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

All right. Thank you. Good morning, everyone. I'm Steve Baxter, health care services analyst at Wells Fargo. We're really pleased to have Universal Health Services with us today. UHS operates a portfolio of acute care hospitals and behavioral assets. From the company, we have CFO, Steve Filton. Thanks again so much for being here. Did you want to make any opening remarks or just get right into the questions?

Get right into it.

Okay. Great. All right. So then maybe we'll start on the acute side of the business and do a few here and pivot to behavioral. So just to start, the first half volume backdrop, demand backdrop feels like it's been pretty strong across the industry. It's been fairly strong for you. As we said you're thinking about the second half of the year, can you talk a little bit of the assumptions you've embedded in the back half of the year around demand? And any update on what you've been seeing would be great.

So we revised our guidance at the end of the second quarter, and I think we were clear that in terms of sort of the core business, particularly volumes, we were sort of reverting back to our original guidance, which for the acute care business for the year was adjusted admissions in the 3% to 4% range. We were -- adjusted admissions grew in Q2 by 3.4%, which, solid. But I think particularly strong in light of the comparison with the prior year quarter, which was like 7.7%, something like that. I think we've been a little bit more conservative about our outlook on acute care volumes. In part, that's a nod to our experience at the back half of last year when our volumes were really quite strong. And I think the volumes that were really strong in the back half of last year were a reflection of some of our slower-to-recover markets like Nevada, California, D.C., coming back a little bit more slowly than some of the other, I'll call them, for profit markets like Texas and Florida, which should come back sooner because they had nothing shut down as much during the pandemic. So we're looking at, I think, what our historically solid acute care volumes maybe a little bit more conservative than some of our peers, but I think some of that because of the difficult comparison we have with the back half of last year.

And when we go to 2-Midnight Rule, your first half same-store admissions, 4.6%, the adjusted admissions 4% for the first half. What impact do you think 2-Midnight is having on your business in the first half? And I guess how are you thinking about whether that is any different in the back half or maybe into next year?

And I know that our answer to this question is a little bit different than some of our peers. But I think we've consistently said that we don't really detect a material change in our volumes as a result of the expansion of the 2-Midnight Rule earlier. So -- and we measure that based on metrics and in terms of how many observation days we record, how many appeals we're successful on, et cetera, and that none of those metrics seem to have really changed. Subjectively, we talked to our folks who are involved in this all the time to say, are you seeing different behavior from our payers. They tell us, not really. And I don't know why because I do know that some of our peers have said they've seen a more material impact from the change in the 2-Midnight Rule expansion of it. I will say that we've really been focused on this area for several years now. We engaged a third-party consultant who really helps us determine what our appropriate admissions versus observation stays. They help us appeal the ones that are -- we dispute with the payers, et cetera. So maybe we're not being impacted because we've been a little bit more focused on this issue than some of our peers in the last few years. But again, the bottom line answer is we just don't think that whatever strength we're seeing in acute care volumes, we don't think any sort of material amount of that is because of the 2-Midnight Rule.

Okay. Got it. And as you've built the guidance, obviously, it's a little bit difficult with some of the noise around like Medicaid supplemental payments, you look at the underlying margin trends. How are you thinking about margin trends in acute, I guess, on an underlying basis, kind of first half and what you've built into the guidance for the second half?

Yes. I mean, I think we have said we believe that acute care margins will continue to improve. We have said that we believe we'll get close to or get back to something pretty close to pre-COVID margins on the acute side. I know we'll talk about behavioral separately, but we have said that I think there are some structural challenges to getting all -- to getting acute care margins all the way back to pre-COVID numbers, the increase in physician expense being probably maybe the biggest, the continued shift from inpatient to outpatient as a pressure point on profitability. Obviously, as you alluded to, the Medicaid supplemental payments offset that some. But I think broadly, and I know we'll talk about the behavioral piece separately, I think we've had the view that we'll get pretty -- we'll get back over the next year or two pretty close to acute care pre-COVID margins. And on the behavioral side, the hope is that we can get above where we were in pre-COVID margins.

Okay. Yes. So as you think about the building blocks to do that on the acute care side, I know you're waiting on a couple of supplemental programs as well. So maybe if we get time to maybe get an update on where those stand. But as we think about building from your current margins, potentially layering on a couple of incremental programs, what's going to solve for the rest of the delta on the acute margin side of things?

Yes. So my previous comments about getting back to pre-COVID margins really exclude any benefit we get from additional supplemental programs. The one program that would affect the acute care business materially is in Washington, D.C., we've sized that program as being worth something in the $80 million to $90 million a year range. We believe that, that program is likely to get approved sometime later this year, maybe next -- early next year, and we anticipate that it would be retroactive to October 1 of this year. So we would only have a quarter's worth of effect. But broadly -- more broadly, the keys, I think, to getting those acute care margins back are really overcoming the things that disrupted those margins so significantly during the pandemic. We talked about volumes earlier. I think acute care volumes have clearly now recovered largely from the pressures of the pandemic, although people have pointed out that if you simply took prepandemic volumes, 2019 volumes and index them forward for a reasonable growth rate, we're still below that -- so it does imply that there's still some additional recovery in catch-up to go, which obviously should help the business. Obviously, the other significant disruption, I think during the pandemic was a dramatic reduction in the labor supply/demand dynamics. We saw wage inflation accelerate dramatically. We saw the use of premium pay increase dramatically. Both of those metrics have really stabilized. We've reduced premium pay by, I think, almost 2/3 from its height -- during the height of the pandemic wage. I would say we're experiencing wage deceleration. What I really mean is the rate of wage acceleration and inflation has clearly slowed. And it feels like that's going to continue. And obviously, and not that I'm rooting for it in any way, but if we see some weakness in the economy, some increased unemployment historically, that has generally been helpful to our business in terms of increasing the supply of labor hours and making it less of a pressure point. So my sense is if acute care volumes can continue at the relatively strong rates they've been at, which I think most people anticipate they will, we certainly do. Expenses have been moderating both from a sort of external factor. And I think we talked a lot about -- in our second quarter call, a lot of the steps that we've taken to drive greater efficiencies. I think we drove a lot of productivity improvements in Q2 that we should get the continued benefit on. So all those things, I think, will contribute to the continued progression of getting back to those -- something close to those pre-COVID acute care margins.

Okay. And obviously, an important driver has been the lagged improved commercial rates that you've seen in the acute care business over the past couple of years. Can you update us on as you're getting further along with contracting for 2025 and maybe even 2026 at this point, how your expectations look there compared to the past couple of years?

So I would say that, beginning in the middle of 2022, we began to get an elevated level of price increases from our payers, which was really an acknowledgment or a reflection of the fact that they were acknowledging that inflation had clearly ticked up. So if you assume that the average length of our -- the average managed care contract has a length of about 2.5 years, we probably still have a little ways to go there and still getting those. Now I think as we start to get into the cycle of '25 and beyond, we'll start to get some pushback from our payers who will argue appropriately so that inflation has slowed some. But I think we'll still get the benefit of those elevated inflationary increases for another 6 or 12 months at least.

Okay. And just can you remind us for your contracts generally like first year increase versus increases in the latter stages, like are you still blending up to a higher rate of commercial update? Or is it something that's more stabilized to this point?

No, no. And I think that's -- and maybe I didn't -- wasn't artful enough, but that's the point that I was trying to make, is we negotiated these increases, multiyear increases beginning in 2022. So we'll continue to get the benefit of that for a while.

Okay. Got it. And then when we think about labor, obviously, you made the point that to the extent that the economy softens a little bit, like historically, that's been a source of easing wage inflation for you. Absent something like that occurring, how much more progress do you think you could see on moderating labor over the next couple of years?

Yes. I mean I think there is still incremental improvement to be made on premium pay. Our temporary -- we call registry nursing expenses are still 70%, 2/3 higher than they were pre-pandemic. And so I don't know that we can get all the way back to those pre-pandemic levels, but there's still some room to go. I think we talked a lot about the productivity improvements that we made in Q2. And I think one of the reasons why you're seeing that is that I don't want to say that our operators ignored the productivity metrics that we've historically focused on during the pandemic because I don't think that's fair to them. But I think we sort of suspended some of that focus because we were finding it so difficult to fill all of our open positions during the pandemic. I think we've returned to kind of a more normalized dynamic now. And so we're managing productivity in a more efficient aggressive way than we had been really, I think, returning kind of to historical practices. So we're getting the benefit of that as well.

Okay. And then obviously, professional fees were a surprise for the industry a couple of years back now. As we think about the future for professional fee expense, it's a little bit hard, I think, externally people to understand whether the providers of those services are now on a little bit firmer footing like much firmer footing. How do you get comfortable that you might not see another step function increase in those costs at some point over the next few years?

Well, I think that the reason that those professional fees and the increase in those professional fees came as a surprise to investors, but I think to providers themselves is that I don't know that we had a -- collectively, we had a full understanding of how much of the profits of those, what we call physician-based or hospital-based physicians, the emergency room physicians, anesthesiologists, how much of their profits came from out-of-network billing. And as a result, when the No Surprise Billing Act was enacted and was implemented, the profitability of that business regardless of who was running it diminished dramatically. Or you can look at it in another way, the expense of providing that service increased dramatically. Again, regardless of who is providing that expense, whether it was a third party, and we've seen some pretty high-profile third-party bankruptcies in that space. But even to the degree that hospitals took over those physicians, we were facing those same dynamics. But I think what happened is essentially over a period of time, I'm going to say, for us, most of '23, the business was sort of reset, and we reset it to a lower reimbursed business. That was the level of expense that rose, and now it's sort of stabilized. And the business is what it is. I don't think it's going to face further headwinds. As a matter of fact, I think, there are some efficiencies we might be able to bring out of the business. We still use a relatively high degree of locums, temporary physicians. We still don't necessarily always have the right mix of like particularly in the anesthesiology of -- anesthesiologists and CRNAs, et cetera, we can probably do that a little bit better. So maybe we can make the business a little more efficient, but I don't think that, no pun intended, but the surprise that the Surprise Billing Act brought is going to be repeated in any significant way. So I do think that the business has settled in at a sort of new norm at an expense level.

So then on the cost side, I mean, we've mostly talked about things that are more traditional blocking and tackling for hospitals. As you think about the opportunity to attack your cost structure differently in light of new technologies or AI, like what's the company's current stance on that? And whether there's opportunities for, I guess, like maybe step function change in your cost structure that wouldn't have been possible maybe 5 years ago?

Yes. I mean, again, and I think what our results showed in Q1, and then again, I think even more dramatically in Q2 is we've driven more productivity, particularly on the labor side, but I think across our expense structure. I think there's certainly more to go. I think technology helps that. One of the difficult parts about driving appropriate levels of productivity and staffing in our business as opposed to businesses that we sometimes get compared to like an airline business or a hotel business is it's a lot harder for us to anticipate demand. We don't book a lot of our demand, particularly the emerging part of our demand is difficult to anticipate. And I think one of the potential uses of AI is to help us better predict that even if we can better predict days ahead, it will help us to better manage our staffing and our productivity, certainly around the edges. So that's helpful. But yes. I mean, I still think that there are -- again, I'm going to say that during the pandemic, especially we became less efficient, not because sort of intentionally, but we were facing certain challenges in terms of the patient population, but also challenges, as I alluded to before, in the sense of really not wanting to in any way to offend, it's probably the wrong word, but offend our labor complement so that they would look to work elsewhere because lots of people were moving around and seeking highest-paying jobs during the pandemic. So again, we've returned to kind of a more normal dynamic that we're in right now.

Yes. And on the acute care side, you have a number of new hospitals you're opening over the next couple of years. Can you just help us think about the cadence of start-up losses maybe into next year or the year after? And just an update on how much capacity you're going to be adding to the system, how you think that's going to flow through over the next couple of years?

Yes. So I think the relevant openings on the acute care side, at least as it relates to 2025 is we'll open a hospital in West Henderson in Las Vegas late this year, mid-November. So -- and then we'll open a second hospital in the Washington, D.C. market sometime in the spring of 2025. As we get closer to giving our 2025 guidance in early '25, we'll be more specific about the impact of those openings. I'm going to say, in both cases, I would anticipate that they will be relatively minimal. And I base that on our openings in Las Vegas have tended historically to ramp up faster than our openings elsewhere. The hospital that we opened in Henderson, Las Vegas, 4 or 5 years ago, probably ramped up faster than the other hospital we've ever owned hoping for something akin to that with the opening of West Henderson. And then with the hospital opening in DC, that's a hospital that we built really in partnership and at the urging of the [indiscernible] of Colombian government. They protected us financially sort of on the downside, both with Medicaid reimbursement and some sort of start-up losses protection. So that again, I think in both cases, will have relatively minimal drags. We'll be much more precise about those when we give our guidance.

Okay. And then it's been interesting. We've watched some really interesting acute care hospital transactions in the market with one of your competitors created a lot of value and some really high multiples on some of these transactions. I guess, has the company seen any inbound interest on the acute side? And how do you think about overall managing the acute care portfolio if there's opportunities like that to potentially create value?

Yes. I mean -- so the peer company, I think you're largely referring to has been involved in a process, I think, for now several years of lessening their exposure to the acute care business and increasing it to ambulatory and to a lesser degree, I guess, the revenue cycle business. We, I think, went through that exercise of, to some degree, lessening our exposure to the acute business decades ago when we invested in the behavioral business and we continue to do that. I think that the acute business that remains for us are in markets and largely in markets and franchises, we're quite confident in, et cetera. I'm sure that if we wanted to transact in some of those markets, we could get a very hefty price. But we -- I'll use Las Vegas as an example. We love our franchise position in Las Vegas, the growth rates, et cetera, the returns we're earning in that market, we're not looking to abandon it. There may be 1 or 2 peripheral markets that we would explore and exit from. But I think, quite frankly, that's part of the normal process in both the acute and behavioral business, where we look at the bottom 5% of the portfolio and think about what the right way to -- if there's not a lot of opportunity for improvement, the right way to think about exiting those markets.

And then a couple of questions, I guess, more -- a little bit more election focused. Maybe the exchange has obviously been a much bigger part of everyone's business over the past few years. As you look at exchange portfolio, just remind us, on average, like how do the reimbursements there compared to maybe a more traditional managed care population. And anything notable about how those people use the system as we're thinking about whether there could be changes or not in the absolute level of enrollment in that market?

Yes. I mean, so we've said that pre -- the ending of the public health emergency and the Medicaid dis-enrollment that sort of started from that, our commercial exchange population as a percentage of our total acute care adjusted admissions was about 4%. It's risen to about 5% subsequently. I know some of our peers have sort of talked about an increase that's a little bit more dramatic than that. Commercial exchange reimbursement is generally closer to Medicare reimbursement than it is to commercial reimbursement, a little bit above Medicare, but not nearly as good as our average commercial reimbursement. So again, I guess our view is if there is an impact on commercial exchange enrollment because there's a change in the administration and the subsidies and/or whatever, while we think, I think it could be a bit of a headwind just given the numbers, I don't think we think it's likely to be a material headwind.

Okay. And then another area that comes up a lot with the elections is just the Medicaid supplemental programs. It seems like the industry has a perspective that they think these are durable and they're not sensitive to elections. But I guess what's your latest perspective on that? And then as we've seen Medicaid enrollment come down a lot nationally as a result of redeterminations, do you think there's any linkages between the size of the Medicaid population and these programs maybe on any kind of lag basis to consider it?

So I think the reason that the industry tends to view the programs as durable as you described it, I think it's twofold. I mean, one is, the hospitals that sort of come to most rely on these programs, what I would describe as safety net hospitals, really sort of these programs being sort of become their lifeblood. And if the programs were to end, would be reduced dramatically, I think what you would see is a lot of the safety net hospitals would not -- would no longer be economically viable. And I think that's a public policy outcome that regardless of party is really not an acceptable outcome. The other point that I think certainly my peers have made is that these are not programs that are specific in any way to certain states that lean one political way or another, I think both Tenet and HCA have made the point that they're probably biggest Medicaid supplemental programs are in Florida and Texas, two very red states. So again, the notion that even if there was to be a change in either administration or congress, et cetera, that all of a sudden these programs will be viewed with this favor, I think would be a tough political sell states like Texas and Florida, I think, would lobby pretty vigorously to maintain these programs because, again, their hospital communities have really come to rely on. And again, the other point I would make, particularly in the acute side of the business is, even with the benefit of these programs, I can't speak for all the other companies, although my guess is their experience is similar. Our Medicaid reimbursement remains well below even our Medicare reimbursement. And so we're -- in many cases, still just largely covering or maybe not even still covering our cost with our Medicaid patients.

And then just as you look at the programs that you have today, do you feel like that if you get there with D.C. that on the acute side, you've kind of reached the layering in of this? Or do you still think as you look across like there are certain programs that are well below the others in terms of like where they've gotten average Medicaid reimbursement still.

Well, I think so. On the acute side, I think D.C. would be the last of the large geographies that -- where we don't have any programs at all or a program at all. But I think there is still some room for expansion. And again, you raised the point that with Medicaid dis-enrollments, some of these programs could see reduced reimbursement. And I think that's true in some cases. But we've gotten the feedback from some of these programs that actually over the last several years, Medicaid utilization has increased dramatically. And so a lot of these programs are based sort of on historical utilization from 3 or 4 years ago and they continue to update them. So if we're seeing more Medicaid utilization even with Medicaid dis-enrollment. And I'll make the point that in states like California and Nevada and Medicaid dis-enrollment has not been nearly as large as it's been in Texas and Florida, et cetera. I think there's a potential for expanded programs in those states.

Okay. And then to move to the behavioral side, I think it's been a little bit of -- on the volume side, at least like same-store patient day growth has taken a little bit longer to reaccelerate. Maybe just level set us on sort of the root causes of that, and I know you're optimistic that potentially as we get towards the later part of this year, that could start to accelerate? Any confirmatory data points you can share on any of that?

Yes. I mean, so if you go back for an extended period of time and look at our behavioral business, the normal same-store growth, I'll call it just top line revenue growth, has been in that sort of 6%, 7%, 8% range, and it's been skewed more to volume than to price. We've generally over the last couple of years, been exceeding that, and then we've been running at 8%, 9%, sometimes 10%. And what has, I think, differentiated it from historical periods is it's been skewed more to price than to volume. The pricing strength seems to have a fair amount of durability associated with it. Although we've said over and over again, we anticipate that we'll start to see some declines in it. And when we do, the burden on us will be to increase our volumes. And as you alluded to, that increase in patient day volume has been sort of slower to come than we've anticipated, although I think we've been incrementally getting there, particularly coming out of the pandemic. I think the most recent sort of shortfall from our expectations, which I'm going to say that shortfall is not all that great. Maybe it's 75, 100 basis points shorter in patient day volume growth than we expected is attributable to a few different things. One is, while I think the overall labor supply/demand dynamic has improved and we've done a much better job of filling vacancies overall throughout the division, we still find that in very specific geographies, very specific hospitals, we do sometimes struggle with filling certain positions. A lot of times it's nursing, but sometimes it can be therapists or counselors. Other times, it can be the nonprofessional folks that we call now health technicians. I think secondly, we've been more impacted by Medicaid dis-enrollments, particularly in Texas, most notably when other kind of red Southern states like Mississippi and Arkansas and Louisiana than we anticipated. I think a lot of those folks are either being reenrolled in Medicaid or are enrolling commercial exchange products, but that's taking some time. And it's, again, a little bit longer process than we imagined. And then I think finally, late last year or in the back half of last year, we identified a handful, maybe half a dozen residential treatment facilities that had faced some very specific, but nuance sort of issues that had caused them to have reduced volumes and profitability. We've seen them recover. But again, at a slightly slower pace than we expected. So I think our sense is and what we said is we had originally set a target for 2023 of 3% patient day volume growth for the year. We now say that that's going to be difficult to achieve, but I think we still believe we can exit the year at that rate of growth. And that, that rate of growth is a pretty reasonable way to think about the business going forward. And if we can grow at 3% given the strong pricing, getting to that 6%, 7%, 8% historical level of behavioral pricing, which is a level at which you can have margin expansion and growth in the business shouldn't be a big stretch.

And then we talked about Medicaid supplemental in the acute business, which I think people struggle pretty hard to follow and model and track. The behavioral side seems like it's even more challenging, but you've had some benefits there. Just kind of level set us on where you are in behavioral with these programs compared to maybe where you are in acute and whether you think there's still maybe more opportunity on behavioral than there might be on the acute side of the business.

Yes. So while the D.C. program is the one most imminent on the acute side, we've been talking about Tennessee for a couple of quarters, and that's sort of a behavioral -- for us, a behavioral impact. We size that program between $42 million and $56 million annually, expect that program to be approved again sometime late this year, early next year and retroactive back, in this case, to July 1. There are a couple of other behavioral states that we operate in, the donut programs. And again, much like I would say, on the acute side, there are states that, quite frankly, either have programs that don't include behavioral or have programs that could be expanded. So I think there is some upside. It's difficult to predict or project. But I think -- and honestly, just because I think of the broader geographic footprint we have in behavioral, there's probably more upside in behavioral than there is in the acute.

And we started to get more questions, I believe it's a ballot initiative in California is starting to attract some attention. It would potentially increase funding for the system overall. It's a little bit hard to know exactly how it flows downstream to providers like yourself. Can you talk a little bit about what you know about that program at this point and the potential materiality of it?

Yes. So I think the law that you're referring to is called Prop 1. It was passed, I believe, earlier this year, and I think it was basically provided for like a $6 billion bond issue, largely geared towards an expansion of behavioral care. And that's a lot of different things. I mean, it's housing, and it's not necessarily just the things that we think about in terms of mental health treatment and care. And even on the mental health treatment and care, side of things, I think it is geared more towards expansion of facilities. There's been a real dearth of new behavioral beds in California in the last decade or maybe more. In part because it's so expensive to build in California, and therefore, it's hard to make the economics work. But -- and to your point, the way this program, I believe, is supposed to work is that monies are being allocated to counties and other local governments. And they're supposed to, I think you have sort of public private partnerships to allow and make the building of more behavioral capacity, more sort of economically viable. We're in conversations with a bunch of facilities or a bunch of localities, both on sort of our acute and behavioral side to build or expand behavioral capacity. But as you said, it's still kind of early in the process. It's not clear to a lot of people not necessarily clear to us, but not even clear to the local government exactly how that money is going to make its way down. But I think broadly, I think we're kind of more intermediate and longer term. It does, I think, bode well for the ability to profitably provide behavioral care in the state of California.

And we had the margin discussion on the acute care side, as you think about the key building blocks to getting back to where you want to be on the behavioral side, what's the rank order, I guess, what you think drives that?

Yes. So again, I think volumes are a big piece of it and a big focus. And again, getting from where we are today, which has been sort of 1% to 2% patient day volume growth to 3%, 3.5%, not a huge leap or in theory, I don't think should be kind of such a tall order, but it makes a big difference in terms of the operating leverage it brings to the business, et cetera. The other way, I think the business benefits is kind of in the same way we were talking about on the acute side. I do think pressure on wage inflation and wage acceleration is diminishing, our use of temporary labor. I think on the behavioral side, where we have used a ton of temporary labor is not as impactful, but we were paying lots of incentives and sign-on bonuses and things like that, that you've seen diminish in frequency. And I think that's helping on the behavioral side, too. We've had some productivity improvements on the behavioral side as well. So I think all of those things contribute to our ability along with the improving volumes to margin improvement on the behavioral side.

Okay. And as we just step back and think about the total company guidance, I asked a little bit about the margin trajectory in the acute side of the business. But if we take your results and we strip Medicaid supplementals out from all periods, I think the first half EBITDA margins for the total company were up something like 70 basis points year-on-year. I believe the guidance implication for the back half of the year is more like 20 basis points. Like how do we think about the opportunity there? And maybe like what the headwinds and tailwinds would be -- would maybe get to a different result in the back half than the front half.

Yes. So -- and I think what I was saying earlier is what we tried to embed and I think we acknowledge that the back half of the year guidance was relatively conservative. It really just assumed the known supplemental payment benefit that we would get didn't include even the new -- Tennessee, Washington, D.C. And it really sort of reverted back to kind of the volumes that we had in the first half of the year for both acute and behavioral, which I think, again, on the conservative side. So that, to me, is sort of the upside for the guidance in the back half of the year. The reason I think we've been a little bit more conservative and taking a more conservative tone in the back half of the year is I do think the comparison to last year is difficult. We had a very strong second half of the year last year. I think a lot of that due to the fact that some of these markets like Nevada, California and D.C. were coming back. But again, we're looking forward to, I think, a strong second half of the year, but the comparison to last year will be a tough one.

Okay. All right, that's perfect. I think we can leave it there. Thanks so much. Appreciate your time.

Okay. Thank you.