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

Hi, everybody. I'm A.J. Rice, the health care service analyst at Credit Suisse. And we're very pleased to have up next in our [indiscernible] I want to kick off the final day of our conference is Steve Filton, Chief Financial Officer at Universal Health Services, a leading hospital and behavioral health company.

Steve, I've started a lot of these presentations off by saying we're 10, almost 11 months through the year. When you look back over the year, what are some of the big wins for UHS, what are some of the challenging areas, maybe just to level set anyone if there's new people in the room.

Yes. So obviously, stating sort of the obvious -- the pandemic has been a challenging environment to operate hospitals, both acute and behavioral hospitals. And the pandemic and particularly COVID surges and COVID volumes have tended to impact our 2 businesses quite differently. The acute business for us, and I think the acute business in general has certainly been challenged by COVID but has also benefited during COVID surges. COVID patients tend to be high-acuity patients, meaning that they generate a lot of revenue. Reimbursement for COVID patients has generally been pretty good during the pandemic. There have been a number of government actions to help hospitals manage through the pandemic. So Medicare has created a 20% add-on for any COVID [ Medicaid ] patient. The government created a program to reimburse hospitals for uninsured COVID patients called HRSA, although that program is generally now expired, the government at least temporarily suspended the Medicare sequestration reductions and reimbursement, although those have now been reimplemented. But the point being that, I think COVID business and COVID surges have benefited the acute business to a degree now. I think where it's been a drag on the acute business is twofold. One is every time there's a COVID surge, it has tended to crowd out other business. And so generally, when we've had a COVID surge, elective and scheduled procedures diminish in number, and those are generally our highest profitability sorts of procedures. And the other thing is, I think the COVID surges have created or exacerbated, I guess, maybe I should say, a labor scarcity problem. So what we've experienced, I think, in 2022 is that as COVID volumes declined early in the year when we had the big Omicron surge that probably ended in late January, early February '22, it's been a bit of a slower rebound or recovery in COVID volumes for the acute business and non-COVID volumes, meaning those elective and scheduled procedures, they've just returned more slowly than they had last year or the year before that. And that's created a bit of a challenge. And again, I think that's -- it's a challenge that's not unique to UHS, but I think is really sort of pretty broadly felt throughout the acute business. I think most acute providers, and we would consider ourselves among them, however, believe that ultimately, the underlying demand for acute care services has not really changed in any material way. And that as we finish off the year and we head into next year, absent another COVID surge, demand patterns, et cetera, should get back to sort of where they were. On the behavioral side of the business, COVID surges when they've occurred have generally had only negative implications for the behavioral business. There's really no positive offset. So they've created much like they have on the acute side, labor scarcity shortages or exacerbated those. They've created challenges with isolating COVID patients in our behavioral facilities, et cetera. So generally, as COVID volumes have declined on the behavioral side or just broadly in the population, the behavioral business has picked up. And you clearly saw that like in Q3, where we, I think, had 8% same-store revenue growth over the third quarter of last year when clearly, there were higher COVID volume. So -- but I'd make the same comment about the behavioral business as well that I don't believe we feel like the COVID dynamics have really changed the underlying demand for our services -- our behavioral services. And as we continue to work out the labor scarcity and the supply-demand labor imbalance issues that have existed for the last 12 or 15 months, I think both businesses will improve, and we'll be able to treat more patients and we'll be able to treat them in a more efficient way and some of the wage pressures that we felt over the last year will diminish.

Yes. That's good. Good recap there. Just to maybe drill down on a couple of things. So COVID-related case, I think we're about 6% in the most recent quarter, and I have down last year, it was a heavy covered quarter, 15%. When you think about -- and I know you're not giving guidance for '23, but when you think about sort of a baseline, are you -- would you assume zero COVID? Would you assume something similar to where you're at today? How do you think about that going forward?

Yes. So it doesn't feel like we, anytime soon, are going to eliminate COVID patients from the environment. So I think we think about, as the data that you ticked off suggested, when the percentage of COVID patients has a total of our overall admissions is in that kind of mid-single digit, 4%, 5%, 6% range. To us, that is sort of, if you will, the new normal, some people describe that as an endemic environment, but in any case, I think that's the way we think about in the absence of something else happening. I mean, I think that's the way we're going to go into 2023 and create our guidance for 2023 is assuming that we'll continue to see COVID patients, but it will be sort of a less kind of volatile level and more in that sort of, again, mid-single-digit range of total admissions, at least on the acute side.

And then the most recent quarter with that relatively modest level of COVID, it sounds like you're saying the non-COVID is pretty close to whatever baseline. I know people [ will find ] baseline differently, but sort of pre-pandemic levels, but maybe a little more skewed to outpatient. On the acute side? Would you just sort of comment on where you're at in terms of relative to normal "for the acute"?

Yes. So again, I think what our experience has been now we're 2.5 years into the pandemic. What our experience, I think, has generally been is that as COVID volumes have surged, we've seen a decline in emergency room visits and non-COVID emergency room visits and non-COVID surgical elective procedures. And then as COVID volumes decline, those other volumes tend to rebound. I think that rebound or recovery or snapback in 2022 has been a little choppier than it was in 2021. Again, not just for us, but for our public peers and certainly for our not-for-profit peers. I think we're all believing that things will settle down. The labor situation, I think, seems to be improving. I think, in some ways, an economy that's under some pressure, maybe with some rising unemployment, higher inflation, actually has the potential to help us on the labor front, encourage clinicians and nurses to value the security of a full-time job, maybe more than they have at other times during the pandemic. So I think the general view is that things have been on an improving trajectory during 2022, albeit a bit choppy. And then that improvement will continue into 2023.

And one thing you have called out is a little more of a shift to outpatient. I'm assuming that's mostly like surgery volumes, but maybe it's something else. Do you think that was mostly just because people didn't want to be in the facility, might be exposed to COVID and some of that may come back to the inpatient setting? Or is that permanent shifts? And what type of procedures have you -- have you seen move that you think may not come back?

Yes. So look, it's worth noting, and I think people who have followed the industry for some time know that the shift that you referred to, the shift from a traditional inpatient setting to more alternative outpatient settings has been one that has been underway for at least a decade, maybe 1.5 decades, maybe even longer. I do think it's been accelerated during the pandemic. And I think A.J., for a lot of the reasons that you suggested, there have certainly been times where people prefer not to visit an acute care emergency room concerned that they're going to be exposed to patients who have COVID, et cetera. And so they preferred to go to freestanding emergency departments of which we run probably 25 around the country and have been very busy during the pandemic or urgent care clinics or retail pharmacy clinics. I think that some patients have seen more comfortable having a surgical procedure in an ambulatory surgery center rather than in a hospital setting. It will be interesting to see. As we kind of reach an endemic where we all get comfortable operating in an endemic sort of environment and people are not locking down and taking the precautions that they took at the beginning of the pandemic, whether we'll see that pendulum shift a little bit back towards the inpatient setting. I think we're prepared either way. I mean I think in both of our businesses, we've spent a lot of time, and again, I don't want to suggest that this really just started with the pandemic, we've been building out our outpatient continuum for some time. But I think we'll continue to do that. So that to your point, I think we're prepared to respond one way or the other. If the shift to outpatient continues or accelerates, hopefully, we'll be able to respond to that. If there's a bit of a kind of a slowdown and the pendulum swings back, hopefully, we'll be able to respond to that as well.

A lot of discussion is sort of we normalize and maybe we'll see a traditional seasonal uptick in the fourth quarter. People get to co-pays and deductible limits. They [ want ] to get an elective procedure done before the [ first ] of the year. There's also been chatter at this conference about early flu and RSV activity, et cetera. Anything you can comment on there? Are you seeing -- any thoughts on the flu season? And are you seeing anything along the lines of more of a normal year-end pickup in volume?

Yes. So those are certainly different things. I mean we've seen a pickup in flu volume, particularly for whatever reason in our South Texas facilities as early as September, which is kind of early for the flu season. I would make this overall comment about busy flu seasons that -- this is a comment that I've made many, many times before. I think the flu broadly has just an incremental effect on our business. Flu patients are relatively low-acuity patients generally. There's no significant reimbursement, but they tend to be incremental. So in a busy flu season, we'll see a pickup of $8 million or $10 million or $12 million of [indiscernible] incremental EBITDA over the course of a few months, doesn't really move the needle a tremendous amount. And the reason that flu is different than the dynamic we saw with COVID, there's a number of reasons, but one is that flu patients have tended historically not to crowd out other business. Every once in a while, the flu season is so busy that emergency rooms become almost overrun or whatever. But people have generally not stayed away from hospitals or health care because of the flu and obviously COVID had somewhat of a different dynamic. So I realize the stats show that flu we seem to be getting into a very busy flu season. We're not seeing it in most of our hospitals yet. We certainly may. I think one way or the other, that's probably not a big needle mover. Your other question about kind of the normal seasonal pickup, I think we're expecting that. We don't know why that wouldn't occur. It's a little -- it actually still would start right around kind of in the middle of November. So we don't have a lot of evidence at the moment. But yes, there's that expectation that we should see. And there's some speculation that with the weakening economy, that dynamic of people who [indiscernible] their co-pays and deductibles taking advantage of that may even be a little bit accelerated if they're concerned that next year, they may lose their job or that sort of thing. So we'll see. We'll see.

Okay. A lot of debate about the acuity. You mentioned that obviously, you got a bump in acuity with some of the really intensive COVID surges. But others have talked about, well, we've been investing and we're going to pick up acuity on some of our non-COVID dynamics and sort of maintain our case mix and some of the revenue per adjusted admissions. The other dynamic is, of course, what's going on with managed care recontracting and whether you're giving any relief on the labor issues. Anything to say about that area?

Yes. Again, in my mind, 2 separate issues. So on the issue of sort of acuity and when COVID patients -- or the volume of COVID patients decline, we see a decline in acuity. We clearly saw that in our third quarter results, where I think in our acute segment, revenue per adjusted admission was down like 3% and that's clearly a function of fewer COVID patients year-over-year, as you gave those data points early on. I think, again, the long-term view for us is that COVID volumes decline, acuity comes down, revenue per adjusted admission comes down, but volumes will come up as we build back those elective and scheduled procedures and from a profitability or margin or EBITDA perspective because that's our most profitable business, even though acuity and revenue per admission might be coming down, we believe overall margins and overall profitability should improve. Your second part of that question was sort of the impact of pricing on being able to negotiate higher prices or revenue from our commercial payers, which make up roughly 50% of our total revenues. I think we're doing that. I think we are, as we renegotiate our contracts, trying to get our payers to acknowledge that in an inflationary environment, we simply need more significant increases than we've been getting historically over the last several years. I think we've made a very specific point then on the behavioral side, we're probably undertaking that exercise even more aggressively in part because we've been generally capacity constrained in our behavioral facilities during the pandemic, meaning that because we've not been able to fill all of our labor vacancies and we are often short staffed, whether it's nurses or technicians or whatever, we've had to turn patients away. So in an environment in which we're turning patients away, it has just made sense for us to really approach our lowest-paying payers and say, "Look, if you're not willing to increase your rates to us, we're more than willing to terminate a contract because at the end of the day, if we're going to turn patients away, we may as well turn away our lowest-paying patients." And I think we've had some success in that exercise. If you look at our, again, in the third quarter, our revenue per adjusted day in behavioral was up 5% over the prior year. That's clearly on the high end of where that number has historically run. And I think it's reflective of the idea that we're getting some higher-than-normal increases from some of our commercial payers.

I want to double back to the behavioral business in a second, but just on the labor front, I think you've given statistics that you were $150 million of contract labor in the first quarter, $117 million in the second and $81 million in the third and said something like maybe you could get another $15 million to $20 million step down. How should we think about that? Can we take that number into next year and say, okay, all that extra payments that were made early in the year, you're at a run rate as you exit this year and you got that as a tailwind? Or do you think, I mean, $35 million, I think, pre-pandemic, do you think there's still some downside on that or some benefit on that to be realized as you move into '23 beyond where you end the fourth quarter?

So one, just a quick clarifying comment that you've cited the numbers correctly. I just want to be clear, that's not just solely contract labor. It's what we describe as premium pay, which is what we -- anything that we would pay over and beyond sort of the normal nurse wage rate. So it would -- it could include overtime pay or shift differential to our own employees, although the bulk of it, to be fair, as you suggested, is contract labor to these temporary and traveling nurses. Now look, I think that, again, you've laid it out correctly, pre-pandemic, we would run about $35 million a quarter in premium pay. During the pandemic, that number peaked at about $150 million a quarter in the first quarter of this year. We've got it down to about $80 million in the third quarter. As you said, we hope to get down maybe to $60 million, $65 million in the fourth quarter. If you sort of do the math and maybe next year, I don't think we believe at the moment, we can get back down to that $35 million, maybe we get down somewhere to $50 million and $60 million a quarter. But if you do that math, that's still a pretty significant maybe $400 million annual reduction in premium pay in 2023. Now that's not, I think, all a bottom line tailwind because at the end of the day, we've had to invest, if you will, in our own recruitment and retention of nurses, increased base wage rates, et cetera. So some of that savings, that $400 million of savings is eaten up. But I think even if you take the approach that half of that savings is eaten up by investment in wage rates, et cetera, it's still a pretty significant tailwind going into next year. So it's another reason why I think we're optimistic about the 2023 trends.

You mentioned that an economic slowdown could potentially help you a little on the labor side as well. I know you and I can remember back to 2008, 2009, I don't know, everybody in the room does. But one of the dynamics that happened then was people -- there's a big chunk of your workforce that works part-time all the time at the local hospital. And a lot of those people said, let me get an extra shift or whatever. Has there been any change -- I was thinking about this the other day between the dynamics in 2008, 2009 and where we are today in the percentage of your workforce that works part-time? And any reason why you think that phenomenon wouldn't potentially recur? I know it has to be a more severe recession than where we're -- anything we're looking at now probably for that to happen, but I'm just trying to think, has there been a change in the workforce where maybe less people are working part-time, maybe more people are working part-time.

Yes. And I'm not even so sure that it's that part-time dynamic that really matters. What I've always tried to remind people in the last year or 2 is that nurses have always had the opportunity to work as temporary or traveling nurses that industry, that opportunity has existed frankly, for as long as I've been in the business. The issue historically is this sort of trade-off that a nurse who worked full-time did so because he or she like the security of that, knew that he or she would have a guarantee of 80 hours every 2 weeks. And to your point, maybe they could pick up another shift or 2 if that they want it, et cetera. The temporary or traveling nurse chose to do something else because they wanted more flexibility. The trade-off was they couldn't always be guaranteed all the hours that they wanted, et cetera, and that was a trade-off they were willing to accept for the flexibility. The way the pandemic changed that whole equation was the concern about not being able to get all the hours you wanted, sort of [ disappeared ], nurses could work. If they wanted to work 80 hours a week, they could do it. I think as we're entering again an environment where COVID volumes are much lower, where there are inflationary pressures and potentially other economic pressures, I think there's a couple of dynamics that are in play. One is, again, the security of a full-time job is becoming more attractive. The guarantee of all the hours you want to work, whenever you want to work, if you're a temporary or a traveling nurse is not going to be out there in the same way. So I think it's a dynamic that generally will help hospitals, again, not in any way trying to suggest that the temporary and traveling business is simply going to disappear or that we're not going to spend more on temporary and traveling nurses in '23 than we did pre-pandemic. But I think that you're going to see some of these trade-offs that had really almost disappeared during the pandemics sort of reemerged.

Okay. Let me plow ahead here and make sure we get some of these other topics in. On the behavioral side, I know the way the labor thing works out could be a little bit of cost pressure, but it's -- as you sort of alluded to earlier, more of capacity ability to take the patients. Do you have any sense of how many potential emissions that would be attractive to you that you're having to pass up now because of either COVID isolation, [indiscernible] beds or because of inability to get staff?

So we track that metric in a number of ways. We track what we describe as closed beds, beds that essentially we make unavailable to patients because we don't have staff for them. We track what we refer to as deflections. These are patients who inquire to us about a problem and that we determine that from a clinical perspective and from a financial perspective, they'd be eligible for admission, but we deflect that admission or turn it down for a reason either because we don't have a bed available or we don't have the staff available to take care of that patient, et cetera. We tend not to disclose those numbers sort of publicly the way we do other metrics because we think our hospitals sort of track them a little bit differently. We're not sure that they're absolutely consistent. But we certainly know that it's a significant number. I think we have -- absolutely have the view that historically, again, pre-pandemic, our volumes in the behavioral business have grown historically kind of mid-single digits, 4%, 5%, 6% a year. Certainly, I think we believe at a minimum that if we could fill, not even all of our vacancies, but I would say the majority of our labor vacancies returning to that level of growth, would not be kind of a stretch goal in any way that it should be very achievable.

I mean, it used to be that you talk about, if you did 2% to 3% admissions growth better than that, it was margin enhancing. If you were less than that, it would be challenged to maintain your margin. Is that still the way you think about it, given all the moving parts that are there?

I think fundamentally, the business model has not changed. And as you described it, A.J., I think that's about right. I think the one dynamic then obviously, we would need to acknowledge is that we're in a higher inflationary environment, and particularly, I think, a wage inflation environment. So if we might be that we used to say that if we could generate same-store revenue growth of 4% or 5%, to your point, split pretty evenly between price and volume, we should generate EBITDA growth and margin growth. I'd say today, maybe that number needs to be 100 or 150 basis points higher to reflect that higher wage inflation. But fundamentally, that's the way the model still works.

Right, right. A lot of discussion about headwinds and tailwinds going to '23, how to think about the reimbursement that's rolling off this year. I know you've got a couple of things. You're -- Hurricane Ian impact and you've got some other items that you've called out. How do you think about what the headwinds you've been a little less about the sequestration relief and the COVID add-ons and so forth? You haven't really baked those in as much it doesn't seem like I guess some of the other guys is rethinking the starting point for this year, jumping off to next year. Maybe give us your philosophy and thoughts about that.

Yes. So as I was saying earlier, I mean, there have been some reimbursement benefits, mostly on the acute side from COVID, and again, I think we've now mentioned them all of the Medicare sequestration and the Medicare 20% add-on and the HRSA reimbursement, all those things have either gone away or will go away once the public health emergency is formally over, which we expect will be early next year. So -- and we disclosed these numbers in our 10-Qs and 10-Ks. I think this year, the gross benefit from those 3 programs is probably in the $110 million, $120 million range. So that certainly, I think, is a headwind going into next year. Now I think it is somewhat offset by the idea that those programs were implemented because the government was acknowledging that there was an incremental expense that hospitals were incurring to treat COVID patients. And that as the COVID volumes decline, those expenses will decline as well. It's difficult to do a precise calculation of that. But when we do try to do that calculation, I think we think that, that $110 million, $120 million headwind becomes maybe a $55 million, $60 million headwind, definitely a headwind, net headwind. To your point, I think we have some sort of offsetting dynamics to that. We've had about $45 million through September and start-up losses, mostly associated with a new acute care hospital in Reno, really no comparable acute care opening next year. So I think most of that goes away. So the 2 items tend to offset. And I think that as we think about 2023, again, sort of on a net basis, it's sort of a more traditional way of thinking about it. And I think if the volumes sort of recover in the way that we're expecting if the labor situation continues to ease in the way that we've been talking about, I think 2023 starts to look like the most normal year, if you will, since 2019 -- and hopefully, that's the case.

We can all hope for that. You've pulled back on your CapEx this year and you had a target for share repurchase that you moderated. Obviously, some of that's been the labor challenges and what that's done with the operating income. But anything else you would like to add to that about capital deployment, how you guys are thinking about that?

No, I think we tap the brakes, if you will, on both CapEx and share repurchase because of some of the pressures on earnings and obviously also because we're entering, I think, a higher interest rate environment, where the cost of debt is clearly rising, et cetera. But I think as we, again, go into 2023, I think we'll still be a pretty active [ repurchaser ] of our own shares. We'll still invest -- reinvest a significant amount of money in the business with CapEX. And quite frankly, I think as the business recovers as we expect that it will, we'll sort of reevaluate those spending levels as well, and then they probably likely increase as the business...

So baseline this year, I think you're going to end up at about $800 million to $850 million in share repurchases. Is that sort of a reasonable run rate to take out for next year?

I think that's a reasonable way to think about 2023.

I'm going to -- we're running low on time, but I do want to throw out one more. I know Marvin was running the acute care division for many years. You just announced that he's decided to -- he's retiring, and you've brought in a fellow from the nonprofit world. Anything to say about what his focus is and what he brings to the table and how that might help you on the acute division.

I think it's largely a sort of a normal succession planning kind of move, the new fellow, Eddie Sim, is somebody who comes with experience in large integrated health systems currently or most recently in Denver, before that in Florida. And his challenge, and I think the way he thinks about it is he's going to try and recreate that not from scratch because I think we're well on our way to doing that but recreate that sort of very competitive integrated system in all of our markets. And it was just the right time. Marvin is a guy in his late '60s and has done, I think, a heck of a job in the decade plus that he's been with us, it's just the right time.

Yes. Well, once again, I really appreciate Universal Health presenting at our conference, and Steve, you particularly. And next up in this room is going to be Amwell.

Thank you.