Tenet Healthcare Corporation (THC) Earnings Call Transcript & Summary

All right. Good morning, everyone. We're going to get started with our next presentation. I'm Jamie Perse, health care provider analyst at Goldman Sachs. Next presentation is with Tenet Healthcare. And we have Saum Sutaria, CEO; Dan Cancelmi, CFO; and Will McDowell, VP of IR. Will, I'm going to turn it over to you first for our internal remarks.

Sure, absolutely. Thanks, Jamie. Just very quickly, in the course of the conversation today, we'll be making some forward-looking statements. I would suggest that you refer back to our -- the cautionary statement that's included within our first quarter materials for any perspective there. And for that, I'll turn it over to Saum for opening comments.

All right. Thank you, Will. Thank you, Jamie. Thanks for having us. We're pleased to be here. Let me just make a few introductory comments and provide you with a couple of updates, and we'll jump into Q&A. First of all, I would say that our ongoing -- we're very committed to our ongoing business transformation. The work in our hospital segment, USPI segment, Conifer segment, as we've described it, continues unabated. We're very pleased by that. The COVID numbers, which, as you have seen in the background are rising, are not material yet at this point to be disrupting hospital operations from an inpatient standpoint. I know that we reported a bit ago that our inpatient numbers were looking like they were down in the 95% below the peak. We're probably somewhere 80%, 85% below the peak that we saw. So again, the numbers are rising, but they have not risen to the point that they've disrupted the inpatient environment. The primary effect of COVID right now is staff that are on quarantine. We do see that number increasing. And obviously, the impact on contract labor comes with that at this point. So we hope that, that moderates very, very quickly. I would remind you at this point that half of our business and half of our EBITDA and, obviously, more of our cash flow from the USPI and the Conifer segments are really insulated from the effect of this contract labor challenge related to COVID. In particular, our USPI segment and the ASCs in that business, which is the bulk of the business, continues to see contract labor as a percentage of net revenue well below 1%. So we're very pleased by our ability to maintain that type of stability in a clinical care environment. And obviously, the USPI segment is quite critical to our earnings going forward. The second update I want to provide you is related to our cybersecurity incident. This was a onetime incident. I am very pleased to report that we are back and fully operational. Systems have been rebuilt. The environment has been locked down and all operations are fully a go across the entire network. I'm very proud of our internal team, in particular, for jumping on this and getting our environment restored very, very quickly from that standpoint. We have a strong insurance claim. We estimate that, that insurance claim will be in and around the $100 million range. Our stack exceeds that, and we plan on pursuing that aggressively. Most importantly, I would say, again, we are fully back and operational, and this onetime event is behind us. The third update I'd like to provide, and I'm very pleased to announce this that we are very close to signing a definitive agreement for a 22-center ambulatory surgery deal with United Urology Group. United Urology is the premier and largest urology group in the country. This is an important diversification and growth strategy at USPI in an area that has a lot of future potential within the ambulatory space. The deal will be in and around the $100 million investment range, and we fully expect that within the first few years, we will drive that EBITDA minus NCI multiple down below 5x -- below 5x. And we're very excited about that further addition to the USPI portfolio. It's a reflection of the strength of the pipeline in USPI as a preferred partner, both to medical groups and to health systems in this environment of ASC expansion. So we're very pleased to announce that here. And with that, Jamie, I'll turn it back over to you.

Okay. Great. I appreciate those updates. We'll come back to a few of the things that you mentioned there. I want to start with volume. It's topical for folks these days just what's going on. We've seen strong recoveries from each COVID wave over the past couple of years. Is anything different this time around? Are you seeing that strong recovery in non-COVID volumes the way you might have expected? Or are there bottlenecks that you'd call out?

Let me make a few high-level comments about that. We're not going to get into the quarter's volumes. And as I've already indicated, assessing our baseline right now, in particular, in the second quarter, given the cyber event is a bit difficult. So let me just say this, from the peak of the COVID Omicron crisis, I would say, in January, which has come down, as I described, the non-COVID volume has been recovering. We're particularly focused on surgical volume and procedure-based volume, where we feel the recovery is stronger for us than general all things to all people type of med-surg type of business. As you know, we have taken a deliberate approach of measuring our expansion of capacity based upon judgments we're making about where it's productive to put labor and not. And we're focused on managing our earnings, not necessarily exactly the volumes for that reason because of the contract labor costs not coming down as quickly as we would have liked. Dan, you want to add to that?

Yes. I mean in terms of -- on the USPI or the Ambulatory side, our volumes have recovered to pre-pandemic levels, and they have been since really the middle part of last year. So the team has done obviously a lot of work to realize that. And it's been relatively consistent even during the peak in Omicron. So certainly, there's more work to do. We want to continue to grow that from organically as well as through M&A or de novo. But inventory has come back to pre-pandemic levels. Listen, on the hospital side, obviously, the first quarter was impacted because of peak in Omicron. Our adjusted admissions were off of about [ 1% ] and that was due in large part to what we saw from Omicron perspective. But surgeries, as Saum mentioned, the focus on surgeries, they're stronger. The volumes were stronger there. And we anticipate, as we move through this year as long as there is no significant surge, whether it's a delta or Omicron type of surge, that volume should continue to strengthen on the acute care side as well.

You mentioned just allocating labor to the most productive resources for you or the surgical setting, in particular. Have you curtailed some of your capacity in lower acuity service lines and invested incrementally in the higher acuity service lines? I'm just trying to get a sense of what's the North Star we should be thinking about getting back to eventually? Is it something below 2019 levels because of how you've reallocated your capacity? Or just any comments on that?

Yes. So a couple of thoughts for you. One is that, I think chasing the exact book of business that we had in 2019 in a post-COVID world is a very difficult thing to do. And there are some care patterns that will have changed a little bit more permanently. From our standpoint, we're shaping some of that change in the middle of the COVID crisis, which is to say that if you go back to 2018, we embarked down a path of moving our system from a broad, what I would describe as, again, all things to all people, hospital strategy to a much more focused excellence in specialty high acuity care comparable to what we would be seeing in tertiary quaternary academic type centers done in the community at a better cost structure. And that strategy, deliberate strategy and migration has not paused during the pandemic. So for us, dedicating resources, labor, capital and other things into that strategy will probably define what our future volume scenario looks like. The other thing we've done is, we've just taken a much more disciplined approach to areas that have been dilutive within the hospitals on a fully loaded cash flow inclusive basis and thought about whether we're the best providers of that care in the community. Of course, there are places where we're sole community providers, and we understand we have obligations to the community from that standpoint, we maintain those. So we're very thoughtful about how we're doing this, but we're reshaping the hospital portfolio to be something that we think is more sustainable over the next decade given the burden of chronic illness in this country, if you're running acute care hospitals. We obviously have embraced the outpatient setting for surgery, we have to. I mean we're the largest providers of that. So we can't sit there and continue to combat the move of things into the ambulatory space. We want that move to happen. We think it's an incredible value for all, including the payers and the government payers from that standpoint. And so we'll continue to push what we can into the ASC setting as a result.

You've made this point in the past that opening up capacity on the ASC side is not cannibalistic of the inpatient setting or a hospital outpatient setting. What data do you have to support that? And are you seeing this capacity expansion manifest so that you have full ASCs and hospitals? Or just any color on what gives you confidence that this is not just drawing volume out of your hospitals.

Yes. Jamie, what I've said before is it's not one-to-one cannibalization, okay? So the -- in the history, in the ASC business, I mean, you think about pre-Tenet, even how long USPI has been in the ASC business. When you look at service lines that have moved into the ASC setting, there are 2 or 3 things that happen. One is there's a bit of a separation of lower acuity, less disease burden that goes into the kind of simple in and out setting. Even if you think about hips and knees, there are plenty of people with chronic illnesses that make it so that they need to be in an acute care setting. Their rehab might take a couple of days. They may have blood sugar issues that have to be managed, I mean, just trying to bring it alive for you. Those cases aren't going to move necessarily into the ASC setting. The second thing is, as you open up a lower cost and definitively higher service environment, the market expands, right? So the bar, if you have to go into a hospital, it might be very expensive, you might have a much larger co-pay for the patient in that environment, you're in and out in the same day. You have satisfaction rates in the very high 90s. Your co-pay is lower, you may move to surgery faster than you sit in a long-term rehab program. So you're expanding the market in many ways. And we've seen that in USPI across all kinds of procedures over time. And I don't think the bone and joint area is going to be that different.

Okay.

Jamie, it's important to remember, USPI has centers, many centers in markets where we have no hospitals. Maryland is a perfect example. We have no hospitals in Maryland. We have no intention to have any hospitals in Maryland. But related to the SCD transaction, we're be able to build a strong portfolio of centers in Maryland. And we don't have any hospitals there. So there's no cannibalization occurring there.

Yes. Absolutely. I want to try to tie some of these volume comments back to your annual guidance, and we can stick with what was said on the first quarter call, just. But the math would imply on the acute care side, you've got the 0% to 2% adjusted admissions guidance. The math implies that March was tracking towards that and not a heroic recovery from there to meet the full year guidance. Wondering if you can comment on what needs to happen, how much improvement from what you saw in March -- your March exit rates to hit that annual guidance on the acute care side and similar question for ASCs.

Yes. I mean the acute care business got up. There was a very strong start in the first quarter in terms of earnings. The volumes that I mentioned earlier, adjusted admissions were off 1.4%. What has to happen is COVID levels need to remain at these lower levels that we believe will result in acute care volume strengthening as we move through the year. But again, we are very focused on generating adequate earnings, and we've made conscious decisions at times for certain volume given the marginal cost of incremental labor. It may not make sense to staff forward certain lower acuity services, particularly if we're not certain that the volumes are.

Let's go to the ASC business. I want to try to decompose the growth algorithm a little bit. Obviously, this is a business you've invested a lot in your announcement today, incrementally investing in that type of setting. There's 3 pieces to it. There's existing capacity and growing into that. There's expanding capacity through de novos and then, of course, M&A. So let's tackle each one of them for a moment. You've got 440 roughly centers today. What's the embedded growth capacity in your existing centers? What's a sustainable same facility growth rate in your existing centers today?

Yes. In terms of that, we have more than adequate capacity to continue to drive what we believe is strong organic growth. And when you talk about what type of target are you talking about, Dan? 2%, 3%, 4% type of organic volume growth. There is -- we have more than adequate capacity. But let me be clear, when we -- because this happens periodically, when the center reaches capacity, it's not like building a new hospital, okay? It's -- you can add capacity to a surgery center setting with minimal capital or -- and we've done this periodically simply relocate to a larger center again, with minimal CapEx. So I wouldn't be concerned about capacity constraints in the surgery center setting. Because even if we max out in a particular center or a group of centers, you can add capacity or move to a different center with not that much CapEx.

Yes, go ahead, Saum.

Yes. Just the one thing I would add is, look, the #1 driver for us of, as Dan pointed out, we're at pre-pandemic levels. In terms of -- getting even beyond that is really the economy opening up fully and people getting back to see their physicians, in particular, in preparation for the types of surgical work that we do in the ASC setting. We still think there's room for growth there. People talk about pent-up demand. I don't think pent-up demand is about -- all of a sudden, there's a bolus. I think this is about a return to normal over the next couple of years of people engaging in the health care system. In that environment, we'll know when the physician practices are running at full tilt that the downstream effect of them choosing to use USPI centers is running at full tilt and what that means in a post-COVID environment. All I would say is I don't think we've hit that yet. I think there's more room to move there.

Okay. So a couple of hundred basis points of growth, same facility for existing capacity and ongoing efforts to expand that. On the de novo side, you've laid out the road map to 2025 and implies mid-teens de novo centers per year. That's another 300 to 400 basis points of growth. Is that the right framework to be thinking about sustainable growth in the Ambulatory business over the next 2 to 4 years?

Yes. I think a couple of things. So our de novo plans include the partnership with SurgCenter and then we have our own USPI development team's de novo plans that kind of fit together from that perspective. And then, of course, there are just one-off center M&A opportunities that exist with existing health system partners, existing markets we're in. And yes, we've said that we would think on a typical basis that's about 20 centers a year. Obviously, we've been committed to a number of around $200 million, $250 million a year in capital investment there. So when you put that picture together and you add on the individual opportunities like the United Urology opportunity, I think you're in the right range. Our other important set of partnerships which are developing are medical group scale-ups, often driven with private equity that are looking for highly capable ASC partners and in multiple specialties. And that's an area where our business and our partnership strategy is growing. And again, our ability to deliver synergies into that environment makes us a very attractive operator without having us exposed to the physician side of the business because it's more dilutive from a P&L standpoint. It's a very healthy partnership. As that environment grows, we see growth potential for ourselves as well.

On the M&A side, it sounds like you're making progress towards this new acquisition. How much capital do you think you can invest in the ASC setting over the next 3 to 5 years? Is the cadence that you've had in the last couple of years, the allocations with SCD? Is that the type of capital allocation we should expect to be sustainable? Or have we gone through a phase that's been above average?

Well, I think as a starting baseline, as Saum mentioned, when we start off feature thinking in terms of investing $200 million to $250 million, okay? And then depending on the opportunities, we'll invest more. And obviously, the past several years, great opportunities to acquire various centers from SurgCenter and we'll allocate capital to continue to grow that business and take advantage of those type of opportunities. But it really depends on what's out there, the economics that we view. But again, we feel very comfortable thinking about $200 million to $250 million annually and investing more if the right opportunities are there.

Okay. Let's turn to labor. Obviously, it's been a challenge for any provider out there. What are you guys seeing in the market right now in terms of the contract labor piece and rates and utilization potentially coming down? And then also just the full-time employment environment, getting nurses back into full-time settings and stabilizing the turnover and hiring environment?

Yes. I mean we're working on all of those issues every day. We've really expanded our strategies when it comes to recruiting of nurses. I mean we have many more affiliations with nursing schools and other things and training programs that we've put into place. We've streamlined our recruitment to offer to first shift time frames in order to have, so to speak, better yield from the investments we're making in doing that. And we think that will pay some dividends over time just in terms of increasing our competitiveness from a recruitment standpoint. It's the same discipline that you apply in the rest of your operations. The contract labor environment, though we didn't make an assumption in our guidance in 2022 that it would return to pre-pandemic levels is certainly not returning to the levels at the pace we would have liked, okay? And it goes back to what I was saying at the beginning with respect to the COVID update is that the COVID rates in the background are probably 5 to 7x what's reported. And so the staff shortages continue. The way I look at that is we might make requests for contract labor, but the fill rates are pretty low in terms of being able to do that at a disciplined price point. So we're still in this. We're still in the thick of this in terms of the contract labor issues in the acute care segment. Obviously, we're not facing these challenges in the USPI segment. So we'll keep at it in the same way that we have. We feel like we have a pretty good algorithm that we've developed for every hospital to understand where we want to add staff at what level of expense and what we think the return on that will be. And at this point, we've been successful for 6 quarters doing that. We're going to keep doing that. The environment is challenging.

Are you seeing any improvement on the margin on the contract labor environment in terms of rates coming down or your need to staff with that type of premium labor?

Jamie, let me give you some historical numbers and for those who may not have heard in the past, and where we were last year and we were at in the first quarter and how we see that progressing through this year. So before the pandemic, our contract labor cost in the acute care setting, roughly 2% to 3% of salary, wages and benefits. What we saw as we moved through last year, demand was significantly higher, the supply wasn't necessarily there and that resulted in those type of costs being roughly 5% of our consolidated SW&B last year. Move forward to the Omicron surge, we got the first quarter peak in end of January, early part of February. We saw those costs roughly 6% to 7% of our consolidated SW&B in the first quarter. Those costs have moderated somewhat, but as Saum mentioned earlier, not necessarily at the pace that we would like. We do expect -- not to repeating ourselves, but we do expect those rates to moderate as we move through the rest of this year, assuming there's not any significant surges.

You guys have managed this pretty reasonably well, maybe in comparison to some other health systems out there. What do you attribute that success to? And how much more opportunity is there around things like care team redesign and helping nurses operate at the top of their license, getting more efficiency out of your clinical staff? So 2 questions there. I mean what's really changed in terms of driving the successes you've had over the last couple of years in managing this? And how much more opportunity is there in terms of nursing efficiency?

Well, our approach to managing this is built upon an environment of using real-time data and analytics that we had built up pre-pandemic as part of our overall transformation of Tenet. It obviously came in very useful during the pandemic to have direct visibility day-by-day, not only at the hospital level but every floor in the hospital to understand our labor environment, the demand, et cetera. The second thing, as I've pointed out in the past, our commitment to appropriate length of stay management has been very helpful because excess length of stay is excess demand for labor. And the clinical care teams and the finance teams that have collaborated to do that have been the second component of doing this in a way that's been effective. And then the third thing is, as we've mentioned, we made some deliberate choices of where to constrain capacity because we didn't believe necessarily the marginal costs were truly marginal. We were cautious that they would affect the total cost environment in the setting. And therefore, the marginal revenue would not actually produce margin. I mean if you look at the broader industry, I think that's been very much the case. But look, Jamie, I would tell you I have a tremendous amount of respect for our investor-owned peers and their operating capabilities. And I certainly watch everything I can to learn from the challenges that we're all facing in terms of how we ought to make decisions going forward. So I think the operating environment is similar, and we've probably had some differentiation just based upon the choices we've made.

Let's talk about margins for a moment, particularly on the acute care side. You've had this expansion over the past couple of years. A lot of that's been sustainable cost takeout, right, a plan that you laid out and executed on -- executed ahead of schedule. So I think some of that's sustainable, but there's been some obvious contributions to acuity during the pandemic. There's been government support and some things that strike me as maybe not sustainable. So how should we be thinking about margins over the next couple of years as some of these dynamics go away? Some of the government support mechanisms, maybe acuity returning to more normalized levels, Medicare patients coming back as those things play out, where do margins go from here?

Let me make a couple of high-level comments about the different segments first and then I'll ask Dan to comment further, especially in the acute care setting. So first of all, the margin improvements. Let me just start with Conifer, 1,000 basis points plus of improvement. We've talked about it for a while. The only reason we keep repeating that is it's sustainable. We continue to believe there are efficiency opportunities and, in particular, continued opportunities to expand our global footprint within that Conifer segment to maintain and enhance the types of margins that we have been delivering there. So that, first of all, has been a great success. It's sustainable, and we see more opportunity. In the USPI segment, obviously, very high-margin segment. I would make 2 comments. One is, again, a simple reminder that the contract labor rates really don't have much effect in the ASC setting. But secondly, I would also remind you that at this point, when we look at our opportunities to acquire centers, deliver synergies and drive the multiples down, it's in all of our interest to continue to expand that even if instead of buying and delivering 35% to 40% margin centers, they're 30% to 35% margin centers, still a tremendously successful investment with cash flow. I worry less about where the margins settle out there. I worry more about our ability to, again, have a very robust pipeline, deliver great results on the M&A with the synergies and ultimately integrate those into the company, regardless of the effect on margin within some range. In the acute care setting, the biggest X factor, so to speak, on margins, will be the balance of our high acuity strategies and what they can deliver over time as we succeed and the market opens up further versus the inflationary costs that we're facing. I would tell you that from our point of view, the #1 strategy to combat the inflation, it's not attempting to pass through 10% rate increases somewhere. That's not realistic. We have to continue to grow and expand our high acuity services in order to help expand the margins from that perspective. And where the offsets will end up between those two, I'm not sure I have a great prediction yet because we're still in the middle of COVID or in the throes of COVID, but that's our strategy.

A couple of other things on the acute care margins. There are several things that have driven that. One, back in 2017, when Ron came on board, we announced the $250 million cost reduction program, ultimately increased that to $450 million. The vast majority of those savings, which were executed on and which were sustainable related to the acute care business, okay? So that's just sort of setting the context. Since then, there's been other cost efficiencies driven in the acute care setting to continue to enhance the margins in the hospital business. Two, we've gone through and looked at our overhead type of spend over the past 4 or 5 years, and integrated many functions, consolidated many functions. We always use this as an example, we had essentially 3 separate corporate offices. We have one now, okay? We had 3 businesses with, in many cases, 3 separate, I'll call them, back office type of functions, whether that's finance, et cetera. And we've integrated those types of functions, okay? So that has helped facilitate margin improvement in the acute care setting. We've also gone through and our other operating expense spend, we have renegotiated or terminated many contracts, going through contract by contract where we may have had 4, 5, 6 contracts with the same vendor, different pricing, different SLAs, all of that. We also have transitioned several thousand roles -- back-office type of roles to our global business center in Manila, which has also helped to drive margin enhancement.

You mentioned passing on cost to the payers is not going to be a panacea. How should investors realistically think about your ability over time to pass on some of these inflationary pressures, which it seemed obvious to everyone, there's cost pressures? And what's the receptivity of payers to over time fairly compensating you for those types of services?

Well, I think the first thing to note is that our insurance contracts have annual escalators. And as the contracts come up, obviously, we will negotiate to the best of our ability to have those escalators improve and reflect the inflationary environment we're in. We have multiple objectives, obviously, in our managed care negotiations given the portfolio of businesses that we own. And so we balance those carefully. But I think the other thing I would say is that the Medicare IPPS, we would take every opportunity to say that the industry needs to fight hard for improvements. And what that initial guidance was, was inadequate for the inflation that we're seeing. It's certainly inadequate for the inflation that we anticipate seeing. And so we need to see improvement in that arena. The point I was making was that the concept that we're not going to have to continue to fight for continuous efficiency within our own system and that we're going to be able to pass through the full magnitude of the inflation to a third party. It's just not realistic.

Let's take the other side of the spectrum here, your suppliers, med tech companies are facing their own cost pressures. Some of them are saying in pockets, they can pass on price. What's your reaction to that? And historically, hospitals and via GPOs have been successful in actually reducing price for medical supplies. Where do you think the balance of power lies right now? And are you seeing suppliers try to pass on price to you at this time?

Well, I think a lot of this is about price. But in the med tech space, you also have to think about utilization pretty heavily. So while unit price increases are certainly there and on the horizon and certainly supply chain disruptions have been part of that, our work is around standardizing and consolidating our utilization in a way that helps us offset that. And that's really what we've been focused on. I mean one of the benefits of our strategy from a high acuity, surgically focused approach in the acute care hospitals, it parallels, obviously, the type of work we do in the ASCs. So -- and having relationships with those physicians allow us to gather them and narrow our choices and narrow the vendor portfolio that we can then use the size of our purchasing to work on discounts that offset the inflation. So this has been a hugely important agenda to us from the standpoint of generating savings to offset inflation over the past couple of years, and it'll continue to be.

Just a moment or so left. I want to get your thoughts on capital allocation. First, just on CapEx, in this type of environment with wage pressure and inflation and a possibility of recession, are you thinking about CapEx in any different ways? And then secondly, just on share repurchases, you've mentioned as early as 2023, they could become a consideration as you reallocate free cash flow in that direction. Markets doing what it's doing. Are you incrementally interested in share repurchases?

So what we've talked about in terms of capital allocation, 4 key priorities: one, allocating capital to grow the USPI Ambulatory business. Starting baseline $200 million to $250 million, the right opportunities are there, we'll invest more. Two, allocating capital to strengthen our hospital portfolio in our key markets. A perfect example of that, we're building a new hospital outside of Charlotte. We know the market very well. We're very comfortable with the returns that we believe will be generated there. Similar type of investment projects, San Antonio market, Phoenix, et cetera. Three, reducing debt. And I think we've demonstrated a commitment to do that. Last year, we reduced -- early retired about $1.6 billion of debt. We just reduced and retired over $800 million of debt so far this year, $60 million of interest savings, improved free cash flow. And fourth, depending on market conditions and investment opportunities out there, share repurchases will be on the table in the future as well.

All right. Well, I think we're out of time. Thank you, Saum and Dan and Will, for your time. Enjoy the rest of the conference.

Thank you, Jamie, for having us.

Thank you.

Thank you.