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

Okay. Great. Welcome, everyone. My name is Michael Ha. I'm the managed care and health care services analyst at Baird. And our next session is with Universal Health Services an operator of acute and behavioral health care facilities. And I am very pleased to have with us today, Chief Financial Officer, Steve Filton. Thank you very much for being here. And I guess, we'll jump right into Q&A.

It would be great.

All right. Great. So 2024 guidance, you raised your full year adjusted EBITDA by about $250 million last quarter. But my sense is there's still a very healthy level of conservatism. And I wanted to drill down a bit deeper into that. And if I'm not mistaken, I believe there's not much in the guide in terms of that assumption of sort of persistence of first half outperformance into second half of the year. And it also excludes Tennessee and D.C. Medicaid supplemental payments, which all could drive some very attractive upside. So I was wondering if you could walk us through the elements of the guide raise, what does that reflect? What could potentially represent upside?

Yes. So Michael, I think to be fair, you've described it pretty well. I think what we attempted to do in revising our guidance and thinking about the second half of the year is, number one, to incorporate all the newer or expanded Medicaid supplemental programs, which have been approved which we are relatively certain about. So they've been included in that detail is included in our second quarter 10-Q. To your point, we did not -- we have two pending programs, there are two pending programs in Tennessee, which for us is a exclusively a behavioral program, and in Washington, D.C., which was -- is largely would be an acute program. And we've scoped out the magnitude of both of those again in our 10-Q. We're waiting for approval of those. Don't expect approval to come until late this year, perhaps early next year. As is our practice, we would not begin to recognize that revenue until their CMS approval, but the expectation is that the Tennessee program if and when approved, would be retroactive to June 1 of this year, and the D.C. program would be retroactive to October 1 of this year after it's approved. So there's that element of it, as you described. I think the other thing, clearly, we have been able to execute on some pretty significant cost improvements. And I think we tried to continue to reflect those in our guidance, feel like those are sustainable, et cetera. But the element of conservatism, I think that you referred to at least in my mind, is the idea that what drove a lot of the outperformance in the two segments was on the acute side, acute care volumes that have been sort of stronger than historical norms, and behavioral pricing that has been stronger than historical norms. And in both cases, our guidance for the back half of the year really reverted back or, I should say, remain the same. We didn't change our assumptions about acute volumes or behavioral pricing from where we were in our original guidance. And to your point, those metrics have outperformed in the first half of the year to the degree that they're sustainable. And I think they are two varying degrees, then that's where I think there's the conservatism lies in the guidance.

Great. Thank you And I definitely want to dive deeper into acute and behavioral. Maybe on supplemental payments really quickly. So Tennessee $42 million to $56 million is your estimated range, D.C. $80 million to $90 million. Would you say those are pretty firm ranges? Or is there potential for some variation outside?

So those numbers come from the state or the district's own estimates, we call them the impact file. So we're really just going off their calculation. So I think in my mind, as long as CMS approves the program as submitted and as long as the state or districts calculations are accurate, then those numbers should be accurate. They're not anything -- none of our judgment, none of our calculation, it's just really taking from what the state has provided us.

Great. Got it. So then -- okay. So back in late June, we made UHS our top hospital pick on the thesis that UHS is at the very beginning of this very powerful margin recovery story magnitude being 400 bps back to pre-COVID, 700 bps back to 2015. So with that said, I'd like to drill into both acute and behavioral, but maybe starting with acute margins. So you had mentioned last week that there may be some structural challenges that might prevent you from getting all the way back to pre-COVID, things like professional fees, et cetera. But you still expect to get pretty close to pre-COVID over the next 1 to 2 years. So number one, I want to firstly confirm related to time frame. Is that true? 1 to 2 years is the right thinking? And then should we think of this recovery being primarily driven by, as you've mentioned before, lagging Nevada, D.C. South Cal markets or are there other specific factors that we should consider in getting back to those levels?

Yes. So I think you can think about the recovery in a couple of different ways. I think you can think about it, I'll describe it as sort of functionally. Obviously, during the pandemic, acute care demand was disrupted, obviously, at the very beginning of the pandemic it disrupted materially, dramatic declines in particularly more discretionary, more elective procedures. And as you know, there's an ongoing debate. Clearly, we have recovered some of those procedures. But I think there is a difference of opinion about how much is sort of left to go. Acute care volumes have certainly been stronger than historical norm, as I'm going to say, for the last 18 months or so. But we saw some moderation in our acute care volumes in the second quarter, although the point that we made on our call was that it was compared to some pretty strong volumes in the same period last year. So, yes, I mean, I think the expectation is that acute care volumes will remain strong and solid. How much? And are they going to be greater than historical norms? I think that's matter that's sort of being debated. And honestly, I would say, I'm not sure anybody really knows for sure. But the other issue that I think really disrupted the business during the pandemic was a really sort of disjointed, disconnected labor supply demand dynamic. And the cost of labor in the acute business went up dramatically. We were using significant amounts of premium pay that is temporary in traveling nurses and over time for our own nurses and we were paying premiums and sign-on bonuses and loan forgiveness and all these things to attract nurses, et cetera. And that was really all caused by the demands put on the labor force by the pandemic itself. And as the pandemic has eased, I think we have seen, I'm not saying it's an easy labor market anymore or now, but it is certainly kind of a more normative. To me, it looks much more like it did 2019 pre-pandemic. And so we clearly -- I think I alluded to this before, we saw our cost structure moderate. We've also, I think, become more aggressive, maybe more focused. I think during the pandemic, I don't want to say that our operators ignored some of the normal efficiencies. But we were so concerned with keeping our labor in force intact and not discouraging people. I do think we kind of eased up on the gas in terms of sort of driving productivity, et cetera. And again, I think what you've seen in the first half of this year is a return to some of those norms. So I think it's really that kind of return to normative demand and a return to, I'm going to say, a more normative expense structure that's really driving the margin improvement. Also, as you alluded to, and I think everything I described -- I just described, I think all hospitals are experiencing certainly all the four private hospitals are experiencing. But I do think we're experiencing at a different pace, depending on geography. I know that our -- my peers have commented for the last year or 2 that they've seen quicker, faster, and more steeper recovery in places like Texas and Florida, states that did not shut down as much during the pandemic and as a consequence, I think, have seen a kind of a faster economic recovery. We have hospitals in Texas and Florida, we experienced that same dynamic. Proportionately, we have fewer hospitals in Texas and Florida than some of our peers. We have more hospitals and like you mentioned in places like Nevada, California, D.C., these are places that tended to shut down more during the pandemic, and I think have recovered more slowly. But I think part of our strength that you've seen, again, in the last at least 6 months, is those markets, particularly the Nevada, particularly the Las Vegas market, getting that traction and recovering now.

Great. So maybe sticking on that topic on the markets. So acute margins, just a couple of years ago, 10%, 600 bps shortfall versus 16% pre-COVID. You just printed basically over 14% this quarter. So at first clients would optically appear there is some significant headway being made in that market recovery. But in terms of like innings for those three markets, Nevada, South Cal, D.C., where would you say we are in that market recovery for each market?

Yes. I mean, you talked about -- you sort of framed the trajectory of the time frame to get back to pre-COVID margins in the 1-, 2-year range. I don't think that's unreasonable, but I think it's probably a little bit on the aggressive side. I was -- tell people, this is probably the single most frequent debate we have internally within the company. I think we all agree sort of what the path and what the trajectory is, the question of how reasonably, how quickly can you expect to get there. Again, I don't think this is a 5- or 6-year recovery, I would certainly be pleased that 1 to 2 years, if it took 3 years, I wouldn't be stunned. So -- but it's in that time frame. And so as you think about that, I don't know, I would sort of describe what we're in the middle innings. We've clearly recovered a good chunk of that. But obviously, we still think there's a decent amount of room to go.

Great. So maybe shifting to behavioral now. So you also mentioned last week that you hope to get to above pre-COVID levels. So thinking on time frame, I know we just went through a Q, but what's the thinking there, 1 to 2 years, 5 to 6 years? And are you envisioning a path back to 2015 type levels, in that sort of high 20s margins. I know the current primary behavioral headwinds, labor redetermination site issues, but if I'm not mistaken, if those headwinds subside that I believe that gets you back to pre-COVID, but to get the 2015 levels, what are the operational, I guess, building blocks to get you there? Could you help us sort of paint that picture?

Yes. I mean, again, I think that the opportunities on the behavioral side, not altogether different than what I described on the acute side again. There was a lot of demand interruption during the pandemic. But the demand interruption in behavioral was exacerbated by the labor supply disconnect. Interestingly, the labor supply disconnect during the pandemic, I think, affected the two businesses differently. In acute care, we tended to be able to fill all of our vacancies during the pandemic. It was an effort and it often required us to pay premium rates either to temporary traveling nurses or to raise our own salaries or to pay overtime whatever. But for the most part, we were able to staff all of our vacancies. And I'm sure there were exceptions, but generally did not have to turn business away during the pandemic. On the behavioral side, I think what we found quite frequently and pervasively throughout the portfolio is that, in many cases, we could not fill all of our vacancies almost regardless of the price we were willing to pay for labor. And as a result, our volumes were extremely muted during the pandemic. And while that's been improving and while we -- I think we've been able to hire more people and fill more of our vacancies, I think we still find that labor scarcity can be an issue in specific geographies, specific hospitals and that continues to mute our volumes. I think we believe that we're going to continue to make incremental progress there. As you noted, I think we've been negatively impacted by Medicaid redeterminations and with some 40-plus percent of our business on the behavioral side being Medicaid, that's had more of an impact on our behavioral business and our acute business, but we're finding those people who are either reenrolling in Medicaid. A lot of the people have been disenrolled either reenrolling in Medicaid, having sort of solve their administrative issues, et cetera? Or they're enrolling in commercial exchange products. It's just taking, I think, a little bit longer than we thought. So again, the pace of recovery on the behavioral side in some ways, has been faster because they probably benefited more proportionately from additional Medicaid supplemental payments. But in terms of sort of the core, it's been a little bit slower. So I'd sort of put it in that same time for 18 months, 24, 36 months. And again, I think what has driven a lot of the behavioral outperformance in the last 18 months has been strong pricing, which we think is reasonably sustainable. But where we think we're going to get the continued improvement is this slow recovery of volumes too, something approaching a more normative historical level, maybe 3%, 3.5% year-over-year patient day growth.

Got it. And then in terms of getting back to 2015 type levels, that's 18, 24, 36 is getting back to pre-COVID?

Yes. I think getting back to really '13, '14, or sort of peak behavioral margins in the high 20s. I would describe that as an aspirational goal. I don't think that it's impossible to think we can get there. But that's, in my mind, a second sort of more incremental, more significant phase that I think would, again, largely be driven by improved volumes.

Got it. So then if acute and behavioral health, you're returning back to pre-COVID margins over the next, let's call it, 3 years on average. The magnitude of margin improvement, the impact to EBITDA growth I guess looking forward to next year, I know it's way too early to comment officially. But in terms of the headwinds and tailwinds, it feels like it's skewing heavily to tailwinds, but maybe you could help us walk through the larger pieces, the building box to the EBITDA bridge?

Yes. And again, I think we've touched on a lot of it. Obviously, there are these two pending Medicaid supplemental programs that we have -- that we have disclosed. I think the historical trend of those Medicaid supplemental programs and people who follow us, I think closely know that we probably disclose more detail about these Medicaid supplemental programs than any of our peers. And if you go back for however long, you'd like to do this, 5 years, 7 years, et cetera, I think what you'll see is the trend is that these programs just continue to grow. They've continued to expand, that's no guarantee that, that will be the case in the future. But we know that there are states that are talking about expanding programs and new states that haven't adopt the program yet, et cetera. So my guess is that in the short and intermediate term, we'll still get an uplift there. And we'll get an uplift, I think, for the things that we sort of talked about originally, demand, I think we'll continue to if not exceed historical levels at a minimum run at historical levels higher than it did during the pandemic. And again, I think the cost structure has become much more reasonable than it was during the pandemic. And I think all those factors that contributed to the growth so far and will continue. I don't know that there's anything -- other than the supplemental programs, that's terribly kind of new and different. It's really just more of the same, I feel.

Got it. So then shifting back to acute. In the second quarter, you mentioned acute same-store revenue growth of 5% to 6% is expected to eventually split evenly price volume and that would exclude supplemental payments. And I know acute pricing has been -- seen a bit of a lag dynamic in recent years, primarily from an acuity lag perspective. But as mentioned, it's been supported by Medicaid supplemental payments. But going forward, just curious from your view on timing of when you believe that pricing can get back to 2% to 3% with that sort of 50-50 split on pricing, and how should we think about the eventual return of acuity mix?

Yes. So I think what I would describe as sort of the distortion in acuity is that, as I noted before, during the pandemic, there was a significant deferral and postponement of procedures. Almost by definition, the procedures that were most likely to be postponed and deferred tended to be those most discretionary, most elective, least acute. If somebody was having a heart attack or a stroke or in an accident or needed cancer surgery, they were having those things during the pandemic, but discretionary orthopedic procedures or colonoscopies, you can go down the list. Those are the things that we sort of found to be deferred. And those are the things that are being sort of caught up on, if you will. And so by nature, I think part of the strong acute care volume that we've all been experiencing is the exhaustion or the utilization of those deferred and postponed procedures, but they tend to be lower acuity. So volumes have been higher on the acute side, acuity has been lower. I think as volumes moderate, acuity will grow. And that's our expectation in the back half of the year. So I don't know that we'll be by the end of the year at sort of that split, 3 to 4 on both acute and volume. But I think we're going to continue to get closer to those numbers.

Got it. So you mentioned there's a lot of cost management in your acute care business that you're doing in second quarter, basically it's prepare for the eventual return to prepandemic volumes. And to be able to still grow EBITDA, expand margins even when things begin to moderate. So could you talk more about what these cost management efforts look like, how they give you confidence in your ability to expand margins in a period of potential volume moderation when hospital models, I think, more broadly are known to be pretty high operating leverage?

Yes. And to be clear, I think in the point that I tried to make before and on the second quarter call was I do think that there was -- and again, I'm still -- I struggle with the right characterization, but suspension, a postponement of some of the -- just historically blocking and tackling that we do to drive productivity, to try and match hours per staff to admissions or adjusted admissions or adjusted days. I don't want to say that was ignored during the pandemic, but it was not, and I was going to say is rigorously pursued as we have historically done, just because there was this sort of overarching notion that you didn't really want to lose any labor that you really didn't absolutely have to. So there's that element of it. What I also said on the second quarter call, which I think is what you articulated is I think that it's good that we're doing that because that way, as acute care volumes moderate, if they continue to moderate as we suspect they might, we'll be better prepared for that and be able to better match expenses and continue to grow EBITDA and drive EBITDA. So it's that idea. It's really nothing terribly new. Again, I'll point to another thing. I mean length of stay exploded during the pandemic, mainly because the COVID patients that really dominated the scene at the beginning of the pandemic were tended to be old and sick and very acutely ill, and tended to have long length of stay. But that was also complicated by the fact that as we try to discharge patients, the availability of our normal sort of discharge or referral sites was limited. So nursing homes and rehab facilities and skilled nursing facilities were unable to take a lot of the patients that we would normally have discharge because they were struggling with labor issues. And again, that's still an issue. But I think if you look at our metrics, we've driven to a much lower length of stay. I think we still have room to go there. And the reason that length of stay is so important in terms of driving productivity is, for the most part, the vast majority of our payers pay us on a per admission per discharge basis. So the sooner we can get patients well and appropriately discharged the more efficient we're going to be. Because we're going to get paid the same amount of money, whether that patient is in the hospital for 6 days or 7 days or 8 days. And so to the degree that we can properly manage that, that's an efficiency driver. So again, I think there are issues. I think that there are technology enablers to help us better manage these issues, et cetera, but I believe we'll be coming more and more productive on a number of these scores.

Great. Shifting to behavioral. I'd love to talk about the pricing strength and the volumes. So pricing strength, you guys are coming off of a quarter where you arguably saw the strongest behavioral pricing in history. I mean, off of a strong 7% prior year comp. Wondering if you can drill deeper into the source of it, even excluding supplemental payments, still over 7% growth. So incredibly strong. So yes, I was wondering if you could discuss that and your view on the sustainability of that trend going forward?

Yes. I think it's driven by a couple of things. We've talked for some time now about the sort of dynamic that in a capacity-constrained industry, where a lot of the providers have been unable to treat all the patients that are essentially out there demanding treatment, yes, I alluded to it earlier that during the pandemic, we would often have to turn patients away because we simply didn't have the staff to accommodate them and to treat them properly. But in that sort of environment, where payers are kind of left with -- left scrambling to find a place to have all their patients treated. I think our leverage over payers and from our perspective, particularly payers who were paying under market rates in a particular market, et cetera, was increased. And so what I saw and most people here know, I've been doing this for a long time, and in my almost 40 years in the business, I think we were we've given more termination notices and actual terminations of managed care contracts in the behavioral space in the last 1.5 years or 2 years than probably in the previous 10 or 12 years that I can remember. And it's really, I think, because of this sort of in my mind, kind of shifting leverage, going to payers and saying, look, if we're going to turn patients away, you're going to have to pay us a fair rate. Otherwise, we'll cancel a contract with you and accept patients for somebody who is willing to pay us a market or fair rate. So that's been, I think, a big help and has driven a lot of the improvement. And then I think secondly, apart from the Medicaid supplemental payments themselves, what the Medicaid supplemental payments do is they sort of change the landscape of how we think about payers. So if we're getting a big Medicaid supplemental payment in a state where we weren't getting it before, it's likely that reimbursement for Medicaid patients has become more attractive. And we are -- somebody on our second quarter call, use the term, can you lean into that business? And I like the term so I've repeated it. But yes, so we're leaning into that business in certain states where it's become more of a generous reimbursement or a fair reimbursement and seeking out those patients where before we have not necessarily, and that's, I think, result in a reasonably significant improvement in our payer mix.

Great. Thank you. So in terms of volume, I'm going to ask you a very long question. Okay, 3% patient day growth target by end of the year, would love to drill into the different scenarios that need to transpire and materialize to get there? And conversely, what would be a scenario where UHS falls short? I know redeterminations is taking longer, but the thinking is it's going to subside and become a tailwind in the back half of this year, your -- those handful of sites that were restricted, I believe they're also improving. And then maybe more importantly, on labor. I know -- behavioral turnover is twice that of acute you faced those labor issues over the past couple of years. You mentioned recently that you're figuring out sort of these new non-compensation-related incentives to attract new hires. So curious if you could sort of expand on that? What does that look like? How do you pitch hires on new career opportunity? And are these recent changes really materially different than in terms of strategic execution versus what you've done historically? If you could expand on that?

Yes. So again, as you have many of your questions, I think you've described it very accurately. Turnover is challenging in behavioral. And I would make the point that I think turnover is challenging in the subacute industry broadly, whether that -- it does include behavioral. It does include nursing homes and skilled nursing and home health, et cetera. And the challenge there has always been that nurses working in those subacute settings have always been able to make a higher salary in an acute care setting. I've seen different sort of estimates of what that gap is, I think historically, it's been in the 15%, 20% range, that a nurse can make more 15% to 20% more in acute care setting. What really happened during the pandemic was that gap sort of exploded and nurses could make at least for short periods of time, not 15% or 20% more, but 200% to 300% more. And many of them took that opportunity, and frankly, it was hard to criticize for doing so. We're getting back to something that's a bit more normative, but one of the challenges is some nurses have now grown accustomed to working in an acute care setting. In some places, that gap now is wider than it's been historically. And so that's challenging. And we're trying to solve that problem, and I think we're trying to solve that problem in hopefully, some new and creative ways. I mean one of the things we find is that turnover of our nurses, in particular, is highest in their first year of employment. And so we are really focused on making that first year of experience as satisfying as it can be, meaning, I want to make sure that the nurse feels that he or she is appropriately and fully trained before they're out on the floor and that they're getting appropriate support from their senior managers and that every nurse who we hire has a mentor and somebody that they can fall back on, et cetera. And these are really important things that are not necessarily just compensation-related. We also -- we're competing, in some cases, the hiring challenges, not nurses, but it's people that used to -- back in the day we called orderlies, we now call them mental health technicians. These are nondegree people. They're critical to the functioning, however, a behavioral hospital, making sure patients are where they're supposed to be and not where they're not supposed to be. But the problem there is these people are making $20, $25 an hour, we're competing with McDonald's and Walmart and UPS and Target for those folks. And again, one of the things we're really trying to do, and it's really kind of a dual strategy is have them feel like they're really making a difference in a behavioral facility versus delivering packages, not criticizing any particular job. But -- and really give them that opportunity to say, but I can further my career, I can train and will help you and pay for you to become an LPN or an RN and create a career path that they might not have in one of these other jobs. So there's a huge focus on, I would say, a variety of things on sort of increasing the pipeline, not just hiring nurses directly, but creating a pipeline of new nurses, increasing nurse satisfaction, et cetera, as well as -- and I don't mean to imply that we're not focused on making sure that we're -- our salary structure is competitive in every market because that's sort of the starting point. If you're not competitive, you're not going to be able to hire anybody.

Great. Thank you. I've like 30 more questions. But maybe the last one. Okay. Biden just finalized another mental health parity rule. Any comments, thoughts on that?

Yes. Look, mental health parity, I think, has been a great development for the industry. It basically says that payers and insurance company can't treat behavioral patients differently than they treat acute patients, but it's been a struggle from the beginning to get insurance companies to comply and it's sort of been in our deal. I think it's an incremental step. The Biden administration sort of trying to strengthen those rules, and I think it will help us. I don't know that it's a seismic change, but it's a tool that I think we'll use as we continue to battle it out with the insurance company.

Great. Thank you so much, Steve.

Thank you. Appreciate it.