HCA Healthcare, Inc. (HCA) Earnings Call Transcript & Summary

I'm Ben Hendrix, health care services and managed care analyst here at RBC Capital Markets. With me here this morning is -- sorry, Bill.

That's all right.

Wrong page. Bill Rutherford, Executive Vice President and CFO of HCA Healthcare, leading publicly traded hospital operator with 182 acute care facilities, 124 freestanding surgery centers and extensive network of outpatient and ancillary services across 20 states. With that, thank you for being with us.

Great. Good to be with you. And Frank Morgan is here.

Frank Morgan is here.

Yes.

The industry is in a difficult transition here. COVID surge, hospitalizations have declined significantly. COVID support payments are waning and will soon be exhausted. And at the same time, the industry faces labor challenges as we saw in your first quarter results. When you assess the near- and long-term outlook from either the top line or the cost side, which gives you more concern and what gives you most hope for opportunities in the future?

Well, it's great. Really, if I step back a little bit and look more at the macros, and if you look at historically at HCA and kind of our thesis is that we still believe there's growing demand for health care in this country. We operate what we think are some of the most economically attractive and vibrant markets. So we continue to see great demand in the markets that we operate in. And we're positioned very well to capture that. So clearly, the whole marketplace has been disrupted with COVID. And if you look at a 10- or 20-year period of time before COVID, we delivered really strong and consistent performance, and we believe we performed extremely well during the COVID period of time. Clearly, because of COVID, there have been some market disruptions in the labor market, and we're having to manage through that. And we have confidence that we can continue to manage through that. And we believe that we can avoid future COVID surges that labor market will begin to settle. I think we started to see labor pressures and third quarter last year, largely due to the Delta variant and really peaked with the Omicron variant in January, where we had to utilize a higher level of premium labor to meet the demand that showed up at our hospitals. We have a fundamental obligation to make sure we have clinical staff to serve that. And that did come with a higher cost, and we're having to manage our way through that going forward. We believe, as we go through the year, we'll see sequential improvement, both in utilization of that premium labor and the cost curve and we'll go through that. And unfortunately, we had to adjust our guidance as a result of what we were seeing in that, but we still believe we're going to deliver really solid results for the year.

Yes. And you noted that labor was 2/3 of your 5% to 6% EBITDA guide down for the year and lower acuity COVID volume accounting for the balance. The most common question we get around the guide-down is, is it enough? And can you discuss the inputs to the outlook revision and what gives you confidence at this level?

Well, we believe it's appropriate based on our read of the marketplace at that point in time. It is labor-driven. And no secret, we're seeing inflationary pressures coupled with the premium labor, and we factored that into our guidance. When we -- if you look historically, we would manage our overall cost per FTE in the 2% to 2.5% range. When we did our original planning, we expected it to go up 1 point, 1.5 points to probably 3.5%. We believe now it may be even 1 point higher in there. And so that's what we've built into our guidance, that 2/3 that you mentioned of our revision was mainly because we anticipate our overall labor cost to run a little higher than even we originally anticipated. And some of the benefits or the decline of the premium labor will be slower to moderate. So we think that we have that appropriately considered in the guidance, and we'll just have to see how the rest of the year unfolds.

There seems to be a lot of investor focus on your margin profile, focus on where margins are, where they're going, what's sustainable on a normalized level. So when you evaluate the hospitals in your enterprise, where do you focus your efforts? Is it margin or actual EBITDA growth or a mixture of both?

We're focused on absolute EBITDA growth, but we -- margin is a factor of that. If you look, again, I think pre-COVID for, pick your time period, 5-, 10-year period, I think HCA has demonstrated a really strong track record of delivering strong margins. You'd see 18% to 20%, historically even higher in there. We were benefited during COVID with margins due to favorable payer mix and favorable acuity. And if you look at even in the first quarter, I think we did close to 20% margin. If you adjust, we're still in a 19% margin level. Guidance suggests somewhere in that range. So I still think that's industry-leading margins there. We're focused on doing everything reasonable and appropriate to operate the company as efficiently as possible. There's a lot of things that go into margins: overall volume, acuity, payer mix and clearly, cost structure. So a lot of variables in there. And we still believe we can continue to deliver reasonable margins going forward. But at the end of the day, we're still focused on delivering absolute EBITDA growth, and that's what we're focused on.

So Omicron clearly set up a noisy first quarter. Can you recap the COVID and non-COVID utilization specifically that you saw in the first quarter and how utilization has trended since? Anything in the first quarter that might be encouraging?

Well, clearly, first quarter was influenced by the Omicron surge. And as we said publicly, about 10% of our admissions in the quarter were due to COVID. And we've been through those cycles, right? You saw the Delta surge in third quarter of last year, you saw the Omicron surge. And we're no longer in a surge. We're running 10% of the COVID levels we did then now. So hopefully, we'll avoid future surges, but we're prepared to manage through those as we can. We were by the non-COVID volume we saw in the quarter. I think our overall non-COVID volume grew about 2% for the quarter. But when we look at just February and March, and I think we said this publicly, we saw 4% to 5% growth on there. And we have this fundamental belief that when COVID settles and becomes maybe part of just normal routine, we'll return back to historical volume trends, which for HCA would hover in that 2% to 3% range, demographic growth, economic indicators and aging of the population live. And there may be a transition period as we go through post-COVID. But again, we were encouraged with the non-COVID volume we saw towards the end of the second quarter. We'll need a few more periods to see it does that settle out. But we think over time, we'll return to those historical volume trends for the non-COVID piece.

Switching to mix. Medicare census still doesn't seem to have fully recovered to pre-COVID levels. Is there anything that you saw in 1Q that's encouraging about the return of Medicare, particularly?

Well, obviously, the Medicare volume was depressed, and we saw a negative Medicare volume during COVID. That was a population that stayed away from a health care setting, I think, for obvious reasons. We believe when COVID surge is settle, we'll see Medicare population returning. And we did see that in the first quarter. I think our non-COVID Medicare grew about 2% in the first quarter. Our non-COVID commercial grew close to 3%. So both of those are really positive indicators for us. It would be our expectation that Medicare growth returns to its historical trends when we avoid these peaks and valleys of COVID, and we'll just have to see exactly when does that show up. But again, I think what we saw in the quarter and towards the end of the first quarter were encouraging for us on that front.

Is there a margin impact that you anticipate from Medicare recovery? Or are you just not worried about it because, as you mentioned, you're just focused on...

I mean there could be a margin impact as you see the mix change or as you see lower acuity, but at the end of the day, it's still positive for us. I mean the incremental Medicare patient will be positive for us, will be productive for us. So as long as it doesn't impact other aspects as a business, we still believe that will deliver an absolute growth that will be productive for the company.

And you guys saw really strong growth in Texas and Florida in the exchange volume. Is that providing a nice offset?

Yes. I mean, part of the commercial trends that we've been reporting recently is a function of the exchange volume. And generally, when the exchange enrollment -- our exchange volume correlates really strongly with the exchange enrollment on there. So we saw a really strong enrollment in '21, and that correlated to really strong exchange volume in '21 and even in the first quarter for us. And given Texas and Florida is 50% of the company, it was equally strong in those 2 markets.

And given that a lot of that growth was SEP-driven, it was enhanced subsidy-driven, do you see a sustainability cliff there with that?

Well, we'll have to see. I know there are questions that health exchange subsidies go away at the end of this year, what will that do to the enrollment. And we'll have to factor that into our analysis for '23. So our belief there's a lot of effort to support people gaining coverage in the exchanges. And so there will be support mechanisms continuing for that. I don't know exactly how that will play out as we conclude the year here and look at '23. I don't think it's a near-term issue for us, but we'll pay attention to that going forward. But we're encouraged by efforts afoot to help people continue and gain coverage in the exchanges.

Given that you operate in 2 very large non-Medicaid expansion states, how are you positioned for redeterminations coming back?

That's almost the same thing. We understand that Medicare redeterminations may impact people's access to Medicaid coverage. But it's also our view that to the extent people get disenrolled for Medicaid that they'll have the opportunity to get coverage in the health insurance exchanges. And so net-net, we'll have to see how that plays out. We understand states may take different approaches and different timing of when that will play out. But if some of that population can find coverage and exchanges, if they get displaced from Medicaid, we'll be able to manage our way through them.

I want to go back just briefly to kind of the labor environment and then kind of maybe some of the indirect costs that it's been driving. You've noticed on a couple of calls, throughput headwinds, inability to discharge downstream. Are you seeing any encouraging signs with that? Is that going to be a lagging recovery? Or how do you think about that?

Well, part of our response to the labor challenges is make sure that we manage capacity as efficiently as we can. And managing that capacity is -- part of that is managing the length of stay and appropriately have an appropriate discharge planning efforts in place. And again, I think it's not a secret. Sometimes you have trouble discharging patients to post-acute settings just due to their own access problems and capacity. So we're working very diligently to make sure we have access to skilled nursing beds, inpatient rehabilitation beds and the like. And we're putting a lot of technologies and a lot of organizational structure around what we call our case management efforts so that we can efficiently process patients through the system and when they're ready to go to -- for their next setting of care that we can appropriately hopefully do that. During COVID surges, that becomes pressure, right? Because you have all of this volume. You're trying to keep create capacity to serve the next patient on there. And sometimes, the market capacity for these post-acute beds is pressured. So we're having to manage through that. And we're making strides on that. We've actually got an organizational structure afoot. We're putting technology in place. We're creating our network -- clinical network affiliations with these post-acute providers. So I think we'll make incremental improvements in that.

And then getting back to nursing and all those efforts that you've made for near term, intermediate term and long term, can you kind of run us through how those are progressing and how you're doing in terms of nurse utilization?

Yes. I mean obviously, the nursing market and labor market more general was disrupted. We attribute most of that to the COVID surges. And it was highlighted in our first quarter results. And what you had going on, in summary, is because of the COVID surges, we had to have nurses to serve our patients. It's our fundamental obligation. And because of that, the nursing agencies, we had to pay a premium for those dollars. Because of that premium, we had nurses leaving their base hospital, and that increased our turnover and actually increased our utilization of them. So now that we're no longer in a surge that what we're trying to do is can we lower the cost of that premium labor because the supply and demand dynamics have changed. Can we improve our retention that will allow us to utilize less premium labor, and we're turning that cycle on there? And we think as we go through these contracting cycles. We'll see lowering of the average hourly rate that we have to pay for those premium labor. We'll improve retention, and that will reduce the amount of hours that we have to use for premium labor. And it will take some time for that to settle out, but all of our assumptions and our guidance are built on sequential improvement from what we saw in the first quarter.

How about changes that you've implemented to nursing utilization models and patient utilization models?

Yes. So our response really has kind of 4 strategies, increase our recruitment effort. We've really invested in recruitment. Increase our retention efforts, we're doing a lot of things to ensure we retain nurses that we do have. We talked about capacity management. And then to your question, the other one is around we kind of call it care model redesign or care transformation. So we have an effort to try to look at how the clinical teams operate, and can we supplement the clinical teams with patient care techs, for example, or patient safety attendants or even paramedics in the emergency room so that we can take some of the work effort off the nurses, allow nurses to operate at the top of their skill set and their license. And we can supplement the care teams with these other skill sets. And we're having really good success in doing that as part of the overall response to the labor environment. In addition, we're trying to bring technology to the table where we can help nurses schedule better, where we can forecast the acuity on a floor, and then we can staff as efficiently as we can. We can supplement that care team with the right array of skill sets. So all of those are just part of the overall response and I think will allow us, I think, to make sequential improvement going forward.

Over the last several months, we've just talked ad nauseam about nursing. You've also called out operating costs around hospital-based physicians. Can you elaborate on that? And kind of what the issue is there and your strategy to offset those costs?

Well, as part of our factor is, if you look at the other operating cost line for us and other, a portion of that is the amount we spend for physician support coverage, mainly around hospital-based physicians. I think emergency room doctors, anesthesiologists, radiologists, and the like, heavy labor force, right? And you can imagine their experience is some of the labor pressures everybody is feeling, and they will often come back to their host hospitals for consideration of that. And so we have seen and we begin to anticipate some increased pressure on that physician support costs in those areas. We try to work through our partnership with those different firms and different professional service arrangements, and we'll manage through that. Again, I think on the overall cost structure of HCA, we'll be able to manage through, but that's an area just like energy procurement that is facing equally pressure in the inflationary environment we find ourselves in. But again, we're able to manage through that with our scope and scale, our programs that we can advance. So that is one area that we're -- pay attention to.

So when we think about offsets on the reimbursement side, groups like the AHA have voiced frustration over the 2023 IPPS proposed rule, given the inflationary environment. Can you give us your view on the 3.1% MBU and how it was calculated? And any thoughts on that?

I don't know about how it's calculated. I mean, our historical Medicare update is 2%. And clearly, that's not keeping pace with inflationary on there. And yes, with voiced frustration, we'd love it to keep pace with inflationary, but we know their indicators sometime lag before we see it in the inpatient side. And we hope over time, they'll -- those -- the inflationary environment will show up in their rate increases that they provide on. So we would share that concern. I'm not necessarily surprised by it. It was based on historical trends. So we're hoping over time that either, one, the inflationary pressures will ease; but number two, that, that will eventually factor into to Medicare rate updates.

Is CMS slow walking this update?

I don't know. I don't have the insight to be able to appropriately comment on that. But -- so I don't know.

Got you. With regard to the commercial reimbursement, how receptive are MCOs to conversations about these inflationary costs and whether...

Well, the good news is we have great relationships with our major payers. We have long-term relationships with them. But as we've talked publicly, we're mostly contracted for this year. We're probably 50% contracted for next year. And as you might imagine, when we go into those contract negotiations, we're obviously bringing the current cost environment. We're having and requesting consideration for that in those discussions. And we'll go through conversations with the payers during the course of those negotiations. And I think there's acknowledgment about the cost environment that everybody finds themselves in, and we want some consideration of that in our contracts. And we'll work our way through that over the next period of time.

So with big market share in your core markets, can you spend a minute or 2 talking about the competitive backdrop, what's happening in your competition? How have they responded to the loss of COVID support and the payments and labor pressure?

Well, it's interesting. I think we'll need a little more time to see how the competitive landscape settles out. During COVID periods of '20 and '21, we actually picked up share during that period of time. So that was encouraging for us. We believe, and we're still very well positioned in all of our markets. We're investing heavily from capital. We're investing heavily from a program standpoint or investing heavily with our physician partnerships and relationships. So I think that will serve us well. And I think each market is a little bit different. We generally compete with well-run, large not-for-profit systems. And they've been operating during this COVID period of time similarly to how we've been operating. They did have the benefit of some government funding. But we're beginning to read some of the financial pressures that we're seeing or flowing through into their operations and so forth. So I don't know yet how that will change their posture or their positioning or some of the competitive initiatives they have. But we still are very positive in our position and believe kind of our approach to building these wide networks, expanding our networks through access points and through ambulatory care settings is the right strategy and hopefully will allow us to continue to grow going forward.

You, like your competitors, have not really scaled back any CapEx. And as you mentioned Economist, what kind of -- is there any consideration over the continuation is difficult labor backdrop that are you going to be able to staff these new programs, these new outpatient access?

No, it's a great question. So you're right. What we're seeing today doesn't change our long-term outlook, right? The long-term belief that there's growing demand for health care in our markets, and we're positioned very well to serve that demand. We'll go through some cyclical pressures. It doesn't change that overall thesis that we have. And it's our ability -- or our ability or willingness to invest into that model on there. And so we -- our capital program -- generally, our long-term capital says we have to bring capacity in the market to me, what we see is this growing demand for health care. So that has not changed. Yes, we have some short-term challenges that we'll have to manage through to make sure we have the labor to staff, the new capacity that comes online. But none of that has yet altered our capital planning. We are starting to see some inflationary cost of construction show itself. So having to manage a little bit, but we still anticipate devoting $4 billion to $4.2 billion of capital to our internal capital program this year.

And then on the flip side of that, given the pressures that not-for-profits have seen during COVID and through the recovery, could we see accelerated M&A?

We could. Again, we'll need some time to settle that out. Our experience indicates that in times of market disruption, that generally creates some opportunities for us. Our balance sheet is very well positioned, and we can pursue those if they present themselves. I believe early on, the M&A will be more in the outpatient setting as we have the ability to round out our networks, whether it be through ambulatory surgery sites. We've seen M&A in urgent care for us. You saw us do M&A with home health acquisition last year. So I think we'll begin to see some M&A or continue to see M&A in our network development side. We may have an opportunity to round out some hospital -- some of our existing markets with hospitals around there. And then our other M&A is, will there be an opportunity for us to move into new markets. Those are generally longer-term transactions for us and bigger transactions. And we'll just have to see how that plays out over the coming period of time.

Do you have a pipeline of new markets that you're considering?

We always have discussions, and we always have markets that we'd love to be in. But we generally then if you think about it, those are larger not-for-profit regional systems. And there generally has to be a compelling reason for them to enter into some discussions with us. But there's always prospects that we're working.

How much of that $4.2 billion would you say is going towards higher-acuity capabilities and specifically in the inpatient setting versus these outpatient?

So the way I would break it down that $4.2 billion is between retain and growth. And probably 50% to 60% of that is in growth capital. In that growth capital bucket, there's 3 really channels. Inpatient capacity consumes a lot of that as we're building -- you may have heard, we've got 8 new hospitals that we've announced between Texas and Florida. We have new inpatient capacity. And so that's bringing in new inpatient beds to meet this growing demand. And that consumes a lot of the dollars in the growth because those are high-capital projects. The second area is around network development and maybe urgent care, maybe surgery centers, maybe freestanding EDs. There's a lot of activity in that space. But fortunately, it doesn't consume that much dollars in terms of the per unit cost. And then the third area, maybe to your question, is around program investments where, as you know, our focus is developing deep clinical capabilities and programs, maybe advancing surgical suites, maybe advancing procedural rooms for cardiology, maybe expanding our neonatal intensive care units. So there is -- a reasonable portion of that is around program and clinical development, some of that development to robotic activity as well. So I can't quote you a number, but probably at least 20% to 30% of that growth capital is being developed to deepening our program capability.

And then the last just a couple of seconds here. We saw the adverse market reaction to your guide-down. Just kind of what's the one liner? Would the market get wrong?

Well, no comment. We understand the market. We surprised the market with the guide-down on there. But we have confident we can manage through the market that we find ourselves in. We've proven that to ourselves over time. I think COVID was a great example of that. I can't comment whether that was an overreaction or not. But again, we believe our guidance is appropriate, and we're focused on delivering value for all of our stakeholders for the long term.

Great. Thanks a lot for being here.

Thank you. Appreciate it.