Select Medical Holdings Corporation (SEM) Q1 2015 Earnings Report, Transcript and Summary

Good morning and thank you for joining us today for Select Medical Holdings Corporation Earnings Conference Call to discuss the First Quarter 2015 Results and the Company’s Business Outlook. Speaking today are the Company’s Executive Chairman and Co-Founder, Robert Ortenzio; and the Company’s Executive Vice President and Chief Financial Officer, Martin Jackson. Management will give you an overview of the quarter highlights and then open the call for questions. Before we get started, we’d 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’ll turn the conference call over to Mr. Robert Ortenzio.

Thank you, operator. Good morning, everyone and thanks for joining us for Select Medical’s first quarter earnings conference call for 2015. For our prepared remarks, I’ll provide some overall highlights for the Company, our operating divisions and then ask our Chief Financial Officer, Marty Jackson to provide some additional financial details before open the call up for questions. Net revenue for the first quarter increased 4.3% to $795.3 million compared to $762.6 million in the same quarter last year. During the quarter, we generated approximately 75% of our revenues from our specialty hospital segment, which includes both our long-term acute care and in-patient rehabilitation hospitals and 25% from our outpatient rehabilitation segment, which includes both our outpatient rehab clinics and our contract services. Net revenue in our specialty hospitals for the first quarter increased 6% to $598.8 million compared to $564.6 million in the same quarter last year. The growth in net revenue on our specialty hospital is attributable to both an increase in patient days and net revenue per patient day. Our patient days in the first quarter increased 3.1% to over 352,000 patient days compared to 342,000 patient days in the same quarter last year. Our net revenue per patient day increased 2.3% to $1,575 per day in the first quarter compared to $1,539 per patient day in the same quarter last year, and was driven by increases in both our Medicare and non-Medicare net revenue per patient day. We generated approximately 82% of our specialty hospital revenue from our long-term acute care hospitals and 18% in our inpatient rehabilitation operations during the first quarter. Net revenue in our outpatient rehabilitation segment for the first quarter declined slightly to $196.4 million compared to $197.9 million in the same quarter last year. The decrease is a related to a reduction revenue from our contract therapy business, which was offset by increases in our outpatient clinics. Net revenue in our outpatient clinic based business increased 5.5% to $156.4 million compared to the same quarter last year. For our owned clinics, patient visits increased 5.3% to over 1.23 million visits compared to the same quarter last year. Our net revenue per visit was a $103 in the first quarter compared to a $104 per visit in the same quarter last year. Net revenue in our contract therapy business in the first quarter decreased to $40 million compared to $49.6 million in the same quarter last year, and resulted from contract terminations. Overall, adjusted EBITDA for the first quarter was $98.9 million compared to $96.8 million in the same quarter last year with overall adjusted EBITDA margins at 12.4% in the first quarter compared to 12.7% margin in the same quarter last year. Specialty hospital adjusted EBITDA for the first quarter was $96.5 million compared to $92.2 million in the same quarter last year. Specialty hospital adjusted EBITDA margin was 16.1% compared to 16.3% in the same quarter last year. Adjusted EBITDA includes start-up losses related to new specialty hospitals of $5.5 million in the first quarter compared to $800,000 in losses in the same quarter last year. Excluding the effect of the start-up losses in both periods, adjusted EBITDA margins would have been 17% in the first quarter of this compared to 16.5% in the same quarter last year. Outpatient rehabilitation adjusted EBITDA for the first quarter was $22.1 million compared to $21 million in the same quarter last year. Adjusted EBITDA margin for the outpatient segment was 11.3% in the first quarter compared to 10.6% in the same quarter last year. For the outpatient clinic portion of our business, adjusted EBITDA increased 15.4% to $19.8 million in the first quarter compared to the same quarter last year. The increase was attributable to volume growth and corresponding revenue with lower cost of service. For our contract services, adjusted EBITDA decreased to $2.4 million in the first quarter compared to $3.8 million in the same quarter last year, primarily as a result of contract terminations. Our reported earnings per fully diluted share were $0.27 in the first quarter of this year compared to $0.24 in the same quarter last year. Our earnings per share for the first quarter of last year included a non-recurring loss on early retirement of debt. Excluding this loss and its related tax effect, adjusted income per share was $0.25 in the first quarter last year. Additionally, I wanted to provide a few updates since our last earnings call in February. I will first give you an update on the pending Concentra acquisition. As you’re aware Select in partnership with Welsh, Carson, Anderson & Stowe has signed a definitive agreement to acquire Concentra. Concentra is the leading provider of occupational medicine services with 488 service locations in 40 states. Concentra generates approximately $1 billion in annual net -- annual revenues. Select own 50.1% of the joint venture and will commence consolidating Concentra’s financial statements upon closing. The Concentra transaction will be financed to the issuance of $650 million in non-recourse debt at Concentra and $435 million in equity contributions from the JV partners. The transaction is expected to close some time in the second quarter. I also want to share that on January 6, we closed the previously announced rehab joint venture with PinnacleHealth Systems located in Central Pennsylvania. The joint venture includes the 55-bed inpatient rehab hospital and 21 outpatient clinics. On the regulatory front both the LTAC and ERF proposals were issued this month. On April 17, the LTAC proposal was released. Proposals includes an update to the market basket which after other adjustments amounts to a standard federal rate increase of approximately 2%. In addition, the proposal will clarify some of the technical applications of patient criteria which becomes effective for hospital cost reporting periods after -- beginning on or after October 1, 2015. On April 27, the inpatient rehab rule was published. The proposal includes a market basket update to the standard payment conversion factor totaling 2.2%. Both the LTAC and the inpatient rehab rules are subject to 60 day common [ph] period before final rules are released sometime later this summer. And finally at our meeting in April -- at our Board meeting on April 28, Select’s Board of Directors decided not to declare a cash dividend due to the capital requirements of the pending Concentra acquisition and other acquisitions and development opportunities. Our pipeline for growth opportunities remains strong and the Board felt these opportunities will generate better investment return for our shareholders than the dividend. I’ll now turn it over to Martin Jackson to cover some additional financial highlights for the quarter and the year before we open it up for questions.

Thank you, 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, increased 4.6% to $698.7 million compared to the same quarter last year. As a percentage of our net revenue, operating expenses for the first quarter increased 20 basis points to 87.8% as compared to 87.6% in the same quarter last year. Cost of services increased 4% to $664.4 million for the first quarter as compared to the same quarter last year. As a percent of net revenue, cost of services decreased 30 basis points to 83.5% in the first quarter compared to 83.8% in the same quarter last year. The decline in cost of services as a percent of net revenue was due to lower relative costs of services in both our specialty hospitals and our outpatient rehabilitation businesses, driven by increased volumes. This was offset in part by incremental start-up losses in our specialty hospital. G&A expense was $21.7 million in the first quarter, which as a percent of net revenue was 2.7%. This compares to $18.1 million or 2.4% of net revenue for the same quarter last year. Primary reason for the growth in G&A as a percent of revenue was the result of one-time severance costs. Bad debt as a percent of net revenue was 1.6% for the first quarter. This compares to 1.4% for the same quarter last year. The increase in bad debt expense was mainly attributable to our specialty hospitals. Total adjusted EBITDA was $98.9 million and adjusted EBITDA margin of 12.4% for the first quarter. This compares to adjusted EBITDA of $96.8 million and adjusted EBITDA margins of 12.7% in the same quarter last year. As we mentioned, our adjusted EBITDA in the quarter was adversely impacted by the $5.5 million in start-up losses in our new specialty hospitals. Excluding the effect of the start-up losses in both periods, adjusted EBITDA margins would have been 13.1% in the first quarter of this year compared to 12.8% in the same quarter last year. Depreciation and amortization expense was $17.3 million in the first quarter which compares to $16.2 million in the same quarter last year. The increase in depreciation results primarily from increased capital expenditures due to the new hospital development and expansion in our specialty hospital segment over the past year. We generated $2.6 million in equity in earnings of unconsolidated subsidiaries during the first quarter compared to $900,000 in the same quarter last year. These increases are mainly the result of contributions from our specialty hospital joint venture partnerships, where we own a minority position. Interest expense was $21.4 million in the first quarter compared to $20.6 million in the same quarter last year. The increase in interest expense in the quarter is a result of additional borrowings compared to the same quarter last year. The company reported income tax expense of $23.2 million in the first quarter. The effective tax rate for the quarter was 38.3% compared to the effective tax rate of 39.1% in the first quarter of last year. Net income attributable to Select Medical Holdings was $35.1 million in the first quarter and fully diluted earnings per share were $0.27 compared to fully diluted earnings per share of $0.24 in the same quarter last year. Our earnings per share for the first quarter of the last year included non-recurring losses on early retirement of debt, excluding this loss and its related tax effect to adjusted income per common share of $0.25 in the first quarter last year. We ended the quarter with $1.58 billion of debt outstanding and $6.6 million of cash in the balance sheet. Our debt balances at the end of the quarter included $749.5 million in term loans, which includes the original issue discounts, $711.4 million in our 6.375% senior notes, which includes issuance premiums, $100 million in revolving loans with the balance of $19.8 million consisting of other miscellaneous debt. Operating activities provided $37.5 million of cash flow in the first quarter. The provision of operating cash flow primarily resulted from cash income, an increase in accrued expenses tax and payables, which was offset in part by increases in our accounts receivable. Day sales outstanding or DSO was 56 days at March 31, 2015. This compares to 53 days at December 31, 2014 and 55 days at March 31, 2014. Investing activities used $31.5 million of cash flow for the first quarter. The use of cash was related to purchases of property and equipment of $27.8 million and acquisition and investment payments totaling $3.7 million during the quarter. Financing activities used $2.8 million of cash in the first quarter. The use of cash for the quarter included $26.9 million to make a mandatory excess cash flow prepayment required under our term loans, $13.1 million in dividend payments, $2.8 million for repayment of bank overdrafts, and $2.4 million in distributions to non-controlling interest in the quarter. This was offset in part by $40 million in net borrowings on a revolving line of credit. Net borrowings of other debt of $2 million and proceeds from the issuance of common stock of $0.5 million in the quarter. In our earnings press release yesterday, we reaffirmed annual guidance for our core Select businesses. We will also be providing updated annual guidance incorporated into Concentra acquisition. We anticipate this update will occur within a couple of weeks post closing of the Concentra transaction. This concludes our prepared remarks. And at this time, we’d like to turn it over to the operator for any calls.

Thank you. [Operator Instructions] Our first question will come from the line of Frank Morgan from RBC Capital Markets. You may begin.

Good morning. In light of the strength on the volumes and your top line growth there, I was just curious as it relates to guidance. What would -- might be holding you back from raising guidance at this point, given the magnitude of the deal?

Yes, Frank, what we were going to do, we’re taking a look at the Concentra transaction. At that point in time we will also take a look at our core businesses. So I think in total we will put all that together and come out with revised guidance.

Okay.

Yes, with Concentra’s closing in the second quarter and just being the -- be in the first quarter, I think we will revise everything at one-time rather than do it now and do it again when Concentra closes.

Okay. And that’s fair. In terms of -- you mentioned other opportunities, obviously electing to not pay the dividend and hold that capital for growth. Can you talk a little bit more about what opportunities, in what direction you may go with that and I take it at above and beyond Concentra? Thanks.

It is, Frank. Let me comment first and I will turn it over Marty. Select has a history of paying some dividends, some large one-time dividend before the tax law change and then some quarterly dividends. We did this at a time when there was, frankly, certainty around a lot of things with the LTAC and our growth prospects. We feel now that we have pretty good visibility with the criteria for LTACs, we have the Concentra acquisition, we have an accelerating pipeline of rehab hospitals coming on and we -- and frankly we see opportunities maybe for some other acquisitions and more development. So we really think we have some visibility toward being getting back to being a growth company again and with those growth opportunities the Board felt that our capital can get a much better return for shareholders by applying it those opportunities. And we’ve consistently said at our conferences that as we see greater growth opportunities, the dividend, the cash dividend was really not something that was a big priority for the Company. We much rather allocate capital to development projects and M&A. So we see that now and that’s the reason and our largest shareholders I think are very supportive with that.

Okay. Thank you very much.

Okay.

And your next question will come from the line of Chris Rigg from Susquehanna Finance Group. You may begin.

Good morning, guys. Just on the Concentra deal, wondering does that change the sort of de novo or joint venture strategy, sort of over the intermediate term, does it put the JV strategy on the back burn or do you think you can do both?

No, absolutely not. We are fully committed to the development in joint venture strategy. It’s been a really great value creator for the Company and we think that, that’s even going to become more evident next year when a lot of the development projects that are coming out of ground open and we’re doing growth in existing one. So that’s been a great story for the Company and the accelerator is down on that and we will continue to push that and we don’t think the Concentra deal at all is an inhibitor to our growth strategy on the joint ventures.

Okay. And then, are there any mandatory buyout provisions in the Concentra JV with Welsh? Because I know Welsh did a deal with another company where there are some mandatory provisions in there. Is there anything like that in this transaction?

Yes, there is, Chris. There is some mandatory -- as a matter of fact, I wouldn’t call mandatory. There is a quick call arrangement starting this third year anniversary and it’s based on fair market value of Concentra at that period of time. And it’s really at the discretion of Welsh, whether they want to exercise that or not. And then at the end of the fifth year, Select has a call provision based on fair market value.

Okay.

Yes, I mean, the expectation is at the end of the fifth year, Select will have Concentra as a wholly-owned subsidiary. That’s our expectation.

Got you. And then just one final one here on the proposed LTAC rule, specifically, the technicalities around criteria, anything surprising there? Thanks a lot.

I’d say that we have a few, what I would call technical concerns, but I have to say that for the most part we think CMS is implementing the new LTAC criteria in a manner that’s pretty much consistent with what Congress passed in 2013. And I think it does recognize the compromises that the sector made to address the public policy concern. So just for those who -- just to refresh memories, that was new criteria was signed into law with the SGR in December of 2013, the new criteria and it will be implemented starting the end of this year.

Thanks a lot.

Your next question will come from the line of A.J. Rice from UBS. You may begin.

Hi, everybody. Couple of quick questions, if I could ask. First, just to make sure, I guess, you ran about $5 million start-up losses for the new LTACs in the first quarter. Is the overall number for this year is still about $70 million, which you think you will run?

A.J., the $5.5 million includes both LTACs and rehab.

Okay.

Okay. And yes we anticipate it would be in that $70 million range for the year.

Okay. And then, the other thing with respect to the quarter, I just wanted to ask was, on these contract cancellations in the contract therapy business, is that you guys proactively walking away from contracts? What sort of going on there?

This was the contract termination that had to do with a large contract that we had with skilled nursing home operator that sold the business.

Okay.

And the new owner had their own contract therapy division.

Okay, all right. That makes sense. Then the bigger picture on the LTAC criteria switch over, obviously there is a phase in period there. I know your strategy has been pretty specific as to really targeting the LTAC specific types of patients. Can you comment, a, on whether those have been any evolution on that strategy, once we go live and as you look at 2016, in particular, I know its early, but just broadly speaking will -- how should we think about the transition. Is it going to be potential for upside, potential for a little bit of a headwind as we go through the transition or is it sort of, because it’s a multi-year thing it won't be that meaningful a change.

Well, A.J. it’s a good question. I think it’s -- the easy part of the question is, is as our strategy change with respect to how we’re going to approach the new criteria. And the answer to that is, no. Our strategy will be to focus on the LTAC compliant patients and not what has been described as the site-neutral paid patients. Now and in terms of a headwind or a tailwind, we think that the criteria is going to be a major event for the LTAC industry. CMS even in this proposed regulation estimated that about 40% of all the LTAC patients would not meet the new criteria. Now having said that, you can assume that, that percentage is not that high for Select Medicals group of LTAC which runs a much higher acuity. So we think that -- we’re focused on it and we’ve been preparing our hospitals to face into the criteria. We think that it is going to be a top transition, but we also think it’s an opportunity. And if you look over the history of our company, we’ve often times done our best in times of uncertainly and transition, because there’s just a lot of factors that go into play. There are clearly going to be winners and losers in the transition from the current criteria to the new criteria. And as we look across most of our markets, we think we have opportunities. That’s not to say that we’re not going to have -- we don’t have work to do, but it really comes down really to execution. So we’re preparing all of our hospitals in various ways of looking at the individual markets to be ready.

Okay. All right. Thanks a lot.

And your next question will come from the line of Kevin Fischbeck from Bank of America. You may begin.

Okay, great. Thanks. So, just to follow-up on that. CMS put out some information at hospital level when we were coming up was based upon their definition about 38% of your patients would be subject to site-neutral payments, is that kind of ballpark of what you’re thinking?

No, its not.

Is it higher?

Lower.

Okay. Because I guess the way -- the way to be looking at the rate is that, of that 38% that CMS was saying some percent is already at site-neutral payments because they already sourced the outlier patients, they meet the criteria but they the LTAC but they’re only going to be there for a few days, so they’re sourced to outlier [ph] patients. So there really wouldn’t be any change in payment rates for those, but if CMS things that there is a 28% rate cut on average for patients that move to site-neutral. It means that the ones who are moving over from a normal patient to the site-neutral rate would see something like a 50% reduction because some portion would see zero because they’re already at the sourced outlier rate and to blend to 28% you’d have to have some seeing a 50% type reduction. Is that the way that you’re interpreting the rate?

Yes, Kevin it’s actually a little more complicated than that. And that the fact to the matter is the site-neutral patients are capped at the lesser of either cost or the ITPS rate. So you’d really have to take a look at that also.

Yes, so I guess, if you were to think about the overall EBITDA, I would assume you were not able to react and switch the patients and replace site-neutral patients with LTAC patients. How did you guys think about the headwind that you guys are having to overcome over next three to four years?

For the most part Kevin we will not be taking site-neutral patients, just flat out we will not be taking that. And to the extent that we’re not successful at replacing some of that volume with compliant patient population, we’ll flex down our staff.

Okay. And Kindred just talked about trying to do the same thing you’re doing to get site of -- get LTAC -- LTAC patients, but then also kind of going after Medicare advantage patients. Is that something that you’re able to do or does the size of your facilities kind of preclude you from making up the margin and made patients, you kind of have to focus on the quarter LTAC patients?

I mean we’re going after Medicare advantage patients right now. As a matter of fact I mean we’ve been working very diligently to change the whole sales cycle if you will for our work for the short-term in acute care hospitals.

Okay, so that is the financial lever that you would board well to kind of offset the criteria?

Sorry, say that again.

I just say that’s a potential level, because I guess historically the 25 day length of stay will -- MA patients kind of against that now with the new criteria they will no longer count against it. So it feels like its something that the LTAC operators could go after more aggressively than they have in the past if you saw a 10 day MA patient you might have been [indiscernible] within the LTAC patient. But now that’s no longer an issue and it could be an LTAC patient. So I wasn’t sure if there was a volume opportunity and they haven’t been explored more aggressively. So have you always been going after it and you’re trying to continue that or is that really a new opportunity for you?

We will continue that.

We’ll just continue it. I think it’s certainly an opportunity, but it’s not a new opportunity, because that it works that way for us now. So, yes we will continue to attract the Medicare advantage patients.

Okay. And just last question, just to confirm the commentary on the dividend. So, basically this is not a situation where you’re saying well we’re going to buy Concentra and we’re going to pay down debt the next few years and then we go back to paying dividends, this is a commentary of, we think that we are now in a growth phase, so dividends don’t make sense. So we see a nice run way of investments we’re going to be growing. Obviously if someway down the road it changes again and there’s uncertainty you might go back paying dividend. But basically as far as you can see, this company is now turning into a growth company rather than a dividend paying company.

Yes, I would say that the Concentra acquisition was a catalyst for us to reassess and suspend the dividend and allocate that capital to more growth opportunities. It’s not really one of using that to pay down debt at Concentra, because Concentra is going to have standalone non-recourse debt in the joint venture. So yes, as I mentioned and I think you reiterated, we see the suspension of the dividend as really one to allocate capital to better growth opportunities, not just Concentra but development and perhaps future acquisitions.

Okay and actually [indiscernible]. One last question just on Concentra, because I don’t think anybody really thought Humana and Concentra made all that much sense. So it makes sense for them to get out of the business. But can you put a little bit color about what you think Concentra can grow at over time, what the opportunity is? How much additional capital you might put into consolidating that, so I guess it’s a little bit different than the outpatient clinic business that you do today.

Well, I’ll just comment on, look we’re very excited about Concentra. We think its one of those opportunities that doesn’t come around often. It is a great platform with 300 clinics in 40 states in 488 sites of service. It’s also very attractive from our standpoint that it concentrates on the 40 state work comp areas. I mean, this is a company that has less than one half of one percent Medicare and so -- and it has its contracts and relationships with employers. So I think Concentra is a great opportunity. We won't be putting out growth statistics or goals at this point and until after closing and after we’ve had more time to spend with management. But we do think it’s an opportunity for it to grow not only on top line but also sufficiently on a bottom line, and I will let Marty follow-on that.

Yes. Kevin, the other important thing for investors to understand with regards to Concentra, is there’s been a lot of discussion about Concentra being an urgent care company. There’s a little bit of urgent care to it, but by far 86% of the business at Concentra is occupational medicine, and that’s a business that, so we know pretty well. Obviously Welsh Carson knows it pretty well. And as Bob mentioned we’re very, very excited about growing that business. In addition to that there’s some synergy potential at the company right now and, so for us short-term is focused on that, long-term we expect to grow this business.

Okay, great. Thanks.

Your next question will come from the line of Dana Nentin from Deutsche Bank. You may begin.

Hi, good morning. Thanks for taking the call. Just to follow back up on the patient criteria. I was wondering if you could update us on your marketing initiatives and the processes that you put in place to prepare for the patient criteria. And I guess, if you could provide any color on whether you started any admission criteria changes yet at this point just to prep for what's ahead?

Well, it’s a difficult question to answer, because in terms of -- I mentioned that we are in the midst of preparation and we are. But it varies -- really that preparation varies per market and it varies per hospital. So, I can give us some examples. I mean, you may need -- some hospitals may need some modifications or some changes or some focus on the physical plan, more high opt areas, better equipment to handle more ventilator dependant patients. Some other hospitals may need modifications in terms of the Medical Directors or the medical staff that tilts, becomes -- tilts more toward preliminary care medicine or intensive medicine and more away from internal medicine and then there is the individual markets. We do an exhaustive and the markets, we do an exhaustive look at the data to determine what -- what is the number of LTAC compliant patients? Where are they coming from? That is what acute care hospital are coming from and what does the competitive landscape look like and handicapping where those competitors will be in facing the criteria. So, those are just some of the factors that we look at. We are then preparing really from various of our corporate and operational functions. Some will come to our -- some modifications or focus will come to our clinical group that’s lead by our Chief Medical Officer, some will come from our real-estate group that will focus on the physical -- any physical plan area, some on the marketing where we may have to modify our number of directors of business development or their territory where they focus. So I think you should assume that, all those activities are ongoing and they’re focused on a very customized fashion at the individual hospitals.

Okay, great. Thanks. And then on the outpatient clinics, volume growth looks good there. Can you provide any color on what you saw there? How much of that might have been driven by same store? Any color there would be great. Thanks.

Sure, Dana the operations group over in the outpatient side continues to do a great, great job. I mean, you saw basically a 5.3% increase on volume. And while we do small acquisitions, I mean this was basically same store and its really just continuing to enhance the relationships they have with referring physicians and new business lines that they’re into. Concussion management seems to be doing very well as well as increasing on the worker comp side. So, as I said they’re doing a terrific job and we’re very pleased with their performance.

All right, sounds great. Thanks a lot.

Thank you.

Your next question will come from the line Gary Lieberman from Wells Fargo. You may begin.

Thanks. Good morning. This is Ryan Halsted on for, Gary. I wanted to go back to patient criteria. I was wondering, you mentioned that you would be potentially evaluating your staffing levels. How about just in terms of the portfolio facilities. I mean, do you think there are some that may not even make sense to continue to operate based on the patient census that’s available?

Yes, I think Marty’s comment on looking at the staffing I think that, the context was that if we were, that once the criteria is phased in, if we’re unable to replace all the non-compliant patients with compliant patients then we’d be looking at flexing our staff. As to you main question which is, do we think that out of our portfolio of 112 LTAC hospitals that through the criteria analysis and phasing the criteria whether some of those hospitals would not make it, I mean the answer to that, is yes. And what you’ve seen even though for the last year is we’ve seen a number of our hospitals have already closed. I think we had, I think two or three that -- three hospitals that have closed in the past six months. You typically don’t see that, we don’t tease that out because they’re not -- typically they are not big charges associated because with the hospital with an hospital model you have a lease expiration if we believe that the hospital is not going to viable on the new criteria we have an opportunity to change it as the lease is expiring. So yes, I think that it would be natural to see some pruning in the portfolio and there’ll be some hospitals that would probably close.

Okay, that’s helpful. And then, as far as the timing, do you still anticipate all of your hospitals will be fall under the say, natural payment policy by third quarter next year?

Yes, by third quarter or next year all should be in -- all should be under criteria.

Okay. Moving to Concentra, just curious how you’re viewing the leverage that would be required, what's sort of a leverage ratio that you would be comfortable with and then as far as the equity portion, I would just be curious if you’re considering all options in terms of funding that portion?

Yes, the funding of Concentra will come off of our revolver, we were basically at $218 million that we will have to fund, and as I said that will come from the revolver.

Okay; and what about the reminder? So, I mean is it right to think of it that, you will have to fund 50% of the $1.1 billion purchase price?

Yes, what we’ve done, if you take a look at the source and uses of funds for the close to $1.1 billion a year, you will see $650 million of non-recourse debt that will be funded at the JV level. And then there’ll be I think it’s, $218 million will be coming from select, $217 million will be coming from WCAS in the form of equity.

Okay. Then last question for me, on the quarter I know you mentioned the bad debt ticked up a little bit from the LTAC. So just curious, if there was any pick up from your ERFs [ph] JVs just some, one of your competitors has been talking about some of the physical intermediaries really holding up claims. I’d be curious if you’re seeing a similar experience?

Yes, we would agree with our competitor. Some of it has to do with the RAC audits and the delays that are occurring at the ALJ level.

Okay. Any views on how quickly you think those claims could be appealed and won or any thoughts on how you can get those receivables?

I wish we knew the answer to that. It’s a very difficult one to answer. I mean, the issue right now is the delays at the ALJ and as we understand it, they are very, very backed up. And there is, at this point in time we don’t see any clear path to getting those claims through the system yet.

Okay. All right. Thanks.

Your next question will come from the line of [indiscernible] from DRW. You may begin.

Good morning. Just a quick clarification on the Concentra financing structure. You mentioned that you plan to raise non-recourse debt there. Is this going to be a fully consolidated subsidiary of Select Medical given the majority ownership?

We will consolidate Concentra’s numbers into Select, but the -- and which would incorporate the debt. But as we said, it will be non-recourse debt.

And would you -- sorry would you consider in order to make the cost of funding cheaper to provide guarantees from Select Medical to the downstream guarantees to that JV unit basically?

No, we would not. As we said, it’s non-recourse debt.

Got it. Okay. Thank you.

Sure.

At this time we have no other questions in the queue. I’d like to turn the call back over to Mr. Robert Ortenzio for your closing remark. End of Q&A

Thank you, operator. Thank you everybody for joining us. I’ll just conclude by saying we feel good about the quarter. I think it was a nice feed on to EPS even with $7 million of startup and severance cost, especially hospital revenue year-over-year up 6%, net revenue per day up 2.3%. And even on our outpatient side which has historically been very strong and we think it was another strong quarter matched a bit by contract therapy, but I mean the outpatients saw a good margin increase and we feel good about that. And we also feel very good about the Concentra acquisition and our prospects going forward. So we’ll look forward to updating you again at our next earnings conference call.

And ladies and gentlemen, this concludes your presentation. You may now disconnect. Enjoy your day.