Tenet Healthcare Corporation (THC) Earnings Call Transcript & Summary

[Audio Gap] for joining us this morning. Again, welcome to the conference. Kicking off our first presentation [indiscernible] team from Tenet Healthcare Corporation. Joining us Saum Sutaria, Chief Executive Officer; Dan Cancelmi, Executive Vice President and Chief Financial Officer; and William McDowell, VP of Investor Relations. And we're going to do a fireside chat format [indiscernible] some questions. My name is [indiscernible]. We're going to turn over to Will for a couple of comments [indiscernible].

Good morning, everyone. I just wanted to briefly say in the course of our conversation today, we'll be making some forward-looking comments. I would suggest you refer to the cautionary statement included in our most recent third quarter earnings release of October 20 for statements regarding forward-looking statements. And with that, I'll turn it over to Saum for some opening comments.

Thank you. And Larry, thank you for again hosting us. We're pleased to be here. Let me just make a few opening comments for this group, in particular, to set a little bit of a broader context before we get into the Q&A discussion. So a few years ago, we set out on a journey to do a few things with this business. The first was clearly to improve performance. The second was to bring leverage to more sustainable levels. The third was really to change the mix of our capital allocation priorities in the business, consistent with the strategy that we've espoused. And the fourth within that context, of course, was to generate free cash flow from a business that was not generating a lot of free cash flow before. And if you look at where we are today and in particular, looking forward, performance has improved significantly. Our Hospital segment has improved on a pretty large chassis by almost 300 basis points. I think people are very familiar with the Conifer story having improved sustainably 1,000 basis points in margin. And we've really grown the USPI platform, we'll talk about in a second, while maintaining high and clearly industry-leading margins in that segment, which is important to all of the other 3 things that I described. Our leverage has come down on an EBITDA minus NCI basis by over 2 turns over this short period of time, which we're happy about, and it continues to be an important priority for us. Capital allocation is an important topic, and I'm sure we'll get into that a little bit more. But if you think about the capital allocation priorities for the company, 5 years ago, it was relatively hospital-centric, new hospital markets were being added. We've really shifted that obviously to a significant amount of capital allocation into the ambulatory business. It's a lower capital intensity business on an ongoing basis and obviously higher margin and better free cash flow. And finally, as a consequence of all that, the company is generating free cash flow, again, giving us more options as we look into the future. 2022 has proven to be a bit more of a challenging year, in particular, relative to very high expectations that we set vis-a-vis the year that we thought largely be free of COVID and be a rebound year for the health care services industry through the first half and a little bit beyond that, the year we managed quite well from a contract labor standpoint and also from the standpoint of growth in our ambulatory business. I think the story of a little bit of the types of challenges that we saw in Q3 that we'll get into are there. But from our standpoint, execution discipline is a hallmark of the organization, and we'll continue to look forward to 2023 from the standpoint of marching along our journey of those 4 priorities that I raised. I look forward to discussing that further.

Thank you, Saum. Thanks for the comments. I know one of the priorities, one of the discussions certainly on the most recent call was kind of the replacing kind of the COVID revenue with higher intense service lines and higher intense [indiscernible] revenue. Can you walk us through kind of that strategy and how that [indiscernible]?

So the performance improvement strategy in the Hospital segment that I described at the very beginning, really was grounded in the notion that we believe moving to a higher acuity portfolio of services across the network and the ability to do so and measure the ability to do so was critically important pre-COVID to the sustainability and growth of our acute care segment. COVID -- at the time we developed that strategy, of course, no one knew COVID was coming, but even through COVID, as we saw, especially in 2021, significant increases in acuity based upon COVID cases and in particular, last year, a significant amount of commercial COVID volume at high acuity, our thought process was very clear about the importance of bridging out of that by doubling down in our high acuity strategy on the acute care side. Effectively, as you said, we had to replace that revenue and margin intensity. And that's exactly what we've been doing. I mean our focus in the areas of cardiovascular, invasive neurosciences, general surgery, high-end orthopedic spine and many of the other surgical specialties has been relentless. All of our work in the acute care segment is dedicated to that. And if you look at it today, we've largely bridged off of a pretty significant amount of commercial COVID intensity last year to an environment where other than COVID spikes, we don't see a huge amount of COVID in our portfolio, but we are seeing and growing the high acuity services that we're interested in providing, and we're pleased that, that gives us a foundation for next year to continue to build off of.

And just maybe off of that, you've also talked about in the ASC in terms of your capital allocation [indiscernible] on earlier. ASC business [indiscernible] talked about the [indiscernible] 4% to 6%. I mean, how do you think about invest capital deployment in ASC side [indiscernible]? And how do you think about the [indiscernible]?

Well, the ASC segment has so many fundamentals that are attractive, right? And then we have USPI within the context of that market that is incredibly attractive. So first of all, the segment from an ambulatory surgery center standpoint is a significant growing market that's fragmented. I mean there's business that's moving out of the acute care setting into the ASC segment. But more importantly, from our standpoint, as things can be done in the ambulatory sites, it stimulates new demand. This is not just a cannibalization event by any stretch of the imagination. It hasn't been, by the way, for 15 to 20 years. Once you put services into that environment at a lower cost with a better service level, demand overall increases. And so that significant tailwind is very important to our thought process there. USPI, and it's -- again, as I said, the industry is incredibly fragmented still. USPI within that context has so many unique features. The first is obviously its position as sustainably the highest margin competitor in that environment. The second is the work that we did over the last 3 or 4 years to really integrate USPI and Tenet, which created the ability to deliver synergies into the USPI environment, which are unique across a number of different fronts, really creates the premier M&A engine in the ambulatory surgery environment. And that's important. We're able to consistently, if you look at the vintages that we've acquired from back in 2016, drive the multiples down below 6x on a pretty consistent basis from that standpoint. We obviously accelerated our capital allocation priority movement in that direction with the 2 SurgCenter transactions. We can talk a little bit more about. And then from the standpoint of the hospitals, look, it is incredibly important that we run high-quality, attractive, desirable acute care hospital markets that are important to our synergy strategy, okay? And when they're not important to our synergy strategy or they don't deliver as much value to that, example in this region, where we divested some of our Florida hospitals, particular in Miami-Dade, which were virtually all government payer mix at a very attractive multiple. We used those proceeds to pay down debt. And we're open to those types of things if there are attractive price [Audio Gap].

Yes. And I guess, shifting topics here a little bit, the favorite labor -- contract labor and so forth. Can you discuss [indiscernible] make sure you [indiscernible] more than a couple of times, but feel free to share your thoughts on labor [indiscernible] that's challenging and what the opportunity [indiscernible]?

Let me start off on that, Larry, in terms [indiscernible] contract labor management. We believe it's been very effective [Audio Gap] the reported contract labor, our contract labor levels [indiscernible] others. Now in the third quarter, we did see an uptick [indiscernible] labor. There was 2 markets, in particular, our California market [indiscernible]. It accounted for about 2/3 of the increased contract labor [Audio Gap] but that certainly had an impact. But our levels did go up, [indiscernible] others were coming down [indiscernible] for quarter. All that said, we're very focused on continuing to manage contract labor spend and other labor costs effectively. And we do think as we think about the fourth quarter here and then move into next year that there will be some moderation in contract labor rates and the availability [indiscernible].

Do you generally view that the second and third quarters of [indiscernible] as it relates to contract?

We think in the third quarter, [indiscernible] that was -- we do think that was the [Audio Gap]. We do expect some moderation order. The key, and we're going to be continuing to look at how [indiscernible] are over the next several months when we put out our guidance [indiscernible] February for next year. Obviously, we'll put some metrics on [indiscernible] think that at that point, where we think it's heading [indiscernible]. Thank you.

Saum, you touched on it, the whole transitioning into USPI [indiscernible] and some of the challenges [indiscernible] buyouts. Walk us [indiscernible].

Sure. So by way of reminder, there were 2 tranches of certain centers acquisitions that we did. First, back at the end of 2020, where we bought a number of centers, they were much more what I would describe mature centers. They've been up and running, if you will, for a period of time. And actually, in that group of centers, our ability to buy up, consolidate and move forward, we actually achieved 100% of those centers at that time, and we were very pleased with that. As we moved into the second tranche of SurgCenter, we actually took a fair amount of time to negotiate the construct of the deal. It was much more complicated. There were mature centers. There were centers that were just opening up and starting there were centers that still needed to open up and somebody had to bring those in an organized way to completion to market. And then as you're aware, we also structured with the RemainCo SurgCenter entity, a development agreement to complement USPI's development team, the development of roughly 50 centers over a 5-year period that would be new and added to the portfolio on a more exclusive basis. And that transaction, again, we're pleased with the performance of the centers. But as we've talked about in prior forums, there are 2 things that really slowed down there. One was our assumption around the number of centers, which would reach a mature level to actually complete the buy-ups in 2022 that we had targeted. And that's really much more of a consolidated EBITDA question versus the equity earnings coming from those centers. The centers are performing well and reasonably close to our expectations from that standpoint. So that's very good. Look, the notion of buying up to a majority stake in these centers is something that you really want to do with a clear cohesion among the physician partners that you're working with because it doesn't help to have a majority vote to consolidate and a few of the physicians in a center that's pretty small, not want to consolidate and leave, you actually care more about the performance of the business, and you would wait until you're in an environment where everybody is comfortable with those moves. So that's kind of the first one. And again, for this year, just to put some dimensions on that, that was probably about a $25 million consolidated EBITDA change in our guidance within USPI. The other one was just the development of these centers that were ramping up and/or actually still needed to be opened, where a variety of issues around supply chain and the labor markets to get those things opened up with the schedule that we had originally developed was delayed. And I'm not -- these are syndicated physician partnerships where they put capital into these businesses. They'll open, they'll grow, they'll develop. It will just be on a more developed time frame. But again, we estimate for this year in the USPI business that amounted to about a $15 million headwind with respect to the original -- with respect to the original guidance. Look, from our standpoint, the SurgCenter portfolio in total is an incredibly important acquisition. First of all, it's really the only other large-scale portfolio out there that was performing at margins similar to the USPI portfolio. The second thing is it solidified our movement into the clear leadership position in the orthopedics bone and joint space. That is really the future over the next, call it, this decade at a minimum of where the ambulatory surgery growth will come, and we're in the midst of our own service line activity within the rest of the USPI portfolio to continue to structure ourselves towards higher and higher acuity procedures in the ASC segment because that's where the growth will come from over time. And so this is all part of a broader aspect of repurposing, if you will, the ASC business towards higher acuity work. I mean just statistically, before we started this journey, orthopedics was probably less than 7% of our portfolio. It's north of 20% today in terms of the USPI portfolio. That's a really important transition we're making.

And where can you take that over the course [Audio Gap] with the orthopedics? [indiscernible] kind of a vision in terms of SurgCenter or the legacy USPI assets that you can shift that?

I think there's still a significant amount of growth. I mean, I would say in terms of business that's being done in the ambulatory setting in orthopedics, we're probably in the third or fourth inning of that ball game. And there's a lot of opportunity there. There's a lot of need to trial and develop the innovative techniques to grow beyond some of the things that are done there today and bring more physicians that comfort zone, and that's why the breadth of the portfolios [Audio Gap].

Is that process of shifting to a higher acuity mix in an ASC setting, does that require a, call it, managing the economics or managing partners [Technical Difficulty]?

Yes, sure. I mean any time in a business like this that you're making migration in the service line mix, you're beginning to affiliate with a different and new set of physicians. And that's a really important dynamic that we're going through. I mean one of the really nice things about USPI is that we don't employ physician USPI. So physician employment in that setting can be very dilutive to margins, right? I mean physician employment can be a 0 margin or in some cases, a negative margin type of venture. And so we don't have that dilution because we generate such high returns in our ASCs, the physicians are independent in their practices or affiliated with other health systems, and they're delighted to be part of the USPI platform because in their work in the ASCs, they're generating returns on their equity with 30-plus percent EBITDA margins. And so we don't -- 35% plus EBITDA margins on average. So we don't want to get into that type of dilution. It's the reason we partner with others who are scaling the physician [indiscernible].

Have you [indiscernible] coming out of COVID, so to speak, have you found that the physician or surgical community as a whole, has any [indiscernible] preference for the outpatient setting versus inpatient setting and/or are you seeing payers any [indiscernible] driving that volume out?

Yes, those are 2 good questions. And I think they're a little bit different. I think in terms of physicians, in environments where there have been significant COVID challenges, in particular, that constrained hospital capacity significantly, surgeons looked disproportionately to say, okay, is there a safe environment to operate in, the ASCs were a nice outlet for that. And that has happened a bit when there are really, really big spikes in the earlier stages of COVID where hospitals is full in the United States. I think that's settled back to normal in terms of the balance between the acute care side and the ambulatory side. From a payer standpoint, I would say there's, at this point, a bit more of a subtle push into the ambulatory setting, where we find the benefit of that is that the ASC business for us at this scale is an incredible value-based care asset. It is Tenant's value-based care asset for the future because the cost of what we're doing in that setting is 30%, 35%, sometimes more percent lower than in an acute care hospital. And that is really important to the health plans in terms of having that lower cost environment, which is why we see the ability to contract for these assets to be significant. So mind you, we have certain advantages from a contracting standpoint, but it's still an incredible value-based [indiscernible] play from the standpoint of both government and [indiscernible] payers.

Dan, I'll flip it over to you. Your -- as your cash flow metrics and your leverage profile are materially improved from [Audio Gap]. I know you necessarily have a target leverage profile out there, but your thoughts around your current leverage profile and payment profile [indiscernible]. Saum was talking about in terms of capital allocation opportunity [indiscernible] side.

We don't have a specific target to put on at this point. I would tell you, we've obviously made significant improvement in driving down our leverage over the past 4 or 5 years. You go back to '17, our leverage [indiscernible] basis. Saum mentioned earlier, we've reduced our leverage [indiscernible] times. Since then, very focused on. We've taken advantage of opportunities [indiscernible] assets to reduce debt. Obviously, the earnings growth of the company helped us to delever. And we're slightly below 4x right now. In terms of going forward, [indiscernible] through some of the capital allocation priorities, where we think about starting out the year, investing about $250 million to continue to grow our Ambulatory business. We'll continue to allocate capital, strengthen our hospital portfolio, particularly higher acuity service lines and in certain markets, adding some capacity. An example, just opened a hospital outside of Charlotte, a very attractive market that we're very familiar with. We analyze the risk [indiscernible] with that investment, we're very comfortable. Again, very focused on higher acuity type of services. And we'll continue to [indiscernible] strengthen the hospital portfolio that way. And we're going to continue to look for opportunities to reduce debt. I think we've demonstrated that over the past 4 years [indiscernible] taken out a lot of the tranches [indiscernible] available proceeds. And we just recently announced we'll be allocating [indiscernible] capital for share repurchase program, given where our equity is. So those are the 4 main capital allocation priorities. As you think about going forward, and again, through continued growth in earnings and taking advantage of opportunities, right opportunities were there. To use proceeds to reduce that, we'll focus on that as well.

Just as one follow-up. Is there -- obviously, USPI was a great transaction [indiscernible] hindsight. Are there other transactions of that size you would look at the early [indiscernible]? It seems like the transaction deployment not of this magnitude that given the size of the company, how that would materially change [indiscernible] that 5, 5-plus times doesn't not come. Would that be safe to say?

Let me just address the market for a second, and then I'll pass it to Dan. I mean USPI today relative to where it was 5, 6, 7 years ago, because of the integration work we've done, certainly has the ability to deliver significant synergies into almost any asset acquisition that we would potentially pursue. And obviously, we track the larger opportunities that are out there. But there's nothing in particular to really say about that at this point. I would tell you that it's important. We've completed 2 large acquisitions and at the same time, we've done those acquisitions, the USPI development engine separate from the larger acquisitions has acquired a significant number of centers at the same time. So while we'll -- as Dan alluded to, continue to deploy $250 million as a target into that segment because we have a great pipeline of assets. We're also going to take the time to appropriately digest what we've acquired. And let's learn from the events of 2022, especially with the second SurgCenter transaction and really work on getting those things fully integrated within the system. We're very comfortable that we can get that done. But obviously, it's going to take a little bit longer from that standpoint to get it done.

We have a couple of minutes here. Do we have any questions in the audience? Pass around the mic.

You mentioned that contract labor ticked up in 3Q. And I think in the May conference, you had quantified what percentage of salaries and benefits that was and what your expectations were for the end of the year. Would you be able to provide like what percentage of sales and benefits of -- salaries and benefits would -- were from contract labor utilization?

In the third quarter, our contract labor kind of consolidated [ SW&B ] was 7.4%.

Good morning. A few questions, if I can. Earlier, you mentioned how the shift to ambulatory care maybe increases demand. How does that work? Are people getting more surgeries because it's shifting towards that type of environment? If you could explain that. And then the second one is maybe you talk about the economic difference between working at a hospital and ambulatory care, you mentioned that the costs are lower. [indiscernible] the reasons why between the 2?

Sure. So if you look historically in the ambulatory surgery space that some of the services that migrated a while ago, right? So think about invasive gastroenterology type of procedures, some of the things in E&T, ophthalmology, et cetera, when those things were done in a more acute care setting, the demand for those services was lower than it is today. I mean at the simplest level, ambulatory surgery centers have probably been the most innovative infrastructure setting to improve the penetration and utilization of preventative and screening colonoscopy, right? When you have a service environment -- I mean you look at USPI, our patient satisfaction rates consistently exceed 96%. You don't see that in the acute care in the acute care setting, generally speaking, largely because of the environment. And so as things move into a setting where there are lower cost, lower co-pays, incredibly high levels of satisfaction, demand [indiscernible] relative to what it would in an acute care setting. Remember, the other thing is for people having invasive surgical procedures there today, it's an ASC. There's no really significant overnight capability. So you're providing that surgery and environment where you show up, you have the surgery, everything for you postop is set up PT and otherwise, and you go home. And so people have a lower threshold to get that kind of procedure done than if they were having to go in for a 3- or 4-day acute care stay. So we're convinced that as we look at the market in orthopedics getting work done in that center versus an acute care setting is going to expand the role of people that demand that type of surgery. To your economic question, look, I mean, the capital profile and economics of the acute care segment versus the ASC segment are very different, right? I mean a really well-performing acute care segment, you're going to have somewhere in the low double-digit to mid-double-digit type of EBITDA margins, and you're going to spend 1/3 of that EBITDA or more on CapEx just to maintain and develop those centers. And it's very capital intensive, very people intensive. SW&B is sometimes 50-plus percent of the cost of doing that. The ASC setting, you're generating 30-something percent margins with our ownership, which is obviously different than the average, and you're spending 10% of that or less on [ capital ]. I mean we spend 2% to 3% of net revenue on CapEx in that segment to maintain and grow earnings on a very long-term basis. The capital profile is terrific, and therefore, the cash flow profile is terrific in that business. It's very different.

I think we'll go ahead and wrap up. We've hit our deadline here. So I want to thank Saum, Dan and Will, thank you for the time today. And everyone, enjoy the conference.