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

Good afternoon, everyone. Pleasure to have Steve Filton, longtime Executive Vice President and Chief Financial Officer for Universal Health Services. I have a little research disclosure to read. For important disclosures, please see the Morgan Stanley research disclosure website at www.morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representative. So Steve, who's been doing this longer? You or me?

I'm going to say you, but it's probably close, probably close.

So maybe just, first of all, talk to us a little bit here, hopefully, knock on wood, post-COVID environment. What you're seeing in terms of returning to the volumes of 2019 in the acute business, acute care business, the behavioral business, inpatient-outpatient, maybe just give us an update.

Yes. So I'm going to take a step back a little bit and just set the stage. We in, I think, creating our expectations and forecast for 2022 did so based on our 2021 experience, which we thought would be reflective in large part because the COVID trajectories and cadence was very similar. In other words, 2021 started with -- if you recall, the Delta surge in late December of '20 into January '21, very significant surge. But by the end of January '21, it diminished pretty rapidly. And we, I think, along with most of our hospital counterparts took a couple of months, but we were able to backfill that volume pretty quickly with non-COVID volume. Our elective and scheduled procedures got back to sort of 100% of our pre-COVID, pre-pandemic numbers, et cetera. And as it turns out, in retrospect, Q2 of '21 was probably our single best quarter for both of our business segments during the entire pandemic. So as we went into 2022, and we're sort of creating our forecast early in the year, we sort of had the same expectations. There had been the -- this was the Delta surge, if you will, in early of January '22, but by the end of January, it resolved itself mostly. And we were expecting that backfill of non-COVID volumes to occur pretty rapidly, might take a couple of months, but we were thinking by the end -- by the end of the first quarter, early in the second quarter, that would occur. As it turns out, I think the hospital industry found that the recovery has been much slower in 2022. April was probably the softest month of the year. All the hospital companies kind of reported slower value. I think a variety of reasons. The labor situation is certainly much tighter in 2022 than it was in '21. We're finding in the spring and the summer that way more people are taking vacations and time off, that includes doctors and patients and employees, and that's hindering the return, et cetera. So second quarter was a soft one for, I think, the industry and for us. Although we were encouraged by the fact that every month in the second quarter got a little bit better, May was better than April, June was better than May. But July, again, I think, for us, and if I believe some of the sell-side surveys I read was a really soft month for the industry. Again, I think a lot of it is this vacation dynamic, et cetera. Now we've seen over the past month or so, maybe four or five weeks in August and September. Finally, that return of volumes and maybe a little bit of return to normal. There's been some speculation that when kids would go back to school, everybody would sort of return more to their normal routines. And again, if the last four or five weeks an indication that seems to be potentially the case. But that's been the struggle. I think this period from, I'm going to call it, April to July of 2022 I think has been particularly challenging and particularly challenging for the acute business because the return as we move further and further away from the COVID surge, the return of those non-COVID volumes has been sort of a stubborn obstacle to get over.

You touched upon staffing. And obviously, there's been pressures on labor cost. Can you walk us through what you mean -- over the last few months in terms of uses of agency nurses versus a year ago versus six months ago? And what you're seeing in terms of being able to retain nursing personnel and other personnel.

Yes. So I'll make the overarching comment at the outset, which for those of you who follow us know, there's certainly been a labor scarcity challenge in both of our business segments during the pandemic. I think it's affected the two business segments quite differently. On the acute side of the business, for the most part, we've always been able to fill our vacant positions during the pandemic, albeit in many cases, we've had to fill them with significantly higher priced labor, either our own employees getting paid overtime or shift differential, et cetera, or more likely, temporary or traveling nurses, Jim, as you allude to. On the behavioral side, quite frankly, we've had some amount of temporary traveling nurses and premium pay. But the reality is, for the most part, we've been unable to fill all of our vacancies on the behavioral side. And so that labor shortage on the behavioral side has manifested itself not so much through higher cost, although there's some of it but through more muted volumes because we've simply been unable to treat all the patients who present themselves to us, we simply don't have the adequate staff to do that. We felt like once the COVID surge ended earlier in the year that the labor situation would improve. And that part of our forecast and expectation has generally proved to be true. We've talked quite a bit about premium pay. On the acute side, we said that it ran $150 million in the first quarter, $120 million in the second quarter. We hope to get to $75 million to $80 million in the fourth quarter. I think we're generally on track to do that, presuming that there's not some really significant surge in COVID late -- in the fall this year and the winter. And on the behavioral side, filling more vacancies, again, I think the disconnect has been our original expectation or forecast was that volumes would recover almost completely in sync with the labor improvement. And again, I think for a variety of reasons, there's been some disconnect between the two. And the volume recovery has been somewhat slower than the labor improvement, which we are seeing. And again, we expected that labor improvement to occur as COVID volumes declined because what was really creating the disconnect between labor supply and demand were hospitals that were hiring people to treat COVID patients. And honestly, not just to treat COVID patients, but to treat their anticipation or their expectation or their concern about COVID volume. So hospitals, I think we felt were in some ways staffing and overstaffing sometimes for the need to be fair to them because then nobody really knew how to project and predict demand in this uncertain environment.

So let's shift gears, talk a little bit about strategy. Obviously, you have two different businesses in the acute care business behavioral. Any thoughts about potentially one of those businesses is separating obviously, behavioral businesses trading at significant multiples. What are the latest thoughts about that?

So I would say, broadly, we have two thoughts in that regard, Jim. I mean, one is, I think from a timing perspective, if we ever were to consider a transaction like that or splitting the companies apart, I think we would view this timing to be ill timed. I think we feel like for the reasons I discussed, mostly the slow demand recovery that both businesses are significantly undervalued at this point in time. So I think we have a perspective that our real focus at the moment is getting the 2 businesses back on track, realizing their what we think is still fundamentally strong underlying demand, working our way through the labor problem, getting back to a business model that looks a lot more like pre-pandemic 2019 with 2019 valuations than it does today. The other, I think, kind of longer-term perspective we have is that, to be perfectly candid, historically, our two business segments have not enjoyed a lot of synergies between them. They've operated largely independently in many cases, in different markets, et cetera. I think we have a view that as we move into the future, more employers, more insurers, more people who are paying the healthcare bill are interested in organizations that can deliver an integrated cohesive continuum of care. And I think we have a feeling that having a strong footprint in both behavioral and acute care segment, we're in a position to do that, that very, very few -- I think few other providers are able to do. And there's a lot of research and sort of evidence that's been gathered over the last several years that really speaks to the interplay of these two businesses that suggest that one way to control, for instance, the healthcare spending on physical illness is to improve the mental health of the chronically ill that if you can improve the mental health of the chronically ill who are often depressed or suffer from other -- may suffer from addiction, illness or whatever, that you can really improve their physical health, their compliance with exercise and diet and medication regimens and those sort of things. And again, I think we sort of feel like we have a unique role to play there. So I think it's both a short-term perspective of really wanting to improve these two businesses, which I think are currently undervalued and a longer-term perspective that there's a real synergy between the two businesses that maybe we've not been able to realize for much of our history.

So just following up in terms of thinking about, obviously, HSA and Tenet have invested heavily in outpatient and urgent care centers, freestanding emergency, et cetera, what -- in terms of that focus on individual markets, are you doing the same or thinking about doing the same where you're spending more of the capital budget on developing or building out primary care capabilities? What's sort of your latest thoughts?

Yes. So I think that's the right approach, and I think it ties a little bit to my previous comment. Again, I think as we move forward over the course of the next several years and quite frankly, probably several decades, the insurers and the employer and the government community are going to look for healthcare solutions that are the most integrated that really span the continuum of care. One of the challenges, and I think one of the reasons why the U.S. healthcare system is more expensive than some of its peers in industrialized nations around the world is it's very fragmented, and it's always been generally siloed, so there's inpatient care and there's outpatient care, and there's a subacute care, after care. But I think as you're suggesting what a lot of the other companies are investing in and we are too, is having a presence sort of along the continuum. So as an example for UHS, I mean, five years ago, we didn't own a single freestanding emergency department. I think at the end of this year, we'll have approximately 25 of them or so. We own urgent care centers. We own a lot more primary care physician practices. And what you're doing there is creating a lot more access points. Historically, the access point from an acute care hospital provider like us was the hospital emergency room. Most of the people entered our hospital either through hospital emergency room, maybe half of our patients did and then the other half were from private physician referrals. But we're looking for ways to create much more -- many more access points. And then on the flip side, on the back end of our treatment as we're discharging patients we want to be able to have more of a role in things like home care and subacute care, nursing care -- skilled nursing care, that sort of thing. And on the behavioral side, the same idea. We sort of talk about it as kind of step up and step down programming through the continuum. So a patient who is an outpatient treatment, but whose condition deteriorates, they become more severely ill, they become suicidal. They develop a significant drug or alcohol problem. Now they can be admitted to an inpatient program or an inpatient patient who is treated and is on the road to recovery, but still needs some level of care can be discharged into an intensive outpatient or what we call a partial hospitalization program, that sort of thing. So in both of our businesses, we continue to invest heavily in what I call sort of pre and post-acute care and behavioral care is a way of really having a place all along the continuum of care.

So Steve, the R word, Recession, people are starting to talk a little bit about and what could that -- what could we see in 2023 or 2024? Maybe historically, just give us an idea, if you look back at prior economic slowdowns, the impact on UHS when you think about increasing unemployment potentially, et cetera. What have you seen? And how do you combat that?

Yes. So as you said at the outset, I've been doing this for a long time. So I've been through a handful of recessions. And I think traditionally, the way that recession impacts the hospital business is mainly from a payer mix perspective. So in particular, as unemployment rises, people lose their jobs, they lose their commercial health insurance that accompanied their job. And we see less commercial business in a recession, more Medicaid, more uninsured. This -- if, in fact, we're in a recession, in fact, we're going to see higher unemployment. This will be the first time that we'll have gone through it post the Affordable Care Act. So I think there is a cushion that exists with the availability of greater access to Medicaid, particularly in states that have expanded Medicaid. I think there exists a cushion in the context of greater exchange products out there that people can rely on rather than having to go uninsured, et cetera. So you have that cushion. And the other issue is -- although I think in some one of either a downturn or certainly a period of economic uncertainty. Right now, it's really been inflation dominating the sort of news about the economy, but unemployment has remained at the moment, at least relatively steady. So we're not seeing much of an impact at least currently. The other point that I'll make is that, historically, demand in our business has not been terribly recession or subject to recessionary factors. So again, most of the demand, particularly for inpatient care are people who are, if not sick from an emergency perspective, although many of them are, they at least have a serious illness. So you can talk about somebody who needs a hip implant or knee implant and you can describe that as an elective procedure, but I'm somebody who's more and more of my peers and friends and family are in this position, you don't go for years needing hip implant and deferring. You might be able to defer it for a period of time. But I think most healthcare procedures, particularly those that were performing. We're not in the cosmetic surgery business or laser eye surgery business, most of the procedures that we perform are procedures that are not going to be terribly economically sensitive that is people are not going to put them off until they don't have to come out of pocket for the expense, et cetera. There's some element of that, but not much.

Any states, obviously, there's some key Governor races taking place. And the whole issue in some of these states about Medicaid expansion is becoming a political issue. Any of the states of where you operate where there's a potential there could be Medicaid expansion over the next few years, you could see the potential Medicaid expansion?

Yes. So the two states, Jim, in which we operate that have not expanded Medicaid, that clearly would be beneficial to us are Florida and Texas. And I think at the moment, those are two pretty darn red states that are unlikely to expand Medicaid. So there are possibilities and there's possibilities for some sort of incremental expansion. But at the moment, those two states are run by very, very conservative governors. I think it's unlikely. But those would clearly be the states that there was some expansion would benefit us the most.

Switch gears, talk a little bit about balance sheet. Leverage, your views on leverage vis-a-vis share buybacks. It's been a while since you've done a substantially large acquisition. So it feels like that you're generating a great deal of free cash flow. Where do you spend the money other than CapEx? And what's your -- philosophically when you think about leverage and buybacks, where the company is headed right now?

Yes. So I think your description at the outset has been largely accurate from a historical perspective. We've been a pretty low leveraged company for quite some time now. We've been a pretty aggressive acquirer of shares over the last several years as well as a pretty significant CapEx spender returning a lot of significant capital into our existing markets and existing franchises. And quite frankly, our leverage was increasing a little bit because of that. Our leverage is increasing a little bit more because of some of the weaker earnings that I've described over the last four or five months. We talked a little bit in Q2 about tapping the brakes on our CapEx trajectory and our share repurchase activity. Just in recognition of some of those earnings pressures. We have some covenants we have to manage our way around debt covenants. And probably we'll do a little bit more of that on sort of a little bit more cautious approach in Q3. But ultimately, our capital deployment strategy, I think, is very much synced up with our overall view of the business, which is as long as underlying and structural demand in the two businesses remains strong from our perspective. I think we view particularly our current trading multiple is attractive. And over time, maybe despite some of the current caution that we have we think that repurchasing our shares in comparison to other opportunities we may have in either the M&A markets or elsewhere is still pretty attractive. So I think some amount of tempering the pace of share repurchase and CapEx in 2022, but I think likely presuming that things get back on track to resume in 2023 and beyond.

There's also been a good deal of talk about the impact of redetermination and what that could mean in terms of people moving to an exchange model, moving to a lot of different spots. What do you think is the potential likely impact of the acute care business on redetermining?

Yes. So again, I think it ties back a little bit to the previous commentary. So the concern is that redeterminations as they accelerate would likely cast people off the Medicaid roles, which could present some challenges to the acute care business, payer mix and uncompensated care and bad debt. Again, I think the presence of the exchanges and the Biden administration policies of exchange expansion and making access to exchanges easier provides some cushion to the redetermination. So I think that's helpful. The other point that I'd make, and I probably should have made before with your initial question about recessionary impacts is, I think the behavioral business historically has been more recession resistance, really not recession proof but more recession-resistant than the acute business because behavioral hospitals, like most healthcare providers that are not acute care hospitals and that don't run acute care emergency rooms have a little bit more optionality in the patients that they accept and don't accept. The fact of the matter is, is that the vast majority of uninsured and underinsured patients enter the U.S. healthcare system through an acute care emergency room. And so they're clearly the provider of last resort, if you will, and providers like ASCs and outpatient imaging centers into I think a lesser degree behavioral hospitals, they can pick and choose their patients a little bit more. So I think all these things that we're talking about is recessionary risks, including the redetermination probably have less exposure to the behavioral business in the [ EQ ].

Great. I'll throw it open to the audience for any questions. We have someone with the microphone in place, but if there are any questions, feel free. Well, Steve, thank you very much. Much appreciated.

Thank you. Appreciate everybody's time.

Thanks.