Select Medical Holdings Corp (SEM) 2004 Q1 法說會逐字稿

Good morning, ladies and gentlemen and welcome to the Select Medical First Quarter 2004 Earnings Release Teleconference. At this time all participants have been placed on a listen-only mode and the floor will be open for questions following the presentation. It is now ply pleasure to turn the floor over to your host to Ms Jane Petrino of eurorsglife nrp. Ma'am, you may begin.

Thank you. Good morning and thank you for joining us today for Select Medical Corporation's investor conference call to discuss recent corporate developments relative to yesterday's first quarter 2004 earnings announcement. By now, you should have received the press release. If for some reason you have not received the press release or are unable to log onto the Webcast, please call me, Jane Petrino of Eurorscg Life NRP (ph) at 212-845-4274 and I will be happy to assist you.

This conference call is being recorded and will also be available through replay starting at 1:00 P.M. Eastern today and running until 1:00 P.M. Eastern on Wednesday, May 5. To access this replay, please dial 877-519-4471 within the United States or 973-341-3080, internationally. The pass code to listen to the replay will be 4632098.

Speaking today, we have the company's President and CEO, Robert Ortenzio and the company's Senior Vice President and Chief Financial Officer, Martin Jackson.

Management will give you an overview of the quarter highlights and business outlook and then open the call for question and answers. Before we get started, we would like to remind that you this conference may contain forward-looking statements regarding future events or the future financial performance of the company including without limitation statements involving operating results in calendar 2004, earnings per share in 2004, growth opportunities and other statements that refer to Select Medical's plans, prospects, expectations, strategies, intentions and beliefs. These forward-looking statements are based on the information available to Select Medical Corporation today and the company assumes no obligation to update these statements as circumstances change. For additional information, please see the cautionary statements included in Select Medical's most recent Form 10-K or other public filings filed Securities and Exchange Commission.

At this time, I will turn the conference call over to Robert Ortenzio. Please go ahead, Mr. Ortenzio.

Good morning, everyone. And welcome to Select Medical's earnings call covering the results of the first quarter 2004.

I'll provide some overall financial performance highlights for the quarter as well as take you through the operating performance of each of our business segments. For the quarter ended March 31st, we again exceeded earnings expectations with fully diluted earnings per share of 27 cents, 3 cents ahead of analyst consensus and the upper end of our previously provided guidance. This represents an 80% increase over fully diluted earnings per share of 15 cents in the same quarter last year on a split adjusted basis. Our net revenue for the quarter increased 35.1% to $422 million compared to $312.3 million for the same quarter last year. Our earnings before interest, income taxes and depreciation amortization or EBITDA for the quarter increased 83.7% to $68.9 million compared to $37.5 million for the same quarter last year. A reconciliation of net income to EBITDA and adjusted EBITDA which we'll use to measure performance in our operating segments is attached to our press release.

Income from operations increased 93% at $59.5 million for the quarter compared to $30.8 million in the same quarter last year.

We had another strong quarter for cash flow, as our cash flow from operations was $76.5 million for the quarter. Day sales outstanding continued to contribute to our strong operating cash flow as DSO dropped to 49 days at March 31st, down from 52 days at December 31st. We ended the quarter with over $210 million of cash on the balance sheet.

Next I'll take you through some of the key performance of each of our operating divisions starting with our specialty hospitals. Our specialty hospitals consist of our 79 long-term acute care hospitals and 4 rehabilitation hospitals. References to same-store hospitals throughout this segment, information refers to the 71 long-term acute care hospitals that were open prior to January 1, 2003 and operated throughout both periods by Select. Our specialty hospital net revenues increased 48.8% for the quarter to $272.9 million compared to $183.4 million in the same quarter last year. For our same-store hospitals, net revenues increased 21.6% to $221.3 million compared to $182 million in the same quarter last year. Our specialty hospital adjusted EBITDA increased a 129.1% for the quarter at $58.4 million compared to $25.5 million in the same quarter last year. Same-store adjusted EBITDA increased 78.9% to $45.8 million compared to $25.6 million in the same quarter last year. Adjusted EBITDA margins for the segment improved to 21.4% for the quarter, compared to 13.9% in the same quarter last year. Same-store adjusted EBITDA margins improved to 20.7% for the quarter compared to 14.1% in the same quarter last year.

Overall, adjusted EBITDA start up losses incurred in the first quarter for hospitals developed in late 2003 or in their pre-opening period were $1.2 million. Overall occupancy in our specialty hospitals was 72% for the quarter, up slightly from 71% in the same quarter last year. Same-store occupancy rates also increased to 72% for the quarter from 71% in the same quarter last year. Admissions in our specialty hospitals increased 46.7% to 8,738 for the quarter, compared to 5,958 in the same quarter last year.

Admissions in our same-store hospitals increased 9.3% to 6,464 compared to 5,915 in the same quarter last year. Specialty hospital patient days increased 28.3% for the quarter to 212,727 days compared to 165,818 days in the same quarter last year. Patient days in our same-store hospitals increased 6.3% to 175,186 days compared to 164,790 days in the same quarter last year. Overall length of stay in our specialty hospitals was 25 days for the quarter, average length of stay for our long-term acute care hospitals was 27 days for the quarter.

Our specialty hospital net revenue per patient day or rate improved 12.4% to $1,243 per day compared to $1,106 in the same quarter last year. Our specialty hospital payer mix based on the latest 12 months ended March 2004 was 71% Medicare, 2% Medicaid and the 27% balance from commercial insurance and managed care. We did not open any new specialty hospitals this past quarter; however, we continue to expect 8 to 10 new long-term acute care hospitals here.

Moving over to our Outpatient Rehabilitation Segment. Our Outpatient Rehab net revenues increased 16% for the quarter to $145.7 million compared to $125.6 million in the same quarter last year. Of our outpatient rehabilitation revenues for the quarter, $91.2 million was from our outpatient rehabilitation clinics, $3.6 million from our managed clinics and $50.9 million from our other outpatient services and our Canadian subsidiary. Our outpatient rehab adjusted EBITDA increased 17.5% for the quarter to $22.9 million compared to $19.5 million in the same quarter last year. Adjusted EBITDA margins improved to 15.7% for the quarter compared to 15.5% in the same quarter last year.

Visits in our U.S. based outpatient rehab clinics increased 2.3% for the quarter, slightly over 1 million visits compared to over 981,000 visits in the same quarter last year. Net revenue per visit in these clinics was $91 for the quarter compared to $88 in the same quarter last year. During the quarter, our outpatient rehab division opened four and acquired two new clinics and closed or consolidated 23 existing clinics including additional closings of a number of Kessler clinics acquired last September. At the end of the quarter, we operated a total of 777 clinics, operating in 27 states, in the district of Columbia and seven Canadian provinces compared to 739 clinics at the end of the same quarter last year.

I'll now turn it over to Marty Jackson, our Chief Financial Officer to cover the financial highlights in greater detail and discuss our outlook for the remainder of 2004.

Thank you, Bob. Once again, we are pleased to report solid financial results for another quarter. Operating expenses, which include our costs of service, general, administrative costs and bad debt expense increased 28.5% to $352 million in the quarter compared to $274 million in the same quarter last year. As a percentage of our net revenue, operating expenses for the quarter decreased 430 basis points to 83.4% compared to 87.7% in the same quarter last year. Of our operating expenses, rent expense was $26.5 million compared to $22.2 million in the same quarter last year.

Costs of services as percentage of net revenue contributed to the decrease in operating expenses as it decreased 290 basis points to 77.9% for the quarter compared to 80.8% in the same quarter last year. G & A as a percent of net revenue decreased by 30 basis points to 2.7% for the quarter compared to 3% in the same quarter last year. Bad debt as percent of net revenue decreased by 110 basis points to 2.8% for the quarter compared to 3.9% in the same quarter last year.

While total EBITDA increased 83.7% for the quarter, EBITDA margins improved 430 basis points for the quarter to 16.3% compared to 12% in the same quarter last year. The improvement was driven by significant margin expansion in our in-patient operations. For our business segments, specialty hospital adjusted EBITDA margins increased 750 basis points for the quarter to 21.4% while same-store margins improved 660 basis points to 20.7% for the quarter.

Outpatient rehab adjusted EBITDA margins increased 20 basis points to 15.7% for the quarter. Depreciation and amortization increased 38.8% to $10.4 million for the quarter compared to $7.5 million in the same quarter last year. This increase was primarily related to depreciation and amortization expense associated with some of the assets we acquired with the Kessler operations as well as increased depreciation on fixed asset additions related to new hospital development and expansion.

Net interest expense increased by $2.8 million for a total of $9.1 million for the quarter compared to $6.2 million in the same quarter last year. This increase was primarily due to the issuance of the 7.5% senior sub-notes for the Kessler acquisition. Tax expense was $19.9 million for the quarter, representing an effective tax rate of 40.2%.

Net income increased 104.6% for the quarter to $29.6 million compared to $14.5 million in the same quarter last year.

And as Bob mentioned, EPS increased 80% to 27 cents per fully diluted share for the quarter compared to 15 cents in the same quarter last year on a split adjusted basis. We ended the quarter with $364.7 million of debt outstanding and total leverage or total debt to trailing 12-month EBITDA pro forma for Kessler of 1.8 times. This compares to total pro forma leverage at year-end of 2 times. Total debt less cash or net debt was $154 million at the end of the quarter -- a $48 million reduction in net debt from the year-end. Net debt to EBITDA pro forma for Kessler was 0.7 times. We ended the quarter with $210.8 million of cash on the balance sheet.

After the end of the quarter on April 2nd, we paid off the $7.3 million remaining balance on our Canadian term loans leaving no outstanding borrowings on our senior credit facilities. Debt to total capitalization was 45% at the end of the quarter compared to 47% at year-end. Net debt to total capitalization was 19% at the end of the first quarter.

We once again had a solid quarter of cash flow from operations with operating activities generating $76.5 million of cash for the quarter. In addition to our earnings in the quarter, contributing to the quarter's operating cash flow was a reduction in day sales outstanding to 49 days compared to 52 days at year-end. Two other factors, improving cash flow, as our ability to defer a portion of our income tax liability and increase in our (INAUDIBLE) third party payer balances. Offsetting these sources of cash was a sizable reduction in our accounts payable and accrued payroll liabilities. Investing activities used $11.2 million of cash in the quarter, including 7$.8 million for the purchase of capital equipment and $3.4 million for acquisition-related payments.

Financing activities used $20 million of cash in the quarter, which includes $19.9 million in repurchases of our common stock, $2.8 million in debt reduction payments, $3.6 million dollar reduction in our bank overdrafts and $3.1 million in stock dividend payments offset by proceeds from stock issuance of $9.6 million for the quarter. We repurchased $1.25 million of share -- 1.25 million shares of our common stock in the open market during the quarter as part of our $18 million stock repurchase program announced on February 23rd. Of our shares outstanding at the end of the quarter, slightly over 10% is held by senior officers, directors and one remaining venture partner. This compares to approximately 45% insider ownership at the end of the first quarter last year.

As outlined in our press release, we have increased guidance for the remainder of 2004. This update includes the actual performance of Q1 and the increased range of objectives for each of the remaining quarters. Our new guidance for annual 2004 net revenue is $1.647 billion to $1.707 billion, which at the high end of our range represents a 22% increase on a year-over-year comparison. Our 2004 guidance for earnings per fully diluted share is now 96 cents to $1.02, which at the high end of our range represents a more than 41% increase on a year-over-year comparison of EPS. With that, I'd like to turn it back over to Bob for some final summary comments.

Thank you, Marty. Before questions, let me say overall, we are very pleased with the results of our first quarter and the prospects for the rest of 2004. I would say that the Kessler integration has progressed ahead of schedule and management's expectations. Our outpatient segment showed significant improvement from the fourth quarter performance and our year over year basis margins improved slightly. We're optimistic that that trend appears to have turned in the right direction and we'll continue to focus on our outpatient area of operations.

Our specialty hospital segment once again performed ahead of expectations and continued to be a driving force behind the company's positive performance, and we're also very pleased with the continuing strengthening of our balance sheet, particularly with our cash flow and day sales continuing to go down. With that, the remainder of the time is allocated for your questions and we'd like to open the call up for questions at this time.

Thank you, sir. The floor is now open for questions. If you do have a question, please press *1 on your touchtone phone. If at any point your question has been answered, you may remove yourself from the queue by pressing the pound key. We do ask that while you pose your question, that you please pick up the handset to provide optimum sound quality. Once again that is *1 to ask a question. Please hold while I poll for questions. Thank you. Our first question is coming from Joel Ray of Wachovia Securities.

Good morning. Was hoping that you might be able to discuss a couple of things for us. One, could you discuss pricing trends for us in the sector. And secondly, I was wondering if you could talk to us a little bit about -- you also probably had some severance expense that rolled over into this quarter. And maybe you could go and give us a little bit of help there as well?

Thanks, Joel. Joel, answering your last question first, the amount of severance that we had rolling over into the first quarter was approximately $400,000 associated with the Kessler terminations. At this junction we're pretty much wrapped up with that, Marty?

There is a small portion, probably a couple hundred thousand dollars left, Joel in Q2, but after Q2, that should be the end of it.

OK.

And with regards to pricing, you're talking about in-patient or outpatient or both?

Well, you had particular strength on the outpatient side at about $91 per visit. That was quite a surge. I was wondering about the re-contracting that maybe is in process with Kessler. Is that what is reflected here? Or...

No, actually the $91 is really reflective of our overall outpatient activities. You know, the $91, there's some increased units per visit, and that's really what that $91 has been all about.

So the point is you still have more re-contracting on the Kessler side to accomplish?

That's correct.

And likewise on the in-patient side it was a bit above my expectations, what is your outlook on the commercial side, especially there?

The commercial side is low single digit increases.

OK.

Obviously the majority of the increase you see there is driven by the PPS change.

Right. And in the meantime, your length of stay has been coming down slightly. Is that one of the key factors behind the enhanced margins that we're seeing?

Actually, Joel, our length of stay remains relatively constant at 27 days.

I think for the long-term acute hospitals, it has stayed constant in sequential quarters at 27 days. The overall has been brought down by the effect of the lower length of stay at the rehab hospitals.

OK. Well, thank you very much.

Thank you, Joel.

Thank you. Our next question is coming from Eric Percher of Thomas Weisel Partners.

Good morning. Strong margin across the board, but I was most surprised on the outpatient rehab side that obviously made up for some of the Kessler severance. I'm wondering, as you've done this before, as you look out over the next 12 to 18 months what is it in terms of goals that you are looking for at the next couple months? Will we see most of that impact now and we have to wait 12 months to really see the rest of the operational changes there?

Yeah, Eric. This is Marty. What we've indicated to people is that it will take us 12 to 18 months to really fully complete the integration of the Kessler outpatient. And we're going to stick to that right now.

OK. And when you say completed, you are focusing on getting those margins up to your margin level of 15% where you were at before?

Yes. What we've indicated to everyone is we feel comfortable for 2004, the margins being in the 15% to 16% range in our outpatient business.

OK. And then a separate question. Down at the MedPac meeting last week, there was a focus on making sure that your patients are appropriate for the LTAC setting, and they talked about the patient criteria, which I'm sure we've all heard about your high acuity. They also talked about facility criteria. And I wonder -- I know you're the low cost provider. Obviously you think your staffing levels are adequate, but do you have any idea for how you stuck up in terms of the industry average in comparison?

Well, I would say that we stack up very well. The facility criteria will just be those criteria that you need to have to be in LTAC. I think what you can expect is that the 25-day length of stay will continue and then you'll see some other things that would come in play, interdisciplinary, team approach or your physician complement at the facility and those elements, which we feel very good about and feel that just about anything that MedPac would suggest, our facilities are probably already complying with.

Very good. Thank you.

Thank you. Our next question is coming from Albert Rice (ph) of Merrill Lynch.

It's actually AJ Rice (ph). Just -- we talked around this a little bit. But just to make sure I understand, so the sequential rebound in outpatient rehab margins about 500 basis points versus the fourth quarter, you would attribute that mostly to what, I guess?

I think the answer to that question, AJ (ph) number one is you've got to understand there's seasonality in business.

Right.

Q1 is typically better than Q4.

OK.

So, some of that differential has to do with seasonality.

OK.

And then, number two is, I think a refocus of the operators concentrating on the business itself.

OK, it's not specificaally to Kessler and the elimination of serverance and better improved results? You say, it's sort of more across the board?

Yes. I would say that is definitely the case, AJ (ph).

OK. Now, you said that, I think in the prepared remarks there was some comments about obviously feeling like the outpatient business was sort of back on track. Does that make you more aggressive in terms of either development or acquisition opportunities that might be there for that business? Are we likely to see that pick up in '04?

Not necessarily. I mean, I think what -- where we want to focus our efforts on outpatient is those locations where we have a strong presence and a good, what we consider good market share. So we will continue to focus on those markets and continue to put, you know, human and capital resources in those markets. The other thing about the outpatient is it's really integrating the Kessler. In other words 92 clinics there and we closed some of those, but they are integrating at various points primarily up and down the Eastern seaboard with our existing NovaCare operations. So no, I would not look for a change in the strategy or enhanced acquisition activities with respect to the outpatient.

We really feel that we're in a mode where we are continuing to refine our operating expertise, our focus on the business at the local markets, and we're very pleased with the way the operators have responded.

OK. On the LTAC side, you reiterated that you're going to be looking at 8 to 10 openings. It's sort of hard to get a feel for what's happening in the overall market out there. I know a couple of the other players have announced their efforts at opening hospitals and hospitals facilities. Can you just sort of, comment on what the dynamic is? And has there been an acceleration you were expecting in the pace of new openings or is it pretty stable?

As you mentioned, AJ (ph), that's kind of hard to get a fix on because there's really only two public companies in this space that announced their openings and the rest is smaller, private companies. I -- just anecdotally, I have not seen what I consider a great surge or increase in openings. I think you still have a couple of players in the industry that are not growing through opening new hospitals, and a couple are opening, you know, 3 or 4 a year or more. I would say that Du Lac is probably at the front of that with our 8 to 10 openings, probably followed by Kindred. So, I haven't seen a great impact and we haven't seen a lot of new entrants into the field, either.

And then this final question that's sort of broad based. Obviously good cash flow generating quarter again. As you think about uses of your cash flow going forward, I mean, how -- maybe comment on acquisition, opportunities, other things that you might see yourself doing with that cash.

Well as you know, AJ (ph), we're always looking at acquisition opportunities. So we rarely find companies that fit strategically and also we feel that the purchase would create good value. But when we -- if we were to find such opportunities, we would, with our balance sheet and cash position, be in a position to move aggressively and we would do that. Having said that, as you know, our guidance, our revised guidance does not include any acquisition. So we feel that we can reach our objectives without doing acquisitions. If you see acquisitions, it will most likely be on the in-patient side of the business either in the LTAC in the rehab hospital arena.

AJ, I think the other thing that we've indicated in the past is that to the extent there is that cash available, our full expectation is to take out the $175 million nine-and-a-halfs (ph) that are callable in June of '05.

OK, all right, thanks a lot.

Thank you.

Thank you.

Thank you. Our next question is coming from Charles Lynch of CIBC World Markets.

Thanks. Good morning. Two questions. One strategic and one technical. There's been a little bit more discussion in Washington about the LTAC industry. Have you seen any kind of change in tone in terms of acute care hospitals and their thoughts about working with you or on the state level related to license share coming from that or is there just not enough to move the needle?

Now, I wouldn't say that I -- that we've seen any of those factors come into play.

OK. And just on a technical side. I'm looking at your interest expense. Can you help do some of the math as I look at your balance sheet debt, it's predominantly or overwhelmingly the public that you have out there and it seems as though the interest for this quarter was a bit higher than would be suggested by the rates on that debt. Is there something that I'm missing in the interest expense line as we look for the rest of this year?

Charlie, we had a small interest expense that went to a former owner as part of a settlement.

Do you know how much that was roughly speaking?

It was around $600,000 or $700,000.

OK. And that's not recurrent?

That's not recurrent.

OK. All right, thanks a lot.

Thanks.

Thank you. Our next question is coming from Kemp Dolliver of SG Cowen Securities.

Hi, guys. A couple of questions. First, on the occupancy data. Did you indicate that both overall occupancy in the in-patient division was the same for -- the same as same-store at 72%?

Yes, that's correct.

OK. What was the allowance for doubtful accounts?

Are you talking about the bad debt expense or the P&L or ...

... On the balance sheet.

It's about 34% of A R.

OK. Great. And Bob, any color on the -- in terms of the timing of openings this year now that you've one quarter down and you are still expecting to do 8 to 10?

Yes. I don't think -- I don't expect us to be as backend loaded for openings as we were last year. My expectation is we will have some openings in -- before June 30th. Before the end of the second quarter, we'll have a number of openings. And then it'll flow through the third and then completing in the fourth quarter. But I remain very optimistic. Our pipeline is very strong. Our signed deals are very strong. And I'm optimist that we'll hit the high end of our range in terms of openings this year.

OK, great. And lastly, I think I've seen just one or two announcements of, you know, some LTACs recently opening with nursing homes or in nursing homes. Is that a -- do you see that as a market opportunity or just something that inconsistent with your strategy?

I'm frankly baffled by LTACs opening up in nursing homes because it's a hospital license and you have to be in a hospital setting. I'm -- I really wouldn't expect to the extent that that's happening has to be very unique situation. So I'm not -- I really don't see that.

That's great. Thanks for your help.

Thanks, Kemp.

Thank you. Our next question is coming from Michael Scarandula (ph) of Merrill Lynch.

Hey, good morning, guys. I have a follow up question on the acquisition question posed earlier. Would you -- can you comment on what size acquisition opportunities you might be looking at? I know a few quarters ago, I think, you said you probably wouldn't do anything too large. You just bought Kessler and you were focused on integration. And I'm wondering since a few quarters have gone by and your cash balance obviously grows, does that change your parameters at all?

No, it really hasn't changed our parameters that much, Michael. One of the things that the Kessler integration has gone as I mentioned ahead of schedule -- very pleased at the progress in terms of our systems and our platforms and our management. We certainly feel that we could do another acquisition very nicely. In terms of range, you know, a sweet spot for us, I would think would be, you know, something probably less than $300 million around that range. I wouldn't look for to us do any big blockbuster acquisitions on the in-patient side but something in that smaller range.

Are you seeing anything in that range or is that just, kind of your sweet spot?

Well, just probably the area that we'll be looking. We're looking all the time. I mean it's a constant process of evaluating opportunities, but, you know, I couldn't comment actually any more, anything beyond that because it's just there as a process.

OK. Second question is, when you brought Kessler, there were some other ancillary businesses -- a nursing home and a few other things. Can you just comment on the status of those businesses and if you're still continuing on keeping them or divesting them?

That's under assessment. You know, that's a contest. As you know, on the outpatient side of the business as we integrated that, we have closed some clinics and consolidated those into our other operations. And we're also assessing the other what we call ancillary businesses that Kessler has to determine, you know, whether they would be integral to the Kessler operations going forward.

OK. It looks like the other specialty revenue went up a little bit. Does that mean the nursing home's doing a little bit better?

I wouldn't think.

OK. All right, guys. Thank you.

You're welcome.

Thank you. Our next question is coming from Frank Morgan of Jeffries.

Good morning. I apologize if this was asked but I got knocked off the call. In two areas, one on the LTAC side and on the rehab side. Could you break out or give us a little more detail in terms of length of stay in the LTAC business between the Medicare and the non-Medicare? I know what the overall average was. But could you break that out. And then secondly in the LTAC area, could you give us a little more color on the mix of your business between normal stay, short stays and high-cost outliers. And then the third one is the case mix index. And then over on the rehab side, could you just give us some examples on where -- if the margin improvement is now attributable to things going on with the Kessler assets. Give us some more details and examples of exactly what's making those margins go up so much? I'm very pleased that they are but I'd just love to get a little more color. Thanks.

Okay. I'm going to try to see if I can get a couple of those. In terms of length of stay for our Medicare and non-Medicare business, Frank, we do not break that out, but I can tell you they are comparable. You would not see a dramatic difference between the length of stay for our Medicare versus our non-Medicare business. In terms of, I think your latter question, in terms of case mix, we continue to have a pretty high case mix relative to the industry. I know Kindred had given some break out. Our case mix is comparable to those. Maybe a little bit less. 1.24 in that range is about where we are, which puts us at the -- probably the top core tile of the industry in terms of case mix at our hospitals.

Frank, the other question you had is could we break out the patients in high cost DRG and short-stay outliers. The high cost is about 4.3%. Short stay is about 20% on a revenue basis, and the balance of it is DRGs.

OK. And then on the outpatient rehab side?

What was your question there?

The -- just some examples of what you were able to do. I mean, it would seem to make a lot of sense if it were just Kessler, but if it's all these other things other than just more focus, I mean, any more detail on exactly what's driving that? Thanks.

I think what you're seeing is the operators when they see patients, they're actually seeing the patients a little bit longer and the number of units per patient visit has gone up. In addition to that, I think the operators are, as we indicated, there's a renewed focus on the business. And I think that's just part of it.

OK. All right. Thank you very much.

Thanks, Frank.

Thank you. Our next question is coming from Jerry Doctrow (ph) of Legg Mason.

Thanks. Actually, I wanted to ask, kind of the, frankly that question on the LTAC side. I just wanted to get a little bit more color on sort of what's driving the improvement, you know, if length of stay is there. I assume that the issue is you're just driving more occupancy and again, trying to get a feel of that just so the ramp up of new facilities are just, I guess it happens to same-store as well. So are you back filling with more, you know, basically non-Medicare patients. Just so you could give me a little more color on say, what's driving improvement there.

Peter, some of the improvement in our LTAC hospitals is obviously the continuing effect on a comparative basis of the PPS system, which will give us an opportunity to make a margin on the Medicare patient and reward providers who see a higher acuity patient and do it at a most efficient basis.

I think the other thing is driving the improvement in the hospitals as we have a number of hospitals that are less than 3 years old. They continue to mature. They continue to change their mix. They continue to refine their cost structure and that's the other thing that's sort of driving the improvement on the in-patient side.

And across the board, is it higher occupancy as well in terms of higher levels of admissions? Or it's really more on the cost side?

I think this quarter you saw an increase by about 1% from 71 to 72% in the occupancy rate. So that may have been a little bit of it. And the other thing we need to point out, I think, is our operators do a tremendous job at making sure they're paying the proper costs. They're constantly re-evaluating contracts or tenders and to the extent it makes sense, they're making changes there.

I think our acuity on a sequential basis -- the acuity is also of our patients overall, our case mix as measured by case mix index is also increasing.

OK. And then I just had one or two little technical things. I think on the Capex stuff, Marty, I just don't think I caught those as you were, kind of, going by them. There was Cap Ex and there was acquisition.

Sure. Let me get that for you. We had spent this past quarter, Jerry, spent $7.8 million for purchase of capital equipment.

And then there was an acquisition number, I think, as well.

$3.4 million.

3.4. And then just on the facility numbers on the outpatient side, I think you said you had closed 23. I want to get the number you added there. If you could give me a little sense of how that's playing out, what additional closures, and how that facility counts may be changing the next quarter or two?

What we had done was acquired two clinics during the quarter. Basically did four start-ups and we closed 23.

JAnd as we go forward, how do you see that kind of playing out?

It's an interim process, Jerry. I mean, the operators are constantly evaluating their clinics and how they're performing. You know, our expectations will continue to improve where it makes sense and we'll grow where it makes sense.

OK. And is Kessler -- most of the closures in Kessler are now done or is there another round of that coming? My sense is that some point we thought another 40 or so that might go?

I think most of it's done.

OK.

I think we closed approximately 24.

OK. Thank you.

Thank you, Jerry.

Once again, ladies and gentlemen, to ask a question, please press *1 on your touchtone phone at this time. Our next question is coming from Michael Weissberg (ph) of ING

Good morning. A couple things if I could. In the past, I think you talked about the potential of specialty hospital margins of being comparable to very well run hospitals. You know, you are sort of, there already. Obviously the Kessler acquisitions, which are high margin businesses, get to you a different margin level because of that. Could you give us a sense of when the PPS thing is fully integrated, where do you think you can take operating or EBITDA margins in that business?

The implementation of PPS is really just part, and I think you've seen a lot of that as our facilities are now all on PPS. That you would see that and it's there to be seen in the quarter.

What I think is not factored in oftentimes is, as I mentioned previously, the relative immature state that many of our hospitals are in. Because when you are opening 8 to 10 new per year, you can conclude that we have probably, you know, 24 to 30, I guess the number is 26 hospitals, that have been open less than three years. As those mature that will drive overall margins. I think the difference that we see in the margins of our more mature hospitals that've been opened 5/7 years, it really shows a difference than those open up to 1 to 2 years.

I think the other thing, Michael is that remember as we continue to develop 8 to 10 hospitals a year, there's about $8 million worth of EBITDA losses.

Right.

Associated with that development. As that is done, over a larger and larger base of hospitals, that naturally is going to expand the EBITDA margins.

OK, is there a way or do you want to, sort of, quantify it? Are we talking like 23%, 25% kind of, margin opportunity in the business?

Now, we really don't quantify it in that way.

If I could just switch to the rehab side. You guys have done a great job through a difficult environment. I was surprised in a way to see EBITDA margins up year to year because you are integrating Kesslers which have lower EBITDA margins, isn't that right?

That's correct.

That's correct.

And is that just a function of you doing a better job at the existing NovaCare facilities? Or maybe you could just talk about that.

Yes, I think you could expect that by looking at these numbers that the improvement to move the numbers as they have in this quarter, the improvement has really been across the board throughout all of our operations. I mean, you just wouldn't get that from just the Kessler facilities, particularly when you recognize that those have very, very low margins or margins that are dramatically below our company average.

I think NovaCare did better, our Canadian operations did better, our outpatient select operations also did better. So as Bob says it's across the board.

Are industry conditions overall somewhat better? You know, obviously, you know, the bad economy hurt people's ability or desire to, you know, visit as often.

I think given just one quarter turn around, we're not in a position to say if the economy's better. That's going to do a complete turn around on this business just yet, Michael. Give it a couple more quarters.

OK, you're doing great (INAUDIBLE), if I may. Let me ask just one more. Same-hospital admits on the specialty side was up 9%. That's an usually high number, isn't it? I mean, us that -- I thought that's higher than one can expect going forward.

No, I actually think last year we did very similar numbers.

OK. So that is a sustainable number then?

Yes, I think for the time being.

Thanks a lot.

Thanks, Michael.

Thank you. Our next question is coming from Kerry Nelson (ph) of Bloom Capital Partners.

Hi, great quarter.

Thanks, Kerry.

Thanks.

Question for you. Could you (INAUDIBLE) in case mix index, just give us a little bit of color as it relates to MedPac and the facility and patient criteria pro-proposals that are being put forth. Can you help us understand how that might impact you on the low end? So if I look at your short stay of only 20% of revenues which seems like a low number, within that, could you help us understand are there patients that you think might no longer be included this these proposals go forth or help us understand how your business might get affected?

It's hard to make any projections exactly on how the business would be affected mainly because the MedPac recommendations were rather general. What MedPac, I think if I can paraphrase said that while LTACs do take care of a -- and are intended to take care of a higher acuity medically complex patient, that the criteria that are in place currently can allow for patients that may be seen in other settings. So that would be rehab or skilled nursing.

Now, from select standpoint as we look at the data and we talk to MedPac, we think that if they put in additional criteria, which we recommend that they do, which provides that the LTACs only take care of the higher severity cases. Obviously the devil's in the detail on how they define those cases and how they define facility criteria and patient criteria, we think that we would not require a shift in our patient population or the profile of our patient in order to be in compliance with anything that might come out if you take MedPac's kind of, general recommendations. If you look at the industry as a whole, Kindred I think, and Select Medical, looking at the (INAUDIBLE) data, would suggest that they take care of a higher case mix index patient as measured by case mix index. So I would not say that I would anticipate any change in our business.

We as a policy, if there are patients that are really more appropriate for skilled nursing level of care, we either don't admit that patient or if they progress far enough, we discharge that patient to a more appropriate level of care if we can. So I wouldn't say that we are bracing for any changes in our business. Just as you saw when the PPS, the DRGs came in, you really did not see, we saw some reduction of length of stay, modest for our company but not being changes in patient profiles.

OK, that's great. Follow up on that, the issue regarding readmissions is not often perfectly clear but relative to what's being discussed right now, can you just talk about your readmission policy vis-à-vis, what's on the table now?

Well, there are some regulations that are already in effect that govern readmission, and I think the Select Medical's policy is that if you have a patient that's in the LTAC and goes out and then is readmitted, that that should be one episode of care that you should not be able to get a restart on the DRG or reimbursement for a case that is admitted, discharged and then readmitted. So we're not troubled at all by that. We don't have those types of patients that are going through our facility.

I think that what MedPac and others have zeroed in on, this is an area where there is potential for abuse. And so we're supportive of any additional regulations that would prevent any of that cycling of patients. Although as I mentioned, there are some regulations on the books currently that govern payment mechanisms for readmissions.

But is the discussion around that extending the number of days that someone could be out of the hospital and then readmitted back in, lengthening that to only include one DRG as opposed to two?

I'm not sure of your question. Right now, if you do have a discharge and the readmission under most circumstances that is one DRG. It's the same payment mechanism.

Got it. OK. And then one last question, is regarding your comfort with leverage. Can you just talk about your overall leverage comfort and then within that, where would you prioritize the buyback given how much cash you guys are generating?

From a leverage perspective, Kerry, you know, today we're at about 1.8 times total debt on a net debt basis 0.7 times. You know, think we're comfortable taking it up to 2, 21/2 , maybe even 3 times.

And with regards to the buyback, we will continue to take a look at the buyback. You can see we bought almost $20 million with the stockback in the month of March and our expectation is to continue to look at the market.

Terrific. Thank you.

Thank you, Kerry.

Thank you. Our next question is a follow-up coming from Joel Ray of Wachovia securities.

Couple follow-ups, guys. Can you discuss with us a little bit how you've been successful at reducing this bad debt ratio and the DSO because certainly every time we've talked you've indicated that you wouldn't expect things to get better and yet every quarter I'm pleased to see it is getting better.

Joel, as we've talked about before, you know, our operators continue to make a liar out of me. You know, I keep on saying that I think it's the lowest it can go and they continue to improve it. The two things that we have talked about, you know, over the last year is at the end of 2002, we put together an in-patient in-house collection agency for commercial accounts. And those people have done just a tremendous job. They've done a great job going out and collecting the dollars. I think that's been a big component of this.

The second thing we did was our IT people were able to put front end edit functions on the 1 billion collection system we have. And that has really also enhanced the reduction of the DSO.

Have you changed any of your policies on reserving on the Medicare side as you phased into the PPS?

What we did early on with regards to PPS is because we did not have historical experience with the secondary payers because the new reimbursement system, we took the bad debt up a bit. But now that we have experience and as you can see the cash collection is very good, we're bringing it down to reflect a more normal cash collection.

OK. So it would be fair to assume we should continue to see fairly comparable trends on this ratio going forward I guess on the bad debt?

Yes.

Lastly, I was wondering if you might be able to tell us -- now that you've done a lot to fold in the Kessler acquisition, any changes or thoughts on your strategies before the in-patient rehab hospital business as far as new development, acquisitions, et cetera?

Yes, new development or acquisitions in the in patient rehab segment is part of our strategy. The rehab (INAUDIBLE) LTAC segment is a much more mature business so the development projects are certainly not as plentiful as we find on the LTAC side. We have dedicated some of our development personnel to look for good areas and markets for us to do some rehab development. And I expect that that pipeline will really start to be built over the balance of 2004. I wouldn't expect that -- and we're not projecting any ground breaking for rehab hospital projects in 2004. We hope to begin to build the pipeline on that.

In terms of acquisitions, I would certainly be interested in rehab hospital acquisitions. They're probably not as plentiful because of the nature of the industry and many of the rehab hospitals are concentrated inside HEALTHSOUTH but we will certainly be amenable to a rehab acquisition if we had the opportunity.

OK, thank you.

Thanks, Joel.

Thank you. Our next question is a follow-up coming from Frank Morgan of Jeffries.

Thanks. Could you give us an idea -- I guess, it's first technical -- could you tell me what the average LTAC or specialty hospital average bed count was in the period and what it was at the end of the period? And then kind of the mix about age (ph), I know you referred to the number that were less than 3 years old. Do you have any more detail you could break those things out by their age. And then, another question on the LTAC side, within those 3 categories I asked about earlier, between the short-stay and the normal and the high-cost outliers. Could you give us kind of an average case rate and length of stay in those three categories? Thanks.

Frank, the number of licensed beds went up a bit -- in Q4 of '03, we had 2882 beds. Q1 of '04, we had 2934.

OK.

Frank, does that answer that?

Yes.

And that is for the LTAC. Obviously the inpatient rehab hospitals were 322 and that remains the same.

As far as your second question, Frank, which was the break out and the case rates, we really don't have that available and don't put that out.

OK. Thank you.

Sure, Frank.

I would like to turn the call back over to Mr. Ortenzio for any closing comments.

Thank you all for joining us on the call. We feel very good about the quarter and we feel good about the prospects for the remainder of the year and we look forward to addressing you with our second quarter results this summer. Thank you.

Thank you. This does conclude today's teleconference. You may disconnect your lines at this time and have a great day. Thank you.