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Executives

Steve Filton - SVP and CFO

Alan Miller - CEO

Analysts

A.J. Rice - Susquehanna Financial Group

Adam Feinstein - Barclays Capital

Tom Gallucci - Lazard Capital Markets

Ralph Giacobbe - Credit Suisse First Boston

Justin Lake - UBS Securities

Gary Lieberman - Wells Fargo Securities

Kevin Fishbeck - Bank of America-Merrill Lynch

Darren Lehrich - Deutsche Bank

Christine Arnold - Cowen & Co.

Whit Mayo - Robert W. Baird

Kimberly Purvis - Cross Current Research

Universal Health Services, Inc. (UHS) Q4 2011 Earnings Call February 28, 2012 9:00 AM ET

Operator

At this time, I would like to welcome everyone to the Q4 earnings conference call. (Operator Instructions) Thank you. I would now like to turn the call over to your host Mr. Filton. Sir, you may begin.

Steve Filton

Thank you and good morning. I am Steve Filton. Alan Miller, our CEO, is also joining us this morning. Welcome to this review of Universal Health Services results for the full year and fourth quarter ended December 31, 2011.

During this conference call Alan and I will be using words such as believes, expects, anticipates, estimates, and similar words that represent forecast projections and forward-looking statements. We 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, 2011. We would 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 recorded net income attributable to UHS per diluted share of $4.04 for the year and $0.98 for the quarter. After adjusting for a reduction in malpractice reserves relating primarily to prior years, our adjusted net income attributable to UHS per diluted share for the quarter ended December 31, 2011, was $0.91.

Included in the quarter is a year-to-date reduction to our effective tax rate due to final implementation of certain state income tax planning and the securing of certain state tax credits.

We define operating margin as operating income or net revenue less salaries, wages, and benefits, other operating expenses, supplies expense and doubtful accounts divided by net revenue. Our operating margins increased to 16.7% during the quarter ended December 31, 2011, as compared to 15.7% during the comparable prior year period.

On a same-facility basis, revenues in our behavioral health division increased 6.3% during the fourth quarter of 2011. We note that the PSI facilities are included in our same-store data for one month this quarter. Adjusted admissions and patient days to our behavioral health facilities owned for more than a year increased 8.3% and 4.1% respectively during the fourth quarter. Revenue per adjusted patient day rose 2.4% during the fourth quarter of 2011 over the comparable prior year quarter.

Operating margins for our behavioral health hospitals owned for more than a year increased to 24.7% during the quarter ended December 31, 2011 as compared to 22.6% during the comparable prior year period.

On a same-facility basis in our acute division, revenues increased 1.6% during the fourth quarter of 2011. The increase resulted primarily from a 1.3% increase in revenues per adjusted admission. Adjusted admissions to our hospitals owned for more than a year were relatively flat. The relatively muted revenue growth reflects a $6 million reduction in the quarter of Medicaid disproportionate share and UPL reimbursements, primarily related to Texas as well as the continued impact of negative economic trends in certain of our local markets.

On a same-facility basis, operating margins for our acute care hospitals decreased to 13.3% during the fourth quarter of 2011 from 14.4% during the fourth quarter of 2010. We also note that they were no EHR related revenues included in our quarterly financial statements.

Our acute care hospitals provided charity care and uninsured discounts based on charges at established rates, amounting to $248 million and $208 million during the three month periods ended December 31, 2011 and 2010.

As a percentage of acute care net revenues, bad debt, charity care expense and the uninsured discount in this year's fourth quarter were at levels higher than those experienced during the fourth quarter of 2010. However, due primarily to the increase in behavioral health revenues in the very low levels of bad debt and uninsured discounts in that business or overall percentage of bad debts, charity care and uninsured discounts were lower than those experienced during the fourth quarter of 2010.

Our cash from operating activities was approximately $156 million during the fourth quarter of 2011 as compared to $89 million in the fourth quarter of 2010. Our accounts receivable days outstanding increased to 49 days during the fourth quarter of 2011, primarily due to a slowdown in Medicaid payments from the State of Illinois.

At December 31, 2011, our ratio of debt to total capitalization was 61%. We spent $90 million on capital expenditures during the fourth quarter. Included in our capital expenditures were the construction cost related to a 97 bed replacement behavioral hospital in Kentucky, which recently opened and the ongoing construction of a new acute care hospital in Temecula, California.

We opened a total of 263 new behavioral health beds at some of our busiest facilities in 2011. And effective in the first quarter of 2012, we have completed all of the divestitures required by the FTC as part of the PSI acquisition. The proceeds from these divestitures totaled approximate $115 million consistent with our expectations.

Excluding the unfavorable $0.04 per diluted share EHR impact described in our press release, our estimated range of earnings per diluted share attributable to UHS for the year ended December 31, 2012, is $4.33 to $4.48 and projected net revenues of $7.2 billion. You should note that this revenue figure excludes the previously announced NAP acquisition, which is not included in our 2012 guidance.

Our net revenues for 2012 have been adjusted to reflect reclassification of our provision for doubtful accounts, which began in January 1, 2012, will be reflected as a deduction from revenues rather than as an operating expense.

Alan and I will be pleased to answer your questions at this time.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of AJ Rice.

A.J. Rice - Susquehanna Financial Group

Could you maybe tell us, in your mind, maybe give us a little bit of flavor for what you see to be the sling factors in 2012 guidance? And I know you key operational variables move into, around and that. And then you don't typically give quarterly guidance, but I think you're facing a fairly tough comp in Vegas in the first quarter, which I think it was fairly strong last year. Can you give us any sense at all about maybe first quarter outlook in light of that? I assume the way you lay out the guidance is the rest of the year the comps will get about considerably easier, particularly as you move to the back half of the year?

Steve Filton

I mean, actually you've asked for a lot of information in short order, but that's fine. I think as we reflect back on 2011 it was a tail, particularly in the acute segment of two-halves of the year. As you suggest, early in the year, particularly in the first quarter and particularly in the Las Vegas market, we saw a significant improvement in our payer mix and as a consequence a rise in our revenue growth per unit. And we were not able to sustain that as the year went on, as unemployment after coming down in the beginning of the year in Las Vegas rose again as the year went on. So revenues in the acute segment rose on average and that's inclusive of bad debt, something live 5.5% in the first half of the year and only about 2.5% in the back half of the year.

Our 2012 guidance for the acute division is more reflective of the way we exited the year and pegs revenue growth for the acute segment in kind of the 3% to 3.5% range, much more closely to what we're currently running.

On the behavioral side, again, the results have been more consistent in our guidance for 2012, reflects that consistency we estimate that we'll be able to grow revenues in 6% to 6.5% range. And that's the premise of our guidance.

From a quarterly perspective, you raised I think a very fair point, and you're right we don't give quarterly guidance but we would certainly will try and remind people that we had a very strong first half of the year and extremely strong first quarter.

I think if you look at it historically, in what I would sort of call a normal year. We've earned something like 52% of our pre-tax earnings in the first half of the year. And 48% in the back half give or take percentage or two. In 2011, I think those numbers were closer to 58%, 59% in the first half of the year.

We would suggest and our own internal guidance suggests that 2012 will return to kind of a normalized allocation with us earning something like 51% or 52% of our overall annual earnings in the first half of the year. So I think as you all think about your models and your allocations of our guidance or your own guidance, obviously I would suggest that that you sort of keep those guidelines in mind.

A.J. Rice - Susquehanna Financial Group

Just last thing, on the NAP acquisition you said that that is not in the guidance. Can you give us sort of your update on that and then if it were to close with that be something that you would say is sort of neutral issue or could it be additive at some point this year?

Alan Miller

We announced the NAP acquisition, I think back at the end of November, subsequent to that the selling board of the hospital realized that they had a legal obligation to obtain approval for the sale from an independent hospital authority board and they have been in the process of attempting to do that and are determined to do it.

They have run into some obstacles. We've largely sort of stepped aside as they try and resolve this problem. We stand ready to complete the deal. If in fact they get the requisite approvals, we're prepared to move forward.

The main reason I mentioned that NAP wasn't in the guidance is because I think some people were struggling a little bit with our revenue projections without NAP in the guidance. As far as an earnings perspective, we were always thinking that in 2012 the NAP transaction would be fairly neutral to having any impact on our 2012 earnings.

Operator

Our next question comes from the line of Adam Feinstein.

Adam Feinstein - Barclays Capital

Maybe just starting at the point and I just want to say it is a great year for you guys. And just looking back through to my notes and I guess we started the year initially at about $3.55. So it's certainly a very strong year even with some of the headwinds you highlighted, Steve, in the acute care space. So maybe just a quick update in terms of just the key markets, just get some more color on Vegas and then on the McAllen market, also Steve?

Steve Filton

Sure, Adam. When I talked about or referred to kind of a tale of the two half of the year, a lot of that I think is a function of our individual and most important markets. The Vegas market really outperformed in the beginning of the year, they saw their unemployment rate dropped in a short period of time from a high of about 15% to something like 12% in the first quarter of 2011. But then as the year progressed unfortunately that employment rate downs back to 14% and our payer mix consistently sort of deteriorated with that metric.

Right now, I think it's sort of status quo in the market. Our Vegas volumes were relatively soft in Q4. Payer mix remains stable to maybe very slightly down. There is a lot that's been written about the market, much more focus quite frankly on the gaming industry that suggests that by the end of 2012 the market will start to see some broader economic recovery.

For the most part we really have not embedded any of that in our guidance. Our guidance simply assumes that the payer mix situation stabilizes and as a result of that that our revenue growth picks up a very slight amount from where we are today.

The South Texas, particularly the McAllen market is much of the same. We've disclosed in number of previous quarters that the economy down there has been a fairly soft over the last four or five quarters. That market is plagued by some unique issues, border violence, issues in Mexico that obviously are again very unique to that market and much of the same our expectations over that not a lot of that changes in a significant way in 2012.

Adam Feinstein - Barclays Capital

And just a couple of follow-up questions. And then I guess with the PSI integration fully ramped up now. I guess, just, you'd outlined the base case $40 million in the synergies and potentially in $20 million just on the improved margins. So just, Steve, any update in terms of just relative to the initial base case in terms of how you're thinking about just the overall impact from that?

Steve Filton

So I think that the corporate overhead synergies, Adam, we estimated, we would achieve about half of it, literally out the gate with the transaction a year ago. And we'd achieved the remaining half of the $40 million that you alluded to over the course of a couple years. I think that has gone, very much according to plan. I think we're largely there. We've gotten most of those overhead savings. There maybe a few million dollars to go in 2012. But I think we are certainly the lion share of the way there.

As far as the margin improvement, I think as you start to see the behavioral result. You start to dig into them a little bit more. I think you'll see that we actually, well, we didn't anticipate getting a lot of margin improvement in 2011. I think you'll see that we actually were able to achieve a little bit of that margin improvement in '11.

I think the general, since that they were somewhere between 50 and 100 basis points of available margin improvement over a couple of years. I think we still share that view. Again, I think we got a little bit of it in '11. And I think our sense is we'll get the rest of it in '12 and to some degree in '13 as well.

Adam Feinstein - Barclays Capital

And it is just a final question for Alan, maybe just if you could just talk a little about your view in terms of the overall environment and just clearly a lot of things going on in Washington but just your thoughts in terms of just managing in this environment with some of the uncertainty in the Washington?

Alan Miller

Adam, I don't think much is going to happen of anything. The election is coming in terms of legislation. As you know, some of the ObamaCare has been modified rollback exemptions. So that will be very interesting to see what the supreme court does and what happens in the election. So we don't anticipate anything much during the year, waiting for the election.

The one thing, I had noticed that there appears to be a lot of opportunities coming up. The non-profits are uncertain, more uncertain than others and there is a lot of opportunities. And we have done well in terms of integration of psych solutions. So we are optimistic.

Operator

Your next question comes from the line of Tom Gallucci.

Tom Gallucci - Lazard Capital Markets

Just two questions. One, both in behavioral health, the first, there has been some focus in Washington on the Medicare side. If you go back a few months in terms of look back to your PPS, just wondering what your latest views are there in terms of the potential for change or not in the Medicare side?

And then, number two, clearly volumes have been very strong. I'm just wondering if it's real big picture, how you sort of seeing the supply demand equation out there. It seems like whenever you build a bed its fills fairly quickly. So where do you think these people getting care before the beds are build. Is there still a significant supply demand imbalance or really where you think the volume is coming from?

Steve Filton

Sure, Tom. So taking the reimbursement question first, CMS had announced previously that when they came out with their annual Medicare rate update for behavioral. They would likely sort of do as you suggest that our retrospective look back on the PPS program and perhaps make some tweaks of the system. Some people I think get delivered to that to me and they would consider some major overhauls. There was some conversation at the MedPAC meeting or two in that regard.

Our expectations, we've said this for while is that sometimes soon in the spring CMS will announce their rate update for fiscal 2012. We think that that's likely to be accompanied if at the most by some small changes in the side PPS system. But at this point we do not anticipate any significant revamps or reduce or overhauls of the system and largely anticipate that it will give business as usual in terms of Medicare reimbursement.

In terms of volume strength in the behavioral business, we've attributed it to a few different dynamics. You focused on the one, which is our continued capacity expansion. And we have certainly benefited from that. And we have been clear that we didn't think we could be putting up the sort of growth numbers that we are. If we were not doing this sort of and have been doing this regular capacity expansion that at least in our own portfolio now then ongoing for probably six or seven years.

I will say this time. I mean I think it's not just a question of the old feel, the dream dynamic that if you build it they will come. I think we have been very prudent and our operators have been very prudent in identifying those situations, those markets, those hospitals that have an unmet demand that are currently turning patients away. They're operating at very high occupancy levels. That's where we have been adding beds.

And as a consequence as you suggested, when we add beds we've been pretty successful in filling them fairly quickly. I think we've also benefited from the fact that behavioral demand has not been as recession sensitive as demand in the acute care services are frankly demand in other health care services, that's been helpful in terms of weathering the recession.

And finally, we certainly have been helped legislatively by mental health parity legislation, which is kind of taken a while to gain traction and to kick-in. But I think we've clearly benefited from that over the last few years. So we continue to pursue our capacity expansion program.

We've got many, many hundreds of beds in the pipeline, various stages in the pipeline. We often have sort of regulatory zoning issues that we have to overcome, but we're working very aggressively because we think that the demand, we're not seeing any diminution in that demand. And so we want to be in a position in those markets whereas called for to take advantage of the growth.

Operator

Your next question comes from the line of Ralph Giacobbe.

Ralph Giacobbe - Credit Suisse First Boston

Just wanted to go back to the guidance, I guess I am sort of wondering, Steve, when you mentioned kind of that 3% to 3.5% on the acute care side and 6% to 6.5% on the behavioral side, maybe if you could help us sort of bridge what that means sort of on the EBITDA side of things, obviously the last couple quarters, topline on the acute care side has been weak, which has led to sort of declines in the EBITDA numbers and so I'm just wondering how you're thinking about sort of the operating earnings growth in both of the businesses?

Steve Filton

I think on the acute side, Ralph, 3%, 3.5% growth would generally get you to EBITDA performance that would be flat to very slightly up. I think that there are few tailwinds that push that up a little bit in the sense that we've talked over the last year to about our acute care capital projects, that's new capital that we've employed in Texoma, and in Handel and new tower at Summerlin and those projects continue to ramp up.

And I think provide a little bit more up lift and then we would get just from kind of same-store results. And also I think we've talked about some of the drag that we felt for more South West facility over the last couple of years, which has been very focused on some regulatory compliance issues. We've seem to be largely have that behind us and so we're hoping for pickup in that market as well. So that maybe pushes the EBITDA. It provides a little bit of cushion for that growth.

On the behavioral side, again, I think our view is that 6% or 6.5% of revenue growth should translate into high-single digit. EBITDA growth and that includes I think going back to Adam's question some improvements in the acquired PSI portfolio. So I think that's where how the guidance rolls up to the growth that we project in the guidance.

Ralph Giacobbe - Credit Suisse First Boston

And then, just going back to the kind of 1Q, tough comp and the commentary, you know, helpful to get sort of that split first half to second half, I guess to get sort of a little more granular and would you be little in this sort of suggest, I mean do you expect EPS to sort of be up or down in the first quarter relative to what you reported in the first quarter of '11. What do you expect EPS to grow?

Steve Filton

I think again if you sort of do the math on the percentages that I suggested, it would sort of lead to the believe that we may well be a little bit behind by as you see in the first quarter and then make it up as the year progresses.

Operator

Your next comes from the line of Justin Lake.

Justin Lake - UBS Securities

Two questions here, first up for Alan. Alan, in the release you discussed being encouraged by opportunities to expand your presence in the behavioral health business, can you push that upwards?

Alan Miller

I have nothing specific to tell you but because of our position, when anyone wants to sell or anyone wants to have a new facility built we are the obvious one that they come to. So we are very, as Steve has pointing out we have been expanding our existing facilities, but we are looking at other things as well.

Justin Lake - UBS Securities

So you're seeing the pipeline for M&A or de novo opportunities expand versus where it's been the last few years or tell me if I'm wrong, I don't think there has been much in the way of M&As and obviously the psych solutions?

Alan Miller

Psych solutions but there is more business out there. We just had a conversation about building beds and seeming to fill them up when we build them. So there is demand out there. And we are preeminent in that business. And people come to us. So we are encouraged that we will continue to have opportunities both internally and for new facilities.

Justin Lake - UBS Securities

And then, just last, Steve, the second question was that I'm wondering if you can walk us through the cash flow and CapEx expectations for 2012?

Alan Miller

I think that our CapEx numbers which I think we disclosed in the 10-K but we're in that sort of 350 range, 350, 360 in terms of estimated CapEx for 2012 which is a little bit of a tick up from this year. And it's reflective of ramp up in the spending on a Temecula hospital that we mentioned in our prepared remarks. It's also reflective of a new patient tower we're building in our hospital in West Palm Beach, Florida as well as kind of smaller but cumulatively impactful numbers of all this behavioral expansion that we're doing both again in our legacy portfolio and in the acquired PSI portfolio as well.

Cash flows, if you sort of run through our guidance and use the income numbers in our guidance, I think cash flows or free cash flows after CapEx is in the kind of 450, 500 range in 2012. And our guidance presumes that bulk of those cash flows go towards the repayment of debt as they have for the past 12 to 15 months.

Justin Lake - UBS Securities

And, Steve, you mentioned the repayment of debt there. And maybe I'll ask this to Allen specifically as you think about capital deployment there own, obviously you brought the side business. You made some commitments to leverage yourself back to investment grade. In the meantime, just recently there has been some really interesting deals from HCA and community in the debt market. You're paying down a low very cost debt for 2013. Any thoughts on where there might be opportunity to change tact there and mend expense to extent to some of these debt deals instead of paying down 4% debt ,buy back stock or do accretive acquisitions that might be more shareholder-friendly?

Alan Miller

I think you covered just about all the opportunities. We're looking at. The company is opportunistic. And we are considering all of the above. In terms of, I might be a little more specific, potentially buyback acquisitions and expansion of our existing portfolio. And having come down to 60%, 61%, we are moving in a very strong direction financially.

Justin Lake - UBS Securities

And If I could just ask one last specific question, Steve, in terms of the debt with these deals going on, just curious if you talked to bankers about what that market might look for you. And if you have any estimate for us in terms of if you were to do a transaction here. This amend may extend maybe even a recap, where would the debt markets looks like versus or the interest expense look like on that debt versus what you currently have?

Steve Filton

The easy answer to your question is we're always talking to our banks and looking at what's happening in the markets currently. So that's a process that literally is sort of ongoing all the time.

I think if you look at what our peers have done in the last month lets say, those I think refinancing deals have been driven by one or two motives or maybe both wanted to lower their interest rates and interest expense and two was to extent their terms out. As far as lowering interest rates, even with the refinances that have taken place our interest rate structure is still by far the best out there.

I think that it would be difficult for us in this market to improve our interest rates much if at all. So that's tough for us. And then in terms of extending our terms out again, not getting into the specifics of our peers. Our terms already are going out at a four five years. So we don't sort of feel that's same, a kind of immediate pressure to do that.

So again, we're always looking at the market and we'll continue to do so. And if opportunities rose along the menu that Alan discussed, we're always interested in what we could access the markets for additional capital. So we're always doing that. But again, I mean I think at the moment the general sense is to continue on the track and the trajectory that we've been on.

Operator

Our next question comes from the line of Gary Lieberman.

Gary Lieberman - Wells Fargo Securities

Maybe you could just give us an update on where you are with regards to managed care contracting for 2012 and 2013 and any color in terms of what you're seeing ion the renegotiations both on the acute and the behavioral side?

Steve Filton

Sure, Gary. It's an interesting area and I know a lot of the folks on the call routinely are having conversations with the managed care companies. And I know that the managed care companies tend only because I read many of your reports to paint a picture of a landscape that's changing a great deal that have a lot of sort of new dynamics in terms of narrower networks and tiered networks. And contracts that are much more aligned with quality metrics, et cetera.

I think in real time and on the ground with our contracts, we're not seeing very many of those same dynamics. Our contracts tend to look very much like they've looked before. And our rate increases have tended to be fairly healthy. We've talked about getting rate increases in the 5% to 7% range for many quarters now. And I think we feel like we continue to be comfortably in that range.

Most of our contracts for 2012 are in the books at this point. There is a small percentage more towards the end of the year. A goodly number of 2013 contracts are already committed to. And again, I think we're very comfortable that we remain in that range of at least 5% to 7% and without a whole lot of other changes to our contracts.

And by the way, I'm not sure that we would be adverse to some of those other dynamics. I think we feel like we've got very strong provider networks in many of our markets and we'd be anxious to be in a tiered network or we rather see the top tier and narrower network, and we're anxious in many of our markets to have quality metrics play a larger role, et cetera. But we're just not seeing a lot of that.

Gary Lieberman - Wells Fargo Securities

Any sense or any thoughts on what types of benefit design changes you saw in '11 or might see in '12 and the impact that that's had on utilization, if any?

Alan Miller

I think the managed care companies are always in a better position than the providers are to give specific information about that. I mean I think our sense generally is that the trends that we've seen for the last few years continue, and that is a continued shift in the payment obligation from the company or the insurance planner, the managed care organization to the patient or the employee themselves.

And so we are in the position of having to collect a larger portion of the bill from the patient themselves than from the insurer. We have a lot of great data on exactly how much that's occurred, et cetera. Certainly, that trend towards a greater payment obligation to the part of the employee or the patient and combined with the weak economy certainly has been a significant and maybe the most significant contributing factor to the muted demand that the acute business has seen over the last few years as patients where they're able to postponing and deferring more discretionary acute care. No question we continue to see that trend.

Operator

Your next question comes from the line of Kevin Fishbeck.

Kevin Fishbeck - Bank of America-Merrill Lynch

I wanted to follow up on a couple of questions that were asked earlier. I just want to clarify around the acute care hospital EBITDA outlook. I think the 3% or 3.5% revenue growth would lead to flat to up slightly EBITDA. Why won't you be able to kind of keep margins flat with that type of revenue growth and then grow EBITDA on that 3% to 3.5% range?

Steve Filton

I think, Kevin, the nature of our business model, no different than our peers, is that this is largely a fixed and semi-fixed cost business. And I think that there has always been sort of a relatively modest amount of revenue growth that sort of covers, if you will, your cost inflation. And I think we believe in this environment it is roughly that sort of 3% to 3.5%. We certainly have a number of initiatives underway to restrain our cost inflation to the degree that we can or the growth of our cost.

But our best guess is kind of in that 2.5% to 3.5% range is probably the rate at which you can keep your EBITDA flat. Now, obviously the corollary to that is a little bit of growth above and beyond that should lead to real margin expansion. And obviously if you can't get there, which is the position we've been in the last couple of quarters, you've seen some margin contraction.

Kevin Fishbeck - Bank of America-Merrill Lynch

But if your revenue and your cost are growing at the same rate, doesn't that mean your EBITDA is going to also be growing 3%, 3.5%?

Steve Filton

Kevin, I don't mean to cut it too finely here. But I think we're right around that. This is just a mass exercise. If revenue grows at 3% and costs grow at 4%, then we should have some expansion. If revenue grows at 3% and costs grow 3.25%, we'd probably have relatively flat EBITDA. I think we're operating in a pretty narrow range when you're talking about those assumptions.

Kevin Fishbeck - Bank of America-Merrill Lynch

And then as far as the deal environment, I don't know if I'm reading too much into, but I think Alan had made some comments about the deal outlook and being encouraged by. Historically, as a company, you guys have been some of the most cautious around acute care hospital acquisitions, because you have a very specific target deal in mind. Do you see that that pipeline is actually starting to heat up there or was I reading too much into that?

Alan Miller

We hear about a lot of deals. We hear about a lot of stresses in the acute business. So we're looking. And some folks thought we wouldn't do this type of deal before. We're always looking and the big thing is getting a good property, good price and having the ability to do it. I think we're there for all of those.

Steve Filton

I also would just clarify, Kevin, you're absolutely right that we haven't done a great deal of external M&A on the acute side in the last few years. As I mentioned earlier, we put about $0.5 billion of new capital into some very large projects, take them off before, Texoma, Palmdale, Summerlin. To a large degree, we've concluded that we could more economically prudently build new capacity than buy it from somebody else.

And I think as Alan suggested before, we continue to go through that thought process as well. We're not stuck on expanding EBITDA in one particular way. If there are opportunities to grow existing EBITDA streams in our existing markets and existing franchises in both real and acute, we're going to pursue that. But we've definitely not been stuck on the notion that kind of one size or one transaction fits everything that we want to do.

So we've been fairly aggressive or employed a fair amount of capital in growing our acute business over the last few years, even though it has not been as you probably really pointed out so much on the M&A side.

Kevin Fishbeck - Bank of America-Merrill Lynch

I guess last quarter, you guys made some bullish commentary about just how you saw the dislocation in the stock price, historic drop, if you will. Q3 and Q4, you're buying back stock. I mean stock has come back up. Is share repurchase still a big part of the mix or should we read into commentary earlier that kind of debt pay down is really still the first use of capital?

Steve Filton

Again, I was clear that debt pay down remains our first use of capital. We continue to generate however a fair amount of cash. And I think Alan I thought was very clear in saying that all other options are on the table including share repurchase. So we're actively evaluating and pursuing all those other options at the same time.

Kevin Fishbeck - Bank of America-Merrill Lynch

On the Medicaid side, I think in the 10-K you said that the fiscal '12 Medicaid rates were down 3% to 4%. What's your calendar '12 outlook for Medicaid?

Steve Filton

Just to frame it for everybody, most state Medicaid year is run from July to June, and we presume or we essentially know now that from July of '11 through June of '12 that our Medicaid rates are down on average about 3% or 4%. What our guidance and our budget presumes is that in July of '12 that Medicaid rates improve, at least relatively improve and maybe are down or flat to down maybe 1% beginning in July of '12.

Operator

Your next question comes from the line of Darren Lehrich.

Darren Lehrich - Deutsche Bank

Just a couple of specific questions here. I guess, first, as it relates to the behavioral business, you obviously picked up some contract related businesses, some things that you have been in the four. I'd be curious to see your thoughts on how you're viewing that set of businesses and whether that's something, you're going to be putting a little more emphasis in terms of growth going forward?

Steve Filton

So, Darren, I mean as part of the PSI acquisition we acquired, what used to be called the legacy Horizon business, which was their management contract business. Just to be clear, we had a management contract business for many years, in more recent years and specifically I think after Psych PPS was implemented, we didn't necessarily see that as a tremendous growth business. But PSI was successful with Horizon and we've embraced that business, and focused on it and continued to try and grow it.

It is still a relatively small piece of the overall behavioral portfolio. And I think quite frankly, just given the size of the portfolio is unlikely the change from a relative level of importance in that sense. But it's a business that Horizon remains I think the biggest contract provider in the country and we certainly wanted to maintain that position.

Darren Lehrich - Deutsche Bank

The contract business that you have in the construction management side of things, obviously separate business entirely. But is there anything at all in 2012 guidance that related to that, maybe just update us briefly on whether there's going to be much there going forward?

Steve Filton

We continue to pursue that business. Again, I would describe it as something that while we think it makes sense and as we're able to get contracts, they can be reasonably lucrative. It's like it would remain a small part of the business.

We do have, I think we've mentioned this before, a new contract to build a hospital in Florida. There's probably a couple of penny of income in our 2012 guidance that are reflective of that particular contract. And again, we continue to look for incremental opportunities to that.

Darren Lehrich - Deutsche Bank

And maybe just last question here as it relates to the Cerner implementation, you've maybe shifted some things around with regard to your high-tech contribution. Can you just update us there on how that's coming together and how we should be thinking about the impact on expenses mainly in 2012 as you move through that process?

Steve Filton

So again, just to put this in historical perspective, we signed our Cerner contract at the very end of 2009, spent the next 18 months or so on the design phase of that project and implemented our first hospital on Cerner in roughly July of 2011. We then have a plan and a schedule that has us converting the balance of our 25 acute care hospitals over the course of the next 24 months or so. And we've been adhering to that schedule.

So, obviously as we implement those hospital, we've been differing from a financial reporting perspective, we've been differing the design and implementation fees and we start to amortize them as we bring each hospital live, that will be the bulk of the sort of incremental effect. And when we talked in our guidance about the incremental expense related to Cerner to EHR implementation Cerner to the EHR implementation, it's really mostly those investment type cost that will start to be amortized.

From an operating perspective, Darren, we had an EHR system in place prior to Cerner, basically a home grown system, and we had operating cost associated with that. We generally feel that the operating cost related to Cerner will simply replace the operating cost that we had in our home grown system and there won't be a whole lot of incremental expense. There maybe some as we do the transition, kind of duplicative expense at each hospital a couple of months a duplication effect, but not a whole lot.

So I think our view is that operating expenses remain largely the same, what I'll sort of call the one-time capital investment, which we've pegged at $6 million or $7 million for each of our acute care hospitals is really the source of the bulk of the incremental expense. And then obviously, we hope that a significant portion, albeit not all of that winds up getting reimbursed through high-tech reimbursement.

Operator

Your next question comes from the line of Christine Arnold.

Christine Arnold - Cowen & Co.

A couple of questions on the behavioral health division, can you clarify, are you expecting your Psych PPS update to be about 3% in October 2012?

Steve Filton

Christine, I believe our guidance presumes it's between 2% and 3%, yes.

Christine Arnold - Cowen & Co.

And then, can we walk through some math here, as I think about the Psych business and the fact that you're converting maybe 150 basis points of revenue from Medicaid's commercial within your behavioral book, because you're taking now commercial patients and residential, and then you're converting residential beds to acute. You're targeting 150 to 200 beds, that's maybe to 2% to 3% of beds. It seems to me, it should get at least a 100 basis point boost to pricing, given that Medicaid pays 40% to 50% of what commercial does. Is that embedded in behavioral guidance in terms of the pricing or is that upside?

Steve Filton

First of all, Christine, I have to say that you are way better doing math in your head than I am. So I'm not sure I'm able to follow that. But I think your point is that, we're doing a number of things to shift away from our reliance on Medicaid, particularly in our residential business.

I think the two things that you cited are that we're taking more commercial patients, which historically we really had very few commercial patients in our residential business. And secondly, we're converting at least a small number of beds from residential to acute, which again should have the effect of shifting away from our reliance on Medicaid.

I think that, again, while I didn't follow the precise math that you went through. The fact that we've been able to sustain fairly high behavioral revenue growth in the third and fourth quarters of this year, despite the fact that we've had 3% or 4% cuts in our Medicaid reimbursement, I think is reflective in part, it's obviously reflective of the strong volumes that we have. But it's also reflective of what you're suggesting, which is some efforts on our part to reconfigure our payer mix a little bit to a more favorable and less Medicaid reliant payer mix. So again, while I can't comment on the precise math that you've talked, I think in general your sentiment is correct.

Christine Arnold - Cowen & Co.

So is there still room to move on, mixing more commercial into the residential and moving up to 200 residential beds to acute?

Steve Filton

Yes, I think we continue to look at those opportunities again to take commercial patients, where we've not necessarily taken them before and to convert residential beds where that opportunity exists. I don't think we feel we've exhausted either of those opportunities yet.

Christine Arnold - Cowen & Co.

And then just on the acute pricing, if I look at your net revenue per adjusted admission it was up 1.3% in the quarter in acute. If I take out the $6 million from the disproportionate share in Texas and EPL and also South Carolina, I get to 1.9%.

Steve Filton

Operator did we lose Christine.

Operator

Your next question comes from Whit Mayo.

Whit Mayo - Robert W. Baird

I have maybe just first it's a random question. There have been a string of what I think are somewhat interesting local press reports in the past month or so, that seem to point to a number of closures of the state owned psych hospitals. And it seems like a lot of these states are just taking the state funds and the patients and transferring them to the private freestanding providers. And I was just curious if you were (devey) of seeing this in any of your markets or just any thoughts on that?

Steve Filton

I mean, I've seen some of those same press releases with. Again, I think as you know historically, the patient population that is tended to occupy state behavioral facilities is not the same as the patient population we normally treat in our facilities. I don't think we've really had the experience of getting a significant load of patients from a state facility in any of our markets. Maybe if that starts to happen with more frequency, we might see that.

But it's not an easy sort of trade in essence, because I think and in a lot of cases these state hospitals are treating a more chronically old population that's designed for people who stay for longer periods of time. And quite frankly, I just don't think we're equipped in many cases to treat that same patient population.

Whit Mayo - Robert W. Baird

It seems interesting some like Medicaid like and Medicare payment that they are giving providers. But I guess maybe to follow on I think with Christine was, just can you talk maybe about UPL in 2011, and how it differed from 2010, and maybe thoughts on 2012? And if you want to comment just on any other pickup in other supplemental funds provider taxes it'd be helpful?

Steve Filton

Yes. So I think that our UPL and disproportionate share, which we sort of combined as our kind of two special Medicaid reimbursement programs. I think in total, we're down somewhere between $12 million and $14 million from 2010 to 2011. We called out that $6 million of that reduction was in Q4.

In our guidance for next year, we presume that that same reimbursement is down probably another $7 million to $9 million in our 2012 guidance. Again, most of that is Texas, although there are some other states. Provider taxes were down, as I recall about $3 million this year, and again I think our guidance presumes that they are down $1 million or $2 million next year. So that gives you a sense of how those numbers move next year.

Whit Mayo - Robert W. Baird

And maybe just back on at the Psych business for a second. Can you just sort of remind us where you are with some of your cost trends as wages, payroll, supplies form? Is there any reason that those unit cost would grow faster than your revenue over the foreseeable future?

Steve Filton

Well, look I think the behavioral business has a number of advantages that you've been able to see in our financial statements now for a while. First of all, the revenue growth in behavioral has clearly been more robust than it's been in acute and that allows us a lot more operating leverage. Getting back to the conversation I was having with Kevin before, if we think 2.5% or 3% is the kind of breakeven EBITDA growth rate or revenue growth rate, we've been well above that in behavioral. And you'll see that in our expanding margins.

The other aspect of it is, is I think we just don't have quite the same level of cost inflation on the behavioral side maybe because you don't have that sort of what I'll call technological component, the cost of drugs or pharmaceuticals and medical equipment technology that you really have on the acute side. So if anything I think which I think refers to your question that cost inflation on the behavioral side maybe 50 basis points or 60 basis points slower than it is on the acute side.

Whit Mayo - Robert W. Baird

And may just one final editorial. I think you've now accumulated over $80 million in prior year favorable developments from med mal for the past three years and most companies would have taken full credit for that. So I just wanted to recognize your progress on that front?

Steve Filton

I appreciate that, Whit, thanks. We've generally been very conservative in that regard. And I appreciate somebody know this thing.

Operator

Your next question comes from the line of Kimberly Purvis.

Kimberly Purvis - Cross Current Research

You had mentioned that EBITDA improvement in the PSI portfolio was expected in 2012. What will be driving that? Is that improved volumes, pricing or something else?

Steve Filton

I think it's a little bit of everything, Kimberly. Although, I think generally we had the sense when we did the acquisition that the UHS facilities on average were run a little bit more efficiently. And that most of the savings or most of the margin gap closer would result from improved expense control.

Kimberly Purvis - Cross Current Research

Can you give a little bit more specific information on that, I mean, is it personal? What exactly is the rental expense? Just a little bit more color there?

Steve Filton

I think it's across the Board. I mean, obviously, if you look at our behavioral segment financial statements and 50% or more of our costs are salaries and wages. So obviously, some of those savings will come from the labor side of the business. But I think we feel it sort of comes pro rata if you will from across the income statement. And just I think is a function of a 30-year history we have of running that business and having the best margins in that business and just doing it as efficiently as anybody else.

Operator

And you have a follow-up with Christine Arnold.

Christine Arnold - Cowen & Co.

I was attempting to ask about the acute pricing, which was up kind of 1.3% in that revenue per adjusted admission in the quarter. And excluding the $6 million from UPL DSH, it was only up 1.9%. So they get to 3%. Are we assuming a payer mix improvement in 2012 or maybe better Medicare pricing? Can you just tease out in addition to the Medicaid improvement where else you see pricing improvement on acute?

Steve Filton

Sure. I would make one point before that, Christine. And that is, when we talk about acute care, we talk about revenue growth in general. We're always talking about an inclusive of bad debt expense. So earlier in the call, when I talked about our revenue in acute care growing at 5.5% in the first half of the year and 2.5% in the back half of the year, that was inclusive of bad debt. So I think if you include the bad debt in either Q3 or Q4, you're looking at a number that is much closer to 2.5%.

But to your point that still is a little lower than our guidance for 2012 presumes. And I think that the increase in our guidance, I did try and tease this out before perhaps I wasn't transparent enough, comes from a couple of things. I mean one is the improvement in some of these facilities that we've invested quite a bit of money in Texoma, Palmdale and Summerlin and that continue to ramp up. That's number one.

And number two is, we do assume while there is no recovery in volumes or uptick in volumes in our guidance. We do assume there is some stabilization or payer mix. And certainly in Q3 and Q4 we saw a payer mix deteriorate, a little bit, not a great deal, but a little bit. And again, the presumption is that in order to reduce that revenue growth number up in acute care, we would have to see that payer mix stabilize in 2012.

Christine Arnold - Cowen & Co.

And Medicare, what are you assuming for Medicare, October 2012?

Steve Filton

Again, I think it's that same 2% to 3% that we talked about. And behavioral, obviously, the two different numbers, but they coincidently wind up being in the same magnitude.

Operator

There are no further questions in queue at this time.

Steve Filton

Well, we thank everybody. And we look forward to speaking to everyone again after our first quarter. Thank you.

Operator

This concludes today's conference. Thank you for your participation. You may now disconnect.

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