UHS

Business Context and Reporting Period

Company: Universal Health Services, Inc. (UHS)
Filing Type: Form 10-K (Annual Report)
Reporting Period: Fiscal year ended December 31, 2006
Business Overview: UHS owns and operates acute care hospitals, behavioral health centers, surgical hospitals, ambulatory surgery centers, and radiation oncology centers. As of February 28, 2007, the company operated 31 acute care hospitals (including 2 under construction and 4 closed due to Hurricane Katrina) and 110 behavioral health centers across 32 states, Washington D.C., and Puerto Rico.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Net revenues increased 7% ($256 million) to $4.19 billion, driven by a 7% increase in same-facility revenues and $170 million from acquisitions (primarily behavioral health facilities acquired in late 2005).
• Profitability: Net income increased 8% ($18.6 million) to $259.5 million. This increase was primarily due to a $240 million rise in income before taxes, offset by a $131 million decrease in income from discontinued operations (due to the 2005 sale of French hospitals).
• Hurricane Katrina Impact: The 2006 results included a net favorable impact of $168 million from Hurricane Katrina insurance recoveries exceeding expenses ($182 million recoveries vs. $14 million expenses). In contrast, 2005 included $165 million in hurricane-related expenses and $82 million in recoveries.
• Cash Flow Decline: Operating cash flow decreased significantly by $256 million to $169 million. This was primarily due to a $107 million unfavorable change in accounts receivable (including Texas Medicaid receivables) and a $176 million unfavorable change in accrued and deferred income taxes (payment of deferred 2005 taxes).
• Acquisitions: The company spent $82 million on acquisitions in 2006, including behavioral health facilities in Utah, Colorado, Kentucky, Florida, and Georgia.

Guidance, Outlook, and Risks

• Capital Expenditures: UHS expects to spend approximately $450 million on capital expenditures in 2007, including $254 million for equipment, renovations, and completion of major construction projects.
• Acquisition Commitments: Following the January 2007 acquisition of Texoma Healthcare System, the company is committed to building a 220-bed replacement facility at an estimated cost of $132 million within three years.
• Regulatory Risks: The company faces significant risks related to Medicare and Medicaid reimbursement rates. A 1% adjustment to estimated Medicare revenues subject to retrospective review could change after-tax net income by approximately $1 million.
• Legal Proceedings:
  • South Texas Health System: Subject to an ongoing False Claims Act investigation and a criminal search warrant regarding physician employment and referral practices. Financial exposure cannot be evaluated at this time.
  • California Wage and Hour Lawsuit: A $10 million pre-tax provision was recorded in 2006 regarding a class action lawsuit filed in Los Angeles Superior Court.
• Market Concentration: Four acute care hospitals in Las Vegas contributed 21% of consolidated net revenues in 2006. Facilities in McAllen/Edinburg, Texas, contributed 8% but have experienced performance declines due to intense competition.

Investor Verification Checklist

• Receivables Quality: Verify the collectibility of the $45 million in Texas Medicaid disproportionate share hospital receivables and the $18 million in Medicaid supplemental payment escrow accounts included in year-end receivables.
• Hurricane Recovery: Confirm the final settlement status of Hurricane Katrina insurance claims and the timeline for reopening or rebuilding the four closed Louisiana facilities.
• Legal Exposure: Monitor the outcome of the False Claims Act investigation into South Texas Health System affiliates and the certification status of the California wage and hour class action.
• Competitive Pressures: Assess the ongoing impact of physician-owned competition in the McAllen/Edinburg, Texas market on future operating margins.
• Debt Covenants: Verify continued compliance with leverage and fixed charge coverage ratios given the increase in long-term debt to $821 million.