the priority for the cash flow here?

I think the priority is still to delever the company. We have a couple of opportunities to take out some debt, potentially capture some discount. We also have some high coupon first lien debt out there that we have the ability to call and/or repurchase that would probably materially benefit our cash flow by taking down our interest. We have some [ 10 and 7/8 and 2 3/4 ] debt out there. So those are good opportunities potentially looking at some smaller pieces where we could reinvest but at this point, most likely, we'll focus on just debt paydown.

So when you look at where you're at leverage-wise, where are you at today? How does that step down, you think, over the next few years?

So we're currently exiting the second quarter, I believe we're a 6.7x levered. That's down. We started the year at 7.4x so made progress this year. These deals will take that down a little bit further, probably get us sub-6.5x. And our goal is still to get kind of mid 5x in the next few years. So continue to work our debt down ultimately much more balanced capital structure.

Right. What about other divestitures? So you had a formal program and now it's been more one-off. Are you still seeing inquiries come in? What's the thought on that?

We are still seeing some inquiries come in, a lot of inbound interest, interest on some assets that we have no interest in selling. But there's still interest at some pretty good multiples. And we'll continue to evaluate by the ones. We don't -- we aren't out there kind of marketing a group of assets currently. No other deals probably in the near-term horizon but we are continuing to kind of have some discussions around some of the inbound interest, and we'll see where that takes us. From time to time, the competitive environment, business environment, reimbursement environment, the market can change, and we want to be flexible and agile and be able to take advantage where we may see a less of an opportunity in a market today. And if selling it gives us an opportunity to reinvest in a market where we see greater opportunities, we want to be able to move our resources there.

That's great. Okay just one or two more. I just -- to make sure, does as anyone in the room want to ask a question? When you think about a long-term growth algorithm and how you build that up, what would be some of the -- not so much give guidance for '26, but thinking about more longer term. What are the building blocks in your mind on that?

As I think about kind of our long-term building blocks and really a growth algorithm and some of the things that -- as I moved into the CEO seat, focusing on really kind of quality physician and patient experience kind of building that reputation in our markets being the provider that is capturing more market share in our markets. And I think that market share is really one of the key building blocks of that growth algorithm as we go into the future.

When you think about volume growth, pricing, I mean a lot of people talk about a 2% to 3% volume, 2% to 3% pricing next year, you might have a little bit of a headwind from exchange volumes. But for you, like you said, you're less than average. I mean are those still sort of the dynamics for the industry long term, do you think?

I think long term, they are. We've seen a little bit of disruption over the past couple of years, kind of coming out of COVID, we had this real high inflation that I think muted some of the volume. And then we saw some pretty good recovery last year, a little bit of disruption. But I think when you look at long term, a 2% to 3% volume growth, 2% to 3% rate growth is a pretty good estimate of what we would expect.

And then when you think about where you're at margin wise, is the goal sort of maintain margin? Do you see an opportunity for improved margin from here? Where are we at on that?

I see a real opportunity for us to improve margin. But as we -- even with our existing margin, as we delever the company, we're in a position where we can begin to generate positive free cash flow with our existing margins in that interest expense goes down, and that really gives us an opportunity to start to grow with additional investments. But with the work that Jason was just talking about with our ERP, we think that, that is a big lever for us to begin to grow, grow margins, take out some more costs out of our systems. And then as we look to make investments in some higher acuity service lines, which also have a higher margin profile, we think that the overall consolidated margins can grow.

And in terms of -- some companies talk about outpatient surgery, other outpatient sort of broadening the catchment area, how much of a priority is that? Is there opportunity for that still?

There is opportunity for that, and it is a priority. We have roughly 50 surgery centers today. We're opening three surgery centers, just in the fourth quarter of this year. So we've kind of been quietly going about expanding that. I do think there's continued opportunity. It's a little different value proposition in our markets versus in urban market but there are still opportunities for us.

And then generally, you're in markets where you have a hospital presence where you're adding these?

Yes. Currently, we are keeping all those investments in markets where we have an acute care presence.

You said currently, is there any thought about moving outside of that?

Not right now.

Okay. All right. Just to -- maybe to wrap up here, any summary comment you'd like us to take away and think about Community?

Sure. I would just say that I think we've been continuing to make good progress, optimistic about our future and progress we can make a big turn this year getting to free cash flow positive, which we are this past quarter on a trailing 12 months basis. I believe we'll be there for the full year. And I looked at -- I believe that, that's something we can continue on into the future. And I think that's a big turning point for the company and look forward to continuing to deliver on results.

All right. Well, with that, we'll wrap up. Thanks so much to the management for Community Health, Kevin and Jason for participating. And thanks, everyone, for attending.

Great. Thank you, A.J.