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Executives

Brent Turner – EVP of Finance & Administration

Joey Jacobs – Chairman, President and CEO

Jack Polson – EVP and Chief Accounting Officer

Analysts

Adam Feinstein – Lehman Brothers

Tom Gallucci – Merrill Lynch

Kevin Campbell – Avondale Partners

Dawn Brock – JPMorgan

Darren Lehrich – Deutsche Bank

Ryan Daniels – William Blair

John Ransom – Raymond James

Gary Lieberman – Stanford Group

Gary Taylor – Citigroup

Jeff Englander – Standard & Poor's

David Bachman – Longbow Research

Mark Arnold – Piper Jaffray

Psychiatric Solutions, Inc. (OTCPK:PSYS) Q2 2008 Earnings Call Transcript July 31, 2008 10:00 AM ET

Brent Turner

Good morning. I'm Brent Turner, Executive Vice President, Finance and Administration, for Psychiatric Solutions, and I'd like to welcome you to our earnings conference call for the second quarter of 2008.

Today's call is being recorded and will be available for replay beginning today through August 15th by dialing 719-457-0820. The confirmation number for the replay is 2292744. The replay may also be accessed through Aug 15th at our website, which is psisolutions.com as well as at earnings.com.

To the extent any non-GAAP financial measures discussed in today's call, you may also find a reconciliation 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 earnings 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 Psychiatric Solutions’ filings with the Securities and Exchange Commission and in our second 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 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. I am very pleased to report that we had another great quarter at Psychiatric Solutions, which follows our strong first quarter performance. Total revenues rose more than 28% for the second quarter driving an increase in adjusted EBIDTA of nearly 35% and growth in earnings per diluted share of more than 40%. Consistent with first quarter growth and same facility revenue of 7.7%. We produced a 7.8% increase in same facility revenue for the second quarter. We also continued to expand our profit margins through greater operating leverage and enhanced productivity. Our revenue growth was mainly driven the addition of inpatient beds including the impact from the Horizon Health transaction, which brought approximately 1600 beds to PSI in June 2007. We also purchased 5 facilities with more than 400 beds from United Medical Corporation in first quarter of 2008. And during the second quarter added a third EAP acquisition to the 2 we completed in the first quarter. Complementing the expansion of our beds through acquisition, we have added and will continue to add hundreds of beds in new and existing facilities. As of the end of the second quarter, we have completed more than 300 beds during 2008, and we expect to complete about 600 by year-end.

We remain on track with this plan and expect to have them all operational by late 2008 or early 2009. The addition of new beds to existing facilities over the past year contributed to our substantial same facility revenue growth for the second quarter. In some cases, these beds enable us to serve patients who might otherwise have been turned away and in other cases the beds have enabled us to ramp up our initiatives in each individual facility to expand market share. Same facility patient days for the second quarter improved 2.7% from the second quarter last year, which is our second consecutive quarterly improvement, and revenue per patient day increased 5.1% consistent with comparable quarter growth in this measure for the first quarter. The additional same facility revenue drove further operating leverage within our same-facility base, which we also enhanced through ongoing programs to improve facility productivity and efficiency. As a result we have continued to expand our same-facility EBITDA margins, which increased to 170 basis points to 21.8% for the second quarter from the same quarter last year. We are pleased with this margin expansion since the Horizon facilities were included in our same-facility base for the first time for the month of June. This improvement is another indication of our ability first to acquire facilities in attractive markets and second to integrate them quickly in a relatively seamless fashion. As we make further progress, we continue to target long-term growth in our same-facility EBITDA margins of several hundred basis points. The expansion of our same-facility margins drove a 110 basis point increase in the EBITDA margin for all our facilities. PSI has consolidated adjusted EBITDA margins for the second quarter increased 34.7% to over $81 million or 18.1% of total revenue. Before closing my remarks, I will add that many of you are aware of the story that was published in a Chicago newspaper on July 17th about incidents that occurred in 2007 and 2006 at Riveredge Hospital. This is not the first story about incidents at one of our facilities and it won't be the last. So, I would like to share my perspective. First, these types of unfortunate incidents do occur in this patient population. Minimizing and eliminating these types of incidents is one of PSI's top priority. We take continuous improvement of quality, safety, and risk management very seriously and we have built a very effective infrastructure over the past several years. As a matter of fact at all in facilities we thoroughly report incidents to relevant agencies as soon as possible and work directly with agencies to continuously improve safety and quality in a timely manner. The incidents referenced in the newspaper story were reported to the relevant agencies and appropriate corrective actions were taken in 2006 and 2007.

Second, it is also important to understand that we operate in a highly regulated industry with nearly continuous oversup [ph]. Our facilities are surveyed multiple times each year on average and less than 1% of these surveys result in serious deficiencies, a testament to our diligent efforts to continuously improve risk management, safety and quality. We are pleased with this track record in light of the fact that we are providing more than 2.7 million patient days of treatment annually. Just before the story was published the Department of Children and Family Services placed an admissions hold on Riveredge. Riveredge is currently in discussions with DCFS and expects to conclude those discussions soon. As a result, we don't expect a much adverse financial impact from the admissions hold.

In closing, PSI continues to be well positioned in an industry whose key growth dynamics remain intact in spite of the challenging economic environment. Among those dynamics demand for inpatient psychiatric care continues to rise as evidenced by the expansion of the industry's patient days and revenue per patient day even in challenging economic conditions. In addition, capacity growth is limited and the industry remains highly fragmented. As a result of our skill and expertise we had an ongoing opportunity to expand our capacity to meet this demand and expand our market share. Our confidence in leveraging these opportunities lies in our proven business model, which has produced a strong long-term record of profitable growth and increased stockholder value. With a highly quality management team focused on the continued strong execution of this model we expect to expand both through additional acquisitions and through the development of beds in existing and new facilities. We are confident in our ability do drive enhanced profit margins through growth and same-facility revenues at a target rate of 7 to 9% annually. Thank you again for your time this morning and now Jack Polson, our Chief Accounting Officer will review our financial results in more detail.

Jack Polson

Thank you, Joey, and good morning. PSI’s revenue for the second quarter increased 28.4% to $451 million from the second quarter last year. Adjusted EBITDA increased 34.7% to $81.5 million or 18.1% of revenue from 17.2% for the prior year period.

Income from continuing operations for the second quarter increased 44.2% compared to adjusted income from continuing operations for the second quarter last year, which excluded the loss on debt refinancing or earnings per diluted share on the same basis rose 40.5% to $0.52.

Cash flow from continuing operations increased for the second quarter to $41.5 million, which is almost one and a half times our income from continuing operation.

Our maintenance capital expenditures for the quarter totaled $9.9 million or 2.2% of revenue and expansion and growth capital expenditures totaled $15.9 million or 3.5% of revenue.

Based on our results for the second quarter and the prospects for the second half we have updated our guidance for earnings from continuing operations to a range of $2.02 to $2.03. As always this guidance does not include any impact from future acquisitions.

This concludes our prepared remarks this morning. Operator, please open the floor for any questions?

Question-and-Answer Session

Operator

Thank you. (Operator instructions) We will go first to Adam Feinstein with Lehman Brothers.

Adam Feinstein – Lehman Brothers

Okay. Thank you. Good morning. A very strong quarter. Just a question on the quarter, then I want to ask on Riveredge. Maybe, just – you know, it looks like in terms of just length of stay, just want to see what is going on there in terms of, you know, the trend being down slightly, I know that is similar to what we saw in the back half of last year but just want to get any updated thoughts in terms of just patient mix and then a couple of follow up questions?

Joey Jacobs

In the second quarter the patient mix was more acute, Adam, versus RTC. But, I personally, this is just my opinion, I think the length of stay tracks at – maybe ticks back up a little bit as the Pines facility and some of the other RTC facilities ramped back up. So, it is pretty consistent you know, if you look at year-to-date and we are at we see nothing unusual there and also that we have bought more acute beds. The UMC transaction had more acute beds versus RTC beds versus the company's average.

Adam Feinstein – Lehman Brothers

Okay, great. And then with HORC moving into the same store, just curious in terms of how you think about that, I just wanted to get updated thoughts in terms of how those assets are doing. It seems like things are going very well but just wondering if you could just provide additional color there?

Joey Jacobs

We have done a terrific job with those facilities, Adam. And if you can see it in the metrics for the same store numbers in the second quarter. You know, there are in for one month. And so, we are very pleased with that. There is more work to be done with those facilities but we are very pleased both with that and with the unit management and EAP company. All three pieces of that business are doing well. There is more work to be done, but we are very pleased that the same store facility EBITDA margin is worth that and we have done a great job, knowing that HORC is really just 13 months old to us and ABS quite frankly is only 19 months old to us. So, bringing in a $0.5 billion of revenue into the company that was having historical lowered margins, we are very pleased with what operations has done.

Adam Feinstein – Lehman Brothers

Okay, great, and just on the Riveredge Hospital, maybe just comment a little bit more about just you know, what the impact has been since some of this noise first surfaced with the Chicago Tribune article, just to the extent you can provide any commentary I would appreciate it?

Joey Jacobs

Adam, there is not lot more I am talk about it. You know, it did create noise for us and the article was visible enough, quite frankly, we expected that all parties whether it is the State of Indiana or joint commission or the department – DOJ we expect them to take a look in review and if they find something that we can improve on absolutely we will improve it. As I mentioned in the comments, these incidents actually occurred back previous years and we have made considerable improvement there and so we will get through this and as my comments mentioned we have weekly meetings with DCFS and we have got our fingers crossed here and if it was material we would disclose that. Right now we do not think it is. And they are working hard up there taking care of the patients and working through the process.

Adam Feinstein – Lehman Brothers

Okay, and then final question, I will get back on the queue here, maybe just if you guys can talk a little bit about your compliance program, just likewise some of these – in other words just be helpful to hear just about how you guys managed that. I don't know if you can provide any commentary but would like to hear more just in terms of your overall compliance program?

Joey Jacobs

Sure, absolutely. Our compliance for us, we have 23000 employees. So, compliance for us starts at that single employee taking care of that single patient, and if the responsibility of the CEO at that facility to make sure there are in compliance and great quality there. We also have a risk management process improvement person in each facility and that is where we begin gathering data for the corporation both to our risk management department, which has I think about 10 employees and to our quality compliance department which has about 25 employees and we are capturing real-time incidents that might be occurring and especially if we internally classify it as a grave incident that is real time to us and that we immediately began a root cause analysis to either way we can improve the facility, improve the process there and it is – then the compliance quality department reports back to the board of directors, those two board members, Dr. Bill Petrie and Edward Wissing. That gets to see the value lines call the incident, what we are doing, how we are doing, and there is multiple indicators that we track real time for example, medication errors we track that real time, and so – and that is something we have really built over the past 3 years and we will continuously be putting more resources to that and unfortunately the story dealt with past years where we made processes improvements. You know, I am much more pleased about yesterday's email from one our facilities in Indiana, David Bell, they just went through their children services survey and quite frankly, score was quite frankly perfect. There was no point of plan correction needed for that facility. The state was very complimentary of their inspection and that is what we want them all to be and we are getting close but there is more resources, more work to be done. But internally, that is how we handle it, Adam; and we constantly are improving the safety looking at ways to improve the safety, quality, meeting standards and regulations.

Adam Feinstein – Lehman Brothers

All right, thank you very much.

Operator

We will go next to Tom Gallucci with Merrill Lynch.

Tom Gallucci – Merrill Lynch

Good morning, thanks. Just couple of questions here, first, I guess if you could address cash flows seasonally it was a little weaker in the first quarter seemed to have bounce back nicely, any particular driver there in terms of working capital or how should we put that in perspective?

Brent Turner

Tom, this is Brent. This is just like clockwork. You know, first quarter for us due to the reason we talked about, the interest payment on our senior sub notes, is a little lower, but as you see in the second quarter strongly re-bounced, and you know if you look at our free cash flow right in line with our net income for the first half of the year. So, it is really nothing you need happening in the quarter just the normal recovery in the second quarter for us.

Tom Gallucci – Merrill Lynch

Okay. The question that has gotten a lot of attention or an issue that has got a lot of attention, especially in the last week or so has been Medicaid, and I know you have addressed Medicaid at a high level in the past, maybe you can – can you talk a little bit more specifically, I know, a lot of states have it July or June fiscal year. So, we are just starting a fiscal year. What is on the table as far as your concern in key places and what percent of your business really is sort of locked up for the next 12 months given that sort of fiscal year timing?

Joey Jacobs

First, Tom, people need to keep in mind that even though we are only located in 31 states we are getting patients from more than 40 states. So, it is very diverse from a lot of states and that gives us protection. I think that will be probably be less than 7 states that probably haven't settled their Medicaid budgets for July 1, '08 going into '09. Some – there are few what have October 1 dates and there is a few that have lingered over from the July 1 date. As you can see, the revenue per day was 5.1% and you know that is nearly 3 years in a row that we have been able to average between 3 to 5%. We feel okay about what Medicaid has done overall for us, as you know, our internal goal there is a 2% to 4% increase for Medicaid from the state and we have seen states hold, we have seen states give us reasonable rates in that range of 2% to 4%. We have had some states give us more than 4% and quite frankly we have done good about any state wanting to cut our rates. So, right now we feel good. We do monitor it and we do have a process about where we keep up with all the states and, for example, I will just give one example, in the state of Indiana which in total, I think for their Medicaid population were total managed Medicaid first part of last year. This year we probably have averaged a little bit over 5% increase for them for this year. So, we feel good and as the ones that follow the company now, our real goal is to go revenue 7 to 9% and we get that from 2 places, patient days and pricing and in the early part of the company's history we got more from patient days than we did pricing. The last 2 or 3 years it has been more a little bit more pricing than patient days and I think you will see over the next 18 months – you could very well see patient days because of all the beds we built that patient days will continue to ramp up and it could be at their higher end of their range. So, we are very optimistic and comfortable with the Medicaid environment that we have today. You know, we watch it just like you all do and hope for no more surprises or reactions to that, and we hope the economy rebounds. So, that is where we are at.

Tom Gallucci – Merrill Lynch

Okay, final question, I just wanted to come back to Riveredge briefly if I could, first, I think I recall that the same article had been mentioned that 2 state run facilities had been shut down. So, can you just sort of describe the market and what are the options there, relatively for people that are in your facilities?

Joey Jacobs

Well, there is a shortage of beds in Illinois just like in many states across the country, and states have for the past 10 years been closing their own facilities, and so those patients are coming over to us. An example of that, a positive example of that is in the state of Illinois where we have opened up Lincoln Prairie in Springfield, Illinois. We opened that up, took our first patient in the mid-May but really started ramping up the center in June there and so that was an area that really, quite frankly had no psych services or very limited psych services and we are stepping in and meeting that need there. There is limited options in Chicago and so there is an acute shortage of psych beds, not only in Illinois but throughout the country, I think just about every time that when you pick up the paper or an industry paper they are talking about the shortage of beds.

Tom Gallucci – Merrill Lynch

Okay, just to be clear of the focus of the matter is more about, I guess, the adequacy of control as opposed to whether the people should have been there, any sort of reimbursement related issues, is that right?

Joey Jacobs

We think it is focused – it was focused towards those 3 incidents that they talk about concerning quality of those in the story. And so, it is – and we welcome them. We have taken action back in '06 and '07, but once again if they want to come in and take a relook at it that is okay with us.

Tom Gallucci – Merrill Lynch

Okay, great. Thank you.

Operator

We will go next to Kevin Campbell with Avondale Partners.

Kevin Campbell – Avondale Partners

Thanks for taking my call, wanted to ask on the 8-k filing from this morning, obviously – I don't know how much detail you will be able to provide at this point, but have your experienced similar types of requests directly from the Department of Justice or other state agencies in the past and how has that played out. So, what might we expect here?

Joey Jacobs

Well, on the Department of Justice, we take that very seriously and there is absolutely no more comment I can make about that. And very limited more going forward about Riveredge. So, if you have got a Riveredge question you could very well get no comment here going forward. Absolutely, other states come and look at us constantly. As I mentioned earlier, states are constantly looking at us asking for information. Most of the time it is real time that. Back in 2006 and in 2007, the appropriate authorities were contacted and they came over whether it was the police or DCFS or licensing, joint commission and looked at us. So, that goes on, on a continuous basis. Today in PSI, we have 96 hospitals probably 8 of those, probably 8 facilities today we will have some sort of regulatory body and whether it is doing an annual survey at Valle Vista, which came up terrific or you know, looking at another facility that might have an issue. So, it is part of our business.

Kevin Campbell – Avondale Partners

Okay, I think looking at the acquisition that you guys made the EAP, when did that occur in the quarter and what sort of revenue impact did that acquisition have this quarter and what might we expect it to have going forward?

Joey Jacobs

It happened on April 1st, revenues quite frankly immaterial to the company, it was several million dollars, but you know – and we have got one more EAP acquisition that we made July 1st. And quite frankly that is end of acquisitions for this year and so I don't have any –

Kevin Campbell – Avondale Partners

On the EAP side?

Joey Jacobs

On the EAP side, and I don't have the details of the revenue with me.

Kevin Campbell – Avondale Partners

And on the facility based acquisitions, any commentary on the pipeline and pricing would be helpful?

Joey Jacobs

The pipeline looks good and pricing is appropriate to fit our model and just there is some information we said no to a couple of things during the second quarter. So, pricing is more disciplined, I think and are tighter and – but is busy, we are very busy. We are very busy looking at acquisitions.

Kevin Campbell – Avondale Partners

And then getting back to the state reimbursement, I mean, I guess there are 7 or 8 states that you said haven't settled their budgets yet. You know, it is likely that those are the states where you might most likely see some cuts though given that if they haven't settled them, probably they are having some issues. So, are you already making any cuts in those states in your 2% to 4% expectations?

Joey Jacobs

Yes, absolutely. When we said that 2% to 4% expectations we are looking at 40 plus states and what will occur there. And so we will have to wait to see now once again people need to keep in mind that Medicaid to us in the child and adolescent population and if someone needs to cut their Medicaid budget many times unfortunately it is the adult that get cut. So, we are just going to wait and see but it is in our 2% to 4% and year-to-date I think we are at 5%. So, I think meeting – having the goal of 3 to 5% for this year is absolutely pretty good.

Kevin Campbell – Avondale Partners

Okay, and no changes to your commercial expectations of 6 to 8%?

Joey Jacobs

No not really. Just enough, you know, salary wages are going up 3 to 3.5% and you know, in supply costs, utility cost. So, we just want to be there.

Kevin Campbell – Avondale Partners

Okay, thank you very much.

Operator

We will go next to Dawn Brock with JPMorgan.

Dawn Brock – JPMorgan

Hi, good morning guys. How are you?

Joey Jacobs

Good.

Dawn Brock – JPMorgan

Great print [ph] last night. I think I've got a follow-up question to Tom’s. Just the sustainability of the same store growth based on the current demand trends and you know, to Tom's question asking about Medicaid as well as the last time, are you seeing any flow or overflow from state run facilities that have added capacity or shutting down or do you anticipate will shut down and then generally just the demand picture overall?

Dawn Brock – JPMorgan

First, yes we do. And I can give one good example of this is our facility in Raleigh, North Carolina. Holly Hill, I think it is approximately a 100 bed facility, we are adding 44 beds there, because the state is closing a hospital and they are in Wake county and the Wake county residents, the county commission there absolutely did the right things that we are going to take care of our Wake county residents and they worked with us on building the 44 beds knowing that some of the beds are going to be dedicated to the patients that would have been going to that state hospital and those beds will come online probably in the next 6 to 9 months there and absolutely that is prime example for the state I think is closing 3 and they built 2, but the private side of the business is absorbing the other patients. So that goes on throughout the country, but that is the first example that comes to my mind about that actually occurring and then the demand you know, we have built our beds, and if you go back, which I know most of you do, when you go back and look at the quarterly trends we trended up from the – well, the first quarter trended up from the fourth quarter last year, the second quarter trended up from the first quarter. I would expect that the third quarter would trend up from the second quarter even though it is our most seasonal quarter. We have good color, good visibility on July, and there is another 60 days to go with – you know, I have got my fingers crossed whether we trend up from the second quarter on patient days demand. Another example is we opened up 22 beds in our facility that needed those beds, brought them online and they ramped up rather quickly. So, we see demand for services and unfortunately in economic hard times there is more demand for services.

Dawn Brock – JPMorgan

Joey just taking that a little bit further, how are the economics, how do the economics work if you could as far as opening new beds at the point of where demand is, are you providing the supply where the demand is versus making an acquisition in that market. Can you just give us an idea of generally how much it costs to build a bed and will do that math on the acquisition side?

Joey Jacobs

Okay, well let us take the example of Springfield. I think that cost us $170,000 a bed or roughly there. We opened it up in May. All our certifications and inspections were done by early June. They are now tripped over 30 patients a day. So, as I have told, many people – as when we bring on a new bed whether it is a de novo project or an expansion project we think the demand is there that after 12 months of operation is going to be over 70% occupied. So, and we see that occurring. So, and then if it is a freestanding bed. The one at Holly Hill is a little tougher building site there. I think those beds are a little bit over $200,000 a bed there, but prior to building the beds, we had negotiated rates with the county there. So, once again, we were comfortable about the revenue what we are going to get. The patient days that we were going to get there. So, that is kind of the process when we look at same store beds or we are adding to existing facilities or de novo projects.

Dawn Brock – JPMorgan

Okay, excellent. And then lastly looking at length of stay kind of trending down a little bit. Can you just talk about the fact that you know, at least of peers as though, you know, with the volume being a little bit stronger the mix is definitely acute. Are you building more acute beds or RTC beds? Is seems although there are two?

Joey Jacobs

Absolutely we are building more acute. Last time I looked at a number of things like 75% acute done, and 25% RTC. So, of the 600 beds that we are building I think it is 75, 25 roughly. Last time I looked at that percentage acute versus RTC.

Dawn Brock – JPMorgan

Okay, excellent thank you very much.

Operator

We will go next to Darren Lehrich with Deutsche Bank.

Darren Lehrich – Deutsche Bank

Thanks, good morning everyone. Few things here – I just wanted to just go back to Adam’s question about your risk management function and Joey just wanting to get a little bit more commentary, I guess, it sounds like you have invested a lot of resources there and as you look at what you have been able to do, I guess, I am curious to know is there anything more than you were evaluating in terms of adding to that infrastructure, have you considered adding a medical director perhaps. I just want to get your sense on where you think that organization is going in the future?

Joey Jacobs

We will add more resources, quite frankly, you know, I don't want to disclose all of the things we are going because other people are listening to our conversation but we are putting more resources. I have just approved an additional five FTEs to Kathy Bolmer’s department and this is first something we're going to a little bit differently than they have in the past and what it does? It just gives us more insurance that we're picking up in all the indicators and that we're implementing corrections as soon as possible to the facilities, but once again quality care happens at the local level. Our expectation is that the CEO with our resources at the corporate office that they have good quality that they are in compliance with the state regulations. We put a lot of responsibility on the CEOs.

Darren Lehrich – Deutsche Bank

Okay that is great. And just a question that is a little further out there, as it relates to the joint commission’s core measures that what I think is kind of going into place in October. Are you guys prepared to begin publishing your results on the seven core measures? I guess I just wanted to get your thoughts on how you think you may start reporting them. I don't think CMS is requiring it but I don't know if you plan to take the lead on anything there?

Joey Jacobs

Dan that is one of the things we're looking at – we have some data that we can put out there on our web site so people could go to it we're thinking about that. We absolutely worked on the core measurements with the joint commission and we are going to be ready for those core measurements and that is something we might do to separate us and share more quality data on our web site. So, we're working through that as we speak but we're very pleased with the core measurements and endorse those and support those the industry does. So we are working through that.

Darren Lehrich – Deutsche Bank

Okay. In just a couple more here. I guess I wanted to get your comment on Horizon and its impact for a full quarter, I guess third quarter, with the same store revenue growth and same store margins, you think it will come on about the same as we have seen in the last few quarters in that same store group or anything different.

Joey Jacobs

Horizon is similar to our other facilities, the ABS facilities and the Horizon facilities. Dan, I want us to trend up from the 2.7% patient day growth and the visibility for July, (inaudible) doing that. So, both Horizon and ABS, the UMC facility. We have three active construction projects that we're looking at for the UMC facilities that we bought back on March 1st. So, all of our facilities – all of our facilities are working on growing and meeting the demands.

Darren Lehrich – Deutsche Bank

Okay, and maybe something for Jack, the startup costs in some of these de novo projects. Obviously, you are still absorbing some in Springfield. How does that look at this point and doesn't get a little worse in the second half, I guess we have been tracking you at about a penny a quarter?

Brent Turner

This is Brent, Darren, and that is about what we are running. We obviously we opened Lincoln Prairie during the quarter. So it kind of peaked for that facility and then later in the year you're going to see the opening of our Rolling Hills hospital here in Franklin. So, that is a good estimate on the impact of some of the preopening operating costs that we're having to absorb.

Darren Lehrich – Deutsche Bank

Okay, then I guess just last thing, on the contract management business which has a number of different things in it, just want to get your comments in 2 areas. First, EAP, it's hard to really sort out just the way it's growing up into one line, how all these acquisitions are contributing versus organic growth. Can you just give us some flavor for your organic growth in the EAP segment and then secondly can you give us some comment on your contract retention and kind of where you are now with – it seems that you've been able to maintain a similar lever of contracts where Horizon let off, but – I know, it's hard to really know for sure.

Joey Jacobs

I will give you a little commentary here the EAP company is still under a run rate of $50 million in revenues. So, I did not know off the top of my head what the organic growth is. I do know on the management contract side because it is much bigger. Actually, Darren, I think as of June 30th we were up plus six contracts from the start of the year. So as I had mentioned on earlier calls, the unit management company has done a – Mike Sol [ph] and those guys have done a terrific job. Now we'll lose, we will not be as good in the third and fourth quarter on retention, but we could very well end up 2008 plus upside. We would have more contracts at the end of the year versus what we had at the beginning of the year. Once again I've always said that was neutral to the slight decline business and quite frankly, Mike Sol and this team are going to prove me wrong and I'm glad they did.

Darren Lehrich – Deutsche Bank

All right, thanks a lot guys.

Operator

We will go next to Ryan Daniels of William Blair.

Ryan Daniels – William Blair

Yes, guys. Couple of quick macro questions up front, first I saw a special report on the AMA about a week ago calling for more of a focus on the psychiatric bed shortages and kind of a call for action to allow more construction there and I'm curious if you see any ramification for that in allowing your facilities to get a little bit easier licensure to start building beds or anything on the construction front that you think that can lead to?

Joey Jacobs

I really don't. California is not going to change their rules. It takes two years to get you through the process. In Texas, where there is no ceilings, we can do that pretty easy in states. I'm glad they made – the awareness that there is a shortage of psych beds in psych services and that this illness needs to be treated exactly like any other illness.

Ryan Daniels – William Blair

Okay, that's helpful color and then if we look at the Medicare physician fee fix, I know there is a little ad on with regards to mental health parity and taking on the copays and understanding Medicare is a big piece of your business. I am curious if you think that'll have any impact may be lowering your bad debt or helping on a little bit more in the Medicare front. Do you really see any changes with that?

Joey Jacobs

Well changes to the outpatient – and as you know we do very little outpatient. What we are waiting is the big mental health parity bill to get passed which would really impact the inpatient. It is a slight positive to a – you know, I don't think I could even quantify what the impact would be to us. But it to be the slight positive to some of our facilities would benefit from that. But the big benefit is going to be broadly so mental health parity, mental health almost needs to be treated just like any other illness.

Ryan Daniels – William Blair

Okay, good. Now a few more specific questions. I know on the last call you talked about a little bit about some of the efforts you're putting in place to control pharmacy costs more effectively this year, and I know that it just started at the time of the last call, but I'm curious if you could give us an update there. I think you had a target of trying to get to $3 million in annual savings, maybe how that is trending towards that level and what kind of progress you've seen?

Joey Jacobs

It's off to a terrific start. Jack Crump is doing the super job for us. Like the management company he's probably going to exceed my expectations. He's off to a great start.

Ryan Daniels – William Blair

Okay great. And then in the quarter, I know that non acquisitions CapEx looks like about $25 million, is there any new facilities, is there some land in there, is that Springfield coming in there, any color on what was involved in those investments during the quarter?

Joey Jacobs

Sure, Ryan. That is going to be a combination of finishing of the Lincoln Prairie facility, but also we are doing expansions as well as the Rolling Hills facility is well underway on its construction phase. So, just a combination of the expansion and a couple of the de novo construction projects.

Ryan Daniels – William Blair

Okay, great. And then last question I guess it is for you Brent, I know LIBOR rates have come up, a little bit of a slug since the last quarter and with your floating rate data, I am curious if the impact of those rising rates is in your updated guidance , are you kind of buffering a little bit higher interest costs then we may have thought last quarter?

Brent Turner

Well, of course, we tried to have the conservative outlook across all of the business, but certainly you know there is a chance that the interest rates could start rising in the second half and so LIBOR right now for us are all in revolver is around 4.25% on that side. So, we certainly were conservative in looking ahead with the uncertainty around just the interest rate environment.

Ryan Daniels – William Blair

Okay, and one quick follow-up, any thoughts given more to fix that given the fact that you know we may see these increases, have you thought about fixing that or are you still onto flexibility for pay downs?

Brent Turner

We think with the roughly 60% of our debt currently fixed and 40% floating, we we're comfortable with the risk benefits to that mix, because we're going to continue to enjoy the floating before anything changes. So, we think that is the right mix for our balance sheet really going forward.

Ryan Daniels – William Blair

Okay, great, thanks a lot guys.

Operator

We will go next to John Ransom with Raymond James.

John Ransom – Raymond James

Hi, good morning. Manatee when we visited that facility their ADC had rebounded to the low forties but they were talking about some local state bed closures down in April, as the census continues to track towards the 60 that I know is your goal there?

Brent Turner

It is tracking towards the 50 and we think hopefully by the end of the year we will be back into the high 50s. You know, we can't go back to 60. At the end of the year our goal is to be between 55 to 60.

John Ransom – Raymond James

That's around 50 now. Okay, and then the other question the Pines, you know you have a multiyear turn there and I know your census is still down as you go against tough comps, has that census stabilized?

Brent Turner

It has stabilized and it is increasing and it will go positive to same store in the third quarter, (inaudible).

John Ransom – Raymond James

Do you have a sense of how much that hit you this quarter? Between the Pines and Manatee, how much of an affect there was this quarter?

Brent Turner

No, I don't. Manatee wouldn't impact us at all because we took it out of – it goes back in the same store numbers this quarter. The Pines – no, I don't know that number John, but it did hurt, it probably hurt us probably I would estimate 10 to 20 basis points maybe.

John Ransom – Raymond James

Okay, so not a big number, okay. Then, I know you talked about Medicaid but if you have to guess today your overall Medicaid book you think it'll be I mean the same budget most of them are July 1 to June 30th. If you look it over the next twelve months is that a flat to up number, is that a up number, if you had to guess what does your kind of overall Medicaid pricing look like and we know California today the court is not going to stop the 10% cut, so I don't know if you factored that in. but what does that look like?

Joey Jacobs

If we were to take all the Medicaid increases that we've got this year and kind of normalize them, annualize them, I don't like to do that. I think it probably tracks a little over 3%.

John Ransom – Raymond James

A 3% increase? Okay.

Joey Jacobs

I think it is right in the middle of the range of 2 to 4.

John Ransom – Raymond James

Okay, and what about the local state agencies the non-Medicaid of the money you get from counties and such what is that? Is that trending any one way or the other relative to history?

Joey Jacobs

It could be in the expectation of 2 to 4 and it could follow Medicaid.

John Ransom – Raymond James

And have you seen any extraordinary cutbacks in eligibility or any ratcheting up of poverty levels and that such sort of thing?

Joey Jacobs

No, we haven't, we have not. Remember, once again, our children that we take care of under Medicaid, you know, once again that criteria would not get those kids. History of positive – we talked about mental health parity but probably that is going to occur you know if the Democrats take over the Presidency. (inaudible) that could very well be the first legislation passed by the new Congress, which would benefit us.

John Ransom – Raymond James

Even in terms of raising the poverty level or that sort of thing?

Joey Jacobs

Yes, once again, you're talking about children. That is the reason you don't see deductibles and co-pays for children.

Brent Turner

And the mother [ph], we are deep into the psych PPS. Have you seen – you know, this is the year of the hospitals don't get the subsidy they've had. Have you seen any step up in inpatient bed closures in your market?

Joey Jacobs

Yes, we’ve seen bed closures. Bed closures occur frequently and somewhere in Texas, I meant to keep the article, I knew somebody was going to ask that question. A Med/Surg Hospital in Texas has recently closed their psych beds.

John Ransom – Raymond James

Okay, all right. Thank you.

Operator

We will go next to Gary Lieberman with Stanford Group.

Gary Lieberman – Stanford Group

Thanks. Good morning. I was wondering maybe you could talk about on the expense side a little bit. Can you quantify or at least help us out with the impact that you've had from some of the drugs that have gone generic this year?

Joey Jacobs

We do not have that detail. It is positive. I guess the one everybody knows about is Risperdal. It is one off, I think, and so it is less than $100,000, I think, but more than 50. The last time I checked Jack – Brent gave me an update, but I don't know that exact number. And that's for the whole company – that could be whole company.

Gary Lieberman – Stanford Group

Got it, and then I guess with regards just to maybe on your salaries and expense side, you know, is there any benefit that you get from a weak labor market. Have you have seen that? Would you expect to see any benefit there?

Joey Jacobs

What we see is during difficult economic times that the possibility of nurses coming back and wanting to do some shifts where they may have not been going or pick up some extra shifts. We could see that. We had a good second quarter, you know, on productivity and salary and wages as a percent of revenue. So, it is the oscillated markets where we have staffing shortages.

Gary Lieberman – Stanford Group

Got it. And then just on the mental health parity bill, you know, what is your expectation for it if it gets through and then, you know, how much do you think it helps you and where do you think the impact is there?

Joey Jacobs

We can't quantify it. It absolutely helps us. This is the best shot we've ever had. This is absolutely – right now they are working on how to pay for it and we're cautiously optimistic. This is our best chance and so just wait and see and it would be a positive but we operate without it now but it would be a positive for us if they would pass this enhanced parity bill.

Gary Lieberman – Stanford Group

And then just lastly one of your competitors mentioned that in the acquisition market there have been some new participants into that market and maybe putting some pressure on price, would you agree with that or not?

Joey Jacobs

I think the new entrants there were referring to we already knew about and occasionally, you know, if we say no to a facility we will let them – they are more than happy to have it for them to have that facility. So, they're not putting pressure on pricing.

Gary Lieberman – Stanford Group

Okay, great. Thanks a lot.

Operator

We will go next to Gary Taylor with Citigroup.

Gary Taylor – Citigroup

Hi, good morning guys. Just a couple of questions on the three hundred new beds or so year-to-date, the de novo beds or expansions, can you kind of talk about, do have an occupancy number on those or can you at least just kind of talk about where those are tracking versus expectations?

Joey Jacobs

They are tracking above expectations but we do not capture the data separately for these expansion beds, whether it is same facilities or de novo projects, but what we will do is that we would expect naturally when those beds come online the occupancy of that facility will drop. What we do expect is for that occupancy after one year to be back to where it was if not better. So, we will catch it monthly, and we will catch it a year from now, but as far as putting all those beds together in a basket and monitoring that we did not.

Gary Taylor – Citigroup

And on the Pines, I got your comment and your anticipation census is building to be same store positive in 3Q, can you give us a ballpark on where occupancy is at that facility now, I think it has come down and presumably it is coming back up?

Joey Jacobs

We don't use occupancy percentages a lot, what we do Gary, is actually just use the raw numbers. The facility in the fourth quarter actually average dropped down below 190, was in the 180s. Probably in the beginning of the second quarter it was in the high 90s slipping into the 200's, it is now slipping into the 210s, we hope by the 220s, 30s maybe by the end of the third quarter. So those lines cross in this quarter about where last year it was going down and now this year it is coming across, but when you get to the fourth quarter, I think the Pines actually averaged right now 190 patients a day, may be a little bit less. This year obviously we're hoping that our plans work and that they could have a census of 220, 230 there, and they would also have the opportunity next year Gary at this facility. It is a very large facility. They have the opportunity next year to add 50 patients a day to that facility. So obviously next year we will – you know, we will be looking for them to continue to grow.

Gary Taylor – Citigroup

And that is helpful. On Horizon, obviously those margins have come up since the acquisition given what your same store margins looks like now, what is going to lift Horizon, is that just continuing to build up the referral base and driving the revenue and census there? Are there any other cost initiatives or reorganization initiatives anything like that outside of just top line?

Joey Jacobs

Gary, there was – you're talking about Horizon

Gary Taylor – Citigroup

Yes.

Joey Jacobs

Of the Horizon facilities, there is probably two to three of those we're working very hard where there is probably more that we can do and get a bigger bang in the next twelve months, that there is still some big opportunity there for us during the next twelve months. The remaining facilities, they have the same expectations as any facility in this company is, your revenue should be growing 7% to 9% and patient day should be growing 3% to 5% and pricing should be 3 to 5, and so we're building beds for those facilities. So there's probably two to three of those facilities where there is some more immediate upside if we execute real well there. And then on the other ones, it is – there in the family now and they are in the family of same store facilities and we expect them to act like the ABS facilities or The Brown School’s facilities or the (inaudible) facilities.

Gary Taylor – Citigroup

My last question, you know, I appreciate the comments you made about the corporate risk management structure and also how much you rely on the local CEOs, and I want to give you a chance to respond to me, kind of the short story or the negative story on the company as you have grown so fast that you have lost span and control and the qualities issues are systemic because of the growth, and so you know we've talked to some referral sources. We don't believe that is true and I think obviously your volume growth might indicate that is not systemically true, but can you talk about how you incentivize those local CEOs for quality, you know, and risk management. Is there any part of their comp that is tied to it, I am sure it is part of the reviews, but anything you can add on what you do to incentivize them, I think, might be helpful to both?

Joey Jacobs

Gary, first absolutely the incentive plans have 20% allocated over to that. And there's probably less than – there is a handful of facilities that for some reason, you know, we're not in a newspaper business, and for some reason the local newspaper wants to continue to write stories about that facility and you know I have seen – went all the way back to 1991. In 1991 as with HCA and the central group taking care of Med/Surg Hospitals, you know we bought the facility in 2005 and we made a lot of improvements there? Yes. You know, I wish I could raise the past that they keep bringing up in the stories, and those stories – in the Chicago, those were 2006 and 2007 incidents and the quality is better there, and the management team is better there, and will continue to get better, and unfortunately we take care of very difficult patients and, you know, I want them all not to have incidents, but some of the incidents will occur and we do our level best to go back and put the resources back to correct it. But as far as noise from the (inaudible) or a negative newspaper article, as I mentioned earlier, we could have one today or we could have one 30 days from now. If somebody wants to write a story about us, but I know the heart of PSI, I know the intent of PSI from my position all the way down to the mental health tech or the dietary employee. We want to take care of our patients and keep them safe, and that's our goal. But when you're taking care of today, we will take care of between the management company and our own facilities today we will take care of probably 9,000 patients, and I want everyone of them to be safe. And that is the reason why I'm so much personally involved in getting resources and I mentioned earlier, we're hiring five employees to embark on a new initiative and we're going to just see how that works. So, as you know, it's top of mind for me. If you follow the company and someone asks you says, Joey what do you worry about? I'll worry about our 9,000 patients today, and one of our employees is taking care of them and taking good care of them, but will those incidents occur, yes. Now from the risk management side, when you take up these incidents and put them through the actual our own process and through our risk management we have great results there. So, there is a disconnect between the sensationalism of an incident that I get put in the paper versus the actual reality.

Gary Taylor – Citigroup

Okay, I appreciate that, thank you.

Operator

We will go next to Jeff Englander with Standard & Poor's.

Jeff Englander – Standard & Poor's

Good morning guys.

Joey Jacobs

Good morning.

Brent Turner

Good morning.

Jeff Englander – Standard & Poor's

Just a couple of quick questions. Joey, can you talk about and you referred to a little bit earlier that the number of different groups that have to be notified in a general sense, you know, you talked about Riveredge with DCFS and the police and maybe the overlap or disconnect that happens there sometimes and how that may come into play and what you do there in a general sense? Can you give us more enlightenment there?

Joey Jacobs

A lot of it is state specific. But then there are Federal standards and then there are joint commission standards that come into play and you know really it is incident specific, how many people get notified, if you think the incident has – someone could be criminally have an issue here, then absolutely you contact the police and get them involved, whether it could be someone getting hold of some matches and trying to start a fire, you know on that one you would report, you know that could go to the state agency, you know it will go to various agencies, and it varies by the state and it varies by the severity or the incident itself. There is not a standard there. States are much different from state to state to state but we are in compliance with those states on reporting. We know when to report, how to report, and also PSI captures incidents that you don't report. We are looking for minor incidents. We want to fix those so those don't become major incidents. So, for PSI, we capture much more than we actually have to report, but we do diligently report anything that an agency needs to see.

Jeff Englander – Standard & Poor's

Can you talk about it at all in the paper or in the article about Riveredge, there was an allegation or there were allegations if the appropriate authorities were not notified in an appropriate and timely manner, could you comment about that at all?

Joey Jacobs

I would just briefly – and then I do know how many more people are out here for questions. This is the last one on Riveredge. In Chicago and in Indiana they had set up a crisis hotline, and if something occurs you call this hotline you report it. Sometimes, we additionally call you know the agency itself directly but the procedure is you call the hotline and report it and that is supposed to notify. It's a great concept and just like 911 is a great concept, but sometimes you know everything doesn't go well or maybe we didn't fail to report something. I'm not saying about this case, and just talking generically, but we think we have reported appropriately and the intent was to absolutely to always report and then when you're dealing with a child or an adolescent, you know you take the patient's well being into effect. Sometimes, you know, you take that into effect and it is dealing with the social worker, the referring agency, and the fire department or the police department, whatever you work together for the betterment of that child, and you look for the best outcome there, but it varies. And that is the last about the article.

Jeff Englander – Standard & Poor's

One last question and then I'll hop off. In terms of the acquisition environment, the UHS commented that they have seen some new players with some new funding coming into market and I wondered if you have seen any of them in any of the deals you have looked at and possibly you noted things, you refused some?

Joey Jacobs

I think that is old information. I think the part of the things that the people they referred to we know about them. So, we've known about them. So we keep pretty close tracks on them if intracapital money is behind the company to start it up or whatever. I did not know of any new ones that have occurred. And so – but venture capital over the past two years probably have started 4 to 6 companies.

Jeff Englander – Standard & Poor's

Great, thanks very much, appreciate it.

Joey Jacobs

Thanks.

Operator

We will go to David Bachman with Longbow Research.

David Bachman – Longbow Research

Hi, good morning guys. It's been a long call already. I'll try and keep this short. Maybe I missed this, but is there any update on what is in the pipeline for 2009 in terms of bed expansion?

Brent Turner

Bed expansions for 2009, I think we're at we've got the schedule here for me, if I read it correctly it is over 400 beds for 2009 already approved.

David Bachman – Longbow Research

400 already approved, okay, great. And then maybe this is a follow on to Gary’s question on same store margins, but you know there is still several hundred basis points there, can you may be breakout for us a little bit what – at this stage in the margin expansion story. What are the drivers of the additional expansion, is it you know, is it the referral base, is it volume, is it pricing expenses. Just give us some understanding of where that comes from?

Joey Jacobs

Sure, absolutely, 80% of this is going to come from the 7% to 9% revenue increase, 80% of that. Now it used to be 90 but we do believe our initiatives there in the pharmacy and the dietary area will generate some expense savings for us so that is the reason I have dropped from 90 to 80 but 80% of the incremental going forward will come from making sure we get the 7% to 9% going forward and adding our beds and getting our rate increases and the remaining 20% will come from the expense side of the P&L.

David Bachman – Longbow Research

Okay, and then just one last question, on the volume growth, any color on the types of diagnosis or treatment that is driving volume and if that has changed at all over the past year?

Joey Jacobs

The top five diagnoses, I think are absolutely the same as they were last year and the year before. You know once again there's only – for Medicare we only track 15 DRGs and a bunch of those are chemical related. And so as far as the peers psychiatric diagnoses the top five they may have changed inside the top five but the top five this year I'm sure is probably what was last year.

David Bachman – Longbow Research

Okay, so nothing going on there with maybe that economy shifting that mix?

Joey Jacobs

No, it will not be material. No.

David Bachman – Longbow Research

Okay, I will hop off. Thank you.

Operator

We will go to Mark Arnold with Piper Jaffray.

Joey Jacobs

Okay.

Mark Arnold – Piper Jaffray

Great guys, I will be quick. Just on the patient day numbers, it looked really strong in the quarter even though the same store isn't all the way back to the 3% to 5% level. You mentioned Horizon's performance having something to do with that earlier but is there anything else there you know that that might be contributing to just really overall volume growth even though we're not seen it all in the same store number?

Joey Jacobs

Mark, my observation there is that some of the beds we built in the first quarter and in April, they are ramping a little faster.

Mark Arnold – Piper Jaffray

Okay, great, and then just on same store again, Springfield, you gave us some color there earlier, is that having any impact or do you expect it to have any impact on the same store volumes from the two Chicago area hospitals going forward?

Joey Jacobs

Very minimal.

Mark Arnold – Piper Jaffray

Great. And then just the one thing that I'm struggling a little bit with is the discontinued operations in the quarter, and the adjustments you guys made to patient days, can you give us any more color on what was discontinued if there was a facility – any facility changes there?

Brent Turner

Sure Mark. This is Brent. In the second quarter we were notified that in Puerto Rico one of juvenile justice facilities there that came through the ABS acquisition, we thought the Prax [ph] facility was the leased facility, but that program was rolled back into the Puerto Rican government operations, so that – the patient day changed there. We lost that facility more of a juvenile justice management contract in a facility that we owned/leased and that impacted the patient days in the second quarter and actually year-to-date.

Mark Arnold – Piper Jaffray

Looks like the revenue for patient days there was pretty low though, so it is not a huge?

Brent Turner

That is right. That is not the core psychiatric inpatient hospitals that we run, but we do have capabilities there and have other places like that but there are much lower revenue per day.

Mark Arnold – Piper Jaffray

Okay, and then just finally on the last earnings call we talked about increasing demand for services to treat military personnel returning from abroad. I know you guys have had some discussions with the government and with the bases located near some of your facilities. Can you give us an update on kind of how those are progressing and will you have to build even more beds in some of these markets to meet that potential demand here over the next couple of years?

Joey Jacobs

The most recent in example of this is that we did build beds in Virginia and we have opened up that military program for them. So that is the most recent example. I know that our facilities where bases are located are looking at this but the one that is real time now online is what we have done in Virginia and we're very pleased with that. It is going to be highlighted in our company newsletter that we send out, and this program and what they've done there. We know there's a lot of need there, so we're looking at that.

Mark Arnold – Piper Jaffray

Great, thank you guys, great quarter.

Operator

We have time for one final question, which is a follow-up from John Ransom with Raymond James.

John Ransom – Raymond James

Hi, my question has been answered. You are free to go.

Joey Jacobs

Thanks, John, (inaudible). Before we close, there are 23,000 employees in this company that work very, very hard today and I want to thank them. I want to thank David Bell and his team, Jeff Caplan [ph] from Gulf Coast was back here today and he had a great – does a great job, him and his team. But Riveredge, Carey and the folks up there, we are behind you and have all the resources of the company, and we will get through this and thanks for all you are doing. Thanks for taking care of our patients and their families and we want to be perfect and have good outcomes. Thanks.

Operator

This does conclude today's call. Again thank you for your participation and have a good day.

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Source: Psychiatric Solutions, Inc. Q2 2008 Earnings Call Transcript
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