Select Medical Holdings Corp (SEM) 2015 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 2015 results and the Company's business outlook. Speaking today are the Company's Executive Chairman and Co-Founder 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 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 Medical'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 turn the conference call over to Mr. Robert Ortenzio. Please proceed, sir.

Thank you, Operator. Good morning, everyone. Thanks for joining us for Select Medical's third quarter earnings conference call for 2015. Prior to discussing the details of the quarter I would like to make a few general statements about our Q3 results. So our results for Q3 for very disappointing three of our four businesses did well. Our outpatient rehab clinic continued to grow patient visits with over a 5.3% growth on a same period year-over-year basis and EBITDA growth of 7.7% for the same period of time. Our inpatient rehab hospitals continue to grow nicely with increased revenue of over 8% on a same year-over-year basis and has several new joint venture hospitals. The Cleveland Clinic, and UCLA Cedar Sinai opening in the next two quarters.

Concentra has exceeded our expectations for its first full quarter and was the primary driver of the 34.7% top-line growth for the Company. Also, we are very excited about their future with Select. We also realized a significant return of over $29 million on our investment in NaviHealth, a post acute managed care company, which was sold to Cardinal Health this quarter. We did experience difficulties with our LTAC this quarter which was driven primarily by two issues associated with our move to patient criteria and a bad debt adjustment.

Important point I would like to make is that we consider all three of these issues as non-recurring in nature. I will now provide some overall highlights for the Company and our operating division and then ask our Chief Financial Officer, Marty Jackson, to provide some additional financial details before we open the call for questions. Net revenue increased 34.7% to $1.02 billion compared to $758.1 million in the same quarter last year. During the quarter we generated approximately 55% of our revenues from our specialty hospital segment which includes both our long-term acute care an inpatient rehab hospitals, 20% our Outpatient Rehabilitation segment which includes both our Outpatient Rehabilitation clinics and our contract therapy services, and 25% from our Concentra segment. Net revenue in our specialty hospitals for the third quarter increased 1.1% to $562.3 million compared to $556.3 million in the same quarter last year.

We generated approximately 81% of our specialty hospital revenue from our long-term acute care hospitals and 19% from our inpatient rehabilitation operations during the quarter. The growth in net revenue in our specialty hospitals is attributable to a 1.9% increase in patient days to over 338,000 patient days compared to 332,000 patient days in the same quarter last year. Our net revenue per patient day decreased to $1,522 per patient day in the third quarter compared to $1,543 per patient day in the same quarter last year and was driven by a increase in our Medicare net revenue per day.

The reduction in our Medicare net revenue per patient day was primarily caused by an anticipated change in our year-end cost report dates for our LTACs. In May of 2015 we received authorization from our largest fiscal intermediary to move a majority of our LTACs existing year-end cost reporting dates, which span all 12, to a single month cost report year-end date of August 31st.

We received similar approvals from all but one of our other fiscal intermediates for the remaining LTACs during the same time period. Based on the approvals to change year-end dates all of our hospitals with the exception of hospitals with an August 31st or August 31st year-end were required to file a stub, or shortened cost report, to bring hospitalities into alignment of the approved August 31st year-end. Many of these hospitalities had average length of stay below 25 days. As you know from a compliance standpoint LTACs must have an average length of stay of 25 days or greater for each of our hospitality's cost reporting periods to maintain their LTAC designation.

We incorporated changes in our admission process for those hospitals that were below 25 day length of stay calculation by pursuing patients with a much longer expected stays. This had the effect of reducing shorter stay patient volumes and increasing longer stay patient volumes in our fixed cost threshold category which had the effect of reducing our Medicare net revenue per patient day. Net revenue in our outpatient rehab segment for the third quarter declined to $199.6 million compared to $201.7 million in the same quart last year. The decrease is related to a reduction in revenue from our contract therapy operations which was offset by increases in our Outpatient Rehabilitation clinics.

Net revenue in our outpatient clinic base business increased 6% to $163.5 million compared to the same quarter last year. For our owned clinics patient visits increased 5.4% to over 1.3 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 therapy business in the third quarter increased to $36.1 million compared to $47.4 million in the same quarter last year, and resulted primarily from a large contract termination due to the sale of health facilities to a company that provided their own therapy services.

Net revenue in our Concentra segment for the third quarter was $259 million. Net revenue-generated in the Concentra centers was $225.5 million in the third quarter. For the Centers, patient visits were over $1.9 million and net revenue per visit was $114 in the third quarter. Concentra also generated $33.5 million in net revenue from its on-site clinics and community base the outpatient clinics in the quarter.

Overall adjusted EBITDA for the third quarter was $84.5 million compared to $86.8 million in the same quarter last year with overall adjusted EBITDA margins at 8.3% for the quarter compared to 11.5% for the same quarter last year. Specialty hospitality adjusted EBITDA for the third quarter was $53.7 million compared to $81 million in the same quarter last year. Specialty hospitality adjusted EBITDA margin was 9.5% compared to 14.6% in the same quarter last year.

In addition to our reduction in Medicare rate that I mentioned previously, our specialty hospitals experienced higher relative cost of services due to increased labor cost in the quarter. In July 2015 we received a letter from our largest fiscal intermediary rescinding the change in cost reporting dates and adjusting cost report periods back to their original periods.

We received similar letters from remaining fiscal intermediates in the year-end date changes they previously approved. These letters resulted in an acceleration of the hiring, training and education programs to address the higher acuity patients expected in a fully compliant LTAC population. This increased our nursing costs while nurses went through onboard training and program updates. In addition, our specialty hospitals saw a 70 basis points increase in bad debt in the third quarter compared to the same quarter last year.

Outpatient Rehabilitation adjusted EBITDA for the third quarter was $23.8 million compared to $23 million in the same quarter last year. Adjusted EBITDA margin for the outpatient segment was 11.9% in the third quarter compared to 11.4% in the same quarter last year. For the outpatient clinic portion of our business adjusted EBITDA increased to $22.5 million in the third quarter compared to $20.9 million in the same quarter last year. The increase was attributable to our volume growth and corresponding revenue.

For contract services adjusted EBITDA decreased to $1.3 million in the third quarter compared to $2.1 million in the same quart last year primarily a result of contract terminations I mentioned. Concentra adjusted EBITDA for the third quarter was $25.6 million and adjusted EBITDA margin was 9.9%. Income taxes in the third quarter included the one time gain of $29.6 million on the sale of an equity investment we had in NaviHealth that I mentioned earlier.

Our reported earnings per fully diluted share were $0.22 of this year compared to $0.20 in the same quarter last year. At this time I would like to provide you with on update on our post quarter activities. As most of you know, we began moving to LTACs patient criteria with three of our hospitals commencing in October. We will give you an early update on the progress of those hospitals. I need to be clear, however, that we have over 100 hospitals to move to criteria and the early results are not an indication of how all or most of our hospitals will progress.

Having said that, of the three hospitals that went into criteria on October 1st, two of the hospitals are located in the southern United States, one is a freestanding hospital and one is a hospital in a hospital. The third is in the western United States and is a hospital within a hospital. All three hospitals are now operating with 100% LTAC compliant patients with no site neutral census.

In addition, all three hospitals have replaced 100% of their lost census with compliant patients. I want to reiterate that while we are pleased with the early progress of our first three adopters we believe that implementation at all of our hospitals will not be smooth and we expect uneven results over the next year to 18 months. Also, as I just mentioned earlier, we are on track to open our new joint venture hospital with the Cleveland clinic at the end of this year and shortly thereafter our new joint venture rehab with UCLA in Cedars which is scheduled to open in late January.

Other signed joint venture deals where we inspect new openings in 2016 include TriHealth in Cincinnati, Ochsner in New Orleans. We are excited about adding these new facilities to our portfolio with our new partners and our pipeline for new deals remains strong. I will now turn it over to Marty Jackson for some additional financial highlights for the quarter.

Thanks, Bob. For the third quarter our operating expenses, which include our cost of services General and Administrative and bad debt expense, were $941.4 million compared to $674.5 million in the same quarter last year. Operating expenses in our Concentra segment were $247.4 million in the third quarter. As a percentage of our net revenue operating expenses for the third quarter increased to 92.2% compared to 89% in the same quarter last year.

The increase as a percent of net revenue is due to 320 basis points increase in cost of services. In addition, we had a 40 basis points increase in bad debt which was offset by 40 basis points reduction in G&A. Cost of services increased to $900.9 million for the third quarter compared to $644.4 million in the same quarter last year. Cost of services in our Concentra segment was $229.7 million in the third quarter.

As a percent of net revenue cost of services increased 320 basis points to 88.2% in the third quarter compared to 85% in the same quarter last year. The increase in cost of services a percent of net revenue was due to the incremental labor cost in our specialty hospital segment which was related to training and turn over in the quarter that Bob mentioned as well as higher cost of services in our recently acquired Concentra segment. G&A expense was $22.2 million in the third quarter which as a percent of net revenue was 2.2%.

This compares to $19.7 million, or 2.6% of net revenue for the same quarter last year. Bad debt as a percent of net revenue was 1.8% for the third quarter compared to 1.4% for the same quarter last year. The increase was the result of higher relative bad debt expense in our specialty hospitals in our Concentra segment in the quarter. Total adjusted EBITDA was $84.5 million and adjusted EBITDA margins were 8.3% for the third quarter.

This compares to adjusted EBITDA of $86.8 million and adjusted EBITDA margins of 11.5% in the same quarter last year. The adjusted EBITDA decline was a result of the decline in our specialty hospitals partially offset by the contribution from Concentra. As Bob mentioned, we had three primary issues that drove the increase in costs in our Specialty Hospitals. First, the move to change the year end cost report date had a negative impact of approximately $15 million on both reduced revenue and increased nursing expenses.

Second, we accelerated training, education and nurse onboarding associated with patient criteria that increased costs by approximately $5 million. And finally, we made adjustment to our specialty hospital bed debt reserves for approximately $4 million. Again, we consider all three of these expenses non-recurring items.

Depreciation and amortization expense was $31.5 million in the third quarter compared to $17.6 million in the same quarter last year. The increase resulted primarily from an incremental $13.3 million of depreciation and amortization expense in our Concentra segment. We generated $6.3 million in equity and earnings on consolidated subsidiaries during the third quarter compared to $2 million in the same quarter last year. The increase was mainly the result of a contribution from NaviHealth and our rehabilitation joint ventures where we own a minority interest.

As Bob mentioned we also had a gain on the sale of equity investment at $29.6 million in the third quarter this year related to NaviHealth. Interest expense was $33.1 million in the third quarter compared to $21.8 million in the same quarter last year. The increase in interest expense in the quarter as a result of the additional borrowings related to the financing of the Concentra acquisition. Company recorded income tax expense of $18.3 million in the third quarter. The effective tax rate for the quarter was 35.9% compared to the effective tax rate of 38.8% in the third quarter of last year.

Net income attributable to Select Medical Holdings was $29.4 million in the third quarter and fully diluted earnings per share was $0.22 compared to the fully diluted earnings-per-share of $0.20 in the same quarter last year. We ended the quarter with $2.35 billion of debt outstanding and $22.6 million of cash on the balance sheet which includes $12.7 million of cash at Concentra. Our debt balance at the end of the quarter included $750 million in select term loans, which includes the original issue discounts, $711 million of the select 6.375% senior notes which include issuance premiums.

$646 million in Concentra term loans which, again, include the original issued discount, $225 million in select revolver loans with the balance of $18 million consisting of miscellaneous debt. Operating activities provided $128.4 million of cash flow in the third quarter, a provision of operating cash is primarily driven by net income and non-cash items of expenses as well as decrease in accounts receivable and other assets and increases in our accrued expenses offset in part by a decrease in accounts payable deferred taxes. DSO was 52 days at September 30, 2015.

This compares to 55 days at June 30, 2015 and 53 days as of December 31, 2014. Investing activities used $13.2 million dollars of cash flow for the third quarter. The use of cash was related to $45 million in purchases of property and equipment, $2.7 million in investments and acquisition payments which was offset by $34.6 million of proceeds from the sale of equity investments and assets during the quarter. Financing activities used $117.8 million of cash during the quarter.

The use of cash was primarily the result of $95 million in net repayment of select revolver credit facility, $13.6 million of stock repurchases, $3.4 million in net repayments of other debt, $3.2 million dollars repayment of bank overdrafts and $3.2 million dollars in distributions to non-controlling interests. During the third quarter we repurchased just over a million shares of common stock at an average price of $13.20 which includes the transaction fees under our authorized share repurchase program.

Under the program we have spent a total of $314.8 million, a $500 million authorization and have repurchased 35.9 million shares. Additionally, I would like to outline our revised financial guidance for calendar year 2015 that was provided in our earnings release. This includes net revenue in the range of $3.675 billion to $3.725 billion, adjusted EBITDA in the range of $400 million to $410 million, and fully diluted earnings per share to be in the range of $0.92 to $0.97. This guidance assumes $575 million of revenue, $55 million of adjusted EBITDA and $0.01 earnings-per-share of contribution from Concentra. We also continue to assume $17 million in the adjusted EBITDA start-up loss in our specialty hospitality segment for the year. This concludes our prepared remarks and at this time we would like to turn it over to the Operator to open up the call for questions.

Thank you. (Operator Instructions). Your first question comes from the line of Frank Morgan with RBC. Please proceed.

Good morning. I would like to go back to the issue in the quarter. Could you talk about what you have seen since the stub period ended in terms of where your overall patient mix and your length of stay mix, sort of the distribution between normal short stay, and long stay outliers?

Yes. Frank, the stub period was a function of us moving to different cost report dates and given the fact we received notification from the FI that we are no longer able to do that, we have gone back to our normal operating procedure. So from a length of stay all of our hospitals, and we anticipate all of our hospitals will meet the 25 day length of stay and there won't be any issues there. With regards to short stay outliers and high cost outliers, we haven't seen the change in the mix there either.

Is it fair to say that you have already seen sort of a recovery now that you called out like $15 million as you look at sort of the run-rate of the business now since the patient population has stabilized would you say that you're back on track and you have recouped most of that $15 million that was sort of lost in the third quarter?

Well, what we have seen is, it was actually, when you say recoup, that was the one time impact that happened. I can tell you that if you take a look at prior to May when we started down this path of changing the year-end cost report dates, we had a very nice Medicare rate. That dropped precipitously in the July and continued into the August time frame. It bounced back in September and as of October, from what we can tell, it's back up to where it was prior to making these, you know, going down the path of attempting to make those changes.

Right. Yes. I guess recoup was a bad word. In terms of just the accelerated training and education and onboarding costs presumably there will be some portion of that $5 million that will probably always continue to be expend. So how should we think about that run-rate? What should that drop down to, the $5 million that you incurred in the quarter? What would be a normalized run-rate for that going forward?

Yes. You raise a good point, Frank. I mean the fact is that in our business there's turnover in our RNs, and so you are constantly going to be educating, going to be training the staff. But to give you a number it's probably less than a million dollars a quarter.

Okay.

You know, just a little information on the types of things that we're doing. I mean when you take a look at the training and the education that we're providing to our nurses, you know, a lot of it has to do with critical care certifications that's taking place. So a lot of our nurses, we're certifying them in critical care and that's really being provided by the, you know, that certification is really backed by the society of critical care medicine. We're also focused on pulmonary centers of excellence. So there's a lot of education happening there. And then finally just the onboarding of NIC/UCCU type nurses.

Yes.

Frank, this is Bob. It's a little hard. Your question is a good one and I know that that's what investors are looking at. You know, when you have as many hospitals as we have coming onto new criteria as they're coming, it's really sometimes difficult. I mean you could look at what we have done and said well, could we have done a better job with spreading the training cost over a longer period of time? Yes. Maybe. But we could have. How much more will we see in the future as we continue to go through the balance of this year and through the first half, three-quarters of next year? That number is a little soft.

I mean we're evaluating that on kind of a real-time basis as each hospital, you know, goes through its preparedness and then implements in terms of how quickly are they replacing their LTAC non compliant patients under the new criteria with compliant patients. If you're really getting an influx and you're replacing those patients faster we nay need to accelerate and train more. That's a good thing. Or, if you have a hospital that can't replace then because they're not clinically ready, that's a bad thing. We will have to spend money there.

So you know it does move around a little bit and this is, as Marty and I continue to use the term, choppiness in terms of implementation, that's really the genesis of that kind of term in our observation on how it's going.

We can assure you, Frank, that we will not see training cost of the magnitude that we have seen. A good portion of the training has taken place with that $5 million.

Okay. One more and I will hop off. Just in terms of the hospitals that have flipped over to criteria, certainly it's always good to be conservative. Is it more a function of just the fact there's something you see as maybe statistically out of the norm for these ones that have gone early or is it just concern over the sheer numbers that will be happening over the next several quarters? I will hop off. Thanks.

Yes. You know, the reason that I articulated where the hospitals were geographically in the United States and the fact that one a free standing and two were hospitals within a hospitals, to try to get a sense that there was not anything necessarily, I mean all hospitals are unique, but anything necessarily unique. I needed to provide all the caveats that, you know, the early success of those is certainly not an indication of future success of all of our hospitals and I think you're absolutely right.

You know, you can assume that the first three got a lot of attention and in the quarter we may have 30 hospitals go in, you know, you may have just some uneven results just as a function of attention. So I think the point that I would make relative to the first three is a point that I and Marty has made in the past is that we feel that we can get there. There may be some choppiness along the way and it's not a question of, you know, if we'll get most of our hospitals adjusted to the new criteria. It's really when. And it's a very big thing.

I think I said on the last conference call that this new criteria is really the biggest most significant systemic change to the LTAC, you know, division since I have been in the business back in the mid-90s.

Your next question comes from the line of Chris Rigg with Susquehanna Financial Group. Please proceed.

Good morning. Just want to follow up on a comment you just made, Bob, with regard to the choppiness. You know, you said something that I never really thought of for some facilities that I not be clinically ready versus others. I mean, when we think about the choppiness, is some of that going to be related to sort of you guys holding back a little bit at certain facilities? Just saying like for whatever reason this facility may not be ready to take on some level of new criteria patients or do you feel like generally speaking most facilities are ready today or will be ready at the time they're moving to the new criteria to take on whatever they can?

Well, it's a good question and we certainly want them to be ready at the time that they go in and we're making all preparations for them to be ready. But having said that, you know, it doesn't always work and I won't sit here and represent that it will work in every one of our hospitals at the time they go in because it clearly won't.

I mean it just won't. And to your first question is we often have what we call bed holds on hospitals that do not accept patients because they either don't have the clinical staff or don't have the preparedness or are not, you know, just don't have the resources that they have to take care of patients and we're really very dialed into our quality data and those things take president over all other things. So yes, if we're not ready the worst thing you can do is accept patients high acuity patients that you're staff is just not ready to care for.

So in those situations we may hold back. That's obviously not the preferred model of our business.

Right.

And we're doing all things that we can to be ready, including spending more than we would have liked in training this quarter. You know, so I hope that's responsive to the question.

Right. Right. It is. And then you touched on this a little. Can you give us a sense for in the 3 facilities that switched over, how the CMI of the patients sort of the none criteria patients that are no longer there compares to the surgeons, to the backfill admissions.

I will let Marty maybe look to the data a little more, but it's fair to say that on all of those facilities that are now running 100% complaint, LTAC compliant patients, the CMI has gone up. And it's exactly what we expected. It's what we knew would happen. As you are not taking the wound care patients and the lower acuity patients, you know, and you're taking patients that are either pulmonary or vent or right from the ICUs, you know, CMI is up.

Alright. And then, okay. Sorry.

Chris, with regards to that it's really kind of early to make that determination, but what we have done is we have really taken a look at the in-house CMI and what we have seen on average across the hospitals is about a 14 point expansion or increase in case mix. And when I say 14 points, I want to make sure that people understand it's not percentage increase. It's actually a 14 point increase. So if we're sitting with a case mix index of 1.2, the 14 points takes you to a 134.

Right. I guess and you may not have the data handy but some of the work that we have done would suggest that the none criteria patients, their CMI is more like .7 to .8 and the criteria patients are obviously closer to 1.4, maybe even a little higher. I guess is that directionally sort of what we should assume?

Yes. I think what you should assume is that probably, I can tell you what our population is, not what the industry is. I think you're probably right on the industry. For our population the non compliant are just a shade under. Just a shade under one. And at the higher end is probably just a little bit higher than that.

Got you. Okay. And then last question. I understand that the need to be conservative, or you're desire to be conservative with how things are going, you know, with regard to the phase in of things you get more facilities. But I guess, when I think about it, the profit that you're going to generate for each criteria patient is going to be substantially more than the profit you would have generated for the non compliant admissions and so I guess, I know you're not going to say you're going to generate maybe not the same amount of admissions, but is it fair to assume that within like a year or two you will be no worse than break even and sort of on an EBITDA basis maybe a little higher?

Yes. We anticipate that given the fact it's a higher acuity patient population some of the staff that we're bringing onboard is ICU, CCU type nurses. There's going to be increased costs so you're going to have staffing cost increases, I suspect, you will have some pharmacy costs, supply costs. So, while yes, you will see increased revenue coming from the compliant patient population I think you will see some increased costs. Now, whether that will expand the margin or not we'll just have to wait and see.

Got you okay. Thanks a lot.

Thanks, Chris.

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

Good morning, thanks for taking the question. Marty, could you just clarify one thing you said?You said in answer to the last question that for select the non compliant patient was just under 1.0 and then you said the higher end was higher than that. What was the number that you were referring to where the higher end is?

Yes. What I was referring to, Gary, is I was referring to the high-end that Chris had mentioned of the 1.4.

Okay. That's what I thought. I just wanted to make sure of that.

Yes.

So we have herd from a lot of acute care companies and it seems like one theme has just been pressure on labor and increased use of contract labor. You made a couple comments about labor. Are you seeing that trend? Are you concerned at all that might continue and put additional pressure on labor costs?

Yes. I would say that from a business standpoint of course we're concerned about that. I mean we are moving into a labor and nursing shortage and pressure. I don't think there's any question about that. And, you know, we compete more now than ever for the same labor as the acute care hospital. So while we might not see it in the same way that they do it we are all certainly seeing the same thing out in the marketplace and I think most companies for-profit, nonprofit, large or small, will tell you the same thing. So it is out there.

So you guys saw an increase in UC contract labor in the quarter?

We did. We see a little increase in there, but a portion of that, Gary, had to do with the fact that we were onboarding some of the nurses that had ICU, CCU that were going through Select training and consequently while we were paying them we were also paying agencies as far as taking care of the patients.

Got it. And then you mentioned a bad debt write-off. Could you give us a little more color on that?

Sure. What we had seen over the last quarter was an increase in a category we refer to as Medicare exhaust and we have seen that kind of creep up over the last two to three quarters and we had decided at this point in time just to take, I mean we're going to continue to pursue those claims but we're going to reserve it and we needed to increase the reserve and consequently solve that debt increase.

I haven't heard that term before. Medicare exhaust. What does that refer to?

Yes. Let me define what Medicare exhaust is. Medicare exhaust is where a patient is admitted in the hospital under Medicare being paid by Medicare but what they would do is exhaust their Medicare days and then what you have to do is go to the secondary insurance.

Got it. Okay. Great. Thanks very much.

Sure. Thanks, Gary.

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

Hi. Thanks. Back to the three facilities that have transitioned into criteria just to be clear are you saying that 100% of the census today is now ventilator and ICU?

We're saying that the 100% of the census today is compliant patients so whether they have either a three plus day ICU stay, or they have a discharge ERG from the short-term acute care hospital it indicates they will be on a vents for 96 hours. LTAC.

Great. And maybe it's impossible to answer this, but how do you think the short stay outliers would be trending on those facilities?

We have not noticed any change in the normal mix, Whit, between outliers either on the the short side or on the high cost side.

But it is early and you might expect that your short stay outliers might be less than the normal distribution in a totally non criteria hospital because some of your dominated by your pulmonary patients and perhaps longer stay patients. But we haven't that. We just don't have enough data.

Yes.

And back to your initial question just so we're clear when we talk about the compliant patients, 100% we're talking about on the Medicare side.

Yes.

Okay.

That's helpful. And is there anything when you look at the characteristics of those markets that are unique, similar, dissimilar to maybe some of your other markets and are there other LTACs in the markets? Is there something about the population? I guess I am trying to put this in context.

It's a good question and when we discussed and decided to put the three first three hospitals into the discussion as we did today to give a little bit more information transparency on how things are going we really tried to think about that and geographically they're different. One freestanding, two HIHs. I would say in one market we are the sole provider. In the other two markets we have competition. So when you stir it around and you kind of take a look at it from a couple different angles it's hard for me to say that these three hospitals have anything that I can see in common that would differentiate them from the rest of the hospitals in the Company's portfolio.

Got it. And I guess one the of the challenges that we have heard or this is something maybe new. I heard in the past months or so is just, you know, the host hospital actually, or the referring hospital has to tell you in fact that this patient does meet the criteria. Have you seen any challenge with getting hospitals to change some of their practices or discharge planning and just any comments just around that process?

Sure, Whit. Early on when we started down this process, that was certainly a challenge. But given the fact that we have been at it for, you know, 12, 18 months as far as collecting the ICU data, most of our hospitals are 100% compliant as far as collecting that data.

Okay. And maybe one last one. I want make sure I'm lined up with some of the joint ventures and just deals that you have coming out of the ground right now. Can you just remind us like what the rehab hospitals are that are going to be head winds or tail winds over the next year? What I'm really trying to think about is what the potential earnings opportunity could be into 2017? Because you have got substantial amount of activity underway.

Yes, we do. We have coming onboard fourth quarter, actually in December, Cleveland Clinic, which is a 60-bed rehab hospital and that's on the west side of Cleveland. And then next year the end of next year we should be coming onboard with another Cleveland Clinic rehab hospital on the east side. In the first quarter of 2016 we have UCLA Cedar Sinai coming onboard. That is a 138 bed rehab hospital right in the middle of Century City, which we're very excited about. And then in second quarter we have TriHealth down in Cincinnati. I think that is a 60 bed, also.

Okay. Should we expect? I'm just trying to think through the head winds and tail winds if we should see anything?

Yes, we're incurring pre-opening expenses right now on both Cleveland Clinic and UCLA Cedar Sinai.

That's in the $17 million.

That is in the $17 million number that's correct.

Okay.

And you will have start-up losses on those hospitals when they open until they get to break even.

Right.

Okay. Perfect. Thanks, guys.

But you are absolutely right. 2017 should be a very good year for joint venture transactions.

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

Great. Thanks. I don't know if it's too early or not, but is there any way to talk about the profitability of those three facilities in Q3? You were talking about before about case mix going up, potentially (inaudible) I mean did you see any change in the profitability of those assets versus what a normal LTAC or what those LTAC looked like previously?

Yes it's a little too early to tell right now, Kevin.

And as far as the, I forget what the word used was, choppiness or bumpiness, evens over the next year or 18 months as far as the transition, I mean how do you think about the profitability of just about the LTAC business itself? Do you think that LTAC EBITDA will be able to grow over the next year during this transition or do you think it will be flattish or down before it comes up? I mean just directionally how do we think about what LTAC profitability might like look like as you go through this transition?

I'll let Marty address maybe more specifically, but I don't have any expectation that the LTAC EBITDA profitability is going to go grow during the transition. You know, we have said that it's going to be choppy. It's the word we keep come back to so we're going to have some winners and we're going to have some laggards so net-net I can't imagine that we would see growth of EBITDA. You know, we're striving hard to maintain our level of profitability and we think the longer-term that these hospitals can have a nice profit profile, but I certainly wouldn't expect that through the latter part of this year and into next year.

Yes. Kevin, as far as profitability LTACs in 2016 I mean it really is a transition year for us and I would see it being, you know, down a little bit on the LTAC side.

And as we get up to the other end of that in 2017 is there an acceleration from there or is it, that's the base and now we're growing kind of what we expect off of that?

Yes. In 2017 we would expect to grow as we backfill the non compliant patients with compliant patients we would inspect to see improvement in the EBITDA number.

And also I think the improvement because the replacements of patients and a reset in the entire industry. Remember we're the first ones that are going through. I think many others in the industry are more back-end loaded own their cost reports so that you're going to have competitors in the market. A lot of the smaller providers I think some of the nonprofit by the time they go through them with some time I think there's a shakeout in a lot of markets. This is what I'm predicting that over the long-term not only will we be fine tuning our operations to take only compliant patients. There's going to be, in my estimation, significant change in the markets and so there will be more patients available for the remaining providers, those that are still standing.

I mean I like to keep coming back and reiterating that this is tough criteria. From a clinical standpoint and a marketing standpoint and a staffing standpoint I mean I think this is tough stuff. I don't think everyone is going to make it and I don't think that they're projected to make it whether it's by CMS or internal AHA resources. I think this is going to be a resetting and this industry, in my opinion, again, will look very different in the out years whether that's late 2017 and 2018.

I guess you guys were trying to change your fiscal year in part because you wanted to go along with everyone else at the same time having the same message out in the market and you didn't want to be potentially disadvantaged, I guess, during that time period. Which makes sense to me because of the disruption that's going to be happen at the peers and wanting to be transitioning when others are struggling makes sense. But I guess conversely, do you think going early may maybe helps these facilities? Are you seeing your competitors in those two markets where you did have competition, are they going out there and more aggressively going after these same patients or have they not done yet because their fiscal years are next year and they're not as focused on it? So you actually have a first move advantage in that scenario?

Well, I would like to think so, but I truly don't know. I mean it is very difficult to predict the behavior of your competitors. Particularly, I mean look, the two big companies that are in this space are high acuity providers and are going to be survivors in this, whenever they go in. But you're right. I mean it's hard to predict, there are clearly some providers that we observe in some of our markets that are small, not big companies, that to our perception are not doing anything for criteria at this time because they may be into the latter part of next year and they're just not doing it.

I think your point and I think you stated it very well. We first moved to change our cost report years because of concern that I had that we would be putting our hospitals at a competitive disadvantage relative to others. Unfortunately, we got approved and then disapproved which put us at a little bit of a disadvantage such that I wish hindsight we never would have applied for the move. And also I think it was reported by some that we were doing it because we were fearful or we weren't ready for the transition, which I think was an unfair characterization of really where we were. I mean we promoted the criteria.

We were supporters of the criteria. We knew it would be tough, but we knew that it had to happen to rationalize the industry. And now we're in it and we're going to have over the next couple, three four quarters we're going to have a tough choppy go of it to get all of our hospitals moved into criteria, but ultimately we will and I think with time we'll be successful.

And then last question. I guess I think your characterization of how things are going to go some will do well, some will struggle makes sense to me but the fact that you got three 100% in surprised me for the upside. So is there anything that you can take-away from where that volume came from that you can give us a little bit more color or comfort about the ability to do this at your other facilities? I know you talked about getting some but just is there any color you can provide about exactly where those came from and so we can get a sense yes, this is something that can be replicated in the market?

It's a good question and I think it's a right question for you to ask. That would be very difficult I think for us to characterize. I mean this is an execution business. I mean this is work on the ground. I mean and it's a number of different elements. It's clinical preparedness. I mean you have to have a safe, good environment for patients or you just will not get the referrals. So I think it starts there. And I think our focus, and I'm pleased with the one month, but I think it's focus by the resources that we have at corporate and more importantly I think the operators at the hospitals that they were in communication with their referral sources, they were prepared internally from a clinical standpoint to lose the non compliant patients and to replace those with complaint patients.

In terms of where they came from I mean with the new criteria it's not hard. They came from ICUs or they are pulmonary patients on vents. So, I can say with assuredness I know where they came were.

One more last question. I think you said 8% (inaudible) same store revenue. If I kind of do the math that implies LTAC revenue was down by half a percent or so in the quarter and obviously the rate change throughout the fiscal year has kind of skewed things. If we adjust for that change, do you know what LTACs revenue would have been up?

Yes. I want to make sure I understand the question, Kevin. If we would have used the same rate of Q3 of 2014 what would the (inaudible).

Yes.

LTACs were up on a volume basis 1.9%, I believe.

Is that for the hospital volume or LTAC volume?

That was the LTAC volume.

Okay. So that was up. So you would have had 1.9% up if the rates were flat year-over-year.

Yes.

Okay.

We can probably provide, there were 5,308 eight days. Patient days up on a same quarter year-over-year basis.

I think that's an important point. I mean look, we had a tough quarter and we're disappointed with the quarter, but you know what, when I look across things that I look at for the health of our Company and I say well, in a relatively tough environment in the LTACs we're up 1.9% on volume. I mean I take something from that. That makes me feel good because the other things I think we can control and we can get through. Things like additional costs or training. Now, a comment that was brought up before about nursing shortages. Those are kind of things that face the industry that sometimes there's not a lot you can do about, but I'm gratified that referrals and admissions were up in our LTAC. The rate, we can always be hurt by rate. I think we tried to explain that the best that we can.

Thank you.

Your next question comes from the line of A.J. Rice with UBS. Please proceed.

Thanks. Hello everybody. Maybe a few questions in other areas. So can you just give us a little bit more flavor for how you feel Concentra is doing anything new or different and your thoughts there? I know you raised your revenue a little built you are sort of holding the line on EBITDA. Any commentary around Concentra more?

Yes. As we indicated, A.J., we thought Concentra performed nicely. They really kind of beat our expectations. I think we're starting to see some synergy's take effect and we will continue to do that over the next couple of quarters and to achieve where we think we should be with Concentra.

It's a strong management team and we have a lot of confidence and their ability to execute is very good.

Okay. Another focus has been on LTAC criteria and obviously that's got the biggest impact on you. There are all these bundle payments initiatives which I guess would be more relevant to the rehab side of the house but wondered, are you guys participating in either the BPCI or the joint replacement initiatives, and any thoughts on that and the impact there or the opportunity?

No impact and I don't think we are not participating in any of those studies. But we're following it and I did talk about that bundling last quarter and I think as I said at the time, you know, it is a bundling program, but it still feels a little bit more like pay for performance to me than a true bundle program. But I think we're going to see bundling is certainly something that is the policy du jour and we are seeing a lot more activity around it and I think we're going to hear a lot more.

Okay. And then, this is a technical modeling question here. Contribution from unconsolidated subsidiaries. Obviously NaviHealth has been settling, that's been contributing. Do you have sort of a run-rate for the fourth quarter or next year that would be a good number to plug-in there?

Yes. Probably on a quarterly basis, A.J., probably $4 million a quarter.

Okay. Alright. That sounds great. Thanks a lot.

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

Hey. Good morning guys. Just had a couple of broader kind of qualitative questions. I know you talked before about the pie of potential patients being quite large. I'm just curious, you know, and realizing it's a small sample here early going have you seen or do you expect to see any incremental competition for these compliant patients either from less compliant LTACs or others like yourselves out there who are trying to capture these guys?

And then second question is for the patients you choose to not accept a non compliant patient, are there any implications from that from the standpoint of like, that discharge planner potentially being incrementally hesitant to send other potentially compliant patients your way? Is there anything to that or is that just not the right way to think about it? Thanks.

Your second question, Miles. I think that is a concern. I mean in a market that's competitive to your first question, yes, we will compete for LTACs compliant patients with other LTAC competitors in the market. And if they can take care of the patient as well as we can, then they will compete with us or I guess if they're geographically better situated they may compete with us. So yes, we expect to see competition.

And to your second point it is the right way to think about and it certainly is a concern. But we have made a determined decision, strategic decision, that where we want to position ourselves in our market is to be the provider for the high acuity post ICU pulmonary vent population. And we're going to be a very specialty provider in that way and hopefully we will distinguish ourselves in the market with the physicians and referral sources and the discharge planners. The answer to your question, absolutely.

We would be vulnerable to a competitor that says give me everything and I'll take care of it. It's easier. Right? And that's something we have to compete against. As I said behavior, I think the good news for us is we have smaller hospitals, often times HIHs. So I think the replacement numbers aren't that good and I think we will fare well as a specialty high acuity provider. I have also said, and I believe it, that I think the site neutral patients and the payment mechanism for the site neutral patient is going to be difficult to manage successfully. And so I think that by us having a little bit more of a narrow focus I believe we will be better off.

Great. Thank you.

And, ladies and gentlemen we have reached the end of our allotted time for questions and answers. I will now turn the call back over to Robert Ortenzio for closing remarks.

Thanks everybody for joining us and we are truly looking forward to next quarter's conference call.

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