Executives
Roland Rapp –General Counsel and Chief Administrative Officer
Boyd Hendrickson – Chairman and CEO
Dev Ghose – EVP and CFO
Jose Lynch – President and COO
Mark Wortley – President, Hallmark Rehabilitation
Analysts
Frank Morgan – Jefferies & Co.
Robert Mains – Morgan, Keegan & Co.
Ralph Giacobbe – Credit Suisse
Donald Hooker – UBS
James Bellessa – D. A. Davidson & Co.
Steve Valiquette – UBS
Adam Feinstein – Lehman Brothers
Skilled Healthcare Group, Inc. (SKH) Q2 2008 Earnings Call Transcript August 5, 2008 1:00 PM ET
Operator
Good day and welcome to the second quarter 2008 Skilled Healthcare Group Incorporated earnings conference call. My name is Candice and I will be your coordinator for today. At this time all participants are in a listen-only mode. After the prepared remarks we will conduct a question-and-answer session. (Operator instructions) I would now like to turn the presentation over to your host for today’s conference, Mr. Roland Rapp, General Counsel. Sir, you may proceed.
Roland Rapp
Thank you, Candice, good morning. I would like to welcome everybody to Skilled Healthcare’s quarterly earnings conference call and introduce our presenters, Boyd Hendrickson, Chairman and Chief Executive Officer, and Dev Ghose, Chief Financial Officer.
I would like to begin by noting that certain statements and information that we discuss this morning may be deemed to be forward-looking statements, including but not limited to guidance for our 2008 financial performance. 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 this 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 cause actual results, developments, and business decisions to differ materially from our forward-looking statements are described in our filings with the SEC.
Additionally, as we discuss performance, we will be referring to, EBITDA, adjusted EBITDA, and adjusted EBIDAR, which we use as a measure of performance but that are not considered as measures of financial performance under generally accepted accounting principles. Therefore, please see the reconciliations included in our earnings release issued this morning, which can be located on our web site at www.skilledhealthcaregroup.com. This report and our discussion 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 its consolidated subsidiaries.
I will now turn the call over to Boyd Hendrickson, Chairman and Chief Executive Officer. Boyd.
Boyd Hendrickson
Thank you, Roland, and good morning everyone. We appreciate you joining us for our call and we are extremely pleased with our performance during the second quarter of 2008 and for the year so far.
For the second quarter revenue increased by 19.3% over the same period last year and adjusted EBITDA and adjusted EBITDAR increased by 15.1% and 20.7%, respectively.
For the first six months of 2008, revenue increased by 22.1% compared to last year’s period and adjusted EBITDA and adjusted EBITDAR increased 17.4% and 22.8%, respectively.
Turning to our key operating statistics, our occupancy measures on an available skilled bed was 84.2% for the second quarter of 2008 compared to 83.8% in the same quarter last year. For the first six months of 2008 our occupancy measured on available skilled beds was 84.8% compared to 84.7% in the first half of a year ago.
Our skilled mix, defined as Medicare plus managed care as a percentage of total skilled nursing facility occupancy was 24.6% in the second quarter of 2008 versus 24.7% in the second quarter of 2007. Excluding the 10 skilled nursing facilities in New Mexico, which we acquired in September of 2007, skilled mix was 25.4% in the second quarter of 2008. For the first six months of this year, our skilled mix is 25.2% versus 25.0% for the six months period in 2007.
Our quality mix, defined as revenue other than Medicaid, was 69.3% in the second quarter of 2008 versus 69.7% in the same quarter a year ago, and 69.3% for the first six month period of 2007 versus 70.1% in the first six month period last year. The decrease was due primarily to the September 2007 New Mexico acquisition.
The percentage of our patients in the upper nine Medicare resource utilization group, or RUG, categories that were implemented in January of 2006 continued to improve as well. We regard that percentage as a key measure providing high acuity care because the RUG categories provide greater reimbursement for and encourage the admission of patients with higher clinical intervention needs.
For the second quarter of 2008 our upper nine RUG continuing utilization increased to 39.4% from 39.3% in the second quarter of last year and 40.0% for the first half of 2008 compared to 38.4% in the comparable period a year ago.
During the second quarter of 2008, we expanded one existing Express Recovery Unit by a total of 30 beds. That brings our total number of Express Recovery Units 34 and the total number of Express Recovery Units to approximately 1121 or 12% of our total SNF licensed beds. The 34 units are located in 33 different facilities, which mean that 44% of our SNF at the end of second quarter now have an Express Recovery Unit.
We plan to open 19 new Express Recovery Units and expand eight other units to a total of 681 additional beds over the remainder of the year. Currently we believe that at the end of 2008, we’ll have approximately 53 ERU units opened with approximately 1802 beds.
Of our current 75 skilled nursing facilities we believe that 78% are candidates for the Express Recovery or ERU-related specialty units. Included in these figures are the Express Recovery Units that we specifically – that are specific specialty units such as our Renew, our Women’s unit, and our Pulmonary Advantage Unit, which specializes in respiratory disease.
As compared to facilities without the Express Recovery Unit, facilities in which we have completed the Recovery Units show significant improvement as measure by the percentage of skilled mix or EBITDAR margin. As such, we continue to evaluate new opportunities for the innovative specialty care units in all of our facilities in addition to our scheduled ERU conversion.
For the second quarter of 2008, our facilities with the Express Recovery Unit had combined skilled mix of 28.7% versus 20.0 for those without the ERU unit. Also, for the second quarter of 2008, our facilities with an Express Recovery Unit had combined EBITDAR that was 2.9 percent points higher than those without the ERU.
Our ownership percentage of our operating assets is an industry-leading 71%. We believe that gives as additional flexibility with regard to our operation and our development activity.
The Centers for Medicare and Medicaid Services released in the filing ruling on July 31, 2008, that resulted in an increase in the market basket for skilled nursing of 3.4% for fiscal 2009. The final ruling also deferred refinements to the nine new case-mix groups developed under the prospective payment system, which would have recalibrated all of the RUG classifications and reduced the payment to skilled nursing facilities by 770 million.
We have reviewed the final ruling, and based on our review taking into account the geographic allocation of our facilities, we currently project 4.3% year-over-year increase in our Medicare rates effective October 1st, 2008.
Now, I’d like to turn the call over to Dev Ghose, Chief Financial Officer, to discuss the Company’s financial results in more detail. Dev?
Dev Ghose
Thank you, Boyd, and good morning to those in the west coast and good afternoon to those in east. We operate our business in two reportable segments. Our long-term care services segment is the most significant part of our business and includes the operation of skilled nursing and assisted living facilities, representing approximately 85% and 3% revenue of revenue, respectively. Our ancillary services segment, including our rehabilitation therapy and hospice businesses, represent approximately 10% and 2% of revenue, respectively.
For the second quarter of 2008, earnings per diluted share were $0.24 compared to a net loss of $0.18 per diluted share for the same period in 2007. Net income for the second quarter of 2008 was $8.9 million, and increase of $13 million compared to a net loss attributable to common stockholders of $4.1 million before accretive on preferred stock for the second quarter of 2007.
For the first six months of 2008, earnings per share were $0.47 compared to a net loss of $0.24 per diluted share for the first half of 2007. Net income for the first half of 2008 was $17.4 million, an increase of $21.7 million compared to a net loss attributable to common stockholders of $4.3 million for the same period in 2007.
Last year’s results for the quarter – for the first half of the year and the second quarter were negatively impacted by approximately $11.6 million of redemption charges relating to the early payment of $70 million of our 11% Senior Subordinate Notes. After adjusting for that payment, the majority of our growth in EPS came from organic growth in our long-term business, from acquisitions, and from the beneficial effects of declining interest rates.
During the second quarter of 2008 we generated approximately $180 million in revenue, an increase of $29 million or 19.3% compared to revenue of approximately $151 million in the second quarter of 2007.
Revenue in our long-term care services segment increased by $26.8 million or 20.4% to $159 million for the second quarter of 2008 from $132.1 million in the same quarter of last year. Approximately $19.4 million or 14.7 percentage points of the increase came from increased occupancy, mostly from the long-term care service revenue resulting from healthcare facilities acquired or developed after April 1, 2007.
Approximately $7.5 million or 5.7 percentage points came from higher rates and increased acuity at skilled nursing and assisted living facilities, which were owned for long periods.
Revenue in our ancillary services segment increased by $2.4 million, or 12.6%, to $21.4 million in the second quarter of 2008 compared to $19 million in the same quarter last year. Approximately $2.1 million, or 11.1 percentage points of the increase in ancillary services revenues resulted from the acquisition of two hospice businesses in New Mexico in September, 2007.
During the first six months of 2008, we generated $361.1 million in revenue, an increase of $65.4 million, or 22.1% compared to revenue of $295.7 million in the first half of 2007. Revenue in our long-term care services segment increased $59.6 million, or 23.1%, to $317.8 million in first six months of 2008, from $258.2 million in the first half of last year.
Approximately $43.4 million, or 16.8 percentage points of increased long-term care service revenues resulted from healthcare facilities acquired or developed after December 31st, 2006.
Revenue in our ancillary services segment increased $5.7 million, or 15.2%, to $43.3 million in the first six months of 2008 compared to $37.6 million in the first six month period last year. Approximately $4.2 million, or 11 percentage points of the increase in ancillary service revenues resulted from the acquisition of the two hospice businesses in New Mexico that we discussed earlier.
Adjusted earnings before interest, tax, depreciation, and amortization, or adjusted EBITDA, for the second quarter of 2008 was $28.9 million, an increase of $3.8 million, or 15.1%, compared to the second quarter of 2007. The primary drivers for the increase in EBITDA were $1.1 million, or 4.4 percentage points, from healthcare facilities acquired or developed after April 1, 2007; and $3.9 million, or 15.6 percentage points from facilities operated for both periods.
This was offset by approximately $1.2 million in growth for general and administrative expenses, leading causes of which were increased costs of being a public company as well as higher compensation costs.
Adjusted EBITDAR for the second quarter of 2008 was $33.3 million, an increase of $5.7 million, or 20.7%, compared to the second quarter of 2007.
Adjusted EBITDA for the first six months of 2008 was $57.4 million, an increase of $8.5 million, or 17.4%, compared to the same period in 2007.
Adjusted EBITDAR for the first six months of 2008 was $66.3 million, an increase of $12.2 million, or 22.6%, compared to last year.
Turning to our balance sheet and statement of cash flows, cash flows provided by operations were $26.7 million for the first six months of 2008 compared to $5.3 million in the same period last year. Additionally, we are continuing with a plan we announced during the first quarter call to collect accounts receivable more rapidly. We have improved our overall days service outstanding, DSO, down from 63.5 days to 56.1 days and project reducing DSOs down to the 50 to 55 day range by the end of 2008 provided there are no reimbursement freezes or delays.
To that end, we have collected the bulk of the backlog New Mexico Medicaid receivables that had been delayed and our acquisition of 10 New Mexico facilities (inaudible) 2007.
We recently learned that California medical [ph] payments would be suspended from July 24th, 2008 to September 11th , 2008, after which it will be reinstated. This delay equates to approximately $1.5 million per week of cash flow.
As of June 30th, 2008, we had approximately $466 million in aggregate indebtedness outstanding consisting of approximately $129 million of our 11% Senior Subordinated Notes, $252ppp million of our first lien senior secured term loan, which matures June 15th, 2012, and $80 million outstanding under our $135 million revolving line of credit, which matures on June 15th, 2010, and finally, capital leases and other debt of approximately $4 million. Furthermore, we had approximately $5 million outstanding lines of credit against our $135 million revolving credit facility, leaving approximately $50 million of additional borrowing capacity under our revolving lines.
Our debt today has a weighted average remaining duration of four years. Also at the end of the second quarter, our leverage ratio, defined under our senior lending arrangements, was $4.1 million, and our interest coverage was 3.1 times.
We are increasing our 2008 full year guidance, taking into account the newly announced Medicare rates that Boyd discussed earlier in the call. We expect full year 2008 revenue between $730 million and $740 million and net income per share, per diluted share that is, between $0.98 and $1.03. 2008 EBITDA is expected to be in the range of $118 million to $122 million and EBITDAR is expected to be in the range of $136 million to $140 million.
With that, I’d like to turn the call back to Boyd.
Boyd Hendrickson
Okay, thank you, Dev. And that will conclude our prepared remarks for today. Before we open up to Q&A I’d like to let everyone know that our management group that will be available for Q&A will include Jose Lynch, the President and Chief Operating Officer of the Company; Mark Wortley, the President of our Ancillary Services segment; and Roland Rapp, our General Counsel.
With that, operator, we are ready to go ahead and take questions.
Question-and-Answer Session
Operator
Thank you, sir. (Operator instructions) Our first question will come from the line of Frank Morgan of Jefferies and Company. Please proceed.
Frank Morgan – Jefferies & Co.
Good morning. A couple of questions. First, just curious if you could talk a little bit about – you mentioned California and the suspension of payments there, but I was hoping you could also give us a little update on the other states where you have, the Medicaid outlook in all the other states that you operate, maybe some color there. And then also a question on the – I know on an adjusted basis you had growth in your skilled mix year-over-year. It looks like it declined sequentially and I am curious if that was just normal seasonality, what was the cause there? Thanks.
Jose Lynch
Sure. On the – it’s Jose, Frank. How are you doing? On the California budget delay, we were – the cash had stopped here relatively quickly. We are optimistic in the next two to three months we should have it completely resolved. In regards to—
Frank Morgan – Jefferies & Co.
Just other states and–
Jose Lynch
Yes, in regards to – in regards to others states on Medicaid, we are looking good in all six states. I don’t think we have negative news in any of them. California, we are – assuming the budget gets passed, we are looking potentially at right around a 4 – little bit over a 4% increase effective August 1. Texas with the RUGs conversion from TILEs to RUGS, we are expecting right around 6% based on the information we have today. New Mexico, we are expecting some increased rates from some of our CHO [ph], change of ownership. When those get processed through we should see some nice increases there; and Missouri, a $6 in July; Kansas, about a percent increase; in Nevada, about 5.5 in July. So, we really don’t have any negative news in all our Medicaid programs. We are really excited about that.
On the Skilled mix quarter-over-quarter decline, I don’t think it’s anything – we are up quarter-over-quarter from prior year, a little bit diluted, obviously, when you look with New Mexico carved out. New Mexico only runs about currently 19% for the year. We took it at right around 15% or 16%. So that diluted the skilled mix, overall sequential quarter-over-quarter. It’s not unusual for us to see summer months slowing with elective surgeries down, hospital volumes down a bit in that so we – it’s not a huge surprise to us, that drop.
Boyd Hendrickson
You know for the last two or three years the first quarter has been our strong one and probably will continue that way in the future.
Frank Morgan – Jefferies & Co.
I got one more. Boyd, let me ask you one here. In terms of your thoughts about this deal in the house that will prevent binding arbitration agreements upon admissions, kind of what do you think about that? Do you utilize that and what do you think of the chances of something like that getting passed? And then finally, and I will hop off, just your take now that you have had a couple of quarters behind you with this New Mexico acquisition, what’s your appetite for more external growth? Thanks.
Boyd Hendrickson
Yes, I will take the growth and then I am going to let Roland Rapp take the one relative to the arbitration agreement. Yes, New Mexico is coming along very good. I think in the third and fourth quarter we will begin to open up Express Recovery Units down there. And I think we feel now that we have got our arms significantly around New Mexico and we are continuing to look for good growth opportunities. And will continue to remain in the geographic profile that we have talked about before where we are continuing to look east of the Mississippi – or west of the Mississippi. With that, I will let Roland talk about the arbitration agreement.
Roland Rapp
Frank, the arbitration agreements we use extensively in all six states. They are various state specific laws that we follow and some that we rely on federal laws as basic – to utilize an arbitration agreement. We have approximately 80% of our admissions due signed arbitration agreements. Our agreement is designed to be – both page called out to the patients or their family members so they are aware of the contents and what it means. There is an opt-out period and then – and they are not required a condition of admission, which is why the rate is somewhere around 80%. So the allegations that came out in the press related to the build-ups in congress both for congress currently, really don’t apply to our Company. It’s our belief, and I participate with the American healthcare in the lobbying effort to try and defeat the bill, that once the information related to the actual use of arbitration agreements by our peers and ourselves, once we are effective in informing congress of what the actual use is, we think that the bill will either get significantly modified or drop entirely. So I don’t see – I think it’s unlikely. Anything is possible, of course, with our congress, but I don’t see it being – likely it will come out in its current form.
Frank Morgan – Jefferies & Co.
Okay, thank you.
Operator
Our next question will come from the line of Rob Mains of Morgan, Keegan. Please proceed.
Robert Mains – Morgan, Keegan & Co.
Good morning, good afternoon.
Boyd Hendrickson
Good morning, Rob.
Robert Mains – Morgan, Keegan & Co.
Afternoon out here. Just to build on Frank’s question about the seasonality, because I think you guys had a little bit more than what some of us are used to seeing in this sector. You also had though pretty nice sequential increases in your Medicare and managed care per diems. Is that a reflection of acuity, is there something that happened specifically with pricing in the managed care side in the quarter?
Jose Lynch
Yes, on the sequential – I mean a little bit more about the volume drops and skilled mix. I mean we obviously run quarter of our patients in that area. So any slight drop in volumes or physicians on vacations or elective surgery patients not electing for surgery will drop that. Any – we, quarter-over-quarter were about – were a tad down on new admits, about seven patients down per day. So that drove most of that. That’s just typical in these months.
In regards to the rate, the rate growth, renegotiating a managed care contract, adding new managed care contracts. On the Medicare side, the upper nine helping to drive it, but there is other components of the Medicare program in regards to the utilization of rehab RUGs in that – that we are running in excess of 90%. I think it’s also continuing to drive that. Quarter-over-quarter, that’s a jump in rehab utilization in the RUGs of about three percentage points. So that’s helping drive most of the Medicare rate (inaudible).
Robert Mains – Morgan, Keegan & Co.
So that sounds like something you don’t give up going forward.
Jose Lynch
Correct.
Robert Mains – Morgan, Keegan & Co.
Okay. And if I read it right in the Q, the seasonal shift that we saw in the second quarter could be a little bit – do we see the same thing in the third quarter effectively and the bounce it back in the fourth quarter.
Jose Lynch
Historically we have seen that trend.
Robert Mains – Morgan, Keegan & Co.
Okay. And I will jump off. I have got couple of (inaudible).
Operator
Our next question will come from the line of Ralph Giacobbe of Credit Suisse. Please proceed.
Ralph Giacobbe – Credit Suisse
Great. Thanks. Just a couple of questions. Last quarter I think the expected number of the ERUs is 55 and did I hear right, it’s now 53 and if that’s the case is it just timing or I guess what’s changed.
Jose Lynch
Yes, the timing on a California center that was putting two units in it and it’s some of the building code out here in California it’s not going to happen until the first or second quarter in 2009 that particular facility.
Ralph Giacobbe – Credit Suisse
Okay. And then can you maybe just talk about the general increases in commodity and food costs? Any impact to margins for you all?
Jose Lynch
Yes, in the last couple of quarters we had that question and really there was not a whole lot of increases outside of some food cost that we are seeing some impact on. We are starting to hear a lot more noise in regards to the cost of medical supplies and petroleum related disposable products that were seeing a lot of medical suppliers show increases in cost. So we are still chewing on it. We don’t know the exact impact to the Company, but we are starting to hear a little bit more about that today.
Ralph Giacobbe – Credit Suisse
Okay. And then I guess just on the other end of it, is the economy helping you all in terms of ability to maybe recruit and retain nurses and staff? I mean can you see that as visible at all?
Jose Lynch
You know we are starting to – it’s kind of a double-edged sword. We are starting to see additional access to lower wage earners and – but we also see a – sometimes we see a quicker revolving doors, folks that want to actually get into – become nursing assistant or a housekeeping assistant like to trial and find out they don’t want to do it. So we are starting to see more of that opportunity. On the other side, a lot of our professional staff will, because of the cost of gas and those things, will – are tending to jump for $0.10 in wage. So we are also battling that, sort of retaining our professional staff and a lot of our staff. So it’s kind of working both ways. We are not really seeing any softness in wage rates. I can let Mark talk about what’s happening in the therapy company.
Mark Wortley
Yes, we are seeing a similar effect on the therapy side where the therapist want to stay close to home in order to minimize their travel expenses, but our turnover has been stabilized over the first half of the year. So, I am not seeing any big impact from another – I just want to stay close to home.
Ralph Giacobbe – Credit Suisse
Okay. And just to be clear, in terms of the rate, the guidance, and the outlook for the second half, does that incorporate some of these or are you hoping that you can sort of offset these increased costs?
Mark Wortley
I think it’s considering pretty much constant growth that we have been running, so right around the 5% wage rate growth.
Ralph Giacobbe – Credit Suisse
Okay, great. Thank you.
Operator
Our next question will come from the line of Donald Hooker of UBS. Please proceed.
Donald Hooker – UBS
Great, good afternoon from the East Coast. Yes, another data point just to kind of help us kind of understand the model a little bit, the occupancy, which I know there are seasonal effects and what not, and I know you acquired up some properties in Kansas and you mentioned in some prior calls that there are some competition in I guess Missouri and Texas and I am sort of trying to summarize what I think I know. How is the occupancy going to trend out? I know – I was kind of hoping that that might sort to trend up over the next few quarters. Am I a bit too optimistic or how do you see that?
Jose Lynch
Yes, I mean we are optimistic that it’s – we have – that’s probably one of our biggest opportunities in the Company is grow occupancy right around 84%. Most of our pressure markets continue to be Texas, Missouri – we had a slight dip in New Mexico this quarter, but with the tail end of summer coming we are hoping that those occupancies continue to trend up.
Donald Hooker – UBS
Is there a meaningful difference? I think in the prior calls you may not maybe happen to have the numbers off the tip of your fingertips, I mean a meaningful difference between occupancy – between the states like Texas versus Missouri versus California.
Jose Lynch
Yes, not really. Typically, the most meaningful difference typically is California. We have most of our properties in metro areas right around 87%-88%. A lot of the other facilities run in the – states run in the 81%-83% occupancy range, Texas – New Mexico typically runs 85%, they were down a bit. Nevada, we are starting to see nice occupancy growth there. So, led by California, followed closely by Nevada, Texas being at the bottom and New Mexico, Missouri, and Kansas not much higher than Texas.
Donald Hooker – UBS
And so is it possible for Texas to ever get to that California type level or (inaudible) get into the high 80s or–?
Jose Lynch
I don’t – I wouldn’t expect that in the next several years just because of – that’s the one market where there is really no barrier to the industry right now. There is no firm COM [ph] process in place where we are seeing new continued new builds in a lot of our markets. So that’s probably one of our most competitive markets. We don’t expect that to soften up much. We are trying to come up with some creative ideas in the state of Texas as well just to kind of offset that.
Donald Hooker – UBS
Okay, and I guess jumping to a different topic in terms of the Laurel Healthcare, you talk about – you give your skilled mix out between the (inaudible) company and Laurel and does that sort of converge and you sort of stop giving that statistic? When is that statistic, when does the difference there get sort of meaningless to analyze?
Boyd Hendrickson
I think after we have owned it for a year.
Donald Hooker – UBS
Okay.
Boyd Hendrickson
Probably we will do it one more time in the third quarter.
Donald Hooker – UBS
Got you.
Boyd Hendrickson
And I think that the skilled mix has improved down there from the time that we bought it.
Donald Hooker – UBS
Sure, yes.
Boyd Hendrickson
In the third and the fourth quarter I think we’ve got the Express Recovery Units that will be opening up and – so I think that after the third quarter where everything would be kind of relative going forward we will quit doing that.
Donald Hooker – UBS
Got you. Got you, okay, and I guess one last question and I will jump off. And again I don’t mean to pick at numbers too much, but it seems like the – and this maybe just quarter-to-quarter noise, but the percentage in the top nine RUG categories, it seems like it dipped a bit in the quarter. Is there any sort of general explanation to that? It seemed like it had been trending nicely for a number of quarters and it sort of dipped. I don’t know if you are heading sort of a natural limit there or is it just a blip in the numbers?
Boyd Hendrickson
I would like to look at one more quarter but sooner or later you are probably going to peak that out. We have been as high as in the 42 area—
Donald Hooker – UBS
Yes.
Boyd Hendrickson
I think somewhere between 40 and 42, 42.5 maybe where we peak out in that area, but here again I think Jose kind of alluded to a even a more meaningful number and that would be the number of people we have that fall into the category as being over 90%–
Donald Hooker – UBS
Sure.
Boyd Hendrickson
That has been a driver of the revenue improvement in the Medicare program.
Donald Hooker – UBS
Okay, well I will jump off. Thanks guys for the comments.
Operator
Our next question will come from the line James Bellessa of Davidson and Company. Please proceed.
James Bellessa – D. A. Davidson & Co.
Good morning. I have two questions. Are you seeing any copycats in the Express Recovery Unit business that you are developing? And then you have talked about in the press release new development activity. Would you elaborate there please?
Jose Lynch
Yes, on the copycat, yes, yes, and yes. And then on the new developments, we are – it’s going real good, actually. We are – we have one of our projects little bit over half way completed in Dallas. That project is coming along very, very nicely. But in our development sort of forecast we have about five to six properties that we are engaging and developing over the next several years. Right now we plan to continue that. We like the development and we have – we are putting these skilled nursing facilities next to hospital relationships that we have and we are doing a little bit of assisted living construction as well surrounding existing markets where we operate. So it’s – we are extremely optimistic on our developments. They are coming along as planned. The only project that’s a little bit slower is the project we have in Fort Worth, which we are now sort of underway and moving that forward as well..
Boyd Hendrickson
Yes, just one more comment on the copycat. I think that there are a number of companies doing that right now, but yet if you look at it market-by-market we are not finding a whole lot of direct competition. And we still feel like there is ample opportunity with the ones that we are continuing to create and will create through 2009 where we won't get a direct competitor that will be doing a like thing at the same time.
James Bellessa – D. A. Davidson & Co.
Got it.
Boyd Hendrickson
But other companies are doing it, which – if we hadn’t have been the innovator rebel, we probably would have copied it. It’s a great idea.
James Bellessa – D. A. Davidson & Co.
Thank you very much.
Jose Lynch
Thank you.
Operator
Our next question will come from the line of Steve Valiquette of UBS. Please proceed.
Steve Valiquette – UBS
Hi thanks for the name, I am sure that was the cute Internet. But just want to follow-up on the putting off of the proposed reimbursement cuts that did not show up in the final rule. It’s very lengthy document but was it your sense that or do you have any read on what you think might happen for the following fiscal year, 2010? Is this just putting it off by a year or do you have any read on that at this point, just give your thoughts on that?
Jose Lynch
Well, I think here again that we what we have said all along I think that the congress and legislators were all worried and concerned about the effect on the quality of care if in fact that convert to have happened. I think if you look at the delay, in all probably the same people will need to be there a year from now in CMS. But to take that one step further, if they go through it really do a full and take a full analytical approach on what’s happened, you got to believe that in fact overall the program is saving money. As you continue to move people into that higher nine RUG category, move them out to higher – out of a higher cost setting, the objective would be for the program as a whole to be able to do it cheaper at the end of the day and I think that we have been able to accomplish that. So I think that it – you can't be really – you can't put your head in the sand either, but I think that we have got ample time to get enough information to kind of turn it around. All they were doing is correcting an arithmetic error.
Steve Valiquette – UBS
Alright. Anyway I tried to stay it in their rhetoric though and final rule that the lower cost setting they have announced did not play a role but I guess it’s your sense that probably did play a role ultimately anyway—
Boyd Hendrickson
Absolutely. And you have to say something at the end of the day if you turned your – if you have done a 180.
Steve Valiquette – UBS
Yes, okay. Okay, that’s helpful. Thanks.
Operator
Our next question will come from the line of Adam Feinstein of Lehman Brothers. Please proceed.
Adam Feinstein – Lehman Brothers
Okay, thank you. Just a couple of questions here and I apologize, I jumped on the call a little bit late with a few calls going on at the same time. Just – I was wondering if you maybe comment a little bit about just the competitive landscape and just in terms of what you are seeing. Just curious in terms of your thought with the 75% rule getting relaxed with the rehab hospitals, have you seen rehab hospitals as bigger competitors? And just your thoughts in general in terms of just what’s going on with the space with a lot of the companies going private in the last couple of years and maybe access to capital drying up a little bit. Just curious in terms of what you are seeing in your core markets of California and Texas.
Jose Lynch
Yes, the competitiveness – in California, I think more folks are going after the Medicare, managed care patients. Now I think that’s something that will allow folks to try to work on a little bit more aggressively. So, in California there is really probably three new builds in the last two or three years in the whole state. So, we are not – the competition on new builds is not a concern. Texas is continuously a concern with about three or four of our markets still having new building (inaudible) up. The 75% rule or the 65% rules, I don’t think it’s really impacting us although we are starting to see the urge – get a little bit more creative. Some – a lot more physician joint venture operations in certain markets where they may in some small markets looking at skilled nursing beds coupled with ER beds. So we are looking really, really closely at a model like that. But right now on the – the falling admissions from us, we are really not seeing that. I think we are hearing a lot more or the ERs are getting looked at a little bit more closely on their admission patterns as well. So – but again, it’s probably the most competitive ER market we operate in is Texas right now.
Adam Feinstein – Lehman Brothers
Okay, and just a follow-up question. You mentioned Medicare Advantage. Just curious in terms of – your thoughts there in terms of how you think about the growth for that business and just in terms of signing new contracts. Also just as that business continues to grow, just curious in terms of what sort of discussions you are having with managed care players?
Jose Lynch
Yes, we have a – we are continuing to be real optimistic on managed care players. We believe that if you don’t continue to be optimistic that you will lose it. So we cater to it, we are constantly out presenting our Express Recovery models, our rehab lengths of stay, our average length of stay. We are trying to (inaudible) percentages, so those are all the buzz words with managed care organizations. We are aggressively contracting with any player we can that has appropriate rates that we can live within. And just what the Uniteds of the world and those folks that are sort of taken over a lot of the market, we really have to keep our eye and our relationships with them. So I think we’ll continue to see that market penetrated and more of those sorts of Medicare enrollees enrolling in the managed care program.
Adam Feinstein – Lehman Brothers
Okay, and then just with respect to liability costs, I heard earlier in the call somebody asked the question just about what was going on there, just in terms of some of the legislation but – with respect to the arbitration there – but I was just curious in terms of the absolute trend there and just in terms of what’s going and just as you think about just your reserves there and everything else. So just want to get an update in terms of what liability cost?
Roland Rapp
Well, this is Roland, let me just comment first on the arbitration issue. We see it continuing to develop the way it has actually probably since we implemented the program in 2003 and pretty steady hovering between 80% and 90% acceptance on those admissions that is presented to. As I commented earlier, I don’t think the legislation as is currently proposed is very likely to get passed. That could change depending on the outcome of the Presidential election. But even there it’s an education process I think for us to communicate to congress on the administration on what’s actually happening rather than having legislation respond to a lot of hype in one-off situations. And I’ll let Dev comments on reserves.
Dev Ghose
Yes, in terms of the risk management side of it, we look at it very carefully. Once a quarter, we have actuarial analyses done and we track that in general. We are – it hasn’t changed very much over the last six months or so. So the results that we have in the balance sheet we deem are appropriate for all the liability claims that are either been put to us or in (inaudible) but not reported.
Adam Feinstein – Lehman Brothers
Okay, and then are you saying just based on the claims experience getting better for the industry, a lot of anecdotes about that, would you anticipate some of that maybe coming back into earnings over the next year?
Jose Lynch
We rely heavily on actuarial analysis and my understanding of that is they tend to be hopefully conservative in their evaluation. So, yes, to the extent that it’s a leading indicator, our statistics will surely lag.
Adam Feinstein – Lehman Brothers
Okay, great. Thank you very much.
Operator
(Operator instructions) Our next question is a follow-up from the line of Rob Mains of Morgan, Keegan.
Robert Mains – Morgan, Keegan & Co.
Thanks. Question about the segment breakdown that you provided in the Q where I saw there was a nice sequential increase in you long-term care EBITDA margin, but the ancillary margin went down quite a bit sequentially and year-over-year to like 13%. Is there anything particular going on in ancillary, is that a seasonal issue or what was the reason for this low margins there?
Dev Ghose
Rob, I will comment on it briefly and then turn it over to Mark. Some of that has to do with right-sizing reserves against accounts receivable. We go through an elaborate aging process and we elected to take a little bit more in that area.
Mark Wortley
Right, so, if we normalize the performance, it was up about one or two basis points quarter-over-quarter adjusted for that bad debt reserve that Dev just spoke about.
Dev Ghose
In relative terms, we see the margins remaining pretty level between the two business lines that comprise the ancillary business segment.
Robert Mains – Morgan, Keegan & Co.
Okay, so for modeling purposes I should look more at the first quarter than a mid-point between the two? You were 16.7% in Q1 and 12.9% in Q2. Is the right answer (inaudible).
Dev Ghose
I see the margin is on average 14.5% area in Q1 and so adjusting for the bad debts, we are – I think we are very, very close.
Robert Mains – Morgan, Keegan & Co.
Okay, alright. So about the mid-point.
Dev Ghose
Around the 14.5% area.
Robert Mains – Morgan, Keegan & Co.
Right, okay, fair enough. And did I hear you right that if there is not legislative relief in California you could receivables slide in the fourth quarter?
Dev Ghose
For now what we know based on the circular that we received is that payments would be suspended from the July 24th period to early September and there is every expectation certainly based on prior years that that gets caught up over time.
Robert Mains – Morgan, Keegan & Co.
Okay, I thought you had said November. Okay, September. (inaudible) third quarter.
Boyd Hendrickson
It will get cleaned up as soon as we get a budget in the state of California.
Robert Mains – Morgan, Keegan & Co.
Right.
Boyd Hendrickson
And if you were a predictor, you may want to – I think that we’ll have a budget sometime around the 22nd of August. That would be when all the democrats have to go to the Democratic Convention, so they are going to want to be out of here.
Robert Mains – Morgan, Keegan & Co.
Okay. So (inaudible) get payments now.
Boyd Hendrickson
That’s only a guess, but yes we won't get – the payments could be suspended as long as we don’t have budget for the—
Roland Rapp
Yes, but the other aspects that’s probably worth considering is the delay in getting the new rate (inaudible) rates under AB1629 in California are effective August 1, but it takes a while to get the rates calculated and set into the system and we have seen those get implanted as late as November I think one year, the first year took until almost January getting them all plugged into the system and paid to us.
Boyd Hendrickson
But we still remain getting paid at the old rate.
Roland Rapp
Yes, yes, right. We get paid at the old rate but we—
Boyd Hendrickson
We are getting cash relief—
Roland Rapp
We accrue a deferral on the revenue because we should be able to get rate letters much earlier than they start paying typically.
Robert Mains – Morgan, Keegan & Co.
Very good. Okay, thanks a lot.
Jose Lynch
Thank you.
Operator
Ladies and gentlemen, this concluded the question-and-answer portion of today’s conference. I will turn the call back to management for any closing remarks.
Boyd Hendrickson
No, we just like to thank everybody for participating and we’ll be back next quarter. Have a good day.
Operator
Thank you for your participation. You may now disconnect. Have a great day.
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