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HCA Holdings, Inc. (HCA)

May 21, 2013 10:30 am ET

Executives

R. Milton Johnson - President, Chief Financial Officer, Principal Accounting Officer and Director

Analysts

Albert J. Rice - UBS Investment Bank, Research Division

Albert J. Rice - UBS Investment Bank, Research Division

I'm A.J. Rice, the Health Care Services Analyst here at UBS. It's my pleasure to introduce HCA, who's next up in the room. Here today, we have Milton Johnson, President and CFO of HCA Holdings. Here to tell us about HCA's story. Obviously, a leader in the health care service delivery market, operating about 6% of all the hospitals in the U.S. in fast growing markets around the country. With that, let me turn it over to Milton.

R. Milton Johnson

Thank you, A.J., and thanks to all of you for taking the time today to hear more about HCA. We believe that HCA occupies a very unique space in America's health care delivery system. We're pleased with our past and more recent performance, and excited about our future opportunities. For those of you who do not know a lot about HCA, I'll spend a few minutes reviewing our portfolio and our overall operating strategies and then, provide some summary information on our recent performance and general observations on the health care reform agenda. So some thoughts about our company.

HCA is America's leading largest private hospital and health care management organization. We have an unmatched asset base, scale of operations, strong operating performance and future potential in a changing health care environment. We are well diversified across 30-plus markets in 20 U.S. states and the U.K. Generally, our assets are positioned in the southern half of the US. We operate in large population centers. We're in 14 of the 25 fastest growing MSAs of -- with more than 500,000 people. We operate in an industry and markets where key macro dynamics: population growth, the health care utilization curve, and perhaps, health care policy reform will continue to drive demand and growth. We operate a sophisticated portfolio of hospitals, many with a large earnings profile. We see about 20 million patient encounters each year. 1 out of every 22 emergency room visits in America goes to an HCA hospital, generally, 20% to 30% market share in key markets. We are among America's largest ASC providers, behavioral provider. We have our own GPO HealthTrust Purchasing Group, with about $18 billion to $20 billion in purchases annually. We have a large ITNS operation and a clinical research organization.

So the takeaway from our footprint is domestically focused, except in the U.K. And we have a large diversified footprint that helps us stabilize our performance by minimizing the influence of any single market or region. And this portfolio is not easily replicable and can expand efficiently.

Our facilities do not function as an independent delivery setting, but in an integrated way, providing care to patients across a continuum of settings and services. A market may typically have 1 or more large tertiary care facilities surrounded by general hospitals providing more primary care than ordinary care. These outlying hospitals are often in the faster-growing suburban communities.

In addition to our hospitals, we have an array of outpatient and ambulatory centers providing convenient access to diagnostics and treatment and surgical services. We also operate freestanding emergency rooms that provide critical access to emergent care for communities whose populations are not large enough to sustain a hospital and open trauma centers to support our network. In addition to our facilities in many markets, we provide access to a network of employed and affiliated physicians and physician extender in both practice settings and employer work sites.

We provide a range of services: inpatient, outpatient, behavioral, rehabilitation, freestanding ERs, urgent care centers and physician practices. We're not a single-agenda focused company, not dependent on 1 market or 1 service line. We have flexibility to provide care across multiple settings. In addition to our health care sites, each market is supported by local and regional consolidated service centers to improve the efficiency of operation. Regional line support services include supply chain, revenue cycle, accounting support, credentialing and workforce management. This regional support strategy provides a competitive advantage to our facilities by providing high-quality, highly-efficient services through scale, standardization and expertise that cannot be reproduced by a standalone hospital or a small local system.

Now consider that this type of network is replicated within each of our markets, this gives you a sense of our approach to operations. This approach, we believe, has distinct advantages: it standardizes performance across markets, allows us to deploy technology and human resources very efficiently in a timely fashion and effectively allows us to harness our scale to improve our cost structure.

As we look ahead, the impact of the Affordable Care Act is on everyone's mind. Let me start by stating that some of the things are better known than others, and just let me make a few observations. The impact of the Affordable Care Act will be incremental and will vary by state, market and even hospital. We anticipate that 2013 will be a year of preparation as consumers become educated about their options, particularly, with health care insurance exchanges and as payers and providers develop new products and negotiate rates. There will be no volume from the nearly insured until 2014 and will grow through to 2015 and 2016, as more lines enter into the exchanges. We are unable to be more precise about impacts by year at this time because there are still many uncertainties. For example, the states' decisions about whether to expand Medicaid eligibility, a degree of employer opt out. How many employers will opt to pay penalties and drop coverage? We anticipate more smaller employers will than larger employers, but time will tell the total number of lives it will affect. The speed and level of consumer uptake on the exchanges, and of course, the reimbursement level on the individual exchange. Greater clarity into the health care reform's impact on HCA will be provided over the next several months. Currently, payers are currently filing products for exchanges. The states, again, some just still deciding on whether to expand Medicaid coverage. And the open enrollment period begins in the fourth quarter of 2013 and then, utilization patterns will emerge. We will continue to build and refine our model, and we'll provide our early thoughts later this year or no later than early 2014, probably at the latest date, when we release our guidance, earnings guidance, for the year 2014, which most likely would be in early February of 2014.

So in the first quarter of 2013 was a quarter with a significant amount of contracting activity for health exchange products. And that activity has carried on into April and even into May. We've taken a very disciplined approach to exchange contracting, factoring in assumptions such as anticipated participation by individuals in exchange products, Medicaid expansion activities, uninsured market share and hospital occupancy rates, to mention a few. And our results, to date, are as follows: we have negotiated contracts in 27 of our 37 markets, we have executed 36 contracts with our major payers and expect to be in active negotiations for additional contracts over the next several months. Currently, 85% of our hospitals are contracted with at least 1 exchange product. We have contracts in 17 of our 20 largest uninsured markets and in non-markets, we'll participate in multiple exchange products. Although we're not going to comment on the detailed rates associated with executed contracts, they generally can be characterized as closer to commercial pricing than Medicare. In some cases, exchange contracts have been coupled with term extensions of other managed care agreements and with -- that we might have with any given payer.

We believe this will be a process that evolves over time. Although we are still in the early stages of America's reform agenda, the exchange contracting results, to date, have been within our expectations and we're encouraged by the dialogue we've had with the payer community, and believe the exchange products, over time, will create value for our organization.

There are 4 attributes to HCA that are unique and differentiate us as an organization. First, diversified markets and integrated networks. We are a geography -- we are geographically diverse, with no market that accounts for more than 8% of the EBITDA of the company. We manage the company as a portfolio. If we see an opportunity in a particular market, we can invest in that opportunity aggressively; flexibility to test different approaches incrementally across markets; and service line diversification. No one service line accounts for any more than 10% to 12% of our overall revenue. Second, we have an efficient cost structure, unique scale and scale creates a lot of opportunity for us, allows us to eliminate duplicate costs that exist across our structure; produce administrative efficiencies and reduces our cost per unit. Third, our clinical investment. Significant investments in clinical and information technology to deliver necessary clinical outcomes and operational performance to compete in a value-based market. And fourth, financial flexibility. We have very strong free cash flow. We expect $1 billion to $1.2 billion in 2013 of free cash flow. This provides an opportunity to deliver shareholder value through different mechanisms. And finally, the HCA management team. Our hospital and division managers, on average, are tenured with the company. We have a strong unique culture, shareholder-friendly through years of different types of transactions and different types of structures. We know that we have a responsibility in delivering patient care, and we recognize that we do business with the government and we have to adhere to various regulations.

So with that, let me close, and A.J. will be happy to take any questions you may have or any from the audience.

Question-and-Answer Session

Albert J. Rice - UBS Investment Bank, Research Division

If someone in the audience would like to ask a question, feel free to raise your hand. Okay, we have one in the back there.

Unknown Analyst

[indiscernible]

Albert J. Rice - UBS Investment Bank, Research Division

Step a little bit closer, I got a little ear problem, so...

Unknown Analyst

As a vendor that is working with HealthTrust, HPG, we signed an agreement, and then, there are other coalitions or regional coalitions and groups of hospitals that are looking for something even more aggressive, I kind of -- I'd like to get your ideas or your thoughts on that.

Albert J. Rice - UBS Investment Bank, Research Division

So a question about HPG and somewhat retention of contracts and...

Unknown Executive

Let me -- I just -- I'm not sure I fully understand the question. But one thing that we do, in some instances, is create a national contract at the starting point and recognize that there are certain items, especially physician-preference items, where local new launch and local preferences have to be respected and addressed. And so our contracting strategy, in certain categories of ours spend, are to do it completely at the national level and not allow any local variation. But for certain physician-sensitive and physician-preference categories, we will operate under a national contract. We give ourselves the flexibility to adapt to the marketplace and respond to our physician request and try to create some scale, if you will, within the local market to create some buying power regionally. So that's been the approach in certain categories. We continue to evolve that model. And our preference, obviously, would be to do it at a national level because we have more scale, more buying power at that level. But we do have to recognize our physicians as our core customers and respect some of those differences that do exist from one market to the other.

Unknown Analyst

I appreciate that. Just one other question. What, if any, financial impact will the loss of that going to have with the continued growth of HealthTrust?

R. Milton Johnson

We haven't quantified the movement of Vanguard away from HealthTrust. HealthTrust continues to have a pipeline of new systems that we're looking to bring into in the organization, and I'm confident that we'll continue to see HealthTrust's purchasing power continue to grow over time.

Albert J. Rice - UBS Investment Bank, Research Division

I might ask a question about -- clearly, we saw some volatility in the volumes in the first quarter. There's been some comments made about an early read on the second quarter. Can you give us -- and would you add a little perspective over time to sort of adjust what others guys have commented and reported? Give us some perspective on what you saw in the first quarter? How much can we explain about the calendar, et cetera?

Unknown Executive

Well HCA has had a fairly consistent track record of growing its volumes over the past few years. I think we've seen a number of consecutive quarters where we have actually had adjusted admission growth on a year-over-year basis. On top of that, we've seen over the past 24 months, I think, a steady state of market share gains across the company. And there's no indications that any of that changed in the first quarter, other than the global trend. And when we went back and evaluated the elements of how our volume structure works, there was no indication that any of that changed in a significant way. And our conclusion, at this particular point in time, until we can get more precise data from real market share data for the first quarter, which we will have hopefully, in the next 90 to 120 days, was that the calendar, the unique nature of this first quarter calendar, we had underestimated somewhat, and with the loss of Leap Year, with the lineup of New Year's, with the lineup of the Easter Holiday, all of that produced a headwind that was maybe a little bit more significant than we had anticipated, and explained a large percentage of the slowdown for the company across most service lines. As we indicated on the call, we don't typically give forward-looking quarter information, but we felt it was important to give you some indications of April activity. And April's volumes for the company were up significantly at 4%, which was above the trend for the first quarter and more consistent with the company's plan. So we've had 2 out of 4 months where the volumes had been better than anticipated, and we had 2 out of 4 where the volumes were actually less than we anticipated. And so we're really not, at this point in time, A.J., able to identify anything specific that would suggest a trend change. We are starting to get fourth quarter market share data, and the company appears to be performing at a consistent level on the early indications for the fourth quarter data, and it would suggest gains for the company on its market share so far and -- and so we're continuing to study it. We continue to invest on our growth strategy in a very significant way and we believe the company is well-positioned, as Milton said, to continue gaining market share.

Albert J. Rice - UBS Investment Bank, Research Division

And I think also, in the context of the back-half of the first quarter, you talked about implementing some cost initiatives to -- when the volumes came back a notch, get yourself aligned for the rest of the year. Can you just maybe give us an update on that and I guess, discuss that a little bit?

Unknown Executive

Well, cost maintenance within the hospital business is a very dynamic process to begin with. I mean, structurally, it's a shift by shift kind of event, where we are actually forecasting volumes for tomorrow, today. We're actually doing that, that's how our hospitals function. And we made judgments around where we think our volumes are going to be. As we moved into the first quarter, we were moving off a very intensive flu season in the fourth quarter of last year. And so our staffing levels were at the high watermark as we were working our way through the flu season. The flu season was in fact was strong in January. And as we started moving through the latter half of the quarter, it became apparent to us that our volume levels had eased off quite a bit and we needed to make some adjustments. And so we started making adjustments in our temporary labor structure where we used outside resources to deal with the seasonality of our volume. And we were able to move those costs out of the system fairly quickly. We had some other situations where we needed to make more structural changes because the volumes have dropped off more than what we had anticipated. Those adjustments were made mostly by the end of the first quarter. And we have adjusted our cost, we believe, to get our trend down to a more appropriate level to deal with the expected revenue growth that we have over the remaining portion of the year. And most of those initiatives were accomplished by the end of the first quarter with a few residual initiatives being accomplished in the second quarter.

Albert J. Rice - UBS Investment Bank, Research Division

Okay. And I might ask -- I appreciate the comments on the exchanges. And I know some of the other companies are starting to talk about what they're seeing on the exchanges. As you step back, does anything surprise you? Are you sort of where you thought you'd be in terms of your exchange contracting? Are you seeing more or less activity on the part of payers coming to you than you had expected? It sounds like the rates are coming at about where you thought, but give us some flavor for whether there's, from your perspective, been surprises.

R. Milton Johnson

A.J., I'd say, probably, the largest or the biggest surprise would be somewhat the conservatism, I use that word with the payers. Of course, the Blues have been the most active in the exchange. Most of our contracts that we have on the exchanges -- on the exchange so far would be with various Blues plans. On the other hand, United, they decided not to put an exchange product in any of our markets. So -- and then, certain payers have been selecting to go into exchanges where maybe it's a federal exchange but not a state exchange. So I would say that in the early look here is that, not having all the payers aggressively coming into the market early has probably been my biggest surprise. I think that's a timing issue. I think that over into '15, we will probably see that change. But I would say that would be the biggest surprise of today.

Albert J. Rice - UBS Investment Bank, Research Division

Okay. And then, we'll also ask you about the Medicaid expansion a little bit. Obviously, couple of key states seem like they're on the fence or probably, may not even come in. First year, Florida, Texas, for example, and maybe Tennessee, your home state. How do you think about that? I mean, there's also the discussion that some of those people might be eligible for subsidized programs on the exchange. How big a foregone opportunity is that? Or how much do you think may be mitigated by some of those other options?

R. Milton Johnson

Well, I think, again, we would like to see states expand the Medicaid eligibility. That being said, we realize that that's not going to happen. It doesn't look like it's going to happen this year in Florida nor Texas nor even Tennessee. But from a financial standpoint, we do believe that we will have a substantial number of lives that would've been eligible for expanded Medicaid that now will also be heavily subsidized on the exchange, and we believe that people will make that decision to buy insurance on the exchange, especially the individuals that may have health concerns or immediate health needs. Also, we believe the cost of the mandate that you will have individuals that are employed that would've been still eligible for Medicaid expansion, for Medicaid underexpansion, that now may choose their employer coverage because of the mandate. Although the penalties in '14 are only $95, they go to $395, eventually, to $695, I think, in 2016. So we think as the penalties increase, that will push more people to elect in 4-year coverage if the states don't expand. So we do believe that although we will still have higher uninsured lives in the markets where Medicaid does not expand, we still though will have some upside in the exchanges with the reported coverage.

Albert J. Rice - UBS Investment Bank, Research Division

And now HCA over the years has been very opportunistic in capital deployment, buybacks. Last year dividends seemed to be more of a priority. Acquisitions, different periods in the company's life. Give us your thoughts on capital deployment and whether we'll continue to see more of what we saw last year or maybe move into different directions?

R. Milton Johnson

Well, I think our first priority for capital would be good acquisitions. Acquisitions, ideally, that would help complement our existing markets. But also, we're open to moving into the new markets that we would find attractive and markets that would fit the profile and how we like to operate. So I think that would be the first priority for use of capital. Quite frankly, last year, we looked at several transactions. We did have a few acquisitions last year but on a smaller scale. And as a result, we deployed capital with special dividends. Now that our sponsors have gone through a couple of secondary offerings, we've increased the float of -- in the public market that may make share repurchase a more attractive option now that we have more float. So we'll put all that in the mix. I'd say that the biggest one -- the biggest driver is going to be opportunity to grow through acquisitions. And again, acquisitions in attractive markets and at what we think would be fair prices, followed by the opportunity to deploy capital back to shareholders either through share repurchase or dividend. And that will depend on the market conditions at the time we make that decision. And all of that, the last 2 opportunities being limited also by our credit agreement and our restricted payments basket.

Albert J. Rice - UBS Investment Bank, Research Division

Maybe just a follow-up on that, then, real quick on the limitations. So how much flexibility do you have when you look over the course of the year under your agreements?

R. Milton Johnson

The way our agreements work is we get -- we increase our restricted payments basket by 1/2 of our net income each quarter. Effectively, that happens upon -- when we file our 10-Q and our 10-K. So each quarter, our capacity there will increase.

Albert J. Rice - UBS Investment Bank, Research Division

Okay. I appreciate -- why don't we continue the questions over in breakout room? That'll be the Carnegie West, which is right across the hall. And I appreciate HCA participating in the conference this year. And next up in this room will be -- actually there's a break and then, CareFusion will be here at 11:30.

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Source: HCA Holdings, Inc. Presents at UBS Global Healthcare Conference, May-21-2013 10:30 AM
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