Universal Health Services, Inc. (UHS) Q3 2016 Earnings Report, Transcript and Summary

Good morning. My name is Sia, and I will be the conference operator today. At this time, I would like to welcome everyone to the Third Quarter Earnings Conference Call. [Operator Instructions] Thank you. At this time, I would like to turn the conference over to Steve Filton. Please go ahead sir.

Thank you. Good morning. Alan Miller, our CEO, is also joining us this morning. Welcome to this review of Universal Health Services results for the third quarter ended September 30, 2016. During this conference call, Alan and I will be using words such as believes, expects, anticipates, estimates and similar words that represent forecasts, projections and forward-looking statements. For anyone not familiar with the risks and uncertainties inherent in those forward-looking statements, I recommend a careful reading of the section on Risk Factors and Forward-looking Statements and Risk Factors in our Form 10-K for the year ended December 31, 2015, and our Form 10-Q for the quarter ended June 30, 2016. We'd like to highlight just a couple of developments and business trends before opening the call up to questions. As discussed in our press release last night, the company reported net income attributable to UHS of $1.54 per diluted share for the third quarter of 2016. After adjusting each quarter's reported results for the incentive income and expenses recorded in connection with the implementation of electronic health record applications at our acute care hospitals, as disclosed on the supplemental schedule included with last night's earnings release, adjusted net income attributable to UHS was $157.2 million or $1.60 per diluted share during the third quarter of 2016, as compared to $155.3 million or $1.53 per diluted share during the third quarter of 2015. On a same facility basis in our acute care division, net revenues during the third quarter of 2016 increased 9.0% over last year's comparable quarter. The increase resulted primarily from a 4.6% increase in adjusted admissions to our hospitals owned for more than a year and a 3.2% increase in revenue per adjusted admission. On a same facility basis, operating margins for our acute care hospitals decreased to 14.7% during the third quarter of 2016 from 15.3% during the third quarter of 2015. On a same facility basis, net revenues in our behavioral health division increased 2.7% during the third quarter of 2016 as compared to the third quarter of 2015. During this year's third quarter, adjusted patient days to our behavioral health facilities increased 1.1%, and revenue per adjusted patient day increased 1.5% as compared to last year's third quarter. Operating margins for our behavioral health hospitals owned for more than a year were 26.0% and 27.4% during the quarters ended September 30, 2016 and 2015, respectively. For the nine months ended September 30, 2016, our net cash provided by operating activities increased approximately 38% to $1.1 billion over the $796 million generated during the comparable nine-month period of 2015. Our accounts receivable days outstanding decreased to 50 days during the third quarter of 2016, as compared to 55 days during the third quarter of 2015. At September 30, 2016, our ratio of debt-to-total capitalization was 45.3%. We spent $148 million on capital expenditures during the third quarter of 2016 and $396 million during the first nine months of 2016. Included in our capital expenditures were the construction costs related to the newly built Henderson Hospital, a 142-bed acute care facility located in Henderson, Nevada, which has been completed and is scheduled to open next week. We have also completed construction on a new 55-bed, 4-story patient tower at Spring Valley Hospital Medical Center in Las Vegas, Nevada, which was opened during the third quarter of this year. As previously announced in August of this year, we purchased Desert View Hospital, a 25-bed facility located in Pahrump, Nevada. Together with our 5 existing acute care facilities in the market, Henderson Hospital and Desert View Hospital further complement our ability to provide a wide array of comprehensive medical services to patients in the Las Vegas, Nevada area. Within our behavioral health division, we have opened a total of 373 new beds at some of our busiest facilities during the first nine-months of 2016. In addition, we have been working on joint venture behavioral health integration projects with industry leaders throughout the country. We're excited about these partnerships that help address the growing demand for inpatient and outpatient mental health services. We are proud to be partnering with Lancaster General Health and Penn Medicine to build and operate a 126-bed behavioral health hospital in Lancaster, Pennsylvania. Groundbreaking of this facility is slated for the spring of 2017, and the hospital is projected to open during the summer of 2018. In addition, we have formed a joint venture with Providence Health Care to build a 100-bed freestanding behavioral health hospital in Spokane, Washington. In connection with our previously announced $800 million stock repurchase program, we have repurchased approximately 458,000 shares at an aggregate cost of approximately $58 million during the third quarter of this year. Since the inception of the program through September 30, 2016, we have repurchased approximately 3.9 million shares at an aggregate cost of approximately $462 million, and had a remaining share repurchase authorization of approximately $338 million as of the end of the third quarter. Based upon the operating trends and financial results experienced during the first nine-months of 2016, we're narrowing our estimated range of adjusted net income attributable to UHS for the year ended December 31, 2016 to $7.16 to $7.43 per diluted share from the previously provided range of $7.12 to $7.58 per diluted share. This narrowed guidance, which excludes the expected electronic health records impact for the year increases the lower end of the previously provided range by approximately 1%, and decreases the upper end of the range by approximately 2%. We'll be pleased to answer your questions at this time.

[Operator Instructions] Your first question will come from Matthew Borsch with Goldman Sachs.

Hi. This is Tejus Ujjani on for Matt. Thanks for taking the question. Can you touch on any regional differences in the volume strength on the acute care side? Really solid numbers there. Any way to parse out in terms of Nevada strength versus broader market?

Sure. I think probably the geographic comments and patterns that we’ve been articulating I would say for the last five or six quarters continued to be true in third quarter of this year. And that is, among our strongest markets have been, as you have highlighted, Las Vegas, Southern California, the District of Columbia. On the other end of the spectrum, we’ve seen some weakness in South Texas and Amarillo. All those trends have, quite frankly, been present for a while now, I would say at least a year and a half, and didn't really change in any measurable way in this current quarter.

Okay, thanks, and a quick follow-up there. Can you share operating metrics for inpatient and outpatient same store surgeries?

Yes. So just in terms of the most critical metrics in the quarter on the acute side, emergency room visits were up 4% to 5%. Inpatient surgeries were up 3% or so, outpatient were up 4%. All those, I think, relatively strong metrics were consistent with the overall admission strengthen and revenue strength in the acute business for the quarter.

Thanks very much.

The next question will come from Justin Lake with Wolfe Research.

Thanks, good morning. Couple questions on behavioral. First, just Steve, can you give us your view on the third quarter in terms of the trajectory here? Volumes improved a little bit. Obviously, you're spending to staff the hospitals. But maybe spike out the 10% of facilities and what you're seeing there. It seems they were down 20%, 30% previously. Are you seeing some improvement there, and what's going on with the rest of the core business, the other 90%?

Sure. I think from the beginning, Justin, and the beginning I think in my mind was the third quarter of last year, so we've been talking about muted volumes in the behavioral business for about a year now, largely driven by staffing shortages, shortages of psychiatrists and nurses. I think it started out as more of a psychiatrist-centered problem and has evolved into more of a nursing shortage problem. I think what we have highlighted, and there's no perfect way to parse this issue, but we identified four or five or six markets that were most problematic in terms of having vacancies for these clinical positions and having to turn away patients, and as a consequence, have significantly and measurably muted volumes in those markets because we simply didn't have enough qualified clinical professionals to treat those patients. Over the course of the year, I think the markets have largely remained the same. We think those markets probably encompass, depending on how you count them, some 20-odd facilities, and again, during the 12 months, maybe a facility entered the list or came off the list, but I think for the most part, the list remained the same. I think we’ve seen some improvement in those markets. By definition, I think our overall volumes are increasing a little bit. I think we see pockets of weakness in some of the other markets, but I think for the most part, we continue to believe that if we focus on the four or five most problematic markets, as we have been that we will continue to make progress. I think, and you alluded to this a little bit in your question, I think the third quarter was a bit of a whipsaw for us in the sense that as we are hiring new nurses, as we're paying sign-on, bonuses as we are investing in the recruitment and retention of nurses, our labor costs are going up. We clearly saw that in Q3, and honestly, our volumes are going up a little bit, but they are not responding as quickly. Part of this is just a mechanical processes. As we hire nurses, they have to give notice at their old jobs if they are coming from another employer. Then they join us, and they go through an orientation or a training. And so we are paying them and we're incurring costs, but we are not necessarily able to increase volumes immediately. And I think what you saw in Q3 was a little bit of that dynamic of increased cost without the complete benefit of the commensurate increase in volumes. We think that's a relatively temporary situation that should continue to improve pretty measurably over the next quarter or two.

So that was my second question, Steve is just the trajectory here. It sounds like you think it's going to improve, and it should improve given the spending you're making here. Can you talk about the pace of improvement and when you think it gets back to that target 4% to 5%, 6% same store revenue growth range? And then given the level of spending, can you walk us through what you would think would be a reasonable equation, let's just say, for 2017 in terms of - if same store growth is 4% or 5%, what does that equate to in terms of EBITDA growth if you get there?

So, our original guidance for 2016 for our behavioral business, same store behavioral business was 5% revenue growth, which was - the implied metrics for that was 3% to 4% volume growth and 1% to 2% pricing. I think for the most part, we’ve been hitting those pricing targets, so this really is a volume issue. And so when you parse those numbers, we are somewhere 200, 250 basis points short of volumes from where we thought we would be. We also thought that if we could get to that 5% volume growth, we would get to something like a 6% to 7% expansion of EBITDA, or growth in EBITDA. I think that assumption and that EBITDA growth already presumed, because when we gave our guidance for the year, we were certainly well aware of the labor shortage already at that time. So, I think it presumes we would be raising salaries, we would be spending and investing more money in recruitment and retention. And so that EBITDA growth in comparison to the revenue growth was already factoring in some amount of labor pressure. So really, the question you are asking, which is a perfectly reasonable one, is when do we get this additional 200, 250 basis points in volume? I think we feel like we are doing most of the right things. I think we feel like we are making progress. I think we feel like at some point next year, in 2017, we will get there. Exactly how quickly we get there, exactly when that improvement comes, and how quickly that improvement comes is difficult to say. Obviously, the next time we speak to this group will be in late February when we give our 2017 guidance. I think we will be in a much better position to be more precise at that time. But we certainly feel that the metrics that we laid out for this year are well within reach and certainly achievable at some point during 2017.

Great, thanks.

The next question will come from Ralph Giacobbe with Citi.

Thanks. Good morning. Just wanted to stick to the labor side, can you give us a sense, Steve, at this point, what the average wage rate increases are today versus, say, a year or two years ago, maybe both across acute and psych and how you think about that on a go-forward basis, even if you do get volume back from the ability to grow EBITDA or the level of EBITDA growth? And then if you could also comment on what was contract labor in the quarter and maybe versus a year ago just to give us some sense of what the magnitude there is of that correction?

So, I think that the challenge in both of these businesses has not really been underlying wage rates. I think on the acute side, I think the challenge has mostly been the use of what we describe as premium pay, and that is paying either our own nurses overtime or shift differentials or whatever to work additional or incremental shifts, or paying temporary or registry nurses, generally a fairly significant premium over what would be our normal rate of pay. And that's really what's driving up our average wage rates. I don't think our underlying, I'll call them normalized wage rates, let's say, in the acute division, are going up much more than 3%, 3.5%. Maybe that's 50 basis points higher than what we might have thought a year ago, but not a huge needle mover. Just as a - to put it in context, I think in a normal environment, we would expect the use of temporary nurses to represent something in any given quarter around 2% of our overall labor force. I think in this quarter, that number was between two and three times that. And even that doesn't - it seems like some relatively small numbers. Because you are paying those temporary nurses in many cases twice what you're paying a regular nurse, the impact starts to add up relatively quickly. The same thing I think is true on the behavioral side. The real issue - and if you've looked at our segment data for the last four quarters or so you, don't see a lot of pressure on our wage line in behavioral, and that's because, quite frankly, we’ve just been unable to find sufficient number of nurses. It's really not been a question of willingness to pay them more to use temporary nurses or whatever. It's just been an absolute inability to find them at all, especially in these markets that I alluded to before. So, I'm going to say the same thing. I think the underlying wage rates in the behavioral division are maybe going up at this point 2.5% or 3%, and maybe that's 50 basis points higher than what we thought. But I don't think it's driving the numbers measurably, other than what I said before. I think already, our EBITDA growth targets that we already had talked about for 2016 for both divisions, I think already incorporated some amount of this labor pressure that we’ve been talking about.

Okay. That's helpful. And then can you give us a sense of payer mix in the quarter?

The payer mix, which I think is largely reflected in - I'm only going to talk on the acute business - in the 3% revenue-per-day increase roughly. I think it reflects our government business, Medicare, Medicaid being up. Our adjusted admissions for the quarter were up 4.5%. I think our government admissions were up in that neighborhood. Commercial admissions, while up, were up slightly less than that, maybe 1%, 1.5%. And then I think on insured admissions, we’re up a little bit more than the average, probably in the 6%, 7% range. And again, these are all trends that I think we have talked about for, I would say, since the middle of last year. As the benefits of the ACA have started to anniversary, we are not continuing to get the benefit from increased Medicaid expansion. Continued commercial enrollment, as a matter of fact, I think we are seeing some level of disenrollment as premiums rise and other factors occur. I think all that payer mix trending has been ongoing for about a year now. We see some volatility between quarters, but if you look at the four-or-five month trend, I think you'll see that we've been hitting that 3% revenue-per-admission growth rate pretty consistently over that period of time.

That's helpful. If I could squeeze one more in, Steve, can you give us a sense of some of the progress of these JVs and partnerships that you've talked about or any other arrangements you have with hospitals around trying to ultimately capture the IMD benefit as we think about next year? When will this get turned on, if you will, and run through the P&L? Can you give us a sense of whether the magnitude to some of these relationships have the ability to move the needle, or are you in the process of still signing these up where it's just not anything we should be expecting to come through the P&L anytime soon?

So, I think it's worth noting that these conversations with acute care hospitals on the behavioral side of the business have been ongoing now for probably a couple of years, and a number of these arrangements have already been entered into, and some of them are already in operation. I think that the first few of the arrangements we entered into were just these lease arrangements where we would joint venture with large not-for-profit healthcare systems. I mentioned in my opening remarks a deal to build a new hospital with Providence in the Washington State market. We already have two other arrangements where we just occupied existing units, which we leased from Providence and run behavioral units there, and both of them ongoing for some time and have been incorporated in our results for some time. Overall, it is a significant focus, probably, from a business development perspective, the single biggest focus in the behavioral division, what we described as acute care integration efforts. And so I think that they will continue, and will continue to enter into new ones. Exactly how significant they’ll be, I think remains to be seen. Some of them will take some time to develop. I mentioned Lancaster General joint venture in my remarks, but that new hospital will not open until 2018. I think when we give our guidance for 2017, we will probably frame it as here is our same store expectations in terms of volume and revenue growth, and then we will probably separately spike out what the impact of these new ventures will be, and I think we’ll probably do that, frankly, on a continuing basis after that.

Great. Thank you.

The next question will come from Paula Torch with Avondale Partners.

Thanks. Good morning. Steve, I guess I wanted to start up with the behavioral business. I had a question on the list of the 20 or for facilities, and maybe you could share with us what the occupancy looks like in those markets currently and maybe how quickly you can ramp up those facilities when you do add on those nurses or potentially a psychiatrist in order, I mean, I realized that you talked about getting that volume and that we're not really sure how much longer it's going to take, but I'm just curious, from that standpoint, in terms of occupancy, what do you see when you add a nurse, and how does that impact your effective beds?

So, I think - and I probably could have been clearer about this. I mean we identified those four, five, six markets in the 20 or so hospitals. The way that we identified them or the criteria we used was that in those hospitals, we had actually closed the unit or closed the number of beds or we capped our census so that in a 80-bed hospital, we were capping or limiting our census to, let's say, 40 patients or whatever the amount of qualified nurses we had would limit us to. Certainly, elsewhere in the portfolio, we were facing some pressures of turning away a patient on this day or not having enough nurses on a particular day. But these were hospitals where, again, we had closed the unit or we had capped our census for an extended period of time, and that's how we were categorizing them. I think at those hospitals - and I don't have the occupancy data in front of me, Paula, but I will say that at those hospitals, on average, I think their patient days or their volumes were down during this period, I would say 10% to 15%. And again, I think that the bulk of the effort to get the division back to the 200 basis points, 250 basis-point shortage in volumes that we’re really facing from our original guidance is getting those hospitals back to the 3% to 4% volume growth that we think most of the rest of the portfolio is posting. Obviously, if we can't get those hospitals back to that level, and we can get the remaining 180 hospitals or whatever the exact number is, to increase their volumes by 25 basis points or 50 basis points, I mean that will get us to the same place. But I think we just tried to frame it that way because I think it, frankly, it helped us as we tried to focus on addressing this problem, and we thought it would help people understand that as with many things, this was really an 80/20 issue, and the bulk of our focus was on a relatively small number of markets and facilities that were facing the most dramatic shortages.

Okay. Thank you. Maybe just as a follow-up, does this - trying to improve the 20% of these hospitals, let's just say, does that impact your ability or your thoughts about growth for next year? You opened, I think you said, 373 beds in the first nine months. I would assume that you're going to close the year with more than that, so does that impact how you are thinking about that growth and bed expansions, or do you feel like the 80% of the market that's left still has a lot of room to grow? And have you really seen any changes or shifts in the demand for your services in the U.S.? From everything that we read, there continues to be a supply-demand disconnect. I would like to know if you would continue to agree with that?

I think, Paula, we share that view, and I think we have said, again, for the last year that this is not a problem of diminishing demand in the underlying fundamentals of this business. As a matter of fact, I think if anything, we believe that, again, the underlying demand has done nothing, but increase and continues to increase. And our view of both the intermediate and long-term prospects from a demand perspective in this business remain extremely robust, and we are very enthusiastic about it. Instead, we are focused on what we believe is a much more near-term issue of making sure that we have, again, enough qualified staff in all of our facilities to satisfy that demand. I think that, obviously, as you pointed, I mean the fact that we are adding beds - and obviously, we're adding beds in markets where we do have enough qualified staff and we can accommodate those patients, and we’re not necessarily adding beds in those markets where we don't have enough staff now. At some point, we may add beds in those markets as we resolve the problem. But our continued investment in capacity in the business is a reflection of the fact that we expect it to grow at fairly robust rates. I'm not going to tell you we are not prepared to give 2017 guidance today, but I think when we give our guidance in 2017, it will reflect the fact that we believe, A, that the businesses going to continue to grow, and, B, that we'll continue to find new ways to enter markets, particularly acute care hospital market, and help to penetrate their behavioral services, which will also help the business grow.

Okay, great. Thank you for the color.

The next question will come from Kevin Fischbeck with BoA. Kevin, your line is open. Okay, he has withdrawn his question. The next question will come from Gary Lieberman with Wells Fargo.

Good morning. Thanks for taking the question. Steve, can you talk a little about the IMD exclusion benefit? Is the expectation that it's still going to take place primarily in 2017 as you enter networks where it's available, and are you on track to achieve that?

Yes, so the listing of the IMD exclusion for the managed Medicaid population could occur as early as July of 2016 if the states approved that. And I think some of our states have done so. I think we always had the view that the immediate impact of the lifting of the IMD exclusion, particularly in a mid-year, cycle was going to be fairly minimal because networks were already established and benefit plan design was already established, and to have, effectively, new hospitals join the network midyear and to really redirect a substantial number of patients was not a terribly practical matter in the middle of a year. So, I think in that sense, we always had the view that beginning with a new plan year in January of 2017, we would get more of a measurable impact. And the reality is some states will not approve the lifting until July of 2017, so some of this may be delayed even till 2018. I think, however, our view of this has also evolved, too - and this really encompasses my previous remarks to believe that, really the greatest opportunity we have here to take advantage of that adult Medicaid population are these arrangements that we will reach collaboratively with acute care hospitals to joint venture with them, to lease beds from them, to help them manage units because those opportunities will give us access, not only to their adult Medicaid patient population, but also to their commercial population, to their Medicare population. And so in some respects, the opportunity that we’re pursuing through that avenue is even greater than the IMD opportunity, although in fairness, it will take some time to realize as we have to negotiate these arrangements and implement them, and in some cases, build new capacity, or in some cases, renovate existing capacity, so there's some time lags in all this, but ultimately, given the fact that half of all the behavioral beds in the U.S. reside in acute care hospitals, we think that this opportunity to penetrate those beds is a tremendous, and as I remarked before, probably the single biggest business development opportunity we have domestically over the next five years or so.

Great. That's very helpful. And you talk about - there's been a fair amount in the news over the past week or so about premium increases on exchange products and different players potentially leaving markets and decreasing choice. Can you talk about maybe what you expect to see in your markets next year and what impact, if any, that might have on the acute care business?

Yes, so look, I think the reality is I don't know that we have a terribly insightful view of how this is all going to play out. I will make just some preliminary comments that we have said from the very beginning of the Affordable Care Act that the bulk of the benefit that we realize from the Affordable Care Act tended to be on the Medicaid expansion side of the ACA. I think on a percentage basis, we had more hospital beds in expansion states than any of our peers, mostly because of our significant oversized presence in Nevada, but obviously, we benefited in California, we benefited in the District of Columbia. The amount of benefit that we got from commercial exchange enrollment was always more limited, and so to the degree that there is some level of disenrollment, which I think there is and probably will continue to be, I think will impact us, but will not impact us in a terribly material and measurable way. And I think it's also worth noting that we’ve said from the outset that I think that ACA has had a relatively minor impact on the behavioral business. And so again, I think to the degree that there is disruption in the markets, that there is disenrollment, that there is a limiting number of payers remaining, I don't think that's going to have a measurable impact on us. I will say that in most of our markets, there still are multiple exchange providers in business, and a Blue Cross plan almost inevitably is one of them. But even though we have seen some players leave the market, I think in most of our markets, there remains some level of choice and competition, so I think that is helpful.

Okay, great. Thanks very much.

The next question will come from A.J. Rice with UBS.

Thanks. Hi, everybody. A couple quick ones hopefully. Just to think about the margin trend on the acute side with those volumes that were, frankly, stronger than we thought they would be. I'm know you're pointing to overtime usage and contract labor, but is the right way to think about it, is that the way it's going to be now, even if you have strong volumes, you are not going to be able to get the margin leverage? Or can we assume that somehow the volumes came in stronger than you were expected, and you were scrambling somewhat to keep staffing in line, and if those volumes continue to be strong, you will get margin leverage?

So, A.J., I'm going to go back again. I talked about our original presumptions for behavioral margins for the year and behavioral business. I'm going to do it on the acute as well. Our 2016 acute care guidance presumed 6% revenue growth and 7% or 8% EBITDA growth. And again, I think those projections and that EBITDA growth already presume that there would be some level of labor inflation because of pressure on wage rates and pressure on increased use of premium pay, et cetera. The acute results have been choppier and a little bit more volatile than the behavioral results I think, and I’ve encouraged people not to look at a particular quarter as reflective or emblematic of the trajectory, but to look at the last four or five quarters combined. And I think if you look at the business that way, we have been pretty routinely hitting at least that 6% revenue growth target, and I think during that period, we also have margin expansion. Again, I don't think we are going to have it every single quarter. I think there will be some quarters that’ll be tighter than others. But I think over time, those metrics that I laid out are still very sustainable from our point of view.

Okay. You mentioned the two deals that you’re working on the behavioral side in collaboration, are those traditional joint ventures? Can you give us a little more flavor? Are you taking on the bulk of the capital commitment there, or are they participating - your partners participating with you on that?

So, I think it's difficult to describe the model deal here. Everyone is different. I described a number of arrangements we have where we simply lease beds from an acute care hospital and run a behavioral unit effectively in their building or on their campus. And in those cases, we take on all the economics other than paying them a lease payment. In the deals I described in my remarks, we are building new facilities, and in each of those cases, I think the acute care partner will contribute their percentage of the capital investment. And the partnership percentages vary. Some of these are 50/50 deals; some of them are 80/20 deals, where we're the 80% partner. Again, I think one of the things that we’re willing to do is provide these acute care hospitals with a lot of optionality as to how we can proceed. And we’d love to have all the economics where - but if we have an acute care partner who wants to retain a significant amount of economics and we can reach an agreement on that, I think we are happy to do that. So, I think you are going to see these deals take a lot of different forms. In the end, I think they all provide us an opportunity to broach a patient population that we've just never been able to really penetrate before in a meaningful way.

A moderate position with regard to that on the corporate level is attractive because people that are dealing with us realize if it works out properly, we have the capital to invest. So it makes us more attractive than others who are overleveraged.

Yes, yes, I understand that. That was my last question on the capital deployment from here. I didn't know you were active on the buyback front in the quarter. I know you have said there are deals out there you are talking to, both on the behavioral and acute side. Any update on where you think the capital is going? Are these projects going to take on more capital you think, or is it more of those other two?

I think, A.J. we always describe ourselves as opportunistic, and that's not a throwaway term from our perspective. We believe that we’re going to try and respond to opportunities on both the acute and behavioral side that make economic sense and that earn a reasonable return, whether those opportunities are organic and building new facilities as we’ve done in Las Vegas, or inorganic through acquisitions on the behavioral side, or inorganic through these investments in new partnerships with acute hospitals. As you point out, we've also been an active acquirer of our own shares. We’re bullish on intermediate and long-term prospects of both our business segments and feel like our current valuations are reasonable, and investing in our own EBITDA stream is a good investment as well. So, I think you're going to continue to see us do all these things, continue to invest capital in our existing franchises that are growing and are strengthening or being strengthened in these new arrangements with acute hospitals on the behavioral side, and we're going to continue to look at M&A on both sides of the business as well, and be an active acquire of our own shares.

Okay. Thanks a lot.

The next question will come from Frank Morgan with RBC Capital Markets.

Good morning. Steve, I was hoping you could give us a little color on the sequential - or I'm sorry - the progression through the months of the quarter maybe on the two lines of business. And then secondly, looking at your updated guidance it implies at the mid-point that your adjustment is really less than the amount of the shortfall of this quarter. So, I am curious, what do you see so far maybe in October that gives us confidence over the balance of the year? Thanks.

So, I will just remind people, everything - a week in healthcare seems like a lifetime, but back in July, there were a number of these sell-side surveys that were suggesting volumes are very weak, and there was a lot of concern and even panic over that. I think providers pointed out the fact that the calendar was working against us and that August would look better. In fact, I think we said at our September conferences that July and August volumes combined looked where we expected they’d be. So, I think other than that dynamic, there was nothing about the progression or trajectory of the quarter that was terribly noteworthy. Look, the take on our guidance from my perspective was we were a little bit short of our own internal projections for the quarter. I think, the midpoint of the revised guidance presumes that the trends for Q3 just continue into Q4, and we'd probably be a little bit short again in Q4. If things improve and we're able to make some more immediate improvements in both the businesses, we should be able to gravitate towards the higher end of the range. And if things worsen, which is not really our expectation at this point, but if they did, we would gravitate more to the lower end of the range.

Just one follow-up to be clear, between the two lines, both behavioral and acute, the trends were similar for both, or did you see any differences across the quarter in the two businesses? Thanks.

No, I don't think we saw any significant differences between the two businesses.

The next question will come from Josh Raskin with Barclays.

Hi. Thanks. Good morning. First question just on behavioral, and I heard some of the comments, Steve, and I apologize if I missed others on the underlying demand for behavioral health services. Do you think there's any potential that we are seeing in the marketplace just better treatment options, better pharmaceuticals, et cetera? Is it possible that's cycling through and that maybe we are seeing a temporary reduction in demand for the services?

Look, I think that there's no question, and there has been an effort, and look, this is not exclusive to the behavioral business, but certainly in the behavioral business, on the part of payers to move patients to lower-cost settings of care. And so we've been under pressure - and none of this is new - to discharge patients as soon as is clinically appropriate, and I think we would argue in some cases even before it's clinically appropriate to move patients into outpatient settings or group homes or whatever it may be. But again, when I say that the underlying demand remains strong, Josh, I think we measure it by - we've talked a little about this concept on previous calls - we measure something we call deflections, which is when a patient is presented to us and they meet clinical criteria and they have some appropriate level of payment and effectively are eligible for admissions, and we are unable to admit them either because - historically the main reason we couldn't admit them is we didn't have a bed available in certain markets, in certain hospitals, and more recently, in the last or so, because we didn't have sufficient number of staff. But the number of deflections remain high. The number of patients who are being presented to us and meet the criteria to be admitted remains quite high, and those patients are being, again, deflected or turned away, and I think in a lot of these markets where a labor shortage is the issue, we think they are being turned away from multiples facilities. In other words, they are not finding treatment anywhere. And so again, I think the scenario you present is perfectly legitimate, and it has been occurring, and frankly, it's been occurring for a long time. I don't think it's necessarily accelerated or is terribly new in its form. But my view would be, the underlying demand remains quite strong despite those efforts.

Okay. That makes sense. And just a quick follow-up on CapEx. I know you had some big projects come online in Las Vegas, et cetera, and I know you've got a moderated view of CapEx next year, but are there any big projects you guys are contemplating where CapEx could be similar to 2016, or would that be highly unlikely at this point of the planning?

There is certainly no whole hospital acute care build projects that I think are on the drawing board for 2017, which I think is why we expect some moderation in the overall level of CapEx spend in 2017. But as I was responding to A.J.'s question before, I do think we see lots of other opportunities to expand services, to build new behavioral beds, et cetera. So again, I think we believe that CapEx will moderate some in 2017, but we’re not going to see a dramatic decline because we think that there are still a lot of good opportunities out there to build revenue and EBITDA producing capacity. Obviously, again, when we give our guidance in February, we’ll have a much more precise number to provide to everybody. But I think at least order of magnitude that shows you where we are headed.

Okay. That's perfect. Thanks.

The next question will come from Ana Gupte with Leerink.

Hi, thanks. Good morning. Hi, Steve. The first question I had - and I just got in a late, but on the acute side, how confident are you that the strength you are seeing will continue? And is there still more Medicare? That was what you had alluded to in previous quarters.

Yes, look, Ana, and I never like to boldly say we’re 100% confident of anything, but if you look, as I have suggested before at the last four or five acute care quarters, even in what I think about, is I think about the third quarter of 2015 really being the beginning of, I'll call it, the post-ACA era where the bulk of the ACA impact had already been realized, et cetera. If you look at our acute care revenue growth in those four or five quarters subsequent to that, we’ve been pretty consistently posting, again, at least that 6% revenue growth, which has been split pretty evenly between volume and price, and in fact, in many quarters, including this most recent quarter, we’ve been exceeding that. So, yes I think our confidence level that we can continue, that that level of growth for our facilities and our markets is sustainable is a reasonable one. It's not pie in the sky. We have been posting those numbers, and we don't see anything on the horizon that really threatens that. The comments that I was making about payer mix was that the government payer mix seems to be moving in lock step with our overall growth. Commercial growth has slowed some; uninsured growth has increased some. I think that's a reflection of some of the premium increases and exchange disenrollment that others have mentioned and people have been talking about. That's been factored into our numbers, and again, I think that's already reflected in the growth that we’ve been able to achieve. So, again, I wouldn't say we have a 100% confidence level, but we’re pretty confident in the sustainable level of our acute care revenue growth.

And then on the pricing side, the volumes were strong. You alluded to the 6%. With the mix shifting, it seems like a little bit at least from commercial to Medicare and the shift in the commercial itself to lower-price sites of service, is that pricing growth as well sustainable? I know it is the outlook, finally, on your managed care contracts, and all of that put together on pricing.

Right, so just to be clear, the 6% was overall revenue growth, and that was split pretty evenly between volume and price. If you look it, revenue per admission in the third quarter per adjusted admission increased by 3%. Yes, I think that is based on acute care commercial pricing growth in the 4% to 6% range. I think we have been hitting those numbers pretty comfortably and don't see that changing dramatically anytime soon.

And then finally, since acute is doing so well at this point, you had said I think at some point that you were at the table on discussions of smaller hospital chains and so on going - coming up for sale. Are you making more aggressive attempts to grow on the acute side given your strength?

I think our development folks would say they are already making a lot of aggressive attempts. I think we have been anxious and have been looking for opportunities to grow the acute care business and find well-positioned not-for-profit hospitals particularly that are for sale. Again, I mentioned in my remarks, it was a relatively small acquisition, but we did the Desert View acquisition in the greater Las Vegas market this quarter. And even though it's small, we feel like it was an important component of our overall strategy in Las Vegas, so we continue to look for those opportunities. So yes, we remain bullish on both of these businesses and their long-term prospects. And as I was saying, again, I think in my remarks to A.J. about capital deployment, we will continue to deploy capital in both businesses where it makes sense and where we can convince ourselves that an adequate return can be earned.

Thanks so much. Appreciate the color.

Thanks Ana.

The next question will come from Whit Mayo with Robert Baird.

Hi, thanks. Steve, if memory serves me, you have a behavioral contract management business buried inside…

Please speak up.

Sorry. Steve, was just asking about Horizon Health behavioral contract management business that you have. That was an organization that had a lot of pricing pressure over the years. Just wondering if you are trying to leverage the infrastructure with Horizon as you pursued joint ventures and other transactions with hospitals and what the pricing has been within that industry, and is that business really helpful as you pursue these conversations?

Sure, so just a tiny bit of context here. Horizon was a stand-alone public company that was in the business of managing behavioral units for acute care hospitals. They were acquired a number of years ago by PSI, and then obviously, we acquired Horizon as part of the PSI acquisition. We continue to run that Horizon business, and they continue to have - I'm doing this off the top of my head, but it was something like 100 of these contracts around the country where they are managing behavioral units for acute care hospitals. The upside of that business is somewhat limited because basically, for the most part, they are just earning a management fee and they're really not able to generally share in the economics of the units that they are running. We certainly are using that Horizon foundation, if you will, as a base to talk to both their existing clients, as well as their prospects. They certainly have had a robust business development function for years that is very helpful because they really - what they have focused on are these acute care hospital behavioral units, and so our focus expands to those businesses, the Horizon knowledge and database is quite useful. So yes, we’re leveraging that platform to effectively, I think, create a newer business model that allows us to participate in more of the economics of those acute care behavioral businesses. But yes, having Horizon is certainly a helpful dynamic.

Got it. And maybe one last one, just remind us the startup cost that you anticipate with the opening of Henderson and the timeframe to break even.

Sure. We talked about at the beginning of the year and embedded in our guidance was the fact that there would probably be a $10 million EBITDA drag in the back half of the year from both the pre-opening and a startup lost perspective at Henderson. We had a $2 million or $3 million drag in the third quarter, which implies a $7 million or $8 million drag in the fourth quarter, and I think those numbers are still largely good. Again, we will be more precise when we give our 2017 guidance, but we certainly think that Henderson will become EBITDA positive for the full year of 2017. We will give more details of that at the end of the fourth quarter.

Great. Thanks.

The next question will come from Kevin Fischbeck with Bank of America.

Great. Thanks. So going back to another question, I guess you said you feel comfortable about the growth rate being sustainable on the acute care side of the business. How do you feel about margins? Because I was a little bit surprised by the margin pressure that we have seen, is this the right way to think about margins over the long term, or do you see upside or downside to that to get - what's the normal margin to think about over time?

So, I think, Kevin, what I said was that our original guidance for 2016 was that acute care revenue would grow by about 6% same store, and that margins or EBITDA would grow by 7% to 8% margins, which means that margins would expand at least somewhat. I think if you go back and you look, not just at this quarter, but at the last four or five quarters, you will see that we’re doing both of those things. We are growing revenue by at least 6%, and we are expanding margins. I can see this; it is somewhat choppy. It’s somewhat volatile. There are some quarters where there's margin contraction, et cetera, but I think over that period of time, we have been able to achieve those metrics, and I think our point of view is going forward, we'll continue to be able to achieve those metrics.

Okay, so you think that over the next several years, margins should be, on average, higher than where they are today in the acute care business?

Certainly, as long as revenue growth continues at a level of 6% or so, I think we believe that over time, margins will continue to expand.

Okay. And then moving to the IMD, when we think about the opportunity, obviously, there's an opportunity to talk to the 1,200 hospitals - well, when you talk about JVs, are you talking about doing a JV with one of the 1,200 hospitals that has a unit already and moving it out, or are you talking to the 3,800 hospitals that don't even have a capability and building something from scratch. Because it seems the 3,800 is the bigger opportunity, trying to collect that volume. How do you think about that?

Well, I think the way to think about it is, the 3,800 acute care hospitals that don't have a behavioral unit have some relationship today where they are sending their adult Medicaid patients, and quite frankly, any of their psych patients, generally to another acute care hospital, certainly the adult Medicaid patients. We may be getting some of their other patients. And so yes, I think our point of view is that the way to penetrate that adult Medicaid business is to go where those patients are being treated today, and that is in the 1,200 or so acute hospitals that have a behavioral unit. We certainly are having conversations with those other hospitals, and honestly, I think we have been having conversations with them all along about referring patients from their EDs to our behavioral units where we live in a market with them.

Do you see any potential threat to your ED, acute care ED volume that comes with psych if those patients now can go to a freestanding facility? Do you think that your acute care hospital volumes could be redirected to a freestanding facility now? Is that an offset, or how do you think about that as a potential offset to IMD?

No, look, I think, first of all, we only have a relatively small number of our acute hospitals that have an existing behavioral unit. I think for the most part, again, acute hospitals control where their patients go, and so I don't think freestanding hospitals can just snap their fingers and redirect patients. I think the acute hospital is still in the position of being able to control their own patients, which is why we're most focused on this collaborative effort to work with acute care hospitals to penetrate that behavioral business. So, no, I don't think we see an offset from the loss of IMD business on our acute side of the business.

It just seems to me that they can steer where those volumes go. They might not want to send it to a competitor on their acute care business. They had to before because they had no other option, but now, they might say, okay, we now have another option, and that they would steer it away. But you are not hearing that or seeing that yet?

No.

All right. Great. Thanks.

And there are no further questions.

Okay, we thank everybody for their time and look forward to speaking with everybody at the end of the fourth quarter.