Select Medical Holdings Corporation (SEM) Q3 2013 Earnings Report, Transcript and Summary

Good morning, and thank you for joining us today for Select Medical Holdings Corporation's Earnings Conference Call to discuss the Third Quarter 2013 Results and the company's business outlook. Speaking today are the company's CEO, Robert Ortenzio; and the company's Executive Vice President and Chief Financial Officer, Martin Jackson. Management will give you an overview of the quarter highlights and then open the call for questions. Before we get started, we would like to remind you that this conference call may contain forward-looking statements regarding future events or the future financial performances of the company, including, without limitation, statements regarding operating results, growth opportunities and other statements that refer to Select's plans, expectations, strategies, intentions and beliefs. These forward-looking statements are based on the information available to management of Select Medical today, and the company assumes no obligation to update these statements as circumstances change. At this time, I would like to turn the conference call over to Robert Ortenzio.

Thank you. Good morning, everyone. Thanks for joining us for Select Medical's third quarter earnings conference call for 2013. For our prepared remarks, I'll provide some overall highlights for the company and our operating divisions and then I'll ask our Chief Financial Officer, Marty Jackson, to provide some additional financial details before we open the call up for questions. I want to first note that the results for the third quarter reflect Medicare payment changes that became effective on April 1, including a 2% reduction in Medicare payments that was implemented as part of the automatic reduction of federal spending mandated under the Budget Control Act of 2011, better known as sequestration; and an increase from 25% to 50% in the multiple procedure payment reduction for therapy services as mandated by the American Taxpayer Relief Act of 2012, or better known as MPPR. Sequestration and MPPR reduced both net operating revenues and adjusted EBITDA approximately $7.2 million and $1.9 million, respectively, in the third quarter. Net revenue for the third quarter was $722.8 million compared to $713.7 million in the same quarter last year. During the quarter, we generated approximately 74% of our revenues from our specialty hospital segment, which includes both our long-term acute care and inpatient rehab hospitals; and 26% from our outpatient rehabilitation segment, which includes both our outpatient clinics and our contract services. Net revenue in our specialty hospitals for the third quarter increased slightly to $532.6 million compared to $531.4 million, same quarter last year. This growth resulted primarily from increases in patient volume, offset by the 2% Medicare sequestration cuts. Medicare sequestration reduction was $6.8 million in our specialty hospitals in the third quarter. Our net revenue per patient day declined to $1,471 in the third quarter compared to $1,517 per patient day in the same quarter last year. The decline resulted from both the Medicare sequestration cuts and a decrease in our average non-Medicare revenue per patient day. Our patient days increased 2.2% to over 336,000 days in the third quarter compared to 329,000 days in the same quarter last year, and our occupancy was 71% in the third quarter compared to 69% same quarter last year. We generated approximately 82% from our specialty hospital revenue from our long-term acute hospitals and 18% in our inpatient rehabilitation hospitals operations during the quarter. Net revenue in our outpatient rehabilitation segment for the third quarter was $190.2 million compared to $182.2 million at the same quarter last year. In the third quarter, our outpatient rehab segment experienced a reduction in revenue of $400,000 due to Medicare sequestration cuts, and $1.9 million due to multiple procedure payment reduction. We were able to increase our net revenue while offsetting reduction that resulted from the sequestration cuts and the MPPR payment reductions. During the third quarter, we generated approximately 77% of our outpatient revenue from our owned and managed clinics, and 23% from contract services. Net revenue in our outpatient clinic-based business, including our owned and managed clinics, increased 6.9% to $147.3 million compared to the same quarter last year. For our owned clinics, patient business increased 6%, or 1.2 million visits, compared to the same quarter last year. Our net revenue per visit was $103 in both the third quarter of this year and last year. Net revenue in our contract services business in the third quarter declined $1.6 million to $42.9 million compared to the same quarter last year. The decline was related to both regulatory changes that affected the annual limit for therapy services and reductions in the number of contracts in which services are provided. Overall adjusted EBITDA for the third quarter was $80.4 million compared to $87.7 million in the same quarter last year, with overall adjusted EBITDA margin at 11.1% for the third quarter compared to 12.3% margin for the same quarter last year. Our decline in adjusted EBITDA and our adjusted EBITDA margin was primarily due to Medicare sequestration cuts and the MPPR payment reductions. Specialty hospital adjusted EBITDA for the third quarter was $75.3 million compared to $83.7 million in the same quarter last year. Again, the primary reason for the decline in adjusted EBITDA in our specialty hospitals was due to Medicare sequestration cuts and a decline in our non-Medicare payment rate, which we're not able to be offset with the corresponding reduction operating costs. Adjusted EBITDA margin for the specialty hospital segment was 14.1% compared to 15.7% in the same quarter last year. Outpatient rehab adjusted EBITDA for the third quarter increased 6.2% to $21.6 million compared to $20.4 million in the same quarter last year. Adjusted EBITDA margins for the outpatient segment was 11.4% in the third quarter compared to 11.2% in the same quarter last year. For the outpatient clinic portion of our business, adjusted EBITDA increased 7% to $19.1 million compared to $17.9 million in the same quarter last year. Adjusted EBITDA margin for our outpatient clinics was 13% for both the third quarter this year and last year. Contract services' adjusted EBITDA was $2.5 million in both the third quarter of this year and last year, and margin was 5.8% in the third quarter this year compared to 5.6% in the same quarter last year. Our reported earnings per fully diluted share were $0.17 in both the third quarter of this year and last year. Our earnings per share in the third quarter of 2012 included nonrecurring loss on early retirement of debt. Excluding this loss and the related tax benefits, adjusted earnings per share was $0.20 for the third quarter of last year. I also want to mention in conjunction with our earnings release yesterday afternoon, the company announced that our Board of Directors has declared a quarterly cash dividend of $0.10 per share in its meeting on October 30. The dividend is expected to be paid on or about November 22 to shareholders of record on November 12. And I'll turn it over to Marty to cover some additional financial highlights for the quarter.

Thanks, Bob, and good morning, everyone. As Bob mentioned, the impact from sequestration and MPPR totaled $9.1 million in the quarter. Had we not experienced these Medicare payment reductions, net revenue would have increased 2.6%, and adjusted EBITDA would have increased 2% in the quarter when compared to the same quarter last year. For the third quarter, our operating expenses, which include our cost of services, general and administrative expense and bad debt expense increased 2.7% to $644.3 million. This compares to the same quarter last year -- as compared to the same quarter last year. As a percentage of our net revenue, operating expenses for the third quarter was 89.2% compared to 87.9% in the same quarter last year. Cost of services increased 3.1% to $617.3 million for the third quarter compared to the same quarter last year. The increase in cost of services was primarily due to an increase in patient volumes. As a percent of net revenue, cost of services was 85.4% for the third quarter compared to 83.9% in the same quarter last year. The primary reason for the 150-basis-point increase in our cost of services as a percentage of our net revenue was the Medicare payment reductions and decline in our non-Medicare rates. However, it is important to note that the operating costs in our specialty hospitals, on a per patient day basis, are actually down compared to the same quarter last year. G&A expense was $17.7 million in the third quarter which is, as a percentage of net revenue, 2.5% compared to $17.1 million or 2.4% of revenue for the same quarter last year. Bad debt as a percentage of net revenue was 1.3% in the third quarter compared to 1.6% for the same quarter last year. As Bob mentioned, total adjusted EBITDA was $80.4 million for the third quarter and adjusted EBITDA margins was 11.1% compared to adjusted EBITDA of $87.7 million and 12.3% adjusted EBITDA margins in the same quarter last year. The primary reason for the decline in adjusted EBITDA and margins was the Medicare sequestration and MPPR reductions previously discussed. Had we not experienced those reductions, adjusted EBITDA margin would have been 12.2% in the third quarter. Depreciation and amortization expense was $16.2 million in the third quarter compared to $15.5 million in the same quarter last year. The equity and losses of $179,000 during the third quarter compared to equity in earnings of $1.2 million in the same quarter last year. The decline was the result of losses incurred by start-up companies and 2 new joint venture rehab hospitals, where we own a minority interest. Interest expense was $21.3 million in the third quarter. This is down from $24.6 million in the same quarter last year. The reduction in interest expense is primarily related to lower interest rates on borrowings. The company recorded income tax of $15.8 million in the third quarter. Effective tax rate for the quarter was 38.5% compared to an effective tax rate of 39.2% in the third quarter of last year. The decline in our effective tax rate has resulted from an increase in earnings of our consolidated subsidiaries, where we have less than 100% ownership interest that are taxed as pass-through entities and which we only record income taxes on our share of the income. This offset, in part, by an increase in our state effective tax rates has resulted from higher proportion of our income being generated in states with higher tax rates. Net income attributable to Select Medical Holdings was $23.3 million in the third quarter, and fully diluted earnings per share was $0.17 in both the third quarter of this year and last year. Our earnings per share in the third quarter of 2012 included a nonrecurring loss on early retirement of debt. Excluding this loss and its related tax effect, adjusted earnings per share was $0.20 for the third quarter last year. The Medicare payment reductions for sequestration and MPPR had a $0.04 negative impact on fully diluted earnings per share in this quarter. We ended the quarter with $1.49 billion of debt outstanding and $9.3 million of cash in the balance sheet. Our debt balances at the end of the quarter included close to $810 million in term loans, which is net of original issue discounts; $600 million in senior notes outstanding; $65 million, which is located on our revolver; with the balance of $14.4 million consisting of other miscellaneous debt. Operating activities provided $93.1 million of cash flow in the third quarter. Provision of cash resulted primarily from cash income generated in the quarter and increases in both accounts payable and accrued expenses, as well as cash tax payments that were less than our tax liability in the quarter. This was offset by increases in our accounts receivable, as days sales outstanding, or DSO, increased to 54 days as of September 30, 2013, compared to 51 days at June 30, 2013. Investing activities used $21.2 million of cash flow for the third quarter. Use of cash included $17.4 million for the purchase of property and equipment and $3.7 million related to investments in businesses during the quarter. Financing activities used $71.3 million of cash for the third quarter. The primary use of cash resulted from $30 [ph] million in net payments on our revolving credit facility, $14 million in dividend payments and $12 million in repayments of bank overdrafts. During the third quarter, we did not repurchase any shares of common stock under our authorized share repurchase program. Under the program, we have spent a total of $173.6 million of the $350 million authorized, and repurchased 23.6 million shares. I'll conclude my comments by reaffirming our financial guidance for calendar year 2013 that we provided in our earnings release. This includes net revenue in the range of $2.925 billion to $3.025 billion; adjusted EBITDA in the range of $375 million to $390 million; fully diluted adjusted earnings per share, which excludes losses on early retirement of debt and the related tax effects, to be in the range of $0.87 to $0.94 a share. This concludes our prepared remarks. And at this time, I'd like to turn it back to the operator to open the call for questions.

[Operator Instructions] First question comes from the line of A.J. Rice of UBS.

A couple of questions, if I might. First of all, looking at pricing year-to-year trends sequentially -- and maybe that's not right the right way to look at it, but it looks like the sequestration impact and the MPPR impact must have been a little more pronounced somehow in the third quarter than the second or maybe there's some other factor there. Because it looked like there was a little bit more of a pronounced dip in price. I just wondered if there was anything behind that.

A.J., we're going to have to take a look at that. We're not -- from a sequential perspective, we don't think there's anything more than that.

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

No. That's what we've had in the past, A.J., that -- up to the $350 million. That was basically authorized by the board back in -- I think it was in the February-March timeframe.

Okay, all right. Yes, that's it, remotely. Can you then, finally, just comment on -- obviously, we got 2 things looming out there in the next 6 months. The doc fix and then, the proposed rule next spring. I know there's been talk about trying to get, for the long-term acute care side patient criteria or facility criteria, whatever you want to call it, incorporated in one of those. Is there any update on where things are -- how things are progressing, and your thoughts on that?

A.J., this is Bob. I don't have a great update. I can kind of give you where I think things stand. The Roberts-Nelson bill, which has been around for some time now, and just to remind you, that was -- the policy behind that was developed by the American Hospital Association, and they really formed the backbone of the provisions of the Roberts-Nelson Bill. And that has been out there. We had always -- I think that it had always been a hope by the AHA that that would be able to be attached to as a "paid-for." Their just has been some difficulty getting it scored, and I think that's still an issue that's kicking around. And so I would suggest to you that there's still some chance that maybe that emerges at year end when we have perhaps, say, a 1 year fixed patch to the doc fix, which, your guess is as good as mine whether that happens. If that doesn't happen, I think it becomes more of a regulatory issue for CMS in the spring. When the rule comes out, we may see some proposal. And CMS has signaled that they are taking another look and have a range of options and alternatives and things that they're looking at, some which, probably, are reasonably consistent with what's in Roberts-Nelson, and some that are not and are probably a bit more concerning to us. But I guess, I would say that there's a lot of discussion going on and, perhaps, an opportunity -- from our standpoint, we really would like to see the patient facility criteria come to the fore, either best case this year or in the spring through the regulatory rulemaking process just so we can get some -- we'll be much better off if we can get some certainty and some clarity around the industry.

Next question comes from the line of Frank Morgan of RBC Capital Markets.

I was hoping you all can walk us through -- obviously, you've had a lot of headwinds here. But when we think about '14 -- I understand you don't want to talk about guidance, but in terms of what we should be thinking about kind of lapping through some of these negative effects you experienced this year and then, with 25 Percent Rule coming back again next year. But just any kind of conceptual, high-level puts and takes that we should be thinking about as we tweak our numbers for 2014?

Sure, Frank, we can certainly take you through that. A couple of different things in that area. Let's walk through the 3 major areas of impact, which would be: sequestration, MPPRs that exist today; and then, the 25 Percent Rule. So on sequestration. Sequestration started April 1, and you've seen what it's done to us on a quarter over -- on the 2 quarters it's been in place so far. I think for next year, you're going to have to make you put that in place for all 4 quarters. The same thing with MPPR. MPPR started April 1 this past year, and that's going to be in place for the full year next year. And then, taking a look at the 25 Percent Rule, we basically said that, including mitigation, we thought that it was going to cost us somewhere in the neighborhood of $15 million.

Okay. And in terms of -- so that's a net number. Are there any incremental mitigation strategies that you have or are contemplating to deal with either the sequestration or MPPR?

Well, I think, on both sequestration and MPPR, the operators are doing a good job. And as I mentioned on the call, on a per patient day basis, our costs are actually down. And we've got to continue to take a look and take every opportunity we can to reduce expenses. Other than that, we don't really see an opportunity to do that. I mean, if you take a look at what we've -- the delta that you've seen between 2012 and 2013 in the third quarter, we saw almost 7,300 additional patient days and just a little bit less than 68,000 additional outpatient visits. And providing services for all those patients cost money. So I mean, our focus is really to make sure that we attempt to get more efficient on a per patient day basis. But to try to recoup that entire cost, we just don't see that in the cards, at least, in the next year or so.

Now Frank, on the 25 Percent Rule, we've given you a number, an estimate, after some level of mitigation. Now are there opportunities there? Yes. I mean, I think there should be and there can be, but you can appreciate that that's a much harder one for us to estimate. So the MPPR and the sequestration is math, and the 25 Percent Rule is, obviously -- has different impacts across 109 hospitals for us. So we're working on plans for next year and strategies for mitigation. So the net number we gave you after mitigation is an estimate, it's a best estimate. But we're going to continue to work on that. And if there's opportunity, we would obviously like to bring that down. And as you can appreciate, there are ways to do that. We have to expand our referral network geographically and from different referral sources to mitigate that. And I think it's possible that we can, but it's just difficult now to give a tighter number on that.

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

There will be some. Some of the deals that we've done and our -- where -- our new opening in Columbus was a new start, the Scottsdale hospital was a new start. And we hope to have an expansion, some new beds in some of our other facilities. We probably like to get to another possible -- another deal or 2 sort of latter part of this year or early next year. We're always looking at acquisition opportunities. So yes, we are looking for ways and pushing on strategies to increase revenue. And I'd like it to be meaningful. But as you know in the business, oftentimes, things are opportunistic. So we'll look for opportunities and we'll keep our development pipeline moving and, hopefully, we can add some facilities.

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

Sure. Frank, it's really a twofold issue. Think of it in terms of some rate reductions, in particular, for us in the Medicaid side and then also commercial. The 3 components we have in that non-Medicare rate would be commercial, Medicare HMO and Medicaid. So we have seen a bit of a reduction in the Medicaid and the commercial rate. In addition to that, we've seen a mix shift, where we've seen an increase in the Medicare HMO and the Medicaid, and those rates are lower than the overall commercial rate. I will tell you that the commercial rate we're seeing is not all across the board, it's in specific areas. Hopefully, that provides you with a little additional color.

Next question comes from the line of Kevin Fischbeck from Bank of America Merrill Lynch.

This actually Joanna Gajuk in for Kevin today. Just a question, I guess, I would like to hear your thoughts around what's going on -- maybe seeing, in terms of net debt -- the next debt ceiling and discussions on the doc fix, and from the perspective of potential, I guess, office that they will be looking for, how you feel about post-acute providers being positioned? Then, any color how you feel in terms of what types of proposals are more likely -- I know that, probably, it's really hard to handicap, but any color that you can provide us with, that will be very helpful.

Well, I don't know that I can give you any better visibility than you might have on your own about the prospects or various pieces of legislation by year end. I mean, I think most people believe that a doc fix will have to be done. Whether it's done by year end or whether it's done sometime in January, we've all seen the deadlines get moved a bit. So -- and whether there is a grand bargain to fix the -- to do the doc fix on a permanent basis or a year, I think most of what I'm hearing is that they'll got a 1 year patch, as they have had done in previous years. So if that's true, then, that piece of legislation would be looking for some offsets. And with the way we've tried to position the LTAC criteria is that it has its best chance of getting something done with the doc fix if it provides some offsets or some savings. They're not going to be meaningful in the context of the overall dollars needed to pay for the doc fix, but when they're looking for dollars, they're doing some. So the other thing is whether I see any opportunity for bigger post-acute care reform -- and I think a lot of the stuff is really bigger -- really bigger ideas that wouldn't impact us in the near term. I mean, there are the conversations about -- out there about bundling and site-neutral provisions and certain other value-based savings pools. I don't really see those as coming to the forefront in the near term. Those are all, I would characterize as, bigger ideas that would be in the out years. So I think the action for the LTACs, particularly, is whether there's any momentum for the Roberts-Nelson bill or something like it, in conjunction with the doc fix. And I would suspect that that has a lot to do with what kind of savings CBO would view that as generating.

Great. And just on the quarter, in terms of any color you might provide about the volumes which were better than what we thought and I guess you -- it sounds like you guys were also happy with where volumes were trending this quarter. And I guess, the second quarter was also pretty good. So I know that at the time, you were not really able to say what was causing that given that overall, I guess, health care utilization in general is weak. But any additional comments you can make around maybe the different regions or anything you can provide us with in terms of the volumes during the quarter?

I think what we'll say is that the operators have done a great job making sure that they continue to educate case managers, physicians as to the benefits of the services that Select provides.

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

I would tell you that we're very pleased with how that joint venture, and speaking more broadly, all of our joint ventures are performing. And particularly, the Baylor JV has grown considerably since we first have done it. And we hope to be able to continue to grow inside that very large market, which is the Dallas and the metroplex. So it's a great region for us, seen a lot of growth. And we think there's still potential to continue to grow there.

Next question comes from the line of Chris Rigg of Susquehanna International Group.

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

Chris, I think if you take a look at same store -- and you probably saw that the mix shift, where we reduced the number of LTACs, increased the number of rehabs, we did on a same-store basis. We actually had a nice increase. About a 2.8% increase on a same-store basis.

And that's combined LTAC and IRF?

Yes.

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

I'd say that's absolutely really right on, particularly, on the LTAC. I mean, I think we have some pretty good visibility on the rehab. But the LTAC, which is our largest division, probably would have -- but for the really lack of clarity, would have some pretty good opportunities there. And we really have taken a much more measured, conservative approach until we see what happens in year end or in the spring because these things could be some things that provide some opportunities. But to move ahead of that, in our mind, just doesn't seem to make a lot of sense. And we discussed this a lot at the last quarter's conference call, and I think that that's exactly what you see as the strategy emerging for the company. We've paid a -- at the end of '12, we paid a kind of a large onetime dividend, and we went on a normalized dividend of $0.10 a share. We're trying to be conservative about allocating our capital and waiting to get some level of clarity on the regulatory environment, particularly on the LTAC side because it's -- the environment that we've been in, kind of looking at all the ideas and proposals that have been out there, just are not a great environment for us to make big commitments of capital or strategy in that direction.

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

I think they do exist, but again, that depends on what the ultimate criteria looks like. That will really define the market. As the LTACs are defined more or less narrowly, that's going to define the market. And then, we would be in a position to, I think, as well as anyone else out there, we'd be in a position to move forward and capitalize on the needs.

Next question comes from the line of Gary Lieberman from Wells Fargo.

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

No. I can't report that we've had any conversations with CMS. We tend to pay close attention to any of the narrative that comes out of CMS. And not only just the rules and the proposed rules, but from time to time, they publish kind of their thoughts or their musings about what they may be thinking about doing in the future. So we pay pretty close attention to that. And so on the positive side, we sense that there's maybe an opportunity that something will be done here over the next, either 3 to 10 months. But on the other hand, there are some things that are coming out of that discussion that appear to us to be relatively arbitrary and potentially concerning to us. So it's 2 sides of the coin.

Is there anything specific that...

I don't know how -- it depends how you define specific. I mean, there are some ideas out there that are being considered. So for example, CMS has, in some of their narrative, has suggested that there's 5 types of patients that would presumptively qualify for LTAC hospital care. And we're in total agreement over that, for example. Of concern to us is an idea that is a -- requiring that LTACs have an ICU stay prior to admission and that would be -- we consider fairly arbitrary and maybe not a good proxy for acuity. And so that's a potential concern to us. So as is usually the case before there is any kind of significant regulatory or even legislation, you start to hear a lot of chatter or discussion about it. And some of the stuff is good and some of the stuff is concerning. And I think that that's the environment that we're in right now and we're likely to be in, either at year end when something gets done on or -- to the rulemaking process next spring.

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

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

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

I think -- I guess, the question for you, Gary, is what did you look at as far as increase in volume? So when we take a look at the increased volume that we had, we were actually pretty happy with where we were. And again, the way we take a look at that is really on a per patient day basis, the expenses associated with that and including SWNB [ph]. And it was actually down on a same quarter, year-over-year basis.

Next question comes from the line of Matthew Gilmore of Robert Baird.

This is just one quick follow-up to the admin criteria discussion. But I was just curious if you had any sense for how committed CMS was to that ICU component. And maybe it's a little bit early to ask, but just sort of curious given that it seems somewhat arbitrary.

I have no reason to think that they're absolutely committed to it. I mean, I think we've seen these things in the past where it's -- I really don't even know how to characterize it. It's a narrative, it's discussion, it's ideas. But I don't think there's any way to know how committed they are to it. I would think that some of it, given the severity of it, it's probably not 100% committed to it. So I think that, that's really a starting point for probably a lot of discussion that's going on inside CMS and probably in the industry, as well. That's my best guess. Although, you don't really get a lot of information coming out of the agency on these things.

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

Yes, Matt, I think -- I think we may have stated in the past that it's just probably in the range of 150 to 200 beds.

In terms of what it could hit in 2014 or what sort of..?

Yes, something that could hit in 2014.

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

Well, yes. I think it should be back to positive territory relatively soon. I think one of the issues had to do with the -- some startup hospitals where we have some minority interest in. And I anticipate that over the next quarter or 2, that those will turn positive. You will see that line, in total, turn positive.

The next question comes from the line of Blake Goodner from Bridger.

Just real quick, 2 questions. First one is, as it relates to the patient functional criteria, CMS, I think has been out suggesting as few as 30% of the LTAC admissions should qualify. But then, the Roberts bill has a plan to, I think, reduce industry volumes by as little as like 10%. I'm wondering what you'd be willing to give up to get this clarity and visibility so that you could pursue your strategy? I mean, I'm wondering what percentage of volumes you'd be willing to give up, recognizing there's a lot of things you can do and a lot of opportunities ahead.

If you look -- if the question is directed about not really so much the industry, but Select Medical specifically, we have among the highest acuity patients in the industry. So when there's discussion about what percent of the patients should not be qualified, whether it's 10% or 20% or 30%, the impact is not going to be equal across the industry. I have said in the past, and I'll reiterate, that we would be willing to give up some volume in exchange for certainty and clarity around the regulations and stability on a go-forward basis because it would enable us to be a little bit more thoughtful about capital allocation and growth opportunities. So I really can't comment on what we'd be willing to give up. The fact of the matter is, is that if Select would be penalized with a big loss of our volume, I think it's fair to say that it would be even more dramatic across the industry. Having said all that, I think, generally, when you look at industry statistics, there is some percentage of patients that probably should be excluded from the higher-cost LTAC segment. And I think Roberts-Nelson tries to get at that out of their -- is there some space above that? I mean, I don't know. That's kind of a bigger policy question. But I will say that we would be willing to give up some volume in exchange for certainty.

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

Well, as I've said, I think, in response to Frank's question, the 25 Percent mitigation strategy is a moving target. It's one thing when it was theoretical and you have your hospitals at any 1 point in time. We can take a snapshot of what percentage of patients come from or are in excess of 25% or 50%. And that's different than it is during another snapshot period. So it doesn't surprise me that that number has moved around a bit. And we're probably, I think now we're trying to be conservative about what the impact would be and we're also working hard to mitigate it as much as possible. So that number is going to move around. And we also talked about how the impact of the 25 Percent Rule doesn't affect all the hospitals equally or on the same time. So there's a timing difference as well, because it's only implemented coincident with the cost reporting years. And all of our hospitals have different cost reporting years. So depending on what point in time we're looking at, that number could move a little bit. But I think for your purposes, you should look at the current -- the current number that we've given you is our best estimate. And I suspect that after Q4 and going into next year, when the impact of the regulation really hits, we'll update that number.

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

Well, I really have no idea. And the only thing I would caution you on is a characterization that this is a negotiation. There really just is no negotiation. This is the industry trying to, I think, put forth -- or the AHA or others trying to put forth ideas or suggestions. And that's, frankly, MedPAC's role as well, to be a recommending agency to the true policymakers, which would either be the relevant committees, which would be House Ways and Means and Senate Finance or the regulators, which would be CMS. And each have their own ideas, kind of big ideas and kind of more smaller reimbursement cut ideas. So the industry really doesn't get to play a role in negotiating with either of those bodies other than making some suggestions. But yes, there are lots of ideas out there. And the more that they're being talked about, I said before, I think I sense that there's at least an opportunity here to actually get something done that would give us some certainty and clarity.

Your next question comes from the line of Kevin Fischbeck of Bank of America Merrill Lynch.

Just a follow-up to the commentary around the 25 Percent Rule impact that now it seems that may be higher than what you guys thought a few months ago. But any change to the view around the impact this year? Because I believe the last time we spoke, the company was talking about less than $1 million impact in calendar 2013. So has that number changed as well?

No, it has not.

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

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