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Edited Transcript of UHS earnings conference call or presentation 1-Mar-17 2:00pm GMT

Thomson Reuters StreetEvents

Q4 2016 Universal Health Services Inc Earnings Call

KING OF PRUSSIA Mar 1, 2017 (Thomson StreetEvents) -- Edited Transcript of Universal Health Services Inc earnings conference call or presentation Wednesday, March 1, 2017 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Steve Filton

Universal Health Services, Inc. - SVP and CFO

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Conference Call Participants

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* Justin Lake

Wolfe Research - Analyst

* A.J. Rice

UBS - Analyst

* Josh Raskin

Barclays Capital - Analyst

* Paula Torch

Avondale Partners - Analyst

* Kevin Fischbeck

BofA Merrill Lynch - Analyst

* Ana Gupte

Leerink Partners - Analyst

* Gary Lieberman

Wells Fargo Securities, LLC - Analyst

* Whit Mayo

Robert W. Baird & Company, Inc. - Analyst

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Presentation

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Operator [1]

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Good morning. My name is Jennifer and I will be your conference operator today. At this time I would like to welcome everyone to today's fourth-quarter earnings call.

(Operator Instructions)

I would like to turn the conference over to Mr. Steve Filton. Sir, you may begin.

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Steve Filton, Universal Health Services, Inc. - SVP and CFO [2]

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Thank you, Jennifer. Good morning. Alan Miller, our CEO, is also joining us this morning. We welcome you to this review of Universal Health Services' results for the full year and fourth quarter ending December 31, 2016.

During the call, Alan and I will be using words such as believes, expects, anticipates, estimates, and similar words that represent forecasts, projections and forward-looking statements. For anyone not familiar with the risks and uncertainties inherent in these forward-looking statements I recommend a careful reading of the section on risk factors and forward-looking statements and risk factors in our Form 10-K for the year ended December 31, 2016.

We'd like to highlight just a couple of developments and business trends before opening the call up to questions. As discussed in our press release last night, the Company recorded net income attributable to UHS per diluted share of $7.14 for the year and $1.78 for the quarter. After adjusting each period for the incentive income and expenses associated with the implementation of electronic health report applications at our acute care hospitals, as disclosed on the supplemental schedule included with last night's earnings release, adjusted net income attributable to UHS increased to $176 million or $1.80 per diluted share for the quarter ended December 31, 2016 as compared to $170.7 million or $1.71 per diluted share during the fourth quarter of 2015.

On a same-facility basis in our acute care division, revenues decreased 9.3% during the fourth quarter of 2016. Adjusted admissions increased 4.7% while revenue per adjusted admission increased 2.6%.

On a same-facility basis, operating margins for our acute care hospitals decreased to 16.5% during the fourth quarter of 2016 as compared to 17.2% during the fourth quarter of 2015. On a same-facility basis revenues in our behavioral health division increased 2.2% during the fourth quarter of 2016.

Adjusted admissions and adjusted patient days to our behavioral health facilities owned for more than a year increased 2.1% and 1.4%, respectively, during the fourth quarter of 2016. Revenue per adjusted patient day rose 0.5% during the fourth quarter of 2016 over the comparable prior-year quarter. Operating margins for our behavioral health hospitals owned for more than a year were 26.0% and 26.8% during the quarters ended December 31, 2016 and 2015, respectively.

Our cash generated from operating activities was $1.288 billion during 2016 as compared to $1.021 billion during 2015. Contributing to the increase is a $200 million favorable change in working capital accounts experienced during 2016 as compared to 2015 resulting from the timing of disbursements.

Our accounts receivable days outstanding remained unchanged at 52 days during each of the fourth quarters of 2016 and 2015. At December 31, 2016 our ratio of debt to total capitalization was approximately 48%.

We spent $124 million on capital expenditures during the fourth quarter of 2016 and $520 million during the full year of 2016. In 2016 we completed and opened 221 new acute care beds including 130 beds at our newest acute care facility, Henderson Hospital in Henderson, Nevada, and 437 new behavioral health beds, including two de novo facilities. During 2016 we expect to spend approximately $475 million to $500 million on capital expenditures, which includes expenditures to capital equipment, renovations, new projects at existing hospitals, and construction of new facilities.

As previously announced, at the end of 2016 we completed the acquisition of Cambian Group, PLC's adult services division consisting of 79 inpatient and 2 outpatient behavioral health facilities located in the United Kingdom. Working in conjunction with our existing behavioral facilities located in the UK we believe these newly acquired facilities will ensure that we're well positioned to serve patients, customers and communities with a broad range of innovative treatment services and products.

In conjunction with our share repurchase program that commenced during the third quarter of 2014 during the fourth quarter of 2016 we repurchased 475,000 shares of our stock at a cost of approximately $52 million or $109 per share. Since inception of the program through December 31, 2016 we have repurchased approximately 4.39 million shares at an aggregate price of approximately $514 million or $117 per share. $286 million remained on this previous share repurchase authorization at the end of 2016.

Our estimated range of earnings before interest, taxes, depreciation and amortization for the year ended December 31, 2017 is $1.746 billion to $1.821 billion, representing an increase of approximately 5% to 10% over the $1.653 billion of EBITDA generated during 2016. Our estimated range of adjusted net income attributable to UHS for the year ended December 31, 2017 is $7.70 to $8.20 per diluted share. This guidance range excludes the unfavorable $0.15 per diluted share of EHR impact expected during 2017 as well as the impact on our provision for income taxes and net income attributable to UHS resulting from our January 1 adoption of ASU 2016-09, as mentioned in our press release.

This adjusted EPS guidance range represents an increase of approximately 5% to 12% over the adjusted net income attributable to UHS of $7.32 per diluted share for the year ended December 31, 2016 as calculated on the supplemental schedule included in last night's press release. During 2017 our net revenues are estimated to be approximately $10.62 billion to $10.76 billion, representing an increase of approximately 9% to 10% over our 2016 net revenues. Alan and I will be pleased to answer your questions at this time.

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Questions and Answers

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Operator [1]

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(Operator Instructions)

Justin Lake, Wolfe Research.

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Justin Lake, Wolfe Research - Analyst [2]

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Thanks, good morning. First question just in terms of the behavioral business, I wanted to see if you can talk about whether there's been any impact to behavioral operations post the BuzzFeed article. And if you could talk to -- I know it came out in December -- potentially even January and February and what you have seen year to date here, Steve, that would be great. And also any change in the level of activity on the investigation post that article, as well.

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Steve Filton, Universal Health Services, Inc. - SVP and CFO [3]

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Sure. When the BuzzFeed article came out, which was in early December, we obviously speculated at the time and anticipated that we did not believe the article would have much, if any, impact on our underlying behavioral operations, on demand, on our referral sources, on the behavior of our clinicians, et cetera. Unfortunately we went into our quiet period about a week after the article so we didn't really comment with any great specificity after that.

So, it's with a measure of relief that I'm happy to say that with the passage now of several months that all that we represented at the time really seems to be valid and verifiable, that there's been little impact on our underlying business. I think you see that in our Q4 volumes which incrementally improved during the quarter and continued to get a little bit better with each passing quarter. And I think we can say that in January and February that improvement continued. So, again, from an underlying operational perspective, we see no material evidence that the BuzzFeed article has had an impact on us.

In terms of the investigation, we filed our 100K last night, and if you read the legal disclosure section you'll see that there's really no change to the disclosure there, which I think is an indication that our conversations with the government and the activity with the government has also not changed, at least in any way that's apparent to us, in any measurable way since the BuzzFeed article came out.

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Justin Lake, Wolfe Research - Analyst [4]

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Great. And if I could just ask a follow up on behavioral, the EBITDA guidance that you've given for the year, can you talk about what you'd expect in terms of -- I know you don't give quarterly guidance -- but how you see the ramp in both behavioral volumes for the year and behavioral EBITDA growth for the year, and what you think EBITDA growth in total would be for behavioral organically and M&A? Thanks.

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Steve Filton, Universal Health Services, Inc. - SVP and CFO [5]

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Sure. What we have talked about, quite frankly, for some time now is that beginning in the middle of 2015, really with the third quarter of 2015, our behavioral revenues and volumes became more muted and we largely attributed that moderation to difficulties in finding an adequate number of clinicians, mostly nurses but to some degrees psychiatrists and mental health technicians, in certain markets to service the demand and the patients who were requesting services at our facilities.

We've been working on that issue ever since and have and have said that we believe in the back half of 2016 that we are beginning to make some incremental progress, and that our expectation was that by the time we got to the end of 2017, we would be back to what we consider a normalized run rate, which would be something like 5% or 5.5% revenue growth and 6% or 7% EBITDA growth. I think if you look at the cadence of how we expect that recovery to continue, I think it's what creates, in large part, the range of our guidance for next year.

So, I would say the mid point of our range for next year assumes that recovery in our behavioral revenues and volumes takes place rather ratably over the course of the year. The low end of the range would suggest it takes place a little more slowly, and I think the high end of the range would suggest it takes place a little more quickly than that.

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Justin Lake, Wolfe Research - Analyst [6]

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Great. Thank you.

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Operator [7]

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A.J. Rice, UBS.

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A.J. Rice, UBS - Analyst [8]

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Hello, Steve. Just maybe to follow up on the guidance a little further, can you just maybe give us some flavor for how your assumptions relate on the acute care side, and also any commentary on your capital deployment assumptions? I know you were buying back stock in the fourth quarter. Are you assuming that continues this year?

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Steve Filton, Universal Health Services, Inc. - SVP and CFO [9]

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Again, I think that our acute care guidance for next year is really something we've been talking about for some time, and that is, while we are extremely pleased with our robust acute care volumes and revenue care growth in 2016, we acknowledge that they are industry-leading numbers and, frankly, industry-leading numbers by quite a large margin. And obviously certainly we're going to try and stem those numbers as much as we can but, realistically, feel like some moderation is likely.

The guidance for next year presumes that acute care same-store revenue growth moderates to something in the neighborhood of 6% next year, and that would translate to 7% or 8% EBITDA growth. And while you didn't ask this, and while we don't normally give quarterly guidance, I will mention that, as people look at their quarterly models, they should just keep in mind that, particularly in Q1, our comparisons for 2016 are very difficult on the acute care side. So, I would, again, suggest to people that's something you keep in mind as you think about the cadence for next year.

As far as capital deployment goes, historically, our convention has been to simply reflect in our guidance the share repurchases we've made already at the time of our guidance but then not assume any further share repurchases, and a just really assume that all of our free cash flow goes toward the repayment of debt, which, in our case, would be the repayment of relatively low-cost debt. So, from a guidance perspective, it's a fairly conservative position to take, but consistent with what we've historically done.

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A.J. Rice, UBS - Analyst [10]

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All right. And just maybe a follow-up -- I know the last two quarters you talked about the fact that the IMD exclusion has given rise to a number of discussions with acute care guys that have units and are either looking to potentially have you managed, outsource, even acquire assets. Can you just comment on what that looks like? Is the acquisition pipeline in behavioral in particular stepped up in any way? Maybe some flavor on that.

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Steve Filton, Universal Health Services, Inc. - SVP and CFO [11]

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Sure. So, I would note this -- in the fourth quarter of 2016, our overall Medicaid volumes have grown by about 3.5%, our overall rotation days, compared to the 1.5% divisional-wide growth. So, our Medicaid volumes are growing faster than our overall volumes. It is impossible for us to attribute that directly to the impacts of the IMD exclusion being lifted, et cetera, but it seems to be consistent with the idea that we'd be getting some benefit from that.

At the same time, and I don't think the two are absolutely directly related, but, as you suggest, we have talked a great deal of the last few quarters about the fact that we are having much more frequent conversations with acute care hospitals about, in some way, penetrating and sharing in the economics of their behavioral health facilities. And we probably have about a half a dozen arrangements that we've had a place for some time representing executed transactions already reflecting that.

Those numbers are already embedded in our same-store results. I think we concluded that there was no point in trying to extract them or really call them out separately. As we move forward, I think we will identify these new arrangements separately and talk about EBITDA impact, et cetera.

We announced in the third quarter, for instance, two joint ventures to build new behavioral freestanding facilities with acute care hospitals, one in Lancaster, Pennsylvania, and one in Spokane, Washington. Neither of those will have an impact in 2017. They will both open in 2018 so they don't really have an impact on guidance but it's something we continue to work on.

And then we probably have about a dozen other conversations that I would describe as likely resulting in some sort of arrangement but still a little too early to discuss them with any level of specificity. And then, quite frankly, a number of other conversations that are at much more preliminary levels or preliminary stages.

So, we continue to view the opportunity to penetrate or integrate the behavioral units within these acute care hospitals as a tremendous development opportunity for us, not just in the next year or two but, frankly, for the intermediate and long term. And we will continue to report on those as we do then. But other than the about half a dozen that, I think, as I said, are already embedded in our same-store numbers, I don't think those conversations and those new arrangements are likely to have a material impact in 2017.

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A.J. Rice, UBS - Analyst [12]

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All right, great. Thanks a lot.

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Operator [13]

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Josh Raskin, Barclays.

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Josh Raskin, Barclays Capital - Analyst [14]

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Thanks, good morning First question, Steve, for you, just on the outpatient environment, the competitive environment, and what you're seeing in your markets. Are you seeing any additional competition from freestanding EDs or surgery centers or even urgent care centers? I'm just curious what your reaction is on the acute care side?

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Steve Filton, Universal Health Services, Inc. - SVP and CFO [15]

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I know that a number of our acute care peers have talked about that dynamic of increased outpatient competition from all the sources that you mentioned -- freestanding EDs, ambulatory surgery centers, et cetera. And certainly we have noticed and continue to feel the same dynamics.

Now, I will say that it appears, if you look just look at the relationship between our admissions and adjusted admissions, that we haven't had the negative impact on our outpatient revenue that at least some of our peers have had. I don't necessarily have any real explanation for that other than it may well be that in some of our more mid-sized urban or suburban markets that outpatient pressure is not quite as severe as it is in some of these really large urban markets.

That's really mostly speculation on my part. It does look, as you compare our outpatient numbers to our peers, that our outpatient volumes are holding up a little bit better, although certainly we feel the same pressures from these niche outpatient providers that our peers report, as well.

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Josh Raskin, Barclays Capital - Analyst [16]

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And do you see that, Steve, in, think of, bigger market -- Vegas or DC -- versus McAllen, or something like that? Are you see that urban versus suburban differential?

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Steve Filton, Universal Health Services, Inc. - SVP and CFO [17]

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Honestly, Josh, I almost have the view that in markets like McAllen and Las Vegas, that outpatient push occurred even earlier. Those happen to be two very, what I would describe as entrepreneurial from a physician perspective, market.

So, while something like freestanding EDs are a relatively new development and concept, things like physician-owned surgery centers and even a physician-owned hospital, when it comes to the McAllen market, are things that we have been dealing with for years and years. So, I also think that maybe one of the issues is that, again, in some of our larger markets, we are maybe a little bit further along on that outpatient competition curve and so the comparisons don't look as difficult for us.

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Josh Raskin, Barclays Capital - Analyst [18]

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Got you. And then just a quick question on the guidance, you guys added EBITDA this year, and I'm just curious -- was that more just helpful for modeling purposes or are you guys thinking about management from a different perspective, EBITDA more of an emphasis than EPS, or any internal management change around metrics?

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Steve Filton, Universal Health Services, Inc. - SVP and CFO [19]

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No, it's really just a function of giving people what they want. I've been asked by investors for a couple of years to include more detailed information, particularly about EBITDA, in the guidance. So, we thought it would just be useful progress.

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Josh Raskin, Barclays Capital - Analyst [20]

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Okay, thanks.

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Operator [21]

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Paula Torch, Avondale Partners.

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Paula Torch, Avondale Partners - Analyst [22]

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Think you. Good morning. I wanted to start my first question with maybe the ACA and talking about behavioral volumes. I know that you said it's hard to parse it out. It's certainly hard for the Street to parse it out. So, I was just wondering, do you have any systems in place to help you track where admissions are coming from? How much of a benefit do you think that the ACA has actually been to your behavioral business? And in your opinion, do you think repeal-replace would do away with essential health benefits for mental health or substance abuse? And anything that you're hearing out of Washington? Our feeling is that this space is pretty immune. I just want to know from your perspective how immune do you think this segment really is?

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Steve Filton, Universal Health Services, Inc. - SVP and CFO [23]

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Paula, I think what we have said up to now is that our view is that the Affordable Care Act has had relatively minimal impact on our behavioral business. The biggest impact we think it's had on our acute business has been on the Medicaid expansion side of it. And on the behavioral side, because most of those new Medicaid expansion patients are adult patients, and because the IMD exclusion has precluded those people from being treated in most freestanding behavioral facilities, that really wasn't a benefit for us.

And on the commercial exchange side, because so many of those plans were high deductible plans, and because behavioral bills tend to be much smaller, we felt that, besides the anecdotal patient here or there or the incidental patient here or there, there really has not been a pervasive positive impact on our behavioral facilities that there has been on the acute facilities.

As far as what the prospects are going forward, as you suggest, speculating how modifications to the ACA are going to deal with the essential health benefit piece of it is very hard to say at this point. While there's been tons of talk about repeal and replace, or repeal and repair, or whatever, there's very little agreement on any details because. The President suggested just a couple of days ago, this is a very complicated subject, and I think everybody's realizing that.

So, I think it would be difficult to speculate how we'd be impacted, although I think we share the view that you articulated, Paula, which is that we believe that behavioral care and behavioral treatment in general is viewed positively at both the federal and state levels at the moment, and that it is not a segment or space that is under a lot of scrutiny or pressure. So, just our general expectations are that it will be treated favorably however the details are worked out progress

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Paula Torch, Avondale Partners - Analyst [24]

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Okay, thank you. That's helpful for that color. And then if I could just move quickly to the UK, I know the CMA is conducting a phase 1 investigation of your Cambian acquisition. I know that this is small in terms of your total business as well as your behavioral business, but I just wonder how those discussions with the CMA are going, if you started to identify any assets that you might possibly need to divest in order to satisfy their findings. And maybe it's too early but could you give us a sense of timing there and what kind of synergies you might be able to get from this acquisition?

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Steve Filton, Universal Health Services, Inc. - SVP and CFO [25]

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Starting backwards, we never imagined that there would be significant synergies from this transaction. As you articulated, Paula, our existing footprint pre-Cambian in the UK was relatively small. So, there was not a great deal of overhead to be ultimately synergized, if you will, between the new Cambian business and our existing business, maybe ultimately $1 million or $2 million of ultimate savings. And we certainly haven't even included that in our guidance, or the assumption of that in our guidance.

We certainly did our own due diligence before the transaction with trade restraint attorneys in the UK and had them look at the geographic overlap of the businesses we were acquiring and those that we already had, and generally concluded that we thought there was relatively minimal overlap and risk of CMA issues. But of course we won't know that until the CMA does there work.

We have been providing information to the CMA almost from, I think even the time that we announced the transaction. They, of course, just announced this past week or last week that they were beginning their formal process. We don't really have a lot of feedback from them. We view this at the moment as just part of their routine exercise. As they communicate with us, we'll keep folks updated, but at the moment it's really impossible for us to know what direction and with what rigor and scrutiny they're going to approach this.

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Paula Torch, Avondale Partners - Analyst [26]

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Okay And then I just have one more follow-up, if I could. On the behavioral pricing, it was a little bit weaker, certainly sequentially. Was that just a function of tougher comps? Or maybe there's any color you can give us on pricing?

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Steve Filton, Universal Health Services, Inc. - SVP and CFO [27]

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I think the one nuance is that our year-over-year UK pricing, even though as you again articulated is a relatively small component of our business, the pound declined in value about 22% from the fourth quarter of 2015 to 2016. And that dramatic decline, even on our relatively small UK business, was enough to drive that same-store pricing metric down about 100 basis points. So, when you adjust for the currency fluctuation, we're at about 1.5% price increase, which is pretty consistent with what we've been running, and pretty consistent with what we, frankly, expect is a sustainable number.

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Paula Torch, Avondale Partners - Analyst [28]

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Okay, great. Thank you.

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Operator [29]

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Kevin Fischbeck, Bank of America Merrill Lynch.

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Kevin Fischbeck, BofA Merrill Lynch - Analyst [30]

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Great, thanks. I just wanted to go back to the improvement that you expect in the behavioral business because, as you mentioned, this has been going on since Q3 of 2015. I think at that time the initial thought was that once we comp against that in the back half of 2016 we'd be seeing acceleration, and it hasn't come back as quickly as we would have thought. Do you have any data around what's driving the sequential improvement as time goes on? Is there something that you're looking at from a workforce addition perspective, that you're onboarding nurses at some pace over the next few quarters that gives you visibility that this is going to happen? Or is it more about comp against easy numbers? Can you just provide a little more color as to why you're confident?

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Steve Filton, Universal Health Services, Inc. - SVP and CFO [31]

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Sure. I think from the outset, based on our previous experience, I can think in my 30-plus years with the Company of maybe two or three other nursing shortages, relatively severe nursing shortages, that I have been through, mostly, honestly, on the acute side. They tend to, I think, have a life cycle to them because I think the market, as markets generally do, tend to correct themselves. So, as a nurse shortage becomes apparent and nurse wages and demand for nursing hours increases, the market responds in a macro way by more and more people enrolling in nursing school, by part-time nurses working extra shifts, by retired nurses coming out of retirement and working an extra shift here or there. There's a natural increase in the supply of nursing hours.

Now, that takes some time, and I think historically has taken 18 to 24 months. So, if you peg the beginning of this shortage as right around the middle of 2015, we're just about at the 18-month mark with the end of 2016. So from a macro perspective, there's some of that, just expectation that the market itself and the macro environment will begin to improve beginning in 2017.

Certainly as a Company, we have not been just sitting on our hands waiting for that to happen and we've been aggressively implementing our own initiatives to increase our recruitment activities and our recruitment focus and our recruitment infrastructure and our internet application process, and a million other things, as well as trying to focus on better retention policies for the nurses we do hire. That's been an enormous focus of ours, as well, so that once we hire nurses, making sure that we have mentoring programs and educational opportunities and career advancement incentives all in place so that we keep the nurses who we to hire.

Now, all that, to be fair, is relatively generic, et cetera. I think what ultimately gives us confidence is that over the last couple of quarters, we clearly see the amount of nurse vacancies being reduced and a lot of those vacancies being filled. We see a number of the units that we have closed or in facilities where we've capped the census or limited the census. We've seen those caps either reduced or lifted.

Now, what we do think Q3, and what we said we expect it to continue into Q4, is that there is this transition period, that as we hire new nurses there is some increased expense as we begin to pay them their salaries, but they are going through orientation, they're going through training. Frankly, one of the tactics that we've had to adopt in some cases is hiring less experienced nurses, more nurses who are directly out of nursing school so they require, frankly, more training, more orientation, which just elongates the period of time it takes.

But it's really that visibility that we have, Kevin, into how many vacancies are open, how many beds we been able to re-open they gives us the confidence that, as we've been talking all along, will really begin to make some traction in 2017 in building those volumes back up to the pre-Q3 2015 levels.

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Kevin Fischbeck, BofA Merrill Lynch - Analyst [32]

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Okay. That makes sense. Based upon that last comment, though, about the timing of costs and everything, does that mean that from an EBITDA growth perspective you would expect EBITDA growth to obviously follow a similar pattern but maybe even more so because at the beginning you're going to have more costs and less revenue, and then by the end the costs stay the same but the revenue accelerates? Or, how do you think about the margin improvement as the year goes on?

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Steve Filton, Universal Health Services, Inc. - SVP and CFO [33]

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I think about it in a couple ways. I think that what we experienced in Q3 and, to some degree, continue to experience in Q4 is some, what I would describe as, duplicate costs, meaning we're paying these nurses, and we have that expense but they're not yet really productive. That is, they're not on the floors treating patients or they're not on the floors treating what we would describe as a normal or average workload of patients as we bring them incrementally into the system. Obviously at some point we will get past that incremental investment and this new expense, et cetera, and I think that will begin to occur in the first quarter of 2017.

I DO think there is an ongoing level of increased expense. We've had to raise wage rates in a number of markets. We're using temporary nurses in markets at an added cost. And we've added temporary psychiatrists, quite frankly, in some markets that we haven't had to do in a long time.

And I think the way we've reflected that is, we've talked about exiting 2017 with something like 5% behavioral revenue growth and 6% or 7% EBITDA growth. If we were having this conversation two years ago, I would have probably suggested at that time that 5% revenue growth translates to maybe 8% or 9% EBITDA growth. The moderation, I think, in the EBITDA growth assumptions is a reflection that some of this wage pressure and wage increase is more permanent in nature and something that we're going to have to deal with on a more permanent basis.

So, I think about it, again, in some ways, as some of these costs are temporary, some are more permanent. But I think we've reflected all that in our guidance for next year and in the assumed and projected ramp-up in our earnings and revenue growth for next year.

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Kevin Fischbeck, BofA Merrill Lynch - Analyst [34]

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Okay, great. Thanks.

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Operator [35]

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Ana Gupte, Leerink Partners.

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Ana Gupte, Leerink Partners - Analyst [36]

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Yes, hi, thanks. Good morning. I wanted to go back to the acute side. Can you just remind me, firstly, why the margins compressed again by 80 basis points year over year in 2016 relative to 2015? And how should we think about the puts and takes around wages and staffing and pricing and contracting and just normalized margins into 2017 and beyond?

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Steve Filton, Universal Health Services, Inc. - SVP and CFO [37]

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Again, I don't think there is anything terribly new in Q4 in terms of the dynamics we've been discussing. Obviously, our volume and revenue growth on the acute side has been rather robust for a while now. But we've seen choppy performance in the resulting EBITDA, and not necessarily the pull-through on margins that we would normally expect. I think the biggest reason for that is, again, the labor shortage and the pressure on nurse wage rates that we've experienced on the acute side.

We've said all along that I think the labor shortage has manifested itself in the two divisions in different ways. On the acute side, I think the labor shortage has manifested itself mostly through higher use of premium pay, overtime for our own nurses, and the use of temporary or registry nurses.

And, by the way, I think it's related to our strong top line. One of the reasons why I think we're experiencing more labor pressure than some of our peers is because our end-market economies are improving faster, unemployment is dropping quickly. There are more labor shortages in our markets, I think, than in some of our peers' markets. That's why, quite frankly, our demand is growing so much. But at the same time there is this offsetting dynamic of higher pressure on wages.

I think our expectation next year is that we will see some stabilization both, again, at a macro level and also we'll see some improvements from some of our own initiatives. And, as a result, I think we're expecting the acute care model to show somewhat moderating revenue trends next year but a return to what we would describe as a more normalized pull-through of EBITDA. So, with revenues growing by 6%, we would expect EBITDA to grow by 7% or 8%, and margins to expand.

Now, again, I will make the same comment I made to Kevin -- if you had asked me this question two years I would have said that maybe with 6% acute care revenue growth, EBITDA margins would expand 8% or 9%. And I think the fact that we've moderated that view is a reflection that we think that some of these wage increases are more permanent in nature.

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Ana Gupte, Leerink Partners - Analyst [38]

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Okay, that's very helpful. Then on the bad debt side, again, you did well this quarter. Your AR receivables you said were trending well. One of your peers has had issues on AR receivables and collectibility from commercial peers. I was just wondering if you were seeing anything. It is related to exchanges or any other businesses that maybe put some pressure going forward?

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Steve Filton, Universal Health Services, Inc. - SVP and CFO [39]

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I think those who listen to our calls and commentary will know that we tend not to really focus on bad debt as a distinctive line. But we tend to focus much more on our overall net revenue growth and net revenue per admission growth on the acute side net of bad debt expense. Our net revenue growth per admission was about 2.5% in the quarter. That's really largely within our expectations, and I think continues to be so.

Now, look, much like I was saying about outpatient competition before, I think we feel like some of the dynamics our peers have talked about we certainly have experienced, as well. There's no question that over the last few years payers have shifted more of the ultimate payment burden to the consumer and to the patient, and we are collecting, we're being asked to collect more, on co-pays and deductibles from the patients themselves than we have been asked to collect from insurance companies historically. And that is certainly a tougher exercise and we certainly are making changes in our approach, in our systems, et cetera, to do that more effectively.

think we feel it has certainly having an impact and has somewhat pressured our overall net revenue yield over the last couple of years, but I don't think we feel like that's accelerated in any material way in the last quarter or two. And I think we just feel like that's a trend that, again, is now just a part of the business and something that we've kept in mind as we've created our 2017 guidance.

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Ana Gupte, Leerink Partners - Analyst [40]

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Okay. And if I could squeeze one last one -- that was very helpful, Steve -- on the acute volumes, you talked a lot about the economy in your specific markets, some of your visibility into peer mix. At earlier times, I think maybe a year ago you used to talk more about Medicare and perhaps driving more volumes through whatever clinical practices and treatment guidelines and the like. Is anything coming from there at all?

And then, finally, on 1Q, is there a positive impact from the flu? You've talked about tough comps, obviously, given your performance last year. How does the leap day comp all work into 1Q guidance -- or just 1Q performance since you don't have guidance?

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Steve Filton, Universal Health Services, Inc. - SVP and CFO [41]

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We have tended, I think, to artificially describe the middle of 2015 as the end of the ACA era. And obviously the ACA has continued to have an impact. But I think our point of view was the most dramatic and meaningful impact from the ACA really occurred in 2015 and the first half of 2015.

And I think since, the back half of 2015 and in the four quarters since then, the payer mix dynamics that we've experienced have been pretty consistent. You repeated them, to some degree. The strongest growing segment of our payer population has been the Medicare population. Medicaid is probably second. We have seen our commercial volumes decline a little bit, and we have seen our uninsured volumes tick back up. And, again, again I think all of those dynamics have really been fairly consistent for the last four quarters or so.

We view that, again, as indicative of the underlying strength in our markets because I think Medicare business is largely unimpacted by the ACA. It's largely impacted by a lot of the economic recovery issues. It just, I think, is reflective of the strong market share position we have in our markets, our ability to take market share and grow demand, et cetera. And I think we have a view that continues.

As far as the flu, interestingly, I think in most of our markets, I know that generally it's been a relatively busy flu season, particularly over the last four to six weeks. I think in most of our markets it's been a pretty moderate flu season. Now, again, I think we tend to largely ignore the transient impact of the flu either way. But I will say that I don't think we're benefiting greatly from the flu in our markets.

And, finally, I think the leap year, leap day, that's just a mathematical issue. It just makes what for us -- which I already said earlier -- was a very difficult comparison in Q1 just even a little bit more difficult, but not something that I think has any real impact on our ultimate and full-year guidance.

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Ana Gupte, Leerink Partners - Analyst [42]

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Thanks, Steve. That was very helpful.

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Operator [43]

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Gary Lieberman, Wells Fargo.

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Gary Lieberman, Wells Fargo Securities, LLC - Analyst [44]

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Good morning. Thanks for taking the question. Steve, in the past you've talked about a shortage of psychiatrists in some markets actually forcing you to put a hold on patient admissions. Is that still the case and to what extent?

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Steve Filton, Universal Health Services, Inc. - SVP and CFO [45]

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When this labor shortage really started to manifest itself in the middle of 2015, we talked a lot about the psychiatrist shortage because, quite frankly, in the beginning that's what I think was most impactful on us. I think what we found was that we were able to devise ways to mitigate the physician and psychiatrist shortage more easily. We used things like telemedicine. We used things like physician extenders, RNs and psychologists, doing some of the work that psychiatrists had traditionally done, to fill in for that. And I think it proved to be fairly effective.

While we continue to have some pockets of psychiatry shortages in a few markets, I think we don't view that as a really pervasive issue at this point. Relatively quickly the bigger issue became nursing shortages and we really couldn't find the same kinds of solutions, meaning there were not technical solutions. You really can't replace a nurse with telemedicine. They really are at the bedside. They're the hands-on provider. You really can't extend the nurses' duties with people under them because the people under them tend to be non-professionals. So, the nurse shortage proved to be a little bit more intractable to us, so that remains an issue.

Again, just back to my overall comments, I think we feel like we've made progress on our clinician shortages in general. I think you've seen that reflected in slightly improving, incremental improvement in volumes in Q3 and Q4. We obviously would hope that the pace of those improvements will accelerate in 2017, and expect that they well.

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Gary Lieberman, Wells Fargo Securities, LLC - Analyst [46]

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Great. And then maybe just a follow-up on the benefit from the IMD exclusion or the potential benefit. Are there things you need to do proactively, like making sure you're in appropriate plans and actually going out and marketing to referral sources? Or is it more reactive just from the perspective, that patients that show up at the hospital you're now allowed to accept them as opposed to previously turning them away?

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Steve Filton, Universal Health Services, Inc. - SVP and CFO [47]

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We have to do what you said, which is, in order to have access to these managed Medicaid patients, we obviously have to make sure that we are a contract provider with the appropriate managed Medicaid plans in particular markets. I think for the most part we have been able to accomplish that and that has not been a real hurdle.

I think the hurdle, which may have been under-appreciated, quite frankly, by providers as well as by investors, has been that this pattern of referrals and this pattern of patient behavior has been in place for decades. These adult Medicaid patients have been accustomed, I think, to going to acute care emergency rooms when they need care. And our ability to step in and just redirect what are these decades old patterns in a very short period of time is somewhat limited.

Now, again, I think we're trying to do that. And we can certainly engage with the managed care companies to help us in that endeavour by competing on the basis of price and offering lower rates. But I think what we've concluded is that the more economically effective way to get to those patients is in some sort of collaborative venture with the acute care hospital -- getting them to close their units down and send their patients to us, or getting them to lease their behavioral units or freestanding behavioral facilities to us, or joint venturing their facilities with us, or joint venturing new facilities with us.

We've done every version of what I just described and we continue to negotiate with more acute care hospitals to do every version of what I just described. I think ultimately that's the way that we will really enjoy the benefit of the lifting of the IMD exclusion, although, again, in the short run, as I was suggesting, I think we're already seeing, we're likely to see some incremental benefit just from an increase in Medicaid utilization, which clearly we have already experienced.

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Gary Lieberman, Wells Fargo Securities, LLC - Analyst [48]

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Great. That's very helpful. Thanks a lot.

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Operator [49]

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Whit Mayo, Robert W. Baird.

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Whit Mayo, Robert W. Baird & Company, Inc. - Analyst [50]

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Hi, thanks. Maybe just an update on Henderson. I know it's early but how is that hospital tracking versus planned? And is that new capacity having any impact on your existing presence within the market? I think it's a lot closer to Dignity's facilities. But just curious how this is playing out versus your initial expectations.

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Steve Filton, Universal Health Services, Inc. - SVP and CFO [51]

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It's still relatively early, Whit. The facility opened in the beginning of October. We had consistently guided and told people that it would have an impact on EBITDA -- an EBITDA drag, if you will -- of $5 million to $10 million in the back half of 2016. I think that the actual results are absolutely in that range. I think our expectation embedded in our guidance for 2017 is a turnaround and some level of accretion.

And, honestly, I think the turnaround at Henderson would otherwise have provided a bigger tailwind for us in our 2017 guidance except for the fact -- and these are unrelated but I think they wind up mathematically offsetting each other -- but we've got a schedule in the 10-K, for when folks get a chance to read it in more detail, that shows our Texas Medicaid reimbursement and our expectations that our Texas Medicaid reimbursement will go down $16 million or $17 million in 2017. That decline, unfortunately, I think, largely offsets the improvement in Henderson. What I think we were hoping would be a standalone tailwind really doesn't. It winds up just being an offset for us.

As far as cannibalizing our existing business, you described as very quickly, I think every other hospital that we've opened in the last 10 or 15 years in Vegas has, to some degree, cannibalized some existing business, mostly on the (inaudible) side of the market. But in the case of Henderson in the southeast part of Las Vegas, that's been a market that has historically been dominated by Dignity. And I think we have the view that most of the market share that we would take would be from Dignity. That seems to certainly be the outcome in the first few months of operation.

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Whit Mayo, Robert W. Baird & Company, Inc. - Analyst [52]

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Are there any other supplemental reimbursement changes we should be aware of? LIP? California provider fee? I think you got a little there. Just curious if there's anything we should be mindful of.

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Steve Filton, Universal Health Services, Inc. - SVP and CFO [53]

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I don't think anything else that's a material change for next year or this year.

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Whit Mayo, Robert W. Baird & Company, Inc. - Analyst [54]

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Okay. And maybe just one last one -- DSOs ticked up a bit. I don't know if that's just Cambian mathematically flowing into the financial statements. But just any color to share would be helpful.

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Steve Filton, Universal Health Services, Inc. - SVP and CFO [55]

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Yes, I think they're actually flat between the fourth quarter of this year and the fourth quarter of last year.

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Whit Mayo, Robert W. Baird & Company, Inc. - Analyst [56]

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Okay. So maybe just seasonality. Okay, thanks.

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Operator [57]

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And we have no other questions in queue at this time.

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Steve Filton, Universal Health Services, Inc. - SVP and CFO [58]

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Okay. We would like to thank everybody for their time and look forward to speaking with everyone again at the end of the first quarter.

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Operator [59]

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