Universal Health Services, Inc.
Q2 2013 Earnings Call Transcript

Published: 26 Jul 2013

[Operator:]

Good morning, my name is Charlene, and I will be your conference operator today. At this time, I would like to welcome everyone to the Universal Health Services Second Quarter Earnings Conference Call. [Operator Instructions] Thank you. I would now like to turn the call over to our host, Mr. Steve Filton. Sir, you may begin your conference.

[Steve G. Filton:]

Thank you. Good morning. I am Steve Filton. Alan Miller, our CEO, is also joining us this morning. Welcome to this review of Universal Health Services results for the second quarter ended June 30, 2013. During this conference 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, 2012, and our Form 10-Q for the quarter ended March 31, 2013. We would like to highlight just a couple of developments and business trends before opening the call up to questions. As discussed in our press release last night, the company recorded net income attributable to UHS per diluted share of $1.53 for the quarter. After adjusting each quarter's reported results for the items disclosed on the supplemental schedule included with last night's earnings release, adjusted net income attributable to UHS increased 7% to $1.20 per diluted share during the second quarter of 2013, as compared to $1.12 per diluted share during the second quarter of last year. On a same facility basis, net revenues in our behavioral health division increased 3.2% during the second quarter of 2013. Adjusted admissions to our behavioral health facilities owned for more than a year increased 5.4%, and adjusted patient days increased 1.8% during the second quarter. Revenue per adjusted patient day rose 1.3% during the second quarter of 2013 over the comparable prior-year quarter. Operating margins for our behavioral health hospitals owned for more than a year remained unchanged at 28.7% during each of the quarters ended June 30, 2013 and 2012. This year's second quarter results include approximately $4 million of legal fees related to our ongoing Department of Justice investigation. On a same facility basis, in our acute division, revenues increased 4.9% during the second quarter of 2013. The increase resulted primarily from a 2% increase in adjusted admissions to our hospitals owned for more than a year and a 2.9% increase in revenue per adjusted admission. On a same facility basis, operating margins for our acute care hospitals decreased to 14.8% during the second quarter of 2013 from 16.1% during the second quarter of 2012. Our acute care hospitals provided charity care and uninsured discounts based on charges at established rates amounting to $258 million and $266 million during the 3-month periods ended June 30, 2013 and 2012, respectively. The decrease in charity care and uninsured discounts recorded at our acute care hospitals during the second quarter of 2013 as compared to the second quarter of 2012 was offset by an increase in the provision for doubtful accounts, which amounted to $216 million during the second quarter of 2013 as compared to $164 million during the second quarter of 2012. As a percentage of acute care net revenues, bad debts, charity care expense and the uninsured discount in this year's second quarter were at levels higher than those experienced during the second quarter of 2012. Our cash from operating activities was approximately $218 million during the second quarter of 2013, as compared to $246 million in the second quarter of 2012. For the 6 months ended June 13, 2013, our cash provided by operating activities increased by approximately 9% to $406 million over the $373 million generated during the comparable 6-month period of 2012. Our accounts receivable days outstanding increased to 57 days during the second quarter of 2013. At June 30, 2013, our ratio of debt to total capitalization was 54.2%. Due to systems issues experienced by our fiscal intermediary, approximately $18 million of Medicare claims payments were delayed during the quarter. Fiscal intermediary system issues have been resolved, and the delayed payments were received in July. We spent $80 million on capital expenditures during the second quarter. Included in our capital expenditures were the construction costs related to Austin Oaks hospital, a new 80-bed behavioral health hospital in Austin, Texas, which opened in May, and ongoing construction of a new acute care hospital in Temecula, California, which we anticipate will open late in the third quarter of this year. We are pleased to answer your questions at this time.

[Operator:]

[Operator Instructions] Your first question comes from the line of Justin Lake with JPMorgan.

[Justin Lake:]

Maybe first, we could talk about the behavioral business, specifically, looked like length of stay continues to be a little bit of a pressure there, but EBITDA growth is still strong. Can you talk a little bit about what's going on there? And Steve, maybe give us your thoughts on what a reasonable kind of long-term same-store revenue and same-store EBITDA growth or EBITDA growth numbers in that behavioral business in your mind?

[Steve G. Filton:]

Sure, Justin. So the length of stay issue is not a new one and certainly one we've spoken about before. We continue to face pressure on our length of stay and declines in our length of stay, primarily in our residential business and primarily amongst our Medicaid, the traditional Medicaid and managed Medicaid payers. In fact, we had very strong admission growth in the quarter, over 5% same-store growth in the behavioral business. So we have a view that when the length of stay issue sort of reaches its trough and levels off, which we think -- and I know we've said this before, but we think we're awfully close to that, that our revenue growth will pick up a little bit. If you look at the 6-months results for behavioral, I think we've got basically kind of 3% same-store revenue growth and a little over 6% EBITDA growth. I think our general sense again, is when the length of stay issue resolves itself, we can push both those numbers up a little bit. And I think that, from our perspective, is the ongoing trajectory of behavioral growth, absent any considerations surrounding reform and the benefits we might get from reform, which is, I think, we view as a separate issue.

[Justin Lake:]

Great. And while I have you guys, last night, one of your peers put out a slide deck that gave some view -- gave their view point on what they think are the potential impact from reform could be. And they appear to think in 2014, the benefit to EBITDA could be double-digits, let's call it 10% to 15%. Just curious if you've seen that, and then any kind of thoughts from your perspective that you want to share with us in terms of what the potential benefit could be to your business from reform.

[Steve G. Filton:]

To be candid, Justin, as you might expect, we're very focused at this time of the year on our own results. And so we did not have a chance to see the slide deck that you're talking about. I mean, in general, I would just say that we have -- we've been very sort of public about the idea that we think both of our business segments will be beneficiaries of health care reform and perhaps different aspects of it. But I think it's difficult at this point to sort of parse the benefit out between years and say how much is in '14 and '15 and '16, I think. And we hope that later in the year, we'll have a better sense of that, as we see the enrollment in the exchanges and the enrollment in expanded Medicaid. And we'll just have a better sense of how quickly this is playing out. But that's, I think, all we would say at this point.

[Operator:]

Your next question comes from the line of Kevin Fischbeck with Bank of America Merrill Lynch.

[Kevin M. Fischbeck:]

I guess, if we look at the acute care business, I thought the volume number was really strong and the overall same-store revenue number was pretty good. And if we -- but if we subtract out and just certainly put aside any kind of malpractice reserve adjustments in the quarter, I'm just wondering why there wasn't more leverage on that type of same-store revenue growth.

[Steve G. Filton:]

I think that, Kevin, the primary explanation is one that we've talked about in probably the last quarter or 2. And that is, I think the margins were depressed primarily by costs associated with our newly-acquired physician practices and newly-employed physicians. When we look at it, our what I'll call our hospital-only entities, tended to show the sort of margin improvement that you're suggesting you'd expect to see and that we'd expect to see, and I think it's mostly those physician-related costs. Obviously, we view those costs as a significant investment in the future and think it positions us well for the upcoming requirements of reform, as well as just the way that markets and the landscape is changing in general. So I think we think it's the right thing to do, but I suggest that, that's sort of a short-term effect that you're seeing.

[Kevin M. Fischbeck:]

Okay. And then can you give an update on the Las Vegas market? Looks like the minority interest number was a bit higher than we thought. Is that -- did Vegas here rebound particularly?

[Steve G. Filton:]

Yes, I mean, I think that the encouraging aspects of the second quarter results, as you point out, one is just the overall strength in revenue in the acute division, which is, I think, probably the strongest revenue growth we've seen in some time, and then the improvement in the Vegas market. Those 2 items are interrelated to some point, but -- to some degree. But we definitely saw stronger results in the Vegas market in Q2. We've been expecting that. We've been talking, I think, on our last few conference calls about the fact that the overarching economic metrics in Vegas surrounding unemployment, surrounding the gaming industry, have all been getting better for the last 3 or 4 quarters, and that we thought it was just a matter of time before we began to experience some of that benefit. And in Q2, it appears at least, we began to experience the starts -- the start of that. So mostly, I think, from an improved payor mix in Vegas, we definitely saw stronger results in Q2, as you suggest, which tend to be manifested on that minority interest line.

[Kevin M. Fischbeck:]

Okay. So is this something that you feel like is going to be more sustainable in the second half of the year? There's nothing like unusual in the Q2 Vegas numbers?

[Steve G. Filton:]

Well, I mean the only caveat I would offer, Kevin, is that sometimes these developments are not uninterrupted. I mean, I think we feel like we're certainly on an upward trajectory at this point in the Vegas market. But whether that, again, is going to continue on uninterrupted or could we have another soft quarter next quarter or a quarter or 2 away, that's possible. But I do think that after, as you know, several years of really softer performance as a result of the local economy in that market, I do think we're poised now for the recovery that we've been expecting.

[Kevin M. Fischbeck:]

Okay. And then maybe last question, I know that -- it looks like on the Medicaid expansion side of things that free-standing psych will not be covered for that population. Is there anything that the industry or you guys can do behind the scenes to try and change that position right now within HHS?

[Steve G. Filton:]

Well, the industry lobbied hard to have the IMD exclusion lifted, and I think will continue to do so. And we believe that it would be the right thing to do. I believe we're also going to pursue at the state level. And it's not entirely clear what the opportunities are to have states continue to apply for waivers for that exclusion. We're participating in the demonstration project that's part of the ACA that waives the exclusion in about 1 dozen states. So we're doing all those things. But to be fair, while we were lobbying as an industry very aggressively for the lifting of the exclusion, I think we were realistic about the chances of that happening. So I don't think that HHS's ultimate position came as a big surprise to us. We're going to continue to work to change it. But we're not shocked at where we are right now.

[Kevin M. Fischbeck:]

Okay. That's interesting, the state-level initiatives, I hadn't heard that. Is there -- are there examples of states today that have gotten waivers too, beyond the demonstration project that you alluded to?

[Steve G. Filton:]

Yes, I mean, unfortunately, I don't have the information in front of me, but I will -- I know, for instance, that Louisiana is a state that has had the exclusion waived for some time. There are other states. I just don't have the information in front of me, Kevin.

[Operator:]

Your next question comes from the line of A.J. Rice with UBS.

[Albert J. Rice:]

Maybe I'll just follow up on the commentary around Las Vegas. First of all, I think Vegas is still about 28% to 30% of your revenues in the acute care division. Would you characterize what you saw in the second quarter as being better than maybe was baked into your expectations? And if you think about the second half, when you formulated the guidance, were you assuming a turn in Vegas to play out or were you sort of assuming a steady-state?

[Steve G. Filton:]

Well, no, I think that, I would have to say, A.J., that the Las Vegas market outperformed our expectations in Q2. Obviously, sort of by definition almost, it means that some other markets underperformed. So I think if the question is, does it really change our view of how the entire year plays out, I'm not sure that it does. Obviously, as we've talked about for a number of years now, a turn in the Vegas market is very important to us, and I think just generally sets us up for stronger performance as we move forward. But I don't know that it changes in any sort of dramatic way our view of the remaining half of this year.

[Albert J. Rice:]

Okay. I know you mentioned reform -- talked about reform briefly. But I know last time, you said you really hadn't had a lot of exchange-related contracting discussion. I'm just curious if you -- if that has changed in any way at this point over the last 3 months?

[Steve G. Filton:]

I think it's fair to say, I mean, we've negotiated exchange contracts in most of our markets. I think, to a large degree, it -- those are with existing payers, and I think in most cases, it is either sort of an add-on or an extension of existing contracts that we have. I think that the real activity and the real changes are going to incur as enrollment takes place and it becomes apparent which exchanges get the greatest amount of market share, and they may be looking to change their networks, et cetera. So I think our view is that we're going to continue to be in a pretty kind of status quo sort of situation until this whole exercise plays out for another few months.

[Albert J. Rice:]

Okay. And then maybe lastly, I'll just ask you a couple of specific things on the psych business. Your legal expense of $4 million to $5 million in the quarter related to the investigations there. Is that unusually high because it's just ramping up, or is that sort of a run rate in your mind? And then also, just with the volume remaining strong, has your target on capacity additions there been tweaked in any way?

[Steve G. Filton:]

Well, as to the legal fees question, I'd love to be real precise about what the ongoing obligation is. But as you might imagine, unfortunately, these are largely out of our control. Those fees are mostly incurred in response to the government's subpoena. And we certainly work with and talk to the government and try and manage the scope of the response as reasonably as possible. But again, we respond to what the government has asked for basically. I do think there's sort of a front-end loading aspect of this. We sort of go from 0 to 60 almost immediately, as we begin to ramp up the effort to respond. But I would also say these are clearly going to be continuing fees. We would hope that they decline as we move forward. We would hope that the issue is resolved quickly. Obviously, we believe, for the most part, that there are not any significant problems in the segment. So that's our point of view. But difficult for us to project how this is going to go going forward. As to your last question or second question about capacity, we are very focused about the opportunities to expand capacity throughout the division, both in terms of responding to current dynamics. We operate right now at occupancy levels in the mid-70s, which means that there are a number of facilities that operate at occupancy levels that are quite a bit higher than that. I mentioned in my remarks that we opened a new 80-bed facility in the quarter. And we continue to work aggressively to add capacity, both to meet current demands, and to the degree that demands increase as a result of reform, we want to be in a position to respond to that as quickly as possible.

[Operator:]

Your next question comes from the line of Josh Raskin with Barclays.

[Joshua R. Raskin:]

Steve, just one more question, I guess, on Vegas. If you look at the economic data, especially employment data, looks like things started getting slightly better, even back in 2011. We're seeing it in -- I guess D.C. is another one of your markets where we're seeing similar types of real strong trends. Why do you think it's taking this long? I know you talked about a little bit of an improvement in 4Q and you talked a little bit last quarter. But it seems like Vegas really improved this quarter. So I'm curious what do you think creates that lag and do you think that's indicative of maybe some of the other markets to come as well?

[Steve G. Filton:]

Josh, I mean, I'm not sure that I'm the macroeconomic expert on this, but I will say that the lag that we're talking about is one that seems to have existed for a long time. We have seen it in previous economic downturns. And by the way, I think we see it on the way down, as well as on the way up. So if you go back and you look at the Vegas results, I mean, the economy in Vegas, and the real estate market, really began to collapse in '07. And we didn't really feel that pinch in our Vegas hospitals until late in '08. So we definitely experienced that lag on the way down, seem to be experiencing it on the way up. I think from sort of an anecdotal perspective, we view it as, as people get employed or reemployed, they don't necessarily have their benefits kick in immediately. And even when their benefits do kick in, I think that there is a natural sort of human reaction that the first thing you do when you get your job back or you get to a new job is you don't necessarily take 3 weeks off to have a hip replacement surgery or some other, we'll call it, sort of discretionary surgery. So I think that's the dynamic that you're seeing. And again, that was our expectation in the Vegas market, and it seems to at least be starting to play out in Q2. Will we see the same thing in other markets? Again, that's our expectation. It's a little bit hard to predict, but that certainly is our expectation.

[Joshua R. Raskin:]

And I think last quarter, you mentioned that surgeries were still weak in the Vegas market. I guess that was -- some of that was calendar, we know, et cetera. Did you get a rebound in surgeries as well?

[Steve G. Filton:]

Somewhat. I think we saw our inpatient surgeries, which have been, quite frankly, declining for a number of consecutive periods, sort of flattened out in Q2. So it was a relative improvement. And I think, along with payor mix improvements, that certainly helped to drive the strong revenue growth in the quarter.

[Joshua R. Raskin:]

Got you. And then just parsing out the 1.6 same-store add that's [ph] on the acute side of the business. Could you give us a monthly progression? Just curious, was a lot of it April? You guys spoke last quarter about a good April when you reported. I'm just curious how May and June looked.

[Steve G. Filton:]

I don't have it in front of me, Josh. But again, I think that when we commented on April in our first quarter call, we were really trying to reassure people that the weakness in March seemed to be relatively transient. My sense of the second quarter is that there were not huge differences in the months. It might have got a little stronger as the quarter went on, but there were not huge ups and downs in the quarter.

[Operator:]

Our next question comes from the line of Tom Gallucci with Lazard Capital Management.

[Thomas Gallucci:]

Steve, I'm not sure if I missed it. Did you quantify any of the buckets of sort of payor mix seemingly improved, but just wondering how specific you could be on each of the moving parts there.

[Steve G. Filton:]

So I think, Tom, in the quarter, the improvements came in our HMO volumes, our commercial volumes, which, again, have been down pretty consistently for the last few periods and were sort of flat in quarter 2. Medicare, traditional Medicare, was still declining in the quarter, but by a little bit of a slower rate than it's been. And Managed Medicare was up pretty strongly in the quarter. So I think those were the big changes that, again, tended to contribute to the strong revenue growth in the quarter.

[Thomas Gallucci:]

Okay, great. And then just following up on one from earlier. You mentioned sort of the cost from the physician practices and employment as being sort of a shorter-term issue. Can you just remind us on sort of the outlook in your strategy there? I mean, should we be expecting you to buy more of those over time or have you done a lot of what you expect to do? Any perspective on that would be helpful.

[Steve G. Filton:]

I think what we've -- our comments in the past have reflected is that we, along with, I think virtually all of our peers, have a view that as we move forward into kind of the new health care landscape that physicians and hospitals will need to be and will be more closely aligned. Unlike, I think, some of our peers, we've not sort of taken the position that the only way to accomplish that is through physician ownership and employment. And so we really view it as a market-by-market kind of an issue, and we're pursuing different strategies in different markets. But bottom line is, I think that we are working towards closer physician alignment in all of our markets. I think in some of our markets, that will mean more physician employment. But I think our biggest focus right now is in integrating the physician practices that we've acquired or that we've -- the physicians that we've employed, getting those practices more efficient, reducing the costs and the losses, and then, just very judiciously, doing additional employment and additional acquisition where it's competitively required.

[Operator:]

Your next question comes from the line of Ralph Giacobbe with Credit Suisse.

[Ralph Giacobbe:]

Steve, outside of exchanges, can you give us just a sense of how much your managed care book you've negotiated for 2014? Maybe what the rates you're getting compared to this year? And then, more generally, is there more pressure or changes that you're seeing on how contracts are structured, whether be in terms of more pay-for-performance or taking on greater risk, et cetera?

[Steve G. Filton:]

Sure, Ralph. So I think probably at this point, I would say a good 2/3 to 3/4 of our 2014 commercial book have been negotiated. I think our rate increases are sort of comfortably in that 5% to 6% range. And generally, I would say we're not seeing huge changes in terms of more pay-for-performance, more quality, more payments tied to quality metrics, narrower networks. I think it's more business as usual than not. Again, I think our expectation is that over time and over the next few years, we will see those kinds of changes implemented more frequently. But at the moment, it's not like we're seeing a big surge of activity.

[Ralph Giacobbe:]

Okay, that's helpful. And then can you give any update on impact of DSH on guidance or how you're thinking about it? I think last time, you sort of sized it as a $50 million headwind when you issued guidance, which I think was before the proposal that was a little bit better. So any updated thoughts there?

[Steve G. Filton:]

Yes. So I think you've described it in an understated way, Ralph. You're absolutely right. We had about a $50 million annual reduction embedded in our guidance. So about 1/4 of that was embedded in our 2013 guidance for the fourth quarter. In fact, at least the preliminary rule that CMS issued would reduce that impact for us from $50 million annually to something more like $5 million. We've chosen not to revise our guidance or reflect that in any way at the moment for 2 reasons. One is the rule remains a preliminary rule. And while we believe that the final rule will largely resemble it, we'd certainly feel better when it's actually issued. And then, finally, I mean, the other issue that we have that caused us to have kind of back-end weaker guidance is we have, as I noted in my opening remarks, the opening of a new hospital in Temecula in Q4. And while we, I think, have a pretty decent sense of what the pre-opening costs will be, the actual results of the hospital and its impact on our surrounding hospitals are always hard to predict. So given that unknown variable, I think we're comfortable leaving guidance where it is at the moment.

[Ralph Giacobbe:]

Okay. And then just last one, if I could. Can you talk maybe about your cash flow expectations for the year? I know some of the bigger projects are somewhat behind. So just kind of wondering what the step up in cash flow this year and maybe into next year. And just your general appetite, debt paydown versus share repo and/or more aggressive on the acquisition plans or even perhaps, on expansion as you talked earlier.

[Steve G. Filton:]

The -- again, the variable in cash flow, obviously, is our earnings. And then, given the fact that we're leaving guidance unchanged, I would say that there's no change in that outlook. I think we're on pace to spend something close to the $375 million or so in CapEx that we guided to for 2013. You're correct that our big project, Temecula, will be finished this year. But -- and we certainly have not, in detail, completed our 2014 capital planning process. But I would generally say that I think we would think about our 2014 capital expenditures as being fairly comparable, maybe a little lower than '13. But as we think about adding new bed capacity in behavioral, as I alluded to in a previous answer, as we think about continuing to invest, particularly in the outpatient business on the acute side of the business, I think just generally, I think we see our capital spending continuing at roughly the current rate.

[Operator:]

Your next question comes from the line of Chris Rigg with Susquehanna.

[Christian Rigg:]

I was wondering if you could be any more specific with regard to the outperformance in the Vegas market or, on the flip side, just the relative underperformance outside of Vegas. I'm just trying to gauge the magnitude of what's happening in the distinct markets.

[Steve G. Filton:]

Yes, Chris, I mean, I think we try and avoid real specific discussions of individual markets only because it really gets to be sort of a granular discussion that I don't know is terribly appropriate for a forum like this. I mean, obviously, we have the sort of unique dynamic of folks being able to look at our minority interest line, which includes both our Vegas market and our Washington, D.C. market, and have a little bit of sense of what's going on. And you can see from that line that there's a fairly significant improvement in both of those markets in the quarter. And obviously, what that suggest is, I think somebody mentioned before or maybe we did, that there's some offsetting weakness elsewhere in the portfolio. I think beyond that, we're not really anxious to get into real detailed specifics about the individual market performance.

[Christian Rigg:]

Okay. And then just over the last, looks like, 3 or 4 quarters, we've seen sort of this inflection between the charity care number and the doubtful accounts. I guess, has there been any -- since we've sort of seen that inflection on the collectibility of the AR, do you feel comfortable with sort of the reserving there?

[Steve G. Filton:]

Yes, I think the change that really is being reflected this quarter and was reflected last quarter, and I think we commented on it last quarter, is we did make a change in our charity care policy, which quite frankly, had the impact of allowing fewer folks to qualify for charity care and thus, allowing us to try and collect from a larger number of people. And really, I think it results in this sort of cosmetic shift that you see, which is a big increase in bad debt and a reduction in charity care and uninsured discount. I think our comment in Q1 was that, ultimately, we didn't think that it would have a material impact on our collections. We just thought that, around the edges, it might help us just collect a few more incremental dollars here and there. And that's really what drove the decision. And I don't think that view has changed at all this quarter. So I think the dynamics you saw in Q2 were a repeat of Q1. And I think our comments would be largely the same.

[Operator:]

Your next question comes from the line of Darren Lehrich with Deutsche Bank.

[Darren P. Lehrich:]

A few things I just wanted to follow up on. First, as it relates to the same-store operating margin in behavioral. I'm assuming you're including the legal costs in the same-store group. So that would imply, excluding those, it was about a 40 or 50 basis point improvement. Is that how I should interpret that, Steve?

[Steve G. Filton:]

That's correct, Darren.

[Darren P. Lehrich:]

Okay. And then, just as it relates to the professional liability reserves, when you sort of back that number up to a pre-tax number, it is pretty significant, and we've seen some fairly consistent numbers like this over the last several years as favorable adjustments. And I guess the question here is, can you just maybe update us a little bit on your process for actuarial reviews and whether you think you need to embed a different assumption going forward, given the experience that you've been having?

[Steve G. Filton:]

Sure, Darren. I mean, I think that, as you note, we have now had a series of favorable adjustments to our malpractice reserves over the last few years. And I think they are driven by, really, 2 dynamics. One is our actual experience, which has tended to be good, obviously. And that's driven by our own quality improvements and focus on risk management and risk reduction, as well as tort reform in a number of the states, particularly in the important states in which we operate, including Texas, Nevada and Florida. And then, secondly, I think there is a methodology issue. Our actuaries, historically,, have used a combination of UHS-specific experience as well as industry data to do their calculations. Over time, I think they have shifted more and more of that emphasis to UHS-specific data. I think that with this last adjustment, they have completely shifted to 100% UHS-specific data. And because we have outperformed the industry, every time they have made that shift, we have benefited from that. So I think at this point, I think we feel like, from a methodology perspective, because we now are -- our actuary is now basing their calculations entirely on our own experience, we ought to be on a more steady and reliable trajectory. So I think our view is that we have probably seen the last of these large adjustments.

[Darren P. Lehrich:]

Okay. That's helpful context. And if I just put that number into perspective, I mean, what time period would it have covered? So if I think about just a quarterly run rate that might be lower, what is it?

[Steve G. Filton:]

So I mean, I think most of the adjustment is related to -- I mean, the entire adjustment is related to prior year. The nature, as you might expect, of actuarial work is there's far greater confidence on the historical period, where they can really -- they see developed losses, et cetera. I think on an ongoing basis, we would expect our malpractice expense maybe to benefit by a few million dollars a year. But again, I mean, I think what the $65 million adjustment really reflects is just simply that, in prior years, we were overstating our provision for malpractice in those years. I think -- in other words, Darren, I think we think the current year is pretty properly stated.

[Darren P. Lehrich:]

Just a couple of other things. On your net leverage, you're below 3x based on our calculations, and we haven't seen you get below that since you did the PSI deal, I guess. Can you just comment a little bit more about how you're thinking about leverage and kind of, go forward, what you think the right level of leverage might be for the company?

[Steve G. Filton:]

Well, look, I think the context of your question is helpful in my answer, Darren, and that is I think we feel like we felt before we did the PSI deal. And that is to run at a leverage level that allows us sort of maximum flexibility to respond to compelling opportunities. We're about to enter into, we'll call it, the health reform era. We continue to look for ways to take advantage of that. We've talked about expanding capacity in behavioral. We've talked about investing briefly, we've talked about investing briefly in outpatient opportunities on the acute side. As far as other M&A opportunities, we are looking at all of those in both of our business segments carefully and closely. And we feel like we have the balance sheet flexibility to respond to those as they arise. And that's, I think, largely the way that we look at them.

[Darren P. Lehrich:]

Last thing, just on the Temecula project. I know you've guided us to some bigger start-up costs in Q4. I wanted to just ask how you feel about those numbers going into the opening, we're getting closer. And then, Alan, I know you guys put this project off a little bit. How do you feel about opening in that market at this juncture, given where the economy is there and where things stand?

[Steve G. Filton:]

So I'll comment on the numbers first and then let Alan comment about more of the strategic approach with the project. But from a numbers perspective, and I think I tried to say this in response to somebody earlier, we obviously have a pretty good idea of what we're going to spend to get the facility open. And I think we're very comfortable about coming closely within that budget. The facility will then open in probably early September. And what happens after that, for the last 3 or 4 months of the year, that's certainly something that we have less sort of control and less visibility over, both in terms of what happens at Temecula, the new hospital itself, as well as what happens in our nearby hospitals. So that's the piece that I think we think has, at least in the short term, a greater degree of uncertainty. And that's why I mentioned that before. As far as sort of putting it into context strategically, I'll let Alan talk about that.

[Alan B. Miller:]

Yes, well, there's a dance between when you have to build a hospital and when -- how long you can develop it. Also, with an eye to competition, you want to keep competition out. So that's what we've done. We have locked up this market a number of years ago. And we're very excited about the fact that we now have Inland, Rancho, Corona, Temecula, we have a very strong strategic market position, and the hospital will open. And we have developed it for as long as we possibly could. And now it will open in September, and we'll be off and running.

[Operator:]

Your next question comes from the line of Gary Taylor with Citigroup.

[Gary P. Taylor:]

I just wanted to revisit something from earlier in the call. Sorry. Just going back to length of stay on the behavioral business, Steve. Just want to make sure, is that still primarily RTC, I presume?

[Steve G. Filton:]

It is, Gary.

[Gary P. Taylor:]

And has the situation evolved with respect to, at all, which states are primarily driving that?

[Steve G. Filton:]

As I think is often the case with any dynamic, it's certainly there. It's a little bit by geography. I think we've called out, for instance, the State of Kentucky, which has moved to much more of a managed Medicaid system, as being particularly stringent. But it certainly is not something that we could only point to 1 or 2 geographies and say, look, this is very specific to this 1 geography, 1 or 2 geographies. It is a pretty pervasive dynamic. Certainly, there are some states and some managed payers that are particularly more aggressive about trying to limit length of stay. But it's a pretty pervasive dynamic in the residential space within Medicaid payers.

[Gary P. Taylor:]

And any sense, I guess, when we first started seeing this, we thought perhaps there would be some pressure on length of stay, but maybe some acceleration eventually in terms of readmissions, I guess, for lack of a better word, as some of these patients are sort of recycled through the system. That dynamic doesn't really appear to be happening.

[Steve G. Filton:]

Well, admissions remain strong, both in our residential and acute segments. So I don't know if that's a result of the dynamic that you're suggesting. We do keep track of readmissions, but it's not entirely clear whether admissions are benefiting, if you will, from this sort of recurring admission, if you will. But just generally, I think our sense is that we're approaching, I think our clinical people would argue we've already gotten to the point of sort of diminishing efficiencies of having this length of stay reduced, again, particularly from a clinical perspective. So our sense is that we ought to be reaching the bottom of this soon.

[Operator:]

And your next question is from the line of Gary Lieberman with Wells Fargo Securities.

[Ryan K. Halsted:]

This is Ryan Halsted, on for Gary. Most of my questions have been addressed. So I thought I'd just ask, I'd be curious if you had any thoughts on the delay in the employer mandate. Just any thoughts in general or specific to how it might affect your business?

[Alan B. Miller:]

Yes, the delay is probably not going to have a great effect because it -- the employers, most of the employers are going to -- or the large companies are going to have coverage anyway. But the only thing I want to mention here is that it is a long delay. And all we've been seeing in Congress about the delays and these votes that they're taking to overturn it, I just think it's -- it looks like a waste of time because of the Senate being democratic and the President. So I just think things are going to roll out a little more slowly, but it's going to happen. And whatever effect we expected will be happening.

[Operator:]

[Operator Instructions] There appears to be no further questions at this time.

[Steve G. Filton:]

Okay. We thank everybody for their time, and we look forward to speaking with everybody next quarter.

[Operator:]

And this concludes today's conference call. Thank you for your participation. You may now disconnect.