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Edited Transcript of ACHC earnings conference call or presentation 31-Jul-19 1:00pm GMT

Q2 2019 Acadia Healthcare Company Inc Earnings Call

PEABODY Sep 25, 2019 (Thomson StreetEvents) -- Edited Transcript of Acadia Healthcare Company Inc earnings conference call or presentation Wednesday, July 31, 2019 at 1:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* David M. Duckworth

Acadia Healthcare Company, Inc. - CFO

* Debra K. Osteen

Acadia Healthcare Company, Inc. - CEO & Director

* Gretchen Hommrich

Acadia Healthcare Company, Inc. - Director of IR

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Conference Call Participants

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* Albert J. William Rice

Crédit Suisse AG, Research Division - Research Analyst

* Benjamin Whitman Mayo

UBS Investment Bank, Research Division - Equity Research Analyst of Healthcare Facilities and Managed Care

* Brian Gil Tanquilut

Jefferies LLC, Research Division - Equity Analyst

* Jason Cassorla;Citibank;Equity Research Senior Associate

* Joanna Sylvia Gajuk

BofA Merrill Lynch, Research Division - VP

* John Wilson Ransom

Raymond James & Associates, Inc., Research Division - MD of Equity Research & Director of Healthcare Research

* Joshua Ryan Harakal

BMO Capital Markets Equity Research - Senior Associate

* Kevin Kim Ellich

Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst

* Matthew Dale Gillmor

Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst

* Nicholas Charles Spiekhout

William Blair & Company L.L.C., Research Division - Associate

* Philip Chickering

Deutsche Bank AG, Research Division - Research Analyst

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Presentation

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Operator [1]

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As a reminder, this call is being recorded. Please proceed.

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Gretchen Hommrich, Acadia Healthcare Company, Inc. - Director of IR [2]

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Good morning and welcome to Acadia's Second Quarter 2019 Conference Call. To the extent any non-GAAP financial measure is discussed in today's call, you will also find a reconciliation of that measure to the most directly comparable financial measure calculated according to GAAP on our website by viewing yesterday's news release under the Investors link.

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 Acadia's expected quarterly and annual financial performance for 2019 and beyond. For this purpose, any statements made during this call that are not statements of historical fact may be deemed 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 Acadia's filings with the Securities and Exchange Commission and in the company's second quarter news release. And consequently, actual operations and results may differ materially from the results discussed in the forward-looking statements. The statement whether as a result of new information, future events or otherwise -- 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 would like to turn the call over to Chief Executive Officer, Debbie Osteen.

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Debra K. Osteen, Acadia Healthcare Company, Inc. - CEO & Director [3]

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Good morning. Thank you for being with us today for our second quarter conference call. I'm here today with Chief Financial Officer, David Duckworth, and other members of our executive management team. David and I each have some remarks about the second quarter and then I will close. Then we'll open the line for your questions.

We are pleased to report a solid financial and operating performance for the second quarter. These results were in line with our expectations and reflect consistent execution of our growth strategy.

Our U.S. operations performed well, with consistent top line growth and favorable trends in key operating metrics. U.S. same facility revenue increased 6.6% for the second quarter, with a 3.3% increase in patient days and a 3.2% increase in revenue per patient day compared with the prior year period. U.S. same facility EBITDA margin was consistent with the second quarter of 2018 at 28.2%.

During the second quarter, we added 118 beds, increasing our size and geographic scale and further enhancing our position as a leading provider of behavioral health care services. These expansions included 72 new beds in existing facilities and 46 beds resulting from the acquisition of Bradford Recovery Center, a specialty treatment facility located in Millerton, Pennsylvania. As we mentioned on the first quarter earnings call, we opened the 44-bed expansion at Sierra Tucson in late May. We are pleased to report that the expansion has exceeded our census projections. Through the first 6 months of the year, we have added 332 beds, and we remain confident that we will achieve our goal of approximately 700 bed additions for the year.

The results from our U.K. operations showed same facility revenue up 3.9%, consisting of a 0.2% decrease in patient days and a 4.1% increase in revenue per patient day. This was driven by 2.7% rate increase from the NHS and local payers and higher returns from our retooled beds. Same facility EBITDA margin increased sequentially 150 basis points to 17.8% for the quarter.

During the second quarter, we accelerated our retooling efforts to respond to the needs of the NHS. We continue to work with the commissioners to develop services they require in a region and identify services that will deliver a better return. We believe we are well positioned to take advantage of future demands across our service lines. With the beds that we've retooled, we have already seen good results and believe this will contribute to our future growth.

Now I will turn the call over to David Duckworth to discuss our financial results and guidance in more detail.

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David M. Duckworth, Acadia Healthcare Company, Inc. - CFO [4]

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Thanks, Debbie, and good morning. Revenue for the second quarter was $789.4 million, an increase of 3.1% compared with $765.7 million for the second quarter of 2018. Net income attributable to Acadia's stockholders was $48.1 million or $0.55 per diluted share for the second quarter of 2019 compared with net income of $58.8 million or $0.67 per diluted share for the second quarter of 2018. Adjusted income attributable to Acadia's stockholders for the second quarter of 2019 was $53.8 million or $0.61 per diluted share, excluding transaction-related expenses of $5.2 million and an income tax effect of adjustments to income of $0.4 million based on a tax rate of 17.2%.

The company's consolidated adjusted EBITDA for the second quarter of 2019 was $158.9 million or 20.1% of revenue. Acadia's operating cash flows from continuing operations were $128.7 million in the first 6 months of 2019 compared with $217.9 million for the same period last year. This decrease primarily relates to the previously announced legal settlement payments made in 2019 and higher cash tax payments in 2019 as compared to a tax refund received in the second quarter of 2018.

Turning to our financial guidance and as noted in our press release, we narrowed our guidance for the full year 2019 as follows: revenue for 2019 in a range of $3.15 billion to $3.175 billion, adjusted EBITDA for 2019 in a range of $610 million to $620 million, adjusted earnings per diluted share for 2019 in a range of $2.15 to $2.23. We've reduced the high end of our guidance to reflect the recent acceleration of retooled beds in the U.K., a slower ramp of the 2 de novo facilities opened in the first quarter of 2019 and an additional facility closure in the U.S. And as we think about the cadence of our earnings for the remainder of the year, we believe the second half of 2019 could be weighted towards the back end due to a number of factors, including the usual seasonal slowdown in the U.K, the timing of the U.K. retooling initiatives, the continuing ramp-up of our de novos, a diminishing impact from our closed facilities and the continuing ramp of bed additions at our existing facilities.

This concludes my prepared remarks this morning, and I'll turn it back over to Debbie for some final comments.

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Debra K. Osteen, Acadia Healthcare Company, Inc. - CEO & Director [5]

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Thanks, David. Now that we have covered the results and before we take your questions, I would like to briefly update you on our strategic review process.

As we shared with you on our call in May, we are working hard to leverage our core strengths and scale and execute our operational improvement initiatives, while meeting our primary objective to deliver the highest quality of patient care. We have now moved into the early stages and have formed internal teams to identify and fully execute these improvements throughout the organization.

One of the largest areas of improvement identified today is within procurement, and we are building a team to oversee this area. We are confident that we will deliver on the $20 million to $25 million savings over the next 2 years. But since we are early in the process, we don't expect to see a material impact until 2020.

Regarding the potential sale of the U.K., we have hired advisers and are moving expeditiously to evaluate alternatives in an organized manner that maximizes value for our shareholders. We will not be commenting further as the Board reviews strategic alternatives in the U.K.

We are closely evaluating all aspects of Acadia's business to see where we can deliver better performance. Our highest priority is to deliver greater value for our shareholders and continue to provide excellent care to the many patients that come to Acadia facilities for help.

I will now ask the operator to open the floor for your questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first question comes from Brian Tanquilut with Jefferies.

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Brian Gil Tanquilut, Jefferies LLC, Research Division - Equity Analyst [2]

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I guess my first question is as you think about the U.K. business and also the de novos that you highlighted, is there anything you'd call out in terms of the retooling effort there, what your plans are for the back half? Like how many beds are we talking about?

And also, as we think about the de novos here, it sounds like the ramp is slower than you had expected. So if you don't mind just walking us through any thoughts on changes that you're seeing in terms of the projected ramp in de novo beds in the U.S.?

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David M. Duckworth, Acadia Healthcare Company, Inc. - CFO [3]

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Brian, I'll take that. First of all, on the de novos, we did open the 2 facilities in the first quarter of 2019, 1 in Texas, 1 in Ohio. Those opened in February, and we did talk about in the first quarter how we pictured the ramp over the course of the year. And I'll say while it has been slower in terms of the second quarter and early July, they have made a lot of progress over the last month. Both facilities now have completed their survey and all the accreditation that they need and are working with the payers and are really seeing some progress more recently here in the start of the third quarter.

So we did see losses from those de novos over the course of the second quarter, around $3 million of losses that did exceed how we thought the ramp-up would go. But I think we are positioned very well going into the second half of the year, both facilities absolutely have a chance to hit breakeven by the end of the year, which was the goal that we had here in the first year of their operations. So optimistic on the continuing ramp from those 2 facilities over the second half of the year.

On the retooled beds in the U.K., we have reopened around 40 beds that we had previously taken offline for retooling and are seeing some -- just great progress in getting those beds reopened. We have identified further opportunities and have looked at an additional 150 beds or so that are now offline for further retooling. We do think that there's going to be tremendous returns from these further opportunities. We work very closely with the NHS, the local commissioners, to identify these projects, and we do think those beds will be offline in the near term, but over the course of the second half of the year, especially the fourth quarter, early next year, we will reopen a service that is aligned better with the demand and will be at a higher return than the previous service that we operated. But see additional opportunities on the retooling and it's really just a temporary factor affecting our third quarter earnings. But over the long term, optimistic about those opportunities.

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Debra K. Osteen, Acadia Healthcare Company, Inc. - CEO & Director [4]

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And I'll just add to what David said. Brian, I'll just add to what David said about the retooling. I think the team in the U.K. has very good visibility around the service needs for the private sector. They're our partner in these collaboratives and they are in 39 of the 42 that exist and the ones they are not in are in areas where we don't have facilities. But I think what we tried to do and what they are doing is being very proactive to reposition our existing facilities to provide care. And it is at a higher acuity but also a higher reimbursement, which David mentioned.

So we think in the long term, we will be positioned. The demand is there, and I think that what we want to do is match that demand with our ability to take care of those patients. And so we try to get ahead of it, and I think that we will be very well-positioned as these beds come back. And we don't foresee a lot more of these retoolings, but when we can generate a better outcome and return, we will pursue that. But right now, we're focused on matching those service needs with our beds.

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Brian Gil Tanquilut, Jefferies LLC, Research Division - Equity Analyst [5]

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Yes, that's a great comment, Debbie. I guess my follow-up, David, just real quickly. As I think about that closures that you've done this year and late last year, I think it was some of the Arkansas facilities, how do we think about the revenue associated with that just for modeling purposes? Because your same-store performance is really strong and I think The Street might have mismodeled the revenue for the quarter a little bit. So just -- if you can give us some color so that we can model it, probably, more accurately.

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David M. Duckworth, Acadia Healthcare Company, Inc. - CFO [6]

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Yes, yes. Brian, we did close an additional facility that was really identified during our strategic review. We made a decision in June to close that facility, and it is winding down its operations over the course of July. As we think about the revenue, there was about $15 million of Q2 2018 revenue associated with the closures that we have completed, and there's -- obviously, these were underperforming facilities, so there was not a lot of EBITDA associated with those facilities. But it does have an impact on our revenue growth. And so going forward, we did have a loss of around $15 million of quarterly revenue.

But obviously, where we're positioned from an EBITDA perspective is much better having closed those facilities.

So that was the revenue associated with the closures. We do have some losses incurred relating to the wind-down of the operations. And as we mentioned, that will become less significant over the second half of the year as we think about those facilities, having completed all of the wind-down activities, hopefully, by the end of the year.

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Operator [7]

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And our next question comes from Pito Chickering with Deutsche Bank.

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Philip Chickering, Deutsche Bank AG, Research Division - Research Analyst [8]

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Just to sort of back up a little bit. With you guys lowering the top end of guidance here, can you just put some -- can you quantify sort of what parts of it brought down that guidance? From the closures to U.K. retooling, can you, I guess, put some numbers around which -- and also FX, operationally, sir, why you reduced it?

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David M. Duckworth, Acadia Healthcare Company, Inc. - CFO [9]

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Yes, Pito. We've already discussed a couple of the factors. But in the U.K., looking at the timing of the retooling projects and the additional opportunities that we identified, there's an impact that, that has just on the third quarter. And so that's certainly reflected in our update. And then in the U.S., we talked about the de novo and the facility closures, those are the 2 factors that are -- that drove the update to the guidance in the U.S.

In terms of quantifying the amount, it's sort of equally split between the U.K. and the U.S. initiatives. We did not update our guidance for the FX, so wanted to provide that clarification. Through -- in the second quarter, the exchange rate was $1.285, which was very close to the forecast that we had of $1.30. We have seen a decline in the exchange rate over the course of July but have not updated our guidance for the second half of the year. I'm, certainly, very much aware of the volatility there.

The impact, as we think about the exchange rate, is for an annual period, for each $0.01 move in the exchange rate would be less than $0.01 on EPS. So I did want to just provide that information for you and -- but we did not update the guidance for FX. We do continue to have the hedging in place around the exchange rate, and that's about 25% of our investment there is hedged, which translates to the value associated with those derivatives.

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Philip Chickering, Deutsche Bank AG, Research Division - Research Analyst [10]

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Okay. And then for follow-up, looking at the retooling of the beds in the U.K. In 2018, you guys also retooled a lot of beds that was part of what led to the margin pressure as getting those beds back online took longer than expected. And I was under the impression that you guys are going to sort of not be retooling beds over the short terms to get just the margins back up. So I guess the question is sort of why now? What have you learned differently? And sort of how will this be executed differently in 2019 than it was in 2018?

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David M. Duckworth, Acadia Healthcare Company, Inc. - CFO [11]

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Well, Pito, part of it is some transition that is happening within the NHS that we were aware of and the timing of that has been somewhat uncertain. This is where, as part of the Transforming Care agenda, more of the beds are being commissioned locally and there's also service lines that the NHS is very much focused on getting to a different setting and a different geography. So that transition within the NHS has been accelerated and so part of the decision was around that.

Additionally, we have identified opportunities for retooling that weren't previously identified. As Debbie mentioned earlier, we do think we've now identified and are moving forward with most of those bed closures and retoolings. But some of that has been the NHS and the timing of them making the changes and then us identifying more opportunities.

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Debra K. Osteen, Acadia Healthcare Company, Inc. - CEO & Director [12]

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I'll just add to David's comments. The -- it's a fluid process in the U.K. with the Transforming Care agenda. And I think that what we saw is their acceleration to move some of these patients out of the higher acuity settings into lower levels. So what we're doing is trying to move those patients and then retool so that we do have the volume coming in for the need. So I think if we had not done anything they would still be moving those patients out, but we would not be prepared for the high acuity patients, which is what we want to do short term and long term.

The other thing I'll say is that as we look back to the retooled beds from at least '18, the -- it's very good result with margin as well as net revenue and it's very clear that by doing so, we had a positive. So again, it is a short-term pressure on volume, but it will be a long-term benefit to the operation in the U.K.

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Operator [13]

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And our next question comes from Matthew Gillmor with Baird.

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Matthew Dale Gillmor, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [14]

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Following up on the bed retooling in the U.K., can you talk about what impact that had on volumes for the second quarter? And then how should we think about the volume impact as it relates to the third quarter?

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David M. Duckworth, Acadia Healthcare Company, Inc. - CFO [15]

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Well, the volume impact, of course, is reflected in the year-over-year growth. We do not take those retooled beds out of our bed count. And so as we look at it internally, we do have that reflected in the occupancy figures that we track.

But as we think about that, there are about 150 beds that are currently being retooled. Those beds, if they were online and when they do get back online, would lead to an overall volume increase of close to 2% higher than what we are reporting right now. And so absolutely, those beds are reflected in the volume. We think once they get back online, we will get back to the volume target that we have for the U.K. going forward, which is around that 1% to 2% level.

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Debra K. Osteen, Acadia Healthcare Company, Inc. - CEO & Director [16]

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And Matthew, I think one thing I would just say before you ask your next question on this subject is the retooling itself is a process. And so it's not just the renovation and change of the unit service. So what has to happen is we have to ramp down the patients that are there, and we find placement for them. Sometimes if they're longer-term patients, they are a little bit more difficult to place. So there is a time period of ramping down and then there is the retooling, which is more around reconfiguring the service. And then once that's complete, then we're ramping back up. And we have received some block contracts from NHS, which is basically protecting us when we do come back online that we will have a certain number of beds that they will utilize and we will be reimbursed for. And we're trying to negotiate more of those as we bring back these retooled beds just to protect ourselves from this ramp-up again for volume.

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Matthew Dale Gillmor, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [17]

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Got it. That's very helpful. And then one more on U.K. margins. It seems like maybe that ran a little bit better than what you indicated on the last call, even with some of the retooling efforts. So I was hoping you could just talk about the margin trend within the U.K. and what drove the stronger sequential performance.

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David M. Duckworth, Acadia Healthcare Company, Inc. - CFO [18]

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Yes. We were -- Matt, we were very pleased with the margin in the second quarter, noted the sequential improvement to 16.4% for our U.K. operations in total. That does reflect the stabilization that we have seen in the labor costs. The progress that we've made around recruiting and retention and all the labor initiatives has continued to show improvement in our labor costs. And then additionally, the rate increases that we saw that apply to about 80% of our revenue in the U.K. effective April 1 had a benefit as well. So the labor, the rate increase is both contributing to what we see is a good improvement in the U.K. margin.

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Operator [19]

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And our next question comes from Whit Mayo with UBS.

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Benjamin Whitman Mayo, UBS Investment Bank, Research Division - Equity Research Analyst of Healthcare Facilities and Managed Care [20]

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David, maybe just on that last point. Can you elaborate a little bit more on the staffing and agency cost? Maybe just put some numbers around how you're tracking and how you've been trending over the last few quarters?

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David M. Duckworth, Acadia Healthcare Company, Inc. - CFO [21]

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Sure, Whit. We do see labor cost as a percentage of revenue that continues to improve. And what we've seen is that this quarter, we are below 67% of revenue on our labor cost. That is an improvement compared to the 3 quarters prior.

And then additionally, just around agency, we were less than 12% again on the agency as a percentage of our total labor, and that's an improvement as well and really, a stable result compared to the first quarter. And we've been talking a lot about improvement compared to the second half of 2018. And we see on both of those labor stats, the agency as well as the total labor, an improvement compared to the second half of the year, last year.

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Benjamin Whitman Mayo, UBS Investment Bank, Research Division - Equity Research Analyst of Healthcare Facilities and Managed Care [22]

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Okay. No, that's helpful. Just when we sort of back into the same-store operating expenses per patient day in the U.K., it still feels like your costs are growing in that high single-digit range. And so is there any other area within your cost structure where you're seeing some pressure? Or is it just some of the transitions that you're seeing with the retooling initiatives right now?

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David M. Duckworth, Acadia Healthcare Company, Inc. - CFO [23]

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Well, I do think we have higher acuity patients. And so we may see some staffing costs associated with that. But I think if you're comparing year-over-year to the second quarter of 2018, we would see the impact there because we're really focused on second half of the year and sequential improvement. And I don't think we've seen significant cost per day increases as we compare more sequentially to the last 3 quarters in the U.K.

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Benjamin Whitman Mayo, UBS Investment Bank, Research Division - Equity Research Analyst of Healthcare Facilities and Managed Care [24]

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Yes, that's fair. And maybe back on the de novo losses for a second, can you just remind us what exactly you have in your plan for those facilities? I wasn't sure if you were budgeting the losses to turn flat or do they have to turn positive for the second half? Any help will be great.

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David M. Duckworth, Acadia Healthcare Company, Inc. - CFO [25]

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Yes, sure. We do think -- I think I mentioned that we had losses in the second quarter and those losses were around $3 million. We think in the third quarter that those could improve and be in the range of $1 million to $2 million. But I mentioned in the fourth quarter, we do hope that they get to breakeven. And so that's -- that is what we have modeled for the remainder of the year for the 2 de novos.

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Debra K. Osteen, Acadia Healthcare Company, Inc. - CEO & Director [26]

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And Whit, this is Debbie. I want to just emphasize that the delay in the ramp-up was related to getting certification and our number from Medicare. So there was -- I think the facility did everything they could to get that in, in expeditious manner, which was really disappointing because it took longer than we would have expected. But I do think that they chose 2 very good markets, and we see a lot of demand in both of those markets. So we're optimistic that we'll be able to recover. They have good plans in place to ramp up as quickly as we can.

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Benjamin Whitman Mayo, UBS Investment Bank, Research Division - Equity Research Analyst of Healthcare Facilities and Managed Care [27]

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Yes. No, that's helpful. I understand, it's generally out of your control. Maybe one last one for you, Debbie. Just has anything changed with the reporting structure in the U.K.? Just curious like how you're looking at span of control within the organization, just with all the changes you're making to the strategy and holding the teams more accountable. Just wasn't sure if there were any developments worth sharing today that may be different than the last update you provided us in your strategic update.

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Debra K. Osteen, Acadia Healthcare Company, Inc. - CEO & Director [28]

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Sure. I think everyone is aware that Ron Fincher has retired, and we had a couple of send-offs for him and really value his contribution to Acadia, and hopefully, he is enjoying his new life in retirement. But as a part of that, the U.K. had previously reported to Ron Fincher, and they now report directly to me. And I've already started and have really made several trips to the U.K. but will be overseeing that more closely than I have in the past since Ron has left the company.

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Operator [29]

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And our next question comes from Ralph Giacobbe with Citibank.

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Jason Cassorla;Citibank;Equity Research Senior Associate, [30]

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This is Jason Cassorla on for Ralph this morning. Just a quick question, you saw length of stay stabilize in the U.S. Do you expect that to remain the case as you move forward? Or is there too many kind of moving pieces to get comfortable with that?

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Debra K. Osteen, Acadia Healthcare Company, Inc. - CEO & Director [31]

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Jason, I'll just say that we've had a very stable length of stay here in the U.S. And we haven't seen that change. So the only differences over the period has been more around of the mix change from RTC to acute. But we've not seen any change in stability of that and don't anticipate any changes in the future.

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Jason Cassorla;Citibank;Equity Research Senior Associate, [32]

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Okay. Great. I guess my follow-up here just as a high level. The business has faced margin pressure for a while now and in some cases even despite mid-single-digit growth, so maybe can you just help level set the margin targets in the U.S. and U.K.? And what kind of organic top line is needed in each segment to kind of hold the line or get margin expansion?

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David M. Duckworth, Acadia Healthcare Company, Inc. - CFO [33]

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Yes. The U.S. business, we've had a strong margin for the second quarter at 28% -- above 28%. That is generally our target for our same facility business. Over the course of the year, just due to some seasonality, we would see the U.S. in the 27% to 28% range. Certainly pleased with the performance there in the second quarter.

In the U.K., we've -- we target on a long-term basis, that 16% to 17% but think we have an opportunity to be better than that. We just hesitate to provide some of those targets with the retooling projects that are underway but think those could be a positive to get us above the 17% level.

And really, in the second half of the year, the target for the U.K. is between 15% and 16% just with the seasonality that we typically see and the retooling initiatives that are underway. But that's how the second quarter will play out in the U.K. with the longer-term target getting back above that 16% to 17% range. In terms of the growth needed to be there, we have 5% to 6% in the U.S. and then the U.K. is more of a single-digit, 4% to 5%, growth that we see in order to get to that margin.

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Operator [34]

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Our next question comes from Kevin Fischbeck with Bank of America Merrill Lynch.

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Joanna Sylvia Gajuk, BofA Merrill Lynch, Research Division - VP [35]

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This is actually Joanna Gajuk filling in for Kevin. So I guess to follow up on that last comment, in terms of the -- in particular, the U.S. segment, so same-store revenues were actually very strong, almost -- up almost 7%. So that will be above the target 5% to 6%. I guess the margin was 28% but I guess it was flat year-over-year. So is there a way to think about it in terms of what kind of growth rate you need year-over-year to keep your margins flat? Because it seems like this quarter actually was exceptionally strong top line but the margin was flat. So any color how to think about that dynamic?

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David M. Duckworth, Acadia Healthcare Company, Inc. - CFO [36]

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Yes. We did see strong performance in the U.S., 6.6% growth, and that was on strong volume and strong revenue per day. I do think while the 28.2% was a strong margin, we would see an improvement. If we look at it over the course of a year and over a longer-term period, we would see margin expansion improvement. And we do expect in the second half of 2019 to see that in the U.S. Some of that is just the timing of the bed additions that are driving both the volume and the revenue growth as well as the margin. And so I think margins will improve as we see over the longer period of time with the new beds coming online. And so that 28%, while it was a strong number, I do think we'll see some margin expansion in the second half of the year in the U.S. same-facility group.

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Joanna Sylvia Gajuk, BofA Merrill Lynch, Research Division - VP [37]

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That's helpful. And I guess to drill in or stay on the topic of U.S. segment, which was very strong. Can you maybe talk about the different pieces inside that segment, if there was a way to think about it? Were there any geographic areas that were driving the strength? Was it across the board? Was there any particular business of the business, specialty versus RTC versus acute? And I guess, on the specialty, there's some trends there in terms of more money flowing into the industry from the government. So I guess how are you positioned there for that?

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Debra K. Osteen, Acadia Healthcare Company, Inc. - CEO & Director [38]

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I'll just say that I think we saw a very strong demand across all our service lines. I will kind of highlight that we had very strong performance from facilities that added beds, which is one of our main strategic focus areas for growth. TrustPoint, which is here in Tennessee, had a successful expansion. I mentioned in my remarks Sierra Tucson. Southcoast, which is in Massachusetts, also added beds and I think the key here is they are adding beds and able to get volume in them. I -- we've seen very strong demand continuing for behavioral services across the U.S., and we really saw solid performance in acute and specialty as well.

We are starting to see some of the funding for opioid come through to the states. We are well positioned to take advantage of that because we have such a large -- in fact, we are the largest provider for those services. So we're optimistic about the growth potential in that business line, and I think that's going to continue for some time.

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Operator [39]

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And our next question comes from Ryan Daniels with William Blair.

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Nicholas Charles Spiekhout, William Blair & Company L.L.C., Research Division - Associate [40]

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This is Nick Spiekhout in for Ryan. Just to start, I was wondering if you guys had an outlook on pricing for next year given CMS rates announced last night and if you are hearing anything from the states regarding Medicaid rates for the upcoming year.

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David M. Duckworth, Acadia Healthcare Company, Inc. - CFO [41]

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So in the U.S., we do see 2% to 3% pricing growth on a longer-term basis. We had a strong performance there in the second quarter.

I'll say on Medicare, the announcement was in line with what we expected. Medicare is 15% or so of our U.S. business, most of which is at our acute facilities. And so that increase there that was announced was in line with our expectations.

And on the Medicaid side, obviously, there's a lot of different payers and states that comprise that component. We're seeing good rate increases there and expect, on an overall basis across all of our payers, to continue at that 2% to 3% range.

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Nicholas Charles Spiekhout, William Blair & Company L.L.C., Research Division - Associate [42]

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All right, great. And then I guess a follow-up, not really related but I know on previous calls, you mentioned having the goal of lowering your leverage ratio. But you didn't have a long-term target yet. I was just wondering if you kind of zeroed in on a target that you're kind of shooting for.

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David M. Duckworth, Acadia Healthcare Company, Inc. - CFO [43]

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We are shooting for a lower leverage, absolutely the goal is to lower our leverage, and we have talked about the ways that we will accomplish that. Some of that is through the earnings growth that we project for the second half of the year. We do continue to expect by the end of the year, we will be down to around 5.1. That is an improvement with where we've been the last couple of quarters, more at the 5.5 level.

On a longer-term basis, we have not yet communicated our target. Obviously, there's a number of initiatives that we are looking at to help us get to a lower leverage. But we think by the end of the year, we'll see some improvement there, and we'll communicate the longer-term target over time.

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Operator [44]

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And our next question comes from John Ransom with Raymond James.

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John Wilson Ransom, Raymond James & Associates, Inc., Research Division - MD of Equity Research & Director of Healthcare Research [45]

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You guys said in May that your real estate was worth $1.7 billion. So we looked at that and said, okay, hypothetically, that was -- if you took $100 million rent stream and if you did a mid-5s cap rate, you kind of get to that $1.7 billion. Are we thinking about -- I mean, when your -- when you did that initial strategic review, is that in line, basically ballpark, with the math that you were getting back from what people were telling you that was worth?

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David M. Duckworth, Acadia Healthcare Company, Inc. - CFO [46]

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John, we are not going to comment right now. Just on -- that is part of the work that we are going through with our advisers, is how we think about the real estate value, how that affects the potential analysis around the U.K. But at this point, we don't have a comment around the math there.

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John Wilson Ransom, Raymond James & Associates, Inc., Research Division - MD of Equity Research & Director of Healthcare Research [47]

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Okay. Second question would be you've lost about -- if memory serves, about 800 points of margin in the U.K. You're starting to claw that back, the 100 bps sequential improvement. I mean, Debbie, now that you've gotten 6 months or so to get your hands around this, how much of that lost margins do you think you could claw back over the next 12, 18 months?

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Debra K. Osteen, Acadia Healthcare Company, Inc. - CEO & Director [48]

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Well, I think that I feel good about the initiatives that are in place in the U.K. I think that a key to margin improvement is going to be through the volume and getting the retooled beds, which we've been talking about on the call today. I think we -- I was pleased to see the improvement from the last quarter, and I think that at this point, we should continue through the quarters to see this improvement continue. I think that as David mentioned and I certainly know, the third quarter in the U.K. does have seasonality to it. But we would like to end the year higher than we are here in the second quarter. But it's going to depend on how we can quickly get those beds back on. And I feel good about the prospects there from just my interactions and also what I know about demand, which I think is very strong. So I don't see any reason that we can't continue to see improved margin.

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John Wilson Ransom, Raymond James & Associates, Inc., Research Division - MD of Equity Research & Director of Healthcare Research [49]

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Right. So just 2 others for me. So David, I'm going to give you a chance here to save us all from ourselves. Obviously, the last few years, your company has missed 3Q. I know you talked about in qualitative terms 3Q versus 4Q. But currency aside, how should we think about the cadence sequentially of EBITDA in 3Q or if you want to do it another way, maybe the back half of the year, sort of the mix of EBITDA 4Q versus 3Q? I just want to do what we can here to try not to engineer another 3Q miss if it's avoidable in terms of providing some proactive guidance, that will be great.

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David M. Duckworth, Acadia Healthcare Company, Inc. - CFO [50]

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Yes. John, appreciate that question. We -- what we're trying to communicate is that we do see some temporary factors. The reason we're bringing this up is, obviously, we do see that the de novos, the facility closures in the U.S., what we have going on in the U.K. is a third quarter item that we need to think about. And we're not providing specific guidance for the -- any quarter. So I hesitate to go all the way to that level, but what we hopefully wanted to highlight is that we do see continuing improvement in those items but it will be weighted more towards the back of the year. And what we did mention specifically on this topic was just that the U.S. bed additions has been really strong, almost 400 beds in the last 12 months added to our existing facilities. So those will continue to ramp, and we see a lot of the bed additions that have already come on online, seeing some census improvements as well as further beds coming online, that also contributes to what we see being a stronger fourth quarter than third quarter.

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John Wilson Ransom, Raymond James & Associates, Inc., Research Division - MD of Equity Research & Director of Healthcare Research [51]

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So if I heard you, you're talking about a sequential $2 million improvement in de novo with the CON delay. So if we took your 3Q run rate -- or excuse me, 2Q EBITDA, add a couple of million for the improvement of de novo losses, should we look at the sequential decline last year in the U.K. and say, kind of expect that same level of sequential decline in -- at least in terms of like building some quantitative framework for trying to get at 3Q? Is there anything else you would think about as we build our models that we should think about?

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David M. Duckworth, Acadia Healthcare Company, Inc. - CFO [52]

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No. I don't -- there's nothing else that we would highlight there other than just to say that in the U.K., the second quarter to the third quarter of 2018 is not the type of decline that we expected this year. That was more than just normal seasonality. So while we -- I did mention earlier we may see a margin in the range of 15% to 16%, that is holding pretty well compared to where we are in the second quarter of 2019. That is the type of seasonality that we expect and what we saw last year was more than just the normal seasonality. But other than that, I think you are on the right track.

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John Wilson Ransom, Raymond James & Associates, Inc., Research Division - MD of Equity Research & Director of Healthcare Research [53]

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All right. Great. And then just to kind of close the obvious question. If we think we can get back -- I'm just going to make up a number. Let's say by the end of 2021, you are saying, gosh, I think we could be at a 20% margin. Would that tempt you to say maybe we should hang on to this asset and we'll get more value from it because people are going to pay us for margin on the come? I mean, is that -- I assume that would all be part of the thinking as you evaluate the long-term plans there.

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Debra K. Osteen, Acadia Healthcare Company, Inc. - CEO & Director [54]

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I think that we can certainly validate that we are considering all our alternatives. And we've said in May, and I'll say again, we are not going to sell the U.K. unless it brings and maximizes value. So that will be part of the consideration as we think about our alternatives.

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Operator [55]

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And our next question comes from Kevin Ellich with Craig-Hallum.

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Kevin Kim Ellich, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [56]

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Debbie, just wanted to start off, you gave good detail on the strategic review update. Wondering if you had any comment though, on progress for the revenue enhancement initiative.

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Debra K. Osteen, Acadia Healthcare Company, Inc. - CEO & Director [57]

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I think as a part of what we talked about in May, we are focused on the cost side of things as well as revenue. We think the cost side will probably be more quickly realized than the revenue. That involves our contracting and looking at our payers and also preparing what we want to do with value to demonstrate our results. So I would think we're probably going to see more short-term around cost and expense reduction and then revenue reduction or increase would actually come probably later just based on the cadence of our contracts and our negotiations with our payers.

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Kevin Kim Ellich, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [58]

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Sure. That's great. And then on the $20 million to $25 million of cost savings, you said procurement's going to account for a large portion of that. I guess how much of it will come from procurement versus contracting and shared services and some of the other things?

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David M. Duckworth, Acadia Healthcare Company, Inc. - CFO [59]

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Yes. We have been working and mobilizing teams to address each of the initiatives that we identified as part of our initial strategic review. We have made progress there, and we do see procurement being a significant share of the targeted savings. We're not providing real precise estimates at this point, but I do think a good percentage will be procurement and other cost where we feel like there's better opportunities to leverage our scale, apply best practices throughout our facilities. But we are in the process of implementing our plan for each of the initiatives. But procurement absolutely is a significant area of focus as part of that.

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Debra K. Osteen, Acadia Healthcare Company, Inc. - CEO & Director [60]

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I think we'll be able to provide more detail around the actual numbers and how we see that breaking out as we develop these plans and move forward with the implementation.

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Kevin Kim Ellich, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [61]

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Great. David, I have one quick one for you as well. So -- and I might have missed this, so correct me if I did. But how many beds did you guys lose with the closures in Q2 and year-to-date? Just wanted to kind of get an accurate bed count in the U.S. and the U.K.

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David M. Duckworth, Acadia Healthcare Company, Inc. - CFO [62]

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Sure, sure. We -- the second quarter, we did have a closure of a 16-bed facility. That was part of the closures that we talked about on our last quarter's call. The additional closure that we've mentioned this morning is -- that is in our bed count at the end of the second quarter because it closed in July. I think the bed count there is around a 70- or 80-bed facility. And so -- but that's not reflected yet in our bed count. The U.S., just to give you -- in case you're wanting this piece of information, the bed count at the end of June is right at 9,400 beds in the U.S.

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Operator [63]

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And our next question comes from A.J. Rice with Crédit Suisse.

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Albert J. William Rice, Crédit Suisse AG, Research Division - Research Analyst [64]

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A couple of quick questions here. In the U.K., obviously, we've had a changeover in prime minister, he's talking about moving forward Brexit, once and for all. I know when that -- when we first got the whole Brexit pushed, it had some impact on labor and the business generally. Is it your view at this point that anything related to how the Brexit plays out from here is probably not going to make much difference other than perhaps on the exchange rate, which we've already started to see? Just wondering whether there's an opportunity or challenge with what's coming there.

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Debra K. Osteen, Acadia Healthcare Company, Inc. - CEO & Director [65]

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A.J., I think that the U.K. management team feels that there is minimal impact to their business from Brexit and where they are at this point. I think they feel that most of the labor has already left previously, when there was all of the discussion around this. But I think that they feel that while it does remain unsettled, that it will have minimal impact on the day-to-day.

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Albert J. William Rice, Crédit Suisse AG, Research Division - Research Analyst [66]

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Okay. And then I know -- I think the comments about labor that you offered earlier were mainly about the U.K. situation. I wondered if I could get you just to comment on what you're seeing here in the U.S., turnover rate, productivity, wage rates, those kind of things. As well as I know there's a lot of buzz about telemedicine and maybe the ability to use that particularly in behavioral health more broadly. Is there anything that you guys are doing around telemedicine or opportunities that, that creates for you to look at in any way?

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Debra K. Osteen, Acadia Healthcare Company, Inc. - CEO & Director [67]

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We do have an initiative around telehealth and looking at where that might fit in our markets. I think that reimbursement has been an issue in the past with regard to getting paid for those services. But I do see that starting to change, and there is an initiative here at Acadia to really provide more options for our patients. And I think that's a greater access for some markets, where they might be in rural settings or in areas where there might be shortages of professionals. So yes, I think A.J., that's something that will be in our future and actually we already have several telehealth initiatives in place at the facilities but we want to expand that because we think it just brings better access.

As far as the labor situation, I think we've seen it fairly stable. I do think there are isolated markets that occur from time to time, where we see some pressure, but nothing that really changed here at Acadia. I think they do a good job of getting staff in at the nursing level as well as the mental health techs. But we do have a focus on recruitment and retention, which we want to be proactive there. So even though it's stable, we want to make sure that we're prepared and that we're meeting the issues out in the market and staying competitive.

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Operator [68]

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And our next question comes from Matt Borsch with BMO Capital Markets.

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Joshua Ryan Harakal, BMO Capital Markets Equity Research - Senior Associate [69]

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This is Josh Harakal on for Matt. I just had a quick question. One of your peers talked about seeing pressure in their addiction treatment in the second quarter. I was just wondering if you could talk about trends that you've seen and kind of what your outlook is here in the back half of the year.

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Debra K. Osteen, Acadia Healthcare Company, Inc. - CEO & Director [70]

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Sure. I think that we have not seen some of the negative trends in addiction. We've actually seen very strong performance from our addiction business. We have a solid referral base, they are supported by our sales and marketing platform. We actually have a plan to add about 200 beds this year. We've added 90 beds that have opened through the first half. We do see increased competition, but I think it's always been in place, maybe a little bit more now but we feel very good about our specialty business. We have less than 5% of our U.S. revenue with out of network or -- yes, out of network. We've done a good job, I think, in negotiating good rates in network. And that's just based on the quality of the service and the relationship that we have with payers.

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Joshua Ryan Harakal, BMO Capital Markets Equity Research - Senior Associate [71]

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Okay, great. And then just another question. Can you kind of speak to if you are seeing any pressure in the U.S. from more of your patients being transitioned from traditional Medicaid to managed Medicaid? Have you seen any of that kind of flow through on your average length of stay? And that'll be it for me.

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Debra K. Osteen, Acadia Healthcare Company, Inc. - CEO & Director [72]

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Well, our length of stay is very stable. It's been the same for a number of years. I think the managed Medicaid movement in some of the states, we have not seen any change in that, in our business lines and the states that we are in. We have seen an increase in total Medicaid and that's related to the CTC growth and acquisition that we did earlier in the year. But as far as managed Medicaid coming into the states that we are in, that's -- there's been no change that we've been able to see.

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Operator [73]

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And that is all the time...

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Debra K. Osteen, Acadia Healthcare Company, Inc. - CEO & Director [74]

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Thank you. I'll just say a few remarks. I want to thank everyone for being with us today. I thank you for the interest in Acadia Healthcare. What I'd like to conclude with is to thank all of our employees and the clinicians for their dedication and focus. They work every day to provide the highest quality of care to our patients and their families, and that's really what makes Acadia a leading provider in behavioral health.

If you have additional questions today, please call us directly. And have a good day.

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Operator [75]

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This does conclude today's call. Thank you for your participation. You may now disconnect.