UNIVERSAL HEALTH SERVICES INC quarterly report, Q2 FY2011

Universal Health Services, Inc. — Q2 2011 Form 10-Q Summary

Business context and reporting period

Unaudited quarterly report for the three and six months ended June 30, 2011, filed August 8, 2011. UHS owned or operated 25 acute-care hospitals, 204 behavioral-health centers, and seven surgical hospitals and surgery/radiation oncology centers. Results include the November 2010 acquisition of Psychiatric Solutions, Inc. (PSI), substantially expanding the behavioral-health segment.

Financial performance and liquidity

Metric	Three months ended June 30	Six months ended June 30
Net revenues	$1.902 billion vs. $1.338 billion	$3.813 billion vs. $2.685 billion
Income from operations	$232.2 million vs. $129.7 million	$492.7 million vs. $270.3 million
Operating margin	12.2% vs. 9.7%	12.9% vs. 10.1%
Net income attributable to UHS	$103.6 million vs. $65.6 million	$217.8 million vs. $137.4 million
Diluted EPS	$1.04 vs. $0.67	$2.20 vs. $1.40
Interest expense, net	$49.8 million vs. $12.3 million	$106.2 million vs. $24.7 million
Operating cash flow	Not separately presented	$355.8 million vs. $227.7 million

Revenue increased 42% in both the quarter and first six months. Same-facility revenue increased approximately 6%; PSI contributed approximately $487 million in second-quarter revenue and $967 million in first-half revenue. Six-month operating cash flow increased $128 million, but accounts receivable growth and other working-capital timing reduced cash generation.

• Cash and cash equivalents were $34.8 million at June 30, 2011, compared with $29.5 million at December 31, 2010.
• Net accounts receivable were $913.7 million; days sales outstanding were 43 days versus 42 days at June 30, 2010.
• Total debt carrying value was $3.75 billion, with fair value of $3.81 billion. Debt represented 63% of total capitalization, down from 66% at December 31, 2010.
• Available borrowing capacity under the credit agreement and receivables securitization was $590 million, net of $65 million of letters of credit. UHS was in compliance with its debt covenants.
• Six-month investing cash outflow was $125.6 million, including $116.2 million of capital expenditures and $11.4 million for electronic health-record implementation.
• Six-month financing cash outflow was $224.8 million, including $200.6 million of debt repayments, $23.5 million of financing costs, $9.8 million of dividends, and $6.2 million of share repurchases.

Material changes versus the prior comparable period

• The PSI acquisition drove the substantial increase in behavioral-health revenue and earnings, but also materially increased borrowings and interest expense.
• Acute-care same-facility income before taxes increased 14% in the quarter and 20% in the first half. Management cited favorable payor mix and patient acuity, stabilized uninsured volumes, and lower supplies expense.
• Acute-care inpatient admissions declined 2.5% in the quarter and 1.7% in the first half, while adjusted admissions declined 0.9% and 0.2%, respectively. Revenue per adjusted admission increased 7.1% in the quarter and 6.5% in the first half.
• Behavioral-health same-facility admissions increased 7.2% in the quarter and 7.0% in the first half. Same-facility income before taxes increased 3% and 5%, respectively, although margins declined modestly.
• The prior-year period included a $16 million favorable reduction in professional and general liability reserves and $18 million of PSI transaction fees; these items affect comparability.
• Four facilities were classified as held for sale pursuant to the FTC remedy related to the PSI acquisition. MeadowWood was divested in July 2011; the Nevada facilities and a Puerto Rico facility remained subject to required divestitures.

Guidance, outlook, management commentary, risks and unusual items

• Management expected approximately $160 million to $185 million of capital expenditures during the remaining six months of 2011, funded through internally generated cash and additional financing as needed.
• UHS estimated that 2012 Medicaid reimbursement could decline 3% to 4%, or approximately $45 million to $55 million annually, from first-half 2011 rates. Texas also proposed reimbursement methodology changes expected to become effective September 1, 2011.
• Approximately $15 million of Medicaid electronic-health-record incentive payments could be received during the second half of 2011, but qualification and timing were uncertain.
• UHS expected to refinance the $200 million of 6.75% senior notes maturing November 15, 2011 using available credit capacity.
• Southwest Healthcare System remained subject to CMS and California licensing oversight. A certification survey began in late July 2011; failure to demonstrate substantial compliance could materially impair the facilities’ ability to operate. The filing did not provide the survey results.
• Two Rivers Psychiatric Hospital’s Medicare and Medicaid termination notice was rescinded under a May 2011 settlement, but CMS planned another survey in early 2012 and continued certification remained uncertain.
• UHS disclosed several False Claims Act investigations, subpoenas, litigation matters, and PSI-related claims. Reserves were recorded where appropriate, generally without a material impact on reported results, but potential exposure in certain matters remained uncertain.
• Professional and general liability reserves were $300 million at June 30, 2011. Letters of credit and surety bonds totaled $76 million, and interest-rate swap liabilities totaled $28 million.
• Key ongoing risks included reimbursement reductions, Medicaid and Medicare policy changes, uninsured and charity-care levels, competition, labor costs, regulatory compliance, litigation, insurance availability, and the integration and leverage effects of the PSI acquisition.

Most important facts for an investor to verify

1. Whether PSI integration produces sustainable earnings and cash-flow synergies after including higher interest expense and corporate overhead.
2. The results of the Southwest Healthcare System CMS certification survey and the effect on Medicare participation and licensing.
3. Progress and proceeds from the remaining FTC-required facility divestitures.
4. Refinancing of the $200 million notes due in November 2011 and subsequent leverage and interest-rate trends.
5. Actual Medicaid rate reductions, Texas reimbursement changes, and the status of Medicaid supplemental and DSH payments.
6. Resolution and ultimate exposure from False Claims Act investigations, DOJ subpoenas, professional-liability claims, and other PSI-related litigation.
7. Accounts-receivable collections, charity care, uninsured discounts, and provision for doubtful accounts, which increased to $314.0 million for the first six months.