Select Medical Holdings Corp (SEM) 2004 Q2 法說會逐字稿

Good morning and welcome to the Select Medical second-quarter 2004 earnings conference call. At this time, all participants have been placed on a listen-only mode and the floor will be opened for questions following the presentation.

It is now my pleasure to turn the floor over to host, Jane Petrino. Ma'am, the floor is yours.

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 second-quarter 2004 earnings announcement.

By now, you should've 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 Euro RSCG Life NRP, at 212-845-4274 and I will be happy to assist you.

This conference call is being recorded and will also be available through a replay starting at 1 PM Eastern today and running until 1 PM Eastern on Wednesday, August 4. To access this replay, please dial 877-519-4471 within the United States or 973-341-3080 internationally. The Passcode to listen to the replay will be 487-0430.

Speaking today, we have the Company's President and Chief Executive Officer, 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 questions and answers.

Before we get started, we would like to remind you that this conference may contain forward-looking statements regarding future events or the future financial performance of the Company, including, without limitation, statements regarding 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. Because forward-looking statements include risks and uncertainties, actual results may differ materially from those expressed or implied by them. Those 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 with the Securities and Exchange Commission.

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

Thank you, Jane. Good morning, everyone, and welcome to Select Medical's earnings call covering the results of the second quarter of 2004. I will provide some overall financial performance highlights for the quarter as well as take you through operating performance for each of our business segments.

For the quarter ended June 30, we again exceeded earnings expectations with fully diluted earnings per share of 29 cents, 2 cents ahead of both analysts' consensus and the upper end of our previously provided guidance. This represents a 61.1 percent increase over fully diluted earnings per share of 18 cents in the same quarter last year on a split-adjusted basis.

Our net revenue for the quarter increased 28.3 percent to $418.7 million compared to 326.2 million for the same quarter last year. Our earnings before interest, income taxes and depreciation and amortization, or EBITDA, for the quarter increased 55.9 percent to $67.5 million, compared to 43.3 million for the same quarter last year. Our reconciliation of net income to EBITDA and adjusted EBITDA, which we use to measure performance in our operating segments, is attached to the press release.

Income from operations increased 62.7 percent to $60 million for the quarter compared to 36.8 million in the same quarter last year.

Next, I'll take you through some of the key performance measures for each of our operating divisions, starting with our specialty hospitals. Our specialty hospitals consist of both our long-term, acute-care hospitals and our rehabilitation hospitals. References to same-store hospitals refers to the 71 long-term acute-care hospitals that were opened prior to January 1, 2003 and operated throughout both periods by Select. Our specialty hospital net revenue increased 41.5 percent for the quarter to $271.4 million, compared to 191.8 million in the same quarter last year.

For our same-store hospitals, net revenues increased 12.7 percent to $215.7 million, compared to 191.5 million in the same quarter last year. Our specialty hospital adjusted EBITDA increased 90.8 percent for the quarter to $58.6 million, compared to 30.7 million in the same quarter last year. Same-store adjusted EBITDA increased 45.5 percent to $46.9 million, compared to 32.3 million in the same quarter last year. Adjusted EBITDA margins for this segment improved to 21.6 percent for the quarter, compared to 16 percent in the same quarter last year. Same-store adjusted EBITDA margins improved to 21.8 percent for the quarter, compared to 16.8 percent in the same quarter last year.

Overall adjusted EBITDA start-up losses incurred in the second quarter for hospitals developed in 2004 and late 2003, or in their pre-opening period, were $1.3 million.

Admissions in our specialty hospitals increased 35.8 percent to 8,306 for the quarter, compared to 6,117 in the same quarter last year. Admissions in our same-store hospitals declined 2.2 percent to 5,962 compared to 6,095 in the same quarter last year. This decrease in admissions is a result of additional admissions criteria we are requiring to admit patients to our long-term acute-care hospitals. We've incorporated additional criteria focused on acuity of the patient in advance of expected new criteria to be established for our industry. Our focus on increased patient acuity has resulted in an increase in our case-mix index, which was 1.24 in the second quarter, up from 1.18 in the same quarter last year.

Specialty hospital patient days increased 21.8 percent for the quarter to 204,525 days, compared to 167,945 days in the same quarter last year. Patient days in our same-store hospitals declined 2 percent to 164,276 days compared to 167,667 days in the same quarter last year for the same reasons as discussed above. Overall length of stay in our specialty hospitals was 24 days for the quarter. Average length of stay for our long-term acute-care hospitals was 27 days for the quarter.

Overall, occupancy in our specialty hospitals was 69 percent for the quarter, down slightly from 70 percent in the same quarter last year. Same-store occupancy rates also declined slightly to 68 percent for the quarter from 71 percent in the same quarter last year. Our specialty hospital net revenue per patient day, or rate, improved 12.9 percent to $1,285 per day compared to $1138 per day in the same quarter last year. Our specialty hospital payor mix, based on the latest 12 months ended June 30, 2004 was 68 percent Medicare, 3 percent Medicaid and the 29 percent balance from commercial insurance and managed care.

We opened three new long-term acute-care hospitals this quarter at Geisinger Medical Center in Danville Pennsylvania, the Queens Medical center in Honolulu, Hawaii and at Mount Carmel Health Systems in Columbus, Ohio. We also opened a hospital earlier this year at Research Medical Center in Kansas City, Missouri.

Moving to our outpatient rehabilitation segment, our outpatient rehab net revenue increased 9.3 percent for the quarter to $144.3 million compared to 132 million in the same quarter last year. Of our outpatient rehab revenues for the quarter, $88.8 million was from our U.S. outpatient rehab clinics, 3.9 million from our managed clinics and $51.6 million from our other outpatient services and our Canadian subsidiary.

Our outpatient rehab adjusted EBITDA increased 3.3 percent for the quarter to $24.2 million, compared to $23.4 million in the same quarter last year. Adjusted EBITDA margins declined to 16.8 percent for the quarter compared to 17.7 percent in the same quarter last year. However, sequentially, adjusted EBITDA margins continued to improve, up from 15.7 percent in the first quarter as we continue to experience improvement in the acquired Kessler outpatient operations.

Visits in our U.S.-based outpatient rehab clinics declined 2.5 percent for the quarter to slightly under 1 million visits, compared to slightly over 1 million visits in the same quarter last year. Net revenue per visit in these clinics was $89 for the quarter compared to 88 in the same quarter last year.

During the quarter, our outpatient rehab division opened 9 clinics, closed and consolidated or sold 22 existing clinics, including some of the Kessler clinics acquired last September. At the end of the quarter, we operated a total of 761 clinics operating in 26 states, the District of Columbia and 7 Canadian provinces, compared to 737 clinics at the end of the same quarter last year.

At this time, I will turn it over to Marty Jackson, our Chief Financial Officer, to cover the financial highlights in greater detail, and then we will conclude with questions.

Thanks, Bob. Once again, we are pleased to report solid financial results for another quarter.

Operating expenses, which include our cost of service, general and administrative costs and bad debt expense, increased 24 percent to 350 million in the quarter, compared to 282.2 million in the same quarter last year. As a percentage of our net revenue, operating expenses for the quarter decreased 290 basis points to 83.6 percent, compared to 86.5 percent in the same quarter last year.

Cost of services as a percent of net revenue contributed to the decrease in operating expenses, as it decreased 170 basis points to 77.5 percent for the quarter, compared to 79.2 percent in the same quarter last year. Of our cost of services expenses, rent expense was 26.4 million, compared to 22.5 million in the same quarter last year.

G&A as a percent of net revenue decreased by 20 basis points to 3.3 percent for the quarter, compared to 3.5 percent in the same quarter last year. G&A expense increased on a sequential basis by 2.3 million to 13.9 million in the quarter. This includes a $1.5 million accrual for the annual incentive compensation plan payments tied to our improved performance.

Bad debt as a percent of net revenue decreased by 100 basis points to 2.8 percent for the quarter, compared to 3.8 percent in the same quarter last year. While total EBITDA increased 55.9 percent for the quarter, EBITDA margins improved 280 basis points for the quarter to 16.1 percent, compared to 13.3 percent in the same quarter last year. The improvement was driven by significant margin expansions in our in-patient operations.

For our business segments, Specialty Hospital adjusted EBITDA margins increased 560 basis points for the quarter to 21.6 percent, while same-store margins improved 500 basis points to 21.8 percent for the quarter. Outpatient rehab adjusted EBITDA margins decreased 90 basis points to 16.8 percent for the quarter but as Bob indicated, we continue to experience improvement sequentially.

Depreciation and amortization increased 21.2 percent to 8.7 million for the quarter, compared to 7.2 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 from the Kessler operations, as well as increased depreciation on fixed-asset additions related to new hospital development and expansion.

On a sequential basis, depreciation and amortization declined $1.7 million. This decline resulted from revisions in depreciation estimates associated with the Kessler acquisition. We believe our depreciation and amortization expense should approximate to 9.6 to 9.8 million for the remaining quarters in 2004.

Net interest expense increased by 1.4 million to 6.8 million for the quarter, compared to 5.5 million in the same quarter last year. This increase was primarily due to the issuance of the 7.5 percent Senior Subordinated Notes for the Kessler acquisition, offset by a one-time gain of approximately $1 million associated with the elimination of our foreign currency hedge on our Canadian subsidiary debt, which we fully repaid in the quarter. We expect interest expense to run approximately 7.8 to $8 million for the remaining quarters in 2004.

Tax expense was 21 million for the quarter, representing an effective tax rate of 40.4 percent.

Net income increased 66.2 percent for the quarter to $31 million, compared to 18.6 million in the same quarter last year. As Bob mentioned, EPS increased 61.1 percent to 29 cents per fully diluted share for the quarter, compared to 18 cents in the same quarter last year on a split-adjusted basis.

Now, moving over to the balance sheet, we ended the quarter with $355.7 million of debt outstanding and total leverage, or total debt to trailing twelve-month EBITDA Pro Forma for Kessler of 1.5 times. This compares to total Pro Forma leverage at year end of two times. Total debt less cash or net debt was 187.7 million at the end of the quarter, compared to 202 million in net debt at the year end for 2003. Net debt to LTM (ph) EBITDA Pro Forma for Kessler was 0.8 times at the end of the quarter. We ended the quarter with 167.9 million of cash on the balance sheet.

Debt-to-total capitalization was 44 percent at the end of the quarter, compared to 47 percent at year end. Net debt-to-total capitalization was 23 percent at the end of the second quarter.

Operating activities used $12.1 million of cash during the quarter. Operating cash flow was a use of cash during the second quarter due to several factors. Offsetting our improved operating performance in the quarter, we experienced a reduction in our third-party liabilities of 30.2 million, a reduction in our income tax liability of 12.3 million, and an increase in our Accounts Receivable, which used 29.5 million of cash in the quarter.

Days of Sales Outstanding increased to 52 days at the end of the second quarter, up from 49 days at the end of the first quarter and consistent with the 52 days reported at year end, 2003. The AR increase from first quarter was primarily the result of the timing of our biweekly Medicare PIP payments for long-term acute-care hospitals, which amounted to 15.5 million of our AR increase. Without this increase, AR days would have remained at 49 days at the end of June.

Investing activities used 6.1 million of cash in the quarter, including 11.4 million for purchases of capital equipment, offset by proceeds from the sale of assets for 4.8 million. We sold our interest in the joint venture that was part of the Kessler acquisition.

Financing activities used 24.5 million of cash in the quarter, which included 28.2 million in repurchases of our common stock, 8.3 million in debt-reduction payments, including the repayment of a remaining senior credit facility Canadian term loans, and $3 million in stock dividend payments, offset by an increase in our bank overdrafts of $10 million and proceeds from stock issuance of 5.4 million in the quarter.

We repurchased 2.1 million shares of our common stock in the open market during the quarter and 3.4 million shares so far this quarter as a total cost year-to-date of 48.1 million, including fees and commissions. These purchases have been executed under our $80 million stock repurchase program announced on February 23 of this year.

As outlined in our press release, we have reconfirmed our financial objectives for the remaining two quarters of 2004, our annual 2004 objectives, which include our first two quarters' actual performance and Q3 and Q4 objectives, our net revenue of 1.66 billion to 1.7 billion, which at the high end of the range represent a 22 percent increase on a year-over-year comparison.

Our 2004 objectives for earnings per fully diluted share is now $1 to $1.04 which, at the high end of our range, represents a 44 percent increase in our year-over-year EPS growth.

I will caution you that our fourth-quarter and full-year expectations do not take into account any impact of CMS' proposed regulatory changes described in our press release. We will review CMS final regulations as soon as they are issued and will advise the market shortly if it will impact our financial objectives for the year.

This concludes our formal remarks on the quarter. The remainder of our time is allotted for your questions, and we'd like to open up the call at this time.

Thank you. The floor is now open for questions. (OPERATOR INSTRUCTIONS). Kevin Fischbeck with Lehman Brothers.

Good morning. I guess if I could get a little more color on the decline in the volume from the LTAC side -- it sounds like this was something that you guys had put together and was doing proactively. I guess it sounded like you were doing it in response to something that you expected to come out. Is this a near-term expectation or I guess I want to get a little more color about why exactly you decided to do it this quarter?

It's really the trend in the industry. If you look at the final report that came out from MedPAC and some of things that you hear out of CMS, the trend in this industry is going to be for the LTAC segment to be narrowed probably with additional criteria to take care of higher-acuity patients. In fact, if you look at the new reimbursement system that was put into effect in October, 2002, it does pay significantly more under the DRGs for the higher-acuity patients.

So if you look at what Select is doing slowly and perhaps subtly but nonetheless, we think it's important to continue to gear our programs to take care of the higher-acuity patients. You really see that reflected in the case-mix index or a measure of the acuity of our patients. So, I think you're going to see that and I think it's gradually -- it's not something that we're doing this quarter. In fact, if you look at this across 71 hospitals, the decline in 2.2 percent, if you look at that across 71 hospitals that are in same-store, it really amounts to less than one-half of admission per month for the quarter; it's about 1.8 admissions per quarter, per hospital, so this is not a dramatic shift. So, I think it's something we described as subtle but something that we will be continuing, and we think it's important.

As a point of fact, as we have higher-acuity patients, we hope that we will continue to see the increases in revenue, EBITDA and margin as you saw in this quarter with revenue on a same-store basis being up 12.7 percent, EBITDA -- again on a same-store basis -- up 45.5 percent and margin up 21.8 percent. So you say, well we have a reduction in the admissions of 2.2 percent same-store, but increase in margin EBITDA and revenue. That also reflects that as you have higher-acuity patients, your reimbursement is higher.

I guess just to clarify again, it's just more an acuity change rather than any kind of change in referrals from the host hospital or anything like that? That's not what this -- (multiple speakers) -- reflecting?

Yes, I think that's right. It's a question of the admissions that we take of the profile of the types of patients that we are taking, taking them more in the higher-acuity and less so on the lower end of the acuity because my expectation -- again, this speculation on my part -- but I think, over time, the evolution of the LTAC industry is going to be reduced reimbursement for the lower-acuity patients as the LTACs are narrowed to take care of just the higher-acuity patients.

Just (indiscernible) more question on the guidance that you guys provided, I'm having a hard time I guess getting there. If I used the midpoint of the EPS range, 22 cents, and let's just Q3, and 106 million shares and a 40 percent tax rate, I get pretax of around 39. If I add in I guess 8 million for expense and let's call it 10 million for the D&A, that you guys are just going -- would be the second-half trend. I get to an EBITDA number based upon the midpoint of let's say 410 (ph) in revenue, I get a margin around 14 percent on EBITDA versus the mid-16s so far year-to-date. I guess I was wondering what exactly you guys are forecasting or maybe my math is wrong but I wanted to see what was going on there.

Kevin, what we can do is talk about this off-line. I think some of your numbers may not be accurate. Okay? So, just give me a call in the office.

Frank Morgan with Jefferies.

Good morning. I had a couple of questions here. What was the average revenue per discharge purely on the LTAC side of the business? Then kind of related to Kevin's question, are there any specific DRGs or diagnoses that you could specifically point out to us that you would be more actively pursuing, going forward?

Then the third is just what is the activity level with regards (indiscernible) UHH (ph) development in light of all this CMS proposed rule-change? Finally, do you expect the rule to come out this Friday?

Let me take a few of those, Frank, and if we miss any of them, you let us know.

In terms of the CMS rule, I will take the easiest one the answer. In terms of when the CMS rule is going to come out, we don't know. We think it could come out -- (technical difficulty) -- we've heard some rumors that they're going to try to get it out on time, which would suggest either Friday or early next week. I have no way for me to either validate that or not. We are waiting, I think, just like everybody else.

The second question, which was our development activity -- as you noticed in my comments, we did open -- we have opened a number of new hospitals, three this past quarter and one recently, so we had a number of hospitals that were in the pipeline that were fairly far along, under renovation when the May 11th rule came out, so we moved forward, as you would expect, to open those hospitals, which we've done. We have a number of others in the pipeline.

Now, in terms of new development activities, the proposed rule has affected those. We are not absolutely committing to new deals until we know exactly what the final rule will say, but we're certainly taking steps to make sure that deals are keyed up and that, if we have to modify the basis or the model which we pursue them, we give ourselves maximum flexibility to do that. So we are active in development but we're not signing deals business as usual in light of the uncertainty from May 11. But it's not a particularly long time -- (technical difficulty) -- really that disruptive. The proposal came out on May 11. We expect to have final rule here shortly.

One of the other questions you had was the average rate per discharge for the LTACs. That's something we don't provide. We don't provide a breakdown for the LTACs, nor do we provided it on a discharge basis. The number we provide is a per daily rate. This quarter, it was 1285 on the specialty hospital side.

I think your other question, Frank, was the types of patients that we are focusing on, (indiscernible) DRG numbers but those DRGs that have the higher acuity are obviously respiratory with ventilator or trachs at the higher end and those tend to be the ones that have your higher case mix index. At the lower end, it would be the kind of rehab cases or the complicated rehab cases. There's also some other DRGs that carry with them lower acuity, lower reimbursement.

Joel Ray with Wachovia Securities.

Good morning. I was wondering if you could discuss with us the consistency of shortening a length-of-stay and contrast to having higher-acuity patients. Because it seems like the length-of-stay has been coming down for the business. I just want to make sure I understand that.

Secondly, is the shortening of length-of-stay impacting our revenues that we are generating on the commercial side of the business, meaning do we have more per-day contracts versus case contracts?

Third, I was hoping you could elaborate on how we are doing with the turnaround or cleanup with the Kessler operations, especially their outpatient rehab clinics.

Thanks, Joel. First, let me address your length-of-stay question. You see length of stay -- reported length of stay moving around a bit, mainly because we include our rehab hospitals from Kessler in the overall length-of-stay. If you look at length-of-stay for the LTACs only, that's really been a rock solid 27 days over the last couple of quarters, so we haven't seen that move and really don't expect to see it. I think that 27 days has held probably for the last five quarters.

So, second question on Kessler -- we feel we've made a lot of progress on the integration of the Kessler outpatient. You really see that reflected in the sequential increase in the outpatient margin. As you may remember, we had a really reduction of the margins when we first made the Kessler acquisitions, because their margins were really quite low. As those have been integrated into our operations, those margins have trended up. They've trended up; their margins have gone up significantly enough that they've moved our overall outpatient margins up, so we're very pleased with how the Kessler outpatient operations have been integrated.

Is there more to go on that side?

Well, you know, we always hope for some improvement and we will be looking for improvement in margins, certainly on a sequential basis.

Finally, with that shortening length-of-stay apparently in the rehab side, is that having much impact on your commercial revenues for that side of the business?

On the LTACs?

Well, the point is you had indicated that the length-of-stay on the LTAC side has been rock solid at 27 days. The overall blended, when you throw in the rehab hospitals, has come down. Obviously, Medicare has (indiscernible) more of a DRG-based system so you want shorter length of stay, but on your commercial side, what are the implications to revenue with the shortening length-of-stay?

Joel, the shortening length-of-stay really hasn't changed at all. If you take a look at -- as Bob mentioned, average length-of-stay on the LTACs has remained very much the same and the 24 days you see there is a combination of the 27 days plus the average length of stay in the rehab hospitals. That's remained pretty constant also. So, there really has not been any change on average length-of-stay for either the LTACs or the rehab hospitals.

A.J. Rice with Merrill Lynch.

It's actually Chris Rigg (ph) for A.J. Looking at the outpatient business, I know you have a bunch of moving parts and you are still selling and investing some facilities, but year-over-year, the number of visits in the U.S. business were still down. Is there some other dynamic -- was there some other dynamic in the quarter that negatively impacted the volumes?

There's basically three things we're looking at on the outpatient side that are impacting the volume. Number one is, as we've said over the past year or so, we continue to prune those contracts that don't give us the margins that we want. I think you see some of the volume decline due to that. The other thing you see is there's been a change in the workers' comp requirements in California. That has had a negative impact on the volume that we see out there. Then third is we are constantly focused on working with physicians. Some of the physicians are actually taking PT services back into their offices, and that has had an impact also.

Okay. In the LTAC business, a little broader question -- but are you seeing any competitive pressures from some of the SNFs or actually even the acute-care guys trying to keep some of these patients in-house or gain new patients that otherwise would have tried to capture in your business?

No.

The last thing, I'm not sure if you mentioned this in your earlier comments but in the cash flow, the operating cash flow, with regard to the do-to/do-froms, is there anything going on there that we would expect that to come down because of the LTAC PPS or is that something we would see come up in the future on a regular basis?

I would imagine you're going to see do-to/do-from continue to come down. Remember that the do-to/do-from, the $30 million that we paid was really closing out cost-report years. As we continue to move towards PPS, our expectations -- you'll see that continue to come down.

Kemp Dolliver with S.G. Cowen & Company.

Thanks and good morning. A couple of questions with regard to the mix shift in the LTACs -- first, what impact is the case mix having on your rate per day? Can you take that increase in the case mix you mentioned this quarter and link it to percentage increase in your average rate?

All we're showing right now, Kemp, is the total increase in the rate itself. We haven't broken it down by acuity.

Fair enough to think that it's netting out still positive?

Our expectation is that it does.

Looking at your acuity another way, there seems to have been a lot of focus on severity level measures and percentage of patients going to LTACs being in severity levels 3 or 4. Can you give us some color on where you stand, given your case mix numbers?

No, I really can't. I mean, I could probably get that information but I don't have it at the moment.

Okay. How are you looking at the market for development opportunities? You know, given the uncertainty -- are you pretty much going to the same kind of hospitals you've pursued historically, or even with this tweaking of the acuity levels in your facilities, are you targeting your development activities more finely?

Well, on development, it's really -- we have had such a developed pipeline, Kemp, that really the basket of hospitals we may be looking at to establish a new hospital are really in existence. So, we are continuing our dialogue with those to bring those in. As I've said in prior calls and at meetings, we probably have a pipeline of 40 or 50 hospitals that we're dealing with at any one time. Then from those, we get the eight to ten that we have done the last couple of years. So at this point, it's really not really as much as targeting new hospitals but it's really working the ones that have been in our pipeline to determine whether those are going to be hospitals that we're going to be able to do, given the new regulations.

So, I don't want to describe it as a holding pattern, but we continue to have our efforts and our dialogue and our work and we are kind of waiting for the guidance that we will get under the new rule before we definitively do additional projects.

Great. Just one other question on Kessler -- where do you stand with divestiture of some of the ancillary assets? You mentioned the one joint venture. Is there much else out for sale right now?

We are exploring the opportunity to sell some of those assets as we speak.

Mike Scarangello (ph) with Merrill Lynch.

I just had a follow-up question, Bob, on your comment that you are changing admissions criteria to increase acuity a little bit at the LTACs. Is there any chance that the rule that we're waiting for currently from CMS includes some acuity component of it, either in conjunction with or in lieu of the host hospital criteria that's been discussed?

I would say I doubt it. I would never try to predict what could be in regs. I've recently been surprised by what's been in the regs, so I would say never but I wouldn't think so. I would think that that kind of trend or movement in the industry is probably going to be into 2005 and beyond because there's a lot more work that has to be done on the MedPAC recommendations. MedPAC made some general recommendations which we agreed with, but there has to be a lot of work around that before it could actually find its way into policy and regs. So I doubt it very much, but I wouldn't say never.

Okay, so more preparing for a longer-term trend. Just a quick question on the specialty hospital margins -- they looked pretty good to me. Marty, I was wondering if, on the LTAC side, are we still seeing some margin expansion from PPS and the LTACs or is that all filtered through? How should we think about specialty hospital margins, going forward?

Yes, I think, right now, the margins, as you've said, continue to improve. We think that there's still an opportunity for them to improve some more, given the current reimbursement system, because of the -- two reasons. One is, what we refer to as the maturation pipeline, those hospitals that are zero to three years old are -- those margins are lower than those hospitals that are more mature.

Number two is, as we continue our development, we typically lose about $8 million in EBITDA a year. As we lose that $8 million a year on an never-increasing base, you are going to see the margins expand.

Can you just remind me generally how many hospitals are in the kind of zero to three age?

The zero to three years is about 26 hospitals.

Thanks. Just quickly, the JV that you sold of Kessler, can you remind me what that was?

We had a joint venture with a rehab hospital.

With the Aventis (ph) system in Maryland.

Jerry Doctorow with Legg Mason.

Good morning. I just had a couple of general things and a couple of specifics. Bob, I was curious whether you actually want to comment at all -- and maybe you've already answered this -- on what we might see out of regulations or how the dialogue might be going with CMS at this point.

Well, I really can't comment on -- the comment period closed on July 12 and leading up to that, I can tell you that CMS got a lot of input, a lot of formal comment letters were submitted, a lot of input to CMS. I was told by a couple of sources when I was spending some time in Washington that the LTAC rule was perhaps -- the LTAC proposal was perhaps the most controversial thing in the IPPS rule, which is saying a lot, given the breadth and scope of that IPPS rule. So I know that there was a lot of input, and I suspect that they are working on that, post-July 12, to get a final rule prepared. I really can't say much more about it than that.

Then if I could come back, one of the things that I think you allude to was some of the changes you are making and certainly that we see as -- regardless of how the 25 percent things sort of plays out, there's clearly a policy shift to try and move people to -- I guess what the euphemism in Washington is the lowest-cost appropriate level of care. That seems to be shifting patients out of LTACs, out of rehab, into things like nursing homes, maybe even home care in some settings. I was wondering if you can, given that general context, how do you see sort of your business developing, going forward? Are you in other lines, or does the LTAC business or the in-patient rehab business still have legs on it if the focus is narrowed -- again, as some of your own strategies start suggesting?

First off, on your policy, on your view of the policy, with respect to LTACs, I really don't see that and that is not going on. If you look at the patients that we see in our LTACs at our current level of case-mix index and the diagnosis, these are patients that could not go to a nursing home or to home health or to "a lower-level of care." The only other place where those patients could be would be in an ICU of an acute-care hospital for the most part. So we really don't see any of that and there probably a chance that there's going to be those patients moving there (sic), out of the LTACs. At least with respect to our LTAC hospitals, I would say that that's very remote because, clinically, they can't be seen in those settings that you described.

Now, on the rehab, that's a little bit different, relative to the rehab industry I can speak to as well as Kessler. There is a raging debate going on in the rehab segment about single-joint replacements and whether they are appropriate for a rehab hospital or whether they are appropriate for a skilled nursing or a lower level of care. So what you describe does apply to that industry-wide in rehab. It does not really apply to our rehab assets. Kessler has, relative to the rest the industry, has a very low percentage of those types of patients that are being debated as to where the appropriate level of care for them -- acute rehab or skilled nursing, for example. Kessler has a very strong market position in the spinal-cord injury, head injury and the more higher-acute rehab patients. So, the phenomenon that you describe applies to the rehab industry but not to Kessler and does not apply to the LTAC industry at all, at least relative to our LTACs.

Okay. Maybe this is a slightly different variation but what I'm trying to get it, I mean, this reg obviously is going to happen soon and we will see how it plays out. What I'm trying to get a handle on is what sort of the growth potential of the business is, maybe with and without sort of this implementation. I don't know if you can touch on a matter. Is your -- you see still strong growth here because I guess development slows and you lose that drag, as Marty said, of the -- those cost dollars or do you see potential for a shift to freestanding or other things that sort of continue to drive growth? I mean, you know, none of us know what the feds are going to do about this reg but I'm trying to get a sense of what the sustainable growth rate is for the business kind of with and without that reg maybe popping in.

I will have Marty address it, but let me make this comment -- we think that there is a need for LTAC services. The rule is really -- the proposed rule was really addressing what the appropriate venue, according to the policy that CMS has really put forth in the proposed rule. So if the proposed rule narrows or even eliminates the possibility of doing LTAC hospitals within hospitals in large tertiary or even teaching hospitals, then that doesn't mean necessarily that the growth were over. I think the growth would slow quite dramatically if that happens but for a company like Select, there will still be opportunities because we obviously have the size, the scope, the expertise and the capital to develop freestanding hospitals or go to other venues. So I think that those growth potential (sic) will still be there.

We have not gone out with guidance on growth in a new reg because there's just too many moving parts and until we see the new reg, we can be I think a bit more definitive on that. But I don't think it impacts -- I don't think the proposed rule impacts the need for the service. I think it just impacts really the growth and the development because of the players that are out there.

Okay, that's helpful. Just two tidbits (indiscernible) and get off line but just the total hospital beds at quarter-end and just also ending share count at quarter-end.

The total bed count was 3359. The total share count I think was 106. I think it was 106 -- shares actually outstanding was 101,350,000.

John Park with Blum Capital.

Would you have the cash for operations number for the quarter as well as the CapEx number?

Yes, John, we will get that for you. It's a net cash provided by operations; it's actually a negative $12 million. That was due -- a good portion of that was due to three reasons -- due to third-party payors; we paid about $30.2 million. Income taxes was about $12.3 million, and increase in Accounts Receivable of $29.5 million.

CapEx?

CapEx for the quarter was 11.4 million in purchases, and we actually have proceeds from the sale of $4.8 million, so net cash used in investing activities was about $6.1 million.

Miles Highsmith with Wachovia Securities.

One clarification -- I guess you mentioned the shares at 101.35. First of all, is that in a period or today? Then secondly, I apologize if you touched on this earlier, a question about the 9.5 percent bonds. Any comments as to whether there's still a potential for calling those when they come into the call in June of next year or do you sort of need to wait on the regs before you can make a decision there?

The share count we gave was as of 6/30. With regards to 9.5, it's our full expectation that we will take those out when they are callable.

We do have a follow-up question coming from A.J. Rice with Merrill Lynch.

Hello, everybody. A couple of questions, actually. I know, last year, you guys had said that 53 percent of your referrals in the LTAC business were coming from the host hospital. In this quarter, is that number still fairly consistent or have you moved to change that in any way?

We've not moved to change it and I would say that that number is probably close, A.J. We don't measure it on a quarter-to-quarter basis, but I would say it's probably still close and no, we've not moved to change any of that.

I guess the hard thing about sort of assessing these regs is you get sort of one number that could be a benchmark (indiscernible) proposed rule of 25 percent. There's some discussion about maybe it will be 50 percent initially and then phase down. How easy is it to move that number? Can you just talk a little bit about how, even though we don't know what a number would be, what is the variation among your facilities in terms of what aggregates to a 53 percent number across the portfolio? How easy is it to move the number around by adjusting referral patterns, etc.?

The variation is great. With 80 hospitals, you can assume that it will look something like a bell curve. I mean, we have -- at the ranges, we have some that may get 5 or 6 percent from the host and we have some that may get 90 percent from the host. That number varies greatly to get to 53 -- to get to whatever that 53 or whatever percent, which is an average.

In terms of how easy it is to change or move the number, I wouldn't describe it as that easy. I mean, if we have regs that look something like the proposed reg, then what it's probably going to require in some of -- many of the hospital -- is really to move those to a different venue.

The point is is that you get the patients where the patients are. So the higher-acuity patients that we have tend to come from larger, tertiary hospitals, oftentimes university or teaching hospitals. We have a great number of those in our portfolio of hospitals.

Now, if you take some that are on the margins, say you pick an arbitrary number and say that it's 40 or 50 percent or whatever it is, and we have a cluster of hospitals that are around that, you know, you could maybe do a few things on the margin to affect that a couple of percent, but you're not going to be able to have wholesale changes in a hospital because most of those patients may likely be discharged from that hospital. So, what you're looking at there is probably moving your hospital to a different location and still have your same referral patterns.

That was another question I was going to ask about moving the hospital or something. How easy is that to do, and how quick could you do it if you were to choose to do it?

That varies in every single market. In some markets -- and we have done, over the years -- we don't announce it but over the years, we've moved many of our hospitals. In terms of the physical ability to do it, it's really quite easy. I mean, you establish another location and on the day that your lease is up or the day that you choose, you basically transport the patients that you have -- usually by ambulance -- and you move them into your new space. We've done that for a variety of reasons over the years, sometimes to get to a different location in a community, sometimes because, you know, we had a couple of situations years ago where we were an HCA hospital that sold the hospital and decided to close the hospital, so we had to move across the street or across town. So, that's not necessarily difficult to do.

As you know, our renovation costs to establish a new hospital tend to run in the $5,000 range, so you may have to do renovations in a new space, so that's an average number of what it would cost. Then you can move the license very easily. The actual hospital -- you don't have to get recertified or go through any other provisions other than make sure you have a life safety of the physical plant, and then you move the license of the hospital and all the staff.

You know, I've described that as relatively easy in some circumstances. In other circumstances, it may be quite difficult to move.

The provisions of the lease would allow you to opt out as well?

No, I wouldn't say that. Some leases have -- we try to have leases fairly the same but they all have variations. Some would be easier than others.

Now, also keep in mind that we have -- the average lease cost is between 10 and $12,000 per bed, per year, so you're looking at your overall lease cost maybe 3, $400,000 per year. Now also, we tend to sign five-year leases with one or more five-year extensions, so we don't have lease obligations that go out 15 or 20 years. So, there's probably opportunities, depending again on the market, to negotiate with a landlord. You know, we have some hospitals that frankly over the years that we've been there, would probably have utilization for the space and would probably be very amenable to negotiating a lease exit if we had to move. I mean, if we are in a hospital where we can no longer accept their patients, it's not really in their best interest or ours for us to stay there.

But again, it's easier or harder depending on the market and kind of similar to the -- if you asked me to handicap it, it would probably look a lot like the bell curve. There are going to do those in the middle that will be marginally difficult, some that will be quite easy and some that would be quite difficult.

Just one other area -- on the acquisition front, I know you guys have looked at a lot of things, have been conservative in your pursuit of things. What do you see out there today? Are we likely to see a move forward maybe in any new -- add new legs to the growth story or something?

Well, on the LTAC side right now, A.J., that's nowhere. I mean, there's nothing going on in the LTAC space for the obvious reasons; we are in a period here where we probably have too much uncertainty.

On the outpatient, we haven't really looked at adding a lot. We really want to continue to perhaps develop in markets where we have a pretty good base and a fair amount of market share to continue to support those markets where we are doing well.

The rehab hospitals, yes, there's an opportunity for us. We think we would be happy to add in the rehab area, either by acquisition or development.

In terms of adding another leg to the stool or getting into a different business line, really no consideration of that at the current time.

All right, thanks.

There are no further questions at this time. I would now like to turn the floor back over to Robert Ortenzio:

Thank all of you for your listening in and your interest. Assuming that the proposed rule goes final in the next couple of weeks, we will assess it as quickly as we can and we will get out to the market with the impact to the Company and our plans on a go-forward basis.

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