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

Good afternoon, and welcome back to the Barclays Global Healthcare Conference. My name is Andrew Mok, I am the facilities and managed care analyst here at Barclays, and I'm pleased to be joined on stage with Steve Filton, CFO of Universal Health System Services. Steve, welcome to the conference.

Thanks, Andrew.

Maybe let's start on the regulatory front. There's obviously been a lot of attention on Medicaid reform and provider taxes from Congress and investors lately. It'd be helpful to get your perspective on the direction to the discussion is taking and how you're thinking about the risk, not only to UHS, but also the broader hospital industry.

Yes. I mean, I think it's worth noting that when the Republicans passed their bill in the House, which is really only a couple of weeks ago, there were a number of Republican congressmen and women who commented that even though the bill contained a significant amount of Medicaid cuts and I think worth noting that they were very sort of generic nonspecific Medicaid cuts, but a number of congressmen and women, including some conservative sort of those described as MAGA members suggested that they only voted for the bill because they were promised by their leadership that there really wouldn't be significant Medicaid cuts. . And we do know that beyond that, obviously, any bill that gets passed or has to be reconciled with the Senate and the Senate is probably even less enthusiastic or seems to have expressed less enthusiasm from big Medicaid cuts. So that seems to be the context that everybody is operating in, meaning the Republicans are certainly aggressively looking for ways to fund the tax cuts extensions, which they very much want to pass. But at the same time, are trying to do so in a way that I think is not terribly disruptive to the health care system, et cetera. And I think there's a recognition, at least among I think members of Congress and the Senate who really do understand the system that significant Medicaid cuts would be, I think, quite disruptive. And so as you know, there are a bunch of sort of, I'll call them menu items on the table about how DPP programs could be ring-fenced, their growth could be slowed. Some of the bigger sort of Medicaid cut alternatives like FMAP and rate caps seem to have been taken off the table, they sort of sometimes kind of get back on it. So we'll see. I mean I think the expectation on our part, and I always say we don't profess to have any greater insight or understanding or predictability than I think anybody else does. But the expectation, I think, that we have is that any COGS and whatever form they're in are likely to be sort of more incremental than dramatic, more incremental than draconian, likely to be over an extended period of time. And that certainly allows us more time to react and manage through, et cetera. The hope is, obviously, there's more clarity. I don't know if that's in the coming weeks or months, but sometimes, there's more clarity. And in the meantime, as we, I think, articulated in our earnings call just recently, that I think fundamentally, we feel good about our 2 businesses. I think we feel probably they're more predictable, they're more steady and solid than they've been in a number of years, probably since the pre-pandemic. So I think for the most part, we -- the message that we convey to our own folks and operators is we can only control the things that we can control, and we should do that and keep our heads down and operate the business as efficiently and appropriately as we can.

Speaking of things that you can control, like should we see Medicaid cuts, what sort of levers are you contemplating that you have at your disposal to potentially offset the impact?

What I've said to people is, I think the most recent playbook, and it's certainly not perfectly analogous, but at the beginning of the pandemic back in March, April of 2020, we implemented a whole series of initiatives to respond to at the time, what was a dramatic decline in volumes and demand. And we had some pretty significant layoffs and we cut our overhead costs and we froze wage increases and 401(k) matches and paused our dividend and reduced our CapEx plans. And all those things, I think, are on the table. Now it's a little bit different with Medicaid cuts because in theory, the demand doesn't change, but just the reimbursement changes. But I think it's an example at that time, I think here, we would have a lot more time to react. It will be a little bit more deliberate. At that point, we were literally making these changes in real time and on the run. But yes, I mean, I think we've always shown that we can be flexible, we can be nimble and prepared to do so once we kind of know what the playing field really looks like.

Great. Tariffs are another issue currently being contemplated by the administration. How do you think about that risk for your business? Do you have enough visibility into where your supplies are sourced to measure the potential risk there?

So the challenge in trying to evaluate the impact of tariffs is, I think, several fold. I mean one is, as you know, tariffs and who's being tariffed and charge changes daily or maybe a little less frequently, but it's pretty fluid. And so that's a challenge. Secondly, as you suggest, it's difficult for us to know a lot of times when we're buying supplies, which I think is the main thing we're talking about, where they're necessarily manufactured and they may not be manufactured from the place that's delivering them or the components may be manufactured elsewhere. So that's a challenge. I think the protection we have when we think about tariffs and its impact on our supplies is that something close to 3/4, maybe 70% of our supply purchases are made under multiyear contracts, either through our group purchasing organization or through contracts that we've negotiated separately with manufacturers on our own. And most of those contracts really don't -- they provide price protection against cost increases of any kind. Some do not, but I think most do. So I think the notion is that if the tariffs begin to have a significant impact, it's unlikely to flow through to our business in a material way, at least this year and maybe into next year, we would continue to be protected under some of those contracts. So don't view that perhaps as an immediate risk as maybe some of the other stuff that we're talking about.

Got it. That's helpful. And maybe lastly, on the regulatory front, Site-neutral reform, there's a handful of proposals out there that range in scope and impact. What are the key items that you're monitoring in terms of potential proposals and what the unintended consequences of some of the more serious proposals might be?

So historically, I think the biggest potential impact to us from Site-neutrality reform would be in our freestanding emergency departments. We have about 30 of those currently and another 10 under development. And those operate for the most part, as they're described, freestanding emergency departments, they operate as if they are an emergency department out of the hospital -- or excuse me, they operated as freestanding and if they were reimbursed at an emergency department of the hospital, they would be reimbursed somewhat differently. Now in most of the Site-neutrality bills that have been bandied about over the last several years, FEDs or freestanding EDs have been excluded. And so the hope or the expectation perhaps is that they would be excluded in any sort of current bill, but that would be the biggest exposure to us. Again, I think at the end of the day, even if they were to be included, I don't know that the impact on our earnings, we wouldn't describe as material.

Great. Let's move on to the more fundamental operations of the business. The 2025 guidance was stronger than expectations despite excluding some of the new Medicaid programs in Tennessee and D.C. The segment level component seem to point to 6% to 7% EBITDA, but the guide has optionality into the low double digits. Can you help us understand why you decided to extend the range of the high end of what needs to happen to achieve that?

So as I was alluding to before, I mean, I think that the forecast and the underlying metrics in the forecast and in the guide, in 2025, return us to mostly sort of historically normative levels and assumptions. So what we talked about was mid-single-digit revenue growth for our acute care business in the 5%, 6%, 7% range, if you pick the midpoint, say 6%, split pretty evenly between price and volume adjusted admission growth. That's pretty consistent with what the business has run historically. The behavioral side may be a little bit more aggressive, maybe 7% at the midpoint, split between volume growth of patient day growth 2.5%, 3% price, 3.5%, 4%, something like that. And again, those metrics in both divisions, I think, are pretty historically reasonable. I think we've talked about the fact that, I think particularly on the behavioral pricing side, I think that's particularly conservative given where we've been running in the last several years. The reason I think we tried to give maybe perhaps a broader range of ultimate earnings and EBITDA earnings was the things that we talked about earlier that if there are some incremental changes to the forecast as a result of reimbursement changes, expense changes as a result of things like tariffs, et cetera, that we would hope that the impact, particularly in 2025, would be incremental and small enough that we could sort of absorb it in that range of guidance that we've given. Obviously, if there are really more dramatic cuts and they really are more impactful and more quickly impactful, then we might be expecting at this time, we have to reforecast. But the notion was to give us a little bit of room, a little bit of cushion so that some of these unknowns depending on how they played out, we could absorb in our existing guidance.

Great. Let's talk a little bit more about the behavioral volumes. You're targeting 2.5% to 3% patient day growth, I think, in 2025. That sounds like an achievable target. But when I look back over the years, that level of growth has been somewhat elusive. Why has that been the case for an industry that seems to indicate structural supply-demand imbalances.

So I think there's a few reasons. I mean probably the single biggest reason, especially during the pandemic and sort of to your point, it's been an elusive target, I would say, over the last several years, but for many years before the pandemic, 2.5% to 3% growth in patient day growth and behavioral would have been considered relatively modest based on our historical experience. And I think the reason it slowed -- there were a number of reasons it slowed during the pandemic. Probably the single and foremost reason was a labor supply and demand disconnect, meaning we struggle to hire all the employees and staff that we needed to treat the patients who are being presented to us. That's mostly -- I think the shortage was mostly in the nursing component of our workforce, but it included things like therapists, and it included quite frankly, some nonclinical or nonprofessional folks like mental health technicians, et cetera. And the main driver of that the main reason that we struggled along with other subacute providers during the pandemic is that we saw a great number of our own staff, nurses, but other clinicians as well leave the subacute environment, the behavioral environment to go work in acute care settings during the pandemic, where they were able to really make -- sort of had an opportunity to make extraordinary premiums over their regular salary. I think as the pandemic ended and well, obviously, COVID is still with us, but as the COVID surges have ended, it's become less of an issue. A lot of those folks have returned to our employee and to full-time employment in our hospitals. And it's not as much of a stretch. And if you get our patient day growth, while we didn't the 3% in 2024, it has grown -- it grew -- I think we were around 1.6% in Q1 of 2024, 1.9% in Q2, 2.2% as I recall, in Q3. And we were averaging 2.5% or so in October and November. And then things really fell off in the back half of December, which I think was largely a function of the calendar and how the holidays played out at the end of December. Bounced back, again, in early January to sort of that 2.5% number. And then we ran into some winter weather in January and February, back half of January and February. So again, I think that 2.5% is sort of -- we've been operating at that level already for a while now, absent the sort of exogenous weather pressures. I think that 2.5% to 3% is an eminently achievable target. To your second -- to your question also about sort of what's preventing us from getting to that number, which, again, sort of on the surface seems pretty modest in an environment where most people seem to characterize behavioral volumes as robust and fairly high demand. I think the other piece, and we talked about this a little bit on our earnings call is I think a lot of behavioral demand has shifted from -- or a chunk of it has shifted from the inpatient setting to the outpatient. And while I think we've always been very good at what we sort of call step-down outpatient care, which is patients being discharged from our facility who need further care, not no longer inpatient care, but outpatient care. We, I think, have really good control and relationships with those patients and have enjoyed the benefits of their outpatient care. But what we haven't done as well, and I think what the industry has probably done a little bit better than us, is what we call that sort of step in care. These are patients who are receiving freestanding outpatient care as their sort of entree into the behavioral system. And those folks tend not to want to have that care on the campus of a behavioral hospital. I think they worry about getting sucked up into that inpatient vortex, if you will. And so I think we're embarking on a much bigger presence in that freestanding outpatient care. And I think as we establish more of a presence as those demand patterns continue to increase. I think you'll see our adjusted patient day growth grow because I think what you've seen over the last several years is our actually patient days are growing faster than our adjusted patient days, meaning that our inpatient volumes are growing faster than outpatient. And I think honestly, from an industry perspective, there's more growth occurring on the outpatient side, and we just need to make sure that we participate in that to the fullest extent that we can. And I think we have the ability, the investment capacity, the know-how of the business, the referral sources, et cetera, to prosper in that segment.

Maybe on that point, what is the appetite to add there? And where are the expansion priorities? Is there any interest to expand into, say, the Methadone business?

Yes. So first of all, on the outpatient side, it's -- as you might imagine, it's a relatively low cost, low capital investment. I think you can build a perfectly appropriate freestanding outpatient facility for an average of $1 million or so. So it's not a big capital commitment. And so we certainly have resources to do that. . As far as the Methadone business goes or the sort of medically assisted treatment business goes, I think we have historically not really warm to that business in the sense that it didn't seem to fit in our broader continuum. The Methadone clinic business is really a dispensing business. It's not necessarily a treatment business. I'm not a clinician, so I don't have a strong feeling about this, but I think if you talk to people who are addictionologists, professional addictionologists, et cetera, they sort of sometimes critiqued that business as really substituting one addiction for another where you're not really treating the fundamental issues that the patient has. And that tends to be what we do, whether, again, that's inpatient, outpatient. We certainly have a significant addiction business or addiction treatment business, it just tends to be more of a traditional kind of 12-step program as opposed to one that relies on medically assisted treatment. I think we're willing and open, and I think we've started to develop more of a presence in that medically assisted treatment business. Although I think it tends to be more integrated for us into the broader continuum of care that we offer inpatient, outpatient, more traditional addiction treatment care. And we just think that, that sort of suits us better and sort of takes advantage of all the other resources that we have in our clinical arsenal.

Great. On the cost side of the business, you booked an elevated level of medical malpractice in 2024 and expect that to moderate, I think, in 2025. Can you elaborate on the trends we've seen in recent years? Why has that increased? And what gives you confidence that this will moderate?

So I think the feedback that we get from insurance brokers, our third-party actuaries that we use to really help us set our level of reserves and consequently, level of expense is that for some time now, the frequency and -- or incidence of malpractice cases is not necessarily increasing, but the value of each individual case seems to be climbing. And honestly, I don't know that, that's -- well, first of all, I think it's an industry-wide issue, meaning a hospital or health care industry-wide issue, but I think it even goes beyond that, that if you listen or you follow sort of things like product liability cases or other sort of tort cases, that -- those dynamics are true more broadly, even beyond the health care and hospital space. So what we did and we discussed this in our earnings call and our announcement is we twice a year, get these actuarial established ranges of what our malpractice reserves and expense should be. And historically, we've sort of always targeted the midpoint of those reserves. Given some of the more recent developments, some of the pressure on malpractice expense in the last few years, it seemed prudent to us to take a more conservative position. And in 2024, we moved ourselves kind of along that continuum of the actuarial range to sort of more of the high end of the guidance. And the notion we hope, as I think you kind of articulated in your question is that by doing so, we'll be able now to return to kind of a more normal kind of inflationary increase for malpractice expense every year. And if there's further pressure points, et cetera, in the industry, we should be able to absorb that now that we're at the higher end of the range.

All right. Let's move on to the acute care hospitals. This year's flu season looks like the most severe we've seen since 2017, 2018, when we saw a lot of callouts from both payers and providers. It's always a bit more nuanced for hospitals because any volume benefit may crowd out higher acuity procedures. What's been your experience with the flu so far? And has it had a meaningful impact on other procedures?

So I think you've described it pretty fairly. I mean -- and I think if you go back, those of you who followed UHS for some time, our commentary about the flu has always been fairly consistent in that. I think we always say it's unlikely to have a material impact on our earnings, busy flu season, not busy flu season doesn't really matter. I think there's a variety of reasons for that. You touched on a few. One is that flu patients tend to be relatively low acuity, relatively low profitability. They don't get a lot of procedures done, et cetera. They're basically in the hospital. They receive perhaps some medication, et cetera, but they're not generating significant either revenues or profits. You also pointed out that the challenge sometimes is that a really busy flu season will crowd out other business. Our emergency room sort of get overwhelmed and overrun and we don't get other patients who might otherwise come to the emergency room. But the other piece of this, I think people tend to overlook is kind of what you talked about, which is in a season where sort of everybody is getting sick or everybody is getting the flu, it really means everybody is getting the flu and that means some of our patients get -- and some of them are getting admitted to the hospital. But some of our patients who have elective procedure scheduled to get the flu and cancel some of our physicians who are surgeons, et cetera, get the flu and cancel for several days and some of our nurses get canceled, and we have to sort of restrict our surgery schedules and things like that. So there's that element of it. The other piece I would just mention, you point out that the macro data suggests that it's the busiest flu season in quite a number of years. And I think we would acknowledge that we've seen an elevated flu season, particularly in the first quarter of this year. But I will tell you that in my experience, we've seen busier flu seasons. I can remember flu seasons not all that long ago where we were so overwhelmed in our emergency rooms that we would erect tents in the parking lot to the hospitals where we were trying to sort of siphon off that flu business so we could sort of isolate it and continue kind of a more normal course of treatment in the emergency room. And we haven't done any of that this year. So my gut is we'll see, and we'll certainly share whatever information we can on sort of what the elevated flu levels were and our best guess of what the impact is going to be in the -- it will be in the first quarter. But at the end of the day, I just don't see it as either material, number one, to -- certainly to our full year results, but even to our first quarter results.

Great. Understood. Despite the strong guidance for this year, acute hospital margins still look to be trailing pre-pandemic levels by a few hundred basis points. It looks like the most significant labor gains are behind us. So what are the primary drivers of margin expansion from here? And what do you think is a realistic target over the next 3 years or so?

So I think what we've said again pretty consistently is that we have an expectation that on a consolidated basis, we should be able to get back to pre-pandemic margins in the next couple of years. I think if you look at our behavioral business, I think we're largely there. In some cases, I think you could argue we're already above pre-pandemic margins. Some of that has been with the help of these DPP payments. So we'll see how that plays out. But I think it's been a little bit more challenging on the acute side. I think the acute business has had some structural headwinds that have been difficult to overcome to get to those pre-pandemic margins. Probably the two most significant in my mind are the increase in professional fees or professional expenses, particularly among the anesthesiology and emergency room physicians that we engage with. It's been widely reported on an industry-wide basis that the expense of providing those services really accelerated by 150 basis points or so in late '22 into '23, et cetera. And it's going to be very difficult to recoup that in any sort of permanent way. And the other issue that I think you see on the acute side that you don't see as much on the behavioral side, is this continued migration or transition of inpatient services to outpatient settings, the continued growth in ambulatory surgery centers and freestanding imaging centers, et cetera. And that continues to put some pressure on acute care margins that I think is difficult to recover. So again, I think our consolidated margin is likely to get back to pre-pandemic margins. And I think what that means is we're likely to get sort of above pre-pandemic margins on the behavioral side and maybe fall a little bit short on the acute side.

Do the new hospitals that you've opened up, does that help from a payer mix and margin perspective? Like are you able to invest or start those hospitals with the right acuity and service lines such that those margins might reflect higher acute care hospital margins overall?

Yes. So I mean, just to be very specific, the two hospitals that we're opening. One is open already in Las Vegas. We've always had a history of relatively rapid ramp-ups of new hospitals in Las Vegas. We're the largest by far market share provider in Las Vegas. This just continues to fill out our network providers, both hospitals, physicians, et cetera. So we're expecting a pretty rapid ramp-up of that Vegas hospital. And it just sort of again, strengthens what's already a very strong franchise for us. The other new hospital that will open in a month or so is in Washington, D.C., where we have one existing hospital. And again, it does -- I think it strengthens the market. It strengthens our position with payers. It allows us to consolidate some overhead expenses. And in this case as well, the district is -- or a hospital in the district is closing essentially coincident with our opening. So it's not like we're ramping up from 0. We expect cohort of patients to literally when we open on day 1 as this other hospital closes.

Great. Well, with that, we're out of time. Steve, thank you so much for joining us here today, and please enjoy the rest of the conference.

Thanks for having me.