Select Medical Holdings Corp (SEM) 2012 Q2 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 second-quarter 2012 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 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 Mr. Robert Ortenzio. You have the floor, sir.

Thank you, operator. Good morning, everyone, and thank you for joining us for Select Medical Holdings' second-quarter earnings conference call for 2012.

For our prepared remarks, I'll provide some overall highlights for the Company and our operating divisions. I'll then ask Marty Jackson, our Chief Financial Officer, to provide some additional financial details before opening the call for questions.

Earnings per fully diluted share increased to $0.31 in the second quarter compared to our reported earnings of $0.08 a share in the same quarter last year, and adjusted earnings per fully diluted share of $0.20, excluding the loss on early retirement of debt and related tax effect from the refinancing we completed in June 1, 2011.

Net revenue for the second quarter increased 7.4% to $750.2 million compared to the same quarter last year.

During the quarter, we generated approximately 74% of our revenues from our Specialty Hospitals segment, which includes both our long-term acute care and inpatient rehab hospitals, and 26% from our Outpatient Rehabilitation segment, which includes both our outpatient clinics and Contract Services.

Net revenue in our Specialty Hospitals for the second quarter increased 7.1% to $557.1 million compared to the same quarter last year. The increase was driven primarily by increases in patient volumes, increases in non-Medicare rates, and revenue from contracted labor services provided to the Baylor joint venture during the quarter.

Our patient days in the second quarter increased 2.8% to 336,016 days and overall occupancy rates were 71% in the second quarter compared to 70% in the same quarter last year. Specialty Hospital net revenue per patient day increased 3.3% to $1554 in the second quarter compared to $1505 per patient day in the same quarter last year. The increase in net revenue per patient day was driven primarily by an increase in our non-Medicare net revenue per patient day, primarily resulting from Medicaid bonus payments which we received during the quarter.

During the second quarter, approximately 84% of our specialty hospital revenue came from our long-term acute care hospitals, and 16% from our rehab hospitals.

Net revenue in our Outpatient Rehabilitation segment for the second quarter increased 8.2% to $193.1 million compared to the same quarter last year. Revenue in our clinic-based business, including our owned and managed clinics, increased 2.9% in the second quarter compared to the same quarter last year. The increase was driven by both volume growth in our own clinics -- owned clinics -- and revenue from contracted labor services provided to the Baylor joint venture. For our owned clinics, our net revenue per visit was flat at $102 per visit and patient visits increased 2% compared to the same quarter last year.

Revenue in our Contract Service business increased 26.6% in the second quarter compared to the same quarter last year. This increase was primarily the result of the addition of a group of new contracts that were added in the fourth quarter of last year. During the second quarter, approximately 74% of our outpatient revenue came from our owned and managed clinics, and 26% from our Contract Services.

Overall adjusted EBITDA for the second quarter increased by 10.4% to $110.3 million compared to $99.9 million in the same quarter last year, with overall adjusted EBITDA margins at 14.7% for the second quarter compared to 14.3% margins for the same quarter last year.

Specialty Hospital adjusted EBITDA for the second quarter increased 12.2% to $102.2 million compared to $91.1 million in the same quarter last year. Adjusted EBITDA margins for the Specialty Hospital segment were 18.3% compared to 17.5% in the same quarter last year. The improvement in adjusted EBITDA and margins in the quarter was the result of a 70 basis point improvement in bad debt expense compared to the same quarter last year, operating improvements attributable to the Regency hospitals we acquired in 2010, and the Medicaid bonus payments we received during the quarter.

Outpatient rehabilitation adjusted EBITDA for the second quarter increased 5.6% to $25.8 million compared to $24.5 million in the same quarter last year. Adjusted EBITDA margins for the Outpatient segment were 13.4% in the second quarter compared to 13.7% in the same quarter last year.

For the clinic portion of our business, adjusted EBITDA increased 3.7% to $21.6 million and adjusted EBITDA margins were up slightly at 15.1% compared to 15% in the same quarter last year.

For our Contract Services, adjusted EBITDA increased 16.3% to $4.3 million and adjusted EBITDA margins were 8.5% in the second quarter compared to 9.2% in the same quarter last year. Our Contract Services margin declined as a result of increased relative labor costs associated with lower productivity related to new business.

Before I turn the call over to Marty Jackson, I want to provide a couple updates since our first-quarter earnings call in May. On the regulatory front, CMS published the policies and payment rates for fiscal year 2013 for inpatient rehab PPS on July 30. The update included a net market basket increase of 1.9% to the standard rates effective October 1, 2012, as well as updating the relative wait and average length of stay for the various CMGs. We expect the impact to our consolidating rehab hospitals to be approximately 1.7%, based on our historical patient population.

On August 1, CMS released the final rule for LTACH PPS for fiscal year 2013. The final rule includes a net 1.7% market basket increase to the standard rates effective October 1, 2012 through December 28, 2012. Effective December 29, 2012, the standard federal rate will be reduced by 1.3% for the first year phased into the budget neutrality adjustment, producing a net market basket increase of 0.4% from fiscal year 2012 rates to fiscal year 2013 rates for the last nine months of fiscal year 2013.

The final rule included updates to the relative waits and average length of stay for the various MSLTACH DRGs. The final rule also included the implementation of very short stay outlier payment, effective December 29, 2012, and the extension of the 25% rule admissions threshold at current levels for an additional year.

We expect the overall impact to our LTACHs to be approximately 1.4% effective October 1, 2012, based on our historical patient population. This increase will essentially be offset by the budget neutrality adjustment that goes into effect December 29, 2012.

Finally, I will comment briefly on the situation at our Evansville hospital and the additional information we disclosed in the 10-Q filed yesterday. The subpoena we received this month seeks much of the same information as the request we received in April and May. As most of us in healthcare services know, these types of investigations tend to take a fair amount of time and follow a process of information gathering by the government. There isn't a lot of information or color we can add other than the substantial disclosures in our 10-Q. I will tell you that the requests have been limited to our one hospital in Evansville, and we have and will continue to cooperate with these investigations.

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 before we open it up for questions.

Thanks, Bob. Good morning.

For the second quarter, our operating expenses, which include our cost of service, general and administrative costs, and bad debt expense, increased 6.9% to $641.3 million compared to the same quarter last year. As a percentage of our net revenue, operating expenses for the quarter decreased 30 basis points to 85.5% compared to 85.8% in the same quarter last year.

Cost of services, a major component of which is labor, were $612.7 million in the second quarter. As a percent of net revenue, cost of services was 81.7% for the second quarter. This compares to 81.5% in the same quarter last year. The increase in cost of services as a percentage of net operating revenue resulted primarily from increased relative labor costs in our Outpatient Rehabilitation segment. This increase in relative labor costs resulted from the increased labor costs associated with the Baylor JV services agreement, increased staffing in our rehabilitation clinics and lower productivity in our Contract Services business.

The costs associated with contracted labor services provided to the Baylor JV in both of our business segments had a 70 basis point negative impact on our cost to services in the quarter. Excluding these costs, cost of services would have been 81% in the quarter compared to 81.1% in the same quarter last year.

G&A expense was $18.6 million in the second quarter, which as a percentage net revenue was 2.5% compared to $16.1 million, or 2.3% of revenue, for the same quarter last year. The primary reason for the increase in G&A is associated with the write-offs of costs associated with the senior note offering we withdrew from during the quarter and increased executive compensation.

Bad debt as a percentage of net revenue was 1.3% for the second quarter compared to 2% for the same quarter last year. The decrease in bad debt as a percent of revenue occurred across both of our operating segments and is attributable to the favorable collections experience of Accounts Receivable during the quarter.

As Bob mentioned, total adjusted EBITDA was $110.3 million for the second quarter and adjusted EBITDA margins was 14.7% compared to adjusted EBITDA of $99.9 million and 14.3% adjusted EBITDA margins in the same quarter last year.

Depreciation and amortization expense was $15.4 million in the second quarter compared to depreciation and amortization expense of $18 million in the same quarter last year. The decline in our depreciation and amortization expense is primarily the result of decreases in depreciation expense related to the assets acquired from HealthSouth, which has now been fully depreciated.

We generated $2.8 million in equity and earnings during the quarter, primarily attributable to the earnings from the Baylor JV, compared to a loss in the same quarter last year of $251,000.

Interest expense, net of interest income, was $23.8 million in the second quarter, down from $25.2 million in the same quarter last year. The reduction in interest expense is related to the lower interest rates on portions of the debt we refinanced during the second quarter of last year as well as lower average debt levels compared to the same quarter last year.

The Company recorded income tax expense of $27.7 million in the second quarter, which represents an effective tax rate of 38.2%. This compares to an effective rate of 44.4% in the same quarter last year. The decline in our effective tax rate is primarily the result of a higher effective tax rate in the same quarter last year associated with a hospital swap we had completed in January of 2011, a reduction in the provision for an uncertain tax position and a lower effective state tax rate.

Net income attributable to Select Medical holding's was $43.2 million in the second quarter and fully diluted earnings per share was $0.31. We ended the quarter with $1.35 billion of debt outstanding and $21.5 million of cash on the balance sheet. Our debt balances at the end of the quarter included $834.3 million of term loans outstanding, which is nettable ID, $345 million of the 7 5/8 senior sub nodes, $167.3 million of the Hold Co. senior floating rate notes, and the balance of $7.3 million consisting of miscellaneous debt.

Operating activities provided $110.6 million of cash flow in the second quarter, compared to $88.6 million in the second quarter last year. The provision of operating cash flow in the second quarter this year was primarily the result of cash earnings, reductions in our Accounts Receivable, and increases in our accrued expenses, which was offset in part by reductions in our Accounts Payable and deferred taxes.

Overall, we experienced a decline in days sales outstanding to 51 days as of June 30, 2012, and this compares to 57 days as of March 31, 2012. The decrease is primarily related to the timing of the periodic interim payments we receive from Medicare for the services provided at our specialty hospitals.

Operating activities provided $118.8 million of cash flow year-to-date. This compares to $83.5 million in the same period last year. The provision of cash was primarily the result of cash earnings, increase in income and deferred taxes, and increases in our accrued expenses, offset in part by a reduction in our Accounts Receivable and Accounts Payable.

Investing activities used $18.6 million of cash flow in the second quarter. The use of cash was related to property improvements and equipment purchases of $16.2 million, business investment payments of $2.2 million, and acquisition related payments of $200,000. Investing activities used $21.6 million of cash flow year-to-date. The use of cash was related to property improvements and equipment purchases of $27.9 million, business investment payments of $10 million related primarily to the additional investment in the Baylor JV and $200,000 in acquisition related payments. The use of cash was offset by $16.5 million in proceeds related to the sale of the building.

Financing activities used $79.8 million of cash in the second quarter. The use of cash resulted from $55 million in net repayments on our revolving credit facility, $21.1 million in repurchases of common stock, or $2.8 million in payments on other debt, $2.1 million amortization payment on our term loan, and $600,000 in distributions to non-controlling interest, offset in part by $1.2 million in proceeds from bank overdrafts and $500,000 in stock issuance proceeds.

Financing activities used $87.7 million of cash year-to-date. The use of cash resulted from $40 million in net repayments on our revolving credit facility, $46.8 million in repurchases of common stock, $4.2 million of amortization payments on the term loan, and $1.7 million in distributions to non-controlling interests, offset in part by $3.7 million in proceeds from bank overdrafts, $800,000 in net borrowings of other debt, and $500,000 in proceeds from the issuance of common stock.

During the second quarter, we repurchased 2,522,090 shares of our common stock in the open market for a total cost of $21.1 million, for an average price of $8.35, including transaction costs. Through June, we have spent a total of $163.6 million of the $250 million authorized under the share repurchase program to repurchase 22,490,389 shares of common stock at an average purchase price of $7.28 per share, including transaction costs.

In our earnings release, we also provided revised guidance for 2012, which includes net revenue in the range of $2.9 billion to $2.975 billion, adjusted EBITDA in the range of $400 million to $410 million, and EPS in the range of $1.01 to $1.06 per fully diluted share.

And finally, as many of you are aware, last week we initiated an offering through our lenders to raise up to $150 million in additional senior secured debt to refinance a portion of our $345 million existing 7 5/8 senior sub note that are due in 2015. We expect to update the market when the deal is finalized.

This concludes our prepared remarks and, at this time, we'd like to turn it back over to the operator to open up the call for questions.

(Operator Instructions) Frank Morgan, RBC Capital.

Just two knit picks and then I'll ask a bigger picture question. The tax rate and the run rate on equity income in the second quarter, is that a good rate for the second half of the year?

Yes, Frank, it is.

Okay. And then I guess a bigger -- a couple of bigger picture questions. I mean, obviously, a great quarter. The business is doing very well. But I'm just curious. Given what appears to be the political and budgetary headwinds in front of us, strategically, what do you really want to do over the next couple of quarters as you work your way through these uncertainties? Is it -- I mean, are you actually willing to commit new capital? Put new capital to work? Or is it mainly just sort of minding what you have right now?

And then secondly, also on the same line of questioning, just kind of your thoughts on the whole patient criteria. It seems like that's coming back to the light of day again. And how do you think about -- assess the odds of that happening this time? And does that, along with the political and budgetary issues, does that influence what you do from a strategic standpoint in the near term? Thanks.

Thanks, Frank. This is Bob. And two good questions. Let me address the first one, which is how we're thinking about strategy and particularly allocation of capital over the next couple of quarters. I think our general view right now is that probably not a great time to commit capital to any what I consider probably large or platform acquisitions at this time, just because we do have the uncertainty going into the election. We do have the moratorium going off of the -- for the LTACHs, at least at this point, through the CMS reg.

If you looked at our history, we typically, in terms of the allocation of capital, really try to take what the market is giving to us. And you heard from Marty's comments over the last year plus, we've used a lot of capital to buy back stock at very attractive rates. And so that's one opportunity.

The second opportunity is obviously to pay back debt if that becomes a good opportunity for us. And then the third is acquisitions. And, as I said, we're always looking and I think the opportunity would maybe be one-off or smaller acquisitions in markets where we want to expand, but over the next couple of quarters, I wouldn't look for us to make any kind of a big move in either of our business segments.

As to your second question, which is the patient facility criteria, as you know, and I think those people who follow the Company know, we continue to work with the American Hospital Association and probably up to probably a dozen US senators on the certification criteria for LTACH hospitals. And we've always been big supporters of the creation of those federal standards, which is tighten up the criteria for LTACHs somewhat.

I always get questions about what are the prospects of that moving because we've actually been attempting to do that for a couple of years now. And I think one of the things that has helped was the recent CMS rule because, in the final regulations, they did impose over a couple of year period the budget neutrality adjustment. This is a big overhang on the industry and I think that now that that has passed us and has taken care of through the CMS rule, I think it actually makes the passage of criteria perhaps somewhat easier because we can have a bill that hopefully scores better without the overhang and the weight of the budget neutrality adjustment, which was always prohibited in the LTACH legislation of 2007 and in the extension of in 2010. So we'll continue to support the AHA's efforts and hopefully what was the Roberts-Nelson bill and try to get that -- get some consensus on that and move it forward. We think that would be a very important step for the industry.

Is that responsive to your questions? Do you have any follow-ons?

Yes, I would just say one is, of these things between election, budget issues, and the criteria, is one of them more important than the other in terms of you making a move to -- a more aggressive move growing the business again or allocating capital?

Yes, I always think that the LTACH specific regulatory environment is probably the most important thing. So we don't know if there's going to be an opportunity to see this legislation get traction before the end of the year. As you know, there is a lame duck session where perhaps some things need to be done and perhaps that will be an opportunity and we will work and support the AHA in trying to move something. So I think that that's monumentally important because, if that can happen at the end of this year or sometime in next year, I think that really gives a lot of clarity to the industry and would really make me feel a lot more comfortable about committing the capital.

And we have a lot of other things that we can focus on now in the interim while that -- maybe we get some more clarity on that. You know, our rehab joint ventures and our outpatient business and -- are still good opportunities for us for growth. And we may have the opportunity to add to some of our -- add some beds to some of our hospitals that have been running full for the last couple of years while the moratorium was in place.

Okay. Thank you very much.

A.J. Rice, UBS.

Hello, everybody. Just maybe to make sure I'm understanding what you were just answering to Frank's question there. I know you were saying no big acquisitions. Are you saying development-wise, other than adding capacity with the moratorium expiring at the end of the year, you're probably going to go slow in opening new LTACHs? And I guess we've been in a moratorium for so long, I wondered if you had -- do you have plans on the drawing board for facilities, but just haven't been able to pursue over the last five years, or are you pretty much starting from scratch on that development side?

Yes, A.J., I think that you probably shouldn't look for us to commit a lot of capital toward the development of new LTACH hospitals. Those hospitals, if they were to be developed after January 1, would have to comply with the full 25% rule. So you still -- the 25% rule has only been extended for one year. So there is still some uncertainty around that.

Now, we do have opportunities to -- I think to increase bed complement at existing hospitals. And we are looking at those hospitals that have run pretty much full occupancy to see if there is opportunity from the real estate standpoint to add beds. We do have a number of our hospitals that enjoy relatively full occupancy with waiting lists. So that to us is probably the best opportunity for some growth through the middle or latter part of next year, which we can get started but we really can't do anything until January 1.

Right. Can you just comment a little bit, maybe an update, on the Baylor JV? It looks like from the line item that that must be doing pretty well at this point. And then I know there has been on-again, off-again discussions about potentially other JVs. As the uncertainty that you are alluding to -- it certainly seems to have picked up the amount of deals in the acute care side -- has it had any impact on people being more willing to work with you potentially on JVs?

The first part of your question, which was the Baylor JV, yes, I think that we could not be more pleased with how the Baylor JV has worked. I updated through the first quarter's conference call that we added two rehab hospitals to that JV through the acquisition of Global Rehab hospitals, one in Dallas and one in Fort Worth. So the Baylor JV now has four freestanding rehab hospitals as part of the JV. So, yes, we are pleased and we really view that as very much a model of joint ventures that we can do.

And so your second part of your question, which was do we see opportunities for joint ventures? We do very much. And the joint ventures that we've done and the ones we're looking at are primarily -- and I'll say primarily -- rehab -- inpatient and outpatient rehab. They may from time to time include LTACHs, but primarily they are rehab joint ventures in the post-acute. And we do see receptivities of systems and interested in having discussions and we're having discussions. I've said, in the past, I'm not pleased with the speed at which we have been able to add those, but I'm not unhappy with the joint ventures we've already done or the level of dialogue that we're having with some good systems. But we do get to need some of those brought across the finish line. And I certainly would commit capital and we are committing efforts to do that.

Okay. Maybe just the last one then on your -- when you think about capital deployment, you obviously have been buying stock in the first half. Is there any expectation baked into the guidance to continue to buy stock in the second half and, more broadly, what are the priorities for use of the free cash flow, looking at the second half and into next year?

Well, we never put -- we never factor in-stock buybacks into our guidance. So the guidance that we have -- the current guidance we have, like prior guidance, does not make any assumptions with respect to stock buybacks. And we will be -- continue to be opportunistic on stock buybacks, the direction and counsel with our Board of Directors.

The other opportunities for capital allocation is very much on joint ventures. I think that that would be probably the number one priority for us in allocation of capital. And then the other ones that I mentioned, whether it would be stock buybacks or debt repayments.

Okay. Thanks a lot.

Kevin Fischbeck, Bank of America Merrill Lynch.

Okay. Great. Thank you. You mentioned a Medicaid bonus payment in the quarter. How much was that?

Yes, Kevin, the Medicaid bonus payment was about $6.8 million. Now, a good portion of that was associated with that quarter. I think it's fair to say, if we took a look at moving out the prior-quarter adjustment, the revenue per patient day rate would still be in the mid-2% range -- 2.5% range as opposed to the 3.3%.

And so this is something that is going to also be kind of now more in the run rate, you're saying, going forward as well?

Yes.

Okay. And then you mentioned also that the margins in the LTACH business -- or the hospital business -- improved because of some of the improvement in Regency. Can you give us an update on what happened there?

Yes. Along the same lines, I think it's also fair to say that the Regency margins are now comparable to our select LTACH legacy margins.

Okay. And then as we think about that kind of 18% margin in the hospital business, that's getting pretty close to what we kind of -- what we normally think of as kind of normalized margins. Where do you think that those margins can go over time and what's the opportunity to continue to move them up?

That's the $64,000 question. I mean, the fact of the matter is we've got sequestration that we're still trying to understand exactly how that's going to happen come next year. Obviously, we've got the 1.25% BNA hit that we're going to have next year. So right now our focus is to try to make sure that we keep those margins. But come next year, I'm not so sure we're going to see any type of improvement in those margins.

Okay. I think that's fair. And how do you guys think about the guidance raise? Because you beat Q1 by $0.07, as we saw it, and then you beat Q2 by $0.07. Are you kind of updating the guidance basically for the first half of the year results? And if so, is there something the second half of the year where you kind of feel like there's a little bit more of a headwind or how do you think about the update?

Yes, I think what we've done is exactly as you said. I mean, we've taken a look at what we've actually done in the first half and assumed basically the guidance that was out there in the second half --

Okay.

-- And added those two together and then took a look at what type of stock we've actually purchased back to make adjustments on the EPS line.

Okay. I think that makes sense. And then last question, maybe just to go back to Frank's point -- or question earlier about the run rate on the equity earnings, and even I guess the minority interest line. I guess the last couple of quarters, you had talked about some higher costs on new contracts and costs associated with the Baylor joint venture. Are those now at normalized rates so that --? I kind of got the sense the last couple of quarters you were kind of ramping up the margins on Baylor. But if you're saying that the Q2 run rate on equity is the right run rate, we're kind of at a normalized margins there, I guess first. And then second on the minority interest line, can you remind me what assets are in those numbers because that number is also ramping up nicely? Is that going to continue or is has kind of reached an equilibrium as well?

Well, I think to the extent that we didn't grow the business any further, I think you could probably say it's pretty close to where it would -- where you can assume it would be the same going forward. But the fact of the matter is we're constantly taking a look to add additional business to the Baylor JV as well as our other JV partners. So from that perspective, I think you can expect to see it continue.

Now, the margin may change because, as we acquire new businesses, the margins may be less when we acquire them, and then the operators do their work and we're able to improve those margins.

Okay. All right. Thanks.

Gary Lieberman, Wells Fargo Securities.

Thanks, good morning. This is Ryan Halsted on for Gary. I guess, just my first question, any update on acuity? I think you said last quarter you saw some shift in acuity. I was curious if that -- if you saw a rebound or if that continued.

Yes, Ryan, this quarter was very similar to what we saw in the first quarter. So it was relatively flat.

Okay. And I guess also, last quarter, you mentioned some pressure on your salary line, I guess based on the acuity shift. Was there -- were you able to I guess adjust your staffing appropriately? It looked like labor was down a lot I guess as a percent of revenue.

Yes, we did see improvement in the second quarter.

Okay. Great. I guess then as far as integrated care, have you guys approached CMS about participating in any demos? Or how are you guys thinking about -- or have you begun thinking more about your position in that?

Well, like a lot of providers, we are monitoring it and we're trying to position ourselves in all of our various markets to make sure that whatever takes hold is something that we can obviously participate in. And when I think about that, I look at really at an individual market. So I obviously think we are very well positioned in central Pennsylvania, in Dallas-Fort Worth, and St. Louis, where we have joint ventures. I also think about our positioning being pretty good in most of our hospital-within-hospital markets, because we have smaller hospitals and we are close with general acute care hospitals, which will have to, one way or the other, lead the initiatives with whatever kind of final models take hold.

I'm not convinced that we're going to have a singular model that will apply equally across all markets. I think you can see different paths in different markets. So we really think about it on a market-by-market basis and not a global basis.

Okay. And I guess just following along with that, it seems like maybe some of the initial demos are even targeting specific subsets of patients. Is that sort of how you are seeing things? And do you anticipate it's going -- I guess is it going to continue sort of along in sort of a slow ramp, initial ramp, or is there going to be sort of greater aspirations with integrated care and bundle as far as post-acute?

My own view is that this will be slow and incremental and some of the things that are being looked at, perhaps in demonstration projects, will not get legs, and others may and there may be some that take hold that even at this moment are not visible to us. And it's not entirely clear to me that, in the future, that this necessarily have to be led exclusively by the government. You're going to see providers, perhaps in some markets, taking the lead themselves and working on unique models with commercial insurance and managed care.

Okay. Great. That's helpful. Thanks.

Whit Mayo, Robert Baird.

Good morning. Can you hear me?

Yes, we can hear you fine, Whit.

Great. Sorry. Marty, looking at the hospital operating cost per patient day in the quarter, based on my rough math, it looks like you saw an increase maybe 3% sequentially. And I think that may be a normal seasonal pattern, but is there anything else playing a role there? Mix? Just wondering if you think those operating costs flatten out for the rest of the year.

Yes, the only other thing you have playing in there is those -- we've talked about the pass-through from Baylor, and that's what you'll see there. You'll see that increased cost associated with that without any additional revenue. So it's really a zero margin business.

What is that pass-through cost? Can you remind me?

Yes, it's -- for the quarter, it was about $19 million.

Okay. That's helpful. Does that number get larger or stay the same for the rest of the year? Is that kind of a normalized number to think about?

Well, I think, based on the business that we currently have, if we didn't grow the business, I'd think that that's probably a pretty good number. But our expectation is we expect to continue to grow the business.

Yes. No. And back on the Medicaid bonus payment for a second, was there an associated expense with that revenue at all?

No, there was not.

Okay. And on the contract management business -- I think it was contract management -- you highlighted, I think, lower margins, maybe higher labor costs, loss of productivity on some business. Does that get any better any time soon, or do you think that takes a little while to really begin to see the productivity and efficiency improve?

Yes. What we've heard from the operators, it typically -- we had a large contract at the end of last year. It typically takes nine to 12 months to kind of make sure you fine-tune your staffing patterns, and just the logistics. So, we anticipate that probably starting next year we will see some improvement on the margins there.

Okay. And last question I had was -- I may have missed it -- but payor mix. Did you give that for the quarter? I don't know if you have it handy or not.

I think we did give it for the quarter. I don't think we've seen so much of a change there. Why don't I get back to you on that.

Yes. That's okay. Thanks.

Walter Branson, Regiment Capital.

Thanks. Just a couple of things. I want to make sure I understand your comments about the impact of the 2013 fiscal update on you versus CMS' estimates. Correct me if I'm wrong, but I believe CMS has estimated the total payments to LTACHs will increase by 1.7% for the fiscal year, including the impact of the budget neutrality adjustment. And you're estimating a 1.4% increase, starting October 1, which falls to zero -- effectively zero at the start of 2013 when the budget neutrality adjustment kicks in. Do I have those numbers right?

CMS is -- the 1.7% is before BNA.

Oh, it is? Okay.

Yes.

And is your -- your number of 1.4% falling to zero, does that include the high cost outlier changes?

Yes, that's everything included.

Okay. Thank you.

Miles Highsmith, RBC Capital.

Hey, Marty. Can you just update us on where your RP capacity stands at quarter end?

Miles, I don't have that in front of me. I'd have to -- I'll get back to on that.

That's fine. I think it was around $350 million last quarter. I assume, absent the share repurchase, nothing really moved that much in the net income you generated?

Yes, I don't think it's -- I think that's correct.

Okay. Thanks, guys.

Ladies and gentlemen, since there are no further questions in queue, I would now like to turn the call over to Mr. Ortenzio for closing remarks.

No closing remarks other than to thank you for joining us for the review and we will look forward to updating you again after the third quarter. Thank you very much.

Ladies and gentlemen, that concludes today's conference. Thank you for your participation. You may now disconnect. Have a wonderful day.