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Select Medical Holdings Corporation (NYSE:SEM)

Q4 2013 Results Earnings Conference Call

February 21, 2014, 09:00 AM ET

Executives

Robert A. Ortenzio - Executive Chairman and Co-Founder

Martin F. Jackson - Chief Financial Officer and Executive Vice President

Analysts

Whit Mayo - Robert W. Baird

Frank Morgan – RBC Capital Markets

Albert J. Rice - UBS Investment Bank

Kevin Fischbeck - Bank of America Merrill Lynch

Christian Rigg - Susquehanna Financial Group

Walter Branson - Regiment Capital Advisors, LLC

Miles Highsmith - RBC Capital Markets

Bernard M. Casey - Fort Washington Investment Advisors, Inc.

Operator

Good morning, and thank you for joining us today for Select Medical Holdings Corporation's Earnings Conference Call to discuss the Fourth Quarter and Full Year 2013 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 would 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'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 call over to Robert Ortenzio. Please proceed, sir.

Robert A. Ortenzio

Thank you, operator. Good morning, everyone. Thanks for joining us for Select Medical's fourth quarter and full year earnings conference call for 2013.

For our prepared remarks I'll provide some overall highlights for the company and our operating divisions and then ask our Chief Financial Officer, Marty Jackson to provide some additional financial details before we open the call up to questions.

I want to first note the results for the fourth quarter and the full year reflect Medicare's payment changes that became effective on April 1, including a 2% reduction in Medicare payments that was implemented as part of the automatic reduction of federal spending mandated under the Budget Control Act of 2011, or better known as sequestration; and an increase from 25% to 50% in the Multiple Procedure Payment Reduction for therapy service as mandated by the taxpayer American Taxpayer Relief Act of 2012, or better known as MPPR.

The reduction, both in net operating revenues and adjusted EBITDA from sequestration was approximately $7.3 million in the fourth quarter and $23.9 million for the full year. The reduction in both net operating revenues and adjusted EBITDA from MPPR was approximately $2.1 million in the fourth quarter and $5.7 million for the full year.

Net revenue for the fourth quarter was $746.2 million compared to $741.1 million in the same quarter last year. Net revenue for the full year was $2.98 billion compared to $2.95 billion last year. During the year we generated approximately 74% of our revenues from our specialty hospital segment which includes both our long-term acute care and in-patient rehab hospitals and 26% from our outpatient rehab patient segment which includes both our outpatient clinics and contract services.

Net revenue in our specialty hospitals for the fourth quarter decreased slightly to $548.4 million compared to $556 million in the same quarter last year. This reduction resulted primarily from sequestration reduction. Sequestration reduction was almost $7 million in our specialty hospitals during the fourth quarter. Our net revenue per patient day declined to $1,509 per day in the fourth quarter compared to $1,542 in the same quarter last year. The majority of the decline resulted from sequestration.

Our overall patient day declined slightly in the fourth quarter to 336,700 days compared to 337,500 days in the same quarter last year. The decline was a result of a reduction in our Medicare patient days while non-Medicare days remained stable compared to the same quarter last year. Our occupancy rate was 71% in both the fourth quarter of this year and last year. We generated approximately 82% of our specialty hospital revenue from our long-term acute care hospitals and 18% in our in-patient rehabilitation operations during the fourth quarter.

Net revenue in our specialty hospitals for the full year was $2.2 billion, flat compared to last year. Sequestration reduction was $22.8 million in our specialty hospitals for the year, which was offset by incremental volume and pass-through revenue related to some of our joint ventures.

Our net revenue per patient day declined to $1,514 per day for the year compared to $1,534 per patient day last year. Decline was driven by sequestration and a decrease in our non-Medicare revenue per patient day. Our overall patient days for the year increased 0.6% to over 1.35 million days compared to last year.

Our occupancy rate was 72% for the year, up from 71% last year. We generated approximately 83% of our specialty hospital revenue from our long-term acute care hospitals and 17% from our in-patient rehab hospitals -- in-patient rehab operations for the year.

Net revenue in our outpatient rehabilitation segment for the fourth quarter increased 6.8% to $197.8 million compared to $185.1 million in the same quarter last year. In the fourth quarter sequestration reduction in our outpatient rehab segment was $400,000 and the MPPR reduction was $2.1 million. We are able to more than offset these reductions through incremental volume in our outpatient clinics.

Net revenue in our outpatient clinics-based business including our owned and managed clinics increased to $150.4 million compared to $139.7 million in the same quarter last year. For our own clinics patient visits increased 7.4% to 1.2 million visits compared to the same quarter last year. Our net revenue per visit was $104 in both the fourth quarter this year and last year.

Net revenue in our contract services business in the fourth quarter increased slightly to $47.4 million compared to $45.4 million same quarter last year. Net revenue in our outpatient rehabilitation segment for the full year increased 3.4% to $777.2 million compared to $751.3 million last year. For the full year the sequestration reduction in our outpatient rehab segment was $1.1 million and MPPR reduction was $5.7 million.

For the full year we generated approximately 76% of our outpatient revenue from our owned and managed clinics and 24% from contract services. Net revenue on our outpatient clinics based business including our owned and managed clinics increased to $593.7 million compared to $561.4 million last year. For our owned clinics patient business increased 4.6% to 4.8 million visits compared to last year. Our net revenue per visit was $104 for the full year compared to $103 per visit last year.

Net revenue in our contract services business for the year declined to $183.5 million, compared to $189.9 million last year. The decline resulted from both a reduction in number of contracts as well as regulatory changes.

Our overall adjusted EBITDA for the fourth quarter was $86.4 million, compared to $98.8 million in the same quarter last year with overall adjusted EBITDA margin of 11.6% for the fourth quarter compared to 13.3% margin for the same quarter last year. Our decline in adjusted EBITDA and our adjusted EBITDA margin was primarily due to sequestration reductions of $7.3 million and MPPR reduction of $2.1 million and an incremental healthcare cost included in our G&A expense in the fourth quarter.

Overall, adjusted EBITDA for the full year was $372.9 million, compared to $405.8 million last year with an overall adjusted EBITDA margin at 12.5% for the full year compared to 13.8% margin last year. Our decline in adjusted EBITDA and our adjusted EBITDA margin was primarily due to the sequestration reduction of $23.9 million, the MPPR reduction of $5.7 million and the incremental healthcare cost included in our G&A expenses during the year.

In addition our results for last year included gains on asset sales of $4.9 million which had the effect of reducing our G&A expenses. Specialty Hospitals adjusted EBITDA for the fourth quarter was $88.8 million, compared to $95.6 million in the same quarter last year. Adjusted EBITDA margin for the Specialty Hospitals segment was 16.2% compared to 17.2% in the same quarter last year.

Specialty Hospitals adjusted EBITDA for the full year was $353.8 million, compared to $381.4 million last year. Adjusted EBITDA margin for the Specialty Hospitals segment was 16.1% for the quarter compared to 17.4% last year. The primary reason for decline of adjusted EBITDA and margin in our Specialty Hospitals for both the fourth quarter and full year was due to sequestration.

Outpatient Rehabilitation adjusted EBITDA for fourth quarter increased 7.9% to $19.8 million, compared to $18.4 million in the same quarter last year. Adjusted EBITDA margin for the Outpatient segment was 10% in the fourth quarter compared to 9.9% in same quarter last year. For the outpatient clinic portion of our business, adjusted EBITDA increased to 8% to $15.9 million, compared to $14.7 million in the same quarter last year. Adjusted EBITDA margins for outpatient clinics for 10.6% for the fourth quarter compared to 10.5% in the same quarter last year.

For our contract services, adjusted EBITDA was $3.9 million for the fourth quarter of this year compared to $3.6 million in the same quarter last year and the margin was 8.3% in the fourth quarter of this year compared to 8% in the same quarter last year. Outpatient Rehab adjusted EBITDA for the full year increased 3.8% to $90.3 million, compared to $87 million last year. Adjusted EBITDA margin for the Outpatient segment was 11.6% for both the full year, this year and last year.

For the Outpatient clinic portion of our business adjusted EBITDA increased 5.8% to $77.1 million for the year. Adjusted EBITDA margin for Outpatient clinic was 13% both this year and last year. For contract services, adjusted EBITDA was $13.2 million for the year and the margin was 7.2%.

Our reported earnings per fully diluted share was $0.21 in the fourth quarter, compared to $0.28 for the same year last year. Reported earning per fully diluted share for the full year was $0.82, compared to $1.05 per share last year. Our earnings per share for both this year and last year included non-recurring loss on early retirement of debt. Excluding these losses and related tax effects, adjusted earnings per share was $0.90 this year, compared to $1.07 last year.

I also wanted to provide some information regarding the LTAC Criteria Bill passed by Congress and signed into law in December. First and foremost, the law resolves a great deal of regulatory uncertainty hanging over the LTAC hospital segment and we were supportive of the legislation. The new law is not a win for Select Medical or the industry but it does better define and clearly establish the role of LTAC hospitals in the healthcare continuum.

We do think the new law represent a tougher regulatory environment and will have the effect of reshaping the LTAC hospital space. The law will also better define the type of patients who belong in LTACs. While the three day ICU stay is a somewhat arbitrary measure it does provide a proxy for patient acuity to justify LTAC admission. FLEX LTAC hospitals are already treating the high acuity patients that Congress and CMS both have identified as the core LTAC population.

In addition to defining the LTAC patient criteria the new legislation continued an extension of the 25% rule for HIH's at the 50% level and suspended it for free standing hospitals until 2016 and after. The legislation also included a new moratorium on the addition of LTAC beds that runs from January 15 through September 17. We have identified a number of opportunities to add hospitals and beds in several markets this year in advance of a moratorium. The new criteria is a win for Medicare as it achieves scorable savings from LTACs and other reforms at CMS side, and a win for the industry as we have gained clarity and certainty about future regulations.

I will now turn it over to Marty Jackson to cover some additional financial highlights and details on the criteria before we open it up for questions.

Martin F. Jackson

Thanks, Bob. As Bob mentioned the impact from sequestration and MPPR totaled $9.4 million in the quarter and close to $30 million for the full year. Had we not experienced these Medicare payment reductions net revenue would have increased 2% in the quarter, and 1.9% for the year compared to the same respective periods last year.

For the fourth quarter our operating expenses, which include our cost of services, general and administrative expense and bad debt expense increased 2.7% to $661.4 million compared to the same quarter last year. As a percentage of our net revenue operating expenses for the fourth quarter were 88.6%, this compares to 86.9% in the same quarter last year. For the year our operating expenses increased 2.4% to $2.6 billion, this compares to $2.5 billion last year. As a percentage of our net revenue operating expenses were 87.7% compared to 86.4% last year.

Cost of services increased 1.2% to $627.6 million for the fourth quarter as compared to the same quarter last year. As a percent of our net revenue cost of services was 84.1% compared to 83.7% in the same quarter last year. The primary reason for the 40 basis points increase in our cost of services as a percent of net revenue is the adverse sequestration and MPPR reductions on our net operating revenue. I think this is important point to note because in our specialty hospitals there was no increase in our operating expense on the cost or operating cost on a per patient day basis compared to the same quarter last year.

Cost of services as a percent of net revenue without the reimbursement changes would have been 83.1%. Our operators did a very effective job managing the cost this past quarter. For the year cost of services increased 2.1% to $2.49 million compared to $2.44 billion last year. As a percent of net revenue cost of services was 83.8% compared to 82.9% last year. The primary reason for the 90 basis point increase in our cost of services as a percent of net revenue for the year was the adverse sequestration and MPPR reductions on net operating revenue.

G&A expense was $23.9 million in the four quarter which as a percentage of net revenue was 3.2%. This compares to $16.3 million or 2.2% of revenue for the same quarter last year. For the full year G&A expense was $76.9 million which as a percent of net revenue was 2.6% compared to $66.2 million or 2.2% of net revenue last year. The primary reason for the increase was incremental healthcare cost related to our group health insurance plans, changes that were implemented during the year. Excluding these costs G&A as a percent of net revenue would have been 2.3%. As Bob also mentioned our results from the last year including gains on asset sales of $4.9 million which had the effect of reducing our G&A expense.

Bad debt as a percent of net revenue was 1.3% for the fourth quarter compared to 1% for the same quarter last year. For the full year bad debt as a percent of net revenue was 1.3% both this year and last year. Total adjusted EBITDA was $86.4 million and adjusted EBITDA margins were 11.6% for the fourth quarter. For the year total adjusted EBITDA was $372.9 million and adjusted EBITDA margins were 12.5%.

Depreciation and amortization expense was $16.5 million in the fourth quarter compared to $16.1 million in the same quarter last year. For the full year depreciation and amortization expense was $64.4 million compared to $63.3 million last year. We generated $1 million in equity earnings during the quarter compared to $1.3 million in the same quarter last year. We generated $2.5 million in equity earnings during the full year compared to $7.7 million last year. The decline in the year was primarily the result of losses incurred by startup companies in the two new joint venture rehab hospitals opened in 2013 where we own a minority interest.

Interest expense was $20.8 million in the fourth quarter. This is down from $22.7 million in the same quarter last year. For the full year interest expense was $87.4 million, down from $95 million last year. The reduction in interest expense is primarily related to the lower interest rates on borrowings which have resulted from our refinancing activities.

The company recorded income tax expense of $17.4 million in the fourth quarter. The effective tax rate for the quarter was 35.9% compared to an effective tax rate of 30.6% in the fourth quarter of last year. For the full year our effective tax rate was 37.8% compared to 36.8% last year.

The increase in our effective tax rate has resulted from an increase in our state effective tax rate that has resulted from a higher proportion of our income being generated in states with higher tax rates offset in part by an increase in earnings of our consolidated subsidiaries where we have less than 100% ownership interest that our tax has passed through entities in which we only record income taxes on our share of the income. Additionally our effective tax rate for last year was reduced by an IRS penalty abatement.

Net income attributable to Select Medical Holdings was $28.9 million in the fourth quarter, and fully diluted earnings per share were $0.21 compared to $39.4 million of net income and fully diluted earnings per share of $0.28 in the same quarter last year. For the full year net income attributable to Select Medical Holdings was $114.4 million and fully diluted earnings per share were $0.82 compared to $1.05 for the prior year.

During both 2013 and 2012 we incurred losses on early retirement of debt related to the refinancing activity. Excluding these losses and their related tax effects adjusted net income per share was $0.90 for the full year 2013 compared to $1.07 for the full year 2012.

The Medicare payment reductions for sequestration and MPPR had a $0.04 negative impact on fully diluted earnings per share in the fourth quarter and $0.12 negative impact for the year.

We ended the year with $1.45 billion of debt outstanding and $4.3 million of cash on the balance sheet. Our debt balances at the end of the year include $807.8 million in term loans, which are net of our original issue discounts; $600 million in the 6.375% senior notes that we have, $20 million in revolver loans with the balance of $17.5 million consisting of other miscellaneous debt.

While speaking of our capital structure I should also note that yesterday we launched a proposed transaction to re-price our existing term loan B tranches, extend the tenure of our Series B 2016 tranche and modify some of our existing covenants.

Operating activities provided $77.4 million of cash flow in the fourth quarter and $192.5 million for the year. The provision of operating cash flow for the year primarily resulted from the cash income and increases in accrued expenses, offset by increase in our accounts receivable and other assets.

Day sales outstanding or DSO was 48 days at December 31, 2013 compared to 54 days at September 2013 and 45 days at the end of last year. The changes in DSO are primarily due to the timing of our periodic interim payments we received for Medicare for services provided at our specialty hospitals.

Investing activities used $29.2 million of cash flow for the fourth quarter and $107.3 million for the full year. For the year the use of cash was primarily related to property improvements and equipment purchases of $73.7 million and investments in businesses and acquisition payments of $36.5 million. This was offset in part by $2.9 million of proceeds from the sale of assets.

Financing activities used $53.2 million of cash in the fourth quarter. The primary use of cash resulted from $45 million in net payments on our revolving line of credit and $14 million in dividend payments offset impart by $5.1 million in proceeds from bank overdrafts in the quarter.

Financing activities used $121 million of cash for the full year. The primarily cash flow activity resulted from the refinancing activities during the year which included the issuance of additional term loan tranches and senior unsecured notes which were used to repay the remaining holding company senior floating rate notes and the senior subordinated notes. In addition we had net repayments of $110 million on a revolving line of credit, $42 million in dividend payments and $11.8 million used for share repurchases during the year.

Additionally I would like to reaffirm the financial guidance for the calendar year 2014 that we provided in our earnings release. This includes net revenue in the range of $3.05 billion to $3.15 billion, adjusted EBITDA in the range of $365 million to $385 million and fully diluted earnings per share to be in the range of $0.84 to $0.93.

I would like to conclude my comments by going over some of the details of the new LTAC legislation that Bob mentioned. The most immediate impact for Select is that the bill provides for the regulatory relief to the 25% rule previously scheduled to go into effect for cost reporting periods reporting on or after last October 1, 2013. The rule provides for four years additional relief from the previous legislation.

For our free standing LTACs this will be subject to the 25% rule for cost reporting periods on or after July 1, 2016 and the for majority of our HIH LTACs they will be subject to the more stringent 25% threshold for cost reporting periods on or after October 1, 2016. CMS is also required to report to Congress by September 2015 whether there continues to be a need to apply the 25% rule. The legislation also contains the new patient criteria which specifically defines the patient eligibility requirements to receive LTAC PPS payments.

In order to meet LTAC PPS payments, payment requirements patients must have a three day or more stay in the intensive care unit or critical care unit while in a short-term acute care hospital immediately preceding the LTAC admission or a prolonged mechanical ventilation which means greater than 96 hours while in an LTAC and the patient must have a short-term acute care hospital stay immediately preceding the admission to the LTAC. All other patients not meeting LTAC payment criteria will be reimbursed under a site-neutral payment. In addition any patient with a primary diagnosis of either a psychiatric condition or the need for intensive rehabilitation will be reimbursed under the same site-neutral payment regardless of the patients ICU, CCU or ventilator status.

The site-neutral reimbursement will be the lesser of the IPPS comparable per diem cap at the IPPS DRG payments plus any outlier amount or 100% of the estimated cost of services. The site-neutral payment rates will be phased in starting with cost reporting periods on or after October 2015. There will be a three year blending payment phase-in during which time patients not meeting LTAC criteria will be paid blended rate between the site-neutral rate and the current LTAC PPS rate.

After the full phase-in in cost reporting periods on or after October 2017 patients not meeting LTAC criteria will be subject to a full site-neutral rate, which is lessor cost or the in-patient PPS per diem as we previously discussed. Ultimately in order to remain certified as an LTAC, more than 50% of the LTAC patients much be paid under LTAC PPS and not the site-neutral rates beginning with cost report period on or after October 2019.

This concludes our prepared remarks and at this time I'd like to turn it back over to the operator to open the call up for questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). Your first question comes from the line of Whit Mayo of Robert W. Baird. Please proceed.

Whit Mayo - Robert W. Baird

Hey, thanks Good morning. I guess just on the patient admission criteria I mean you guys have obviously seen the AHA analysis they put out on site-neutral payments which estimates that approximately 53% or so of industry cases were either vent or meet the ICU requirement. Do you happen to know what you complying case load is or any way to think about that?

Martin F. Jackson

Yeah, Whit, we haven't put out what Select is. I can tell you that we are better than what the industry is and as there is a lot of time until October 1, 2015 to make some modifications.

Whit Mayo - Robert W. Baird

Okay. I know there is a lot of uncertainty but I mean do you see any new clinical programs that you guys may need to invest in to ensure that you are successful with this change? I guess I'm curious of what's changed in terms of the conversations you are having with some of your hospitals or what you anticipate will change?

Robert A. Ortenzio

Well, Whit it's Bob, we actually haven't started in depth conversations with a lot of our referral sources but the way we are looking at the criteria, our clinical programs I don't think that we will require new programs. I think we have the programs in place to take care of the patients that are identified as LTAC patients, so the vent patients and generally the ICU patients. We may also have some additional programs that may be less valuable that will be the reduction to the site-neutral patients.

So if you look at patients with a primarily diagnosis of wound care for example which would not normally fit the ICU or the vent diagnosis, we do see a fair amount of those patients today, and we may see lots of those patients. So I don't think it's so much an addition of new clinical programs as much as it is an emphasis on the programs that we have that are more likely to see patients that have a three day or greater ICU stay. So the reality is that it's a narrowing and for us the goal here is not necessarily to have the site-neutral payments patients but to have more of patients that fit the LTAC criteria. I hope that helps?

Whit Mayo - Robert W. Baird

No, it does. And I guess the corollary to that, that I am getting to is that, there are a number of LTACs within the industry that aren't nearly as compliant as you are with respect to the new rule and if am an LTAC today in a market that has a very low vent mix, potentially no ICU patients, how do I adapt to the change? Do you have any thought for how this will evolve, I guess more broadly speaking for the industry?

Robert A. Ortenzio

It's a good question and I do have some thoughts on it. I mean, it depends on that LTAC that you describe, it depends where it is and why it is that it has a low percentage of those patients that will be LTAC patients under the new criteria. For example, it's an LTAC that's in a rural area that doesn't have referral sources that have a lot of ICU beds or a high percentage of those in vent patients then I think there is probably no place for that hospital to go because they are going to be in a market that has a dearth of qualified patients.

On the other hand if you are an LTAC hospital in the metropolitan area that happens to be over bedded and that the LTAC compliant, future LTAC compliant cases are spread across many hospitals and you compete for patients and therefore you take a low acuity patient to fill your beds then the market is going to sort that out, right?

So not everyone will survive but there are certainly markets. And there is no secret that there are few cities in the country that are over bedded for LTAC and if you look at the data, so you can take Houston for example. There are plenty of LTAC eligible patients in Houston but there are far too many LTACs in that city. So there'll have to be a rationalization because if you have an over bedding situation, more hospitals competing for fewer patients you tend to take a lower acuity patient. And if you look at the data that’s exactly what it shows.

The lower acuity patients in LTAC hospitals tend to be in over bedded markets and in more rural markets, with the exception I would say geographically of the Northeast in the Massachusetts area and the like where you just have a different set of facts and history for how LTAC hospitals evolve.

Whit Mayo - Robert W. Baird

No, that’s helpful and I guess one last one and I will hop off, just Marty on the term B refi, can you elaborate more on some of the details, pricing I think you mentioned an ease in the covenants. Thanks.

Martin F. Jackson

What we are looking at is, we have two series, series B and C. Series B currently has a spread of 325. We’re looking to reduce that to 275 and the series C has a spread of 300, we’re looking to reduce that to 275 also. So all-in-all net-net the expected savings on something like this is close to $2.8 million on an annualized basis.

Whit Mayo - Robert W. Baird

Perfect, thanks.

Robert A. Ortenzio

Hey, Whit great job on that report.

Whit Mayo - Robert W. Baird

Thanks.

Operator

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

Frank Morgan – RBC Capital Markets

Good morning. I think you made a comment about you might have the ability to add some beds before the moratorium goes into place. Could you talk about where or how many beds and any color on how much you could add before the moratorium starts back?

Robert A. Ortenzio

Well Frank on the first comment on the ability to add beds, as you know there is a window and I think this is -- I won't describe it as a fluke but the moratorium goes into effect in Q2 you have kind of a narrow window but we don't have a lot of regulatory guidance on how the licensure people will look at whether you completed what you needed to complete in order to qualify to come in under the moratorium. So we are still studying that.

We have some bed additions that we think that we can do easily and a couple of projects and I don't want to give the impression that these are going to be a lot or meaningful or material new hospital additions in the window that we can add and so we’re still looking at it and I don't know Marty if we have given some information on that.

Martin F. Jackson

We have provided information.

Robert A. Ortenzio

Okay

Martin F. Jackson

Frank we think it’s probably in the 150 bed range.

Robert A. Ortenzio

That would include any new hospitals that we can get in under the deadline of the moratorium and bed additions.

Frank Morgan – RBC Capital Markets

Okay, that’s helpful. And then on the guidance could you maybe also provide a little bit of color about how you see the cash flow and CapEx for the year? I am trying to get a picture what free cash flow might be for 2014?

Martin F. Jackson

Yeah Frank with regards to our CapEx we anticipate it won’t be materially different from this year.

Frank Morgan – RBC Capital Markets

Okay. Any reason like what about the cash flow from off-site, any thoughts there?

Martin F. Jackson

Yeah I think pretty similar.

Frank Morgan – RBC Capital Markets

Okay and just on the outpatients out of the business or rehabs out of the business, could you remind us kind of at what point do we kind of lap our way through these incremental negative hits on the regulatory path, do you see that from a modeling standpoint is there -- when do we lap through this and when do the incremental kind of headwinds of that, when do we work our way through that?

Martin F. Jackson

Yeah, that's surely the second quarter, I mean April 1 of last year is when sequestration and MPPR commenced. So we will have one more quarter here and then it should be an apples-to-apples comparison.

Frank Morgan – RBC Capital Markets

And there is not another level of cuts to MPPR coming, we will be where we are going to be?

Robert A. Ortenzio

We certainly hope so, Frank.

Frank Morgan – RBC Capital Markets

Okay. That's what I wanted to make sure. Thank you.

Robert A. Ortenzio

Yeah.

Operator

Your next question comes from the line of A.J. Rice with UBS. Please proceed.

Albert J. Rice - UBS Investment Bank

Hi, everybody. A couple of questions, if I might. First on the patient criteria, hopefully, I've heard your comments. Obviously your model has been skewed historically more to hospitals and hospital versus free standing although you have some free standing too. Would you say you are thinking about the relative attractiveness of either one of those approaches improves under patient criteria or maybe gives us a little flavor for what those models allow you to do under patient criteria?

Robert A. Ortenzio

Well A.J., again it's fairly out in the future. But I will tell you that I think we are feeling pretty good about the HIH model under that new criteria. If you make some assumptions, if you say that the universal eligible patients will be small and I am not saying that it will be but let's just say for the moment that if you made that assumption then and are high acuity patients then smaller hospitals closer to the referral sources should have a bit of advantage.

So if you lose some of our patient population or HIHs tend to be smaller in bed size than free standing, they tend to be closer to the larger referral hospitals that maybe have more ICU beds, so that's not universally true but it's true in the main then I feel pretty good about the HIH model. As is always, the benefit of the free standings where you have more beds, is that your opportunity to make more dollars and spread your cost further are greater.

So it of course depends on the market and it of course depends on the location. But if you look across our -- all of our LTACs as we are looking at the new criteria I think we feel very good about the HIHs. And if the moratorium was not in existence we would probably be looking at those markets.

Now you have to balance that with the fact that 25% rule is still from a regulatory standpoint is still temporary even though it's a couple of years and it could come back and your HIH rules if it goes to 25% naturally penalize the – can over times penalize your HIHs more than your free standing. So it does cut both ways but you asked for a comment I would tell you I am feeling pretty good about our predominance of our HIH model right now.

Albert J. Rice - UBS Investment Bank

Yeah, now that's helpful. I guess as we think about the doc fix coming in potentially in the spring whether it's a permanent one or now increasingly looks like it might just be a short-term one again. There has been a lot of discussion about post-acute care being one of the areas to look for pay-fors. Do you believe that the fact you offered savings in the patient criteria will somehow sort of take sales tax off the table or do you have any broader thoughts on what the doc fix might mean?

Robert A. Ortenzio

Well, I have no view on what the doc fix might be. I would hope that the significant cuts or gives, pay-fors from the LTACs would not be part of future doc fix. I think that my general view of how the LTAC legislation that contributed $3 billion to the short-term fix in December was looked at by a really good cross section of both the House and the Senate both committees Senate Finance and Ways and Means and leadership, I mean I think it was generally acknowledged across most all of the leadership that the LTACs were contributing pretty significantly in a meaningful way and a material impact to the business even though it has some out years.

So my assumption is that if the doc fix is going to be paid for by provider, pay-fors I think that it will not come in the main from LTAC. Of course that's what we'll certainly -- our representatives in DC will certainly be pushing that and reminding to guys in jurisdiction and leadership that this was -- we were part of the first temporary doc fix pay-for.

Albert J. Rice - UBS Investment Bank

All right and then real quick I have got separate two detail questions. So I must take it from your comments on the G&A in the fourth quarter that sort of the 3.2% is more indicative of the run-rate to go forward and then also on the 1 million in the non-consolidated subs year-to-year that doesn't look much different but it certainly is a pick up from which we've been reporting, can we say that the losses on the new investments and start-ups are starting online and may be $1 million a quarter run rate is a reasonable run rate for 2014?

Martin F. Jackson

A.J. the answer to your first part of the question on the G&A, we think that that is a -- we had to take a hit because of that, that really increased the 3.2%. We think the applicable rate is probably in the 2.3% range.

Albert J. Rice - UBS Investment Bank

Okay.

Martin F. Jackson

And with regard to the $1 million a quarter that's probably a pretty good run-rate.

Albert J. Rice - UBS Investment Bank

Okay, all right. Thanks a lot.

Operator

Your next question comes from the line of Kevin Fischbeck with BofA. Please proceed.

Kevin Fischbeck - Bank of America Merrill Lynch

Okay, great guys. I guess a couple of questions, the commentary in the press release around the dividend and I guess you had a similar commentary in the 10-Q but just wanted to see it sounds like you are kind of backing off a commitment to pay the dividend every quarter, or is it that was just the reason you had put in or whether you are trying to signal and may be free cash flow won't be used for share repurchase or other?

Robert A. Ortenzio

I think that to your comment this is more of a detailed description by counsel is I think more of an explanation for the change in the language. And I think as Marty and I have already said that the company is constantly looking at where is the best use of our free cash flow and I think that the point that's made is that the Board will make a decision every quarter about the dividend but that was not meant to signal that the dividend is in jeopardy in the near term.

But that the Board takes a look at it every quarter and I assume that there could be certain things that happened in the company that would have the Board change their view on the dividend if we made a big acquisition and levered up because of it for example but I think that you shouldn't read more into that then just counsel refining the language to make it clear that the Board decides on divided every quarter.

Kevin Fischbeck - Bank of America Merrill Lynch

Okay. And then on the out-patient side the volume number was up a lot and you obviously had [some issues] year-over-year but is there anything going on there that's sort of started that kind of growth I think in the volumes?

Martin F. Jackson

Kevin the operators have done a terrific job increasing the volume and I mean again what they've done is they have continued to add incremental programs. For example hand therapy is an area they really focused on and they've done a good job and you've got hand therapists coming on board, they bring their patients with them, not just the hand therapist but other patients also.

So we are very pleased with what we've seen on our outpatient business and expect that to continue.

Robert A. Ortenzio

Yeah, the outpatient really is at operators business. I mean if you look across the outpatient industry you'll find some companies that are doing well and some companies that are not doing well. And I think the difference is really in the execution and so just want to echo what Marty said we're very pleased and proud of what our operators in the outpatient business have been able to perform this past year.

Kevin Fischbeck - Bank of America Merrill Lynch

Okay. And then just to clarify, when you say you're doing better than the industry as far ICU compliance admissions or LTAC compliant admissions are you referring to the ASA 53% number as your benchmark or some other number that you are -- you seem to use just trying to say we're doing better than that?

Martin F. Jackson

Yeah I mean it's a combination of the lot of day and the information that we look at. I mean it's not just AHA data but other things that we look at in case mix index and percent of ventilator patients and the like. So as a general statement not pointing necessarily to one data set or anything that's generally our view to look at the information we have available to us.

Kevin Fischbeck - Bank of America Merrill Lynch

Okay. Just last question, I think as we take the midpoint of our guidance this year and then may be add back, maybe $9 million of sequestration cuts, I guess if you kind of call it 385ish which would be high 4.5% EBITDA growth, is that the way to think about what's this business generally should be able to grow each year, absent additional rate pressures or is there something either a tailwind or headwind effecting that growth rate this year?

Martin F. Jackson

Kevin, no, I think that's probably fair for this year coming up. I think what we have done is we also have some -- as one of the previous callers had asked about additional beds, we got additional beds coming on board. So we think that's going to be helpful, we've got the JVs that are out there bringing in additional revenue and EBITDA. So ultimately, we think now that we have clarity in our space we think we'll be able to grow and probably -- albeit at a decent clip.

Kevin Fischbeck - Bank of America Merrill Lynch

Okay, great. Thanks.

Operator

You next question comes from the line of Chris Rigg with Susquehanna Financial Group. Please proceed. Chris, your line is open. Your phone may be muted.

Christian Rigg - Susquehanna Financial Group

Can you hear me?

Robert A. Ortenzio

Yeah go ahead.

Christian Rigg - Susquehanna Financial Group

Okay. Just following up on the last question a little bit with regards the growth. You've sort been on a decline with regard to sizable [runway] over the last year so just waiting for the visibility on the LTAC side. I guess at this point can you give us a sense for what the deal pipeline might look like philosophically where your minds are right now, just any sort of way to put sort of the M&A outlook into context? Thanks

Robert A. Ortenzio

I would say that the clarity on the -- that comes from the legislation allows us to be a little bit more thoughtful on the M&A front across all of our lines of business. Recall where we were at the last conference call, at the end of the third quarter with the uncertainty and looking at the potential of CMS regulatory action on the LTACs it put the company just in a very uncertain position and made committing capital really a difficult judgment for management.

Now that we have this, I think it allows us to think about allocation of capital towards acquisitions and I would tell you that we would be more aggressive in looking at opportunities across all of our business lines. That would include rehab, inpatient and outpatient and LTAC and that could involve small transaction what's available to us that are strategic and we think provide good value. It will not represent a departure from our normal discipline about what we pay for assets and we are still in a low interest rate environment. We still get a lot of competition for acquisitions from financial sponsors that are looking at paying some pretty healthy premiums for assets set that may not be able to yield the kind of return that we look for.

So I think we will be more aggressive at looking at stuff across our business lines.

Christian Rigg - Susquehanna Financial Group

Okay, and then on the inpatient rehab side, have you guys ever disclosed if as part of the budget process here longer term doc fix, short-term doc fix what a phase up to the 75% threshold could mean in your IRF franchise?

Robert A. Ortenzio

We have not and we probably would not. We have a pretty disciplined policy about not commenting on proposed legislation regulations and in the case of rehab in the 75%, I know that's been chatted about but I think our strong view is that we wouldn't comment on that and we would resist that from a regulatory or legislative, we would resist that rigorously.

Christian Rigg - Susquehanna Financial Group

Understood. And then just lastly….

Robert A. Ortenzio

I believe for the rehab what was paid for from other cuts from rehab industry some years ago when it was solidified at the new levels at the 50%.

Christian Rigg - Susquehanna Financial Group

Right. And then now last question just with regard to the cash flow I think you said you would expect to be about the same in '14 as it was '13 but you did have that build, I think on the Medicare AR side, is that AR build just in the base line going forward or should we actually expect that to help you out a little bit this year? Thanks.

Martin F. Jackson

Chris I would assume it's just in the base line.

Christian Rigg - Susquehanna Financial Group

Okay, thanks a lot.

Operator

Your next question comes from the line of Walter Branson with Regiment Capital. Please proceed.

Walter Branson - Regiment Capital Advisors, LLC

Thanks, so just a couple of things I may have missed this but on the G&A for the quarter, which I had up about $4.5 million after factoring out the asset sale gain and the stock comp, was that healthcare cost thru-up in the fourth quarter?

Martin F. Jackson

Yes, it was.

Walter Branson - Regiment Capital Advisors, LLC

Okay. And then can you comment on commercial rates, are you seeing commercial rates holding in okay and do you expect them to continue to holding okay or is there any deterioration going on there, I am talking about for the LTACs?

Martin F. Jackson

For the LTAC the LTAC commercial rates were a little down in the third quarter, they came back in the fourth quarter. I anticipate that there will be -- what we are finding is it's hand-to-hand combat in negotiating those rates. So we've -- our projections were probably 1% to 2% increases.

Walter Branson - Regiment Capital Advisors, LLC

Okay. And then just on the 25% to make sure I have it right I thought that was a four year delay but you are saying that it actually will be coming back as of now for the HIH's in October 2016?

Martin F. Jackson

Yeah the four years that they were talking about has to do with four years of prior legislation.

Walter Branson - Regiment Capital Advisors, LLC

I see, does include the extension that's already occurred.

Martin F. Jackson

Right.

Walter Branson - Regiment Capital Advisors, LLC

Got it, thanks.

Robert A. Ortenzio

Sure.

Operator

Your next question comes from the line of Miles Highsmith with RBC. Please proceed.

Miles Highsmith - RBC Capital Markets

Hi, good morning guys. I am curious if you've looked at this. When I think about the Medicare payment rate in terms of the LTAC rate versus the IPPS plus outlier I know it's going to vary sort of by code and how long that patient is in general acute care hospitals in there and looking at outlier payments that would trigger, but I am just wondering kind of as a general though have you looked at that differential as it relates to compliant and non-compliant cases between the LTAC rate and IPPS plus outlier?

And then Marty another question for you is the RP capacity, thanks.

Robert A. Ortenzio

Yeah Miles could be a little more definitive on the IPPS versus the LTAC rate, I am not sure where…

Miles Highsmith - RBC Capital Markets

Yeah in terms of what Medicare is paying, the LTAC rate versus the IPPS post outlier rate that differential is it different between compliant cases and non-compliant cases is there anything just to say there?

Robert A. Ortenzio

When you say compliant versus non-compliant what do you mean?

Miles Highsmith - RBC Capital Markets

Those that would be ultimately be compliant cases, through the ICU 96 plus hours that versus those that would…

Robert A. Ortenzio

Are you talking about patient eligibility, so if they are eligible for LTAC payment versus IPPS payment?

Miles Highsmith - RBC Capital Markets

Correct.

Robert A. Ortenzio

Yeah, I mean the issue on the -- we talked to a number of investors where there is a little bit of confusion on the IPPS rate because it is the IPPS per diem and that is defined basically taking a look at that particular DRG, with the DRG payment divided by the geometric mean average length of stay, to get to your per diem. And I think some people are saying are -- in some cases depending on the DRG the IPPS per diem rates greater than the LTAC per diem rate.

But the thing that I think is missing is that there is a cap on the IPPS rate. The cap is the full DRG payment.

Miles Highsmith - RBC Capital Markets

Right.

Robert A. Ortenzio

Okay. So if I have a DRG, if I have an LTAC DRG it has a geometric mean of 20 days versus an IPPS it's five days. It's going to take a -- there is really no comparison, I mean the fact of the matter is the LTAC payment is going to be a much greater than the IPPS payment.

Miles Highsmith - RBC Capital Markets

Yeah, okay. That’s what I thought, great and then the RP?

Martin F. Jackson

The RP currently is on the bank side its $87 million, on the bond side it’s 135.

Miles Highsmith - RBC Capital Markets

Thanks very much.

Robert A. Ortenzio

Thanks Miles.

Operator

Your next question comes from the line of Barney Casey with Fort Washington. Please proceed.

Bernard M. Casey - Fort Washington Investment Advisors, Inc.

Yeah, that was kind of my question but maybe I am just looking for maybe a little more guidance. I guess the difference between an LTAC rate in the most general terms between an LTAC rate and the fully phased in site-neutral rate, is that might that be 20% cut, I am just looking for the roughest guidance.

Martin F. Jackson

Bernie when you say a fully phased in IPPS rate could you describe?

Bernard M. Casey - Fort Washington Investment Advisors, Inc.

It phases in over two years, right?

Martin F. Jackson

Yes, so you are saying assume you are getting paid a 100% of the IPPS per diem.

Bernard M. Casey - Fort Washington Investment Advisors, Inc.

Yes.

Martin F. Jackson

Yeah it really depends on the DRG itself. So I know a lot of people are taking a look at what's a rule of thumb and I think it’s fair to say that probably there is no rule of thumb. But let me tell you that it is a substantial discount to the LTAC DRG payment.

Bernard M. Casey - Fort Washington Investment Advisors, Inc.

Thanks.

Martin F. Jackson

Sure.

Operator

And with no further questions I would now like to turn the conference over to Mr. Robert Ortenzio for closing remarks.

Robert A. Ortenzio

Yeah thanks everybody for joining us and we look forward to updating you again after the first quarter.

Operator

Thank you for joining today’s conference. That concludes the presentation. You may now disconnect and have a great day.

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