Tenet Healthcare Corporation (NYSE:THC) Q4 2022 Earnings Call Transcript

Tenet Healthcare Corporation (NYSE:THC) Q4 2022 Earnings Call Transcript February 9, 2023

Operator: Good morning. Welcome to Tenet Healthcare’s Fourth Quarter 2022 Earnings Conference Call. After the speaker remarks, there will be a question-and-answer session for industry analysts. I’ll now turn the call over to your host, Mr. Will McDowell, Vice President of Investor Relations. Mr. McDowell you may begin.

Will McDowell: Good morning, everyone, and thank you for joining today’s call. I am Will McDowell, Vice President of Investor Relations. We’re pleased to have you join us for a discussion of Tenet’s fourth quarter 2022 results, as well as a discussion of our financial outlook. Tenet senior management participating in today’s call will be Dr. Saum Sutaria, Chief Executive Officer; and Dan Cancelmi, Executive Vice President and Chief Financial Officer. Our webcast this morning includes a slide presentation, which has been posted to the Investor Relations section of our website tenethealth.com. Listeners to this call are advised that certain statements made during our discussion today are forward-looking and represents management’s expectations based on currently available information.

Actual results and plans could differ materially. Tenet is under no obligation to update any forward-looking statements based on subsequent information. Investors should take note of the cautionary statement slide in today’s presentation, as well as the risk factors discussed in our most recent Form 10-K and other filings with the Securities and Exchange Commission. With that, I’ll turn the call over to Saum.

Saum Sutaria: Thank you Will, and good morning, everyone. To kick us off, I want to thank all of our physicians and caregivers for their commitment and attention to our patients’ needs throughout 2022. Three years into the pandemic, I continue to be inspired by the people I meet who have chosen to forge ahead and find their calling in health care. Second, I want to take a moment to acknowledge three of our leaders who have announced their retirements this year. Roger Davis came to Conifer in 2020, planning to transition to become the CEO of a spun out independent company. Roger has been a selfless leader acting upon the opportunities to improve Conifer’s technology, point solutions, AR operations and global footprint with Conifer remaining a part of Tenet rather than advancing his own personal goals.

For that we will always remember his leadership as a role model in the company. Brett Brodnax has devoted over 20 years to building today’s USPI. He is a pioneer in ambulatory surgery and a rock star in his field. The relationships he has cultivated with health system partners and doctors will remain a hallmark of USPI, because he has never treated them as his, but ingrained them into the fabric of USPI. He and I jointly selected Andy Johnston to return to the company after gaining additional operating experience outside of the organization and I could not be more pleased with the way the three of us will lead this transition over a full year. And generously Brett’s desire for USPI’s success is so strong that he has offered the option for additional time beyond 2023 with us.

Dan Cancelmi is approaching 30 years with Tenet, starting as a CFO in a hospital and building his career succeeding in every role he took as he ascended to our company’s CFO. At every step, Dan championed his team members, brought the perspective of the leaders in the field to our home office, and relentlessly works to be solution oriented to the problems we face. In the last few years he’s been instrumental in every aspect of our turnaround efforts, demonstrating his ability to adapt and take a fresh perspective on a company he’s known his entire career. He creates value for our shareholders. Dan represents the highest model of integrity in our organization and I’m grateful for his dedication to help onboard a new CFO at Tenet. In the last five years, we’ve built a model for leadership transitions that are stable and collaborative handoffs and these should be no different thanks to all three of you.

With that, let’s turn to our 2022 results. In 2022, we recorded net operating revenues of $19.2 billion and consolidated adjusted EBITDA of $3.47 billion, which translates into an attractive 18.1% adjusted EBITDA margin. We finished the year strong and delivered results in the fourth quarter consistent with or slightly above the expectations we set for all three of our businesses, driven by stronger volumes and excellent cost management. For the year, USPI delivered $1.327 billion in EBITDA, with strong margins at 40.9%. Importantly, in 2022, USPI had 4.6% growth in same-facility revenues in the range of our long-term goal of 4% to 6% top line growth. But as we’ve discussed, the performance in 2022 was not consistent quarter-to-quarter and same-store EBITDA growth was below our expectations.

We are pleased that the fourth quarter returned to positive same-store growth and the typical seasonality of strong December volumes that we used to see pre-pandemic. USPI’s M&A engine under the Tenet umbrella continues to be an industry-leading differentiator. In 2022, we added 45 centers to the portfolio through M&A and de novo development, in addition to the SCD centers. This was highlighted by our acquisition of 22 facilities in our partnership with the United Urology Group. Turning to our hospital segment. We generated nearly $1.8 billion of adjusted EBITDA in 2022 during a challenging operating environment. Our operators navigated a cybersecurity attack, as well as continued COVID-related pressures. Importantly, we saw a meaningful improvement in clinical quality and patient safety metrics such as a 50% reduction in both MRSA infections and hospital-acquired pressure ulcers.

We saw our peak in contract labor expense in September and by December we had reduced that by almost 23%, exiting the year with contract labor below 6.5% of our consolidated SW&B expense. We are confident in our labor management system and we’ll continue to adjust as needed for critical patient needs. Over the past year, we have also invested in our workforce with increased pay bonus programs and incremental benefits. Importantly, our nurse retention and recruitment efforts continue to pay dividends, with RN hires up in 2022 over 2021. Retention has improved as well. In the fourth quarter, nurse turnover improved by 22%, compared to the average of the prior four quarters. Finally, Conifer had another strong year, with third-party customer revenue growth of 10%.

Adjusted EBITDA margins remained strong at nearly 28%. Conifer’s pipeline of sales opportunities remains robust, reflecting the investments that we have made in our commercial capabilities for both integrated and point solution initiatives. Let’s transition to 2023 guidance. We are projecting full year 2023 adjusted EBITDA of $3.16 billion to $3.36 billion, which represents an attractive growth rate of 7.2% at the midpoint on a normalized basis. First, in our industry-leading ambulatory surgery business, we anticipate normalized adjusted EBITDA growth at USPI of 11% at the midpoint of our guidance, based upon our expectation of 4% to 6% growth in same-facility revenues, further accretion from the second SCD transaction and continued strong contributions from our M&A and de novo initiatives.

Our guidance reflects a healthy 5% organic EBITDA growth rate for this year. Let me address the second SCD transaction in same-facility growth in more depth. The most direct way to characterize the second SCD transaction is that we are behind our expected ramp-up by approximately one year. Recall, unlike the first SCD transaction, where we acquired mature centers and achieved 100% in buy-ups to consolidate and deliver synergies into those centers. The second transaction had a broad range of assets, including many that were early in development. We had some planned buy-ups and center openings that did not happen on our original time line in 2022. The agenda to make progress has not stalled. Since Q3 we have completed six more buy-ups at multiples unchanged from prior buy-ups.

We have opened the majority of the de novo centers, with the remaining seven on track to open this year. Collectively, the SCD transactions deliver a total of 135 centers, which have margins of approximately 40% and were acquired for an average multiple under 10 times pre-synergies. Turning to same-facility growth. The continued migration of procedural services into an ambulatory setting acts as a sustained and far-reaching tailwind for our business. Looking back from 2019 to 2022, the same facility business has recovered to pre-pandemic volumes. And at the same time our net revenue per case has risen by 12.8%, as a testament to our ongoing addition of higher acuity cases. We are also positioned to drive attractive growth in 2023 and beyond.

Let’s unpack that further given our Q4 2022 same-facility volumes and how we bridge into our 2023 guidance. First, as a foundational element, in 2022, on a same-facility basis, our active physician population grew over prior year. Second, the impact of Hurricane Ian causing facility closures during the fourth quarter was about 0.3%. Those facilities are now repaired and operational in the current year. Finally, reductions in certain lower acuity services and investment in higher acuity services are still ongoing. For example, in Q4 2022, this impacted same-facility growth by approximately 1.1%. We will continue to seek opportunities for service line acuity enhancements into the future. It is noteworthy that our same facility ASC total joint cases, as one of the highest acuity orthopedic sub-service lines, grew by 13.2% in 2022 relative to 2021.

For these reasons, we have conviction in our strategy and we are comfortable with our guidance of same-facility growth returning to 2% to 3% in 2023. Let’s turn to our USPI M&A engine, which represents the other critical value driver for Tenet shareholders. For many years we have consistently acquired centers at attractive valuations and driven post-synergy multiples for our acquisitions to below 5 times. And our latest 2022 vintage is estimated to do the same by the end of year two. We intend to invest approximately $250 million in ambulatory M&A each year and have a robust pipeline to support that level of investment. We continue to be active in the construction of new centers originating from our USPI development team and separately from our SCD partnership pipelines.

We currently have 22 centers that are in active syndication or under construction. Adding centers with strong margins, and attractive post-synergy multiples, remains the best use of our cash for investments, to enhance tenants free cash flow. We recently announced a new development agreement with Providence Health System, a leading innovator in health care services in the Western United States, that will expand our strategic partnership and increased ambulatory access across new markets. We expect this relationship will expand to 15 to 20 centers in the next two years. Stepping back, USPI is among the best examples of value-based care in our industry. Our services are generally 30% to 50% more affordable than similar services delivered in a hospital setting.

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USPI is the preferred partner, for both high-quality physicians and health systems as our teams deliver the full range of management services. The linkage to our hospital business creates an unquestionably superior platform, from which to draw talent operating expertise and scale benefits. Turning to our hospital segment. We are expecting adjusted EBITDA growth of 4.6%, on a normalized basis at the midpoint of 2023. We anticipate this will be driven by 2% to 4% adjusted admissions growth, continued operating discipline and the expectation for further moderation in contract labor costs, partially offset by increases in employed labor costs. The year-over-year core adjusted EBITDA growth rate for 2023 is higher than our long-term forecast of 2% to 3% annually, because of the tailwinds created by the points I’ve noted, and also the continued recovery of our Massachusetts market and ramp-up of our hospital in Fort Mill.

Our portfolio transformation also continues as we recently reached an agreement for John Muir Health to purchase Tenet’s 51%, interest in the Santa Ana Regional Medical Center for $142.5 million slightly above a 10 times multiple. This transaction is expected to be completed in 2023 and subject to regulatory approvals, and customary closing conditions. Finally, Conifer is expecting adjusted EBITDA growth of 11% for 2023, on a normalized basis for changes in Tenet’s contract terms and client hospital divestitures, driven by new sales and a continued focus on automation and offshoring activities, to realize greater efficiencies in our operations. All in, our full year 2023 guidance of $3.16 billion to $3.36 billion, represents an attractive recovery target that is also respectful of the continued challenges of the current operating environment.

Our management discipline has been a hallmark of our success, and we are focused on accelerating efficiencies and across our business segments, and investing for the future. And with that, Dan will now provide a more detailed review of our financial results.

Dan Cancelmi: Thanks, Saum. And good morning, everyone. We were very pleased with how we finished the year, with fourth quarter adjusted EBITDA excluding grand income, coming in at or above the midpoint of our guidance ranges, for all three of our businesses, driven by renewed same-store volume growth for USPI, strong same-store adjusted admissions growth in our hospital business, and lower levels of contract labor exiting the quarter, all of which gives us momentum as we begin 2023. In the quarter, we generated consolidated adjusted EBITDA of $897 million, which included $40 million of grant income. Our performance reflected strength in volumes and improved management of labor costs. Additionally, our results were supported by continued focus on high acuity service lines.

Now I’d like to highlight a few key items for each of our segments, beginning with USPI, which delivered strong operating results. USPI’s fourth quarter adjusted EBITDA grew 18.7% compared to last year excluding grant income and its EBITDA margin continues to be very strong at 43.6%. Surgical case volumes were 101% of 2019 pre-pandemic levels. Also USPI delivered a solid 2.3% increase in revenue per case and surgical cases were 70 basis points higher than fourth quarter 2021 on a same-facility basis. For the full year, USPI produced case volume growth of 2% and net revenue per case growth of 2.5%. We continue to be pleased with the strong margins and cash flow generated by our ambulatory business. Turning to our acute care hospital business.

Fourth quarter same-hospital adjusted admissions increased 2.9% over the fourth quarter of 2021 and total same-hospital inpatient admissions increased 50 basis points, while non-COVID inpatient admissions increased 4.3%. Our labor management continues to be very effective, despite the cost pressures, specialty temporary contract and our staffing costs. On a consolidated basis, we exited the year with December contract labor at 6.4% of consolidated SWMB providing us momentum as we move into 2023. Total hospital costs were well managed in the quarter, as these costs were 3.1% lower than the fourth quarter of 2021 on a per adjusted admission basis. SWMB costs per adjusted admission were up only 50 basis points compared to the fourth quarter of 2021, despite more severe labor pressures this year.

Our case mix index and revenue yield remains strong, as we continue our strategic focus on investments in higher acuity, higher margin service lines. Our 2022 CMI has grown at a 4% CAGR since 2019. Turning to Conifer, which again delivered a solid quarter. Conifer produced fourth quarter EBITDA of $90 million with a strong EBITDA margin of about 28%. For the year, Conifer resumed top line revenue growth of about 4% and revenue from external clients increased 10%. Next, let’s review our cash flow, balance sheet and capital structure. As of the end of the year, we had $858 million of cash on hand and no borrowings outstanding under our $1.5 billion line of credit facility. We generated $321 million of free cash flow for the year or $1.329 billion before the repayment of about $1 billion of Medicare advances and deferred payroll taxes related to the pandemic that were received or deferred in 2020.

All of these advances and deferred taxes have now been repaid. During the fourth quarter, we repurchased approximately 5.9 million shares of our stock for 250 million. Our December 31 leverage ratio was 4.1 times EBITDA, consistent with year-end 2021. As a reminder, we have no significant debt maturities until the third quarter of 2024 and have approximately $1.8 billion of secured debt borrowing capacity available, if needed. We have strengthened our balance sheet over the past several years and retired or pushed out debt maturities, which we believe provides us ample financial flexibility to support our growth initiatives. Let me now turn to our outlook for this year. Our projected consolidated adjusted EBITDA for the year is in the range of $3.160 billion to $3.360 billion.

As we have discussed previously, there are a number of items that impact the comparison of our 2022 results to our 2023 outlook, which are outlined on slide 7 of our investor presentation. Let me summarize them. First, we are assuming consolidated organic EBITDA growth at the midpoint of approximately 6% over 2022, after normalizing for various items that I’ll discuss shortly. The organic growth is anticipated to be driven by stronger ambulatory and hospital volumes lower levels of contract labor and other cost efficiencies, negotiated commercial rate increases and continuing investments in hospital higher acuity service lines. Second, we anticipate the USPI will drive $65 million of organic EBITDA growth which is about 5% growth. This organic growth coupled with approximately $78 million of additional earnings related to USPI’s acquisition and development activities, is anticipated to result in normalized EBITDA growth of about 11%, for USPI.

Third, we anticipate year-over-year EBITDA growth of about $100 million due to the estimated impact of the cyber attack on our hospitals last year and an additional $10 million of earnings from proceeds related to the attack that we received this year. No other insurance proceeds for this matter have been assumed in our 2023 guidance. There are also several other items impacting our 2023 EBITDA guidance compared to last year, many of which we previewed on our third quarter earnings call. First, we recognized $194 million of grant income in 2022, related to the pandemic. Our guidance, for 2023, does not assume any noteworthy amount of grants this year. Second, we realized $114 million of gains on asset sales completed in 2022. Next, there was $31 million of Texas Medicaid supplemental funding revenue, related to 2021 that we recognized early last year when the program was approved.

Also, there are various revenue reductions this year that total almost $200 million for reimbursement changes substantially related to the pandemic, the 340B outpatient issue and the ACA that are detailed at the bottom of the slide. Finally, our 2023 guidance assumes a $14 million reduction in EBITDA, due to our planned sale of the San Ramon facility that we announced last month and a $27 million reduction in Conifer’s EBITDA this year, due to transition contract expirations related to the sale of our former Miami Hospitals and CHI’s divestiture of certain Iowa facilities. After adjusting for these items, our 2023 outlook represents year-over-year normalized consolidated EBITDA growth of 7.2%. A few additional assumptions related to our outlook.

We are assuming 2023 same-hospital admissions increased 1% to 3% and adjusted admissions increased 2% to 4%. COVID admissions of approximately 3% down from 6% in 2022 same-facility USPI surgical cases are projected to increase 2% to 3% and USPI’s net revenue per case is also projected to increase 2% to 3%. Another assumption I want to mention is that we are revising the rates and scope of services under the revenue cycle contract between Conifer and our hospitals. The revised contract continues to be on a commercially reasonable basis is anticipated to result in an approximately $40 million EBITDA reduction for Conifer this year and its corresponding $40 million increase in our hospital segment EBITDA. This has no net impact to consolidated revenues, EBITDA or margins.

Finally, we would expect first quarter 2023 consolidated adjusted EBITDA to be $775 million at the midpoint of our range. And we anticipate that USPI’s EBITDA in the first quarter this year at the midpoint will be approximately 22% of our full year 2023 USPI EBITDA guidance. Turning to our cash flows for 2023. From a cash flow perspective, we continue to target another strong year of free cash flow generation. We are expecting cash flow from operations of $1.850 billion at the midpoint of our range and capital expenditures of $650 million at the midpoint. We anticipate this will result in free cash flow of $1.200 billion at the midpoint, which does incorporate an estimated $170 million increase in income tax payments this year compared to 2022 due to us nearly fully utilizing our tax NOL carryforwards as a result of our improved profitability over the past several years.

This free cash flow will be used in part to fund approximately $560 million of anticipated cash payments to non-controlling interests. I do want to point out that our 2023 guidance does not reflect the use of any capital deployment for share repurchases or debt repayment. However, this is not to say that we won’t deploy capital for these items. It’s just that we have not reflected any 2023 share repurchases or debt retirement in our guidance. Our free cash flow generation has improved substantially over the past several years and we expect to continue to drive strong cash flows, while executing on our growth plans. As a reminder, our capital deployment priorities have not changed. First, we plan to continue allocating approximately $250 million of capital annually to grow our USPI surgery center business; second, to enhance our hospital growth opportunities, including the continued focus on higher acuity service offerings; third, evaluate further opportunities to retire and/or refinance debt; and finally, share repurchases depending on market conditions and other investment opportunities.

And with that, we’re ready to begin the Q&A. Operator?

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Q&A Session

Operator: Thank you. We will now be conducting a question-and-answer session. Our first question comes from Kevin Fischbeck with Bank of America. Please proceed with your question.

Kevin Fischbeck: Great. Thanks. I appreciate all the color on the USPI side of the equation and the expectations for improvement there. But I just would love a little bit more color on as you do the postmortem on what happened in 2022 and why you’re a year behind on that first — on the second part of the transaction, how much visibility do you have in that normalizing? What went wrong then? Why do you have visibility in improvement this year? And is there anything you’re going to be doing differently around future deals or de novo developments? Thanks.

Saum Sutaria: Hey, it’s Saum. Just real quickly on that. I think it goes — this goes back to the commentary that I made about a wide range of the types of centers that we purchased, many of which were much, much in earlier stages of development ramp-up. And again, some of them were literally just breaking ground. And so when you couple that with the disruption from COVID to physician practices that would impact ramping centers, you look at some of the supply chain issues we faced in getting centers opened and running with the right equipment and infrastructure on time, the ramp-up of those centers being slowed slowing potential timing for buy-ups. I mean all those things kind of played into a bit of a perfect storm on a great set of assets as we noted they’re the center level asset performance on the ones that were more mature, we’re doing just fine.

But just when you look at all of that put together, we had a set of assumptions that entered not expecting a lot of that disruption and it just didn’t play out that way. And that’s why I figured, it’s just easier to just be clear. It’s a year behind the expectations but we still feel great about the portfolio.

Operator: Our next question comes from Jamie Perse with Goldman Sachs. Please proceed with your question.

Jamie Perse: Hey. Good morning, guys. I was wondering if you could just spend a minute on what’s in guidance for reimbursement, particularly on the commercial side. What kind of success are you getting in renegotiating contracts? And what visibility does that give you in terms of the rate update you’ll see over the next two to three years, the contract duration?

Saum Sutaria: Hey Jamie, it’s a Saum. Good morning. We believe we’re in a very good position from a health plan contracting perspective, where is essentially fully contracted this year about 95% and in terms of the negotiated terms and provisions we negotiate contracts for all of our facilities hospitals, USPI facilities, our physicians on the national basis with the national plans and on a statewide basis for the Blues. So we feel very good where we’re at. We get asked a lot about in terms of percentage increases. And are we having conversations about given the inflationary environment, we absolutely are. We talk about rate increases typically in the 3% to 5% range, and some more recent negotiations. We’ve, obviously, been discussing the inflationary aspects and I think we’ve been making progress on that too. So we feel really good where we’re at from a contracting perspective.

Operator: Our next question comes from Justin Lake with Wolfe Research. Please proceed with your question.

Justin Lake: Thanks. Good morning. I wanted to ask another question on USPI. I appreciate all the detail. Dan said, I think 22% of EBITDA for the year in the first quarter that looks like it’s up about 6% year-over-year, if I’m measuring that correctly versus 11% for the year. So what’s driving that? What do you think is going to drive the significant ramp through the year to get to 11%? And then just quickly on NCI it looks like it’s up a lot year-over-year materially faster than growing faster than EBITDA. Can you walk through the driver of that? I assume, it’s at least partially due to the buy-ups. Thanks.