Select Medical Holdings Corp (SEM) 2016 Q2 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 second-quarter 2016 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 your questions.

Before we get started, we would like to remind you that this conference 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 will turn the conference over to Mr. Robert Ortenzio.

Thank you, operator.

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

Before I provide the details on our second-quarter results, I wanted to summarize for investors some of the significant activity we had in the second quarter. Of course, we had the continued implementation process for the LTAC hospitals going into Patient Criteria during the quarter, as well as the fine-tuning of the LTACHs that had previously transitioned to Criteria. In addition, we are integrating the LTACHs that we received through the previously announced swap with Kindred Healthcare in June.

On the inpatient rehab side of the Business, we recently opened two new rehab hospitals, one with our joint venture partners, UCLA and Cedars-Sinai in Los Angeles, California, and the second one with TriHealth in Cincinnati, Ohio. We also continue to build census in the rehab hospital that we opened with Cleveland Clinic, our joint venture partner, and that hospital opened last year.

Our outpatient business is continuing to integrate the Physiotherapy operations we acquired in March, as well as to provide transition services for the contract therapy business that we sold at the end of the first quarter. Finally, we continue to realize additional synergies through the integration of our Concentra business segment.

With that, I will now cover some of the highlights for the quarter. Net revenue for the second quarter increased 23.7% to $1.1 billion compared to $887.1 million in the same quarter last year. During the quarter, we generated approximately 54% of our revenues from our specialty hospital segment, which includes both our long-term acute care and inpatient rehab business; 23% from our outpatient rehabilitation segment; and 23% from our Concentra segment.

Net revenue in our specialty hospitals decreased 1.1% in the second quarter to $585.8 million compared to $592.3 million in the same quarter last year. The decline in net revenue was driven by the decline in patient days.

Patient days were 317,000 days compared to 344,000 days in the same quarter last year. The decrease resulted from a decline in occupancy in our LTAC hospitals that are transitioning to Patient Criteria and hospital closures. We owned 105 LTAC hospitals at June 30, 2016, 72 of which were operating under the new Patient Criteria regulations.

The decline in net revenue, due to the reduction in our patient days, was offset, in part, by an increase in our net revenue per patient day, which was $1,680 per day in the second quarter compared to $1,590 per day in the same quarter last year. The increase was primarily driven by an increase in our Medicare revenue per patient day, principally due to an increase in patient acuity at our LTACHs now operating under Patient Criteria.

Net revenue in our outpatient rehabilitation segment for the second quarter increased 23.6% to $256.9 million compared to $207.8 million in the same quarter last year. The increase is the result of additional volume from our Physiotherapy clinics, which we acquired during the first quarter of this year, as well as growth in our existing clinics. So it's partially offset by the sale of our contract therapy business at the end of the first quarter. For our owned clinics, patient visits increased to over 2.12 million visits compared to 1.34 million visits in the same quarter last year.

Our net revenue per visit was $102 in the second quarter of this year, compared to $103 per visit the same quarter last year. The slight decrease in net revenue per visit was the result of the acquired Physio clinics having a lower average net revenue per visit.

Net revenue in our Concentra segment for the second quarter was $254.9 million, including $222.6 million from the medical centers and $32.3 million balance coming from the on-site clinics, community-based outpatient clinics, and other services. For the centers, patient visits were over 1.89 million and net revenue per visit was $118 in the second quarter. From the second quarter of last year, which includes the results from our Concentra segment beginning at June 1, we had approximately 674,000 visits and net revenue per visit of $112.

Overall adjusted EBITDA for the second quarter was $141.5 million compared to $114.9 million in the same quarter last year, with overall adjusted EBITDA margin at 12.9% for the second quarter compared to 13% margin the same quarter last year. Specialty hospital adjusted EBITDA for the second quarter was $82.7 million compared to $91.4 million in the same quarter last year.

Adjusted EBITDA margin for the specialty hospital segment was 14.1% compared to 15.4% in the same quarter last year. The decline in adjusted EBITDA was primarily due to a decline in our long-term acute care hospitals related to the volume declines previously mentioned. Also, incurred adjusted EBITDA start-up losses of $6.6 million in our new inpatient rehab hospitals, an additional $2.8 million in adjusted EBITDA losses related to the closed hospitals during the second quarter.

Outpatient rehabilitation adjusted EBITDA for the second quarter increased 32.8% to $38.1 million compared to $28.7 million the same quarter last year. The increase resulted from our newly acquired clinics, as well as the growth of our existing clinics, offset slightly by the sale of our contract therapy business.

Adjusted EBITDA margin for the outpatient segment was 14.8% in the second quarter compared to 13.8% in the same quarter last year. The increase in adjusted EBITDA margin was primarily the result of divestiture of our contract therapy business, which had a lower adjusted EBITDA margin than our outpatient clinic business.

Concentra adjusted EBITDA for the second quarter was $43 million and adjusted EBITDA margin was 16.9%. Concentra had $11.2 million of adjusted EBITDA and 12.9% margin in the same quarter last year, under our ownership beginning June 1, 2015.

Our reported earnings per fully diluted share were $0.26 in the second quarter this year, compared to $0.28 in the same quarter last year. We had a non-operating gain of $13 million in the quarter related to the sale and exchange of businesses. Excluding a non-operating gain in related tax effects, earnings per fully diluted share would have been $0.23 in the second quarter of this year.

Finally, I would like to provide you with a few updates since our last earnings call in May. On the regulatory front, late last week, CMS published the final rules for FY17 for inpatient rehab hospitals. Standard payment rate was increased approximately 1.5%, which was slightly better than the proposed rule. Earlier this week, CMS published the final rules for FY17 for LTACHs; standard federal rate was increased approximately 1.7%.

In addition to the LTACH payment rate update, CMS made changes to the 25% rule that combined two previously separate rules. The full implementation of the 25% rule is now scheduled to go into effect for cost reporting periods, beginning on or after July 1, 2016, for freestanding LTACHs, and on or after October 1, 2016, for the balance of RHIHs. On a side note, in July, the Ways & Means Committee unanimously approved a bill which would once again raise the 25% rule to 50%, and we are hopeful that that rule gets passed -- that gets passed sometime in the fall.

I also wanted to make a brief comment about CMS proposed expansion of their mandatory bundling programs. First of all, these programs just came out, and we're still evaluating how these new policies are going to work and what it will mean to Select Medical. I do think these new policies are likely to make general acute care hospitals pay more attention to the post-acute care continuum, and that's not necessarily a bad thing for Select. I also think, from a public policy perspective, for the past several years CMS has been trying to discourage readmissions from post-acute back to general acute care hospitals, and these policies may help with that.

As you know, Select Medical is privileged to work with some of the best hospital systems in the country, and many of our post-acute care facilities are joint ventures with these systems. So we already have some established close working relationships with our referring general acute care hospitals to ensure that we provide high-quality, cost-effective care. I think this is a situation where Select can benefit, since we have already have these established relationships and partnerships.

As we previously announced, in June we completed a hospital exchange with Kindred, where we transferred five LTAC hospitals to Kindred in exchange for three LTAC hospitals, including two hospitals in Cleveland, Ohio, and one in Atlanta, Georgia. On July 1, we contributed the two LTACHs in Cleveland acquired in the Kindred Hospital exchange and the two LTACHs previously owned by Select in the Cleveland market, to a new LTACH joint venture with the Cleveland Clinic.

In July, we opened a 138-bed California Rehab Hospital in Los Angeles with our joint venture partners, UCLA Medical Center and Cedars-Sinai. And as I mentioned on our last earnings call, in early May we opened a 60-bed TriHealth Rehabilitation Hospital in Cincinnati, Ohio, in partnership with TriHealth.

Also in July, we announced a partnership with the University of Florida Health to manage its 40-bed Shands Rehab Hospital with longer-term plans to incorporate the hospital into a joint venture partnership. We also entered into a separate joint venture agreement with the University of Florida Health for LTACH services, and contributed Select's 44-bed LTACH in Gainesville to the new joint venture.

Finally, I wanted to update you on the progress we have made on all of our hospitals that have gone through the Patient Criteria implementation through June. As of the end of June, 72 of our 105 owned LTACHs were subject to the new LTACH Patient Criteria rules, with 33 remaining LTACHs transitioning in the third quarter.

Please note that we have adjusted the following data to normalize our hospitals for seasonality. The seasonality adjustment from Q1 to Q2 represents a reduction of about 1 ADC per hospital per day.

Our criteria-compliant rate for all patients at all of our LTACHs at the end of June was 93.4%. Total post-criteria average daily census was 2,061 patients. The change in ADC from pre-criteria to post-criteria was a negative 9%. The daily patient impact was a negative 204 average daily census, and the average patient impact per hospital per day was a negative 2.9 on average daily census.

As I mentioned, we had a very strong increase to our LTACH Medicare rate due to increased compliant Medicare population that has a much higher case mix index. Medicare Case Mix Index in our criteria hospitals was 1.30. We are pleased with the progress we're making on our transition to Patient Criteria.

With that, I will turn it over to Marty Jackson to cover some additional financial highlights for the quarter, before we open the call up for questions.

Thanks, Bob.

Good morning, everyone. For the second quarter, our operating expenses, which include our cost of services, general and administrative expense, and bad debt expense, was $960.4 million. This compares to $780.2 million in the same quarter last year. The increase in operating expenses is primarily due to the acquisitions of Concentra and Physiotherapy.

As a percentage of our net revenue, operating expenses for the second quarter were 87.5%; this compares to 88% in the same quarter last year. The 50-basis-point decrease as a percentage of net revenue consists of 40-basis-point reduction in cost of services and a 30-basis-point reduction in G&A, which was partially offset by 20-basis-point increase in bad debt.

Cost of services increased to $917 million for the quarter compared to $743.9 million in the same quarter last year. As a percent of net revenue, cost of services decreased 40 basis points to 83.5% in the second quarter; this compares to 83.9% in the same quarter last year. The decrease is primarily due to a decrease in expenses relative to the revenue in our Concentra segment, as a result of cost-saving initiatives we have implemented.

G&A expense was $25.9 million in the second quarter, which, as a percent of net revenue, was 2.4%; this compares to $24 million, or 2.7% of net revenue, for the same quarter last year. Our G&A function includes our shared services activities, which have expanded as a result of the significant acquisitions we have completed both this year and last year.

As Bob mentioned, total adjusted EBITDA was $141.5 million and adjusted EBITDA margins was 12.9% for the second quarter. This compares to adjusted EBITDA of $114.9 million and adjusted EBITDA margins of 13% in the same quarter last year.

Depreciation and amortization expense was $36.2 million in the second quarter compared to $21.8 million in the same quarter last year. The increase results primarily from the acquisitions of Concentra and Physiotherapy.

We generated $4.5 million in equity and earnings of unconsolidated subsidiaries during the second quarter compared to $3.8 million in the same quarter last year. This increase is primarily the result of growth in our inpatient rehabilitation hospital joint venture partnerships. As Bob mentioned, during the quarter we had pre-tax non-operating gain of $13 million related to the sale of businesses.

Interest expense was $44.3 million in the second quarter, compared to $25.3 million in the same quarter last year. The increase in interest expense in the second quarter is primarily the result of additional borrowings related to financing the Concentra acquisition in 2015 and the Physiotherapy acquisition in the first quarter of this year, as well as an increase in interest rates on the debt we refinanced in the first quarter.

The Company recorded income tax expense of $33.5 million in the second quarter. The effective tax rate for the quarter was 45% compared to the effective tax rate of 37% in the second quarter of last year. The increase in our effective tax rate is primarily related to a hospital exchange transaction, where our tax basis in the specialty hospitals was less than our book basis, creating a tax gain that exceeded our booking.

Net income attributable to Select Medical Holdings was $33.9 million in the second quarter and fully diluted earnings per share was $0.26 compared to fully diluted earnings per share of $0.28 in the same quarter last year.

At the end of the quarter, we had $2.72 billion of debt outstanding and $78.4 million of cash on the balance sheet, which includes $17.5 million of cash at Select and $60.9 million of cash at Concentra. Our debt balance at the end of the quarter included $1.15 billion in Select term loans; $240 million in Select revolver loans; $710 million in Select 6 3/8% senior notes; $645.5 million in Concentra term loans. These were offset by close to $60 million in unamortized discounts, premiums, and debt issuance costs that reduced the balance sheet debt liability. In addition, we had close to $31 million consisting of other miscellaneous debt.

Operating activities provided $66.8 million of cash flow in the second quarter. This compares to $37.5 million in the same quarter last year. Our days sales outstanding was 51 days at June 30, 2016; this compares to 52 days at March 31, 2016 and 53 days at December 31, 2015.

Investing activities used $34.3 million of cash during the second quarter. The use of cash was related to $33.5 million in purchases of property and equipment, and $9.6 million of acquisition and investment in business costs, which were offset, in part, by $8.8 million in net proceeds from the sale of assets during the quarter.

Financing activities used close to $40 million of cash in the second quarter; the use of cash primarily resulted from $75 million in net repayments on Select's revolving credit facility, term loan payments of $2.7 million, and $1.6 million in distributions to non-controlling interests. This was offset, in part, by $9.9 million in net proceeds from other debt, proceeds from bank overdrafts of $26.5 million, and $3.1 million of proceeds from the issuance of non-controlling interests.

Additionally, in our earnings press release we provided revised financial guidance for calendar year 2016. This includes net revenue in a range of $4.25 billion to $4.35 billion, adjusted EBITDA in a range of $500 million to $530 million, and fully diluted earnings per share to be in the range of $0.87 to $1. The update to our guidance for 2016 includes revised expectations to our inpatient rehabilitation joint venture hospital openings, closures in our long-term acute care hospitals, and the effective tax rate impact in the second quarter.

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

Thank you.

(Operator Instructions)

Chris Rigg, Susquehanna Financial Group.

Good morning. This is Frank Lee on for Chris. Thanks for taking my question. 33 facilities are going into criteria in the third quarter. What proportion entered in July and can you give a sense for how this impacted second quarter admissions and EBITDA?

Frank, of the 33 that are going in the third quarter, 10 will be going in July and there's just a shade below 900 days, where impacted by -- in essence, as you know, that we do is we start the month before hospitals go into criteria with regards to the admissions of only criteria, only those patients that will meet criteria. And consequently, there was about close to 900 days of reduced patient days in the second quarter for those 10 hospitals.

Okay. Thanks. And then the opening of the California Rehab Institute was delayed from your original expectations. I think that was February of this year. Can you give a sense for what the negative carry from rent in the quarter was? And how much of a drag on 2016 EBITDA is created by start-up costs for that facility versus your original expectations?

Frank, I can go one better than that. I can tell you that because of approximately a six-month delay, that represents that represents a little bit more than the $10 million of reduction of the top line on EBITDA that we're reducing it by. So it -- that was really a function of what was going on with CRI.

All right. Thanks a lot.

Frank Morgan, RBC Capital Markets.

Good morning. Two questions. I guess, one high-level legislatively. I wondered if I could get some comments from Bob on the possibility of this 25% rule legislation actually getting passed and how you see that playing out over the next several months?

And then the second question was on, if you look back at some of the early hospitals that have converted over to criteria, now that you look at them. I guess, if you've got your first batch from last September through December, how do those look today, really, the occupancies that, obviously, we know what the compliance is.

But how much -- have you seen any kind of improvement in the occupancy of the -- or on the buildings that have been under criteria the longest? Thanks.

Sure, Frank. Let me take a stab at the first one. I was -- we obviously had a goal to get the 25% rule release extended before it lapsed and we, obviously, were not able to get that accomplished because it goes into effect in July. Having said that, we were pleased that in mid-July, we were able to get the Ways and Means Committee to approve a bill HR 5713, which would -- it's not really an extension of the old relief but it's actually a new bill that would extend the 25% rule to 50%.

It was not a 2 year -- it's not a 2 year relief; it's more like a 9- to 12-months relief. There is a companion bill in the Senate that essentially does the same thing. So we're pleased that we had enough support in the House, particularly through Ways and Means and on the -- and in the Senate that there were enough members paying attention that they passed through these bills for relief on the 25% rule.

The problem is, is finding a vehicle under which this can be attached that is Medicare bill that has any expectation of moving anytime soon. I think my best estimate, it's really hard to handicap this but I'd be very surprised if there was any bill that moved that we could be on before October, November.

Now this being a presidential election year, I'm being advised that there's a pretty good chance that nothing will move unless there's some must-move provisions. There may be a vehicle that comes in the Fall but there may not be. So I think optimistically, I'd say 50/50, but that's the best I can handicap it.

Frank, in your question on the 72 hospitals that have gone into criteria and the timing in the improvement that's occurring on a quarter-over-quarter basis, what we're finding, Frank, is that while the timeframe that the hospitals have gone on to criteria is a -- it's an indicator that there has been improved performance.

The real variable that we're seeing is making a difference here is the size of the hospital. So if you were to take a look at and it's something that Bob and I have talked about consistently, is our expectation was that the smaller hospitals, the HIH type hospitals, we would have an easier time replacing the patients; that's exactly what we're seeing.

So let me give you an example. If you take a look at the number of hospitals that we have in criteria right now and what we've done is we've taken a look at 60 in detail -- or 69 in detail because we have not added in the three hospitals that we've gotten from Kindred yet. But if you take a look at those, for those hospitals that are 50 beds or higher, we have 16 of the 69.

The -- when I take a look at the ADC per hospital per day, on a seasonally adjusted basis, that's almost 8 and 53 hospitals are under 50 beds; seasonally adjusted ADC is 1.4 per hospital per day. So you can see the significant difference there.

Obviously, our focus is to make sure that those 16 hospitals that we have, we've got to make sure that we're out in the marketplace, going to the tertiary hospitals and increasing that volume. But that -- for us, that's really been the key indicator, or the key variable to focus on.

Got you. And then of the -- have you noticed in markets where there are multiple LTAC operators in some of these bigger markets, is there any kind of confusion out in the marketplace with regard to, like, we're only looking for compliant cases versus we'll take anybody. Have you seen any of that effect out there or how would you assess where the market is in terms of education to the new rule? And I'll hop off. Thanks.

Frank, it's a good question and I will tell you that it was something that we were concerned about and we talked about even before we went into criteria but I think, factually, we really haven't seen that much.

There is not that much confusion in the markets, as we look across -- I mean, we've staked out our strategy and our communication and to our referral sources of exactly where we're positioning ourselves in the market, which is to take just a very high acuity patient, the ICU and the pulmonary and vent-related patients. And that's been, as you can see from the -- just from the data and the statistics, it's been fairly well received.

I think it's also the fact that most of the other LTACs in the industry are just now beginning to transition in any large measure. We'll start to see probably the dynamics change in some of the markets and I think that, that can be positive for us. So I mentioned in my prepared comments that I'm really, pretty pleased with how we've done under that transition to criteria.

I mean, there were a lot of unknowns about it and we made a bunch of assumptions based on a lot of analytics and data but I think the results have exceeded my expectation. And I think the other point that I would make is, we can continue to get better. I mean, the first couple months after the transition to criteria is obviously not as good as it gets. This will -- we think we can continue to prove over the next couple of years.

So I feel okay with our position now. I've already made the comment about we've had less success with our larger hospitals. And we think that, that is just a testimony that there's no thought of changing our strategy that takes site neutral patients, even in those larger facilities. So we're staying with our strategy and we think that, over time, those larger facilities will do well under criteria and under our strategy.

Gary Lieberman, Wells Fargo.

Good morning. Thanks for taking the question. You made some comments about the seasonality in the 2Q and the impact it had on ADC. Can you talk about the third quarter, which as we know, is a seasonally weak quarter? How should we think about the impact of the seasonality in the third quarter on what we might see in the results?

Yes, Gary, there will be, as you know, going from the second quarter to the third quarter, there would be a downward adjustment with that also.

Is there any way to help us quantify that in terms of the number of days?

I think you would probably see another -- if we did it on a per hospital, per day basis, we'd probably see a reduction of another 1 ADC.

Okay. And then as additional competing LTACs have had to deal with criteria or incrementally, as they will, have you seen any greater degree of competition for the patients or are you expecting that?

Well, we always expect competition. And it's -- that's going to be a market by market, but I can't say that overall, that when I hear from the operators that it's about competition. It's really more about the education and us working with our referral sources. So I really think -- we think that this -- much of this is within our control, that if we execute, from what we've seen so far, we think if we execute, we'll be successful.

And I've said before, I think the competition, particularly with some of the smaller providers, I do believe that they are going to struggle. This is not just a marketing issue. This is a -- it's a clinical preparedness and the ability to take these higher acuity patients and -- in a good, safe, productive, efficient environment.

So I feel I feel pretty good about where we are right now and while we had some trepidation of being the first Company to go into criteria, I think having done it to where we are right now, I can look back on it and say I'm glad we did. And we think that it maybe turned out to be a little advantage to be able to go through it first.

Got it. And then maybe final question, Marty. In the past, you had quantified the impact of the 25% rule. I think it was, like, $15 million annual number. Have you guys had a chance to recently go back and look at that again?

Yes, Gary, good question. We have taken a look at that; $15 million is a pretty good number right now. I will say that the $15 million is an unmitigated number and we will be focused on that to reduce that number. I think, just to add to that, is if you take a look at 2016 impact of the 25% rule, we do not anticipate that, that's going to be significant at all. Just as you know, it goes in October and it goes based on year-end cost report date.

Got it. Thanks a lot.

Kevin Fischbeck, Bank of America Merrill Lynch.

Great. Thanks. I just want to understand the comparison that you made, I guess from Q1 to Q2, on the LTAC criteria. If I understand correctly, you're saying that seasonally, ADC is down about 1, seasonally, a minus 9%. Would that have been minus 10% on a reported basis but you would expect it down 1% anyway, so minus 9% is the way to think about the effect of criteria. Is that -- that's the way to think --

Yes, it would have been a higher than 9%, Kevin; it was about 11.5% on a percentage basis.

Okay, and is this -- you guys have given the impact for the last few quarters. Is this the first time that you've adjusted for seasonality or do you know what the -- because I guess in the Q4 comparison, you would have expected ADC to be up a couple percent from Q3. Is that number you gave us in Q4 an adjusted number or was it a reported number?

It was not adjusted.

Okay, do you have any sense of what that impact from Q3 to Q4 would have been in the number?

No, I haven't gone through that analysis.

Okay. And then I guess when we think about the -- you said the case mix and the facility after it's moved over is 1.3; what's the case mix of the facility that haven't moved over yet?

What we've done is, if you take a look at the -- actually, there's about 12 to 13 point differential. I think the case mix associated with the hospitals that have not gone, probably in that 1.17 to 1.18 range, which is historical --

Is that -- and how do we think about that, from like a pricing? What is 0.1 the case mix mean from a pricing perspective

Say that again?

What is it -- what if you move case mix from 1.2 to 1.3? What impact does that have on a facility's pricing?

A significant impact. The way that, that works is if it is a 10 point differential, that 10 points is applied against your base rate, so if your base rate is $40,000, it's about a $4,000 impact per case.

Okay. So the 12 to 13 point differential means that there's a 12 to 13 point -- or percentage increase potentially, at least from the Medicare component of the revenue at that site?

That's correct.

Okay.

Kevin, that's why we've been focused on talking to people about the differential between -- it's really focused on a spread which is the differential between the compliant versus non-compliant patients, and we've talked all along about that spread differential being in the 30-point range.

Okay and this -- I still don't really remember you guys ever doing JVs on the LTAC side before. Can you talk a little bit about what you expect to get from those?

When you look at our model, which it started out as during the joint ventures and went back to days when we first did the Baylor Heath System and then Penn State University, and then moved onto Emory and Cleveland Clinic. Once we're in the partnerships, it does make sense and we're in the rehab or the outpatient.

It does make sense, as I think our partners see our scales on the post-acute, to snap on additional services so this makes all the sense in the world for us. I think the first place we did it was in Emory where Emory took a small, in addition to the rehab joint venture, Emory took a small interest in our LTACs.

And then in Cleveland, where we obviously signed a deal and built the first rehab hospital, after our swap with Kindred, we owned four LTACs in the Cleveland market. So adding them to the joint venture, this begins to -- these joint ventures begin to look a lot more like post-acute joint ventures rather than just rehab joint ventures and that's obviously our goal.

So if we can move the Company toward being at a partner in all the post-acute with our partners and we've seen that. In some of our joint ventures we do day rehab, we do outpatient, now we do LTAC, we do rehab, and we can snap on other post-acute elements to it, if the market calls for it and our partner wants us to. So I think that, that something you could probably expect; it would be our goal to continue to do that and now we've done it with -- hope to be doing with Florida Shands, Cleveland Clinic, Emory and hopefully others.

Okay, and I guess the last question. The margins on both Concentra and the outpatient rehab business really improved noticeably. I guess the outpatient one seems more like it's just because you divested a lower margin business, so that seems to me to be sustainable.

The Concentra boost, it just sounds like there are a lot of the cost-cutting there so that one also sounds sustainable. Are these good run rates or how -- is there anything unusual either due to seasonality or any other reasons to think that this isn't the right run rate for those margins?

Yes, Kevin, there is seasonality in the business. If you take a look at the Concentra business in second quarter, we're -- the margins at 16.9% was very significant. Second and third quarter for the occupational medicine is typically their best quarters and the first and the fourth quarters are down. On the outpatient clinic business, first and second quarters are typically the better margin quarters and third quarter is typically down further and fourth quarter, we come back.

If you look at the quarter on the outpatient, I think it's really nothing but good news. The revenue off was the -- just because of the divestiture of the contract therapy business but beyond that, this is on a same-store basis and Physio integration, I think this is a stronger quarter in the outpatient, as you will see.

Okay. All right. Great, thanks

A.J. Rice, UBS.

Hi, everyone. A couple of questions. First of all, on the labor side across your business portfolio. It had a mixed message from some providers are saying they are seeing a little pressure; other people are saying they really haven't seen much of a change.

I just wonder, inpatient therapist to outpatient therapist to nursing talent, you've got a spectrum of nursing talent. What are you -- give us an update on what you're seeing?

Well, AJ, it's Bob. I think there's -- we believe that there's pressure on the nursing side and we've seen it and we think that, that's real and less so on the therapy side. The therapy side is, I think, always difficult to recruit and retrain -- retain and pay therapists but I don't -- we don't see a dramatic difference in that; where we have gradually over the last couple quarters and I think we've said that we do think we are entering into a pressure on the nursing side of business. So we do see it.

Okay. Any metric like your average yearly increases or annual updates that you're providing is that changed in any way, your use of contract labor? Any thoughts about any of that?

AJ, what we've seen over the past five or six years, as far as increases are concerned for nursing, it's been in the neighborhood of a 1.5% to 2%. We're seeing that escalate so were seeing in the 3% range 3%-plus range. Now, I will tell you that some of that also is a function of the types of nurses we're hiring. I mean, historically, we may have hired a standard RN where now we're really focused on either critical care nurses or ICU nurses, so I think that may also play a role.

All right. The other thing I wanted to ask you about is, obviously, just in your case, there's been a lot of focus on criteria. The whole post-acute space though is also dealing with mode of payments, episode of care type of discussions, that type of thing.

And I could see based on some of the comments we're hearing from the health systems, it might even be an opportunity for the outpatient rehab if people are getting pushed out of a natural flow to nursing homes into home health or something but having to still do rehab.

I'm just curious, we had the joint replacement program and what you're seeing -- I know it's still early and now we've got this proposal around the cardiac. How -- are you guys engaged at any level with your different aspects of your business and what -- how do you think about what's happening in those areas?

Well, in a lot of our -- I think you're absolutely AJ. There's more discussion and more energy and focus around this post-acute than I think I've ever seen in my career and in a lot of ways, it's good for us. In some ways, I think people take a little pause because there's a little uncertainty around it.

But yes, we are engaged, really, with our partners on this. I don't -- as much as we look and we know what our capabilities are, we really follow our partner. So for example, if the Cleveland Clinic or Emory or UCLA or Cedars or Penn State University or Pinnacle Health, any of our partners, if they want to embark or need to, we are there at the table with them having discussions>

We can bring in our analytics team. We can bring in our clinical people and we can do what the -- we want to be responsive to what's happening in that market with our referral source. So I think we have all the capabilities but -- and I don't want to give you the sense that we're as driving it as much as we are being responsive to what we see in the market.

I mean, our heads aren't in the sand in this. We see a lot of the stuff that's happening but at the end of the day, a lot of this is going to be driven by the referral sources. It's going to be driven by the general acute care hospitals. We -- some that are very, very focused on readmission and we're right there with them, either with our LTACs or our rehab hospitals, usually like the outpatient, same with the bundling proposals. So that's where we're trying to go.

Okay. All right. Thanks a lot.

David Common, JPMorgan.

Yes, good morning. Thanks for the opportunity. You mentioned that part of moving the compliance ratio up has been a closure of a handful of locations. Did you mention -- have you mentioned what the outlook for additional possible closures is for your own Company? And then also, could you speak to competitor closures that you're -- that you've seen and expect to see? Thanks.

Thanks David. No, I don't think we've given a lot more guidance. Marty and I gave guidance on our expectation some quarters ago about closure. I think we said we were going to close around 10 hospitals. I think we've closed that many and as we go forward over the balance of this quarter and the next quarter, balance of this year, we could be looking critically at a couple.

I don't have any that are really on the block right now. So if there is anything for us, it's not going to be material. It's not going to be something that -- it disrupts a quarter. And I think it's also testimony to the profile of our hospitals.

We have leases coming due all the time through our hospitals. Our lease tenure is a lot shorter than it would be if we had long 10- or 15-year REIT or third-party lease payments. They are longer term.

As for the rest of the market, again, many of them are early in criteria. I'm going to stand behind my prediction of a couple quarters ago that when the dust really settles on this, there's going to be considerable closings, mainly in the smaller, non-chain, maybe perhaps in the nonprofit world.

I think it's usually always takes longer than what I might think it would, but I'm going to stand by that so I think you could seek considerably less LTACs two years from now than you have today.

And would it be pretty much a function simply of the percentage of non-compliant Medicare patients heads in the beds; is that really the main driver overwhelmingly?

I think it will be because you have your first two years when a hospital moves into criteria, that they get a blended rate on, what they call the site neutral patient, and I think that, that, potentially given the profile of the hospital can be helpful but when that goes way, I think it's going to be trying.

Okay, well. Thanks for the color.

Thank you. I'm not showing any further questions. I would like to turn the call back over to Mr. Ortenzio for any further remarks.

We have no further comments. Thanks for joining us and we will look forward to updating you next quarter.

Ladies and gentlemen, thank you for participating in today's conference call. That does conclude today's program. You may all disconnect. Everyone, have a great day.