Select Medical Holdings Corp Q3 FY2021 Earnings Call

Good morning, and thank you for joining us today for Select Medical Holdings Corporation's earnings conference call to discuss the third 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 then 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 the future financial performance of the company, including, without limitation, statements regarding operating results, growth opportunities and other statements that refer to 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. At this time, I will turn the conference call over to Mr. Robert Ortenzio.

Thank you, operator. Good morning, everyone, and thank you for joining us for Select Medical's third quarter earnings conference call for 2021. We are pleased with our clinical and financial performance for the quarter. Our clinical teams continue to excel with high-quality compassionate care for our patients during challenging times, and for that, I'm very grateful. Our business diversification that we built over the last decade has helped us achieve the growth and stability we were targeting. Three of our four business segments realized double-digit top line growth. Outpatient rehabilitation and occupational medicine saw over a 24% increase in same quarter year-over-year EBITDA growth. We continue to be active on the development front. As I mentioned during the second quarter conference call, we entered into new joint ventures with Ascension Saint Thomas in Nashville. Construction is underway on a new 30-bed critical illness recovery hospital within a hospital at the Saint Thomas West campus, which will be a satellite campus of our existing flex specialty hospital in Nashville, and we expect it to open by the end of the year. We also entered into a new joint venture with Community Health Systems' Northwest Healthcare in Tucson and acquired Curahealth Tucson, a critical illness recovery hospital. We plan to relocate to our joint venture partner's Northwest Medical Center campus by the end of the year. Also during the third quarter, we entered into a new outpatient joint venture with Cedars-Sinai in Los Angeles, contributing our 26 outpatient clinics in that market to the joint venture. On October 1, we closed on the acquisition of Acuity Healthcare, which operates five critical illness recovery hospitals through joint venture partnerships in New Jersey and West Virginia. We've been working with our new partners, integrating these hospitals into our portfolio of critical illness recovery hospitals. And on November 1, we entered into a new outpatient joint venture in Birmingham, Alabama with CHS Grandview, contributing Select's five outpatient clinics in the market. Our development pipeline remains strong as we continue to look for opportunities to expand our footprint and partner with leading healthcare institutions throughout the country. In addition, as we have included in our earnings press release yesterday, our Board has declared a $0.125 per share dividend that will be payable on November 29 to shareholders of record November 16. The Board also increased the capacity of our authorized share repurchase program by $500 million to $1 billion and extended the program two years until December 31, 2023. As we have done over the past year, we have outlined our business segments' monthly revenue, volume and occupancy statistics in our earnings press release and public filings, including monthly results from 2019 to provide a data point for each of our business segments prior to the pandemic compared to where they are currently. We will continue to include this information as long as it provides meaningful insight into the impact of COVID-19 and the company's financial performance. Overall revenue for the third quarter grew 7.8% to $1.53 billion, and for the year-to-date has increased 14.1% to $4.64 billion. Revenue in our critical illness recovery hospital segment in the third quarter increased 2.2% to $531 million compared to $519 million in the same quarter last year. Patient days were down 2.4% compared to the same quarter last year, with 272,000 patient days in the quarter. Occupancy in our critical illness recovery hospital segment was 68% in the third quarter compared to 71% in the same quarter last year and 67% in the third quarter of 2019. We did increase our bed count on a year-over-year same-quarter basis from 2020 to 2021 by 119. This increase in beds was a result of the acquisition of our new Tucson hospital, which added 51 beds. And the balance of the beds, 68, came from bed relocations, bed additions and temporary beds at nine of our hospitals. Revenue per patient day increased 4.7% to $1,931 per patient day in the third quarter. Revenue in our rehabilitation hospital segment in the third quarter increased 13% to $212 million compared to $188 million in the same quarter last year. Patient days increased 7.6% compared to the same quarter last year to almost 103,000 patient days. Occupancy in our rehab hospitals was 82% in both the third quarter this year and last year and 75% in the third quarter of 2019. Revenue per patient day increased 6% to $1,881 per day in the third quarter. Revenue in our outpatient rehab segment in the third quarter increased 14.4% to $275 million compared to $240 million in the same quarter last year. Patient visits were up 18.3%, with 2.3 million visits in the quarter compared to 2 million visits in the same quarter last year and 2.2 million visits in the third quarter of 2019. Our revenue per visit was $102 in the third quarter compared to $104 per visit in the same quarter last year. This reduction in rate is due to a change in our payer mix caused by the pandemic and the related lockdowns in the third quarter last year, which is now normalized to a payer mix consistent with our experience prior to the onset of the pandemic. Revenue in our Concentra segment in the third quarter increased 12.8% to $442 million compared to $392 million in the same quarter last year. For the centers, patient visits were up 14% to 3.22 million visits compared to 2.83 million visits in the same quarter last year and 3.15 million visits in the third quarter of 2019. Revenue per visit in the centers increased $124 in the third quarter compared to $121 in the same quarter last year. Total company adjusted EBITDA for the third quarter declined 2.2% to $208.6 million compared to $213.2 million in the same quarter last year. Our consolidated adjusted EBITDA margin was 13.6% for the third quarter compared to 15% for the same quarter last year. We did incur one-time expenses during the quarter totaling $6.5 million. These included a write-down of PPE supplies, costs of integration for our Tucson acquisition, and costs associated with the forced relocation of one of our hospitals. In addition, Q3 of 2020 included $3.2 million of EBITDA associated with the CBOC business, which we sold in August of 2020. Our critical illness recovery hospital segment adjusted EBITDA was $57.2 million in the third quarter compared to $88.8 million in the same quarter last year. Adjusted EBITDA margin for the segment was 10.8% in the third quarter compared to 17.1% in the same quarter last year. We continue to experience significantly higher nursing costs, which is being driven by an increase of both hours and rates of agency staffing. Salary, wages and benefits increased by 560 basis points on a same quarter year-over-year basis. Our rehabilitation hospital segment adjusted EBITDA declined 1.3% to $44.1 million in the third quarter compared to $44.6 million in the same quarter last year. Adjusted EBITDA margin for the rehab hospital segment was 20.7% in the third quarter compared to 23.7% in the same quarter last year. We've also experienced increased labor costs of clinicians in our rehab hospitals. Salary, wages and benefits increased on a same quarter year-over-year basis by 140 basis points. Our outpatient rehabilitation adjusted EBITDA increased 26.6% to $38.8 million in the third quarter compared to $30.6 million in the same quarter last year. Adjusted EBITDA margin for the outpatient segment was 14.1% in the third quarter compared to 12.8% in the same quarter last year. The increase in EBITDA is primarily driven by increases in patient visit volumes. Our Concentra adjusted EBITDA increased 23.9% to $99.8 million in the third quarter compared to $80.5 million in the same quarter last year. Concentra recognized $1.6 million of CARES Act payments in the third quarter this year compared to $400,000 in the same quarter last year. Adjusted EBITDA margin was 22.6% in the third quarter compared to 20.6% in the same quarter last year. The increase in EBITDA is driven by both increased patient volumes as well as COVID screening and testing services provided by our centers to on-site clinics located at employer work sites. Earnings per common share was $0.57 in both the third quarter this year and the same quarter last year. Adjusted earnings per common share was $0.56 in the third quarter last year, which excluded non-operating gains and the related tax impacts. I'll now turn it over to Marty Jackson for some additional financial details before opening the call up for questions.

Thanks, Bob, and good morning, everyone. For the third quarter, our operating expenses, which include our cost of services and general and administrative expense, were $1.34 billion or 87.1% of revenue. For the same quarter last year, operating expenses were $1.22 billion and 85.4% of revenue. The increase in our operating expenses as a percent of revenue was primarily driven by the increased staffing costs in our critical illness recovery hospitals and rehabilitation hospital segments. Cost of services were $1.3 billion for the third quarter. This compares to $1.18 billion in the same quarter last year. As a percent of revenue, cost of services were 84.6% for the third quarter. This compares to 82.9% in the same quarter last year. General and administrative expenses were $37.9 million in the third quarter. This compares to $35.5 million in the same quarter last year. G&A as a percent of revenue was 2.5% in both the third quarter this year and the same quarter last year. As Bob mentioned, total adjusted EBITDA was $208.6 million, and the adjusted EBITDA margin was 13.6% for the third quarter, which compares to total adjusted EBITDA of $213.2 million and an adjusted EBITDA margin of 15% in the same quarter last year. Depreciation and amortization was $50.1 million in both the third quarter of this year and the same quarter last year. We generated $11.5 million in equity and earnings of unconsolidated subsidiaries during the third quarter. This compares to $8.8 million in the same quarter last year. Interest expense was $33.8 million in the third quarter. This compares to $34 million in the same quarter last year. We recorded income tax expense of $27.7 million in the third quarter this year, which represents an effective tax rate of 21.6%. This compares to the tax expense of $31.6 million and an effective tax rate of 23.2% in the same quarter last year. Net income attributable to non-controlling interests was $23.3 million in the third quarter. This compares to $27.5 million in the same quarter last year. Net income attributable to Select Medical Holdings was $76.9 million in the third quarter, and earnings per common share was $0.57. At the end of the third quarter, we had $3.4 billion of debt outstanding and $748 million of cash on the balance sheet. Our debt balance at the end of the quarter included $2.1 billion in term loans, $1.2 billion in 6.25% senior notes, and $74 million of other miscellaneous debt. Net leverage based on our credit agreement EBITDA was 2.6x at the end of the third quarter compared to 2.51x at the end of the second quarter and 3.48x at the end of last year. Operating activities provided $99 million of cash flow in the third quarter, which includes the repayment of $92 million of Medicare advances. As of September 30, 2021, we have $159.5 million of Medicare advances remaining on the balance sheet. We expect this remaining balance to be recouped now through April of '22. Our DSO was 54 days at September 30, '21. This compares to 54 days as of June 30, '21, and 56 days at the end of December 30, 2020. Investing activities used $69.1 million of cash in the third quarter. The use of cash included $48.9 million in purchases of property and equipment and $21.9 million in acquisition and investment activity in the quarter. We also generated $1.8 million in proceeds from the sale of assets in the third quarter. Financing activities used $85.4 million of cash in the third quarter. This included $64.4 million in the repurchases of common stock, $47.5 million of which constituted repurchases under our Board authorization repurchase program. This also included $16.9 million in dividend payments and $7 million in net payments and distributions to non-controlling interests in the quarter. The company repurchased over 1.38 million shares for a total cost of $47.5 million during the third quarter under our Board-authorized share repurchase program. Since inception, the company has repurchased close to 40 million shares for a total consideration of $404 million. As Bob mentioned, our Board authorized a $500 million increase in availability under the program and extended through December 31, 2021. Our total available liquidity at the end of the third quarter was over $1.34 billion. This includes $748 million of cash and close to $595 million in revolver availability under the Select credit agreement. Additionally, in our earnings press release, we provided updated business outlook for the calendar year 2021. For the full year 2021, we now expect revenue in the range of $6.05 billion to $6.15 billion, expected adjusted EBITDA to be in the range of $980 million to $1 billion and expected earnings per common share to be in the range of $2.98 to $3.09. This concludes our prepared remarks. And at this time, we'd like to turn it back over to the operator to open up the call for additional questions.

Our first question comes from Justin Bowers with Deutsche Bank.

So LTAC, just in terms of the labor situation, I mean that's not a surprise for anyone in health care services these days. But can you just talk about some of the tactics and the strategies that you guys are doing to mitigate the situation and just making sure you guys have enough capacity?

Sure, Justin, we would be happy to do so. As you might expect, we are implementing several strategies to ensure we have the necessary clinical staffing in place to handle increases in volume. A significant part of this involves continuously evaluating each market to adjust pay as required. We're spending considerable time on agency staffing, especially since our PRN pool has largely diminished and transitioned to agency support. We're focused on securing longer-term contracts with agencies for several months rather than just weeks. Additionally, we're enhancing our CNA programs to boost our CNA workforce. We are also exploring technology solutions in our telemetry units and nurse centers to optimize the use of nurses on the floor.

Understood. In the fourth quarter, which is usually a strong season for the LTACs, there has traditionally been some benefit from incrementals. While I realize that this may not follow the same pattern in terms of order of magnitude, should we expect some margin benefit as volumes increase? Or will the labor situation potentially offset that historical benefit when volumes go up?

Yes. You're absolutely right. The fourth quarter is typically, we see a bit of a pop in census, and we are seeing that. Having said that, we're also seeing labor increases. So we would hesitate at this time, Justin, to say that there's going to be margin expansion in the fourth quarter due to the volume increase, specifically because of the additional labor costs.

Understood. Regarding the $6.3 million in one-time expenses that you mentioned, was that primarily related to LTAC, or did it affect any other segments as well?

Yes. It was mostly all in LTACs. I think it was $5.5 million to $6.5 million in LTACs.

Okay. And then with all the new beds coming online, which I think is roughly 200, is there any other thing that we should be keeping in mind in terms of start-up, ramp-up or any one-timers for the segment in 4Q?

Yes. That's a great question. I think there will be some additional integration costs related to Acuity, and we should expect to see those in October and possibly a little in November. After that, I believe it will be full steam ahead.

Our next question comes from the line of Frank Morgan with RBC Capital Markets.

Is there any specific information regarding the implied fourth quarter guidance? Are you expecting any improvements in the LTAC, or will things remain as they are? Will the other operations, such as IRFs, outpatient services, and Concentra, continue to improve to offset any shortfalls? Is that your approach, or are there other factors you're considering for the fourth quarter regarding LTACs or critical care recovery hospitals?

Yes. Frank, I think from our perspective, we're really taking a look at LTACs probably being in that same ballpark. Again, it's really a question of the negotiation with the nursing agencies and what the rates are.

Got you. And on that, can you give us any kind of color around what's the difference between, say, contracting on a weekly basis versus a monthly or a two- or three-month basis? Is it a meaningful difference there in terms of price?

Regarding pricing, there's not much of a difference. It's mainly about securing a longer-term commitment for the nurses. As you may know, we typically see some good increases in the fourth quarter, and there’s usually a significant jump in the first quarter. Therefore, we want to ensure we have adequate staffing to meet the needs of our patients.

Got you. But this is entirely about staffing. There are no other changes like units opening, closing, or transitioning during the quarter. You would attribute most of this to the nursing issue.

We would.

Got you. And then I'm just curious over on the IRF side. Good pricing growth, presumably, that's mostly Acuity. Just curious your thoughts on how sustainable that type of rate growth is as we start thinking about next year.

Yes. We think that we'll continue to see those same types of increases, Frank.

Got you. And just curious, obviously, this news out of Pfizer today, but I know we're not a large-cap pharma analyst. But how does that news strike you? Do you think that's a good thing for your business? And that it certainly, hopefully, would help on the labor side. But just any initial reactions to how you think that would affect providers?

Could you please be a bit more specific, Frank?

Well, I'm sorry. Yes, just the...

We prepared for our earnings call. I'm not saying we are out on the pike.

So supposedly, Pfizer has an old pill that is highly effective in reducing hospitalization for COVID and requesting quick approval on it sort of...

Yes, that's going to be a game changer, of course. It's going to be strong. I see it as a positive for staffing and for all of health care. I think that's a great thing. The more therapeutics we have, the better off we'll be. I'm not concerned about the availability of LTAC patients for our hospitals.

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

This is Courtney on for Kevin. So I guess one quick one first. You guys called out in your prepared remarks and also in the press release that LTAC occupancy was down sequentially quarter-over-quarter as well as year-over-year. So could you just talk a bit about your occupancy in markets that are seeing higher COVID disruption versus markets with lower COVID disruption?

Yes, Courtney, we would be pleased to address that. During our second quarter earnings call, we mentioned that several hospitals were experiencing bed holds, primarily due to our decision to cap agency fees at a specific dollar amount. We have since decided to eliminate that cap and continue to provide additional funding to the agencies. Consequently, we observed a 65% occupancy rate in July, 68% in August, and around 70% in September. The transition was not instantaneous; we implemented these changes mostly in August. As a result, we noticed a slight increase in August and continued to see the 71% occupancy rate in September, which has remained above 70%.

Okay. That's super helpful. And so I guess you guys talked about how you restarted the share repurchase program this quarter, and the Board authorized a larger program that's double the size of what it was before. So I guess, just generally, how are you guys thinking about share repurchase now? And obviously, you guys reiterated your long-term growth CAGR. So was this always a lever that you plan to use to hit that 17% to 20% EPS CAGR? Or is this like an upside lever?

This is really an upsize, Courtney. What we decided to do was we went through the repurchase program and were at $404 million of the $500 million program. We wanted to ensure that we're in a position to be opportunistic.

Yes. Also, when you look toward the end of the year or the beginning of next year when we finalize our purchase of Concentra, the company will become a significant cash generator. We are preparing ourselves to take advantage of any opportunities that may arise next year.

Yes. That makes sense. And then I guess one last quick one, giving you guys a break from the labor question. I guess what would you say is the ongoing role of telehealth and telemedicine for Select now that it seems like patient care has really largely returned to the actual health care settings and actual facilities itself? And if you could give any segment-level color.

Both in outpatient rehab and particularly at Concentra, we have the capabilities to offer a lot of telehealth services. During the peak of the pandemic, both segments saw a significant increase in their telehealth usage. However, that has decreased quite a bit, and I don't think we see this as a lasting trend in our business. This may vary in other segments, but in occupational medicine and outpatient rehab, we are observing a return to more normal levels that we experienced before the pandemic.

Our next question comes from the line of Bill Sutherland with The Benchmark.

So I just want to think a little bit more about the staffing issue. And I suppose it's a little more acute at critical illness than IRF because of the profile of the employees. In other words, more therapists at IRF, and I guess that's not as tough a situation as the nursing picture.

That's absolutely true. The rehab hospitals have nurses, but they are very therapy-driven. In contrast, our critical illness recovery hospitals have a much higher concentration of nurses, and the training and sophistication of our nursing staff is also greater. This means we often compete with acute hospital ICUs for the nurses we require, making it even more challenging to maintain the nursing levels we need at the critical illness recovery hospitals.

So Bob, when you look at the last year or two and the mix of your staff at critical illness that are contractors, can you give us a sense of the change in percentage of total over a year or two?

Yes. Bill, historically, the agency percentage has been in the 10% to 13% range. Over the past year, we've seen it rise significantly to the 22% to 25% range. This increase is largely due to our previous practice of relying on fully employed nurses first, then using PRN staff, and finally turning to agency workers. However, PRN staff has largely disappeared, with most of them now going to the agency.

Just because of economics, I mean for you.

Yes. Absolutely, Bill. As you know, I mean, the economics here are very, very significant.

And is part of the issue also that you just had more turnover in your permanent employee base, and are you taking any strategies? If that's the case, are you taking any strategies on that as well?

We are definitely focused on turnover. The operators have dedicated a lot of time to retention and mentoring programs. They have several initiatives in place to support these efforts.

So you're hopeful you can better manage that. I mean that's another way to address the issue with agency costs, clearly.

Yes. No, I think that's right.

Okay. And then last one, how are you looking at the outlook for the compensation increases into next year just given this whole labor picture and benefits for that matter and insurance?

Hey, Bill, when you say the labor cost, are you talking about what we just talked about, the staffing?

No. I'm thinking more about your permanent ranks and what you will consider regarding the impact of inflation.

Well, I think what we've done is we're probably in the 2.5% to 3% range across the board for next year, is what we've been planning for.

Okay. I just didn't know if you're seeing more pressure on that as well. That was the point of the question.

Yes. I mean the only pressure is coming from the clinical staff.

So not to dwell on this, but I wanted to ask about labor. Some other providers have mentioned that during the COVID surge or Delta surge, they had nurses in quarantine, which worsened the situation. However, that might be more of a short-term issue compared to some of the long-term dynamics that could continue. How much of the labor issue you are facing do you believe is related to the lingering effects of the surge and might resolve, versus something that will persist for a longer period?

I wish it was the case, A.J., but I would tell you that we don't really see that.

Okay. Okay. Let me ask you about the vaccine mandate. Where are you guys at with respect to your employee base? And do you think that's going to be a further challenge in the fourth quarter here? Or have you absorbed most of whatever is going to happen as a result of that?

I believe the vaccine mandates will present challenges for all healthcare providers. We are actively addressing it. While we haven't mandated vaccinations, we have strongly encouraged and educated our employees, resulting in a growing number of vaccinations among them. With the new federal mandate, we plan to act swiftly like others in the industry. In fact, having a requirement that applies universally will simplify things compared to individual hospitals making different decisions, as that could lead to significant inconsistencies in various markets. We did not, A.J. We felt it was full speed ahead on both of those segments with increasing volumes. And we're not able to track any negative impact from the Delta surge.

Yes, A.J., I mean, the great thing that we feel very good about is that when you take a look and compare '21's volume numbers to '19, which is before all the COVID started, we're well ahead of that. And that's a very good signal.

Yes. I wanted to ask about the development activity. It seems there might be an increase in activity. In the aftermath of the pandemic, are you seeing more urgency or interest from the critical access facilities or the IRF joint ventures? Are people more aware of your capabilities and looking to partner? Also, regarding the outpatient initiatives, which are new, what opportunities exist to enhance the branding of a strong hospital system locally through those outpatient relationships? What motivates the joint ventures in outpatient rehab?

Let me address the first part of your question regarding the demand for the joint venture and development. Since the pandemic, we have observed an increase in demand for joint ventures in critical illness recovery hospitals, particularly in the LTAC segment. This heightened demand stems from the pandemic highlighting the importance of having these services available to alleviate the strain on ICUs, which are often overcrowded in acute care hospitals. As a result, there is greater interest in establishing specialty critical illness recovery hospitals in markets that currently lack them. On the outpatient side, growth has come naturally from successful joint ventures and collaborations with significant partners. For example, when we start a partnership with a rehabilitation hospital, adding outpatient services becomes a logical next step as we strengthen those relationships and explore new opportunities. Additionally, we find that leveraging the brand of a prominent local health system is beneficial for us. For instance, our new joint venture with Cedars, a major player in Southern California, allows us to develop new centers under their brand, which has proven to be advantageous. This pattern has been observed in various regions, where some joint ventures are expansions of existing ones while others are entirely new initiatives. Therefore, you can expect to see an increasing number of these developments.

I wanted to follow up on two things. Regarding the LTAC pipeline, how does it compare between your traditional hospital-in-hospital model and new builds? Also, I wanted to ask about Concentra.

Yes. Justin, could you repeat that question just so we understand?

Yes. In terms of the LTAC pipeline, looking at the current portfolio, it primarily consists of the traditional hospital-in-hospital model. There have been a few mixed projects in the latter half of this year. As you look ahead at your pipeline and future developments, will it continue to focus more on the traditional hospital-in-hospital model, or will there be an increase in new builds or freestanding facilities?

Yes, Justin. Yes, thanks for specifying that. Yes, it is all associated with, for the most part, HIHs. So depending on the circumstances, I mean, we may do a new build. But for the most part, we're very focused on HIHs.

I wanted to revisit Concentra because it seems like this quarter has likely set a record in terms of volumes for your team. Could you provide more insight into the sources of this strength? Additionally, as we look ahead to the fourth quarter, we're aware that there’s usually some seasonality in the business. How should we anticipate that strength impacting the typical seasonal trends? What factors should we consider for the fourth quarter regarding the business?

Concentra is currently performing exceptionally well. With the return of employment, they are experiencing an increase in preemployment services. As more individuals return to work, there are more injuries, which is beneficial for their business. The numbers indicate that they have been incredibly strong. They are also excelling in mergers and acquisitions, expanding to new locations and centers. All the fundamental aspects of Concentra are robust, and we remain optimistic about their performance.

Yes. Justin, what we've seen is, when you go into the specific areas, we've seen growth in hospitality. We've seen growth in airlines. We've seen growth in the schools coming back online, and actually, state and local governments coming back online. So those areas were pretty dormant over the past year, but we've seen some nice increases there.

Okay. Got it. So it sounds like part recovery, part picking up share as well.

I'm showing no further questions at this time. I would now like to turn the conference back to the management for their closing remarks.

Thanks, everybody, for joining us, and we look forward to talking to you next quarter. Thank you.

This concludes today's conference call. Thank you for participating. You may now disconnect.