Good morning, and thank you for joining us today for Select Medical Holdings Corporation Earnings Conference Call to discuss the second quarter 2012 results and the company's business outlook. Speaking today are the company's CEO, Robert Ortenzio; and the company's Executive Vice President and Chief Financial Officer, Martin Jackson. [Operator Instructions] 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 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 Mr. Robert Ortenzio. You have the floor, sir.

Thank you, operator. Good morning, everyone, and thank you for joining us for Select Medical Holdings Second Quarter Earnings Conference Call for 2012. For our prepared remarks, I'll provide some overall highlights for the company and our operating division. And then I'll ask Marty Jackson, our Chief Financial Officer, to provide some additional financial details before opening the call for questions. Earnings per fully diluted share increased to $0.31 in the second quarter compared to our reported earnings of $0.08 a share in the same quarter last year, and adjusted earnings per fully diluted share of $0.20, excluding the loss on early retirement of debt and related tax effect from the refinancing we completed in June 1, 2011. Net revenue for the second quarter increased 7.4% to $750.2 million compared to the same quarter last year. During the quarter, we generated approximately 74% of our revenues from our Specialty Hospital segment, which includes both our long-term acute care and inpatient rehab hospitals and 26% from our Outpatient Rehabilitation segment, which includes both our outpatient clinics and contract services. Net revenue in our Specialty Hospitals for the second quarter increased 7.1% to $557.1 million compared to the same quarter last year. The increase was driven primarily by increases in patient volumes, increases in non-Medicare rates and revenue from contracted labor services provided to the Baylor joint venture during the quarter. Our patient days in the second quarter increased 2.8% to 336,016 days and overall occupancy rates were 71% in the second quarter compared to 70% in the same quarter last year. Specialty Hospital net revenue per patient day increased 3.3% to $1,554 in the second quarter compared to $1,505 per patient day in the same quarter last year. The increase in net revenue per patient day was driven primarily by an…

Thanks, Bob. Good morning. For the second quarter, our operating expenses, which include our cost of service, general and administrative costs and bad debt expense increased 6.9% to $641.3 million compared to the same quarter last year. As a percentage of our net revenue, operating expenses for the quarter decreased 30 basis points to 85.5% compared to 85.8% in the same quarter last year. Costs of services, a major component of which is labor were $612.7 million in the second-quarter. As a percent of net revenue, cost of services was 81.7% for the second quarter. This compares to 81.5% in the same quarter last year. The increase in cost of services as a percentage of net operating revenue resulted primarily from increased relative labor cost in our Outpatient Rehabilitation segment. This increase in relative labor cost resulted from the increased labor costs associated with the Baylor JV services agreement, increased staffing in our rehabilitation clinics and lower productivity in our contract services business. A cost associated with contracted labor services provided to the Baylor JV in both of our business segments had a 70-basis point negative impact on our cost of services in the quarter. Excluding these costs, cost of services would've been 81% in the quarter compared to 81.1% in the same quarter last year. G&A expense was $18.6 million in the second quarter which as a percentage net revenue was 2.5% compared to $16.1 million or 2.3% of revenue for the same quarter last year. The primary reason for the increase in G&A is associated with the write-offs of cost associated with the senior note offering we withdrew from during the quarter and increased executive compensation. Bad debt as a percentage of net revenue was 1.3% for the second quarter compared to 2% for the same quarter last…

[Operator Instructions] Our first question comes from the line of Frank Morgan with RBC Capital.

Just 2 nitpicks, and then I want to ask a bigger picture question. The tax rate and the run rate on equity income in the second quarter, is that a good rate for the second half of the year?

Yes, Frank, it is.

Okay. And then I guess a bigger -- a couple of bigger picture questions. I mean, obviously a great quarter, the business is doing very well. But I'm just curious, given the -- what appears to be the political and budgetary headwinds in front of us, strategically, what do you really want to do over the next couple of quarters as you work your way through these uncertainties? Is it -- I mean, are you actually willing to commit new capital, put new capital to work or is it mainly just sort of minding what you have right now? And then secondly, also on the same line of questioning, just kind of your thoughts on the whole patient criteria. It seems like that's coming back to the light of day again. And how do you think about -- assess the odds of that happening this time, and does that, along with the political and budgetary issues, does that influence what you do from a strategic standpoint in the near-term?

Frank, this is Bob. Two good questions. Let me address the first one which is, how we're thinking about strategy and particularly allocation of capital over the next couple of quarters. I think our general view right now is that, probably, not a great time to commit capital to any, what I consider probably, large or platform acquisitions at this time just because we do have the uncertainty going in to the election. We do have the moratorium going off of the -- for the LTAC at least at this point through the CMS reg. If you look at our history, we typically -- in terms of the allocation of capital, really try to take what the market is giving to us. You heard from Marty's comments over the last year plus, we've used a lot of capital to buy back stock at very attractive rates. And so that's one opportunity. The second opportunity is obviously to pay back debt, if that becomes a good opportunity for us. And then the third is acquisitions. And as I said, we are always looking and I think the opportunity may be one-off for smaller acquisitions in markets we want to expand. But over the next couple of quarters, I wouldn't look for us to make any kind of a big move in either of our business segments. As to your second question which is the patient facility criteria. As you know, and I think most people who follow the company know the -- we continue to work with the American Hospital Association and probably up to -- probably a dozen U.S. senators on the certification criteria for LTAC hospitals. And we've always been big supporters of the creation of those federal standards which just tightened up the criteria for LTACs somewhat. I always get questions about what are the prospects of that moving, because we've actually been attempting to do that for a couple of years now. And I think one of the things that has helped was the recent CMS rule, because in the final regulations, they did impose over a couple of year period the budget-neutrality adjustment. This is a big overhang on the industry. And I think that now that, that has passed us and it's taken cared of through the CMS rule, I think it actually makes the passage of criteria, perhaps, somewhat easier because we can have a bill that hopefully scores better without the overhang and the weight of the budget-neutrality adjustment which was always prohibited in the LTAC legislation of 2007 and in the extension in 2010. So we'll continue to support the AHA's efforts and hopefully what was the Roberts-Nelson bill and try to get that -- get some consensus on that and move it forward. I mean, it got to be a very important step for the industry. Is that responsive to your question, do you have any follow-ons?

Yes. I would just say, one, is -- of these things between election, budget issues and the criteria, is one of them more important than the other in terms of you making the move to more aggressive move growing the business again or allocating capital?

Yes. I always think that the LTAC-specific regulatory environment is probably the most important thing. So we don't know if there's going to be an opportunity to see this legislation get traction before the end of the year. As you know, there's no lame duck session or perhaps something needs to be done and perhaps that will be an opportunity, and we'll work and support AHA and try to move something. So I think that, that's monumentally important because if that can happen near the end of this year or sometime in the -- in next year, I think that really gives a lot of clarity to the industry and would really make me feel a lot more comfortable about committing the capital. And we have a lot of other things that we can focus on now in the interim while that -- maybe we get some more clarity on that. Our rehab joint ventures and our Outpatient business and -- are still good opportunities for us for growth. And we may have the opportunity to add to some of our -- add some beds to some of our hospitals that have been running full for the last couple of years while the moratorium was in place.

Our next question and comes from the line of A.J. Rice with UBS.

Just maybe make sure I'm understanding what you just answered to Frank's question there. I know you said no big acquisitions, are you saying development-wise other than adding capacity, with the moratorium expiring at the end of the year you're probably going to go slow on opening new LTACs? And I guess we've been in the moratorium for so long, I wonder if you had -- do you have plans on the drawing board for facilities that just haven't been able to pursue over the last 5 years or you're pretty much starting from scratch on that development side?

Yes, A.J. I think that you probably shouldn't look for us to commit a lot of capital toward the development of new LTAC hospitals. Those hospitals, if they were to be developed after January 1, would have to comply with the full 25% rule. So you still -- the 25% rule has only been extended for 1 year. So there's still some uncertainty around that. Now we do have opportunities to -- I think to increase bed complement at existing hospitals. And we are looking at those hospitals that have run pretty much full occupancy to see if there's opportunity from the real estate standpoint to add beds. We do have a number of our hospitals that enjoy relatively full occupancy with waiting lists. So that to us is probably the best opportunity for some growth through the middle or latter part of next year which really -- we can get started, we really can't do anything until January 1.

Right. Can you just comment a little bit, maybe an update on the Baylor JV. It looks like from the line item that, that must be doing pretty well at this point. And then, I know there's been on-again, off-again discussions about potentially other JVs, as the uncertainty that you're alluding to certainly seems to have picked up the amount of deals in the acute-care side, has it had any impact on people being more willing to work with you potentially on JVs?

Well yes, the first part of your question which is the Baylor JV, yes, I think that we could not be more pleased with how the Baylor JV has worked. And I updated to the class -- for first quarter's conference call that we added 2 rehab hospitals to that JV through the acquisition of the global rehab hospitals, one in Dallas and one in Fort Worth. So the Baylor JV now has 4 free-standing rehab hospitals as part of the JV. So yes, we're pleased and we really view that as very much a model of joint ventures that we could do. And so your second part of your question which was, do we see opportunities for joint ventures? We do, very much. And the joint ventures that we've done and the ones that we're looking at are primary -- and I'll say primarily rehab, inpatient and outpatient rehab. They may from time to time include LTACs, but primarily they're rehab joint ventures in the post-acute. And we do see receptivities of systems and interested in having discussions and we're having discussions. As I've said in the past, I'm not pleased with the speed of which we've been able to add those. But I am not unhappy with the joint ventures we've already done or the level of dialogue that we're having with some good systems. But we do need to get some of those brought across the finish line. And we -- and I certainly would commit capital and we are committing efforts to do that.

Okay. Maybe just the last one then. On your -- when you think about capital deployment, you obviously been buying back stock in the first half. Is there any expectation baked in the guidance that you'll continue to buy stock in the second half? And more broadly, what are the priorities for use of the free cash flow looking at the second half and in the next year?

We never put -- we never factor in stock buybacks into our guidance. So the guidance that we have, the current guidance that we have like prior guidance does not make any assumptions with respect to stock buybacks. And we will be -- continue to be opportunistic on stock buybacks at the direction and counsel with our Board of Directors. The other opportunities for capital allocations very much on joint ventures, I think that, that would be probably the #1 priority for us in allocation of capital. And then the other ones that I mentioned whether it would be stock buybacks or debt repayments.

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

You mentioned a Medicaid bonus payment in the quarter? How much was that.

Yes, Kevin. The Medicaid bonus payment was about $6.8 million. Now a good portion of that was associated with that quarter. I think it's fair to say, if we took a look at moving out the prior quarter adjustment, the revenue per patient day rate would still be in the mid-2% range, 2.5% range. As opposed to the 3.3%.

And so this is something that is going to also be kind of now more in the run rate, you're saying, going forward as well?

Yes.

Okay. And then you mentioned also that the margin in the LTAC business or the hospital business improved because of the improvement in Regency. Can you give us an update on what happened there?

Yes. Along the same lines, I think, it's also fair to say that the Regency margins are now comparable to our Select LTAC legacy margins.

Okay. And then as I think about that kind of 18% margin in the hospital business, that's getting pretty close to what we've kind of -- what we normally think of as kind of normalized margins. Where do you think that those margins can go over time and what's the opportunity to continue to move them up?

That's a $64,000 question, Kevin. I mean, the fact of the matter is we've got sequestration that we're still trying to understand exactly how that's going to happen come next year. Obviously, we've got the 1.25% B&A hit that we're going to have next year. So right now our focus is to try to make sure that we keep those margins. But come next year, I'm not so sure we're going to see any type of improvement in those margins.

Okay. I think that's fair. And how do you guys think about the guidance raised? Because you beat Q1 by $0.07 as we have saw it and then you beat Q2 by $0.07. Are you kind of updating the guidance basically for the first half of the year results and if so, is there something in the second half of the year where you kind of feel like there's little bit more of a headwind, or how did you think about the update?

Yes, I think what we've done is exactly as you said. I mean, we've taken a look at what we've actually done in the first half and assumed basically the guidance that was out there in the 2nd half. And added those 2 together, and then took a look at what -- where we -- what type of stock we've actually purchased back to make adjustments on the EPS line.

Okay. I think that makes sense. And then last question, maybe just to go back to Frank's point -- question earlier about the run rate on the equity earnings and even I guess the minority interest line. I guess, the last couple of quarters you've talked about some higher costs on the new contacts and costs associated with the Baylor joint venture. Are those now at normalized rates so that -- I guess, kind of this is the last couple of quarters,you're kind of ramping up the margins on Baylor, but if you're saying that the Q2 run rate on equity is kind of the right run rate, we're kind of at a normalized margin there. That's first and then second on the minority interest line, can you remind me what assets are in those numbers? Because that numbers are also ramping up nicely. Is that going to continue, or is that kind of reached the equilibrium as well?

Well, I think to the extent that we didn't grow the business any further, I think you could probably say it's pretty close to where you can assume it would be the same going forward. But the fact of the matter is, we're constantly taking a look to add additional business to the Baylor JV as well as our other JV partners. So from that perspective I think you can expect to see it continue. Now the margin may change because as we acquire new businesses, the margin may be less when we acquired them and then we -- the operators do their work and we are able to improve those margins.

Our next question comes line of Gary Lieberman with Wells Fargo Securities.

This is Ryan Halsted on for Gary. I guess, just my first question, any update on acuity. I think you said last quarter, you saw some shift in acuity. I was curious of that, if you saw a rebound or if that continued?.

Yes, Ryan. This quarter was very similar to what we saw in the first quarter, so it was relatively flat.

Okay. And I guess also last quarter, you mentioned some pressure on your salary line. I guess, based on the acuity shift and -- was there -- were you able to adjust your staffing appropriately? It looked like labor was down a lot, I guess, as a percent of revenue.

Yes, we did see improvement in the second quarter.

Okay, great. I guess then as far as integrated care, have you guys approached CMS about participating in any demos? Or how are you guys thinking about -- or have you began thinking more about your position in that?

Well, we're -- like a lot of providers, we're monitoring it and we're trying to position ourselves in all of our various markets to make sure that whatever takes hold is something that we can obviously participate in. And when I think about that, I look at really at an individual markets. So I obviously think we're very well-positioned in Central Pennsylvania, in Dallas-Fort Worth and St. Louis where we have joint ventures. I also think about our positioning being pretty good in most of our hospital within hospital markets because we have smaller hospitals and we're close with general acute care hospitals, which will have to, one way or another lead the initiatives with whatever kind of final models take hold. I'm not convinced that there will going to have a single model that will apply equally across all markets. I think you can see kind of different caps in different markets. So we really think about it on a market by market basis and not a kind of a global basis.

Okay. And I guess, just following along with that, I mean, it seems like maybe some of the initial demos are even targeting specific subsets of patients. Is that sort of how you're seeing things and do you anticipate it's going -- I guess, is it going to sort of continue along in sort of a slow ramp, initial ramp? Or is there going to be sort of greater aspirations with integrated care and bundle as far as post-acute?

My own view is that this will be slow and incremental and some of the things that are being looked at, perhaps, in demonstration projects will not get legs and others may. And there may be some that take hold that even at this moment are not visible to us. And it's not entirely clear to me that in the future this necessarily has to be led exclusively by the government. And you're going to see providers and perhaps in some markets taking the lead themselves and working on unique models with commercial insurance and managed care.

Our next question comes from the line of Whit Mayo with Robert Baird.

Marty, looking at the hospital operating cost per patient day in the quarter, based on my rough math, it looks like you saw an increase maybe 3% sequentially and I think that may be a normal, seasonal pattern. But is there anything else playing a role there, mix? Just wondering if you think those operating costs kind of flatten out for the rest of the year?

Yes, Whit, the only other thing you have playing in there is those -- we've talked about the pass-through from Baylor. I mean, that's what you'll see there. You'll see that increased costs associated without any additional revenue. So it's really a 0 margin business.

What is that passed-through cost, can you remind me?

Yes, it's -- for the quarter it was about $19 million.

Okay, that's helpful. Does that number get larger, or kind of stay the same for the rest of the year? Is that kind of a normalized number to think about?

Well, I think based on the business that we currently have, if we didn't grow the business, I think that, that's probably a pretty good number. But our expectation is we expect to continue to grow the business.

And back on the Medicaid bonus payment for a second, was there an associated expense with that revenue at all?

No, there was not.

Okay. And on the contact management business -- I think it was contract management, you highlighted I think lower margins, may be higher labor cost, loss of productivity on some businesses. Does that get any better anytime soon or do you think that takes a little while to really begin to see the productivity and efficiency improved?

Yes. What we've heard from the operators, it typically -- this -- we had large contract at the end of last year. It typically takes 9 to 12 months to kind of make sure you fine tune your staffing patterns and just the logistics. So we anticipate that probably starting next year, we'll see some improvement on the margins there.

Okay. And last question I had was just, I may have missed this, but payer mix, did you give that for the quarter? I don't know if you have it handy or not.

I think we did give it for the quarter. I don't think we've seen too much of a change there. Let me see. Whit, why don't I get back to you on that.

Our next question comes from the line of Walter Branson with Regiment Capital.

Just a couple of things. I want to make sure I understand your comments about the impact of the 2013 fiscal update on you versus CMS' estimates. Correct me if I'm wrong, but I believe CMS has estimated the total payment sales tax will increase by 1.7% for the fiscal year including the impact of the budget neutrality adjustment. And you're estimating a 1.4% increase starting this October 1, which falls to 0 -- affectively 0 at the start of 2013 when the budget neutrality adjustment kicks in. Do I have those numbers right?

Walter, CMS is -- the 1.7% is before B&A.

Oh, it is? Okay. And is your -- your number the 1.4% fall into 0, does that include the high cost and the high-cost outlier changes?

Yes, that's everything included.

Our next question comes from line of Miles Highsmith with RBC Capital.

Marty, can you just update us on where your RP [ph] capacity stands at quarter-and?

Yes, Miles, I don't have that in front of me. I'd have to -- I'll get back to you on that.

That's fine. I think it's around 350 last quarter. I assume as the share repurchases nothing really moved that much in the net income you generated?

Yes, I don't think it's-- I think that's correct.

Ladies and gentlemen, since there are no further questions in queue, I would now like to turn the call over to Mr. Ortenzio for closing remarks.

No closing remarks other than to thank you for joining us for the review and we'll look forward to updating you again after the third quarter. Thank you very much.

Ladies and gentlemen, that concludes today's conference. Thank you for your participation. You may now disconnect. Have a wonderful day.