Select Medical Holdings Corp Q1 FY2021 Earnings Call

Good morning, and thank you for joining us today for the Select Medical Holdings Corporation earnings conference call to discuss the first quarter 2021 results and the company's 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 Officer, Martin Jackson. Management will give you an overview of the quarter and open the call for questions. Before we get started, we would like to remind you that this conference call may contain forward-looking statements regarding future events or future financial performance of the company, including, without limitation, statements regarding operating results, growth opportunities and other statements that refer to the Select plans, expectations, strategies, intentions and beliefs. These forward-looking statements are based on the information available to the management of Select Medical today, and the company assumes no obligation to update these statements as circumstances change.

Thank you, operator. Good morning, everyone. Thanks for joining us for Select Medical's first quarter earnings conference call for 2021. First, I’d like to say we’re very pleased with the results of this quarter. Our inpatient businesses, including our critical illness recovery hospitals and our inpatient rehabilitation hospitals realized significant growth in revenue, EBITDA, and occupancy rates. Occupancy rates in both business segments grew 500 basis points on a same quarter year-over-year basis. Our Concentra business segment has continued the trend we saw in Q4 with nice growth in revenue, EBITDA, and EBITDA margins. And while our outpatient rehabilitation business experienced double-digit negative variance in patient visits in both January and February, we saw a surge of visits in March, and this has continued through April. All in all, it was a stellar quarter for Select. In addition, you may have seen in our earnings press release that our Board of Directors has authorized a cash dividend of $0.125 for holders of our stock as of May '19. As we've done over the past year, we have outlined our business segment monthly revenue, volume, and occupancy statistics in our earnings press release and public filings. We will continue to outline this information as long as we believe it provides insight to the impact of COVID-19 on the company's financial performance. Overall, our net revenue for the first quarter increased 9.3% to $1.55 billion. Net revenue in our critical illness recovery hospital segment in the first quarter increased 18.9% to $595 million compared to $501 million in the same quarter last year. Patient days were up 8.4% compared to the same quarter last year with over 293,000 patient days. Occupancy in our critical illness recovery hospital segment was 75% in the first quarter compared to 70% the same quarter last year. Net revenue per patient day increased 10.1% to $2,024 per patient day in the first quarter. We continue to see strong referrals and higher acuity patients, which is driving both volume and rate in our critical illness recovery hospitals. Case mix index in our critical illness recovery hospitals was 1.35 in the first quarter compared to 1.27 in the same quarter last year. Net revenue in our rehabilitation hospital segment in the first quarter increased 14.2% to $208 million compared to $182 million in the same quarter last year. Patient days increased 8.3% compared to the same quarter last year with over 102,000 patient days. Occupancy in our rehabilitation hospitals was 84% in the first quarter compared to 79% the same quarter last year. Net revenue per patient day increased 7% to $1,853 per day in the first quarter.

Thanks, Bob, and good morning, everyone. For the first quarter, our operating expenses, which include our cost of services and general and administrative expenses were $1.33 billion or 85.9% of net revenue. For the same quarter last year, operating expenses were $1.23 billion and 87.3% of net revenues. Cost of services were $1.29 billion for the first quarter. This compares to $1.2 billion in the same quarter last year. As a percent of net revenue, cost of services were 83.6% for the first quarter. This compares to 84.9% in the same quarter last year. G&A expense was $35.4 million in the first quarter. This compares to $33.8 million in the same quarter last year. G&A as a percent of net revenue was 2.3% in the first quarter. This compares to 2.4% of net revenue for the same quarter last year. As Bob mentioned, total adjusted EBITDA was $258.3 million and the adjusted EBITDA margin was 15.7% for the first quarter. This compares to total adjusted EBITDA of $187.3 million and adjusted EBITDA margin of 13.2% in the same quarter last year.

Our first question comes from the line of Justin Bowers of Deutsche Bank.

Congratulations on another strong quarter of performance. Just wanted to get your updated thoughts on capital allocation and capital deployment. With the initiation of the dividend, is there kind of a target payout ratio or free cash flow distribution ratio you guys are targeting for that? And I'll pause for the follow-up.

Thanks, Justin, it's Bob. In terms of capital deployment, our number one priority is the balance of the Concentra buyout of our minority partners that will happen early next year. So that's the number one priority. I think the dividend reflects our Board of Directors' and the company’s confidence in where we are and our cash flow through the balance of this year and through next year and beyond. We will continue to look at opportunities to deploy capital in M&A, but they'll be relatively small given the size of the company. We certainly hope that having initiated the dividend, we will be able to continue that in the foreseeable future.

Yes, Justin, as far as a percentage, we expect to be in that 1.5% range as far as the dividend is concerned.

Understood. And then on a related note, can you just remind us of the facility or bed additions across the hospitals that have been announced over the next 1 to 2 years? And then how the pipeline looks for other capacity expansion?

Yes. I'll comment on the pipeline. We typically do not project bed additions, either on the rehab hospitals or on the critical illness recovery hospitals. We will probably institute a practice of announcing new hospitals when they open. We often announce significant joint ventures when signed, and we will do that. I will say that our pipeline is as good as it's ever been. We have a strong pipeline of deals, and we expect to add some new partners. When we sign those and add them, we will announce them at that time. But I feel very good about the pipeline and feel good about growing in the inpatient segment, both critical illness and rehab, as well as pursuing some fold-in acquisitions on the outpatient side and some de novo.

Understood. And then maybe just one more. Do you have some additional capacity coming online later this year in the IRF segment? And then the volumes look pretty good there this quarter. Do you think we're going to continue on that trajectory for the rest of the year?

Yes. Our plan is to open, subject to the construction schedule, our third rehabilitation hospital with the Banner Health System in Arizona this year, and we will probably be announcing some new hospitals that are in the pipeline now, which will be new hospitals that will be opening either in the latter part of this year or next year. You can assume, given that time frame, that those would be in the hospital within a hospital model.

Next question comes from the line of Frank Morgan of RBC Capital Markets.

Really good, strong quarter. I'm just amazed at the level of acuity that you're able to sustain here. And I think the 1.35 in is even up from last quarter, 1.31. So as good as that is, I'm just curious about your thoughts. When you think about the balance of the year, the ability to sustain that level of acuity in your buildings, and how that's reflected in your pricing? But I also wanted to ask, as it relates to pricing, did the 10% pricing growth include the prior period settlement? Or was that literally all pure acuity in the period?

Yes, Frank, it's a good catch on the case mix index. The level of acuity this quarter is the highest in the company's history on that critical illness. This reflects last year and the performance of our hospitals in the local markets and their ability to be good, strong referral partners with large acute care hospitals with significant ICU bed capacity. We hope to be able to continue that through the balance of this year and beyond. But as you know, that's always dependent upon the level of occupancy and census at the acute care hospitals. We see a strong pipeline and have strong optimism relative to our acuity and our census. To the latter question, I'll let Marty take that.

Yes, Frank, the settlement with CMS is not included in the pricing that you see. So that is actually below the revenue line in other income.

Okay. Really strong. And then when I think about margins in that segment, I know labor is a major issue, particularly for ICU nurses. How do you assess your ability to manage labor in this very difficult environment when you clearly have lots of demand?

It's a big issue. It is probably one of the top issues in our critical illness recovery hospitals is nursing. As you know, and I think most all the provider side have announced this earnings season, the cost for contract or temporary labor is very high. Recruitment costs are very high and the scarcity of nurses is significant. It's not the first time that we've seen a nursing shortage in this industry. We will manage through it, and there will be some additional costs. At this point, I would say that we do not see significant bed holds, where we're not able to admit. If that is happening, it’s minimal at this point. So we're still able to admit our patients and not been able to put a hold on admissions.

Frank, we'll also say that we think Q1 really was probably the high mark for agency nursing rates. We have seen that start to come down, and we're hopeful that it will continue through the balance of the year to more historical rates.

Got you. And then my second one is just — you sort of touched on this in your prepared remarks, but just a little more color on the momentum that you carried over out of March into April, if you could maybe go into a little more detail by segment in terms of the magnitude of that continuation of growth in utilization?

Well, what you're referring to is really on the outpatient rehab segment. That's the segment that is probably the most remarkable in terms of that. You see in our hospital side of the business that it's the momentum — we've already seen the momentum. We are at an all-time high in terms of occupancies. On outpatient rehab, we've really seen the business come back in the latter part of the quarter, and that momentum is continuing. I think that's just a function of being on the backend of the pandemic, with more people being out, more elective surgeries, and people coming back to outpatient clinics. So we saw it strong, and it seems to be continuing. The momentum seems to be very good right now.

Next question comes from the line of Kevin Fischbeck of Bank of America.

This is actually Courtney on the line for Kevin. So just to dig into these trends a little bit more. In your critical illness section, the occupancy rate fell a little bit in March. Is that just because COVID moderated? Or is that a normal fluctuation? And can you give some color on how that's trending in April?

Yes, Courtney, the difference there is really immaterial. We saw a very little drop-off in March.

Yes. I wouldn't read anything into that. We would consider that just normal variances.

Okay. That makes sense. And then I guess just to circle back a little bit. I know you’ve kind of flushed out the labor trends and labor dynamics, but are you seeing any other barriers on the labor front to fully ramping up occupancy and capacity? It sounds like now everything is kind of falling in line. Is there anything else on the labor side that you think might prevent you from hitting full stride?

No. We have a close eye on cost and with respect to attracting and maintaining labor. But beyond what we’ve seen, as Marty commented, we’d like to think that we could see some improvement from here on the labor.

Next question comes from the line of Bill Sutherland of Benchmark.

Marty, did you mention the impact of the sequester relief extension in your guidance changes for the year?

Bill, we have incorporated that into our new guidance. It's going to be probably a little bit north of $20 million.

The top line. Well, it's EBITDA as well.

Yes.

Yes. And then just so I understand the LTAC margin, just to clarify, that litigation settlement is in the critical illness EBITDA?

Yes, it is. But the way it gets there, Bill, is through other income, so it doesn’t impact the revenue.

Right. But just the margin is what I’m thinking about, is thinking about what that would be, absent the so...

Yes. The way — yes, Bill, the way that we take a look at the margin, you’re right, it was 19%. If you back out the 17.9%, what you also have to do is — as you recall, the grant dollars that we spent $16.1 million, about $14 million of that was associated with the critical illness recovery hospitals. Those are for expenses that we’ve incurred. That’s not in the segment reporting. You really have to add that back. If you take the $113.3 million of EBITDA, minus the $17.9 million, add back the $14 million, you’re at $109 million. That gets you to about 18.3% margin.

Okay. Good clarification. And then last one for me. Maybe, Bob, could you widen the lens a little bit on your 3-year CAGR outlook for the businesses? And maybe just talk a bit about some of the assumptions that underlie that color.

Yes. In terms of our longer-term, Marty and I felt it was important last quarter to give some sense to shareholders and investors of how we’re thinking about the growth of the business long term. The bigger assumptions are obviously the complete consolidation of all the ownership interest in Concentra, which we will look to see incremental growth. Now 2021 is an unusual year with all the things that you see that have been coming through the income statement and the aftermath of COVID. We see growth in all of our segments. That’s the most important thing that I can say about the color and us being able to achieve the longer-term growth targets. We have a lot of runway on our outpatient business, even though outpatient has been the slowest to recover from the pandemic. We believe that that business is a very strong segment going forward. We have a lot of opportunities to grow with snap-on acquisitions and de novo. The critical illness recovery hospitals have never been stronger in terms of their perception in the market. As I mentioned from an earlier question, our pipeline has never been stronger. We will see growth in new hospitals in the critical illness segment. In rehab, our joint venture partners continue to grow with us. We have the opportunity to grow with new partners such as Rush in Chicago, which we recently signed and will be starting construction soon. With some new partners that are interested in rehabilitation hospitals as well as potentially critical illness recovery hospitals and outpatient. If you look at all four segments, they all play a role in giving us some sense of being able to project growth rates in the out years. I will say there are no large significant acquisitions in Marty's and my thinking in terms of what we can do through 2023. Hope that answers the question. Marty, do you want to add anything?

Yes, Bill, I think one additional thing that we wanted to make sure that investors realize is that on the EPS line, when you take a look at our capital structure, some of the refinancings that we've done, today we pay on our $2.1 billion senior secured proceeds, we pay 2.36%. Through September of '24, with a cap that we've put in place, the maximum rate we’ll pay is 3.25%. We wanted to make sure that people understood that you wouldn’t see any increase in the rates there.

Right. That’s good. I guess one, just — that’s great color. One thing I hear from investors is how critical illness trends as COVID recedes. Maybe you addressed this before, but just on a same-store basis, do you think you can replace those cases and the case mix for the most part?

Well, that’s certainly our plan. There are LTAC criteria-compliant patients that are out there in the ICUs of large acute care hospitals. Marty and I have spoken on that many times in the past before the pandemic. The issue is continuing to expand the breadth of the referrals and the timeliness of the referrals we get from those hospitals and those ICUs. The pandemic accelerated our education and the opportunity for us to prove the importance of the services we provide. It is our plan to build on that as we took the most complex patients during the pandemic, which you can see through our case mix index. We plan to continue that with referral sources to ensure they have the comfort level with other highly complex patients that we are capable of treating. So yes, it is our plan to continue that. And Marty can backstop those comments with some data and some information that we often look at and consider.

Yes. Bill, to put Bob's comments in quantitative terms, if you look at the Medicare mid-part data, we believe there are approximately 325,000 to 350,000 patients a year that qualify for LTAC services. The most recent MEDPAR data release shows that the total LTAC industry had only 69,000 total LTAC-qualified discharges. Most of the potential patients don't utilize LTAC services but continue to stay in acute care hospitals. As Bob mentioned, we believe with continued education of the referral sources, there is an opportunity to provide the specialized clinical programs that this population requires in the LTAC setting.

There are no further questions at this time. I would like to turn the call back to management for closing remarks.

No closing remarks. Thank you, operator. Thanks all of you for joining us to review the results.

Thank you. Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect. Have a great day.