Earnings Call Transcript - MD Q2 2023

Operator, Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Pediatrix Second Quarter Earnings Conference Call. At this time, your telephone lines are in a listen-only mode. Later, there will be an opportunity for questions and answers, with instructions given at that time. As a reminder, your call today is being recorded. I will now turn the conference call over to your host, Charles Lynch. Please go ahead.

Charles Lynch, Host

Thank you, Allen, and good morning, everyone. Welcome to our call. I will quickly read our forward-looking statements before we get into our comments. 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's 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 finally on our website at pediatrix.com. With that, I'll turn the call over to our CEO, Dr. Jim Swift.

Jim Swift, CEO

Thank you, Charlie, and good morning, everyone. Also with me today is Marc Richards, our Chief Financial Officer. Our operating results for the second quarter continue to track very near our expectations. Patient volume trends decelerated somewhat from the first quarter, but remained stable to positive. Within our hospital-based services, NICU days increased year-over-year, offset by softer volumes in the pediatric ICU and the pediatric floor. We attribute this to a return to normal summer seasonality after a number of years of distortions from COVID and non-seasonal respiratory diagnoses. And we anticipate that volumes in these settings will increase seasonally as we move through the fall and into the winter. On the ambulatory side, our volume growth was driven by maternal fetal medicine and pediatric cardiology. Certain of our ambulatory subspecialties, such as our ENT practices, saw a similar seasonal deceleration in volume growth to what we saw in both the peds ICU and the peds floor. And similarly, we would anticipate a seasonal reacceleration in patient traffic as the school year begins. Turning to rate, our reported pricing was quite strong, which largely reflects the progress we've made in improving our revenue cycle operations. Our payer mix was also stable year-over-year. On the cost side, our practice-level compensation and benefits expense reflected a deceleration in underlying salary growth as compared both to the first quarter and the fourth quarter of 2022. Additionally, our G&A expense declined by roughly 5% year-over-year, reflecting our ability to maintain efficiencies and generate leverage against our revenue growth. Lastly, we generated strong cash flow during the quarter which allowed us to repay roughly 75 million in borrowings. As you'll see in our press release this morning, based on our second quarter results, we are maintaining our full year outlook for adjusted EBITDA between 235 million and 245 million. Now I'll touch on a number of business and strategic priorities. First, as I mentioned, our second quarter results reflect improved AR collections, which in turn reflect the efforts we put forth to staff our frontend activities internally. We remain focused on further improvement through the second half of this year. Second on growth, we're working on three fronts. On the sales side, we believe we continue to have great relationships with our existing hospital partners, which we view as our strongest pathway to new contract growth. But we're also focused on new relationships. As a good example of this, we finalized an arrangement with Blythedale Children's Hospital, the only independent specialty children's hospital in New York State, under which pediatrics affiliated clinicians will provide pediatric hospitalists and intensivist services. We're excited about the opportunity to work with the leadership of Blythedale and to help ensure that patients there receive the highest quality care possible. Within our primary urgent care platform, we're also expanding. In the Houston market, we opened our first de novo pediatrics branded clinic this past fall. We are scheduled to open an additional de novo clinic during the second half of this year. In both Houston and Orlando, we are actively rebranding our acquired clinics under the Pediatrix name. Lastly, during the second half of 2023, we are planning to open three de novo clinics in the Denver market, marking our entry into a third priority market for us. Finally, we haven't completed any acquisitions year-to-date. We believe there are opportunities in the market, and we anticipate that we may begin committing a modest amount of capital during the second half of the year, focusing on our core service lines. Lastly, I'll comment briefly on the No Surprises Act. As we've discussed at length in the past, our focus has been maintaining strong payer relationships and our predominantly in-network status, while at the same time, undertaking a comprehensive, thoughtful approach to the arbitration process in those instances where we're in an out-of-network position. Our success rate in arbitration continues to lead industry averages for providers. I want to commend our managed care team for this success. Against that backdrop, I'm also pleased to note that we have now been able to reestablish an in-network payer agreement in one of our markets following a period when we were previously out of network. We believe this reflects our ability to work constructively with our payer partners and arrive at a structure that, first and foremost, benefits our patients but also represents an economically appropriate level of compensation for the critical services provided by our affiliated clinicians. With that, I'll turn the call over to Marc Richards.

Marc Richards, CFO

Thanks, Jim. Good morning, everyone. I'll provide some additional details for the quarter. First, as Jim mentioned, we continued to decrease both our gross and net accounts receivable in the second quarter. Our net AR days at June 30 were 49, down from 51 at March 30 and 53 at December 31 for a four-day improvement year-to-date. In turn, this improvement supported the contribution to our revenue growth from the rate that we reported this morning. Quickly turning to our P&L. Underlying same-unit salary growth remained above our historical norms, but that growth did decelerate by over 100 basis points as compared to the first quarter of this year and to Q4 of '22. Within our practice-level salaries, wages, and benefits line, this sequential improvement was modestly offset by higher incentive compensation accruals, which are based on practice-level revenue and financial performance. Also within our P&L, G&A expense remained under 60 million in the quarter. And within our financial outlook for the full year of '23, we continue to anticipate that our G&A will be less than 12% of revenue. Turning finally to our balance sheet. We repaid roughly 73 million in revolver borrowings during the second quarter. Our total debt at June 30 was 675 million for net leverage of 3x based on trailing 12 adjusted EBITDA. Notably, over the past 12 months, we have repaid a total of 125 million in borrowings on our revolver and term loan A. We anticipate that we will generate sufficient cash flow to repay all of our revolver borrowings during the third quarter and begin to build a cash position following that. We believe this is appropriate given our outlook that we may commit capital to acquisitions in the coming year. Keep in mind that our liquidity position is very strong, with total revolver capacity of $450 million. With that, I'll turn the call back over to Jim.

Jim Swift, CEO

Thank you, Marc. Operator, let's now open up the call for questions.

Operator, Operator

Thank you. We'll first go to the line of Pito Chickering with Deutsche Bank. Go ahead.

Pito Chickering, Analyst

Good morning, guys. Thanks for taking my questions. Can you help us bridge the EBITDA margins from 2Q into the back half of the year? And then can we use the implied margins in the back half of the year as a launch pad for 2024?

Marc Richards, CFO

Hi, Pito. This is Marc Richards. Let me clarify a few points regarding our margins, particularly for the second quarter of this year. You will see that same-store rate growth quarter-over-quarter contributed approximately 12.5 million, even though our compensation salary and benefits line increased by around 23 million. Thirteen million of that was attributed to salaries and wages, while the rest, roughly 9.5 million to 10 million, was due to our incentive compensation plan. Therefore, the rate growth for same-store was 12.5 million, with incentive compensation rising by about 10 million quarter-over-quarter. I want to draw your attention to the margins for the quarter. Although there was a corporate-wide improvement in rate growth, this does not necessarily reflect practice-by-practice results. Consequently, some practices that are in bonus are receiving a larger share compared to previous periods. As our revenue cycle management improves and stabilizes across the portfolio, so too will the associated incentive compensation.

Pito Chickering, Analyst

Okay. Fair enough. DSOs have come down five quarters in a row. So is this all revenue cycle management? Is it just a change of process? And also, have you been able to collect any of the receivables that have been previously written off?

Marc Richards, CFO

Sure. Yes, I'll even expand on your observation there. Over the past 12 months, our DSO has come down by nine days. The vast majority of this is associated with great improvement. Despite the fact that we are at 49 days here at the end of the second quarter, there is still room for improvement, and our guidance anticipates that improvement over the coming quarters.

Pito Chickering, Analyst

And then, like have you guys been able to recover any of the receivables that have been previously written off?

Marc Richards, CFO

Yes. Our revenue recognition is an experience-based model. To the extent we have been catching up on prior reserved receivables, to the extent they're collected, those amounts are flowing through to the P&L, which is a very small component of the 2.5% plus same-store rate growth. But it is a negligible component of that.

Pito Chickering, Analyst

Perfect. Great. Thanks so much.

Operator, Operator

One moment please for our next question. And that will come from the line of Brian Tanquilut with Jefferies.

Brian Tanquilut, Analyst

Thanks for taking the question. I guess, Jim, you guys called out same-unit salary being up because of incentive compensation. So that's probably a good sign. But how do we think about the opportunity to reset or adjust back down that specific cost item across line?

Jim Swift, CEO

You want to start and I'll follow up?

Marc Richards, CFO

Sure. Those incentive plans are in place and they're contractual and in most cases, renew automatically from year-to-year. So it really is dependent on a practice-specific discussion.

Jim Swift, CEO

And Brian, we're having some of those conversations just internally across the practices to make sure that we're looking at the averages across the country in terms of compensation for these different specialties, making sure that we're at market or slightly above market to be competitive in some of these areas, but that's an active conversation this year and into '24.

Brian Tanquilut, Analyst

Got it. And then, Marc, obviously, free cash flow or cash flow in general were strong. Some of this is collecting some of that AR, right? But as we look forward, what do you think is the right way to think about your more normalized cash generation?

Marc Richards, CFO

Well, you're right. We have had some lumpiness over the past 12 months with respect to that. The balance sheet has flexed, of course, from quarter to quarter. Our bonus payments go out in the first quarter. Therefore, in the first quarter of the year, we were a net borrower, but I would think about that as the year tails on that borrowing coming down to zero here in the third quarter with free cash flow, then building up as we approach the end of the year.

Brian Tanquilut, Analyst

Got it. One last question for me, if I may. You mentioned that you are entering the Denver market with your clinic and urgent care strategy. How should we view the margin difference between your core legacy businesses and this new strategy? Thanks.

Charles Lynch, Host

Hi, Brian. It's Charlie. I think your best rule of thumb is as these clinics mature, they are pretty comparable to or a little bit accretive to our overall margin profile. Keep in mind we've got experience in two markets, in Houston and Orlando, with pre-existing clinics, with pre-existing patient traffic, albeit only on the urgent care side and not primary care. So that's a little bit new ground, but that's been our experience. And then obviously with the new openings, another opening in Houston this year and a few in Denver, there will be a ramp period where we'll sustain some start-up losses as we get those clinics opened, staffed, and then build patient traffic.

Jim Swift, CEO

Yes. Brian, it's Jim. I'll just add that it's an important market for us with our presence in the newborn nurseries, in the NICUs, in the PICU, and in the pediatric floor in multiple hospitals in the Denver metro market. We think this is a natural extension of the services we provide in the community and feel that we have a patient relationship that will be an advantage for us in that market.

Brian Tanquilut, Analyst

Awesome. Thank you, guys.

Operator, Operator

We'll go next to Kevin Fischbeck from Bank of America. Please go ahead.

Unidentified Analyst, Analyst

Hi. This is on for Kevin. Thanks for taking the question. So on pricing, that was strong in the quarter. Can you clarify how much of that was due to the improving collections versus rate update in the comps?

Marc Richards, CFO

Sure. As I said earlier, the vast majority of that is driven by improved collections, which directly corresponds with the balance sheet. AR is down, which of course is driving a piece of that as well as the DSO coming into place. So it's primarily a reversion to a normalized reserve rate, which is still ongoing.

Unidentified Analyst, Analyst

Thank you. And then on the No Surprises Act, can you talk about what you're seeing and how the process is working and what your win rate is compared to the industry?

Charles Lynch, Host

Yes, I'll touch on it and let Jim add some more detail. As you may know, CMS reports that the average win rate for those initiating arbitration cases, primarily providers, is just over 70%, approximately 71% according to their latest report. In previous discussions, we have mentioned a success rate of over 75%. Over time, our success rate has actually shown improvement. Jim, feel free to add more.

Jim Swift, CEO

Yes, we believe that the industry needs to have this capability from a physician or provider service perspective. We have continued to develop this internally to ensure we understand the arbitration process and have accurate data on the qualified payment amount in various markets, rather than just relying on some of the contracted QPAs that may be lowered by the payers. We think our process is solid, and we are continually enhancing it. We take pride in our team that is managing this and are confident that we will keep working with payers. We certainly want to be in-network, but if we find ourselves out-of-network, we will engage in the arbitration process.

Unidentified Analyst, Analyst

Thanks.

Operator, Operator

We have a follow-up question from the line of Pito Chickering with Deutsche Bank. Go ahead.

Pito Chickering, Analyst

Yes. Good morning. Thanks for letting me come back in. One more margin question for you. It looks like the back half of your guidance is around 11%. And while I know you aren't giving 2024 guidance, can you help us think about using the 11% as a bridge into 2024, kind of where are the headwinds and tailwinds for next year that we should be thinking about?

Marc Richards, CFO

I think heading into next year, of course, rate continues to be a concern despite the improvements that we have seen. We're not in a position at this point to provide '24 guidance. Obviously, where we end up this year with our revenue cycle management efforts and the related financial impact of that will be heavily driving our '24 forecast and related guidance.

Charles Lynch, Host

And Pito, just one last piece, and it's a little bit more related to Q2 of '23 than '24 but may be helpful. As we talked the last couple of quarters about overall compensation trends, particularly on the salary side. And as Marc referenced on the incentive compensation and how that closes this quarter, one thing to think about is the way we view it, which is here in the second quarter, we've kind of passed something of a high watermark in the delta between overall compensation trend and top line trend, which informs our outlook for the remainder of this year, and hopefully you as you think about exiting and going into '24.

Pito Chickering, Analyst

Okay, great. You have been downplaying the risks that have been affecting other practices. I appreciate your comments on in and out-of-network exposure. As you prepare for contracting with managed care for next year, could you share your observations regarding rate increases compared to historical ranges? That would be helpful.

Jim Swift, CEO

Well, I'll start and then Charlie can follow on. I think one of the things we're not shrugging off anything related to the No Surprises Act. These are the relatively early innings of this process. There are still decisions to be made on some of the court cases coming to bear. We want to be engaged in this work. More importantly, we are having substantive conversations with those payers where we are out-of-network to try to come back in-network and not being gleeful about what we've done from a success standpoint in the arbitration process. The goal is largely being in-network. Charlie, if you want to follow on with that.

Charles Lynch, Host

Yes, Pito, I would say our visibility regarding contracted rates for next year is quite similar to what you hear from other providers. We have a wide range of managed care contracts that usually span multiple years, so we have a significant percentage of in-network agreements that are fully visible for 2024. As we have mentioned before, our underlying rate trend for allowable charges is modest. My previous discussions highlighted that our pricing experience, excluding factors like revenue cycle management and payer mix distortions, falls within the 1% to 2% range, which includes relatively flat Medicaid pricing. This is likely your best reference point as we approach 2024, with the understanding that there are uncertainties surrounding the No Surprises Act that we don't want to overlook.

Pito Chickering, Analyst

Okay. Just one quick follow up on there. Obviously, there are massive inflationary pressures across the healthcare system. Is that giving you guys the ammunition to increase those rate increases or do you think that's just sort of the world that you guys have to live in?

Charles Lynch, Host

I'd say it's a pretty firm environment out there related to physician services when you try to counterbalance the inflationary pressures that providers are feeling and trying to pass along against an admittedly consolidated payer environment. Some of the unknowns around how the No Surprises Act components can be handled on the payer side. So those are counterbalancing measures in our experience that place a bit of restriction on how fully we could pass through some of the inflationary pressures that we felt at this point.

Pito Chickering, Analyst

Okay, great. Thanks so much and great job on getting those DSOs down, guys.

Jim Swift, CEO

Thank you.

Operator, Operator

Speakers, we have no further questions in queue at this time.

Jim Swift, CEO

Thank you, operator. Thank you all for joining the call. We'll see you in the third quarter.

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.