Tenet Healthcare Corporation (THC) Earnings Call Transcript & Summary

All right. Great. We're going to start our next session here with Tenet Healthcare. By the way, I'm Steve Valiquette, the health care services analyst here at Barclays. With us from Tenet, we have Dr. Saum Sutaria, the company's CEO; also Dan Cancelmi, the CFO; and also Will McDowell, from Investor Relations. And I think Will wants to make some disclaimers first, and then we'll dive into a fireside chat.

Just briefly, in the course of the conversation today, we'll be making some forward-looking comments. I would suggest you refer back to the cautionary statement, including our most recent earnings release for any risk factors associated with that. I'll turn it back to you, Steve.

Okay. Great. All right. So I guess just to kick things off. You guys had some nice deceleration in your ASC volume in the fourth quarter versus the third quarter. I think overall, I think people see a lot of promise in just ASC industry growth overall. I think people are -- you're hoping to see maybe stronger volume accelerating further for you guys over the next couple of years or so versus the past couple of years. So this question seems to come up a lot, but maybe just to kind of throw that out there as far as the outlook for any potential acceleration of the volume growth within USPI.

Yes. No, Steve, I appreciate that. I mean, first of all, we too are incredibly bullish about the ASC segment. I mean there's just such a nice natural tailwind of movement into that environment. Especially in our case, USPI has always been at the leading edge of innovation and higher acuity work in the ASC space, which is really where we're focusing our energy. As you know, we were a very large provider of orthopedics care before that surge center transactions. We're incredibly strategic in that they were almost 100% orthopedic. And we really want to ensure that we are the unquestionable leaders in that space. As you look forward, I think it's probably the area of most significant growth. Look, USPI has had a pretty consistent track record. If you go back to Tenet's acquisition of USPI from 2015 to 2022, it's been consistently between 4% and 6% top line growth, which is what we say looking forward, we were at 4.6% in 2022. The EBITDA performance on that was a little bit disappointing in the end, given some of the things that happened, including with progress on our transaction integration. But as we look forward, we're very optimistic about not just this year, but the coming years with the ASC business. And there's nothing that I would tell you we see right now that would cause us to change our guidance at this point.

Okay. Yes, certainly helpful. Also, on USPI, so the growth outlook for 2023, I think, is pretty strong overall. You're putting the components for organic and some of the additional openings and everything. But just coming out of the last quarterly call, just want to just tackle and confirm that I think the growth will be pretty consistent through a lot of the quarters throughout '23, around the 11% growth. I think there might have been a confusion it might be back-end loaded. I don't think that's the case. Maybe just to clarify that as far as the kind of the trend line throughout the year in the context of the full year guidance.

Yes, Steve, that's right. First quarter, what we said was that USPI's EBITDA would be roughly 22% of its full year guidance in the first quarter. And that represents roughly 13% year-over-year growth compared to the first quarter of last year when you normalize for a little bit of grant income was in there last year. So 13% growth first quarter and 11% for the full year.

Okay. Yes. That makes it very clear. I guess maybe moving off of USPI for a moment, maybe just on the overall acute care business. And certainly, one of the positives for the industry in '23 should be some continued recovery in admissions ever as comparing that still to the 2019 levels pre-COVID and you're trying to normalize for that going forward. I don't know if you're in a position today to talk about how utilization or admissions are trending so far in calendar '23, but maybe just if you're able to just give any color on how things are trending so far relative to your expectations and your guidance is certainly helpful just to get a sense for some of those trends.

Yes. No, I appreciate it. I mean, we're not going to comment intra-quarter on volumes. But as I said, with the USPI business, there's nothing that causes me to want to change my guidance at this point that we see. The most important thing I would say about where we're headed from a volume standpoint in the acute care business at Tenet is a continued focus on the high acuity services, both emergent and elective procedure based but also intensive care based type of work that we've been putting our energy in capital and physician strategy is dedicated towards building because we think that's going to be not only the most defensible area, but it's also going to be an area where the revenue generated from such strategies, including, by the way, trauma programs and rural outreach, patient transfer programs and other things will generate the kind of net revenue intensity that will help to replace some of the volume that we're not seeing return from back in 2019. I mean I think that chasing the exact mix that we had in 2019, looking forward, probably doesn't make a whole lot of sense, and we're not spending a lot of time doing that. What we focus our energy on is really looking at our consistent improvement in performance in non-COVID acuity growth as we look forward. And look, if lower acuity business starts to come back into the hospital and that may affect what Dan recall kind of mathematical acuity case mix index, that's fine. I mean in our environment and our level of efficiency that's going to help spread fixed costs. But strategically, what we want to do is be at the top of that pyramid and earning more than our fair share in our markets of that kind of work because that's what we think is going to drive our acute care business longer term.

We're optimistic about our hospital volumes. This year, we're anticipating 1% to 3% admissions growth and 2% to 4% adjusted admissions growth. Listen, our fourth quarter hospital admissions, adjusted admissions, they were up 2.9%. And our non-COVID admissions were up over 4%. So we like the trends we're seeing. So that's -- we're optimistic about this year.

Okay. Great. Okay. So I guess moving on to the topic of staffing and labor expense, still pretty topical for investors around all this as well. Yes. I think, again, kind of setting the stage around that. I think everybody expects generally speaking, for some of those trends to improve in '23 versus '22. Maybe you could just talk about, again, anything that you can opine at as far as how that's tracking relative to your expectations so far this year. You guys are pretty good about giving some metrics around that, just given the contract labor as a percent of total SWB, I think that was between 6%, 6.5% exiting '22, but maybe just an update on how that's progressing.

That's right. We were around 6.4% in December. And that's despite the winter volume surge of respiratory illness that we saw, which in the case of December, January, really weren't overwhelming for the hospitals at this point in time. So our -- we're confident in our management approach. We still believe continuing to run contract labor tighter than what we might see around different parts of the industry makes sense and being thoughtful about the capacity that we're opening up and not opening up from that perspective. And I would say that so far, '23 is trending pretty much like we would expect. Rates are coming down modestly from where we were back in the October, November time frame of last year. And that's a good thing as they should. And I think increasingly, as in particular, some of the not-for-profit industry, which has started to post some very challenging financials as they release labor, it will create some more liquidity in the marketplace, which will help with those rates on a short-term basis. Medium to longer term, this is going to get solved much more through adequate hiring relationships with nursing schools that we've built. We're doing a lot from the standpoint of what I would describe as more rebuilding our workforce rather than just trying to manage the marginal cost of the most expensive workforce. The agenda shifts in '23 towards that while we continue our management approach on contract labor.

Okay. And not to get too granular on all of this, but the -- as far as the rates coming down, that's obviously talking about the temp agency staff. But as far as the -- what you're having to pay for full-time employee hires on the nursing side. There's some inflation there, obviously, versus where that was previously, but how is that tracking relative to your expectations?

Yes. What we're going to do, we've been taking the savings from contract labor reductions and reinvesting a portion of those into our full-time staffing, and we're going to continue to do that. Obviously, the economics are much more attractive. It's better for the overall employee base. So we're going to continue to do that. We are anticipating further moderation in our contract labor rates this year. We're not anticipating we get back to pre-pandemic levels, which was roughly 2% to 3% of our SW&B, but we landed last year, roughly 6.9%, as Saum mentioned. We exited the quarter in December at 6.4%. So we do anticipate some moderation this year. In terms of the overall the full-time employees, historically, wage rate increases typically in the 2% to 3% range depending on the market conditions. And obviously, last year, the increases that we provided to attract and retain employees was a little bit more than that. I'm not saying we're -- that's all behind us. But I would say this year, we will continue to have some wage increases, a little bit above what we would normally see in the industry.

Okay. Great. Okay. Maybe jumping on to another topic here, just around supplies and other expenses. It seems like across some of the hospital operators, there's been some mixed commentary around levels of inflation on supplies overall. Maybe just give us an update on how these costs are trending for you guys. Is there anything to be mindful of for that kind of exiting '22 and into '23, that might be helpful as well.

Well, let me just say, overall, to start with, that without question, there's pressure in all of the nonlabor cost categories, it just hasn't mimicked the kind of pressure that we've seen on the labor side, right? So just start there. So for us, we began in late 2018, early 2019, a pretty comprehensive review, which we accelerated at the beginning of the pandemic of all of our -- both commodity physician preference, supply relationships and our purchased services contracts. And so we've been working on making changes in what was a little bit more of a decentralized environment in Tenet as those contracts came up over -- most of these things can be 2- to 3-year type maybe even longer, in some cases, relationships. And so as they've come up, we've been negotiating consolidating vendors and probably in some ways, managing our demand in a lot of those areas. And what that's helped us do overall is mitigate some of the pressures because those opportunities existed at Tenet when the environment was a little bit more decentralized from the decision-making standpoint than the way we operate today. And so I don't think -- when you talk about mixed commentary, I do think there are pressures in nonlabor costs. I don't think they're going away. I think they're more significant than they've been in the past. But we also see opportunities in our business to try to offset some of what we see in the macro environment.

Yes, that's right. In terms of supplies, specifically, Steve, obviously, we have, in addition to some of the items that Saum mentioned, we have a relationship partnership with HealthTrust. They've obviously entered into various longer-term contracts, which has helped. So the pressure on supplies has been somewhat mitigated. But clearly, the most significant inflationary pressure for us has been on the temporary contract labor side. That's not to say there hasn't been cost increases in like construction materials and other items. Not surprisingly, I'm sure you've heard other companies talk about some pressures on physician support or subsidies. But as Saum mentioned, we're managing through that, and we've done a really good job managing costs these past several years, and we fully expect to be able to continue to do that.

Okay. Great. Actually, one other question on labor, [ on as we ] brought it back to that for a second here. The -- I think investors always want to hear more about -- this goes back to the USPI side of the business. As far as the arrangements with the surgeons, as far as direct employment versus more just a contractual affiliation, just curious if you want to maybe just spend a little more time talking about that dynamic and again, certainly helps your margin profile. But I guess people wonder, does that play any role in the volume trends. I just want to make sure, are there any shifts going on within those contractual affiliations with the surgeons within USPI?

Yes. Well, it's -- those multifactor I'll answer that. So let me unpack it a little bit. First of all, by generating the industries by far best returns in our ASC partnerships, we're able to support physicians remaining independent more so than other platforms that exist, okay? Because when you're generating a return that's, call it, a 35-plus percent EBITDA margin at that level, the returns the physicians get from that investment are often substantive enough where they don't need to look in an area for subsidy from a health system to be employed, okay? So that's -- we have -- I mean, USPI materially does not employ physicians. And we have partnerships with those physicians, sometimes they're joint venture partnerships with their equity owners in the centers. Sometimes those physicians are part of groups that may have some equity ownership but they also participate in our centers without being equity owners, but they are future potential equity owners. So I look at it a little bit differently, which is the ability to generate those returns mitigates the impact. I mean I always find it amusing when people talk about what does it mean to be an independent operator of surgery centers? Tenet has really nothing to do with those centers from a hospital standpoint other than having a national contracting platform. The reality is USPI is probably most capable of supporting physicians remaining independent because of the returns we generate. Now when you have independent physicians, you obviously rely on them refreshing their practices in order to see growth. And I would say, legitimately, over the last couple of years during the pandemic, any small business physicians included, have been more careful about how they replenish. Are we going to bring on another surgeon? Or are we going to try to manage what we've got and not take on that additional cost. One of the things we're optimistic about given the ability to add physicians we saw, in particular, in late '22 and what we hear from our physician groups in '23 is they're returning to a growth mode. And you're right, we ought to see some of that flow downstream. It's one of the reasons we had more confidence this year in returning to our normal type of volume growth that we've seen over many, many years from that standpoint. On the employment side and the impact of the employment side, USPI has partnerships with sort of the leading brand name health systems, over 50 of them. And again, because the types of returns we generate for the physicians and the health system partners are so good, in many cases, those health systems will employ physicians as part of their own strategic network and they allow them to practice in our centers without USPI necessarily being exposed to the cost of employment. And those health system partnerships prove very strategic in those markets because where there is a need for employment, they cover that strategic initiative on behalf of the partnership. And that's very helpful to us so that employment doesn't become a major headwind for the USPI business in those cities.

Okay. Great. That's helpful just to get that extra color on that. Maybe a final question around USPI, and this kind of ties into a balance sheet question as well. You've done a pretty good job improving the balance sheet, getting the leverage down to around 4 turns somewhere in there. Just curious whether you're still focused on further deleveraging or because of the opportunity and just the ASC, the business overall, where do you stand as far as potentially being more aggressive on acquisitions relative to what kind of the numbers you talked about previously as far as the targets around expenditures on the USPI expansion?

Yes. We absolutely still are very focused on reducing our leverage. Every capital allocation decision we make, what it means to our leverage, what it means to our free cash flow, what it means to our margins, stating the obvious. Listen, we've made a lot of progress over the past 5 years. Leverage if you go back then was roughly 6x. We exited last year at roughly 4x. We have pushed out maturities, refinance various tranches. And we've also retired a lot of debt to generate interest savings. We are only noteworthy maturities coming up in the third quarter of 2024. And then there's nothing after that until 2026. So in terms of -- we're very focused on continuing to look for opportunities to reduce leverage through earnings growth and depending on market conditions, actually retiring debt outright. All of this has helped us improve our free cash flow significantly over the past 4 or 5 years. We're anticipating free cash flow of roughly $1.2 billion this year. It enables us to self-fund the M&A and de novo development activity for USPI. And we start off the year targeting roughly $250 million of capital to be allocated to continue to grow the ambulatory platform. The pipeline is very robust, and we fully expect to deploy that level of capital. If the right opportunities are there, as you've seen several -- past several years, we'll invest more if it makes sense if returns are there.

And I'd just add one other comment to this, which is, not surprisingly, we're very focused on the quality of assets we acquire. We see a lot of opportunities where we may have the ability to deploy synergies, but we don't see them as necessarily quality assets or assets that have long-term strategic potential. So we're very careful at this point about how we deploy capital into the USPI business from a growth standpoint. We still believe that there are quality assets out there that would allow us to spend our target $250 million. But the one thing I would say about the business and where we're headed with the business that's important from a leverage standpoint is that if we can continue to acquire centers at very reasonable multiples the way we do because the sellers, in particular, the physicians don't necessarily expect the highest multiple upfront because they believe that the return will -- that USPI will generate for them over time is attractive. And then we can drive those multiples down below 6x or whatever pretty quickly. The more we acquire those types of businesses where you've got a 30%-plus margin, it cost you 2% to 3% of net revenue and maintenance capital to continue to generate earnings. That's Tenet's best ability to generate free cash flow to ultimately deploy not only in the self-funding M&A, but excess free cash over time to manage our leverage. And so we view the M&A opportunity and the growth of that platform as an important lever for us to not just grow earnings but use that excess cash to deleverage the company. And that's -- I think that's a very unique position we're in because of the types of margins that we can run in the ASC business so that the cash generation vastly exceeds the capital needs of the business. It's obviously different than the acute care business.

Right. Yes. Okay. And that's all certainly helpful. And also maybe just one last thing on the capital deployment and tying that into the -- managing the leverage ratio is really just where share buybacks kind of fit into capital deployment as well. Obviously, you're getting a pretty good bang for the buck on that as far as where the stock has been trading, but I just want to get just your latest thoughts around that.

As you know, Steve, the Board approved a $1 billion share authorization -- share repurchase authorization. We invested $250 million in the fourth quarter of last year. And we'll continue to -- it's -- as I said, it's another tool in the toolbox to allocate capital depending on market conditions and other investment opportunities.

Yes. Okay. Great. Okay. Just finally on CapEx. Aside from USPI and some of the de novos and everything there, where else are you allocating CapEx sellers. Maybe remind us again kind of what you're focused on, on the acute side as far as CapEx, beyond just the maintenance, but just curious.

I mean we're largely focused on expansion of services and very, very selectively infrastructure in the markets that we think we have long-term potential in that are important to our contracting strategy and ultimately, where we see good payer mix expansion in new and growing communities. That's really what we're focused on. I mean our clinical technology environment is pretty solid right now from the standpoint of being able to produce the type of volume that Dan talked about earlier. And also very selectively, we continue to focus on some of the tools and technology investments that help drive more automation and in particular, predictive AI technology within Conifer that has really helped us continue to be ahead of the trends with respect to the payer provider interaction on where claims and collections issues are arising. It's an important part of our platform there, and we continue to invest in that.

Okay. Great. All right. Well, with that, I think we're out of time. So I want to thank you guys for your time today and enjoy the rest of the conference.

Thanks for having us.

Thank you, Steve.