Encompass Health Corp (EHC) 2011 Q3 法說會逐字稿

Good morning, everyone, and welcome to HealthSouth's third-quarter 2011 earnings conference call. At this time I would like to inform all participants that their lines will be in a listen-only mode. After the speakers' remarks there will be a question-and-answer period. (Operator Instructions). Today's conference call is being recorded. If you have any objections you may disconnect at this time. I would now like to turn the call over to Mary Ann Arico, Chief Investor Relations Officer. Please go ahead.

Thank you, Jackie, and good morning, everyone. Thank you for joining us today for the HealthSouth third-quarter 2011 earnings call. With me on the call in Birmingham today are Jay Grinney, President and Chief Executive Officer; Doug Coltharp, Executive Vice President and Chief Financial Officer; Mark Tarr, Executive Vice President and Chief Operating Officer; John Whittington, our Executive Vice President and General Counsel and Secretary; Andy Price, Senior Vice President and Chief Accounting Officer; Ed Fay, Senior Vice President and Treasurer; and Julie Duck, Vice President of Financial Operations.

Before we begin, if you do not already have a copy, the press release, financial statements, the related 8-K filing with the SEC, and the supplemental slides are available on our website at www.HealthSouth.com. Moving to slide 2, the Safe Harbor, which is also set forth in greater detail on the last page of the earnings release.

During the call we will make forward-looking statements which are subject to risks and uncertainties, many of which are beyond our control. Certain risks, uncertainties and other factors that could cause actual results to differ materially from management's projected forecasted estimates and expectations are discussed in the Company's Form 10-Q for the third quarter of 2011, which will be filed next week, and its previously filed 10-Q for second and first quarter 2011, Form 10-K for year-end 2010 and other SEC filings. We encourage you to read them.

You are cautioned not to place undue reliance on the estimates, projections, guidance and other forward-looking information presented. Statements made throughout this presentation are based on current estimates of future events and speak only as of today. The Company does not undertake a duty to update or correct these forward-looking statements.

Our slide presentation and discussion on this call will include certain non-GAAP financial measures. For such measures reconciliation to the most directly comparable GAAP measure is available at the end of this slide presentation or at the end of the related press release, both of which are available on our website as part of the Form 8-K filed last night with the SEC.

Before I turn it over to Jay I would like to remind you that we will adhere to the one question and one follow-up question rule to allow everyone to submit a question. If you have additional questions, please feel free to put yourself back in the queue. And with that I will turn it over to Jay.

Great, thank you Mary Ann and good morning everyone. We're pleased to report the results of another excellent quarter for HealthSouth that again highlights the strength of our business model. Total discharges were up 5.1% while same-store discharges grew 4% as demand for our services increased. Discharge growth occurred across all regions and was characterized by the continued shift to more neurological and stroke patients with fewer lower extremity joint replacement patients.

Our care management initiative yielded positive results as the discharge status of our patients improved through the utilization of standardized protocols for assessing and admitting patients, enhancing the care coordination of these patients and involving family members with the discharge process. By reducing the number of patients transferred back to acute care hospitals we improved our Medicare payments which in turn contributed to a 3.3% increase in our net patient revenue per discharge.

We also continue to leverage our cost structure by treating more patients and achieving improved patient outcomes on a highly efficient basis. Of the $36.9 million of incremental net operating revenues generated in the quarter compared to last year $14.6 million, or approximately 40%, flow to adjusted EBITDA resulting in third-quarter adjusted EBITDA of $110.5 million, a 15.2% increase over the third quarter of 2010.

Finally, we realized an important milestone in the quarter with the retirement of our 10.75% Senior Notes which brought our trailing 12-month leverage ratio to 2.9 times.

Before Doug reviews the quarter in more detail I'd like to discuss our share repurchase authorization. HealthSouth generates a significant amount of cash and, despite the near-term uncertainty surrounding potential Medicare cuts, we believe the highest and best long-term use of this cash is to reinvest it into growing the Company.

This is predicated on our condition that the long-term outlook for HealthSouth remains positive for reasons we have previously articulated, including -- we are in a growing segment of healthcare. The demand for inpatient rehabilitative care is expected to increase by an average of 2.5% per year. HealthSouth is a market leader in this segment and we have a strong balance sheet that provides flexibility and the ability to adapt to changes affecting our business.

While we still believe investing in growth is the correct long-term strategy, we are modifying our near-term strategy until we have better line of sight into the changes coming from Washington.

First, we're going to move forward only with those de novo projects for which we have certificates of need, those in Ocala, Florida; Martin County, Florida and Middletown, Delaware.

Second, we will slow walk the other projects in the pipeline, acquiring land if we have to in order to preserve our long-term flexibility, but not beginning any new construction on these projects until we have regulatory clarity.

Third, we have added another alternative for deploying our cash by adopting a share repurchase plan in the event we experience the kind of stock price volatility we had in the third quarter. This authorization along with the ability to prepay debt and strategically invest in our business gives us a full range of cash flow investment alternatives to choose from during this period of uncertainty.

With that I'll turn it over to Doug who will provide more detail on the quarter.

Thank you, Jay, and good morning, everyone. As reminder, we completed the sale of five of our LTACs and closed the sixth during the third quarter. The results of the LTACs were reclassified as discontinued operations for all of 2011 and prior periods beginning in the second quarter.

As Jay summarized, we had another excellent quarter. Our consolidated net operating revenues grew by 8% over the third quarter of last year, driven by an 8.6% increase in inpatient revenue. Discharges grew by 5.1% -- continued strong same-store growth of 4% and the balance coming from our hospitals opened required subsequent to June 30, 2010. For the first three quarters of 2011 discharges increased by 6.3% over last year.

As we look forward to Q4, please recall that we will be facing a tougher comparison as discharge growth in Q4 2010 was 5.9%. Revenue per discharge rose 3.3% in Q3 primarily attributable to a Medicare price increase of 2.25% which was effective October 1, 2010, higher managed-care pricing, the impact of the initial Medicare enrollment period for newly opened and acquired hospitals on Q3 2010 reimbursement and improved patient outcomes.

We expect our Medicare reimbursement rates for Q4 of this year to increase by approximately 1.6% over Q4 2010. Please recall that this is just one of the components of our net revenue per discharge.

Outpatient and other revenue rose 1.8% for the quarter as a $1.7 million benefit from state provider taxes was partially offset by the decline in revenue associated with satellite clinic closings. I remind you that the vast majority of our outpatient revenue is generated from our hospitals and not the satellite clinics.

That said, at the end of Q3 2011 we operated 28 satellite clinics versus 35 such units at the end of Q3 2010. We expect to close at least two additional satellite clinics in Q4.

Our continued focus on disciplined expense management combined with the solid increase in discharge volume resulted in operating leverage across all major categories of expenses. SWB for Q3 was 49.2% of net operating revenues, an improvement of 110 basis points over the prior year period. As a reminder, SWB in the third quarter of 2010 was burdened by the ramp up of newly opened or acquired hospitals. Also, as we again look forward to Q4, recall that SWB in Q4 of 2010 benefited from a $3.3 million favorable adjustment related to workers' compensation.

Hospital-related expenses for Q3 were 22.6% of net operating revenues, an improvement of 10 basis points from Q3 of last year. The operating leverage achieved within this category was partially offset by an increase in bad debt expense. Bad debt expense for Q3 of 2011 was 1% of net operating revenues, better than we had anticipated, but still a 20 basis point increase over the prior year period.

Looking to Q4, we expect bad debt to be in a range of 1.2% to 1.3% of net operating revenues against 0.3% last year with the year-over-year change primarily attributable to the increase in medical necessity claims reviews and a decline in prior period recoveries. G&A, which excludes stock-based compensation expense for Q3, was 4.3% of net operating revenues, a 40 basis point improvement over the prior year period.

Our strong top-line growth and disciplined expense management led to another double-digit percentage increase in adjusted EBITDA. Adjusted EBITDA for Q3 was $110.5 million, an increase of 15.2% over Q3 of 2010. For the first nine months of 2011 adjusted EBITDA of $343.3 million reflects 15.4% year-over-year growth.

Our updated guidance for 2011 calls for adjusted EBITDA in a range of $450 million to $455 million representing a 9.9% to 11.1% increase over 2010. Among other factors this rate of increase would reflect the aforementioned tougher comparison for Q4 discharge volume growth as well as the benefits of the low bad debt expense and favorable workers' compensation adjustment experienced in Q4 of 2010.

Interest expense for Q3 was $26.3 million as compared to $30.8 million in Q3 of last year. As Jay mentioned, we completed the retirement of our 10.75% Senior Notes on September 1 and as a result continue to expect Q4 interest expense of approximately $24 million.

As anticipated, Q3 EPS was impacted by an $18.5 million, or $0.20 per share, increase in income tax expense primarily attributable to the release of the valuation allowance in Q4 2010, and by the $12.7 million, or $0.14 per share, loss on early extinguishment of debt related to the retirement of the 10.75% Notes.

Please recall that Q3 2010 included a $9 million, or $0.10 per share, loss on interest rate swaps which have since expired or been terminated. We are not anticipating any further loss on early extinguishment of debt in Q4 and expect the effective tax rate to be in a range of 38% to 40% for the quarter.

Adjusted free cash flow for Q3 of $32.4 million is compared to $53.8 million in Q3 of last year. The third quarter of this year was negatively impacted by the timing of approximately $16 million in interest payments which effectively shifted out of Q4 and into Q3.

We also experienced a $17 million increase in accounts receivable of which approximately $8 million is another timing difference with the balance relating primarily to our revenue growth. The approximately $8 million timing difference in AR stems from the deferral of Medicare reimbursement at two hospitals which were subject to legal entity reorganizations during the quarter.

Specifically we changed the legal entity structure for our Harmarville, Pennsylvania and Miami, Florida hospitals as part of an ongoing effort to create a more simplified and efficient corporate structure.

Although these reorganizations were completely internal, in the case of these two hospitals we were required to undergo a Medicare change of ownership which resulted in the temporary suspension of Medicare reimbursement. We have since received all requisite approvals and expect the deferred reimbursement to be wholly reversed in Q4.

We anticipate strong fourth-quarter adjusted free cash flow aided by the normalization of these timing issues and resulting in full-year 2011 adjusted free cash flow of at least $210 million, an increase of at least 16% over 2010.

Maintenance CapEx for the first nine months of 2011 was approximately $35 million versus approximately $25 million in the comparable period last year. We expect maintenance CapEx for full-year 2011 to be approximately $50 million increasing to approximately $75 million in 2012. As a reminder, we include the capital cost associated with the rollout of our clinical information system in maintenance CapEx.

Turning now to the balance sheet, the closing of the sale of five of our LTACs facilitated the completion of the retirement of our 10.75% Senior Notes on September 1. This was the final step in the implementation of the capital structure strategy we first outlined for you in Q2 of last year and began initiating in Q3 of last year.

We now have in place a debt capital structure characterized by manageable well spaced maturities with no significant maturities prior to 2016, sufficient unfunded availability under our revolving credit facility, limited principal amortization requirements, numerous debt repayment options and flexible covenants.

Additionally, through the first nine months of 2011 we have reduced our funded debt by approximately $184 million and, as Jay referenced in his comments, our leverage ratio at the end of Q3 stood at 2.9 times versus 3.7 times at the end of 2010. The elimination of the expensive 10.75% Notes and the reduction of the leverage ratio to less than three times have been long-standing objectives of our Company and both were achieved well ahead of schedule.

The restructuring of our debt capital and the reduction in funded debt have a favorable impact on our future free cash flows and enhance our ability to invest in the array of strategic initiatives we have discussed on many previous occasions including de novos, acquisitions, bed expansions, voluntary debt prepayments and share repurchases.

Our cash flow allocation decisions between the investment alternatives will continue to be influenced by factors such as the relative risk return analysis, prevailing macroeconomic and regulatory environments, and the price and availability of assets within each category.

As Jay mentioned in his opening remarks, the recent volatility in our share price, which we believe has been largely related to investor uncertainty over the potential outcome of that deficit reduction debate, together with the strengthening of our balance sheet led to our $125 million share repurchase authorization.

This authorization is not meant to signal a reprioritization of our investment allocation decisions. Rather it is intended to enhance our flexibility to invest cash across the above referenced spectrum of opportunities as and when we deem it appropriate based on current market conditions and our assessment of emerging opportunities and challenges.

Please note that the share repurchase authorization does not have an expiration date, is subject to certain terms and conditions, and may be revoked at any time at the discretion of our Board of Directors. With that, I'll turn it back over to Jay.

Thanks, Doug. Before taking questions I'd like to comment on the E&Y arbitration and review our revised 2011 guidance. With respect to E&Y, hearings have occurred since our last call and additional hearing dates are scheduled through April of next year. While we hope these will be sufficient to conclude the formal proceedings, as we've stated in the past, we can't guarantee that they will be.

As a reminder, once the formal proceedings are finished the panel will begin their deliberations and we can't predict how long it will take them to render a final decision. Meanwhile, we continue to believe our claims are valid and are pursuing them aggressively.

Now turning to guidance. On the strength of our year-to-date performance, and as noted in the press release, we are raising full-year guidance for both adjusted EBITDA and earnings per share. The new range for adjusted EBITDA is $450 million to $455 million which represents growth of between 9.9% and 11.1% compared to full-year 2010.

Full-year earnings per share guidance has been raised to between $1.18 per share and $1.23 per share on a GAAP basis. As a reminder, last year we reported full-year adjusted earnings per share of $1.59 on a non-GAAP basis. As we've done in the past, we've included a schedule on page 18 of the supplemental slides that shows the differences between these two EPS measures.

Some of the key assumptions of our revised guidance are as follows. We expect fourth-quarter discharge growth of between 1% and 2% which would yield very strong full-year discharge growth of between 4.9% and 5.2%. Fourth-quarter volumes are difficult to predict because of fluctuations in discharges around the holidays and, as Doug noted, we're up against tough comps from last year's fourth quarter when discharges grew 5.9%.

From a pricing perspective we anticipate sequential net revenue per discharge growth of between 1.3% and 1.8% compared to the third quarter. This growth incorporates the Medicare pricing increase that went into effect on October 1. Finally, we expect labor as a percent of net operating revenues to be between 49% and 50%.

Last year's fourth-quarter SWB as a percent of net operating revenues was 48.4%, but, as Doug pointed out, this number benefited from the $3.3 million or 60 basis point adjustment related to workers' compensation. Additionally, the fourth quarter of 2011 will include an average 2% merit increase for all nonexecutive employees which was effective October 1. With that, operator, we'll open the line for questions.

(Operator Instructions). Darren Lehrich, Deutsche Bank.

Thanks, good morning, everybody. So I wanted to just ask about pricing. It was just a little stronger than we expected this quarter and I'm just wondering if you can comment on your managed-care pricing trends and if you've got any commentary on how your updates from the Medicare Advantage side of things has also trended and if there's any mix influencing the numbers there.

So the managed-care pricing has been pretty consistent in that 3% to 4% range. Most of the contracts that we have renew on January 1 -- certainly not all of them but the majority of them do. And so we really didn't see much of that on a sequential basis.

I think the strength in the pricing can really be seen in two ways. First, last year we had several new hospitals that were in that first start-up period for receiving Medicare payments where we treat 30 patients and we don't get any reimbursement. So that negatively impacted our pricing last year.

And then this year, as I noted in my comments, the care management initiative, which we've talked a lot about and have said throughout the previous calls, was designed to improve outcomes and specifically to discharge patients -- more patients directly home and fewer patients back into acute care hospitals.

So when that occurs and we see better patient outcomes we get more of our payments on the full CMG basis rather than on a per diem basis. So managed-care is still in that 3% to 4% range and then the balance coming in because last year was benefited from the fact that we had those new hospitals in that start-up period and then the effect of the care management TeamWorks initiative.

Okay, that's real helpful. Nice job and thank you.

Matthew Gilmore, Robert W. Baird.

Good morning, everybody. Just on the volume comments you provided about the strength and thereof, can you just sort of talk about some of the drivers there and also how might that affect your compliance threshold?

Yes, this is Mark Tarr. As you may have heard us talk in past quarters, we put a big program focus on our hospitals to better enable us to care for neurological patients. That includes training for the staff, equipment, medical leadership within our hospitals, overall program marketing for those neurological cases.

We did that twofold -- one is the vast majority of these neurological cases pass the medical necessity guidelines that we're under. And a big proportion of those neurological cases are in fact compliant cases. So we have put a big focus on them for the past couple years and we're seeing that in the growth that we have in the other neurological as well as our stroke cases.

Okay, thanks. And then if I could just as kind of an open-ended question about the discussions in DC and the joint committee process. I was just wondering if there are any sort of updated thoughts around that and what the kind of current discussions are happening with policymakers?

I don't know that there's really an update that I can provide. I think we've all seen in the press over the last several days both sides of the aisle have publicized their respective plans. And as we would expect I guess, or some of us would expect, the other side of the aisle in each case dismissed those as being inadequate for whatever reason.

I've spent a lot of time up in DC over the last six to eight weeks. I have to tell you that there's not a lot of optimism that I've been able to pick up that the Joint Select Committee is going to come to a resolution. I think that certainly that's very disappointing for the country, but, specific to HealthSouth, I think that it tips the balance a little bit more into that sequestration situation than not.

But I think it's going to be very difficult to predict with any accuracy. I think it's going to be very fluid. Obviously the 2012 elections and posturing and positioning for those elections unfortunately in my opinion will influence the proceedings in Washington. I think that we just have to wait and see.

I think the take away on this call however ought to be certainly the way we look at it. And that is that the demand for healthcare services is not going away. And specific to HealthSouth, people who -- there's a huge cohort, the baby boom cohort that is getting older and it's inevitable that people are going to get sick with the kinds of ailments that we treat.

So somebody is going to have to be there ultimately to take care of those patients and to contribute to the communities in which we serve. We believe what we've done over the last several years has been exactly the right thing to position us to be that provider.

And so you know, Matt, I think it's a legitimate question and certainly we're very involved with the process, but in the final analysis nobody knows. But what we do know is that someone at the other end of this is going to be there providing care. And if the environment is really tough there are going to be fewer providers.

And those who have strong balance sheets, have flexible strategies are going to prevail and in fact we believe we will be able to take advantage of market dislocations as they occur. That's been proven throughout the last 40 years. Every time something big comes up there are going to be winners and there are going to be losers. And you guys have to write notes and make predictions on who those are going to be. We think we're going to be the winner.

Okay, great. Thanks very much.

Sheryl Skolnick, CRT Capital.

Hi, thanks very much and I'll apologize in advance for the background noise, but I'm in an airport. Jay, the discussion -- your discussion of Washington is very helpful and I realize that nobody really knows what's going to happen. But as a senior, and I would argue, very capable management team in an industry that's constantly whacked by Washington be it CMS or Congress, you've got to have some experience in the kind of crisis management strategic planning that you need to do.

So can you talk to us a little bit about what your contingency plans are in terms of we're going to get something on November 23 whether it's "we give up" or it's a bill, and then we're all going to gag on our turkey on November 24 when we try to digest it.

But I guess what I would say is do you have contingency plans in place so that you can start implementing them in the event that they do, A, propose something along the lines of the Obama budget or anything else you might have heard; and B, should that proposal actually pass a month later, be able to move forward very quickly with whatever you need to do to implement it?

Yes, we certainly do and I think that the preparation has really occurred over the last several years. As we all know, you can't clean up a balance sheet overnight, you can't create a maturity profile that is out six, seven, eight, 10 years with manageable tranches and so on.

So that obviously in our opinion in step number one, make sure that the financial foundation is very strong. Number two, we have deliberately pulled back on the accelerated de novo strategy that we announced on the last call in order to preserve cash and then to strategically deploy that cash as we see the opportunities present themselves across a pretty broad spectrum.

We could continue to prepay debt; as you know, the 18s and the 22s have prepayment options on it. If the bonds traded down like they had in the third quarter we could conceivably go out into the open market and purchase the bonds there. We now have the opportunity to go in and to buy back shares.

And more importantly, we have the opportunity to pursue acquisitions of competitors should the market reaction be such that there's an opportunity to do so. So really there are a broad range of contingencies and I think that the way to characterize where we are today is that we are in a bit of a wait-and-see mode.

We're moving forward with the de novos where we have a certificate of need. Those are hard to come by. We fought hard to get them. There's a demand and frankly there's less risk when you build a de novo.

So I think all of those together really position us pretty nicely to be in a bit of a wait-and-see mode, not get out there extensively with any kind of strategy that would compromise our ability to be flexible and adapt in 2012.

I would just add to that the position that we've taken on our real estate is another strength that factors into contingency planning. Recall that we own roughly two-thirds of our hospitals, that means that we have great flexibility in terms of how we manage those assets. It also means that we're not subject to the automatic escalators that are found in so many leases (multiple speakers) companies engaged in wholesale opco/propco transactions.

Right. So let me just follow up with that first, Doug. Congratulations on a year at the Company. I think this is your anniversary call and it's set. That comment that you just made speaks very much to how much exposure you've had to the charms of the healthcare services delivery over the last year. But let me follow up with this and I'm going to ask this with all kind intentions meant.

Given that sometimes, and often in Washington, once an idea is floated it gets legs and it doesn't want to go away, it keeps boomeranging back. In a perverse way might it not be better for -- if Washington is thinking at some point in time it might step up the 60% rule to 75% and it might do this unified or uniform (inaudible) approach at some point in time, wouldn't it actually be better for you if they did it now rather than later?

So you take the hit, you adjust the model, you acquire -- you gain your market share, you acquire the strategic assets in places where others can't cope because their balance sheets or access to liquidity is not as strong and you move on -- as opposed to having this boomeranging and overhanging. Might that not actually be a better strategic outcome for you?

Well, there's no question that the single biggest headwind and overhang frankly is the uncertainty. I think that that goes right to the heart of it. Anything that removes the uncertainty is a good thing. Why? Because of what you just implied. We would then be able to know what are the rules of engagement and we can then respond accordingly.

So there's no question that getting clarity from Washington, as you've heard throughout my comments today and previously, getting clarity is of utmost importance. And not only for our ability to grow this Company, but also for you and your colleagues and shareholders to have a better sense of what the playing field is going to be and how we can respond.

So there's no question getting clarity is absolutely important. The good news though is I do believe we're going to have that. And I don't think we're going to be sitting here a year from now wondering what the rules of engagement are going to be. We're going to have some idea within the next 30 to 60 days.

Great, thank you so much, Jay.

Adam Feinstein, Barclays Capital.

Good morning. It's actually Brian on the line for Adam. I just wanted to ask you a question on the tougher comps you're facing in Q4. And I know you've had strong discharge growth actually throughout 2011. So maybe is it ever going to be facing these tougher growth numbers and we can expect a little bit slower growth I guess in 2012 as well?

Well, first of all with respect to 2012, we're just now putting the budgets together. We haven't presented it to the Board and so we're not going to be really commenting on '12. I will tell you that what we've seen thus far we're pleased with. So I think that the final forecast and so on guidance, we'll wait until we report Q4.

But I think we've always been fairly conservative as we go into a quarter on volume. Just look at some of the acute care hospitals, what they've reported on their same-store [ad nets] -- down 7%, down 2%. I mean, we operate in a pretty uncertain and somewhat volatile market still. So I think being reasonably cautious is not a bad way to go.

Okay great. And just a follow-up from me here. You mentioned the care management rollout benefiting the pricing in this quarter. As it looks like you're completed with that stage of TeamWorks, is this going to be able to boost your pricing or revenue per discharge, I guess, for an ongoing impact into '12 as well?

Yes, we certainly believe that the program that we put in place with care management is sustainable and will continue to benefit, first of all, the patients and then secondly, it will help our reimbursement from Medicare.

Okay, great. Thanks a lot.

Colleen Lang, Lazard Capital Markets.

Hi, good morning, Jay. Just a quick question on the volumes. They've been better than expected all year and can you just talk about what's driving the better than expected growth? Is it more demand than you thought you'd initially see or are you taking more share?

I think it's both. I think it's a reflection of the underlying dynamic of our segment of healthcare. As we've said many times before, a lot of that business is nondiscretionary. It's not as subject and elastic to pricing issues as you find in some of the commercial businesses. So I think that's it -- but we've also taken market share we believe.

We put a lot of focus on, as Mark said, a variety of neurological programs focusing on strokes. We've really put an emphasis on extending our reach, if you will, in each of our markets going to new physicians and introducing them to our services. And then obviously the new hospitals that we brought on last year as we saw in the first, second and now this third quarter, have also contributed to the overall increase in our discharges.

Okay, great. And then last quarter you talked about encouraging your nurses and therapy associates to seek additional accreditations. About what percentage of your workforce is taking advantage of this and how should we think about the impact on SWB going forward?

I don't have that number right at my fingertips in terms of how many of the CRRNs, the Certified Rehabilitation Registered Nurses there are, but we certainly have seen that program be very successful. It does add to the cost. Clearly we pay more and help support the actual process of getting the training and then there's an additional compensation component that is related to that.

I think the other thing that you have to keep in mind from an SWB standpoint that we've talked about in the past is the fact that with this care management we've added probably 100 employees across our portfolio, about one in each hospital, to help supplement that process and to get the kinds of outcomes that we achieve.

Another benefit that we've seen with the CRRN or that higher level of accreditation for nurses is the reduced turnover. So once they commit themselves to achieving this additional certification and rehabilitation they're going to be around a while and they're going to want to practice in our hospitals.

I will also add that the impact of the care management program is factored into the guidance that Jay gave you earlier in this call on SWB for the fourth quarter.

Doug Simpson, Morgan Stanley.

Hey, I joined a little late, but I appreciate the commentary around volumes. I'd just be curious your perspective, we've heard from the payors, the providers and we've seen some utilization pressure in areas where one wouldn't necessarily expect any impact from the economy, things like cardiac. IRF volumes have tracked much more steadily.

Just curious beyond what you've said any, read understanding the nature of the patients is different, but again we have seen some pressure in areas you wouldn't necessarily expect it. So I'd just be curious now with looking back over the nine last nine to 12 months if you've picked up anything incremental that informs your view of that dynamic?

No, the answer is really no, we haven't. I think that the demand is pretty steady. Certainly we have seen the number of knee and hip replacement patients continue to go down. And with our focus on neurological and stroke patients we've actually seen an uptick. So there's nothing fundamental in the demand profile that would cause us to believe that going forward is going to be radically different.

I think part of what you see in the cardiac areas is frankly driven by technology and the ability to treat patients using enhanced technology and, as we all know, stents are going up and cardiovascular surgeries are going down. So -- and then you throw in all of the drug therapies.

You don't quite have the same dynamic in the aging process. I mean a lot of those conditions are environmental. They're related to diet and lifestyle and frankly most of the patients we treat, the conditions are a function more of the aging process and the fact that the older we get the more the systems that we have start to break down and the more chronic conditions that show up. So I think it's really that in my mind is more of a driver than anything else.

That's a fair point. I think the aging process has been shown to accelerate during earnings season (laughter). But maybe you could just talk a little bit about, there's been a lot of discussion over the last couple of months obviously about reimbursement, you touched on it earlier. But maybe talk a little bit about your efforts to educate people down on the Hill about the relative patient status differential between what you all do versus a typical SNF rehab unit and how is that process going?

I think that the process is going very well because all we're doing is presenting facts. First of all, when we go on the Hill we share the information that we've shared with our shareholders in the past on the total spending that Medicare spends on inpatient rehabilitation, the fact that that's flat since 2004; as a percent of total Medicare spending it's actually gone down.

And then we share with members of Congress and staff members on congressional committees some of the recent reports coming out of CMS with the final rate setting file -- excuse me, the final rules for skilled nursing where CMS came out and said, listen, the assertions by some that there's really no difference between skilled nursing and rehabilitative care, that assertion is false.

The assertion that skilled nursing saves the program money, it's not substantiated. So it is really pretty easy to talk about our position, the industry's value proposition if you will, for the program and for beneficiaries by just presenting the facts. And those facts are very well received.

Kevin Fischbeck, Bank of America Merrill Lynch.

Good morning. Actually, this is [Joanna Gedrick] for Kevin today. I actually had a question on bad debt. It seems like the numbers keep on coming better than expected. This quarter was 1.0; now the expectation for fourth quarter is 1.2% to 1.3%. So that is below the prior guidance for 1.5% in the second half of the year, and the numbers imply 1.1% around for the full year. So the question I have is whether the full-year number is a good run rate or whether you expect actually the bad debt to increase going forward?

Again, the primary reason for the fluctuation in bad debt has been the unpredictability of the medical necessity claims reviews. And there are a number of things that are unpredictable about that. One is the volume. Two is the speed with which the adjudication process proceeds.

And we think that on a go-forward basis it is probably prudent to continue to expect bad debt in that 1.4% to 1.5% range. We are obviously going to undertake all efforts to bring that number in lower than that based on how we code things and our interaction with Medicare. But because it's so unpredictable we think that the better course of action is to plan conservatively.

Okay, that's helpful. And also I want to follow-up to something, not mentioned on this call but on a prior call, in terms of the when you quantify the impact of the change to the 75% rule and you indicated you would hit the revenue by $42 million but be EBITDA by $26 million. So that implies an incremental margin of about 60% on the loss volumes. So the question I have is that the right way to think about it or there's some cost that we're missing here?

I think that is the right way to think about it. That implied $16 million in mitigating cost reductions. You may recall that about $12 million, so almost three-quarters of that, was our ability to fluctuate labor costs in conjunction with the decrease in the volume.

We had predicted that as a result of the adoption of the 75% rule our net discharges would decline by about 2,500. So $12 million in that expense reduction related to adjusting our SWB in conjunction with that volume loss. And the other $4 million was predominately in the supply area as, again, with the lower volumes we'd have some variable expenses there.

The reason that you don't see the same flow-through rate on the way down as you do on the way up is that we do have some fixed expenses out there, most notably in the form of occupancy expenses and then there are certain components of our labor costs that are relatively fixed as well, those being the administrative staff at each one of our hospitals as well as just core staffing levels.

A.J. Rice, Susquehanna Financial Group.

Hi, everyone. I have two fairly technical things here just to ask about. One, one of the things you guys have talked about using your cash for is buying in properties that are currently under operating leases. And with the pause or the staging out of the development program I wondered if that might become more of a priority and how much you might spend on that.

And then I just wanted to ask about professional fees. You know, that's been trending down for -- well, third quarter is lower than second and it looks like you're guiding it down. A, I know that's something you call out. Can you just remind me what it is? And then second, is that related to the E&Y or something else? And do you think it's basically you're winding that number down at this point and it will largely go away next year?

On the first question regarding lease buyouts we actually did consummate one of those in the third quarter. It was a relatively small one for a facility that we had in Kentucky and the buyout was in about the $7 million to $7.5 million range.

We have one pending which would be a roughly $20 million payout. Whether that closes in the fourth quarter of this year or the first quarter of next year it's difficult to discern.

Those are purely opportunistic. For those to arise a couple of things have to happen. One is we have to be -- we have to have a purchase option embedded in the lease. We have to be coming to the end of the lease term and then our negotiations with the existing landlord have to be such that we determine that it's economically preferable to engage in the buyout first as a renegotiation of the lease.

I think that these will happen sporadically over time. I don't think anything in the reimbursement environment necessarily suggests that we want to pursue those any more aggressively than we have in the past.

Pro fees?

The professional fees have run the a little bit higher this year than we anticipated simply because, as everyone on the call knows, the proceedings with E&Y have gone on for a more protracted period than we had anticipated.

We continue to believe that the most likely timeframe for a resolution is sometime in the first half of 2012. And obviously if we're looking at a partial year of expenditures in 2012 versus the full-year 2011 we'd see a reduction in those fees and then hopefully as we move out of 2012 we'll see that category eliminated completely.

Frank Morgan, RBC Capital Markets.

Good morning. I thought it was interesting that you called out one of the drivers to rate growth related to your better discharge to home and I guess effectively not having a short stay outlier payment. Can you tell us how your staffs compare to the industry overall? I don't know if that's something that's included in UDS data, but your discharge to home rates, how would that compare to the industry?

And then are there any other kind of potential drivers within the Medicare system that could perhaps help you continue to drive rate growth? So that's the Medicare question. And then, how were you doing on the managed-care pricing side? Anything you're seeing there growing the mix or how does the pricing look there? Thanks.

First of all, we don't have any short stay outlier payments. What happens is the difference between a patient who gets discharged back to an acute care hospital versus staying in for the full length of stay that is expected is the difference between getting the full CMG payment versus getting a per diem.

So that's part of what is happening is clearly the more patients that we're able to treat first and foremost we feel that they get better outcomes if we can treat them for the entire expected period of time and then discharge them home.

In terms of comparing us to others, the only data source we have is the UDS data and what we do is they look at it compared to what is expected based on the database that they have of similar patients being discharged from other providers. And we, on a hospital-by-hospital basis, look at that pretty carefully.

So overall we're right in the zone. Sometimes we're a little bit better than expected. And so we feel pretty good about the effort and the fact that this has a lot of sustainability to it, not only from a patient outcome standpoint, which is really the most important thing, but it does enhance our payments.

And then on the managed-care side, as we said before, really not a big difference there., We're still in that 3% to 4% range. As we've said for I guess quite a while now, that's pretty much what we expect. That's pretty much in line with what we're getting.

Rob Mains, Morgan, Keegan.

Good morning. I know this is a fairly small part of the business, but I know that the outpatient business this year was affected by the MPPR cuts. Assuming that we get some sort of reasonable (inaudible) am I correct in assuming that the reimbursement at least in that business should be stable next year?

Yes.

Okay, but they would just be layered on to a likely decline in the number of clinics?

Yes. The outpatient business that is not conducted in our hospitals will continue to decline.

Fair enough. Okay, that's all I had. Thank you.

Gary Lieberman, Wells Fargo Securities.

Good morning, this is Ryan on for Gary. Just a question on the healthcare IT spend. I guess could you just refresh my memory, are there incentive payments that you can expect to be receiving as you're spending this?

No, we're not eligible for the high-tech reimbursement.

Okay. And then I guess as we think about -- you guys have done a good job on taking market share and you mentioned extending your reach as being a part of that. Should we be thinking about healthcare IT as potentially extending your reach even further and maybe enabling more share to be taken or is it more about sort of just overall productivity enhancement? How should we be thinking about the potential upside from that?

The way we're looking at the IT spend is really from a quality of care and it will definitely benefit the patient to have the nurses and the therapists spending more time with them and less time charting. So first and foremost we think that this is going to be a plus from a patient care standpoint.

Secondly, longer-term, we need to make sure that we have the ability to connect with other providers should the market evolve into a bundled environment or an accountable care organization. I think that the sharing of information, both clinical and financial, across providers is going to be extremely important. And so that really requires obviously that we have that on an electronic platform.

David McDonald, SunTrust.

I had a couple of questions. First, Jay I was wondering since some these concerns about the potential resurfacing of the 75% rule I'm curious have you seen any uptick in terms of incoming phone calls, whether it's a hospital kind of rethinking their wing potentially again or a freestanding guy in terms of just strategic acquisition opportunities?

You know, nothing that really would be in those categories. I think that what's happening is that everybody that we're certainly talking to is really in a wait-and-see kind of mode. I mean, I mentioned that earlier. The uncertainty that is out there is pretty significant and I think a lot of people, us included, were waiting to get some clarification and then once we have that we'll be able to respond.

I do believe, however, that there are going to be certain circumstances where our competitors are simply not going to be able to maintain the same level of support, maintain their programs at the same level of quality as certainly as we have.

When you think about the fact that 920 of the 1,150 inpatient rehabilitation facilities out there are departments or units of acute care hospitals, and if you believe that the reimbursement environment for acute care hospitals, along with all other providers, is going to become more intense rather than less, more challenging rather than less, those acute care hospitals are going to have fewer resources to spread across their organization. And they're going to have to make some tough calls about what are their core services and what are the services that they're going to have to outsource or somehow rely on others to provide.

That I think will occur. When, I don't know. I think a lot of it will depend on what happens in Washington. But I do think that that will create an opportunity for us and it's frankly one of the reasons why we're slow walking the de novos. We do think that that uncertainty may create some acquisition opportunities and we want to make sure we've got enough dry powder to execute those.

And then just a quick follow-up. With you guys driving more neuro and stroke cases, the vast majority of which I assume are compliant, just a little color on the $26 million impact you talked about. Was that kind of a snapshot in time when the budget was released?

Yes.

So that could be a potentially noticeably lower number if you continue to see the strong growth that you're seeing in neuro and stroke, is that a fair way to think about it?

Yes, I mean it could. I think a lot of it really also depends on what's going on in the competitive landscape. I mean if that, as we just said, if that resulted in other units having to close that creates market share opportunities for us.

Paxton Scott, Jefferies & Co.

Good morning, thanks for squeezing me in here; I'll be brief. Just going back to the de novos, Jay. If we do get to the end of the year and it's the 2% sequestration, does that give you enough visibility to where you re-accelerate back on the de novo strategy or do you kind of hang out and see what else could come up in the ensuing months that could provide greater opportunity for you? Thanks.

Well, I mean, if the sequestration goes into effect and if there is some resolution on the [doc fix], and let's say that's done with a modest amount of additional cuts from providers, yes, we could definitely see reinvigorating that de novo.

I think, Paxton, what we really have to do is just say that we're really in a wait-and-see mode. It really depends on what kind of environment we find ourselves in, what has been or not been approved in Washington. I think the good news is, and what I hope you take away from it, is the fact that we're continuing to generate a lot of cash, as Doug mentioned.

We hope to get at least $210 million this year. That's an additional, what, $60 million, $70 million in the quarter if you just look at where we are thus far. So I mean that's a lot of additional cash. We'll be waiting, looking to see how we deploy that. But we've got a lot of flexibility on how we do so.

Okay, thank you very much.

Operator, are there any other questions?

That was our final question. I now turn the floor back over to you for closing remarks.

As a reminder, we will be attending the Lazard Healthcare Conference and the Citi North American Credit Conference in New York City in November. If you have additional questions we will be available later today. Please call me at 205-969-6175. Thank you.

Thank you. This concludes today's conference call. You may now disconnect.