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Skilled Healthcare Group (NYSE:SKH)

Q2 2013 Earnings Call

August 06, 2013 12:00 pm ET

Executives

Roland G. Rapp - Chief Administrative Officer, Executive Vice President, General Counsel and Secretary

Boyd W. Hendrickson - Chairman and Chief Executive Officer

Christopher N. Felfe - Acting Chief Financial Officer and Principal Accounting Officer

Jose C. Lynch - President, Chief Operating Officer, Director and Member of Corporate Governance, Quality & Compliance Committee

Laurie Thomas - Former Chief Operating Officer of Hallmark Rehabilitation

Analysts

Ralph Giacobbe - Crédit Suisse AG, Research Division

Frank G. Morgan - RBC Capital Markets, LLC, Research Division

Gary P. Taylor - Citigroup Inc, Research Division

Robert M. Mains - Stifel, Nicolaus & Co., Inc., Research Division

Dana Hambly - Stephens Inc., Research Division

Kevin M. Fischbeck - BofA Merrill Lynch, Research Division

Joanna Gajuk - BofA Merrill Lynch, Research Division

Operator

Good day, ladies and gentlemen, and welcome to the Second Quarter 2013 Skilled Healthcare Group, Inc. Earnings Conference Call. My name is Stephanie, and I will be your coordinator for today. [Operator Instructions] I would now like to turn the presentation over to your host for today's call, Mr. Roland Rapp, General Counsel. You may proceed.

Roland G. Rapp

Thank you, Stephanie. Good morning. I'd like to welcome everybody to Skilled Healthcare's Quarterly Earnings Conference Call and introduce our presenters: Boyd Hendrickson, Chairman and Chief Executive Officer; and Chris Felfe, acting Chief Financial Officer.

Before we begin, I'd like to note that certain statements and information we discuss this morning may be deemed to be forward-looking statements. These statements include statements relating to our objectives, plans and strategies as well as statements other than statements of historical fact that address activities, events or developments that we expect or anticipate will occur in the future. Any forward-looking statements discussed on this call are made as of the date of the call, and Skilled Healthcare undertakes no duty to update or revise any such statements. Forward-looking statements are not guarantees of future performance and are subject to risks and uncertainties. Important factors that could cause actual results, developments and business decisions to differ materially from our forward-looking statements are described in our filings with the Securities and Exchange Commission.

Additionally, as we discuss performance, we'll be referring to adjusted net income and adjusted net income per diluted share. We will also be discussing EBITDA, EBITDAR, adjusted EBITDA and adjusted EBITDAR and adjusted net income per share, which we use as measures of performance but are not considered measures of financial performance under accounting principles generally accepted in the United States of America.

EBITDA is net income before depreciation, amortization and interest expense, net of interest income and the provision for income taxes. Adjusted EBITDA excludes from EBITDA non-recurring, non-core business items, which for the period reported [indiscernible] modification or retirement cost, organization and restructuring cost, and change in fair value of contingent consideration. EBITDAR is EBITDA excluding rent cost of revenue. Adjusted EBITDAR is adjusted EBITDA excluding rent cost of revenue. Adjusted net income per share is net income per share excluding certain non-recurring, non-core business items noted in the earnings release that we issued yesterday.

Please see the definitions and reconciliations of the non-GAAP measures included in our earnings release that we issued yesterday, which can be located on the Investor Information section of the website at www.skilledhealthcaregroup.com. With the exception of the foregoing measures, this report and our discussions today are presented on a consolidated basis under GAAP, and as such, references to the company, Skilled Healthcare Group, Skilled Healthcare, us, we and our refer to Skilled Healthcare Group, Inc. and each of the consolidated subsidiaries.

Now I'll turn the call over to Boyd Hendrickson, Chairman and Chief Executive Officer. Boyd?

Boyd W. Hendrickson

Thank you, Roland, and good morning, everyone. Before we begin today, I'd like to take a moment to honor our board member, Bill Scott, who recently passed away. Bill was not only a good friend but a brilliant and considerate gentleman who provided tireless service for the company for many, many years. Bill had been on our board since 1998 and served as Chairman from 1998 until 2005. He played a key role in the company's growth and success over many, many years, and he and his counsel will sorely be missed.

Now turning to our discussion on the second quarter. As mentioned at our earnings release issued yesterday, we're continuing to see a shift of Medicare patient days to managed care days, while our overall admissions have increased in the first half of this year as compared to the first half of 2012. The average length of stay of the patients has decreased, which has resulted in lower-than-expected occupancy. We have also been impacted by the manual medical review process that was put in place last October. The Medicare administrative contractors and the recovery auditors have not been able to keep pace with the volume of claims for patients exceeding the $3,700 threshold. As a result, the review and payment of these claims have been significantly delayed. This not only harms the patient who needs the care, it also harms the care provider who are not getting paid for providing the services that are needed by the patient. As a result, there is a hesitancy by the third-party skilled nursing facilities to contract with Hallmark Rehabilitation to provide therapy to their patients beyond the $3,700 threshold, even where the medical necessity of the therapy is apparent. This was less of an issue in the first quarter as each individual patient cap got reset to 0 on January 1, so the therapy provided at that time was less likely to exceed the $3,700 threshold. We estimate that the MMR issue negatively impacted revenue by about $1 million in the second quarter. At this point, the MMR challenges are likely to continue to negatively impact us and other contract therapy providers for the foreseeable future.

Another CMS policy, the multiple procedure payment reduction, or MPPR, which automatically reduces Medicare Part B payments for multiple therapy services provided to a single patient on a single day, negatively impacted our revenue in the bottom line in the second quarter by approximately $300,000, which is in line with what we had expected.

In our Signature segment, a few of our hospice subsidiaries continue to experience hospice cap issues. While it is difficult to predict how long any patient will be on hospice service, our agencies are focused on admitting patients who likely to have a shorter stay. Nevertheless, a few of the agencies have a number of patients whose continued eligibility for service has exceeded the expectation, which has negatively impacted the 2012 and 2013 cap estimate. We took reserves of approximately $700,000 for each of 2012 and the 2013 cap periods in the second quarter. We previously had not recorded any reserve for 2013 cap year. The hospice cap applies on a per-agency basis and, as such, each agency reassesses their patient routinely to ensure that they continue to meet the eligibility requirements for hospice care. We expect that our affected agencies will continue to focus their admission efforts on patients who are not likely to need care beyond the initial certification period in order to minimize the effect of the cap, the hospice cap, at those agencies.

On the finance front, our contemplated HUD financing is taking longer and proving to be a little more complicated than we had anticipated. We're hopeful to be able to move forward with it in the very near future. We will continue to focus on paying down debt while HUD financing is pending and, of course, continue to stay apprised of any alternative as we focus on strengthening our balance sheet.

In an effort to remain competitive and efficient as possible in spite of the various challenges facing us and others in our industry, we have implemented a restructuring of our administrative services organization. We have effectively eliminated 2 layers of operational support within our long-term care division and a reduced overhead in other administrative functions as well. We have fortunately been able to retain much of our best and most experienced operational leadership talent in that process, moving them closer to the operation that they will be supporting. We expect that the changes will enable the key operational support personnel to work more closely and actively with business units that they serve, particularly in the long-term care division. We expect that this will help drive increased performance, both financially and otherwise, at those business units.

While it is difficult to part with some of our colleagues, we felt the changes and related overhead reductions were in the interest of the company. We expect the changes will save the company approximately $6 million in employee-related cost annually, effective August of 2013. I should emphasize that all of the headcount reductions were in the administrative support function. We did not eliminate any position to any of the operating subsidiaries, so there is no impact to the direct and indirect patient care staff whatsoever.

As you probably know, in conjunction with the restructuring, I announced that I'll be retiring around the end of the year. The board has engaged Korn/Ferry to assist the board in identifying both qualified external and internal candidates to replace me as CEO. We expect the research to be concluded before the end of the year and I'm committed to providing whatever assistance to the board the board requests of me to ensure a smooth transition when that time comes.

Now for the second quarter results. Yesterday, we reported GAAP net income per diluted share of $0.04 for the second quarter of 2013 as compared to $0.09 for the same period in 2012. Our adjusted net income per diluted share was $0.09, a decrease of 50% over the second quarter of 2012. Total consolidated revenue decreased 1.7% to $213.7 million in the second quarter of 2013, and adjusted EBITDA margins decreased 410 basis points to 8.2% in the second quarter of 2013 compared to the same period a year ago. Chris will go over the 2013 updated guidance in his discussion.

Now let's discuss the key operating metrics for the quarter and our long-term care division services segment. There are 3 key metrics that we believe are important performance indicators. These are occupancy, skill mix and quality mix. First, occupancy in our skilled nursing facilities decreased by 100 basis points to 82% in the second quarter of 2013 as compared to 83% in the second quarter of 2012. Next, our skill mix decreased 50 basis points, 21.9% in the second quarter of 2013 as compared to the 22.4% in the second quarter of 2012. We define skill mix as the total number of Medicare and managed care patient days as the percentage of total patient days. The third metric, quality mix, decreased 130 basis points to 68.9% in the second quarter of 2013, compared to 70.2% in the prior year period, driven primarily by the decrease in Medicare revenue from our skilled nursing facilities. We define quality mix as all non-Medicaid revenue as a percentage of total revenue.

Moving on to the other 2 reportable segments, Hallmark Rehabilitation and Signature Hospice and Home Health. In the second quarter of 2013, the third-party therapy business experienced a growth in revenue of $0.2 million to $26.6 million or 12.5% of our total revenue. Our signature business, consisted of hospice care and home health care, had a decrease of 5.9% in revenue compared to second quarter of 2012 and represented 11.8% of our total revenue.

Now I'll turn the call over to Chris, our acting Chief Financial Officer, to discuss our financial results in more detail. Chris?

Christopher N. Felfe

Thanks, Boyd, and good morning. As Boyd mentioned, our adjusted net income per diluted share was $0.09 compared to $0.18 for the same quarter of last year. This decline was driven by the factors Boyd discussed earlier.

Turning to our reportable segments. In long-term care services, revenue decreased 1.4% from $164.1 million in the second quarter of 2012 to $161.8 million in the second quarter of 2013. The year-over-year decrease in revenue was primarily due to drop incentives as well as the change in payer mix. SNF PT rates decreased 0.4%, which was due to the ongoing shift from Medicare days to managed care days as Medicare recipients elect Medicare Advantage in lieu of direct Medicare benefits. We receive a lower per-patient-day revenue amount from managed care as compared to Medicare. Adjusted EBITDA for the long-term care segment decreased to $17.8 million for the quarter from $23.7 million a year ago, with the adjusted EBITDA margin decreasing to 11% from 14.4%. Long-term care services represented approximately 75.7% of total consolidated revenue in the second quarter of 2013, up from 75.5% in the year-ago quarter.

Total revenue from third-party contracts in our Hallmark Rehabilitation therapy services segment increased $0.2 million or 0.8% to $26.6 million in the second quarter of 2013 as compared to the second quarter of 2012. Adjusted EBITDA for the same periods for the segment decreased $1 million to $2.9 million, with the adjusted EBITDA margin decreasing to 7.1% from 9.1% a year ago. Total third party rehabilitation segment revenue represented 12.4% of consolidated revenue in the second quarter of 2013 as compared to 12.1% in the second quarter of 2012.

As of June 30, 2013, Hallmark had 126 third-party contracts, an increase of 80 from the second quarter of 2012. The growth in new third-party contracts also typically results in increased costs and lower margins from new contracts until the programs of the new facilities mature.

Moving on to Signature Hospice and Home Health services. Total revenue decreased $1.6 million or 5.9% to $25.3 million in the second quarter of 2013 from $26.9 million in the second quarter of 2012. The decrease was due to a reduction in ADC in the second quarter of 2013 to 1,324 as compared to 1,402 in the year-ago quarter and due to a hospice cap reserve of $1.4 million recorded in 2013 as compared to a hospice cap reserve of $1 million recorded in the year-ago quarter.

Our Hospice business accounts for 72.8% of Signature's revenue. Adjusted EBITDA for Signature decreased to $1.8 million, representing a 7.1 margin on revenue in the second quarter of 2013 and $5.3 million for the year ago or 19.5% of revenue. $0.4 million of this decrease was directly due to higher hospice cap reserve recorded in the second quarter of 2013. Total hospice and home care segment revenue represented 11.9% of consolidated revenue in the second quarter of 2013 as compared to 12.4% in the second quarter of 2012.

Moving on to our balance sheet. As of June 30, 2013, our debt decreased by $3.5 million to $445.5 million as compared to December 31, 2012. Long-term debt, including the current portion, consisted of approximately $403.8 million of first-lien senior secured term loan net of a $205 million original issue discount. We had $39 million outstanding on our revolving credit facility, which is due in 2015, and we had $2.7 million of other debt.

As of June 30, 2013, we had approximately $56.6 million in available liquidity through our revolver after considering the $4.4 million in outstanding letters of credit. In addition, we had approximately $2 million in cash and cash equivalents on our balance sheet at June 30. In addition, our interest coverage and leverage ratio continued to gain within our debt covenants. For the second quarter of 2013, our fixed charge coverage ratio was approximately 2.4 compared to the minimum requirement of 1.75, and our leverage ratio was approximately 4.8 compared to the maximum of 5.25.

As of June 30, our long-term debt had a weighted average remaining duration of 2.7 years and an average all-in interest rate of 7.8%. Interest expense decreased for the 3-month period ended June 30 compared to the same period a year ago by $1.8 million due to a replacement of higher-cost subordinated bonds with term debt in the second quarter of 2012. Our tax expense this quarter was $1 million, compared to $2.4 million for the same period a year ago. The lower tax expense was primarily due to the lower pre-tax income in the second quarter of 2013 as compared to the same period a year ago.

Days sales outstanding on a consolidated basis was 51.2 days in the second quarter of 2013, up from 44.5 at the end of 2012. This was caused by 3 factors. First, California once again decided to withhold payments to health care providers at the end of June, which is the end of their fiscal year. This caused our California skilled nursing facilities to not receive $3.4 million that they normally would have received in June. Second, the same issue impacted Hallmark's third-party customers through delayed payments of another $2.9 million dollars. Third, our own administrative error delayed receipt of $5.6 million of hospice receipts. All of this $11.9 million was received in the first 10 days of July.

As we disclosed in our earnings release yesterday, we have adjusted our guidance for 2013. We anticipate 2013 consolidated revenue to be between $860 million and $870 million. Adjusted EBITDAR is now expected to be between $97.5 million and $99.5 million and adjusted EBITDA between $78 million and $82 million. Earnings per diluted share are expected to be between $0.39 and $0.45, that's adjusted earnings per diluted share. This 2013 guidance also assumes the following: a Medicare rate increase of 1.3% beginning October 1 of this year; CapEx for all of 2013 between $15 million and $18 million; average interest rate on our debt of about 7.8%; no benefit from HUD financing; an effective tax rate of 36%; weighted average shares outstanding of $38.2 million; and no additional acquisitions, developments or divestitures.

With that, I'd like to turn it back to Boyd.

Boyd W. Hendrickson

Okay, thank you, Chris. On the call today besides Chris and me are Jose Lynch, our President and Chief Operating Officer; Roland Rapp, our General Counsel; Jon Monks, Executive Vice President of Signature; and Laurie Thomas, President of Hallmark Rehabilitation. With that, operator, we're ready to take questions.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Ralph Giacobbe with Credit Suisse.

Ralph Giacobbe - Crédit Suisse AG, Research Division

I guess I understand there's some things, obviously, on the cost side. But the shift to manage care and thinking about the top line, it's something that we've seen and may accelerate. And if the macro sort of volume picture doesn't improve, is there anything -- or what are you doing from a top line perspective to prevent sort of the current run rate from not deteriorating further?

Jose C. Lynch

Yes, so 2 things -- Ralph, it's Jose. The volume, obviously, we're pressing to get more of those -- more, obviously, patients in bed, that's the key to get occupancy up. But on the latter side, we have some flexibility on going after those managed care rates to get those contracts. We're still about 30% to 35% lower than the Medicare rate, so we have some opportunities there in certain markets to where we could afford to cancel contracts if we don't get rate increases to increase that top line.

Ralph Giacobbe - Crédit Suisse AG, Research Division

Any sense of timing on that? I mean, are you -- can you break those contracts or do you have to wait for them to sort of expire before you go and ask for those rate increases? And then, again, to your 30% to 35% lower, is the answer somewhere between Medicare in that 30%, 35%? Or are you looking to get sort of full or as close to full capture rate as possible? Or is that not realistic?

Jose C. Lynch

Yes, no, that's not realistic to think it's the full capture rate. But our goal across the company right now, we sit like about $389 a day. We should be able to get into the low $400s or $415 range by execution of certain contracts and terms. Most of them have out clauses, some of them have -- there's a variety of different contracts. Some of them have built-in escalators. But the ones that we're focused on have the ability for us to either renegotiate a new rate and/or exit them in 60-day period. So we -- it would be something that we'd be working on aggressively through the end of the year.

Ralph Giacobbe - Crédit Suisse AG, Research Division

Okay. And then any more context on the $6 million sort of cost savings and where exactly that's going to come from? Is that all salary? I mean, it seems like a pretty hefty number considering sort of G&A spend of $25 million on an annual basis. And then is that savings number assumed in you guidance, so call it $2.5 million beginning August 1?

Jose C. Lynch

Yes, so basically it's about 14% of our spend coming out of all overhead administrative services, and it's all a combination of salary -- mostly about 85%, 90% of its salary, a little bit of stock comp. And we have that sort of modeled into most of where we think our guidance went.

Boyd W. Hendrickson

And everything included in that number has already been done. It was done and effective at the beginning of the month, at the beginning of August.

Ralph Giacobbe - Crédit Suisse AG, Research Division

And then just my last one, just the change in fair value contingent consideration. It's a pretty big number. I guess I just wanted to get the context of that. Was that level expected? Is that more of kind of a onetime item, at least of that magnitude? Just any context there will be helpful.

Jose C. Lynch

Yes, sure. So we have some earn-out. We do acquisitions. We typically have an earn-out as a component of the acquisition. And so that earn-out is based on the acquired companies meeting an EBITDA target. And as we've taken these hospice cap reserves, we've lowered our projections for those acquired businesses, which has lowered the fair value of that future earn-out on our balance sheet. And the companies that we acquired in May 2010, they have an earn-out that's measured for the trailing 12 months at June 30 each year, and that ends in 2015. And they didn't meet the earn-out target for 2013, so part of the reduction was that. Most of it was that, and part of it was the fair value that was on the balance sheet for the next 2 years. So that, I would describe that -- we're not going to have that big of a reduction in the future, and we'd like those businesses to perform better and -- so that we have to pay that earn-out. That would be the best-case scenario.

Operator

Your next question comes from the line of Frank Morgan with RBC Capital.

Frank G. Morgan - RBC Capital Markets, LLC, Research Division

You mentioned California, about the delay in payments, but I was just curious if you had any color on the actual rate outlook prospectively going forward? Does it seem to be getting any better or any change there?

Jose C. Lynch

Frank, it's Jose. We're still optimistically expecting about a 2% in August net of the provider fee. So that would be about...

Frank G. Morgan - RBC Capital Markets, LLC, Research Division

Then in terms of the velocity of the movement from your patient population from traditional fee-for-service over to the managed care population, do you sense that, that velocity is increasing? Is it decreasing? Do you feel like it's about to stabilize? Or how do you see that trend in the movement?

Jose C. Lynch

Yes, I think it's continuing to increase. I mean, I think we're more and more and more penetration in markets. And it seems to be following sort of that tick in Medicare managed care, sort of Medicare Advantage enrollment growth. We're seeing more and more and more penetration. We're just having to be cautious in regards to certain markets where occupancy is high to be a little pickier as to those contracts that we take that are profitable and we can perform with our current cost structure.

Frank G. Morgan - RBC Capital Markets, LLC, Research Division

And with regard to your pricing power to go back and renegotiate higher managed care, just curious how many markets -- where do you think you stand the best chance of being able to go back and negotiate better rates? And then I'll hop off.

Jose C. Lynch

No problem. So California, we have the most opportunity just because we sit in the low 90s in the occupancy and we can choose a little bit more in that market, followed by New Mexico. In some of the other markets, we -- in Nevada, excuse me. In the other markets, we have a lot more opportunity to grow volume. So we're cautious of rates, but we'll be willing to take a lower margin in those markets.

Operator

Your next question comes from the line of Gary Taylor with Citigroup.

Gary P. Taylor - Citigroup Inc, Research Division

I just wanted to go back to that same issue of the Medicare Advantage. And I guess, first of all, those patient days go to your managed care or commercial bucket as you disclose the days, correct?

Boyd W. Hendrickson

Correct.

Gary P. Taylor - Citigroup Inc, Research Division

So can you give us a sense of, just on absolute days, maybe, year-over-year? Like what were the Medicare Advantage patient days in the 2Q of '13 versus 2Q of '12?

Jose C. Lynch

Yes, so just on strict ADC, it would be equivalent -- Q2 '13 of 715 versus Q2 '12 of 664.

Gary P. Taylor - Citigroup Inc, Research Division

Okay, and maybe just kind of walk us through conceptually and maybe strategically what changed -- I guess a year or 2 ago, it seemed like you were very pleased to be signing those MA contracts and really viewed it as an opportunity to pull in new high-acuity days that might have previously been a IRF or some other setting and, really, I think -- unless I'm misstating, I think we're optimistic that you'd have a tailwind from this opportunity. And now, it's really just turned into fee-for-service days or turning into the Medicare Advantage days at lower rates as the population shifts. And so is the first trend still prevalent and it's just being overwhelmed by the second trend? Or is the first opportunity not really played out?

Jose C. Lynch

Yes, and that's a good question. I think we didn't expect the Medicare A volume to drop like it did. We -- collectively, we thought the 2 and skilled mix volume would continue to climb further than it was. So I think that's burdened and the focus on profitability on the managed care days. So I think that's predominantly what the issue is. I think we have a lot more flexibility as we see volume and total occupancy and total skilled mix grow. We're taking rates that we don't have that much higher demand for those rates. So most of the issues in Medicare A portion of the skilled mix of volume dropping putting pressure on the actual rates and profitability on HMO.

Gary P. Taylor - Citigroup Inc, Research Division

And geography of this negative trend is still largely being driven by California? Or pretty prevalent across the portfolio?

Jose C. Lynch

It's pretty prevalent on the Med A drop. We probably have experienced more traditional Medicare drop in other markets in California. Although all of them are down. We've probably seen the greatest hit in our Texas and some of our Midwest markets.

Gary P. Taylor - Citigroup Inc, Research Division

And last question, just thinking about the competitive environment. So obviously, you've negotiated Medicare Advantage rates that are materially lower than prevailing Medicare fee-for-service. So I guess that implies that there is plenty of potential competitive capacity to take these levels of still relatively high-acuity SNF patients at these discounted rates, right? Otherwise, your willingness to negotiate such a discount really wouldn't be there. Is that fair?

Jose C. Lynch

Yes, but there's somewhat of a haircut we get on the cost side as well just from what's required on those contracts from the amount of services we deliver that are expected, i.e., ancillary services, and different requirements that the managed care contracts won't require that the CMS does require. So there's some opportunities on the cost side there, call it 8% to 10%. But it's -- there's still a lot more opportunity to get those rates a lot higher.

Gary P. Taylor - Citigroup Inc, Research Division

And just last question, so when you're seeing that shift from fee-for-service to Medicare Advantage, what's the -- obviously, you talked about the per diem being lower, but how much differential on average length of stay?

Jose C. Lynch

Yes, so we're -- it's about 10 days. So we ran about -- in Q2 of '13, we ran 29 under Med A, and HMO was about 19. That was an all-time low for us. And most of that is driven by, of course, the doctors that are assigned to the medical groups that are assigned in -- are at risk and move the patients out a lot more quickly.

Gary P. Taylor - Citigroup Inc, Research Division

So you view that as a relatively apples-to-apples patient population comparison, the 29 versus the 19, or...

Jose C. Lynch

Yes, it's pretty similar, I think. On the managed care side, you see a lot more just coordination. And we see discharges going out. They might be a lot more frail going out, but they're comfortable with that risk. So on the Medicare side, we typically are a little bit more cautious in making sure that we don't see sort of those frequent flyers come back through the facility. Because we're -- a lot of the focus is on our hospital partnerships, and the better we do with reducing unnecessary discharges to the hospital, the better we'll do. So we -- on the volume side, obviously, that's hurting us as well, the better we do on the readmission side.

Operator

Your next question comes from the line of Rob Mains with Stifel.

Robert M. Mains - Stifel, Nicolaus & Co., Inc., Research Division

One question on the guidance, the 36% tax rate, you had kind of a funny tax rate in the first quarter. Is that what we should be modeling for the last 2 quarters of the year?

Boyd W. Hendrickson

The last 2 quarters of the year, your should model about 39%. So the 36% is blended for the year.

Robert M. Mains - Stifel, Nicolaus & Co., Inc., Research Division

Okay, got it. And just to push to this volume issue again, when you're talking about the softness, are you talking just about short-stay patient? Because I know that Medicaid days were down year-over-year. Any softness that you're seeing that you want to address, even on the traditional long-term care patient?

Jose C. Lynch

Yes, I mean, the question's how we're addressing it. I mean, most of the -- I mean, the length of stay overall for all patients is dropping as well. So you're finding your typical routine or privates finding their way to assisted living and/or Medicaid finding their way to Medicaid-assisted living and/or group homes and those things. So we're -- the environment's changing for skilled nursing. We're just taking care of the secrets of the 6 [ph], so most of the drop is just -- if you just compare it over like sequentially, we went down like 9% in new admits. So some of it, I think, in the summer months, which we have historically seen, we have just probably a sharper drop in volumes than we have historically seen in the summer. So most of that's just true acute volumes admissions down.

Robert M. Mains - Stifel, Nicolaus & Co., Inc., Research Division

Okay, so when you're talking about kind of remediation strategies, that's the short stay that you're focused on?

Jose C. Lynch

Yes, we're focused on everything. I think if we could get a routine custodial Medicaid or private resident, we would take those all day long. So we really have -- we're admitting -- if you look now, wherein in the past, I think we might be admitting 95% skilled patient. I think we -- our percentage of longer-term patients we would admit today is going up pretty dramatically.

Robert M. Mains - Stifel, Nicolaus & Co., Inc., Research Division

Okay, and then turning over to therapy. The MMR issue, obviously, it's not -- this has been around a little while. Do I surmise that the problem is that we've reached a point where the MACs and RACs are getting overwhelmed? Or how would you characterize what's different now from what you've seen in the last couple of quarters?

Laurie Thomas

Rob, this is Laurie. What we've seen [indiscernible] back in October, there was a prepayment review, and it's quite confusing. And it caused us to get paid on may be about 6% of those claims that were sent in and reviewed by the MMR. We went to the first quarter, that improved to 11%, but since April 1, when the RACs got involved, it's actually dropped to about 3%. So it caused a major industry-wide issue. And our belief is that they weren't prepared. They don't have the resources. They don't have the processes. I guess if you looked at it very negatively, you could say this is all intentional to slow payment and to reduce volume overall, which is the effect that it's having. Because, obviously, if we got a patient that has a need, and we're trying to meet that need, and not getting paid for it, there's some ramifications. But we believe it's just inefficiencies, lack of processes and now, since April 1, the additional complication of having the RACs involved in addition to the MACs.

Robert M. Mains - Stifel, Nicolaus & Co., Inc., Research Division

Just -- I know this is getting into like painful detail. Why are the RACs involved?

Laurie Thomas

Because that's -- because of the government. The new ruling that was put into place in 2013 was as of April 1, the MACs were relieved of this manual medical review, although we still have to send them a copy of all the files. And then they turn it over to the recovery audit contractors, because I guess the government felt that they were better equipped to handle this. They're also incentivized on a percentage of whatever they deny, and I don't think they were any better equipped, because it's a large volume. It's a significantly large volume.

Robert M. Mains - Stifel, Nicolaus & Co., Inc., Research Division

Right. And I guess from an accounting perspective, the decision as to whether to book the revenues and just take a receivable rather than hold off on the revenues. Is kind of the driver there the fact that you're also seeing because of the denials less patient demand for the service? Or is it you being conservative based on the level of denials or non-approvals that you're getting?

Laurie Thomas

No, if you take a look at the decision-making when you pick up a Part B patient, there's a range. And I would say we were more aggressive before, and we've become less aggressive. We've become more conservative because of that outlying risk.

Robert M. Mains - Stifel, Nicolaus & Co., Inc., Research Division

Okay. And last question on therapy, can you just remind us, 126 contracts as of June 30. Where were you on -- at March 31?

Laurie Thomas

I think 124. We picked up 2.

Operator

Your next question comes from the line of Dana Hambly with Stephens.

Dana Hambly - Stephens Inc., Research Division

Just the guidance for the second half of the year backing into the EBITDAR margin, around 12.5% versus about 10.5% in the first half of the year. I know you get some of it from the savings, but where should we think about the rest of that margin expansion come coming from?

Jose C. Lynch

Yes, some of that's coming from an uptick in volume on the census side, which we typically would see in end of fourth quarter, latter quarters. We expect some progress in rate from Medicare growth in October and a few Medicaid increases. And then we expect the cost structure to drop a bit, not only with that $6 million in savings but also coming from some of the other agencies or segments that we expect to see less sort of onetime items, cap and those type of things.

Dana Hambly - Stephens Inc., Research Division

Okay, and then just on some of the quality initiatives you guys are doing right now, could you just go over some of the biggest ones you're working on, and maybe where the hospital readmission rate has gone from and where it is now? And I'd just be curious if you're tracking hospital readmissions for the 19 "average length of stay" managed Medicare guys versus the 29-day fee-for-service guys, if there's any big discrepancy there.

Jose C. Lynch

Yes, we track -- so industry-wide, there's really no nationally -- there's not a national program where everyone's on the same system to track readmission. So different companies will come with different numbers, but we have a pretty conservative way of counting it. We've gone down 2%. I think we're about 20% return to acute, and that's across the company. So we've seen nice progress in that over time. And in some of the other big-quality -- but for Medicare, that's collectively between Medicaid and managed care. We track those all together. The other CMS initiatives sort of on the long-term care side are sort of a reduction in antipsychotic medications. We've seen -- the government's expected a 15% drop in the run rate from prior years, and we've seen great progress with that in some of our segments. So those are sort of the large items, sort of the CMS initiatives out there. And -- but if there's any other questions, I'm happy to answer.

Operator

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

Kevin M. Fischbeck - BofA Merrill Lynch, Research Division

This is actually Joanna Gajuk in for Kevin. Thank you so much for the color in terms of second half of the year versus first half, but I just want to clarify something. So is that your view that the cost-cutting that you will do this year should help you, I guess, going forward, the next year, 2014, to start off on a more firmer footing and sort of closer to maybe what you were thinking 2014 would look like before the quarter?

Boyd W. Hendrickson

Yes, I think to answer your question, we'll see the savings on the $6 million annualized continue to go through '14. And in '14 that number might grow a tad just because of additional stock comp savings, and maybe another 5% to 10% higher. Does that answer your question?

Joanna Gajuk - BofA Merrill Lynch, Research Division

Yes. And then the second question I have is on your covenants, on the financial covenants, because it seems like, I guess, there's a step down from 5.25 to 5x through next year third quarter. So how are you feeling in terms of being up close? Or is there any worry in your mind in terms of getting too close to these covenants? Or do you have any carve-outs there?

Boyd W. Hendrickson

Yes, there are covenant -- or carve-outs in our covenant calculation, and we're obviously watching it very closely, but we expect to be able to comply with our debt covenants for the remainder of the year. And there is a quarter-turn step-down in leverage ratio at year end.

Operator

[Operator Instructions] I would like to turn the conference back over for closing remarks.

Boyd W. Hendrickson

Okay, we'd just like to thank everybody for joining the call today. We appreciate it very much. Thank you.

Operator

Thank you. This concludes today's conference. You may now disconnect.

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