Select Medical Q2 2023 Earnings Call Transcript

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August 4, 2023

There are 7 speakers on the call.

Operator

Morning and thank you for joining us today for Select Medical Holdings Corporation's Earnings Conference Call to discuss the Q2 2023 results and the business company 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 of Martin Jackson. Management will give you an overview of the quarter and then the call will open for questions. Before we started, we would like to remind you that this conference may contain forward looking statements regarding future events or future financial performance of the company's, including without limitation statements regarding operational results, growth opportunities and other statements that purchase Select Medical's plans, expectations, strategies, intentions and beliefs. These forward looking statements are based on the information available to management of Select Medical today, and the company assumes no obligation to update these statements as circumstances change.

Operator

I would now like to turn the conference over to Mr. Robert Ortenzio. Please go ahead, sir.

Speaker 1

Thank you, operator. Good morning, everyone. Welcome to Select Medical's earnings call for the Q2 of 2023. Before providing detail on each of our 4 operating division. I'd like to provide some updates and commentary.

Speaker 1

As you are aware, we announced our preliminary estimate of certain financial results for the Q2 on July 19 in connection with plans to launch a refinancing of some of the company's debt. We completed our refinancing on July 31, and Marty Jackson will provide further details in his commentary. Sorry, I wanted to highlight that on August 1, U. S. News and World Report released its annual best hospitals list.

Speaker 1

I'm pleased to share with you that our Kessler Institute For Rehabilitation Hospital and 6 of our partnered inpatient rehab hospitals are ranked among the nation's best for 2023, 2024. Number 3, Kessler Institute For Rehabilitation. Number 21, California Rehab Institute number 22, Baylor Scott and White Institute For Rehabilitation Dallas number 34, Ohio Health Rehabilitation Hospital in Columbus number 38, Cleveland Clinic Rehabilitation Hospital, number 46, TriHealth Rehabilitation Hospital in Cincinnati and number 48, Banner Rehabilitation Hospital in Phoenix. This marks the 31st consecutive year that Kessler Institute has been named among the nation's best hospitals for rehabilitation and the 3rd year in a row for Baylor Scott and White Dallas and Ohio Health. This recognition is a testament to our teams and the attention to quality at each of these institutions.

Speaker 1

On the financial front, we had another strong quarter with all 4 of our operating divisions exceeding prior year revenue. Overall revenue grew 6% and adjusted EBITDA by 21% compared to prior year Q2. The full reinstatement of Medicare sequestration and CARES Act grant income received in Q2 prior year were headwinds when compared to prior year same quarter financial performance in the amounts of $4,800,000 for Medicare sequestration and $15,100,000 for CARES grant income. For the quarter, Total company adjusted EBITDA was $219,500,000 compared to $181,000,000 in the prior year. Our consolidated adjusted EBITDA margin was 13.1% for Q2 compared to 11.4% in the prior year.

Speaker 1

Excluding grant income and the Medicare sequestration impact of Q2 prior year, our prior year adjusted EBITDA was $161,100,000 with a 10.2% margin. Our critical illness recovery hospital division experienced the most significant increase in performance compared to prior year With a 2 27 percent increase in adjusted EBITDA along with an 8 point reduction in their salary, wages and benefit to revenue ratio. The CRH division SW and B to revenue ratio was 56.7%, which was within our target range of 55% to 57%, along with a $43,000,000 reduction in agency expenses compared to same quarter prior year. Consistent with last quarter, Marty Jackson will provide additional detail regarding Critical Wellness sustained labor improvements within his commentary. Grubhub Wellness had a lot of activity on the development front with 3 more openings this past quarter.

Speaker 1

In May, we opened 2 hospitals with joint venture partners located in Tucson, Arizona and Alexandria, Virginia. In June, we also acquired a 60 bed critical illness hospital in Richmond, Virginia. We incurred 5,100,000 and our new critical illness recovery hospitals this quarter. As previously mentioned, we have an agreement to open a critical illness recovery hospital for a distinct part rehabilitation unit in Chicago with our joint venture partner, Rush University System For Health in Q2 of 2024. There is also a strong pipeline of additional opportunities for growth that are under consideration.

Speaker 1

The inpatient rehab hospital division continued their strong performance exceeding prior year quarter revenue and adjusted EBITDA. As mentioned in Q1, the development pipeline remains strong with a 36 bed inpatient rehab hospital in Fort Wayne, Indiana expected to close in Q3 with our joint venture partner, CHS. Also, as previously noted, we have partnered with AtlantiCare to build a new rehabilitation hospital in Southern New Jersey. Contingent upon regulatory approval, the hospital will be called Bacharach Institute for rehab and is slated to open in either 2025 or 2026. The pipeline for growth is strong and we anticipate strong performance throughout this year.

Speaker 1

Concentra continued their exceptional performance exceeding prior year revenue, EBITDA and patient volume. During the quarter, Concentra completed two transactions. The acquisition of Holland MediCenter in Michigan included a standalone clinic location as well as a mobile unit used for episodic events, extending our footprint approximately 30 miles from Grand Rapids into nearby Holland, Michigan market. Incentra also acquired OneSource Occupational Medicine, transaction that resulted in a fold in of the practice into our nearby clinic located in Tulsa, Oklahoma. Accenture has 4 signed leases for new de novo locations that are expected to open in Q4 2023.

Speaker 1

Additionally, There's a strong pipeline of acquisition and de novos that are currently being evaluated. This quarter, our outpatient rehabilitation division surpassed prior year revenue and patient volume. Outpatient entered into a joint venture partnership with AtlantiCare in our South Jersey market contributing 13 clinics where we are the managing partner and majority owner. Division added 8 clinics this quarter via acquisitions and de novos. The pipeline for additional growth remains strong with 27 executed leases for de novo clinics, which are scheduled to open in the second half of twenty twenty three.

Speaker 1

There are also many additional opportunities for acquisitions and de novo development that are under consideration. At this point, I'll provide some further data points on each of our divisions. Critical Wellness Recovery Hospital division experienced increases of 5% of net revenue, 2% in occupancy rates and 2 27% in EBITDA for us extremely successful quarter. Our occupancy was 68%, up from 67%. Our case mix index decreased from prior year of 1.29 to 1.26%.

Speaker 1

Nursing agency rates decreased 31% and nursing agency utilization decreased 44% when compared to prior year Q2. Nursing agency rates decreased 7%, While nursing agency utilization remained consistent compared to Q1 2023. Orientation hours decreased 14% compared to prior year Q2, but increased 24% compared to Q1 2023 as we continue to add full time nurses. Nursing sign on and incentive bonus dollars decreased 35% from prior year Q2 and 25% from the prior sequential quarter. Our adjusted EBITDA margin was 11.4% for the quarter compared to 3.7% in the prior year Q2.

Speaker 1

Our positive reductions in labor contributed to the improvement in earned EBITDA margin. On the regulatory front this week, CMS issued the final LTAC rules for fiscal year 2024, which will be effective October 1 this year. The final rule includes a 3.6% increase in the federal base rate, which is higher than the proposed rule. The high cost outlier threshold increased by $21,355 which was much lower than the increase outlined in the proposed rule of 55,800 and 55,860. The MS LTACH DRG relative weight and expected length of stays were also updated in the final rule.

Speaker 1

Our inpatient rehab hospital division experienced a 5% increase in net revenue with patient volumes increasing 1% and our rate per patient day by 4%. Occupancy was 84% compared to 86% prior year. The adjusted EBITDA margin for inpatient rehab was 23% for Q2 compared to 21.8 percent in the prior year. Last week, CMS also issued the final inpatient rehab rules for fiscal 2024, which are effective October 1. Final rule includes a 3.7% increase to standard payment amount, which is higher than the 3.3 percent including the proposed rule.

Speaker 1

The high cost outlier threshold increased $2,103 which was slightly less than the 2,836 decrease in the proposed rule. The CMG relative weight and average length of stay values were also updated in the final rule. Concentra experienced an increase in 6% in net revenue driven by 2% increase in volume and a 6% increase in rate. Our work comp net revenue per visit increased by 2% and our employer services rate increased by 9%. Concentra's adjusted EBITDA margin was 21.5% for the quarter compared to 21% in the same quarter prior year.

Speaker 1

Our outpatient rehab division experienced an increase of 6% in net revenue, patient volumes increasing by 11%, offset by a decrease in rate from 103 net revenue per visit to 100 net revenue per visit compared to same quarter prior year. The increase in volume compared to prior year was spread amongst multiple markets was partially attributed to organizational initiatives focusing on improving clinical productivity via patient access. The decline in rate was due to decline in outpatient Medicare fee schedule, full implementation of Medicare sequestration, payer mix and variable discounts when compared to prior year. The outpatient division's EBITDA declined slightly by $751,000 compared to prior year, EBITDA margin was 10.8 percent this quarter versus 11.7% same quarter prior year. Earnings per fully diluted share were $0.61 for the Q2 compared to $0.43 per share in the same quarter prior year.

Speaker 1

In regards to our allocation deployment of capital, our Board of Directors declared a cash dividend of $0.125 payable on September 1, 2023 to shareholders of record as of the close of business on August 15, 2023. This past quarter, we did not repurchase shares under our board authorized share repurchase program will continue to evaluate stock repurchases, reduction of debt and development opportunities. This concludes my remarks. With that, I'll turn it over to Marty Jackson for some additional financial details before we open the call up for questions.

Speaker 2

Great. Thank you, Bob. Good morning, everyone. Consistent with the prior three quarters, I'd like to provide some additional details with the progress we continue to make regarding labor costs with Critical Inness Recovery Hospital division. This past quarter, we had a sequential reduction from Q1 to Q2 in our total RN agency costs And our RN agency rates, while utilization of agency remained consistent.

Speaker 2

The reductions we realized were 7% in the RN agency costs and 7% in the agency RN hourly rate from $83 down to $77 Our utilization of agency remained at 18% for the past three quarters. We experienced slight fluctuations in our agency rates and costs as the quarter progressed with the rate fluctuation from April June of 1% from $79 down to $78 and RN Agency costs of $7,900,000 in April, dollars 7,400,000 in May And $6,700,000 in June. Agency utilization was 19% in April May. This dropped to 17% in June. Other areas where we saw improvement compared to the sequential quarters were reductions of 25% in nursing sign on and incentive bonuses, While our hospital administrative SW and B remained relatively consistent with Q1.

Speaker 2

This quarter, we had an increase of orientation hours compared to compared sequentially to Q1 2023 of 24% and the hours remain relatively consistent during the quarter at an average of $40,000 per month. Overall, our SWNB to net revenue ratio increased slightly from Q1 to 56.7%, up from 56.3%, which is remaining within the targeted rate that we previously had communicated. Moving on to our financials. In Q2, equity and earnings of unconsolidated subsidiaries were $10,500,000 This compares to $6,200,000 in the same quarter prior year. Net income attributable to non controlling interest was $13,600,000 compared to $11,100,000 in the same quarter last year.

Speaker 2

Interest expense was $49,000,000 in the 2nd quarter. This compares to $41,100,000 in the same quarter prior year. The increase in interest expense was primarily attributable to an increase in the interest rates compared to Q2 of 2022. At the end of the quarter, we had $3,800,000,000 of debt outstanding and $101,200,000 of cash on the balance sheet. Our debt balance at the end of the quarter included $2,100,000,000 in term loans, dollars 345,000,000 in revolving loans, $1,200,000,000 in our 6.25 percent senior notes and $77,100,000 of other miscellaneous debt.

Speaker 2

We ended the quarter with net leverage of our senior secured credit agreement of 5.06x. As of June 30, we had close to $250,000,000 of availability on our revolver. As Bob previously noted, we completed A refinancing transaction on July 31st this year. We amended and extended our $2,100,000,000 Term Loan B Secured on loan with along with increasing our senior secured revolving credit facility $60,000,000 from $650,000,000 up to $710,000,000 Both the term loan and the revolver have been extended 2 years and will mature on March 6, 2027 with an early springing maturity of 90 days prior to the senior notes maturity, triggering more than $300,000,000 of senior notes remains outstanding at May 15, 2020 mix. The refinancing term loan is priced at silver plus 300 bps with a step down of 25 basis points if our net leverage ratio falls low 4 times.

Speaker 2

The revolver has been priced at sulfur plus It's important to note that the 1% SOFR interest rate cap on the $2,000,000,000 of our term loans will remain in place through September 30, 20 24, our $1,200,000,000 of 6.25 percent senior notes still mature on August 15, 2026. For the Q2, operating activities provided close to $235,000,000 in cash flow. Our day sales outstanding or DSO is 52 days at June 30, 'twenty three compared to 53 days June 30, 2020 2, 54 days as of March 31, 23. Investing activities used $66,800,000 of cash in the 2nd quarter. This includes $59,500,000 in purchases of property and equipment and $7,300,000 in acquisition and investment activity.

Speaker 2

Financing activities used 150 point $6,000,000 of cash for the 2nd quarter. We had $115,000,000 in net payments on our revolving line of credit, $14,300,000 of net payments on other debt and $15,900,000 in dividends on our common stock. As stated previously, we did not repurchase any shares under our Board authorized repurchase program this quarter. The program remains in effect until December 31, 'twenty three, unless further extended or earlier terminated by the Board. We are adjusting our business outlook for 2023 with expected revenue to be in the range of 6.55 $1,000,000,000 to $6,700,000,000 expected adjusted EBITDA in the range of $795,000,000 to $825,000,000 and a fully diluted earnings per share to be in the range of 1.77 to $1.94 Select Medical expects adjusted earnings per share to be in the range of 1.86 to $2.03 adjusted earnings per share excludes the loss of early retirement of debt and its related costs and tax effects.

Speaker 2

Capital expenditures are expected to be in the range of $190,000,000 to $210,000,000 for 20 3. This concludes our prepared remarks. And at this time, we'd like to turn it back over to the operator to open the call up for questions. Thank

Operator

Please wait for your name to be announced. Please stand by while we compile the Q and A roster. One moment for our first question please. Our first question comes from the line of Justin Bowers with Deutsche Bank. Your line is now open.

Speaker 3

Hi, good morning, everyone. Bob, just wanted to clarify one thing on the LTACs. Is that is the next De Novo or JV coming online in 2024? Or is there anything left in the rest of the year, this year?

Speaker 1

Just Rush is the one that we have that would be next based on deals that we've announced. So anything else that we would do that would be before that, we've not announced yet.

Speaker 3

Got it. And then just on outpatient, sort of given the landscape over the last So, is the plan for you guys sort of stay the course with your The JV approach and sort of building around your existing or is there any appetite to do something Yes, of greater scale.

Speaker 1

I would say at this point, there is no appetite to do anything on a broader scale. We feel really good about our opportunities for creation of value by adding incrementally in markets where we. We have a presence and also snapping outpatient on to our many joint venture agreements that are growing pretty rapidly. So I would say to you that we are probably not in a market for a bigger transaction in the outpatient space.

Speaker 3

Okay. Thanks. And Marty, healthy free cash flow generation in the first half, especially in 2Q. How are you guys thinking about CapEx in the second half? And then just given the attractive spread in T Bills versus the rate cap, How should we think about the deleveraging going forward through September 24?

Speaker 3

Is that just more of a function of The EBITDA growth or is there going to be some pay down too along the way?

Speaker 2

Yes, Justin. With regards to I mean, Bob had talked about the use of free cash flow. We anticipate that we will By the end of 'twenty four, that should completely be eliminated, any cash, any borrowings on that revolver. So, no, we will continue to pay down debt. So you can expect to see leverage come down not only from increased EBITDA, but also reduction of debt.

Speaker 3

Okay, understood. Yes, I'll hop back in queue. Thank you.

Operator

Thank you. One moment for our next question please. Question comes from the line of Ben Hendricks with RBC Capital Markets. Your line is now open.

Speaker 4

Thank you very much. Just a follow-up question on your LTACH final rule comments. We're definitely glad to see that outlier threshold come down from the proposal, It still seems like a pretty significant hike. How are you thinking about the financial impact of that to your critical illness segment from 3Q to 4Q and then into next year? Thank you.

Speaker 2

Yes, Ben. There's no doubt that that increase in the high cost outlier Number will have we will certainly have some headwinds there, but there are certainly ways to mitigate that and that's what we're focused on

Speaker 4

Okay. And then just overall, the rate increase, 3.5% or thereabouts, how does that translate you think for Select Medical specifically, kind

Speaker 1

of given your case mix?

Speaker 5

Thanks.

Speaker 2

Ben, could you clarify that question when you say how does it Yes.

Speaker 4

Just how the rate update, if you expect it to be any different for Select than the 3.5% finalized?

Speaker 2

No. We anticipate it will be in that neighborhood for us. You can expect to see increases for our Medicare Dollars increased by that percent. I think that's a good number to use in your model. I think you'll see better increases on the commercial side.

Speaker 2

I think we've been in that Negotiated rates, we've been in that 5 plus percent range. But with Medicare, I think it's 3.5% and then I think there is a deduct of about 0.2% for efficiency improvements.

Speaker 1

And as usual, Ben, these LTACs, because it's a complicated business, there's In these final rules, the aftermath of the final rules, there's a lot of give and takes in this. You have the high cost outlier threshold, which has an impact. You have the rate increase and then you have our mix of business, the case mix index And our percentage of respiratory cases and pulmonary, all of these have an effect on the business. So Post the rule and going into next year, we'll be taking a look at all of those to adjust all the levers that we have at our disposal to make sure that we can get some growth out of the segment.

Speaker 4

Got you. Thank you. And just quickly finally, do you expect the high cost outlier to drive any industry disruption that could create a consolidation opportunity for you guys?

Speaker 1

I do not.

Speaker 4

Okay. Thank you.

Operator

Thank you. One moment for our next question. The next question comes from the line of Kevin Fischbeck with Bank of America. Your line is now open.

Speaker 6

Great. Thanks. Maybe just to stay on Medicare rates. Do you have a similar comment On IRFs, what do you think the kind of net rate to you guys will be on the IRF rule?

Speaker 1

Yes. I mean, I think that we're pretty satisfied with the LTAC rule and or the rehab rule, and I We've got a little bit of a tailwind on the final rule there We're looking forward to Q4 and in the next year, Kevin.

Speaker 6

Okay. And then obviously a lot of progress on SWB. Wanted to get a sense from you guys where you thought you were in that progress. We all love baseball analogies. So like what inning are we on the improvement there?

Speaker 6

Is there much to go still from here? Or is this the right way to think about SWBO heading into 2024?

Speaker 2

Yes, Kevin. I think throughout the balance of the year, we'll be in that 55% to 57% range. Now we see that dropping down in 2024 and 2025. And the reason being, remember, we're not just focused on the cost here. I mean SWMB as a percentage of revenue has a revenue component to it.

Speaker 2

So Our commercial contracts are basically 3 years. The terms on those are 3 years. So we'll be negotiating increases In those, we're done about a third of our contracts now. So we'll be negotiating in 2024, 2025 For the balance of the contracts, we anticipate as we do that, we get decent increases there. We would expect to see SWNB as a percentage of revenue continue to come down through 2025.

Speaker 2

And Our focus is really to get it back to that historical rate of 52%.

Speaker 6

Okay. That's great. So When we think about that improvement though, you're saying that the improvement is less about further declines in bill rates or utilization per se and it's more about getting the top line growth to kind of match inflation?

Speaker 2

That's correct.

Speaker 6

Okay, great. And then maybe just last question. On the outpatient side, the rates being down, is that something that we should be modeling going into next year. I guess there's still another rehab rate cut, at least proposed, next year or is there anything kind of unusual Keith, you mentioned that payer mix is kind of in there. Is there a reason to believe that rates next year will be better than rates this year?

Speaker 2

Yes, there is. We anticipate that going into next year, we think it's going to rebound back to at least Be in that $102,000 $103 range.

Speaker 6

What's driving that?

Speaker 2

Again, contracts and improvements in some other in our in the CBO area.

Speaker 6

Okay. All right. Perfect. Thank you.

Operator

Thank you. One moment for our next question. Our next question comes from the line of A. J. Rice with Credit Suisse Financial.

Operator

Your line is now open.

Speaker 5

Hi, good morning. This is Anja on for A. J. So I wanted to ask about the larger volume trends that we're seeing. Your volumes, especially in IRFs and outpatient rehab are very strong.

Speaker 5

Do you see this as mostly deferred care flowing through the system or We see this more as more sustainable volume. Thank you.

Speaker 2

Yes. Could you repeat that question?

Speaker 6

Yes. You're

Speaker 1

not coming through very clearly.

Speaker 5

Yes. I was asking about whether the volume that you're seeing on IRFs as well as outpatient rehab, is it more The deferred care flowing through the system after the pandemic or is it more sustainable volume?

Speaker 1

I think the business on the if I'm understanding your question, I think the business in the IRFs and the outpatient is very sustainable in this If you characterize it as a post pandemic growth, I mean the business on the demand side in IRF and outpatient is very good. I mean for For a company like ours or others, I mean, it's just a question of navigating your local market and your competition and year rate negotiations, but I don't think in either of those businesses, it's necessarily there's no systemic volume issue.

Speaker 2

Yes, we don't really think that it's a function of pent up demand due to the pandemic. We think it's really We think we'll continue to see increases like this.

Speaker 1

Yes. There's lots of things that can affect it in local markets. For example, staffing challenges that large systems continue to have can oftentimes or sometimes affect their surgical volumes. And If surgical volumes, particularly on the orthopedic side, are impacted in a local market, we're going to certainly see some pull through negative on that. But Overall, when we look nationally, we see a return to a pretty strong business.

Speaker 1

That answer your question?

Speaker 5

Yes, got it. Thanks. Maybe one more on LTACH pricing. I think revenue per patient day was up 4.5 percent and sequestration should be a headwind and it seems like the QED mix stepped down as well. Why is the pricing going up and how does the back half of the year shake out?

Speaker 1

Well, I can tell you one thing on the acuity mix in the winter months when we tend to see more Pulmonary, the acuity mix will go up. I don't think you should look at the acuity, the case mix index reduction that we commented on as being any kind of systemic signal reduction in acuity of our patients. In fact, we continue to see increased acuity in our critical illness hospitals. So I mean, I think that will continue to remain strong. And as you know, there is some seasonality in our business.

Speaker 2

Yes. I think the other thing is, as you know, we're paid on a DRG. So to the extent that the length of stay goes down, which it did during the quarter, that's going to have a positive impact on the rate.

Speaker 5

Thank you.

Operator

Thank you. I am currently showing no further questions at this time. I'd like to hand the conference back over to Mr. Robert Ortenzio for closing remarks.

Speaker 1

Closing remarks. Thanks everybody for joining us and look forward to updating you again next quarter.

Operator

This concludes today's conference call. Thank you for your participation. You may now disconnect. Everyone have a wonderful

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