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

Good morning, everyone. On behalf of Morgan Stanley, we're delighted to have Bill Rutherford, Executive Vice President and Chief Financial Officer, from HCA here along with Frank Morgan, Vice President and Investor Relations. Thank you all for coming. I'm going to read a brief research disclosure. For important disclosures, please see the Morgan Stanley research disclosure website at www.morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representative.

Well, guys, I'm just going to throw different categories, demand, labor, regulatory, et cetera. So let's talk about volumes. Obviously, the last couple of quarters, we've seen a return to more normalized volumes here. How much of that do you attribute to sort of pent-up demand from COVID versus, okay, you've been investing a great deal of capital into your facilities, particularly on the outpatient side? How do you think about that? And how do you see the trends continuing before? Are you still seeing pent-up demand.

Well, it's a great question. It's hard for us to really discern how much of kind of the volume, at least we saw in the first half of this year, was pent-up demand versus just a return to kind of normal activity. We see, I think, some positive macros. Obviously, we operate in great markets. Many of our markets have experienced probably outsized population growth. We're still seeing really strong economic indicators, full employment area. I think the exchange enrollment helped support that, and people returning to normal in a post-COVID environment. And so we've been very pleased with kind of the volume profile as we went through the first half of this year. And as we've said publicly, we think there's going to be a return to kind of normal seasonal patterns and normal volume on there. So my sense, it's more of those macros that are leading to it and the pent-up demand of care that was deferred. I think by now, most of it has probably worked its way back into the system. But I think people are just more comfortable and back active in their community, and that's yielding a certain demand that we're seeing.

Great. There's also been a real burst in your emergency room volume, particularly in the commercial payer side of the emergency room volume. What do you attribute that to? What are the factors you think about?

Yes. I mean when we look at fourth quarter emergency room volume in first quarter in particular, it definitely outpaced our expectations. And I'm not so sure if there was one thing that we would attribute that to. I mean, we were seeing 9% emergency volume in one period, almost 10% in another. I think that's settled back, and I think we'll return to normal. I think there are probably a host of factors. I think there was a heavy flu season towards the end of last year, maybe early part of this year that may have influenced that. And again, I think just more return back to activity that we were seeing. We're trying to hold on to those as much as we can, but I don't know if those will continue at those levels going forward. I think it will return to more of our historical patterns over time.

Great. Obviously, there's been a great deal in the press over the last 6 weeks about new variant of COVID. Have you started to see -- have you seen an increase in activity in ER visits as a result or ICU admissions? What have you seen in terms of any activity related...

I think it's fair to say we would see what is typically going on across the country. And it's going up a little bit. I haven't -- I can't give you specific numbers yet. When we report third quarter, we will. But I can tell you, it's nothing like that we saw during the COVID spikes that we saw in '21 and early '22. But sure, we would see what you would read about the typical kind of growth in COVID right now. We're seeing a little bit of it.

Got you. Let's maybe switch gears of labor. Obviously, it looks like the first half of the year, you did a really good job in terms of managing labor costs. Some other companies struggled with it, particularly on the nursing side. What are the key factors that have enabled you to really focus on those costs but also control the cost?

Yes. So as everyone knows, that was the #1 topic as we went through last year. And our labor costs really peaked at a high level. And first quarter of '22 really disrupted by the COVID surges, and we're really pleased with the progress we've made since that point in time. It was really generated by a high use of contract and premium labor. So our focus was to reduce the utilization of that premium labor. As the labor market tend to settle, we didn't have the disruption with COVID surges that benefited us. We were able to reduce not only our average hourly rate for contract labor, but we were able to reduce the number of hours. And we made investments into our employed workforce that helps stabilize that. We saw a turnover being reduced. We saw recruitment going up. And so that ended up stabilizing the labor cost, and we're pleased with that trend. We made investments into our employed workforce, but we were able to compensate or pay for those through the reduction of the premium labor. And that really carried us through the second half of '22 and into the first half of this year.

What are you seeing then in terms of wage increases? Let's say, here we are September '23 versus last year when you're thinking about and you're getting ready to go into the budget cycle in a month or two. What are you sort of seeing this year? And what do you think next year when you sort of think about wage increases overall in the work?

Yes. We're going through our planning cycle to kind of forecast that. We had to make and did make some outsized wage adjustments in the last half of last year to be responsive to the market. And I don't see us having to do that at the same level of last year. And I think, over time, wages should blend in that 3%, 3.5% range going forward. And I think if it's in that range, we can manage through that.

Okay. All right. You've also -- it seems you have went on the strategy of sort of let's build and buy our own nursing schools. Let's create our own labor force. Maybe you could just walk us through what the latest on that is. I know the Galen School of Nursing is a big emphasis. But how many -- ultimately, let's look out 3, 5 years, how many RNs do you think you're capable of turning out, out of these school?

Yes. I mean we were very fortunate to bring Galen College of Nursing in the fold early on before all this labor market disrupted, and you can hopefully see the strategic implications of that. We're one of the largest employer of nurses in the country. They're quickly becoming one of the largest educator of nurses in the country. And our goal is to have a Galen campus, a Galen College of Nursing in every 1 of HCA's market. Some of our big markets are made even more than 1. I think we're up to 14, 15 campuses right now, probably 13,000 students enrolled. We have plans by in the next couple of years to be up to 25 campuses and potentially even 30 campuses by the end of the decade. I don't know exactly what the enrollment will be at that point in time, but it could potentially reach 18,000, 20,000 enrollees by that time. And so as we can think about the integration of a school of nursing and a provider where the students can do the clinical rotations in our hospitals, where our existing faculty -- our existing nurses can service faculty at those schools. It's a nice strategic overlap. And hopefully, we'll be a major channel, not the major channel of our sourcing of nurses into the future.

So what's the capital investment? Let's just use that. You open a school in a market like Las Vegas or Austin, Texas or something like that. What's the capital investment to create the school and then roughly the annual operating cost that you might see?

Well, each one is a little different based on the size and there's some start-up costs. And we've been fortunate most of the campuses that we've opened up have really ramped up very, very quickly. We opened one up in Nashville. The start-up costs, I'd say, in the backdrop of HCA is fairly nominal per campus. Many times it's leased space, and we have to do some build-outs and then you do some start-up with marketing enrollment and so forth. So we can open those campuses at a fairly efficient level. Yes, there's some incremental costs, but it's not material on a per campus level. And then hopefully, we're opening them up in these markets where they're ramping very, very quickly. And so it doesn't create that much of a burden. And those campuses become productive relatively quickly.

Last quarter on the call, you highlighted the fact that you're starting to see some increases in hospital-based physician costs, like anesthesiologists, emergency room physicians, hospitalists, et cetera. Can you give us an update on that? And what do you think is driving that? Because obviously, some of the companies who provide that have struggled, but what's sort of driving that? And what sort of increases are you seeing?

Yes. Well, I think that area is going through a lot of disruption. I mean, obviously, you're seeing that with companies that have rolled up these providers having trouble. And as a hospital system, we have to have the provision of those emergency room doctors and anesthesiologists. And we often find ourselves having to land those programs in when they're in somewhat of a distress and/or were having to respond to request for increased subsidies to try to help stabilize those programs. So there's pressure in that area, as we've talked about publicly. We're having to respond to that, and we think we can respond to it over time. And it's hard to call exactly where we are in those cycle, but we've had many instances where programs have kind of said, we're no longer in it, and you've got -- we have to take it over. And I think there are some factors that are influenced in it. I mean, they had revenue pressure because many of them couldn't get in network with some of the payers. They had their own wage pressures that they're experiencing with the labor market. I think many of them had some private equity participation, and they didn't have the balance sheets to navigate through these cycles. And we're having to land those very quickly in period of time of distress because we have to have those provisions of services. So we're doing our best to manage through it, and I think we'll need a little bit more time to call to see what the long-term impact of that will be.

Okay. Let me switch gears a little bit. Let's talk about some of the recent partnerships and investment in technology, Augmedix, Google. Maybe you could give the audience just an overview of what those relationships are, what it means to you, what you're hoping to accomplish by these partnerships with each of those companies.

Well, we think there's a tremendous opportunity to continue to differentiate HCA through the investment in technology and innovation. And clearly, there's a lot of opportunities we believe within health care. So we entered into a large strategic relationship with Google last year to take advantage of their capabilities and engineering resources in our health care setting. And we have multiple kind of initiatives underway. We have an initiative we call it Care Transformation initiative led by a physician, Dr. Michael Schlosser, where we're looking at what can we take and how can we use technology to improve routines that go on inside the walls of the hospital or inside the room. So we have claims around scheduling, how can we predict volume and acuity of patients better and then how can we schedule our own staff better, satisfier to our staff, better scheduling, better outcomes for the patient. We have an investment, you mentioned Augmedix, which is really ambient listening and how can we improve documentation through listening and through documenting interactions between caregivers and patients into the record. And as you get better and more complete documentation, then you can provide better next-decision points on there. So we have a host of initiatives and commitments that we're making in this technology, innovation, trying to use large language models. We are undertaking an effort to replace our core clinical systems as well and move much of our data structure into the cloud, which will facilitate it. So it's a major initiative that the company is committed to in the next couple of years that we think has tremendous value to improve the experience of our nurses to be more attractive to our caregivers to provide a better experience to our patients.

So I know that Sam Hazen, the CEO, was an early adopter of using ChatGPT. So what do you see in terms of the impact potentially that AI could have on your business?

I think it's tremendous. And I think it's even too early to even visualize all of those. We have multiple initiatives in these large language models. I'd tell you right now, we're focused more on the administrative aspects to make sure we learn and can understand the capability that eventually will move into the clinical aspects. And the administrative aspects, really around how the claims get paid and adjudicated, especially when you think about this process of reviewing medical necessity and denials where, historically, you'd have a nurse or a human go through the record and go through clinical documentation and justification. Now we can put large language models over here and help document the medical necessity in these cases and really become a lot more production oriented in that effort. So obviously, I think sitting here today at this stage, it's almost unlimited what the potential would be, but we have a number of use cases that we're applying through the organization to, I think, bring better value.

Okay. I want to try a little bit just now about what's happening in the regulatory environment and maybe in particular, focus on that terminology of site-neutral payment. There seems to be some renewed focus and congress on site-neutral payment programs. There's a bill in the House on Ways and Means Committee looking at site neutral. I think one of the Senate committees as well is looking at it. What's the latest? And it seems to be focused on drug administration and prescription of drugs. What can you tell us about that? And where does that...

Well, I may ask Frank to add in here in a minute because he's staying close to the regulatory piece. I think it's evolving. And from what I understand now, it's mostly tied to Medicare outpatient drug administration. If that's the case, that's -- I don't think we'll have a material impact on us. But as it moves in and maybe -- if it moves into hospital-based outpatient reimbursement, it could. But those would be big moves, and I think there's enough policy process that you would have to go through and enough impacted. There'll be a lot more conversation before anything, I think material could implement. And Frank, I know if you're staying close to that.

Yes. And I think -- I mean probably the bigger concern away from this bill specifically is this is the first step in a slippery slope. And I think when we talk about it, we talk with our government affairs people. We believe that any incremental movement would require additional legislation. So it would be a very difficult process along the way. So I don't think it's anything that's going to move from one extreme to the other very quickly. I think if anything happens, it seems like it will be more in this drug administration area for now.

Focus on the outpatient.

Yes.

Yes. And very specific...

And focus on Medicare outpatient, which wouldn't be material for us. And there's been -- over the years, this isn't new. There's been topics around site neutrality before. And when you get into the detail of how to administer that, it can be very difficult and be somewhat impactful. So that generally elongates how much policy changes could occur, how quickly, right?

Maybe you could also just discuss the Medicaid supplemental payment programs. In particular, there's a couple of states, Florida being one, where there's some debate going on about the supplemental payment program there. What's the latest? What are you hearing?

Each state has its nuances regarding the supplemental payment programs that are really unique to the dynamics of that state. Florida is waiting for CMS approval for their DPP, their Directed Payment Program. And so the timing of when that occurs is unclear. There's a lot of dynamics between the CMS in the States. I think last year, the approval came in, in the third quarter. The previous year, it came in, in the fourth. So we think eventually that program will go forward, and we'll get approved. But it's unclear exactly when the timing of that will occur. And again, each state has its own nuances. Texas has historically been our large supplemental payment program. Well, we have programs now in Georgia. There's one being contemplated in North Carolina. There's one contemplated in Nevada that probably is a next year event. So we try to stay very close to those. But each one unfolds at a little bit pace and timing on that.

Let's talk about the relationships with some of the key payers out there. Where do you stand here in mid-September in terms of having contracts locked in with the major payers? Anyone that's a holdout that you're concerned about?

Over the years, we really value our strategic relationships with major payers. We've tried to evolve that relationship to be much more of a contract transactional to more of a strategic opportunity. And so we're pleased with the progress and the relationship we have with our major payers. And I think that shows itself in the pacing by which we're able to secure contracting. I think we're 70% contracted for next year at reasonable rates, and I think we're probably 30%, 40% per year after that. So to me, that gives an indication that we're able to secure our contracts at reasonable rates and pacing. I mean, obviously, when you go into the negotiation table, there's always a discussion. We come to the table, why we should be paying more. They come and pay less. But we tend to find common ground on that. So again, I think we're pleased with mostly the relationships with -- that we have with our major payers and able to secure contracts at an appropriate level.

Okay. So I know you're just beginning the budget cycle, as we discussed earlier. So maybe you could just walk us through your latest thinking on capital allocation between existing facilities, new facilities, outpatient versus inpatient. It's a multibillion dollar budget. Maybe you could just walk us through.

Yes. I mean our capital allocation philosophy of HCA is such a tremendous value add for us over the years. Unfortunately, we're blessed. We have a lot of resources to be able to think about investing. Our first priority is to invest capital into our existing markets to meet what we view as growing demand for health care in our markets. And so we first sized what is the right capital investment for us, and you've seen us grow that. And that is an indication of the opportunities we see to put capital in the market to meet growth opportunity. Let me come back and talk about that for a minute about how do we allocate capital. Our second one is to maintain the balance sheet in a really strong position. So we can be opportunistic as either strategic M&As, opportunities showed itself. And our balance sheet, our leverage is at the low end of our historical ratio. We think it's in a very good level. Historically, we paid a relatively small dividend. And then historically, the balance of our free cash flow has been dedicated to a share repurchase program. In some years, like in '21 and '22, we had an enhanced program. So it's a pretty balanced allocation of capital that I think helps drive long-term value to a lot of our constituencies. And our capital deployment, I think roughly 40% to 50% of our capital is routine maintenance, replacement, but 50% to 60% is growth capital. And then the growth capital, think about 3 kind of domains. One is adding inpatient capacity. And we have to add inpatient capacity, so we have the bed capacity to meet growing demand. We're running at sometimes some of the highest occupancies we've had in the low 70s. So we have to put inpatient capacity on the ground in order to meet what we see as continued strong inpatient demand in our market. So that consumes a lot of our dollars of capital. It may be new hospitals. It may be expansions of wings or building on to our existing campuses. The second domain is in our outpatient or network development. I think freestanding EDs, ambulatory surgery centers, urgent care, really building out the network. There's a lot of that activity. I think we have 50 to 60 freestanding EDs in our currently approved pipeline. So there's a lot of activity. It doesn't consume as much dollars because the investments are lower, but a lot of activity in the outpatient network development. And the third area, I just classify as more program development. And it may be expanding surgical suites and maybe a robotics program and maybe expanding a cardiology program where it's very targeted to certain programs by market on there. And again, we see that opportunity growing to meet what we see as growing demand as it help facilitate, over time, our ability to grow market share.

Going back to the question, the bucket that's allocated to M&A. I assume there's still a robust pipeline you're seeing on the not-for-profit side. Where does that stand here? I know coming out of COVID, there was some view that maybe there would be that opportunity.

Yes. It ebbs and flows, as you might imagine. There are a lot of dynamics when it comes in to the hospital M&A. I mean, we have to pay attention to the FTC and their activity in looking at those. We see from time to time opportunities to smaller M&A in existing markets. We may have 1 or 2 kind of hospitals at any one time that we're rounding out an existing network. But when you think about the large-scale hospital M&A, it would largely be new market opportunities for us in and of a profit. And those are difficult transactions to progress, they take time. Generally, there has to be a reason for those systems to sell us. So those conversations ebb and flow, and we'll just have to see where that plays out. In the meantime, we see opportunities in the M&A for network development, mostly around the outpatient side. You've seen us do urgent care. You've seen us do some freestanding EDs, some ambulatory surgery. So I'd say it's more smaller complementary than these larger acquisitions. And so that gives us the opportunity to deploy capital through our existing programs in our existing markets. We can invest a couple of billion dollars maybe in DFW to be productive over time as maybe putting that kind of money in a new market.

I think what I'll do is we're still open it up to the audience. If there are questions that's -- in the back there. There's a microphone coming your way.

Bill, those labor -- amongst the sell side, there seems to be a debate about how to model the second half seasonality of your business on both the revenue side and the EBITDA side. Can you just offer some perspective in terms of how you want us to think about modeling seasonality for the back half of the year?

Well, I think what we said historically that we believe recently is that we think volume patterns will returned to normal seasonal patterns. Obviously, '21, '22, we had COVID disruption. It was hard to call. '23, we haven't had the COVID disruption. So all of our beliefs is we'll return to normal seasonal volume patterns where ebb and flows as you go through the calendar on there. And we'll need time to see how that plays out, but that's our fundamental belief. Right now, absent anything different that those volume patterns should trade what they would have historically done pre-COVID. If you go back to '17, '18, '19, we think that we'll return mostly to those type of trends.

And those would be essentially, correct me if I'm wrong, Q4 and Q1 being the strongest in terms of volume and the summer being sort of the...

I think that's right. Yes, that is right.

Other questions?

What trends are you seeing on the procurement side of the business, particularly for equipment on the logistics side of the business?

It's improving. If you talk about procurement on equipment or supplies, we are very pleased with the team's efforts around our supply chain processes during COVID. We are fortunate. During COVID, we were able to extend many of our contracting. So we had some firm pricing in -- when we were in these peak inflationary periods. And so now that those contracts are coming up, we don't see the inflation levels quite the levels that they were. And so we're seeing a little bit of increase, but we're managing through that at very decent levels. And we think we can manage that through what's embedded in our guidance, and we're seeing our teams procure new contracts at reasonable rates. The other factor we had to deal with, probably COVID, which is more of logistics, the time to order, whether it be even in our construction, the supply chain disruption and how quickly could you get equipment to be able to open up a new project. And a lot of times, we had to buy ahead in order to compensate for those supply chain challenges just in terms of timing and delivery. And we're seeing that -- we're not out of the woods on that, but we're seeing that improve. So again, I hope that eventually returns to some level or normal level.

All right. Well, thank you all very much.

Yes. Thank you, James. Thank you, everyone.

Take care.

Bye.