Select Medical Holdings Corp (SEM) 2017 Q1 法說會逐字稿

Good morning, and thank you for joining us today for Select Medical Holdings Corporation earnings conference call to discuss the first quarter 2017 results and the company's business outlook. Speaking today are the company's Executive Chairman and Cofounder, 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 will turn the conference call over to Mr. Robert Ortenzio.

Good morning, everyone. Thanks for joining us for Select Medical's First Quarter Earnings Conference Call for 2017.

Before I outline our operational metrics for the quarter, I want to provide some highlights for Q1. We continue to make good progress on our LTAC business. Our key volume indicators continue to improve nicely, and Marty will provide you with the updated statistics through April 30.

Occupancy rate for this quarter was 68%, which compares to 61% and 63% for the third and fourth quarters last year. Our average patient impact per hospital per day has dropped to 1.7 from 2.5 at the end of last year, and the percentage of compliant patients to total patients was at 99.9%. We had a nice improvement in our per patient day rate, which is primarily driven by admitting only LTAC-compliant patients, which tend to have a higher acuity. We experienced an increase of $91 per patient day for the quarter compared to the same period last year. We realized a decrease in our cost of services as a percent of patient revenue for the quarter.

Finally, despite having 7 fewer LTACs last year's Q1 period, our LTACs exceeded same period prior year adjusted EBITDA. Our adjusted EBITDA margin improved 120 basis points to 16%. We're very pleased with the progress the LTACs have made to date and expect to see continued improvement over the coming quarters.

Concentra had another very good quarter, with EBITDA growing by almost 25% and achieving an EBITDA margin of 16.6%. As we have discussed with you before, the management team's focus over the past 18 months has been to realize the available synergies post acquisition, and they have done a very good job in achieving over $44 million on an annual basis. They have now turned their primary focus to growing the business. We expect to achieve this through increased sales activities as well as tuck-in acquisitions and the opening of de novo sites. During the first quarter, Concentra acquired 6 new centers and opened 2 new locations.

Our inpatient rehab business continues to grow. Two of the 3 start-ups from last year are profitable at this time, and we expect the third rehab hospital to break even over the next 2 quarters. We have 4 additional hospitals in development at this time and expect them all to be open by the first or second quarter of next year.

As I mentioned on our last call, our development pipeline is robust. This quarter, we announced 3 new joint venture partnerships, including Dignity Health in the Las Vegas market. This joint venture will consist of a new 60-bed rehab hospital as well as outpatient rehab services. We expect the hospital to open sometime in the fourth quarter of 2018.

We entered into a joint venture with Riverside Health System in Virginia, which will include both inpatient rehab and LTAC services. The joint venture will consist of a 50-bed rehab hospital and a 25-bed long-term acute care hospital. The joint venture is expected to close in the second or third quarter this year, subject to regulatory approval.

Finally, we announced a joint venture with Spectrum Health in Michigan, which will be a 36-bed LTAC and is expected to close sometime in the third quarter.

Our outpatient business has experienced substantial growth over the past several quarters with the acquisition of Physio. Our rehab clinic business grew revenue by more than $60 million on a year-over-year same-quarter basis. The number of patient visits grew by 31.7%. Our legacy business was very strong in the quarter, with same-store growth in patient business of 3.7% and pricing increases of 2%. Excluding Physio, our clinics achieved an EBITDA margin of 13.9%.

Having said that, we did face some headwinds in our Physio assets as several operational changes were made and we have had a negative short-term impact. These changes were necessary to achieve longer-term success. We're very confident that our seasoned, long-tenured operators have positioned the Physio assets to achieve our legacy margins of 13% to 14%.

Let me take you through some of the operational highlights for the quarter. Net revenue for the first quarter was $1.1 billion compared to $1.09 billion in the same quarter last year. Net revenue in our specialty hospitals for the first quarter was $598.9 million compared to $599 million in the same quarter last year. Overall patient days decreased by 6.1%, with just over 317,000 patient days in the quarter. The decrease was in our LTAC hospitals, which have now fully transitioned to patient criteria and effect of hospital closures. Average net revenue per patient day increased 5.1% to $1,716 in the first quarter compared to $1,632 in the same quarter last year.

Net revenue on our outpatient rehabilitation segment for the first quarter increased 7.4% to $255.8 million compared to $238.1 million in the same quarter last year. The increase is a result of additional volume from our Physiotherapy clinics, which we acquired during the first quarter of last year as well as continued growth in our existing clinics, offset by the sale of our contract therapy business at the end of the first quarter of last year.

For our owned outpatient clinics, patient visits increased to almost 2.1 million visits compared to 1.6 million visits in the same quarter last year. Our net revenue per visit was $102 in the first quarter of this year compared to $103 per visit in the same quarter last year. The slight decrease in net revenue per visit was the result of the acquired Physiotherapy clinics having lower average net revenue per visit.

Net revenue in our Concentra segment for the first quarter increased 2.1% to $256.1 million compared to $250.9 million in the same quarter last year. The increase is primarily from newly acquired and developed medical centers. For the first quarter, revenue from our medical centers was $223 million, and the balance of $33.1 million was generated from on-site clinics, community-based outpatient clinics and other services. For the centers, patient visits were over 1.88 million, and net revenue per visit was $118 in the first quarter compared to 1.85 million visits and $118 per visit in the same quarter last year.

Total adjusted EBITDA for the first quarter was $138.9 million compared to $128.6 million in the same quarter last year, with consolidated adjusted EBITDA margin at 12.5% for the first quarter compared to 11.8% margin in the same quarter last year.

Specialty hospital adjusted EBITDA for the first quarter was $88.7 million compared to $86.8 million in the same quarter last year. Adjusted EBITDA margin for the specialty hospital segment was 14.8% compared to 14.5% in the same quarter last year. The increase in adjusted EBITDA is primarily related to a decline in start-up losses at our newly opened specialty hospitals. Adjusted EBITDA start-up losses were $2 million in the first quarter compared to $3.8 million in the same quarter last year.

Outpatient rehabilitation adjusted EBITDA for the first quarter increased 8.6% to $31.4 million compared to $28.9 million in the same quarter last year. The increase resulted from both the acquired Physiotherapy clinics as well as our existing clinics. Adjusted EBITDA margin for the outpatient segment was 12.3% in the first quarter compared to 12.1% in the same quarter last year.

Concentra adjusted EBITDA for the first quarter was $42.6 million compared to $34.2 million in the same quarter last year. Adjusted EBITDA margin was 16.6% compared to 13.6% in the same quarter last year. The increases in adjusted EBITDA and adjusted EBITDA margin were primarily related to the cost reduction initiatives implemented in 2016.

Earnings per fully diluted share were $0.12 in the first quarter of this year. Excluding the loss on early retirement of debt and related tax effects, earnings per fully diluted share would have been $21 in the first quarter of this year.

During the first quarter of last year, we had several onetime events, including a gain on sale of our contract therapy business, a loss on impairment of equity investment and a loss on early retirement of debt. Excluding those onetime events and their related tax effects, earnings per fully diluted share would have been $0.22 in the first quarter last year.

Before I turn it over to our Chief Financial Officer, Marty Jackson, I'll make one final comment on the recent regulatory activity. As you're probably aware, both LTAC and IRF proposed rules for fiscal 2018 have been released by CMS. As a general practice, we don't comment publicly on proposed rules before they are finalized. However, the recent LTAC proposal -- proposed rule included an additional year of regulatory relief from the 25% Rule. The 21st Century Cures Act extended relief from full implementation of the 25% Rule through October 2017, and the proposed CMS rule for fiscal 2018 extends the moratorium on the implementation of the 25% Rule through October 2018. The company has long felt that the 25% Rule is unnecessary given the LTAC -- where the LTAC industry is now operating under patient criteria rules. While we'll still seek a permanent solution [or] elimination of the 25% Rule, extension from relief for an additional year is a good sign for the industry.

At this point, I'll turn it over to Marty Jackson for some additional financial details before opening the call up for questions.

Thanks, Bob. Good morning, everyone. For the first quarter, our operating expenses, which include our cost of services, general and administrative expense and bad debt expense, were $977.1 million. This compares to $966.9 million in the same quarter last year. As a percentage of our net revenue, operating expenses for the first quarter were 87.9% compared to 88.8% in the same quarter last year.

Cost of services were $928.4 million for the first quarter compared to $922.3 million in the same quarter last year. As a percent of net revenue, cost of services decreased 120 basis points to 83.5% in the first quarter. This compares to 84.7% in the same quarter last year. The decrease in cost of services as a percentage of revenue is primarily due to the sale of our contract therapy business, specialty hospital closures and cost reductions achieved by Concentra.

G&A expense was $28.1 million in the first quarter, which, as a percent of net revenue, was 2.5% compared to $28.3 million or 2.6% of net revenue for the same quarter last year. G&A expense in the first quarter of last year included $3.2 million of Physiotherapy acquisition costs.

Bad debt as a percent of net revenue was 1.9% in the first quarter compared to 1.5% in the same quarter last year. The increase in bad debt expense is primarily related to the Physiotherapy entity and high bad debt at Concentra compared to the same quarter last year.

As Bob mentioned, total adjusted EBITDA was $138.9 million, and adjusted EBITDA margin was 12.5% for the first quarter compared to adjusted EBITDA of $128.6 million and adjusted EBITDA margin of 11.8% in the same quarter last year.

Depreciation and amortization expense was $42.5 million in the first quarter compared to $34.5 million in the same quarter last year. The increase is primarily due to new inpatient rehabilitation facilities and the addition of Physiotherapy.

We previously mentioned the company was in the process of refinancing its senior credit facilities. We completed the refinancing on March 6. And during the first quarter, we recorded a loss on early retirement of debt of $19.7 million. The new Select credit facilities includes a new 7-year $1.15 billion term loan priced at LIBOR plus 3.50% and a new 5-year $450 million revolving loan priced at LIBOR plus 3.25%. The refinancing transaction will reduce our annual interest expense by approximately $17 million to $18 million and extend the maturity of our senior secured debt to 2024. We also had a small loss on early retirement of debt in the first quarter of last year.

During the first quarter of last year, we also had several onetime gains and losses, including the gain on sale of contract therapy business and impairment loss on our equity investment. These items were recognized on our income statement as nonoperating items.

We generated $5.5 million in equity in earnings of unconsolidated subsidiaries during the first quarter. This compares to $4.7 million in the same quarter last year. This increase was driven by improved performance in existing inpatient rehab joint ventures where we hold a minority position.

Interest expense was $40.9 million in the first quarter compared to $38.8 million in the same quarter last year. The company recorded income tax expense of $13.2 million in the first quarter. The effective tax rate for the quarter was 36%.

Net income attributable to Select Medical Holdings was $15.9 million in the first quarter, and fully diluted earnings per share were $0.12. Excluding the loss on early retirement of debt in the quarter and its related tax effect, earnings per share would have been $0.21.

At the end of the quarter, we had $2.8 billion of debt outstanding and $65.2 million of cash on the balance sheet, which includes $10.3 million of cash at Select and $54.9 million of cash at Concentra. Our debt balance at the end of the quarter includes $1.15 billion in Select term loans; $335 million in Select revolving loans; $710 million in the Select 6 3/8% senior notes; $619.2 million in Concentra term loans; $50.1 million of unamortized discounts, premiums and debt issuance cost that reduced the overall balance sheet debt liability. And we had a $29.3 million consisting of other miscellaneous borrowings and notes payable.

Operating activities used $55.9 million of cash flow in the first quarter. The use of operating cash for the quarter is primarily driven by an increase in accounts receivable and reductions in accrued expenses.

Our days sales outstanding, or DSO, was 56 days at March 31, 2017. This compares to 51 days at December 31, 2016. The increase in our days sales outstanding and related decline in our operating cash flows is primarily related to the current underpayments we're receiving through the periodic interim payment program from Medicare in our LTACs. These underpayments will be corrected over the next couple of months as our periodic interim payments are reconciled and reset by our fiscal intermediaries.

Investing activities used $41.2 million of cash in the first quarter. The use of cash was related to $50.7 million in purchase of the property and equipment and $9.7 million in acquisitions and investments, which were offset in part by $19.5 million in proceeds from asset sales during the quarter.

Financing activities provided $63.3 million of cash in the first quarter. The provision of cash primarily related to $115 million in net borrowings on our revolving loans, which were offset in part by net term loan repayments and financing costs totaling $34.9 million, repayment of bank overdrafts of $17.1 million and $3.6 million in distributions to noncontrolling interests.

As I mentioned, Select refinanced its senior credit facilities during the quarter, and the impact of the financing has now been included in the update to our financial guidance for calendar year 2017, which was included in our earnings release yesterday. This includes net revenue expected to be in the range of $4.4 billion to $4.6 billion; adjusted EBITDA expected to be in the range of $540 million to $580 million; fully diluted earnings per share expected to be in the range of $0.69 to $0.87; and adjusted earnings per share, which excludes the loss on retired -- on the retirement of the debt and its related tax effect, to be in the range of $0.78 to $0.96.

Finally, as Bob mentioned, I will update the key volume indicators we had been providing to you since the LTACs have gone into criteria. Our last update of these indicators was December 31, 2016, and we're going to update you through April 30, 2017.

Total post-criteria average daily census, ADC, grew to 2,703 compared to 2,656. The percentage change in ADC on a pre/post comparison has dropped to 5.9% from 8.7%. The daily patient impact has improved by 85 ADC and now stands at 169. And our patient impact per hospital per day has dropped to 1.7 from 2.5.

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

(Operator Instructions) Our first question or comment comes from the line of Frank Morgan from RBC Capital Markets.

I was hoping you could give us a little more detail on the stabilization and improvement in the LTACs as you kind of get further into criteria. What are you really seeing out there? Do you think it's getting better because of just general education in the market and [just] time has passed, people are getting used of it? Is there anything that you're doing from a process standpoint that you think is differently? That would be my first question.

Thanks, Frank. This is Bob. From a -- I do think it's all of the above. There is a certain element of just consistency in an individual market, fine-tuning your programs, working with your referral sources. So yes, under the broader heading of education, yes. Certainly, in terms of our process, I think what we're seeing today is, hopefully, the positive results of all the processes that we've put in place and that we've been talking about for the last year as we've gone into criteria and we've kind of reshaped our hospitals to be these highly specialty acute care locations where just -- we just see the post-ICU and the ventilator-dependent patients. So yes, I think it's both of those. And I think at this point, it's just continuing to push. It's -- we would consider more blocking and tackling now. I mean, I think we feel good about our decision to go the direction we did, and we just need to continue to do more of what we've been doing. And I think we can achieve kind of the goals that we set out and laid out at the beginning of the year and through our guidance.

Is there any particular area where you're noticing the most improvement? I mean, is it just as simple as facilities that have been on criteria the longest are doing better? Or is there anything unique to markets? Any insights on where you're getting the most traction?

No, I can't say that we've been able to draw any discernible pattern that makes a difference, either regionally -- the only thing that we have said previously, which I think holds true, is that our larger facilities tended to struggle a little bit more than our smaller facilities for reasons that we've outlined, and I think that makes intuitive sense. So no, we haven't been able to discern any pattern that says any geographic area in particular does better than another. I mean, I think we're seeing -- the results that you see, I think, generally, you can assume is spread throughout our 108, 109 LTACs.

Got you. And I was glancing through the 10-Q last night. Just to verify there, it was showing the improvement. Is that still aggregate specialty hospitals? Or does that break out the LTACs from the IRFs? And yes, I guess, that would be my question.

Yes, it's the aggregate, Frank. What we did was in the beginning or the -- as Bob was going through some of the highlights, what we did was we outlined both the LTAC improvements. So when we took a look at some of the margins and the margin improvements, that was the LTAC specifically. We talked about the inpatient rehab. But in the 10-Q, they're talking about the specialty hospitals in aggregate.

Got you. Just one final question. I know we talked about wage and labor issues in the past. And certainly, you held your staffing levels there, anticipating this volume recovery. Just any color there, and I'll hop off.

Yes. I mean, look, I don't think that -- I think probably what you've heard from providers across the board is that we do have a nurse staffing shortage. We have seen headwinds on rate. We've seen an increase in agency labor, and I think we'll continue to see that. So we're managing through that. As I've said, it's not our first nursing shortage that we've seen, although it's been a while since we've had one. And it does become difficult. Now that is an area where you do see some individual hospitals are struggling more than others maybe in terms of filling open nursing positions. So we have seen an increase in our wage, and we have seen an increase in agency.

Our next question or comment comes from the line of Gary Lieberman from Wells Fargo.

If I could just follow up on one of Frank's questions. Is it possible to get a breakout of the EBITDA for the IRFs separately from the LTACs?

As far as total EBITDA? Is that what you're looking at, Gary, for both?

Yes.

Sure. If we take a look at the LTACs, the LTAC EBITDA for the quarter was $72.3 million, and the EBITDA for the IRFs was $16.3 million.

Okay. So do you happen to have how that compares with the year ago?

Yes. The LTACs prior year was $71.5 million and the IRFs were $15.2 million.

Great, that's very helpful. And then in the past, you guys have discussed, and Bob, you sort of alluded to it, the difference in the performance of the hospitals that had greater than 50 beds and the hospitals that had less than 50 beds. Do you have any statistics just to break out the performance of how those 2 categories were?

Gary, what we can tell you is that the larger hospitals continue to lag the smaller hospitals. The smaller hospitals are, I would say, are probably very close to precriteria volume. They're less than one patient per hospital per day, whereas the larger ones are greater.

Okay. Is the gap closing? Or it would appear that the larger ones must be improving.

The larger ones are improving.

Yes, and I think they'll continue to improve.

Okay, that's helpful. And then maybe just to move to Concentra. The margins were extremely strong there. Should we expect that to continue? Or should they revert maybe back to kind of a more normalized level?

Yes. As we've said historically, we think the -- that business -- you ought to expect margins somewhere in that 15% range. As you know, there's seasonality in that business. Q4 is typically a low-EBITDA margin during the fourth quarter. But yes, on average, I think what you ought to assume on an annual basis, you're really looking at 15%.

Yes, I think that's our best estimate. We -- the margins have been strong. And I will just say that the management team at Concentra just continues to surprise on the upside, and they are really doing a very good job. So their margins have been very strong and hats off to them.

Our next question or comment comes from the line of A.J. Rice from UBS.

Maybe on the -- just following up on the questions regarding the improvement in the performance in the LTACs in terms census and all. Is -- I know last year there was some discussion about some of your competitors maybe targeting you as you were going through criteria. Now that other -- they're going through the process of converting to criteria and still in the early stages of that, has that changed the competitive dynamics, do you think, in any way? Or is that less of a factor? And I wondered if there was a target where you thought you'd settle out. And I don't know whether the right metrics is occupancy, but you've obviously stepped up the last 3 quarters nicely in occupancy, 68% today. Do you think that settles out somewhere in the 70s? Or any view on that?

Yes. A.J., this is Bob. On the first question about when we were going through criteria, competitors targeting us, I just want to be clear that, that was suggested by others than us. I mean, that was suggested in the investor community and the analyst community. I mean, we did say that we didn't think that was the case for a couple reasons, because of overlap, where markets were competitive and for other reasons. So we didn't really see that. And I would tell you that as those LTACs that are going through criteria now later than we did, we really don't have a good sense of how they're doing or what's happening in the market. What we do try to watch for is -- as an indicator is closures. As we have been -- Marty and I have been vocal that we thought that, by the completion of the full implementation of criteria, including the 50-50 blend, that there -- that we felt that there would be a lot of LTACs that would close, that wouldn't be able to get through it, either because of the market or they just weren't able to navigate the criteria. And so we do watch for that. And we do continue to see one-off closings here and there. And I think that is a sign that the criteria will continue to have impact and that this industry is being reshaped. And that at the conclusion of the 50-50 blend, I think you will see a different industry, and we continue to believe that.

But in terms of this advantage/disadvantage of the timing of when you go in, we do not see that there is any more advantage or disadvantage in terms of a market position of whether you were earlier, as we were, or whether you are later, as some of the other participants in the industry. Does that answer your question?

Yes, that's good. And then I'll...

A.J., I think the other part of your question was on occupancy. Yes, I mean, our target is to get back to the same occupancy levels that we had precriteria. And all indications are -- is that is achievable, and I think it'll probably take a little bit of time. But we're well on our way.

Yes, I think the other thing that we've said previously on the criteria and our return to precriteria census that -- I know I have said publicly, is that I do believe that it's a question of when, not if. And if you look at the first quarter, I'm encouraged. And I will reiterate that statement that I do believe we can get back. And I've said -- I've made comments like whether it's going to be in 2017 or 2018 or whenever, we will. And I would say that all indications right now, that I'm actually more bullish about the time frame that we'll be able to achieve return to our precriteria levels of occupancy.

Okay. And if I might ask a follow-up on another topic. I mean, it's quite large in the swing factor from the start-up costs last year to hitting profitability this year. It was enough, I think, to move the whole company's results. Can you just give us an update on where you stand with the California Rehabilitation Institute? Are you sort of at the level of profitability that you expect to be at for the full year? Or does there continue to be a ramp as this year progresses? And then also on the development side, I think you've started, as you mentioned in the prepared remarks, off pretty well with 3 new announced deals so far this year. I know we want you to announce as many as possible because that's long-term positive, but it also has start-up costs associated with it. Can we assume that the start-up cost associated with those deals is embedded in the current guidance that you have? Or is there leeway in case you do a few more deals for more? Or do you sort of just do them as you announce them?

Well, A.J., there's certainly a lot of questions in that one sentence that you just gave. Let's talk about CRI. CRI, as of now, is in a profitable state. We are past breakeven, and you are going to see that climb nicely. And as you said, that will have a nice impact on the company's earnings. Cleveland Clinic, which is one of the other 3 start-ups that we had last year, is also in the black. And TriHealth is the only one left that's in the red right now, and we anticipate over the next 2 quarters that to be in the black also. The 4 projects that are going -- that are essentially in the ground right now, that's really -- those probably will not open up until the first and second quarter of next year. You will see a bit of start-up losses. But I would anticipate you're going to see those start-up losses be somewhere in the neighborhood of $500,000 to $1 million a quarter, and that may go up a little bit in the fourth quarter.

What we have said is that you will probably not see another hospital that will have the start-up losses that California Rehab, just because of its size, the lease, the regulatory environment that we found ourselves in with the reimbursement in California, which is unique to that state and very challenging. So the losses from last year were disproportionately weighted toward the -- that California location. So we would not expect the other deals, at least not the ones we've announced, that would have losses that would even approach the kind of losses that we saw there. So -- and to your question as to the development, we will continue -- if we get an opportunity to do a transaction like an Ochsner or a Dignity or some of the others that we've done previously or have recently announced, we will continue to do those. That is long-term value, and that is our -- really our first priority for allocation of capital.

Our next question or comment comes from the line of Kevin Fischbeck from Bank of America.

I just want to follow up on the commentary around LTACs and -- so in terms of admissions and how they were flat in Q1, I mean, there's some impact from closures. There are 2. So did you disclose those on a same-store, excluding closures number? And also on that front, was there any impact from the leap year or flu or some other seasonality that some of the providers are talking about?

We do not -- we did not disclose and we're not disclosing kind of a same-store without backing out the closures. I guess it's the 7 hospitals that we don't have.

Yes.

And no, I can't comment on any necessary impact on illnesses, flu, the like. I think that was your second question. When -- you have pockets of this. I mean, when you have LTACs in as many states as we have, you may see outbreaks, and we certainly haven't had any kind of nationwide epidemic of flu or other respiratory that would drive. So I would say that nothing unique to report on that score and nothing on -- and really don't have any more guidance that we can give you on the closed hospitals.

Okay. And now on the cash flow, I appreciate the commentary of the increase in DSOs. But can you kind of just flush it out exactly what's that other payments? Or it's just that the fiscal intermediaries are holding the payments longer than the past? Or is there anything specific there? And then on that front, you mentioned you expect this to -- I guess, to see some improvement over the next few months. So are you willing to talk about sort of full year operating cash flow outlook?

Sure. It really does have to do with criteria and how the PIP payments work. And just as a tutorial, what we ought to do is kind of go through how PIP actually works. I mean, the increase in the receivables is really due to -- it's referred to as PIP. PIP is a biweekly Medicare payment process, where we get paid based on the estimated volume and rate that's set by our fiscal intermediaries. The PIP amount for each hospital is reset based on the historical claims data, and the reset happens about every 6 months. As more of our hospitals cost report periods end and the hospitals transition into the new patient criteria payment model, we started to be overpaid through our biweekly PIP payments. This occurred because the volumes dropped as we focused on only accepting compliant patients. And that continued through December of 2016. But beginning in January, the situation began to reverse itself, and all of our hospitals had gone through a reset cycle. So in February and March, we really started to experience significant underpayments as our volumes increased. Additionally, because we had to -- we had our increasing CMI, we were realizing higher case rates, which are also not fully reflected in our current PIP payments. And I think if you -- we talked about being overpaid. We repaid the fiscal intermediaries in the first quarter, $46 million. So combining the underpayment from PIP and then the payment -- the repayments that were made, that's really what caused that substantial increase in growth in AR. Is that helpful?

Yes, that's very helpful. And then would you venture into talking about what's the kind of the annual outlook for cash flows for the company?

Yes. I think it's the same as we've provided before, which I think was north of $100 million free cash flow.

Free cash flow, okay.

Yes.

Great. And then if I might, on the D&A, just to clarify. So it was up in Q1 year-over-year [clearly]. And even sequentially, it was up. But then for the year, the number that you gave in the -- your disclosures in the press release implies that a -- the kind of per quarter number will come down to add up to $157 million, I guess, for the year. So how would you describe that?

Yes. Could you -- Joanna, could you repeat that question again?

Yes. So it was -- the D&A in the quarter went up. So you explained the reason it makes sense, so you have new openings (inaudible) $42.5 million. But for the year, you talk about $157 million. So that implies that it's going to come down a couple of million dollars per quarter. So is there any particular reason? I thought you -- you talk about new hospitals opening, so I would expect this to be rising, not declining. So that's what I'm trying to reconcile there, the full year number versus the quarterly number.

Yes. The quarterly number had some onetime impacts. We had closed some hospitals, so there were some write-offs associated with it. So it's tough to annualize that number to get to the year-end number.

Okay. So you're saying that this is not a good run rate number to use. Okay, good.

That's correct.

Our next question or comment comes from the line of Whit Mayo from Robert Baird.

I think you mentioned in your prepared remarks that you made a few acquisitions within the Concentra segment. Is that right? Is this something new? And maybe just any commentary to frame up the contribution and how active you plan to be there going forward.

Sure, Whit. We did. We acquired 6 centers in the first quarter. Now you have to recognize that these are typically one-off types of acquisitions, and they're very, very modest in size. So if you take a look at the 6 that we acquired, I think the total payment for those 6 was about $9.7 million.

Got it. Any criteria around how you target those transactions? Are these focused on new markets, markets that complement other assets? Just kind of curious how you think about it.

Yes. For the most part, what we like to do is we like to do tuck-in acquisitions. So it's really locations where we already have a critical mass and just are able to add to -- add additional centers in those markets.

Got it. And these are all in the joint venture, correct?

These are all in the joint venture with Welsh, Carson, yes.

Yes, yes. Got it. And any more detail you can provide around, I guess, the self-inflicted headwinds in the outpatient division, what changes you made, what the impact was and just kind of expectations going forward?

Sure. The changes that were made were both operational. We've got standard operating procedures that we have in place in all of our 1,000 clinics before the Physio acquisition, and what we were doing was implementing that into the 600 that were owned by Physio. And we've also made some management changes on the Physio side, too. So between those 2, there was a little bit of headwind.

Okay. And maybe one more, I think, for Bob. There have been some advocacy efforts from the industry to try to push expanding the types of cases that can be in the LTAC criteria rule, and I think wound care has been tossed around. Is there any traction being made at all? I mean, I know Congress has got a lot of things they're focused on. I'm just curious what your view is of the prospects of CMS, revisiting that. Or is this anything that you are really advocating yourself?

Well, I can say that on relief from criteria, we are not putting in, right now, any direct advocacy efforts. I do understand just peripherally that some LTAC hospitals are asking Congress for relief from the new criteria. You have to appreciate that CMS does not really have the flexibility to modify the criteria, because the criteria was a legislative initiative, not a regulatory one. So yes, my understanding is, is that some hospitals are asking Congress to look at the criteria so that they can continue treating patients with some conditions that are currently excluded. Wound care would be probably an obvious example of that. For us, we obviously would've been happy to continue to treat the complex wound patients, but I'm not sure how realistic it is politically to think that it will be changed. But I don't really want to say anything more about it than that. I mean, I just think it's -- that's an uphill battle. I mean, we really don't have full implementation yet. And even CMS, on something as -- that they could do something about, which was the 25% Rule, have been loath to even roll that back even in the face of new criteria. So although I'm encouraged that the new CMS administrator and Secretary Price did put into the proposed rule, I mean, I think that's a very positive step. But that does fit into trying the kind of the idea that we should eliminate regulations that are really no longer needed. But I do think that trying to change the legislation on the criteria is an uphill battle.

Our next question or comment comes from the line of Bill Sutherland from Benchmark Company.

All I have left now is -- I know you guys don't like to talk about proposed CMS rules, but I'm curious if you've kind of studied this short-stay outlier adjustment that they're talking about for fiscal '18. And just at a high level, what you think -- what kind of impact that might have.

Sure, Bill. We have done some analysis on it, and we'll be commenting on the proposal. I guess our major concern is the reduction in the standard rate. They're basically saying what we're going to do is change it from a cost base-type of setting to a per diem. And because that's going to be better -- it's going to be a better price for the LTACs, then what we've got to do is deduct that benefit from the standard rate, and we're not sure how that actually works. So we're doing a lot of work and analysis on that and whether the reduction in rate is really appropriate or not.

Okay. So hard to figure at this point.

Yes. Yes, it is.

Our next question or comment comes from the line of Frank Morgan from RBC Capital Markets.

I just had a couple of follow-ups. Could you tell us where you are on Physiotherapy on the synergy recognitions? Like, where you are relative to your initial goals?

Sure. I mean, on the synergy side, we're doing well. And we're -- because most of the synergies are coming from back-office administrative types of things, we're certainly achieving that. Where we're seeing some headwinds that we've talked about is really on the volume side, Frank. Once we get the volume back, we'll be fine.

Okay. No, that's fine. And then second, my numbers are probably a little stale here. But just curious, what's your overall -- your Texas exposure? I think I had it maybe just a little bit over 600 beds in the state of Texas. Where is that now? Did it -- has that changed any -- with any of the divestitures you've done?

Well, you probably want us to break that out between LTAC and rehab. As you know, we have a very large joint venture with Baylor, right? We have 4 rehab hospitals.

Yes. I'm sorry, I meant to ask -- meant to say LTACs, I'm sorry.

Well, the LTACs, we've exited the Houston market last year. And I think we have a couple LTACs in Dallas and I think one other -- we had San Antonio, but that -- we -- was included in the swap. I think we have 4 total LTACs in the State of Texas. I think at one time, we probably had 10 or more, maybe 12. So...

So number of beds is probably in that 160- to 200-bed range.

Yes. And the one LTAC is in the large Baylor Hospital -- Baylor University Medical Center downtown. And I think 2 others in Dallas, and then I think...

Okay. No, that's good. Glad to hear that. And then finally, as you've gone through patient criteria...

You got something against Texas, Frank?

Well, your -- one of your competitors was talking about how Texas was so overbedded and very competitive so...

Yes, no, that's actually true. Well, the Houston market was legendary as being overbedded, and I think that that's really been rationalized. But yes, I see what you mean.

No, no. Okay, and then finally, any -- yes?

Frank, the total number of beds in Texas are 166.

Okay, okay. All right. And the last one, any changes you're seeing in payer mix as you kind of go through this process? I know Kindred had talked about they were really picking up some on the Medicare Advantage side here. But are you seeing any -- is most of what we're talking about here related to your traditional fee-for-service business? Or is there anything going on in Medicare Advantage that might be an opportunity?

Sure, Frank. We continue to see Medicare Advantage grow as a total percentage of our payer mix, and we expect that to continue.

Thank you. I'm showing no further questions in the queue at this time. I'd like to turn the conference back over to Mr. Ortenzio for any final comments.

Thank you, operator. No further comments. Thanks, everyone, for joining us this morning.

Ladies and gentlemen, thank you for participating in today's conference. This concludes the program. You may now disconnect. Everyone, have a wonderful day.