Select Medical Holdings Corp (SEM) 2010 Q3 法說會逐字稿

Good morning, and thank you for joining us today for Select Medical Holdings Corporation's earnings conference call to discuss the third quarter 2010 results. Speaking today are the Company's CEO, Robert Ortenzio, and the Company's Executive Vice President and Chief Financial Officer, Martin Jackson. Management will give you an overview of the quarter highlights and then open the call for questions.

Before we get started, we would like to remind you that this conference call may contain forward-looking statements regarding future events or the future financial performance of the Company, including without limitation, statements regarding operating results, growth opportunities, and other statements that refer to Select's plans, expectations, strategies, intentions, and beliefs. These forward-looking statements are based on the information available to Management of Select Medical today, and the Company assumes no obligation to update these statements as circumstances change.

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

Good morning, everyone, and thank you for joining us for Select Medical Holdings' third-quarter conference call for 2010. For our prepared remarks I'll provide some overall highlights for the Company and our Operating Divisions, and then I'll ask Marty Jackson, our CFO, to provide some additional financial details before opening the call for questions.

Earnings per diluted share was $0.05 for the third quarter compared to a reported loss per share in the same quarter last year of $0.09 and earnings of $0.09 per share on an adjusted basis in the same quarter last year.

Net revenue for the third quarter increased 7.8% to $588.3 million compared to the same quarter last year. We generated approximately 71% of our revenues from our Specialty Hospital segment, which includes both our long-term acute care hospitals and inpatient rehab hospitals, and 29% from our Outpatient Rehabilitation segment, which includes both our outpatient clinics and contract services.

Net revenue in our Specialty Hospitals for the third quarter increased 11.4% to $419.8 million compared to the same quarter last year. The increase was primarily the result of the hospitals we acquired in 2009 and 2010, which accounted for 74% of the revenue increase. The remaining increase in our same-store hospitals was primarily the result of increases in our patient days, which were up for the same-store hospitals by 2.4% compared to the same quarter last year.

Overall occupancy rates were 65% in both the third quarter this year and the same quarter last year. Net revenue per patient day was stable in the third quarter at $1,478 compared to $1,479 per patient day in the same quarter last year.

Our growth in volume in the Specialty Hospital segment, excluding the affects of the Regency Hospitals, fell almost 5% short of our expectations in the third quarter or approximately 13,400 patient days. Had we achieved our volume expectations we would have realized close to $20 million in additional net revenue and approximately $10 million in adjusted EBITDA which translates to $0.04 per share.

Approximately 80% of our shortfall to plan was concentrated among 15 hospitals and centered around three identifiable issues. First, certain facilities that relocated or need to be relocated to new hospitals, physician coverage issues or physician recruitment issues in specific markets and new competition in several markets.

Net revenue in our Outpatient Rehab segment for the third quarter was basically flat at $168.4 million compared to the same quarter last year. Revenue in our clinic based business increased as our patient visits grew by 1.6% in the quarter compared to the same quarter last year, while rate remained stable at $101 per visit in both the third quarter this year and last.

The former HealthSouth clinics continue to improve their margins. The increase in the clinic business was offset by a decline in our contract service business in the third quarter when compared to the same quarter last year. This decline, though, was a result of a termination of a large contract. During the third quarter approximately 69% of our outpatient revenue came from our own clinics and 31% from our contract services and managed clinics.

Overall adjusted EBITDA for the third quarter declined by 18.6% to $59.4 million compared to the same quarter last year, with overall adjusted EBITDA margins at 10.1% for the third quarter compared to 13.4% margins for the same quarter last year.

Specialty Hospital adjusted EBITDA for the third quarter declined by 9.5% to $58.3 million compared to $64.4 million in the same quarter last year. Adjusted EBITDA margins for the Specialty Hospital segment declined 320 basis points to 13.9% compared to 17.1% in the same quarter last year.

The results of the hospitals acquired from Regency were included in the results of our Specialty Hospitals beginning with the close of the acquisition on September 1, 2010. The Regency Hospitals contributed an overall $1.3 million adjusted EBITDA loss for the month of September. Excluding the results of the Regency Hospitals in September adjusted EBITDA margins would have been 15% for the Specialty Hospital segment in the third quarter.

For our same-store hospitals or those hospitals opened and operated by us prior to January 1, 2009, adjusted EBITDA margins declined 200 basis points to 15.7% in the third quarter compared to 17.7% in the same quarter last year.

The primary reason for the decline was the result of increased operating costs in these hospitals. Our labor costs or salary, wages, and benefits in our same-store hospitals increased over 150 basis points in the third quarter compared to the same quarter last year. The increase in labor costs was primarily due to increased patient care hours that resulted from higher acuity patient population during the quarter, as well as a $4 million charge due to an increase in our workers compensation program costs in the third quarter.

Our other operating costs in our same-store hospitals increased over 80 basis points in the third quarter compared to the same quarter last year. The increase in other operating costs was caused by increasing onsite physician services at certain hospitals, increased equipment leasing costs, and increased purchases of minor equipment and supplies during the quarter. These increases were partially offset by a reduction in our bad debt expense at these hospitals.

Outpatient Rehabilitation adjusted EBITDA for the third quarter declined 2.7% to $20.3 million compared to $20.9 million in the same quarter last year. Adjusted EBITDA margins for the outpatient segment declined by 30 basis points to 12.1% in the third quarter compared to 12.4% in the same quarter last year. The decline in both the adjusted EBITDA and adjusted EBITDA margin in the outpatient segment in the third quarter was primarily the result of the loss of the large therapy services contract I mentioned previously.

I also want to provide some updates since our last quarter. As you are aware, we closed on the Regency Hospital acquisition on September 1st. We've made a lot of progress on the integration of Regency Hospital into select systems and processes. We expected to have a transition in severance expense, along with this transaction, which we did incur. We expect them to provide a positive contribution in the fourth quarter.

The proposed joint venture for rehabilitation services with the Baylor Health System is still awaiting necessary regulatory approvals and will close once those are received.

On November 2nd CMS announced that it would be adopting a multiple procedure payment reduction policy for outpatient therapy services effective January 1, 2011. The MPPR will reduce payments where multiple services are provided during a single visit. The reduction was originally proposed to cut the practice expense by approximately 50% for multiple procedures in the same visit. The final rule will reduce the practice expense component by 25% for the second and any subsequent procedures provided during a single visit. We estimate the rule will result in an approximate $5 million annual reduction to our outpatient net revenue.

And, now, I'll turn it over to Marty Jackson, our Chief Financial Officer, to cover some additional financial highlights for the quarter.

Thanks, Bob.

Our operating expenses, which include our cost of service, general and administrative costs, and bad debt expense in the third quarter, increased 6.9% to $529.3 million compared to the same quarter last year. As a percentage of our net revenue, operating expenses for the quarter were 90% compared to 90.8% in the same quarter last year.

Cost of services increased 11.2% to $498.7 million for the third quarter. As a percent of net revenue cost of services was 84.8% for the third quarter compared to 82.3% in the same quarter last year. The primary driver behind this increase was the result of the increased operating costs in our Specialty Hospitals that Bob had previously mentioned.

G&A expense was $19.2 million in the third quarter, which as a percent of net revenue was 3.3% compared to $34.6 million or 6.3% of revenue for the same quarter last year.

There were several items in both the third quarter this year and last that affected our G&A expense. During the third quarter 2010 our G&A costs included approximately $2.1 million in expenses related to the transition and closing of the Regency Corporate Office. We also incurred $4.8 million in incremental employee healthcare costs in the third quarter resulting from an increase in claims affecting our self-insured health program.

These increases were offset by a $1.8 million reduction in incentive compensation for our Executive Officers. In the third quarter 2009 we incurred $18.3 million in long-term incentive compensation and $3.7 million in stock compensation expense and G&A, both related to the Company's initial public offering last year.

Bad debt as a percentage of net revenue was 1.9% for the third quarter. This compares to 2.2% for the same quarter last year. We have continued to experience favorable accounts collection activity in both our business segments, and currently expect our bad debt expense to continue to run under 2% for the foreseeable future.

As Bob mentioned, total adjusted EBITDA was $59.4 million for the third quarter, and adjusted EBITDA margins were 10.1% compared to adjusted EBITDA of $73 million and 13.4% adjusted EBITDA margins in the same quarter last year.

Much of the reduction in the EBITDA this quarter came from what I would refer to as a onetime expense, such as increased healthcare expenses, workers compensation, and the Regency transaction and severance expenses. The additional costs in the quarter for each of these items are $4.8 million for healthcare, $4 million for workers compensation, and $3.4 million for Regency costs, or $12.2 million in additional expenses, which represents $0.05 a share. We do not believe the increased expenses for healthcare and workers compensation represents a long-term trend, and Regency should provide a positive contribution in Q4.

Depreciation and amortization expense was $17 million in the third quarter compared to $17.7 million in the same quarter last year. The decline was primarily the result of fully amortizing the contract therapy rights, which happened in the first quarter this year. This was offset, in part, by increases in depreciation expense. The annual amortization expense related to the contract therapy rights was approximately $4.1 million.

Net interest expense was $27.7 million in the third quarter, down from the $33.4 million in the same quarter last year. The reduction in interest expense was the result of both lower interest rates and lower debt levels during the quarter compared to the same quarter last year. Our lower debt balances were the result of the repurchases of our Holding Company senior floating rate notes and prepayments of our credit facility debt with proceeds from our initial public offering. Our lower interest rates were primarily the result of the maturation of a portion of the interest rate swaps that we had in place.

We had $175 million in fixed rate swaps on the Holding Company senior floating rate notes that matured September 15th, 2009. In the third quarter last year we had approximately $900,000 in incremental interest expense related to these swaps. We also had $200 million in fixed rate swaps on the credit facility debt that matured May 24th, 2010, and $200 million that matured August 23rd, 2010. These swaps were adding approximately $4.2 million in interest expense per quarter prior to their maturation.

We have one remaining fixed rate swap totaling $100 million on the credit facility debt that will mature November 22nd, 2010 which is currently adding approximately $1 million in interest expense per quarter. In total the elimination of fixed rate swaps assuming the same based interest rates would have an approximate $6 million impact on interest expense on a quarterly basis.

The Company recorded income tax expense of $5.6 million in the third quarter, which represents an effective tax rate of 39.1%. Net income attributable to Select Medical holdings was $8 million in the third quarter, and fully diluted earnings per share was $0.05.

We ended the quarter with $1.4 billion of debt outstanding and $15.3 million of cash on the balance sheet. Our debt balances at the end of the third quarter included $167.3 million of Hold Co. senior floating rate notes; $138.7 million of Hold Co. senior sub notes; $611.5 million of our 7-5/8s senior sub notes; $191.8 million of the term loan B loans outstanding that mature February 2012; and $291.3 million of term loan B-1 outstanding maturity which is 2014, August of 2014; and then $20 million in revolving loans outstanding, with the balance of $5.4 million consisting of other miscellaneous debt.

You will again notice a significant increase in the current course in long-term debt in the quarter; this relates to our term loan B which has $47.8 million quarterly amortization payments required at the end of the first three quarters of 2011 and a final payment due in February of 2012.

Operating activities provided $51.5 million of cash flow for the third quarter, and cumulative operating cash flow year-to-date was $110.3 million. We continue to experience improvement in days sales outstanding, which was 47 days at the end of the quarter compared to 53 days at June 30th, 2010, and 49 days at December 31st, 2009. The decline in DSO over the last quarter was primarily the result of the timing of our periodic interim payments, or PIC, from Medicare for our Specialty Hospitals, and the affect of the Regency accounts receivables.

Investing activities used $178 million of cash flow for the third quarter, including $165.8 million in the acquisition related payments, and $12.2 million for purchase of property and equipment in the quarter. Investing cash flow for purchases of property and equipment year-to-date has been $38.6 million.

Financing activities provided $13 million of cash for the third quarter, including $20 million in net borrowings on our revolving credit facility, offset by net payments of other debt, payments of bank overdrafts, and distributions to non-controlling interests. Year-to-date financing activities has provided $25.8 million of cash flow.

Our expectations for the fourth quarter are net revenue in a range of approximately $628 million to $642 million, adjusted EBITDA in a range of $84 million to $91 million, and EPS in a range of $0.14 to $0.17 per share. Please note that these numbers do not include any potential onetime restructuring costs associated with the Regency transaction.

We currently expect to provide annual guidance in late December or early January.

At this time, I'd like to turn the call back over Bob Ortenzio for some closing comments.

Before we take questions let me make some concluding comments. Like our investors, the Management Team at Select is disappointed with the financial results of the third quarter. We are a competitive group, and I believe that we can and we will do better. While I don't propose to offer excuses, by way of summary and context I would like to offer the following.

Over the years our hospital operators have constantly and consistently tweaked our models and operations to stay in front of the changing nature of the LTACH business. I firmly believe that the successful LTACH operators of the future will continually position themselves to take higher and higher acuity patients.

Our increase, albeit small, in direct care nursing hours per patient day and increased physician presence in our hospitals will allow us to take higher acuity patients which we did see in the quarter as evidenced by an increase in our case mix index, which I believe is among the highest in the LTACH industry. However, we did not achieve the volume growth in the third quarter that we anticipated. As these volumes return I am confident the changes we are making will result in enhanced performance.

Unfortunately, the shortfall this quarter was exacerbated by onetime issues with healthcare expense and workers comp claims. I believe the healthcare expense is an aberration and the workers comp claims will return to historical levels.

Finally, I will say that the Regency acquisition will prove to be a significant value creator for our shareholders in the future. The hospitals are in good markets and have strong operators. Although they were not a contributor in September, I believe we will see a gradual positive contribution through the fourth quarter and a significant contribution in 2011.

I would now like to open the call up for questions.

(Operator instructions.)

Your first question comes of Frank Morgan with RBC Capital Markets. Please proceed. Frank, your line is open, your phone may be muted.

Okay, yes. Yes, just first question, looking at the volume issues, the three issues that you specifically mentioned and called out, could you go into a little detail about how you see those three issues changing and evolving in the fourth quarter in light of the guidance that you're giving right now?

Sure, thanks, Frank. As I think we mentioned in the narrative, as is often the case under the 80, 20 rule, about 80% of our shortfall in patient days came from 15 of our hospitals, and we were able to identify three basic categories that we can place most of these in, although it is a mixed bag.

First is those hospitals that either have moved, and these are HIHs, or that need to move, and there are five of those hospitals. Three have already moved to new locations, and their census is ramping up, and I'm confident that they will return to historical levels. Two more need to be moved at this point as a result of being in locations where the acute care hospital hosts are reducing services or have moved. Those are waiting various approvals in order to move, and I suspect until they do we will continue to see some softness in the volume at those locations.

The second category was physician recruitment issues. We have four markets where in order to take the volume and the acuity of the patients that we need, that we want to take, we need to have some physicians recruited into those markets and hospitals. Two of those locations are among what I would consider our new hospitals, and one is in a university setting town where university physicians often stay in the university, and so we have to recruit physicians from outside and perhaps even outside the market to be able to take the kind of patients that we want to take.

Another one of the hospitals is -- was in the Gulf Coast area, and with the number of physicians that left there even though it was some time ago, we continue to experience some difficulty in recruiting to that location but I believe we will be successful. And once those -- and the volume of patients, these are hospitals that are in good markets, and once we get physicians recruited into our hospital I believe that volumes will go up considerably in those markets.

Finally, the third category was new competition. You would expect to be unusual because of the amount of time that the moratorium has been in place but, however, we saw new competition come into four of our markets -- two hospitals that had leases signed before the moratorium were both physician owned hospitals and have opened near our existing markets. What we typically see in situations like that, that our volumes will take a temporary reduction when the new hospital opens and staffs up and begins to take patients, as physicians maybe try that, particularly for physician owned. But I expect our volumes to recover.

A third competition was a new hospital that opened in the northeast. And the fourth one was a hospital that relocated from a market that was not in our market area, to one of our market areas, in Texas, and I think those hospitals will continue to pose trouble to get volume in light of the new competition.

Okay, that's very helpful. One more and I'll hop back in the queue. With regard, you mentioned acuity and the increase in labor cost; is there anything that you can do differently on the cost side, the acuity side? And actually how much did the -- and I saw where your patient days were up when your admissions were down, so length of stay was clearly getting longer -- any kind of comments about the case management or cost management side relative to this higher acuity that you're seeing and any developments on the change in the high cost outlier profile? Thanks.

Well, Frank, I would say that -- I would characterize it as notable, although not seismic. We -- if you look at the quarter our direct nursing hours per patient day went from 10.0 to 10.4, so I would characterize that as a slight increase, although across the whole system it's a fair amount of money. We did that to accommodate the higher acuity patients that we are seeing in our hospitals. Our case mix index for the quarter hit 1.2, up from the same quarter last year. And these are the patients, particularly the pulmonary patients, that we want to see with increasing frequency and with increasing volume, because I believe that that is, as I commented, where the industry is going.

Some of the other expenses that we saw that we highlighted were some of the equipment purchases. Some of that was the purchase of additional ventilators or leases of ventilators; all of that was positioning our hospitals to take the higher acuity patients, which we are seeing and we will continue to see.

Is any part of the vent of the equipment costs, is any of that -- will that stabilize now and not go up as much going forward? Or was there just a onetime kind of incremental step-up that you needed in equipment expense, or will you expect that to continue to go up as volume recovers?

Frank, the only reason that that would go up is to the extent the volume of our vent patients went up, which is a good thing.

Yes, yes.

So, yes, it is a onetime unless we have increase in volume.

Okay, thanks.

Your next question comes from the line of Whit Mayo with Robert W. Baird & Company. Please proceed.

Thanks. I wanted to first follow-up on Frank's last question, just about the high cost outliers. I don't think I heard an explicit answer to it, but just how did that trend throughout the quarter for maybe your legacy business in both Regency and maybe give us some flavor for where Regency's mix is and where you think that can go over time?

Sure, let me take it first. We did see some additional high cost outliers in our base business, which you would expect with having the higher acuity patient, particularly the pulmonary patient, you can see an uptick, and we did see in the high cost outlier.

I think more significantly with the Regency, when we closed on the Regency transaction on September 1st approximately 25% of the patients that they had in-house were high cost outliers, and that is -- will have a very significant negative impact on their results. So we took action through September to put in the case management and the admissions procedures that we did to bring those hospitals more in line with Select.

So the answer to the question, and I apologize, Frank did ask that question as well, is in our base business we did see an uptick in our high cost outliers, which you would expect because of the acuity, and it was quite significant at the closing of the Regency Hospitals, in the Regency Hospitals.

Since you negotiated the transaction, did the legacy LTACH see an increase in their short stay outliers? I guess I'm trying to get a sense of the trajectory on where that went and where it can go, and maybe a timeframe?

Yes, with what we have seen is on average, at least over the past couple years, we've been in the 5% range of our total discharges in the high cost outlier. What we have seen is we've seen an increase, I think this quarter we were up to about 7.4%.

Okay. And maybe just looking at the G&A, it certainly doesn't look like much came out of Regency's overhead. Marty, maybe can you refresh us as to how the WARN Act may be playing a factor here and size-up the run rate, G&A overhead savings you think you can achieve with Regency over time?

Sure, Whit, let me take you through that. As everyone on the call probably knows, when you lay off more than 50 people, which we have done at the Corporate Office of Regency, you have to provide a WARN Act, W-A-R-N, and that requires you to provide notice of at least 60 days before the layoff.

We provided that as of September 1st and, in essence, that goes through till the end of October. So you will see, you saw some costs, the administrative costs in September, you'll see those also in October, and then you'll see a substantial reduction in expenses in November and December associated with that.

$2.1 million I expect to see in October. I think that should drop down to probably $400,000 to $500,000 in November and December. And then on an ongoing basis in January I think you should see the admin costs associated with Regency in the $350,000 to $400,000 range per month.

Okay, maybe just one other question, back to the volumes. Of the 15 LTACHs you've highlighted as having some issue, of those 15 are any of those the 10 newer LTACHs that you have that are still sort of in ramp-up phase? And maybe refresh us where those hospitals are? And are they hitting your budgets at this point?

Some of those are, Whit. I mean the market, those 15 is a mixed bag. And, yes, there are some in there that are what we would consider the newer hospitals, but some of them are some legacy hospitals, going back really almost to the beginning of the Company, particularly those that I mentioned, the five that we needed to move. All of those are legacy hospitals, and as I look down the list those are hospitals that we probably had in the Company maybe 10, 12, 13 years. And it's what you'd expect because those are hospitals where the market for the acute care services may tend to change in those markets, so that's why those had to be relocated.

Those in the category of new competition, I would tell you that I think one of those was a newer hospital, and the balance, particularly the ones that were impacted by competition where the physician owned hospitals, the two physician owned hospitals opened, those were also legacy and not new hospitals. The ones where we had physicians, where we needed to recruit physicians those are the ones that I would say would be the newer hospitals, and I supplemented that by the one that is in the Gulf Coast.

So the summary would be the newer hospitals would be in the category where we have physician recruitment issues, and in the move and the new competition those would be the legacy hospitals.

Okay, and just I guess one last question on the buyback that was announced. When can you be in the market buying? And should we view that as a top priority next to closing the Baylor transaction?

Well, Whit, we can be in the market on Monday, and it's our expectation that we will be in the market on Monday.

Okay, great. Thanks a lot.

Sure.

Your next question comes from the line of A.J. Rice with Susquehanna Financial Group. Please proceed.

Good morning. It's [Chris Wright] filling in for A.J. I guess I was just hoping for some color as you look forward as to how you think about balancing out sort of new growth, acquisitions versus a buyback, at least over the near to intermediate term?

Sure. Well, as was mentioned and as we announced, the buyback is a priority because if we look at valuations and deployment of capital a buyback I think to our Board probably looks reasonably attractive at this point.

In terms of our growth area we are committed to the rehab hospital joint venture strategy, and that is a strategy that in the hospitals or in the markets where we have employed that strategy and are operating we have seen very positive and good results, and that's St. Louis with SSM, I would categorize as an unmitigated success. We continue to see that business continue to get better every single month. I'm very pleased there.

And, similarly, since we've opened the new hospital with Penn State, Hershey Medical Center, that's successful. My expectation is that the Baylor joint venture when finally approved and implemented we'll see similar success. So that is a strategy that will go on unabated.

We are always looking at acquisitions, as we've said in prior calls, and acquisitions are balanced, do them or not do them is balanced on a myriad of factors. But obviously one of the main ones is deployment and use and allocation of capital. And to the extent that we have better allocations of the capital, whether it be paying down debt, buying back stock, acquisitions can become a more or probably in the foreseeable future less of a priority.

Yes, Chris, if you take a look at the capital structure we currently have, we have sufficient capacity to do all of the above in the short term.

Okay, sorry, I know I've got a lot of background noise here. I'm actually at a Med Tech meeting, and the good news is they're talking about LTACHs and IRF.

So but a follow-up to that, I know and I ask this with some reservation because I know there are a lot of competing and conflicting interests here, but obviously a lot of Select stock is still held by some of the financial sponsors in large blocks. And is there any thought or any consideration given to reaching out to them and just taking a decent chunk of stock from them, because if the object of the share repurchase, is to reduce shares outstanding and drive earnings accretion, that might make some sense. Do you have any comments on that?

No, that would not be a -- that's not one of the things that's -- that is not one of the things that's under consideration.

Okay, and then, lastly, just on the acuity bump in the quarter is that -- was that sort of across the board or is that at all impacted by the trends you saw at just those 15 hospitals? I mean you saw some lower or rather the lower acuity admissions at those 15 facilities sort of decrease, and across the board acuity may have stayed the same but the results from the 15 hospitals skewed the impact in the quarter?

No, I would say that my comments with respect to the increased acuity from our Company would be across the system.

Okay, thanks a lot.

Your next question comes from the line of Shelley Gnall with Goldman Sachs. Please proceed.

Hi. Thank you. I guess my first question would be on your Specialty Hospitals, not the 15 you've broken out, but on the remainder of the Specialty Hospitals, what was the volume trend?

If you look at the balance of our hospitals and put them into buckets we mentioned that 80% of the 13,000, the little over 13,000 shortfall to our plan of patient days was in 15 hospitals. I would say that 35 -- of the remaining hospitals I would say 35 I would characterize as maybe slightly off plan with respect to volume, and 40 hospitals that were at or above plan.

And what would be the driver there, is it fair just to think that maybe just decreasing commercial coverage is reducing the pool of patients you'd be willing to admit to Select hospitals? Or presumably the demand for this type of service is unchanged, so what would be driving the weakness?

Well, I think as I outlined earlier, if you look at 80% of the shortfall to our plan it was in the three categories that I've given a lot of detail on -- the moves, the physician recruitment, and new competition. The balance of the hospitals, as I've said, either slightly up or at or above plan. I think that it's a market by market. It's difficult to draw any more kind of generalizations other than the ones that I've given you, which is the moves, the physician recruitment, and the new competition, which was 15 hospitals which was approximately 80% of the shortfall to our plan on volume of patient days.

Understood. Thanks for all the color. And then on the patient acuity, it sounds like this is really a stepped up strategy here to increase the acuity. It sounds like positioning for some changes to the regulatory environment? Is there anything new on that front?

I don't think there's anything new on the regulatory front on the LTACH side of the business. I mean it is ongoing, as most of our investors know that we have the legislation which imposed a moratorium and the hold on some of the other CMS regs, which is in effect till the end of 2012. I have stated that I think that's the right direction for the industry to go, and I believe that the industry is united in going toward a patient and facility criteria, which I really think is the most important thing that can happen for this industry.

So our move to continue to take higher acuity patients you could say is in part a factor going in that direction because it is the long-term trend in the industry, but it's also where your higher revenue patient population is and what LTACHs were really set-up to do, was to take the pulmonary patients and the higher acuity patients.

Okay, understood. And then just because there were a number of onetime items in the quarter, can you give us a sort of broad range of your expectation for the sort of run rate cost of services? Are we going to be between 82% and 84% going forward?

I think it's going to be at the lower end of that, Shelley, I would think 82%, 83%. I think we've talked about one of the reasons why you saw the spike-up had to do with both workers comp and the higher number of high cost outliers that we had.

Right, but the increased nursing and physician staffing and presumably some higher equipment costs will be carried forward as you're pursuing this higher acuity patient population?

Yes, there will be some higher cost there.

Okay, great.

But also remember with that higher cost also comes higher reimbursement.

Yes, understood, but it -- okay, understood. And then, just sorry, one last question. I know in the past you've been sort of against buyback because of the limited float. I just wanted to make sure I'm understanding the reason that you appear to be a little bit more in support of the buyback now is just from where the stocks are trading?

That's correct.

Got it. Okay. Okay, thanks very much.

Your next question comes from the line of Miles Highsmith with RBC Capital Markets. Please proceed.

Hi, good morning, guys. If my memory is right I'm thinking over the last eight or 10 years, your case mix index has kind of been in the 115, 120 range. Bob, I'm just wondering if you sort of have a vision as you look towards the next couple of years, and let's assume hypothetically for a second that the industry didn't move at all, it just stayed where it was. On your sort of specific thoughts and initiatives is that something you would envision like in the 125, 130 type range or any sort of order of magnitude you could give us there?

I think I'd be hesitant to try to project that other than to say that it is I think where this industry is and is going, and this isn't a new revelation for us as we have, as you have pointed out we have gradually moved up the acuity scale over the years. And I think that that's where the regulatory environment is going and I think that we're fully cognizant of that.

I mean the issue, and I don't want to make too much, you know, we continue to push on getting the higher acuity patients but that has been a strategy of ours for some time. The issue that we had is that as we continue to make the kind of modifications and the changes in our business we just saw a real departure from our expectations on what the volumes were. If we'd have seen the volumes in the quarter that we expected a lot of this other stuff would not even probably be on the discussion topics because we would have been talking about case mix index and the future of the regulatory and reimbursement environment, but I don't -- it doesn't come as a surprise to anybody that the LTACHs are going to have to continue to take higher and higher acuity patients.

Fair enough. And I appreciate all the detail you gave us on the volumes for this quarter. I'm just curious, it's been suggested in recent quarters that maybe contrary to an intuitive thought that the LTACHs and IRFs would have very little sensitivity to any economic weakness that some of the volume weaknesses associated with hospitals hanging on to patients a little bit longer. Anything to comment on there, is there anything going on there?

Yes, it's a great question, and it's a very interesting point. I have never been a believer in this construct that has come from various areas that acute care hospitals refer patients to LTACHs for economic versus clinical reasons. And if you go back over time you've heard that hospitals discharge patients quicker because it's in their financial interest to do so, and now you hear some suggestions that hospitals are holding on to patients longer because it's in their financial interest to do so.

So, you know, to those I'd say which way do you want it? I mean I think that in my estimation hospitals and physicians refer patients to LTACH for clinical reasons, not for financial reasons. And you can make an argument that it is in their financial interests to do so earlier, and I guess that some are making that it's in their financial interests not to refer. And I, frankly, do not believe either one of those. And I've heard arguments out of CMS over the years that this is, you know, many years ago that they were referring patients for financial reasons and not for clinical reasons, earlier. And now this idea that they would hold on. So I really don't buy into either one of them.

I think that as this industry has matured, physicians, discharge planners, case managers, commercial insurers refer patients to LTACH because it's the appropriate medical venue and they improve better and faster. So I -- the other I really -- I don't see the other.

Okay, great. And then just a last one for me. Marty, you guys have had $100 million authorized on the repurchase. If my math is right you could technically, your RP basket would probably live north of $500 million now, and realizing that would be a big chunk relative to your market cap, but is there anything I've missed sort of in terms of covenant limitations or other things that would prevent you from getting additional authorizations if the price remains attractive?

No, Miles, your calculation is correct, it is north of $500 million at the Hold Co. level, so we do have a basket that size.

All right. Thanks a lot, guys.

Sure.

Your next question comes from the line of Gary Lieberman with Wells Fargo Securities. Please proceed.

Thanks. Good morning. I was maybe hoping you could give us a little bit of an update on how the various joint ventures are progressing and how the strategy as a whole is progressing?

Well, there's two parts of the strategy. One is the success in those that we've already done and the prospect for future ones. As I mentioned earlier, I am -- I actually couldn't be more pleased with how we're doing at SSM in St. Louis joint venture or at the Penn State Hershey operation. And I could give you some more detail on that, but suffice it to say that we feel that that's going very well. There's good growth opportunities. They've been improving month, after month, after month.

I'm very excited about the prospects in Dallas with Baylor if we can get it through the regulatory process. I do think that once that's done our pipeline will continue to be strong and then it's just going to be a function next year of closing a couple more deals. And these are always long lead-time, but I think the reputation of Kessler and the success at our existing joint ventures would hopefully be a catalyst to getting more deals. But I want to reiterate that we continue to be completely committed to that strategy.

How, if at all, has sort of the volume weakness that the industry has experienced on the acute side impacted the conversations that you're having or maybe the timeline of some of the deals getting done?

I wouldn't say that anecdotally as I hear about the projects that are under discussion that that is probably not a factor. I think it's probably a bigger factor is that potentially systems thinking about the future of healthcare reform, wanting to have the full continuum and wanting to have it focused, that element. And also the element of what hospitals are doing in terms of construction, constructing new assets on their campuses. I think they're being much more judicious with capital, and as they do that companies, like Select, that are willing to employ capital and take over a segment of the continuum I think become more attractive.

Okay, thanks a lot.

Thanks, Gary.

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

Hi, thanks. Good morning. This is actually [Josh Marens] in for Kevin. Coming back to the Regency deal, I know you guys had spoken about some of the metrics there and the margins there, and you had spoken about a 7.5% margin there, and the goal to improve those margins to your level over time. Can you talk about some of the specific line items you'll be focusing on heading into next year and maybe the trajectory for next year and timeline there?

Let me start on kind of giving you a little bit more detail on how the Regency transaction has gone since we closed on September 1. As of September 15th all of the systems at Regency had been integrated and cut over to Select Systems, that includes billing, collections, admissions, case management, payroll and HR. Also, post closing every hospital has been visited by Select's Operating Team, and a plan has been put in place for positioning each one of those hospitals.

As Marty pointed out earlier, the Corporate Office is staffed, the former Regency Corporate Office in Atlanta, is staffed with a skeleton crew to run off some of their legacy billings, and that office will be closed by the end of November. We have also closed one of their hospitals, which was an overlap in Dallas with one of Select's LTACHs, so the Regency Hospital in Dallas has been closed, and that building is up for sale. By December 15th we believe that Select's staffing model will be fully transitioned to all of the Regency Hospitals.

So I think that the integration has gone well, and I'll let Marty comment on the kind of what we expect to see in terms of an economic result from that through the fourth quarter and into 2011.

Hey, Josh, we do expect to see a positive contribution from Regency in Q4, but when you take a look at 2011 we expect to see a clean slate there. We will be through all the Corporate types of expenses, so you can expect to see somewhere in the neighborhood of $20 million to $21 million of incremental benefit to us versus the $25 million of Corporate expense that they had. I anticipate you'll see the margin somewhere in the 13% range, and the majority of those dollars come from the Corporate side. I think over the next two years you'll probably see those margins move, gravitate more towards our margins, our legacy LTACH margins.

Okay, great. Thanks. And then coming back to the comments on new competition impacting volumes in your markets, looking forward are you more focused on trying to identify those issues ahead of time? How much predictability is there? I imagine that these issues don't come up suddenly, and is it related -- you mentioned that some of the leases were signed before the moratorium; how much does that issue die down as any leases signed before the moratorium run out?

Yes, well, let me comment on that. I mean again I don't want to overdramatize the affect. We had four markets, you know, we have 111 LTACH hospitals throughout the country, so we had four markets where we had some new competition came in that I believe which we have seen have impacted volumes, what I will say in the short term. And we've seen this in the past. I mean typically those volumes will return, and we believe they will as that -- as the market kind of evens out.

You obviously will see less and less of that in the future as the moratorium continues to be in place. However, you will -- you can still see the impact of kind of "new competition," through hospitals that relocate or move, and that was one of the four markets that I articulated was a relocation into one of our markets, three was new competition.

So I don't know that there's much you can do to anticipate that. We know that these hospitals open. When they do open there's usually a lot of competition for the recruitment of staff. As the established provider we usually have competitors go after our staff with large payment increases. And we just have to backfill that with our staff, do the things that we do well, and usually we compete and get those patients back.

So I don't know that there's much that you can do in advance, but there's obviously things that you can do post-competition, like any business, like any market that's competitive. Fortunately, we have a lot of markets where we don't have competition, but in those that we do I think we compete effectively, although sometimes you see these short-term dips in volumes.

Okay, thanks. And then one last one on some of the expenses that you thought won't recur, won't recur as much going forward. You mentioned healthcare expenses, workers comp -- what caused the spike in the healthcare expenses? And then also on the workers comp?

Josh, on the -- on both healthcare and workers comp, I mean you should know that we go through an actuarial review every quarter on both of these costs, and in essence when we went through the actuarial review on the healthcare side there were two primary reasons why we saw our healthcare costs spike.

One had to do with basically what we believe is the sunset of the Federal Cobra premium reduction program. We saw when that program went in place first quarter of last year we actually saw an uptick in the participation of ex-employees. And given the fact that that program has sunset we had seen in this past quarter a substantial increase in the costs. And really we think that that's purely a function of people saying, you know, given the fact that this program is going away and my premium is going to go from $350 to $1,000 I'm not going to participate in the program moving forward; I'm going to get all my healthcare costs today. And that's in essence what's happened. That was a pretty big bump for us.

In addition to that, we saw some aberrations in our regular program. So when you take a look from an actuarial perspective and go back and take a look at the trends over the past five to six years these were purely aberrations.

Then when you take a look at the workers comp side, we didn't see an increase in the volume of claims, what we did see is an increase in the cost of those claims. And, again, going back and taking a look at historical trends, it's just something that we haven't seen. We drilled down further, and we found that there were a portion of those claims were just pure aberrations. I mean we had an individual that was an employee of ours that was out on the road for us, and got hit by a truck. The truck had no insurance. I mean those types of claims you just don't see. That was worth about $600,000 for us. And, again, those types of claims are aberrations.

Okay. Thank you.

Sure.

Your next question comes from the line of Doug Simpson with Morgan Stanley. Please proceed.

Hey, good morning. A lot of my questions have been answered, and I apologize if you addressed this earlier, but just if we look at those 15 hospitals across the different payer classes was there any divergence there and is there anything to glean maybe from differential trends in the commercial side versus the Government side? Anything of note?

No, Doug, though we could say that there are no aberrations across the payer class. And we would certainly highlight if we saw a variance or divergence in terms of commercial or Medicare, and we have not.

Okay, so if we just, you know, putting all the comments together then, if it was pretty consistent across them and you had to take a stab at the one to two major drivers of the change in acuity and the preponderance of outliers, what is your take looking at the last three to six months as to what changed to create that dynamic?

Well, the higher acuity is our patient population, which is not something that we shy away from. That's what we want.

Right.

We want the higher acuity patient population. With that comes a little bit higher percentage of high cost outliers perhaps, but also comes with it higher reimbursement. And that's both on the commercial side and on the Medicare side.

Okay. And then with the acuity level --

The problem was that we were prepared and we did have higher acuity patients, we just did not have the volume. And as the volume dropped these other things became the explanation for why the costs are. But had we had, as I commented earlier, had we had the volumes most of these things would have -- most of these other issues, the four-tenths or the 0.4 nursing, direct nursing hours per patient day, the purchase of additional equipment and ventilators, you know, they would have been invisible had we had the 13,000 patient days that we expected.

Right, and the patient day differential you were saying was pretty evenly spread on a proportional basis across the payer classes?

Yes, yes, accurate.

Okay. And then maybe just as we think about it going forward, given the acuity, the average acuity lift you've seen and the differential this quarter does that at all come back to you in rates down the road through negotiations or adjustors?

Yes, Doug, just the way the Medicare reimbursement system works is you submit a cost report, those cost reports are reviewed, and in essence that's how the reweighting occurs. So to the extent that those incremental costs are added you'll see an increase in the average length of stay and you'll see an increase in the costs or the pricing of those specific DRGs, where you see the high cost outliers.

So is there any way to gauge maybe what that could mean on sort of an apples-to-apples basis relative to the EBITDA differential in the quarter?

I mean the difficulty, Doug, is we can do it certainly for our own population but it's really the aggregate population that you have to have the information on.

Okay, and then --

It's a good thought, though.

Okay, and then given the trends you saw in the quarter I mean presumably when you go back on the payer side you'll try to work this in your negotiations with the payers, I mean is that fair?

No, I don't think our -- I mean I don't think that there's anything wrong with our commercial rate. It's held and it's strong, so I wouldn't want to leave you with the impression that we have flexibility to increase our commercial rates. And there's, frankly, nothing wrong with our commercial rates that will not be solved with a return or an increase in volume.

Okay, all right, great. Thanks.

Thanks, Doug.

Ladies and gentlemen, we are currently at the end of our time for the conference call. I would now like to turn the call over to Mr. Robert Ortenzio for closing remarks.

The only thing I'll close with, I think most of the -- hopefully, all the questions have been answered. If not, we're certainly available. Marty is available for follow-up. And we'll look forward to having a better result at the end of the fourth quarter. Thank you for your time.

Thank you for joining today's conference. That concludes the presentation. You may now disconnect, and have a great day.