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Executives

Brent Turner - EVP- Finance and Administration

Joey Jacobs - Chairman, President and CEO

Jack Polson - EVP, Chief Accounting Officer

Analysts

Adam Feinstein - Lehman Brothers

Ryan Daniels - William Blair

Sujeet Singh - Deutsche Bank

John Ransom - Raymond James

Tom Gallucci - Merrill Lynch

Andreas Dirnagl - J.P. Morgan

Kevin Campbell - Avondale Partners

Gary Taylor - Citigroup

Kenneth Weakley - Credit Suisse

Mark Arnold - Piper Jaffray

Psychiatric Solutions Inc. (OTCPK:PSYS) Q1 2008 Earnings Call May 1, 2008 10:00 AM ET

Brent Turner

Good morning. I am Brent Turner, Executive Vice President, Finance and Administration, for Psychiatric Solutions, and I'd like to welcome you to our Earnings Call for the first quarter of 2008. Today's call is being recorded and will be available for replay beginning today through May 16th by dialing 719-457-0820. The confirmation number for the replay is 5264414. The replay may also be accessed through May 16th at our website, which is psysolutions.com and at earnings.com.

To the extent any non-GAAP financial measure is discussed in today's call, you may also find a reconciliation of that measures to the most directly comparable financial measure calculated according to GAAP on our website by following the Investors link to news releases and clicking on yesterday's press release.

This conference call may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, including statements, among others, regarding Psychiatric Solutions', expected financial performance for 2008. For this purpose, any statements made during the call that are not statements of historical fact may be deemed to be forward-looking statements. Without limiting the foregoing, the words believes, anticipates, plans, expects and similar expressions are intended to identify forward-looking statements. You are hereby cautioned that these statements may be affected by the important factors among others set forth in PSI's filings with the Securities and Exchange Commission and in our first quarter news release, and consequently, actual operations and results may differ materially from the results discussed in the forward-looking statements. The company undertakes no obligation to update publicly any forward-looking statements, whether as a result of new information, future events or otherwise.

At this time, for opening remarks, I'd like to turn the conference over to our Chairman, President and Chief Executive Officer, Joey Jacobs.

Joey Jacobs

Thanks, Brent, and good morning. We appreciate you are being with us this morning to discuss an outstanding performance by PSI for the first quarter. As you can see from our earnings release, we once again produced very strong results. Given the acute focus on our same facility revenue growth metric, I am pleased to report that we delivered 7.7% same facility revenue growth, solidly within the range we had target on an annual basis.

I would also like to highlight very strong corporate-wide growth. Total revenue increased 33%, consolidated adjusted EBITDA grew 43%, earnings from continuing operations increased 39%. And, once again, we are raising our earnings guidance again for the year, and now expect to deliver earnings per share growth of 34% to 36% as compared to 2007. Our strong growth reflects the addition of the new inpatient beds, primarily through acquisition.

Since the end of the first quarter of 2007, we acquired 20 inpatient psychiatric facilities with approximately 2000 beds in two transactions. We completed the acquisition of Horizon Health in May 2007, and purchased the five facilities from United Medical Corporation in March of this year. We also have purchased two EAP companies during the first quarter of 2008. We also continued to expand our bed count through the addition of beds to new and existing facilities. These beds will help us meet increasing demand for high-quality inpatient psychiatric care, while serving patients whom we cannot admit today.

In the first quarter, we added approximately 80 beds, and we expect to add another 250 beds in the second quarter, of which more than 100 have already opened. As we had previously discussed, we are on track to add nearly 600 beds this year, and we continue to believe we will have all of those beds operational by late this year or very early next year. As I mentioned earlier, we were very pleased with the 7.7% growth in PSI same-facility revenue for the first quarter, consistent with our annual target of 7% to 9% growth for 2008.

We produced this growth in spite of the negative affect of Easter shifting into the first quarter this year compared with the second quarter last year. The increase in same facility revenue resulted from a 2.4% increase inpatient days and a 5.1% increase in revenue per day. Our same-facility growth also continued to drive increased operating leverage.

Our same-facility EBITDA margin increased 180 basis points to 21.9% for the quarter. Considering this was the first full quarter in which the nine facilities acquired from ABS were included in our same-facility base, this growth demonstrates our ongoing progress in operating those facilities more effectively. We also produced an increase of 80 basis points to 20.8% in EBITDA margin for all of our facilities. This improvement contributed significantly to the 120 basis point increase in our margin for consolidated adjusted EBITDA, which totaled $77 million for the quarter, up 43% from the first quarter of 2007.

Looking forward, we intend to continue executing PSI's proven business model. Our pipeline of potential acquisitions remains healthy in a favorable pricing environment. And we have the financial capacity to carry out our plans. Steady growth in the industry demand also provides a solid foundation for the growth in our existing facilities and supports our development of new beds. With an anticipated 7% to 9% expansion in same-facility revenue annually, we expect to continue increasing our EBITDA margins over time. We remain confident about our ability to continue to expand our same-facility EBITDA margin.

In summary, we are well-positioned for a future significant growth. We enjoy positive industry conditions, a successful strategy and a highly experienced management team. As in the first quarter, the key to leveraging this momentum is primarily a matter of execution. And let me assure you that we are very focused on getting the job done.

Thank you again for your time this morning. Here is Jack Polson, our Chief Account Officer, to review our first quarter financial results in more detail.

Jack Polson

Thank you, Joey. We produced record revenue of $429.7 million for the first quarter of 2008, up 33.3% from the first quarter of 2007. Consolidated adjusted EBITDA increased 42.5% to $76.8 million, which was 17.9% of revenue from $53.9 million for the first quarter last year, which was 16.7% of revenue. Income from continuing operations grew 41.4% to $25.8 million, while income from continuing operations per diluted share rose 39.4% to $0.46 from $0.33 for the first quarter of 2007.

Cash flow from continuing operations was $11.4 million in the first quarter, up from $5.2 million for the first quarter of 2007. Our first-quarter cash flow was impacted by the $18.2 million of semiannual interest payments on our senior subordinated notes, as well as performance based bonuses for 2007 paid during the quarter.

Additionally, the $19.9 million increase in accounts receivable in the first quarter was primarily the result of sequential growth in revenue. Our DSOs improved to 52.5 days as compared to 53.3 days in the fourth quarter 2007.

Regarding our acquisition activity, we paid approximately $120 million for the UMC facilities and $20 million for the EAP that Joey mentioned earlier. In addition, expansion in growth capital expenditures totaled 3.2% of revenue for the quarter and ongoing maintenance CapEx was 2.1% of revenue. As noted in our news release, we increased our guidance for 2008 income from continuing operations to a new range of $2 to $2.03 per diluted share, primarily to reflect exceeding our guidance for the first quarter.

As always, our guidance does not include the effect of any future acquisitions. This concludes our prepared remarks this morning. Melissa, would you please open the floor for any questions?

Questions-and-Answers Session

Operator

Thank you. (Operator Instructions). We'll go first to Adam Feinstein with Lehman Brothers.

Adam Feinstein - Lehman Brothers

Okay. Thank you. Good morning, everyone. A few questions here. I guess just to start, maybe just talk a little bit about just looking at the same-store growth here in the quarter, I was just curious if there was any change in mix. Revenue per patient day was up slightly relative to the fourth quarter, and just curious if you saw any changes in mix in other quarter.

Joey Jacobs

Adam, this is Joey. No, really, the mix was pretty consistent. As with previous quarter, as I've been mentioning in the presentations and group meetings this year, we think that pricing is going to be around that 5% number for this year as it was last year. So, it’s the similar quarter to what we've had for 2007.

Adam Feinstein - Lehman Brothers

Okay. And just you had mentioned about ABS ramping up. So just curious if you had more details in terms of I know there was an issue at one of the bigger hospitals there. Just curious if you've seen that turn the corner?

Joey Jacobs

Adam, ABS had a good quarter, as I mentioned earlier. They were in for the full quarter. They were just in one month for the fourth quarter, but in for the full quarter this year. And you really see that show up in the margins and in the revenue growth. The one facility, the Pines facility, is doing much better. It still cost us about 80 basis points on the patient day metrics for the first quarter, but it's improving every day.

And so it's on track. Once again, that was a four-year turnaround versus what we usually do in three years, so it's on track and improving every day.

Adam Feinstein - Lehman Brothers

Okay. And then you guys have a lot of opportunity with the new beds coming online and some of these development projects also. If you could just refresh our memory on the timing just in terms of as we think about the rollout. You had given some numbers out, I guess on the last call. But just wanted a quick update in terms of how we should think about the new beds coming on, as well as the opening of the newer projects?

Joey Jacobs

Adam, it looks like that we will be right at 300 beds for the first six months of this year. We had 150-bed project, same-store project, that we wanted to open in March that actually got opened in April. And then we have our Springfield facility that's going through licensure as we speak. So I feel real good that we'll have about 300 beds opened up during the first six months of this year, with another 300 going in the last six months.

So that's how the beds are coming online. And it can move a little bit, just to construction and punch lists and finishing up. But we think we will have 300, maybe over 300 beds in the first six months of this year, with 180 of those, approximately, same-store beds and 120 would be the de novo project in Springfield.

Adam Feinstein - Lehman Brothers

Okay. And just final question for me. In terms of your ability to borrow, just wanted to get your update thoughts there in terms of what your intentions are going forward, just thoughts in terms of expanding your credit facility or anything of that nature.

Brent Turner

Okay. Adam, this is Brent. We have $100 million in liquidity, right as we sit today, in between our revolver availability and cash. And obviously, cash flow for the balance of the year will pick up significantly. So we're actually in good shape to continue to finance our growth strategy. We always look at our cap structure and evaluate opportunities. And as we said, our senior subordinated notes are trading above par, and the revolver can be expanded if we desire to go that direction. And we will be extending our revolver between now and the end of the year to push out the maturity.

So we have several different options open. But as far as just continuing to meet the requirements on our pipeline, we are in good shape with the liquidity we have today.

Adam Feinstein - Lehman Brothers

Okay. Thank you.

Operator

We'll our next question from Ryan Daniels with William Blair.

Ryan Daniels - William Blair

Yeah, guys good morning. A couple quick questions. First, on the EAP acquisitions, one, can you give us a feel going forward for what the revenue should like in the management contract segment? I know you've been guiding us toward the $42 million, $41 a quarter range. Might that tick up a little bit with these two deals, or should we think of that as still being relatively flat and maybe the acquisitions offsetting some contract losses? Any color there would be helpful.

Joey Jacobs

Ryan, this is Joey. It'll probably tick up a little bit. We did make two acquisitions in the first quarter and we'll make a small one in the second quarter, EAP transaction. But that will be it for the year. So it'll tick up. The first quarter was a very good quarter for our management contract division, so it could tick up just a little. But once again, we think it's neutral and nothing significant there. But if we come across a small EAP company that we need to roll into the company, we will do that.

Ryan Daniels - William Blair

Okay. And was there much revenue contribution in Q1, those are pretty late in the quarter, right?

Joey Jacobs

Correct, there wasn't much contribution at all to those.

Ryan Daniels - William Blair

Okay, great. A question we haven't asked in a while, but I'm curious if you are seeing more, on the acute hospital side, more bed closures now that PPS is fully rolled in. I know you guys have tended to kind of track that in the past, even if it is more anecdotal. But do you have any more color on that now, kind of four years into it, what you're seeing on that side and if it's creating more opportunity for you to capture that geriatric business?

Joey Jacobs

Once again, the last story I read was a facility in California just closed its psych beds. And that has occurred in the last 30 days. And they were acute psych beds. So once again, we do see the acute facilities continuing to close, psychiatric programs.

Ryan Daniels - William Blair

If those are in your markets, can you capture those referrals pretty quickly by going --?

Joey Jacobs

If they are in our market, absolutely. We might have to start a service, but however, we got to have beds. In California, we turn away patients every month. So, we have to have beds and we are getting those built. So, we will be able to take that market as acute facilities close their psych beds, we should be able to take those patients.

Ryan Daniels - William Blair

Okay, great. A little bit broader question. If we look at the US economy slowing a bit, it's not impacting your volumes at all. But I'm curious if you guys look at state budgets and maybe some of the pressures on budgetary issues there, if you are having any more discussions about Medicaid rate freezes or maybe lower than the 2% to 4% you were thinking as we go into the back half of the year. Are you guys still pretty comfortable that you'll get the rate updates on average across the US that you are modeling?

Joey Jacobs

We feel confident that we will get our model. And as I mentioned earlier, we think we're going to be at the 5% range for the company. First quarter came out that way. Two of our larger states, we've already gotten rate increases there. But the states do have to get through their budget cycles, and, as you know, state are usually, July 1 start of a new year, or October 1. So, we'll just wait and see, but we feel good about the 5% revenue per day pricing for us.

Ryan Daniels - William Blair

Okay, great. And then last question and I will hop off. Just on the new build, the Springfield facility, can you give a little color on how that ramps up? Is that something you are kind of premarketing already to referral sources? Obviously you have facilities in Illinois, so you know that market. But how do you market that and how quickly will that ramp up? And can you remind us when that might break even on a 1, 2, 3 quarter basis? Is it to 2 3 quarters out? Thanks.

Joey Jacobs

It's probably three quarters out. Ryan, I don't have that detail in front of me. For example, in this market, the medical/surgical hospital that has a psych unit is going to close their psych unit once our psych beds become operational. So, we will have a transfer of patients day one, once we become operational. So once again, it's a good market for us. But I don't have their detailed budget in front of me.

Ryan Daniels - William Blair

Okay, no, that's good color. Thanks and congrats on a great quarter.

Joey Jacobs

Thanks, Ryan.

Operator

We will go next to Darren Lehrich with Deutsche Bank.

Sujeet Singh - Deutsche Bank

Good morning. It's actually Sujeet Singh calling in for Darren. I had a question on, one of the major drugs in your formularies going generic. And just wanted to get your comments from you as to whether it is a top drug for you guys and what kind of savings could you expect from Risperdal going generic?

Joey Jacobs

It will be savings to us. If you're not familiar with the story, part of our strategy this year is we have hired a corporate director of pharmacy to work on those issues as you mentioned there, plus work on better purchasing and contract compliance. And he has a target goal, we have a target goal for him to find us $3 million of annual savings through our pharmacy purchasing and making sure we're taking advantage of drugs going generic.

So, I couldn't give you the exact number on this particular drug, but we do know we have a target of $3 million on an annual basis, and Jack Cronk, who is our Director of Pharmacy for the company. He is off to a good start. He's been with us now about 60 days and we're very pleased with what he's finding and the opportunities we have in the drug area.

Sujeet Singh - Deutsche Bank

Great. And the just a second question is relative to the UMC deal. Could you just give us a sense for what plans you have for bed editions there? And specifically in DuPont, is that facility starting to work together with the facility you have in Jeffersonville?

Joey Jacobs

Absolutely, we have two facilities in Louisville, KMI and DuPont. And both of those facilities are working with our facility in Jeffersonville, Indiana, Wellstone. And we actually have been able to be more efficient and getting patients more referrals to the Wellstone facility; so that is already a positive there.

We're looking at the DuPont campus as we speak. We would like to do a 20-bed expansion for that campus as soon as possible. And so, we have great expectations for the Louisville, Jacksonville and Ocala markets, and this was a terrific transaction, off to a great start.

Sujeet Singh - Deutsche Bank

Great. Thanks very much.

Operator

We will go next to John Ransom with Raymond James.

John Ransom - Raymond James

Good morning.

Joey Jacobs

Hey, John.

John Ransom - Raymond James

Tell me, including the ABS facilities and I know you mentioned 80-bp hit from the Pines, but overall, what kind of effect does including those facilities then have, if you including the Pines and everything else?

Joey Jacobs

Say that one more time. What is the impact on --?

John Ransom - Raymond James

What was the impact on same-store sales and volume from including the ABS facilities in for the full quarter? You mentioned an 80-bp hit from the Pines. But if you take everything into effect, what was the effect of rolling those facilities in?

Brent Turner

I don't have those numbers, and I doubt if we would give those specifically for that group of assets. You can look at the margin and you can see how strong the margin was for the first quarter, and that is with all those nine facilities in there. And that's covering the Pines, who is down about 80 basis points on the sense of that.

Joey Jacobs

We really track the Pines, the other eight facilities, we monitor them through the normal process. The Pines is kind of an exception. It is something that, something that the whole executive team thinks about every day.

John Ransom - Raymond James

Sure. And then my other question would be, it looks like you paid about an [audit] multiple for the UMC facilities, about 1.9 times revenue. Can you talk about what else might be in there other than the $65 million in revenue that would push that purchase price toward the high end of your historical range? Thanks.

Joey Jacobs

Well, actually, John, I'll give you just a little bit more color. We already have one month of that transaction with us and they had a fantastic March, exceeding our expectations. We think starting March 1 for the next 12 months that they're going to generate closer to $69 million of revenue.

John Ransom - Raymond James

Okay.

Joey Jacobs

So that should be a number you should be using. And then we think the EBITDA multiple is below 9, when you look at it for this year. So, it's a great transaction. It gives us three markets. It gives us the Louisville market and Ocala and Jacksonville. Those are two very tough CON states for new entrants into the markets there.

So, these were Ardent Quality facilities. They have grown their earnings the one month we have had them and expanded their margins. So they are off to a great start. We got [John Hollingsworth] heads up our Louisville market for us, and [Paul Andrews] heads up our Jacksonville/Ocala market for us. And just great teams that we got from them and great leaders leading those markets.

John Ransom - Raymond James

Were there any additional beds that you picked up from a CON standpoint that aren't reflected in the current revenue base?

Joey Jacobs

Yes, there is. It's mainly in the Florida facilities.

John Ransom - Raymond James

Okay.

Joey Jacobs

And there is, I don't have the exact numbers. But it's around 50 to 60 more beds there for us, so that we can grow into, especially at the Wekiva campus. So, we are very optimistic. This group, the Florida market had expansion capabilities there already. We'll just execute there. And Paul Andrews is doing a great job for us.

John Ransom - Raymond James

Great. And then finally we were done at the Manatee facilities, couple of weeks ago. And that management team expressed a goal to have that census back into the 60 range by the end of the second quarter. Just help us clarify when that facility rolls back into the same-store base and also if you endorse that goal of getting that facility back to capacity. And maybe somebody can give us an idea of what the census was back half of '08, so we can plug in sort of an estimate of what that does to your same-store metrics. Thanks.

Joey Jacobs

Well, absolutely we would like to have 60 patients by the end of the second quarter for the facility. It's actually gone into the '40s. I don't know what it was when you were there, John --

John Ransom - Raymond James

43. After I checked myself in, it was 43.

Joey Jacobs

Okay. You are so severe, we count you twice. But we have the goal of 60. Probably in the third quarter of last year it may have run a census of 10, maybe, 12, something like that.

John Ransom - Raymond James

Great. Thank you.

Operator

We will go next to Tom Gallucci with Merrill Lynch.

Tom Gallucci - Merrill Lynch

Thank you very much. I think a lot of my questions frankly have been asked at this point. But I would be curious about two things. Acquisition landscape, both on the traditional hospital side, as well as, you've talked maybe about doing some more creative things with maybe some universities or things like that. Wondering if you have any update there. And then on the management business, just a quick update on that.

Joey Jacobs

Okay, sure. On the university front, we have two projects, two discussions going on there. One project further down the road, the other project is just in the beginning stages. So, we are keeping our fingers crossed there. We are optimistic that that will work out. We will acquire more one-off facility this year, and I would expect us to have one in the second quarter, hopefully, we will keep our fingers crossed there.

And on the management contract side, they had a good first quarter. So, we are very pleased with what Mike Saul is doing with the management contract company. He was in here last week and just had a great update.

Tom Gallucci - Merrill Lynch

Just one last one, on the EAP type acquisitions. I hadn't heard a lot about that business in the past. Can you maybe talk to us a little bit about the dynamics there and if it is sort of standalone, if it's attractive, or is it also sort of synergistic at all in terms of the core business?

Joey Jacobs

It's a combination of both. The EAP, as we talk about in our presentations concerning inpatients in our acute facilities, employers are very much aware that time off from work because of mental health issues is a huge expense to them. And you'll see more and more employers stepping up and putting EAP products as a benefit there. And the EAP company that we got is a premier EAP company in the country. So, it's small growth and we will continue to help them grow. So, we will continue to make small acquisitions for them. But it is synergistic to us. Some of the national employers look at our hospital network too, so we like the EAP company and what it's doing. But it's very much a standalone company.

Tom Gallucci - Merrill Lynch

Okay. Thank you very much, guys.

Operator

We will go next to Andreas Dirnagl with JPMorgan.

Andreas Dirnagl - J.P. Morgan

Hi, guys. Good morning. a couple of different questions. First, just housekeeping, quick, could we get a bed count?

Joey Jacobs

Sure, Andreas. It's a little over 10,800 licensed beds.

Andreas Dirnagl - J.P. Morgan

Okay, great. Then when he comes to the same-store revenue growth, 7.7% in the quarter, Joey, you had sort of been highlighting for the past couple of weeks and months that the Easter shift was going to have a negative effect on that. Do you have any estimate as to without that Easter shift what that number could have been?

Joey Jacobs

It would have been well in the 3% ranges, and probably towards the higher end. So, Easter impacts you from Good Friday until the second Monday following Easter. So, there is about a 10, 11 day period where Easter and the spring breaks affect you.

So, we would have been well within the over 3% for patient day growth, if Easter had not been there.

Andreas Dirnagl - J.P. Morgan

Okay, great. When it comes to the 5% pricing that you're talking about going forward and your comfort level with that, first, just to check, you are talking, pricing includes your pricing plus acuity mix shift, right?

Joey Jacobs

Sure, when we look at revenue per day, that is how that stat comes out. We do expect commercial contracts to give us 6% to 8% pricing. We do expect the governmental payors to give us 2% to 4% pricing. Today, CMS or Friday, CMS will put out their rate increase for July 1st for us. It's not material to us, but they will be putting it out, and we think it's above 3%.

So, on the pricing front, the metrics is 6 to 8 on commercial, 2 to 4 on governmental, and we think Medicare this week will give us a 3% increase effective July 1st.

Andreas Dirnagl - J.P. Morgan

Great, just a couple more quick ones. You talked about potentially doing a hospital acquisition in the second quarter. That would get you to your six in the first half of the year. Can I just get you to say that after that, you are looking for the next 12 months to be another minimum of six acquisitions?

Joey Jacobs

No, you caught me once; you're not going to catch me twice. But we would expect to make more acquisitions in the last six months.

Andreas Dirnagl - J.P. Morgan

Okay. On the margin side of the business, really good same-store 180 basis point growth. Can you just talk about, Joey, sort of where you are, both on a same-store and a full sort of facility count basis and where you think you can take it and over sort of what timeframe?

Joey Jacobs

Well, once again, we will have a group of assets that come in for the month of June; the Horizon transaction will come in for the month of June. So, if we were not -- if we were just to stop acquiring, within 24 months we would probably be in that 23%, 24% range for EBITDA margins. We would be there if we quit dropping in. Now, the best part of the first quarter was, as you saw we dropped in the ABS for the full quarter. And you can see how strong the margin was for the first quarter.

So we have improved their operations and to deliver a 21.9% margin dropping in those group of nine facilities, that's pretty good work for our management team. Terry Bridges and the division presidents and the CEOs have done a great job.

Andreas Dirnagl - JPMorgan

Okay, great. And final one, Jack, you were just speaking a little quickly for me to get it down. The cash flow number, which did increase obviously nicely in the quarter, sort of what were some of the impacts that you are talking about there?

Jack Polson

Yeah, we have semiannual interest payments, this quarter it was $18 million of that semiannual interest payment. And then on the accounts receivable, we had sequential growth of over 6% in our revenues and so over $20 million and so that's the dynamic there. Also, the last one was we paid our incentive compensation out for 2007 first quarter.

Andreas Dirnagl - JPMorgan

Great. So it was mostly just timing issues then, okay. Great, thank you very much.

Jack Polson

Thank you, Andreas.

Operator

We'll go next to Kevin Campbell, with Avondale Partners.

Kevin Campbell - Avondale Partners

Thanks for taking my questions. I wanted to ask a couple on the same-store growth metric sort of looking forward. You had mentioned I think last quarter that you have a facility where you had the infection control issue, and you thought that it would be fully ramped by the end of the first quarter. Did that in fact happen?

Joey Jacobs

Yes, it did.

Kevin Campbell - Avondale Partners

Okay, great. And then looking at the Pines facility, can you give us an idea as to at what point last year census sorted reach the low before you started to ramp it back up?

Joey Jacobs

It was in the fourth quarter.

Kevin Campbell - Avondale Partners

Okay. And then with the inclusion of Horizon, as you mentioned, coming into the same-store base here for a month, is there any specific impact we might look for there, any reason why that might cause that to come down or at least towards the lower end of your guided range or anything in particular?

Joey Jacobs

We wouldn't give that out, Horizon will come in and we're doing a good job, those facilities improve every day. So we are very pleased with our Horizon facilities and they will just come in. We have no other detail to give on those.

Kevin Campbell - Avondale Partners

Okay, great. And is there a point down the road two or three years maybe where you guys focus less on acquisitions and more new bed development and at what point do you get there or do you feel like there is still several years worth of acquisitions that you can be doing in the six plus per year range?

Joey Jacobs

There is several years of acquisitions to go, several years, minimal of five years in my mind. Five years is a long ways out. But we are going to continue to build beds. We approve projects just about every day about expanding beds in the future. So we will be building more beds.

Kevin Campbell - Avondale Partners

And then looking at the bed development, I think you had said previously 600 this year, 400 next year. Is that 400 number still the same or is '09, has that gone up?

Joey Jacobs

I don't know -- I do not have that schedule, but I would expect us to build 400 beds.

Kevin Campbell - Avondale Partners

Okay. All right, thank you very much.

Operator

We'll go next to Gary Taylor, with Citigroup.

Gary Taylor - Citigroup

Hi, good morning, thanks for taking the call. Just two quick questions. If I'm not mistaken, the acquisition spend this quarter also includes the Three Rivers facility, is that correct?

Joey Jacobs

No, three Rivers was bought last year, 2007.

Gary Taylor - Citigroup

I'm off -- looking at the wrong (inaudible), sorry. And the other question is, what is the current cost on your revolver?

Brent Turner

Gary, its Brent. Its grid-based pricing and we're at LIBOR plus 1.75. So that's roughly 4.65% before the drop yesterday. That would actually come in a little bit with the subsequent rate drop that we saw the Fed do yesterday.

Gary Taylor - Citigroup

Is the grid driven by total leverage ratio?

Brent Turner

Total leverage, correct.

Gary Taylor - Citigroup

Okay. That's it. Thank you.

Operator

We'll go next to Kenneth Weakley, with Credit Suisse.

Kenneth Weakley - Credit Suisse

Thanks. Good morning, everyone. I was curious about return on capital in the business, I know you're acquisition intensive and it kind of dilutes it. But maybe you could spend a little time talking about the aggregate return on capital for the company versus what you think your weighted average cost of capital is? Thanks.

Joey Jacobs

Ken, as we've discussed before, obviously, when we look at that metric, we evaluate it on the facilities that we are acquiring and we recognized that that metric does not look favorable when you look at our results in periods where we've made acquisitions and obviously, we have to get the benefit of having the 12 months of the acquired facilities in our results. But our goal and our expectation is that our return on invested capital is in the mid-teens and we see that on facility specific levels. And we would see that if we stopped acquiring things, everyone would see that on our consolidated results.

However, we still have a very favorable outlook on the opportunities in the acquisition arena. And you can see from our same-facility results that we absolutely translate those investments into higher returns for the company and for our shareholders. So we're going to keep doing what's worked for us.

Kenneth Weakley - Credit Suisse

So, as I look at your invested capital base has gone from about $1.4 billion in '06 to roughly $2.2 billion today. And your net income has gone -- your net income is growing nicely obviously, from $18 million last year to $25.5 million. As you know, the returns there are pretty small. So at some point, as the company matures, maybe five years down the road, the invested capital base will grow more slowly, and then your net margin should go up dramatically.

So if you could forecast, I think Joey had mentioned earlier, if you stopped doing deals you would get some sense of where your growth would be. Spend a little time on where you think the growth of the company is without doing deals, because at some point, from what I understand, there's three or four or five, there's not too many $100 million plus deals left, unless that is wrong.

So address -- I guess address your market share today, your revenue base, versus the total market and then the available acquisition pipeline. And then secondarily, at what point you think those -- clearly your returns are below your weighted average. I'll move first, I guess Brent, what do you think your return -- your weighted average cost of capital is and then when do you think, you actually start to earn a real return on your capital base? Thanks.

Joey Jacobs

Okay, Ken, this is Joey. Let me talk about the future and whatever. As I mentioned earlier, for the next five years, can PSI acquire a minimum of six facilities a year? Absolutely.

Kenneth Weakley - Credit Suisse

Do you know what that revenue base would be, Joey, just --?

Joey Jacobs

Sure. You can take an average facility for us is going to generate somewhere between $13 million to $15 million of revenue. And you can use six or ten or twelve or whatever number you want to plug in there as far as the revenue growth coming from acquisitions and we see that good for the next five years. We do still see some good-size acquisitions that we can do, that we have done in the past. And so we're very bullish for at least the next five years that we will be buying a minimum of six facilities a year.

So, I do not see that changing at all and absolutely, if PSI was to stop acquiring, generate its margin up to the 23%, 24% and just pay down the debt, use all that cash, absolutely, the return on capital, the return on investment absolutely goes up. But we are going to take advantage of the opportunities before us. The worst thing we could have done for this company was not make the UMC transaction. It is absolutely a fantastic transaction, gave us three terrific, growing markets. And they're already exceeding our financial returns. So we will continue to execute on those strategies.

Kenneth Weakley - Credit Suisse

And I guess just the last question, if I could, was about the -- if you look at cash flow to EBITDA or cash flow to net income on a rolling 12-month basis, you can kind of, I guess, kind of pick it apart. But at the end of the day, there is a big delta between the two metrics. Brent, do have any observations for us on when the quality of that cash flow will get better?

Brent Turner

Well, I think if you look -- again, the first quarter for PSI is always seasonally impacted but as we've looked -- if you look back and what we expect going forward is our free cash flow should somewhat reflect our net income for the reported earnings of the company. So, again, we are very comfortable with the quality of our earnings and expect that that free cash flow be pretty close to the reported net income for PSI.

Kenneth Weakley - Credit Suisse

I'm sorry, do you mean cash flow or free cash flow after acquisitions or before?

Brent Turner

Just looking at -- taking out maintenance capital, yes. Not obviously taking into total CapEx for acquisitions.

Kenneth Weakley - Credit Suisse

Understood. Thanks so much.

Operator

We'll take our next question from Mark Arnold, with Piper Jaffray.

Mark Arnold - Piper Jaffray

Good morning. Lot of my questions have been asked or answered already, but I guess a couple of things. Just on the interest rate, and with your decent amount of floating rate debt, are you guys looking at all at fixing out some of that and taking advantage of the low LIBOR rates right now, could you comment on that at all?

Brent Turner

Well Mark, We fixed $225 million of our floating rate back in the end of November. So we only have about roughly 40% of our debt that floats and some of that's on the revolver, which we want to keep floating, with the ability to pay it down from cash flow. So we're comfortable with 40% floating and 60% of our debt fixed. And quite frankly, we've benefited -- continue to benefit some from the declining interest rates. So, we probably don't have any imminent plans to lock in any other of our floating rate debt.

Mark Arnold - Piper Jaffray

Okay. And then you talked a little bit about capacity, bed capacity additions this year and next. They look like they are pretty much on track but, can you talk a little bit about next year and you talked about somewhere in the 400 bed range. How good do you feel about meeting capacity demand next year with that bed growth? I've noticed that you guys have kind of ramped up over the last few months. I think even in these newer facilities you acquired from UMC, there is definitely some CON applications out there to grow those beds even more. Do you feel pretty good about meeting the capacity demand in all of your markets here with kind of where your plans are for next year?

Joey Jacobs

Absolutely and in fact, let me clarify -- the 400 beds that we mentioned for 2009 last call and this one that is 400 beds that are already on the books with plans and are in process of the construction. So, 400 will actually grow as we go forward, because we will do other expansions that will add to that. So I think what you saw is that we did not build beds to meet the demand timely in 2007. And we are much more focused on ensuring that we do that timely going forward, which is reflected in the 600 beds that should come on this year and the already 400 bed plans for 2009, which will also grow.

Mark Arnold - Piper Jaffray

Great. Couple of other questions then, UMC, I guess, given the comments you made earlier about EBITDA multiples and such, those margins were -- I guess appear to be quite a bit higher than a lot of the facilities you have acquired over the last number of years. So we should look at that as really a new growth opportunity of moving into some new markets with some pretty attractive growth fundamentals?

Joey Jacobs

Over the course of our acquisitions, we have come across transactions where they have good margins. Ardent being one, UMC being another, some individual stand-alone facilities and we have found that we can grow those, improve their margins and we like acquiring those facilities.

Mark Arnold - Piper Jaffray

Okay. And then Just one last question and Joey, maybe you could address this. Talking about overall market demand, kind of going forward, I think there was a report out, I think it was the Rand Corporation that put it out a few weeks ago, talking about some of the increase in demand for mental health services as a result of our military involvement overseas, and significant need for additional mental health services, which a good portion of which may need to be addressed by the private sector. How do you kind of perceive growth in overall industry demand here occurring over the next say, three or four years?

Joey Jacobs

The best thing I can talk about is a little bit about the military. We are fortunate that several of our facilities are close to large military bases. And we have ongoing and new programs being developed for those bases to treat the soldiers as they are returning and their needs for mental health issues. So we have several of our facilities working closely with the military, trying to meet their demand. And quite frankly, I think we may even have a meeting scheduled in Washington in May to go up and talk to them on a more global basis about meeting the demand. It's obvious that the war, the economy, people losing their houses, there is more stress out there throughout the country and we think the demand for mental health services will grow much faster than medical/surgical demand.

Mark Arnold - Piper Jaffray

Great, thank you guys. Great quarter.

Joey Jacobs

Thanks.

Operator

And it appears, we have no further questions at this time. I would like to turn the call back to Mr. Jacobs for any additional or closing remarks.

Joey Jacobs

Well, I thank you. And just in closing remarks, to all the CEOs and the teams out there, thank you for a great first quarter. We are so blessed here at PSI that you guys continue every quarter to deliver great results for us and take care of the patients. So once again, thanks to you all out there. Had a great visit to Fox Run and Karen and her team there and so I just wanted to mention that. So we'll talk to you at the next quarter.

Operator

And once again, that does conclude today's call. We do appreciate your participation. You may disconnect at this time.

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Source: Psychiatric Solutions Inc. Q1 2008 Earnings Call Transcript
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