Earnings Call Transcript - MD Q2 2022

Operator, Operator

Thank you for joining us, and welcome to the Pediatrix Medical Group Second Quarter 2022 Earnings Conference Call. Your call is being recorded. I will now hand the call over to your host, Charles Lynch. Please continue.

Charles Lynch, Host

Thank you, Allen, and good morning, everyone. With me this morning are Mark Ordan, Chief Executive Officer, and Marc Richards, our Chief Financial Officer. I will quickly read our disclaimer and then turn the call over to Mark. Certain statements and information during this conference call may be deemed to be forward-looking statements within the meaning of the Federal Private Securities Litigation Reform Act of 1995. These forward-looking statements are based on assumptions and assessments made by Pediatrix' management in light of their experience and assessment of historical trends, current conditions, expected future developments, and other factors they believe to be appropriate. Any forward-looking statements made during this call are made as of today, and Pediatrix undertakes no duty to update or revise any such statements, whether as a result of new information, future events, or otherwise. Important factors that could cause actual results, developments, and business decisions to differ materially from forward-looking statements are described in the company's most recent annual report on Form 10-K, its quarterly reports on Form 10-Q, and its current reports on Form 8-K, including the sections entitled Risk Factors. In today's remarks by management, we will be discussing non-GAAP financial metrics. A reconciliation of these non-GAAP financial measures to the most comparable GAAP measures can be found in this morning's earnings press release, our quarterly reports on Form 10-Q, and our annual report on Form 10-K and on our website at www.pediatrix.com. With that, I'll turn the call over to Mark Ordan.

Mark Ordan, CEO

Thanks, Charlie. I'll comment this morning on three areas; our results for the quarter and how they play into our outlook for the year; our strategy and our name change to the Pediatrix Medical Group; and some thoughts on the No Surprises Act. We had mixed results in Q2. Patient volumes grew both in hospital-based and office-based services despite more difficult comparisons in the second quarter to what we faced in the first quarter. However, our revenue was impacted by both payer mix and our ongoing transition to R1 as our RCM partner. As a result, our adjusted EBITDA for the quarter was slightly below the expectations we shared on our last call with a differential primarily in revenue. We're pleased with our RCM function today, but in retrospect, the speed with which we transitioned from our internal team to R1 gave rise to a revenue impact that set back our Q1 results and to a lesser extent, our Q2 results. I want to stress that this impact, of which I speak, and which Marc will further detail is related only to our RCM transition and not to any change in pay relationships or behavior. We are pleased that today our day-to-day RCM function is substantially improved compared to the challenges we faced during this transition. By that I mean that our front-end activity is moving well, which is significant given that that area was meaningfully impacted in the early stages of this transition. Its impact should affect 2022 alone, and we see no effect therefore beyond this year. We are also still actively working to mitigate the effect on our 2022 P&L. On clinical labor, we reported in Q1 that we had not seen any material change in clinical labor costs but were certainly aware of the tough environment around us. In Q2, our clinical salary costs were roughly $3 million above our forecast. While this is a much smaller change in cost trend than what other providers have discussed, I'm calling it out only given the tough labor environment we're in. We continued to reduce overheads and generate efficiencies in our support services as part of our turnaround strategy. Our G&A expense declined significantly compared to last year and versus our internal projections, and we believe that we will continue to find enhanced operating efficiency without taking away from our dedication to care. We also saved significantly to our Q1 debt refinancing; interest expense was down more than half year-over-year, enabling 50% growth in adjusted EPS. And finally, our strong cash flow enabled us to fund the repurchase of 3.3 million of our shares, our CapEx and one acquisition without changing our debt levels. The confluence of all the factors I've described thus far leads us to expect that $270 million in adjusted EBITDA for 2022 does remain achievable, but we now point to a range of between $260 million and $270 million for the year. I'll turn to our growth and strategy. All of our efforts are focused on women's, children's, and baby's health, and on our amazing affiliated clinicians who provide care, as well as the research, education, and quality and safety improvements required to be the leaders in their vital field. On July 1, we formally changed our name to Pediatrix Medical Group to underscore this complete focus. Our move into a combination of pediatric primary and urgent care will help us serve this population much more broadly and effectively. I discussed last quarter that additions to our team under Dr. Jim Swift, our Chief Operating Officer, and we're now fully underway in our growth plan. Between now and the end of 2023, we anticipate we will expand from our current footprint of 21 clinics across three markets and two states to between 40 to 50 clinics across eight to ten markets in a half dozen states. We expect this growth will come from a combination of de novo clinic openings and acquisitions. We're also confident that we can fund this growth with internally generated cash flow and intend to execute in a fashion that will not dilute our adjusted EBITDA. On the No Surprises Act, as I mentioned earlier today, we haven't seen any notable change in payer behavior related to out-of-network cases; we are still waiting for HHS to finalize the tools, guidance, and details of the arbitration process. That said, we're certainly not sitting idle; our managed care team alongside our partners at R1 have built a really robust capability to manage this arbitration process in a thoughtful, data-driven way. Here again, we're much better prepared for this process than we could have been on our own. Before I turn the call to Marc, I want to thank our affiliated clinicians, our operators, and our support team for all their hard work and dedication to this organization. In my now two years at Pediatrix, I am really awestruck by what our people do for families across the nation.

Marc Richards, CFO

Thanks, Mark. Good morning, everyone. I'll focus my comments today on our revenue cycle management transition process, then add to Mark's comments on our outlook and financial position. At the top line, the decline in our same unit pricing was measurably less than we reported in Q1 when you exclude the contribution from CARES dollars in both periods. The revenue impact from the RCM related matters Mark discussed, which we bucket as a component of pricing, was less than half the magnitude of the first quarter. We are roughly $5 million. Payer mix, which can fluctuate quarter-to-quarter, represented a headwind in Q2 versus a modest tailwind in Q1. Looking at RCM, our transition to R1 created an increase in accounts receivable and related reserves, which unfavorably affected our revenue in the first quarter and to a lesser degree, the second quarter of this year. This accounts receivable buildup continued beyond March, followed by a significant improvement in cash collections towards the end of the quarter. The impact related to our private pay business not managed by R1 was negligible for the quarter and is a small component of the $5 million I referenced. All told, you'll see in our press release in our 10-Q filed this morning that both our gross and net accounts receivable declined modestly for the quarter and days sales outstanding came down by one day compared to March 31 to 58 days. We're certainly pleased with this direction, but days sales outstanding at quarter end are still higher than normal. As of today, we view our RCM activities as bifurcated. As Mark noted, we are now running normal billing and collecting activity related to current patient services. Separately, we're also working the more aged accounts receivable and will continue to do so through the remainder of the year. The pace and trajectory of this activity could represent a swing factor within our range of expected EBITDA for the year. For modeling purposes, our 2022 outlook reflects adjusted EBITDA in the first half of the year by $116.2 million. Additionally, within our outlook, we expect our adjusted EBITDA for the third quarter to increase in the mid-single digit percent range compared to $73 million in the third quarter of 2021. Lastly, we remain in a strong financial position. We generated $82 million in operating cash flow in the second quarter, up about $11 million year-over-year, funded $64 million in share repurchases, our normal CapEx, and a small practice acquisition. At quarter end, our total debt of $800 million was effectively unchanged from March 31, and our leverage based on trailing 12 adjusted EBITDA was just under three times. With that, I'll turn the call back over to Mark.

Mark Ordan, CEO

Thanks, Marc. We'll now open the call to any questions.

Operator, Operator

Our first question will come from Tao Qiu from Stifel.

Tao Qiu, Analyst

Hey, good morning. You mentioned that you saw some improvement in collection towards the end of the second quarter, and DSO is down one day in the second quarter, but still pretty much elevated. How fast do you think you can get the numbers down in the next few quarters?

Marc Richards, CFO

Hey, Tao, it's Marc Richards. How are you doing? I mean, that's certainly the goal here in the third and fourth quarter; we'd expect improvement through the third quarter and into the fourth quarter. As you know, historically, our days sales outstanding sit right around 50 days. So we still have work to do to shave that down to normal cycles, Tao.

Tao Qiu, Analyst

Got it. In terms of pricing, could you give us an update on what kind of rates you are seeing out there in terms of either Medicaid and commercial rates? I know that some states have increased their Medicaid rates; I think commercial payers are often more open to higher rate growth recovering inflation; any commentary you could provide would be much appreciated. Thank you.

Charles Lynch, Host

Hey, Tao, it's Charlie. I don't know that we saw anything in the quarter on the Medicaid side to call out. Our general expectation is something in the flat range, and that's generally how it came through. As Mark Ordan mentioned, we're still in effectively business as usual related to managed care renewals and contracting. And as I've said in the past, our general view related to overall same unit peer pricing, excluding the impacts of payer mix, or as we've seen in the first half of this year, some of the RCM matters, something in the modest range of 1% plus one to 2%. Digging through some of the impacts to our reported pricing this quarter, we're in that similar range.

Tao Qiu, Analyst

Got you. If I may, squeeze in one more. Congrats on the rebranding efforts. I remember that during the pandemic, there was a delay of this initiative due to cost concerns. What kind of G&A impact would this have on the second quarter? Any lingering impact in the second half you'd expect here?

Charles Lynch, Host

It actually had a very modest effect. If we had done so much of the work internally, we have a terrific head of marketing and a marketing team. We had made a lot of the changes. So the incremental expense to formally change the name was negligible and I think is really going to have a galvanizing effect on the organization.

Tao Qiu, Analyst

Got you. Thank you.

Operator, Operator

We'll go next to the line of Brian Tanquilut with Jefferies.

Brian Tanquilut, Analyst

Hey, good morning, guys. I guess Mark and Marc. Mark, just on the guidance, maybe without going into quarterly guidance, any color or qualitative comments you can make for us to consider as we model Q3?

Mark Ordan, CEO

Sure. We entered the quarter expecting that $270 million was the right figure. I believe that $270 million is within reach due to some significant challenges we faced during the transition from R1, which impacted our revenue. However, I view this cost as something incurred primarily in Q1 and somewhat in Q2, and we will assess how much we can recover from it. Our team has been working diligently to determine the outcome by the year's end. Additionally, the payer mix varied this quarter and had a negative impact on us. Therefore, we consider it more suitable to estimate a range of $260 million to $270 million. However, we cannot specify where we will land within that range, as our recovery from the transition efforts will greatly influence our final outcome.

Marc Richards, CFO

Brian, specific to your question on Q3, we expect quarter-over-quarter growth when looking back to Q3 of 2021 in the low single digits.

Brian Tanquilut, Analyst

Got it. Okay, that's very helpful. And then I guess, Mark, since you touched on payer mix. Do you think, are you seeing any signs that this is like the broader macro environment starting to show up in the payer mix? I mean, we saw this obviously during the last recession. So just curious what you're seeing maybe ahead of time?

Mark Ordan, CEO

No, we haven't. No, we're not seeing that. As a matter of fact, payer mix, and I know from other organizations, same thing; payer mix can really fluctuate a lot. And there is no pattern that we see that would indicate any shift or I would have called it out.

Brian Tanquilut, Analyst

All right, got it. Thank you.

Operator, Operator

We'll go next to the line of Kevin Fischbeck with Bank of America. Go ahead.

Kevin Fischbeck, Analyst

Great, thanks. So I think you mentioned a $10 million headwind in Q1 and $5 million in Q2 on the R1 transition. Is that $15 million kind of something that we should think about as potentially coming back in, and I guess in your guidance range? How to think about the high and the low end of that range? Are there other factors besides how much of that you're recouping?

Marc Richards, CFO

No, I would think of a component of that loss in the first half of the year; it's gone. Some of it, of course, is still recoverable and that's what we're parsing out right now.

Kevin Fischbeck, Analyst

There is uncertainty regarding the mix shift and whether there is labor pressure. How should we consider the situation, especially if we assume at least $270 million versus at least $260 million? What other significant factors should we take into account?

Mark Ordan, CEO

Labor is a relatively small factor. As I said, I called it out this time because I didn't want people to think that we're not focused on the fact that we're in a tough labor environment. We have a different labor mix than others do. So I think that other factors may hit us less. So the primary swing factors for 2022 that we see today are a combination of mix and what we can recover in the RCM transition process. Obviously, we don't forecast what is going to be, but we had solid gains in volume for the quarter. So all those things will determine where we are in that range.

Kevin Fischbeck, Analyst

Okay. But there's no change in your volume outlook, per se, from last year through the other factors?

Marc Richards, CFO

No.

Kevin Fischbeck, Analyst

And then on the labor side, you have a lot of different businesses. Would you say the labor is more difficult in any specific part of the business?

Mark Ordan, CEO

That's not really something I would call out there. I mean, last time we have a terrific recruiting arm, and they integrate it. So we've done a very good job of keeping pace with turnover, and there's no particular area that's driving the increase in costs. The increase in costs are relatively modest, but I thought worth calling out, nonetheless.

Kevin Fischbeck, Analyst

All right. Great. Thank you.

Operator, Operator

And we'll move next to the line of Pito Chickering with Deutsche Bank.

Pito Chickering, Analyst

Hey, good morning, guys. Thanks for taking my questions here. On that $50 million of charges sort of in the first half of the year due to R1. My understanding is that was simply the aging of receivables in a different bucket tends to charges. But you said that part of the first core component of $10 million is gone. Can you explain sort of why that's gone? I thought that simply didn't get a bill out into a payer. Hence, it's aged out; a little unclear why it would not be recoverable when R1 sort of caught up with the billings?

Marc Richards, CFO

Now, the component of that is denials and timely filings. So at any point in time, to the extent bills haven't been set out, at that point in time, it's a timing issue. If those bills are not set out under the correct timing as dictated by your payer contracts, that money has been lost. So that's a component I referred to.

Mark Ordan, CEO

And that plays into, just based on experience, that is what effectively plays into the buckets of accounts receivable, and we will reserve against them as they flow through.

Pito Chickering, Analyst

Okay, fair enough. And then to follow up on Kevin's question on the sort of the salary costs about $3 million above the forecast, I was under the impression that most of your physicians were under multiyear contracts with both fixed and variable components. So you are always more insulated from some of these labor pressures. So I guess you are walking through where that $3 million sort of came from because I thought you actually been more insulated in that.

Marc Richards, CFO

Yes, Pito, it's keep in mind, we've got thousands of clinical providers across the organization. So as pleased as we are with our general turnover rates, there is still turnover; it's relatively modest, but there is. So as we looked at the second quarter and dug into those individual practices, where there was a financial call out, the majority of instances were related to that modest level of turnover and open positions that hadn't yet been filled. Thus, there was a need for either existing clinicians in that practice to take extra shifts on call overtime, and the like, prior to refilling that position. So in each one of those instances, obviously, there's been a work plan. And we do think that there's recapture there with some cost savings, but that is a general tone of how we saw in the quarter. And again, as Mark mentioned, roughly $3 million run over versus our internal forecast is relatively minor.

Pito Chickering, Analyst

All right. Last question here on pricing, just can you refresh us on where the out-of-network revenues are today? Does this change sort of versus year-end? And also on the government versus commercial payer mix? As you will think about potential environments, where are we today versus where we were in 2008? Thanks so much.

Mark Ordan, CEO

If I understand your question correctly, we continue to be overwhelmingly in-network; less than 5% of our volume is out-of-network, with over 95% in-network. So that hasn't changed at all over the last two years. As I mentioned, we haven't observed any pattern or change in behavior. While we await clarity from HHS, I'm not sure I answered your question exactly. Did I?

Pito Chickering, Analyst

Yes. Then that's from Friday networking. I guess the question is, as people are thinking about different recessionary risks here, what's our government-commercial mix today? And where was that in ’08?

Marc Richards, CFO

I don't know if I have stats from ’08 on hand right now. But I can speak to what our experience has been over the past four or five years. From an absolute standpoint, in terms of the percent of our patient volume, as measured by gross charges on either the two sides, government or non-government, where we stand today, the government component is very comparable to where it's been over the past couple of years. Actually, even for this quarter, it's maybe 100 basis points or more lower than where it kind of topped out about four years ago. During that period, as we view it, it is likely that employment growth through the middle and latter stages of economic expansion prior to the pandemic had a favorable role for us.

Operator, Operator

Next, we'll go to the line of Whit Mayo with SVB Securities.

Whit Mayo, Analyst

Thanks. Maybe just to follow up on the payer mix question. I don't know if you've disclosed this, but I was just curious what percent of your commercial revenues today are coming from patients on the exchanges?

Marc Richards, CFO

I don't know if we've ever had a perfectly clean view on that, Whit. Generally, and even going back to the initiation of the exchanges, oftentimes, we would be submitting a claim to the same carrier, whether it was an exchange program or not. We've never had a perfectly clear view of ACA volume. But that said, in general, any kind of contracts we had that covered that were under the existing contract we have with the payer. So they had an exchange program or a normal insurance program, our contracts were comparable.

Whit Mayo, Analyst

I guess maybe to ask it in a different way. If you look back to 2014, did you see an uptick in maybe your commercial mix, where that could be attributed to exchange patients? I'm just trying to get a sense of sort of how you guys think about that.

Mark Ordan, CEO

I think, Whit, we will get back to you on that.

Marc Richards, CFO

Yes. By my recollection, we didn't. But we can track back. I don't remember being anything.

Whit Mayo, Analyst

That's fair. I'm just trying to think about if the subsidies go away, what the potential headwind could be if there is a headwind. But the other question, United has a notice on their website that indicates that you may be out of network in Georgia in 2023. I'm sure you probably can't discuss this. But maybe there's nothing abnormal about this. I presume this is just ongoing negotiation. So I just thought I'd ask if there's anything to talk about there. And then really a final question, just on the G&A target 250. Are you feeling any better or worse about that?

Mark Ordan, CEO

On the first, we wouldn't comment on that. There's a normal negotiating process with all of our payers. We have over 500 contracts. I'm aware of that, so there's nothing else that will factor into that. And our G&A targets, yes, we're comfortable with what we've laid out.

Whit Mayo, Analyst

Okay. Thanks, guys. Appreciate it.

Operator, Operator

We'll go next to Ryan Daniels with William Blair.

Unidentified Analyst, Analyst

Hey, guys, this is Jack on for Daniels. Thanks for taking my question. I just have one quick question. I think all my other questions have really been answered. So I know the Brave integration wasn't an outright acquisition. But kind of given the inflationary environment and other current market conditions with rising rates, et cetera. Do you have any update on the acquisition pipeline and possible investments? I guess, just to kind of rephrase this, what's your mindset when it comes to M&A and investments like Brave? Are you kind of looking at areas to supplement growth on the urgent care side, more technology investments, et cetera? Any color you have on that would be appreciated.

Mark Ordan, CEO

Well, not to sound too vague, we are excited to grow in any area where it fits our core business and where it's accretive. So in many of our subspecialties, we're actively looking at ways to increase our footprint. We'd like to grow in serving NICUs; a lot of my time and Swift's time is spent with our hospital systems and prospective hospital partners to find ways to increase. Certainly, in primary and urgent care, you mentioned Brave; we acquired outright NightLight of Orlando and NightLight of Houston, and we will look at both de novo growth and also acquisition growth. We think both of those we can do without undue pressure on using our cash flow. As we mentioned, which I think is very important. We were also able to buy back 3.3 million shares of our stock with all of this without changing debt levels at all. So we are eager to grow when there are opportunities. Some of it the lack of clarity from HHS probably informed some lack, but we're still out there.

Operator, Operator

We'll go to the line of AJ Rice with Credit Suisse. Go ahead.

AJ Rice, Analyst

Hi, thanks. Hello, everybody. A couple of things. Obviously, the step up on the buybacks, I wanted to ask you about that. Is that an opportunistic value in the second quarter, or should we begin to think that you're going to commit more capital to that going forward?

Mark Ordan, CEO

Well, I have the classic CEO answer. These are the kind of decisions that we work closely with our Board on. When we believe it is a strong use of capital, that's where we allocate our resources. The Board felt unanimously that this was a good time to buy back our shares. Therefore, I cannot comment on any future activities.

AJ Rice, Analyst

There's been a lot of discussion regarding the R1 transition and its current effect on revenues. I'm curious, in this context, whether you consider this a typical outcome of such a transition. Do you believe R1 failed to perform adequately, or was there something on your end that contributed to the situation? Additionally, is there any possibility for recourse or concessions from them due to these issues?

Mark Ordan, CEO

I said in my comments that we had, in retrospect, moved too abruptly. So I'd say we had an RCM team, a big RCM team, and in the move from the RCM team to R1, I'd say with hindsight, which is always handy, we should have retained our team longer to give R1 more time to get up to speed. We did that more abruptly. That's what I mean by more abruptly than I wish we had. There's no recourse to R1. I would say it just collectively didn't go as smoothly as we had hoped. And now this is the kind of thing that can happen. We have an enormous RPM function. So I think we did it pretty well, but not as well as I wish we had. Having said that, importantly, we're at a point today, where we have a very solid RCM function. And as I mentioned, in addition to that, we have an arbitration capability that we would never have been able to match on our own. So as Marc rightly pointed out, the other side of the RCM effort right now is collecting as much as we can from the earlier month to recover as much as possible. But I think it was a very good transition, a very good move to transition to R1. We're not disappointed with our decision at all. We're disappointed by the turbulence and by the fact that had we kept people on our team longer, it would have been a better transition and less costly for us.

AJ Rice, Analyst

Okay. You mentioned regarding the No Surprise Act that your team is prepared to handle any potential arbitration issues. I wanted to know if you are seeing an increase in cases going to arbitration right now, or is your preparation more about being proactive?

Mark Ordan, CEO

We are overwhelmingly in network, so we haven't seen the increase in arbitration. The only areas where we're out of network, and we have had arbitration, we've been very pleased with the results. But we know that one of these days there will be some final ruling, and things will settle in, and we will need to have a process to settle these in arbitration.

AJ Rice, Analyst

And it doesn't sound like you're seeing any delay in MCL recontracting as people are waiting for those final rules to come out. Is this just sort of normal course? It sounds like it’s the way you're describing it. Is that correct?

Mark Ordan, CEO

Yes, that's correct. I would say that towards the end of last year, many people were anticipating a much more challenging environment. So far, we haven't experienced that.

AJ Rice, Analyst

All right. And just my last area, just a quick question on the push for the pediatric urgent care centers. Obviously, you've owned some of them for a little while now. Anything developing either making you more or less optimistic about the economics of that business and the opportunity set? A lot of this during COVID was put in place, and maybe parents were saying, “Hey, I'd go to a pediatric urgent care center, because I want to keep my kids away from places where they might catch COVID from adults.” Are you seeing any change in the demand profile as we progress through the pandemic?

Mark Ordan, CEO

We weren't making our decision based on what we saw at the time as a COVID-related increase. In any acquisition, you evaluate not just the current situation but also historical performance. We did not pursue this due to a temporary boost in earnings from COVID. We remain very satisfied with the financial performance of these operations and the economic potential, and our perspective on this has not changed. If there are occasional increases due to COVID, which we obviously hope to avoid, that is not the reason behind our decision. Our motivation has always been that we are the largest employer of pediatricians in our key markets, and we significantly influence pediatric care in those areas. We believe this is a crucial step in enhancing our ability to support mothers, babies, and children.

AJ Rice, Analyst

Okay. That's great. Thanks so much.

Operator, Operator

We have a follow-up question from the line of Kevin Fischbeck with Bank of America.

Kevin Fischbeck, Analyst

Great, thanks. I just wanted to get maybe a little more color about what you mean about the arbitration improvements with R1. What exactly are you guys have in place now that maybe you wouldn't have been able to do before?

Mark Ordan, CEO

Well, the arbitration process right now is only where we are out of network. The only place where we're principally out of network is in Texas. The arbitration process, which many people don't know, is a case-by-case process. You can imagine how laborious a process like that could be if it ever became significant. You have to have a machine in place to handle that and to handle that intelligently. I think we have that today with thanks to our partnership with our team, our managed care team, and R1. I think that would have been very difficult to build on our own.

Kevin Fischbeck, Analyst

Okay, I guess do you have a sense about where your pricing is versus kind of meeting in-network? My assumption is that if you're out of network, almost definitionally, it's because you'd be above the median in-network rate. I guess in that 5%, there might be some risk, but broadly speaking, any way to think about that?

Mark Ordan, CEO

We don't. It varies payer by payer and contract by contract, so I don't have that.

Operator, Operator

And gentlemen, we have no further lines in queue at this time.

Mark Ordan, CEO

Great, well, thank you all for your understanding, your support, and we look forward to updating you on our progress as we move forward. Enjoy the rest of your summer.

Operator, Operator

Ladies and gentlemen, that will conclude your conference call for today. Thank you for your participation and for using AT&T Event Teleconferencing. You may now disconnect.