Select Medical Holdings Corp (SEM) 2009 Q4 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Select Medical Holdings Corporation earnings conference call. My name is Madge, and I will be your coordinator for today. At this time, all participants are in a listen-only mode. Following the prepared remarks, there will be a question-and-answer session. (Operator Instructions) As a reminder, this conference is being recorded for replay purposes.

Before we begin, the Company has asked me to read the following statement. Today's presentation by management contains forward-looking statements within the meaning of the Securities and Exchange Act of 1934. These forward-looking statements represent the Company's present expectations or beliefs concerning future events. The Company cautions that such statements are necessarily based on certain assumptions which are subject to risks and uncertainties, which could cause actual results to differ materially from those indicated today.

These risk factors include changes in general economic conditions, recent geopolitical events and price competition, work stoppages and slowdown, exchange rate fluctuations, variations in the mix of products sold, fluctuation in the effect tax rates resulting from shifts and sources of income, and the ability to successfully integrate and operate accurate businesses. Further information on these risk factors is included in the Company's filings with the Securities and Exchange Commission.

I would now like to turn the presentation over to Mr. Robert Ortenzio, CEO of Select Medical. Please proceed, sir.

Thank you. Good morning, everyone, and thanks for joining us for Select Medical Holdings' fourth-quarter and full-year earnings conference call for 2009. For our prepared remarks, I will provide some overall highlights for the Company in our operating divisions. And then I'll ask Marty Jackson, our Chief Financial Officer, to go over some additional financial details before opening the call up for questions.

Net revenue for the fourth quarter increased 4.8% to $473.5 million compared to the same quarter last year. For the full year, net revenues increased 4% to $2.4 billion compared to the previous year. For both the fourth quarter and the full year, we generated approximately 70% of our revenues from our Specialty Hospital segment, which includes both our long-term acute care and our inpatient rehabilitation hospitals; and 30% from our Outpatient Rehabilitation segment.

Specialty Hospital net revenue for the fourth quarter increased 4.6% to $401.4 million compared to the same quarter last year. This increase was driven by both volume and pricing increases. In the fourth quarter, admissions increased 6%, patient days increased 3.4%, and net revenue per patient day was up 1.3% compared to the same quarter last year.

The increase in volume was driven by both increases in our same-store hospitals, as well as hospitals added in 2008 and 2009. Our same-store hospitals experienced 3.9% growth in admissions and a 1.4% increase in patient days compared to the same quarter last year.

For the full year, Specialty Hospital net revenue increased 4.7% to $1.56 billion compared to the previous year. This increase was driven by both volume and pricing increases. Admissions increased 3.6%, patient days increased 1%, and net revenue per patient day was up 3.7% compared to the previous year. Volume increases were the result of increases in our hospitals added in 2008 and 2009.

Net revenue in our Outpatient Rehab segment for the fourth quarter increased 5.4% to $172.1 million compared to the same quarter last year. This increase resulted from additional revenue in our contract services business, a 1.2% increase in our clinic visit volumes, and a 1% increase in our revenue per visit in our clinics compared to the same quarter last year.

For the full year, Outpatient Rehab net revenue increased 2.6% to $681.9 million compared to the previous year. Increases in our contract services business was a driving factor behind the increase, more than offsetting a 0.7% reduction in our clinic-based revenues, which was visit volume driven compared to the previous year.

Overall adjusted EBITDA for the fourth quarter increased 14.9% to $87.9 million compared to the same quarter last year, with an overall adjusted EBITDA margin at 15.3% for the fourth quarter compared to 14% margins for the same quarter last year. For the full year, overall adjusted EBITDA increased 22.2% to $330.2 million compared to the previous year. Adjusted EBITDA margins for the year were 14.7% compared to 12.6% in the previous year.

Specialty Hospital adjusted EBITDA for the fourth quarter increased 13.8% to $78.2 million compared to $68.8 million in the same quarter last year. Adjusted EBITDA margins for the Specialty Hospital segment increased 160 basis points to 19.5% compared to the same quarter last year. The majority of the growth in the adjusted EBITDA and margin for the segment was a result of the financial improvement of hospitals added in 2008.

For the full year, Specialty Hospital adjusted EBITDA increased 22.8% to $290.4 million compared to the previous year. Adjusted EBITDA margins were 18.6% for the year compared to 15.9% in the prior year. The adjusted EBITDA improvement was the result of both the adjusted EBITDA contribution from the new hospitals opened and acquired in 2008, and improvements in our same-store hospitals.

The new hospitals added in 2009 had adjusted EBITDA losses of less than $200,000 in 2009, compared to losses of $25 million last year. Our same-store hospitals adjusted EBITDA improved by $31.1 million compared to last year, as they benefited from increased revenue due to severity of Medicare cases we cared for, while at the same time controlling costs of those higher severity cases.

Outpatient Rehab adjusted EBITDA for the fourth quarter increased 26.8% to $21.6 million compared to $17 million in the same quarter last year. Adjusted EBITDA margins for the outpatient segment improved 210 basis points to 12.5% compared to the same quarter last year. The improvement in the quarter was driven by improvements in both our contract services and the clinic businesses.

For the full year, outpatient adjusted EBITDA increased 15.3% to $89.1 compared to last year. Adjusted EBITDA margins for the outpatient segment improved 150 basis points to 13.1% in 2009. The growth in adjusted EBITDA was primarily the result of growth in our contract services business, as well as some incremental contribution from our clinic-based business.

Earnings per fully diluted share were $0.19 in the fourth quarter and $0.61 for the full year. After adjusting for one-time gains and losses from the early retirement of debt and one-time expenditures related to the initial public offering, earnings per fully diluted share would have been $0.20 for the fourth quarter and $0.67 for the full year.

As we previously announced on December 8, Select closed on its second rehab joint venture arrangement with SSM Health Care in St. Louis. The partnership with SSM includes 80 inpatient rehab beds, 33 outpatient physical therapy clinics, 3 occupational medicine clinics, and contract and on-site rehab services. The joint venture is progressing as planned, and we are excited about the partnership with SSM.

As many of you know, The New York Times recently published a story about Select Medical in the LTAC industry. As we said at this time, the story was misleading and incorrect on many points. In the wake of the article, we have communicated extensively with our business partners, our host hospitals, our CEOs and our medical directors. Their support, I'm glad to say, has been strong and unwavering, and we have not experienced any negative effect on our operations.

I've gotten a number of questions the past weeks about the prospect of an extension of the 2007 MMSEA legislation. I would remind everyone that the law passed in 2007 was a balanced public policy with provisions to address issues of concern to both federal regulators and the industry.

In other words, it was not a windfall for the LTAC industry. Besides the moratorium, there were provisions which authorized CMS to conduct aggressive medical audits and to further development of certification criteria for LTAC hospitals.

Yes, we would like to see Congress extend the MMSEA legislation of 2007, not necessarily because it is a windfall for the LTAC hospitals, but because it provided us with a level of regulatory certainty. The MMSEA extension was included in both the Senate health reform bill and the Baucus-Grassley jobs bill, but given the current situation on Capitol Hill, it is difficult to predict what and when Congress might take action.

I will now turn this over to Marty Jackson, our Chief Financial Officer, to cover some additional financial highlights for the quarter.

Thanks, Bob. Good morning, everyone. Our operating expenses which include our cost of service, general and administrative costs, and bad debt expense, in the fourth quarter increased 3.2% to $486 million compared to the same quarter last year. As a percentage of our net revenue, operating expenses for the quarter was 84.7% compared to 86.1% in the same quarter last year.

For the full year, operating expenses were 86.3% of revenue compared to 87.6% in the prior year. Excluding $22 billion in one-time IPO related compensation costs included in our general and administrative costs line item during the year, operating expenses would have been 85.3% of revenue for the year. This represents a 230 basis point improvement on a year-over-year basis.

Cost of services increased 4% to $466.7 million for the quarter. As a percentage of net revenue, cost of services was 81.4% for the fourth quarter compared to 82% in the same quarter last year. For the full year, cost of services as a percent of revenue was 81.3% compared to 83.2% in the prior year.

G&A was $12.1 million in the fourth quarter, which as a percent of net revenue was 2.1% compared to 1.8% for the same quarter last year. For the full year, G&A as a percent of revenue was 3.2% compared to 2.2% in the prior year. Excluding the $22 million in one-time IPO compensation related costs, G&A as a percent would have been 2.3% for the year.

Bad debt as a percent of net revenue was 1.3% for the fourth quarter compared to 2.3% in the same quarter last year. For the full year, bad debt expense as a percent of net revenue was 1.8% compared to 2.2% in the prior year.

We realized significant cash collections for receivables over 180 days in the fourth quarter, which obviously had a positive impact on our bad debt accruals. It's important to note that we continue to utilize the same methodology for the bad debt calculation since the early days of the Company over a decade ago.

As Bob mentioned, total adjusted EBITDA was $87.9 million for the fourth quarter, and adjusted EBITDA margins were 15.3%, compared to the adjusted EBITDA of $76.5 million and 14% adjusted EBITDA margins in the same quarter last year. For the full year, adjusted EBITDA was $330.2 million and adjusted EBITDA margins were 14.7% compared to adjusted EBITDA of $270.3 million and 12.6% adjusted EBITDA margins in the prior year.

Depreciation and amortization expense was $17.6 million in the fourth quarter, down from $18.6 million in the same quarter last year. For the full year, depreciation and amortization was $71 million compared to $71.8 million in the prior year.

Net interest expense was $30.7 million in the fourth quarter, down from $36.1 million in the same quarter last year. The reduction in interest expense was the result of lower debt levels during this quarter. For the year, net interest expense was $132.4 million compared to $145.4 million in the previous year.

The Company recorded a one-time loss of $2.9 million on the early retirement of debt in the fourth quarter related to the write-down of deferred financing costs due to the prepayment of term loans associated with the proceeds from the IPO.

The Company recorded income tax expense of $4.4 million in the fourth quarter and $37.5 million for the full year. This represented a tax rate significantly lower than our statutory rate, principally due to tax refunds and associated interest we received in the fourth quarter related to the resolution of federal tax returns from prior to the leverage buyout.

Net income attributable to Select Medical Holdings was $29.9 million in the fourth quarter, and fully diluted earnings per share were $0.19. For the full year, net income attributable to Select Medical Holdings was $75.3 million, which after deducting deferred stock dividends produced fully diluted earnings per share of $0.61.

Excluding the effects of the one-time events related to the IPO, and gains and losses on the early retirement of debt and the estimated tax effects of both, earnings per fully diluted both would have been $0.20 for the quarter and $0.67 for the year.

Assuming a normalized tax rate of 42% and adjusting for the one-time expenditures related to the IPO and the gains and losses on debt retirement, fully diluted EPS would have been $0.14 for the quarter and $0.55 for the full year.

We ended the quarter with $1.4 billion of debt outstanding and $83.7 million of cash on the balance sheet. During the fourth quarter, we made mandatory repayments of $156.3 million and an additional $12.1 million voluntary prepayments on the term loan portion of your credit facility. And we also paid $90 million outstanding on our revolving facility.

Operating activities provided $72.2 million of cash flow for the quarter and $165.6 million for the full year ended December 31, 2009. Days sales outstanding was 49 days at the end of the year compared to 53 days at December 31, 2008.

Investing activities used $43.6 million of cash flow for the fourth quarter, which included $21 million in acquisition-related payments for the SSM joint venture. For the full year, investing activities used $77.9 million of cash flow, including $57.9 million for the purchases of property and equipment.

Financing activities used $225.4 million of cash for the fourth quarter and $68.3 million of cash flow for the year. The primary activities related to the financing cash flows were the result of the IPO and the use of proceeds of those.

I also wanted to reaffirm the financial guidance for the Company previously included in the 8-K filed on January 11 with the SEC. The guidance includes expectations for net revenue of $2.38 billion to $2.42 billion, adjusted EBITDA of $360 million to $370 million, capital spending of $50 million to $60 million, and free cash flow of $120 million.

That concludes our prepared remarks, and we would like to ask the operator to open up the call for questions.

Thank you, sir. (Operator Instructions) Frank Morgan, RBC Capital Markets.

Two questions. First, on the bad debt, obviously you noted the change there year-over-year. I was wondering if you could, in light of some of those changes, could you comment about where you think that trends out over the course of 2010, in terms of a percentage of revenue?

Then secondly -- this is a good question for Bob -- any thoughts about the current environment, be it the MMSEA extension or the apparent lack of healthcare reform, any impact that might have on your overall JV strategy? Does it help you or hurt you? And just any other comments you've got about your JVs and the prospects over the near-term. Thanks.

Yes, Frank, why don't I take your first question referring to the bad debt. We anticipate that bad debt is going to run probably somewhere in the neighborhood of 2%, 2% or less. So when we take a look at 2010, I'm pretty sure all of you analysts are at the 2% range. We think that that is a good number.

Okay. Frank, on the healthcare reform, I guess for everybody that is on this call that makes their living following healthcare companies, the last couple weeks, the last month has been a wild ride, particularly post the Massachusetts senatorial election. And everything is really up in the air and has some uncertainty to it.

As it directly impacts our business, I don't see the near-term healthcare reform initiatives, whatever they might be, having a direct impact. There is obviously some things that are going on for some extensions. The MMSEA 2007 extension is but one of those. There is the doc fix and a lot of other things that will have some impact, although I can't imagine -- for our company it will not have, and we've said before not a material impact.

The JV strategy I think will be unaffected by that, because I think that the drivers that initiate some of the large systems that we are dealing with to enter into discussions to joint venture, as did SSM or Penn State Hershey Medical Center, really stand outside of those kind of broader healthcare reform initiatives that they might be.

So I am encouraged that we still have a good model with the joint ventures. An update would be that, as you know, we closed SSM and that operation is going well. We have a couple in the pipeline that we are working on, and I'm still optimistic that we are going to get another one this year as we projected, and we are working diligently on those.

Okay, thanks.

Whit Mayo, Robert W. Baird.

Thanks. Just want to go back to the bad debt for a second. Can you maybe, Marty, comment a little bit on what happened in the quarter, whether or not that was just cleaning up some old AR, just trying to reconcile that?

Yes, what has occurred is we actually did a very good job collecting cash for receivables over 180 days. I think it is very important to note that the methodology that we use for determining our bad debt requirements, the accrual for our bad debt requirements, have been the same pretty much since the inception of the Company.

So, in essence, we've dealt with a couple of managed care entities where we have cleaned a lot of the old AR up, and that is really the reason why you see that low bad debt.

Okay, that is helpful. And maybe just one random question. I know there are several balls in the air right now, but how do you reconcile the risk right now with the expiration of the physician fix in March and whether it is extending the moratorium, or just maybe on your outpatient business in general? I know it is a broad and large topic; just wanted to hear your thoughts, Bob or Marty, with regards to that.

You know, the moratorium for the extension for the LTACs recall that the 2007 legislation goes through the end of December of 2010. So if you look toward Washington and you forced rank the urgency of getting some things done, ours is probably not the top of the list.

Now, having said that, we were in the Baucus-Grassley bill; we were in the Senate finance bill; we were in the healthcare reform bill. It has not been necessarily a controversial piece of legislation because, number one, it is budget neutral; and number one, it's sound policy both on the side of the regulators and for the industry.

Now, as to the prospect of getting the other things done. The biggest one that I think most people are aware of are the doc fix, but in that doc fix, extensions historically have been other extensions of favorable reimbursement policy.

And this is just a personal view on my part is I don't know how the doc fix does not get done. I mean that is a very big cliff for physician payments, and I think that it has to get done -- I mean when it gets done. I believe there has been some precedent for getting it done and making it past the deadline and making it retroactive to the time of the deadline.

So I personally believe that there will be some healthcare legislation that will move when Congress reconvenes next week. Whether the healthcare things come through tax extenders or whether they come through a healthcare reform bill or whether they come out of Senate Finance, I am not sure. I am not sure anybody knows at this point, but I think something will move. And I think the one -- and again, I am not an expert in this area, but I think the one that has the biggest -- one of the biggest priorities is the doc fix.

Whit, as you know, on the outpatient side with regards to the doc fix, our PT -- our clinics are paid on the physician fee schedule. I think everyone understands that on the outpatient side, Medicare represents less than 10% of our overall business. So we have actually gone through and calculated what the potential impact would be. And we anticipate on a quarterly basis, it would be somewhere in the neighborhood of $2 million to $2.5 million.

Okay, $2 million to $2.5 million. And maybe just two housekeeping items. Marty, do you have what the same-store revenue dollar amount was for the quarter and the prior year? And also maybe an idea for what a good go-forward deferred financing expense number would be?

Just to make sure I understand the question, Whit, you are looking for the same-store --?

Yes, the same-store -- just the revenue, the dollar amount?

Yes, for Q4 '09, obviously we are at $573.5 million. For Q4 of '08, we are at $547 million.

Okay. And then deferred financing, any good idea for what a full-year number could be there now?

At this point in time, Whit -- I will catch up with you later. No, we don't have that right now.

That's fine, we'll take that offline. Thanks a lot, guys.

Kevin Fischbeck, Bank of America Merrill Lynch.

Okay, thank you. Looks like the non-same-store facilities were a slight loss in Q4 compared to like a $1.3 million positive in Q3. Can you talk about that sequential decline? Was that just the hospital you opened up in Q4?

Kevin, could you repeat that question? We are not sure we understand it.

So in the reconciliation of EBITDA, you guys talk about -- you show your same-store EBITDA number, you show Specialty Hospitals in development opened since 2008 as being a loss of about $460,000 in the quarter. And when I look back at the Q3 results, it was a $1.2 million EBITDA positive.

So I just wanted to see what sequentially why that group assets would have swung from a positive to a negative? I know you opened up -- I think you opened up a facility in Q4; wanted to see if that was it or whether there was something else going on.

Kevin, we are going to have to get back to you. The only thing we can think of is that we had an additional opening. But I will get back to you on that question.

Okay. And the admissions continued to ramp up sequentially, but were a little bit weaker than I guess I had in my model anyway. I was just wondering if you could give a little color there about how you think the admissions are ramping up on your assets versus your internal plan; any color there?

Yes, I think as far as the admissions were concerned, we were pleased with the year-over-year change. They were a little bit lighter than we thought. But as we indicated, we are very comfortable with the expectations moving forward.

Okay. And you mentioned that the Contract Therapy business was strong in the quarter. Do you have any thoughts there about what the impact of RUG IV or the current therapy might have on that business if, in fact, it does get implemented in Q4 this year?

We have looked kind of tentatively at that. There is still some question of exactly how that is going to impact, particularly because of the way our contracts are scheduled or structured. So we think that it would have -- will be an impact, but we don't think it would be a material impact on that business.

Okay. And you mentioned that $2 million, $2.5 million impact of the doc fix on the therapy business. That is just the physician rates being cut, right? Do you have a sense of what, if the therapy caps are not extended, how much that might impact the --?

Yes, for the most part, the therapy caps really are not impacting us. If you take a look at the number of visits per new patient, Kevin, it's really like 9, 10 visits. Average Medicare rate is a little bit less than the $102 that we are reporting on a net revenue per visit basis. So it doesn't get close to the $1800.

Okay, great. And then I get the last question here. For the first few quarters of the year, you guys have been showing some pretty significant year-over-year improvement in the cost of services line; Q4 down 60 basis points of what is obviously a much more difficult comp. Should we be thinking about that Q4 improvement as the improvement we should be looking for for the first three quarters of 2010? Is that kind of how to be thinking about cost of services going forward?

Yes, I think the time we did the IPO, we talked about the changes that we made in the first of the year. And I think what you are going to see is the comps are going to be -- you are not going to see the 200 plus basis point improvements anymore. It's going to be -- I think it is going to still be double-digit, but you are not going to seek triple-digit expansion of the EBITDA margins.

All right. Could you just review kind of what the biggest driver to that improvement is? Is it still just the ramp-up in the newly opened facilities or is there anything else that you would point to as --?

Well, the SW&B is another -- is the other area, improvement in the SW&B.

Okay, great, thanks.

Thanks, Kevin.

Gary Lieberman, Wells Fargo.

Thanks, good morning. You talked about the acuity being strong in the Specialty Hospital business in the quarter. Can you comment on that? Was that driven by company policy marketing, or was that just a function of something else?

Yes, typically we would see in the fourth quarter, because your winter months, you are going to have more of the respiratory ventilator type patients that are the higher acuity patients. So I think some of that is seasonal, and some of that us gravitating more toward programmatically those types of patients in many of our hospitals, particularly the ones that are newly opened that are maturing, the ones from 2007. So I would say the combination of those two factors.

Okay, thank you.

Shelley Gnall, Goldman Sachs.

Hi, thank you. I guess just one quick follow-up to that last question. Did flu contribute any meaningful upside to admissions in the fourth quarter, especially at the respiratory admissions?

The flu always has an impact on the winter months in our Specialty Hospital business. There was some talk some months ago whether the H1N1, because of the severity of that flu and often manifesting itself in very significant respiratory conditions. And I can't report that we have seen a meaningful amount of that.

But the flu is always a contributor to winter census, particularly in the LTAC hospitals. But anything that is out of the ordinary this year because of the flu, I would say probably not.

Because I think one of the questions that we had was with this strain of H1N1, while I think the bulk of patients weren't as severely ill, those that were more likely to need ventilator assistance than in prior flu seasons. But are you saying that did not have a meaningful impact on your admissions trends?

I would say, yes, it did not have a meaningful impact. I can't tell you that on a one-off because any time we would admit someone with the H1N1, it triggers a lot of other isolation and some other things. So we track that pretty closely, and we had some of that. But the characterization -- you could not characterize that as being a meaningful to the overall operations this flu season.

Okay, understood. Thanks. And then on the Specialty Hospital segment, wondering if you would be willing to give us an update on occupancy for those hospitals that have been opened in 2008 and 2009? I need sort of rough estimate of the occupancy, because those EBITDA margins were very good.

Yes, Shelley, with regards to occupancy what we have typically done and we are going to continue to do is really give just give overall occupancy, which you know is 67%.

Okay, maybe another way to ask my question. On the EBITDA margins for the Specialty segment, that was quite good. In your view, is there room to improve that margin going forward, or has it been maxed out here? And should we expect EBITDA growth going forward really to come from the top line and M&A activity?

No, I think you will continue to see EBITDA growth and margin expansion as those 2008 new hospitals really get into the positive generation of EBITDA.

Okay, great. Thank you.

Doug Simpson, Morgan Stanley.

Good morning, everyone. Marty, maybe if you could just talk a little bit about it looks like the year-over-year lift in the outpatient margins picked up a little bit in the quarter. I think it ran about 210 bps versus about 150 for the entire year.

Could you just update us on the convergence between the legacy select Kessler and HealthSouth assets; kind of where that stands and where do you see that progressing over the next 12 months and what are really the drivers behind that?

Yes, Doug, as we talked about when we were on the roadshow, there was at least a 500 basis points difference between our legacy PT clinics and the old HealthSouth clinics. And we are starting to see some improvement in that area, and that is one of the reasons why you see the margins continuing to get better.

Is there any --?

And we expect that over the next two years, as we reported on the roadshow, to see those margin gaps be reduced.

Okay. And then just given all of the snow that we have all had to deal with, anything we need to worry about with Q1 weather? Any impact on activity at those facilities in the Philly, New Jersey markets?

I mean, absolutely. That is going to be an issue. I can't quantify it at this time. But we have clinics -- our biggest concentration of clinics is Philadelphia and South Jersey, North Jersey around Kessler. We have operations in Maryland. We have not quantified it and at this point, I would not be in a position to tell you that it would have an impact on the quarter, because obviously as a large company, we have business coming from lots of different sources.

So whether the reduction in revenue that we will see as a result of the weather, which will surely be there, could potentially be made up in other segments of our business. And there also is a phenomenon where sometimes you do, after the weather, you do get some pick-up. And I would note that one of the major storms that we had here in the Northeast came on a weekend, which was frankly very helpful for us.

Another one of the storms came right in the workweek, and that will have an impact on our volumes, particularly where it hit because of the concentration of clinics that we have. But we will do our best to quantify that and make sure we report it.

Doug, I can tell you in speaking to the operators, they are very focused on getting those patients rescheduled and back into the clinic.

Right, right. Usually just delays them, right?

That is correct.

Right, okay. And then just maybe -- you talked a little bit about this earlier, but it sounds like you are optimistic on the pipeline for this year on the JV side. Can you just talk to us about what are you hearing out in the market from potential JV partners as well as maybe small tuck-in type M&A candidates, given what is going on with the economy? Any change in their interest level in talking with you in the last six months?

No, I can't characterize it as a change. Because the systems that we have targeted for our rehab strategy are very significant and very stable operations. So I can't tell you that there has been a change driven by the general economic conditions that are out there. But I would tell you that those elements that are motivating -- that might motivate those large systems are every bit as strong today as they were two or three months ago or four or five months ago when you told you this was an important strategy.

But overall from the Company -- and I really see this as I spend more time, and I was out in St. Louis this week and look at these operations -- I am more convinced than ever that it is the right strategy and it is a sound strategy to have our rehab operations integrated with a partner which is a large system. So I am even more committed to the strategy.

And as I have said before, it is difficult to predict when these things move forward to completion. I mean they never get done as quickly as you would like them to get done. But I would tell you that in my mind, they are worth the continuing focus, even if they take longer than you would expect.

And on the clinic side, obviously that area went under a lot of change in the -- over the last five years with the HealthSouth issues. You had a lot of people strike out on their own. Is there any rebound to be expected there? Are there people out there who struck out on their own and now are thinking about moving back under a larger umbrella? Anything you are seeing there?

Well, I can only comment anecdotally, but I would say that a recent classic rollup strategy of PT clinics, I think, is a strategy that is unwinding a little bit and is struggling, particularly as we'd see in any businesses, those that were highly leveraged. So I think some of those might be weaker because they don't have the platform, the systems, the leverage and the economies that we have.

Having said that, there are small regional players that continue to do well in local markets. In terms of your question, and I think it is whether therapists will be more willing to work in a environment such as ours as opposed to being on their own, I can't say that I have seen that change a lot.

But I tell you what we have seen change a little bit was we talked I know a year ago about physicians going in-house with therapy. And I think that that was a big threat to the business and had a meaningful impact on the business two years ago and even a year ago. And we have seen that phenomenon, either because those that have done it are going to do it and those aren't, but we don't see that as much as we used to. There is still some of it, but there is not as much as we used to.

Okay. All right, thank you.

Miles Highsmith, RBC.

Good morning, guys. Bob, just on that last comment. Can you maybe expound just a little bit on why you believe we are seeing less of the doctors going in-house on the clinic side?

Well, again, I will preface my remarks by saying it is anecdotal. Typically, to make those physician in-house deals work, you had to have I think a meaningful size, typically orthopedic, practice. So it could be that most of the larger ones that were going to do it have already done it over the last couple of years, and there is just fewer of those larger practices around that are going to do it. That could be one reason.

The other reason is again anecdotally, after you are in this business or the physicians get in the business expecting to generate large relatively easy margins, find that running, billing, collecting, staffing the business is more difficult than what they thought. And they also see just by definition patient -- what we call patient leakage, just because the clinics may not be in locations that are convenient for patients to return post their surgical procedures.

So I think that that could be another reason, the difficulty of actually running the business and difficulty of keeping the volumes up and being as profitable as they thought they were.

Okay, great. Just staying with that for a couple seconds, kind of following on some earlier questions. It sounds like in terms of having the right therapist and the right PT, the right processes, et cetera, from the time when you were acquiring HealthSouth to sort of working through some of that and the ensuing years that you are pretty well there at that point; is that right?

Miles, we still have a ways to go, I think. One of the things we are doing is we've got to have therapists that are focused on not only just providing clinical care to the patients but also generating business. And I know the operators are going through and they have been going through this over the past year to make the necessary modifications. I don't want to tell you that that is completely done yet.

I would echo that and say that we continue to think that there is opportunity to the upside on our clinic business in that what we call the former HealthSouth clinics, that they have been a great addition to the Company. They are fully integrated with our operations at this point. But as we look at the business from 10,000 feet, we think that there's still opportunities for margin improvement.

Okay, great. Just a couple more. Sticking with outpatient rehab, seeing that contract services has been kind of a driver, can you just remind us -- kind of parse out what proportion of the business is traditional standard outpatient rehab and what is coming from contract right now?

Hold on one second. Miles, it is about -- it is a little bit north of 20% of the business.

Okay, great. Great, last one from me. Marty, as you kind of look at the capital structure and potentially paying down some debt going forward with free cash flow as well, you have got some bonds that are trading a lot better but your bank debt is pretty cheap too. Any thoughts on what you can buy in terms of bonds in the open market or restricted pay permissibility?

You know, Miles, our expectation is that we will continue to pay down debt. Now having said that, we are always taking a look at potential acquisitions. So to the extent an acquisition that comes along that meets our criteria, we will do that and we will use excess cash flow to do that. Otherwise, we will be paying down debt.

Thanks a lot, guys.

Elie Radinsky, Summit Securities Group.

First of all, congratulations on the very good quarter. When you look at the outpatient rehab business, and a lot of people have been focusing on this, it appears that it has more than stabilized and now is increasing despite having a much more difficult employment environment with unemployment up.

The thought is over the next couple of years if we were to see that the unemployment numbers start declining, and declining meaningfully, what should we be expecting from this business? I mean can margins move up? Do you have any ratios that with a 100 basis points decline in the unemployment rate, that should be impacting the outpatient business by X percent?

Elie, we haven't really done any correlation between the unemployment and expected volume. I think Bob has been using the word anecdotally. I can tell you that to the extent that the unemployment rate goes down, we have seen increases in volume. But as far as specifics, we haven't done that.

And I would also then say that in terms of staffing, even though we have high unemployment, I will tell you that there is still a pretty significant shortage of physical therapists. And while we have seen the -- I think across-the-board in healthcare you have seen some softness in SW&B because of unemployment, we have not benefited from that on the outpatient side that we have been able to see. Because there is still a significant shortage of physical therapists who really are able to work in a variety of healthcare settings. So we probably -- that is a reality of that business that I don't see abating.

Okay. In regards to the New York Times article, I know that you came out and said that many things in that article was misleading, and I believe some of that was also quite dated. Is there going to be any sort of a formal response that you are going to have to clarify some of the issues?

Yes. Probably over the next week or so, we will be posting some more information that I would -- I'm going to characterize as more educational and clarifying on some of the things that we just thought were inaccurate, particularly in terms of the amount of scrutiny that LTAC hospitals get, a little bit more color and specifically of how physicians are employed, and some things on reimbursement and audits and so forth.

So we do plan to have more information that I'm going to characterize at this point as educational, but it is clearly -- that the article was certainly a catalyst.

Excellent. And the last thing, can you just go over your capital structure, how much do you have outstanding on your term loans as well as your other debt? I know the total is $1.4 billion.

Sure. I think the bank debt, I'm speaking off the top of my head, is $483 million, and that is really between the term loan B and term loan B1. There is about $611 million associated with the senior subs at the opco level. And then there is about -- a little bit north of $300 million at the holdco level.

Excellent. Well, thank you very much.

Having no further questions, I will turn it back to management for any final comments.

I don't have any final comments, but I want to thank you all for participating and asking your questions. We will look forward to reporting to you again after the next quarter.

Thank you for participation in today's conference. This concludes the presentation. You may now disconnect. Good day.