Select Medical Holdings Corp (SEM) 2018 Q3 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 third quarter 2018 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 the conference call may contain forward-looking statements regarding future events or 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 information available to the 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. Please go ahead.

Thank you, operator. Good morning, everyone. Thanks for joining us for Select Medical's Third Quarter Earnings Conference Call for 2018. Before I outline our operational metrics, I want to provide you some summary comments and updates since we spoke last quarter.

Once again, we were generally pleased with the performance in the quarter with a 17.7% year-over-year growth in revenue, over a 35% growth in adjusted EBITDA, including double-digit growth in all 4 of our business segments. Cash flow from operations was again very strong this quarter, generating over $164 million. We repaid an additional $85 million of Select's revolving debt this quarter and reduced net debt on a consolidated basis by just over $100 million. We reduced our credit facility leverage from over 5x at the end of the first quarter of this year to 4.64x at the end of this third quarter. We are confident we will hit our previously stated year-end credit facility leverage target of under 4.6x.

U.S. HealthWorks integration continues to proceed as planned, and our core Concentra business continues to exhibit strong growth in terms of both rate and volume with over 6% revenue growth in the core business alone. We realized nice top line growth in our core outpatient rehab business and continue to see improvement in the physio markets.

In our critical illness recovery hospital division, we had nice growth in adjusted EBITDA and margins, driven by improvements in non-Medicare rates while controlling operating costs.

Our rehabilitation hospital business continues to achieve double-digit growth in both revenue and adjusted EBITDA as the maturation of the hospital portfolio continues. As I mentioned last quarter, we're currently on track to open a new joint venture rehabilitation hospital with the University of Florida at Shands expected to open in the first quarter of next year.

Also, a joint venture rehab hospital with Dignity Health in Las Vegas is expected to open in the second quarter next year, and a new joint venture rehab hospital with Riverside Health in Virginia expected sometime in the third quarter next year. We also plan to begin construction on 2 new rehabilitation hospitals in 2019 with Banner Health in Arizona, which would open sometime in 2020.

Let me take you now through our operational metrics. Overall, our net revenue for the third quarter increased by $190 million to $1.27 billion, which included top line growth in each of our 4 business segments. Net revenue in our critical illness recovery hospital segment in the third quarter increased slightly to $420 million compared to $417 million in the same quarter last year. The increase was driven by our rate, which increased 2.6% to $1,705 per patient day in the third quarter.

Occupancy in our critical illness recovery hospital segment was 65% in both the third quarter this year and last year. Our outpatient days and admissions both declined compared to same quarter last year. The decline was driven by 4 hospitals we closed since the third quarter of last year.

Net revenue in our rehabilitation hospital segment in the third quarter was 12.3% to $177 million compared to $157 million in the same quarter last year. Patient days increased 16.2% to 79,000 patient days compared to 68,000 days in the same quarter last year.

Net revenue per patient day increased slightly to $1,582 in the third quarter compared to $1,573 per day in the same quarter last year. Net revenue in our outpatient rehab segment in the third quarter increased 7.8% to $266 million compared to $247 million in the same quarter last year.

Patient visits increased 2.7% to 2.04 million visits in the third quarter compared to 199 -- 1.99 million visits in the same quarter last year. Our net revenue per visit was $103 in the third quarter compared to $102 per visit in the same quarter last year.

Net revenue in our Concentra segment for the third quarter increased 58.1% to $404 million compared to $256 million in the same quarter last year, driven by both the contribution of U.S. HealthWorks and over 6% growth in the legacy Concentra business.

For the third quarter, revenue from our centers was $369 million, and the balance of approximately $35 million was generated from the on-site clinics, community-based outpatient clinics and other services.

For the centers, we had patient visits of 2.98 million and net revenue per visit of $124 in the third quarter. This compares to 1.98 million visits and $113 per visit in the same quarter last year. Increases in our net revenue per visit related to both higher reimbursement rates at the U.S. HealthWorks centers and improved workers' comp and employer service payment rates at the existing Concentra centers.

Total adjusted EBITDA for the third quarter increased 35.2% to $156.6 million compared to $115.8 million in the same quarter last year, with consolidated adjusted EBITDA margin at 12.4% for the third quarter compared to 10.8% for the same quarter last year.

Our critical illness recovery hospital segment adjusted EBITDA was $53.3 million in the third quarter compared to $46.9 million in the same quarter last year. Adjusted EBITDA margin for the segment was 12.7% in the third quarter compared to 11.2% in the same quarter last year. The increase in our adjusted EBITDA and margin was primarily due to improvement in our net revenue per patient day rate I previously mentioned.

Our rehabilitation hospital adjusted EBITDA increased 12.2% in the third quarter to $25.3 million compared to $22.6 million in the same quarter last year. Adjusted EBITDA margin for the rehab hospital segment was 14.3% in both the third quarter this year and last year. The increase in adjusted EBITDA was primarily driven by an increase in patient volume at the new hospitals that we opened in 2016 and 2017.

Outpatient rehab adjusted EBITDA was $34.5 million in the third quarter this year compared to $29.3 million in the same quarter last year. Adjusted EBITDA margin for the outpatient segment was 13% in the third quarter compared to 11.9% in the same quarter last year. We experienced improvement in both adjusted EBITDA and margin in both the Select and physio clinics.

Concentra adjusted EBITDA was $68.8 million for the third quarter compared to $40 million in the same quarter last year. Adjusted EBITDA margin was 17% in the third quarter compared to 15.6% in the same quarter last year. The increase in adjusted EBITDA and margin is primarily attributable to lower -- achieving lower relative operating costs across our combined business with U.S. HealthWorks.

Earnings per fully diluted share was $0.24 for the third quarter compared to $0.14 for the same quarter last year. Adjusted earnings per fully diluted share was $0.23 per diluted share for the third quarter. Adjusted earnings per fully diluted share excludes the nonoperating gains and the related tax effects in the third quarter.

I'm also pleased to announce that Marilyn Tavenner has joined the Select Medical board. Ms. Tavenner is the former President and CEO of American (sic) [America's] Health Insurance Plans and former administrator of the Centers for Medicare and Medicaid services. She also served as a Secretary of Health and Human Resources in the State of Virginia. In addition, from 1981 to 2005, she was employed by Hospital Corporation of America. We believe Marilyn's proven skill through her experience in the state and federal health care government operations, senior executive level health care administration and her nursing background will be a significant benefit to Select.

I'll now turn the call over to Marty Jackson for some additional financial details before we open the call up for questions.

Thanks, Bob. Good morning, everyone. For the third quarter, our operating expenses, which include our cost of services and general and administrative expense, were $1.1 billion. This compares to $966 million in the same quarter last year. As a percentage of our net revenue, operating expenses for the third quarter were 88.2% as compared to 89.7% in the same quarter last year.

Cost of services were $1.09 billion for the third quarter. This compares to $939 million in the same quarter last year. As a percentage of net revenue, cost of services were 85.8% for the third quarter. This compares to 87.2% in the same quarter last year.

G&A expense was $30 million in the third quarter. This compares to $27.1 million in the same quarter last year. G&A as a percent of net revenue was 2.4% in the third quarter as compared to 2.5% of net revenue for the same quarter last year. As Bob mentioned, total adjusted EBITDA was $156.6 million, and the adjusted EBITDA margin was 12.4% for the third quarter. This compares to an adjusted EBITDA of $115.8 million and adjusted EBITDA margin of 10.8% in the same quarter last year.

Depreciation and amortization was $50.5 million in the third quarter. This compares to $38.8 million in the same quarter last year. The increase is primarily the result of the U.S. HealthWorks acquisition.

We generated $5.4 million in equity and earnings of unconsolidated subsidiaries in the third quarter. This compares to $4.4 million in the same quarter last year. In addition, we recognized a nonoperating gain of $2.1 million during the third quarter, which relates to the sale of our outpatient rehab clinics to a non-consolidating subsidiary.

Interest expense was $50.7 million in the third quarter. This compares to $37.7 million in the same quarter last year. This increase in interest expense is primarily related to the financing of the U.S. HealthWorks acquisition at Concentra.

The company recorded an income tax expense of $14.1 million for the third quarter. This compares to the income tax of $14 million in the same quarter last year. This represents an effective tax rate of 24.8% and 36.1%, respectively. The lower effective tax rate this year is the result of federal tax reform legislation that was enacted in December of last year.

Net income attributable to Select Medical Holdings was $32.9 million for the third quarter, with fully diluted earnings per share of $0.24. Adjusted EPS, excluding the nonoperating gain and its related tax effects, were $0.23 in the quarter.

At the end of the quarter, we had $3.33 billion of debt outstanding and $160.4 million of cash on the balance sheet. Our debt balance at the end of the quarter includes: $1.13 billion in Select term loans; $65 million in Select revolving loans; $710 million in Select 6 3/8% senior notes; $1.17 billion in Concentra first-lien term loans; $240 million in Concentra second-lien term loans; $50 million in unamortized discounts, premiums and debt issuance costs that reduced the overall balance sheet debt liability; and we also had $58 million of other miscellaneous debt.

We had a very strong quarter of cash flow in the third quarter with operating activities providing $164 million of cash flow compared to $89.6 million in the same quarter last year. Our days sales outstanding or DSO was 54 days at September 30, 2018. This compares to 54 days at June 30, 2018, and 58 days as of December 31, 2017.

Investing activities used $50.6 million of cash in the third quarter. The use of cash was primarily related to $39.4 million in purchases of property and equipment and $11.2 million of acquisition and investment activity during the quarter.

Financing activities used $94.1 million of cash in the quarter. We had net repayments of $85 million on the revolver loans, $5.2 million in distributions to noncontrolling interest and $2.9 million in term loan payments in the quarter.

Additionally, in our earnings press release, we updated our business outlook for calendar year 2018. We now expect net operating revenue to be in the range of $5.05 billion to $5.1 billion and adjusted EBITDA to be in the range of $640 million to $655 million. We now expect fully diluted earnings per share to be in the range of $1.02 to $1.08 and adjusted earnings per share to be in the range of $1.01 to $1.07. Adjusted earnings per share excludes nonoperating gains, loss on early retirement of debt and U.S. HealthWorks acquisition cost and the related tax effects.

The updated business outlook does not include any negative impact from the expected loss on early retirement of debt incurred in the fourth quarter of 2018, resulting from the repricing amendments to both the Select credit facilities and the Concentra first-lien credit facilities that closed on October 26, 2018.

We completed a repricing amendment to selected terms and revolving loans, resulting in 25 basis point reduction in our borrowing spreads. We also completed an amendment to Concentra's first-lien credit facilities, which resulted in a 50 basis point reduction in its revolving loan spread and the pricing gird on the first-lien term loan that could result in a 25 basis point reduction should Concentra credit ratings improve. This concludes our prepared remarks.

And at this time, I'd like to turn it back over to the operator to open up the call for questions.

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

Bob, I'd like to get just a little more color on that sort of the state of the movement with patient criteria. Obviously, you've made a lot of progress there, and you lapped through it. But now that you've had this opportunity to really get it behind you, do you see -- still see much of an opportunity for upside on occupancies? And is there any LTAC pruning left to be done? I know you -- I think you may have pruned out one in the last quarter and 4 over the last year. But any color there?

Yes. Thanks, Frank. Generally, we're extremely pleased about the way we came through the criteria. As I've said previously, the LTAC criteria is probably the biggest change to the LTAC segment in the last 20 years, and it's really changed this industry, which is the reason why we've -- you see that we started referring to our hospitals more descriptively as critical illness recovery hospitals. I think the answer to your question of do we see upside from the 65% or the kind of sense that we're seeing is, yes, of course, we do. It's really more of an education. It is a narrower group of patients that we can take where virtually all of our patients are ICU patients or patients that are dependent on mechanical ventilation. So that is a smaller subset of patients. They're highly acute patients. So making sure that our referral sources feel comfortable with us in terms of the safety of the patients and the things that we can do for them. But yes, I do think -- we've said that we think that there is upside, and it will take time. The occupancy numbers move around a bit. As we pointed out, we did have 4 hospitals that closed. Unfortunately, we also lost our hospital in Panama City from the most recent hurricane, and we don't think that, that hospital may not be back in service at least for another year. We hope it will be sooner. So we continue to see a lot of traction and feel good about it and do feel that there's upside. As far as additional closures, I don't think that we'll see additional closings of our critical illness hospitals as a result of their inability to compete for the high acuity patients. If there's any closures, it will be what I would call more ordinary course of business.

Got you. How big a drag would the loss of Panama City be? And how will you account for that?

Yes, Frank, the drag going into '19, our expectation is that was about $4.8 million to EBITDA. And that will be reflected in the guidance we provide at the end of December, beginning in January.

Got you. Switching gears on reimbursement changes having weathered through the patient criteria, just curious about some initial thoughts on the new changes that are coming over on the IRF side, specifically over it, I think, in 2020 with the new patient assessment tool and all those changes. Just any kind of initial thoughts on how that looks and how would you be prepared for that?

I don't -- really don't have any details for you on that, Frank. I mean it is, as you said, 2020. We'll adapt to it. We don't see that as any kind of -- those as any kind of game changers. With the model that we have and the operations of our hospitals, I think that we feel we'll be okay with it.

Got you, okay. And then the last one, and I'll hop. Obviously, appreciate the color on the rollout of the IRFs coming over the next year. When you think about these geographies where these hospitals are open, does it really matter in terms of the process time to get these certified? I know in California, it seems like everything takes a little bit longer. But will the certification cycle be a little shorter in some of these other geographies you're in so that you don't have these retracted start-up losses and that's it.

Unfortunately, we can't count on it. We can't count on it being shorter in some regions than others. It is -- the regulatory environment in -- as you pointed out in California does tend to be a little bit more rigorous and time consuming than other markets. But we saw some delays in getting our Medicare provider number in Louisiana when we opened our hospital with Ochsner. And some places, it's quicker; some places, a little longer. I wish we could predict it better, but that -- I think that's the nature of opening these hospitals. And you know as the company gets larger, the impact of the delay against our projections or our budgets of when we would receive our provider numbers in order to bill, I think, will become less and less overall. So it won't be as big of impact as you saw, particularly when we had the opening of California rehab and some others on a smaller basis. As the base gets larger, I don't think it will be as big of impact.

Our next question comes from the line of Peter Costa from Wells Fargo Securities.

My first question is on the outpatient rehab segment. You had a nice pickup in EBITDA margin there. And I kind of forgot, is that all tied to the rebound from Physiotherapy Associates? Or is there some core stuff going on in there? And how much of that do you think is sort of what we should project going into the future or run rate for the business?

It's actually a combination of both. We've seen improvement on the physio clinics, but our legacy business continues to improve and drive additional volume, and therefore, have additional efficiencies because of that. The operators have done -- they did great job this past quarter.

So do you think that the pickup from the Physiotherapy Associates' purchase is still going to add to EBITDA going forward in a more accelerated way? So we should think about that -- where do you think those EBITDA margins will settle out?

Yes, we think the EBITDA margins should be in that 14% range. And we do think there's still upside on the physio acquisition. There's still some more room to grow there. I wouldn't say accelerated, I would say there's still upside. It will happen over a period of time.

All right. And then on the negative side, your occupancy in the LTAC business, critical illness recovery hospital business, that stayed sort of flat year-over-year, 65%. Do you believe that's going to move forward in the near term? And why do you think it didn't move forward over this past year?

Yes. We certainly think that, that occupancy, we will be in a position to get back to where we are historically. Now third quarter is typically lighter than first and second and actually even the fourth quarter. So historically, 65% for both periods. We do believe that we'll see increases as we continue to educate our referral sources.

And then why do you think it didn't pick up from the third quarter of last year?

I think it was a combination of couple of different factors. You know there's -- we had 4 closures. Management was spending time on some of these closures. And in addition to that, we've had some changes in management in some of our hospitals. Some hospitals, we've seen nice pickups; and other hospitals, we've seen some decreases.

Okay, so still going through a transition. Did the Panama City hospital affect the occupancy at all in the quarter?

It did not.

Next question comes from the line of Bill Sutherland from Benchmark Company.

The final rule from CMS, I think, the impact for your IRF side is going to be around 1.2%. Correct me if I'm wrong. And also what -- how's it going to net out for you on the critical illness recovery side?

Yes, Bill, could you repeat that question? We're trying to figure out. Are you talking about market basket increase?

Yes. And these things are always -- I know the numbers that CMS put out with the update. But the impact to you specifically because there's always specific issues of how it applies to a provider.

Yes, it's a good question. The way that we take a look at it, I'll walk you through how we take a look at it. CMS announced the 2.7% market basket increase. But as you know that you also have to back out some of the negative adjustments that are occurring. There is a 75 basis point adjustment, negative adjustment that will occur. There's a 0.8% negative adjustment, an additional 0.8% negative adjustment. And then there's a 0.947% negative reduction due to the elimination of the 25% threshold policy. And then, finally, there's a 0.0287% negative reduction due to the area of wage level budget neutrality factor. Totaling all those up, we actually have seen a 16 basis point increase for Medicare starting October 1.

Okay. That's pretty close to 0. How about the -- I also asked about LTAC.

Bill, the other thing you should note is these -- all the things that I just said, those are outlined in the 10-Q just do you have that. I now I stated them pretty quickly. Writing them down, that could be tough.

Okay. And the other side, is that in the Q as well, the other hospitals?

Yes, the IRFs, yes.

IRFs, yes, okay. So the outpatient rehab growth was nice, very nice lift. What -- how should we think about the sort of sustainable -- as you look at your expansion plans and what's going on with rates, et cetera, what do you feel is a sustainable level that you guys can target?

We think that on the outpatient side, probably 2%, 2% to 3% volume growth on visits. And what we penciled out for next year is 0% to 1% increases on the pricing side.

Okay. And the -- let me see what else I have. And then finally, on the LTAC capacity, I think you had mentioned you might be expanding or adding a few beds with one of your JVs. Is there anything in the works as far as adding to LTAC capacity?

Yes, I think we did mention that in the last call. And if we -- I think we're responding to your question if we saw growth in the LTACs, I said that we weren't likely to be in the acquisition mode but that we would consider opening some new LTACs. As you probably know, since criteria, and I mentioned it being such a big change, the number of hospitals is going down very rapidly as is the Medicare spend as the lower acuity LTAC hospitals that weren't really able to make the conversion to the higher acuity requirements are closing. But we do see some opportunities, perhaps, in some of our joint venture markets. As you know, our rehab joint ventures are with some extremely large systems. We do have LTAC or our critical illness recovery hospital partnerships with Cleveland Clinic and some other markets. So we do have some of those in the pipeline and would consider joint venturing perhaps those with some of our partners.

Okay. Nothing specific at the moment. Last one from me. You mentioned on Concentra, the revenue -- the net revenue per visit improving on both sides. There is better workers' comp at Concentra. What led a little bit of an increase at U.S. Health? I didn't catch that.

Yes, the rate increase -- some of that had to do with the integration of U.S. HealthWorks. A significant number of centers that U.S. HealthWorks had are in California, and their rates are typically higher than the rest of the country.

So we're talking about a mix issue then?

Well, we're talking about -- it wouldn't necessarily be a mix. Well, if you want to put in terms of geographical mix, yes.

I mean, in terms of how USH coming in is -- as to the -- it's a mix -- a positive mix impact on your...

On the rate.

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

Wanted to ask about the seasonality of the business. It looks like your guidance implies that Q4 is going to be below Q3. And I know we usually would expect at least the hospital business to be up from Q3 into Q4. Can you talk a little bit about what's going on with Q4 this year? And whether that's the way to think about things going forward relative to these mix changes?

Yes, Kevin, good question. As you know, we provide annual guidance. And so consequently, and we understand you guys, do it on a quarterly basis, which is exactly what you should be doing. In particular, on the critical illness recovery hospitals, there's fluctuations in those rates, as you saw in the second quarter. We're comfortable with the guidance that we provided out there. And to a certain extent, quite candidly, when we take a look at the fourth quarter that some of the analysts have provided, I think they've -- historically, I think they've done that right, but third quarter was good for us. But at the end of the day here, we're very comfortable with the guidance that we provided.

Okay, so I guess, maybe then thinking about how to think about 2019, 2020 going forward as we do this, I mean, just maybe help us -- remind us what quarters do you think may be the strongest from a company-wide perspective? I wasn't sure if Q4 being higher -- or being lower than Q3 is something that we should be modeling going forward as well just to your point Q3 being maybe a little bit better?

Yes, I think Q3 was a little bit better. So I think that's the best place to leave it right now. With regards to what's the best quarter for us, the best quarter for us has always been Q1.

Okay, great. And then, I guess, Concentra's revenue declined sequentially by about 2%. Is that -- is there seasonality in that business? Last year, it was kind of more flattish despite the hurricane. So I wasn't sure how to think about that.

Yes. Normally, for Concentra, what you have is -- typically in that business, first quarter is -- first and fourth quarters are typically down. What -- and that's what we've had historically, although the past 2 years, first quarter has been up a lot higher than we've normally seen in the industry, but fourth quarter is always down. Second and third quarter are typically pretty close to one another.

Okay, so down 2% is not that far off of flat. Okay. And then, going to the IRF side, obviously, 16% volume growth is huge number, but the margins were flat with that. Why aren't you able to get a little bit more leverage. I would have thought that, that kind of patient day growth there might be more leverage on the margin.

Yes, I think, again, good question. We have start-ups. So we have the Ochsner start-up. We called out, and there's probably a little bit -- it's about $800,000 of losses in the quarter because of that start-up. And then we have some hospitals that have only been around for 1 year, 1.5 years. And what we've said is some of the -- it takes typically 2 to 3 years for those hospitals to mature. So -- and I think Bob mentioned, Kevin, that, as we continue to open up new hospitals, the base gets larger. And these types of openings will become a smaller and smaller percentage of the total IRF business.

Yes, I thought that the start-up losses were higher last year than they were this year. I thought it was like a little over $1 million last year. I think around about that. But are you just saying, recently opened hospitals are a little bit uneven as far as the margin performance, but nothing you're worried about at this point?

Yes, we're not.

Okay. And then last question. You guys have done a good job knocking down the rates on these refinancings, but obviously interest rates are rising. Are there any thoughts about terming out the loans at these points? Or how do you think about that?

When you say terming out the loans, do you mean fixing?

Yes, exactly, putting the bonds into term-out some of the floating rate debt?

Yes. We're always evaluating whether that makes sense or not. We've gone from -- we're constantly paying attention to what's going on there. We've gone from a 3-month LIBOR to a 1-month LIBOR. And we'll continue to keep at the 1-month LIBOR. From our perspective and taking a look at all the banks, economists and what they anticipate, we're going to see probably going to be 3% for the next couple of years. So if it makes sense to fix, we will do that. And I think as a vehicle what we would probably use to do that would be a cap, but it's got to be from our perspective. We've got to buy something that's economically opportunistic for us. At this point in time, we've been -- over the past couple of years, we've been in that 5% to 6% range on our floating. We continue to be there. And even if LIBOR hits 3%, we will still be in that 5% to 6% range.

Our next question comes from the line of A.J. Rice from Crédit Suisse.

Just a couple of questions. Concentra up 6% ex U.S. HealthWorks this quarter. It looks like it's now been a handful of quarters where it's been growing in that mid-single digits sort of organically. I know at one point, early days, the discussion was, well, long term, that sort of run rate for Concentra is about 3%. Do you think the normalized run rate is somehow now higher and would sort of evolved -- that would -- has driven that higher rate of growth?

A.J., first of all, it's good to have you back.

Glad to be back.

Good, good. With regards to growth, listen, the operators at Concentra have just done an absolutely fabulous job with that growth. I believe, and I think both Bob and I believe that over the next 1 year to 1.5 years, that's probably going to moderate a little bit as we integrate U.S. HealthWorks as far as the legacy businesses is concerned. But then subsequent to full successful integration, I think it could potentially return to those types of levels.

Okay, all right. And then, just a follow-up to that. The U.S. HealthWorks, I think the stated synergy target is $38 million. Can you update us on whether that's moved around at all? Is there timing expectation when you're going to realize that? Any update on that? And generally, just how U.S. HealthWorks is doing.

Yes, U.S. HealthWorks integration is going very well. The $38 million is a very good number. We're very comfortable with that. There may be some upside to that. As far as timing on that, we anticipate the majority of that will be realized in 2019. And certainly, $38 million on an annual basis will be obtained in 2020.

Okay. And then my last question was, obviously, a lot of the businesses have shown nice margin improvement. Your biggest cost item is labor across those segments. What are you seeing in the major segments in terms of cost trends with respect to labor? Any metrics that you can reference, either turnover, productivity, anything that you're tracking, just general wage increases may be that you're seeing?

Yes, what we're seeing A.J. is the labor for us is really on the clinical side, the nursing side. And what we're seeing is wage increases annually of about 30%.

Okay. That's pretty consistent with what you saw last year?

Yes.

Okay. And when you think about therapists and all the similar dynamic, not a lot of wage pressure there, I'm assuming?

Well, it depends on the geographic locations that you're talking about is with the therapist, there's always different pockets where you've got some increases, but nothing that we haven't seen over the past 5 to 6 years.

Our next question comes from the line of Peter Costa from Wells Fargo Securities.

Just want to follow up on the last quarter's issues with the threshold days. We saw the revenue per patient day continue to drift a little bit lower here. While it's up year-over-year, it's lower sequentially. And length of stay is up a little bit. Can you tell us -- did you have like the threshold day problem again this quarter? Or did that more largely go away? Or did you manage through it with cutting labor cost? Can you talk about that a little bit?

Sure, Pete. Yes, threshold days were -- they bounced back this quarter. So we were in good shape with regards to threshold days. You had talked about the length of stay. On a same quarter year-over-year basis, the -- it's actually down...

Down year-over-year, but up sequentially.

Yes.

No, but it was a bit same.

It's about the same sequentially.

Looks like 10 bps.

Okay.

Sorry, I'm just -- how did you get the improvement? Or are we just having an easier comp with the third quarter of last year? So threshold days are down. I guess, that helps, but your revenue per patient day is still a little bit down from where it was in Q2.

Pete, I should tell you, I think the rate per patient day in second quarter, I'll have to go back and take a look at, was talking $1,710. You're talking about $1,705. We're talking about $5, Pete.

It's a small amount, but I'm just trying to figure out what's going on.

You are killing me, Pete.

I understand. But it was such a topic last quarter, I'm just trying to make sure that we have it resolved this quarter.

Yes, well, again, I mean, the point that we made last quarter is there is fluctuations in those rates, and there'll continue to be fluctuations. So it's not a problem, it's -- that's part of the Medicare reimbursement system is based on averages.

Yes, when we had the threshold day issue, I think that when we talked about it last quarter, we didn't say there was a problem. We just said it was what it was and not necessarily a remedial action. Those are critical patients that are -- we said -- I think what we said at that time, it would tend to average out over the year, and we had a quarter where the higher threshold days were there, but I don't want to give anybody the impression that we had to take remedial actions for the threshold day because they are what they are, and they'll be down, they'll be up across the course of a full year. So we actually can't manage that.

As we said last quarter, it's really based on the physicians determination as to when you're going to discharge the patient.

Perfect. Solved or not solved because this is normal.

Yes. Thanks, Pete.

Exactly. And that's a good clarification. Because I do think that when we started calling it out, I mean, people first time, they heard about threshold days. And now I think it's natural for people wanting to track one more indicator, but it's not a good indicator to track. I mean, it shows up in the rate, right? And so that's just the way it's going to be.

Our next question comes from the line of Matthew Gillmor from Baird.

I had another reimbursement question. I know those are most popular. For the 2020 changes with the -- on the IRF side moving from the SEM to the CARE tool measure. And you've got one of your peers, I think, most people think that will create a little bit of a pressure in terms of their rates in 2020. But just curious in terms of how you're thinking about the change and what impact it might have?

Yes, I mean, I'd just say the way we've looked at it, we just don't see it as being a big game-changer for us. So I...

And Matt, as we get closer to 2020 and we see some more specifics, we'll be able to comment a little bit more on it. Usually, what we don't do is, we don't comment on proposed rates.

Yes, but I think the comment we have made is we're not alarmed by it. I mean, yes, look, anytime, we go through these changes, it's a little bit hard. You know the rehab industry has been stable for so many years and maybe we just have -- we live in with post-traumatic stress because we're always going through LTAC changes all the time that one in the grand scheme of our last 10 years is that it'll be an adjustment, but it's not. We don't see it as -- it's not going to be like LTAC criteria. So I think we'll soldier through it.

We have no further questions at this time. I will now turn the call back to the management for closing remarks.

No, that's all. Thanks, everybody, for joining us, and we look forward to updating you next quarter or when our guidance comes out for '19 at the end of the fourth quarter or the beginning of next year.

Ladies and gentlemen, this concludes today's conference. Thank you for participation. You have a wonderful day. You may disconnect.