Universal Health Services, Inc. (UHS) Earnings Call Transcript & Summary

Hi. My name is Justin Lake. I want to thank everybody for being here today to kick-off Day 2 of our Wolfe Healthcare Conference. I'm kicking it off with an old friend, very handsome man, Steve Filton here, CFO of UHS. Steve, I really appreciate you being here with us this morning. As hopefully everyone knows, feel free to send me an e-mail with any questions for Steve. We'll try to squeeze those in at the end here. E-mail addresses is [email protected]. Steve, why don't you give us a 2-minute kind of state of the union here in terms of what you're seeing. Kind of, as we came out of the third quarter into the fourth, what you're seeing on COVID, labor and how you're thinking about the world going into next year. And then we'll kind of get started.

Yes. So Justin, I mean, we're about a little more than 3 weeks out from our third quarter conference call. Where we gave people an update at the time. And not a great deal has changed. I mean obviously, the third quarter results were dominated by the COVID surge on both sides of the business. I think the impacts of the 2 businesses are different. But clearly, we were impacted on the acute side by much, much higher labor cost, premium pay, et cetera. Although on the acute side, I think overall results were quite robust. Because in the end, the higher acuity and reimbursement associated with COVID patients and the recovery in non-COVID patients overwhelmed or at least largely offset the higher labor costs. On the behavioral side, as has been the case in previous surges, the surge in COVID patients creates a real squeeze on our labor. And in turn, the labor shortages inhibit our ability to admit as many patients as are being presented to us. What we said at the end of the third quarter is that by the end of September, we were seeing the COVID surge and COVID numbers easing, and that has continued. Although, I will say they've kind of plateaued. And again, I'm not an infectious disease expert, so you don't know where we go from here. But obviously, cases have been rising in Europe generally, and in some places around the U.S. We'll see what happens. But I think what we talked about -- and again, we have this perspective because we go back not all that far into -- back to Q2 when COVID volumes were much lower and the businesses both performed sort of better than internal forecasts. But that took a while. In other words, it was January -- mid-January of 2021 when the COVID volumes really began to decline. And it took until kind of early April for the businesses to really start to get the traction from that. So if you sort of assume the same kind of time frame, we're talking about mid-September to mid-December, late December. And of course, then we're right in the middle of holidays. We'll see. We've seen a little bit of pickup, I mean, a little bit of pickup in behavioral volumes. We've seen a little bit of easing in behavioral labor pressures. And I think that probably incrementally continues throughout the fourth quarter would be our best guess. But again, I think the real improvement, assuming that COVID -- and the COVID volumes remain relatively stable, is we'll really get that traction beginning next year.

Got it. That's helpful. So you talked about a little bit of improvement in volumes. Are you seeing improvements in surgeries, ER volumes? Where are you kind of seeing that the most, behavioral?

Yes. So look, the reality and the reason again that the acute performance was so strong -- by the way, not just for us, but I think for our peers as well in Q3, was there were high COVID volumes. And the COVID patients tend to have much higher acuity, therefore, higher reimbursement. There's some special government reimbursement associated with COVID patients, the 20% add-on, Medicare sequestration waiver, the HRSA reimbursement from uncompensated patients, all those things help. But what really, I think, characterized the third quarter for the acute segment, which is unlike previous surges, is there really wasn't that same crowding out of non-COVID business. We have the occasional canceled or deferred surgery, but nothing really pervasive or comprehensive. And so you just really have this very strong revenue on the acute side again. And so in the fourth quarter, honestly, you're not seeing much of a recovery. As a matter of fact, I think the challenge on the acute side -- and I'm sure it's true for all acute care hospitals. As COVID volumes decline, you've got to sort of backfill that volume with non-COVID business. And again, I suspect we'll be able to do that just as we were able to do it in Q2. I suspect there might be somewhat of a delay. So I think the fourth quarter may be a bit of a step down from Q3. But I think by the time we get to the beginning of the year; it should be a much stronger performance. On the behavioral side, same thing, we're seeing that recovery in volumes, behavioral admissions and patient days. But I think it's relatively incremental. Because I think the issue is on the labor side, a lot of these premium arrangements, the arrangements we make with temporary nurses and traveling nurses, have become multi-week, multi-month. A lot of these deals now are 12-, 13-week deals, et cetera. So they take away -- and they take a while to work out. And as I described it on both ends, meaning the arrangements that we make with temporary nurses take a while to work out, and then the arrangements that our nurses who have left us make in a city 200 miles away, they're going for 12 or 13 weeks before they come home. So again, I think our expectation is that by the end of the year, early next year, a lot of those nurses who are going to come back and not everybody will. But a lot of the nurses who really only left temporarily and a lot of the temporary arrangements we have will start to roll off, and things will look a bit more normal, not completely back to where they were, but certainly a lot more normal.

So maybe you could share some numbers with us there, Steve. In terms of temporary staffing, what's a normal percentage? Typically, you hear about kind of low single digits as a percentage of hours. What is that running today?

Yes. And so again, I think the dynamics are different in the 2 segments. On the acute side, the pressure is on what we describe as premium hours. So what we really focus on is the percentage of our nursing hours that are being paid at something other than the underlying base wage rates. So it could be overtime for our own employees. It could be temporary nurses or traveling nurses, whatever. And you're right. I think in what we would describe as sort of an ideal situation, maybe the percentage of premium hours is at 2%, 3%. I think at the height of the pandemic back in January of last year, it was probably in the low double digits, 11%, 12%. I think we've been running more like 8% or 9% for most of the third quarter and into even early October or into October. But the other issue is the rate at which we're paying. So we generally track the percentage of premium dollars, and that premium is usually somewhere between 50% and 75% of our base wage rates. But the other pressure point here on the acute side has been the rates have gone up. So now we're paying 125%, 150% of our base wage rates to get these temporary nurses and traveling nurses. Or even our own nurses, we're paying an extra $750 a shift to work or whatever it may be. So that expense has really gone up. And again, the issue on the acute side is this sort of short term. As the COVID volumes decline, and is it takes us a little bit of time to backfill those COVID volumes and the premium dollars are still in place, the acutes are caught a little bit in a whipsaw. I think that will all even out over a couple of months, but that's kind of where I think we are a bit in the fourth quarter. On the behavioral side, the percentage of premium hours really, unfortunately, hasn't gone up. We're probably still only running about 2% of our nursing hours as premium labor. We would like to run much more. We just can't find the nurses. We can't pay the nurses, et cetera. And because we can't and fill certain other positions, like therapists and some nonprofessional technicians, we're turning patients away. Again, that -- the early signs of that pressure easing are there in October, November, but I think it's a slow process until we get closer to the end of the year.

Got it. So those are some interesting numbers you threw out there. And you said, look, some of this stuff is locked in. Where would you expect to be if you kind of -- if we just stay where we are in terms of COVID, right, like to your point. It plateaus here and we kind of live with this. But let's just say, the next 3 to 6 months, the -- versus that 8% to 9%, where would you expect to be kind of when those contracts roll off?

Yes. So again -- and rather than just speculate, I think we often return to our second quarter experience. So in our second quarter, the percentage of our overall acute admissions that were COVID diagnosis was in that mid-single-digit range, low to mid-single digits, it's 4%, 5% kind of thing. If we return to that level, I think we would expect the acute premium pay percentage to drop into more again mid-single digits, 4%, 5%. And again, very importantly, for those rates to drop as well. Now we're paying 50% premium or 75% premiums, which is kind of more the norm than what we're paying now. And again, same thing on the behavioral side, as those volumes dropped in Q2, we saw volumes recover, which is what we would expect to see later this year, early next year as well.

Are you actually seeing that, Steve? Meaning, like I get that you've had to pay some nurses and lock in rates that are 150% of normal, right? But the temp nursing contracts that you're signing today or the travel nurse that you're signing today, are they already back to that 50% to 75%? Or is that something you expect to happen?

Yes. So I think it's a little bit of both. So we're just -- the timing is such that we're just starting to go over our October results with the hospitals in detail. And we're here -- so I think October was, again, a high month for premium pay. But at least some of the hospitals are starting to report pretty significant declines in November and projecting their November use the premium labor to be half, et cetera. Now again, that's only certain hospitals and at some hospitals, November is kind of a repeat of October. But I think certainly, the signs are there that more broadly, the pressure is starting to ease, and we would expect it to ease more in December. Again, with the caveat, which is an important one, that the COVID volumes remain at a lower, more stable level.

Okay. Maybe you can talk -- let's flip over to the behavioral business for a second here. And the -- today, like you said, it's less about premium pay, and it's more about staffing levels overall. And I remember over the summer, we did a great meeting with the head of your behavioral business, Matt Peterson. And he was throwing around some interesting metrics, and one of them was conversion percentage, right? He was expecting to improve staffing, and conversion percentage is going to start improving. So obviously, that didn't happen because of COVID, right. Nobody saw the variant coming. But can you give us some color there in terms of maybe kind of similar to what you were talking about? What was conversion percentage, right, which is the percentage of the referrals that come to you that you're able to take in on the behavioral side? What was that back, let's say, in the first quarter of last year? What did it improve to in the second quarter? And kind of what are we seeing now?

Yes. So you make some really, I think, salient points, Justin. So we had that meeting, or you had that meeting I believe it was last week in June. And I think Matt talked about a number of things. He was quite bullish at the time. And I think legitimately so, and that really reflected sort of our view of the world. Now we were probably a week or 2 before the real beginning of the increase in the COVID cases as a result of the Delta Variant. So I think Matt was expecting and our outlook at the time was Q3, at least from a COVID perspective, it was going to be largely a repeat of Q2. We have done really well in Q2. We were hiring more and more nurses. I think Matt made the point at the time that we were hiring record numbers I think not only nurses, but therapists and techs and that sort of thing. And in truth, some of that activity continued into the third quarter. We continue to hire people at record rates for most of the third quarter. I mean, internal record rates for us. The problem was that because of the surge, we were losing people on the back end. People were leaving, people were chasing these premium dollars and opportunities. Nurses and other employees were out sick because of the virus. All those things were really challenging us on sort of the back end. And as a result, I think we had clearly a more severe underperformance than we were anticipating back in June. But yes, so what Matt was focused on, I think, is that in the second quarter, we've made the point throughout the pandemic that underlying volume, which we measure by the amount of what we call inbound inquiries, calls to us, to our hospitals, to our 800 numbers, Internet inquiries, et cetera, we measure all that as inbound activity. And we convert a lot of that inbound activity to inpatient admissions to the degree that patients qualify medically and, obviously, if they have appropriate insurance, et cetera. And again, those rates had really increased. So our conversion rate historically sort of runs in the 30% to 40% of those inbound calls. I think during the worst parts of the pandemic and the surges, we're at definitely the low end of that. And I think Matt was pretty bullish because in the second quarter, we were sort of creeping back up to the high end. And I think his expectation was, as we filled more and more of these labor vacancies, that percentage would likely increase at least incrementally. And of course, I think what we really experienced in Q3 was, again, a return to the bottom end of that range in part because so many of these calls, even though patients really qualified for admission, we didn't have the staff to treat them in many cases.

Got it. Got it. Kind of stepping forward to 2022, Steve, you've been -- you gave us some color on the third quarter call that you thought kind of -- rebasing off 2019 and growing kind of high single digits off there was the right way to think about. And I think that makes sense in an uncertain world. The question I had was more along the lines of, I would assume that's much more probably acute-driven than behavioral-driven, right? I assume it's not going to be similar. Do you think behavioral has much growth at all? Is it kind of low single digits behavioral off 2019 and kind of mid-teens off acute? Or how should we think about that roughly?

Yes. Look, again, I don't mean to sound like a broken record, but I think to some degree, the themes really are the same. I think a lot of this really depends on the level of COVID. And again, I think the second quarter is the perfect example of this. I mean to your point, yes, I mean, I think our expectation is that COVID volumes in 2022 look more like Q2 where they are 3%, 4%, 5% of acute admissions. I think that the acceleration and recovery of behavioral earnings will outpace the acute earnings recovery. And honestly, the acute earnings are already recovering. If we go into 2022 and it's more of a repeat of '21, meaning higher COVID volumes or at least this sort of ebbs and flows and surges and recessions of volumes, then I think it would be more skewed to acute performance. But one of the reasons why I think we, or I, declined a number of questions on the third quarter call to be more specific about assumptions, et cetera, is we really wanted to see how the last couple of months of the year and the first couple of months of next year play out. To really get more specific about answering your question, like, how quickly does the behavioral business recover? How quickly does acute fill in and backfill their COVID volumes, et cetera, and -- it's been difficult. I'll go back to the example you were giving before. We had a conversation with you at the end of June, and we had a view of what the rest of the year would look like. And a week or 2 later, it changed very dramatically. So as you described in an uncertain environment, trying to wait as long as we can to see how this develops. But I think the 2 major variables and I think you can almost describe them as a single variable, are the volume of COVID and then the way that the volume of COVID affects the labor markets. And again, I think with the expectation that as COVID volumes go down, labor pressures ease. As COVID volumes go up, labor pressures increase. There's certainly been a lot of conversation about the fact that some of these labor pressures are more permanent in nature. They're not absolutely just tied to COVID. And I think that's true. None of us, I think, know exactly how much is temporary, how much is permanent or structural. And we're certainly, I think, preparing for some structural changes. But I'd also think that there's no question. And again, I think Q2 is the perfect example of this, that with lower COVID volumes, the 2 business segments, but most importantly, behavioral should outperform.

Got it. So if I had to read into that, Steve, it sounds like, to your point, we don't know what COVID's going to do. But maybe a way to think about it is if COVID does -- like I think one of your peers had assumed kind of 3% to 5%, 4% to 5% COVID when they talked about 2022. If that is a reasonable estimate for like, let's say that's how things play out, then you're saying, look, the businesses are probably more equal in terms of that high single digit versus '19. If it's higher, it's more skewed to acute. Maybe if it's lower, it might be even more skewed to behavioral. Is that the way to think about it?

I think that's absolutely fair, Justin.

Okay. That's helpful. And then going back, as I thought about your discussion around Q4 for the acute business, again, the COVID moderating, but not fully. You're dragging a bit of higher labor costs through the fourth quarter. So as I look back, 2Q, 3Q year-over-year, especially let's look at 3Q, was decent growth, right? It was mid-teens, let's call it, off 2021. Is it more likely that 4Q gets a little bit of -- you don't have the benefits of the COVID, right? So under -- non-COVID volumes are similar. COVID volumes decline, but unfortunately, you're still carrying that higher labor cost. So you get a little bit of the worst of both from a COVID perspective. And maybe it's more kind of a flat, maybe even down kind of year-over-year quarter in acute?

Yes. And again, a lot of this is sort of timing and temporary in nature in the sense that -- the question becomes, how quickly does COVID decline? How quickly the labor pressures ease? How quickly are you able to roll off those really high-cost contracts? And again, I think we're fairly confident. I often say to people, I have a lot more confidence the more we want to extend our outlook from a time perspective. So -- and if you don't want to talk about the next month, which I think can be uncertain, but the next quarter or 2 quarters from now, a lot more confidence that it plays out the way you describe. But in the short term, we can get squeezed a little bit in both businesses. Again, I would say mid-November, where we are, we're starting to see some improvement. But then we get into the holidays, and that's always a little bit of a kind of a crapshoot, particularly this year. What does that mean? Do we experience the surge and all those things?

Got it. Got it. And before we jump to kind of the -- especially the labor question, I did have one client question come in. And that was, Steve, you talked about labor getting better in a few markets. Can you give us some color on what markets those might be so we can get a little bit more read across? Is it more like Texas, Vegas?

Yes. And honestly, I mean, I think that was more a comment on the behavioral side. And on the behavioral side, no particular market. It's not like Las Vegas on the acute side, where a single market dynamics, good or bad, can drive performance. So it's just a mix. On the behavioral side, we're just seeing some markets where our applications are up pretty significantly. It just has this feel that nurses and other employees are returning. We presume that with applications up, we'll be able to hire more conversion -- that hiring conversion goes up. And then volume, I think, follows that in 4 and 8 weeks or whatever it may be. But yes, I wouldn't -- and honestly, I'm not even sure I could identify in my head that the markets where that's happening. I'm not sure it really matters because I don't know that in behavioral any one market really drives performance. I think on the acute side, like I said, -- and honestly, I really don't know. I have not seen the Vegas numbers, so that would be the one market that would be worth commenting on specifically. But as I said, it's been a mixed bag. I probably talked to a few of the hospitals in detail in the last week. And some sort of absolutely report that the labor situation is getting better. Others say, not quite yet.

Got it. You brought up Vegas, Steve, and I know how important that is to your acute business. What does that market look like just because it's so tied to travel and what's going on? You heard rough things about the real estate market, for instance, in Vegas. Apparently, the only one that's not going up 30% over the last year. The -- can you tell us what's going on there?

Yes. Look, I think the Vegas market has recovered in much of the same way as we were sort of discussing in broad terms earlier about the acute business. Meaning, COVID volumes have receded some, non-COVID volumes have recovered. I think broadly, the Vegas economy is pretty strong. I think domestic travel to Vegas is up. Obviously, international travel is still not back to where it was, et cetera. Look, I still think there's a lot of growth to be had in the Vegas market. I think the whole conference sort of market will improve as COVID continues to decline. Again, international travel and all that will be helpful. And clearly, we're putting our money where our mouth is in that regard in the sense that we talked about continued expansion in the Vegas market on our third quarter call. We bought a micro hospital that's right off the Strip. We bought a specialty surgical hospital to complement our surgical activity in the market. We've expanded our Henderson facility, which is probably our fastest sort of growth facility out of the gate. And we will probably build another hospital in that part of the market over the next few years. So all in all, we still feel very bullish about Vegas. I mean, I think it's experiencing, again, on the COVID side and on the labor side, all the issues that we're experiencing in our other markets, not terribly better or worse. But I think the underlying metrics and particularly the underlying economic metrics are still quite good in that market.

Got it. And then in terms of -- obviously, the stock has been under some pressure. You guys have been pretty aggressive buyers in terms of using cash flow to buy back stock. But the leverage is still at all-time lows. I've seen -- I've been covering the company for 20 years. I have seen Alan and -- kind of step up a couple of times and do a bigger repurchase, even use some leverage, right, do a Dutch auction, things like that. Is there -- what would be the catalyst for something like that? Is there -- when you sit around talking to the executive team once a quarter and you think about the long-term plans, I'm sure you look at the business as being undervalued relative to what you think it can do. How is that being met? Is there any level of kind of thinking about being more opportunistic? Or is it just more of kind of the last 5 years, which is kind of hold the course, keep the leverage low and run a business?

Yes. So look, as you said, I think we feel like we've been more aggressive. We went into the year in the very beginning of the year with the notion that we buy back like $250 million worth of stock in Q2 and Q3. Each, we bought back more than almost 50% more $375 million on average in the 2 quarters. I think we will certainly keep going, at least at that pace, if not at a greater pace. And again, for the reasons that you described. I think we feel like the stock is undervalued because I think we feel that, particularly the behavioral segment, is going to recover when COVID volumes moderate. But also because we're just not finding that I cited a few opportunities of transactions that we've done. But there's relatively small transactions. There certainly has not been a really big M&A transaction for several years. And we continue to look at a bunch of those, and we'll certainly entertain anything that's compelling. But it's not like, I think, we've got a whole chunk of cash set aside for something that we really think is imminent. So I think if both of those dynamics continue for some time, which is that the stock appears to be a compelling buy, which I can't imagine that won't be the case. And if there really are not other external opportunities, I suspect we just continue to be an aggressive buyer, either at the current rates, what I would say the Q2, Q3 rates or at even a more accelerated rate.

And so it's interesting. You say that rate or even more accelerated. Like the company generates a lot of cash, but it doesn't generate $375 million a quarter, right? So part of this is you catching up from not having bought stock during COVID, right? Are you saying that you think you -- once you kind of run through the built-up cash on hand, right, and you go back to buying off cash flow, you're saying you don't think it comes down? Which would mean that leverage -- you would start taking on leverage to raise some debt to buy back stock.

Yes. Yes. So look, I think again, you described it well, Justin. I think that's a good -- you make the point. We suspended our share repurchase, as did most of the rest of the world in March of 2020 for about a year. We had gone into 2020 thinking we would buy back $700 million to $800 million worth of stock I think we went into 2021 with sort of the same idea. I think in the end, we'll come out of 2021 having repurchased over the 2-year period, sort of what our original intent was, something close to $700 million, $800 million on average in each of the years. So I think, like I said, we'll continue to buy at that pace, which is a little bit of a catch-up, but I think that will be then caught up. Or if we continue to buy at that pace, I think we will start to more than eat into our cash flow. And if we accelerate it, obviously, that would certainly be the case.

And so what's the trigger there to -- when you say you're going to accelerate, like are you -- this is -- this would get pretty interesting, Steve. If you're saying, look, rough numbers, we're going to buy back at least $400 million a quarter. For how long are you going to do that? Like, if you're saying like for the next -- like through 2022, you could see yourself buying $400 million a quarter or maybe even more.

Yes. And like I said, getting back to what I said. To me, it's a question, Justin, number one, you have to continue to believe that, that's a compelling economic investment. Again look, obviously, I'd be thrilled if our stock was at $200 tomorrow. That's likely not going to happen. So we're trading at, whatever, a 7.5 multiple today, depending on how you want to look at it. I just think that based on all of our other opportunities, that's likely to continue to be a pretty compelling investment. If that were to change, that would certainly -- but I think probably the bigger variable is, look, if tomorrow or a quarter from now or whatever, some really significant external opportunity arose, it might cause us to tap the brakes a little bit, et cetera. I don't see that happening. There's certainly nothing in the pipeline, but you don't want to say never because I will say we certainly look at all the opportunities that cross our transit.

Got it. So let's just put some numbers around this in terms of your capital. Like at the end of the third quarter -- I apologize, I don't have this off the top of my head. What's your kind of -- what was the cash sitting on the balance sheet at that point as of third quarter?

Yes. I mean we really don't -- the nature of our capital structure, we don't really have cash sit on the balance sheet. So it's really the leverage issue.

Right. Okay. So you've been paying down debt. So what was the debt to cap? It was under 2, right?

Yes, correct.

Okay. So -- and the business generates, what, $200 million, $250 million a quarter of free cash flow?

Yes.

Okay. So you're talking about doing almost twice that in capital, right? So in deployment, we would expect that to continue at least through 2022 unless something else came up.

Yes. Yes. I think that's fair.

Got it. I feel like that's a -- have you guys been saying that pretty consistently? Or is that -- is it a little bit of a switch since the third quarter?

Well, I mean, I think we said at the end of the third quarter that we would likely continue at the same rate. So I think that's relatively consistent.

Okay. So from that perspective, you would take on -- if you're buying $400 million plus that's, let's call it, $2 billion. You're going to generate more like $1 billion over that next 5 quarters, let's say, give or take. So you put on another $1 billion of debt effectively?

Yes.

Got it. And would you -- how would you do that? Would you just issue at what's pretty compelling rates today? Or do you just take it off the you -- do you take it off the line?

Well, 2 things. I mean, number one, I mean, I think we have plenty of unused capacity at the moment. But also -- and partly, I think some of this also is we're expecting the business to improve during this period as well. So you're sort of saying you're sort of basing on this on current cash flows. And we actually assume that there's a fair amount of runway for improved cash flow. Maybe not tomorrow, but over the next 4, 5, 6 quarters.

Got it. Well, look, Steve, I think investors will welcome that in terms of the company getting out there and buying the stock. I really appreciate you walking us through that. I think -- let me just double check and make sure there are no last questions here. Nope. Looks like we're good. Steve, it's always a pleasure doing business with you. You're the best.

Thanks, Justin.

Have a great Thanksgiving. Everybody, have a great day. We'll be back in 5 minutes with Agilent. Thanks.

Thanks, Justin.