Select Medical Holdings Corp Q1 FY2023 Earnings Call

Good morning, and thank you for joining us today for Select Medical Holdings Corporation's Earnings Conference Call to discuss the First Quarter 2023 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 now turn the conference call over to Mr. Robert Ortenzio.

Thank you, operator. Good morning, everyone. Welcome to Select Medical's earnings call for the first quarter of 2023. As I've done in past calls, I'll first provide some overall commentary on the quarter and then provide some detail on each of our four operating divisions. I'll then turn it over to Marty Jackson, and he'll provide further detail on the progress we have made on our labor costs for the critical illness recovery hospital division and also discuss some other financial metrics. First, I'd like to say, by almost any standard, we had a very good first quarter. And I'd like to commend and thank all of our colleagues who encountered and overcame many challenges over the past three years while continuing to provide a high level of quality care and a great patient experience within our facilities. Last call, we noted encouraging signs heading into 2023, and we continue to be encouraged with all four of our operating divisions exceeding prior year EBITDA this past quarter. Overall revenue grew 4% and adjusted EBITDA by 31% compared to prior year Q1. The impact of the restatement of the Medicare sequestration was a $9.7 million headwind when comparing Q1 to prior year same quarter. For the quarter, total company adjusted EBITDA was $214.1 million compared to $163.8 million in the prior year. Our consolidated adjusted EBITDA margin was 12.9% for Q1 compared to 10.2% in the prior year. Our critical illness recovery hospital division experienced the most significant increase in performance compared to prior year with a 114% increase in adjusted EBITDA, along with a 13% reduction in their salary, wage and benefit to revenue ratio. The critical illness recovery hospital division's salary, wage and benefit to revenue ratio was 56.3%, which was within our target range of 55% to 57% along with an $87 million reduction in agency expense compared to the same quarter prior year. In addition to the labor improvements, critical illness has had a lot of activity on the development front with three openings this past quarter. In January, we opened a distinct part unit in our Springfield, Missouri hospital. And in February, we opened a 31-bed satellite in our current Toledo, Ohio hospital. March was also a busy month with the opening of another rehab distinct part unit in our Pensacola, Florida critical illness recovery hospital as well as a new 50-bed hospital with a joint venture partner in Jackson, Tennessee. There are two hospitals with joint venture partners expected to open in Q2 that are located in Tucson, Arizona; and Alexandria, Virginia. We have also signed an agreement to acquire a 60-bed hospital in Richmond, Virginia, which is expected to close in June. As previously mentioned, we have an agreement to open a critical illness recovery hospital with a distinct part unit in Chicago with our joint venture partner, Rush University System for Health in 2024. We're very excited about the tremendous improvement in the critical illness division and optimistic about the remainder of the year. I'll now turn to inpatient rehab. The inpatient rehab hospital division continued their strong performance, exceeding prior year revenue, occupancy and adjusted EBITDA. In March, we acquired Reunion Rehabilitation Hospital in Dublin, Ohio with our joint venture partner, OhioHealth. This hospital has 40 private rooms and has been renamed OhioHealth Rehabilitation Hospital. We also entered into a joint venture partnership with CHS, under which Select will purchase a majority interest in a 36-bed inpatient rehab hospital currently owned by CHS in Fort Wayne, Indiana. This transaction is expected to close after the second quarter this year. As previously noted, we have partnered with AtlantiCare to build a new inpatient rehab hospital in Southern New Jersey. Contingent upon regulatory approval, the hospital will be called the Bacharach Institute for Rehab and is slated to open either in 2024 or 2025. The development pipeline for our inpatient rehab division remains strong, and we anticipate continued strong performance throughout this year. Concentra continued their exceptional performance exceeding prior year revenue, EBITDA and patient volume. This quarter, Concentra completed two transactions and continued to build its pipeline of future acquisitions and de novo projects. The acquisition of Lehigh Valley Health Network's occupational health business was a fold-in of their five locations into Concentra's recently opened two practices in Allentown and Bethlehem, Pennsylvania, which solidifies our position in this new market. Concentra also acquired the Connecticut occupational health business of PhysicianOne, a fold-in of the business from their 16 Connecticut locations into Concentra's statewide footprint. Concentra has a strong pipeline of development opportunities, including four signed leases for de novo locations and several additional acquisitions and de novo opportunities that are under consideration. I'll now turn to outpatient. As expected, our outpatient rehabilitation division's performance improved, surpassing prior year's revenue, adjusted EBITDA and patient volume. The division has 37 executed leases for de novo clinics, which are scheduled to open throughout 2023. There are also many additional opportunities that are under consideration. At this point, I'll provide some further data points on each of our operating divisions. Our critical illness recovery hospital division experienced a 1% decrease in net revenue compared to prior year, primarily due to decreases of less than 1% in both volume and rate. Even though we experienced a slight decrease in volume, we did see an increase in our occupancy from 71% to 72%. Our case mix index decreased from prior year, which was 1.35, down to 1.28, but did increase from prior sequential quarter. Nursing agency rates decreased 42% and nursing agency utilization decreased 53% when compared to prior year Q1. Nursing agency rates decreased 10%, while nursing agency utilization remained consistent compared to Q4 2022. Orientation hours increased 11% compared to prior year Q1, but decreased 17% compared to Q4 2022. Nursing sign-on and incentive bonus dollars decreased 29% from prior year Q1 and 11% from prior sequential quarter. Our adjusted EBITDA margin was 12.9% for the quarter compared to 6% in the prior year Q1. Our positive reductions in labor contributed to the improvement in our EBITDA margin. Finally, in April, the long-term acute care proposed rule for fiscal 2024 was posted by CMS. If adopted, we would see an increase in the federal base rate of 3.3% and an increase in high-cost outlier threshold. We expect the rule to be finalized in August after the required comment period. Our inpatient rehabilitation hospital division experienced a 5% increase in net revenue with patient volumes increasing 4% and our rate per patient day by 1%. Our occupancy was 86% compared to 84% prior year. The adjusted EBITDA margin for the inpatient rehab was 20.4% for Q1 compared to 19.2% in the prior year. CMS also posted their proposed inpatient rule in April for fiscal 2024. If adopted, we would see an increase of 3.3% in the federal base rate. We also expect this rule to be finalized in August after the required comment period. Concentra experienced an increase of 8% in net revenue, driven by a 3% increase in volume and a 7% increase in rate. The increase in rate is attributable to a 3% increase in our workers' comp net revenue per visit, along with a decrease in our employer services mix, which has a lower level of reimbursement and work comp. Concentra's adjusted EBITDA margin was 20.5% for the quarter compared to 21.5% in the same quarter prior year. Turning to our outpatient rehab division, this division experienced an increase of 9% in net revenue, with patient volumes increasing by 14%, offset by a slight decrease in rate from $102 net revenue per visit to $101 net revenue per visit compared to same quarter prior year. The increase in volume compared to prior year was spread amongst multiple markets and was primarily attributable to improved patient access and clinical productivity. The decline in rate was primarily due to a decline in Medicare reimbursement, along with the full implementation of sequestration when compared to prior year. The outpatient division's EBITDA improved by $3.6 million compared to prior year, while their EBITDA margin was 10.2% this quarter versus 9.8% same quarter prior year. Earnings per fully diluted share was $0.56 for the quarter compared to $0.37 per share in the same quarter prior year. In regards to our allocation and deployment of capital, our Board of Directors declared a cash dividend of $0.125 payable on May 31st to stockholders of record as of the close of business on May 18th, 2023. This past quarter, we did not repurchase shares under our Board-authorized share repurchase program. We will continue to evaluate stock repurchases, reduction of debt, and development opportunities. This concludes my remarks. At this point, I'll turn it over to Marty Jackson to give you some additional financial details before we open the call up for questions.

Thanks, Bob, and good morning, everyone. Consistent with the prior two quarters, I would like to provide some additional details with the significant progress we have made regarding labor costs within the critical illness recovery hospital division. This past quarter, we had a sequential reduction from Q4 to Q1 in our total RN agency costs and our RN agency rate, while our utilization of agency remained the same. The reductions we realized were 12% in agency costs moving from $27.2 million in Q4 to $23.8 million in Q1, and 10% in our agency rate, moving from $92 in Q4 to $83 in Q1. Our utilization of agency remains at 18%. We experienced a reduction in our agency rate as the quarter progressed from January to March, 11%, moving from $89 in January to $79 in March. While we slightly fluctuated within the quarter in both RN agency costs and our utilization numbers. This quarter, we had another decline in orientation hours compared sequentially to Q4 of '22 of 17%. Other areas where we saw improvement compared to the sequential quarter were reductions of 11% in nursing sign-on and incentive bonus dollars and 2% in hospital administration salaries, wages, and benefits. Overall, our salaries, wages, and benefits to net revenue ratio improved 6% compared to the fourth quarter. Fourth quarter, we ran at 59.8%. And as you know, we were down this quarter down to 56.3%. This is within the target range that we had previously communicated. Moving on to our financials. In Q1, equity and earnings of unconsolidated subsidiaries were $8.6 million. This compares to $5.4 million in the same quarter the prior year. The increase in earnings was the result of increased earnings in a few of our unconsolidated joint ventures. Net income attributable to non-controlling interest was $14.5 million. This compares to $6.8 million in the same quarter the prior year. The increase is primarily due to improved performance of our consolidated joint ventures. Interest expense was $48.6 million in the first quarter. This compares to $35.5 million in the same quarter last year. The increase in interest expense was primarily attributable to an increase in the 1-month LIBOR rate compared to Q1 of '22 as well as borrowings made under our revolving credit facility. The interest rate on $2 billion of our term loans is capped at 1% LIBOR plus 250 basis points through September 30th of '24, which provides us with a level of protection and predictability moving forward in the current interest rate environment. At the end of the quarter, we had $3.9 billion of debt outstanding and $83.7 million of cash on the balance sheet. Our debt balance at the end of the quarter included $2.1 billion in term loans, $460 million in revolving loans, $1.2 billion in the 6.25% senior notes, and $90.5 million of other miscellaneous debt. We ended the quarter with net leverage for our senior secured credit agreement of 5.57x. As of March 31, we had $134 million of availability on our revolving loans. For the first quarter, operating activities provided $51.4 million in cash flow. Our days sales outstanding, or DSO, was 54 days at the end of March '23. This compares to 53 days March '22 and 55 days at the end of December 2022. Investing activities used $69.1 million of cash in the first quarter. This includes $58.9 million purchases of property and equipment and $10.2 million in acquisition and investment activity. Financing activities provided $3.4 million of cash for the fourth quarter. We had $15 million in net borrowings on our revolving line of credit and $10.3 million in net borrowing on other debt. These borrowings were offset by dividends on our common stock, $15.9 and $5.2 million in net payments and distributions to non-controlling interests. As stated previously, we did not purchase any shares under our Board-authorized repurchase program this quarter, but have the capacity to purchase an additional $400 million worth of shares. This program remains in effect until December 31st of '23, unless further extended or earlier terminated by the Board. We issued our business outlook for 2023 with expected revenues to be in the range of $6.5 billion to $6.7 billion, expected EBITDA in the range of $780 million to $820 million and earnings per share to be in the range of $1.75 to $1.99. Capital expenditures are expected to be in the range of $190 million to $210 million for 2023. Operator, this concludes our prepared remarks. And at this time, please open up the call for questions.

Our first question will come from Justin Bowers from Deutsche Bank. Your line is open.

Hi, good morning, everyone. Congratulations on the quarter and reinstating the guide. Marty, can you talk us through the progress you made in LTAC and labor, and it still sounds like there's some training costs in the segment. And maybe you can help us think through sort of how the labor plays out through the rest of the year? And then just more broadly, any seasonality that we should take into account with the guide back in place.

Sure, Justin. The key point to note is that we assessed salary, wage, and benefits as a percentage of revenue and provided guidance earlier this year, expecting it to be in the 55% to 57% range. We ended up right in the middle of that range. For the entire year, we expect to remain within that same range. There may be some quarterly fluctuations, but I anticipate that in the second quarter we will be within that range, possibly a bit higher in the third quarter due to seasonality. By the fourth quarter, we should return to that same range.

Got it. And then in terms of the development pipeline and maybe this one for Bob. You guys have a lot of activity going on, and it sounds like the pipeline is building up in the outpatient as well. Is the plan still to do sort of organic and inorganic? And what's the landscape look like in outpatient these days?

If you examine some of our competitors, the outpatient sector appears somewhat inconsistent due to struggles faced by certain companies. However, we believe our business remains quite stable, which is why we are focusing on new projects. I don't anticipate many mergers or acquisitions in the outpatient space unless they are small and particularly attractive, typically in markets where we already have a strong presence. We might consider some one-off or small merger activities. Right now, pursuing new locations makes a lot of sense for us as margins and staffing efficiency improve. We see significant potential and untapped opportunities in the outpatient sector. However, sequestration, Medicare reductions, and the outpatient fee schedule are challenges affecting the entire industry. We view this as an opportunity for us. Marty and I are being prudent with our capital allocation. At this stage in the company’s development, we prefer growth opportunities that require less capital, and new outpatient projects certainly meet that criterion.

Appreciate it. I'll hop back in queue.

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

Hi, this is Nabil Gutierrez on for Kevin. Thanks for taking the question. So I appreciate you saying that you expect salary, wage, and benefits to be in the 55% to 57% range for the year. Can you give us some color on what you're assuming for labor costs in each segment?

We haven't done that before. What we've done is provide information for the critical illness recovery hospital due to significant variations. Historically, we've maintained salary, wage, and benefits as a percentage of revenue in the 52% range, but during the pandemic, this increased significantly, reaching as high as 66% in one quarter. That's why we shared this information to ensure that all investors understand the situation. The other business segments are relatively stable, and we haven't seen any significant variations in those areas. Therefore, at this time, we're not providing that information.

Yes. I wouldn't expect to see volatility in those other business segments, and we haven't in the near-term.

And then my follow-up is, what are the swing factors to the low- and high-end of your EBITDA guidance?

It's going to be the usual drivers, primarily occupancies and volumes. As we have approached this quarter with stability on the labor side, we have good visibility on rates. Ultimately, it's all going to depend on volume.

Awesome. Thank you.

Thank you. One moment for our next question. Our next question will come from the line of Ben Hendrix from RBC Capital Markets. Your line is open.

Hi. Thanks guys. With the kind of the productivity headwinds that you saw in outpatient in the fourth quarter unwinding. I was just wondering if you could just talk about the dynamics there and the levers that you can pull to keep productivity high in that segment.

Yes, Ben, I believe it’s fair to say that Bob and I were very pleased with the improvement we observed in the outpatient business. As we discussed, this improvement was primarily due to enhancements in clinical efficiency. Additionally, there was significant growth in volume. We are optimistic that this trend will continue. Our goal is to improve just a bit more, as we believe there is still some potential for further enhancement in clinical efficiency. We anticipate seeing this trend sustain throughout the remainder of the year.

Just a follow-up on Concentra. Against the current economic backdrop, we just heard from Cigna noting that there could be some economic impact on commercial membership through the year. I just wanted to get your comments on the persistency of Concentra's patient base kind of versus any economic concerns for the balance of the year.

Sure. I think that we haven't had an earnings call in the last year where, at some point, I didn't say that a really bad economic environment would be a headwind for Concentra, and I have to repeat that. But what we found is that it's a little bit more nuanced than that. I mean, Concentra has such a big platform now across the entire United States, and they have such a mix of volume from different industries. And this was never more apparent than during the pandemic when they still saw a lot of strong business from those industries that did well during the pandemic. So you talk about the UPSs and the Amazons and the FedEx, those that were really busy, but yet it's all others that were a downturn. So today, you look at the strength in the economy, in the hospitality sector and in transportation and that drives it. And then real estate and construction is hanging on. So I guess, what I would say is, it all depends on what the economic downturn looks like. I can tell you that if, for example, in the extremes, if you see most of your job reductions and softness in the economy that's coming out of the tech sector, that is not a headwind for Concentra as long as these other segments of the economy stay strong and home construction, transportation, hospitality for now are good. So it's been strong. So we don't see any cracks in the strength that Concentra saw in the first quarter. And so we remain optimistic. So we have, I think, what we would consider a pretty good situation where staffing costs are coming down in our hospital division, but yet the economic activity throughout the economy is still driving Concentra's business. So we feel pretty good about that right now.

Thank you.

One moment for our next question. And our next question will come from the line of A.J. Rice from Credit Suisse. Your line is open.

Hi, everybody. A couple of quick questions here. I think you said you were down 12% on agency costs sequentially, and I think the number is roughly about $23.8 million. You baked your guidance for the year now that you're going back out with EBITDA guidance. Are you assuming further improvement as the year progresses? Or is that sort of $23.8 million, something in that neighborhood, sort of the run rate to anticipate?

Yes, A.J., we are aligning with the run rate we expect. Historically, our business has typically operated in the range of the high $100 million, possibly slightly above that, down to about $80 million.

Okay.

So it really kind of fits that $23.8 million, kind of fits right in that range.

Okay. I think we all welcome the return to offering the EBITDA outlook. Looking at your first quarter margin trends by segment, I'm not requesting a specific margin target for each segment. However, is this a good general estimate to consider for the rest of the year? Is there a segment that was particularly elevated or particularly low that still has potential to adjust to meet your full year targets? Or is it expected to remain stable from here on regarding margins by segment?

Yes, A.J., there is seasonality in the business. I think what you'll see is that the second quarter will likely mirror the first quarter. Typically, the third quarter tends to show a slight dip in the outpatient margin. In the fourth quarter, there is usually a decrease in the Concentra margin. Additionally, in the third quarter, we expect to see a slight dip in critical illness recovery hospitals.

I'm sorry, with that last one, what quarter was that for the critical illness?

That would be the third quarter.

In the third quarter, there are seasonal aspects to consider. We haven't experienced a typical seasonal year for some time. From your perspective, the margin trend across the business appears normalized. As we consider the remainder of the year, seasonality will be taken into account, but there doesn't seem to be a division that is significantly overperforming or underperforming that would alter this view. Is that the correct understanding?

Yes, we think so.

All right. Okay. Thanks so much.

All right, A.J.

One moment for our next question. Our next question comes from Bill Sutherland from The Benchmark Company. Your line is open.

Hi, good morning. Bob, is there any color that would be helpful on the CMI change at critical illness?

Bill, what you're talking about is the drop in CMI?

Yes.

Yes, I think that, that's really just a function of the types of patients we were receiving.

I don't think there's anything significant to take away from that. It's still a high case mix index in the industry, and it will vary slightly depending on the acuity of some of the patients we receive. So, I wouldn't draw any conclusions from it. We report on it because it remains strong and high for the industry, but I would not identify anything meaningful about that change.

Okay. And on the admissions growth, which was kind of flat, how should we think about that going forward?

With regards to growth there, I think you can anticipate just on all numbers because of some of the additional activity we're having on development, you can expect to see that rise a bit, Bill. Probably in the 2% to 3% range is probably a good range.

Okay. And then on top of that, of course, the bits of additional beds coming in at a point or 2, I suppose.

Yes, I think that's right.

I'm curious, when you look at your plans for capital expenditures focused on technology, are there any initiatives in any of the four groups that stand out and could have a significant impact in the future?

Well, when you say

I'm sorry, I'm thinking about everything from just the more typical EHR kinds of things to maybe some of the new frontier stuff in AI and so forth.

Well, I think what we've really focused on in the past year or two is adding automation to several of our processes. The use of bots in certain areas where routine activity typically occurs has seen a significant increase in utilization, which has been very helpful. Regarding AI, we don't really observe a lot of developments.

We won't be taking the lead in AI initiatives. Our main focus will be on improving efficiency through technology in our hospitals, which should yield immediate benefits across our network of 137 hospitals. This immediate return on investment will be where we concentrate our efforts, rather than on AI.

I didn't expect that to be a top priority for you. Another aspect is the virtualization, which I assume for you would just be an outpatient. In the past, you mentioned that it hasn't really had a meaningful impact, but I'm just curious.

So are you talking about telemedicine?

Yes, physical therapy has been done virtually alongside the program for in-clinic rehabilitation as well.

Our clinicians and patients found it useful during the pandemic when there was a lot of infectious activity. However, we have noticed a significant decline in its utilization, particularly in outpatient settings, as physical therapy relies heavily on physical manipulation.

Yes. I would also say that as the largest provider of physical therapy and likely the largest employer of physical therapists in the country, we are very aware of the ongoing discussion about virtual physical therapy. We are closely monitoring this issue. While some companies advocate for the possibility of providing physical therapy virtually, we currently do not see strong viability for that approach, except in very limited circumstances. This is our perspective based on our position in the industry.

Yes, someone just had physical therapy fairly recently. I'm surprised by the contracts that companies like Sword and Hinge are securing, but it seems like it should be more hands-on than not. You're right. That's it for my questions. Thanks, everyone.

Thank you. And with no further questions in the queue, I'll turn the call back over to Mr. Ortenzio for any closing comments.

No closing comments. Thanks for joining us, and thanks for your questions, and we look forward to updating you. And if there's other questions, feel free to reach out to Marty.

This concludes today's conference call. Thank you for participating. You may now disconnect. Everyone, have a great day.