Tenet Healthcare Corporation (THC) Earnings Call Transcript & Summary

I want to thank everyone for joining us today. It's my pleasure to be introducing Tenet Healthcare. Tenet is one of the largest providers of hospital services but also a large provider of ambulatory surgery center services in the country. Presenting today, we have Saum Sutaria, who's the CEO; Dan Cancelmi, who's the CFO; as well as Will McDowell from Investor Relations. Before we jump into Q&A, Dan, I think it might be best for some forward-looking statements.

Yes, we'll be making forward-looking statements this morning. So I just encourage you to look at our cautionary statements that we always provide in our earnings presentation. The most recent one was our earnings call from a few weeks ago. I'm also really pleased to announce to you, Will McDowell joined us about a month ago. We're really pleased to have Will on board. Most of you know Will, he spent many years running IR for Cigna, and we're thrilled to death to have him on board. Welcome.

Thanks, Dan. Thank you.

Welcome.

All right. Great. So maybe the place to start for this is the Q1 because you guys were the first to report. Your quarter was good. You had some onetime items, but you had a strong quarter even excluding the onetime items. And everything seemed good. It seems like you're putting some conservatism into the guidance for the year and then everyone else reported. And we saw a burgeoning labor cost problem kind of hit the industry, and many companies that have taken down guidance or hinting they might later on. So all of a sudden, it looked like a really conservative Q1 for you. People starting to wonder, do you need it? Or do you not need it? So I don't know how do you frame kind of how the quarter was and how you're thinking about the guidance for the year [indiscernible]

Well, let me put this in context a little bit. I mean I think our view is that the labor challenges are not really burgeoning. I think we've sort of approached this over the last almost 5 quarters or more during the pandemic, but our ability to manage labor, productivity, length of stay, appropriate utilization of our capacity given the revenue that's available out there is something that we have been committed to throughout the year. And we maybe have taken an approach that balance those items in a way that helped us manage our earnings through the last year, 1.5 years. And I think the first quarter was no different than that. I mean we rely very much on our judgment of our markets positions, the learnings from the prior COVID spikes and what they mean in terms of the timing of return of volume and our analytics around labor costs, in particular, using contract labor costs as a bellwether for how we think about total labor cost, and we manage capacity that way. It's what we did during the first quarter and it worked. So we feel good about the start to the year. We're glad that the COVID spike has -- from January has diminished significantly. And we've turned our attention back to growing the business in the same recovery mode from COVID we've been before. Probably the most important thing to note in all of that, including in Q1, is that just remember, half of our business between USPI and Conifer is largely insulated from the labor challenges that we are talking about right now that affect the hospitals. I think when you talk about the turbulence over the last few weeks in the sector, it's my perspective that, that gets forgotten a little bit, which is if you look at our needs for that type of contract labor on a short-term basis or even a multi-month basis, in particular, in our large USPI segment, as we continue to acquire and integrate facilities, it's de minimis. And so we're very bullish about the recovery that will occur there, plus starting to see some top line growth in our Conifer business. So again, half the business is insulated here.

And one data point to reinforce the point about the contract labor being substantially lower in the surgery center business. USPI's contract labor costs are typically less than 10% of the same type of spend that you see in our acute care setting. So substantially lower than what we see in our hospitals.

So I guess to maybe pull that apart a little bit. So are you saying that on the hospital side of the business that maybe there's a little bit of change in -- or not change, but difference in how you run the hospital business that you're much more willing to aggressively pull back on service lines that the staffing costs don't make sense? And then when things get better, grow them again, is it...

Our point of view has been very simple, which is that the marginal cost of labor, in particular, when you think about the contract labor costs, which got very high through the COVID spikes and frankly, are still high relative to prepandemic are not really marginal costs. They spill into the total labor cost of your hospital. They spill in other ways, they spill through shift bonuses over time, other things when you create a disparity. So you have to think about the total cost of labor when you decide what capacity you're going to open up and you have to think about the revenue that's available based upon the demand you see in the market post a COVID spike. There is a recovery phase for hospitals in terms of people's willingness to come back to the hospital. It's worse in markets that lock down more tightly than markets that don't, I mean, from a government standpoint. And so you just have to understand what that recovery curve looks like. It's longer in some markets than others. And we've kind of built a pattern based upon the first 4 or 5 COVID spikes that seem to make sense, and this one is following a similar trajectory. So that's what we're managing to. We're managing to the recovery plan that we've used in the prior 4 to 5 COVID spikes that worked pretty well for us.

Okay. And then maybe just to kind of go back to the other part of the question, which is kind of how the Q1 performance goes and your guidance goes? You kind of -- at the end of the day, say, "Hey, we'll provide an update of Q2," which, again, at the time seemed like a conservative way to think about it. But now in retrospect, do you feel like labor, to your point, is the same it has been in the last 5 quarters? Or do you believe that it actually has gotten -- the market is actually worse and is more of a potential headwind than it was, and therefore, there is a little bit more caution on the guidance?

Yes. I mean, look, what I said at the time was that what concerned us that we saw emergence of new variants in particular, on the eastern -- in the eastern half of the United States. And we sat here roughly a year ago at the time that we had our earnings call after the January spike of 2021. And we all looked around and said, we got vaccines. We just saw the last spike, COVID's going to be gone for 2021. And we all talked about that. And the year was dominated by Delta and then Omicron, right? So what I struggle with is making predictions that COVID has gone when we're starting to see new variants. Now how much of it will affect hospitals versus -- I don't know. And so the statement was as simple as, look, we're going to wait to see what happens with these new variants before updating our guidance at the end of Q2. We think that's fair. We think that's prudent. The question underlying your thesis about guidance, though, we don't see that the labor challenges are any different today than they were in the first quarter as they were in the third and fourth quarter of last year. We're continuing to manage it exactly the same way.

Okay. So there's no change in how you initially set the guidance, you had a view on labor and it's based -- that view is largely intact.

Look, we expect contract labor costs to come down. We expect premium labor costs to come down. We've made a set of assumptions around that. And we are hopeful that the market will track to that for the rest of the year. We'll have a better sense of that at the end of the second quarter.

All right. Perfect. And then I guess when we think about where labor ends up, you say, to moderate, I mean are you talking about getting back to normal by the end of the year, getting back to normal in 2023? How should we think about that trajectory?

No, we're not assuming that contract labor rates go back to pre-pandemic levels, Kevin. As a reminder, we've talked about this in past few quarters. Before the pandemic, our contract labor costs were roughly 2% to 3% of our consolidated salary, wages and benefits costs. What we saw last year earlier in the year was the rate's 4% to 5% type of territory. And then as we ended the year, mid-single digits, around 5%, maybe a little north of 5%. What we actually saw in the first quarter was actually the rates were -- those costs were about 6% to 7% of our consolidated SW&B and driven in large part due to the Omicron surge. We are anticipating that those rates do moderate as we move through the year, but we're not assuming that they get back to pre-pandemic levels, the 2% to 3% type of territory that we saw before COVID.

Yes. I think just as importantly, as the labor assumptions for the year, I would go back to the concept. We're delighted that half of our business is insulated largely from this problem. So we have the potential to perform at USPI. We have an incredibly large pipeline. We have integration of the SurgCenter facilities that's moving on track this year. I mean there are a lot of potential positive drivers within the insulated part of the business that we're obviously very bullish about. And we have further cost opportunity at Conifer, in addition. I think we've talked about the fact that this year, the work in our global business center in Manila will largely be Conifer-focused and we'll potentially have another 1,000 or so colleagues added in that setting, further enhancing margins and our ability to successfully run an offshore enterprise in that business. So there are a lot of other things that play into this besides just the labor because half the business is insulated from that problem.

And maybe it makes sense to switch for a second to the surgery center part of the business. I guess, how has that been so resilient? I guess, we think about COVID spikes and people pulling back on low-acuity services, almost definitionally outpatient surgery is lower acuity than inpatient surgery. So like why has the volume been so strong during this time period?

Yes. I mean, look, 3 or 4 things. One is that if you look at USPI's platform, aside from the scale and the industry-leading margins and the ability to deliver synergies, there are some underlying things that are really important. I mean the quality of our health system partners, you're talking about the A players in the markets in which we participate, right? We just -- we have a collection of the top or leading players in those markets, our health system partners. We also have an incredibly high-caliber physician group that's invested in these centers. They have been successful more so than others in their environments, whether it's ortho, GI, ENT, in keeping their practices busy. We've done very little work. Remember, we're not in the physician employment business at USPI. So there's no dilutive segment, so to speak, within USPI. They've done -- those physicians have done incredibly well, and we have managed to provide them an outlet to perform surgeries that were hard to perform in hospitals that were struggling with labor at the same time. Most -- we have 50s -- 55-plus not-to-profit health system partners who have struggled a little bit more in their hospital platform than we have in terms of OR capacity and staffing. So the ASCs have become a bit of a respite for some of those surgeons to bring those cases in. That's why we've been adding so many new surgeons into the USPI environment over the pandemic because they wanted to try somewhere else they could operate and of course, then they tend to stay. So I think the platform is well set up to grow and recover from COVID the way that it's been set up. And then you add to that, we've made substantial investments. USPI was the leader in orthopedics or bone and joint care prior to the SurgCenter acquisitions. But our -- we were very deliberate in thinking about SurgCenter strategically, given that orthopedics is the largest growth vehicle over the next 10 years in the ASC setting. So there's a lot of room for growth from a service line standpoint.

And how much room is there? So you said 10 years. Is that kind of how you think the orthopedics [indiscernible] to be the driver? Or is there going to be another service type that's going to come in and pick up the...

Well, I mean, think about this, I mean, I think we're probably -- people like to use kind of baseball analogies. I mean, we're kind of in the first few innings here with respect to bone and joint care in ASCs. I mean right now, there's a fair amount of what I would describe as straightforward low-acuity hip and knee work that goes on. There's certainly pain management that goes on, hand surgery that goes on. But the entirety of shoulder surgery is still done in hospitals, for example, right, virtually. I mean -- so there's a lot of expansion opportunity in new orthopedic services in ASCs in addition to the market over time becoming fully penetrated in just hips and knees. The aging of the population helps. But I think the service levels in the ASC over time, convince more people who are commercially insured to accelerate their therapy options. They're in and out of an ASC in a few hours and walking the same evening with a great service level and great outcomes, I think you're going to grow the market, not just cannibalize what's in the hospitals. And that's been our experience. Consistently at USPI, our experience has been that we grow the pie, we don't just cannibalize in every service that we've moved into that setting.

And when you think about the deal environment in that marketplace because USPI has got a very strong organic growth, but you supplement that with deals every year. How have multiples progressed? And has your view on M&A at all changed from rising interest rates or anything else?

In terms of the multiples, I would say there hasn't been really much movement in terms of the multiples that we believe that we can consummate transactions on. If anything, maybe half a turn -- but we point out quite a bit that what's probably most important to us is, ultimately, after the centers are integrated into the enterprise. And we begin to execute on our operating efficiencies and our contract synergies that we bring to the table, whether it's on the supply chain side or the contracting side for reimbursement. The EBITDA minus NCI multiple after 2 or 3 years, we feel very comfortable with those transactions being 5x or less within 2 to 3 years. Listen, in larger transactions, the multiples can be a little bit higher than one-off type of transactions. But there really hasn't been much change from at least what we're seeing. The pipeline is incredibly strong at this point as well as not only M&A, but from a de novo development perspective, particularly this new 5-year partnership that we have with SCD to build 50 centers or more over the next 5 years.

And let me just unpack that for you a little bit more because there's some attractive features of that partnership. It's not just 50 centers, but the largely 50 bone and joint focused centers is probably what they'll end up being. And importantly, USPI has the ability to buy in at 18 months, which means if a typical ASC is ramping up at 2.5 years to full run rate, we're buying in early in order to end up getting to an ownership share that we like. So even in the original guidance post deal, the value of those 50 centers wasn't really contemplated other than -- I mean, we never put numbers out in terms of what those would be worth. And just think about this, that's roughly half what we expect USPI's kind of leading development engine to do on an annual basis. So if you're averaging 10 a year with the SurgCenter partnership, USPI's development pipeline on a normal basis without larger transactions, would be delivering 20 a year. And so the combination of the 2 becomes very powerful and it allows us to divide and conquer a bit in the market in terms of multi-specialty, single-specialty and things of that nature. It creates options for physicians, right, that are attractive. And that's really helpful.

And one of the things about Tenet historically because the company was levered -- and I often deal with this whenever I talk to clients about you is that people think about Tenet, it feels like from 5 years ago where the company was overlevered and wasn't generating cash flow and now that really has changed. It's still a little bit hard to see it this year with the Medicare accelerated payments still kind of coming out. But if you kind of adjust for that, even if you exclude the payments to the minority interest, you're doing close to $1 billion of normalized free cash flow. I mean, -- are there $1 billion of ASC deals? Or like could it really accelerate? Or how are we thinking about excess capital deployment above what you've been doing on the deal side?

Yes, you're right, Kevin. How we look at it, our free cash flow generation platform when you normalize for the repayment of the Medicare advances that will be completed this year, before the distributions to minority shareholders, is a little over $1.5 billion. And then the NCI distributions were about, say, around $500 million. So you're right, there's $1 million -- or $1 billion of free cash flow generation. In terms of how we think about it, our capital allocation priorities are going to be continued to grow the surgery center business. We start off a given year, assuming that we're going to invest either $200 million to $250 million in M&A on the surgery center side or to have a development. Some years, it will be more. In the past 2 years, obviously, with the great investment opportunities with the SCD transactions, we obviously invested more. So that free cash flow will continue to allocate capital to grow surgery center business. We're also allocating capital in certain of our hospital markets to grow and enhance our hospital portfolio in various key markets of our. We're building a new hospital outside of Charlotte. It's a great market. We're very comfortable with the returns there. We know the market. We think the risk associated with that investment is pretty small. And so it's a -- that facility will open in September and really looking forward to it. We're also making additional investments in our San Antonio market. We know the market very well. We feel very comfortable with the returns that we'll generate there. And then there's other markets too where we're doing similar things in South Florida and in the Phoenix area. So again, allocating capital to grow and enhance our hospital portfolio. We're also going to look for opportunities to retire debt or refinance debt. We -- so far this year, we've retired over $800 million of debt with cash on our balance sheet. It'll save us over $60 million of interest. So we assume we'll continue to look for opportunities to reduce debt as well. And then we've talked about as well, once we get into 2023 and beyond, depending on market conditions and investment opportunities, maybe share repurchases would be something we'd consider too, again, depending on investment opportunities and where the market's at.

Okay. That's useful. I guess, like the comments about the investments into the hospital business because it really feels like you guys are shifting the business to the surgery center business in the way that you kind of talked before about adjusting capacity to the incremental cost of labor. It almost felt to me like you were managing the hospital business for margin and cash flow and really looking at USPI as the growth side of the business. But that's not right to think about [indiscernible].

No. Kevin, that's a very fair question. So let me back us up for a second. What are we trying to do with the hospital business, okay? There's 3 or 4 things. One is we want to be in markets where we believe we can be competitive, in particular, in our high-acuity procedure-based strategy in hospitals, right? So that's intensive care, emergency care, operating room care and complex cardiovascular care, okay? And neurovascular now with all of the things that are going on vis-a-vis stroke care and how that's being funneled to the highest acuity hospitals and markets. With that platform, we have repositioned what Tenet has been doing operationally, capital investments, service lines, we've restructured our physician portfolio. I mean we have probably on the order of 500 to 600 physicians that have left and almost 1,000 that have come in. So we've restructured the entire portfolio to be focused on that. It's most defensible, right? We're not doing low acuity -- let me say this, we're not targeting low acuity work in the hospitals. I mean, obviously, we're the first we're doing things in the ambulatory setting. So really, it forces you to think about that. What's important also about how we're approaching our hospital investments is unlike the Tenet of the past, which might have taken inbounds in all kinds of markets that they look at. Every one of these is an extension from an existing leading market position within an x mile radius, where there's a large growing commercial and Medicare population where we can extend the platform. And what we're not doing is building large, large hospitals. If you look at, for example, the hospital that Dan described in South Carolina, it's an extension of a major trauma center. It's a little more than a micro hospital but it's not a full-service 300-bed hospital. It's roughly 100-bed surgically focused high-acuity hospital set up to do what we do. So it's much more capital efficient. So the whole platform -- the platform has changed to follow that strategy. Why is that relevant? It gives us more scale in what we do in our supply chain environment, and it's highly relevant to whoever is covering lives in those markets. That helps continue the strategy of having contracts that can deliver synergies to both sides of the business. So we have to have strong, well-performing hospital markets with attractive assets in order to continue to deliver the contracting synergies that we do on the USPI side. They're self-reinforcing.

That's very helpful. I guess maybe just probably more of a question for the hospital side of the business. But labor costs are rising, inflation is rising. How do you feel about, broadly speaking, your ability to get the rates that you need to offset that?

Yes, I'll let Dan comment.

Yes. Well, we just actually signed 2 very important contracts for us. With 2 large payers, Aetna, a multiyear contract; as well as Blue Cross of Texas, which the Aetna contract is a national contract that covers all of our hospitals, physicians, surgery centers and other care providers. And Blue Cross of Texas covers all of our facilities across the state of Texas. Part of those negotiations, there was certainly -- we took inflation into consideration for those contract extensions or renewals. So how we negotiate contracts and ultimately agree to terms with the plans as we have escalators built in. That's what we negotiate for each year. And we focus on our service lines that are most important to us whether it's in the hospital setting or in the surgery center setting. So we'll continue to look at this and evaluate this. There's additional contracts come up for renewal. That's not to say they're going to easily just provide, look at CPI, what that's doing and provide those type of rates, but it's all about negotiating appropriate fair reimbursement for the quality of services that we deliver.

I mean -- I think the article in the Wall Street Journal a couple of days ago, got a lot of people's attention, some hospitals pushing for 7.5%, 15% type rate updates. I mean are those things the type of thing that you are trying to do or...

Let me comment on this a little bit more broadly. Look, the concept that, hopefully, short-term inflationary pressures in this area are going to be fully covered by any contract or Medicare's IPPS rule is foolish. I mean, we didn't start down this path 4 or 5 years ago in restructuring the operations of Tenet because we believed that we were just going to get reimbursement. We take accountability for our own efficiency, right? It's the reason we built the global business center in Manila. It's the reason why during this pandemic, we've taken the opportunity, to be honest with you, in a way that probably would have taken longer to restructure the cost base of our hospitals. We've taken the opportunity to initiate a program starting at the beginning of '21, halfway through the pandemic of looking at every purchase services contract that exists in the company and going down the path of restructuring many of those contracts. I mean, it's our view that we will continue to seek and identify and deliver efficiencies within the platform because you know they're there in health care services. And so it's a combination of reimbursement, government reimbursement, focus on higher margin, higher-acuity service lines and frankly, ongoing efficiency initiatives that we're very committed to that really ought to help us stabilize this platform post-COVID. I don't think we can rely on pure top line, call it, pricing to help us solve this problem.

That's helpful. I guess that maybe brings some kind of point that our [ profession ] often get is that the company has made progress on margins over the last couple of years during COVID. And so I think from a lot of times just from the outside, it's like, okay, well, how much of the margin improvement is actually core real margin improvement? How much is because COVID somehow added to earnings and how much is because of government support. And then if COVID [indiscernible] go away, why is your margin guidance, the right starting point and not something more similar to 2019?

Well, I mean, we obviously have improved our margin significantly over the past 4 or 5 years. If you go back to 2017, where margins were 12%, 12% to 13%. And more recently, there's been 400 or 500 basis points improvement from that. Listen, it's been driven by focus on cost efficiencies that Saum has talked about. It's our focus on higher-acuity service lines within our hospital portfolio as well as our USPI surgery center business, it's the growth in our surgery center business. The USPI platform has margins in excess of 40%. And so that's been a contributing factor, too. It's been also driven by our contracting strategies. And it's just -- in the global -- our global business center that we developed about 2 or 3 years ago and transitioning rolls over to our global business center in Manila. So -- and Conifer has played a part of it, too. Conifer's margin, if you go back to 2017, it was roughly 17% and now Conifer's margin is at 27%, 28%. A lot of focus on the cost structure there in creating additional cost efficiencies, whether that's on domestic efficiencies or roles being transitioned over to the GBC. So I mean, it's all part of the focus that we've had on improving margins and growing the business, and that's what we're going to continue to focus on.

Yes. And I guess one of the things that people -- maybe last question here that people focus on is that the business mix has shifted a lot during COVID that your acuity is higher that therefore, if volume is going go return to normal, it will be low acuity volumes coming back. That's the missing piece. Or that commercial has been strong, so if the volumes return to normal, it will be Medicare or Medicaid volumes coming back. And all three of those are lower-margin businesses, all those equal. So how do you think about incremental volume coming back and what that might mean from a margin perspective. Is that additive or dilutive?

No, I think -- look, there's 2 things. One is, if you just look at our internal metric or measure of how we think about efficiency, we're always pushing towards a platform that can be profitable on Medicare reimbursement, okay? I mean that's a basic strategy. And goalposts that you got to keep out there in order to continue to drive towards efficiency, okay? And that's how you structure your thinking effectively. So you've got to continue to deliver efficiencies over time. Look, I think the way the recovery is going from the pandemic low acuity business coming back into the hospital, even if the mix is a little bit different, is okay. We have a chassis that's set up to welcome Medicare-type medical cases and business and do that efficiently, primarily because we have invested very heavily during the pandemic in a very good length of stay management program. I mean it's been a big driver for us in avoiding excess days, which have driven a lot of the excess contract labor needs that I think other providers have seen. Medicare business is the same thing, right? You usually got high-acuity ill people with a medical illness, and you have to be very good at managing the length of stay if you want to be successful in managing margins in that book. And that's kind of the capability that really helped us through COVID, and I think will help us on an ongoing basis.

All right. Great. I think that's all we have time for. Thank you very much.

Thank you.