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

Great. Thanks, everybody. Thanks for joining us. Gary Taylor, healthcare services analyst at Cowen. Enjoying my first healthcare conference at Cowen this year. My pleasure to introduce Universal Health Services. As many of you know, they operate acute care and behavioral health facilities across 39 states, D.C., the U.K. and Puerto Rico. Through its subsidiaries, UHS operates 27 acute care hospitals, 335 behavioral facilities, 40 outpatient facilities and ambulatory care. And it's our pleasure to have the very well-known, I think, Chief Financial Officer, Steve Filton, joining us today. So Steve, good to see you. Thanks for being here.

Thank you.

So UHS just reported, I think, last week, I can't even keep track with all the earnings flying in. So we decided we're just going to jump right into Q&A. And I think I'll just start with, I get this question a lot from investors, so I'll blame it on them instead of trying to sound antagonistic. But just when I to think about the growth algorithm, and I think you get asked about that almost every call. But the fact of the matter is we haven't seen more than 2% EBITDA growth from UHS I think since 2015, which was also the last year the behavioral segment actually grew EBITDA faster than 3%. And I know you still generally believe the growth algorithm should be at least mid-single-digit organic revenue growth with mid-single-digit to higher, maybe mid-single-digit to high single-digit EBITDA growth. Right now, it seems like labor costs are probably the biggest headwind to that and a big reason why you're guiding '22 EBITDA roughly flat. But I guess the question is this. What is the surest path back to the mid-single-digit or better EBITDA growth? Does it still really lie in the behavioral segment? And are we just -- is there something in terms of key systems, capabilities that you think are needed really to get there?

Yes. So I don't think it's an antagonistic question, and you are correct that I get it all the time. So I do think -- and I get why, because to your point, our revenue and EBITDA growth has been more muted than it had been historically for quite some time, and they've been historically much higher and then you're correct. Right around 2015, it slowed considerably, and we've really not been able to recover from that slowness for 5 or 6 years. The original, I think, reason for the slowing was coming out of the great recession, unemployment coming down dramatically. We were sort of at full employment in 2015 and 2016. And for the first time, we really began to experience those sorts of pangs of labor scarcity in our behavioral business. First, the psychiatrists actually, but then pretty quickly into nurses, and that was an issue. And as a result, our volumes declined pretty dramatically in 2015 and '16 from kind of a historical 3%, 4%, 5% pretty predictable average growth rate to sort of flattish for a couple of years. Interestingly, we began to, I think, solve that labor shortage at the time in 2017, '18. If you go back and you look, our behavioral admissions start to pick up nicely at that point in time. The problem is we start to face a new problem, length of stay pressure, particularly from our Managed Medicaid population, which largely offset. So even though admissions are growing 3% or 4%, length of stay is coming down at a similar rate. And therefore, again, our patient bases are relatively flat. We suggested that both of those issues were going to be sort of exhausting themselves or naturally anniversary themselves. And I think by the end of 2019, they really had, and our behavioral volumes had started to pick up again in November, December of '19 into January and February '20. We were probably feeling about as bullish about the behavioral business as we had felt in 4 or 5 years. And then, of course, the pandemic hit in March of 2020. And now we're faced with a whole new slew of labor scarcity issues and other sort of challenging issues, almost all of which relate to COVID. And now we've been 2 years into COVID. So you're right, it's been a long time, et cetera. But at the end of the day, I think what fuels our confidence and our bullishness throughout has always been indications of the underlying demand, whether they are our micro indications meaning the inquiries or the volume of inquiries we get from our own patient population or macro metrics that we get from the behavioral industry that suggests that demand continues to grow. And really the challenge for us is just to solve the problems most recently, the labor scarcity problems to be able to satisfy that demand. And again, I think we've seen as recently as just about a year ago in the second quarter of 2021, with lower COVID volumes, the behavioral business posted EBITDA growth, revenue growth ahead of expectations, had a very kind of bullish second quarter last year along with the acute division. So we have experience that is not really even a year old that suggests that when COVID volumes decline, a lot of these issues should -- if not completely disappear, but at least ease to a measurable degree.

Got it. Can de novo play a larger part in terms of growth really for both segments? When I think about one of the things that really differentiates or has historically differentiated UHS was, I guess, excluding the acquisition of Psych Solutions, which was very large, certainly in the acute care side, so much success building assets and the Vegas market being the greatest example of that for your company. But really, not overpaying for stuff, identifying opportunities to build capacity and grow EBITDA out of the ground, basically. So can you talk about your strategies there a little bit? I know you've got a few patient towers coming online this year on the acute care side. But I don't think we've talked on the 4Q much about that growth targets on the behavioral side from a de novo perspective. So what are you looking at there?

Yes. To a degree, Gary, I think part of the reason it doesn't get talked about as much for UHS as it may be for others, particularly from a behavioral perspective is we've been doing it for so long. We really started to build behavioral capacity back in the 2004, 2005 period, so almost 15 years ago, when our inpatient behavioral occupancy rates have climbed into the mid-80s. And at 85%, we really thought that was an inefficient occupancy rate in the sense that we were turning away a lot of patients for a lot of times during the year at a lot of hospitals because we simply didn't have beds. And that's when we began adding beds at a pretty measurable clip. And I would say for that 15-year period from '05 to the current time, we probably added on average 300 or 400 beds a year. And I think in recent years, probably more than that. We continue to do that. A lot of what we're doing more recently are these joint ventures. And as you described, in sort of de novo developments with acute care hospital joint venture partners where they're taking their existing behavioral capacity, which is usually within the hospital, a floor or whatever. And they're converting that to some other acute care use, alternative acute care use. And they're building in conjunction with us new capacity, generally, a new freestanding facility. And we're encouraged by that for a couple of reasons. I mean one is, as your initial suggestion suggested, it's a significant source of growth for us. More than 50% of the behavioral beds in the U.S. are run by acute care hospitals. And we find this is not an absolute generalization, but we have found that most of those acute care hospitals seem to acknowledge that they don't do a very good job of running that service line. It's not a huge focus. It plays second fiddle to orthopedics, oncology and cardiology, et cetera. It's probably their 10th or 12th priority. So they're anxious to have somebody who's really focused on the behavioral business come in, run that for them. But they don't want to exit the business. They don't want to exit the business, I think, for a lot of reasons. One is they see behavioral demand just continuing to grow. They see more and more behavioral patients in their hospital emergency rooms. And so they know the demand is there. They also see that demand sometimes creating obstacles in the emergency room. I think it's fair to say that acute care hospitals generally don't love having behavioral patients in their ER. So if they have a means of moving those patients quickly through the system, getting them into an inpatient setting, getting them into appropriate other levels of alternative care, they're looking forward to that. So I think that's a big opportunity for us. Again, I think what has limited that opportunity over the last several years even though we're building the beds, et cetera, is -- we're having trouble staffing the beds, et cetera, the issues that we talked about before, we haven't always been able to meet the demand created by these new beds. But at the end of the day, again, we have every indication that the demand is there. And over the course of the next several years, we should recapture, I think, a lot of that sort of more muted or lost demand that we've suffered over the last 4 or 5 years.

Let's talk a little bit more about labor. That certainly, I'm sure, top 2 or 3 questions that you've been getting for months and months. And just starting with the acute side, there's been so much discussion of all the dynamics, the burn out, 3 waves of COVID through -- over a 2-year period, the aging of the nurse workforce already before this started, so forth and so on. But it just strikes me, I've been in healthcare for almost 30 years, and I'll just say you've been doing it longer, I think. But it just strikes me that disruptions in the labor market tend to get resolved, I think, faster than investors usually anticipate. Usually, every time there's a change, then it's like, okay, this is the secular outlook for labor, good or bad forever. It just strikes me that surely January, Omicron must have been in the peak of contract labor utilization, shift differentials, over time, et cetera. Barring another wave, how you feel about this, how your nurses feel about this, your nurse managers feel about this 6 months from now, 3 months from now, may just feel a lot less tight, a lot different than it does now. But anyway, do you think that's fair? Do you -- how would you push back on that? Is there any evidence, yet you know moving into March that maybe January pressures were the peak? Or do you think it's still very difficult, and there's still probably months to go to anticipate anything that would be measurably improved?

Yes. So I would say a couple things, Gary. I mean you made one, I think, important point and that is I've certainly been doing this as long as you have, and you look better for the wear than I do, so good for you. But every other time that I've been through a labor shortage, and there have been a number in my tenure of 30-plus years, you're right, the market sort of self-corrects for it. I've always made the point that -- and I have enormous respect for nurses. I literally believe they're doing God's work. But for the amount of education that a nurse has, the amount of money that they can make is really a nice return. And so I think whenever nurse salaries go up and nurses are in short supply, et cetera, there has always been sort of an infusion of talent, more people go to nursing school, et cetera. One of the current challenges is the nursing schools can't take in enough nurses because they don't have enough nurse educators. Now again, at the end of the day, all these things will be worked out. Nurse educators are making more money. I think retired nurses are coming back. Even if they're not going to practice, they're going to go into teaching, all that sort of stuff. So the pipeline, I think, will increase over the next few years as it has happened in the past. The other thing I think is, while I think there are some structural changes that have taken place, and you've kind of enumerated why the burn out and -- just -- but what's really created the disruption has been the COVID dynamic and the opportunity for nurses to earn extraordinary amounts of money. And when I say extraordinary, literally 4 or 5x their base salary, working as temporary or traveling nurses or moving from the sub-acute or behavioral setting to an acute setting, whether temporary or permanent, et cetera. So what we have found is that when the COVID volumes diminished, those opportunities diminished pretty significantly. We saw that as recently as a year ago in the second quarter of last year when COVID volumes were down. So I think a couple things. I mean I think one is, as COVID volumes decline, the labor pressures will naturally ease significantly. I do think there are some structural changes. I think, again, the market will address some of those. We're certainly and when I say we, I mean, hospitals in general are addressing them with different patients -- different models of patient care that are not so reliant on RNs, which have been the most difficult position to place over the last couple years. So we'll do all those things. We're training more and more people and creating a pipeline. We're training LPNs and CNAs and techs to be LPNs and CNAs and RNs, et cetera. So we're creating our own pipeline for the future, et cetera. So I do think it will get better. Now again, I think it will take a little bit of time. It took 3 or 4 months last year in 2021 from the decline in COVID volumes, which peaked around mid-January of '21 last year. They peaked again in mid-January of '22 this year. I think it takes at least 3 or 4 months, maybe a little bit longer. But I don't think presuming that there's not another surge later in the year of significance, I don't think we're having the same conversation a year from now as an example. That's not to say that there won't be COVID cases. That's not to say that there won't be a tight labor market. But I think the extraordinary pressures and we've never seen anything like this before, will have diminished significantly.

And is there anything to add on the dynamic on the psychiatric hospital side that is different? I mean I think there's a general view that it's more difficult to recruit into that environment. Some of those nurses might have preferred to work in acute. So if they got -- if there was demand there and at better wages, maybe they got pulled away. But I also think, you've talked over the years a little bit about the mental health techs and how kind of there's new competition from shortages of lower-paying labor wages just broadly in the economy that's making it a little more difficult there. Is there anything new to add on the behavioral side and any new strategies in terms of being able to source the workers that you need?

Yes. So look, the truth of the matter is that for as long as I've been doing this, there has always been a disconnect, maybe disconnect may be the wrong word, but a gap between what a nurse in a subacute setting would make as a base salary, whether that was behavioral or home health or skilled nursing or nursing homes and what they would make in an acute care hospital. Depending on the service and the geography, that gap was traditionally 15% or 20%. And so to your point, I think what I always found, and I've talked to many, many nurses over the years is that it's a very different work milieu. What a behavioral nurse historically has said to me is he or she likes the idea that her patients are up and about. They're not in their bed all day long. She's not changing, he or she's not changing bedpans or by hanging IVs and bodily fluids, et cetera. And they like that. They like the fact that their patients are not sick and generally not dying, et cetera. The acute care nurse has a much different view. And they'll tell you that, they like the fact that their patient is in bed all day, isn't going to take a swing at them unexpectedly or have that sort of issue. And so again, what we found is there was a universe of nurses who wanted to work in one or the other setting. And if they chose to work in a subacute setting, particularly behavioral, they were willing to take that 15% to 20% discount to do it. COVID turned that all upside down because all of a sudden, the 15% to 20% discount turned into an opportunity to make 4 or 5x your salary in a COVID unit in an acute care hospital. And honestly, and again, I mean, I didn't -- have not had these conversations personally. But during the pandemic, I've heard that a million times where our supervisors would say, "Nurse, we understand. We understand why you want to make this move. We think it is largely temporary. We think ultimately, you will want to come back and work in the environment that you chose initially. And when you're ready, we're happy to welcome you back." And I think what we have found is that every time COVID volumes decline, a lot of that occurs, not entirely, but a lot of that occurs. So that's a big chunk of it. In the meantime, we certainly are not just sitting around passively waiting for COVID volumes to decline. We've increased dramatically the resources dedicated to recruitment. We've increased a number of initiatives in terms of retaining nurses and creating mentorship programs and educational opportunities. You alluded a little bit to the techs and you're right. So the techs are non-professionals, they're making generally $15, $20 an hour. They're critical to the patient care model, though in behavioral because they're making sure that the patients who are up and about and not in their beds all day are where they should be, getting to therapy sessions, et cetera, and not, frankly, where they're not supposed to be, getting in trouble, et cetera. So they're critical and we're competing quite frankly, for those folks with UPS and FedEx and Walmart and Target, et cetera. Again, one of the things that we really stress is that, first of all, much more of a career path. If you want to become a tech and then become an LPN or become an RN, we're ready and willing and able to create that career path for you. And the other thing is we just feel like we're able to offer a more meaningful job for those folks. They're taking care of people. They're seeing people get better. I'm not diminishing anybody's job, but that's different than delivering packages, et cetera. Now again, at the end of the day, there's some people who'd rather deliver packages and not have to deal with some of the stresses of a hospital setting. But I do think we have enough of a differentiation to attract people, not just by a competitive wage, which we have to offer but by other sort of nonfinancial kinds of incentives.

Steve, how are you going to get -- how is UHS going to get paid for all this labor cost? We've talked about government payment sort of lagging in terms of wage [ and seize ] being built into the rate updates. On the commercial side, I think you talked about being more willing now than in some time to potentially terminate contracts or walk away from contracts. Maybe just help us think about on the commercial side, what percentage of contracts are multiyear versus something you're having a chance to work on renewals now for 2023? How many of those have an escalator that's tied to CPI or something that isn't reflecting what you wish it was reflecting, how do we think about your opportunity there?

Yes, so a couple things and you really touched on this. Obviously, in terms of our government reimbursement, we really have to wait for the government to react. And to be fair, I think the Medicare system is pretty sensitive to inflation and will -- now again, we haven't seen this level of inflation in 40 years. So it's a little bit difficult to project. But historically, Medicare reacts with their wage index adjustments, et cetera, it takes -- there is a bit of a lag. It's a 12- or 18-month lag because they do it based on historical information. And then Medicaid usually follows that. As far as the commercial payers go, the reality is the vast majority of our contracts have short cancellation clauses. They can be canceled within 90 days or usually 6 months at the most, by either party, quite frankly. So to the degree that we feel we have leverage, and that was sort of what I was trying to allude to on our call a week or so ago is if we feel we have leverage with a payer, we have a lot of market share, if they don't have a lot of options, there's not a lot of excess capacity in the market, they don't have another place to send their patients, we're pushing those payers harder and more willing to cancel contracts or midstream, et cetera. But we're making that judgment every step of the way. In the end, however, what I will say is, I'm not sure we can keep pace with the increased costs, particularly the increased wage costs solely through contract renegotiations. But at the end of the day, I think the volume growth will in every case, sort of outweigh or swamp the increase in labor costs. I mean it was interesting early on in the pandemic, this was a conversation I would have with our behavioral hospitals a lot, in the sense that they were reluctant because they had not done it historically to pay a lot of premium pay and engage temporary nurses and traveling nurses. And we would go through this mathematical exercise of demonstrating that almost no matter what they pay, I don't want to exaggerate too much, but almost no matter what they paid, if it could result in higher volumes, they would almost always be better off. And that's just going to be the case. So to the degree that we can't make it up through pricing increases, the real focus that we have is to make it up through volume recovery. And from a volume recovery standpoint, we feel ultimately in 2022, we ought to be 10% or 15% ahead of 2019 volumes. Now it will take some time to get there, and we're not going to recover it all at once. But that sort of normal annual progression of volume growth that we have always experienced really ought to return to both of the business segments.

So you're a firm believer in the volume backlog and as the year goes by, you're going to see that continue to come through as COVID [indiscernible]?

That's not just wishful thinking, Gary. I mean we get that on the behavioral side, from our inbound call and Internet activity and inquiries. We get it on the acute side by talking to our proceduralist and our surgeons about what their backlog is like, et cetera. So it's not just wishful thinking on our part that we think the demand is there. We absolutely have all sorts of indications that it's there. The challenge for us is to solve the problems that have prevented us from exhausting that demand or utilizing that demand. And solving those problems is not by any stretch just a flip of a switch, but we certainly can do it.

Some of the labor cost issues have absolutely impacted post-acute providers as well. So some of our recent conversations with hospitals have talked about, particularly during Omicron when there were so many employees quarantined, were talking about having difficulty discharging the post-acute, and that creates some length of stay pressure on the acute side that really hasn't been so visible the last couple years because COVID occupancy drove your length of stay so much higher 1/10 of a day, 2/10 of a day in length of stay. If it was related to post-acute, you never would have seen it or even been able to prioritize it given everything else that was going on. So are you seeing any of that now? Is there any concern about, as you see COVID occupancy and length of stay come down, that there's some length of stay component on the cost side that's going to be sticky just because you're not able to discharge as fast as you like?

Yes. So you've described it perfectly. And it really, I think, is an especially Omicron dynamic in the sense that our experience and pretty much what you've read generally is that the Omicron patients, while more frequent and a higher number than we ever experienced, tended to be less acutely ill, fewer ICU patients, just fewer patients who are really acutely ill. So we expected when we started to get those Omicron patients to see our length of stay for COVID patients go down. And it didn't. And I think as we dove into it more, the main reason was exactly as you described. When we tried to discharge those patients to home health or skilled nursing or back to the nursing home, we would often get the response that, well, we've got 16 of it's nursing and we've got 40 of our beds are closed because we don't have enough staff or we don't have enough home health workers or whatever. And this gets back to what I was saying before. We have found generally during the pandemic that the experience of our subacute peers, not just behavioral peers, but all subacute peers has been very similar. We've all sort of suffered through losing our employees to the acute care setting during the COVID environment. So I think we sort of went with the opposite that as the COVID volumes decline and as all these other service lines and businesses recover from the labor shortage, it will provide some opportunity for us to discharge some of these patients and have a more efficient discharge process, which really hurt us, particularly again, I would say, during that, I'll call it, 6-week period of really the high Omicron COVID volumes.

Last question, I just wanted to think about CapEx for 2022. It looks like your guidance would be up $100 million, $200 million. So it does sound like, again, you're finishing off some acute towers that are going to open this year, continue to do some behavioral de novo, but didn't necessarily sound like that was accelerating. But I did hear Marc talk about more ambulatory and some freestanding ED a little bit on the call. So when we think about up $100 million or a couple hundred million dollars, where do we think about that heading towards?

So I think it's a couple of things. I mean one is we continue to enhance our franchises, our existing franchises. I think Vegas is sort of the poster child for that. Even during the pandemic, we continued to build out towers. We're building out a tower on our Henderson Hospital, which has really come out strong. We're going to build a brand-new hospital in West Henderson. We built towers at Centennial Hills. We're continuing to invest. We bought during the pandemic a micro hospital as well as a specialty surgical hospital in Las Vegas, really just continuing to expand. But the other thing that -- and we're doing that in other markets, Vegas is sort of the -- clearly the biggest. And so the example is easier. But the other thing that I think Marc talked about on both acute and behavioral was really building out the continuum of care. You alluded to freestanding EDs, but we talked about ASC development and home health development on the acute side, primary care development, Medicare Advantage plans, some commercial insurance plans that we have in some of our select markets. And then on the behavioral side, we talked about things like telemedicine and more intensive outpatient services, et cetera. And the real goal, I think, is we feel like a differentiating advantage for us as an inpatient provider is that if we can provide a full continuum of care, it's much more seamless and efficient for the payer or the employer who is concerned about managing their patient population. An ASC might be able to do it cheaper, a freestanding imaging center might be able to do it cheaper on a stand-alone basis. But at the end of the day, they don't have the ability to manage that patient sort of up the continuum and back down the continuum. And I think by building out our care of continuum in both acute and behavioral, we really create a sort of differentiating advantage for ourselves, and that's a big focus of ours over the next several years.

Great. We're out of time. Steve, thanks so much for joining us. And everybody, have a good afternoon. Thanks.

Thanks, Gary. Good to see you.