Good morning, and thank you for joining us today for the Select Medical Holdings Corporation earnings conference call to discuss the second quarter 2017 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 this conference call may contain forward-looking statements regarding future events or the future financial performance of the company including, without limitation, statements regarding operation results, growth opportunities and other statements that refer to Select Medical's plans, expectations, strategies, intentions and beliefs. These forward-looking statements are based on the information available to management of Select Medical today, and the company assumes no obligation to update these statements as circumstances change. At this time, I will turn the conference over to Robert Ortenzio.

Thank you, operator. Good morning, everyone. Thanks for joining us for Select Medical's Second Quarter Earnings Conference Call for 2017. Before I outline our operational metrics for the quarter, I wanted to provide some highlights for our business segments. Overall, our second quarter results were very strong across the entire enterprise. For 2016, we advised investors that we were making strategic changes in integrating transaction that would set us up for a strong 2017. We're pleased with the progress we have made, which has resulted in improving margins. Our operators have done an excellent job on the execution of our strategy and integration. We're very pleased about the continued improvement in growth of our company. Starting with the LTAC group. We couldn't be more pleased with the progress to date. Our LTACs continue to improve as we have a singular focus on the higher acuity compliant patient population. Since the transition to patient criteria, we have maintained a compliant patient mix of over 99%, and through the end of June, we had a 99.8% compliant patient rate so far, this year. Our occupancy rate in our LTACs was down just 10 basis points from the same quarter year-over-year basis as we replaced 318 average daily census site neutral patients with compliant patients. Case Mix Index increased to 1.28, which has a positive impact on our per patient day rate. We continued to see improvement in rate in our LTACs with a close to a $42 per patient day increase compared to the same quarter last year. In addition, after weakness last year and into the first quarter, the hospitals acquired through a swap with Kindred last year have shown significant improvement, particularly in the Cleveland market. We have successfully integrated these hospitals into our operations and are now generating positive…

Thank you, Bob. For the second quarter, our operating expenses, which include our cost of services, general and administrative expense and bad debt expense, were almost $967 million. This compares to $960 million in the same quarter last year. As a percent of our net revenue, operating expenses for the second quarter were 86.2%. This compares to 87.5% in the same quarter last year. Cost of services were $920 million for the second quarter, this compares to $917 million in the same quarter last year. As a percent of net revenue, cost of services decreased 140 basis points to 82.1% in the second quarter. This compares to 83.5% in the same quarter last year. The decrease in the cost of services as a percent of revenue was primarily due to improved operating performance in our Specialty Hospitals and outpatient rehabilitation clinics. G&A expense was $28.3 million in the second quarter, which as a percent of net revenue was 2.5%. This compares to $25.9 million or 2.4% of net revenue for the same quarter last year. Bad debt as a percent of net revenue was 1.6% in both the second quarter of this year and last year. As Bob mentioned, total adjusted EBITDA was $158.7 million and adjusted EBITDA margins were 14.2% for the second quarter compared to adjusted EBITDA of $141.5 million and adjusted EBITDA margins of 12.9% in the same quarter last year. Depreciation and amortization expense was $38.3 million in the second quarter. This compares to $36.2 million in the same quarter last year. We generated $5.7 million in equity and earnings of unconsolidated subsidiaries during the second quarter. This compares to $4.5 million in the same quarter last year. This increase was driven by improved performance in existing inpatient rehab joint ventures where we hold a minority…

[Operator instructions] Our first question will come from the line of Frank Morgan of RBC Capital Markets.

Marty, I'll guess I'll start on that last comment you made about the over 50. I want to make sure I understood. So, the ADC impact, prior to -- or early on in criteria, was 5 ADC, it's down to 2.7 now. Is it fair to extrapolate that over the next year that might -- the total impact may completely be mitigated from a census standpoint? Or is there something else we should consider?

Frank, we certainly hope so.

Our next question will come from the line of A.J. Rice with UBS.

This is Caleb Harris on for A.J. The start-up losses were pretty modest in the quarter, kind of that $1 million range, which is kind of what you've been indicating in the past. Do you think it will be similar in Q3 and Q4 in that $1 million to $2 million range? And what are the most significant projects you have going on right now?

Yes, I would expect to see start-up losses probably in that, as you pointed out, that $1 million to $2 million range in the third quarter. I would expect them to go up a little bit in the fourth quarter as we get ready to open up the doors. And as Bob mentioned, it's probably in the first quarter of -- early first quarter of next year.

Okay, and then just more generally on the capital deployment opportunities. I assume you're seeing the JV IRFs is kind of the biggest opportunity right now, but what else are you guys looking at in the pipeline?

Well, the joint ventures on the rehab is really our focus. I mean -- and as you've seen from our announcements, our focus is on the large systems. But we have done some LTAC joint ventures, but I expect them to be probably more modest and smaller. And in the main, our focus is on those large multibillion systems where we usually lead within inpatient rehab and then also outpatient and then other rehab services as relationship matures. So, I'd say that that's our primary focus.

Our next question will come from the line of Kevin Fischbeck with Bank of America Merrill Lynch.

This is actually Chidinma Iwueke on for Kevin. So, the first question we have is around guidance. It seems like this is the second straight quarter that you guys have beat consensus, that you haven't raised guide. Why is that? And is there something in the back half of the year that might restrict growth?

Well, as you know, the sense -- or the guidance that we provided has a pretty wide range, given the fact that we are going into full criteria for the first full year with the LTACs. So, we think that we are still within that range. And at this point in time, there's really not a need to reduce it. We'll reevaluate that in the third quarter and we can talk then.

Okay, just a follow-up on that. Is there anything you would highlight as far as seasonality for Q3 and Q4?

Well, absolutely. As you know, for everyone that follows us, the first 2 quarters are typically the best quarters for our businesses followed by fourth quarter is typically the third best. And we do have some substantial seasonality in the third quarter.

Our next question will come from the line of Bill Sutherland with Benchmark Company.

Just a couple of numbers, Bob, in your opening comments that I didn't quite write down quick enough. The LTAC occupancy was what for the quarter?

The LTAC occupancy for the quarter was 66%.

And that -- I'm sorry, could you give a comparison from the first quarter? I didn't get that.

What we do is we gave a comparison for the prior year, Bill, by basically saying that it was -- there was about a 10-basis point differential. So, if you take a look at our filings, our filings we really don't go into the decimal points. So, you'll see occupancy rate for Q2 of 2016 at 67%. And you'll see this quarter at 66%. When you go to the first decimal point, you'll actually see occupancy rate for Q2 of '16 at 66.5%. And you'll see occupancy rate for the second quarter of this year at 66.4%.

Okay. And then you, just like last quarter, gave us the improvement in rate per patient day for LTAC. And so, where is that -- what is the actual rate at this point?

Hold on just a second, Bill. We're getting that for you.

That's fine. Missed one other number back in -- I'll throw that out there, but IRF EBITDA margin I didn't quite jot down quick enough.

Bill, the LTAC rate was 17.64% for the quarter. And the LTAC margin that we talked about was 16.8%.

Right. And the IRF?

And the IRF was 15%.

Okay. And I know you've got a lot going on in the -- as far as the 2 or 3 hospitals still building in terms of their -- in terms of really filling up and getting to target market margins. So, should I think about IRF margins on a total basis being potentially as high as LTAC? Or are they -- are there other reasons for them not to be in line?

No, I think you can certainly assume that the rehab margins will be as high or higher than the LTAC margins on a mature hospital portfolio.

Okay, that's what I'm trying to say. And then finally, kind of to the point of a prior question. Where are you kind of thinking, in the 3 groups, as you look into the back half? I know you're expecting some growth pick up, I'm not trying to get down on that. But just some color on kind of the -- on the 2 or 3 key elements that you see helping the growth trajectory into the back half?

Sure. I mean, the growth in the back half, we certainly expect to continue to grow inpatient rehab, in particular CRI and our Cleveland Clinic, new start. And we are -- all indications are we will continue to see those grow census nicely and therefore we'll see some nice growth on the revenue side. We talked about the seasonality in the business. We think that the LTAC operators have done a fantastic job continuing to grow census there. So, on a year-over-year basis, we expect to see some nice growth there. And our outpatient rehab people have done a great job too. So, we would expect to see some decent opportunities and growth from the outpatient rehab. And then finally, Concentra. Concentra, where you've seen growth on the volume side, you've seen a little bit of dip on the pricing. That was really a payer mix shift or it was actually a business mix shift where we saw an increase in employer services, more specifically drug testing, where we made a conscious decision to actually reduce the pricing on a drug testing a little bit. And so, we've seen a significant influx of volume from the drug testing. So -- and that pricing is substantially lower than what you would typically see in our workers' comp business.

Did you drop the prices to drive volume?

Well, what we did, Bill, was we thought that the drug testing actually had an impact on pull-through of workers' comp business. So, we reduced the pricing in the drug testing to see if that was actually the case or not.

Our next question will come from the line of Frank Morgan of RBC Capital Markets.

Got cut off on that last one, but the (inaudible)

We were wondering, Frank. What happened to you?

That's a quick answer, but anyway. Yes, so some more color on that improvement that you're seeing in the -- in that loss census. Have you been able to identify any specific things that's driving that? Is it just basically market knowledge to criteria? Is it some new clinical program? Is it some new marketing capability? Anything that you're doing that's giving you that traction for that backfill.

Sure. There's a lot of different things that we're doing, Frank. But I would say we've always had in place our clinic liaisons, they are on the ground. In addition to that, we've enhanced that with teams that we have that are out dealing with, in many cases, the C-suite in many of our referral sources. That team would include both our Chief Medical Officer or physicians that work with him, some financial people, as well as our operators. And that seems to have made significant traction as far as improving our ADC.

Yes, Frank, this is Bob. You'll recall, as we were leading in to criteria and expected to get a lot of questions on how we were preparing. And I think what we said at the time is we -- leading up, we really were trying to get the operators all the tools that they needed, whether it would be enhanced physician specialties, better equipment, more data analytics. But at the end of it we always did say that it was really going to be a function of that and an execution of the local teams. And I think that's really what we've seen. I mean this is -- it is not one thing. It is really just attention to detail and a focus at all the hospitals. Because as you know, all the markets are different. So, I can't give enough credit to the operators that are just in these markets doing the job from the CEOs up to the divisional teams. And that's -- it's really just an execution process at this point.

Have you seen anybody exit the market? Any competitors in those markets where you do have competition? Or any significant changes in that landscape?

Yes, it's a good question. We are watching that. I mean there is a fairly significant data delay for cost reports going out that you can actually track when hospitals close. So, we really rely, for a real-time data, on really more information coming from the field. But yes, it's absolutely more hospitals are closing all the time. We did have one small LTAC chain, I think 12, 13 LTACs that did file for bankruptcy. They were based in Louisiana. We've seen hospitals close literally in all of our markets. Some of the bigger markets, a lot of closures in Dallas, in Houston, one recently in Ohio, one in Michigan. So yes, we are seeing the announcements of closed LTACs or conversions of LTACs from LTAC to some other type of service. So, we are seeing that. And quite honestly, we expect that to accelerate once the hospitals -- the LTAC hospitals go out of the blended rate of -- for the site-neutral patients.

Got you. If I could jump over up quickly on the IRF side. You mentioned in your remarks about CRI breaking even now. Just any general thoughts about kind of the timing there for where that one will actually reach sort of a stabilized margin level? I mean that's big enough to really matter. But any thoughts or color on kind of timing there?

Yes, Frank. What we talked about was not only breaking even but they're making some nice positive EBITDA in the second quarter. We expect to see that continue to grow. Probably won't reach full maturation until first or second quarter of next year. But the back-end of the year, we should see some nice improvement on the EBITDA that's generating for the rehab division.

And in the quarter, Frank, the CRI, just because we talk about that a lot about that because it's our largest development project for the company. But it was solidly profitable in the quarter. It has surpassed breakeven.

That's great. Final question on that subject of IRFs. Should we expect the start-up losses to, over the balance of year what's implied in your guidance, should that be around where it is now? Or how close are we to -- on that number?

Yes, what we've talked about is somewhere in that $1 million to $2 million range probably in the third quarter. We would expect to see a jump just a little bit in the fourth quarter just because we've got a couple of hospitals opening up their doors in the first quarter of 2018. But not material, not material.

If you look at the kind of start-up losses that we had last year, I don't think that that's going to be repeated anytime soon in the company's history. It was just a one-off occurrence given the size of CRI.

Our next question will come from the line of Chris Rigg with Deutsche Bank.

The LTAC moratorium or the ability to open new LTACs, you can start doing that in the fourth quarter. How are you guys thinking about growing in that area versus IRF at this point? It does seem like maybe some of the JV partners in the inpatient rehab side would be natural partners for LTACs. But can you just give us a sense for how you're thinking about that?

Well, that is true. And I think you're starting to see that a little bit. If you look at the Ochsner partnership, relatively new under construction, that's LTAC and rehab. If you look at the Riverside partnership, that's LTAC and rehab. I would say that we could see some more of that. The primary focus -- and the more capital will be going toward the rehab side of the business. But we will -- won't hesitate to do an LTAC if we see fit. It's not going to be the biggest part of the growth engine.

Okay. And then on the LTAC occupancy, can you give us a sense for your sort of longer-term targets there? Not necessarily even in 2018 but over the next 2 to 3 years where you would -- sort of your aspirational levels?

Yes, Chris, our focus really is to get back to historical levels, which are is that 70%, 71%. And then we'll reassess it at that point in time. There's certainly opportunities to increase it further than that, but that's really the short-term goal to get back to historical levels.

Got you. CapEx in the quarter was up about $20-ish million year-to-year and about the same level through the 6 months. What's driving that?

Yes. A good portion of that has to do with what's going on with our Ochsner construction. We're doing the rehab project down at Ochsner.

Got you. And then just one final one here, I think I probably know the answer but I figured I'd ask it anyway. With regard to a dividend, you had a period there where you were paying one. Is that at all under consideration at this point?

No. I would say a dividend is not under active consideration. I mean we're always opportunistic, but I think the focus that we have is reducing leverage at this point. Given the Concentra acquisition and the Physio acquisition and the capital that we're deploying in the new rehabs, I think our focus is really leverage at this point.

Our next question will come from the line of Whit Mayo with Robert W. Baird.

Bob, you guys were pretty reluctant to adjust your staffing last year and I believe the thesis was the volume will be there, we're confident that it will be there, it's just a matter of when. And so, it made little sense to change the labor model. So, can you just talk about your staffing matrix now that you're seeing the first full year of criteria and how you think about adjusting that going forward?

Yes, with -- this is Marty, it's a great question. You are absolutely right. We did not make adjustments last year and expecting volume to come. It has come. And consequently, I think that's why you've seen some nice improvements in both the much, much lower than expected costs as well as the EBITDA margins. I think we've always talked about the staffing models and the LTAC being, depending on the acuity of the patient, somewhere in the neighborhood of 4 patients or 5 patients per nurse. And that's -- that staffing matrix is what we'll continue to utilize.

Got it. Okay. And maybe just one last one, covered a lot this morning. But I think it was in the third quarter last year where you swapped some assets and LTACs with Kindred, maybe it wasn't. But if it was, can you just remind us about the distraction -- the disruption that you had in the third quarter and just how we should anticipate the year-over-year comparisons being distorted because of that?

Well, it was the second quarter of last year.

Yes, it was June 1 of the second quarter. And you are absolutely right, there was a lot of distortion in Q3. What we did mention, Whit, is that those assets have turned around. They're operating on Select's metrics now. And are -- and basically, all compliant patients. And they are performing nicely. I mean in the -- if you take a look at same quarter year-over-year basis, there's about a $3 million swing for the quarter.

I'm showing no further questions at this time. So now it's my pleasure to hand the conference back over to Mr. Robert Ortenzio for some closing comments or remarks.

Thanks, operator. Thanks, everyone for joining us and we are pleased at the quarter and we look forward to updating you again next quarter.

Ladies and gentlemen, thank you for your participation on today's conference. This does conclude the program and you may all disconnect. Everybody, have a wonderful day.