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.

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 want to remind everyone that this conference call may include forward-looking statements, which are not solely based on historical or current information. These statements carry various known and unknown risks, detailed in our annual report and other filings with the Securities and Exchange Commission. Therefore, actual results could vary significantly from any forward-looking statements made during this discussion. We do not plan to update any forward-looking statements. Yesterday afternoon, we released our financial statements and explanations of adjusted EBITDA and adjusted EPS. We have also made a supplemental presentation available on our website. The calculations we will discuss today exclude gains or losses from early debt extinguishment, impairment expenses, business sales, legal matters, employee termination benefits, and restructuring charges. Now, I will turn the call over to Tim Hingtgen, Chief Executive Officer.

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 healthcare 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 advance 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 healthcare settings 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 in nursing turnover rates on top of the significant gains in 2022. Advancing safety and quality remains one of our most important priorities. 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. healthcare systems for online reputation, a distinction that is the result of positive online ratings and reviews for our healthcare 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.

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 non-labor 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 healthcare 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 salaries, wages, benefits, 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 non-labor-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 two items contributed to an increase of approximately 6.9% in non-labor 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 non-labor-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 to 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 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 two 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 into 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 healthcare 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.

Thank you, Kevin. Jamie, we're ready to open the call for questions.

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

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?

Sure. Yes, absolutely. So as we expected, we expect the first quarter to step backwards a little bit. Certainly, some of that we anticipated as 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, they 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 much weighted towards the MA plans in the first quarter.

Our next question comes from Brian Tanquilut from Jefferies.

Guys, can you hear me okay?

Yes, we can now.

All right, sorry about that. Yes, my question is about labor. It seems to have picked up a bit here, especially in contract labor, as we see bill rates for temporary staff decreasing. Should we consider this when thinking about trends for Q2 and Q3 regarding that specific line item? Additionally, I know you faced a higher-than-expected inflation rate for labor in Q1. What factors could contribute to reducing that over the year?

Certainly. I'll address both parts of your question. Regarding contract labor, there are a few differences from last year that are noteworthy. Most of our recent hiring, especially in the first quarter, has focused on new graduates. Last year, when we started our centralized nurse recruiting initiative, which we celebrated this past April, we were bringing back many nurses who had left our facilities for travel nursing. This meant they had a shorter ramp-up time. In contrast, the new graduates we are hiring now will take a bit longer to get settled in, which might slightly delay our efforts to reduce contract labor. We had strong success in nurse hiring during the first quarter, and we anticipate this trend will continue with our centralized nurse recruiting. We also expect to transition more contract labor nurses to international nurses, who typically require more time to integrate into their roles. This change will allow us to cut down on some contract labor expenses and help manage the average hourly rate. In terms of employee costs, we saw a 5.9% increase in average hourly rates, which is slightly above our previous guidance of 5% wage inflation for the year. However, we're optimistic that the rate increases we implemented in 2022 won't carry on into 2023, allowing us to potentially reduce wage inflation in the latter half of the year. We still believe that an average of 5% for the year is achievable. Despite the 5.9% wage inflation, we managed to achieve productivity gains, so our actual same-store weighted labor costs only increased by 5.4% compared to last year.

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

I wanted to ask for more details regarding expenses in two areas. First, with the managed care recontracting you are currently doing, are you noticing any improvements that could offset the inflationary pressures, particularly related to labor? Secondly, you mentioned hospital-based physicians and their professional fees. Can you specify which areas this includes, such as emergency room management or anesthesia? What do you foresee for improving this trend throughout the year? Are you expecting it to remain at the current elevated level, or is there potential for enhancement?

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 as 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 quarters. 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.

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 providers 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.

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

I would like to explore the shift in product mix further because I am not entirely clear on how it has affected pricing. Can you break down how much of this shift is attributable to the factors you mentioned regarding COVID impacts? Specifically, if this is related to Medicare Advantage dynamics, could you remind us of the rate differential between Medicare Advantage and fee-for-service? If it is indeed Medicare Advantage, do you expect this to be a long-term challenge? Why wouldn't this continue to apply pressure on rates moving forward?

Yes. So if I think about kind of year-over-year, about two-thirds of our growth in volume year-over-year related to governmental payers. And of that, probably two-thirds 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 are 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 two-thirds government, one-third 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.

Yes, Kevin, this is Tim. I'll add to that. The commercial mix this quarter was lighter compared to the growth in government revenues. As Kevin mentioned, the first quarter is usually our lowest for commercial mix, so I anticipated this as people hit their deductibles and co-pays, following the stronger procedural surgery volume in the fourth quarter that created some lag into the first quarter. Throughout the quarter, we did see some improvements in the mix as we moved into March and April, and we expect that to normalize. However, regarding the growth in Medicare Advantage volumes, we need to be more focused and determined in achieving a better balance in our commercial mix. We are pursuing this through strategic access points in our service line development, particularly in obstetrics, neonatal intensive care, and trauma programs, as well as deeper investments in cardiac service lines that tend to draw a better age mix. We are also developing specific direct-to-employer strategies, including new contracting models, and we look forward to implementing these in the upcoming quarters.

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 the 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.

Our next question comes from Josh Raskin from Nephron Research.

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 excluding the grant income. 1Q was down 7.5%. So the rest of the 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.

Yes. Compared to last year, a significant factor is the reduction in contract labor, which should result in a decline in contract labor costs. We anticipate that the increasing demand for healthcare services will contribute positively to revenue. Additionally, we expect some moderation in other operating expenses and are continuing our margin improvement initiatives, which we have been implementing for a couple of years. We believe there is still an opportunity to keep our other operating expenses below inflation, which we can then utilize to enhance our EBITDA. We will also benefit from the investment projects we have undertaken recently, which will yield greater returns this year. Furthermore, we opened a new hospital in June of last year, which will be fully operational this year. There are various factors driving that growth.

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

No. At this point, we still feel comfortable at the midpoint. The difference 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.

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?

I'm not sure I would say more than we have in the past considering we went through several years of a very formalized program. We did pause for a while during COVID, but we have completed a few smaller transactions recently. There is one announced in North Carolina that is larger, and we are currently in talks about some other interests. If those come to fruition and are at prices that are beneficial or allow us to reduce our leverage and improve our margin profile or future cash generation, we will seriously consider them.

Our next question comes from Jason Cassorla from Citi.

The surgery growth number this quarter was impressive, exceeding 10%. Can you discuss the factors contributing to this and clarify the trends in inpatient versus outpatient surgery? Did this affect the mix during the quarter? Also, it would be useful to understand the durability and sustainability of these surgery growth trends.

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.

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. 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. 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 the first quarter. We had a very robust orthopedic surgery quarter compared to prior year, but also beating almost every surgical statistic 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.

Our next question comes from Stephen Baxter from Wells Fargo.

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?

Certainly, a portion of that is due to increasing EBITDA. However, we had some timing issues with payments related to professional liability claim settlements in the first quarter, as well as accounts payable and compensation liabilities that we settled. These did not all impact the income statement since they were already accrued. We expect to recover these in the later quarters of the year, and we anticipate improvements in working capital year-over-year. This should result in enhanced cash flow from operations by the end of the year.

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.

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 one 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.

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.