UNIVERSAL HEALTH SERVICES INC quarterly report, Q2 FY2016

Universal Health Services, Inc. — Form 10-Q Summary

Business Context and Reporting Period

UHS is a healthcare operator focused on acute care hospitals and behavioral health services. As of June 30, 2016, it owned or operated 24 inpatient acute care hospitals, 3 free-standing emergency departments, 213 inpatient and 16 outpatient behavioral health facilities, plus surgical hospitals and outpatient centers. The filing covers the three and six months ended June 30, 2016, compared with the corresponding 2015 periods. The financial statements are unaudited.

Financial Performance and Key Metrics

Metric	Q2 2016	Q2 2015	Six Months 2016	Six Months 2015
Net revenues	$2.431 billion	$2.275 billion	$4.881 billion	$4.501 billion
Income from operations	$333.3 million	$335.4 million	$689.6 million	$662.4 million
Operating margin	13.7%	14.7%	14.1%	14.7%
Income before taxes	$302.8 million	$307.7 million	$629.6 million	$604.7 million
Net income attributable to UHS	$185.6 million	$182.2 million	$376.3 million	$356.5 million
Diluted EPS	$1.89	$1.80	$3.81	$3.54
Net cash from operating activities	Not separately provided	Not separately provided	$801.2 million	$531.6 million

Q2 net revenues increased 7%, primarily from 5% same-facility growth in acute care and behavioral health services and revenue from 2015 acquisitions. Six-month revenue increased 8%, including 6% same-facility growth. Q2 income before taxes declined $5 million, while six-month income before taxes increased $25 million. Net income attributable to UHS increased despite the Q2 pretax decline, primarily because the Las Vegas minority interests were purchased in May 2016, reducing income attributable to noncontrolling interests.

Q2 net income attributable to UHS represented a 7.6% net margin versus 8.0% in the prior year. The six-month net margin was 7.7% versus 7.9%. The effective tax rate was 35.5% in Q2 and 34.7% for the six-month period, compared with 34.5% and 34.6%, respectively.

Acute care same-facility revenue increased 7.4% in Q2 and 9.7% for the six months. Same-facility acute care pretax income decreased 1% in Q2 but increased 10% for the six months.
Behavioral health same-facility revenue increased 2% in Q2 and 3% for the six months. Same-facility behavioral health pretax income was broadly unchanged, with margins pressured by higher labor costs.
Acute care admissions increased 2.5% in Q2 and 4.5% for the six months on a same-facility basis; adjusted admissions increased 3.9% and 5.8%, respectively.
Provision for doubtful accounts increased to $208.0 million in Q2 from $177.5 million and to $377.8 million for the six months from $332.2 million. Total uncompensated care at acute care facilities was $339 million in Q2 and $684 million for the six months.

Cash Flow, Liquidity and Debt

Operating cash flow increased $269.6 million year over year to $801.2 million, helped by working-capital timing, improved accounts-receivable cash flow, and $50 million of net inflows from foreign-exchange contracts.
Investing cash outflows were $275.2 million, including $247.7 million of capital expenditures and $27.5 million for acquisitions and property.
Cash used in financing was $528.5 million. Uses included $418 million to buy minority interests in six Las Vegas acute care hospitals and $239.1 million for share repurchases, partly offset by $1.022 billion of new borrowings.
Cash and cash equivalents were $56.3 million at June 30, 2016, compared with $61.2 million at December 31, 2015. Accounts receivable were $1.345 billion, net of a $397 million allowance. Days sales outstanding improved to 50 days from 55 days at June 30, 2015.
Total debt was approximately $3.6 billion at June 30, 2016, or 46% of total capitalization, compared with approximately $3.5 billion and 45% at year-end 2015. The company reported compliance with all debt covenants.
The $800 million revolving facility had no borrowings outstanding and $751 million of available capacity after short-term borrowings and letters of credit. The accounts-receivable securitization had $280 million outstanding and $120 million of additional capacity.
UHS refinanced its $400 million 7.125% senior secured notes at maturity in June 2016 through new 2022 and 2026 notes and additional term-loan borrowings. Interest expense rose to $30.4 million in Q2 and $60.0 million for the six months.

Material Changes, Outlook and Unusual Items

In May 2016, UHS purchased the third-party minority interests in six Las Vegas hospitals for $445 million, including a $418 million purchase price and $27 million return of reserve capital.
UHS issued $400 million of additional 4.75% senior secured notes due 2022 and $400 million of 5.00% senior secured notes due 2026, and increased its Term Loan A by $200 million.
Management expected to spend approximately $200 million to $225 million on capital expenditures during the remaining six months of 2016, including construction of the 142-bed Henderson, Nevada hospital, scheduled to open in the fourth quarter of 2016.
Management stated that operating cash flow, cash, available revolver and securitization capacity, and access to capital markets should be sufficient for operating, investing and financing needs over the next twelve months, while noting that future financing may not be available on acceptable terms.
UHS estimated approximately $170 million of 2016 net benefit from various state Medicaid supplemental programs, net of $152 million of provider taxes. The company estimated 2016 Texas and South Carolina DSH-related net benefit of approximately $55 million, subject to required funding transfers and program conditions.
Management identified clinician shortages as limiting behavioral health capacity in certain markets and stated that recruitment and retention initiatives were underway.
CMS subsequently determined in July 2016 that Texoma Medical Center complied with applicable Medicare conditions, rescinding the related termination notice and completing the Systems Improvement Agreement. This occurred after the reporting date.

Risks, Contingencies and Regulatory Matters

UHS and multiple behavioral health facilities remain subject to DOJ, OIG and state investigations concerning alleged False Claims Act, Stark Law, billing, compensation and regulatory issues. The company stated that potential liability and financial exposure cannot currently be estimated.
River Point Behavioral Health remained subject to Medicare and Medicaid payment suspensions, materially affecting that facility’s results and financial condition, although not materially affecting consolidated results for the period.
Timberlawn Mental Health System’s Medicare and Medicaid provider agreement remained terminated, and its Texas license revocation and administrative penalty were being contested. The facility’s results were not material to consolidated results, but the termination materially affected the facility.
Seven Pennsylvania behavioral health facilities faced demands for approximately $4 million of alleged excess FFY2011 Medicaid DSH payments. UHS appealed and warned that unsuccessful appeals could adversely affect future results and financial condition.
Illinois receivables were approximately $24 million and Texas Medicaid supplemental-program receivables were approximately $38 million at June 30, 2016. No reserves were recorded, but collection could be delayed or ultimately fail.
Professional and general liability reserves were $215 million, and workers’ compensation reserves were $68 million. The company is substantially self-insured and warned that claim severity or frequency could materially affect future results.
Medicare and Medicaid reimbursement changes, Medicaid supplemental-program renewals, provider taxes, DSH reductions, managed-care pricing, labor shortages, payer collection risk, litigation, government investigations and healthcare regulation remain significant risks.

Investor Verification Priorities

Verify the sustainability of same-facility growth and whether labor, supplies and other operating-cost inflation continue to compress margins.
Assess the cash-flow and leverage impact of the Las Vegas minority-interest purchase, Henderson hospital construction and planned capital expenditures.
Monitor government investigations, River Point payment suspensions, Timberlawn’s re-enrollment and Pennsylvania DSH appeals for potential financial exposure.
Reconcile Medicaid supplemental-program revenue, provider taxes, DSH funding and state receivables, particularly in Texas, Illinois and Pennsylvania.
Review the maturity profile, variable-rate exposure, interest-rate hedges, covenant headroom and availability under the revolver and accounts-receivable securitization.
Track uncompensated-care trends, doubtful-account provisions and payer mix, including the increasing contribution from managed care.