UHS

Business Context and Reporting Period

Company: Universal Health Services, Inc. (UHS)
Filing Type: Form 10-Q (Unaudited)
Reporting Period: Quarter and nine months ended September 30, 2007
Operations: UHS owns and operates acute care hospitals, behavioral health centers, surgical hospitals, and ambulatory surgery centers. As of September 30, 2007, the company operated 31 acute care hospitals and 113 behavioral health centers across 32 states, Washington D.C., and Puerto Rico. Four acute care facilities in Louisiana remain closed due to Hurricane Katrina damage.

Key Financial Metrics

Note: Free Cash Flow calculated as Operating Cash Flow less Property/Equipment additions and Acquisitions. Debt figures derived from Balance Sheet.

Material Changes vs. Prior Period

• Revenue Growth: Net revenues increased 13% ($137 million) for the quarter and 14% ($431 million) for the nine-month period compared to 2006. Growth was driven by same-facility increases (8%), acquisitions (Texoma Healthcare System and others), and a new construction management contract.
• Profitability Decline: Net income decreased 75% ($85 million) for the quarter and 42% ($95 million) for the nine-month period. The primary driver was the absence of $130 million in hurricane insurance recoveries recorded in Q3 2006 and $167 million in the first nine months of 2006.
• Expense Trends: Salaries, wages, and benefits increased due to inflation and the transition of pharmacy services in-house. Supplies expense increased significantly in the first half of 2007 due to the pharmacy transition, though this was partially offset by a decrease in other operating expenses.
• Liability Reserves: The company recorded an $18 million favorable reduction in professional and general liability self-insured claims reserves in Q2 2007 due to tort reform and patient safety initiatives.

Guidance, Outlook, Risks, and Unusual Items

• Hurricane Katrina Impact: Four facilities in Louisiana remain closed. While 2006 results included significant insurance recoveries, 2007 results reflect only minor ongoing remediation expenses ($707,000 for nine months).
• Legal Proceedings:
  • South Texas Health System: Subject to ongoing civil and criminal investigations by the OIG and U.S. Attorney's Office regarding Medicare/Medicaid compliance, physician employment, and patient referrals. Financial exposure cannot be evaluated at this time.
  • California Wage and Hour Lawsuit: Settled in Q3 2007 for $10.4 million (pre-tax provision of $10 million recorded in 2006).
• Medicaid Risks: CMS has deferred approximately 25% of federal financial participation on Medicaid supplemental payments for Texas facilities pending review. The company has established reserves for potential ineligibility of Inter-Governmental Transfers (IGTs).
• Capital Expenditures: Expected to spend $100-$110 million in Q4 2007 on capital projects, including new hospitals in Las Vegas and Palmdale, and renovations in Bradenton and Chicago.
• Stock Repurchases: Repurchased 221,546 shares in Q3 2007 at an average price of $49.95. Approximately 1.8 million shares remain available for purchase.

Investor Verification Checklist

• Insurance Recoveries: Verify the sustainability of profitability without the one-time hurricane insurance recoveries that inflated 2006 earnings.
• South Texas Investigation: Monitor the status of the OIG and Grand Jury investigations into South Texas Health System affiliates for potential fines, penalties, or repayment demands.
• Medicaid Reimbursement: Track the resolution of the CMS deferral on Texas Medicaid supplemental payments and the potential impact of the established reserves on future earnings.
• Uninsured Patient Trends: Assess the impact of rising uninsured patient volumes on the provision for doubtful accounts and charity care costs, which increased significantly year-over-year.
• Debt Capacity: Review the utilization of the $800 million credit facility and the new $200 million accounts receivable securitization program to ensure liquidity remains sufficient for planned capital expenditures.