UNIVERSAL HEALTH SERVICES INC quarterly report, Q2 FY2018

Universal Health Services, Inc. — 2018 Q2 Form 10-Q

Reporting period: Three and six months ended June 30, 2018; filed August 8, 2018. UHS operates acute care hospitals and outpatient facilities and behavioral health facilities in the United States, United Kingdom, Puerto Rico and the U.S. Virgin Islands. At June 30, 2018, it owned or operated 327 inpatient and 32 outpatient and other facilities.

Key financial metrics

Metric	Q2 2018	Q2 2017	Six months 2018	Six months 2017
Net revenues	$2.681 billion	$2.612 billion	$5.369 billion	$5.225 billion
Income from operations	$324.5 million	$330.2 million	$658.3 million	$684.1 million
Operating margin	12.1%	12.6%	12.3%	13.1%
Net income attributable to UHS	$226.1 million	$185.4 million	$449.9 million	$391.4 million
Diluted EPS	$2.39	$1.91	$4.76	$4.03
Net cash from operating activities	Not separately reported	Not separately reported	$629.3 million	$533.8 million

Q2 net revenue increased 2.6%; six-month revenue increased 2.7%.
Net income attributable to UHS increased 22.0% in Q2 and 14.9% for the first six months, principally because of lower income taxes following the Tax Cuts and Jobs Act, which reduced the federal corporate tax rate from 35% to 21%.
Effective tax rates declined to 23.5% in Q2 and 23.2% for the first six months, versus 35.3% and 34.6%, respectively, in the prior-year periods.
Operating profit declined despite revenue growth, with salary, wage and benefit expense rising to 48.7% of revenue in Q2 from 47.3% and to 48.5% for six months from 47.4%.
Cash and cash equivalents were $76.9 million at June 30, 2018; total cash, cash equivalents and restricted cash were $170.4 million.
Accounts receivable increased to $1.557 billion from $1.501 billion at December 31, 2017. Reported days sales outstanding increased to 53 days from 50 days at June 30, 2017.
Capital expenditures were $370.3 million in the first six months, compared with $262.5 million in the prior-year period. Investing cash outflow was $415.7 million.
Financing cash outflow was $209.3 million, including $134.8 million of share repurchases and $18.8 million of dividends.

Debt and liquidity

Total debt was approximately $4.0 billion, representing approximately 43% of total capitalization, compared with 45% at December 31, 2017.
Debt consisted principally of $1.731 billion outstanding under the term loan A, $366 million under the revolving facility, $450 million under the accounts receivable securitization program and $1.4 billion of senior secured notes.
The $800 million revolving facility had $365 million of available capacity after borrowings, letters of credit and other outstanding borrowings. The $450 million receivables securitization facility was fully drawn.
The credit agreement matures in August 2019. Management stated that operating cash flow, cash, cash equivalents and capital-market access should provide sufficient resources for the next 12 months, including refinancing the credit agreement, but cautioned that financing may not be available on acceptable terms.
UHS was in compliance with its debt covenants at June 30, 2018.

Material changes versus the prior comparable period

Same-facility acute care revenue increased 3.3% in Q2 and 3.5% for six months. Acute care income before taxes increased 3% in Q2 and 4% for six months. Acute care admissions, adjusted admissions and occupancy improved.
Same-facility behavioral health revenue increased 2.8% in Q2 and 2.9% for six months, but income before taxes declined 1% in both periods. Management cited clinician shortages that constrained available behavioral health capacity.
Behavioral health results included the continuing effects of government investigations, facility closures or restructurings and related reserve activity.
Uncompensated care based on charges declined to $474 million in Q2 and $883 million for six months, from $492 million and $914 million, respectively. Uninsured discounts increased while charity care declined.
UHS adopted the new revenue recognition standard on January 1, 2018 using the modified retrospective method. The reported effect on net revenue was an increase of $4.1 million in Q2 and $6.6 million for six months, with a corresponding increase in other operating expenses; management stated the overall impact was not material.
UHS exercised a five-year renewal option for McAllen Medical Center, extending the lease through December 2026 at the existing lease rate.

Guidance, outlook, commentary and unusual items

Management expected remaining 2018 capital expenditures of approximately $290 million to $310 million.
Management estimated a 2018 net benefit of approximately $162 million from Texas and other state Medicaid supplemental payment programs, net of approximately $170 million of provider taxes. The estimate depends on program approvals, hospital eligibility and governmental funding transfers.
CMS’s 2019 final Medicare IPPS rule was estimated to increase UHS payments approximately 2.7%; the 2019 psychiatric PPS rule was estimated to increase payments approximately 1.35%. These are reimbursement estimates, not consolidated earnings guidance.
In July 2018, UHS acquired The Danshell Group in the U.K. for approximately $92 million, adding 25 facilities and 288 beds.
The DOJ civil investigation concerning behavioral health facilities remained unresolved. UHS recorded a $9 million pre-tax reserve increase in Q2 and $22 million for the first six months, bringing the aggregate reserve to $43 million. Final settlement amounts could differ materially.
River Point Behavioral Health remained subject to a Medicare payment suspension; aggregate funds withheld since inception were approximately $9 million. The company could not predict when suspended payments would resume.
Professional and general liability and workers’ compensation reserves totaled $306 million at June 30, 2018. Management warned that future reserve adjustments could be material.
Illinois accounts receivable totaled approximately $22 million, including $14 million outstanding more than 60 days, with no related reserve recorded. Collection remains delayed by state budgetary and funding pressures.
Other contingencies include False Claims Act litigation, shareholder class and derivative actions, Pennsylvania Medicaid DSH repayment demands and other government investigations. Potential exposure beyond recorded reserves was not clearly estimable.

Most important facts for investors to verify

Progress and ultimate cost of the DOJ behavioral health investigation and whether the $43 million reserve is sufficient.
Refinancing plans and terms for the credit agreement and $300 million of senior notes due in August 2019.
Cash conversion, accounts receivable aging and collectability, particularly Illinois receivables and the rise in DSO.
Sustainability of Medicaid supplemental payments, including Texas UC/UPL and DSRIP, and the potential effect of future DSH reductions.
Behavioral health staffing constraints, capacity utilization and the performance of recently acquired or restructured facilities.
Potential liability from pending litigation, regulatory investigations, payment suspensions and self-insurance claims.
Whether planned capital expenditures, acquisitions, dividends and share repurchases remain consistent with leverage and liquidity objectives.