Universal Health Services, Inc. (UHS) Q3 2012 Earnings Report, Transcript and Summary

Good morning. My name is Felicia, and I'll be your conference operator today. At this time, I would like to welcome everyone to the UHS Third Quarter Earnings Conference Call. [Operator Instructions] At this time, I will now turn the conference over to Mr. Steve Filton, Chief Financial Officer. Mr. Filton, you may begin your conference.

Thank you, and good morning. Alan Miller, our CEO, is also joining us this morning. Welcome to this review of Universal Health Services results for the third quarter ended September 30, 2012. During this call, Alan and I will be using words such as believes, expects, anticipates, estimates and similar words that represent forecasts, projections and forward-looking statements. For anyone not familiar with the risks and uncertainties inherent in these forward-looking statements, I recommend a careful reading of the section on Risk Factors and Forward-Looking Statements and Risk Factors in our Form 10-K for the year ended December 31, 2011, and our form 10-Q for the quarter ended June 30, 2012. We would like to highlight just a couple of developments and business trends before opening the call up to questions. As discussed in our press release last night, the company reported net income attributable to UHS per diluted share of $0.73 for the quarter. After adjusting for the after-tax cost of debt extinguishment recorded during the quarter and the incentive income and expenses associated with the implementation of electronic health records applications at our acute care hospitals, our adjusted net income attributable to UHS per diluted share for the quarter ended September 30, 2012, was $0.91 compared to $0.86 per diluted share recorded in the third quarter of 2011, as calculated on the supplemental schedules included with last night's press release. On a same-facility basis, revenues in our behavioral health division increased 3.4% during the third quarter of 2012 over the comparable prior year quarter. Adjusted admissions and patient days to our behavioral health facilities owned for more than a year increased 2.6% and 0.7%, respectively, during the third quarter. Revenue per adjusted patient day rose 2.6% during the third quarter of 2012 over the comparable prior year quarter. Operating margins for our behavioral health hospitals owned for more than a year increased to 27.8% during the quarter ended September 30, 2012, as compared to 26.5% during the comparable prior year period. On a same-facility basis, in our acute care division, revenues decreased 0.4% during the third quarter of 2012. The decrease resulted primarily from a 1.7% decrease in adjusted admissions, partially offset by a 1.3% increase in revenue per adjusted admission to our hospitals owned for more than a year. The rate of organic growth -- the rate of organic revenue growth was weaker than expected, contributing to a decline in operating margins. On a same-facility basis, operating margins for our acute care hospitals decreased to 13.4% during the third quarter of 2012, from 14.8% during the third quarter of 2011. Our acute care hospitals provided charity care and uninsured discounts based on charges at established rates amounting to $259 million and $246 million during the 3-month periods ended September 30, 2012 and 2011, respectively. As a percentage of acute care net revenues, bad debts, charity care expense and the uninsured discount in this year's third quarter were at levels higher than those experienced during the third quarter of 2011. However, due primarily to the increase in behavioral health revenues and the very low levels of bad debt and uninsured discounts in that business, our overall percentage of bad debts, charity care and uninsured discounts were lower than those experienced during the third quarter of 2011. Our cash provided by operating activities was approximately $162 million during the third quarter of 2012, as compared to $207 million in the third quarter of 2011. Our accounts receivable days outstanding increased to 57 days during the third quarter of 2012, from 51 days during the third quarter of last year, as we continue to have a substantial outstanding Medicaid receivable from the State of Illinois. At September 30, 2012, our ratio of debt-to-total capitalization was 56.9% and debt-to-EBITDA was 2.96x. We spent $100 million on capital expenditures during the third quarter. Included in our capital expenditures during the first 9 months of 2012 were the construction costs related to the ongoing construction of a new hospital in Temecula, California. We opened a new bed tower at our Wellington Hospital in West Palm Beach early in October and expect to open a new behavioral facility in Chicago later in the quarter. The operating trends and financial results experienced by our behavioral health facilities met our expectations during the first 9 months of 2012. However, against the backdrop of a continued sluggish economic recovery, the operating trends and financial results experienced by our acute hospitals were below our expectations for the third quarter of 2012, and those trends are expected to continue during the fourth quarter of this year. Based upon our consolidated financial results experienced during the first 9 months of 2012 and, most notably, the results experienced by our acute care hospitals during the third quarter of 2012, our revised estimated range of adjusted net income attributable to UHS for the year ended December 31, 2012, is $4 to $4.10 per diluted share. This revised guidance, which includes the EHR impact and the impact of the other items, reflected on the supplemental schedule for the 9 months ended September 30, 2012, represents a decrease of approximately 6% from the previously provided range of $4.25 to $4.35 per diluted share. The operating pressures that we continue to experience in many of our acute care markets has increased the volatility of the financial results of our acute care hospitals, making estimation of future results more challenging. However, we continue to actively and aggressively respond to these challenges through strategic initiatives and operational enhancements, such as physician recruitment and integration, and implementation of expense controls and other operating efficiencies. Alan and I will be pleased to answer your questions at this time.

[Operator Instructions] And your first question comes from the line of Tom Gallucci of Lazard Capital Markets.

This is Colleen Lang on for Tom. Steve, just on the guidance, I was just wondering if you could walk us through what changed in Q3 versus what you were thinking at the time of Q2. Were the admissions worse? Or did the mix not improved as you would have hoped?

Sure, Colleen. So I think in our original guidance for the full year, we were anticipating acute care revenue growth of 3% for the full year. And that was broken down into a slightly lower amount, let's say 2% in the first half of the year and a slightly higher amount of like 4% in the back half of the year, which was reflective of the fact that we were aware that our comparisons were going to be more difficult in the first half of the year. At the end of the second quarter, when we revised our guidance down slightly, it was really an acknowledgment on our part that acute care revenue growth would likely not even meet that 4% level in the back half of the year. So we revised it down to about 2% growth. And as you can see in Q3, we didn't meet the 2%. We -- our acute care same-store revenue growth was actually slightly negative. And really, the revised guidance for the fourth quarter is really just reflective of that trend and the expectation that, that trend is likely to continue into Q4.

Okay, great. And then just quickly on the behavioral side. I think last quarter, you talked about how you took some beds offline for construction projects in converting some beds from RTC to acute. Did you see that impact again this quarter?

We did. I mean, the 3.4% same-store revenue growth that we saw in acute in Q3, I would remind people different than the acute dynamic, is compared to a pretty robust number in Q3 of 2011, close to 7% same-store revenue growth. So the 3.4% was against a difficult comparison. But it did -- it does reflect sort of the metric that we talked about last quarter, which is that probably, the single greatest pressure we feel on the behavioral side is continued pressure on our Medicaid length of stay in the residential business. That has been driving our same-store revenue growth down. And we are, as we discussed last quarter, doing any number of things to try and counter that, including adding more acute care beds. Obviously, the Ascend transaction will add a significant number of acute care beds, converting residential beds to acute. And all those initiatives continue. And so, yes, I think that had a little bit of a dampening impact on our revenue growth in the quarter. And we think that as the initiatives gain traction, that number will start to climb back to a level that we saw just a few quarters ago.

Your next question comes from the line of Kevin Fischbeck of Bank of America.

I was wondering about this guidance reduction in 2012 and how to think about it for 2013. I know that you're not providing 2013 guidance at this point. But if you took down EPS guidance by 6% in the second half of the year, is there a reason not to kind of say, "Well, let's annualize that and take down the number by 12% for the year" and use that as our basis for how we think about growing into 2013? I guess you mentioned cost cutting initiatives that should help offset this next year. But why isn't taking this impact, annualizing it and then growing off of that, the right way to think about 2013?

Well, Kevin, I want to reinforce what you said, which is that we're not giving 2013 guidance and we're not prepared to do that. But I'll talk a little bit. I mean, I think some of the dynamics that have weighed heavily on acute care revenue growth in 2012 are the economic weakness in our local markets. And when we do give our 2013 guidance at the end February, we'll talk, I think, more about what our outlook is for those metrics in 2013. But, obviously, there is a hope that we will start to see some recovery in some of those markets, albeit we tend to believe it'll be a relatively gradual incremental recovery. The other issue is a number of other companies have talked about, I think, that there has been this continued shift from inpatient to outpatient, which has muted revenues, some in the acute space. Some of that, I think, is a real shift, where the delivery of services has truly changed from one setting to another. And then some of it is this reimbursement dynamic of just more days being billed and reimbursed as observation days rather than as inpatient. And I think, at some point, we will begin to anniversary that impact. I think some of the companies may have already started to see that sort of anniversary-ing impact. So those would be, at least, in my mind, Kevin, the 2 reasons why I would think that you wouldn't necessarily just want to take the third and projected fourth quarter performance and assume that that's to be extrapolated to 2013.

Okay, that's helpful. And I guess, as we think about the -- I guess, the economic weakness that you mentioned, could you just talk a little bit about, on the acute care business, some of the major markets and where most of that weakness was or was it more broad-based. And then if it's broad-based, just give an update on Vegas?

Yes, I think the weakness was generally broad-based. I mean, Vegas was down in the third quarter compared to last year but so were, quite frankly, a number of other markets, including South Texas, which we certainly have talked about before, as well as a handful of others. So I don't think the weakness is isolated to a particular market. As far as Vegas goes and, quite frankly, as far as a number of other markets go, the overarching metrics, as we've mentioned before, seem to be getting better. Unemployment is improving in a number of these markets, et cetera. I would think it's fair to say that in most of these markets, that sort of macro growth or macro recovery isn't yet filtering down to the hospital business. But we expect that in the near and intermediate future that it should.

Okay, great. And then just one last quick question. The behavioral facility in Chicago; is that a new facility or is that a replacement facility?

It's effectively a new facility. So we had a facility called Hartgrove that we closed a few years ago and built a replacement facility. We have now, subsequently, renovated the Hartgrove physical plant and are reopening it. But it's effectively a net new facility for us in the Chicago market.

Your next question comes from the line of Kevin Campbell of Avondale Partners.

I just wanted to start with maybe some color you could give us on the EHR incentive income and maybe what you expect to receive there in the fourth quarter? And I know you break it out in your guidance or exclude it. But just in general, maybe what we should expect from that line in the fourth quarter and beyond, if possible.

Yes, I mean, I will sort of just recap. I think what we've said about our EHR experience in total, and that is we've projected to spend something in the neighborhood of $190 million to $200 million dollars to implement this EHR over the course of 4 or 5 years, beginning in -- at the very end of 2009 and into 2010. We expect to get Medicaid and Medicare reimbursement related to those expenditures in the $140 million to $150 million range. And, therefore, our net expenditure will be $50 million to $60 million, Kevin. We will -- as we have in the press release and as we will in our 2013 guidance, we'll give our best guesses as to what we think those numbers, both from an income and expense line, will be in 2013. I don't think we're prepared to do that today.

Okay. And as we think about that, in general, the cost that you associate there and you break out in the adjusted net income, are those theoretically onetime costs as well? Or are those ongoing costs associated with that, that once those incentive payments go away, you'll still have those higher costs?

No. The reason that we choose to exclude them, because we think that it gives a better picture of what ongoing operating results are, is because we believe that both the income and the expenses are onetime. I will just remind people that we had an EHR system before implementing the current one and we had operating costs associated with that. We believe that the operating costs associated with the new implementation are fairly comparable. And so we have a universe of operating EHR costs that have been embedded in our results for years and will continue to be in our operating results and will not be excluded.

Okay. And just a couple of sort of housekeeping items. The D&A went up sequentially. It looks like a lot of that was related to the EHR costs. What sort of -- should we assume that sort of -- that same sort of run rate that you had in the quarter, what was it, $77 million, $78 million?

Yes, I mean, as we continue to bring facilities live on this current version of EHR, obviously, the D&A expense will go up. I haven't really thought this through all the way, but we may consider trying to break that out when we give our 2013 guidance. Obviously, we break it out in total, but we may want to beak it out by functional line item.

Yes. Okay. And then on the other operating expenses, that ticked up sequentially, but when you look back versus maybe the first quarter, it was not materially different. Can you -- was it just unusually low in the second quarter? It was around $347,000 versus $363,000 here in the third. And maybe what sort of a more normalized run rate we should use there?

Yes, I mean, as I think about it, Kevin, there's only a couple of sort of unusual items, I think, that are in the third quarter, none of which are terribly material. There's probably a couple of million dollars of Ascend transaction cost. There's probably $5 million of costs related to our small construction management business. And those costs are offset by a very like amount of revenues. I think other than those 2 items, I would say that other operating expenses in Q3 reflect a pretty reasonable run rate going forward.

Okay. And what were the Ascend costs in the quarter? I don't think you broke those out, did you, in the adjusted?

Yes, I mean, I don't have it in front of me. But it's only a couple of million dollars.

Your next question comes from the line of John Ransom of Raymond James. John W. Ransom - Raymond James & Associates, Inc., Research Division: I just wanted to drill down into the behavioral business a little bit more. The same-store revenue missed our model by about 160 bps. And I know you mentioned the length of stay issue in Medicaid. How is the adult side and the commercial side doing relative to your expectations?

John, I think that -- and I called out the Medicaid length of stay issue as really the 1 metric that has been sort of pressuring the business. I would say that, generally, trends on the acute side of the behavioral business are strong, both from an admission or a volume perspective, length of stay remains fairly constant because it is almost exclusively non-Medicaid pricing on the acute side. Pricing remains strong, et cetera. So the pressures really have been almost exclusively on the residential side of the acute business. And almost exclusively on the Medicaid part of that, which is the biggest piece of it. John W. Ransom - Raymond James & Associates, Inc., Research Division: And just 2 follow-ups on that. One is remind me how much, if we were to look at your overall plan over the next 2 or 3 years, what's your plan to expand your headcount on a percentage basis in your behavioral? And then, secondly, I guess it's not entirely clear if Medicaid's imposing shorter lengths of stay, what you can do to specifically counteract that. I'm not sure -- I'm not familiar with the tactics you might use to push against that.

Yes. So I think, obviously, we're always, and I think this has always been the case, I mean, we're always fighting for the appropriate length of stay and justifying medically necessary length of stay, et cetera. That's something we always do. But quite frankly, I mean, the main technique and tactic that we've talked about in the last few quarters is we're trying to lessen our reliance on the residential business. We've talked before about 1 of the significant attractions and compelling arguments for Ascend was that it's a business that is very highly weighted to acute beds rather than residential beds. We've been adding, in response to your question, John, something in the neighborhood of 300, 350 new beds a year in the behavioral segment. And those beds have been largely acute beds. And then, finally, we've talked in the last quarter or so about conversion of residential beds to acute beds. And we're probably on pace in 2012 to convert a couple of hundred residential beds to acute beds. And my guess would be we probably have a like amount in the Q for next year as well. John W. Ransom - Raymond James & Associates, Inc., Research Division: And what's your mix now between adult and RTC -- or I'm sorry, RTC, non-RTC [indiscernible]?

Yes, so before the Ascend transaction, our historical, I think, revenue mix was like 75% acute, 25% residential. John W. Ransom - Raymond James & Associates, Inc., Research Division: And you can move -- how much can you move that a year with your conversions and your bed adds?

Well, again, if you think about, basically, a base of roughly 20,000 beds, and if you're adding 300 to 350 acute and converting another couple of hundred, it's sort of 500 beds on a basis of 20,000 gives you some sense of what we're able to do. John W. Ransom - Raymond James & Associates, Inc., Research Division: So a couple of percent.

Exactly. John W. Ransom - Raymond James & Associates, Inc., Research Division: I know ourselves and others have tried to allocate your G&A, and we come up with an EBITDA mix, if you allocate you G&A, of something in the range of 67% to 70% of EBITDA now comes from behavioral and the remainder comes from acute. Would you agree with that math or would you allocate the overhead differently? Or is there something that we need to adjust in our thinking?

No, I think we've said publicly that post the Ascend transaction, our run rate will reflect an EBITDA contribution from the behavioral segment of about 70% of the total.

Your next question comes from the line of A.J. Rice of UBS.

A couple of questions, if I might. First of all, maybe I missed this, but is the Ascend results in your fourth quarter guidance?

No, A.J., I was just referring to the fact that we had some transaction costs related to Ascend -- oh, I'm sorry, in the third quarter. In the fourth quarter, yes, I'm sorry, the -- we do assume we will get a couple of pennies benefit from having Ascend in the fourth quarter.

Okay. When I look at the margin trend, and I know you commented on the other operating, obviously, the -- behavioral's moving in a positive direction and the acute's in a negative direction. I think you'd probably say that both of those are largely driven by top line performance. But could you comment on the individual expense items? And in the 2 divisions, what was under pressure on the acute side, and what was -- where was the positive leverage on the psych side?

Hey, look, A.J., I think you've got to the crux of the point or the crux of the matter. Because both of these businesses are largely fixed and semi-fixed cost businesses, they really require some amount of revenue growth to create operating leverage. Not a significant amount. And I think our performance -- our behavioral performance in Q3 is reflective of that. So we have 3.5% revenue growth in behavioral in Q3, 8% or 9% EBITDA expansion. A very positive, strong, robust result in our minds and something that we think we can and will continue to replicate. On the acute side, it's really sort of just the opposite. I think we've been, quite frankly, for many years now, for a good 3 or 4 years now, focused on really creating leaner, more efficient operating structures in the acute division. And I think we've been largely successful in doing it. The fact of the matter, however, is that unless we can sort of drive 2% or 3% revenue growth, it's pretty hard to avoid margin contraction, which is what you saw in Q3. I think that's largely true across the board again in both divisions, but where the real leverage tends to come, again, is in the more fixed and semi-fixed costs. You just can't cut your utilities and your taxes and your insurance, et cetera, as your revenue shrinks, in the same way that you can adjust headcount and things like that, which I think we've done a good job of doing.

Okay. And maybe just lastly, any update on your thinking around provider tax, UPL, a DSH payments either, as they reflected in the third quarter or going forward from here?

I mean, again, I think we'll certainly, I think, provide more color when we give our 2013 guidance. But I think, for now, our expectation is that, I'll sort of call those special items, UPL, DSH pro, provider taxes will likely continue at or around the same levels that they're at now.

Okay. And there wasn't anything unusual in the quarter around any of those?

No.

[Operator Instructions] And your next question comes from the line of Anton Hie of RBC Capital Markets.

Frank Morgan here. Steve, my question is on, hopefully, getting an update on the state reimbursement outlook for the new fiscal year we're in. Particularly on the behavioral side, are you seeing any improvement at all? Or is it basically about the same?

No, I think beginning in the sort of July of 2011 time frame, Frank, we talked about the outlook for the next 12 months, which is basically the Medicaid fiscal year as being Medicaid cuts of sort of flat to down 1%. I think we've probably trended to the, however you want to think about it, the lower end, meaning the 1% cuts rather than flattish. And again, that contributes to a little bit of that same Medicaid pressure that I was alluding to before, mostly as a length of stay pressure, but also a little bit of rate pressure. I think it's too early to say what that will look like come July of 2012 -- excuse me, 2013. And, obviously, what I meant was July of 2012 for the flat to down 1%. Obviously, when we give our guidance for 2013, we will embed in that an estimate for the back half of the year for Medicaid pricing and, hopefully, we'll have a better sense of it at that point in time.

Okay. In terms of -- could you talk a little bit more about the cost reduction efforts? I mean, you touched on this with A.J. a little bit, but the cost reduction efforts going on through the process of the third quarter relative to the slowdown in volumes. And I'm just curious, could the fourth quarter be a quarter where you get the full benefit of the cost reductions you were making across the course of the third quarter and then with any pickup in volume and that maybe the effect here reverses the other way? And then maybe could you just talk a little bit about what you're seeing in volumes so far in the fourth?

Well, I think it's worth noting, and I know a number of the other companies that have previously reported this quarter, mention that September, for them, was clearly the weakest month of the quarter. That was certainly true for us as well. And so, as I think normally occurs with that sort of thing, I mean, both our volumes and payor mix weakened in September. It's difficult to respond in real time to that almost immediately. But we did -- we do and we have responded and so, we will get some continuing benefit from that in Q4. Now, part of our revised guidance assumptions in Q4, quite frankly, is that the negative trends that we experienced in September will largely continue into Q4. Certainly, we hope that they improve. And I would say the very first glimpses we've had of Q4, which are basically October volumes, look a little bit better, although, I wouldn't draw too many definitive conclusions from that on its own. So I think the question you're asking, Frank, is the third quarter deteriorated. We began making some more aggressive cost cuts towards the end of the third quarter. If the revenue trajectory improves a little bit in Q4 from where it was in September, we should certainly benefit from that and get a pickup, and that would make our revised guidance look a little more conservative. But I think it's way too early to make that judgment.

[Operator Instructions] And there are no further questions at this time.

Okay. Well, we'd like to thank everybody. We hope that everybody stays safe and continues to recover from the hurricane. And look forward to talking with you at the end of the year. Thank you.

And this does conclude today's conference. You may now disconnect at this time.