Select Medical Holdings Corp (SEM) 2010 Q4 法說會逐字稿

Good morning and thank you for joining us today for Select Medical Holdings Corporation earnings Conference Call to discuss the Fourth Quarter and full year 2010 results and the Company's business outlook. 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 and annual 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, sir.

Thank you, Operator. Good morning, everyone, and thank you for joining us for Select Medical Holdings Fourth Quarter and full year earnings Conference Call for 2010. For our prepared remarks I'll provide some overall highlights for the Company and our operating divisions and then ask Marty Jackson to provide some additional financial details before opening the call up for questions. Earnings per diluted share were $0.13 for the fourth quarter and $0.48 for the full year. Net revenue for the fourth quarter increased 11.1% to $637.4 million compared to the same quarter last year. During the quarter we generated approximately 73% of our revenues from our Specialty Hospital segment, which includes both our long-term acute care and our inpatient rehab hospitals, and 27% from our Outpatient Rehabilitation segment, which includes both our outpatient clinics and contract services.

Net revenue for the full year increased 6.7% to $2.39 billion compared to last year. During the full year, we generated approximately 71% of our revenues from our Specialty Hospital segment and 29% from our Outpatient Rehabilitation segment. Net revenue in our Specialty Hospitals for the fourth quarter increased 16.5% to $467.6 million compared to the same quarter last year. The increase was a result of the hospitals acquired in 2009 and 2010, which contributed $80 million of incremental net revenue in the quarter. Offsetting this increase were declines in our same-store hospitals net revenue. The same-store net revenue declines were primarily a result of reductions in net revenue per patient day or rate. Specialty Hospital net revenue per patient day was down 3.8% to $1,457.00 in the fourth quarter compared to $1,514.00 per patient day in the same quarter last year. This decline was primarily due to a reduction in the severity of cases we treated in the quarter compared to the same quarter last year.

In addition, our Medicare outlier per patient day rate was higher in Q4 2009 due to higher costs and lower patient days associated with our 2008 startup hospitals. Overall occupancy rates were 66% in the fourth quarter compared to 67% in the same quarter last year. Our patient days in the fourth quarter increased 20.7% to 311,433 patient days. This increase was a result of the hospitals acquired in a Regency transaction. Let me give you an update on the 15 hospitals we discussed last quarter that made up the majority of our shortfall to plan. In the fourth quarter we saw sequential improvement from the third quarter in our average daily census in 9 of those 15 hospitals.

More importantly, 13 of the 15 had significant improvement in their financial performance on a sequential basis, improving from less than $300,000 in EBITDA contribution in the third quarter to over $5.3 million in the fourth quarter. Specialty Hospital net revenue for the full year increased 9.3% to $1.7 billion compared to last year. The increase was, again, primarily the result of hospitals we acquired in 2009 and 2010 which contributed $127.5 million in incremental revenue for the year. The $17 million growth in Specialty Hospital net revenue for the year, excluding the effect of the hospitals acquired, was primarily the result of both Medicare and non-Medicare volume increases and rate increases for our non-Medicare patients offset by rate declines for our Medicare population.

Net revenue in our Outpatient Rehabilitation segment for the fourth quarter declined 1.4% to $169.7 million compared to the same quarter last year. Revenue in our clinic based business increased slightly, as our patient visits grew 0.8% in the fourth quarter compared to the same quarter last year. Rate remained stable at $102 per visit in both the fourth quarter this year and last year. The increase in the clinic business was offset by a decline in our contract services business in the fourth quarter when compared to the same quarter last year. The decline was the result of the termination of a large contract, which was the result of business we were serving being sold earlier this year that we discussed in the last quarter earnings call. During the fourth quarter, approximately 68% of our outpatient revenue came from our own clinics and 32% from our contract services and managed clinics.

Net revenue in our Outpatient Rehab segment for the full year increased 0.9% to $688 million compared to last year. Revenue in our clinic based business increased approximately 1% for the year, as our patient visits grew 1.4% in the year and rate declined slightly to $101 per visit compared to $102 per visit last year. Our contract service and managed clinic revenue for the full year increased slightly at 0.6% compared to last year. During the year approximately 67% of our outpatient revenue came from our own clinics and 33% from our contract services and managed clinics. Overall adjusted EBITDA for the fourth quarter declined 23.6% to $67.2 million compared to the same quarter last year, with overall adjusted EBITDA margins at 10.5% for the fourth quarter compared to 15.3% margins in the same quarter last year.

Overall adjusted EBITDA for the year declined 7% to $301.1 million compared to $330.2 million last year. We did have several one time expenditures in the third and fourth quarters this year that adversely affected our EBITDA, including $9 million in costs associated with the closing of the Regency corporate office in the third and fourth quarters and $4.8 million in incremental healthcare costs and $4 million in Workers Compensation costs in the third quarter and $900,000 in severance expense at Select's corporate office in the fourth quarter.

Specialty Hospital adjusted EBITDA for the fourth quarter declined 10.5% to $70 million compared to $78.2 million in the same quarter last year. Adjusted EBITDA margins for the Specialty Hospital segment declined to 15% compared to 19.5% in the same quarter last year. Regency Hospitals contributed overall $1.4 million of adjusted EBITDA for this segment in the quarter.

Excluding the results of Regency Hospitals, adjusted EBITDA margins would have been 17.3% for the Specialty Hospital segment in the fourth quarter. Specialty Hospital adjusted EBITDA for the full year declined 2% to $284.6 million compared to $290.4 million last year. Adjusted EBITDA margins for the Specialty Hospital segment declined to 16.7% compared to 18.6% last year. The decline in adjusted EBITDA was the result of year-over-year declines in both the third and fourth quarters, which resulted from incremental costs we discussed on last quarter's conference call and the third quarter and the reductions in payment rates this past quarter. The Regency Hospitals contributed less than $100,000 in adjusted EBITDA to our Specialty Hospital results since inception. Excluding the results of Regency Hospitals, adjusted EBITDA margins would have been 17.7% for the Specialty Hospital segment for the full year.

Outpatient Rehabilitation adjusted EBITDA for the fourth quarter declined 21.5% to $17 million compared to $21.6 million in the same quarter last year. Adjusted EBITDA margins for the outpatient segment declined to 10% in the fourth quarter compared to 12.5% in the same quarter last year. Decline in both the adjusted EBITDA and the adjusted EBITDA margin in the outpatient segment in the fourth quarter was primarily the result of the loss of the large therapy contract services contract I mentioned previously, as well as higher relative labor costs in our contract services business that resulted from change in our treatment models to adapt to RUGS IV therapy rules that became effective October 1.

I also want to provide a couple updates since the third quarter earnings conference call. As you're probably aware, we announced that we received the necessary regulatory approvals to proceed with our proposed joint venture partnership for rehabilitation services with the Baylor Healthcare System. We're in the process of finalizing integration details of the partnership and currently expect to close the transaction in April. We also acquired a 60 bed rehabilitation hospital in Miami, Florida, in a related transaction that sold a LTAC hospital to rehab care. That transaction closed on January 1. I'll now turn it over to Marty Jackson, our Chief Financial Officer, to cover some additional financial highlights for the quarter and the full year.

Thanks, Bob. I want to start by walking everyone through the financial business outlook we provided for the fourth quarter and provide a bridge to our actual results in the quarter. Our net revenue expectation for fourth quarter was a range of $628 million to $642 million. And while our actual net revenue of $637 million met those expectations, we were disappointed with our per patient day rate in our Specialty Hospitals. We experienced a negative variance of $57 per patient day rate in Q4 of '10 versus Q4 of '09. There were 3 primary reasons for the per patient rate decline. First, we had a reduction in our case mix index in Q4 of 2010 relative to Q4 of 2009. Second, we experienced integration issues when we converted the Regency Hospitals over to our information technology platforms, which included Select's patient accounting system and charge capture systems.

And 3, we experienced a higher Medicare outlier per patient day rate in Q4 of 2009 due to higher costs and lower patient days associated with our 2008 startup hospitals. We believe both the case mix index reduction and the systems conversion issue were temporary in most of the declines and our per patient day rate is not a permanent phenomenon. Without the impact of these 2 items we would have well exceeded the top range of our guidance. Our adjusted EBITDA expectation for the fourth quarter was a range of $84 million to $91 million and, as we mentioned, excluded any restructuring charges associated with the Regency acquisition. Our reported adjusted EBITDA of $67.2 million included $6.8 million in onetime charges associated with the closing of the Regency corporate office and severance expenses for a comparable $74 million of adjusted EBITDA, which is still $10 million shortfall to the low end of our guidance.

Primary factor for this negative variance has to do with the per patient day rate reduction. As we discussed, the rate reduction can be attributed to the case mix index reduction, the Regency IT conversion, and the higher than normal per patient day Medicare outlier rates.

Let me spend a little bit of time walking through the Regency IT system conversion. This resulted in a reduction in gross charges for patient care services due to lower gross charges in Select's charge master compared to the gross charges in the Regency charge master. While gross charges are generally not utilized by payers in compensating us, Medicare does compute its payments for outlier cases based on gross charges for those outlier patient discharges. We have estimated that our payments for Medicare for outlier cases at these hospitals was approximately $6 million lower for the period than if these patient discharges had been remitted and paid under the legacy Regency systems.

While we have experienced a current reduction in revenue and cash flow as a result of this conversion, the Medicare system annually recalibrates for each hospital the rate at which it pays for outlier cases. This revised rate is based on the relationship of cost to gross charges. Since these hospitals experienced a decline in gross charges, the relationship of cost to gross charges will increase and result in a higher revised rate. Thus, assuming our mix in volume of outlier cases remains consistent in subsequent periods, we anticipate receiving higher payments for these outlier cases in the future. We have corrected this issue as of January 1 for all Regency claims and do not expect to experience this reduction in rate in the future.

Case mix index is an indicator of patients acuity in medical services provided to them. During the fourth quarter we had a drop in case mix index due to lower admissions of higher acuity patients. I will note that we have seen our case mix index return to a more normalized historical levels in January and February. We also experienced a $900,000 reduction in severance expenses at our corporate office, as we made some adjustments to our corporate structure. We are reaffirming the 2011 business outlook, which includes net revenues in the range of $2.65 billion to $2.75 billion, adjusted EBITDA in a range of $365 million to $385 million, and EPS in the range of $0.67 to $0.72 per share. For the fourth quarter, our operating expenses, which include our cost of service, general and administrative costs and bad debt expense, increased 17.5% to $571 million compared to the quarter last year.

As a percentage of our net revenue, operating expenses for the quarter were 89.6% compared to 84.7% in the same quarter last year. For the year, our operating expenses increased 7.9% to $2.1 billion compared to last year. As a percentage of our net revenue, operating expenses for the year was 87.2% compared to 86.3% last year. Included in our operating costs in 2010 was the $4 million incremental Workers Compensation charge we took in the third quarter. Cost of services increased 15.9% to $541 million for the fourth quarter. As a percent of net revenue, cost of services was 84.9% for the fourth quarter compared to 81.4% in the same quarter last year. The primary driver behind this increase was the result of the increased relative operating cost in our Specialty Hospitals acquired in 2009 and 2010 and the rate reductions experienced in our Specialty Hospitals during that quarter.

Cost of services increased 8.9% to $1.98 billion for the full year. As a percentage of net revenue, cost of services was 82.9% for the full year compared to 81.2% last year. G&A expense was $20.3 million in the fourth quarter, which as a percent of net revenue was 3.2% compared to $12.1 million or 2.1% of revenue for the same quarter last year. Excluding the $6.8 million Regency transaction cost in the quarter, G&A as a percent of revenue would have been 2.1% in the quarter. G&A expense was $62.1 million for the full year, which is a percent of net revenue was 2.6% compared to $72.4 million or 3.2% of revenue for last year. There were several items in both this year and last that affected our G&A expense. During 2010, our G&A costs included approximately $9 million in expense 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. In 2009 we incurred $18.3 million in long-term incentive compensation and $3.7 million in stock compensation expense in G&A, both related to the Company's initial public offering last year. Excluding the effect of these items, G&A as a percent of revenue would have been 2% in 2010 and 2.3% in 2009.

Bad debt as a percentage of net revenue was 1.5% for the fourth quarter compared to 1.3% for the same quarter of last year. Bad debt as a percent of net revenue was 1.7% for the full year compared to 1.8% last year. Our bad debt levels continue to run consistent with our expectations.

As Bob mentioned, total adjusted EBITDA was $67.2 million for the fourth quarter and adjusted EBITDA margins were 10.5%. This compares to adjusted EBITDA of $87.9 million and 15.3% adjusted EBITDA margins in the same quarter last year. Total adjusted EBITDA was $307.1 million for the full year and adjusted EBITDA margins were 12.8% compared to adjusted EBITDA of $330.2 million and 14.7% adjusted EBITDA margins last year. We did have several onetime expenditures in the third and fourth quarter this year that adversely affected our EBITDA, including $9 million in costs associated with closing the Regency corporate office in the third and fourth quarters, $4.8 million in incremental healthcare expenses and $4 million in Workers Compensation cost in the third quarter, and $900,000 of severance expense at Select's corporate office in the fourth quarter. Depreciation and amortization expense was $17.4 million in the fourth quarter compared to $17.6 million in the same quarter last year.

Depreciation and amortization expense was $68.7 million for the full year compared to $71 million last year. The decline was primarily the result of fully amortizing the contract therapy rights and the Kessler non-compete, which happened in the first and third quarters respectively this year. These decreases in amortization were offset in part by increases in depreciation expense primarily as the result of the Regency acquisition. The annual amortization expense related to the contract therapy rights was approximately $4.1 million and the Kessler non-compete was approximately $3.4 million.

Net interest expense was $25.3 million in the fourth quarter down from $30.7 million in the same quarter last year. The reduction in interest expense was the result of lower interest rates during the quarter compared to the same quarter last year. Net interest expense was $112.3 million for the full year down from $132.4 million last year. The reduction in interest expense was the result of lower interest rates and lower debt levels during the year compared to 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 the interest rate swaps we had outstanding on portions of our floating rate debt. Cash interest payments in 2010, including $14.6 million related to the interest rate swaps on our senior credit facility that matured over the course of 2010.

The Company recorded income tax expense of $1.6 million in the fourth quarter and $41.6 million for the full year, which represented an effective tax rate of 33.6%. Our effective tax rate was below statutory rates due to the reversal of valuation allowances previously recorded on capital losses and some FIN48 reserves. We do anticipate moving forward that our tax rate will be in the 41% range.

Net income attributable to Select Medical Holdings was $20.9 million in the fourth quarter and fully diluted earnings per share was $0.13. Net income attributable to Select Medical Holdings was $77.6 million for the full year and fully diluted earnings per share was $0.48.

We ended the quarter with $1.4 billion of debt outstanding and $4.4 million of cash on the balance sheet. Our debt balances at the end of the year included $167.3 million of Hold Co senior floating rate notes, $139.2 million of Hold Co senior subnotes, $611.5 million of the 7.625% senior subnotes, $191.3 million of the Term B loans outstanding that mature February 2012, and $290.6 million of the Term loan B 1 loans outstanding that mature on August 2014. We do have $25 million in revolving loans outstanding with the balance of $5.9 million consisting of other miscellaneous debt.

The current portion of our long-term debt on the balance sheet at year-end primarily relates to our Term Loan B, which has $47.8 million quarterly amortization payments required at the end of each of the first 3 quarters of 2011 and a final payment due in February of 2012. We did note in our press release that we have begun discussions with our financial advisors regarding refinancing both our senior secured credit facility and a 7.625% senior subordinated notes. I should point out that these discussions are preliminary and Select can provide no assurance that it will be able to successfully refinance either its current senior secured credit facility or the 7.625% notes.

Operating activities provide $34.3 million of cash flow in the fourth quarter and cumulative operating cash flow for the year of $144.5 million.

Day sales outstanding, or DSO, was 51 days at December 31, 2010 compared to 49 days at the end of last year. The primary reason for the increase related to the timing of our periodic interim payments, or PIP, from Medicare.

Investing activities used $12.6 million of cash flow for the fourth quarter and $217 million for the full year. This includes $165.8 million in the acquisition related payments and $51.8 million for the purchase of property and equipment in the year. Financing activities used $32.7 million of cash for the fourth quarter and $6.9 million for the year. This includes $44.1 million for the repurchase of our common stock in the fourth quarter under our previously announced $100 million share repurchase program. This concludes our prepared remarks and at this time we would like to turn it back to the Operator to open up the call for questions.

(Operator Instructions)Frank Morgan with RBC Capital.

A couple of questions here. Could you give a little bit more commentary, Bob, on the facility issues? It sounds like you've made some progress in improving those problematic facilities that you identified in the third quarter call. In terms of those different buckets between relocations, doctor recruiting and the different buckets of problem facilities, can you tell us where you saw the most improvement relative on a sequential basis from the third to the fourth quarter and then any updates on patient criteria legislation. And then finally maybe one for Marty. Just looking at the whole issue about this charge capturing for calculating the outlier payments, is this something you picked up on as you were in the process of the IT conversion in terms of where their charge master was and when did that become an issue or when did you identify that?

Thanks, Frank. I'll start first. With respect to the hospitals that we identified and I gave some details on the 15 hospitals that made up the most of our shortfall of patient volumes in the third quarter, it was about 13,000 patient days as I recall and I had put those just for purposes of explanation into the three buckets. I will say that the most important thing about if you look at those 15 hospitals, 13 of 15 have recovered very significantly from a financial standpoint on a sequential basis. And as I mentioned in my prepared remarks, because of costs and volumes, that group of hospitals as a group contributed less than $300,000 in EBITDA. They improved in the fourth quarter to $5.3 million of contribution.

While many of those may not be up to our plan or budget, it does show that they are going in the right direction and you can assume that in each of the areas that where we discussed the challenges, physician recruitment, which we have been successful in placing physicians in a couple of those locations, or new hospitals that we needed the physicians to get the admissions that we needed. We've have a number of those in place. The relocations that we had completed and were, I mentioned, were in the process of ramping in the third quarter did ramp in terms of patient visits or patient days. And so we did see an increase in those, which translated into the increase of EBITDA. And the third bucket was the impact of new competition and I think what I'd mention in the third quarter call was we saw that as, we perceived that that was going to be a temporary reduction in our volumes.

And on a number of those that's exactly what happened and we've recovered both patient days and EBITDA. So we're pleased with the progress in all of those areas. Let me go to your second question which is the patient and facility criteria. Just to recap where we've been on that, about a year ago the American Hospital Association took on the job to come up with patient facility criteria for the LTACs. I'm pleased that we were able to be a part as well as general short-term acute care hospitals and other LTAC providers as part of that process which went on for about a year, was quite exhaustive and the AHA has pretty much completed their work.

And that patient facility criteria is now being finalized and has been taken up to policy makers in order to get, garner the support that we hope that it will get. And so the Company plans to be completely supportive of the AHA's efforts and I think other trade groups and other groups will be as well. So we obviously have a December 2012 deadline of when the current legislation sunsets and it would be my hope that we would be able to get something done with patient facility criteria well in advance of that and the Company will be doing everything they can to support it. And the criteria is generally, I would say, it's based on severity and making sure that the LTAC hospitals take care of the higher severity cases. As far as the charge master, I'll turn that over to Marty.

Yes, Frank. The charge master capture issue, we actually went through a conversion mid to late September of the Regency billing system and it was really in December that we recognized that the charge master was really the issue for the lower rates. I mean, we evaluate the rates on a monthly basis and over that period of time we basically honed in, drilled down and found out that indeed it was the charge master. We have subsequently made the necessary changes and as we indicated from January on we're in good shape with that.

Good deal. So the actual census mix itself in terms of the outlier census relative to, say, your legacy portfolio, there was really no difference there, but it's just the charge capture issue makes the revenue lower and therefore the reimbursement of costs lower? Is that right?

That's correct. As you know, there's a certain portion of the Medicare revenue that we receive is based on outlier payments. That outlier payment is based on cost and that's really a function of your gross charges multiplied by your cost to charge ratio. And if you went in and took a look at the rates for Select's charge master versus the rates for Regency charge master, Selects were lower. So that's where that differential occurs.

Okay, thank you very much.

Thanks.

A.J. Rice with Susquehanna Financial Group.

Just a few questions if I could ask. First of all just to follow-up on the charge master adjustment, the fact that Regency's charge master was higher than yours, you guys are comfortable that what they were doing was appropriate though, right? I mean, we obviously had outlier issues on the acute care side and I want to just make sure we're confident that it's not that kind of a situation.

It is not that type of situation, A.J. We are comfortable that it is appropriate.

Okay. I noticed the AR stepped up from third to fourth quarter. You mentioned that the year to year change in DSOs was largely a matter of PIP payments. Is that true for the difference between the third and fourth quarter? Is there anything related to Regency going on in the AR there as well?

No, it is truly related with the PIP payment. Regency was -- their AR was in our Q3 numbers.

Right.

So, no, it was basically related to the PIP.

Okay. Now I think in the prepared remarks you said the case mix pressure that you saw in the fourth quarter has sort of rebounded in the first quarter. Can you just maybe broaden that comment? And you said also I guess the Regency Hospitals continue to improve so far in the first quarter. Just generally, the Specialty Hospital business and I guess even the outpatient business, any comments about year-to-date, weather issues, some of the acute care guys are saying they are seeing a volume rebound. Can you just comment on what you're seeing so far in the first quarter?

We can talk a little bit about the case mix index. Case mix index we have seen rebound back to a more historical norm for us, which is in the 1.16 to 1.17 range.

Okay and overall volumes in the specialty? Do you have any sense on that at this point or it's too early?

No, I mean we have seen a nice rebound on the volume also. We have seen a decent increase on the volume side, which basically mirrors what you're seeing on the acute care side.

And then on the outpatient side of the business, the outpatient business remains pretty stable and solid. I will say that given the weather we had in the Northeast and our presence in Philadelphia and North Jersey, we could see some impact of that in January and February. I think it's well known the significant weather issues that the Northeast had going the first quarter. So we obviously lost some visits on that, but I was pleased with how our operators responded and got a lot of patients rescheduled. So I don't expect the impact to be material.

Okay and then maybe last, just you raised the possibility of the refinancing, obviously on the one piece of the bank debt, that's maturities coming within a year pretty quickly here, but what is sort of the thinking and objective there? Is it to get more flexibility, stretch out maturities or is it -- I mean, will it result, do you think, in incremental accretion on the bottom-line? How should we think about that?

AJ, I think you ought to think about it in terms of it generally does provide us with a little bit more flexibility. As far as interest rate improvement or reduction in interest expense, I think it is potentially just a wash. So what you ought to do is assume that this is a wash, but it does also add -- provides us with additional tenor and obviously we don't need to point out to all of the listeners that the markets are very good right now for debt refinancing.

Sure. Okay, thanks a lot.

Shelley Gnall with Goldman Sachs.

Could I just go back to the regulatory outlook for a second? I think the latest that we've seen from the GAO was talking about issuing maybe some preliminary LTAC Regs in May of 2011 for implementation in May of 2012. Is there anything, do you have any update? Is that still the expected timing?

I can't comment. I did see the GAO report and I think they reported that they had an interview or discussions with CMS. As you know, Shelley, the CMS does not telegraph anything that's going to be in their Regs and so we really don't know what's going to be in their May Reg. We have not seen the RTI report, which has been pending for some number of years, so I don't really know, I really can't give any color on CMS views of patient facility criteria, except that what was mentioned in that GAO report, which was kind of a passing comment. So the American Hospital Association's path on patient facility has been quite separate and has, I guess, been updated on from time to time, so I really can't shed anymore light on CMS's activities and I doubt very many of the people could as well.

Okay, thanks. And then I guess is it fair to assume you'll continue to target patient acuity during the interim until we see those Regs, so my questions are I guess first, can you confirm in the fourth quarter we did actually see a reduction in patient acuity that's separate from coding issues?

Yes, that's, I can confirm that. We did see a reduction in our case mix index, which is a measure of acuity, in the fourth quarter and I think we mentioned that it was an anomaly compared to our historical levels of case mix index and we've seen that it has recovered to more normal levels in the first two months of Q1. So I can confirm that.

Okay. And then I know you've been positioning for the higher acuity population, I think, through staffing and I think we heard about some medical equipment purchases and what not. Can you just remind us or provide us some of the detail on your initiatives to pursue that higher acuity population? How do those initiatives actually work? How do your discussions with the physician community go?

Well, the Company has been pleased with the level of acuity our case mix index relative to the industry for a number of years now and that's really a function of your clinical programs. It's a function of your programs to take care of the higher acuity patients, which is oftentimes particularly the ventilator dependent patients and we publish our vent weaning statistics and so forth. So, there's certain amount of equipment that's associated with that and clinical readiness, your staffing and so forth. So, that's been a continuing process for the Company over the last couple of years and with the exception of the fourth quarter, we've been pleased with our case mix index and our acuity and our mix of patients and we did have what I considered an anomaly in the fourth quarter and it has returned. So, that's a continuing process, Shelley, of clinical readiness and then really marketing that service to the local communities where we provide for services.

Okay, thank you.

Gary Lieberman with Wells Fargo.

Maybe just to follow-up on the reduction in case mix index. Was there any indication that any of it was due to increased competition from any other LTACs or other post-acute facilities that might take similar patients?

No. No indication. No indication of that and we've looked across the system and kind of drilled down to the results of individual hospitals and no, no indication of that.

Okay. And then just maybe to go back to the outlier issue for one second. Just want to make sure I understand the mechanism, Marty. I think you said that it's the ratio of the cost over the charges times the gross charges and it sounds like you're pretty confident that as of January 1 there won't be any remaining issues. Is it not the case that it wouldn't it take longer to work through in that, is the cost to charge ratio based on the prior year or just the prior quarter? How do the mechanics of that actually work?

It's really based on the cost report of each individual hospital, Gary. So in essence, yes, it's going to take some time to work out. I anticipate it will probably take 18 to 24 months.

Okay, so is there any lingering financial impact from it or is it or are you where you would have been as of January 1 had you not have the issue in the fourth quarter?

As of January 1, we are where we need to be. There will be no lingering effects of that moving forward. Now, the only lingering effect will be there will be a catch up, as I said, probably 18 to 24 months out.

And can you quantify the dollar amount of that?

$6 million.

Okay, thanks a lot.

Kevin Fischbeck with Bank of America.

Actually this is Joanna Gajuk for Kevin. I just have a quick question on your margins in the hospital segment. It seems like that the non same-store margins were maybe similar in the single digits area. So the question that I have is what does your guidance assume happens here and specifically, where do you see Regency margins in 2011?

It's really the improvement in the Regency margins for '11.

I believe in the past you had said that you expect Regency margins to get to 13% in 2011, so is that still the case?

Yes, it is.

13% for Regency segment. I think we're having a little bit of trouble understanding the question, so was your question where we think the Regency margins are going to go to in 2011?

Yes, and also, yes, basically that's the question.

Yes, I think that what we're anticipating if you look at the charge master issue and the charge with the closing of their corporate office and the margins that the Regency base business has now, we feel confident that we can get that to 13% margins in 2011.

Great, thank you. And then did I hear it right that you said that you expect the Baylor JV to close around in April, because I think before it was announced that it would be on or before April 1, so is there some sort of delay in closing that?

No, what we indicated was we expect the Baylor JV to close on the first of April.

Okay, on the first of April. So then does your guidance in some way assume any contribution from the JV?

Our guidance does assume, our guidance for 2011 assumes that the JV is consummated the first of April.

Okay, great. And then the last one, can you talk about a little bit more about your outlook for capital deployment?

Capital deployment. Our capital expenditures for 2011 our expectations are somewhere in the $60 million to $70 million range.

But I was more thinking about in terms of your activity on the share repurchase front versus the debt repayment.

We expect to continue to be active in the share repurchase. As you know, we purchased $44 million. We've utilized $44 million and purchased close to 7 million shares. The share repurchase program is $100 million, so obviously, we've got $56 million left.

All right, great. Thank you so much.

Thank you.

Michael Meyers with Arcoda Capital.

So as I look at the $57 reduction in per patient rate in the fourth quarter, if you were to adjust that number for the charge master and then look at that increment, multiply it by 311,000 patient days, wouldn't that be substantially more additive whatever that increment is to the fourth quarter EBITDA? So if I'm taking a portion of that, multiplying it by your patient days, making some assumptions about what piece of that related to the charge master that if you rebuild and recouped wouldn't that result in several million dollars of additional EBITDA?

Yes, you're absolutely right, Michael. It would basically be $6 million.

So, Marty, can you quantify the portion of that that you expect to recoup over the next 18 to 24 months?

Yes, we expect to recoup all $6 million of that.

Is there any interest on that? Can that number move up or down?

No, it really can't. I mean, can the number move up and down? It can move up and down depending on volume. Our expectation is and historically the numbers have basically remained relatively constant. So our expectations will see that moving forward, but we expect to recoup that $6 million over the next 18 to 24 months.

Okay. And just one question on cost of services and I might have missed this during the call. You expect to get back to a sort of more normalized margin in the 82%, 82.5% range going forward post the RUGS IV and other sort of training implementation?

That's absolutely correct, Michael. If you take a look at the rate reduction that we experienced, which we think is a little abnormal, if you move that rate back to just last year's levels and then take a look at our SW, our cost of services, you're down in that 82.7% range as opposed to the 84.9% range where we are right now.

Okay, great. Thank you, Marty.

Thanks, Michael.

Doug Simpson with Morgan Stanley.

Okay, just wanted to talk about the timing of the 2011 outlook that you offered and then reaffirmed today. How did the timing of that when you were coming up with that budget coincide with your sense of the Q4 trends and just want to confirm that everything you saw in the quarter was you factored it into the 2011 outlook?

Yes, Doug. If you recall what we did was we did not release that guidance until the latter part of January.

Right.

But we saw what was going on in Q4 and that guidance is reflective of what we saw in Q4.

Okay and then as you think about the range this year, the EBITDA expectation, what would you say are the one or two primary drivers on that front?

Well, let's think about it in terms of a bridge going from the $307 million to the $365 million. If I take a look at the $307 million and add back the $9 million associated with Regency and then another $9 million associated with Workers Comp and healthcare expense that gets me to $325 million and our expectation is Regency will do $45 million in EBITDA. Obviously that gets you a little bit above the $365 million.

Okay.

And that's without taking a look at the base business.

Okay. And then I apologize if you gave this earlier and I missed it, but did you talk about the payer mix that you're expecting as you think about 2011 and specifically just on the commercial pricing side? What you are seeing there.

Yes, we did not talk about the payer mix, but we can certainly do it now. Our expectation is the payer mix will remain relatively constant on both sides of the house, on both sides of our businesses, whether it be the inpatient or the outpatient. On the outpatient side, we've assumed that the rates will remain relatively flat. On the inpatient side they will be typically we've been seeing 3% to 4% increases.

Okay and that same type of increase is included in the outlook?

That's correct.

Okay, thanks.

Thanks, Doug.

Miles Highsmith with RBC Capital Markets.

So, I know all this debt refinancing commentary is very preliminary, but I was just curious, you didn't specifically mention the Hold Co floaters in the commentary in the press release of the call. Is there anything to read into that? Is there any reason why you wouldn't address everything or was that specifically left out for a reason? Thanks.

Miles, we'll be taking a look at the entire debt structure and evaluating based on what's available in the marketplace based on rates. So as you know, the floaters right now are pretty attractive from an interest expense perspective.

Okay, got you. Thanks guys.

Sure.

(Operator Instructions) Michael Meyers with Arcoda Capital.

Just to the rate comment, Marty. As we've been watching long-term care and other peers reporting this quarter, it looks like they're able to take rates and can you just comment on what you're seeing in the industry and you just mentioned the 3% to 4% increase potential on the inpatient side. Can you comment on the commercial side and what you're seeing and whether it looks like there's an ability to take rates generally now?

Yes, that's a good question, Michael. I talked about the outpatient being flat on a rate basis is really on the clinic side that we've seen. We do anticipate and we have seen the ability to get a little bit of an increase on our contract therapy rates, in particular as it relates to RUGS IV. So we expect to see an increase there.

Okay. Great.

A.J. Rice with Susquehanna Financial group.

Just had a couple more if I could ask. Thanks for the information on the CapEx. Do you have a target for free cash flow for 2011?

Yes, AJ. We've been in that 130 range, $130 million of free cash flow.

Okay. And maybe just comment on, I don't think you've done this yet. Obviously you did the Regency deal, maybe that's enough to keep you busy, but what is the acquisition JV environment look like? Obviously, there was a transaction by, I guess, I'd consider a peer with the rehab care. Did you look at that and what was your thought on that from Select's perspective?

Well, the environment for acquisitions and joint ventures I would just say this. You've seen two transactions in the LTAC space, our acquisition of Regency and then the Kindred Rehab Care. So I think that that does signal confidence in the major players in the LTAC business, which I certainly agree with. The question is whether other opportunities, I suspect there are. For us we'll really be focused on the full integration and bringing the margin to the Regency business up in 2011, so I wouldn't say that we are active in the area of acquisitions.

In terms of the Rehab Care Kindred deal, my comment is I think it's a good deal for probably both Kindred and for the Rehab Care shareholders and we did not look at that, in specific answer to your question, but I think it certainly is probably a good strategy for both companies. So we'll be looking at probably any transactions that we are likely to do are probably one-off, maybe smaller deals in both our outpatient or our rehab or our LTAC sides of our business and we'll stay focused on the Regency transaction and being supportive of the patient facility criteria, that hopefully something gets done in the near to mid-term.

Okay, all right, thanks a lot.

And at this time, with no further questions in queue, I would like to turn the conference over to Mr. Robert Ortenzio for the closing remarks.

I just want to thank everybody for their attendance on the call and the questions and we'll look forward to updating you in the next quarter.

Thank you for joining today's conference. That concludes your presentation. You may now disconnect. Good day.