Select Medical Holdings Corp (SEM) 2013 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 2013 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 performances 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 would like to turn the conference call over to Robert Ortenzio.

Thank you. Good morning, everyone. Thanks for joining us for Select Medical's third-quarter earnings conference call for 2013. For our prepared remarks I will provide some overall highlights for the Company and our operating divisions, and then ask our Chief Financial Officer, Marty Jackson, to provide some additional financial details before we open the call up for questions.

I wanted to first note that the results for the third quarter reflect Medicare payment changes that became effective on April 1, including a 2% reduction in Medicare payments that was implemented as part of the automatic reduction in federal spending mandated under the Budget Control Act of 2011, better known as Sequestration, and an increase from 25% to 50% in the Multiple Procedure Payment Reduction for therapy services as mandated by the American Taxpayer Relief Act of 2012, better known as MPPR. Sequestration and MPPR reduced both net operating revenues and adjusted EBITDA by approximately $7.2 million and $1.9 million, respectively, in the third quarter.

Net revenue for the third quarter was $722.8 million compared to $713.7 million in 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 our contract services.

Net revenue in our specialty hospitals for the third quarter increased slightly to $532.6 million, compared to $531.4 million the same quarter last year. This growth resulted primarily from increases in patient volume, offset by the 2% Medicare Sequestration cuts. The Medicare Sequestration reduction was $6.8 million in our specialty hospitals in the third quarter.

Our net revenue per patient day decline to $1,471 in the third quarter compared to $1,517 per patient day in the same quarter last year. The decline resulted from both the Medicare Sequestration cuts and a decrease in our average non-Medicare revenue per patient day.

Our patient days increased 2.2% to over 336,000 days in the third quarter compared to 329,000 days in the same quarter last year. And our occupancy was 71% in the third quarter compared to 69% same quarter last year.

We generated approximately 82% of our specialty hospital revenue from our long-term acute care hospitals and 18% in our inpatient rehabilitation hospitals' operations during the quarter.

Net revenue in our outpatient rehabilitation segment for the third quarter was $190.2 million, compared to $182.2 million in the same quarter last year. In the third quarter our outpatient rehab segment experienced a reduction in revenue of $400,000 due to the Medicare Sequestration cuts and $1.9 million due to Multiple Procedure Payment Reduction. We were able to increase our net revenue while offsetting reductions that resulted from the Sequestration cuts and the MPPR payment reduction.

During the third quarter we generated approximately 77% of our outpatient revenue from our owned and managed clinics and 23% from contract services. Net revenue on our outpatient clinic-based business including our owned and managed clinics increased 6.9% to $147.3 million compared to the same quarter last year.

For our owned clinics, patient visits increased 6% to 1.2 million visits compared to the same quarter last year. Our net revenue per visit was $103 in both the third quarter of this year and last year.

Net revenue in our contract services business in the third quarter declined $1.6 million to $42.9 million compared to the same quarter last year. The decline was related to both regulatory changes that affected the annual limit for therapy services, and reductions in the number of contracts in which services are provided.

Overall adjusted EBITDA for the third quarter was $80.4 million compared to $87.7 million in the same quarter last year, with overall adjusted EBITDA margin at 11.1% for the third quarter compare to 12.3% margin for the same quarter last year. Our decline in adjusted EBITDA and our adjusted EBITDA margin was primarily due to the Medicare Sequestration cuts and the MPPR payment reductions.

Specialty hospital adjusted EBITDA for the third quarter was $75.3 million compared to $83.7 million in the same quarter last year. Again, the primary reason for the decline in adjusted EBITDA in our specialty hospitals was due to Medicare Sequestration cuts and a decline in our non-Medicare payment rates, which were not able to be offset with a corresponding reduction in operating costs. Adjusted EBITDA margin for the specialty hospitals segment was 14.1% compared to 15.7% the same quarter last year.

Outpatient rehab adjusted EBITDA for the third quarter increased 6.2% to $21.6 million compared to $20.4 million in the same quarter last year. Adjusted EBITDA margin for the outpatient segment was 11.4% in the third quarter compared to 11.2% in the same quarter last year.

For the outpatient clinic portion of our business, adjusted EBITDA increased 7% to $19.1 million compared to $17.9 million in the same quarter last year. Adjusted EBITDA margin for our outpatient clinics was 13% for both the third quarter this year and last year. For contract services, adjusted EBITDA was $2.5 million for both the third quarter this year and last year, and the margin was 5.8% in the third quarter this year compared to 5.6% in the same quarter last year.

Our reported earnings per fully diluted share were $0.17 in both the third quarter of this year and last year. Our earnings per share in the third quarter of 2012 included nonrecurring loss on early retirement of debt. Excluding this loss and the related tax benefits, adjusted earnings per share was $0.20 for the third quarter of last year.

I also want to mention in conjunction with our earnings release yesterday afternoon the Company announced that our Board of Directors has declared a quarterly cash dividend of $0.10 per share at its meeting on October 30. The dividend is expected to be paid on or about November 22 to shareholders of record on November 12.

I will now turn it over to Marty to cover some additional financial highlights for the quarter.

Thanks, Bob. Good morning, everyone. As Bob, mentioned the impact from Sequestration and MPPR totaled $9.1 million in the quarter. Had we not experienced these Medicare payment reductions, net revenue would have increased 2.6% and adjusted EBITDA would have increased 2% in the quarter when compared to the same quarter last year.

For the third quarter, our operating expenses, which include our cost of services, general and administrative expense, and bad debt expense, increased 2.7% to $644.3 million, as compared to the same quarter last year. As a percentage of our net revenue, operating expenses for the third quarter was 89.2% compared to 87.9% in the same quarter last year.

Cost of services increased 3.1% to $617.3 million for the third quarter compared to the same quarter last year. The increase in cost of services was primarily due to an increase in patient volumes.

As a percent of net revenue, cost of services was 85.4% for the third quarter compared to 83.9% in the same quarter last year. The primary reason for the 150 basis point increase in our cost of services as a percentage of our net revenue were the Medicare payment reductions and decline in our non-Medicare rates. However, it is important to note that the operating costs in our specialty hospitals on a per patient day basis were actually down compared to the same quarter last year.

G&A expense was $17.7 million in the third quarter, which is as a percentage of net revenue 2.5%, compared to $17.1 million or 2.4% of revenue for the same quarter last year. Bad debt as a percentage of net revenue was 1.3% for the third quarter compared to 1.6% for the same quarter last year.

As Bob mentioned, total adjusted EBITDA was $80.4 million for the third quarter and adjusted EBITDA margins was 11.1%, compared to adjusted EBITDA of $87.7 million and 12.3% adjusted EBITDA margins in the same quarter last year. The primary reason for the decline in adjusted EBITDA and margins was the Medicare Sequestration and MPPR reductions previously discussed. Had we not experienced those reductions, adjusted EBITDA margin would have been 12.2% in the third quarter.

Depreciation and amortization expense was $16.2 million in the third quarter compared to $15.5 million in the same quarter last year. We had equity and losses of $179,000 during the third quarter compared to equity and earnings of $1.2 million in the same quarter last year. The decline was the result of losses incurred by startup companies in two new joint-venture rehab hospitals where we own a minority interest.

Interest expense was $21.3 million in the third quarter. This is down from $24.6 million in the same quarter last year. The reduction in interest expense is primarily related to lower interest rates on borrowings.

The Company recorded income tax of $15.8 million in the third quarter. The effective tax rate for the quarter was 38.5% compared to an effective tax rate of 39.2% in the third quarter of last year.

The decline in our effective tax rate has resulted from an increase in earnings of our consolidated subsidiaries where we have less than 100% ownership interest, that are taxed as pass-through entities in which we only record income taxes on our share of the income. This is offset in part by an increase in our state effective tax rates that has resulted from higher proportion of our income being generated in states with higher tax rates.

Net income attributable to Select Medical Holdings was $23.3 million in the third quarter, and fully diluted earnings per share was $0.17 in both the third quarter of this year and last year. Our earnings per share in the third quarter of 2012 included a nonrecurring loss on early retirement of debt. Excluding this loss and its related tax effect, adjusted earnings per share was $0.20 for the third quarter last year.

The Medicare payment reductions for Sequestration and MPPR had a $0.04 negative impact on fully diluted earnings per share in this quarter.

We ended the quarter with $1.49 billion of debt outstanding and $9.3 million of cash on the balance sheet. Our debt balances at the end of the quarter included close to $810 million in term loans, which is net of original issue discounts; $600 million in senior notes outstanding; $65 million which is located on our revolver; with the balance of $14.4 million consisting of other miscellaneous debt.

Operating activities provided $93.1 million of cash flow in the third quarter. The provision of cash resulted primarily from cash income generated in the quarter and increases for both accounts payable and accrued expenses, as well as cash tax payments that were less than our tax liability in the quarter. This was offset by increases in our accounts receivable, as days sales outstanding or DSO increased to 54 days as of September 30, 2013, compared to 51 days at June 30, 2013.

Investing activities used $21.2 million of cash flow for the third quarter. The use of cash included $17.4 million for the purchase of property and equipment and $3.7 million related to investments in businesses during the quarter.

Financing activities used $71.3 million of cash for the third quarter. The primary use of cash resulted from $40 million in net payments on our revolving credit facility; $14 million in dividend payments; and $12 million in repayments of bank overdrafts.

During the third quarter, we did not repurchase any shares of common stock under our authorized share repurchase program. Under the program we have spent a total of $173.6 million of the $350 million authorized and have repurchased 23.6 million shares.

I will conclude my comments by reaffirming the financial guidance for calendar-year 2013 that we provided in our earnings release. This includes net revenue in the range of $2.925 billion to $3.025 billion; adjusted EBITDA in the range of $375 million to $390 million; fully diluted adjusted earnings per share, which excludes losses on early retirement of debt and the related tax effects, to be in the range of $0.87 to $0.94 a share. This concludes our prepared remarks, and at this time we would like to turn it back to the operator to open the call for questions.

(Operator Instructions) A.J. Rice, UBS.

Hi, everybody. A couple of questions if I might. First of all, looking at pricing, year-to-year trends sequentially -- and maybe that is not the right way to look at it -- but it looks like the Sequestration impact and the MPPR impact must have been a little more pronounced somehow in the third quarter than the second. Or maybe there is some other factor there.

Because it looked like there was a little bit more of a pronounced dip in pricing. I just wondered if there was anything behind that.

A.J., we are going to have to take a look at that. From a sequential perspective we don't think there is anything more than that.

Okay. All right. Just making sure I understand on the buyback, so the $350 million that you have availability to early next year, I guess, the program. Does that include what was already available? Or is that new repurchase authorization?

No, that is what we have had in the past, A.J., up to the $350 million.

Okay, all right.

That was basically authorized by the Board back in -- I think it was in the February, March time frame.

Okay. All right, yes. (technical difficulty) remotely. Can you then finally just comment on -- obviously we have got two things looming out there in the next six months, the doc fix and then the proposed rule next spring. I know there has been talk about trying to get, for the long-term acute care side, patient criteria or facility criteria, whatever you want to call it, incorporated in one of those.

Is there any update on where things are -- how things are progressing? And your thoughts on that?

Yes, A.J., this is Bob. I don't have a great update; I can give you where I think things stand.

The Roberts-Nelson Bill, which has been around for some time now -- and just to remind you, the policy behind that was developed by the American Hospital Association, and they really formed the backbone of the provisions of the Roberts-Nelson Bill. And that has been out there.

We had always -- I think there had always been a hope by the AHA that that would be able to be attached to as a pay-for. There just has been some difficulty getting it scored, and I think that that is still an issue that is kicking around.

So I would suggest to you that there is still some chance that maybe that emerges at year-end, when we have perhaps a one-year fix, patch, to the doc fix -- which your guess is as good as mine whether that happens. If that doesn't happen, I think it becomes more of a regulatory issue for CMS in the spring.

When the rule comes out we may see some proposal. And CMS has signaled that they are taking another look and have a range of options and alternatives and things that they are looking at, some which probably are reasonably consistent with what is in Roberts-Nelson, and some that are not and are probably a bit more concerning to us.

But I guess I would say that there is a lot of discussion going on and perhaps an opportunity. From our standpoint we really would like to see the patient facility criteria come to the fore, either best case this year or in the spring through the regulatory rulemaking process, just so we can get some -- we would be much better off if we could get some certainty and some clarity around the industry.

Right. Okay. All right. Thanks a lot.

Thanks, A.J.

Frank Morgan, RBC Capital Markets.

Good morning. I was hoping you all could walk us through -- obviously you have had a lot of headwinds here. But when we think about 2014, understanding you don't want to talk about guidance, but in terms of what we should be thinking about, lapping through some of these negative effects you experienced this year, and then the 25% rule coming back in next year. But just any kind of conceptual high-level puts and takes that we should be thinking about as we tweak our numbers for 2014?

Sure, Frank, we can certainly take you through that. A couple different things in that area. Let's walk through the three major areas of impact, which would be Sequestration, MPPR as it exists today, and then the 25% rule.

So on Sequestration, Sequestration started April 1 and you have seen what it has done to us on a quarter over -- for the two quarters it has been in place so far. I think for next year you are going to have to make sure you put that in place for all four quarters.

The same thing with MPPR. MPPR started April 1 of this past year, and that is going to be in place for the full year next year.

And then taking a look at the 25% rule, we basically said that, including mitigation, we thought that it was going to cost us somewhere in the neighborhood of $15 million.

Okay. In terms of -- so that is a net number. Are there any incremental mitigation strategies that you have or are contemplating, to deal with either the Sequestration or MPPR?

Well, I think on both Sequestration and MPPR the operators are doing a good job. As I mentioned on the call, on a per patient day basis our costs are actually down. I mean we have got to continue to take a look and take every opportunity we can to reduce expenses, but other than that we don't really see an opportunity to do that.

I mean, if you take a look at the delta that you have seen between 2012 and 2013 in the third quarter, we saw almost 7,300 additional patient days and just a little bit less than 68,000 additional outpatient visits. Providing services for all those patients costs money.

So I mean, our focus is really to make sure that we attempt to get more efficient on a per patient day basis. But to try to recoup that entire cost, we just don't see that in the cards, at least in the next year or so.

Now, Frank, on the 25% rule, we have given you a number, an estimate after some level of mitigation. Now, are there opportunities there? Yes. I mean, there should be and there can be.

But you can appreciate that that is a much harder one for us to estimate. So the MPPR and the Sequestration is math; and the 25% rule obviously has different impacts across 109 hospitals for us. So we are working on plans for next year and strategies for mitigation.

So the net number we gave you after mitigation is an estimate, is a best estimate. But we are going to continue to work on that. And if there is opportunity we would obviously like to bring that down.

And as you can appreciate, there are ways to do that. We have to expand our referral network geographically and from different referral sources to mitigate that. I think it is possible that we can, but it is just difficult now to give a tighter number on that.

Understood. Then in terms of considering all those puts and takes, what about just either external growth or ramp-up? I know you did some de novos and made a couple acquisitions. Do you think that would be any kind of meaningful offset to these other headwinds we are dealing with?

Well, there will be some. Some of the deals that we have done and our new opening in Columbus was a new start, the Scottsdale hospital was a new start; and we hope to have an expansion, new beds in some of our other facilities.

We would probably like to get to another -- possible another deal or two for the latter part of this year or early next year. We are always looking at acquisition opportunities.

So yes, we are looking for ways and pushing on strategies to increase revenue. I would like it to be meaningful; but as you know in the business, oftentimes things are opportunistic. So we will look for opportunities, and we will keep our development pipeline moving and hopefully we can add some facilities.

That's fair. Let me ask one more and I will hop off. Just in terms of non-Medicare rate, I think you commented that might have been down. Just curious. Are you seeing anything on the non-Medicare book of business, either more active utilization review, or just any commentary there? And I will hop off. Thank you.

Sure. Frank, it's really a twofold issue. Think of it in terms of some rate reductions, in particular for us in the Medicaid side, and then also commercial. The three components we have in that non-Medicare rate would be commercial, Medicare HMO, and Medicaid.

So we have seen a bit of a reduction in the Medicaid and the commercial rate. In addition to that we have seen a mix shift, where we have seen an increase in the Medicare HMO and the Medicaid, and those rates are lower than the overall commercial rate.

Now, I will tell you that the commercial rate we are seeing is not all across the board. It is in specific areas. Hopefully that provides you with a little additional color.

Okay, thanks.

Kevin Fischbeck, Bank of America Merrill Lynch.

Good morning. This is actually Joanna Gajuk in for Kevin today. Just a question; I guess I would really like to hear your thoughts around what is going on in DC in terms of the next debt ceiling and discussions on a doc fix.

And from the perspective of potential, I guess, offers that they will be looking for, how you feel about postacute providers being positioned, and any color how you feel in terms of what types of proposals are more likely. I know that probably it's really hard to handicap, but any color that you can provide us with, that would be very helpful.

Well, I don't know that I can give you any better visibility than you might have on your own about the prospects for various pieces of legislation by year-end. I think most people believe that a doc fix will have to be done. Whether it is done by year-end or whether it is done sometime in January, we have all seen the deadlines get moved a bit.

And whether there is a grand bargain to do the doc fix on a permanent basis or year, I think most of what I am hearing is that they will get a one-year patch, as they have had done in previous years. So if that is true, then that piece of legislation would be looking for some offsets.

And the way we have tried to position the LTAC criteria is that it has its best chance of getting something done with the doc fix if it provides some offsets or some savings. They are not going to be meaningful in the context of the overall dollars needed to pay for the doc fix; but when they are looking for dollars they are doing some.

So the other thing is whether I see any opportunity for bigger postacute care reform. I think a lot of this stuff is really bigger really bigger ideas that wouldn't impact us in the near-term.

I mean, there are the conversations about out there about bundling and site-neutral provisions, and certain other value-based savings pools. I don't really see those as coming to the forefront in the near term. Those are all -- I would characterize as bigger ideas that would be in the out years.

So I think the action for the LTACs particularly is whether there is any momentum for the Roberts-Nelson Bill or something like it in conjunction with the doc fix. And I would suspect that that has a lot to do with what kind of savings CBO would view that as generating.

Great, thanks. Just on the quarter in terms of any color you might provide about the volumes, which were better than what we thought; and I guess it sounds like you guys were also happy with where volumes were trending this quarter; and I guess second quarter was also pretty good.

So I know that at that time of year we are not really able to say what was causing that, given that overall I guess healthcare utilization in general is weak. But any additional comments you can make around maybe the different regions? Or anything you can provide us with in terms of the volumes in the quarter. Thank you.

No, I think all we will say is that the operators have done a great job making sure that they continue to educate case managers, physicians as to the benefits of the services that Select provides.

Okay. If I just might squeeze a very quick one on the Baylor JV, since some of these numbers that I guess are being lumped together with Baylor JV are -- it sounds like they still are being -- they are still generating losses there. But can you give us color how that JV is surviving there?

I would tell you that we are very pleased with how that joint venture and, speaking more broadly, all of our joint ventures are performing. Particularly the Baylor JV has grown considerably since we first have done it, and we hope to be able to continue to grow inside that very large market, which is the Dallas and the Metroplex.

It is a great region for us. It is seeing a lot of growth, and we think there is still potential to continue to grow there.

Great. Thank you so much.

Chris Rigg, Susquehanna International Group.

Good morning, thanks for taking my questions; and I apologize I did get on here a little bit late. But when I look at your admissions growth and patient date growth, obviously the facility count is stable but the facility mix has shifted. Is that a reasonable proxy for same-store admission patient day growth? Or any way to provide some color there would be helpful.

Yes, Chris, I think if you take a look at same-store -- and you probably saw the mix shift where we reduced the number of LTACs, increased the number of rehabs.

Yes. That's what I was talking about.

We did -- on a same-store basis we actually had a nice increase, about a 2.8% increase on a same-store basis.

And that is combined LTAC and IRF?

Yes.

Okay. Then to Frank's question earlier about top-line growth and just general strategy there, is it the regulatory environment that is keeping you moving at a measured pace? Or once you get visibility on what is going on in the LTAC side or even the inpatient rehab side it might -- that would be the catalyst to start moving more aggressively one way or another?

I would say that is absolutely right on, particularly on the LTAC. I mean, I think we have some pretty good visibility on the rehab. But the LTAC, which is our largest division, probably would have -- but for the really lack of clarity would have some pretty good opportunities there.

And we really have taken a much more measured, conservative approach until we see what happens in year-end or in the spring. Because these things could be some things that provide some opportunities, but to move ahead of that in our mind just doesn't seem to make a lot of sense.

We discussed this a lot at the last quarter's conference call, and I think that that is exactly what you see, is the strategy emerging for the Company. At the end of 2012 we paid a large one-time dividend, and we went on a normalized dividend of $0.10 a share. We are trying to be conservative about allocating our capital and waiting to get some level of clarity on the regulatory environment, particularly on the LTAC side.

Because the environment that we have been in, looking at all the ideas and proposals that have been out there, just are not a great environment for us to make big commitments of capital or strategy in that direction.

Okay. Then just a quick follow-up on that. On the LTAC side, from an organic or de novo standpoint, do you sense that there is sufficient demand with regard to just the industry in general? That if you wanted to move forward with the more aggressive de novo policy, that those opportunities do exist; it's not just M&A?

Well, I think they do exist. But again, that depends on what the ultimate criteria looks like.

I mean, that will really define the market. As the LTACs are defined more or less narrowly, that is going to define the market. And then we would be in a position to -- I think as well as anyone else out there, would be in a position to move forward and capitalize on the need.

Okay, great. Thanks a lot.

Gary Lieberman, Wells Fargo.

Good morning, thanks for taking my questions. Bob, I think it sounded like from some of your comments that perhaps the industry or you guys have had some conversations with CMS. Is that right? Or is there anything, any color you could give us on that?

No, I can't report that we have had any conversations with CMS. We tend to pay close attention to any of the narrative that comes out of CMS. And not only just the rules and the proposed rules, but from time to time they publish their thoughts or their musings about what they may be thinking about doing in the future. So we pay pretty close attention to that.

On the positive side, we sense that there is maybe an opportunity that something will be done here over the next either 3 to 10 months. But on the other hand, there are some things that are coming out of that discussion that appear to us to be relatively arbitrary and potentially concerning to us. So it is two sides of the coin.

I guess is there anything specific -- I'm sorry. Go ahead.

Yes, I don't know how -- it depends how you define specific. I mean, there are some ideas out there that are being considered. So for example, CMS in some of their narrative has suggested that there's five types of patients that would presumptively qualify for LTAC hospital care. And we are in total agreement over that, for example.

Of concern to us is an idea that is a requiring that LTACs have an ICU stay prior to admission. That would be, we consider, fairly arbitrary and maybe not a good proxy for acuity. So that is a potential concern to us.

So as is usually the case, before there is any kind of significant regulatory or even legislation you start to hear a lot of chatter, discussion, about it and some of the stuff is good and some of the stuff is concerning. I think that is the environment that we are in right now and we are likely to be in, either at year-end when something gets done or through the rulemaking process next spring.

Okay. Then, Marty, from a guidance perspective, the range is fairly wide. Are there a couple of things or a handful of things that you are keeping in mind that could be the biggest drivers of the variation there?

Well, Gary, as you know, what we do is we do not provide quarterly guidance. It is really on an annual basis. And we feel comfortable that we will be within that range. Given where we are today, given some of the additional impact of Sequestration and MPPR, it is probably at the lower end of the range.

Okay. Then finally on the expenses, it looked like salaries and benefits -- at least it was a little bit higher than what we were including in our model. Was there anything specific? Or were you guys happy with the way it came out in the quarter?

I think, I guess the question for you, Gary, is -- what did you look at as far as increase in volume? When we take a look at the increased volume that we had, we were actually pretty happy with where we were.

And again the way we take a look at that is really on a per patient day basis, the expenses associated with that, and including SW&B. And it was actually down on a same-quarter year-over-year basis.

Right. Okay, thanks very much.

Sure.

Matthew Gilmore, Robert Baird.

Hey, good morning, everyone. This is just one quick follow-up to the admitting criteria discussion. But I was just curious if you had any sense for how committed CMS was to that ICU component. Maybe it is a little bit early to ask, but just curious given that it seems somewhat arbitrary.

Yes, I have no reason to think that they are absolutely committed to it. I think we have seen these things in the past where it's -- I really don't even know how to characterize it. It is narrative, it is discussion, it is ideas; so I don't think there is any way to know how committed they are to it.

I would think that some of it, given the severity of it, is probably not 100% committed to it. So I think that that is really a starting point for probably a lot of discussion that is going on inside CMS and probably in the industry as well. That is my best guess, although you don't really get a lot of information coming out of the agency on these things.

Then you also mentioned the opportunity to potentially add some beds next year to some of the LTACs with higher occupancy. Is there any way to size up either how many beds you could be looking to add, or maybe how many of your LTACs are running at occupancy levels where it would make sense to add some beds?

Yes, I think we may have stated in the past that it is probably in the range of 150 to 200 beds.

In terms of what could hit in 2014 or what (multiple speakers)?

Yes, something that could hit in 2014.

Okay. And the last question, the equity earnings line obviously was negative this quarter, and I think it has been running $1 million to $2 million. Is this -- the loss that you saw this quarter, will that reverse rather quickly or will that take time to get back to positive territory?

Well, I think it should be back to positive territory relatively soon. I think one of the issues had to do with some startup hospitals where we have some minority interest in. And I anticipate that over the next quarter or two that those will turn positive, and you will see that line in total turn positive.

Okay, thanks a lot.

Sure.

Blake Goodner, Bridger.

Yes, good afternoon or good morning. Just real quick, two questions. The first one is, as it relates to the patient functional criteria, CMS I think has been out suggesting as few as 30% of the LTAC admissions should qualify. But then the Roberts Bill has a plan to, I think, reduce industry volumes by as little as like 10%.

I am wondering what you would be willing to give up to get this clarity and visibility so that you could pursue your strategy. I am wondering what percentage of volumes you would be willing to give up, recognizing there's a lot of things you can do and a lot of opportunities ahead. Thanks.

If you look -- the question, directed about not really so much the industry but Select Medical specifically, we have probably among the highest-acuity patients in the industry. So when there is discussion about what percent of the patients should not be qualified, whether it is 10% or 20% or 30%, the impact is not going to be equal across the industry.

I have said in the past and I will reiterate that we would be willing to give up some volume in exchange for certainty and clarity around the regulations and stability on a go-forward basis. Because it would enable us to be a little bit more thoughtful about capital allocation and growth opportunities.

I really can't comment on what we would be willing to give up. The fact of the matter is that if Select would be penalized with a big loss of our volume, I think it is fair to say it would even be more dramatic across the industry.

But having said all that, I think generally when you look at industry statistics, there is some percentage of patients that probably should be excluded from the higher-cost LTAC segment, and I think Roberts-Nelson tries to get at that. Now, is there some space above that? I don't know; that is kind of a bigger policy question. But I will say that we would be willing to give up some volume in exchange for certainty.

Then the other question is just, I heard you suggested that the 25% rule would have a negative $15 million impact after mitigation next year. But in the March 10-Q there was some disclosure that suggested, with execution of successful mitigation strategies, the impact on 2014 would be between $5 million and $10 million. So I am just confused a little as to why that has increased so much.

Well, as I said I think in response to Frank's question, the 25% mitigation strategy is a moving target. It is one thing when it was theoretical and you have your hospitals at any one point in time. We could take a snapshot of what percentage of patients come from or are in excess of 25%, or 50%; and that is different than it is during another snapshot period.

So it doesn't surprise me that that number has moved around a bit. We are probably -- I think now we are trying to be conservative about what the impact would be, and we are also working hard to mitigate it as much as possible. So that number is going to move around.

And we also talked about how the impact of the 25% rule doesn't affect all the hospitals equally or on the same time. So there is a timing difference as well, because it is only implemented coincident with the cost reporting years, and all of our hospitals have different cost reporting years. So depending on what point in time we are looking at it, that number could move a little bit.

But I think for your purposes, you should look at the current -- the current number that we have given you is our best estimate; and I suspect that after Q4 and going into next year, when the impact of the regulation really hits, we will update that number.

Okay. Then lastly MedPAC also talked about the SSO as something -- the short-stay outlier policy as something they were looking at. Is that something that is on the table as part of these negotiations on the same parallel process as the patient functional criteria? Or is that not something you expect to be changed?

Well, I really have no idea. And the only thing I would caution you on is a characterization of this as a negotiation. I mean, there really just is no negotiation.

This is the industry trying to I think put forth, or the AHA or others trying to put forth, ideas or suggestions. And that's frankly MedPAC's role as well, to be a recommending agency to the true policymakers, which would either be the relevant committees, which would be House Ways and Means and Senate Finance, or the regulators, which would be CMS.

And each have their own ideas, kind of big ideas and then kind of more smaller reimbursement cut ideas. So the industry really doesn't get to play a role in negotiating with either of those bodies, other than making some suggestions.

But yes, there are lots of ideas out there. And the more that they are being talked about -- I said before I think I sense that there is at least an opportunity here to actually get something done that would give us some certainty and clarity.

Got it. Thanks.

Kevin Fischbeck, Bank of America, Merrill Lynch.

Thank you, just a follow-up to the commentary around the 25% rule impact, that now it seems like maybe it's higher than what you guys thought three months ago. But any change to the view around the impact in this year? Because I believe that last time we spoke the Company was talking about less than a $1 million impact in calendar 2013. So has that number changed as well?

No, it has not.

Great, thank you.

Sir, you have no more questions at this time. I would now like to turn the call over to Robert for closing remarks.

Thank you for joining us for this quarter's results, and we will look forward to updating you at year-end.

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