Tenet Healthcare Corporation (THC) Earnings Call Transcript & Summary

I think the clock is on. So I think we're going to get started here. So good morning, everyone. I'm Steve Baxter, the health care services analyst here at Wells Fargo. I'm very pleased to have Tenet Healthcare with us. So Tenet is an operator of ASCs, acute care hospitals and a revenue cycle management business. From the company, we have Saum Sutaria, CEO; CFO, Sun Park; and Will McDowell from IR. Will, did you want to make an initial comment and then we'll kick it over to Saum.

Sure. Thanks, Steve. Good morning, everyone. Thank you for joining us today. In the course of our conversation today, we may be making some forward-looking statements. In that context, I suggest you refer back to the cautionary statement in our most recent earnings release and SEC filings. And with that, I'll turn it over to Saum for some opening comments.

Thank you, Will. Just very brief comments to kick us off. Obviously, this has been a transformative year for the company. A lot of things look like they came together relatively quickly, but obviously, we've been working on many of these things for a few years. I think when we started in this journey, 5 or 6 years ago, we were very clear that we had a commitment to deleveraging the company, realizing the fair value for the assets that we had if we divested assets, growing the ambulatory business and taking advantage of kind of a generational tailwind in movement of procedures into the outpatient setting at a lower cost. And ultimately, over time, and it has taken us some time building upon the improvements we've made in the results, client orientation and frankly, profitability of Conifer to restore it to a pathway of positive top line growth, which we'll see in the coming year based upon client additions that we're building in. So the momentum is good and our ability to de-leverage the company with the types of proceeds we've generated, again, I ascribe that to the quality of the assets that we've been able to put on the market have been very good. And seeing the company at a place where the leverage generates not only a degree of strategic and financial flexibility, but stability for the organization's ability to invest in growth over the next few years is terrific. So look, as we look forward, we're focused on one thing, and that's continuing our long track record of execution on what we're doing organically from a cost efficiency standpoint and inorganically, we notice, of course, that as we continue to execute over time despite the value that's been created the multiple described to the company and the value it's generating and the confidence that people have in the company continues to creep up towards what we think would be more appropriate levels for what the organization is capable of doing over the next decade. And we absolutely expect to continue to work at that in the coming years. So look forward to the Q&A, and we appreciate the opportunity.

Yes. Thanks so much. Yes, so that's a good place to start. I mean, obviously, the company has created a huge amount of value over the past couple of years through some of the hospital divestitures that you've done. I guess just taking a step back, could you just talk a little bit about the market conditions that have allowed for those deals to come together? Like how is the buyer thinking about the decisions they're trying to make strategically and how are you guys becoming engaged in those conversations?

Yes. I mean I can't put myself in the heads of the buyers. Obviously, that's difficult. But none of these were processes that we ran, right? These were sales based upon an understanding of the strategic value these assets had. And again, as I said, the quality of the portfolio that we were willing to transact. And obviously, we had requirements in terms of the proceeds we needed to generate, because we weren't going to go down a path of divesting assets that did not allow us to materially de-lever, and we were also very deliberate about not starting down this path 4 or 5 years ago or 6 years ago, before improving both the earnings and the quality safety service components of those assets so that they would indeed be worth more than what people think of as kind of market averages. And that strategy worked out pretty nicely.

As we think about what could still be in front of you, it seems like it's obviously -- been a very like opportunistic set of circumstances that have allowed some of these deals to come together. Is there any way to think about like what inning you're in? Or if you get to a certain point with the size of the hospital portfolio where you start to have to make different decisions about trade-offs either scale, negotiations, purchasing, things like that?

Sure. I mean, there's probably some point at which you reach that. I think it's a little different for us, which is we've been pretty comfortable given the improvement we made that the portfolio that we had at each stage was something that we can operate, and we could do well with and we could grow earnings with, et cetera. Now it helps that part of what we've done strategically is actually improved the nature of the portfolio, and we probably need to do a little bit more in terms of articulating what that means to the investor community. But we like the portfolio better where it is. And that's good because we can invest more in the growth of those assets. At the same obviously, we have our priorities from a capital deployment standpoint that include building and scaling USPI. And so when you start to generate attractive returns across both of those books, you're in a better position over the longer term. And I feel good about the fact that we should be able to increase our investment in our hospital segment and generate better returns.

Okay. That was going to be a good question. I mean you said maybe you could do more over time to articulate how you think you could better position the businesses. Maybe this is a good chance to do that. In terms of the investments now that you can maybe make, because your balance sheet is in a different position, or some of maybe like the capacity-driven changes that could come as a result of now that we're kind of in a more stable operating environment than it's really been over the past couple of years. I guess what do you think are going to be the key things that people notice differently about the operations and performance of the remaining hospital portfolio a year or 2 years from now?

Yes. Well, let's just start with the fact that we're in a good demand environment right now. I think we're coming to -- and again, no one has a crystal ball around this. I've been consistent in saying that I think we would see 5 years of post-COVID demand stimulus just simply by filling the demand hole from all the premature deaths, like simple concept. And I think for the hospital business, that will run its course through 2025. I actually think one of the more important things as we restore the marketplace for stores to more of a normal demand profile after that is that while the industry is benefiting from a lot of this demand and probably some of the financial benefit from the expansion of the exchanges like we are due to redetermination, ultimately, the discipline around operating efficiency when you end up in a normal demand environment is what's going to allow you to grow earnings. I mean, that has always been the case in this industry, and I think it will always be the case, especially when a rapid demand environment flows because for those systems that are enjoying that demand, but growing their cost base as aggressively when that demand slows. And we and a few other operators have spent a lot of time putting discipline into the operations in a very data-driven way. And that's hard -- at this point, that is hardwired in the company. It is just how we operate, the people who come to work for us, join the Tenet operating system. I mean, it's nice to be able to say that from a few years ago when that just wasn't the case, right? And it's -- and so that's good, because we know what kind of talent we want to attract, we know what kind of talent we want to develop. We know that as we scale people into larger roles, whether inside or outside the company as [ Alumni ], there's a system in which they're going to work and the operating performance is going to continue to deliver what people expect of it. And so because of that, as we look out to the future over the next 1, 2, 3 or 4 years, we are starting to be more comfortable with some of the long investments in the segment to help grow and build the earnings, right? I mean think about how many acute care hospitals focused surgical, high acuity, specialty, acute care hospitals, though, we're building in our markets, right? We've built in San Antonio, we've built just outside of Charlotte, growth areas, we're building further in Palm Beach, et cetera. So I think we have good confidence that as those markets extend, we can extend our footprint profitably.

Yes. So then just to kind of bring that point home. I know when you think about the level of maybe growth CapEx you've had in the hospital business over the past, call it, 3 to 5 years, I guess, how different do you think that could look on a relative basis, right? I mean, you now have a smaller portfolio than you did. I guess how do you think about the level of the magnitude of growth CapEx that you'll have going forward on the hospital side?

Yes, I think that will change year by year, but just using this chart as an example, right, so obviously, with a smaller footprint, we've increased our total CapEx spend. Now some of that is chunky, as Saum mentioned, over the last 3, 4, 5 years. A big component of that or a material component of that has been these new hospital builds that we've been able to absorb as part of that. So you could imagine year over year that might change a little bit chunky. But overall, I mean, I think if you look at our total financial footprint, our de-leveraged position, our annual free cash flow generation, I think we can -- we have the affordability to dial that up or down as the market demands dictate versus being limited in some way.

Okay. That makes sense. And then when we think about the volume performance this year, I mean, obviously, you guys had a strong start to the year in inpatients and especially strong, you taken up your inpatient admission guidance. As you think about kind of like what the drivers of that, the faster inpatient growth, can you spend a little bit time just kind of unpacking what you think is leading to sort of the inpatient results outperforming? And to the extent that you guys have a view specifically on to midnight rule and how that's impacting things this year? I would love to hear more about that as well.

Sure. Well, a few things. I mean from an inpatient standpoint, we're -- because of our focus on higher acuity admissions and intensive care and surgical care and procedural cardiovascular care that we've been investing in, it's not surprising that we're seeing more growth in that inpatient book than we are perhaps in other areas. That's deliberate. I mean our strategy all along in recovering from the pandemic was to recover the revenue not every single adjusted admission that we had. And again, we said that from the start. We thought -- and there was no [ hidden note ], but we thought based upon our math that, that would also improve earnings more quickly and allow us to reduce contract labor more quickly, because you have less volume, but a higher acuity. And that worked out very nicely. And so we were able to improve the profitability of the portfolio. And -- so I think that's good, right? I mean we're happy with the fact that, that is the case. It also allows us to rationalize in some ways, the amount of just infrastructure capital that we spend on existing facilities, because we're managing that capacity. Look, I think some of the growth that we're seeing this year is also because we've opened up some capacity. And not surprisingly, we're filling that capacity with demand. It takes a little while to get it going, but that's, of course, working. Personally, I struggle with 2-midnight rule. I think the most appropriate questions about the 2-midnight rule are really about how effectively the plans are adhering to CMS' guidance than they are to the providers about whether -- we're taking care of the patients one way or the other. And I still struggle to see that it's a large or material quantifiable benefit. I'm sure it's slightly positive, right? But it's not something that we've really quantified as being largely or materially positive.

Okay. Yes. I mean, that makes sense. It seems like it's very planned and system specific. So that could definitely be the case. Okay. And then when you think about the exchanges and the contribution, you mentioned it's been quite positive, the contribution of growth that's made over the past couple of years. Let's just get a better sense of, like, I think, one thing that the market as a whole is trying to understand is to the extent that there is some chance that the exchange population 1 year from now or 2 years from now is smaller because the enhanced subsidies potentially not being extended. How to think about that and the exposure that you guys would have to that issue? If you step back, like I don't expect to have a prediction for the size of the market or anything like that. But as you think about how exchange volume flows through your system and maybe it's that to how it would look for a more traditional managed care population. Is there anything to know about how the exchange volume is impacting your business that might look different or financially present itself differently.

I'll start and Saum, please. Yes. Just to quantify a little bit. We've said that just using Q2 in '24 versus '23 as an example, our exchange volume is up 60%, or thereabouts year-over-year, so very material. From a revenue perspective, it represents about somewhere between 6% to 7% of our total Tenet enterprise revenue, so mature, right? Now to your question about financial impact, I think it's also no secret that from a reimbursement basis, it's very similar to commercial. So obviously, a big driver compared to Medicaid rates. So all those things have been good, it's been showing up in our results. As we project that forward from how it looks different, I mean, there are certain probably signals in terms of indications where there might be a little bit more cardiovascular user, for example, in the exchange population and if you look at it broadly across our commercial, things like that. But I think it's right now tough to say like if something happens over the next 2 years, where we have a reduction in exchange volume, like which procedures or which acute levels we had. So I think that's [indiscernible]. But yes, no doubt, it's a material aspect of our business this year.

Yes. And just a few additional comments about this topic. I mean, first of all, it's material. I mean there's no question about the fact that if I put my this year, Federation of American Hospitals Chair hat on, there's no question about the fact this is the #1 issue that I and the Federation and the AHA and others or focused on, obviously, the insurance industry is very focused on this, too. I just step back and think about the same principles that I outlined when redeterminations began. On principle, it is not a good thing to take away coverage from people that rely on that coverage for the health care they have. Now if they didn't have the coverage that's a different thing. But when they have the coverage, it's difficult to take that away, because it fragments their care. That's never a good thing. I understand we're benefiting from redeterminations economically as it turns out. It's still not a good thing. And -- so that's number one. And I think that principle probably should be well understood by everybody is going to have to make a decision on this. The second thing to understand is that if you go and look at who the exchange participants are, they are younger than the average commercial participant. But there still in that young, middle-aged voter American citizen category, just to be blunt about it. And therefore, these are highly relevant individuals, whether you're in a blue state or a red state, and I think it's going to take people time to come around and understand who this population is. But I think as that progress is made by the industry in helping to educate the politicians about what is going on with these exchanges, we're likely to see a softening of perspectives here that help maintain coverage for this population.

And I think kind of the other area, maybe with the political sensitivity to it has been some of the improvement in Medicaid reimbursement streams. Obviously, Medicaid is still probably not a profitable business for you guys, but good to see that the reimbursements there have improved. You think about where that process sits? Like do you still think that there are states that you operate in on the hospital that have material opportunities? Do you think it's kind of played itself out at this point? And just broadly, how do you feel about the sustainability of this improved level of Medicaid reimbursement?

I mean I think the last question is probably by far the most relevant because, every time there are changes in the program or set of programs, that question comes up. I mean, ultimately, if you really step back again and think why is this happening, it's because the access to care can become so limited and the states who are supporting Medicaid programs need infrastructure, physician access, outpatient access, diagnostic access, et cetera. And therefore, these programs begin to take what unit reimbursement is well under the cost of providing that care and starting to move it in a direction that allows at least efficient providers and some safety net providers to make investments in that capacity to take care of the population that needs it. And we are absolutely in that bucket because with our level of efficiency, we welcome government care, and we welcome commercial care and we believe that's an important part of what we do. I think the program is because the fundamental economic reasons they exist are right, are sustainable. And in the states that have had them for a long time, California, et cetera, they've been highly sustainable. So at the most, you see is sometimes people pick away a little bit of the unit reimbursement on basic Medicaid to offset a little bit of what's -- but they are generally sustainable. In terms of additional states, we hear rumors and obviously, we follow the legislative activity in Tennessee. We don't have a huge footprint there. But we would imagine if that program passes that we would see some benefit.

And then just a bit of a more like near-term numbers question. It would just be the hospital EBITDA progression into the third quarter, I think you guys gave us an information on the second quarter to kind of back into the level of EBITDA you expect on the hospital side in the third quarter. And if you take out sort of an out-of-period Medicaid impact in the second quarter, I think you'd be looking at an increase sequentially, and I think a lot of investors are used to seeing in the hospital business, a little softer sequentially in the third quarter. So I would love if you could give us just an update on what you're thinking about might be a little bit different this year on the hospital side, whether that's calendar or any other factors you want to call out?

So color commentary first. I thought one of the purposes or benefits for us of deleveraging was to avoid quarter-by-quarter question. This allows us to think more long term which is what we're doing. Look, we're comfortable with the demand environment right now. We're comfortable with our cost management. We're comfortable with the fact that what we're seeing from the first half of this year looks good and therefore, our guidance looks a little bit weird. I mean, the portfolio is different from a historical perspective, too, right, in terms of the markets that we still own versus we've transitioned. So that's probably all I have to say.

Okay. That's totally fair. All right. So then to pivot a little bit on the USPI side of the business and obviously, a huge focus for you. As you think about the health and demand in the current end markets for that business, I know 2023 is presenting some kind of unusual comp issues as you've seen a recovery of volumes. But how do you think we kind of sit? And how do things really progress into the back half of the year? I think you guys are expecting a little bit better growth in the back half than you saw in the first half. Like give us -- to the extent you have like better line of sight to that now. I'd love to hear a bit more about it and progression into the next couple of years, more normalized? How are we thinking about outside of things?

Again, the long-term thinking on this is pretty straightforward. First of all, yes, there are mathematical comp issues that you have to deal with in any given year. But the reality is that of all the ASC platforms and the recovery that ASC platform has been going through, USPI being the ASC platform in the country, had the strongest recovery in 2023 from a volume perspective. And we look at that as a measure of strength and as a measure of preference of the USPI platform. And that's great news. Our medical groups have done well. ASCs, therefore, have done well and that's great. And yes, the growth was more than 2x what our annual guidance would look like from a midpoint standpoint. So yes, the comp issue this year is what it is. But actually, the reality is some of that was recovery volumes, so there's organic growth built into that because of onetime recovery. So we feel great about it. And the more important fundamental thing for us is that as we see that happening, the acuity keeps improving in what we're doing in the ASCs. And therefore, our earnings -- we're beating our earnings expectations this year at USPI. And we put out a pretty bold earnings target for the year at the beginning of the year when we gave guidance. So we're pleased with that and the fact that we've been able to raise that guidance in the middle of the year based upon performance. So USPI from performance, organic growth, cost management standpoint, et cetera, it's going very well. And obviously we've been busy on the acquisition side, in addition, which creates headwind, because you got the expense of integration, you got to migrate platforms. You've got to -- but we've sort of taken that on in the middle of this year in what would otherwise be a difficult comp year, and we're just rolling with it, and I think it will be fine as the year goes on.

Yes. And definitely, the notable progress on acuity and calling out things like the growth you've seen in the total joint procedures has been definitely a highlight. I mean, that opportunity just seems so clearly attractive and visible as more of that moves to ASC over time. I guess, how do you think about competitive dynamics around driving that volume into your centers? And what attracts physicians and surgeons to USPI to operate in your centers versus other potential places in the market?

Yes. Look, at the end physician partners are making a choice and they're making an investment that is often -- for many of them, it's the second largest investment behind their home that they're going to make. So you have to treat the asset as if this is part of their family's retirement, right? We have administrators that come and go and whatnot. But from a mindset perspective, you have to treat that investment as if that's a lifetime investment for that physician or other physicians that come in. And that's the mindset that we take. And so you think long term, you work to create the industry's best profitability, because ultimately, the return is based on the profitability of what you're doing. You work to have good outcomes, good policies, good procedures, good safety, good compliance, because that's how you safeguard the investment. We're very good about that. I mean, I often say, in a flattering way, being a part of USPI is like being part of a reputable country club. There are a lot of benefits from being part of the club, but you got to follow some of the rules, because we intend to safeguard the investments that our partners make and not put them at risk with the things we do. And that's true about how we work there. And then finally, have the flexibility to expand and diversify the ASCs to be multi-specialty or grow their footprint over time to do that. And we're just better at doing that, right? We're better at running multi-specialty. We're better at expanding the facilities. We're more comfortable running ASCs with 4, 6, 8-plus operating rooms than typical smaller ASCs as we expand them. So we give them a runway. And that's really what I think partners look for.

Okay. And on the total joint side. I mean, one of the things that was notable at least on the hospital side was how dramatic the shift was for things that were done in the inpatient to outpatient setting in the hospital. As you think about process potentially getting accelerated versus what have organically would have happened without COVID, I guess does that pull forward your opportunity on the ASCs? Or I guess, how do you think about the impact that could have over the next few years potentially pulling forward the opportunity closer to you than it would have been before?

No, it's a very good insight because as you know, when hospital capacity was constrained during COVID, a number of surgeons had an opportunity to go trial looking at ASCs that they may not have otherwise done. We opened up the ASCs in our markets to physicians, who needed capacity and credential them and whatnot. So it did create a pool of doctors to get comfortable in a different environment than otherwise. I think there's still plenty of room to go with outpatient surgeries in orthopedics to move into a freestanding ASC setting. And that's important. And to do it in a cost effective way, I remind people all the time that our ASC portfolio is virtually 100% on freestanding rates. So the cost savings from moving into that setting aside from the service and all that stuff is quite beneficial, right? And again, it opens the market when things are more affordable for more growth.

And then the pipeline on the ASC side seems like it remains quite healthy. You guys have been doing a lot of like more tuck-in style acquisitions, it seems like recently. As the balance sheet is improved, the target level of deployment. It feels like it's been pretty stable. I guess, like as you evaluate the $250 million that you talked about historically, allocated into this business. Any thoughts, so like whether that could potentially be drifting higher or whether there's maybe larger assets that you can consider now that you might not have before the improvement in balance sheet and cash flows that you've seen?

Yes. Well, I mean, this is like one of these things where you're challenged to give some prediction of what you're going to do from an M&A standpoint. But if you look historically in the last 5 years, the average obviously sits well above $200 million originally and then $250 million a year, right? So -- and that's because of platforms that were opportunities. But curious what I'll say about the M&A environment. The value proposition that USPI hasn't changed, it's only strengthened. And the multiples at which we're acquiring and synergizing to haven't changed. They're kind of in the same range in terms of what we do. We have developed a disciplined process around diligence and evaluation of deals, we're going to do. And I don't I would not say that because of the change in the flexibility with respect to our balance sheet that we plan on eliminating or somehow eroding the discipline that we've developed in the M&A environment for USPI. So that should give some sense of how we're going to approach this going forward, right? There's not really a lot of sense in going out and taking risks on asset classes that are not really that interesting to us or groups that are in turnaround situations or et cetera, like we're going to maintain the same amount of discipline that we've had in this. And the opportunities are there, right, for us to acquire high-quality assets that have good margins. And so we'll keep at it that way.

Okay. And it sounds like any orientation towards more like mature assets, like I know there's been a balance historically of things to become available that were earlier on in development stage. Like do you think going forward, there's fewer of those and you're looking at more mature opportunities or any kind of characteristics there that might look a little different than they have in some of those larger transactions?

Yes. No, that's a great question, because obviously, in particular, through the SCD portfolio, which strategically really was all about just firmly establishing our leadership position in orthopedics. And there were mature assets and some whole portfolio, very early-stage assets and some de novo development assets. And so that process allowed us to learn a lot more about developing early stage. So if we look forward, I think what you'll see is, in fact, more of a bent towards de novo development, early-stage assets and the things of that nature that we build up in addition to our acquisition activity.

Okay. And you mentioned Conifer in the lead and it's a little bit difficult for us to know that you guys report it as a consolidated entity to track the progress of Conifer. Would love to just get an update on how things are going this year? And I know you had a notable win alongside one of your divestitures with Adventist, I believe, to roll out broadly across their whole system, which seems like it's quite a meaningful win for you and the size of the Conifer business. Would love to just get an update on the Conifer and how that's performing?

Sure. Yes. And we haven't yet been specific, and so we'll do that at the right time. But no, look, Conifer is doing great. I mean the environment has been somewhat challenging based upon things that have happened in the industry, cyber attacks, both with clients, I mean and with Change Healthcare. And Conifer has performed remarkably for these clients. The recovery has been faster, the ability to move billing collections and cash receipts and distribution to other platforms and then replatform with Change has been remarkable. And you just look at our cash performance as a proxy for what we're doing for other clients and the recovery has been outstanding. And look, for a variety of reasons, our performance based some on our own work and some based upon difficulties that may exist out there in the market for others, we've differentiated. In terms -- I mean all that matters in this business is actually operating performance, cash collections and reliability when you transition an organization onto your platform. I'd like to tell you, you don't get a do-over. If you do a transition and you screw it up, you don't get another change because -- and if you do those three things well, the performance is differentiated, and that's what you should be looking for in outsourcing rather than complex deals and this that and the other thing, which we don't engage in. So we feel great about the fact that the momentum going into the coming year ought to generate incremental growth opportunity and also using that platform to get back out in terms of other opportunities, which may exist in the marketplace.

And then maybe just the last question would be, I guess maybe it's a good sign that I haven't asked you about labor and wage inflation. So it's been quite a while since maybe that hasn't been the first question. I would love to just get a sense of where you guys are tracking there. Like there's push and pull of maybe as you add capacity, maybe there are some investments that you need to make. But as you think about opportunities for further improvement in wage inflation, do you think they exist? Or do you think we're kind of at a more stabilized level that we'll continue at?

Yes. I would say largely, we're at a very stable position, right? If you look at wages -- base wages, we're probably still not back to pre-COVID levels, but pretty close. I think, again, whether it's contract labor or base wages or all the other different dynamics. I think the important thing is that, to Saum's point, we're being operationally very disciplined. So the rates are now at which we can manage them, we can drive profitability. And then to your point, investor want to in the right markets to -- for additional capacity, additional growth or -- so I think it's a good position right now. We expect it to continue in our guidance. And there's maybe market-by-market things that we can do whether it's contract labor or others that are so left. But I think largely, if you look across RPs, it's more of a stable position and where we can invest a little bit as we see.

Awesome. Well, I think that's a good place to leave here. Thanks so much for your time. Thank you coming the conference. Appreciate it.

Thank you.

Thanks so much.