Community Health Systems, Inc. (NYSE:CYH) Q1 2023 Earnings Call Transcript

Community Health Systems, Inc. (NYSE:CYH) Q1 2023 Earnings Call Transcript May 2, 2023

Operator: Good morning, everyone, and welcome to the Community Health Systems First Quarter 2023 Earnings Conference Call. . Please also note that today’s call is being recorded. At this time, I’d like to hand the floor over to Shelly Schussele, Senior Director of Investor Relations. Ma’am, please go ahead.

Shelly Schussele: Thank you, Jamie. Good morning, and welcome to Community Health Systems’ First Quarter 2023 Conference Call. Joining me on today’s call are Tim Hingtgen, Chief Executive Officer; Kevin Hammons, President and Chief Financial Officer; and Dr. Lynn Simon, President of Clinical Operations and Chief Medical Officer. Before we begin, I would like to remind everyone — this conference call may contain certain forward-looking statements, including all statements that do not relate solely to historical or current facts. These forward-looking statements are subject to a number of known and unknown risks which are described in headings such as Risk Factors in our annual report on Form 10-K and other reports filed with or furnished to the Securities and Exchange Commission.

As a consequence, actual results may differ significantly from those expressed in any forward-looking statements in today’s discussion. We do not intend to update any of these forward-looking statements. Yesterday afternoon, we issued a press release with our financial statements and definitions and calculations of adjusted EBITDA and adjusted EPS. We have also posted a supplemental slide presentation on our website. All calculations we will discuss on today’s call exclude gain or loss from early extinguishment of debt, impairment expense as well as gains or losses on the sale of businesses, expense from governments and other legal matters and related costs, expense related to employee termination benefits and other restructuring charges. With that said, I will turn the call over to Tim Hingtgen, chief Executive Officer.

Tim Hingtgen: Thank you, Shelly. Good morning, and welcome to our first quarter conference call. Our first quarter results include solid growth metrics and other promising indicators that demonstrate core demand for health care services is returning and that we are making progress with our initiatives and investments to capture volume. Some other more challenging dynamics such as payer mix changes and increased medical specialist fees affected our earnings in the quarter despite our ability to favorably manage other controllable expenses. Over the past few quarters, we have been sharing updates on our near-term priorities, which include specific tactics and resources designed to accelerate growth, strengthen the workforce, control expenses and advanced safety and quality.

During my remarks today, I want to touch on these priorities and the results we are achieving, starting with our determination to accelerate growth. We experienced strong volume gains during the first quarter as consumers increasingly return to health care setting now that COVID-19 has substantially subsided. Key volume metrics improved on a year-over-year basis, and they improved sequentially, continuing positive trends from the fourth quarter. Same-store admissions increased by 4.8%, and adjusted admissions increased 9.4% year-over-year. Same-store surgery showed particular strength, increasing 10.6% with broad-based gains in orthopedics, cardiovascular, GI, urology and gynecology. Growth in these specialties, along with the continued positive impact of our transfer center service resulted in medical and surgical case mix index improvements sequentially and growth in non-COVID acuity year-over-year.

Capital investments designed to further develop our strongest markets are positively impacting growth in both inpatient and outpatient services. Recent examples include the full opening of a 112-bed expansion in our Naples, Florida health system as well as the opening of a new ambulatory surgery center and a freestanding ER in our Birmingham, Alabama market. Major bed expansions and facility improvements are underway in other markets such as Foley, Alabama; Warsaw, Indiana, which is part of our Lutheran Health Network and Knoxville, Tennessee. A number of other investments that are designed to fuel growth continue across the portfolio. Provider recruitment remains key to growth and further expansion of service lines in our markets. To that end, we continue to post favorable gains on the heels of a very strong 2022 recruitment year.

Strengthening our workforce is a constant priority and we are pleased with continued progress in this area. After its first full year of operation, our centralized nurse recruitment function continues to perform extremely well with strong mid-single-digit gains in the higher end of nurses in the first quarter compared to the fourth quarter of last year. Due to the success of our centralized recruitment resources, we are in the process of expanding the scope to include sourcing and hiring of all clinical positions, not just nursing. Our partnership with Jersey College School of Nursing will expand again when our eighth program opens in our Tennova East Tennessee market later this month. Eventually, through this initiative, we expect to graduate 1,000 new nurses every year.

And we remain focused on a variety of programs designed to strengthen retention rates as well. We ended the first quarter with an improvement of approximately 500 basis points and nursing turnover rates on top of the significant gains in 2022. Advancing safety and quality remains one of our most important. Last quarter, we highlighted our work over the past decade to reduce serious safety events noting an impressive 87.9% reduction in our serious safety event rate since the baseline established in 2013. That improvement is now 89% and a testament to the commitment of our medical professionals, caregivers, support teams and health system leaders. I want to take a moment to express my gratitude for what they do every day to ensure safe quality care for their patients.

And CHS recently was ranked #1 among the top 30 U.S. health care systems for online reputation, a distinction that is the result of positive online ratings and reviews for our health care providers and services, along with a high level of responsiveness to the voice of the customer. We use those insights to continuously improve and we know a strong online reputation helps cultivate new patient acquisition and loyalty. This is our second year in a row to achieve this top ranking. Through targeted investments in innovative technologies to improve outcomes, we continue to see positive results in clinical quality and customer experience. These programs include virtual sitters for patients at high risk for falls, maternal fetal monitoring technology that enables earlier interventions when needed in labor and delivery and the current rollout of at-home remote patient monitoring for individuals with chronic health conditions.

We are also in discussions with other potential innovation partners that offer clinical technologies to further advance patient care and that have the potential to generate returns for our company in the years ahead. In summary, despite the persistent pressures on near-term margins, our team continues to prioritize and position the organization for growth, successfully deliver upon key initiatives to improve operations and advance the long-term competitive position of our health systems. As a result, we expect to make incremental progress both throughout the year and for the longer-term. Kevin, I’ll now turn the call over to you.

Kevin Hammons: Thank you, Tim, and good morning, everyone. As Tim mentioned, we were very pleased with the volume results we achieved in the first quarter and remain optimistic about 2023 and thereafter. Year-over-year, our top line was pressured by the COVID comp and sequentially by payer mix, while increases in some nonlabor expenses impacted our adjusted EBITDA. However, the sequential improvements we have seen in key volume metrics. And what we see as a return in core demand for health care services are encouraging as we move through 2023. Further, we remain focused on improvements in our workforce and expense management to moderate the impact of inflation. Now let me discuss the first quarter results. Net operating revenues came in at $3,108 million on a consolidated basis.

On a same-store basis, net revenue was up 1.7% compared to the first quarter of 2022. This was the net result of a 9.4% increase in adjusted admissions and a 7.1% decrease in net revenue per adjusted admission, which, as noted, was a result of higher prevalence of COVID admissions during the first quarter of 2022 and an outsized growth of governmental volume compared to growth in commercial volumes. On a sequential basis, net revenue per adjusted admission decreased by only 60 basis points and was also caused primarily by a shift in payer mix as Medicare managed care adjusted admissions accounted for all of the sequential growth. Adjusted EBITDA was $335 million with an adjusted EBITDA margin of 10.8%. During the first quarter, we recorded an immaterial amount of pandemic relief funds compared to the $47 million recognized in the prior year period.

Going forward, we do not expect to receive or recognize any material pandemic relief funds from the government. With regard to expenses, on the labor expense side, combined salaries, wages and benefits and contract labor expense improved on a year-over-year basis by approximately $65 million. On a sequential basis, combined SWB and contract labor increased approximately $13 million. Specifically related to employee costs, we experienced an increase of 5.9% in our average hourly rate for employees on a year-over-year basis. However, total salary and benefit expenses on a same-store basis increased by a lesser amount of 5.4% demonstrating our ability to offset inflation and cost of increased hiring with productivity gains. On contract labor expense, we made significant progress over the prior year reducing the expense by over 54%.

Compared to the fourth quarter of ’22, our contract labor expense increased slightly from $80 million in the fourth quarter to $85 million in the first quarter. As a reminder, our contract labor was $190 million in the first quarter of 2022. With the additional advances we expect to make with nurse hiring, we anticipate continued progress reducing contract labor throughout the remainder of 2023. On nonlabor-related expenses, while we have been effectively managing these expenses over the last several quarters, during the first quarter of 2023, we experienced a $40 million year-over-year increase in medical specialist fees and a $20 million year-over-year increase in professional liability expense, which were not mitigated by other reductions.

These 2 items contributed to an increase of approximately 6.9% in nonlabor expenses over the prior year. Sequentially, medical specialist fees increased $14 million. We continue to execute on our cost reduction initiatives, including supply chain management and our margin improvement program to prudently manage nonlabor-related expenses going forward. Moving to cash flows. Cash flows provided by operations were $5 million for the first quarter of 2023 compared to $101 million for the first quarter of 2022. The timing of certain payments, including incentive compensation, the settlement of certain professional liability claims and accounts payable led to lower cash flows during the quarter. We expect we will recapture these cash flows in future quarters.

Turning to CapEx. For the first quarter of 2023, our CapEx was $122 million compared to $97 million in the prior year period. The increase in the first quarter of 2023 was due primarily to the timing of payments related to several growth projects that are in flight. Company’s net debt-to-EBITDA is currently 8.3x and due mostly to lower trailing 12-month EBITDA, which still includes periods of disruptive care from the prior year. As we manage through this environment, we remain focused on our longer-term goals of lowering our leverage and increasing our free cash flow. We retained $144 million of cash on the balance sheet at the end of the first quarter, and we have approximately $800 million of borrowing base capacity available under our ABL.

As such, we have adequate liquidity to meet our needs going forward. As we assess the opportunities to evolve our portfolio for growth and success, we continue to evaluate interest from outside parties related potential divestitures as well as considering opportunities to expand our portfolio. As these opportunities emerge, we analyze the future growth and earnings profile of specific assets and assess the impact of potential transactions would have on our future EBITDA, financial leverage and free cash flow generation. During the quarter, we received $92 million of cash proceeds from the sale of our last remaining facility in West Virginia, which closed on April 1, 2023. We also signed an agreement to sell our 2 facilities in North Carolina, which remains subject to regulatory approval.

In addition, following the end of the quarter, we signed a definitive agreement to sell our facility in El Dorado, Arkansas. We remain engaged in continuing discussions about other potential transactions, which if they come to fruition, could provide opportunities to pay down debt as well as allow opportunities to reinvest resources to areas of our portfolio to further accelerate their long-term growth in earnings. In summary, we remain optimistic about 2023. We are encouraged by the progress we are seeing and the indicators that demonstrate that core demand for health care services is returning. We remain committed to our objectives to position the company for long-term and sustainable success and are focused on executing on opportunities for growth in our markets.

Kelly, at this point, I’ll turn the call back to you.

Shelly Schussele: Thank you, Kevin. Jamie, we’re ready to open the call for questions.

Q&A Session

Operator: . Our first question today comes from Ben Hendrix from RBC Capital Markets.

Benjamin Hendrix: I wonder if you could dig into the commercial mix progression we saw sequentially versus what you had in your expectations, kind of what you believe accounts for any of the divergence and how we should think about the pace of recovery to the reaffirmed guidance?

Kevin Hammons: Sure. Yes, absolutely. So as we expected — we expect the first quarter to step backwards a little bit. Certainly, some of that we anticipated some payer mix shift, largely due to some of the economic pressures, inflation and the pressure that has on household incomes. If you think about patients with high co-pays and deductibles that would be most impacted by the pressure on household income. Those are the commercial patients, whereas government patients have lower co-pays and deductibles and MA patients often have 0 co-pay and deductible. So we did expect some pressure there. What we saw sequentially was substantially all of the increase in volume was from MA patients, and we did not expect it to be that — that much weighted towards the MA plans in the first quarter.

Operator: Our next question comes from Brian Tanquilut from Jefferies.

Brian Tanquilut: Guys, can you hear me okay?

Kevin Hammons: Yes, we can now.

Brian Tanquilut: All right, sorry about that. Yes, I guess my question just surrounds around labor, right? I mean obviously, picked up a little bit here, even in contract labor as we see bill rates in a temp staff go down, is that something that we should be thinking about as we think about or contemplate Q2, Q3 trends, just on that specific line item. And maybe taking it a step further. I just — I know you had a higher-than-expected inflation rate for labor in Q1. What would bring that down over the course of the year?

Kevin Hammons: Sure. So I’ll try to capture both of those, Brian. Thanks for the question. As it relates to contract labor, a couple of things I’d point out maybe a little bit different than last year not unexpected. So more of the hiring that we’re doing, particularly in the first quarter are new grads. Last year, as we began hiring in our nurse recruiting — centralized nurse recruiting function, which we just anniversaried this past April. We were repatriating many of the nurses who had previously left our facilities to become travel nurses. And so the time period for those nurses to get back up and running was a little bit shorter as opposed to more new graduates or new nurses being hired today that have a little bit longer lead in time.

So that may delay us slightly in taking out some of the contract labor. We had great success during the first quarter in terms of nurse hiring. We expect that to continue with our centralized nurse recruiting function and do continue to — or expect to continue to make progress throughout the year. We also are transitioning more contract labor nurses to international nurses, which also have a little bit longer lead time to get them up and fully integrated into their positions. But as we do that, we’ll be able to take out some additional contract labor expense and that will also help mitigate some of that average hourly rate. As it relates to employee costs, we did experience, I mentioned, 5.9% inflation on an average hourly rate basis. We had previously indicated when we put out guidance that our assumption was 5% wage inflation for the year.

So we were slightly above that. But as we think about the rate increases that we gave throughout 2022, which I don’t think will continue throughout 2023. I think we’ll actually be able to bring that wage inflation down in some of the future quarters in the back half of the year, so that the average of 5% for the year is still where we think we’ll be. And I think last point I’d just make on that is with the productivity gains, that we had, despite the 5.9% wage inflation, we overpaying the hiring additional hiring and gain productivity so that our actual same-store SWB was only up 5.4% from the prior year.

Operator: Our next question comes from A.J. Rice from Crédit Suisse.

A.J. Rice: I wanted to just ask a little more on the expense side in 2 ways. The managed care recontracting you’re doing at this point, are you seeing any bump in — to cover some of the inflationary pressures, both labor and otherwise that you’re experiencing? And then specifically because you called out the hospital-based physicians, I guess, professional fees. Where specifically is that? Is that ER management, anesthesia or other areas? And what’s the prospect for improving that trend over the course of this year? Is there anything — are you just assuming it’s going to stay at this elevated level? Or can you improve that?

Kevin Hammons: So let me start off and Tim, feel free to jump in if I miss something. So the medical specialist fees we are seeing some increases related to kind of the inflationary costs as well as the no surprise billing kind of impact from that is some of these physicians may have been terminated by the providers and now they’re looking to recoup some of their billable revenue from us and from the providers. And I think that we’re seeing that maybe across the industry. Our kind of profile of providers was primarily regional and local providers. So we do have an opportunity to in-source some of those doctors to renegotiate contracts to change out some of these contracts and maybe even some skill mix amongst those doctors. So we do have plans that we can mitigate some of that cost going forward, I do not expect it to stay at the current run rate that we saw in the first quarter.

It did start to go up kind of mid-’22. So we saw increases in the third and fourth quarter. So at a minimum, we’ll start to anniversary that in the back half of the year, so will not continue to be a year-over-year headwind in the back half of the year, but we do see opportunities to be able to bring some of that cost down on a quarterly run rate basis.

Tim Hingtgen: Yes. And I’ll just add. This is Tim. I’ll go ahead and add a few comments to that. As Kevin said, we think the first quarter would be the peak of the medical specialist fee incremental increases. We’ve already had some new agreements put in place with alternative vendors at better pricing. There is a skill mix change, adapting hours of service, if you will, on the anesthesia side. which was, I would say, an overweight in terms of the proportional increase in the spend, all those things, I think, should start stabilizing as we head into the future quarters. I would also say that continuing our favorable growth rates increasing the numbers of surgeries and billable procedures for all of our hospital-based provider should also take away some of the fixed subsidies for their staffing and their overhead. So we think all those things in combination make it more manageable as we lead into the next few quarters.

Operator: Our next question comes from Kevin Fischbeck from Bank of America.

Kevin Fischbeck: Okay. Great. I just want to dig into this mix shift — fair mix shift a little bit more because it’s not clear to me exactly how it explained contributed to the pricing. Can you just maybe disaggregate exactly how much was that versus some of the things you mentioned COVID impacts? And in particular, if this is an MA dynamic. Can you just remind us how — what the rate differential is between MA and fee-for-service? And if it is MA, then is this going to be a long-term headwind? Why is this not something that would continue to your pressure on rates going forward?

Kevin Hammons: Yes. So if I think about kind of year-over-year, about 2/3 of our growth in volume year-over-year related to governmental payers. And of that, probably 2/3 of the governmental growth was Medicare and primarily MA versus Medicaid. So that’s kind of the breakout kind of year-over-year on a volume basis. Of course, the other factors our acuity and rate lift, which we got our best rate lift in commercial. So as you think about kind of proportional revenue, it doesn’t quite flow with those because of the rate lift we get in commercial. But volume again year-over-year, about 2/3 government, 1/3 of commercial volume increases. Sequentially, all the increases were MA. And then to your question about kind of rate, we’re seeing kind of between 85% and 90% payment for MA patients compared to Medicare fee-for-service.

Tim Hingtgen: Yes, Kevin, this is Tim. I’ll go ahead and add on to that. The commercial mix in the quarter was lighter proportionally to the growth in the governmental as Kevin points out, the first quarter is typically our lowest commercial mix quarter. So I kind of expected that coming into the quarter as people kind of hit their deductibles and co-pays with our stronger procedural — commercial surgery volume in the fourth quarter kind of putting a little bit of a lag into the first quarter. As we look throughout the quarter, we did see as we normally do some improvements in the mix as we hit March and into April. So again, we expect some of that to normalize. But in terms of the absolute growth in MA volumes, we have to be more disciplined and determined in our approaches to targeting a more, I guess, I’ll say, balanced or a better balance commercial mix.

We’re doing that through access point strategies to our service line development, of OB and NICU and trauma programs, deeper investments in cardiac service lines, which tend to attract, I think, a better mix from an age perspective. And we’re also working on some very specific direct-to-employer strategies, including some direct-to-employer contracting models. So looking forward to kind of rolling that out in the quarters ahead as well.

Kevin Hammons: And maybe just to add one more point, and thanks for that, Tim. Our expectation, as we mentioned, was first quarter was going to step backwards and would be the lowest quarter of the year. We would grow sequentially kind of throughout the year from an EBITDA standpoint. Part of that is because of the pressure on commercial business that we had anticipated. We do think that, that’s magnified by inflation in the economy. But likewise, we think in the back half of the year, as people try to get more of their procedures in before their co-pays and deductibles reset, that’s again in the following year. We think that, that recovery in the back half of the year will also be magnified.

Operator: Our next question comes from Josh Raskin from Nephron Research.

Joshua Raskin: Just want to talk about the guidance, the reiteration there. Even the low end of guidance, the $1.475 billion would be up about 14% year-over-year ex the grant income. 1Q was down 7.5%. So rest of year, up 22% plus. I’m just trying to figure out the drivers of that increase. It doesn’t seem like a revenue issue. So it seems as though some of these costs have to dissipate on an absolute basis, not even on a percentage of. So maybe you could just help us first with some of the buckets there.

Kevin Hammons: Yes. On a year-over-year basis, we’re — certainly a big piece of that is contract labor. So there’s going to be an absolute reduction in contract labor year-over-year that should flow through. And then we do expect the volume that we’re seeing in the return of demand for health care services to drive revenue. And then there is some moderation in the — other cost moderation in SWB that we expect and then continued margin improvement program efforts that we’re taking and have been working on for a couple of years, and we still think there’s a runway to be able to moderate our other operating expenses below inflation that we can then leverage to more EBITDA. We’ll also have the benefit of some of the investment projects that we’ve worked on over the past couple of years, getting a fuller benefit of those.

And as we think about — we opened up a de novo hospital in June of last year that we’ll have a full year of operations. This year, there are a number of things that are driving that growth, Josh.

Joshua Raskin: Would you orient us to the lower end of guidance at this point? Is that prudent? Or you still feel comfortable with the midpoint?

Kevin Hammons: No. At this point, we still feel comfortable at the midpoint. The between our actual results and consensus is bigger than the mix between our actual results and what we had anticipated for the first quarter. So as we think about where we’re at compared to where we expected to be, we’re not as far off as consensus would suggest. And so therefore, getting back to the midpoint, we still feel comfortable with.

Joshua Raskin: And then last one, if I could sneak it in. Are you thinking about additional asset sale opportunities? Is that more of a priority today? I heard in the preamble that you’re still getting inbound interest, but are you prioritizing your asset sales more than you would have in the past?

Kevin Hammons: I’m not sure I’d say more than we have in the past given that we went through several years of a very formalized program. And then we did pause for a period during COVID, but we have completed a few smaller transactions recently. We do have the one announced in North Carolina, which is more sizable. And we do have some other interest that we’re just currently in talks about. So if those — as that interest comes in and if those do come to fruition and are at prices that are accretive or allow us to reduce our leverage and/or accretive to our margin profile, our future cash generation, we do take a hard look at those.

Operator: Our next question comes from Jason Cassorla from Citi.

Jason Cassorla: Great. The surgery growth number in the quarter definitely stood out over — up over 10%. Can you talk about the drivers there and just help bifurcate between inpatient and outpatient surgery trend? And if that had any impact on mix in the quarter? And then importantly, just the durability and sustainability of those surgery growth trends would be helpful.

Kevin Hammons: Yes. So let me start. And then see if I get your question answered. In terms of kind of inpatient versus outpatient, I think we saw approximately 5% inpatient growth and double-digit outpatient growth in surgeries. We’re still seeing some of that movement of inpatient to outpatient. I think that’s slowing down a little bit. But our outpatient surgery growth certainly outpaced inpatient. But we did see acuity increase on both inpatient and outpatient.

Tim Hingtgen: And I’ll just add to that, Jason. In terms of where the volumes are coming from, we believe that’s part of the investments we’ve made into not just physical capacity in some of our key markets, but also the recruitment of key specialists. We’ve talked for the last several quarters about the insights we gained from our transfer center service. I mean we can’t say yes to accepting a patient from a non-CHS hospital. It helps us approximate certain demand to add higher acuity specialists to our networks. And we believe that’s taking root in many of our tertiary markets in particular. But in any market, we’ve seen good growth in orthopedic services, again, some through recruitment, some through the return of those, I guess, I’ll say, senior age, Medicare-aged patients in particular in the first quarter.

We had a very robust orthopedic surgery quarter compared to prior year, but also beating almost every surgical stat to the pre-COVID baseline of 2019. So in general, I think we’ve built out good systems of care to drive not just sequential improvements in surgeries, but it’s the area where we certainly are outshining the 2019 comp because of those deliberate investments.

Operator: . Our next question comes from Stephen Baxter from Wells Fargo.

Stephen Baxter: I was hoping you could remind us how you think cash flow plays out throughout the year. You’re guiding to a pretty big increase in cash flow from ops, but didn’t see much in the way of cash flow in the first quarter. just beyond the improving EBITDA performance throughout the year. I guess what else should we keep in mind in terms of working capital dynamics to get to that number?

Kevin Hammons: Sure. So yes, certainly, a portion of that is increasing EBITDA. But we did have, just from a timing of payments, respect some professional liability claim settlements in the first quarter and some accounts payable and compensation liabilities that we paid out. It didn’t necessarily all run through the income statement because they were previously accrued. That should — we should kind of recapture those in later quarters in the year. And we actually are anticipating some improvement from a working capital standpoint year-over-year. So that should all lead to improved cash flow from operations by the end of the year.

Operator: And ladies and gentlemen, with that, we’ll be concluding today’s question-and-answer session. I would like to turn the floor back over to Tim for any closing remarks.

Tim Hingtgen: Great. Thanks, Jamie. I want to finish by noting that Nurses Week and Hospital Week will begin this coming weekend, 22,000 nurses work across our organization, and we appreciate every single 1 of them and all nurses everywhere. We also recognized the positive impact that CHS hospitals have in their communities and thank our entire team for what they do every day until people get well and live healthier. Thank you for joining today’s call. If you have any additional questions, you can always reach us at 615-465-7000.

Operator: Ladies and gentlemen, with that, we’ll be concluding today’s conference call and presentation. We thank you for joining. You may now disconnect your lines.