Tenet Healthcare Corporation (THC) Earnings Call Transcript & Summary

Hi, everybody. I'm A.J. Rice. The health care service analyst at Crédit Suisse, and welcome to our 31st Crédit Suisse Healthcare Conference, and we appreciate everyone being here. We're really excited to kick off the conference with Tenet Healthcare. We've got Saum Sutaria, CEO; and we've got Dan Cancelmi, CFO of Tenet with us. I think Saum was going to make a few sort of general comments to get us started, and I'll let him do that.

Yes. Good morning, everyone. Before Saum gets started, I just want to mention that we will likely be making some forward-looking statements this morning. And so please refer to our cautionary statement language in our latest earnings slide presentation that's on our website that's dated October 21, 2022. Thank you.

All right. Thank you, A.J., and thanks for having us, and thanks for joining us this morning. We're going to get into a lot of issues today, but let me just start by saying, as I did on our last call, despite the tough quarter, let's be clear, USPI for us is an important strategic priority. We will continue to dedicate capital to what business and has generated terrific returns. We continue to be the leader and will be the leader in this space going forward and believe very strongly in our opportunities there as we look ahead. We think this market continues to benefit from significant tailwinds in terms of the opportunities, the platform at USPI, not just because of its scale, but its ability to deliver synergies into the environment in which we operate makes us the partner of choice. And in addition, we have a significant runway in particular, as we'll get into with our more recent large transactions as we look forward. The hospital business for us, despite, again, a tough quarter, in particular, with contract labor increases, which again, we'll get into in a little bit more detail. Our high acuity strategy that we've executed over the last few years will continue to serve us well. We believe that the net revenue intensity that we're putting into place, including, as I described a year ago, the goal of replacing a lot of the COVID net revenue intensity from a year ago with true organic high net revenue intensity work has gone very well and will continue to go well, and that's how we'll continue to deploy capital and prioritize physician relationships from our standpoint because we believe it will be margin accretive over time. And it will also be important to our supply chain scaling strategies as we get synergies between the 2 businesses from purchasing some of the same items, including physician preference items, which again lend themselves towards margin expansion over time. Conifer is doing very well. We continue to have good opportunity and growth. Our pipeline has expanded. Our third-party client revenue is growing and we see further opportunity to continue to deploy technology and offshore capabilities there, which -- into our captive in particular, which will create ongoing opportunities. So we're bullish about the future. And we're looking forward to having a discussion about some of the items that are more recent, but also keeping our eyes on the longer term here for Tenet.

That's a great setup. I think -- maybe just to delve into USPI, the ambulatory surgery center business first. I think you've called out 3 items this year. I'd love for you to spend a little bit more time on each one of them as to where you're at, how quickly you might come out of it. And I think the first one was sort of this transition. It sounded like you may have accelerated that this year toward getting pain management out of some of the facilities and moving towards orthopedics, which I think economically, you said is neutral, but it does have some impact on your volume statistics. How -- where are you at? How much more needs to be done on that and give us some flavor for what was the decision point to move ahead with that.

Yes. No, A.J., that's a good point. So first of all, let me just be clear about one thing. We perform a lot of pain management services, and we'll continue to perform a lot of pain management services in our business. For those of you who are familiar with the space, there are more invasive procedures, many of which require significant amounts of anesthesia and other things to actually perform and those pain management procedures, which are truly less acute and could be done in other settings. And so our priority has been looking forward over the year to start to migrate and be part of the migration of those types of procedures into alternative settings and do the work to replace that volume with higher acuity volume that's much more sustainable in the surgical hospital and ambulatory surgery environment. That makes all the sense in the world from a long-term perspective, both in terms of the health of the physician partnerships that we're in, but also the financial performance over the longer term for these assets. When you look in total, at the amount of volume in that area, I mean pain management for us is down almost 6% this year. And again, it's being replaced with things that have much higher net revenue intensity. But that takes time. And it's okay, we're going to work through that transition. I'd rather create the capacity and be able to actually reenergize the partnerships with longer term with higher net revenue cases and physicians in different specialties that over time will bring in to replace that capacity.

And when you think about moving into next year, is this -- the bulk of this transition or at least the transition that's impacting your volume statistics, will that be behind you? Or do you see that as something that continues into next...

No, I think it will continue into the coming year. And if anything, I think as we get into this coming year, some of the early work that's been done in that area, hopeful -- hopefully, we'll start to have physicians ramping up more actively in the centers on the high acuity work.

Okay. A second item that you've called out with respect to USPI, it relates to -- I think it's -- you made that assumption coming into the year that you wouldn't have much impact from COVID and there aren't a lot of COVID patients getting surgeries in those ASCs, but it's had other impacts. Can you comment on how that impacted you? And I'm assuming as we get into the fourth quarter that, that's pretty much gone away, is that correct?

Well, we had -- this year, we did make the assumption, as I stated at the beginning of the year that this would be somewhat of a rebound year in the USPI business because we really didn't think COVID would have any material effect, and we figured as many have spoken about that there would be pent-up demand from the prior year. So if you look at -- if you just look at the numbers, we had initially estimated $1.4 billion in EBITDA in that segment, which would have been a 23% year-over-year increase from the prior year. Now remember, we had completed the SurgCenter center transaction. So that would have factored into why the number was higher than our long-term average. But even then, our assumption taking out the acquisition would have put us in a place where our organic growth would have been above our kind of long-term 4% to 6% EBITDA growth goal. So we really did expect a rebound year. I don't know, there's no other way to describe it, that we really, at that [ 1,400 ] had a belief that we would have the ability to hit a pretty aggressive target. Bringing the guidance down to [ 13 25 ], there's 2 things to talk about what were the components, which I did talk about qualitatively, and I'll spend a few minutes here quantifying them for you. But also reminding everybody that that's still a 16.5% growth over prior year. And despite the fact, as I'll go through some of the challenges with the buy-ups and other things that we're dealing with it still implies organic growth in the business. The third quarter was disappointing, frankly, to be flat over a pretty good third quarter last year for us, a very good third quarter. But nevertheless, it was disappointing. And as we look forward into where we are today, we've gotten back to positive organic growth even as we speak today. But it was -- there's no question about the fact that, that was a little bit disappointing to us from that standpoint. When you look at the reasons that I talked about on the earnings call, and I think if you just take the $75 million, we think about $30 million of that is related to the core business and some of the impact that we discussed vis-a-vis COVID, more broadly speaking, the cancellation rates, the lower demand that we're seeing from physician offices, especially in some geographies, which haven't opened up as actively from that standpoint. The second category relates to -- the second and third categories actually relate to our second SurgCenter transaction. And if you recall, I talked about 2 different things. One was the pace of buy-ups and the second was the develop -- what we call the development centers. Those are centers that still needed to go through the work of going from what we purchased, which was a well syndicated partnership to actually opening up and ramping up, which had slowed down. So let me just start with the first category which was the buy-ups. That's probably on a consolidated EBITDA basis, probably about $25 million of the gap. Now let's just step back and talk about that for just 1 second because as I indicated, and certainly, since that time have confirmed, those centers are performing well, very, very close to our budget expectations on an EBITDA basis. You got to think about it from the perspective of -- we own 35% of that well-performing portfolio, in some cases, as a minority owner, the ones that haven't been bought up yet versus 51% or above, which would have brought them into a consolidating position. So obviously, there's a gap there, but the performance of those centers in terms of how they're doing, we're very comfortable with. In fact, they're ahead of some volume estimates that we had at the time of the transaction. The development centers probably represent about $15 million in EBITDA. I went through the reasons that delayed in opening up. There's a lot of different reasons for it in this time frame. And you can imagine not only for ourselves, but for our physician partners, we're working through the process of getting those things opened up and ramped up as would be expected. I think de novo centers in this environment with the kind of supply chain and labor issues that we're seeing probably, it's not that surprising that they're delayed. But again, we're working through that. And the remainder of its [ Ian ], I mean, we do have centers that are still not operating at full capacity from that standpoint. In fact, a number of them didn't even open up until mid-October really for cases, but that's a pretty small number, $5 million-ish that kind of brings you to that total of $75 million.

So let me just drill down a couple of those things. So on the doctor -- the physician buyouts, it sounds like the dynamic is that some doctors are seeing the upsurge, and they sort of want to wait a little while longer before they sell out to you, if I got that right? And when do you think that will occur? Do you have any way to force that? Does that happen by the end of the year? Does that spill into next year? Any thoughts on that?

So 2 things, A.J. One is we don't buy them out fully. The physicians remain invested in the centers. It's a question of when the asset both parties believe is at a stable point for buy-up to then layer on the next level of synergies which we can bring. And that's got to be an agreement between both parties. There's no way to force it. In fact, our view has generally been there's no reason to force it. Even if you have a majority of the partnership at the center willing to do it, you don't want to isolate the minority of physicians that aren't ready because if you complete the buy up and they leave the center, actually, the center overall has been damaged from that standpoint. So we look for -- we look for quite a bit of consensus before we move in that direction. And we've been very disciplined about the multiple that we're willing to pay on those buy-ups given the synergy that we're able to bring from that standpoint.

Okay. And then on the development pipeline, I understand supply chain issues and all of that and how that impacted this year. Do you think by the end of the year, you'll be sort of where you thought you'd be in the openings? Or is that going to spill over into next year and be something that some of those developments that were originally targeted for this year will come online at some point next year?

No, it will spill over into next year. I mean, I would think about it as a delay in the ramp-up of these centers which ultimately will get into when we talk in the future about our 2023 guide. We'll have the vast majority of them open for cases this year, but the ramp-up will be more delayed. In other words, we won't catch up what we expected by December of this year but we will have the vast majority of them opened up and running for cases. Again, these are well syndicated partnerships. There's no risk to the centers from that standpoint.

Right. Right. I mean, there is debate on the ASC space coming out of the COVID years. Some call it 6 to 8 -- 4 to 6, 6 to 8 growers, some call it, you're more in the 4 to 6. Any way, it's just you're being a little conservative in the way you think about it? Is there some reason why your portfolio might grow a little slower than what we're hearing from some others? Are they just more optimistic? What do you think?

Yes. We can't -- A.J., we can't comment on others and their long-term growth rates specifically. But we feel comfortable with our long-term growth rate of 4% to 6% with roughly half of it, 2% to 3% coming from organic volume increases as well as 2% to 3% coming from pricing, acuity, strengthening. So listen, the business is doing incredibly well, very strong margins, roughly 40% margins, strong cash flow generation business. And we're very focused on continuing to grow that business, allocate capital to grow the business. And we're comfortable at this point with long-term organic growth targets of 4% to 6%.

Right, right. it straddles both businesses, and I'm going to move over to the hospital business here. But any comment on the outpatient payment rule and how that's...

Yes. Thanks for asking that, A.J. The outpatient payment rule, the final rule obviously improved roughly 100 basis points for us. For our hospitals with the -- when you take into consideration the adjustment for the 340B issue, our outpatient rates will increase roughly 1.4%, 1.5% in calendar 2023 compared to this year. In terms of just sizing the dollar impact of that, that could be roughly $10 million to $15 million when you include Medicare Advantage as well. From -- on the ASC and surgical hospitals perspective, the net update when you take into consideration 340B impact on the surgical hospitals, it's roughly about 3% year-over-year growth, which is roughly $30 million of incremental revenue on a, I'll call it, consolidated GAAP basis, system-wide across the portfolio, it's probably closer to $40 million.

Okay. That's good. Just to flip over to the hospital business. What -- I mean, labor has been the big issue. Where do you sort of see things now? Are we at a point where we're stabilizing a bit on the inpatient use of contract labor, you find in your ability to recruit and get new talent has picked up, turnover rates? Any comment on some of the metrics you follow there?

Yes. Let me kind of break that down into contract labor, which was a little bit more of an acute issue for us in the third quarter. And then ultimately, let's just talk about the inflationary environment from a hospital labor standpoint. A couple of things that are important to understand, first of all, our contract labor has been incredibly well managed. And as I've seen where contract labor ended up among a variety of peer organizations and others. Our increase in Q3 landed very much in line with where a number of our peers were. We've run it, I think, quite a bit more effectively in the past because of our day-to-day ability to manage our productivity and length of stay that we've been incredibly focused on. Frankly, it served us very well. If you look at the third quarter after digging into it, because as you can imagine, we haven't had a quarter in the [ 7s ] from a contract labor standpoint. 2/3 of our contract labor increase in the third quarter came from California and Michigan, okay, which are states that have significantly expanded lockdown rules for staff. And as I mentioned, overall, in the organization, we had almost 10% of our staff at some point, in particular, during the month of July, have exposure to COVID -- personally exposure to COVID, which in those states generally require a 10-day lockdown. We began increasing our procurement of contract labor in the middle of July and through the first week of August in order to preserve the capacity. We were worried at the time that even though our strategy is much more focused on high acuity business that the loss of that labor to quarantine would actually create risk to the portfolio of services that we really, really care about. And so we staffed up from a contract labor standpoint. Here we stand in the end of October, and we're finally shedding some of those 12-week type of contracts that we had put into place. And I think we'll enter the next couple of months with a lower total FTE count of contract labor. Our recruiting pipeline and both partnership with nursing schools, for new grads and also our recruiting pipeline has been exceeding our attrition rates for multiple -- many months this -- most of the months this year, frankly. And so we're going to continue that work to get more full-time staff. Obviously, this year, we've been more aggressive than prior years in terms of base salary and wages in order to be competitive from a recruiting standpoint. And that's good because it will mitigate some of what needs to be done in future years if we can be more competitive from that standpoint. So I don't -- our commitment to running the hospitals efficiently and effectively while we strategically work on the acute care -- on the high acuity strategy is not changed and it's not going to change in terms of our focus. There will be times where the conditions in the market result in increases and decreases in contract labor. And as long as the environment remains turbulent, I won't be very surprised by that. But we'll react and adjust accordingly.

How about -- [ so those 12 week ] contracts roll off from the summer. I know part of it is how many placements you take, but part of it's the rate what kind of rate change have you seen? I know it's coming down and people have argued whether it's coming down fast or not. But what are you seeing?

Well, we haven't seen that much change in the rates over this period of time. But -- again, one of the elements of discipline over the past 2 years in the way we utilize contract labor is we're more careful about the rates that we accept to begin with. We haven't seen much moderation through the summer and into this current period at all.

Okay. You've mentioned a couple of times the -- go ahead.

Yes, just one other thing on it. If you go back to earlier in the year, there certainly has been some moderation, but nowhere near the level that we would have anticipated in our original guidance. Encouragingly, there hasn't necessarily been any significant spike recently in the rates, which gives us some optimism as we think about our fourth quarter guidance and when we developed it, we did assume that there would be some aggregate moderation in contract labor costs in the fourth quarter.

And you mentioned a couple of times the investment you're making in higher acuity service lines and so forth. Are you -- there's been this concern as COVID rolls off, that net revenue per adjusted admission acuity might drop. Maybe comment on where you are? Do you think you're at a normalized level now and you can plan for that going forward?

Inpatient COVID today is kind of at the troughs that we've seen through the pandemic. Even the acuity of the COVID cases is lower. I mean the fact that we have had increases and improvements in our case mix index with the absence of the very high acuity commercially oriented COVID that we saw in 2021, we're really pleased by because it suggests that our ability to maintain net revenue per case with the book of business that will be sustainable on a long-term basis is a transition that we're making successfully. We don't think that some of the really low acuity work is, a, going to be accretive to us, given contract labor issues will continue into 2023 at that kind of cost structure and also is probably not the best use of our hospital capacity looking forward.

And on the third quarter conference call, you guys laid out some of the reimbursement headwinds that you face and some of these COVID benefits roll off next year. You didn't spend a lot of time -- I mean, some of the Medicare sequestration, some supplemental payments at the state level. You didn't spend a lot of time talking about the headwinds and tailwinds from an operational standpoint. I know that formally will come out with the guidance. But you want to comment a little bit more on that aspect of what you're thinking about as you look at the year ahead, labor? I mean, is it going to be a meaningful pickup because you were hit pretty hard in the earlier part of the year. Any other comments that you would have about headwinds and tailwinds away from some of those comments on reimbursement. And you can remind people how much of a reimbursement headwind in aggregate you think you'll have, so they have that maybe as a baseline.

Yes. Let me go through the various pieces because they're -- we've obviously had a lot of follow-up questions on that. And certainly, we outlined primarily headwinds going into 2023. But in the -- in our earnings call, we did talk about some of the tailwinds that we absolutely would expect to see. We're in the middle of the business planning process for next year. We will be wrapping that up relatively shortly. But at this point, we're just not ready to specifically identify a specific exact number that we will have for some of these items for next year. We want to see how the fourth quarter evolves and ultimately get where we get to in the fourth quarter and just see where some of the trends are going into next year. And on our February earnings call, we'll go through our guidance in detail. We called out the various headwinds. Sequestration will have a full year impact of that. And you can see this -- a lot of these numbers on our slides. I won't go through each one of them, but Medicare sequestration will be in place for a full year. The grant income that we've earned this year, we would anticipate that there would not be any additional funding. We have earned that. It relates to lost revenues or incremental costs that we've incurred because of the pandemic. And the grant earnings that we had in the fourth quarter, we had more than -- our lost revenues incremental cost in the third quarter alone were in excess of the $50 million roughly that we recognize. So it's not like a lot of this money relates to prior years, 2 years ago or last year. There will be some headwinds related to -- in terms of -- we had some asset gains this year. Created a lot of value for the company, over $100 million, but we wouldn't necessarily count on those repeating. However, when you think about -- when we think about the tailwinds going into the next year, a couple of things, we would anticipate at this point that patient volumes not only in the acute care business, but in the surgery center business should strengthen next year. We would anticipate that as we move further past the pandemic, that hopefully, we do not have any significant surges. And so we would expect to see some rebound in patient volumes compared to this year. Next, we'll continue to execute on cost efficiency. I think we've done a pretty good job through the years identifying and realizing cost efficiencies. We'll certainly continue to do that. including additional rules transitioning to our global business center in Manila. From a contracting perspective, we think we're very well positioned. So there will be incremental revenues from our contracting positions next year that we've already have signed up. So we feel we have very good visibility into our pricing for next year. Saum talked at great length about USPI, there's going to be continued growth in the USPI platform, not only organically, but we felt the pipe, the development pipeline -- we'll continue to grow that business. And there's still additional synergies that we will capture next year related to some of the transactions over the past several years that will help. And so there are some other items that are out there that it's uncertain depending on what happens with the public health emergency. Some of those items, if the PHE gets extended, some of those headwinds may not be there next year.

You had talked for a while that maybe you get into 2023 and you look at a share repurchase program. With the third quarter release, you guys went on ahead and announced that early. I mean it says something about, I think, where you feel like you are relative to your leverage. But -- also, I've gotten the question from people, okay, they announced it, what is the pacing on what they're likely to do. Will we see some active buybacks in the fourth quarter here? Or is that going to stretch more still into next year, given that, that was you originally thought. Any comment you can give us on all of that?

Well, let me just make an overarching comment there, which is we talked about the potential for share buybacks becoming a part of our active capital allocation strategy about a year ago. We've spent 4 or 5 years really working on deleveraging. So there should be no question about the commitment to that. A lot of that's happened through earnings improvement, frankly, which is the best way to do it, but we've retired debt as well. And that commitment isn't going to change. Look, where we sit right now, it makes all the sense in the world to us to begin to allocate some capital to share repurchases. And we're not going to get into specifics in terms of when and what our strategy is, but we have begun to execute our share purchase -- repurchase strategy in the market.

Okay. Good. We've got a couple of seconds left. Anyone -- a question in the audience that maybe I didn't ask that you'd love to make sure we get? No, that's great. How about where you are with respect to leverage? And do you see it coming down further from here? Is this sort of a stable place for you?

We're certainly focused on continuing to reduce our leverage, A.J., as Saum mentioned, primarily through earnings growth, but we'll continue to look for opportunities to retire debt. As we've done over the past several years.

And your -- beyond the share repurchase , you've got -- what's your commitment on USPI and development just to reaffirm?

Our baseline as we think about each year, annually, roughly $250 million, investing in M&A or de novo development. However, as we've -- the past couple of years, we've demonstrated if the right opportunities are there, we'll allocate more than $250 million. If that makes sense.

All right. Well, I really appreciate Tenet kicking off our conference. Thank you, Saum. Thank you, Dan. And next up in this room will be Select Medical.

Thanks, A.J.