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

All right. Good afternoon, everyone. Thanks for joining. We're going to get started with our last company session of the day. We've got UHS joining us, and Steve Filton, CFO. Thank you for joining.

My pleasure.

Well, I wanted to start with the current state of the acute care market to begin. And there's a lot of questions on utilization. Maybe just give us your latest views on what you're seeing broadly from a macro utilization perspective in the acute care setting.

Yes. So look, I think -- and I've made this comment, I would say, during the last month, there's been, I think, some volatility in particularly acute care volumes. A lot of the companies, I think, talked about March being a softer month. We generally attributed that softness to the calendar dynamics. But as I sit here in mid-June and take a look at both of our business segments, I think they've generally performed well. And they've generally performed, I think, slightly above our expectations. I think acute care volumes have been particularly strong. And I know investors are very focused on the idea of how sustainable is this sort of elevated level of volume growth. And I don't know that anybody has a precise answer to that question, but it certainly appears as if whatever March softness the provider community sort of talked about was really calendar-related. I think volumes have remained pretty strong in Q2. Now again, how sustainable that is, I think, still is an open question. But again, I think the 2 factors that really contributed to our outperformance in Q1, which were acute care volumes and behavior pricing, have both generally continued into the second quarter.

Okay. And one way to frame this is we certainly had really strong growth levels certainly in the first half of last year that were unsustainable. They've come down. But from a procedure volume, just level of patients going through the system, that has not been unsustainable. That's my characterization. I'm curious if you think from a level of patient demand perspective, we've been at levels that are unsustainable.

No, I think that the crux of your question and because a number of people have sort of framed it this way is that if you look at what pre-pandemic patient levels were like in acute care, and you assume that the pandemic never happened, and you just index those levels forward for normal annual growth rates that here in 2024, we're still short of what those levels would otherwise be. And I think that's not an unreasonable approach to this. It does make an assumption, however, that everything else has remained constant, that utilization patterns didn't change, that the mortality -- accelerated mortality rates resulting from the pandemic didn't have an impact. And again, I will be honest, Jamie, I'm not smart enough to tell you that I know that, that's true or not true. So I think we've probably been more cautious and more conservative than others in saying, "Look, we do expect acute care volumes to moderate," but have been candid about saying that they haven't yet. And we're not rooting for them to moderate but wouldn't be surprised if at some point they moderate. This idea of some of the strength in those acute care volumes being this bolus of deferred and postponed care during the pandemic, that's finally being exhausted.

I guess if you asked me 2 years ago, and we were expecting -- I think a lot of people were expecting normalization and some deferred care, some combination of both. And that would present itself in electives and in surgical volume. And those have been strong, but it's actually medical admissions, so it's nonsurgical volume that's been really strong. What does that tell you or should tell us about sort of the state of utilization and what's going on?

Yes. It's a great point. And I think from our perspective, it's -- I think it's the elevated utilization, at least from our perspective, and I think consistent with a lot of the pay or other provider commentary, has been in that Medicare population. And that's the population that I think tends to have more medical admissions, more age-related illnesses and diagnoses than the younger population, who tends to be more procedure-oriented. So I think that's sort of -- it's consistent with this idea that it's the Medicare population, at least to date, that has been driving this elevated utilization.

I guess a longer-term question on this. How are you planning strategically in terms -- has the environment at all changed your maybe capital allocation decisions or how you design facilities to more ORs, more capital -- the things needed to accommodate a potentially sustainable higher utilization environment?

Yes. I mean I think if you think about it, whether acute care admissions or adjusted admissions grow at sort of a more historical 3%, 3.5% level or a more elevated level of 5.5%, 6%, which we've been sort of growing at, I don't know that, that affects our capital deployment decisions as much as I think what we've talked about is diversifying our capital spend so that we have a greater presence, a more fulsome presence, I would say, along the broader continuum of care in both of our business segments, meaning we know that more and more care is shifting over the years out of a more traditional inpatient setting to more ambulatory settings, whether that's ambulatory surgery or freestanding imaging or even more access points. We've had a lot of success in our acute care division with freestanding emergency departments. We probably had none of those 5 years ago. We'll probably finish this year with 30 or some-odd FEDs around the country. That's been a real, I think, attractive point of entry to the system with patients. It relieves some of the pressure on our existing hospital ERs. So that's a growth dynamic. So I think it's more of that idea, not so much adjusting to the exact level of admission growth as much to the changing ways and the changing settings in which care is delivered.

Okay. I guess on that point, some of your peers have talked more specifically about outpatient strategies. Is this a newer strategic direction for you? I mean it sounds like over the last 5 years, there's been some change at least on the freestanding ED side. But is this a new kind of strategic direction for the company? Or how is that piece of it shifted over the last 3 years or so?

Yes. No, I don't think it's new. I mean obviously, I know you've been -- you haven't done this quite as long as I have, but I think you've been doing for a while. And obviously, the shift from in to outpatient has been ongoing for at least a decade, maybe 1.5 decades. As an example, I mean, I think we have at least one freestanding ambulatory surgery center in almost every major market in which we operate, sometimes more than one. So it certainly has been a dynamic for a number of years. And again, I think the point sometimes when people hear me or hear us collectively as traditional inpatient providers talking about a shift to outpatient, they sort of think that we're losing that business that when it shifts from inpatient to outpatient, we're losing it. And that's not true at all. I mean our outpatient surgical growth as an example has been growing faster than our inpatient for a number of years, reflective of the fact that these procedures are just moving -- they're really not even moving what I would describe as location. They're just moving in the way that we're being reimbursed for them. But we're still providing a lot of that outpatient care. And we're very focused on providing it in a way that physicians are going to find most efficient and comfortable and patients are going to find most efficient and comfortable. And I think we're doing so in a way that patients having an outpatient procedure today is going to find the registration process, the recovery process, everything about the hospital experience to be more customer-centric or patient-centric than it was 10 years ago. So we're accomplishing that. And that doesn't always, by any means, need to be accomplished with a freestanding center. I think a lot of the motivation behind doing freestanding centers is to do that in partnership with a physician group, et cetera, which again, I think sometimes makes tons of sense. But I think some of the convenience and patient experience sort of dynamics can be accomplished without a freestanding.

Okay. That's helpful. I want to talk about revenue per adjusted admission. In 2022, I was expecting this to decelerate as there was normalization in patient mix. And that hasn't occurred at all. It continued to be really strong. Some of that's been the Medicaid supplemental payments. Some of it's been commercial pricing. What are you seeing in terms of just the sustainability of revenue per adjusted admission? And then maybe you can touch on the Medicaid piece specifically. One question we get is just are these programs mature enough to assume they'll continue in future years? What's the funding environment going to look like longer term? Any perspectives on that?

Yes. I mean my almost 4-decade history in the business suggests that once a reimbursement program is established, it's difficult, whether it's at the federal level with Medicare, at the state level with Medicaid to dramatically reduce or eliminate programs like that because the providers become really dependent on those. And I think that's really true even more so with these supplemental Medicaid programs because those programs are designed to help the biggest Medicaid providers or the providers with the biggest Medicaid utilization. And very often, these are the safety net hospitals that come to literally rely on those programs for their financial survival. And so I think it's unlikely that the states would have a motivation to do away with them. CMS came out with sort of a recent pronouncement about these programs and in no way did they suggest that there was a cap on growth. They talked about the program and all-in Medicaid reimbursement shouldn't exceed commercial reimbursement. I think that's a pretty tall order and leaves a lot of headroom for the programs to grow and certainly to be sustainable. So yes, I think that there certainly could be some tweaks in individual states. Program amounts could go up or down a little bit. But I think broadly, however long you want to go back for the last 3 years, 5 years, 10 years, the programs have steadily grown. And maybe the rate of growth will slow, but I don't think we're going to see any significant retrenchment in these programs in the future. Because I think, again, the Medicaid -- the biggest Medicaid providers that have come to depend on these programs literally for their financial survival or it wouldn't be able to survive without them.

And any new programs or states you're watching potentially adding supplemental Medicaid funding?

Yes. I mean so we certainly are aware that there are states that don't have programs that are looking at implementing the programs, and there are states that have programs that are looking at expanding them. We tend not to discuss those because, first of all, I'm not sure we have the most up-to-date information. But secondly, I think until the programs are submitted, there's a formal program submitted to CMS for approval is really at the point we have publicly disclosed these programs. I think for our acute hospitals, sort of doing the mental check list, I think virtually all of our major markets have these programs with the exception of the District of Columbia, which, for purposes of Medicaid, functions as a separate -- as a state with its own separate Medicaid program. I think on the behavioral side, there's probably 10 or 15 of our states that don't have programs that could. So I think there is some additional potential tailwind impact but not as great as what we've seen in the last few years. But I still think there's some room for some incremental headroom here.

Okay. Just on your commercial partners. Obviously, there's a lot of moving pieces in this space. But I'd love to hear just, one, if the contract is being renegotiated today are still getting the 150 or so basis points of incremental pricing relative to kind of the longer-term trend; two, if you've seen any changes in payer behavior around denials and just activity to manage utilization, given some of the pressures that they've publicly talked about. And also just the inpatient status change that started this year, if there's been any benefit yet or what you're seeing there?

Yes. So I think what -- the crux of your question alludes to the fact that what we have said is that beginning probably the middle of 2022 as inflation became kind of a more embedded part of the business, we started as we were renewing our managed care contracts around that time to get 125, 150 basis points bigger increases, I think reflective of the fact that we were dealing with higher cost, particularly wage costs, et cetera. And I think that has continued, and we're not seeing a ton of pushback from the payers in terms of contractual pricing. I think where we are more likely to see pushback is in the other couple of examples that you raised, which is a higher level of denials, a higher level of what we would describe as patient status changes where we would submit a patient bill as an inpatient, and we will get it back paid as an observation or outpatient. I think we saw a big increase in that level of activity end of '22, beginning of '23 as I think overall utilization really kind of stepped up going back to sort of, I think, the very part of our initial conversation. I think the payers responded to that because they had, I think, become much less aggressive about denials and patient status changes during the pandemic because utilization was already kind of at a depressed level. But as utilization increased, I think they kind of returned to sort of what I'll call the more normal practices. And I think that's kind of where we are today. We are paying attention or focused or sensitive to the idea that we could see an uptick in denials, patient status changes. I would say that I don't know that we're seeing that yet or now. We're very sort of focused on responding to that if we do.

And just specifically on the 2-Midnight Rule and how that affects patient status, have you seen any change in your business year-to-date?

Yes. So we've generally answered that question in the negative, saying no. And I know that's a little different than some of the commentary of our peer providers and quite frankly, some of the payers as well. But as we look at the metrics that I was sort of alluding to earlier, the amount or the rate of denials or the rate of patient status or observation status changes, we're not really seeing a measurable impact. So that objectively, I don't think we see evidence of that. Subjectively, when we ask our own employees who -- this is what they deal with day to day is denials and denials, appeals. And we use outside firms to help us do that as well. They kind of give us that same feedback subjectively that they're not really seeing measurable behavior changes on the part of payers as a result of the 2-Midnight Rule change. So we would say no. I mean, obviously, we think the change can only be helpful to us. And I think in the long run, we think it will be most helpful as we go through appeals and we go through, in some cases, litigation or arbitration. Using that argument, I think will be helpful to us. But I would say, to date, we haven't seen a big change.

Okay. That's helpful. Let's go to the behavioral side for a minute. You've talked recently about the demand backdrop, and that's been some of the basis for your expectation of improving volumes here. It's been a little bit slower, I think, recently than your longer-term expectations. Just what's your latest reflection on what's been holding back that business and your level of confidence in getting to I think it's 2% to 3% of the long-term target there?

Yes. So again, I think you framed the question absolutely appropriately. And I think we talked about like in the most recent quarter, our patient day year-over-year same-store patient day growth or adjusted patient day growth was like 2%. We were anticipating something closer to 2.5%. So the gap is small, but it's a gap. I think we attribute it to a bunch of different things. I think the impact of Medicaid disenrollments has been higher on the behavioral population for a couple of reasons. Number one, it seems to be more weighted to the child and adolescent population. We clearly see more child and adolescent populations on a relative or a proportional basis in behavioral than we do in acute. Also, as those patients get reenrolled in a commercial exchange product to the degree that they do, those products tend to have a higher deductible. So if a product has a $10,000 deductible, a lot of behavioral patient bills won't even reach that limit. So early in the year, we're seeing that some of these patients who have commercial exchange coverage are still struggling for that coverage to be effective early in the year. We think that will obviously get better [indiscernible] for medical costs. We talked about, I think, in the back half of '23 a handful of our residential facilities that struggled with a very nuanced kind of specific regulatory referral issues. Those I think have been improving their results, but it's been a little slower than we thought. And while I think we've made a ton of progress on the labor front, filling more of our vacancies, we still find that in some markets, in some geographies and for some positions, and it may vary by geography. In some geographies, it could be nurses, it could be therapists, it could be nonprofessionals or mental health technicians. We still struggle in some markets in filling the positions that we need to accept more patients. So I think all those things combined have contributed to what a slight but definitely a shortfall in what our expectations for behavioral volume growth would have been or should have been.

So I guess on the forward, do you still have confidence in the kind of 2% to 3%, and that's a sustainable level you can achieve?

Yes. I mean I think our, again, overall view is that the intermediate longer-term sustainable level of growth in behavioral is sort of revenue growth -- same-store revenue growth in that 6% to 8%. We've been hitting those numbers for a while although we've been more reliant on pricing growth than we've been on volume growth. We think that as time goes on, pricing growth will moderate a little bit, but volume growth will continue to improve even if it's only incrementally.

And historically, bed count growth, capacity growth has been a key piece of the growth algorithm for the behavioral business, not so much in the last few years, in part because of just the labor dynamics. Are we at a point now where because the labor environment has improved and you can hire more readily, you can start to begin to get back to, I think, historically 400 to 500 beds per year?

Yes. No. And I think frankly, in a number of years, pre-pandemic, those numbers were even closer to like 600 or 800 bed additions a year. And you're right, during the pandemic, in some cases, I think we were down to 100, 200. And it was just a -- it was a very sort of straightforward kind of notion that if we couldn't staff the beds that we had, what was the point of building new beds. But you're right, as we make more and more progress on being able to staff those beds in those markets where we think the demand supports it, I think over the next few years, you'll see us resurrect our bed addition programs to kind of get closer to those historical levels.

And you mentioned pricing. That's been really strong in this businesses as well the last couple of years. You guys sort of made more aggressive comments than you have historically a couple of quarters ago around your approach to some of these contracts and potentially walking away from lower quality contract. I guess where are we in that? And I think you've always framed it as it's a continuous process. And -- but what's the environment like in terms of just your ability to continue kind of the trajectory of above normal rate growth?

Yes. So again, I mean, I think you've framed it very appropriately. I think during the pandemic, where we were clearly -- and in this case, when I say we, I'm going to say the industry more collectively we're capacity constrained. We took a hard look at some of our lowest paying payers, which tend to be managed Medicaid payers. And we went to those payers and said, "Look, if we're turning patients away, it only made sense to us to turn away those who were not paying us what we viewed as a market or competitive rate." And that we either gave formal notice of contract termination or suggested that we would give notice if the payers didn't increase their rates because I think we had a view that one way or the other, if we had patients waiting to get into the facility, we would admit the patients who were paying us fair or kind of more competitive market rates. And I think that strategy has clearly been an effective one. Behavioral pricing increases per patient day or per adjusted patient day increases, which I think for years averaged generally 2%, 3%. During the last several years have averaged closer to 6% or 6.5%, and that's been pretty sustainable. Now we predicted that those percentages would moderate some partly because as we're getting these increases, and we're now into year 1, year 2, in some cases, these increases we're anniversary-ing the impact, et cetera. So the year-over-year impact is not as great. The other, which I think is probably a longer-term dynamic is as the industry, again, collectively is able to admit more patients, is able to solve the labor problem, I think some of the leverage that we will have over our payers is going to diminish. And the pendulum will shift a little bit, and then we won't have that, again, that same ability to sort of demand those increases. But to be fair, much like acute care volumes have remained stronger than we originally anticipated they might -- behavioral pricing has remained stronger for a longer period of time than we [indiscernible]. And I think, again, that trend at a minimum will continue through Q2.

Okay. That's helpful. Let's go to the financial side of things. You guys have had some margin pressure since 2019. Much of this has been in the acute segment. Behavior has been a lot more stable. So on the acute care side, I mean, I guess just where are we in some of the labor pressure dynamic? It feels like that's been more manageable but maybe still elevated. And then the physician subsidy expense, it sounds like that was in line with sort of what you were expecting in the first quarter, but it's not clear to me that, that's entirely stable. There's still a lot of things that are impacting that market. So just where are we on the cost side for those 2 pieces?

Yes. So I think on the physician expense side, we do largely believe that, that dynamic, which has been very volatile, I'm going to say at least for us, back half of '22 and into much of '23 has really stabilized. And I think the issue there is that this business of physician -- the people we call hospital-based physicians, mostly emergency room doctors and anesthesiologists, these are people who don't have a private practice of patients but only see patients in the hospital setting that the profitability of those businesses diminished pretty significantly in the last several years. I would say mostly as a result of No Surprises billing act, which limited the amount that those doctors could bill for out-of-network patients, but also just broad pressure from the payers who've had some pretty public disputes with some of the larger hospital-based providers about the rates they were billing, et cetera. So we just saw those businesses largely become less profitable regardless of whether they were being run by some of the sort of bigger name companies or by kind of a smaller regional group or even if they were being run by the hospitals themselves, employing the doctors. And so as those business economics were sort of reset and either we were paying greater subsidies to our incumbent providers or greater subsidies to a new provider or we were bringing the doctors in and employing them ourselves, one way or the other, those businesses were less profitable. And that was reflected in a sort of higher cost. And the way I think we framed it is that physician subsidy expense was like 6% acute care revenue a few years ago, and it's now 7.5%. I think that 7.5% is pretty stable. And I don't feel like we feel like that's increasing some. But that 150 basis point of margin decline is not easily recoverable. We can probably drive some efficiencies incrementally in that business to reduce our cost. We can try and recover some of that from our payers. But that's a tough nut to get over in terms of recovering acute care margins. I think on the wage side, we've got a lot more improvements. I think the overall -- as we've been disclosing the amount of premium pay has diminished by more than half since the height of the pandemic. We've gone from $150 million, I think, the high -- in the first quarter, $22 million a quarter in premium paid, $65 million to $70 million in the last couple of quarters. I think we've been unable to reduce further from that level because of the strong acute care volumes. I do think if acute care volumes begin to moderate, one of the offsets to that will be an ability to reduce premium pay further. So -- and we're not paying nearly as many incentives, sign-on bonuses, loan forgiveness, all those kinds of things that we were paying at the height of the pandemic. So I think that's been helpful, too. And finally, I think we've made some productivity gains. We've had some headcount reductions in our -- in both of our businesses, quite frankly. And I'm going to say the last 2 or 3 quarters that we have been reluctant, I think, to make it the height of the pandemic when labor was so challenging. So I think all those things are contributing to a better labor/wage environment. And I think that's been helpful to recovering at least some of those acute care margins that had been diminished or deteriorated during the pandemic.

Okay. And on supplies, I mean this is only about mid-teens percent of your revenue on the acute care side of the business. There seems to be a more firm tone from medical device companies around their pricing strategy. Is any of that showing up or material enough to impact margins? Is it manageable? How would you frame it?

Yes. I mean if you look at it, as I'm sure people do, I think the supply line has probably been the most controlled expense line over the course of the last several years. Now I think one of the reasons for that is those supply contracts tend to be more longer term than wages, et cetera, which are sort of much more subject to sort of real-time adjustments. And I think what the manufacturers are suggesting is that as these contracts, the longer-term contracts expire, they would expect bigger increases. I don't really quarrel with that. I will say that I think this is an area that the industry has exercised its purchasing power, mainly through a handful of very large group purchasing organizations. So I think that the leverage that these manufacturers have to really extract, I'm going to say excessive or really large increases, I think, is somewhat limited. But I wouldn't be surprised to see some pressure in the next couple of years on that line. I don't think it's going to be a huge drag on earnings or margin, but I wouldn't be surprised if we see slightly higher increases in supply expense than we've been seeing over the last several years because I think we've been contract-protected.

Okay. Taking a step back when you had a 16.5% in the acute care segment in 2019, last year, like 11%. You've talked about being able to get back some of that margin over time. What's your latest thinking on just the cadence of improving margins? And really, I guess, where mature or your peak margins, once you kind of digest some of these headwinds and tailwinds?

Yes. So I think if you think back and at a very high level about what caused the deterioration in margins during the, I'll call them the COVID years, we saw that COVID business crowd out both, I'm going to say, physically and psychologically other higher margin, better paying business. So we had COVID patients basically, medical patients that had a lower margin than some of the elective surgical patients that they we're replacing, I think, over time. And we talked about this early in the presentation. We've gotten back to kind of more normal surgical elective levels. That [indiscernible] some of the loss margin. The wage expense particularly we never really -- we didn't have all the position to fill in the acute business during the pandemic. But we [indiscernible] traveling temporary nurses or over time with our own employees, et cetera. I think that's gotten a lot better, and that's been a big improvement there. So again, I think that a lot of what has caused the margin deterioration, and then the last thing I'll comment on is, I think, kind of a geographic disparity. I think a couple of our peers, Tenet and HCA have recovered from their pandemic losses and margin contraction faster than we have. And I think a lot of that is geographically determined. They talked about and we've talked about places in states like Texas and Florida recovering from the pandemic more strongly and economically strongly than some other states. The challenge for us is that those companies have a bigger proportional footprint of [indiscernible]. The places that we tend to have a bigger proportional footprint, Nevada especially, but California, D.C. have been somewhat slower to recover. But I think what we've seen in the last several quarters is in Nevada especially recovering, really gaining some traction. And that tends to have a much bigger impact on our business. So yes, I think our margin recovery in acute care certainly has accelerated in the last year or so and I think is likely to continue. There's not a lot that should prevent that other than things we've already talked about, the difficulty in recovering some of that physician expense, et cetera.

I guess very specifically, is there -- it's lower than the 16.5 that you were at historically or structural costs and headwinds. But do you have a view on what the right kind of target is over the next 2 to 3 years that you can get back to in acute?

Yes. So again, what I would say is I think we feel like we can get pretty close to pre-pandemic margins in the acute division, maybe not get all the way back. And conversely or alternatively, I think we get back on the behavioral side not just the pre-pandemic margins, but something slightly above that just because I don't think the behavioral division faces some of the same sort of structural challenges in terms of the physician expense, in terms of some of that impact of inpatient to outpatient shift that the acute business does.

Okay. We've got about a minute left on with one short-term and one long-term question. So the short-term one, which is very typical, you guys rarely [indiscernible] irrespective of what's going on. I guess how are you feeling about the momentum in the business broadly? You've already signaled you're tracking towards kind of the higher end of the range if trends were to continue, I guess, have trends continued? And how should we think about the guidance that you have out there at this point?

Yes. As I said, again, I think the couple of metrics that really were primarily [indiscernible] in Q1, acute care volumes, behavioral pricing haven't really continued into Q2. So unless something happens in the next few weeks, I think -- we had an expectation and I think you know that guidance wouldn't likely be raised at the end of the second quarter, and I still think that's the case.

Okay. And a little bit longer term, just free cash flow priorities. Historically, you've been very aggressive at share repurchases. I think you've repurchased like 30% in the last 5 years of your share count. Is that a key use of cash? How should we think about that?

Yes. I mean we said going into this year that our intent was to devote most of our free cash flow to share repurchase. I think we became a little bit more cautious about that in Q2 as a result of this verdict we had in the malpractice case in Illinois. I think we paused a little bit as we try and sort of figure out exactly what our cash needs are going to be there, even just in the short term. But I think more broadly and over time, it could change, and we could find a really compelling acquisition. But I think the likelihood is that over, I'm going to say, the intermediate term, we still devote the greatest portion of our free cash flow to share repurchase. We still think that's a pretty compelling investment for us.

Perfect. Well, I think with that, we can leave it there. Thank you, Steve.

Thank you. Appreciate it.